20-F 1 d322256d20f.htm FORM 20-F Form 20-F
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 20-F

ANNUAL REPORT

PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the fiscal year ended December 31, 2011

Commission file number: 001-33878

 

 

 

Gushan Environmental Energy Limited

(Exact name of Registrant as specified in its charter)

 

 

Cayman Islands

(Jurisdiction of incorporation or organization)

 

 

No. 12, Harbour District

Changan Investment Zone,

Fuzhou Mawei Economic & Technical Development Area

Fujian Province

People’s Republic of China

(Address of principal executive offices)

 

 

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

 

Title of each Class

       

Name of each exchange on which registered

American Depositary Shares, each representing ten ordinary shares, par value HK$0.00001 per share       New York Stock Exchange

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

None

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

None

 

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

 

Ordinary shares, par value HK$0.00001 per share    190,831,943

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

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

Note—Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x     

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

 

U.S.GAAP  x    International Financial Reporting Standards as issued

by the International Accounting Standards Board  ¨

   Other  ¨

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

 

 

 


Table of Contents

GUSHAN ENVIRONMENTAL ENERGY LIMITED

TABLE OF CONTENTS

 

INTRODUCTION

     1   

FORWARD-LOOKING STATEMENTS

     2   
PART I.   

ITEM 1.

 

IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

     3   

ITEM 2.

 

OFFER STATISTICS AND EXPECTED TIMETABLE

     3   

ITEM 3.

 

KEY INFORMATION

     3   
 

A. Selected Financial Data

     3   
 

B. Capitalization and Indebtedness

     7   
 

C. Reasons for the Offer and Use of Proceeds

     7   
 

D. Risk Factors

     7   

ITEM 4.

 

INFORMATION ON THE COMPANY

     36   
 

A. History and Development of the Company

     36   
 

B. Business Overview

     37   
 

C. Organizational Structure

     53   
 

D. Property, Plant and Equipment

     54   

ITEM 4A.

 

UNRESOLVED STAFF COMMENTS

     56   

ITEM 5.

 

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

     56   
 

A. Operating Results

     57   
 

B. Liquidity and Capital Resources

     87   
 

C. Research and Development

     90   
 

D. Trend Information

     90   
 

E. Off-Balance Sheet Commitments and Arrangements

     90   
 

F. Tabular Disclosure of Contractual Obligations

     90   

ITEM 6.

 

DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

     91   
 

A. Directors and Senior Management

     91   
 

B. Compensation

     93   
 

C. Board Practices

     95   
 

D. Employees

     97   
 

E. Share Ownership

     97   

ITEM 7.

 

MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

     103   
 

A. Major Shareholders

     103   
 

B. Related Party Transactions

     103   
 

C. Interests of Experts and Counsel

     104   

ITEM 8.

 

FINANCIAL INFORMATION

     105   
 

A. Consolidated Statements and Other Financial Information

     105   
 

B. Significant Changes

     106   

ITEM 9.

 

THE OFFER AND LISTING

     107   
 

A. Offering and listing details

     107   
 

C. Markets

     108   

ITEM 10.

 

ADDITIONAL INFORMATION

     109   
 

A. Share capital

     109   

 

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B. Memorandum and Articles of Association

     109   
 

C. Material Contracts

     109   
 

D. Exchange Controls

     109   
 

E. Taxation

     109   
 

F. Dividends and Paying Agents

     114   
 

G. Statement by Experts

     114   
 

H. Documents on Display

     114   
 

I. Subsidiaries Information

     115   

ITEM 11.

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     116   

ITEM 12.

 

DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

     118   
 

A. Debt Securities

     118   
 

B. Warrants and Rights

     118   
 

C. Other Securities

     118   
 

D. American Depositary Shares

     118   
PART II.   

ITEM 13.

 

DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

     120   

ITEM 14.

 

MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

     120   

ITEM 15.

 

CONTROLS AND PROCEDURES

     120   

ITEM 16A.

 

AUDIT COMMITTEE FINANCIAL EXPERT

     121   

ITEM 16B.

 

CODE OF ETHICS

     121   

ITEM 16C.

 

PRINCIPAL ACCOUNTANT FEES AND SERVICES

     121   

ITEM 16D.

 

EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

     122   

ITEM 16E.

 

PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

     122   

ITEM 16F.

 

CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

     122   

ITEM 16G.

 

CORPORATE GOVERNANCE

     122   
PART III.   

ITEM 17.

 

FINANCIAL STATEMENTS

     124   

ITEM 18.

 

FINANCIAL STATEMENTS

     124   

ITEM 19.

 

EXHIBITS

     124   

 

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INTRODUCTION

Unless the context otherwise requires, in this annual report on Form 20-F,

 

   

“we,” “our,” “us,” “Company,” “our Group,” “the Group,” “Gushan” or “Gushan Environmental” refers to Gushan Environmental Energy Limited, a Cayman Islands company and its predecessor entities and consolidated subsidiaries, as the context requires;

 

   

“China” or the “PRC” refers to the People’s Republic of China, and, for the purposes of this annual report, excludes Hong Kong, Macau, and Taiwan;

 

   

“RMB” or “Renminbi” refers to the legal currency of China;

 

   

“$,” “US$” or “U.S. dollars” refers to the legal currency of the United States;

 

   

“HK$,” “HKD” or “Hong Kong dollars” refers to the legal currency of Hong Kong;

 

   

“production capacity” for any given year is estimated based upon 300 annual working days for our biodiesel and copper operations;

 

   

“tons” refers to metric tons;

 

   

“diesel” refers to conventional, petroleum-based diesel fuel;

 

   

“vegetable oil offal” refers to both acidified and non-acidified vegetable oil offal;

 

   

“2006 Notes” refers to the US$25.0 million zero coupon convertible notes that we issued in February 2006 in an aggregate principal amount of US$25.0 million, all of which were converted into 13,011,943 of our ordinary shares in November and December 2007;

 

   

“ordinary shares” refers to our ordinary shares, par value HK$0.00001 per share;

 

   

“PRC subsidiaries” refers to our subsidiaries incorporated in the People’s Republic of China, including Chongqing Gushan, Hunan Gushan, Shanghai Gushan, Beijing Gushan, Fujian Gushan, Handan Gushan, Sichuan Gushan, Biomass, Jin Xin and Xiangbei;

 

   

“ADSs” refers to our American depositary shares, each of which represents ten of our ordinary shares; and

 

   

“U.S. GAAP” refers to generally accepted accounting principles in the United States.

 

   

“IFRS” refers to the International Financial Reporting Standards, as issued by the International Accounting Standards Board.

Discrepancies in any table between the amounts identified as total amounts and the sum of the amounts listed therein are due to rounding.

On November 12, 2010, we changed the ratio of our ordinary shares to ADSs from two ordinary shares to one ADS to ten ordinary shares to one ADS. We present all per ADS data and number of ADSs in this annual report as if the ratio change was effective as of the beginning of the earliest period presented.

We and certain selling shareholders of our Company completed our initial public offering of 18,000,000 ADSs (equivalent to 3,600,000 ADSs after the ratio change on November 12, 2010), representing 15,000,000 ADSs (equivalent to 3,000,000 ADSs after the ratio change on November 12, 2010) sold by our Company and 3,000,000 ADS (equivalent to 600,000 ADSs after the ratio change on November 12, 2010) sold by the selling shareholders, on December 24, 2007. On December 19, 2007, we listed our ADSs on the New York Stock Exchange, or NYSE, under the symbol “GU.” In January 2008, the underwriters exercised their over-allotment option for the purchase of an additional 1,227,306 ADSs (equivalent to 245,461 ADSs after the ratio change on November 12, 2010) from the selling shareholders.

Unless otherwise indicated, all translations from Renminbi to U.S. dollars and from U.S. dollars to Renminbi are made at US$1.00 = RMB6.2939, the noon buying rate for U.S. dollars in effect on December 31, 2011 in The City of New York for cable transfers of RMB as certified for customs purposes by the Federal Reserve Bank of New York. See Item 3.A, “Key Information—Selected Financial Data—Exchange Rate Information.” All translations from Hong Kong dollars to U.S. dollars were made at the rate of HK$7.7663 = US$1.00, the noon buying rate reported by the Federal Reserve Bank of New York on December 31, 2011. We make no representation that any amounts in Renminbi, Hong Kong dollars or U.S. dollars could be or could have been converted into each other at any particular rate or at all.

 

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FORWARD-LOOKING STATEMENTS

This annual report on Form 20-F, including in particular Item 3.D, “Key information—Risk Factors,” Item 4, “Information on the Company,” and Item 5, “Operating and Financial Review and Prospects,” contains statements that relate to future events, including our future operating results and conditions, our prospects and our future financial performance and condition. These statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.

In some cases, these forward-looking statements can be identified by words or phrases such as “anticipate,” “believe,” “expect,” “estimate,” “predict,” “seek,” “potential,” “continue,” “future,” “intend,” “may,” “ought to,” “plan,” “should,” “target,” “will,” negatives of such terms or other expressions. 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:

 

   

changes in governmental policies, laws or regulations in China, including PRC tax laws that may have uncertain implications on biodiesel and recycled copper companies;

 

   

the effects of price fluctuations for biodiesel, biodiesel by-products and copper;

 

   

estimates of future production capacities, volumes and operating costs;

 

   

the effects of natural disasters;

 

   

the effect of intensifying competition in the biodiesel, alternative energy industries, and metal and metal consuming industries;

 

   

the availability of suitable raw materials on terms acceptable to us;

 

   

changes in the general operating environment in China;

 

   

various business opportunities that we may pursue; and

 

   

general economic, market and business conditions in China.

The forward-looking statements contained in this annual report speak only as of the date of this annual report 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 annual report. 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 annual report or to reflect the occurrence of unanticipated events. All forward-looking statements contained in this annual report are qualified by reference to this cautionary statement.

 

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PART I.

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable.

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

ITEM 3. KEY INFORMATION

A. Selected Financial Data

The following tables present our selected consolidated financial information. You should read this information together with our consolidated financial statements and related notes and the information included under Item 5, “Operating and Financial Review and Prospects,” included elsewhere in this annual report. Our audited consolidated financial statements are prepared 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.

The selected consolidated statement of operations data and other selected consolidated financial data (other than ADS and U.S. dollar data) for the years ended December 31, 2009, 2010 and 2011 and the selected consolidated balance sheet data (other than U.S. dollar data) as of December 31, 2010 and 2011 included in the tables below are derived from our audited consolidated financial statements included elsewhere in this annual report. The selected consolidated statement of operations data and other selected consolidated financial data (other than ADS and U.S. dollar data) for the years ended December 31, 2007 and 2008, and selected consolidated balance sheet data (other than U.S. dollar data) as of December 31, 2007, 2008 and 2009, included in the tables below is derived from, and qualified in its entirety by, our audited consolidated financial statements and related notes for such years which are not included in this annual report.

 

     Year ended December 31,  
     2007     2008     2009     2010     2011     2011  
     RMB     RMB     RMB     RMB     RMB     US$  
     (in thousands, except for percentage and per share data)  

Selected Consolidated Statement of Operations Data:

            

Revenues

     1,008,056        1,495,614        628,186        408,498        1,449,734        230,340   

Cost of revenues

     (568,973     (962,606     (766,686     (481,857     (1,404,926     (223,220
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit (loss)

     439,083        533,008        (138,500     (73,359     44,808        7,120   

Operating expenses(1)

     (55,955     (110,963     (129,092     (165,227     (140,173     (22,272

Impairment loss of property, plant and equipment

     —          —          —          (992,620     (603,266     (95,849

Impairment loss of goodwill

     —          —          —          —          (41,440     (6,584

Other operating income

     —          —          —          103,780        18,161        2,885   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

     383,128        422,045        (267,592     (1,127,426     (721,910     (114,700

Other income (expense)

     (104,356     (71,342     1,606        3,415        3,370        536   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) before income tax

     278,772        350,703        (265,986     (1,124,011     (718,540     (114,164

Income tax (expense) benefit

     (48,499     (81,693     (17,523     17,746        (18,083     (2,873
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

     230,273        269,010        (283,509     (1,106,265     (736,623     (117,037

Less: Net income attributable to non-controlling interests

     —          —          —          (2,750     (11,058     (1,757
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to the Company

     230,273        269,010        (283,509     (1,109,015     (747,681     (118,794
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) per share

            

—Basic

     1.84        1.61        (1.70     (6.68     (4.48     (0.71

—Diluted

     1.83        1.61        (1.70     (6.68     (4.48     (0.71

 

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     Year ended December 31,  
     2007     2008     2009     2010     2011  

Other Selected Consolidated Financial Data:

          

Gross profit (loss) margin(2)

     43.6     35.6     (22.0 )%      (18.0 )%      3.1

Operating profit (loss) margin(2)

     38.0     28.2     (42.6 )%      (276.0 )%      (49.8 )% 

Net income (loss) margin(2)

     22.8     18.0     (45.1 )%      (271.5 )%      (51.6 )% 

Earnings (loss) per ADS

     18.40        16.10        (16.99     (66.79     (44.75

Effect of tax holiday on earnings (loss) per share – basic (in RMB)(3)

     0.75        0.44        0.01        —          —     

Effect of tax holiday on earnings (loss) per share – diluted (in RMB)(3)

     0.75        0.44        0.01        —          —     

Dividends declared (in thousands of RMB)(4) (5)

     —          68,401        26,693        —          —     

Dividend declared per ordinary share (in RMB)(4) (5)

     —          0.41        0.16        —          —     

 

(1) Operating expenses consist of research and development expenses, selling, general and administrative expenses, other operating expenses, loss on disposal of property, plant and equipment, impairment loss of land use rights, impairment loss on VAT recoverables and change in fair value of contingent consideration liabilities.
(2) Gross profit (loss) margin, operating profit (loss) margin and net income (loss) margin represent gross profit (loss), operating profit (loss) and net income (loss), respectively, divided by revenues.
(3) Our PRC subsidiaries enjoyed tax holidays provided by local and national PRC tax authorities. See Item 5, “Operating and Financial Review and Prospects.” If our PRC subsidiaries had not enjoyed these tax holidays, our effective income tax rate would have been higher.
(4) Dividends declared and dividend declared per ordinary share expressed in US$ during the year ended December 31, 2008 amounted to US$10,026 and US$0.06, respectively, if translated at US$1.00 = RMB6.8225, the noon buying rate for U.S. dollars in effect on December 31, 2008 in The City of New York for cable transfers of RMB as certified for customs purpose by the Federal Reserve Bank of New York.
(5) Dividends declared and dividend declared per ordinary share expressed in US$ during the year ended December 31, 2009 amounted to US$3,911 and US$0.02, respectively, if translated at US$1.00 = RMB6.8259, the noon buying rate for U.S. dollars in effect on December 31, 2009 in The City of New York for cable transfers of RMB as certified for customs purpose by the Federal Reserve Bank of New York.

 

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     Year ended December 31,  
     2007      2008      2009      2010      2011  

Selected Operating Data:

              

Sales volume of biodiesel(1) (tons)

     182,969         231,377         143,818         42,391         8,178   

Average selling price of biodiesel(1) (in RMB/ton)

     4,621         5,748         4,040         4,505         5,742   

Sales volume of by-products(2) (tons)

     22,134         23,878         18,469         6,314         1,464   

Average selling price of by-products(2) (in RMB/ton)

     7,346         6,936         2,554         1,972         2,589   

Sales volume of copper products(3) (tons)

     —           —           —           3,787         23,154   

Average selling price of copper products(3) (in RMB/ton)

     —           —           —           53,697         57,113   

 

(1) Sales volume of biodiesel includes biodiesel sold as a refined oil product to the fuel market and biodiesel sold as fatty acid methyl ester, an intermediate product to the chemical industry. Average selling price of biodiesel represents total average selling price of biodiesel sold as a refined oil product to the fuel market and biodiesel sold as an intermediate product to the chemical industry.
(2) By-products are composed of glycerine, stearic acid, erucic acid, erucic amide, plant asphalt and refined glycerine.
(3) On November 3, 2010, we acquired an initial 67% indirect ownership interest in Mian Yang Jin Xin Copper Company Limited (“Jin Xin”). The results of Jin Xin’s operations have been included in our consolidated financial statements since that date. Jin Xin manufactures copper rods, copper wires and copper granules from recycled copper in Sichuan. Jin Xin has one plant in Sichuan, with a daily production capacity of approximately 160 tons of copper products. On January 1, 2011, we acquired an additional 8% indirect ownership interest in Jin Xin and increased our indirect ownership interest in Jin Xin to 75%. On August 1, 2011, we acquired a 75% indirect ownership interest in Hunan Yin Lian Xiangbei Copper Company Limited (“Xiangbei”). The results of Xiangbei’s operations have been included in our consolidated financial statements since that date. Xiangbei manufactures copper rods and copper plates from recycled copper and electrolytic copper in Hunan Xiangbei has one plant in Hunan with a daily production capacity of approximately 50 tons of copper products.

 

     As of December 31,  
     2007      2008      2009      2010      2011      2011  
     RMB      RMB      RMB      RMB      RMB      US$  
     (in thousands, except number of shares)  

Selected Consolidated Balance Sheet Data:

                 

Cash

     1,380,735         963,228         571,188         272,822         65,519         10,410   

Accounts receivable

     31,110         12,926         2,414         48,639         215,772         34,283   

Inventories

     31,580         59,246         33,418         176,023         155,008         24,628   

Property, plant and equipment

     807,371         1,451,533         1,641,096         663,946         96,929         15,400   

Total assets(1) (2)

     2,309,794         2,604,036         2,379,129         1,338,650         706,685         112,281   

Short-term bank loans

     —           —           —           60,000         110,000         17,477   

Net assets

     2,181,301         2,377,770         2,096,863         1,001,913         251,619         39,978   

Total shareholders’ equity

     2,181,301         2,377,770         2,096,863         1,001,913         251.619         39,978   

Total liabilities and shareholders’ equity

     2,309,794         2,604,036         2,379,129         1,338,650         706,685         112,281   

Number of ordinary shares

     166,831,943         166,831,943         166,831,943         190,831,943         190,831,943         190,831,943   

 

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(1) During the year ended December 31, 2010, we determined that the fair value of property, plant and equipment related to our biodiesel business was lower than its carrying value and we recognized an impairment loss on property, plant and equipment of RMB951.0 million. In addition, we recognized an impairment loss of RMB41.7 million on property, plant and equipment in connection with the relocation of the production facilities of Sichuan Gushan Vegetable Fat Chemistry Co., Ltd. (“Sichuan Gushan”).
(2) During the year ended December 31, 2011, we determined that the fair value of property, plant and equipment and certain land use rights related to our biodiesel business was lower than their carrying value and we recognized an impairment loss on property, plant and equipment of RMB603.3 million (US$95.9 million) and an impairment loss of land use rights of RMB2.9 million (US$0.5 million). In addition, we recognized an impairment loss on goodwill of RMB41.4 million (US$6.6 million). We also determined that the VAT recoverables of our biodiesel business will not be utilized in the near future, therefore we recognized an impairment loss of VAT recoverable of RMB28.2 (US$4.5 million).

Exchange Rate Information

Our business is conducted in China and all of our revenues and the majority of our expenses are denominated in Renminbi. This annual report contains translations of Renminbi amounts into U.S. dollars at specified rates. Unless otherwise noted, all translations from Renminbi to U.S. dollar amounts 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, as of December 31, 2011, which was RMB6.2939 to US$1.00. We make no representation that the Renminbi or U.S. dollar amounts referred to in this annual report 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.

The following table sets forth information concerning exchange rates between the Renminbi and the U.S. dollars for the periods indicated. These rates are provided solely for your convenience and are not necessarily the exchange rates that we used in this annual report or will use in the preparation of our periodic reports or any other information to be provided to you. The exchange rate of Renminbi per U.S. dollar as set forth in the H.10 statistical release of the Federal Reserve Board was RMB6.3059 to US$1.00 as of May 4, 2012.

 

     Exchange Rate (Renminbi per U.S. Dollar)(1)  
     Average(2)      High      Low      Period-end  
     (RMB per US$1.00)  

2007

     7.6032         7.8127         7.2946         7.2946   

2008

     6.9477         7.2946         6.7800         6.8225   

2009

     6.8307         6.8470         6.8176         6.8259   

2010

     6.7696         6.8330         6.6000         6.6000   

2011

     6.4630         6.6364         6.2939         6.2939   

 

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     Exchange Rate (Renminbi per U.S. Dollar)(1)  
     Average(2)      High      Low      Period-end  
     (RMB per US$1.00)  

2011

           

November

     6.3564         6.3839         6.3400         6.3765   

December

     6.3482         6.3733         6.2939         6.2939   

2012

           

January

     6.3119         6.3330         6.2940         6.3080   

February

     6.2997         6.3120         6.2935         6.2935   

March

     6.3125         6.3315         6.2975         6.2975   

April

     6.3043         6.3150         6.2790         6.2790   

May (through May 4)

     6.3068         6.3089         6.3052         6.3059   

 

Source: Federal Reserve Bank of New York

 

(1) The source of the exchange rate is: (i) with respect to any period ending on or prior to December 31, 2008, the Federal Reserve Bank of New York, and (ii) with respect to any period ending on or after January 1, 2009, the H.10 statistical release of the Federal Reserve Board.
(2) Averages for a period are calculated by using the average of the exchange rates at the end of each month during the periods. Monthly averages are calculated by using the average of the daily rates during the relevant period.

B. Capitalization and Indebtedness

Not applicable.

C. Reasons for the Offer and Use of Proceeds

Not applicable.

D. Risk Factors

An investment in our ADSs involves significant risks. The risks and uncertainties described below are not the only ones we face. You should consider carefully all of the information in this annual report, including the risks and uncertainties described below and our consolidated financial statements and related notes, before making an investment in our ADSs. Any of the following risks could have a material adverse effect on our business, financial condition and results of operations. In any such case, the market price of our ADSs could decline, and you may lose all or part of your investment.

RISKS RELATING TO OUR BUSINESSES

A material disruption of our operations could adversely affect our businesses.

Our biodiesel and copper operations are subject to uncertainties and contingencies beyond our control that could result in material disruptions in our operations and adversely affect our business. These include industrial accidents, fires, floods, droughts, storms, earthquakes, natural disasters and other catastrophes, equipment failures or other operational problems, strikes or other labor difficulties and disruptions of public infrastructure. Any breakdown or malfunction of any production equipment could cause a material disruption of our operations that could lead to a reduction in, or halt in our production of biodiesel and/or copper products. Any reduction or halt in production could prevent us from meeting customer orders, adversely affect our business reputation, increase our costs of production or require us to make unplanned capital expenditures, all which could materially and adversely affect our businesses, financial condition and results of operations.

Electricity shortages could adversely affect our business, financial condition and results of operations and increases in the price of electricity and natural gas could increase our costs and lower our profitability.

All of our manufacturing assets and operations for our biodiesel and copper products businesses are located in China. Our operations are vulnerable to power shortages that generally affect enterprises located in China. Certain manufacturers in China, especially in eastern and southern China, have in recent years experienced electricity shortages. If there is insufficient electricity supply to satisfy our requirements and accommodate our planned growth, we may need to limit or delay our production or expansion plans. For example, our copper products business is dependent on electricity and natural gas to operate equipment and convert scrap copper into copper products. Accordingly, the successful operation of our facilities requires a reliable supply of electricity and natural gas. If the cities in which we have operations are affected by power outages or must ration power, our production volumes would decrease and our results of operations may be adversely affected.

 

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We cannot assure you that power shortages will not affect us in the future. In addition, we do not have any insurance coverage for business interruptions, including loss of profits resulting from such interruptions. Any losses that may occur as a result of these kinds of events could adversely affect our business, financial condition and results of operations.

In addition, increases in the price of electricity or natural gas would increase our operating costs. The energy industry in China has historically experienced shortages and price volatility as a result of a variety of factors, including surging demand as a result of rapid growth in China and disruptions in the supply of coal used to produce electricity. Any significant shortages of electricity and/or natural gas or prolonged blackouts would disrupt our operations, and as a result, negatively impact our operating results. In addition, significant increases in the price of electricity and/or natural gas would adversely affect our profitability if we were unable to pass on those additional costs to our customers.

We may not be able to adequately protect our intellectual property rights or may be subject to infringement claims.

We rely on a combination of patents, trademarks, domain names and contractual rights to protect our intellectual property. We cannot assure you that the measures we take to protect our intellectual property rights will be sufficient to prevent any misappropriation of our intellectual property, or that our competitors will not independently develop alternative technologies that are equivalent or superior to technologies based on our intellectual property.

We have three registered patents, which relate to our biodiesel business, two in China, each with a validity period of 20 years from August 7, 2002 and from March 9, 2005, respectively, and one in the United States with a validity period of 20 years and 5 months from April 25, 2008. We cannot assure you that these patent registrations will not be revoked or challenged during their validity periods. In addition, we have filed two patent applications with the State Intellectual Property Office of the PRC relating to methods of producing certain copper products. The legal regime governing intellectual property in China is still evolving and the level of protection of intellectual property rights in China may not be as effective as those in other jurisdictions. In the event that the steps we have taken and the protection afforded by law do not adequately safeguard our proprietary technology, we could suffer losses due to the sales of competing products that exploit our intellectual property, and our profitability would be adversely affected. Furthermore, we may incur additional overhead costs related to any intellectual property claims we initiate, which will impact our operating results.

Many international and domestic biodiesel producers and copper product manufacturers may have also patented certain technologies in connection with the production of their products. To the best of our knowledge, our production processes do not infringe any third party’s intellectual property rights. However, intellectual property rights are complex and there exists the risk that our processes may infringe, or be alleged to infringe, on another party’s intellectual property rights. The defense and prosecution of intellectual property suits, patent opposition proceedings 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. An adverse determination in any such litigation or proceeding to which we may become a party could subject us to significant liability to third parties, require us to seek licenses from third parties, to pay ongoing royalties, or to redesign our products or manufacturing processes or subject us to injunctions prohibiting the manufacture and sale of our products or the use of our technologies.

 

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Failure to comply with environmental regulations could harm our business.

We are subject to various PRC national and local environmental regulations related to our operations, including regulations governing the use, storage, discharge and disposal of hazardous substances and waste emission levels. If we fail to comply with the applicable environmental regulations, we could be subject to significant monetary damages and fines or suspensions of our operations, and our business, reputation and results of operations would be adversely affected. Further, any amendments to these laws and regulations may impose substantial pollution control measures that may require us to make significant expenditures to modify our production process or change the design of our products to limit actual or potential impact to the environment. Moreover, new laws, new interpretations of existing laws, increased governmental enforcement of environmental laws or other developments could require us to make significant additional expenditures, which may adversely affect our business, results of operations and financial condition.

In November 2006, we installed a covered storage tank at our Fujian plant at the recommendation of the local environmental bureau. We currently use uncovered storage tanks at our Hebei facilities. If we are required to undertake further compliance measures at any of our plants, our results of operations may be materially and adversely affected. As of the date of this annual report, Shanghai Gushan, which commenced operation in June 2008, has obtained a water discharge permit as required by the management authority of the industrial area in Fengxian, from the Fengxian branch of the Shanghai Water Authority. Beijing Gushan, which commenced operation in January 2008, has not obtained waste discharge permit from the relevant local environmental authorities.

We cannot assure you that waste discharge permits will be obtained or that our Beijing plant will not be materially and adversely affected as a result of its failure to obtain such permits. In addition, any perception of our noncompliance with environmental regulations could harm our business. For example, in August 2007, we experienced protests at our Fujian plant alleging environmental issues. As a result, our operations at the Fujian plant were disrupted for several hours. These and other risks relating to environmental compliance may materially and adversely affect our business, results of operations and financial condition.

We do not possess valid title to certain buildings that we occupy and commenced construction of certain buildings prior to obtaining the requisite construction approvals.

For some of the buildings and land we occupy, we have not yet obtained sufficient land use or title certificates that allow us to occupy, freely use or transfer the land or properties. As of December 31, 2011, Fujian Gushan, Beijing Gushan, Shanghai Gushan, Sichuan Gushan and Jin Xin have not obtained the building ownership certificates for buildings with a total gross floor area of approximately 319 square meters, 9,941 square meters, 7,956 square meters, 9,630 square meters and 16,736 square meters, respectively. As of December 31, 2011, the carrying value of these buildings amounted to RMB21.4 million (US$3.4 million). We currently use these properties as production facilities and ancillary facilities. We are in the process of carrying out completion inspections of these buildings and applying for the relevant building ownership certificates. Beijing Gushan and Jin Xin are also applying for land use right certificates with respect to land occupying a total gross floor area of approximately 54,965 and 8,391 square meters, respectively. As of December 31, 2011, the carrying value of these land use rights amounted to RMB18.3 million (US$2.9 million) and nil, respectively. On October 18, 2011, we signed an agreement to acquire the land use rights for the site on which we are currently constructing our new copper products facility for consideration of approximately RMB1.0 million. As of December 31, 2011, no payment had been made with respect to the acquisition of such land use rights. We cannot assure you that such building ownership or land use right certificates will be obtained. As a result of our lack of land use right certificates or vested legal title in these properties, we may incur additional costs to relocate our operations and our business operations and our financial condition may be adversely affected.

 

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In addition, Fujian Gushan, Beijing Gushan, Shanghai Gushan, Chongqing Gushan, Sichuan Gushan, Hunan Gushan and Jin Xin commenced construction of certain workshops or ancillary facilities prior to obtaining the construction approvals required by PRC construction law. Each of Fujian Gushan, Beijing Gushan, Shanghai Gushan, Chongqing Gushan, Sichuan Gushan, Hunan Gushan and Jin Xin may be subject to a maximum administrative penalty of RMB30,000 (US$4,767). As of December 31, 2011, Fujian Gushan, Beijing Gushan, Sichuan Gushan and Shanghai Gushan have not obtained all necessary approvals for construction of certain workshops or ancillary facilities of a total gross floor area of approximately 319 square meters, 9,941 square meters, 4,460 square meters and 2,335 square meters, respectively, and the relevant government authorities may require the buildings located on these sites to be demolished. As of December 31, 2011, the carrying value of these buildings amounted to nil. As of December 31, 2011, Jin Xin had not obtained all necessary approvals for construction of certain workshops or ancillary facilities of a total gross floor area of approximately 16,736 square meters, and the relevant government authority may require the buildings located on these sites to be demolished. As of December 31, 2011, the carrying value of these buildings amounted to RMB21.4 million (US$2.9 million). If the relevant government authorities impose penalties on us and require us to cease construction of or demolish these properties, we may incur additional costs and expenses for the relocation of these facilities.

Our insurance coverage may not be sufficient to cover our liability risks.

Consistent with customary practice in China, we do not carry any business interruption insurance, third-party liability insurance for personal injury or coverage for environmental damage arising from accidents at our production facilities. In addition, we have no product liability insurance coverage for our products, and prior to 2011, we had very limited product liability insurance coverage for our biodiesel business. The historical maximum payout for each claim was capped at RMB100,000, and the cumulative maximum payout under our product liability insurance policies ranges from RMB500,000 to RMB1,000,000. Should an uninsured or underinsured liability claim occur, our business operations and financial condition may be adversely affected. Further, if such incidents are publicized, our reputation maybe adversely affected, which could result in reduced and/or cancelled sales, thereby adversely affecting our revenues.

Our future performance depends on the continued service of our senior management and our ability to attract, train and retain skilled personnel.

Our future success depends on the continued service of our key management and technical staff, in particular, our founder, chairman and principal executive officer, Mr. Jianqiu Yu, our chief technology officer for our biodiesel business, Mr. Deyu Chen, the managing director of Jin Xin, Mr. Hanjiu Liu and the managing director of Xiangbei, Mr. Weiping Huang. Mr. Yu, our founder, plays a key role in the formation of our business strategy and has extensive knowledge of the local markets in which we operate our biodiesel business. In addition, Mr. Yu is instrumental in formulating our strategies for entering into new markets. Mr. Chen was instrumental in the development of our proprietary biodiesel manufacturing process and continues to play a key role in our technological development. Mr. Liu and Mr. Huang were instrumental in the development of our copper manufacturing processes and are responsible for the overall operation of Jin Xin and Xiangbei, including in key areas such as production, procurement and sales and distribution. If one or more of our key executives were unable or unwilling to continue in their present positions, we may not be able to replace them easily, our future growth may be constrained and our business may be disrupted and our financial condition and results of operation may be materially and adversely affected. While we have non-competition agreements with most members of our senior management, including Mr. Chen, Mr. Liu, Mr. Yu and Mr. Huang, we may be unable to continue to retain their services and there can be no assurance that they will not compete against us.

Our success also depends upon the continued service of our skilled personnel and on our ability to continue to attract, retain and motivate such personnel. There is intense competition to recruit technically competent personnel with expertise in the biodiesel and recycled copper industries and we have periodically experienced difficulties in recruiting suitable personnel. We may also need to offer relatively better compensation and other benefits in order to attract and retain these personnel in the future, and we cannot assure you that we will have the resources to achieve our staffing needs. Due to the skills involved in operating some of our equipment, skilled production workers are not easily replaceable, and considerable training is required for new hires. These difficulties could limit our output capacity or reduce our operating efficiency and product quality, which could reduce our profitability and limit our ability to grow.

 

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RISKS RELATING TO OUR COPPER PRODUCTS BUSINESS

Our dependence on a limited number of third-party raw material suppliers could adversely impact our production or increase our costs, which could harm our reputation or materially and adversely affect our business, results of operations and financial condition.

We purchase most of the raw materials for our copper products business from a limited number of third-party suppliers. In 2011, our five largest suppliers of our copper products business accounted for approximately 50.2% of our consolidated cost of revenues and our largest supplier accounted for 14.9% of our consolidated cost of revenues. We generally scrap copper on an order-by-order basis at prevailing market prices and do not have any long-term purchase contracts. As a result we may be unable to obtain scrap copper at acceptable prices and adequate quantities to satisfy our requirements. For example, during the fourth quarter of 2011, a number of our suppliers were unwilling to sell all of their inventories to us at market prices due to a decrease in the market price of scrap copper of 23.5% as compared to the third quarter of 2011. This in turn caused our revenue from our copper products business to decrease by 16.4% from RMB473.5 million (US$75.2 million) for the third quarter of 2011 to RMB395.8 million (US$62.9 million) for the fourth quarter of 2011.

The failure of any of our key suppliers to supply raw materials satisfying our quality, quantity and cost requirements in a timely manner could impair our ability to produce our products or could increase our costs. If we fail to maintain our relationships with major raw materials suppliers or fail to develop new relationships with other raw materials suppliers, we may be unable to produce our copper products, or we may only be able to produce our products at a higher cost or after lengthy delays.

Our operations are materially affected by the cost and availability of raw materials.

The raw materials used for our copper products business consist of scrap copper, primarily sourced from suppliers located in China. The price of such raw materials has fluctuated significantly since 2009. For example, the spot price of copper in China ranged from a low of approximately RMB27,000 per ton to a high of approximately RMB75,000 per ton during the period from 2009 to the end of the first quarter of 2012. As we generally pay prevailing market prices for scrap copper at the time of purchase, an increase in scrap copper prices would increase our need for working capital and financing, which may not be available on favorable terms, or at all, and may also increase our customers’ working capital requirements, which could result in delays in payments by our customers and increases in our trade receivables and bills receivable. Decreases in copper prices may result in a decrease in the selling price of our inventory, which would negatively affect our gross profit margin.

In the event we are unable to obtain a sufficient quantity of raw materials at reasonable prices, or to pass on higher raw material costs to our customers, our business, financial condition and results of operations could be materially and adversely affected.

We derive a significant portion of our revenues from a small number of customers and the loss of any of our major customers may cause significant declines in our revenues.

In 2011, the total revenues from our copper products business accounted for 96.3% of our consolidated revenues. However, we derive a significant portion of the revenues from our copper products business from a small number of customers, and we may be unable to maintain and expand our current customer relationships. In 2011, the five largest customers of our copper products business accounted for approximately 46.5% of the revenues from our copper products business and 44.8% of our consolidated revenues, while the largest customer accounted for approximately 14.3% of the revenues from our copper products business and 13.8% of our consolidated revenues.

We expect that we will continue to depend on a relatively small number of customers for a significant portion of our sales volume and revenues. If we lose any of our major customers for any reason, including, for example, if our reputation declines, a customer materially reduces its orders from us, our relationship with one or more of our major customers deteriorates, or a major customer becomes insolvent or otherwise unable to pay for our products, our business and results of operations may be materially and adversely affected.

 

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If the unit cost of raw materials increase and the average selling price of our products does not similarly increase or if the average selling price of our products decreases and the unit cost of our raw materials does not similarly decrease, our margins will decrease and our results of operations will be harmed.

Our gross margins from sales of copper products are principally dependent on the spread between raw material prices and copper product prices. If the unit cost of raw materials increase and the average selling price of copper products does not similarly increase or if the average selling price of copper products decrease and the unit cost of raw materials do not similarly decrease, our margins will decrease and results of operations will be harmed. Currently, there is a close correlation between production costs and prices of copper products, meaning that we are able to pass increased raw material costs on to our customers. However, any decrease in the spread between copper product prices and raw material prices, whether as a result of an increase in raw material prices or a reduction in copper product prices, would adversely affect our financial performance and cash flow.

We may not be able to effectively manage our current expansion, the failure of which could materially and adversely affect our business, results of operations and financial condition.

We are currently in the process of constructing an additional copper production facility located next to our Sichuan copper production facility. This facility, when completed, is expected to have a daily production capacity of 160 tons of copper products and an annual production capacity of approximately 48,000 tons of copper products. We expect to complete the construction of this facility during 2012. The construction of this facility may be subject to construction delays, cost overruns, failures or delays in obtaining government approvals or the inability to secure the necessary production equipment.

Any future expansion plans would require us to secure raw materials at competitive prices and to host a sufficiently large local customer base to support such expanded production. In addition, we may not have the necessary management or financial resources to oversee the successful and timely construction of new production facilities or expansion of existing facilities.

Furthermore, to effectively manage any future expansion we would need to improve our operational and financial systems and procedures and system of internal control. Our past growth has strained our resources and made it difficult to maintain and update our internal procedures and controls as necessary to meet the expansion of our overall business. We would need to expand, train and manage our employee base, or successfully establish new subsidiaries for the new or expanded facilities. We would also need to continue to maintain and expand our relationships with our customers, suppliers and other third parties.

We cannot assure you that we will be able to effectively manage any expansion or achieve any expansion at all in the future. If we are unable to do so, we may not be able to take advantage of market opportunities, execute our business strategies or respond to competitive pressures, any of which could materially and adversely affect our business, results of operations and financial condition.

We face significant competition, and if we do not compete successfully against existing and new competitors as well as competing technologies and other products, we may lose our market share and our results of operations may be materially and adversely affected.

With respect to our copper products business, we compete primarily with local companies and new entrants to the market, some of which may have lower cost structures than us due to lower capital expenditures or lower labor costs. As the barriers to entry in the industry are relatively low, the recycled copper industry in China is highly fragmented and competitive, with a large number of manufacturers throughout the country. We also compete with large companies and may face competition from foreign companies and metal manufacturers seeking to vertically integrate their operations. Some of our recycled copper competitors may have greater financial and other resources than us. Our copper products also compete with imported recycled copper and further appreciation of the Renminbi may lower the cost of imported recycled scrap copper and may intensify such competition. We cannot assure you that we will be able to compete successfully in our existing markets for copper products. Any increase in competition may adversely affect our business, financial condition and results of operations.

 

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We may not be able to successfully integrate our newly acquired copper products businesses or achieve expected profitability from our acquisitions.

Acquisitions have been, and are expected to continue to be, an element of our growth strategy for our copper products business. We acquired a 67% ownership interest in Jin Xin in November 2010 and subsequently increased our ownership interest to 75% in January 2011. We also acquired a 75% indirect ownership interest in Xiangbei in August 2011. In November 2011 we signed definitive agreements to acquire Guangzhou Taiyue Communications Cable Co. Ltd. (“Taiyue”), the consummation of which are subject to the satisfaction of customary closing conditions. If we cannot successfully integrate these or future acquisitions, joint ventures and other partnerships on a timely basis, we may be unable to generate sufficient revenue to offset acquisition costs, we may incur costs in excess of what we anticipate and our expectations of future results of operations and synergies may not be achieved. In addition, our results of operations may be adversely affected if we are unable to improve the efficiency of Jin Xin’s and Xiangbei’s operations.

Acquisitions involve substantial risks, including:

 

   

unforeseen difficulties in integrating operations, accounting systems and personnel;

 

   

diversion of financial and management resources from existing operations;

 

   

the need to attract and retain management and key employees;

 

   

unforeseen difficulties related to entering geographic regions where we do not have prior experience;

 

   

risks relating to obtaining sufficient equity or debt financing;

 

   

potential undisclosed liabilities; and

 

   

the loss of customers or suppliers.

In addition, if we finance future acquisitions by issuing equity or equity-related securities or issue such securities as part or all of the consideration for future acquisitions, the equity interests of our shareholders would be diluted, which, in turn, could adversely affect the market price of our ADSs. Moreover, we may finance acquisitions with debt, resulting in higher leverage and finance costs.

We may not be able to consummate the proposed acquisition of Taiyue.

On November 3, 2011, we entered into definitive agreements to acquire a controlling interest in Taiyue, a PRC-based company that is currently engaged in the manufacture and sale of copper cable for applications that include communications and personal computing. The consummation of the acquisition is subject to the satisfaction of, among others, customary closing conditions, including obtaining approvals from relevant PRC governmental authorities and no assurance can be given that the proposed acquisition will be consummated.

Our copper products business is subject to seasonality.

Demand for our copper products is subject to seasonal fluctuations. Demand for our copper products in China is generally higher in the second half of the year due to the Chinese New Year holiday in the first half of the year, during which some of our customers recess their operations for as long as three weeks. As a result, fluctuations in the demand for copper products during in the second half of the year may have a disproportionate impact on our results of operations.

Our copper products business and prospects depend heavily on the performance of metal and metal consuming industries in China.

Our copper products business and prospects depend heavily on the performance of the metal industry in China, particularly the copper industry, and the industries that consume copper in China. China has experienced rapid growth in recent years, which has contributed to the strong demand for copper. This, in turn, has resulted in strong demand for recycled scrap copper. A significant slowdown in the Chinese economy, or a downturn in the construction or manufacturing sectors in China, would likely adversely affect demand for copper in China. Demand for copper products may also be affected by various other factors, such as changes in industry preferences, the cost and availability of substitute materials and raw material prices.

 

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As a result, we cannot assure you that there will be continued or growing demand for copper products in China. If demand for copper products in China does not continue to grow or grows more slowly than expected, copper product prices may decline and our business, financial condition and results of operations could be materially and adversely affected.

Our copper products business is subject to risks related to transportation systems.

Our copper products business is highly dependent upon the transportation systems we use to acquire raw materials and deliver our products. We receive raw materials from suppliers and deliver copper products to our customers primarily by truck, using third-party providers. Because we generally keep only 15 to 30 days of inventory on hand, our business is substantially dependent on reliable and efficient transportation systems.

Transportation services are subject to disruption from a variety of causes, including shortages of supplies, equipment or operating problems, labor disputes or strikes, storms and adverse weather, energy shortages, natural disasters and other causes. Disruptions in the transportation systems we use for these or any other reasons could adversely affect our ability to receive raw materials and deliver products to our customers on a timely basis. A prolonged disruption in these transportation services, or a significant increase in transportation costs, may adversely affect our business, financial condition and results of operations.

Our copper products business may be subject to liability in connection with industrial accidents at our production facilities.

Our copper operations involve the operation of heavy machinery that could result in industrial accidents that may cause injuries or death. We cannot assure you that industrial accidents, whether due to malfunctions of machinery or other reasons, will not occur in the future at our production facilities. In such an event, we may be liable for loss of life and property, medical expenses, medical leave payments and fines and penalties for violation of applicable PRC laws and regulations. In addition, we may experience interruptions in our operations and may be required to change the manner in which we operate as a result of governmental investigations or the implementation of safety measures due to accidents. Any of the foregoing could adversely affect our business, financial condition and results of operations.

Our copper products business requires a high level of working capital to sustain our operations and overall growth.

Because the purchase of raw materials requires substantial capital, we require a high level of working capital to sustain our copper operations and maintain our overall growth. Historically, Jin Xin and Xiangbei have financed their working capital through cash from operations derived from customer payments, short term bank loans, advances from shareholders and capital contributions from shareholders. Accordingly, our liquidity and financial condition could be materially and adversely affected if we do not receive payments from our customers on a timely basis to satisfy payments to our suppliers and other working capital requirements, or if we are unable to obtain financing on satisfactory terms.

We cannot assure you that our copper products business will be able to maintain positive operating cash flow or obtain adequate financing to meet our future working capital requirements. The inability to achieve positive operating cash flow or obtain additional short-term bank loans, advances from shareholders or other additional financing on a timely basis or on acceptable terms would adversely affect our ability to satisfy our working capital requirements, including payments to suppliers in accordance with the terms of our agreements with them. In addition, we cannot assure you that our copper products business will be able to obtain additional working capital for our expansion plans, or that additional working capital needs of our new production facilities will not adversely impact the current or future level of working capital for our existing production facilities.

 

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We may be unable to obtain adequate financing to fund our capital requirements.

We expect that over the next several years, a substantial portion of our cash flow and available cash may be used to finance the upgrading and/or modification of our existing copper production facilities, or investments in businesses in the copper industry. We may need to obtain additional financing to fund our capital expenditures and potential acquisitions. We cannot assure you that we will be successful in obtaining such financing at a reasonable cost or at all. Our inability to finance our planned capital expenditures and potential acquisition could adversely affect our business, financial condition, results of operations or liquidity position.

Rising interest rates would increase our borrowing costs.

We currently rely in part on short-term bank borrowings to finance our copper products business’s working capital and operations, much of which bears interest at variable rates. As of December 31, 2011, we had bank borrowings, all of which were borrowed by Jin Xin, due within one year of RMB110.0 million (US$17.5 million), with interest rates ranging from 6.941% to 8.528% per annum. If interest rates on bank borrowings increase, our cost of borrowing will increase and our profitability may be adversely affected. The People’s Bank of China, or the PBOC, has adjusted the benchmark one-year lending rate and the deposit reserve ratio for PRC commercial banks a number of times in 2010 and 2011. Such tightening measures caused interest rates to increase and limited the amount that commercial banks in China were able to lend. A significant increase in prevailing interest rates could substantially increase our finance costs, which could adversely affect our business, financial condition and results of operations.

Our copper products business requires significant capital investments.

Our copper products business requires a high level of working capital to sustain our growth, maintain our equipment, comply with environmental laws and regulations and remain competitive. We will also be required to make substantial capital investments in connection with our planned new copper product production facilities in Sichuan. Since our acquisition of Jin Xin in November 2010, we have made total capital expenditures of RMB23.5 million and RMB11.6 million (US$1.8 million) in 2010 and 2011, respectively, primarily related to the expansion of our copper product production capacity. In 2012, we expect to make further capital expenditures in connection with the construction of an additional copper production facility located next to our Sichuan copper production facility. We intend to finance these capital expenditures through our internal resources and bank loans.

We have relied in part on external financing, such as bank loans, to fund our capital investments. The availability of external financing depends on many factors beyond our control, including but not limited to market conditions and policies of the PRC government. The current tightening of credit markets in the PRC may also limit our ability to obtain external financing. Our current financing may not be adequate to sustain our operations or to fund future expansion plans and we may not be able to obtain additional financing in the future to continue to fund these programs. If we do not have sufficient internally generated cash or acceptable external financing to make necessary capital expenditures in the future, we may be unable to develop or enhance our copper production facilities, take advantage of business opportunities and respond to competitive pressures. Any failure to obtain adequate financing for our current operations or our expansion plans may materially and adversely affect our business, financial condition and results of operations.

Any increase in the market price of our ADSs would increase the fair value of the contingent consideration liabilities incurred in connection with, the acquisition of Jin Xin and Xiangbei and may adversely affect our results of operations.

In November 2010 we acquired an initial 67% indirect ownership interest in Jin Xin through a series of transactions in exchange for up to 24 million of our newly issued ordinary shares (the “Jin Xin Consideration Shares”).

The Jin Xin Consideration Shares are subject to an earn-out arrangement whereby 6 million ordinary shares were delivered to Gold Hero Holdings Limited (“Gold Hero”), at the closing of the transactions, while the remaining 18 million ordinary shares (the “Jin Xin Contingent Consideration Shares”), were placed into escrow to be released in stages in amounts determined based on the ratio of Jin Xin’s net income, under U.S. GAAP, for the year ending December 31, 2010 and the three-year period ending December 31, 2012 to net income targets of RMB30.0 million and RMB190.0 million, respectively. Under the earn-out arrangement, the maximum earn-out award for 2010 of 6 million Jin Xin Contingent Consideration Shares was released to Gold Hero on April 8, 2011, as Jin Xin’s net income for the year ended December 31, 2010, was greater than RMB30.0 million. The remaining Jin Xin Contingent Consideration Shares are to be released to Gold Hero based on the ratio of Jin Xin’s cumulative net income for the three-year period ending December 31, 2012 to the net income target of RMB190.0 million.

 

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In August 2011, we acquired a 75% indirect ownership interest in Xiangbei through a series of transactions in exchange for (i) RMB30 million in cash, (ii) up to 20 million newly issued ordinary shares of our Company, and (iii) up to 14.17% of Engen’s enlarged share capital, subject to adjustment pursuant to an earn-out arrangement (together with (ii), the “Xiangbei Contingent Consideration Shares”).

The Xiangbei Contingent Consideration Shares are subject to an earn-out arrangement under which such shares may be issued in stages to Gold Wide Enterprises Limited (“Gold Wide”), and Silvery Boom Limited (“Silvery Boom”) in amounts determined based on the ratio of Xiangbei’s net income, under U.S. GAAP, for the years ending December 31, 2011, 2012 and 2013 to net income targets of RMB20.0 million, RMB50.0 million and RMB80.0 million, respectively. Under this earn-out arrangement, if Xiangbei does not achieve a cumulative net income target for the three-year period ending December 31, 2012, Gold Wide and Silvery Boom may be required to return part or all of the Xiangbei Contingent Consideration Shares, as well as up to RMB30 million in cash. In addition, we may be required to issue additional ordinary shares of our Company with a value of up to RMB20 million to Gold Wide and Silvery Boom if the volume weighted average trading price of our ADSs over the 30 calendar day period immediately after the public announcement of our 2013 annual financial results is below US$12.50 per ADSs.

The contingent consideration payable in connection with each of these two acquisitions is classified as a liability and stated at its fair value as of the relevant acquisition date and each reporting date. The subsequent change in the fair value of such contingent consideration as of each reporting date is recognized in our statement of operations. Key assumptions behind the calculation of the fair value of contingent consideration include, among others, the market price of our ADSs at each reporting date. An increase in the market price of our ADSs will increase the fair value of contingent consideration and thus may negatively affect our future financial results.

RISKS RELATING TO OUR BIODIESEL BUSINESS

Our biodiesel operations have been and may continue to be subject to significant suspensions and interruptions, which have resulted in a reduction of our sales volume and may continue to materially and adversely affect our results of operations.

Our biodiesel plants have been and may continue to be subject to significant suspensions or interruptions for a variety of reasons including the following:

 

   

government policies such as taxation regulations introduced by the PRC government which significantly raised the consumption tax on diesel products from January 1, 2009. Although it was later clarified that, subject to fulfillment of certain conditions, pure biodiesel made from animal fats or vegetable oils is exempted from such consumption tax, the consumption tax issue had a substantial impact on our operations, resulting in the suspension and deferral of commencement of operations at certain of our plants. It also had a material impact on our financial condition and results of operations as we recognized provisions for consumption tax in 2009 and in the first three quarters of 2010. The consumption tax issue also caused us to shift our sales channel to chemical plants, the market of which is smaller than biodiesel. This contributed in part to the decrease in our revenue and resulted in an impairment charge on our property, plant and equipment;

 

   

repair and maintenance or technological upgrades of our production processes;

 

   

transport network interference;

 

   

relocation of production facilities;

 

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accidents, natural disasters, epidemics and other unexpected or catastrophic events;

 

   

local protests, activism and labor disruptions; and

 

   

raw material shortages due to disruptions in the operations of our suppliers.

We have also made the decision to extend the suspension of certain biodiesel plants and initiate the suspension of substantially all of our other biodiesel plants due to raw material shortages, high raw material input costs, and slowing demand.

Further, unscheduled downtime or operational hazards inherent in the biodiesel industry, such as equipment failures, fires, explosions, release of toxic chemicals such as methanol, abnormal pressures, blowouts, pipeline ruptures, transportation accidents, power outages or shortages or other events outside of our control, may also result in the prolonged suspension of our operations. Some of these events may also cause personal injury or loss of life, severe damage to or destruction of property and equipment or environmental damage, and may result in the imposition of civil or criminal penalties. Our insurance may not be adequate to fully cover the potential events described above and we may not be able to renew this insurance on commercially reasonable terms or at all.

We cannot assure you that we will be in a position to resume production at our biodiesel plants in the foreseeable future or that if we do resume production, that we will not experience further suspensions or interruptions or experience damage to our facilities as a result of future natural disasters, governmental directives or policies, including other taxation regulations, expansion of production capacity, repair and maintenance, relocation of facilities or other consequences associated with such events, which could materially and adversely affect our biodiesel business and its results of operations and financial condition.

We may not be able to resume production at certain of our plants in time to meet customer demand for our products.

Production at substantially all of our biodiesel plants was suspended during 2011. We cannot assure you that the operating condition of our machinery and equipment will allow us to resume production at such plants in a timely manner or at all. To resume production operations, we need to undertake substantial planning and mechanical work to, among other things, inspect, reconfigure, test and fine tune our machinery and equipment and it is uncertain how long this process will take. We may also experience equipment breakdowns or other technical problems during resumption of production that will delay our production and increase our operating expenditures. When we resume production, we may not be able to resume our production operations at the necessary production levels and our production facility may be permanently impaired by our suspension of operations. We will also need to procure an adequate amount of raw materials at acceptable costs in order to resume production. The price and availability of raw materials are affected by a number of factors beyond our control. We cannot assure you that we will be able to procure an adequate amount of raw materials at acceptable costs or at all in order to resume production. See “—Our dependence on a limited number of third-party raw materials suppliers could adversely impact our production or increase our costs, which could harm our reputation or materially and adversely affect our business, results of operations and financial condition.” In addition, our supplier and customer base may have been materially and adversely affected by our suspension of operations. As a result of any of the foregoing, we cannot assure you that we will be able to resume production in time to meet customer demand for our products, which may result in a loss of customer orders and have a material adverse effect on our biodiesel business and its results of operations, financial condition and cash flows. As of December 31, 2012, only our biodiesel plant that we hold and operate through Sichuan Gushan, was in operation.

A decline in the price of diesel or other fuel sources or an increase in their supply could constrain the selling price of our biodiesel and materially and adversely affect our business, results of operations and financial condition.

Our biodiesel prices are influenced by market prices for diesel, the pricing of which is affected by global and domestic market prices for crude oil. As a result, any decline in the price of diesel may adversely affect our business, results of operations and financial condition. The PRC government also publishes “guidance prices” with respect to diesel. These guidance prices typically establish a ceiling for retail prices for diesel that are generally followed by industry participants. As biodiesel prices are affected by the price of diesel, the PRC government’s prevailing guidance prices typically limit the price range for our biodiesel.

 

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In recent years, the demand for and price of biodiesel in the PRC has also been influenced by the level of energy consumption and prices of crude oil and natural gas in relation to the level of growth in the PRC economy. Demand for biodiesel in the PRC declined significantly in 2009 as a result of the economic slowdown due to the global financial crisis. For example, the price of biodiesel in the PRC began to decline significantly from the fourth quarter of 2008 and such decline continued throughout the third quarter of 2009, resulting from significant decreases in global oil prices and from the rapid contraction of the PRC’s industrial production amid the global financial crisis. During the same period, the average selling price of our biodiesel decreased from RMB6,344 per ton in the third quarter of 2008, to RMB3,960 per ton in the second quarter of 2009. Although the average selling price of biodiesel began to recover steadily to RMB4,835 per ton in the fourth quarter of 2010, this represented a decrease of 23.8% in the average selling price of our biodiesel from the third quarter of 2008 to the fourth quarter of 2010. This decrease in average selling price contributed to our gross loss for 2009 and 2010. If supply of other energy sources continues to increase and exceed the demand for fuel products, demand for our biodiesel may cease to recover or may decline further and our biodiesel business and its results of operations and financial condition may continue to be adversely affected.

Although the average selling price of biodiesel further increased by 39.7% to RMB6,754 (US$1,073.1) per ton for the fourth quarter of 2011 from RMB4,835 per ton for the fourth quarter of 2010, the positive effect was largely offset by an increase of 16.7% in the unit cost of raw materials from RMB3,981 per ton for the fourth quarter of 2010 to RMB4,647 (US$738.3) per ton for the fourth quarter of 2011. Taking into account of the conversion loss from raw materials to biodiesel, manufacturing costs and selling and administration costs, we are still unable to make a profit at these price levels.

In addition, the prices for the by-products of biodiesel production may decrease significantly due to increased production of biodiesel in the PRC, or a slowdown in the PRC economy, or for other reasons beyond our control.

Our operations are materially affected by the cost and availability of raw materials.

The principal raw materials we use in the production of biodiesel include vegetable oil offal, used cooking oil and methanol. From 2005 through 2011, the prices we have been required to pay for raw materials for our biodiesel business have steadily increased. For the years ended December 31, 2009, 2010 and 2011, the overall average unit costs of raw materials for our biodiesel business, which have primarily consisted of used cooking oil and vegetable oil offal, amounted to RMB2,634.5, RMB3,573.2 and RMB4,431.2 (US$704.0) per ton, respectively.

Vegetable oil offal is a waste by-product of vegetable oil production, and the availability of vegetable oil offal depends on production levels of vegetable oil. Production levels of vegetable oil are affected by factors beyond our control, such as the quality of harvests of plant crops. Used cooking oil is the oil left over from food processing or preparation, mostly by restaurants and food producers. Therefore, any fluctuations in cooking oil consumption in the food industry in China will affect the supply of used cooking oil. If cooking oil consumption in China decreases, the supply of used cooking oil for our production would be adversely affected. Natural gas is the principal feedstock for our suppliers to produce methanol, and our operations depend on the availability, security of supply and price of methanol. If our suppliers are unable to obtain continued access to sufficient natural gas or if they experience significant interruptions in their supply of natural gas, our biodiesel production would be adversely affected. Any such events that reduce the supply of our raw materials could reduce our production volumes, increase our manufacturing costs, or both, either of which may adversely affect our biodiesel business and its results of operation and financial condition.

The failure of a supplier to supply raw materials satisfying our quality, quantity and cost requirements in a timely manner could impair our ability to produce our products or could increase our costs. In particular, interruptions or shortages of supplies from our key suppliers could disrupt production or impact our ability to increase production and sales. During 2011, local governments cracked down on certain alleged illegal practices of vendors of used cooking oil, forcing a number of our suppliers to suspend operations, which in turn resulted in a shortage of raw material inputs for our biodiesel business. This shortage was one of the main factors contributing to our decision to extend and/or implement the suspension of substantially all of our production of biodiesel and biodiesel by-products. Given the increasingly high raw material input costs and shortage in supply, we do not expect to resume our production of biodiesel and biodiesel by-products on a large scale basis in the near future.

 

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Our gross margins in our sales of biodiesel products are principally dependent on the spread between feedstock prices and product prices.

Our gross margins from sales of biodiesel are principally dependent on the spread between feedstock prices and biodiesel prices. If the unit cost of feedstock increases and the average selling price of biodiesel does not similarly increase or if the average selling price of biodiesel decreases and the unit cost of feedstock does not similarly decrease, our margins will decrease and our results of operations will be harmed. The spread between biodiesel prices and feedstock prices has narrowed significantly since September 2008. Prices for vegetable oil offal and used cooking oil, which have historically been our principal feedstock and comprised approximately 71.3% of total cost of revenues for our biodiesel business during the year ended December 31, 2011, do not necessarily have a direct price relationship to the price of biodiesel in a particular period. Prices for vegetable oil offal and used cooking oil are principally influenced by general inflation, market and regulatory factors. Biodiesel prices, however, are primarily influenced by the guidance prices set by the National Development and Reform Committee of China, or the NDRC, and supply and demand for petroleum-based diesel fuel, rather than biodiesel production costs. This lack of correlation between production costs and product prices means that we may be unable to pass increased feedstock costs on to our customers. Any decrease in the spread between biodiesel prices and feedstock prices, whether as a result of an increase in feedstock prices or a reduction in biodiesel prices, would adversely affect our ability to resume our production of biodiesel and biodiesel by-products on a large scale basis in the near future.

 

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The biodiesel industry faces a number of challenges, and there is no established market for biodiesel in China where biodiesel is considered a principal source of energy for any purpose.

Biodiesel has only been produced for commercial applications during the last 10 years in China, and the market for biodiesel products is currently confined to specific regions and is relatively small at the national level. There is no established market in China where biodiesel is considered a principal source of energy for vehicles operating on diesel, or an intermediate product for the manufacture of chemicals, or for any other purpose. We cannot assure you that biodiesel will be accepted or will reach a broader consumer base in China. Our future prospects and operational results will be adversely affected if biodiesel and the biodiesel industry in China fail to develop.

The global biodiesel industry is also at an early stage of development and acceptance as compared to other more established industries, and has experienced significant growth only in recent years. Demand for biodiesel may not grow as rapidly as expected or at all. Biodiesel and the global biodiesel industry also face a number of obstacles and drawbacks, including:

 

   

potentially increased nitrogen oxide, or NOx, emissions as compared with most formulations of diesel;

 

   

gelling at lower temperatures than diesel, which can require the use of low percentage biodiesel blends in colder climates or the use of heated fuel tanks;

 

   

potential water contamination that can complicate handling and long-term storage;

 

   

reluctance on the part of some auto manufacturers and industry groups to endorse biodiesel and their recommending against the use of biodiesel or high percentage biodiesel blends;

 

   

potentially reduced fuel economy due to the lower energy content of biodiesel as compared with diesel; and

 

   

potentially impaired growth due to a lack of infrastructure such as dedicated rail tanker cars and truck fleets, sufficient storage facilities, and refining and blending facilities.

We may face overcapacity if the biodiesel market in China does not develop as expected. If overcapacity occurs, the expenditures we incur to expand our facilities and increase our capacity may not result in increased revenues, which could cause the results of operations of our biodiesel business to be materially and adversely affected.

We derive a significant portion of our biodiesel revenues from a small number of customers.

We derive a significant portion of our biodiesel revenues from a small number of customers, and we may be unable to maintain and expand our current customer relationships. For 2009, 2010 and 2011 our five largest biodiesel customers represented approximately 22.4%, 44.5% and 42.2% of our biodiesel revenues, respectively, while our largest biodiesel customer represented approximately 7.4%, 18.6% and 14.4% of our biodiesel revenues during such periods, respectively.

 

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If we lose any of our major customers for any reason, including, for example, the continued suspension of our biodiesel operations, a decline in our reputation, a customer materially reduces its orders from us, our relationship with one or more of our major customers deteriorates, or a major customer becomes insolvent or otherwise unable to pay for our products, the probability of our resuming production of biodiesel and biodiesel by-products on a large scale basis in the near future may be decreased and as a result, our business prospects may be materially and adversely affected.

We face significant competition, and if we do not compete successfully against existing and new competitors as well as competing technologies and other products, we may lose our market share and our results of operations may be materially and adversely affected.

With respect to our biodiesel business, existing and future domestic competitors, who may have a greater presence in other regions through government support or enjoy greater popularity among local consumers, may be able to secure a significant market share in regions where we currently do not have plants in operation. We have only seven biodiesel production plants in a limited number of regions in China, including Mianyang in Sichuan province, Fuzhou in Fujian province, Handan in Hebei province, Liuyang in Hunan province and Beijing, Shanghai and Chongqing. See Item 4.D, “Information on the Company—Property, Plant and Equipment—Production Facilities” for further information. In addition, our potential biodiesel competitors might be able to secure raw materials at a lower cost than we can and could therefore threaten our competitive position, which could significantly impact our results of operations and future prospects. Our domestic biodiesel competitors include China Biodiesel International Holding Co., Ltd., China Clean Energy Inc., East River Energy Resources and Science Technology (Zhejiang) Ltd., or East River Energy Resources, China Petroleum and Chemical Corporation, or SINOPEC, China National Offshore Oil Corporation, or CNOOC, and PetroChina Co. Ltd., or PetroChina, some of which have greater resources, brand recognition and access to more extensive distribution channels than we do. Moreover, some of our biodiesel competitors have the ability to manage their risk through diversification, whereas we lack diversification in both the geographic scope and the nature of our biodiesel business. As a result, we could potentially be impacted more by factors affecting the biodiesel industry or the regions in which we operate than we would if our biodiesel business were more diversified.

We also face potential competition from foreign producers of biodiesel, which may have greater financial and research and development resources. Biodiesel is a relatively new product that was initially introduced outside China, and the technology for producing biodiesel may be more advanced in countries other than China. If foreign competitors, or domestic competitors relying on alliances with or support from foreign producers, enter the PRC biodiesel market, they may develop biodiesel that is more economically viable, which would adversely affect our ability to compete and the results of operations of our biodiesel business.

In addition, new technologies may be developed or implemented for alternative energy sources and products that use such energy sources. Advances in the development of fuels other than biodiesel or diesel, or the development of products that use energy sources other than diesel, such as gasoline hybrid vehicles and plug-in electric vehicles, could significantly reduce demand for biodiesel and thus affect our sales. Biodiesel also faces competition from fuel additives that help diesel burn cleaner and therefore reduce the comparative environmental benefits of biodiesel in relation to diesel. Other clean energy sources such as ethanol, liquefied petroleum gas, hydrogen and electricity from clean sources may be more cost-effective to produce, store, distribute or use, more environmentally friendly, or otherwise more successfully developed for commercial production in China than our products. These other energy sources may also receive greater government support than our products in the form of subsidies, incentives or minimum use requirements. As a result, demand for our products may decline and our business model may no longer be viable and the results of operations and financial condition of our biodiesel business may be materially and adversely affected.

Any increase in competition arising from an increase in the number or size of competitors or from competing technologies or other clean energy sources may result in price reductions, reduced gross profit margins, loss of our market share and departure of key management, any of which could adversely affect the financial condition and results of operations of our biodiesel business.

 

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If we fail to keep up with new technology, our ability to offer cost-effective, technologically advanced and environmentally friendly products may be materially and adversely affected and our competitiveness may erode.

Our success depends on our ability to offer cost-effective and environmentally friendly products. As the technology for manufacturing biodiesel is at an early stage of development, failure to keep up with technological improvements or to implement such improvements in commercial applications would impede our efforts to reduce unit production costs and correspondingly hinder our efforts to strengthen our competitiveness. Moreover, if alternative technologies that are more cost-effective and environmentally friendly become available to the market, the biodiesel industry in general and our business in particular may not be able to compete against such new alternative energy sources. Further, the PRC government may introduce new standards regulating biodiesel quality with which we may be unable to comply, or we may have to incur additional costs to invest in technology or equipment to meet a new PRC or industry-wide standard. If we fail to achieve any new standard, or if the cost of achieving such standard is prohibitively expensive, we may have to raise prices and our biodiesel may become less attractive to customers or we may have to suspend all or part of our operations, which could materially and adversely affect our biodiesel business and its results of operations and financial condition.

The modification or elimination of government initiatives promoting the adoption of clean energy sources in China could cause demand for our products and our revenues to decline.

A number of PRC government initiatives promote the adoption of clean energy sources, such as biodiesel. For example, pursuant to the Twelfth Five-Year Plan and the Medium and Long-Term Development Plan, China targets to increase its consumption of energy from renewable sources to 15% of total energy consumption in China by 2020. The plan also includes the promotion of renewable energy sources. Under the plans, China aims to increase its annual consumption of biofuel, with the consumption of biodiesel targeted at two million tons per year by 2020. According to the Law of Renewable Energy Resources, local governments are required to prepare a renewable energy development plan and provide financial support to renewable energy projects in rural areas. Further, the government may grant businesses engaged in biodiesel production certain benefits and incentives, while petroleum marketing enterprises are required to include biodiesel products that comply with the state standard with respect to fuel sales. These government initiatives could be modified or eliminated altogether. Such a change in policy could adversely affect the growth of the biodiesel market and cause our revenues to decline. Changes to or elimination of initiatives designed to increase general acceptance of clean energy sources could result in decreased demand for our products and have a material adverse effect on our biodiesel business and its results of operations and financial condition.

In addition, the PRC government has enacted regulations that are intended to affect corporate behavior pertaining to the environment. Many of these regulations may be favorable to companies, such as us, that are engaged in environmentally friendly or “green” industries. According to the Medium and Long-Term Development Plan, the share of renewables used in primary energy consumption is to be increased from 7.5% in 2005 to roughly 10% by 2010 and nearly 15% by 2020. However, we cannot assure you that demand for our products will increase or that we will otherwise benefit from such regulations. For example, the PRC Ministry of Finance has issued the Temporary Regulation on the Management of Special Funds for the Development of Renewable Resources. Pursuant to this regulation, special funds will be provided to companies for the development of renewable resources, including petroleum substitutes. These funds may be used to promote advancement in the development of energy sources that compete with biodiesel, which may in turn reduce demand for biodiesel.

If environmental regulations are relaxed in the future, or if the enforcement of environmental regulations is not sufficiently rigorous, we may not be able to compete effectively against other manufacturers of energy products, including traditional and other clean energy source products. Our business prospects and the results of operations of our biodiesel business may be adversely affected as a result of any of the foregoing factors.

RISKS RELATING TO BUSINESS OPERATIONS IN CHINA

If foreign ownership of the biodiesel production business in China is restricted, we would have to rely on contractual arrangements to derive economic benefits from, and to control, our new PRC operating entities in the future, which may not be as effective in providing control over these entities as direct ownership.

The NDRC and the Ministry of Commerce of China jointly promulgated a newly revised Catalog for Guiding Foreign Investment in Industries on October 31, 2007, or the Catalog, which came into effect on December 1, 2007. The Catalog was further amended on December 24, 2011, which came into effect on January 30, 2012. Pursuant to the Catalog, biodiesel production is classified as a sub-category of the agricultural food processing industry, which is a restricted industry, and, as a result, any such biodiesel production business in China must be majority-owned by PRC citizens and/or entities.

 

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Our PRC legal counsel, Chen & Co. Law Firm, has advised us that based on their understanding of the Catalog, only biodiesel production using agricultural food products as raw materials falls within the “restricted industry” category pursuant to the Catalog. In the opinion of Chen & Co. Law Firm, our biodiesel production process, which utilizes used cooking oil and vegetable oil offal as raw materials, does not fall within the restricted industry category under the Catalog. Further, even if biodiesel production utilizing used cooking oil and vegetable oil offal is classified as a restricted industry, Chen & Co. Law Firm is of the opinion that only new biodiesel production businesses established after December 1, 2007, or existing biodiesel production businesses that require new approvals from the PRC Ministry of Commerce or its local branch in order to, for example, increase their registered capital or conduct an equity transfer, would be classified as falling within a restricted industry.

There are substantial uncertainties in the interpretation and application of existing and new PRC laws, regulations or policies, including the Catalog. In the event our existing biodiesel production business is deemed a restricted business in China, we would have to reorganize our corporate structure and rely on contractual arrangements with our operating entities in China and their owners of record to derive economic benefits from and exercise control over these entities. These contractual arrangements may not be as effective in providing control over our operating entities as direct ownership. If our operating entities were to fail to perform their obligations under any agreements with us, we would have to resort to legal remedies which could be time consuming and costly and we cannot assure you that such remedies would be available. In addition, we cannot assure you that any of the future direct record owners of our operating entities in China would always act in our best interests.

A global financial and economic crisis, and its impact on the Chinese economy, may adversely affect our business, results of operations and financial condition.

The global financial and economic crisis that began in 2008 adversely affected the U.S. economy and many other parts of the world, including the PRC. As a result of this crisis, financial markets experienced significant disruptions, leading to extreme volatility and dislocation of the global capital markets. Many of the world’s major economies entered into recession and have not fully recovered. The PRC economy also slowed down significantly in the second half of 2008 and during 2009. Due in part to the global financial crisis, beginning in September 2008, among other measures, the PRC government began to loosen macroeconomic measures and monetary policies by reducing interest rates and decreasing the statutory reserve rates for banks. In addition, in November 2008, the PRC government announced an economic stimulus package in the amount of RMB4 trillion. In 2010, China’s economic growth has approached its pre-crisis level a year after the adoption of a stimulus package. However, the country’s strategy has raised concern that loose monetary policy could inflate the consumer price index, or CPI, form a real estate bubble, build up redundant production capacity and saddle the economy with bad debts. As a result, the PBOC has recently raised the reserve ratio to tighten liquidity in the financial system.

As we operate substantially in the PRC where we primarily sell our products, a prolonged recession or a slowing of the PRC economy, or a decrease in business activity in our end markets could reduce demand for our products, which could materially and adversely affect our financial condition and results of operations.

Changes in China’s political and economic policies could have a material adverse effect on our business operations.

The PRC economy has been transitioning from a centrally planned economy to a more market-oriented economy. For approximately three decades, the PRC government has implemented economic reform measures to utilize market forces in the development of the PRC economy. Many of the reforms are unprecedented or experimental and are expected to be modified from time to time. Other political, economic and social factors may also lead to further readjustment or introduction of other reform measures. This process of reform may have a material impact on our operations in China or may adversely affect our results of operations as our current revenue is substantially derived from our operations in China. Our financial condition and results of operations may be adversely affected by changes in China’s political, economic and social conditions and by changes in laws, regulations or the interpretation or implementation thereof.

 

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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, as the Chinese economy experienced high rate of increase in residential property prices in recent years, to combat high property prices and prevent the economy from overheating, the PRC government adopted a number of measures, including raising statutory reserve rates for banks and controlling bank lending to certain industries or economic sectors. We cannot assure you that the various macroeconomic measures and monetary policies adopted by the PRC government to guide economic growth and the allocation of resources will be effective in improving the growth rate of the Chinese economy. In addition, such measures, even if they benefit the overall Chinese economy in the long-term, may materially and adversely affect us if they reduce the demand for biodiesel or copper products.

Our business, financial condition and results of operations could be adversely affected by PRC labor laws and regulations.

On June 29, 2007, the National People’s Congress promulgated the Labor Contract Law of the PRC, or the Labor Contract Law, effective January 1, 2008. On September 18, 2008, the State Council passed the relevant implementation regulations. The Labor Contract Law is aimed to provide employees greater protections with respect to establishing and terminating employment relationships. For example, the Labor Contract Law requires employers to enter into written contracts with their employees, and if an employer fails to enter into a written contract with an employee within one month after commencement of employment, the employer is required to pay the employee double its salary every month for up to 11 months. In addition, the Labor Contract Law calls for implementation of open-ended contracts rather than fixed-term contracts under certain circumstances. In particular, an employer cannot enter into a one-year or short-term contract with an employee upon the third consecutive renewal of the employment contract unless otherwise requested by the employee. As a result, the Labor Contract Law limits our discretion in the hiring and termination processes and could in turn affect our labor costs and our profitability.

Interpretation of PRC laws and regulations involves uncertainty that could materially impact our operations.

Our business and operations in China are governed by the legal system of China. The PRC legal system is based on written statutes. Prior court decisions may be cited for reference but have limited precedential value. Since the late 1970s, the PRC government has promulgated laws and regulations dealing with such economic matters as foreign investment, corporate organization and governance, commerce, taxation and trade. However, as these laws and regulations are relatively new and continue to evolve, interpretation and enforcement of these laws and regulations involve significant uncertainties and different degrees of inconsistency.

For example, the PRC’s Ministry of Commerce released the Regulations for Oil Product Market and Regulations for Crude Oil Market, which were implemented in January 2007. The PRC Ministry of Commerce does not currently interpret these regulations as applicable to biodiesel producers. However, we cannot assure you that the PRC Ministry of Commerce will not change its interpretation. If we are ever subject to these regulations and are unable to obtain any required permits, we may be subject to monetary fines and our production of biodiesel may be temporarily or permanently interrupted. Furthermore, due to the limited volume of published cases and the non-binding nature of prior court decisions, the outcome of dispute resolution may not be as consistent or predictable as in other more developed jurisdictions, which may limit legal protections available to us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.

 

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Our PRC subsidiaries are subject to restrictions on dividend payments that could materially impact our ability to receive dividends.

We are a holding company, and we rely principally on dividends and other distributions paid by our intermediate holding companies, Carling Technology Limited (“Carling Technology”), Brightest Resources Limited (“Brightest Resources”), Joywin Technology Limited (“Joywin Technology”), Profit Faith Technology Limited (“Profit Faith Technology”), Engen, Gushan Holdings Limited (“Gushan Holdings”), Kim Yau Limited (“Kim Yau”), True Excel Holdings Limited (“True Excel”), and our PRC subsidiaries for our cash requirements, including the funds necessary to service any debt we may incur or financing we may need for operations other than through our PRC subsidiaries. If our PRC subsidiaries incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability to pay dividends or make other distributions to our intermediate holding companies and us. Each of Chongqing Gushan, Hunan Gushan, Shanghai Gushan, Beijing Gushan, Fujian Gushan, Handan Gushan, Sichuan Gushan, Biomass, Jin Xin and Xiangbei, as a foreign-invested enterprise in China, is required under PRC laws and regulations to provide for statutory general reserves. Each is also required to allocate at least 10% of their after tax profits as reported in the PRC statutory financial statements to the statutory general reserves and has the right to discontinue allocations to these funds once the cumulative amount of such reserves has reached 50% of their registered capital. These statutory reserves are not available for distribution to the shareholders, except in a liquidation, and may not be transferred in the form of loans, advances, or cash dividends. As of December 31, 2011, the amount of these restricted portions was RMB78.4 million (US$12.5 million) in total for our PRC subsidiaries. Limitations on the ability of our PRC subsidiaries or affiliated PRC entities to transfer funds to our intermediate holding companies and us in the form of dividends, loans or advances could materially and adversely limit our ability to grow, make investments or acquisitions that could be indirect to our business, pay dividends, and otherwise fund and conduct our business.

PRC laws and foreign exchange controls may affect our ability to receive dividends and other payments from our PRC subsidiaries.

Our operating PRC subsidiaries are subject to the PRC rules and regulations on currency conversion. The ability of our operating PRC subsidiaries to pay dividends or make other distributions to us may be restricted by these PRC foreign exchange control restrictions. We cannot assure you that the relevant regulations will be amended to our advantage such that the ability of our operating PRC subsidiaries to distribute dividends to us will not be adversely affected.

Changes in foreign exchange regulations and fluctuation in the value of the Renminbi may adversely affect our business and results of operations.

We receive all of our revenue in Renminbi, which is not freely convertible into other currencies, except under certain circumstances. Current foreign exchange regulations have significantly reduced the PRC government’s foreign exchange control on current account transactions, including trade and service related to foreign exchange transactions and payment of dividends. The PRC government may, however, at its discretion, restrict access in the future to foreign currencies for current account transactions under certain circumstances. Any such change to the foreign exchange regulations may adversely affect our ability to pay dividends or satisfy other foreign exchange requirements.

The value of the Renminbi against other foreign currencies is subject to changes in the PRC’s policies and international economic and political developments. Under the current managed floating exchange rate system, the conversion of Renminbi into foreign currencies, including U.S. dollars, has been based on rates set by the PBOC, which are quoted daily based on the previous day’s inter-bank foreign exchange market rates. Since 1994, the official exchange rates for the conversion of Renminbi into U.S. dollars have been relatively stable. In July 2005, the PRC government discontinued pegging the Renminbi to the U.S. dollar. However, the Renminbi exchange rate versus the U.S. dollar is restricted to a rise or fall of no more than 1.0% per day and the PBOC regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate. Nevertheless, 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, PRC authorities may lift restrictions on fluctuations in the Renminbi exchange rate and lessen intervention in the foreign exchange market. Fluctuations in the exchange rate will also affect the relative value of any dividend that will be exchanged into U.S. dollars and earnings from and the value of any U.S. dollar-denominated investments or deposits we make, if any.

 

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Any change in the preferential tax rates or tax holidays we enjoy in China, or the status of our subsidiaries as foreign-invested enterprises, may reduce our net profits.

Prior to January 1, 2008, a foreign-invested enterprise in China, or FIE, was typically subject to corporate income tax, or CIT, at the rate of 33%, which comprises 30% national income tax and 3% local income tax, on taxable income. The PRC government authorities provided various incentives to FIEs. For example, as a result of such preferential rates and tax holidays, each of Handan Gushan and Fujian Gushan enjoyed full exemption from CIT in the first two years followed by a 50% exemption from CIT in the next three years starting with their respective first profitable year after being an FIE, which began in 2005 for Handan Gushan and 2006 for Fujian Gushan. Sichuan Gushan enjoyed full exemption from CIT in 2005 and exemption from national income tax in 2006, followed by a 50% exemption from national income tax/unified CIT from 2007 to 2009. See Item 5, “Operating and Financial Review and Prospects.” On March 16, 2007, the National People’s Congress of China enacted a new corporate income tax law, or the New CIT Law, under which foreign-invested enterprises, such as our PRC subsidiaries and domestic companies, would be subject to CIT at a uniform rate of 25%. Preferential tax treatments will continue to be granted to entities that conduct business in encouraged sectors, whether FIEs or domestic companies. The New CIT Law became effective on January 1, 2008. Under the New CIT law and the Notice on the Implementation of Transitional Preferential Policies on Corporate Income Tax, issued by the State Council on December 26, 2007, effective from January 1, 2008, the tax rate of enterprises that were established and were entitled to preferential tax rates or tax holidays before March 16, 2007 are to (i) in the case of preferential tax rates, gradually increase from the preferential tax rate to a 25% rate over a period of five years beginning January 1, 2008, or (ii) in the case of tax holidays, continue until the expiration of such term. Therefore, our subsidiaries in China will continue to be entitled to the tax holidays currently enjoyed by them until the expiration of the tax holiday term. We cannot assure you that any of our PRC subsidiaries will continue to be entitled to any preferential tax rates or tax holidays after the transition period expires.

The Rules on Acquisition of Domestic Enterprises by Foreign Investors, or the New M&A Rules, were promulgated on August 8, 2006 jointly by the Ministry of Commerce, the State-owned Assets Supervision and Administration Commission of the State Council of the PRC, or the SASAC, the PRC SAT, the State Administration for Industry and Commerce, the China Securities Regulatory Commission and the State Administration of Foreign Exchange of China, or SAFE, and came into effect on September 8, 2006. The New M&A Rules were further amended on June 22, 2009.

Under the New M&A Rules, FIEs established by way of acquisition of related domestic companies by offshore companies which are established or controlled by PRC domestic companies, enterprises or persons will not be entitled to be treated as FIEs except when, if the offshore companies offer to buy the company through a capital increase of the domestic companies, or increased capital to the enterprises established by the offshore companies after merger, the sum of capital increase is equal to more than 25% of the FIE’s registered capital. According to Chen & Co. Law Firm, our PRC legal advisor, PRC laws and regulations with specific effective dates generally have no retroactive effect. However, we cannot assure you that the New M&A Rules will not apply to our subsidiaries in the PRC. If the New M&A Rules are applicable to our subsidiaries in the PRC, our PRC subsidiaries may not be able to enjoy preferential treatment as FIEs and our financial condition and results of operations could be adversely affected.

The New CIT Law could affect tax exemptions on dividends received by us and our shareholders and increase our CIT rate.

The New CIT Law provides that, if an enterprise incorporated outside the PRC has its “de facto management organization” located within the PRC, such enterprise may be recognized as a PRC tax resident enterprise and thus may be subject to CIT at the rate of 25% on its worldwide income. The Implementation Rules of the Corporate Income Tax Law prescribe that a “de facto management organization” means an organization that exercises substantive and overall management and control over the enterprise’s business operations, personnel, finance, property and other functions. Although the Implementation Rules provide a definition of “de facto management organization,” such definition has not been tested and there remains uncertainty as to the circumstances under which a non-PRC enterprise’s de facto management organization is considered to be located in the PRC. We may be deemed a PRC tax resident enterprise and therefore subject to a CIT rate of 25% on our worldwide income because a majority of the members of our management are located in China.

 

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Moreover, under the New CIT Law, if we are categorized as a PRC tax resident enterprise, foreign ADS holders may be subject to a 10% withholding tax on dividends payable by us and gains realized on the sale or other disposition of ADSs or ordinary shares.

The New CIT Law also provides that qualified dividends received by a PRC tax resident from another PRC tax resident are exempt from CIT. However, given the short history of this law, it remains unclear as to the detailed qualification requirements for such exemption and whether the dividends which the Company receives indirectly from our PRC subsidiaries will be exempt from CIT if it is recognized as a PRC tax resident enterprise.

PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident shareholders to personal liability and limit our ability to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute profits to us, or otherwise adversely affect our financial position.

SAFE issued a public notice in October 2005, or the SAFE notice, requiring PRC residents, including both legal persons and natural persons, to register with the competent local SAFE branch before establishing or controlling any company outside China, referred to as an “offshore special purpose company,” for the purpose of acquiring any assets of or equity interest in PRC companies and raising funds from overseas. In addition, any PRC resident that is the shareholder of an offshore special purpose company is required to amend its SAFE registration with the local SAFE branch with respect to that offshore special purpose company in connection with any increase or decrease of capital, transfer of shares, merger, division, equity investment or creation of any security interest over any assets located in China. If any PRC shareholder of an offshore special purpose company fails to make the required SAFE registration and amendment, the PRC subsidiaries of that offshore special purpose company may be prohibited from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to the offshore special purpose company. Moreover, failure to comply with the SAFE registration and amendment requirements described above could result in liability under PRC laws for evasion of applicable foreign exchange restrictions.

We cannot provide any assurances that all of our indirect owners who are PRC residents will register as required. The failure of these indirect owners to register as required or to amend their SAFE registrations in a timely manner pursuant to the SAFE notice or the failure of future indirect owners of our Company who are PRC residents to comply with the registration procedures set forth in the SAFE notice may subject such indirect owners to fines and legal sanctions and may also result in restrictions on our PRC subsidiaries’ ability to distribute profits to us or otherwise materially and adversely affect our business.

The approval of the Chinese Securities Regulatory Commission might have been required in connection with our initial public offering under a recently adopted PRC regulation, and, if approval was required, we could be subject to sanctions, fines and other penalties.

The New M&A Rules, among other things, include provisions that purport to require that an offshore special purpose vehicle formed for purposes of overseas listing of equity interests in PRC companies and controlled directly or indirectly by PRC companies or individuals obtain the approval of the Chinese Securities Regulatory Commission, or CSRC, prior to the listing and trading of such special purpose vehicle’s securities on an overseas stock exchange.

On September 21, 2006, the CSRC published on its official website procedures regarding its approval of overseas listings by special purpose vehicles. The CSRC approval procedures require the filing of a number of documents with the CSRC, which would take several months to complete.

The application of the New M&A Rules remains unclear with no consensus currently existing among leading PRC law firms regarding the scope of the applicability of the CSRC approval requirement. The CSRC currently has not issued any definitive rule or interpretation concerning whether offerings like ours under our initial offering prospectus are subject to this new procedure.

Our PRC counsel, Chen & Co. Law Firm, has advised us, based on their understanding of the current PRC laws and regulations as well as the procedures announced on September 21, 2006, that:

 

   

Because we completed our onshore restructuring before September 8, 2006, the effective date of the new regulation, and Gushan Environmental Energy Limited was formed for the sole purpose of facilitating private equity investment, this regulation does not require an application to be submitted to the CSRC for its approval of the issuance and sale of the ADSs and the ordinary shares, or the listing and trading of our ADSs on the NYSE; and

 

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The issuance and sale of the ADSs and the ordinary shares and the listing and trading of the ADSs on the NYSE did not conflict with or violate this new PRC regulation.

If the CSRC or other PRC regulatory body subsequently determines that the CSRC’s approval was required for our initial public offering, we may face regulatory actions or other sanctions from the CSRC or other PRC regulatory agencies. In that case, these regulatory agencies may impose fines and penalties on our operations in China, limit our operating privileges in China 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. Also, if the CSRC subsequently requires that we obtain its approval, we may be unable to obtain a waiver of the CSRC approval requirements, if and when procedures are established to obtain such a waiver. Any uncertainties and/or negative publicity regarding this CSRC approval requirement could have a material adverse effect on the trading price of our ADSs.

SAFE rules and regulations may limit our ability to transfer the net proceeds from any of our future securities offerings to our subsidiaries in the PRC, which may adversely affect our business expansion and we may not be able to convert our U.S. dollar or Hong Kong dollar denominated cash balances deposited in Hong Kong into Renminbi to invest in or acquire any other PRC companies.

On August 29, 2008, SAFE promulgated Circular 142, a notice regulating the conversion by a foreign-invested company of foreign currency into Renminbi by restricting how the converted Renminbi may be used.

The notice requires that the registered capital of a foreign-invested company settled in Renminbi converted from foreign currencies may only be used for purposes within the business scope approved by the applicable governmental authority and, unless otherwise stipulated, may not be used for equity investments within the PRC. In addition, SAFE strengthened its oversight of the flow and use of the registered capital of a foreign-invested company settled in Renminbi converted from foreign currencies. The use of such Renminbi capital may not be changed without SAFE’s approval, and may not in any case be used to repay Renminbi loans if the proceeds of such loans have not been used. Violations of Circular 142 will result in severe penalties, such as heavy fines. As a result, Circular 142 may significantly limit our ability to transfer the net proceeds from any of our future securities offerings to our subsidiaries in the PRC, which may adversely affect our business expansion and we may not be able to convert our U.S. dollar or Hong Kong dollar denominated cash balances deposited in Hong Kong into Renminbi to invest in or acquire any other PRC companies.

The outbreak of any severe transmissible disease in China, if uncontrolled, could adversely affect our results of operations.

The outbreak of any severe communicable disease in China, such as Severe Acute Respiratory Syndrome, avian flu or swine flu, if uncontrolled, could adversely affect the overall business sentiment and environment in China, which in turn may have an adverse impact on domestic consumption and, possibly, the overall gross domestic product, or GDP, growth in China. As our revenue is currently derived from our China operations, any contraction or slow down in domestic consumption and slowdown in the GDP growth of China will adversely affect our financial condition, results of operations and future growth. In addition, if any of our employees is infected or affected by any severe communicable diseases outbreak, it could adversely affect or disrupt our production at the relevant plants and adversely affect our results of operations, as we may be required to close our facilities to prevent the spread of the disease. The spread of any severe communicable disease in China may also affect the operations of our customers and suppliers, which may have an adverse effect on our business, financial condition and results of operations.

 

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All employee participants in our share option scheme who are PRC citizens may be required to register with SAFE. We may also face regulatory uncertainties that could restrict our ability to adopt additional share incentive plans for our directors and employees under PRC law.

To implement the Administrative Rule on Foreign Exchange Matters of Individuals and its related Implementing Rule, on February 15, 2012, SAFE issued the Circular on Relevant Issues Concerning Foreign Exchange Regulation for Domestic Individuals Participating in Equity Incentive Plans of Overseas Listed Companies, or Circular No. 7. For any share option plans which are covered by Circular No. 7 and are adopted by an overseas listed company, Circular No. 7 requires the employee participants conduct the foreign exchange registration of the share option plan. In addition, Circular No. 7 also requires the employee participant to follow a series of requirements, including written applications for participation of the share option plan, the evidence on the share option plan (such as the overseas listed company announcement).

Our share option scheme is subject to Circular No. 7. We are planning to register our chare options issued to our employees in due course. The failure to comply with such provisions may subject us and the participants of our share option scheme who are PRC citizens to fines and legal sanctions and may prevent us from further granting options under our share option scheme to our employees. Such events could adversely affect our business operations.

RISKS RELATED TO OUR ORDINARY SHARES AND ADSs

If we fail to meet all applicable NYSE continued listing standards and the NYSE determines to delist our common stock, the delisting could adversely affect the market liquidity of our ADSs and the market price of our ADSs could decline.

On May 1, 2012, we received a letter from the NYSE notifying us that we were not in compliance with one of the NYSE’s standards for continued listing of our ADSs on the exchange. Specifically, the NYSE indicated that it considers our Company to be “below criteria” because, as of December 31, 20111, our average global market capitalization over a consecutive 30 trading-day period was less than USD50 million and, at the same time, our total stockholders’ equity was less than USD50 million. On April 27, 2012, we reported that as of December 31, 2011, our total shareholders’ equity attributable to our Company was approximately USD36.2 million. As of December 31, 2011, our average global market capitalization over a consecutive 30 trading-day period was approximately USD27.5 million.

Under NYSE continued listing rules, we have 90 days from the receipt of the letter to submit a plan advising the NYSE of definitive action we have taken, or are taking, that would bring us into conformity with the applicable standards within 18 months of receipt of the letter. If the NYSE staff determines that we have not made a reasonable demonstration of our ability to come into conformity with the applicable standards within 18 months, the NYSE staff will promptly initiate suspension and delisting procedures. Otherwise, if the NYSE staff accepts the plan, we will be subject to semi-annual review by the NYSE staff for compliance with the plan until either we are able to demonstrate that we have returned to compliance for a period of two consecutive quarters or until the expiration of the 18 month period. The NYSE staff will promptly initiate suspension and delisting procedures if we fail to meet the continued listing standards by the end of the 18-month period.

If our ADSs are delisted then: (i) our market liquidity could be adversely affected and the market price of our ADSs could decline and (ii) our ability to obtain financing could also be adversely affected.

Our principal shareholders exert significant influence over us and their interests may not coincide with yours.

Our principal shareholders, acting individually or together, have significant influence over our business and could control all matters requiring shareholder approval, including the election of most directors and approval of significant corporate transactions. In addition, this concentration of ownership may delay or prevent a change in control of our Company and make some transactions more difficult or impossible without the support of these shareholders. The interests of these shareholders may not always coincide with our interests as a company or the interest of other shareholders. Accordingly, these shareholders could cause us to enter into transactions or agreements with which you may not approve or make decisions with which you may disagree.

 

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Anti-takeover provisions in our charter documents may adversely affect the rights of holders of our ADSs and common shares.

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

We have included the following provisions in our amended and restated articles of association:

 

   

At each annual general meeting, one-third of our directors (or, if their number is not a multiple of three, the number nearest to but not less than one-third) must retire from office by rotation, and every director is subject to retirement at least once every three years. This provision would delay the replacement of a majority of our directors and would make changes to the board of directors more difficult than if such provision were not in place.

 

   

Our board of directors has the authority to establish from time to time one or more series of preferred shares without action by our shareholders and to determine, with respect to any series of preferred shares, the terms and rights of that series, including the designation of the series, the number of shares of the series, the dividend rights, conversion rights, voting rights, and the rights and terms of redemption and liquidation preferences.

 

   

Our board of directors may issue series of preference shares without action by our shareholders to the extent authorized but unissued. Accordingly, the issuance of preference shares may adversely affect the rights of the holders of the ordinary shares. In addition, the issuance of preference shares may be used as an anti-takeover device without further action on the part of the shareholders. Issuance of preference shares may dilute the voting power of holders of ordinary shares.

 

   

Subject to applicable regulatory requirements, our board of directors may issue additional ordinary shares without action by our shareholders to the extent of available authorized but unissued shares.

Our interests may conflict with those of the non-controlling shareholders of Engen and the selling shareholders of Xiangbei.

We have a 75% ownership interest in Engen, the holding company of our copper products business, and there are two non-controlling shareholders that own the remaining 25% ownership interest in Engen, as of the date of this annual report. The selling shareholders of Xiangbei may acquire up to 14.17% of Engen’s enlarged share capital if Xiangbei is able to achieve the profit targets as specified in the relevant earn-out arrangement. These non-controlling shareholders have significant influence over management and operations of our copper products business, through, among other things, a representative on the board of directors of Jin Xin and in the management teams of Jin Xin and Xiangbei as well as shareholders’ voting rights.

To the extent that there are any conflicts of interest between these non-controlling shareholders and us, we cannot assure you that we will be able to resolve them in a manner that will be in our best interests. These non-controlling shareholders may:

 

   

have economic or business interests or goals that are inconsistent with ours;

 

   

take actions contrary to our instructions or requests or contrary to our policies and objectives;

 

   

be unable or unwilling to fulfill their obligations under the relevant joint venture arrangements or agreements;

 

   

have financial difficulties;

 

   

be acquired or undergo a change in control; or

 

   

have disputes with us.

A serious dispute with these non-controlling shareholders or the early termination of our cooperation arrangements or agreements with them could adversely affect our business, financial condition and results of operations.

 

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The market price of our ADSs has been and is likely to continue to be highly volatile.

The market price for our ADSs has been, and is likely to continue to be, highly volatile in response to factors such as variations in our operating results; failure of our quarterly financial and operating results to meet market expectations or failure to meet our previously announced guidance; changes in financial estimates by securities research analysts; sales or perceived sales of additional shares or ADSs; technological improvements in the biodiesel manufacturing process by us or our competitors; reduction or elimination of PRC government grants and economic incentives for the renewable energy industry; any change in applicable PRC law adversely affecting the renewable energy industry as a whole or the biodiesel industry in particular, including recent assessments of consumption tax on sales of our biodiesel products; news regarding any gain or loss of customers by us; news regarding recruitment or loss of key personnel by us or our competitors; adverse claims and allegations about our Company, our business, our financial reporting, our executives or directors, or other matters relating to us, see Item 4.B, “Information on the Company—Business Overview—Legal and Administrative Proceedings”; announcements of competitive developments, acquisitions or strategic alliances in the biodiesel or copper industry; general market conditions or other developments affecting the renewable energy industry; agricultural or other conditions in the PRC that may impact our supply of raw materials; and sales of additional ordinary shares or ADSs.

In addition, the securities markets have from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our ADSs.

We may not be able to pay any dividends on our ordinary shares and ADSs.

Under Cayman Islands law, we may only pay dividends out of our profits or our share premium account subject to our ability to service our debts as they become due in the ordinary course of business. Our ability to pay dividends therefore depends on our ability to generate sufficient profits. We cannot give any assurance that we will declare dividends of any amounts, at any rate or at all in the future. Future dividends, if any, will be at the discretion of our board of directors, subject to the approval of our shareholders, and will depend upon our results of operations, our cash flows, our financial condition, the payment of our subsidiaries of cash dividends to us, our capital needs, future prospects and other factors that our directors may deem appropriate. You should refer to Item 8.A, “Financial Information—Consolidated Statements and Other Financial Information—Dividend Policy” for additional information regarding our current dividend policy and the risk factor entitled “—Risks Relating to Business Operations in China—PRC laws and foreign exchange controls may affect our ability to receive dividends and other payments from our PRC subsidiaries” above for additional legal restrictions on the ability of our PRC subsidiaries to pay dividends to us.

Future financing may cause a dilution in your shareholding or place restrictions on our operations.

We may be required to raise additional funding to meet our working capital or capital expenditure requirements or issue additional ordinary shares for future acquisitions or other purposes in the future. If we raise such funding through issuance of new equity or equity-linked securities it may cause a dilution in the percentage ownership of our then existing shareholders. Alternatively, if we meet such funding requirements by way of additional debt financing, we may have restrictions placed on us through such debt financing arrangements which may:

 

   

limit our ability to pay dividends or require us to seek consents for the payment of dividends;

 

   

increase our vulnerability to general adverse economic and industry conditions;

 

   

limit our ability to pursue our business strategies;

 

   

require us to dedicate a substantial portion of our cash flows from operations to service our debt, thereby reducing the availability of our cash flow to fund capital expenditure, working capital requirements and other general corporate needs; and

 

   

limit our flexibility in planning for, or reacting to, changes in our business and our industry.

 

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Future sales or issuances, or perceived intentions of future sales or issuances, of substantial amounts of our ordinary shares or ADSs could adversely affect the price of our ADSs.

Sales of our ADSs or ordinary shares in the public market, or the perception that these sales could occur, could cause the market price of our ADSs to decline. Such sales, or perceived potential sales, by our existing shareholders might make it more difficult for us to issue new equity or equity-related securities in the future at a time and place we deem appropriate. As of the date of this annual report, we had 190,831,943 ordinary shares outstanding, including 101,391,628 ordinary shares outstanding under the name of the depositary on behalf of the holders of 10,139,162 ADSs and 12,000,000 ordinary shares held in escrow in relation to the acquisition of Jin Xin. In addition, in relation to the acquisition of Xiangbei, we are subject to a three year earn-out arrangement under which we may be required to issue up to 20,000,000 ordinary shares by 2014 and if the volume weighted average trading price of our ordinary shares over the 30 calendar day period immediately after the public announcement of our 2013 annual financial results is below US$1.25 per ordinary share or US$12.50 per ADS, we may also be required to issue additional ordinary shares to Gold Wide and Silvery Boom up to a maximum value of RMB20 million.

In addition, we may issue additional ADSs or ordinary shares for future acquisitions or other purposes. If we issue additional ADSs or ordinary shares, your ownership interests in our Company would be diluted and this in turn could have a material adverse effect on the price of our ADSs.

You may not be able to exercise your right to vote.

As an ADS holder, 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 these instructions. Otherwise, you will not be able to exercise your right to vote unless you withdraw the ordinary shares underlying your ADSs. Pursuant to our amended and restated articles of association, we may convene a shareholders’ meeting upon 10 clear days’ notice. When a shareholder’s meeting is convened, you may not receive sufficient advance notice to withdraw the ordinary shares underlying your ADSs to allow you to vote with respect to any specific matter. If we give timely notice, the depositary will notify you of the upcoming vote and arrange to deliver our voting materials to you. We cannot assure you that you will receive the voting materials in time to instruct the depositary to vote the ordinary shares underlying your ADSs. 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 there may be nothing you can do if the ordinary shares underlying your ADSs are not voted as you requested.

You may not receive distributions on ordinary shares or any value for them if it is unlawful or impractical to make them available to you.

Subject to the terms and conditions of the deposit agreement, 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 and expenses. You will receive these distributions in proportion to the number of ordinary shares your ADSs represent. However, the depositary is not responsible if it decides that it is unlawful or impractical to make a distribution available to any holders of ADSs, in which case it may determine not to make such a distribution. Neither we nor the depositary has any obligation to register ADSs, ordinary shares, rights or other securities subject to such distribution under U.S. securities laws. Neither we nor the depositary have any 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 the distribution we make on our ordinary shares or any value for them if it is unlawful or impractical for us to make them available to you. These restrictions may have a material adverse effect on the value of your ADSs.

You may be subject to limitations on transfer of your ADSs.

Your ADSs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time and 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 deem 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.

 

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You may not be able to participate in rights offerings or elect to receive stock dividends and may experience dilution of your holdings, and the sale, deposit, cancellation and transfer of our ADSs issued after exercise of rights may be restricted.

If we offer holders of our ordinary shares any rights to subscribe for additional shares or any other rights, the depositary may make these rights available to you after consultation with us. We cannot make rights available to you in the United States unless we register the rights and the securities to which the rights relate under the Securities Act or an exemption from the registration requirements is available. In addition, under the deposit agreement, the depositary will not distribute rights to holders of ADSs unless the distribution and sale of rights and the securities to which these rights relate are either exempt from registration under the Securities Act with respect to all holders of ADSs, or are registered by us under the provisions of the Securities Act. We can give no assurance that we can establish an exemption from the registration requirements under the Securities Act, and we are under no obligation to file a registration statement with respect to these rights or underlying securities or to endeavor to have a registration statement declared effective. Accordingly, you may be unable to participate in such rights offerings and may experience dilution of your holdings as a result. The depositary may allow rights that are not distributed or sold to lapse. In that case, you will receive no value for them. In addition, U.S. securities laws may restrict the sale, deposit, cancellation and transfer of ADSs issued after the exercise of rights.

You may face difficulties in protecting your interests because we are incorporated under Cayman Islands law.

We are incorporated in the Cayman Islands and our corporate affairs are governed by our amended and restated memorandum and articles of association and by the Companies Law, Cap.22 (Law 3 of 1961, as consolidated and revised) of the Cayman Islands, which we will refer to as the Cayman Companies Law below, and common law of the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law may not be as clearly established as they are under statutes or judicial precedents in existence in the United States. In particular, the Cayman Islands has a less developed body of securities law as compared to the United States and provides significantly less protection to investors. Therefore, our public shareholders may have more difficulties in protecting their interests in the face of actions by our management, directors or controlling shareholders than would shareholders of a corporation incorporated in a jurisdiction in the United States. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action before federal courts of the United States.

There is uncertainty as to whether the courts of the Cayman Islands would (i) recognize or enforce judgments of U.S. courts obtained against us or our directors and officers predicated upon the civil liability provisions of the federal securities laws of the United States or the securities laws of any state or territory within the United States or (ii) entertain original actions brought in the courts of the Cayman Islands, against us or our directors and officers predicated upon the federal securities laws of the United States or the securities laws of any state or territory within the United States.

The Cayman Islands would recognize as a valid judgment, a final and conclusive judgment in personam obtained in the federal or state courts in the United States under which a sum of money is payable (other than a sum of money payable in respect of multiple damages, taxes or other charges of a like nature or in respect of a fine or other penalty) and would give a judgment based thereon provided that: (a) such courts had proper jurisdiction over the parties subject to such judgment; (b) such courts did not contravene the rules of natural justice of the Cayman Islands; (c) such judgment was not obtained by fraud; (d) the enforcement of the judgment would not be contrary to the public policy of the Cayman Islands; (e) no new admissible evidence relevant to the action is submitted prior to the rendering of the judgment by the courts of the Cayman Islands; and (f) there is due compliance with the correct procedures under the laws of the Cayman Islands.

You may experience difficulties in effecting service of legal process and enforcing judgments against us and our management.

Substantially all of our assets and our subsidiaries are located in China. In addition, most of our directors and officers reside within China and Hong Kong. As a result, it may not be possible to effect service of process within the United States or elsewhere outside of China upon most of our directors and officers, including with respect to matters arising under the U.S. federal securities laws or applicable state securities laws. Moreover, our PRC legal advisor, Chen & Co. Law Firm, has advised us that China is not a party to any treaties providing for reciprocal enforcement of judgments of courts with the United States, the United Kingdom, Japan or certain other jurisdictions. As a result, recognition and enforcement in China of judgments of a court in the United States or any other jurisdictions mentioned above in relation to any matter may be difficult or impossible.

 

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As a result of being a public company, we are subject to financial reporting and other requirements for which our accounting internal audit and other management systems and resources may not be adequately prepared.

We are subject to reporting and other obligations under the Securities Exchange Act of 1934, as amended, or the Exchange Act, and the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, including the requirements of Section 404 of the Sarbanes-Oxley Act, or Section 404. These requirements of Section 404 first applied to our annual report on Form 20-F for the fiscal year ended on December 31, 2008. Section 404 requires annual management assessment of the effectiveness of our internal controls over financial reporting. Although our management determined that our internal controls over financial reporting were effective at December 31, 2011, see Item 15, “Controls and Procedures,” in the future our management may conclude that our internal controls over our financial reporting are not effective.

If we fail to timely achieve and maintain the adequacy of our internal controls in the future, 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 trading price of our ADSs. Furthermore, we continue to incur considerable costs and use significant management time and other resources in an effort to comply with our reporting and other obligations, including Section 404.

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.

We do not expect to be a “passive foreign investment company,” or PFIC, for U.S. federal income tax purposes for our current taxable year ending December 31, 2012 or in the foreseeable future. However, the application of the PFIC rules is subject to ambiguity in several respects, and PFIC status is tested each taxable year and will depend on the composition of our assets and income and the value of our assets, which may change from time to time. Because the value of our assets is likely to be determined in large part by reference to the market prices of our ordinary shares or ADSs, which has been fluctuating and is likely to continue to fluctuate, we may be a PFIC for any taxable year. If we are treated as a PFIC for any taxable year during which a U.S. Holder, as defined under Item 10.E, “Additional Information—Taxation—United States Federal Income Taxation,” held our ADSs or ordinary shares, certain adverse U.S. federal income tax consequences would apply to such U.S. Holder.

For more information on the tax consequences to you if we were treated as a PFIC, see Item 10.E, “Additional Information—Taxation—U.S. Holders—Passive foreign investment company.”

 

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Our independent registered public accounting firm’s audit documentation related to their audit reports included in this annual report may include audit documentation located in the Peoples’ Republic of China. The Public Company Accounting Oversight Board currently cannot inspect audit documentation located in China and, as such, you may be deprived of the benefits of such inspection.

Our independent registered public accounting firm that issued an audit opinion in the financial statements included herein, as auditors of companies that are traded publicly in the United Stateds and a firm registered with the PCAOB, is required by the laws of the United States to undergo regular inspections by the PCAOB. Since the significant portion of the audit is conducted in China and the work papers related to such portion are located in China, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of the Chinese authorities, the work papers of our auditors that are located in China are not currently inspected by the PCAOB.

Inspections of certain other firms that the PCAOB has conducted outside of China have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality. However, the PCAOB is currently unable to inspect an auditor’s audit work related to a company’s operations in China and where such documentation of the audit work is located in China. As a result, our investors may be deprived of the benefits of PCAOB’s oversight of our auditors through such inspections.

The ability of the PCAOB to conduct inspections of our auditors’ work papers in China makes it more difficult to evaluate the effectiveness of our auditor’s audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections. Investors may consequently lose confidence in our reported financial information and procedures and the quality of our financial statements.

 

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ITEM 4. INFORMATION ON THE COMPANY

A. History and Development of the Company

Our predecessor company, Sichuan Gushan, was established in China on June 14, 2001. In April 2005, the shareholders of Sichuan Gushan contributed their equity interests in Sichuan Gushan to Carling Technology, a company incorporated on January 5, 2005 in the British Virgin Islands. Since then, Carling Technology has become the ultimate holding company of four additional subsidiaries in China, three of which were established by us and one of which was acquired by us. In anticipation of our initial public offering, we incorporated Gushan Environmental Energy Limited in the Cayman Islands on May 16, 2006, as our listing vehicle and our holding company. Through a series of transactions, Gushan Environmental Energy Limited became the holding company of Carling Technology in September 2007. In December 2007, we completed the initial public offering of our ADSs and listed our ADSs on the NYSE.

We currently conduct our operations primarily through the following subsidiaries in China:

 

   

Sichuan Gushan, a wholly foreign-owned enterprise established in China on June 14, 2001;

 

   

Fujian Gushan, a wholly foreign-owned enterprise established in China on May 13, 2005;

 

   

Handan Gushan, formerly known as Feixiang Gushan Vegetable Fat Chemistry Co., Ltd., a sino-foreign joint venture established in China on May 15, 2003, which we acquired on June 1, 2005;

 

   

Beijing Gushan, a wholly foreign-owned enterprise established in China on August 17, 2006;

 

   

Shanghai Gushan, a wholly foreign-owned enterprise established in China on December 18, 2006;

 

   

Chongqing Gushan, a wholly foreign-owned enterprise established in China on January 24, 2008;

 

   

Hunan Gushan, a wholly foreign-owned enterprise established in China on January 14, 2008;

 

   

Jin Xin, a registered company established in China on February 3, 2009, in which we acquired an initial 67% indirect ownership interest on November 3, 2010 and subsequently acquired an additional 8% interest on January 1, 2011, increasing our indirect ownership interest to 75%; and

 

   

Xiangbei, a registered company established in China on January 18, 2011, in which we acquired 75% indirect ownership interest on August 1, 2011.

See Item 4.C, “Information on the Company—Organizational Structure” for further information.

On February 24, 2012, we received a preliminary non-binding proposal letter from Mr. Jianqiu Yu, our Chairman and Principal Executive Officer, to acquire all of our outstanding ordinary shares not currently owned, legally or beneficially, by him, for US$1.599 per ADS or US$0.1599 per ordinary share in cash. As of February 24, 2012, Mr. Yu controlled approximately 34.8% of our outstanding shares. Our Board of Directors formed a special committee of independent directors (the “Special Committee”) consisting of Messrs. Denny Ting Bun Lee, Kang Nam Chu and Dongming Zhang to consider the proposed transaction. On March 9, 2012, the Special Committee retained PiperJaffray as its financial advisor, Akin Gump Strauss Hauer & Feld LLP as its United States legal counsel, and Walkers Global as its Cayman Islands legal counsel to assist it in its work. As of the date of this annual report, the Special Committee is continuing its evaluation of the proposed transaction.

For a description of our principal capital expenditures since January 1, 2009 and principal capital expenditures currently in progress, including the amount invested and method of financing, see Item 5.B, “Operating and Financial Review and Prospects—Liquidity and Capital Resources—Acquisition and Capital Expenditures.”

Our principal executive offices are located at No. 12, Harbour District, Changan Investment Zone, Fuzhou Mawei Economic & Technical Development Area, Fujian Province, People’s Republic of China. Our telephone number at this address is (86 591) 8369–0555 and our fax number is (86 591) 8369–2555. Our registered office in the Cayman Islands is located at Cricket Square, Hutchins Drive, P.O. Box 2681, Grand Cayman, KY1-1111, Cayman Islands. Our telephone number at this address is (345) 945-3901. Our Hong Kong office is located at Room 908, China Merchants Tower, Shun Tak Centre, 168-200 Connaught Road Central, Central, Hong Kong. Our telephone number at this address is (852) 2587-7212 and our fax number is (852) 2587-7199.

Investor inquiries should be directed to us at the address and telephone number of our Hong Kong office set forth above or to our investor relations agent, Hill & Knowlton, Inc., located at 909 Third Avenue, New York, NY 10022. Our website is www.chinagushan.com. The information contained on our website does not form part of this annual report. 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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B. Business Overview

Overview

We are a manufacturer of copper products and a producer of biodiesel and biodiesel by-products. We commenced our copper products business in 2010 with our acquisition of Jin Xin. Our aggregate annual copper product production capacity was approximately 18,000 and 63,000 tons of copper products as of December 31, 2010 and 2011, respectively. We sold 3,787 and 23,154 tons of copper products for the years ended December 31, 2010 and 2011, respectively. Our aggregate annual biodiesel production capacity was 450,000, 390,000 and 490,000 tons of biodiesel as of December 31, 2009, 2010 and 2011, respectively. We sold 143,818, 42,391 and 8,178 tons of biodiesel for the years ended December 31, 2009, 2010 and 2011, respectively.

The following table sets forth our revenues for our copper products and biodiesel businesses for the periods indicated:

 

     Year ended December 31,  
     2009      2010      2011      2011  
     RMB      %      RMB      %      RMB      %      US$  
     (in thousands, except for percentage)  

Copper Products Business

     —           —           205,059         50.2         1,396,375         96.3         221,862   

Biodiesel Business

     628,186         100.0         203,439         49.8         53,359         3.7         8,478   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     628,186         100.0         408,498         100.0         1,449,734         100.0         230,340   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

For 2009, 2010 and 2011, our five largest customers contributed 22.4%, 33.7% and 44.8% of our consolidated revenues, respectively, while our largest customer contributed 7.4%, 10.0% and 13.8% of our consolidated revenues, respectively. In 2009, none of our customers accounted for more than 10.0% of our revenues. In 2010, one of our customers accounted for more than 10.0% of our consolidated revenues and in 2011, three of our customers each accounted for more than 10.0% of our consolidated revenues.

We generated revenues of RMB628.2 million, RMB408.5 million and RMB1,449.7 million (US$230.3 million) for the years ended December 31, 2009, 2010 and 2011, respectively. For the years ended December 31, 2009, 2010 and 2011, we had net loss attributable to our Company of RMB283.5 million, RMB1,109.0 million and RMB747.7 million (US$118.8 million), respectively.

Copper Products Business

We manufacture and sell copper rods, copper wires, copper granules, copper bars and copper plates primarily from copper and, to a lesser extent, electrolytic copper. We operate our copper products business through our 75%-owned subsidiaries, Jin Xin and Xiangbei.

We entered the copper products business in November 2010 with our acquisition of a 67% indirect ownership interest in Jin Xin. In January 2011, we acquired an additional 8% indirect ownership interest, increasing our indirect ownership in Jin Xin to 75%. In August, 2011, we expanded our copper products business by acquiring a 75% indirect ownership interest in Xiangbei.

We currently have two production facilities, located in Sichuan and Hunan. As of December 31, 2011, our daily production capacity was approximately 210 tons of copper products and we had a total designed annual production capacity of approximately 63,000 tons. We purchase scrap copper from domestic suppliers located throughout the PRC. We then manually separate the scrap copper into product categories and process it for sale. We sell our copper products to both downstream manufacturers, for use primarily in the production of power cables and communication cables, and to raw material traders.

Our copper products business generated revenues of RMB205.1 million and RMB1,396.4 million (US$221.9 million) for the years ended December 31, 2010 and 2011, respectively. For the years ended December 31, 2010 and 2011, we had net profit attributable to our copper products business of RMB8.3 million and RMB2.9 million (US$0.5 million), respectively.

 

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The following map sets forth the locations of our existing and planned copper production facilities:

 

LOGO

Our Products

We obtain and process scrap copper to produce a range of products to meet our customers’ needs in terms of size, purity and other specifications. We then sell our products to intermediaries and manufacturers for further processing into power cables, communication cables and a wide variety of other products. Furthermore, we also sell scrap materials left in our production lines, such as copper ash to our customers to recycle into raw materials. In addition, we also perform processing services, whereby we will process scrap copper owned by our customers into copper products based on our customers’ specifications to earn processing income.

Raw Material Supply

Raw materials for our copper products business primarily include scrap copper from household appliances and from manufacturing. Our major copper raw material suppliers are private enterprises engaged in the collection of unprocessed scrap copper in China. Our suppliers are located throughout the PRC. We believe there is an abundance of scrap copper suppliers in the PRC from which we can source our inputs at reasonable prices.

As we buy scrap copper at prevailing market prices, the market price of copper affects our raw material costs. The price of copper has fluctuated significantly since 2009. For example, the spot price of copper in China ranged from a low of approximately RMB27,000 per ton to a high of RMB75,000 per ton during the period from 2009 to the end of the first quarter of 2012.

We generally conduct our copper products business with suppliers on an order-by-order basis and do not enter into any long-term purchase contracts. Our scrap copper suppliers in Sichuan and Hunan generally grant us credit periods of approximately seven days. We also pay our suppliers in cash on delivery terms.

In 2010, we had only two scrap copper suppliers who supplied all of the raw materials for our copper products business. In 2011, our five largest scrap copper suppliers accounted for 50.2% of our consolidated cost of revenues, while our largest supplier represented 14.9% of our consolidated cost of revenues. For each of the years ended December 31, 2010 and 2011, we had two suppliers that each represented more than 10% of our consolidated cost of revenues. For the years ended December 31, 2010 and 2011, we used 4,517 tons and 22,100 tons of scrap copper, respectively, in our copper products business.

Manufacturing

Production Process

The following chart illustrates our production process in our copper products business:

 

LOGO

 

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We purchase scrap copper from our suppliers and sort it manually into product categories. Scrap copper wires and cables are processed using a wire stripper to strip off their plastic coating. Scrap copper is sheared and cut in a shredder into copper granules. We process scrap copper into copper concentrates, or secondary copper, through melting and drawing into copper rod and wires.

Quality Control

We apply rigorous quality control standards and have implemented safety procedures at all of our production facilities.

We assess our raw material suppliers regularly in accordance with specified criteria on pricing, quality of raw materials supplied, the source of the scrap copper and quality of service. Before entering into a relationship with a new supplier, we conduct diligence on the supplier’s background and reputation to assess its suitability to act as one of our suppliers.

We physically inspect raw materials for dangerous materials by examining samples taken from each type of scrap copper to determine its purity and metal content. We also inspect our raw materials to determine whether they contain significant amounts of chemical residuals or other environmental pollutants, which would then be removed by our suppliers.

Our management team has implemented policies to proactively safeguard against accidents. In addition, we conduct regular inspections and maintenance of our copper production facilities.

Customers

Our copper customers are primarily power cable manufacturers and raw material traders. Demand for our copper products is subject to seasonal fluctuations. Due to the Chinese New Year holiday in the first half of each year, demand for our copper products is generally lower than demand in the second half of the year. As a result, fluctuations in demand for copper products in the second half of the year may have a disproportionate impact on our results of operations. We grant credit periods of approximately 10 days to our major copper customers for account receivables and sell to other customers on cash on delivery terms.

For 2010 and 2011, our five largest customers of our copper products business contributed 27.2% and 44.8% of our consolidated revenues, respectively, while our largest customer contributed 10.0% and 13.8% of our consolidated revenues, respectively. In 2010, one of our copper products customers accounted for more than 10.0% of our consolidated revenues. In 2011, three of our copper products customers each accounted for more than 10.0% of our consolidated revenues.

Sales and Marketing

We conduct all of our sales through direct sales by our own sales personnel of our operating subsidiaries. We sell copper products to customers located throughout China. We generally deliver our copper products to our customers.

Our sales team places strong emphasis on building long-term relationships with our customers by actively seeking customer feedback. Our sales personnel regularly contact our customers and visit them to obtain feedback and gather market information.

Intellectual Property

In September 2010 we filed two patent applications with the State Intellectual Property Office of the PRC relating to certain of our manufacturing processes.

Competition

The recycled copper industry in China is fragmented and the competition is intense. We compete with numerous other recycled copper companies for both raw materials and sales of copper products. Competition for raw materials is based on price and proximity to the source of raw materials. Competition for sales is primarily based on price, quality of products, sales, capacity and proximity to customers. We compete primarily with local metal recycling companies, and those who import recycled scrap copper from overseas.

Environmental Matters

According to PRC environmental laws and regulations, we are required to adopt effective measures to prevent and control pollution to the environment in connection with our copper products business. We monitor our compliance with applicable environmental regulations relating to noise and solid waste discharge and have established an environmental control system pursuant to the applicable regulations.

 

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All of our products meet the relevant requirements under PRC laws and we have not been subject to any material fines or legal action involving non-compliance with any relevant environmental regulation, nor are we aware of any threatened or pending action, including by any environmental regulatory authority. See Item 3.D, “Key Information—Risk Factors—Risks Relating to Our Business and Industry—Failure to comply with environmental regulations could harm our business.”

Biodiesel Business

We produce and sell biodiesel and by-products of biodiesel production, including glycerine, plant asphalt, erucic acid and erucic amide. Biodiesel is a renewable, clean-burning and biodegradable fuel and a raw material used to produce chemical products, primarily produced from a variety of feedstocks, such as vegetable oil, animal fat and recycled cooking oil. Biodiesel can be used to fuel a wide range of diesel engines, typically after blending with diesel, including diesel engines found in trucks, mass transit vehicles, marine vessels and generators and is also used as fatty acid methyl ester in the chemical industry. The by-products of our biodiesel production have numerous commercial applications in the food, pharmaceutical and manufacturing industries.

We pursue technological innovations and improvements to our manufacturing methods and processes. We have obtained three patents in China, one for a biodiesel manufacturing method we invented, one for a method of producing fatty acid methyl ester and the other for a method of producing certain by-products. We also have four pending patent applications in China relating to methods of producing different types of by-products of biodiesel production. We have also obtained a patent for a biodiesel manufacturing method from the United States Patent and Trademark Office. We believe our emphasis on technological innovations and production efficiency has contributed significantly to our competitive position as a leader in the PRC biodiesel industry.

We sell our products in China to direct users, including marine vessel operators and chemical companies, in addition to petroleum wholesalers and individual retail gas stations. We primarily use vegetable oil offal and used cooking oil to produce biodiesel. We acquire the raw materials supply for each of our production facilities primarily from local suppliers.

Our biodiesel business currently has seven production facilities located in Fujian, Sichuan, Hebei, Beijing, Shanghai, Chongqing and Hunan in China. Our aggregate annual biodiesel production capacity has increased from 10,000 tons in 2001 to 490,000 tons as of April 30, 2012. Since the first quarter of 2011, our raw material input costs have increased at a rate higher than the rate of increase in our average biodiesel selling prices. The cost of increase in our raw material input costs appeared to be stabilizing during the third and fourth quarter of 2011. However, since the third quarter of 2011, local governments began to crack down on illegal practices of collectors of used cooking oil to prevent them from allegedly selling used cooking oil to processors who illegally process and resell the used cooking oil as virgin edible oil for public consumption. This action by the local governments has forced many used cooking oil collectors, including our suppliers, to suspend their operations. Consequently, there has been a shortage in supply of raw materials that contributed to our decision to suspend substantially all of our biodiesel production. Given the high raw material input costs, the shortage of raw materials, and slowing demand, we do not expect to resume our production of biodiesel and biodiesel by-products on a large scale basis unless our plants are able to operate on a positive cash flow basis. We consider the probability of resuming such production on a large scale basis in the near future to be remote. As of the date of this annual report, only our Sichuan biodiesel production facility is currently in operation.

Our biodiesel business generated revenues of RMB628.2 million, RMB203.4 million and RMB53.3 million (US$8.4 million) for the years ended December 31, 2009, 2010 and 2011, respectively. For the years ended December 31, 2009, 2010 and 2011, we had net loss attributable to our biodiesel business of RMB283.5 million, RMB1,066.9 million and RMB716.8 million (US$113.9 million), respectively.

The following map sets forth the locations of our existing biodiesel production facilities, of which only our Sichuan biodiesel production facility is currently in operation:

LOGO

 

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Our Products

Our biodiesel production process generates biodiesel and the by-products of biodiesel production, such as glycerine, a distillation residue of biodiesel production known as plant asphalt, erucic acid and erucic amide, which have numerous commercial applications. Our products include:

 

   

Biodiesel. A renewable, clean-burning and biodegradable alternative to diesel and a raw material in the chemical industry, which can be used to power a wide range of diesel vehicles, including trucks, mass transit vehicles and marine vessels and can be used as fatty acid methyl ester to produce chemical products;

 

   

Glycerine and refined glycerine. A colorless, odorless, nontoxic liquid with numerous uses, including use in foods and beverages, for example, as a preservative, sweetener or softening agent, in pharmaceuticals, for example, as a lubricant, alcohol substitute or expectorant, as a paint dissolving solvent, and in personal care products, for example, in soap, shampoo and lotion. Refined glycerine has a higher level of purity than glycerine;

 

   

Plant asphalt. As fuel for boilers, casting plaster and a stain remover;

 

   

Erucic acid. A fatty acid that can be extracted from rapeseed and used in the production of lubricants and polyesters, for example, in skin and health care products, plastic photographic film manufacturing processes and as a transmission fluid additive;

 

   

Erucic amide. An anti-felt, anti-static agent for fabrics and a plastics lubricant;

 

   

Stearic acid. A fatty acid used in making plastics, soaps, cosmetics and candles; and

 

   

Fatty acid methyl ester. An intermediate product sold to the chemical industry.

The properties of the raw materials we use at our particular plants determine our product mix at our respective production facilities. Although our biodiesel by-products do not enjoy comparable demand to biodiesel, in general, they generate greater profit margins than our biodiesel.

Many of our customers mix the biodiesel they purchase from us with their own diesel.

The following table sets forth information regarding our biodiesel and biodiesel by-products sales volumes for the periods indicated:

 

     Year ended December 31,  
     2009      2010      2011  
     Sales volume
(in tons)
     % of biodiesel
sales  volume
     Sales volume
(in tons)
     % of biodiesel
sales  volume
     Sales volume
(in tons)
     % of biodiesel
sales  volume
 

Biodiesel

     143,818         88.6         42,391         87.0         8,178         84.8   

Biodiesel by-products

     18,469         11.4         6,314         13.0         1,464         15.2   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     162,287         100.0         48,705         100.0         9,642         100.0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Beginning in 2009, the PRC government introduced regulations to, among other things, increase consumption tax rates on various refined oil products, including diesel, eliminate the specific exemption for biodiesel products that are produced from animal and vegetable fats and oils and subject biodiesel that is processed from diesel or predominately mixed with diesel to consumption tax.

In December 2010, the Ministry of Finance and the PRC SAT issued Caishui 118. According to Caishui 118, subject to fulfillment of certain conditions, pure biodiesel made from animal fats or vegetable oils is exempt from consumption tax in the PRC. Caishui 118 was effective immediately and applies retroactively to January 1, 2009. On June 15, 2011, the Ministry of Finance and the PRC SAT issued Caishui [2011] No.46 which clarifies the scope of the consumption tax-free waste animal and plant oils for biodiesel production. We believe that biodiesel produced at all of our production facilities will satisfy the conditions set forth by Caishui 118 and Caishui [2011] No. 46 and therefore qualify for the exemption.

We did not pay consumption tax for our sales of biodiesel products in 2009 but made a provision of RMB103.8 million, which was reversed in 2010 and recorded as other operating income in 2010.

 

 

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Although the consumption tax issue was resolved in December 2010, our sales volume of biodiesel and biodiesel by-products in 2011 decreased significantly compared to 2010 as a result of our decision to extend the suspension of certain biodiesel plants and initiate the suspension of substantially all of our other biodiesel plants due to raw material shortages, high raw material input costs, and slowing demand. Given the high raw material input costs and the shortage of raw materials, we do not expect to resume production of biodiesel and biodiesel by-products on a large scale basis unless our plants are able to operate on a positive cash flow basis. We consider the probability of resuming such production on a large scale basis in the near future to be remote.

Raw Material Supply

We use vegetable oil offal, which is the waste or by-product generated in connection with the manufacturing of vegetable oil, and used cooking oil as the primary raw materials for our biodiesel manufacturing process. Recycling of vegetable oil offal and used cooking oil also carries additional environmental benefits as disposal without proper processing can be hazardous. These inedible oils were sourced from provinces in the southern and western part of China. Our proprietary production technology enables us to produce biodiesel using lower-grade, lower-cost vegetable oil offal and used cooking oil, as compared to relatively higher-grade, higher-cost feedstock. For example, we are able to process raw materials with lower oil and free fatty acid content and which may contain a mixture of different types of oil, and we do not have any requirements on the ratio of oil and free fatty acid content, thus allowing us greater flexibility in the raw materials that we purchase.

To help secure adequate raw materials supplies and minimize purchasing costs, historically we have used one to two main feedstock suppliers and several secondary suppliers for each production facility. We conduct business with suppliers on an order by order basis. We determine raw material prices based on arm’s-length negotiations with our suppliers shortly prior to delivery with reference to market prices.

The following table sets forth a summary, for the periods indicated, of the aggregate amounts of vegetable oil offal, used cooking oil and castor bean oil used in our operations:

 

     Year ended December 31,  
     2009      2010      2011  
     (in tons)      (in tons)      (in tons)  

Vegetable oil offal and used cooking oil

     182,512         53,034         12,883   

Castor bean oil

     6,023         5,123         —     
  

 

 

    

 

 

    

 

 

 

Total

     188,535         58,157         12,883   
  

 

 

    

 

 

    

 

 

 

We historically have secured supplies of vegetable oil offal from vegetable oil producers near our production facilities through local privately owned collecting agencies. The raw material suppliers for used cooking oil are also local collecting agencies that collect used cooking oil from restaurants and other sources. Our suppliers typically deliver raw materials directly to us. Under our typical terms with our suppliers, we settle payments within 30 days. To ensure adequate supplies and to better support the working capital needs of the raw materials collecting agencies, we have sought to settle our payables with our raw material collecting agencies over a shorter period of time, typically three to seven days, or in the form of prepayment.

 

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In order to help diversify and secure our source of feedstock at a stable price, we signed two contracts in respect of supplies of castor bean oil with a supplier in Sichuan and castor beans with another supplier in Indonesia in 2009. Castor bean oil itself is an intermediate product in the chemical industry as well as a raw material used to produce biodiesel. During the fourth quarter of 2010, due to continuous problems with the climate and quality of the castor bean, we decided to terminate the supply contract in Indonesia. The payment of RMB4.8 million in connection with such supply contract for castor bean was written off in the fourth quarter of 2010. In 2011, our contract with the supplier in Sichuan was cancelled and we received a compensation of RMB5.2 million (US$0.8 million).

Our raw material input costs have increased at a rate higher than the rate of increase in our average biodiesel selling prices. In particular, our raw material input costs have risen significantly since the first quarter of 2011. In addition, since the third quarter of 2011, local governments began to clamp down on collectors of used cooking oil to prevent them from allegedly selling used cooking oil to processors who illegally process and resell the used cooking oil as virgin edible oil for public consumption. This action by the local governments has forced many used cooking oil collectors, including our suppliers, to suspend their operations. Consequently, there was a shortage in supply of raw materials. This shortage was one of the main factors contributing to our decision to extend and/or implement the suspension of substantially all of our biodiesel and by-products production. We consider the probability of resuming such production on a large scale basis in the near future to be remote. As of the date of this annual report, only Sichuan Gushan’s biodiesel production facility is in operation.

For 2009, 2010 and 2011, the five largest suppliers to our biodiesel business represented 35.7%, 35.0% and 4.0% of our consolidated cost of revenues, respectively, while our largest supplier to our biodiesel business represented 9.6%, 16.7% and 2.2% of our consolidated cost of revenues, respectively. One of our biodiesel suppliers accounted for over 10% of our consolidated cost of revenues in each of 2009 and 2010. In 2011, none of our biodiesel suppliers accounted for more than 10% of our consolidated cost of revenues.

Manufacturing

Production Process

Our biodiesel production method utilizes production technologies for which we have obtained patents. The following chart illustrates our biodiesel manufacturing process:

 

LOGO

We begin the production process by purifying raw materials, which are typically already acidified when purchased by us. We filter the acidified oil, after which it is stored and allowed to settle before entering our production process. We then continuously dehydrate the raw materials by vacuum and reduce the water content in the raw materials to less than 0.2%. The dehydrated raw materials are then blended with methanol.

Transesterification (the process by which vegetable oil is combined with methanol to produce biodiesel and glycerine) of the raw materials then takes place in a reactor tower under heat and pressure. Water is removed from the reaction at the bottom of the methanol recovery tower. Methanol is then recycled at the top of the tower back to the reactor for further reaction. The resulting material is then dehydrated in a precipitator for continuous distillation at lower pressure in a distillation tower to produce biodiesel.

 

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We collect the by-product glycerine during the transesterification process. We produce plant asphalt and erucic acid during the distillation process. To produce erucic amide, we hydrolyze erucic acid to produce erucic, which is then combined with amine and catalysts to produce erucic amide following purification.

We believe our manufacturing process is innovative and cost-effective. Our production process does not require the use of catalysts. Our process utilizes low cost raw materials, namely vegetable oil offal and used cooking oil, and adopts continuous vacuum dehydration, which reduces the water content level of raw materials to less than 0.2%. In addition, our specially designed compact structure can quickly remove the water produced during the reaction and our medium-pressure continuous esterification tower can be scaled for industrial mass production.

Quality Control

We apply rigorous quality control standards and have implemented safety procedures at all of our production facilities. In April 2004, our Sichuan plant obtained ISO9001:2000 international quality management standard certification and we have strictly abided by the requirements for maintaining this certification.

Currently, there is no mandatory national standard in China for biodiesel quality. On May 1, 2007, the General Administration of Quality Supervision, Inspection and Quarantine of China and the committee of the Standardization Administration of China implemented recommended standards for biodiesel blend stock (BD100) for diesel engine fuels. We set our own biodiesel production standard based on EN14214, the European Biodiesel Standard, and the National Light Diesel Standard. According to a report of SGS Group, an independent inspection and testing company, as of August 2006, biodiesel produced by us satisfied the EN 14214 production standard, which is generally perceived as one of the most stringent standards in the world.

Our management team has implemented policies to proactively safeguard against accidents. In addition, we conduct regular inspections and maintenance of our biodiesel production facilities.

Customers

Our biodiesel customers are based in China and can be classified into three major groups: direct users, petroleum wholesalers and individual retail gas stations. Direct users include marine vessel operators, chemical companies and factories. Petroleum wholesalers purchase biodiesel from us for subsequent distribution to individual gas stations. Petroleum wholesalers include local subsidiaries of state-owned enterprises or privately owned companies. Beginning in March 2008, we also commenced sales of some of our biodiesel products to chemical companies at higher average selling prices than to our other customers. These customers use our biodiesel to produce a variety of products, including elasticizers, surfactants, alkyd resin, leather greasing agents and anticoagulants.

We adopt similar credit policies and sales, marketing and distribution strategies across three groups of biodiesel customers. We usually sign sales contracts for a term of approximately one year with our customers for biodiesel and approximately one year or less with our customers for by-products. The total sales volume, the pricing, product specifications, the delivery schedule and the method of delivery are agreed and set out in the sales contracts. Depending on the market conditions, we sell our biodiesel either at no discount or at a discount to the local retail market prices for diesel products. In most cases, customers will arrange their own delivery from our facilities to their own locations. We set the payment methods depending on our business relationship, customers’ credit records and the current market conditions. We occasionally provide our customers with 30-day credit terms.

Our by-products customers are based in China and include direct customers and chemical trading companies. Direct customers include manufacturers in various industries, for example, the foundry industry, pharmaceutical industry and food industry. We price our by-products by reference to prevailing market prices for such products. Our management and sales executives monitor the prices of these products and consider various factors, including prices being offered by our competitors, purchase order volumes and seasonal factors when they set our product prices.

For 2009, 2010 and 2011, our five largest biodiesel and by-products customers contributed 22.4%, 22.2% and 1.6% of our consolidated revenues, respectively, while our largest customer of our biodiesel business contributed 7.4%, 9.3% and 0.5% of our consolidated revenues, respectively. In 2009, 2010 and 2011, none of our customers accounted for more than 10.0% of our consolidated revenues.

 

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Sales and Marketing

We conduct all of our sales through direct sales by our own sales personnel of our operating subsidiaries. We sell our biodiesel mainly to customers located in close proximity to our production facilities in operation. Our by-products are mainly sold to chemical plants and other companies.

Our sales team places strong emphasis on building long-term relationships with our customers by actively seeking customer feedback. Our sales personnel regularly contact our customers and visit them to obtain feedback and gather market information.

Most of our biodiesel customers pick up our products directly from our production facilities. Our products are typically transferred by pipeline to trucks at our facilities.

Intellectual Property

Our biodiesel manufacturing processes are based on technology substantially developed in-house by our research and development and engineering personnel. We rely on a combination of patents, trademarks, domain names and confidentiality agreements to protect our intellectual property. We require all members of our senior management and our key research and development personnel to sign agreements with us which stipulate, among other things, confidentiality obligations and restrictions on the assignment of intellectual property.

One of our biodiesel production processes is protected by an invention patent (patent no. ZL02133591.5) granted by the State Intellectual Property Office of the PRC and effective as of August 7, 2002. The term of this patent is 20 years from August 7, 2002. This patent is held by Sichuan Gushan, which has licensed the patent to our other subsidiaries.

On January 23, 2008 we obtained an invention patent (patent no. ZL200510020486.6) for a method of producing certain by-products, granted by the State Intellectual Property Office of the PRC. This patent has a term of 20 years starting from March 9, 2005. This patent is held by Sichuan Gushan.

On February 23, 2010, we obtained an invention patent (patent no. US 7,667,060 B2) for one of our biodiesel production methods, granted by the United States Patent and Trademark Office. This patent is effective from April 25, 2008 to September 13, 2028 and is held by Sichuan Gushan.

On June 9, 2010 we obtained an invention patent (patent no. ZL200610022443.6) for a method of producing fatty acid methyl ester, granted by the State Intellectual Property Office of the PRC. This patent has a term of 20 years starting from December 8, 2006. This patent is held by Sichuan Gushan.

In September 2010, we filed two applications with the State Intellectual Property Office of the PRC relating to methods of producing different types of copper products. We also have four pending patent applications that have been filed in China involving technologies for producing new fuel additives, and erucic acid and fatty acid.

We are currently using the registered trademark “GS LOGO ” for our biodiesel. The mark is owned by Sichuan Gushan, which has licensed the trademark to our other subsidiaries. We also have registered trademarks for “ LOGO ”, “Gushan” and “Gushan LOGO ” in Hong Kong. We are not aware of any material infringement of our intellectual property rights.

Competition

We believe the principal competitive factors for biodiesel producers in China are as follows:

 

   

Pricing. A producer’s ability to control and flexibility over the pricing of products and the ability to use economies of scale to secure competitive pricing advantages;

 

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Technology. A producer’s ability to produce biodiesel and by-products efficiently and to utilize low-cost raw materials; and

 

   

Barriers to entry. A producer’s technical knowledge, local market knowledge and established relationships with suppliers and customers to support the development of commercially viable production facilities.

The biodiesel industry is still at an early stage in China and we have thus far experienced limited competition from domestic biodiesel producers. Our competitors include China Biodiesel International Holding Co., Ltd., East River Energy Resources, SINOPEC, CNOOC, and PetroChina and domestic manufacturers that are currently in the development stage of biodiesel production.

China represents a potentially lucrative market for international competitors, many of whom may seek to enter the PRC market. We believe that there are no foreign competitors with a material presence in the biodiesel industry in China. However, in the past it has been reported that certain Malaysian producers have expressed interest in establishing biodiesel production facilities in China and that they will likely use imported Malaysian palm oil as a feedstock. Although the current price of palm oil appears prohibitively too high for overseas manufacturers to commercially validly operate in the PRC market, we expect that some overseas manufacturers will enter China once the price of palm oil or other alternative feedstock becomes more affordable. The biodiesel industry in China may become more competitive due to competition from overseas manufacturers in the future. We believe that our annual production capacity, early entry into the commercial biodiesel market in China, strong customer relationships and reputation for high quality products has differentiated us from our competitors. Nevertheless, existing and future domestic competitors, who may have a greater presence in other regions through government support or enjoy greater popularity among local customers, may be able to secure a significant market share in regions where we currently do not have active operations. Further, our international competitors may have comparatively greater financial and research and development resources. Any increase in the number or size of competitors may affect our competitive position in the biodiesel market and our overall performance and profitability.

Environmental Matters

Given the nature of our biodiesel business, we generate waste water, exhaust fumes and noise during our production process. We have implemented a comprehensive set of environmental protection measures to treat emissions generated during our production process to minimize the impact of our production process on the environment. These measures include the following:

 

   

Waste water. Waste water processed by our facilities meets the PRC national standard for discharge. To conserve water resources, we also recycle and reuse waste water generated during our production process, which decreases our consumption of water and reduces the discharge of waste water into the environment;

 

   

Exhaust fumes. We generate exhaust fumes during our production process. Exhaust fumes generated during our production process are filtered to reduce dust, sulfur dioxide, trisodium phosphate (TSP), NOx and organic elements. In each case, exhaust fumes are treated to comply with PRC national air quality standards; and

 

   

Noise. We generate noise through the operation of our heating, ventilation and pumping systems. We typically reduce the noise generated by these activities to a range of 60 decibels to 80 decibels by employing various noise reduction measures that comply with applicable law.

All of our products meet the relevant requirements under PRC laws and we have not been subject to any material fines or legal action involving non-compliance with any relevant environmental regulation, nor are we aware of any threatened or pending action, including by any environmental regulatory authority. See Item 3.D, “Key Information—Risk Factors—Risks Relating to Our Business and Industry—Failure to comply with environmental regulations could harm our business.”

 

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Real Property

We both own and lease properties for our operations. With respect to our existing and planned production facilities, we have land use rights certificates for approximately 327,251 square meters of land and expect to obtain land use rights certificates for a total of approximately 63,356 square meters of land. We occupy our owned properties for purposes of production, research and development and employee living quarters. Our principal executive and administrative offices are located at Fujian Gushan’s production plant.

The following table sets forth the buildings for which we did not have building ownership certificates as of December 31, 2011:

 

Subsidiary owning the
buildings

  

Net book value of

the buildings as of
December 31, 2011

  

Expected

probability of not

obtaining building

ownership

certificates

  

Expected timing to obtain building ownership certificates

Fujian Gushan   

Nil

   Probable    This is a small engine room measuring 319 sq.m., representing approximately 4.4% of Fujian Gushan’s total floor area. We are seeking to amend the existing building ownership certificate for Fujian Gushan with the relevant authority to cover this engine room. We do not believe that the consequences of the failure to amend the building ownership certificate to cover the engine room, including imposition of any fines or penalties, would be material to its operations at Fujian Gushan.
Beijing Gushan   

Nil

   Remote    We expect to obtain the building ownership certificate within 18 months from the date of this annual report.
Shanghai Gushan   

Nil

   Remote    We expect to obtain the building ownership certificate within 12 months from the date this annual report.
Sichuan Gushan   

Nil

   Remote    We expect to obtain the building ownership certificate within 12 months from the date this annual report.
Jin Xin (Sichuan Province)    RMB21.4 million    Remote    We expect to obtain the building ownership certificate within 12 months from the date this annual report.

Insurance

We maintain various insurance policies to safeguard against risks and unexpected events. We provide social security insurance including pension insurance, unemployment insurance, work related injury insurance and medical insurance for our employees. We also maintain insurance for our projects under construction, plants, machinery, equipment, inventories and motor vehicles. We do not maintain product liability insurance for our biodiesel products or our copper products.

Legal and Administrative Proceedings

We may be subject to legal proceedings, investigations and claims incidental to the conduct of our business from time to time. In August 2009, a contractor for our production facility filed a lawsuit against us in the People’s Court of Fengxian District, Shanghai, alleging that we failed to pay the contract sum due for the contractor’s construction work on our Shanghai plant. We defended this lawsuit on the basis that the quality of the construction did not meet the standard agreed upon between us and the contractor and that we were entitled to withhold the remaining balance. On January 18, 2010, the court issued a judgment in favor of the contractor and held us liable for approximately RMB5.9 million. We appealed this decision to the Shanghai No. 1 Intermediate People’s Court but our demurrer was overruled on April 2, 2011, and we were found liable to the contractor for approximately RMB6.1 million, which we paid in full on June 28, 2011.

Other than the allegations described above, we are not aware of any legal proceeding, investigation or claim, or other legal exposure that has a more than remote possibility of having a material adverse effect on our business, financial condition or results of operations or cash flows.

PRC Regulations

This section sets forth a summary of the most significant regulations and requirements that affect our business activities in China and our shareholders’ right to receive dividends and other distributions from us.

 

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On March 27, 2007, the Ministry of Commerce, the Ministry of Construction, the Ministry of Public Security, the State Administration for Industry and Commerce, the State Administration of Environmental Protection, and the NDRC jointly promulgated Administrative Measures for the Recovery of Renewable Resources (the “Measures”), which came into effect on May 1, 2007. The Measures require that enterprises engaging in the renewable resources recovery business must register with the relevant local department of commercial administration within 30 days after obtaining business license. Enterprises engaging in recycling of waste metals are required to register with the relevant local public security organ within 15 days after obtaining a business license. Enterprises that violate these requirements will be notified by the relevant local department of commercial administration or public security organ, as applicable, and required to correct such violation within a specified time limit or be subject to fines of between RMB500 to RMB2,000. Departments of commercial administration and public security organs may also publicly announce such violations.

On November 30, 2004, the NDRC and the Ministry of Commerce of the PRC jointly promulgated the Catalog, which came into effect on January 1, 2005. The Catalog lists those industries and economic activities in which foreign investment in China is encouraged, restricted or prohibited. On October 31, 2007, the NDRC and the Ministry of Commerce jointly promulgated a further revised catalog, which came into effect on December 1, 2007 and supersedes the Catalog promulgated on November 30, 2004. The Catalog was further amended on December 24, 2011, which came into effect on January 30, 2012 (as amended, the “Catalog”).

With respect to our biodiesel business, pursuant to the Catalog, although the comprehensive utilization and disposal of exhaust gas, discharge liquid, waste residue, and the technology for recycling and comprehensive utilization of resources falls within the encouraged category, biodiesel production is classified as a sub-category of the agricultural food processing industry as a restricted industry. A foreign-invested enterprise engaged in such biodiesel production therefore must be majority owned by PRC citizens or entities because foreign investment in such biodiesel production is restricted. Our PRC legal counsel, Chen & Co. Law Firm, has advised us that based on their understanding of the Catalog, only biodiesel production using agricultural food products as raw materials falls within the “restricted industry” category pursuant to the new catalog. In the opinion of Chen & Co. Law Firm, our biodiesel production process, which utilizes used cooking oil and vegetable oil offal as raw materials, does not fall within the restricted industry category under the new catalog.

According to the Catalog, the “production of high tech non-ferrous metallurgical materials such as super-thin copper strips and copper and iron alloy strips” is classified as programs that foreign investors are encouraged to invest in. We believe that our copper products business falls into the encouraged category.

Our operations have been significantly affected by government policies such as taxation regulations. The PRC government introduced three regulations in relation to consumption tax rates to be levied on diesel products, effective as of January 1, 2009, which raised the consumption tax on diesel products levied on diesel producers from RMB0.10 per liter to RMB0.80 per liter. In order to minimize operating cash outflows that would result from the assessment of consumption tax, we extended the suspension of operations at Fujian Gushan, following the completion of road maintenance by the Fuzhou municipal government in early June 2009. We have also deferred the commencement of production at our Chongqing and Hunan production facilities, which were completed in May and July 2009, respectively. See Item 3.D, “Key Information—Risk Factors—Our operation have been subject to significant suspensions and interruptions which have resulted in a reduction of our sales volume and may continue to materially and adversely affect our results of operations,” and “Key Information Risk Factors—Risks Relating to Business Operations in China—PRC tax policies may continue to affect our business, results of operations and financial condition.” In December 2010, the Ministry of Finance and the PRC SAT issued Caishui 118. According to Caishui 118, pure biodiesel made from animal fats or vegetable oils is exempted from consumption tax in China, subject to the satisfaction of certain conditions. Caishui 118 was effective immediately and applies retroactively to January 1, 2009. Accordingly, any consumption tax paid on any such biodiesel since January 1, 2009 will be refunded. On June 15, 2011, the Ministry of Finance and the PRC SAT issued Caishui [2011] No.46, which clarifies the scope of the consumption tax-free waste animal and plant oils for biodiesel production. We expect that biodiesel produced at all of our production facilities will satisfy the conditions set forth by Caishui 118 and Caishui [2011] 46 and qualify for the exemption.

There are substantial uncertainties in the interpretation and application of existing and new PRC laws, regulations or policies. See Item 3.D, “Key Information—Risk Factors—If foreign ownership of the biodiesel production business in China is restricted, we would have to rely on contractual arrangements to derive economic benefits from, and to control, our new PRC operating entities in the future, which may not be as effective in providing control over these entities as direct ownership.”

In light of the rapid growth of the PRC economy and rising consumption of energy, the PRC government increasingly encourages the development and use of renewable energy resources. According to the Medium and Long Term Development Plan of the PRC, the share of renewable energy used in primary energy consumption is to be increased from 7.5% in 2005 to roughly 10% by 2010 and nearly 15% by 2020. The PRC government expects that the renewable energy sector in China will experience rapid expansion in the next few years.

 

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The Law of Renewable Energy Resources

The use of renewable energy sources has gained widespread support from the PRC government. The “Eleventh Five-Year Plan” of the PRC encourages the development of petroleum substitutes, including bioliquid fuel. The “Twelfth Five-Year Plan” of the PRC encourages the implementation of energy saving and/or petroleum substitute projects.

The newly amended Energy-Saving Law of China which came into effect on April 1, 2008 also encourages the development and utilization of petroleum substitutes.

Pursuant to the Law of Renewable Energy Resources, which came into effect on January 1, 2006 and as amended on December 26, 2009, the PRC government encourages the manufacturing and application of bioliquid fuel, and mandates petroleum-selling enterprises to include bioliquid fuel that meets the PRC national standards into their fuel-selling system. If any petroleum-selling enterprise fails to do so, such petroleum-selling enterprise will be liable for the economic loss suffered by the manufacturers of bioliquid fuel. Financial institutions may provide government-subsidized interest loans to renewable energy projects which fall within the National Guidance Catalog for Renewable Energy Resources Industry Development and meet relevant credit requirements.

The PRC Law of Renewable Energy Resources also provides that the PRC government shall set up a special fund for the development of renewable energy resources, or the Special Fund. The PRC Ministry of Finance issued the Temporary Regulation on the Management of the Special Fund for the Development of Renewable Energy Resources on June 16, 2006, which came into effect on May 30, 2006. Pursuant to this regulation, the Special Fund shall mainly provide assistance to the development and use of renewable energy resources, including petroleum substitutes.

The Implementation Opinion on Financial and Taxation Supportive Policy for the Development of Bioenergy and the Biochemical Industry was issued jointly by the PRC Ministry of Finance, NDRC, Ministry of Agriculture, the PRC SAT, and State Forestry Administration on September 30, 2006. The Implementation Opinion proposed various supportive policies for enterprises engaging in the bioenergy and biochemical industries, including government subsidies and preferential tax treatment.

The Newly Established National Biodiesel Standard

On January 5, 2007, the General Administration of Quality Supervision, Inspection and Quarantine and the State Standardization Supervision Committee jointly promulgated the National Standard of Biodiesel Blend Stock (BD100) for Diesel Engine Fuels, or the National Biodiesel Standard (B100), which took effect as of May 1, 2007. To our knowledge, the National Biodiesel Standard is currently deemed to be a recommended standard by the General Administration of Quality Supervision, Inspection and Quarantine and the State Standardization Supervision Committee, which biodiesel manufacturers are encouraged to comply with pursuant to relevant laws and regulations.

Stringent Standards for the Disposal of Used Cooking Oil

Under the Rules on the Management of Waste Grease for Food Producers promulgated on April 15, 2002 (abrogated on August 20, 2010), food producers must sell used cooking oil to waste grease processing entities or waste collection entities rather than discharging used cooking oil into the environment or reusing it for human consumption. Any entity or individual that purchases waste grease for the purpose of using waste grease to process and sell food is subject to penalties by the regulatory authorities. Further penalties will be imposed for any harm suffered by consumers resulting from consumption of food prepared with used cooking oil.

Under the Opinion on Strengthening the Management of the Use of Waste Cooking Oil and Kitchen Waste, promulgated by general office of the State Council on July 13, 2010, extracted kitchen waste oil may not be used for cooking or sold to food production entities.

The misuse of used cooking oil, such as in connection with the production of food for sale and consumption, also violates the PRC Food Safety Law, which came into effect on June 1, 2009. The PRC Food Safety Law imposes penalties on violations relating to food hygiene, including the suspension of food production by the violating entities.

 

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On March 2, 2010, the General Office of the State Council of the PRC promulgated Guobanfa [2010] No. 17 on “Rectification Arrangement of Food Safety for the Year of 2010” and on March 19, 2010, the State Food and Drug Administration promulgated Guoshiyaojianshi [2010] No. 106 on “Rectification Implementation of Food Safety in Restaurants,” both regulations aim to, among other things, reinforce the prohibition of processing food by using waste grease and used cooking oil.

Environmental Protection

We are subject to various PRC national and local environmental laws and regulations related to our operations, including regulations governing the use, storage, discharge and disposal of hazardous substances in the ordinary course of our manufacturing processes. The major environmental regulations applicable to us include the PRC Environmental Protection Law, the PRC Law on the Prevention and Treatment of Water Pollution and its implementation rules, the PRC Law on the Prevention and Treatment of Air Pollution, the PRC Law on the Prevention and Treatment of Solid Waste Pollution, and the PRC Law on the Prevention and Treatment of Noise Pollution.

According to the PRC Environmental Protection Law, the State Environmental Protection Administration sets national pollutant emission standards and provincial governments may set stricter local standards which are required to be registered at the State Administration for Environmental Protection. Enterprises are required to comply with the stricter of the two standards.

The relevant PRC laws and regulations generally impose discharge fees based on the level of emission of pollutants. These laws and regulations also impose fines for violations of laws, regulations or decrees and provide for possible closure by the central or local government of any enterprise that fails to comply with orders requiring it to rectify the activities causing environmental damage.

Tax Incentives

On December 9, 2008, the PRC SAT and Ministry of Finance jointly issued Policies for Products Generated from Comprehensive Utilization of Resources (Cai Shui [2008] No. 156), a circular on Value-added Tax, or VAT, which stipulated that a VAT refund upon levy would be applicable to enterprises that produce biodiesel by making use of waste animal oil or plant oil to the extent of not less than 70% as their raw materials. This VAT incentive policy is effective from July 1, 2008. To obtain the VAT refund, an enterprise must first apply for and obtain the relevant “Comprehensive Utilization of Resources Verification Certificate”, or CURV Certificate, and then apply for the VAT refund.

According to article 33 of the New CIT Law issued on March 16, 2007 and article 99 of the Implementation Rules on Corporate Income Tax Law issued on December 6, 2007 and the relevant circulars on “Comprehensive Utilization of Resources CIT Incentive” (Cai Shui [2008] No. 47 and Cai Shui [2008] No. 117), when calculating its taxable income, an enterprise that makes use of waste biomass oil or waste lubricant as 100% of its raw materials is entitled to a 10% reduction in revenue. To qualify for this reduction, an enterprise must first apply for and obtain the CURV Certificate and then apply for the tax reduction.

As of the date of this annual report, each of the CURV Certificates of Beijing Gushan, Shanghai Gushan, Fujian Gushan and Handan Gushan has expired, and Sichuan Gushan has made application for, but not yet obtained its CURV Certificate.

Jin Xin is a social welfare enterprise to which the state and local tax bureau of Mianyang granted preferential tax benefits. According to the Chuanminfa [2007] No. 342 and Guoshuifa [2007] No. 67, Jin Xin is eligible for a VAT refund and concessions subject to the annual review by the state and local tax bureau of Mianyang. According to Mizhenghan [2011] No. 6 and No. 50 and Mishuihan [2011] No. 41, Xiangbei is eligible for a VAT refund and concessions subject to annual review by the state and local tax bureau of Miluo.

In 2011, we recognized VAT refunds and government subsidy income of RMB24.2 million (US$3.8 million).

 

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Regulation of Foreign Currency Exchange and Dividend Distribution

Foreign Currency Exchange

The principal regulation governing foreign currency exchange in China is the Foreign Currency Administration Rules (1996), as amended. Under these rules, the Renminbi is freely convertible for trade and service-related foreign exchange transactions, but not for direct investments, loans or investments in securities outside China without the prior approval of SAFE.

Pursuant to the Foreign Currency Administration Rules, foreign-invested enterprises in China may purchase foreign exchange without approval of SAFE for trade and service-related foreign exchange transactions by providing commercial documents evidencing these transactions. They may also retain foreign exchange, subject to a cap approved by SAFE, to satisfy foreign exchange liabilities or to pay dividends. However, the relevant PRC government authorities may limit or eliminate the ability of foreign-invested enterprises to purchase and retain foreign currencies in the future. In addition, foreign exchange transactions for direct investments, loans and investments in securities outside China are still subject to limitations and require approval from SAFE.

Dividend Distribution

The principal PRC regulations governing the distribution of dividends by foreign-invested enterprises include:

 

   

The Sino-foreign Equity Joint Venture Law (1979), as amended;

 

   

The Regulations of Implementation of the Sino-foreign Equity Joint Venture Law (1983), as amended;

 

   

The Foreign Investment Enterprise Law (1986), as amended;

 

   

The Regulations of Implementation of the Foreign Investment Enterprise Law (1990), as amended;

 

   

The Company Law (2005);

 

   

The New CIT Law (2007); and

 

   

The Implementation Rules on Corporate Income Tax Law (2007).

Under these regulations, foreign-invested enterprises in China may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, wholly foreign-owned enterprises in China are required to set aside at least 10% of their accumulated profits each year, if any, to fund certain statutory reserve funds unless such reserve funds have reached 50% of their respective registered capital. Sino-foreign equity joint ventures are required to set aside certain reserve funds, with the percentage of their accumulated annual profits to be set aside determined by their board of directors. These reserves are not distributable as cash dividends.

Withholding Tax

On March 16, 2007, the Fifth Plenary Session of the Tenth National People’s Congress passed the New CIT Law, which took effect on January 1, 2008. Under the New CIT Law, from January 1, 2008, foreign invested enterprises, such as our subsidiaries, and domestic companies are subject to CIT at a uniform rate of 25%, with certain exceptions.

In addition, according to the New CIT Law and its relevant regulations, PRC-resident enterprises are levied withholding tax at 10% on dividends to their non-PRC-resident corporate investors for earnings accumulated beginning on January 1, 2008. Undistributed earnings generated prior to January 1, 2008 are exempted from such withholding tax. Under the previous income tax laws and rules, no withholding tax was required. Since our PRC subsidiaries are invested by non-PRC-resident corporate investors, our Group is subject to withholding tax for earnings accumulated beginning on January 1, 2008. Under the Arrangement between the Mainland of China and Hong Kong Special Administration Region for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income, or Mainland China/HKSAR DTA, a qualified Hong Kong tax resident which is the “indirect owner” and holds 25% or more of the equity interest of a PRC-resident enterprise is entitled to a reduced withholding rate of 5%. All of our Group’s foreign-invested enterprises are directly held by Hong Kong tax residents.

 

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On October 27, 2009, the PRC SAT issued Guoshuihan [2009] No. 601 on “How to understand and recognize the “Beneficial Owner” in Double Taxation Agreements,” or Circular 601. Circular 601 clarifies the general rules and the onus of proof in determining whether a tax relief applicant qualifies as a “beneficial owner.” Pursuant to Circular 601, a “beneficial owner” under a tax treaty is determined not purely by its place of legal registration but also by other factors which are dependent on the specific facts and circumstances and significant judgment may be involved. In view of the above and after seeking professional advice on the matter, a withholding tax rate of 10% is applied on our undistributed earnings as of December 31, 2009, resulting in a dividend withholding tax expense of RMB7.7 million for the year ended December 31, 2009 and a deferred tax liability of RMB29.6 million as of December 31, 2009. In 2010, we reduced the provision for dividend withholding tax by RMB23.6 million in respect of our biodiesel business as a result of the net loss incurred by various PRC subsidiaries, and recognized a provision of RMB1.1 million for Jin Xin’s profit since our initial acquisition in November 2010. In 2011, we reduced the provision for dividend withholding tax by RMB6.1 million (US$1.0 million) as a result of the losses incurred by our biodiesel business, and recognized a provision of RMB5.0 million (US$0.8 million) for profits made by our copper products business.

Under the New CIT Law, an enterprise established outside the PRC with its “de facto management organization” within the PRC is considered a resident enterprise and will be subject to the CIT at the rate of 25% on its worldwide income. A “de facto management organization” is defined as an organizational body that effectively exercises overall management and control over production and business operations, personnel, finance and accounting, and properties of the enterprise. It remains unclear how the PRC tax authorities will interpret this definition. Notwithstanding the foregoing provision, the New CIT Law also provides that, if a resident enterprise directly invests in another resident enterprise, the dividends received by the investing resident enterprise from the invested enterprise are exempted from income tax, subject to certain conditions. However, given the short history of this law, it remains unclear as to the details of the qualifications required for such exemption and whether the dividends which our Company receives from our PRC subsidiaries will be exempt from CIT if it is recognized as a PRC resident enterprise.

Moreover, under the New CIT Law, foreign ADS holders may be subject to a 10% withholding tax upon dividends payable by us and gains realized on the sale or other disposition of ADSs or ordinary shares if we are categorized as a PRC tax resident enterprise.

Regulation of Foreign Exchange in Certain Onshore and Offshore Transactions

In October 2005, SAFE issued the Notice on Issues Relating to the Administration of Foreign Exchange in Fund raising and Return Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies, or Notice 75, which became effective as of November 1, 2005, and was further supplemented by an implementing notice issued on November 24, 2005. Notice 75 suspends the implementation of two prior regulations promulgated in January and April of 2005 by SAFE. Notice 75 states that PRC residents, whether a natural or legal person, must register with the relevant local SAFE branch prior to their establishment or control of an offshore entity established for the purpose of overseas equity financing involving onshore assets or equity interests held by them. The term “Chinese residents” as used in Notice 75 refers to those entities with legal person status or other economic organizations established within the territory of China. The term “Chinese natural person residents” as used in Notice 75 includes all Chinese citizens and all other natural persons, such as foreigners, that habitually reside in China for economic benefit. The SAFE implementing notice of November 24, 2005 further clarifies that the term “Chinese natural person residents” as used under Notice 75 refers to those Chinese natural person residents defined under the relevant PRC tax laws and those natural persons who hold any interests in domestic entities which are classified as “domestic-funding” interests. Chinese residents are required to complete amended registrations with the local SAFE branch upon (a) injection of equity interests or assets of an onshore enterprise to the offshore entity, or (b) subsequent overseas equity financing by such offshore entity. Chinese residents are also required to complete amended registrations or file with the local SAFE branch within 30 days of any material change in the shareholding or capital of the offshore entity, such as changes in share capital, share transfers and long-term equity or debt investments, and providing security. Chinese residents who have already incorporated or gained control of offshore entities that have made onshore investment in China before Notice 75 was promulgated must register their shareholding in the offshore entities with the local SAFE branch on or before March 31, 2006. Under Notice 75, Chinese residents are further required to repatriate back into China all of their dividends, profits or capital gains obtained from their shareholdings in the offshore entity within 180 days upon their receipt of such dividends, profits or capital gains.

 

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The registration and filing procedures under Notice 75 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.

Please refer to Item 3.D, “Key Information—Risk Factors—Risks Relating to Business Operations in China —The approval of the China Securities Regulatory Commission might have been required in connection with our initial public offering under a recently adopted PRC regulation, and, if approval was required, we could be subject to sanction, fines and other penalties.”

C. Organizational Structure

Sichuan Gushan was established in China on June 14, 2001. In April 2005, the shareholders of Sichuan Gushan contributed their equity interests in Sichuan Gushan to Carling Technology, a company incorporated on January 5, 2005 in the British Virgin Islands, or BVI. Since 2005, Carling Technology became the ultimate holding company of four additional subsidiaries in China, three of which were established by us (Shanghai Gushan, Beijing Gushan and Fujian Gushan) and one of which we acquired (Handan Gushan). In anticipation of a public offering, we incorporated Gushan Environmental Energy Limited in the Cayman Islands as our listing vehicle and our holding company.

On September 20, 2007, we underwent a reorganization pursuant to which the shareholders of Carling Technology subscribed to 123,820,000 of our ordinary shares in exchange for all of the outstanding shares of Carling Technology. Our proportionate ownership immediately after the reorganization and the proportionate ownership of Carling Technology before the reorganization remained the same, as Carling Technology was reorganized as our wholly owned subsidiary. We established Hunan Gushan and Chongqing Gushan, both wholly foreign-owned enterprises in China, on January 14, 2008 and January 24, 2008, respectively.

On April 1, 2008, we acquired Eagle Sight Holdings Limited, (“Eagle Sight”), a newly established shell holding company incorporated in Hong Kong. On June 19, 2008, we changed the name of Eagle Sight to Gushan Holdings. On September 11, 2008, we acquired Gushan Bio-Energy, a newly established shell holding company incorporated in Hong Kong. We established Biomass, a wholly foreign-owned enterprise in China on November 3, 2008.

On August 17, 2010, we acquired Engen, a newly established shell holding company in the BVI. On August 27, 2010, we acquired True Excel, a newly established shell holding company in Hong Kong. On November 3, 2010, we acquired a 67% indirect ownership interest in Jin Xin. On January 1, 2011, we acquired an additional 8% of the issued share capital of Engen, increasing our indirect ownership interest in Jin Xin to 75%. Jin Xin is engaged in the manufacturing of copper rods, copper wires and copper granules from recycled copper in Sichuan. On June 1, 2011, Jin Xin established a wholly owned subsidiary, Mian Yang Tong Xin Copper Company Limited (“Tong Xin”), in China.

On August 1, 2011, we acquired 75% indirect ownership interest in Xiangbei. Xiangbei is engaged in the manufacturing of copper rods, copper bars and copper plates from recycled copper and electrolytic copper in Hunan. On August 10, 2011, we acquired Alpha Legend Holdings Limited, a newly established shell holding company in Hong Kong. On October 26, 2011, we acquired Alpha Business Investments Limited, a newly established shell holding company in Hong Kong.

 

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The following diagram illustrates our corporate structure as of the date of this annual report:

 

LOGO

D. Property, Plant and Equipment

Biodiesel Production Facilities

The following table sets forth certain information regarding our biodiesel production facilities as of December 31, 2011:

 

    

Sichuan

  

Hebei

  

Fujian

  

Beijing

  

Shanghai

  

Chongqing

  

Hunan

Location

   Qin Dong Bei Industrial Park, Mianyang (relocation)(11)    Feixiang, Handan, Hebei    Mawei Investment Park, Fuzhou, Fujian    Daxing District, Beijing    Fengxian District, Shanghai   

Changshou

Chemical

Park,

Chongqing

   Liuyang Industrial Park, Liuyang, Hunan

Began construction

   August 2010    May 2003    June 2005    May 2007    October 2007    April 2008    April 2008

Began production

   June 2011    January 2004    February 2006    January 2008    June 2008      (9)      (9)

Capacity as of December 31, 2011(1)

   Biodiesel: 100,000 tons    Biodiesel: 30,000 tons    Biodiesel: 100,000 tons    Biodiesel: 100,000 tons    Biodiesel: 100,000 tons   

Biodiesel:

30,000 tons

   Biodiesel: 30,000 tons

2007 capacity utilization(2)

   —      114.4% (biodiesel)    106.7% (biodiesel)(3)    —      —      —      —  

2008 capacity utilization(2)

   —      95.4% (biodiesel)(5)    99.0% (biodiesel)(5)    65.0% (biodiesel)(4)    78.6% (biodiesel)    —      —  

2009 capacity utilization(2)

   —      52.2% (biodiesel)    27.9% (biodiesel)(6)    41.9% (biodiesel)(7)    40.9%
(biodiesel)(8)(12)
  

0%

(biodiesel)(9)

   0% (biodiesel)(9)

2010 capacity utilization

   —      29.4% (biodiesel)(13)    0% (biodiesel)(6)    18.6% (biodiesel)(13)    6.6% (biodiesel)(12)    0% (biodiesel)(9)    0% (biodiesel)(10)

2011 capacity utilization(14)

   0.28% (biodiesel)(15)    7.8% (biodiesel)    0% (biodiesel)    5.6% (biodiesel)    0.1% (biodiesel)    0.1% (biodiesel)    0% (biodiesel)

Site Area

   47,211 square meters(10)    20,575 square meters    61,367 square meters    54,965 square meters    39,699 square meters    41,838 square meters    46,223 square meters

 

(1) Capacity refers to the maximum annual amount of biodiesel that we can concurrently produce when we operate at full production as of December 31, 2010. The capacity of Shanghai Gushan was 50,000 tons from January to July 2009 and 100,000 tons from August to December 2009.
(2) Our production levels can be adjusted to exceed the design production capacity, which is estimated based upon 300 annual working days. As our production facilities typically operate 50 working weeks annually and 24 hours a day, our capacity utilization can exceed 100%. The utilization rate is calculated based on actual sales volume and weighted average annual capacity.
(3) In October 2007, we suspended production at our Fujian plant for approximately two weeks in order to carry out maintenance operations.
(4) From August 1 to September 20, 2008, we suspended operations at our Beijing plant for about seven weeks due to the heightened enforcement of traffic control measures adopted by the Beijing municipal government in preparation for the hosting of the 2008 Beijing Olympic and Paralympic games.
(5) In November and December of 2008, we suspended production at our Fujian, Hebei and our prior Sichuan plants for a few weeks to carry out repair and maintenance operations.
(6) From April 19, 2009, we suspended operations at our Fujian plant due to road maintenance that resulted in restricted access to the plant by our suppliers and customers. We subsequently extended the suspension of operations in order to minimize operating cash outflows that would result from the assessment of consumption tax from a local tax bureau. As of the date of this annual report, Fujian Gushan has not resumed production.
(7) In January 2009, we suspended production at our Beijing plant for approximately one month in order to perform a capacity upgrade from 50,000 tons to 100,000 tons.
(8) From mid June to mid August 2009, we suspended production at our Shanghai plant for approximately two months in order to perform a capacity upgrade from 50,000 tons to 100,000 tons.
(9) Following completion of construction of our Chongqing and Hunan plants in May and July 2009, we deferred the commencement of operations at those plants pending resolution of the consumption tax issue. Although the consumption tax issue was resolved in our favor in December 2010, as of the date of this annual report, we have not commenced production at our Chongqing and Hunan plants.
(10) Excludes 28,665 square meters of land used for Sichuan Gushan’s old plant in San Tai, Mianyang, Sichuan.
(11) Sichuan Gushan suspended production in San Tai County beginning August 1, 2010 for the relocation to its new plant in Qin Dong Bei Industrial Park.
(12) Shanghai Gushan suspended production from April 2010 due to Expo 2010 and a lawsuit filed against us by a construction contractor. As of the date of this annual report, Shanghai Gushan has not resumed production.
(13) In 2010, to help mitigate the potential adverse impact from the consumption tax issue, we continued our efforts to expand our alternative sales channels, including biodiesel sales as fatty acid methyl ester to the chemical industry, which are not subject to consumption tax, while reducing our sales of biodiesel to the refined oil market. This strategy contributed in part to the year-to-year decrease in the sales volume of biodiesel because the size of our customer base in the chemical industry is smaller than that of the refined oil market.
(14) In 2011, we suspended or continued the suspension of substantially all of our production at our production facilities due to raw material shortages and adverse market conditions.
(15) Sichuan Gushan commenced operation at its new plant in Qin Dong Bei Industrial Pak from the third quarter of 2011.

 

 

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In 2001, our Sichuan production facility began biodiesel production with an annual biodiesel production capacity of 10,000 tons, which we expanded in 2004 by building a new 30,000 ton biodiesel production line, increasing the annual biodiesel production capacity to 40,000 tons and production lines to produce erucic amide and stearic acid, a saturated fatty acid used to harden soaps. To further expand our operations and diversify our customer base, in 2004, we began to produce biodiesel at our Hebei production facility, which has an annual biodiesel production capacity of 30,000 tons. In 2006, we commenced biodiesel production in Fujian, with an annual biodiesel production capacity of 100,000 tons. In November 2007, we further expanded the production capacity of the Sichuan facility to 60,000 tons. In January 2008, we commenced biodiesel production in Beijing, with an initial annual biodiesel production capacity of 50,000 tons, and we commenced operation of the additional facilities in March 2009, adding another 50,000 tones of annual biodiesel production capacity. In June 2008, we commenced biodiesel production in Shanghai, with an initial annual biodiesel production capacity of 50,000 tons, and we commenced operation of the additional facilities in August 2009, adding another 50,000 tones of annual biodiesel production capacity. In May and July 2009, we completed the construction of Chongqing and Hunan plants respectively, each with initial annual biodiesel production capacity of 30,000 tons. In August 2010, we suspended production at our Sichuan plant in San Tai County pending its relocation to Qin Dong Bei Industrial Park.

We commenced relocation of our Sichuan plant in August 2010. The disposal and relocation of its property, plant and equipment was completed as of December 31, 2010. We completed construction of the new Sichuan plant in the second quarter of 2011 with an initial annual biodiesel production capacity of 100,000 tons and commenced operations during the third quarter of 2011.

In 2011, except for Sichuan Gushan, we suspended or continued the suspension of substantially all of our production at our production facilities due to raw material shortages, high raw material input costs and slowing demand.

 

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Copper Products Production Facilities

The following table sets forth certain information regarding our copper production facilities as of December 31, 2011:

 

     Jin Xin    Xiangbei

Location

   Song Ya Town, Farm District, Mianyang, Sichuan    Miluo Industrial Park, Miluo, Hunan

Period operation commenced

   February 2009(1)    February 2011(2)

Daily production capacity of copper products as of December 31, 2011

   160 tons    50 tons

Capacity utilization from November to December 2010

   89.1%    —  

Capacity utilization 2011 (Jin Xin only)

   42.3%    —  

Capacity utilization from August to December 2011 (Xiangbei only)

   —      52.4%

Site Area

   25,502 square meters(3)    24,563 square meters

 

(1)

In November 2010, we acquired a 67% indirect ownership interest in Jin Xin. We subsequently increased our indirect ownership interest in Jin Xin to 75% in January 2011.

(2)

In August 2011, we acquired 75% indirect ownership interest in Xiangbei.

(3)

Includes 8,391 square meters of land on which our new copper products production facility is currently under construction.

We are currently in the process of constructing an additional copper products production facility located next to our Sichuan copper products production facility. This facility, when complete, is expected to have a daily production capacity of 160 tons of copper products and an annual production capacity of 48,000 tons of copper products. We began construction of this facility in October 2011 and we expect to complete its construction during 2012. The total estimated cost of this new facility is RMB40 million (US$6.4 million), of which we have spent approximately RMB1.7 million (US$0.3 million). We intend to finance these capital expenditures through our internal resources and short-term bank loans.

Equipment Suppliers

Our production facilities use equipment and machinery manufactured by domestic PRC equipment vendors. We seek to ensure the quality of our equipment and machinery and safeguard our technical know-how by utilizing a small number of equipment vendors. Our equipment vendors have been supplying equipment and machinery to us for several years and we are satisfied with the quality of their products.

ITEM 4A. UNRESOLVED STAFF COMMENTS

None.

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with Item 3.A., “Key Information—Selected Financial Data,” our consolidated financial statements and related notes included elsewhere in this annual report. The discussion in this section contains forward-looking statements that involve risks and uncertainties. See “Forward-Looking Statements.” Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under Item 3.D, “Key Information—Risk Factors” and elsewhere in this annual report.

 

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A. Operating Results

Overview

Our revenues increased significantly in 2011 as a result of the increase in revenues contributed by our copper business accompanying the expansion of our copper products business. We acquired an initial 67% indirect ownership interest in Jin Xin in November 2010. In January 2011, we acquired an additional 8% indirect ownership interest in Jin Xin, increasing its indirect ownership in Jin Xin to 75%. Jin Xin’s revenues contributed RMB205.1 million to our revenues in 2010 and RMB1,211.9 million (US$192.6 million) in 2011. We acquired a 75% indirect ownership interest in Xiangbei in August 2011. Xiangbei’s revenues contributed RMB184.5 million (US$29.3 million) in 2011. Our copper products business contributed RMB1,396.4 million (US$221.9 million) to our revenue in 2011. In 2011, our revenues from our biodiesel business declined due to our decision to extend the suspension of certain biodiesel plants and initiate the suspension of substantially all of our other biodiesel plants due to raw material shortages, high raw material input costs, and slowing demand.

We generated revenues of RMB628.2 million, RMB408.5 million and RMB1,449.7 million (US$230.3 million) for the years ended December 31, 2009, 2010 and 2011, respectively. We incurred a net loss attributable to our Company of RMB283.5 million, RMB1,109.0 million and RMB747.7 million (US$118.8 million) for the year ended December 31, 2009, 2010 and 2011, respectively.

In 2010, we reversed the provision for consumption tax of RMB103.8 million we had made in 2009 based on the issuance of Caishui 118 and Caishui [2011] No. 46 by the Ministry of Finance of the PRC and SAT. We recognized impairment losses on property, plant and equipment of RMB992.6 million and RMB603.3 million (US$95.9 million) in the third quarter of 2010 and the fourth quarter of 2011, respectively, with respect to our biodiesel plants. In 2011, we recognized an impairment loss on goodwill of RMB41.4 million (US$6.6 million), an impairment loss on VAT recoverables of RMB28.2 million (US$4.5 million), and an impairment loss on land use rights of RMB2.9 million (US$0.5 million). In 2010, we incurred a loss on disposal of property, plant and equipment of RMB3.3 million as a result of the disposal and relocation of our Sichuan production facility. In addition, we recognized an increase in fair value of contingent consideration liabilities of RMB2.9 million and a decrease of RMB10.4 million (US$1.6 million) in 2010 and 2011, respectively, as a result of the change in fair value of contingent consideration liabilities in connection with the acquisition of an initial 67% indirect ownership interest in Jin Xin in November 2010 and our acquisition of 75% indirect ownership interests in Xiangbei in August 2011.

The most significant factors that affect our financial condition and results of operations are:

 

   

economic, political and social conditions in China;

 

   

tax laws in China;

 

   

production capacity and utilization;

 

   

market prices for diesel and copper;

 

   

demand for, and market awareness of, biodiesel and demand for copper products;

 

   

supply and costs of principal raw materials;

 

   

product mix and effect on gross margins; and

 

   

availability of financing for our copper products business.

Economic, Political and Social Conditions in China

We conduct all of our production in China and we derive all of our revenues from sales to customers in China. As such, economic conditions in China and the geographic markets where we operate will affect virtually all aspects of our operations, including the demand for our products, the availability and prices of our raw materials and our other expenses. During the past three decades, the PRC government has implemented a series of economic reform measures to expand the influence of market forces in the development of the domestic economy. As a result of these reforms, China experienced significant economic growth, achieving a compound annual growth rate, or CAGR, of 14.0% in GDP from 1999 through 2008. Due in part to the global financial crisis, however, the PRC economy slowed down significantly in the second half of 2008. As a result, domestic demand for and consumption of energy and energy products, including biodiesel products, has been adversely affected. Furthermore, there was a slow rebound in refined diesel demand beginning in the fourth quarter of 2009. This trend continued in 2010 and 2011 as China’s economy continued to recover. We believe that economic conditions in China and the geographic markets where we operate will continue to affect our business and results of operations. Our financial condition and results of operations may also be affected by changes in China’s political and social conditions and by changes in laws, regulations or the interpretation or implementation thereof.

 

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Tax Laws in China

In recent years, the PRC government has made a number of amendments to its existing tax laws and introduced a number of new regulations.

On October 27, 2009, the PRC SAT issued Circular 601, which clarifies that a “beneficial owner” under a tax treaty is determined not purely by its place of legal registration but also by other factors dependent upon the specific facts and circumstances, and significant judgment and uncertainty may be involved with such determination. In view of the uncertainty in the definition of “beneficial owner” under the Mainland China/HKSAR DTA and after seeking professional advice on the matter, a withholding tax of 10% is applied on the undistributed earnings as of December 31, 2009, resulting in an income tax expense of RMB7.7 million for the year ended December 31, 2009 and a deferred tax liability of RMB29.6 million as of December 31, 2009, in view of the uncertainty in the definition of “beneficial owner” under the Mainland China/HKSAR DTA. See Item 4.B, “Business Overview—PRC Government Regulations—Regulation of Foreign Currency Exchange and Dividend Distribution—Withholding Tax in China.” In 2010, we recorded a reversal of the accrual for dividend withholding tax of RMB23.6 million as a result of the net loss incurred by our various PRC subsidiaries, and a provision of RMB1.1 million (US$0.2 million) for Jin Xin’s profit since our acquisition of an initial 67% indirect ownership interest in Jin Xin in November 2010. In 2011, we recorded a reversal of the accrual for dividend withholding tax of RMB6.1 million (US$1.0 million) as a result of the losses incurred by our biodiesel business, and we recognized a provision of RMB5.0 million (US$0.8 million) for profits made by our copper products business.

Utilization Production Capacity of Biodiesel

As of December 31, 2011, substantially all of our biodiesel production was suspended and we consider the probability that we will be in a position to resume such production on a large-scale basis in the near future to be remote.

While our production capacity has increased in recent years, we have experienced significant disruptions and suspensions of our operations that have affected our production output and the utilization of our production facilities. Specifically, we suspended production at Fujian Gushan from April to June 2009 due to road maintenance, which restricted access to the plant. From mid June 2009 to mid August 2009, we suspended production at Shanghai Gushan to install additional facilities. From mid September 2009 to the end of November 2009, we suspended production at Handan Gushan as a result of road maintenance by the Handan municipal government of Hebei province, which restricted access to the plant by our suppliers and customers. From mid April 2010 to October 2010, we suspended production at Shanghai Gushan due to heightened enforcement of control measures adopted by the Shanghai municipal government during the Expo 2010. We continued to suspend production at Shanghai Gushan due to a lawsuit filed against us by a production facility contractor in the People’s Court of Fengxian District, Shanghai alleging that we failed to pay the contract sum payable with respect to its construction of our Shanghai plant. We also suspended production in Sichuan Gushan for the relocation of its production facility since August 2010.

 

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As a result of assessments of consumption tax by a local SAT in 2009, we extended the suspension of operations at Fujian Gushan following completion of road maintenance in June 2009 and deferred the commencement of production at our Chongqing and Hunan production facilities, which were completed in May and July 2009, respectively, pending resolution of the consumption tax issue. Although the consumption tax issue was resolved in our favor in December 2010, as of the date of this annual report, we have not resumed production at Fujian Gushan and have not commenced production at our Chongqing and Hunan production facilities. To avoid negative operating cash flows caused by the increasingly high raw material input costs, shortage of raw materials and reduced demand, we suspended the operations of Beijing Gushan and Heibei Gushan and continued the suspension of production at substantially all of our other biodiesel plants. As a result, our revenues for 2010 and 2011 were materially and adversely affected. See Item 3.D, “Key Information—Risk Factors—Risks Relating to Our Businesses and Our Industries—Our biodiesel operations have been subject to significant suspensions and interruptions which have resulted in a reduction of our sales volume and may continue to materially and adversely affect our results of operations.”

Market Prices for Diesel and Copper

We price our biodiesel based on the market price for diesel. Depending on the market conditions, we sell biodiesel at no discount or at a discount as compared to local retail diesel prices when the diesel market was slack. We believe biodiesel partially replaces or supplements diesel since biodiesel is often used on a blended basis with diesel. For these reasons, our products are affected by the market price and supply of diesel.

The market price for diesel is affected by the price for crude oil. As a result, changes in global prices of crude oil, any interruption in the supply of crude oil or any governmental regulation of the price of diesel may have a material effect on the selling price of our biodiesel products. Over the past three years, crude oil prices have fluctuated significantly. Nonetheless, the PRC diesel guidance prices described below historically have insulated the market price of diesel in China from short-term fluctuations in global crude oil prices.

The PRC government occasionally publishes guidance prices for diesel. Since 2009, these guidance prices set the maximum retail prices of diesel and are generally followed by industry participants. Because biodiesel prices are affected by the price of diesel, these guidance prices tend to limit the range in which we can set prices for our biodiesel products. Any material decrease in these guidance prices or delay in adjusting guidance prices despite any rapid increase in the crude oil price may have a material effect on the selling prices for our biodiesel products, which in turn may adversely affect our financial condition and results of operations of our biodiesel business .

Our results of operations are also affected by fluctuations in the market price of copper. As we buy scrap copper and sell our copper products at prevailing market prices, copper prices affect both our raw material costs and our sale prices. We are also exposed to commodity price risk because we purchase our raw materials in advance of sales to customers. The price of copper has fluctuated significantly since 2009. For example, the spot price of copper in China ranged from a low of approximately RMB27,000 per ton to a high of approximately RMB75,000 per ton during the period from 2009 to the end of the first quarter of 2012. During periods of increasing prices, competitive conditions may limit our ability to pass on price increases to our customers. During periods of declining prices, we may be unable to fully recoup the costs of scrap copper that we purchase for producing our recycled copper products.

 

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Demand for, and Market Awareness of, Biodiesel and Demand for Copper Products

China’s biodiesel industry remains in an early stage, with biodiesel production currently representing only a small portion of China’s annual diesel production. Our three principal groups of biodiesel customers are direct users, petroleum wholesalers and individual retail gas stations. Direct users include marine vessel operators, chemical companies and factories, while petroleum wholesalers and retail gas stations generally distribute fuel that will be used in diesel-powered trucks and automobiles. Certain users, such as marine vessel operators, use biodiesel as a complete substitute for diesel, while others typically use a blend of 20% biodiesel and 80% diesel to fuel diesel trucks and automobiles. We believe demand for biodiesel will continue to grow as demand for diesel grows and as market awareness of biodiesel increases. In addition, PRC law and government policies encourage the development and utilization of renewable sources of energy. The consumption volume of biofuel in China is expected to further increase and the proportion of renewable energy consumption is expected to reach approximately 15% of China’s total energy consumption by 2020, from approximately 7.5% in 2005. We expect demand for our biodiesel products to increase over time.

Our copper product sales in 2010 and 2011 were all to customers located in China. Accordingly, our results of operations are also dependent on demand for copper rods, copper plates, copper wires and copper granules made from recycled copper within China. The copper recycling industry tends to be cyclical in nature, reflecting general economic conditions. In periods of slow economic growth or recession, the construction and manufacturing industry may experience significant cutbacks in production, which results in decreased demand for metals such as copper. China’s rapid growth in recent years, however, has resulted in strong demand for copper and recycled scrap copper from copper consuming industries in China. As copper resources are currently in relatively short supply in China, we expect demand for copper products in China to strengthen over time.

Supply and Costs of Principal Raw Materials

Our ability to manage our operating costs depends significantly on our ability to secure affordable supplies of raw materials.

With respect to our biodiesel business, we have historically been able to secure a sufficient supply of raw materials, which primarily consist of vegetable oil offal and used cooking oil. Our production facilities are able to process a range of different types and grades of raw materials, which allows us to use less costly grades of materials when available. However, the prices we have paid for raw materials for our biodiesel business have steadily increased. Between 2009 and 2011, for example, we experienced an increase in the average cost per ton of vegetable oil offal and of used cooking oil of 68.2%, from RMB2,634.5 to RMB4,431.2 (US$704.0). The overall average unit costs of our raw materials for our biodiesel business was RMB4,646.8 (US$738.3) per ton for the fourth quarter of 2011. Our raw material input costs for our biodiesel business have risen significantly in 2011. We believe that this increase in raw material cost is primarily due to general cost inflation in China, in particular, labor and transportation costs, and in part due to our suppliers’ perception that such raw materials constitute an increasingly valuable commodity as a result of the PRC government’s enactment of the Law of Renewable Energy Resources of China.

Further, during 2011, local governments cracked down on certain alleged illegal practices of vendors of used cooking oil, forcing a number of our suppliers to suspend operations, which in turn has resulted in a shortage of raw material inputs for our biodiesel business.

Our operating costs for our biodiesel business may increase significantly if other businesses, including but not limited to other biodiesel manufacturers and oleochemical producers, compete for the raw materials we use. Our operating costs may also increase if the price of our raw materials increases due to changes in consumption patterns or as a result of price fluctuations in the commodities from which our raw materials are derived, which may be caused by weather conditions and other factors affecting agriculture and general market, economic and regulatory factors, including government policies with respect to agriculture and local supply and demand.

 

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The prices of the raw materials for our biodiesel business vary according to the type and the grade of raw materials we use. The prices of our primary raw materials also vary from one region to another, which affect our cost of revenues in each region. For example, as of June 30, 2011, the market price of vegetable oil offal and used cooking oil in Beijing was comparatively higher than in other regions where we operated our plants due to a limited availability of low grade vegetable oil offal in Beijing. As of June 30, 2011, our Beijing plant paid an average of RMB4,824.0 (US$766.5) per ton for vegetable oil offal and used cooking oil compared with RMB4,662.6 (US$240.7) per ton for our Hebei plant. We anticipate that costs of raw materials for our biodiesel business will also be higher in the larger cities where we have established and currently plan to commence operations, such as Shanghai and Chongqing, respectively. The higher cost of raw materials we experience in some regions has a negative effect on our margins in these regions because we are unable to pass the costs of higher raw material costs in urban areas on to customers due to the constraints of the diesel guidance price. The diesel guidance price may follow the trend of global oil price; however, because any increase or decrease will be determined by the PRC government, the timing and magnitude of such increase or decrease may not correspond to increases or decreases in raw material costs. As a result, we anticipate that during certain periods of time, raw material costs for our biodiesel business will change without a corresponding change in the diesel guidance price, causing our margins to change during those periods.

The primary raw material used in our copper operations is scrap copper, including scrap copper from household appliances and manufacturing industries. Our major copper raw material suppliers are private enterprises engaged in the collection of unprocessed scrap copper in China. We do not enter into any long-term purchase contracts and conduct our copper products business with suppliers on an order by order basis at prevailing market prices at the time of purchase. Accordingly, our results of operations are subject to fluctuations in the price of scrap copper. During periods of low scrap copper prices, suppliers may elect to hold scrap to wait for higher prices or may slow their collection activities. In addition, a slowdown of industrial production in the areas where we source raw materials could reduce the supply of scrap copper. A shortage of raw materials could adversely affect our sales volume and increase our raw material costs, which could adversely affect our profitability if we were unable to pass along the higher costs to our customers.

The prices for scrap copper also vary between different regions within China. We currently purchase raw materials for our copper products business primarily from two third-party suppliers in Sichuan and our business and financial results could be impacted if we were to expand our supplier network to other regions of China in order to reduce our reliance on the local suppliers in Sichuan. Since 2009, the price of scrap copper has fluctuated significantly. For example, the spot price of copper in China ranged from a low of approximately RMB27,000 per ton to a high of approximately RMB75,000 per ton during the period from 2009 to the end of the first quarter of 2012. As we generally pay prevailing market prices for scrap copper at the time of purchase, an increase in scrap copper prices would increase our need for working capital and financing, which may not be available on favorable terms, or at all, and may also increase our customers’ working capital requirements, which could result in delays in payments by our customers and increases in our trade receivables and bills receivable. Decreases in copper prices may result in a decrease in the selling price of our inventory, which would negatively affect our gross profit margin.

Availability of Financing for Our Copper Products Business

As a result of a combination of (i) increased copper product sales, (ii) the relatively high prevailing market prices for copper and scrap copper and (iii) increases in the cost of raw materials in recent years, we require a high level of working capital to sustain our copper operations. Historically, Jin Xin and Xiangbei have financed their working capital through cash from operations derived from customer payments, short term bank, capital contributions and loans from shareholders. We expect our working capital requirements to continue to grow as we expand our copper operations. As a result, our copper products business will continue to be dependent on the availability of financing on acceptable terms for our working capital requirements.

Principal Components in Statements of Operations

Revenues

Our revenues are derived from sales of our biodiesel, biodiesel by-products produced during the biodiesel production process, and copper products, net of value-added taxes. Biodiesel revenues represented 92.5%, 46.8% and 3.3% of our revenues for 2009, 2010 and 2011, respectively, while biodiesel by-products represented 7.5%, 3.0% and 0.4% for 2009, 2010 and 2011, respectively, and copper products represented, 50.2% and 96.3% for 2010 and 2011, respectively.

 

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The most significant factors that affect our revenues are sales volume and average selling prices. We generally collect cash payment at the time of delivery and on occasions extend credit for 30 days or less to certain of our established customers. Our accounts receivable as of December 31, 2011 totaled RMB215.8 million (US$34.3 million), with approximately RMB12.4 million (US$2.0 million) more than 90 days overdue. For 2009, 2010 and 2011, our five largest customers represented 22.4%, 33.7% and 44.8% of our consolidated revenues, respectively. For 2011, each of our top five customers were customers of our copper products business. Our largest customer in 2009, Xiapu Sansha Baoyinlai Seining Co., Ltd, accounted for 7.4% of our consolidated revenues for 2009. In 2010, our largest customer, Ning Bo Jin Tian Copper (Group) Limited, accounted for 10.0% of our consolidated revenues. In 2011, our largest customer, Chongqing City South Retardant Wire and Cable Factory, accounted for 13.8% of our consolidated revenues.

Cost of Revenues

Our cost of revenues primarily consists of direct material costs, depreciation cost and, to a lesser extent, other overhead costs. Direct material costs are the cost of the raw materials that we use in the manufacturing of our products. We use vegetable oil offal and used cooking oil as the primary raw materials for our biodiesel manufacturing process. Our proprietary production technology enables us to produce biodiesel using lower-grade, lower-cost vegetable oil offal and used cooking oil, as compared to the relatively higher-grade, higher-cost feedstock. We buy scrap copper at prevailing market prices. As such, our raw material cost for our copper products business is affected by fluctuations in the market price of scrap copper. Direct material cost is the largest component of our cost of revenues, accounting for approximately 72.6%, 87.1% and 94.3% of our total cost of revenues for 2009, 2010 and 2011, respectively. As a result of our acquisition of Jin Xin and Xiangbei, our cost of revenues in 2011 increased in line with the revenue contribution from our copper products business.

Gross Profit (Loss)

Our gross loss from sales of biodiesel is determined primarily by the cost of raw materials and the price of diesel. As discussed above and in the section titled “—Overview—Supply and costs of principal raw materials,” our cost of raw materials has increased consistently since 2006 up to the fourth quarter of 2011 and has also risen significantly since the third quarter of 2011. At the same time, the price of diesel in China has increased since 2006 and up to the third quarter of 2008. Since the fourth quarter of 2008, however, the price of diesel began to decline. This trend was consistent with the general trend of oil prices worldwide, which has had a negative impact on the price of biodiesel since the third quarter of 2008. From 2009, the PRC government has allowed the price of diesel to adjust in accordance to the global oil price through an adjustment in the diesel guidance price.

Our gross profit from sales of copper products is determined primarily by the cost of raw materials and copper products price. Currently, there is a close correlation between production costs and prices of copper products.

Operating Expenses

Our operating expenses consist of selling, general and administrative expenses, research and development expenses and other operating expenses. In 2010, our operating expenses included impairment loss of property, plant and equipment, loss on disposal of property, plant and equipment, and changes in fair value of contingent consideration liabilities in connection with the contingent consideration shares that formed part of the consideration for the Jin Xin acquisition. In 2011, we also recorded operating expenses relating to impairment of property, plant and equipment, impairment of goodwill arising from our acquisitions of Jin Xin and Xiangbei, impairment of VAT recoverables with respect to our biodiesel business, impairment of land use rights, and changes in fair value of contingent consideration liabilities in connection with the contingent consideration shares that formed part of the consideration for the Jin Xin and Xiangbei acquisitions.

 

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Selling, General and Administrative Expenses

Our selling, general and administrative expenses include salaries and transportation expenses for our sales personnel, administrative staff costs and other benefits, depreciation of office equipment, professional service fees and other miscellaneous expenses related to our administrative corporate activities.

Our sales activities are conducted through direct selling by our internal sales staff. Since substantially all of our biodiesel products are collected by our customers at or near our biodiesel production facilities, our selling expenses have been relatively small as a percentage of our revenues. We usually deliver our copper products to our customers by truck, using third-party providers. As most of our copper product customers are located near our production facilities, our selling expenses with respect to our copper business have been small relative to our revenues.

Our selling, general and administrative expenses also include share-based compensation expenses attributable to options that we have granted to our directors and executives. Our selling, general and administrative expenses will increase with any growth of our business. We expect our selling, general and administrative expenses will also increase in anticipation of our continued expansion of our copper products business. In connection with share options that we granted to certain directors, executives and employees, we recognized share-based compensation expenses in the amount of approximately RMB28.8 million in 2009, RMB21.8 million in 2010 and RMB17.0 million (US$2.7 million) in 2011. See “—Critical Accounting Policies—Valuation of share-based compensation” for additional information regarding the assumptions and methodologies we use in determining share-based compensation expense.

On September 21, 2007, in connection with our reorganization, we entered into a new employment agreement with Mr. Wilson Wai Sun Kwong which replaced a former employment agreement, pursuant to which we replaced the previously granted options with new options to acquire 1,094,656 ordinary shares of our Company. The options fully vested on June 15, 2008. As a result of the changes made to the vesting period, the new options were considered as a modification of the former options granted. There was no difference between the fair value of the new options and that of the old options immediately prior to such modification. The remaining unamortized share-based compensation as of the date of such modification was recognized over the shorter vesting period. See Item 6.B, “Directors, Senior Management and Employees—Compensation.”

Pursuant to our Share Option Scheme, which was approved on November 9, 2007, we granted share options for the purchase of an aggregate of 867,527, 3,055,000, 1,276,000, 4,706,000, 5,120,000 and 4,000,000 ordinary shares to certain employees, officers and directors at exercise prices of US$4.80, US$5.30, US$5.30, US$1.33, US$0.61 and US$0.61, respectively, per ordinary share on December 18, 2007, March 25, 2008, September 1, 2008, January 22, 2009, March 16, 2010 and January 11, 2011, respectively. On November 11, 2010, we cancelled a total of 3,799,527 share options which were granted on December 18, 2007, March 25, 2008 and September 1, 2008. The remaining unamortized amount of share-based compensation of RMB3.5 million (US$0.5 million) was recognized in our statement of operations upon cancellation. We recognize compensation cost based on the grant date fair value over the period the grantees are required to provide services in exchange for the award, and adjusted to reflect the number of share options that are expected to be forfeited prior to vesting. As of December 31, 2011, there is an aggregate of 11,200,000 ordinary shares (excluding the share options granted in July 2006 to an executive prior to the adoption of the Share Option Scheme) issuable upon exercise of outstanding share options and there are 2,483,194 ordinary shares available for future issuance upon the exercise of future grants under our Share Option Scheme.

On October 31, 2011, the board of directors of Engen granted Mr. Jianqiu Yu, a director of Engen and our Chairman and Principal Executive, share options to purchase up to 1,013 ordinary shares of Engen at an exercise price of RMB63,179 per ordinary share. We recognized share-based compensation expense for these options of approximately RMB7.7 million (US$1.2 million) in 2011.

See “Share-Based Compensation” in the notes to our audited financial statements, included elsewhere in this annual report, for additional information with respect to the assumptions and methodologies we use in determining share-based compensation expenses.

Research and Development Expenses

Our research and development expenses primarily relate to costs incurred in connection with running Biomass, one of our PRC subsidiaries engaging in in-house research and development projects. We recognize research and development expenses as they are incurred. See Item 5.C, “Operating and Financial Review and Prospects—Research and Development” for additional information with respect to our research and development policies.

 

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Other Operating Expenses

Other operating expenses are mainly comprised of depreciation on buildings and machinery and salary paid to factory workers of our suspended biodiesel plants. For example, Fujian Gushan suspended its production due to the consumption tax issue since June 2009, Chongqing Gushan and Hunan Gushan also deferred the commencement of production because of the consumption tax issue since the construction of their production facilities were completed in May and July 2009, respectively. Sichuan Gushan suspended production since August 2010 for relocation of its production facilities, and, from mid April 2010 to October 2010, Shanghai Gushan suspended its production due to heightened enforcement of control measure adopted by Shanghai municipal government during the Expo 2010, and Shanghai Gushan continued to suspend its production due to a lawsuit filed against us by a production facility contractor in the People’s Court of Fengxian District, Shanghai alleging that we failed to pay the contract sum with respect to its construction of our Shanghai plant. In 2011, to avoid negative operating cash flows caused by the increasingly high raw material input costs, shortages of raw materials and slowing demand, we suspended operations of Beijing Gushan and Heibei Gushan and continued the suspension of production in most of our other biodiesel plants. In 2010, we also recognized a loss from writing off a long-term payment of RMB4.8 million relating to the termination of our supply contract in Indonesia, and a provision for compensation of RMB1.5 million to a construction contractor of Shanghai Gushan in accordance with the court’s latest ruling.

We recognized an impairment loss on VAT recoverables of RMB28.2 million (US$4.5 million) in 2011. This represented the biodiesel business’s VAT recoverables as of December 31, 2011, that we expected would be not utilized in the near future. No impairment loss on VAT recoverables was recorded in 2010.

We also recognized a loss from the impairment of land use rights of RMB2.9 million (US$0.5 million) on land use rights of Hebei Gushan and Chongqing Gushan in 2011. This represented the excess of the net book value of the land use rights over the fair value which was determined from recent market transaction prices of comparable properties in neighboring areas. No impairment losses of land use rights were recorded in 2010.

Impairment Loss on Property, Plant and Equipment

We recognized impairment losses of RMB992.6 million and RMB603.3 million (US$95.9 million) on certain property, plant and equipment in the third quarter of 2010 and the fourth quarter of 2011, respectively. The impairment loss represented the excess of the carrying amount over the fair value of these assets. For the purpose of estimating the fair value, we utilized the projected cash flows of the property, plant and equipment discounted at its weighted average cost of capital. The recognition of the impairment loss of RMB951.0 million for the facilities of Fujian Gushan, Handan Gushan, Beijing Gushan, Shanghai Gushan, Chongqing Gushan, Hunan Gushan and Biomass was driven by a combination of a series of adverse changes in the operating environment, in particular, the unresolved consumption tax issue and the increase in the cost of raw materials. The recognition of the impairment loss of RMB603.3 million (US$95.9 million) for our biodiesel plants was driven by a combination of a series of adverse changes in the operating environment, in particular, the persistently increasing high costs of raw materials in recent years and a shortage of raw materials due to governments cracking down on certain alleged practices of vendors of used cooking oil that forced some of our suppliers to suspend operations in 2011.

We suspended production at Sichuan Gushan beginning on August 1, 2010 in preparation for the relocation of the production lines of its existing plant in San Tai County to its new plant in Qin Dong Bei Industrial Park. Pursuant to the agreement signed between Sichuan Gushan and San Tai ECB, San Tai ECB agreed to pay RMB38.8 million as compensation to Sichuan Gushan for its losses in disposing of certain machinery and equipment that cannot fit into the setting of the new plant, its relocation expenses and its losses from forfeiting the land use rights and returning the land to the municipal government of San Tai County. Furthermore, Sichuan Gushan is also responsible for the cost of changing the registration of the land from industrial land to non-industrial land. All these losses and expenses were expected to amount to approximately RMB80.5 million. As such, in relation to the relocation, Sichuan Gushan recognized an impairment loss of RMB41.7 million on its property, plant and equipment in 2010.

 

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Impairment Loss of Goodwill

We recognized impairment loss of goodwill of RMB41.4 million (US$6.6 million) for the year ended December 31, 2011. Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Goodwill is not amortized, but is instead tested for impairment. Goodwill is reviewed for impairment annually at reporting unit level in accordance with the provisions of FASB ASC Topic 350, Intangibles—Goodwill and Other. The goodwill impairment test is a two-step test. Under the first step, the fair value of the reporting unit is compared with its carrying value (including goodwill). If the fair value of the reporting unit is less than its carrying value, an indication of goodwill impairment exists for the reporting unit and the enterprise must perform step two of the impairment test (measurement). Under step two, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation and the residual fair value after this allocation is the implied fair value of the reporting unit goodwill. We determine we have two reporting units, biodiesel business and our copper products business. All the goodwill arises from the acquisition of the subsidiaries that operate our copper products business. Fair value of our copper products business is determined with reference to the excess of the fair value of our Company over the fair value of our biodiesel business. The fair value of our Company as a whole, is determined with reference to the quoted market price of our ADSs. The first step of the impairment test concluded that the carrying value of our copper products business exceeded its fair value. As a result, we performed the second step of the goodwill impairment test. We determined that the implied fair value of goodwill was nil. Therefore, a goodwill impairment loss of RMB41.4 million (US$6.6 million) was recognized in the year ended December 31, 2011. No impairment of goodwill was recorded in 2010.

Loss on Disposal of Property, Plant and Equipment

The disposal and relocation of Sichuan Gushan’s property, plant and equipment was completed as of December 31, 2010. The loss on disposal of property, plant and equipment mainly represented certain additional machinery and equipment that was scrapped during the fourth quarter of 2010 and relocation expenses.

Change in Fair Value of Contingent Consideration Liabilities

In November 2010, we acquired an initial 67% indirect ownership interest in Jin Xin through a series of transactions in exchange for the Jin Xin Consideration Shares. In January 2011, we repurchased 8% of the issued share capital of Engen from Gold Hero and Silver Harvest.

The Jin Xin Consideration Shares are subject to an earn-out arrangement whereby 6 million ordinary shares were delivered to Gold Hero (an affiliate of one of Jin Xin’s selling shareholders) at the closing of the transactions, while the remaining 18 million ordinary shares were placed into escrow to be released to in stages in amounts determined based on the ratio of Jin Xin’s net income, under U.S. GAAP, for the year ending December 31, 2010 and the three-year period ending December 31, 2012 to net income targets of RMB30.0 million and RMB190.0 million, respectively. On April 8, 2011, pursuant to this earn-out arrangement, 6 million Jin Xin Contingent Consideration Shares were released from escrow to Gold Hero as Jin Xin’s net income surpassed the net income target of RMB30.0 million for 2010.

In August 2011, we acquired a 75% indirect ownership interest in Xiangbei through a series of transactions in exchange for RMB30 million in cash, and the Xiangbei Contingent Consideration Shares, comprising: (i) up to 20 million newly issued ordinary shares of our Company, and (ii) up to 14.17% of Engen’s enlarged share capital, subject to adjustment pursuant to an earn-out arrangement.

The Xiangbei Contingent Consideration Shares are subject to an earn-out arrangement under which such shares may be issued in stages to Gold Wide, and Silvery Boom in amounts determined based on the ratio of Xiangbei’s net income, under U.S. GAAP, for the years ending December 31, 2011, 2012 and 2013 to net income targets of RMB20.0 million, RMB50.0 million and RMB80.0 million, respectively. Under this earn-out arrangement, if Xiangbei does not achieve a cumulative net income target for the three year period ending December 31, 2012, Gold Wide and Silvery Boom may be required to return part or all of the Xiangbei Contingent Consideration Shares, as well as up to RMB30 million in cash. In addition, we may be required to issue additional ordinary shares of our Company of up to a maximum value of RMB20 million to Gold Wide and Silvery Boom if the volume weighted average trading price of our ADSs over the 30 calendar day period immediately after the public announcement of our 2013 annual financial results is below US$12.50 per ADSs.

Under U.S. GAAP, the Contingent Consideration Shares is classified as a liability and stated at fair value at the acquisition date and each reporting date. The subsequent change in the fair value of the Contingent Consideration Shares at each reporting date is recognized in our statement of operations. We recognized a decrease in fair value of RMB10.4 million (US$1.6 million) for 2011 and an increase in fair value of RMB2.9 million in 2010.

 

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Other Operating Income

Our other operating income in 2011 amounted to RMB18.2 million (US$2.9 million), comprising VAT refunds of RMB13.0 million (US$2.1 million) and compensation from the supplier of castor beans in Sichuan as a result of the cancellation of the supply contract of castor beans signed with Sichuan Gushan. VAT refunds and coneccsions are subject to annual review by the state and local tax bureau of Mianyang and Hunan. Other operating income in 2010 represented the reversal of a provision for consumption tax of RMB103.8 million, which was previously made in 2009.

Other Income (Expense)

Other income includes interest income, interest expense, foreign currency exchange losses, government grant income and other income (expense).

We incurred a interest expense of nil in 2009, RMB0.7 million in 2010 and RMB7.5 million (US$1.2 million) in 2011. Interest expense in 2011 was mainly incurred by Jin Xin in respect of short term loans and by Engen in respect of a loan from related parties.

Other income (expenses) principally comprised of government grant income, income from a depositary bank and a provision for business tax on intercompany advances. We received grants from the local government authorities in china from time to time.

We also received income from our depositary bank in accordance to the depositary agreement and the income recognized amounted to RMB5.7 million, RMB4.0 million and RMB3.8 million (US$0.6 million) in 2009, 2010 and 2011, respectively. We also made a provision for business tax on intercompany advances and the provision amounted to RMB2.9 million, RMB3.1 million and RMB3.8 million (US$0.6 million) in 2009, 2010 and 2011, respectively.

Income Taxes

Under the current laws of the Cayman Islands and British Virgin Islands, we are not subject to any income or capital gains tax and dividend payments we make are not subject to any withholding tax in the Cayman Islands or British Virgin Islands. Under the current laws of Hong Kong, we are not subject to any income or capital gains tax and dividend payments and we are not subject to any withholding tax in Hong Kong.

Prior to January 1, 2008, a domestic enterprise without foreign investment was subject to corporate income tax, or CIT, at the rate of 33% on its taxable income and a foreign investment company established in the PRC was typically subject to CIT at the rate of 30%, national income tax and 3% local income tax on its taxable income. However, PRC state and local tax laws used to provide for certain tax holidays and preferential tax rates applicable to certain enterprises, industries and locations, and our subsidiaries in China benefited from such tax holidays and preferential tax rates.

 

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Under the New CIT Law, from January 1, 2008, foreign invested enterprises, such as our subsidiaries, and domestic companies are subject to CIT at a uniform rate of 25%, with certain exceptions. The State Council of the PRC passed an implementation guidance note, or the Implementation Guidance, on December 26, 2007, which sets out details of how existing preferential income tax rates will be adjusted to the standard rate of 25%. According to the Implementation Guidance, certain of our PRC subsidiaries which have not fully utilized their five-year tax holidays are allowed to continue to enjoy the full exemption from, or a 50% reduction in income tax rate until expiry of the tax holiday, after which the 25% standard rate will apply.

Based on the above, our PRC subsidiaries are subject to the following tax rates:

Sichuan Gushan and Handan Gushan are subject to CIT at 12.5% for 2009, and at 25% from 2010 onwards.

Fujian Gushan is subject to CIT at 10% and 11% for 2009 and 2010, respectively, at 24% for 2011 and at 25% from 2012 onwards.

Beijing Gushan and Shanghai Gushan were exempted from CIT for 2009 and are subject to income tax at 12.5% from 2010 to 2012 and at 25% from 2013 onwards.

Chongqing Gushan, Hunan Gushan and Biomass were incorporated in 2008 after the enactment of the New CIT Law on March 16, 2007. Therefore, Chongqing Gushan, Hunan Gushan and Biomass are subject to the unified CIT rate of 25% from 2008 onwards. Jin Xin and Xiangbei were incorporated in 2010 and 2011, respectively, after the enactment of the New CIT Law on March 16, 2007. Therefore, Jin Xin and Xiangbei are subject to the unified CIT rate of 25% since their incorporations.

According to article 33 of the New CIT Law issued on March 16, 2007 and article 99 of the Implementation Rules on Corporate Income Tax Law issued on December 6, 2007 and the relevant circulars on “Comprehensive Utilization of Resources CIT Incentive” (Cai Shui [2008] No. 47 and Cai Shui [2008] No. 117), when calculating its taxable income, an enterprise that makes use of waste biomass oil or waste lubricant as 100% of its raw materials is entitled to a 10% reduction in revenue. To qualify for this reduction, an enterprise must first apply for and obtain the CURV Certificate and then apply for the tax reduction.

As of the date of this annual report, each of the CURV Certificate of Beijing Gushan, Shanghai Gushan, Fujian Gushan and Handan Gushan has expired, and Sichuan Gushan has made application for, but has not yet obtained, its CURV Certificate.

Critical Accounting Policies

We prepare our consolidated financial statements in accordance with U.S. GAAP, which requires us to make judgments, estimates and assumptions that affect:

 

   

the reported amounts of our assets and liabilities;

 

   

the disclosure of our contingent assets and liabilities at the end of each reporting period; and

 

   

the reported amounts of revenues and expenses during each reporting period.

We continually evaluate these estimates based on our own experience, knowledge and assessment of current business and other conditions and on our expectations regarding the future based on available information and reasonable assumptions, which together form our basis for making judgments about matters that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, our actual results could differ from those estimates. Some of our accounting policies require a higher degree of judgment than others in their application. When reading our consolidated financial statements, you should consider:

 

   

our selection of critical accounting policies;

 

   

the judgment and other uncertainties affecting the application of such policies; and

 

   

the sensitivity of reported results to changes in conditions and assumptions.

 

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We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements:

Long-lived Assets

We depreciate property, plant and equipment on a straight-line basis over their estimated useful lives. We assess annually the useful lives of property, plant and equipment and if the assessment differs from the original estimate, such difference will be accounted for prospectively over the remaining economic useful lives, beginning in the year of the change in estimate. We estimate the useful lives of property, plant and equipment at the time the assets are put into production and we base our estimates on our experience as well as any anticipated technological evolution that may render an existing asset obsolete more quickly and therefore accelerate the rate at which such asset depreciates. If technological changes were to occur more rapidly than anticipated, the useful life of the assets may need to be shortened, resulting in the recognition of increased depreciation in future periods.

We assess annually whether property, plant, equipment and other long-lived assets have an indication of impairment. We also review long-lived assets, primarily consisting of property, plant and equipment and land use rights, for impairment whenever events or changes in the circumstances indicate that the carrying value of an asset may not be recoverable. We determine recoverability of long-lived assets to be held and used by comparing the carrying amount of an asset to the estimated future undiscounted cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future undiscounted cash flows, we recognize an impairment charge by the amount by which the carrying amount of the asset exceeds the fair value of the asset. We measure fair value by the asset’s discounted cash flows or market value, if readily determinable. Restoration of previously recognized impairment charge is prohibited. Assets to be disposed of are separately presented in the consolidated balance sheet and reported at the lower of carrying amount or fair value less costs to sell, and are no longer depreciated.

We recognized impairment losses of RMB992.6 million and RMB603.3 million (US$95.9 million) on certain property, plant and equipment in 2010 and 2011, respectively. The impairment losses represented the excess of the carrying amount over the fair value of these assets.

For the purpose of estimating the fair value, we utilized the projected cash flows of the property, plant and equipment discounted at its weighted average cost of capital. The recognition of the impairment loss of RMB951.0 million for the facilities of Fujian Gushan, Handan Gushan, Beijing Gushan, Shanghai Gushan, Chongqing Gushan, Hunan Gushan and Biomass, was driven by a combination of a series of adverse changes in the operating environment, in particular, the consumption tax issue was unresolved when the impairment test was performed during the third quarter of 2010 and the continual increase in costs of raw materials over the last few quarters. In the second quarter of 2010, we also recognized an impairment loss of RMB41.7 million on its property, plant and equipment in relation to the relocation of Sichuan Gushan’s production lines from San Tai County to our new plant in Qin Dong Bei Industrial Park.

As of December 31, 2011, due to the continually increased cost and persistent shortage of raw materials, the overall production and sales volume of the Group’s biodiesel and biodiesel by-products was in substance suspended. We consider that the possibility is remote that we will be in a position to resume our production of biodiesel and biodiesel by-products on a large scale basis in the near future. An impairment loss of RMB603.3 million (US$95.9 million) was made on the production facilities of Fujian Gushan, Sichuan Gushan, Beijing Gushan, Shanghai Gushan, Chongqing Gushan and Hunan Gushan.

Significant judgment was involved in estimating the projected cash flows of these plants and key assumptions included, among others:

 

         2010    2011
(a)  

Discount rates

   15.9% to 17.9%    15.0%
(b)  

Overall utilization rates during the forecast period

   5.0% to 60.0%    10.0%
(c)  

Consumption tax issue

  

Consumption tax issue on biodiesel sold to the fuel market would not be resolved and our Company will only produce fatty acid methyl ester sold to the chemical market.

  

N/A

(d)  

Useful lives of the plants

  

Useful lives of the plants will not be extended.

  

Useful lives of the plants will not be extended.

(e)  

Gross profit (loss) margin during the forecast period

   -24.4% to 11.7%    5.7% to 6.0%
(f)  

Operating profit (loss) margin during the forecast period

   -27.6% to 8.4%    -4.7% to 6.6%

 

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The estimated future undiscounted cash flows were based on assumptions which included, among other, (b) through (f) above. As the carrying amount of an asset exceeded its estimated future undiscounted cash flows, it indicated that the carrying amount of an asset cannot be recovered. Accordingly, we measured the fair value of the asset by applying the discount rates as mentioned in (a) above to recognize the impairment charge. Changes in projections or estimates could significantly change the estimated fair value of the property, plant and equipment of these plants. If we used different assumptions or estimates, the impairment charge could be different. In particular, if the overall utilization rate is significantly below our estimate, or if the average unit cost of raw materials increases at a rate significantly higher than our estimate, the fair value of the property, plant and equipment of these plants would be substantially lower and the impairment losses would have been higher.

We relocated the production lines of Sichuan Gushan’s old plant in San Tai County to its new plant in Qin Dong Bei Industrial Park. In preparing for the relocation, Sichuan Gushan suspended production beginning on August 1, 2010. Pursuant to the agreement signed between Sichuan Gushan and San Tai ECB, San Tai ECB agreed to pay Sichuan Gushan RMB38.8 million as compensation for its losses in disposing of certain machinery and equipment that cannot fit into the setting of the new plant, its relocation expenses and its losses from forfeiting the land use rights and returning the land to the municipal government of San Tai County. Furthermore, Sichuan Gushan will also be responsible for the cost of changing the registration of the land from industrial land to non-industrial land. All these losses and expenses were expected to amount to approximately RMB80.5 million. As such, in relation to the relocation, Sichuan Gushan recognized an impairment loss of RMB41.7 million on its property, plant and equipment upon signing the agreement in 2010.

Fair Value of Contingent Consideration

For the years ended December 31, 2010 and 2011, we recognized the increase in fair value of RMB2.9 million as an operating expense and decrease in fair value of RMB10.4 million (US$1.6 million) as an operating income, respectively, for the contingent consideration shares in respect of our acquisitions of Jin Xin and Xiangbei.

Acquisition of Jin Xin

On November 3, 2010, we acquired a 67% indirect ownership interest in Jin Xin to expand the scope of its environmental businesses. The consideration paid by us for the acquisition consisted principally of 24 million Jin Xin Consideration Shares to be issued to Gold Hero.

The Jin Xin Consideration Shares are subject to an earn-out arrangement whereby 6 million shares were issued to Gold Hero at the closing of the acquisition, while the remaining 18 million ordinary shares are placed into escrow. The contingent consideration shares are to be released in stages in amounts determined based on the ratio of Jin Xin’s net income, under U.S. GAAP, for the year ending December 31, 2010 and the three-year period ending December 31, 2012 to net income targets of RMB30.0 million and RMB190.0 million, respectively. Under the earn-out arrangement, the maximum earn-out award for 2010 of 6 million Jin Xin Contingent Consideration Shares was released to Gold Hero on April 8, 2011, as Jin Xin’s net income for the year ended December 31, 2010, was greater than RMB30.0 million. The remaining contingent consideration shares are to be released to Gold Hero if Jin Xin achieves a cumulative net income of RMB190.0 million or more during the three-year period ended December 31, 2012. Based on the formula as set out in the purchase agreements in connection with the acquisition, if Jin Xin’s cumulative net income for the three-year period ending December 31, 2012, is nil or below, Gold Hero is required to return to us, all of the Jin Xin Consideration Shares received in connection with the acquisition (or Gold Hero has an option to pay in cash an amount equal to the number of Jin Xin Consideration Shares received in connection with the acquisition times US$1.00 per share) plus US$4.5 million in cash to our Company.

 

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The contingent consideration shares are classified as a liability and stated at their fair value at the acquisition date and each reporting date. The subsequent change in the fair value of the contingent consideration liabilities at each reporting date is recognized in our statement of operations.

As of the acquisition date, the future possible outcome for our Company under the contingent consideration arrangement was between an issuance of 18 million ordinary shares to, and a return of 6 million ordinary shares and US$4.5 million in cash from Gold Hero. The fair value of the contingent consideration arrangement of RMB17.5 million was estimated by applying the income approach. Key assumptions include (a) a discount rate range of 6.10% to 7.38% and (b) a probability adjusted level of net income in Jin Xin between nil or below and RMB190.0 million or above for the three-year period ending December 31, 2012.

As of December 31, 2010, the amount recognized for the contingent consideration arrangement increased by RMB2.9 million, mainly as a result of an increase of market price of our Company’s ordinary shares as of December 31, 2010 compared to the acquisition date, changes in the discount rate range of 6.61% to 7.87% and a passage of time of discounting. Other assumptions used to develop the estimates have not changed.

As of December 31, 2011, the fair value of contingent consideration liabilities was determined to be RMB0.5 million by applying income approach. In April 2011, our Company issued 6 million ordinary shares to selling shareholder in accordance with the Jin Xin earn-out arrangement as a result of Jin Xin’s net income exceeding the applicable net income target of RMB30.0 million for December 31, 2010. As a result of issuance of such contingent consideration shares, the fair value of contingent consideration liabilities decreased by RMB16.2 million. The fair value of contingent consideration liabilities also decreased by RMB3.7 million, that was recognized in the consolidated statements of operations, mainly as a result of a decrease in the market price of our Company’s ordinary shares as of December 31, 2011 compared to December 31 2010, the change in the discount rate range from 7.87% to 8.55% and the passage of time. Other assumptions used to develop the original estimate did not change.

Acquisition of Xiangbei

On August 1, 2011, we acquired 75% indirect ownership interest in Xiangbei to diversify and expand our copper products business to different locations in China. The results of Xiangbei’s operations have been included in our consolidated financial statements since that date. Xiangbei manufactures copper rods and copper pads from recycled copper.

The consideration to be paid for the acquisition principally consists of RMB30.0 million and the issuance of up to 14.17% of Engen’s share capital and 20 million ordinary shares of our Company (collectively, the “Xiangbei Contingent Consideration Shares”) to Gold Wide and Silvery Boom.

The Xiangbei Contingent Consideration Shares are subject to an earn-out arrangement and are to be issued in stages in amounts determined based on the ratio of Xiangbei’s net income, under U.S. GAAP, for the years ending December 31, 2011, 2012 and 2013 to net income targets of RMB20.0 million, RMB50.0 million and RMB80.0 million, respectively. Under the earn-out arrangement, (i) up to 4.72% of Engen’s enlarged share capital and a maximum of 6.6 million newly issued Gushan Shares may be issued to Gold Wide and Silvery Boom with respect to the year ended December 31, 2011, if Xiangbei achieves net income of RMB20.0 million for that year, (ii) up to 4.72% of Engen’s enlarged share capital and a maximum of 6.6 million new Gushan Shares may be issued to Gold Wide and Silvery Boom with respect to the year ending December 31, 2012, if Xiangbei achieves net income of RMB50.0 million for that year, and (iii) up to 4.73% of Engen’s enlarged share capital and a maximum of 6.8 million new Gushan Shares may be issued to Xiangbei’s selling shareholders with respect to the year ending December 31, 2013, if Xiangbei achieves net income of RMB80.0 million for that year. If Xiangbei’s net income over the three years do not meet the overall net income target of the three-year earn-out, the selling shareholders may be required to return to Engen or Gushan, as applicable, part or all of the Xiangbei Contingent Consideration Shares (or pay Engen or Gushan an amount in cash equal to the value of such shares as determined under the earn-out arrangement) and cash of up to RMB30.0 million.

 

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In addition, Gushan will issue additional ordinary shares of Gushan (the “Additional Gushan Shares”) to Gold Wide and Silvery Boom if the volume weighted average trading price of Gushan Shares (as represented by Gushan’s ADSs) over the 30 calendar day period immediately after the public announcement of Gushan’s 2013 annual financial results is below US$1.25 per share (hence, US$12.50 per Gushan’s ADSs). The number of Additional Gushan Shares to be issued will be determined based on the shortfall amount per share multiplied by the number of Gushan Shares issued to the selling shareholders under the three-year earn-out arrangement, limited to a maximum value of RMB20.0 million.

The contingent consideration shares are classified as a liability and stated at their fair value at the acquisition date and each reporting date. By applying the income approach, the subsequent change in the fair value of the contingent consideration liabilities at each reporting date is recognized in our statement of operations.

As of the acquisition date, the future possible outcome for our Company under the contingent consideration arrangement was between an issuance of 20 million ordinary shares to, and a return of RMB30.0 million in cash from Gold Wide and Silvery Boom. The fair value of the contingent consideration arrangement of RMB17.4 million was estimated by applying the income approach. Key assumptions include (a) a discount rate range of 7.44% to 8.03% and (b) a probability adjusted level of net income of Xiangbei for the three-year period ending December 31, 2013 and (c) a valuation of Engen’s ordinary shares. Depending on the level of the cumulative net income of Xiangbei for the three-year period ending December 31, 2013, the future possible outcome for our Company under the contingent consideration arrangement is between an issuance of 20 million ordinary shares of our Company, an issuance of additional ordinary shares of our Company equivalent to a maximum of RMB20.0 million and an issuance of 14.17% of Engen’s enlarged share capital to Gold Wide and Silvery Boom and a return of RMB30.0 million in cash from the selling shareholders.

As of December 31, 2011, the fair value of contingent consideration liabilities was determined to be RMB10.8 million by applying the income approach. The change in fair value of contingent consideration liabilities of RMB6.6 million was recognized in the consolidated statements of operations, mainly as a result of a decrease of market price of our Company’s ordinary shares as of December 31, 2011 compared to the acquisition date, the change in the discount rate range of 8.20% to 8.83%, a decrease in the valuation of Engen’s ordinary shares and the passage of time. Other assumptions used to develop the original estimate did not change.

Fair Value of Assets Acquired

The property, plant and equipment and land use rights of the newly acquired subsidiaries were stated at valuations reported by a third party valuation firm. The “Sales Comparison Approach” was the primary basis upon which the equipment was valued. The Sales Comparison Approach is a set of procedures in which an appraiser derives a value indication by comparing the assets being appraised to similar assets that have recently been sold, applying appropriate units of comparison, and making adjustments based on the elements of comparison to the sale prices of the comparable. The “Depreciated Replacement Cost Approach” was used in valuing the building and structure portions of the property. The Depreciated Replacement Cost Approach requires an estimation of the new replacement cost of the buildings and structures from which deductions are then made to allow for the age, condition and functional obsolescence. The Depreciated Replacement Cost Approach is subject to adequate potential profitability of the business. In respect of the land use rights, the “Direct Comparison Method” was adopted by making reference to comparable site transaction as available in the relevant industrial land market.

Goodwill

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Goodwill is not amortized, but is instead tested for impairment. Goodwill is reviewed for impairment annually at reporting unit level in accordance with the provisions of FASB ASC Topic 350, Intangibles—Goodwill and Other. The goodwill impairment test is a two-step test. Under the first step, the fair value of the reporting unit is compared with its carrying value (including goodwill). If the fair value of the reporting unit is less than its carrying value, an indication of goodwill impairment exists for the reporting unit and the enterprise must perform step two of the impairment test (measurement). Under step two, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation and the residual fair value after this allocation is the implied fair value of the reporting unit goodwill. We determine that we have two reporting segments, which are the biodiesel business and copper products business. All the goodwill arises from the acquisition of subsidiaries in the copper products business. The first step of the impairment test concluded that the carrying value of our copper products business exceeded its fair value. As a result, we performed the second step of the goodwill impairment test. We determined that the implied fair value of goodwill was nil. Therefore, a goodwill impairment loss of RMB41.4 million was recognized in the year ended December 31, 2011. No impairment of goodwill was recorded in 2010.

 

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Valuation of Share-based Compensation

We measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award and recognize the cost over the period during which an employee is required to provide service in exchange for the award, which is generally the vesting period. The amount of cost recognized is adjusted to reflect the number of share options that are forfeited prior to vesting. If an award is cancelled and is not accompanied by the concurrent grant of a replacement award, any previously recognized compensation cost is not reversed and any previously measured but unrecognized cost is fully recognized at the cancellation date.

The determination of fair value of share options requires making complex and subjective judgments about our projected financial and operating results. It also requires us to make certain assumptions such as cost of capital, general market and macroeconomic conditions, industry trends, comparable companies, share price volatility of the subject company, expected lives of options and discount rates. These assumptions are inherently uncertain. Changes in these assumptions could significantly affect the amount of employee share-based compensation expense we recognize in our consolidated financial statements.

Pursuant to the Share Option Scheme approved on November 9, 2007, we granted share options for the purchase of an aggregate of 867,527 ordinary shares to our directors and officers on December 18, 2007. The exercise price is US$4.80 per ordinary share (equivalent to US$48.00 per ADS, being the initial public offering price). The options vest one third 12 months from the date of grant, one third 24 months from the date of grant and the remaining one third 36 months from the date of grant. The options will expire ten years from the date of grant.

We determined, based on the “Binomial Option Pricing Model”, that the estimated fair value of the options at the grant date was approximately US$2.13 (RMB15.71) per ordinary share, or US$1.8 million (RMB13.6 million) in aggregate.

The expected volatility of 53.35% was based on the average volatility of several listed companies in the renewable energy sector. Since we did not have a sufficient trading history for valuation purpose at the grant date, we estimated the potential volatility of the ordinary shares price by referring to the average volatility of these comparable companies because management believed that the average volatility of such companies was a reasonable benchmark to use in estimating the expected volatility of our Company’s ordinary shares. We did not have any plan to declare dividends as of the date of grant on December 18, 2007.

Changes in the above assumptions could significantly affect the amount of employee share-based compensation expenses for the share options granted on December 18, 2007 that we recognize in our consolidated financial statements. If the expected volatility of our Company’s stock price were 43.35% per annum or 63.35%, compared to a volatility of 53.35%, the fair value of the share options would be US$1.7 million (RMB12.5 million) or US$2.0 million (RMB14.8 million), respectively.

These options were cancelled on November 11, 2010. The remaining unamortized amount of share-based compensation was fully recognized in our statement of operations upon the cancellation.

 

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Pursuant to the Share Option Scheme, we granted share options for the purchase of an aggregate of 3,055,000 ordinary shares to 65 of our officers and employees on March 25, 2008. The exercise price is US$5.30 per ordinary share (equivalent to US$53.00 per ADS). The options will vest one third 12 months from the date of grant, one third 24 months from the date of grant and the remaining one third 36 months from the date of grant. The options will expire ten years from the date of grant.

We determined, based on the Binomial Option Pricing Model, that the estimated fair value of these options at the grant date was approximately US$2.67 (RMB18.79) per ordinary share, or US$8.1 million (RMB57.4 million) in aggregate.

The expected volatility of 80.26% was based on the implied volatility of the options in the market which were based on our ordinary shares as the underlying asset. We believed that such implied volatility was a reasonable estimation of the expected volatility of our Company’s ordinary shares. The expected dividend yield of 0.83% was used as an assumption.

Changes in the above assumptions could significantly affect the amount of employee share-based compensation expenses for the share options granted on March 25, 2008 that we recognize in our consolidated financial statements. If the expected volatility of our Company’s stock price were 70.26% per annum or 90.26%, compared to a volatility of 80.26%, the fair value of the share options would be US$7.6 million (RMB53.4 million) or US$8.6 million (RMB60.5 million), respectively.

These options were cancelled on November 11, 2010. The remaining unamortized amount of share-based compensation was fully recognized in our statement of operations upon the cancellation.

Pursuant to the Share Option Scheme, we granted share options for the purchase of an aggregate of 1,276,000 ordinary shares to 27 individuals, including officers and employees and one director of our Company on September 1, 2008. The exercise price is US$5.30 per ordinary share (equivalent to US$53.00 per ADS). The options will vest one third 12 months from the date of grant, one third 24 months from the date of grant and the remaining one third 36 months from the date of grant. The options will expire ten years from the date of grant.

We determined, based on the Binomial Option Pricing Model, that the estimated fair value of these options at the grant date was approximately US$2.41 (RMB16.49) per ordinary share, or US$3.1 million (RMB21.0 million) in aggregate.

The expected volatility of 65.62% was based on the implied volatility of the options in the market which were based on our ordinary shares as the underlying asset. We believed that such implied volatility was a reasonable estimation of the expected volatility of our Company’s ordinary shares. The expected dividend yield of 0.97% was used as an assumption.

Changes in the above assumptions could significantly affect the amount of employee share-based compensation expenses for the share options granted on September 1, 2008 that we recognize in our consolidated financial statements. If the expected volatility of our Company’s stock price were 55.62% per annum or 75.62%, compared to a volatility of 65.62%, the fair value of the share options would be US$2.8 million (RMB19.0 million) or US$3.3 million (RMB22.8 million), respectively.

These options were cancelled on November 11, 2010. The remaining unamortized amount of share-based compensation was fully recognized in our statement of operations upon the cancellation.

Pursuant to the Share Option Scheme, we granted share options for the purchase of an aggregate of 4,706,000 ordinary shares to 97 individuals, including officers and employees and directors of our Company on January 22, 2009. The exercise price is US$1.33 per ordinary share (equivalent to US$13.30 per ADS). The options will vest one third 6 months from the date of grant, one third 18 months from the date of grant and the remaining one third 30 months from the date of grant. The options will expire ten years from the date of grant.

We determined, based on the Binomial Option Pricing Model, that the estimated fair value of the options at the grant date was approximately US$0.50 (RMB3.40) per ordinary share, or US$2.3 million (RMB16.0 million) in aggregate.

The expected volatility of 138.94% was based on the implied volatility of the options in the market which were based on our ordinary shares as the underlying asset. We believed that such implied volatility was a reasonable estimation of the expected volatility of our Company’s ordinary shares. The expected dividend yield of 5.22% was used as an assumption.

 

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Changes in the above assumptions could significantly affect the amount of employee share-based compensation expenses for the share options granted on January 22, 2009 that we recognize in our consolidated financial statements. If the expected volatility of our Company’s stock price were 128.94% per annum or 148.94%, compared to a volatility of 138.94%, the fair value of the share options would be US$2.3 million (RMB15.5 million) or US$2.5 million (RMB16.9 million), respectively.

Pursuant to the Share Option Scheme, we granted share options for the purchase of an aggregate of 5,120,000 ordinary shares to 93 individuals, including officers and employees and directors of our Company on March 16, 2010. The exercise price is US$0.61 per ordinary share (equivalent to US$6.10 per ADS). The options will vest one third 12 months from the date of grant, one third 24 months from the date of grant and the remaining one third 36 months from the date of grant. The options will expire ten years from the date of grant.

We determined, based on the Binomial Option Pricing Model, that the estimated fair value of the options at the grant date was approximately US$0.37 (RMB2.52) per ordinary share, or US$1.9 million (RMB12.9 million) in aggregate.

The expected volatility of 126.59% was based on the implied volatility of the options in the market which were based on our ordinary shares as the underlying asset. We believed that such implied volatility was a reasonable estimation of the expected volatility of our Company’s ordinary shares. The expected dividend yield of 1.93% was used as an assumption.

Changes in the above assumptions could significantly affect the amount of employee share-based compensation expenses for the share options granted on March 16, 2010 that we recognize in our consolidated financial statements. If the expected volatility of our Company’s stock price were 116.59% per annum or 136.59%, compared to a volatility of 126.59%, the fair value of the share options would be US$1.8 million (RMB12.2 million) or US$2.0 million (RMB13.4 million), respectively.

Pursuant to the Share Option Scheme, we granted share options for the purchase of an aggregate of 4,000,000 ordinary shares to 17 individuals, including 1,000,000 ordinary shares to eight employees of our wholly owned subsidiaries engaged in our biodiesel business and 3,000,000 ordinary shares to nine employees of Jin Xin, on January 11, 2011. The exercise price is US$0.61 per ordinary share (equivalent to US$6.10 per ADS). The options will vest one third 12 months from the date of grant, one third 24 months from the date of grant and the remaining one third 36 months from the date of grant. The options will expire ten years from the date of grant.

We determined, based on the Binomial Option Pricing Model, that the estimated fair value of the options at the grant date was approximately US$0.36 (RMB2.36) per ordinary share, or US$1.4 million (RMB9.4 million) in aggregate.

The expected volatility of 82.48% was based on the implied volatility of the options in the market which were based on our ordinary shares as the underlying asset. We believed that such implied volatility was a reasonable estimation of the expected volatility of our Company’s ordinary shares. The expected dividend yield of 0.87% was used as an assumption.

Changes in the above assumptions could significantly affect the amount of employee share-based compensation expenses for the share options granted on January 11, 2011 that we recognize in our consolidated financial statements. If the expected volatility of our Company’s stock price were 92.48% per annum or 72.48%, compared to a volatility of 82.48%, the fair value of the share options would be US$1.5 million (RMB9.8 million) or US$1.3 million (RMB8.9 million), respectively.

 

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A summary of assumptions for the valuation of share options granted as of the date of this annual report is set forth as follows:

 

     Options
granted on
July 6, 2006
    Options
granted on
January 22, 2009
    Options
granted on
March 16, 2010
    Options
granted on
January 11, 2011
 

Valuation model

     Black-Scholes        Binomial        Binomial        Binomial   

Expected dividend yield

     0     5.22     1.93     0.87

Expected volatility

     40     138.94     126.59     82.48

Risk-free interest rate

     5.145     2.62     3.66     3.43

Suboptimal factor

     —          1.5        1.5        2.2   

Fair value of underlying ordinary share (per share)

   US$ 3.49(RMB27.19   US$ 0.99(RMB6.80   US$ 0.57(RMB3.86   US$ 0.58(RMB3.82

Share Options on Engen’s Ordinary Shares

On October 31, 2011, the board of directors of Engen granted Mr. Jianqiu Yu, a director of Engen and the Chairman and Principal Executive Officer of our Company, share options to purchase up to 1,013 ordinary shares of Engen at an exercise price of RMB63,179 per share. These options are exercisable immediately and will expire ten years from the date of grant. Any ordinary shares of Engen issued upon the exercise of these options will be subject to a right of first refusal in favor of Engen before they may be validly transferred.

Our Company determined, based on the Binomial Option Pricing Model, that the estimated fair value of the options at grant date was approximately RMB7,561 per ordinary share of Engen. The amount of share-based compensation expense recognized for these options was RMB7.7 million for the year ended December 31, 2011.The expected volatility of 50.5% was based on the average volatility of several listed companies in the metal recycling sector. Since Engen did not have a trading history at the grant date, our Company estimated the potential volatility of the ordinary shares price by referring to the average volatility of these comparable companies because management believes that the average volatility of such companies was a reasonable benchmark to use in estimating the expected volatility of Engen’s ordinary shares. The grant date fair value of the underlying ordinary shares of RMB21,235 per share, was based on the results using an income approach. The expected dividend yield of 0% was used as an assumption.

Changes in the above assumptions could significantly affect the amount of employee share-based compensation expenses for the share options on Engen’s ordinary shares granted on October 31, 2011 that we recognize in our consolidated financial statements. If the expected volatility of Engen’s ordinary shares were assumed to be 60.5% per annum or 40.5%, compared to a volatility of 50.5%, the fair value of the share options would be RMB9.0 million or RMB5.8 million, respectively.

Recently Issued Accounting Standards

Accounting Standards Update (“ASU”) 2011-11, an update to ASC 210, Balance Sheet

In December 2011, the Financial Accounting Standards Board (“FASB”) issued ASU 2011-11, an update to ASC 210, Balance Sheet—Disclosures about Offsetting Assets and Liabilities. The FASB issued this ASU in conjunction with the International Accounting Standards Board’s (“IASB”) issuance of amendments to Disclosures – Offsetting Financial Assets and Financial Liabilities (Amendments to IFRS 7, Financial Instruments: Disclosures). ASU 2011-11 requires disclosures to allow investors to better compare financial statements prepared under U.S. GAAP with financial statements prepared under IFRS while retaining the existing offsetting models under U.S. GAAP and IFRS. For the Group, ASU 2010-11 is effective for annual periods beginning January 1, 2013 and interim periods within those annual periods. Retrospective application is required. Since this standard impacts disclosure requirements only, the Group expects the adoption of ASU 2011-11 will not have a material impact on the Group’s consolidated results of operations or financial condition.

 

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ASU 2011-05, an update to ASC 220, Comprehensive Income

In June 2011, the FASB issued ASU 2011-05, an update to ASC 220, Comprehensive Income—Presentation of Comprehensive Income. ASU 2011-05 increases the prominence of other comprehensive income in financial statements. ASU 2011-05 permits entity to present the components of net income and comprehensive income in either one or two consecutive financial statements and eliminates the option in U.S. GAAP to present other comprehensive income in the statement of changes in equity. For the Group, ASU 2011-05 is effective for fiscal years, and interim periods within those years beginning after December 15, 2011. Retrospective application is required and early adoption is permitted. Since the standard impacts presentation and disclosure requirements only, the Group expects the adoption of ASU 2011-05 will not have a material impact on the Group’s consolidated results of operations or financial condition.

ASU 2011-04, an update to ASC820, Fair Value Measurements and Disclosures

In May 2011, the FASB issued ASU 2011-04, an update to ASC 820, Fair Value Measurements and Disclosures—Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. ASU 2011-04 is issued to provide largely identical guidance about fair value measurement and disclosure requirements with the IASB’s new IFRS 13, Fair Value Measurement. ASU 2011-04 provides guidance about how fair value should be applied where it already is required or permitted under U.S. GAAP and most of changes are clarifications of existing guidance or wording changes to align with IFRS 13. ASU 2011-04 requires a reporting entity to disclose a change, if any, in valuation technique and related inputs that result from applying the ASU and to quantify the total effect, if practicable in the period of adoption. For the Group, ASU 2011-04 is effective prospectively for interim and annual periods beginning after December 15, 2011. The Group expects the adoption of ASU 2011-04 will not have a material impact on the Group’s consolidated results of operations or financial condition.

ASU 2010-29, an update to ASC 805, Business Combinations

In December 2010, the FASB issued ASU 2010-29, Business Combinations (ASC 805): Disclosure of Supplementary Pro Forma Information for Business Combination. ASU 2010-29 requires disclosure about pro forma information including revenues and earnings of the combined entity within the notes to the financial statements and pro forma information be presented as if business combination occurred at the beginning of the prior annual reporting period for purposes of calculating both the current and prior reporting period pro forma financial information. ASU 2010-29 also requires that the disclosure be accompanied by narrative description of the amount and nature of material nonrecurring pro forma adjustment. For the Group, ASU 2010-29 is effective for business combinations with effective dates on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Prospective application is required with early adoption permitted. The Group adopted the provisions of this standard prospectively to business combinations with effective dates on or after January 1, 2011. The adoption of ASU 2010-29 did not have any impact on the Group’s consolidated results of operations or financial condition.

 

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Results of Operations

The following table sets forth a summary, for the periods indicated, of our consolidated statement of operations and operating data and certain items expressed as a percentage of our total net revenues:

 

     Year ended December 31,  
     2009     2010     2011  
     RMB     %     RMB     %     RMB     US$     %  
     (in millions, except for percentages, per share and operating data)  

Consolidated Statements of Operations Data

              

Revenues(1)

     628.2        100.0     408.5        100.0     1,449.7        230.3        100.0

Cost of revenues(2)

     (766.7     (122.0 )%      (481.8     (117.9 )%      (1,404.9     (223.2     (96.9 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit (loss)

     (138.5     (22.0 )%      (73.3     (17.9 )%      44.8        7.1        3.1

Operating expenses:

              

Research and development

     (5.7     (0.9 )%      (3.9     (1.0 )%      (0.5     —          —  

Selling, general and administrative

     (89.9     (14.3 )%      (84.5     (20.7 )%      (81.7     (13.0     (5.6 )% 

Other operating expenses

     (33.4     (5.3 )%      (70.7     (17.3 )%      (68.3     (10.8     (4.7 )% 

Impairment loss of property, plant and equipment

     —          —       (992.6     (243.0 )%      (603.3     (95.9     (41.6 )% 

Impairment of goodwill

     —          —       —          —       (41.4     (6.6     (2.9 )% 

Loss on disposal of property, plant and equipment

     (0.1     —       (3.3     (0.8 )%      (0.1     —          —  

Change in fair value of contingent consideration liabilities

     —          —       (2.9     (0.7 )%      10.4        1.6        0.7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     (129.1     (20.5 )%      (1,157.9     (283.5 )%      (784.9     (124.7     (54.1 )% 

Other operating income

     —          —       103.8        25.4     18.2        2.9        1.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

     (267.6     (42.5 )%      (1,127.4     (276.0 )%      (721.9     (114.7     (49.8 )% 

Other income (expense):

              

Interest income

     2.4        0.4     1.4        0.3     0.4        0.1        —  

Interest expense

     —          —       (0.7     (0.2 )%      (7.5     (1.2     (0.5 )% 

Foreign currency exchange losses, net

     (0.1     (0.1 )%      (0.2     —       0.2        —          —  

Other income (expense), net

     (0.7     (0.1 )%      2.9        0.7     10.3        1.6        0.7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) before income tax expense

     (266.0     (42.3 )%      (1,124.0     (275.2 )%      (718.5     (114.2     (49.6 )% 

Income tax benefit (expense)

     (17.5     (2.8 )%      17.8        4.4     (18.1     (2.8     (1.2 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

     (283.5     (45.1 )%      (1,106.2     (270.8 )%      (736.6     (117.0     (50.8 )% 

Net income attributable to non-controlling interest

     —          —       (2.8     (0.7 )%      (11.1     (1.8     (0.8 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to the Company

     (283.5     (45.1 )%      (1,109.0     (271.5 )%      (747.7     (118.8     (51.6 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) per share

              

—Basic

     (1.70       (6.68       (4.48     (0.71  

—Diluted

     (1.70       (6.68       (4.48     (0.71  

Consolidated Operating Data

              

Sales volume of biodiesel (in tons)

     143,818          42,391          8,178       

Average selling price of biodiesel (in RMB per ton)

     4,040          4,505          5,742       

Sales volume of by-products (in tons)

     18,469          6,314          1,464       

Average selling price of by-products (in RMB per ton)

     2,554          1,972          2,589       

Sales volume of copper products (tons)

     —            3,787          23,154       

Average selling price of copper products (in RMB/ton)

     —            53,697          57,113       

 

(1) Revenues are comprised of:

 

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     Year ended December 31,  
     2009     2010     2011  
     RMB      %     RMB      %     RMB      US$      %  
     (in millions, except for percentages)  

Biodiesel

     581.0           92.5     191.0         46.8     47.0         7.4         3.3

Biodiesel by-products:

                  

Glycerine and Stearic acid

     24.8         3.9     3.5         0.9     1.9         0.3         0.1

Erucic acid

     2.7         0.4     0.3         —       —           —           —  

Erucic amide

     1.0         0.2     —           —       —           —           —  

Plant asphalt

     17.2         2.8     8.6         2.1     1.8         0.3         0.1

Refined glycerine

     1.5         0.2     —           —       —           —           —  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total biodiesel by-products

     47.2         7.5     12.4         3.0     3.7         0.6         0.2
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Biodiesel raw materials

     —           —       —           —       2.6         0.4         0.2

Total biodiesel products

     628.2         100     203.4         49.8     53.3         8.4         3.7
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Copper products

     —           —       205.1         50.2     1,322.4         210.1         91.2

Copper raw materials and scrap

     —           —       —           —       74.0         11.8         5.1

Total copper products

     —           —       205.1           50.2     1,396.4         221.9         96.3
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 
                  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total revenues

     628.2         100     408.5         100     1,449.7         230.3         100
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

 

(2) Cost of revenues is comprised of:

 

     Year ended December 31,  
     2009     2010     2011  
     RMB      %     RMB      %     RMB      US$      %  
     (in millions, except for percentages)  

Cost of revenues

                  

Direct material cost

     557.0         88.7     419.8         102.7     1,324.4         210.4         91.4

Depreciation

     89.7         14.3     50.6         12.4     26.2         4.2         1.8

Provision for consumption tax

     103.8         16.5     —           —       —           —           —  

Other

     16.2         2.5     11.4         2.8     54.3         8.6         3.7
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total cost of revenues

     766.7         122.0     481.8         117.9     1,404.9         223.2         96.9
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Year Ended December 31, 2011 Compared to Year Ended December 31, 2010

Revenues

Our revenues amounted to RMB1,449.7 million (US$230.3 million) for 2011, representing an increase of 254.9% from RMB408.5 million for 2010. This increase was primarily due to the increase in revenues from our copper products business. We acquired controlling interests in and began consolidating the operating results of each of Jin Xin and Xiangbei in November 2010 and August 2011, respectively.

This increase was mainly due to the consolidation of Jin Xin’s full-year results for 2011 and the consolidation of Xiangbei’s results beginning in August 2011. As a result, revenues from our copper products business totaled RMB1,396.4 million (US$221.9 million) for 2011, representing an increase of 581.0% from RMB205.1 million for 2010. The inclusion of Jin Xin’s full-year revenues in our 2011 financial statements resulted in an increase in Jin Xin’s revenue contribution of by 490.9% from RMB205.1 million for 2010 to RMB1,211.9 million (US$192.6 million) for 2011, reflecting mainly an increase in the sales volume of Jin Xin’s copper products by 435.7% from 3,787 tons for 2010 to 20,288 tons for 2011 and an increase in sales of scrap materials. The acquisition of a controlling interest in Xiangbei resulted in an increase in our revenues of RMB184.5 million (US$29.3 million), reflecting a sales volume of 2,866 tons of copper products and sales of scrap materials since August 2011. The average selling price of copper products increased by 6.4% from RMB53,697 per ton for 2010 to RMB57,113 (US$9,074.3) per ton for 2011.

 

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Revenue from our biodiesel business totaled RMB53.3 million (US$8.4 million) for 2011, representing a decrease of 73.8% from RMB203.4 million for 2010. The decline in revenues from our biodiesel business was due to a decrease in the sales volume of both biodiesel and biodiesel by-products attributable to the continued suspension of production at most of our biodiesel plants primarily due to the continued shortage of raw materials resulting from local governments cracking down on certain alleged practices of vendors of used cooking oil, which forced some of our suppliers to suspend operations, high raw material input costs and weakening demand due to a slowing PRC economy. We do not expect to resume production at our biodiesel plants on a large scale basis in the near future.

Our sales volume of biodiesel amounted to 8,178 tons for 2011, representing a decrease of 80.7% from 42,391 tons for 2010. The decrease in sales volume was partly offset by an increase of the average selling price of biodiesel by 27.5% from RMB4,505 per ton in 2010 to RMB5,742 (US$912.3) per ton for 2011. The sales volume of biodiesel by-products amounted to 1,464 tons for 2011, representing a decrease of 76.8% from 6,314 tons for 2010. The average selling price of biodiesel by-products was RMB2,589 (US$411.4) per ton for 2011, representing an increase of 31.3% from RMB1,972 per ton for 2010.

Cost of Revenues

Cost of revenues for 2011 totaled RMB1,404.9 million (US$223.2 million), representing an increase of 191.5% from RMB481.8 million for 2010. The increase was mainly due to cost of revenues of RMB1,321.4 million (US$210.0 million) from our copper products business, representing an increase of 589.3% from RMB191.7 million for 2010. The increase was mainly due to an increase in the sale volume of our copper products by 511.4% from 3,787 tons for 2010 to 23,154 tons for 2011 as a result of our acquisitions of Jin Xin and Xiangbei. The unit cost of raw materials increased by 8.5% from RMB48,544 per ton for 2010 to RMB52,671 (US$8,368.6) per ton for 2011.

The cost of revenues of our biodiesel business totaled RMB83.5 million (US$13.3 million) for 2011, representing a decrease of 71.2% from RMB290.1 million for 2010. This decrease in our cost of revenues was primarily attributable to the decrease in our sales volume of both biodiesel and biodiesel by-products. The decrease in cost of revenues was partially offset by an increase in the overall average unit cost for vegetable oil offal and used cooking oil, which increased by 24.0% from RMB3,573 per ton for 2010 to RMB4,431 (US$704.0) per ton in 2011. The increases in the cost of vegetable oil offal and used cooking oil were caused by the increase in our suppliers’ costs, which are primarily affected by general cost inflation, particularly in labor and transportation in China, as well as a general increase in prices charged by their suppliers.

Gross Profit (Loss)

Our gross profit for 2011 totaled RMB44.8 million (US$7.1 million), compared to a gross loss of RMB73.3 million for 2010. Our gross profit consisted of a gross profit of RMB75.0 million (US$11.9 million) from our copper products business, representing a gross profit margin of 5.4%, and a gross loss of RMB30.1 million (US$4.8 million) from our biodiesel business, representing a gross loss margin of 56.5%.

The deterioration of the gross margin from our copper products business was mainly due to a narrowing spread between the average selling price of copper products and the average unit cost of raw materials, which primarily consist of scrap copper. The average unit cost of raw materials used in the production of our copper products increased by 8.5%, while the average selling price of our copper products increased by 6.4% during the same period, resulting in a deterioration of our profit margin which was partly offset by the profit margin derived from an increase in the proportion of sales from scrap and raw materials and from processing income, all of which have higher profit margins than from sales of copper products.

The gross loss margin of our biodiesel business was 56.5% for 2011, compared to a gross loss margin of 42.6% for 2010. The deterioration of the gross margin from our biodiesel business was mainly due to a provision for inventory write-downs of RMB15.7 million (US$2.5 million) for 2011, representing an increase in such provision over RMB1.9 million for 2010. In addition, average unit costs of raw materials used by our biodiesel business increased by 24.0%, while the average selling prices of our biodiesel increased by 27.5% during the same period, however, the manufacturing costs per ton of output increased significantly as our utilization rate further decreased in 2011.

 

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Research and Development Expenses

Research and development expenses totaled RMB0.5 million (US$0.1 million) in 2011, representing a decrease from RMB3.9 million for 2010. The decrease was mainly due to the suspension of R&D activities and a decrease in depreciation expenses as a result of a lower cost base for certain of our property, plant and equipment after these assets were impaired in 2010.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for 2011 totaled RMB81.7 million (US$13.0 million), representing a decrease from RMB84.5 million for 2010. This decrease was primarily due to a decrease in share-based compensation of RMB4.8 million (US$0.8 million) as we recognized the unamortized expenses on certain share options upon their cancellation in 2010. Such decrease was offset by the recognition of RMB4.9 million (US$0.8 million) related to the options granted on January 11, 2011 to 17 individuals, including 1,000,000 ordinary shares granted to eight employees of our biodiesel business and 3,000,000 ordinary shares granted to nine employees of Jin Xin, and the recognition of RMB7.7 million (US$1.2 million) related to a fully-vested option granted on October 31, 2011 to our chairman to purchase up to 1,013 ordinary shares of Engen.

Other Operating Expenses

Other operating expenses for 2011 amounted to RMB68.3 million (US$10.8 million), representing a decrease from RMB70.7 million for 2010. Other operating expenses for 2011 mainly consisted of depreciation of buildings and machinery, other amortization and salaries paid to factory workers of suspended plants, totaling RMB37.2 million (US$5.8 million), an impairment loss of RMB28.2 million (US$4.5 million) on VAT recoverables and an impairment loss of RMB2.9 million (US$0.5 million) on land use rights. The other operating expenses for 2010 amounted to RMB70.7 million, mainly consisted of depreciation of buildings and machinery, other amortization and salary to factory workers, totaling RMB64.4 million during the periods in which certain plants suspended production, an impairment loss on a long-term payment of RMB4.8 million as a result of terminating a supply contract in Indonesia and a provision for a compensation payment of RMB1.5 million to a construction contractor of Shanghai Gushan in accordance with a court ruling.

The decrease in other operating expenses was mainly due to a decrease in depreciation expenses as a result of a lower cost base for certain of our property, plant and equipment after these assets were impaired in 2010.

We recognized an impairment loss of RMB28.2 million (US$4.5 million) on VAT recoverables of certain subsidiaries of our biodiesel business in 2011 as we did not expect such amounts would be utilized in the near future under the current difficult operating environment. We also recognized an impairment loss of RMB2.9 million (US$0.5 million) on land use rights of Hebei Gushan and Chongqing Gushan in 2011, such loss represented the excess of the net book value of the land use rights over their fair value, determined based on purchase prices for recent sales comparable lands in neighboring areas. No impairment losses on VAT recoverables and land use rights were recorded in 2010.

Other Operating Income

Other operating income for 2011 amounted to RMB18.2 million (US$2.9 million) which included VAT refunds of RMB13.0 million (US$2.1 million) and compensation of RMB5.2 million (US$0.8 million) from the supplier of castor beans in Sichuan as a result of its breach and our subsequent cancellation of a supply contract for castor beans. Other operating income in 2010 amounted to RMB103.8 million, which represented the reversal of our provision for consumption tax.

Impairment Loss on Property, Plant and Equipment

As of December 31, 2011, we had suspended most of our production of biodiesel and biodiesel by-products due to the continued shortage of raw materials, high raw material input costs and weakening demand due to a showing PRC economy. We consider the probability that current operating conditions will improve enough to enable us to resume the production of biodiesel and biodiesel by-products on a large scale basis in the near future to be remote.

 

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We recognized impairment losses of RMB603.3 million (US$95.9 million) on certain of our biodiesel production plants in 2011. This impairment loss represented the excess of the carrying amount of these assets over their fair value. For the purpose of estimating fair value, we utilized the projected cash flows of the property, plant and equipment discounted at our weighted average cost of capital. This impairment loss was driven by a combination of a series of adverse changes in the operating environment, in particular, the continued shortage of raw materials due to local governments cracking down on certain alleged practices of vendors of used cooking oil which forced some of our suppliers to suspend operations in 2011, high raw material input costs and weakening demand due to a slowing PRC economy.

We recognized an impairment loss of RMB992.6 million on certain property, plant and equipment in the third quarter of 2010. The recognition of an impairment loss of RMB951.0 million for the facilities of Fujian Gushan, Hebei Gushan, Beijing Gushan, Shanghai Gushan, Chongqing Gushan, Hunan Gushan and Biomass was driven by a combination of a series of adverse changes in the operating environment, in particular, the then unresolved consumption tax issue and the increase in costs of raw materials over the previous few quarters. As previously announced, Sichuan Gushan relocated the production lines of its old plant in San Tai County to its new plant in Qin Dong Bei Industrial Park. As such, in relation to the relocation, Sichuan Gushan recognized an impairment loss of RMB41.7 million on its property, plant and equipment in the second quarter of 2010.

Impairment Loss of Goodwill

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Goodwill is not amortized, but is instead tested for impairment. Goodwill is reviewed for impairment annually at reporting unit level in accordance with the provisions of FASB ASC Topic 350, Intangibles—Goodwill and Other. The goodwill impairment test is a two-step test. Under the first step, the fair value of the reporting unit is compared with its carrying value (including goodwill). If the fair value of the reporting unit is less than its carrying value, an indication of goodwill impairment exists for the reporting unit and the enterprise must perform step two of the impairment test (measurement). Under step two, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation and the residual fair value after this allocation is the implied fair value of the reporting unit goodwill. All of our goodwill arises from our acquisitions of companies in the copper products business. The first step of the impairment test concluded that the carrying value of our copper products business exceeded its fair value. As a result, we performed the second step of the goodwill impairment test. We determined that the implied fair value of goodwill was nil. Therefore, a goodwill impairment loss of RMB41.4 million (US$6.6 million) was recognized in 2011. No impairment of goodwill was recorded in 2010.

Loss on Disposal of Property, Plant and Equipment

Our loss on disposal of property, plant and equipment for 2011 was RMB20,000, as compared to RMB3.3 million in 2010. The disposal and relocation of Sichuan Gushan’s property, plant and equipment was completed as of December 31, 2010. The loss on disposal of property, plant and equipment mainly in 2010 represented certain additional machinery and equipment that was scrapped during the fourth quarter of 2010 and relocation expenses, net of proceeds from selling scraps and a compensation of RMB37.0 million received from the San Tai ECB. The remaining RMB1.8 million compensation receivable from San Tai ECB will be recognized in future income statements on a cash basis, of which RMB1.0 million has been received in 2011.

Change in Fair Value of Contingent Consideration Liabilities

In November 2010, we acquired an initial 67% indirect ownership interest in Jin Xin through a series of transactions in exchange for up to 24 million of our newly issued ordinary shares, which are subject to an earn-out arrangement whereby 6 million ordinary shares were delivered to the selling shareholder at the closing of the transactions, while the remaining 18 million ordinary shares were placed into escrow (“Jin Xin Contingent Consideration Shares”) to be released in stages in amounts determined based on the ratio of Jin Xin’s net income, under U.S. GAAP, for the year ending December 31, 2010 and the three-year period ending December 31, 2012 to net income targets of RMB30.0 million and RMB190.0 million, respectively.

 

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In August 2011, we acquired a 75% indirect ownership interest in Xiangbei through a series of transactions in exchange for RMB30 million in cash and the Xiangbei Contingent Consideration Shares, comprising: (i) up to 20 million newly issued ordinary shares of our Company, and (ii) up to a 14.17% interest in Engen. The Xiangbei Contingent Consideration Shares are subject to an earn-out arrangement under which they may be issued in stages in amounts determined based on the ratio of Xiangbei’s net income, under U.S. GAAP, for the years ending December 31, 2011, 2012 and 2013 to net income targets of RMB20.0 million, RMB50.0 million and RMB80.0 million, respectively.

Under U.S. GAAP, the Contingent Consideration Shares should be classified as a liability and stated at fair value at the acquisition date and each reporting date. The subsequent change in the fair value of the contingent consideration liabilities at each reporting date would be recognized in our statement of operations.

We recognized a decrease in fair value of RMB10.4 million (US$1.6 million) for 2011 and an increase in fair value of RMB2.9 million in 2010. The decrease in the fair value of the Contingent Consideration Shares in 2011 were mainly due to a decrease in the market price of our ADSs, the change in discount rates used in calculating the fair value of the liabilities and decreases in the valuation of Engen as a result of downward adjustments of our expectations about the financial prospects of our copper products business. The increases in the fair value of Jin Xin Contingent Consideration Shares in 2010 were mainly due to an increase in the market price of our ADSs and a change in the discount rates used in calculating the fair value of the liabilities.

Other Income (Expense)

Other income (expense) primarily consists of interest income, interest expenses, foreign currency exchange gain (loss) and other income, net. Interest income for 2011 amounted to RMB0.4 million as compared to RMB1.4 million in 2010. Interest expenses amounted to RMB7.5 million (US$1.2 million), incurred mainly by Jin Xin in respect of short term loans and by Engen in respect of a loan from related parties, as compared to RMB0.7 million in 2010. Foreign currency exchange gains amounted to RMB0.2 million as compared to an exchange loss of RMB0.2 million in 2010.

Other income, net for 2011 amounted to RMB10.3 million (US$1.6 million) and included, among others, income from our depositary bank, a provision for business tax on intercompany advances among companies in China and government subsidies.

The increase in other income net in 2011 was mainly due to government subsidy income of RMB11.3 million (US$1.8 million) received by Jin Xin and Xiangbei.

Income Tax Benefit (Expense)

Income tax expense primarily consisted of CIT, and provisions for dividend withholding tax and other withholding tax.

CIT for 2011 amounted to RMB18.1 million (US$2.8 million), compared to RMB3.5 million for 2010. The increase in CIT was mainly due to an increase in the taxable profit derived from our copper products business.

In respect of our biodiesel business, we reduced the provision for dividend withholding tax by RMB6.1 million (US$1.0 million) for 2011, as compared to a reduction of RMB23.6 million in 2010. The decrease was due to the losses incurred in the biodiesel business.

In respect of our copper products business, we made a provision for dividend withholding tax of RMB5.0 million (US$0.8 million) for 2011, as compared to RMB1.1 million in 2010. The increase was due to the increase in profits attributable to our recent acquisitions of Jin Xin and Xiangbei.

 

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Other overseas withholding tax amounted to RMB1.1 million (US$0.2 million) for 2011, as compared to RMB1.2 million for 2010.

Net Loss Attributable to the Company

Net loss attributable to the Company amounted to RMB747.7 million (US$118.8 million) for 2011, compared to a net loss of RMB1,109.0 million for 2010.

Year Ended December 31, 2010 Compared to Year Ended December 31, 2009

Revenues

Our revenues amounted to RMB408.5 million for 2010, representing a decrease of 35.0% from RMB628.2 million for 2009. The revenues included revenue of RMB205.1 million from the copper product business of Jin Xin for November and December 2010. As a result of our acquisition of an initial 67% indirect ownership interest in Jin Xin, from November 2010, we began consolidating Jin Xin’s operating results into our operating results.

Our revenue from our biodiesel business totaled RMB203.4 million for 2010, representing a decrease of 67.6% from RMB628.2 million for 2009. The decline in revenues from our biodiesel business was due to a decrease in the sales volume of both biodiesel and biodiesel by-products and a decrease in the average selling prices of biodiesel by-products.

The sales volume of biodiesel amounted to 42,391 tons for 2010, representing a decrease of 70.5% from 143,818 tons for 2009. The average selling price of biodiesel was RMB4,505 per ton for 2010, representing an increase of 11.5% from RMB4,040 per ton for 2009.

The sales volume of biodiesel by-products amounted to 6,314 tons for 2010, representing a decrease of 65.8% from 18,469 tons for 2009. The average selling price of biodiesel by-products was RMB1,972 per ton for 2010, representing a decrease of 22.8% from RMB2,554 per ton for 2009.

The decrease in the sales volume of biodiesel was mainly due to the temporary suspension of operations at our Shanghai plant, Sichuan plant and Fujian Plant since April 2010, August 2010 and April 2009, respectively, and our previously announced strategy to shift our major sales channels from the refined oil market to the chemical market. We suspended production at our Shanghai plant beginning April 2010 due to the heightened enforcement control measures relating to poisonous, hazardous and flammable chemicals adopted by the Shanghai municipal government during the hosting of the Expo 2010 from May 1, 2010 to October 31, 2010. We decided to extend the suspension of production at our Shanghai plant as a result of an ongoing lawsuit filed against us by a construction contractor. We also suspended production at our old plant in San Tai County in Sichuan in August 2010 in preparation for the relocation of the production lines to our new plant in Qin Dong Bei Industrial Park. Fujian Gushan suspended production on April 19, 2009 due to road maintenance that restricted access to the plant by our suppliers and customers. Subsequently, we also decided to extend the suspension of operations at Fujian Gushan to minimize operating cash outflows that would result from the assessment of consumption tax from the local tax bureau based on the consumption tax regulation at that time. The consumption tax issue was resolved in our favor in December 2010.

Furthermore, to help mitigate the potential adverse impact from the consumption tax issue at that time, we continued our efforts to expand alternative sales channels, including biodiesel sales as fatty acid methyl ester to the chemical industry, while reducing our sales of biodiesel to the refined oil market. This strategy contributed in part to the year-to-year decrease in the sales volume of biodiesel because the size of our customer base in the chemical industry is smaller than that of the refined oil market. However, the proportion of biodiesel sold to the chemical market continued to increase from 23.3% of the total volume of biodiesel sold in 2009 to 67.2% in 2010.

The year-to-year increase in the average selling price of biodiesel was mainly attributable to improved conditions in the refined oil market in China following the decline in the market price of diesel in China, which began in the fourth quarter of 2008 and continued throughout the third quarter of 2009, resulting from a decrease in global oil prices and weaker industrial production in China amid the global financial crisis. The average selling price of biodiesel began to increase gradually from the fourth quarter of 2009.

 

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Cost of Revenues

Cost of revenues for 2010 totaled RMB481.8 million, representing a decrease of 37.2% from RMB766.7 million for 2009. The cost of revenues included RMB191.7 million from Jin Xin.

The cost of revenues of our biodiesel business totaled RMB290.1 million for 2010, representing a decrease of 62.2% from RMB766.7 million, that included a provision for consumption tax of RMB103.8 million for 2009. The provision for consumption tax was made in 2009, but was reversed in 2010 and recorded as an item of other operating income in 2010.

Excluding the effect of provision for consumption tax, cost of revenues of our biodiesel business for 2010 decreased by 56.2% from 2009. The decrease in cost of revenues was primarily attributable to a decrease in our sales volume of both biodiesel and biodiesel by-products. The decrease in cost of revenues was partially offset by an increase in the overall average unit cost for vegetable oil offal and used cooking oil, which increased by 35.6% from RMB2,634.5 per ton for 2009 to RMB3,573.2 per ton in 2010. The increases in the cost of vegetable oil offal and used cooking oil were caused by the increase in our suppliers’ costs, which are primarily affected by general cost inflation, particularly in labor and transportation in China, as well as a general increase in prices charged by their suppliers.

Gross Loss

Our gross loss for 2010 totaled RMB73.3 million, compared to a gross loss of RMB138.5 million for 2009. Our gross loss consisted of a gross loss of 86.7 million from our biodiesel business, representing a gross loss margin of 42.6%, and a gross profit of RMB13.4 million from our copper product business, representing a gross profit margin of 6.5%. The gross loss margin of our biodiesel business was 42.6% for 2010, compared to a gross loss margin of 22.0% for 2009.

The deterioration of the gross margin in our biodiesel business was mainly due to a general increase in the average unit costs of raw materials relative to selling prices and an increase in the average fixed production costs, resulting from a decrease in the production and sales volume of our biodiesel and biodiesel by-products. The average unit costs of our raw materials increased by 35.6%, while the average selling prices of our biodiesel only increased by 11.5% during the same period.

Research and Development Expenses

Research and development expenses totaled RMB3.9 million in 2010, representing a decrease from RMB5.7 million for 2009. The decrease was mainly due to a decrease in materials used for research and development purposes in 2010.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for 2010 totaled RMB84.5 million, representing a decrease from RMB89.9 million for 2009. The overall decrease was mainly due to decreases in share-based compensation. Share-based compensation included in selling, general and administrative expenses for 2010 amounted to RMB21.8 million, representing a decrease from RMB28.8 million for 2009, mainly as a result of the fact that amounts of share-based compensation recognized are declining as the options become vested over the vesting period. The share-based compensation also included RMB3.5 million recognized for the unamortized expenses on certain options upon the cancellation of such share options in the fourth quarter of 2010.

Other Operating Expenses

Other operating expenses for 2010 amounted to RMB70.7 million, compared to RMB33.4 million for 2009. The expenses for 2010 mainly consisted of depreciation of buildings and machinery, other amortization of the prepayment in relation to the long-term supply contract of castor bean oil with a supplier in Sichuan and salary paid to factory workers, totaling RMB64.4 million during the periods in which certain plants suspended production, loss of writing off a prepayment of RMB4.8 million as a result of terminating the supply contract in Indonesia and a provision for compensation of RMB1.5 million to a construction contractor of Shanghai Gushan in accordance with the court’s latest ruling. The expenses for 2009 mainly consisted of depreciation of buildings and machinery and salary paid to factory workers of the suspended plants.

 

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We suspended or deferred production due to the consumption tax issue, traffic controls under government directive and relocation of production facilities. As previously announced, we suspended production in Fujian Gushan beginning April 2009 due to road maintenance which restricted access to the plant by our suppliers and customers and, as of the date of this annual report, it has not resumed production. We suspended production in Shanghai Gushan since April 2010 due to heightened enforcement of control measures relating to poisonous, hazardous and flammable chemicals adopted by the Shanghai municipal government during the hosting of the Expo 2010 and have not resumed production as a result of an ongoing lawsuit brought against it by a construction contractor of Shanghai Gushan’s plant. Although construction of the production facilities for Chongqing Gushan and Hunan Gushan was completed in 2009, we deferred the commencement of production at these plants due to the consumption tax issue. We suspended production at our old plant in San Tai County in Sichuan in August 2010 in preparation for the relocation of the production lines to our new plant in Qin Dong Bei Industrial Park. If these suspensions and deferrals had not occurred, the depreciation of buildings and machinery, the amortization of the prepayment in relation to the long-term supply contract of castor bean oil with a supplier in Sichuan and salary paid to factory workers of these plants would have been classified as cost of revenues. These expenses totaled RMB64.4 million, representing an increase from RMB33.5 million for 2009, mainly because Shanghai Gushan and Sichuan Gushan also suspended their operations during 2010.

Due to continuous problems with the climate and quality of the castor bean produced, we decided to terminate our supply contract in Indonesia. The long term payment in connection with such supply contract for castor bean was written off in the fourth quarter of 2010.

As previously announced, one of Shanghai Gushan’s construction contractors filed a lawsuit against us in respect of the contract sum payment and the quality of certain facilities. According to the latest decision issued by the People’s Court of Fengxian District, Shanghai, we are liable for a compensation of approximately RMB1.5 million in addition to the contract sum payable. The compensation and contract sum payable has been accounted for as a liability in our balance sheet as of December 31, 2010.

Impairment Loss on Property, Plant and Equipment

We recognized impairment losses of RMB992.6 million on certain property, plant and equipment in 2010 as compared to nil in 2009. The impairment loss represented the excess of the carrying amount over the fair value of these assets and consists of (i) an impairment loss of RMB951.0 million for the facilities of Fujian Gushan, Handan Gushan, Beijing Gushan, Shanghai Gushan, Chongqing Gushan, Hunan Gushan and Biomass that was driven by a combination of a series of adverse changes in the operating environment, in particular, the unresolved consumption tax issue and the continual increase in the cost of raw materials over the last few quarters and (ii) an impairment loss of RMB41.7 million in relation to the relocation of Sichuan Gushan’s production lines from San Tai County to our new plant in Qin Dong Bei Industrial Park. Reversal of previously recognized impairment loss is specifically prohibited under U.S. GAAP. For the purpose of estimating the fair value, we utilized the projected cash flows of the property, plant and equipment discounted at its weighted average cost of capital.

Loss on Disposal of Property, Plant and Equipment

We recognized a loss on disposal of property, plant and equipment of RMB3.3 million as compared to RMB0.1 million in 2009. The loss on disposal of property, plant and equipment in 2010 primarily relates to the disposal and relocation of Sichuan Gushan’s property, plant and equipment which was completed as of December 31, 2010. The loss on disposal of property, plant and equipment mainly represented certain additional machinery and equipment that was scrapped during the fourth quarter of 2010 and relocation expenses.

 

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Change in Fair Value of Contingent Consideration Liabilities

We recognized an increase in fair value of contingent consideration liabilities of RMB2.9 million as an operating expense in 2010. This change in fair value was related to our previously announced initial acquisition of a 67% indirect ownership interest in Jin Xin through a series of transactions in exchange for the Jin Xin Consideration Shares. The Jin Xin Consideration Shares are subject to an earn-out arrangement whereby 6 million ordinary shares were delivered to Gold Hero at the closing of the transactions, while the Jin Xin Contingent Consideration Shares were placed into escrow to be released in stages upon the determination of Jin Xin’s net income under U.S. GAAP for the year ended December 31, 2010 and the three-year period ending December 31, 2012. See “—Liquidity and Capital Resources—Acquisition and Capital Expenditures.”

The Contingent Consideration Shares should be classified as a liability and stated at their fair value at the acquisition date and each reporting date. The subsequent change in the fair value of the Contingent Consideration Shares at each reporting date would be recognized in our statement of operations.

During 2009, we held cash balances only in Renminbi, Hong Kong dollars and U.S. dollars. Other income (expense), net included, among others, income in the amount of RMB5.7 million from our depositary bank and a provision for business tax of RMB2.9 million on intercompany advances.

Other Operating Income

We had other operating income of RMB103.8 million in 2010 as compared to nil in 2009 representing the reversal of a provision for consumption tax of RMB103.8 million that represented the amount of the provisions made in 2009. The reversal of the provision for consumption tax was based on the issuance of Caishui 118 by the Ministry of Finance of the PRC and the SAT, which clarified that, subject to fulfillment of certain conditions, pure biodiesel made from waste animal fat or vegetable oil is exempt from consumption tax in China.

Other Income (Expense)

Other income (expense) primarily consists of interest income, interest expenses, foreign currency exchange gains or losses and other expenses, net. Interest income for 2010 amounted to RMB1.4 million as compared to RMB2.4 million in 2009. Interest expenses amounted to RMB0.7 million, incurred by Jin Xin in respect of short-term loans and discounting bills receivable, as compared to nil in 2009. Foreign currency exchange losses amounted to RMB0.2 million as compared to RMB0.1 million in 2009. Other income, net, amounted to RMB2.9 million included, among others, income from our depositary bank, a provision for business tax on intercompany advances among our subsidiaries in China and government subsidy income, as compared to other expense, net of RMB0.7 million in 2009.

Income Tax Benefit (Expense)

Income tax expense primarily consisted of CIT, a reversal of provision for dividend withholding tax and other withholding tax.

CIT for 2010 amounted to RMB3.5 million, compared to RMB8.1 million for 2009. CIT for the fourth quarter of 2010 included RMB2.9 million incurred by Jin Xin for the period since the acquisition. The decrease in CIT was mainly due to a decrease in the taxable profit derived from our PRC operating subsidiaries engaged in the biodiesel business.

Our withholding tax expense for 2010 included a reversal of provision for dividend withholding tax of RMB23.6 million in respect of our biodiesel business as a result of the net loss incurred by various PRC subsidiaries, a provision of RMB1.1 million in respect of dividend withholding tax for Jin Xin’s profit since the acquisition in November 2010 and RMB1.2 million in respect of other overseas withholding tax. We made a provision of RMB9.4 million for withholding tax in respect of 2009.

Net Loss Attributable to the Company

Net loss attributable to the Company amounted to RMB1,109.0 million for 2010, compared to a net loss of RMB283.5 million for 2009. Jin Xin’s net income since our acquisition amounted to RMB8.3 million which is consolidated into our financial statements, of which 67% of such profit or RMB5.6 million is attributable to our Company.

 

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B. Liquidity and Capital Resources

Liquidity and Capital Resources

We have historically met the majority of our working capital and other capital requirements principally from cash generated from operations and our initial public offering in December 2007. As of December 31, 2010 and 2011, we had working capital of RMB275.7 million and RMB108.0 million (US$17.1 million), respectively, reflecting a sufficient position for our present requirements. Of our total current assets, as of December 31, 2010 and 2011, we had RMB272.8 million and RMB65.5 million (US$10.4 million), respectively, in cash. As of December 31, 2011, our cash primarily consisted of interest bearing bank deposits of RMB34.7 million and US$4,000 deposited in licensed commercial banks in the PRC and HK$0.8 million and US$4.8 million deposited in licensed commercial banks in Hong Kong. In the future, we anticipate that our primary sources of liquidity will be cash provided by operations, bank loans, and the proceeds of debt or equity capital markets transactions, if necessary. We believe our current cash, cash flow from operations and available sources of financing will be sufficient to meet our anticipated cash needs, including our cash needs for working capital and planned capital expenditures, for the foreseeable future. As of December 31, 2011, we had RMB110.0 million short term bank loans outstanding.

The ability of our PRC operating subsidiaries to pay dividends may be restricted by PRC foreign exchange control restrictions. Each of Chongqing Gushan, Hunan Gushan, Shanghai Gushan, Beijing Gushan, Fujian Gushan, Handan Gushan, Sichuan Gushan, Biomass, Jin Xin and Xiangbei, as a wholly owned foreign enterprise, is required under PRC laws and regulations to provide for a statutory surplus reserve fund. Each of these subsidiaries is required to allocate at least 10% of its after tax profits as reported in its PRC statutory financial statements to the general reserve fund and enterprise expansion fund and has the right to discontinue allocations to these reserve funds once the reserve balance has reached 50% of its registered capital. These statutory reserves are not available for distribution to the shareholders, except in liquidation, and may not be transferred in the form of loans, advances, or cash dividends. As of December 31, 2011, the amount of these restricted portions was RMB78.4 million (US$12.5 million) in total for our PRC subsidiaries. Limitations on the ability of our PRC subsidiaries or affiliated PRC entities to transfer funds to our intermediate holding companies and to us in the form of dividends, loans or advances could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends, and otherwise fund and conduct our business.

The following table summarizes our cash flows for each of the periods indicated:

 

     Year ended December 31,  
     2009     2010     2011     2011  
     RMB     RMB     RMB     US$  
     (in thousands)  

Net cash provided by (used in) operating activities

     529        (130,230     (136,766     (21,730 )

Net cash used in investing activities

     (365,413     (130,626     (78,843     (12,527

Net cash used in financing activities

     (26,693     (26,263 )     13,156        2,090   

Effect of foreign exchange rate changes

     (463     (11,247     (4,850     (770
  

 

 

   

 

 

   

 

 

   

 

 

 

Net decrease in cash

     (392,040     (298,366     (207,303     (32,937

Cash at beginning of year

     963,228        571,188        272,822        43,347   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash at end of year

     571,188        272,822        65,519        10,410   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating Activities

Our net cash used in operating activities for the year ended December 31, 2011 was RMB136.8 million (US$21.7 million) compared to RMB130.2 million for the year ended December 31, 2010. The increase in cash outflow used in operating activities was primarily due to an increase in the working capital requirements of our copper products business. This increase in working capital requirements included an increase of RMB131.7 million in accounts receivable and an increase of RMB53.8 million in prepaid expenses and other current assets resulting from the expansion of our copper products business in 2011, which was partially offset by a decrease in inventory of our copper products business.

Our net cash outflow from operating activities for the year ended December 31, 2010 was RMB130.2 million compared to net cash inflow of RMB0.5 million for the year ended December 31, 2009. The decrease in cash inflow from operating activities was primarily due to a decrease in revenues and the increasing cost of raw materials during 2010. The decrease in revenues was primarily caused by the decrease in the production and sales volume of our biodiesel and biodiesel by-products, which was, in turn, due to the temporary suspension of operations at our Shanghai and Sichuan plant since April and August 2010, respectively. The net cash outflow was further increased by an increase in working capital needs which include an increase in inventory, increase in prepaid expenses and other current assets which were partially offset by an increase in accounts payable of Jin Xin.

 

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Our net cash inflow from operating activities for the year ended December 31, 2009 was RMB0.5 million compared to RMB507.9 million for the year ended December 31, 2008. The decrease in cash inflow from operating activities was primarily due to a decrease in revenues during 2009. The decrease in revenues was caused primarily by a decrease in the average selling price of our biodiesel and biodiesel by-products and a decrease in the production and sales volume of our biodiesel and biodiesel by-products, which was, in turn, due to our strategy to seek to mitigate the potential adverse impact of the consumption tax issue.

Investing Activities

For the year ended December 31, 2011, we had a net cash outflow of RMB78.8 million (US$12.5 million) primarily due to amounts paid in satisfaction of accounts payable related to certain of our biodiesel production facilities, totalling RMB 32.7 million (US$5.3 million), amounts paid in connection with the construction and/or expansion of our copper products production facilities, totalling RMB18.6 million (US$2.9 million) and the acquisition of a 75% indirect ownership interest in Xiangbei for RMB27.5 million (US$4.3 million), which was partially offset by net cash of RMB7.1 million (US$1.1 million) acquired in connection with the acquisition of Xiangbei.

For the year ended December 31, 2010, we had a net cash outflow of RMB130.6 million from investing activities, primarily due to the purchase of property, plant and equipment for RMB169.8 million, payment for land use rights of RMB0.6 million mainly in connection with the construction of Chongqing Gushan, Hunan Gushan, additional facilities of Beijing Gushan and Shanghai Gushan and the new plant in Sichuan, which were partly offset by the proceeds from disposal of property, plant and equipment for RMB36.9 million of Sichuan Gushan, and net of cash of RMB2.9 million acquired in connection with the acquisition of an initial 67% indirect ownership interest in Jin Xin.

For the year ended December 31, 2009, we had a net cash outflow of RMB365.4 million from investing activities, primarily due to the purchase of property, plant and equipment for RMB349.4 million and payment for land use rights for RMB16.0 million mainly in connection with the construction of Chongqing Gushan, Hunan Gushan, additional facilities of Beijing Gushan and Shanghai Gushan and the new plant in Sichuan.

Financing Activities

For the year ended December 31, 2011, we had a net cash inflow of RMB13.2 million (US$2.1 million) from financing activities, primarily due to the proceeds from new short term bank loans of RMB120.0 million (US$19.1 million) incurred in connection with the construction of our new copper products production facility, and our receipt of advances from related parties of RMB76.3 million (US$12.1 million), which were partly offset by the acquisition of an additional 8% of the issued share capital of Engen for RMB42.7 million (US$6.8 million) our repayment of RMB70.0 million (US$11.1 million) of bank loans and RMB70.4 million (US$11.1 million) of advances from related parties.

For the year ended December 31, 2010, we had a net cash outflow of RMB26.3 million from financing activities, primarily due to the purchase of treasury stock for RMB33 million under our share repurchase program and our repayment of advances received from directors of Jin Xin of RMB3.3 million which was partly offset by the proceeds from new short term loans of RMB10.0 million.

For the year ended December 31, 2009, we paid RMB26.7 million in respect of dividends, which was the only cash outflow for financing activities.

Acquisitions and Capital Expenditures

In August 2011, we acquired a 75% ownership interest in Xiangbei through a series of transactions in exchange for RMB30 million (approximately US$4.5 million) and the issuance of up to 14.17% of Engen’s ordinary shares and 20 million ordinary shares of our Company, subject to an earn-out arrangement. For more information about Xiangbei’s operations, see Item 4B, “Information on the Company—Copper Products.”

In November 2010, we acquired an initial 67% indirect ownership interest in Jin Xin for a consideration of up to 24 million ordinary shares of our Company of which 18 million shares were put in escrow for release in stages, subject to an earn-out arrangement. We also made a capital contribution to Jin Xin of RMB30 million (approximately US$4.5 million). On January 1, 2011, we acquired an additional 8% of the issued share capital of Engen, the holding company of our copper products business, which increased our indirect ownership in Jin Xin to 75%. For more information about Jin Xin’s operations, see Item 4.B. “Information on the Company—Copper Products.”

 

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In 2009, 2010 and 2011, our capital expenditures were RMB365.4 million, RMB170.4 million and RMB51.3 million (US$8.2 million). Our capital expenditures in the table below are cash outflows for the purchase of long-lived assets and land use rights, for the expansion of our production facilities. In 2009, 2010 and 2011, we funded our capital expenditures primarily through cash flows from operating activities, bank loans and proceeds from the issuance of ordinary shares. We intend to fund our future capital expenditures through cash flows from operations. The following table sets forth our capital expenditures by plant or office locations for the periods indicated:

 

     Year ended December 31,  
     2009      2010      2011      2011  
     RMB      RMB      RMB      US$  
     (in millions)  

Hong Kong office

     0.2         —           —           —     

Sichuan Gushan

     127.6         110.0         17.1         2.7   

Fujian Gushan

     6.8         1.0         3.9         0.6   

Handan Gushan

     —           —           0.1         —     

Beijing Gushan

     23.5         3.3         0.5         0.1   

Shanghai Gushan

     74.4         5.5         7.9         1.3   

Chongqing Gushan

     53.0         10.0         2.5         0.4   

Hunan Gushan

     68.8         13.4         0.7         0.2   

Biomass

     11.1         3.7         —           —     

Jin Xin

     —           23.5         11.6         1.8   

Xiangbei

     —           —           7.0         1.1   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     365.4         170.4         51.3         8.2