Fufeng Group Limited — Annual Report 2007

Apr 21, 2008

Fufeng Group Limited 阜豐集團有限公司

(incorporated in the Cayman Islands with limited liability)

(Stock code: 546)

ANNOUNCEMENT OF ANNUAL RESULTS FOR THE YEAR ENDED 31 DECEMBER 2007

ANNUAL RESULTS

The Board is pleased to announce the consolidated results of the Group prepared under HKFRS for the year ended 31 December 2007, together with the comparative figures for the year ended 31 December 2006, as follows:

Consolidated Income Statement

		Year ended 31 December	Year ended 31 December
		2007	2006
	Note	RMB’000	RMB’000
Revenue	2	2,445,652	1,787,247
Cost of sales		(2,195,986 )	(1,432,105 )
Gross profit		249,666	355,142
Other income		32,795	19,223
Selling and marketing expenses		(104,156 )	(61,806 )
Administrative expenses		(113,709 )	(40,529 )
Other operating expenses		(16,746 )	(7,376 )
Interest income from Initial Public Offering (“IPO”) subscription deposits		42,837	–
Finance costs		(45,202 )	(14,846 )
Profit before income tax		45,485	249,808
Income tax expense	3	(416 )	(9,325 )
Profit for the year attributable to the Shareholders		45,069	240,483
Earnings per share for profit attributable to the Shareholders
during the year(expressed in RMB cent per share)
– basic and diluted	4	2.80	20.04
Dividends	5	13,529	156,210

– 1 –

Consolidated Balance Sheet

Consolidated Balance Sheet
		As at 31 December
		2007	2006
	Note	RMB’000	RMB’000
ASSETS
Non-current assets
Leasehold land payments		63,070	64,918
Property, plant and equipment		1,674,021	1,288,340
Deferred income tax assets		6,390	601
		1,743,481	1,353,859
Current assets
Inventories		326,351	148,077
Trade and other receivables	6	540,984	357,814
Restricted bank deposits		42,170	23,500
Cash and cash equivalents		228,849	41,094
		1,138,354	570,485
Total assets		2,881,835	1,924,344
EQUITY
Capital and reserves attributable to the Shareholders
Share capital		169,034	123,372
Share premium
– Proposed final dividend		13,529	96,114
– Others		1,078,144	182,212
Other reserves		(276,084 )	(301,478 )
Retained earnings		464,193	426,173
Total equity		1,448,816	526,393
LIABILITIES
Non-current liabilities
Deferred income		24,951	27,599
Borrowings		312,000	335,000
Deferred income tax liabilities		898	707
		337,849	363,306
Current liabilities
Trade, other payables and accruals	7	770,810	610,573
Current income tax liabilities		875	4,244
Current portion of deferred income		5,485	5,198
Borrowings		318,000	414,630
		1,095,170	1,034,645
Total liabilities		1,433,019	1,397,951
Total equity and liabilities		2,881,835	1,924,344
Net current assets/(liabilities)		43,184	(464,160 )
Total assets less current liabilities		1,786,665	889,699

– 2 –

Notes to the Consolidated Financial Statements

For the year ended 31 December 2007

1 Basis of preparation

The consolidated financial statements of the Group have been prepared in accordance with the HKFRS. The consolidated financial statements have been prepared under the historical cost convention, as modified by the revaluation of derivative financial instruments.

The preparation of financial statements in conformity with HKFRS requires the use of certain critical accounting estimates. It also requires management to exercise its judgement in the process of applying the accounting policies of the Group. The accounting policies adopted are consistent with those as described in the Group’s financial statements.

Certain new HKFRS to existing standards have been published that are mandatory for the Group’s accounting periods beginning on or after 1 January 2008 or later period. The Group has not early adopted such new HKFRS, the adoption of which will not result in substantial changes to the Group’s accounting policies.

2. Revenue and segmental information

The Group is principally engaged in the manufacture and sales of corn-based biochemical products, including glutamic acid, MSG, fertilisers, xanthan gum, starch sweeteners and corn refined products. Turnover and revenue for the years ended 31 December 2007 and 2006 are analysed as follows:

	Year ended 31 December	Year ended 31 December
	2007	2006
	RMB’000	RMB’000
Glutamic acid	1,049,470	1,050,090
MSG	550,825	199,441
Corn refined products	421,808	227,390
Fertilisers	195,870	134,824
Xanthan gum	149,486	139,620
Starch sweeteners	78,193	35,882
	2,445,652	1,787,247

– 3 –

As at 31 December 2007, the Group is organised into two main business segments: MSG (which includes the sales of glutamic acid, MSG, corn refined products, fertilisers and starch sweeteners) and xanthan gum. There are no significant sales or other transactions between the business segments.

The segment results for the year ended 31 December 2007 are as follows:

		Xanthan
	MSG	gum	Unallocated	Group
	RMB’000	RMB’000	RMB’000	RMB’000
Total segment revenue	2,296,166	150,152	–	2,446,318
Inter-segment revenue	–	(666 )	–	(666 )
Revenue	2,296,166	149,486	–	2,445,652
Segment results	41,574	39,446	(33,170 )	47,850
Interest income from IPO subscription deposits				42,837
Finance costs				(45,202 )
Profit before income tax				45,485
Income tax expense				(416 )
Profit for the year				45,069

The segment results for the year ended 31 December 2006 are as follows:

	MSG	Xanthan gum	Unallocated	Group
	RMB’000	RMB’000	RMB’000	RMB’000
Revenue	1,647,627	139,620	–	1,787,247
Segment results	223,662	47,636	(6,644 )	264,654
Finance costs				(14,846 )
Profit before income tax				249,808
Income tax expense				(9,325 )
Profit for the year				240,483

– 4 –

Other segment items included in the income statement are as follows:

			2007
	MSG	Xanthan gum	Unallocated	Group
	RMB’000	RMB’000	RMB’000	RMB’000
Depreciation	101,939	14,646	362	116,947
Amortisation of leasehold land payments	1,620	228	–	1,848
Reversal of write-down of inventories	(4,005 )	–	–	(4,005 )
Loss on disposals of property,
plant and equipment	283	–	–	283
			2006
	MSG	Xanthan gum	Unallocated	Group
	RMB’000	RMB’000	RMB’000	RMB’000
Depreciation	51,054	3,947	3	55,004
Amortisation of leasehold land payments	1,414	201	–	1,615
Write-down of inventories	4,005	–	–	4,005
Loss on disposals of property,
plant and equipment	440	–	–	440

– 5 –

The segment assets and liabilities at 31 December 2007 and capital expenditure for the year then ended are as follows:

	MSG	Xanthan Gum	Unallocated	Group
	RMB’000	RMB’000	RMB’000	RMB’000
Assets	2,372,359	418,435	91,041	2,881,835
Liabilities	1,116,638	313,521	2,860	1,433,019
Capital expenditure	363,354	139,557	–	502,911

The segment assets and liabilities at 31 December 2006 and capital expenditure for the year then ended are as follows:

	MSG	Xanthan Gum	Unallocated	Group
	RMB’000	RMB’000	RMB’000	RMB’000
Assets	1,605,432	187,863	131,049	1,924,344
Liabilities	1,273,620	122,393	1,938	1,397,951
Capital expenditure	731,263	113,661	–	844,924

Segment assets consist primarily of property, plant and equipment, inventories, trade and other receivables restricted bank deposit, and cash and cash equivalents. Unallocated assets comprise property, plant and equipment, other receivables, and cash and cash equivalents held by non-PRC established companies and Shandong Fufeng Biotechnologies.

Segment liabilities comprise operating liabilities. Unallocated liabilities comprise operating liabilities of the Company except borrowings of RMB305,630,000 denominated in US$ as at 31 December 2006.

Capital expenditure comprises additions to leasehold land payments and property, plant and equipment.

No geographical segment information is presented as over 90% of the Group’s revenue and segment result are attributable to the market within the PRC and all operating assets of the Group are located in the PRC.

– 6 –

3. Income tax expense

	Year ended 31 December	Year ended 31 December
	2007	2006
	RMB’000	RMB’000
Current income tax
– PRC enterprise income tax (“EIT”)	6,014	9,332
Deferred income tax	(5,598 )	(7 )
	416	9,325

The Company was incorporated in the Cayman Islands as an exempted company with limited liability under the Companies Law (Law 3 of 1961, as consolidated and revised) of the Cayman Islands and is exempted from payment of the Cayman Islands income tax.

Hong Kong profits tax has not been provided for as the Group has no estimated assessable profit in Hong Kong for the years ended 31 December 2007 and 2006.

PRC EIT is calculated based on the effective tax rate on assessable profit of subsidiaries established in the PRC in accordance with PRC tax laws and regulations.

4. Earnings per share

(a) Basic

Basic earnings per Share for the year ended 31 December 2007 is calculated by dividing the profit attributable to Shareholders by the weighted average number of Shares in issue during the year.

Basic earnings per share for the year ended 31 December 2006 is calculated by dividing the profit for the year attributable to the Shareholders by the weighted average number of Shares in issue during the year adjusted for as if the Shares issued by the Company for acquiring Acquest Honour had been outstanding throughout the year.

	2007	2006
Profit attributable to Shareholders (RMB’000)	45,069	240,483
Weighted average number of Shares in issue (thousands)	1,610,027	1,200,000
Basic earnings per share (RMB cent per Share)	2.80	20.04

(b) Diluted

The diluted earnings per share is the same as basic earnings per share because the average market price of ordinary shares for the year ended 31 December 2007 did not exceed the exercise prices of each tranche of the share options, hence the share options are anti-dilutive and are ignored in the calculation of the diluted earnings per share.

– 7 –

5. Dividends

	Year ended 31 December	Year ended 31 December
	2007	2006
	RMB’000	RMB’000
Declared by Acquest Honour to its then shareholders (a)	–	60,096
Final proposed	13,529	96,114
	13,529	156,210

• (a) Dividend for the year ended 31 December 2006 represented dividend declared by Acquest Honour to its then shareholders before it became a subsidiary of the Company.

• (b) At a meeting held on 17 April 2007, the Board proposed a final dividend in respect of the year ended 31 December 2006 of RMB96,114,000, representing RMB5.79 cents per Share. The annual general meeting held on 6 June 2007 approved the Board’s dividend proposal. Such final dividend was paid on 11 June 2007.

At a meeting held on 21 April 2008, the Board proposed a final dividend in respect of the year ended 31 December 2007 of RMB13,529,000, representing RMB0.82 per Share. This proposed dividend is not reflected as a dividend payable in these financial statements, but will be reflected as an appropriation of share premium for the year ending 31 December 2008.

6. Trade and other receivables

	As at 31 December	As at 31 December
	2007	2006
	RMB’000	RMB’000
Trade receivables (a)	67,164	82,783
Notes receivables (b)	426,214	244,190
Prepayments	12,695	21,803
Deposits and other receivables	34,911	9,038
	540,984	357,814

(a) As at 31 December 2007 and 2006, the ageing analysis of trade receivables was as follows:

	As at 31 December	As at 31 December
	2007	2006
	RMB’000	RMB’000
Within 3 months	59,320	77,055
Over 3 months	7,844	5,728
	67,164	82,783

– 8 –

The Group sold its products to customers and received settlement either in cash or in form of bank acceptance notes upon delivery of goods. The bank acceptance notes are usually with maturity dates within six months. Major customers with good repayment history are normally offered credit terms for not more than three months.

• (b) As at 31 December 2007, notes receivable were all bank acceptance notes aged less than six months, including amounts of RMB334,299,000 (2006: RMB216,815,000) applied for settling the amounts payable to the Group’s suppliers.

7. Trade, other payables and accruals

	As at 31 December	As at 31 December
	2007	2006
	RMB’000	RMB’000
Trade payables (a)	447,664	227,374
Notes payable (b)	8,950	27,249
Advances from customers (c)	89,650	61,217
Payables for leasehold land, property, plant and equipment	181,065	255,724
Other payables and accruals	43,481	39,009
	770,810	610,573

• (a) At 31 December 2007 and 2006, the ageing analysis of the trade payables is as follows:

	As at 31 December	As at 31 December
	2007	2006
	RMB’000	RMB’000
Within 3 months	426,788	221,479
3 to 6 months	5,642	2,961
6 to 12 months	10,097	2,237
Over 1 year	5,137	697
	447,664	227,374

As at 31 December 2007, notes receivable of RMB334,299,000 (2006: RMB216,815,000) were applied for settling the amounts payable to the Group’s suppliers.

• (b) At 31 December 2007 and 2006, notes payable were all bank acceptance notes with maturity dates within six months and aged less than six months.

• (c) Advances from customers represented cash advances received from customers for purchase of the Group’s products and would be applied for settlement when sales were incurred.

• (d) Trade and other payables are unsecured and interest-free. The carrying amounts of trade and other payables approximate their fair values.

– 9 –

MANAGEMENT DISCUSSION AND ANALYSIS

Review of Operations

The Group aims at becoming the leading corn-based biochemical products manufacturer in the PRC by way of expanding the production capacity, diversifying the product range, expanding the sales network and strengthening the research and development capabilities.

The turnover of the Group for the year 2007 was approximately RMB2,445.7 million which represents a growth of approximately RMB658 million or 37% as compared with that in the year 2006 and the annualised compound growth rate for the previous 5 years is 53%.

The profit attributable to the Shareholders of the Group for the year 2007 was approximately RMB45 million which represents a decrease of approximately RMB195 million or 81% as compared with that of the year 2006. The decrease is mainly due to the decrease in the gross profit and rise in various expenses of the Group during the year 2007.

In the year 2007, the sales volume and turnover of the Group, especially MSG, increased from that of 2006 although the ASP of the major products dropped. However, gross profit decreased significantly from that of 2006 due to the drop in ASP and increase in the price of corn kernel, the major raw material of the Group. The decrease in gross profit together with the increase in various expenses led to the substantial decrease in the results of the Group for the year 2007.

Although the results for the year 2007 was not encouraging, the production facilities of the Group were almost fully utilised and the increase in sales volume which meant increase in the market share of the Group’s products, representing a positive sign on the strategy of the Group.

In the year 2007, in addition to the export of xanthan gum, the Group also exported glutamic acid and MSG mainly to South East Asia. The total export sales of the Group for the year 2007 is approximately 8% (2006: 5%) in terms of the turnover. The Group increases its export sales due to the higher ASP and enlargement of market share.

Macro Control on corn refinery industry by the PRC government

Between the beginning of the year 2006 and the end of the year 2007, the price of corn kernel increased significantly about 42%. According to the Directive Statement, approximately 65% of corn kernel produced in the PRC was consumed by animal feeding industry, in which, pig farming shared approximately 55%; approximately 27% of corn kernel produced in the PRC was consumed by corn refinery industry, including corn sweeteners, MSG, lysine, ethanol and various amino acid.

– 10 –

The Directive Statement issued in September 2007 highlighted the following four major issues facing the corn refinery industry in the PRC:

1. The production capacity in corn refinery industry is unreasonably expanding at a rate faster than the increase in corn production;

2. Most of the manufacturers in the corn refinery industry engage only in the basic level of refinery with low utilisation rate;

3. Certain manufacturers engage only in low technology level refinery and do not attend to environmental protection requirement;

4. Insufficient specialised farmland for corns which led to production of low quality corn kernel and in turn low return on corn refinery industry.

The shortage in supply of pork, the unreasonable expansion of production capacity in corn refinery industry, and the expected increasing consumption of corn kernel for production of ethanol resulted in the increase in demand and in turn the price of corn kernel in the PRC in the year 2007.

According to the NBS, the yearly increase in price of corn kernel in Shandong Province, Shaanxi Province and Inner Mongolia Autonomous Region was approximately 18% in 2007. The price of corn kernel of the Group, which resemble the market price, was approximately RMB1,300 per tonne in the early of 2007 to approximately RMB1,450 per tonne in late 2007.

In order to control the price of corn kernel, being one of the basic foods, the PRC government adopted certain administrative measures in 2006 and 2007 by curbing the production of ethanol from corn kernel and the expansion of corn refinery facilities (including the closure of MSG production facilities of 30,000 tonnes or below). Further, on 20 December 2007, the PRC government revoked the tax rebate on the export of certain agriculture products including corn kernel in order to lower the export of corn kernel.

Segmental Information

From 2007 onwards, the Group has re-organised its operations around two business segments. The segmental analysis has therefore been restated as MSG segment and Xathan gum segment. Management believes that this analysis better reflects the way in which the business is now managed and its future strategic direction.

MSG segment represents the glutamic acid, MSG, fertilisers, sweeteners and corn-refined products. Xathan gum segment represents the production and sales of xanthan gum.

– 11 –

Segment Highlights

Segment Highlights
Revenue Gross Profit Gross profit ratio Segment results Segment net assets Assets Liabilities Net assets	2007 Xanthan MSG gum Group RMB’000 RMB’000 RMB’000 2,296,166 149,486 2,445,652 203,543 46,123 249,666 8.86% 30.85% 10.21% 41,574 39,446 2,372,359 418,435 1,116,638 313,521 1,255,721 104,914	2006 Xanthan MSG gum Group RMB’000 RMB’000 RMB’000 1,647,627 139,620 1,787,247 304,278 50,864 355,142 18.47% 36.43% 19.87% 223,662 47,636 1,605,432 187,863 1,273,620 122,393 331,812 65,470	Increase/(Decrease)
			Xanthan MSG gum Group % % % 39% 7% 37% (33% ) (9% ) (30% ) (52% ) (15% ) (49% ) (81% ) (17% ) 48% 123% (12% ) 156% 278% 60%

MSG segment

During the year 2007, the products of this segment were glutamic acid, MSG, fertilisers, sweeteners and corn refined products.

Market supply and demand of glutamic acid and MSG

In the year 2006, the market supplies of glutamic acid and MSG were relatively stable. With the increase in demand, the selling prices increased gradually throughout the year and reached the highest level in late 2006. These high selling prices attracted many competitors entering the market in the year 2007. As a result, the market supply of these products increased significantly, leading to market prices drop. The table below shows the approximate selling prices of the glutamic acid and MSG:–

		Glutamic
		acid	MSG
		_(RMB/Tonne) _	(RMB/Tonne)
2006	– Early	5,800	6,100
	– Late	6,500	6,700
2007	– Early	6,500	6,500
	– Late	5,700	5,700

– 12 –

It is expected that market restructuring resulting from the significant drop in selling prices of glutamic acid and MSG since 2007 should be close to an end in the year 2008. As a result, a few major players, of which the Group being one of them, are able to denominate the market in the near future.

Sales and ASP

The table below shows the sales amount of the products in this segment for the years 2007 and 2006:–

	2007	2006	% of
	RMB’000	RMB’000	change
Glutamic acid	1,049,470	1,050,090	–
MSG	550,825	199,441	176
Fertilisers	195,870	134,824	45
Corn refined products	421,808	227,390	85
Sweeteners	78,193	35,882	118

Set out below the ASP of the Group’s major products for the years 2007 and 2006:

Product	2007	2006	% of
	RMB/tonne	RMB/tonne	Change
Glutamic acid	5,872	6,140	(4 )
MSG	5,997	6,394	(6 )
Fertilisers	467	541	(14 )

Glutamic acid

Highlighted above, the increase in market supply led to a fierce market competition among glutamic acid manufacturers and the ASP of glutamic acid dropped.

MSG

With the strategy of moving from glutamic acid to MSG in order to capture the expansion opportunities in the consolidating MSG market, the Group increased the production capacity which in turn increased the MSG available for sales. In addition, increase in the MSG production of the Group by consuming the self-produced glutamic acid reduced the glutamic acid available to the market which in turn reduced the supply of MSG by competitors. Hence, the sales volume of MSG for the year 2007 showed a remarkable increase by approximately 194%. The significant increase in sales of MSG greatly enlarged the market share of the Group proving that the strategy of the Group was successful. Being a downstream product of glutamic acid, the ASP of MSG follows the same pattern as that of glutamic acid.

Fertilisers

Following the market development in the past few years, the Group’s fertilisers were recognised by the farmers and the sales volume increased by 68% in the year 2007. The increase in cost of raw materials led to the increase in selling price of the fertilisers in the PRC.

– 13 –

Sweeteners

The selling price of sweeteners remained at low level after reaching ceiling in 2006. With an increase in corn price, the profit margin from the sale of sweeteners was narrowed.

Corn refined products

The short fall in supply of pork during 2007 attracted more people entering the pig farming industry which increased the demand for corn-based animal feeds. Hence, the sales for corn refined products increased significantly.

Gross Profit

Set out below the gross profit for this segment and its major products for the years 2007 and 2006:

	2007		2006
	(RMB’000)	%	(RMB’000 )	%
Segment	203,543	9	304,278	18
Glutamic acid	107,362	10	222,925	21
MSG	23,772	4	31,883	16
Fertilisers	57,128	29	23,602	18

Except fertilisers, the gross profit of the major products of this segment decreased in the year 2007 when compared with that of the year 2006 due to the decrease in ASP of all the major products and increase in the cost of production.

Production

Following the commencement of production of IM Plant in December 2006, the production capacities of the Group was expanded in the year 2007.

The annual design production capacity, the actual production output and the utilisation rate of each of the major products in the year 2007 together with the comparative figures in the year 2006 were as follows:

Product Glutamic acid Annual design production capacity_(Note 1) Actual production output Utilisation rate MSG Annual design production capacity(Note 1) Actual production output Utilisation rate Fertilisers Annual design production capacity(Note 1)_ Actual production output Utilisation rate	2007 2006 Change (Tonnes) (Tonnes) (%) 280,000 180,000 56 279,420 197,560 41 100% 110%
	75,000 33,333 125 77,128 30,927 149 103% 93%
	490,000 306,667 60 387,928 272,036 43 79% 89%

Note 1: The production capacity is expressed on pro-rata basis.

– 14 –

Regarding sweeteners, the selling price of sweeteners remained at the low level after reaching ceiling in 2006. After considering the cost and benefit, there was no production of sweeteners in Junan Plant due to high cost of production while IM Plant kept its normal production in the year 2007. During the year 2007, IM Plant produced 25,217 tonnes of crystallised glucose which represented approximately 25% of the annual design production capacity.

Cost of production

The two major raw materials of this segment are corn kernel and coal.

In the year 2007, corn kernel represented approximately 57% (2006: 55%) of the total cost of production of this segment. The Group’s cost of corn kernel increase from the yearly average of RMB1,190 per tonne in the year 2006 to RMB1,399 per tonne in the year 2007 which represented an increase of approximately 17.6%. The level of increase is similar to the market benchmark as mentioned above.

In 2007, coal represented approximately 8% (2006: 11%) of the total cost of production of the segment. The decrease in the percentage is mainly due to the reduction in cost of coal used in the production in IM Plant. Following the commencement of IM Plant, the Group’s cost of coal was lowered from approximately RMB315 per tonne in the year 2006 to about RMB285 per tonne in the year 2007 which resulted in the decrease in percentage even though the general market price of coal increased during the year 2007 because of the closing down of small coal mines due to market restructuring and safety purposes, and the increase international coal price due to the import of coal in PRC.

In addition to corn kernel and coal, the cost of sulphuric acid and liquid ammonia, which represents 5% and 11% of the total cost of production of this segment also increased in the year 2007.

Xanthan gum segment

The market supply of xanthan gum increased gradually over the years. The market of xanthan gum is growing. The increase in supply of xanthan gum was well absorbed by the increasing demand, therefore, the yearly average market price of xanthan gum only dropped slightly in the year 2007.

The selling prices of xanthan gum of the Group were approximate RMB26,000 per tonne in the early of 2007 and approximate RMB23,000 per tonne in late 2007.

The market supply is expected to be stabilised in the year 2008 and maintain at approximately 90,000 tonnes to 93,000 tonnes for a foreseeable future. It is further expected that the market will continue to grow with more customers realising the advantage of using xanthan gum.

– 15 –

The Development

The development of xanthan gum of the Group is shown in the time chart below:

				Between
				late 2008
	November	September	September	and first half
	2003	2006	2007	of 2009 *
Location	Junan Plant	Junan Plant	IM Plant	IM Plant
	Phase II	Phase II
Events	Production	Increase in	Commencement	Increase in
	trail run	production	of production	production
		capacity		capacity
Production Capacity:
Increased by	4,000 Tonnes	4,000 Tonnes	10,000 Tonnes	10,000 Tonnes
Accumulated	4,000 Tonnes	8,000 Tonnes	18,000 Tonnes	28,000 Tonnes

* Expected time on the commencement of production

The Group started the commercial production of xanthan gum in the year 2003 with the production capacity of 4,000 tonnes. In response to the market needs, the Group decided to increase the production capacity by adding additional 4,000 tonnes in Junan Plant Phase II and the construction of 20,000 tonnes production facilities in IM Plant. Out of the 20,000 tonnes production capacity in IM Plant, the production of the first 10,000 tonnes commenced in September 2007 and the rest of 10,000 tonnes is expected to commence production between late 2008 and first half of 2009.

Before the commencement of operation in IM Plant, the Group is the second largest xanthan gum manufacturer in the PRC. After the full operation of IM Plant, the Group is expected to become one of the major xanthan gum manufacturers in the world.

Sales and Customers

The xanthan gum of the Group is sold to both domestic and overseas customers. Set out below certain sales information of xanthan gum over the years 2003 to 2007:

	2007	2006	2005	2004	2003
Turnover (RMB’000)	149,486	139,620	66,488	17,293	893
Average selling price (RMB/tonne)	24,049	25,598	26,061	27,533	26,809

From the above table, the turnover increased significantly between 2003 and 2006. The increase is mainly due to the enlargement of the xanthan gum market and the expansion of production capacity of the Group. Although there was a keen market competition, with the hardworking of the sales team of the Group, the sales volume of xanthan gum grow by approximately 14% in the year 2007 when compared with that in the year 2006.

Currently, the Group exported to 34 countries including Oman, Indonesia, Russia, Turkey, United Kingdom, Vietnam, Korea, Singapore, Italy, Egypt, Belgium, Pakistan, Mexico, Poland and Ukraine. Among the sales of xanthan gum, 83% (2006: 65%) in terms of turnover for the year 2007 were exported.

– 16 –

During the year 2007, as major competitors increased their production capacity at the same time as that of the Group, the increase in supply of xanthan gum led to the decrease in its ASP. However, as the market of xanthan gum is developing, the decrease in ASP was compensated by the increase in market size.

Set out below the gross profit and gross profit ratio of xanthan gum for the years 2007 and 2006:–

	2007	2006
Gross profit (RMB’000)	46,123	50,864
Gross profit ratio (%)	31	36

Production and cost of sales

Set out below certain information on the production and cost of sales for xanthan gum over the year 2005 to 2007:

	2007	2006	2005
Annual design production capacity (tonnes)(Note)	11,333	5,333	4,000
Actual production output (tonnes)	9,930	5,079	1,972
Utilisation rate	88%	95%	49%

Note: The production capacity is expressed on pro-rata basis.

From the above table, about 90% utilisation rate of the production capacity of xanthan gum for the years 2006 and 2007 represents the production capacity were nearly fully utilised.

The major raw materials of xanthan gum are corn kernel and coal. The rising cost of corn kernel has a lesser effect on the production cost of xanthan gum because cost of corn kernel is approximately 20% of the total production cost of xanthan gum in the year 2007. The production cost of xanthan gum is also affected by the cost of energy (ie mainly cost of coal) which is approximately 46% of the total cost of production of the xanthan gum in the year.

IM Plant

The cost of raw materials, especially cost of coal, is lower in the Inner Mongolia Autonomous Region than that in Shandong Province and the Group’s third production plant is strategically located in the Inner Mongolia Autonomous Region in order to capture lower production cost.

For IM Plant, the cost of coal is similar to that of Baoji Plant but 50% lower than that of Junan Plant. As the consumption of coal accounts for approximately 46% of the total production cost, the production of xanthan gum in IM Plant can substantially reduce the production cost. Hence, the average cost of production of xanthan gum in IM Plant was approximately 29% lower than that of Junan Plant. Due to the production of xanthan gum in IM Plant only commenced in the fourth quarter for the year 2007, the overall cost reduction in xanthan gum of the Group in the year 2007 was not significant. However, with the full year contribution of xanthan gum in IM Plant in 2008 and an additional 10,000 tonnes of xanthan gum in IM Plant which is scheduled to commence production between late 2008 and first half of 2009, the overall cost of production of xanthan gum should be reduced significantly.

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Other business information

Renovation

In addition to the increase in production capacity as mentioned above, there were a few renovations in the production processes of the Group.

In the year 2006 or before, the Group produced MSG by using glutamic acid. Since the year 2007, part of glutamic acid was crystallised for the production of MSG. The crystallised glutamic acid can produce higher quality MSG and is expected to be more acceptable by the market.

The cinder generated from the electricity plant was sold out directly before 2007. In 2007, cinder further processed to brick which is expected to be sold at higher value.

Research and development

The Group obtained various significant achievements during the year 2007.

The R&D Center was promoted from county level technology center to provincial level technology center. In addition, it was accredited as “Research Center on Amino Acid Fermentation Technology of Shandong Province”.

The Group applied for 32 patents on its own-developed production technology and one patent was granted in 2007. Furthermore, the Group obtained various government subsidies and citations on the new technology developed by the Group.

Finally, the Group led the drafting of standards on bio-chemical fertilisers which were finalised and effective on 1 December 2007. These standards strengthen the quality control on the production of bio-chemical fertilisers.

Recent development

70,000 tonnes MSG in Baoji Plant

The Group paid deposit for the acquisitions of a piece of land adjacent to the Baoji Plant for the construction of 70,000 tonnes MSG production facilities in the second half of the year 2007. Due to the delay in the clearance of the land by the local government, the construction of the MSG production facilities has not yet been commenced. Hence, the original schedule on the commencement of production in early 2008 will be postponed to late 2008.

Close down of Junan Plant Phase I

Junan Plant Phase I, with the production facilities of 130,000 tonnes of corn starch, 40,000 tonnes of glutamic acid, 25,000 tonnes MSG, 90,000 tonnes of fertilisers and 40,000 tonnes of sweeteners, is located in the downtown of the Junan County, the PRC. During the year 2007, the raw material cost, especially the cost of corn kernel, in Shandong Province increased significantly. The cost of corn kernel in December 2007 was about RMB1,500 per tonne which is higher than that of Baoji Plant and IM Plant. The cost of coal was double of that in Baoji Plant and IM Plant. The high cost of production in Junan Plant Phase I led to a low gross profit or even gross loss on the products it produced. In order to avoid the loss, the Board decided to close down Junan Plant Phase I in late February 2008. The production facilities of Junan Plant Phase I will be relocated to Baoji Plant and IM Plant over the year 2008 in order to maintain the production capacity of the Group. Upon the commencement of operation of IM Plant, the production capacity in Junan Plant Phase I is relatively insignificant and hence, the effect on the close down of Junan Plant Phase I is not expected to be material.

Following the close down of Junan Plant Phase I, Junan Plant Phase II is positioned as the research and development center of the Group. All the research activities on new products or production processes of the Group will be conducted in Junan Plant Phase II in the future. Of course, Junan Plant Phase II will continue its manufacturing of 8,000 tonnes of xanthan gum and 50,000 tonnes of MSG.

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Acquisition of a pharmaceutical company

The Group acquired Shenhua Pharmaceutical from a third party in late January 2008. Shenhua Pharmaceutical is operated in the biochemical field by applying fermentation technology on its production processes which is the same as that of the Group. In the year 2007, Shenhua Pharmaceutical sold 34 products which included raw material medicines, prescription medicines, over-the-counter medicines and health products. The consideration of the acquisition is approximately RMB4,000,000.

The Board considered that being one of the leading manufacturers in the corn-based biochemical products by applying fermentation technology in the PRC, the acquisition extends our knowledge and technique in fermentation technology and diversify into a fast growing and high profit margin pharmaceutical business in the PRC. The move strengthened the leading position of the Group in the biochemical field by applying fermentation technology. In addition, sweeteners consumed by Shenhua can be supplied internally which further enhances the vertical integration of the Group.

Enterprise Income Tax

(i) Tax rate

Before the enactment of the EIT Law, the standard enterprise income tax rate of the Group’s subsidiaries is 33%. Being foreign invested enterprises and were established in the Western part of the PRC, the Group’s subsidiaries enjoy various tax concession including tax holiday on the enterprise income tax of the PRC.

After the enactment of the EIT Law, the standard enterprise income tax rate was reduced to 25%. The Group’s subsidiaries can continue to enjoy the tax concession until the expiry of the tax concession.

The above effects are analysed in the table below:

	Shandong Fufeng	Baoji Fufeng	IM Fufeng
Before 1 January 2008
Standard/preferential tax rate	33%	15% (Note 2)	15% (Note 1)
Tax holiday
Full exemption (year)	Already expired	Already expired	2007 and 2008
50% exemption (year)	2006 to 2008	2007 to 2009	2009 to 2011
After 1 January 2008
Standard/preferential tax rate	25%	15% (Note 2)	15% (Note 1)
Tax holiday
Full exemption (year)	Already expired	Already expired	2007 and 2008
50% exemption (year)	2006 to 2008	2007 to 2009	2009 to 2011

• Note 1: with the Opening Up of Western China policy, IM Fufeng is entitled to a preferential enterprise income tax rate of 15% until 31 December 2010.

• Note 2: with the approval of “High Technology Enterprise”, Baoji Fufeng was entitled to a preferential enterprise income tax rate of 15% for the year ended 31 December 2007. For the year ending 31 December 2008 or after, Baoji Fufeng is entitled to opt for preferential tax treatment for the Opening Up of Western China policy or applying for the status of “High Technology Enterprise”.

(ii) Withholding tax on distribution

Before the enactment of the EIT Law, distribution of the Group’s subsidiaries in the PRC to their foreign investors is free from withholding tax. Since 1 January 2008, distribution in respect of earnings for annual period beginning on or after 1 January 2008 is subject to withholding tax under the EIT Law.

– 19 –

Other financial information

Other income

Other income increased by approximately RMB14 million or 71% from RMB19 million in the year 2006 to RMB33 million in the year 2007. The increase was mainly due to the increase in interest income and approximately RMB7 million government subsidies received by Shandong Fufeng.

Selling and marketing expenses

Selling and marketing expenses increased by approximately RMB42 million or 69% from RMB62 million in the year 2006 to RMB104 million in the year 2007. The increase was mainly due to the bearing of the cost of transportation for customers in order to promote sales in IM Plant.

Administrative expenses

Administrative expenses increased by approximately RMB73 million or 181% from RMB41 million in 2006 to RMB114 million in 2007. The increase was mainly due to the following:

1. the commencement of operation of IM Plant which amounted to approximately RMB24 million;

2. the charging of fair values on the options granted under the Pre-IPO Share Option Scheme which accounted for approximately RMB18 million.

Finance cost

Finance cost increased by approximately RMB30 million or 204% from RMB15 million in the year 2006 to RMB45 million in the year 2007.

The increase in interest expenses contributed approximately RMB8 million to the increase in finance cost. In the year 2007, average bank borrowings were maintained approximately at RMB600 million while for the year 2006, average borrowings were only approximately RMB500 million. Together with the increase in interest rate in the year 2007 caused the increase in interest expenses.

The discontinuation of interest capitalization contributed approximately RMB19 million to the increase in finance cost. In the year 2006, most of the capital expenditures of the Group (including the construction of IM Plant) were financed by bank borrowings and the related interest expenses was capitalised. After the listing of the Shares in the Stock Exchange, the listing proceeds were used in the capital expenditures of the Group and hence, no interest expense was capitalised.

The Group is a growing enterprise which requires external funding to finance its expansion. One of the major sources of funding is bank borrowings. Currently, all bank borrowings are denominated in RMB. The Directors anticipate that the PRC government will continue to increase the interest rate in order to control the inflation in the PRC. High interest rate would increase the cost of financing to the Group. As such, the Group will explore different financing channels to lower the cost of financing.

Staff cost

Staff cost of the Group increased by approximately RMB84 million or 118% from RMB72 million in 2006 to RMB156 million in 2007. The increase was mainly due to the increase in salaries and allowance of approximately RMB48 million on the commencement of operation of IM Plant in late 2006. The charging of fair value on the Pre-IPO Share Option Scheme contributed another approximately RMB18 million to the increase in staff cost.

– 20 –

Depreciation

The depreciation of the Group increased by approximately RMB62 million or 113% from RMB55 million in 2006 to RMB117 million in 2007. The increase was mainly due to the commencement of operation of IM Plant.

Exchange difference

During the year 2007, RMB appreciated by approximately 6.8% as compared with the HK$. The appreciation of RMB led to a net exchange loss of approximately RMB13 million on the group’s assets and liabilities denominated in HK$. In order to minimise the effect of exchange rate risk, the not-yet in use listing proceeds were place in HK$ short term fixed deposits before translating into RMB, which earned approximately RMB8 million for the year 2007.

Following the listing of the Shares on the Main Board of the Stock Exchange in 2007, the Group enlarged its overseas funding platform. The funding from this platform is largely in foreign currencies. In 2007, the RMB appreciated and it is expected that the appreciation will continue in 2008. Hence, the Group will consider possible alternatives from time to time to reduce the effect of RMB appreciation.

Taxation

The income tax expenses for the year 2007 represented the PRC Enterprise Income Tax.

Outlook

Following the market restructuring of glutamic acid and MSG together with the substantial reduction in energy cost due to the production of xanthan gum in IM Plant, it is believed that the Group will step out from difficulty gradually in the year 2008.

MSG segment

The selling prices of glutamic acid and MSG decreased continuously during the year 2007. It is expected that the small players in the market is facing difficulties in maintaining normal operation and incurred substantial losses. According to the Group’s internal research, the market demand and supply of glutamic acid and MSG already came to balancing status. Hence, we expect that the market restructuring may speed up and hence, the selling prices could be anticipated to recover in the year 2008. In the meanwhile, the speed up of market restructuring in glutamic acid and MSG would stabilise the market supply by a few leading players, of which the Group is one of them.

With the continuous input from the PRC government on agriculture business, it is expected that the demand for fertilisers and corn refinery products for farming and animal feeding business is still high and hence, the selling price and profit margin of fertilisers and corn refinery products can be sustained at a high level in 2008. However, it is expected that the corn kernel will maintain at a high level and hence the cost of production will remain at high level too. In addition the cost of sulphuric acid and liquid ammonia, the subsidiary raw materials, will also increase in the year 2008.

Xanthan gum segment

The commencement of xanthan gum production in IM Plant represents a significant reduction in cost of production which in turn the gross profit margin will be pushed upward. The Group will focus on the marketing development for the xanthan gum both in the international and domestic markets.

In addition, following an additional 10,000 tonnes xanthan gum production capacity in IM Plant which is expected to commence production in late 2008 or the first half of 2009, the total production capacity for xanthan gum of the Group will be increased to 28,000 tonnes. It is expected that the production cost will be further decreased and our market share will increase further upon then and become one of the major xanthan gum manufacturers in the world.

– 21 –

IM plant

The production and sales system in IM Plant is improving gradually after operation for a year. The Group believes that in the year 2008, IM Plant enjoys the economies of scale together with advantages from the lower costs in major raw materials and energy.

Liquidity and financial resources

The Group maintained a healthy liquidity position throughout the year 2007. At 31 December 2007, the cash and cash equivalent and restricted bank deposits of the Group were RMB271 million (2006: RMB65 million). The current bank borrowings were approximately RMB318 million (2006: RMB415 million) and non-current bank borrowings were approximately RMB312 million (2006: RMB335 million).

Purchase, redemption or sales of listed securities of the Company

Neither the Company, nor any of its subsidiaries purchased, redeemed or sold any of the Company's listed securities during the year ended 31 December 2007.

Corporate governance report

The listing of the Shares on the Main Board of the Stock Exchange took place on 8 February 2007 and the Directors are of the opinion that the Company has complied with the code provision as set out in the Code since the listing of Shares.

Audit Committee

The Company has established an audit committee in compliance with the Listing Rules. The audit committee comprises three independent non-executive directors, and is responsible for reviewing the Group's audit, interim and annual accounts of the Group and the system of internal control. The audit committee has reviewed the Group's consolidated financial statements for the year ended 31 December 2007, including the accounting principles and practices adopted by the Group.

Closure of register of members

The register of members of the Company will be closed from Monday, 2 June 2008 to Friday, 6 June 2008 (both dates inclusive), during which on transfer of shares will be registered. In order to qualify for the proposed final dividend, all transfers of shares accompanied by the relevant share certificates must be lodged with the Company's branch registrar in Hong Kong. Tricor Investor Services Limited at 26th Floor, Tesbury Centre, 28 Queen's Road East, Hong Kong not later than 4:00 p.m. on Friday, 30 May 2007.

Annual general meeting

The annual general meeting is expected to be held on Friday, 6 June 2008. A notice convening the annual general meeting will be despatched to the Shareholders in due course.

As at the date of this announcement, the executive Directors are Mr. Li Xuechun, Mr. Wang Longxiang, Mr. Wu Xindong, Mr. Yan Ruliang, Mr. Feng Zhenquan, Mr. Xu Guohua, Mr. Li Deheng, Ms. Li Hongyu and Mr. Gong Qingli and the independent nonexecutive Directors are Mr. Choi Tze Kit, Sammy, Mr. Chen Ning and Mr. Liang Wenjun.

By Order of the Board Fufeng Group Limited Li Xuechun Chairman

Hong Kong, the PRC, 21 April 2008

– 22 –

Glossary

Acquest Honour	Acquest Honour Holdings Limited, a wholly-owned subsidiary of the Company
ASP	average selling price(s) of the products of the Group
Baoji Plant	the production plant of the Group located at Baoji City (寶雞市), Shaanxi Province,
	the PRC
Board	the board of Directors
Code	Code on Corporate Governance Practice under Appendix 14 of the Listing Rules
Company	Fufeng Group Limited
Directive Statement	“關於促進玉米深加工健康發展的指導意見” issued by NDRC in September 2007
Directors	the director(s) of the Company
EIT Law	Enterprise Income Tax Law of the PRC which came into effect on 1 January 2008
Group	the Company and its subsidiaries
HKFRS	the Hong Kong Financial Reporting Standards
Hong Kong	the Hong Kong Special Administrative Region of the PRC
IM Plant	the production plant of the Group located at Inner Mongolia Autonomous Region,
	the PRC
Junan Plant	the production plant of the Group located at Junan County (莒南縣), Shandong
	Province, the PRC
Junan Plant Phase I	phase I of the Junan Plant which commenced commercial production in June
	1999
Junan Plant Phase II	phase II of the Junan Plant which commenced commercial production in
	November 2003
Listing Rules	the Rules Governing the Listing of Securities on the Stock Exchange
MSG	monosodium glutamate, a salt of glutamic acid which is commonly used as a
	flavour enhancer and additive in the food industry, restaurant and household
	application

– 23 –

NBS	The National Bureau of statistics of the PRC
NDRC	The National Development and Reform Commission
PRC	the People’s Republic of China, which for the purpose of this annual report
	exclude Hong Kong, the Macau Special Administrative Region of the PRC and
	Taiwan
Pre-IPO Share Option Scheme	the share options granted to certain Directors and employees of the Company
	pursuant to the share option scheme adopted by the Company on 10 January
	2007
R&D Center	the research and development center of the Group which is situated in Junan
	County, Shandong Province, the PRC
Shandong Fufeng	山東阜豐發酵有限公司(Shandong Fufeng Fermentation Co. Ltd.), an indirect
	wholly-owned subsidiary of the Company
Shandong Fufeng Biotechnologies	山東阜豐生物科技開發有限公司(Shandong Fufeng Biotechnologies Development
	Co. Ltd.), an indirect wholly-owned subsidiary of the Company
Shenhua Pharmaceutical	江蘇神華藥業有限公司(Shenhua Pharmaceutical Co. Ltd), a company with
	limited liability established in Jiangsu Province of the PRC
Share(s)	share(s) in the share capital of the Company
Shareholder(s)	holder(s) of the Share(s)
Stock Exchange	the Stock Exchange of Hong Kong Limited
RMB	Renminbi, the lawful currency of the PRC
HK$	Hong Kong dollars, the lawful currency of Hong Kong
US$	United States dollars, the lawful currency of United States
%	per cent

– 24 –