UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F/A
(AMENDMENT NO.1)
ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
| For the fiscal year ended December 31, 2008 | 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. 37, Golden Pond Road
Golden Mountain Industrial District
Fuzhou City, 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 two 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 | 166,831,943 |
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
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 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 x | Non-accelerated filer ¨ |
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
EXPLANATORY NOTE
This Amendment No. 1 on Form 20-F/A (“Amendment No. 1”) to our annual report on Form 20-F for the year ended December 31, 2008, filed with the Securities and Exchange Commission (the “SEC”) on April 30, 2009 (the “Original Form 20-F”) by Gushan Environmental Energy Limited (the “Company”), is filed in order to correct a clerical error appearing in Item 3.D, “Risk Factors” of the Original Form 20-F. In addition, this Amendment No.1 includes (i) currently dated certifications of the Chief Executive Officer and Chief Financial Officer of the Company pursuant to Rule 13a-14(a) and Rule 13a-14(b) under the Securities Exchange Act of 1934, as amended and (ii) a currently dated letter from Chen & Co. Law Firm consenting to, among others, the reference to its name in the Original Form 20-F, as amended by Amendment No. 1.
Other than as set forth below, this Amendment No. 1 does not, and does not purport to, amend, update or restate any other information or disclosure included in the Original Form 20-F or reflect any events that have occurred after the filing date of the Original Form 20-F. Among other things, forward-looking statements contained in the Original Form 20-F have not been revised to reflect events, results or developments that occurred or facts that became known to us after the original filing date, and such forward-looking statements should be read in their historical context.
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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 BUSINESS AND INDUSTRY
We may not be able to effectively manage our planned expansion, the failure of which could materially and adversely affect our business, results of operations and financial condition.
The further expansion of our business and production capacity is one of our key growth strategies. We intend to expand our annual production capacity to 450,000 tons by the end of 2009 from our capacity of 340,000 tons as of the date of this annual report. We also plan to expand into new geographic markets in China. We are currently constructing production facilities in Chongqing and Hunan, which are each targeted to open during the second quarter of 2009 with an initial annual production capacity of 30,000 tons. We are also constructing additional production facilities in our Shanghai plant which are expected to increase our annual biodiesel production capacity by 50,000 tons during the third quarter of 2009.
Our planned expansion requires us to identify suitable locations that will enable us to secure raw materials at competitive prices and that host a sufficiently large local customer base to support the expanded production. Even if we successfully identify suitable locations, we may be unable to expand our business into these new locations if potential competitors enter the market before us. 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. Our expansion plans could also be affected by construction delays, cost overruns, failures or delays in obtaining government approvals of necessary permits and our inability to secure the necessary production equipment.
Furthermore, to effectively manage our planned expansion we must improve our operational and financial systems and procedures and system of internal control. Our rapid 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 must expand, train and manage our employee base, and successfully establish new subsidiaries for the new or expanded facilities. We must also 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 our planned expansion or achieve our expansion plans at all. 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.
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 range 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.
Prior to 2008, the demand for and price of biodiesel in China has also been influenced by increases in energy consumption and rising prices of crude oil and natural gas accompanying the growth of the PRC economy. However, demand for biodiesel may not continue to grow at historic levels, or at all, and demand for biodiesel in China could decline. In addition, the price of fuel remains the principal factor that determines how
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consumers make their energy purchasing decisions. For example, in the fourth quarter of 2008, the price of biodiesel in China declined significantly, resulting from decreases in global oil prices and from the rapid contraction of China’s industrial production amid the global financial crisis. During the same period, the average selling price of our biodiesel decreased from RMB6,344 (US$929.9) per ton in the third quarter of 2008 to RMB5,092 (US$746.4) per ton in the fourth quarter of 2008, based on our internal sales data. This represented a decrease of 19.7% in the average selling price of our biodiesel and contributed to the decrease of our net income for the fourth quarter of 2008. If increased supply of other energy sources matches or exceeds the demand for fuel products, or other fuels become more affordable than biodiesel, demand for our biodiesel may decline and our business, results of operations and financial condition may be adversely affected.
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.
We purchase our raw materials, including vegetable oil offal, used cooking oil and methanol, from a limited number of third-party suppliers, including waste management companies and vegetable oil producers. Our five largest suppliers accounted for approximately 45.1% of our total cost of revenues in 2008 and we conduct business with some of these suppliers under contracts with durations of up to two years or through purchase orders. 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. 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 products, or we may only be able to produce our products at a higher cost or after lengthy delays.
If our suppliers identify alternative sales channels, such as to chemical plants or distributors, they may choose to sell to other buyers or raise their prices. As a result, we may be compelled to pay higher prices to secure our raw material supplies, which could adversely affect our business, results of operations and financial condition.
Our operations are materially affected by the cost and availability of raw materials in the regions in which we operate production facilities.
The principal raw materials we use in the production of biodiesel include vegetable oil offal, used cooking oil and methanol. From 2005 to the third quarter of 2008, the prices we have paid for raw materials have steadily increased, and the market price for used cooking oil has also risen significantly in the recent past. For the years ended December 31, 2006, 2007 and 2008, the overall average unit costs of our raw materials, which primarily consist of used cooking oil and vegetable oil offal, amounted to RMB1,655, RMB1,925 and RMB2,538 (US$372.0) 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 methanol production, and our operations depend in large part on the availability, security of supply and price of natural gas. 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 business, results of operation and financial condition.
Our overall operating performance is also affected by the mix of raw materials we use as well as the product mix of our biodiesel and by-products, which command different profit margins. We source our vegetable oil offal and used cooking oil from local used cooking oil disposal companies and vegetable oil manufacturers. Because
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the long-distance transport of used cooking oil and vegetable oil offal is not economical, we have limited control over the mix of raw materials we can supply to each of our facilities. In addition, the composition of our raw materials is determined by the geographical regions in which we operate, which may affect our profit margins. For example, rapeseed is a raw material essential for producing erucic acid, a by-product of biodiesel production which generates a higher profit margin than biodiesel. Vegetable oil offal and used cooking oil containing rapeseed are only available in a few regions in China, such as Sichuan. As we expand our facilities into other regions of China, we may be unable to purchase vegetable oil offal or used cooking oil which contains rapeseed to enable us to produce erucic acid as a by-product in these new production facilities. Other than selecting the regions in which we locate our facilities, we have limited ability to change our product mix to concentrate on products with higher profit margins. In addition, given that by-products command a higher profit margin than biodiesel in some regions while the opposite may be true in other regions, our ability to maximize profits through control of our product mix is further constrained.
Our gross margins in our biodiesel segment 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 results of operations will be harmed.
Our gross margins depend principally on the spread between feedstock and biodiesel prices. 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 90% of total cost of revenues during the year ended December 31, 2008, 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 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 financial performance and cash flow.
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 recently been produced for commercial applications 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 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 energy industries, and has experienced significant growth only recently. 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 (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; |
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| • | 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. |
The success of our expansion plans depends on growth in domestic demand for biodiesel, and 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 our results of operations to be materially and adversely affected.
We derive a significant portion of our revenues from a small number of customers and a loss of any of our major customers may cause significant declines in our revenues.
We derive a significant portion of our revenues from a small number of customers, and we may be unable to maintain and expand our current customer relationships. For 2006, 2007 and 2008, our five largest customers represented approximately 37.1%, 24.3% and 20.6% of our total revenues, respectively, while our largest customer represented approximately 14.4%, 8.7% and 9.1% of our total revenues, respectively. We expect 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.
We face significant competition, and if we do not compete successfully against existing and new competitors as well as competing technologies and other clean energy sources, we may lose our market share and our profitability may be materially and adversely affected.
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 operations. We are only active in a limited number of regions in China, including Mianyang in Sichuan province, Fuzhou in Fujian province, Handan in Hebei province and Beijing and Shanghai. In addition, our potential 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 profitability and future prospects. Our domestic competitors include China Biodiesel International Holdings 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, most of which have greater resources, brand recognition and access to more extensive distribution channels than we do. Moreover, some of our competitors have the ability to manage their risk through diversification, whereas we lack diversification in both the geographic scope and the nature of our business. As a result, we could be potentially impacted more by factors affecting the biodiesel industry or the regions in which we operate than we would if our 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 our results of operations.
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
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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 our results of operations and financial condition 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 our financial condition and profitability.
Any disruption or suspension of our operations could result in a reduction of our sales volume and may materially and adversely affect our results of operations.
Our operations may be subject to significant interruption or prolonged suspension if any of our facilities experience a major accident or are damaged by natural disasters, severe weather or unexpected or catastrophic events (such as typhoons, earthquakes, fires, floods, epidemics such as Severe Acute Respiratory Syndrome, avian flu, swine flu or other similar events) or interruptions in the operations of our plants caused by such events. On May 12, 2008, Sichuan province experienced a severe earthquake. As a result, our Sichuan facility experienced a temporary interruption of power supply and was required by the local government to suspend production for approximately two weeks as a safety precaution.
Our operations may also be subject to significant interruption or prolonged suspension due to repair and maintenance or technological upgrades of our production processes. An interruption or suspension of our operations could result in decreased capacity utilization, which could lead to decreased sales volumes and adverse effects on our results of operations. For example, in July 2006, we suspended production at our Sichuan and Hebei plants for approximately one month and two months, respectively, in order to perform technological equipment upgrades, which resulted in decreased capacity utilizations of 10% and 14% in 2006 as compared to 2005 for these plants, respectively. We also periodically suspend production at certain of our facilities, typically for a few days to four weeks at a time, in order to carry out repair and maintenance operations or expand production capacity. We have also suspended production as a result of interference with transportation networks. For example, in the third quarter of 2008, we suspended production at our Beijing plant from August 1 to September 20, 2008 due to the heightened enforcement of traffic control measures adopted by the Beijing municipal government in preparation for the hosting of the Beijing 2008 Olympic and Paralympic games. More recently, the Fuzhou municipal government has begun carrying out road maintenance near our Fujian plant which is expected to last until July 31, 2009. Such road maintenance has resulted in restricted access to our plant by suppliers and customers’ trucks. As a result, we have suspended operations since April 19, 2009 and expect that there may be subsequent suspensions of production at our Fujian plant during the course of such road maintenance.
In addition, our operations may be subject to other disruptive events such as local protests, activism and labor disruptions. For example, in August 2007, we experienced local protests at our Fujian plant and our operations at the plant were disrupted for several hours. For more details, see “—Failure to comply with environmental regulations could harm our business.” Unscheduled downtime or operational hazards inherent in our 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
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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 not experience further interruptions or experience damage to our facilities as a result of further earthquakes, aftershocks, floods, governmental directives, expansion of production capacity, repair and maintenance or other consequences associated with such events, which could materially and adversely affect our business, results of operations and financial condition.
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, and our chief technology officer, Mr. Deyu Chen. 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. In addition, Mr. Yu is instrumental in formulating our strategies for entering new markets. Mr. Chen was instrumental in the development of our proprietary manufacturing process and continues to play a key role in our technological development. 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, 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 industry and we have periodically experienced difficulties in recruiting suitable personnel. We may also need to offer 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.
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 two registered patents in China, one with a validity period of 20 years from August 7, 2002 and another with a validity period of 20 years from March 9, 2005. We cannot assure you that these patent registrations will not be revoked or challenged during their 20-year validity period. 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 in any intellectual property claims we initiate, which will impact our operating results.
Many international biodiesel producers and other domestic biodiesel producers in China may have also patented certain technologies in the production of their biodiesel products. To the best of our knowledge, our patented process does not infringe any third party’s intellectual property rights. However, intellectual property rights are complex and there exists the risk that our process may infringe, or be alleged to infringe, 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
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significantly divert the efforts and resources of our technical and management personnel. An adverse determination in any such litigation or proceedings 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.
It is difficult to evaluate our results of operations and future prospects due to our limited operating history and the rapidly evolving biodiesel market in China.
We began our business in 2001 and commenced commercial operations at our production facilities in Mianyang, Sichuan province in December 2001. We commenced operations at our facilities in Hebei, Fujian, Beijing and Shanghai in January 2004, February 2006, January 2008 and June 2008, respectively. Accordingly, we have a limited operating history from which you can evaluate our business and future prospects. Moreover, with the rapid growth of the biodiesel industry in China, we have experienced a high growth rate since our inception. As such, our historical operating results may not provide a meaningful basis for evaluating our business, results of operations and financial condition. We may be unable to expand our production capacity in future periods and the ability of our business model to operate at higher volumes is unproven. Accordingly, you should not rely on our results of operations for any prior periods as an indication of our future performance. In addition, our business and prospects should be considered in light of the risks and uncertainties commonly encountered by a company in rapidly evolving markets, such as the PRC biodiesel market, where supply and demand may change significantly within a short period of time.
The prices of our by-products may decrease significantly, which may adversely affect our operating results.
The prices for the by-products of biodiesel production may decrease significantly due to increased production of biodiesel in China, a slowdown in the PRC economy, or for other reasons beyond our control. For the fourth quarter of 2008, our average selling price for biodiesel by-products was RMB4,921 (US$721.3) per ton, which represented a 37.0% decrease from our average selling price of RMB7,815 (US$1,145.5) per ton for the third quarter of 2008. This decrease contributed in part to the decrease of our net income in the fourth quarter of 2008 as compared to the previous quarter. By-products accounted for 15.3%, 16.1% and 11.1% of our total revenue for the years ended December 31, 2006, 2007 and 2008, respectively. Accordingly, decreases in the market prices of by-products could materially and adversely affect our business, results of operations and financial condition.
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 will be used to finance the expansion of capacity in our existing production facilities, construction of new production facilities and research and development. We may need to incur additional financing in order to fund our capital expenditures. 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 could adversely affect our business, financial condition, results of operations or liquidity position.
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
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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 business, results of operations and financial condition.
We have not received NDRC approval for certain of our foreign investment-related projects, which could materially and adversely affect our further expansion and our ability to benefit from certain preferential policies that might otherwise be available to us.
Our subsidiaries incorporated in the PRC are foreign invested enterprises that we established either through acquisition or incorporation. Certain of our subsidiaries have not obtained approval from the National Development and Reform Committee of China, or the NDRC, for certain foreign investment related projects. PRC law requires the Ministry of Commerce, or its local counterparts, to issue final government approval as a pre-condition to foreign investment in China. Before this final approval may be granted, however, approval from the NDRC, or its local counterparts, is required for projects except for trade or services related projects that do not relate to fixed asset investment. In practice, the Ministry of Commerce, or its local counterparts, often grant final approval for foreign invested projects before such projects have first obtained NDRC approval. Our further expansion and ability to benefit from certain preferential policies that might otherwise be available to us may be adversely affected because the competent authorities for land, planning, quality supervision, safety supervision, customs, taxation, foreign exchange and the administration of industry and commerce could refuse to grant approval or consent to our future projects due to the lack of NDRC approval.
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 profitability 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 Sichuan and 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. In November 2007, we completed construction on a biodiesel production line with a capacity of 20,000 tons located at our Sichuan plant before our environmental impact assessment for the production line received approval from the local environmental authorities. We received approval of the environmental impact assessment from the local environmental authorities on March 10, 2008. However, because we completed construction before receiving approval of the assessment, we could be fined up to RMB200,000 (US$29,315) or required to remove the new production line and restore the construction site to its original condition, which would materially and adversely affect our operations. Furthermore, because we commenced operation of the biodiesel production line before the environmental protection inspection was conducted by the local environmental protection bureau, we could be fined up to RMB100,000 (US$14,657) or could be required to stop operations, which would materially and adversely affect our operations. In addition, as of the date of this annual report, Beijing Gushan Bio-sources Energy Co., Ltd., or Beijing Gushan, and Shanghai Gushan Bio-Energy Technologies Co. Ltd., or Shanghai Gushan, which commenced operation in January 2008 and June 2008, respectively, have not obtained waste discharge permits from the relevant local environmental authorities.
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We cannot assure you that waste discharge permits will be obtained or that any of our Beijing or Shanghai plants will not be materially 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, 2008, Fujian Gushan Bio-diesel Energy Co., Ltd., or Fujian Gushan, Beijing Gushan and Shanghai Gushan have not obtained the building ownership certificates for buildings with a total gross floor area of approximately 319 square meters, 9,941 square meters and 7,956 square meters, respectively. 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, Shanghai Gushan and Hunan Gushan Bio-Sources Energy Co., Ltd., or Hunan Gushan, are also applying for land use right certificates with respect to land occupying a total gross floor area of approximately 54,965 square meters, 13,333 square meters and 46,666 square meters, respectively. We cannot assure you that such building ownership or land use right certificates will be obtained. As a result of the absence 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.
In addition, Fujian Gushan, Beijing Gushan, Shanghai Gushan, Chongqing Gushan Bio-Sources Co., Ltd., or Chongqing Gushan and Hunan Gushan 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 and Hunan Gushan may be subject to a maximum administrative penalty of RMB30,000 (US$4,397). As of the date of this annual report, Fujian Gushan, Beijing 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 and 2,335 square meters, respectively, and the relevant government authority may require the buildings located on these sites to be demolished. As of December 31, 2008, the carrying value of these buildings amounted to RMB44.8 million (US$6.7 million). If the relevant government authority imposes penalties on us and requires us to cease construction of or demolish these properties, we may incur additional costs and expenses for the relocation of our facilities.
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 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 plan, 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
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result in decreased demand for our products and have a material adverse effect on our business, 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 to roughly 10% by 2010 and nearly 15% by 2020, up from 7.5% in 2005. 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. For example, under the Rules on the Management of Waste Grease for Food Producers, food producers must properly dispose of used cooking oil or sell used cooking oil to used cooking oil processing entities or waste collection entities rather than discharging used cooking oil into the environment or reusing it for human consumption. However, in practice, these rules may not be strictly enforced and waste grease may be disposed of through illegal means by some food producers, which would reduce the supply of used cooking oil available for our production. Our business prospects and results of operations may be adversely affected as a result of any of the foregoing factors.
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 very limited product liability insurance coverage for our biodiesel. The maximum payout for each claim is 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 liability or a liability claim in excess of our insured limits 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 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.
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
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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. |
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.
On October 31, 2007, the NDRC and the Ministry of Commerce of China jointly promulgated a newly revised Catalogue for Guiding Foreign Investment in Industries, or the Catalogue, which came into effect on December 1, 2007. Pursuant to the Catalogue, 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.
Our PRC legal counsel, Chen & Co. Law Firm, has advised us that based on their understanding of the Catalogue, only biodiesel production using agricultural food products as raw materials falls within the “restricted industry” category pursuant to the Catalogue. 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 Catalogue. 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 Catalogue. 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
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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.
The 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 is adversely affecting the U.S. economy and many other parts of the world, including the PRC. As a result of this crisis, financial markets are experiencing significant disruptions, leading to extreme volatility and dislocation of the global capital markets in recent months. Many of the world’s major economies have entered into recession. The PRC economy has also slowed down significantly since the second half of 2008. According to the National Bureau of Statistics of China, or NBSC, China’s GDP growth was only 6.8% on a quarter-to-quarter basis for the fourth quarter of 2008, the lowest growth rate since the first quarter of 2002. A number of other factors have also contributed to this slowdown, including the appreciation of the Renminbi, which has adversely affected China’s exports, and the tightening of macroeconomic measures and monetary policies by the PRC government in 2008 which are aimed at preventing overheating of China’s economy and controlling China’s high level of inflation. The slowdown in the PRC economy may continue through the rest of 2009 and beyond.
Because we sell our products primarily in the PRC, a 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.
Since 1978, the PRC government has promulgated various reforms of its economic system. These reforms have resulted in economic growth for China in the last two decades. 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.
While the Chinese economy has grown significantly in the past 30 years, the growth has been uneven geographically among various sectors of the economy, and during different periods. We cannot assure you that the Chinese economy will continue to grow, or that if there is growth, such growth will be steady and uniform, or that if there is a slowdown, such slowdown will not have a negative effect on our business. For example, the Chinese economy experienced high inflation in the second half of 2007 and the first half of 2008. China’s consumer price index rose 7.9% during the six months ended June 30, 2008 as compared to the same period in 2007. To combat inflation and prevent the economy from overheating, the PRC government adopted a number of tightening macroeconomic measures and monetary policies, including increasing interest rates, raising statutory reserve rates for banks and controlling bank lending to certain industries or economic sectors. 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 $586 billion. We cannot assure you that the various macroeconomic measures, monetary policies and economic stimulus package adopted by the PRC government to guide economic growth
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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.
The newly amended PRC consumption tax policies may affect our business, results of operations and financial condition.
The PRC government introduced three new regulations in relation to consumption tax rates to be levied on diesel products which took effect on January 1, 2009. Measures introduced under these new regulations include, among others, increases in consumption tax on various refined oil products, including diesel. Pursuant to these regulations, consumption tax on diesel products levied on diesel producers would increase from RMB0.10 per liter to RMB0.80 per liter.
Prior to January 1, 2009, biodiesel products, which are produced from animal and vegetable fats and oils, were specifically exempted from consumption tax. The new regulations redefined diesel products that are subject to consumption tax. Under the new regulations, biodiesel that is processed from diesel or predominately mixed with diesel would be subject to consumption tax. We have requested confirmation from our local tax authority that our biodiesel products, which are produced from used cooking oil, vegetable oil offal and jatropha oil, are not subject to such consumption tax. However, we have not yet received a reply from the local tax authority. We did not pay consumption tax for our sales of biodiesel products during the first quarter of 2009 and have not received any demand in respect of such unpaid consumption tax from local authorities or the PRC State Administration of Taxation as of the date of this annual report.
Due to ambiguity surrounding the application of the consumption tax, we cannot assure you that our biodiesel products are not subject to consumption tax under the new regulations. Based on our internal estimates, we sold approximately 64.6 million liters of biodiesel during the three months ended March 31, 2009. If the relevant authorities later determine that our biodiesel products are subject to such consumption tax and we are taxed for our sales of biodiesel products as from January 1, 2009, we would be required to pay significant assessments and our business, results of operations and financial condition could be materially and adversely affected.
Our business, financial condition and results of operations could be adversely affected by the 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.
Electricity shortages could adversely affect our business, financial condition and results of operations.
All of our manufacturing assets and operations 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. If the cities where 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 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.
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.
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, or Carling Technology, Brightest Resources Limited, or Brightest Resources, Joywin Technology Limited, or Joywin Technology, Profit Faith Technology Limited, or Profit Faith Technology, Gushan Holdings Limited, or Gushan Holdings and Gushan Bio-Energy Limited, or Gushan Bio-Energy, 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 Bio-sources Energy Co., Ltd., or Handan Gushan, Sichuan Gushan Vegetable Fat Chemistry Co., Ltd., or Sichuan Gushan and Biomass, 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 general reserves and have 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, 2008, the amount of these restricted portions was RMB68.1 million (US$10.0 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 beneficial to our business, pay dividends, and otherwise fund and conduct our business. In addition to general reserves, Handan Gushan, a sino-foreign joint equity enterprise, is also required by its articles of association to allocate at least 5% of its after-tax profit, as reported in the PRC statutory financial statements, to a staff welfare fund. Handan Gushan’s staff welfare fund is classified as a current liability under U.S. GAAP and cannot be distributed as a dividend. Other than Handan Gushan, the Company’s operating subsidiaries are not required to transfer a fixed percentage of net income after tax to a staff welfare fund.
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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 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 People’s Bank of China, or 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 0.5% 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 future U.S. dollar-denominated investments or deposits we make, if any.
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 enterprise income tax, or EIT, 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 EIT in the first two years followed by a 50% exemption from EIT in the next three years starting with 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 EIT in 2005 and exemption from national income tax in 2006, followed by a 50% exemption from national income tax/unified EIT 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 enterprise income tax law, or the New EIT Law, under which foreign-invested enterprises, such as our PRC subsidiaries and domestic companies, would be subject to EIT 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 EIT Law became effective on January 1, 2008. Under the New EIT law and the Notice on the Implementation of Transitional Preferential Policies on Enterprise Income Tax, issued by the State
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Council on December 26, 2007, effective from January 1, 2008, 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, increase from a 24% rate to a 25% rate beginning on January 1, 2008 or gradually increase from a 15% rate to a 25% rate over a period of five years beginning January 1, 2008, or (ii) in the case of tax holidays continue to enjoy them 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 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.
On August 8, 2006, the Rules on Acquisition of Domestic Enterprises by Foreign Investors, or the New M&A Rules, were promulgated 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 State Administration of Taxation, 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.
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 advisors, 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 operation could be adversely affected.
The newly enacted PRC Enterprise Income Tax Law could affect tax exemptions on dividends received by us and our shareholders and increase our EIT rate.
We are incorporated under the laws of the Cayman Islands. Our PRC subsidiaries’ immediate parent companies are mainly incorporated in the British Virgin Islands. As foreign legal persons, dividends derived from our business operations prior to January 1, 2008 in China were not subject to income tax under the then previous EIT law regime and the subsequent transitional arrangement. Under the New EIT Law and its Implementation Rules promulgated by the State Council on December 6, 2007, we and our PRC subsidiaries’ immediate parent companies may be deemed to be non-PRC tax resident enterprises without offices or premises in China, in which case withholding tax at the rate of 10% is applicable to dividends paid, for earnings accumulated beginning on January 1, 2008, by our PRC subsidiaries to their immediate parent companies incorporated in the British Virgin Islands.
Under the Arrangement between the Mainland of China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income, signed in August 2006, or the Mainland China/HKSAR DTA, dividends paid, for earnings accumulated beginning on January 1, 2008, by an FIE in China to a direct holding company with resident status in Hong Kong are subject to withholding tax at a rate of 5%, provided that such foreign investor directly owns a minimum of 25% of the equity interest of the FIE. We believe that withholding tax at the rate of 5% applies to dividends paid by our FIEs in China to their direct holding companies incorporated in the British Virgin Islands because these holding companies are normally managed or controlled in Hong Kong. As of the date of this annual report, the Inland Revenue Department of Hong Kong has granted each of Carling Technology, Brightest Resources and Profit Faith Technology, our holding companies incorporated in the British Virgin Islands, a Certificate of Resident Status for the year 2008 pursuant to the Mainland China/HKSAR DTA. However, we cannot assure you that withholding tax at the rate of 5% will apply to dividends paid by our FIEs in China to a direct holding company that has not yet obtained such certificate.
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In addition, the New EIT 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 EIT at the rate of 25% on its worldwide income. The Implementation Rules of the Enterprise Income Tax Law prescribes that a de facto management body means the 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 body,” such definition has not been tested and there remains uncertainty as to the circumstances under which a non-PRC enterprise’s de facto management body is considered to be located in the PRC. We may be deemed a PRC tax resident enterprise and therefore subject to an EIT rate of 25% on our worldwide income (including dividend income received from our subsidiaries) because a majority of the members of our management are located in China.
Moreover, under the New EIT 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 and if such income is paid from our PRC subsidiaries.
The New EIT Law also provides that qualified dividends received by a PRC tax resident from another PRC tax resident are exempt from EIT. 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 EIT if it is recognized as a PRC tax resident.
Recent 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.
Although our executive officers Jianqiu Yu and Gonghao Chen have registered with the local SAFE branch as required under the SAFE notice, we cannot provide any assurances that all of our beneficial owners who are PRC residents will register as required. The failure of these beneficial 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 beneficial owners of our Company who are PRC residents to comply with the registration procedures set forth in the SAFE notice may subject such beneficial 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.
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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 sanction, 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 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 |
| • | 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 our initial public offering to our subsidiaries in the PRC, which may adversely affect our business expansion and we may not be able to convert the net proceeds from the offering 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
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a result, Circular 142 may significantly limit our ability to transfer the remaining net proceeds from our initial offering to our subsidiaries in the PRC, which may adversely affect our business expansion and we may not be able to convert the net proceeds from the offering 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 the growth of domestic consumption and possible 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.
RISKS RELATED TO OUR ORDINARY SHARES AND ADSs
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; 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 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
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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 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. |
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 166,831,943 ordinary shares outstanding, including 101,391,628 ordinary shares under the name of the depositary on behalf of the holders of 50,695,814 ADSs. Our ADSs are freely transferable without restriction or additional registration under the U.S. Securities Act of 1933, or the Securities Act.
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
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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 has 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.
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
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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 advisors, 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.
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 and an attestation report by our independent registered public accounting firm on 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, 2008 (see Item 15, “Control and Procedures”), in the future, our management may conclude that our internal controls over our financial reporting are not effective. Moreover, even if our management concludes that our internal controls over financial reporting are effective, our independent registered public accounting firm may disagree and issue an adverse opinion on the effectiveness of our internal controls over financial reporting. Any of these possible outcomes could result in the loss of investor confidence in the reliability of our financial statements.
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Prior to our initial public offering in December 2007, we were a private company with limited accounting personnel with U.S. GAAP experience and other resources with which to adequately address our internal control over our financial closing and reporting process and other procedures. Our independent registered public accounting firm did not conduct an audit of our internal control over financial reporting as of December 31, 2004, 2005, 2006 or 2007. However, in connection with the audits of our consolidated financial statements for the years ended December 31, 2004, 2005, 2006 and 2007, our independent registered public accounting firm identified several control deficiencies in our internal controls, including our lack of an internal audit function and adequate U.S. GAAP resources. In addition, at the time of our initial public offering, we made revisions to our previously issued audited financial statements as of and for the year ended December 31, 2006 and our unaudited financial statements as of and for the nine months ended September 30, 2007 and 2006 to correct an error in the calculation method of interest capitalization. The revisions resulted in a decrease in interest expense of RMB13.7 million for the year ended December 31, 2006, RMB9.6 million for the nine months ended September 30, 2006 and RMB7.3 million for the nine months ended September 30, 2007, as compared to our previously issued financial statements. The revisions resulted in an increase in property, plant and equipment of RMB13.7 million for the year ended December 31, 2006, RMB9.6 million for the nine months ended September 30, 2006 and RMB21.0 million for the nine months ended September 30, 2007, as compared to our previously issued financial statements.We expect to continue to upgrade our systems, implement additional financial and management controls, reporting systems and procedures, implement an internal audit function and hire additional accounting, internal audit and finance staff. In April 2008, we recruited an internal audit director to head our internal audit department. While we plan to expand our financial and accounting staff, we expect to encounter substantial difficulty attracting qualified staff with requisite experience due to the high level of competition for experienced financial and accounting professionals in China. 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, 2009 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 including, among others, goodwill and equity investments in less than 25%-owned entities, which may change from time to time. Because we currently hold, and expect to continue to hold, a substantial amount of cash or cash equivalents and other passive assets, and, because the value of our assets is likely to be determined in large part by reference to the market prices of our 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—United States Federal Income Taxation—Passive Foreign Investment Company.”
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SIGNATURE
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F/A and that it has duly caused and authorized the undersigned to sign this amendment to its annual report on Form 20-F for the year ended December 31, 2008 on its behalf.
Date: May 1, 2009
| GUSHAN ENVIRONMENTAL ENERGY LIMITED | ||
/s/ Frank Ngai Chi Chan | ||
| Name: | Frank Ngai Chi Chan | |
| Title: | Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) | |
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