424B4 1 h03898b4e424b4.htm 424B4 424b4
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    Filed Pursuant to Rule 424(b)(4)
    Registration No. 333-164275
     
     
3,545,000 American Depositary Shares
 
DUOYUAN GLOBAL WATER INC.
 
Representing 7,090,000 Ordinary Shares
 
(DUOYUAN GLOBAL WATER LOGO)
 
$29.50 per ADS
 
 
 
  •  We and GEEMF III Holdings MU, one of our shareholders, are offering American depositary shares, or ADSs, each representing two of our ordinary shares, par value $0.000033 per share.
 
  •  Of the 3,545,000 ADSs offered by this prospectus, we are offering 2,760,000 ADSs and the selling shareholder is offering 785,000 ADSs. We will not receive any proceeds from the sale of the ADSs by the selling shareholder.
 
  •  On January 27, 2010, the closing price of our ADSs on the New York Stock Exchange was $29.74 per ADS.
 
  •  Trading Symbol: New York Stock Exchange — DGW.
 
 
 
This investment involves risk. See “Risk Factors” beginning on page 11.
 
                 
    Per ADS   Total
 
Public offering price
  $ 29.50000     $ 104,577,500  
Underwriting discount
  $ 1.40125     $ 4,967,431  
Proceeds, before expenses, to Duoyuan Global Water Inc. 
  $ 28.09875     $ 77,552,550  
Proceeds, before expenses, to the selling shareholder
  $ 28.09875     $ 22,057,519  
 
The underwriters have a 30-day option to purchase up to 416,750 additional ADSs from us and up to 115,000 additional ADSs from the selling shareholder to cover over-allotments, if any.
 
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.
 
The ADSs will be ready for delivery on or about February 2, 2010.
 
Credit Suisse Piper Jaffray
 
Macquarie Capital Rodman & Renshaw, LLC Janney Montgomery Scott
 
 
The date of this prospectus is January 27, 2010


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You should rely only on the information contained in this prospectus. Neither we, the selling shareholder nor the underwriters have authorized any other person to provide you with different information. This prospectus is not an offer to sell, nor is it seeking an offer to buy, these securities in any state where the offer or sale is not permitted. The information in this prospectus is complete and accurate as of the date on the front cover, but the information may have changed since that date.


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SUMMARY
 
The items in the following summary are described in more detail later in this prospectus. This summary provides an overview of selected information and does not contain all of the information you should consider. Therefore, you should also read the more detailed information set out in this prospectus and the financial statements.
 
Overview
 
We are a leading China-based domestic water treatment equipment supplier. Our product offerings address key steps in the water treatment process, such as filtration, water softening, water-sediment separation, aeration, disinfection and reverse osmosis. Founded in 1992, we offer a comprehensive set of more than 90 complementary products across the following three product categories:
 
  •  Circulating Water Treatment Equipment.  We currently produce 39 products, including electronic water conditioners, fully automatic filters, circulating water central processors, cyclone filters and water softeners, used in the process of treating water and removing buildup in circulating water systems.
 
  •  Water Purification Equipment.  We currently produce 33 products, many of which use ultraviolet, ozone, membrane-based and electrodeionization, or EDI, technologies, in the process of treating and purifying water for various applications and end-user customers, including residential communities and commercial businesses.
 
  •  Wastewater Treatment Equipment.  We currently produce 19 products, including grit separators, microporous aerators and belt-type thickener-filter press mono-block machines, used in the process of treating wastewater, such as municipal sewage and industrial and agricultural wastewater.
 
With over 80 distributors throughout China in 28 provinces, including most of China’s key economic regions, we believe our nationwide distribution network is one of the largest among water treatment equipment suppliers in China. This extensive network allows us to be closer to our end-user customers and enables us to be more responsive to local market demand than many of our competitors. As one of the first privately owned companies in China to supply water treatment products and through joint efforts with our distributors, we have developed a broad base of end-user customers throughout China, consisting primarily of wastewater treatment plants, water works facilities, manufacturing plants, commercial businesses, residential communities and individual customers.
 
By leveraging our in-house research and development team, we continually broaden our market reach by introducing new products that help us diversify our revenue base, stay current with technological developments in the water treatment equipment industry and maintain our competitive advantage. Since 2004, we have developed more than 70 new products across our three product categories, many of which utilize non-chemical and energy saving technologies that are, we believe, increasingly important features to our end-user customers. Of these new products, 38 were introduced into the market in 2008. In September and October of 2009, we introduced six new or enhanced products across our three product categories. We plan to continue developing new and enhanced products to maintain and expand our competitive advantage and market reach.
 
We believe our manufacturing and assembly operations are complex and integrated, involving the coordination of raw materials and components, internal production processes and external distribution processes. In addition to utilizing common components and materials within and across product categories, we employ common manufacturing and assembly practices for our product lines, providing us a highly scalable and efficient operating structure. To further save costs, increase operational efficiencies, improve the quality of our products, and protect our key technologies, we also produce certain core components in-house.
 
Our revenues grew 44.8% from RMB292.9 million in 2006 to RMB424.0 million in 2007 and 39.8% to RMB592.7 million ($86.8 million) in 2008. Our revenues grew 33.0% from RMB443.2 million for the nine months ended September 30, 2008 to RMB589.6 million ($86.4 million) for the nine months ended September 30, 2009. Our net income grew 55.7% from RMB52.8 million in 2006 to RMB82.2 million in 2007 and 62.7% to RMB133.8 million ($19.6 million) in 2008. Our net income decreased 34.8% from


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RMB118.3 million for the nine months ended September 30, 2008 to RMB77.2 million ($11.3 million) for the nine months ended September 30, 2009, primarily due to the impact of share-based compensation expense. Excluding the impact of our share-based compensation expense, our net income would have increased 42.6% or RMB50.4 million ($7.4 million) from RMB118.3 million for the nine months ended September 30, 2008 to RMB168.8 million ($24.7 million) for the nine months ended September 30, 2009. For the year ended December 31, 2008, our three product categories, circulating water treatment, water purification and wastewater treatment, accounted for 41.5%, 21.6% and 36.2% of our revenues, respectively. For the nine months ended September 30, 2009, circulating water treatment, water purification and wastewater treatment accounted for 37.5%, 21.3% and 39.6% of our revenues, respectively.
 
Industry
 
Due to urbanization and industrialization, China faces severe water shortages and natural water resource pollution. To address those issues, the Chinese government has enacted stricter environmental standards and invested significantly in water treatment projects to promote sustainable economic growth and to provide its population with affordable, purified water. Accordingly, the demand for water treatment equipment has experienced and is expected to continue to experience rapid growth.
 
According to the Freedonia Group, a market research firm, the demand for water treatment products in China is estimated to increase nearly 15.5% per year between 2008 and 2012. We expect China’s ongoing industrialization and urbanization will drive demand for water treatment equipment in China for the foreseeable future.
 
Our Strengths and Strategy
 
We believe that the following competitive strengths enable us to compete effectively in and capitalize on the growing water treatment industry in China:
 
  •  strong customer recognition and industry reputation;
 
  •  established nationwide distribution network with over 80 distributors in 28 provinces;
 
  •  proven research and development capabilities, including the development of non-chemical, membrane-based and other energy efficient water treatment processes;
 
  •  comprehensive and high-quality product offerings with more than 90 complementary products across our three product categories; and
 
  •  vertically integrated and local cost structure.
 
Our strategy is to capitalize on our competitive strengths to expand our current market penetration and to benefit from the anticipated growth in China’s water treatment industry. Our strategy consists of the following key elements:
 
  •  expand our manufacturing facilities to increase in-house production of key components used in existing or new product offerings;
 
  •  expand our product offerings and increase sales of integrated systems;
 
  •  focus on advanced technologies to enhance energy saving and recycling features of our products and reduce their operational costs;
 
  •  increase our market share in China by introducing additional advanced products and actively managing our existing distribution network; and
 
  •  enter into new water market segments, some of which may include water conservation equipment for agricultural irrigation and sludge dryers, either through selective strategic acquisitions or by developing complementary products.


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Recent Developments
 
Initial Public Offering
 
On June 29, 2009, we completed our initial public offering of 6,325,000 of our ADSs, representing 12,650,000 of our ordinary shares, at an initial public offering price of $16.00 per ADS.
 
New Product Offerings
 
In September and October of 2009, we introduced six new products and marketed them through our existing distribution channels. Of our new products, the side stream processor and multifunctional automatic decontaminating equipment are in our circulating water treatment equipment category, the IMT central water processor is in our water purification equipment category and the COD on-line testing equipment, UV shelving disinfection system and flocculant preparation system are in our wastewater treatment equipment category.
 
Capacity Expansion Update
 
Commencing in early 2009, we began purchasing equipment for our planned expansion at our facility. Additionally, we have identified and submitted a bid for 14 hectares of land to expand our production capacity for several of our product lines. We intend to continue our capacity expansion plans for our existing and new product lines in 2010. We believe that that the cash proceeds from our initial public offering, cash flow from operations, and net proceeds from this offering will allow us to meet our capacity expansion targets.
 
New Director Appointments
 
On November 26, 2009, we appointed Charles V. Firlotte to our board of directors and as a member of the audit committee, the compensation committee and the nominating and corporate governance committee, each effective as of January 1, 2010. Mr. Firlotte is currently the president and chief executive officer of Aquarion Water Company. Mr. Firlotte replaced Thomas S. Rooney, Jr., who resigned from our board of directors effective January 1, 2010.
 
On August 26, 2009, we appointed Ms. Ping Wei to our board of directors and as chairperson of the audit committee and as a member of the compensation committee and the nominating and corporate governance committee. Ms. Wei replaces Christopher P. Holbert, who resigned from the Company’s Board of Directors effective August 26, 2009 to become the chief executive officer of Duoyuan Printing, Inc., an affiliated company.
 
Sales and Marketing Plan
 
In the third quarter of 2009, we engaged China Central Television, or CCTV, to develop a television advertising campaign to further increase brand awareness and further drive sales growth. Through December 31, 2009, we incurred expenses of RMB22.9 million ($3.4 million) for this campaign, which includes RMB15.6 million ($2.3 million) for the fourth quarter of 2009. TV advertising expenses for the fourth quarter of 2009 included (1) two contracts that were signed with CCTV in August 2009 for airtime expenses through December 2009 and (2) monthly payments on a separate broker contract that was signed in September 2009 for advertising production and airtime expenses that was scheduled to run through September 2010. In December 2009, the broker contract was terminated and we entered into two new advertising contracts with CCTV for which we expect to incur selling expenses of RMB15.0 million ($2.2 million) and RMB15.3 million ($2.2 million) for the first and second quarters of 2010, respectively. These two contracts expire at the end of June 2010.
 
Selected Estimated Results for the Quarter and Year Ended December 31, 2009
 
On January 19, 2010, we announced the following estimates of our selected preliminary unaudited financial results for the quarter and year ended December 31, 2009. The audit of our consolidated financial


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statements as of and for the year ended December 31, 2009 has not been completed and changes may result during the completion of our audit.
 
         
    Estimated results for the quarter ended
  Estimated results for the year ended
    December 31, 2009(1)   December 31, 2009(1)
    (Unaudited)   (Unaudited)
 
Revenue
  RMB191.9 million to RMB 195.8 million
($28.1 million to $28.7 million)
  RMB781.5 million to RMB785.3 million
($114.5 million to $115.1 million)
Gross profit
  RMB90.3 million to RMB93.1 million
($13.2 million to $13.6 million)
  RMB375.8 million to RMB378.6 million
($55.1 million to $55.5 million)
Net income(2)
  RMB35.8 million to RMB39.6 million
($5.2 million to $5.8 million)
  RMB113.0 million to 116.8 million
($16.6 million to $17.1 million)
 
 
(1) Translations of estimated results from Renminbi into U.S. dollars have been made at the noon buying rate in effect on December 31, 2009, which was RMB6.8259 to $1.00.
(2) Net income includes estimated share-based compensation expenses of RMB1.1 million ($0.2 million) to RMB1.3 million ($0.2 million) for the fourth quarter and RMB92.7 million ($13.6 million) to RMB93.5 million ($13.7 million) for the year.
 
Our raw material costs increased in the third quarter of 2009. Also, in the fourth quarter of 2009, we incurred increased depreciation expenses following an increase in our fixed assets (manufacturing equipment upgrades and furniture and fixtures) during the period. As a result, our estimated gross margin of approximately 46.5% to 48.0% for the fourth quarter of 2009 is slightly lower than the 49.5% gross margin for the third quarter of 2009.
 
Estimated net income for the quarter and year ended December 31, 2009 reflects fourth-quarter TV advertising expenses of approximately RMB15.6 million ($2.3 million) for nationwide TV advertising on CCTV, China’s national TV station, which represents an increase of RMB8.3 million ($1.2 million) from TV advertising expenses of RMB7.3 million ($1.1 million) incurred in the third quarter of 2009. Estimated net income for the quarter and year ended December 31, 2009 also includes estimated share-based compensation expenses of RMB1.1 million ($0.2 million) to RMB1.3 million ($0.2 million) for the fourth quarter and RMB92.7 million ($13.6 million) to RMB93.5 million ($13.7 million) for the year. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Components of Revenue and Expenses” for additional information regarding these advertising and share-based compensation expenses.
 
Our operating results may differ materially from our current expectations because our final operating results are subject to adjustment based upon, among other things, the finalization of our year-end closing, annual audit and reporting processes. For additional information regarding the various risks and uncertainties inherent in such estimates, see “Special Note Regarding Forward-Looking Statements.”
 
Our Corporate Structure
 
We were incorporated on June 21, 2007 under the laws of the British Virgin Islands and act as a holding company. We conduct substantially all of our business through our two wholly owned Chinese subsidiaries: Duoyuan Clean Water Technology Industries (China) Co., Ltd., or Duoyuan Beijing, and Duoyuan Water Treatment Equipment Manufacturing (Langfang) Co., Ltd., or Duoyuan Langfang. We are in the process of establishing several new wholly owned Chinese subsidiaries to organize our corporate structure. Each new subsidiary will undertake the development, manufacturing, marketing and sales of one or more specific product types. We registered two of these new subsidiaries in October 2009 in Beijing: Duoyuan Global Centrifuge Manufacturing (China) Co., Ltd, or Duoyuan Centrifuge, and Duoyuan Global Water Conservation Equipment (China) Co., Ltd., or Duoyuan Water Conservation. We registered a third new subsidiary in November 2009, Langfang Duoyuan Aeration System and Equipment Manufacturing Co., Ltd., or Duoyuan Aeration. None of these new subsidiaries have commenced operations. We anticipate that the remaining new subsidiaries will be duly registered by March 2010. We do not have any other subsidiaries or equity interests in any other entity. Our majority shareholder is Duoyuan Investments Limited, which is a British Virgin Islands company wholly owned by Wenhua Guo, our chairman and chief executive officer.


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The following chart summarizes our corporate structure, including our subsidiaries, as of the date of this prospectus:
 
(FLOW CHART)
 
Our Chinese subsidiaries may be foreign-owned as a result of Chinese regulations encouraging or permitting foreign investment in the water treatment equipment business in China. As required under Chinese law, the establishment of our Chinese subsidiaries was approved by the local counterpart authorized by the Ministry of Commerce in accordance with the business scale and total amount of investment.
 
Office Location
 
We were incorporated in the British Virgin Islands on June 21, 2007. Our principal executive offices are located at No. 3 Jinyuan Road, Daxing Industrial Development Zone, Beijing 102600, People’s Republic of China. Our telephone number at this address is (8610) 6021-2222. Our registered office in the British Virgin Islands is located at P.O. Box 957, Offshore Incorporation Centre, Road Town, Tortola, British Virgin Islands.
 
Investor inquiries should be directed to us at the address and telephone number of our principal executive offices set forth above. Our website is www.duoyuan-hq.com. The information contained on our website is not incorporated by reference into this prospectus and is not part of this prospectus. Our agent for service of process in the United States is CT Corporation System, located at 111 Eighth Avenue, New York, New York 10011.


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Conventions That Apply to This Prospectus
 
Unless otherwise indicated, references in this prospectus to:
 
  •  “ADRs” are to the American depositary receipts that evidence our ADSs;
 
  •  “ADSs” are to our American depositary shares, each of which represents two ordinary shares;
 
  •  “China” and the “PRC” are to the People’s Republic of China, excluding, for the purposes of this prospectus, Hong Kong, Macau and Taiwan;
 
  •  “revenue” are to net revenue;
 
  •  “RMB” and “Renminbi” are to the legal currency of China;
 
  •  “shares” and “ordinary shares” are to our ordinary shares, par value $0.000033 per share;
 
  •  “U.S. GAAP” are to the generally accepted accounting principles in the United States of America; and
 
  •  ‘‘$” and “U.S. dollars” are to the legal currency of the United States of America.
 
Unless the context indicates otherwise, “we,” “us,” “our company,” “our” and “Duoyuan Water” refer to Duoyuan Global Water Inc., a British Virgin Islands company, its predecessor entities and subsidiaries. See “Corporate Structure.”
 
Unless otherwise indicated, our financial information presented in this prospectus has been prepared in accordance with U.S. GAAP.
 
Solely for your convenience, this prospectus contains translations of certain Renminbi amounts into U.S. dollar amounts at specified rates. All translations from Renminbi to U.S. dollars were made at the noon buying rate in The City of New York for cable transfers of Renminbi as certified for customs purposes by the Federal Reserve Bank of New York. Unless otherwise stated, translations of Renminbi into U.S. dollars have been made at the noon buying rate in effect on September 30, 2009, which was RMB6.8262 to $1.00. We make no representation that the Renminbi or U.S. dollar amounts referred to in this prospectus could have been or could be converted into U.S. dollars or Renminbi, as the case may be, at any particular rate or at all. See “Risk Factors — Risks Related to Doing Business in China — Restrictions on currency exchange may limit our ability to receive and use our revenue effectively and limit the ability of our PRC subsidiaries to obtain financing” and “— Fluctuations in exchange rates could adversely affect our business and the value of our securities” for discussions of the effects of currency control and fluctuating exchange rates on the value of our ADSs. Any discrepancies in any table between totals and sums of the amounts listed are due to rounding.
 
Unless otherwise indicated, all information in this prospectus:
 
  •  is based on 43,702,631 ordinary shares outstanding on September 30, 2009;
 
  •  assumes no exercise of the underwriters’ over-allotment option;
 
  •  reflects the conversion by GEEMF III Holdings MU of 4,000,000 ordinary shares into ADSs immediately prior to this offering;
 
  •  assumes that the number of ordinary shares to be outstanding immediately after the completion of this offering excludes ordinary shares issuable upon exercise of options outstanding as of the date of this prospectus; and
 
  •  gives effect to the 3-for-1 ordinary share split effective June 2, 2009.


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The Offering
 
Total number of ADSs offered in this offering 3,545,000 ADSs, representing 7,090,000 ordinary shares.
 
ADSs offered by us 2,760,000 ADSs, representing 5,520,000 ordinary shares.
 
ADSs offered by the selling shareholder 785,000 ADSs, representing 1,570,000 ordinary shares.
 
Over-allotment option We and the selling shareholder have granted the underwriters a 30-day option to purchase up to 416,750 additional ADSs from us and 115,000 additional ADSs from the selling shareholder to cover over-allotments at the public offering price less the underwriting discount and commission.
 
ADSs outstanding immediately prior to this offering 8,588,160 ADSs.
 
ADSs outstanding immediately after this offering 11,348,160 ADSs (or 11,764,910 ADSs if the underwriters exercise the over-allotment option in full).
 
Ordinary shares outstanding immediately prior to this offering 43,702,631 ordinary shares.
 
Ordinary shares outstanding immediately after this offering 49,222,631 ordinary shares (or 50,056,131 ordinary shares if the underwriters exercise the over-allotment option in full).
 
Offering price per ADS $29.50 per ADS.
 
The ADSs Each ADS represents two ordinary shares, par value $0.000033 per share. The ADSs initially will be evidenced by ADRs. The depositary will be the registered holder of the ordinary shares underlying your ADSs.
 
You will have the rights of an ADR holder as provided in a deposit agreement among us, the depositary and holders and beneficial owners of ADSs from time to time. You will be required to pay fees to the depositary upon issuance and cancellation of ADSs and distributions of cash or securities and an annual services fee, and certain fees, charges, costs or expenses incurred by the depositary.
 
To better understand the terms of our ADSs, including fees, charges, costs or expenses, you should carefully read the section in this prospectus entitled “Description of American Depositary Shares.” We also encourage you to read the deposit agreement, which is incorporated by reference as an exhibit to the registration statement that includes this prospectus. We may amend or terminate the deposit agreement for any reason without your consent. If an amendment becomes effective, you will be considered, by continuing to hold your ADSs, to have agreed to be bound by the deposit agreement as amended.
 
Use of proceeds We estimate that we will receive net proceeds from this offering of approximately $76.8 million, after deducting the underwriting discount and commission and the estimated offering expenses payable by us. If the underwriters exercise their over-allotment option in


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full, we estimate that our net proceeds will be approximately $88.5 million. We will not receive any proceeds from the sale of ADSs by the selling shareholder.
 
We intend to use our net proceeds from this offering as follows:
 
• to expand our manufacturing facilities to increase in-house production of key components used in existing or new product offerings; and
 
• for general corporate purposes.
 
Risk factors See “Risk Factors” and other information included in this prospectus for a discussion of factors you should carefully consider before deciding to invest in our ADSs.
 
Lock-up We, the selling shareholder, our directors and executive officers and certain of our other employees have agreed with the underwriters that, without the prior written consent of Credit Suisse and Piper Jaffray, subject to certain exceptions, neither we, the selling shareholder nor any of our directors or executive officers or such other employees will, for a period of 90 days following the date of this prospectus, offer, sell or contract to sell any of our ADSs, ordinary shares or securities convertible into or exchangeable or exercisable for any of our ADSs or ordinary shares. Certain employees who are not executive officers and who hold an aggregate of 466,941 ADSs on an as-converted basis executed lock-up agreements in anticipation of selling securities in this offering. We have been informed that, because these employees have determined not to sell securities in this offering, the representatives of the underwriters intend to release them from their lock-up agreements prior to the expiration of the lock-up period. See “Underwriting.”
 
Dividend policy We do not anticipate paying any cash dividends in the foreseeable future.
 
Listing Our ADSs are listed on the New York Stock Exchange under the symbol “DGW.” Our ordinary shares are not listed on any exchange or quoted for trading on any over-the-counter trading system.
 
Depositary Deutsche Bank Trust Company Americas.
 
Payment and settlement We expect our ADSs to be delivered against payment on or about February 2, 2010.


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Summary Combined and Consolidated Financial and Operating Data
 
The following summary combined and consolidated statements of income data for the years ended December 31, 2006, 2007 and 2008 and the summary consolidated balance sheet data as of December 31, 2007 and 2008 have been derived from our audited combined and consolidated financial statements for the years ended December 31, 2006, 2007 and 2008 included elsewhere in this prospectus. The following summary unaudited consolidated statements of income data for the nine months ended September 30, 2008 and 2009 and the summary unaudited consolidated balance sheet data as of September 30, 2009 have been derived from our unaudited consolidated financial statements for the nine months ended September 30, 2008 and 2009 included elsewhere in this prospectus. The summary unaudited consolidated statements of income data for the nine months ended September 30, 2008 and 2009 and the summary unaudited consolidated balance sheet data as of September 30, 2009 were prepared on the same basis as our audited combined and consolidated financial statements. The unaudited financial information includes all adjustments, consisting only of normal and recurring adjustments, as we consider necessary for a fair presentation of our financial condition and results of operations for the periods presented. Our combined and consolidated financial statements are prepared and presented in accordance with U.S. GAAP. Our historical results for any period are not necessarily indicative of results to be expected in any future period. Our results for the nine months ended September 30, 2009 are not necessarily indicative of the results that may be expected for the full year. You should read the following information in conjunction with our combined and consolidated financial statements and related notes included elsewhere in this prospectus, “Selected Combined and Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
                                                         
    Year Ended December 31,   Nine Months Ended September 30,
    2006(1)   2007   2008   2008   2008   2009   2009
                    (Unaudited)   (Unaudited)   (Unaudited)
    RMB   RMB   RMB   $   RMB   RMB   $
    (In thousands, except share and per share data)
 
Combined and Consolidated Statements of Income Data:
                                                       
Revenue
    292,863       423,962       592,699       86,827       443,168       589,579       86,370  
Cost of revenue
    178,125       272,402       326,809       47,876       243,195       304,062       44,543  
                                                         
Gross profit
    114,738       151,560       265,890       38,951       199,973       285,517       41,827  
Research and development expenses
    12,856       14,405       16,370       2,398       11,594       13,683       2,005  
Selling expenses
    27,672       30,698       37,076       5,431       26,277       41,490       6,078  
General and administrative expenses
    10,243       11,034       35,792       5,243       11,069       97,162       14,234  
                                                         
Operating income
    63,967       95,423       176,652       25,879       151,033       133,182       19,510  
Interest expense
    7,372       5,759       3,118       457       2,588       923       135  
Other income
    2,507       4,523       1,279       187       1,020       805       118  
Loss from sale of property
                3,216       471       3,204              
                                                         
Income from continuing operations before income taxes
    59,102       94,187       171,597       25,138       146,261       133,064       19,493  
Provision for income taxes
    7,403       11,799       37,830       5,542       27,951       55,868       8,184  
                                                         
Income from continuing operations
    51,699       82,388       133,767       19,596       118,310       77,196       11,309  
Income (loss) from discontinued operations
    1,113       (180 )                              
                                                         
Net income
    52,812       82,208       133,767       19,596       118,310       77,196       11,309  
                                                         


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    Year Ended December 31,   Nine Months Ended September 30,
    2006(1)   2007   2008   2008   2008   2009   2009
                    (Unaudited)   (Unaudited)   (Unaudited)
    RMB   RMB   RMB   $   RMB   RMB   $
    (In thousands, except share and per share data)
 
Earnings per basic share: Income from continuing operations
          2.75       4.46       0.65       3.94       2.22       0.33  
Income (loss) from discontinued operations
          (0.01 )                              
Net income
          2.74       4.46       0.65       3.94       2.22       0.33  
Earnings per diluted share: Income from continuing operations
          2.75       4.46       0.65       3.94       2.22       0.33  
Income (loss) from discontinued operations
          (0.01 )                              
Net income
          2.74       4.46       0.65       3.94       2.22       0.33  
Weighted average number of basic shares outstanding
          30,000,000       30,000,000       30,000,000       30,000,000       34,718,122       34,718,122  
Weighted average number of diluted shares outstanding
          30,000,000       30,000,000       30,000,000       30,000,000       34,767,287       34,767,287  
 
                                         
    As of December 31,   As of September 30,
    2007   2008   2008   2009   2009
                (Unaudited)   (Unaudited)
    RMB   RMB   $   RMB   $
    (In thousands)
 
Consolidated Balance Sheet Data:
                                       
Cash
    28,053       198,518       29,082       937,210       137,296  
Total assets
    420,243       538,086       78,827       1,385,812       203,014  
Total current liabilities
    110,316       94,393       13,828       141,314       20,702  
Total shareholders’ equity
    309,926       443,693       64,999       1,244,498       182,312  
 
 
(1) During the years ended December 31, 2005 and 2006, we were capitalized under the laws of the PRC and did not have shares outstanding.

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RISK FACTORS
 
You should carefully consider the following risk factors before you decide to buy our ADSs. You should also consider the other information in this prospectus. This prospectus contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks faced by us described below and elsewhere in this prospectus.
 
Risks Related to Our Business
 
If the market for water treatment equipment does not grow at the rate we expect or at all, our sales and profitability may be materially and adversely affected.
 
We derive all of our revenue from sales of our products in China. Our business development depends, in large part, on continued growth in the demand for quality water treatment equipment in China. Although this market has grown rapidly, the growth may not continue at the same rate. The Freedonia Group, a market research firm, projects demand for water treatment products in China will increase nearly 15.5% per year between 2008 and 2012. However, developments in our industry are, to a large extent, outside of our control and any reduced demand for water treatment equipment, any downturn or other adverse changes in China’s economy could materially and adversely harm our sales and profitability.
 
If we fail to meet evolving customer demands and requirements for water treatment equipment, including through product enhancements or new product introductions, or if our products do not compete effectively, our financial results may be materially and adversely affected.
 
The market for water treatment equipment is characterized by changing technologies, periodic new product introductions and evolving customer and industry requirements, including solution requirements for different contaminants or varying volumes of water. Our competitors are continuously searching for more cost effective and efficient water treatment methods and technologies which, if successful, could render our products obsolete in whole or in part. Our research and development efforts will focus on (1) developing new processes, applications and technologies to enhance our existing products, including automation of our circulating water treatment equipment, ozone disinfection products such as large ozone generators, ultraviolet usage in water treatment and enhancement of the performance index for belt-type filter press and high-performance aerators, and (2) establishing a research and development center for water environment and equipment, which will be responsible for studying and researching the characteristics of the water environment and the theories of water treatment systems for different water qualities. If we fail to timely develop new product enhancements and new products or if our products are rendered obsolete, we may be unable to grow our revenue as expected and may incur expenses relating to the development or acquisition of new products and technologies that are not fully offset by the revenue they generate, which could materially and adversely affect our financial results.
 
We may be unable to successfully expand our manufacturing capacity, which could result in material delays, quality issues, increased costs and loss of business opportunities, and if we fail to accurately gauge demand for our products or our product and customer initiatives fail, we may have overcapacity, which may negatively impact our product margins and profitability.
 
Many of our distributors aggressively bid for contracts to sell our water treatment equipment to real property developers, construction companies and municipalities. If a significant number of our distributors successfully bid for or obtain such contracts or projects, we may not have sufficient manufacturing capacity to meet their increased demand for our products. We plan to expand our manufacturing capacity and upgrade existing facilities to meet increasing demand. These projects may not be constructed on the anticipated timetable or within budget. We may also experience quality control issues as we implement these manufacturing upgrades and ramp up production. Any material delay in completing these projects, or any substantial increase in costs or quality issues in connection with these projects, could materially and adversely affect our business, financial condition and results of operations, and result in a loss of business opportunities. Also, if


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we fail to successfully gauge distributor and end-user customer demand for our products or if our products and customer initiatives fail, we may experience overcapacity which may negatively impact our product margins and profitability.
 
If we fail to maintain or improve our market position or respond successfully to changes in the competitive landscape, our business, financial condition and results of operations may be materially and adversely affected.
 
We operate in a highly competitive industry characterized by rapid technological development and evolving industry standards. Our competitors include a number of global and China-based companies that produce and sell products similar to ours. We compete with both major international conglomerates and local companies in each of our product categories as follows:
 
  •  Circulating Water Treatment Equipment.  Our electronic water conditioner competes primarily with products from three other local companies: Zhejiang De’an New Technology Development Co. Ltd. (China), Jiangyin Jialong Environment Technology Co. Ltd. (China) and Beijing Kejingyuan Huanyu Technology Development Co. Ltd. (China). Our automatic filter competes primarily with products from Claude Laval Co. (USA), FILTOMAT Ltd. (Israel) and Shijiazhuang Yuquan Environmental Protection Equipment Co. Ltd. (China).
 
  •  Water Purification Equipment.  Our ozone generator competes primarily with products from Ozonia Ltd. (Switzerland), WEDECO AG (Germany) and Shanghai Environmental Protection Equipment Factory (China). Our industry pure water equipment with EDI functions compete primarily with products from GE Water & Process Technologies, CANPURE Corporation (Canada) and Zhejiang Omex Environmental Engineering Ltd. (a subsidiary of Dow Chemical).
 
  •  Wastewater Treatment Equipment.  Our microporous aerator competes primarily with products from REHAU (Germany), ITT (Sweden) and Zhejiang Yuhuan Jieda Water Supply & Disposal Equipment Co. Ltd. (China). Our belt-type thickener-filter press mono-block machine competes primarily with products from Wuxi Tongyong Machinery Co. Ltd. (China), DWT Project Co. Ltd. (Finland) and Passavant-Roediger GmbH (Germany).
 
Some of our international competitors have stronger brand names, greater access to capital, longer operating histories, longer or more established relationships with their customers, stronger research and development capabilities and greater marketing and other resources than we do. In response, we engaged CCTV to develop a television advertising campaign in order to further increase brand awareness and further drive sales growth of our products. Through December 31, 2009, we incurred expenses of RMB22.9 million ($3.4 million) for this campaign, which includes RMB15.6 million ($2.3 million) for the fourth quarter of 2009. TV advertising expenses for the fourth quarter of 2009 included (1) two contracts that were signed with CCTV in August 2009 for airtime expenses through December 2009 and (2) monthly payments on a separate broker contract that was signed in September 2009 for advertising production and airtime expenses that was scheduled to run through September 2010. In December 2009, the broker contract was terminated and we entered into two new advertising contracts with CCTV for which we expect to incur selling expenses of RMB15.0 million ($2.2 million) and RMB15.3 million ($2.2 million) for the first and second quarters of 2010, respectively. These two contracts expire at the end of June 2010. These expenditures will have a direct adverse impact on our profitability without any guarantee that they will increase the awareness of our brand. Some of our domestic competitors have stronger distribution networks and end-user customer bases, better access to government authorities and stronger industry-based backgrounds than us. Due to the evolving markets in which we compete, additional competitors with significant market presence and financial resources may enter those markets, and thereby intensify competition. These competitors may be able to reduce our market share by adopting more aggressive pricing policies than we can or by developing technology and services that gain wider market acceptance than our products. Existing and potential competitors may also develop relationships with our distributors in a manner that could significantly harm our ability to sell, market and develop our products. As a result of these competitive pressures and expected increases in competition, we may price our products lower than our competitors to maintain market share. Any lower pricing may negatively affect our


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profit margins. If we fail to maintain or improve our market position or fail to respond successfully to changes in the competitive landscape, our business, financial condition and results of operations may be materially and adversely affected.
 
Our net income may fluctuate significantly from quarter to quarter, which may cause volatility in the price of our ADSs.
 
Our net income may fluctuate from quarter to quarter. For example, our net income has fluctuated significantly from one quarter to the next during the nine quarters in the period from July 1, 2007 to September 30, 2009. Historically, quarterly fluctuation has been primarily due to lower sales during the winter months as construction activities decrease. Historically, our revenue has been the highest during the third quarter and lowest during the first quarter and we expect our net income to continue to fluctuate due to seasonality. We may also experience losses in the future depending on a number of additional factors, including the extent to which our products continue to gain or maintain market acceptance, changes in our end-user customers’ budgets, the rate and size of expenditures we incur, product and price competition in our market and other factors, many of which are outside our control. If our revenue for a particular quarter is lower than we expect, we may be unable to reduce our fixed costs and operating expenses for that quarter by a corresponding amount, which would negatively impact our net income for that quarter. You should not rely on quarter-to-quarter comparisons of our net income as an indication of our future performance. Our net income may fall below the expectations of market analysts and investors in some future periods and may not be consistent with our past results. If this occurs, even temporarily, it could cause volatility in the market price of our ADSs.
 
Our business is capital-intensive and our growth strategy may require additional capital which may not be available on favorable terms or at all.
 
We may require additional cash resources due to changed business conditions, implementation of our strategy to expand our manufacturing capacity or potential investments or acquisitions we may pursue. To meet our capital needs, we may sell additional equity or debt securities or obtain additional credit facilities. The sale of additional equity securities could result in dilution of your holdings. The incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operating and financial covenants that would restrict our operations. Financing may not be available in amounts or on terms acceptable to us, if at all. Any failure by us to raise additional funds on terms favorable to us, or at all, could limit our ability to expand our business operations and could harm our overall business prospects.
 
Our expansion strategy may not prove successful.
 
One of our key strategies to grow our business is to expand our production capacity and distribution network through organic expansion as well as through the acquisition of complementary companies. Consequently, we are subject to all of the risks inherent in the unforeseen costs and expenses, challenges, complications, and delays frequently encountered in connection with the expansion and acquisition of any new businesses or production lines, as well as those risks that are specific to our industry. For example, we may expand into a product line in which we have no prior experience, we may have to rely on new distributors with which we have no prior relationship and introduce ourselves to a new and unfamiliar customer base. Pursuing our growth strategies, including integrating and expanding our facilities and service offerings to meet our customers’ needs, has resulted in, and will continue to result in, substantial demands on our resources and management’s time. Managing this growth and our growth strategies will require, among other things:
 
  •  continued enhancement of our research and development capabilities;
 
  •  effective coordination and integration of our research facilities and teams, particularly those located in different facilities, including newly opened sites;
 
  •  successful hiring and training of personnel;
 
  •  effective management of a business geographically distributed in China;


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  •  effective cost control;
 
  •  sufficient liquidity;
 
  •  effective and efficient financial and management control;
 
  •  increased marketing and sales-support activities;
 
  •  effective quality control;
 
  •  management of our distribution network; and
 
  •  management of our suppliers to leverage our purchasing power.
 
Any failure to effectively manage our anticipated growth and execute on our growth strategies could adversely affect our business, including our financial condition, results of operations, cash flows and prospects. No assurance can be given that these expansions will occur or result in revenue or profit. While we believe that our expansion plans can be paid for with proceeds from our initial public offering, proceeds from this offering and cash generated by our operating activities, if due to unforeseen factors, there is insufficient cash on hand at the time of such plant expansions and/or proposed business acquisitions, we would be required to either forgo the expansions and/or proposed business acquisitions, use shares as consideration for the acquisitions, which could have a dilutive effect on existing shareholders, and/or seek debt financing for the plant expansions and/or proposed business acquisitions, which may not be available on commercially reasonable terms, or at all.
 
We depend on distributors for all of our revenue. Failure to maintain relationships with our distributors or to otherwise expand our distribution network could negatively affect our ability to effectively sell our products.
 
We depend on distributors for all of our revenue. We do not have long-term distribution agreements, and most distribution agreements have one-year terms. As our existing distribution agreements expire, we may be unable to renew with our desired distributors on favorable terms or at all. We compete for quality distributors with both international conglomerates and local companies. Our competitors often enter into long-term distribution agreements that effectively prevent their distributors from selling our products. In addition, we rotate our sales and marketing personnel among geographic areas periodically to reduce our reliance on any single employee’s relationship with distributors in any market. This practice may make us less attractive to some distributors. 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. Our distributors could suspend their distribution services and the supply of our products to end users could be interrupted by unforeseen events. Delivery disruptions may occur for various reasons beyond our control, including improper handling by distributors or third-party transport operators, transportation bottlenecks, natural disasters and labor strikes. Improper handling by distributors or third-party transport operators could also result in damage to our products. If our products are not delivered to end users on time, or if they are delivered damaged, we could lose business and our reputation could be harmed.
 
We may be unable to effectively manage our distribution network, and our business, prospects and brand may be materially and adversely affected by our distributors’ actions.
 
Our ability to manage the activities of our independent distributors is limited. Our distributors could take one or more of the following actions, any of which may have a material adverse effect on our business, prospects and brand:
 
  •  sell products that compete with our products, including possibly counterfeit products utilizing the “Duoyuan” name;
 
  •  sell our products outside their designated territory, possibly in violation of the distribution rights of other distributors;
 
  •  fail to adequately promote our products;


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  •  fail to provide proper training and service to our end-user customers; or
 
  •  violate the anti-corruption laws of China, the United States or other countries.
 
Failure to adequately manage our distribution network, or non-compliance by distributors with our distribution agreements could harm our corporate image among our end-user customers and disrupt our sales, which could result 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 the FCPA. In particular, we may be held liable for actions taken by our distributors even though 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 may materially and adversely affect our business, financial condition and results of operations. In addition, our brand and reputation, our sales activities or the market price of our ADSs could be adversely affected if we become the target of any negative publicity as a result of actions taken by our distributors.
 
Our failure to adequately protect, or uncertainty regarding the validity, enforceability or scope of, our intellectual property rights may undermine our competitive position, and litigation to protect our intellectual property rights may be costly.
 
We strive to strengthen and differentiate our product portfolio by developing new and innovative products and product improvements. As a result, we regard our intellectual property as critical to our success. Implementation and enforcement of intellectual property-related laws in China has historically been lacking due primarily to ambiguities in Chinese intellectual property law. Accordingly, protection of intellectual property and proprietary rights in China may not be as effective as in the United States or other countries. Currently, we hold eight Chinese patents, two of which are for inventions, five are for utility models and one is for design. We also have 11 pending Chinese patent applications. We will continue to rely on a combination of patents, trade secrets, trademarks and copyrights to protect our intellectual property, but this protection may be inadequate. For example, our pending or future patent applications may not be approved or, if allowed, they may not be of sufficient strength or scope to protect our intellectual property. As a result, third parties may use the technologies and proprietary processes that we have developed and compete with us, which may negatively affect any competitive advantage we enjoy, dilute our brand and materially and adversely affect our results of operations.
 
In addition, policing the unauthorized use of our proprietary technology can be difficult and expensive. Litigation may be necessary to enforce our intellectual property rights and due to the relative unpredictability of China’s legal system and potential difficulties of enforcing a court’s judgment in China, there is no guarantee litigation would result in an outcome favorable to us. Furthermore, any such litigation may be costly and may divert our management’s attention away from our core business. An adverse determination in any lawsuit involving our intellectual property is likely to jeopardize our business prospects and reputation. We have no insurance coverage against litigation costs so we would be forced to bear all litigation costs if we cannot recover them from other parties. All of the foregoing factors could harm our business, financial condition and results of operations.
 
Limitations on our use of the “Duoyuan” name and third-party use of our trademarks and the “Duoyuan” name may dilute their value and materially and adversely affect our reputation, goodwill and brand.
 
On December 1, 2007, we transferred all our Duoyuan-related trademarks to Duoyuan Investments Limited, our majority shareholder, which is wholly owned by Mr. Wenhua Guo, our chairman and chief executive officer. On September 17, 2008 and May 27, 2009 Duoyuan Investments Limited granted us an exclusive, royalty-free perpetual license to use these trademarks for our business. Such license would terminate upon certain events, including a change in control. Duoyuan Investments Limited and Duoyuan Printing, Inc. may use these trademarks for other products, which may create confusion regarding our brand. In addition,


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some of our distributors use the Chinese characters of our name, “Duoyuan”, in their company name and we may be unable to prevent such use. The use of “Duoyuan” in their legal names by these distributors may confuse our end-user customers who may associate our name with the distributor and incorrectly believe our distributors are our affiliates. Due to ambiguities in Chinese intellectual property law, the cost of enforcement and our prior lack of enforcement, we may be unable to prevent third parties from using the Duoyuan trademark and our name, Duoyuan.
 
We may be exposed to infringement or misappropriation claims by third parties, which, if determined adversely against us, could disrupt our business and subject us to significant liability to third parties.
 
Our success largely depends on our ability to use and develop our technology, know-how and product designs without infringing upon the intellectual property rights of third parties. We may be subject to litigation involving claims of patent infringement or violation of other intellectual property rights of third parties. The holders of patents and other intellectual property rights potentially relevant to our product offerings may be unknown to us or may otherwise make it difficult for us to acquire a license on commercially acceptable terms.
 
There may also be technologies licensed to and relied on by us that are subject to infringement or other corresponding allegations or claims by third parties which may damage our ability to rely on such technologies. In addition, although we endeavor to ensure that companies that work with us possess appropriate intellectual property rights or licenses, we cannot fully avoid the risks of intellectual property rights infringement created by suppliers of components used in our products or by companies we work with in cooperative research and development activities. Our current or potential competitors, many of which have substantial resources and have made substantial investments in competing technologies, may have obtained or may obtain patents that will prevent, limit or interfere with our ability to make, use or sell our products in China or other countries. The defense of intellectual property claims, 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 proceeding to which we may become a party could cause us to:
 
  •  pay damage awards;
 
  •  seek licenses from third parties;
 
  •  pay additional ongoing royalties, which could decrease our profit margins;
 
  •  redesign our products; or
 
  •  be restricted by injunctions.
 
These factors could effectively prevent us from pursuing some or all of our business and result in our end-user customers or potential end-user customers deferring, canceling or limiting their purchase or use of our products, which may have a material adverse effect on our business, financial condition and results of operations.
 
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 the acquisition of new technologies, businesses, products or services or the creation of strategic alliances in areas in which we do not currently operate. These acquisitions could require that our management develop expertise in new areas, manage new business relationships and attract new types of customers. Furthermore, acquisitions may require significant attention from our management, and the diversion of our management’s attention and resources could have a material adverse effect on our ability to manage our business. We may also experience difficulties integrating acquisitions into our existing business and operations. Future acquisitions may also expose us to potential risks, including risks associated with:
 
  •  the integration of new operations, services and personnel;


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  •  unforeseen or hidden liabilities;
 
  •  the diversion of resources from our existing businesses and technologies;
 
  •  our inability to generate sufficient revenue to offset the costs of acquisitions; and
 
  •  potential loss of, or harm to, relationships with employees or customers, any of which may have a material adverse effect on our ability to manage our business.
 
Failure to manage our growth could strain our management, operational and other resources, which may materially and adversely affect our business, financial condition and results of operations.
 
Our growth strategy includes increasing market penetration of our existing products, developing new products, expanding our product offerings and providing a comprehensive integrated set of products. 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:
 
  •  continued enhancement of our research and development capabilities;
 
  •  continued growth of our manufacturing capacity;
 
  •  stringent cost controls and sufficient liquidity;
 
  •  strengthening of financial and management controls;
 
  •  increased marketing, sales and sales support activities; and
 
  •  hiring and training of new personnel.
 
We may not be able to effectively manage any expansion in one or more of these areas, and any failure to do so could harm our ability to maintain or increase revenue and operating results. In addition, our growth may require us to make significant capital expenditures or to incur other significant expenses. If we are not able to manage our growth successfully, our business, financial condition and results of operations may be materially and adversely affected.
 
The slowdown of China’s economy caused in part by the recent challenging global economic conditions may adversely affect our business, results of operations and financial condition.
 
China’s economy has experienced a slowdown after the second quarter of 2007, when the quarterly growth rate of China’s gross domestic product reached 11.9%. A number of factors have contributed to this slowdown, including appreciation of the Renminbi, which has adversely affected China’s exports, and tightening macroeconomic measures and monetary policies adopted by the Chinese government aimed at preventing overheating of China’s economy and controlling China’s high level of inflation. The slowdown has been further exacerbated by the challenging global economic conditions in the financial services and credit markets, which in recent months has resulted in extreme volatility and dislocation of the global capital and credit markets.
 
It is uncertain how long the challenging global economic conditions in the financial services and credit markets will continue and how much of an adverse impact it will have on the global economy in general and the Chinese economy specifically. In response to the challenging global financial conditions, in September 2008 the Chinese government began to loosen economic measures and monetary policies by reducing interest rates and decreasing the statutory reserve rates for banks. On November 5, 2008, the State Council of China announced an economic stimulus plan in the amount of $585 billion to stimulate economic growth and bolster domestic demand. The economic stimulus plan includes, among others, increased spending on basic infrastructure construction projects for water, electricity, gas and heat to improve the standard of living in China and protect the environment. Although the economic stimulus plan could generate increased demand for our water treatment equipment, we cannot assure you that the economic stimulus plan or various macroeconomic measures and monetary policies adopted by the Chinese government to guide economic growth and the allocation of resources will be effective in sustaining the growth of the Chinese economy. The slowdown of


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the Chinese economy could lead to a decrease in business and construction activity nationwide, which could reduce demand for our products and adversely affect our business, results of operations and financial condition.
 
If we fail to accurately project demand for our products, we may encounter problems of inadequate supply or oversupply, which would materially and adversely affect our business, 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. In addition, our contracts with our distributors are typically renewable on an annual basis. Our distributor contracts contain annual sales targets for each distributor, and we take such targets into account when we formulate our overall operation plans. We project demand for our products based on rolling projections from our distributors, distributor inventory levels, and our understanding of industrial policies and government plans for future residential developments that may affect demand for water treatment equipment. The varying sales and purchasing cycles of our distributors, however, make it difficult for us to accurately forecast future demand for our products.
 
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 reduce our procurement and inventory costs by matching our inventories closely with our projected manufacturing needs and by deferring our purchase of raw materials and components from time to time 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 inability to accurately predict and to timely meet our demand would materially and adversely affect our business, financial conditions and results of operations as well as damage our reputation and brand.
 
If we cannot obtain sufficient raw materials and components that meet our production standards at a reasonable cost or at all, our ability to produce and market our products, and thus our business, could suffer.
 
The key raw materials and components used in the manufacturing of our products are steel, rubber, resin and plastics, standardized mechanical parts and electric machinery. We purchase a small percentage of our electronic components from suppliers who import these components. Our other raw materials and components are purchased from Chinese subsidiaries of foreign suppliers or local suppliers, each of whom manufacture these components in China. We produce all other components internally. We may experience a shortage in the supply of certain raw materials and components in the future, and if any such shortage occurs, our manufacturing capabilities and results of operations could be negatively affected.
 
For 2006, 2007, 2008 and the nine months ended September 30, 2009, purchases from our largest supplier accounted for 27.0%, 21.5%, 18.8% and 19.6%, respectively, of our total purchases of raw materials and components. For the same periods, our ten largest suppliers combined accounted for 70.3%, 69.5%, 77.6% and 78.0%, respectively, of our total purchases of raw materials and components. As of September 30, 2009, our top three suppliers accounted for 19.6%, 15.6% and 12.4%, respectively, of our total purchases. If any supplier is unwilling or unable to provide us with high-quality raw materials and components in required quantities and at acceptable costs, we may not be able to find alternative sources on satisfactory terms in a timely manner, or at all. In addition, some of our suppliers may fail to meet qualifications and standards required by our customers now or in the future, which could impact our ability to source raw materials and components. Our inability to find or develop alternative supply sources could result in delays or reductions in manufacturing and product shipments. We may be required to redesign our products to conform to the materials and components provided by these alternative suppliers. Moreover, these suppliers may delay shipments or supply us with inferior quality raw materials and components that may adversely impact the performance of our products. If raw material prices increase rapidly or to levels significantly higher than normal, we may not be able to pass price increases through to our customers, which could adversely affect our operating margins and cash flows. Even if we are able to increase prices, any such price increases may reduce demand for our


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products. If any of these events occur, our ability to produce and market our products, and thus our business, could suffer.
 
Any interruption in our manufacturing operations or production and distribution processes could impair our financial performance and negatively affect our brand.
 
Our manufacturing operations involve the coordination of raw materials and components (some sourced from third parties), internal production processes and external distribution processes. While these operations are modified on a regular basis in an effort to improve manufacturing and distribution efficiency and flexibility, we may experience difficulties in coordinating the various aspects of our manufacturing processes, thereby causing downtime and delays. We manufacture, assemble and store almost all of our products, as well as conduct some of our primary research and development activities, at a principal facility located in the Langfang Economic & Technical Development Zone near Beijing, China. We do not maintain back-up facilities, so we depend on this facility for the continued operation of our business. A natural disaster or other unanticipated catastrophic event, 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 facility and certain equipment located in this facility would be difficult to replace and could require substantial replacement lead-time. Catastrophic events may also destroy any inventory located in our facility. The occurrence of such an event could materially and adversely affect our business. In addition, any stoppage in production, even if temporary, or delay in delivery to our customers could severely affect our business or reputation. We currently do not have business interruption insurance to offset these potential losses and any interruption in our manufacturing operations or production and distribution processes could impair our financial performance and negatively affect our brand.
 
Our insurance coverage may be inadequate to protect us against losses.
 
Although we maintain property insurance coverage for our facilities and certain equipment, we do not have any business liability, loss of data or business interruption insurance coverage for our operations in China. If any claims for injury are brought against us, or if we experience any business disruption, litigation or natural disaster, we might incur substantial costs and diversion of resources.
 
Problems with product quality or product performance could result in a decrease in customers and revenue, unexpected expenses and loss of market share.
 
Our operating results depend, in part, on our ability to deliver quality products on a timely and cost effective basis. As our products become more advanced, it may become more difficult to maintain our quality standards. If we experience deterioration in the performance or quality of any of our products, including as a result of the expansion of our manufacturing capabilities, it could result in delays in delivery, cancellations of orders or customer returns and complaints, loss of goodwill and harm to our brand and reputation. Furthermore, our products are manufactured using raw materials and components that have been produced by third parties, and when a problem occurs, it may be difficult to identify the source of the problem. These problems may lead to a decrease in customers and revenue, harm to our brand, unexpected expenses, loss of market share, the incurrence of significant repair costs, diversion of the attention of our personnel from our product development efforts or customer relation problems, any one of which may materially and adversely affect our business, financial condition and results of operations.
 
Our products may become subject to recall in the event of defects or other performance related issues.
 
Our products may become subject to recall and we may be at risk for product recall costs which are costs incurred when, either voluntarily or involuntarily, a product is recalled through a formal campaign to solicit the return of specific products due to a known or suspected performance defect. Costs typically include the cost of the product, part or component being replaced, the cost of the recall borne by our customers and labor to remove and replace the defective part or component. Our products have not been the subject of an open recall. If a recall decision is made, we will need to estimate the cost of the recall and record a charge to earnings in that period. In making this estimate, judgment is required as to the quantity or volume to be


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recalled, the total cost of the recall campaign, the ultimate negotiated sharing of the cost between us and the customer and, in some cases, the extent to which the supplier of the part or component will share in the recall cost. As a result, these estimates are subject to change. Excessive recall costs or our failure to adequately estimate these costs may negatively affect our operating results.
 
If our end-user customers that use our products successfully assert product liability claims against us due to defects in our products, our results of operations may suffer and our reputation may be harmed.
 
Our products are used for various purposes, such as treating municipal sewage and industrial wastewater and purifying water for food and beverage and pharmaceutical production. These uses tend to affect large geographic areas and significant numbers of people, and often have serious impact on the environment and people’s health and safety and daily lives. Consequently, the malfunctioning of our products could potentially cause tremendous damage. If our products are not properly designed or manufactured or if they do not perform adequately in the treatment of water, we could be subject to claims for damages based on theories of product liability and other legal theories. The costs and resources to defend such claims could be substantial and, if such claims are successful, we could be responsible for paying some or all of the damages. We do not have product liability insurance for our products. In addition, negative publicity from such claims may also damage our reputation, regardless of whether such claims are successful. Any of these consequences resulting from defects in our products would harm our results of operations, adversely affect our safety reputation among customers and potential customers, decrease our overall market share and increase our costs by requiring us to take additional measures to ensure our safety precautions are even more visible and effective.
 
Environmental claims or failure to comply with any present or future environmental regulations may require us to spend additional funds and may harm our results of operations.
 
We are subject to environmental, health and safety laws and regulations that affect our operations, facilities and products in China. Any failure to comply with any present or future environmental, health and safety laws and regulations could result in the assessment of damages or imposition of fines against us, suspension of production, cessation of our operations or even criminal sanctions. New laws and regulations could also require us to acquire costly equipment or to incur other significant expenses. Our failure to control the use of, or adequately restrict the discharge of, hazardous substances could subject us to potentially significant monetary damages and fines or suspension of our business operations, which may harm our results of operations.
 
In connection with the construction of our Duoyuan Langfang manufacturing facilities, which became operational in July 2000, we obtained the required environmental protection assessment. Pursuant to the Regulations of Hebei Province on the Administration and Supervision of Environmental Pollution Prevention, effective as of March 1, 2008, enterprises discharging pollutants must obtain a pollutant discharging permit from relevant governmental authorities. According to the attestation issued by the Environmental Protection Bureau at Langfang Economic and Development Zone dated September 18, 2009, Duoyuan Langfang has obtained all approvals and permits required by relevant environmental laws and regulations and its discharge of hazardous substances is under the limit set by relevant environmental laws and regulations. If Duoyuan Langfang or any of our other PRC subsidiaries discharge pollutants or hazardous substances in excess of the limit set by relevant environmental laws and regulations, we may be required to obtain a pollutant discharging permit from the relevant environmental protection authority. Any failure to timely obtain this permit may result in us being reprimanded by the relevant governmental authorities, which may result in a monetary fine in an amount equal to three times any illegal gains, or RMB5,000 to RMB10,000, if we have no illegal gains, subject to the discretion of the governmental authorities. If we are deemed to have materially violated the regulation regarding the discharge of pollutants, the governmental authorities may order us to rectify the situation of noncompliance within a time limit. If more stringent regulations are adopted in the future, the related compliance costs could be substantial. Any failure by us to control the use of or to adequately restrict the discharge of hazardous substances could subject us to potentially significant monetary damages and fines or suspensions in our business operations.


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We may not possess all of the licenses required to operate our business, or we may fail to maintain the licenses we currently hold. This could subject us to fines and other penalties, which may have a material adverse effect on our business, financial condition and results of operations.
 
We are required to hold a variety of permits and licenses to operate our business in China. We may not possess all of the permits and licenses required for all of our business activities. Under PRC laws, a public health permit is required for products related to sanitation and safety of drinking water. Duoyuan Beijing obtained a health permit from the Chinese Ministry of Public Health for its Ultraviolet Water Purifier. We have updated Duoyuan Beijing’s health permit and listed Duoyuan Langfang as the actual manufacturing enterprise of the Ultraviolet Water Purifier. For certain of our water purification treatment products, we have determined that a public health permit is not required either because a permit is not technically required because the water following related treatment is not meant for human drinking consumption or the related product is sold as part of an integrated solution and we possess the requisite public health permit for some key part of such integrated solution. If governmental officials do not agree with these determinations, we may be required to apply for a separate public health permit for some of our water purification treatment products or some part of our integrated water purification solution, to stop sales of the product pending receipt of the permit or subject to fines or penalties of no more than RMB30,000 for failure to possess the required permit. In addition, there may be circumstances under which an approval, permit or license granted by a governmental agency is subject to change without substantial advance notice, and it is possible that we could fail to obtain an approval, permit or license that is required to expand our business as we intend. If we fail to obtain or to maintain such permits or licenses or renewals are granted with onerous conditions, we could be subject to fines and other penalties and be limited in the number or the quality of the products that we would be able to offer. As a result, our business, financial condition and results of operations could be materially and adversely affected.
 
We depend heavily on key personnel, and the loss of certain employees and senior management could harm our business.
 
Our future success depends in significant part upon the continued contributions of certain of our technical and senior management personnel, including Messrs. Wenhua Guo, our chairman and chief executive officer, Ronglin Qiao, our chief operating officer and the general manager of our operating subsidiary Duoyuan Beijing, and Lixin Wang, our chief technology officer and the general manager of our operating subsidiary Duoyuan Langfang. It also depends in significant part upon our ability to attract and retain additional qualified management, technical, sales and marketing and support personnel for our operations. Competition for such personnel is intense and we may fail to retain certain of our personnel or fail to attract, assimilate or retain other high-qualified personnel in the future. If we lose a key employee, if a key employee fails to perform in his or her current position or if we are not able to attract and retain skilled employees as needed, our business and expansion plans could suffer. Turnover in our senior management could significantly deplete institutional knowledge held by our existing senior management team and impair our operations, which could harm our business.
 
In addition, if any of these key personnel joins a competitor or forms a competing company, we may lose some of our distributors or end user customers. In such cases, our profitability and financial performance may be adversely affected. We have entered into confidentiality and non-competition agreements with all of these key personnel. However, if any disputes arise between these key personnel and us, it is not clear, in light of uncertainties associated with the Chinese legal system, what the court decisions will be and the extent to which these court decisions could be enforced in China, where all of these key personnel reside and hold some of their assets. See “— Risks Related to Doing Business in China — Uncertainties with respect to the Chinese legal system could limit the legal protections available to you and us.”


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Wenhua Guo, our chairman and chief executive officer and 54.9% beneficial owner of our ordinary shares, has substantial influence over our company, and his interests may not be aligned with the interests of our other shareholders.
 
Wenhua Guo, our chairman and chief executive officer, beneficially owns 54.9% of our ordinary shares prior to this offering, and he will beneficially own approximately 48.8% of our ordinary shares following this offering, assuming no exercise of the underwriters’ over-allotment option. As a result, he has significant influence over our business, including decisions regarding mergers, consolidations and the sale of all or substantially all of our assets, election of directors and other significant corporate actions. This concentration of ownership may also have the effect of discouraging, delaying or preventing a future change of control, which in turn could prevent our shareholders from recognizing a gain in the event that a favorable offer is extended and may materially and adversely affect the market price of our ADSs.
 
In addition, on December 1, 2007, we transferred all our Duoyuan-related trademarks to Duoyuan Investments Limited, our majority shareholder, which is wholly owned by Mr. Guo. On September 17, 2008 and May 27, 2009 Duoyuan Investments Limited granted us an exclusive, royalty-free perpetual license to use these trademarks for our business, which license may terminate in certain instances. Mr. Guo’s refusal to allow us to use the Duoyuan name on reasonable terms or at all could have the effect of discouraging, delaying or preventing a future change of control, which in turn could prevent our shareholders from recognizing a gain in the event that a favorable offer is extended and may materially and adversely affect the market price of our ADSs.
 
Concurrent positions held by Wenhua Guo, our chairman and chief executive officer, with other businesses could impede his ability to devote sufficient time to our business and could pose conflicts of interest.
 
Wenhua Guo serves as chairman of Duoyuan Printing, Inc., a public company. He is also the beneficial owner of 100% of the equity interest in our majority shareholder, Duoyuan Investments Limited, which owns a controlling interest in Duoyuan Printing, Inc. Through its subsidiaries in China, Duoyuan Printing, Inc. is principally engaged in the manufacture and sale of offset printing equipment to the Chinese market. Mr. Guo devotes most of his business time to our affairs and the remainder of his business time to the affairs of these printing equipment-related companies. Mr. Guo’s decision-making responsibilities for these printing equipment-related companies are in the areas of public relations, management of human resources, risk management and strategic planning. As a result, conflicts of interest may arise from time to time. Additionally, even though Mr. Guo is accountable to us and our shareholders as a fiduciary, which requires that he exercise good faith and due care in handling our affairs, his existing responsibilities to other entities may limit the amount of time he can spend on our affairs.
 
The termination and expiration or unavailability of preferential tax treatments once available to us may have a material adverse effect on our operating results.
 
Prior to January 1, 2008, entities established in China were generally subject to a 30% state and 3% local enterprise income tax rate. However, entities that satisfied certain conditions enjoyed preferential tax treatment. In accordance with PRC Income Tax Law for Enterprises with Foreign Investment and Foreign Enterprises, or FIE Income Tax Law, which was effective until December 31, 2007, both Duoyuan Beijing and Duoyuan Langfang enjoyed preferential income tax rates. See “Regulation — Taxation.” Effective January 1, 2008, the PRC National People’s Congress enacted the PRC Enterprise Income Tax Law, or the new EIT law. The new EIT law imposes a single uniform income tax rate of 25% on all Chinese enterprises, including foreign-invested enterprises, and eliminates or modifies most of the tax exemptions, reductions and preferential treatment available under the previous tax laws and regulations. The preferential tax treatment enjoyed by Duoyuan Beijing expired prior to the effective date of the new EIT law. As a result, Duoyuan Beijing is subject to the uniform income tax rate of 25%. The preferential tax treatment enjoyed by Duoyuan Langfang expired at the end of 2008. As a result, the tax rate applicable to Duoyuan Langfang increased from the rate of 12.5% to the uniform rate of 25% in 2009. The expiration and termination of such preferential tax treatment may have a material adverse effect on our operating results in 2009. Moreover, the preferential tax treatment


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Duoyuan Beijing enjoyed included a tax holiday for which only manufacturing enterprises were eligible. This tax holiday was approved by the relevant local state tax bureau. Although we believe Duoyuan Beijing was a qualified manufacturing enterprise, the definition of manufacturing enterprise is unclear and subject to discretionary interpretation and enforcement by the PRC authorities. If we are deemed not qualified for prior periods, we may be required to refund prior tax benefits received.
 
The newly enacted Chinese enterprise income tax law will affect tax exemptions on the dividends we receive and increase the enterprise income tax rate applicable to us.
 
We are a holding company incorporated under the laws of the British Virgin Islands. We conduct substantially all of our business through our wholly owned Chinese subsidiaries and we derive all of our income from these subsidiaries. Prior to January 1, 2008, dividends derived by foreign legal persons from business operations in China were not subject to the Chinese enterprise income tax. However, such tax exemption ceased after January 1, 2008 with the effectiveness of the new EIT law.
 
The New EIT Law provides that enterprises established outside China whose “de facto management bodies” are located in China are considered “tax resident enterprises” and will generally be subject to the uniform 25% enterprise income tax rate as to their global income. In addition, a recent circular issued by the State Administration of Taxation on April 22, 2009 regarding the standards used to classify certain Chinese-invested enterprises established outside of China as “resident enterprises” clarified that dividends and other income paid by such “resident enterprises” will be considered to be PRC source income, subject to PRC withholding tax, currently at a rate of 10%, when recognized by non-PRC enterprise shareholders. This recent circular also subjects such “resident enterprises” to various reporting requirements with the PRC tax authorities. Under the implementation regulations to the enterprise income tax, a “de facto management body” is defined as a body that has material and overall management and control over the manufacturing and business operations, personnel and human resources, finances and other assets of an enterprise. In addition, the recent circular mentioned above details that certain Chinese-invested enterprises will be classified as “resident enterprises” if the following are located or resident in China: senior management personnel and departments that are responsible for daily production, operation and management; financial and personnel decision making bodies; key properties, accounting books, company seal, and minutes of board meetings and shareholders’ meetings; and half or more of the senior management or directors having voting rights. However, as this circular only applies to enterprises established outside of China that are controlled by PRC enterprises or groups of PRC enterprises, it remains unclear how the tax authorities will determine the location of “de facto management bodies” for overseas incorporated enterprises that are controlled by individual PRC residents like us.
 
Currently, there are no detailed rules or precedents governing the procedures and specific criteria for determining “de facto management bodies” which are applicable to our company. A substantial majority of the members of our management team are located in China. If our company is considered a PRC tax resident enterprise for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, our company will be subject to the uniform 25% enterprise income tax rate as to our global income as well as PRC enterprise income tax reporting obligations. Second, although under the New EIT Law and the Implementing Rules dividends paid to us from our PRC subsidiaries would qualify as “tax-exempted income”, we can not assure you 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, dividends payable by us to our investors and gain on the sale of our shares may become subject to PRC withholding tax. As a result of such changes, our historical operating results will not be indicative of our operating results for future periods and the value of our ordinary shares or ADSs may be adversely affected.


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The contractual arrangements entered into between our Chinese subsidiaries or between us and one of our Chinese subsidiaries and those arrangements entered into between us or one of our Chinese subsidiaries and an entity affiliated with us may be subject to audit or challenge by the Chinese tax authorities. A finding that we, Duoyuan Beijing or Duoyuan Langfang owe additional taxes could substantially reduce our net earnings and the value of your investment.
 
Under Chinese laws and regulations, arrangements and transactions among affiliated parties may be subject to audit or challenge by the Chinese tax authorities. The new EIT Law became effective on January 1, 2008 and provides authority for the PRC tax authority to make special adjustments to taxable income as well as new reporting requirements. In particular, an enterprise must submit its annual tax return together with information on related party transactions to the tax authorities. The tax authorities may impose reasonable adjustments on taxation if they have identified any related party transactions that are inconsistent with arm’s-length principles. In addition, the PRC tax authorities recently issued Implementation Measures for Special Tax Adjustments (Trial) which set forth tax-filing disclosure and contemporaneous documentation requirements, clarify the definition of “related party”, guide the selection and application of transfer pricing methods, and outline the due process procedures for transfer pricing investigation and assessment. We could face material and adverse tax consequences if the Chinese tax authorities determine that the contractual arrangements between our Chinese subsidiaries or between us and one of our Chinese subsidiaries or those arrangements entered into between us or one of our Chinese subsidiaries and an entity affiliated with us do not represent arm’s-length prices and as a result, adjust any of the income in the form of a transfer pricing adjustment. A transfer pricing adjustment could, among other things, result in a reduction of expense deductions for Chinese tax purposes recorded by us or our Chinese subsidiaries or an increase in taxable income, all of which could increase our tax liabilities. In addition, the Chinese tax authorities may impose late payment fees and other penalties on us or our Chinese subsidiaries for under-paid taxes.
 
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 through independent non-U.S. distributors which are responsible for interacting with the end users of our products. Although none of these independent non-U.S. distributors are located in or to our knowledge conduct business with countries subject to U.S. economic sanctions such as Cuba, Sudan, Iran, Syria and Myanmar, we may not be able to ensure that such non-U.S. distributors comply with any applicable 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.
 
As a result of being a public company, we incur increased costs that may place a strain on our resources and our management’s attention may be diverted from other business concerns.
 
As a public company, we incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the Securities and Exchange Commission and the New York Stock Exchange, have required changes in corporate governance practices of public companies. Compliance with these rules and regulations has increased our legal and financial compliance costs and is expected to make some activities more time-consuming and costly. These requirements may place a strain on our systems and resources. The Securities Exchange Act of 1934, or the Exchange Act, requires that we file annual and current reports with respect to our business and financial condition. The Sarbanes-Oxley Act requires that we maintain effective disclosure controls and


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procedures and internal controls for financial reporting. Significant resources and management oversight have been dedicated to maintaining and improving the effectiveness of our disclosure controls and procedures and internal control over financial reporting. This may divert management’s attention from other business concerns, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.
 
These rules and regulations have made it more expensive for us to obtain director and officer liability insurance, and we have incurred substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified persons to serve on our board of directors or as executive officers. We are currently evaluating and monitoring developments with respect to these rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.
 
We may be exposed to potential risks relating to our internal controls over financial reporting and our ability to have those controls attested to by our independent auditors.
 
We are a public company in the United States that is or will be subject to the Sarbanes-Oxley Act of 2002. As directed by Section 404 of the Sarbanes-Oxley Act of 2002, or SOX 404, the Securities and Exchange Commission adopted rules requiring public companies to include a management’s assessment of the company’s internal controls over financial reporting in their annual reports, including Form 20-F. The 2009 annual report does not require a report of management’s assessment regarding internal control over financial reporting or an attestation report of our registered public accounting firm due to a transition period established by the rules of the Securities and Exchange Commission for newly public companies. Under current law, we will be required to include a management report beginning with our annual report for the 2010 fiscal year. Beginning with the 2010 fiscal year, our independent registered public accounting firm will also be required to attest to the system of internal controls over financial reporting. Our management may conclude that our internal controls over our financial reporting are not effective. Even if our management concludes that our internal controls over financial reporting are effective, our independent registered public accounting firm may still issue a report that is qualified if it is not satisfied with our controls or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us. We can provide no assurance that we will be in compliance with all of the requirements imposed by SOX 404 or that we will receive a positive attestation from our independent auditors. In the event we identify significant deficiencies or material weaknesses in our internal controls that we cannot remediate in a timely manner or we are unable to receive a positive attestation from our independent auditors with respect to our internal controls, investors and others may lose confidence in the reliability of our financial statements. Any of these possible outcomes could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our reporting processes, which could adversely affect the market price of our ADSs.
 
In the course of preparing our combined and consolidated financial statements as of and for the years ended December 31, 2006, 2007 and 2008, several material weaknesses, significant deficiencies and control deficiencies have been identified. If we fail to achieve or maintain an effective system of internal control over financial reporting, our ability to accurately and timely report our financial results or prevent fraud may be adversely affected.
 
Prior to completion of our initial public offering in June 2009, we were a private company with limited accounting personnel and other resources with which to address our internal control and procedures over financial reporting. In preparing our combined and consolidated financial statements, several material weaknesses, significant deficiencies and control deficiencies have been identified, as defined in the standards established by the U.S. Public Company Accounting Oversight Board. The material weaknesses identified in our 2008 audit related to our failure to implement a month-end process to properly accrue expenditures at period-end and record purchases and sales following the closing of our books and proper review of these items. Previously identified material weaknesses mainly related to: (1) an inability to timely identify disputed balances or unpaid aged balances of revenue and accounts receivable; (2) differences and errors in the recording of cost of revenue and inventory; (3) a lack of effective controls over the financial reporting process due to an insufficient complement of personnel with an appropriate level of accounting knowledge, experience


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and training in the application of U.S. GAAP commensurate with our financial reporting requirements; and (4) inadequate retention and maintenance of legal and accounting documents. The significant deficiencies identified in our 2008 audit primarily related to (1) failure to record inventory balances at the time of delivery rather than after inspection and (2) sales tax rebates paid without corresponding official receipts. Previously observed significant deficiencies included (1) errors in the classification of expenses and (2) related party transactions not entered into on arm’s-length basis. To remedy these weaknesses and deficiencies, we have adopted several measures to improve our internal controls over financial reporting. If we fail to timely achieve and maintain the adequacy of our internal controls, we may not be able to conclude that we have effective internal controls over financial reporting. Moreover, effective internal controls over financial reporting are necessary for us to produce reliable financial reports and are important to help prevent fraud. As a result, our failure to achieve and maintain effective internal controls over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the market price of our ordinary shares. Furthermore, we anticipate that we will incur considerable costs and use significant management time and other resources in an effort to comply with SOX 404.
 
Risks Related to Doing Business in China
 
Adverse changes in political and economic policies of the Chinese government could impede the overall economic growth of China, which could reduce the demand for our products and have a material adverse effect on our business and prospects.
 
We conduct all of our operations and generate all of our sales in China. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. The Chinese economy differs from the economies of most developed countries in many respects, including:
 
  •  the higher level of government involvement;
 
  •  the early stage of development of the market-oriented sector of the economy;
 
  •  the rapid growth rate;
 
  •  the higher level of control over foreign exchange; and
 
  •  the allocation of resources.
 
As the Chinese economy has been transitioning from a planned economy to a more market-oriented economy, the Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources. While the Chinese economy has grown significantly in the past 30 years, the growth has been uneven geographically among various sectors of the economy, and during different periods. We cannot assure you that the Chinese economy will continue to grow, or that if there is growth, such growth will be steady and uniform, or that if there is a slowdown, such slowdown will not have a negative effect on our business. For example, the Chinese economy experienced high inflation in the second half of 2007 and the first half of 2008. China’s consumer price index soared 7.9% during the six months ended June 30, 2008 as compared to the same period in 2007. To combat inflation and prevent the economy from overheating, the Chinese government adopted a number of tightening macroeconomic measures and monetary policies, including increasing interest rates, raising statutory reserve rates for banks and controlling bank lending to certain industries or economic sectors. However, due in part to the challenging global economic conditions facing the financial services and credit markets and other factors, the growth rate of China’s gross domestic product decreased to 6.8% in the fourth quarter of 2008, down from 11.9% in the second quarter of 2007. As a result, beginning in September 2008, among other measures, the Chinese government began to loosen macroeconomic measures and monetary policies by reducing interest rates and decreasing the statutory reserve rates for banks. In addition, on November 5, 2008, the State Council of China announced an economic stimulus plan in the amount of $585 billion to stimulate economic growth and bolster domestic demand. The economic stimulus plan includes, among others, increased spending on basic infrastructure construction projects for water, electricity, gas and heat to improve the standard of living in China and protect the


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environment. Although the economic stimulus plan could generate increased demand for our water treatment equipment, we cannot assure you that the economic stimulus plan or various macroeconomic measures and monetary policies adopted by the Chinese government to guide economic growth and the allocation of resources will be effective in sustaining the growth of the Chinese economy.
 
The Chinese government will continue to exercise significant control over economic growth in China through the allocation of resources, controlling payment of foreign currency denominated obligations, setting monetary policy and imposing policies that impact particular industries or companies in different ways. Any adverse change in the economic conditions or government policies in China could have a material adverse effect on the overall economic growth and the level of water treatment investments and expenditures in China, which in turn could lead to a reduction in demand for our products and consequently have a material adverse effect on our business and prospects.
 
Uncertainties with respect to the Chinese legal system could limit the legal protections available to you and us.
 
We are a holding company, and we conduct our business primarily through our operating subsidiaries incorporated in China. We and our operating subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to foreign-invested enterprises. The Chinese legal system is based on written statutes, and prior court decisions may be cited for reference, but have limited precedential value. Since 1979, a series of new Chinese laws and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since the Chinese legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which may limit legal protections available to you and us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. In addition, all but two of our directors are residents of China and not of the United States, and substantially all the assets of these Chinese persons are located outside the United States. As a result, it could be difficult for investors to effect service of process in the United States or to enforce a judgment obtained in the United States against our Chinese officers, directors and subsidiaries. There is also uncertainty as to whether the courts in China would enforce judgments of United States courts against us or our directors and officers based on the civil liabilities provisions of the securities laws of the United States or any other state, or adjudicate an original action brought in China based upon the securities laws of the United States or any other state.
 
The Chinese government exerts substantial influence over the manner in which we must conduct our business activities.
 
The Chinese government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land-use-rights, property and other matters. We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of the jurisdictions in which we operate may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations. Accordingly, government actions in the future, including any decision not to continue to support China’s economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures.
 
Restrictions on currency exchange may limit our ability to receive and use our revenue effectively and limit the ability of our PRC subsidiaries to obtain financing.
 
All of our revenues and expenses are denominated in Renminbi. Under Chinese law, the Renminbi is currently convertible under the “current account,” which includes dividends and trade and service related


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foreign exchange transactions, but not under the “capital account,” which includes foreign direct investment and loans. Currently, our Chinese operating subsidiaries may purchase foreign currencies for settlement of current account transactions, including payments of dividends to us, without the approval of the State Administration of Foreign Exchange, or SAFE, by complying with certain procedural requirements. However, the relevant Chinese government authorities may limit or eliminate our ability to purchase foreign currencies in the future. Since a significant amount of our future revenue will be denominated in Renminbi, any existing and future restrictions on currency exchange may limit our ability to utilize revenue generated in Renminbi to fund our business activities outside China that are denominated in foreign currencies.
 
Foreign exchange transactions by Chinese operating subsidiaries under the capital account continue to be subject to significant foreign exchange controls and require the approval of or need to register with Chinese government authorities, including SAFE. In particular, if our Chinese operating subsidiaries borrow foreign currency through loans from us or other foreign lenders, these loans must be registered with SAFE and if the loans exceed certain borrowing limits, must be approved by SAFE. In addition, if we finance the subsidiaries by means of additional capital contributions, these capital contributions must be approved by certain government authorities, including the Ministry of Commerce, or their respective local counterparts. These limitations could affect our Chinese operating subsidiaries’ ability to obtain foreign exchange through debt or equity financing.
 
Failure to comply with Chinese regulations relating to the establishment of offshore special purpose companies by Chinese residents may subject our Chinese resident shareholders to personal liability, limit our ability to acquire Chinese companies or to inject capital into our Chinese subsidiaries, limit our Chinese subsidiaries’ ability to distribute profits to us or otherwise materially and adversely affect us.
 
The SAFE issued 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 in October 2005, which became effective in November 2005, and an implementing rule in May 2007, collectively the SAFE Rules. According to the SAFE Rules, Chinese residents, including both legal persons and natural persons, who reside in China, are required to register with the SAFE or its local branch before establishing or controlling any company outside China, referred to in the SAFE Rules as an “offshore special purpose company,” for the purpose of financing that offshore company with their ownership interests in the assets of or their interests in any Chinese enterprise. In addition, a Chinese resident that is a shareholder of an offshore special purpose company is required to amend its SAFE registration with the local SAFE branch with respect to that offshore special purpose company in connection with the injection of equity interests or assets of a Chinese enterprise in the offshore company or overseas fund raising by the offshore company, or any other material change in the capital of the offshore company, including any increase or decrease of capital, transfer or swap of share, merger, division, long-term equity or debt investment or creation of any security interest. The registration and filing procedures under SAFE Rules are prerequisites for other approval and registration procedures necessary for capital inflow from the offshore entity, such as inbound investments or shareholder loans, or capital outflow to the offshore entity, such as the payment of profits or dividends, liquidating distributions, equity sale proceeds, or the return of funds upon a capital reduction. The SAFE Rules retroactively required registration by March 31, 2006 of direct or indirect investments previously made by Chinese residents in offshore companies. If a Chinese shareholder with a direct or indirect stake in an offshore parent company fails to make the required SAFE registration, the Chinese 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 Chinese subsidiaries. Further, failure to comply with the various SAFE registration requirements described above could result in liability under Chinese law for violation of the relevant rules relating to foreign exchange.
 
Currently, our majority shareholder is Duoyuan Investments Limited, which is wholly owned by Wenhua Guo, our chairman and chief executive officer and a Chinese resident as defined in the SAFE Rules. Mr. Guo has registered with the relevant branch of SAFE, as currently required, in connection with his interests in us and our acquisitions of equity interests in our Chinese subsidiaries. Furthermore, as required by SAFE Rules, our 2008 Omnibus Incentive Plan has been filed with the SAFE or its authorized branch. Mr. Guo has updated


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his SAFE registration to reflect the completion of our initial public offering in June 2009, his interest in Duoyuan Investments Limited and filing the 2008 Omnibus Incentive Plan with the SAFE. We attempt to comply and attempt to ensure that each of our Chinese resident shareholders who is subject to the SAFE Rules and other related rules, complies with the relevant requirements of the SAFE Rules. However, we cannot provide any assurances that our Chinese resident shareholders will fully comply with all applicable registrations or approvals required by the SAFE Rules. Moreover, because of uncertainty over how the SAFE Rules will be interpreted and implemented, and how or whether the SAFE Rules will apply to us, we cannot predict how it will affect our business operations or future strategies. For example, our present and prospective Chinese subsidiaries’ ability to conduct foreign exchange activities, such as the remittance of dividends and foreign currency denominated borrowings, may be subject to compliance with the SAFE Rules by Mr. Guo or our other Chinese resident shareholders. In addition, such Chinese residents may not always be able to complete the necessary registration procedures required by the SAFE Rules. We also have little control over either our present or prospective direct or indirect shareholders or the outcome of such registration procedures. The failure or inability by Mr. Guo or our other Chinese resident shareholders to comply with the SAFE Rules, if SAFE requires it, may subject them to fines or other sanctions and may also limit our ability to contribute additional capital into or provide loans to our Chinese subsidiaries (including using our net proceeds from this offering for these purposes), limit our Chinese subsidiaries’ ability to pay dividends to us, repay shareholder loans or otherwise distribute profits or proceeds from any reduction in capital, share transfer or liquidation to us, or otherwise adversely affect us. Failure by our Chinese resident shareholders or beneficial owners to comply with SAFE filing requirements described above could result in liability to these shareholders or our Chinese subsidiaries under Chinese laws for evasion of applicable foreign exchange restrictions.
 
If the China Securities Regulatory Commission, or CSRC, or another Chinese regulatory agency determines that CSRC approval was required for our initial public offering or is required in connection with this offering, this offering may be delayed or cancelled, or we may become subject to penalties.
 
On August 8, 2006, six Chinese regulatory agencies, including the Ministry of Commerce, the State Assets Supervision and Administration Commission, the State Administration for Taxation, the State Administration for Industry and Commerce, CSRC and the SAFE, jointly issued the Regulation on Mergers and Acquisitions of Domestic Companies by Foreign Investors, or the New M&A Rule, which became effective on September 8, 2006. This new regulation, among other things, has certain provisions that require offshore special purpose vehicles formed for the purpose of acquiring Chinese domestic companies and directly or indirectly established or controlled by Chinese entities or individuals, to obtain the approval of the CSRC prior to publicly listing their securities on an overseas stock market. On September 21, 2006, the CSRC published on its official website a notice specifying the documents and materials that are required to be submitted for obtaining CSRC approval. Although we acquired the equity interests in Duoyuan Beijing and Duoyuan Langfang after the New M&A Rule became effective, they were established as qualified foreign invested enterprises prior to the effective date and we acquired such equity interests from another offshore company. It is not clear how the provisions in the new regulation regarding the offshore listing and trading of the securities of a special purpose vehicle apply to us. We believe, based on the interpretation of the new regulation and the practice experience of our Chinese legal counsel, Commerce & Finance Law Offices, that CSRC approval was not required for our initial public offering in June 2009 and listing of our ADSs on the New York Stock Exchange and is not required for this offering. Since the new regulation has only recently been adopted, there remains some uncertainty as to how this regulation will be interpreted or implemented. If the CSRC or another Chinese regulatory agency subsequently determines that the CSRC’s approval was required for our initial public offering or is required for this offering, we may face sanctions by the CSRC or another Chinese regulatory agency. If this happens, these regulatory agencies may impose fines and penalties on our operations in China, limit our operating privileges in China, delay or restrict the repatriation of our net proceeds from this offering into China, restrict or prohibit payment or remittance of dividends to us or take other actions that could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our ADSs. The CSRC or other Chinese regulatory agencies may also take actions requiring us, or making it advisable for us, to delay or cancel this offering before settlement and delivery of the shares being offered by us.


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We may be unable to complete a business combination transaction efficiently or on favorable terms due to complicated merger and acquisition regulations which became effective on September 8, 2006.
 
The New M&A Rule also governs the approval process by which a foreign investor may participate in an acquisition of assets or equity interests of a Chinese company. Depending on the structure of the transaction, the new regulation will require the investors to make a series of applications and supplemental applications to the government agencies. In some instances, the application process may require the presentation of economic data concerning a transaction, including appraisals of the target business and evaluations of the acquirer, which are designed to allow the government to assess the transaction. Government approvals will have expiration dates by which a transaction must be completed and reported to the government agencies. Compliance with the new regulations is likely to be more time consuming and expensive than in the past and the government can now exert more control over the combination of two businesses. Accordingly, due to the new regulation, our ability to engage in business combination transactions has become significantly more complicated, time consuming and expensive, and we may not be able to negotiate a transaction that is acceptable to our shareholders or sufficiently protect their interests in a transaction. The new regulation allows Chinese government agencies to assess the economic terms of a business combination transaction. Parties to a business combination transaction may have to submit to the Ministry of Commerce and other relevant government agencies an appraisal report, an evaluation report and the acquisition agreement, all of which form part of the application for approval, depending on the structure of the transaction. The regulations also prohibit a transaction at an acquisition price obviously lower than the appraised value of the Chinese business or assets and in certain transaction structures, require that consideration must be paid within defined periods, generally not in excess of a year. The regulation also limits our ability to negotiate various terms of the acquisition, including aspects of the initial consideration, contingent consideration, holdback provisions, indemnification provisions and provisions relating to the assumption and allocation of assets and liabilities. Transaction structures involving trusts, nominees and similar entities are prohibited. Therefore, such regulation may impede our ability to negotiate and complete a business combination transaction on financial terms that satisfy our investors and protect our investors economic interests.
 
On July 1, 2007, our wholly owned subsidiaries, Duoyuan Beijing and Duoyuan Langfang, each transferred their respective 50% equity interest in Huanan Duoyuan Water Supply Co. Ltd., or Duoyuan Huanan, to Duoyuan Asian Water Inc., another offshore company wholly owned by Wenhua Guo. We obtained the approval from the Heilongjiang provincial investment promotion bureau for this transaction. According to the New M&A Rule, this transaction might require the approval of the Ministry of Commerce. As the interpretation and implementation of the New M&A Rule are unclear, if the approval of Ministry of Commerce is required, the approval that Duoyuan Huanan has obtained may be deemed incomplete and the purchaser, namely Duoyuan Asian Water Inc., may need to obtain further approval from the Ministry of Commerce.
 
We may be subject to fines and legal sanctions imposed by SAFE or other Chinese government authorities if we or our Chinese employees or directors fail to comply with recent Chinese regulations relating to employee share options or shares granted by offshore special purpose companies or offshore listed companies to Chinese citizens.
 
On December 25, 2006, the People’s Bank of China, or PBOC, issued the Administration Measures on Individual Foreign Exchange Control, and the corresponding Implementation Rules were issued by SAFE on January 5, 2007. Both of these regulations became effective on February 1, 2007. According to these regulations, all foreign exchange matters relating to employee stock holding plans, share option plans or similar plans with PRC citizens’ participation require approval from the SAFE or its authorized branch. On March 28, 2007, the SAFE issued the Application Procedure of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Holding Plan or Stock Option Plan of Overseas-Listed Company, or the Stock Option Rule. Under the Stock Option Rule, Chinese citizens who are granted share options or shares by an offshore listed company are required, through a Chinese agent or Chinese subsidiary of the offshore listed company, to register with the SAFE and complete certain other procedures. We are an offshore listed company and as a result we and our Chinese employees who have been granted share options


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or shares under our 2008 Omnibus Incentive Plan are subject to the Stock Option Rule. We are in the process of filing with the SAFE and undertaking certain other procedures according to the Stock Option Rule. If we or our Chinese employees fail to comply with these regulations, we or our Chinese employees may be subject to fines or other legal sanctions imposed by the SAFE or other Chinese government authorities. See “Regulation — SAFE regulations on overseas investment of Chinese residents and employee share options or stock holding plans.”
 
Fluctuations in exchange rates could adversely affect our business and the value of our securities.
 
The value of our ADSs will be indirectly affected by the foreign exchange rate between U.S. dollars and the Renminbi and between those currencies and other currencies in which our revenue may be denominated. Because all of our earnings and cash assets are denominated in Renminbi and our proceeds from this offering will be denominated in U.S. dollars, fluctuations in the exchange rate between the U.S. dollar and the Renminbi will affect the relative purchasing power of these proceeds, as well as our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business, financial condition or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue after this offering that will be exchanged into U.S. dollars and earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.
 
Since July 2005, the Renminbi has not been pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the Renminbi may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future the Chinese authorities may lift restrictions on fluctuations in the Renminbi exchange rate and lessen intervention in the foreign exchange market.
 
Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by Chinese exchange control regulations that restrict our ability to convert Renminbi into foreign currencies.
 
Currently, we purchase a small percentage of our electronic components from suppliers who import these components. If the U.S. dollar appreciates against the Renminbi, our costs will increase. If we cannot pass the resulting cost increases on to our customers, our profitability and operating results will suffer.
 
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 two wholly owned Chinese operating subsidiaries, Duoyuan Beijing and Duoyuan Langfang, 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 either of our operating subsidiaries 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 Chinese laws and regulations permit payments of dividends by each of our operating subsidiaries only out of its retained earnings after tax, if any, determined in accordance with Chinese accounting standards and regulations.
 
Under Chinese laws and regulations, each of our operating subsidiaries 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, 2006, 2007 and 2008 and as of September 30, 2009, the amount of these restricted portions was approximately RMB11.4 million, RMB20.3 million, RMB36.4 million ($5.3 million) and RMB53.5 million ($7.8 million), respectively. As a result of these Chinese laws and regulations, each of our operating subsidiaries 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


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the ability of our operating subsidiaries 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.
 
We face risks related to health epidemics and other outbreaks that may disrupt our operations and have a material adverse effect on our business and results of operations.
 
Our business could be materially and adversely affected by the effects of H1N1 flu (swine flu), avian flu, severe acute respiratory syndrome or other epidemics or outbreaks. In April 2009, an outbreak of H1N1 flu (swine flu) first occurred in Mexico and quickly spread to other countries, including the U.S. and China. In the last decade, China has suffered health epidemics related to the outbreak of avian influenza and severe acute respiratory syndrome. Any prolonged occurrence or recurrence of H1N1 flu (swine flu), avian flu, severe acute respiratory syndrome or other adverse public health developments in China may have a material adverse effect on our business and operations. These health epidemics could result in severe travel restrictions and closures that would restrict our ability to ship our products. Potential outbreaks could also lead to temporary closure of our manufacturing facilities, our suppliers’ facilities and/or our end-user customers’ facilities, leading to reduced production, delayed or cancelled orders, and decrease in demand for our products. Any future health epidemic or outbreaks that could disrupt our operations and/or restrict our shipping abilities may have a material adverse effect on our business and results of operations.
 
We face risks related to natural disasters, terrorist attacks or other events in China that may affect usage of public transportation, which could have a material adverse effect on our business and results of operations.
 
Our business could be materially and adversely affected by natural disasters, terrorist attacks or other events in China. For example, in early 2008, parts of China suffered a wave of strong snow storms that severely impacted public transportation systems. In May 2008, Sichuan Province in China suffered a strong earthquake measuring approximately 8.0 on the Richter scale that caused widespread damage and casualties. The May 2008 Sichuan earthquake may have a material adverse effect on the general economic conditions in the areas affected by the earthquake. In July 2008, explosive devices were detonated on several buses in Kunming, Yunnan Province of China, which resulted in disruptions to public transportation systems in Kunming and casualties. Any future natural disasters, terrorist attacks or other events in China could cause a reduction in usage of, or other severe disruptions to, public transportation systems and could have a material adverse effect on our business and results of operations.
 
Risks Related to Our ADSs and This Offering
 
The market price of our ADSs has been volatile and could continue to be volatile, leading to the possibility of their value being depressed at a time when you want to sell your holdings.
 
The trading prices of our ADSs have been and are likely to continue to be volatile. Since June 24, 2009, the trading price of our ADSs on the New York Stock Exchange has ranged from $20.40 to $44.00 per ADS, and the last reported sale price on January 27, 2010 was $29.74 per ADS. The trading prices of our ADSs could fluctuate widely in response to factors beyond our control. Broad market and industry factors may significantly affect the market price and volatility of our ADSs, regardless of our actual operating performance, including the following:
 
  •  our earnings releases, actual or anticipated changes in our earnings, fluctuations in our operating results or our failure to meet the expectations of financial market analysts and investors;
 
  •  changes in financial estimates by us or by any securities analysts who might cover our ADSs;
 
  •  speculation about our business in the press or the investment community;
 
  •  significant developments relating to our relationships with our customers or suppliers;


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  •  stock market price and volume fluctuations of other publicly traded companies and, in particular, those that are in the water treatment or environmental technology industries;
 
  •  customer demand for our products;
 
  •  investor perceptions of the water treatment and environmental technology industries in general and our company in particular;
 
  •  the operating and stock performance of comparable companies;
 
  •  general economic conditions and trends;
 
  •  major catastrophic events;
 
  •  announcements by us or our competitors of new products, significant acquisitions, strategic partnerships or divestitures;
 
  •  changes in accounting standards, policies, guidance, interpretation or principles;
 
  •  loss of external funding sources;
 
  •  expiration of lock-up agreements;
 
  •  sales of our ordinary shares or ADSs, including sales by our directors, officers or significant shareholders; and
 
  •  additions or departures of key personnel.
 
We cannot predict the effect that this offering will have on the volume or trading price of our ADSs. We cannot provide assurances that the market price of our ADSs will not fall below the public offering price, or that following this offering a shareholder will be able to sell ADSs acquired in this offering at a price equal to or greater than the offering price.
 
In addition to market and industry factors, the price and trading volume for our ADSs may be highly volatile for specific business reasons. In particular, factors such as variations in our revenues, earnings and cash flow, announcements of new investments or acquisitions could cause the market price for our ADSs to change substantially. Any of these factors may result in large and sudden changes in the volume and trading price of our ADSs. In the past, following periods of volatility in the market price of a company’s securities, shareholders have often instituted securities class action litigation against that company. If we were involved in a class action suit, it could divert the attention of senior management, and, if adversely determined, could have a material adverse effect on our financial condition and results of operations.
 
Future sales or perceived sales of our ordinary shares or ADSs could depress the price of our ADSs.
 
We, the selling shareholder, our directors and executive officers and certain of our other employees have agreed with the underwriters that, without the prior written consent of Credit Suisse and Piper Jaffray, subject to certain exceptions, neither we, the selling shareholder nor any of our directors or executive officers or such other employees will, for a period of 90 days following the date of this prospectus, offer, sell or contract to sell any of our ADSs, ordinary shares or securities convertible into or exchangeable or exercisable for any of our ADSs or ordinary shares. See “Underwriting.” The ordinary shares and ADSs subject to these lock-up agreements will become eligible for sale in the public market upon expiration of these lock-up agreements, subject to limitations imposed by Rule 144 under the Securities Act of 1933, as amended, or Securities Act. See “Shares Eligible for Future Sale.” If the holders of the ordinary shares or ADSs were to attempt to sell a substantial amount of their holdings at once, the market price of our ADSs could decline. Moreover, the perceived risk of this potential dilution could cause shareholders to attempt to sell their ordinary shares or ADSs and investors to short the stock, a practice in which an investor sells shares that he or she does not own at prevailing market prices, hoping to purchase shares later at a lower price to cover the sale. As each of these events would cause the number of ADSs being offered for sale to increase, our ADSs’ market price would likely further decline. All of these events could combine to make it very difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate.


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In addition, since a 180-day lock-up period that commenced on the date of our initial public offering in June 2009 has now expired, certain holders of our ordinary shares have the right to cause us to register the sale of those shares under the Securities Act. Registration of these shares under the Securities Act would result in these shares becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of that registration. Sales of additional registered shares in the public market could cause the price of our ADSs to decline. For a description of the registration rights that we have granted, see “Description of Share Capital — Registration Rights.”
 
We do not intend to pay dividends on our ordinary shares for the foreseeable future.
 
We have never declared or paid any cash dividends on our ordinary shares. We intend to retain any future earnings to fund the operation and expansion of our business and, therefore, we do not anticipate paying cash dividends on our ordinary shares in the foreseeable future.
 
Even if we pay dividends or other distributions on our ordinary shares, you may not receive them or any value for them if it is illegal or impractical to make them available to you.
 
The depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian receives on ordinary shares or other deposited securities after deducting its fees, charge, and expenses and any taxes withheld, duties or governmental charges. You will receive these distributions in proportion to the number of ordinary shares your ADSs represent as of the record date (which will be as close as practicable to the record date for our ordinary shares). However, the depositary is not responsible if it decides that it is illegal or impractical to make a distribution available to any holders of ADSs. For example, the depositary may determine that it is not feasible to distribute certain property through the mail. Additionally, the value of certain distributions may be less than the cost of mailing them. In these cases, the depositary may determine not to distribute such property. We have no obligation to register under U.S. securities laws any ADSs, ordinary shares, rights or other securities received through such distributions. We also have no obligation to take any other action to permit the distribution of ADSs, ordinary shares, rights or anything else to holders of ADSs. This means that you may not receive any distributions we make on our ordinary shares or any value for them if it is illegal or impractical to make them available to you. These restrictions may have a material adverse effect on the value of your ADSs.
 
Your right to participate in any future rights offerings may be limited, which may cause dilution of your holdings.
 
We may from time to time distribute rights to our shareholders, including rights to acquire our securities. Under the deposit agreement, the depositary will not offer you those rights unless the distribution to ADS holders of both the rights and any related securities is either registered under the Securities Act, or exempt from registration under the Securities Act. We are under no obligation to file a registration statement with respect to any such rights or securities or to endeavor to cause such a registration statement to be declared effective. Moreover, we may not be able to establish an exemption from registration under the Securities Act. Accordingly, you may be unable to participate in our rights offerings and may experience dilution in your holdings.
 
You may not be able to exercise your right to vote.
 
As a holder of ADSs, you may only exercise the voting rights with respect to the underlying ordinary shares in accordance with the provisions of the deposit agreement. Under the deposit agreement, you must vote by giving voting instructions to the depositary. Upon receipt of your voting instructions, the depositary will vote the underlying ordinary shares in accordance with your instructions. Otherwise, you will not be able to exercise your right to vote unless you withdraw the shares. Under our Fourth Amended and Restated Memorandum and Articles of Association, the minimum notice period required for convening general shareholders’ meetings is seven days. When a general shareholders’ meeting is convened, you may not receive sufficient advance notice to withdraw the shares to allow you to vote with respect to any specific matter. If we ask for your instructions, the depositary will notify you of the upcoming vote and will arrange to deliver our


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voting materials to you. We cannot assure you that you will receive the voting materials in time to ensure that you can instruct the depositary to vote your ordinary shares. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions or for the manner of carrying out voting instructions. This means that you may not be able to exercise your right to vote and the ordinary shares underlying your ADSs may not be voted as you requested.
 
You may be subject to limitations on transfer of your ADSs.
 
Your ADSs represented by the ADRs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from time to time when it deems expedient in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers of ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary thinks it advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.
 
We may be classified as a passive foreign investment company, which may result in adverse U.S. federal income tax consequences to U.S. holders of our ADSs or ordinary shares.
 
Depending on 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. Based on our projections of the value of our outstanding ordinary shares and ADSs during the current taxable year, our use of the proceeds of the initial public offering and this offering of our ADSs and other cash that we will hold and generate in the ordinary course of our business throughout the current taxable year, we do not expect to be a PFIC for the taxable year 2009. However, there can be no assurance that we will not be a PFIC for the taxable year 2009 or for any future taxable year, as PFIC status is determined at the end of each taxable year and depends on the composition of our assets and income in such year. We will be considered a PFIC for any taxable year if either (1) at least 75% of our gross income for the taxable year is passive income or (2) at least 50% of the value of our assets (based on an average of the quarterly values of the assets during the taxable year) is attributable to assets that produce or are held for the production of passive income. The market value of our assets may be determined in large part by the market price of our ADSs and ordinary shares, which is likely to fluctuate after this offering and may fluctuate considerably. If we were treated as a PFIC for any taxable year during which a U.S. person held our ADS or ordinary shares, certain adverse U.S. federal income tax consequences could apply to such U.S. person. See “Taxation — U.S. Federal Income Taxation — Passive Foreign Investment Company.”
 
We may use our net proceeds from this offering in ways with which you may not agree.
 
We have considerable discretion in the application of our net proceeds from this offering. You will not have the opportunity, as part of your investment decision, to assess whether the proceeds are being used in a manner agreeable to you. You must rely on our judgment regarding the application of our net proceeds from this offering. Our net proceeds may be used for corporate purposes that do not improve our profitability or increase the price of our ordinary shares or ADSs. Our net proceeds may also be placed in investments that do not produce income or that lose value.
 
As the rights of shareholders under British Virgin Islands law differ from those under U.S. law, you may have fewer protections as a shareholder.
 
Our corporate affairs is governed by our Fourth Amended and Restated Memorandum and Articles of Association, the BVI Business Companies Act, 2004, or the BVI Act, of the British Virgin Islands and the common law of the British Virgin Islands. The rights of shareholders to take legal action against our directors, actions by minority shareholders and the fiduciary responsibilities of our directors under British Virgin Islands law are to a large extent governed by the common law of the British Virgin Islands and by the BVI Act. The common law of the British Virgin Islands is derived in part from comparatively limited judicial precedent in the British Virgin Islands as well as from English common law, which has persuasive, but not binding, authority on a court in the British Virgin Islands. The rights of our shareholders and the fiduciary


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responsibilities of our directors under British Virgin Islands law are not as clearly established as they would be under statutes or judicial precedents in some jurisdictions in the United States. In particular, the British Virgin Islands has a less developed body of securities laws as compared to the United States, and some states (such as Delaware) have more fully developed and judicially interpreted bodies of corporate law.
 
As a result of all of the above, holders of our ADSs may have more difficulty in protecting their interests through actions against our management, directors or major shareholders than they would as shareholders of a U.S. company. For a discussion of significant differences between the provisions of the BVI Act and the laws applicable to companies incorporated in the United States and their shareholders, see “Description of Share Capital — Differences in Corporate Law.”
 
British Virgin Islands companies may not be able to initiate shareholder derivative actions, thereby depriving shareholders of the ability to protect their interests.
 
British Virgin Islands companies may not have standing to initiate a shareholder derivative action in a federal court of the United States. The circumstances in which any such action may be brought, and the procedures and defenses that may be available in respect to any such action, may result in the rights of shareholders of a British Virgin Islands company being more limited than those of shareholders of a company organized in the United States. Accordingly, shareholders may have fewer alternatives available to them if they believe that corporate wrongdoing has occurred. The British Virgin Islands courts are also unlikely to recognize or enforce against us judgments of courts in the United States based on certain liability provisions of U.S. securities law; and to impose liabilities against us, in original actions brought in the British Virgin Islands, based on certain liability provisions of U.S. securities laws that are penal in nature. There is no statutory recognition in the British Virgin Islands of judgments obtained in the United States, although the courts of the British Virgin Islands will generally recognize and enforce the non-penal judgment of a foreign court of competent jurisdiction without retrial on the merits. This means that even if shareholders were to sue us successfully, they may not be able to recover anything to make up for the losses suffered.
 
The laws of the British Virgin Islands provide little protection for minority shareholders, so minority shareholders will have little or no recourse if the shareholders are dissatisfied with the conduct of our affairs.
 
Under the law of the British Virgin Islands, there is little statutory law for the protection of minority shareholders other than the provisions of the BVI Act dealing with shareholder remedies. The principal protection under statutory law is that shareholders may bring an action to enforce the constituent documents of the corporation, our Fourth Amended and Restated Memorandum and Articles of Association. Shareholders are entitled to have the affairs of the company conducted in accordance with the general law and the articles and memorandum.
 
There are common law rights for the protection of shareholders that may be invoked, largely dependent on English company law, since the common law of the British Virgin Islands for business companies is limited. Under the general rule pursuant to English company law known as the rule in Foss v. Harbottle, a court will generally refuse to interfere with the management of a company at the insistence of a minority of its shareholders who express dissatisfaction with the conduct of the company’s affairs by the majority or the board of directors. However, every shareholder is entitled to have the affairs of the company conducted properly according to law and the constituent documents of the corporation. As such, if those who control the company have persistently disregarded the requirements of company law or the provisions of the company’s memorandum and articles of association, then the courts will grant relief. Generally, the areas in which the courts will intervene are the following: (1) an act complained of which is outside the scope of the authorized business or is illegal or not capable of ratification by the majority; (2) acts that constitute fraud on the minority where the wrongdoers control the company; (3) acts that infringe on the personal rights of the shareholders, such as the right to vote; and (4) where the company has not complied with provisions requiring


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approval of a special or extraordinary majority of shareholders, which are more limited than the rights afforded minority shareholders under the laws of many states in the United States.
 
Anti-takeover provisions in our Fourth Amended and Restated Memorandum and Articles of Association could delay and discourage takeover attempts that shareholders may consider favorable.
 
Some provisions of our Fourth Amended and Restated Memorandum and Articles of Association may discourage, delay or prevent a change in control of our company or management that shareholders may consider favorable. Any delay or prevention of a change of control transaction or changes in our board of directors or management could deter potential acquirors or prevent the completion of a transaction in which our shareholders could recognize a gain in the event that a favorable offer is extended and may materially and adversely affect the market price of our ADSs.


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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This prospectus contains forward-looking statements, principally in the sections entitled “Summary,” “Risk Factors,” “Use of Proceeds,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” Generally, you can identify these statements because they include words and phrases like “expect,” “estimate,” “anticipate,” “predict,” “believe,” “plan,” “will,” “should,” “intend,” and similar expressions and variations. These statements are only predictions. Although we do not make forward-looking statements unless we believe we have a reasonable basis for doing so, we cannot guarantee their accuracy, and actual results may differ materially from those we anticipated due to a number of uncertainties, many of which cannot be foreseen. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this prospectus. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including, among others, the risks we face that are described in the section entitled “Risk Factors” and elsewhere in this prospectus.
 
We believe it is important to communicate our expectations to our investors. There may be events in the future, however, that we are unable to predict accurately or over which we have no control. The risk factors listed on the previous pages, as well as any cautionary language in this prospectus, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. Before you invest in our ADSs, you should be aware that the occurrence of the events described in the previous risk factors and elsewhere in this prospectus could negatively impact our business, operating results, financial condition and ADS price.
 
We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements include, without limitation, statements relating to:
 
  •  our goals and strategies;
 
  •  our future business development, results of operations and financial condition;
 
  •  our ability to maintain a strong relationship with any particular distributor or end-user customer or to attract new distributors and end user customers;
 
  •  our ability to control our operating costs and expenses;
 
  •  our potential need for additional capital and the availability of such capital;
 
  •  our planned use of proceeds, including our planned expansion of manufacturing capacity and manufacturing upgrades;
 
  •  changes in our management team and other key personnel;
 
  •  our ability to train and retain new employees;
 
  •  introduction by our competitors of new or enhanced water treatment equipment products or services;
 
  •  the effect of competition on demand for and prices of our services and products;
 
  •  fluctuations in general economic conditions;
 
  •  Chinese government policies relating to the environment and water treatment sectors;
 
  •  Chinese tax policies and regulations; and
 
  •  expected growth and change in the environmental and water treatment industry in China.
 
This prospectus also contains data related to the water treatment sector in China and broad macroeconomic factors that we believe drive the growth of our industry. These market data and industry statistics, based on independent industry publications and other publicly available information, includes projections that are based on a number of assumptions. The water treatment sector in China may not expand at the rates projected


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by the market data, or at all. The failure of the market to grow at the projected rates may have a material adverse effect on our business and the market price of our ADSs. In addition, the complex and changing nature of the environmental and water treatment industry in China, and the broad macroeconomic factors discussed in this prospectus, subjects any projections or estimates relating to the growth prospects or future conditions of our market to significant uncertainties. If any one or more of the assumptions underlying the market data proves to be incorrect, actual results may differ from the projections based on these assumptions. You should not place undue reliance on these forward-looking statements.
 
The forward-looking statements contained in this prospectus speak only as of the date of this prospectus or, if obtained from third-party studies or reports, the date of the corresponding study or report, and are expressly qualified in their entirety by the cautionary statements in this prospectus. Since we operate in an emerging and evolving environment and new risk factors emerge from time to time, you should not rely upon forward-looking statements as predictions of future events. Except as otherwise required by the securities laws of the United States, we undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, to reflect events or circumstances after the date of this prospectus or to reflect the occurrence of unanticipated events. All forward-looking statements contained in this prospectus are qualified by reference to this cautionary statement.


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USE OF PROCEEDS
 
Our net proceeds from this offering will be approximately $76.8 million after deducting underwriting discounts and commissions and estimated offering expenses payable by us. If the underwriters exercise their over-allotment option in full, our net proceeds will be approximately $88.5 million. We will not receive any proceeds from the sale of ADSs by the selling shareholder. We intend to use our net proceeds from this offering as follows:
 
  •  to expand our manufacturing facilities to increase in-house production of key components used in existing or new product offerings; and
 
  •  for general corporate purposes.
 
We may also use our net proceeds from this offering to fund potential acquisitions of complementary businesses as such opportunities may arise from time to time, although we do not presently have specific plans and are not currently engaged in any discussions or negotiations with respect to any such transactions. We intend to use the remaining net proceeds from this offering for general corporate purposes, which may include expanding our sales efforts, opening new offices and developing new products and services. Management has not determined the specific allocation of our net proceeds from this offering and will have broad discretion in the allocation of our net proceeds.
 
Depending on future events and other changes in the business climate, we may determine at a later time to use our net proceeds for different purposes. Pending their use, our net proceeds from this offering will be invested in interest-bearing debt instruments or bank deposits. These investments may have a material adverse effect on the U.S. federal income tax consequences of your investment in our ADSs. It is possible that we may become a passive foreign investment company for U.S. federal tax purposes, which could result in negative tax consequences for you. For a more detailed discussion of these consequences, see “Taxation — United States Federal Income Taxation — Passive Foreign Investment Company.” Also see “Risk Factors — Risks Related to Our ADSs and This Offering — We may be classified as a passive foreign investment company, which could result in adverse U.S. federal income tax consequences to U.S. holders of our ADSs or ordinary shares.”
 
DIVIDEND POLICY
 
We have not declared or paid any dividends on our ordinary shares and we do not anticipate paying any cash dividends in the foreseeable future. The timing, amount and form of future dividends, if any, will depend, among other things, on our future results of operations and cash flows, our general financial condition and future prospects, our capital requirements and surplus, contractual restrictions, the amount of distributions, if any, received by us from our Chinese subsidiaries, and other factors deemed relevant by our board of directors. Any future dividends on our ordinary shares would be declared by and subject to the discretion of our board of directors.
 
Holders of our ADSs will be entitled to receive dividends, if any, subject to the terms of the deposit agreement, to the same extent as holders of ordinary shares, less the fees and expenses payable under the deposit agreement, and after deduction of any applicable taxes. See “Description of American Depositary Shares.”


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PRICE RANGE OF OUR ADSs
 
Our ADSs are listed for trading on the New York Stock Exchange under the symbol “DGW”. The following table sets forth the monthly high and low trading prices of our ADSs on the New York Stock Exchange for the periods indicated:
 
                 
    High   Low
 
2009 (from June 24, 2009)
               
June
  $ 25.97     $ 20.40  
July
  $ 31.75     $ 21.75  
August
  $ 34.86     $ 26.51  
September
  $ 36.35     $ 29.55  
October
  $ 43.65     $ 30.09  
November
  $ 41.96     $ 33.10  
December
  $ 44.00     $ 33.50  
2010
               
January (through January 27, 2010)
  $ 40.50     $ 27.34  
 
On January 27, 2010, the closing sale price of our ADSs as reported on the New York Stock Exchange was $29.74 per ADS.


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EXCHANGE RATE INFORMATION
 
The following table sets forth the noon buying rates for U.S. dollars in effect in New York City for cable transfers of Renminbi as certified for customs purposes by the Federal Reserve Bank of New York, for the periods indicated.
 
                                 
    Renminbi per U.S. Dollar Noon Buying Rate
    Average   High   Low   Period-End
 
Year ended December 31,
                               
2005(1)
    8.1826       8.2765       8.0702       8.0702  
2006(1)
    7.9579       8.0702       7.8041       7.8041  
2007(1)
    7.5806       7.8127       7.2946       7.2946  
2008(1)
    6.9193       7.2946       6.7800       6.8225  
2009(1)
    6.8307       6.8470       6.8176       6.8259  
For the months of
                               
July 2009
    6.8317       6.8342       6.8300       6.8319  
August 2009
    6.8323       6.8358       6.8299       6.8299  
September 2009
    6.8277       6.8303       6.8247       6.8262  
October 2009
    6.8267       6.8292       6.8248       6.8264  
November 2009
    6.8271       6.8300       6.8255       6.8265  
December 2009
    6.8275       6.8299       6.8244       6.8259  
January 2010(2)
    6.8272       6.8295       6.8258       6.8268  
 
 
(1) The average rate of exchange is calculated using the average of the exchange rates on the last day of each month during the period.
 
(2) Through January 25, 2010.
 
We publish our financial statements in Renminbi. This prospectus contains translations of Renminbi amounts into U.S. dollars at specified rates solely for the convenience of the reader. Unless otherwise noted, all translations from Renminbi to U.S. dollars were made at the noon buying rate in New York City for cable transfers in Renminbi per U.S. dollar as certified for customs purposes by the Federal Reserve Bank of New York, as of September 30, 2009, which was RMB6.8262 to $1.00. No representation is made that the Renminbi amounts referred to in this prospectus could have been or could be converted into U.S. dollars at any particular rate or at all.
 
Since July 2005, the Renminbi has not been pegged solely to the U.S. dollar. Instead, it 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 in the future. See “Risk Factors — Risks Related to Doing Business in China — Fluctuations in exchange rates could adversely affect our business and the value of our securities.”


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CAPITALIZATION
 
The following table sets forth our capitalization as of September 30, 2009:
 
  •  on an actual basis; and
 
  •  on a pro forma basis, to give effect to the issuance and sale by the Company of 2,760,000 ADSs in this offering, assuming the underwriters do not exercise their over-allotment option, and after deducting underwriting discounts and commissions and estimated offering expenses.
 
You should read this table together with our combined and consolidated financial statements and related notes included elsewhere in this prospectus and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
                                 
    As of September 30, 2009
    Actual   Pro Forma
    RMB   $   RMB   $
    (In thousands, except share data)
 
Notes payable
    20,000       2,930       20,000       2,930  
Shareholders’ equity:
                               
Ordinary shares, US$0.000033 par value: 1,500,000,000 shares authorized, 43,702,631 shares issued and outstanding, actual; 49,222,631 shares issued and outstanding, pro forma
    10       2       12       2  
Additional paid-in capital
    856,062       125,408       1,380,530       202,240  
Statutory reserves
    53,468       7,833       53,468       7,833  
Retained earnings
    334,958       49,069       334,958       49,069  
                                 
Total shareholders’ equity
    1,244,498       182,312       1,768,968       259,144  
                                 
Total capitalization
    1,264,498       185,242       1,788,968       262,074  
                                 
 
 


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CORPORATE STRUCTURE
 
We were incorporated on June 21, 2007 under the laws of the British Virgin Islands and act as a holding company. We conduct substantially all of our business through our two wholly owned Chinese subsidiaries: Duoyuan Clean Water Technology Industries (China) Co., Ltd., or Duoyuan Beijing, and Duoyuan Water Treatment Equipment Manufacturing (Langfang) Co., Ltd., or Duoyuan Langfang. We are in the process of establishing several new wholly owned Chinese subsidiaries to organize our corporate structure. Each new subsidiary will undertake the development, manufacturing, marketing and sales of one or more specific product types. We registered two of these new subsidiaries in October 2009 in Beijing: Duoyuan Global Centrifuge Manufacturing (China) Co., Ltd, or Duoyuan Centrifuge, and Duoyuan Global Water Conservation Equipment (China) Co., Ltd., or Duoyuan Water Conservation. We registered a third new subsidiary in November 2009, Langfang Duoyuan Aeration System and Equipment Manufacturing Co., Ltd., or Duoyuan Aeration. None of these new subsidiaries have commenced operations. We anticipate that the remaining new subsidiaries will be duly registered by March 2010. We do not have any other subsidiaries or equity interests in any other entity. Our majority shareholder is Duoyuan Investments Limited, which is a British Virgin Islands company wholly owned by Wenhua Guo, our chairman and chief executive officer.
 
We were incorporated as part of a restructuring of the equity interests in our two Chinese subsidiaries: Duoyuan Beijing and Duoyuan Langfang. As part of the restructuring, on September 3, 2007 and November 29, 2007, HydroResource Technology Limited, a British Virgin Islands company wholly owned by Duoyuan Investments Limited, transferred to us all of its equity interest in Duoyuan Beijing and Duoyuan Langfang. On July 1, 2007, Duoyuan Beijing and Duoyuan Langfang transferred each of their respective 50% equity interest in Huanan Duoyuan Water Supply Co. Ltd., or Duoyuan Huanan, a company primarily engaged in the construction, operation and service of local tap water supplying systems, to Duoyuan Asian Water Inc., a British Virgin Islands company wholly owned by Wenhua Guo. Duoyuan Beijing and Duoyuan Langfang had jointly owned Duoyuan Huanan since its inception on November 15, 2002 and currently do not have any equity interest in other entities.
 
On February 5, 2008, Duoyuan Investments Limited sold 20% of its then-equity interest in us, or 6,000,000 shares of our ordinary shares, to the selling shareholder, GEEMF III Holdings MU, an affiliate of Global Environment Fund, for an aggregate cash purchase price to Duoyuan Investments Limited of $30.2 million.

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The following chart summarizes our corporate structure, including our subsidiaries, as of the date of this prospectus:
 
(FLOW CHART)
 
Duoyuan Beijing.  Duoyuan Beijing was incorporated on April 7, 1992 with an initial registered capital of RMB1.2 million. Wenhua Guo has served as its chairman since its inception. Its principal business activities include the marketing, sale and service of water treatment products. Since its inception, Duoyuan Beijing has undergone a series of equity transfers, each approved by the Chinese local approval authorities and registered with the Beijing Administration for Industry and Commerce. Its registered capital was increased to $30.0 million in July 2009.
 
Duoyuan Beijing, originally named Beijing Multiformity Electronic Co., Ltd., was initially owned by Tian Yi New Technology Institute, which was affiliated with Wenhua Guo, and Taiwan Gaodian International Co., Ltd. On January 10, 1999, Tian Yi New Technology Institute transferred all of its 53% equity interest in Duoyuan Beijing to Beijing Duoyuan Electric (Group) Corporation. On February 5, 1999, Beijing Duoyuan Electric (Group) Corporation transferred 43% of its 53% equity interest in Duoyuan Beijing to China Duoyuan Communications (Holding), Inc. and the remaining 10% equity interest to Beijing Duoyuan Electric Co., Ltd. Additionally, Taiwan Gaodian International Co. Ltd. transferred all of its 47% equity interest in Duoyuan Beijing to China Duoyuan Communications (Holding), Inc., whose name was changed to Duoyuan Technologies, Inc. on March 17, 1999. On May 19, 2000, Beijing Duoyuan Electric Co., Ltd. transferred the remaining 10% equity interest to Duoyuan Technologies, Inc. On June 7, 2001, Duoyuan Technologies, Inc. changed its name to HydroResource Technology Limited.
 
Duoyuan Langfang.  Duoyuan Langfang was incorporated by HydroResource Technology Limited on July 4, 2000 with an initial registered capital of $5.0 million. Wenhua Guo has served as its chairman since its inception. Its principal business activities include the development, manufacturing and after-sale service of water treatment products. Its registered capital was increased to $15.0 million in July 2009, which increase


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was approved by the Chinese local approval authorities and registered with the Langfang Administration of Industry and Commerce.
 
Duoyuan Centrifuge.  Duoyuan Centrifuge was incorporated on October 16, 2009 with a registered capital of $15.0 million. Sihai Wang is the legal representative of Duoyuan Centrifuge. It has not yet begun operations. Its contemplated principal business activities include the development, manufacturing and after-sale service of sludge screw, industrial centrifuge and other centrifuge equipment.
 
Duoyuan Water Conservation.  Duoyuan Water Conservation was incorporated on October 23, 2009 with a registered capital of $15.0 million. Liqiu Wu is the legal representative of Duoyuan Water Conservation. It has not yet begun operations. Its contemplated principal business activities include the development, manufacturing and after-sale service of water conservation equipment for commercial and domestic use.
 
Duoyuan Aeration.  Duoyuan Aeration was incorporated on November 3, 2009 with a registered capital of $4.0 million. Ronglin Qiao is the legal representative of Duoyuan Aeration. It has not yet begun operations. Its contemplated principal business activities include the development, manufacturing and after-sale service of various types of aerators.


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SELECTED COMBINED AND CONSOLIDATED FINANCIAL DATA
 
The following selected combined and consolidated statements of income data for the years ended December 31, 2006, 2007 and 2008 and the selected consolidated balance sheet data as of December 31, 2007 and 2008 have been derived from our audited combined and consolidated financial statements for the years ended December 31, 2006, 2007 and 2008 included elsewhere in this prospectus. The following selected combined and consolidated statements of income data for the year ended December 31, 2005 have been derived from our audited combined and consolidated financial statements for the year ended December 31, 2005 that are not included in this prospectus. The following selected unaudited consolidated statements of income data for the nine months ended September 30, 2008 and 2009 and the selected unaudited consolidated balance sheet data as of September 30, 2009 have been derived from our unaudited consolidated financial statements for the nine months ended September 30, 2008 and 2009 included elsewhere in this prospectus. The selected unaudited consolidated statements of income data for the nine months ended September 30, 2008 and 2009 and the selected unaudited consolidated balance sheet data as of September 30, 2009 were prepared on the same basis as our audited combined and consolidated financial statements. The unaudited financial information includes all adjustments, consisting only of normal and recurring adjustments, as we consider necessary for a fair presentation of our financial condition and results of operations for the periods presented. Our combined and consolidated financial statements are prepared and presented in accordance with U.S. GAAP. Our historical results for any period are not necessarily indicative of results to be expected in any future period. Our results for the nine months ended September 30, 2009 are not necessarily indicative of the results that may be expected for the full year. Selected combined financial data as of December 31, 2004 and for the year ended December 31, 2004 have been omitted because such information could not be provided without unreasonable effort or expense. You should read the following information in conjunction with our combined and consolidated financial statements and related notes included elsewhere in this prospectus and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 


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    Year Ended December 31,   Nine Months Ended September 30,
    2005(1)   2006(1)   2007   2008   2008   2008   2009   2009
    RMB   RMB   RMB   RMB   $   (Unaudited)
  (Unaudited)
  (Unaudited)
                        RMB   RMB   $
    (In thousands, except share and per share data)
 
Combined and Consolidated Statements of Income Data:
                                                               
Revenue
    229,550       292,863       423,962       592,699       86,827       443,168       589,579       86,370  
Cost of revenue
    150,256       178,125       272,402       326,809       47,876       243,195       304,062       44,543  
                                                                 
Gross profit
    79,294       114,738       151,560       265,890       38,951       199,973       285,517       41,827  
Research and development expenses
    12,762       12,856       14,405       16,370       2,398       11,594       13,683       2,005  
Selling expenses
    24,333       27,672       30,698       37,076       5,431       26,277       41,490       6,078  
General and administrative expenses
    9,409       10,243       11,034       35,792       5,243       11,069       97,162       14,234  
                                                                 
Operating income
    32,790       63,967       95,423       176,652       25,879       151,033       133,182       19,510  
Impairment loss
    1,263                                            
Interest expense
    7,465       7,372       5,759       3,118       457       2,588       923       135  
Other income
    2,545       2,507       4,523       1,279       187       1,020       805       118  
Loss from sale of property
                      3,216       471       3,204              
                                                                 
Income from continuing operations before income taxes
    26,607       59,102       94,187       171,597       25,138       146,261       133,064       19,493  
Provision for income taxes
    1,318       7,403       11,799       37,830       5,542       27,951       55,868       8,184  
                                                                 
Income from continuing operations
    25,289       51,699       82,388       133,767       19,596       118,310       77,196       11,309  
Total income (loss) from discontinued operations
    667       1,113       (180 )                              
                                                                 
Net income
    25,956       52,812       82,208       133,767       19,596       118,310       77,196       11,309  
                                                                 
Earnings per basic share:
                                                               
Income from continuing operations
                2.75       4.46       0.65       3.94       2.22       0.33  
Income (loss) from discontinued operations
                (0.01 )                              
Net income
                2.74       4.46       0.65       3.94       2.22       0.33  
Earnings per diluted share:
                                                               
Income from continuing operations
                2.75       4.46       0.65       3.94       2.22       0.33  
Income (loss) from discontinued operations
                (0.01 )                              
Net income
                2.74       4.46       0.65       3.94       2.22       0.33  
Weighted average number of basic shares outstanding
                30,000,000       30,000,000       30,000,000       30,000,000       34,718,122       34,718,122  
Weighted average number of diluted shares outstanding
                30,000,000       30,000,000       30,000,000       30,000,000       34,767,287       34,767,287  
 

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    As of December 31,   As of September 30,
    2007   2008   2008   2009   2009
                (Unaudited)   (Unaudited)
    RMB   RMB   $   RMB   $
    (In thousands)
 
Consolidated Balance Sheet Data:
                                       
Cash
    28,053       198,518       29,082       937,210       137,296  
Total assets
    420,243       538,086       78,827       1,385,812       203,014  
Total current liabilities
    110,316       94,393       13,828       141,314       20,702  
Total shareholders’ equity
    309,926       443,693       64,999       1,244,498       182,312  
 
 
(1) During the years ended December 31, 2005 and 2006, we were capitalized under the laws of the PRC and did not have shares outstanding.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
You should read the following discussion and analysis together with our financial condition and results of operations in conjunction with the section entitled “Selected Combined and Consolidated Financial Data” and our combined and consolidated financial statements and the related notes included elsewhere in this prospectus. This discussion contains forward-looking statements that are subject to risks, uncertainties and assumptions, including those discussed under “Risk Factors.” Our actual results may differ materially from those expressed in or implied by these forward-looking statements.
 
Overview
 
We are a leading China-based domestic water treatment equipment supplier and offer products to address key steps in the water treatment process. Our products include circulating water treatment equipment, water purification equipment and wastewater treatment equipment. As one of the first privately owned companies in China to supply water treatment products and through joint efforts with our distributors, we have developed a broad base of end-user customers throughout China, consisting primarily of wastewater treatment plants, water works facilities, manufacturing plants, commercial businesses, residential communities and individual customers. We also have one of the largest distribution networks for water treatment equipment suppliers in China. With over 80 distributors throughout China in 28 provinces, we believe our extensive network allows us to be closer to our end-user customers and enables us to be more responsive to local market demand than many of our competitors.
 
We were incorporated on June 21, 2007 as a holding company under the laws of the British Virgin Islands. We conduct substantially all of our business through our two wholly owned Chinese subsidiaries: Duoyuan Beijing and Duoyuan Langfang. Duoyuan Beijing’s principal business activities include the marketing, sale and service of water treatment products. Duoyuan Langfang’s principal business activities include the development, manufacturing and after-sale service of water treatment products. Until the third quarter of 2007, both companies each held a 50% equity interest in Huanan Duoyuan Water Supply Co., Ltd., or Duoyuan Huanan, which engaged in the construction, operation and service of local tap water supplying systems. We are in the process of establishing several new wholly owned Chinese subsidiaries to organize our corporate structure. Each new subsidiary will undertake the development, manufacturing, marketing and sales of one or more specific product types. We registered two of these new subsidiaries in October 2009 in Beijing: Duoyuan Global Centrifuge Manufacturing (China) Co., Ltd, or Duoyuan Centrifuge, and Duoyuan Global Water Conservation Equipment (China) Co., Ltd., or Duoyuan Water Conservation. We registered a third new subsidiary in November 2009, Langfang Duoyuan Aeration System and Equipment Manufacturing Co., Ltd., or Duoyuan Aeration. None of these new subsidiaries have commenced operations. We anticipate that the remaining new subsidiaries will be duly registered by March 2010. We do not have any other subsidiaries or equity interests in any other entity. Our majority shareholder is Duoyuan Investments Limited, which is a British Virgin Islands company wholly owned by Wenhua Guo, our chairman and chief executive officer.
 
On August 12, 2007, we entered into an agreement to sell substantially all of the business activities of Duoyuan Huanan, effective July 1, 2007, to Duoyuan Asian Water Inc., a company wholly owned by Wenhua Guo, for RMB12.5 million. As a result, the assets and liabilities and results of operations of Duoyuan Huanan are classified as a discontinued operation in our financial statements.
 
Outlook
 
To capitalize on the increased demand for our products, we have undertaken significant capital expansion and capital improvement efforts, including renovations to our manufacturing facilities and corporate headquarters, utilizing cash generated from operations and existing short-term notes. In 2007, we purchased various advanced and high-volume equipment to expand and enhance our manufacturing capabilities, including high-power injection and molding machines and high-volume microporous aerator machines. In 2008, we made a RMB9.9 million down-payment for a new production line to manufacture our belt-type thickener-filter press mono-block machines (wastewater treatment equipment) and spent RMB16.2 million upgrading our


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manufacturing equipment to produce our products more efficiently. For the nine months ended September 30, 2009, we spent RMB24.9 million ($3.6 million) on various advanced manufacturing equipment upgrades to increase our production capacity, including purchasing highly advanced microporous aerator machines. We intend to use the net proceeds from this offering: (1) to expand our manufacturing facilities to increase in-house production of key components used in existing or new product offerings; and (2) for general corporate purposes.
 
We had gross profit margins of over 35% in each of 2006, 2007 and 2008, and the nine months ended September 30, 2009, and remain committed to maintaining our gross profit margins at comparable levels by continuing to reduce overall production costs. We have invested, and plan to continue to invest, in research and development efforts to reduce our costs and raw material consumption per unit of production. We also have attempted to source quality product materials and components, while negotiating favorable pricing and volume discounts from our suppliers, leading to historically low raw material costs (particularly for steel) for the nine months ended September 30, 2009. Finally, we have expended resources and leveraged our production experience to develop an efficient and flexible manufacturing and operational infrastructure. As a result, we enjoyed a gross profit margin of over 48% for the nine months ended September 30, 2009. While we plan to continue these initiatives to maximize gross margins, due to the rising costs of raw materials beginning in September 2009, we expect our gross profit margin to trend slightly downward in 2010 compared to the nine months ended September 30, 2009, but still higher than gross profit margins experienced in 2006, 2007 and 2008.
 
Since 2006, we have expanded our relationships with suppliers by collaborating with them during each step of the manufacturing process to ensure the efficient manufacture of sourced components and to enhance the compatibility of these components with our production processes. To further save costs, increase operational efficiencies and protect our key technologies, we began producing certain core components in-house beginning in 2006, particularly components for our circulating water central processors and the membrane-based rubber coating for our microporous aerators.
 
We also plan to continue expanding our relationships with our distributors by providing attractive incentives, in-depth training in the use of our products and assistance with the promotion of our products. In addition, we have increasingly focused our sales efforts on distributors that place larger orders in order to reduce our overall selling expenses.
 
Through our in-house research and development team, we broaden our market reach by introducing new products that could become new sources of revenue for us and help us to diversify our revenue base. Since 2004, we have developed more than 70 new products across our three product categories. Of these new products, 38 products were introduced into the market in 2008. In September and October of 2009, we introduced six new or enhanced products across our three product categories. We plan to continue developing new and enhanced products to maintain and expand our competitive advantage and market reach. We are using approximately $10 million of the net proceeds from our June 2009 initial public offering to build a research and development laboratory which is scheduled to be operational in mid-2011. By that time we expect to increase our research and development staff, including through the addition of foreign-trained engineers. Our research and development efforts will focus on (1) developing new processes, applications and technologies to enhance our existing products, including automation of our circulating water treatment equipment, ozone disinfection products such as large ozone generators, ultraviolet usage in water treatment and enhancement of the performance index for belt-type filter press and high-performance aerators, and (2) establishing a research and development center for water environment and equipment, which will be responsible for studying and researching the characteristics of the water environment and the theories of water treatment systems for different water qualities.
 
Our revenue grew 44.8% from RMB292.9 million in 2006 to RMB424.0 million in 2007 and 39.8% to RMB592.7 million ($86.8 million) in 2008. Our revenue grew 33.0% from RMB443.2 million for the nine months ended September 30, 2008 to RMB589.6 million ($86.4 million) for the nine months ended September 30, 2009. Although we expect that the challenging global economic conditions, including its impact on industry in China, will affect our revenue growth for the remainder of 2009, we believe that our year over


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year revenue will continue to grow. While some of our revenues, primarily water treatment equipment sold to industry, are being impacted by China’s economic slowdown (which to date has been less dramatic than in the rest of the world), we believe demand for water treatment equipment will generally continue to increase. Factors contributing to our expected revenue growth include the economic stimulus plan being implemented by the Chinese government in response to the challenging global economic conditions, our production capacity expansion and a business-friendly regulatory environment in China.
 
Principal Factors Affecting our Financial Performance
 
We believe that the following factors will continue to affect our financial performance:
 
Increasing Demand for Water Treatment Equipment
 
An important factor that positively affects our financial condition is the increasing demand for water treatment equipment in China. The growth in the water treatment equipment industry in China has been driven by several factors, including rapid population growth, industrialization and urbanization, and more recently, the economic stimulus plan being implemented by the Chinese government. These factors have led to an increased demand for affordable purified water. According to the Freedonia Group, the demand for water treatment products in China is estimated to increase nearly 15.5% per year between 2008 and 2012. We also anticipate that water treatment will become a priority issue for municipalities, industries and commercial businesses as the Chinese government imposes stricter environmental and water quality standards to promote sustainable economic growth.
 
On November 5, 2008, the State Council of China announced an economic stimulus plan in the amount of $585 billion to stimulate economic growth and bolster domestic demand. The economic stimulus plan includes, among others, increased spending on basic infrastructure construction projects for water, electricity, gas and heat to improve the standard of living in China and protect the environment. We believe that this increased spending on infrastructure generally, and on the water infrastructure specifically, will further increase the demand for our water treatment products as local governments build facilities to improve their water supplies and treat wastewater in response to the economic stimulus plan. In recent months, we have experienced an increase in the demand for our wastewater treatment products from our distributors as they bid for contracts to supply these products for the new wastewater facilities being built. Because of the economic stimulus plan and the projected increase in demand for affordable purified water as China continues to industrialize and modernize, we believe that the water treatment industry, and in turn the demand for our products, will continue to experience strong growth for the next couple of years. However, any adverse changes in China’s economic conditions or any continued decline in the global economy may adversely affect the demand for water treatment equipment products. In addition, regulatory changes could adversely affect the ability of companies such as ours to service and compete in this market.
 
We believe that these initiatives should generate strong demand for water treatment equipment and promising business prospects for the water treatment equipment industry and our company, especially as China continues to industrialize and modernize. We intend to focus our efforts on utilizing our tangible and intangible resources to expand and strengthen our products and increase our market share in response to these demands.
 
Expansion of our Production Capacity
 
We need to expand our production capacity to satisfy increased demand for our products. We are using a portion of the net proceeds from our June 2009 initial public offering to make capital investments that improve the efficiency and capacity of our manufacturing facilities and equipment. Our major projects include in-house production of certain core components of our current products, building new manufacturing facilities and production lines to produce new water treatment products and upgrading our existing manufacturing facilities and production lines. We invested $5.6 million in equipment upgrades for the nine months ended September 30, 2009 and anticipate investing approximately $6 million more during the six months ending June 30, 2010. Combined, this will increase the production capacity of our facilities so that they will be able to meet demand


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for our products in 2010. Additionally, we are building a new facility to meet additional demand for our products beyond 2010. We expect that the construction of this new facility will be completed and operational by December 31, 2010.
 
Fluctuations in Raw Material and Components Costs
 
Our operations require substantial amounts of a variety of raw materials and components. Some raw materials and components, especially steel, have been susceptible to fluctuations in price and availability. Prior to the global economic slowdown which started in the fall of 2008, costs for our components generally increased each year. For example, the cost of our key raw materials, such as steel, rubber and electronic components increased between 2.1% to 73.7% during the first half of 2008 over the same period in the prior year.
 
However, due to a drop in commodity prices resulting from the recent global economic slowdown, the cost of our raw materials decreased by between 1.1% and 57.1% during the fourth quarter of 2008 over the same period in the prior year. By the third quarter in 2009, due to another increase in commodity prices, the cost of several of our raw materials increased by between 2.3% and 9.1% over the first quarter of 2009.
 
Significant increases in raw materials and components prices have a direct and negative impact on our gross profits. We attempt to offset raw materials and components price increases by producing key components for most of our products at our manufacturing facilities, sourcing large quantities to achieve economies of scale, reducing raw material component consumption per unit through research and development and by focusing on suppliers within close proximity to our facilities. Ultimately, we may need to raise finished product prices to recover higher raw material and component costs and maintain our profit margin.
 
Changes in Chinese Enterprise Income Tax Law
 
We are incorporated in the British Virgin Islands and, under the current laws of the British Virgin Islands, are not subject to income taxes. In addition, our Chinese subsidiaries have enjoyed preferential tax treatment applicable to foreign-invested manufacturing enterprises established in certain preferred economic zones in China. The additional tax that would otherwise have been payable without these preferential tax treatments totaled RMB12.3 million, RMB19.5 million and RMB12.4 million ($1.8 million) in 2006, 2007 and 2008, respectively. However, the PRC Enterprise Income Tax Law and its implementation rules, or the new EIT laws, both of which became effective on January 1, 2008, impose a single uniform income tax rate of 25% for all Chinese enterprises and eliminate or modify most of the tax exemptions, reductions and preferential treatment available under the previous tax laws and regulations. The termination of preferential tax rates from January 1, 2008 and the termination of the preferential tax holiday adversely impacted our operating results in 2008 and will adversely impact our future operating results. As a result of these changes in Chinese tax laws, our historical operating results will not be indicative of our operating results for future periods and the value of our ordinary shares or ADSs may be adversely affected. See “Regulation — Taxation.”
 
Components of Revenue and Expenses
 
Revenue
 
We report revenue net of value-added taxes, or VAT, levied on our products. As of September 30, 2009, our products, all of which were sold in China, were subject to a VAT at a rate of 17% of the gross sales price or at a rate approved by the Chinese government. We offer annual sales rebates to our distributors as an incentive to increase sales and for early payment. We record these sales rebates as a reduction of revenue.
 
We derive substantially all our revenue from circulating water treatment equipment, water purification equipment and wastewater treatment equipment sales to our distributors. In 2008, our three product categories accounted for approximately 41.5%, 21.6% and 36.2% of our revenue, respectively. For the nine months ended September 30, 2009, our three product categories accounted for approximately 37.5%, 21.3% and 39.6% of our revenue, respectively. In 2008 and the nine months ended September 30, 2009, our electronic water conditioners and fully automatic filters (circulating water treatment) and belt-type thickener-filter press


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mono-block machines and microporous aerators (wastewater treatment equipment) each accounted for more than 10% of our total revenue.
 
Increases in demand and unit sales in each of our product categories contributed to our increase in revenue from 2006 to 2008. Until the first quarter of 2009, our circulating water treatment equipment was our best selling category. Based on recent sales trends and the economic stimulus plan being implemented by the Chinese government, we expect that wastewater treatment equipment will become our best selling category in 2009. We anticipate that, subject to possible fluctuations, revenue from sales of our circulating water treatment equipment and water purification equipment will also continue to increase. A breakdown of our revenue, by product category, is set forth below:
 
                                                                                                 
    Year Ended December 31,   Nine Months Ended September 30,
    2006   2007   2008   2008   2009
        % of
      % of
          % of
      % of
          % of
    RMB   Revenue   RMB   Revenue   RMB   $   Revenue   RMB   Revenue   RMB   $   Revenue
                                (Unaudited)   (Unaudited)
    (In thousands, except percentages)
 
Circulating water treatment
    145,346       49.6 %     193,259       45.6 %     245,871       36,019       41.5 %     184,637       41.7 %     221,209       32,406       37.5 %
Water purification
    54,808       18.7       97,899       23.1       128,097       18,766       21.6       92,562       20.9 %     125,296       18,355       21.3 %
Wastewater treatment
    88,047       30.1       135,690       32.0       214,557       31,431       36.2       162,287       36.6 %     233,606       34,222       39.6 %
Construction projects
    6,197       2.1                                                              
Spare parts
                            8,717       1,277       1.5       5,568       1.2       12,225       1,791       2.1 %
Adjustments
    (1,535 )     (0.5 )     (2,886 )     (0.7 )     (4,543 )     (666 )     (0.8 )     (1,885 )     (0.4 )%     (2,757 )     (404 )     (0.5 )%
                                                                                                 
Revenue
    292,863       100.0 %     423,962       100.0 %     592,699       86,827       100.0 %     443,169       100.0 %     589,579       86,370       100.0 %
                                                                                                 
 
In 2006, 2007 and 2008 and the nine months ended September 30, 2009, sales to distributors accounted for 97.9%, 100%, 100% and 100% of our revenue, respectively. We use an extensive distribution network to reach a broad distributor base. We make sales on a purchase order or short-term agreement basis. We do not have long-term contracts with any of our distributors or end-user customers. No single distributor accounted for more than 3% of our revenue in 2006, 2007 or 2008 or the nine months ended September 30, 2009.
 
In 2008, we began selling certain spare parts that we previously gave to our distributors free of charge. For the year ended December 31, 2008, revenue from spare parts sales was RMB8.7 million ($1.3 million). For the nine months ended September 30, 2009, revenue from spare parts sales was RMB12.2 million ($1.8 million). We anticipate that revenues derived from selling spare parts will increase in 2010 as compared to 2009. During 2006, we accounted for revenue derived from long-term construction projects for the installation of our water treatment equipment. We did not enter into any contracts for construction projects in 2007, 2008 and the nine months ended September 30, 2009, and we do not anticipate entering into any construction projects in the future.
 
Adjustments to revenue accounted for 0.5%, 0.7%, 0.8% and 0.5% of total revenue in 2006, 2007, 2008 and the nine months ended September 30, 2009, respectively, for sales rebates paid to distributors. We offer annual sales rebates to our distributors as an incentive to increase sales and for early payment. We intend to continue this incentive program.
 
Cost of Revenue
 
Our cost of revenue consists primarily of direct costs to manufacture our products, including component and material costs, salaries and related manufacturing personnel expenses, depreciation costs of plant and equipment used for production purposes, shipping and handling costs, and repair and maintenance costs. Our cost of revenue was RMB178.1 million, RMB272.4 million, RMB326.8 million ($47.9 million) and RMB304.1 million ($44.5 million) in 2006, 2007, 2008 and the nine months ended September 30, 2009, respectively.
 
The direct costs of manufacturing a new product are generally highest when a new product is first introduced due to start-up costs associated with manufacturing a new product and generally higher raw


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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. Also, when production volumes become sufficiently large, we often gain further cost efficiencies by producing additional components in-house.
 
We purchase a small percentage of our electronic components from suppliers who import these components. Our other raw materials and components are purchased from Chinese subsidiaries of foreign suppliers or local suppliers, each of which manufacturers these components in China. We produce all other components internally. As a result, we believe we currently have a relatively low cost base compared to other water treatment equipment suppliers, especially when compared to international water treatment equipment suppliers. Also, the relatively low operation, labor and raw material costs in China have historically allowed us to decrease our cost of revenue as we increase purchase volumes and make improvements in manufacturing processes. Primarily due to a drop in commodity prices as a result of the recent global economic slowdown, the cost of our raw materials decreased by between 1.1% and 57.1% during the fourth quarter of 2008 over the same period in the prior year. However, by the third quarter of 2009, the cost of several of our raw materials increased by between 2.3% and 9.1% over the first quarter of 2009 due to an increase in commodity prices. Once global economic conditions improve and our existing supply agreements expire, we expect our raw material costs will increase.
 
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 manufacturing of components and adopting more uniform manufacturing and assembly practices.
 
Gross Margins
 
Our gross profit margins in 2006, 2007, 2008 and the nine months ended September 30, 2009 were 39.2%, 35.7%, 44.9% and 48.4%, respectively. Our gross profit margins are impacted by changes in the average selling prices of our products, product sales mix and cost of revenue. The average selling prices of our products are subject to downward pressures due to the highly competitive industry in which we operate and, most recently, have also been affected by global economic conditions. The average selling prices for our products may decline if competitors lower their prices as a result of decreased costs or in order to gain market share. From time to time, we reduce our prices for certain products to compete more effectively. For example, in 2006, we reduced the average selling price of our fully automatic filters due to increased competition, which resulted in a decrease in revenue from this product line in that year despite increased unit sales. Alternatively, we increase our average selling prices in certain circumstances, including when we introduce new or enhanced products into the market, or to offset the rising costs of raw materials and components. For example, during the first half of 2008, we raised the prices of all of our products two separate times by 4.2% to 18.5% to offset the rising costs of raw materials and components. As a result of the recent global economic conditions and competitive pressures, however, we reduced the prices of all of our products in the fourth quarter of 2008 by 3.2% to 4.4% to maintain or increase our market presence. For the first three quarters of 2009, low raw materials costs and our ability to leverage our manufacturing process to further decrease costs have combined to improve our gross margin to nearly 50%. However, due to aforementioned raw material cost increases in September 2009 and further anticipated increases in such costs in 2010, we expect gross margins to trend slightly downward in 2010.
 
Since the average selling prices and gross margins of our products vary by product line, changes in our product sales mix will also impact our overall gross margins. Our more sophisticated and technologically advanced products, such as our fully automatic filters and circulating water central processors (circulating water treatment equipment), industrial pure water equipment (water purification equipment), sludge screws and microporous aerators (wastewater treatment equipment) generally have higher gross profit margins than our low technology products such as our cyclone filters (circulating water treatment equipment) and water decanters (wastewater treatment equipment). In addition, our new or enhanced products, such as our new fully


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automatic filters (circulating water treatment equipment), which we introduced in March and April 2008, generally have higher gross profit margins than our older models. As a result, our gross profit margin for a period is affected by the proportion of sales of our higher gross profit margin products compared to sales of our lower gross profit margins products. For example, our gross profit margin as a percentage of our revenue increased from 35.7% in 2007 to 44.9% in 2008 and to 48.4% for the nine months ended September 30, 2009, reflecting increased sales in 2008 and in 2009 of a new model of fully automatic filter, a high margin product, and the sale of sample products, at or slightly greater than cost, to our distributors of RMB38.4 million in 2007.
 
Lastly, our gross profit margins are also affected by changes in our cost of revenue and our ability to manage such cost as described in further detail in “— Cost of Revenue” above.
 
Research and Development Expenses
 
Our research and development expenses consist primarily of costs associated with the design, development and testing of our products. Among other things, these costs include employee compensation and benefits for our research and development staff, expenditures for purchases of supplies and raw materials, depreciation expenses related to equipment used for research and development activities, and other related costs. Our research and development expenses as a percentage of revenue were 4.4%, 3.4%, 2.8% and 2.3% in 2006, 2007, 2008 and for the nine months ended September 30, 2009, respectively. Although as a percentage of revenue, research and development expenses have decreased from 2006 to 2008, the decrease was mainly a function of our revenue increasing faster than our research and development expenses. From 2006 to 2008, our research and development expenses increased by RMB3.5 million, or 27.3%, from RMB12.8 million in 2006 to RMB16.4 million ($2.4 million) in 2008. Our research and development expenses increased by RMB2.1 million ($0.3 million), or 18.0%, from RMB11.6 million for the nine months ended September 30, 2008 to RMB13.7 million ($2.0 million) for the nine months ended September 30, 2009. In 2010, research and development expenses are expected to be approximately 3.0% of revenue as we continue to fund construction of our new research and development facility.
 
We expect to continue to invest in research and development. We are committed to creating, developing and commercializing new and more advanced products.
 
Selling Expenses
 
Our selling expenses consist primarily of employee compensation and benefits, including share-based compensation, for our sales and marketing staff, expenses for promotional, advertising, travel and entertainment activities, and depreciation expenses related to equipment used for sales and marketing activities. Our selling expenses were RMB27.7 million, RMB30.7 million, RMB37.1 million ($5.4 million) and RMB41.5 million ($6.1 million) in 2006, 2007, 2008 and the nine months ended September 30, 2009, respectively.
 
Between 2006 and the nine months ended September 30, 2009, our selling expenses increased primarily as a result of increased sales and marketing activities and the hiring of additional sales representatives. Our selling expenses as a percentage of revenue decreased from 2006 to 2008, reflecting improved selling and marketing efficiencies. In the near term, we expect that certain components of our selling expenses will increase as we increase our market penetration in China. Specifically, we expect that advertising expenses will increase as we expand our advertising into new forms of media, including online advertising and television. For example, our advertising expense increased from RMB9.5 million for the nine months ended September 30, 2008 to RMB16.4 million ($2.4 million) for the nine months ended September 30, 2009, as we began advertising on television in 2009. Through December 31, 2009, we incurred expenses of RMB22.9 million ($3.4 million) for our CCTV television advertising campaign, which includes RMB15.6 million ($2.3 million) for the fourth quarter of 2009. TV advertising expenses for the fourth quarter of 2009 included (1) two contracts that were signed with CCTV in August 2009 for airtime expenses through December 2009 and (2) monthly payments on a separate broker contract that was signed in September 2009 for advertising production and airtime expenses that was scheduled to run through September 2010. In December 2009, the


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broker contract was terminated and we entered into two new advertising contracts with CCTV for which we expect to incur selling expenses of RMB15.0 million ($2.2 million) and RMB15.3 million ($2.2 million) for the first and second quarters of 2010, respectively. These two contracts expire at the end of June 2010. In addition, we anticipate that industry trade conference and exhibition expenses will increase as we plan to participate in more industry trade conferences and exhibitions all across China to develop and enhance our reputation in the commercial and construction industries. We also expect salary expenses to increase as we continue to hire additional sales representatives to help broaden our end-user customer base. This anticipated increase in selling expenses will be a direct result of our plan to grow, strengthen and support our extensive distribution network.
 
Because we sell all of our products to distributors, we believe our selling expenses as a percentage of revenue are significantly lower than manufacturers of water treatment equipment that primarily sell to end-user customers. While we intend to continue to sell our products primarily to distributors, we also seek to build recognition of our brand through increasing marketing activities, which may increase our sales and marking expenses.
 
General and Administrative Expenses
 
Our general and administrative expenses consist primarily of employee compensation and benefits, including share-based compensation, for our general management, finance and administrative staff, depreciation and amortization with respect to equipment used for general corporate purposes, professional, legal and consultancy fees, and other expenses incurred for general corporate purposes. Our general and administrative expenses were RMB10.2 million, RMB11.0 million, RMB35.8 million ($5.2 million) and RMB97.2 million ($14.2 million) in 2006, 2007, 2008 and the nine months ended September 30, 2009, respectively.
 
In 2008, general and administration expenses included expensed offering costs of RMB20.5 million ($3.0 million) resulting from the delay of our initial public offering. These offering costs included legal, audit, and other charges related to our initial public offering.
 
Our general and administrative expenses increased by RMB86.1 million ($12.6 million), or 777.8%, from RMB11.1 million for the nine months ended September 30, 2008 to RMB97.2 million ($14.2 million) for the nine months ended September 30, 2009, primarily due to a share-based compensation expense of RMB86.2 million ($12.6 million) related to our grant of restricted share awards and stock options to certain employees in June 2009.
 
We expect that our overall general and administrative expenses will increase after the closing of this offering due to the continued expansion of our business and the various additional legal, accounting and other requirements that are applicable to us as a public company since June 2009 in the United States. Our general and administrative expenses as a percentage of revenue were 3.5%, 2.6%, 6.0% and 16.5% for 2006, 2007, 2008 and the nine months ended September 30, 2009, respectively. Excluding the offering costs related to our initial public offering filing, our general and administrative expenses, as a percentage of revenue, would have been 2.6% for 2008. For the nine months ended September 30, 2009, our general and administrative expenses, as a percentage of revenue, would have been 1.9% if share-based compensation expense was excluded. In 2010, we expect that general and administrative expenses, exclusive of employee share-based compensation expenses, will be approximately 2.0% to 4.0% of our revenue.
 
Employee Share-Based Compensation Expenses
 
We account for employee share-based compensation expenses at the fair value of the share awards on the date of grant and recognized over the service period for awards expected to vest. The fair value of restricted stock units is determined based on the number of shares granted and the quoted price of our common stock. We did not incur any employee share-based compensation expenses in 2006, 2007 or 2008.
 
On June 29, 2009, we granted certain employees, including members of our executive management team, but excluding our chief executive officer and chief financial officer, 1,052,631 fully vested ordinary shares, for no consideration, other than par value, which was deemed paid by services already rendered to us. As a result of this ordinary share grant to our employees, we incurred employee share-based compensation charges of


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$12.6 million in the second quarter of 2009, based on the closing price of $23.96 per ADS on the New York Stock Exchange on June 29, 2009.
 
In addition, pursuant to the terms of our amended and restated employment agreement with Stephen C. Park, our chief financial officer, on June 24, 2009, we granted him an option to purchase up to 300,000 ordinary shares at the initial public offering price. One quarter of these options vested on June 24, 2009, with the remainder of the options vesting ratably on a monthly basis through June 24, 2012. This grant resulted in additional stock-based compensation expense of $0.8 million for the nine months ended September 30, 2009. We currently anticipate employee share-base compensation expense will be minimal in 2010.
 
Interest Expense
 
Interest expense is paid on our outstanding bank debt obligations on a quarterly basis. Our interest expense as a percentage of revenue was 2.5%, 1.4%, 0.5% and 0.2% in 2006, 2007, 2008 and the nine months ended September 30, 2009, respectively.
 
Other Income
 
Other income is primarily comprised of interest income earned on our cash deposits and rental income which we received in 2006, 2007 and the first half of 2008 from the lease of our office space located at No. 3 Jinyuan Road to Duoyuan Digital Printing Technology Industries (China) Co. Ltd., an entity controlled by our chairman and chief executive officer, Wenhua Guo. For further details, see “Related Party Transactions — Real Property Related Transactions.”
 
Loss from Sale of Property
 
In June 2008, we executed the transfer of properties with Duoyuan Information Terminal Manufacture (Langfang) Co., Ltd. As a result of costs related to the transfer, we experienced a loss on the sale of our property in the amount of RMB3.2 million ($0.5 million) in 2008. For further details, see “Related Party Transactions — Real Property Related Transactions.”
 
Critical Accounting Policies
 
We prepare financial statements in conformity with U.S. GAAP, which requires us to make estimates and assumptions that affect the amounts reported in our combined and consolidated financial statements and related notes. We periodically evaluate these estimates and assumptions based on the most recently available information, our own historical experience and various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from those estimates. Some of our accounting policies require higher degrees of judgment than others in their application. We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements.
 
Revenue Recognition
 
We primarily generate revenue from water treatment equipment sales to distributors. We also began generating revenue in 2008 from spare parts sales made to distributors.
 
We consider revenue from the sale of our water treatment equipment realized or realizable and earned upon meeting all of the following criteria: persuasive evidence of a sale arrangement exists, delivery has occurred, the price to the distributor is fixed or determinable, and collectibility of payment is reasonably assured. These criteria are met at the time of shipment when the risk of loss passes to the distributor.
 
We record revenue from spare parts sales at the time of shipment. Revenue from spare parts sales was RMB8.7 million ($1.3 million) in 2008 and RMB12.2 million ($1.8 million) for the nine months ended


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September 30, 2009. We anticipate that revenues derived from selling spare parts will increase in 2010 as compared to 2009.
 
During 2006, we accounted for revenue derived from long-term construction projects using the completed contract method of accounting which recorded results that were not materially different from using the percentage of completion method of accounting. We did not enter into any contracts for construction projects in 2007, 2008 or the nine months ended September 30, 2009.
 
Revenue represents the invoiced value of sold goods, net of VAT. Our products, all of which are sold in China, are subject to a Chinese VAT at a rate of 17% of the gross sales price or at a rate approved by the Chinese local government. This VAT may be offset by VAT we paid on raw materials and other materials included in the cost of producing the finished product. The VAT amounts paid and available for offset are maintained in our current liabilities.
 
We offer annual sales rebates to our distributors as an incentive to increase sales and for early payment. These annual sales rebates are based upon payments of accounts receivable received from our distributors for sales made to them. Sales rebates are recorded as a current liability at the time of the sale based upon the percentage of sales rebate that each distributor is estimated to earn for the year. At year-end, the accrued rebate amount is adjusted to the actual amount earned. Sales rebates are deducted from revenue in the accompanying combined and consolidated statements of income.
 
Accounts Receivable
 
During the normal course of business, we extend to some of our distributors interest-free unsecured credit for an initial term of 180 days. Depending on a distributor’s credit history, as well as local market practices, we may extend to some of our distributors an additional 90 to 180 days of such unsecured credit. Our accounts receivable turnover in days for 2006, 2007, 2008 and the nine months ended September 30, 2009 were 106, 96, 83 and 75 days, respectively.
 
Prior to January 1, 2008, we reviewed our accounts receivable quarterly and determined the amount of allowances, if any, necessary for doubtful accounts. Historically, we have not had any bad debt write-offs and, as such, we do not provide an arbitrary reserve amount for possible bad debts based upon a percentage of sales or accounts receivable balances. Rather, since January 1, 2008, we review our accounts receivable balances to determine whether specific reserves are required due to such issues as disputed balances with distributors, declines in distributors’ credit worthiness, or unpaid balances exceeding agreed-upon terms. Based upon the results of these reviews, we determine whether a specific provision should be made to provide a reserve for possible bad debt write-offs. We determined that no allowances for doubtful accounts were necessary or required in 2006, 2007, 2008 or for the nine months ended September 30, 2009.
 
Since January 1, 2008, we have been communicating with our distributors each month to identify any potential issues and reassess our credit limits and terms with them based on their prior payment history and practice. We also plan to continue building upon our existing relationships and history with each of our distributors to assist us in the full and timely collection of outstanding payments.
 
As of December 31, 2008 and September 30, 2009, we had outstanding accounts receivable totaling RMB137.5 million ($20.2 million) and RMB184.1 million ($27.0 million), respectively. We believe that these outstanding amounts will be collected pursuant to the terms, conditions, and within the time frames agreed upon between our distributors and us primarily due to the enhanced collection measures we implemented on January 1, 2008.
 
During the reported periods, we did not experience any material problems relating to distributor payments and had no bad debt write-offs.
 
In terms of our liquidity, we reflect the extended interest-free unsecured credit in our cash flows for the reported periods. Therefore, we anticipate no changes from past cash flow patterns.


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Inventories
 
We state inventories at the lower of cost or market value. We determine cost on a weighted average basis and we include all expenditures incurred in bringing the goods to the point of sale and putting them in sellable condition. Our accounting for inventory is described in Note 2 to our Notes to Combined and Consolidated Financial Statements as of December 31, 2006, 2007 and 2008 included elsewhere in this prospectus. We evaluate inventory annually for possible obsolescence of our raw materials, work in process and finished goods to determine if a provision for obsolescence is necessary. We reserved RMB0.6 million for obsolescence at December 31, 2006 and 2007, and we reserved RMB0.1 million ($18,770) for obsolescence at December 31, 2008. We reserved RMB0.1 million ($15,026) for obsolescence at September 30, 2009. Our estimates for determining the provision for obsolescence may be affected by technological changes and developments to our product offerings and changes in governmental regulations.
 
Valuation of Share-Based Compensation
 
We account for share-based compensation to our employees at the fair value of the share awards on the date of grant and recognized over the service period for awards expected to vest. The fair value of restricted stock units is determined based on the number of shares granted and the quoted price of our common stock.
 
Warranty Costs
 
We generally warrant our products against defects for the initial six months period of use for small equipment to one year for large equipment. Warranty costs are accrued in other payables based upon our expectation of such costs. We review warranty costs on a quarterly basis and determine the amount of a warranty reserve based upon a review of historical costs. A reserve for warranty costs of RMB2.2 million ($0.3 million) was provided at December 31, 2008, and a reserve for warranty costs of RMB2.4 million ($0.4 million) was provided at September 30, 2009. Our estimates for determining the reserve for warranty costs may be affected by substandard materials that could be provided by our suppliers and new product developments.
 
Internal Control Over Financial Reporting
 
Prior to completion of our initial public offering in June 2009, we were a private company with limited accounting personnel and other resources with which to address our internal control and procedures over financial reporting. See “Risk Factors — Risks Related to Our Business — In preparing our combined and consolidated financial statements, several material weaknesses, significant deficiencies and control deficiencies have been identified, as defined in the standards established by the U.S. Public Company Accounting Oversight Board. If we fail to achieve or maintain an effective system of internal control over financial reporting, our ability to accurately and timely report our financial results or prevent fraud may be adversely affected.”
 
The material weaknesses identified in our 2008 audit related to our failure to implement a month-end process to properly accrue expenditures at period-end and record purchases and sales following the closing of our books and proper review of these items. Previously identified material weaknesses mainly related to: (1) an inability to timely identify disputed balances or unpaid aged balances of revenue and accounts receivable; (2) differences and errors in the recording of cost of revenue and inventory; (3) a lack of effective controls over the financial reporting process due to an insufficient complement of personnel with an appropriate level of accounting knowledge, experience and training in the application of U.S. GAAP commensurate with our financial reporting requirements; and (4) inadequate retention and maintenance of legal and accounting documents. The significant deficiencies identified in our 2008 audit primarily related to (1) failure to record inventory balances at the time of delivery rather than after inspection and (2) sales tax rebates paid without corresponding official receipts. Previously observed significant deficiencies included (1) errors in the classification of expenses and (2) related party transactions not entered into on arm’s-length basis.


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To remedy these weaknesses and deficiencies, we have adopted several measures to improve our internal controls over financial reporting. With respect to the recently identified weaknesses and deficiencies, we have implemented (1) month-end procedures to properly record and review expenditures, accruals, purchases and sales activities and (2) procedures related to better record and track inventory upon delivery and payment of sales rebates without corresponding official receipts. With respect to the earlier weaknesses and deficiencies, we communicate with our distributors on a monthly basis to reconcile any outstanding receivables balances and require them to clearly identify the invoice being paid when sending in payments. This practice has remedied our past inability to timely identify disputed or unpaid aged balances of revenue and accounts receivable. To remedy the differences and errors in the recording of cost of revenue and inventory, we have assigned a raw material code to each individual raw material part to correctly identify and value our inventory. We also hired Stephen C. Park in June 2007 as our chief financial officer. Mr. Park is experienced in U.S. GAAP and Securities and Exchange Commission reporting and has been training our accounting staff on the application of U.S. GAAP. We have also established an archive room in our corporate offices in Beijing to retain our legal and accounting documents and have assigned an individual to organize and maintain them. To remedy the previously identified significant deficiencies, we now classify our expenses to conform to U.S. GAAP and require that all related party transactions be reviewed by our chief financial officer to determine whether they are at arm’s-length before being executed. We have also hired additional qualified accounting personnel who have been trained in U.S. GAAP accounting and other personnel who are being trained to establish an internal audit function. We are also in the process of, among other things, supplementing and documenting our accounting policies and procedures for use by our personnel (including policies and procedures with respect to: recording and evaluating our revenue; cost of revenue; accounts receivable; accounts payable and inventory balances; our quarterly closing and inventory valuation procedures; and our record and document retention and maintenance). We also engaged PricewaterhouseCoopers in September 2009 to assist us, and our internal audit function, with the foregoing activities and with preparing for future SOX 404 compliance matters.


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Selected Quarterly Results of Operations
 
The following table presents our selected unaudited combined and consolidated quarterly results of operations for the nine quarters in the period from July 1, 2007 to September 30, 2009. You should read the following information in conjunction with our combined and consolidated financial statements and related notes included elsewhere in this prospectus. We have prepared the unaudited combined and consolidated quarterly financial information on the same basis as our audited combined and consolidated financial statements. The unaudited combined and consolidated quarterly financial information includes all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the quarters presented. Our quarterly operating results have fluctuated and will continue to fluctuate from period to period. The operating results for any quarter are not necessarily indicative of the operating results for any future period or for a full year. Factors that may cause our revenue and operating results to vary or fluctuate include those discussed in the “Risk Factors” section of this prospectus.
 
                                                                         
    Three Months Ended
    September 30,
  December 31,
  March 31,
  June 30,
  September 30,
  December 31,
  March 31,
  June 30,
  September 30,
    2007   2007   2008   2008   2008   2008   2009   2009   2009
    RMB   RMB   RMB   RMB   RMB   RMB   RMB   RMB   RMB
    (Unaudited)
    (In thousands)
 
Revenue
    143,965       99,589       86,822       161,375       194,972       149,531       120,646       213,729       255,204  
Cost of revenue
    85,197       61,029       52,273       87,248       103,675       83,614       66,178       109,031       128,853  
                                                                         
Gross profit
    58,768       38,560       34,549       74,127       91,297       65,917       54,468       104,698       126,351  
Research and development expenses
    3,612       3,856       3,591       4,005       3,999       4,776       5,110       4,159       4,413  
Selling expenses
    7,677       7,997       7,450       8,290       10,537       10,799       8,859       13,405       19,226  
General and administrative expenses
    3,150       2,087       3,466       3,839       3,763       24,723       829       89,326       7,008  
                                                                         
Operating income (loss)
    44,329       24,620       20,042       57,993       72,998       25,619       39,670       (2,192 )     95,704  
Interest expense
    1,447       1,502       1,047       830       711       530       326       298       298  
Other income
    2,707       579       326       448       246       258       197       245       363  
Loss from sale of property
                      3,204             11                    
                                                                         
Income (loss) from continuing operations before income taxes
    45,589       23,697       19,321       54,407       72,533       25,336       39,541       (2,245 )     95,769  
Provision for income taxes
    5,711       2,968       4,277       10,749       12,925       9,879       10,608       22,889       22,372  
                                                                         
Income (loss) from continuing operations
    39,878       20,729       15,044       43,658       59,608       15,457       28,933       (25,134 )     73,397  
Discontinued operations net income (loss) from discontinued operations, net of taxes
    (582 )                                                
                                                                         
Net income (loss)
    39,296       20,729       15,044       43,658       59,608       15,457       28,933       (25,134 )     73,397  
                                                                         
 


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    Three Months Ended
    September 30,
  December 31,
  March 31,
  June 30,
  September 30,
  December 31,
  March 31,
  June 30,
  September 30,
    2007   2007   2008   2008   2008   2008   2009   2009   2009
    % of Revenue   % of Revenue   % of Revenue   % of Revenue   % of Revenue   % of Revenue   % of Revenue   % of Revenue   % of Revenue
    (Unaudited)
 
Revenue
    100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100 %     100 %
Cost of revenue
    59.2       61.3       60.2       54.1       53.2       55.9       54.9       51.0       50.5  
                                                                         
Gross profit
    40.8       38.7       39.8       45.9       46.8       44.1       45.1       49.0       49.5  
Research and development expenses
    2.5       3.9       4.1       2.5       2.1       3.2       4.2       2.0       1.7  
Selling expenses
    5.3       8.0       8.6       5.1       5.4       7.2       7.3       6.3       7.5  
General and administrative expenses
    2.2       2.1       4.0       2.4       1.9       16.6       0.7       41.8       2.7  
                                                                         
Operating income (loss)
    30.8       24.7       23.1       35.9       37.4       17.1       32.9       (1.1 )     37.5  
Interest expense
    1.0       1.5       1.2       0.5       0.3       0.4       0.3       0.1       0.1  
Other income
    1.9       0.6       0.4       0.3       0.1       0.2       0.2       0.1       0.1  
Loss from sale of property
                      2.0                                
                                                                         
Income (loss) from continuing operations before income taxes
    31.7       23.8       22.3       33.7       37.2       16.9       32.8       (1.1 )     37.5  
Provision for income taxes
    4.0       3.0       5.0       6.6       6.6       6.6       8.8       10.7       8.8  
                                                                         
Income (loss) from continuing operations
    27.7       20.8       17.3       27.1       30.6       10.3       24.0       (11.8 )     28.8  
Discontinued operations net income (loss) from discontinued operations, net of taxes
    (0.4 )                                                
                                                                         
Net income (loss)
    27.3 %     20.8 %     17.3 %     27.1 %     30.6 %     10.3 %     24.0 %     (11.8 )%     28.8 %
                                                                         
 
Our net income has fluctuated significantly during the nine quarters in the period from July 1, 2007 to September 30, 2009. Historically, quarterly fluctuation has been primarily due to lower sales during the winter months as construction activities decrease.
 
Our third-quarter revenues in 2008 and 2009 were sequentially higher compared to second-quarter revenues in 2008 and 2009 primarily due to seasonality as we benefited from an increase in construction activities which typically begin in the second quarter. Similarly our sequential revenues in the fourth quarter and first quarter are lower than the immediately prior quarter because of seasonality, namely the harsh winter climate and holiday season in China during those quarters which result in decreased construction activities.
 
We introduced 38 new products in 2008. Seventeen of these new products were in our circulating water treatment equipment category. We also introduced 15 new products in our water purification equipment category and six new products in our wastewater treatment equipment category. New product introductions contributed to revenues in each period being higher than the corresponding periods in the prior years. In September and October of 2009, we introduced into the market six new or enhanced products across our three product categories. Three of these new products were in our wastewater treatment category; two new products were in our circulating water treatment equipment category; and one new product was in our water purification equipment category.
 
Our cost of revenue can vary significantly from quarter to quarter, but generally it is in proportion to the number of products we sell in any given quarter. We typically incur higher costs in the third quarter primarily due to the increase in the volume of our products sold.
 
For the nine quarters in the period from July 1, 2007 to September 30, 2009, our gross profit margins ranged from 38.7% to 49.5%. The higher gross profit margins beginning in the second quarter of 2008 reflect increased sales of our higher margin products. We also increased our average selling prices two times in the

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first half of 2008 to offset the rising costs of our raw materials and components. However, due to the challenging global economic conditions and competitive pressures, we lowered our average selling prices on certain products in the fourth quarter of 2008. Our gross margins, however, remained relatively unchanged because of a corresponding decrease in our cost of raw materials. Accordingly, when combined with our ability to leverage our manufacturing process to further decrease costs, our gross margins increased in the second and third quarters of 2009.
 
Between the fourth quarter of 2008 and the second quarter of 2009, we had three quarters of higher than average general and administrative expenses. The fourth quarter of 2008 included expensed offering costs of RMB20.5 million ($3.0 million) resulting from the delay of our initial public offering. These offering costs included legal, audit, and other charges related to the initial public offering filing. Accordingly, general and administrative expenses, as a percentage of revenue, were 16.6% for the fourth quarter of 2008. The first quarter of 2009 included a RMB4.3 million ($0.6 million) adjustment of our estimated accrual of costs provided at December 31, 2008 in connection with the initial public offering. As a result, general and administrative expenses, as a percentage of revenue, were 0.7% for the first quarter of 2009. The second quarter of 2009 included a RMB90.5 million ($13.3 million) share-based compensation expense related to our grant of restricted share awards and share options to certain employees in June 2009. The breakdown of share-based compensation expense was as follows: RMB1.4 million ($0.2 million) from cost of revenue; RMB4.0 million ($0.6 million) from selling expenses; and RMB85.1 million ($12.5 million) from general and administrative expenses. As a percentage of revenue, general and administrative expenses for the second quarter of 2009 was 41.8%. In the absence of these additional expenses, general and administrative expenses, as a percentage of revenue, would have been 2.8%, 4.3% and 1.9% for the fourth quarter of 2008, the first quarter of 2009 and the second quarter of 2009, respectively.
 
Our interest expense decreased each quarter from July 1, 2007 to September 30, 2009, as we continued to repay our short-term bank notes without taking on additional borrowings. In the first quarter of 2009, we renewed our remaining short-term bank note for another one year period at a lower interest rate from 8.217% to 5.841%.
 
The significant increase in our provision for income taxes since the first quarter of 2008 is primarily due to an increase in the applicable tax rate of Duoyuan Beijing from 12% to the new tax rate of 25%. This new tax rate for Duoyuan Beijing, which went into effect on January 1, 2008. We expect that our provision for income taxes will increase with any increase in our income from operations. Our provision for income taxes for the second quarter of 2009, as a percentage of revenue, increased significantly due to our share-based compensation expense of RMB90.5 million ($13.3 million) not being deductible from our income subject to PRC taxes.


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Results of Operations
 
The following table sets forth selected data from our combined and consolidated statements of income for the periods indicated, in Renminbi and as a percentage of revenue:
 
                                                                                                 
    Year Ended December 31,   Nine Months Ended September 30,
    2006   2007   2008   2008   2009
        % of
      % of
          % of
      % of
          % of
    RMB   Revenue   RMB   Revenue   RMB   $   Revenue   RMB   Revenue   RMB   $   Revenue
                                (Unaudited)   (Unaudited)
    (In thousands, except percentages)
 
Revenue
    292,863       100.0 %     423,962       100.0 %     592,699       86,827       100.0 %     443,168       100.0 %     589,579       86,370       100.0 %
Cost of revenue
    178,125       60.8       272,402       64.3       326,809       47,876       55.1       243,195       54.9       304,062       44,543       51.6  
                                                                                                 
Gross profit
    114,738       39.2       151,560       35.7       265,890       38,951       44.9       199,973       45.1       285,517       41,827       48.4  
Research and development expenses
    12,856       4.4       14,405       3.4       16,370       2,398       2.8       11,594       2.6       13,683       2,005       2.3  
Selling expenses
    27,672       9.5       30,698       7.2       37,076       5,431       6.3       26,277       5.9       41,490       6,078       7.0  
General and administrative expenses
    10,243       3.5       11,034       2.6       35,792       5,243       6.0       11,069       2.5       97,162       14,234       16.5  
                                                                                                 
Operating income
    63,967       21.8       95,423       22.5       176,652       25,879       29.8       151,033       34.1       133,182       19,510       22.6  
Loss from sale of property
                            3,216       471       0.5       3,204       0.7                    
Interest expense
    7,372       2.5       5,759       1.4       3,118       457       0.5       2,588       0.6       923       135       0.1  
Other income
    2,507       0.9       4,523       1.1       1,279       187       0.2       1,020       0.2       805       118       0.1  
                                                                                                 
Income from continuing operations before income taxes
    59,102       20.2       94,187       22.2       171,597       25,138       29.0       146,261       33.0       133,064       19,493       22.6  
                                                                                                 
Provision for income taxes
    7,403       2.5       11,799       2.8       37,830       5,542       6.4 %     27,951       6.3       55,868       8,184       9.5  
Income from continuing operations
    51,699       17.7       82,388       19.4       133,767       19,596       22.6 %     118,310       26.7       77,196       11,309       13.1  
Total income (loss) from discontinued operations
    1,113       0.3       (180 )                                                      
                                                                                                 
Net income
    52,812       18.0 %     82,208       19.4 %     133,767       19,596       22.6 %     118,310       26.7 %     77,196       11,309       13.1 %
                                                                                                 
 
Comparison of Nine Months Ended September 30, 2008 and Nine Months Ended September 30, 2009
 
Revenue
 
Our revenue increased RMB146.4 million ($21.5 million), or 33.0%, from RMB443.2 million for the nine months ended September 30, 2008 to RMB589.6 million ($86.4 million) for the nine months ended September 30, 2009, with revenue increasing in each of our product categories. Specifically, revenue for our circulating water treatment equipment, water purification equipment and wastewater treatment equipment for the nine months ended September 30, 2009 increased by RMB36.6 million, or 19.8%, RMB32.7 million, or 35.4%, and RMB71.3 million, or 43.9%, respectively, when compared to the nine months ended September 30, 2008. This increase in revenue was mainly attributable to increased demand for our products as a result of governmental regulations mandating the utilization of water treatment products and stricter enforcement of environmental protections laws, increased updating or replacing existing and outdated equipment, and our expanded production capacity. Demand for our water purification equipment as a percentage of revenue outpaced the demand for our circulating water equipment and wastewater treatment equipment as a result of new models of water purification equipment we introduced in March and April 2008.
 
Circulating Water Treatment Equipment.  Revenue for our circulating water treatment equipment category increased for the nine months ended September 30, 2009 by RMB36.6 million ($5.4 million), or 19.8%, from RMB184.6 million for the nine months ended September 30, 2008 to RMB221.2 million ($32.4 million) for the nine months ended September 30, 2009. This increase was primarily due to the increase in demand for our new fully automatic filter models, electronic water conditioners and our circulating water central processors, which we believe resulted from our increased marketing efforts. Our new fully automatic filter models use less energy than our previous models and have wider uses and applications because of its improved filtration capabilities. We believe that our electronic water conditioners have gained greater market acceptance due to their quality and performance track records.


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Water Purification Equipment.  Revenue for our water purification equipment category increased for the nine months ended September 30, 2009 by RMB32.7 million ($4.8 million), or 35.4%, from RMB92.6 million for the nine months ended September 30, 2008 to RMB125.3 million ($18.4 million) for the nine months ended September 30, 2009. This increase was primarily due to the increase in demand for our central water purifiers, industry pure water equipment, ozone generators and ultraviolet water purifiers. During 2008, we introduced several new models of central water purifiers, a new model of our ozone generator and several new models of our ultraviolet water purifiers. We believe that, in addition to new product introductions, each of which we believe has high quality to price ratios, our increased revenue resulted from enhanced marketing efforts, greater market acceptance of our products and stricter enforcement of governmental regulations mandating a higher nationwide standard for drinking water.
 
Wastewater Treatment Equipment.  Revenue for our wastewater treatment equipment category increased for the nine months ended September 30, 2009 by RMB71.3 million ($10.5 million), or 43.9%, from RMB162.3 million for the nine months ended September 30, 2008 to RMB233.6 million ($34.2 million) for the nine months ended September 30, 2009. This increase in revenue was primarily due to the increase in demand for and sales of our belt-type thickener-filter press mono-block machines, sludge screws, online testing equipment, ultraviolet shelving disinfection systems and microporous aerators. Demand for our belt-type thickener-filter press mono-block machines and sludge screws increased due to the increase in construction of new municipal wastewater treatment facilities. In the second quarter of 2008, we introduced our online testing equipment and ultraviolet shelving disinfection system to address needs resulting from governmental regulations mandating higher wastewater discharge standards.
 
Cost of Revenue
 
As a percentage of revenue, our cost of revenue decreased from 54.9% for the nine months ended September 30, 2008 to 51.6% for the nine months ended September 30, 2009. This decrease was primarily due to the decrease in raw material costs by between 1.1% and 57.1% during the fourth quarter of 2008 over the same period in the prior year and our ability to leverage our manufacturing process to further decrease costs. Due primarily to sales volume increases, our cost of revenue increased RMB60.9 million ($8.9 million), or 25.0%, from RMB243.2 million for the nine months ended September 30, 2008 to RMB304.1 million ($44.5 million) for the nine months ended September 30, 2009. We have attempted to source quality product materials and components, while negotiating favorable pricing and volume discounts from our suppliers, leading to historically low raw material costs (particularly for steel) for the nine months ended September 30, 2009. We have also expended resources and leveraged our production experience to develop an efficient and flexible manufacturing and operational infrastructure.
 
Gross Profit
 
As a result of the factors above, our gross profit increased RMB85.5 million ($12.5 million), or 42.8%, from RMB200 million for the nine months ended September 30, 2008 to RMB285.5 million ($41.8 million) for the nine months ended September 30, 2009. Our gross profit margin increased from 45.1% for the nine months ended September 30, 2008 to 48.4% for the nine months ended September 30, 2009, primarily due to the decrease in raw material costs that went into effect during the fourth quarter of 2008 as a result of the challenging global economic conditions.
 
Research and Development Expenses
 
Research and development expenses increased RMB2.1 million ($0.3 million), or 18.0%, from RMB11.6 million for the nine months ended September 30, 2008 to RMB13.7 million ($2.0 million) for the nine months ended September 30, 2009. This increase was primarily due to a 4% increase in employee salaries and the salaries of four new employees. Additionally, increased raw materials usage for developing the six new products in 2009 contributed to the increase in research and development expenses by RMB0.5 million ($0.1 million), or 33.2%, from RMB1.4 million for the nine months ended September 30, 2008 to RMB1.9 million ($0.3 million) for the nine months ended September 30, 2009.


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As a percentage of revenue, research and development expenses decreased from 2.6% for the nine months ended September 30, 2008 to 2.3% for the nine months ended September 30, 2009. This decrease was mainly a function of our revenue increasing faster than our research and development expenses. We continue to be committed to creating, developing and commercializing new and more advanced products.
 
Selling Expenses
 
Selling expenses increased RMB15.2 million ($2.2 million), or 57.9%, from RMB26.3 million for the nine months ended September 30, 2008 to RMB41.5 million ($6.1 million) for the nine months ended September 30, 2009. This increase was primarily due to an increase in advertising costs of RMB6.9 million ($1.0 million) as we began advertising on television. Also, we incurred additional salary expense from hiring 29 new employees as compared to the same prior year period and incurred a share-based compensation expense related to our grant of restricted share awards to certain employees in our sales division. Finally, we increased our participation in industry trade conferences and exhibitions, incurring increased costs related to preparing promotional materials and transportation costs incurred by our sales representatives to attend these industry trade conferences and exhibitions.
 
As a percentage of revenue, selling expenses increased from 5.9% for the nine months ended September 30, 2008 to 7.0% for the nine months ended September 30, 2009. This increase was primarily due to increases in our advertising costs, salaries and participation in trade conferences and exhibitions.
 
General and Administrative Expenses
 
General and administrative expenses increased RMB86.1 million ($12.6 million), or 777.8%, from RMB11.1 million for the nine months ended September 30, 2008 to RMB97.2 million ($14.2 million) for the nine months ended September 30, 2009. This increase was primarily due to a RMB86.2 million ($12.6 million) share-based compensation expense related to our grant of restricted share awards to certain employees in our management and administration division and share options to our CFO in June 2009.
 
As a percentage of revenue, general and administrative expenses increased from 2.5% for the nine months ended September 30, 2008 to 16.5% for the nine months ended September 30, 2009. This increase was mainly due to our share-based compensation expense in June 2009. Excluding the impact of this expense, as a percentage of revenue, general and administrative expenses in the nine months ended September 30, 2009 would have been 1.9%.
 
Operating Income
 
As a result of the factors above, our operating income decreased RMB17.9 million ($2.6 million), or 11.8%, from RMB151.0 million for the nine months ended September 30, 2008 to RMB133.2 million ($19.5 million) for the nine months ended September 30, 2009. As a percentage of revenue, our operating income decreased from 34.1% for the nine months ended September 30, 2008 to 22.6% for the nine months ended September 30, 2009. Excluding the impact of our share-based compensation expense, operating income for the nine months ended September 30, 2009 would have been RMB224.7 million ($32.9 million).
 
Interest Expense
 
Interest expense decreased RMB1.7 million ($0.2 million), or 64.3%, from RMB2.6 million for the nine months ended September 30, 2008 to RMB0.9 million ($0.1 million) for the nine months ended September 30, 2009 as we reduced our outstanding bank debt obligation in the same period.
 
Other Income
 
Other income decreased RMB0.2 million ($31,520), or 21.1%, from RMB1.0 million for the nine months ended September 30, 2008 to RMB0.8 million ($0.1 million) for the nine months ended September 30, 2009. This decrease was primarily the result of rental income received from a related party in 2008 which we did not receive for the nine months ended September 30, 2009.


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Provision for Income Taxes
 
Provision for income taxes increased RMB27.9 million ($4.1 million), or 99.9%, from RMB28.0 million for the nine months ended September 30, 2008 to RMB55.9 million ($8.2 million) for the nine months ended September 30, 2009. This increase in the provision for income taxes was primarily attributable to the increase in our income subject to PRC taxes over the same period and the termination of Duoyuan Langfang’s tax exemption on December 31, 2008. However, our share-based compensation expense of RMB91.6 million ($13.4 million) for the nine months ended September 30, 2009, was not deductible from our income subject to PRC taxes. Accordingly, the effective tax rate increased 22.9% from 19.1% for the nine months ended September 30, 2008 to 42.0% for the nine months ended September 30, 2009.
 
Net Income
 
As a result of the foregoing, net income decreased RMB41.1 million ($6.0 million), or 34.8%, from RMB118.3 million for the nine months ended September 30, 2008 to RMB77.2 million ($11.3 million) for the nine months ended September 30, 2009. Excluding the impact of our share-based compensation expense, our net income would have increased RMB50.4 million ($7.4 million), or 42.6%, from RMB118.3 million for the nine months ended September 30, 2008 to RMB168.8 million ($24.7 million) for the nine months ended September 30, 2009.
 
Comparison of 2007 and 2008
 
Revenue
 
Our revenue increased RMB168.7 million, or 39.8%, from RMB424.0 million in 2007 to RMB592.7 million ($86.7 million) in 2008 with revenue increasing in each of our product categories. Specifically, revenue for our circulating water treatment equipment, water purification equipment and wastewater treatment equipment in 2008 increased by RMB52.6 million, or 27.2%, RMB30.2 million, or 30.8% and RMB78.9 million, or 58.1%, respectively, when compared to 2007. This increase in revenue was mainly attributable to increased demand for our products as a result of governmental regulations mandating the utilization of water treatment products and stricter enforcement of environmental protections laws, the increased demand in updating or replacing existing and outdated equipment, our expanded production capacity and increased sales to our existing distributors. Also, demand for our new products, such as our enhanced fully automatic filters (circulating water treatment equipment), ultraviolet water purifiers, central water purifiers and ozone generators (water purification equipment), and online testing equipment and ultraviolet shelving disinfection system (wastewater treatment equipment), also attributed to the increase in revenue in 2008.
 
Circulating Water Treatment Equipment.  Revenue for our circulating water treatment equipment category increased in 2008 by RMB52.6 million, or 27.2%, from RMB193.3 million in 2007 to RMB245.9 million ($36.0 million) in 2008. This increase was primarily due to the increase in demand for our new fully automatic filter models. We believe demand for our new models of fully automatic filters, which we introduced in March and April 2008, was a result of governmental enforcement of environmental protection laws mandating the use of energy saving and low emissions water treatment products. In 2008, we introduced 17 new models of fully automatic filters that met or exceeded the environmental standards and we believe we priced these new models competitively. With greater market awareness and acceptance, revenue for our fully automatic filters increased by RMB66.6 million, or 95.8%, from RMB69.5 million in 2007 to RMB136.1 million ($19.9 million) in 2008.
 
Water Purification Equipment.  Revenue for our water purification equipment category increased in 2008 by RMB30.2 million, or 30.8%, from RMB97.9 million in 2007 to RMB128.1 million ($18.8 million) in 2008. This increase was primarily due to the increase in demand for our central water purifiers, industrial pure water equipment, ozone generators and ultraviolet water purifiers. The increase in demand for our central water purifiers, industrial pure water equipment and ozone generators, which we believe have high quality to price ratios, was primarily a result of our enhanced marketing efforts. Demand for our ultraviolet water purifiers, which is our basic water purification product, increased primarily due to stricter enforcement of governmental regulations mandating a higher nationwide standard for drinking water. To capitalize on such stricter


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enforcement, in 2008 we introduced five new models of our ultraviolet water purifiers to gain market share and with greater market awareness and acceptance, demand for our existing and new models of our ultraviolet water purifiers increased.
 
Wastewater Treatment Equipment.  Revenue for our wastewater treatment equipment category increased in 2008 by RMB78.9 million, or 58.1%, from RMB135.7 million in 2007 to RMB214.6 million ($31.4 million) in 2008. This increase was primarily due to the increase in demand for our belt-type thickener-filter press mono-block machines, sludge screws and microporous aerators. Demand for our belt-type thickener-filter press mono-block machines, sludge screws and microporous aerators increased as the market expanded with the construction of new municipal wastewater treatment facilities and more capital becoming available to governmental agencies and other enterprises to purchase our products. The stricter enforcement of environmental regulations also led to the increase in demand for these products.
 
Cost of Revenue
 
Our cost of revenue increased RMB54.4 million, or 20.0%, from RMB272.4 million in 2007 to RMB326.8 million ($47.9 million) in 2008. This increase was primarily due to the increase in volume of our products sold during this period, contributing to the increase in consumption of raw materials and components across all three product categories as our revenue increased by 39.8% from 2007 to 2008.
 
As a percentage of revenue, the cost of revenue decreased from 64.3% for 2007 to 55.1% for 2008. This decrease was primarily due to the increase in the sale of products with higher gross profit margins, in particular, our new fully automatic filter models and microporous aerators, as a percentage of our total revenue in 2008 and the sale of sample products, at or slightly greater than cost, to our distributors in 2007, which increased our cost of revenue in that year.
 
Gross Profit
 
As a result of the factors above, our gross profit increased RMB114.3 million, or 75.4%, from RMB151.6 million in 2007 to RMB265.9 million ($39.0 million) in 2008. As a percentage of revenue, our gross profit margin increased from 35.7% for 2007 to 44.9% for 2008, primarily due to the increase in sale of our new fully automatic filter models, a high margin product, in 2008 and the sale of sample products, at or slightly greater than cost, to our distributors of RMB38.4 million in 2007, which decreased our gross profit in that year.
 
Research and Development Expenses
 
Research and development expenses increased RMB2.0 million, or 13.6%, from RMB14.4 million in 2007 to RMB16.4 million ($2.4 million) in 2008. This increase was primarily due to an increase in costs from the purchase of raw materials in connection with our sample product development.
 
As a percentage of revenue, research and development expenses decreased from 3.3% for 2007 to 2.8% for 2008. This decrease was mainly a function of our revenue increasing faster than our research and development expenses.
 
Selling Expenses
 
Selling expenses increased RMB6.4 million, or 20.8%, from RMB30.7 million in 2007 to RMB37.1 million ($5.4 million) in 2008. This increase was primarily due to the increase in advertising costs and our increased participation in industry trade conferences and exhibitions and the related costs of preparing promotional materials, as well as increased transportation costs incurred by our sales representatives in connection with attending these industry trade conferences and exhibitions, from RMB17.8 million in 2007 to RMB23.7 million ($3.5 million) in 2008.
 
As a percentage of revenue, selling expenses decreased from 7.3% for 2007 to 6.3% for 2008. This decrease was primarily due to our increased sales volume, which created economies of scale and reduced our per unit selling expenses.


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General and Administrative Expenses
 
General and administrative expenses increased RMB24.8 million, or 224.4%, from RMB11.0 million in 2007 to RMB35.8 million ($5.2 million) in 2008. This increase was primarily due to public offering costs totaling RMB20.5 million ($3.0 million) and an increase in salaries expense of RMB2.5 million, from RMB1.8 million in 2007 to RMB4.4 million ($0.6 million) in 2008, as we hired 17 new employees.
 
As a percentage of revenue, general and administrative expenses increased from 2.6% for 2007 to 6.0% for 2008. This increase was mainly attributable to expensing public offering costs as a result of the delay in this public offering.
 
Operating Income
 
As a result of the factors above, our operating income increased RMB81.2 million ($11.9 million), or 85.1%, from RMB95.4 million in 2007 to RMB176.7 million ($25.9 million) in 2008. As a percentage of revenue, our operating income increased from 22.5% for 2007 to 29.8% for 2008.
 
Interest Expense
 
Interest expense decreased RMB2.6 million, or 45.9%, from RMB5.8 million in 2007 to RMB3.1 million ($0.5 million) in 2008 as we reduced our outstanding bank debt obligation in 2008.
 
Other Income
 
Other income decreased RMB3.2 million, or 71.7%, from RMB4.5 million in 2007 to RMB1.3 million ($0.2 million) in 2008. This decrease was primarily the result of interest income received from our discontinued operations in 2007 which was not received in 2008.
 
Loss on Sale of Property
 
In June 2008, we executed the transfer of properties with Duoyuan Information Terminal Manufacture (Langfang) Co., Ltd. As a result of a business tax incurred on the transfer, we experienced a loss on the sale of our property in the amount of RMB3.2 million.
 
Provision for Income Taxes
 
Provision for income taxes increased RMB26.0 million, or 220.6%, from RMB11.8 million in 2007 to RMB37.8 million ($5.5 million) in 2008. This increase in the provision for income taxes was primarily attributable to the increase in our pre-tax income by 82.2% over the same period and the new tax rate for Duoyuan Beijing which went into effective on January 1, 2008. Our effective tax rates for 2007 and 2008 were 12.5% and 22.0%, respectively.
 
Total Income (loss) from Discontinued Operations
 
Total loss from Duoyuan Huanan, a discontinued operation, decreased RMB0.2 million, or 100.0%, from RMB0.2 million in 2007 to a loss of nil in 2008 as the sale of our discontinued operations became effective on July 1, 2007.
 
Net Income
 
As a result of the foregoing, net income increased RMB51.6 million, or 62.7%, from RMB82.2 million in 2007 to RMB133.8 million ($19.6 million) in 2008.


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Comparison of 2006 and 2007
 
Revenue
 
Our revenue increased RMB131.1 million, or 44.8%, from RMB292.9 million in 2006 to RMB424.0 million in 2007. Our revenue increased for each of our product categories in 2007 as compared to 2006. This increase in revenue was mainly attributable to increased demand for our products as a result of governmental regulations mandating the utilization of water treatment products and stricter enforcement of environmental protections laws, the increased demand in updating or replacing existing and outdated equipment, the growth in the office and residential construction market, our expanded production capacity and increased sales to our existing distributors.
 
Circulating Water Treatment Equipment.  Revenue for our circulating water treatment equipment category increased in 2007 by RMB48.0 million, or 33.0%, from RMB145.3 million in 2006 to RMB193.3 million in 2007. This increase was primarily due to the increase in demand for our electronic water conditioners, which was partially offset by a decrease in demand for our circulating water central processors and cyclone filters. The increase in demand for our electronic water conditioners was primarily due to demand for conditioners that use non-chemical (physical) means to treat water in circulating water systems. Compared to our water softeners, which chemically treat water in circulating systems, our electronic water conditioners are more energy efficient, safer for the environment and also aid in rust prevention. Because of these advantages, revenue generated from our electronic water conditioners outpaced revenue from our water softeners. We believe that the decrease in demand for our circulating water central processors in 2007 was primarily because our product did not provide the high quality water output required by our most demanding end-user customers. Specifically, the original design for our circulating water central processors did not include a pre-filtering component and certain electronic components, which would have provided for a higher quality water output. To address the concerns of those end-user customers who required a higher quality water output, our distributors, at their cost, purchased a separate pre-filtering component to install in our circulating water central processors. To meet the needs of all of our end-user customers, including the most demanding, we modified the design of our circulating water processors to include a pre-filtering component and advanced electrical components. We reintroduced our modified circulating water central processors in October 2008. Actual sales of our circulating water central processors in 2007 represented a decrease of approximately RMB31.9 million when compared to our sales target for that product in the same period. We believe that the decrease in demand for our cyclone filters, a low technology product, was due to increased domestic competition.
 
Water Purification Equipment.  Revenue for our water purification equipment category increased in 2007 by RMB43.1 million, or 78.6%, from RMB54.8 million in 2006 to RMB97.9 million in 2007. This increase was primarily due to the increase in demand for our ultraviolet water purifiers, central water purifiers, and industrial pure water equipment, which was partially offset by a decrease in demand for our ozone generators. We believe that the increase in demand for our ultraviolet water purifiers, which is our basic water purification product, was primarily due to stricter enforcement of governmental regulations mandating a higher nationwide standard for drinking water. The increase in demand for our central water purifiers was a result of the growth in office and residential construction market. Specifically, builders installed our central water purifiers in newly constructed office buildings and homes as tenants and homeowners increasingly demanded a higher quality of tap water. We believe that the increase in demand for our industrial pure water equipment, which we believe has a high quality to price ratio, was primarily a result of our enhanced marketing efforts and a decrease in the average selling price of the product to make it more cost competitive. We believe that the decrease in demand for our ozone generators was primarily due to increased competition from international competitors.
 
Wastewater Treatment Equipment.  Revenue for our wastewater treatment equipment category in 2007 increased by RMB47.6 million, or 54.1%, from RMB88.0 million in 2006 to RMB135.7 million in 2007. This increase was primarily due to the increase in demand for our sludge screws and microporous aerators, which was partially offset by a decrease in demand for our water decanters. The increase in demand for our sludge screws was due to increased market awareness and acceptance of this new product which we introduced in


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2005. We believe that the increase in demand for our microporous aerators was also due to an increased demand for a more sophisticated and technologically advanced product than those existing in the market. We believe that the decrease in demand for our water decanter, a low technology product, was due to increased domestic competition.
 
Cost of Revenue
 
Our cost of revenue increased RMB94.3 million, or 52.9%, from RMB178.1 million in 2006 to RMB272.4 million in 2007. This increase was primarily due to the increase in volume of our products sold during this period.
 
As a percentage of revenue, the cost of revenue increased from 60.8% for 2006 to 64.3% for 2007. This increase was mainly attributable to the increase in raw materials and component cost across all three product categories, particularly for our water purification equipment, and the upgrading of our existing production lines for our wastewater treatment equipment, particularly the production line for our microporous aerators.
 
Gross Profit
 
As a result of the factors above, our gross profit increased RMB36.8 million, or 32.1%, from RMB114.7 million in 2006 to RMB151.6 million in 2007.
 
Our gross profit margin decreased from 39.2% in 2006 to 35.7% in 2007 primarily as a result of the increase in the cost of raw materials and components and the upgrading of our existing productions lines. Our total purchases of materials and components increased 54.3% in 2007 compared to 2006 as a result of an increase in the cost of raw materials and components for all three product categories. We also upgraded our existing production lines for our wastewater treatment equipment in the amount of RMB15.5 million which affected our gross margins. Our gross margins were also affected by the sale of sample products, at or slightly greater than cost, to our distributors of RMB38.4 million in 2007. This sale resulted in a loss of revenue of up to RMB10.7 million because we sold the sample products at a discount rather than at normal profit margins. This reduction of revenue reflected a decrease of 1.6% in our gross margins.
 
Research and Development Expenses
 
Research and development expenses increased RMB1.5 million, or 12.0%, from RMB12.9 million in 2006 to RMB14.4 million in 2007. This increase was primarily due to an increase in costs from the purchase of raw materials in connection with our sample product development.
 
As a percentage of revenue, research and development expenses decreased from 4.4% in 2006 to 3.3% in 2007. This decrease was mainly a function of our revenue increasing faster than our research and development expenses.
 
Selling Expenses
 
Selling expenses increased RMB3.0 million, or 10.9%, from RMB27.7 million in 2006 to RMB30.7 million in 2007. This increase was primarily due to the increase in costs relating to our increased participation in industry trade conferences and exhibitions and the related costs of preparing promotional materials, as well as increased transportation costs incurred by our sales representatives attending these industry trade conferences and exhibitions, from RMB14.6 million in 2006 to RMB17.8 million in 2007.
 
As a percentage of revenue, selling expenses decreased from 9.5% in 2006 to 7.3% in 2007. This decrease was primarily due to our increased sales volume, which created economies of scale, reducing our per unit selling expenses.
 
General and Administrative Expenses
 
General and administrative expenses increased RMB0.8 million, or 7.7%, from RMB10.2 million in 2006 to RMB11.0 million in 2007. This increase was primarily due to a decrease in depreciation expense from


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RMB3.9 million in 2006 to RMB3.2 million in 2007 as certain fixed assets were fully depreciated. This decrease in depreciation expense was partially offset by a 191.4% increase in expenditures for general office supplies, from RMB0.5 million in 2006 to RMB1.6 million in 2007.
 
As a percentage of revenue, general and administrative expenses decreased from 3.5% in 2006 to 2.6% in 2007. This decrease was mainly a function of our revenue increasing faster than our administrative expenses.
 
Operating Income
 
As a result of the factors above, our operating income increased RMB31.5 million, or 49.2%, from RMB64.0 million in 2006 to RMB95.4 million in 2007. As a percentage of revenue, our operating income increased from 21.8% for 2006 to 22.5% for 2007.
 
Interest Expense
 
Interest expense decreased RMB1.6 million, or 21.9%, from RMB7.4 million in 2006 to RMB5.8 million in 2007 as we reduced our outstanding bank debt obligation in 2007.
 
Other Income
 
Other income increased RMB2.0 million, or 80.4%, from RMB2.5 million in 2006 to RMB4.5 million in 2007. This increase was primarily the result of a non-recurring rental charge Duoyuan Digital Printing Technology Industries (China) Co. Ltd., an entity controlled by Wenhua Guo, our chairman and chief executive officer, for the office space located at No. 3 Jinyuan Road. Interest income remained relatively unchanged from 2006 to 2007.
 
Provision for Income Taxes
 
Provision for income taxes increased RMB4.4 million, or 59.4%, from RMB7.4 million in 2006 to RMB11.8 million in 2007. This increase in the provision for income taxes was primarily attributable to the increase in our profits by 59.4% over the same period. Our effective tax rates for 2006 and 2007 were 12.5% and 12.5%, respectively.
 
Due to various special tax rates, tax holidays and incentives that have been granted to us in China, our taxes have been relatively low. The additional amounts of tax that we would have otherwise been required to pay had we not enjoyed the various preferential tax treatments would have been RMB12.3 million in 2006 and RMB19.5 million in 2007.
 
Total Income (loss) from Discontinued Operations
 
Total income (loss) from Duoyuan Huanan, a discontinued operation, decreased RMB1.3 million, or 116.1%, from RMB1.1 million in 2006 to a loss of RMB0.2 million in 2007. Income (loss) from Duoyuan Huanan’s operations is classified as discontinued operations as a result of our agreement, dated August 12, 2007, to sell substantially all of the business activities and operations of Duoyuan Huanan to Duoyuan Asian Water Inc., a British Virgin Islands company wholly owned by our chairman and chief executive officer, Wenhua Guo. The net loss of RMB0.2 million in 2007 consisted of a RMB0.6 million loss on the sale of Duoyuan Huanan offset by net income of RMB0.4 million from Duoyuan Huanan prior to the sale.
 
Net Income
 
As a result of the foregoing, net income increased RMB29.4 million, or 55.7%, from RMB52.8 million in 2006 to RMB82.2 million in 2007.
 
Liquidity and Capital Resources
 
As of December 31, 2006, 2007, 2008 and September 30, 2009, we had cash of RMB7.4 million, RMB28.1 million, RMB198.5 million ($29.1 million) and RMB937.2 million ($137.3 million), respectively.


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The increase in our cash as of December 31, 2008 was primarily due to the collection of amounts due from related parties totaling RMB102.0 million. For a description of these related party receivables, see “Related Party Transactions — Loans to Related Parties — Accounts Receivable.” For our current level of borrowing, see the discussion below on our existing short-term notes. There is no seasonal fluctuation to our borrowing requirements.
 
We relied primarily on cash flow from operating activities and our bank notes for our capital requirements in 2006, 2007, 2008 and the nine months ended September 30, 2009. We expect that our future capital expenditures primarily will be to improve and upgrade our existing manufacturing facilities and production lines, build new manufacturing facilities and production lines, expand our research and development capabilities, and pay the registered capital required for the establishment of our new subsidiaries. We expect that approximately $80 million of our cash resources will be required for these projects, the majority of which, approximately $70 million, will be incurred for the improvement and upgrading of our existing manufacturing facilities and production lines and the building of new manufacturing facilities and production lines. In addition, we intend to use approximately $10 million to complete construction of a research and development laboratory. Since we have not encountered any difficulties in meeting our cash obligations to date, we believe that the net proceeds from this offering, net proceeds from our initial public offering, cash flow from operating activities and our bank notes will be sufficient to meet our presently anticipated cash needs for at least the next 12 months.
 
Our long-term liquidity needs will relate primarily to working capital to pay our suppliers, as well as any increases in manufacturing capacity or acquisitions of third party businesses or licenses that we may seek in the future. We expect to meet these requirements primarily through the proceeds of this offering and revolving short-term bank borrowings, as well as our cash flow from operations, which we expect will increase with the planned increase in our manufacturing capacity. We believe our working capital is sufficient for these current requirements, though we may require additional cash due to changing business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If our existing cash is insufficient to meet our requirements, we may seek to sell additional equity securities or increase our borrowing level. The actual amount and timing of our future capital requirements may differ materially from our estimate depending on our actual results of operations.
 
Sources and Uses of Cash
 
The following table sets forth cash flow data for the periods indicated:
 
                                                         
    Year Ended December 31,   Nine Months Ended September 30,
    2006   2007   2008   2008   2009
    RMB   RMB   RMB   $   RMB   RMB   $
                    (Unaudited)   (Unaudited)   (Unaudited)
    (In thousands)
 
Cash flow data:
                                                       
Net cash provided by operating activities
    30,785       72,070       241,686       35,405       184,527       150,485       22,045  
Net cash used in investing activities
          (37,031 )     (22,221 )     (3,255 )     (22,229 )     (43,847 )     (6,423 )
Net cash (used in) provided by financing activities
    (36,000 )     (15,000 )     (49,000 )     (7,178 )     49,000       632,054       92,592  
Net increase (decrease) in cash of discontinued operations
    (155 )     584                                
                                                         
Net changes in cash
    (5,370 )     20,623       170,465       24,972       113,298       738,692       108,214  
Cash at beginning of period
    12,800       7,430       28,053       4,110       28,053       198,518       29,082  
                                                         
Cash at end of period
    7,430       28,053       198,518       29,082       141,351       937,210       137,296  
                                                         
 
The increase in net cash provided by financing activities for the nine months ended September 30, 2009 was from the receipt of $92.6 million in net proceeds from our initial public offering.


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Our outstanding short-term notes as of December 31, 2006, 2007 and 2008 were RMB84.0 million, RMB69.0 million and RMB20.0 million ($2.9 million), respectively. As of September 30, 2009, we had one short-term note outstanding for RMB20.0 million ($2.9 million) with Bank of Agriculture, Chongwen branch, in China. This note has an expiration date of less than one year and an interest rate of 5.841% accruing quarterly. This note is secured by our real property located in Langfang.
 
Operating Activities
 
Net cash provided by operating activities in 2006, 2007, 2008 and the nine months ended September 30, 2009 was generated from our net income of RMB52.8 million, RMB82.2 million, RMB133.8 million ($19.6 million) and RMB77.2 million ($11.3 million), respectively, after adjustment in each year for non-cash items such as depreciation and amortization, and for changes in various assets and liabilities such as accounts receivable, accounts payable and inventories.
 
Net cash provided by operating activities decreased by RMB34.0 million from RMB184.5 million for the nine months ended September 30, 2008 to RMB150.5 million ($22.0 million) for the nine months ended September 30, 2009. This decrease was primarily due to (1) a decrease in net income from RMB118.3 million to RMB77.2 million ($11.3 million) over the same period and (2) cash provided by the collection of a RMB102.0 million related party receivable in the nine months ended September 30, 2008. By December 31, 2008, we had collected all outstanding related party receivables. For a description of these related party receivables, see “Related Party Transactions — Loans to Related Parties — Accounts Receivable.” Offsetting this decrease in operating cash flow were increases in cash provided by a share-based compensation expense of RMB91.6 million ($13.4 million) and an increase of accounts payable of RMB30.7 million ($4.5 million) for the nine months ended September 30, 2009.
 
Net cash provided by operating activities increased by RMB169.6 million from RMB72.1 million in 2007 to RMB241.7 million ($35.4 million) in 2008. This increase was primarily due to (1) an increase in net income from RMB82.2 million to RMB133.8 million ($19.6 million) over the same period and (2) cash provided by the decrease in related party receivables of RMB102.0 million ($14.9 million) in 2008 as compared to the increase in related party receivables of RMB58.5 million in 2007. This increase in operating cash flow was offset by an increase in inventory of RMB24.2 million ($3.5 million) in 2008 as compared to a decrease in inventory of RMB40.1 million in 2007. The inventory balance at December 31, 2007 decreased from December 31, 2006 due to the sale of sample products, at or slightly greater than cost, to our distributors. The inventory balance at December 31, 2008 increased from December 31, 2007 due to an increase in raw materials and finished goods inventories. We did not sell any sample inventory in 2008.
 
Net cash provided by operating activities increased from RMB30.8 million in 2006 to RMB72.1 million in 2007. This increase was primarily due to: (1) an increase in net income from RMB52.8 million to RMB82.2 million over the same period; (2) a decrease in inventories of RMB40.1 million; and (3) an increase in accounts payable of RMB11.5 million. The decrease in inventories was primarily the result of a RMB38.4 million sale of our sample products, at or slightly greater than cost, to our distributors. These sample products included models which were on display at the offices of our distributors. The increase in accounts payable was primarily due to the increase in sales in the same period causing our purchase of raw materials and components to increase, resulting in an increase in our accounts payable. This increase in operating cash flow was partially offset by an increase in related party receivables of RMB58.5 million and an increase in accounts receivable of RMB41.1 million. The increase in related party receivables was due to our deposit of RMB44.5 million paid on the aggregate purchase price of RMB75.6 million for a manufacturing facility owned by Duoyuan Information Terminal Manufacture (Langfang) Co., Ltd., an entity controlled by Wenhua Guo, our chairman and chief executive officer. In connection with the property swap with Duoyuan Information Terminal Manufacture (Langfang) Co., Ltd. described in “Related Party Transactions — Real Property Related Transactions,” the amount of our deposit will be returned to us before the completion of this offering. The increase in accounts receivable was primarily due to a marked increase in sales volume for our products. In addition, we granted certain of our distributors preferred credit terms, reducing the amount of advanced payments due to us as a reward for meeting or exceeding their sales targets in the prior year.


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Investing Activities
 
Cash used in our investing activities primarily consist of purchases of property, plant and equipment and renovation of existing facilities and buildings. Cash used in investing activities increased from RMB 22.2 million to RMB 43.8 million ($6.4 million) for the nine months ended September 30, 2008 and 2009, respectively. This increase was primarily due to increased purchases of production equipment for our Duoyuan Langfang manufacturing facility. Net cash used in investing activities decreased from RMB37.0 million in 2007 to RMB22.2 million ($3.3 million) in 2008. This decrease was primarily due to decreased capital expenditures for our Duoyuan Langfang manufacturing facility. Net cash used in investing activities increased from nil in 2006 to RMB37.0 million in 2007. Cash was mainly used to renovate the Duoyuan Langfang manufacturing facility and the Duoyuan Beijing office building as well as to purchase additional production equipment.
 
Financing Activities
 
Cash provided by and used in our financing activities consist of borrowings from and repayments to our short-term notes. In the nine months ended September 30, 2009, the cash impact of financing activities was RMB632.1 million ($92.6 million), representing the net proceeds from our June 2009 initial public offering, and during the nine months ended September 30, 2008 we repaid three short-term notes in the amount of RMB69.0 million and borrowed from one short-term note in the amount of RMB20.0 million for a net cash flows used in financing activities of RMB49.0 million. Net cash used in financing activities was RMB49.0 million ($7.2 million) in 2008 as we reduced our outstanding bank debt from the previous year. Net cash used in financing activities was RMB15.0 million in 2007 as we reduced our outstanding bank debt from the previous year. Net cash used in financing activities was RMB36.0 million in 2006 as we reduced our outstanding bank debt from the previous year.
 
Capital Expenditures
 
Our capital expenditures in 2006, 2007 and 2008 were nil, RMB38.9 million and RMB22.2 million ($3.3 million), respectively. Our capital expenditures in 2007 were used primarily to purchase production equipment and the renovation of our manufacturing facilities and office buildings. For 2008, our capital expenditures were primarily used for the purchase of manufacturing equipment for our facilities in Langfang. For the nine months ended September 30, 2009, we spent RMB24.9 million ($3.6 million) on various advanced manufacturing equipment upgrades to increase our production capacity, including purchasing highly advanced microporous aerator machines. Additionally, we paid a deposit of RMB13.7 million ($2.0 million) on equipment with a remaining balance of $4.6 million to be paid in 2010. Finally, we paid a deposit of RMB5.3 million ($0.8 million) towards the purchase of a land use right in Beijing, upon which we intend to construct our new manufacturing facility in 2010. We expect to have significant capital expenditures relating to that land use right in 2010.
 
Our future capital requirements will depend on many factors including our rate of revenue growth, the timing and extent of spending to support research and development efforts, the expansion of manufacturing and sales activities, and the introduction of new products. Although we are not currently a party to any agreement or letter of intent with respect to potential investments in, or acquisitions of, complementary businesses, products or technologies, we may enter into these types of arrangements in the future, which could also require us to seek additional equity or debt financing. The sale of additional equity securities or convertible debt securities would result in additional dilution to our shareholders. Additional debt would result in increased interest expense and could result in covenants that would restrict our operations. We have not made arrangements to obtain additional financing and there is no assurance that such financing, if required, will be available in amounts or on terms acceptable to us, if at all.


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Contractual Obligations
 
The following table sets forth our contractual obligations as of September 30, 2009:
 
                                                         
    Payments Due by December 31,
    Total   2009   2010   2011   2012   2013   Thereafter
    (RMB in thousands)
 
Current debt
    20,000             20,000                          
Operating lease obligations
    281       281                                
Purchase obligations
    61,788       8,299       53,489                          
                                                         
Total
    82,069       8,580       73,489                          
                                                         
 
Seasonality
 
The sales of our products fluctuate on a seasonal basis each year. Our sale numbers tend to be lower during the winter months, when cold weather slows the pace of construction activities that involve installation of water treatment equipment, and higher during the spring, summer and autumn months when construction projects are more active.
 
Off-Balance Sheet Arrangements
 
We do not have any off-balance sheet arrangements.
 
Recently Issued Accounting Pronouncements
 
In August 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2009-05, “Fair Value Measurements and Disclosures (Topic 820) — Measuring Liabilities at Fair Value”. This ASU provides amendments for fair value measurements of liabilities. It provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more techniques. ASU 2009-05 also clarifies that when estimating a fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability. ASU 2009-05 is effective for the first reporting period (including interim periods) beginning after issuance or fourth quarter 2009. The Group is assessing the impact of ASU 2009-05 on the Group’s consolidated financial position, liquidity, results of operations or disclosures.
 
In June 2009, the FASB issued ASU No. 2009-01 (formerly SFAS No. 168), “Topic 105 — Generally Accepted Accounting Principles — FASB Accounting Standards Codificationtm and the Hierarchy of Generally Accepted Accounting Principles.” The Codification is the single source of authoritative nongovernmental US GAAP. The Codification does not change current US GAAP, but is intended to simplify user access to all authoritative US GAAP by providing all the authoritative literature related to a particular topic in one place. All existing accounting standard documents are superseded and all other accounting literature not included in the Codification is considered nonauthoritative. The Codification is effective for interim or annual reporting periods ending after September 15, 2009. The Group has made the appropriate changes to US GAAP references in these consolidated financial statements.
 
In June 2009, the FASB issued Accounting Standards Codification (“ASC”) 810 (formerly SFAS No. 167), “Amendments to FASB Interpretation No. 46(R)”. ASC 810 amends the consolidation guidance applicable to variable interest entities. The amendments to the consolidation guidance affect all entities currently within the scope of FIN 46(R), as well as qualifying special-purpose entities (QSPEs) that are currently excluded from the scope of FIN 46(R). ASC 810 is effective as of the beginning of the first annual reporting period that begins after November 15, 2009. The Group is assessing the impact of ASC 810 on the Group’s consolidated financial position, liquidity, results of operations or disclosures.
 
In May 2009, the FASB issued ASC 855 (formerly SFAS No. 165), “Subsequent Events”. ASC 855 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date


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but before financial statements are issued or available to be issued. ASC 855 is effective for interim or annual periods ending after June 15, 2009. The adoption of ASC 855 did not have an effect on the Group’s consolidated financial position, liquidity, results of operations or disclosures.
 
In April 2009, the FASB issued ASC 825 (formerly FASB Staff Position (FSP) 107-1 and APB 28-1), “Interim Disclosures about Fair Value of Financial Instruments.” ASC 825 requires a public entity to provide disclosures about fair value of financial instruments in interim financial information. ASC 825 is effective for interim and annual financial periods ending after June 15, 2009. The adoption of ASC 825 did not have an effect on the Group’s consolidated financial position, liquidity, results of operations or disclosures.
 
Quantitative and Qualitative Disclosures about Market Risk
 
Interest Rate Risk
 
We are exposed to interest rate risk due primarily to our short-term notes. As of September 30, 2009, we had one short-term note of RMB20.0 million ($2.9 million), in the aggregate, and cash on hand and in banks of approximately RMB937.2 million ($137.3 million). Although the interest rates on our short-term notes are fixed during their respective terms, the terms are typically 12 months or less and the interest rates are subject to change upon renewal. The interest rates on our short-term notes are determined by reference to the benchmark interest rates set by the People’s Bank of China, or the PBOC. Since April 28, 2006, the PBOC has increased the benchmark interest rate of Renminbi bank notes with a term of 6 to 12 months 12 times, seven consecutive increases followed by five consecutive decreases, by 0.27% on most occasions. As a result, from 2006 to the nine months ended September 30, 2009, the benchmark interest rate for these Renminbi bank notes increased from 5.85% to 7.47% then decreased to 5.31% and the interest rate applicable to us increased from 6.696% to 8.217% then decreased to 5.841% over the same period. Any future increase in the PBOC’s benchmark interest rate will result in an increase in our interest expense. A 1.0% increase in the annual interest rates for all of our credit facilities as of September 30, 2009 would decrease income before income taxes by approximately RMB150,000 ($21,974) for the nine months ended September 30, 2009. We monitor interest rates in conjunction with our cash requirements to determine the appropriate level of debt balances relative to other sources of funds. We have not entered into any hedging transactions in an effort to reduce our exposure to interest rate risk.
 
Foreign Exchange Risk
 
Although the conversion of the Renminbi is highly regulated in China, the value of the Renminbi against the value of the U.S. dollar (or any other currency) may fluctuate and be affected by, among other things, changes in China’s political and economic conditions. Under the currency policy in effect in China today, the Renminbi is permitted to fluctuate in value within a narrow band against a basket of certain foreign currencies. China is currently under significant international pressures to liberalize this currency policy, and if such liberalization occur, the value of the Renminbi could appreciate or depreciate against the U.S. dollar.
 
All of our revenue and expenses are denominated in Renminbi. We use the Renminbi as the reporting and functional currency for our financial statements.
 
Fluctuations in the exchange rate between the U.S. dollar and the Renminbi will affect the relative purchasing power of the proceeds from this offering, our balance sheet and our financial results in U.S. dollars following this offering. For example, to the extent that we need to convert U.S. dollars received in this offering into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount that we receive from the conversion. Assuming we were to convert the net proceeds received in this offering into Renminbi, a 1.0% increase in the value of the Renminbi against the U.S. dollar would decrease the amount of Renminbi we receive by RMB 6.3 million. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of making dividend payments on our ordinary shares or ADSs or for other business purposes, appreciation of the U.S. dollar against the Renminbi would have a negative effect on the U.S. dollar amount available to us. In addition, fluctuations in the exchange rate would affect our financial results translated in U.S. dollar terms without giving effect to any underlying change in our business or results of operations.


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Since our exposure to foreign exchange risks is limited, we have not used any forward contracts or currency borrowings to hedge our exposure and do not currently intend to do so.
 
Inflation
 
Inflationary factors, such as increases in the cost of our products and overhead costs, could impair our operating results. Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of gross profit and selling, general and administrative expenses as a percentage of revenue if the selling prices of our products do not increase with these increased costs.


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INDUSTRY
 
Overview: Water Scarcity and Water Resource Development in China
 
Due to rapid growth in population, urbanization and industrialization in China, the country faces severe water shortages and natural water resource pollution. To address those issues, the Chinese government has enacted stricter environmental standards and invested significantly in water treatment projects to promote sustainable economic growth and to provide its population with affordable, purified water. Accordingly, the demand for water treatment equipment has experienced and is expected to continue to experience rapid growth. Frost & Sullivan predicts that the Chinese domestic water treatment industry will grow 12% to 15% in 2009 alone.
 
Acute Water Shortage Problem
 
According to the U.S. Department of Commerce, the average annual water resource volume in China is estimated at approximately 2.8 trillion cubic meters, making China the fourth largest source of water in the world. However, only 2,200 cubic meters of water is available per person in China compared with the average global water availability of 8,800 cubic meters per person, ranking China 88th in the world. With China’s population expected to grow to 1.6 billion people by the mid-21st century, China’s per capita water resource is expected to decrease to 1,760 cubic meters, which would further exacerbate current water shortages.
 
Poor water management in China has also led to significant water waste. According to the Chinese Ministry of Water Resources, the percentage of available water used, or the water utilization rate, for a number of rivers in China, including the Huai River, Liao River and Yellow River, was approximately 60% in 2007 and as high as 100% for the Hai River. By comparison, international standards are set at 30% to 40% with the intention of conserving water resources. In addition, China also has severe regional water imbalances, with southern China having approximately four-fifths of China’s water supply. The region, however, still lacks sufficient water resources due to extensive water pollution.
 
Severe Natural Water Resource Pollution
 
According to the National Surface Water Quality Monthly Report of February 2009 issued by the China National Environmental Monitoring Center, 46% of China’s seven major water bodies were designated as Type IV and V water bodies, which indicates that they are polluted and unsuitable for humans (a designation of Type I, II or III is required for drinking water). Furthermore, a November 2006 circular of the Chinese Ministry of Water Resources stated that of the 71.7 billion tons of wastewater drained into various bodies of water in China in 2005, two-thirds were released without being treated resulting in pollution of 90% of the surface water in urban areas.
 
Stricter Environmental Standards
 
China has enacted numerous water reforms to address the country’s water shortage and water pollution problems. The Water Resource Law, amended and put into effect on October 1, 2002, compared with the Water Resource Law enacted in 1988, significantly enhances water resource management systems, water resource protection, water conservation and legal responsibilities. The amended law is expected to play an important role in the sustainable use of water resources in China. We believe stricter water quality regulations for existing infrastructure will continue to drive incremental spending in water treatment methods.
 
China has also introduced new policies, Standards for Drinking Water Quality, effective July 1, 2007, to improve drinking water standards, including limiting the level of microbe content, organic matter and disinfectants in drinking water. In testing tap water for contaminates, the new drinking water standards raised the number of items classified as potential pollutants from 35 to 106. Since conventional equipment is unlikely to comply with these stringent new regulations, this creates significant opportunities for advanced water treatment equipment.


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Increasing Water Tariffs Making Water Treatment Projects More Attractive
 
According to the Ministry of Water Resources, the average water tariff of waterworks increased 919% from RMB0.0280 per cubic meter in 2000 to RMB0.26 per cubic meter in 2008. Despite these rising tariffs, considerable room for increases remain as tariffs still represent approximately 1% of the average household’s discretionary income. We expect that increases in water tariffs will lead to higher investment returns on water treatment investments and therefore spur additional water treatment projects, including additional purchases of advanced water treatment equipment not previously economically attractive to investors.
 
Increasing Investment in the Water Treatment Sector
 
China’s water shortage and pollution control strategies are driving increased water treatment investment by the Chinese government and private investors. For example, approximately 3,000 wastewater plants were built in China between 2001 and 2005 according to Frost & Sullivan. In addition, major water supply projects in China, such as the South-to-North Water Diversion Project providing for a network of water transfer canals from the relatively water rich south to the north, will cost approximately $22 billion before 2013.
 
According to the municipal south-to-north water diversion office, the municipal government will spend RMB26 billion ($3.8 billion) on the plants and plans to build and expand 13 facilities by 2014 to process water from the Yangtze River, with combined capacity of approximately one billion cubic meters annually.
 
The Chinese government’s National Environmental Protection 11th Five-Year Plan (2006-2010), or the Five-Year Plan, establishes explicit objectives for water resource protection, drinking water quality improvement and water treatment development. For example, the plan requires all urban municipalities to build wastewater treatment facilities with wastewater treatment rate of no less than 70% and a nationwide urban wastewater treatment capacity of 100 million tons per day. To accomplish those goals, planned investment of urban wastewater infrastructure (including the cost of wastewater treatment, sewers, sludge treatment and wastewater recycling) in China is expected to be RMB332 billion between 2006 and 2010 according to the National Urban Wastewater Treatment and Recycling Facilities Construction 11th Five-Year Plan.
 
On November 5, 2008, the State Council of China announced an economic stimulus plan in the amount of $585 billion to stimulate economic growth and bolster domestic demand. The economic stimulus plan includes, among others, increased spending on basic infrastructure construction projects for water, electricity, gas and heat to improve the standard of living in China and protect the environment. Specifically, the State Council of China established ten measures to promote economic growth and further expand domestic consumption and demand. In applicable part, these measures further the Chinese government’s environmental protection efforts by encouraging the construction of sewage and waste treatment facilities and preventing water pollution in key areas. Frost & Sullivan expects water treatment to be one of the biggest beneficiaries of this economic stimulus plan. Specifically, RMB350 billion ($51 billion) has been set aside for wastewater and solid waste treatment, of which approximately 60% to 70% will be channeled to wastewater management and water supply projects with a particular focus on helping to alleviate the worsening water shortage in China’s Northern provinces. Many of those projects are connected to water conditions, stimulating the demand for equipment serving the water and wastewater treatment sectors in China. According to the National Development and Reform Commission, of the RMB230 billon ($34 billion) the central government has approved on the stimulus spending over the past two quarters, 10 percent ($3.4 billion) went towards energy conservation, emission control and environmental protection projects. The government has earmarked RMB13 billion ($1.9 billion) in the next three years to expand sewage and garbage disposal facilities to most townships. It has also allocated RMB4 billion ($586 million) for tackling water pollution in major rivers such as the Huaihe and the Songhuajiang.
 
The Chinese government has also implemented market reforms and encouraged private sector participation to improve operational efficiencies at municipal wastewater treatment facilities. As a result of such reforms, two market-based management models — build-operate-transfer, or BOT, and transfer-operate-transfer, or TOT — have been developed in an effort to expand available sources of capital and improve operational efficiencies within the water sector.


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Market Potential for the Water Treatment Industry in China
 
According to the Freedonia Group, the global demand for water treatment products is projected to grow nearly 6.4% per year to $39.9 billion in 2011, and the demand for water treatment products in China is estimated to increase nearly 15.5% per year between 2008 and 2012. We expect a significant demand for water treatment equipment in China in the foreseeable future, given China’s ongoing industrialization and urbanization.
 
The sources of demand and resulting customers in the Chinese market for water treatment equipment can be classified into the following three broad categories: the circulating water treatment industry, the water purification industry and the wastewater treatment industry.
 
Circulating Water Treatment Industry
 
According to The China Association of Environmental Protection Industry, or CAEPI, the market for (1) circulating water treatment equipment in China will grow from $277 million in 2004 to $1.0 billion in 2010 with a compound annual growth rate, or CAGR, of 24.1%, and (2) related service revenue, which includes technical support, consulting services, facility operation and management, and international trade and financial services, will grow from $345 million in 2004 to $1.2 billion 2010 with a CAGR of 23.1%. Many industrial sectors, such as food and beverages, electronics, pharmaceuticals and chemical/petroleum processors, require treated circulating water in their products or as part of their manufacturing processes. The use of untreated circulating water in manufacturing processes can result in inconsistent product quality and substantial equipment degradation, which can lead to high maintenance or replacement costs. As a result, most manufacturers treat their process water to maintain a consistently acceptable degree of purity. Depending on their process specifications, industrial customers often require a broad range of treatment technologies to treat water.
 
The following chart illustrates the historical and projected revenue for the circulating water treatment equipment market in China:
 
(CHART)
Source: CAEPI
 
Water Purification Industry
 
The water purification industry in China will experience rapid growth from 2008 to 2010 according to CAEPI. In the municipal water purification sector, CAEPI forecasts the market for (1) municipal water purification equipment in China will grow from $2.8 billion in 2004 to $6.6 billion in 2010 with a CAGR of 15.4%, and (2) related service revenue will grow from $4.6 billion in 2004 to $8.4 billion in 2010 with a


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CAGR of 10.4%. Pollution in tap water has become a serious problem in China. According to the Organization for Economic Co-operation and Development’s Environmental Performance Reviews on China, water in nearly half of China’s major cities fails to meet the national standards for drinking water. Defects in chemical treatment of tap water and aging municipal water supply systems have caused additional pollution. Traditional processes of using chemicals for water treatment have only limited capability in removing organic matters in water and may result in the concentration of harmful substances such as ammonia nitrogen and bio-assimilating organic carbon and odor in the treated water. Improving the quality of drinking water has become an urgent task in China.
 
The following chart illustrates the historical and projected revenue for the municipal water purification equipment market in China:
 
(CHART)
Source: CAEPI
 
In the industrial water purification sector, CAEPI forecasts the market for (1) industrial water purification equipment in China will grow from $3.1 billion in 2004 to $6.4 billion in 2010 with a CAGR of 12.8%, and (2) related service revenue will grow from $4.3 billion in 2004 to $8.0 billion in 2010 with a CAGR of 11.1%. The pharmaceutical, chemical, food and beverage, food processing and electronics industries all require highly purified water in their manufacturing processes and significantly affects the business outlook of those industries in China.


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The following chart illustrates the historical and projected revenue for the industrial water purification equipment market in China:
 
(CHART)
Source: CAEPI
 
Wastewater Treatment Industry
 
The wastewater treatment industry in China has experienced rapid growth since 2004 due to increasing industrialization and increasing awareness of environmental protection. CAEPI forecasts the market for (1) wastewater treatment equipment in China will grow from $2.1 billion in 2004 to $3.8 billion in 2010 with a CAGR of 10.1%, and (2) related service revenue will grow from $3.0 billion in 2004 to $14.6 billion in 2010 with a CAGR of 30.0%. Chinese regulations regarding the disposal of aqueous industrial waste, combined with public concern for industrial pollution, have led to increased awareness on the part of businesses and public utilities as to the benefits of wastewater treatment and waste minimization. In response to higher water prices and rising wastewater discharge fees, industrial manufacturers have also become aware of the cost-effectiveness of recycling their wastewater. As a result of these factors, industrial manufacturers increasingly require complex systems and equipment to treat and recycle process water and wastewater.


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The following chart illustrates the historical and projected revenue for the wastewater treatment equipment market in China:
 
(CHART)
Source: CAEPI


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BUSINESS
 
Overview
 
We are a leading China-based domestic water treatment equipment supplier. Our product offerings address key steps in the water treatment process, such as filtration, water softening, water-sediment separation, aeration, disinfection and reverse osmosis. Founded in 1992, we offer a comprehensive set of more than 90 complementary products across three product categories: circulating water treatment, water purification and wastewater treatment.
 
With over 80 distributors throughout China in 28 provinces, including most of China’s key economic regions, we believe our nationwide distribution network is one of the largest among water treatment equipment suppliers in China. Our extensive distribution network allows us to be closer to our end-user customers and enables us to be more responsive to local market demands than many of our competitors. Through joint efforts with our distributors, we have developed a broad base of end-user customers throughout China, consisting primarily of wastewater treatment plants, water works facilities, manufacturing plants, commercial businesses, residential communities and individual customers.
 
By leveraging our in-house research and development team, we broaden our market reach by introducing new products that help us diversify our revenue base, stay current with technological developments in the water treatment equipment industry and maintain our competitive advantage. Since 2004, we have developed more than 70 new products across our three product categories, many of which utilize non-chemical and energy saving technologies that are, we believe, increasingly important features to our end-user customers. Of these new products, 38 were introduced into the market in 2008. In September and October of 2009, we introduced into the market six new or enhanced products across our three product categories. We plan to continue developing new and enhanced products to maintain and expand our competitive advantage and market reach.
 
We believe our manufacturing and assembly operations are complex and integrated, involving the coordination of raw materials and components, internal production processes and external distribution processes. In addition to utilizing common components and materials within and across product categories, we employ common manufacturing and assembly practices for our product lines, providing us a highly scalable and efficient operating structure. To further save costs, increase operational efficiencies and protect our key technologies, we also produce certain core components in-house.
 
We believe we are well-positioned to become the leading supplier of water treatment equipment for municipal, industrial, commercial and residential applications in China. Water treatment in China has been and is expected to continue to be a fast-growing industry driven by the increasing demand for affordable, purified water as a result of industrialization and urbanization. According to the Freedonia Group, demand for water treatment products in China is projected to increase nearly 15.5% per year between 2008 and 2012. We also believe water treatment will become a priority for municipalities, industries and commercial businesses as the Chinese government imposes stricter environmental and water quality standards to promote sustainable economic growth.
 
Our revenues grew 44.8% from RMB292.9 million in 2006 to RMB424.0 million in 2007 and 39.8% to RMB592.7 million ($86.8 million) in 2008. Our revenues grew 33.0% from RMB443.2 million for the nine months ended September 30, 2008 to RMB589.6 million ($86.4 million) for the nine months ended September 30, 2009. Our net income grew 55.7% from RMB52.8 million in 2006 to RMB82.2 million in 2007 and 62.7% to RMB133.8 million ($19.6 million) in 2008. Our net income decreased 34.8% from RMB118.3 million for the nine months ended September 30, 2008 to RMB77.2 million ($11.3 million) for the nine months ended September 30, 2009. Excluding the impact of our share-based compensation expense, our net income would have increased 42.6% or RMB50.4 million ($7.4 million) from RMB118.3 million for the nine months ended September 30, 2008 to RMB168.8 million ($24.7 million) for the nine months ended September 30, 2009. For the year ended December 31, 2008, our three product categories: circulating water treatment, water purification and wastewater treatment accounted for approximately 41.5%, 21.6% and 36.2%,


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respectively. For the nine months ended September 30, 2009, circulating water treatment, water purification and wastewater treatment accounted for approximately 37.5%, 21.3% and 39.6% of our revenue, respectively.
 
Our Competitive Strengths
 
We believe that the following competitive strengths enable us to compete effectively in and capitalize on the growing water treatment industry in China:
 
Strong Customer Recognition and Industry Reputation.  We were one of the first privately owned domestic companies to supply circulating water treatment equipment in China when we commenced operations in 1992. We expanded our product offerings to include water purification equipment in 1998 and wastewater treatment equipment in 2001. As a company that has been operating for over 17 years, we have been able to secure our position within the Chinese water treatment equipment market, create strong customer recognition and enhance our industry reputation. We believe our strong operating history has allowed us to develop a broad base of end-user customers, expand our sales channels and facilitate more rapid acceptance of our new products.
 
Established Nationwide Distribution Network.  Comprised of over 80 distributors throughout China in 28 provinces, including most of China’s key economic regions, we believe our distribution network is one of the largest among water treatment equipment suppliers in China. Our distribution network provides us with established access to end-user customers throughout China, enables us to be responsive to local market demand and allows us to effectively diversify our end-user customer base and enhance our ability to provide superior customer service. By actively managing our distribution network, we are able to maximize local market penetration and increase sales opportunities. We complement our distribution network with over 85 internal sales and marketing personnel and a coordinated marketing effort, which allows us to proactively educate current and potential distributors and end-user customers about the features and benefits of our products.
 
Proven Research and Development Capabilities.  We have made and will continue to make significant investments in research and development. Since 2004, we have developed more than 70 new products across all three product categories as a result of our research and development capabilities. Of these new products, 38 were introduced into the market in 2008. In September and October of 2009, we introduced into the market six new or enhanced products across our three product categories. We operate a dedicated research and development center with 148 professionals and collaborate with leading universities and institutes in water treatment related research activities. Our research and development capabilities have enabled us to stay current with technological developments in the water treatment equipment industry by developing new products using advanced technologies, such as non-chemical (e.g., ozone and ultraviolet rays), membrane-based and other energy saving water treatment processes. In addition to developing new products, our research and development efforts also focus on improving our manufacturing processes, allowing us to more quickly and efficiently produce our products. We believe our investment in research and development has enabled us to continuously expand our product offerings and proactively anticipate market changes in the water treatment equipment industry. In 2010, we plan to market and sell over 35 new products.
 
Comprehensive and High-Quality Product Offerings.  Unlike most other manufacturers in China, which we believe supply only a limited range of water treatment equipment products, we have developed a comprehensive and complementary set of more than 90 complementary products across three product categories. Our products address the major steps in the water treatment process, including filtration, water softening, water-sediment separation, aeration, disinfection and reverse osmosis. In addition, many of our products utilize non-chemical and energy efficient water treatment technologies, which we believe are increasingly important features in water treatment equipment. Our experience producing various types of water treatment equipment has allowed us to identify cross-selling opportunities and create production and marketing synergies among our product lines. We have also implemented a rigid quality control system for our products, and have complied with the ISO 9001 Quality Assurance System Standards since 1996 and the ISO 14001 Environmental Management System Standards since 1999.


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Vertically Integrated and Local Cost Structure.  We employ a vertically integrated operating model that enables us to efficiently develop, manufacture and market quality products at competitive prices. As a result of generally lower operation, labor and raw material costs in China, we are often able to charge lower prices than our international competitors while maintaining comparable quality. We believe our vertically integrated approach, accentuated by our in-house manufacturing capabilities, allows us to (1) lower material and component costs through the use of common components and materials within and across product categories, (2) improve workflow and quality control through the use of common manufacturing and assembly practices, and (3) lower production costs and dependency on key suppliers through the use of components manufactured in-house. In addition, we believe manufacturing certain core components ourselves allows us to better protect our key technologies, know-how and other intellectual property from our competitors, while also further improving the quality and performance of our products to meet the demanding and changing needs of our end-user customers.
 
Our Strategies
 
Our strategy is to capitalize on our competitive strengths to expand our current market penetration and to benefit from the anticipated rapid growth in China’s water treatment industry. We plan to grow our business by pursuing the following strategies:
 
Expand Our Manufacturing Capacity and Increase In-House Production.  We are seeking to build new manufacturing facilities and production lines to produce new water treatment products. We also plan to improve and upgrade our existing manufacturing facilities and production lines to enhance our quality control and to meet increasing demand for our current products. With the increased manufacturing capacity, we also expect to bring additional production steps in-house and increase the in-house manufacturing of certain core components to further improve our cost structure, the protection of our intellectual property, the quality and performance of our products and our operational efficiencies.
 
Expand our Product Offerings and Increase Sales of Integrated Systems.  We are focused on becoming a “one-stop” equipment supplier for our end-user customers. Many of our end-user customers, especially municipalities and industries, have complex water purification or treatment equipment needs that require an integrated, comprehensive set of water treatment equipment products. We plan to continue expanding our product offerings to increase the customization of the integrated systems we offer and address the key elements of our end-user customers’ water treatment equipment needs. We believe offering these integrated systems will promote higher end-user customer satisfaction, higher margins, the establishment of long-term service contracts to maintain the systems and increased barriers to entry for potential competitors.
 
Focus on Advanced Technologies to Enhance Energy Saving and Recycling Features of Our Products and Reduce Their Operational Costs.  We are currently utilizing our research and development capabilities to develop new processes, applications and technologies to, for example, further automate our products, introduce low energy consumption features and develop products that reuse sludge and other waste materials resulting from wastewater treatment processes. We believe these automation, energy saving and recycling features not only improve efficiency but also lower maintenance and end-user operating costs of our products and increase the life of our products. We believe there will be a growing demand for products possessing such features as governments, businesses and consumers become increasingly focused on sustainable economic growth and environmental issues.
 
Increase Our Market Share in China.  We plan to continue to expand our market share of the growing water treatment equipment industry in China. To do so, we are developing additional advanced products across our comprehensive product lines, which will further create cross-selling opportunities and production and marketing synergies. We have also increased our marketing activities and are actively seeking to increase the number of distributors carrying our products, specifically new distributors that will provide us with greater access to a wider range of end-user customers. In addition, we will continue to actively manage our existing distribution network by annually reviewing the performance of each distributor for potential improvement areas.


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Enter New Water Market Segments.  We plan to pursue disciplined and targeted market entry strategies for product lines in which we do not currently compete. We believe that we have the flexibility to pursue acquisitions or develop new product lines in-house through our existing research and development team and distributor relationships depending on the market dynamics for the targeted product line. Our market entry strategy will focus on obtaining or developing complementary product offerings, product line extensions, research and development capabilities and access to new market segments and customers.
 
For example, we have evaluated the market for water conservation equipment for agricultural irrigation, which we believe has the potential to contribute to our growth. We believe that we have the in-house capability to design, manufacture and sell these products; however, we will continue to evaluate acquisition opportunities in this market that could supplement our capabilities with existing commercial products, distributor relationships and/or product design and integration.
 
Our Products
 
Our products can be classified into three categories: circulating water treatment equipment, water purification equipment and wastewater treatment equipment. The following table shows an overview of these product categories and their application:
 
             
   
Circulating Water Treatment
 
Water Purification
 
Wastewater Treatment
 
Commenced Production
  1992   1998   2001
Number of Products
  39   33   19
Nine Months 2009 Revenue
  RMB221.2 million
($32.4 million)
  RMB125.3 million
($18.4 million)
  RMB233.6 million
($34.2 million)
Sample Products Offered
  • Fully automatic filter

• Electronic water conditioner

• Circulating water central processor

• Water softener

• Cyclone filter
  • Central water purifier

• Industrial pure water equipment

• Ultraviolet water purifier

• Ozone generator

• Super clean water tank

• Tank water treatment apparatus
  • Belt-type thickener-filter press mono-block machine

• Microporous aerator

• Sludge screw

• Ultraviolet shelving disinfection system

• Online testing equipment

• Grit separator

• Water decanter
Sample Applications
  • Disinfect water in circulating water systems

• Removal and filtration of buildups
  • Pre-treatment process

• Disinfection process

• Production of industrial-use pure water

• Production of pure drinking water
  • Separation of sludge and tiny particles from wastewater

• Aeration of wastewater to kill or remove organic materials

• Removal of clear liquid from wastewater storage tanks

• Sterilization and treatment to discharged wastewater

• Monitoring of wastewater discharge
Sample Industries/Uses
  • Industrial cooling

• Air conditioning and refrigeration

• Heat exchange systems

• Water boiler systems

• Hot water supply systems
  • Pharmaceuticals

• Chemicals

• Food and beverage

• Food processing

• Electronics
  • Municipal sewage

• Petroleum

• Paper

• Pharmaceuticals

• Food and beverage


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Circulating water treatment equipment
 
We currently produce 39 products that are used in the process of treating water and removing buildup in circulating water systems. Circulating water systems, such as industrial cooling water systems, air conditioning and refrigeration systems, heat exchange systems, water boiler systems and hot water supply systems help control temperatures in heat-producing equipment and are widely used in engineering designs. The high temperature of water in circulating water systems causes scale, algae, microorganisms and other particles to build up inside the water system over time. This buildup can lead to reduced water flow, corrosion and contamination. We produce equipment for the removal and filtration of these buildups. Many of our products in this category are also used to clean and disinfect water in non-circulating water systems. Compared with other similar circulating water products which often only perform one single function, our circulating water treatment equipment is designed to address multiple issues such as waste, corrosion and structural problems in one integrated equipment.
 
The chart below shows the basic process for treating circulating water. The white boxes represent each stage in the circulating water treatment process, and the shaded boxes represent equipment that is used in a specific stage.
 
Circulating Water Treatment Process:
 
(FLOW CHART)
 
 
* Indicates equipment we produce.
 
Circulating water systems usually use tap water as the source water. If the water to be treated is not tap water, pre-treatment equipment (such as a grit separator or sand filter) is used at the initial stage. The source water is passed through a water softener, which can remove some of the metal ions present in the water. Circulating water systems are typically driven by water pumps and ancillary equipment and contain water-cooling units. A water treatment apparatus is often attached to a unit in the circulating water treatment equipment as a bypass system.


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The following describes our core products and the key features and competitive benefits of our circulating water treatment equipment:
 
  •  Fully Automatic Filter.  Our fully automatic filter measures impurity concentration levels within the circulating water system and automatically starts the cleansing process to collect and remove impurities from the water system once the concentration reaches a pre-set level.
 
  •  Electronic Water Conditioner.  Our electronic water conditioner uses electrodes for scale removal and prevention, sterilization and algae and corrosion removal. Additionally, these products, through the use of microcurrents, can prevent rust formation inside water pipelines by interrupting certain electrochemical reactions in water and killing microorganisms.
 
  •  Circulating Water Central Processor.  Our circulating water central processor both disinfects and removes impurities from circulating water without the use of chemicals. This equipment applies micro-electrolysis technology to remove metal ions and generates oxidizing particles to kill microorganisms in the circulating water system. This equipment is also effective in scale and algae removal and prevention.
 
  •  Water Softener.  Our water softener can be connected to the water supply to remove calcium and magnesium ions in the water by replacing them with sodium ions, which do not precipitate. Our water softener can automatically regenerate ion-exchange resin, a key material used for replacement of metal ions. Applications include softening hard water in hot-water or low-pressure boilers, heat exchangers, refrigerators and air-conditioning systems.
 
  •  Cyclone Filter.  Our cyclone filter can separate and eliminate tiny solids such as grits, scale-up, dirt or lime from circulating or non-circulating water systems. This product can be used at any temperature and can be easily cleaned and automation can be done easily.
 
Water purification equipment
 
We currently produce 33 products, many of which use ultraviolet, ozone, membrane-based and electrodeionization, or EDI, technologies, in the process of treating and purifying water for various applications. By employing both reverse osmosis and EDI technology, our products are highly effective in desalinating water and can produce water with high resistance to electric current, or highly purified water. These products do not use any chemical agents and, as a result, do not produce unwanted by-products that may be created in other types of desalination processes. Products in this category are used in industries that require highly purified water, such as pharmaceuticals, chemicals, food and beverages, food processing and electronics. Some of the products, such as the central water purifier, ozone generator and ultraviolet water purifier, are used to produce drinking water for residential communities and commercial businesses such as hotels. As noted in the “— Wastewater Treatment Equipment” section below, our ozone generator and ultraviolet water purifiers are also used to disinfect water as part of the treatment process for municipal sewage and industrial and agricultural wastewater. Compared with other similar water purification products, the most significant advantage of our water purification equipment is the comprehensive integrated solution offered. We offer industrial water purification equipment that integrate design, manufacture and service functions for the numerous processes ranging from pretreatment, intermediate treatment (such as micro-filtration and ultra-filtration and mixed bed), deionized treatment (such as nano-filtration and reverse osmosis treatment) to advanced water purification treatment (such as EDI) and adjustments of water quality parameters.


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The chart below shows the basic process for industrial or commercial water purification. The white boxes represent each stage in the water purification process, and the shaded boxes represent equipment that is used in a specific stage.
 
Water Purification Process:
 
(FLOW CHART)
 
 
* Indicates equipment we produce.
 
The water purification process, especially in an industrial context, generally involves pre-treatment (filtering and softening of the water), reverse osmosis, disinfection and EDI. Our products in the water purification category address each step of this process and can be integrated to provide an integrated water purification system for our end-user customers. In the first step of water purification, conventional filtration equipment, such as sand or carbon filters, pre-treats water to remove hardness and chlorine. Doing so protects the reverse osmosis membranes, which are susceptible to damage due to large amounts of iron, chlorine or other types of impurities typically found in untreated water. During this step, water may be processed further by using a water softener to remove hardness. Water is deemed “hard” when it contains a significant amount of calcium and magnesium. As such metals precipitate, hard water will scale on the interior walls of pipes, boilers, heat exchangers, water tanks or other water reserve facilities, thereby reducing the life-span of the equipment.
 
The second step is reverse osmosis, a non-chemical separation process utilizing pressure to force water through filter membranes that restrict the passage of impurities to produce purified water on the other side. The third step, EDI, is a continuous process that applies electric power to dissolve water molecules into hydrogen ions and hydroxyl ions. This process enables continuous regeneration of ion-exchange resin, which is used to remove impure ions to further purify the water. Depending on the quality of the source water and the required purity level of the processed water, some of our end-user customers choose to disinfect water


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between the reverse osmosis and the EDI steps. Our ultraviolet water purifier and ozone generator are used in this intermediate step.
 
The following describes our core products and the key features and competitive benefits of our water purification equipment:
 
  •  Central Water Purifier.  Our central water purifier uses filtration, ultraviolet disinfection and separation through reverse osmosis to remove impurities and microorganisms from raw water. Our central water purifier can monitor water quality, record data and alert users based on set parameters.
 
  •  Industrial Pure Water Equipment.  Our industrial pure water equipment integrates a number of processes and technologies, including pre-treatment, softening, membrane-based separation, disinfection and EDI treatment into one equipment. Water processed with our industrial pure water equipment meets or exceeds the requirements mandated by the Ministry of Machinery Industry of PRC in 1995. Our industrial pure water equipment is a sophisticated product that includes many automated control features. It also has low maintenance expenses and is an eco-friendly product.
 
  •  Ultraviolet Water Purifier.  Our ultraviolet water purifier is effective in disinfecting both drinking water and wastewater. Ultraviolet light alters the DNA of pathogens, killing them or making it impossible for them to reproduce. Our ultraviolet water purifier uses ultraviolet rays to quickly disinfect contaminated water and improve its quality up to or beyond the applicable hygienic criteria. It is also suitable for small-scale water supply systems that use water from rivers, lakes, ponds and wells, especially when elevated water tanks and water storage tanks are used.
 
  •  Ozone Generator.  Our ozone generator produces large amounts of ozone to disinfect water by destroying microorganisms in water through oxidization. In addition, the ozone generated by our products can be used for industrial purposes as an oxidant or a catalyst. Our ozone generator is compact in design and can produce a high degree of ozone concentration: 20 mg/L — 150 mg/L when an oxygen source is used and 12 mg/L — 50 mg/L when an air source is used.
 
  •  Super Clean Water Tank.  Similar to the tank water treatment apparatus, our super clean water tank integrates filtration, ultraviolet sterilization, electromagnetic activation and water storage to eliminate heavy metals and harmful organic materials from tap water through filtration and absorption by high-quality filtration materials. Through combination of various water processing techniques, our super-clean water tank can store sterile super clean water, keep water in good quality, and eliminate secondary pollution that may arise in connection with the use of a traditional water tank or pool.
 
  •  Tank Water Treatment Apparatus.  Our tank water treatment apparatus integrates filtration, ultraviolet sterilization and electromagnetic activation to effectively remove heavy metals and harmful organic materials from tap water. By enhancing the activation of water molecules through high-frequency electromagnetism, it also makes the water easier to be absorbed by the human body. Through the combination of different processing techniques, this product can eliminate secondary pollution in water tanks or pools. Our tank water treatment apparatus also improves water quality, reduces turbidity and color of the water and improves the taste of water using the absorption effect of active carbon.
 
Wastewater treatment equipment
 
We currently produce 19 products used in the process of treating wastewater, including municipal sewage and industrial and agricultural wastewater. Industries such as petroleum, paper, pharmaceuticals and food and beverage also use our wastewater treatment equipment to separate solids from liquid in their manufacturing processes. Our belt-type thickener-filter press mono-block equipment is used to compress and dehydrate sludge in the wastewater treatment process for easy transportability. Compared with other similar water treatment products, we believe that the most significant advantage of our equipment is the integrated sludge concentration system designed to minimize space occupancy and lower energy consumption. We also produce aeration equipment designed to introduce an optimal level of oxygen to kill harmful microorganisms and to increase the growth of certain microorganisms that consume organic contaminants remaining in the wastewater. This


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equipment facilitates microorganisms’ digestion of organic contaminants in the water. To extend the lifespan of our aeration equipment, we cover or attach our proprietary rubber coating to our aeration pipes.
 
The chart below shows the basic process for wastewater treatment. The white boxes represent each stage in the wastewater treatment process, and the shaded boxes represent equipment that is used in a specific stage.
 
Wastewater Treatment Process:
 
(FLOW CHART)
 
 
* Indicates equipment we produce.
 
In wastewater treatment, wastewater is processed in multiple stages before the resulting clear liquid is reintroduced to a body of water or is otherwise reused. The goal of wastewater treatment is to reduce or remove organic matter, solids, disease-causing organisms and other pollutants. After wastewater is moved to adjusting tanks, large solid objects are screened and removed by grit equipment. Wastewater is then treated to physically separate solids and sludge from the liquid, allowing solid particles to settle to the bottom and greases to float to the top at the primary sedimentation tank. After that, water is transmitted to biochemical pools where aerators are used to introduce an optimal level of oxygen to kill harmful microorganisms or to increase the growth of certain microorganisms that consume organic contaminants remaining in the wastewater. Separation of smaller solids from wastewater is conducted at the secondary sedimentation stage. Afterwards, the resulting clear liquid is disinfected to kill harmful microorganisms before being reintroduced to a body of water or is otherwise reused. With proper treatment, solids and sludge collected in the treatment process can be recycled into useful materials such as fertilizers, coal and methane. We are currently researching technology for recycling sludge into reusable materials.


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The following describes our core products and the key features and competitive benefits of our wastewater treatment equipment:
 
  •  Belt-Type Thickener-Filter Press Mono-Block Machine.  After the aeration process, several of our products are used to separate the remaining solids from the wastewater. Our belt-type thickener-filter press mono-block machine uses gravity and compression to thicken and dehydrate sludge, creating a dry cake of separated solids and water ready for disinfection. We have developed this machine to minimize noise, odor and vibration and have also incorporated energy saving features to minimize operational costs.
 
  •  Microporous Aerator.  Aeration is a water treatment process that introduces an optimal level of oxygen to kill harmful microorganisms or to increase the growth of certain microorganisms that consume organic contaminants remaining in the wastewater. This product uses numerous dense micro-pores to introduce large amounts of oxygen into the wastewater.
 
  •  Sludge Screw.  Our sludge screw separates particles as small as 0.005 to 2 millimeters in diameter from the wastewater. This machine uses a fast-rotating helix that generates a strong centrifugal force to separate solid particles from the wastewater. It also produces a dry cake of separated solids and water ready for disinfection. We have developed this machine to minimize noise, odor and vibration and have also incorporated energy saving features to minimize operational costs.
 
  •  Ultraviolet Shelving Disinfection System.  Our ultraviolet shelving disinfection system purifies and disinfects wastewater. By using ultraviolet lamps with high efficiency, high intensity and long lifespan, this system generates C waveband (wavelength in T254nm) ultraviolet rays to effectively kill bacteria, pathogens and viruses in wastewater.
 
  •  Online Testing Equipment.  Our online testing equipment monitors water quality. It is an integrated online automatic monitoring system that employs modern remote sensing technology and special analyzing software. It can continuously monitor water quality on a real-time and remote basis, improving the efficiency of the transmission and analysis of water quality data. It can also quickly obtain the status of the water quality of key water bodies in major drainage areas. Our online testing equipment can be widely used in industrial sewage discharge monitor stations, automatic water monitor stations and wastewater plants.
 
  •  Grit Separator.  Our grit separator is used in a waste water treatment plant to separate grits from the mixture exhausted from a grit chamber. The grits are fully dehydrated and then unloaded to barrels through an outlet while the water, after being separated from grits, is drained into an inlet water channel. With a non-axle spiral and without bearings in the water, our grit separator is easy to install and maintain.
 
  •  Water Decanter.  Our water decanter is made of corrosion proof stainless steel and is used to remove clear water from wastewater storage tanks.
 
Manufacturing and Assembly
 
Our manufacturing and assembly operations involve the coordination of raw materials and components, some of which are sourced from third parties, internal production processes and external distribution processes. We manufacture, assemble and test our products at our manufacturing facility in the Langfang Economic & Technical Development Zone located approximately 40 kilometers outside of Beijing, China. We employ common manufacturing and assembly practices for our production lines, thus allowing us to leverage our current facility to expand our range of product offerings. Our manufacturing facility includes machining, welding and plastic and rubber workshops, a general-purpose assembly line and an equipment assembly line, as well as a specialized assembly line for producing specific electrical components. We are seeking to build new manufacturing facilities and production lines for new water treatment products. We also plan to improve and upgrade our existing manufacturing facilities and production lines related to the following products: ozone generators, sludge screws, circulating water treatment equipment, water purification equipment and belt-type thickener-filter press mono-block machines.


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As part of our overall strategy to lower production costs, we intend to produce more of our components for our products in-house to increase operational efficiencies. In addition, we plan to standardize certain components of our products within and across product lines to enable us to lower raw material and component costs and create a more efficient workflow. We apply an enterprise resource planning system to manage our manufacturing process. Specifically, we integrate all of our data and processes into a unified system and use a centralized database to store information on various system modules.
 
Distribution and Marketing
 
Distribution Network
 
We sell our products almost exclusively through distributors. Our nationwide distribution and sales network in China consisted of over 80 distributors and over 85 internal sales and marketing personnel. A distributor may distribute one or more of our products in one or more of our three product categories. Of these distributors, 57 distribute our circulating water treatment products, 46 distribute our water purification products and 35 distribute our wastewater treatment products. We generally have a diverse group of end-user customers throughout China for our three product categories, and our sales are not concentrated in one or a few major distributors. We believe our end-user customer and distributor diversity reduces our exposure to potential market risks. No single distributor accounted for more than 2.4%, 2.8%, 2.2% or 2.3% of our sales for 2006, 2007, 2008 and the nine months ended September 30, 2009, respectively. Our top five distributors accounted for approximately 13.0% of our sales for 2006, 2007 and 2008, and approximately 10.8% of our sales for the nine months ended September 30, 2009.
 
We believe that we have established a relatively mature and stable distribution network. Approximately 80% of our distributors have been working with us for over three years, approximately 70% have been working with us for over six years and approximately 20% have been working with us for over ten years. Our distribution network provides us with established access to end-user customers throughout China, enables us to be responsive to local market demand, allows us to effectively diversify our end-user customer base and enhances our ability to further penetrate the market within a short period of time. Our distributors are employed and compensated on a competitive basis based on sales performance. We enter into annual agency agreements with distributors specifying the terms of sales targets for that given year. At the beginning of each year, we hold conferences for our distributors for each of our product lines, during which new products and sales policies are often released. We also conduct monthly market analysis meetings to collect market information, analyze the market environment and solve existing marketing issues. We actively manage our distribution network. In order to maximize our penetration of target markets and our sales opportunities, we regularly evaluate the performance of our distributors and terminate distributors that fail to meet their sales targets at the end of their agreement term. For distributors who meet or exceed their sales targets, we provide incentives in the form of better product pricing and extended credit terms.
 


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(MAP)
 
As indicated in the map above, our distributors are widely dispersed throughout each major region in China. As of September 30, 2009, we had 13 distributors in northeast China, 20 distributors in north China, seven distributors in northwest China, seven distributors in southwest China, 15 distributors in mid-south China, five distributors in south China and 15 distributors in east China. The expansive reach of our distribution and sales network allows our end-user customers, no matter where they are located in China, easy access to our products and services. If there is substantial economic activity relating to water treatment in any given province, we divide that province into several regions. Each year, we designate a select number of distributors in each region to promote our products. Our sales personnel often operate from the offices of our distributors and provide distributors on-site support.
 
Our distributors have the right to sell our products in one or more of our three product categories in a defined territory. We ensure that our distributors do not compete with each other in a defined territory by either assigning them different product categories or different end-user customer base for the same product category. We select distributors based on their prior sales performance. We also make selections based on factors such as sales experience, knowledge of water treatment equipment, contacts in the water treatment industry, reputation and market coverage.
 
Marketing
 
We support our distributors’ sales efforts through a coordinated marketing effort. We promote our products by participating in biennial government-sponsored environmental protection equipment conferences and annual food and power industry conferences. In the third quarter of 2009, we engaged China Central Television, or CCTV, to develop a television advertising campaign to further increase brand awareness and further drive sales growth. Through December 31, 2009, we incurred expenses of RMB22.9 million ($3.4 million) for this campaign, which includes RMB15.6 million ($2.3 million) for the fourth quarter of 2009. TV advertising expenses for the fourth quarter of 2009 included (1) two contracts that were signed with CCTV in August 2009 for airtime expenses through December 2009 and (2) monthly payments on a separate broker


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contract that was signed in September 2009 for advertising production and airtime expenses that was scheduled to run through September 2010. In December 2009, the broker contract was terminated and we entered into two new advertising contracts with CCTV for which we expect to incur selling expenses of RMB15 million ($2.2 million) and RMB15.3 million ($2.2 million) for the first and second quarters of 2010, respectively. These two contracts expire at the end of June 2010. We also advertise our products in industry journals, post our product information on various e-commerce websites and distribute brochures and sales manuals to potential end-user customers. In addition, we promote our products at monthly symposiums held in engineering design institutes and at training sessions held for local branch chiefs of the Chinese environmental protection agency. We continue to foster our relationships with relevant industry associations (e.g., those for steel and iron, pharmaceuticals and power generation) and potential large end-user customers (e.g., oil fields and wastewater treatment plants) to ensure our products can easily accommodate the needs of these customers. We provide training to sales representatives who promote our products on behalf of our distributors and rotate them annually to avoid entrenchment of sales personnel with a specific distributor.
 
We channel most of our sales with end-user customers through our distribution network, and we acquire many of our sales contracts through competitive bidding processes for construction projects, in which our distributors often submit bids on our behalf. Engineering design institutes are another sales channel for us. Our distributors promote our products with mid-sized engineering design institutes while we direct our selling efforts to the larger institutes. We also hold promotional conferences for our products at certain design institutes on a monthly basis. Institutes often recommend our products for use in construction projects and cross-market our products to their own customers. When we develop new products, these institutes may install sample products for our key end-user customers before the products are introduced on a commercial scale to other customers.
 
Suppliers and Raw Materials
 
The key raw materials and components used in the manufacturing of our products are steel, rubber, resin and plastics, standardized mechanical parts and electric machinery. We purchase a small percentage of electronic components from suppliers who import these components. Our other raw materials and components are purchased from Chinese subsidiaries of foreign suppliers or local suppliers, each of whom manufacture these components in China. We produce all other components internally. The use of local suppliers in close proximity to our facility enables us to closely supervise them, provide technical training relating to our product requirements and suggest technical improvements and innovations. Although we outsource the production of certain non-critical components to third-party contractors in China, we produce key components for most of our products, including those with patented applications, at our manufacturing facility. Producing key components at our manufacturing facility allows us to ensure product quality, protect our proprietary rights, reduce unnecessary costs and enhance the market competitiveness of our products.
 
We obtain raw materials and components from suppliers through non-exclusive purchase orders and supply contracts. The purchase order or contract specifies the price for the raw material or component and design-related specifications, if any. Although we allow for adjustments in the price for certain raw materials, such as steel, under extraordinary circumstances, the prices for our materials are generally fixed for the effective term of the purchase agreement. Our contracts with our suppliers are generally renewable on an annual basis. We typically negotiate with our suppliers to renew supply contracts at the beginning of each year, taking into account the quality and consistency of the materials and services provided. We maintain multiple supply sources for each of our key raw materials so as to minimize any potential disruption of our operations and maintain sourcing stability. For 2006, 2007, 2008 and the nine months ended September 30, 2009, purchases from our largest supplier accounted for 27.0%, 21.5%, 18.8% and 19.6%, respectively, of our total purchases of raw materials and components. For the same periods, our ten largest suppliers combined accounted for 70.3%, 69.5%, 77.6% and 78.0%, respectively, of our total purchases of raw materials and components. As of September 30, 2009, our top three suppliers accounted for 19.6%, 15.6% and 12.4% of our total purchases.


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Quality Control
 
We have implemented a rigid quality control system and devote significant attention to quality control procedures at every stage of our manufacturing process. We monitor our manufacturing process closely and conduct performance and reliability testing to ensure our products meet our end-user customer expectations. In addition, we seek regular feedback from our end-user customers on the quality of our products. Our quality control group as of September 30, 2009 included eight employees that implement various management systems to improve product quality and standardization programs, 20 employees that administer quality-related solutions in the manufacturing process and 38 employees that inspect our raw materials and finished products prior to shipping. Our quality control process includes:
 
  •  Inspection of Raw Materials and Components.  We inspect by random sampling our raw materials and components, including those purchased from or designed by third parties, to ensure compliance with quality standards. We also evaluate the quality and delivery performance of each supplier periodically and adjust quantity allocations accordingly.
 
  •  In-Process Quality Control.  We monitor every stage of our manufacturing process to verify conformity with specific quality control requirements. We compile statistical data for analysis and inspect and conduct performance testing to ensure compliance with quality standards.
 
  •  Outgoing Quality Control.  We inspect each shipment of finished products prior to delivery. Products that do not meet our quality standards will be re-worked and subjected again to the same inspection and performance testing process.
 
We passed the ISO 9001 Quality Assurance System Standards in 1996 and the ISO 14001 Environmental Management System Standards in 1999 and will continue to maintain registration under these standards.
 
Our Customer Support and Services
 
During the warranty period, we provide installation, training, technical support, warranty, maintenance and repair services to our end-user customers. Although these after-sale services to our end-user customers are not provided for under the terms of the sales contracts, we provide these services to maintain good relationships with them. Our distributors often handle simple maintenance and repair matters for end-user customers, while our technical service personnel provide customer service for more complex repairs or training. Our products have warranty periods of either six months or one year, which we believe are typical for water treatment products. Services that we provide during the warranty period include training, telephone support, replacement of components and on-site maintenance and repair. At the end of the warranty period, maintenance and repair services are provided to end-user customers by our distributors for a fee charged by and paid to our distributors. For all of our services to our end-user customers, our technical service staff attempts to quickly identify whether an issue can be resolved over the telephone or if it will require a visit to our end-user customer’s premises. Solutions to simple problems can be delivered over the telephone. Otherwise, we will, typically within 24 hours thereafter, either mail replacement components to our end-user customer or provide on-site operating guidance, training and repair.
 
During the warranty period, we provide comprehensive after-sales repair and maintenance services to our end-user customers not only to satisfy the needs of these customers but also to obtain systematic feedback on the performance of our products. We periodically review distributor and end-user customer calls to ensure that issues raised are resolved to their satisfaction. Our service staff solicits customer satisfaction on a monthly basis through telephone interviews or on-site visits. Our service staff compiles data on services provided, analyzes feedback solicited from end-user customers and suggests corresponding measures for improvement by working with our relevant production groups.
 
Research and Development
 
As of December 31, 2009, we had 148 members in our research and development group. Our research and development activities are based in our research and development center located in the Langfang Economic & Technical Development Zone near Beijing, China. In addition, we have established a


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post-doctorate, Chinese government approved research center that focuses on the development of water treatment technology. Our research and development center is comprised of water, chemical, bio-analysis, pollution control, segregation, membrane and electrical control laboratories. Through this center, we are cooperating with leading universities and institutes, such as the Research Center for Eco-Environmental Sciences of the Chinese Academy of Sciences, or the Center for Environmental Sciences, and the Chemistry Department of Tsinghua University, or Tsinghua University, in water treatment related research activities.
 
In March 2005, we entered into a cooperative agreement with the Center for Environmental Sciences to recruit post-doctoral researchers in the field of water treatment technology development. In connection with this agreement, we have established a post-doctorate research center, providing funding to post-doctoral researchers working on research projects proposed by us. We pay the Center for Environmental Sciences management fees for these post-doctoral researchers who stay at our center for two years. We own all rights, title and interest in any proprietary information resulting from the post-doctoral researchers’ work at our center. The Center for Environmental Sciences may, upon our consent, publish dissertations or academic articles relating to this proprietary information.
 
In March 2005, we also entered into a cooperative agreement with Tsinghua University to cooperate in the development of photocatalysis and drinking water purification technologies. Under the terms of this agreement, we have provided Tsinghua University with research funding of RMB100,000. Tsinghua University has the right, title and interest in the proprietary information and the Company has the right to use any proprietary information in connection with this agreement. Tsinghua University may not transfer any proprietary information under the agreement without our consent.
 
We believe we have a strong and balanced research and development team and are not dependent on a small number of key researchers. Of the 148 members that comprise our research and development group, 83 have a bachelor’s degree, 58 have a master’s degree and 7 have a doctorate degree. Approximately 14.9% of our research and development group have been with us for over ten years.
 
Drawing upon the talents of our research and development group and elsewhere, our research and development activities have led to eight patent grants in China covering a wide range of water treatment devices, including devices for multi-function water tank, water purification, centralized water treatment device, and chemical-oxygen-demand online monitoring.
 
In addition to improving our existing product offerings, our research and development efforts will focus on establishing a research and development center for water environment and equipment, which will be responsible for studying and researching the characteristics of the water environment and the theories of water treatment systems for different water qualities, and the development of new production methodologies to improve our manufacturing processes. We follow advanced project selection procedures prior to the development of new products, including the use of detailed market and technological analyses. All new products are subject to rigorous testing prior to production and sample products are often delivered to end-user customers for their trial use. We begin manufacturing new products only after the sample product from a trial production passes internal inspection and achieves customer satisfaction. This integrated approach allows us to identify potential difficulties in commercializing our product and make adjustments as necessary to develop cost-efficient manufacturing processes prior to mass production. We recognize the importance of customer satisfaction for our newly-developed products and continue to seek feedback from our end-user customers even after the formal launch of a product.
 
Intellectual Property
 
We regard our copyrights, trademarks, trade secrets and other intellectual property rights as critical to our business. We rely on trademark and copyright laws, trade secret protection, non-competition and confidentiality and/or licensing agreements with our executive officers, clients, contractors, research and development personnel and others to protect our intellectual property rights. Except with respect to the trademarks described in the following paragraph, we do not possess any licenses to use third-party intellectual property rights nor do we license to third-parties any intellectual property rights we own.


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Prior to the trademark transfer described below, through one of our subsidiaries, Duoyuan Beijing, we have 21 trademarks registered with the Chinese Trademark Office and five applications pending for Chinese trademark registration. On December 1, 2007, we entered into four separate agreements to transfer and assign all of our rights, title and interest in our trademarks to Duoyuan Investments Limited, our majority shareholder, without monetary consideration. We entered into these transfer agreements with our then sole shareholder to reflect and affirm the original intent and understanding of the parties that not just we, but any affiliate and subsidiary of Duoyuan Investments Limited, would have the right to use these trademarks. These trademarks were transferred to allow Duoyuan Investments Limited, as the sole owner and holder of the trademarks, to have the right to license these trademarks to its affiliates and subsidiaries. We received final regulatory approval for the transfer of these trademarks on July 21, 2008 and August 21, 2008. On September 17, 2008 and May 27, 2009, Duoyuan Investments Limited granted us an exclusive, royalty-free perpetual license to use these trademarks for our business. Such license would terminate upon certain events, including a change in control.
 
Through Duoyuan Beijing, we have eight patents registered with the Chinese Patent Office, two of which will expire on September 2010, one of which will expire on October 2010, three of which will expire on October 2017, one of which will expire on October 2020, and one of which will expire on August 2023. Of the eight patents, two are for inventions, five are for utility models and one is for design. In addition, we have three applications pending for Chinese patent registration. We currently have a number of consultants that work for us on various technological issues. Each of these consultants are contractually obligated to assign to us all intellectual property rights produced by such consultants during the consulting period.
 
The protection afforded by our intellectual property may be inadequate. It may be possible for third parties to obtain and use, without our consent, intellectual property that we own or are licensed to use. Unauthorized use of our intellectual property by third parties, and the expenses incurred in protecting our intellectual property rights, may adversely affect our business. See “Risk Factors — Risks Related to Our Business — Our failure to adequately protect, or uncertainty regarding the validity, enforceability or scope of, our intellectual property rights may undermine our competitive position, and litigation to protect our intellectual property rights may be costly.”
 
We may also be subject to litigation involving claims of patent infringement or violation of other intellectual property rights of third parties. In May 2005, we implemented and continue to follow a procedure under which our product development teams are required to conduct a patent clearance search of Chinese patents for each product at the beginning of the product development process. Typically, our research and development engineers conduct this search with guidance and oversight from our in-house patent team. The product development project is approved only if the result of the patent search is that the proposed product would not infringe on any third party intellectual property uncovered in the search. We believe that our risk of infringing third party intellectual properties can be effectively reduced by our adherence to these procedures. To date, we have not been sued on the basis of, nor have we received any notification from third parties that allege infringement of their intellectual property rights. However, due to the complex nature of water treatment technology patents and the uncertainty of construing the scope of these patents, as well as the limitations inherent in our patent searches, the risk of infringing on third party intellectual properties cannot be eliminated. See “Risk Factors — Risks Related to Our Business — We may be exposed to infringement or misappropriation claims by third parties, which, if determined adversely against us, could disrupt our business and subject us to significant liability to third parties.”
 
Competition
 
We operate in a highly competitive industry characterized by rapid technological development and evolving industry standards. We compete primarily on the basis of customer recognition and industry reputation, established nationwide distribution network, research and development strength, comprehensive product offerings, and a competitive cost structure. We believe we can continue to compete successfully with international competitors because of our competitive cost structure and with local competitors because of our superior technology. Our established nationwide distribution and customer service network and knowledge of local markets provide us with an advantage over international competitors who typically appoint only one


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distributor in the Chinese market who is responsible for selling and servicing their products. In addition, we provide a more comprehensive set of products than most of our international or local competitors. In order to maintain and enhance our competitive advantage, we must continue to focus on competitive pricing and technological innovation by being at the forefront of market trends and improving our proprietary manufacturing processes.
 
We compete with both major international conglomerates and local companies in each of our product categories as follows:
 
  •  Circulating Water Treatment Equipment.  Our electronic water conditioner competes primarily with products from three other local companies: Zhejiang De’an New Technology Development Co. Ltd. (China), Jiangyin Jialong Environment Technology Co. Ltd. (China) and Beijing Kejingyuan Huanyu Technology Development Co. Ltd. (China). Our automatic filter competes primarily with products from Claude Laval Co. (USA), FILTOMAT Ltd. (Israel) and Shijiazhuang Yuquan Environmental Protection Equipment Co. Ltd. (China).
 
  •  Water Purification Equipment.  Our ozone generator competes primarily with products from Ozonia Ltd. (Switzerland), WEDECO AG (Germany) and Shanghai Environmental Protection Equipment Factory (China). Our industry pure water equipment with EDI functions compete primarily with products from GE Water & Process Technologies, CANPURE Corporation (Canada) and Zhejiang Omex Environmental Engineering Ltd. (a subsidiary of Dow Chemical).
 
  •  Wastewater Treatment Equipment.  Our microporous aerator competes primarily with products from REHAU (Germany), ITT (Sweden) and Zhejiang Yuhuan Jieda Water Supply & Disposal Equipment Co. Ltd. (China). Our belt-type thickener-filter press mono-block machine competes primarily with products from Wuxi Tongyong Machinery Co. Ltd. (China), DWT Project Co. Ltd. (Finland) and Passavant-Roediger GmbH (Germany).
 
Although we believe that our competitive strengths provide us with advantages over many of our competitors, some of our international competitors have stronger brand names, greater access to capital, longer operating histories, longer or more established relationships with their customers, stronger research and development capabilities and greater marketing and other resources than we do; and some of our domestic competitors have stronger customer bases, better access to government authorities and stronger industry-based background than us. If we fail to maintain or improve our market position or fail to respond successfully to changes in the competitive landscape, our business, financial condition and results of operations may suffer.
 
Properties
 
Under Chinese law, all of the land in China is either state-owned or collectively-owned, depending on its location and the specific laws governing such land. Collectively-owned land is owned by rural collectives and generally cannot be used for non-agricultural purposes unless approved by the Chinese government. Collectively-owned land cannot be transferred, leased or mortgaged to non-collectives without first being converted into state-owned land. Individuals and entities may acquire rights to use state-owned land, or land-use-rights, for commercial, industrial or residential purposes by means of mutual agreement, tender, auction or listing for sale from local land authorities or an existing holder of a land-use-right. Land-use-rights granted for commercial, industrial and residential purposes may be granted for a period of up to 40, 50 or 70 years, respectively. This period may be renewed at the expiration of the initial and any subsequent terms, subject to compliance with relevant laws and regulations. Land-use-rights are transferable and may be used as security for borrowings and other obligations.
 
We are headquartered at No. 3 Jinyuan Road in the Daxing Industrial Development Area located in Beijing, China. Prior to the sale transaction described below, our subsidiary, Duoyuan Beijing, owned approximately 15,400 square meters of building area and the right to use the underlying land area of approximately 7,230 square meters for 50 years commencing in October 1998. In August 2007, Duoyuan Beijing entered into a sale agreement to sell its office premises in Beijing to Duoyuan Information Terminal Manufacture (Langfang) Co., Ltd., or Langfang Terminal. Since the execution of this transfer of properties in


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