EFGHI JK ?;:@ABCD:8A; · public. No new H shares will be issued in connection with, or pursuant to, the publication of this document. The Company is incorporated, and its businesses

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If you are in any doubt about this document, you should consult your stockbroker, bank manager, solicitor, professional accountantor other professional adviser.

The Stock Exchange of Hong Kong Limited takes no responsibility for the contents of this document, makes no representation asto its accuracy or completeness and expressly disclaims any liability whatsoever for any loss howsoever arising from or in relianceupon the whole or any part of the contents of this document.

*

(a Sino-foreign joint stock limited company incorporated in the People’s Republic of China with limited liability)

LISTING BY WAY OF INTRODUCTION OFTHE ENTIRE ISSUED H SHARE CAPITAL ON

THE MAIN BOARD OFTHE STOCK EXCHANGE OF HONG KONG LIMITED

Stock code on Main Board: 568Stock code on GEM: 8261

Sponsor

Guotai Junan Capital Limited

Financial Advisor

China Merchants Securities (HK) Co., Ltd.

This document is published in connection with the listing by way of introduction of the entire issued H shares of Shandong MolongPetroleum Machinery Company Limited (the “Company”) on the Main Board (the “Main Board”) of The Stock Exchange of Hong KongLimited (the “Stock Exchange”). This document contains particulars given in compliance with the Rules Governing the Listing ofSecurities on the Stock Exchange (the “Listing Rules”) and the Securities and Futures (Stock Market Listing) Rules of Hong Kong forthe purpose of giving information with regard to the Company.

This document does not constitute an offer of, nor is it calculated to invite offers for, the H shares or other securities of the Company,nor have any such H shares or other securities been allotted with a view to any of them being offered for sale to members of thepublic. No new H shares will be issued in connection with, or pursuant to, the publication of this document.

The Company is incorporated, and its businesses are located, in the People’s Republic of China (“PRC”). Potential investors of theCompany should be aware of the differences in the legal, economic and financial systems between the mainland of the PRC and HongKong and that there are different risk factors relating to investment in PRC-incorporated businesses. Potential investors should alsobe aware that the regulatory framework in the PRC is different from the regulatory framework in Hong Kong and should take intoconsideration the different market nature of the shares of the Company. Such differences and risk factors are set out in AppendixIV of this document headed “Summary of relevant PRC and Hong Kong laws and regulations” and the section headed “Risk factors”in this document, respectively.

The H shares of RMB0.10 each in the capital of the Company (the “H Shares”) have been accepted as eligible securities by Hong KongSecurities Clearing Company Limited (“HKSCC”) for deposit, clearance and settlement in the Central Clearing and Settlement System(“CCASS”) with effect from 15 April, 2004, the date on which dealings in the H Shares on the Growth Enterprise Market of the StockExchange commenced. Subject to the granting of the listing of, and permission to deal in, the H Shares on the Main Board and thecontinual compliance with the stock admission requirements of HKSCC, the H Shares will continue to be accepted as eligible securitiesby HKSCC for deposit, clearance and settlement in CCASS once dealings in the H Shares on the Main Board commence.

All necessary arrangements have been made with HKSCC for the H Shares to continue to be accepted as eligible securities of CCASS.All activities under CCASS are subject to the General Rules of CCASS and CCASS Operational Procedures in effect from time to time.

* For identification purpose only

IMPORTANT

R11.20

A1A(1)Rules 8.02

A1A(2)

R19A.42(63)

19 October 2006

Despatch of this document, Shareholders’ circular, notices of

the Extraordinary General Meeting and Class Meetings and related forms of

proxy and reply slips to the Shareholders in relation to the Introduction . . . . . . .19 October 2006

Latest time for lodgement with the instrument of

transfer accompanied by the relevant share

certificate in order to qualify for attending the

EGM and/or the separate Class Meetings . . . . . . . . . . . . . . . . . . .4:00 p.m. on 3 November 2006

Latest time for return of related reply slips for

the Extraordinary General Meeting and Class Meetings . . . . . . . . . . . . . . . . .14 November 2006

Latest time for lodgment of related forms of proxy

for the Extraordinary General Meeting and Class Meetings . . . . . . . . . . . . . . .4 December 2006

Extraordinary General Meeting and Class Meetings . . . . . . . . . . . . . . . . . . . . . . .5 December 2006

Date of the announcement of results of the Extraordinary

General Meeting and Class Meetings which are to be published in

The Standard (in English), Hong Kong Economic Times (in Chinese)

and on the GEM website . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6 December 2006

Notice of the Proposed Withdrawal on or before . . . . . . . . . . . . . . . . . . . . . . . . . .6 December 2006

The CSRC granting approval for the listing of the H Shares

on the Main Board on or before . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2 January 2007

Date of the announcement in respect of the CSRC granting approval

for the listing of the H Shares on the Main Board on or before . . . . . . . . . . . . . .2 January 2007

Last day of dealings in the H Shares on GEM . . . . . . . . . . . . . . . . . .4:00 p.m. on 9 January 2007

Proposed Withdrawal to be effective from . . . . . . . . . . . . . . . . . . . . .9:30 a.m. on 10 January 2007

Dealings in the H Shares on the Main Board to commence on . . . . . .9:30 a.m. on 10 January 2007

Note:

All time stated herein refers to Hong Kong local time.

If there is any revision to the above timetable, a separate announcement will be made by the Company.

EXPECTED TIMETABLE

— i —

A1A(22)

You should rely only on the information contained in this document with respect to theCompany.

The Company has not authorised anyone to provide you with information that is different fromthe information contained in this document.

Any information or representation not made in this document must not be relied on by you ashaving been authorised by the Company, the Sponsor, financial advisor, the directors, officers,employees, agents or representatives of any of them, or any other parties involved in theIntroduction.

The contents contained in the websites at www.molonggroup.com and www.molong.cn do notform part of this document.

Page

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Glossary of technical terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

Risk factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

Waivers from strict compliance with the requirements under the Listing Rules . . . . . . . . 37

Information about this document and the Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

Directors, supervisors and parties involved in the Introduction . . . . . . . . . . . . . . . . . . . . . 42

Corporate information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

Industry overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

History and Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53

BusinessIntroduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60Strengths and competitive advantages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60Products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61Raw materials and components . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79Inventory control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80Sales and marketing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81Competition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85Environmental protection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86Business licence and permit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86Litigation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87Research and development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87Quality control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90Independence of the controlling shareholder from the Group . . . . . . . . . . . . . . . . . . . . . . 91Comparison of business objectives with actual business progress . . . . . . . . . . . . . . . . . . . 93

CONTENTS

— ii —

Page

Relationships with Maolong Machinery, Molong Equipment,

Maolong Recycle and Weihai Baolong . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98

Connected Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102

Future Plans and Prospects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126

Directors, Supervisors, senior management and staff . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127

Substantial Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134

Share capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135

Financial information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 136

Appendices

I. — Accountants’ report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . I-1

II. — Interim Results 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . II-1

III. — Property valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . III-1

IV. — Summary of relevant PRC and Hong Kong laws and regulations . . . . . . IV-1

V. — Summary of the Articles of Association . . . . . . . . . . . . . . . . . . . . . . . . . . V-1

VI. — Statutory and general information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . VI-1

VII. — Documents available for inspection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . VII-1

CONTENTS

— iii —

This summary aims to give you an overview of the information contained in this document. As

this is a summary, it does not contain all the information that may be important to you.

INTRODUCTION

The Group principally engages in the design, manufacture and sale of petroleum drilling and

extraction machinery and related accessories, which can be grouped into six main categories of

products, namely, oil well pipes, oil well sucker rods, oil well pumps, casings, oil well pumping

machines and other petroleum drilling and extraction machinery accessories. These products are

principally used for petroleum drilling and extraction. The products of the Group are largely for sale

to domestic oil fields within the PRC and some are for export to overseas customers. For the three

years ended 31 December 2005 and the four months ended 30 April 2006, the Group sold

approximately 84.8%, 81.7%, 72.2% and 62.7% of its products to domestic customers within the PRC

and approximately 15.2%, 18.3%, 27.8% and 37.3% of its products to overseas customers,

respectively.

The Directors believe that the Group has an established reputation in the PRC petroleum drilling

and extraction machinery industry for its capability to manufacture quality petroleum drilling and

extraction machinery and related accessories, as exemplified by the Company having been awarded

the “quality management system certificate” (GB/T19001-2000-ISO9001: 2000) accredited by

(China Classification Society Quality Assurance Ltd), an independent ISO

quality assurance organization in the PRC, for, inter alia, the design, development and manufacture

of its petroleum machinery for oil extraction in 2003. This quality management system certificate

(GB/T19001-2000-ISO9001:2000) will be expired on 19 January 2009. The Company has also been

granted with API’s certificates regarding its licensed right to use the API Monogram on certain

Group’s principal products, namely pumps and pump parts (API Spec 11AX), sucker rods and

couplings (API Spec 11B) and casing and oil well pipes products (API Spec 5CT).

The Group’s main customers are oil fields in the PRC including (Daqing Oil Field),

(Shengli Oil Field ), (Xinjiang Oil Field), (Zhongyuan Oil Field) and

(Liaohe Oil Field), all of them being subsidiaries or branch oil fields of PetroChina or

Sinopec. The overseas customers of the Group were distributed in North America, the United

Kingdom, Russia, Indonesia, Brunei, Egypt, Syria and etc.

HISTORY AND DEVELOPMENT

The Company was established in the PRC on 30 December 2001 as a joint stock limited company.

Its business was founded more than a decade ago.

Petroleum Machinery Parts Factory, the predecessor entity of the Company, was established in

March 1987 as a collectively owned enterprise and was situated in (Shangkou

Town, Shouguang City, Shandong Province, the PRC). It was principally engaged in the manufacture

SUMMARY

— 1 —

3rd Sch(1)3rd Sch(3)R11.67A1A28(1)(a)

R19A.42(57)

and sale of petroleum machinery parts. The registered share capital was RMB1,200,000. In 1989,

Petroleum Machinery Parts Factory was re-registered as Petroleum Machinery Factory which changed

its name to Weifang Molong in 1993. The registered share capital was then increased to

RMB16,420,000.

In 1994, after getting the approval from (Committee for Restructuring

The Economic System of Shandong Province), Weifang Molong was transformed into Molong

Holdings. The registered share capital was further increased to RMB30,040,000.

In 1997, Molong Holdings started to implement joint stock cooperative reform. On 6 September

1997, (Shouguang City Shangkou Town People’s Government) and Zhang En

Rong entered into an agreement (“First Agreement”). Zhang En Rong was the legal representative and

factory manager of Petroleum Machinery Parts Factory, Petroleum Machinery Factory and Weifang

Molong from 1987 to 1993 and the general manager of Molong Holdings since 1995. According to the

First Agreement, (Shouguang City Shangkou Town People’s Government) agreed

to dispose of and Zhang En Rong agreed to acquire 35% equity interests in Molong Holdings for a

consideration of RMB18,738,000. The aforesaid agreement was approved by

(Office for Restructuring The Economic System of Shouguang City) on 20 September 1997. On 30

September 1997, Zhang En Rong entered into an engagement agreement (“Engagement Agreement”)

with (Shouguang City Shangkou Town People’s Government). Pursuant to the

Engagement Agreement, Zhang En Rong engaged (Shouguang City Shangkou

Town People’s Government) to hold his interests in Molong Holdings on his behalf.

On 8 October 1997, (Shouguang City Shangkou Town People’s Government)

issued a notice regarding the reform of Molong Holdings (“Notice”). According to the Notice, the

shareholders of Molong Holdings were (i) Zhang En Rong (holding 35% equity interest); (ii)

(Shouguang City Shangkou Town People’s Government),

(Shouguang City Shangkou Town Economic and Trade Committee)

and (Shouguang City Shangkou Town Economic and Management Office)

(together holding 65% equity interest). Furthermore, the Notice stated that

(Shouguang City Shangkou Town People’s Government), (Shouguang

City Shangkou Town Economic and Trade Committee) and (Shouguang City

Shangkou Town Economic and Management Office) agreed to foresake their voting, corporate control

and management rights relating to Molong Holdings.

On 8 April 2001, a meeting was held by the management team of Molong Holdings whereby it

was decided that Molong Holdings be converted to become a privately owned enterprise.

On 18 August 2001, (Shouguang City Shangkou Town People’s Government)

and Zhang En Rong entered into a supplemental agreement (“Supplemental Agreement”). According

to the Supplemental Agreement, (Shouguang City Shangkou Town People’s

Government) and Zhang En Rong agreed that both the First Agreement and the Engagement Agreement

that were signed between them in 1997 be terminated.

SUMMARY

— 2 —

On 18 August 2001, (Shouguang City Shangkou Town People’s

Government), Zhang En Rong, Lin Fu Long, Zhang Yun San, Xie Xin Cang, Liu Yun Long, Cui Huan

You and Liang Yong Qiang entered into another agreement (“Second Agreement”) pursuant to which

(Shouguang City Shangkou Town People’s Government) agreed to sell all its

interest in Molong Holdings to Zhang En Rong, Lin Fu Long, Zhang Yun San, Xie Xin Cang, Liu Yun

Long, Cui Huan You and Liang Yong Qiang for a consideration of RMB55,715,900, which was

financed by their respective personal savings, bank loan and bonus granted to each of them by

(Shouguang City Shangkou Town People’s Government). After the aforesaid

transfer, the structure of the capital contribution and the percentage of shareholding of Molong

Holdings was as follows:

Name of shareholders

Amountof capital

contribution

Approximatepercentage

of registeredcapital in

MolongHoldings

(RMB) (%)

Zhang En Rong 39,279,700 70.50

Lin Fu Long 4,808,300 8.63

Zhang Yun San 4,301,300 7.72

Xie Xin Cang 3,008,600 5.40

Liu Yun Long 2,061,500 3.70

Cui Huan You 1,298,200 2.33

Liang Yong Qiang 958,300 1.72

55,715,900 100.00

On 18 September 2001, the management of Molong Holdings decided to promote the Company

together with Kaiyuan Oil and Alloy Factory. The registered capital of the Company would be

RMB40,500,000. The seven then individual shareholders of Molong Holdings, namely Zhang En

Rong, Lin Fu Long, Zhang Yun San, Xie Xin Cang, Liu Yun Long, Cui Huan You and Liang Yong

Qiang contributed RMB60,477,800 in aggregate by transferring the production and operational net

assets of Molong Holdings to the Company for an aggregate of 39,647,800 Domestic Shares and each

of Kaiyuan Oil and Alloy Factory contributed RMB800,000 and RMB500,000 in cash for 524,400

Domestic Shares and 327,800 Domestic Shares respectively. Altogether, the Promoters contributed

RMB61,777,800 which was converted at the rate of 1:0.6556 into 40,500,000 Domestic Shares of

RMB1.00 each.

On 8 November 2001, Zhang En Rong, Lin Fu Long, Zhang Yun San, Xie Xin Cang, Liu Yun

Long, Liang Yong Qiang, Cui Huan You, Kaiyuan Oil and Alloy Factory entered into the Promoters

Agreement for the purpose of, among other things, regulating their respective rights and obligations

as promoters of the Company. Pursuant to an approval issued by (Office for

SUMMARY

— 3 —

Restructuring The Economic System of Shandong Province) on 27 December 2001 and a business

licence issued by (Shandong Provincial Administration for Industry and

Commerce) on 30 December 2001, the establishment of the Company was completed and the Company

was converted into a joint stock limited company. The shareholding structure after the establishment

of the Company was as follows:

Name of Promoters

Amountof capital

contribution

Number ofDomesticShares ofRMB1.00each held


of registeredcapital in the

Company

(RMB) (%)

Zhang En Rong 42,636,900 27,951,700 69.02

Lin Fu Long 5,219,200 3,421,600 8.45

Zhang Yun San 4,668,900 3,060,800 7.56

Xie Xin Cang 3,265,800 2,141,000 5.29

Liu Yun Long 2,237,700 1,467,000 3.62

Cui Huan You 1,409,100 923,800 2.28

Liang Yong Qiang 1,040,200 681,900 1.68

Kaiyuan Oil 800,000 524,400 1.29

Alloy Factory 500,000 327,800 0.81

61,777,800 40,500,000 100.00

On 26 October 2002, the Company entered into an agreement with TMR Group Inc., under which

both parties agreed to terminate the operation of their Sino-foreign joint venture, Weifang Dragon

upon the expiry of its then current term of operation (i.e. 26 January 2003). The assets and liabilities

of Weifang Dragon as at 26 January 2003 were subsequently transferred to Molong Equipment for the

consideration of approximately RMB8,200,000, which was calculated on the basis of the unaudited net

asset value of Weifang Dragon as at 26 January 2003. Weifang Dragon was established in the PRC on

27 January 1992, in which the Company was interested in 70% and TMR Group Inc. was interested

in 30% of its registered capital of Weifang Dragon at that time. According to the Sino-foreign joint

venture agreement entered into between the Company and TMR Group Inc., the term of the joint

venture was 11 years. Thus, on 26 October 2002, TMR Group Inc. and the Company intended to

discontinue their Sino-foreign joint venture by entering into an agreement, pursuant to which both

parties agreed to terminate the operation of Weifang Dragon at the expiry of its term of operation (i.e.

26 January 2003). Weifang Dragon was principally engaged in the production and sales of alloy

precision castings. Weifang Dragon was deregistered on 2 April 2003.

Special Steel was a limited liability company incorporated in the PRC which was principally

engaged in the manufacture and sale of steel. On 28 February 2003, the Company entered into a series

of sale and purchase agreements to dispose of an aggregate of 52% equity interests in Special Steel

because the Company was not optimistic about the then prospect of Special Steel due to the fact

SUMMARY

— 4 —

Special Steel did not generate any profit at that time. Immediately before such disposal, Special Steel

was held as to 52% by the Company and as to 48% by Shandong Shouguang Ju Neng Electric Group

Company Limited. In accordance with these agreements, the Company agreed to transfer 44.32%,

6.7% and 0.98%, respectively, of equity interests in Special Steel to Zhang En Rong, a Director, and

Liu Fa You and Xu Shou Lu, both being Independent Third Parties, respectively, for consideration of

RMB39,000,000, RMB5,900,000 and RMB860,000, respectively. Immediately after such disposal,

Special Steel was owned as to 48% by Shandong Shouguang Ju Neng Electric Company Limited, as

to 44.32% by Zhang En Rong, as to 6.7% by Liu Fa You and 0.98% by Xu Shou Lu. The total

consideration was calculated on the basis of the original investment cost in Special Steel, being

equivalent to 52% of the then registered capital of the Company of RMB45,760,000.

On 28 February 2003, the General Office of the (Ministry of Finance of the

PRC) issued to Alloy Factory Cai Ban Qi (2003) No. 30 “Approval Concerning the Allocation of

State-owned Shares of Shandong Molong Petroleum Machinery Company Limited”, pursuant to which

all the 327,800 Domestic Shares held by Alloy Factory were allocated to (the

National Council of Social Security Fund of the PRC). The General Office of the

(Ministry of Finance of the PRC) also requested that such Domestic Shares allocated to

(the National Council of Social Security Fund of the PRC) to be offered to the

public at the time of the Company’s public offer and placing of H shares in 2004. The Company paid

the relevant net proceeds from public offer and placing of H shares to (the

Ministry of Finance of the PRC). Thus, upon the Company’s H shares were listed on the GEM on 15

April 2004, (the National Council of Social Security Fund of the PRC) no longer

held any interests in the Company.

Yalong Oil Pump, which was a limited liability company incorporated in the PRC, was

principally engaged in the business of manufacture and sale of petroleum extraction machinery. On 29

May 2003, the Company entered into an agreement with (Liu Chun Yuan), an Independent Third

Party, under which the Company has agreed to transfer the 30% equity interest held by it in Yalong

Oil Pump to (Liu Chun Yuan) at the consideration of RMB1,666,300 because Yalong Oil Pump

operates at a relatively small scale. The Directors were therefore not optimistic about the development

of Yalong Oil Pump at that time. The total consideration was calculated on the basis of the unaudited

net asset value of Ya Long Oil Pump as at 31 December 2002. On 1 April 2005, the same 30% equity

interests held by (Liu Chun Yuan) were transferred to Maolong Machinery at the consideration

of RMB1,888,500 on the basis of the unaudited net asset value of Ya Long Oil Pump as at 31

December 2004 because, as advised by the management of Maolong Machinery, Xinjiang Oil Field

experienced development in 2004-2005 which led to its increase in the demand for petroleum

equipment.

As a welfare enterprise established on 11 April 2001, Molong Machinery was entitled to full

exemption from corporate income tax. Such exemption, however, was subject to annual application by

Molong Machinery to and approval by the local tax bureau. Under the then regime, Molong Machinery

was required to pay the full amount of corporate income tax to the local tax bureau first and then

applied for exemption and refund. Application was made by Molong Machinery and approval was

granted for the year ended 31 December 2001. Molong Machinery did not apply for such exemption

from corporate income tax for the year ended 31 December 2002 as Molong Machinery was informed

that applications for exemption from corporate income tax would not be allowed in that year. Approval

SUMMARY

— 5 —

was granted to Molong Machinery for exemption of the corporate income tax for the year ended 31

December 2003. The Directors believe that there is an inherent uncertainty associated with whether

the local tax bureau would approve the tax exemption application, which is largely based on policy

reason or local financial condition in that year.

However, pursuant to (the Notice on the

Scope of Collection, Charge and Administration after the Reform of Revenue Sharing System Relating

to Corporate Income Tax) [2002]8 (Guo Shui Fa [2002] No. 8) issued by (the State

Tax Bureau) of the PRC (the “Notice”), the corporate income tax for all enterprises established and

registered on or after 1 January 2002 will be collected by (the State Tax Bureau) of the PRC

only, without having to go through the local tax bureau. Accordingly, a welfare enterprise established

on or after the 1 January 2002 is required to submit application to (the State Tax Bureau)

of the PRC for exemption of corporate income tax annually. The Directors believe that as long as the

welfare enterprise satisfies the required application procedures under the relevant PRC laws, it would

be likely for (the State Tax Bureau) of the PRC to grant the exemption of corporate income

tax. Thus, the uncertainty in association with the approval from the local tax bureau on the tax

exemption application as stated in the preceding paragraph would be eliminated.

In order to reorganize the businesses of the Group and to take advantage of the less burdensome

tax regime for enterprises established in the PRC on or after 1 January 2002, the Board resolved on

2 September 2004 to set up Molong Drilling Equipment to take up the oil well sucker rods, pumps and

related parts and components business, all of which were being conducted by Molong Machinery. On

the same day, the Company and (Shouguang City Shangkou Town People’s

Government) entered into the shareholders’ agreement and executed the articles of association.

Pursuant to the resolution of the shareholders’ meeting of Molong Machinery held on 2

September 2004, the undistributed profits of RMB66,310,000 standing in the books of Molong

Machinery as at 31 August 2004 had been distributed to its shareholders, namely the Company and

Maolong Machinery in accordance with their respective proportion of investment in Molong

Machinery. Such undistributed profit were distributed to Maolong Machinery by cash and the

remaining profits were distributed to the Company by way of transfer of assets and liabilities.

On 30 September 2004, the liquidation committee of Molong Machinery as vendor and Molong

Drilling Equipment as purchaser entered into a sale and purchase agreement, pursuant to which, the

liquidation committee of Molong Machinery has agreed to sell and Molong Drilling Equipment has

agreed to purchase the assets relating to oil well sucker rods and oil well pumps at a consideration of

approximately RMB5.9 million, which was determined based on the unaudited book value of such

assets as at 30 September 2004. The consideration was duly paid by cash and the transaction was

completed.

SUMMARY

— 6 —

On 24 November 2004, the Board also resolved that, upon completion of the transfer of assets

relating to oil well sucker rods and oil well pumps from Molong Machinery to Molong Drilling

Equipment by the liquidation committee, the assets of Molong Machinery were distributed among the

Company and Maolong Machinery in accordance with their respective proportion of investment in

Molong Machinery. The deregistration application by Molong Machinery was approved on 6

December 2004.

With a view to capitalizing on the favourable business environment and low tax regime in Hong

Kong and enhancing the profile of and competitiveness of the Group internationally, MPM was

incorporated in Hong Kong in May 2004 and became a member of the Group in May 2005. The

Company intends to develop its overseas business (such as selling of the Group’s petroleum machinery

products) through MPM in the long term. However, as at the Latest Practicable Date, MPM has not

commenced any business.

The H Shares were listed on the GEM since 15 April 2004 (stock code: 8261). As at the Latest

Practicable Date, based on the closing price of the H Shares on GEM of HK$2.12 per H Share, the

Company had a market capitalization of approximately HK$522 million.

On 9 July 2004, with the approval granted by (Ministry of Commerce of the

PRC), the Company transformed into a Sino-foreign joint stock limited liability company. The

Company is a Sino-foreign equity joint venture regulated by the Law of the PRC on Sino-foreign

Equity Joint Ventures.

On 12 May 2005, the Company completed the placement of 108,000,000 new H Shares at

HK$0.92 per H Share to raise the net proceeds of approximately HK$94.8 million. The Group applied

the net proceeds from the aforesaid placement for further expanding the production capacity of

petroleum casings.

STRENGTHS AND COMPETITIVE ADVANTAGES

The Directors consider that the success of the Group is primarily attributable to the following

principal factors:

● the Group’s commitment to deliver quality and reliable petroleum drilling and extraction

machinery products to its customers;

● its well-established customer base including well known oil fields in the PRC such as

PetroChina and Sinopec;

● its comprehensive quality control monitoring procedures used throughout the production

process as demonstrated by the Company having been awarded the ISO9001:2000

certificate and the right to use the API Monogram on certain of the Group’s principal

products;

SUMMARY

— 7 —

A1A(17)

● its strong in-house research and development teams which enable the Group to develop

efficient methods of production and modify its existing products to meet changing market

trends and customers’ needs;

● the steady demand for the Group’s products by its main customers. Since 1949, the PRC

Government has adopted the view that petroleum was an important strategic resource and

has adopted special policies to develop its national petroleum industry. In particular, it has

provided funding for and allocated other resources to the petroleum industry;

● the Group’s ability to adapt and respond quickly to customers’ demands and to provide

efficient after-sale services; and

● the Group’s advantages over its competitors. As compared with its primary competitors who

are state-owned petroleum drilling and extraction machinery manufacturers, the Group is

able to adapt more quickly to changes in market conditions, provide products with more

reliable quality and offer more efficient after-sale services.

PRODUCTS

The petroleum industry is generally divided into upstream and downstream operations. Upstream

operations include the drilling, extraction and production of petroleum, while downstream operations

refer to the transportation, refining and marketing of petroleum products.

Petroleum drilling and extraction requires oil well pumps, oil well pumping machines, oil well

pipes, casings, oil well sucker rods and other petroleum drilling and extraction machinery accessories.

The Group manufactures and sells petroleum drilling and extraction machinery and related

accessories primarily for use in upstream operations. A wide range of the Group’s products are

necessary for petroleum drilling and extraction.

SUMMARY

— 8 —

The Group primarily manufactures six types of products, namely, oil well pumps, oil well sucker

rods, oil well pipes, casings, oil well pumping machines and other petroleum drilling and extraction

machinery accessories. The majority of such products is for sale to major oil fields in the PRC, while

some of the products, such as oil well pipes, casings, oil well sucker rods, valves and mud pump steel

sleeves, are for export to the US, Europe and other countries.

The Group

Oil well pipesOil well

sucker rodsOil wellpumps

Regular oil wellpipes

Regular oil wellsucker rods

Regular oil wellpumps

Tip thickenedoil well pipes

Super-strengthoil well

sucker rods

Underground petroelectric pumps

Special seamlessoil well pipes

Special oil wellpumps

Other petroleumdrilling andextractionmachineryaccessories

Mud pumpsteel sleeves

Regular valves

Large-size highpressure

spherical valves

Fluid injectionpumps

Blade-guidepulleys

Oil well pumpingmachines

Regular oil wellpumping machines

Energy-savingoil well pumping

machines

Casings

Ordinary casings

Seamless casings

Notes:

The fundamental differences between the oil well pipe and casing are as follows:

1. The oil well pipe and casing are different products in nature. Oil well pipe is used as an oil stream channel whichallows oil to flow from underground to the surface, whereas casing is a cylinder which serves as the wall of andstabilizes the oil well. Therefore, the oil well pipe and casing are not inter-changeable due to their differentfunctions.

2. The oil well pipe is placed inside the casing.

3. The oil well pipe and casing require different production and raw material specifications. The production facilitiescan not be switched between the manufacture of the two products with minimal costs.

4. The oil well pipe and casing have different measurements.

5. Although the oil well pipe and casing bear the API Monogram, they are subject to different requirements andspecifications of the API.

6. The casing could only be used once but the oil well pipe can be used repeatedly.

SUMMARY

— 9 —

The Directors believe that the Group has the ability to modify its products speedily in response

to customers’ needs, has strong commitment on quality control and has established a reputation in the

PRC as a quality petroleum drilling and extraction machinery and related accessories manufacturer.

The following table sets out the percentages of the Group’s total revenue by product types for

each of the three years ended 31 December 2005 and the four months ended 30 April 2006.

For the year ended 31 December For the four months ended 30 April

2003 2004 2005 2005 2006

(Unaudited)

RMB’000 % RMB’000 % RMB’000 % RMB’000 % RMB’000 %

Oil well pipes 134,500 44.5 261,477 53.6 500,198 64.4 157,222 68.9 211,348 69.5

Oil well sucker rods 52,642 17.4 63,860 13.1 80,652 10.4 22,836 10.0 31,820 10.5

Oil well pumps 21,683 7.2 21,761 4.5 7,758 1.0 4,053 1.8 5,521 1.8

Casings 2,906 1.0 20,625 4.2 27,337 3.5 16,016 7.0 11,019 3.6

Oil well pumping

machines 3,669 1.2 6,087 1.2 9,287 1.2 3,067 1.3 3,815 1.3

Other petroleum drilling

and extraction

machinery accessories 86,874 28.7 113,878 23.4 151,290 19.5 25,186 11.0 40,691 13.3

Total 302,274 100 487,688 100 776,522 100 228,380 100 304,214 100

The following sets out the gross profit margin of the Group’s products for the three years ended

31 December 2005 and four months ended 30 April 2006.

For the year ended31 December

For the four monthsended 30 April

2003 2004 2005 2005(unaudited)

2006

(%) (%) (%) (%) (%)

Oil well pipes 12.5 15.3 23.9 18.9 24.5Oil well sucker rods 37.1 24.4 28.3 24.9 26.8Oil well pumps 33.4 36.4 39.7 23.2 53.9Casings 14.0 13.8 14.9 9.0 10.3Oil well pumping machines 27.9 18.0 7.6 11.7 9.9Other petroleum drilling and

extraction machinery

accessories 35.0 25.6 18.5 23.3 18.8

SUMMARY

— 10 —

For the three years ended 31 December 2005 and the four months ended 30 April 2006, the gross

profit margin of the Group’s oil well pump were approximately 33.4%, 36.4%, 39.7% and 53.9%

respectively. The Directors consider that the increase in profit margin of the oil well pumps for the

four months ended 30 April 2006 was attributed to the improvement of product quality so as to

increase the sales of the oil well pump products. For the three years ended 31 December 2005 and the

four months ended 30 April 2006, the gross profit margin of the Group’s oil well pumping machines

were approximately 27.9%, 18.0%, 7.6% and 9.9% respectively. Oil well pumping machines are

principally made of ordinary steel of which the steel prices increased significantly between 2004 and

2005. As such, the gross profit margin of oil well pumping machines had declined significantly since

2004.

SUMMARY

— 11 —

TRADING RECORD

The following table summarizes the consolidated audited results of the Group for the three yearsended 31 December 2005 and the four months ended 30 April 2006. The summary should be read inconjunction with the Accountants’ Report as set out in Appendix I to this document.

Year ended 31 DecemberFour months ended

30 April2003 2004 2005 2005 2006

(Unaudited)RMB’000 RMB’000 RMB’000 RMB’000 RMB’000

Revenue 302,274 487,688 776,522 228,380 304,214

Cost of sales (226,872) (391,030) (596,113) (184,460) (231,638)

Gross profit 75,402 96,658 180,409 43,920 72,576

Other revenue and gains 21,995 15,458 14,146 4,818 8,970Selling and distribution costs (11,299) (20,128) (24,853) (6,247) (9,563)Administrative expenses (11,099) (14,300) (33,162) (6,649) (10,274)Other expenses (10,914) (7,540) (17,577) (2,096) (5,732)Finance costs (4,738) (4,572) (3,444) (1,338) (1,920)

PROFIT BEFORE TAX 59,347 65,576 115,519 32,408 54,057Tax (13,197) (1,485) (27,271) (7,997) (18,396)

PROFIT FOR THE YEAR/PERIOD 46,150 64,091 88,248 24,411 35,661

Attributable to:Equity holders of the parent 43,977 61,366 85,227 23,866 34,977Minority interests 2,173 2,725 3,021 545 684

46,150 64,091 88,248 24,411 35,661

DIVIDENDSInterim — 10,806 12,982 — —Proposed final — 8,100 11,016 — —

— 18,906 23,998 — —

EARNINGS PER SHAREATTRIBUTABLE TOORDINARY EQUITYHOLDERS OF THE PARENT— Basic (RMB) 0.109 0.122 0.141 0.044 0.054

SUMMARY

— 12 —

3rd Sch(27)3rd Sch(30)Rules 8.05(1)a

FUTURE PLANS

The Group engages in the production of petroleum drilling and extraction machinery and related

accessories. The Group mainly supplies oil well pumps, oil well sucker rods, oil well pipes, casings,

oil well pumping machines and other petroleum drilling and extraction machinery accessories to oil

fields in the PRC.

According to China Statistical Yearbook 2005, the proportion of oil consumption in total energy

consumption in the PRC has risen from 18% in 1996 to 22.7% in 2004. The Group expects the demand

for petroleum drilling and extraction machinery and related accessories will remain strong in the

foreseeable future.

Expansion of market coverage

In order to develop a more extensive sales and distribution network, the Group intends to

increase its sales presence in both the PRC and overseas markets by expanding its sales force and

marketing activities. These activities will include participation in petroleum extraction machinery

exhibitions, regular oil fields visit and strengthening its relationships with existing customers. As at

the Latest Practicable Date, the Group has four domestic sales offices and an export department. The

four domestic sales offices are Northeast China office, Northwest China office, North China office and

Middle China office, respectively. Such domestic marketing offices provide sales and after-sale

services for its customers, which cover the oil fields in China, such as (Daqing Oil Field),

(Xinjiang Oil Field), (Shengli Oil Field), (Liaohe Oil Field),

(Zhongyuan Oil Field), (Changqing Oil Field) and (Dagang Oil Field). The Group

also intends to appoint authorized sales agents in overseas markets, particularly in strategic locations

such as the South East Asia region and the Middle East. The Group believes that appointing authorized

sales agents in such locations would assist the Group to increase sales of its products and to maintain

closer contacts with overseas markets.

Research and development

The Group will continue to focus on research and development in line with changing market

demands and customers’ needs. The Group is currently conducting research co-operations with

Zhongyuan Institute, Daqing Institute and Material Science and Engineering School of Xi’an Jiaotong

University in order to improve the production technology, in particular, such series of products as

special seamless oil well pipes, oil well pipes, oil well sucker rods and casings. The Directors believe

that the Group’s commitment to research and development for further enhancement of the product

quality and production efficiency with the efforts of the research and development centre of the

Company is critical in maintaining the Group’s competitive edge in the PRC and overseas market. In

addition, the Group will strengthen its research and development capability by recruiting more

research personnel with a view to improve the quality and functionality of its products in response to

the market trends.

SUMMARY

— 13 —

RISK FACTORS

The principal business of the Company is subject to a number of risk factors, the details of which

are set out in the section headed “Risk Factors” of this document. These risk factors can be categorised

into (i) risk factors relating to the Company; (ii) risk factors relating to the industry; and (iii) risk

factors relating to the PRC.

Risk factors relating to the Company

● Product concentration

● Reliance on major suppliers

● Reliance on Weihai Baolong for the supply of oil well pipe billets and casing billets

● Reliance on major customers

● Renewal of API Monogram licences

● Reliance on senior management

● Product liability

● Environmental protection

● Tax exemption and reduction

● Dividend policy

● Reliance on the PRC market

● Expansion into overseas markets

● The Group’s liquidity position

● Renewal of membership with Beijing Information Services Branch of PetroChina Sales

Company and Sinopec Market and Equipment Department

● Absence of building ownership certificates of certain properties

SUMMARY

— 14 —

Risk factors relating to the industry

● Technological innovation

● PRC Government regulations may limit the oil and gas industry activities and adversely

affect the Group’s business

● The PRC’s accession to the WTO results in relaxation of the restrictions on foreign

companies conducting business in petroleum drilling and extraction machinery industry and

may adversely affect the Group’s business

Risk factors relating to the PRC

● Foreign exchange and currency conversion in the PRC

● Political and social considerations

● PRC legal system

● Different regulatory systems

● Securities laws and regulations

● Enforcement of court judgements and arbitration

SUMMARY

— 15 —

In this document, unless the context otherwise requires, the following expressions have the

following meanings:

“Alloy Factory” (Gansu Industrial University Alloy

Materials Factory), a state-owned enterprise established in the

PRC on 1 April 1996 with a registered capital of

RMB5,000,000 and one of the Promoters

“API” American Petroleum Institute

“Articles of Association” the articles of association of the Company to be amended by

its shareholders at the Extraordinary General Meeting on 5

December 2006, a summary of which is set out in Appendix

V to this document

“associate” has the meaning ascribed to it under the Listing Rules

“Board” the board of Directors

“BOE” barrels of oil or equivalent

“Casting Supply Agreements” an agreement entered into between the Company and Molong

Equipment on 20 March 2004 (as amended by supplemental

agreements dated 20 December 2005 and 22 September 2006)

in relation to the supply of casting products to the Company

by Molong Equipment

“Class Meetings” the respective class meetings of the holders of the H Shares

and holders of Domestic Shares to be held at 10:00 a.m. and

11:00 a.m. respectively on 5 December 2006 at No. 99, Beihai

Road, Shouguang City, Shandong Province, the PRC or any

adjournment thereof

“CCASS” the Central Clearing and Settlement System established and

operated by HKSCC

“CIETAC” China International Economic and Trade Arbitration

Commission

“CNACL” China National Accreditation of Laboratories

“CNOOC” CNOOC Limited ( ), an Independent Third

Party

“Companies Ordinance” the Companies Ordinance (Chapter 32 of the Laws of Hong

Kong)

DEFINITIONS

— 16 —

“Company” (Shandong Molong Petroleum

Machinery Company Limited), a Sino-foreign joint stock

company incorporated in the PRC with limited liability

“Company Law” the Company Law of the PRC ( ) enacted

by the Standing Committee of the Eighth National People’s

Congress ( ) on 29 December

1993 and effective from 1 July 1994, as amended,

supplemented or otherwise modified from time to time

“Co-operative Agreement” an agreement entered into between Molong Drilling

Equipment and Ya Long Oil Pump on 12 July 2006 in relation

to the supply of oil well pumps and related accessories by

Molong Drilling Equipment to Ya Long Oil Pump

“CSRC” the China Securities Regulatory Commission

( ), a regulatory body responsible for the

supervision and regulation of the PRC securities markets

“Cui Huan You” , who is interested in approximately 1.43% of the

registered capital of the Company as at the Latest Practicable

Date and is one of the Promoters

“Director(s)” the director(s) of the Company

“Domestic Share(s)” ordinary domestic share(s) of nominal value of RMB1.00 each

(prior to the Share Sub-division) or RMB0.10 each (after the

Share Sub-division) in the registered capital of the Company

which are subscribed for in Renminbi, and which, as the date

of this document, are all promoter shares

“Dongying Factory” (Dongying Wukang Machinery Factory), a

collectively owned enterprise established in the PRC on 28

August 1992 with a registered capital of RMB6,090,000, who

is interested in approximately 34.29% of the registered capital

of Kaiyuan Oil

“Extraordinary General Meeting” an extraordinary general meeting of the Company to be held

at 9:00 a.m. on 5 December 2006 at No. 99 Beihai Road,

Shouguang City, Shandong Province or any adjournment

thereof

“GEM” the Growth Enterprise Market operated by the Stock

Exchange

“GEM Listing Committee” the sub-committee of the board of the Stock Exchange with

responsibility for GEM

“GEM Listing Rules” the Rules Governing the Listing of Securities on GEM

DEFINITIONS

— 17 —

“Group” the Company and its subsidiaries

“Guotai Junan” or “Sponsor” Guotai Junan Capital Limited, a licenced corporation under

SFO permitted to engage in type 6 of the regulated activities

(as defined in SFO)

“HKIAC” Hong Kong International Arbitration Centre

“HKSCC” Hong Kong Securities Clearing Company Limited

“Hong Kong” the Hong Kong Special Administrative Region of the PRC

“Hong Kong Government” the government of Hong Kong

“H Shares” overseas listed foreign invested shares with a nominal value

of RMB0.10 each in the registered share capital of the

Company

“Independent Third Party” or

“Independent Third Parties”

a person(s) or company(ies) which is/are not connected with

the Directors, Supervisors, chief executive, substantial

shareholders (as defined under the Listing Rules) of the

Company or any of its subsidiaries or any of their respective

associates

“Introduction” the proposed listing of the entire issued H Shares of the

Company on the Main Board by way of introduction pursuant

to the Listing Rules

“Kaiyuan Oil” (Shengli Oil Field Kaiyuan

Oil Exploitation Company Limited), a limited liability

company established in the PRC on 30 November 1994 with

a registered capital of RMB3,500,000, which was interested

in approximately 0.81% of the registered capital of the

Company as at the Latest Practicable Date and is one of the

Promoters. It is owned as to 65.71% by Tongli Industrial and

as to 34.29% by Dongying Factory

“Latest Practicable Date” 16 October 2006, being the latest practicable date prior to the

printing of this document for ascertaining certain information

contained herein

“Liang Yong Qiang” , who is interested in approximately 1.05% of the



“Lin Fu Long” , a Director who is interested in approximately 5.28%

of the registered capital of the Company as at the Latest

Practicable Date and is one of the Promoters

DEFINITIONS

— 18 —

“Listing Committee” the Listing Committee of the Stock Exchange

“Listing Date” the date on which dealings in the H Shares on the Main Board

commence, expected to be on 10 January 2007

“Listing Rules” the Rules Governing the Listing of Securities on The Stock

Exchange of Hong Kong Limited

“Liu Yun Long” , who is interested in approximately 2.26% of the



“Mackenzie” Mackenzie Cundill Investment Management Ltd. and

Mackenzie Cundill Investment Management (Bermuda) Ltd.

“Main Board” the stock market operated by the Stock Exchange which for

the avoidance of doubt, excludes GEM

“Mandatory Provisions” the “Mandatory Provisions for Articles of Association

of Companies to be Listed Overseas” (

) promulgated by the former Securities Commission

( ) and the former State Commission for

Restructuring the Economic System of the PRC

( ) on 27 August 1994, as amended,

supplemented and modified from time to time, for inclusion in

the articles of association of companies incorporated in the

PRC and seeking for a listing on a stock market outside the

PRC (including Hong Kong)

“Metallurgy Accessories Supply

Agreement”

an agreement entered into between the Company and Molong

Equipment on 22 September 2005 in relation to the supply of

metallurgy accessories to the Company by Molong Equipment

“Maolong Machinery” (Shouguang Maolong Machinery

Company Limited), a limited liability company established in

the PRC on 1 August 2000 with a registered capital of

RMB12,380,000. Maolong Machinery is interested in

approximately 6.9% of the registered capital of Molong

Machinery. Maolong Machinery is a connected person to the

Company. The shareholding structure of Maolong Machinery

as at the Latest Practicable Date is disclosed under the section

“Relationship with Maolong Machinery, Molong Equipment,

Maolong Recycle and Weihai Baolong”

DEFINITIONS

— 19 —

“Maolong Recycle” (Shouguang Maolong Old

Metals Recycle Company Limited), a limited liability

company established in the PRC on 13 December 2002 in

which the Company and Maolong Machinery is interested in

10% and 90% of its registered capital respectively

“Molong Drilling Equipment” (Weifang Molong Drilling Equipment


the PRC on 29 September 2004 with a registered capital of

RMB6,000,000, which is owned as to 90% by the Company

and 10% by Shangkou Town People’s Government

“Molong Equipment” (Shouguang Molong Electro-

mechanical Equipment Company Limited), a Sino-foreign

joint venture established in the PRC in which Maolong

Machinery and Mr. Fang are interested in 75% and 25%

respectively of its registered capital

“Molong Holdings” (Shandong Molong Holdings Company).

The predecessor of Molong Holdings was Weifang Molong,

which changed its name to Molong Holdings on 30 June 1994.

Molong Holdings was converted into the Company on 30

December 2001

“Molong Machinery” (Shouguang Molong Machinery


the PRC on 11 April 2001 in which the Company and Maolong

Machinery was interested in 93.10% and 6.90% of its

registered capital respectively. Molong Machinery was

deregistered on 6 December 2004

“MPM” MPM International Limited (formerly known as Molong

(Asia) Holding Limited), a limited liability company

established in Hong Kong on 24 May 2004 whose issued share

capital is owned as to 90% by the Company and 10% by

Maolong Machinery. MPM became a member of the Group in

May 2005

“Mr. Fang” (Luke Fang), one of the shareholders of Molong

Equipment, who is not connected with any of the Directors,

Supervisors, chief executive and substantial shareholders (as

defined under the Listing Rules) of the Company or any of its

subsidiaries or any of their respective associates

“Oil Well Pipe Billets and Casing

Billets Supply Agreement”

an agreement entered into between the Company and Weihai

Baolong on 22 September 2005 in relation to the supply of oil

well pipe billets and casing billets to the Company by Weihai

Baolong

DEFINITIONS

— 20 —

“OPEC” Organization of Petroleum Exporting Countries

“PBOC” the People’s Bank of China ( ), the central bank of

the PRC

“PBOC Exchange Rate” the exchange rate for foreign exchange transactions published

daily by PBOC

“PetroChina” PetroChina Company Limited ( ) or

its holding company, China National Petroleum Corporation

( ). Both are Independent Third Parties

“Petroleum Machinery Factory” (Shandong Shouguang Petroleum

Machinery Factory), which changed its name to Weifang

Molong on 8 August 1993 and subsequently to Molong

Holdings on 30 June 1994

“Petroleum Machinery Parts

Factory”

(Shandong Shouguang Petroleum

Machinery Parts Factory), the predecessor of the Company. It

was re-registered as Petroleum Machinery Factory on 8

September 1989 which changed its name to Weifang Molong

on 8 August 1993 and to Molong Holdings on 30 June 1994

“PRC” or “China” the People’s Republic of China which, for the purpose of this

document, excludes Hong Kong, the Macau Special

Administrative Region and Taiwan

“PRC Securities Law” the “Securities Law of the PRC” ( )

promulgated by the Standing Committee of the National

People’s Congress ( ) on 29

December 1998 and effective since 1 July 1999, as amended,

supplemented or otherwise modified from time to time

“Promoter(s)” the promoter(s) of the Company, which includes Zhang En

Rong, Lin Fu Long, Zhang Yun San, Xie Xin Cang, Liu Yun

Long, Cui Huan You, Liang Yong Qiang, Kaiyuan Oil and

Alloy Factory

“Promoters Agreement” the promoters agreement dated 8 November 2001 entered into

by the Promoters in relation to, among other matters, the

rights and obligations of the Promoters in connection with

capital injection and the conversion into and establishment of

the Company as a joint stock limited company

“Proposed Withdrawal” the proposed withdrawal of trading of the H Shares on GEM

“Prospectus” the prospectus issued by the Company on 30 March 2004 in

respect of the public offer and placing of H Shares

DEFINITIONS

— 21 —

“Regulations for the Reduction of

State Shares”

Provisional Administrative Measures for the Reduction of

State Shares and the Raising of the Social Security Fund

( ) promulgated by the

State Council on 12 June 2001

“SAFE” (the State Administration of Foreign

Exchange of the PRC)

“SAIC” (the State Administration for Industry

and Commerce of the PRC)

“SAT” (the State Administration of

Taxation of the PRC)

“Scrap and Used Metals Supply

Agreement”

an agreement entered into between the Company and Molong

Equipment on 22 September 2005 in relation to the supply of

scrap and used metals by the Company to Molong Equipment

“Securities Commission” the former Securities Commission of the State Council of the

PRC ( )

“Securities Provisional

Regulations”

(the Provisional Regulations

Concerning the Issue and Trading of Shares in the PRC)

“SFC” The Securities and Futures Commission of Hong Kong

“SFO” the Securities and Futures Ordinance (Chapter 571 of the

Laws of Hong Kong)

“Share(s)” Domestic Share(s) and/or H Share(s), as the case may be

“Shareholder(s)” holder(s) of the Share(s)

“Share Sub-division” the sub-division of each Share with a nominal value of

RMB1.00 to ten Shares with a nominal value of RMB0.10

each as approved by CSRC on 29 December 2003, details of

which are described in the section headed “Further

information about the Company” in Appendix VI to this

document

“Sinopec” China Petroleum & Chemical Corporation (

) or its holding company, China Petroleum

Corporation ( ). Both are Independent

Third Parties

“SIPO” (State Intellectual Property Office

of the PRC), previously known as (the

State Patent Office of the PRC)

DEFINITIONS

— 22 —

“Special Regulations” (the Special

Regulations of the State Council on the Overseas Offering and

Listing of Shares by Joint Stock Limited Companies)

promulgated by the State Council on 4 August 1994, as

amended, supplemented or otherwise modified from time to

time

“Special Steel” (Shandong Molong Special Steel

Company Limited), a limited liability company established

under the PRC law on 5 December 2002. On 28 February

2003, the Company entered into a series of sale and purchase

agreements to dispose of its 52% equity interests in Special

Steel. For further details, please refer to the “History and

development” section of this document

“State” or “PRC Government” the government of the PRC

“State Council” (the State Council of the PRC)

“State Restructuring

Commission”

(the State Commission for

Restructuring the Economic System of the PRC)

“Stock Exchange” The Stock Exchange of Hong Kong Limited

“Subsidiaries” have the meaning given to it by the Listing Rules

“Substantial Shareholders” have the meaning given to it by the Listing Rules

“Supervisor(s)” member(s) of the supervisory committee of the Company

“Takeovers Code” the Code on Takeovers and Mergers issued by the SFC, as

amended, supplemented or otherwise modified from time to

time

“Tongli Industrial” (Shengli Oil Field Tongli Industrial

Company Limited), a collectively owned enterprise

established in the PRC on 15 April 1992 with a registered

capital of RMB10,540,000 and is interested in approximately

65.71% of the registered capital of Kaiyuan Oil

“Track Record Period” the period from 1 January 2003 to 30 April 2006

“US” or “United States” The United States of America, its territories and possessions,

any state of the United States, and the District of Columbia

“VAT” value added tax of the PRC

DEFINITIONS

— 23 —

“Weifang Dragon” (Weifang Dragon Machinery Company

Limited), a Sino-foreign joint venture established in the PRC

in which the Company was interested in 70% and

(TMR Group Inc.) was interested in 30% of

its registered capital. Pursuant to an agreement dated 26

October 2002 entered into between the Company and TMR

Group Inc., the parties had agreed to terminate the operation

of Weifang Dragon at the expiry of its term of operation (i.e

26 January 2003). Weifang Dragon was deregistered on 2

April 2003

“Weifang Molong” (Weifang Molong Industrial Company).

The predecessor of Weifang Molong was Petroleum

Machinery Factory which changed its name to Weifang

Molong on 8 August 1993. Weifang Molong changed its name

to Molong Holdings on 30 June 1994

“Weihai Baolong” (Weihai Baolong Special Petroleum

Materials Co., Ltd.), a limited liability company established

in the PRC, which is owned as to 95% by Maolong Machinery

and as to 5% by Molong Equipment

“WTO” the World Trade Organization

“Xie Xin Cang” , a Director who is interested in approximately 3.3% of

the registered capital of the Company as at the Latest


“Yadong Company” (Kelamayi Yadong Company

Limited), a limited liability company established in the PRC

on 1 July 1999 with a registered capital of RMB13,930,000

who is interested in 70% of the registered capital of Yalong

Oil Pump. Yadong Company is owned as to 9% by Xinjiang

Petroleum Management Bureau ( ); as to 44% by

employee union ( ); and as to 47% by collective

enterprise planning funds ( ), Yadong

Company is an Independent Third Party

“Yalong Oil Pump” (Kelamayi Yalong Oil Pump


the PRC on 20 May 1996 which is owned as to 30% by the

Maolong Machinery and as to 70% by Yadong Company

“Zhang En Rong” , a Director who is interested in approximately 43.14%



DEFINITIONS

— 24 —

“Zhang Yun San” , a Director who is interested in approximately 4.72%



“HK$” and “cent(s)” Hong Kong dollars and cents respectively, the lawful currency

of Hong Kong

“RMB” or “Renminbi” Renminbi yuan, the lawful currency of the PRC

“US$” or “US dollar(s)” United States dollars, the lawful currency of the US

“sq.ft.” square feet

“sq.m.” square metre(s)

“%” or “per cent.” percentage

Unless otherwise specified in the document, brand names and trademarks referred to in the

document do not belong to the Group but are owned by various Independent Third Parties.

For ease of reference, the English names of PRC established companies, government authorities

and departments, entities and documents have been included in this document as translations of their

Chinese names for identification purpose only. In the event of any inconsistency, the Chinese version

shall prevail.

Unless otherwise specified in this document, amounts denominated in RMB and US$ have been

translated, for the purpose of illustration only, into HK$ as follows:

HK$1.00 = RMB1.04

HK$7.80 = US$1.00

The exchange rates above are for reference only. No representation is made by the Group that

any amounts in RMB, US$ or HK$ could have been or could be converted at the above rate or at any

other rates or at all.

The contents contained in the websites at www.molonggroup.com and www.molong.cn do not

form part of this document.

DEFINITIONS

— 25 —

This glossary contains explanations of certain terms used in this document in connection with the

Group and its business. The terminologies and their meanings may not correspond to standard

industry meanings or usage of those terms.

“API” The American Petroleum Institute that provides quality

certification programs, including the API Monogram

Program, with regard to equipment, products and services

relating to the oil and natural gas industry

“API Monogram” API’s mark represents quality of the products that carry such

mark to have met with the relevant standards as laid down in

the corresponding API Monogram Program

“API Monogram Program” The API Monogram Equipment Licensing Program operated

by API whereby companies are licensed to feature the API

Monogram on their products subject, among others, to

meeting certain quality standards as prescribed by API

“FSU” former Soviet Union

“GDP” gross domestic product

“ISO” The International Organization for Standardization, a

worldwide federation of national standards bodies of about

148 countries

“ISO 9000 series” a series of international standards on quality management and

quality assurance developed by ISO Technical Committee 176

“ISO 9001” a constituent part of the ISO 9000 series which covers the

areas of design control, management responsibility, quality

system, purchasing, process control, control of non-

conforming product, corrective and preventive action, and

other areas

“ISO 9002” a constituent part of the ISO 9000 series which covers the

areas of management responsibility, quality system,

purchasing, process control, control of non-conforming

product, corrective and preventive action, and other areas

“mb/d” million barrels per day

GLOSSARY OF TECHNICAL TERMS

— 26 —

You should consider carefully all the information containing in this document including the

risk factors set out below.

RISK FACTORS RELATING TO THE COMPANY

Product concentration

A significant portion of the Group’s turnover is generated from the sale of oil well pipes. For

each of the three years ended 31 December 2005 and the four months ended 30 April 2006, sales from

oil well pipes accounted for approximately 44.5%, 53.6%, 64.4% and 69.5% of the Group’s turnover,

respectively. As described in the section headed “Industry Overview”, revenue of the oil field

equipment and service industry is dependent on the exploration and production capital expenditures

of oil and gas producers, which in turn is dependent on current prices of and future trends in, global

oil and gas prices. The number of worldwide active rigs increases and decreases with fluctuation in

the price of oil. Thus, the oil price decline may have an indirect adverse impact on the future demand

of the petroleum drilling and extraction equipment manufactured by the Group. Accordingly, any

significant fluctuation in the market demand for and/or the price of oil well pipes may adversely affect

the sales of oil well pipes and hence the Group’s profitability.

Reliance on major suppliers

For each of the three years ended 31 December 2005 and the four months ended 30 April 2006,

purchases from the largest supplier of raw material of the Group, accounted for approximately 24.2%,

31.0%, 22.8% and 12.0% of the total purchases of raw material of the Group, respectively. The

Group’s purchases from the five largest suppliers of raw material accounted for approximately 60.3%,

61.1%, 52.8% and 43.1% of the total purchases of raw material of the Group, respectively. If the

Group’s major suppliers cease to supply to the Group or increase the price of the materials and the

Group is not able to identify an alternative source for such materials, the operation and profitability

of the Group may be adversely affected.

Reliance on Weihai Baolong for the supply of oil well pipe billets and casing billets

On 22 September 2005, the Company entered into the Oil Well Pipe Billets and Casing Billets

Supply Agreement with Weihai Baolong. Weihai Baolong is a non wholly-owned subsidiary of

Maolong Machinery. Both Maolong Machinery and Weihai Baolong are connected persons of the

Company.

In relation to the continuing connected transactions under the Oil Well Pipe Billets and Casing

Billets Supply Agreement which is effective from 28 November 2005 to 31 December 2007 (both dates

inclusive), (i) for the six months ended 30 June 2006, the Company sourced 21,725.35 tonnes of oil

well pipe billets and casing billets in the amount of approximately RMB70,000,000 from Weihai

Baolong. The Directors estimate that the Company would source 126,000 tonnes of oil well pipe

billets and casing billets in the amount of approximately RMB400,000,000 from Weihai Baolong for

the six months ending 31 December 2006. These purchases would represent approximately 72.3% of

the total estimated purchase amount of the Company for oil well pipe billets and casing billets and

RISK FACTORS

— 27 —

44.4% of the total estimated raw material costs of the Company for the year ending 31 December 2006;

and (ii) for the year ending 31 December 2007, the Directors estimate that the Company would source

250,000 tonnes of oil well pipe billets and casing billets in the amount of approximately

RMB790,000,000 from Weihai Baolong. These purchases would represent 69.7% of the total estimated

purchase amount of the Company for oil well pipe billets and casing billets and 48.82% of the total

estimated raw material costs of the Company for the year ending 31 December 2007.

If Weihai Baolong ceases to supply or suspends its supply of billets to the Group or increases

the price of billets and the Group encounters difficulties to source sufficient billets from other

suppliers, the operation and profitability of the Group may be adversely affected.

Reliance on major customers

A significant portion of the Group’s revenue has been, and may continue to be, derived from a

limited number of customers. For each of the three years ended 31 December 2005 and the four months

ended 30 April 2006, the Group’s sales to its largest customer, PetroChina, accounted for

approximately 68.6%, 57.5%, 55.2% and 46.3% of the Group’s turnover respectively and the Group’s

sales to its five largest customers accounted for approximately 96.3%, 90.3%, 87.4% and 84.2% of the

Group’s turnover respectively. The five largest customers of the Group are independent of and not

connected with any of the Directors, chief executives, Supervisors, substantial shareholders of the

Company or its subsidiaries or any of their respective associates. In the event that the Group fails to

secure new contracts from such major customers, and is not able to obtain new customers and/or any

of the major customers encounters operating and/or financial difficulties, the Group’s business and

financial position may be adversely affected.

Renewal of API Monogram licences

The Group has been granted the licenses to put on certain of its products the API Monogram

which is an indicator of the quality standards of its products. Pursuant to the practice of API, the API

certificate has to be renewed every three years. During the examination process, API will send its

technical staff to audit the manufacturing facilities as well as the production management of the

applicant for the API certificate. The Group has to pay an annual fee of approximately US$5,450 of

which such amount covers three API certificates. In addition, the Group has to pay the examination

fees (approximately US$2,520 for the examination in December 2004) and the travelling expense

reimbursement to API.

After the Group fulfilled the examination from API in December 2000, the Group obtained the

API certificates (valid between 2001 and 2004).

Before the expiry of the API certificates, the Group also fulfilled the examination requirements

from API and obtained the API certificates (valid between 2004 and 2007). Each of the three existing

licences by API in favour of the Group to use the API Monogram on certain of the Group’s principal

products, namely, pumps and pump parts, casings and oil well pipes, oil well sucker rods and

couplings will be expired on 2 January 2007. Currently, over 80% of the Group’s products bears the

API Monogram. In the petroleum machinery industry, products bore with the API Monogram are the

very common standard/requirements set by the oil producers (both domestic and foreign countries).

RISK FACTORS

— 28 —

However, it is by no means certain at this stage that renewal for such licences would be successful

after the above expiry. In the event that the Group does not obtain a renewal of any of such licences,

the Company may not be able to participate in certain significant bidding and tender activities and the

export volume of the Group may be reduced, and as a result, the Group’s business may be adversely

affected.

Reliance on senior management

The Group’s success is attributable to, among other things, the contribution and continuous

service and performance of the Group’s senior management team as stated in the section headed

“Directors, supervisors, senior management and staff”. Each executive Director has entered into a

service contract with the Group for a term of 3 years commencing from 20 March 2004. However,

there is no assurance that the Group is able to retain member(s) of the senior management team or

recruit further competent personnel for its future development. The unanticipated departure of any

member of the Group’s senior management team without immediate and adequate replacement or the

inability to recruit competent successor(s) or further competent personnel for its future development

could have a material adverse impact on the Group’s business.

Product liability

The products developed or to be developed by the Group are usually critical to the operations of

its customers. Should there be any defect or error in such productions that causes damage to operations

and/or business of the customers, the Group may have to incur additional expenses either to rectify

the defect or error or to indemnify the customers for any losses that the customers may suffer.

In addition, the Group has maintained no insurance to cover any liability arising from or as a

result of any defect in its products.

As a result, occurrence of product liability arising from the Group’s operation could have a

material adverse impact on the Group’s results and financial position.

Environmental protection

The Group’s operations are subject to environmental protection laws and regulations

promulgated by national, provincial and/or local environmental protection authorities of the PRC. The

Directors confirmed that the Group complies in all material respects with all relevant environmental

protection laws and regulations. However, any amendment of existing laws or regulations may impose

additional or more stringent requirements in this regard. The Group’s compliance with such new laws

or regulations may require the Group to incur significant capital expenditures or other obligations or

liabilities, which could create a substantial financial burden on the Group.

RISK FACTORS

— 29 —

In addition, the Group does not have any insurance policy covering liabilities relating to breach

of environmental laws and/or regulations. The incurring of any substantial amount of such liabilities

could have a material adverse impact on the Group’s results and financial position.

Tax exemption and reduction

The tax document Cai Shui Zi [1999] No. 290

(Provisional Measures on the Deduction and Exemption of Enterprise Income Tax for Investment on

Technology Adaptation of State-owned Assets) allows the deduction of the excess amount of current

year corporate income tax over prior year corporate income tax by an approved amount of purchasing

domestic manufactured equipment used for qualified technological improvement projects.

Molong Drilling Equipment was approved by Department of Civil Affairs of Shandong Province

as a welfare enterprise. As a welfare enterprise, Molong Drilling Equipment was entitled to a full

exemption from corporate income tax according to the tax document Cai Shui Zi [1994] No. 1

(The Notice regarding Certain Preferential Policies on Enterprises

Income Tax) and the refund of output VAT according to the tax document Guo Shui Fa [1994] No. 155

(The Notice about the Levy of Turnover Tax of

Welfare Enterprise issued by the State Tax Bureau), both are subject to annual approval.

There is no assurance that these preferential tax treatments will continue to apply to the

Company and/or Molong Drilling Equipment in the future. In the event of any unfavourable changes

in relation to such preferential tax treatments, the Group’s profitability and financial position may be

adversely affected.

Dividend policy

Potential investors should note that the previous dividend payments of the Company should not

be used as a reference for the Company’s dividend policy. The Directors expect that, in future,

dividend recommendation will be dependent upon the Company’s earnings, financial condition, cash

requirements and availability, and other relevant factors. Further details regarding the dividend policy

of the Company are set out in the paragraph headed “Dividends” under the section headed “Financial

information” in this document.

Reliance on the PRC market

The Group principally focused on the PRC market during the Track Record Period. For the three


approximately 84.8%, 81.7%, 72.2% and 62.7% of its products to domestic customers in the PRC. The

Directors anticipate that the sales of the Group’s products in the PRC will continue to represent a

significant proportion of the Group’s total revenue in the near future. Accordingly, the Group is

RISK FACTORS

— 30 —

exposed to changes in the economic, political and social conditions, legal and regulatory requirements

and taxation treatment in the PRC as well as changes in the domestic demands for the Group’s

products. There is no assurance that such changes will not affect the performance of the Group.

Expansion into overseas markets

The products of the Group are partly for the export to overseas customers. The Group also

intends to expand its sales network by appointing authorised sales agents in overseas markets,

particularly in strategic locations such as the South East Asia region and the Middle East. The Group

faces risks in maintaining and expanding its business overseas, which include differences in legal and

regulatory requirements, fluctuations in currency exchange rates and changes in political and

economic conditions. The deployment of human and financial resources in pursuit of such expansion

plans would have an adverse impact on the Group.

The Group’s liquidity position

As at 31 December 2003, 2004, and 2005, and 30 April 2006, the net current assets of the Group

were approximately RMB50.92 million, RMB113.28 million, RMB55.15 million and RMB49.41

million, respectively. As at 31 December 2003, the Group’s current liabilities was approximately

RMB239.45 million, which mainly included trade and bill payables of RMB120.32 million. As at 31

December 2004, the Group’s current liabilities were approximately RMB220.41 million, which mainly

included trade and bill payables of RMB169.09 million. As at 31 December 2005, the Group’s current

liabilities was RMB544.06 million, which mainly included trade and bill payables of approximately

RMB421.18 million. As at 30 April 2006, the Group’s current liabilities were RMB631.42 million,

which mainly included trade and bill payables of approximately RMB482.38 million. As at 31

December 2003, 2004, and 2005, and 30 April 2006, the current assets of the Group were

approximately RMB290.37 million, RMB333.69 million, RMB599.21 million and RMB680.82

million, respectively, which included cash balances of approximately RMB63.08 million, RMB26.07

million, RMB110.16 million and RMB31.52 million, respectively. For the three years ended 31

December 2005 and the four months ended 30 April 2006, the Group’s current assets to current

liabilities ratio was approximately 1.21, 1.51, 1.10 and 1.08, respectively.

There is no assurance that the Group’s net current assets position will be maintained in the

future. The Group’s liquidity position in the future will primarily depend on its ability to maintain

adequate cash inflow from operations to meet the Group’s liabilities as they become due and the

Group’s ability to maintain adequate external financing to fund its operations. In the event that the

Group is unable to generate sufficient cash flow from its operations and maintain adequate external

financing, the Group’s financial position will be adversely affected, which will in turn weaken the

Group’s financing ability and the performance of the Group is likely to be adversely affected. Further

details of indebtedness and liquidity, financial resources and capital structure of the Group are set out

in the section headed “Financial Information” in this document.

RISK FACTORS

— 31 —

Renewal of membership with Beijing Information Services Branch of PetroChina Sales

Company and Sinopec Market and Equipment Department

The Company has been a member of the Beijing Information Services Branch of PetroChina

Sales Company and a First Class Network Supplier of Sinopec Material and Equipment Department

the predecessor of which was Sinopec Materials Resources Market. Such memberships are necessary

for the Company to sell its products to the subsidiaries or branch oil fields of PetroChina and/or

Sinopec. The Company’s membership in Sinopec Material and Equipment Department has no expiry

date, whereas the Company’s membership in the Beijing Information Services Branch of PetroChina

Sales Company will expire on 6 December 2006. It is uncertain as to whether the renewal for such

membership would be successful. In the event that the Group is not able to renew such membership,

there may be an adverse impact on the Group’s business.

Sinopec maintains an evaluation system to examine the performance of its network suppliers.

Suppliers who fail in the evaluation may result in its membership being suspended or terminated.

The membership of network suppliers of Sinopec Material and Equipment Department would be

suspended when: (i) the supplier delays in supplying relevant products to the extent that the

production is adversely affected; (ii) the supplier fails to provide after-sale services in accordance

with the terms and conditions stipulated in the relevant agreement; or (iii) products supplied by the

suppliers (including the replacement products, where applicable) do not conform with the relevant

quality requirements.

The above membership may be terminated if the supplier fails to perform the relevant supply

agreement without any justification or loses its ability to perform the same agreement.

Absence of building ownership certificates for certain properties

As at the Latest Practicable Date, the Group had not obtained the related building ownership

certificates for certain buildings (Please refer to the paragraph headed “Properties” under the

“Business” section of this document), as disclosed in pages III-8 to III-12 of this document. The Group

owns the land use rights of such buildings and has commenced the application process to obtain the

relevant building ownership certificates. However, there is no assurance that the Group would be able

to obtain such building ownership certificates in the near future. If the Group is unable to obtain such

building ownership certificates, the Group may not be able to transfer or dispose of such buildings.

As at the Latest Practicable Date, such buildings are not susceptible to any demolition order and the

Group is not liable for any penalty in relation thereto. The aggregate of the construction costs for the

buildings without ownership certificates is approximately RMB57 million. In addition, should the

Group mortgage such buildings in the future, the lack of the relevant building ownership certificates

would affect its right to register the mortgage with the relevant governmental authorities, and thus

such mortgage would have no legal effect and would not be binding on any third party.

RISK FACTORS

— 32 —

RISK FACTORS RELATING TO THE INDUSTRY

Technological innovation

The Group’s ability to maintain its competitiveness in the market is largely dependent on its

ability to enhance and upgrade its existing products and to develop competitively priced, new and

technologically more advanced products to meet customers’ requirements. Although the Group has

successfully adapted to market needs in the past, the Group may encounter difficulties in identifying,

developing, manufacturing and marketing its products in the future. The Group’s profits may be

adversely affected in the event that the Group is unable to respond to rapid technological advances or

new innovative products developed by its competitors.

PRC Government regulations may limit the oil and gas industry activities and adverselyaffect the Group’s business

PRC oil and gas companies are extensively regulated by the PRC government. Central

government authorities, such as the National Development and Reform Commission, the Ministry of

Finance, the Ministry of Land and Resources, the Ministry of Commerce and the State Bureau of

Taxation and the local price bureaus, have extensive control over various aspects of PRC’s oil and gas

industry. As a result, any unfavorable material change in policy towards petroleum companies may

significantly restrain the Group’s ability to develop or expand its business operations or to maximize

its profitability.

The PRC’s accession to the WTO results in relaxation of the restrictions on foreigncompanies conducting business in petroleum drilling and extraction machinery industry andmay adversely affect the Group’s business

The PRC’s entry to the WTO may result in the PRC eventually lifting its restrictions which

prohibit the direct sales of petroleum drilling and extraction machinery and related accessories by

foreign companies to the PRC or other restrictions that limit competition by foreign companies in the

PRC petroleum drilling and extraction machinery and related accessories industry. Accordingly, the

Group’s profits may be adversely affected in the event that more foreign competitors enter into the

PRC market.

RISK FACTORS RELATING TO THE PRC

Foreign exchange and currency conversion in the PRC

Renminbi is currently not freely convertible against other currencies. However, the Company

may need to pay dividends to overseas shareholders in Hong Kong dollars. Pursuant to the

“Regulations on the Administration of the Settlement, Payment and Sale of Foreign Exchange”

( ), foreign exchange required for the payment of dividends to the Company’s

overseas shareholders may be purchased from designated banks upon approval of board resolutions

authorising the distribution of profits or dividends of the Company.

RISK FACTORS

— 33 —

R19A.42(64)

On 1 January 1994, the PRC government abolished its two-tier exchange rate system and

replaced it with a unified floating exchange rate system, which is largely based on market supply and

demand. Since the introduction of this unified floating exchange rate system, movements in the

exchange rate of Renminbi against other currencies, such as HK$, are to a certain extent subject to

market forces. However, the value of Renminbi is also subject to changes as a result of the PRC

government’s policies or international economic and political developments.

In addition, there is no assurance that Renminbi will not be subject to devaluation or depreciation

due to administrative or legislative intervention by the PRC government. Since the Company is

required to convert Renminbi into Hong Kong dollars for the payment of dividends to overseas

shareholders and Renminbi is not freely convertible, any devaluation of Renminbi may have an

adverse impact on the value of dividends payable on the H Shares in Hong Kong dollars term. Apart

from that, since export of the Company increases, any substantial appreciation of Renminbi may have

an adverse impact on the export performance and financial status of the Company.

Political and social considerations

Since 1987, the PRC has been undergoing a series of economic reforms, gradually transforming

from a planned economy into a market economy. Most of these reforms are expected to be refined

further. Other political and social factors may also lead to further adjustments and improvements of

the reform measures. However, the reform measures implemented by the PRC government may not

always have a positive effect on the operations of the Company. Political and social changes in the

PRC arising from the implementation of government policies may have an adverse impact on the

operations and performance of the Company.

PRC legal system

The PRC legal system is based on statutory law. While prior court decisions may be cited as

persuasive authority, they do not constitute binding precedents. Since 1979, the PRC government has

been developing a comprehensive system of commercial laws and a considerable number of laws and

regulations dealing with economic matters such as corporate organisation and governance, securities,

foreign investment, taxation and trade have been introduced. Since these laws and regulations are

relatively new and there is only a limited number of published case law and judicial interpretations

on these laws and regulations, their interpretation and enforcement involve some uncertainty.

Different regulatory systems

As the operation of the Company is solely carried out in the PRC, the Company is subject to legal

regulations of the PRC. Being a PRC-incorporated company issuing shares and listed outside the PRC,

the Company is also subject to the Special Regulations and the Mandatory Provisions. The Mandatory

Provisions contain certain provisions required to be included in the articles of association of PRC

companies to be listed outside the PRC, including those to be listed in Hong Kong. Such provisions

RISK FACTORS

— 34 —

are intended to regulate the internal affairs of such companies. Generally, the Company Law and

Special Regulations, in particular those relating to the protection of shareholders’ rights and access to

information, are not as developed as those applicable to companies incorporated in Hong Kong, the

United Kingdom, the US and other developed countries or regions.

There are material differences between the Company Law and the company laws of Hong Kong,

the US and other common law countries or regions, particularly in respect of investor’s protection,

including such areas as minority derivative action, minority protection, restrictions on directors,

financial disclosure, variations of class rights, procedures at general meetings and payments of

dividend.

The limited protection for investors offered by the Company Law may be compensated by a

certain extent by the introduction of the Mandatory Provisions and certain additional provisions

required by the Listing Rules. This narrows the differences between the Companies Ordinance and the

Company Law. The Mandatory Provisions and the additional provisions are required to be included

into the articles of association of PRC companies listed in Hong Kong. The Articles of Association

have included Mandatory Provisions and the additional provisions required by the Listing Rules.

However, the inclusion of the Mandatory Provisions and the additional provisions required by the

Listing Rules does not guarantee that holders of the H Shares can enjoy similar protections offered to

them in other jurisdictions.

Securities laws and regulations

The securities regulatory framework in the PRC is still in an early stage of development. The

securities markets of the PRC are regulated and administered by the CSRC, which is also responsible

for drafting the relevant laws and regulations. Laws and regulations promulgated by the State Council

and relevant measures implemented by the CSRC, such as acquisition and disclosure rules of listed

PRC companies, may be applicable to a joint stock limited company incorporated in the PRC whose

shares are listed on stock exchanges outside the PRC, such as the Company.

The Securities Law of the PRC ( ) became effective on 1 July 1999 and its most recent

amendment took effect on 1 January 2006. This is the fundamental legislation that regulates the PRC

securities market. The Securities Law of the PRC ( ) is applicable to, among other matters,

the issue and sale and purchase of shares within the PRC. The Company Law, relevant laws and

regulations promulgated recently and other legislations relating to PRC companies with public share

offerings outside the PRC (including Hong Kong), to a certain extent, form the legal framework

regulating the behaviour of companies (such as the Company) and their directors and shareholders.

Investors are reminded that the regulatory framework for the PRC securities industry is still at an early

stage of development. Any changes to this framework are beyond the control of the Company.

RISK FACTORS

— 35 —

Enforcement of court judgments and arbitration

The PRC is not a party to any agreements or arrangements for the endorsement and enforcement

of any judgement of the courts of Hong Kong or in most of the other jurisdictions except that on 14

July 2006, the Hong Kong Government and PRC Government signed an agreement entitled “An

Arrangement on Reciprocal Enforcement of Judgements in Civil and Commercial Matters by the

Courts of the Mainland and of the Hong Kong Special Administrative Region pursuant to the Choices

of Court Agreements between Parties Concerned” under which they agreed to recognize money

judgements on disputes arising from commercial contracts where the parties concerned, on the basis

of freedom of contract, have made an agreement in writing in which a court of the mainland China or

a court of Hong Kong is expressly designated as the court to have sole jurisdiction for resolving the

dispute concerned. Please note that the above money judgements do not cover all judgements made

by any of the courts of the mainland China or of Hong Kong. As a result, it may be difficult for the

Company to seek endorsement and enforcement in the PRC of any judgement of the courts of Hong

Kong or other jurisdictions. It should be stressed that, pursuant to the Articles of Association, any

disputes between holders of H Shares and the Company, the Directors, Supervisors, managers or

members of the management, or any claim, related to any matter of the Company, arising out of the

rights or obligations under the Articles of Association, Company Law or Companies Ordinance, should

be put before HKIAC or CIETAC for arbitration. Arbitral award from such organization should be

final and binding on all parties involved.

The PRC is one of the signatories of the Convention on the Recognition and Enforcement of

Foreign Arbitral Awards (the “New York Convention”) and accordingly allows the enforcement of

arbitral awards given by the arbitration bodies of other New York Convention signatories. Since the

sovereignty over Hong Kong was reverted to the PRC on 1 July 1997, the New York Convention is

no longer applicable for the enforcement of arbitral awards of Hong Kong in other regions of the PRC.

The new mutual arrangement for the enforcement of arbitral awards of the PRC and Hong Kong in

such regions, which has been approved by the Supreme People’s Court of the PRC

( ) and the Legislative Council of Hong Kong, became effective on 1 February 2000.

Additional information relating to arbitration, including the Arbitration Law of the People’s

Republic of China ( ) which became effective on 1 September 1995, are set out in the

paragraph headed “Arbitration and enforcement of arbitral awards” in Appendix IV to this document.

RISK FACTORS

— 36 —

CONTINUING CONNECTED TRANSACTIONS

The Company has entered into certain transactions which would constitute non-exempt

continuing connected transactions of the Company under the Listing Rules after the H Shares are listed

on the Main Board. The Company has received from the Stock Exchange a waiver from strict

compliance with the announcement and/or independent shareholders’ approval requirement set out in

Chapter 14A of the Listing Rules for such non-exempt continuing connected transactions. Further

details of such non-exempt continuing connected transactions and the waiver are set out in the section

headed “Connected Transactions” in this document.

MANAGEMENT PRESENCE

Pursuant to Rules 8.12 and 19A.15 of the Listing Rules, the Company must have a sufficient

management presence in Hong Kong. This normally means that at least two of its executive directors

must be ordinarily resident in Hong Kong. As the principal business operations and manufacturing

facilities of the Group are primarily located in the PRC, the senior members of the Group are therefore

based in China. As at the Latest Practicable Date, Mr. Chan Wing Nang, Billy, the company secretary

and qualified accountant of the Company, is ordinarily resident in Hong Kong and none of the

executive Directors are Hong Kong residents and are based in Hong Kong. The Directors believe that

it would be practically difficult and commercially infeasible for the Company to appoint two Hong

Kong residents as executive Directors or to relocate the Company’s executive Directors who are

resident in China to Hong Kong merely for the purpose of complying with Rules 8.12 and 19A.15 of

the Listing Rules.

The Company has received from the Stock Exchange a waiver from compliance with Rules 8.12

and 19A.15 of the Listing Rules subject to the following conditions:

(a) The Company will appoint two authorised representatives pursuant to Rule 3.05 of the

Listing Rules who will act as the Company’s principal communication channel with the

Stock Exchange and will ensure that they comply with the Listing Rules at all times. The

two authorised representatives appointed are Mr. Chan Wing Nang, Billy who is an

ordinarily resident in Hong Kong and Mr. Xie Xin Cang, an executive Director;

(b) Each of the authorised representatives will be available to meet with the Stock Exchange

in Hong Kong within a reasonable period of time upon request and will be readily

contactable by mobile or residential telephone, facsimile or email. Each of the two

authorised representatives has been duly authorised to communicate on behalf of the

Company with the Stock Exchange;

(c) In addition, the Company has appointed a compliance adviser pursuant to Rule 3A.19 of the

Listing Rules who will also act as the Company’s communication channel with the Stock

Exchange;

WAIVERS FROM STRICT COMPLIANCE WITHTHE REQUIREMENTS UNDER THE LISTING RULES

— 37 —

(d) Both authorised representatives have means to contact all members of the board of

Directors (including the independent non-executive Directors) promptly at all times as and

when the Stock Exchange wishes to contact the members of the Board for any matters. The

Company will implement a policy whereby (a) each executive Director will provide his or

her respective mobile phone number, residential phone number, fax number and email

address to the authorised representatives; (b) each executive Director will provide valid

phone numbers or means of communication to the authorised representatives when he or she

travels; and (c) each executive Director will provide his or her mobile phone number,

residential phone number, office phone number, fax number and email address to the Stock

Exchange; and

(e) all executive Directors and independent non-executive Directors who are not ordinarily

resident in Hong Kong have confirmed that either they possess or will be able to apply for

valid travel documents to visit Hong Kong and will be able to meet with the relevant

members of the Stock Exchange within a reasonable period of time, when required.

NON-DISPOSAL OF SHARES

The Company has applied to the Stock Exchange for, and the Stock Exchange has granted, a

waiver from strict compliance with the restrictions on further issues of securities within six months

of listing on the Main Board as required by Rule 10.08 of the Listing Rules and a consequential waiver

from strict compliance with the restrictions under Rule 10.07(1)(a) of the Listing Rules in respect of

the deemed disposal of Shares by the controlling shareholder of the Company upon the issue of

securities by the Company within six months of listing on the Main Board subject to the following

conditions:

(i) any issue of Shares (or convertible securities) during the first six months after listing on

the Main Board must be either for cash to fund a specific acquisition or as part or full

consideration for an acquisition;

(ii) the acquisition must be for assets or business(es) that will contribute to the growth of the

operation of the Group; and

(iii) Zhang En Rong, the controlling shareholder of the Company, should not cease to be a

controlling shareholder of the Company upon the issue of any Shares within six months of

the listing on the Main Board.


— 38 —

The Company has applied to the Stock Exchange for waivers from strict compliance with Rules

10.07(1)(a) and 10.08 of the Listing Rules for the following reasons:

(1) the Company will not raise any new funds pursuant to the Introduction. Therefore, the

Shareholders would not suffer any dilution of their interests as a result of the Company’s

listing on the Main Board;

(2) Mr. Zhang En Rong, the controlling shareholder of the Company, has not disposed of any

Shares since the establishment of the Company and intends not to dispose of any Shares

owned by him within 6 months from the date on which the H Shares are listed on the Main

Board; and

(3) the interests of the Shareholders are protected since any further issue of Shares by the

Company would be subject to Shareholders’ approval as required under Rule 19A.38 of the

Listing Rules.


— 39 —

DIRECTORS’ RESPONSIBILITY FOR THE CONTENTS OF THIS DOCUMENT

This document, for which the Directors collectively and individually accept full responsibility,

includes particulars given in compliance with the Securities and Futures (Stock Market Listing) Rules

and the Listing Rules for the purpose of giving information with regard to the Group. The Directors,

having made all reasonable enquiries, confirm that, to the best of their knowledge and belief:

(a) the information contained in this document is accurate and complete in all material respects

and not misleading;

(b) there are no other matters the omission of which would make any statement in this

document misleading; and

(c) all opinions expressed in this document have been arrived at after due and careful

consideration and are founded on bases and assumptions that are fair and reasonable.

NO CHANGE IN BUSINESS

No change in the business of the Group is contemplated following the Introduction.

APPLICATION FOR LISTING ON THE MAIN BOARD

The Company has applied to the Listing Committee for the listing of, and permission to deal in,

on the Main Board the 246,276,000 H Shares in issue.

DISCONTINUATION OF QUARTERLY REPORTING

Under the GEM Listing Rules, the Company is required to publish its quarterly results on the

internet website operated by the Stock Exchange. Upon the listing of the H Shares on the Main Board,

the Company will cease the practice of quarterly reporting and will follow the relevant requirements

of the Listing Rules which include, among other things, through paid announcements in newspapers

generally circulated in Hong Kong, publish its interim results and annual results within three months

and four months from the end of the relevant period or financial year end, respectively. The Directors

are of the view that following the reporting requirements under the Listing Rules will provide

investors and the Shareholders with a high degree of transparency and a more complete picture of the

performance of the Group during the relevant period. The Directors also believe that the cessation of

quarterly reporting would save significant publishing costs and other related expenses, and enable

management to devote greater management time to other key aspects of the operation of the Group’s

business.

INFORMATION ABOUT THIS DOCUMENT AND THE INTRODUCTION

— 40 —

R11.12R19.08(1)

A1A(30)

A1A(14)(1)

H SHARES WILL CONTINUE TO BE ELIGIBLE FOR ADMISSION INTO CCASS

The H Shares have been accepted as eligible securities by HKSCC for deposit, clearance and

settlement in CCASS with effect from 15 April 2004, the date on which dealings in the Shares on GEM

commenced. Subject to the granting of the listing of, and permission to deal in, the H Shares on the

Main Board by the Stock Exchange and the continual compliance with the stock admission

requirements of HKSCC, the H Shares will continue to be accepted as eligible securities by HKSCC

for deposit, clearance and settlement in CCASS once dealings in the H Shares on the Main Board

commence. Settlement of transactions between participants of the Stock Exchange on any trading day

is required to take place in CCASS on the second trading day thereafter.

All necessary arrangements have been made with HKSCC for the H Shares in issue to continue

to be accepted as eligible securities of CCASS. All activities under CCASS are subject to the general

rules of CCASS and CCASS operation procedures in effect from time to time.

PROFESSIONAL TAX ADVICE

If you are unsure about the taxation implications of subscribing for the H Shares, or about the

purchasing, holding or disposing of or dealing in the H Shares, you should consult an expert.

Prospective investors for the H Shares are recommended to consult their professional advisers if

they are in any doubt as to the taxation implications of subscribing for, holding, purchasing or

disposing of or dealing in the H Shares or any rights thereof. None of the Company, the Directors, the

Supervisors, the Sponsor, any of their respective directors, officers, employees and/or representatives

and any other parties involved in the Introduction accepts any responsibility for any tax effects on,

or liability of, any person resulting from subscribing for, holding, purchasing or disposing of or

dealing in the H Shares or any rights thereof.

STAMP DUTY

Dealings in the H Shares registered on the Company’s H Share register of members maintained

in Hong Kong will be subject to Hong Kong stamp duty.

All necessary arrangements have been made for the H Shares to be admitted into CCASS.

CONDITIONS OF THE INTRODUCTION

The Introduction is subject to fulfillment of conditions, amongst other things, (1) the CSRC

approving the listing of the H Shares on the Main Board; and (2) the Listing Committee granting the

listing of, and permission of deal in, the H Shares on the Main Board.

The H Shares are currently listed on GEM. Immediately prior to the Introduction, the listing of

the H Shares on GEM will be withdrawn in accordance with the GEM Listing Rules. The Extraordinary

General Meeting and the separate Class Meetings will be convened to approve, amongst other things,

the Proposed Withdrawal.

INFORMATION ABOUT THIS DOCUMENT AND THE INTRODUCTION

— 41 —

Rules 8.13A(1)A1A(14)(2)

Rules 8.14

DIRECTORS

Name Address Nationality

Executive Directors:

Zhang En Rong No. 99 Beihai Road,

Shouguang City,

Shandong Province (Note)

Chinese

Lin Fu Long No. 99 Beihai Road,

Shouguang City,


Chinese

Zhang Yun San No. 99 Beihai Road,

Shouguang City,


Chinese

Xie Xin Cang No. 99 Beihai Road,

Shouguang City,


Chinese

Non-executive Directors:

Chen Jian Xiong #30-5, No. 8, Jinan Road,

Dongying District,

Dongying City,

Shandong Province

Chinese

Wang Ping No. 162, Yuhuayuan,

Yiheshanzhaung Villa,

Haidian District,

Beijing

Chinese

Independent non-executive Directors:

Qin Xue Chang 5511, No. 365,

Yuanxiaoshengli Street,

Kuiwen District,

Weifang City,

Shandong Province

Chinese

Yan Yi Zhuang Flat 3, 11/F, Block 36,

Hang Fa Chuen,

Chai Wan,

Hong Kong

Australian

Loke Yu Flat 8C, 13/F

Block C,

Elizabeth House,

250-254, Gloucester Road,

Hong Kong

Malaysian

DIRECTORS, SUPERVISORS AND PARTIES INVOLVED IN THE INTRODUCTION

— 42 —

3rd Sch(6)A1A(41)(1)

Rules 19A.18(1)

SUPERVISORS

Name Address Nationality

Li Bao Hui No. 99 Beihai Road,

Shouguang City,

Shandong Province

Chinese

Liu Wan Fu #1-1202,

12th Building Liupukang,

Dongcheng District,

Beijing

Chinese

Fan Ren Yi No. 308, Wenmiao Street,

Shouguang City,

Shandong Province

Chinese

Note: Zhang En Rong, Lin Fu Long, Zhang Yun San and Xie Xin Cang reside at No. 99 Beihai Road but at different residences.


— 43 —

SPONSOR Guotai Junan Capital Limited

27th Floor, Low Block

Grand Millennium Plaza

181 Queen’s Road Central

Hong Kong

LEGAL ADVISERS TOTHE COMPANY

As to Hong Kong Law:

Coudert Brothers

in association with

Orrick, Herrington & Sutcliffe LLP

39th Floor, Gloucester Tower

The Landmark

11 Pedder Street

Central

Hong Kong

As to PRC Law:

Kingfield & Partners

406-408, CYTS Plaza

5 Dongzhimen South Avenue

Dongcheng District

Beijing 100007

China

AUDITORS AND REPORTINGACCOUNTANTS

Ernst & Young

Certified Public Accountants

18th Floor

Two International Finance Centre

8 Finance Street

Central

Hong Kong

PROPERTY VALUER Sallmanns (Far East) Limited

22nd Floor, Siu On Centre

188 Lockhart Road

Wanchai

Hong Kong

FINANCIAL ADVISOR China Merchants Securities (Hong Kong) Co., Ltd.

48th Floor, One Exchange Square

Central

Hong Kong


— 44 —

A1A(3)

3rd Sch(18)A1A(4)

REGISTERED ADDRESS No. 99 Beihai Road

Shouguang City

Shandong Province

PRINCIPAL PLACE OF BUSINESSIN HONG KONG

Suite A, 11th Floor

Ho Lee Commercial Building

38-44 D’Aguilar Street

Central

Hong Kong

COMPANY SECRETARY Chan Wing Nang, Billy, CPA

COMPLIANCE OFFICER Xie Xin Cang

QUALIFIED ACCOUNTANT Chan Wing Nang, Billy, CPA

AUDIT COMMITTEE Yan Yi Zhuang

Qin Xue Chang (Chairman)

Loke Yu

REMUNERATION COMMITTEE Zhang Yun San

Qin Xue Chang

Yan Yi Zhuang

Loke Yu (Chairman)

NOMINATION COMMITTEE Zhang Yun San

Qin Xue Chang

Yan Yi Zhuang (Chairman)

Loke Yu

AUTHORISED REPRESENTATIVES Xie Xin Cang

No. 99 Beihai Road

Shouguang City

Shandong Province

Chan Wing Nang, Billy

Suite A, 11th Floor

Ho Lee Commercial Building

38-44 D’Aguilar Street

Central, Hong Kong

AUTHORISED PERSON TOACCEPT SERVICE OFPROCESS AND NOTICES

Chan Wing Nang, Billy

CORPORATE INFORMATION

— 45 —

A1A(43)

Rules 19A13(2)

Rules 8.17(2)(3)A1A(42)

A1A(42)

A1A(3)

PRINCIPAL BANKERS Agricultural Bank of China ( )

Bank of China ( )

China CITIC Bank ( )

Weifang Commercial Bank ( )

China Everbright Bank ( )

H SHARE REGISTRAR Tricor Investor Services Limited

26th Floor

Tesbury Centre

28 Queen’s Road East

Hong Kong

COMPLIANCE ADVISOR Guotai Junan Capital Limited

27th Floor, Low Block

Grand Millennium Plaza

181 Queen’s Road Central

Hong Kong

CORPORATE INFORMATION

— 46 —

A1A(3)

A1A(3)Rules 19A13(3)aRules 8.16

Certain information presented in this section have been derived, in part, from various

government or official sources. Whilst the Directors have taken reasonable care to ensure that the

relevant information is accurately reproduced from these sources, such information have not been

prepared or independently verified by the Company, the Sponsor, their respective affiliates,

directors, advisers or any parties involved in the Introduction. The Company makes no

representations as to the accuracy or completeness of such information and accordingly, such

information should not be unduly relied upon.

THE PRC CRUDE OIL INDUSTRY

Introduction

The PRC government views petroleum as an important strategic resource and has adopted

policies to develop the national petroleum industry. Exploration and production activities are

controlled by the following companies:

Net provedreserves as of

31 December 2005Share of domestic

production in 2005

(million barrels)

PetroChina 11,536 70.83%

Sinopec 3,294 20.23%

CNOOC 1,456 8.94%

Source: Annual reports of respective companies

Crude Oil Production and Consumption

Since the early 1980’s, China has experienced rapid economic growth which has generated strong

increases in the demand for petroleum resources. Between 2001 and 2005, China’s real GDP increased

by an average annual growth rate of 9.48%, making China one of the fastest growing economies in the

world.

Due to this rapid growth, China was the second highest consumer of crude oil in the world in

2005, behind the US. However, China’s crude oil consumption on a per capita basis in 2005 remained

significantly below that of developed countries and the worldwide average.

According to OPEC report, China added 32% to the world oil demand in 2005. Chinese oil

demand is expected to increase by 0.5 mb/d in 2006. Meanwhile, the world oil demand growth in 2006

is forecasted at 1.4 mb/d or 1.7% to average 84.6 mb/d.

INDUSTRY OVERVIEW

— 47 —

The following table shows data for the world’s major crude oil consuming countries for the year

ended 2004:

SELECTED COUNTRY OIL CONSUMPTION DATA, 2004

Per day Per year PopulationPer capita oil

consumption 2004

(million

barrels)

(million

barrels)

(million) (barrels per annum)

United States 20.73 7,566.45 298.84 25.32

China 6.52 2,379.80 1,313.97 1.81

Japan 5.35 1,952.75 127.46 15.32

Germany 2.65 967.25 82.42 11.74

Canada 2.17 792.05 33.10 23.93

South Korea 2.15 784.75 48.85 16.06

Mexico 2.02 737.30 107.45 6.86

France 1.98 722.70 60.88 11.87

Italy 1.88 686.20 58.13 11.80

United Kingdom 1.83 667.95 60.61 11.02

Australia &

New Zealand 1.03 375.95 24.34 15.45

Other countries 34.17 12,472.05 4,309.51 2.89

WORLD TOTAL 82.48 30,105.20 6,525.16 4.61

Source: U.S. Energy Information Administration, International Petroleum Monthly November 2005; World Bank Group

From 1990 to 2000, China’s annual crude oil consumption increased at a compound rate of 6.7%

from 114.8 million tonnes to 224.4 million tonnes while its annual crude oil production increased at

a slower compound rate of 1.6% from 138.3 million tonnes to 163.0 million tonnes over the same

period. This resulted in China becoming a net importer of oil in every year since 1996 with net imports

reaching 75.8 million tonnes in 2000, which was equivalent to about 46.5% of total PRC oil

production.

Data for 2005 shows oil production rose by approximately 3.7% to 181.5 million tonnes while

consumption rose to approximately 300 million tonnes, leaving China to import a net approximately

of 118.7 million tonnes of oil.

INDUSTRY OVERVIEW

— 48 —

China’s growing annual import requirement, coupled with increases in global crude oil prices in

recent years, have heightened oil security concerns and have prompted the PRC government to

emphasise the importance of (i) more rapid exploitation of its existing oil and other energy reserves,

(ii) increased focus on new oil exploration efforts, and (iii) purchases of oilfields with reserves outside

China.

China’s oil security concerns are expected to boost exploitation and production efforts by the

three key oil producers in 2003 and beyond.

Crude Oil Reserves

Estimates by the Oil and Gas Journal, allowing for as yet undiscovered oilfields, put China’s

end-2003 oil reserves at 12.76 billion barrels, equivalent to 14.3 years’ worth of production.

Set out below shows the three major oil producers’ existing oil reserves in the PRC.

Crude oilproduction

in 2005

Net proved oilreserves at

31 December 2005

Net proved oilreserves at

31 December 2005

(million barrels) (million barrels) (years of production)

PetroChina 828 11,536 13.93

Sinopec 279 3,294 11.81

CNOOC 131 1,456 11.11

Total 1,238 16,286 13.16


INDUSTRY OVERVIEW

— 49 —

Estimates of crude oil production and reserves released by the International Energy Agency and

the Oil & Gas Journal respectively show that China has 14.3 years worth of reserves at its 2003

production level. This places China in a relatively favourable reserve position, compared to most other

oil producing regions. Only OPEC members and Latin America have higher reserve positions. Some

of the developed countries in the North America and Europe only have reserves sufficient to cover 5

to 8 years at current production levels.

Crude oilproduction

in 2003

Crude oilreserves at

31 December 2003

Crude oilreserves at

31 December 2003

(million barrels) (million barrels) (years of production)

North America 5,344 215,300 40.29

Europe 2,324 15,800 6.80

FSU 3,773 77,800 20.62

Latin America

(excluding Venezuela) 1,457 100,600(1) N/A

China 1,276 18,300 14.34

Other Asia/Pacific

(excluding Indonesia) 1,194 18,000(1) N/A

Certain countries in Africa 1,113 100,800(1) N/A

Certain countries in Middle East 732 729,600(1) N/A

Others 62 1,500 24.19

Non-OPEC 17,275

OPEC 11,225

World Total 28,500 1,277,700 44.83

Note (1): Including OPEC countries.

Sources: Oil & Gas Journal and International Energy Agency

The Oil Field Equipment and Services Industry

According to OPEC report, the growth rate of world oil demand in 2006 is forecasted at

approximately 1.7% to a total of approximately 84.6 million barrels per day. On a regional basis, oil

demand growth in North America is expected to ease by approximately 0.2 million barrels per day. The

major share of world oil demand growth is expected to come mainly from China.

Since 2000, under the impulse of high oil prices, the world oil exploration expenditure has

maintained a double digit growth rate. In 2005, the world expenditure on oil exploration investment

increased by 19.1%, which is more than the estimate of 5.5% at the end of 2004. In the coming 5 years,

the actual investment in the oil exploration sector is expected to be even higher.

INDUSTRY OVERVIEW

— 50 —

In 2006, the world total expenditure budget on oil exploration investment will be US$226.2

billion, representing a growth rate of 14.1% when comparing with 2005. The oil exploration

investment in the US, Canada and other areas will be increased by 16.5% to US$56.4 billion, 12% to

US$26.2 billion and 13.6% to US$143.6 billions, respectively. The major increase comes from Latin

America, especially Brazil.

The oil field equipment and services industry consists of two major sectors — contract drilling

and oil field services — and a wide number of sub-sectors, each of which requires specialized skills.

Industry revenues are dependent on the exploration and production capital expenditures of oil

and gas producers, which in turn are dependent on current prices of, and future trends in global oil

and gas prices. This relationship is illustrated below. The number of worldwide active rigs, as tracked

by Baker Hughes, increases and decreases with fluctuations in the price of oil.

Number of rigs/barrel oil price X 100

8,000

1990

1992

1994

1996

1998

2000

2002

2003

7,000

6,000

5,000

4,000

3,000

2,000

1,000

0

1991

1993

1995

1997

1999

2001

2004

2005

Baker Hughes World Rig CountWest Texas Intermediate Oil Price x 100

Source: Baker Hughes, Bloomberg, November 2005

Oil prices corrected sharply as war broke out in mid-March 2003, dipping to a low of about

US$25 per barrel in late April 2003. However, there has been a strong recovery up to March 2004. oil

prices are exceeding US$37 per barrel after OPEC, which represents one-third of world supply, agreed

in February 2004 to reduce its production quotas by 1 million barrel a day from April 2004. With the

strong demand of developing countries in recent years, oil prices increase sharply up to an average

approximately US$68 per barrel in July 2006.

INDUSTRY OVERVIEW

— 51 —

In China, capital expenditures on oil and gas exploration and production have risen steadily in

recent years, as illustrated in the table below. Some 84% of this expenditure in 2004 was concentrated

on onshore projects.

PRC Capital Expenditure on Oil & Gas Exploration & Production

RMB billion

1999 2000 2001 2002 2003 2004

PetroChina 32.88 38.65 41.19 46.08 54.72 61.87

Sinopec 9.80 14.55 17.58 20.23 27.96 28.95

CNOOC 4.03 4.40 4.34 6.83 10.91 17.81

PRC Total 46.71 57.60 63.11 73.14 93.59 108.63

Annual growth 23.3% 9.6% 15.9% 28.0% 16.1%

PRC Onshore 42.68 53.20 58.77 66.31 82.68 90.82

Annual growth 24.6% 10.5% 12.8% 24.7% 9.9%


PRC government regulations in oil and gas industry

The PRC government owns all of China’s petroleum resources and exercises regulatory control

over petroleum exploration and production activities in the PRC. Under the Mineral Resources Law

of the PRC ( ), the Ministry of Land and Resources ( ) exercises

administrative authority over the exploration and production of crude oil and natural gas. In addition,

the PRC government also controls the pricing, production volume, sales, imports and exports of

petroleum products in the PRC. After China became a member of the WTO, the PRC government

released certain restrictions on imports and exports of crude oil. Since 2003, petroleum companies in

the PRC were classified as state-owned trading enterprises and non-state-owned trading enterprises.

Since then, domestic companies can apply to the relevant PRC authorities for the qualification as

non-state-owned petroleum trading enterprises. Currently, state-owned petroleum trading enterprises

are allowed to import petroleum products according to market condition and export petroleum

products subject to quota restriction while non-state-owned petroleum trading enterprises are only

allowed to import petroleum products subject to quota restriction.

PRC Government regulations on petroleum drilling and extraction machinery industry

As advised by the Company’s PRC legal advisor, petroleum drilling and extraction machinery

products such as oil well sucker rods, oil well pumping machines and oil well pumps are required to

comply with the provisions for industry production permit issued by PRC government authority

.

INDUSTRY OVERVIEW

— 52 —


The Company was established in the PRC on 30 December 2001 as a joint stock limited company.

Its business was founded more than a decade ago.

Petroleum Machinery Parts Factory, the predecessor entity of the Company, was established in

March 1987 as a collectively owned enterprise and was situated in (Shangkou

Town, Shouguang City, Shandong Province, the PRC). It was principally engaged in the manufacture

and sale of petroleum machinery parts. The registered share capital of Petroleum Machinery Parts

Factory was RMB1,200,000. In 1989, Petroleum Machinery Parts Factory was re-registered as

Petroleum Machinery Factory which changed its name to Weifang Molong in 1993. The registered

share capital was then increased to RMB16,420,000.

In 1994, after getting the approval from (Committee for Restructuring

The Economic System of Shandong Province), Weifang Molong was transformed into Molong

Holdings. The registered share capital was further increased to RMB30,040,000.

In 1997, Molong Holdings started to implement joint stock cooperative reform. On 6 September

1997, (Shouguang City Shangkou Town People’s Government) and Zhang En

Rong entered into an agreement (“First Agreement”). Zhang En Rong was the legal representative and

factory manager of Petroleum Machinery Parts Factory, Petroleum Machinery Factory and Weifang

Molong from 1987 to 1993 and the general manager of Molong Holdings since 1995. According to the

First Agreement, (Shouguang City Shangkou Town People’s Government) agreed

to dispose of and Zhang En Rong agreed to acquire 35% equity interests in Molong Holdings for a

consideration of RMB18,738,000. The aforesaid agreement was approved by

(Office for Restructuring The Economic System of Shouguang City) on 20 September 1997. On 30

September 1997, Zhang En Rong entered into an engagement agreement (“Engagement Agreement”)

with (Shouguang City Shangkou Town People’s Government). Pursuant to the

Engagement Agreement, Zhang En Rong engaged (Shouguang City Shangkou

Town People’s Government) to hold his interests in Molong Holdings on his behalf.

On 8 October 1997, (Shouguang City Shangkou Town People’s Government)

issued a notice regarding the reform of Molong Holdings (“Notice”). According to the Notice, the

shareholders of Molong Holdings were (i) Zhang En Rong (holding 35% equity interest); (ii)

(Shouguang City Shangkou Town People’s Government),



(together holding 65% equity interest). Furthermore, the Notice stated that

(Shouguang City Shangkou Town People’s Government), (Shouguang

City Shangkou Town Economic and Trade Committee) and (Shouguang City

Shangkou Town Economic and Management Office) agreed to foresake their voting, corporate control

and management rights relating to Molong Holdings.

On 8 April 2001, a meeting was held by the management team of Molong Holdings whereby it

was decided that Molong Holdings be converted to become a privately owned enterprise.


— 53 —

R19A.42(57)

On 18 August 2001, (Shouguang City Shangkou Town People’s Government)

and Zhang En Rong entered into a supplemental agreement (“Supplemental Agreement”). According

to the Supplemental Agreement, (Shouguang City Shangkou Town People’s

Government) and Zhang En Rong agreed that both the First Agreement and the Engagement Agreement

that were signed between them in 1997 be terminated.

On 18 August 2001, (Shouguang City Shangkou Town People’s

Government), Zhang En Rong, Lin Fu Long, Zhang Yun San, Xie Xin Cang, Liu Yun Long, Cui Huan

You and Liang Yong Qiang entered into another agreement (“Second Agreement”) pursuant to which

(Shouguang City Shangkou Town People’s Government) agreed to sell all its

interest in Molong Holdings to Zhang En Rong, Lin Fu Long, Zhang Yun San, Xie Xin Cang, Liu Yun

Long, Cui Huan You and Liang Yong Qiang for a consideration of RMB55,715,900, which was

financed by their respective personal savings, bank loan and bonus granted to each of them by

(Shouguang City Shangkou Town People’s Government). After the aforesaid

transfer, the structure of the capital contribution and the percentage of shareholding of Molong

Holdings was as follows:

Name of shareholders

Amountof capital

contribution


of registeredcapital in

MolongHoldings

(RMB) (%)

Zhang En Rong 39,279,700 70.50

Lin Fu Long 4,808,300 8.63

Zhang Yun San 4,301,300 7.72

Xie Xin Cang 3,008,600 5.40

Liu Yun Long 2,061,500 3.70

Cui Huan You 1,298,200 2.33


55,715,900 100.00

On 18 September 2001, the management of Molong Holdings decided to promote the Company

together with Kaiyuan Oil and Alloy Factory. The registered capital of the Company would be

RMB40,500,000. The seven then individual shareholders of Molong Holdings, namely Zhang En

Rong, Lin Fu Long, Zhang Yun San, Xie Xin Cang, Liu Yun Long, Cui Huan You and Liang Yong

Qiang contributed RMB60,477,800 in aggregate by transferring the production and operational net

assets of Molong Holdings to the Company for an aggregate of 39,647,800 Domestic Shares and each

of Kaiyuan Oil and Alloy Factory contributed RMB800,000 and RMB500,000 in cash for 524,400

Domestic Shares and 327,800 Domestic Shares respectively. Altogether, the Promoters contributed

RMB61,777,800 which was converted at the rate of 1:0.6556 into 40,500,000 Domestic Shares of

RMB1.00 each.


— 54 —

On 8 November 2001, Zhang En Rong, Lin Fu Long, Zhang Yun San, Xie Xin Cang, Liu Yun

Long, Liang Yong Qiang, Cui Huan You, Kaiyuan Oil and Alloy Factory entered into the Promoters

Agreement for the purpose of, among other things, regulating their respective rights and obligations

as promoters of the Company. Pursuant to an approval issued by (Office for

Restructuring The Economic System of Shandong Province) on 27 December 2001 and a business

licence issued by (Shandong Provincial Administration for Industry and

Commerce) on 30 December 2001, the establishment of the Company was completed and the Company

was converted into a joint stock limited company. The shareholding structure after the establishment

of the Company was as follows:

Name of Promoters

Amountof capital

contribution




Company

(RMB) (%)

Zhang En Rong 42,636,900 27,951,700 69.02

Lin Fu Long 5,219,200 3,421,600 8.45

Zhang Yun San 4,668,900 3,060,800 7.56

Xie Xin Cang 3,265,800 2,141,000 5.29

Liu Yun Long 2,237,700 1,467,000 3.62

Cui Huan You 1,409,100 923,800 2.28

Liang Yong Qiang 1,040,200 681,900 1.68

Kaiyuan Oil 800,000 524,400 1.29

Alloy Factory 500,000 327,800 0.81

61,777,800 40,500,000 100.00

On 26 October 2002, the Company entered into an agreement with TMR Group Inc., under which

both parties agreed to terminate the operation of their Sino-foreign joint venture, Weifang Dragon

upon the expiry of its then current term of operation (i.e. 26 January 2003). The assets and liabilities

of Weifang Dragon as at 26 January 2003 were subsequently transferred to Molong Equipment for the

consideration of approximately RMB8,200,000, which was calculated on the basis of the unaudited net

asset value of Weifang Dragon as at 26 January 2003. Weifang Dragon was established in the PRC on

27 January 1992, in which the Company was interested in 70% and TMR Group Inc. was interested

in 30% of its registered capital of Weifang Dragon at that time. According to the Sino-foreign joint

venture agreement entered into between the Company and TMR Group Inc., the term of the joint

venture was 11 years. Thus, on 26 October 2002, TMR Group Inc. and the Company intended to

discontinue their Sino-foreign joint venture by entering into an agreement, pursuant to which both

parties agreed to terminate the operation of Weifang Dragon at the expiry of its term of operation (i.e.

26 January 2003). Weifang Dragon was principally engaged in the production and sales of alloy

precision castings. Weifang Dragon was deregistered on 2 April 2003.


— 55 —

Special Steel was a limited liability company incorporated in the PRC which was principally

engaged in the manufacture and sale of steel. On 28 February 2003, the Company entered into a series

of sale and purchase agreements to dispose of an aggregate of 52% equity interests in Special Steel

because the Company was not optimistic about the then prospect of Special Steel due to the fact

Special Steel did not generate any profit at that time. Immediately before such disposal, Special Steel

was held as to 52% by the Company and as to 48% by Shandong Shouguang Ju Neng Electric Group

Company Limited. In accordance with these agreements, the Company agreed to transfer 44.32%,

6.7% and 0.98%, respectively, of equity interests in Special Steel to Zhang En Rong, a Director, and

Liu Fa You and Xu Shou Lu, both being Independent Third Parties, respectively, for consideration of

RMB39,000,000, RMB5,900,000 and RMB860,000, respectively. Immediately after such disposal,

Special Steel was owned as to 48% by Shandong Shouguang Ju Neng Electric Company Limited, as

to 44.32% by Zhang En Rong, as to 6.7% by Liu Fa You and 0.98% by Xu Shou Lu. The total

consideration was calculated on the basis of the original investment cost in Special Steel, being

equivalent to 52% of the then registered capital of the Company of RMB45,760,000.

On 28 February 2003, the General Office of the (Ministry of Finance of the

PRC) issued to Alloy Factory Cai Ban Qi (2003) No. 30 “Approval Concerning the Allocation of

State-owned Shares of Shandong Molong Petroleum Machinery Company Limited”, pursuant to which

all the 327,800 Domestic Shares held by Alloy Factory were allocated to (the

National Council of Social Security Fund of the PRC). The General Office of the

(Ministry of Finance of the PRC) also requested that such Domestic Shares allocated to

(the National Council of Social Security Fund of the PRC) to be offered to the

public at the time of the Company’s public offer and placing of H shares in 2004. The Company paid

the relevant net proceeds from public offer and placing of H shares to (the

Ministry of Finance of the PRC). Thus, upon the Company’s H shares were listed on the GEM on 15

April 2004, (the National Council of Social Security Fund of the PRC) no longer

held any interests in the Company.

Yalong Oil Pump, which was a limited liability company incorporated in the PRC, was

principally engaged in the business of manufacture and sale of petroleum extraction machinery. On 29

May 2003, the Company entered into an agreement with (Liu Chun Yuan), an Independent Third

Party, under which the Company has agreed to transfer the 30% equity interest held by it in Yalong

Oil Pump to (Liu Chun Yuan) at the consideration of RMB1,666,300 because Yalong Oil Pump

operates at a relatively small scale. The Directors were therefore not optimistic about the development

of Yalong Oil Pump at that time. The total consideration was calculated on the basis of the unaudited

net asset value of Ya Long Oil Pump as at 31 December 2002. On 1 April 2005, the same 30% equity

interests held by (Liu Chun Yuan) were transferred to Maolong Machinery at the consideration

of RMB1,888,500 on the basis of the unaudited net asset value of Ya Long Oil Pump as at 31

December 2004 because, as advised by the management of Maolong Machinery, Xinjiang Oil Field

experienced development in 2004-2005 which led to its increase in the demand for petroleum

equipment.


— 56 —

As a welfare enterprise established on 11 April 2001, Molong Machinery was entitled to full

exemption from corporate income tax. Such exemption, however, was subject to annual application by

Molong Machinery to and approval by the local tax bureau. Under the then regime, Molong Machinery

was required to pay the full amount of corporate income tax to the local tax bureau first and then

applied for exemption and refund. Application was made by Molong Machinery and approval was

granted for the year ended 31 December 2001. Molong Machinery did not apply for such exemption

from corporate income tax for the year ended 31 December 2002 as Molong Machinery was informed

that applications for exemption from corporate income tax would not be allowed in that year. Approval

was granted to Molong Machinery for exemption of the corporate income tax for the year ended 31

December 2003. The Directors believe that there is an inherent uncertainty associated with whether

the local tax bureau would approve the tax exemption application, which is largely based on policy

reason or local financial condition in that year.

However, pursuant to (the Notice on the

Scope of Collection, Charge and Administration after the Reform of Revenue Sharing System Relating

to Corporate Income Tax) [2002]8 (Guo Shui Fa [2002] No. 8) issued by (the State

Tax Bureau) of the PRC (the “Notice”), the corporate income tax for all enterprises established and

registered on or after 1 January 2002 will be collected by (the State Tax Bureau) of the PRC

only, without having to go through the local tax bureau. Accordingly, a welfare enterprise established

on or after the 1 January 2002 is required to submit application to (the State Tax Bureau)

of the PRC for exemption of corporate income tax annually. The Directors believe that as long as the

welfare enterprise satisfies the required application procedures under the relevant PRC laws, it would

be likely for (the State Tax Bureau) of the PRC to grant the exemption of corporate income

tax. Thus, the uncertainty in association with the approval from the local tax bureau on the tax

exemption application as stated in the preceding paragraph would be eliminated.

In order to reorganize the businesses of the Group and to take advantage of the less burdensome

tax regime for enterprises established in the PRC on or after 1 January 2002, the Board resolved on

2 September 2004 to set up Molong Drilling Equipment to take up the oil well sucker rods, pumps and

related parts and components business, all of which were being conducted by Molong Machinery. On

the same day, the Company and (Shouguang City Shangkou Town People’s

Government) entered into the shareholders’ agreement and executed the articles of association.

Pursuant to the resolution of the shareholders’ meeting of Molong Machinery held on 2

September 2004, the undistributed profits of RMB66,310,000 standing in the books of Molong

Machinery as at 31 August 2004 had been distributed to its shareholders, namely the Company and

Maolong Machinery in accordance with their respective proportion of investment in Molong

Machinery. Such undistributed profit were distributed to Maolong Machinery by cash and the

remaining profits were distributed to the Company by way of transfer of assets and liabilities.


— 57 —

On 30 September 2004, the liquidation committee of Molong Machinery as vendor and Molong

Drilling Equipment as purchaser entered into a sale and purchase agreement, pursuant to which, the

liquidation committee of Molong Machinery has agreed to sell and Molong Drilling Equipment has

agreed to purchase the assets relating to oil well sucker rods and oil well pumps at a consideration of

approximately RMB5.9 million, which was determined based on the unaudited book value of such

assets as at 30 September 2004. The consideration was duly paid by cash and the transaction was

completed.

On 24 November 2004, the Board also resolved that, upon completion of the transfer of assets

relating to oil well sucker rods and oil well pumps from Molong Machinery to Molong Drilling

Equipment by the liquidation committee, the assets of Molong Machinery were distributed among the

Company and Maolong Machinery in accordance with their respective proportion of investment in

Molong Machinery. The deregistration application by Molong Machinery was approved on 6

December 2004.

With a view to capitalizing on the favourable business environment and low tax regime in Hong

Kong and enhancing the profile of and competitiveness of the Group internationally, MPM was

incorporated in Hong Kong in May 2004 and became a member of the Group in May 2005. The

Company intends to develop its overseas business (such as selling of the Group’s petroleum machinery

products) through MPM in the long term. However, as at the Latest Practicable Date, MPM has not

commenced any business.

The H Shares were listed on the GEM since 15 April 2004 (stock code: 8261). As at the Latest

Practicable Date, based on the closing price of the H Shares on GEM of HK$2.12 per H Share, the

Company had a market capitalization of approximately HK$522 million.

On 9 July 2004, with the approval granted by (Ministry of Commerce of the

PRC), the Company transformed into a Sino-foreign joint stock limited liability company. The

Company is a Sino-foreign equity joint venture regulated by the Law of the PRC on Sino-foreign

Equity Joint Ventures.

On 12 May 2005, the Company completed the placement of 108,000,000 new H Shares at

HK$0.92 per H Share to raise the net proceeds of approximately HK$94.8 million. The Group applied

the net proceeds from the aforesaid placement for further expanding the production capacity of

petroleum casings.


— 58 —

A1A(17)

SHAREHOLDING AND GROUP STRUCTURE

As at the Latest Practicable Date, the shareholding structure of the Company and the structure

of the Group is as follows:

43.14% 4.72% 2.26% 1.05% 27.36%

5.28% 3.3% 0.81%

90% 10%

1.43%

90%

10.65%

ZhangEn Rong

ZhangYun San

LiuYun Long

LiangYong Qiang

Other PublicShareholders

Shandong Molong Petroleum Machinery Company Limited

Kaiyuan OilLinFu Long

XieXin Cang

CuiHuan You

Maolong Recycle(Note 2)

MPM(Note 3)

Molong Drilling Equipment(Note 1)

Mackenzie

Notes:

1. Molong Drilling Equipment is a limited liability company established under the PRC laws on 29 September 2004 with

a registered capital of RMB6,000,000, which is owned as to 90% by the Company and 10% by Shangkou Town People’s

Government. Maolong Drilling Equipment is principally engaged in the business of oil well sucker rods, oil well pumps

and their accessories. Molong Drilling Equipment was approved by (the Ministry of Civil Affairs of

Shandong Province) as (welfare enterprise).

2. Maolong Recycle is a limited liability company established under the PRC laws on 13 December 2002 with a registered

capital of RMB500,000. Its shareholders are the Company (with 10% equity interest) and Maolong Machinery (with 90%

equity interest). Maolong Recycle engages in purchasing unwanted or used metals.

3. MPM is a limited liability company established under Hong Kong laws on 24 May 2004. MPM became a member of the

Group in May 2005. The issued share capital of MPM is HK$7,800,000 divided into 7,800,000 shares of HK$1.00 each,

which is owned as to 90% by the Company and as to 10% by Maolong Machinery. MPM has not commenced any business

since the date of incorporation.


— 59 —

A1A(29)(1)

A1A(29)(2)

INTRODUCTION






to domestic oil fields within the PRC and some are for export to overseas customers. For the three


approximately 84.8%, 81.7%, 72.2% and 62.7% of its products to domestic customers within the PRC

and approximately 15.2%, 18.3%, 27.8% and 37.3% of its products to overseas customers,

respectively.

The Directors believe that the Group has an established reputation in the PRC petroleum drilling

and extraction machinery industry for its capability to manufacture quality petroleum drilling and

extraction machinery and related accessories, as exemplified by the Company having been awarded

the “quality management system certificate” (GB/T19001-2000-ISO9001: 2000) accredited by

(China Classification Society Quality Assurance Ltd), an independent ISO

quality assurance organization in the PRC, for, inter alia, the design, development and manufacture

of its petroleum machinery for oil extraction in 2003. This quality management system certificate

(GB/T19001-2000-ISO9001:2000) will be expired on 19 January 2009. The Company has also been

granted with API’s certificates regarding its licensed right to use the API Monogram on certain

Group’s principal products, namely pumps and pump parts (API Spec 11AX), sucker rods and

couplings (API Spec 11B) and casing and oil well pipes products (API Spec 5CT).

The Group’s main customers are oil fields in the PRC including (Daqing Oil Field),

(Shengli Oil Field ), (Xinjiang Oil Field), (Zhongyuan Oil Field) and

(Liaohe Oil Field), all of them being subsidiaries or branch oil fields of PetroChina or

Sinopec. The overseas customers of the Group were distributed in North America, the United

Kingdom, Russia, Indonesia, Brunei, Egypt, Syria and etc.

STRENGTHS AND COMPETITIVE ADVANTAGES

The Directors consider that the success of the Group is primarily attributable to the following

principal factors:

● the Group’s commitment to deliver quality and reliable petroleum drilling and extraction

machinery products to its customers;

● its well-established customer base including well known oil fields in the PRC such as

PetroChina and Sinopec;

BUSINESS

— 60 —

3rd Sch(1)3rd Sch(3)R11.67A1A28(1)(a)

● its comprehensive quality control monitoring procedures used throughout the production

process as demonstrated by the Company having been awarded the ISO9001:2000

certificate and the right to use the API Monogram on certain of the Group’s principal

products;

● its strong in-house research and development teams which enable the Group to develop

efficient methods of production and modify its existing products to meet changing market

trends and customers’ needs;

● the steady demand for the Group’s products by its main customers. Since 1949, the PRC

Government has adopted the view that petroleum was an important strategic resource and

has adopted special policies to develop its national petroleum industry. In particular, it has

provided funding for and allocated other resources to the petroleum industry;

● the Group’s ability to adapt and respond quickly to customers’ demands and to provide

efficient after-sale services; and

● the Group’s advantages over its competitors. As compared with its primary competitors who

are state-owned petroleum drilling and extraction machinery manufacturers, the Group is

able to adapt more quickly to changes in market conditions, provide products with more

reliable quality and offer more efficient after-sale services.

PRODUCTS

The petroleum industry is generally divided into upstream and downstream operations. Upstream

operations include the drilling, extraction and production of petroleum, while downstream operations

refer to the transportation, refining and marketing of petroleum products.

Petroleum drilling and extraction requires oil well pumps, oil well pumping machines, oil well

pipes, casings, oil well sucker rods and other petroleum drilling and extraction machinery accessories.

The Group manufactures and sells petroleum drilling and extraction machinery and related

accessories primarily for use in upstream operations. A wide range of the Group’s products are

necessary for petroleum drilling and extraction.

BUSINESS

— 61 —

The Group primarily manufactures six types of products, namely, oil well pumps, oil well sucker

rods, oil well pipes, casings, oil well pumping machines and other petroleum drilling and extraction

machinery accessories. The majority of such products is for sale to major oil fields in the PRC, while

some of the products, such as oil well pipes, casings, oil well sucker rods, valves and mud pump steel

sleeves, are for export to the US, Europe and other countries.

The Group

Oil well pipesOil well

sucker rodsOil wellpumps

Regular oil wellpipes

Regular oil wellsucker rods

Regular oil wellpumps

Tip thickenedoil well pipes

Super-strengthoil well

sucker rods

Underground petroelectric pumps

Special seamlessoil well pipes

Special oil wellpumps

Other petroleumdrilling andextractionmachineryaccessories

Mud pumpsteel sleeves

Regular valves

Large-size highpressure

spherical valves

Fluid injectionpumps

Blade-guidepulleys

Oil well pumpingmachines

Regular oil wellpumping machines

Energy-savingoil well pumping

machines

Casings

Ordinary casings

Seamless casings

Notes:

The fundamental differences between the oil well pipe and casing are as follows:

1. The oil well pipe and casing are different products in nature. Oil well pipe is used as an oil stream channel whichallows oil to flow from underground to the surface, whereas casing is a cylinder which serves as the wall of andstabilizes the oil well. Therefore, the oil well pipe and casing are not inter-changeable due to their differentfunctions.

2. The oil well pipe is placed inside the casing.

3. The oil well pipe and casing require different production and raw material specifications. The production facilitiescan not be switched between the manufacture of the two products with minimal costs.

4. The oil well pipe and casing have different measurements.

5. Although the oil well pipe and casing bear the API Monogram, they are subject to different requirements andspecifications of the API.

6. The casing could only be used once but the oil well pipe can be used repeatedly.

BUSINESS

— 62 —

The Directors believe that the Group has the ability to modify its products speedily in response

to customers’ needs, has strong commitment on quality control and has established a reputation in the

PRC as a quality petroleum drilling and extraction machinery and related accessories manufacturer.

The following table sets out the percentages of the Group’s total revenue by product types for

each of the three years ended 31 December 2005 and the four months ended 30 April 2006.


2003 2004 2005 2005 2006

(Unaudited)


Oil well pipes 134,500 44.5 261,477 53.6 500,198 64.4 157,222 68.9 211,348 69.5


Oil well pumps 21,683 7.2 21,761 4.5 7,758 1.0 4,053 1.8 5,521 1.8

Casings 2,906 1.0 20,625 4.2 27,337 3.5 16,016 7.0 11,019 3.6

Oil well pumping

machines 3,669 1.2 6,087 1.2 9,287 1.2 3,067 1.3 3,815 1.3

Other petroleum drilling

and extraction

machinery accessories 86,874 28.7 113,878 23.4 151,290 19.5 25,186 11.0 40,691 13.3

Total 302,274 100 487,688 100 776,522 100 228,380 100 304,214 100

The following sets out the gross profit margin of the Group’s products for the three years ended

31 December 2005 and four months ended 30 April 2006.



2003 2004 2005 2005(unaudited)

2006

(%) (%) (%) (%) (%)

Oil well pipes 12.5 15.3 23.9 18.9 24.5Oil well sucker rods 37.1 24.4 28.3 24.9 26.8Oil well pumps 33.4 36.4 39.7 23.2 53.9Casings 14.0 13.8 14.9 9.0 10.3Oil well pumping machines 27.9 18.0 7.6 11.7 9.9Other petroleum drilling and

extraction machinery

accessories 35.0 25.6 18.5 23.3 18.8

For the three years ended 31 December 2005 and the four months ended 30 April 2006, the gross

profit margin of the Group’s oil well pump were approximately 33.4%, 36.4%, 39.7% and 53.9%

respectively. The Directors consider that the increase in profit margin of the oil well pumps for the

four months ended 30 April 2006 was attributed to the improvement of product quality so as to

increase the sales of the oil well pump products. For the three years ended 31 December 2005 and the

BUSINESS

— 63 —

four months ended 30 April 2006, the gross profit margin of the Group’s oil well pumping machines

were approximately 27.9%, 18.0%, 7.6% and 9.9% respectively. Oil well pumping machines are

principally made of ordinary steel of which the steel prices increased significantly between 2004 and

2005. As such, the gross profit margin of oil well pumping machines had declined significantly since

2004.

The following diagram illustrates how typical petroleum machinery and related accessories work

for oil extraction:

Petroleum machinery on an oil well

OIL WELL PIPES

Source: California Department of Conservation

Principal Products

Oil well pipes

Column tube is formed by connecting oil well pipes together. It extends from the ground through

the oil well down to the oil layer. As an oil stream pipeline which allow oil to flow from underground

to the surface, oil well pipes are very important elements in the oil extraction process.

The Group produces three kinds of oil well pipes, the regular oil well pipes, the tip thickened

oil well pipes and special seamless oil well pipes.

In 1996, the Group successfully developed its oil well pipes and established facilities that could

manufacture approximately 8,000 tonnes of oil well pipes annually. Between 2001 and 2002, the

Group invested approximately RMB14 million to modernize and expand its oil well pipe production

facilities with additional capacity to produce tip thickened oil well pipes. In January 2001, API

granted the Group the right to use the API Monogram for API Specification 5CT (licence number

5CT-0519) on the Group’s manufactured products, namely, oil well pipes.

BUSINESS

— 64 —

Between 2003 and 2004, the Group invested approximately RMB44.05 million (approximately

HK$42.40 million) to construct special seamless oil well pipe production facilities with an annual

production capacity to produce 60,000 tonnes of special seamless oil well pipes.

Sales of oil well pipes represented the largest portion of the Group’s sale. It represented

approximately 44.5%, 53.6%, 64.4% and 69.5% of the Group’s total turnover for each of the three

years ended 31 December 2005 and the four months ended 30 April 2006, respectively.

Oil well pipes

Oil well sucker rods

An oil well sucker rod is placed inside an oil well pipe and attached between an oil well pump

and an oil well pumping machine. In the pump system, oil well pumping machine pushes and pulls the

oil well sucker rod up and down which creates forces in the oil well pump to draw oil from the well.

The Group currently produces two kinds of oil well sucker rods, the regular oil well sucker rods

and the super-strength oil well sucker rods.

During 2000 and 2001, the Group started to develop oil well sucker rod. Initially, the Group was

capable of manufacturing up to approximately 200,000 meters of oil well sucker rods annually. Later

in that year, the Group made further investments in the development of oil well sucker rods by

purchasing new equipment and facilities and as a result of which the Group was capable of

manufacturing approximately 3 million meters of oil well sucker rods annually in June 2002. In May

2001, API granted the Group the right to use the API Monogram for API 11B Specification (license

number 11B-0051) on its oil well sucker rods.

In 2004, the Group invested approximately RMB28.3 million (approximately HK$27.2 million)

to construct production facilities with an annual production capacity of 3,000,000 metres of

super-strength oil well sucker rods.

BUSINESS

— 65 —

The sale of oil well sucker rods accounted for approximately 17.4%, 13.1%, 10.4% and 10.5%

of the Group’s total turnover for each of the three years ended 31 December 2005 and the four months

ended 30 April 2006, respectively.


Oil well pumps

An oil well pump is used in the process of oil extraction. An oil well pump is used to lift oil from

underground to the surface. It is placed inside an oil well. The oil well sucker rod forces the pump

up and down, creating a suction that draws oil up through the oil well.

The Group mainly manufactures three principal kinds of oil well pumps, namely, regular oil well

pumps, special oil well pumps and underground petro-electric pumps and oil well pumps is the major

equipment of oil extraction process.

In 1994, the Group developed its first assembled ( ) oil well pump. In 1995, when the

Group was able to manufacture nickel-plating phosphorous ( ) anti-corrosion pump. In 1996, the

Group achieved another milestone in the development of oil well pump when it started to develop

carbon-nitrogen immerse ( ) oil well pump and special oil well pumps. Currently, the oil

well pumps produced by the Group utilizes the above techniques and are anti-corrosive, reliable, high

in endurance and highly effective. In January 2001, API granted the Group the right to use the API

Monogram for API 11AX Specification (license number 11AX-0056) on its sub-surface sucker rod

pumps and fittings.

BUSINESS

— 66 —

Sales of oil well pumps accounted for approximately 7.2%, 4.5%, 1.0% and 1.8% of the Group’s

total turnover for each of the three years ended 31 December 2005 and four months ended 30 April

2006, respectively.

Casings

Casings are used for the assembly of cylinders which extend from the ground surface to the oil

level and serve as the wall the oil well. They are essential components for the construction of oil wells.

The Group produces two types of casings, namely ordinary casings and seamless casings. In

January 2001, the Group obtained licensed right from API to use API Monogram for API Specification

5CT (license number: 5CT-0519) on its oil pipe and casing products.

The Group successfully developed its own casing products in 2003. In 2004, the Group

constructed casing production facilities with an annual production capacity of approximately 10,000

tonnes.


sales of casings represented 1.0%, 4.2%, 3.5% and 3.6% of the total sales of the Group, respectively.

From 2005, the Group started to construct the new casing production line with a maximum

production capacity of 250,000 tonnes per year. The construction of an additional casing production

line with an annual capacity of 250,000 tonnes has been completed. The total cost of the casing

production line and heat treatment processing line for casing products is estimated to be approximately

RMB331.28 million which included (i) approximately RMB258.44 million for the plant and

production facilities for casing production line, and (iii) approximately RMB72.84 million for heat

treatment processing line for casing products. As at 30 April 2006, the Group has incurred

approximately RMB260.84 million on the new casing production line project and has an outstanding

amount of capital commitments of approximately RMB70.44 million.

BUSINESS

— 67 —

The Group intends to finance the outstanding amount of capital commitments from the cash

inflows generated from its business operations and bank borrowings.

Oil well pumping machines

Oil well pumping machine is the power for oil extraction.

In 2001, the Group started to develop oil well pumping machines and to construct new facilities.

In August 2001, the Group commenced design of energy-saving oil well pumping machines which

were successfully developed in June 2002. The energy-saving oil well pumping machines can save

approximately 20% to 40% energy over the normal type of oil well pumping machines it produces. The

Group had the ability to manufacture approximately 200 units of oil well pumping machines.

BUSINESS

— 68 —

The sale of oil well pumping machines accounted for approximately 1.2%, 1.2%, 1.2% and 1.3%

of the Group’s total turnover for each of the three years ended 31 December 2005 and the four months

ended 30 April 2006, respectively.



Other petroleum drilling and extraction machinery accessories

Other petroleum drilling and extraction machinery accessories refer to the accessories such as

mud pump steel sleeves, the regular valves, the large-size high pressure spherical valves, the

blade-guide pulleys and the fluid injection pumps.

Valves fixed in the oil pipeline are designed to control the oil flow. The Group currently produces

two kinds of valves, the regular valves and the large-sized high pressure spherical valves. All such

products are for export to the North America.

Mud pump steel sleeves are very important for the oil extraction process and they can be

damaged easily during such process. Mud pump steel sleeves that the Group produces are made of high

chromium alloys and all of which are for export to the North America.

Blade-guide pulleys are essential component of underground petro-electric pump and form the

core part of multistage centrifugal pump. Blade-guide pulleys that the Group produces are primarily

made of ferro-nickel alloys.

BUSINESS

— 69 —

Fluid injection pumps are used to inject high polymer and/or water at an extremely high pressure

to the stratum of an oil well in order to drive out oil from the oil well. The main purpose of injecting

water into an oil well is to balance the geological pressure inside the oil well so as to avoid possible

collapse of the oil well. The main purpose of injecting high polymer into an oil well is to force any

residual oil that cannot be extracted by the normal oil extraction process up to the ground.

The sale of other petroleum drilling and extraction machinery accessories accounted for

approximately 28.7%, 23.4%, 19.5% and 13.3% of the Group’s total sales for each of the three years

ended 31 December 2005 and the four months ended 30 April 2006 respectively.

Valves Valves Valves

Blade-guide pulleys Blade-guide pulleys

Mud pump steel sleeves packing Mud pump steel sleeves

Products licenses requirements

(Measures for the Administration of Manufacturing License for

Industrial Products) was first promulgated by (State Economic & Trade Commission)

(the name of the State Economic & Trade Commission has been changed) on 7 July 1984, and were

used at the time when the PRC was undergoing the planned economy. As at the Latest Practicable Date,

it was not possible to trace and ascertain the then scope of the license at that time.

BUSINESS

— 70 —

On 19 April 2002, (State General Administration of Quality Supervision,

Inspection and Quarantine) promulgated the new (Measures for the

Administration of Manufacturing License for Industrial Products) (the “New Measures”). This New

Measures was effective on 1 June 2002, and at the same time, the abovementioned

(Measures for the Administration of Manufacturing License for Industrial

Products) became void and invalid.

According to the New Measures, the State uniformly formulated and promulgated

(Catalog of Products Subject to the System of Manufacturing

License for Industrial Products) (the “Catalog”). The Catalog states that oil well pumps, oil well

sucker rods and their connecting parts, and oil well pumping machines are required to obtain

(National Industrial Product Manufacturing License). Kingfield & Partners, the

PRC legal adviser of the Company, confirmed that, apart from the aforesaid

(National Industrial Product Manufacturing License) in which the Group is required to obtain for its

production of oil well pumps, oil well sucker rods and their connecting parts and oil well pumping

machines, there is no other production manufacturing license which the Group is required to obtain

for the production and manufacturing of its products.

(National Industrial Product Manufacturing License) issued by

(State General Administration of Quality Supervision, Inspection and

Quarantine) is the official approval for industrial products produced in the PRC.

(National Quality Supervision and Inspection Centre for

Petroleum Drilling, Production, Refinery and Chemical Plate Equipment) and

(China National Oil & Gas Field Wellhead Equipment Quality

Supervision and Inspection Centre), being the laboratories recognized by CNACL, and

(Tubular Goods Quality Supervising, Inspecting and Testing Centre),

being the direct research and development unit of PetroChina, are the inspection centers for the

petroleum machinery and related products of the PRC. The inspection reports produced by them are

considered necessary for obtaining (National Industrial Product Manufacturing

License) issued by (State General Administration of Quality Supervision,

Inspection and Quarantine).

The Directors and the PRC legal adviser to the Company confirmed that the Company has

obtained all the necessary reports and approvals for the production of its products during the Track

Record Period.

In order for the Company to sell its products to the subsidiaries or branch oil fields of PetroChina

or Sinopec, it is necessary for the Company to become a member of

(Beijing Information Services Branch of PetroChina Sales Company) and

(Sinopec Material and Equipment Department).

BUSINESS

— 71 —

The Company has been a member of (Beijing Information

Services Branch of PetroChina Sales Company) and a First Class Network Supplier of

(Sinopec Material and Equipment Department), which is formerly

known as (Sinopec Materials Resources Market) since 2001.

In respect of (Beijing Information Services Branch of

PetroChina Sales Company), detailed membership requirements have not been published and the right

to grant membership of the same is solely at the discretion of PetroChina. On the other hand, in order

to qualify as a member of (Sinopec Material and Equipment

Department), the Company must have achieved a certain level of experience and reputation, be able

to provide products which meet the relevant quality requirements, have strong commitment on sales

and after sale services and comply with the relevant laws and regulations. The prices of the products

of the Company must also be reasonable. In addition, the Company must be able to become part of

the merchandising network of Sinopec and provide relevant information within the network.

Beijing Information Services Branch of PetroChina Sales Company reviews the membership

status of its members every year. The Company’s membership of Beijing Information Services Branch

of PetroChina Sales Company is subject to annual review on 6 December every year. Membership of

the First Class Network Supplier of Sinopec Material and Equipment Department is subject to

Sinopec’s examination.

API Monogram license and ISO9001 are necessary for becoming member of

(Beijing Information Services Branch of PetroChina Sales Company)

and (Sinopec Material and Equipment Department).

The API Monogram license is specifically designed for the oil field equipment and product

services in the oil and natural gas industry. The program covers more than 60 standardized product

specifications, which include oil well pipes, valves and etc. The ISO9001 registration represents a

standard of quality applies to all types and sizes of organizations and to their products. The issuance

of the API Monogram license and ISO9001 are both dependent upon a successful evaluation of the

applicants’ relevant documentation and an on-site examination of the manufacturers’ facility and

process by their designated auditors.

The Directors consider that it is important for the Company to obtain the API Monogram license

if the product is for export or newly launched to the market because API Monogram is a benchmark

for oilfield equipment and product service, safety and quality.

Production facility

The production facilities of the Group are located in Shouguang City, Shandong Province, the

PRC. Certain of the Group’s principal workshops are erected on a parcel of land with a site area of

approximately 70,126 sq.m.. These workshops are owned by the Group whereas the land use right was

granted to the Company by (Shouguang City Planning and Land Resources

BUSINESS

— 72 —

A1A28(8)

Bureau) for a period of 50 years, commencing from 9 August 2002. These workshops are principally

used in the production of special seamless oil well pipes, oil well pipes, oil well sucker rods, oil well

pumping machines and etc. A new casing production facility with an annual production output of

250,000 tonnes was erected on a parcel of land with a site area of 297,321 sq.m. in 2005. This new

casing production plant will provide the Group with an additional of 250,000 tonnes of casing

production capacity per year. As the newly installed casing production plant is expected to be in full

production capacity in October 2006, the Group’s sales of casing products will increase substantially

and the operations of the newly installed casing production plant will have direct profit contribution

to the Group when it becomes in full operations. The land use right was granted to the Company by

(Shouguang City Planning and Land Resources Bureau) for a period of 50 years,

expiring on 29 October 2055. The construction of the production facility was completed and the

production facility went through the testing successfully in March 2006. As at the Latest Practicable

Date, it was in the process of trial production.

The following table sets out the Group’s principal production capacity and volume for the three

years ended 31 December 2005 and eight months ended 31 August 2006.

31 December 31 August

2003 2004 2005 2006

Oil well pipes

Production capacity (’000 tonnes) 30 55 60 80

Volume (’000 tonnes) 25.4 42.2 54 53.4


Production capacity (’000 metres) 3,000 3,500 3,500 3,500

Volume (’000 metres) 2,600 2,500 3,390 2,191

Oil well pumps

Production capacity (no. of units) 10,000 10,000 10,000 10,000

Volume (no. of units) 9,800 8,300 7,797 6,806

Casings

Production capacity (’000 tonnes) — 10 10 90

Volume (’000 tonnes) — 2.9 3.8 24.2


Production capacity (no. of sets) 200 200 200 200

Volume (no. of sets) 120 185 198 141

* Note: product capacity is calculated on annual basis.

BUSINESS

— 73 —

The following table sets out the detailed breakdown of the Group’s oil well pipes production

capacity and volume for the three years ended 31 December 2005 and eight months ended 31 August

2006.


2003 2004 2005 2006

Regular oil well pipes


Volume (’000 tonnes) 20 33 35 34.4

Tip thickened oil well pipes


Volume (’000 tonnes) 5.4 9.2 19 19

Special seamless oil well pipes

Production capacity (’000 tonnes) — 60 60 60

Volume (’000 tonnes) — 30 60 40.2

Note: The production capacity of oil well pipes equals to the aggregate production capacity of regular oil well pipes

and tip thickened oil well pipes. The production volume of oil well pipes equals to the aggregate production

volume of regular oil well pipes and tip thickened oil well pipes.

The following table sets out the detailed breakdown of the Group’s oil well sucker rods

production capacity and volume for the three years ended 31 December 2005 and eight months ended

31 August 2006.


2003 2004 2005 2006

Regular oil sucker rods

Production capacity (’000 metres) 3,000 700 700 700

Volume (’000 metres) 2,600 700 620 488

Super-strength oil sucker rods

Production capacity (’000 metres) — 2,800 2,800 2,800

Volume (’000 metres) — 1,800 2,770 1,703

BUSINESS

— 74 —

Production process

The following diagram illustrates the major production process of the Group’s principal

products:


(1) In general:

Decelerator

Refining

AssemblingRefiningCasting

Steel cutting WeldingHeat

treatmentCrack

detecting

Assemblingparts

Assemblingdecelerator

Testing

Testing

Testing

Assemblingbody

machine anddecelerator

Dessemblingand

packaging

TestingPreliminaryprocessing

Heattreatment(2) Decelerator:


(1) Regular oil well sucker rods

Crackdetecting

Rod headshaping

Heattreatment Straightening

Surfacesmoothening

Rod headcrack

detecting

Screw groovecarving onrod head

Connectingrod headwith nut

PaintingPackaging Storage

Raw materialpurchase

(2) Super-strength oil well sucker rods

Raw materials StraighteningCrack

detecting Shaping Polishing Surface crackdetecting

Heattreatment

Shot blastingand

Strengthening

Mechanicalprocessing Inspection

Connecting rod headwith nut, gasket and

protection capPackaging Painting Storage

BUSINESS

— 75 —

Oil well pumps

(1) Pump pipes

Raw pipepurchasing

Acid andphosphorus

chemicalprocessing

Alkalinprocessing Stretching

Acid andphosphorus

chemicalprocessing

PressingLengthsetting

Heattreatment Straightening

Inside surfacepolishingfor pump

pipe groove

Inside surfacepolishing andscrew groove

carving for pipe tips

Assembling

(2) Pump rods

AssemblingRaw rodpurchasing

Preliminaryshaping of

exteriorsurface

Paintspraying

Preliminarysmootheningof exterior

surface

Refining ofscrew groove

on rod tips

(3) Assembling

Collectingsuitable

parts

Assemblingaccording to

blueprint

Test matchingof pump pipeand pump rod

Leak testingPressuretesting

undersealTip sealing

Packagingand storing

Oil well pipes

(1) Regular oil well pipes

Straightening

Packaging

LabellingRaw pipepurchasing

Blockingproof testing

Screwgroovecarving

Connectingpipe headwith nut

Waterpressuretesting

Rustpolishing

Spraypainting and

marking

BUSINESS

— 76 —

(2) Tip thickened oil well pipes

Polishing Straightening

Labelling Packaging

Raw pipepurchasing

Tipthickening

Crackdetecting

Heattreatment

Blockingproof testing

Screwgroovecarving

Connectingpipe headwith nut


Rustpolishing

Spraypainting and

marking

Casings

Measuring weightand length and

impressing

ColourSpraying ring

Interstone

Applyingprotection layer

Packaging Storage

FeedingPipe-end

crackdetecting

Pathinspection

Threading

Printing

Threadinspection

Blowingand sucking

of scrap

Twisting ofchain

Fasteningof chain


ThreadingThread

inspection

Blowingand sucking

of scrap

coatingthread dope

Fastening ofprotection

ring

Pipe processing production line

Coldstraightening

InterstoneHeat

treatment offeed

Heating withquenching

furance

Quenchingwith

quenchingmachine

Temperingwith tempering

machineHot sizing Cooling Thermal

straighteningCooling withcooling bed

Blowing andsucking of dust

Ultrasonictesting

Humaninspection

Packaging forstorage Interstore

Heat treatment production line

Production line of hot roll

Straightening withsix-roll straightening

machine

End Cutting with1600 pipe layer

saw, cut-to-lengthCutting of pipe withpipe cutting machine

Blowing andsucking of dust

Human inspectionCrack detectingMeasuring length

and weight, markingand spraying

Packaging Interstore

Milling head,chamfarring

Raw materialsInspection of

billetsCuttingmaterial

Heating with ring-shaped furnace

Punching AR mill and pipe

Cooling withChain-typecooling bed

Heating withwalking beam

reheating furnace14 Stand

stretch reducer

Cooling withwalking beamcooling bed

Online normalization

Other petroleum drilling and extraction machinery accessories

(1) Valves

Casting Cleaning Spraying Refining

Packaging Delivery

Polishing CleaningCrackdetecting

Preliminaryprocessing


Measurementtesting

BUSINESS

— 77 —

(2) Mud pump steel sleeves

PaintingCleaning

Casting Crackdetecting

Preliminaryprocessing Refining

Heattreatment

CastingCrack

detectingPreliminaryprocessing Refining

Heattreatment

ExternalSleeves

InternalSleeves

Storage bylabel Delivery

Assembling Refining

(3) Blade-guide pulleys

Raw materialanalysisCasting

Preliminaryprocessing Refining

Packagingand storing

TestingCleaningExaminingBlade-guide

cleaning

(4) Fluid injection pumps

SpraypaintingCleaning Packaging

Steel cutting AssemblingPreliminaryprocessing Welding

Heattreatment Refining

Testing

BUSINESS

— 78 —

RAW MATERIALS AND COMPONENTS

The major raw materials and components required by the Group include (seamless pipes),

(steel billet), (casting) and (round steel bar). During each of the three years ended

31 December 2005 and the four months ended 30 April 2006, the largest five suppliers of the Group

accounted for approximately 60.3%, 61.1%, 52.8% and 43.1% respectively of the Group’s total

purchases, while the largest supplier, accounted for approximately 24.2%, 31.0%, 22.8% and 12.0%

of the Group’s total purchases respectively for the same periods.

The Group has relatively long-standing relationships with its major suppliers for two to six years

and has not experienced any significant difficulties in sourcing raw materials and components

throughout the Track Record Period. The Directors do not anticipate that the Group will face any

difficulties in sourcing its raw materials and components in future given its long-standing

relationships with its major suppliers. The Directors are also of the view that the raw materials and

components can be sourced locally without difficulties.

The Group has implemented a set of procedures for selecting its major suppliers. Prior to

becoming an approved supplier of the Group, potential suppliers would be assessed by the Group’s

procurement division based on the following criteria:

● supplier’s production capacity and quality control;

● whether the raw materials manufactured by the supplier meet the national and the Group’s

standard;

● whether the supplier has previously committed any major production accident; and

● the Group’s other major appraisals towards the supplier such as price, delivery time, service

quality, integrity and reputation in the relevant industry.

To ensure the continual fitness of the approved suppliers, the Group will conduct the following

control procedures:

● review the production process of the supplier;

● collect information regarding the supplier on its product development, production facility,

management team and any other major development in the industry;

● to maintain control on the level of inventory and accounts payable through financial

management; and

● conduct quality assessment on the supplier’s raw materials to ensure that the raw materials

meet the Group’s standard.

BUSINESS

— 79 —

A1A(28)(1)(b)(i)A1A(28)(1)(b)(ii)

The major raw materials are sourced locally and are denominated and settled in RMB. Terms of

payment for the raw materials range from 90 to 180 days after delivery. They are usually settled by

bills and telegraphic transfer.

Save and except for the purchase of oil well pipe billets and casing billets from Weihai Baolong

by the Company, none of the Directors, the Supervisors, their respective associates or, Shareholders

interested in more than 5% of the issued share capital of the Company nor any of their respective

associates had any interest in any of the five largest suppliers of the Group during the three years

ended 31 December 2005 and the four months ended 30 April 2006.

INVENTORY CONTROL

As of 30 April 2006, the Group had inventories of approximately RMB182.79 million,

comprising of raw materials, work-in-progress and finished goods. For the three years ended 31

December 2005 and the four months ended 30 April 2006, the inventory turnover days of the Group

were approximately 82 days, 105 days, 101 days and 72 days, respectively. The Directors consider that

this level of inventories is necessary in order to maintain a smooth production and to satisfy

just-in-time delivery to customers.

The Group adopts stringent inventory control that allows the Group to monitor closely the level

of inventories of each of the raw materials, work-in-progress and finished goods. A complete inventory

check is conducted monthly and the Group’s warehouse staff reviews the Group’s inventories

accordingly to maintain accurate and up-to-date perpetual inventory records. In addition, the Directors

believe that the Group will base on its estimation and keep about 20% buffer stock in order to

maximize the Group’s potential sales.

Purchases are primarily made on sales order basis. Once a sales order is received, the engineering

department and production department of the Group will determine the nature and quantity of

materials necessary for that particular order. The Group’s logistics center will then make purchases

accordingly. After producing and testing the finished products, they will be delivered to the customers

of the Group. The Company will review any damaged, slow moving and obsolete inventory on a

quarterly basis. The stock provision is made for the differences between the book costs and the net

realizable values of the inventories. The stock provision is assessed on an individual basis.

When obsolete items are identified by the Group, they will be written-down to net realizable

value and all losses of inventories are recognized as expenses in the period in which such write-downs

or losses occur. Inventory would be regarded as obsolete when they are considered not saleable or no

longer suitable for production. For each of the three years ended 31 December 2005 and the four

months ended 30 April 2006, provision for obsolete inventory amounting to RMB20,000,

RMB-150,000, RMB4,499,000 and RMB1,836,000, respectively, was recorded.

BUSINESS

— 80 —

A1A(28)(1)(b)(v)

SALES AND MARKETING

Sales


sales to oil fields in the PRC accounted for approximately 84.8%, 81.7%, 72.2% and 62.7% of the

Group’s turnover respectively and the export sales accounted for approximately 15.2%, 18.3%, 27.8%

and 37.3% of the Group’s turnover, respectively.

The Directors believe that the Group has an established reputation in the PRC and international

petroleum drilling and extraction machinery industry for its capability to manufacture quality

petroleum drilling and extraction machinery and related accessories. The Group sells its products

primarily to oilfields in the PRC such as (Daqing Oil Field), (Xinjiang Oil Field),

(Zhongyuan Oil Field) and (Liaohe Oil Field).

Major customers of the Group

31 December

2003

31 December

2004

31 December

2005

30 April

2005

30 April

2006

Sales amount Sales amount Sales amount Sales amount Sales amount

Notes RMB’000

% of

Turnover RMB’000

% of

Turnover RMB’000

% of

Turnover RMB’000

% of

Turnover RMB’000

% of

Turnover

PetroChina

Daqing Oil Field

( ) 103,382 34.20 125,285 25.69 160,258 20.64 48,799 21.37 71,683 23.57

Xinjiang Oil Field

( ) 67,443 22.31 58,809 12.06 99,696 12.82 22,950 10.05 36,811 12.10

Liaohe Oil Field

( ) 14,259 4.72 15,290 3.14 6,212 0.80 105 0.05 3,817 1.25

Dagang Oil Field

( ) 7,497 2.48 9,740 2.00 29,806 3.84 4,649 2.04 — —

Jilin Oil Field

( ) — — 9,692 1.99 25,746 3.32 8,646 3.79 — —

Changqing Oil Field

( ) — — 27,769 5.69 66,372 8.55 7,784 3.41 17,378 5.72

Qinghai Oil Field

( ) — — 6,982 1.43 10,093 1.30 3,203 1.40 4.085 1.34

Yanchang Oil Field

( ) — — 11,079 2.27 23,039 2.97 8,066 3.53 5,964 1.96

Tuha Oil Field

( ) 14,980 4.96 15,700 3.22 7,298 0.94 3,488 1.52 1,169 0.38

Sub-total 207,561 68.67 280,346 57.49 428,520 55.18 107,690 47.16 140,907 46.32

BUSINESS

— 81 —

31 December

2003

31 December

2004

31 December

2005

30 April

2005

30 April

2006

Sales amount Sales amount Sales amount Sales amount Sales amount

Notes RMB’000

% of

Turnover RMB’000

% of

Turnover RMB’000

% of

Turnover RMB’000

% of

Turnover RMB’000

% of

Turnover

Sinopec

Shengli Oil Field

( ) 10,418 3.45 32,880 6.74 53,346 6.87 16,605 7.27 21,696 7.13

Zhongyuan Oil Field

( ) 27,267 9.02 28,595 5.86 48,699 6.27 13,880 6.08 6,081 2.00

Jiangsu Oil Field

( ) 3,819 1.26 12,565 2.58 10,663 1.37 3,136 1.37 930 0.31

Qinghe Oil Field

( ) — — 3,084 0.63 215 0.03 215 0.09 — —

Jianghan Oil Field

( ) 293 0.10 5,587 1.15 6,486 0.84 — — — —

Sub-total 41,797 13.83 82,711 16.96 119,409 15.38 33,836 14.81 28,707 9.44

Other domestic customers 7,120 2.35 35,294 7.25 13,063 1.68 22,768 9.97 21,276 6.99

Export customers

Petroleum Pipe Company 1 — — 28,347 5.8 36,940 4.8 9,561 4.19 6,246 2.05

ITE Inc 2 2,250 0.74 3,716 0.76 2,346 0.3 530 0.23 1,186 0.39

Other export customers 43,546 14.41 57,274 11.74 176,244 22.66 53,995 23.64 105,892 34.81

Total 302,274 100 487,688 100 776,522 100 228,380 100 304,214 100

Notes:

1. The Group has started to trade with Petroleum Pipe Company since 2004.

2. ITE Inc is one of the Group distributors in the US since 1996.


the largest five customers of the Group accounted for approximately 96.3%, 90.3%, 87.4% and 84.2%

respectively of the Group’s total turnover by value, and the largest customer of the Group accounted

for approximately 68.7%, 57.5%, 55.2% and 46.3% respectively of the Group’s total turnover by

value.

The Group’s sales were settled in Renminbi for transaction completed in the PRC while sales

generated from export were settled in US dollars. For each of the three years ended 31 December 2005

and the four months ended 30 April 2006, 84.8%, 81.7%, 72.2% and 62.7% of the Group’s sales was

settled in Renminbi while 15.2%, 18.3%, 27.8% and 37.3% was settled in US dollars.

BUSINESS

— 82 —

A1A(28)(1)(b)(iii)A1A28(i)(b)(iv)

None of the Directors, the Supervisors, their respective associates or, Shareholders interested in

more than 5% of the issued share capital of the Company nor any of their respective associates had

any interest in any of the five largest customers of the Group during the three years ended 31

December 2005 and the four months ended 30 April 2006.

Marketing

The Group’s sales and marketing team has been expanding over the years. As at 30 April, 2006,

it comprised of 58 sales and marketing staff members. The Group recognizes the importance of the

sales and marketing team on the Group’s corporate image and therefore offers extensive training in

order to enable the Group to provide the best customer services. The primary responsibility of the

sales and marketing team is fostering business relationships with both existing and potential customers

of the Group. It has been concentrating its marketing effort to large oil fields in the PRC and overseas

customers.

Apart from the one-to-one marketing performed by the marketing staff, the Group’s marketing

efforts also include aperiodic visits by the Group’s management and technical staff, inviting

representatives and agents of the customers to visit the Company and its plants, etc. These measures

enable the Group to maintain closer contacts and relationships with its customers and obtain

customers’ feedback on the Group’s products in time. Such feedback also provide the Group with the

latest market information and useful information for improving its products to monitor and work

towards meeting expectations of its current and potential customers.

The table below sets out a breakdown by different regions of the turnover of the Group’s

petroleum drilling and extraction machinery for the Track Record Period:


2003 2004 2005 2005 2006

(Unaudited)


The PRC 256,478 84.8 398,351 81.7 560,992 72.2 164,294 71.9 190,890 62.7

U.S. 42,972 14.2 52,052 10.7 101,284 13.1 34,068 14.9 55,205 18.1

Europe 2,358 0.8 28,347 5.8 69,497 9.0 19,295 8.5 41,003 13.5

Others 466 0.2 8,938 1.8 44,749 5.7 10,723 4.7 17,116 5.7

Total 302,274 100 487,688 100 776,522 100 228,380 100 304,214 100

BUSINESS

— 83 —

A1A28(i)(b)(v)

Customer service

The Group is committed to ensure consumers’ satisfaction with its products and has established

four domestic sales offices in Northeast China, Northwest China, North China and Middle China to

provide customer services (such as technical advice and support, and customer relationship) at major

oilfields in the PRC. As such, the Group is capable to provide adequate and quick responses to

customers’ demands as well as efficient after-sale services.

Pricing of products

The Group usually determines the price of its products based on the following steps. Firstly, the

finance department will set the initial price of a product based on the production costs. Then the sales

and marketing team will determine the final price of a product by adjusting the initial price based on

factors such as marketing expense, financial expense, administrative expense and other operating

expense, the mark-up set by the Group and the price of similar product in the market.

Payment terms

The Group’s payment terms are usually negotiated between the customers and the Group on a

case by case basis and are principally approved by managers of each sales office. The Group considers

it not practicable to adopt standard payment terms on sale of products to its customers. Payment terms

are negotiated based on each individual circumstance such as customer’s payment track records and

the types of products being sold. As the agreements entered into between the Company and its

customers do not contain any warranty clause in the sale of its products, customers will be entitled

to have an inspection period ranging from one to three months, depending on the types of the products,

to inspect the quality and quantity of the products. As soon as customers are satisfied with the quality

and quantity of the products, the Company will then issue invoices to customers for settlement.

However the Group would not normally agree to terms which would enable its customers to have an

inspection period for more than 3 months after delivery of products by the Group. Sales of the Group

are usually settled by telegraphic transfer or irrevocable letter of credit.

If customers are not satisfied with the quality or quantity of the products, customers will be

entitled to return the products to the Company and the Company will have to replace the products with

new ones and/or to provide repairing services to customers and/or to indemnify the losses suffered by

customers as a result thereof.

During the Track Record Period, the Group did not experience any return of products from its

customers and there was no indemnity paid to customers due to return of products.

The Group provides credit sales facilities to its two largest domestic customers (namely: the oil

fields of PetroChina and Sinopec). In general, the Group grants one to three months credit sales

facilities to the oil fields of PetroChina and Sinopec. The Group may extend some of major oil fields

of PetroChina and Sinopec with credit sales facilities to a maximum of six months period.

BUSINESS

— 84 —

The Group has not experienced any significant difficulties in claiming the full purchase price

from its customers throughout the Track Record Period. The provision made for doubtful debts for the

three years ended 31 December 2005 and the four months ended 30 April 2006 were approximately

RMB969,000, RMB2,171,000, RMB3,488,000 and RMB-2,960,000, respectively. Given that the

Group’s customers are mainly subsidiaries or branch oil fields of PetroChina or Sinopec, both of

which are reputable, of substantial size and Hong Kong listed companies and from past experience,

the Directors do not anticipate that the Group will face any difficulty in claiming the full purchase

price from its customers and the provision made is considered adequate.

No significant amount of trade receivables has been written off during the Track Record Period

and the Directors do not anticipate that the Group will face any difficulty in claiming the full purchase

price from its customers in the future.

The Group would make specific provision for accounts receivable when the estimated collection

of the full amount is no longer probable.

COMPETITION

Domestically, although there are other manufacturers which manufacture petroleum drilling and

extraction machinery and related accessories with functions similar to the principal products

manufactured by the Group, the Directors consider that products from other manufacturers are not as

competitive as those of the Group’s in terms of quality, product range and meeting customers’ needs.

Leveraging on its research and development capability and its well established status in the industry,

the Directors believe that the Group will continue to maintain its edge over its local competitors in

the foreseeable future.

Direct competitors at the international level include overseas petroleum drilling and extraction

machinery and related accessories manufacturers. These manufacturers are of limited numbers and are

mainly located in the US. The Directors are of the view that petroleum drilling and extraction

machinery products manufactured by these overseas competitors are often offered at a higher price

range than those of the Group’s. As such, the Directors believe that the petroleum drilling and

extraction machinery products produced by these overseas manufacturers lack pricing competitiveness

against those produced by the Group.

The Directors do not anticipate significant competition posed by new entrants to the industry.

Firstly, substantial capital investment is required for setting up production facilities. Secondly, strong

expertise and experience in the petroleum drilling and extraction machinery technology is needed for

establishing a foothold in the petroleum drilling and extraction machinery market. Accordingly, the

Directors consider that the entry barrier to the industry is high and therefore competition from new

competitors in the petroleum drilling and extraction machinery market would unlikely be significant

in the near future.

BUSINESS

— 85 —

ENVIRONMENTAL PROTECTION

The Group is principally engaged in the production of petroleum drilling and extraction

machines which is required to comply with national, provincial and local environmental laws and

regulations, including the Environmental Protection Law of the PRC, the Law on the Prevention and

Control of Water Pollution of the Company and the Law on the Prevention and Control of Air Pollution

of the PRC.

The Group has complied with the applicable environmental protection laws and regulations

(such as , , ,

, , and

) and has not been penalised for breach of any national, provincial or local

environmental protection laws or regulations during the Track Record Period. As advised by the PRC

legal advisors to the Company, the Group has complied with these environmental laws and regulations

in all material respects. In addition, the Directors believe that the Group can effectively manage the

environmental liability risk because the Group has compiled with the applicable environmental laws

and regulations in the PRC.

The Group invested approximately RMB4.85 million to install the water treatment facilities to

recycle all the turbidity water produced by the Group. The Group has used natural gas as the fuel to

heat the raw materials during the production process, which complies with the standard for the

emission of polluted gas in the PRC. Furthermore, the Group’s wasted metal produced during the

production process has been sold for recycling.

BUSINESS LICENCE AND PERMIT




machines and other petroleum drilling and extraction machinery accessories. As advised by the PRC

legal advisors of the Company, the Company’s business operations described above have complied

with the law and regulations in the PRC. Save and except for the absence of related building ownership

certificates for certain buildings as disclosed in pages III-8 and III-12 of this document, the Group has

obtained all licenses, approvals and certificates from the relevant government authorities to conduct

its operations in the PRC.

LITIGATION

There is no litigation or arbitration proceedings threatened against the Group which could have

a material adverse effect on the Group’s financial condition and results of operations. None of the

members of the Group is subject to any intellectual property right infringement claim.

BUSINESS

— 86 —

INSURANCE

The Group has bought insurance for its properties, equipment and production facility. However,

the Group has maintained no insurance to cover (i) any liability arising from or as a result of any

defect in its products and (ii) environmental damage.

The Group’s production facilities, technical capabilities, product testing and quality control have

passed the ISO and API certifications which enable the Group’s products to satisfy the specific

technical standards and product quality. The Directors confirm that the Group has never experienced

any material third party liability claim in relation to its products. In fact, the agreements entered into

between the Company and its customers do not contain any warranty clause in the sale of its products

and the customers are entitled to have an inspection period ranging from one to three months after

delivery of the products, the Directors therefore are of the view that the liability as a result of product

defects is remote and the insurance coverage for product liability is not necessary. The Directors

believe that the Group can effectively manage the product liability risk through its stringent quality

control such as ISO and API certifications.

RESEARCH AND DEVELOPMENT

The petroleum drilling and extraction machinery industry in which the Group operates is

characterized by rapid technological development and increasing demand for high quality advanced

technology products. The Directors understand successful technological development is important for

the Group to stay competitive in the market.

The Group’s research and development that is carried out by its engineering centre mainly

constitutes two parts, namely product development and production technology research. The product

development team is responsible for developing high quality reliable new products while the

production technology research team conducts research, designs and provides detailed production

engineering for the production process. In order to maintain competitiveness in the industry, the Group

keeps abreast of the latest industry development and market trends, in particular with regard to new

technology development. In addition, the Group continues to seek opportunities to cooperate with

major petroleum drilling and extraction machinery research organizations, such as Xian Jiaotong

University and (the Institute of Daqing Petroleum Extraction Sixth Factory

Planning and Design).

On 16 June 2002, the Company signed a “technological cooperation agreement” with

(the Institute of Daqing Petroleum Extraction Sixth Factory Planning and

Design) (“Daqing Institute”) to establish a 5-year technological cooperation relationship with regard

to the research and development of petroleum extraction machinery.

BUSINESS

— 87 —

A1A(28)(5)

Objective: To form a technological cooperative relationship on the

development of petroleum extraction machinery.

Responsibilities: 1. The Company will be responsible to initiate the topics

and the requirements for exploration and research of

new products and to participate in the research and

development process of new products by utilizing the

technology owned by Daqing Institute.

2. the Company will also be responsible for manufacturing,

sale and after sale services of new products.

3. Daqing Institute will transfer the newly developed

technology to the Company in priority for the exclusive

use by the Company in its product development process.

Separate agreement will be entered into between Daqing

Institute and the Company for such transfer of

technology.

4. Daqing Institute will also need to provide technological

support to the Company when needed and to assist the

Company to promote the products in Daqing Oil Field.

Cost of allocation: The Company will need to pay for the cost of testing and the

patent utilization and Daqing Institute will need to pay for

cost of research. Daqing Institute will be entitled to 0.5% to

1% of the sales revenue of the newly developed products by

the Company in Daqing Oil Field market.

Ownership of the intellectual

rights:

The ownership of the new products will be equally owned by

both parties.

Duration of the agreement: 5 years.

On 6 January 2006, the Company signed an agreement of “Petroleum Engineering Material

Development” with Xian Jiaotong University. The agreement summary is set out below:

Objective: To set up a research centre for developing new materials for

petroleum engineering usage.

Responsibilities: 1. Both parties will jointly select research topics.

2. Provide technical supporting advisory and information

services to the Company.

3. Provide training to the Group’s senior engineering staff.

4. Provide the Group with some material analysis.

BUSINESS

— 88 —

Cost of allocation: The Company will need to pay for the cost of RMB150,000

per year. Should the cost of the project be more than

RMB150,000, the Company will make advance payment from

the next year’s cost or make additional payment.

Ownership of the intellectual

rights:

The ownership of the new products will be equally owned by

both parties.

Duration of the agreement: 3 years.

As at the Latest Practicable Date, the Group’s research and development teams employ a total

of 57 staff (of which included 3 senior qualified engineers and 28 qualified engineers) with product

enhancement, industrial design, machinery production and applied technology capabilities.

During the Track Record Period, the Group incurred research and development expenditure of

approximately RMB3,435,000, RMB3,777,000, RMB5,724,000 and RMB2,183,000, and representing

approximately 1.1%, 0.7%, 0.7% and 0.7% of the Group’s total turnover, respectively.

QUALITY CONTROL

The Group is committed to manufacturing quality products. The Directors believe that product

quality is vital in enhancing the Group’s competitiveness, market position and reputation.

The quality control of the Group’s products is divided into three phases:

Purchase control

The Group has implemented a set of procedures for selecting its major suppliers and only

places orders from those qualified suppliers. In addition, all the raw materials are subject to

inspections and examinations in accordance with quality standards before acceptance.

Production control

The production process involves different procedures. The Group carries out its quality

control in accordance with ISO9000 (valid until 19 January 2009) and API Specifications (valid

until 2 January 2007). All production procedures are documented and are guided by the

instruction manual with appropriate personnel and advanced equipment.

Product control

All final products will be tested in accordance with the technical standards and only

qualified products will be accepted.

BUSINESS

— 89 —

PROPERTIES

The Company owns a total of three parcels of land in Shouguang City Shandong province, China.

These parcels of land contain 48 buildings and various ancillary structures that support the Group’s

petroleum machinery equipment production activities. All of the production facilities are on these

parcels of land. The total site area of the land is 395,121.08 square metres. The total gross floor area

of the 48 buildings and structures is 178,773.58 square metres.

At the northern side of Wenmiao Street Development Zone Shouguang City, the Group has 19

completed industrial buildings with gross floor area of approximately 42,749.8 sq.m. Amongst these

completed buildings, 7 industrial buildings with approximately gross floor area of 4616.8 sq.m. have

not been obtained the building ownership certificate. The valuation amount of these buildings without

building ownership certificate is approximately RMB2,445,000.

At northern side of Beihuan Road Science Technology Industrial Park Development Zone

Shouguang City, the Group has 17 industrial buildings with gross floor area of approximately

119,923.86 sq.m. which have not obtained the building ownership certificate. The valuation amount

of these buildings without building ownership certificate is approximately RMB77,759,000.

As at the Latest Practicable Date, these buildings mentioned above have not obtained the

building ownership certificates. However, according to the document issued by the Real Estate

Administrative Bureau of Shouguang City, the building ownership certificate for the completed

buildings of the property is under application.

As advised by the PRC legal advisor of the Company, the Group has obtained the land use rights

certificates and the confirmation from the Real Estate Administrative Bureau of Shouguang City that

(i) the application for building ownership certificate of these 24 completed buildings is being in

process and (ii) the application has fulfilled the application requirements. Hence, the PRC legal

advisor of the Company advises that the Group has the legal rights to use, occupy and lease the

completed buildings of the property and there is no impediment. The Group leased two industrial

workshops with total gross floor area of 11,232.71 square metres from Maolong Machinery and

Molong Equipment, and two dormitory buildings, a canteen building and a port of composite building

with a total gross floor area of 8,729.74 square metres from Maolong Machinery.

In addition, the Company leased an industrial workshop with a gross floor area of 16,021.67

square metres to Molong Equipment. For further detail of this investment property, please refer to the

section headed “Investment properties” of the Accountants Report of appendix I and the section

headed “Group II — Property interests held for investment by the Group in the PRC — Property no.

4” of the Property Valuation of appendix III of this document.

The summary of values and the valuation certificates for the property interest to these properties

issued by Sallmanns (Far East) Limited are set out in “Appendix III — Property Valuation Report”.

BUSINESS

— 90 —

INDEPENDENCE OF THE CONTROLLING SHAREHOLDER FROM THE GROUP

Zhang En Rong, the controlling shareholder of the Company, has confirmed that he is not

currently engaged in any business which, either directly or indirectly, competes with the Group’s

business. According to the non-competition undertaking signed by Zhang En Rong dated 28 September

2006, Zhang En Rong has undertaken unconditionally, inter alia:

(i) he will not and will procure his associates and companies controlled by him not to directly

or indirectly invest or participate in any other business which may compete with the

business that the Group is engaged or will engage in;

(ii) he will not take advantage of his relationship with or position as a shareholder of the

Company to engage or participate in any behaviour which may prejudice the Company and

its other shareholders;

(iii) if there is any project or new business which is related to the business that the Group is

engaged or will engage in, inter alia, the design, manufacture and sale of petroleum

extraction machinery and related accessories, such projects or new business should be

offered to the Group on a preferential basis;

(iv) he will allow that the independent non-executive Directors would review, at least on an

annual basis, the compliance with the non-competition undertaking;

(v) he will provide all information necessary for the annual review by the independent

non-executive Directors and procuring the enforcement of the non-competition

undertaking;

(vi) he will procure the Company to disclose decisions on matters reviewed by the independent

non-executive Directors relating to the compliance and enforcement of non-competition

undertaking either through the annual report, or by way of public announcements to the

public; and

(vi) he will make an annual declaration on compliance with the non-competition undertaking

which will be disclosed in the annual report of the Company.

BUSINESS

— 91 —

A1A 27A

The Group is capable of carrying on its business independently of the controlling shareholder of

the Company and its associates on the basis that:

(i) the Group is financially independent from Mr. Zhang En Rong. As disclosed in the

“Financial Information” section of this document, all the loans of the Group are bank

borrowings. The Company also set up a audit department and a finance department which

implements independent accounting audit procedure and finance management system. The

audit committee of the Company, which is comprised of three independent non-executive

directors of the Company, reviews and supervises external auditors, financial information,

financial reporting systems and internal control procedures of the Company;

(ii) the Group has an independent access to sources of supplies/raw materials for production.

The current as well as the currently intended sourcing strategy of the Group is to purchase

raw materials primarily from one or several major supplier(s) (not necessarily a connected

person), but where appropriate and/or necessary, supplemented with the same products from

other suppliers. Such strategy would enable the Group to, negotiate for better pricing, have

a better safeguard for quality assurance, maintain a stable supply of billets, and maintain

better understanding and consequently a more harmonious business relationship through

long term co-operation with its major supplier(s);

(iii) the Group has independent production and operation capabilities. Neither the controlling

shareholder of the Company nor his associates have any influence on the production and

operation of the Group; and

(iv) the Group has independent access to customers and independent management. The

Company has comprehensive personnel and remuneration management regulation system.

BUSINESS

— 92 —

COMPARISON OF BUSINESS OBJECTIVES WITH ACTUAL BUSINESS PROGRESS

The net proceeds from the placing and public offer of H Shares by the Company on 15 April

2004, after deducting the underwriting and other expenses payable for the above placing and public

offer of H Shares, which amounted to approximately HK$70,950,000, was intended to be used by the

Company as stated in the Prospectus. As at 30 June 2006, the Group had utilized the proceeds as

follows:

Proposed use ofproceeds as

stated inthe Prospectus

Actual amountused up to

30 June 2006

Remainingnet proceeds for

the six monthsending 31

December 2006

HK$ (in million) HK$ (in million) HK$ (in million)

Research and development 6.20 6.20 0.20

Expansion of production capacity 37.00 37.30 —

Product improvement and

development 23.10 23.10 0.20

Sales and marketing 1.75 1.75 0.20

Human resources 1.30 1.30 0.20

Certification 0.40 0.35 0.15

Total 69.75 70.00 0.95

The Group has accelerated its production capacity expansion and certain projects were completed

prior to their scheduled time as set out in the Prospectus due to the increase in demand for petroleum

drilling and extraction machinery.

BUSINESS

— 93 —

Comparisons of the business objectives with the actual business progress set out in the

Prospectus for the period from 22 March 2004 to 30 June 2006 are as follows:

Business objectives as stated in Prospectus Actual business progress


Technology for production of super-strength

oil well sucker rods (to be completed by 30

June 2004)

Technology for production of super-strength oil

well sucker rods has been developed (completed

by 30 June 2004)

Energy conservation technology in oil well

pumping machines (to be completed by 30

June 2004)

Energy conservation technology has been

developed (completed by 31 December 2004;

delay caused by technical difficulty)

To develop a packer jointly with the

Zhongyuan Institute (to be completed by 31

December 2004)

The development of the packer has been

completed (completed by 31 December 2004)

To continue the research and development on

petroleum drilling and extraction machinery

and related accessories (to be completed by 30

June 2006)

The planned research and development has been

achieved (completed by 30 June 2006)

Expansion of production capacity

To achieve annual production capacity of oil

well pumps to approximately 10,000 units (to

be completed by 30 June 2004)

The planned annual production capacity has

been achieved (completed by 30 June 2004)


well sucker rods to approximately 3,000,000

meters (to be completed by 30 June 2004)

The annual production capacity of oil well

sucker rods has been increased to approximately

3,500,000 meters (completed by 31 December

2004; due to the increase in market demand, the

Company speeded up the enhancement of the

production capacity)


well pumping machines to approximately 200

units (to be completed by 30 June 2004)



To maintain annual production capacity of

underground petro-electric pumps to

approximately 200 units (to be maintained by

30 June 2004)


been maintained (maintained by 30 June 2004)


blade-guide pulleys to approximately 150,000

sets (to be maintained by 30 June 2004)



BUSINESS

— 94 —


To achieve annual production capacity of

valves to approximately 60,000 pieces (to be

completed by 30 June 2004)




fluid injection pumps to approximately 300

units (to be maintained by 30 June 2004)



To achieve annual production capacity of mud

pump steel sleeves to approximately 33,000

pieces (to be completed by 30 June 2004)



To complete the construction of new

production facilities for super-strength oil well

sucker rods (to be completed by 30 June 2004)

and to achieve annual production capacity to

approximately 40,000 tonnes (to be completed

by 31 December 2004)

The construction of new production facilities for

super-strength oil well sucker rods has been

completed and the planned annual production

capacity has been achieved (completed by 31

December 2004)

To complete the construction of new

production facilities for special seamless oil

well pipes to achieve annual capacity to

approximately 60,000 tonnes (to be completed

by 30 June 2005)

The construction of new production facilities for

special seamless oil well pipes has been

completed with an annual production capacity of

approximately 60,000 tonnes (completed by 30

June 2004; due to the increase in market

demand, the Company speeded up the

enhancement of the production capacity)

To achieve the annual production capacity of

oil well pipes to approximately 50,000 tonnes

(to be completed by 30 June 2006)

The annual production capacity of oil well pipes

has reached 60,000 tonnes (completed by 31

December 2005; due to the increase in market

demand, the Company speeded up the

enhancement of the production capacity)

Production improvement and development

To develop oil well pipes which can withstand

high pressure (to be completed by 30 June

2004)

Successfully developed special seamless oil

well pipes which can withstand high pressure

(completed by 30 June 2004)

To develop advanced and reliable oil well

sucker rods by utilizing high quality steel raw

materials and to construct the production

facilities of the oil well sucker rods (to be

completed by 31 December 2004)

Advanced and reliable oil well sucker rods have

been developed. Construction of production

facilities of the oil well sucker rods has been


BUSINESS

— 95 —


To enhance oil well pumps performance under

specific oil well conditions, such as anti-

corrosion, sand-proof, etc (to be completed by

31 December 2004)

The objective has been achieved (completed by

31 December 2004)

To enhance system operations for oil well

pumping machines (to be completed by 31

December 2004)


31 December 2004)

To continue to improve and develop products

in response to market trends and changes (to

be completed by 31 December 2005)

Successfully developed a number of oil well

sucker rods of various specifications (completed


Sales and marketing

To refine and increase the speed for the

Group’s official website and to further

understand domestic and foreign market of

petroleum drilling and extraction machinery

(to be completed by 30 June 2004)

The official website’s content of the Group has

been modified and its connection speed has been

improved (completed by 30 June 2004)

To reinforce current sales network (domestic

and foreign) and simultaneously to further

explore markets in North America and the

Middle East by sending sales principals to

North America and the Middle East (to be

completed by 31 December 2004)

Sales principals have been sent to North

America and the Middle East, sales agents were

appointed and direct business relationships with

certain clients has been established (completed


To further explore market in North America

and the Middle East (to be completed by 30

June 2006)


30 June 2006)

Human resources

To expand the Group’s work force by

recruiting high caliber individuals from time

to time (on-going)

The objective, including the recruitment of

suitable personnel responsible for research and

development, production, quality control, sales

and marketing and administration, has been

achieved (on-going)

Certification

To obtain new and/or renew existing National

Industrial Product Manufacturing Licenses for

oil well pumps, oil well sucker rods and oil

well pumping machines (to be completed by

31 December 2004)

The renewal of existing National Industrial

Product Manufacturing Licenses has been


BUSINESS

— 96 —


To renew the right to use API Monogram for

oil well pumps, oil well sucker rods and oil

well pipes (to be completed by 30 June 2005)

The renewal of the right to use API Monogram

for oil well pumps, oil well sucker rods and oil

well pipes has been completed (completed by 30

June 2005)

To apply for the right to use API Monogram

for oil well pumping machines (to be

completed by 30 June 2005)

The application for the right to use API

Monogram for oil well pumping machines has

been postponed (the Company is still

considering if the application should be put

through)

To apply for rights to use API Monogram for

newly developed petroleum drilling and

extraction machinery (to be completed by 30

June 2006)

No fresh application for API Monogram is

required for the petroleum drilling and

extraction machinery being developed

The net proceeds from the placing in May 2005 amounted to approximately HK$94.80 million.

As at 30 June 2006, the Group has utilized the proceeds as follows:

Use of proceedsextracted from

the PlacingAnnouncement

Actual amountused up to

30 June 2006

Remaining netproceeds as at

30 June 2006

HK$ (in million) HK$ (in million) HK$ (in million)

Purchase of the production line of

oil casing and related accessories 94.80 94.80 0.00

Comparison of the business objectives with the actual business progress set out in the Placing

Announcement of the Company for the period from 13 May 2005 to 30 June 2006 are as follows:

Business objective as stated in the PlacingAnnouncement

Actual business progress

Purchase of the production line of oil casing

and related accessories

The construction has been completed and has

gone into trial production

BUSINESS

— 97 —

RELATIONSHIPS WITH MAOLONG MACHINERY, MOLONG EQUIPMENT, MAOLONGRECYCLE AND WEIHAI BAOLONG

Background

Maolong Machinery

Maolong Machinery is a limited liability company established in the PRC on 1 August 2000. It

was principally engaged in the production and sale of oil equipment and accessories

( ), high pressure isolation switches and high pressure electric appliances, related

equipment sets ( ); processing and sale of alloy accessories ( )

since establishment. For the purpose of delineating the business of the Group, the production and sale

of oil equipment and accessories ( ) of Maolong Machinery was transferred to the

Group in July 2001. After reorganizations of the Group and the business of Maolong Machinery, the

principle activities of Maolong Machinery became solely the production and sale of high pressure

isolation switches, high pressure electric appliances and related equipment sets

( ) and processing and sale of alloy accessories ( ), which are

not for use in petroleum extraction and totally different from the business of the Group and do not

compete with the Group’s business. All these products are used for supply of electricity.

The shareholding structure of Maolong Machinery as at the Latest Practicable Date is as follows:

Name of shareholder

Approximatepercentage ofshareholdings

(%)

(Zhang Yun Qi) (Note 1) 53.15

(Lin Fu Long) (Note 2) 6.46

(Zhang Yun San) (Note 3) 6.46

(Zhang Jin Chuan) (Note 7) 6.46

(Li Bao Hui) (Note 5) 6.11

(Guo Huan Ran) (Note 7) 4.85

(Liu Yun Long) (Note 6) 4.85

(Zhang Guang He) (Note 10) 2.10

(Zhang Zhi Jun) (Note 10) 1.96

(Cui Huan You) (Note 8) 1.94

(Xie Xin Cang) (Note 4) 1.94

(Ren Chun Qing) (Note 9) 1.86

(Zhang Jin Sheng) (Note 10) 1.86

Total: 100.00

RELATIONSHIPS WITH MAOLONG MACHINERY,MOLONG EQUIPMENT, MAOLONG RECYCLE AND WEIHAI BAOLONG

— 98 —

Notes:

1. Zhang Yun Qi is the brother of Zhang Yun San and the son of Zhang En Rong. He is also a director of Maolong

Machinery. Zhang Yun San and Zhang En Rong are Directors and Promoters.

2. Lin Fu Long is a director of Maolong Machinery. He is also a Director and Promoter.

3. Zhang Yun San is a director of Maolong Machinery. He is also a Director and Promoter. Zhang Yun San is the

brother of Zhang Yun Qi and the son of Zhang En Rong.

4. Xie Xin Cang is a supervisor of Maolong Machinery. He is also one of the Directors and Promoters. He is the

husband of Li Bao Hui.

5. Li Bao Hui is a director of Maolong Machinery. She is also a Supervisor. She is the wife of Xie Xin Cang.

6. Liu Yun Long is a director of Maolong Machinery. He is also one of the Promoters.

7. Zhang Jin Chuan and Guo Huan Ran are directors of Maolong Machinery.

8. Cui Huan You is a Promoter.

9. Ren Chun Qing is a supervisor of Maolong Machinery.

10. Each of Zhang Jin Sheng, Zhang Guang He and Zhang Zhi Jun is a third party independent of and not connected

with any of the directors, supervisors, chief executive and substantial shareholders of the Company or its

subsidiaries or any of their respective associates.

As shown above, Zhang En Rong and Zhang Yun San are connected persons of the Company

pursuant to Rule 14A.11(1) of the Listing Rules. Pursuant to Rule 14A.11(4)(b) of the Listing Rules,

as Zhang Yun Qi is the son of Zhang En Rong and the brother of Zhang Yun San, he is regarded as

an associate of the Directors and accordingly, is also a connected person of the Company. As Zhang

Yun Qi is interested in approximately 53.15% of the equity interest in Maolong Machinery, Maolong

Machinery is deemed to be a connected person of the Company by the Stock Exchange.

Molong Equipment

Molong Equipment is a limited liability company established in the PRC on 6 November 2001

and was principally engaged in the production and sale of electrical equipment set ( )

before the transfer of entire assets, liabilities and employees of Weifang Dragon to Molong

Equipment. After the transfer, Molong Equipment is also engaged in the production and sale of casting

( ). The shareholders of Molong Equipment are Maolong Machinery and Mr. Fang which are

interested in 75% and 25% respectively of the registered capital of Molong Equipment. Mr. Fang is

an Independent Third Party. Given that Maolong Machinery is deemed to be a connected person of the

Company by the Stock Exchange and Molong Equipment is a subsidiary of Maolong Machinery,

Molong Equipment is also deemed to be a connected person of the Company by the Stock Exchange.


— 99 —

Maolong Recycle

Maolong Recycle is a limited liability company established in the PRC on 13 December 2002 and

is principally engaged in the purchase of unwanted and used metals. The shareholders of Maolong

Recycle are the Company and Maolong Machinery which are interested in 10% and 90% of the

registered capital of Maolong Recycle, respectively. Given that Maolong Machinery is deemed to be

a connected person of the Company by the Stock Exchange and Maolong Recycle is a subsidiary of

Maolong Machinery, Maolong Recycle is also deemed to be a connected person of the Company by

the Stock Exchange.

Weihai Baolong

Weihai Baolong is a limited liability company established in the PRC on 26 November 2003 and

is principally engaged in the production of special metallic materials used in the manufacture of oil

well pipes and casings. Weihai Baolong, which is a non wholly-owned subsidiary of Maolong

Machinery, is owned as to 95% by Maolong Machinery and 5% by Molong Equipment. Given that

Maolong Machinery is deemed to be a connected person of the Company and Weihai Baolong is a

subsidiary of Maolong Machinery, Weihai Baolong is also deemed to be a connected person of the

Company.

Non-competition Undertaking

The Directors are of the view that no competition, whether in general or in terms of the

application and the customers of Maolong Machinery’s products and those of the Group, exists

between the Group, Maolong Machinery, Molong Equipment, Maolong Recycle and Weihai Baolong

which can also be demonstrated by the principal businesses of each of these companies.

Since the listing and trading of the H Shares on GEM, each of Maolong Machinery, Molong

Equipment and Maolong Recycle has undertaken (the “GEM Undertaking”) to the Company that,

inter alia:

(1) it will not and procure its associates and companies controlled by it not to invest or

participate in any other business which may compete with the business that the Group is

engaged or will engage in;

(2) it will not take advantage of its relationship with the shareholders of the Company to

engage or participate in any behaviour which may prejudice the Company and its

shareholders; and

(3) if there is any project or new business which is related to the business that the Group is

engaged or will engage in, inter alia, the design, manufacture and sale of petroleum drilling

and extraction machinery and related accessories, such projects or new business should be

offered to the Group on a preferential basis.


— 100 —

For the purpose of the Introduction, the Company has also entered into a non-competition

undertaking on 26 September 2006 with each of Maolong Machinery, Molong Equipment, Maolong

Recycle and Weihai Baolong (the “Main Board Undertaking”), which is conditional upon the

Company on or before 31 March 2007 obtaining the approval from the Listing Committee for the

listing of, and permission to deal in, the H Shares in issue on the Main Board. Under the Main Board

Undertakings, each of Maolong Machinery, Molong Equipment, Maolong Recycle and Weihai Baolong

has undertaken to the Company that, inter alia:

(1) the GEM Undertaking be terminated (Note);

(2) it will not and procure its associates and companies controlled by it not to, directly or

indirectly, invest or participate in any other business which may compete with the business

that the Group is engaged or will engage in;

(3) it will not take advantage of its relationship with the shareholders of the Company to

engage or participate in any behaviour which may prejudice the Company and its

shareholders;

(4) if there is any project or new business which is related to the business that the Group is

engaged or will engage in, inter alia, the design, manufacture and sale of petroleum drilling

and extraction machinery and related accessories, such projects or new business should be

offered to the Group on a preferential basis;

(5) it will allow that the independent non-executive Directors would review, at least on an

annual basis, the compliance with the Main Board Undertaking;

(6) it will provide all information necessary for the annual review by the independent

non-executive Directors and procuring the enforcement of the Main Board Undertaking;

(7) it will procure the Company to disclose decisions on matters reviewed by he independent

non-executive Directors relating to the compliance and enforcement of Main Board

Undertaking either through the annual report, or by way of public announcements to the

public; and

(8) it will make an annual declaration on compliance with the Main Board Undertaking which

will be disclosed in the annual report of the Company.

(Note: The Main Board Undertaking given by Weihai Baolong in favour of the Company does not contain this clause

because Weihai Baolong was established by Maolong Machinery in 2005 (i.e. after the H Shares were listed on

GEM in April 2004).)


— 101 —

A number of transactions (the “Continuing Connected Transactions”) have been entered into

and will continue to be carried out between the Company and its connected persons. A summary of

these Continuing Connected Transactions is set out below:

Summary of the Continuing Connected Transactions

A. Non-exempt Continuing Connected Transactions

Type of transaction TermApplicableListing Rule Waiver sought

A.1 Purchase of oil well pipe

billets and casing billets

from Weihai Baolong by

the Company

From 28 November 2005

to 31 December 2007

Rule 14A.35 Announcement and

independent

shareholders’

approval

requirements

A.2 Purchase of metallurgy

accessories from Molong

Equipment by the Company


to 31 December 2007


independent

shareholders’

approval

requirements

A.3 Supply of scrap and used

metals by the Company to

Molong Equipment


to 31 December 2007


independent

shareholders’

approval

requirements

A.4 Supply of casting by

Molong Equipment to the

Company

From 15 April 2004

to 31 December 2007


independent

shareholders’

approval

requirements

A.5 Supply of oil well pumps

and related accessories by

Molong Drilling Equipment

to Ya Long Oil Pump

From 1 January 2006 to

31 December 2007

Rule 14A.34 Announcement

requirement

CONNECTED TRANSACTIONS

— 102 —

B. Exempt Continuing Connected Transactions


B.1 Supply of goods and raw

materials to Maolong

Machinery and Molong

Equipment

From 15 April 2004

to 31 December 2006

Rule 14A.33(3) —

B.2 Property leased from

Maolong Machinery

From 1 January 2002

to 30 December 2011

Rule 14A.33(3) —

B.3 Property leased to

Molong Equipment


to 31 October 2015

Rule 14A.33(3) —

B.4 Property leased from

Molong Equipment

From 1 October 2005

to 30 September 2015

Rule 14A.33(3) —

B.5 Equipment leased to

Molong Equipment

From 1 December 2005

to 30 November 2008

Rule 14A.33(3) —

C. Discontinued Exempt Continuing Connected Transaction


C.1 Subcontracting expenses paid

to Molong Equipment and

Maolong Machinery

— — —

A. Non-exempt Continuing Connected Transactions

Set out below are the terms of the non-exempt continuing connected transactions which are

subject to reporting, announcement and/or independent shareholders’ approval requirements under

Rules 14A.45 to 14A.54 of the Listing Rules (the “Non-exempt Continuing Connected

Transactions”).


— 103 —

A.1 Purchase of oil well pipe billets and casing billets from Weihai Baolong by the Company

Terms of the Oil Well Pipe Billets and Casing Billets Supply Agreement

Weihai Baolong and the Company entered into the Oil Well Pipe Billets and Casing Billets

Supply Agreement on 22 September 2005 pursuant to which Weihai Baolong has agreed to sell and the

Company has agreed to purchase oil well pipe billets and casing billets in the following terms:

Parties: Weihai Baolong as seller

The Company as purchaser

Subject: Pursuant to the Oil Well Pipe Billets and Casing Billets

Supply Agreement, Weihai Baolong has agreed to supply to

the Company oil well pipe billets and casing billets.

Term: The Oil Well Pipe Billets and Casing Billets Supply

Agreement has been effective from 28 November 2005 to 31

December 2007 (both dates inclusive).

Pricing basis: Pursuant to the Oil Well Pipe Billets and Casing Billets

Supply Agreement, since the oil well billets and casing billets

are not subject to any fixed rates prescribed by the relevant

authorities of the PRC, it has been agreed that the supply

price of oil well pipe billets and casing billets charged by

Weihai Baolong to the Company will be the prevailing market

price less an agreed discount of not more than

RMB100/tonne. The above discount is determined as a result

of the commercial negotiation between the Company and

Weihai Baolong.

The current prevailing market price for oil well pipe billets

and casing billets are approximately RMB3,400/tonne and

RMB3,200/tonne respectively.

Other significant terms: (1) The Company shall make payments to Weihai Baolong

in cash monthly in arrears;

(2) In the event that defects are found in the oil well pipe

billets and casing billets supplied by Weihai Baolong,

Weihai Baolong has agreed to exchange new oil well

pipe billets and casing billets to the Company free of

charge or indemnify the losses incurred by the Company

in respect of the defects; and

(3) Weihai Baolong has agreed to be responsible for

distributing oil well pipe billets and casing billets to the

factory of the Company, the costs of which would be

borne by the Company.


— 104 —

The Oil Well Pipe Billets and Casing Billets Annual Cap Amounts

There have been no purchases of oil well pipe billets and casing billets from Weihai Baolong bythe Company before the Oil Well Pipe Billets and Casing Billets Supply Agreement was entered into.

The Directors expect that the maximum aggregate annual value of sales of oil well pipe billetsand casing billets by Weihai Baolong to the Company under the Oil Well Pipe Billets and CasingBillets Supply Agreement is estimated not to exceed RMB470,203,600 (equivalent to approximatelyHK$452,118,800) and RMB789,670,000 (equivalent to approximately HK$759,298,000) (each, an“Oil Well Pipe Billets and Casing Billets Annual Cap”) respectively for each of the two years ending31 December 2007, which represents the target purchases agreed between the Company and WeihaiBaolong.

The Group sources its oil well pipe billets and casing billets from either the Independent ThirdParties or Weihai Balong during the Track Record Period. Set out below is the table showing (a) thehistorical dollar amount of tonnage of oil well pipe billets and casing billets purchased by the Groupin each of the three years ended 31 December 2005 and the six months ended 30 June 2006; and (2)the dollar amount and tonnage of oil well pipe billets and casing billets that the Group plans topurchase in the remaining six months of 2006:

The volume and amount of oil well pipes billets and casing billets purchased from Weihai Baolong

Product

The year ended31 December 2003



Six months ended30 June 2006

Six months ended31 December 2006

Purchasevolume

Purchaseamount

Purchasevolume

Purchaseamount

Purchasevolume

Purchaseamount

Purchasevolume

Purchaseamount

Projectedpurchase

volume

Projectedpurchase

amount

(tonnes) (RMB) (tonnes) (RMB) (tonnes) (RMB) (tonnes) (RMB) (tonnes) (RMB)

Oil well pipebillets 0 0 0 0 850 2,433,760.75 15237.05 50,789,658.77 30,000 99,999,000

Casing billets 0 0 0 0 0 0 6488.30 20,221,435.78 96,000 299,193,600

The volume and amount of oil well pipe billets and casing billets purchased from Independent

Third Parties

Product




Six months ended30 June 2006

Six months ended31 December 2006

Purchasevolume

Purchaseamount

Purchasevolume

Purchaseamount

Purchasevolume

Purchaseamount

Purchasevolume

Purchaseamount

Projectedpurchase

volume

Projectedpurchase

amount

(tonnes) (RMB) (tonnes) (RMB) (tonnes) (RMB) (tonnes) (RMB) (tonnes) (RMB)

Oil well pipebillets 0 0 46,471.922 184,676,946.30 63,714.07 247,433,560.40 17,978.10 61,165,091 5,000 17,050,000

Casing billets 0 0 0 0 0 0 7,729.06 24,734,538 24,000 76,804,800

Note: The prices at which the oil well pipe billets and casing billets are supplied from the Independent Third Parties are the

prevailing market rates.


— 105 —

Set out below is the calculation of and the basis for the Oil Well Pipe Billets and Casing Billets

Annual Cap for the 2 years ending 31 December 2007:

Product

Projected

production

capacity

Production

efficiency

rate on the

consumption

of oil well

pipe billets

and casing

billets

during the

course of

production

Projected

volume of oil

well pipe billets

and casing

billets to be

consumed by

the Company

Projected

volume of oil

well pipe billets

and casing

billets to be

purchased from

Weihai Baolong

Oil well pipe

billets and

casing billets

annual cap

(tonnes) (Note 3) (tonnes) (tonnes) (RMB)

For the year ending

31 December

2006

Special seamless

oil well pipe

Casing

60,000

(Note 1)

Approximately

86.9%

68,215.15 45,237.05

(Note 4)

150,788,600

90,000

(Note 2)

Approximately

80.0%

134,217.36 102,488.30 319,415,000

Total 150,000 202,432.51 147,725.35 470,203,600

For the year ending

31 December

2007

Special seamless

oil well pipe

Casing

60,000

(Note 1)

Approximately

86.9%

69,000 48,500

(Note 4)

161,670,000

250,000

(Note 2)

Approximately

86.9%

287,000 201,500 628,000,000

Total 310,000 356,000 250,000 789,670,000

Notes:

(1) The annual production capacity of special seamless oil well pipes of the Company was approximately 60,000

tonnes in 2005 and the annual production capacity of special seamless oil well pipes of the Company is expected

to be constant for the two years ending 31 December 2007 because the existing production facilities of the special

seamless oil well pipes have reached their optimum production capacity.

(2) The construction of the new 250,000-tonnes casing production facilities of the Company has been completed in

March 2006. It is anticipated that the annual production capacity of casings will be approximately 90,000 tonnes

for the year 2006 and approximately 250,000 tonnes for the year 2007 after the new production facilities have gone

through a certain testing period in 2006,

(3) Oil well pipe billets and casing billets are the main raw materials for the production of special seamless oil well

pipes and casings.

(4) The Company expects to purchase the oil well pipe billets and casing billets from both independent third parties

and Weihai Baolong in order to avoid the risk of relying on a single supplier.


— 106 —

Reasons for the transaction

The Group is engaged in the design, manufacture and sale of petroleum drilling and extraction

machinery and related accessories. Oil well pipe billets and casing billets are used in the production

of special seamless oil well pipes and casings.

Before the construction of the new 250,000-tonne casing production facilities was completed, the

Group was only equipped with the 10,000-tonne casing production facilities. Due to the low

production capacity, the Group only recorded casing sales of 2,900 tonnes and 3,800 tonnes,

respectively, for each of the two years ended 31 December 2005.

The new 250,000-tonne casing production facilities were scheduled to commence production

from the end of April 2006. However, due to the delay of the fine-tuning in the production process of

the new production facilities, the actual production date is expected to be deferred to October 2006.

Due to the delay in the production schedule, the Directors estimated that the Company would only

manufacture approximately 90,000 tonnes of casing for the year ended 31 December 2006 (the

“Adjusted Casing Production Volume”).

The Directors consider that the recent expansion of casing production facilities is justified and

the Adjusted Casing Production Volume is achievable on the basis that (a) the total domestic demand

for casing reached 1,000,000 tonnes for the year ended 31 December 2005 in the PRC. Coupled with

the strong demand for casing from the overseas, the Directors are of the view that there is a strong

market potential for casing; and (b) as at 30 June 2006, the Company has recorded purchase orders

or sales contracts for 80,000 tonnes of casings from its customers for the year ended 31 December

2006.

As the annual production volume of casings of the Company has increased and is anticipated to

continue to increase in the future as set out above, subject to market demand and market competition,

its demand for oil well pipe billets and casing billets is likely to increase accordingly. The Directors

expect to secure long-term and steady relationships with Weihai Baolong since the long-term suppliers

enable a stable supply of raw materials to the Company which in turn guarantee a smooth production

of the Company’s products.

The current as well as the currently intended sourcing strategy of the Company is to purchase oil

well pipe billets and casing billets primarily from one or several major supplier(s) (not necessarily

connected person(s)), but where appropriate and/or necessary, supplemented with the same products

from other suppliers. Such strategy would enable the Group to, negotiate for better pricing, have a

better safeguard for quality assurance, maintain a stable supply of billets, and maintain better

understanding and consequently a more harmonious business relationship through long term

co-operation with its major supplier(s).


— 107 —

The Board also believe the terms and conditions of the Oil Well Pipe Billets and Casing Billets

Supply Agreement have been negotiated on an arm’s length basis and on normal commercial terms

which are no less favourable than terms available from independent third parties since (a) Weihai

Baolong has agreed to ensure timely supply of oil well pipe billets and casing billets according to the

demands of the Company; (b) in the event that defects are found in the oil well pipe billets and casing

billets supplied by Weihai Baolong, Weihai Baolong has agreed to exchange new oil well pipe billets

and casing billets to the Company for free of charge or indemnify the losses incurred by the Company

in respect of the defects; (c) the performance of oil well pipe billets and casing billets supplied by

Weihai Baolong is suitable for the production of special seamless oil well pipes and casings of the

Company and Weihai Baolong has agreed to set up a research and development centre for oil well pipe

billets and casing billets to enhance the quality of oil well pipe and casing billets to be supplied to

the Company; As at the Latest Practicable Date, the research and development centre for oil well pipe

billets and casing billets has commenced operation. The research and development centre, which is

staffed with professors and engineers, is an internal institution of Weihai Baolong. The research and

development centre makes use of the VOD (Vacuum Oxygen Decarburization) furnace to conduct

relevant technical experiments. As at the Latest Practicable Date, Weihai Baolong has not supplied any

oil well pipe billets and casing billets to any Independent Third Parties; and (d) the supply price will

be lower than the prevailing market price. The Board considers that the above help the Company to

save its production costs, including but not limited to, the costs of raw materials and research and

development costs. The Company can source the oil well pipe billets and casing billets from

independent third parties.

A.2 Purchase of metallurgy accessories from Molong Equipment by the Company

Terms of the Metallurgy Accessories Supply Agreement

Molong Equipment and the Company entered into the Metallurgy Accessories Supply Agreement

on 22 September 2005 pursuant to which Molong Equipment has agreed to sell and the Company has

agreed to purchase metallurgy accessories at the following terms:

Parties: Molong Equipment as seller


Subject: Pursuant to the Metallurgy Accessories Supply Agreement,

Molong Equipment has agreed to supply to the Company

metallurgy accessories.

Term: The Metallurgy Accessories Supply Agreement has been

effective from 28 November 2005 to 31 December 2007 (both

dates inclusive).


— 108 —

Price: Pursuant to the Metallurgy Accessories Supply Agreement, it

has been agreed that the price at which metallurgy accessories

(which include roller, mandril and etc.) are supplied to the

Company by Molong Equipment will be as follows:

(1) if the metallurgy accessories are subject to any fixed

rates prescribed by the relevant authorities of the PRC

(the “Prescribed Rates”), the unit price of the relevant

metallurgy accessories will adopt the Prescribed Rates.

If the Prescribed Rates increase after the Company

places its orders with Molong Equipment, the Prescribed

Rates at the time of the placing of the order will be

adopted. If the Prescribed Rates decrease after the

Company places its orders but before delivery of

metallurgy accessories by Molong Equipment, the

Prescribed Rates at the time of delivery will be adopted;

(2) if the metallurgy accessories are not subject to any

Prescribed Rates, the price will be negotiated and agreed

by both parties with reference to the prevailing market

price (the “Market Price”); and

(3) Under normal circumstances, the price of metallurgy

accessories could be adjusted once annually by

reference to the actual price of the relevant metallurgy

accessories of the previous year plus an amount

calculated based on the price index published by

Weifang City Statistics Bureau. Where the price of the

relevant metallurgy accessories suffers significant

fluctuations (increase/decrease of more than 10%), the

price could be re-negotiated between the parties.

Currently, there are no prevailing Prescribed Rates and the

Market Price is approximately RMB11,600/tonne. The

Company has been purchasing metallurgy accessories from

Independent Third Parties, but Molong Equipment has agreed

to provide a discount of RMB500/tonne for the supply of

metallurgy accessories. Hence the supply price of metallurgy

accessories charged by Molong Equipment to the Company is

RMB11,100/tonne (the “Metallurgy Accessories SupplyPrice”).


— 109 —

Other significant terms: (1) The Company shall make payments to Molong

Equipment in cash monthly in arrears; and

(2) Molong Equipment has agreed to be responsible for

distributing metallurgy accessories to the Company, the

costs of which would be borne by Molong Equipment;

the Company has agreed to be responsible for the

expenses for inspecting the metallurgy accessories

delivered.

The Metallurgy Accessories Annual Cap Amounts

There have been no purchases of metallurgy accessories from Molong Equipment by the

Company for the three years ended 31 December 2005. For the four months ended 30 April 2006, the

total purchases of metallurgy accessories from Molong Equipment by the Company was approximately

RMB1,459,000 (or approximately HK$1,403,000).

The Directors expect that the maximum aggregate annual value of purchases of metallurgy

accessories from Molong Equipment by the Company under the Metallurgy Accessories Supply

Agreement is estimated not to exceed RMB14,450,000 (equivalent to approximately HK$13,900,000)

and RMB25,760,000 (equivalent to approximately HK$24,770,000) (each, a “Metallurgy AccessoriesAnnual Cap”) respectively for each of the two years ending 31 December 2007 which represents the

target purchases agreed between the Company and Molong Equipment.

Set out below is the calculation of and basis for the Metallurgy Accessories Annual Cap for the

two years ending 31 December 2007:

Projected

volume of

purchase of

metallurgy

accessories

for the special

seamless oil

well pipes

Market price

of metallurgy

accessories

for the special

seamless oil

well pipes

Total purchase

amount of

metallurgy

accessories

for the special

seamless oil

well pipes

Projected

volume of

purchase of

metallurgy

accessories

for the special

seamless casings

Market price

of metallurgy

accessories

for the special

seamless casings

Total purchase

amount of

metallurgy

accessories

for special

seamless casings

Metallurgy

Accessories

Annual Cap

(tonne)

(note 1)

(RMB) (RMB) (tonne)

(note 1)

(RMB) (RMB) (RMB)

For the year ending

31 December 2006

209

(note 2)

18,798 3,930,000

(note 3)

965

(note 4)

10,897 10,520,000

(note 3)

14,450,000

For the year ending

31 December 2007

218

(note 2)

18,798 3,989,964

(note 3)

2,094

(note 4)

10,897 21,771,318

(note 3)

25,760,000

(note 5)

Notes:

(1) Metallurgy accessories are the accessories required for the production of special seamless oil well pipes and

casings.


— 110 —


tonnes in 2005 and the annual production capacity of the special seamless oil well pipes is expected to be constant

for the two years ending 31 December 2007 because the existing production facilities of the special seamless oil

well pipes have reached their optimum production capacity.

(3) The total purchase amount has deducted an agreed discount of RMB500 per tonne.

(4) The construction of new 250,000-tonne casing production facilities of the Company has been completed in March

2006 and it is anticipated that the annual production capacity of casings of the Company will be approximately

90,000 tonnes for the year 2006 and approximately 250,000 tonnes for the year 2007. The Directors expect that

there will be an increase in the production capacity for the year 2007 after the new production facilities have gone

through a testing in 2006.

(5) The Metallurgy Accessories Supply Price of RMB11,100 is calculated by reference to (i) the Metallurgy Accessory

Annual Cap for the year ending 31 December 2007, divided by the total purchase volume of metallurgy accessories

for special seamless oil well pipes and casings for the same year; and (ii) the agreed discount of RMB500 per

tonne.

Reason for the transaction

Metallurgy accessories are important accessories used for the proper operation of the production

lines of special seamless oil well pipes and casings.

As the annual production volume of special seamless oil well casings of the Company has

increased and is anticipated to continue to increase in the future, as set out in sub-paragraph (4) under

the paragraph headed “The Metallurgy Accessories Annual Cap Amounts” above, subject to market

demand and market competition, its demand for metallurgy accessories is likely to increase

accordingly. The Directors consider that long-term and steady relationships with suppliers are of

importance to the Company as they enable a stable supply of accessories to the Company which in turn

guarantee the proper operation of the production lines of special seamless oil well pipes and casings.

The Board (including the independent non-executive Directors) also believe the terms and

conditions of the Metallurgy Accessories Supply Agreement have been negotiated on an arm’s length

basis and on normal commercial terms which are no less favourable than terms available from

Independent Third Parties since (a) Molong Equipment has agreed to be responsible for the expenses

for distributing metallurgy accessories to the Company; (b) the performance of metallurgy accessories

supplied by Molong Equipment is suitable for the production lines of special seamless oil well pipes

and casings of the Company; and (c) the Metallurgy Accessories Supply Price will not be higher than

the Market Price and the price of the same products purchased by the Company from independent third

parties in their normal course of business over the same period. The Board considers that the above

help the Company to save its costs, including but not limited to, the production costs. The Company

can source the metallurgy accessories from independent third parties.


— 111 —

A.3 Supply of scrap and used metals by the Company to Molong Equipment

Terms of the Scrap and Used Metals Supply Agreement

The Company and Molong Equipment entered into the Scrap and Used Metals Supply Agreement

pursuant to which the Company has agreed to sell and Molong Equipment has agreed to purchase scrap

and used metals at the following terms:

Parties: The Company as seller

Molong Equipment as purchaser

Subject: Pursuant to the Scrap and Used Metals Supply Agreement, the

Company has agreed to supply to Molong Equipment scrap

and used metals.

Term: The Scrap and Used Metals Supply Agreement has been

effective from 28 November 2005 to 31 December 2007 (both

dates inclusive).

Price: Pursuant to the Scrap and Used Metals Supply Agreement, it

has been agreed that the price at which scrap and used metals

are supplied to Molong Equipment by the Company will be as

follows:

(1) if the scrap and used metals are subject to any

Prescribed Rates, the unit price of the relevant scrap and

used metals will adopt the Prescribed Rates. If the

Prescribed Rates increase after Molong Equipment

places its orders with the Company, the Prescribed Rates

at the time of the placing of the order will be adopted.

If the Prescribed Rates decrease after Molong

Equipment places its orders but before delivery of scrap

and used metals by the Company, the Prescribed Rates at

the time of delivery will be adopted;

(2) if the scrap and used metals are not subject to any

Prescribed Rates, the price will be negotiated and agreed

by both parties with reference to the market price; and


— 112 —

(3) Under normal circumstances, the price of scrap and used

metals could be adjusted once annually by reference to

the actual price of the scrap and used metals of the

previous year plus an amount calculated based on the

price index published by Weifang City Statistics Bureau.

Where the price of the relevant scrap and used metals

suffers significant fluctuations (increase/decrease of

more than 10%), the price could be re-negotiated

between the parties.

Currently, there is no prevailing Prescribed Rate and the

market price is approximately RMB1,930/ton and the supply

price of scrap and used metals charged by the Company to

Molong Equipment has been agreed to be RMB1,930/ton (the

“Scrap and Used Metal Supply Price”).

Other significant terms: (1) Molong Equipment shall make payments to the

Company in cash monthly in arrears; and

(2) The Company has agreed to be responsible for the

expenses for distributing scrap and used metals to

Molong Equipment, and Molong Equipment has agreed

to be responsible for the expenses for inspecting the

scrap and used metals delivered.

The Scrap and Used Metals Annual Cap Amounts


the total sales of scrap and used metals by the Company to Molong Equipment was approximately

RMB541,000 (equivalent to approximately HK$520,000), approximately RMB622,000 (equivalent to

approximately HK$598,000), RMB4,530,000 (equivalent to approximately HK$4,356,000) and

approximately RMB2,006,000 (equivalent to approximately HK$1,929,000).

The Directors expect that the maximum aggregate annual value of sales of scrap and used metals

to Molong Equipment by the Company under the Scrap and Used Metals Supply Agreement is

estimated not to exceed RMB13,080,000 (equivalent to approximately HK$12,580,000) and

RMB27,020,000 (equivalent to approximately HK$25,980,000) (each, a “Scrap and Used MetalsAnnual Cap”) respectively for each of the two years ending 31 December 2007 which represents the

target sales agreed between the Company and Molong Equipment.

The Directors expect that there will be a substantial increase in the Scrap and Used Metals

Annual Cap from 2006 to 2007 on the basis that (1) the scrap and used metals are side products

generated during the production process of special oil well pipes and casing, whereas scrap and used

metals are the main raw materials for producing Molong Equipment’s casting products; (2) the casing

production capacity of the Company is expected to be increased from approximately 90,000 tonnes for

the year 2006 to approximately 250,000 tonnes for the year 2007, as explained below; and (3) the

production capacity of Molong Equipment has increased and is anticipated to continue to increase in

future which has resulted and will result in an increase in demand of scrap and used metals.


— 113 —

Set out below is the calculation of and the basis for the Scrap and Used Metals Annual Cap for

the two years ending 31 December 2007:

Projectedproductioncapacity of

specialseamless oil

well pipes andcasings

The yield of thescrap and used

metals generatedduring the

course ofproduction of oil

well pipe andcasing billets

Projectedscrap and

used metals tobe supplied by

the Company

Scrap andUsed MetalsAnnual Cap

(tonne) (note 3) (tonne) (RMB)

For the year ending

31 December 2006

150,000

(notes 1 and 2)

4.52% 6,780 13,080,000

For the year ending

31 December 2007

310,000

(notes 1 and 2)

4.52% 14,000 27,020,000

Notes:


tonnes in 2005 and the annual production capacity of special seamless oil well pipes is expected to be constant

for the two years ending 31 December 2007 because the existing production facilities of the special seamless oil

well pipes have reached their optimum production capacity.

(2) The construction of new 250,000-tonne casing production facilities of the Company has been completed in March

2006. It is anticipated that the annual production capacity of casings will be approximately 90,000 tonnes for the

year 2006 and approximately 250,000 tonnes for the year 2007. The Directors expect that there will be an increase

in the production capacity for the year 2007 after the new production facilities have gone through testing in 2006.

(3) Scrap and used metals are side products generated during the production process of special seamless oil well pipes

and casings, whereas scrap and used metals are the main raw materials for producing Molong Equipment’s casting

products.


Molong Equipment is principally engaged in the production and sale of electrical equipment set

and casting products, and scrap and used metals are the main raw materials for producing its casting

products. The Company is engaged in the design, manufacture and sale of petroleum drilling and

extraction machinery and related accessories, and scrap and used metals are the side products

generated during the production process of special seamless oil well pipes and casings.

As the annual production capacity of Molong Equipment has increased and is anticipated to

continue to increase in the future subject to market demand and market competition, its demand for

scrap and used metals is likely to increase accordingly. At the same time, the amount of scrap and used

metals generated by the Company will increase as its production volume of casings increases. The


— 114 —

Directors consider that the long-term relationship with Molong Equipment in the supply of scrap and

used metals is of importance to the Company as this can enable a stable demand of scrap and used

metals from Molong Equipment which in turn generates a smooth income from sales of the Company’s

side products.

A.4 Casting Supply Agreements

Terms of the Casting Supply Agreements

Molong Equipment and the Company entered into the Casting Supply Agreements on 20 March

2004, 20 December 2005 and 22 September 2006 pursuant to which Molong Equipment agreed to sell

and the Company agreed to purchase casting products at the following terms:

Parties: Molong Equipment as seller


Subject: Pursuant to the Casting Supply Agreements, Molong

Equipment has agreed to supply to the Company casting.

Term: The Casting Supply Agreements have been effective from 15

April 2004 to 31 December 2007 (both dates inclusive).

Price: Pursuant to the Casting Supply Agreements, it has been

agreed that the price at which the casting products are

supplied to the Company by Molong Equipment will be as

follows:

(1) if the casting products are subject to any Prescribed

Rates, the unit price of the casting product will adopt the

Prescribed Rates. If the Prescribed Rates increase after

the Company places its orders with Molong Equipment,

the Prescribed Rates at the time of the placing of the

order will be adopted. If the Prescribed Rates decrease

after the Company places its orders but before delivery

of casting product by Molong Equipment, the Prescribed

Rates at the time of delivery will be adopted;

(2) if the casting product is not subject to any Prescribed

Rates, the price will be negotiated and agreed by both

parties with reference to the Market Price (as defined

below);

(3) the purchase price of casting by the Company will not be

higher than that of the same product sold by Molong

Equipment to independent third parties in its normal

course of business over the same period; and


— 115 —

(4) the market price (“Market Price”) is the prevailing

market price of the products which are not subject to

Prescribed Rates and where:

(a) Molong Equipment has been supplying the

products to the Company will be determined by

reference to historical figures; and

(b) Molong Equipment has not supplied the products

to the Company before but which Molong

Equipment may supply to the Company in future

will be negotiated and agreed by both parties with

reference to the sale price charged by Molong

Equipment to independent third parties for same

type of products over the same period.

Under normal circumstances, the price of the products could

be adjusted once annually by reference to the actual price of

the relevant products of the previous year plus an amount

calculated based on the price index published by Weifang City

Statistics Bureau. Where the price of the raw materials suffer

significant fluctuations (increase/decrease of more than 10%)

of the price of the price could be re-negotiated between the

parties.

The Casting Annual Cap Amounts


the aggregate purchases of casting made by the Company from Molong Equipment amounted to

approximately RMB18,629,000 (HK$17,913,000), approximately RMB30,408,000 (HK$29,238,000),

approximately RMB40,760,870 (HK$39,193,144) and approximately RMB20,508,000 (or

approximately HK$19,719,000), respectively.

The Directors expect that the annual aggregate purchases of casting from Molong Equipment will

not exceed RMB70,000,000 (HK$67,307,700) and RMB105,000,000 (HK$100,962,000) (each, a

“Casting Annual Cap”) respectively for each of the two years ending 31 December 2007.

The basis of the Casting Annual Cap is determined by reference to (i) the average historical

growths of the purchase of casting from Molong Equipment during the Track Record Period by

approximately 50%; and (ii) the growth rate of the Company’s turnover of over 50% during the Track

Record Period.


The castings supplied by Molong Equipment are used for the production of exported products of

the Group such as steel sleeves and valves. In this regard, the Board considers that the high quality


— 116 —

products supplied by Molong Equipment would guarantee the more stringent requirement of exported

products. In addition, since Molong Equipment supplies the goods in a timely manner and at the price

which is not higher than that offered by independent third parties, the Company shall benefit from

continuing purchases of castings from Molong Equipment.

A.5 Supply of oil well pumps and related accessories from Molong Drilling Equipment and

Ya Long Oil Pump

Terms of the Co-operative Agreement

Molong Drilling Equipment and Ya Long Oil Pump entered into the Co-operative Agreement on

12 July 2006 pursuant to which Molong Drilling Equipment agreed to sell and Ya Long Oil Pump

agreed to purchase oil well pumps and related accessories at the following terms:

Parties: Molong Drilling Equipment as seller

Ya Long Oil Pump as purchaser

Subject: Pursuant to the Co-operative Agreement, Molong Drilling

Equipment has agreed to supply to Ya Long Oil Pump oil well

pumps and related accessories (including but not limited to

pump pipes, plunger assembly, pump rods, snap ring, rods,

polished rod grips, oil well pipe couplings, standing valve

assembly, stationary valve seats, draining valve covers).

Term: The Co-operative Agreement has been effective from 1

January 2006 to 31 December 2007 (both dates inclusive).

Price: Pursuant to the Co-operative Agreement, it has been agreed

that the supply price of oil well pumps charged by Molong

Drilling Equipment to Ya Long Oil Pump would make

reference to the then prevailing market price from time to

time.

Historical figures: For the year ended 31 December 2003, the total sales of oil

well pumps and related accessories by the Group to Ya Long

Oil Pump was approximately RMB8,552,000 (equivalent to

approximately HK$8,223,000). For the year ended 31

December 2004, the total sales of the oil well pumps and

related accessories by the Group to Ya Long Oil Pump was

approximately RMB896,000 (equivalent to approximately

HK$861,500). There were no sales of oil well pumps and

accessories by the Group to Ya Long Oil Pump for the year

ended 31 December 2005 on the basis that (i) the total sales

of oil well pumps and related accessories by the Group to Ya


— 117 —

Long Oil Pump were small for the year ended 31 December

2004; (ii) the location of Ya Long Oil Pump was far from the

Group geographically; and (iii) the limitation of sales volume

by the small production capacity of oil well pumps and

accessories by the Group for the year ended 31 December

2005. Therefore, the Group did not sell any oil well pumps

and related accessories to Ya Long Oil Pump for the year

ended 31 December 2005. For the four months ended 30 April

2006, the total sales of the oil well pumps and related

accessories by the Group to Ya Long Oil Pump was

approximately RMB262,000 (equivalent to approximately

HK$252,000).

Other significant terms: (1) Ya Long Oil Pump shall make payments to Molong

Drilling Equipment in cash upon delivery;

(2) Ya Long Oil Pump shall inspect the oil well pumps and

related accessories in accordance with the PRC national

standards. In the event that defects are found by Ya Long

Oil Pump, Molong Drilling Equipment has agreed to

exchange them with the qualified oil well pumps and

related accessories to Ya Long Oil Pump; and

(3) The parties will enter into separate agreements from

time to time in respect of the actual market price and

quantities of oil well pumps and related accessories to

be transacted.

The Oil Well Pump Annual Cap Amounts

The Directors expect that the maximum aggregate annual value of sales of oil well pumps and

related accessories by Molong Drilling Equipment to Ya Long Oil Pump under the Co-operative

Agreement is estimated not to exceed RMB13,920,000 (equivalent to approximately HK$13,380,000)

and RMB18,200,000 (equivalent to approximately HK$17,500,000) (each, an “Oil Well Pump AnnualCap Amount”) respectively for each of the two years ending 31 December 2007, which represents the

target supplies agreed between Molong Drilling Equipment and Ya Long Oil Pump.

The Oil Well Pump Annual Cap Amount is reached on the basis of (i) the expected demand of

Ya Long Oil Pump for the oil well pumps and related accessories for each of the 2 years ending 31

December 2007; and (ii) the oil well pump and related accessories production capacity of Molong

Drilling Equipment for each of the 2 years ending 31 December 2007.

The significant increase in Oil Well Pump Annual Cap Amount for the year ended 31 December

2006, as compared with the historical figures for each of two years ended 31 December 2005, was

because (i) the Group invested approximately RMB2,500,000 (or approximately HK$2,404,000) to

purchase 7 sets of production facilities at the end of 2005 which enhanced the production capacity of

oil well pump and accessories by Molong Drilling Equipment for the year ended 31 December 2006.


— 118 —

For instance, after the production enhancement, Molong Drilling Equipment expects to produce

12,000 pump pipes annually, as compared with 4000 pump pipes for the year ended 31 December

2005. Due to the increase in the production capacity, Molong Drilling Equipment has been eager to

explore new markets and strengthen the business relationships with existing customers (including Ya

Long Oil Pump); (ii) Ya Long Oil Pump increased its production capacity and expanded its market

scale for the year ended 31 December 2006. As compared with other suppliers, due to the superior

quality of products and timely fulfillment of orders by Molong Drilling Equipment, Ya Long Oil Pump

would like to develop closer business relationship with Molong Drilling Equipment. It has expected

to shift orders from other suppliers to Molong Drilling Equipment. Ya Long Oil Pump has therefore

significantly increased its expected purchases from Molong Drilling Equipment for the year ended 31

December 2006.

The projected increase of 31% in the Oil Well Pump Annual Cap Amount for the year ending 31

December 2007 is determined on the basis of the increase in the turnover of Ya Long Oil Pump for

the year ended 31 December 2005 by 35% and the corresponding projected increase in the turnover

and demand for the oil well pump and related accessories by Ya Long Oil Pump for the year ending

31 December 2007.

Reasons for the transaction

The Board believes that since Ya Long Oil Pump has the local expertise and sales and marketing

advantage in (Kelamayi Oilfield), the co-operation with Ya Long Oil Pump to explore the

local market at Kelamayi Oilfield would be beneficial to the Group and the shareholders as a whole.

In addition, as the annual volume of oil well pumps and related accessories produced by Molong

Drilling Equipment has increased and is expected to increase, the exploration of market such as

Kelamayi Oilfield would enhance the sales of Molong Drilling Equipment.

B. Exempt Continuing Connected Transaction

Set out below are the terms of the exempt continuing connected transactions which are exempt

from reporting, announcement and independent shareholders’ approval requirements under Rules

14A.45 to 14A.54 of the Listing Rules (the “Exempt Continuing Connected Transactions”).

B.1 Supply of goods and raw materials to Maolong Machinery and Molong Equipment

On 20 March 2004, the Company entered into an agreement with each of Maolong Machinery and

Molong Equipment respectively (each a “Material Supply Agreement”) pursuant to which the

Company agreed to sell and each of Maolong Machinery and Molong Equipment agreed to purchase

certain goods and raw materials (such as measurement tools, general standard pieces, lubricant, petrol,

imported knitting machinery accessories and office equipment) in connection with the operation of

Maolong Machinery and Molong Equipment. The Company, Maolong Machinery and Molong

Equipment would from time to time enter into contracts setting out the detailed terms for the supply

of materials by the Company provided that such detailed terms shall not be inconsistent with the terms

of the respective Material Supply Agreement between the parties.


— 119 —

The principal terms of the Material Supply Agreement are as follows:

(i) if the product is subject to any Prescribed Rates, the unit price of the relevant product will

adopt the Prescribed Rates. If the Prescribed Rates increase after Maolong Machinery or

Molong Equipment placed its orders with the Company, the Prescribed Rates at the time of

the placing of the order will be adopted; if the Prescribed Rates decrease after Maolong

Machinery or Molong Equipment placed its orders but before delivery of the product by the

Company, the Prescribed Rates at the time of delivery will be adopted provided that in any

event, the selling price of the Company will not be less than its costs;

(ii) if the product is not subject to any Prescribed Rates, the price will be negotiated and agreed

by the parties with reference to the prevailing market price; and

(iii) the sale price of the goods and raw materials charged by the Company to Maolong

Machinery or Molong Equipment will not be lower than the sales price charged by the

Company to Independent Third Parties in its normal course of business in respect of the

same period.

Each of the Material Supply Agreements has taken effect from 15 April 2004 and shall remain

in force for a term until 31 December 2006. For each of the three years ended 31 December 2005 and

the four months ended 30 April 2006, the aggregate value of transactions under the Material Supply

Agreement with Maolong Machinery was RMB1,389,000 (approximately HK$1,336,000),

RMB244,000 (approximately HK$235,000), RMB624,000 (approximately HK$600,000) and nil

(approximately nil). For each of the three years ended 31 December 2005 and the four months ended

30 April 2006, the aggregate value of transactions under the Material Supply Agreement with Molong

Equipment was RMB1,837,000 (approximately HK$1,766,000), RMB656,000 (approximately

HK$631,000), RMB1,026,000 (approximately HK$987,000) and nil (approximately nil). As the

Directors expect that the aggregate annual value of transactions under each of the Material Supply

Agreements for each of the three years ending 31 December 2008 will be less than HK$1,000,000 per

annum and each of the percentage ratios is expected to be less than 2.5%, the Directors are of the

opinion that the above transactions fall below the de minimis threshold of HK$1,000,000 under Rule

14A.33(3) of the Listing Rules thus are not subject to the reporting, announcement or shareholders’

approval requirements under Chapter 14A of the Listing Rules.

B.2 Properties leased from Maolong Machinery

Pursuant to an agreement dated 18 January 2002 made between the Company (as lessee) and

Maolong Machinery (as lessor) (as amended by a supplemental agreement on 1 January 2005),

Maolong Machinery has agreed to lease to the Company certain buildings located at Beihai Road,

Shouguang City with a total gross floor area of 8,729.74 sq.m. and a factory building located at Beihai

Road East, Shouguang City with a total gross floor area of 5,141.60 sq.m. for a period of 10 years

commencing from 1 January 2002 to 30 December 2011 at the rent of RMB390,000 per annum.

For the three years ended 31 December 2005 and the four months ended 30 April 2006, the

Company paid rental expenses of approximately RMB267,000 (or approximately HK$257,000),

RMB267,000 (or approximately HK$257,000), RMB390,000 (or approximately HK$375,000) and

RMB67,000 (or approximately HK$64,423), respectively.


— 120 —

Since the amount of the rental payable by the Company under the lease agreement will be less

than HK$1 million per annum, the above transactions will fall below the de minimis threshold under

Rule 14A.33(3) of the Listing Rules thus are not subject to any reporting, announcement or

shareholders’ approval requirements under Chapter 14A of the Listing Rules.

The Sponsor has confirmed that the aforesaid exempt continuing connected transaction is on

normal commercial terms and in the interests of the Company and its shareholders as a whole.

Sallmanns (Far East) Limited, an independent property valuer, has confirmed that the rentals payable

by the Company under the abovementioned lease agreements are at discounts of approximately 22%

to 44% on the market rents.

B.3 Property leased to Molong Equipment

Pursuant to an agreement dated 20 October 2005 made between the Company (as lessor) and

Molong Equipment (as lessee), the Company has agreed to lease to Molong Equipment a factory

building located at North Beihuan Road, Shouguang City with a total gross floor area of 16,021.67

sq.m. for a period of 10 years commencing from 1 November 2005 to 31 October 2015 at the rent of

RMB540,000 per annum.

For the three years ended 31 December 2005, no rental was received by the Company in 2003

and 2004, and the rental received by the Company in 2005 was RMB90,000 (approximately

HK$86,000). For the four months ended 30 April 2006, the rental received by the Company was

RMB180,000 (approximately HK$173,100).

Since the amount of the rental received by the Company under the lease agreement will be less

than HK$1 million per annum, and each of the percentage ratios will be less than 2.5%, the Directors

are of the opinion that the above transactions will fall below the de minimis threshold under Rule

14A.33(3) of the Listing Rules thus are not subject to any reporting, announcement or shareholders’




Sallmanns (Far East) Limited, an independent property valuer, has confirmed that the rental receivable

by the Company under the abovementioned lease agreement is fair and reasonable.

B.4 Property leased from Molong Equipment

Pursuant to an agreement dated 30 September 2005 made between the Company (as lessee) and

Molong Equipment (as lessor), Molong Equipment has agreed to lease to the Company certain

buildings located at Beihai Road, Shouguang City with a total gross floor area of 6,091.11 sq.m. for

a period of 10 years commencing from 1 October 2005 to 30 September 2015 at the rent of

RMB168,000 per annum.


— 121 —

For the three years ended 31 December 2005, there are no rental expenses in 2003 and 2004, and

the rental expense paid by the Company in 2005 was RMB42,000 (approximately HK$40,000). For the

four months ended 30 April 2006, the rental expenses paid by the Company was RMB56,000

(approximately HK$54,000).

Since the amount of the rental payable by the Company under the lease agreement will be less

than HK$1 million per annum, the above transactions will fall below the de minimis threshold under

Rule 14A.33(3) of the Listing Rules thus are not subject to any reporting, announcement or

shareholders’ approval requirements under Chapter 14A of the Listing Rules.



Sallmanns (Far East) Limited, an independent property valuer, has confirmed that the rental payable

by the Company under the abovementioned lease agreement is fair and reasonable.

B.5 Equipment leased to Molong Equipment

Pursuant to an agreement dated 1 December 2005 made between the Company (the lessor) and

Molong Equipment (the lessee), the Company has agreed to lease to Molong Machinery 4 units of

electric crane for a period of 3 years from 1 December 2005 to 30 November 2008 at the rent of

RMB150,000 per annum. For the four months ended 30 April 2006, the rental expense paid to the

Company was RMB50,000 (approximately HK$48,000).

Since the amount of the rental received by the Company under the lease agreement will be less

than HK$1 million per annum, and each of the percentage ratios will be less than 2.5%, the Directors

are of the opinion that the above transactions will fall below the de minimis threshold under Rule

14A.33(3) of the Listing Rules thus are not subject to any reporting, announcement or shareholders’




C. Discontinued Exempt Continuing Connected Transaction

C.1 Subcontracting expenses paid to Molong Equipment and Maolong Machinery

At the time when the GEM prospectus was published, the Directors have confirmed that the

subcontracting expenses paid by the Company to Molong Equipment and Maolong Machinery would

not continue after listing on GEM (the “GEM Listing”). Subsequent to the GEM Listing, relevant

subcontracting businesses were conducted by the Independent Third Parties. However, due to the

change of circumstances and/or new operational developments of the Group as explained below, there

have been certain subcontracting transactions recorded for each of the two years ended 31 December

2005. In any event, the Directors would like to emphasize that such subcontracting transactions are

de minimis transactions under GEM Listing Rule 20.31(2).


— 122 —

(i) Subcontracting expenses paid to Molong Equipment

Part of the material testing business of the Company was carried out by an Independent Third

Party after the GEM Listing. The Company found inconvenient to conduct such business with the

above Independent Third Party since it was a bit far away from the Company geographically. Thus,

after negotiation with Molong Equipment, a material testing agreement was reached between the

Company and Molong Equipment in November 2004. According to such agreement, Molong

Equipment has agreed to provide material testing services to the Company. Subcontracting fees paid

to Molong Equipment in 2004 and 2005 were generated from the above-mentioned agreement. As the

volume of material testing business of the Company increases, the Company purchased a direct-

reading spectrum analyzer in May 2006 and ceased the above subcontracting transactions with Molong

Equipment ever since.

(ii) Subcontracting expenses paid to Maolong Machinery

There was no subcontracting business between the Company and Maolong Machinery

immediately after the H Shares were listed on GEM. After the special seamless oil well pipes

production facilities were put into production in late 2004, parts of the high pressure electric

equipment need periodic repairs. Since Maolong Machinery has the relevant professionals, an

agreement was reached between the Company and Maolong Machinery. According to such agreement,

professionals of Maolong Machinery would make periodic repairs to the high pressure electric

equipment of the Company and the Company would pay subcontracting fees to Maolong Machinery.

As the 250,000-tonne casing production facilities went into trial production, the Company expected

that there would be a sharp increase in the high pressure equipment that require periodic repairs.

Therefore, the Company employed relevant professionals in December 2005 and ceased such

subcontracting transactions with Maolong Machinery even since.

The Directors confirm that the above subcontracting transactions with both Molong Equipment

and Maolong Machinery would not continue after the H shares are listed on the Main Board.

D. Application for waiver for Non-exempt Continuing Connected Transactions

The Directors (including the independent non-executive Directors) consider that the transactions

under each of the Non-exempt Continuing Connected Transactions has been entered into in the

ordinary and usual course of business of the Group and has been based on arm’s length negotiation

and on normal commercial terms that are fair and reasonable and in the interest of the shareholders

as a whole so far as the shareholders of the Company are concerned. The Directors also confirm that

each of the proposed annual caps set out herein are fair and reasonable.

Each of the Non-exempt Continuing Connected Transactions is subject to the reporting,

announcement and/or independent shareholders’ requirement set out in Rules 14A.45 to 14A.54 of the

Listing Rules.


— 123 —

As the Non-exempt Continuing Connected Transactions will continue after the H Shares are

listed on the Main Board on a recurring basis, the Directors consider that strict compliance with the

announcement and/or independent shareholders’ approval requirement under the Listing Rules would

be unduly burdensome and impracticable. As such, the Company has received from the Stock

Exchange a waiver from strict compliance with the announcement and/or independent shareholders’

approval requirements set out in Chapter 14A of the Listing Rules.

The maximum aggregate annual cap for each of the Non-exempt Continuing Connected

Transactions shall not exceed the applicable limit set out below:

Proposed Annual Cap(RMB)

Year ending 31 December

Transaction 2006 2007

Purchase of oil well pipe billets and casing billets from

Weihai Baolong by the Company 470,203,600 789,670,000

Purchase of metallurgy accessories from Molong Equipment

by the Company 14,450,000 25,760,000

Supply of scrap and used metals by the Company to Molong

Equipment 13,080,000 27,020,000

Supply of casting by Molong Equipment to the Company 70,000,000 105,000,000

Supply of oil well pumps and related accessories by Molong

Drilling Equipment to Ya Long Oil Pump 13,920,000 18,200,000

All of the Non-exempt Continuing Connected Transactions are current and valid. In addition, the

respective terms of these connected transactions will be same as described by the Company’s existing

waiver in the GEM, and these connected transactions were approved by the independent shareholders

of the Company and are complying with the GEM Listing Rules (save and except for the supplemental

agreement to the Casting Supply Agreement for the purpose of extending the term of the Casting

Supply Agreement to 31 December 2007 and providing for the casting annual caps for each of the two

years ending 31 December 2007 would be put to independent Shareholders for consideration, and if

thought fit, approval at the Extraordinary General Meeting to be held in or about December 2006).

If any of the above annual cap is exceeded, or when a relevant agreement is renewed or there is

any material change to the terms of the relevant agreement, the Company shall fully re-comply with

the requirements of the Listing Rules (including but not limited to Chapter 14A of the Listing Rules)

prevailing from time to time, including but not limited to seeking independent shareholders’ approval

by poll at a general meeting, if required.

E. Confirmation from the Sponsor

The Sponsor has independently reviewed relevant documentation, information and historical data

provided by the Company and has participated in the due diligence and discussions with the Company,

and has also considered representations and confirmations from the Company and the Directors, to


— 124 —

satisfy itself of the reliability of the information provided in relation to the Non-exempt Continuing

Connected Transactions described in the document. Pursuant to the letter from the independent

financial advisor as set out in the circular of the Company dated 7 October 2005 in relation to the three

Non-exempt Continuing Connected Transactions: namely (i) Purchase of oil well pipe and casing

billets from Weihai Baolong by the Company, (ii) Purchase of metallurgy accessories from Molong

Equipment by the Company, (iii) Supply of scrap and used metals by the Company to Molong

Equipment as set out above and their respective proposed annual cap (collectively “Three

Non-exempt Continuing Connected Transactions”), the independent financial advisor advised the

independent board committee and the independent Shareholders that the terms of the Three

Non-exempt Continuing Connected Transaction are fair and reasonable so far as the Company and the

independent Shareholders are concerned. In addition, the Three Non-exempt Continuing Connected

Transactions were approved by the independent Shareholders of the Company on 29 November 2005.

The Sponsor is of the view that: (i) the Non-exempt Continuing Connected Transactions are

entered into in the ordinary and usual course of business of the Company on normal commercial terms

which are no less favourable than those available from or to independent third parties and are fair and

reasonable and in the interest of the shareholders as a whole so far as the Company and shareholders

as a whole are concerned; and (ii) the proposed annual caps for the Non-exempt Continuing Connected

Transaction are in the ordinary and usual course of the Group’s business and in the interests of the

Company’s shareholders as a whole.


— 125 —

FUTURE PLANS

The Group engages in the production of petroleum drilling and extraction machinery and related

accessories. The Group mainly supplies oil well pumps, oil well sucker rods, oil well pipes, casings,

oil well pumping machines and other petroleum drilling and extraction machinery accessories to oil

fields in the PRC.

According to China Statistical Yearbook 2005, the proportion of oil consumption in total energy

consumption in the PRC has risen from 18% in 1996 to 22.7% in 2004. The Group expects the demand

for petroleum drilling and extraction machinery and related accessories will remain strong in the

foreseeable future.

Expansion of market coverage

In order to develop a more extensive sales and distribution network, the Group intends to

increase its sales presence in both the PRC and overseas markets by expanding its sales force and

marketing activities. These activities will include participation in petroleum extraction machinery

exhibitions, regular oil fields visit and strengthening its relationships with existing customers. As at

the Latest Practicable Date, the Group has four domestic sales offices and an export department. The

four domestic sales offices are Northeast China office, Northwest China office, North China office and

Middle China office, respectively. Such domestic marketing offices provide sales and after-sale

services for its customers, which cover the oil fields in China, such as (Daqing Oil Field),

(Xinjiang Oil Field), (Shengli Oil Field), (Liaohe Oil Field),

(Zhongyuan Oil Field), (Changqing Oil Field) and (Dagang Oil Field). The Group

also intends to appoint authorized sales agents in overseas markets, particularly in strategic locations

such as the South East Asia region and the Middle East. The Group believes that appointing authorized

sales agents in such locations would assist the Group to increase sales of its products and to maintain

closer contacts with overseas markets.


The Group will continue to focus on research and development in line with changing market

demands and customers’ needs. The Group is currently conducting research co-operations with

Zhongyuan Institute, Daqing Institute and Material Science and Engineering School of Xi’an Jiaotong

University in order to improve the production technology, in particular, such series of products as

special seamless oil well pipes, oil well pipes, oil well sucker rods and casings. The Directors believe

that the Group’s commitment to research and development for further enhancement of the product

quality and production efficiency with the efforts of the research and development centre of the

Company is critical in maintaining the Group’s competitive edge in the PRC and overseas market. In

addition, the Group will strengthen its research and development capability by recruiting more

research personnel with a view to improve the quality and functionality of its products in response to

the market trends.

FUTURE PLANS AND PROSPECTS

— 126 —

DIRECTORS

The board consists of 9 Directors, 3 of whom are independent non-executive Directors. The

Directors are initially elected at a meeting of the shareholders of the Company for a term of three

years, renewable upon reelection and re-appointment. An independent Director cannot concurrently

hold the position of a Supervisor, manager or financial controller of the Company. The functions and

duties conferred on the Board include convening shareholders’ meetings, reporting its work to the

shareholders’ meetings, implementing the resolutions of the shareholders, determining the Company’s

business plans and investment plans, formulating the Company’s annual budget and final accounts,

formulating proposals for the Company’s dividend and bonus distributions and for the increase or

reduction of capital, as well as exercising other powers, functions and duties as conferred by the

Articles of Association.

Executive Directors

Mr. Zhang En Rong ( ), aged 66, is the chairman of the Company and executive

Director. Mr. Zhang is a founder of the Company and is responsible for the overall strategic planning

and management and business development of the Group. Since its establishment, Mr. Zhang held

various positions in the Group including general manager. Mr. Zhang was also a member of the 12th

session, 13th session and 14th session of the Weifang City People’s Congress of the PRC, a member

of the 5th session and the 6th session of the Shandong Shouguang City Committee of the Chinese

People’s Political Consultative Conference. Mr. Zhang was the legal representative and factory

manager of Shandong Shouguang Petroleum Machinery Parts Factory (“Petroleum Machinery Parts

Factory”), Shandong Shouguang Petroleum Machinery Factory (“Petroleum Machinery Factory”) and

Weifang Molong Industrial Company (“Weifang Molong”) from 1987 to 1993 and the general manager

of Shandong Molong Holdings Company (“Molong Holdings”) from 1994 to 2001. Mr. Zhang was also

a director of Weifang Dragon Machinery Co., Ltd (“Weifang Dragon”) and Shouguang Molong

Machinery Company Limited (“Molong Machinery”), respectively. Weifang Dragon and Molong

Machinery have been de-registered. Mr. Zhang was granted the “Good Enterprise Management

Personnel” certificate in 1988, the “Modern Industrial Manufacturing Producer” in 1991 and the

“Wealth Attainment and Development of Shandong” medal of Shandong Province in 2004

( ). Mr. Zhang is the father of Mr. Zhang Yun San, an executive Director.

Mr. Zhang Yun San ( ), aged 44, is a founder, the deputy chairman, executive Director

and deputy general manager of the Company. He is responsible for assisting the chairman in overall

strategic planning and management and business development of the Group. Since 1993, Mr. Zhang

has held various positions in Molong Holdings and the Group, including deputy general manager and

deputy chairman of the Company. Mr. Zhang graduated from Nanjing University with a bachelor of

laws degree and holds an advanced certificate in Training Course of Chinese Communist Party School

for Entrepreneurs and was granted the “Excellent Private Enterpriser of Weifang City” in 2004 and

“Top Ten Young Entrepreneurs of Weifang City” in 2005. He has extensive experience in the

development, manufacture and sales of petroleum exploitation machinery and the management of the

Group. Mr. Zhang is the son of Mr. Zhang En Rong, an executive Director.

DIRECTORS, SUPERVISORS, SENIOR MANAGEMENT AND STAFF

— 127 —

A1A(41)(1)Rule 8.05(1)bRule 8.15

Mr. Lin Fu Long ( ), aged 53, is a founder, an executive Director and the general

manager of the Company. He is responsible for the overall management of the Group. Mr. Lin was

deputy factory manager of Petroleum Machinery Parts Factory, Petroleum Machinery Factory and

Weifang Molong from 1989 to 1993 and was deputy general manager of Molong Holdings from 1994

to 2001. Mr. Lin was also a director of Weifang Dragon, which has been de-registered. Mr. Lin was

awarded as an “Capable Sales Person” by the Shouguang City People’s Government in 1994.

Mr. Xie Xin Cang ( ), aged 44, is a founder, an executive Director, the secretary to the

Board and deputy general manager of the Company. Mr. Xie has served in Molong Holdings since

1995 as deputy general manager. During his employment, Mr. Xie has applied the nickel plating

phosphorus alloy technology in the manufacturing of petroleum exploitation machinery and

successfully invented the “MB424 steel wire teasel” that possesses international advanced level. Mr.

Xie graduated from Xi’an Jiaotong University in mechanical engineering and specialised in metal

studies and heat treatment and earned the degree of Bachelor of Engineering. Mr. Xie was awarded

the “Shandong Province Town and Village Enterprise Technology Innovation Leader” certificate by

the Shandong Province Town and Village Enterprise Management Bureau in 1998. Mr. Xie is a

member of the 7th Session of the Shandong Shouguang City Committee of the Chinese People’s

Political Consultative Conference. He was granted the “Excellent Member of Shandong Shouguang

City Committee of the Chinese People’s political Consultative Conference” in 2006. Mr Xie is the

husband of Ms. Li Bao Hui, a Supervisor.

Non-executive Directors

Mr. Chen Jian Xiong ( ), aged 51, is a non-executive Director. Mr. Chen has worked for

Rodless Oil Pump Company of Shengli Petroleum Administration Bureau for over 10 years. Since

1994, Mr. Chen is the managing director of Shengli Oil Field Kaiyuan Oil Exploitation Company

Limited (“Kaiyuan Oil”) and was assistant manager and then the general manager of Rodless Oil Pump

Company of Shengli Petroleum Administration Bureau. Mr. Chen is the Chairman of Shengli Oil Field

Kaiyuan Oil Exploitation Company Limited and Shengli Pump Industry Co., Ltd., Shengli Oilfield.

Mr. Chen was appointed as a non-executive Director on 28 December 2001, and was re-appointed as

a non-executive Director on 7 May 2005.

Mr. Wang Ping ( ), aged 51, is a non-executive Director. Mr. Wang has over 20 years of

experience in metallurgy and received his doctorate degree in engineering from the University of

Science and Technology Beijing. Since 2000, Mr. Wang is a professor at the University of Science and

Technology of Beijing and a director of Fushun Hanking Group and Shenyang Dongyang Steel

Manufacturing Co., Ltd., respectively, was appointed as a non-executive Director on 29 March 2003

and was re-appointed as a non-executive Director on 12 May 2006.

Independent non-executive Directors

Mr. Qin Xue Chang ( ), aged 41, is an independent non-executive Director and the

Chairman of the Audit Committee. Mr. Qin has over 10 years of experience in accounting and auditing

industry. He received his bachelor degree in economics from Shanxi University of Finance and

Economics and is a practicing certified public accountant in the PRC. Mr. Qin is a director and deputy

chief accountant of Beijing Yongtuo Certified Public Accountants Co., Ltd., and general manager of


— 128 —

Rules 19A.18(1)

Shandong Branch Office, Beijing Yongtuo Certified Public Accountants Co., Ltd. He is also the

Chairman of Shandong Hengchang Auction Co., Ltd. He was appointed as an independent

non-executive Director on 29 March 2003 and was re-appointed as an independent non-executive

Director on 12 May 2006.

Mr. Yan Yi Zhuang ( ), aged 49, is an independent non-executive Director and the

Chairman of the Nomination Committee. He is also a operation manager of Shougang Concord

Technology Holdings Ltd., a company listed on the Main Board of the Stock Exchange. Mr. Yan has

over 10 years of management experience in electronics technology and graduated from the University

of Western Sydney, Australia. Mr. Yan was appointed as an independent non-executive Director on 29

March 2003 and was re-appointed as an independent non-executive Director on 12 May 2006.

Mr. Loke Yu alias Loke Hoi Lam ( ), aged 57, is an independent non-executive Director

and a chairman of the Remuneration committee of the Company. Mr. Loke has over 30 years’ of

experience in accounting and auditing for private and public companies, financial consultancy and

corporate management. He holds a Master of Business Administration Degree from Universiti

Teknologi Malaysia and a Doctor of Business Administration Degree from University of South

Australia. He is a Fellow of The Institute of Chartered Accountants in England and Wales; a Fellow

of Hong Kong Institute of Certified Public Accountants; and a Fellow of The Hong Kong Institute of

Directors. He is also an Associate member of The Hong Kong Institute of Chartered Secretaries and

a member of the Malaysian Institute of Accountants. He is an independent non-executive director of

United Metals Holdings Limited (a Main Board listed issuer), New Chinese Medicine Holdings

Limited (a GEM Board listed issuer), Matrix Holdings Limited (a Main Board listed issuer), China

Fire Safety Enterprise Group Holdings Limited (a GEM Board Listed issuer), Yanion International

Holdings Limited (a Main Board listed issuer) and Wealthmark International (Holdings) Limited (a

Main Board listed issuer), companies listed on the Stock Exchange.

Supervisors

Ms. Li Bao Hui ( ), aged 43, is a Supervisor and the chairman of the supervisory

committee of the Company (the “Supervisory Committee”). She is currently a quality control manager

of the Company and works in the quality control department of Molong Holdings since 1995. She has

over 10 years of experience in quality control and quality management and graduated from Shanxi

Radio and Television University. Ms. Li is a director of Shouguang Maolong Machinery Company

Limited. Ms. Li is the wife of Xie Xin Cang, an executive Director, and was appointed as a Supervisor

on 29 March 2003 and re-appointed as a Supervisor on 12 May 2006.

Mr. Liu Wan Fu ( ), aged 67, is a Supervisor. Mr. Liu is a consultant of China National

Petroleum Corporation. Mr. Liu has over 40 years of experience in the petroleum industry. Mr. Liu was

appointed as a Supervisor on 29 March 2003 and re-appointed as a Supervisor on 12 May 2006.

Mr. Fan Ren Yi ( ), aged 40, is a Supervisor. Mr. Fan is the Vice General Manager and

CFO of Shandong Charming Home-Textiles Co., Ltd.. Mr. Fan holds a bachelor degree from Xian

Jiaotong University and is a certified public accountant in the PRC. Mr. Fan was appointed as a

Supervisor on 29 March 2003 and re-appointed as a Supervisor on 12 May 2006.


— 129 —

Rules 19A18(2)

ORGANIZATION OF THE GROUP

NominationCommittee

MarketingCompany

LogisticsCenter

AdministrationDepartment

ProductionDepartment

Finance andAccountingDepartment

ViceMarketingManager

ViceOperatingManager

ViceAdministration

Manager

ViceProduction &Technology

Manager

ViceFinancialController

AuditCommittee

GeneralManager

Secretary tothe Board of

Directors

RemunerationCommittee

Board ofDirectors

Shareholders

Import &Export

Company

SupervisoryCommittee

HumanResources

Department

InformationCenter

TechnologyCenter

EquipmentDepartment

AuditDepartment

AUDIT COMMITTEE

The Company has established an audit committee on 20 March 2004 with written terms of

reference in compliance with provisions as set out in Rules C.3.1 to C.3.3 of the “Code on Corporate

Governance Practices” set out in Appendix 14 of the Listing Rules. The primary duties of the audit

committee are to review and supervise the financial reporting process and internal control system of

the Company and provide advice and comments to the Board.

The audit committee has 3 members comprising the 3 independent non-executive Directors,

namely Qin Xue Chang, Yan Yi Zhuang and Loke Yu alias Loke Hoi Lam. Qin Xue Chang is the

chairman of the audit committee.

REMUNERATION COMMITTEE

The Company has established a remuneration committee on 18 January 2005. The remuneration

committee comprises of Mr. Zhang Yun San, who is an executive Director and Mr. Qin Xue Chang,

Mr. Yan Yi Zhuang and Mr. Loke Yu who are independent non-executive Directors. Mr. Loke Yu is the

chairman of the remuneration committee of the Company. The primary duties of the remuneration


— 130 —

committee is to make proposals to the Board on the remuneration adjustment policy and structure in

respect of the Director and senior management of the Company and to determine the designated

remuneration for all the executive Directors and senior management.

NOMINATION COMMITTEE

The Company has established a nomination committee on 18 January 2005, which aims to ensure

the procedures for the appointment of Directors to comply with the principle of fairness and

transparency. The principal rights and duties of the nomination committee is to make regular review

on the structure, number and composition (including skill, knowledge and experience) of the Board

and to make recommendations to the Board on any intended change. The nomination committee

comprises of Mr. Zhang Yun San, who is an executive Director and Mr. Qin Xue Chang, Mr. Yan Yi

Zhuang and Mr. Loke Yu who are independent non-executive Directors. Mr. Yan Yi Zhuang is the

chairman of the nomination committee.

SENIOR MANAGEMENT, QUALIFIED ACCOUNTANT AND COMPANY SECRETARY

Mr. Zhang Yu Zhi ( ), aged 47, is a deputy general manager of the Company. He is

responsible for the sales of the Group. Mr. Zhang has over 10 years of experience in petroleum

exploitation machinery industry. Before joining the Group, he was responsible for management of

Shouguang Shangkou Sales Agency. He joined the Group in October 1994 as general manager of its

Xinjiang representative office, and has participated in the petroleum exploitation machinery industry

since then.

Mr. Guo Huan Ran ( ), aged 39, is the deputy general manager of the Company and is

responsible for production and technology research and development of the Group. Mr. Guo joined

Molong Holdings in March 1991. Mr. Guo graduated from Weifang College, majoring in Machine

Manufacturing and Processing Equipment, and held various positions in the Company including

technician, workshop supervisor and production director. Mr. Guo has extensive experience in areas

including production management and technology research and development of petroleum exploitation

machinery. Mr. Guo has directed the innovation of various items for export, such as liner for mud

pump and valve body. Some of the products, such as “Special Centralizer for Electrical Submersible

Pump System”, gained the third prize of “Science and Technology Achievements Award from Village

& Township Enterprises Administration of Ministry of Agriculture of People’s Republic of China”. Mr.

Guo was granted the “Wealth Attainment and Development of Shouguang” medal of Shouguang city

in 2006 ( ).

Mr. Cui Huan You ( ), aged 57, is in charge of the finance of the Company. Mr. Cui has

significant experience in finance, accounting and taxation. He joined Molong Holdings as an

accounting supervisor in June 1995. He graduated from Shandong Province Financial Zhigong

University. Mr. Cui was awarded the “Outstanding Financial Management Personnel” in 1992 and the

“Advanced Accountant of Weifang City” in 2004.


— 131 —

Rules 19A18(2)Rules 8.17(2)(3)

Mr. Liang Yong Qiang ( ) , aged 38, is the chief engineer of the Company. Mr. Liang

joined Molong Holdings in July 2001. He graduated from Xian Jiaotong University, Bachelor Degree.

Mr. Liang participated in the development of certain models of oil well pumps and has won a second

prize in the “Shandong Province Weifang City Kuiwen District First Science and Technology

Enhancement Contest”.

Mr. Chan Wing Nang, Billy ( ), aged 45, is the qualified accountant and company

secretary of the Company. Mr. Chan is one of the senior management staff of the Company. Mr. Chan

graduated from the University of Newcastle upon Tyne, United Kingdom with a bachelor degree in

Civil Engineering in 1986. He also read a master degree in business administration at the University

of Warwick, United Kingdom. Mr. Chan is a member of the Hong Kong Institute of Certified Public

Accountants and The Institute of Chartered Accountants in England and Wales. Mr. Chan has over 10

years of experience in the accounting and consulting field. Prior to joining the Group, Mr. Chan was

a director in a consulting company. Mr. Chan joined the Group on 13 December 2004.

COMPLIANCE OFFICER

Xie Xin Cang ( )

COMPLIANCE ADVISER

Pursuant to the Listing Rules 3A.19, the Company appointed Guotai Junan as its compliance

adviser to assist and advise the Company in connection with the Listing Rules and applicable laws,

rules, codes and guidelines. The appointment of Guotai Junan as the Company’s compliance adviser

will commence on the Listing Date and end on the date on which the Company distributes its annual

reports in respect of the Company’s financial results for the financial year ending 31 December 2007

or the date on which such agreement is terminated pursuant to the terms thereof, whichever is the

earlier.

STAFF

Overview

As at the 30 April 2006, the Group had 1,698 full-time employees, whose functions in the

Company are analyzed as follows:

Research and development 56

Production 1,324

Quality control 92

Sales and marketing 58

Administration 168

Total 1,698


— 132 —

A1A(28)(7)

Relationship with staff

Since its establishment, the Group has not experienced any disruption to its normal business

operations as a result of labour disputes and/or significant turnover of staff. The Directors consider

the Group has maintained a very good relationship with its staff.

Staff benefits

The Group provides employee benefits including retirement scheme, medical insurance scheme

and work injury insurance scheme.

The basis figure for determining the amount of insurance premium payable for each employee

is calculated in accordance with the requirements of the relevant authorities. For employees at levels

1.5 to 5, 5.5 to 7.5 and 8 to 10, the amount payable is 60%, 80% and 100% of the average salary of

Shandong Province of the previous year respectively. For the year ended 31 December 2005, the

annual and monthly average salary of Shandong Province was RMB16,614 and RMB1,384.5

respectively.

The contribution made by the Group in respect of retirement scheme benefits for the ten months

ended October 2003 was 20% of the basis figure for each employee. For the two months ended

December 2003, the contribution was 10% following a change of government regulations. The total

amount of contribution made by the Group for the three years ended 31 December 2005 and the four

months ended 30 April 2006 amounted to approximately RMB1,416,073, RMB935,474,

RMB1,162,996 and RMB751,815 respectively. If the employee leaves the Group, the Group would not

forfeit the contributions made.

The contribution made by the Group in respect of medical insurance scheme for the year ended

December 2005 was 7% of the basis figure of each employee. For the year ended 31 December 2005,

the contribution in respect of medical insurance amounting to RMB426,109.

The contribution made by the Group in respect of work injury insurance scheme for the year

ended 31 December 2005 was 2% of the basis figure of each employee.

Adequate provisions have been made at the accounts based on the relevant laws and regulations.

In respect of the issue regarding the housing provident fund, the State Council promulgated

(the Administrative Regulations on Housing Provident Fund) in 1999. However,

based on the understanding of Kingfield & Partners, the PRC legal advisers of the Company, the

execution of the policies with regarding to the housing provident fund varies among different areas

of the PRC, and there are still a number of local enterprises which have not adopted the housing

provident fund. Currently, the People’s Government of Shouguang City has not promulgated the

relevant provisions in respect of the execution of the housing provident fund. Therefore, the

distribution by the Company of the housing allowances directly to its employees does not contravene

with relevant laws and regulations of the PRC.


— 133 —

App 1A33(4)(d)

SUBSTANTIAL SHAREHOLDERS

At the Latest Practicable Date, the following persons will be entitled to exercise, or control the

exercise of, 10% or more of the voting power at any general meeting of the Company:

Name

Number ofDomestic/H Shares

of RMB0.10 eachheld at the Latest

Practicable Date

Approximate percentageof holding in the registered

share capital of theCompany at the Latest

Practicable Date

Zhang En Rong (Note 1) 279,517,000

Domestic Shares

43.14%

Paul G. Desmarais (Note 2) 69,000,000 H Shares 10.65%Nordex Inc. (Note 2) 69,000,000 H Shares 10.65%Gelco Enterprises Ltd. (Note 2) 69,000,000 H Shares 10.65%Power Corporation of Canada

(Note 2) 69,000,000 H Shares 10.65%2795957 Canada Inc. (Note 2) 69,000,000 H Shares 10.65%171263 Canada Inc. (Note 2) 69,000,000 H Shares 10.65%Power Financial Corporation (Note 2) 69,000,000 H Shares 10.65%IGM Financial Inc. (Note 2) 69,000,000 H Shares 10.65%Mackenzie Inc. (Note 2) 69,000,000 H Shares 10.65%Mackenzie Financial Corporation

(Note 2) 69,000,000 H Shares 10.65%

Note 1:

Zhang En Rong is also a controlling shareholder (as defined in the Listing Rules) of the Company.

Note 2:

Mackenzie Cundill Investment Management Ltd. is a wholly-owned subsidiary of Mackenzie Financial Corporation,

which in turn is a wholly-owned subsidiary of Mackenzie Inc.. Mackenzie Inc. is a wholly-owned subsidiary of IGM Financial

Inc. which in turn is owned as to 55.99% by Power Financial Corporation. Power Financial Corporation is owned as to 66.4%

by 171263 Canada Inc. which in turn is a wholly-owned subsidiary of 2795957 Canada Inc. 2795957 Canada Inc. is a

wholly-owned subsidiary of Power Corporation of Canada which in turn is owned as to 54.18% by Gelco Enterprises Ltd. Gelco

Enterprises Ltd. is owned as to 94.95% by Nordex Inc., which in turn is owned as to 68% by Paul G. Desmarais.

Mackenzie Cundill Investment Management (Bermuda) Ltd. is a wholly-owned subsidiary of Mackenzie (Rockies) Corp.,

which in turn is a wholly-owned subsidiary of Mackenzie Financial Corporation.

Mackenzie Financial Corporation, Mackenzie Inc., IGM Financial Inc., Power Financial Corporation, 171263 Canada

Inc., 2795957 Canada Inc., Power Corporation of Canada, Gelco Enterprises Ltd., Nordex Inc. and Paul G. Desmarais will be

entitled to control the exercise of 10.65% of the voting powers at any general meeting of the Company, in respect of 60,000,000

H Shares held by Mackenzie Cundill Investment Management Ltd. and 9,000,000 H Shares held by Mackenzie Cundill

Investment Management (Bermuda) Ltd..

Mackenzie Financial Corporation is a manager of mutual funds in Canada.

SUBSTANTIAL SHAREHOLDERS

— 134 —

A1A 27A

REGISTERED CAPITAL

The registered capital of our Company as at the Latest Practicable Date was as follows:

RMB

401,722,000 Domestic Shares in issue 40,172,200

246,276,000 H Shares in issue 24,627,600

647,998,000 64,799,800

GENERAL MANDATE TO ISSUE NEW SHARES

At the Company’s annual general meeting held on 12 May 2006, the Directors were granted

general unconditional mandate to allot, issue and deal with additional Shares with an aggregate

nominal amount not exceeding 20% of the aggregate amount of Domestic Shares in issue as at the date

of passing of the relevant resolution on 12 May 2006 (which may be revoked at the Extraordinary

General Meeting to be held on or about 5 December 2006).

The above general mandate does not apply to situations where the Directors allot, issue or deal

with Shares under a scrip dividend or similar arrangement providing for the allotment of such Shares

in lieu of the whole or part of a dividend on such Shares or any share option scheme adopted by the

Company and in accordance with the Articles of Association.

This general mandate will expire:

(1) at the conclusion of the next annual general meeting of the Company following the passing

of the relevant resolution on 12 May 2006;

(2) the expiry date of the 12-month period following the passing of the relevant resolution on

12 May 2006; or

(3) the passing of a special resolution of the Company in a general meeting revoking or varying

the authority set out in the relevant resolution on 12 May 2006.

SHARE CAPITAL

— 135 —

3rd Sch(2)A1A(23)R19A.42(55)(1)

The following discussion should be read in conjunction with the audited financial statements for

the three years ended 31 December 2005 and four months ended 30 April 2006, together with the

accompanying notes, set out in the accountants’ report in Appendix I of this document. The financial

statements were prepared in accordance with Hong Kong Financial Reporting Standards (“HKFRS”).

The following discussion contains certain forward looking statements that involve risks and

uncertainties. The Group’s future results could differ materially from those discussed below. Factors

that could cause or contribute to such differences include, without limitation, those discussed in the

section headed “Risk Factors” in this document.

OVERVIEW



products, namely, oil well pipes, oil well sucker rods, oil well pumps, casing, oil well pumping



to domestic oil fields within the PRC and are partly for export to overseas customers. During the Track

Record Period, the Group’s revenue and cash was generated by selling of its products such as oil well

pipes, oil well sucker rods, oil well pumps, casings, oil well pumping machines and other petroleum

drilling and extraction machinery accessories. For the three years ended 31 December 2005 and the

four months ended 30 April 2006, oil well pipes which are the Group’s key product accounted for

approximately 44.5%, 53.6%, 64.4% and 69.5% of the Group’s product revenue respectively.

The Group’s business is primarily affected by the capital expenditure of the petroleum driller and

extractor and producer which in turn will depend on the present and future trend of market price of

petroleum. Furthermore, price fluctuations of raw materials (especially special steel prices) have a

direct impact on the costs of the Group’s products.


Group’s product revenue by product breakdown is set out below:


30 April

2003 2004 2005 2005 2006

(Unaudited)


Oil well pipes 134,500 44.5 261,477 53.6 500,198 64.4 157,222 68.9 211,348 69.5


Oil well pumps 21,683 7.2 21,761 4.5 7,758 1.0 4,053 1.8 5,521 1.8

Casings 2,906 1.0 20,625 4.2 27,337 3.5 16,016 7.0 11,019 3.6

Oil well pumpingmachines 3,669 1.2 6,087 1.2 9,287 1.2 3,067 1.3 3,815 1.3

Other petroleum drilling andextraction machineryaccessories 86,874 28.7 113,878 23.4 151,290 19.5 25,186 11.0 40,691 13.3

Total 302,274 100 487,688 100 776,522 100 228,380 100 304,214 100

FINANCIAL INFORMATION

— 136 —


Group’ revenue breakdown by geographical area is set out below:


30 April

2003 2004 2005 2005 2006

RMB’000 % RMB’000 % RMB’000 %(unaudited)

RMB’000 % RMB’000 %

The PRC 256,478 84.8 398,351 81.7 560,992 72.2 164,294 71.9 190,890 62.7

US 42,972 14.2 52,052 10.7 101,284 13.0 34,068 14.9 55,205 18.1

Europe 2,358 0.8 28,347 5.8 69,497 9.0 19,295 8.5 41,003 13.5

Others 466 0.2 8,938 1.8 44,749 5.8 10,723 4.7 17,116 5.7

Total 302,274 100 487,688 100 776,522 100 228,380 100 304,214 100

For the three years ended 31 December 2005 and the four months ended 30 April 2006, the major

cost breakdown of the Group is set out below:

For the year ended 31 DecemberFor the four months ended

30 April

2003 2004 2005 2005 2006

RMB’000 % RMB’000 % RMB’000 %(unaudited)

RMB’000 % RMB’000 %

Cost of rawmaterials 209,530 92.4 361,078 92.3 552,973 92.8 170,059 92.2 214,770 92.7

Labour cost 7,106 3.1 11,964 3.1 18,103 3.0 5,578 3.0 6,795 2.9

Production cost 10,236 4.5 17,988 4.6 25,037 4.2 8,823 4.8 10,073 4.4

Sub total 226,872 100 391,030 100 596,113 100 184,460 100 231,638 100

Factors affecting the Group’s results of operations and financial conditions

Growth of the petroleum drilling and extraction machinery industry

Pursuant to the OPEC report, China added 32% to the world oil demand in 2005. Oil demand

from the PRC is expected to increase by 0.5mb/d in 2006. The Directors considered that the

continuous increase of demand for oil in the PRC will lead to the domestic oil producers (of which

PetroChina and Sinopec are the major customers of the Group) to purchase more petroleum drilling

and extraction machinery and equipment. Hence, there will be a direct effect on the demand for

petroleum drilling and extraction machinery and equipment which, in return, will have a direct effect

on the Group’s turnover. For more details of the PRC crude oil industry, please refer to the section

headed “Industry overview” of this document.


— 137 —

Foreign currency exchange rate risk

The Group is subject to certain foreign currency exchange risk which the Company has not

hedged against. The Group operates primarily in the PRC and a certain portion of its products are

exported to overseas markets. For the three years ended 31 December 2005 and four months ended 30

April 2006, revenue denominated in US dollars represent 15.2%, 18.3%, 27.8% and 37.3%,

respectively, of the Group’s total revenue while all of the Group’s operation expenses such as purchase

of raw materials and labour costs are denominated in RMB.

During the Track Record Period, the Group has realised losses in relation to foreign currency

fluctuations. For the three years ended 31 December 2005 and four months ended 30 April 2006, the

Group recorded loss of approximately RMB41,000, RMB86,000, RMB1,314,000 and RMB512,000,

respectively.

CRITICAL ACCOUNTING POLICIES

Critical accounting policies are that the Group’s management make subjective judgments and

estimates, actual results could differ significantly from these assumptions and estimates.

The Group’s financial statements have been prepared in accordance with the Hong Kong GAAP.

The major accounting policies are included in section 3 of the Accountants’ Report in this document.

The Hong Kong GAAP requires the Group’s directors to adopt accounting policies under the current

conditions to reflect the true and fair view of our results and financial conditions. The most complex

and sensitive judgments (due to the importance for those estimates to our financial statements) are

estimated from the uncertain market conditions. The results of the Group may differ as a result from

those estimates. The following accounting policies are considered to be critical to the consolidated

financial statements.

Revenue recognition

The Group’s revenue recognition from sales of goods upon customers’ satisfaction and passage

of inspection period ranging from one to three months, and there is no unbilled revenue and unbilled

trade receivable recognized in the Group’s financial statements as at each balance sheet date.

Property, plant and equipment

Property, machinery and equipment, electrical appliances, motor vehicles and other equipment

are recorded in the books based on the estimated useful lives, residual value, the fair value of the

assets, the expected cash flow and the potential impairment to the value of the assets.


— 138 —

The followings are the estimated lives of the Group’s property, machinery and equipment,

electrical appliances, motor vehicles and other equipment. The depreciation is charged annually based

on the straight line method:

Building 20 years

Plant and machinery 2 to 10 years

Electrical appliances 5 years

Motor vehicles 5 years

Other equipment 5 years

Building, plant and machinery, electrical appliances, motor vehicles and other equipment are

assessed at the book value if an event occurs which may result in an impairment on the book value

of the assets. The events include but not limited to a material change in the circumstance and negative

cash outflow of the assets. The revaluation of the assets will be recorded in the profit and loss

accounts. Uncertainties exist on the future cash flow test on the value of an asset. If the actual cash

flow deviate from the estimates, the value impairment may become inaccurate and the assets may need

further revaluation.

Inventories

Inventories are recorded at lower of cost or net realisable value. Cost in bringing the inventories

to the following conditions are listed below:

Raw materials — weighted average cost basis

Work in progress and finished goods — direct materials, direct labour and manufacturing costs.

Provisions for the inventories is computed based on the type of the products, after assessing the

future demand and the market condition. For the three years ended 31 December 2005 and the four

months period ended 30 April 2006, the provision for inventories are RMB20,000, RMB-150,000,

RMB4,499,000 and RMB1,836,000 respectively.

Provision for doubtful debts

The Group’s trading terms with its customers are mainly on credit, except for new customers,

where payment in advance is normally required. The credit period is generally for a period of one to

three months, extending up to six months for major customers. Each customer has a maximum credit

limit. The Group seeks to maintain strict control over its outstanding receivables to minimize credit

risk. Overdue balances are reviewed regularly by senior management. Provision for doubtful debts is

made based on assessment of the recoverability of trade receivables and other receivables. The

identification of doubtful debts requires management judgment and estimates. Where the actual

outcome or expectation in future is different from the original estimate, such differences will impact

the carrying value of the receivables and doubtful debt expenses/write-back in the period in which

such estimate has been changed. For the three years ended 31 December 2005 and the four months

period ended 30 April 2006, provision for bad debts were RMB969,000, RMB2,171,000,

RMB3,714,000 and RMB-2,960,000 respectively.


— 139 —

Tax

Molong Drilling Equipment and Molong Machinery (which was deregistered on 6 December2004) were approved by (the Ministry of Civil Affairs of Shandong Province) as welfareenterprises ( ). According to the tax document Cai Shui Zi [1994] No.1

(The Notice Regarding Certain Preferential Policies on EnterprisesIncome Tax), Molong Drilling Equipment and Molong Machinery were entitled to an exemption fromcorporate income tax. For further details in relation to the tax exemption of Molong DrillingEquipment and Molong Machinery, please refer to the Accountants’ Report in Appendix I of thisdocument.

Impact of new and revised Hong Kong Financial Reporting Standards

The Financial Information has been prepared in accordance with HKFRS (which also includeHong Kong Accounting Standards (“HKAS”) and Interpretations) issued by the HKICPA, accountingprinciples generally accepted in Hong Kong and the disclosure requirements of the Hong KongCompanies Ordinance.

The Financial Information has been prepared under the historical cost convention, except for theremeasurement of certain equity investments, the accounting policies of which are disclosed below.

The HKICPA has issued the following new and revised HKFRS, which are generally effective foraccounting periods beginning on or after 1 January 2005. The Financial Information has been preparedin accordance with these new and revised HKFRS throughout the Relevant Periods and the four-monthperiod ended 30 April 2005.

HKAS 1 Presentation of Financial StatementsHKAS 2 InventoriesHKAS 7 Cash Flow StatementsHKAS 8 Accounting Policies, Changes in Accounting Estimates and ErrorsHKAS 10 Events after the Balance Sheet DateHKAS 12 Income TaxesHKAS 14 Segment ReportingHKAS 16 Property, Plant and EquipmentHKAS 17 LeasesHKAS 18 RevenueHKAS 19 Employee BenefitsHKAS 20 Accounting for Government Grants and Disclosure of Government

AssistanceHKAS 21 The Effects of Changes in Foreign Exchange RatesHKAS 21 Amendment The Effects of Changes in Foreign Exchange Rates — Net Investment

in a Foreign OperationHKAS 23 Borrowing CostsHKAS 24 Related Party DisclosuresHKAS 27 Consolidated and Separate Financial StatementsHKAS 32 Financial Instruments: Disclosure and PresentationHKAS 33 Earnings per ShareHKAS 36 Impairment of AssetsHKAS 37 Provisions, Contingent Liabilities and Contingent AssetsHKAS 38 Intangible AssetsHKAS 39 Financial Instruments: Recognition and MeasurementHKAS 39 Amendment Transition and Initial Recognition of Financial Assets and Financial

Liabilities


— 140 —

HKAS 39 Amendment Cash Flow Hedge Accounting of Forecast Intragroup TransactionsHKAS 39 Amendment The Fair Value OptionHKAS 39 & HKFRS 4

AmendmentsFinancial Guarantee Contracts

HKAS 40 Investment PropertyHKFRS-Int 4 Determining whether an Arrangement contains a Lease

RESULTS OF OPERATIONS

The following table summarizes the consolidated audited results of the Group for the three yearsended 31 December 2005 and the four months ended 30 April 2006. The summary should be read inconjunction with the Accountants’ Report as set out in Appendix I to this document.


30 April2003 2004 2005 2005 2006

(Unaudited)RMB’000 RMB’000 RMB’000 RMB’000 RMB’000

Revenue 302,274 487,688 776,522 228,380 304,214

Cost of sales (226,872) (391,030) (596,113) (184,460) (231,638)

Gross profit 75,402 96,658 180,409 43,920 72,576

Other revenue and gains 21,995 15,458 14,146 4,818 8,970Selling and distribution costs (11,299) (20,128) (24,853) (6,247) (9,563)Administrative expenses (11,099) (14,300) (33,162) (6,649) (10,274)Other expenses (10,914) (7,540) (17,577) (2,096) (5,732)Finance costs (4,738) (4,572) (3,444) (1,338) (1,920)

PROFIT BEFORE TAX 59,347 65,576 115,519 32,408 54,057Tax (13,197) (1,485) (27,271) (7,997) (18,396)

PROFIT FOR THE YEAR/PERIOD 46,150 64,091 88,248 24,411 35,661

Attributable to:Equity holders of the parent 43,977 61,366 85,227 23,866 34,977Minority interests 2,173 2,725 3,021 545 684

46,150 64,091 88,248 24,411 35,661

DIVIDENDSInterim — 10,806 12,982 — —Proposed final — 8,100 11,016 — —

— 18,906 23,998 — —

EARNINGS PER SHAREATTRIBUTABLE TOORDINARY EQUITYHOLDERS OF THE PARENT— Basic (RMB) 0.109 0.122 0.141 0.044 0.054


— 141 —

REVIEW OF HISTORICAL OPERATING RESULTS

Year ended 31 December 2004 compared to year ended 31 December 2003

Revenue

For the year ended 31 December 2004, the Group’s turnover increased significantly as a result

of increasing market demand in petroleum machinery industry. The Group’s turnover was

approximately RMB302.27 million for the year ended 31 December 2003 and surged to approximately

RMB487.69 million for the year ended 31 December 2004, which represented an increase of 61.3%.

This was principally derived from the sale of oil well pipes, oil well sucker rods, oil well pumps,

casing, oil well pumping machines and other petroleum extraction machinery accessories.

As compared to the year ended 31 December 2003, the Group’s turnover rapidly increased due

to the growing sales of oil well pipes. In addition, the Company devoted more marketing efforts to

develop the overseas customers in the year of 2004, oil well pipes, oil well sucker rods and casing

were successfully launched into new overseas markets. In addition, the number of marketing staff

increased from 45 at the year end of 2003 to 52 at the year end of 2004. The additional number of

marketing staff was mainly deployed to serve overseas customers (such as preparing for marketing

materials of the Group’s products, maintaining regular business contact through mail/email with

customers, providing technical advice to customers’ enquiries and following up with customers’

purchase orders). As a result, the Group’s export sales increased by approximately 95.1% from

approximately RMB45.79 million for the year ended 31 December 2003 to approximately RMB89.34

million for the year ended 31 December 2004.

Cost of sales

For the year ended 31 December 2004, the Group’s cost of sales increased by 72.4% to

approximately RMB391.03 million, compared with approximately RMB226.87 million in the same

corresponding period of 2003. The increase in cost of sales for the year ended 31 December 2004 grew

in line with the Group’s turnover for the year. The composition of the cost of sales remain stable in

2003 and 2004 are basically the same.


— 142 —

Gross profit

The Group’s gross profit increased from approximately RMB75.4 million for the year ended 31

December 2003 to approximately RMB96.66 million for the year ended 31 December 2004. This

represented an increase of approximately 28.2% as compared to the previous year. The substantial

growth was mainly due to the rapid increase in turnover.

Gross profit margin

The following sets out the gross profit margin of the Group’s products for the years ended 31

December 2003 and 31 December 2004, respectively:


2003 2004

% %

Oil well pipes 12.5 15.3

Oil well sucker rods 37.1 24.4

Oil well pumps 33.4 36.4

Casing 14.0 13.8

Oil well pumping machines 27.9 18.0

Other petroleum drilling and extraction machinery accessories 35.0 25.6

Gross profit margin of the Group decreased from approximately 24.9% for the year ended 31

December 2003 to approximately 19.8% for the year ended 31 December 2004, representing a decrease

of approximately 5.1%. The main reason for the slight decrease in the gross profit margin was the

change of the products mix of the Group, compared to other products’ gross profit margins, oil well

pipes was approximately 15.3%, which is relatively lower due to higher market competition for oil

well pipes than other products. Owing to the higher demand for oil well pipes, the rapid market

development as well as enhancement of production capacity, turnover of oil well pipes increased

rapidly from approximately RMB134.5 million in 2003 to approximately RMB261.48 million in 2004,

the ratio in total turnover increased from approximately 44.5% in 2003 to approximately 53.6% in

2004. Prior to the special seamless oil well pipes production facilities commenced operation in 2004,

oil well pipes were produced with purchased seamless pipes. Since the special seamless oil well pipes

production facilities commenced operation during 2004, the Group can manufacture oil well pipes by

using raw materials such as billets which reduced the cost of production, thereby, enhancing the gross

profit margin.

Other revenue and gains

The Group’s other revenue and gains decreased by approximately 29.7% from approximately

RMB22 million for the year ended 31 December 2003 to approximately RMB15.46 million for the year

ended 31 December 2004. Such decrease was mainly attributable to lower subcontract income and no

disposal gain of subsidiaries during the year ended 31 December 2004.


— 143 —

Selling and distribution costs

The Group’s selling and distribution costs increased from approximately RMB11.3 million for

the year ended 31 December 2003 to approximately RMB20.13 million for the year ended 31

December 2004, representing a growth rate of approximately 78.1%. For the two years ended 31

December 2004, the ratio of selling and distribution costs to turnover were approximately 3.7% and

4.1% respectively. The increase is due to the increase in turnover and the increase in the ratio of

selling and distribution costs to turnover is due mainly to the increase in sales commission to an

overseas sales agent during 2004.

Administrative expenses

Administrative expenses of the Group increased from approximately RMB11.1 million for the

year ended 31 December 2003 to approximately RMB14.3 million for the year 31 December 2004,

representing an increase of approximately 28.8% when compared to the corresponding period previous

year. Such increase was mainly attributable to the increase in the cost of emoluments and staff benefits

by approximately RMB1.2 million for the year ended 31 December 2004.

Other expenses

Other expenses decreased by 30.8% from approximately RMB10.9 million to RMB7.54 million.

This is mainly due to the fact that a lower subcontracting income (machinery maintenance services)

was provided to a related company.

Finance costs

The Group’s finance costs for the year ended 31 December 2004 was approximately RMB4.57

million, representing approximately 0.9% of the Group’s total turnover and a decrease of

approximately RMB0.2 million over the same period last year. The decrease in finance costs was

primarily due to the Group’s enhancement of capital control and the capital raised from the issue of

H shares in GEM during the year of 2004.

Tax

The Group’s income tax decreased by approximately 88.7% from approximately RMB13.2

million for the year ended year 31 December 2003 to approximately RMB1.49 million. This is

primarily due to the tax exemption of approximately RMB11.33 million and RMB1.62 million granted

to a subsidiary of the Company as a welfare enterprise for the previous year and the current year,

respectively. The statutory tax rate was 33% but the effective tax rates were 22.2% and 2.3% for the

years ended 2003 and 2004. In 2003, the lower effective tax rate was due to profit tax exemption

totaling approximately RMB6.36 million for the qualified technological improvement projects. In

2004, the lower effective tax rate was due to approximately RMB12.95 million tax exemption granted

to the Group as a welfare enterprise, and approximately an aggregate of RMB6.02 million tax

exemption for the qualified investments.


— 144 —

Profit attributable to Shareholders

Profit attributable to shareholders increased by approximately 39.5% from approximately

RMB43.97 million for the year ended 31 December 2003 to approximately RMB61.37 million for the

year ended 31 December 2004. The increase was due mainly to the profit contribution as a result from

the increase of sales and the tax exemption totaling approximately RMB18.97 million received in

2004, as compared with approximately RMB6.36 million in 2003.

The net profit margins decreased from 14.5% for the year ended 2003 to 12.6% for the year ended

2004. The reason for the decrease in the net profit margins is due mainly to the decrease in the gross

profit margins from 24.9% for the year ended 31 December 2003 to 19.8% for the year ended 31

December 2004.

Year ended 31 December 2004 compared to year ended 31 December 2005

Revenue

For the year ended 31 December 2005, the Group’s turnover further increased as a result of

increasing market demand in petroleum machinery industry. The Group’s turnover was approximately

RMB487.69 million for the year ended 31 December 2004 and surged to approximately RMB776.52

million for the year ended 31 December 2005, which represented an increase of 59.2%. This was

principally derived from the sale of oil well pipes, oil well sucker rods, oil well pumps, casing, oil

well pumping machines and other petroleum extraction machinery accessories.

As compared to the year ended 31 December 2004, the Group’s turnover rapidly increased due

to the growing sales of oil well pipes. In addition, the Company continued to devote marketing efforts

to develop the overseas customers in the year of 2005, oil well pipes, oil well sucker rods and casing

were successfully launched into new overseas markets. By the end of year 2005, the Group continued

to employ another six marketing staff to a total of 58. More marketing staff enables the Group to serve

and handle overseas customers’ enquiries and purchase orders. As a result, the Group’s export sales

increased by approximately 141.2% from approximately RMB89.34 million for the year ended 31

December 2004 to approximately RMB215.53 million for the year ended 31 December 2005. The

Directors believe that the Group’s commitment in providing quality products is crucial in maintaining

its competitive edge in the PRC and overseas markets.

Cost of sales

For the year ended 31 December 2005, the Group’s cost of sales increased by 52.4% to

approximately RMB596.11 million, compared with approximately RMB391.03 million in the same

corresponding period last year. The increase in cost of sales for the year ended 31 December 2005

grew in line with the Group’s turnover for the year. The composition of cost of sales remain stable in

2004 and 2005.


— 145 —

Gross profit

The Group’s gross profit increased from approximately RMB96.66 million for the year ended 31

December 2004 to approximately RMB180.41 million for the year ended 31 December 2005. This

represented an increase of approximately 86.6% as compared to the previous year. The substantial

growth was mainly due to the rapid increase in turnover and higher gross profit margin.

Gross profit margin

The following sets out the gross profit margin of the Group’s products for the two years ended

31 December 2004 and 31 December 2005, respectively:


2004 2005

% %




Casing 13.8 14.9



Gross profit margin of the Group increased from approximately 19.8% for the year ended 31

December 2004 to approximately 23.2% for the year ended 31 December 2005. The main reason for

the increase in the gross profit margin was due to higher gross profit margin of oil well pipes which

increased from approximately 15.3% in 2004 to approximately 23.9% in 2005. The increase is due

mainly to full year operation of the special seamless oil well pipes production facilities which

commenced operation during 2005. The full operation of the special seamless oil well pipes reduced

the cost of production for oil well pipes which in turn enhanced the gross profit margin.


The Group’s other revenue and gains decreased by approximately 8.5% from approximately


year ended 31 December 2005. This is primarily due to lower VAT refund and government subsidies

which is partly set off by a higher sale of scrap metal during the year of 2005.



the year ended 31 December 2004 to approximately RMB24.85 million for the year ended 31

December 2005, representing a growth rate of approximately 23.4%. For the two years ended 31


— 146 —

December 2005, the ratio of selling and distribution costs to turnover were approximately 4.1% and

3.2%, respectively. The increase was due to the increase in turnover. The decrease in the ratio of

selling and distribution cost to turnover is due mainly to the decrease in sales commission to an

overseas agent.



year ended 31 December 2004 to approximately RMB33.16 million for the year 31 December 2005,

representing an increase of approximately 131.9% when compared to the corresponding period

previous year. Such increase for the year ended 31 December 2005 was mainly attributable to (i) the

increase in the cost of emoluments and staff benefits due to the payment of discretionary bonus, (ii)

higher social insurance expense where additional insurance policy was taken out and (iii) higher

expense for professional fees (such as audit fees, expense in relation to issue of additional new H

shares in GEM during the year 2005).

Other expenses

Other expenses increased by approximately 133% from approximately RMB7.54 million for the

year ended 31 December 2004 to approximately RMB17.58 million for the year ended 31 December

2005. This is mainly due to (i) higher cost of bad debts provision where provision was made on

receivables over one year, (ii) exchange loss where Renminbi appreciated against the US dollars, and

(iii) the increase in the cost element of sales of scrap metal where sales of raw materials increased.

Finance costs

The Group’s finance costs for the year ended 31 December 2005 was approximately RMB3.44

million, representing approximately 0.4% of the Group’s total turnover and a decrease of

approximately RMB1.1 million over the same period last year. The decrease in finance costs was

primarily due to the Group’s enhancement of capital control and the issue of additional H shares in

GEM during the year of 2005.

Tax

The Group’s income tax increased from RMB1.49 million for the year ended year 31 December

2004 to approximately RMB27.27 million for the year ended 31 December 2005. The statutory tax rate

was 33%, but the effective tax rate was 23.6% in 2005. The reason for the lower effective tax rate was

due to a total of approximately RMB10.02 million profit tax exemption granted to a subsidiary of the

Company as a welfare enterprise.


— 147 —




year ended 31 December 2005. The increase was due mainly to the increase of sales by approximately

59.23% as compared with the sales in the year ended 2004 and was offset by the lower tax exemption

of approximately RMB10.02 million received in 2005 as compared with RMB18.97 million in 2004.

The net profit margins decreased from 12.6% in 2004 to 11.0% in 2005. The reason for the

decrease in the net profit margins was also due mainly to the lower tax exemption.

Four months ended 30 April 2005 compared to four months ended 30 April 2006

Revenue

For the four months ended 30 April 2006, the Group’s turnover rapidly increased as a result of

increasing market demand in petroleum machinery industry. The Group’s turnover was approximately

RMB228.38 million for the four months ended 30 April 2005 and surged to approximately RMB304.21

million for the four months ended 30 April 2006, which represented an increase of approximately

33.2%. This was principally derived from the sale of oil well pipes, oil well sucker rods, oil well

pumps, casing, oil well pumping machines and other petroleum extraction machinery accessories.

As compared to the previous period last year, the Group’s turnover rapidly increased due to the

growing sales of oil well pipes. For the four months ended 30 April 2006, the Group’s export sales

increased by approximately 76.8% to approximately RMB113.32 million when compared with

approximately RMB64.09 million for the same corresponding period in 2005. Such increase of export

sales was mainly attributed to higher demand from overseas customers.

Cost of sales

For the four months ended 30 April 2006, the Group’s cost of sales increased by approximately

25.6% to approximately RMB231.64 million, as compared with approximately RMB184.46 million in

the same corresponding period last year. The increase in cost of sales for the four months ended 30

April 2006 grew in line with the Group’s turnover for the year. The composition of cost of sales for

the corresponding period in 2005 and 2006 are basically the same.

Gross profit

The Group’s gross profit increased from approximately RMB43.92 million for the four months

ended 30 April 2005 to approximately RMB72.58 million for the year ended 30 April 2006. This

represented an increase of approximately 65.3% as compared to the corresponding period previous

year. Such substantial growth rate was mainly due to the rapid increase in turnover and higher gross

profit margin.


— 148 —

Gross profit margin

The following sets out the gross profit margin of the Group’s products for the four months period

ended 30 April 2005 and 30 April 2006.


2005 2006

% %




Casing 9.0 10.3



Gross profit margin of the Group increased from approximately 19.2% for the four months ended

30 April 2005 to approximately 23.9% for the four months ended 30 April 2006. The main reason for

the increase in the gross profit margin was due to higher gross profit margin of oil well pipes which

increased from approximately 18.9% for the four months ended 30 April 2005 to approximately 24.5%

for the four months ended 30 April 2006. In addition, the Directors attributed the improvement of

gross profit margin for the four months ended 30 April 2006 to the substantial increase of self-supply

rate of seamless pipe.


The Group’s other revenue and gains increased by approximately 86.1% from approximately

RMB4.82 million for the four months ended 30 April 2005 to approximately RMB8.97 million for the

four months ended 30 April 2006. This is primarily due to higher sale of scrap metal during the four

months period ended 30 April 2006.



the four months ended 30 April 2005 to approximately RMB9.56 million for the four months ended

30 April 2006, representing a growth rate of approximately 53.2%. For the four months ended 30 April

2005 and 2006, the ratio of selling and distribution costs to turnover were approximately 2.7% and

3.1% respectively. Such ratio increase was primarily due to higher transportation fee and export sales

commission. It is mainly due to the increase of export sales.


— 149 —



four months ended 30 April 2005 to approximately RMB10.27 million for the four months ended 30

April 2006 representing an increase of approximately 54.4% when compared to the corresponding

period last year. Such increase for the four months ended 30 April 2006 was mainly attributable to

higher depreciation charges where depreciation charges for newly built factory which has not

commenced operation are charged here.

Other expenses

Other expenses increased by 172.9% from approximately RMB2.1 million for the four months

ended 30 April 2005 to RMB5.73 million for the four months ended 30 April 2006. This is mainly due

to higher amount of sales of scrap metal occurred in the four months ended 30 April 2006 as compared

with the corresponding period in 2005.

Finance costs

The Group’s finance costs for the four months ended 30 April 2006 was approximately RMB1.92

million, representing an increase of approximately 43.5% was due to increase in interest bearing loans

from RMB50 million as at 31 December 2005 to RMB100 million as at 30 April 2006.

Tax

The Group’s income tax increased by approximately 130% from approximately RMB8 million

for the four months ended 30 April 2005 to approximately RMB18.4 million for the four months ended

30 April 2006. The effective tax rates were 24.7% and 34% for the four months ended 30 April 2005

and 30 April 2006 respectively. For the four months ended 30 April 2005, the lower effective tax rate

was due to approximately RMB2.68 million of profit tax exemption as a welfare enterprise was

granted to Molong Drilling Equipment. For the four months ended 30 April 2006, tax exemption

approvals have not been received.



RMB23.87 million for the four months ended 30 April 2005 to approximately RMB34.98 million for

the four months ended 30 April 2006. The increase was mainly due to an increase in sales by 33.2%

together with an increase in the gross profit margin from approximately 19.2% to 23.9%, which was

partially offset by no tax exemption received as compared with approximately RMB2.68 million

received in the four months ended 30 April 2005.

The net profit margins increased from approximately 10.5% for the four months ended 30 April

2005 to approximately 11.5% for the four months ended 30 April 2006. The reason for the increase

is mainly due to an increase in the gross profit margin from approximately 19.2% for the same period

in 2005 to approximately 23.9% for the four months ended 30 April 2006.


— 150 —

UNAUDITED CONSOLIDATED PROFIT AND LOSS ACCOUNT FOR THE SIX MONTHS

ENDED 30 JUNE 2006

On 15 August 2006, the Group announced the unaudited consolidated profit and loss account for

the six months ended 30 June 2006, which together with the comparative unaudited consolidated

figures for the corresponding period in 2005 are as follows:

Six months ended 30 June

2006 2005

RMB’000 RMB’000

Revenue 443,398 323,866

Cost of sales (334,778) (255,378)

Gross profit 108,620 68,488

Other revenue and gains 19,476 3,908

Selling and distribution costs (13,142) (9,340)

Administrative expenses (14,693) (10,267)

Other operating expenses (19,572) (1,613)

Profit from operating activities 80,689 51,176

Finance costs (3,803) (1,677)

Profit before tax 76,886 49,499

Tax (25,374) (11,682)

Profit for the period 51,512 37,817

Attributable to:

Equity holders of the parent 50,424 36,556

Minority interests 1,088 1,261

51,512 37,817

Earnings per share

— basic (RMB) 0.078 0.064

Interim dividend per share (RMB) 0.015 0.020


— 151 —

Revenue

For the six months ended 30 June 2006, the Group’s turnover continues to increase as a result

of increasing market demand in the petroleum machinery industry. The Group’s turnover was

approximately RMB323.87 million for the six months ended 30 June 2005 and surged to

approximately RMB443.4 million for the six months ended 30 June 2006, which represented an

increase of approximately 36.9%. This was principally derived from the sale of oil well pipes, oil well

sucker rods, oil well pumps, casing, oil well pumping machines and other petroleum extraction

machinery accessories.

As compared to the previous period last year, the Group’s turnover rapidly increased due to the

growing sales of oil well pipes and oil well sucker rods. For the six months ended 30 June 2006, the

Group’s export sales increased by approximately 50.1% to approximately RMB152.54 million when

compared with approximately RMB101.6 million for the same corresponding period in 2005. The

increase of export sales was attributed to the higher sale growth for the oil well pipes and other

petroleum extraction machinery accessories.

Cost of sales

For the six months ended 30 June 2006, the Group’s cost of sales increased by approximately

31.1% to approximately RMB334.78 million, compared with approximately RMB255.38 million in the

same corresponding period last year. The increase in cost of sales for the six months ended 30 June

2006 grew in line with the Group’s turnover for the year. The composition of cost of sales for the

corresponding period in 2005 and 2006 are basically the same.

Gross profit

The Group’s gross profit increased from approximately RMB68.49 million for the six months

ended 30 June 2005 to approximately RMB108.62 million for the six months ended 30 June 2006. This

represented an increase of approximately 58.6% as compared to the corresponding period previous

year. Such substantial growth rate was attributed to (i) the rapid increase in turnover and (ii) higher

gross profit margin of product mix.

Gross profit margin

Gross profit margin of the Group increased from approximately 21.1% for the six months ended

30 June 2005 to approximately 24.5% for the six months ended 30 June 2006. The main reason for the

increase in the gross profit margin was due to higher gross profit margin of oil well pipes which

increased from approximately 20.6% for the six months ended 30 June 2005 to approximately 27.5%

for the six months ended 30 June 2006. In addition, the Directors attributed the improvement of gross

profit margin for the six months ended 30 June 2006 to the substantial increase of self-supply rate of

seamless pipe.


— 152 —


The Group’s other revenue and gains increased by approximately 3.98 times from approximately

RMB3.91 million for the six months ended 30 June 2005 to approximately RMB19.48 million for the

six months ended 30 June 2006. This is primarily due to higher sale of scrap metal during the six

months period ended 30 June 2006.



the six months ended 30 June 2005 to approximately RMB13.14 million for the six months ended 30

June 2006, representing a growth rate of approximately 40.7%. For the six months ended 30 June 2005

and 2006, the ratio of selling and distribution costs to turnover were approximately 2.88% and 2.96%

respectively. The composition of cost of selling and distribution for the corresponding period in 2005

and 2006 are basically the same.



six months ended 30 June 2005 to approximately RMB14.69 million for the six months ended 30 June

2006 representing an increase of approximately 43% when compared to the corresponding period last

year. Such increase for the six months ended 30 June 2006 was mainly attributable to higher

depreciation charges and higher staff cost.

Other operating expenses

Other operating expenses increased by 11.2 times from approximately RMB1.61 million for the

six months ended 30 June 2005 to RMB19.57 million for the six months ended 30 June 2006. This is

mainly due to higher cost from research and development expense of RMB5.78 million which related

to the casing, and higher sales to related parties of RMB13.47 million.

Finance costs

The Group’s finance costs for the six months ended 30 June 2006 was approximately RMB3.8

million, representing an increase of approximately 126.8% which was due to higher bank borrowing

of RMB138 million in 2006 compared with RMB50 million in 2005.

Tax

The Group’s income tax increased by approximately 117.2% from approximately RMB11.68

million for the six months ended 30 June 2005 to approximately RMB25.37 million for the six months

ended 30 June 2006. The effective tax rates were 23.6% and 33% for the six months ended 30 June

2005 and 30 June 2006 respectively. For the period ended 30 June 2005, the lower effective tax rate

was that Molong Drilling Equipment was granted as a welfare enterprise and no profit tax was paid

for Molong Drilling Equipment during the same period in 2005. For the period ended 30 June 2006,

tax exemption has not been taken into accounts.


— 153 —



RMB36.56 million for the six months ended 30 June 2005 to approximately RMB50.42 million for the

six months ended 30 June 2006. The increase was due mainly to an increase in sales by 36.9% together

with an increase in the gross profit margin from 21.1% to 24.5%, which was partially offset by no tax

exemption received as compared with the corresponding period in 2005.

The net profit margins increased from 11.3% for the six months ended 30 June 2005 to 11.4%

for the six months ended 30 June 2006. The net profit margins remained stable for the corresponding

period in 2005 and 2006.

LIQUIDITY AND CAPITAL RESOURCES

The Company has historically met its working capital and other capital requirements principally

from cash provided by operations, while raising the remainder of its requirements primarily through

bank borrowings and equity market. The following discussion is based on the consolidated cash flow

statement for the three years ended 31 December 2005 and the four months ended 30 April 2006.

Net current assets/liabilities

As at 30 April 2006, the Group’s net current assets was of approximately RMB49.41 million of

which includes approximately RMB680.82 million of total current assets and approximately

RMB631.42 million of total current liabilities. The Group’s current assets included approximately

RMB182.79 million of inventories, RMB188.79 million of trade and notes receivables, RMB57.60

million of prepayment, deposits and other receivables, RMB45.07 million of amount due from related

parties, RMB175.04 million of pledged deposits and RMB31.53 million of cash and bank balance. The

Group’s current liabilities included approximately RMB482.38 million of trade and bills payables,

RMB34.65 million of other payables and accruals, RMB29.48 million of tax payable, RMB70 million

of bank loans and RMB14.91 million of amount due to related parties. The Group’s liquidity in the

first quarter became tightened, the Directors attributed that (i) during the first quarter 2006

(particularly during the Chinese New Year period), the Group recorded higher credit sales. Higher

amount of trade receivable was recorded and less cash from business operations were received in the

first quarter 2006. However, according to the past cash inflow patterns, the Group may receive higher

cash inflow in the second half of the year, (ii) the banks allow the Group to issue bills payable

provided that the Group can have pledged deposit ratio of approximately 30% - 50% to the amount

of bills payable. In other words, a certain amount of pledged deposits will be used to settle a certain

portion of bills payable which is due for mature, and (iii) the Group used bills payable to order the

machinery and equipment for the new casing production facilities for the year ended 31 December

2005 and the four months ended 30 April. As such, the bills payable was increased significantly during

the above period.

As at 31 July 2006, the Group had unaudited net current assets of approximately RMB35 million

which included current assets and current liabilities of approximately RMB866.2 million and

RMB831.2 million respectively.


— 154 —

As at 31 July 2006, the unaudited current assets of the Group included approximately

RMB278.06 million of inventories, RMB167.6 million of trade receivables, RMB109.87 million of

prepayment, deposits and other receivables, RMB47.77 million of amount due from related parties and

RMB262.95 million of cash and deposits (including pledged deposits). As at 31 July 2006, the

unaudited current liabilities of the Group included approximately RMB617.49 million of trade and

bills payables, RMB34.31 million of tax payable, RMB128 million of bank loans, RMB51.43 million

of deposits, prepayments and other payables.

Cash flows

Set out below summarizes the cash flow of the Company for the three years ended 31 December

2005 and the four months ended 30 April 2006:


30 April

2003 2004 2005 2005 2006

(Unaudited)

RMB’000 RMB’000 RMB’000 RMB’000 RMB’000

Net cash from operating activities 41,388 35,434 302,623 73,454 (25,783)

Net cash used in investing activities (49,871) (44,660) (273,851) (102,838) (113,463)

Net cash generated from financing

activities 7,831 3,667 99,394 31,900 50,808

Cash and cash equivalents at

the end of the year 63,087 57,528 185,694 60,044 97,256

The Company has cash and cash equivalents of approximately RMB97.26 million as at 30 April

2006, and reported a net cash outflow from operating activities of approximately RMB25.78 million

during the four months ended 30 April 2006. The Group sources of cash in the past were sufficient

to meet the capital requirement. The Group’s management perform forecast on the collection from

customers based on credit terms, past experience and repayment pattern in the previous months to

ascertain certainty of cash flow. Cash inflow from customers with long term relationship is expected

to follow similar pattern as in the past. The capital commitments for the four months ended 30 April

2006 related primarily to the construction of the new casing production line. The Company intends to

fund the construction of the new casing production line from the proceeds from the placing of

additional H Shares in May 2005, internal resources and bank borrowings. The Company continuously

manages its liquidity situation to ensure that it is adequate to meet its expansion plans.

Operating activities

Net cash from operating activities in 2003 was approximately RMB41.39 million, while profit

from ordinary activities before taxation for the same period was approximately RMB59.35 million.

The difference of approximately RMB17.96 million was primarily attributable to an increase of trade,

notes receivables and prepayment, deposits and other receivables.


— 155 —


from ordinary activities before taxation for the same year was approximately RMB65.58 million. The

difference of approximately RMB30.15 million was primarily attributable to (i) an increase in

inventories and trade receivables and (ii) the decrease in trade and bills payable, and prepayment and

deposits and other payables and accruals for the year.


from ordinary activities before taxation for the same year was approximately RMB115.52 million. The

difference of approximately RMB187.10 million was primarily attributable to (i) an increase in trade

and bills payables, amount due from related parties and (ii) the decrease in trade receivables which

resulted from an improvement of the trade receivables turnover rates.

Net cash outflow from operating activities for the four months ended 30 April 2006 was

approximately RMB25.78 million, while profit from ordinary activities before taxation for the same

year was approximately RMB54.06 million. The difference of approximately RMB79.84 million was

primarily attributable to (i) an increase in trade and bills payables, amount due from related parties

and (ii) the increase in trade receivables.

Investing activities

For the three years ended 31 December 2005 and the four months ended 30 April 2006, the Group

had a net cash used in investing activities of approximately RMB49.87 million, RMB44.66 million,

RMB273.85 million and RMB113.46 million, respectively.

For the year ended 31 December 2003, the cash outflow was mainly used to the payment of

construction of the new production line for super-strength oil well sucker rods and special seamless

oil well pipes.

For the year ended 31 December 2004, the cash outflow was mainly used to the payment of new

production equipment for super-strength oil well sucker rods and special seamless oil well pipes.

For the year ended 31 December 2005, the cash outflow was mainly used to the partly payment

of new production line for casing.

For the four months ended 30 April 2006, the Group’s investing activities were primarily related

to the payment for purchases of the new production line casing.

Financing activities

The Group had net cash inflow from financing activities in 2003 of approximately RMB7.83

million. This primarily reflected new net bank borrowings.

The net cash inflow of the Group from financing activities in 2004 was approximately RMB3.67

million. The cash inflow was mainly attributable to (i) the net proceeds from issue of new H Shares

in GEM, (ii) new net bank borrowings and (iii) the payment of dividends.


— 156 —

The net cash inflow of the Group from financing activities in 2005 was approximately RMB99.39

million. The cash inflow was mainly attributable to (i) the net proceeds from issue of additional new

H Shares, (ii) new net bank borrowings and (iii) the payment of dividends.

The net cash inflow of the Group from financing activities for the four months ended 30 April

2006 was approximately RMB50.81 million. The cash inflow was mainly attributable to new net bank

borrowings.

CAPITAL EXPENDITURES AND INVESTMENT

Capital expenditures are comprised of purchases of plant and equipment and increases in

construction in progress. For the three years ended 31 December 2005 and the four months ended 30

April 2006, the Group’s capital expenditures were approximately RMB53.44 million, RMB55.77

million, RMB223.02 million and RMB77.38 million, respectively.

The Group’s capital expenditures increased during the two years ended 31 December 2004

primarily because of the investment in the new product line for super-strength oil well sucker rods and

special seamless oil well pipes.

During the year ended 31 December 2005 and the four months ended April 2006, the Group’s

capital expenditures increased primarily because of the investment in the new product line for casing

which was completion in the second quarter of 2006.

The capital commitments of the Group as at 30 April 2006 was approximately RMB70,443,000.

The Group expects to pay approximately RMB53 million in the year ending 2006 which will be

financed by future operating cash flows and bank borrowings. Apart from the commitments as

disclosed herein, the Directors are not aware of other commitments of the Group.

WORKING CAPITAL

The Directors after due and careful enquiry are of the opinion that, taking into consideration the

financial resources available to the Company including its internally generated funds, the Company

has sufficient working capital in the next 12 months commencing from the date of this document. No

significant change is expected on the current capital structure in the near future. The Directors expect

the cost of capital resources to remain stable in the near future.

INVENTORIES

The Group’s inventories increased by approximately 106.3% from approximately RMB67.99

million as at 31 December 2003 to approximately RMB140.28 million as at 31 December 2004. The

reason for the increase in the inventory level is mainly due to the increase in the level of raw materials

and work in progress as a result of a 60,000 tonnes special seamless oil well pipes production line

commenced operation in 2004 and the increase of raw materials prices.


— 157 —

Rules 8.21A(1)(a)(b)

App1A 36

The Group’s inventories increased by approximately 52.4% from approximately RMB140.28


increase in the inventory level is due to increase in the level of sales activities where the inventory

turnover days remained stable between 105 days in 2004 and 101 days in 2005.

As at 30 April 2006, the Group’s inventories decreased by approximately 14.5% from

approximately RMB213.85 million as at 31 December 2005 to approximately RMB182.79 million. The

decrease in the inventory level is due to seasonal factor where a larger amount of finished goods were

sold as at 30 April 2006.

As at 31 December 2003, 2004 and 2005 and 30 April 2006, the Group made provision for

slowing moving and obsolete inventory of approximately RMB0.89 million, RMB0.74 million,

RMB5.24 million and RMB7.07 million respectively. The Directors consider that the current provision

for inventories debts is adequate and no further provision is considered necessary.

Subsequent to 30 April 2006, approximately 94.48% of the inventory balance which amounted

to RMB182.79 million as at 30 April 2006 have been utilised or sold as at 31 July 2006.

TRADE AND NOTES RECEIVABLE

Trade receivables increased by approximately 62.45% from approximately RMB55.32 million as

at 31 December 2003 to approximately RMB89.87 million as at 31 December 2004 primarily as a

result that the significant increase in sales was driven by growth in demand for oil well pipes, oil well

sucker rods, oil well pumps, casing, oil well pumping machines and other petroleum drilling and

extraction machinery accessories and the contribution from new production line during the year ended

31 December 2004. Sales volume also increased as a result of more sales derived from oil well pipes

and the Group’s products were successfully launched into new overseas markets.

Trade receivables decreased slightly by approximately 15.7% from approximately RMB89.87

million as at 31 December 2004 to approximately RMB75.74 million as at 31 December 2005

primarily as a result of the adoption of a more stringent credit policy where credit periods were

shortened by 15 days to 30 days depending on customers due to heavy demand of the Group’s product.

In addition, the sales of the Group’s products to overseas customers continued to increase and

the most of the overseas customers are settled by letter of credits.

The Group’s trade receivables increased by approximately 93.9% from approximately RMB75.74

million as at 30 April 2005 to approximately RMB146.86 million as at 30 April 2006. Such increase

was mainly due to the increase in credit sales to domestic customers during the four months ended 30

April 2006.

The trade receivables balance amounted to RMB146.86 million and the notes receivable balance

amounted to RMB41.94 million as at 30 April 2006. Approximately 90.92% of the trade receivables

balance and 81.15% of the notes receivable balance were then settled as at 31 July 2006.


— 158 —

As at 31 December 2003, 2004 and 2005 and 30 April 2006, the Group made provisions for bad

or doubtful debts of approximately RMB4.05 million, RMB6.22 million, RMB9.71 million and

RMB6.75 million respectively.

The Directors consider that the current provision for bad or doubtful debts is adequate and no

further provision is considered necessary.

PREPAYMENT

Prepayment in 2004 decreased by approximately 72.2% from RMB48.425 million as at 31

December 2003 to RMB13.421 million as 31 December 2004. Such decline in prepayment was due to

the prepayment for the ordering of production equipment and additional raw materials. Between 2004

and 2005, the prepayment level of the Group maintained at a very stable level. the Group’s prepayment

amount increased by approximately 314% from RMB13.578 million as at 31 December 2005 to

RMB56.278 million as at 30 April 2006. This is mainly due to the increase in bulk purchase of raw

materials which need to be paid approximately 50%-70% deposit.

TRADE AND BILLS PAYABLES

Trade and bills payables increased by approximately 40.5% from approximately RMB120.32


increase was primarily as a result of increase in sales which leads to a higher level of purchases during

2004. Trade and bills payables further increased to approximately RMB421.19 million as at 31

December 2005 as outstanding payables for new production line for casing were made in 2005. The

payable amount was approximately RMB65 million for this production line as at 31 December 2005.

As at 30 April 2006, the Group’s trade and bills payables increased by approximately 14.5% to

approximately RMB482.38 million. This is mainly due to a further outstanding payables for new

production line for casing were made in 2006 which amounted to approximately RMB133 million. Up

to 31 July 2006, approximately 40.6% of the trade and bills payable has been settled.

PLEDGED DEPOSITS

The Group’s pledged deposits increased by approximately 81.7% from approximately RMB34.07

million as at 31 December 2003 to approximately RMB61.89 million as at 31 December 2004. This

was mainly due to the increase of the Group’s turnover. In turn, the Group had to purchase more raw

materials by paying by way of bank acceptance to suppliers. As at 31 December 2005, the Group’s

pledged deposits increased by approximately 138.5% to approximately RMB147.63 million as

compared with approximately RMB61.89 million as at 31 December 2004. Such increase was mainly

attributed to (i) the increase in order amount of raw materials for its operations as a result of paying

more bank acceptance to raw material suppliers and (ii) the payment by way of bank acceptance for

the equipment suppliers of the newly installed casing production line. As at 30 April 2006, the Group’s

pledged deposits increased by approximately 18.6% which was the increase of payment by way of

bank acceptance to raw material suppliers and equipment suppliers for the newly installed casing

production line. The Directors consider that the Group has pledged its time deposits in exchange for

payment by way of bank acceptance which is in line with the PRC banking industry practice.


— 159 —

FINANCIAL RATIOS

Year ended 31 December

Four monthsended

30 April

2003 2004 2005 2006

Gross profit margin (%) (Note 1) 24.9 19.8 23.2 23.9

Net profit margin (%) (Note 2) 14.5 12.6 11.0 11.5

Debtor turnover (days) (Note 3) 63 56 42 55

Creditor turnover (days) (Note 4) 167 155 169 296

Inventory turnover (days) (Note 5) 82 105 101 72

Gearing ratio (%) (Note 6) 37.6 11.0 12.8 16.1

Return on equity (%) (Note 7) 38.5 25.0 20.8 7.9

Notes:

1. Gross profit ratio is calculated based on gross profit divided by total sales for the year/period. The numbers in the

table above reflect this ratio and these numbers are expressed as a percentage.

2. Net profit ratio is calculated based on net profit attributable to equity holders of the parent divided by total sales

for the year/period. The numbers in the table above reflect this ratio and these numbers are expressed as a

percentage.

3. Debtor turnover day is calculated by dividing the average year end balances of trade and bills receivables by sales,

multiplied by 365.

4. Creditor turnover day is calculated by dividing the average year end balances of trade and bills payables by

purchase, multiplied by 365.

5. Inventory turnover day is calculated by dividing the year end balances of inventories by cost of sales, multiplied

by 365.

6. Gearing ratio is calculated based on the total debt divided by the total assets at the end of the year. Debts are

defined to include payables incurred not in the ordinary course of business.

7. Return on equity is calculated by dividing net profit attributable to equity holders of the parent by capital and

reserves and shareholders’ equity. The numbers in the table above reflect this ratio and these numbers are

expressed as a percentage.

The Group’s gross profit margin decreased from approximately 24.9% for the year ended 31

December 2003 to approximately 19.8% for the year ended at 31 December 2004. The main reason for

the slight decrease in gross profit margin for the year ended 31 December 2004 was the change of the

products mix of the Group. Owing to the higher demand for oil well pipes, the rapid market

development as well as enhancement of production capacity, turnover of oil well pipes increased

rapidly from approximately RMB134.5 million in 2003 to approximately RMB261.47 million in 2004,

the total turnover ratio of oil wellpipes increased from approximately 44.5% in 2003 to approximately

53.6% in 2004. In addition, when compared with other products’ gross profit margins, oil well pipes


— 160 —

was approximately 15.2% which is relatively lower than other products of the Group. For the year

ended 31 December 2005, the Group’s gross profit margin increased to approximately 23.2%. The

main reason for the increase in the gross profit margin was due to higher gross profit margin of oil

well pipes which increased from approximately 15.2% for the year ended 31 December 2004 to

approximately 23.2% for the year ended 31 December 2005. For the four months ended 30 April 2006,

the Group’s gross profit margin slightly improved to approximately 23.9%, comparing with 23.2% for

the year ended 31 December 2005.

The decrease in the net profit margin for the year ended 2003 of 14.5% to 12.6% for the year

ended 2004 is due mainly to the drop in gross profit margin. The decrease in the net profit margin for

the year ended 31 December 2005 of 11.0% is due mainly to lower tax exemption in 2005 as a

percentage to 2005 sales of approximately 1.3% as compare with the 2004 tax exemption as a

percentage to 2004 sales of approximately 3.9%.

The decrease in debtor turnover days from approximately 63 as at 31 December 2003 to

approximately 56 as at 31 December 2004 and to approximately 42 as at 31 December 2005 was

primarily attributable to the Group’s efforts to increase debt collection, the adoption of more stringent

credit control policies and stronger demand for the Group’s products resulting in better credit terms

from customers. The improvement in the years 2004 and 2005 was also attributable to export sales

representing a higher percentage of the total sales, with such sales generally paid on an up-front basis

by way of letter of credit. The Group’s debtor turnover days increased from approximately 42 as at

31 December 2005 to approximately 55 as at 30 April 2006. Such increase in debtor turnover days was

caused mainly by a distortion to the debtors turnover days due to substantially higher sales recorded

in March 2006 and April 2006 as compared with November 2005 and December 2005.

The decrease in creditor turnover days from approximately 167 as at 31 December 2003 to

approximately 155 as at 31 December 2004 was mainly attributed to more payables relating to more

raw material requirements for the production line being settled during 2004. As at 31 December 2004,

the Group’s creditor turnover days increased from 155 to approximately 169 as at 31 December 2005

mainly attributable to the settlement of substantial payables relating to its production line for casing

during the year of 2005 that had been outstanding as at 31 December 2005. The Group’s creditor

turnover days increased from 196 as at 31 December 2005 to 296 as at 30 April 2006. This is mainly

due to the increased amount of bank acceptance to be made to the Group’s suppliers and the settlement

of substantial payables relating to its newly installed production line for casing.

The increase in the inventory turnover days from approximately 82 as at 31 December 2003 to

approximately 105 as at 31 December 2004 was mainly due to the increase of raw materials and work

in progress as a result of a new production plant for oil well pipes with a capacity of 60,000 tonnes

commencing operation in 2004. As at 31 December 2005, the Group inventory turnover days

maintained at approximately 101. However, the Group’s inventory turnover days decreased from

approximately 101 as at 31 December 2005 to approximately 72 as at 30 April 2006. Such decline in

inventory turnover days was mainly attributed to the fact that the Group implemented a new raw

material policy to hold the raw materials only when the Group received purchase orders from

customers since January 2006.


— 161 —

The Group’s gearing ratio decreased from approximately 37.6% as at 31 December 2003 to

approximately 11.0% as at 31 December 2004 and then increased to approximately 12.8% as at 31

December 2005. The decrease in gearing ratio in 2004 from 2003 was mainly attributable to the

repayment of bank and other loans. The increase in gearing ratio in 2005 was mainly attributable to

the increase of bank loans and a higher amount due to subsidiaries which mainly utilised for

construction payments of the Group’s new production for casing. The Group’s gearing increased from

approximately 12.8% as at 31 December 2005 to approximately 16.1% as at 30 April 2006. Such

increase was mainly attributed to more bank borrowings for the construction of the new production

line for casing.

The Group’s return on equity decreased from approximately 38.5% for the year ended 31

December 2003 to approximately 25% for the year ended 31 December 2004 and approximately 20.8%

for the year ended 31 December 2005. The decrease in the return on equity was primarily attributable

to the dilution effect from the issue of H Shares between 2004 and 2005.

INDEBTEDNESS

Borrowings

As at the close of business on 31 July 2006, being the latest practicable date for the indebtedness

statement prior to the printing of this document, the used and unused banking facilities of the Group

are RMB158 million and RMB367 million respectively.

Material Changes

The Directors have confirmed that there have been no material changes in the indebtedness of

the Group since 31 July 2006.

Commitments

As at 30 April 2006, the Group’s operating lease commitment was approximately RMB3,138,000.

On the same date, the Group had capital expenditure commitments of approximately RMB70,443,000.

Except as described above, the Group did not have any outstanding loan capital, mortgages,

charges, bank overdrafts, finance leases or hire purchase commitments, guarantee indemnities or

others material contingent liabilities at the close of business on 30 April 2006.


— 162 —

NET TANGIBLE ASSETS

The following statement shows the Group’s net tangible assets as at 30 April 2006 which has

been prepared based on the audited consolidated net assets of the Group as at 30 April 2006, shown

in the Accountants’ Report set out in Appendix I to this document.

RMB’ 000

Audited net tangible assets of the Group as at 30 April 2006 (Note 1) 450,727

Audited net tangible asset value per Share (Note 2) RMB 0.696

Notes:

1. The audited net tangible assets of the Group as at 30 April 2006 is arrived at based on the audited consolidated net assets

of the Group from the Accountants’ Report set out in the section headed “Accountants’ Report” in Appendix I to this

document.

2. The net tangible asset value per Share has been arrived at based on the 647,998,000 Shares in issue as at the date of this

document as if such Shares were outstanding throughout the financial period ended 30 April 2006.

MARKET RISKS

Interest rate risk

The Group’s cash and cash equivalents are mainly deposited with licensed banks in the PRC. The

carrying amount of trade receivables and cash included in the consolidated financial statements

represent our maximum exposure to credit risk in relation to its financial assets. The Group has no

significant exposure to interest rate risk.

Foreign currency risk

The Group exposed to the foreign currency exchange rate risk which relates primarily to certain

trade receivable and certain cash and cash equivalents in currencies other than the functional currency

of RMB.

Credit risk

The Group trades mainly with recognised and creditworthy third parties. The Group’s policy is

to provide its customers who wish to trade on credit terms are subject to credit verification procedures.

In addition, receivable balances are monitored on an ongoing basis and the Group’s exposure to bad

debts is not significant.


— 163 —

With respect to credit risk arising from the other financial assets of the Group, comprising of

cash and cash equivalents, available-for-sale financial assets and other receivables, the Group’s

exposure to credit risk arises from default of the other party, with a maximum exposure equal to the

carrying amount of these instruments. There are no significant concentrations of credit risk within the

Group in relation to the other financial assets.

Since the Group trades mainly with recognised and creditworthy third parties, there is no

requirement for collateral.

DISCLOSURE REQUIRED UNDER THE LISTING RULES

The Directors confirm that there are no circumstances that would give rise to a disclosure

requirement under Rules 13.13 to 13.19 of the Listing Rules.

DIVIDENDS

For the two years ended 31 December 2005, the Company declared dividends of approximately

RMB18,906,000 and RMB23,998,000, respectively. The payment of these dividends were financed by

internal resources of the Company. There is no assurance that future dividends will be paid in similar

amount or at similar dividend yield. The above payment of dividends cannot be construed as a

reference or bases for the determination of future dividends.

Holders of H Shares are entitled to the dividends and other distributions declared by the

Directors on a per share basis in respect of their respective shareholdings. The Directors may declare

the payment of dividend on H Shares (if any) in Renminbi each year. However, the dividends will be

paid in Hong Kong dollars only.

Payment of dividends will be determined by the Directors at their discretion. The actual amount

of dividends to holders of H Shares will depend on the following factors:

● the overall operation results;

● the financial results of the Company;

● capital requirement;

● interests of the shareholders of the Company;

● credit rating of the Company; and

● other relevant factors as determined by the Directors.


— 164 —

The Company may only pay dividends after the following allocations:

● outstanding loss (if any);

● statutory surplus reserve; and

● discretionary common reserve (subject to Shareholders’ approval).

The respective allocation to statutory reserve fund and statutory welfare fund shall be 10% and

5%~10% of the net profit of the Company determined in accordance with the PRC accounting

standards. Pursuant to PRC laws and the Articles, the distributable profits of the Company shall be the

net profit determined in accordance with the PRC accounting standards or the HKFRS, whichever is

less after the allocations to statutory surplus reserve, statutory welfare fund and discretionary common

reserve.

In accordance with the Articles, the cash dividends for H Shares shall be declared in Renminbi

but shall be paid in Hong Kong dollars. The conversion of Renminbi into Hong Kong dollars shall

comply with the regulations of the PRC on foreign currency control. Renminbi shall be converted into

Hong Kong dollars at the average conversion rate quoted by the People’s Bank of China during the

week immediately before the date on which the payment of dividend was declared. If the Company

has no sufficient foreign currency for payment of dividends in Hong Kong dollars, it will obtain the

necessary Hong Kong dollars by converting Renminbi through authorised banks and other financial

institutions.

DISTRIBUTABLE RESERVES

The Company and its subsidiary registered in the PRC are required to follow the laws and

regulations of the PRC and their articles of association to provide for certain statutory funds, namely

the statutory reserve fund and the statutory welfare fund, which are appropriated from net profit after

tax, but before dividends distribution at the discretion of their board of directors on at least 10% and

5% of net profit, respectively. The statutory reserve fund is provided for each entity until the balance

of such fund has reached 50% of the entity’s registered capital. The statutory reserve fund may only

be used, upon approval by the relevant authority, to offset accumulated losses or to increase capital.

The statutory welfare fund is only permitted to be used for special bonuses or for the collective

welfare of the employees. Assets acquired through this fund are not treated as assets of the Group.

According to the revised Company Law, the statutory reserve fund shall be provided at 10% of the

profit after tax of the current year. The discretionary common reserve may be drawn subject to the

approval of Shareholders on general meetings, while the 5% requirement of the statutory welfare fund

has been cancelled. Upon the listing of the Company’s H Shares on the Main Board of the Stock

Exchange, the Company may not distribute dividends exceeding the lower of the Group’s distributable

reserves as determined under PRC GAAP and those under HKFRSs. In accordance with the Company

Law of the PRC, profit after tax can be distributed as dividends after appropriation to the statutory

common reserve and statutory common welfare reserve. As at 30 April 2006, the Company has

RMB164,289,000 available for distribution to the Shareholders of the Company.


— 165 —

NO MATERIAL ADVERSE CHANGE

The Directors have confirmed that there has been no material adverse change in the financial or

trading position since 30 April 2006, being the date of the latest audited consolidated financial results

as set out in Appendix I “Accountants’ Report” to this document.


— 166 —

App1A (38)

The following is the text of a report, prepared for the purpose of incorporation in this prospectus,

received from the Company’s reporting accountants, Ernst & Young, Certified Public Accountants,

Hong Kong. As described in the section headed “Documents Available for Inspection” in Appendix

VII, a copy of the accountants’ report is available for inspection.

18th Floor

Two International Finance Centre

8 Finance Street, Central

Hong Kong

19 October 2006

The Board of Directors


Guotai Junan Capital Limited

Dear Sirs,

We set out below our report on the financial information regarding Shandong Molong Petroleum

Machinery Company Limited (the “Company”) and its subsidiaries (hereinafter collectively referred

to as the “Group”), and associate for each of the three years ended 31 December 2005 and the

four-month period ended 30 April 2006 (the “Relevant Periods”) and the four-month period ended 30

April 2005 (the “30 April 2005 Financial Information”), prepared on the basis of presentation set forth

in Section 2 below, for inclusion in the Introduction Document of the Company dated 19 October 2006

(the “Introduction Document”) in connection with the proposed listing of the entire issued H Shares

of the Company on the Main Board (the “Main Board”) of the Stock Exchange of Hong Kong Limited

(the “Stock Exchange”) by way of introduction.

The predecessor of the Company, known as Shandong Shouguang Petroleum Machinery Factory

( ) (the “Predecessor”), was established as a collectively owned enterprise in

the People’s Republic of China (the “PRC”) on 13 March 1987. As set out in the section headed

“Statutory and general information” in Appendix VI to the Introduction Document, the Predecessor

was transformed into the Company on 30 December 2001 and became a joint stock limited company.

The background information of the Company was set out in more details in Section 1 of this report.

The Group is principally engaged in the design, manufacture and sale of petroleum drilling and

extraction machinery and related accessories, which include oil well pipes, casing, oil well sucker

rods, oil well pumps and oil well pumping machines.

The Company, its subsidiaries, and associate have adopted 31 December as their financial year

end date. The management accounts of these companies were prepared in accordance with the relevant

accounting principles and financial regulations applicable to these companies. Particulars of the

Company and its principal subsidiaries, and associate are set out in Section 5 below.

The consolidated income statements, consolidated statements of changes in equity and

consolidated cash flow statements of the Group for the Relevant Periods and the four-month period

APPENDIX I ACCOUNTANTS’ REPORT

— I-1 —

3rd Sch(31)3rd Sch(43)3rd Sch(41)A1A(9)(3)

Rules 4.08(5)

ended 30 April 2005 and the consolidated balance sheets of the Group and the balance sheets of the

Company as at 31 December 2003, 2004, and 2005 and 30 April 2006, together with the notes thereto

set out in this report (collectively the “Financial Information”), have been prepared based on the

audited consolidated financial statements of the Group for the three years ended 31 December 2005

and the unaudited management accounts of the Group for the four-month periods ended 30 April 2005

and 30 April 2006 prepared in accordance with the PRC Enterprise Accounting Standards and PRC

Enterprise Accounting System (“PRC GAAP”), after making such adjustments as are appropriate to

comply with Hong Kong Financial Reporting Standards (“HKFRS”) as promulgated by the Hong Kong

Institute of Certified Public Accountants (the “HKICPA”).

The directors of the Company (the “Directors”) are responsible for the preparation of the

financial information which gives a true and fair view. The Directors of the respective companies of

the Group, and its associate are responsible for the preparation of the respective financial statements

and, where appropriate, management accounts which give a true and fair view. In preparing the

Financial Information, the financial statements and the management accounts which give a true and

fair view, it is fundamental that appropriate accounting policies are selected and applied consistently,

that judgements and estimates are made which are prudent and reasonable, and that the reasons for any

significant departure from applicable standards are stated. It is our responsibility to form an

independent opinion and a review conclusion on such information in respect of the Relevant Periods

and for the four-month period ended 30 April 2005, respectively, and to report our opinion and review

conclusion to you.

Procedures Performed in Respect of the Relevant Periods

For the purpose of this report, we have carried out an independent audit on the financial

information for the Relevant Periods in accordance with the Hong Kong Standards on Auditing issued

by the HKICPA, and have carried out such additional procedures as are necessary in accordance with

the Auditing Guideline “Prospectuses and the Reporting Accountant” issued by the HKICPA.

Procedures Performed in Respect of the 30 April 2005 Financial Information

For the purpose of this report, we have also performed a review of the 30 April 2005 Financial

Information in accordance with SAS 700 “Engagements to review interim financial reports” issued by

the HKICPA. A review consists principally of making enquiries of management and applying

analytical procedures to the financial information and, based thereon, assessing whether the

accounting policies and presentation have been consistently applied unless otherwise disclosed. A

review excludes audit procedures such as tests of controls and verification of assets and liabilities and

transactions. It is substantially less in scope than an audit and therefore provides a lower level of

assurance than an audit. Accordingly, we do not express an audit opinion on the 30 April 2005

Financial Information.

Opinion in Respect of the Relevant Periods

In our opinion, the Financial Information prepared on the basis of presentation set out in Section

2 below gives, for the purpose of this report, a true and fair view of the consolidated results and

consolidated cash flows of the Group for the Relevant Periods and of the state of affairs of the

Company and of the Group as at 31 December 2003, 2004 and 2005 and 30 April 2006.


— I-2 —

Rules 4.08(1)(a)(1)(b)(2)(3)

Review Conclusion in Respect of the 30 April 2005 Financial Information

On the basis of our review, for the purpose of this report, we are not aware of any material

modification that should be made to the consolidated results and consolidated cash flows of the Group

as set out in the 30 April 2005 Financial Information.

1. CORPORATE INFORMATION

The Company is a joint stock limited company incorporated on 30 December 2001 in the PRC.

The registered office of the Company is located at No. 99, Beihai Road, Shouguang City, Shandong

Province, the PRC. Particulars of the principal companies comprising the Group, and its associate are

set out in Section 5 below.

On 30 December 2001, the Predecessor was transformed into the Company and became a joint

stock limited company. At the time of its establishment, the Company’s registered capital was

RMB40,500,000 divided into 40,500,000 domestic shares of RMB1 each. On 29 December 2003, the

China Securities Regulatory Commission (the “CSRC”) issued an approval document, Zheng Jian Guo

He Zi [2003] No. 50 ( [2003]50 ) approving the subdivision of each of the Company’s

shares of RMB1 each into 10 shares of RMB0.10 each. Particulars of the changes in the Company’s

registered capital are set out in Section 8 (a) below.

2. BASIS OF PRESENTATION

The Financial Information has been prepared in accordance with HKFRS (which also include

Hong Kong Accounting Standards (“HKAS”) and Interpretations) issued by the HKICPA and

accounting principles generally accepted in Hong Kong.

The HKICPA has issued the following new and revised HKFRS, which are generally effective for

accounting periods beginning on or after 1 January 2005. The Financial Information has been prepared

in accordance with these new and revised HKFRS throughout the Relevant Periods and the four-month

period ended 30 April 2005.

HKAS 1 Presentation of Financial Statements

HKAS 2 Inventories

HKAS 7 Cash Flow Statements

HKAS 8 Accounting Policies, Changes in Accounting Estimates and Errors

HKAS 10 Events after the Balance Sheet Date

HKAS 12 Income Taxes

HKAS 14 Segment Reporting

HKAS 16 Property, Plant and Equipment

HKAS 17 Leases

HKAS 18 Revenue

HKAS 19 Employee Benefits

HKAS 20 Accounting for Government Grants and Disclosure of Government

Assistance


— I-3 —

Rules 4.04(11)

Rules 4.11(a)4.1319.1219.3919A.10

HKAS 21 The Effects of Changes in Foreign Exchange Rates

HKAS 21 Amendment The Effects of Changes in Foreign Exchange Rates — Net

Investment in a Foreign Operation

HKAS 23 Borrowing Costs

HKAS 24 Related Party Disclosures

HKAS 27 Consolidated and Separate Financial Statements

HKAS 32 Financial Instruments: Disclosure and Presentation

HKAS 33 Earnings per Share

HKAS 36 Impairment of Assets

HKAS 37 Provisions, Contingent Liabilities and Contingent Assets

HKAS 38 Intangible Assets

HKAS 39 Financial Instruments: Recognition and Measurement

HKAS 39 Amendment Transition and Initial Recognition of Financial Assets and

Financial Liabilities

HKAS 39 Amendment Cash Flow Hedge Accounting of Forecast Intragroup Transactions

HKAS 39 Amendment The Fair Value Option

HKAS 39 & HKFRS 4

Amendments

Financial Guarantee Contracts

HKAS 40 Investment Property

HKFRS-Int 4 Determining whether an Arrangement contains a Lease

The Financial Information has been prepared under the historical cost convention, except for the

remeasurement of certain equity investments, which have been measured at fair value, the accounting

policies of which are disclosed below.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The principal accounting policies adopted by the Group in arriving at the Financial Information

set out in this report, which conform to HKFRS, are set out below:

Basis of consolidation

The Financial Information includes the financial statements of the Company and its

subsidiaries for the Relevant Periods, and the four-month period ended 30 April 2005.

The results of subsidiaries are consolidated from the date of acquisition, being the date on

which the Group obtains control, and continue to be consolidated until the date that such control

ceases.

All significant intercompany transactions and balances within the Group are eliminated on

consolidation.

Minority interests represent the interests of outside shareholders in the results and net

assets of the Company’s subsidiaries.


— I-4 —

Rules 4.04(11)Rules App16(2.2)

Subsidiaries

A subsidiary is an entity whose financial and operating policies the Company controls,

directly or indirectly, so as to obtain benefits from its activities.

The results of subsidiaries are included in the Company’s income statement to the extent

of dividends received and receivable. The Company’s interests in subsidiaries are stated at cost

less any impairment losses.

Associate

An associate is an entity, not being a subsidiary or a jointly-controlled entity, in which the

Group has a long term interest of generally not less than 20% of the equity voting rights and over

which it is in a position to exercise significant influence.

The Group’s share of the post-acquisition results and reserves of its associate is included

in the consolidated income statement and consolidated reserves, respectively. The Group’s

interest in the associate is stated in the consolidated balance sheet at the Group’s share of net

assets under the equity method of accounting, less any impairment losses. Adjustments are made

to bring into line any similar accounting policies that may exist.

The results of the Company’s associate are included in the Company’s income statement to

the extent of dividends received and receivable. The Company’s interest in the associate is

treated as a non-current asset and is stated at cost less any impairment losses.

Impairment of assets

Where an indication of impairment exists, or when annual impairment testing for an asset

is required (other than inventories, deferred tax assets, and financial assets), the asset’s

recoverable amount is estimated. An asset’s recoverable amount is calculated as the higher of the

asset’s or cash-generating unit’s value in use and its fair value less costs to sell, and is

determined for an individual asset, unless the asset does not generate cash inflows that are

largely independent of those from other assets or groups of assets, in which case, the recoverable

amount is determined for the cash-generating unit to which the asset belongs.

An impairment loss is recognised only if the carrying amount of an asset exceeds its

recoverable amount. In assessing value in use, the estimated future cash flows are discounted to

their present values using a pre-tax discount rate that reflects current market assessments of the

time value of money and the risks specific to the asset. An impairment loss is charged to the

income statement in the period in which it arises.

An assessment is made at each reporting date as to whether there is any indication that

previously recognised impairment losses may no longer exist or may have decreased. If such

indication exists, the recoverable amount is estimated. A previously recognised impairment loss

of an asset other than goodwill is reversed only if there has been a change in the estimates used


— I-5 —

Rules 4.04(11)

to determine the recoverable amount of that asset, however not to an amount higher than the

carrying amount that would have been determined (net of any depreciation/amortisation), had no

impairment loss been recognised for the asset in prior years. A reversal of such impairment loss

is credited to the income statement in the period in which it arises.

Related parties

A party is considered to be related to the Group if:

(a) the party, directly or indirectly through one or more intermediaries, (i) controls, is

controlled by, or is under common control with, the Group; (ii) has an interest in the

Group that gives it significant influence over the Group; or (iii) has joint control over

the Group;

(b) the party is an associate;

(c) the party is a jointly-controlled entity;

(d) the party is a member of the key management personnel of the Group or its parent;

(e) the party is a close member of the family of any individual referred to in (a) or (d);

or

(f) the party is an entity that is controlled, jointly controlled or significantly influenced

by or for which significant voting power in such entity resides with, directly or

indirectly, any individual referred to in (d) or (e).

Property, plant and equipment and depreciation

Property, plant and equipment, other than construction in progress, are stated at cost less

accumulated depreciation and any impairment losses. The cost of an item of property, plant and

equipment comprises its purchase price and any directly attributable costs of bringing the asset

to its working condition and location for its intended use. Expenditure incurred after items of

property, plant and equipment have been put into operation, such as repairs and maintenance, is

normally charged to the income statement in the period in which it is incurred. In situations

where it can be clearly demonstrated that the expenditure has resulted in an increase in the future

economic benefits expected to be obtained from the use of an item of property, plant and

equipment and the cost of the item can be measured reliably, the expenditure is capitalised as an

additional cost of that asset or as a replacement.


— I-6 —

Rules 4.04(11)

Depreciation is calculated on the straight-line basis to write off the cost of each item of

property, plant and equipment to its residual value over its estimated useful life. The estimated

useful lives of the items are as follows:

Buildings 20 years

Plant and machinery 2-10 years

Electronic equipment 5 years

Motor vehicles 5 years

Other equipment 5 years

Where parts of an item of property, plant and equipment have different useful lives, the cost

of that item is allocated on a reasonable basis among the parts and each part is depreciated

separately.

Residual values, useful lives and the depreciation method are reviewed, and adjusted if

appropriate, at each balance sheet date.

An item of property, plant and equipment is derecognised upon disposal or when no future

economic benefits are expected from its use or disposal. Any gain or loss on disposal of property,

plant and equipment recognised in the income statement in the year the asset is derecognised is

the difference between the net sales proceeds and the carrying amount of the relevant asset.

Construction in progress represents the assets incurred under construction, which is stated

at cost less any impairment losses, and is not depreciated. Cost comprises the direct costs of

construction incurred during the period of construction, installation and testing. Construction in

progress is reclassified to the appropriate category of property, plant and equipment or

investment properties when completed and ready for use.

Investment properties

Investment properties are interests in land and buildings held to earn rental income, rather

than for use in the production or supply of goods or services, or for administrative purposes; or

for sale in the ordinary course of business. Such properties are measured initially at cost,

including transaction costs. Subsequent to initial recognition, investment properties are stated at

cost less accumulated depreciation and any impairment losses.

Any gains or losses on the retirement or disposal of an investment property are recognised

in the income statement in the year of the retirement or disposal.

Intangible assets (other than goodwill)

Intangible assets with finite lives are amortised over the useful economic life and assessed

for impairment whenever there is an indication that the intangible asset may be impaired. The

amortisation period and the amortisation method for an intangible asset with a finite useful life

are reviewed at least at each balance sheet date.


— I-7 —

Rules 4.04(11)

Know-how

Purchased know-how is stated at cost less any impairment losses and is amortised on the

straight-line basis over its estimated useful life of five years.

Research and development costs

All research costs are charged to the income statement as incurred.

Operating leases

Leases where substantially all the rewards and risks of ownership of assets remain with the

lessor are accounted for as operating leases. Where the Group is the lessor, assets leased by the

Group under operating leases are included in non-current assets, and rentals receivable under the

operating leases are credited to the income statement on the straight-line basis over the lease

terms. Where the Group is the lessee, rentals payable under the operating leases are charged to

the income statement on the straight-line basis over the lease terms.

Prepaid land lease payments under operating leases are initially stated at cost and

subsequently recognised on the straight-line basis over the lease terms.

Investments and other financial assets

Financial assets in the scope of HKAS 39 are classified as financial assets at fair value

through profit or loss, loans and receivables and available-for-sale financial assets, as

appropriate. When financial assets are recognised initially, they are measured at fair value, plus,

in the case of investments not at fair value through profit or loss, directly attributable transaction

costs. The Group determines the classification of its financial assets after initial recognition and,

where allowed and appropriate, re-evaluates this designation at the balance sheet date.

All regular way purchases and sales of financial assets are recognised on the trade date, i.e.,

the date that the Group commits to purchase the asset. Regular way purchases or sales are

purchases or sales of financial assets that require delivery of assets within the period generally

established by regulation or convention in the marketplace.

Financial assets at fair value through profit or loss

Financial assets classified as held for trading are included in the category “financial assets

at fair value through profit or loss”. Financial assets are classified as held for trading if they are

acquired for the purpose of sale in the near term. Gains or losses on investments held for trading

are recognised in the income statement.


— I-8 —

Rules 4.04(11)

Loans and receivables

Loans and receivables are non-derivative financial assets with fixed or determinable

payments that are not quoted in an active market. Such assets are carried at amortised cost using

the effective interest method. Gains and losses are recognised in the income statement when the

loans and receivables are derecognised or impaired, as well as through the amortisation process.

Available-for-sale financial assets

Available-for-sale financial assets are those non-derivative financial assets in listed and

unlisted equity securities that are designated as available for sale or are not classified in any of

the other two categories. After initial recognition, available for sale financial assets are measured

at fair value with gains or losses being recognised as a separate component of equity until the

investment is derecognised or until the investment is determined to be impaired, at which time

the cumulative gain or loss previously reported in equity is included in the income statement.

When the fair value of unlisted equity securities cannot be reliably measured because (a)

the variability in the range of reasonable fair value estimates is significant for that investment

or (b) the probabilities of the various estimates within the range cannot be reasonably assessed

and used in estimating the fair value, such securities are stated at cost less any impairment losses.

Fair value

The fair value of investments that are actively traded in organised financial markets is

determined by reference to quoted market bid prices at the close of business at the balance sheet

date. For investments where there is no active market, fair values are determined by using

valuation techniques. Such techniques include using recent arm’s length market transactions;

reference to the current market value of another instrument, which is substantially the same; a

discounted cash flow analysis, and option pricing models.

Impairment of financial assets

The Group assesses at each balance sheet date whether there is any objective evidence that

a financial asset or group of financial assets is impaired.

Assets carried at amortised cost

If there is objective evidence that an impairment loss on receivables carried at amortised

cost has been incurred, the amount of the loss is measured as the difference between the asset’s

carrying amount and the present value of estimated future cash flows (excluding future credit

losses that have not been incurred) discounted at the financial asset’s original effective interest

rate (i.e., the effective interest rate computed at initial recognition). The carrying amount of the

asset is reduced either directly or through the use of an allowance account. The amount of the

impairment loss is recognised in profit or loss.


— I-9 —

Rules 4.04(11)

The Group first assesses whether objective evidence of impairment exists individually for

financial assets that are individually significant, and individually or collectively for financial

assets that are not individually significant. If it is determined that no objective evidence of

impairment exists for an individually assessed financial asset, whether significant or not, the

asset is included in a group of financial assets with similar credit risk characteristics and that

group is collectively assessed for impairment. Assets that are individually assessed for

impairment and for which an impairment loss is or continues to be recognised are not included

in a collective assessment of impairment.

If, in a subsequent period, the amount of the impairment loss decreases and the decrease can

be related objectively to an event occurring after the impairment was recognised, the previously

recognised impairment loss is reversed. Any subsequent reversal of an impairment loss is

recognised in the income statement, to the extent that the carrying value of the asset does not

exceed its amortised cost at the reversal date.

Assets carried at cost

If there is objective evidence that an impairment loss on an unquoted equity instrument that

is not carried at fair value because its fair value cannot be reliably measured has been incurred,

the amount of the loss is measured as the difference between the asset’s carrying amount and the

present value of estimated future cash flows discounted at the current market rate of return for

a similar financial asset. Impairment losses on these assets are not reversed.

Available-for-sale financial assets

If an available-for-sale asset is impaired, an amount comprising the difference between its

cost (net of any principal payment and amortisation) and its current fair value, less any

impairment loss previously recognised in profit or loss, is transferred from equity to the income

statement. Impairment losses on equity instruments classified as available for sale are not

reversed through profit or loss.

Derecognition of financial assets

A financial asset (or, where applicable, a part of a financial asset or part of a group of

similar financial assets) is derecognised where:

— the rights to receive cash flows from the asset have expired;

— the Group retains the rights to receive cash flows from the asset, but has assumed an

obligation to pay in full without material delay to a third party under a “pass-through”

arrangement; or

— the Group has transferred its rights to receive cash flows from the asset and either (a)

has transferred substantially all the risks and rewards of the asset, or (b) has neither

transferred nor retained substantially all the risks and rewards of the asset, but has

transferred control of the asset.


— I-10 —

Rules 4.04(11)

Where the Group has transferred its rights to receive cash flows from an asset and has

neither transferred nor retained substantially all the risks and rewards of the asset nor transferred

control of the asset, the asset is recognised to the extent of the Group’s continuing involvement

in the asset. Continuing involvement that takes the form of a guarantee over the transferred asset

is measured at the lower of the original carrying amount of the asset and the maximum amount

of consideration that the Group could be required to repay.

Where continuing involvement takes the form of a written and/or purchased option

(including a cash-settled option or similar provision) on the transferred asset, the extent of the

Group’s continuing involvement is the amount of the transferred asset that the Group may

repurchase, except that in the case of a written put option (including a cash-settled option or

similar provision) on an asset measured at fair value, the extent of the Group’s continuing

involvement is limited to the lower of the fair value of the transferred asset and the option

exercise price.

Interest-bearing loans

All loans are initially recognised at the fair value of the consideration received less directly

attributable transaction costs.

After initial recognition, interest-bearing loans are subsequently measured at amortised

cost using the effective interest method.

Gains and losses are recognised in net profit or loss when the liabilities are derecognised

as well as through the amortisation process.

Inventories

Inventories are stated at the lower of cost and net realisable value. Cost is determined on

the weighted average basis and, in the case of work in progress and finished goods, comprises

direct materials, direct labour and an appropriate proportion of overheads. Net realisable value

is based on estimated selling prices less any estimated costs to be incurred to completion and

disposal.

Cash and cash equivalents

For the purpose of the consolidated cash flow statement, cash and cash equivalents

comprise cash on hand and demand deposits, and short term highly liquid investments which are

readily convertible into known amounts of cash and which are subject to an insignificant risk of

changes in value, and have a short maturity of generally within three months when acquired, less

bank overdrafts which are repayable on demand and form an integral part of the Group’s cash

management.

For the purpose of the balance sheet, cash and cash equivalents comprise cash on hand and

at banks, including term deposits, which are not restricted as to use.


— I-11 —

Rules 4.04(11)

Income tax

Income tax comprises current and deferred tax. Income tax is recognised in the income

statement, or in equity if it relates to items that are recognised directly in equity in the same or

a different period.

Current tax assets and liabilities for the current and prior periods are measured at the

amount expected to be recovered from or paid to the taxation authorities.

Deferred tax is provided, using the liability method, on all temporary differences at the

balance sheet date between the tax bases of assets and their carrying amounts for financial

reporting purposes.

Deferred tax liabilities are recognised for all taxable temporary differences, except:

● where the deferred tax liability arises from goodwill or the initial recognition of an

asset or liability in a transaction that is not a business combination and, at the time

of the transaction, affects neither the accounting profit nor taxable profit or loss; and

● in respect of taxable temporary differences associated with investments in

subsidiaries, where the timing of the reversal of the temporary differences can be

controlled and it is probable that the temporary differences will not reverse in the

foreseeable future.

Deferred tax assets are recognised for all deductible temporary differences, carryforward of

unused tax credits and unused tax losses, to the extent that it is probable that taxable profit will

be available against which the deductible temporary differences, and the carryforward of unused

tax credits and unused tax losses can be utilised except:

● where the deferred tax asset relating to the deductible temporary differences arises

from the initial recognition of an asset or liability in a transaction that is not a

business combination and, at the time of the transaction, affects neither the accounting

profit nor taxable profit or loss; and

● in respect of deductible temporary differences associated with investments in

subsidiaries, deferred tax assets are only recognised to the extent that it is probable

that the temporary differences will reverse in the foreseeable future and taxable profit

will be available against which the temporary differences can be utilised.

The carrying amount of deferred tax assets is reviewed at each balance sheet date and

reduced to the extent that it is no longer probable that sufficient taxable profit will be available

to allow all or part of the deferred tax asset to be utilised. Conversely, previously unrecognised

deferred tax assets are reassessed at each balance sheet date and are recognised to the extent that

it is probable that sufficient taxable profit will be available to allow all or part of the deferred

tax asset to be utilised.


— I-12 —

Rules 4.04(11)

Deferred tax assets and deferred tax liabilities are measured at the tax rates that are

expected to apply to the period when the asset is realised or the liability is settled, based on tax

rates (and tax laws) that have been enacted or substantively enacted at the balance sheet date.

Deferred tax assets and deferred tax liabilities are offset, if a legally enforceable right

exists to set off current tax assets against current tax liabilities and the deferred taxes relate to

the same taxable entity and the same taxation authority.

Government grants and subsidies

Government grants and subsidies from the government are recognised at their fair values

where there is reasonable assurance that the grant or subsidy will be received and all attaching

conditions will be complied with. When the grant or subsidy relates to an expense item, it is

recognised as income over the periods necessary to match the grant or subsidy on a systematic

basis to the costs that it is intended to compensate. Where the grant or subsidy relates to an asset,

the fair value of the grant or subsidy is deducted from the carrying amount of the asset and

released to the income statement by way of a reduced depreciation charge.

Revenue recognition

Revenue is recognised when it is probable that the economic benefits will flow to the Group

and when the revenue can be measured reliably, on the following bases:

(a) from the sale of goods, when the significant risks and rewards of ownership have been

transferred to the buyer, provided that the Group maintains neither managerial

involvement to the degree usually associated with ownership, nor effective control

over the goods sold;

(b) from the rendering of services, on the percentage of completion basis.

(c) rental income, on a time proportion basis over the lease terms;

(d) interest income, on an accrual basis using the effective interest method by applying

the rate that discounts the estimated future cash receipts through the expected life of

the financial instrument to the net carrying amount of the financial asset; and

(e) value-added tax (the “VAT”) refunds, when the acknowledgment of a refund from the

PRC tax bureau has been received.

Pension scheme

The Company and its PRC subsidiaries comprising the Group operating in Mainland China

participate in the central pension scheme (the “CPS”) operated by the PRC government for all

of their staff. The Company and its PRC subsidiaries are required to contribute a certain


— I-13 —

Rules 4.04(11)

percentage of their covered payroll to the CPS to fund the benefits. The only obligation of the

Group with respect to the CPS is to pay the ongoing required contributions under the CPS.

Contributions under the CPS are charged to the income statement as they become payable in

accordance with the rules of the CPS.

Borrowing costs

Borrowing costs directly attributable to the acquisition, construction or production of

qualifying assets, i.e. assets that necessarily take a substantial period of time to get ready for

their intended use or sale, are capitalised as part of the cost of those assets. The capitalisation

of such borrowing costs ceases when the assets are substantially ready for their intended use or

sale. Investment income earned on the temporary investment of specific borrowings pending

their expenditure on qualifying assets is deducted from the borrowing costs capitalised.

Dividends

Final dividends proposed by the directors are classified as a separate allocation of retained

profits within the equity section of the balance sheet, until they have been approved by the

shareholders in a general meeting. When these dividends have been approved by the shareholders

and declared, they are recognised as a liability.

Interim dividends are simultaneously proposed and declared, because the Company’s

memorandum and articles of association grant the directors the authority to declare interim

dividends. Consequently, interim dividends are recognised immediately as a liability when they

are proposed and declared.

Foreign currencies

The Financial Information is presented in Renminbi (“RMB”), which is the Company’s

functional and presentation currency. Each entity in the Group determines its own functional

currency and item included in the financial statements of each entity are measured using that

functional currency. Foreign currency transactions are initially recorded using the functional

currency rates ruling at the date of the transactions. Monetary assets and liabilities denominated

in foreign currencies are retranslated at the functional currency rates of exchange ruling at the

balance sheet date. All differences are taken to profit or loss.

The functional currencies of the overseas subsidiary, is currency other than RMB. As at the

balance sheet date, the assets and liabilities of the entity is translated into the presentation

currency of the Company at the exchange rates ruling at the balance sheet date and, their income

statements are translated into RMB at the weighted average exchange rates for the year/period.

The resulting exchange differences are included in the exchange fluctuation reserve. On disposal

of a foreign entity, the deferred cumulative amount recognised in equity relating to that particular

foreign operation is recognised in the income statement.


— I-14 —

Rules 4.04(11)

For the purpose of the consolidated cash flow statement, the cash flows of overseas

subsidiary is translated into RMB at the exchange rates ruling at the dates of the cash flows.

Frequently recurring cash flows of overseas subsidiary which arises throughout the year is

translated into RMB at the weighted average exchange rates for the year/period.

Impact of issued but not yet effective HKFRS

The Group has not applied the following new and revised HKFRS, that have been issued

but are not yet effective, in the Financial Information. Unless otherwise stated, these HKFRS are

effective for annual periods beginning on or after 1 May 2006:

HKAS 1 Amendment Capital Disclosures

HKFRS 7 Financial Instruments: Disclosures

HK(IFRIC)-Int 8 Scope of HKFRS 2

HK(IFRIC)-Int 9 Reassessment of Embedded Derivatives (effective for annual

periods beginning on or after 1 June 2006)

The HKAS 1 Amendment shall be applied for annual periods beginning on or after 1

January 2007. The revised standard will affect the disclosures about qualitative information

about the Group’s objective, policies and processes for managing capital; quantitative data about

what the Company regards as capital; and compliance with any capital requirements and the

consequences of any non-compliance.

HKFRS 7 incorporates the disclosure requirements of HKAS 32 relating to financial

instruments. This HKFRS shall be applied for annual periods beginning on or after 1 January

2007.

Except as stated above, the Group expects that the adoption of the pronouncements listed

above will not have any significant impact on the Group’s financial statements in the period of

initial application.

4. SIGNIFICANT ACCOUNTING JUDGEMENTS AND ESTIMATES

Judgements

In the process of applying the Group’s accounting policies, management has made the

following judgements, apart from those involving estimations, which have the most significant

effect on the amounts recognised in the financial statements:

Operating lease commitments — Group as lessor

The Group has entered into commercial property leases on its investment property

portfolio. The Group has determined that it retains all the significant risks and rewards of

ownership of these properties which are leased out on operating leases.


— I-15 —

Rules 4.04(11)

Classification between investment properties and owner-occupied properties

The Group determines whether a property qualifies as an investment property and has

developed criteria in making that judgement. Investment property is a property held to earn

rentals or for capital appreciation or both. Therefore, the Group considers whether a

property generates cash flows largely independently of the other assets held by the Group.

Some properties comprise a portion that is held to earn rentals or for capital

appreciation and another portion that is held for use in the production or supply of goods

or services or for administrative purposes. If these portions could be sold separately (or

leased out separately under a finance lease), the Group accounts for the portions separately.

If the portions could not be sold separately, the property is an investment property only if

an insignificant portion is held for use in the production or supply of goods or services or

for administrative purposes.

Judgement is made on an individual property basis to determine whether ancillary

services are so significant that a property does not qualify as investment property.

Estimation uncertainty

The key assumptions concerning the future and other key sources of estimation uncertainty

at the balance sheet date, that have a significant risk of causing a material adjustment to the

carrying amounts of assets and liabilities within the next financial year, are discussed below.

(i) Provision against slow-moving inventories

Provision against slow-moving inventories is made based on the aging and estimated

net realisable value of inventories. The assessment of the provision amount required

involves management judgement and estimates. Where the actual outcome or expectation in

future is different from the original estimate, such differences will have impact on the

carrying value of the inventories and provision charge/write-back in the period in which

such estimate has been changed.

(ii) Provision for doubtful debts

Provision for doubtful debts is made based on assessment of the recoverability of

trade receivables and other receivables. The identification of doubtful debts requires

management judgement and estimates. Where the actual outcome or expectation in future

is different from the original estimate, such differences will have impact on the carrying

value of the receivables and doubtful debt expenses/write-back in the period in which such

estimate has been changed.


— I-16 —

(iii) Impairment of items of property, plant and equipment

The carrying value of the property, plant and equipment is reviewed for impairment

when events or changes in circumstances indicate the carrying value may not be recoverable

in accordance with the accounting policies as disclosed in the relevant parts of Section 3.

The recoverable amount of the property, plant and equipment is the greater of the fair value

less costs to sell and value in use, the calculations of which involve the use of estimates.

5. PARTICULARS OF THE PRINCIPAL SUBSIDIARIES COMPRISING THE GROUP

AND THE ASSOCIATE OF THE GROUP

At the date of this report, the Company has direct interests in the following subsidiaries:

Company name

Place of

incorporation/

registration

and operations

Nominal value

of issued

ordinary/

registered

share capital

Percentage of equity directly

attributable to the Company

Principal

activities

As at 31 December

As at

30 April

2003 2004 2005 2006

Weifang Molong

Drilling Equipment

Company Limited

(“Molong Drilling

Equipment”) (i)

PRC/

Mainland China

RMB6,000,000 N/A 90% 90% 90% Manufacture

and sale of

petroleum

extraction

machinery

MPM International

Limited (formerly,

Molong (Asia)

Holding Limited)

(ii)

Hong Kong HKD7,800,000 N/A N/A 90% 90% Trading of

petroleum

extraction

machinery and

electro-mechanical

equipment

Notes:

N/A — Not yet incorporated or not yet acquired by the Company.

(i) Molong Drilling Equipment is a welfare enterprise established on 29 September 2004.

(ii) On 28 March 2005, the Company obtained approval from the Department of Foreign Trade and Economic

Cooperation (“FTEC”) of Shandong Province approval document “Lu Wai Jing Mao Jing Wai [2005] No.125”,

pursuant to which the Company was authorised to set up a new subsidiary in Hong Kong. MPM International

Limited has no trading activity during the Relevant Periods.


— I-17 —

Rules 4.04(11)

The Group’s Financial Information for the Relevant Periods include the results of operations and financial positions of

Shandong Molong Special Steel Company Limited (“Special Steel”), Weifang Dragon Machinery Company Limited (“Weifang

Dragon”), Shouguang Molong Machinery Company Limited (“Molong Machinery”) and Kelamayi Yalong Oil Pump Company

Limited (“Yalong Oil Pump”). Details of the termination of operations/disposal of these companies except for the associate,

Yalong Oil Pump, are set out in Section 7 of this report. The particulars of these subsidiaries and the associate are set out below:

Company name

Place of

incorporation/

registration

and operations

Nominal value

of issued

ordinary/

registered

share capital

Percentage of equity directly

attributable to the Company

Principal

activities

As at 31 December

As at

30 April

2003 2004 2005 2006

Subsidiaries

Special Steel (iii) PRC/

Mainland China

RMB88,000,000 — — — — Manufacture and

sale of steel

Weifang Dragon (iv) PRC/

Mainland China

USD350,000 — — — — Manufacture and

sale of precision

casting components

Molong Machinery (v) PRC/

Mainland China

RMB8,000,000 93.1% 93.1% — — Manufacture and

sale of petroleum

extraction

machinery

Associate

Yalong Oil Pump (vi) PRC/

Mainland China

RMB4,500,000 — — — — Manufacture and

sale of petroleum

extraction

machinery

Notes:

(iii) On 28 February 2003, the Company entered into a sale and purchase agreement to dispose of its entire 52% equity

interest in Special Steel. In accordance with the agreement, the Company agreed to transfer 44.32%, 6.7% and

0.98% equity interests in Special Steel to Zhang En Rong, a shareholder and a director of the Company, and to

Liu Fa You and Xu Shou Lu, both are independent third parties for considerations of RMB39,000,000,

RMB5,900,000 and RMB860,000, respectively, which resulted in a gain on disposal of a subsidiary amounting to

RMB2,185,000. The consideration included a cash consideration of RMB30,000,000 and the remaining

RMB13,733,000 and RMB2,027,000 were recorded as amounts due from a shareholder and Special Steel,

respectively. The amount due from the shareholder was subsequently used to set off against the dividend payable

to shareholders. The total consideration was calculated on the basis of the original investment cost in Special

Steel, which was equivalent to 52% of the registered capital of Special Steel amounting to RMB45,760,000.

Special Steel had no sales for the period from 1 January 2003 to 28 February 2003. It recorded a net loss of

RMB778,000 for the period from 1 January 2003 to 28 February 2003.


— I-18 —

(iv) On expiry of the term of the operations of Weifang Dragon as according to its business license on 26 January 2003,

the Board of Directors decided to discontinue its operations. The audited net asset value of Weifang Dragon as

at 26 January 2003 was RMB7,518,000. The assets and liabilities of Weifang Dragon at 26 January 2003 were

transferred to Shouguang Molong Electro-mechanical Equipment Company Limited ( )

(“Molong Equipment”) for a consideration of RMB8,194,000, which resulted in a gain on disposal of a subsidiary

amounting to RMB473,000. The consideration was calculated on the basis of the unaudited net asset value of

Weifang Dragon at 26 January 2003 amounting to RMB8,194,000.

The turnover and net loss of Weifang Dragon for the period from 1 January 2003 to 26 January 2003 were

RMB1,257,000 and RMB6,000 respectively.

(v) According to a resolution in a shareholders’ meeting passed on 24 November 2004, Molong Machinery was

voluntarily liquidated on 6 December 2004. The remaining assets and liabilities of Molong Machinery were

distributed to its shareholders, i.e., the Company and Shouguang Maolong Machinery Company Limited

(“Maolong Machinery”) ( ), in proportion to their respective percentages of interests held in

Molong Machinery. As such, an amount of RMB2,477,000 was distributed to Maolong Machinery by cash, and the

remaining assets and liabilities were taken over by the Company.

The turnover and net profit of Molong Machinery for the year ended 31 December 2003 and the period from 1

January 2004 to 6 December 2004 were as follow:

Year ended

31 December

2003

Period from

1 January 2004

to 6 December

2004

RMB’000 RMB’000

Turnover 134,045 160,806

Net profit 31,601 32,507

(vi) On 29 May 2003, the Company entered into a sale and purchase agreement to dispose of its entire 30% equity

interest in Yalong Oil Pump. In accordance with the agreement, the Company agreed to transfer its equity interest

in Yalong Oil Pump to Liu Chun Yuan, an independent third party, for a cash consideration of RMB1,666,000

which resulted in a loss on disposal of an associate amounting to RMB14,000.

The turnover and net profit of Yalong Oil Pump for the period from 1 January 2003 to 29 May 2003 were

RMB3,940,000 and RMB16,000, respectively.


— I-19 —

6. CONSOLIDATED INCOME STATEMENT

Year ended 31 DecemberFour-month period

ended 30 AprilNotes 2003 2004 2005 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

(Unaudited)

RMB’000

Revenue (b) 302,274 487,688 776,522 228,380 304,214Cost of sales (d) (226,872) (391,030) (596,113) (184,460) (231,638)

Gross profit 75,402 96,658 180,409 43,920 72,576Other income and gains (b) 21,995 15,458 14,146 4,818 8,970Selling and distribution

costs (11,299) (20,128) (24,853) (6,247) (9,563)Administrative expenses (11,099) (14,300) (33,162) (6,649) (10,274)Other expenses (10,914) (7,540) (17,577) (2,096) (5,732)Finance costs (c) (4,738) (4,572) (3,444) (1,338) (1,920)

PROFIT BEFORE TAX (d) 59,347 65,576 115,519 32,408 54,057Tax (g) (13,197) (1,485) (27,271) (7,997) (18,396)

PROFIT FOR THE

YEAR/PERIOD 46,150 64,091 88,248 24,411 35,661

Attributable to:Equity holders of the parent (h) 43,977 61,366 85,227 23,866 34,977Minority interests 2,173 2,725 3,021 545 684

46,150 64,091 88,248 24,411 35,661

DIVIDENDS (i)Interim — 10,806 12,982 — —Proposed final — 8,100 11,016 — —

— 18,906 23,998 — —

EARNINGS PER SHARE

ATTRIBUTABLE TO

ORDINARY EQUITY

HOLDERS OF THE

PARENT

— Basic (RMB) (j) 0.109 0.122 0.141 0.044 0.054


— I-20 —

Rules 4.04(1)

Rules 4.04(8)

Rules App16(2)(2)

Rules App16(4)(1)(a)(b)(c)(d)(e)(f)(g)(h)(i)(j)(k)(m)

Rules 4.05(1)(i)(j)(k)

Rules App16(4)(2)

(a) Segment information

Segment information is presented on the Group’s primary segment reporting basis, by geographical segment. The Group’s

operating business is with customers based in Mainland China, the United States, Europe and other countries. Each of the

Group’s geographical segments represents a customer destination to which the Group sells products or provides services which

are subject to risks and returns that are different from those of the other geographical segments. No further business segment

information is presented as over 90% of the Group’s operations relate solely to the sale of petroleum machinery.

In determining the Group’s geographical segments, revenues are attributed to the segments based on the locations of the

customers, and assets are attributed to the segments based on the locations of the assets.

Intersegment sales and transfers are transacted with reference to the selling prices used for sales made to third parties

at the then prevailing market prices.


— I-21 —

RulesApp16(4)(3)(a)

The following tables present revenue, profit and certain asset, liability and expenditure information for the Group’s

geographical segments:

Group

As at 31 December 2003

The PRC

United

States Europe

Other

countries ConsolidatedRMB’000 RMB’000 RMB’000 RMB’000 RMB’000

Segment revenue:Sales to external customers 256,478 42,972 2,358 466 302,274

Other revenue 4,593 — — — 4,593

Total revenue from continuing operations 261,071 42,972 2,358 466 306,867

Segment result 53,159 12,303 491 — 65,953

Unallocated income (i) 17,402

Unallocated expenses (i) (19,270)

Finance costs (4,738)

Profit before tax 59,347

Tax (13,197)

Profit for the year 46,150

Segment assets and liabilities:Segment assets 383,356 — — — 383,356

Total assets 383,356

Segment liabilities 264,457 — — — 264,457

Total liabilities 264,457

Depreciation and amortisation 5,943 — — — 5,943

Impairment losses recognised in the income

statement — — — — —

Capital expenditure 53,321 — — — 53,321

Provision/(reversal of provision) against

obsolete inventories 20 — — — 20

Provision for doubtful debts 969 — — — 969


— I-22 —

Rules 4.05(4)(a)

RulesApp16(4)(3)(a)

Group


The PRC

United

States Europe

Other

countries Consolidated


Segment revenue:

Sales to external customers 398,351 52,052 28,347 8,938 487,688

Other revenue 1,768 — — — 1,768

Total revenue from continuing operations 400,119 52,052 28,347 8,938 489,456

Segment result 93,289 11,536 5,953 1,869 112,647





Tax (1,485)


Segment assets and liabilities:

Segment assets 448,916 17,269 — 874 467,059


Segment liabilities 210,416 — — 9,999 220,415







obsolete inventories (150) — — — (150)

Provision for doubtful debts 2,171 — — — 2,171


— I-23 —

Rules 4.05(4)(a)

RulesApp16(4)(3)(a)

Group


The PRC

United

States Europe

Other



Segment revenue:


Other revenue 8,258 — — — 8,258


Segment result 118,901 23,270 12,840 8,803 163,814





Tax (27,271)



Segment assets 858,972 82,112 5,994 12,051 959,129


Segment liabilities 534,064 9,976 — 23 544,063







obsolete inventories 4,499 — — — 4,499

Provision for doubtful debts 3,714 — — — 3,714


— I-24 —

Rules 4.05(4)(a)

RulesApp16(4)(3)(a)

Group

As at 30 April 2006

The PRC

United

States Europe

Other



Segment revenue:


Other revenue 8,019 — — — 8,019


Segment result 45,914 13,641 8,279 3,199 71,033

Unallocated income (i) 950




Tax (18,396)

Profit for the period 35,661


Segment assets 1,031,708 64,633 15,804 2 1,112,147

Total assets 1,112,147

Segment liabilities 653,343 5,674 1,697 706 661,420







obsolete inventories 1,836 — — — 1,836

Provision for doubtful debts (2,960) — — — (2,960)


— I-25 —

Rules 4.05(4)(a)

RulesApp16(4)(3)(a)

Group

As at 30 April 2005 (Unaudited)

The PRC

United

States Europe

Other



Segment revenue:


Other revenue 1,175 — — — 1,175


Segment result 27,353 6,174 3,197 2,124 38,848





Tax (7,997)







obsolete inventories — — — — —

Provision for doubtful debts — — — — —

(i) Mainly represent sundry revenue and corporate expenses as well as the depreciation of property, plant and

equipment.


— I-26 —

Rules 4.05(4)(a)

RulesApp16(4)(3)(a)

(b) Revenue, other income and gains

Revenue, which is also the Group’s turnover, represents the net invoiced value of goods sold, after allowances for returns

and trade discounts during the year/period. All significant intra-group transactions have been eliminated on consolidation.

An analysis of revenue, other income and gains is as follows:


Four-month period

ended 30 April

Notes 2003 2004 2005 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

(Unaudited)

RMB’000

Revenue

Sale of petroleum machinery 302,274 487,688 776,522 228,380 304,214

Other income

Subcontracting income 4,491 446 342 52 174

Investment income from a trust

investment — 289 — — —

Bank interest income (d) 893 1,029 2,048 709 891

Government subsidies (i) 2,391 3,019 710 — —

VAT refund (ii) 10,039 9,168 2,165 2,165 —

Rental income (d) 98 98 153 98 173

Insurance claim/ Compensation

income 863 — — — —

Sale of raw materials (iii) — 1,122 7,559 856 7,622

Others 562 185 965 769 60

19,337 15,356 13,942 4,649 8,920

Gains

Gain on disposal of

subsidiaries (d), Section 7 (p) 2,658 — — — —

Gain on disposal of items of

property, plant and

equipment (d) — 102 204 169 50

2,658 102 204 169 50

21,995 15,458 14,146 4,818 8,970


— I-27 —

Rules4.05(1)(a)(b)(c)

Rules App 16(4)(1)(a)(h)(m)

Rules4.05(1)(a)(b)(c)

Rules App16(4)(1)(I)

Notes:

(i) The government subsidies for the year ended 31 December 2003 mainly represented an enterprise technology

subsidy and a loan discount subsidy, which amounted to RMB1,850,000 and RMB440,000 respectively.

The government subsidies for the year ended 31 December 2004 consisted of an export subsidy, and bonus for

being successfully listed on the Growth Enterprise Market (the “GEM”) of the Stock Exchange, which amounted

to RMB1,219,000 and RMB1,800,000 respectively.

The government subsidies for the year ended 31 December 2005 represented an export subsidy and a product

innovation subsidy, which amounted to RMB160,400 and RMB550,000 respectively.

Except for the bonus for being successfully listed on the GEM of the Stock Exchange amounting to RMB1,800,000

in 2004, government subsidies were generally available to other companies, which were mainly for the purpose

of promoting export sales and encouraging domestic enterprises to focus more on technological advancement.

All government subsidies are non-recurring in nature, and there are no unfulfilled conditions or contingencies

relating to the subsidy income.

(ii) The VAT refund for the year ended 31 December 2003 and 2004 represented VAT received by Molong Machinery,

a subsidiary of the Company which was liquidated in year 2004.

The VAT refund for the year ended 31 December 2005 represented VAT received by Molong Drilling Equipment,

a subsidiary of the Company which was set up in 2004.

Both subsidiaries were approved by the Ministry of Civil Affairs of Shandong Province ( ) as

welfare enterprises ( ). According to the tax document Guo Shui Fa [1994] No.155,

(Notice about the levy of turnover tax of welfare enterprises issued

by the State Tax Bureau), the amount of VAT paid by Molong Machinery and Molong Drilling Equipment is

refundable.

(iii) The sale of raw materials for the Relevant Periods represented the sale of scrap and used metal to related parties

and third parties. The prices were determined at the fixed rate prescribed by the relevant authorities of the PRC

(if any). If no fixed prices were prescribed by the relevant authorities of the PRC, the sales prices would be

negotiated and agreed by both parties with reference to the then prevailing market prices.

(c) Finance costs


Four-month period

ended 30 April

2003 2004 2005 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

(Unaudited)

RMB’000

Interest on bank borrowings wholly

repayable within five years 4,738 4,572 3,444 1,338 1,920


— I-28 —

RulesApp16(4)(1)(h)

Rules 4.05(1)(e)Rules App16(4)(1)(j)

(d) Profit before tax

The Group’s profit before tax is arrived at after charging/(crediting):


Four-month period

ended 30 April

Notes 2003 2004 2005 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

(Unaudited)

RMB’000

Cost of inventories sold 226,872 391,030 596,113 184,460 231,638

Depreciation Section 7

(a), (b)

5,713 9,056 13,382 3,668 4,977

Amortisation of know-how Section 7

(d)

— 8 39 6 273

Recognition of prepaid land lease

payments

Section 7

(c)

230 113 276 64 159

Research and development costs:

Current year/period expenditure 4,232 3,983 5,724 766 2,183

Minimum lease payments under

operating leases:

Plant and machinery — — 108 36 36

Land and buildings located in the

PRC 267 267 434 145 145

267 267 542 181 181

Auditors’ remuneration 1 600 1,000 — 300

Employee benefits expense (including

directors’ and supervisors’

remuneration (e)):

Wages and salaries 11,182 16,675 24,403 6,112 10,063

Pension scheme contributions (i) 1,416 1,765 5,015 585 1,146

12,598 18,440 29,418 6,697 11,209

Foreign exchange differences, net 41 86 1,314 677 512

Provision/(Reversal of provision) for

bad and doubtful debts 969 2,171 3,714 — (2,960)

Rental income (b) (98) (98) (153) (98) (173)

Bank interest income (b) (893) (1,029) (2,048) (709) (891)

Gain on disposal of property, plant

and equipment (b) — (102) (204) (169) (50)

Gain on disposal of subsidiaries (b) (2,658) — — — —


— I-29 —

Rules 4.05(1)(d)(f)(g)

Rules App16(4)(1)(i)

Rules4.05(1)(d)(f)(g)

Rules App16(4)(1)(b)(i)(k)

Notes:

(i) All of the Group’s full-time employees in the PRC are covered by a government-regulated pension scheme and

are entitled to an annual pension determined according to their basic salaries upon their retirement. The PRC

government is responsible for the pension liabilities to these retired employees. The Group is required to make

annual contributions to the government-regulated pension scheme at a fixed percentage of the employees’ basic

salaries subject to a cap. This defined contribution pension scheme continued to be available to the Group’s

employees for the Relevant Periods. The related pension costs are expensed as incurred.

(e) Directors’ and supervisors’ remuneration

Directors’ and supervisors’ remuneration, disclosed pursuant to the Listing Rules of the Stock Exchange and Section 161

of the Companies Ordinance, is as follows:

Directors


Four-month period

ended 30 April

2003 2004 2005 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

(Unaudited)

RMB’000

Fees — — — — —

Other emoluments:

Salaries, allowances and benefits in kind 171 243 270 89 90

Performance related bonuses 41 540 578 — —

Pension scheme contributions 6 6 9 3 3

218 789 857 92 93

Supervisors


Four-month period

ended 30 April

2003 2004 2005 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

(Unaudited)

RMB’000

Fees — — — — —

Other emoluments:

Salaries, allowances and benefits in kind 42 49 52 16 17

Performance related bonuses — 50 50 — —

Pension scheme contributions 2 2 3 1 1

44 101 105 17 18

During the Relevant Periods and the four-month period ended 30 April 2005, no director or supervisor waived or agreed

to waive any emolument.

During the Relevant Periods, no emoluments were paid by the Group to the Directors of the Company as an inducement

to join or upon joining the Group.


— I-30 —

RulesApp16(4)(1)(b)

The remuneration of each of the Directors and Supervisors for the year ended 31 December 2003 is as follows:

Salaries,

allowances

and benefits

in kind

Performance

related

bonuses

Pension

scheme

contributions

Total

remuneration

RMB’000 RMB’000 RMB’000 RMB’000

Executive directors:

Mr. Zhang En Rong ( ) 25 41 — 66

Mr. Zhang Yun San ( ) 22 — 2 24

Mr. Lin Fu Long ( ) 23 — 2 25

Mr. Xie Xin Cang ( ) 23 — 2 25

93 41 6 140

Non-executive directors:

Mr. Chen Jian Xiong ( ) — — — —

Mr. Wang Ping ( ) — — — —

— — — —

Independent non-executive directors:

Mr. Qin Xue Chang ( ) 30 — — 30

Mr. Yan Yi Zhuang ( ) 48 — — 48

78 — — 78

171 41 6 218

Supervisors:

Mr. Li Bao Hui ( ) 19 — 2 21

Mr. Liu Wan Fu ( ) 15 — — 15

Mr. Fan Ren Yi ( ) 8 — — 8

42 — 2 44


— I-31 —


Salaries,

allowances

and benefits

in kind

Performance

related

bonuses

Pension

scheme

contributions

Total

remuneration

RMB’000 RMB’000 RMB’000 RMB’000


Mr. Zhang En Rong ( ) 28 189 — 217

Mr. Zhang Yun San ( ) 25 122 2 149

Mr. Lin Fu Long ( ) 20 137 2 159

Mr. Xie Xin Cang ( ) 26 92 2 120

99 540 6 645




— — — —




Mr. Loke Yu alias Loke Hoi Lam ( ) 50 — — 50

144 — — 144

243 540 6 789

Supervisors:

Ms. Li Bao Hui ( ) 19 50 2 71

Mr. Liu Wan Fu ( ) 20 — — 20

Mr. Fan Ren Yi ( ) 10 — — 10

49 50 2 101


— I-32 —


Salaries,

allowances

and benefits

in kind

Performance

related

bonuses

Pension

scheme

contributions

Total

remuneration

RMB’000 RMB’000 RMB’000 RMB’000


Mr. Zhang En Rong ( ) 32 208 — 240

Mr. Zhang Yun San ( ) 28 135 3 166

Mr. Lin Fu Long ( ) 26 135 3 164

Mr. Xie Xin Cang ( ) 28 100 3 131

114 578 9 701




— — — —





156 — — 156

270 578 9 857

Supervisors:

Ms. Li Bao Hui ( ) 22 50 3 75

Mr. Liu Wan Fu ( ) 20 — — 20

Mr. Fan Ren Yi ( ) 10 — — 10

52 50 3 105


— I-33 —

The remuneration of each of the Directors and Supervisors for the four-month period ended 30 April 2006 is as follows:

Salaries,

allowances

and benefits

in kind

Performance

related

bonuses

Pension

scheme

contributions

Total

remuneration

RMB’000 RMB’000 RMB’000 RMB’000


Mr. Zhang En Rong ( ) 11 — — 11


Mr. Lin Fu Long ( ) 9 — 1 10


40 — 3 43




— — — —





50 — — 50

90 — 3 93

Supervisors:

Ms. Li Bao Hui ( ) 8 — 1 9

Mr. Liu Wan Fu ( ) 6 — — 6

Mr. Fan Ren Yi ( ) 3 — — 3

17 — 1 18


— I-34 —

The remuneration of each of the Directors and Supervisors for the four-month period ended 30 April 2005 (unaudited)

is as follows:

Salaries,

allowances

and benefits

in kind

Performance

related

bonuses

Pension

scheme

contributions

Total

remuneration

RMB’000 RMB’000 RMB’000 RMB’000


Mr. Zhang En Rong ( ) 11 — — 11


Mr. Lin Fu Long ( ) 8 — 1 9


37 — 3 40




— — — —





52 — — 52

89 — 3 92

Supervisors:

Ms. Li Bao Hui ( ) 7 — 1 8

Mr. Liu Wan Fu ( ) 6 — — 6

Mr. Fan Ren Yi ( ) 3 — — 3

16 — 1 17


— I-35 —

(f) Five highest paid employees

Details of the five highest paid employees of the Group during the Relevant Periods and the four-month period ended

30 April 2005 are as follows:


Four-month period

ended 30 April

2003 2004 2005 2005 2006

(Unaudited)

Directors and supervisors — 4 4 2 2

Non-director and non-supervisor employees 5 1 1 3 3

5 5 5 5 5

Details of the remuneration of the above non-director and non-supervisor highest paid employees during the Relevant

Periods and the four-month period ended 30 April 2005 are as follows:


Four-month period

ended 30 April

2003 2004 2005 2005 2006


(Unaudited)

Salaries and allowances 274 20 192 148 148

Performance related bonus — 98 — — —

Pension scheme contributions 6 2 — — —

280 120 192 148 148

During the Relevant Periods and the four-month period ended 30 April 2005, no emoluments were paid by the Group to

any of these non-director and non-supervisor highest paid employees as an inducement to join or upon joining the Group.

(g) Tax

The Company is located in the PRC and as a result is subject to the PRC corporate income tax at a rate of 33% on its

assessable profits. No provision for Hong Kong profits tax has been made as the Group did not generate any assessable profits

in Hong Kong during the Relevant Periods.

The Company has applied to the Shouguang local tax bureau for a deduction of corporate income tax for the three year

ended 31 December 2005 in accordance with the tax document Cai Shui Zi [1999] No. 290

(Provisional Measures on the Deduction and Exemption of Enterprise Income Tax for

Investment on Technology Adaptation of State-owned Assets) issued by the Ministry of Finance and the State Tax Bureau in

1999, which allows the deduction of the excess amount of current year corporate income tax over that of prior year corporate

income tax by an approved amount of locally purchased plant and equipment used for qualified technological improvement

projects. Pursuant to approval documents issued by the Shouguang local tax bureau on 18 January 2004 and 3 March 2005 in


— I-36 —

RulesApp16(4)(1)(c)Rules 4.05(1)(h)

respect of the aforementioned application of a tax deduction made by the Company, the Company was granted deductions of

corporate income tax of RMB3,049,000 and RMB5,465,000 for the year ended 31 December 2003 and 2004, respectively. The

Company did not obtain approval document from the local tax bureau and hence there was no tax deduction for the year ended

2005 and the four-month period ended 30 April 2006.

Special Steel did not earn any assessable profits during fiscal year 2003 as it was still in the start-up period.

Weifang Dragon was a foreign investment enterprise and was subject to PRC corporate income tax at a rate of 24% on

its assessable profits for period from fiscal year of 2003 to 26 January 2003, the date of discontinuation of its operations.

Molong Drilling Equipment, which was set up on 29 September 2004, was approved by (the Ministry of Civil

Affairs of Shandong Province) as a welfare enterprise ( ) and hence was entitled to a full exemption from corporate

income tax for the year ended 31 December 2004 and 2005 respectively according to the tax document Cai Shui Zi [1994] No.1

(The Notice Regarding Certain Preferential Policies on Enterprises Income Tax).

Molong Machinery, which was voluntarily liquidated on 6 December 2004, was approved by the (the Ministry

of Civil Affairs of Shandong Province) as a welfare enterprise ( ). Hence, it was entitled to a full exemption from

corporate income tax for the year ended 31 December 2003 and throughout its operation period in the year ended 31 December

2004 until its liquidation date, respectively, according to the tax document Cai Shui Zi [1994] No.1

(The Notice Regarding Certain Preferential Policies on Enterprises Income Tax).

Group


Four-month period

ended 30 April

2003 2004 2005 2005 2006


(Unaudited)

Total current - PRC tax charge for the

year/period 13,197 12,818 32,509 10,215 18,025

Tax exemption granted for prior year/period — (11,333) — — —

Deferred (Section 7 (g)) — — (5,238) (2,218) 371

Total tax charge for the year/period 13,197 1,485 27,271 7,997 18,396


— I-37 —

RulesApp16(4)(1)(c)

A reconciliation of the tax expense applicable to profit before tax using the statutory rate for the PRC in which the

Company and its subsidiaries are domiciled to the tax expense at the effective tax rates, and a reconciliation of the applicable

rates (i.e., the statutory tax rate) to the effective tax rates, are as follows:

Year ended 31 December Four-month period ended 30 April

2003 2004 2005 2005 2006


(Unaudited)

Profit before tax 59,347 65,576 115,519 32,408 54,057

Tax at the statutory tax rate 19,585 33.00 21,640 33.00 38,122 33.00 10,695 33.00 17,839 33.00

Additional research and

development expenses deductible

due to increase in research and

development expenses in current

year/period by more than 10% — — (539) (0.82) (944) (0.82) (14) (0.04) — —

Expenses not deductible for tax 849 1.43 37 0.06 114 0.1 — — 557 1.03

Tax exemption granted to a welfare

enterprise for prior year/period — — (11,333) (17.28) — — — — — —

Tax exemption granted to a welfare

enterprise for current year/period — — (1,617) (2.47) (10,021) (8.67) (2,684) (8.28) — —

Adjustments in respect of current

tax of prior year/period — — (680) (1.04) — — — — — —

Tax exemption of purchased

property, plant and equipment

used for qualified technological

improvement projects (6,360) (10.72) (6,023) (9.18) — — — — — —

Gain on disposal of subsidiaries not

taxable for income tax purposes (877) (1.48) — — — — — — — —

Tax expense at group’s effective tax

rates 13,197 22.23 1,485 2.27 27,271 23.61 7,997 24.68 18,396 34.03

(h) Net profit from ordinary activities attributable to equity holders of the parent

The net profit from ordinary activities attributable to equity holders of the parent for the Relevant Periods and for the

four-month periods ended 30 April 2005 and 30 April 2006 dealt with in the financial information of the Company (Section 8)

are as follows:

RMB’000

Year ended 31 December 2003 17,131



Four-month period ended 30 April 2005 (Unaudited) 18,961

Four-month period ended 30 April 2006 29,225


— I-38 —

RulesApp16(4)(1)(c)

RulesApp16(4)(1)(e)

(i) Dividends

Group and Company Year ended 31 December

Four-month period

ended 30 April

2003 2004 2005 2005 2006


(Unaudited)

Interim-2003: nil, 2004: RMB0.02 per

ordinary share, 2005: RMB0.02 per

ordinary share — 10,806 12,982 — —

Proposed final-2003: nil, 2004: RMB0.015

per ordinary share, 2005: RMB0.017 per

ordinary share — 8,100 11,016 — —

— 18,906 23,998 — —

The proposed final dividends for the years ended 31 December 2004 and 2005 were approved by the Company’s

shareholders at the annual general meetings on 7 May 2005 and 12 May 2006 respectively.

(j) Earnings per share attributable to ordinary equity holders of the parent

The calculation of basic earnings per share amounts for the years ended 31 December 2003, 2004, 2005 and four-month

periods ended 30 April 2005 and 2006 are based on the net profit for the year/period attributable to ordinary equity holders of

the parent of RMB43,977,000, RMB61,366,000, RMB85,227,000, RMB23,866,000 and RMB34,977,000 and the weighted

average numbers of ordinary shares in issue during the years ended 31 December 2003, 2004, 2005 and the four-month periods

ended 30 April 2005 and 2006 which are 405,000,000, 501,261,934, 604,798,000, 539,998,000 and 647,998,000, respectively

as adjusted to reflect the issue of shares during the year/period.

No diluted earnings per share amounts have been presented as no diluting events existed during the Relevant Periods and

the four-month period ended 30 April 2005.


— I-39 —

RulesApp16(4)(1)(f)

Rules 4.04(8)RulesApp16(4)(1)(g)

(k) Related party transactions

The Group had the following material transactions with related parties during the Relevant Periods and the four-month

period ended 30 April 2005:

(1) Recurring


Four-month period

ended 30 April

Group Notes 2003 2004 2005 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

(Unaudited)

RMB’000

Purchases of raw materials and

spare parts from:

Weihai Baolong Special

Petroleum Materials Company

Limited (“Weihai Baolong”) (a) (i) — — 2,434 — 23,487

Molong Equipment (b) (i) 18,629 30,408 58,427 29,035 21,967

18,629 30,408 60,861 29,035 45,454

Sales of raw materials and

goods to:

Molong Equipment (b) (ii) 1,837 656 5,556 407 2,006

Special Steel (d) (ii) 985 — — — —

2,822 656 5,556 407 2,006

Rental income from:

Molong Equipment (b) (iii) — — 90 — 172

Rental expenses to:

Maolong Machinery (c) (iii) 267 267 390 374 67

Molong Equipment (b) (iii) — — 42 — 42

267 267 432 374 109

Dividends to:

Mr. Zhang En Rong — 5,590 9,783 — —

Notes:

(a) Weihai Baolong is a subsidiary of Maolong Machinery. A 95% equity interest and 5% equity interest of it

are held by Maolong Machinery and Molong Equipment respectively.


— I-40 —

(b) Molong Equipment is a subsidiary of Maolong Machinery, which holds a 75% equity interest in it.

(c) Mr. Zhang Yun San, a director of the Company, is a shareholder of Maolong Machinery.

(d) Special Steel was a subsidiary of the Company before 28 February 2003. A 52% equity interest of it was

held by the Company. On 28 February 2003, the Company disposed of all of its 52% equity interest in

Special Steel. Equity interests of 44.32%, 6.7% and 0.98% were disposed of to Zhang En Rong, a

shareholder and a director of the Company, and to Liu Fa You and Xu Shou Lu, both are independent third

parties respectively.

(i) The directors consider that the purchases of raw materials and spare parts were made according to the

published prices and conditions similar to those offered to the major customers of the related parties.

(ii) The sales of raw materials and goods to the related parties were made according to the published prices and

conditions offered to the customers of the Group.

(iii) These transactions were determined at rates mutually agreed between the related parties, which were lower

than the market rates for properties of similar locations.

(2) Non-recurring


Four-month period

ended 30 April

Group Notes 2003 2004 2005 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

(Unaudited)

RMB’000

Purchases of raw materials from:

Maolong Machinery (i) 310 283 623 59 —

Shouguang Maolong Old Metals

Recycle Company Limited

(“Maolong Recycle”) (a)(ii) 114 412 — — —

424 695 623 59 —

Sales of raw materials and

goods to:

Maolong Machinery (iii) 1,389 244 624 425 —

Yalong Oil Pump (b)(iv) 8,552 — — — —

9,941 244 624 425 —


transfers from:

Maolong Machinery (v) 4 — 805 — —

Molong Equipment (v) — — — — 5,040

4 — 805 — 5,040


— I-41 —


Four-month period

ended 30 April

Group Notes 2003 2004 2005 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

(Unaudited)

RMB’000


transfers to:

Molong Equipment (vi) 14 — — — —

Maolong Machinery (vii) 15 — — — —

29 — — — —

Disposal of leasehold land to:

Maolong Machinery (viii) 125 — — — —

Molong Equipment (viii) 1,008 — — — —

1,133 — — — —

Disposal of a subsidiary to:

Mr. Zhang En Rong (ix) 39,000 — — — —

Molong Equipment (x) 8,194 — — — —

47,194 — — — —

Rental income from:

Maolong Machinery (xi) 98 98 103 98 —

Purchase of leasehold land from:

Molong Equipment (xii) 125 — — — —

Subcontracting income from:

Maolong Machinery (xiii) 595 79 258 — —

Molong Equipment (xiii) — 295 — 42 171

595 374 258 42 171

Subcontracting fees to:

Maolong Machinery (xiii) 71 422 151 67 —

Molong Equipment (xiii) 94 146 474 215 122

165 568 625 282 122

Dividends to:

Maolong Machinery — 4,559 — — —


— I-42 —

Notes:

(a) Maolong Recycle is a subsidiary of Maolong Machinery. A 90% equity interest and 10% equity interest of

it are held by Maolong Machinery and the Company respectively.

(b) Yalong Oil Pump was an associate of the Group before 29 May 2003. The Company disposed of its entire

30% equity interest in Yalong Oil Pump on 29 May 2003 to Liu Chunyuan, an independent third party.

(i) The directors consider that the purchases of raw materials were made according to the published prices and

conditions similar to those offered to the major customers of the related party.

(ii) The purchase of raw materials from Maolong Recycle was made at cost.

(iii) The sales of raw materials and spare parts to Maolong Machinery were made according to the published

prices and conditions offered to the customers of the Group.

(iv) The Group made sales of petroleum machinery to Yalong Oil Pump during the year ended 31 December

2003. Such sale transactions were made with reference to prevailing market price.

(v) The property, plant and equipment transferred from Maolong Machinery included plant and machinery,

which were transferred at their net book value amounts. The property, plant and equipment transferred from

Molong Equipment were made according to the published prices and conditions similar to those offered to

the major customers of the related party.

(vi) The property, plant and equipment transferred to Molong Equipment included plant and machinery, which

were transferred at their net book value amounts.

(vii) The property, plant and equipment transferred to Maolong Machinery included office buildings and

machinery, which were transferred at their net book value amounts.

(viii) On 30 April 2003, the Company disposed of certain leasehold land to its related parties at their net book

value amounts.

(ix) The subsidiary was disposed of at a consideration calculated on the basis of the original investment cost

in the subsidiary.

(x) The subsidiary was disposed of at a consideration calculated on the basis of the unaudited net asset value

of the subsidiary at 26 January 2003.

(xi) The transaction was determined at rates mutually agreed with the related party, which were lower than the

market rates for properties of similar locations.

(xii) On 28 January 2003, the Company purchased certain leasehold land from Molong Equipment at its net book

value amount.

(xiii) These transactions were conducted on the basis of rates mutually agreed between the related parties, which

were set at cost incurred plus a margin of 5%.

The directors of the company are of the opinion that the above transactions with related parties were conducted

on normal commercial terms and in the ordinary and usual course of the Group’s business.


— I-43 —

(3) Balances due from and to related parties

(i) The balances due from related parties

The balances as at 31 December 2003 composed of amount due from Molong Equipment of RMB9,101,000

and that due from Special Steel of RMB1,328,000.

The balances due from related parties at 31 December 2005 were advance to Weihai Baolong of

RMB21,197,000 for the purchase of casing billets and receivable of RMB780,000 from Maolong Machinery for

its share of the issued share capital of Molong Asia.

The balances as at 30 April 2006 was advance to Weihai Baolong of RMB45,077,000 for purchase of casing

billets.

(ii) The balances due to related parties

The balances due to related parties at 31 December 2005 were payables of RMB2,274,000

(2004:RMB673,000, 2003: nil) to Maolong Machinery and RMB8,368,000 (2004:RMB138,000, 2003: nil) to

Molong Equipment.

The balances as at 30 April 2006 were payable of RMB6,973,000 to Maolong Machinery and

RMB7,937,000 to Molong Equipment.

The balances due from and to the related parties at 31 December 2003, 2004, 2005 and 30 April 2006 were

interest-free, unsecured and did not have fixed payment terms.

The amount payable to Molong Equipment and an amount of RMB623,000 payable to Maolong Machinery

as at 30 April 2006 were related to the purchases of raw materials. The balance of RMB6,350,000 payable to

Maolong Machinery as at 30 April 2006 represented non-trade in nature, which had been fully repaid to Maolong

Machinery on 15 September 2006.

(4) Compensation of key management personnel of the Group


Four-month period

ended 30 April

2003 2004 2005 2005 2006


(Unaudited)

Short term employee benefits 196 1,038 1,219 85 74

Post-employment benefits 13 20 19 7 8

Total compensation paid to key

management personnel 209 1,058 1,238 92 82

Further details of directors’ emoluments are included in Section 6 (e).


— I-44 —

7. CONSOLIDATED BALANCE SHEET

Group

As at 31 DecemberAs at

30 April2003 2004 2005 2006

Notes RMB’000 RMB’000 RMB’000 RMB’000

NON-CURRENT ASSETSProperty, plant and equipment (a) 77,802 124,330 326,114 398,453Investment properties (b) — — 8,037 7,917Prepaid land lease payment (c) 9,128 8,872 20,201 20,032Intangible assets (d) — 112 273 —Available-for-sale equity

investments (f) 6,050 50 50 50Deferred tax assets (g) — — 5,238 4,867

Total non-current assets 92,980 133,364 359,913 431,319

CURRENT ASSETSInventories (h) 67,985 140,284 213,854 182,793Trade receivables (i) 55,319 89,871 75,744 146,859Notes receivable (j) 4,500 — 15,164 41,935Prepayments, deposits and

other receivables (k) 54,984 15,577 14,681 57,598Due from related parties Section 6 (k)(3) 10,429 — 21,977 45,077Pledged deposits (l) 34,072 61,886 147,630 175,039Cash and bank balances (l) 63,087 26,077 110,166 31,527

Total current assets 290,376 333,695 599,216 680,828

CURRENT LIABILITIESTrade and bills payables (m) 120,321 169,096 421,189 482,376Other payables and accruals (n) 47,256 20,206 38,877 34,654Tax payable 6,880 302 23,355 29,480Interest-bearing bank loans (o) 65,000 30,000 50,000 70,000Due to related parties Section 6 (k)(3) — 811 10,642 14,910

Total current liabilities 239,457 220,415 544,063 631,420

NET CURRENT ASSETS 50,919 113,280 55,153 49,408


— I-45 —

RulesApp16(4)(2)(a)(b)(c)(d)(e)(f)(g)(h)

Rules4.05(2)(d)(e)(h)

Rules4.04(3)(a)

RulesApp16(2)(1)


30 April2003 2004 2005 2006


TOTAL ASSETS LESS

CURRENT LIABILITIES 143,899 246,644 415,066 480,727

NON-CURRENT LIABILITIESInterest-bearing bank loans (o) 25,000 — — 30,000

Net assets 118,899 246,644 415,066 450,727

EQUITYEquity attributable to equity

holders of the parentIssued capital Section 8 40,500 54,000 64,800 64,800Reserves Section 8 73,585 183,454 334,359 369,336Proposed final dividend Section 8 — 8,100 11,016 11,016

114,085 245,554 410,175 445,152Minority interests 4,814 1,090 4,891 5,575

Total equity 118,899 246,644 415,066 450,727


— I-46 —

Rules App16(2)(1)

Rules 4.04(3)(a)

Company


30 April2003 2004 2005 2006


NON-CURRENT ASSETS

Property, plant and equipment (a) 60,684 117,655 316,523 387,676

Investment properties (b) — — 10,302 11,779

Prepaid land lease payments (c) 9,128 8,872 20,201 20,032

Intangible assets (d) — 112 273 —

Interests in subsidiaries (e) 7,450 5,400 12,420 12,610

Available-for-sale equity

investments (f) 6,050 50 50 50

Deferred tax assets (g) — — 5,238 4,867

Total non-current assets 83,312 132,089 365,007 437,014

CURRENT ASSETS

Inventories (h) 22,627 115,180 176,474 156,213

Trade receivables (i) 33,140 89,871 75,338 146,859

Notes receivable (j) 4,200 — 15,163 41,935

Prepayments, deposits and other

receivables (k) 52,731 15,537 12,818 48,568

Tax recoverable 1,842 — — —

Due from subsidiaries (e) — 19,452 — —

Due from related parties 2,260 — 21,197 45,077

Pledged deposits (l) 34,072 61,886 147,630 175,039

Cash and cash equivalents (l) 42,981 25,837 107,312 21,427

Total current assets 193,853 327,763 555,932 635,118

CURRENT LIABILITIES

Trade and bills payables (m) 109,377 166,020 401,795 475,209

Other payables and accruals (n) 12,896 22,245 36,508 29,956

Tax payable — 302 23,826 26,687

Interest-bearing bank loans (o) 65,000 30,000 50,000 70,000

Due to subsidiaries (e) 8,554 — 21,989 22,835

Due to related parties — 138 8,241 9,640

Total current liabilities 195,827 218,705 542,359 634,327


— I-47 —

RulesApp16(4)(2)(a)(b)(c)(d)(e)RulesApp16(2)(1)Rules4.04(3)(a)


30 April2003 2004 2005 2006


NET CURRENT

ASSETS/(LIABILITIES) (1,974) 109,058 13,573 791

TOTAL ASSETS LESS

CURRENT LIABILITIES 81,338 241,147 378,580 437,805

NON-CURRENT LIABILITIES

Interest-bearing bank loans (o) 25,000 — — 30,000

Net assets 56,338 241,147 378,580 407,805

EQUITY

Equity attributable to equity

holders of the parent

Issued capital Section 8(a) 40,500 54,000 64,800 64,800

Reserves Section 8 15,838 179,047 302,764 331,989

Proposed final dividend Section 8 — 8,100 11,016 11,016

Total equity 56,338 241,147 378,580 407,805


— I-48 —

Rules App16(2)(1)

Rules App16(4)(2)(f)

(a) Property, plant and equipment

Group Buildings

Plant and

machinery

Electronic

equipment

Motor

vehicles

Other

equipment

Construction

in progress Total

RMB’000 RMB’000 RMB’000 RMB’000 RMB’000 RMB’000 RMB’000

Cost:

At 1 January 2003 38,169 36,274 1,295 4,231 2,887 27,355 110,211

Additions 2,160 26,935 1,141 1,572 1,029 20,606 53,443

Transfers from

construction

in progress 5,563 904 — 344 313 (7,124) —

Disposals (18,207) (4,600) (882) (713) (2,251) (40,082) (66,735)

At 31 December 2003 27,685 59,513 1,554 5,434 1,978 755 96,919

Additions 2,219 12,514 237 1,008 244 39,550 55,772

Transfers from

construction

in progress — 1,891 — — — (1,891) —

Disposals — (231) — (381) — — (612)

At 31 December 2004 29,904 73,687 1,791 6,061 2,222 38,414 152,079

Additions 523 19,899 354 1,742 657 199,843 223,018

Transfers from

construction

in progress 52,685 2,461 — — 24 (55,170) —

Transfer from a related

party (Section 6

(k)(2)) — 1,300 — — — — 1,300

Transfers to investment

properties (b) (8,069) — — — — — (8,069)

Disposals (229) (708) (72) (953) (34) — (1,996)

At 31 December 2005 74,814 96,639 2,073 6,850 2,869 183,087 366,332

Additions 2,864 7,917 69 65 158 61,265 72,338


party (Section 6

(k)(2)) — — — — — 5,040 5,040

Transfers from

construction in

progress 2,101 18 — 1,004 — (3,123) —

Disposals — (558) — (274) (349) — (1,181)

At 30 April 2006 79,779 104,016 2,142 7,645 2,678 246,269 442,529


— I-49 —

Rules4.05(2)(a)

RulesApp16(4)(2)(a)

Group Buildings

Plant and

machinery

Electronic

equipment

Motor

vehicles

Other

equipment

Construction

in progress Total


Accumulated

Depreciation:

At 1 January 2003 3,048 10,129 600 1,598 585 — 15,960

Depreciation during the

year 1,000 3,735 120 713 145 — 5,713

Disposals (473) (1,266) (361) (303) (153) — (2,556)

At 31 December 2003 3,575 12,598 359 2,008 577 — 19,117


year 1,443 6,073 304 973 263 — 9,056

Disposals — (112) — (312) — — (424)

At 31 December 2004 5,018 18,559 663 2,669 840 — 27,749


year 1,611 9,874 324 1,121 420 — 13,350


party (Section 6

(k)(2)) — 495 — — — — 495

Disposals (45) (294) (72) (939) (26) — (1,376)

At 31 December 2005 6,584 28,634 915 2,851 1,234 — 40,218


period 1,265 2,868 120 458 146 — 4,857

Disposals — (467) — (193) (339) — (999)

At 30 April 2006 7,849 31,035 1,035 3,116 1,041 — 44,076

Net Carrying Amount:

At 31 December 2003 24,110 46,915 1,195 3,426 1,401 755 77,802

At 31 December 2004 24,886 55,128 1,128 3,392 1,382 38,414 124,330

At 31 December 2005 68,230 68,005 1,158 3,999 1,635 183,087 326,114

At 30 April 2006 71,930 72,981 1,107 4,529 1,637 246,269 398,453


— I-50 —

Rules 4.05(2)(a)

Rules App16(4)(2)(a)

Company Buildings

Plant and

machinery

Electronic

equipment

Motor

vehicles

Other

equipment

Construction

in progress Total


Cost:

At 1 January 2003 19,753 10,470 321 2,650 698 1,439 35,331

Additions 2,151 24,177 1,076 1,292 916 5,192 34,804

Transfers from

construction in

progress 5,563 — — — 313 (5,876) —

Disposals — — (14) (178) — — (192)

At 31 December 2003 27,467 34,647 1,383 3,764 1,927 755 69,943

Additions 2,076 11,176 191 879 240 39,550 54,112

Transfer from a

subsidiary 347 16,100 217 1,739 55 — 18,458

Transfers from

construction in

progress — 1,891 — — — (1,891) —

Disposals — (231) — (321) — — (552)

At 31 December 2004 29,890 63,583 1,791 6,061 2,222 38,414 141,961

Additions 588 19,444 352 1,742 646 199,804 222,576

Transfers from

construction in

progress 52,632 2,514 — — 24 (55,170) —


party (Section

6(k)(2)) — 1,300 — — — — 1,300

Transfer to investment

properties (b) (12,123) — — — — — (12,123)

Disposals (229) (3,582) (90) (953) (34) — (4,888)

At 31 December 2005 70,758 83,259 2,053 6,850 2,858 183,048 348,826

Additions 2,864 7,917 69 65 158 61,265 72,338


party (Section 6

(k)(2)) — — — — — 5,040 5,040

Transfers from

construction in

progress 2,101 18 — 1,004 — (3,123) —


properties (b) (2,072) — — — — — (2,072)

Disposals — (558) — (274) (349) — (1,181)

At 30 April 2006 73,651 90,636 2,122 7,645 2,667 246,230 422,951


— I-51 —

Rules 4.05(2)(a)


Company Buildings

Plant and

machinery

Electronic

equipment

Motor

vehicles

Other

equipment

Construction

in progress Total


Accumulated

Depreciation:

At 1 January 2003 2,461 2,570 174 618 416 — 6,239


year 968 1,316 102 569 66 — 3,021

Disposals — — (1) — — — (1)

At 31 December 2003 3,429 3,886 275 1,187 482 — 9,259


year 1,429 3,902 279 773 324 — 6,707

Transfer from a

subsidiary 158 7,443 108 1,021 34 — 8,764

Disposals — (112) — (312) — — (424)

At 31 December 2004 5,016 15,119 662 2,669 840 — 24,306


year 1,316 8,788 322 1,121 418 — 11,965


party (Section

6(k)(2)) — 495 — — — — 495


properties (b) (1,492) — — — — — (1,492)

Disposals (45) (1,883) (78) (939) (26) — (2,971)

At 31 December 2005 4,795 22,519 906 2,851 1,232 — 32,303


period 1,174 2,459 119 458 145 — 4,355


properties (b) (384) — — — — — (384)

Disposals — (467) — (193) (339) — (999)

At 30 April 2006 5,585 24,511 1,025 3,116 1,038 — 35,275

Net Carrying Amount:

At 31 December 2003 24,038 30,761 1,108 2,577 1,445 755 60,684

At 31 December 2004 24,874 48,464 1,129 3,392 1,382 38,414 117,655

At 31 December 2005 65,963 60,740 1,147 3,999 1,626 183,048 316,523

At 30 April 2006 68,066 66,125 1,097 4,529 1,629 246,230 387,676


— I-52 —

Rules4.05(2)(a)


At 31 December 2003 and 2004, machinery with a net book value of RMB27,980,000 and RMB13,155,000 respectively

was pledged to secure to the Group’s bank loans (note (o) of Section 7).

As at the date of this report, the Group and the Company had not obtained the related building ownership certificates

for certain buildings with net book value of approximately RMB56,869,000. The Group and the Company are in the process

of applying for the related building ownership certificates as at the date of this report.

At 31 December 2005 and 30 April 2006, none of the Group’s machinery was pledged to secure the Group’s bank loans.

The Group’s buildings as set out above are all situated in Shouguang, the PRC.

(b) Investment properties

Group Company

Note RMB’000 RMB’000

Cost:

At 31 December 2003, 2004 and 1 January 2005 — —

Transfer from property, plant and equipment (a) 8,069 12,123

At 1 January 2006 8,069 12,123

Transfer from property, plant and equipment (a) — 2,072

At 30 April 2006 8,069 14,195

Accumulated depreciation:

At 31 December 2003, 2004 and 1 January 2005 — —

Transfer from property, plant and equipment (a) — 1,492

Recognised depreciation in current year 32 329

At 1 January 2006 32 1,821

Transfer from property, plant and equipment (a) — 384

Recognised depreciation in current period 120 211

At 30 April 2006 152 2,416

Carrying amount:

At 31 December 2003 — —

At 31 December 2004 — —

At 31 December 2005 8,037 10,302

At 30 April 2006 7,917 11,779

As at 31 December 2005 and 30 April 2006, the fair values of the Group’s investment properties were RMB9,373,000

and RMB9,560,460 respectively, which were based on a valuation by Shouguang Lu Dong Certified Public Accountants, an

independent professionally qualified valuer, on an open market, existing use basis. The investment properties are leased to

related parties under operating leases.


— I-53 —

(c) Prepaid land lease payment

Group and Company

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Carrying amount at beginning of the year/period 10,479 9,241 9,128 20,690

Additions 125 — 11,838 —

Recognised during the year/period (230) (113) (276) (159)

Disposals (1,133) — — —

Carrying amount at end of the year/period 9,241 9,128 20,690 20,531

Current portion included in prepayments, deposits

and other receivables (113) (256) (489) (499)

Non-current portion 9,128 8,872 20,201 20,032

The leasehold land is all situated in Shandong, the PRC and is held under a medium lease term.

(d) Intangible assets

Group and Company

As at 31 December

As at

30 April

2003 2004 2005 2006

Know-how RMB’000 RMB’000 RMB’000 RMB’000

Cost at beginning of the year/period, net of

accumulated amortisation: — — 112 273

Additions — 120 200 —

Amortisation provided during the year/period — (8) (39) (273)

At end of the year/period: — 112 273 —

At end of the year/period

Cost — 120 320 320

Accumulated amortisation — (8) (47) (320)

Net carrying amount — 112 273 —


— I-54 —

(e) Interests in subsidiaries/due to subsidiaries

Company

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Unlisted shares, at cost 7,450 5,400 12,420 12,610

Due from subsidiaries — 19,452 — —

Due to subsidiaries (8,554) — (21,989) (22,835)

(1,104) 24,852 (9,569) (10,225)

The amounts due from and to subsidiaries included in the Company’s current assets and current liabilities respectively

are unsecured, interest-free and have no fixed terms of repayment. The carrying amounts of these amounts due from/to

subsidiaries approximate to their fair values.

Particulars of the principal subsidiaries of the Group are set out in Section 5.

(f) Available-for-sale equity investments

Group and Company

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Unlisted equity investment, at cost (i) 50 50 50 50

Others, at estimated fair value (ii) 6,000 — — —

6,050 50 50 50

(i) The unlisted equity investment represented a 10% equity interest held in Shouguang Maolong Old Metals Recycle

Company Limited ( ), which was established in the PRC on 13 December 2002 with a

registered capital of RMB500,000.

(ii) Pursuant to a fund management trust agreement (the “Fund Management Trust Agreement”) entered into between

the Company and Shandong International Trust and Investment Corporation (“SDITIC”)

( ), an independent third party, on 27 September 2003, the Company has deposited an

amount of RMB6,000,000 with SDITIC as part of a collective trust and investment plan structured by SDITIC.

According to the Fund Management Trust Agreement, the Company entrusted SDITIC the right to invest in the

equities of three PRC enterprises, namely Qingdao Growful Pharmaceutical Company Limited

( ), Shandong Longlive Bio-technology Company Limited ( ), and

Tai An City Nong Xing Seeds Company Limited ( ) indirectly through Shandong High-Tech

Investment Corporation ( ). The period of such Fund Management Trust Agreement is from

8 October 2003 to 7 October 2006.


— I-55 —

On 29 September 2004, the Company signed an agreement to transfer its entire beneficiary interests pursuant to

the Fund Management Trust Agreement mentioned above to Ji Nan Tian Yi Printing Company Limited

( ), an independent third party, for an amount of RMB6,000,000. In addition, the Company was

entitled to the initial return in an amount of RMB289,000 arising from the equity investments in the investee

companies as stated by the Fund Management Trust Agreement. The Company has received the full amount of

RMB289,000 in 2004.

(g) Deferred tax

The movements in deferred tax assets are as follows:

Deferred tax assets

Group and Company

Provision available for offsetting

against future taxable profit

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

At beginning of the year/period — — — 5,238

Deferred tax credited to the income statement

during the year/period (Section 6 (g)) — — 5,238 (371)

At end of the year/period — — 5,238 4,867

(h) Inventories

Group

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Raw materials 11,629 42,546 60,670 48,887

Work in progress 15,867 34,158 60,466 58,650

Finished goods 40,489 63,580 92,718 75,256

67,985 140,284 213,854 182,793


— I-56 —

Rules4.05(2)(b)RulesApp16(4)(2)(b)

Company

As at 31 December

As at

30 April2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Raw materials 6,320 36,080 44,757 40,104

Work in progress 2,477 31,716 56,569 55,236

Finished goods 13,830 47,384 75,148 60,873

22,627 115,180 176,474 156,213

(i) Trade receivables

The Group’s trading terms with its customers are mainly on credit, except for new customers, where payment in advance

is normally required. The credit period is generally less than three months, extending up to six months for major customers.

Each customer has a maximum credit limit. The Group seeks to maintain strict control over its outstanding receivables to

minimise credit risk. Overdue balances are reviewed regularly by senior management. Trade receivables are non-interest-

bearing.

An aged analysis of the trade receivables as at the balance sheet date, based on the invoice date, and net of provisions,

is as follows:

Group

As at 31 December

As at

30 April2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Within 3 months 45,234 81,408 73,461 134,560

3 to 6 months 4,462 7,746 999 11,456

6 months to 1 year 3,578 717 1,284 843

1 to 2 years 2,045 — — —

55,319 89,871 75,744 146,859

Company

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Within 3 months 32,002 81,408 73,055 134,560

3 to 6 months 697 7,746 999 11,456

6 months to 1 year 131 717 1,284 843

1 to 2 years 310 — — —

33,140 89,871 75,338 146,859


— I-57 —


(j) Notes receivable

The maturity profiles of the notes receivable are as follows:

Group

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Within 3 months 3,000 — 5,664 26,935

3 to 6 months 1,500 — 9,500 15,000

4,500 — 15,164 41,935

Company

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Within 3 months 3,000 — 5,663 26,935

3 to 6 months 1,200 — 9,500 15,000

4,200 — 15,163 41,935

(k) Prepayments, deposits and other receivables

Group

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Prepayments 48,425 13,421 13,578 56,278

Deposits and other receivables 6,559 2,156 1,103 1,320

54,984 15,577 14,681 57,598


— I-58 —


Company

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Prepayments 46,781 13,381 11,797 47,282

Deposits and other receivables 5,950 2,156 1,021 1,286

52,731 15,537 12,818 48,568

(l) Cash and cash equivalents and pledged deposits

Group

As at 31 December

As at

30 April

2003 2004 2005 2006

Note RMB’000 RMB’000 RMB’000 RMB’000

Cash and bank balances 63,087 26,077 110,166 31,527

Time deposits pledged as security for

bills payable (m) 34,072 61,886 147,630 175,039

97,159 87,963 257,796 206,566

Less: Time deposits with original maturity

of over three months when acquired,

pledged as security for bills payable (34,072) (30,435) (72,102) (109,310)

Cash and cash equivalents 63,087 57,528 185,694 97,256

Company

As at 31 December

As at

30 April

2003 2004 2005 2006

Note RMB’000 RMB’000 RMB’000 RMB’000

Cash and bank balances 42,981 25,837 107,312 21,427

Time deposits pledged as security

for bills payable (m) 34,072 61,886 147,630 175,039

77,053 87,723 254,942 196,466

Less: Time deposits with original maturity

of over three months when acquired,

pledged as security for bills payable (34,072) (30,435) (72,102) (109,310)

Cash and cash equivalents 42,981 57,288 182,840 87,156


— I-59 —


At 31 December 2003, 2004, 2005 and 30 April 2006, the cash and bank balances of the Group denominated in RMB

amounted to RMB95,504,000, RMB87,960,000, RMB255,672,000 and RMB195,940,000 respectively. The RMB is not freely

convertible into other currencies, however, under the PRC Foreign Exchange Control Regulations and Administration of

Settlement, Sale and Payment of Foreign Exchange Regulations, the Group is permitted to exchange RMB for other currencies

through banks authorised to conduct foreign exchange business.

The carrying amounts of the cash and cash equivalents and the pledged deposits approximate to their fair values.

(m) Trade and bills payables

An aged analysis of the trade and bills payables as at the balance sheet date, based on the invoice date, is as follows:

Group

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Within 3 months 67,261 102,871 237,954 254,273

3 to 6 months 48,213 62,893 173,551 208,892

6 months to 1 year 3,872 1,690 4,752 10,003

1 to 2 years 975 1,642 3,946 5,008

2 to 3 years — — 986 4,200

120,321 169,096 421,189 482,376

Company

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Within 3 months 60,101 100,281 219,720 253,205

3 to 6 months 46,810 62,493 172,959 205,410

6 months to 1 year 2,123 1,631 4,206 8,046

1 to 2 years 343 1,615 3,924 4,348

2 to 3 years — — 986 4,200

109,377 166,020 401,795 475,209

The Group and the Company’s bills payables of RMB64,702,000, RMB124,822,000, RMB325,711,000, and

RMB392,605,000 at 31 December 2003, 2004, 2005 and 30 April 2006 respectively were secured by the pledge of certain of

the time deposits amounting to RMB34,072,000, RMB61,886,000, RMB147,630,000 and RMB175,039,000 respectively.

The trade payables are non-interest-bearing and are normally settled on 6-month terms.


— I-60 —

Rules4.05(2)(c)RulesApp16(4)(2)(c)

(n) Other payables and accruals

Group

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Advance from customers 28,180 10,573 7,863 4,998

Payroll payables 1,946 2,565 11,675 14,120

Welfare payables 2,158 2,458 2,416 1,950

Other payables 12,132 2,659 10,938 8,554

Accruals 2,840 1,951 5,985 5,032

47,256 20,206 38,877 34,654

Company

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Advance from customers 1,513 10,570 7,863 4,996

Payroll payable 1,698 2,269 10,614 13,017

Welfare payable 1,850 2,417 2,090 1,522

Other payables 6,211 5,585 10,325 5,695

Accruals 1,624 1,404 5,616 4,726

12,896 22,245 36,508 29,956

Other payables are non-interest-bearing and have an average term of three months.


— I-61 —

Rules4.05(2)(c)RulesApp16(4)(2)(c)

(o) Interest-bearing bank loans

Group and Company

Effective

interest rate Maturity

As at 31 December

As at

30 April

2003 2004 2005 2006

(%) RMB’000 RMB’000 RMB’000 RMB’000

Current

Secured — — 30,000 15,000 — —

Unsecured 5.22~5.58 2006-2007 35,000 15,000 50,000 70,000

65,000 30,000 50,000 70,000

Non-current

Secured — — 25,000 — — —

Unsecured 5.58 2007-2008 — — — 30,000

25,000 — — 30,000

90,000 30,000 50,000 100,000

Group and Company

Effective

interest rate Maturity

As at 31 December

As at

30 April

2003 2004 2005 2006

(%) RMB’000 RMB’000 RMB’000 RMB’000

Analysed into:

Bank loans repayable:

within one year 5.22~5.58 2006-2007 65,000 30,000 50,000 70,000

in the second year 5.58 2007-2008 25,000 — — 30,000

90,000 30,000 50,000 100,000

As at 31 December 2003, short term bank loans amounting to RMB30,000,000 were secured by certain of the Group’s

plant and machinery with an aggregate net book value of approximately RMB27,980,000 (note (a) of Section 7). In addition,

Maolong Machinery and Molong Equipment guaranteed certain of the Company’s bank loans up to an amount of

RMB12,000,000 and RMB10,000,000 as at 31 December 2003, respectively.

As at 31 December 2003, long term bank loan amounting to RMB25,000,000 was secured by certain of the Group’s

prepaid land lease payment and buildings, which had an aggregate net book value at 31 December 2003 of approximately

RMB15,847,000.

At 31 December 2004, short term loans amounting to RMB15,000,000 were secured by mortgages over the Group’s

machinery, which had an aggregate net book value at 31 December 2004 of approximately RMB13,155,000 (note (a) of Section

7). All borrowings are in RMB at fixed interest rates.

The carrying amounts of the Group’s and the Company’s loans approximate to their fair values.


— I-62 —

Rules 4.05(2)(f)

Rules4.04(10)Rules4.05(2)(c)

Rules App16(4)(2)(c)

(p) Disposals of subsidiaries

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Net assets disposed of:

Property, plant and equipment 63,908 — — —

Cash and bank balances 7,434 — — —

Trade receivables 4,698 — — —

Prepayments and other receivables 27,908 — — —

Inventories 356 — — —

Trade payables (3,839) — — —

Other payables and accruals (9,148) — — —

Minority interests (42,479) — — —

48,838

Gain on disposals of subsidiaries 2,658 — — —

51,496 — — —

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Satisfied by:

Cash 30,000 — — —

Prepayments, deposits and other receivables 21,496 — — —

51,496 — — —

An analysis of the net inflow of cash and cash equivalents in respect of the disposal of a subsidiary is as follows:

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Cash consideration 30,000 — — —

Cash and bank balances disposed of (7,434) — — —

Net inflow of cash and cash equivalents in respect

of the disposal of a subsidiary 22,566 — — —


— I-63 —

The results of the subsidiary disposed of in the year ended 31 December 2003 had no significant impact on the Group’s

consolidated revenue or profit after tax for the year of 2003.

(q) Operating lease commitments

(i) As lessor

The Group leases its investment properties (note (b) of Section 7) under operating lease arrangements, with leases

negotiated for terms ranging from 10 to 20 years.

The Group had total future minimum lease receivables under non-cancellable operating leases with its tenants

falling due as follows:

Group

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Within one year 143 98 690 690

In the second to fifth years, inclusive 626 392 1,908 1,908

After five years 512 196 3,150 2,920

1,281 686 5,748 5,518

Company

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Within one year 143 98 1,006 1,006

In the second to fifth years, inclusive 626 392 2,856 2,856

After five years 512 196 4,731 4,396

1,281 686 8,593 8,258


— I-64 —

(ii) As lessee

The Group leases certain production facilities and staff dormitories under operating lease arrangements. Leases

for production facilities and staff dormitories are negotiated for terms ranging from 2 to 10 years.

The Group and the Company had total future minimum lease payments under non-cancellable operating leases

falling due as follows:

Group and Company

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Within one year 267 267 516 516

In the second to fifth years, inclusive 800 1,068 1,304 1,304

After five years 1,066 532 1,499 1,318

2,133 1,867 3,319 3,138

(r) Commitments and contingent liabilities

In addition to the operating lease commitments, the Group and the Company had the following commitments at 31

December 2003, 2004, 2005 and 30 April 2006:

(i) Capital commitments

Group and Company

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Contracted, but not provided for:

Land and buildings — 37,144 25,549 7,695

Plant and machinery 1,923 90,640 120,790 62,748

Intangible assets — 186 — —

1,923 127,970 146,339 70,443

Authorised, but not contracted for:

Plant and machinery — 43,750 — —

1,923 171,720 146,339 70,443


— I-65 —

(ii) Contingent liabilities

As at 31 December 2003, the Company had provided counter-guarantee to SDITIC in relation to the guarantee

granted by SDITIC to the Company for bills payable of RMB6,000,000. The counter-guarantee provided by the Company

to SDITIC was by way of pledging the Company’s beneficiary interests under a fund management trust agreement entered

into between the Company and SDITIC (note (f) of Section 7).

As at 31 December 2004, 2005 and 30 April 2006, neither the Group, nor the Company had any significant

contingent liabilities.

(s) Pledge of assets

There were no assets pledged for bank loans at 31 December 2005 and 30 April 2006.

Details of bank loans at 31 December 2003 and 2004, which were secured by certain assets of the Group, are included

in note (o) of Section 7.

(t) Financial risk management objectives and policies

The Group’s principal financial instruments comprise interest-bearing bank loans, cash and bank balances and pledged

deposits. The main purpose of these financial instruments is to raise finance for the Group’s operations. The Group has various

other financial assets and liabilities such as trade receivables and trade payables, which arise directly from its operations.

It is the Group’s policy that no trading in financial instruments shall be undertaken.

The main risks arising from the Group’s financial instruments are cash flow interest rate risk, foreign currency risk,

credit risk and liquidity risk.

The Group does not have written risk management policies and guidelines. However, the management meets periodically

to analyse and formulate measurements to manage the Group’s exposure to financial risks. Generally, the Group employs a

conservative strategy regarding its risk management.

(i) Cash flow interest rate risk

The interest rates and the terms of repayment of the Group’s interest-bearing bank loans are disclosed in note (o)

of Section 7 to the Financial Information. The Group has no significant exposure to interest rate risk.

(ii) Foreign currency risk

The Group’s exposure to market risk for changes in foreign currency exchange rates relates primarily to certain

trade receivables and certain cash and cash equivalents in currencies other than RMB, the functional currency.

(iii) Credit risk

The Group trades mainly with recognised and creditworthy third parties. It is the Group’s policy that all customers

who wish to trade on credit terms are subject to credit verification procedures. In addition, receivable balances are

monitored on an ongoing basis and the Group’s exposure to bad debts is not significant. For transactions that are not

denominated in the functional currencies of the relevant operating units, the Group does not offer credit terms without

specific approval of the Head of Credit Control.


— I-66 —

With respect to credit risk arising from the other financial assets of the Group, comprising cash and cash

equivalents, available-for-sale financial assets and other receivables, the Group’s exposure to credit risk arises from

default of the counterparty, with a maximum exposure equal to the carrying amount of these instruments. There are no

significant concentrations of credit risk within the Group in relation to the other financial assets.

Since the Group trades mainly with recognised and creditworthy third parties, there is no requirement for

collateral.

(iv) Liquidity risk

The Group’s objective is to maintain a balance between continuity of funding and flexibility through the use of

interest-bearing bank loans.


— I-67 —

8. CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

Group

Attributable to equity holders of the parent

Issuedshare

capitalCapitalreserve

Statutoryreserve

fund (c)

Statutorywelfare

fund (c)

Enterpriseexpansion

fund (c)Retained

profits

Subtotalof

reserves

Proposedfinal

dividend TotalMinorityinterests

TotalEquity

Notes RMB’000 RMB’000 RMB’000 RMB’000 RMB’000 RMB’000 RMB’000 RMB’000 RMB’000 RMB’000 RMB’000

At 1 January 2003 40,500 21,278 3,476 2,322 10 2,522 29,608 — 70,108 45,630 115,738

Net profit for the year — — — — — 43,977 43,977 — 43,977 2,173 46,150

Disposal of a subsidiary — (651) — (10) (10) 671 — — — (42,989) (42,989)

Transfer from retained

profits to statutory

funds — — 4,107 2,058 — (6,165) — — — — —

At 31 December 2003 40,500 20,627 7,583 4,370 — 41,005 73,585 — 114,085 4,814 118,899

Issue of shares (a) 13,500 89,169 — — — — 89,169 — 102,669 — 102,669

Share issue expenses (a) — (21,760) — — — — (21,760) — (21,760) — (21,760)


Liquidation of a subsidiary — — — — — — — — — (6,449) (6,449)


profits to statutory

funds — — 8,456 3,649 — (12,105) — — — — —

Interim 2004 dividend Section 6 (i) — — — — — (10,806) (10,806) — (10,806) — (10,806)

Proposed final 2004

dividend Section 6 (i) — — — — — (8,100) (8,100) 8,100 — — —

At 31 December 2004 54,000 88,036 16,039 8,019 — 71,360 183,454 8,100 245,554 1,090 246,644


— I-68 —

Rules 4.04(6)(9)

Rules 4.05(2)(g)

Rules App16(2)(4)

Rules App16(4)(2)(g)

Group

Attributable to equity holders of the parent

Issuedshare

capitalCapitalreserve

Statutoryreserve

fund (c)

Statutorywelfare

fund (c)

Enterpriseexpansion

fund (c)Retained

profits

Subtotalof

reserves

Proposedfinal

dividend TotalMinorityinterests

TotalEquity

Notes RMB’000 RMB’000 RMB’000 RMB’000 RMB’000 RMB’000 RMB’000 RMB’000 RMB’000 RMB’000 RMB’000

At 1 January 2005 54,000 88,036 16,039 8,019 — 71,360 183,454 8,100 245,554 1,090 246,644

Final 2004 dividend declared — — — — — — — (8,100) (8,100) — (8,100)

Issue of new shares (a) 10,800 94,831 — — — — 94,831 — 105,631 — 105,631

Share issue expenses (a) — (5,155) — — — — (5,155) — (5,155) — (5,155)


Investment in a subsidiary — — — — — — — — — 780 780


profits to statutory funds — — 7,926 3,963 — (11,889) — — — — —

Interim 2005 dividend Section 6 (i) — — — — — (12,982) (12,982) — (12,982) — (12,982)

Proposed final 2005

dividend Section 6 (i) — — — — — (11,016) (11,016) 11,016 — — —

At 31 December 2005 64,800 177,712 23,965 11,982 — 120,700 334,359 11,016 410,175 4,891 415,066

Net profit for the period — — — — — 34,977 34,977 — 34,977 684 35,661

At 30 April 2006 64,800 177,712 23,965 11,982 — 155,677 369,336 11,016 445,152 5,575 450,727

(Unaudited)

At 1 January 2005 54,000 88,036 16,039 8,019 — 71,360 183,454 8,100 245,554 1,090 246,644

Final 2004 dividend declared — — — — — — — (8,100) (8,100) — (8,100)

Net profit for the period — — — — — 23,866 23,866 — 23,866 545 24,411

At 30 April 2005 54,000 88,036 16,039 8,019 — 95,226 207,320 — 261,320 1,635 262,955


— I-69 —

Rules 4.04(6)(9)

Rules 4.05(2)(g)

Rules App16(2)(4)

Rules App 16(4)(2)(g)

Company

Capitalreserve

Statutoryreserve

fund (c)

Statutorywelfare

fund (c)Retained

profits Total

Notes RMB’000 RMB’000 RMB’000 RMB’000 RMB’000

Balance at 1 January

2003 18,568 1,352 675 (21,888) (1,293)

Net profit for the year Section 6 (h) — — — 17,131 17,131

Transfers — 1,284 642 (1,926) —

At 31 December 2003 18,568 2,636 1,317 (6,683) 15,838

Issue of shares (a) 89,169 — — — 89,169

Share issue expenses (a) (21,760) — — — (21,760)


Interim 2004 dividend Section 6 (i) — — — (10,806) (10,806)

Proposed final 2004

dividend Section 6 (i) — — — (8,100) (8,100)

Transfers — 6,136 3,068 (9,204) —

At 31 December 2004 85,977 8,772 4,385 79,913 179,047

Issue of shares 94,831 — — — 94,831

Share issue expenses (5,155) — — — (5,155)


Interim 2005 dividend Section 6 (i) — — — (12,982) (12,982)

Proposed final 2005

dividend Section 6 (i) — — — (11,016) (11,016)

Transfers — 7,926 3,963 (11,889) —

At 31 December 2005 175,653 16,698 8,348 102,065 302,764

Net profit for the

period Section 6 (h) — — — 29,225 29,225

At 30 April 2006 175,653 16,698 8,348 131,290 331,989


— I-70 —

Rules 4.04(6)(9)

Rules 4.05(2)(g)

Rules App16(2)-(4)

Rules App16(4)(2)(g)

(a) Issued share capital

Group and Company

As at 31 December

As at

30 April

2003 2004 2005 2006

RMB’000 RMB’000 RMB’000 RMB’000

Shares

Authorised:

647,998,000 (2005: 647,998,000, 2004:

539,998,000, 2003: 405,000,000) ordinary

shares of RMB0.10 each 40,500 54,000 64,800 64,800

Issued and fully paid:

647,998,000 (2005: 647,998,000, 2004:

539,998,000, 2003: 405,000,000) ordinary

shares of RMB0.10 each 40,500 54,000 64,800 64,800

(i) Pursuant to a special resolution passed on 20 March 2004 and the approval document issued by the CSRC on 29

December 2003, the Company was authorised to offer H shares for subscription and apply for the listing on GEM

of 138,276,000 ordinary shares of RMB0.10 each, comprising 134,998,000 new H shares and 3,278,000 H Shares

converted from 3,278,000 state-owned domestic shares.

(ii) On 15 April 2004, 138,276,000 ordinary shares of RMB0.10 each, comprising 134,998,000 new H shares and

3,278,000 H shares converted from 3,278,000 state-owned domestic shares, were issued to the public by way of

public offering and placing of shares at a price of HK$0.70 (equivalent to approximately RMB0.7425) per share.

The net proceeds from the above share offer, after deducting the related underwriting and other expenses, were

RMB80,909,000.

(iii) Pursuant to the approval document by the CSRC, Zheng Jian Guo He Zi [2005] No.13, the Company was

authorised to issue new H shares. On 26 April 2005, 108,000,000 ordinary shares of RMB0.10 each were issued

to the public by way of public offering at a price of HK$0.92 (equivalent to approximately RMB0.9781) per share.

The net proceeds from the above share offer, after deducting the related underwriting and other expenses, were

RMB100,476,000.

(iv) Pursuant to the special resolution (the “Special Resolution”) passed in the extraordinary general meeting (the

“EGM”) and the two separate class meetings held on 30 December 2005 respectively, the Board is authorised to

propose migration of the listing of the H shares from GEM to the Main Board of the Stock Exchange.


— I-71 —

RulesApp16(4)(2)-(g)

A summary of the transactions during the year with reference to the above movements in the Company’s issued share

capital is as follows:

Number of

shares in issue

Issued

share capital

Capital

Reserve Total

RMB’000 RMB’000 RMB’000

At 1 January 2003 405,000,000 40,500 21,278 61,778

Disposal of a subsidiary — — (651) (651)

At 1 January 2004 405,000,000 40,500 20,627 61,127

Issue of new shares (ii) 134,998,000 13,500 89,169 102,669

Share issue expenses — — (21,760) (21,760)

At 1 January 2005 539,998,000 54,000 88,036 142,036

Issue of new shares (iii) 108,000,000 10,800 94,831 105,631

Share issue expenses — — (5,155) (5,155)

At 1 January 2006 and 30 April 2006 647,998,000 64,800 177,712 242,512

(b) Capital reserves

The capital reserve of the Group includes the non-distributable reserves of the Company and its subsidiaries created in

accordance with accounting and financial regulations of the PRC.

(c) Statutory funds

The Company and its subsidiary registered in the PRC are required to comply with the laws and regulations of the PRC

and their articles of association to provide for certain statutory funds, namely the statutory reserve fund and the statutory

welfare fund, which are appropriated from the net profit after tax, but before any dividend distribution.

The statutory reserve fund is made at 10% of the net profit. The statutory reserve fund is provided for each entity until

the balance of such fund has reached 50% of the entity’s registered capital. The statutory reserve fund may only be used, upon

approval by the relevant authority, to offset accumulated losses or to increase capital. According to the articles of association,

the statutory welfare fund is made at 5%-10% of the net profit. It is only permitted to be used for special bonuses or for the

collective welfare of the employees.


— I-72 —

Rules App 16(4)(2)(g)

9. CONSOLIDATED CASH FLOW STATEMENTS

The consolidated cash flow statements of the Group for the Relevant Periods and the four-month

period ended 30 April 2005 are as follows:


Four-month period

ended 30 April2003 2004 2005 2005 2006

Sections RMB’000 RMB’000 RMB’000 RMB’000 RMB’000

(Unaudited)

CASH FLOWS FROM OPERATINGACTIVITES

Profit before tax 59,347 65,576 115,519 32,408 54,057

Adjustments for:

Finance costs 6(c) 4,738 4,572 3,444 1,338 1,920

Investment income from a trust investment — (289) — — —

Interest income 6(d) (893) (1,029) (2,048) (709) (891)

Gain on disposal of property, plant andequipment 6(d) — (102) (204) (169) (50)

Amortisation of know-how 7(d) — 8 39 6 273

Gain on disposal of subsidiaries 6(b) (2,658) — — — —

Loss on disposal of an associate 5(vi) 14 — — — —

Depreciation 6(d) 5,713 9,056 13,382 3,668 4,977

Recognition of prepaid land lease payments 6(d) 230 113 276 64 159

Operating profit before working capital changes 66,491 77,905 130,408 36,606 60,445

(Increase)/decrease in inventories (11,257) (72,299) (73,570) (28,526) 31,061

(Increase)/decrease in trade receivables (14,860) (34,552) 14,127 (280) (71,115)

(Increase)/decrease in notes receivable (4,339) 4,500 (15,164) (4,750) (26,771)

(Increase)/decrease in prepayment, deposits andother receivables (37,622) 39,550 1,129 3,851 (42,907)

(Increase)/decrease in amounts due from relatedparties (39) 10,429 (21,197) — (23,908)

Increase in trade and bills payables 38,760 48,775 252,093 30,585 61,187

Increase/(decrease) in other payables andaccruals 10,304 (27,050) 18,671 46,202 (4,223)

Decrease in an amount due to an associate (61) — — — —

Increase/(decrease) in amounts due to relatedparties 3,584 811 9,026 (811) 4,268

Cash generated from/(used in) operations 50,961 48,069 315,523 82,877 (11,963)

Interest paid (4,738) (4,572) (3,444) (1,338) (1,920)

Income tax paid— all in Mainland China (4,835) (8,063) (9,456) (8,085) (11,900)

Net cash inflow from operating activities 41,388 35,434 302,623 73,454 (25,783)


— I-73 —

Rules 4.04(5)Rules App16(2)(3)

Rules App16(2)(3)


Four-month period

ended 30 April2003 2004 2005 2005 2006

Sections RMB’000 RMB’000 RMB’000 RMB’000 RMB’000

(Unaudited)

CASH FLOWS FROM INVESTINGACTIVITIES

Investment income from a trust investment 6(b) — 289 — — —

Interest received 6(d) 893 1,016 2,048 709 891

Purchases of property, plant and equipment 7(a) (53,443) (55,772) (223,018) (51,586) (77,378)

Additions to prepaid land lease payment 7(c) (125) — (11,838) — —

Additions to know-how 7(d) — (120) (200) (200) —

Proceeds from disposal of property, plant andequipment 271 290 824 260 232

Proceeds from disposal of prepaid land leasepayment 1,133 — — — —

Proceeds from disposal of a long terminvestment 7(f) — 6,000 — — —

Proceeds from disposal of an associate 1,666 — — — —

Disposal of a subsidiary 7(p) 22,566 — — — —

Purchase of a long term investment 7(f) (6,000) — — — —

Loans to related companies 17,240 — — — —

Increase in pledged time deposits (34,072) 3,637 (41,667) (52,021) (37,208)

Net cash outflow from investing activities (49,871) (44,660) (273,851) (102,838) (113,463)

CASH FLOWS FROM FINANCINGACTIVITIES

Proceeds from issue of shares 8(a) — 102,669 105,631 — —

Share issue expenses 8(a) — (21,760) (5,155) — —

Capital contributed by a minority shareholder — 600 — — 808

New bank loans 100,000 38,000 105,000 60,000 60,000

Repayment of bank loans (86,700) (98,000) (85,000) (20,000) (10,000)

Dividends paid (5,469) (10,806) (21,082) (8,100) —

Dividends paid to a minority shareholder — (4,559) — — —

Distribution of minority interests — (2,477) — — —

Net cash inflow from financing activities 7,831 3,667 99,394 31,900 50,808

NET INCREASE/(DECREASE)IN CASH AND CASH EQUIVALENTS (652) (5,559) 128,166 2,516 (88,438)

Cash and cash equivalents at beginning of year 63,739 63,087 57,528 57,528 185,694

CASH AND CASH EQUIVALENTS AT END OFYEAR/PERIOD 7(l) 63,087 57,528 185,694 60,044 97,256

ANALYSIS OF BALANCES OF CASH ANDCASH EQUIVALENTS

Cash and bank balances 7(l) 63,087 26,077 110,166 25,838 31,527

Time deposits with original maturity of less thanthree months when acquired, pledged assecurity for bills payable — 31,451 75,528 34,206 65,729

63,087 57,528 185,694 60,044 97,256


— I-74 —

Rules 4.04(5)

Rules 4.04(5)

Rules App16(2)(3)

Rules App16(2)(3)

10. DIRECTORS’ AND SUPERVISORS’ REMUNERATION

Save as disclosed herein, no remuneration has been paid or is payable in respect of any of the

Relevant Periods referred to in this report by the Company or any of its subsidiaries to the directors

or supervisors of the Company.

The amounts of directors’ fees and other emoluments payable to the directors, and the amounts

of supervisors’ fees and other emoluments payable to the supervisors for the year ending 31 December

2006 will be approximately RMB1,466,800 and RMB105,000 respectively under the service contracts

with the directors and the supervisors, if any.

11. SUBSEQUENT FINANCIAL STATEMENTS

No audited financial statements have been prepared by the Company or any of the companies

now comprising the Group in respect of any period subsequent to 30 April 2006.

Yours faithfully,

Ernst & YoungCertified Public Accountants

Hong Kong


— I-75 —

Rules 4.08(4)

Extracted from the Interim Report 2006 published by the Company

UNAUDITED CONDENSED CONSOLIDATED PROFIT AND LOSS ACCOUNT

For the six months ended 30 June 2006

The unaudited results of the Group for the six months ended 30 June 2006 together with the

unaudited comparative figures for the corresponding period in 2005 are as follows:


2006 2005

Notes RMB’000 RMB’000

Revenue (2) 443,398 323,866

Cost of sales (334,778) (255,378)

Gross profit 108,620 68,488

Other income and gains (3) 19,476 3,908

Selling and distribution costs (13,142) (9,340)

Administrative expenses (14,693) (10,267)

Other operating expenses (19,572) (1,613)

Profit from operating activities (4) 80,689 51,176

Finance costs (3,803) (1,677)

Profit before tax 76,886 49,499

Tax (5) (25,374) (11,682)

Profit for the period 51,512 37,817

Attributable to:

Shareholders of the Company 50,424 36,556

Minority interests 1,088 1,261

51,512 37,817

Earnings per share

— basic (RMB) (6) 0.078 0.064

Interim dividend per share (RMB) 0.015 0.020

APPENDIX II INTERIM RESULTS 2006

— II-1 —

Notes:

1. GENERAL INFORMATION AND BASIS OF PREPARATION

The interim financial statements were unaudited. The interim financial statements have been reviewed by the audit

committee of the Company.

The Company was incorporated as a joint stock company with limited liability in the People’s Republic of China (the

“PRC”) on 30 December 2001 and its H shares were listed on the GEM (the “Listing”) on 15 April 2004. On 5 July 2004, the

Company became a Sino-foreign joint stock limited company.

The unaudited financial statements of the Group have been prepared in accordance with Hong Kong Financial Reporting

Standards (“HKFRSs”) (which also include Hong Kong Accounting Standards (“HKASs”) and Interpretations) issued by the

Hong Kong Institute of Certified Public Accountants, accounting principles generally accepted in Hong Kong and the disclosure

requirements of chapter 18 of the Rules Governing the Listing of Securities on the Growth Enterprise Market of the Stock

Exchange of Hong Kong Limited (the “Stock Exchange”) (the “GEM Listing Rules”)

The principal accounting policies used in the preparation of the unaudited financial statements are consistent with those

used in the preparation of the Group’s annual financial statements for the year ended 31 December 2005.

The Group has adopted the following standards that have been issued and effective for the periods beginning on or after

1 January 2006. The adoption of such standards did not have material effect on these financial statements.

HKAS 19 (Amendment) Actuarial gains or losses, group plans and disclosures

HKAS 21 (Amendment) Net Investment in a Foreign Operation

HKAS 39 (Amendment) The Fair Value Option

The Group has not early adopted the following standards that have been issued but not yet effective. The adoption of

such standards will not result in substantial changes to the Group’s accounting policies.

HKAS 1 (Amendment) Capital Disclosures

HKFRS 7 Financial Instruments - Disclosures


— II-2 —

2. REVENUE & SEGMENT INFORMATION

Revenue represents the invoiced value of goods sold, and after allowances for goods returned and trade discounts. All

significant intra-group transactions have been eliminated on consolidation.

The Group’s operating business is with customers based in the PRC, the United States, Europe and other countries. Each

of the Group’s geographical segments represents customer destinations to which the Group sells products or provides services

which are subject to risks and returns that are different from those of the other geographical segments. Save as disclosed below,

no further business segment information is presented as over 90% of the Group’s revenue and assets relate to the sales of

petroleum machinery.


PRC

United

States Europe

Other



Revenue


Other revenue 14,392 — — — 14,392


Segment results 64,200 18,865 10,691 5,016 98,772

Unallocated income 5,084

Unallocated expenses (23,167)

Profit from operating activities 80,689



Tax (25,374)



— II-3 —


PRC

United

States Europe

Other



Revenue


Other revenue 97 — — — 97


Segment results 37,749 9,247 5,765 6,400 59,161

Unallocated income 3,811

Unallocated expenses (11,796)

Profit from operating activities 51,176



Tax (11,682)


3. OTHER INCOME AND GAINS


2006 2005

RMB’000 RMB’000

Other income and gains

Sale of materials 14,392 —

Subcontracting income 258 97

Interest income 1,632 1,004

Government grant and subsidies — 160

VAT refund 2,794 2,165

Rental income 172 98

Others 228 384

19,476 3,908


— II-4 —

4. PROFIT FROM OPERATING ACTIVITIES

The Group’s profit from operating activities is arrived at after charging:


2006 2005

RMB’000 RMB’000

Cost of inventories sold 334,778 255,253

Depreciation of fixed assets 7,557 5,250

Provision for obsolete inventories 1,836 855

Provision for doubtful debts (410) (980)

Research and development costs 5,780 989

5. TAXATION


2006 2005

RMB’000 RMB’000

The charge comprises

PRC income tax 25,845 11,682

Deferred tax (471) —

25,374 11,682

The Company is located in the PRC and as a result is subject to the PRC corporate income tax at a rate of 33% on their

assessable profits. No provision for Hong Kong profits tax has been made as the Group did not generate any assessable profits

in Hong Kong during the period under review.

A subsidiary of the Company, namely, Weifang Molong Drilling Equipment Company Limited (“Molong Drilling

Equipment”) was approved by the Ministry of Civil Affairs of Shandong Province as a welfare enterprise and hence is entitled

to a full exemption from corporate income tax. However, the exemption is only granted after the approval from the local tax

administration. As at 30 June 2006, Molong Drilling Equipment did not receive the approval document of the exemption for

2006.

The Group has no significant unprovided deferred tax as at 30 June 2005 and 2006.


— II-5 —

6. EARNINGS PER SHARE

The calculation of the basic earnings per share is based on the profit attributable to shareholders of approximately

RMB25,838,000 and RMB50,424,000 for the three months and six months ended 30 June 2006 (2005: RMB19,852,000 and

RMB36,556,000) and on the weighted average number of approximately 647,998,000 shares (2005: 569,832,000 shares) in issue

during the period.

Diluted earnings per share is not presented for the three months and six months ended 30 June 2006 and 2005 as there

were no potential dilutive securities in existence during the relevant periods.


— II-6 —

The following is the text of a letter, summary of values and valuation certificates, prepared for

the purpose of incorporation in this prospectus received from Sallmanns (Far East) Limited, an

independent valuer, in connection with its valuation as at 31 July 2006 of the property interests of the

Group.

19 October 2006

The Board of Directors


No. 99 Beihai Road

Shouguang City

Shandong Province

The People’s Republic of China

Dear Sirs,

In accordance with your instructions to value the properties in which Shandong Molong

Petroleum Machinery Company Limited (the “Company”) and its subsidiaries (hereinafter together

referred to as the “Group”) have interests in the People’s Republic of China (the “PRC”), we confirm

that we have carried out inspections, made relevant enquiries and searches and obtained such further

information as we consider necessary for the purpose of providing you with our opinion of the capital

values of the property interests as at 31 July 2006 (the “date of valuation”).

Our valuations of the property interests represent the market value which we would define as

intended to mean “the estimated amount for which a property should exchange on the date of valuation

between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing

wherein the parties had each acted knowledgeably, prudently, and without compulsion”.

Due to the nature of buildings and structures of properties of this nature in the PRC, there are

frequently no market sales comparables readily available, and consequently we have valued the

property interests in Group I on the basis of their depreciated replacement cost, which we consider to

be the best alternative approach.

Depreciated replacement cost is defined as “the current cost of replacement (reproduction) of a

property less deductions for physical deterioration and all relevant forms of obsolescence and

optimization.” It is based on an estimate of the market value for the existing use of the land, plus the

APPENDIX III PROPERTY VALUATION

— III-1 —

3rd Sch(34)3rd Sch(46)A1A(9)(3)

I.F.5.06(8) & 5.07

current cost of replacement (reproduction) of the improvements, less deduction for physical

deterioration and all relevant forms of obsolescence and optimization. The depreciated replacement

costs of the property interests are subject to adequate potential profitability of the concerned business.

We have valued the property interest in Group II by the investment method by capitalizing the

net rental income of the property derived from the existing tenancy with due allowance for the

reversionary value of the property.

We have attributed no commercial value to the property interests in Group III, which are leased

by the Group, due either to the short-term nature of the leases or the prohibition against assignment

or sub-letting or otherwise due to the lack of substantial profit rents.

Our valuations have been made on the assumption that the seller sells the property interests in

the market without the benefit of a deferred term contract, leaseback, joint venture, management

agreement or any similar arrangement, which could serve to affect the values of the property interests.

No allowance has been made in our report for any charges, mortgages or amounts owing on any

of the property interests valued nor for any expenses or taxation which may be incurred in effecting

a sale. Unless otherwise stated, it is assumed that the properties are free from encumbrances,

restrictions and outgoings of an onerous nature, which could affect their values.

In valuing the property interests, we have complied with all the requirements contained in

Chapter 5 and Practice Note 12 to the Rules Governing the Listing of Securities issued by The Stock

Exchange of Hong Kong Limited; the RICS Appraisal and Valuation Standards (5th Edition May 2003)

published by the Royal Institution of Chartered Surveyors; and the HKIS Valuation Standards on

Properties (1st Edition January 2005) published by the Hong Kong Institute of Surveyors.

We have relied to a very considerable extent on the information given by the Group and have

accepted advice given to us on such matters as tenure, planning approvals, statutory notices,

easements, particulars of occupancy, lettings, and all other relevant matters.

We have been shown copies of various title documents including State-owned Land Use Rights

Certificates, Building Ownership Certificates and official plans relating to the property interests and

have made relevant enquiries. Where possible, we have examined the original documents to verify the

existing titles to the property interests in the PRC and any material encumbrances that might be

attached to the property interests or any lease amendments. We have relied considerably on the advice

given by the Company’s PRC legal advisers — Kingfield & Partners, concerning the validity of the

Group’s titles to the property interests.

We have not carried out detailed site measurements to verify the correctness of the site areas in

respect of the properties but have assumed that the site areas shown on the documents and official site

plans handed to us are correct. All documents and contracts have been used as reference only and all

dimensions, measurements and areas are approximations. No on-site measurement has been taken.


— III-2 —

I.F.5.05 & 5.06(9)

We have inspected the exterior and, where possible, the interior of the properties. However, no

structural survey has been made, but in the course of our inspection, we did not note any serious

defects. We are not, however, able to report whether the properties are free of rot, infestation or any

other structural defects. No tests were carried out on any of the services.

We have had no reason to doubt the truth and accuracy of the information provided to us by the

Group. We have also sought confirmation from the Group that no material factors have been omitted

from the information supplied. We consider that we have been provided with sufficient information to

reach an informed view, and we have no reason to suspect that any material information has been

withheld.

Unless otherwise stated, all monetary figures stated in this report are in Renminbi (RMB).

Our valuations are summarized below and the valuation certificates are attached.

Yours faithfully,

for and on behalf of

Sallmanns (Far East) LimitedPaul L. Brown

B.Sc. FRICS FHKIS

Director

Note: Paul L. Brown is a Chartered Surveyor who has 23 years’ experience in the valuation of properties in the PRC and 26

years of property valuation experience in Hong Kong, the United Kingdom and the Asia-Pacific region.


— III-3 —

PN12-14

I.F.5.06(7)

I.F.5.06(7)

SUMMARY OF VALUES

Group I — Property interests held and occupied by the Group in the PRC

No. Property

Capital value inexisting state as at

31 July 2006

Interestattributable

to the Group

Capital valueattributable to the

Group as at31 July 2006

RMB RMB

1. A parcel of land, various buildings

and structures

No. 99 Beihai Road

Shouguang City

Shandong Province

The PRC

13,394,000 100% 13,394,000


and structures located at the

northern side of Wenmiao Street

Development Zone

Shouguang City

Shandong Province

The PRC

26,908,000 100% 26,908,000


and structures located at the

northern side of Beihuan Road

Science Technology Industrial Park

Development Zone

Shouguang City

Shandong Province

The PRC

34,035,000 100% 34,035,000

Sub-total: 74,337,000


— III-4 —

I.F.5.06(8)

Group II — Property interest held for investment by the Group in the PRC

No. Property


31 July 2006

Interestattributable

to the Group

Capital valueattributable to

the Group as at31 July 2006

RMB RMB

4. An industrial building located at

the northern side of

Beihuan Road

Science Technology Industrial Park

Development Zone

Shouguang City

Shandong Province

The PRC

No commercial

value

100% No commercial

value

Sub-total: Nil

Group III — Property interests rented and occupied by the Group in the PRC

No. Property


31 July 2006

RMB

5. Two industrial buildings

located at the middle of Beihai Road

Shouguang City

Shandong Province

The PRC

No commercial

value

6. Various buildings

No. 99 Beihai Road

Shouguang City

Shandong Province

The PRC

No commercial

value

Sub-total: Nil

Grand-total: 74,337,000


— III-5 —

I.F.5.06(8)I.J.8.05(7)

I.F.5.06(8)

VALUATION CERTIFICATE

Group I — Property interests held and occupied by the Group in the PRC

Property Description and tenure

Particulars of

occupancy

Capital value

in existing state as at

31 July 2006RMB

1. A parcel of land,

various buildings

and structures

No. 99 Beihai

Road

Shouguang City

Shandong Province

The PRC

The property comprises a parcel of land with a

site area of approximately 27,674 sq.m. on

which are erected 12 buildings and various

ancillary structures completed in various stages

between 1994 and 1999.

The buildings have a total gross floor area of

approximately 16,099.92 sq.m.

The buildings mainly include an office building,

a warehouse, a garage and various industrial

buildings.

The structures mainly include sheds and gate.

The land use rights of the property were granted

to the Company for two terms expiring on 29

September 2034 and 14 December 2034 for

industrial use.

The property is

currently

occupied by the

Group for

production and

ancillary office

purposes.

13,394,000

(100% interest

attributable to

the Group:

RMB13,394,000

Notes:

1. Pursuant to a State-owned Land Use Rights Certificate - Shou Guo Yong (2002) Zi No. (10) 001 issued by the

State-owned Land Resources Bureau of Shouguang City, the land use rights of a parcel of land with a site area

of approximately 27,674 sq.m. were granted to the Company for two terms expiring on 29 September 2034 and

14 December 2034 for industrial use.

2. Pursuant to 3 Building Ownership Certificates - Shou Fang Quan Zheng Zhang Jian Qiao Gong Zi Nos. 0086, 0087

and 0089 issued by the Real Estate Administrative Bureau of Shouguang City, 11 buildings with a total gross floor

area of approximately 16,037.42 sq.m. are owned by the Company.

3. Pursuant to a tenancy agreement dated 9 January 2005 entered into between the Company and Weifang Molong

Drilling Equipment Company Limited (“Molong Drilling Equipment”), a 90% owned subsidiary of the Company,

4 industrial buildings and portion of a building with a total gross floor area of approximately 8,186 sq.m. out of

the above 12 buildings and 1 building included in Property no. 2 with a gross floor area of approximately 5,083.73

sq.m. are leased to Molong Drilling Equipment for a term of 10 years commencing from 1 January 2005 and

expiring on 31 December 2014 at an annual rental of RMB316,231 for production purpose.

4. Pursuant to a Building Ownership Certificate - Shou Fang Quan Zheng Zhang Jian Qiao Gong Zi No. 0085 dated

10 June 2002, 4 buildings with a total gross floor area of approximately 9,785.73 sq.m. are owned by Shouguang

Maolong Machinery Company Limited (“Maolong Machinery”), a connected party of the Company. These 4

buildings were erected on the land of the property and these buildings are excluded from our valuation.


— III-6 —

I.F.5.06(8)

I.F.5.06(1)

5. According to a tenancy agreement dated 18 January 2002 entered into between Maolong Machinery and the

Company, the Company permitted Maolong Machinery to construct the 4 buildings mentioned in note. 4 on the

site of the property. The 3 buildings with a total gross floor area of approximately 7,673.75 sq.m. and a portion

of Yanjie building with a gross floor area of approximately 1,055.99 sq.m. are rented to the Company from

Maolong Machinery for a term of 10 years expiring on 30 December 2011 at an annual rental of RMB179,880.

The remaining portion of Yanjie building with a gross floor area of approximately 1,055.99 sq.m. is occupied by

Maolong Machinery (see Property no. 6).

6. We have been provided with a legal opinion regarding the property interest by the Company’s PRC legal advisers,

which contains, inter alia, the following:

(i) The Group has legally obtained the building ownership rights of the buildings mentioned in note. 2 and the

land use rights of the property and has the rights to occupy, use, transfer, lease or mortgage them; and

(ii) The property is not subject to any mortgage, charge or other third party interests.

7. In the valuation of this property, we have not attributed any commercial value to a building with a gross floor area

of approximately 62.5 sq.m. without a proper title certificate. However, for reference purposes, we are of the

opinion that the capital value of the building (excluding the land) as at the date of valuation would be RMB22,000

assuming all relevant title certificates have been obtained and the building could be freely transferred.


— III-7 —



Particulars of

occupancy

Capital value


31 July 2006RMB


various buildings

and structures

located at the

northern side of

Wenmiao Street

Development Zone

Shouguang City

Shandong Province

The PRC


site area of approximately 70,126.08 sq.m. on






The buildings mainly include a dormitory

building, a reception room, a canteen and

various industrial buildings.

The structures mainly include roads, gates,

boundary walls and various landscaping

structures.


to the Company for a term expiring on 8 August

2052 for industrial use.

The property is

currently

occupied by the

Group for

production

purpose.

26,908,000

100% interest

attributable to

the Group:

RMB26,908,000

Notes:

1. Pursuant to a State-owned Land Use Rights Grant Contract - Shou Tu He Zi (2002) No. 132 dated 9 August 2002

entered into between the Company and the Planning and State-owned Land Resources Bureau of Shouguang City,

the land use rights of the property were contracted to be granted to the Company for industrial use. The land

premium is RMB3,226,500.

2. Pursuant to a State-owned Land Use Rights Certificate - Shou Guo Yong (2002) Zi No. 03013 issued by the

Planning and State-owned Land Resources Bureau of Shouguang City, the land use rights of a parcel of land with

a site area of approximately 70,126.08 sq.m. were granted to the Company for a term expiring on 8 August 2052

for industrial use.

3. Pursuant to 3 Building Ownership Certificates - Shou Fang Quan Zheng Zhang Jian Qiao Gong Zi Nos. 01033,

0124 and 0104 issued by the Real Estate Administrative Bureau of Shouguang City, 12 buildings with a total gross

floor area of approximately 38,133 sq.m. are owned by the Company.

4. Pursuant to a tenancy agreement dated 9 January 2005 entered into between the Company and Weifang Molong

Drilling Equipment Company Limited (“Molong Drilling Equipment”), a 90% owned subsidiary of the Company,

a building with a gross floor area of approximately 5,083.73 sq.m. on the above site, 4 industrial buildings and

portion of a building with a total gross floor area of approximately 8,186 sq.m. included in Property no.1 are

leased to Molong Drilling Equipment for a term of 10 years commencing from 1 January 2005 and expiring on

31 December 2014 at an annual rental of RMB316,231 for production purpose.


— III-8 —

I.F.5.06(8)

I.F.5.06(1)



(i) The Group has legally obtained the building ownership rights of the 12 buildings mentioned in note. 3 and

the land use rights of the property and has the rights to occupy, use, transfer, lease or mortgage them;

(ii) For the buildings without building ownership certificates as stated in note. 6, there will be no legal

impediment for the Group to obtain the relevant title certificates; and

(iii) The property is not subject to any mortgage, charge or other third party interests.

6. In the valuation of this property, we have not attributed any commercial value to the 7 buildings with a total gross

floor area of approximately 4,616.80 sq.m. without proper title certificates. However, for reference purposes, we

are of the opinion that the capital value of the 7 buildings (excluding the land) as at the date of valuation would

be RMB2,445,000 assuming all relevant title certificates have been obtained and the buildings could be freely

transferred.


— III-9 —



Particulars of

occupancy

Capital value


31 July 2006RMB


various buildings

and structures

located at the

northern side of

Beihuan Road

Science Technology

Industrial Park

Development Zone

Shouguang City

Shandong Province

The PRC


site area of approximately 297,321 sq.m. on






The buildings mainly include a dormitory

building, workshops, a dining room, warehouses

and reception rooms.

The structures mainly include roads, boundary

walls, cisterns, gates and sheds.


for a term of 50 years expiring on 29 October

2055 for industrial use.

The property is

currently

occupied by the

Group for

production and

ancillary

purposes.

34,035,000

(100% interest

attributable to

the Group:

RMB34,035,000

Notes:

1. Pursuant to a State-owned Land Use Rights Grant Contact - Shou Tu He Zi (2004) No. 94 entered into between

the Company and the State-owned Land Resources Bureau of Shouguang City, the land use rights of a parcel of

land with a site area of approximately 297,321 sq.m. were contracted to be granted to the Company for a term of

50 years for industrial use. The land premium is RMB18,876,054.

2. Pursuant to a State-owned Land Use Rights Certificate - Shou Guo Yong (2005) Zi No. 1027 issued by the

State-owned Land Resources Bureau of Shouguang City, the land use rights of the property were granted to the

Company for a term expiring on 29 October 2055 for industrial use.

3. On the land of the property, there also erected an industrial building which is individually valued as Property no.

4.



(i) The Group has legally obtained the land use rights of the property and has the rights to occupy, use, transfer

lease or mortgage the land of the property;


— III-10 —

I.F.5.06(8)

I.F.5.06(1)

(ii) According to a document issued by the Real Estate Administrative Bureau of Shouguang City, the building

ownership certificates for the buildings of the property are under application. The Group has the legal rights

to use, occupy and lease the buildings of the property and there is no legal impediment for the Group to

obtain the relevant title certificates; and

(iii) The property is not subject to any mortgage, charge or other third party interests.

5. In the valuation of this property, we have not attributed any commercial value to the buildings with a total gross

floor area of approximately 103,902.19 sq.m. for which the building ownership certificates are under application.

However, for reference purposes, we are of the opinion that the capital value of the buildings (excluding the land)

as at the date of valuation would be RMB68,386,000 assuming all relevant title certificates have been obtained

and the buildings could be freely transferred.


— III-11 —


Group II — Property interest held for investment by the Group in the PRC


Particulars of

occupancy

Capital value


31 July 2006RMB

4. An industrial

building located at

the northern side

of Beihuan Road

Science Technology

Industrial Park

Development Zone

Shouguang City

Shandong Province

The PRC

The property comprises an industrial building

constructed on the site as stated in Property

no. 3 completed in 2004.

The building has a gross floor area of


The property is

currently leased

to a connected

party for

production

purpose.

No commercial value

Notes:

1. Pursuant to a tenancy agreement dated 20 October 2005 entered into between the Company and Shouguang Molong

Electromechanical Equipment Company Limited (“Molong Equipment”), a connected party of the Company, an

industrial building with a gross floor area of approximately 16,021.67 sq.m. is leased to Molong Equipment for

a term of 10 years commencing from 1 November 2005 and expiring on 31 October 2015 at an annual rental of

RMB540,000 for production purpose.

2. The property is erected on the land with a site area of approximately 297,321 sq.m., which is included and valued

in Property no. 3. For the industrial building of the property, we have not been provided with any title certificates.



(i) According to a document issued by the Real Estate Administrative Bureau of Shouguang City, the building

ownership certificate for the subject industrial building is under application. The Group has the legal rights

to use, occupy and lease the industrial building and there is no legal impediment for the Group to obtain

the relevant title certificates; and

(ii) The property is not subject to any mortgage, charge or other third party interests.

4. In the valuation of this property, we have not attributed any commercial value to the property for which the

building ownership certificate is under application. However, for reference purposes, we are of the opinion that

the capital value of the property (excluding the land) as at the date of valuation would be RMB9,373,000 assuming

all relevant title certificates have been obtained and the building could be freely transferred.


— III-12 —

I.F.5.06(8)I.J.8.05(7)

I.F.5.06(1)I.J.8.05(1)


Group III — Property interests rented and occupied by the Group in the PRC


Particulars of

occupancy

Capital value


31 July 2006RMB

5. Two industrial

buildings located

at the middle of

Beihai Road

Shouguang City

Shandong Province

The PRC

The property comprises two 1-storey industrial

buildings completed in about 2000.

The property has a total gross floor area of


According to two tenancy agreements dated 18

January 2002 and 30 September 2005, the

property is leased to the Company from

Shouguang Maolong Machinery Company

Limited (“Maolong Machinery”) and Shouguang

Molong Electromechanical Equipment Company

Limited (“Molong Equipment”) respectively, two

connected parties of the Company, for terms of

10 years. One term is commencing from 1

January 2002 and expiring on 30 December 2011

at an annual rental of RMB86,700 and another

term is commencing from 1 October 2005 and

expiring on 30 September 2015 at an annual

rental of RMB168,000, all exclusive of water

and electricity charges. Pursuant to a

supplemental agreement dated 1 January 2005

entered into between Maolong Machinery and

the Company, the annual rental of an industrial

building of this property (annual rental at

RMB86,700) together with Property no. 6 was

altogether increased to RMB390,000 with

effective from 1 January 2005.

The property is

currently

occupied by the

Group for

production

purpose.

No commercial value

Notes:

1. Pursuant to 2 Building Ownership Certificates � Shou Fang Quan Zheng Zhang Jian Qiao Gong Zi Nos. 0093 and

0094 issued by the Real Estate Administrative Bureau of Shouguang City, 2 buildings with a total gross floor area

of approximately 11,232.71 sq.m. are owned by Maolong Machinery and Molong Equipment respectively.

2. We have been provided with a legal opinion on the legality of the tenancy agreements to the property issued by

the Company’s PRC legal advisers, which contains, inter alia, the following:

(i) Maolong Machinery and Molong Equipment have obtained the relevant title certificates of the property and

have the legal rights to lease the property under the PRC laws; and

(ii) The tenancy agreements are legal and valid.


— III-13 —

I.F.5.06(8)

I.F.5.06(1)



Particulars of

occupancy

Capital value


31 July 2006RMB

6. Various buildings

No. 99 Beihai

Road

Shouguang City

Shandong Province

The PRC

The property comprises a single-storey canteen

building, two 5-storey dormitory buildings and a

portion of a 2-storey composite building

completed in various stages between 1995 and

1996.

The property has a total gross floor area of


According to a tenancy agreement dated 18

January 2002, the property is leased to the

Company from Shouguang Maolong Machinery

Company Limited (“Maolong Machinery”), a

connected party of the Company, for a term of

10 years expiring on 30 December 2011 at an

annual rental of RMB179,880, exclusive of

water and electricity charges. Pursuant to a

supplemental agreement dated 1 January 2005

entered into between Maolong Machinery and

the Company, the annual rental of this property

together with an industrial building of Property

no. 5 (annual rental at RMB86,700) was

altogether increased to RMB390,000 with

effective from 1 January 2005.

The property is

currently

occupied by the

Group for

production and

ancillary

purposes.

No commercial value

Note:

1. Pursuant to a Building Ownership Certificate � Shou Fang Quan Zheng Zhang Jian Qiao Gong Zi No. 0085 issued

by the Real Estate Administrative Bureau of Shouguang City, the property with a total gross floor area of

approximately 8,729.74 sq.m. are owned by Maolong Machinery.

2. We have been provided with a legal opinion on the legality of the tenancy agreement to the property issued by

the Company’s PRC legal advisers, which contains, inter alia, the following:

(i) Maolong Machinery has obtained the relevant title certificates of the property and has the legal rights to

lease the property; and

(ii) The tenancy agreement is legal and valid.


— III-14 —

I.F.5.06(8)

I.F.5.06(1)

This Appendix sets out summaries of certain aspects of the PRC legal and judicial system, its

arbitration system and its company and securities regulations. It also contains summaries of certain

Hong Kong legal and regulatory provisions, certain material differences between PRC and Hong Kong

company laws, certain requirements of the Listing Rules and the additional provisions required by the

Stock Exchange for inclusion in the articles of association of PRC issuers. It also contains a summary

of the articles of association of the Company.

1. PRC LAWS AND REGULATIONS

(a) Legal System

The PRC legal system is based on the PRC Constitution and is made up of written laws,

regulations, directives and local laws and regulations. Decided court cases do not constitute binding

precedents although they are used for the purpose of judicial reference and guidance.

The National People’s Congress of the PRC (“NPC”) and the Standing Committee of the NPC are

empowered by the PRC Constitution to exercise the legislative power of the State. The NPC has the

power to amend the PRC Constitution and to enact and amend primary laws governing the state organs,

civil and criminal matters. The Standing Committee of the NPC is empowered to interpret, enact and

amend laws other than those required to be enacted by the NPC.

The State Council is the highest organ of State administration and has the power to enact

administrative regulations, issue decisions and orders. Ministries and commissions under the State

Council are also vested with the power to issue orders, directives and regulations within the

jurisdiction of their respective departments. Administrative rules, regulations, directives and orders

promulgated by the State Council and its ministries and commissions must not conflict with the PRC

Constitution or any national laws enacted by the NPC. In the event that any conflict arises, the

Standing Committee of the NPC has the power to annul such administrative rules, decisions and orders

enacted by the State Council and the State Council has the power to amend and revoke those

inappropriate, regulations, directives and orders for its ministries and commissions.

At the regional level, the people’s congresses of provinces and municipalities and their

respective standing committees may enact local rules and the people’s governments may promulgate

rules and directives applicable to their own administrative areas. These local rules and regulations

shall not conflict with the PRC Constitution, any national laws or any administrative rules

promulgated by the State Council.

Administrative or local rules may be enacted or issued at the provincial or municipal level or by

the State Council in the first instance for experimental purposes. After sufficient experience has been

gained, the State Council may submit legislative proposals to be considered by the NPC or the

Standing Committee of the NPC for enactment at the national level.

APPENDIX IV SUMMARY OF RELEVANT PRC ANDHONG KONG LAWS AND REGULATIONS

— IV-1 —

R19.68(3)R19.10(3)R19A.27(3)

The power to interpret laws is vested by the PRC Constitution in the Standing Committee of the

NPC. According to the Decision of the Standing Committee of the NPC Regarding the Strengthening

of Interpretation of Laws ( ) passed on 10 June 1981,

the Supreme People’s Court has the power to give general interpretation on application of laws in

judicial proceedings apart from its power to issue specific interpretation in specific cases. The State

Council and its ministries and commissions are also vested with the power to give interpretation of

the rules and regulations which they promulgated. At the regional level, the power to give

interpretation is vested in the regional legislative and administration organs which promulgate such

rules and directives. All such interpretations carry legal effect only if such interpretation is consistent

with the laws or regulations at the higher level.

(b) Judicial system

The people’s courts are the judicial organs of the PRC. Under the PRC Constitution and the Law

of Organisation of the People’s Courts of the PRC ( ) the People’s Courts

comprise the Supreme People’s Courts, the local people’s courts, military courts and other special

people’s courts. The local people’s courts are divided into three levels, namely, the basic people’s

courts, intermediate people’s courts and higher people’s courts. The basic people’s courts are divided

into civil, criminal and administrative divisions. The intermediate people’s courts have divisions

similar to those of the basic people’s courts and, where the circumstances so warrant, may have other

special divisions (such as intellectual property divisions). The judicial functions of people’s courts at

lower levels are subject to guidance of people’s courts at higher levels. The people’s procuratorates

also have the right to exercise legal supervision over the proceedings of people’s courts of the same

and lower levels. The Supreme People’s Court is the highest judicial organ of the PRC. It issues

guidance as to the administration of justice by the people’s courts of lower levels.

The people’s courts adopt a two-tier final appeal system. A party may, before the taking effect

of a judgment or order, appeal against the judgment or order of the first instance of a local people’s

court to the people’s court at the next higher level. Judgments or orders of the second instance at the

next higher level are final and binding. Judgments or orders of the first instance of the Supreme

People’s Court are also final and binding. If, however, the Supreme People’s Court or a people’s court

at a higher level finds an error in a final and binding judgment which has taken effect in any people’s

court at a lower level, or the president of a people’s court finds an error in a final and binding

judgment which has taken effect in the court over which he presides, a retrial of the case may be

conducted according to the judicial supervision procedures.

The PRC civil procedures are governed by the Civil Procedure Law of the PRC

( ) (the “Civil Procedure Law”) adopted on 9 April 1991. The Civil Procedure

Law contains regulations on the institution of a civil action, the jurisdiction of the people’s courts, the

procedures for conducting a civil action, trial procedures and procedures for the enforcement of a civil

judgment or order. All parties to a civil action conducted within the territory of the PRC must comply

with the Civil Procedure Law. A civil case is generally heard by a court located in the defendant’s


— IV-2 —

place of domicile. The jurisdiction may also be selected by agreement by the parties to a contract

provided that the jurisdiction of the people’s court selected has some actual connection with the

dispute, that is to say, the plaintiff or the defendant is located or domiciled, or the contract was

executed or implemented in the jurisdiction selected, or the subject-matter of the proceedings is

located in the jurisdiction selected. A foreign national or foreign enterprise is accorded the same

litigation rights and obligations as a citizen or legal person of the PRC. If any party to a civil action

refuses to comply with a valid judgment or order made by a people’s court or an award made by an

arbitration body in the PRC, the aggrieved party may apply to the people’s court to enforce the

judgment, order or award. There are time limits on the right to apply for such enforcement. Where at

least one of the parties to the dispute is an individual, the time limit is one year. If both parties to the

dispute are legal persons or other entities, the time limit is six months.

A party seeking to enforce a judgment or order of a people’s court against a party who or whose

property is not within the PRC may apply to a foreign court with jurisdiction over the case for

recognition and enforcement of such judgment or order. A foreign judgment or ruling may also be

recognised and enforced according to PRC enforcement procedures by the people’s courts in

accordance with the principle of reciprocity or if there exists an international or bilateral treaty

between the PRC and the relevant foreign country or which is acceded to by the PRC that provides

for such recognition and enforcement, unless the people’s court considers that the recognition or

enforcement of the judgment or ruling will violate fundamental legal principles of the PRC or its

sovereignty, security or social or public interest.

(c) Arbitration and enforcement of arbitral awards

The Arbitration Law of the PRC ( ) (the “Arbitration Law”) was promulgated

by the Standing Committee of the NPC on 31 August 1994 and came into effect on 1 September 1995.

It is applicable to, among other matters, trade disputes involving foreign parties where the parties have

entered into a written agreement to refer the matter to arbitration before an arbitration tribunal

constituted in accordance with the Arbitration Law and arbitration rules of arbitration commission

thereof. Under the Arbitration Law, an arbitration tribunal may, before the promulgation by the PRC

Arbitration Association of arbitration rules, formulate interim arbitration rules in accordance with the

Arbitration Law and the Civil Procedure Law. Where the parties have by an agreement provided

arbitration as a method for dispute resolution, the parties are not permitted to institute legal

proceedings in a people’s court.

The Listing Rules and the Mandatory Provisions require an arbitration clause to be included in

the articles of association of a company incorporated in the PRC and listed in Hong Kong and in the

case of the Listing Rules, also in a contract between the company and each of its directors and

supervisors, to the effect that whenever any dispute or claim arises from any rights or obligations

provided in the articles of association, the PRC Company Law and other relevant laws and

administrative regulations concerning the affairs of the company between (i) a holder of overseas

listed foreign shares and the company; (ii) a holder of overseas listed foreign shares and the directors,


— IV-3 —

supervisors, manager or other officers of the company; or (iii) a holder of overseas listed foreign

shares and a holder of domestic shares, then, unless otherwise specified in the articles of association

of the company concerned, such parties shall submit that dispute or claim to arbitration before either

the China International Economic and Trade Arbitration Commission (“CIETAC”) or the Hong Kong

International Arbitration Centre (“HKIAC”). If the party seeking arbitration elects to arbitrate the

dispute or claim at HKIAC, then any party to the dispute may apply to have such arbitration conducted

in Shenzhen according to the securities arbitration rules of HKIAC. CIETAC is a comprehensive

affairs arbitration body in the PRC. It is located in Beijing with branch offices in Shenzhen and

Shanghai.

Under the Arbitration Law and the Civil Procedure Law of PRC an arbitral award is final and

binding on the parties and if a party fails to comply with an award, the other party to the award may

apply to the people’s court with jurisdiction for enforcement. A people’s court may refuse to enforce

an arbitral award made by a domestic arbitration committee if there were mistakes in applicable laws,

an absence of material evidence, or irregularities over the arbitration proceedings or the jurisdiction

or constitution of the arbitration committee.

A party seeking to enforce an arbitral award of a foreign affairs arbitration body of the PRC

against a party who or whose property is not within the PRC may apply to a foreign court with

jurisdiction over the case for enforcement. Similarly, an arbitral award made by a foreign arbitration

body may be recognised and enforced by the PRC courts in accordance with the principles of

reciprocity or any international treaty concluded or acceded to by the PRC.

In respect of contractual and non-contractual commercial-law-related disputes which are

recognised as such for the purposes of the PRC laws, the PRC has acceded to the Convention on the

Recognition and Enforcement of Foreign Arbitral Awards (the “New York Convention”) adopted on 10

June 1958 pursuant to a resolution of the Standing Committee of the NPC passed on 2 December 1986.

The New York Convention provides that all arbitral awards made by a state which is a party to the New

York Convention shall be recognised and enforced by other parties to the New York Convention

subject to their right to refuse enforcement under certain circumstances including where the

enforcement of the arbitral award is against the public policy of the state to which the application for

enforcement is made. It was declared by the Standing Committee of the NPC at the time of the

accession of the PRC that (1) the PRC would only recognise and enforce foreign arbitral awards on

the principle of reciprocity and (2) the PRC would only apply the New York Convention in disputes

considered under PRC laws to be arising from contractual and non-contractual mercantile legal

relations.

Following the resumption of sovereignty over Hong Kong by the PRC on 1 July 1997, the New

York Convention no longer applies to the enforcement of Hong Kong arbitral awards in other parts of

the PRC. A Memorandum of Understanding on the arrangement for mutual enforcement of arbitral

awards between Hong Kong and the PRC signed on 21 June 1999. Under the Arbitration Ordinance

(Chapter 341, Laws of Hong Kong) an arbitral award made by a recognised PRC arbitral commission

in accordance with the Arbitration Law is enforceable in Hong Kong.


— IV-4 —

(d) Foreign Exchange Control

Major reforms have been introduced on the foreign exchange control system of the PRC since

1993.

The PBOC, with the authorisation of the State Council, issued on 28 December

1993 the Notice on the Further Reform of the Foreign Exchange Control System

( ) and on 26 March 1994 the Provisional Regulations on

the Settlement, Sale and Payment of Foreign Exchange ( ), which came into

effect on 1 January 1994 and 1 April 1994 respectively. On 29 January 1996, the State Council

promulgated the PRC Foreign Exchange Control Regulations ( ) which took

effect on 1 April 1996. On 20 June 1996, the PBOC issued the Administration Regulations on the

Settlement, Sale and Payment of Foreign Exchange ( ), which took effect on 1

July 1996. These regulations contain detailed provisions regulating the holding, sale and purchase of

foreign exchange by individuals, enterprises, economic bodies and social organisations in the PRC. On

21 July 2005, the People’s Bank of China issued the Announcement on Improving the Reform of

Renminbi Exchange Rate Formation Mechanism and introduced a regulated, floating exchange rate

mechanism based on market supply and demand and with reference to a basket of currencies.

In general, all organisations and individuals within the PRC, including foreign-invested

enterprises, are required to remit their foreign exchange earnings to the PRC. In relation to PRC

enterprises, their recurrent foreign exchange earnings are generally required to be sold to designated

banks unless specifically approved otherwise. Foreign-invested enterprises, on the other hand, are

permitted to retain certain percentage of their recurrent foreign exchange earnings and the sums

retained may be deposited into foreign exchange bank accounts maintained with designated banks.

Capital foreign exchange must be deposited into foreign exchange bank accounts maintained with

designated banks and can generally be retained in such accounts.

At present, control on the purchase of foreign exchange is being relaxed. Enterprises which

require foreign exchange for their current account transactions such as trading activities and payment

of staff remuneration may purchase foreign exchange from designated banks, subject to the production

of relevant supporting documents.

In addition, where an enterprise requires any foreign exchange for the payment of dividends that

are payable in foreign currencies under applicable regulations, such as dividends on the H Shares and

the distribution of profits by a foreign invested enterprise to its foreign investment party, then, subject

to the due payment of tax on such dividends the amount required may be withdrawn from funds in

foreign exchange accounts maintained with designated banks, and where the amount of the funds in

foreign exchange is insufficient, the enterprise may purchase additional foreign exchange from

designated banks upon the presentation of the resolutions of the directors on the profit distribution

plan of that enterprise.


— IV-5 —

A1A(31)

The foreign exchange proceeds of an issue of shares by a PRC enterprise (such as the Company)

constitute a capital account item under the PRC Foreign Exchange Control Regulations. Under the

Regulations, such proceeds are required to be remitted to the PRC and maintained in an account with

a designated bank or, with the approval of the foreign exchange regulatory authorities, sold to

designated banks.

Despite the relaxation of foreign exchange control over current account transactions, the

approval of SAFE is still required before an enterprise may borrow a loan in foreign currency or

provide any foreign exchange guarantee or to make any investment outside of the PRC or to enter into

any other capital account transaction which involves the purchase of foreign exchange.

When conducting actual foreign exchange transactions, designated banks may, based on the

exchange rate published by the PBOC and subject to certain limits, freely determine the applicable

exchange rate. The China Foreign Exchange Trading Centre (“CFETC”) was formally established and

came into operation on 1 January 1994. CFETC has set up a computerised network with sub-centres

in several major cities, thereby forming an interbank market in which designated PRC banks can trade

in foreign exchange and settle their foreign currency obligations.

On 25 October 1998, the PBOC and SAFE promulgated the Notice Concerning the

Discontinuance of Foreign Exchange Swapping Business ( ), pursuant to which

and with effect from 1 December 1998, all foreign exchange swapping business in the PRC for

foreign-invested enterprises was discontinued, while the settlement and sale of foreign exchange by

foreign-invested enterprises has to be effected under the PRC banking system.

On 13 January 1994, CSRC and SAFE jointly issued the Notice Relating to Certain Exchange

Control Matters for the Overseas Listed Enterprises ( ). The

Notice provides that:

— upon the approval of SAFE, an overseas listed enterprise may open a foreign exchange

account with a bank within the PRC for the deposit of foreign currency proceeds received

from overseas share offers;

— within 10 days after receiving the share offer proceeds, the enterprise should transfer such

proceeds into a PRC bank account;

— upon the approval of SAFE, the enterprise may remit the foreign exchange from its foreign

currency bank account to foreign investors outside the PRC for the purposes of payment of

dividends or other profit distribution; and

— where the fund raised by Share Offer exceed 25% of the net assets of the enterprise held

by foreign investors, such enterprise may apply to MOFTEC for joint venture status, and

upon the approval of MOFTEC, the foreign exchange matters of such enterprise shall be

dealt with in accordance with foreign exchange regulations applicable to foreign invested

enterprises.


— IV-6 —

The provisions of the Notice summarised above appear not to be entirely consistent with the PRC

Foreign Exchange Control Regulations. It is unclear whether the provisions of the Notice or the

provisions of the Regulations prevail.

(e) Taxation

(i) Income tax on enterprises

Under the Provisional Regulations of the PRC Concerning Income Tax on Enterprises

( ) promulgated by the State Council and which came into effect

on 1 January 1994, income tax is payable by state owned enterprises, collectively owned

enterprises, private enterprises, joint stock enterprises and other entities at a rate of 33% of their

taxable income. Preferential tax treatment may, however, be granted pursuant to any laws or

regulations from time to time promulgated by the State Council.

(ii) Value added tax

The Provisional Regulations of the PRC Concerning Value Added Tax

( ) promulgated by the State Council came into effect on 1 January

1994. Under these regulations and the Implementing Rules of the Provisional Regulations of the

PRC Concerning Value Added Tax ( ), value added tax is

imposed on goods sold in or imported into the PRC and on processing, repair and replacement

services provided within the PRC.

Value added tax payable in the PRC is charged on an aggregated basis at a rate of 13% or

17% (depending on the type of goods involved) on the full price collected for the goods sold or,

in the case of taxable services provided, at a rate of 17% on the charges for the taxable services

provided, but excluding, in respect of both goods and services, any amount paid in respect of

value added tax included in the price or charges, and less any deductible value added tax already

paid by the taxpayer on purchases of goods and services in the same financial year.

(iii) Business tax

Under the Provisional Rules of the PRC on Business Tax ( )

effective from 1 January 1994 and the relevant implementing rules, business that provide

services (save for entertainment business), assign intangible assets or sell immovable property

became subject to business tax at the rate of 3 to 5% of the turnover attributable to the services

provided, intangible assets assigned or immovable property sold, as the case may be. Business

that provides entertainment services is subject to business tax at the rate of 5 to 20 per cent. of

the turnover attributable to the services provided. Business tax and value added tax are mutually

exclusive.


— IV-7 —

(iv) Tax on dividends

On 21 July 1993, SAT issued the Notice Concerning Taxation of Income from Share

(Equities) Transactions and Dividends Received by Foreign Investment Enterprises, Foreign

Enterprises and Foreign Nationals (Guo Shui Fa [1993] No. 045) (

) (the “1993 Tax

Notice”). The 1993 Tax Notice provides that dividends received by a foreign enterprise or a

foreign individual from a PRC enterprise with shares listed on an overseas stock exchange

(“overseas shares”) or with special Renminbi-denominated shares listed on a PRC stock

exchange will not for the time being be subject to any withholding tax.

On 26 July 1994, SAT issued the Notice on Matters Concerning Taxation on

Dividend Income Received by Foreign Individuals from Shares in Domestic

Listed or Overseas Listed PRC Companies (the “1994 Tax Notice”)

( ). The 1994 Tax Notice

provides that dividends or other distributions received by foreign individuals who hold overseas

shares and/or domestic listed foreign shares from a PRC listed company are, for the time being,

exempted from individual income tax.

Accordingly, under current PRC laws and regulations, no withholding tax is payable in

respect of dividends or other distributions on overseas shares held by any foreign enterprise or

foreign individuals. If, however, the 1993 Tax Notice and/or the 1994 Tax Notice are withdrawn,

a 20% withholding tax may apply on such dividends or distributions, unless such tax is reduced

pursuant to an applicable double taxation avoidance treaty.

(v) Taxation on transfer of shares

The 1993 Tax Notice provides that gains realised by a foreign enterprise or a foreign

individual through the transfer of overseas shares are exempted from capital gains tax. Under the

Provisions for Implementation of Individual Income Tax Law of the PRC

( ) (the “Implementation Provisions”) promulgated on 28

January 1994, gains realised on the sale of securities by an individual are subject to income tax

at a rate of 20% and the Ministry of Finance is empowered to enact detailed rules for the

collection of such tax. No such rules have yet been promulgated and it is not certain how such

tax is to be paid to the PRC tax authorities. On 30 March 1998, the PRC Ministry of Finance and

the SAT issued the Notice on the Continued Non-Levy on a Temporary Basis of Individual

Income Tax on Gains from Share Transfers ( )

which provides for the exemption of income tax payable by individuals arising from the transfer

of shares in listed companies with effect from 17 January 1997.


— IV-8 —

The exemption enjoyed by foreign companies under the 1993 Tax Notice is not affected by

the Implementation Provisions and continues to apply.

PRC stamp duty is not payable on a transfer of overseas shares provided that such transfer

is not executed or received in the PRC.

(vi) Tax treaties

Foreign enterprises with no establishment in the PRC and individuals who are not resident

in the PRC and are resident in countries which have entered into double taxation treaties with

the PRC may be entitled to a reduction of withholding tax on dividends. At present, the PRC has

entered into double taxation treaties with a number of countries, including Australia, Canada,

France, Germany, Japan, Malaysia, the Netherlands, Singapore, the United Kingdom and the

United States.

(vii) Estate Duty

No liability for estate duty under the PRC laws will arise from non-PRC nationals holding

overseas listed foreign shares.

(f) Company Law

On 29 November 1993, the standing committee of NPC promulgated the PRC Company Law

which came into effect on 1 July 1994. Before the implementation of the PRC Company Law, the

formation and operation of joint stock limited companies were governed by the Standard Opinion for

Joint Stock Companies (the “Standard Opinion”) ( ) promulgated by the State

Commission for Restructuring the Economic System of the PRC ( ) (the “State Restructuring

Commission”) on 15 May 1992. The Standard Opinion was superseded by the PRC Company Law. The

legal status of joint stock limited companies established pursuant to the Standard Opinion is preserved

and these companies are required to comply with the requirements of the PRC Company Law within

a specified period of time. The Special Regulations applicable to joint stock limited companies to be

listed overseas were passed by the State Council on 4 August 1994 pursuant to Articles 85 and 155

of the PRC Company Law. On 27 August 1994 the Mandatory Provisions, being provisions which must

be incorporated in the articles of association of all PRC joint stock limited companies to be listed

overseas, were jointly promulgated by the Securities Commission of the State Council and the State

Restructuring Commission. The Mandatory Provisions were supplemented by the Letter on the

Opinion Regarding the Supplemental Amendments to the Articles of Association of Companies to be

listed in Hong Kong ( ) (the “Supplemental

Amendments”) jointly promulgated by the Securities Commission of the State Council and the State

Restructuring Commission. The Mandatory Provisions as supplemented by the Supplemental

Amendments have been incorporated in the Articles of Association.


— IV-9 —

Set out below is a summary of the provisions of the PRC Company Law, the Special Regulations

and the Mandatory Provisions as supplemented by the Supplemental Amendments.

(i) General

The PRC Company Law regulates two types of companies, namely companies incorporated

in the PRC with limited liability and companies incorporated in the PRC as a joint stock limited

company. Both types of companies have the status of an enterprise legal person.

The liability of shareholders of a limited liability company is limited to the extent of the

amount of capital contributed by them and the company is liable to its creditors to the full

amount of its assets. A joint stock limited company is a company having a registered share capital

divided into shares of equal par value. The liability of its shareholders is limited to the extent

of the amount payable, paid or credited as paid on the shares subscribed by them and the

company is liable to its creditors to the full amount of its assets.

A company may invest in other companies. However, save as otherwise provided by laws,

such company may not become a contributor taking up joint liability in respect of the debts of

the investee. The Mandatory Provisions provide that a company may, subject to the approval of

the companies supervisory department which is authorised by the State Council, operate as a

holding company.

On 10 January 1995, the Ministry of Foreign Trade and Economic Co-operation

promulgated the Provisional Regulations on Certain Issues Governing the

Establishment of Companies Limited by Shares with Foreign Investment

( ) (“Regulations on Foreign Invested Companies”)

which regulates the procedures and other matters regarding the establishment of joint stock

limited companies with foreign investment in the PRC. Any matter relating to a joint stock

limited company with foreign investment which is not provided in the Regulations on Foreign

Invested Companies is continued to be governed by the PRC Company Law and the Special

Regulations.

References below to “company” are to a joint stock limited company incorporated under the

PRC Company Law with overseas listed foreign shares to be directly offered and listed in Hong

Kong. References below to “foreign invested company” are to a joint stock limited company with

foreign investment incorporated under the Regulations on Foreign Invested Companies.

(ii) Incorporation

Under the PRC Company Law, a company may be incorporated by either the promotion

method or the public subscription method.

The entire issued share capital of a company incorporated by the promotion method must

be subscribed by the promoters. If a company is established by the public subscription method,


— IV-10 —

not less than 35% of the issued shares of the company must be subscribed by its promoters.

Companies established by public subscription through public offering shall obtain prior approval

from the securities regulatory authority under the State Council. Public offering means one

meeting any of the following criteria:

(1) offering to non-specific targets;

(2) offering to a total of more than 200 specific targets; and

(3) other offerings provided by laws and administrative regulations.

Under the PRC Company Law, the establishment of a company, regardless of the method

of incorporation, requires more than two but fewer than two hundred promoters and over half of

the promoters are required to have a residence in the PRC.

Any overseas entity, organisation or individual may establish a foreign invested company

with any entity in the PRC. At least one promoter of a foreign invested company established by

the promotion method must be a foreign investor.

In addition to this, a foreign investor of a foreign invested company established by the

public subscription method is required to have three years of profitable track record immediately

preceding the share subscription by the public.

(iii) Procedures for establishment of companies

The establishment of a foreign invested joint stock company must be approved by the

Ministry of Foreign Trade and Economic Co-operation.

In respect of a company established by the promotion method, the promoters will be

required to elect a board of directors and a supervisory committee after they have paid the

amount of the first contributions for the shares subscribed by them. The first contributions paid

by the promoters should not be less than 20% of the amount of all subscribed shares and the

aggregate amount of the subscribed shares should be settled in two years. The board of directors

of the company shall submit supporting documents such as the company’s articles of association

and a capital verification certificate to the relevant Administration for Industry and Commerce

for the registration of the company.

In respect of a company established by the public subscription method, upon approval by

the securities regulatory authority of the State Council, the promoters must publish a prospectus

and prepare the subscription forms. An inaugural meeting of the company is required to be

convened and chaired by the promoters within 30 days after the shares have been paid up in full.

Matters that are required to be transacted at the inaugural meeting include the adoption of the

company’s articles of association, the election of directors, the election of members of a

supervisory committee and the review of the value attributed to the assets injected by the


— IV-11 —

promoters into the company in return for its shares. The board of directors of the company is

required to apply for the registration of the company within 30 days after the inaugural meeting

by submitting all relevant documents to the relevant Administration for Industry and Commerce.

The date of establishment of a company is the day when its business licence is issued by

SAIC.

(iv) Responsibilities of promoters

Under the PRC Company Law, the promoters of a company are jointly liable for:

(1) the payment of expenses and liabilities incurred in connection with the establishment

of the company if the company fails to be incorporated;

(2) the repayment of subscription monies to the subscribers together with interest at bank

rates for a deposit of the same term if the company cannot be incorporated; and

(3) damages suffered by the company as a result of the default of the promoters in the

course of the incorporation of the company.

Under the Provisional Regulations Concerning the Issue and Trading of Shares

( ) promulgated by the State Council on 22 April 1993, the promoters of

a company are required to assume joint and several responsibility for the accuracy of the contents

of the document and to ensure that the document does not contain any misleading statement or

omit any material information.

(v) Shares

(aa) Registered capital

The registered capital of a company is the total paid up capital of the company

registered with the Administration of Industry and Commerce. The minimum registered

capital of a company is RMB5,000,000. The minimum registered capital of a foreign

invested company is RMB30,000,000. The registered capital of a company shall be divided

into shares of equal par value.

A company’s promoters may contribute by way of injection of monetary and

non-monetary assets that can be valued in monetary terms and transferred legally, such as

physical assets, intellectual property rights and land use rights, provided that monetary

injection from all shareholders may not be less than 30% of the registered capital. The

non-monetary assets to be injected shall be valued and their titles shall be verified prior to

injection.


— IV-12 —

(bb) Allotment and issue of shares

The issue of shares must be based on the principles of equality and fairness. The same

class of shares must carry equal rights. Where shares are issued at the same time, the terms

(including the subscription price) of allotment of each share must be identical to the other.

Shares may be issued at par or at a premium but may not be issued below their par

value.

(cc) Registered or bearer shares

Shares may be issued in registered or bearer form. Shares issued to promoters and

legal persons must be in registered form and may not be held in the names of nominees. The

Special Regulations and the Mandatory Provisions provide that shares issued to foreign

investors and listed overseas shall be issued in registered form, denominated in Renminbi

and subscribed for in foreign currency.

Under the Special Regulations and the Mandatory Provisions, shares issued to foreign

investors and investors from the territories of Hong Kong, Macau and Taiwan and listed

overseas are called overseas listed foreign shares, and shares issued to investors within the

PRC other than the territories specified above are called domestic shares.

A company may offer its shares to the public overseas with the approval of the

securities administration department of the State Council. The State Council is empowered

to prescribe detailed measures in connection with any such offer. Under the Special

Regulations, a company may, with the prior approval of the securities regulatory

authorities, agree in its underwriting agreement to set aside shares of up to 15% of the total

number of overseas listed foreign shares as part of the total number of shares to be offered

in addition to the shares underwritten.

A register of shareholders shall be maintained by the company in respect of shares

issued in registered form. Information such as the particulars of shareholders, the number

of shares held by each shareholder and the dates on which the shareholders became holders

of the relevant shares are required to be entered in the register.

A company is required to record the amount of bearer shares issued, the number

designated to each bearer share and the date of issue of each bearer share.

(vi) Increase of share capital

Under the PRC Company Law, an issue of shares must be approved by shareholders in

general meeting. If the share issuing by a company constitutes a public offering, the approval of

the securities regulatory authority under the State Council must also be obtained. Following the

completion of the subscription of new shares, the company is required to register the increase in

registered capital with the relevant Administration of Industry and Commerce.


— IV-13 —

(vii) Reduction of share capital

Subject to the minimum registered capital requirements, a company may reduce its

registered capital in accordance with the following procedures prescribed under the PRC

Company Law:

(1) the company shall prepare a balance sheet and a schedule of properties;

(2) the reduction of registered capital must be approved by shareholders in general

meeting;

(3) the company shall inform its creditors of the reduction in capital within 10 days and

publish an announcement of the reduction in the newspaper within 30 days after the

resolution approving the reduction has been passed;

(4) the creditors of the company may within the statutory prescribed time limit require the

company to pay its debts or provide guarantees to the extent of the amount of its debts;

and

(5) the company must apply to the relevant Administration of Industry and Commerce for

registration of the reduction in registered capital.

(viii) Repurchase of shares

A company may not acquire its own shares except in the following cases where:

(1) a company effects a cancellation of shares due to a reduction in registered capital;

(2) a merger with another company which holds shares in the company;

(3) grant shares to the employees of a company as an incentive;

(4) or a shareholder who disagrees with the resolutions relating to company merger and

demerger passed in general meetings requires the company to acquire its own shares.

The Mandatory Provisions provide that upon obtaining the necessary approvals in

accordance with the articles of association of a company and that of the relevant supervisory

authorities, a company may repurchase its issued shares for the foregoing purposes by way of a

general offer to the shareholders of the company or purchase on a stock exchange or by way of

an off market contract.


— IV-14 —

Under the PRC Company Law, the acquisition of its own shares by a company in cases (1)

to (3) requires the approval in general meetings. In the event of acquisition in case (1), within

10 days following a repurchase of a company’s own shares, a company must cancel the amount

of shares repurchased. And for case (4), the repurchased shares must be transferred or cancelled

within six months.

(ix) Transfer of shares

Shares may be transferred in accordance with relevant laws and regulations.

A shareholder may only transfer its shares on a stock exchange established in accordance

with laws or by other ways as required by the State Council. Registered shares may be transferred

by the holder of the shares endorsing his signature on the back of the certificate(s) for the shares

or in any other manner as specified by the applicable laws and regulations.

Upon the transfer of registered shares, the particulars of the transferee shall be entered into

the register of shareholders by the company. Shares issued to promoters may not be transferred

within three years after the establishment of the company. Directors, supervisors and the senior

management of a company may not transfer more than 25% of the aggregate number of shares

held in the company in each year during their term of office with the company, and may not

transfer such shares within one year from the date of listing and trading of shares of the company.

There is no restriction under the PRC Company Law on the percentage shareholding of a

single shareholder of a company.

(x) Shareholders

The rights of a shareholder include:

(1) the right to attend and vote in person and to appoint a proxy to attend and vote on his

behalf at general meetings of the company;

(2) the right to inspect the articles of association of the company, the minutes of

shareholders’ meeting and the financial reports of the company and to put forward

proposals and make enquiries relating to the operations of the company;

(3) the right to transfer the shares held by the shareholder in accordance with laws on a

stock exchange established in accordance with relevant laws;

(4) the right to receive surplus assets of the company upon its winding up; and

(5) the right to file a lawsuit in the people’s court if a resolution passed at a shareholders’

meeting or directors’ meeting infringes any laws or administrative regulations or the

legitimate interests of the shareholders.


— IV-15 —

A shareholder is liable to the company to the extent of the amount payable, paid or credited

as paid on the shares subscribed by them.

A shareholder may enjoy such other rights and is required to assume such other obligations

as specified in the company’s articles of association.

(xi) Shareholders in general meetings

(aa) Powers of shareholders in general meeting

The general meeting is the organ of authority of the company and may exercise the

following powers:

(1) to determine the company’s business policies and investment plans;

(2) to elect and replace directors and supervisors who are not representatives of the

employees union and to fix the remuneration of relevant directors and

supervisors;

(3) to consider and approve the reports of directors;

(4) to consider and approve the supervisory committee or the reports of supervisors;

(5) to consider and approve the annual financial budget and final accounts of the

Company;

(6) to consider and approve the profit distribution plan and plans for making up

accrued losses of the Company;

(7) to pass resolutions concerning increases and reductions in the registered capital

of the company;

(8) to pass resolutions concerning the issue of bonds by the company;

(9) to pass resolutions concerning the merger, demerger, dissolution, liquidation or

the changing of the formation of the Company;

(10) to amend the company’s articles of association;

(11) other powers under the company’s articles of association.


— IV-16 —

(bb) Annual general meetings and extraordinary general meetings

General meetings are divided into annual general meetings and extraordinary general

meetings. Annual general meetings must be held once every year. Extraordinary general

meetings are general meetings other than annual general meetings and shall be convened

within two months after the occurrence of any of the following:

(1) the number of directors is fewer than two thirds of the number required under the

PRC Company Law or the company’s articles of association;

(2) the company’s accumulated losses amount to one-third of its paid up capital;

(3) upon the requisition by holder(s) of not less than 10% of the shares of the

company alone or in aggregate;

(4) the board of directors considers such a meeting necessary; or

(5) the supervisory committee proposes the meeting to be convened.

(cc) Proceedings of general meetings

A general meeting is required to be convened by the board of directors and presided

by the chairman of the board of directors. Under the PRC Company Law, notice of general

meeting shall be given not less than 20 days before the date of the meeting. Notice of

extraordinary general meeting shall be given not less than 15 days before the date of the

meeting. A company which has bearer shares in issue shall make public announcement of

the general meeting at least 45 days prior to the meeting being held. Under the Special

Regulations and the Mandatory Provisions, 30 days’ notice of general meeting is required

to be given to shareholders specifying the matters to be considered at and the date and place

of the meeting. Under the Special Regulations and the Mandatory Provisions, shareholders

who intend to attend a general meeting are required to provide the company with a written

confirmation of their attendance 20 days prior to the meeting. Shareholders holding 5% or

more of the voting rights of a company are entitled, under the Special Regulations, to

propose to the company in writing new resolutions to be considered at an annual general

meeting and the company shall include any proposed resolutions which are within the

powers of a general meeting in the agenda for that meeting.

The PRC Company Law does not specify any quorum requirement for a general

meeting. The Special Regulations and the Mandatory Provisions provide that a general

meeting may be held if shareholders holding 50% or more of the voting rights of a company

have replied in writing 20 days prior to the proposed date of the meeting that they intend

to attend the meeting. In the event that the 50% level is not attained, a general meeting may

be held if the company shall within five days after the last day for receipt of the replies

notify shareholders by public announcement of the matters to be considered at and the place

and date of the meeting. The general meeting may be held after the public notice is sent.


— IV-17 —

Each shareholder present at a general meeting is entitled to one vote for every share

held by him. A shareholder may appoint a proxy to attend and vote on his behalf at a general

meeting. Resolutions proposed at a general meeting must be passed by more than half of

the votes cast by shareholders present in person or by proxy at the meeting except that (1)

amendments to the company’s articles of association; (2) the merger, demerger or

dissolution of the company; (3) the increase and reduction of capital of the company; (4)

the change of the formation of the Company; (5) other matters which the general meeting

has resolved by way of ordinary resolution as having a potentially material effect on the

company and should be approved by special resolution are required under the Mandatory

Provisions to be approved by more than two thirds of the votes cast.

An extraordinary general meeting shall not decide on any matters which are not set out

in the notice convening that meeting.

The Mandatory Provisions require class meetings to be held in the event of a variation

or abrogation of the class rights of a class of shareholders. Holders of domestic shares and

holders of overseas listed foreign shares are deemed to be different classes of shareholders.

(xii) Directors

(aa) Board of directors

The board of directors of a company is required to consist of between 5 and 19

directors. The term of office of a director shall be prescribed by the company’s articles of

association, but a term of office shall not exceed three years. A director may serve

consecutive terms if re-elected. The board of directors of a company may exercise the

following powers:

(1) to convene general meetings and to report on their work to shareholders;

(2) to implement resolutions passed by shareholders;

(3) to decide on the company’s business plans and investment plans;

(4) to prepare annual budgets and final accounts;

(5) to prepare profit distribution plans and plans for making up accrued losses;

(6) to prepare plans for the increase and reduction in registered capital and plans for

the issue of bonds;

(7) to prepare plans for the merger, demerger, dissolution or the change of the

formation of the company;


— IV-18 —

(8) to decide on the internal management structure of the company;

(9) to employ and dismiss the manager, and at the recommendation of the manager,

employ and dismiss deputy managers and financial controllers and to fix their

remuneration; and

(10) to establish the company’s basic management system.

In addition, the Mandatory Provisions provide that the board of directors is also

responsible for preparing proposals for amendment of the articles of association of a

company.

(bb) Board meetings

Regular meetings of the board of directors of a company shall be held at least twice

every year. Notice of regular board meetings shall be given at least 10 days before the date

of the meeting. Notices of any other extraordinary board meetings shall be given in such

manner and subject to such notice period as may be determined by the board of directors.

A quorum of board meeting shall be constituted by more than half of the directors. A

director may attend a board meeting personally or may appoint another director as his

alternate to attend on his behalf. All board resolutions must be passed by the affirmative

votes of more than half of the directors. All resolutions passed at a board meeting are

required to be recorded in the minutes of the relevant meeting and the minutes are required

to be signed by the directors who attended the meeting and the person who recorded the

minutes. If any board resolution contravenes any applicable laws and regulations or the

company’s articles of association and results in substantial damages to the company, any

director who participated in passing the resolution (except those who voted against the

resolution and whose dissenting vote is recorded in the relevant minutes) will be personally

liable to the company.

(cc) Chairman and vice-chairman of the board of directors

The board of directors is required to appoint a chairman and certain vice-chairmen.

The appointment of the chairman and vice-chairman is required to be approved by more

than half of the directors.

In the event of the chairman being unable to carry out his duties, the vice-chairman

shall exercise the powers of the chairman; if the vice-chairman is unable to carry out his

duties, a director elected by more than half of the directors shall takeover the duties.


— IV-19 —

(dd) Qualification of directors

The PRC Company Law provides that the following persons are not eligible to act as

directors:

(1) any person who suffers from any incapacity or restricted capacity from

undertaking civil obligations and assuming civil responsibilities;

(2) any person who has been convicted of offences relating to bribery, corruption,

trespass to assets, misappropriation of assets, or of causing socialistic market

economic disorder, where less than five years have elapsed since the completion

of the sentence; and any person who has been deprived of his political rights as

a result of him having been convicted of offences, and less than five years have

elapsed since the completion of the term of such deprivation;

(3) persons who are former directors, factory managers or managers of a company

or enterprise which has become bankrupt or has been liquidated due to

mismanagement and who are personally liable for the bankruptcy or liquidation

of such company or enterprise, and less than three years have elapsed since the

date of completion of the bankruptcy or liquidation of the company or enterprise;

(4) any person who has been a legal representative of a company or an enterprise the

business licence of which has been revoked and be ordered to close due to that

company or enterprise having contravened any laws and the person is personally

responsible, where less than three years have elapsed since the date of such

revocation;

(5) any person who is liable for a relatively large amount of indebtedness which has

not been repaid when due; or

(6) any person who is a public servant of the PRC.

Other circumstances under which a person is disqualified from acting as a director of

a company are set out in the Mandatory Provisions which have been incorporated in the


(xiii) Supervisory committee

A company is required to establish a supervisory committee comprising not less than three

members. The supervisory committee is responsible for:

(1) examining the financial matters of the company;


— IV-20 —

(2) supervising the directors and the senior management of the company and propose to

remove those directors and senior management who breach relevant laws and

regulations and the company’s articles of association when carrying out their duties;

(3) requiring the directors and the senior management to rectify any action which

adversely affects the interests of the company;

(4) proposing the convening of extraordinary general meetings; and

(5) carrying out other duties specified in the company’s articles of association.

A supervisor may attend board meetings as a non-voting delegate.

Under the Supplemental Amendments, resolutions of a supervisory committee are required

to be passed by the affirmative votes of two thirds or more of the supervisors.

A supervisory committee is required to comprise representatives elected by the employees

of the company and representatives elected by shareholders in general meeting in an appropriate

proportion specified in the company’s articles of association. A director or the senior

management of the company may not become a supervisor. The term of office of a supervisor is

three years and a supervisor may serve consecutive terms if re-elected. The circumstances under

which a person is disqualified from acting as a director of a company under the PRC Company

Law and the Mandatory Provisions apply equally to a supervisor of the company.

(xiv) Manager and officers

A company is required to appoint a manager. The manager is appointed and may be removed

by the board of directors. The manager is accountable to the board of directors and may exercise

the following powers:

(1) to take charge of the production, operations and management of the company and to

organise the implementation of resolutions of the board of directors;

(2) to organise the implementation of the company’s annual operation plans and

investment plans;

(3) to prepare plans for the establishment of the company’s internal management

structure;

(4) to prepare the basic management system of the company;

(5) to establish the company’s internal rules;


— IV-21 —

(6) to recommend the appointment and dismissal of deputy managers and financial

controller and to appoint and dismiss other officers (other than those required to be

appointed or dismissed by the board of directors);

(7) to attend board meetings; and

(8) to exercise other powers conferred by the board of directors or the company’s articles

of association.

The Special Regulations provide that the officers of a company shall include its financial

controller, company secretary and other executives specified in the company’s articles of

association.

The circumstances under which a person is disqualified from acting as a director of a

company under the PRC Company Law and the Mandatory Provisions apply equally to

supervisors and managers of the company.

(xv) Duties of directors, supervisors, manager and officers

A director, supervisor, manager and an officer of a company are required under the PRC

Company Law to comply with the relevant laws, regulations and the company’s articles of

association, and act in good faith and diligence for the company. A director, supervisor, manager

and an officer of a company is also under a duty of confidentiality to the company and is

prohibited from divulging any secret information of the company save as permitted by the

relevant laws and regulations or by the shareholders.

A director, supervisor, manager and an officer who contravenes any laws, regulation or the

company’s articles of association in the performance of his duties which results in any loss to

the company shall be personally liable to the company.

The Special Regulations and the Mandatory Provisions provide that directors, supervisors,

managers and officers of a company owe fiduciary duties to the company and are required to

perform their duties faithfully and diligently, protect the interests of the company and not to

make use of their positions in the company for their own benefit.

(xvi) Finance and accounting

A company is required to establish a financial and accounting system in accordance with

the relevant laws and regulations.


— IV-22 —

A company is required to prepare its financial accountant report to be audited by accountant

firms as required by laws at the end of each financial year. The financial accountant report are

required to be made available in the Company for inspection by the shareholders of the company

20 days prior to the annual general meeting of the company. A company with public issued shares

must publish its financial statements.

A company is required to make the following transfers from its after tax profit before

distributing its profits to the shareholders of the company:

(1) a transfer of 10% of its after tax profit to the statutory common reserve of the

company provided that no further transfer is required to be made if the accumulated

statutory common reserve exceeds 50% of the registered capital of the company;

(2) after the transfer of its after tax profit to the statutory public welfare fund and subject

to the approval of the general meeting, any amount from the after tax profit of the

company to the discretionary common reserve; and

(3) any balance of the after tax profit subsequent to making up accrued losses and

transfers to the common reserve shall be distributed to the shareholders in proportion

to their respective shareholdings in the company.

When a company’s statutory common reserve is insufficient to make up the company’s

accrued losses from the previous year, the profits of the company for the current year shall be

applied to make up such losses before making allocations to the statutory common reserve and

the statutory public welfare fund pursuant to the requirements described above.

The common reserve of a company comprises the statutory common reserve, discretionary

common reserve and the capital common reserve.

A company which has made a transfer to its statutory common reserve from its after tax

profits may, with the approval of its shareholders in general meeting, make appropriations from

its discretionary common reserve.

The capital common reserve of a company is made up of the premium over the nominal

value of the shares of the company and other amounts required by the fiscal department of the

State Council to be treated as the capital common reserve.

The common reserve of a company shall be applied for the following purposes:

(1) to make up the company’s accrued losses;

(2) to expand the business operations of the company; and


— IV-23 —

(3) to pay up the registered capital of the company by the issue of new shares to

shareholders in proportion to their existing shareholdings in the company, or by

increasing the par value of the shares currently held by the shareholders; provided that

if the statutory common reserve is converted into registered capital, the balance of the

statutory common reserve after such conversion shall not be less than 25% of the

registered capital of the company before the conversion. However, the capital common

reserve shall not be applied for recovering the loss of the company.

(xvii) Appointment and retirement of auditors

The Special Regulations require a joint stock company to employ an independent PRC

qualified firm of accountants to audit the company’s annual financial statements and to review

its other financial reports.

Auditors are required to be appointed for a term commencing from the close of an annual

general meeting to the close of the next annual general meeting.

If a company removes or ceases to continue to appoint its auditors, it is required by the

Special Regulations to give prior notice to the auditors and the auditors are entitled to make

representations before the shareholders in general meeting. Auditors who resign from their office

should make a statement to the shareholders stating whether or not the company has undertaken

any inappropriate transactions. The appointment, removal and non re-appointment of auditors are

required to be decided by the shareholders and shall be registered with the securities supervisory

authority for records.

(xviii) Distribution of profits

The Special Resolutions provide that the dividends and other distributions payable to

holders of overseas listed foreign shares shall be declared and calculated in Renminbi and paid

in foreign currency. Under the Mandatory Provisions, the payment of foreign currency to

shareholders is required to be made through a receiving agent.

(xix) Amendments to articles of association

Amendments to a company’s articles of association must be approved by more than two

thirds of the votes cast by shareholders present at a general meeting. Any amendment of the

provisions incorporated in a company’s articles of association in accordance with the Mandatory

Provisions will only be effective after approval by the relevant department authorised by the

State Council and the approval of the Securities Commission of the State Council shall have been

obtained. A company must change its registration particulars in accordance with the applicable

laws if any amendments to its articles of association involving registration matters are adopted.


— IV-24 —

(xx) Merger and demerger

The merger or demerger of a company is required to be approved by the shareholders in

general meeting. The merger of a company may be effected either by way of absorption followed

by the dissolution of the company being absorbed or the establishment of a new entity followed

by the dissolution of the entities being merged.

All parties to a merger are required to sign a merger agreement and to prepare their

respective balance sheets and inventory of assets. Each party to a merger shall notify the

creditors of the merger within 10 days and publicly announce the merger in the newspapers

within 30 days after the resolution approving the merger has been passed. The creditors may

within the statutory prescribed time limit request the company to repay any outstanding

indebtedness or provide guarantees covering such indebtedness.

A company is required to prepare its balance sheet and inventory of assets prior to its

demerger. A company seeking a demerger is required to issue notices of the demerger to

creditors, to publish notices of the demerger and to make repayment of or provide guarantees to

creditors.

Any change in the registration particulars of the companies resulting from merger or

demerger must be registered in accordance with the applicable laws and regulations.

(xxi) Dissolution and liquidation

Under the PRC Company Law, a company is required to be dissolved upon occurrence of

any of the following events:

(1) upon the expiry of the term of operations stipulated in the company’s articles of

association or on the occurrence of dissolution events specified in the company’s

articles of association;

(2) the shareholders in general meeting have resolved to dissolve the company;

(3) a merger or demerger of the company which requires the company to be dissolved;

(4) upon revoking its business licence or being ordered to close or terminate as required

by laws;

(5) upon dissolution as declared by the people’s court;


— IV-25 —

Where a company is dissolved in any of the circumstances referred to in (1), (2), (4) or (5)

above, the directors or the shareholders in general meeting shall within 15 days of the occurrence

of the event appoint the members of the liquidation committee and begin the dissolution. If the

liquidation committee is not established within the specified time, the creditors of the company

may apply to the people’s court to appoint the members of the liquidation committee. A

liquidation committee is responsible for liquidating the assets of the company, preparing a

balance sheet and an inventory of the company’s assets, notifying the creditors of the company’s

dissolution and publish an announcement, handling and liquidating the outstanding business of

the company, discharging the unpaid taxes, cleaning up the debts and the credit, distributing the

company’s surplus assets after the discharge of all its indebtedness and representing the company

in all civil litigation.

The liquidation committee is required to notify the creditors within 10 days after its

establishment and to issue a public announcement within 60 days after its establishment. A

creditor is required to lodge his claim with the liquidation committee within the statutory

prescribed time limit.

A company’s assets are required to be applied to pay off all expenses incurred in connection

with the liquidation expenses, employees’ wages, social insurance, statutory compensation and

the indebtedness of the company. Any surplus assets after the discharge of the company’s

liabilities are required to be distributed to the shareholders in proportion to their respective

shareholdings in the company. If the assets of the company are inadequate to pay off its

indebtedness, the liquidation committee shall apply to the people’s court for an insolvency

declaration and shall transfer the liquidation proceedings to the people’s court.

A company may not engage in any new business operations during its liquidation.

On completion of the liquidation process, the liquidation committee is required to submit

a liquidation report to the shareholders in general meeting or the people’s court for confirmation.

The liquidation committee is also required to apply to relevant Administration of Industry and

Commerce for the write off of the company’s registration and to make a public announcement of

the company’s dissolution. Members of the liquidation committee are required to discharge their

duties honestly and in compliance with laws. A member of the liquidation committee is liable to

indemnify the company or its creditors in respect of any loss arising from his wilful or material

default.

(xxii) Overseas listing

The shares of a company shall only be listed overseas after obtaining approval from the

securities regulatory authority of the State Council and the listing must be arranged in

accordance with procedures specified by the State Council.


— IV-26 —

According to the Special Regulations, a company’s plan to issue overseas listed foreign

invested shares and domestic invested shares which has been approved by the CSRC may be

implemented by the board of directors of a company by way of separate issues, within 15 months

after approval is obtained from the CSRC.

(xxiii) Loss of share certificates

In the event that share certificates in registered form are either stolen or lost, a shareholder

may apply, in accordance with the relevant provisions set out in the applicable laws where the

original copy of the role of the foreign shareholder, to a court for a declaration that such

certificates will no longer be valid. After such a declaration has been obtained, the shareholder

may apply to the company for the issue of replacement certificates. A separate procedure

regarding loss of H share certificates is provided in the Mandatory Provisions.

(xxiv) Suspension and termination of listing

The listing of a listed company may be suspended by the Stock Exchange if any of the

following events shall occur:

(1) the total Share capital of the company or the distribution of Share holding no longer

satisfy the relevant listing requirements;

(2) the company has failed to disclose its financial position in accordance with the

relevant laws and regulations or the financial report of the company contains any false

information, which may mislead investors;

(3) the company has committed a material breach of the law;

(4) the company has incurred losses for each of the immediately preceding three years;

(5) other conditions set out in the listing rules of the stock exchange.

If the circumstances referred to in (2) or (3) above shall have occurred and it has been

established by investigation that the consequences are serious, or if the circumstances referred

to in (1) or (4) above shall have occurred and the situation is not rectified within the time

stipulated, the Stock Exchange may decide to terminate the listing of a company’s shares.

The Stock Exchange may also terminate the listing of a company’s shares in the event that

the company has resolved to be wound up or is ordered by the relevant governmental authority

to be dissolved, or the company is declared insolvent.


— IV-27 —

(g) Securities laws and regulations

The PRC has promulgated a number of regulations in relation to the issue and trading of shares

and the disclosure of information.

In early 1993, the State Council established the Securities Commission of the State Council and

the CSRC. At the time of its establishment, the Securities Commission of the State Council was

responsible for co-ordinating the drafting of securities regulations, formulating securities related

policies, planning the development of securities markets, directing, co-ordinating and supervising all

securities related institutions in the PRC and administering the CSRC. At that time, the CSRC was the

regulatory arm of the Securities Commission of the State Council and was responsible for the drafting

of regulatory provisions of securities markets, supervising securities companies, regulating public

offerings of securities by PRC companies in the PRC and overseas, regulating the trading of securities,

compiling securities related statistics and undertaking research and analysis. In early 1998, the State

Council dissolved the Securities Commission of the State Council and the functions formerly

undertaken by the Securities Commission of the State Council have been assumed by the CSRC.

On 22 April 1993, the State Council promulgated the Provisional Regulations Governing the

Issue and Trading of Shares ( ) (the “Securities Provisional Regulations”).

These regulations deal with the application and approval procedures for public offerings of equity

securities, trading in equity securities, the acquisition of listed companies, deposit, settlement, and

transfer of listed equity securities, the disclosure of information with respect to a listed company,

enforcement and penalties and dispute settlements. These regulations specifically provide that the

offer of shares by a PRC company directly and indirectly outside the PRC require the approval of the

Securities Commission of the State Council and also provide that separate measures will be

promulgated in relation to the issue of and trading in special Renminbi-denominated shares. However,

(i) if a PRC joint stock limited company proposes to issue Renminbi-denominated ordinary shares as

well as special Renminbi-denominated shares, it has to comply with the Securities Provisional

Regulations.

On 10 June 1993, the CSRC promulgated the Implementation Measures (Provisional) on

Disclosure of Information ( ) pursuant to the Securities Provisional

Regulations. Under these measures, the CSRC is responsible for supervising the disclosure of

information by companies which have offered shares to the public in the PRC. These measures contain

provisions regarding prospectuses and listing reports to be issued in connection with a public offering

of shares in the PRC, publication of interim and annual reports and announcement of material

transactions or matters by companies which have offered shares to the public. Material transactions

or matters are those the occurrence of which may have a material effect on the share price of a

company. They include alterations to a company’s articles of association or registered capital, removal

of auditors, mortgage or disposal of major operating assets or the writing down of the value of such

assets where the amount being written down exceeds 30% of the total value of such assets, revocation

by a court of any resolution passed by the shareholders or the supervisors of a company and the merger

or demerger of a company. These measures also contain disclosure provisions in relation to the

acquisition of listed companies which supplement the requirements contained in the Securities

Provisional Regulations.


— IV-28 —

On 2 September 1993, the Securities Commission of the State Council promulgated the

Provisional Measures on Prohibiting Fraudulent Conduct Relating to Securities

( ). The prohibitions imposed by these measures include the use of insider

information in connection with the issue of or trading in securities (insider information being defined

to include undisclosed material information known to any insider, which may affect the market price

of securities); the use of funds or information or through an abuse of power in creating a false or

disorderly market or influencing the market price of securities or inducing investors to make

investment decisions without knowledge of actual circumstances; and the making of any statement in

connection with the issue of and trading in securities which is false or materially misleading or in

respect of which there is any material omission. Penalties imposed for contravening any of the

provisions of the measures include fines, confiscation of profits and suspension of trading. In serious

cases, criminal liability may be imposed. The PRC Securities Law imposes similar prohibitions on

insider in possession of insider information or other person who illegally obtains insider information

from dealing in securities, divulge such insider information or conselling another person to deal in

securities.

The PRC Securities Law also prohibits certain dealings activities which are manipulative of the

market price and/or the trading volume of securities.

The Special Regulations promulgated on 4 August 1994 also contain regulations which deal with

the issue and subscription of and the declaration of dividends and other distributions on overseas listed

foreign shares.

On 25 December 1995, the State Council promulgated the Regulations of the State Council

Concerning the Domestically Listed Foreign Shares of Joint Stock Limited Companies

( ). These regulations deal mainly with the issue, subscription,

trading and declaration of dividends and other distributions of domestically listed foreign shares and

the disclosure of information by joint stock limited companies having domestic listed foreign shares.

On 29 December 1998, the PRC Securities Law was passed by the Standing Committee of the

NPC. The PRC Securities Law took effect on 1 July 1999. It was then substantially modified on 27

October 2005. The revised Securities Law came into effect on 1 January 2006 This is the first national

PRC Securities Law in the PRC, which regulate, among other things, the issue and trading of

securities, takeovers of listed companies, continuing disclosure obligations of issues of equities and

bonds, prohibitions on certain securities trading activities, securities exchanges, securities companies,

securities clearing institutions and the duties and functions of the State Council’s securities regulatory

authorities. The PRC Securities Law provides, among other matters, that (i) enterprises in the PRC

which intend to issue directly or indirectly securities outside the PRC or to list their securities outside

the PRC must obtain prior approval from the State Council’s securities supervisory authorities, and (ii)

specific measures in respect of shares of PRC domestic companies which are to be subscribed and

traded in foreign currencies by persons and organisations outside the PRC will be formulated by the

State Council separately. Currently, the issue and trading of shares subscribed and traded in foreign

currencies (including H shares and B shares) are still mainly governed by the rules and regulations

promulgated by the State Council and the CSRC.


— IV-29 —

On 29 March 1999, the State Economic and Trade Commission and the CSRC jointly issued the

Opinion Regarding Further Conformity in Operations and Reform of Companies Listed outside the

PRC ( ) (the “Conformity Opinion”). The Conformity

Opinion sets out measures recommended to be adopted by companies whose securities are listed

outside the PRC (the “Overseas Listed Companies”) in order to encourage these companies to comply

with the applicable domestic and foreign laws and regulations, to perform their continuing obligations

towards investors and to establish a good corporate image in capital markets whether in or outside the

PRC. These measures include generally segregating certain functions and activities of the Overseas

Listed Companies from their respective controlling entities (and for purpose of the Conformity

Opinion, a “controlling entity” refers to any company, enterprise or institution having a legal person

status and which has a controlling interest in an Overseas Listed Company), establishing a clear

decision making process and enhancing directors’ responsibilities, strengthening the composition of

the board of directors and supervisors and segregating the administrative affiliation between

government departments and the Overseas Listed Companies. Specific recommendations contained in

the Conformity Opinion include that: (i) the board of directors, the management and the financial and

marketing departments of an Overseas Listed Company should be independent from those of its

controlling entities; (ii) no more than two senior management from the controlling entity (whether the

chairman, vice-chairman or executive directors) may concurrently hold the position of senior

management in the Overseas Listed Company; (iii) a State-owned controlling entity whose principal

business and assets have been assumed by an Overseas Limited Company is required to reduce its

connected transactions with the Overseas Limited Company and avoid competing with the Overseas

Listed Company in the same industry; (iv) the directors of an Overseas Listed Company owe a

fiduciary obligation and a duty of due diligence to the company. A director is required to express

unequivocal opinions on matters discussed at board meetings; (v) an Oversea Listed Company is

required to increase the proportion of external directors so that external directors shall make up of one

half or more of the board and there shall be two or more independent directors; (vi) an Overseas Listed

Company is required to increase the proportion of external supervisors (who do not hold any position

in the Overseas Limited Company) so that the external supervisors shall make up of one half or more

of the supervisory board and there shall be two or more independent supervisors.

(h) Legal opinion

Kingfield & Partners, the Company’s legal advisers on PRC laws, has sent to the Company a PRC

legal opinion confirming that they have reviewed the summary of relevant PRC laws and regulations

contained in this Appendix and that, in their opinion, the summary is a correct summary of the relevant

PRC laws and regulations. A copy of this PRC legal opinion is available for inspection as referred to

Appendix VII to this document. Any person wishing to have detailed advice on PRC laws is

recommended to seek independent legal advice.


— IV-30 —

2. HONG KONG LAWS AND REGULATIONS

LISTING RULES

The Listing Rules provide additional requirements which apply to the Company as an issuer

incorporated in the PRC as a joint stock limited liability company and seeking a primary listing or

whose primary listing is on the Stock Exchange. Set out below is a summary of the principal

provisions containing the additional requirements which apply to us.

Compliance adviser

The Company is required to retain for at least one year following the listing of the H Shares on

the Main Board, or such shorter period as the Stock Exchange may in its absolute discretion permit,

the services of a compliance adviser which is acceptable to the Stock Exchange, to provide the

Company with professional advice on continuous compliance with the Listing Rules, and to act at all

times, in addition to the Company’s two authorized representatives, as the principal channel of

communication with the Stock Exchange. The appointment of the compliance adviser may not be

terminated until a replacement acceptable to the Stock Exchange has been appointed.

If the Stock Exchange is not satisfied that the compliance adviser is fulfilling its responsibilities

adequately, it may require the Company to terminate the compliance adviser’s appointment and

appoint a replacement.

The compliance adviser must keep the Company informed on a timely basis of changes in the

Listing Rules and any new or amended law, regulation or code in Hong Kong applicable to the

Company. It must act as the Company’s principal channel of communication with the Hong Kong

Stock Exchange if the authorized representatives of the Company are expected to be frequently outside

Hong Kong.

Accountants’ Report

An accountants’ report will not normally be regarded as acceptable by the Stock Exchange unless

the relevant accounts have been audited to a standard comparable to that required in Hong Kong. Such

report will normally be required to conform to either Hong Kong accounting standards or International

Accounting Standards.

Process Agent

The Company is required to appoint and maintain a person authorized to accept service of

process and notices on its behalf in Hong Kong throughout the period during which the securities are

listed on the Stock Exchange and must notify the Stock Exchange of his, her or its appointment, the

termination of his, her or its appointment and his, her or its contact particulars.


— IV-31 —

Public Shareholding

If at any time we issue securities other than the H Shares which are listed on the Stock Exchange,

the Listing Rules require that all of the H Shares must be held by the public, the H Shares must

represent not less than 15% of the issued share capital of the company having an expected market

capitalization at the time of listing of not less than HK$50,000,000 and the aggregate number of our

H Shares and other securities held by the public must constitute not less than 25% of our issued share

capital.

Independent Non-Executive Directors and Supervisors

Independent non-executive Directors are required to demonstrate an acceptable standard of

competence and adequate commercial or professional expertise to ensure that the interests of our

general body of shareholders will be adequately represented. Supervisors must have the character,

expertise and integrity and be able to demonstrate a standard of competence commensurate with their

position as Supervisors.

Restrictions on Purchase of its Own Securities

Subject to governmental approvals and the Articles of Association, the Company may repurchase

its own H Shares on the Stock Exchange in accordance with the provisions of the Listing Rules.

Approval by way of special resolution of the holders of Domestic Shares and the holders of H Shares

at separate class meetings conducted in accordance with the Articles of Association is required for

share repurchases. In seeking approvals, the Company is required to provide information on any

proposed or actual purchases of all or any of our equity securities, whether or not listed or traded on

the Stock Exchange. The Company must also state the consequences of any purchases which will arise

under either or both of the Hong Kong Takeovers Code and any similar PRC law of which Directors

are aware, if any. Any general mandate given to Directors to repurchase H Shares must not exceed 10%

of the total number of our existing issued H Shares.

Redeemable Shares

The Company must not issue any redeemable shares unless the Stock Exchange is satisfied

that the relative rights of the holders of our H Shares are adequately protected.


— IV-32 —

Pre-emptive Rights

Except in the circumstances mentioned below, Directors are required to obtain the approval

by a special resolution of shareholders in general meeting, and the approvals by special

resolutions of the holders of Domestic Shares and H Shares each being otherwise entitled to vote

at general meetings) at separate class meetings conducted in accordance with the Articles of

Association, prior to:

(a) authorizing, allotting, issuing or granting Shares or securities convertible into Shares,

options, warrants or similar rights to subscribe for any Shares or such convertible

securities; or

(b) any major subsidiary making any such authorization, allotment, issue or grant so as

materially to dilute the percentage of our equity interest in such subsidiary.

No such approval will be required, except to the extent that the existing shareholders of the

Company have by special resolution in general meeting given a mandate to Directors, either

unconditionally or subject to such terms and conditions as may be specified in the resolution, to

authorize, allot or issue, either separately or concurrently once every 12 months, not more than 20%

of each of the existing issued Domestic Shares and H Shares as at the date of the passing of the

relevant special resolution or, such Shares as are part of our plan at the time of our establishment, to

issue Domestic Shares and H Shares and which plan is implemented within 15 months from the date

of approval by the State Council Securities Policy Committee.

Amendment to Articles of Association

The Company may not permit or cause any amendment to our Articles of Association which

would cause them to cease to comply with the PRC Company Law, the Mandatory Provisions or the

Listing Rules.

Documents for Inspection

The Company is required to make available at a place in Hong Kong for inspection by the public

and our shareholders free of charge, and for copying by its shareholders at reasonable charges the

following:

● a complete duplicate register of shareholders;

● a report showing the state of our issued share capital;

● our latest audited financial statements and the reports of the Directors, auditors and (if any)

Supervisors, if any, thereon;

● special resolutions of the Company;


— IV-33 —

● reports showing the number and nominal value of securities repurchased by us since the end

of the last financial year, the aggregate amount paid for such securities and the maximum

and minimum prices paid in respect of each class of securities repurchased (with a

breakdown between Domestic Shares and H Shares);

● a copy of the latest annual return filed with the PRC State Administration for Industry and

Commerce or other competent PRC authority; and

● for shareholders only, copies of minutes of meetings of shareholders.

Receiving Agents

Under Hong Kong law, the Company is required to appoint one or more receiving agents in Hong

Kong and pay to such agents dividends declared and other monies owed in respect of the H Shares to

be held, pending payment, in trust for the holders of such H Shares.

Statements in Share Certificates

The Company is required to ensure that all its listing documents and share certificates include

the statements stipulated below and to instruct and cause its share registrars not to register the

subscription, purchase or transfer of any of its Shares in the name of any particular holder unless and

until such holder delivers to the share registrar a signed form in respect of those Shares bearing

statements to the following effect, that the acquirer of Shares:

● agrees with the Company and each Shareholder, and the Company agree with each

shareholder, to observe and comply with the PRC Company Law, the Special Regulations

and the Articles of Association;

● agrees with the Company, each Shareholder, Director, Supervisor, manager and other

officer and the Company acting both for the Company and for each Director, Supervisor,

manager and other officer, agree with each shareholder to refer all differences and claims

arising from the Articles of Association or any rights or obligations conferred or imposed

by the PRC Company Law or other relevant laws and administrative regulations concerning

the Company’s affairs to arbitration in accordance with the Articles of Association. Any

reference to arbitration will be deemed to authorize the arbitration tribunal to conduct its

hearing in open session and to publish its award. Such arbitration will be final and

conclusive;

● agrees with the Company and each Shareholder that Shares are freely transferable by the

holder thereof; and

● authorizes us to enter into a contract on his behalf with each Director and officer whereby

such Directors and officers undertake to observe and comply with their obligations to

shareholders as stipulated in the Articles of Association.


— IV-34 —

R19A.42(62)R19A.52

Company law

The Hong Kong laws applicable to a company having a share capital incorporated in Hong Kong

is based on the Companies Ordinance and supplemented by the common laws and the rules of equity

which apply to Hong Kong by a decision adopted at the 24th Session of the Standing Committee of

the 8th NPC on 23 February 1997 on treatment of the laws previously in force in Hong Kong in

accordance with Article 160 of the Basic Law of Hong Kong.

The Company, which is a joint stock limited company established in the PRC is governed by the

PRC Company Law which came into effect on 1 July 1994 and all other rules and regulations

promulgated pursuant to the PRC Company Law applicable to a joint stock limited company

established in the PRC issuing overseas listed foreign shares to be listed on the Stock Exchange.

Set out below is a summary of the material differences between the Hong Kong company laws

applicable to a company incorporated in Hong Kong and the PRC Company Law applicable to a joint

stock limited company incorporated and existing under the PRC Company Law. This summary is not

intended to be an exhaustive comparison:

(i) Corporate existence

Under Hong Kong company laws, a company having a share capital is incorporated by the

Registrar of Companies in Hong Kong issuing a certificate of incorporation and upon its

incorporation, a company will acquire an independent corporate existence. A company may be

incorporated as a public company or a private company. The articles of association of a private

company incorporated in Hong Kong is required by the Hong Kong Companies Ordinance to

contain certain provisions restricting the right of transfer of its shares. Any company which does

not contain such provisions in its articles of association is a public company.

Under the PRC Company Law, a company may be incorporated by either the promotion

method or the public subscription method. A company established by the public subscription

method will only acquire its corporate existence after it has completed its initial share offering

to the public

Under the PRC Company Law, a company which is authorised by the relevant securities

administration authority to list its shares on a stock exchange must have registered a capital of

not less than RMB30,000,000. Hong Kong laws does not prescribe any minimum capital

requirements for a Hong Kong company.

Under the PRC Company Law, the shares allotted by a joint stock limited company in return

for injection of non-monetary assets which can be assessed in monetary value and legally

transferred, such as industrial property rights and land use rights, shall not, as a general

principle, exceed 70% of the registered capital of a company. There is no such restriction on a

Hong Kong company under Hong Kong laws.


— IV-35 —

R19A.42(65)

(ii) Share capital

Under Hong Kong laws, the authorised share capital of a Hong Kong company is the

amount of share capital which the company is authorised to issue and a company is not bound

to issue the entire amount of its authorised share capital. The PRC Company Law does not have

the concept of authorised share capital. The registered capital of a joint stock limited company

established by way of promotion is the amount of the total share capital subscribed in writing by

all promoters and the registered capital of a company established by way of subscription is the

amount of the total paid-in capital. Any increase or reduction in registered capital must be

approved by the shareholders in general meeting. After the completion of an approved new issue,

the company has to register the increase in share capital with the relevant regulatory authority

for industry and commerce.

(iii) Restrictions on shareholding and transfer of shares

Under the PRC laws, the domestic shares (“domestic shares”) in the share capital of a joint

stock limited company which are denominated and subscribed for in Renminbi may only be

subscribed or traded by the State, PRC legal and natural persons. The overseas listed foreign

shares (“foreign shares”) issued by a joint stock limited company which are denominated in

Renminbi and subscribed for in a currency other than Renminbi may only be subscribed and

traded by investors from Hong Kong, Macau and Taiwan or any country or territory outside the

PRC.

Under the PRC Company Law, shares in a joint stock limited company held by its promoters

may not be transferred within one years after the date of establishment of the company. Directors,

supervisors and managers of a joint stock limited company may not transfer more than 25% of

the aggregate number of the shares held in the company in each year during their term of office.

There are no such restrictions on shareholdings and transfer of shares under Hong Kong

laws.

(iv) Financial assistance for acquisition of shares

The PRC Company Law does not contain any provision prohibiting or restricting a joint

stock limited company or its subsidiaries from providing financial assistance for the purposes of

an acquisition of its own or its holding company’s shares. The Mandatory Provisions contain

certain restrictions on a company and its subsidiaries providing such financial assistance similar

to those under Hong Kong company laws.

(v) Variation of class rights

Under the Companies Ordinance, no rights attached to any class of shares can be varied

except with the approval of a special resolution of the holders of the relevant class at a separate


— IV-36 —

meeting or the consent in writing of the holders of three-fourths in nominal value of the issued

shares of the class in question or by agreement of all the members of the Company or if there

are provisions in the articles of association relating to the variation of those rights, then in

accordance with those provisions.

The PRC Company Law does not contain any specific provision relating to variation of

class rights. Under the Mandatory Provisions, class rights may not be varied or abrogated unless

approved by a special resolution of shareholders in general meeting and by two thirds of the

votes cast by shareholders of the affected class present in person or by proxy at a separate class

meeting. For the purposes of a variation of class right, domestic shares and foreign shares are

treated as separate classes of shares except in the case of (i) an issue of shares by the joint stock

limited company in any 12 month period either separately or concurrently following the approval

by a special resolution of shareholders in general meeting not exceeding 20% of each of the

issued domestic shares and foreign shares existing as at the date of such special resolution; and

(ii) an issue of domestic shares and foreign shares in accordance with the plan of the company

approved by CSRC and which are completed within 15 months following the establishment of the

company. The Mandatory Provisions contain detailed provisions relating to circumstances which

are deemed to constitute a variation of class rights.

(vi) Directors

The PRC Company Law, unlike Hong Kong company laws, does not contain any

requirements relating to the declaration of interests in material contracts, restrictions on

interested directors being counted towards the quorum of and voting at a meeting of the board

of directors at which a transaction in which a director is interested is being considered,

restrictions on directors’ authority in making major dispositions, restrictions on companies

providing certain benefits such as loans to directors and guarantees in respect of directors’

liability and prohibition against compensation for loss of office without shareholders’ approval.

The Mandatory Provisions contain requirements and restrictions in relation to the foregoing

matters similar to those applicable under Hong Kong laws to Hong Kong incorporated

companies.

(vii) Supervisory committee

Under the PRC Company Law, the board of directors of a joint stock limited company is

subject to the supervision of a supervisory committee but there is no mandatory requirement for

the establishment of a supervisory committee for a company incorporated in Hong Kong.

The Mandatory Provisions provide that each supervisor owes a duty, in the exercise of his

powers, to act in good faith and honestly in what he considers to be in the best interests of the

company and to exercise the care, diligence and skill that a reasonably prudent person would

exercise in comparable circumstances.


— IV-37 —

(viii) Derivative action by minority shareholders

Hong Kong laws permits minority shareholders to commence a derivative action on behalf

of all shareholders against directors who have been guilty of a breach of their fiduciary duties

to the company, if they control a majority of votes at a general meeting thereby effectively

preventing a company from suing the directors in breach of their duties in its own name.

Although the PRC Company Law gives a shareholder of a joint stock limited company the right

to initiate proceedings in the people’s court to restrain the implementation of any resolution

passed by shareholders in general meeting or by the board of directors which violates any laws

or infringes the lawful rights and interests of shareholders, the PRC laws does not have a form

of proceedings which is the same as a derivative action. The Mandatory Provisions, however,

provide for remedies of the company against directors, supervisors and officers in breach of their

duties to the company. In addition, every director and supervisor of a joint stock limited company

applying for a listing of its foreign shares on the Main Board is required to give an undertaking

in favour of the company to comply with the company’s articles of association. This allows

minority shareholders to bring action against directors and supervisors in default.

(ix) Protection of minorities

Under Hong Kong laws, a shareholder who complains that the affairs of a company

incorporated in Hong Kong are conducted in a manner unfairly prejudicial to his interests may

petition to court either to wind up the company or to make an appropriate order regulating the

affairs of the company. In addition, the Financial Secretary of the Hong Kong Government may

on the application of a specified number of members, appoint inspectors who are given extensive

statutory powers to investigate the affairs of a company incorporated in Hong Kong. PRC laws

does not contain similar safeguards. The Mandatory Provisions, however, contain provisions to

the effect that a controlling shareholder may not exercise its voting rights in a manner prejudicial

to the interests of the shareholders generally or of some part of the shareholders of a company

to relieve a director or supervisor of his duty to act honestly in the best interests of the company

or to approve the expropriation by a director or supervisor of the company’s assets or the

individual rights of other shareholders. However, there is specific provisions in the PRC

Company Law to guard against oppression by majority shareholders of minority shareholders.

(x) Notice of shareholders’ meetings

Under the PRC Company Law, notice of a general meeting must be given not less than 20

days before the meeting or, in the case of a company having bearer shares, public announcement

of a general meeting must be made at least 45 days prior to it being held. Under the Special

Regulations and the Mandatory Provisions, 45 days’ written notice must be given to all

shareholders and shareholders who wish to attend the meeting must reply in writing 20 days

before the date of the meeting. For a company incorporated in Hong Kong, the minimum notice

period of a general meeting convened for passing an ordinary resolution and a special resolution

is 14 days and 21 days respectively; and the notice period for an annual general meeting is 21

days.


— IV-38 —

(xi) Quorum for shareholders’ meetings

Under Hong Kong laws, the quorum for general meeting is provided by the articles of

association of the company which may not in any event be fewer than two members, except for

single shareholder companies and unless the articles of association of the Company provide

otherwise. The PRC Company Law does not specify any quorum requirement for general meeting

but the Special Regulations and the Mandatory Provisions provide that a company’s general

meeting may be held when replies to the notice of that meeting have been received from

shareholders whose shares represent 50% of the voting rights in the company at least 20 days

before the proposed date of the meeting, or if that 50% level is not achieved, the company shall

within five days notify shareholders by public announcement and the general meeting may be

held thereafter.

(xii) Voting

Under Hong Kong laws, an ordinary resolution is passed by a simple majority of votes cast

by members present in person or by proxy at a general meeting and a special resolution is passed

by a majority of not less than three fourths of votes cast by members present in person or by

proxy at a general meeting.

Under the PRC Company Law, the passing of any resolution requires more than half of

votes cast by shareholders present in person or by proxy at a general meeting except in cases of

proposed amendment to the articles of association, merger, demerger or dissolution of a joint

stock limited company which require two thirds of votes cast by shareholders present in person

or by proxy at a general meeting.

(xiii) Dividends

The Articles of Association empower the Company to withhold, and pay to the relevant tax

authorities, any tax payable under PRC laws on any dividends or other distributions payable to

a shareholder. Under Hong Kong laws, the limitation period for an action to recover a debt

(including the recovery of dividends) is six years, whereas under PRC laws, the relevant

limitation period is two years.

Before the end of limitation period, the Company shall not exercise its power to receive the

dividend not collected by anyone.

(xiv) Financial disclosure

A joint stock limited company is required under the PRC Company Law to make available

at its office for inspection by shareholders its financial statement audited by accountancy firms

20 days before the annual general meeting of shareholders. In addition, a company established

by the public subscription method under the PRC Company Law must publish its financial

statements. The annual financial statements of a PRC joint stock limited company is required to

be verified by registered accountants. The Companies Ordinance requires a company to send to


— IV-39 —

every shareholder (whether he is or is not entitled to receive notices of general meetings of the

Company) a copy of its balance sheet and its annexures, auditors’ report and directors’ report

which are to be laid before the company in its annual general meeting not less than 21 days

before such meeting.

A joint stock limited company is required under the PRC laws to prepare its financial

statements in accordance with the PRC accounting standards. The Mandatory Provisions require

that the company must, in addition to preparing accounts according to the PRC standards, have

its accounts prepared and audited in accordance with International Accounting Standards or

Hong Kong accounting standards and its financial statements must also contain a statement of

the financial effect of the material differences (if any) from the financial statements prepared in

accordance with the PRC accounting standards.

The Company is further required to publish its interim and annual accounts within 60 days

from the end of the first six months of a financial year, and first nine months of a financial year

and within 120 days from the end of a financial year respectively.

The Special Regulations require that there should not be any inconsistency between the

information disclosed in within and outside the PRC and that, to the extent that there are

differences in the information disclosed in accordance with the relevant PRC and overseas laws,

regulations and requirements of the relevant stock exchanges, such differences should also be

disclosed simultaneously.

(xv) Information on directors and shareholders

Under the PRC Company Law, neither the public nor the shareholders of a joint stock

limited company have access to information on its directors and shareholders. Under the

Mandatory Provisions, shareholders have the right to inspect and copy (at reasonable charges)

certain information about the shareholders and directors of a PRC joint stock limited company

similar to that available under Hong Kong laws to shareholders of a company incorporated in

Hong Kong.

(xvi) Receiving agent

Under both the PRC and Hong Kong laws, dividends once declared become debts payable

to shareholders (except in relation to interim dividends of Hong Kong companies, which do not

constitute debts until the time they are paid generally). The limitation period for debt recovery

action under Hong Kong laws is six years while that under the PRC laws is two years. The

Mandatory Provisions require the appointment of a trust company registered under the Hong

Kong Trustee Ordinance as receiving agent to receive on behalf of holders of foreign shares

dividends declared and all other monies owing by a joint stock limited company in respect of

such foreign shares.


— IV-40 —

(xvii) Merger and demerger

A merger or demerger involving a company incorporated in Hong Kong may be effected in

a number of ways, such as a transfer of the whole or part of the business or property of the

company in the course of being wound up voluntarily to another company pursuant to section 237

of the Companies Ordinance or a compromise or arrangement between the company and its

creditors or between the company and its members pursuant to section 166 of the Companies

Ordinance which requires the sanction of the court. Under the PRC laws, the merger or demerger

of a joint stock limited company has to be approved by shareholders in general meeting.

(xviii) Arbitration of disputes

In Hong Kong, disputes between shareholders and a company incorporated in Hong Kong

or its directors, general managers and other senior officers may be resolved through the courts.

The Mandatory Provisions and the Listing Rules provide that disputes between a holder of H

Shares and the Company and its directors, general managers or other senior administrative

officers or a holder of Domestic Shares arising from the Articles of Association, the PRC

Company Law or other relevant laws or administrative regulation which concerns the affairs of

the Company must, with certain exceptions (such as disputes over who is a shareholder), general

managers and other senior officers be referred to arbitration at the claimant’s election at either

the Hong Kong International Arbitration Centre or CIETAC. Such arbitration is final and

conclusive.

(xix) Mandatory transfers

Under the PRC Company Law, a joint stock limited company is required to make transfers

equivalent to certain prescribed percentages of its after tax profit to the statutory common

reserve. There are no such requirements under Hong Kong laws.

(xx) Fiduciary duties

In Hong Kong, there is the common laws concept of the fiduciary duty of directors. Under

the PRC Company Law and the Special Regulations, directors, supervisors, officers, and general

managers owe a fiduciary duty towards their company and are not permitted to be engaged in any

activities which compete with or damage the interests of their company.

(xxi) Closure of register of shareholders

The Companies Ordinance requires that the register of shareholders of a company must not

generally be closed for the registration of transfers of shares for more than 30 days (extendable

to 60 days in certain circumstances) in a year, whereas the Articles of Association provide, as

required by the PRC Company Law, that share transfers may not be registered within 30 days

before the date of a shareholders’ meeting or within five days before the record date set for the

purpose of distribution of dividends.


— IV-41 —

Other Legal and Regulatory Provision

Upon the listing of the Company on the Main Board, the provisions of the Securities and Futures

Ordinance (Chapter 571 of the Laws of Hong Kong), the Hong Kong Codes on Takeovers and Mergers

and Share Repurchases and such other relevant ordinances and regulations as may be applicable to

companies listed on the Stock Exchange will apply to the Company.

Securities Arbitration Rules

The Articles of Association provide that certain claims arising from the Articles of Association

or the PRC Company Law shall be arbitrated at either CIETAC or HKIAC in accordance with their

respective rules.

The Securities Arbitration Rules of the HKIAC contain provisions allowing an arbitral tribunal

to conduct a hearing in Shenzhen for cases involving the affairs of companies incorporated in the PRC

and listed on the Main Board so that PRC parties and witnesses may attend. Where any party applies

for a hearing to take place in Shenzhen, the tribunal shall, where satisfied that such application is

based on bona fide grounds, order the hearing to take place in Shenzhen conditional upon all parties

including witnesses and the arbitrators being permitted to enter Shenzhen for the purposes of the

hearing. Where a party (other than a PRC party) or any of its witnesses or any arbitrator is not

permitted to enter Shenzhen, then the tribunal shall order that the hearing be conducted in any

practicable manner, including the use of electronic media. For the purpose of the Securities Arbitration

Rules, a PRC party means a party domiciled in the PRC other than the territories of Hong Kong, Macau

and Taiwan.

Taxation

(i) Dividends

Under the current practice of Hong Kong Inland Revenue Department, no tax is payable in

Hong Kong in respect of dividends paid by the Company.

(ii) Profits tax

No tax is imposed in Hong Kong in respect of capital gains from the sale of property (such

as the H Shares). Persons who carry on a trade, profession or business in Hong Kong and derive

income in Hong Kong from such trade, profession or business are liable to profits tax. Securities

dealers carrying on a business in Hong Kong and who make trading gains from the sale and

purchase of shares will be subject to profits tax. Currently, profits tax for corporations is payable

at the rate of 17.5% of their assessable profits. Profits tax for individuals is levied at a rate of

16%.


— IV-42 —

(iii) Stamp duty

The sale and purchase of shares are subject to stamp duty payable by both the seller and

the buyer. Duty is payable with reference to the amount of the consideration or, if higher, the fair

value of the shares being sold. In respect of every HK$1,000 or part thereof, of the consideration

or, if higher, the fair value of the shares, the current rate of duty is HK$2 for the sale and

purchase of shares. Stamp duty is usually shared between the buyer and the seller equally in

respect of transactions on the Stock Exchange. A fixed rate of duty of HK$5 is also payable in

respect of every instrument of transfer which is required to be registered on a register or branch

register maintained in Hong Kong.

(iv) Estate duty

The Revenue (Abolition of Estate Duty) Ordinance 2005 abolished estate duty in respect of

death occurring on or after 11 February 2006.


— IV-43 —

Set out below is a summary of the principal provisions of the Articles of Association which have

incorporated the Mandatory Provisions as supplemented by the Opinion Regarding the Supplemental

Amendments to the Articles of Association of Companies to be Listed in Hong Kong jointly

promulgated by the CSRC and the State Commission for Restructuring the Economic System of the

PRC and which will be amended at the Extraordinary General Meeting to be held on or about 5

December 2006. Copies of the full Chinese text of the existing articles of association of the Company

are available for inspection as mentioned in the section headed “Documents available for inspection”

in Appendix VII.

1. Directors

(a) Power to allot and issue shares

There are no provisions in the Articles of Association empowering the Directors to

allot and issue shares.

In order to increase the share capital of the Company, the Directors shall prepare a

proposal for an allotment of shares in the Company, and submit the same to shareholders

in shareholders’ meeting for their approval by way of a special resolution. The Directors

shall then submit the proposal for the share allotment to the securities regulatory authorities

of the State Council for approval, and, subject to such approval being obtained, make

separate arrangements to implement the share allotment.

Subject to the relevant PRC laws and regulations, the Company may by special

resolution at a shareholders’ meeting authorise the Directors to allot or issue, either

separately or concurrently once every 12 months, not more than 20% of each of the existing

issued domestic shares and overseas listed foreign shares of the Company.

(b) Power to dispose of the assets of the Company or of any of its subsidiaries

The Directors shall not, without the prior approval of shareholders in shareholders’

meeting, dispose or agree to dispose of any fixed assets of the Company if the aggregate

of:

(i) the expected value of the fixed assets proposed to be disposed of; and

(ii) the total consideration received by the Company for all disposals of fixed assets

which took place within the period of four months immediately preceding the

proposed disposal,

exceeds 33% of the value of the Company’s fixed assets as shown in the last balance sheet

placed before the shareholders in shareholders’ meeting. The validity of a disposal of fixed

assets by the Company shall not be affected by a breach of this provision. For the purposes

of this provision, disposal includes an act involving the transfer of an interest in fixed

assets other than by way of security.

APPENDIX V SUMMARY OF THE ARTICLES OF ASSOCIATION

— V-1 —

R19.08(3)R19.10(2)R19A.27(2)App13 Part DSection (1)(a)

3rd Sch(22)

App13 Part DSection (1)(f)

(c) Compensation for payments for loss of office

Payment to a Director or Supervisor by way of compensation for loss of office or

retirement shall be stipulated in his contract with the Company. A Director or Supervisor

shall not institute proceedings against the Company for any benefit due to him in respect

of any such arrangement except under a contract entered into in accordance with the

foregoing.

In connection with a takeover of the Company, a Director or a Supervisor is entitled

to compensation or other payment for loss of office or retirement subject to the obtaining

of an informed approval of shareholders in shareholders’ meeting. A “takeover of the

Company” refers to any one of the following circumstances:

(i) an offer made by any person to all shareholders of the Company; or

(ii) an offer made by any person with a view to the offeror becoming a controlling

shareholder (as defined in the Articles of Association) of the Company.

If the relevant Director or Supervisor does not comply with the above provision, any

monies received by him shall belong to those persons who have sold their shares by reason

of their acceptance of the offer made, and the expenses incurred in distributing the monies

pro rata amongst those persons shall be borne by that Director or Supervisor and shall not

be deducted out of the monies to be distributed.

(d) Loans to Directors

The Company is prohibited from directly or indirectly making a loan or providing any

guarantee in connection with a loan made to: (i) its Director, Supervisor, general manager,

deputy manager or other senior management officers, or (ii) a Director, Supervisor, general

manager, deputy manager or other senior management officers of its holding company, or

(iii) to a person connected with the aforementioned officers in the manner described in

paragraph 1(f) below.

The prohibitions contained in this paragraph 1(d) shall not apply in the following

circumstances:

(i) the provision of a guarantee for a loan by the Company to a subsidiary of the

Company;

(ii) the provision by the Company to a Director, Supervisor, general manager, deputy

manager or other senior management officers pursuant to an employment

contract approved by the shareholders’ meeting of the Company, of a loan or a

guarantee for a loan or other funds to meet expenditure incurred by him in the

interest of the Company or for the purpose of enabling him to perform his duties

towards the Company; and


— V-2 —

(iii) where the ordinary course of business of the Company includes the lending of

money or the giving of guarantees, the Company may make a loan to or provide

a guarantee for a loan to a Director, Supervisor, general manager, deputy

manager or other senior management officers or persons connected with them (as

described in paragraph 1(f) below), provided that the terms of the loan or

guarantee for a loan are on normal commercial terms.

A loan made by the Company in breach of the prohibition described above shall be

repaid immediately by the recipient of the loan, regardless of the terms of the loan.

A guarantee provided by the Company in breach of the prohibition described above

shall not be enforceable against the Company, except in the following circumstances:

(i) the lender was not aware of the relevant circumstances at the time the loan was

advanced to the connected person of a Director, Supervisor, general manager,

deputy manager or other senior management officers of the Company or its

holding company; and

(ii) the security provided by the Company has been lawfully sold by the lender to a

bona fide purchaser.

For the purpose of the foregoing provisions, a guarantee includes giving an

undertaking of obligations or provision of security to secure the performance of obligations

of the obligor.

(e) Financial assistance for the acquisition of shares in the Company

Subject to the exceptions provided in the Articles of Association, where a person is

purchasing or proposing to purchase shares in the Company, the Company and its

subsidiaries shall not at any time and in any manner give any financial assistance to that

person. The aforesaid purchaser of shares includes a person who directly or indirectly

assumes obligations by virtue of such purchase of shares. The Company and its subsidiaries

shall not at any time and in any manner give financial assistance for the purposes of

reducing or discharging such obligations.

The following transactions are not prohibited:

(i) the provision of financial assistance by the Company in good faith in the interest

of the Company and the principal purpose of that assistance is not to acquire

shares in the Company or that financial assistance is an incidental part of some

larger overall plan of the Company;

(ii) a lawful distribution of the Company’s assets by way of dividend;

(iii) the distribution of dividend by way of an allotment of bonus shares;


— V-3 —

(iv) a reduction of the Company’s registered capital, repurchase of shares or

reorganisation of the share capital in accordance with the Articles of

Association;

(v) provision of a guarantee for a loan by the Company within its scope of operations

in the ordinary course of its business, provided that the Company’s net assets are

not thereby reduced or, to the extent that those assets are thereby reduced, the

financial assistance is provided out of distributable profits of the Company; and

(vi) the provision of moneys by the Company for contribution to employees’ share

scheme, provided that the Company’s net assets are not thereby reduced or, to the

extent that those assets are thereby reduced, the financial assistance is provided

out of distributable profits of the Company.

For the purpose of the Articles of Association,

(i) “financial assistance” includes (but is not limited to) financial assistance

provided:

(aa) by way of gift;

(bb) by way of guarantee (including the provision of an undertaking or property

to secure the performance of obligations by the obligor), indemnity (other

than an indemnity given in respect of the Company’s own negligence or

default), release or waiver;

(cc) by way of a loan or entering into a contract under which the obligations of

the Company have to be fulfilled before the obligations of the other party

to the contract, or by way of the change of the party to that loan or contract,

or the assignment of any rights arising thereunder; and

(dd) in any other form when the Company is unable to pay its debts or has no

net assets or when its net assets may be reduced to a material extent; and

(ii) the meaning of “assumed obligations” includes obligations assumed by the

obligor as a result of entering into a contract or making any arrangement

(whether or not such contract or arrangement is enforceable, and whether or not

assumed by him personally or together with any other party) or by any other

means whereby his financial position is changed.

(f) Disclosure of interests in contracts with the Company or any of its subsidiaries

Where a Director, Supervisor, general manager, deputy manager or other senior

management officers of the Company has, directly or indirectly, a material interest in a

contract, transaction or arrangement entered into or proposed to be entered into by the

Company (other than his contract of service), he shall declare the nature and extent of his


— V-4 —

interest to the Board as soon as possible, whether or not the matters in question are

otherwise subject to the approval of the Board. Unless the interested Director, Supervisor,

general manager, deputy manager or other senior management officers has disclosed his

interests in accordance with the Articles of Association and that matter has been approved

by the Directors at a meeting at which the interested Director has not been counted in

quorum and has refrained from voting, the Company may cancel that contract, transaction

or arrangement except as against a bona fide party thereto acting in good faith and without

notice of the breach of duty by that Director, Supervisor, general manager, deputy manager

or senior management officers. For the purposes of this provision, a Director, Supervisor,

general manager, deputy manager or other senior management officers is deemed to have

an interest in a contract, transaction or arrangement in which a person connected to him is

interested.

If a Director, Supervisor, general manager, deputy manager or other senior

management officers, before the question of entering into the relevant contract, transaction

or arrangement is first considered, gives to the Board a notice in writing, stating that by

reason of the matters specified in the notice, he is interested in a contract, transaction or

arrangement proposed to be entered into by the Company, then the relevant Director,

Supervisor, general manager, deputy manager or senior management officers shall be

deemed to have made a disclosure for the purpose of the above provision within the scope

of that specified notice.

A person is connected with a Director, Supervisor, general manager, deputy manager

or other senior management officers if he is:

(i) the spouse or minor child of that Director, Supervisor, general manager, deputy

manager or other senior management officer;

(ii) a person acting in the capacity of trustee of that Director, Supervisor, general

manager, deputy manager or other senior management officers or any person

referred to in (i) above;

(iii) a person who is a partner of that Director, Supervisor, general manager, deputy

manager or other senior management officers or any person referred to in (i) and

(ii) above;

(iv) a company over which that Director, Supervisor, manager or other senior

management officers, alone or together with any persons referred to in (i), (ii)

and (iii) above, or together with other Director(s), Supervisor(s), general

manager, deputy manager or senior management officer(s) have de facto control;

or

(v) a director, supervisor, general manager, deputy manager or other senior

management officers of a company referred to in (iv) above.


— V-5 —

App1A 4(1)

(g) Remuneration

The Company shall enter into a contract in writing with each Director and Supervisor

in respect of remuneration, with the prior approval of the shareholders’ meeting of the

Company. Such remuneration includes:

(i) remuneration in respect of his service as Director or Supervisor of the Company;

(ii) remuneration in respect of his service as director or supervisor a subsidiary of

the Company;

(iii) remuneration in respect of other services provided in connection with the

management of the affairs of the Company or its subsidiaries; and

(iv) monies payable as compensation for loss of his office or retirement from office

that Director or Supervisor.

A Director or Supervisor shall not institute any proceedings against the Company for

any benefit due to him in respect of the above matters except under a contract entered into

in accordance with the foregoing.

(h) Retirement, appointment and removal

A person shall be disqualified from being a Director, Supervisor, general manager,

deputy manager or other senior management officers of the Company in any of the

following circumstances:

(i) any person who suffers from any incapacity or restricted capacity from

undertaking civil obligations;

(ii) any person who has been convicted of offences relating to bribery, corruption,

trespass to assets, misappropriation of assets, or causing social economic

disorder or any person who has been deprived of his political rights as a result

of him having committed an offence, and a period of five years has not elapsed

since the completion of the term of sentence or deprivation;

(iii) any person who was a former director, factory manager or manager of a company

or enterprise which had become bankrupt or had been liquidated because of

unsound management and who incurred personal liability for the insolvency or

liquidation of such company or enterprise, and a period of three years has not yet

elapsed since the completion of insolvency or liquidation of the company or

enterprise;


— V-6 —

App1A 7(2)

(iv) any person who was a legal representative of a company or enterprise the

business licence of which was revoked on the ground of contravention of law,

and who incurred personal liability therefor, where a period of three years has

not yet elapsed since the revocation of the business licence;

(v) any person who has failed to repay his relatively large amount of indebtedness

when due;

(vi) a person who, because of suspected contravention of criminal law, is under

investigation by judicial authorities and the case has not yet been settled;

(vii) a person who is not eligible for enterprise leadership according to PRC law and

administrative regulations;

(viii) a person who is not a natural person; or

(ix) any person who has been determined by the relevant supervisory authority of

having contravened the provisions of the relevant securities laws involves

fraudulent or dishonest acts on his part and a period of five years from the date

of such determination has not yet elapsed.

A Director is not required to hold any shares of the Company. There is no stipulation

that a Director must retire at a certain age.

All Directors shall be elected by shareholders’ meeting of the Company and shall

serve a term of three years from the date of their respective elections. Upon the expiry of

his term of office, a Director may be re-elected to serve consecutive terms.

A notice of intention to propose a person for election as a Director and a notice in

writing by that person of his willingness to be elected shall be given to the Company at least

seven days before the date of the relevant shareholders’ meeting. The period of lodgment

of the notice will commence no earlier than one day after the despatch of the notice of the

meeting appointed for such election and end no more than 7 days prior to the date of such

meeting.

The board of Directors shall consist of nine Directors, comprising one chairman, and

one vice-chairman and half of the Directors are external directors, i.e. those who do not

assume any executive office in the Company and inclusive of two independent Directors.

The chairman and vice chairman shall be appointed and removed by a majority of the

Directors. The chairman and vice chairman shall serve a term of three years from the

respective dates of their elections and may be re-elected to serve consecutive terms upon

the expiry of the terms of their offices. A Director may concurrently hold the position of

general manager or any other senior position (other than the position of Supervisor.)


— V-7 —

3rd Sch(5)App1A 7(5)

App3 (4)(4)App3 (4)(5)

Subject to compliance with the relevant laws and administrative regulations,

shareholders in shareholders’ meeting may by way of an ordinary resolution remove any

Director before the expiry of the term of his officers (but without prejudice to any claim

for compensation pursuant to any contract).

A person appointed by the Board as casual vacancy or as an addition to the Board shall

hold office only until the next following annual general meeting of the Company, and shall

then be eligible for re-election.

(i) Borrowing powers

Subject to applicable laws and regulations, the Company has power to raise capital

and borrow money by way of, among other means, the issue of bonds and creation of

security over its assets, provided that the exercise of such powers shall not prejudice or

abrogate the rights of different classes of shareholders.

2. Alterations to constitutional documents

Any amendment to any provision contained in the Articles of Association requires the

sanction of a special resolution at a shareholders’ meeting of the Company in accordance with

the following procedures:

(i) the Board shall adopt a proposal to amend the Articles of Association in accordance

with the Articles of Association and shall formulate proposal for amendments;

(ii) shareholders shall be informed of the proposal for amendments and a shareholders’

meeting of shareholders shall be convened to vote on amendments;

(iii) the amendments shall require the sanction of more than two-thirds of the voting rights

held by shareholders attending shareholders’ meeting.

Any amendment to such provisions that are included in the Articles of Association in

accordance with the Mandatory Provisions shall only be effective after the approval thereof by

the companies supervisory authorities of the State Council and the approval accredited by the

securities regulatory authorities of the State Council. Any amendment involving companies

registration matters shall be registered in accordance with the PRC law.

3. Variation of rights of existing shares or classes of shares

Any proposal to vary or abrogate the rights conferred on any class of shareholders (“Class

Rights”) must be approved by a special resolution of shareholders’ meeting of the Company and

approved by holders of shares of that class at a separate meeting conducted in accordance with

the provisions of the Articles of Association.


— V-8 —

App3 (4)(3)App3 (4)(2)

App1A 7(3)

A1A25(3)

The following circumstances shall be deemed to be a variation or abrogation of Class

Rights:

(i) the change in the number of shares of such class, or a change in the number of shares

of a class which have voting rights or distribution rights or other privileges which are

equal or superior to the shares of such class;

(ii) the exchange of all or part of the shares of such class for the shares of another class

or the conversion of all or part of the shares of another class for the shares of such

class or the grant of a right to such conversion;

(iii) the removal or reduction of rights to accrued dividends or rights to cumulative

dividends attached to such class of shares;

(iv) the reduction or removal of a preferential right to dividends or a distribution of

surplus assets upon liquidation of the Company of such class of shares;

(v) the addition, removal or reduction of any conversion privileges, option, voting right,

transfer rights, pre-emptive rights or rights to acquire securities of the Company

attached to such class of shares;

(vi) the removal or reduction of any right attached to such class of shares to receive money

payable by the Company in particular currencies;

(vii) the creation of a new class of shares which have voting rights, distribution rights or

other privileges equal or superior to such class of shares;

(viii) the imposition of restrictions or increase in restrictions on the transfer right or

ownership right of the shares of such class;

(ix) the issue of rights to subscribe for, or convert into, shares of such class or another

class;

(x) the increase of the right or privileges of another class of shares;

(xi) the restructuring of the Company which results in classes of shareholders bearing

disproportionate responsibilities in such restructuring; and

(xii) the variation or abrogation of provisions concerning the protection of shareholder

rights of various classes of shares in the Articles of Association.

Shareholders of the affected class, whether or not having the right to vote at shareholders’

meetings, shall nevertheless be entitled to vote at class meetings in respect of matters concerning

sub-paragraphs (ii) to (viii), (xi) and (xii) above, but Interested Shareholder(s) (as defined

below) shall have no voting rights at class meetings.


— V-9 —

Resolutions of a class meeting shall be passed by two thirds of the votes of the shareholders

of that class (including proxies) present at and who are entitled to vote at the class meeting.

Notice of class meetings needs only be served on shareholders entitled to vote thereat.

Class meetings shall be conducted in a manner as nearly as is possible as shareholders’

meetings. The provisions of the Articles of Association relating to the proceedings of

shareholders’ meetings shall apply to class meetings.

Besides other class of shareholders, holders of domestic shares and overseas listed foreign

shares shall be deemed to be different classes of shares.

For the purposes of the Class Rights provisions of the Articles of Association, an Interested

Shareholder is:

(i) in the case of a repurchase of shares by the Company by way of a general offer to all

shareholders in equal proportion or on a stock exchange by public transaction method,

the controlling shareholder as defined in the Articles of Association;

(ii) in the case of a repurchase of shares by the Company by an off-market agreement in

accordance with a the Articles of Association, the shareholder to which the proposed

agreement relates; and

(iii) in the case of a restructuring proposal of the Company, a shareholder who bears less

than a proportionate responsibility than other shareholders of the same class or a

shareholder who has an interest different from the interests of the other shareholders

of that class.

4. Ordinary and special resolutions — majority required

Resolutions of shareholders’ meetings may be passed by way of ordinary resolutions or

special resolutions.

An ordinary resolution shall be passed by more than one half of the votes held by the

shareholders present in person or by proxy at a shareholders’ meeting and voting in favour of the

resolution.

A special resolution shall be passed by more than two thirds of the votes held by the

shareholders present in person or by proxy at a shareholders’ meeting and voting in favour of the

resolution.


— V-10 —

5. Voting rights

A shareholder has the right to attend and vote in person and to appoint a proxy to attend

and vote on his behalf at shareholders’ meetings. A proxy need not be a shareholder.

Subject to any special rights or restrictions as to voting rights for the time being attached

to any class of shares, shareholders (including proxies) who vote at the shareholders’ meeting

shall exercise their voting rights in relation to the number of shares carrying the right to vote

which they hold. Each share shall carry one vote.

At any meeting of shareholders, voting shall be decided on a show of hands unless a poll

(before or after any vote by a show of hands) is demanded by the following persons:

(a) the chairman of the meeting;

(b) at least two shareholders having the right to vote present in person or by proxy; or

(c) one or more shareholders present in person or by proxy who, alone or together, hold

10% or more of the shares carrying the right to vote at that meeting.

Unless a poll is demanded, a declaration by the chairman that a resolution has been passed

based on the result of the show of hands and an entry to that effect in the minutes of the meeting,

shall be conclusive evidence of that fact without further proof of the number or proportion of the

votes recorded or the percentage of votes recorded in favour of or against such resolution. The

demand for a poll may be withdrawn by the person or persons who demanded it.

A poll demanded on the election of the chairman of the meeting, or on a question of

adjournment, shall be taken immediately. A poll demanded on any other matters shall be taken

at such time as the chairman of the meeting decides, and the meeting may continue to proceed

to discuss other matters. The result of the poll shall be deemed to be the resolution of the meeting

at which the poll was demanded.

On a poll taken at a meeting, a shareholder (including his proxy) entitled to two or more

votes need not cast all his votes in the same way.

In the case of an equality of votes, whether on a show of hands or on a poll, the chairman

of the meeting shall be entitled to an additional vote.

6. Requirements for annual shareholders’ meetings

General meetings are divided into annual shareholders’ meetings and extraordinary

shareholders’ meetings. General meetings shall be convened by the Directors. Annual

shareholders’ meetings shall be held once every year within six months after the end of each

financial year.


— V-11 —

A1A25(1)

A1A(13A)

7. Accounts and audit

(a) Financial and accounting system

The Company shall formulate its financial accounting system in accordance with the

relevant requirements of PRC law, administrative regulations and the principles relating to

PRC accounting standards formulated by the financial supervisory authority of the State

Council.

The Company shall prepare a financial report at the end of every financial year and

shall have it audited in accordance with laws and regulations.

The Directors shall place before the shareholders at every annual shareholders’

meeting financial report required by the relevant laws, administrative regulations or

prescribed documents required by regional governments and supervisory authorities to be

prepared by the Company.

The financial reports of the Company shall be placed at the Company 20 days prior

to the holding of the annual shareholders’ meeting of the Company for inspection by

shareholders. A printed copy of the financial reports together with the print copy of the

report of the Directors shall, at least 21 days before the date of the annual shareholders’

meeting, be delivered or sent by prepaid post by the Company to every holder of H Shares

at his address as shown on the register of members.

The financial statements of the Company shall, in addition to complying with the PRC

accounting standards and regulations, be prepared in accordance with either international

accounting standards or the accounting standards of the place at which foreign shares of the

Company are listed. If there are material differences between the financial statements

prepared in accordance with the aforesaid accounting standards, then those financial

statements shall specify such differences in the annotations. For the purposes of

distributing the Company’s profits after tax in a given financial year, the Company’s profits

after tax shall be deemed to be the lesser of the amounts stated in the two sets of financial

statements.

Any interim results or financial information announced or disclosed by the Company

shall be prepared in accordance with PRC accounting standards and regulations as well as

in accordance with either international accounting standards or the accounting standards of

the place where the foreign shares of the Company are listed.

The Company shall prepare an annual report for each financial year which contains the

information required by the Listing Rules. The information shall be sent to every holder of

its listed shares not less than 21 days before the date of the company’s annual shareholders’

meeting and not more than 120 days after the date upon which the financial period ended.


— V-12 —

App3 (5)

The Company shall prepare a half-year report in respect of each of the first 6 months

period in each of the financial year of the Company containing at least the information

required by the Listing Rules and publish the same not later than 60 days after the end of

such period.

(b) Appointment of auditors

The Company shall at each annual shareholders’ meeting appoint one or more

independent firms of accountants which satisfy the relevant PRC requirements to audit the

annual financial report and other financial reports of the Company. The accounting firm so

appointed by the Company from time to time shall be the auditor of the Company. The term

of appointment of auditors shall commence from the conclusion of the current annual

shareholders’ meeting until the conclusion of the next annual shareholders’ meeting.

The first auditor of the Company may be appointed at the inaugural meeting of the

Company or failing which, by the Board, and the auditor so appointed shall hold office until

the conclusion of the first annual shareholders’ meeting.

If a casual vacancy arises in the office of an auditor, the Board may prior to the

holding of a shareholders’ meeting appoint an independent firm of accountants to fill the

casual vacancy, but if any such vacancy continues, the surviving or continuing auditor(s),

if any, may continue to act.

The shareholders’ meeting may by ordinary resolution remove an auditor before the

expiration of its term of office, notwithstanding any terms of contract between the Company

and the auditor, but without prejudice to the auditor’s claim, if any, against the Company

arising from termination of its office.

The remuneration of an auditor appointed by the Board shall be determined by the

Board. In all other cases, the remuneration and the method of remuneration of an auditor

shall be determined by the shareholders’ meeting.

(c) Change and removal of auditors

Where a resolution is passed at a shareholders’ meeting to appoint a firm of

accountants not currently in office to fill a casual vacancy in the office of auditor, to

re-appoint as auditor a retiring auditor who was appointed by the Board to fill a casual

vacancy, or to remove an auditor before the expiration of its term of office, the following

provisions shall apply:

(i) the proposed resolution shall be sent, before notice of a shareholders’ meeting of

the Company is given, to the firm of accountants proposed to be appointed or the

auditor who propose to leave office or the auditor who has left office in the

relevant financial year (leaving office includes leaving by removal, resignation

and retirement);


— V-13 —

App13 Part DSection 1(e)(i)

(ii) if the auditor leaving its office makes representations in writing and requests the

Company to notify the shareholders of its representations, the Company shall

implement the following measures (unless the representations are received too

late):

(aa) state in the notice in connection with the resolution the fact that

representations have been made by the auditor leaving office; and

(bb) send a copy of the representations to every shareholder entitled to receive

notice of shareholders’ meetings;

(iii) if the auditor’s representations have not been despatched in accordance with (ii)

above, the auditor may request such representations be read at the meeting and

may make further representations;

(iv) an auditor leaving office shall be entitled to attend:

(aa) the shareholders’ meeting at which its term of office would otherwise

expire;

(bb) any shareholders’ meeting at which it is proposed to fill the vacancy caused

by its removal; and

(cc) any shareholders’ meeting convened as a result of his resignation;

and to receive all notices of, and other communications relating to, the meetings

referred to above, and to speak at any such meeting on any matter which

concerns it as former auditor of the Company.

(d) Resignation of auditors

Any auditor may resign from office by a notice in writing deposited at the Company’s

legal address and such notice shall contain either of the following statements:

(i) a statement to the effect that there are no circumstances connected with the

resignation which it considers should be brought to the attention of the

shareholders or creditors of the Company; or

(ii) a statement of any such circumstances which should be accounted for.

Any such notice shall be effective on the date on which it is deposited at the legal

address of the Company or on such later date as may be specified therein.

After receipt of the written notice referred to in the preceding paragraphs, the

Company shall within 14 days send a copy of the notice to the relevant supervisory


— V-14 —

App13 Part DSection 1(e)(ii)

App13 Part DSection 1(e)(iii)

authority. If the notice contains a statement referred to in sub-paragraph (ii) above, a copy

of that notice shall be deposited at the Company for inspection by shareholders. The

Company shall also send a copy of the notice to every holder of H Shares by prepaid post

to his address as recorded in the register of shareholders.

Where the auditor’s notice of resignation contains a statement referred to in

sub-paragraph (ii) above, it may require the Board to convene an extraordinary

shareholders’ meeting for the purposes of receiving an explanation of the circumstances

connected with its resignation.

(e) Rights of auditors

Every auditor of the Company shall have a right:

(i) to inspect at all times the books, records and vouchers of the Company, and to

require the Directors, managers or other officers to provide relevant information

and explanations;

(ii) to require the Company to take all reasonable steps to obtain from its

subsidiaries such information and explanations as are necessary for the purposes

of performing its duties as auditor of the Company; and

(iii) to attend any shareholders’ meeting and to receive all notices of, and other

communications relating to, any shareholders’ meeting which a shareholder is

entitled to receive, and to speak at any shareholders’ meeting on any matter

which concerns it as auditor of the Company.

For the purpose of the Articles of Association, any reference to “a firm of

accountants” has the same meaning as a reference to “auditors”.

8. Notice of meetings and business to be conducted thereat

The shareholders’ shareholders’ meeting is the organ of power of the Company and its

functions and powers shall be exercised in accordance with law.

The Company shall not without the prior approval of shareholders in shareholders’ meeting

enter into any contract with any person other than a Director, Supervisor, general manager,

deputy manager or other senior management officers of the Company whereby the responsibility

for the management of the whole or any substantial part of the business of the Company is given

to such person.

The Directors shall convene an extraordinary shareholders’ meeting within two months of

the occurrence of any of the following events:

(i) when the number of Directors is fewer than the number prescribed by PRC Company

Law or fewer than two thirds of the number prescribed by the Articles of Association;


— V-15 —

App13 Part DSection 1(e)(iv)

(ii) when the accumulated losses of the Company amount to one third of the total amount

of its share capital;

(iii) upon the written requisition of shareholders holding 10% or more of the Company’s

issued shares carrying the right to vote;

(iv) when the Directors consider it necessary or when the supervisory committee proposes

to convene a shareholders’ meeting; and

(v) when two or more independent Directors propose to convene a shareholders’ meeting.

Written notice of shareholders’ meeting shall be given not less than 45 days before the date

of the meeting, exclusive of the day on which the notice is despatched and the day of the meeting.

A notice of shareholders’ meeting shall:

(i) be given in writing;

(ii) specify the place, the date and the time of the meeting;

(iii) state the registration dates of the shareholders who are entitled to attend the meeting;

(iv) record the telephone number and name of the contact person of the meeting;

(v) state the matters to be considered at the meeting;

(vi) provide such information and explanation as necessary for the shareholders to make

an informed decision on the matters proposed to be considered. Without limiting the

generality of the foregoing principle, where the Company proposes to merge with

another, to repurchase its shares, to reorganise its share capital, or to restructure in any

other way, the details of the terms of, and the contract (if any) for the proposed

transaction shall be provided and the effect of such proposal must be properly

explained;

(vii) disclose the nature and extent of the material interests, if any, of any Director,

Supervisor, general manager, deputy manager or other senior management officers in

the matter to be considered at the meeting, and the effect of such matter, if any, on him

in his capacity as shareholder in so far as it is different from the effect on other

shareholders of the same class;

(viii) contain the full text of any special resolution proposed to be passed at the meeting;

(ix) contain conspicuously a statement that a shareholder entitled to attend and vote is

entitled to appoint one or more proxies to attend and vote instead of him and that a

proxy so appointed need not be a shareholder; and


— V-16 —

(x) specify the time and place for lodging the proxy forms.

Any matter not set out in the notice convening an extraordinary shareholders’ meeting shall

not be decided at that meeting.

Where the Company convenes an annual shareholders’ meeting, shareholders holding 5% or

more of the Shares carrying voting rights are entitled to propose to the Company in writing new

matters to be considered. The Company shall include in the agenda of that meeting those matters

contained in the proposal which are within the scope of the duties of the shareholders’ meeting.

In respect of holders of H Shares, notice of shareholders’ meetings shall be served on all

shareholders (whether or not they are entitled to vote thereat) by personal delivery or prepaid

mail to the addresses recorded on the register of holders of H Shares. In respect of holders of

Domestic Shares, notice of shareholders’ meetings may be served in the aforesaid manner or

published on any one day within the period specified in the Articles of Association in one or more

newspapers specified by the securities regulatory authorities authorised by the State Council.

Once published, all holders of Domestic Shares shall be deemed to have received the relevant

notice.

The Company shall give a notice so that those foreign shareholders whose registered

address is in Hong Kong have sufficient time to exercise their rights or act in accordance with

the terms of the notice.

The accidental omission to give notice of a meeting to, and the non-receipt of notice of a

meeting by, any person entitled to receive notice shall not invalidate that shareholders’ meeting

or any resolution passed at that meeting.

Shareholders may convene an extraordinary shareholders’ meeting or class meeting in

accordance with the following procedures: two or more shareholders holding on the date of the

deposit of a requisition 10% or more of the Shares carrying voting rights at the proposed meeting

may, by signing one or more counterpart requisitions require the Directors to, and the Directors

shall as soon as possible proceed to, convene an extraordinary shareholders’ meeting or the

relevant class meeting. If the Directors fail to issue a notice convening such a meeting within 30

days of their receipt of the requisition, the requisitioning shareholders may on their own convene

such a meeting within four months of the receipt of such requisition by the Directors in a manner

as nearly as possible to that of a shareholders’ meeting convened by the Directors.

The following matters shall be approved by special resolution of a shareholders’ meeting

of the Company:

(i) an increase or reduction of the Company’s capital and the issue of any class of shares,

warrants or other similar securities;

(ii) change of abrogation of Class Rights;


— V-17 —

App3 (7)(1)(7)(3)

App1A 7(6)

(iii) issue of bond of the Company;

(iv) the demerger, merger, dissolution and liquidation of the Company;

(v) any amendment to the Articles of Association: and

(vi) any other matters which the shareholders’ meeting has resolved (by way of ordinary

resolution) as having a material effect on the Company and should be approved by

special resolution.

Subject to such matters as may be specified in the Articles of Association as requiring

approvals at class meetings, the following matters shall be approved by ordinary resolution of

a shareholders’ meeting of the Company:

(i) work reports of the Directors and the supervisory committee;

(ii) proposals formulated by the Board for the distribution of profits and for making up

accrued losses;

(iii) appointment and removal of the members of the Board and the supervisory committee,

their remuneration (including but not limited to compensation payable upon the loss

of office of a Director or on completion of his term of appointment) and the method

of payment of such remuneration;

(iv) annual financial budgets and final accounts, balance sheet, profit and loss account and

other financial reports of the Company; and

(v) all other matters required to be approved by a shareholders’ meeting other than those

required to be approved by way of special resolution under PRC law, administrative

regulations or the Articles of Association.

9. Transfer of H shares

Unless otherwise prescribed by law and/or administrative regulations, shares of the

Company are freely transferable free from all liens.

All transfers of H Shares shall be effected by a transfer in writing in the usual common form

or in such other form as the Directors may accept, and shall be duly signed by the transferor.


— V-18 —

App3 (1)(2)

App3 (1)(1)

All fully paid up H Shares are freely transferable in accordance with the provisions of the

Articles of Association, but except where the conditions set out below are satisfied, the Directors

may refuse to recognise any transfer document without providing any reason:

(i) payment of HK$2.50 or higher charge as permitted by the Stock Exchange has been

made to the Company for the purpose of registering the instrument of transfer and

other documents in connection of or may affect the title of the shares;

(ii) the transfer document relates only to H Shares which are listed on the Main Board;

(iii) the stamp duty payable on the instrument of transfer has been paid;

(iv) relevant share certificates and evidence that the transferor has the right to transfer

such shares as reasonably required by the Board have been provided;

(v) if the shares of the Company are transferred to joint holders, the number of joint

holders does not exceed four; and

(vi) the relevant shares of the Company are free from all liens.

No shares of the Company shall be transferred to any person who is not of legal age or has

mental or other legal incapacity.

Changes in the shareholders’ register due to the transfer of shares should not be made

within 30 days of the shareholders’ shareholders’ meeting or less than 5 days before the record

date for the Company’s distribution of dividends.

All share certificate of the Company shall be affixed with the seal of the Company or the

mechanically imprinted seal of the Company, which shall be affixed with the authority of the

Board.

10. Power of the Company to purchase its own shares

Subject to the approval of the relevant PRC supervisory authorities and to the provisions

of the Articles of Association, the Company may repurchase its issued shares in the following

circumstances:

(i) to cancel its shares for the purpose of reducing its share capital;

(ii) to merge with another company which holds shares of the Company; or

(iii) under any other circumstances permitted by law and administrative regulations.


— V-19 —

App1A 7(8)App3 (1)(2)

App3 (1)(3)

App3 (1)(2)

App1A 7(9)

A share repurchase may only be made by one of the following methods:

(i) under a general offer to all shareholders in the same proportion;

(ii) through open trading method on the stock exchange; or

(iii) by an off-market agreement outside a stock exchange.

The Company may, with the prior approval of a shareholders’ meeting obtained in

accordance with the Articles of Association, repurchases its own shares pursuant to an off-market

agreement. The Company may release, vary or waive its rights under an agreement so entered

into by the Company if the prior approval of a shareholders’ meeting is given in the same manner.

An agreement to repurchase shares includes, but is not limited to, an agreement to assume an

obligation to repurchase or to acquire rights to repurchase shares of the Company.

For the redeemable shares which the Company has the rights to repurchase, the price shall

not exceed the highest limit specified by the instrument relating to the issue of the redeemable

shares other than those repurchased in the market or by way of tender. For those shares which

are repurchased by way of tender, a tender offer must be offered to all the shareholders with the

same conditions.

Shares repurchased by the Company shall be cancelled within the period stipulated by laws

and administrative regulations and the amount of the Company’s registered capital shall be

reduced by the par value of those shares. The Company shall apply to the authority for companies

registration with which it was originally registered to amend the registration as to registered

capital.

The Company shall not assign a contract to repurchase its shares or any of its rights under

such a contract.

Unless the Company is in liquidation:

(i) where the Company repurchases its shares at nominal value, payment shall be made

out of distributable profits of the Company or out of the proceeds of an issue of new

shares made for that purpose;

(ii) where the Company redeems or repurchases its shares at a premium, payment up to the

nominal value of those shares may be made out of the distributable profits of the

Company or out of the proceeds of an issue of new shares made for that purpose.

Payment of the portion in excess of the nominal value shall be made as follows:

(aa) if the shares being repurchased were issued at nominal value, payment shall be

made out of the distributable profits of the Company;


— V-20 —

App3 (8)

(bb) if the shares being repurchased were issued at a premium, payment shall be made

out of the book balance of the distributable profits of the Company or out of the

proceeds of an issue of new shares made for that purpose, provided that the

amount paid out of the said proceeds do not exceed the aggregate amount of

premium received by the Company on the issue of the shares being repurchased

nor shall it exceed the current amount of the Company’s share premium account

or capital reserve fund account, including the premium on the new shares issued;

(iii) payment by the Company for the following purposes shall be made out of the

Company’s distributable profits:

(aa) the acquisition of rights to repurchase its own shares;

(bb) the variation of any agreement to repurchase its own shares; or

(cc) the release of any of the Company’s obligations under any agreement to

repurchase its shares.

To the extent that shares are repurchased out of an amount deducted from distributable

profits of the Company, such amount shall be charged to the Company’s share premium account

or the capital reserve fund account.

Upon the reduction of registered capital, the Company shall prepare a balance sheet and a

list of its assets. The Company shall notify its creditors within 10 days from the date of passing

of the resolution for the reduction of registered capital and shall publish the notice at least three

times in a newspaper within 30 days thereof. Creditors who receive this notice shall have the

right within 30 days from the date of receiving the notice, and the creditors who have not

received the notice shall have the right within 90 days from the date the notice was first

published in the newspaper, to require the Company to settle the debt or to provide corresponding

security in respect of the debt.

11. Power of any subsidiary of the Company to own shares in its parent company

There are no restrictions in the Articles of Association preventing any subsidiary of the

Company from holdings shares in its parent company.

12. Dividends and other methods of distribution

After making payment of relevant taxes and levies, the profits of the Company shall be

applied in the following order:

(i) making up of accrued losses;

(ii) allocation to statutory common reserve;


— V-21 —

(iii) allocation to statutory public welfare fund;

(iv) allocation to discretionary common reserve as resolved in shareholders’ meeting;

(v) 10% of the Company’s distributable profits be allocated to reward fund; and

(vi) payment of dividends in respect of ordinary shares.

The detailed proportion of distributions in respect of items (v) to (vi) above for any year

shall be formulated by the Directors in accordance with the operating conditions and

development requirements of the Company and shall be submitted to the shareholders’ meeting

for approval.

No dividends shall be paid before the Company has made up its accrued losses and has

made allocation to its statutory common reserve and its statutory public welfare fund.

The Company shall allocate 10% of its profits after tax to the statutory common reserve

provided that no allocation is required if the accumulated statutory common reserve exceeds 50%

of the registered capital.

The Company shall allocate its profits to the discretionary common reserve in accordance

with the resolutions passed at shareholders’ meetings.

The following sums shall be appropriated to the capital common reserve:

(i) the amount of share premium arising from the issue of shares at a premium; and

(ii) other income required by the financial supervisory authority of the State Council to

be appropriated to the capital common reserve.

The Company’s common reserve (which comprises the statutory common reserve,

discretionary common reserve and the capital common reserve) shall only be used for the

following purposes:

(i) to make up accrued losses;

(ii) to expand the business operations of the Company; and

(iii) to be converted into capital. The Company may, upon the approval of a shareholders’

meeting, convert its common reserve into capital and issue bonus shares to existing

shareholders in proportion to their existing shareholdings or to increase the nominal

value of each share. When converting the statutory common reserve into capital, the

balance of such fund after such conversion must not be less than 25% of the registered

capital of the Company.


— V-22 —

The Company shall allocate 5 to 10% of its profits after tax to the statutory public welfare

fund. The Company shall apply its statutory public welfare fund for the collective welfare of the

employees of the Company from time to time.

Subject to the provisions of the Articles of Association, annual dividends shall be paid

within six months after the end of each financial year in proportion to the shareholding of each

shareholder. Annual dividends shall be sanctioned by the shareholders’ meeting but the amount

of dividends payable shall not exceed the amount recommended by the Directors.

No powers shall be taken to freeze or otherwise impair any of the rights attaching to any

share by only that the person or persons who are interested directly or indirectly therein have

failed to disclose their interests to the Company.

The Board may, subject to the approval of the shareholders in shareholders’ meeting,

resolve to distribute interim dividends.

The Company may distribute dividends by way of cash and/or bonus shares.

Dividends and other distributions declared by the Company to be payable to domestic

shares shall be calculated, declared and paid in Renminbi. Dividends and other distributions

payable on H Shares shall be calculated and declared in Renminbi but paid in Hong Kong dollars.

When distributing dividends, the Company shall make such withholdings for tax on the

dividends payable to shareholders in accordance with PRC tax law.

The Company shall appoint a receiving agent to receive on behalf of holders of H Shares

dividends and all other monies payable in respect of the Shares. Such receiving agent shall be

a trust corporation registered under the Trustee Ordinance of Hong Kong.

The Company shall not exercise its powers to forfeit any unclaimed dividend in respect of

H Shares until after the expiry of the applicable limitation period.

Any amount paid up in advance of calls of any share may carry interest but shall not entitle

the holder of the share to participate in respect thereof in a dividend subsequently declared.

13. Proxies

A shareholder may attend and vote at or appoint a proxy to attend and vote on his behalf

at shareholders’ meetings. If a shareholder is a company, its legal representative or any person

authorised by its board of directors or other governing body to act as its representative may

attend the shareholders’ meeting.


— V-23 —

App3 (12)

App13 Part DSection 1 (1)(c)

App1A 7(7)App3 (3)(1)and (3)(2)

Any shareholder entitled to attend and vote at a shareholders’ meeting shall be entitled to

appoint one or more persons (whether or not a shareholder) as his proxy or proxies to attend and

vote instead of him, and a proxy so appointed shall:

(i) have the same rights as the shareholder to speak at the meeting;

(ii) have the right to demand or join with others to demand a poll; and

(iii) have the right to vote on a show of hands or on a poll, but a proxy of a shareholder

who has appointed more than one proxy may only vote on a poll.

The instrument appointing a proxy shall be in writing under the hand of the appointor or

its proxy duly authorised in writing. If the appointor is a legal person, the instrument shall be

signed under a legal person’s seal or under the hand of its director or an proxy duly authorised

in writing.

The instrument appointing a proxy shall be deposited at the legal address of the Company,

or such other place as prescribed in the notice convening the meeting, 24 hours before the

holding of the relevant meeting or 24 hours before the time at which the poll is to be conducted.

If such instrument is signed by a person under a power of attorney or other document of authority

on behalf of the appointor, a notarially certified copy of that power of proxy or other document

of authority shall also be deposited together with the said instrument at the Company’s legal

address or such other place prescribed in the notice convening the meeting.

Any form issued to shareholders by the Board for appointing a proxy shall enable the

shareholder, according to his intention, to instruct his proxy to vote in favour of or against each

resolution proposed at the meeting. Such a form shall contain a statement that in the absence of

instructions from the appointor, the proxy may vote as he thinks fit.

If the shareholder of overseas listed foreign shares in the Company is a recognised clearing

house as defined in the Securities and Futures (Clearing Houses) Ordinance (Chapter 420 of the

Laws of Hong Kong), it may authorise any appropriate person(s) as it thinks fit to act as its

representative(s) at any shareholders’ meeting or any class meeting. If more than one person is

so authorised, the instrument of authorisation must clearly state the class(es) and number of

shares in respect of which each such person is so authorised. The aforementioned authorised

person is entitled to exercise rights on behalf of the recognised clearing house (or its proxy(ies)),

as if such person were an individual shareholder of the Company.

A vote given in accordance with the terms of the instrument of proxy shall be valid

notwithstanding the previous death or loss of capacity of the appointor or revocation of the proxy

or the authority under which the proxy was executed, or the transfer of the share in respect of

which the proxy is given, provided that no notice in writing of those matters shall have been

received by the Company before the commencement of the relevant meeting.


— V-24 —

14. Inspection of register of members

The Company shall keep a register of shareholders and enter therein the following matters:

(i) the names and addresses, and the occupation or nature of occupation of each

shareholder;

(ii) the number of each class of shares held, the amount paid or payable on the shares, and

the serial number of the shares in respect of each shareholder;

(iii) the date on which each person is entered in the register as a shareholder; and

(iv) the date on which any person ceases to be a shareholder.

The register of shareholders shall be sufficient evidence of the holding of Shares by the

shareholders unless there is evidence to the contrary.

The Company shall keep a complete register of shareholders which shall comprise the

following parts:

(i) a part maintained at the Company’s legal address which shall be the register of all

shareholders other than those registered in accordance with sub-paragraphs (ii) and

(iii) below;

(ii) a register of holders of overseas listed foreign shares maintained at the place of

listing; and

(iii) such parts in such other places as the Directors may deem necessary for the purpose

of listing the Company’s shares.

A duplicate of the register of holders of overseas listed foreign shares shall be made and

maintained at the Company’s legal address. The Company may appoint an overseas agent to keep

the register of holders of such shares. The appointed overseas agent shall ensure at all times that

the original and duplicate registers of holders of overseas listed foreign shares are the same. In

the event of inconsistencies between any information recorded in the original register and that

in the duplicate, the original shall prevail. Different parts of the register of shareholders shall not

overlap. No transfer of any shares registered in one part of the register shall, during the

continuance of the registration of those shares, be registered in any other parts of the register of

shareholders.

The alteration and rectification of each part of the register of shareholders shall be made

in accordance with the law of its situs.


— V-25 —

Holders of ordinary shares of the Company shall enjoy, inter alia, the right to receive

relevant information in accordance with the Articles of Association, including:

(i) to receive a copy of the Articles of Association upon payment of the cost thereof;

(ii) to inspect and receive a copy of, upon payment of reasonable charges:

(aa) all parts of the register of shareholders; and

(bb) the following personal particulars of each of the Directors, Supervisors,

managers and other officers of the Company:

(1) his present and former name(s) and alias(es);

(2) his principal (residential) address;

(3) his nationality;

(4) his main occupation and all other occupations and positions;

(5) his identification document and its number; and

(6) financial report(s);

(iii) the status of the Company’s share capital;

(iv) a report showing the aggregate nominal value, the number and the maximum and

minimum prices paid by the Company in respect of each class of the shares

repurchased by the Company since the previous financial year, and the aggregate

amount paid by the Company for this purpose; and

(v) minutes of shareholders’ meetings of the Company.

15. Quorum for shareholders’ meetings and class meetings

A shareholder who intends to attend a shareholders’ meeting shall deposit at the Company’s

legal address a written reply confirming his intention of attendance at least 20 days prior to the

date of the meeting. The Company shall, according to the written replies received 20 days prior

to the shareholders’ meeting, calculate the number of shares carrying the right to vote

represented by the shareholders proposing to attend the meeting. If the number of shares carrying

the right to vote represented by shareholders proposing to attend the meeting reaches half of the

total number of shares in the Company which carry rights to vote, the Company may proceed to


— V-26 —

R19A.42(56)

hold the shareholders’ shareholders’ meeting; if that number is not reached, the Company shall

within five days notify the shareholders again of the matters proposed to be discussed at the

meeting, the date and venue of the meeting by way of public announcement. After such public

announcement, the Company may proceed to hold the shareholders’ meeting.

The above procedure applies, mutatis mutandis, to shareholders of each class of shares in

respect of class meetings.

16. Rights of the minorities in relation to fraud or oppression

Apart from the obligations imposed by law, administrative regulations or the listing rules

of the stock exchange(s) on which shares of the Company are listed, a controlling shareholder

when exercising his rights as a shareholder shall not, by virtue of the exercise of his voting

rights, cause a decision to be made in a manner prejudicial to the interests of the shareholders

generally or any part thereof in connection with the following matters:

(i) to relieve a Director or Supervisor of his responsibility to act honestly in the best

interests of the Company;

(ii) to approve the expropriation in any form by a Director or Supervisor (for his own

benefit or for the benefit of another person), in any manner, of the Company’s assets

including, without limitation, opportunities beneficial to the Company; or

(iii) to approve the expropriation by a Director or Supervisor (for his own benefit or for

the benefit of another person) of the personal rights of other shareholders, including

without limitation, rights to distributions and voting rights, but not including a

restructuring of the Company submitted to and approved by shareholders in

shareholders’ meeting in accordance with the Articles of Association.

For these purposes, a controlling shareholder means a person who satisfies any one of the

following conditions:

(i) he, when acting alone or together with others, has the power to elect more than half

of the Directors;

(ii) he, when acting alone or together with others has the power to exercise or to control

the exercise of 30% or more of the voting rights in the Company;

(iii) he, when acting alone or together with others, holds 30% or more of the issued shares

of the Company; or

(iv) he, when acting alone or together with others, in any other manner has de facto control

of the Company.


— V-27 —

17. Procedures on liquidation

The Company shall be dissolved and liquidated in any one of the following circumstances:

(i) a shareholders’ meeting resolves by special resolution to dissolve the Company;

(ii) dissolution is necessary by reason of its merger or demerger;

(iii) the Company is declared insolvent in accordance with law because it is unable to pay

its debt as they fall due; or

(iv) the Company was ordered to be closed down by reason of its contravention of law or

administrative regulations.

Where the Board decide to liquidate the Company (for reasons other than a declaration of

insolvency), the Board shall, in the notice convening a shareholders’ meeting for this purpose,

include a statement to the effect that, after having made a full enquiry into the affairs of the

Company, it is of the opinion that the Company will be able to pay its debts in full within 12

months from the date of commencement of the liquidation. Upon the passing of a resolution by

the shareholders’ meeting to commence liquidation, the functions and powers of the Board shall

cease immediately.

In the event the Company shall be dissolved under (i) above, it shall set up within 15 days

thereof a liquidation committee, the members of which shall be determined by an ordinary

resolution passed in the shareholders’ meeting. If the team has not been set up within the said

period, its creditors may petition to the People’s Court for the designation of the members of the

liquidation committee so as to proceed with the liquidation thereof.

In the event the Company shall be dissolved under (ii) above, liquidation shall be proceeded

by parties to the merger or demerger in accordance with the merger or demerger agreement.

In the event the Company shall be dissolved under (iii) above, the People’s Court shall form

a liquidation committee comprising of the shareholders, relevant authorities and relevant

professionals in accordance with the laws to proceed with the liquidation thereof.

In the event the Company shall be dissolved under (iv) above, the relevant supervisory

authorities shall form a liquidation committee comprising of the shareholders, relevant

authorities and relevant professionals in accordance with the laws to proceed with the liquidation

thereof.

The liquidation committee shall notify creditors within 10 days of its establishment and

shall make at least three public announcements in newspapers within 60 days of its

establishment. The liquidation committee shall carry out registration of creditors’ rights.


— V-28 —

After the liquidation committee has administered the assets of the Company and prepared

a balance sheet and an inventory of the Company’s assets, it shall draw up a proposal for the

liquidation and submit the same to the shareholders’ meeting or the relevant supervisory

authorities for approval.

The assets of the Company shall be distributed in the order required by laws and

regulations. In case there is no applicable law, the assets of the Company shall be distributed in

accordance with the order regarded as just and reasonable by the liquidation committee.

Any surplus assets remaining after the above payments have been made in full shall be

distributed to the shareholders according to the class(es) and proportion of shares they hold.

Upon completion of the liquidation of the Company, the liquidation committee shall prepare

a liquidation report and accounts of its income and expenditure and financial reports for the

period of the liquidation. Once these accounts and reports are verified by a certified accountant

of the PRC, they shall be submitted to the shareholders’ meeting or the relevant supervisory

authorities for confirmation.

The liquidation committee shall, within 30 days of the date of confirm by the shareholders’

meeting or the relevant supervisory authorities, submit the accounts and reports mentioned above

to the companies registration authority, apply for cancellation of the Company’s registration and

announce the cessation of the Company.

If the Company is being liquidated as a result of its dissolution and subsequent to the

administration of the Company’s assets and preparation of the balance sheet and inventory of

assets, the liquidation committee discovers that the Company’s assets are insufficient to repay its

debts in full, it shall immediately suspend liquidation and apply to the people’s court for a

declaration of insolvency.

Once the people’s court has declared the Company to be insolvent, the liquidation

committee shall hand all matters relating to the liquidation over to the people’s court.

18. Other provisions material to the Company or its shareholders

(a) General provisions and limited liability

The Company is a joint stock limited company of perpetual duration and was

established by way of promotion. It is an enterprise with independent legal status.

The capital of the Company is divided into shares of equal nominal value. The liability

of a shareholder to the Company is limited by the amount payable on subscription of the

shares held by him. The Company shall be liable for its debts up to the extent of all its

assets.


— V-29 —

The Company may invest in other limited liability companies and joint stock limited

companies and accept liability in respect of such companies up to the amount of its

investment in such companies. The Company shall not become a shareholder with unlimited

liability of any other economic organisations. Subject to the approval of the companies

supervisory authority authorised by the State Council, the Company may, in accordance

with its business and operational requirements, operate as a holding company as provided

under Article 12 of the PRC Company Law.

(b) The Articles of Association

The Articles of Association constitute a legal document regulating the constitution and

activities of the Company, the rights and obligations between the Company and its

shareholders and the shareholders inter se. The Articles of Association are binding upon the

Company and its shareholders, Directors, Supervisors, managers and other officers. Such

persons may bring claims on matters relating to the Company in accordance with the


Shareholders may bring actions against the Company and vice versa, and shareholders

may bring actions against other shareholders, Directors, Supervisors, managers and other

officers of the Company in accordance with the Articles of Association. For these purposes,

actions include proceedings commenced in court and arbitration proceedings commenced in

arbitration tribunals.

(c) Shares and registered capital

The entire capital of the Company is divided into shares of equal nominal value.

The Company shall at all times have ordinary shares. The Company may, in

accordance with its needs and upon obtaining approval of the companies supervisory

authority authorised by the State Council, create other types of shares.

The Shares in issue and to be issued as mentioned in this document are in the form

of registered ordinary shares and each has a nominal value of RMB0.10.

The Company may issue shares to either or both of domestic investors and foreign

investors upon obtaining approval the supervisory authorities accredited by the State

Council.

For the purpose of the preceding paragraph, “foreign investors” means investors from

outside the PRC and from the territories of Hong Kong, Macau and Taiwan who subscribe

for shares issued by the Company; “domestic investors” means investors who subscribe for

shares issued by the Company from within the PRC other than from the aforesaid territories.

The part of the register of holders of overseas listed foreign shares relating to holders

of H shares listed on the Stock Exchange shall be maintained in Hong Kong.


— V-30 —

App3 (9)

The shares issued by the Company to domestic investors which are subscribed for in

RMB are called “domestic shares”. The shares issued by the Company to foreign investors

which are subscribed for in foreign currencies are called “foreign shares”. Foreign shares

which are listed outside the PRC are called “overseas listed foreign shares” (and for the

purpose of this document, such overseas listed foreign shares are defined as “H Shares” in

the “Definitions” section of this document) and shall be maintained in Hong Kong.

The following methods may be used for increase in capital:

(1) by offering new shares to general investors;

(2) by placing new shares with existing shareholders;

(3) by a bonus issue of shares to existing shareholders; or

(4) by any other methods permitted under PRC law and administrative regulations.

The Company may reduce its registered capital in accordance with the provisions of

the Articles of Association. The registered capital of the Company after a capital reduction

shall not be lower than the lowest limit prescribed by law. Where the Company reduces its

registered capital, it shall prepare a balance sheet and inventory of assets. The Company

shall notify its creditors within 10 days from the date of a shareholders’ resolution to reduce

its registered capital, and shall make a public announcement in newspapers at least three

times within 30 days thereof. The creditors shall have the right, within 30 days of receipt

of the notice or within 90 days of the date of the first public announcement if the notice

has not been received, to require the Company to pay its debts or provide guarantee to the

amount of its debts.

(d) The Board

The Board is accountable to the shareholders in shareholders’ meeting and shall have

the following functions and powers:

(i) to convene shareholders’ meetings and to report on their work at shareholders’

meetings;

(ii) to implement resolutions passed at shareholders’ meetings;

(iii) to determine the Company’s business plans and investment proposals;

(iv) to prepare the Company’s annual financial budget and final accounts;

(v) to formulate proposals for profit distribution and for making up accrued losses

of the Company;


— V-31 —

App 13 Part DSection 1 (b)

(vi) to formulate proposals for an increase or reduction of registered capital and the

issue of debt securities of the Company;

(vii) to formulate proposals for the demerger, merger or dissolution of the Company;

(viii) to formulate the internal management structure of the Company;

(ix) to appoint or dismiss the general manager of the Company and, at the

recommendation of the general manager, to appoint and dismiss deputy general

manager(s), financial controller and other officers of the Company and to

determine their remuneration and method of payment, to appoint or remove

directors and members of the supervisory committee of wholly-owned

subsidiaries of the Company and to appoint, change or recommend

representative for the shareholders, directors and supervisors of subsidiaries or

associated companies of the Company;

(x) to formulate the basic management regime of the Company;

(xi) to prepare proposals for amendments to the Articles of Association;

(xii) to formulate proposals for major acquisitions or disposals of the assets of the

Company;

(xiii) subject to compliance with the requirements of the relevant laws, regulations, the

Articles of Association, to exercise the Company’s power to raise capital, borrow

money, and make decisions on the charging, letting, sub-contracting or transfer

of the Company’s major assets; and

(xiv) other powers conferred by shareholders’ meetings or the Articles of Association.

A majority of at least two-thirds or more of the Directors shall be required for the

passing of any resolution in respect of items (vi), (vii) and (xi) above. A majority of one

half of the Directors shall be required for the passing of any resolutions in respect of the

other matters specified above.

A meeting of the Directors shall only be held if more than one half of the Directors

are present. Each Director shall have one vote. In the case of an equality of votes, the

chairman shall have an additional vote.


— V-32 —

Directors’ meetings shall be held at least four times every year and shall be convened

by the chairman, provided that when an urgent matter arises, extraordinary meetings of the

Directors may be convened upon the requisition of one third or more of the Directors jointly

or upon the proposal of the general manager of the supervisory committee.

(e) Secretary of the Board

Secretary of the Board shall be appointed and may be dismissed by the Board. The

secretary of the Board shall be a natural person who, in the opinion of the Directors, has

the requisite professional knowledge and experience.

The primary responsibilities of the secretary of the Directors are:

(i) to ensure that the documentation and records of the Company are complete;

(ii) to ensure that the Company prepares and submits all reports and documents to

the relevant authorities as required under the applicable laws; and

(iii) to ensure that the Company’s register of shareholders is properly established and

that persons entitled to the relevant records and documents of the Company are

promptly furnished with the same;

(iv) to be responsible for the disclosure of information by the Company and to ensure

the timely, correct, legal, true and complete information disclosure by the

Company; and

(v) other responsibilities stipulated under the Articles of Association or required by

the listing rules of the stock exchange on which the Company’s shares are listed.

General manager (excluding deputy manager) and chief financial officers shall not

concurrently act as secretary of the Board. Director or other senior management officers

may concurrently act as secretary of the Board. An accountant of an accountants’ firm

retained as auditor by the Company shall not concurrently act as secretary of the Board.

(f) General manager

The Company shall have one general manager and four deputy general managers, who

shall be appointed and dismissed by the Board. The general manager shall be accountable

to the Board and shall have the following functions and powers:

(i) to be in charge of the production, operation and management of the Company and

to organise the implementation of Board resolutions;

(ii) to organise the implementation of the Company’s annual operational plans and

investment proposals;


— V-33 —

(iii) to propose plans for the internal management structure of the Company;

(iv) to propose the basic management structure of the Company;

(v) to establish the internal administrative rules and regulations of the Company;

(vi) to recommend the appointment or dismissal of deputy manager(s) and other

senior management officers of the Company including financial controller(s);

(vii) to employ or dismiss management officer(s) other than those should be employed

or dismissed by the Board;

(viii) to determine the grant or imposition of any awards or penalties, promotion or

demotion, increase or reduction in salaries/wages, appointment, employment,

dismissal or resignation of staff and workers of the Company;

(ix) to represent the Company to deal with important business matter as authorized

by the Board; and

(x) to perform and exercise any other functions and powers conferred by the Articles

of Association and the Board.

(g) Supervisory committee

The Company shall have a supervisory committee which is responsible for the

supervision of the Board, the Director(s), the general manager, the deputy manager(s) and

other officers of the Company to prevent them from abusing their positions and powers and

infringing the interests of the shareholders, the Company and the employees.

The supervisory committee shall consist of 3 Supervisors, two of whom shall be

representatives of the shareholders, one of whom shall be a representative of the employees.

The representatives of the shareholders should not assume any office nor hold any interest

in the Company. The representative of employees shall be elected and removed by the

employees of the Company democratically and the representatives of the shareholders shall

be elected and removed by the shareholders in shareholders’ meeting. Supervisors shall be

appointed for a term of three years from the date(s) of their elections and may be re-elected

to serve consecutive terms. The chairman of the supervisory committee shall be appointed

and removed by two-thirds or more of the Supervisors. Decisions of the supervisory

committee shall be made by the affirmative vote of the two-thirds or more of the

Supervisors.

None of the Directors, general managers, deputy managers or chief financial officers

of the Company shall undertake concurrently the duties of supervisors.


— V-34 —

App13D Section 1(d)(i) and (ii)

The supervisory committee shall exercise the following functions and powers in

accordance with law:

(i) to check the Company’s financial affairs;

(ii) to monitor whether the Directors, managers and other officers have, in the

performance of their duties, acted in contravention of any law, administrative

regulations, the Articles of Association or the resolutions passed at shareholders’

meetings;

(iii) if the conduct of a Director, manager or other officers is detrimental to the

interests of the Company, to require him to rectify such conduct;

(iv) to review the Company’s financial information such as the financial reports,

business reports and profit distribution plans which the Board proposes to submit

to the shareholders’ meeting, and in case of doubt, to appoint on behalf of the

Company registered accountants or practising auditors to assist in the review;

(v) to propose the convening of extraordinary shareholders’ meetings;

(vi) to represent the Company in negotiations with Directors or to institute

proceedings against Directors; and

(vii) other functions and powers stipulated the Articles of Association. Supervisors

shall attend Board meetings.

(h) Obligations of Directors, Supervisors, general manager, deputy manager(s) and

senior management officers of the Company

Each Director, Supervisor, general manager, deputy manager(s) and other senior

management officers is under a duty, in the exercise of his powers and the discharge of his

obligations, to exercise such care, diligence and skill that a reasonable and prudent person

would exercise in similar circumstances.

In addition to the obligations imposed by laws, administrative regulations or the rules

of the stock exchange(s) on which shares of the Company are listed and the duty of

confidential and fiduciary obligations, each Director, Supervisor, general manager, deputy

manager and other senior management officers, when exercising the functions and powers

conferred upon him by the Company, owes to each of the shareholders the following

obligations:

(i) not to cause the Company to exceed the scope of operations stipulated in its

business licence;


— V-35 —

(ii) to act in what he considers to be in the best interests of the Company;

(iii) not to expropriate in any manner the Company’s assets, including (but not

limited to) opportunities beneficial to the Company; and

(iv) not to expropriate personal rights of shareholders, including (but not limited to)

rights to distribution and voting rights, but not including a proposed

restructuring of the Company submitted to and approved by the shareholders’

meeting in accordance with the Articles of Association.

Each Director, Supervisor, general manager, deputy manager and other senior

management officers has, in the performance of his duties, the duty to observe the

principles of good faith and the duty not to place himself in a position where his duties and

his interests may conflict. This includes (but is not limited to) the duty:

(i) to act honestly in the best interests of the Company;

(ii) to exercise his powers within the scope of his authority and not act in excess of

his powers;

(iii) to exercise the discretion vested in him personally and not to allow himself to act

under the manipulation of another person and, except where permitted by law or

administrative regulations, or with the informed consent of shareholders in

shareholders’ meeting, not to delegate the exercise of such discretion to another

person;

(iv) to treat shareholders of the same class equally and to treat shareholders of

different classes fairly;

(v) not to enter into any contract, transaction or arrangement with the Company,

except in accordance with the Articles of Association or with the informed

consent of shareholders in shareholders’ meeting;

(vi) not to use the Company’s assets for his own benefit in any manner without the

informed consent of shareholders in shareholders’ meeting;

(vii) not to abuse his position by accepting bribes or other unlawful income, and not

to exappropriate in any manner the Company’s assets including (without

limitation) opportunities beneficial to the Company;

(viii) not to accept any commission in connection with any transaction in which the

Company is involved without the informed consent of shareholders in

shareholders’ meeting;


— V-36 —

(ix) to comply with the Articles of Association, to carry out his duties honestly, to

safeguard the Company’s interests, not to make use of his position and rights

arising therefrom for his own benefit;

(x) not to compete with the Company in any manner without the informed consent

of shareholders in shareholders’ meeting;

(xi) not to expropriate the fund of the Company or lend the fund to others, not to open

bank accounts for the Company’s assets in his own name or in the name of

others, not to use the Company’s assets to guarantee personal loans of the

Company’s shareholders or others; and

(xii) not to disclose confidential information relating to the Company obtained during

the term of office without the informed consent obtained in the shareholders’

shareholders’ meeting, not to make use of the said information unless such use

is for the interest of the Company, However, disclosure of the said information

to the courts or other governmental and administrative bodies shall be allowed

in the following circumstances:

(1) as required by law;

(2) as required by the public interests;

(3) as required by the self-interests of Directors, Supervisors, general manager,

deputy managers and other senior management officers.

A Director, Supervisor, general manager, deputy manager or other senior

management officers shall not direct persons connected with them (as described in

section 1(f) above) to do what the Director, Supervisor, general manager, deputy

manager or other senior management officers himself is prohibited from doing.

(i) Shareholders’ obligations

A shareholder of the Company is a person who lawfully holds shares of the Company

and whose name is entered in the register of shareholders.

A shareholder shall enjoy the rights and shall bear the obligations attached to the

class(es) and the proportion of shares held by him; shareholders holding the same class of

shares shall be entitled to the same rights and shall bear the same obligations.

A shareholder is, under any applicable laws, required to abstain from voting on any

particular resolution or restricted to voting only for or against any particular resolution, any

votes cast by or on behalf of such shareholder in contravention of such requirement or

restriction shall not be counted.


— V-37 —

A1A(14)

In addition to their right to obtain relevant information in accordance with the Articles

of Association as mentioned in paragraph 14 above, shareholder of ordinary shares of the

Company shall enjoy the following rights:

(i) to receive dividends and other distributions in proportion to the number of shares

held by him;

(ii) to attend and vote or appoint proxies to attend and vote on his behalf at

shareholders’ meetings;

(iii) to supervise and to put forward proposals or to make enquiries relating to the

business operation of the Company;

(iv) to transfer his shares in accordance with the applicable laws, administrative

regulations and the Articles of Association;

(v) to receive information regarding the Company in accordance with the Articles of

Association;

(vi) in the event of the termination or liquidation of the Company, to participate in

the distribution of surplus assets of the Company according to the proportion of

shares held by him; and

(vii) other rights conferred by relevant laws and administrative regulations, and the


A holder of ordinary shares in the Company shall have the following obligations:

(i) to abide by the Articles of Association;

(ii) to pay subscription monies according to the number of shares subscribed and the

method of subscription; and

(iii) other obligations imposed by law, administrative regulations and the Articles of

Association.

(j) Untraceable members

Where power is taken to cease sending dividend warrants by posts, if such warrants

have been left uncashed, it will not be exercised until such warrants have been so left

uncashed on 2 consecutive occasions. However, such power may be exercised after the first

occasion on which such a warrant is undelivered.


— V-38 —

A1A(13)

Where power is taken to sell the shares of the shares of a member who is untraceable

it will not be exercised unless:

(a) during of 12 years at least three dividends in respect of the shares in question

have become payable and no dividend during that period has been claimed; and

(b) on expiry of the 12 years the Company gives notice of its intention to sell the

shares by way of an advertisement published in the newspapers and notifies the

Stock Exchange of such intention.

Save in respect of terms agreed by the subscriber at the time of subscription, a

shareholder shall not be liable to subscribe for any further share.

The register of shareholders shall be sufficient evidence of the holding of the shares

of the Company by the shareholders, unless there is other evidences to the contrary.

Alteration or rectification of each part of the register of shareholders shall be made in

accordance with the law of the place where that part of the register of shareholders is

deposited. Any person who has any objection in relation to the register of shareholders and

seeks to register his name on the register of shareholders or to delete his name from the

register of shareholders may in each case apply to a court of competent jurisdiction to

rectify the register of shareholders.

The Company shall not be bound to register more than four persons as the joint

holders of any Share.

On the death of any one of such joint holders, the survivor(s) shall be the only person

or persons recognised by the Company as having any title to any such shares but the Board

may require such evidence of death as it may deem fit.

Only the person whose name stands first in the register of shareholders as one of the

joint holders of any share shall be entitled to delivery of the certificate relating to such

share, or to receive notices from the Company, or to attend or vote at shareholders’

meetings of the Company, and any notice given to such person shall constitute notice to all

the other joint holders.

Any shareholder who has lost his share certificate (the “original certificate”) may

apply to the Company for a new certificate in respect of the shares (the “relevant shares”)

represented by the original certificate. The Articles of Association contain provisions

prescribing the procedures for the application for replacement certificate in respect of

holders of Domestic Shares and H Shares. In respect of holders of H Shares, an applicant

is required to submit an application in the prescribed form accompanied by a notarial

certificate or a statutory declaration. Where the Company is satisfied beyond reasonable

doubt that the original certificate is lost having regard to the requirements set out in the

Articles of Association, the Company will issue a new share certificate and cancel the


— V-39 —

App3 (2)(2)

original certificate. All expenses of the Company relating to the cancellation of an original

certificate and the issue of a new share certificate shall be borne by the applicant. The

Company is entitled to refuse to take any action before reasonable security is provided by

the applicant in respect of those expenses.

Subsequent to issuance of a new replacement share certificate by the Company in

accordance with the above provisions, the name of the bona fide purchaser who shall

thereby obtain the new share certificate or a person whose name is subsequently entered

into the register of shareholders in respect of the relevant shares (if a bona fide purchaser)

shall not be removed from the register of shareholders. The Company shall not be liable for

any damages suffered by any person by reason of the cancellation of the original certificate

or the issue of the new share certificate unless the parties concerned succeed to prove that

the Company has acted fraudulently.

(k) Resolution of disputes

Whenever any dispute or claim arises from any rights or obligations provided in the

Articles of Association, the PRC Company Law and other relevant laws and administrative

regulations concerning the affairs of the Company between the following parties:

(i) a holder of H Shares and the Company;

(ii) a holder of H Shares and the Directors, Supervisors, general manager, deputy

manager or other senior management officers of the Company; and

(iii) a holder of H Shares and a holder of Domestic Shares.

then, unless otherwise specified in the Articles of Association, such parties shall submit that

dispute or claim to arbitration before either (1) CIETAC in accordance with its rules or (2)

the HKIAC in accordance with its securities arbitration rules.

Once the claimant refers a dispute or claim to arbitration, the other party or parties

must submit to the arbitral body selected by the claimant. If the claimant selects to arbitrate

at the HKIAC, then any party to the dispute shall be entitled to request, in accordance with

the requirements of the securities arbitration rules of the HKIAC, for that arbitration to be

conducted in Shenzhen, the PRC.

If arbitration is sought to resolve a dispute or claim as described above, the applicable

law shall be the PRC law, unless otherwise prescribed by law and administration

regulations. Such arbitration shall be final and conclusive and shall be binding on all parties

to the dispute.


— V-40 —

In respect of a dispute or claim referred to above, the entire claim or dispute must be

referred to arbitration and all persons (being the Company or the shareholders, Directors,

Supervisors, managers or other officers of the Company) who have a cause of action based

on the same facts giving rise to the dispute or claim or whose participation is necessary for

the resolution of that dispute or claim shall be subject to the arbitral awards rendered by

CIETFC or HKIAC.

Disputes in connection with the determination of whether a person is or is not a

shareholder or of the register of shareholders need not be resolved by arbitration.


— V-41 —

A1A25(2)

1. FURTHER INFORMATION ABOUT THE COMPANY

1. Incorporation

The Company was established as a joint stock limited company in the PRC on 30 December 2001

with Zhang En Rong, Lin Fu Long, Zhang Yun San, Xie Xin Cang, Liu Yun Long, Cui Huan You, Liang

Yong Qiang, Kaiyuan Oil and Alloy Factory as Promoters. At the time of its establishment, the

registered capital of the Company was RMB40,500,000, divided into 40,500,000 Domestic Shares of

RMB1.00 each. Such Domestic Shares were paid up and held by the Promoters as follows:

Name of Promoters

Number ofDomestic Shares

of RMB1.00each held

Approximatepercentage of

registeredcapital

(%)

Zhang En Rong 27,951,700 69.02

Lin Fu Long 3,421,600 8.45

Zhang Yun San 3,060,800 7.56

Xie Xin Cang 2,141,000 5.29

Liu Yun Long 1,467,000 3.62

Cui Huan You 923,800 2.28


Kaiyuan Oil 524,400 1.29

Alloy Factory 327,800 0.81

Total 40,500,000 100.00

The Company has established a place of business in Hong Kong at Suite A, 11/F, Ho Lee

Commercial Building, 38-44 D’ Aguilar Street, Central, Hong Kong and has been registered as an

oversea company in Hong Kong in compliance with Part XI of the Companies Ordinance on 4 March

2004, Chan Wing Nang, Billy has been appointed as the agent of the Company for the acceptance of

service of process in Hong Kong.

Since the Company was established in the PRC, it is required to comply with the laws and

regulations of the PRC. A summary of the relevant laws and regulations of the PRC and a summary

of Articles of Association are set out in Appendix V to this document.

The establishment of the Company involved, among other matters, the following procedures and

approvals:

(1) a meeting of the management of Molong Holdings was held on 8 April 2001 approving the

conversion of Molong Holdings from a collective enterprise to a privately owned

enterprise;

APPENDIX VI STATUTORY AND GENERAL INFORMATION

— VI-1 —

3rd Sch(29)5.342(1)(a)(iv)A1A(5)Rules 8.02Rules 8.05(1)(c)

A1A(6)S.342(1)(a)(iii)S.342(1)(a)(v)Rules19A.13(2)(a)(b)

S.342(1)(a)(i)S.342(1)(a)(ii)

(2) (agreement for the sale of the entire asset of Molong

Holdings) dated 18 August 2001 was entered into between (Shouguang

City Shangkou Town People’s Government), Zhang En Rong, Lin Fu Long, Zhang Yun San,

Xie Xin Cang, Liu Yun Long, Cui Huan You and Liang Yong Qiang pursuant to which

Shouguang City Shangkou Town People’s Government agreed to sell all interests in, and all

creditors’ rights, debts and liabilities of Molong Holdings to Zhang En Rong, Lin Fu Long,

Zhang Yun San, Xie Xin Cang, Liu Yun Long, Cui Huan You and Liang Yong Qiang at an

aggregate consideration of RMB55,715,900 being the net asset value of Molong Holdings

as at 30 April 2001;

(3) (Office for Restructuring the Economic System of Shouguang City)

issued an approval ( [2001]23 ) on 22 August 2001 approving, among other things,

the sale as referred to in item (2) above;

(4) a meeting of the management of Molong Holdings was held on 18 September 2001 at which

Molong Holdings decided to establish the Company together with Kaiyuan Oil and Alloy

Factory;

(5) (Shouguang City Town and Village Enterprise Management Bureau)

issued an approval ( (2001)20 ) on 20 October 2001, approving, among other

things, the establishment of the Company by the Promoters and the conversion of an

aggregate capital contribution of RMB61,777,800 made by the Promoters into Shares at the

rate of 1: 0.6556 such that the registered capital of the Company would be RMB40,500,000

divided into 40,500,000 Shares of RMB1.00 each;

(6) an asset reorganization agreement dated 8 November 2001 was entered into between Zhang

En Rong, Lin Fu Long, Zhang Yun San, Xie Xin Cang, Liu Yun Long, Cui Huan You and

Liang Yong Qiang and (the Preparation Committee for the

Company);

(7) a promoters agreement dated 8 November 2001 was entered into between the Promoters

pursuant to which the Promoters had agreed, among other matters, to establish the

Company;

(8) (Office for Restructuring the Economic System of Shandong

Province) issued a letter ( [2001]53 ) (“Letter”) on 27 December 2001

approving, among other things, the establishment of the Company and the articles of

association of the Company;


— VI-2 —

(9) (Shandong Province People’s Government) issued a certificate

(Shandong Province Joint Stock Limited Company Approval

Certificate) ( [2001]67 ) (“Approval Certificate”) on 27 December 2001.

According to the Letter set out in item (8) above, the Promoters were required to present

the Approval Certificate and other relevant documents to the Administration for Industry

and Commerce at provincial level to undertake the registration procedures;

(10) an inaugural general meeting of the Company was held on 28 December 2001 at which,

among other matters, the following resolutions were passed:

(i) the adoption of the articles of association of the Company (draft);

(ii) the appointment of Zhang En Rong, Lin Fu Long, Zhang Yun San, Xie Xin Cang, Chen

Jian Xiong as Directors and Liu Yun Long and Liang Yong Qiang as Supervisors; and

(iii) the conversion of capital contribution from each of the Promoters into Domestic

Shares of RMB1.00 each at the rate of 1:0.6556 be confirmed;

(11) (Shandong Administration for Industry and Commerce) granted a

business licence to the Company (registration number: 3700001807083) on 30 December

2001;

(12) (Ministry of Finance) issued an approval document ( [2002]489 ) on 15

November 2002, approving, among other things, that as at 30 September 2002, the total

number of Shares in issue was 40,500,000 Shares, among which Alloy Factory held 327,800

Shares, representing 0.81% of the entire capital and that such Shares are state-owned

shares;

(13) an extraordinary meeting of the Company was held on 8 November 2002, at which, amongst

others, the following resolutions were passed:

(i) the application to the CSRC for the issue of H Shares and listing of the H Shares on

GEM be approved; and

(ii) subject to the approval of the CSRC, the nominal value of the Shares of the Company

be reduced from RMB1.00 each to RMB0.10 each;

(14) an extraordinary meeting of the Company was held on 29 March 2003 at which, amongst


(i) subject to the approval of the CSRC and the Stock Exchange, the Company be

converted to a foreign listed company;

(ii) the Over-allotment Option be granted to the Underwriters (or their representative(s));


— VI-3 —

(iii) an application be made to the CSRC for the issue of not less than 138,278,000 and not

more than 158,528,000 H Shares (including the H Shares which may fall to be issued

pursuant to the exercise of the Over-allotment Option) to the overseas public, among

which 3,278,000 Domestic Shares will be offered for sale pursuant to Regulations for

the Reduction of State Shares;

(iv) the proceeds from the public offer and placing of H Shares in 2004 be utilized

principally for super-strength oil well sucker rods ( ) and special

seamless oil well pipes ( );

(v) the articles of association (draft), which shall take effect upon the listing of the

Company, be approved and the Directors be authorized to make such amendments as

may be required to the articles relating to the structure of the Company’s share capital;

(vi) (Qin Xue Chang), (Wang Ping) and (Yan Yi Zhuang) be appointed

as additional Directors, among whom, (Qin Xue Chang) and (Yan Yi

Zhuang) are independent non-executive Directors; and

(vii) (Liu Wan Fu) and (Fan Ren Yi) be appointed as Supervisors and shall

form the supervisory committee together with (Li Bao Hui), the representative

of the employees.

(15) an approval document ( [2003]50 ) was issued on 29 December 2003 by the

CSRC approving, among other things, (i) the issue of foreign listed shares and the listing

of the Company on the GEM. The new H Shares and the sale H Shares are all foreign listed

shares (all being ordinary shares); and (ii) the subdivision of the Company’s shares of

RMB1.00 each into 10 shares of RMB0.10 each; and

(16) an extraordinary meeting of the Company was held on 20 March 2004, at which, amongst


(i) the adoption of the Articles of Association; and

(ii) that the public offer and placing of H Shares be approved in accordance with the terms

and conditions of the Prospectus.


— VI-4 —

2. Changes in share capital and shareholding structure of the Company

The predecessor of the Company, Petroleum Machinery Parts Factory, was established as a

collective enterprise in the PRC on 13 March 1987. Its registered capital was RMB1,200,000.

On 8 September 1989, Petroleum Machinery Parts Factory was re-registered as Petroleum

Machinery Factory and increased its registered capital to RMB2,070,000.

On 16 May 1992, Petroleum Machinery Factory increased its registered capital to

RMB12,320,000.

On 8 August 1993, Petroleum Machinery Factory changed its name to Weifang Molong and

increased its registered capital to RMB16,420,000.

On 30 June 1994, Weifang Molong changed its name to Molong Holdings and increased its

registered capital to RMB30,040,000.

On 6 September 1997, Shouguang City Shangkou Town People’s Government entered into an

agreement with Zhang En Rong pursuant to which Zhang En Rong acquired 35% interests in Molong

Holdings at a consideration of RMB18,738,000. The transfer was approved by the Office for

Restructuring the Economics System of Shouguang City on 20 September 1997.

On 30 September 1997, Zhang En Rong and Shouguang City Shangkou Town People’s

Government entered into an engagement agreement pursuant to which Zhang En Rong agreed to

engage Shouguang Shangkou Town People’s Government to hold his 35% interests in Molong

Holdings on his behalf.

On 8 October 1997, Shouguang City Shangkou Town People’s Government issued a notice

( (1997)20 ). According to that notice, Zhang En Rong was interested in 35% of the registered

capital of Molong Holdings and Shouguang City Shangkou Town People’s Government,



were jointly interested in 65% of the registered capital of Molong Holdings.

On 18 August 2001, (agreement for the sale of the entire

assets of Molong Holdings) was entered into between Shouguang City Shangkou Town People’s

Government and Zhang En Rong, Lin Fu Long, Zhang Yun San, Xie Xin Cang, Liu Yun Long, Cui

Huan You and Liang Yong Qiang pursuant to which Shouguang City Shangkou Town People’s

Government agreed to sell all interests and all creditors’ rights in, and all debts and liabilities of

Molong Holdings to Zhang En Rong, Lin Fu Long, Zhang Yun San, Xie Xin Cang, Liu Yun Long, Cui

Huan You and Liang Yong Qiang at an aggregate consideration of RMB55,715,900, being the net asset

value of Molong Holdings as at 30 April 2001. The sale was approved by Office for Restructuring the


— VI-5 —

A1A(15)(1)

Economic System of Shouguang City on 22 August 2001 as evidenced by the approval document,

( [2001]23 ). After this sale, the structure of the capital contribution of Molong Holdings was

as follows:

Name of shareholdersAmount of capital

contribution


registered capitalin Molong

Holdings(RMB) (%)

Zhang En Rong 39,279,700 70.50Lin Fu Long 4,808,300 8.63Zhang Yun San 4,301,300 7.72Xie Xin Cang 3,008,600 5.40Liu Yun Long 2,061,500 3.70Cui Huan You 1,298,200 2.33Liang Yong Qiang 958,300 1.72

55,715,900 100.00

On 20 October 2001, Shouguang City Town and Village Enterprise Management Bureau issued

an approval ( (2001)20 ) approving, among other things, the establishment of the Company

by the Promoters and the conversion of an aggregate capital contribution of RMB61,777,800 made by

the Promoters into Domestic Shares at the rate of 1:0.6556 such that the registered capital of the

Company became RMB40,500,000 divided into 40,500,000 Shares of RMB1.00 each as follows:

Name of Promoters

Amountof capital

contribution

Numberof Domestic

Shares ofRMB1.00each held



Company(RMB) (%)

Zhang En Rong 42,636,900 27,951,700 69.02Lin Fu Long 5,219,200 3,421,600 8.45Zhang Yun San 4,668,900 3,060,800 7.56Xie Xin Cang 3,265,800 2,141,000 5.29Liu Yun Long 2,237,700 1,467,000 3.62Cui Huan You 1,409,100 923,800 2.28Liang Yong Qiang 1,040,200 681,900 1.68Kaiyuan Oil 800,000 524,400 1.29Alloy Factory 500,000 327,800 0.81

61,777,800 40,500,000 100.00


— VI-6 —

3rd Sch(4)

On 29 December 2003, the CSRC issued the approved document ( [2003]50 )

approving, among other things, the subdivision of each of the Company’s shares of RMB1.00 each into

10 shares of RMB0.10 each. The shareholding structure of the Company became as follows:

Name of Promoters




Company

(RMB) (%)

Zhang En Rong 279,517,000 69.02

Lin Fu Long 34,216,000 8.45

Zhang Yun San 30,608,000 7.56

Xie Xin Cang 21,410,000 5.29

Liu Yun Long 14,670,000 3.62

Cui Huan You 9,238,000 2.28

Liang Yong Qiang 6,819,000 1.68

Kaiyuan Oil 5,244,000 1.29

Alloy Factory 3,278,000 0.81

405,000,000 100.00

Immediately after the completion of the listing of the H Shares on GEM on 15 April 2004, the

registered capital of the Company was RMB53,998,000 and was held as follows:

Name of Shareholders Nature of Shares held

Numberof Shares

of RMB0.10each held



Company

(%)

Zhang En Rong Domestic Shares 279,517,000 51.76

Lin Fu Long Domestic Shares 34,216,000 6.34

Zhang Yun San Domestic Shares 30,608,000 5.67

Xie Xin Cang Domestic Shares 21,410,000 3.96

Liu Yun Long Domestic Shares 14,670,000 2.72

Cui Huan You Domestic Shares 9,238,000 1.71

Liang Yong Qiang Domestic Shares 6,819,000 1.26

Kaiyuan Oil Domestic Shares 5,244,000 0.97

Public Shareholders H Shares 138,276,000 25.61

539,998,000 100.00


— VI-7 —

3rd Sch(9)3rd Sch(11)

On 12 May 2005, the Company issued 108,000,000 H Shares for cash pursuant to a placing

agreement entered into between the Company and Guotai Junan Securities (Hong Kong) Limited on

26 April 2005, pursuant to which Guotai Junan Securities (Hong Kong) Limited has agreed to place

108,000,000 H Shares at the placing commission rate of 3.5% of the placing proceeds, on a fully

underwritten basis, at HK$0.92 per H Share. These 108,000,000 H Shares were successfully placed to

29 placees. As at the Latest Practicable Date, the registered capital of the Company was

RMB64,799,800 and was held as follows:

Name of ShareholdersNature ofShares held

Number ofShares of RMB0.10 each held


registered capitalin the Company

(%)

Zhang En Rong Domestic Shares 279,517,000 43.14

Lin Fu Long Domestic Shares 34,216,000 5.28

Zhang Yun San Domestic Shares 30,608,000 4.72

Xie Xin Cang Domestic Shares 21,410,000 3.30

Liu Yun Long Domestic Shares 14,670,000 2.26

Cui Huan You Domestic Shares 9,238,000 1.43

Liang Yong Qiang Domestic Shares 6,819,000 1.05

Kaiyuan Oil Domestic Shares 5,244,000 0.81

Mackenzie Cundill Investment

Management Ltd.

H Shares 60,000,000 9.26

Mackenzie Cundill Investment

Management (Bermuda) Ltd.

H Shares 9,000,000 1.39

Other public Shareholders H Shares 177,276,000 27.36

647,998,000 100.00

Save as disclosed above, there has been no other significant changes in the share capital of the

Company since the date of its establishment.


— VI-8 —

A1A 133rd Sch(9)

3. Changes in the Directors and Supervisors

Set out below are the changes in the Directors and the Supervisors since the establishment of the

Company:

Date Directors Supervisors

28 December 2001 Zhang En Rong

Lin Fu Long

Zhang Yun San

Xie Xin Cang

Chen Jian Xiong

Liu Yun Long

Liang Yong Qiang

Ren Chun Qing

8 November 2002 Zhang En Rong

Lin Fu Long

Zhang Yun San

Xie Xin Cang

Chen Jian Xiong

Ma Xin Cai

Qin Xue Chang

Liu Yun Long

Liang Yong Qiang

Ren Chun Qing

29 March 2003 Zhang En Rong

Lin Fu Long

Zhang Yun San

Xie Xin Cang

Chen Jian Xiong

Qin Xue Chang

Wang Ping

Yan Yi Zhuang

Li Bao Hui

Liu Wan Fu

Fan Ren Yi

20 March 2004 Zhang En Rong

Lin Fu Long

Zhang Yun San

Xie Xin Cang

Chen Jian Xiong

Qin Xue Chang

Wang Ping

Yan Yi Zhuang

Loke Yu

Li Bao Hui

Liu Wan Fu

Fan Ren Yi

Save as disclosed above, there has been no change in the Directors and the Supervisors.


— VI-9 —

II. SUBSIDIARIES

The Company’s subsidiaries are referred to in the accountants’ report of the Group, the text of

which is set out in Appendix I to this document:

The following changes in the issued share capital/registered capital of the subsidiaries and

associated companies of the Company has taken place within the two years preceding the date of this

document:

(1) Molong Drilling Equipment was established on 29 September 2004 with a registered capital

of RMB6,000,000, which has been fully and timely paid, with no alteration in its registered

capital up to the Latest Practicable Date;

(2) MPM was incorporated on 24 May 2004 with the issued share capital of HK$1.00 divided

into 1 share of HK$1.00 each; and

(3) MPM increased its issued share capital on 15 May 2005 from HK$1.00 to HK$7,800,000.

As at the Latest Practicable Date, the issued share capital of MPM in the amount of

HK$7,800,000 has been fully and timely paid.

Save as disclosed herein, there has been no change in the issued share capital/registered capital

of the subsidiaries and associated companies of the Company within the two years preceding the date

of this document.

III. INFORMATION ON THE PRC ENTITIES WITHIN THE GROUP

(i) Name: Molong Drilling Equipment

Nature: Limited liability company

Legal representative: Guo Huan Ran

Registered capital: RMB6,000,000 (fully and timely paid)

Percentage of attributable

equity interest:

the Company: 90%

Shangkok Town People’s Government: 10%

Term of the entity: 29 September 2004 through 26 September 2019

(ii) Name: Maolong Recycle

Nature: Limited liability company

Legal representative: Liu Yun Long

Registered capital: RMB500,000 (fully and timely paid)

Percentage of attributable

equity interest:

the Company: 10%

Maolong Machinery: 90%

Term of the entity: 13 December 2002 through 12 December 2012


— VI-10 —

A1A(26)

R19A.42(58)

IV. GENERAL MANDATE TO ISSUE NEW SHARES

At the Company’s annual general meeting held on 12 May 2006, the Directors was granted

general unconditional mandate to allot, issue and deal with additional Shares with an aggregate

nominal amount not exceeding 20% of the aggregate amount of Domestic Shares in issue and 20% of

the aggregate nominal amount of H Shares in issue as at the date of passing of the relevant resolution

on 12 May 2006 (which may be revoked at the Extraordinary General Meeting to be held on or about

5 December 2006).

The above general mandate does not apply to situations where the Directors allot, issue or deal

with Shares under a scrip dividend or similar arrangement providing for the allotment of such Shares

in lieu of the whole or part of a dividend on such Shares or any share option scheme adopted by the

Company and in accordance with the Articles of Association.

This general mandate will expire:

(1) at the conclusion of the next annual general meeting of the Company following the passing

of the relevant resolution on 12 May 2006;

(2) the expiry date of the 12-month period following the passing of the relevant resolution on

12 May 2006; or

(3) the passing of a special resolution of the Company in a general meeting revoking or varying

the authority set out in the relevant resolution on 12 May 2006.


— VI-11 —

V. FURTHER INFORMATION ABOUT DIRECTORS, SUPERVISORS, MANAGEMENT,STAFF AND SUBSTANTIAL SHAREHOLDER

1. Directors and supervisors

1. Particulars of service contracts and remuneration of Directors and Supervisors

Each of the Directors and Supervisors has entered into a service contract with the

Company. Particulars of these contracts, except as indicated, are in all material respects

identical and are set out below:

(i) each service contract is for an initial term of three years commencing from the

date of signing of the service contract and may be renewed thereafter subject to

the approval of the shareholders’ meeting of the Company;

(ii) the annual salary and/or allowance (subject to actual adjustments) for each of the

Directors and Supervisors during their initial term of three years are as follows:

Executive Director

Annual salaryand/or

allowance

(RMB)

Zhang En Rong 220,000

Lin Fu Long 160,000

Zhang Yun San 150,000

Xie Xin Cang 120,000

Non-executive Director

Chen Jian Xiong 0

Wang Ping 0

Independent Non-executive Director

Qin Xue Chang 30,000

Yan Yi Zhuang 62,400

Loke Yu alias Loke Hoi Lam 62,400

Supervisor

Li Bao Hui 70,000

Liu Wan Fu 20,000

Fan Ren Yi 10,000


— VI-12 —

A1A(46)(1)

(iii) subject to resolution passed at shareholders’ meeting of the Company, the

remuneration of each of the Directors and Supervisors may be changed;

(iv) each of the Directors and Supervisors is entitled to out-of-pocket expenses

reasonably incurred during his/her term of office;

(v) the actual salary payable to each of the executive Directors is subject to

adjustment dependent upon the results of internal review of the executive

Directors concerned;

(vi) each of the executive Directors is entitled to such bonus as decided by the Board,

calculated by reference to the operating results of the Company as a whole and

the performance of the executive Directors.

Pursuant to the service contracts entered into between the Company and the respective

Directors and Supervisors, the aggregate annual remuneration payable to the executive

Directors, non-executive Directors, independent non-executive Directors and Supervisors

are approximately RMB650,000, RMB NIL, RMB154,800 and RMB100,000 respectively

for an initial term of three years.

The aggregate remuneration paid to the Directors (including the non-executive

Directors and the independent non-executive Directors) and Supervisors for the year ended

31 December 2005 are RMB857,000 and RMB105,000 respectively. The aggregate

remuneration payable to the Directors (including the non-executive Directors and the

independent non-executive Directors) and Supervisors for the year ended 31 December

2006 will be RMB1,466,800 and RMB105,000 respectively.

2. Disclosure of the Directors’ and Supervisors’ interests or short positions in the

share capital of the Company

As at the Latest Practicable Date, the interest or short positions of the Directors,

Supervisors or chief executive of the Company in the shares, debentures or underlying

shares of the Company and its associated corporations (within the meaning of Part XV of

the SFO) which will be required to be notified to the Company and the Stock Exchange

pursuant to Divisions 7 and 8 of Part XV of the SFO (including interests or short positions

which they are taken or deemed to have under such provisions of the SFO) or which will

be required, pursuant to section 352 of the SFO, to be entered in the register referred to


— VI-13 —

A1A(46)(2)

A1A(46)(3)

therein, or which will be required pursuant to the Model Code for Securities Transactions

by Directors of Listed Issuers set out in the Listing Rules, to be notified to the Company

and the Stock Exchange will be as follows:

Name of Directors/Supervisors Capacity

Number ofDomestic Shares

of RMB0.10each held

Approximatepercentage of the

registered capital ofthe Company as at

the LatestPracticable Date

(%)

Zhang En Rong Beneficial owner 279,517,000 43.14

Lin Fu Long Beneficial owner 34,216,000 5.28

Zhang Yun San Beneficial owner 30,608,000 4.72

Xie Xin Cang Beneficial owner 21,410,000 3.30

2. Shareholder

So far as the Directors are aware, as at the Latest Practicable Date, the following persons

will have an interest or short position in the shares, debentures or underlying shares of the

Company which would fall to be disclosed to the Company under the provisions of Divisions 2

and 3 of Part XV of the SFO, or will be directly or indirectly interested in 10% or more of the

nominal value of any class of share capital carrying rights to vote in all circumstances at general

meetings of the Company:

Long positions in Domestic Shares

Name ofshareholders Capacity

Number ofDomestic

Shares


total DomesticShares as

at the LatestPracticable Date


total issuedshare capital

as at the LatestPracticable Date

Zhang Xiu Lan

(Note 1)

Interests of spouse 279,517,000 69.58% 43.14%

Li Xiu Fen

(Note 2)


Zhang Xin Lan

(Note 3)


Li Bao Hui

(Note 4)



— VI-14 —

A1A45(1)

A1A45(2)

Long positions in H Shares

Name ofshareholders Capacity

Numberof H

Shares


total H Sharesas at the Latest

Practicable Date


total registeredcapital as

at the LatestPracticable Date

Paul G. Desmarais

(Notes 5 and 6)

Interest of controlled

corporation

69,000,000 28.02% 10.65%

Nordex Inc.

(Notes 5 and 6)


corporation

69,000,000 28.02% 10.65%

Gelco Enterprises

Ltd.

(Notes 5 and 6)


corporation

69,000,000 28.02% 10.65%

Power Corporation

of Canada

(Notes 5 and 6)


corporation

69,000,000 28.02% 10.65%

Power Financial

Corporation

(Notes 5 and 6)


corporation

69,000,000 28.02% 10.65%

IGM Financial Inc.

(Notes 5 and 6)


corporation

69,000,000 28.02% 10.65%

RAB Energy Fund

Limited

(Notes 5 and 7)

Investment manager 33,832,000 13.74% 5.22%

Commonwealth

Bank of Australia

(Note 5)


corporation

19,718,000 8.01% 3.04%

Martin Currie

Investment

Management

Limited

(Note 5)


corporation

12,400,000 5.04% 1.91%

China Development

Capital Partnership

LP (Note 5)

Beneficial owner 12,400,000 5.04% 1.91%

Note 1: Zhang Xiu Lan is the wife of Zhang En Rong and is taken to be interested in the 279,517,000 Domestic

Shares held by Zhang En Rong under the SFO.

Note 2: Li Xiu Fen is the wife of Lin Fu Long and is taken to be interested in the 34,216,000 Domestic Shares held

by Lin Fu Long under the SFO.

Note 3: Zhang Xin Lan is the wife of Zhang Yun San and is taken to be interested in the 30,608,000 Domestic Shares

held by Zhang Yun San under the SFO.


— VI-15 —

Note 4: Li Bao Hui is the wife of Xie Xin Cang and is taken to be interested in the 21,410,000 Domestic Shares

held by Xie Xin Cang under the SFO.

Note 5: Interests in H Shares.

Note 6: Mackenzie Cundill Investment Management Ltd. is a wholly-owned subsidiary of Mackenzie Financial

Corporation, which in turn is a wholly-owned subsidiary of Mackenzie Inc.. Mackenzie Inc. is a

wholly-owned subsidiary of IGM Financial Inc. which in turn is owned as to 55.99% by Power Financial

Corporation. Power Financial Corporation is owned as to 66.4% by 171263 Canada Inc. which in turn is

a wholly-owned subsidiary of 2795957 Canada Inc. 2795957 Canada Inc. is a wholly-owned subsidiary of

Power Corporation of Canada which in turn is owned as to 54.18% by Gelco Enterprises Ltd. Gelco

Enterprises Ltd. is owned as to 94.95% by Nordex Inc., which in turn is owned as to 68% by Paul G.

Desmarais.

Mackenzie Cundill Investment Management (Bermuda) Ltd. is a wholly-owned subsidiary of Mackenzie

(Rockies) Corp., which in turn is a wholly-owned subsidiary of Mackenzie Financial Corporation.

By virtue of the SFO, Mackenzie Financial Corporation, Mackenzie Inc., IGM Financial Inc., Power

Financial Corporation, 171263 Canada Inc., 2795957 Canada Inc., Power Corporation of Canada, Gelco

Enterprises Ltd., Nordex Inc. and Paul G. Desmarais are deemed to be interested in the 60,000,000 H Shares

held by Mackenzie Cundill Investment Management Ltd. and 9,000,000 H Shares held by Mackenzie

Cundill Investment Management (Bermuda) Ltd.

Note 7: According to its Form 2 filed on 27 May 2005, RAB Energy Fund Limited derives all or part its interest

in the 33,832,000 H Shares from certain cash settled equity derivatives which are listed or traded on a stock

exchange or traded on a futures exchange.

3. Related party transactions

The Company had entered into certain related party transactions during the Track Record

Period, the details of which are set out in note k of the paragraph headed “Related party

transactions” in the accountants’ report in Appendix I to this document.

4. Disclaimers

Save as disclosed herein:

(i) none of the Directors, Supervisors or chief executive has any interest or short

positions in the Shares, underlying shares and debentures of the Company or any

associated corporations (within the meaning of Part XV of the SFO) which are under

a duty of disclosure pursuant to Divisions 7 and 8 of Part XV of the SFO (including

interests and short positions which they are taken or deemed to have taken under such

provisions of the SFO) and will have to be notified to the Company and the Stock

Exchange pursuant to section 347 of the SFO, or to be entered into the register

referred to therein or which will be required, pursuant to the Model Code for

Securities Transactions by Directors of Listed Issuers set out in the Listing Rules, to

be notified to the Company and the Stock Exchange and in the case of Supervisors,

which will be required to be notified as described above if they had been Directors;


— VI-16 —

(ii) so far as is known to any of the Directors or Supervisors, there is no person who will

directly or indirectly have an interest or short position in the shares or underlying

shares of the Company which would fall to be disclosed to the issuer under the

provisions of Divisions 2 and 3 of Part XV of the Securities and Futures Ordinance

or, who is expected, directly or indirectly, to be interested in 10% or more of the

nominal value of any class of share capital carrying rights to vote in all circumstances

at general meetings of any other member of the Group;

(iii) none of the Directors or Supervisors has entered or has proposed to enter into any

service contracts with the Company (other than contracts expiring or determinable by

the Company within one year without payment of compensation other than statutory

compensation);

(iv) none of the Directors or Supervisors or any of the experts whose names are listed in

the paragraph headed “Consents of experts” in this appendix has any direct or indirect

interest in the promotion of, or in any assets which have been acquired or disposed of

by or leased to the Company within the two years immediately preceding the date of

this document, or which are proposed to be acquired or disposed of by or leased to the

Company;

(v) none of the Directors or Supervisors or any of the experts whose names are listed in

the paragraph headed “Consents of experts” in this appendix is materially interested

in any contract or arrangement subsisting at the date of this document which is

significant in relation to the business of the Company;

(vi) none of the experts whose names are listed in the paragraph headed “Consents of

experts” in this appendix has any shareholding in the Company or the right (whether

legally enforceable or not) to subscribe for or to nominate other persons to subscribe

for securities in the Company.

VI. FURTHER INFORMATION ABOUT THE BUSINESS

1. Summary of material contracts

The following contracts (not being contracts in the ordinary course of business) have beenentered into by the Company within the two years preceding the date of this document and areor may be material:

(1) the placing and underwriting agreement between the Company and Guotai JunanSecurities (Hong Kong) Limited dated 26 April 2005 pursuant to which the GuotaiJunan Securities (Hong Kong) Limited has agreed to place the 108,000,000 H Sharesat HK$0.92 per H Share;

(2) The compliance advisor agreement dated 31 October 2005 between the Company andGuotai Junan; and

(3) The Main Board Undertakings.


— VI-17 —

3rd Sch(19)

A1A47(1)(a)(b)

A1A47(2)

A1A9(1)

3rd Sch(17)

A1A(52)

2. Intellectual property rights

(1) Trademark (and service trademark)

(A) PRC

As at the Latest Practicable Date, the following trademarks have been registered

under the name of the relevant member of the Group in the PRC:

Mark

TrademarkRegistrationNo.

RegisteredOwner Effective Period Class

(Note)

548488 The Company From 10 April 2001to 9 April 2011

7

Note: The relevant subject products are oil extraction equipment and oil drilling machines

( ); gears for drilling machines ( ); accessories for oil-drillers

( ).

Mark



(Note)

3308900 The Company From 21 July 2004

to 20 July 2014

7

Note: The relevant subject products are petroleum extraction and petroleum refining machinery

( ); slurry pumps for petroleum ( ); petroleum

extractor pump ( ).


— VI-18 —

A1A(28)(4)

(B) Hong Kong

As at the Latest Practicable Date, the following trademark has been registered in

Hong Kong:

Mark



(Note)

300170036 The Company From 3 March 2004

to 3 March 2014

7

Note: The relevant subject products are petroleum extraction and petroleum refining machinery,

slurry pumps for petroleum, petroleum extractor pump.

(2) Domain Names

As at the Latest Practicable Date, the Group has registered the following domain

names:

Domain Name Registrant Registration Date

molonggroup.com The Company 27 December 1998

molong.cn The Company 17 March 2003

Note: The contents contained in the websites at www.molonggroup.com and www.molong.cn do not form

part of this document.

VII. OTHER INFORMATION

1. Estate duty and other tax indemnity

Under the Deed of Indemnity entered into between the Promoters (other than the Alloy

Factory) in favour of the Company, each of the Promoters (other than the Alloy Factory) has

given indemnities in favour of the Company in relation to taxation and any other liabilities which

might fall upon the Company in respect of any income, profits or gains earned, accrued or

received on or before the date on which the conditions set out in the Deed of Indemnity are

fulfilled. Such indemnities will continue to be effective after the commencement of trading of

the H Shares on the Main Board.

The Directors have been advised that no material liability for estate duty is likely to fall

on the Company under PRC law.


— VI-19 —

A1A(10)

2. Litigation

As at the Latest Practicable Date, the Company or any of its subsidiaries had not engaged

in any litigation or arbitration of material importance, no litigation, arbitration or claim of

material importance was pending or threatened against the Company or any of its subsidiaries.

3. Sponsor

Guotai Junan has made an application on behalf of the Company to the Listing Committee

for the listing of, and permission to deal in, any of the H Shares in issue on the Main Board. All

necessary arrangements have been made to enable the H Shares to be admitted into CCASS.

4. Expenses

The expenses of the Company in relation to the Introduction are estimated to be

approximately HK$4 million (not including the reimbursement and miscellaneous expenses) and

are payable by the Company.

5. Promoters

The promoters of the Company are Zhang En Rong, Lin Fu Long, Zhang Yun San, Xie Xin

Cang, Liu Yun Long, Cui Huan You, Liang Yong Qiang, Kaiyuan Oil and Alloy Factory. Save as

disclosed in this document, within the two years preceding the date of this document, no cash

amount or security or other benefit has been paid, allotted or given or proposed to be paid,

allotted or given to the Promoters.

6. No material adverse change and interruption of business

There has been no adverse change in the financial position, state of affairs or future

prospects of the Company since 30 April 2006 (being the date of the most recently published

audited financial statements of the Company).

There has not been any interruption in the business of the Company which has had or may

have a material adverse effect on the financial position of the Company in the 24 months

preceding the date of this document.

7. Taxation of holders of the H Shares

Dealings in the H Shares are subject to Hong Kong stamp duty.


— VI-20 —

App1A(40)

3rd Sch(15)A1A(20)

3rd Sch(16)A1A(8)(1)

8. Qualifications of the experts

Name Qualification

Guotai Junan a licensed corporation holding license to

conduct type 6 (advising on corporate finance

activities) regulated activities under SFO

Sallmanns (Far East) Limited Professional surveyors and independent valuer

Kingfield & Partners Qualified PRC lawyers

Ernst & Young Certified public accountants

9. Consents of experts

Each of Guotai Junan, Sallmanns (Far East) Limited, Kingfield & Partners and Ernst &

Young has given and has not withdrawn its respective written consent to the issue of this

document with the inclusion of its report and/or letter and/or advice and/or valuation certificate

and/or the references to its name in the form and context in which they are respectively included

or appeared.

10. Miscellaneous

Save as disclosed in this document:

(1) within the two years preceding the date of this document, no share or loan capital of

the Company or any of its subsidiaries has been issued or agreed to be issued, as fully

or partly paid, either for cash or for a consideration other than cash;

(2) no share or loan capital of the Company or any of its subsidiaries is under any option

or is agreed conditionally or unconditionally to be put under option;

(3) within the two years preceding the date of this document, no commissions, discounts,

brokerages or other special terms (if any) have been granted in connection with the

issue or sale of any share or loan capital of the Company or any of its subsidiaries;

(4) Neither the Company nor any of its subsidiaries has issued or agreed to issue any

founders or management or deferred shares;

(5) none of the equity and debt securities of the Company is listed or dealt in any other

stock exchange nor is any listing or permission to deal being or proposed to be sought;

(6) there had been any interruption in the business of the Group which may have had a

significant effect on the financial position of the Group in the 12 months preceding the

date of this document;


— VI-21 —

S.342BA1A(9)(1)

A1A(9)(2)

A1A(8)(2)

A1A24

(7) the Company does not have any outstanding convertible debt securities;

(8) within the two years proceeding the date of this document, no commissions (except

the commissions to sub-underwriters) have been paid or payable for subscription or

agreeing to subscribe, procure subscription or agreeing to procure subscription of any

share in the Company; and

(9) none of the experts whose names appear in the paragraph headed “Consents” in this

appendix is interested in any shares in any member of the Group, nor has any right or

option (whether legally enforceable or not) to subscribe for or to nominate persons to

subscribe for any securities in any member of the Group.


— VI-22 —

3rd Sch(14)A1A(13)

Copies of the following documents will be available for inspection at the office of Coudert

Brothers in association with Orrick, Herrington & Sutcliffe LLP on the 39th Floor, Gloucester Tower,

The Landmark, Central, Hong Kong during normal business hours from 9:00 a.m. to 5:00 p.m. from

the date of this document up to and including 3 November 2006:

(a) the articles of association of the Company;

(b) the accountants’ report prepared by Ernst & Young, the text of which is set out in appendix

I of this document, and the related statement of adjustments;

(c) the audited financial statements of the Group for the three years ended 31 December 2005

prepared in accordance with PRC GAAP;

(d) the letter, summary of values and valuation certificate relating to the property interests of

the Company prepared by Sallmanns (Far East) Limited, the text of which is set out in

appendix III of this document;

(e) the PRC legal opinion issued by Kingfield & Partners, the Company’s PRC legal advisers;

(f) copies of material contracts referred to in the paragraph headed “Summary of material

contracts” in appendix VI of this document;

(g) the Company Law;

(h) the Special Regulations;

(i) the Mandatory Provisions;

(j) the interim report of the Company for the six months ended 30 June 2006;

(k) the written consents referred to paragraph VII-9 of Appendix VI of this document; and

(l) the service contracts referred to under the sub-section “Particulars of service contracts and

remuneration of Directors and Supervisors” of Appendix VI of this document.

APPENDIX VII DOCUMENTS AVAILABLE FOR INSPECTION

— VII-1 —

R19.10(6)

R19A.27(4)A1A(53)