Operation Review

REVIEW OF OPERATIONS

Integration of Wastewater Treatment Facilities

As part of the ongoing requirement to meet stringent environmental safety standards in the PRC, we started the implementation of a wastewater treatment solution in early 2007 and the project was completed by June 2007. During the second quarter of 2007, we began integrating the wastewater treatment facilities with our paper production lines, resulting in an estimated 35 days of work stoppages. Since then, the utilisation rate of our paper production plant had risen gradually, as we adopted a cautious approach to the integration. We expect the utilisation rate to return to its pre-existing level of 94% in the coming year.

With lower utilisation from the second half of 2007, we experienced lower output, reflected in the lower revenue performance in FY2007. In addition, our gross margins were affected by the higher depreciation costs and operating overheads associated with maintaining the wastewater treatment facilities.

Capacity and Utilisation

The Group's paper production capacity stands at 180,000 tonnes per annum and our utilisation stood at an average of 87% for the whole of FY2007. The Group will continue to explore capacity expansion in the long term, since the new wastewater treatment plant has been well integrated into our production process.

The new water treatment facilities were constructed with expanded capacities in mind. Hence, the Group would be able to cope with the increased volume of effluent that is generated by higher production output.

Wood Pulp Prices

The prices of wood pulp have risen in FY2007 by 5% to 10%. Nonetheless, despite the higher prices of wood pulp, we had been able to largely mitigate the effects of higher wood pulp costs due to our paper manufacturing processes which blend wood pulp with locally-sourced wheat pulp. Nonetheless, the Group expects prices of wood pulp to stabilise in the coming 12 months and will seek to maintain a stable gross margin by continuing to increase utilisation and operational efficiency.

REVIEW OF FINANCIAL PERFORMANCE

Group Revenue

The Group's revenue declined by 6.9% from RMB815.9 million for the 12 months ended 31 December 2006 (“FY2006”) to RMB759.9 million for the 12 months ended 31 December 2007 (“FY2007”). The lower turnover is mainly attributable to lower paper production output during the year affected by the installation of the Group's wastewater treatment plant in June 2007.

Segmental Revenue

Overall, sales of paper products declined 7.9% from RMB787.7 million in FY2006 to RMB725.6 million in FY2007. Sales of paper chemical rose from RMB28.3 million in FY2006 to RMB34.5 million in FY2007. This is due to lower production output in FY2007 resulting in the increased volume of excess paper chemical products that were sold externally.

In terms of paper product, sales of printing paper which formed our largest revenue segment decreased by 8.7% or RMB62.7 million to RMB656.6 million in FY2007 from RMB719.3 million in FY2006. In contrast, sales of newsprint paper rose 2.8% to RMB44.8 million in FY2007 from RMB43.6 million.

Profitability

Gross profit declined by 22.9% from RMB225.6 million in FY2006 to RMB173.9 million in FY2007 due to increased depreciation charges with respect to the wastewater treatment plant. The Group had also incurred additional expenses in related to chemical usage for the purpose of wastewater treatment. Moreover, increases in wood pulp prices during FY2007 have an impact on the gross profit. Gross profit margin decreased by 4.7% from 27.6% in FY2006 to 22.9% in FY2007.

In line with the decline in sales volume, the Group's selling and distribution costs have also decreased by 7.9% from RMB43.4 million in FY2006 to RMB40.0 million in FY2007. Administrative expenses decreased 13.3% from RMB18.2 million in FY2006 to RMB15.8 million in FY2007.

Profit before tax for the Group declined 26.6% from RMB163.2 million in FY2006 to RMB119.7 million in FY2007. Net profit declined by 27% from RMB135.6 million in FY2006 to RMB99.0 million in FY2007.

Balance Sheet and Cash Positions

As at 31 December 2007, fixed asset stood at RMB306.3 million, compared to RMB239.2 million as at 31 December 2006 due mainly to the investment in the wastewater treatment plant. Inventories rose to RMB67.3 million as at 31 December 2007 from RMB60.8 million as at 31 December 2006. This is in anticipation of increased production as the Group continues to take steps to increase the pace of production.

As at 31 December 2007, the Group registered net cash generated from operating activities of RMB117.5 million. Net cash outflow of RMB96.6 million was attributable to the investment in the wastewater treatment plant. As at 31 December 2007, cash and cash equivalent stands at RMB272.4 million, an increase of RMB21.0 million from the previous year.