UNITED STATES
 SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 
 FORM 20-F/A
 (AMENDMENT NO. 1)
 (Mark One)
 
  ̈
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
 OR
 
 x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 For the fiscal year ended December 31, 2010
 OR
 
  ̈
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 OR
 
  ̈
SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 Date of even requiring this shell report .........
 
 For the transition period from _____________ to ____________
 
 Commission file number000-51625
 
 CHINA LINEN TEXTILE INDUSTRY, LTD
 (Exact name of the Registrant as specified in its charter)
 
 N/A
 (Translation of Registrant’s name into English)
 
 Cayman Islands
 (Jurisdiction of incorporation or organization)
 
 Chengdong Street, Lanxi County, Heilongjiang Province
 People’s Republic of China
 Tel: +86-455-563-5885
 Fax: +86-451-8230-9971
 (Address of principal executive offices)
 
 Zhao Chunfu
 Chengdong Street, Lanxi County, Heilongjiang Province
 People’s Republic of China
 Tel: +86-451-82292393Fax: +86-451-8230-9971
 (Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)
 Securities registered or to be registered pursuant to Section 12(b) of the Act:
 
 Title of Each Class

Name of each exchange on which registeredNone

None
 
 Securities registered or to be registered pursuant to Section 12(g) of the Act.
 
 Ordinary Shares, par value $0.007 per share
 (Title of Class)
 
 Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
 
 None
 (Title of Class)
 
 Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report. 20,412,203 ordinary shares, par value $0.002 per share, as of December 31, 2010. 5,832,058 ordinary shares, par value $0.007 per share, as of March 31, 2010.
 
 Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  ̈ Yes xNo
  If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.x Yes  ̈ No
  Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.
  Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes  ̈ No
  Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ̈ Yes  ̈ No
  Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
   ̈ Large Accelerated filer                                 ̈ Accelerated filer                                x Non-accelerated filer
  Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
  U.S. GAAP x

International Financial reporting Standards as issued

Other  ̈by the International Accounting Standards Board  ̈
  If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow. ̈ Item 17  ̈ Item 18
  If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ̈ Yes x No
  (APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)
  Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. ̈ Yes  ̈ No
  
  EXPLANATORY NOTE TO 20-F/A
 
 This Amendment No. 1 (“Amendment No. 1”) amends the Annual Report on Form 20-F of China Linen Textile Industry, Ltd. (the “Company”) for the year ended December 31, 2010, originally filed with the Securities and Exchange Commission (the “SEC”) on April 5, 2011 (the “Original Filing”). The Company’s edgar agent filed the Original Filing in error and as a result, the Company is filing this Amendment No. 1 solely to correct the changes in 2010 Diluted shares outstanding due to weighted shares changes, and changes accordingly to Diluted earnings per share and Pro forma Diluted shares outstanding and Pro forma Diluted earnings per share in 2010.
 
 In connection with filing this Amendment No. 1, the Company is also filing currently dated certifications of the Company’s principal executive officer and principal financial officer pursuant to Rules 13a-14(a) and 13a-14(b) under the Securities Exchange Act of 1934, as amended. Except as described above, no other amendments are being made to the Original Filing. This Amendment No. 1 does not reflect events occurring after the filing of the Original Filing or modify or update the disclosure contained therein in any other than as required to reflect the amendments discussed above.
  
 
 Table of Contents
  PagePART I


1ITEM 1.
IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

1ITEM 2.
OFFER STATISTICS AND EXPECTED TIMETABLE

1ITEM 3.
KEY INFORMATION

1ITEM 4.
INFORMATION ON OUR COMPANY

22ITEM 4A.
UNRESOLVED STAFF COMMENTS

37ITEM 5.
OPERATING AND FINANCIAL REVIEW AND PROSPECTS OVERVIEW

37ITEM 6.
DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

46ITEM 7.
MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

51ITEM 8.
FINANCIAL INFORMATION

55ITEM 9.
THE OFFER AND LISTING

55ITEM 10.
ADDITIONAL INFORMATION

57ITEM 11.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

70ITEM 12.
DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

70PART II


71ITEM 13.
DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

71ITEM 14.
MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

71ITEM 15.
CONTROLS AND PROCEDURES

71ITEM 16.
[RESERVED]

72ITEM 16A.
AUDIT COMMITTEE FINANCIAL EXPERT

72ITEM 16B.
CODE OF ETHICS

72ITEM 16C.
PRINCIPAL ACCOUNTANT FEES AND SERVICES

73ITEM 16D.
EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

73ITEM 16E.
PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

74ITEM 16F.
CHANGES IN REGISTRANT’S CERTIFYING ACCOUNTANT

74ITEM 16G.
CORPORATE GOVERNANCE

74PART III


75ITEM 17.
FINANCIAL STATEMENTS

75ITEM 18.
FINANCIAL STATEMENTS

75ITEM 19.
EXHIBITS

75
 
 
  CERTAIN INFORMATION
 
 Unless otherwise indicated and except where the context otherwise requires, in this annual report on Form 20-F (“ Annual Report”) references to:
 
 ·
“Bright” refers to our wholly owned subsidiary Bright International Group Co., Ltd., a Republic of Vanuatu corporation;
 
 ·
“China Linen,” “we,” “us,” “our,” “our company” or “the company” refer to China Linen Textile Industry, Ltd. (together with its subsidiaries, Bright and Lanxi Sunrise);
 
 ·
“Creation” refers to Creation International Development Investments Limited, an exempted company incorporated under the laws of the Cayman Islands that holds approximately 40.51% of our ordinary shares;
 
 ·
“dollars” or “$” refer to the legal currency of the United States;
 
 ·
“Lanxi Sunrise” refers to Heilongjiang Lanxi Sunrise Linen Textile Industry Co., Ltd., a People’s Republic of China corporation of which Bright is a 95% holder and Mr. Gao Ren, our Chief Executive Officer and chairman, is a 5% holder;
 
 ·
“Lanxi Tianxianfang” refers to Heilongjiang Lanxi Tianxianfang Linen Co., Ltd., a People’s Republic of China corporation of which Lanxi Sunrise is the 100% parent and holder.
 
 ·
“ordinary shares” or “our ordinary shares” refers to the ordinary shares of the company, par value $0.007 per share;
 
 ·
“PRC” or “China” refer to the People’s Republic of China;
 
 ·
“RMB” refers to Chinese Renminbi; and
 
 ·
On March 23, 2011 the Company filed an Amended and Restated Memorandum of Association of the Company, which consolidates the share capital of the Company at a ratio of 3.5:1 by increasing the par value of the Company’s share capital from US$0.002 par value each to US$0.007 par value each, thereby reducing the number of authorized shares from US$1,000,000 divided into 500,000,000 ordinary shares of US$0.002 par value each to US$1,000,000 divided into 142,857,142.86 ordinary shares of US$0.007 par value each (the “Share Consolidation”). The market date of effectiveness of the Share Consolidation is March 30, 2011. The pro forma number of Ordinary Shares and earnings per share referred to throughout this annual report on Form 20-F assumes the Share Consolidation occurred as of the relevant report date.
 
 FORWARD-LOOKING STATEMENTS
 
 We believe that some of the information in this Annual Report constitutes forward-looking statements within the definition of the Private Securities Litigation Reform Act of 1995. You can identify these statements by forward-looking words such as “may,” “expect,” “anticipate,” “contemplate,” “believe,” “estimate,” “intends,” and “continue,” or similar words. You should read statements that contain these words carefully because they discuss future expectations, contain projections of future results of operations or financial condition or state other “forward-looking” information.
  
  We believe it is important to communicate our expectations to our security holders. However, there may be events in the future that we are not able to predict accurately or over which we have no control. The risk factors and cautionary language included in this Annual Report provide examples of risks, uncertainties and events that may cause actual results to differ materially from the expectations described by us in such forward-looking statements, including among other things:
 
 ·
changing principles of generally accepted accounting principles;
 
 ·
outcomes of government reviews, inquiries, investigations and related litigation;
 
 ·
continued compliance with government regulations;
 
 ·
legislation or regulatory environments, requirements or changes adversely affecting the textile industry in China;
 
 ·
fluctuations in customer demand;
 
 ·
management of rapid growth;
 
 ·
general economic conditions;
 
 ·
changes in government policy;
 
 ·
the fluctuations in sales of consumer and commercial textiles in China;
 
 ·
China’s overall economic conditions and local market economic conditions;
 
 ·
our business strategy and plans;
 
 ·
the results of future financing efforts; and
 
 ·
and geopolitical events.
 
 You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report.
 
 All forward-looking statements included herein attributable to us are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. Except to the extent required by applicable laws and regulations, we do not undertake any obligation to update these forward-looking statements to reflect events or circumstances after the date of this Annual Report or to reflect the occurrence of unanticipated events.
 
 This Annual Report should be read in conjunction with our audited financial statements and the accompanying notes thereto, which are included in Item 18 of this Annual Report.
  
  PART I
  Item 1.
Identity of Directors, Senior Management and Advisers
 
 Not required.
 
 Item 2.
Offer Statistics and Expected Timetable
 
 Not required.
 
 Item 3.
Key Information
 
 A.
Selected Financial Data
 
 Selected financial data for the company for the twelve-month periods ended December 31, 2010, 2009, 2008 and 2007 presented below is derived from the audited consolidated financial statements of the company. The selected financial data for the twelve-month periods ended December 31, 2006 is derived from the audited financial statements of Lanxi Sunrise.
 
 All currency referenced in this report refers to United States dollars unless otherwise indicated. Our results of operations in any period may not necessarily be indicative of the results that may be expected for any future period. See “Risk Factors” included elsewhere in this Annual Report.
 
 Fiscal Year Ended December 31,2010


2009


2008(3)


2007


2006$


$


$


$


$Revenues


49,090,643



29,386,131



22,945,122



20,782,804



14,518,393Income from Operations


11,467,008



7,076,487



3,111,181



4,455,735



3,535,282Net Income


9,565,032



5,730,519



2,856,769



3,473,191



2,713,090Total Assets


51,647,250



36,130,959



36,224,260



31,332,222



26,389,323Total Current Liabilities


10,258,210



12,394,217



18,168,708



18,695,620



18,902,671Net Current Assets


21,971,457



12,011,508



6,192,533



3,367,908



612,248Stockholders’ Equity


32,164,532



21,473,612



15,603,140



10,993,352



6,939,639Weighted Average Number of Shares Outstanding –Basic


20,251,490



20,108,333



19,511,256



18,963,005



N/A
(1)Basic Earnings Per Share


0.47
(4)


0.28
(2)


0.15
(2)


0.18
(2)


N/A
(1)Weighted Average Number of Shares Outstanding –Diluted


20,987,990



20,108,333



19,511,256



18,963,005



N/A
(1)Diluted Earnings Per Share


0.46
(4)


0.28
(2)


0.15
(2)


0.18
(2)


N/A
(1)Pro Forma Weighted Average Number of Shares Outstanding –Basic(5)


5,786,140



5,745,238



5,574,645



5,418,001



N/A
(1)Pro Forma Basic Earnings Per Share (5)


1.65



1.0



0.51



0.64



N/A
(1)Pro Forma Weighted Average Number of Shares Outstanding –Diluted(5)


5,996,569



5,745,238



5,574,645



5,418,001



N/A
(1)Pro Forma Diluted Earnings Per Share(5)


1.61



1.0



0.51



0.64



N/A
(1)
  1
  (1) The financial data for 2006 was derived from the results of operation for Lanxi Sunrise, which is a limited liability company. As a result, the information on net income per share, number of shares outstanding and diluted net income per share is not applicable.
 
 (2) The Company did not have any dilutive potential shares or issue any stock options. As a result, the diluted earnings for 2007, 2008 and 2009 is the same as the basic earnings per share.
 
 (3) The Company has restated its consolidated financial statements as of December 31, 2008 and for the year then ended, after having identified a share based compensation adjustment due to an Advisory Agreement between Lanxi Sunrise and Mid-Continental Securities Corp., dated March 30, 2007, not accounted for in the consolidated financial statements. Pursuant to that agreement, Mid-Continental Securities Corp., or its designees, was entitled to receive a total of 229,714 shares of common stock of the Company as compensation for services after the reverse merger. Such shares were transferred to Mid-Continental Securities Corp. and its designees by certain shareholders of the Company in 2008. In the restated 2008 Financial Statements, the Company has accounted for this event as a contribution of capital by its shareholders and recorded a charge to operations as a general and administrative expense in the amount of $844,200. Such shares were valued based on the closing market price of $1.05 per share on the date of transfer. For the year ended December 31, 2008, the effect of the restatements was to decrease previously reported net income of $3,700,969 to $2,856,769.
 (4) As of November 3, 2010, the Company entered into a securities purchase agreement (the “Purchase Agreement”), with certain institutional and accredited investors (the “Investors”) for the issuance and sale of an aggregate of approximately $7,045,000 of 7.5% notes (the “Notes”) that are convertible into the Company’s ordinary shares, par value $.002 per share (the “Ordinary Shares”). The after-tax interest on the Notes for the year ended December 31, 2010 was $87,926 and the weighted average number of conversion shares was 736,500. The effect of the Notes diluted the earnings per share from $0.47 to $0.46.
 (5)On March 23, 2011 the Company filed an Amended and Restated Memorandum of Association of the Company, which consolidates the share capital of the Company at a ratio of 3.5:1 by increasing the par value of the Company’s share capital from US$0.002 par value each to US$0.007 par value each, thereby reducing the number of authorized shares from US$1,000,000 divided into 500,000,000 ordinary shares of US$0.002 par value each to US$1,000,000 divided into 142,857,142.86 ordinary shares of US$0.007 par value each (the “Share Consolidation”). The market date of effectiveness of the Share Consolidation is March 30, 2011. The pro forma number of weighted average number of shares outstanding and earnings per share, assume the Share Consolidation occurred as of December 31, 2010, 2009, 2008 and 2007.
 
 Exchange Rate Information
 
 We conduct our business in China and substantially all of our revenues are denominated in Renminbi. However, periodic reports made to shareholders will be expressed in U.S. dollars using the then current exchange rates. This annual report contains translations of Renminbi amounts into U.S. dollars at specified rates solely for the convenience of the reader. Unless otherwise noted, all translations from Renminbi to U.S. dollars were made at the noon buying rate in The City of New York for cable transfers in Renminbi per U.S. dollar as certified for customs purposes by the Federal Reserve Bank of New York, as of December 31, 2010, which was RMB6.6000 to US$1.00. No representation is made that the Renminbi amounts referred to in this annual report could have been or could be converted into U.S. dollars at any particular rate or at all. On March 25, 2011, the noon buying rate was RMB6.5568 to US$1.00.
 
 The following table sets forth information concerning exchange rates between the Renminbi and the U.S. dollar for the periods indicated.
  2
  Renminbi per U.S. Dollar Noon Buying RateAverage(1)


High


Low


Period-EndYear ended December 31, 2006


7.9579



8.0702



7.8041



7.8041Year ended December 31, 2007


7.5806



7.8127



7.2946



7.2946Year ended December 31, 2008


6.9193



7.2946



6.7800



6.8225Year ended December 31, 2009


6.8295



6.8470



6.8244



6.8259Year ended December 31, 2010


6.7696



6.833



6.600



6.60002011January


6.5964



6.6364



6.5809



6.6017February


6.5761



6.5965



6.5520



6.5731March (through March 25, 2011)


6.566



6.5743



6.5510



6.55682010October


6.6678



6.6912



6.6397



6.6707November


6.6539



6.6892



6.6330



6.6670December


6.6497



6.6745



6.6000



6.6000
 
 Source Federal Reserve Bank of New York
 
 (1)
Annual averages are calculated from month-end rates. Monthly and interim period averages are calculated using the average of the daily rates during the relevant period.
 
 B.
Capitalization and Indebtedness
 
 Not required.
 
 C.
Reasons for the Offer and Use of Proceeds
 
 Not required.
 
 D.
Risk Factors
 
 Risks Relating to Our Business
 
 In order to produce our products we must be able to purchase sufficient quantities of flax. If we are unable to purchase sufficient quantities of flax, it will affect the production capacity of our products, and we may fail to satisfy the demand of our customers.
 
 We may become unable to source and purchase sufficient quantities of flax, which presents a significant risk to our business. Ordinary quality flax is widely available, and most of the flax grown in China is ordinary quality. However, we currently import the flax we require primarily from France, Belgium and the Netherlands and partially rely on our affiliate, Harbin Zhongyi Sunshine Linen Co., Ltd., which is controlled by our Chief Executive Officer and chairman, to source and import the flax we require annually on our behalf. Harbin Zhongyi Sunshine Linen Co., Ltd sources approximately 25% of the flax used by us in the fiscal year of 2010. There is no assurance that we will be able to continue to rely on contacts and business relationships established by Harbin Zhongyi Sunshine Linen Co., Ltd. to source and acquire flax on our behalf, and there is no assurance that we will continue to be able to source and purchase sufficient quantities of flax for use in our production process. In the event we are unable to acquire sufficient quantities of flax, our production process will be adversely affected and we may be unable to produce our products. In such an event, our business could be adversely affected. The availability and price of flax are subject to fluctuations due to unpredictable factors such as weather, plantings, government farm programs and policies, and market demand. Reduced supply of flax due to weather-related factors or other reasons could adversely affect our profitability by increasing the cost of raw materials used in our processing operations. Reduced supplies of flax could also limit our ability to procure, transport, store, process and merchandise our products in an efficient manner, which could adversely affect our profitability. In addition, the availability and price of flax can be affected by other factors, such as plant disease, which can result in crop failures and reduced harvests.
 
 3
 
 Our operating results will suffer if the price of raw materials increases and we cannot pass the increased cost through to our customers.
 
 The primary raw materials included in our products are flax and other supplementary materials. The prices for these raw materials are subject to market forces largely beyond our control, including weather, plantings, government farm programs and policies, and market demand. The prices for these raw materials may fluctuate significantly based upon changes in these forces. Our operating results may be harmed if we are unable to pass any raw material price increases through to our customers. If we are forced to increase prices of our products due to increases in the prices of raw materials, the demand for our products could decrease, which could harm our operations and financial results.
 
 We are subject to market and channel risks due to our dependence on third-party distributors.
 
 We sell our products through distributors. Because of this, we are dependent to a large degree upon the success of our European and PRC based distribution channels as well as the success of specific retailers in the distribution channel. We rely on these distribution channels to purchase, market, and sell our products. Our success is dependent, to a large degree, on the growth and success of these retailers and distributors, which may be outside our control. There can be no assurance that our distribution channels will be able to grow or prosper as they face price and service pressure from other channels. There can be no assurance that retailers in our distribution channel, in the aggregate, will respond or continue to respond to our marketing commitment in these channels.
 
 In order to grow at the pace expected by management, we will require additional capital to support our long-term business plan. If we are unable to obtain additional capital in future years, we may be unable to proceed with our long-term business plan and we may be forced to limit or curtail our future operations.
 
 We will require additional working capital to support our long-term business plan, which includes expanding our current production capacity, establishing a yarn-dyed fabric factory and identifying suitable targets for horizontal or vertical mergers or acquisitions. Our working capital requirements and the cash flow provided by future operating activities, if any, is expected to vary greatly from quarter to quarter, depending on the volume of business during the period and payment terms with our customers. We may not be able to obtain adequate levels of additional financing, whether through equity financing, debt financing or other sources. Additional financings could result in significant dilution to our existing shareholders or the issuance of securities with superior rights to our current outstanding securities. In addition, we may grant registration rights to investors purchasing future equity or debt securities, which will increase the number of shares that are eligible for sale. In addition, a lack of additional financing could force us to substantially slow down our operations if our cash flows are insufficient at that time to maintain our operations.
 
 Our failure to comply with the covenants contained in our bank loans, including as a result of events beyond our control, could result in an event of default that could cause repayment of the debt to be accelerated.
 
 As of December 31, 2007 and during the first quarter of 2008, as a result of a delay in required payments on certain outstanding bank loans with Agricultural Bank of China, the bank charged higher interest rates than set forth in the original loan agreements on an aggregate outstanding loan amount of $5,754,890. For the year ended December 31, 2007, interest expense arising from these bank loans was $817,596, including the additional interest expense of $357,178 incurred from the higher interest rates. For the year ended December 31, 2008, we incurred an additional $102,808 of interest expense due to the event of default with respect to the bank loans outstanding as of December 31, 2007. In the future, if we are not able to comply with the covenants and other requirements contained in our loan agreements or other debt instruments, another event of default under the relevant loan agreement could occur. If an event of default were to occur again, it could trigger additional excess interest payments, a default under our other debt instruments and we could be prohibited from accessing additional financing. In addition, we may not be able to obtain additional financing to refinance or restructure the payments on the applicable debt. Even if we were able to secure additional financing, it may not be available on favorable terms.
  4
  Our future success depends in part on attracting and retaining key senior management and qualified technical and sales personnel. We also face certain risks with respect to changes in our management team.
 
 Our future success depends in part on the contributions of our management team and key technical and sales personnel and our ability to attract and retain qualified new personnel. In particular, our success depends on the continuing employment of our management team led by our Chief Executive Officer and chairman. There is significant competition in our industry for qualified managerial, technical and sales personnel and we cannot assure you that we will be able to retain our key senior managerial, technical and sales personnel or that we will be able to attract, integrate and retain other such personnel that we may require in the future. We also cannot assure you that our employees will not leave and subsequently compete against us. If we are unable to attract and retain key personnel in the future, our business, financial condition and results of operations could be adversely affected.
 
 Our growth strategy includes making acquisitions in the future, which could subject us to significant risks, any of which could harm our business.
 
 Our growth strategy includes identifying and acquiring, or investing in, suitable acquisition candidates on acceptable terms. Over time, we may acquire or make investments in other companies with products that complement our business and other companies in the linen textile industry.
 
 Acquisitions involve a number of risks and present financial, managerial and operational challenges, including:
 
 ·
diversion of management’s attention from running our existing business;
 
 ·
potential difficulty in successfully implementing, upgrading and deploying in a timely and effective manner new operational information systems and upgrades of our internal controls and disclosure procedures and financing, accounting and product distribution systems;
 
 ·
increased expenses, including travel, legal, administrative and compensation expenses resulting from newly hired employees;
 
 ·
increased costs to integrate personnel, customer base and business practices of the acquired company with our own;
 
 ·
adverse effects on our reported operating results due to possible write-down of goodwill associated with acquisitions;
 
 ·
potential disputes with sellers of acquired businesses, technologies, services or products; and
 
 ·
dilution to shareholders if we issue securities in any acquisition.
 
 Moreover, performance problems with an acquired business’ technology, products or services could also have a material adverse impact on our reputation as a whole. In addition, any acquired business, technology, product or service could significantly under-perform relative to our expectations, and we may not achieve the benefits we expect from our acquisitions. For all these reasons, our pursuit of an acquisition and investment strategy or any individual acquisition or investment, could have a material adverse effect on our business, financial condition and results of operations.
 
 We expect a significant part of our sales revenues will be derived from our five largest customers in 2011 and any reduction in revenues from any of these customers would reduce our revenues and net income.
 
 In fiscal year 2010, we derived 47% of our revenue from our five largest customers. In fiscal year 2009, we derived 94.5% of our revenue from our five largest customers and in fiscal year 2008, we derived 95.8% of our revenue from our five largest customers. Harbin Zhongyi Sunshine Linen Co., Ltd., which is controlled by our Chief Executive Officer and Chairman, was among our five biggest customers in each of 2008 and 2009 but not for 2010. Harbin Zhongyi Sunshine Line Co., Ltd. is an agent of Lanxi Sunrise, through which our sales to some customers are conducted. While we have somewhat successfully worked towards diversifying our customer base to put less reliance on any one customer, the loss of one of our major customers could still decrease our revenues and net income significantly.
  5
 
 We are subject to credit risk given that approximately 47% of our sales revenues is derived from our five largest customers in 2010 and any failure to collect, or untimely collection of the trade receivables could affect our liquidity.
 
 In fiscal year 2010, we derived approximately 47% of our revenue from our five largest customers. Although we have insurance to protect us against the non-payment of amounts due by our customers, some of our customers pay in installments, with a portion of the payment upfront and a portion of the payment upon receipt of our products by our customers. We perform ongoing credit evaluations of our customers’ financial condition and generally have no difficulties in collecting our payments. If we encounter future problems collecting amounts due from our clients or if we experience delays in the collection of amounts due from our clients, our liquidity could be negatively affected.
 
 We may not be able to manage our expected growth and enlarged business.
 
 Our growth strategy may not be successful for the following reasons:
 
 ·
Our ability to obtain additional capital for growth is subject to a variety of uncertainties, including our operating results, our financial condition, general market conditions for capital raising activities, and economic conditions in China.
 
 ·
Our profitability will be adversely affected by the additional costs and expenses associated with the operation of new facilities, increased marketing and sales support activities, technological improvement projects, the recruitment of new employees, the upgrading of our management, operational and financial systems, procedures and controls, and the training and management of our growing employee base.
 
 ·
Failure to manage our growth and enlarged business effectively could have a material adverse effect on our business, financial condition and results of operations.
 
 We do not know whether our revenues will grow at all or grow rapidly enough to absorb the capital and expenses necessary for our growth. Failure to manage our growth and enlarged business effectively could have a material adverse effect on our business, financial condition and results of operations.
 
 Our limited operating history does not serve as an adequate basis to predict our future prospects and results of operations.
 
 We have a limited operating history. From June 2002 until June 2007, Lanxi Sunrise operated as a state-owned holding company under the Company Law of the PRC. In June 2007, Lanxi Sunrise converted from a state-owned holding company into a privately owned business enterprise. However, we consummated our reverse acquisition with Bright in which Bright became our wholly owned subsidiary and Lanxi Sunrise became our 95% owned subsidiary in April 2008. We acquired Lanxi Tianxianfang in November 2010. As such, we have a limited operating history upon which the viability and sustainability of our business may be evaluated. We cannot assure you that we will not incur losses in the foreseeable future. Our future prospects should be considered in light of the risks and uncertainties we may face in managing a relatively new business in China. Please see “Risk Factors – Risks Relating to Operations in China.”
 
 If we are unsuccessful in addressing any of these risks and uncertainties, our business, financial condition and results of operations would suffer. In particular, as most of our expenses are fixed in the near future or incurred in advance of anticipated revenues, we may not be able to modify our business plan in time to address any shortfall in revenues and profits.
  6
  Our internal controls over financial reporting and our disclosure controls and procedures have been ineffective, and as a result we may be unable to accurately report our financial results, report our financial results in a timely manner or prevent fraud, and investor confidence and the market price of our ordinary shares may be adversely affected.
 
 Our reporting obligations as a public company place a significant strain on our management, operational and financial resources and systems. Based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, our management has concluded that, as of December 31, 2009, we had a material weakness in our internal controls over financial reporting relating to a failure of certain departments of the Company to communicate promptly and effectively with our management. We have made some improvements so far. We are a relatively young company with limited accounting personnel and other resources with which to address our internal controls and procedures. In addition, we must implement financial and disclosure control procedures and corporate governance practices that enable us to comply, on a stand-alone basis, with the Sarbanes-Oxley Act of 2002 and related Securities and Exchange Commission, or the SEC, rules. For example, we will need to further develop accounting and financial capabilities, including the establishment of an audit committee and development of documentation related to internal control policies and procedures. While we have taken action, which we believe are adequate to remediate the material weaknesses in our internal controls, we may still be unable to accurately report our financial results or prevent fraud and investor confidence and the market price of our ordinary shares may be adversely impacted.
 
 We are in the process of instituting changes to our internal controls and management systems to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002. We will also engage external Sarbanes-Oxley consultants or recruit experienced professionals to advise us on Sarbanes-Oxley compliance issues. Section 404 requires us to perform an evaluation of our internal controls over financial reporting and file annual management assessments of their effectiveness with the Securities and Exchange Commission. The management assessment to be filed is required to include a certification of our internal controls by our chief executive officer and chief financial officer. In addition to satisfying requirements of Section 404, we may also make improvements to our management information system to computerize certain manual controls, establish a comprehensive procedures manual for U.S. GAAP financial reporting, and increase the headcount in the accounting and internal audit functions with professional qualifications and experience in accounting, financial reporting and auditing under U.S. GAAP.
 
 In the future, our auditors will be required to attest to our evaluation of internal controls over financial reporting. Unless we successfully design and implement changes to our internal controls and management systems, or if we fail to maintain the adequacy of these controls as such standards are modified or amended from time to time, we may not be able to comply with Section 404 of the Sarbanes-Oxley Act of 2002. As a result, our auditors may be unable to attest to the effectiveness of our internal controls over financial reporting. This could subject us to regulatory scrutiny and result in a loss of public confidence in our management, which could, among other things, adversely affect the price of our ordinary shares and our ability to raise additional capital.
 
 We plan to purchase flax according to an annual plan, which may not be possible if we are unable to accumulate funds or obtain financing to make purchases at that time.
 
 We import flax primarily from France, Belgium and the Netherlands. Although there is typically a sufficient supply of raw material, we cannot predict when our operations may not generate sufficient cash flows to fund our purchasing requirements. In such case, we will be required to finance our cash needs through public or private equity offerings, bank loans or other debt financing, or otherwise. There can be no assurance that international or domestic financing will be available on terms favorable to us or at all, which could force us to delay, reduce or abandon our purchases, increase our financing costs, or both.
 
 The transfer of state-owned equities in China is subject to approval by certain governmental authorities. Any failure by us to comply with PRC laws and regulations in respect of the transfer of state-owned equities may result in the imposition of fines or other penalties.
 
 Lanxi Sunrise was established as a state-owned holding company in June 2002 and changed into a privately owned business enterprise in June 2007, when Mr. Gao, our Chief Executive Officer and chairman, purchased all of the state-owned equities of Lanxi Sunrise. Under PRC law, the transfer of state-owned equities is subject to certain procedures and approvals. There was no approval regarding the transferring of the stated-owned equities; however, the State-Owned Assets and Administration Commission of Lanxi County subsequently issued a Confirmation Letter stating that it recognized the transfer of such state-owned assets to Mr. Gao. Although this letter was issued, we cannot exclude the possibility that higher levels of the PRC government may revoke the letter which may result in the imposition of fines or other penalties.
  7
 
 We may not possess all of the approvals, permits and licenses required to operate our business, or we may fail to maintain the approvals, permits and licenses we currently hold. This could subject us to fines and other penalties, which may have a material adverse effect on our business, financial condition and results of operations.
 
 We are required to hold a variety of approvals, permits and licenses to operate our business in China. We may not possess all of the approvals, permits and licenses required for all of our business activities. In addition, there may be circumstances under which an approval, permit or license granted by a governmental agency is subject to change without substantial advance notice, and it is possible that we could fail to obtain an approval, permit or license that is required to expand our business as we intend. If we fail to obtain or to maintain such permits or licenses or renewals are granted with onerous conditions, we could be subject to fines and other penalties and be limited in the number or the quality of the products that we would be able to offer. As a result, our business, financial condition and results of operations could be materially and adversely affected.
 
 Our Articles of Association include certain provisions that may discourage a change of control.
 
 Certain provisions of our memorandum and articles of association may have an anti-takeover effect and may delay, defer or prevent a tender offer or takeover attempt that a shareholder might consider to be in its best interests, including those attempts that might result in a premium over the market price being paid for the shares held by shareholders.
 
 Certain of these provisions provide for:
 
 ·
requiring a special resolution, namely the affirmative vote of not less than sixty-six and two-thirds percent (66 2/3%) of such shareholders as being entitled to vote at a general meeting of the company in person or by proxy or a written resolution signed by all shareholders entitled to vote, generally to remove a director; and
 
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appointing additional directors to the board by resolution of the existing directors (provided that such additional directors shall not exceed 1/3 in number of the directors elected at the last annual general meeting) or by an ordinary resolution, namely the affirmative vote of a majority of the shareholders entitled to vote at a duly convened meeting in person or by proxy.
 
 These anti-takeover provisions could make it more difficult for a third party to acquire us, even if the third-party’s offer may be considered beneficial by many shareholders. As a result, shareholders may be limited in their ability to obtain a premium for their shares.
 
 The effects of the global financial crisis are far-reaching and difficult to predict.
 
 During the second half of 2008, the international capital markets experienced severe volatility and exhibited overall significant declines in prices of equity securities, which events taken in combination with a freezing of international credit markets and lack of availability of private capital led to a near shutdown of private flows of capital. In addition, the fraud perpetrated by Bernard Madoff exacerbated a lack of confidence in global financial institutions and their oversight.
 
 Government responses to these events have included partial nationalization of certain industries and enterprises, “bail-out” packages intended to provide liquidity to market participants and several high profile acquisitions and bankruptcies. While global economies have begun to show signs of stabilizing and, in some instances, the beginnings of recovery, it is difficult to predict the effect that the global financial crisis may have on our business, our expansion plans and our ability to raise capital required to implement our expansion plans.
  8
  We do not presently maintain business disruption insurance. Any disruption in the operations of our production facility would damage our business and disrupt our production and have a material adverse effect on our business, financial position on results of operations.
 
 Our business could be materially and adversely affected by power shortages, natural disasters, terrorist attacks or other events in the PRC. For example, in early 2008, parts of the PRC suffered a wave of strong snow storms that severely impacted public transportation systems and the power supply in those areas. In May 2008, Sichuan Province in the PRC suffered a strong earthquake measuring approximately 8.0 on the Richter scale that caused widespread damage and casualties. The May 2008 Sichuan earthquake may have a material adverse effect on the general economic conditions in the areas affected by the earthquake. In July 2008, explosive devices were detonated on several buses in Kunming, Yunnan Province of the PRC, which resulted in disruptions to public transportation systems in Kunming and casualties. Any future natural disasters, terrorist attacks or other events in the PRC could cause a reduction in usage of, or other severe disruptions to, public transportation systems and could have a material adverse effect on our business and results of operations.
 
 While we have property damage insurance and automobile insurance, we do not carry business disruption insurance, which is not readily available in the PRC. Any disruption of the operations in our production facility would have a significant negative impact on our ability to manufacture and deliver products, which would cause a potential diminution in sales, the cancellation of orders, damage to our reputation and potential lawsuits.
 
 Risks Relating to Our Industry
 
 The linen textile industry is competitive and includes many competitors which are larger, have more resources and more technological capability than us. There is no assurance that we will be able to effectively compete with our competitors or that we will be able to maintain or increase our market share.
 
 The global market for linen production is growing rapidly and includes many competitors both in China and in other parts of the world. We have many large competitors in China which only make yarn and do not also produce cloth. We also have many competitors in China and in other parts of the world that produce cloth. In addition, although the market for sale of linen products is expected to grow rapidly in China, consumers for linen textile products are currently mainly in foreign markets outside of China. Therefore, in order to compete effectively we must establish and maintain connections with buyers in foreign markets. There is no assurance that we will be able to continue to compete in this market and to maintain or increase our market share.
 
 Risks Relating to Operations in China
 
 Changes in political, economic and legal developments in China may adversely affect our business.
 
 As we derive substantially all of our revenues in China and substantially all of our assets and operations are in China, our continued growth would depend heavily on China’s general economic condition. The Chinese economy has grown significantly in recent years, especially after China’s accession to the World Trade Organization in 2001. We, however, cannot assure you that the Chinese economy will continue to grow, or that such growth will be steady or in geographic regions or economic sectors that will benefit us. A downturn in China’s economic growth or a decline in economic condition may have material adverse effects on our results of operations.
 
 Further, we will continue to be affected by the political, social and legal developments of China. Since the late 1970s, the PRC government has introduced a series of economic and political reforms, including measures designed to effectuate the country’s transitioning from a planned economy to a more market-oriented economy. During such economic and political reforms, a comprehensive system of laws were promulgated, including many new laws and regulations seeking to provide general guidance on economic and business practices in China and to regulate foreign investment. Although the Chinese economy has been transitioning from a planned economy to a more market-oriented economy, a substantial portion of the productive assets in China is still owned by the PRC government. The continued control of these assets and other aspects of the national economy by the Chinese government could materially and adversely affect our business.
  9
  In the past twenty years, the growth of the Chinese economy has been uneven across different geographic regions and different economic sectors. In order to stabilize national economic growth, the PRC government adopted a series of macroeconomic policies. These policies include measures that restricted excessive growth and investment in specific sectors of the economy. More recently, on the other hand, the PRC government has implemented stimulus responses to the global financial crisis. We cannot predict the future direction of economic reforms or the effects that any such measures may have on our business, financial condition or results of operations.
 
 The Chinese government exerts substantial influence over the manner in which we must conduct our business activities.
 
 China only recently has permitted provincial and local economic autonomy and private economic activities. The Chinese government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property and other matters. We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of these jurisdictions may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations.
 
 Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof, and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures.
 
 Most of our revenues are denominated in Renminbi, which is not freely convertible for capital account transactions and may be subject to exchange rate volatility.
 
 We are exposed to the risks associated with foreign exchange controls and restrictions in China, as our revenues are primarily denominated in Renminbi, which is currently not freely exchangeable. The PRC government imposes control over the convertibility between Renminbi and foreign currencies. Under the PRC foreign exchange regulations, payments for “current account” transactions, including remittance of foreign currencies for payment of dividends, profit distributions, interest and operation-related expenditures, may be made without prior approval but are subject to procedural requirements. Strict foreign exchange control continues to apply to “capital account” transactions, such as direct foreign investment and foreign currency loans. These capital account transactions must be approved by or registered with the PRC State Administration of Foreign Exchange, or “SAFE.” Further, any capital contribution by an offshore shareholder to its PRC subsidiaries should be approved by the Ministry of Commerce, “MOFCOM,” in China or its local counterparts. We cannot assure you that we are able to meet all of our foreign currency obligations to remit profits out of China or to fund operations in China.
 
 On August 29, 2008, SAFE promulgated the Circular on the Relevant Operating Issues concerning the Improvement of the Administration of Payment and Settlement of Foreign Currency Capital of Foreign-invested Enterprises, or “Circular 142”, to regulate the conversion by foreign invested enterprises, or FIEs, of foreign currency into Renminbi by restricting how the converted Renminbi may be used. Circular 142 requires that Renminbi converted from the foreign currency-dominated capital of a FIE may only be used for purposes within the business scope approved by the applicable government authority and may not be used for equity investments within the PRC unless specifically provided for otherwise. In addition, SAFE strengthened its oversight over the flow and use of Renminbi funds converted from the foreign currency-dominated capital of a FIE. The use of such Renminbi may not be changed without approval from SAFE, and may not be used to repay Renminbi loans if the proceeds of such loans have not yet been used.
  10
  We rely principally on dividends and other distributions on equity paid by our PRC Subsidiary, and limitations on its ability to pay dividends to us could have a material adverse effect on our business and results of operations.
 
 As an entity established in the PRC, our PRC subsidiary is subject to certain limitations with respect to dividend payments. PRC regulations currently permit payment of dividends only out of accumulated profits as determined in accordance with accounting standards and regulations in the PRC. Pursuant to the Sino-Foreign Equity Joint Venture Law (1979), as amended, and Regulations of the Implementation of the Sino-Foreign Equity Joint Venture Law (1983), as amended, a Foreign Invested Enterprise (“FIE”) in the PRC may pay dividends only out of the FIE’s profits, if any, after the payment of its enterprise income tax and contributions to its reserve fund, employee bonus and welfare fund and enterprise development fund at percentages that are decided by its board of directors; and such net profits shall be distributed in proportion to the contributions to the registered capital of the parties to the venture. Our PRC subsidiary as a Sino-foreign joint venture enterprise may not distribute its after-tax profits to us if it has not already made contributions to its reserve fund, enterprise development fund and employee bonus and welfare fund at percentages that are decided by its board of directors. The total amount of our restricted net assets was RMB48.3 million ($7.1 million) as of December 31, 2009. Based on the foregoing, we have been advised by our accountants that we are only permitted to pay RMB 116.8 million ($15.9 million) in dividends as we are required to set aside RMB 3.9 million ($0.6 million), being 10% of our after-tax profits net of contributions to our PRC subsidiary’s reserve fund, enterprise development fund and employee bonus and welfare fund. Under the relevant PRC foreign exchange regulations, conversion of the Renminbi is permitted, without the approval from the PRC State Administration of Foreign Exchange, or “SAFE”, for “current account” transactions, which include dividends, trade, and service-related foreign exchange transactions. However, pursuant to Regulations on Exchange Control of the People’s Republic of China (2008) and Administrative Regulations Regarding Settlement, Sale and Payment of Foreign Exchange (1996), as amended, the registered capital contribution of an FIE must be fully paid before any profit or dividend of the FIE is remitted abroad; where the registered capital contribution of an FIE is not been fully paid due to special circumstances, profits or dividends of the FIE can be remitted abroad only if approvals from competent authorities have been obtained; furthermore, an FIE may only remit profits or dividends abroad at authorized banks and must comply with certain procedural requirements, such as providing the Foreign Invested Enterprise Foreign Exchange Registration Certificate, the resolution of the board of directors for the distribution of profits, the capital verification report issued by certified public accountants, the audit report and the tax payment documentation, etc. There is no guarantee that PRC regulatory authorities will not impose additional restrictions on the convertibility of the Renminbi. These restrictions could prevent our PRC subsidiary from distributing dividends. In addition, if our PRC subsidiary in the PRC incurs further debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other distributions to us. Limitations on the ability of our PRC Subsidiary to pay dividends to us could adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our businesses, pay dividends, or otherwise fund and conduct our business. Accordingly, if for any of the above or other reasons, we do not receive dividends from our PRC subsidiary, our liquidity, financial condition and ability to make dividend distributions to our shareholders will be materially and adversely affected.
 
 Fluctuation in the value of the Renminbi and of the U.S. dollar may have a material adverse effect on investments in our ordinary shares.
 
 Any significant revaluation of the Renminbi may have a material adverse effect on the U.S. dollar equivalent amount of our revenues and financial condition as well as on the value of, and any dividends payable on, our ordinary shares in foreign currency terms. For instance, a decrease in the value of Renminbi against the U.S. dollar could reduce the U.S. dollar equivalent amounts of our financial results, the value of your investment in our ordinary shares and the dividends we may pay in the future, if any, all of which may have a material adverse effect on the prices of our ordinary shares. As of December 31, 2010, we had cash denominated in U.S. dollars of approximately $68,415. Any further appreciation of Renminbi against U.S. dollars may result in significant exchange losses.
 
 Prior to 1994, Renminbi experienced a significant net devaluation against most major currencies, and there was significant volatility in the exchange rate during certain periods. Upon the execution of the unitary managed floating rate system in 1994, the Renminbi was devalued by 50% against the U.S. dollar. Since 1994, the Renminbi to U.S. dollar exchange rate has largely stabilized. On July 21, 2005, the People’s Bank of China announced that the exchange rate of U.S. dollar to Renminbi would be adjusted from $1 to RMB8.27 to $1 to RMB8.11, and it ceased to peg the Renminbi to the U.S. dollar. Instead, the Renminbi would be pegged to a basket of currencies, whose components would be adjusted based on changes in market supply and demand under a set of systematic principles. On September 23, 2005, the PRC government widened the daily trading band for Renminbi against non-U.S. dollar currencies from 1.5% to 3.0% to improve the flexibility of the new foreign exchange system. Since the adoption of these measures, the value of Renminbi against the U.S. dollar has fluctuated on a daily basis within narrow ranges, but overall has further strengthened against the U.S. dollar. There remains significant international pressure on the PRC government to further liberalize its currency policy, which could result in a further and more significant appreciation in the value of the Renminbi against the U.S. dollar. The Renminbi may be revalued further against the U.S. dollar or other currencies, or may be permitted to enter into a full or limited free float, which may result in an appreciation or depreciation in the value of the Renminbi against the U.S. dollar or other currencies.
  11
 
 Adverse changes in PRC economic and political policies could have a material adverse effect on the overall economic growth of China and that could increase inflation, which may reduce the demand for our products and materially and adversely affect our business.
 
 Our PRC subsidiary is based in China. As such, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. China’s economy differs from the economies of most developed countries in many aspects, including:
 
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the level of government involvement;
 
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the level of development;
 
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the growth rate;
 
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the level and control of capital investment; and
 
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the control of foreign exchange.
 
 While the Chinese economy has grown significantly in the past two decades, the growth has been uneven geographically, among various sectors of the economy and during different periods. We cannot assure you that the Chinese economy will continue to grow or to do so at the pace that has prevailed in recent years, or that if there is growth, such growth will be steady and uniform. In addition, if there is a slowdown, such slowdown could have a negative effect on our business. For example, the Chinese economy experienced high inflation in the second half of 2007 and the first half of 2008. China’s consumer price index increased by 7.0% during the nine months ended September 30, 2008 as compared to the same period in 2007. To combat inflation and prevent the economy from overheating, the PRC government adopted a number of tightening macroeconomic measures and monetary policies. Due in part to the impact of the global crisis in financial services and credit markets and other factors, the growth rate of China’s gross domestic product as measured against the same period of the previous year decreased to 7.1% in the first half of 2009, down from 10.4% in the first half of 2008. Beginning in September 2008, among other measures, the PRC government began to loosen macroeconomic measures and monetary policies, including reducing interest rates and decreasing the statutory reserve rates for banks. In addition, in November 2008 the PRC government announced an economic stimulus package in the amount of $586 billion. It is uncertain whether the various macroeconomic measures, monetary policies and economic stimulus packages adopted by the PRC government will be effective in restoring or sustaining the fast growth rate of the Chinese economy. In addition, such measures, even if they benefit the overall Chinese economy in the long term, may have a negative effect on us. For example, our financial condition and results of operations may be materially and adversely affected by government control over capital investments.
 
 China’s legal system is different from those in most other countries.
 
 China is a civil law jurisdiction. Under the civil law system, prior court decisions may be cited as persuasive authority but do not have binding precedential effect. Although progress has been made in the promulgation of laws and regulations dealing with economic matters, such as corporate organization and governance, foreign investment, commerce, taxation and trade, China’s legal system remains less developed than the legal systems in many other countries. Furthermore, because many laws, regulations and legal requirements have been recently adopted, their interpretation and enforcement by the courts and administrative agencies may involve uncertainties. Sometimes, different government departments may have different interpretations. Licenses and permits issued or granted by one government authority may be revoked by a higher government authority at a later time. Government authorities may decline to take action against unlicensed operators which may work to the disadvantage of licensed operators, including us. The PRC legal system is based in part on government policies and internal rules (some of which may not be published on a timely manner or at all) that may have a retroactive effect. We may even not be aware of our violation of these policies and rules until some time after the violation. Changes in China’s legal and regulatory framework, the promulgation of new laws and possible conflicts between national and provincial regulations could adversely affect our financial condition and results of operations. In addition, any litigation in China may result in substantial costs and diversion of resources and management attention.
  12
 
 Because our funds are held in banks in the PRC that do not provide insurance, the failure of any bank in which we deposit our funds could affect our ability to continue in business.
 
 Banks and other financial institutions in the PRC do not provide insurance for funds held on deposit. A significant portion of our assets are in the form of cash deposited with banks in the PRC, and in the event of a bank failure, we may not have access to our funds on deposit. Depending upon the amount of money we maintain in a bank that fails, our inability to have access to our cash could impair our operations, and, if we are not able to access funds to pay our suppliers, employees and other creditors, we may be unable to continue in business.
 
 PRC regulations relating to the establishment of offshore companies by PRC residents may subject our PRC resident shareholders to personal liability and limit our ability to inject capital into the PRC subsidiary, limiting our subsidiary’s ability to distribute profits to us or otherwise adversely affect us.
 
 SAFE issued the Notice on Issues Relating to the Administration of Foreign Exchange in Fund-raising and Reverse Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies, or “Notice 75,” on October 21, 2005, which became effective as of November 1, 2005 and the operating procedures in May 2007, collectively the SAFE Rules. According to the SAFE Rules, prior registration with the local SAFE branch is required for PRC residents to establish or to control an offshore company for the purposes of financing that offshore company with assets or equity interests in an onshore enterprise located in the PRC. An amendment to registration or filing with the local SAFE branch by such PRC resident is also required for the injection of equity interests or assets of an onshore enterprise in the offshore company or overseas funds raised by such offshore company, or any other material change involving a change in the capital of the offshore company. Moreover, the SAFE Rules have retroactive effect. As a result, PRC residents who had established or acquired control of offshore companies that had made onshore investments in the PRC before promulgation of the SAFE Rules were required to complete the relevant registration procedures with the local SAFE branch by March 31, 2006. The SAFE rules define “PRC residents” to include both legal persons and natural persons who either hold legal PRC identification documents, or who habitually reside in China due to economic interests or needs. If any PRC resident fails to file its SAFE registration for an existing offshore enterprise, any dividends remitted by the onshore enterprise to its overseas parent after October 21, 2005 will be considered to be an evasion of foreign exchange purchase rules, and the payment of the dividend will be illegal. As a result, both the onshore enterprise and its actual controlling persons can be fined. In addition, failure to comply with the registration procedures may result in restrictions on the relevant onshore enterprise, including prohibitions on the payment of dividends and other distributions to its offshore parent or affiliate and capital inflow from the offshore enterprise. The PRC resident shareholders of the offshore enterprise may also be subject to penalties under Chinese foreign exchange administration regulations.
 
 To date, we have not received any communications from, or had contact with, the PRC government with respect to SAFE Rules. Neither do we have information regarding whether our shareholders who may be subject to SAFE Rules have made necessary applications, filings and amendments as required under SAFE Rules. However, we have requested our shareholders and beneficial owners who may be subject to SAFE Rules to make the necessary applications, filings and amendments as required under SAFE Rules. We have advised these shareholders and beneficial owners to comply with the relevant requirements. However, we cannot provide any assurance that all of our shareholders and beneficial owners who may be PRC residents will comply with our request to make or obtain any applicable registrations or comply with other requirements required by SAFE Rules. The failure or inability of our PRC resident shareholders or beneficial owners to make any required registrations or comply with other requirements may subject such shareholders or beneficial owners to fines and legal sanctions and may also limit our ability to contribute additional capital into or provide loans to our PRC subsidiaries, limit the ability of our PRC subsidiaries to pay dividends or otherwise distribute profits to us, or otherwise adversely affect us.
  13
 
 In January 2007, SAFE promulgated the Detailed Rules for the Implementation of the Measures for the Administration of Individual Foreign Exchange, and the Operating Rules on the Foreign Exchange Administration of the Evolvement of Domestic Individuals in the Employee Stock Ownership Plans and Share Option Schemes of Overseas Listed Companies, or “Circular 78.” Under Circular 78, where PRC domestic individuals are involved in the employee stock ownership plans or share option schemes of overseas listed companies, such plans or schemes must be submitted to competent foreign exchange administration authorities for approval, and the PRC employees shall entrust its agent or the affiliates or branches of the overseas listed company to apply to competent authorities for purchasing certain amount of foreign exchange at certain times each year, in order to purchase the stock or exercise its option right under the employee stock ownership plans or the share option schemes within the amounts approved by the authorities. In addition, the PRC employees involved must declare the progress of such plans or schemes to the administration authorities periodically. All the proceeds obtained by such employees from the overseas listed company through the employee stock ownership plans or the share option schemes, or from sale of the shares of such overseas listed company, after deducting relevant fees and costs incurred overseas, shall be remitted to the domestic account of the employees in full amount. As of the date of this annual report on Form 20-F, no employee share option has been granted and is outstanding under the current share option scheme. All the options for the shares of our Company to be granted to and all the stock ownership plans to be made for our PRC employees in the future, including exercise of the option rights and performance of such plans, would be subject to Circular 78 since we become an overseas listed company. If we or our PRC employees fail to comply with the provisions of Circular 78, we and/or our PRC employees may be subject to fines and legal sanctions imposed by the SAFE or other PRC government authorities. If our PRC employees fail to obtain the approval from or make relevant registrations with SAFE or its local branches, it will prevent us from conducting the share option schemes or the stock ownership plans for our PRC employees. In addition, it may impose cost on us for obtaining the approval from SAFE or its local branches in connection with the foreign exchange registration.
 
 In addition, the PRC employees involved in the Incentive Plan must be subject to approval by the competent foreign exchange administration authorities and make the registrations as required under Circular 78. We cannot assure you that the administration authorities would approve the Incentive Plan, or permit such PRC employees to go through the registration procedures. If this occurs, the management, operations and financial conditions of the listed company may be adversely affected.
 
 The discontinuation of any preferential tax treatment currently available to us and the increase in the enterprise income tax in the PRC could in each case result in a decrease in our profits and materially and adversely affect our results of operations.
 
 According to Lan Zheng Fa (2006) No. 14 issued by Lanxi County People’s Government on August 20, 2006, Lanxi Sunrise enjoyed a loan interest discount of approximately $125,800 over a five-year period until December 31, 2010, and Lanxi Sunrise was awarded a subsidy equivalent to the income taxes payable by the company to the PRC State Administration of Taxation and local administration of taxation for three years until December 31, 2008. Upon expiration of the three-year period, Lanxi Sunrise enjoyed a subsidy equivalent to the income taxes payable by the company to the local administration of taxation for two years until December 31, 2010. Lanxi Tianxianfang enjoys no preferential tax treatment. The discontinuation of such preferential tax treatment may result in a decrease in our profits for 2011. Our corporate tax rate is presently 25%.
 
 Under the EIT Law, we and/or Bright may be classified as a “resident enterprise” of the PRC. Such classification could result in PRC tax consequences to us and our non-PRC shareholders and/or Bright.
 
 Under the Enterprise Income Tax Law of the PRC (“EIT Law”), which became effective on January 1, 2008, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes, although the dividends paid to one resident enterprise from another may qualify as “tax-exempt income.” The implementing rules of the EIT Law define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise. The EIT Law and its implementing rules are relatively new and ambiguous in terms of some definitions, requirements and detailed procedures, and currently no official interpretation or application of this new “resident enterprise” classification is available; therefore, it is unclear how tax authorities will determine tax residency based on the facts of each case.
  14
 
 If the PRC tax authorities determine that we and/or Bright is a “resident enterprise” for PRC enterprise income tax purposes, a number of PRC tax consequences could follow. First, we and/or Bright may be subject to enterprise income tax at a rate of 25% on our worldwide taxable income, as well as PRC enterprise income tax reporting obligations. Second, although under the EIT Law and its implementing rules, dividends paid to us from our PRC Subsidiary through Bright (assuming we and Bright are treated as resident enterprises under the EIT Law) may qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to PRC withholding tax. Finally, if we are determined to be a resident enterprise under the EIT Law, it could result in a situation in which a 10% PRC tax is imposed on dividends we pay to our non-PRC shareholders and gains derived by our non-PRC shareholders from transferring our shares, if such income is considered PRC-sourced income by the relevant PRC authorities.
 
 If any such PRC tax applies, a non-PRC shareholder may be entitled to a reduced rate of PRC tax under an applicable income tax treaty and/or a deduction of such PRC tax against such shareholder’s domestic taxable income or a foreign tax credit in respect for such PRC tax against such shareholder’s domestic income tax liability (subject to applicable conditions and limitations). You should consult with your own tax advisors regarding the applicability of any such taxes, the effects of any applicable income tax treaties, and any available deductions or foreign tax credits.
 
 Changes in PRC government policy on foreign investment in China may adversely affect our business and results of operations.
 
 Our PRC subsidiary is a foreign invested enterprise. As we conduct a significant portion of our businesses through a foreign investment enterprise in the PRC, we are subject to restrictions on foreign investment policies imposed by the PRC law from time to time. Generally, foreign invested enterprises enjoy more favorable tax treatment in the form of tax incentives and other preferential policies but are subject to more stringent restrictions in their business operations. If we cannot obtain approval from relevant approval authorities to engage in businesses that become restricted or prohibited for foreign investors, we may be forced to sell or restructure the businesses that have become restricted or prohibited for foreign investment. If we are forced to adjust our business portfolio as a result of changes in government policy on foreign investment, our business, financial condition and results of operations would likely be materially adversely affected.
 
 Changes in PRC laws and regulations on labor and employee benefits may adversely affect our business and results of operations.
 
 As we conduct a significant portion of our business through our PRC subsidiary, we are subject to PRC laws and regulations on labor and employee benefits. In recent years, the PRC government has implemented policies to strengthen the protection of employees and obligate employers to provide more benefits to their employees. In addition, an employment contract law came into effect in China on January 1, 2008. The PRC employment contract law and related legislations require more benefits to be provided to employees, such as an increase in pay or compensation for termination of employment contracts. As a result, we expect to incur higher labor costs, which would have an adverse impact on our business and results of operations.
 
 We may be unable to complete a business combination transaction efficiently or on favorable terms due to complicated merger and acquisition regulations that became effective on September 8, 2006.
 
 On August 8, 2006, six PRC regulatory agencies promulgated the Regulation on Mergers and Acquisitions of Domestic Companies by Foreign Investors, which became effective on September 8, 2006. This new regulation, among other things, governs the approval process by which a PRC company may participate in an acquisition of assets or equity interests. Depending on the structure of the transaction, the new regulation will require the PRC parties to make a series of applications and supplemental applications to the government agencies. In some instances, the application process may require the presentation of economic data concerning a transaction, including appraisals of the target business and evaluations of the acquirer, which are designed to allow the government to assess the transaction. Government approvals will have expiration dates by which a transaction must be completed and reported to the government agencies. Compliance with the new regulations is likely to be more time consuming and expensive than in the past and the government can now exert more control over the combination of two businesses. Accordingly, due to the new regulation, our ability to engage in business combination transactions has become significantly more complicated, time consuming and expensive, and we may not be able to negotiate a transaction that is acceptable to our shareholders or sufficiently protect their interests in a transaction.
  15
 
 The new regulation allows PRC government agencies to assess the economic terms of a business combination transaction. Parties to a business combination transaction may have to submit to MOFCOM and other relevant government agencies an appraisal report, an evaluation report and the acquisition agreement, all of which form part of the application for approval, depending on the structure of the transaction. The regulations also prohibit a transaction at an acquisition price obviously lower than the appraised value of the PRC business or assets and in certain transaction structures, require that consideration must be paid within defined periods, generally not in excess of a year. The regulation also limits our ability to negotiate various terms of the acquisition, including aspects of the initial consideration, contingent consideration, holdback provisions, indemnification provisions and provisions relating to the assumption and allocation of assets and liabilities. Transaction structures involving trusts, nominees and similar entities are prohibited. Therefore, such regulation may impede our ability to negotiate and complete a business combination transaction on financial terms that satisfy our investors and protect our shareholders’ economic interests.
 
 The approval of the China Securities Regulatory Commission may be required in connection with an offering of our securities under PRC regulations, and, if required, we cannot currently predict whether we would be able to obtain such approval.
 
 On August 8, 2006, six PRC regulatory agencies, including the China Securities Regulatory Commission, or “CSRC,” MOFCOM the State-Owned Assets Supervision and Administration Commission, or “SASAC”, the State Administration of Taxation, or “SAT”, the State Administration for Industry and Commerce, or “SAIC” and SAFE jointly promulgated the Regulation on Mergers and Acquisitions of Domestic Companies by Foreign Investors, which became effective on September 8, 2006 and was amended on June 22, 2009 (the “M&A Regulation”). This M&A Regulation addresses that a special purpose vehicle, or “SPV,” refers to an offshore company directly or indirectly controlled by PRC individuals or companies for the purpose of taking the interests of their domestic company to list on an overseas stock market and further regulates that the listing and trading of the SPV on an overseas stock market whose shareholders intend to acquire a PRC company in consideration of the SPV’s equity (“cross-border equity swap” ) shall be subject to the examination and approval of CSRC. On September 21, 2006, CSRC promulgated the approval procedures for the overseas listing of an SPV on its official website. In our case, our equity structure does not involve a cross-border equity swap governed by the M&A Regulation, therefore we believe that the requirement of CSRC approval under the M&A Regulation is not applicable to us. We are not aware of any entity with a similar corporate structure having been required an approval from CSRC. However, CSRC currently has not issued the implementing rules, and there may be some uncertainties as to how this M&A Regulation will be interpreted or implemented. Moreover, CSRC or other relevant government authorities may disagree with this conclusion and if prior CSRC approval is required for an offering, we could face regulatory actions or other sanctions by the CSRC or other PRC regulatory agencies. If this happens, these regulatory agencies may impose fines and penalties on our operations in the PRC, limit our operating privileges in the PRC, delay or restrict the repatriation of the proceeds from this transaction into the PRC, or take other actions that could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our ordinary shares. The CSRC or other PRC regulatory agencies may also take actions requiring or advising us to halt such an offering.
 
 16
  The approval of MOFCOM may be required in connection with the acquisition of Lanxi Sunrise by Bright under PRC regulations, and, if required, we cannot currently predict whether we will be able to obtain such approval.
 
 The M&A Regulation also established additional procedures and requirements that could make merger and acquisition activities by foreign investors in the PRC more time-consuming and complex, including requirements in some instances that the approval of the MOFCOM or its competent local office shall be required in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise. Where offshore companies set up or controlled by PRC enterprises or individuals intend to acquire their affiliated PRC non-foreign investment companies (a “related acquisition”) they shall be subject to the approval of MOFCOM. Currently, the sole shareholder of Creation, our major shareholder, is Mr. Gabriele Sanesi, a citizen of Italy. In accordance with an agreement dated April 15, 2010 among Creation, Mr. Gao and Mr. Sanesi, or the “April 2010 Agreement,” Mr. Sanesi has agreed to transfer 100% of his equity interests in Creation to Mr. Gao (the “Acquisition Right”) if the net income of the Company from January 1, 2010 to June 30, 2010 is no less than US$2.0 million. However, Mr. Gao has not exercised the Acquisition Right under the April 2010 Agreement so far. Provided that he decides to exercise his Acquisition Right, Mr. Gao shall apply for the approval from MOFCOM. We are not aware of any entity with a similar corporate structure having been required an approval from MOFCOM. However, MOFCOM or other relevant PRC government authorities may disagree with this conclusion and if relevant PRC government authorities deem the current corporate structure to be a related acquisition subject to the M&A Regulation, we may have violated the M&A Regulation and could be subject to administrative fines and other penalties from relevant PRC authorities, and we may be required to obtain approval for such transactions from the MOFCOM and could be required to divest Lanxi Sunrise, in which case we would lose the benefit of the revenues from such entity, which is substantial. There are no specific declarations of fines or penalties for such violations under current PRC laws and regulations and so the penalties we may suffer are uncertain. In the future, we may grow our business in part by acquiring additional businesses in China. Compliance with the requirements of the M&A Regulation to complete such transactions could be time-consuming, and any required approval processes, including obtaining approval from the MOFCOM or its competent local office, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand business.
 
 If there are any adverse public health developments in China, our business and operations may be severely disrupted.
 
 Any prolonged occurrence of avian flu, severe acute respiratory syndrome, or “SARS,” swine flu, or other adverse public health developments in China or other regions where we have an operation or presence may have a material adverse effect on our business operations. These could include the ability of our personnel to travel or to promote our services within China or at other regions where we have an operation or presence, as well as temporary closure of our facilities. In particular, there have been reports of occurrences of avian flu and swine flu in various parts of China in recent years, including confirmed human cases. In response, the PRC government has authorized local governments to impose quarantine and other restrictions on movements of people and goods in the event of an epidemic. Any closures or travel or other operational restrictions would severely disrupt our business operations and adversely affect our results of operations. We have not adopted any written preventive measures or contingency plans to combat any future outbreak of avian flu, SARS, swine flu, or any other epidemic.
 
 You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based on United States or other foreign laws against us, our management or the experts named in this Annual Report.
 
 We conduct substantially all of our operations in China and substantially all of our assets are located in China. In addition, most of our directors and executive officers reside within China. As a result, it may not be possible to effect service of process within the United States or elsewhere outside China upon some of our directors and senior executive officers, including with respect to matters arising under U.S. federal securities laws or applicable state securities laws. It would also be difficult for investors to bring an original lawsuit against us or our directors or executive officers before a Chinese court based on U.S. federal securities laws or otherwise. Moreover, our PRC legal counsel has advised us that the PRC does not have treaties with the United States or many other countries providing for the reciprocal recognition and enforcement of judgment of courts. As such, recognition and enforcement in China of judgments against us, our directors, executive officers or the experts named in this annual report on Form 20-F obtained from a court in any of those jurisdictions may be difficult or impossible to enforce.
 
 The Chinese government could change its policies toward private enterprise or even nationalize or expropriate private enterprises, which could result in the total loss of our investment in that country.
 
 Our business is subject to significant political and economic uncertainties and may be adversely affected by political, economic and social developments in China. Over the past several years, the Chinese government has pursued economic reform policies including the encouragement of private economic activity and greater economic decentralization. The Chinese government may not continue to pursue these policies or may significantly alter them to our detriment from time to time with little, if any, prior notice.
  17
 
 Changes in policies, laws and regulations or in their interpretation or the imposition of confiscatory taxation, restrictions on currency conversion, restrictions or prohibitions on dividend payments to shareholders, devaluations of currency or the nationalization or other expropriation of private enterprises could have a material adverse effect on our business. Nationalization or expropriation could even result in the total loss of our investment in China and in the total loss of your investment in us.
 
 Contract drafting, interpretation and enforcement in China involve significant uncertainty, which could leave us vulnerable to legal disputes and challenges related to our contracts.
 
 We have entered into numerous contracts governed by PRC law, many of which are material to our business. As compared with contracts in the United States, contracts governed by PRC law tend to contain less detail and are not as comprehensive in defining contracting parties’ rights and obligations. As a result, contracts in China are more vulnerable to disputes and legal challenges. In addition, contract interpretation and enforcement in China is not as developed as in the United States, and the result of any contract dispute is subject to significant uncertainties. Therefore, we cannot assure you that we will not be subject to disputes under our material contracts, and if such disputes arise, we cannot assure you that we will prevail.
 
 If our land use rights are revoked, we would have no operational capabilities.
 
 Under Chinese law land is owned by the state or rural collective economic organizations. The state issues to the land users the land use right certificate. Land use rights can be revoked and the land users forced to vacate at any time when redevelopment of the land is in the public interest. The public interest rationale is interpreted quite broadly and the process of land appropriation may be less than transparent. Each of our facilities relies on these land use rights as the cornerstone of their operations, and the loss of such rights would have a material adverse effect on our company.
 
 We could be liable for damages for defects in our products pursuant to the Tort Liability Law of the PRC.
 
 The Tort Liability Law of the People’s Republic of China, which was passed during the 12th Session of the Standing Committee of the 11th National People’s Congress on December 26, 2009, states that manufacturers are liable for damages caused by defects in their products and sellers are liable for damages attributable to their fault. If the defects are caused by the fault of third parties such as the transporter or storekeeper, manufacturers and sellers are entitled to claim for compensation from these third parties after paying the compensation amount.
 
 We are subject to a variety of environmental laws and regulations related to our manufacturing operations. Our failure to comply with environmental laws and regulations may have a material adverse effect on our business and results of operations.
 
 Our manufacturing process generates noise, waste water, gaseous and other industrial wastes and we are required to comply with national and local regulations regarding environmental protection. We may not have all necessary environmental permits to conduct our business as it is presently conducted or control the use of, or may not be able to restrict adequately the discharge of hazardous substance. We are now in the process of applying for the waste disposal permit. Our failure to obtain such permit on time may result in fines or penalties to us and may have an adverse effect on our operations. If we fail to comply with any environmental regulations, we may be required to pay substantial fines, suspend production or cease of operations. Additionally, these regulations may change in a manner that could have a material adverse effect on our business, results of operations and financial condition. We have made and will continue to make capital and other expenditures to comply with environmental requirements.
  18
  We face uncertainty from PRC’s Circular on Strengthening the Administration of Enterprise Income Tax on Non-Resident Enterprises’ Share Transfer that was released in December 2009 with retroactive effect from January 1, 2008.
 
 On December 10, 2009, the State Administration of Taxation, or the SAT issued the Notice on Strengthening Administration of Enterprise Income Tax for Equity Transfers by Non-PRC Resident Enterprises, or SAT Circular 698 with retroactive effect from January 1, 2008, which addresses the regulations on the purchase and sales of a PRC resident enterprise’s equity interests by a non-PRC resident enterprise excluding purchase and sales of shares of PRC resident enterprises listed on a public stock exchange market.
 
 Pursuant to SAT Circular 698, if a non-PRC resident enterprise transfers the equity interests of a PRC resident enterprise indirectly by disposing its interests in an overseas holding company which in turn holds equity interests in the PRC resident enterprise, ( an “Indirect Transfer”), and such overseas holding company is located in a tax jurisdiction that: (i) has an effective tax rate lower than 12.5% or (ii) does not tax foreign income of its residents, the non-PRC resident enterprise, being the transferor, shall report to the competent tax authority of the PRC resident enterprise this Indirect Transfer within 30 days from the date of the execution of the equity transfer agreement and submit the following documents:
 
 ·
Equity transfer contract/agreement;
 ·
Documents illustrating the relationship between the non-PRC resident investor and the overseas holding company in respect of financing, operation, sales and purchase, etc.;
 ·
Documents illustrating the operation, personnel, finance and properties of the overseas holding company;
 ·
Documents illustrating the relationship between the overseas holding company and the PRC resident enterprise in respect of financing, operation, sales and purchase, etc.;
 ·
Documents explaining the reasonable commercial purpose of the non-PRC resident investor in setting up the overseas holding company; and
 ·
Other relevant documents required by the tax authority.
 
 Based on the examination of the aforementioned reporting documents, the PRC competent tax authority may disregard the existence of the overseas holding company by applying a “substance over form principle” if such equity transfer of the overseas holding company lacks a reasonable commercial purpose and was established for the purpose of reducing, avoiding or deferring PRC taxes. As a result, gains derived from such Indirect Transfer may be subject to a PRC withholding tax at a rate of up to 10%. SAT Circular 698 also provides that, where a non-PRC resident enterprise transfers its equity interests in a PRC resident enterprise to its related parties at a price lower than the fair market value, the relevant tax authority has the power to make a reasonable adjustment to the taxable income of the transaction.
 
 However, there is uncertainty as to the application of SAT Circular 698. Currently the relevant authority has not yet promulgated any formal provisions for implementation nor has it formally declared or stated how to calculate the effective tax rates in the foreign tax jurisdictions. Moreover, the term “Indirect Transfer” is not clearly defined and the specific reporting process and form of an Indirect Transfer to the competent tax authority of the relevant PRC resident enterprise remain unclear. In addition, there are not any formal declarations with regard to how to determine whether a non-PRC resident investor has adopted an abusive arrangement in order to reduce, avoid or defer PRC taxes. SAT Circular 698 may be determined by the relevant PRC tax authorities to be applicable to our non-PRC resident investors, if any equity transfer transaction by these non-PRC resident investors was determined by the relevant PRC tax authorities to lack reasonable commercial purpose, we and our non-PRC resident investors may become at risk of being taxed under SAT Circular 698 and may be required to expend valuable resources to comply with SAT Circular 698 or to establish that we should not be taxed under SAT Circular 698, which may have a material adverse effect on our financial condition and results of operations or such non-PRC resident investors' investments in us.
 
 Risks Relating to Our Ordinary Shares
 
 Our ordinary shares are currently quoted only on the OTC Bulletin Board, which may have an unfavorable impact on our stock price and liquidity.
 
 Our ordinary shares are currently quoted on the OTC Bulletin Board. The OTC Bulletin Board is a significantly more limited market than the New York Stock Exchange or NASDAQ system. The quotation of our shares on the OTC Bulletin Board may result in a less liquid market available for existing and potential shareholders to trade shares of our ordinary shares, could depress the trading price of our ordinary shares and could have a long-term adverse impact on our ability to raise capital in the future.
 
 19


We are subject to penny stock regulations and restrictions.





The SEC has adopted regulations which generally define so-called “penny stocks” to be an equity security that has a market price less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exemptions. As of March 11, 2011, the closing bid price for our ordinary shares was $1.00 per share and our shares are considered to be a “penny stock.” As a “penny stock,” our ordinary shares may become subject to Rule 15g-9 under the Exchange Act of 1934, or the “Penny Stock Rule.” This rule imposes additional sales practice requirements on broker-dealers that sell such securities to persons other than established customers and “accredited investors” (generally, individuals with a net worth in excess of $1,000,000 or annual incomes exceeding $200,000, or $300,000 together with their spouses). For transactions covered by Rule 15g-9, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transaction prior to sale. If such a suitability determination cannot be made for whatever reason, then the sale will not be able to be consummated under Rule 15g-9. Accordingly, this rule may affect the ability of broker-dealers to sell our securities and may affect the ability of purchasers to sell any of our securities in the secondary market.





For any transaction involving a penny stock, unless exempt, the rules require delivery, prior to any transaction in a penny stock, of a disclosure schedule prepared by the SEC relating to the penny stock market. Disclosure is also required to be made about sales commissions payable to both the broker-dealer and the registered representative and current quotations for the securities. Finally, monthly statements are required to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stock.





There can be no assurance that our Ordinary Shares will qualify for exemption from the Penny Stock Rule. In any event, even if our ordinary shares were exempt from the Penny Stock Rule, we would remain subject to Section 15(b)(6) of the Exchange Act, which gives the SEC the authority to restrict any person from participating in a distribution of penny stock, if the SEC finds that such a restriction would be in the public interest.





One of our shareholders holds a significant percentage of our outstanding voting securities.





Mr. Gao, who is our Chief Executive Officer and chairman, controls approximately 40.12% of our outstanding voting securities through a contractual agreement with a 40.12% shareholder, which is Creation International Development Investments Limited, the sole registered shareholder of which is Mr. Gabriele Sanesi. As a result, Mr Gao possesses significant influence, giving him the ability, among other things, to prevent proposed significant corporate transactions. His ownership and control may also have the effect of delaying or preventing a future change in control, impeding a merger, consolidation, takeover or other business combination or discourage a potential acquirer from making a tender offer, all of which may prevent us from implementing our business strategies.





The market price for our Ordinary Shares may be volatile.





The market price for our Ordinary Shares is likely to be highly volatile and subject to wide fluctuations in response to factors including the following:


·
actual or anticipated fluctuations in our quarterly operating results and changes or revisions of our expected results;
 
 ·
changes in financial estimates by securities research analysts;
 
 ·
announcements by us and our affiliates or our competitors of new products, acquisitions, strategic relationships, joint ventures or capital commitments;
 
 ·
addition or departure of our senior management and key research and development personnel;
 
 20
  ·
fluctuations of exchange rates between the Renminbi and the U.S. dollar;
 
 ·
litigation related to our intellectual property;
 
 ·
release or expiry of lock-up or other transfer restrictions on our outstanding ordinary shares; and
 
 ·
sales or perceived potential sales of our ordinary shares.




In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also have a material adverse effect on the market price of our ordinary shares.





There will be a substantial number of our Ordinary Shares available for sale in the future that may adversely affect the market price of our Ordinary Shares.





We currently have an authorized share capital of 142,857,142.86 ordinary voting shares with a par value of $0.007 per share, of which 5,832,058 are issued and outstanding. Our outstanding shares are currently eligible for resale under Rule 144. Sales of substantial amounts of ordinary shares, or the perception that such sales could occur under Rule 144 or otherwise, could reduce the market price of our ordinary shares and could impair our ability to raise capital through the sale of our equity securities. The availability of such a significant number of securities for trading in the public market may have an adverse effect on the market price of our ordinary shares.





Cayman Islands law may be less protective of shareholder rights than the laws of the U.S. or other jurisdictions.





We were incorporated as an exempted company under the laws of the Cayman Islands. Our corporate affairs are governed by our memorandum and articles of association, the Companies Law (2009 Revision) of the Cayman Islands and the common law of the Cayman Islands. The rights of shareholders to take action against our directors and us, the rights of minority shareholders to institute actions, and the fiduciary responsibilities of our directors to us are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from judicial precedent in the Cayman Islands as well as from English common law, the latter of which has persuasive, but not binding, authority on a court in the Cayman Islands. Any shareholder of a company may petition the Court which may make a winding up order if the Court is of the opinion that it is just and equitable that the company should be wound up or, as an alternative to a winding up order, (a) an order regulating the conduct of the company’s affairs in the future, (b) an order requiring the company to refrain from doing or continuing an act complained of by the shareholder petitioner or to do an act which the shareholder petitioner has complained it has omitted to do, (c) an order authorizing civil proceedings to be brought in the name and on behalf of the company by the shareholder petitioner on such terms as the Court may direct, or (d) an order providing for the purchase of the shares of any shareholders of the company by other shareholders or by the company itself and, in the case of a purchase by the company itself, a reduction of the company’s capital accordingly. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law may be different to those provided for under statutes or judicial precedent in some jurisdictions in the United States. In particular, the Cayman Islands has a less developed body of securities laws than the United States.





As a result of all of the above, our shareholders may have more difficulty in protecting their interests in the face of actions taken by management, our directors or principal shareholders than they would as a shareholder of a U.S. company.





21





Your ability to bring an action against us or against our directors and executive officers, or to enforce a judgment against us or them, will be limited.





We are not incorporated in the United States. We are a Cayman Islands exempted company, Bright is a Republic of Vanuatu company and Lanxi Sunrise and Lanxi Tianxianfang are PRC companies, and some of our officers and directors reside outside the United States. We conduct our business outside the United States, and substantially all of our assets are located outside the United States. Most of our directors and executive officers are non-U.S. citizens and reside, and substantially all of the assets of those persons are located, outside the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the United States in the event that you believe that your rights have been infringed under U.S. securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands or the PRC may render you unable to enforce a judgment against our assets or the assets of our directors and executive officers. In addition, there is uncertainty as to whether the courts of the Cayman Islands or the PRC would (i) recognize or enforce judgments of U.S. courts against us or our directors or officers predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States; or (ii) entertain original actions brought in the Cayman Islands or the PRC against us or our directors or officers predicated upon the securities laws of the United States or any state in the United States. There are presently no treaties providing reciprocity of enforcement of judgments between the United States, Cayman Islands and the PRC. There is however no bar against US shareholders originating actions in either the Cayman Islands or the PRC based on their respective laws.





We may not be able to pay any dividends on our Ordinary Shares.





Under Cayman Islands law, we may only pay dividends out of our profits or our share premium account subject to our ability to service our debts as they become due in the ordinary course of business. Our ability to pay dividends will therefore depend on our ability to generate sufficient profits. We cannot give any assurance that we will declare dividends of any amounts, at any rate or at all in the future. We have not paid any dividends in the past. Future dividends, if any, will be at the discretion of our board of directors and will depend upon our results of operations, our cash flows, our financial condition, the payment of our subsidiaries of cash dividends to us, our capital needs, future prospects and other factors that our directors may deem appropriate. You should refer to the “Dividend Policy” section in this Registration Statement for additional information regarding our current dividend policy for additional legal restrictions on the ability of our PRC subsidiaries to pay dividends to us.





In addition, due to the failure of the Measures to define or interpret the terms “non-profit,” “for-profit” or “for the purpose of making a profit” as they relate to our business, we cannot assure you that the PRC government authorities will not request our subsidiaries to use their after-tax profits for their own development and restrict our subsidiaries’ ability to distribute their after-tax profits to us as dividends.





Volatility in the price of our Ordinary Shares may result in shareholder litigation that could in turn result in substantial costs and a diversion of our management’s attention and resources.





The financial markets in the Unites States and other countries have experienced significant price and volume fluctuations, and market prices of textile companies have been and continue to be extremely volatile. Volatility in the price of our ordinary shares may be caused by factors outside of our control and may be unrelated or disproportionate to our results of operations. In the past, following periods of volatility in the market price of a public company’s securities, shareholders have frequently instituted securities class action litigation against that company. Litigation of this kind could result in substantial costs and a diversion of our management’s attention and resources.





Item 4.
Information on the Company





A.
History and Development of the Company





We are an exempted company incorporated under the Companies Law (1998 Revision) of the Cayman Islands on February 3, 2000 as Aquasol Envirotech, Ltd. On June 9, 2008, we changed our name to China Linen Textile Industry, Ltd. On July 9, 2008, we acquired all of the shares of capital stock of Bright from its shareholders in exchange for the issuance of 5,418,001 of our ordinary shares and Bright became our wholly owned subsidiary. The Company, through Bright, which is the registered beneficial owner of 95% of Lanxi Sunrise, is engaged in research, production and sales of linen textile products. Lanxi Sunrise and Bright entered into an equity transfer agreement in August 2007, pursuant to which Bright was to become the 95% holder of Lanxi Sunrise upon satisfaction of certain conditions set forth in the agreement, which occurred in April 2008. Mr. Gao, our Chief Executive Officer and chairman, is the owner of the remaining 5% of Lanxi Sunrise.





22





Reverse Acquisition with Bright





Lanxi Sunrise and Bright entered into an equity transfer agreement in August 2007, pursuant to which Bright was to become the 95% holder of Lanxi Sunrise upon satisfaction of certain conditions set forth in the agreement, which occurred in April 2008. Mr. Gao, our Chief Executive Officer and chairman, remains the owner of the remaining 5% of Lanxi Sunrise.





Immediately prior to our reverse acquisition with Bright, on June 9, 2008, Mr. Gao, our Chief Executive Officer and chairman, along with two employees of Lanxi Sunrise, purchased a total of 257,143 shares, or approximately 39.58% of our issued and outstanding ordinary shares, from seven previous shareholders. None of the seven previous shareholders were affiliates of our Company. The purchase price was $309,996, or approximately $0.34 per share, and resulted in the acquisition of 39.58% of our ordinary shares by Mr. Gao and the two employees of Lanxi Sunrise while we were still a shell company.





Following this stock purchase transaction by Mr. Gao and the two Lanxi Sunrise employees, on July 9, 2008, the company acquired 100 shares of Bright, constituting all of the issued and outstanding capital stock of Bright. The 100 shares of Bright were acquired from the individual shareholders of Bright in a share exchange transaction in return for the issuance of 5,418,001 ordinary shares of the company. As a result of the transaction, Bright became a wholly owned subsidiary of the company. Bright is the registered beneficial owner of 95% of Lanxi Sunrise. For accounting purposes, Bright is regarded as the accounting acquirer, while the company before the reverse acquisition is deemed to have been acquired by Bright. As a result the consolidated financial statements of the company have been prepared as a continuation of the consolidated financial statements of Bright.





The completion of the stock purchase transaction and the share exchange transaction described above (together the “Reverse Acquisition”) resulted in a change of control of the company. On June 9, 2008, in anticipation of completion of the Reverse Acquisition, we changed our name to China Linen Textile Industry, Ltd.





Immediately following these transactions, we had a total of 5,742,858 shares issued and outstanding, of which 5,546,573, or approximately 96.58%, were owned by Mr. Gao and other former shareholders of Bright.





On June 30, 2008, we completed a 1:2 reverse stock split, thereby reducing our issued and outstanding shares from 649,713 to approximately 324,857.





2010 Restructuring





On April 15, 2010, so as to not violate certain applicable PRC regulations, all direct equity interests in us (approximately 40.51% of our outstanding ordinary shares) held by or on behalf of Mr. Gao, our Chief Executive Officer and chairman, was transferred to Creation. Mr. Gabriele Sanesi, a citizen of Italy, is the sole shareholder and director of Creation. Pursuant to an agreement dated April 15, 2010 among Creation and Messrs. Gao and Sanesi (the “April 2010 Agreement”), Mr. Sanesi has granted Mr. Gao the irrevocable right to exercise his rights as a shareholder and director of Creation. In addition, in accordance with the April 2010 Agreement, Mr. Sanesi has agreed to transfer 100% of his equity interests in Creation to Mr. Gao if our net income from January 1, 2010 to June 30, 2010 is no less than US$2.0 million.





Acquisition of Lanxi Tianxianfang Linen Co., Ltd.





On November 15, 2010, we, through our indirect 95% owned subsidiary, Lanxi Sunrise, entered into a Share Acquisition Agreement (the “Acquisition Agreement”) with Lanxi Tianxianfang Linen Co., Ltd. (“Lanxi Tianxianfang”) and Shufan Wang (“Wang”) and Lijie Fu (“Fu”), the two shareholders of Lanxi Tianxianfang. Pursuant to the Acquisition Agreement, Lanxi Sunrise has purchased all of the equity of Lanxi Tianxianfang for a price of RMB 44,401,485 (approximately $6.7 million) (the “Purchase Price”), which Purchase Price was based on an appraisal report of Lanxi Tianxianfang’s assets, liabilities and net assets as of March 31, 2010 by Heilongjiang Zhongming Guolin Asset Appraisal Co., Ltd.





On July 1, 2010, the Company, through Lanxi Sunrise, entered into a Fixed Asset Lease Agreement (the “Lease Agreement”) with Lanxi Tianxianfang. Pursuant to the Lease Agreement, Lanxi Sunrise leased all of the fixed assets, including real estate, production facilities, and equipment (“Facility”) owned by Lanxi Tianxianfang in the People’s Republic of China (“PRC”). The Facility was leased to expand Lanxi Sunrise’s existing production capacity of linen yarn. The Facility includes a building with an area of 7,120 square meters (23,358 square feet), and includes spinning machines, bleaching machines and other equipment. The Facility is located at Fourth Neighborhood, Chengdong Street (East Town Street), Lanxi Town, PRC. Lanxi Sunrise commenced operations at the Facility on July 2, 2010. The Lease Agreement was terminated on November 15, 2010, the effective date of the Acquisition Agreement.





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The Purchase Price was paid in one installment by Lanxi Sunrise to Wang and Fu on November 16, 2010. Wang and Fu deposited RMB 22,750,642 (approximately $3.4 million) into a bank account of the Target for the repayment of the sum of the debts of the Target outstanding on March 31, 2010, which funds will be distributed by the Company in accordance with a payment schedule for such debts.





On November 24, 2010, the equity transfer was officially completed upon the effectiveness of the change in registration of the equity interest from Wang and Fu to Lanxi Sunrise with the relevant PRC authority.





Share Consolidation





On March 23, 2011 the Company filed an Amended and Restated Memorandum of Association of the Company, which consolidates the share capital of the Company at a ratio of 3.5:1 by increasing the par value of the Company’s share capital from US$0.002 par value each to US$0.007 par value each, thereby reducing the number of authorized shares from US$1,000,000 divided into 500,000,000 ordinary shares of US$0.002 par value each to US$1,000,000 divided into 142,857,142.86 ordinary shares of US$0.007 par value each (the “Share Consolidation”). The market date of effectiveness of the Share Consolidation is March 30, 2011. The pro forma number of Ordinary Shares and earnings per share referred to throughout this annual report on Form 20-F assumes the Share Consolidation occurred as of the relevant report date.





See “Organizational Structure” for a chart depicting our corporate structure as of the date hereof.





Our registered office is located at the offices of Appleby Trust (Cayman) Ltd., Clifton House, 75 Fort Street, PO Box 1350, George Town, Grand Cayman, KY1-1108, Cayman Islands. Our principal executive offices are located at Chengdong Street, Lanxi County, Heilongjiang Province, PRC and the telephone number at this address is 86-455-5635885. Investor inquiries should be directed to us at our principal executive offices. Our website is www.chinalinentextile.com. The information contained on our website does not form part of this annual report. Our agent for service of process in the United States is Island Stock Transfer, 100 Second Avenue South, Suite 705S, St. Petersburg, Florida, 33701. Our public filings can be accessed at www.sec.gov.





B.
Business Overview





We are principally engaged in the production and sale of linen yarn and various types of linen fabric. We are also involved in consultation, research and development related to linen technology and linen products.





We conduct all of our business activities through our majority-owned subsidiary, Lanxi Sunrise, which was incorporated in Lanxi County, Heilongjiang Province, PRC on June 11, 2002, as a state-owned holding company under the Company Law of the PRC. Lanxi Sunrise converted from a state-owned holding company into a privately owned business enterprise in June 2007. Its manufacturing facility is located in Lanxi County, Heilongjiang Province.





Since November 24, 2010, we completed the acquisition of Lanxi Tianxianfang Linen Co., Ltd. and accordingly, expanded our operations through Lanxi Tianxianfang.





The linen industry chain involves a 5-step process including (i) yarn spinning; (ii) fabric weaving; (iii) bleaching; (iv) dyeing; and (v) finishing. Our current operations are focused on three of the steps in this process, yarn spinning, fabric weaving and bleaching. Generally, sales of bleached fabric have a higher added value than grey, or unbleached fabric, which consequently can yield a higher margin of profits. Currently, the Company engages in the process of bleaching solely as part of our linen production process. While bleaching can be a separate service and source of revenue offered by the Company, currently, the Company does not offer such a separate linen bleaching service. In the future, we plan to expand our operations to other segments of the industry chain including dyeing and finishing





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We import flax primarily from France, Belgium and the Netherlands. The raw flax is put through a multi-step process at our manufacturing facility to make yarn. A portion of the yarn is sold to customers and a portion is used by us to weave various types of linen fabric. Our primary products include linen yarn, linen fabric, gray linen fabric, linen/cotton interwoven fabric and linen/rayon interwoven fabric.





Products and Services





We operate one yarn-spinning factory, one bleaching factory, two weaving factories and one yarn dyeing workshop at our facility in Lanxi County, PRC. The main products we produce at this facility are linen yarn and linen fabric. We also design and produce other linen fabrics in various specifications requested by our customers including linen fabric, interwoven or blended fabrics including both cotton/linen blend and a rayon/linen blend, semi-bleached fabric, piece-dyed fabric and jacquard fabric.





We process raw flax into yarn through an automated multi-step process. The annual production capacity totals approximately 2,200 tons with 50 different types of yarn and 10 million meters of fabric with 110 types, including linen gray fabric, linen fabric, blended or interwoven fabric such as cotton/linen and rayon/linen blends, and semi-bleached linen fabric. The revenue for sales of linen fabric accounted for approximately 89% and linen yarn accounted for approximately 11% of our sales revenue in 2010.





Our products and services are divided into four principal groups:





Linen Fabric





We can produce over 100 types of linen fabric. We mainly produce linen gray fabric, semi-bleached fabric and line yarn-dyed fabrics. Linen fabric is produced by arranging the flax yarn both horizontally and vertically on the loom during the production process. Linen gray fabric is the main raw material for dyeing and finishing plants. In the future, we plan to expand our production of linen fabric in order to accomplish our development strategy.





Linen Yarn





Linen yarn is thin and long, which has tensile strength and flexibility due to being twisted through several processes. Linen yarn is an unfinished product in linen textile industry, and is a main raw material for weaving. Linen yarn is supplied to weaving mills to process into fabric. There are approximately 50 types of yarn produced by our company, which are mainly used by us for weaving fabric. In the future, we plan to increase our production capacity of linen yarn in order to accomplish our development strategy.





Linen Fabric Processing





We have a subcontracting business that processes linen yarn provided by other factories into linen fabric by using our weaving machines, for which we charge a processing fee. In 2010, we did not accept any subcontracting business for linen fabric processing because we were operating at maximum capacity and were unable to meet demand from our own customers. Although we may continue this line of business, it will not be our primary source of revenue or focus and is not part of our long-term growth strategy.





Linen Yarn Processing





We have a subcontracting business that processes flax provided by other factories into linen yarn by using our weaving machines, for which we charge a processing fee. In 2010, we accepted very little subcontracting business for linen yarn processing because we were operating at maximum capacity and were unable to meet own demand from our own customers. Although we may continue this line of business, it will not be our primary source of revenue or focus and is not part of our long-term growth strategy.





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Distribution and Marketing





Our products are sold to both wholesalers and end users. Both the importation of raw materials and the export of finished goods are partially done through Agency Agreements with Harbin Zhongyi Sunshine Linen Co., Ltd. (“Harbin Zhongyi” ) and Harbin Sunshine Linen Textile Co., Ltd. (“Harbin Sunshine”), our affiliates, which are controlled by Gao Ren, our Chief Executive Officer and chairman. Under the terms of the Agency Agreements, Harbin Zhongyi and Harbin Sunshine purchase and import flax on our behalf and resell it to us at a price equal to cost plus 6%. Harbin Zhongyi and Harbin Sunshine also act as our agents for export of finished goods, but do not charge a fee as part of the export process. Accordingly, finished goods to be exported are sold to Harbin Zhongyi and Harbin Sunshine and at a price equal to the price to be paid by the overseas buyer of the goods. In 2010, the amount of products sold to Harbin Zhongyi accounted for 6.0% of total revenue, the amount sold to Harbin Sunshine was 0.4% of total revenue. The amount of purchase from Harbin Zhongyi accounted for 25.0% of total purchase.





Harbin Zhongyi was established in 2006 and Harbin Sunshine was established in 1997, engaging in the import/export business and having special licenses from the central government of the PRC which allow them to take advantage of waivers of import/export taxes created to encourage business development in certain areas of northeast China. By importing raw materials and exporting finished goods through Harbin Zhongyi and Harbin Sunshine, we are able to benefit from the special licenses held by Harbin Zhongyi and Harbin Sunshine. In the process of distributing finished goods, we also benefit from our Agency Agreements with Harbin Zhongyi and Harbin Sunshine by taking advantage of long-term customer contacts established by Harbin Zhongyi and Harbin Sunshine.





Seasonality





The cyclical period of purchasing for raw materials is approximately quarterly based on an annual plan, in order to satisfy production needs. Sales during each of the four quarters do not present strong seasonality.





Customers





We have a diversified customer base. Our largest customer markets are currently located in China, Italy, USA, Brazil, Belgium, Spain and Greece. In the domestic market in China, our customers are located primarily in the Yangtze River Delta area and include Zhejiang Huili Garments Co, Ltd., Shaoxing Yinxiang Cotton and Linen Textile Co., Ltd., Shaoxing Hongda Linen and Cotton Textile Co, Ltd., and Zhejiang Shaoxing Xinsanjiang Printing and Dyeing Co, Ltd.





In 2010, we derived 47.1% of our revenue from our five largest customers. In fiscal year 2009, we derived 94.5% of our revenue from our five largest customers. In fiscal year 2008, we derived 95.8% of our revenue from our five largest customers. Harbin Sunshine Linen Textile Co., Ltd. and Harbin Zhongyi Sunshine Linen Co., Ltd., which are controlled by our Chief Executive Officer and Chairman, were among our five biggest customers in each of 2008 and 2009. Harbin Zhongyi and Harbin Sunshine are agents of Lanxi Sunrise, through which our sales to some customers are conducted. We have successfully worked towards diversifying our customer base to put less reliance on any one customer; however, the loss of one of our major customers would decrease our revenues and net income.





Raw Materials





We import flax primarily from Europe where there is a sufficient supply of flax but limited linen production as the center of the world’s linen production has shifted from Europe to China in the past two decades. The areas of China where flax is typically grown include areas near our factory in Lanxi County, Heilongjiang Province. Flax grown in China is generally of lower quality than the flax available from Europe.




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Historically, the price of flax has been stable and only experienced small fluctuations. We usually have long term relationships with our suppliers and were able to obtain raw materials at stable prices with long term contracts. In 2009, because of the effects of the 2008 financial crisis and the slow recovery of the global economy, we believed in the possibility that the price of flax would decrease. The price of fax actually rose slightly in 2010 due to higher cotton prices. In light of this and based our many years of business operation experience, we expect the raw material price of flax will continue to succumb to slight fluctuations going forward. The ability to continue to source flax is a significant risk faced by us.





We currently import the flax we require primarily from France, Belgium and the Netherlands and we currently rely on our affiliate, Harbin Zhongyi Sunshine Linen Co., Ltd., Ltd., which is controlled by our Chief Executive Officer and chairman, to source and import part of the flax we require annually on our behalf. We have an Agency Agreement with Harbin Zhongyi pursuant to which Harbin Zhongyi purchases and imports flax on our behalf and resells it to us at a price equal to cost plus 6%. The price of flax is subject to market forces largely beyond our control, including weather, plantings, government farm programs and policies, and market demand. We have not faced a shortage in supply of flax and do not anticipate such shortage in foreseeable future.





Competition





The linen textile industry is highly competitive, but our management believes that, for various reasons, we are well positioned to maintain a competitive position within the industry.





We have many competitors, several of which are larger than us. However, many of the large competitors only make thread and do not have the capability of also producing fabric. These competitors sell their thread to smaller companies which weave the thread into cloth. We make and sell thread to other companies, but we are also one of the largest manufacturers of linen cloth in China. In addition, our production facility operates on a continuous 24-hour per day basis, and is capable of producing different grade and quality products in order to satisfy the specifications and meet the demands of clients.





Heilongjiang province is considered to be the base of the linen industry in China because it is the area of the country where flax has traditionally been grown. As a result, we have been able to hire an experienced and capable management team. In addition, we have a good supply of labor available at rates of pay which are lower than those typically paid to workers in southern China.





We have been able to take advantage of special laws established by the central government of the PRC which are designed to encourage and support growth of industry in northeast China. These include a special waiver of tax on imports of manufacturing equipment, and a waiver of import tax on raw materials imported by companies, such as ours, which manufacture goods for export.





We are positioned to supply end-users for linen yarn and linen fabric, as linen yarn is sold to weaving factories and linen fabric is sold to dyeing and finishing plants. Due to the long industrial chain, the gross profit of linen fabric is higher than that of linen yarn. We predominantly sell linen fabric, which accounts for around 89% of our revenue.





Our subcontracting businesses specialize in processing linen yarn and linen fabric on behalf of third parties, which are handled by our spinning factory and weaving factory. Our subcontracting businesses only account for a small proportion of our production capacity. Our subcontracting business that specializes in processing linen yarn accounted for 0.2% of our revenue and no subcontracting business that specializes in processing linen fabric accounted for our revenue in 2010.





We also face many competitive challenges. If we wish to maintain a dominant position, we must recruit the most talented personnel with experience in industry technology, marketing, production, and management. We must also purchase and maintain the most advanced equipment as well as create or purchase unique technology that will keep us at the forefront of the industry. Finally there is also the challenge of maintaining a long term and stable customer base while also developing new customers.





Intellectual Property





We have registered the trademark “Fairy Deer” which we intend to use to seek to establish a recognizable brand for our products.





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We have established a technological center where we conduct our research on processes related to linen production, including such projects as work in developing high count flax yarn, multi-fiber blended fabric and other functional products as well as research related to linen yarn dyeing techniques, linen fabric bleaching and dyeing technologies, development of linen yarn-dyed fabric and development of finished linen garments. We seek to use any technological advances we make in our own production process but have not sought patent protection for any such advances.





Legal Proceedings





From time to time, we have disputes that arise in the ordinary course of our business. Currently, there are no material legal proceedings to which we are a party, or to which any of our property is subject, that will have a material adverse effect on our financial condition.





C.
Organizational Structure





The chart below depicts our corporate structure as of the date hereof. As depicted below, we own 100% of the capital stock of Bright and have no other subsidiaries. Bright owns 95% of the capital stock of Lanxi Sunrise, the entity through which we conduct all of our business operations. Mr. Gao, our Chief Executive Officer and chairman, owns the remaining 5% of Lanxi Sunrise. As of November 24, 2010, Lanxi Sunrise acquired Lanxi Tianxianfang and we have expanded our operations through Lanxi Tianxianfang.




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*Mr. Gao, our Chief Executive Officer and chairman, is party to an agreement (the “Creation Agreement”), dated April 15, 2010, with Creation International Development Investments Limited (“Creation”), and its sole shareholder, Mr. Gabriele Sanesi, pursuant to which Mr. Gao may acquire all of the shares of Creation if the net income of Lanxi Sunrise from January 1, 2010 to June 30, 2010 is no less than US$2 million upon the affirmative exercise of Mr. Gao’s right to receive such shares upon the achievement of this net income level. Although the net income of Lanxi Sunrise was no less than US$2 million from January 1, 2010 to June 30, 2010, Mr. Gao has not affirmatively exercised his right to receive all of the shares of Creation as of the date hereof. Further, pursuant to the Creation Agreement, Mr. Sanesi has granted to Mr. Gao an irrevocable right to exercise Mr. Sanesi’s rights as shareholder and director of Creation. Accordingly, although Mr. Gao has not affirmatively exercised his right to receive shares of Creation as of the date hereof, Mr. Gao still controls Creation and may ultimately also own as record holder all of the stock of Creation.





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D.
Property, Plants and Equipment




All land in the PRC is owned by the government and cannot be sold to any individual or entity. Instead, the government grants landholders a "land use right" after a purchase price for such "land use right" is paid to the government. The "land use right" allows the holder the right to use the land for a specified long-term period of time and enjoys all the incidents of ownership of the land. The following are the details regarding China Linen’s land use rights with regard to the land that it uses in its business.





Land Use Rights





User of the Land
Heilongjiang Lanxi Sunrise Linen Textile Industry Co. Ltd.Location
Second Neighborhood, Xinli Street, LanxiUsage
For Industrial EnterpriseArea ( m2)
1,495.55 m2Form of Acquisition
TransferExpiration Date
December 29, 2054User of the Land
Heilongjiang Lanxi Sunrise Linen Textile Industry Co. Ltd.Location
Ninth Neighborhood, Xinli Street, LanxiUsage
For Industrial EnterpriseArea ( m2 )
6,685.4 m2Form of Acquisition
TransferExpiration Date
December 29, 2054User of the Land
Heilongjiang Lanxi Sunrise Linen Textile Industry Co. Ltd.Location
Fourth Neighborhood, East Town Street, LanxiUsage
For Industrial LandArea ( m2 )
44,134 m2Form of Acquisition
TransferExpiration Date
August 15, 2056


User of the Land
Lanxi Tianxianfang Linen Co., Ltd.Location
Fourth Neighborhood, East Town Street, LanxiUsage
For Industrial LandArea (m2)
12,002 m2Form of Acquisition
TransferExpiration Date
August 22, 2056
 
 User of the Land
Lanxi Tianxianfang Linen Co., Ltd.Location
Fourth Neighborhood, East Town Street, LanxiUsage
For Industrial LandArea (m2)
29,212 m2Form of Acquisition
TransferExpiration Date
July 12, 2056




In accordance with the aforementioned land use rights, our principal executive offices are located at Chengdong Street, Lanxi County, Heilongjian Province, PRC, where the Company owns an office building of approximately 28,000 square meters on a land space of 52,000 square meters.





The Company operates one yarn-spinning factory, two weaving factories, one bleaching factory and one yarn dyeing workshop, office facilities and a dormitory for works . The equipment in the factories includes 10,000 wet-spinning spindles, 192 sets of rapier looms and more than 400 sets of other types of textile technological processing equipment.





The main products we produce at this facility are linen yarn and linen fabric. We also design and produce other linen fabrics in various specifications requested by our customers including linen fabric, interwoven or blended fabrics such as cotton/linen blend or rayon/linen interwoven or blended, semi-bleached fabric, piece-dyed fabric, jacquard fabric and yarn dyed fabric.





We currently operate our factories on a 24-hour per day basis with three shifts of employees. Operating at full capacity, the factories have an annual production capacity of 2,200 tons of pure semi-bleached linen yarn and gray yarn in various specifications, and approximately 10 million meters of linen fabric.





E.
China Regulations





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





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Measures for the Administration of Quality Supervision of BastFibres





On April 22, 2005, General Administration of Quality Supervision, Inspection and Quarantine of the PRC, or AQSIQ issued Measures for the Administration of Quality Supervision of BastFibres (“Quality Measure”) which came into effect on July 1, 2005. Quality Measure has set out the requirements on quality assurance with which the PRC enterprises engaging in the sales and processing of hemp fibres (including flax fibres) shall comply. Moreover, AQSIQ has the authority to collect product sample for the purpose of quality inspection.





Foreign Investment in PRC Operating Companies





The Foreign Investment Industrial Catalogue issued jointly by MOFCOM and the National Development and Reform Commission or the NDRC in 2007 classified various industries/businesses into three different categories: (i) encouraged for foreign investment; (ii) restricted to foreign investment; and (iii) prohibited from foreign investment. For any industry/business not covered by any of these three categories, they will be deemed industries/businesses permitted to have foreign investment. Except for those expressly provided restrictions, encouraged and permitted industries/businesses are usually 100% open to foreign investment and ownership. With regard to those industries/businesses restricted to or prohibited from foreign investment, there is always a limitation on foreign investment and ownership. The PRC Subsidiary’s business does not fall under the industry categories that are restricted to, or prohibited from foreign investment and is not subject to limitation on foreign investment and ownership.





Regulation of Foreign Currency Exchange





Foreign currency exchange in the PRC is primarily governed by a series of regulations, including the Regulations on Exchange Control of the PRC (2008), and the Administrative Regulations Regarding Settlement, Sale and Payment of Foreign Exchange (1996), as amended. Under these regulations, the Renminbi is freely convertible for trade and service-related foreign exchange transactions, but not for direct investment, loans or investments in securities outside the PRC without the prior approval of the SAFE. Pursuant to the Administrative Regulations Regarding Settlement, Sale and Payment of Foreign Exchange (1996), foreign invested enterprises (“FIEs”), such as Lanxi Sunrise, may purchase foreign exchange without the approval of the SAFE for trade and service-related foreign exchange transactions by providing commercial documents evidencing these transactions. They may also retain foreign exchange, subject to a cap approved by SAFE, to satisfy foreign exchange liabilities or to pay dividends. However, the relevant Chinese government authorities may limit or eliminate the ability of FIEs to purchase and retain foreign currencies in the future. In addition, foreign exchange transactions for direct investment, loan and investment in securities outside the PRC are still subject to limitations and require approvals from the SAFE.





Regulation of FIEs’ Dividend Distribution





The principal laws and regulations in the PRC governing distribution of dividends by FIEs include:





(i)
The Sino-foreign Equity Joint Venture Law (1979), as amended, and the Regulations for the Implementation of the Sino-foreign Equity Joint Venture Law (1983), as amended;





(ii)
The Sino-foreign Cooperative Enterprise Law (1988), as amended, and the Detailed Rules for the Implementation of the Sino-foreign Cooperative Enterprise Law (1995), as amended;





(iii)
The Foreign Investment Enterprise Law (1986), as amended, and the Regulations of Implementation of the Foreign Investment Enterprise Law (1990), as amended;





(iv)
Regulations on Exchange Control of the PRC (2008); and





(v)
Administrative Regulations Regarding Settlement, Sale and Payment of Foreign Exchange (1996).





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Under these regulations, an FIE in the PRC may pay dividends only out of the FIE’s profits, if any, after the payment of its enterprise income tax and contributions to its reserve fund, employee bonus and welfare fund and enterprise development fund at percentages that are decided by its board of directors; and such net profits shall be distributed in proportion to the contributions to the registered capital of the parties to the venture. Moreover, the registered capital contribution of an FIE must be fully paid before any profit or dividend of the FIE is remitted abroad; where the registered capital contribution of an FIE is not been fully paid due to special circumstances, profits or dividends of the FIE can be remitted abroad only if approvals from competent authorities have been obtained; furthermore, an FIE may only remit profits or dividends abroad at authorized banks and must comply with certain procedural requirements, such as providing the Foreign Invested Enterprise Foreign Exchange Registration Certificate, the resolution of the board of directors for the distribution of profits, the capital verification report issued by certified public accountants, the audit report and the tax payment documentation, etc.





Regulation of a Foreign Currency’s Conversion into RMB and Investment by FIEs





On August 29, 2008, the SAFE issued a Notice of the General Affairs Department of the State Administration of Foreign Exchange on the Relevant Operating Issues concerning the Improvement of the Administration of Payment and Settlement of Foreign Currency Capital of Foreign-Invested Enterprises or Notice 142, to further regulate the foreign exchange of FIEs. According to the Notice 142, FIEs shall obtain verification report from a local accounting firm before converting its registered capital of foreign currency into Renminbi. The Notice 142 provides that the Renminbi capital converted from foreign currency registered capital of a FIE may only be used for purposes within the business scope approved by the applicable governmental authority and may not be used for equity investments within the PRC, unless it is provided for otherwise.





Regulation of Foreign Exchange in Certain Onshore and Offshore Transactions





On October 21, 2005, the SAFE issued the Notice on Issues Relating to the Administration of Foreign Exchange in Fund-raising and Return Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies, or SAFE Notice 75, which became effective as of November 1, 2005. SAFE Notice 75 states that PRC residents, whether natural or legal persons, must register with the relevant local SAFE branch prior to establishing or taking control of an offshore entity established for the purpose of overseas equity financing involving onshore assets or equity interests held by them. The term “PRC legal person residents” as used in SAFE Notice 75 refers to those entities with legal person status or other economic organizations established within the territory of the PRC. The term “PRC natural person residents” as used in SAFE Notice 75 includes all PRC citizens and all other natural persons, including foreigners, who habitually reside in the PRC for economic benefit.





PRC residents are required to complete amended registrations with the local SAFE branch upon: (i) injection of equity interests or assets of an onshore enterprise to the offshore entity, or (ii) subsequent overseas equity financing by such offshore entity. PRC residents are also required to complete amended registrations or filing with the local SAFE branch within 30 days of any material change in the shareholding or capital of the offshore entity, such as changes in share capital, share transfers and long-term equity or debt investments or, providing security, and these changes do not relate to return investment activities. PRC residents who have already organized or gained control of offshore entities that have made onshore investments in the PRC before SAFE Notice 75 was promulgated must register their shareholdings in the offshore entities with the local SAFE branch on or before March 31, 2006.





Under SAFE Notice 75, PRC residents are further required to repatriate into the PRC all of their dividends, profits or capital gains obtained from their shareholdings in the offshore entity within 180 days of their receipt of such dividends, profits or capital gains. The registration and filing procedures under SAFE Notice 75 are prerequisites for other approval and registration procedures necessary for capital inflow from the offshore entity, such as inbound investments or shareholders loans, or capital outflow to the offshore entity, such as the payment of profits or dividends, liquidating distributions, equity sale proceeds, or the return of funds upon a capital reduction.





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Government Regulations Relating to Taxation





On March 16, 2007, the National People’s Congress, approved and promulgated the EIT Law, which took effect on January 1, 2008. Under the EIT Law, FIEs and domestic companies are subject to a uniform tax rate of 25%. The EIT Law provides a five-year transition period starting from its effective date for those enterprises which were established before the promulgation date of the EIT Law and which were entitled to a preferential lower tax rate under the then-effective tax laws or regulations.





On December 26, 2007, the State Council of the PRC issued Circular 39, providing that the enterprises that had been approved to enjoy a low tax rate prior to the promulgation of the EIT Law will be eligible for a five-year transition period since January 1, 2008, during which time the tax rate will be increased step by step to the 25% unified tax rate set out in the EIT Law. From January 1, 2008, for the enterprises whose applicable tax rate was 15% before the promulgation of the EIT Law, the tax rate will be increased to 18% for year 2008, 20% for year 2009, 22% for year 2010, 24% for year 2011, and 25% for year 2012. For the enterprises whose applicable tax rate was 24%, the tax rate was changed to 25% beginning on January 1, 2008.





Under the EIT Law, enterprises are classified as “resident enterprise” and “non-resident enterprise” and an enterprise established outside of the PRC with “de facto management bodies” within the PRC is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. On December 6, 2007, the State Council promulgated the implementation rules to the EIT Law, which also became effective on January 1, 2008 and define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise.





On April 22, 2009, the State Administration of Taxation issued the Notice Regarding the Determination of Chinese-Controlled Offshore Incorporated Enterprises as PRC Tax Resident Enterprises on the Basis of De Facto Management Bodies, or SAT Circular 82. SAT Circular 82 provides certain specific criteria for determining whether the "de facto management body" of a Chinese-controlled offshore-incorporated enterprise is located in China. “Chinese-controlled offshore enterprise” refers to an enterprise which is formed and registered abroad by an enterprise or enterprise group located in China as the major controlling investor under the law of a foreign country (region).





According to the SAT Circular 82, a Chinese-controlled offshore incorporated enterprise will be regarded as a PRC tax resident by virtue of having "de facto management body" in China only if all of the following conditions set forth in the SAT Circular 82 are met: (i) the primary location of the day-to-day operational management is in the PRC; (ii) decisions relating to the enterprise's financial and human resource matters are made or are subject to approval by organizations or personnel in the PRC; (iii) the enterprise's primary assets, accounting books and records, company seals, and board and shareholder resolutions are located or maintained in the PRC; and (iv) at least 50% of voting board members or senior executives habitually reside in the PRC.





Furthermore, a Chinese-controlled enterprise may file a resident enterprise application to the competent tax authority of the place where its de facto management body or where the major Chinese investor is located, and the competent tax authority shall, after the preliminary examination, report, level by level, its identity of resident enterprise to the State Administration of Taxation for confirmation. If an overseas Chinese-controlled enterprise fails to file a resident enterprise application, the competent tax authority of the place where its major Chinese investor is located may make a preliminary judgment about whether it is a Chinese resident enterprise according to the information available to it, and report to the State Administration of Taxation for confirmation.





Although SAT Circular 82 only applies to offshore enterprises controlled by PRC enterprises, not those controlled by PRC individuals, the determining criteria set forth in the SAT Circular 82 may reflect the State Administration of Taxation's general position on how the "de facto management body" test may be applied in determining the tax resident status of offshore enterprises.





Currently, the tax resident status of an enterprise is subject to determination by the competent PRC tax authorities and uncertainties remain with respect to the interpretation of the term "de facto management body" as applicable to our offshore entities, we may be considered a resident enterprise. If the PRC tax authorities determine that we and/or Bright is a “resident enterprise” for PRC enterprise income tax purposes, a number of PRC tax consequences could follow. Firstly, we and/or Bright may be subject to enterprise income tax at a rate of 25% on our worldwide taxable income, as well as PRC enterprise income tax reporting obligations. Secondly, dividends paid to us from our PRC Subsidiary through Bright (assuming we and Bright are treated as resident enterprises under the EIT Law) may qualify as “tax-exempt income”, but we cannot guarantee that such dividends will not be subject to PRC withholding tax. In addition, it could result in a situation in which a 10% PRC tax is imposed on dividends we pay to our non-PRC shareholders and gains derived by our non-PRC shareholders from transferring our shares, if such income is considered PRC-sourced income by the relevant PRC authorities.





33





According to Notice of the State Administration of Taxation on Issuing the Interim Measures for the Administration of Source-based Withholding of Enterprise Income Tax on Non-resident Enterprise (No. 3 [2009] of the State Administration of Taxation), the source-based withholding shall apply to the income from return on equity investment such as dividends and bonuses, interest, rents, royalties, income from assignment of property and other income subject to the enterprise income tax derived from China by non-resident enterprise, and the entities or individuals which are directly liable to make the relevant payments to the non-resident enterprises under the relevant legal or contractual provisions shall be the withholding agents; where the withholding agent failed to withhold or cannot perform the withholding obligations, the non-resident enterprise shall, within seven days after the payment or payment due for the dividends, file enterprise income tax to the competent tax authorities; where both parties to an equity transfer transaction which is conducted outside the PRC are non-resident enterprise, the non-resident enterprise which obtains the income shall file a tax return to the competent tax authority of the enterprise whose equity interests are transferred. The enterprise whose equity interests are transferred shall assist the tax authority in taxing the non-resident enterprise; where the non-enterprise again fails to pay tax within a certain time limit under a tax authority’s warning notice, the competent tax authority has the right to collect the enterprise income tax and charge late-payment surcharges from the non-enterprise’s income from other project(s) and its payable person in China, and send a Notice of Tax-related Matters, other income projects and its payable person is liable for the payable tax and overdue fine.





In such event, we may be required to withhold a 10% PRC tax on any dividends paid to non-resident investors. In addition, non-resident investors may be responsible for paying PRC tax at a rate of 10% on any gain realized from the sale or transfer of our shares if such non-resident investors and the gain satisfy the requirements under the EIT Law and its implementing rules, and we would not have an obligation to withhold income tax in respect of such gains.





If the PRC tax authorities determine that we and Bright are non-resident enterprises, dividends paid to us from our PRC Subsidiary will be subject to PRC withholding tax. The EIT Law and the implementing rules of the EIT Law provide that (A) an income tax rate of 25% will normally be applicable to non-resident enterprises which (i) have establishments or premises of business inside the PRC, and (ii) the income in connection with their establishment or premises of business is sourced from the PRC or the income is earned outside the PRC but has actual connection with their establishments or places of business inside the PRC, and (B) an income tax rate of 10% will be applicable to non-resident enterprises which (i) do not have an establishment or place of business in the PRC or (ii) have an establishment or place of business in the PRC, but the relevant income is not effectively connected with the establishment or place of business, to the extent such dividends are derived from sources within the PRC.





Regulations of Overseas Investments and Listings





On August 8, 2006, six PRC regulatory agencies, including the MOFCOM, the CSRC, the SASAC, the SAT, the SAIC and the SAFE, jointly amended and released the M&A Regulation, which became effective on September 8, 2006. The M&A Regulation is applicable to (i) foreign investors acquire equity interests or subscribe the capital increase of a PRC non-foreign investment company, or (ii) foreign investors establish a foreign investment company to acquire and operate assets of a PRC non-foreign investment company, or acquire assets of a PRC non-foreign investment company to establish a foreign investment company for operating such assets. The M&A Regulation requires that, if an overseas company established or controlled by PRC domestic companies or citizens intends to acquire equity interests or assets of any other PRC domestic company affiliated with the PRC domestic companies or citizens, such acquisition must be submitted to the MOFCOM, rather than local regulators, for approval. The M&A Regulation further addresses the special purpose vehicle, or “SPV” refers to an offshore company directly or indirectly controlled by a PRC individual or company for the purpose of taking the interests of its domestic company to list on an overseas stock market and further regulates that listing and trading of a SPV on an overseas stock market whose shareholders intend to acquire a PRC company in consideration of the SPV’s equity (“cross-border equity swap” ) shall be subject to the examination and approval of CSRC.





34





On September 21, 2006, the CSRC published on its official website procedures regarding its approval of overseas listings by SPVs. Other than documents required to be submitted, no other details with respect to the timing, criteria and process for obtaining any required approval from CSRC have been specified. Therefore, it remains unclear how the M&A Regulation or the CSRC procedures will be interpreted, amended and implemented by the relevant authorities.





Environmental Regulations





On December 26, 1989, the Standing Committee of the National People’s Congress issued the Environment Protection Law, setting forth the legal framework for environment protection in China. The Environmental Protection Law requires the State Administration of Environmental Protection to implement uniform supervision and administration of environmental protection standards nationwide and to establish national waste discharge standards. Local environmental protection bureaus are responsible for environmental protection in their jurisdictions and may set stricter local standards which are required to be registered at the State Administration of Environmental Protection. Companies are required to comply with the stricter of the two standards. Enterprises producing environmental contamination and other public hazards must incorporate the relevant environmental protection standards into their planning and establish environmental protection systems. These companies must also adopt effective measures to prevent environmental contamination and hazardous emissions, such as waste gas, waste water, deposits, dusts, pungent gases and radioactive matters as well as noise, vibration and magnetic radiation. Companies discharging contaminated wastes in excess of the discharge standards prescribed by the State Administration of Environmental Protection must pay non-standard discharge fees in accordance with national regulations and be responsible for the applicable remediation. Government authorities may impose different penalties against persons or companies in violation of the environmental protection laws and regulations depending on individual circumstances. Such penalties may include warnings, fines, imposition of deadlines for remediation, orders to cease certain operations, orders to reinstall contamination prevention and remediation facilities that have been removed or left unused, imposition of administrative actions against the responsible persons or orders to close down the company. Where the violation is deemed serious, responsible persons may be required to pay damages, and may be subject to criminal liability.





Regulations Relating to Employee Share Options





In December 2006, the People’s Bank of China promulgated the Administrative Measures of Foreign Exchange Matters for Individuals, setting forth the respective requirements for foreign exchange transactions by individuals (both PRC or non−PRC citizens) under either the current account or the capital account. In January 2007, the SAFE issued implementing rules for the Administrative Measures of Foreign Exchange Matters for Individuals, which, among other things, specified approval requirements for certain capital account transactions, such as a PRC citizen’s participation in employee stock ownership plans or share option plans of an overseas publicly listed company. On March 28, 2007, the SAFE promulgated the Application Procedures of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Ownership Plan or Stock Option Plan of Overseas Listed Company, or the Stock Option Rules. The purpose of the Stock Option Rules is to regulate the foreign exchange administration of PRC domestic individuals who participate in employee stock holding plans and share option plans of overseas listed companies.





According to the Stock Option Rules, if a PRC domestic individual participates in any employee stock ownership plan or share option plan of an overseas listed company, a PRC domestic qualified agent or the PRC subsidiary of such overseas listed company must, among other things, file, on behalf of such individual, an application with the SAFE or its local counterpart to obtain approval for an annual allowance with respect to the purchase of foreign exchange in connection with stock holding or share option exercises as PRC domestic individuals may not directly use overseas funds to purchase shares or exercise share options. Concurrent with the filing of such application with the SAFE or its local counterpart, the PRC domestic qualified agent or the PRC subsidiary shall obtain approval from the SAFE or its local counterpart to open a special foreign exchange account at a PRC domestic bank to hold the funds required in connection with the stock purchase or option exercise, any returned principal or profits upon sales of shares, any dividends issued on the stock and any other income or expenditures approved by the SAFE or its local counterpart. The PRC domestic qualified agent or the PRC subsidiary is also required to obtain approval from the SAFE or its local counterpart to open an overseas special foreign exchange account at an overseas trust bank with custody qualifications to hold overseas funds used in connection with any shares purchase.





35





Many issues with respect to the Stock Option Rules require further interpretation. We and our PRC citizen employees who have been granted share options, or PRC optionees, will be subject to these rules when our company becomes an overseas publicly-listed company. If we or our PRC optionees fail to comply with these regulations, we or our PRC optionees may be subject to fines and legal sanctions. However, as these rules have only been recently promulgated, it is currently unclear as to how these rules will be interpreted and implemented.





Regulations on Trademarks





Both the PRC Trademark Law, adopted in 1982 and revised in 1993 and 2001, and the Implementation Regulation of the PRC Trademark Law adopted by the State Council in 2002, give protection to the holders of registered trademarks. The Trademark Office, under the authority of the State Administration for Industry and Commerce, handles trademark registrations and grants rights for a term of ten years for registered trademarks, which may be renewed by the Trademark Office. The PRC Trademark Law has adopted a “first-to-file” principle with respect to trademark registration. Where a trademark for which a registration has been made is identical or similar to another trademark which has already been registered or been subject to a preliminary examination and approval for use on the same kind of or similar commodities or services, the application for registration of such trademark may be rejected. Any person applying for the registration of a trademark may not prejudice the existing right first obtained by others, nor may any person register in advance a trademark that has already been used by another party and has already gained a “sufficient degree of reputation” through such party’s use. Trademark license agreements must be filed with the Trademark Office or its regional offices.





Regulation on Employment





On June 29, 2007, the National People’s Congress promulgated the Labor Contract Law of PRC, or the Labor Law, which became effective as of January 1, 2008. On September 18, 2008, the PRC State Council issued the PRC Labor Contract Law Implementation Rules, which became effective as of the date of issuance.





Pursuant to the PRC Labor Contract Law and its implementation rules, employers must execute written labor contracts with full-time employees. All employers must compensate their employees with wages equal to at least the local minimum wage standards. All employers are required to establish a system for labor safety and sanitation, strictly abide by state rules and standards and provide employees with workplace safety training. Violations of the PRC Labor Contract Law may result in the imposition of fines and other administrative liabilities. Criminal liability may arise for serious violations.





In addition, employers in China are obliged to provide employees with welfare schemes covering pension insurance, unemployment insurance, maternity insurance, work-related injury insurance, medical insurance and housing funds.





PRC Antitrust Law





The PRC Antitrust Law was promulgated on August 30, 2007 and became effective on August 1, 2008. The government authorities in charge of antitrust matters in China are the Antitrust Commission and other antitrust authorities under the State Council. The PRC Antitrust Law regulates (i) monopoly agreements, including decisions or actions in concert that preclude or impede competition, entered into by business operators; (ii) abuse of dominant market position by business operators; and (iii) concentration of business operators that may have the effect of precluding or impeding competition.





Except for the exemptions set forth under Article 15 of the PRC Antitrust Law, competing business operators are prohibited from entering into monopoly agreements that fix or change commodity prices, restrict the production volume or sales volume of commodities, divide markets for sales or procurement of raw materials, restrict procurement of new technologies or new equipment or development of new technologies or new equipment, result in joint boycott of transactions or constitute monopoly agreements as determined by the antitrust authority.





36





In addition, business operators with the ability to control the price or quantity of commodities or other trading conditions or those with the ability to block or affect other business operators into the relevant markets are prohibited from engaging in certain business conducts that would result in abuse of their dominant market position.





Moreover, concentration of business operators refers to (i) merger with other business operators; (ii) gaining control over other business operators through acquisition of equity interest or assets of other business operators; and (iii) gaining control over other business operators through exerting influence on other business operators through contracts or other means. In the event of occurrence of any concentration of business operators and to the extent required by the Antitrust Law, the relevant business operators must file with the antitrust authority under the State Council prior to conducting the contemplated business concentration. If the antitrust authority decides not to further investigate whether the contemplated business concentration has the effect of precluding or impeding competition or fails to make a decision within 30 days from receipt of relevant materials, the relevant business operators may proceed to consummate the contemplated business concentration.





Tort Liability Law





The Tort Liability Law of the People’s Republic of China, which was passed during the 12th Session of the Standing Committee of the 11th National People’s Congress on December 26, 2009, states that manufacturers are liable for damages caused by defects in their products and sellers are liable for damages caused by defects attributable to their fault. If the defects are caused by the fault of third parties such as the transporter or storekeeper, manufacturers and sellers are entitled to claim for compensation from these third parties after paying the compensation amount.





Item 4A.
Unresolved Staff Comments





None.





Item 5.
Operating and Financial Review and Prospects





Explanatory Note





As discussed above, on March 23, 2011 the Company filed an Amended and Restated Memorandum of Association of the Company, which consolidates the share capital of the Company at a ratio of 3.5:1 by increasing the par value of the Company’s share capital from US$0.002 par value each to US$0.007 par value each, thereby reducing the number of authorized shares from US$1,000,000 divided into 500,000,000 ordinary shares of US$0.002 par value each to US$1,000,000 divided into 142,857,142.86 ordinary shares of US$0.007 par value each (the “Share Consolidation”). The market date of effectiveness of the Share Consolidation is March 30, 2011. The pro forma number of Ordinary Shares and earnings per share referred to throughout this annual report on Form 20-F assumes the Share Consolidation occurred as of the relevant report date.




Critical Accounting Policies




1.
In the application by us of accounting policies, which are described in the notes of the audited financial statements, management is required to make judgments, estimates and assumptions about the carrying amounts of assets and liabilities that are not readily apparent from other sources. The estimates and associated assumptions are based on historical experience and other factors that are considered to be relevant. Actual results may differ from these estimates.




The estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimate is revised if the revision affects only that period or in the period of the revision and future periods if the revision affects both the current and future periods.




37




The followings are 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.




(a)
Impairment of property, plant and equipment




Our property, plant and equipment comprise a significant portion of our total assets. Changes in technology or industry conditions may cause the estimated period of use or the value of these assets to change. Long-lived assets including property, plant and equipment are reviewed for impairment at least annually or whenever events or changes in circumstances have indicated that their carrying amounts may not be recoverable. If any such indication exists, the recoverable amount is estimated. The recoverable amount of an asset is the greater of its net selling price and value-in-use. In assessing value-in-use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset, which requires significant judgment relating to level of revenue and amount of operating costs. We use all readily available information in determining an amount that is a reasonable approximation of the recoverable amount, including estimates based on reasonable and supportable assumptions and projections of revenue and operating costs. Changes in these estimates could have a significant impact on the carrying value of the assets and could result in additional impairment charge or reversal of impairment in future periods.




(b)
Depreciation




Depreciation is calculated to write off the cost of items of property, plant and equipment, less their estimated residual value, if any, using the straight-line method over their estimated useful lives.




We review the estimated useful lives and residual values of the assets annually in order to determine the amount of depreciation expense to be recorded during any reporting period. The useful lives and residual values are based on our historical experience with similar assets and taking into account anticipated technological changes. The depreciation expense for future periods is adjusted if there are significant changes from previous estimates.




(c)
Impairment loss for doubtful accounts




We assess impairment loss for doubtful accounts based upon evaluation of the recoverability of the accounts receivable and other receivables at each balance sheet date. The estimates are based on the ageing of the accounts receivable and other receivables balances, customer credit-worthiness and the historical write-off experience, net of recoveries. If the financial condition of the customers were to deteriorate, actual write-offs would be higher than estimated.




(d)
Allowance for inventories




We make allowances for inventories based on assessment of the net realizable value of inventories. These estimates are based on the current market condition and the historical experience of manufacturing and selling products of similar nature. In addition, these estimates could change significantly as a result of change in customer preference and competitor actions in response to serve industry cycles. Allowance is applied to inventories where events or changes in circumstances indicate that the net realizable value is lower than the cost of inventories. The identification of obsolete inventories required the use of judgment and estimates on the conditions and usefulness of the inventories.




38




(e)
Sensitivity analysis




The functional currency of our subsidiary, Lanxi Sunrise, is in PRC currency “Renminbi,” or “RMB.”




The following table indicates the approximate change in our net income and retained profits that would arise if foreign exchange rate of RMB to which we have significant exposure at the balance sheet date had changed at that date, assuming all other risk variables remained constant.




2010


2009Increase / decrease in

Foreign exchange rate


Effect on net

Income

USD’000


Increase / decrease in

Foreign exchange rate


Effect on net

Income USD’000RMB


1
%


503



1
%


60




If the aggregate amount of our imports and exports were substantially similar for future periods, our sensitivity to foreign exchange rate fluctuation resulting from such activity could be reduced.




A.
Operating Results




Fiscal Years Ended December 31, 2010, 2009 and 2008




The following table summarizes the results of operations through Lanxi Sunrise during the fiscal years ended December 31, 2010, 2009 and 2008 and provides information regarding the dollar and percentage increase or (decrease) from the 2010 to 2009 fiscal period, and from the 2009 to 2008 fiscal period:





39




Item

2010


2009


2008


2010 V 2009


2009 V 2008Increase /

(Decrease)


Increase /

(Decrease)%


Increase /

(Decrease)


Increase /

(Decrease)%Revenue


49,090,643



29,386,131



22,945,122



19,704,512



67
%


6,441,009



28
%Cost of Goods Sold


33,880,012



20,675,443



17,648,852



13,204,569



64
%


3,026,581



17
%Gross Profit


15,210,631



8,710,688



5,296,270



6,499,943



75
%


3,414,418



64
%Gross Profit rate


31.0
%


29.6
%


23.1
%


1.4
%


5
%


6.5
%


28
%Operating Expenses


3,743,623



1,634,201



2,185,089



2,109,422



129
%


(550,888
)


25
%Other Income (expense)


1,600,771



795,716



952,502



805,055



101
%


(156,786
)


16
%Provision for Taxes


3,502,747



2,141,684



1,206,914



1,361,063



64
%


934,770



77
%Net income


9,565,032



5,730,519



2,856,769



3,834,513



67
%


2,873,750



101
%Basic Earnings per Share


0.47



0.28



0.15



0.19



68
%


0.13



87
%Diluted Earnings per Share


0.46



0.28



0.15



0.18



64
%


0.13



87
%Pro Forma Basic Earnings per Share


1.65



1.0



0.51



0.65



65
%


0.49



96
%Pro Forma Diluted Earnings per Share


1.61



1.0



0.51



0.61



61
%


0.49



96
%Weighted Average Shares Outstanding – Basic


20,251,490



20,108,333



19,511,256



143,157



1
%


597,077



3
%Weighted Average Shares Outstanding – Diluted


20,987,990



20,108,333



19,511,256



879,657



4
%


597,077



3
%Pro Forma Weighted Average Shares Outstanding – Basic


5,786,140



5,745,238



5,574,645



40,902



1
%


170,593



3
%Pro Forma Weighted Average Shares Outstanding – Diluted


5,996,569



5,745,238



5,574,645



251,331



4
%


170,593



3
%





40





Revenue




Revenue increased from $29,386,131 for the fiscal year ended December 31, 2009 to $49,090,643 for the fiscal year ended December 31, 2010, representing an increase of $19,704,512, or approximately 67%. The increase in revenue was primarily attributable to increased sales volume of linen fabric and linen yarn.




Revenue increased from $22,945,122 for the fiscal year ended December 31, 2008 to $29,386,131 for the fiscal year ended December 31, 2009, representing an increase of $6,441,009, or approximately 28%. The increase in revenue was primarily attributable to increased sales volume of linen fabric.




Cost of Goods Sold




Cost of goods sold increased from $20,675,443 for the fiscal year ended 2009 to $33,880,012 for the fiscal year ended 2010, representing an increase of $ 13,204,569 or approximately 64%. The increase in cost of goods sold was primarily attributable to the increase in sales volume.




Cost of goods sold increased from $17,648,852 for the fiscal year ended 2008 to $20,675,433 for the fiscal year ended 2009, representing an increase of $3,026,581, or approximately 17%. The increase in cost of goods sold was primarily attributable to the increase in sales volume.




41




Gross Profit




Gross profit increased from $8,710,688 for the fiscal year ended December 31, 2009 to $15,210,631 for the fiscal year ended December 31, 2010, representing an increase of $ 6,499,943, or approximately 75%. The increase in gross profit was mainly attributable to increases in sales in 2010. Gross profit for the fiscal year ended December 31, 2010 was approximately 31.0% of revenues as compared to gross profit of approximately 29.6% of revenues for the fiscal year ended December 31, 2009.




Gross profit increased from $5,296,270 for the fiscal year ended December 31, 2008 to $8,710,688 for the fiscal year ended December 31, 2009, representing an increase of $3,414,418, or approximately 64%. The increase in gross profit was mainly attributable to increases in sales in 2009, and because revenue per unit increased more than the cost per unit. Gross profit for the fiscal year ended December 31, 2009 was approximately 29.6% of revenues as compared to gross profit of approximately 23.1% of revenues for the fiscal year ended December 31, 2008.




Operating Expenses




Operating expenses increased by $ 2,109,422, or approximately 129%, in the fiscal year ended December 31, 2010 as compared to the fiscal year ended December 31, 2009. The increase in operating expenses was mainly attributable to an increase in general and administrative expenses such as counsel service fees and audit fees, etc.




Operating expenses decreased by $550,888, or approximately 25%, in the fiscal year ended December 31, 2009 as compared to the fiscal year ended December 31, 2008. The decrease in operating expenses was mainly attributable to a decrease of $772,716, or approximately 43%, in general and administrative expenses. Generally administrative expenses decreased primarily because of a decrease in stock-based compensation, which accounted for $844,200 of operating expenses for the fiscal year ended December 31, 2008, compared with only $8,984 in the fiscal year ended December 31, 2009.




Other Income




Other income increased from $795,716 for the fiscal year ended December 31, 2009 to $1,600,771 for the fiscal year ended December 31, 2010, representing an increase of $805,055 or approximately 101% compared to the fiscal year ended December 31, 2009. This increase was mainly due to the increase of government subsidies to Lanxi Sunrise of $845,262.




Other income decreased from $952,502 for the fiscal year ended December 31, 2008 to $795,716 for the fiscal year ended December 31, 2009, representing a decrease of $156,786, or approximately 16%. This decrease was mainly due to a decrease in government subsidies received by Lanxi Sunrise.




Provision for Taxes




Income taxes increased by $1,361,063 or 64% from $2,141,684 for the fiscal year ended December 31, 2009 to $ 3,502,747 for the fiscal year ended December 31, 2010, primary attributable to increase in income before tax, which was increased by $5,195,576 or 66%. Increase in income before tax is mainly derived from increase in revenues.




Provision for taxes increased by $934,770 or 77% from $1,206,914 for the fiscal year ended December 31, 2008 to $2,141,684 for the fiscal year ended December 31, 2009. Income before tax was $7,872,203 for the fiscal year ended December 31 2009, and $4,063,683 for the fiscal year ended December 31 2008. The decrease in operating expenses for the fiscal year ended December 31, 2009 compared to the fiscal year ended December 31, 2008 was primarily due to a decrease in stock-based compensation of $835,216, which resulted in a corresponding decrease in general and administrative expenses. Gross profit increased by $3,414,418 for the fiscal year ended December 31, 2009 compared to the fiscal year ended December 31, 2008, which was primarily due to an increase in revenue. As a result, income before tax increased by $3,808,520 for the fiscal year ended December 31, 2009 compared to the fiscal year ended December 31, 2008, and provision for taxes was accordingly increased.




42




Net income (profit after taxes)




Net income was $9,565,032 for the fiscal year ended December 31, 2010 as compared to $5,730,519 for the fiscal year ended December 31, 2009, representing an increase of $ 3,834,513, or approximately 67%. The increase in net income is primarily attributable to the below reasons. Revenue increased by $19,704,512, or 67% for the fiscal year ended December 31, 2010 compared to the fiscal year ended December 31, 2009. Gross profit increased by $6,499,943, or 75% from $8,710,688 for the fiscal year ended December 31, 2009 to $15,210,631 for the fiscal year ended December 31, 2010. Operating income increased by $4,390,521, or 62% from $7,076,487 in 2009 to $11,467,008 in 2010. Income before tax was $13,067,199 for the fiscal year ended December 31, 2010 compared to $7,872,203 for the fiscal year ended December 31, 2009, which accordingly resulted in an increase in net income.




Net income was $5,730,519 for the fiscal year ended December 31, 2009 as compared to $2,856,769 for the fiscal year ended December 31, 2008, representing an increase of $2,873,750, or approximately 101%. This increase in net income is primarily attributable to the below reasons. Revenue increased $6,441,009 for the fiscal year ended December 31, 2009 compared to the fiscal year ended December 31, 2008. Gross profit increased by $3,414,418 for the fiscal year ended December 31, 2009 compared to the fiscal year ended December 31, 2008, which was primarily due to the increase in revenue. The decrease in operating expenses for the fiscal year ended December 31, 2009 compared to the fiscal year ended December 31, 2008 was primarily due to a decrease in stock-based compensation of $835,216, which resulted in a $550,888 decrease in operating expenses for the fiscal year ended December 31, 2009. Income before tax was $7,872,203 for the fiscal year ended December 31, 2009 compared to $4,063,683 for the fiscal year ended December 31, 2008, which accordingly resulted in an increase in net income.




Inflation




The Company believes its operations have not been and will not be materially adversely affected by inflation or changing prices in the foreseeable future.




Foreign Currency Translation Gain




The Company’s operating subsidiary is located in China. Its functional and reporting currency is the Chinese Renminbi (“RMB”). The Company does not engage in currency hedging.




We incurred a foreign currency translation gain of $782,016 for the year ended December 31, 2010 as compared with a foreign currency translation gain of $32,149 for the fiscal year ended December 31, 2009. We used different exchange rates in translating Renminbi into U.S. dollars in our financial statements for the two fiscal years. Owners’ equity was translated at historic rates, assets and liabilities were translated at the applicable exchange rates on December 31, 2010 and 2009, respectively, and income and expenses during the year were translated at applicable average monthly end rates for 2010 and 2009, respectively.




Chinese Economic, Fiscal, Monetary and other Policy




The Company’s majority-owned operating subsidiary Lanxi Sunrise is located in China and the Company uses RMB as its functional currency, therefore, changes in Chinese economic, fiscal, monetary or political policies could materially affect our operations and investors. See Item 3 “- Key Information - D. Risk Factors - Risks Relating to Doing Business in China” for more details.




43




B.
Liquidity and Capital Resources





As of December 31, 2010, we had cash and cash equivalents of $4,162,069, and total current assets of $32,229,667. Management believes we have sufficient cash and current assets to fund current operations for the next fiscal year. As of December 31, 2010, we had a working capital surplus of $21,971,457. We anticipate that the combination of our sales and collection of accounts receivables, customer deposits and proceeds from bank and shareholder loans will generate sufficient cash flow to sustain our working capital needs. However we may require other sources of capital.




As of December 31, 2010, we had outstanding loans from the Agricultural Bank of China equal to $3,623,900 with an annual interest rate of 6.903%. As of December 31, 2009, we had outstanding loans from the Agricultural Bank of China equal to $4,048,583 with an annual interest rate of 6.903%.




On November 3, 2010, the Company entered into a securities purchase agreement with certain institutional and accredited investors (the “Investors”) for the issuance and sale of an aggregate of approximately $7,045,000 of 7.5% notes (the “Notes”) that are convertible into the Company’s ordinary shares, par value $0.002 (Pro forma par value $0.007) per share (the “Ordinary Shares”) for aggregate net proceeds of $6,418,293.As of November 3, 2010, the fair value of the Notes was evaluated as $8,580,000 by Roma Appraisals Limited, a Hong Kong professional appraisal and consulting firm. The effective interest rate of the Notes was 7.948% per annum and the liabilities on straight bond were $6,987,000. The embedded conversion option and call option of the Notes was $1,654,000 and ($61,000).




The following chart illustrates the percentage of accounts receivable attributable to our three largest customers.




Customer

Percentage of Accounts ReceivableSHAOXING YINXIANG LINEN AND COTTON TEXTILE CO., LTD.


4
%DISPLAY FASHION S.R.L./TANNY TEX S.R.L.


10
%PETA D.O.O.R.F./EAST &WEST TEXTILE TRADING LLP


9
%




C.
Research and Development




In April 2005, we established a technological center through which we conduct research and development activities related to production of linen products. The current research and development projects include development of high-count flax yarn, multi-fiber blended fabrics, research related to linen yarn dyeing and linen fabric bleaching and dyeing technologies. The research and development center includes approximately 25 research and technical staff including 5 staff members who are senior professionals.




Our technological center has established cooperative relationships with Tianjin Institute of Technology and Donghua University to take advantage of their research activities and our advanced production equipment to seek to develop new varieties of linen spinning yarns, woven cloth, yarn-dyed fabrics and other printed and dyed products.




And at the end of 2009, the Heilongjiang provincial government has formally approved Lanxi Sunrise, our majority-owned subsidiary, to build China’s first and only linen research and development center in China, the “Heilongjiang Provincial Linen New Products Research and Development Center.” The establishment of the linen research center in Heilongjiang will further our research and development capabilities and expedite the introduction of new linen products. The center is also expected to expand brand awareness of our products, thereby broadening our market reach.





44




D.
Trend Information





We do not foresee in the future any events that are reasonably likely to have a material effect on the Company’s continuing operations, capital liquidity, and profitability or capital resources. Nevertheless, generally, significant price changes in raw materials, continuing appreciation of RMB and rising labor cost could adversely affect our operation.





We will continue to increase sales volume by expanding in domestic and international markets. We plan to accomplish this by increasing our sales force and selling new high-demand products, such as yarn-dyed fabric, by increasing local agent counts, and by expanding into new markets like India and Turkey.





China’s linen industry traditionally has been fragmented. Small manufacturers hold a sizeable portion of the market, even though many of them are inefficient, outdated and have poor safety records. We believe that, in our industry, government policy is encouraging industry consolidation and greater investment in new technologies to improve production and safety. Given this fragmentation and the opportunity to grow, we will actively pursue advantageous acquisition opportunities to expand or improve the gross and net profit margins on our core products, or expanding by expanding overall margins by expanding into new operations, such as bleaching or yard-dyed fabric manufacturing.




E.
Off-Balance Sheet Arrangements




We currently do not engage in any off-balance sheet arrangements.




F.
Tabular Disclosure of Contractual Obligations




Below is a brief summary of the payment obligations under materials contracts to which we are a party as of December 31, 2010:




Contractual Obligations

Payments due by periodLess than 1

year


1-3 years


3-5 years


More than 5

yearsShort-Term Debt Obligations

$
3,623,900


$
-


$
-


$
-Capital (Finance) Lease Obligations


-



-



-



-Operating Lease Obligations


-



-



-



-Purchase Obligations


-



-



-



-Other Long-Term Liabilities Reflected on the Company’s Balance Sheet under the GAAP of the primary financial statements


-



-



-



-Total

$
3,623,900


$
-


$
-


$
-





45




Item 6.
Directors, Senior Management and Employees





A.
Directors, Senior Management and Employees





Executive Officers and Directors





Set forth below is information regarding our directors and executive officers as of April 4, 2011. All of the directors will serve until the next annual meeting of shareholders and until their successors are appointed, or until their earlier death, retirement, resignation or removal. Provided below is a brief description of our directors’ and executive officers’ business experience during the past five years and any directorships he/she has held in other companies, if any, subject to the reporting requirements under the federal securities laws. The business address of each such person is the address of the company, which is Chengdong Street, Lanxi County, Heilongjiang Province.





NAME

AGE

POSITIONGao Ren

47

Chief Executive Officer and Chairman of the BoardJodie Zheng Wehner

37

Chief Financial OfficerMa Yongfeng

49

Vice General ManagerTeng Yunhai

49

Vice General Manager and Executive DirectorZhao Chunfu

47

Vice General Manager, Secretary and DirectorLi Songyun

39

Chief Marketing OfficerStephen Monticelli

55

Independent director





Mr. Gao Ren has been the Chief Executive Officer and Chairman of our Board of Directors since July 2008. Before serving as the Chairman of the Board and general manager of our Company from June 2002 to July 2008, he was workshop director and section manager of the quality management section of Heilongjiang Lanxi Linen Textile Industry United General Corporation, and manager in the marketing department of Harbin Import & Export Group Corp. He graduated from Heilongjiang Radio and Television University in July 1984 with a degree in Industrial and Electric Automation. He also studied in the President Management Program of Tsing Hua University, Mr. Gao is a deputy to Heilongjiang Province People’s Congress, and has been awarded as “National Entrepreneur with Honesty in Business,” “China Enterprise New Man of the Year,” “Entrepreneur with Honesty in China Textile Industry Business” and “Model Worker of National Textile Industry.”





Ms. Jodie Zheng Wehner joins the Company with over 10 years of business and financial experience in both China and the US. During early 2010, Ms. Wehner was a portfolio manager at Gerken Capital Associates, an emerging markets hedge fund, where she oversaw the company’s Greater China fund. During 2008, she served as a senior equity analyst at Global Hunter Securities and was responsible for equity research on Chinese companies. From 2005 to 2007, Ms. Wehner was an equity analyst at CIBC Oppenheimer. Ms. Wehner graduated from the Medical School of Peking University with a bachelor’s degree in 1993 and earned her MBA degree from the University of Chicago Booth School of Business in 2002.





Mr. Ma Yongfeng is a general accountant and is a Vice General Manager of our Company. Mr. Yongfeng has been with the company since 2002. He was previously accountant, vice section chief, chief accountant, and financial officer of Heilongjiang Lanxi Linen Textile Industry United General Corporation from 1984 to 2002. He graduated from Heilongjiang Suihua College with an associate degree in linen textile in July 1983. He is also a graduate of CEO class of Tsinghua University.





Mr. Teng Yunhai is a senior engineer and currently serves as Vice General Manager and Executive Director of our Company. Mr. Yunhai has been with the company since June 2005. He was previously director of the equipment department of linen processing branch factory, director of equipment repair branch factory, and director of processing branch factory of Heilongjiang Lanxi Linen Textile Industry United General Corporation, and equipment principal engineer of Xinlong Holding Group Co., Ltd. from February 2002 to May 2005. He graduated from Qiqihar Light Industry Institute in July 1983 with a B.S. in light industry equipment.





46





Mr. Zhao Chunfuis a senior engineer and currently serves as the Vice General Manager, Secretary and as a Director of our Company since December 2007. He was previously Branch Factory Director, Technology Innovation Director and Manager of Import and Export Department of Heilongjiang Lanxi Linen Textile Industry United General Corporation, and Section Chief of Maintenance Operation Department of Xinlong Holding Group Co., Ltd. from February 2002 to November 2007. He graduated from North-East Heavy Machinery Institute in July 1984 with a B,S. degree in industrial and electric automation.





Ms. Li Songyun has been our chief marketing officer since June 2002. Her main responsibility is management of the sales of linen products. She was previously business manager of Harbin Import & Export Group Corp. She graduated from Heilongjiang University in July 1994 with B.A. in English.





Mr. Stephen Monticelliis founder and President of Mosaic Investments, an investment management firm based in San Francisco. Mosaic launched its first fund in 1998 and has since shifted its emphasis toward investing in China-based US listed companies. Mr. Monticelli has an investment career spanning 23 years and encompassing both private equity (buyouts and venture capital) and public equity. He previously served as principal at The Fremont Group (the primary investment vehicle for the Bechtel family) and also a Managing Director with Baccharis Capital, a venture-capital firm funded by another “Forbes 400” family. Prior to his investment career, Mr. Monticelli was a management consultant with Marakon Associates and a CPA with Deloitte and Touche. During his career, he has served on the board of directors of more than ten private and public companies, including currently serving on the Board of China New Media Corp (OTC-BB: CMDI), an outdoor media company based in Dalian, China. He holds an MBA and a BS degree from the Haas School of Business at the University of California at Berkeley.





Family Relationships





There are no family relationships between any of our directors or executive officers.





Understandings with Respect to Directors and Senior Management





There is no arrangement or understanding between any of the directors or officers of the Company and any other person pursuant to which any director or officer was or is to be selected as a director or officer, and there is no arrangement, plan or understanding as to whether non-management shareholders will exercise their voting rights to continue to elect the current directors to the company’s board. There are also no arrangements, agreements, or understandings between non-management shareholders and management under which non-management shareholders may directly or indirectly participate in or influence the management of the company’s affairs.





Employment Agreements





We have entered into employment agreements with each of our employees and officers. None of the employment agreements between a director and the Company or any of the Company’s subsidiaries provides for benefits upon termination of such director’s employment.





Gao Ren entered into an employment agreement without a fixed term with Lanxi Sunshine effective in January 2008 for an annual salary of RMB 42,000 ($6,070), which salary was adjusted by the board of directors to RMB 120,000 ($17,590) for 2009. Lanxi Sunrise may terminate the employment of Mr. Gao with thirty days’ advance written notice or by paying Mr. Gao an additional month of salary if 1) Mr. Gao is not competent to perform the job under the employment agreement, and remains so after being trained to take another position; 2) Mr. Gao falls ill or is injured due to work, after a medical leave is unable to return to his duties, and remains so after receiving training for his original or modified duties; or 3) the employment agreement cannot be fulfilled due to material changes of the objective circumstances and the parties cannot reach an agreement on the modification of the contract.





Jodie Zheng Wehner entered into an employment agreement for a term of three years, beginning September 1, 2010 and ending on August 31, 2013, with the Company for a base annual salary of RMB 850,000 ($125,000), plus any bonus program approved by the Company’s board of directors for the benefit of its senior executives. The Company may terminate the employment of Ms. Wehner for cause (as defined in the Employment Agreement) with sixty days’ advance written notice, in which event Ms. Wehner will be entitled to receive only her base salary and authorized benefits through the date of termination. In the event that the Company terminates the employment of Ms. Wehner without cause (as defined in the Employment Agreement) following the delivery of a notice of termination to Ms. Wehner, or should Ms. Wehner decide to resign from her position for good reason (as defined in the Employment Agreement), Ms. Wehner will receive a lump sum payment of any earned but unpaid base salary through the date of termination and any unpaid bonus for any calendar year preceding the year in which the termination occurs. In addition, should Ms. Wehner be terminated without cause by the company or should she resign for good reason, Ms. Wehner shall receive an additional year of base salary as set forth in the Employment Agreement.





47





Ma Yongfeng entered into an employment agreement for the position of Vice General Manager for a term of five years, beginning in January 2008 and ending in January 2013, with Heilongjiang Lanxi Sunshine Linen Textile Co., Ltd. for an annual salary of RMB 31,200 ($4,509), which salary was adjusted by the board of directors to RMB 60,000 ($8,795) for 2009. Lanxi Sunrise may terminate the employment of Mr. Ma with thirty days’ advance written notice or by paying Mr. Ma an additional month of salary if 1) Mr. Ma is not competent to perform the job under the employment agreement, and remains so after being trained to take another position; 2) Mr. Ma falls ill or is injured due to work, after a medical leave is unable to return to his duties, and remains so after receiving training for his original or modified duties; or 3) the employment agreement cannot be fulfilled due to material changes of the objective circumstances and the parties cannot reach an agreement on the modification of the contract.





Teng Yunhai entered into an employment agreement for a term of five years, beginning in January 2008 and ending in January 2013, with Lanxi Sunshine for an annual salary of RMB 25,200 ($3,642), which salary was adjusted by the board of directors to RMB 36,000 ($5,277) for 2009. Lanxi Sunrise may terminate the employment of Mr. Teng with thirty days’ advance written notice or by paying Mr. Teng an additional month of salary if 1) Mr. Teng is not competent to perform the job under the employment agreement, and remains so after being trained to take another position; 2) Mr. Teng falls ill or is injured due to work, after a medical leave is unable to return to his duties, and remains so after receiving training for his original or modified duties; or 3) the employment agreement cannot be fulfilled due to material changes of the objective circumstances and the parties cannot reach an agreement on the modification of the contract.





Zhao Chunfu entered into an employment agreement for the position of Vice General Manager for a term of five years, beginning in January 2008 and ending in January 2013, with Heilongjiang Lanxi Sunshine Linen Textile Co., Ltd. for an annual salary of RMB 27,600 ($3,989), which salary was adjusted by the board of directors to RMB 36,000 ($5,277) for 2009. Lanxi Sunrise may terminate the employment of Mr. Zhao with thirty days’ advance written notice or by paying Mr. Ma an additional month of salary if 1) Mr. Zhao is not competent to perform the job under the employment agreement, and remains so after being trained to take another position; 2) Mr. Zhao falls ill or is injured due to work, after a medical leave is unable to return to his duties, and remains so after receiving training for his original or modified duties; or 3) the employment agreement cannot be fulfilled due to material changes of the objective circumstances and the parties cannot reach an agreement on the modification of the contract.





Li Songyun entered into an employment agreement for a term of five years, beginning in January 2008 and ending in January 2013, with Lanxi Sunshine for an annual salary of RMB 25,200 ($3,694). Lanxi Sunrise may terminate the employment of Ms. Li with thirty days’ advance written notice or by paying Ms. Li an additional month of salary if 1) Ms. Li is not competent to perform the job under the employment agreement, and remains so after being trained to take another position; 2) Ms. Li falls ill or is injured due to work, after a medical leave is unable to return to her duties, and remains so after receiving training for her original or modified duties; or 3) the employment agreement cannot be fulfilled due to material changes of the objective circumstances and the parties cannot reach an agreement on the modification of the contract.





Stephen Monticelli entered into an employment agreement with the Company on August 30, 2010 to serve as an independent director of the Company until his respective successor is elected and qualified or he is reelected at the next annual stockholders’ meeting, or until his earlier death or resignation. Pursuant to the Independent Director Agreement, the compensation for the services to be provided by Mr. Monticelli shall consist of cash payments and grants of restricted ordinary shares as follows: 1) a one-time cash fee of $12,000, a fee of $3,000 per month in cash, paid in quarterly installments, and, in the event Mr. Monticelli is appointed to be the chair of an audit committee for the Company, a fee of $500 per month in cash, paid in quarterly installments, and 2) an aggregate of one hundred thousand restricted shares, par value $0.007 per share, that vest over a 3-year period in three installments of 9,524, 9,524 and 9,523 shares, on the date of the Independent Director Agreement, August 30, 2012 and August 30, 2013, respectively. The shares will be issued pursuant to a Restricted Stock Award Agreement by and between the Company and Mr. Monticelli dated August 30, 2010. Mr. Monticelli will also be reimbursed for reasonable out-of-pocket expenses associated with his service to the Company.





48





B.
Compensation





We have not paid our directors fees in the past for attending scheduled and special meetings of our board of directors. In the future, we may adopt a policy of paying independent directors a fee for their attendance at board and committee meetings. We do reimburse each director for reasonable expenses related to such director’s attendance at board of directors and committee meetings.





Summary Compensation Table





The following is a summary of the compensation we paid to our officers and directors for the three years ended December 31, 2008, 2009 and 2010.





Name and

principal position

Year

Salary

($)


Bonus

($)


Stock

awards

($)


Option

awards

($)


Non-equity

incentive

plan

compensation

($)


Change in

pension value

and

nonqualified

deferred

compensation

earnings

($)


All other

compensation

($)


Total

($)(a)

(b)

(c)


(d)


(e)


(f)


(g)


(h)


(i)


(j)Gao Ren

Chief Executive Officer and Chairman of the Board

2010


17,590



-



-



-



-



-



-



17,5902009


17,590



-



-



-



-



-



-



17,5902008


6,070



-



-



-



-



-



-



6,070Jodie Zheng Wehner (2)

Chief Financial Officer

2010


31,860



-



-



-



-



-



-



31,860Ma Yongfeng

Vice General
Manager

2010


8,795



-



-



-



-



-



-



8,7952009


8,795



-



-



-



-



-



-



8,7952008


4,509



-



-



-



-



-



-



4,509Teng Yunhai

Vice General Manager and Executive Director

2010


5,277



























5,2772009


5,277



-



-



-



-



-



-



5,2772008


3,642



-



-



-



-



-



-



3,642Zhao Chunfu

Vice General Manager, Secretary and Director

2010


5,277



























5,2772009


5,277



-



-



-



-



-



-



5,2772008


3,989



-



-



-



-



-



-



3,989Li Songyun

Chief Marketing Officer

2010


3,694



























3,6942009


3,694



-



-



-



-



-



-



3,6942008


3,642



-



-



-



-



-



-



3,642Stephen Monticelli

Director

2010


24,000



-



114,000



-



-



-



-



138,000Qi Shaofeng (1)(2)

Chief Financial Officer

2010


58,566



-



44,100



-



-



-



-



102,666Huang Xiaofang (1)

Chief Financial Officer

2010


308



-



-



-



-



-



-



3082009


3,694



-



-



-



-



-



-



3,6942008


3,642



-



-



-



-



-



-



3,642





49




(1) Mr. Qi Shaofeng replaced Mr. Huang Xiaofang as our chief financial officer on January 31, 2010.





(2) Ms. Jodie Wehner replaced Mr. Qi Shaofeng as chief financial officer on September 1, 2010.





C.
Board Practices





Director Independence





The board of directors currently composed of one independent director, Stephen Monticelli, and three non-independent directors, who are Gao Ren, our Chief Executive Officer, Teng Yunhai, our Vice General Manager and Executive Director, and Zhao Chunfu, our Vice General Manager and Secretary.





Board Composition and Committees





The board of directors is currently composed of four members. All board action requires the approval of a majority of the directors in attendance at a meeting at which a quorum is present.





We do not currently have a standing audit, nominating or compensation committee. Currently, our entire board of directors is responsible for the functions that would otherwise be handled by these committees. We intend to establish an audit committee, a governance and nominating committee and a compensation committee of the board of directors as soon as is practicable. We envision that the audit committee will be primarily responsible for reviewing the services performed by our independent auditors, evaluating our accounting policies and our system of internal controls. The governance and nominating committee will be responsible for nominating directors to our board and will also be generally responsible for overseeing our corporate governance policies and practices. The compensation committee will be primarily responsible for reviewing and approving our salary and benefits policies (including stock options) and other compensation of our executive officers. The board of directors has not made a determination as to whether any member of the board of directors is an audit committee financial expert.





Our board of directors has not made a determination as to whether any member of our board is an audit committee financial expert. Upon the establishment of an audit committee, the board will determine whether any of the directors qualify as an audit committee financial expert.





Board of Directors





Each of the directors named above were elected or appointed to serve until the next annual meeting of the company’s shareholders or until their successors have been appointed or duly elected and qualified. Thereafter, directors will be elected for one-year terms at the annual shareholders’ meeting. Officers are elected by and serve at the discretion of the Board.





There is no arrangement or understanding between any of our directors or officers and any other person pursuant to which any director or officer was or is to be selected as a director or officer, and there is no arrangement, plan or understanding as to whether non-management shareholders will exercise their voting rights to continue to elect the current directors to the board of directors. There are also no arrangements, agreements, or understandings between non-management shareholders and management under which non-management shareholders may directly or indirectly participate in or influence the management of our affairs.





50





Audit Committee Financial Expert





We do not currently have an audit committee, and our Board of Directors has not determined that one of its members is an audit committee financial expert.





Code of Ethics





We have adopted a Code of Ethics that applies to our Board of Directors, chief executive officer, chief financial officer, and other senior financial officers.





D.
Employees





As of December 31, 2008, we had 1,500 full-time employees, of whom approximately 70 were administrative and accounting staff, 110 were research and development staff, 40 were sales staff, and the remaining 1,280 were production workers.





As of December 31, 2009, we had approximately 1,246 full-time employees, of whom 60 were administrative and accounting staff, 70 were information technology staff, 40 were sales staff, and the remaining 1,076 were production workers.





As of December 31, 2010, we have 1400 full-time employees, of whom 62 are administrative and accounting staff (including 40 who also perform duties as technological staff), 73 are technological staff, 40 are sales staff, and the remaining 1,225 are production workers.





As required by applicable Chinese law, we have entered into employment contracts with all of our officers, managers and employees. Our employees in China participate in a state pension plan organized by Chinese municipal and provincial governments. We are required to contribute a percentage of their monthly salary to the plan.





E.
Share Ownership





See Item 7, below.





Item 7.
Major Shareholders and Related Party Transactions





A.
Major Shareholders





The following table sets forth, as of March 31, 2011, the stock ownership of each executive officer and director of the company, of all the executive officers and directors of the company as a group, and of each person known by the company to be a beneficial owner of 5% or more of its ordinary shares. Except as otherwise noted, each person listed below is the sole beneficial owner of the shares and has sole investment and voting power as to such shares. No person listed below has any options, warrant or other right to acquire additional securities of the company, except as may be otherwise noted. All shares have identical voting rights. Beneficial ownership is determined in accordance with SEC rules and generally includes voting or investment power with respect to securities. All share ownership figures include ordinary shares issuable upon securities convertible or exchangeable into ordinary shares within sixty (60) days.





51





Name and Address

Number of Shares

Beneficially Owned (6)


Percent

of Class (1)Creation International DevelopmentInvestments Limited (4)


2,339,683



40.12
%Gao Ren (4)


2,339,683



40.12
%Ma Yongfeng (2)(3)


–



–Teng Yunhai (2)(3)


911



0.02
%Li Songyun (2)(3)


41,102



0.71
%Zhao Chunfu (2)(3)


143,571



2.46
%Jodie Zheng Wehner (2)


–



–Stephen Monticelli (2)(5)


28,571



0.49
%All directors and officers as a group (7 persons)


2,553,838



43.8
%





(1)
Percentage of beneficial ownership held by each person is determined by dividing (i) the number of ordinary shares beneficially owned by such person as of March 31, 2011 by (ii) 5,832,058 ordinary shares outstanding as of March 31, 2011, plus, in the case of (ii), the number of ordinary shares such person has the right to acquire within 60 days of the date of March 31, 2011.


(2)
The person is an officer, a director or both. The business address of our directors and officers is Chengdong Street, Lanxi County, Heilongjiang Province, PRC.


(3)
These shares were received in connection with our share exchange that we consummated with Bright on July 9, 2008.


(4)
Mr. Gao, our Chief Executive Officer and chairman, is party to an agreement, dated April 15, 2010, with Creation International Development Investments Limited (“Creation”), and its sole shareholder, Mr. Gabriele Sanesi, pursuant to which Mr. Gao may acquire all of the shares of Creation in accordance with the terms and conditions set forth therein. Mr. Gabriele Sanesi has granted to Mr. Gao an irrevocable right to exercise his rights as shareholder and director of Creation International. Development Investments Limited. Accordingly, Mr. Gao is deemed the beneficial owner in the shares of the Company held by Creation.


(5)
Stephen Monticelli entered into an employment agreement with the Company on August 30, 2010 to serve as an independent director of the Company. Pursuant to the employment agreement, as part of compensation for services, the Company shall award to Mr. Monticelli an aggregate of 28,571 restricted shares, par value $0.007 per share.




(6)
On March 23, 2011 the Company filed an Amended and Restated Memorandum of Association of the Company, which consolidates the share capital of the Company at a ratio of 3.5:1 by increasing the par value of the Company’s share capital from US$0.002 par value each to US$0.007 par value each, thereby reducing the number of authorized shares from US$1,000,000 divided into 500,000,000 ordinary shares of US$0.002 par value each to US$1,000,000 divided into 142,857,142.86 ordinary shares of US$0.007 par value each (the “Share Consolidation”). The market date of effectiveness of the Share Consolidation is March 30, 2011. The number of shares beneficially owned by the majority of shareholders is set as of March 31, 2011.





As of February 15, 2011, the Company had 217 shareholders in the United States. The percentage of ordinary shares held in the United States was 6.69%.





B.
Related Party Transactions





2010 Restructuring





On April 15, 2010, so as to not violate certain applicable PRC regulations, all direct equity interests in us (approximately 40.51% of our outstanding ordinary shares) held on or behalf of Mr. Gao, our Chief Executive Officer and chairman was transferred to Creation. Gabriele Sanesi, a citizen of Italy, is the sole shareholder and director of Creation. Pursuant to an agreement dated April 15, 2010 among Creation and Messrs. Gao and Sanesi, or the “April 2010 Agreement,” Mr. Sanesi has granted Mr. Gao the irrevocable right to exercise his rights as a shareholder and director of Creation. In addition, in accordance with the April 2010 Agreement, Mr. Sanesi has agreed to transfer 100% of his equity interests in Creation to Mr. Gao if the net income of our company from January 1, 2010 to June 30, 2010 is no less than US$2.0 million.





52





Related Party Transactions





The Company’s relationships with related parties are described as follows:




Name

RelationshipRen Gao

CEO and Chairman of the GroupHarbin Zhongyi Sunshine Linen Co., Ltd.

Under common control by Ren GaoHarbin Sunshine Linen Textile Co., Ltd.

Under the control by Jun Gao*





* Jun Gao, the elder brother of Ren Gao, is considered as a related party.





Since the beginning of 2008, we entered into the following transactions with certain related parties, in addition to the share transactions noted above.





Agency Agreements





Both the importation of raw materials and the export of finished goods are partially done through Agency Agreements with Harbin Zhongyi Sunshine Linen Co., Ltd. (“Harbin Zhongyi” ) and Harbin Sunshine Linen Textile Co., Ltd. (“Harbin Sunshine”), our affiliates, which are controlled by Gao Ren, our Chief Executive Officer and chairman. Under the terms of the Agency Agreements, Harbin Zhongyi and Harbin Sunshine purchase and import flax on our behalf and resell it to us at a price equal to cost plus 6%. Harbin Zhongyi and Harbin Sunshine also act as our agents for export of finished goods, but do not charge a fee as part of the export process. Accordingly, finished goods to be exported are sold to Harbin Zhongyi and Harbin Sunshine and at a price equal to the price to be paid by the overseas buyer of the goods. Pursuant to these arrangements, we had amounts due from Harbin Sunshine Linen Textile Co, Ltd., totaling $79,879, as of December 31, 2010.





The following table summarizes related party transactions in the fiscal years 2010 and 2009, relating to selling finished goods, purchasing raw materials, processing products and selling linen yarn:





For the Year Ended

December 31, 2010


For the Year Ended

December 31, 2009Transactions

Amount


Percentage of

Total Similar

Transactions


Amount


Percentage of

Total Similar

Transactions(a) Selling finished goods to

Harbin Sunshine Linen Textile Co., Ltd.

$
186,162



0.4
%

$
4,169,833



14.2
%(b) Selling finished goods to

Harbin Zhongyi Sunshine Linen Co., Ltd

$
2,931,298



6.0
%

$
7,289,137



24.8
%(a) Purchasing raw materials from

Harbin Sunshine Linen Textile Co., Ltd.

$
-



0
%

$
41,337



1.05
%(b) Purchasing raw materials from

Harbin Zhongyi Sunshine Linen Co., Ltd

$
4,809,323



25
%

$
1,382,827



35.2
%





53





The following table summarizes related party transactions in the fiscal years ending December 31, 2009 and 2008 relating to selling finished goods, purchasing raw materials, processing products and selling linen yarn:





For the Year Ended December 31,2009


2008Transactions

Amount


Percentage

of

Total

Similar

Transaction


Amount


Percentage

of

Total

Similar

Transaction(a)
Selling finished goods to

Harbin Sunshine Linen Textile Co., Ltd.

$
4,169,833



14.2
%

$
4,161,201



18.9
%Purchasing raw materials from

Harbin Sunshine Linen Textile Co., Ltd.

$
7,289,137



24.8
%

$
1,444,461



54.5
%(b)
Selling finished goods to

Harbin Zhongyi Sunshine Linen Co., Ltd

$
41,337



1.05
%

$
1,554,289



7.1
%Purchasing raw materials from

Harbin Zhongyi Sunshine Linen Co., Ltd

$
1,382,827



35.2
%

$
911,015



34.4
%





Due from/to Related Parties





The Group purchases some raw materials from, and sells some finished goods to related parties. In addition, Harbin Zhongyi Sunshine Linen Co., Ltd and Harbin Sunshine Linen Textile Co., Ltd., at times act as the Group’s agents in importing raw materials and exporting products on similar terms with unrelated parties. Due from/to related parties derived from such transactions are disclosed separately from arm's length trading accounts receivable and payable. Cash flows from these activities are classified as cash flows from operating activities.




Due to related parties consist of the followings:




December 31,


December 31,Name of related parties

2010


2009Ren Gao

$
-


$
45,672Songyuan Qianan Sunshine Linen Co., Ltd.


-



29,216$
-


$
74,888




54




Due from related parties consist of the followings:




Name of related parties

December 31,


December 31,2010


2009Harbin Sunshine Linen Textile Co., Ltd.

$
79,879


$
515,479Harbin Zhongyi Sunshine Linen Co., Ltd.


-



2,061,100$
79,879


$
2,576,579





C.
Interests of experts and counsel.





Not required.





Item 8.
Financial Information





A.
Consolidated Statements and Other Financial Information.





The financial statements attached to this report were prepared in accordance with accounting principles generally accepted in the United States of America (“ U.S. GAAP”). The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. U.S. GAAP differs from that used in the statutory financial statements of Lanxi Sunrise, which were prepared in accordance with the relevant accounting principles and financial reporting regulations as established by the Ministry of Finance of the China. Certain accounting principles stipulated under U.S. GAAP are not applicable in China.





The Company and its subsidiary, Bright, maintain their books and accounting records in USD, which is determined as the functional currency. However, the functional currency of the company’s subsidiary, Lanxi Sunrise 1.using the historical rate of exchange when capital is injected. Income and expense accounts are translated at the average rate of exchange during the reporting period. Translation adjustments resulting from translation of these financial statements are reflected as other comprehensive income in the statements of operations and other comprehensive income and accumulated other comprehensive income in the statements of changes in shareholders’ equity.





The financial statements filed herewith are found in Item 17.





B.
Significant Changes





None.





Item 9.
The Offer and Listing





A.
Offer and Listing Details





Our ordinary shares are currently quoted by the Over the Counter Bulletin Board (“ OTC Bulletin Board”) under the symbol “CTXIF”.





55





The table below reflects the high and low bid prices for our ordinary shares for the period from November 1, 2009 through March 29, 2011. Prior to November 1, 2009, however, there was limited trading of our ordinary shares. The OTC Bulletin Board quotations reflect inter-dealer prices, are without retail markup, markdowns or commissions, and may not represent actual transactions.





Ordinary SharesHigh


LowAnnual Highs and Lows2009 (from November 1 through December 31) (1)

$
1.89


$
0.452010


1.99



0.80Quarterly Highs and Lows2009Fourth Quarter

$
1.89


$
0.452010First Quarter

$
1.90


$
1.32Second Quarter


1.90



0.80Third Quarter


1.65



0.82Fourth Quarter


1.55



1.152011First Quarter (through March 29)


1.60



0.81Monthly Highs and LowsMarch 2011(through March 29)

$
1.05



0.81February 2011


1.25



1.00January 2011


1.60



1.01December 2010


1.52



1.35November 2010


1.55



1.15October 2010


1.51



1.29





(1)
There were a limited number of trades of our ordinary shares during the period prior to November 1, 2009, which are not meaningful to report.





Number of Holders. As of March 29, 2011, there were 114 holders of record of our outstanding ordinary shares, though we believe that the number of beneficial holders is significantly greater.





Dividend Policy. We have not paid cash dividends on any of our ordinary shares since formation and we do not anticipate paying any dividends on our outstanding ordinary shares in the foreseeable future. We plan to retain any earnings to finance the development of the business and for general corporate purposes.





B.
Plan of Distribution





Not required





C.
Markets





Our ordinary shares have been quoted on the OTC Bulletin Board since June 3, 2008.





D.
Selling Shareholders





Not required.





E.
Dilution





Not required





56





F.
Expenses of the Issue





Not required








Item 10.
Additional Information





A.
Share Capital





Not required.





B.
Memorandum and Articles of Association





Charter





Our charter documents consist of our memorandum of association and articles of association. A brief description of our memorandum of association and articles of association follows. This description and summary does not purport to be complete and does not address all differences between United States and Cayman Islands corporate laws. Copies of our memorandum of association and articles of association have been filed as exhibits to this report and readers are urged to review these exhibits in their entirety for a complete understanding of the provisions of our charter documents.





Corporate Powers





We were incorporated in the Cayman Islands on February 3, 2000, under the Companies Law. The memorandum of association allows for the company to carry on business for a broad variety of purposes, and the company is not restricted from any lawful business activity.





Ordinary Shares





All issued and outstanding ordinary shares are fully paid and non-assessable. At any general meeting of the shareholders a resolution put to the vote of the meeting will be decided on a show of hands and every shareholder present in person or by proxy and entitled to vote will have one vote. On a poll every shareholder present in person or by proxy and entitled to vote will have one vote for each ordinary share of which he is the holder. The holders of ordinary shares will be entitled to dividends on a pro-rata basis, if declared by the board of directors and subject to the requirements of the Companies Law. There are no preferences, conversion rights, preemptive rights, subscription rights, or restrictions or transfers attached to the ordinary shares. In the event of liquidation, dissolution, or winding up of the company, the holders of ordinary shares are entitled to participate in the assets of the company available for distribution after satisfaction of the claims of creditors.





Changes in Capital





The company may, by ordinary resolution of the shareholders, amend the memorandum and articles of association to increase its authorized capital, and increase or decrease the number of authorized but unissued shares, or the par value of such shares.





The company may, by special resolution:





(a)
consolidate and divide all or any of its share capital into ordinary shares of a larger amount than its existing ordinary shares;





(b)
sub-divide its existing ordinary shares, or any of them, into ordinary shares of smaller amount than is fixed by the Memorandum of Association, subject nevertheless to the provisions of section 13 of the Companies Law; and





57





(c)
cancel any ordinary shares which, at the date of the passing of the resolution, have not been taken or agreed to be taken by any person.





Powers and Duties of Directors





Under the provisions of the Articles, Directors’ meetings must be held in the Cayman Islands every year. Annual General Meetings must be held once in every calendar year. Both Annual and Extraordinary General meetings must provide at least 21 days notice to shareholders. A quorum must be present to conduct business at any Annual or Extraordinary General meeting.





The directors manage or supervise the management of the affairs and business of the company and have authority to exercise all such powers of the company as are not, by the Companies Law (2009 Revision), or by the memorandum and articles of association, required to be exercised by the company or consented to by the shareholders.





Directors will serve as such until the next annual general meeting. In general, a director who is, in any way, directly or indirectly interested in an existing or proposed contract or transaction with the company whereby a duty or interest might be created to conflict with his duty or interest as a director, is to declare the nature and extent of his interest in such contract or transaction or the conflict or potential conflict with his duty and interest as a director. Such director may not vote in respect of any such contract or transaction with the company in which he is interested and if he does so, his vote will note be counted, but he will be counted in the quorum present at the meeting at which such vote is taken.





The directors may from time to time on behalf of the company: (a) borrow money in such manner and amount from such sources and upon such terms and conditions as they think fit; (b) issue bonds, debentures and other debt obligations; or (c) mortgage, charge or give other security on the whole or any part of the property and assets of the company. There is no minimum share ownership requirement for the company's directors.





Shareholders





An annual general meeting is to be held once in every calendar year at such time and place as may be resolved by the company in general meeting or, in default, at such time and place as the directors may determine, or, in default, at such time in the third month following that in which the anniversary of our continuation occurs, and at such place as the directors shall determine. A quorum at an annual general meeting and extraordinary meeting is two or more shareholders present in person or by proxy and entitled to vote.





Certain provisions of our memorandum and articles of association may have an anti-takeover effect and may delay, defer or prevent a tender offer or takeover attempt that a shareholder might consider to be in its best interest, including those attempts that might result in a premium over the market price being paid for the shares held by shareholders.





Certain of these provisions provide for:





·
requiring a special resolution, namely the affirmative vote of not less than sixty-six and two-thirds percent (66 2/3%) of such shareholders as being entitled to vote at a general meeting of the company in person or by proxy or a written resolution signed by all shareholders entitled to vote, generally to remove a director; and





·
appointing additional directors to the board by resolution of the existing directors (provided that such additional directors shall not exceed 1/3 in number of the directors elected at the last annual general meeting) or by an ordinary resolution, namely the affirmative vote of a majority of the shareholders entitled to vote at a duly convened meeting in person or by proxy.





These anti-takeover provisions could make it more difficult for a third party to acquire us, even if the third-party’s offer may be considered beneficial by many shareholders.





58





Ownership Threshold





There is no threshold at which an individual must declare shareholdings. SEC disclosure regulations require that holders of 5% or more of the issued securities must disclose such holdings


Transfer Agent and Registrar





The Transfer Agent and Registrar for our ordinary shares is Island Stock Transfer 100 Second Avenue South, Suite 705S, St. Petersburg, Florida, 33701, (727) 289-0010.





C.
Material Contracts





Immediately prior to our reverse acquisition with Bright, on June 9, 2008, Mr. Gao, our Chief Executive Officer and chairman, along with two employees of Lanxi Sunrise, purchased a total of 9257,143 shares, or approximately 39.58% of our issued and outstanding ordinary shares, from seven previous shareholders. The purchase price was $309,996, or approximately $0.34 per share, and resulted in the acquisition of 39.58% of our ordinary shares by Mr. Gao and the two employees of Lanxi Sunrise while we were still a shell company.





On June 30, 2008, we completed a 1:2 reverse stock split, thereby reducing its issued and outstanding shares from 649,713 to approximately 324,857.





Following this stock purchase transaction by Mr. Gao and the two Lanxi Sunrise employees, also on July 9, 2008, we acquired 100 shares of Bright, constituting all of the issued and outstanding capital stock of Bright. The 100 shares of Bright were acquired from the individual shareholders of Bright in a share exchange transaction in return for the issuance of 5,418,001 of our ordinary shares. As a result of the transaction, Bright became our wholly owned subsidiary. Bright is the registered beneficial owner of 95% of Lanxi Sunrise.





On April 15, 2010, so as to not violate certain applicable PRC regulations, all direct equity interests in our Company (approximately 40.51% of our outstanding ordinary shares) held by or on behalf of Mr. Gao, our Chief Executive Officer and chairman, was transferred to Creation. Mr. Gabriele Sanesi, a citizen of Italy, is the sole shareholder and director of Creation. Pursuant to an agreement dated April 15, 2010 among Creation and Messrs Gao and Sanesi (the “April 2010 Agreement”), Mr. Sanesi has granted Mr. Gao the irrevocable right to exercise his rights as a shareholder and director of Creation. In addition, in accordance with the April 2010 Agreement, Mr. Sanesi has agreed to transfer 100% of his equity interests in Creation to Mr. Gao if the net income of our company from January 1, 2010 to June 30, 2010 is no less than US$2.0 million.





On November 3, 2010, the Company entered into a securities purchase agreement with certain institutional and accredited investors (the “Investors”) for the issuance and sale of an aggregate of approximately $7,045,000 of 7.5% notes (the “Notes”) that are convertible into the Company’s ordinary shares, par value $.002 (pro forma $.007) per share.




On November 15, 2010, we, through our indirect 95% owned subsidiary, Lanxi Sunrise, entered into a Share Acquisition Agreement (the “Acquisition Agreement”) with Lanxi Tianxianfang Linen Co., Ltd. (“Lanxi Tianxianfang”, “Target”) and Shufan Wang (“Wang”) and Lijie Fu (“Fu”), the two shareholders of the Target. Pursuant to the Acquisition Agreement, Lanxi Sunrise has purchased all of the equity of the Target for a price of RMB 44,401,485 (approximately $6.7 million) (the “Purchase Price”), which Purchase Price was based on an appraisal report of the Target’s assets, liabilities and net assets as of March 31, 2010 by Heilongjiang Zhongming Guolin Asset Appraisal Co., Ltd.





D.
Exchange Controls.





Under Cayman Islands law, there are no exchange control restrictions in the Cayman Islands.





59




E.
Taxation.





The following summary of the material Cayman Islands and United States federal income tax consequences of an investment in ordinary shares is based upon laws and relevant interpretations thereof in effect as of the date of this annual report on Form 20-F, all of which are subject to change. Save for our discussion on local tax laws in the PRC, this summary does not deal with all possible tax consequences relating to an investment in our ordinary shares, such as the tax consequences under state, local and other tax laws.





Cayman Islands Taxation





The Government of the Cayman Islands, will not, under existing legislation, impose any income, corporate or capital gains tax, estate duty, inheritance tax, gift tax or withholding tax upon the company or its shareholders. The Cayman Islands are not party to any double taxation treaties.





We received an undertaking from the Governor-in-Cabinet of the Cayman Islands dated March 2000 that, in accordance with section 6 of the Tax Concessions Law (1999 Revision) of the Cayman Islands, for a period of 20 years from the date of the undertaking, no law which is enacted in the Cayman Islands imposing any tax to be levied on profits, income, gains or appreciations shall apply to us or our operations and, in addition, that no tax to be levied on profits, income, gains or appreciations or which is in the nature of estate duty or inheritance tax shall be payable (i) on the shares, debentures or other obligations of the company or (ii) by way of the withholding in whole or in part of a payment of dividend or other distribution of income or capital by the company to its members or a payment of principal or interest or other sums due under a debenture or other obligation of the company.





To be enforceable in the courts of the Cayman Islands, stamp duty will be chargeable on certain documents entered into by the Company as follows:





(i)
on agreements, in the sum of CI$2.00 each;


(ii)
on deeds, in the sum of CI$50.00 each;


(iii)
on a Promissory Note, in the sum of CI$500 if paid on execution or, if the fixed sum of CI$500 is not paid on the Promissory Note on execution, at the ad valorem rate of CI$0.25 (US$0.30) for each CI$100 (US$121.95) covenanted to be paid thereunder with a maximum duty on the Promissory Note of CI$250.00 (US$304.88);


(iv)
on mortgages or other documents creating a security interest, where the moveable property charged thereunder is located outside of the Cayman Islands, in the sum of up to CI$50.00 each as a deed or agreement; and


(v)
on any mortgages or other documents creating a security interest, where the property charged thereunder is located in the Cayman Islands, at the ad valorem rate of up to 1.5% of the principal sum secured, with a maximum duty of CI$500.00 in the case of a charge granted by an exempted company, an ordinary non-resident company or an exempted trust or a body corporate incorporated outside the Cayman Islands of moveable property situated in the Cayman Islands or over shares in such exempted company or an ordinary non-resident company, (or in the case of any charge determined to be collateral to a charge on which the ad valorem duty aforesaid has been paid, in the sum of CI$30.00 per collateral charge).





Ad valorem stamp duty is payable within 45 days of execution or, if executed outside of the Cayman Islands, within 45 days of an executed, completed and delivered original of such document being brought into the Cayman Islands, for example, for enforcement. Otherwise stamp duty is payable on execution in order to avoid penalties if such document is to be admitted in evidence in a Cayman Islands court.





People's Republic of China Taxation





On March 16, 2007, the National People's Congress of China enacted the Enterprise Income Tax Law of the PRC (“EIT Law”), which became effective on January 1, 2008. Under the EIT Law, enterprises are classified as “resident enterprise” and “non-resident enterprise” and an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. On December 6, 2007, the State Council promulgated the implementation rules to the EIT Law, which also became effective on January 1, 2008 and define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise.





60





On April 22, 2009, the State Administration of Taxation issued the Notice Regarding the Determination of Chinese-Controlled Offshore Incorporated Enterprises as PRC Tax Resident Enterprises on the Basis of De Facto Management Bodies, or SAT Circular 82. SAT Circular 82 provides certain specific criteria for determining whether the "de facto management body" of a Chinese-controlled offshore-incorporated enterprise is located in China. “Chinese-controlled offshore enterprise” refers to an enterprise which is formed and registered abroad by an enterprise or enterprise group located in China as the major controlling investor under the laws of a foreign country (region).





According to the SAT Circular 82, a Chinese-controlled offshore incorporated enterprise will be regarded as a PRC tax resident by virtue of having "de facto management body" in China only if all of the following conditions set forth in the SAT Circular 82 are met: (i) the primary location of the day-to-day operational management is in the PRC; (ii) decisions relating to the enterprise's financial and human resource matters are made or are subject to approval by organizations or personnel in the PRC; (iii) the enterprise's primary assets, accounting books and records, company seals, and board and shareholder resolutions are located or maintained in the PRC; and (iv) at least 50% of voting board members or senior executives habitually reside in the PRC.





Furthermore, a Chinese-controlled enterprise may file a resident enterprise application to the competent tax authority of the place where its de facto management body or where the major Chinese investor is located, and the competent tax authority shall, after the preliminary examination, report, level by level, its identity of resident enterprise to the State Administration of Taxation for confirmation. If an overseas Chinese-controlled enterprise fails to file a resident enterprise application, the competent tax authority of the place where its major Chinese investor is located may make a preliminary judgment about whether it is a Chinese resident enterprise according to the information available to it, and report to the State Administration of Taxation for confirmation.





Although SAT Circular 82 only applies to offshore enterprises controlled by PRC enterprises, not those controlled by PRC individuals, the determining criteria set forth in the SAT Circular 82 may reflect the State Administration of Taxation's general position on how the "de facto management body" test may be applied in determining the tax resident status of offshore enterprises.





We do not believe that either we or Bright meets all of the conditions above. We and Bright are companies incorporated outside the PRC. As holding companies, these two entities' seal stamp, the resolutions of their respective board of directors and the resolutions of their respective shareholders, are located and maintained outside the PRC. Furthermore, decisions relating to our financial matters are made or are subject to approval by personnel outside the PRC. In addition, we are not aware of any offshore holding companies with a similar corporate structure as ours ever have been deemed a PRC "resident enterprise" by the PRC tax authorities. We believe that we and/or Bright shall not be treated as resident enterprises for PRC tax purposes if the criteria for "de facto management body" as set forth in the SAT Circular 82 were deemed applicable to us.





However, as the tax resident status of an enterprise is subject to determination by the competent PRC tax authorities and uncertainties remain with respect to the interpretation of the term "de facto management body" as applicable to our offshore entities, we may be considered a resident enterprise. If the PRC tax authorities determine that we and/or Bright is a “resident enterprise” for PRC enterprise income tax purposes, a number of PRC tax consequences could follow. Firstly, we and/or Bright may be subject to enterprise income tax at a rate of 25% on our worldwide taxable income, as well as PRC enterprise income tax reporting obligations. Secondly, dividends paid to us from our PRC Subsidiary through Bright (assuming we and Bright are treated as resident enterprises under the EIT Law) may qualify as “tax-exempt income”, but we cannot guarantee that such dividends will not be subject to PRC withholding tax. In addition, it could result in a situation in which a 10% PRC tax is imposed on dividends we pay to our non-PRC shareholders and gains derived by our non-PRC shareholders from transferring our shares, if such income is considered PRC-sourced income by the relevant PRC authorities.





61





According to Notice of the State Administration of Taxation on Issuing the Interim Measures for the Administration of Source-based Withholding of Enterprise Income Tax on Non-resident Enterprise (No. 3 [2009] of the State Administration of Taxation), the source-based withholding shall apply to the incomes from return on equity investment such as dividends and bonuses, interest, rents, royalties, income from assignment of property and other incomes subject to the enterprise income tax derived from China by non-resident enterprise, and the entities or individuals which are directly liable to make the relevant payments to the non-resident enterprises under the relevant legal or contractual provisions shall be the withholding agents; where the withholding agent makes each payment or due payment of the aforesaid incomes, it shall withhold an enterprise income tax from such incomes at a rate of 10%; where the withholding agent has the obligation to withhold an enterprise income tax, it shall file a Withholding Enterprise Income Tax Return with the competent tax authority and turn the relevant withholding tax over to the State Treasury within seven days from the date of the withholding date; where the withholding agent fails to withhold or cannot perform the withholding obligations, the non-resident enterprise shall, within seven days after the payment or payment due, file enterprise incoming tax to the competent tax authorities; where both parties to an equity transfer transaction which is conducted outside the PRC are non-resident enterprise, the non-resident enterprise which obtains the income shall file a tax return to the competent tax authority of the enterprise whose equity interests are transferred. The enterprise whose equity interests are transferred shall assist the tax authority in taxing the non-resident enterprise; where the non-enterprise again fails to pay tax within a certain time limit under a tax authority’s warning notice, the competent tax authority has the right to collect the enterprise income tax and charge an overdue fine from the non-enterprise’s income from other project(s) and its payable person in China, and send a Notice of Tax-related Matters, other income projects and its payable person is liable for the payable tax and overdue fine.





In such event, we may be required to withhold a 10% PRC tax on any dividends paid to non-resident investors. In addition, non-resident investors may be responsible for paying PRC tax at a rate of 10% on any gain realized from the sale or transfer of our shares if such non-resident investors and the gain satisfy the requirements under the EIT Law and its implementing rules, and we would not have an obligation to withhold income tax in respect of such gains.





If the PRC tax authorities determine that we and Bright are non-resident enterprises, dividends paid to us from our PRC Subsidiary will be subject to PRC withholding tax. The EIT Law and the implementing rules of the EIT Law provide that (A) an income tax rate of 25% will normally be applicable to non-resident enterprises which (i) have establishments or premises of business inside the PRC, and (ii) the income in connection with their establishment or premises of business is sourced from the PRC or the income is earned outside the PRC but has actual connection with their establishments or premises of business inside the PRC, and (B) an income tax rate of 10% will be applicable to non-resident shareholders, to the extent of incomes derived from sources within the PRC which (i) do not have any establishment or premises of business in the PRC or (ii) have establishments or premises of business in the PRC, but the relevant income is not effectively connected with the establishments or premises of business.





Lanxi Sunrise has not paid dividends to us and/or Bright as of the date of this prospectus, and therefore Lanxi Sunrise has not been liable for the payment of the 10% withholding tax on dividends to its non-resident shareholder as of the date of this prospectus.





As of the date of this prospectus, there has not been a definitive determination as to the “resident enterprise” or “non-resident enterprise” status of us or Bright. We and Bright will consult with the PRC tax authorities and make any necessary tax withholding if, in the future, the Board of Directors of Lanxi Sunrise makes a resolution to pay any dividends to us and/or Bright and if we and/or Bright (based on future clarifying guidance issued by the PRC), or the PRC tax authorities, determine that we and/or Bright are/is a non-resident enterprise(s) under the EIT Law.





As to the specialized regulations related to enterprise income tax for equity transfers of PRC resident enterprises by non-PRC resident enterprises, please refer to “We face uncertainty from China’s Circular on Strengthening the Administration of Enterprise Income Tax on Non-Resident Enterprises’ Share Transfer that was released in December 2009 with retroactive effect from January 1, 2008” in the “Risk Factors–Risks Relating to Operations in China” section of this prospectus.





The statement in this subsection “People’s Republic of China Taxation” constitutes the opinion of Beijing DeHeng Law Office.





62





United States Federal Income Taxation





In the opinion of Windes & McClaughry Accountancy Corporation, the following is a summary of the material U.S. federal income tax consequences to an investor of the acquisition, ownership and disposition of our securities covered by this prospectus. The tax opinion provided to us by Windes & McClaughry Accountancy Corporation does not provide a "will" level of comfort on certain of the U.S. federal income tax issues discussed in the tax disclosure below and does not address all tax issues, (e.g., those are dependent on future facts or events). Because of the absence of guidance directly on point as to how certain tax consequences discussed in the tax disclosure below would be treated for U.S. federal income tax purposes, it is not possible to predict what contrary positions, if any, may be taken by the Internal Revenue Service ("IRS") or a court considering these tax issues and whether such position would be materially different from those discussed in the tax disclosure (although the tax disclosure does describe certain possible alternative tax consequences). As a result, the word "should" rather than "will" is used in certain portions of the tax disclosure in order to indicate a degree of uncertainty concerning these issues that is greater than would be indicated by a "will" level of opinion, but is less than would be indicated by a "more-likely-than-not" level of opinion. Moreover, certain tax issues that are discussed in the tax disclosure are dependent on future facts or events, such as whether we will be classified as a PFIC for U.S. federal income tax purposes, and therefore cannot be addressed by a tax opinion. Accordingly, each prospective investor is urged to consult is own tax advisors regarding the tax issues discussed in the tax disclosure below and how they may relate to the investor's particular circumstances.





The following is a summary of the material United States federal income tax consequences of the ownership and disposition of our ordinary shares by a U.S. Holder described below that will hold our ordinary shares as "capital assets" (generally, property held for investment) under the United States Internal Revenue Code. This summary is based upon existing United States federal tax law, which is subject to differing interpretations or change, possibly with retroactive effect. This summary does not discuss all aspects of United States federal income taxation that may be important to particular investors in light of their individual investment circumstances, including investors subject to special tax rules (for example, financial institutions, insurance companies, broker-dealers, traders in securities that elect mark-to-market treatment, partnerships and their partners, and tax-exempt organizations (including private foundations)), investors who are not U.S. Holders, investors who own (directly, indirectly, or constructively) 10% or more of our voting stock, investors that will hold their ordinary shares as part of a straddle, hedge, conversion, constructive sale, or other integrated transaction for United States federal income tax purposes, or investors that have a functional currency other than the United States dollar, all of whom may be subject to tax rules that differ significantly from those summarized below. In addition, this summary does not discuss any non-United States, state, or local tax considerations save for our brief discussion on local tax laws in the PRC. Each potential investor is urged to consult its tax advisor regarding the United States federal, state, local, and non-United States income and other tax considerations of an investment in our ordinary shares.





General





For purposes of this summary, a "U.S. Holder" is a beneficial owner of our ordinary shares that is, for United States federal income tax purposes, (i) an individual who is a citizen or resident of the United States, (ii) a corporation (or other entity treated as a corporation for United States federal income tax purposes) created in, or organized under the law of, the United States or any state thereof or the District of Columbia, (iii) an estate the income of which is includible in gross income for United States federal income tax purposes regardless of its source, or (iv) a trust (A) the administration of which is subject to the primary supervision of a United States court and which has one or more United States persons who have the authority to control all substantial decisions of the trust or (B) that has otherwise elected to be treated as a United States person under the United States Internal Revenue Code.





If a partnership is a beneficial owner of our ordinary shares, the tax treatment of a partner in the partnership will generally depend upon the status of the partner and the activities of the partnership. Partners of a partnership holding our ordinary shares are urged to consult their tax advisors regarding an investment in our ordinary shares.





63





Dividends





Any cash distributions (including the amount of any PRC tax withheld) paid on our ordinary shares out of our current or accumulated earnings and profits, as determined under United States federal income tax principles, will generally be includible in the gross income of a U.S. Holder as dividend income on the day actually or constructively received by the U.S. Holder, in the case of ordinary shares. Because we do not intend to determine our earnings and profits on the basis of United States federal income tax principles, any distribution paid will generally be treated as a "dividend" for United States federal income tax purposes. For taxable years beginning before January 1, 2011, a non-corporate recipient of dividend income generally will be subject to tax on dividend income from a "qualified foreign corporation" at a maximum United States federal tax rate of 15% rather than the marginal tax rates generally applicable to ordinary income, provided, however, that certain holding period and other requirements are met. For example, in order to treat the dividend income as qualified dividend income and taxed at 15% reduced rate, on the date the dividends are paid, the investor must hold the stock for more than 60 days during the 121 day period beginning 60 days before the ex-dividend date (more than 90 days during the 181 day period beginning 90 days before the ex-dividend date for preferred stock dividends attributable to a period of more than 366 days). In addition, the following dividend income will not be treated as qualified dividend:





a)
Dividends on stock to the extent that the investor is under an obligation to make related payments with respect to positions in substantially similar or related property;


b)
Any amount that the investor elects to treat it as investment income to support an investment interest deduction;


c)
Dividends from corporations that for the distributing year or the preceding year are exempt from U.S. income tax under IRC Sec. 501 or 521;


d)
Dividends deductible under IRC Sec. 591 by mutual savings banks; and


e)
Dividends paid on employer securities owned by an employee stock ownership plan (ESOP), which are deductible under IRC Sec. 404(k).





For dividend income received from a foreign corporation, it will be treated as qualified dividend income only if the foreign corporations are U.S. possession corporations or corporations eligible for benefits of a comprehensive income tax treaty with the U.S. that includes an exchange of information program, but not passive foreign investment companies (PFIC). Dividends paid by certain foreign corporation may also qualify if the stock or ADRs are readily tradable on an established U.S. securities market.





As described above, under the current U.S. federal income tax rule, the U.S. non-corporate investors will pay 15% federal individual income tax on the dividends and long-term capital gains. If a PRC income tax applies to cash dividends paid to a U.S. investor on the ordinary shares, such PRC income tax should be treated as a foreign tax eligible for a deduction from such investor's U.S. federal taxable income or a foreign tax credit against such investor's U.S. federal income tax liability dollar-by-dollar. However, the utilization of a foreign tax credit will be subject to applicable conditions and limitations. Since the U.S. investors are allowed to claim a foreign tax credit on the PRC income tax paid, generally the U.S. investors will not be subject to double taxation.





In addition, if such PRC tax applies to any dividends, a U.S. investor should be entitled to certain benefits under the U.S.-PRC Income Tax Treaty, including a possible reduction in PRC tax withholding on a dividend distribution. The current reduced withholding tax rate on dividends per the treaty is 10%.





U.S. Holders should consult their tax advisors regarding the availability of the reduced tax rate on dividends in their particular circumstances. Dividends received on our ordinary shares will not be eligible for the dividends received deduction allowed to corporations.





Dividends generally will be treated as income from foreign sources for United States foreign tax credit purposes and generally will constitute passive category income. In the event that we are deemed to be a PRC resident enterprise under the PRC Enterprise Income Tax Law, a U.S. Holder may be subject to PRC withholding taxes on dividends paid, if any, on our ordinary shares. A U.S. Holder may be eligible to claim a foreign tax credit in respect of any foreign withholding taxes imposed on dividends received on our ordinary shares, subject to a number of complex limitations, For example, there are some limitations on the U.S. holders' ability to utilize the foreign tax credit. Generally, the total foreign tax credit that the U.S. holder can utilize is limited to the amount of U.S. federal income tax that would be imposed on the U.S. holder's foreign source income and separate calculations are required for different categories of income. A U.S. Holder who does not elect to claim a foreign tax credit for foreign tax withheld, may instead claim a deduction, for United States federal income tax purposes, in respect of such withholdings, but only for a year in which such holder elects to do so for all creditable foreign income taxes. The rules governing the foreign tax credit are complex. U.S. Holders are urged to consult their tax advisors regarding the availability of the foreign tax credit under their particular circumstances.





64





Sale or Other Disposition of Ordinary Shares





A U.S. Holder will generally recognize capital gain or loss upon the sale or other disposition of ordinary shares in an amount equal to the difference between the amount realized upon the disposition and the holder's adjusted tax basis in such ordinary shares. Any capital gain or loss will be long-term if the ordinary shares have been held for more than one year and will generally be United States source gain or loss for United States foreign tax credit purposes. In the event that we are deemed to be a PRC resident enterprise under the PRC Enterprise Income Tax Law and gain from the disposition of the ordinary shares is subject to tax in the PRC, such gain may be treated as PRC source gain for foreign tax credit purposes under the United States-PRC income tax treaty. The deductibility of a capital loss may be subject to limitations. U.S. Holders are urged to consult their tax advisors regarding the tax consequences if a foreign tax is imposed on a disposition of our ordinary shares, including the availability of the foreign tax credit under their particular circumstances.





Passive Foreign Investment Company Rules





A foreign (non-U.S.) corporation will be a "Passive Foreign Investment Company" (“PFIC”) if at least 75% of its gross income in a taxable year of the foreign corporation, including its pro rata share of the gross income of any corporation in which it is considered to own at least 25% of the shares by value, is passive income. Alternatively, a foreign corporation will be PFIC if at least 50% of its assets in a taxable year of the foreign corporation, ordinarily determined based on fair market value and averaged quarterly over the year, including its pro rata share of the assets of any corporation in which it is considered to own at least 25% of the shares by value, are held for the production of, or produce, passive income. Passive income generally includes dividends, interest, rents and royalties (other than certain rents or royalties derived from the active conduct of a trade or business) and gains from the disposition of passive assets.





If we are classified as a PFIC for any taxable year during which a U.S. Holder holds our ordinary shares, unless the U.S. Holder makes a mark-to-market election (as described below), the U.S. Holder will generally be subject to special tax rules that have a penalizing effect, regardless of whether we remain a PFIC, on (i) any excess distribution that we make to the U.S. Holder (which generally means any distribution paid during a taxable year to a U.S. Holder that is greater than 125% of the average annual distributions paid in the three preceding taxable years or, if shorter, the U.S. Holder's holding period for the ordinary shares), and (ii) any gain realized on the sale or other disposition, including, under certain circumstances, a pledge, of ordinary shares. Under the PFIC rules the:





•
excess distribution and/or gain will be allocated ratably over the U.S. Holder's holding period for the ordinary shares;





•
amount allocated to the current taxable year and any taxable years in the U.S. Holder's holding period prior to the first taxable year in which we are classified as a PFIC, or pre-PFIC year, will be taxable as ordinary income;





•
amount allocated to each prior taxable year, other than the current taxable year or a pre-PFIC year, will be subject to tax at the highest tax rate in effect applicable to you for that year; and





•
interest charge generally applicable to underpayments of tax will be imposed on the tax attributable to each prior taxable year, other than the current taxable year or a pre-PFIC year.





It does not appear that the Company will ever be classified as PFIC in the future since the Company is actively engaged in a trade or business which includes research, production and sales of linen textile products. However, if we are determined to be a PFIC for any taxable year (or portion thereof) that is included in the holding period of a U.S. Holder of our ordinary shares or redeemable warrants and, in the case of our ordinary shares, the U.S. Holder did not make either a timely qualified electing fund ("QEF") election for our first taxable year as a PFIC in which the U.S. Holder held (or was deemed to hold) ordinary shares, or a mark-to-market election, as described below, such holder generally will be subject to special rules with respect to:





65





a)
any gain recognized by the U.S. Holder on the sale or other disposition of its ordinary shares or redeemable warrants; and





b)
any "excess distribution" made to the U.S. Holder (generally, any distributions to such U.S. Holder during a taxable year of the U.S. Holder that are greater than 125% of the average annual distributions received by such U.S. Holder in respect of the ordinary shares during the three preceding taxable years of such U.S. Holder or, if shorter, such U.S. Holder's holding period for the ordinary shares).





Under these rules:





The U.S. Holder's gain or excess distribution will be allocated ratably over the U.S. Holder's holding period for the ordinary shares or redeemable warrants;





The amount allocated to the U.S. Holder's taxable year in which the U.S. Holder recognized the gain or received the excess distribution, or to the period in the U.S. Holder's holding period before the first day of our first taxable year in which we qualified as a PFIC, will be taxed as ordinary income;





The amount allocated to other taxable years (or portions thereof) of the U.S. Holder and included in its holding period will be taxed at the highest tax rate in effect for that year and applicable to the U.S. Holder; and





The interest charge generally applicable to underpayments of tax will be imposed in respect of the tax attributable to each such other taxable year of the U.S. Holder.





In general, a U.S. Holder may avoid the PFIC tax consequences described above in respect to our ordinary shares by making a timely QEF election to include in income its pro rata share of our net capital gains (as long-term capital gain) and other earnings and profits (as ordinary income), on a current basis, in each case whether or not distributed, in the taxable year of the U.S. Holder in which or with which our taxable year ends. A U.S. Holder may make a separate election to defer the payment of taxes on undistributed income inclusions under the QEF rules, but if deferred, any such taxes will be subject to an interest charge.





A U.S. Holder may not make a QEF election with respect to its redeemable warrants. As a result, if a U.S. Holder sells or otherwise disposes of a redeemable warrant (other than upon exercise of the redeemable warrant), any gain recognized will be subject to the special tax and interest charge rules treating the gain as an excess distribution, as described above, if we were a PFIC at any time during the period the U.S. Holder held the redeemable warrants. If a U.S. Holder that exercises such redeemable warrants properly makes a QEF election with respect to the newly acquired ordinary shares (or has previously made a QEF election with respect to our ordinary shares), the QEF election will apply to the newly acquired ordinary shares, but the adverse tax consequences relating to PFIC shares, adjusted to take into account the current income inclusions resulting from the QEF election, will continue to apply with respect to such newly acquired ordinary shares (which generally will be deemed to have a holding period for purposes of the PFIC rules that includes the period the U.S. Holder held the redeemable warrants), unless the U.S. Holder makes a purging election. The purging election creates a deemed sale of such shares at their fair market value. The gain recognized by the purging election will be subject to the special tax and interest charge rules treating the gain as an excess distribution, as described above. As a result of the purging election, the U.S. Holder will increase the adjusted tax basis in its ordinary shares acquired upon the exercise of the warrants by the gain recognized and also will have a new holding period in such shares for purposes of the PFIC rules.





The QEF election is made on a shareholder-by-shareholder basis and, once made, can be revoked only with the consent of the IRS. A U.S. Holder generally makes a QEF election by attaching a completed IRS Form 8621 (Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund), including the information provided in a PFIC annual information statement, to a timely filed U.S. federal income tax return for the tax year to which the election relates. Retroactive QEF elections generally may be made only by filing a protective statement with such return and if certain other conditions are met or with the consent of the IRS.





66





In order to comply with the requirements of a QEF election, a U.S. Holder must receive certain information from us. Upon request from a U.S. Holder, we will endeavor to provide to the U.S. Holder no later than 90 days after the request such information as the IRS may require, including a PFIC annual information statement, in order to enable the U.S. Holder to make and maintain a QEF election. However, there is no assurance that we will have timely knowledge of our status as a PFIC in the future or of the required information to be provided.





If a U.S. Holder has made a QEF election with respect to our ordinary shares, and the special tax and interest charge rules do not apply to such shares (because of a timely QEF election for our first taxable year as a PFIC in which the U.S. Holder holds (or is deemed to hold) such shares or a purge of the PFIC taint pursuant to a purging election, as described above), any gain recognized on the sale or other taxable disposition of our ordinary shares will be taxable as capital gain and no interest charge will be imposed. U.S. Holders of a QEF are currently taxed on their pro rata shares of the QEF's earnings and profits, whether or not distributed. In such case, a subsequent distribution of such earnings and profits that were previously included in income should not be taxable as a dividend to such U.S. Holders. The adjusted tax basis of a U.S. Holder's shares in a QEF will be increased by amounts that are included in income, and decreased by amounts distributed but not taxed as dividends, under the above rules. Similar basis adjustments apply to property if by reason of holding such property the U.S. Holder is treated under the applicable attribution rules as owning shares in a QEF.





Although a determination as to our PFIC status will be made annually, an initial determination that we are a PFIC will generally apply for subsequent years to a U.S. Holder who held ordinary shares or redeemable warrants while we were a PFIC, whether or not we meet the test for PFIC status in those subsequent years. A U.S. Holder who makes the QEF election discussed above for our first taxable year as a PFIC in which the U.S. Holder holds (or is deemed to hold) our ordinary shares, however, will not be subject to the PFIC tax and interest charge rules discussed above in respect to such shares, In addition, such U.S. Holder will not be subject to the QEF inclusion regime with respect to such shares for any taxable year of us that end within or with a taxable year of the U.S. Holder and in which we are not a PFIC. On the other hand, if the QEF election is not effective for each of our taxable years in which we are a PFIC and during which the U.S. Holder holds (or is deemed to hold) our ordinary shares, the PFIC rules discussed above will continue to apply to such shares unless the holder makes a purging election, as described above, and pays the tax and interest charge with respect to the gain inherent in such shares attributable to the pre-QEF election period.





Alternatively, if a U.S. Holder, at the close of its taxable year, owns shares in a PFIC that are treated as marketable stock, the





U.S. Holder may make a mark-to-market election with respect to such shares for such taxable year. If the U.S. Holder makes a valid mark-to-market election for the first taxable year of the U.S. Holder in which the U.S. Holder holds (or is deemed to hold) our ordinary shares and for which we are determined to be a PFIC, such holder generally will not be subject to the PFIC rules described above in respect to its ordinary shares. Instead, in general, the U.S. Holder will include as ordinary income each year the excess, if any, of the fair market value of its ordinary shares at the end of its taxable year over the adjusted tax basis in its ordinary shares. The U.S. Holder also will be allowed to take an ordinary loss in respect of the excess, if any, of the adjusted tax basis of its ordinary shares over the fair market value of its ordinary shares at the end of its taxable year (but only to the extent of the net amount of previously included income as a result of the mark-to-market election). The U.S. Holder's adjusted tax basis in its ordinary shares will be adjusted to reflect any such income or loss amounts, and any further gain recognized on a sale or other taxable disposition of the ordinary shares will be treated as ordinary income. Currently, a mark-to-market election may not be made with respect to warrants.





The mark-to-market election is available only for stock that is regularly traded on a national securities exchange that is registered with the Securities and Exchange Commission, including the NASDAQ Capital Market, or on a foreign exchange or market that the IRS determines has rules sufficient to ensure that the market price represents a legitimate and sound fair market value. Although we have applied to list our ordinary shares on the NASDAQ Capital Market, we cannot guarantee that our application will be approved, or, if approved, that our ordinary shares will continue to be listed on the NASDAQ Capital Market. U.S. Holders should consult their own tax advisors regarding the availability and tax consequences of a mark-to-market election in respect to our ordinary shares under their particular circumstances.





67





If we are a PFIC and, at any time, have a foreign subsidiary that is classified as a PFIC, a U.S. Holder of our ordinary shares should be deemed to own a portion of the shares of such lower-tier PFIC, and could incur liability for the deferred tax and interest charge described above if we receive a distribution from, or dispose of all or part of our interest in, or the U.S. Holder were otherwise deemed to have disposed of an interest in, the lower-tier PFIC. Upon request, we will endeavor to cause any lower-tier PFIC to provide to a U.S. Holder no later than 90 days after the request the information that may be required to make or maintain a QEF election with respect to the lower-tier PFIC. However, there is no assurance that we will have timely knowledge of the status of any such lower-tier PFIC or will be able to cause the lower-tier PFIC to provide the required information. A mark-to-market election generally would not be available with respect to such a lower-tier PFIC. U.S. Holders are urged to consult their own tax advisors regarding the tax issues raised by lower-tier PFICs.





If a U.S. Holder owns (or is deemed to own) shares in a PFIC during any taxable year of the U.S. Holder, such holder may have to file an IRS Form 8621 (whether or not a QEF election or mark-to-market election is or has been made) and any other information as may be required by the U.S. Treasury Department.





The rules dealing with PFICs and with the QEF and mark-to-market elections are very complex and are affected by various factors in addition to those described above. Accordingly, U.S. Holders of our ordinary shares and redeemable warrants should consult their own tax advisors concerning the application of the PFIC rules to our ordinary shares and redeemable warrants under their particular circumstances.





Although a determination as to our PFIC status will be made annually, an initial determination that we are a PFIC will generally apply for subsequent years to a U.S. Holder who held ordinary shares or redeemable warrants while we were a PFIC, whether or not we meet the test for PFIC status in those subsequent years. A U.S. Holder who makes the QEF election discussed above for our first taxable year as a PFIC in which the U.S. Holder holds (or is deemed to hold) our ordinary shares, however, will not be subject to the PFIC tax and interest charge rules discussed above in respect to such shares. In addition, such U.S. Holder will not be subject to the QEF inclusion regime with respect to such shares for any taxable year that ends within a taxable year of the U.S. Holder and in which we are not a PFIC. On the other hand, if the QEF election is not effective for each of our taxable years in which we are a PFIC and during which the U.S. Holder holds (or is deemed to hold) our ordinary shares, the PFIC rules discussed above will continue to apply to such shares unless the holder makes a purging election, as described above, and pays the tax and interest charge with respect to the gain inherent in such shares attributable to the pre-QEF election period.





If we are a PFIC for any taxable year during which a U.S. Holder holds our ordinary shares and any of our non-United States subsidiaries is also a PFIC, such U.S. Holder would be treated as owning a proportionate amount (by value) of the shares of the lower-tier PFIC and would be subject to the rules described above on certain distributions by a lower-tier PFIC and a disposition of shares of a lower-tier PFIC even though such U.S. holder would not receive the proceeds of those distributions or dispositions. U.S. Holders should consult their tax advisors regarding the application of the PFIC rules to any of our subsidiaries.





Because a mark-to-market election cannot be made for any lower-tier PFICs that we may own, a U.S. Holder may continue to be subject to the PFIC rules with respect to such U.S. Holder's indirect interest in any investments held by us that are treated as an equity interest in a PFIC for United States federal income tax purposes.





We do not intend to provide information necessary for U.S. Holders to make qualified electing fund elections, which, if available, would result in tax treatment different from the general tax treatment for PFICs described above.





If a U.S. Holder owns our ordinary shares during any taxable year that we are a PFIC, the holder must file an annual report with the U.S. Internal Revenue Service. In the case of a U.S. Holder who has held ordinary shares during any taxable year in respect of which we were classified as a PFIC and continues to hold such ordinary shares (or any portion thereof) and has not previously determined to make a mark-to-market election, and who is now considering making a mark-to-market election, special tax rules may apply relating to purging the PFIC taint of such ordinary shares. Each U.S. Holder is urged to consult its tax advisor concerning the United States federal income tax consequences of purchasing, holding, and disposing ordinary shares if we are or become classified as a PFIC, including the possibility of making a mark-to-market election.





68





Information Reporting and Backup Withholding





Pursuant to the Hiring Incentives to Restore Employment Act enacted on March 18, 2010, in tax years beginning after the date of enactment, an individual U.S. Holder and certain entities may be required to submit to the Internal Revenue Service certain information with respect to his or her beneficial ownership of the ordinary shares, if such ADSs or ordinary shares are not held on his or her behalf by a U.S. financial institution. This new law also imposes penalties if an individual U.S. Holder is required to submit such information to the Internal Revenue Service and fails to do so.





In addition, dividend payments with respect to the ordinary shares and proceeds from the sale, exchange or redemption of the ordinary shares may be subject to information reporting to the Internal Revenue Service and United States backup withholding at a rate of 28%. Backup withholding will not apply, however, to a U.S. Holder who furnishes a correct taxpayer identification number and makes any other required certification, or who is otherwise exempt from backup withholding. U.S. Holders should consult their tax advisors regarding the application of the United States information reporting and backup withholding rules. Backup withholding is not an additional tax. Amounts withheld as backup withholding may be credited against a U.S. Holder's United States federal income tax liability, and a U.S. Holder generally may obtain a refund of any excess amounts withheld under the backup withholding rules by filing the appropriate claim for refund with the Internal Revenue Service and furnishing any required information.





The statements in this subsection “United States Federal Income Taxation” constitute the opinion of Windes & McClaughry Accountancy Corporation.





F.
Dividends and paying agents





Not required.




G.
Statement by experts





Not required.


H.
Documents on display





Documents concerning us that are referred to in this document may be inspected at our principal executive offices at Chengdong Street, Lanxi County, Heilongjiang Province, PRC and the telephone number at this address is 86-455-5635885.


In addition, we will file annual reports and other information with the Securities and Exchange Commission. We will file annual reports on Form 20-F and submit other information under cover of Form 6-K. As a foreign private issuer, we are exempt from the proxy requirements of Section 14 of the Exchange Act and our officers, directors and principal shareholders will be exempt from the insider short-swing disclosure and profit recovery rules of Section 16 of the Exchange Act. Annual reports and other information we file with the Commission may be inspected at the public reference facilities maintained by the Commission at Room 100 F. Street, N.E., Washington, D.C. 20549, and copies of all or any part thereof may be obtained from such offices upon payment of the prescribed fees. You may call the Commission at 1-800-SEC-0330 for further information on the operation of the public reference rooms and you can request copies of the documents upon payment of a duplicating fee, by writing to the Commission. In addition, the Commission maintains a web site that contains reports and other information regarding registrants (including us) that file electronically with the Commission which can be assessed at http://www.sec.gov.





I.
Subsidiary Information




Not required.





69





Item 11.
Quantitative and Qualitative Disclosure About Market Risk





Not required.





Item 12.
Description of Securities Other than Equity Securities





Not required.





70





PART II





Item 13.
Defaults, Dividend Arrearages and Delinquencies





There has been no default of any indebtedness nor is there any arrearage in the payment of dividends.





Item 14.
Material Modifications to the Rights of Security Holders and Use of Proceeds





Not required.





Item 15.
Controls and Procedures.





A.
Disclosure Controls and Procedures





The Securities and Exchange Commission defines the term “disclosure controls and procedures” to mean the company's controls and other procedures of an issuer that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. The Company maintains such a system of controls and procedures in an effort to ensure that all information which it is required to disclose in the reports it files under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified under the SEC's rules and forms and that information required to be disclosed is accumulated and communicated to principal executive and principal financial officers to allow timely decisions regarding disclosure.





As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are designed to provide reasonable assurance of achieving the objectives of timely alerting them to material information required to be included in our periodic SEC reports and of ensuring that such information is recorded, processed, summarized and reported with the time periods specified. However, our chief executive officer and chief financial officer also concluded that our disclosure controls and procedures were not effective as of the end of the period covered by this report to provide reasonable assurance of the achievement of these objectives solely because of the material weakness in internal control over financial reporting set forth below.





B.
Management’s Annual Report on Internal Control over Financial Reporting





Our management is responsible for the preparation of the financial statements and related financial information appearing in this Annual Report on Form 20-F. The financial statements and notes have been prepared in conformity with accounting principles generally accepted in the United States of America. Our management also is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. A company's internal control over financial reporting is defined as a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the issuer are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.





71





Management, including the Chief Executive Officer and Chief Financial Officer, does not expect that the Company's disclosure controls and internal controls will prevent all error and all fraud. Because of its inherent limitations, a system of internal control over financial reporting can provide only reasonable, not absolute, assurance that the objectives of the control system are met and may not prevent or detect misstatements. Further, over time control may become inadequate because of changes in conditions or the degree of compliance with the policies or procedures may deteriorate.





Report on Internal Control Over Financial Reporting





With the participation of the Chief Executive Officer and Chief Financial Officer, our management evaluated the effectiveness of our internal control over financial reporting as of December 31, 2010 based upon the framework in Internal Control –Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on that evaluation, our management has concluded that, as of December 31, 2010, we believe that we have weaknesses in our internal control over financial reporting. We do not have an audit committee and rely upon our internal auditor to conduct internal control supervision, which creates a weakness in the sufficiency of our internal controls design and regular review. Further, our internal controls system needs to be improved and updated. To remediate the weakness, our management intends to continue to review and make changes to the overall design of our internal control environment, as well as policies and procedures to improve the overall effectiveness of internal controls over financial reporting and our disclosure controls and procedures. We intend to improve the communication between our departments and management, to perfect and update the internal controls system, to improve supervision over financial reporting by management, and to regularly conduct self-assessments of the effectiveness of our internal controls system. We plan to establish an audit committee in order to improve and reinforce internal audit functions, ensure the availability of an independent assessment of our internal audit, and integrate this assessment into the internal controls of the company. We plan to appoint all independent directors, including the chairperson, to our audit committee. The chairperson will supervise the formulation of systems and resources to assist the audit committee in its functions.





C.
Attestation report of the registered public accounting firm





This Annual Report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only management's report in this Annual Report on Form 20-F.





D.
Changes in Internal Controls over Financial Reporting





There was no change in our internal control over financial reporting during the period covered by this Annual Report, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.





Item 15.
Controls and Procedures





Not applicable.





Item 16.
[Reserved]





Item 16A.
Audit Committee Financial Expert.





We do not currently have an audit committee, and our Board of Directors has not determined that one of its members is an audit committee financial expert.





Item 16B.
Code of Ethics.





We have adopted a Code of Ethics that applies to our Board of Directors, chief executive officer, chief financial officer, and other senior financial officers.





72





Item 16C.
Principal Accountant Fees and Services.





Audit Fees





UHY HK was the company’s principal accountant for the fiscal year ended December 31, 2008. UHY HK also provided audit services to us in connection with the fiscal year ended December 31, 2009, prior to the time of its resignation. The aggregate fees billed by UHY for audit of the company's annual financial statements were $62,000 for the fiscal year ended December 31, 2009 and $0 for the fiscal year ended December 31, 2010.





On July 5, 2010, we engaged Parker Randall CF (H.K.) (“Parker Randall”) as our new auditor as approved by our Board of Directors on July 3, 2010.





The aggregate fees billed by Parker Randall for audit of the company's annual financial statements was $130,552 for the fiscal year ended December 31, 2010.





Audit-Related Fees





UHY HK billed the Company $8,228 and $3,000 for assurance-related services that were related to its audit of the company's financial statements during the fiscal year ended December 31, 2010 and 2009.





Parker Randall billed the Company $10,138 for assurance-related services that were related to its audit of the Company’s financial statements during the fiscal year ended December 31, 2010.





Tax Fees





UHY HK did not bill the Company any amounts for tax compliance, advice and planning for the fiscal years ended December 31, 2010 and 2009.




Parker Randall did not bill the company any amounts for tax compliance, advice and planning for the fiscal years ended December 31, 2010.





All Other Fees





UHY HK billed the Company $50,410 and $0 for other products and services during the fiscal years ended December 31, 2010 and 2009.





Parker Randall did not bill the company any amounts for other products and services during the fiscal years ended December 31, 2010.





Pre-Approval of Services





We do not have an audit committee. As a result, our board of directors performs the duties of an audit committee. Our board of directors evaluates and approves in advance the scope and cost of the engagement of an auditor before the auditor renders its audit and non-audit services. We do not rely on pre-approval policies and procedures.





Item 16D.
Exemptions from the Listing Standards for Audit Committees.





None.





73





Item 16E.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers.





2010 Restructuring





On April 15, 2010, so as to not violate certain applicable PRC regulations, all direct equity interests in our Company (approximately 40.51% of our outstanding ordinary shares) held by or on behalf of Mr. Gao, our Chief Executive Officer and chairman, was transferred to Creation International Development Investments Limited, an exempted company incorporated under the laws of the Cayman Islands (“ Creation”). Mr. Gabriele Sanesi, a citizen of Italy, is the sole shareholder and director of Creation. Pursuant to an agreement dated April 15, 2010 among Creation and Messrs Gao and Sanesi (the “ April 2010 Agreement”), Mr. Sanesi has granted Mr. Gao the irrevocable right to exercise his rights as a shareholder and director of Creation. In addition, in accordance with the April 2010 Agreement, Mr. Sanesi has agreed to transfer 100% of his equity interests in Creation to Mr. Gao if the net income of our company from January 1, 2010 to June 30, 2010 is no less than US$2.0 million.





Item 16F.
Change in Registrant’s Certifying Accountant.





On June 24, 2010, we received a letter of resignation from UHY Vocation HK CPA Limited (“ UHY HK”), our independent registered public accounting firm, which letter stated that the resignation would be effective immediately. UHY HK was engaged by us on April 9, 2009, until its resignation on June 24, 2010 (the “ Engagement Period”).





Prior to June 24, 2010, UHY HK had not previously advised our management or our board of directors of its intention to resign its engagement as our independent registered public accounting firm. The resignation was not sought or recommended by our board of directors.





The report of UHY HK for the financial statements for the fiscal year ended December 31, 2008 does not contain an adverse opinion or a disclaimer of opinion, and was not qualified or modified as to uncertainty, audit scope, or accounting principles.





During the Engagement Period, there were no disagreements within the meaning of Item 304(a)(1)(iv) of Regulation S-K between UHY HK and us on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to UHY HK’s satisfaction, would have caused UHY HK to make reference to the subject matter of the disagreement in connection with its reports. During the Engagement Period, except as described below in this Form 20-F, there were no reportable events within the meaning of Item 304(a)(1)(v) of Regulation S-K for the fiscal years ended December 31, 2008 and 2009 and through the date of this report. However, in connection with the 2009 audit of the Company’s financial statements, it was discovered that the Company had recorded sales transactions with related parties which did not appear to be in accordance with Generally Accepted Accounting Principles. Although the Company ultimately agreed to reverse the occurred transactions, UHY HK decided not to continue to be associated with the Company because of certain material weaknesses in the Company's internal controls. This constituted a “reportable event" as described in Item 304(a)(1)(v) of Regulation S-K.





We provided UHY HK with the disclosure in this annual report on Form 20-F. We requested that UHY HK furnish us with a letter addressed to the Securities and Exchange Commission stating whether UHY HK agreed with the above statements related to UHY HK. A copy of UHY HK’s letter, dated August 17, 2010, was attached as exhibit 15.1 to our annual report on Form 20-F filed with the SEC on August 18, 2010.





On July 5, 2010, we engaged Parker Randall CF (H.K.) (“Parker Randall”) as our new auditor as approved by our Board of Directors on July 3, 2010.





In the years ended December 31, 2007 and 2008 and the subsequent interim period prior to engaging Parker Randall, neither we nor anyone on our behalf consulted with Parker Randall with respect to either (i) the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on our consolidated financial statements, and no written report or oral advice was provided by Parker Randall to us that Parker Randall concluded was an important factor considered by us in reaching a decision as to the accounting, auditing or financial reporting issue, or (ii) any matter that was either the subject of a disagreement (as defined in Item 16F(a)(1)(iv) of Form 20-F and the related instructions to that Item) or a "reportable event" (as defined in Item 16F(a)(1)(v) of Form 20-F).





Item 16G.
Corporate Governance.





Not required.




74





PART III





Item 17.
Financial Statements





We have elected to provide financial statements pursuant to Item 17.





Item 18.
Financial Statements





Audited consolidated financial statements of China Linen Textile Industry, Ltd. for the fiscal years ended December 31, 2010 and 2009 are filed as part of this Annual Report beginning on page F-1.





Item 19.
Exhibits





INDEX TO EXHIBITS





ExhibitNumber1.1

Certificates of Incorporation of Aquasol EnviroTech Ltd., a Cayman Island company dated October 1, 2002

(1)1.1.1

Certificate of Incorporation of China Linen Textile Industry, Ltd., dated May 26, 2008.

(2)1.2

Memorandum of Association of Aquasol Envirotech Ltd.

(1)1.2.1

Articles of Association of China Linen Textile Industry, Ltd., dated May 26, 2008.

(2)1.2.2

Amended and Restated Memorandum of Association of China Linen Textile Industry, Ltd.

(10)1.3

Certificate of Extraprovincial Registration in the Province of British Columbia, Canada dated October 11, 2002.

(1)1.4

Certificate of Incorporation of Aquasol EnvironTech Inc., a British Columbia company, dated November 25, 1998.

(1)1.5

Certificate of Name Change of Aquasol EnvironTech Inc. to Aquasol EnviroTech (Canada) Inc., a British Columbia company, dated December 11, 2000.

(1)1.6

Articles and Memorandum of Aquasol EnviroTech (Canada) Inc.

(1)1.7

Certificate of Incorporation dated June 19, 1997 of Noralta Technologies Corporation (an Alberta, Canada Corporation)

(1)1.8

Certificates of Name Change dated February 23, 1998 from Noralta Technologies Corporation to Aquasol Technologies Inc. (Alberta)

(1)1.9

Certificate of Dissolution of Aquasol Technologies Inc. (Alberta) dated May 20, 2005

(1)4.1

Agency Agreement between Heilongjiang Lanxi Sunrise Linen Textile Industry Co., Ltd., and Harbin Sunshine Linen Textile Co., Ltd., dated November 7, 2005.

(1)4.2

Agreement for Share Exchange between Aquasol Envirotech, Ltd., Bright International Group. Co., Ltd. and the shareholders of Bright International Group Co., Ltd., dated April 11, 2008.

(2)




75




4.3

Fixed Asset Lease Agreement between Heilongjiang Lanxi Sunrise Linen Textile Industry Co., Ltd. and Lanxi Tianxianfang Linen Co., Ltd., dated July 1, 2010

(3)4.4

Loan Agreement between Heilongjiang Lanxi Sunrise Linen Textile Industry Co., Ltd. and Lanxi Branch, Agricultural Bank of China, dated March 18, 2009

(4)4.5

Loan Agreement between Heilongjiang Lanxi Sunrise Linen Textile Industry Co., Ltd. and Lanxi Branch, Agricultural Bank of China, dated March 18, 2009.

(4)4.6

Loan Agreement between Heilongjiang Lanxi Sunrise Linen Textile Industry Co., Ltd. and Lanxi Branch, Agricultural Bank of China, dated March 20, 2009

(4)4.7

Loan Agreement between Heilongjiang Lanxi Sunrise Linen Textile Industry Co., Ltd. and Lanxi Branch, Agricultural Bank of China, dated March 23, 2009.

(4)4.8

Loan Agreement between Heilongjiang Lanxi Sunrise Linen Textile Industry Co., Ltd. and Lanxi Branch, Agricultural Bank of China, dated March 25, 2009

(4)4.9

Loan Agreement between Heilongjiang Lanxi Sunrise Linen Textile Industry Co., Ltd. and Lanxi Branch, Agricultural Bank of China, dated March 22, 2010

(4)4.10

Loan Agreement between Heilongjiang Lanxi Sunrise Linen Textile Industry Co., Ltd. and Lanxi Branch, Agricultural Bank of China, dated March 24, 2010

(4)4.11

Loan Agreement between Heilongjiang Lanxi Sunrise Linen Textile Industry Co., Ltd. and Lanxi Branch, Agricultural Bank of China, dated March 30, 2010

(4)4.12

Maximum Pledge Agreement between Agricultural Bank of China and Heilongjiang Lanxi Sunrise Linen Textile Industry Co., Ltd., dated March 21, 2008

(4)4.13

Land Use Right Certificate, dated April 24, 2009

(4)4.14

Land Use Right Certificate, dated April 24, 2009

(4)4.15

Land Use Right Certificate, dated September 5, 2006

(4)4.16

Labor Contract with Gao Ren, dated January 7, 2008

(4)4.17

Labor Contract with Teng Yunhai, dated January 7, 2008

(4)4.18

Labor Contract with Ma Yongfeng, dated January 7, 2008

(4)4.19

Labor Contract with Li Songyun, dated January 7, 2008

(4)4.20

Labor Contract with Zhao Chunfu, dated January 7, 2008

(4)4.21

Off-Shore Employment Agreement with Shaofeng Qi, dated January 31, 2010

(4)4.22

Agency Agreement between Heilongiang Lanxi Sunrise Linen Textile Industry Co., Ltd. and Harbin Zhongyi Sunrise Linen Co., Ltd., dated January 4, 2008

(4)4.23

Form of Senior Unsecured Convertible Note

(5)4.24

For of Securities Purchase Agreement

(5)




76




4.25

Form of Registration Rights Agreement

(5)4.26

Form of Lock-up Agreement

(5)5.1

2005 Stock Option Plan

(1)8.1

List of Subsidiaries of the Company

*10.1

Independent Director Agreement of Stephen Monticelli

(6)10.2

Stock Acquisition Agreement between Heilongiang Lanxi Sunrise Linen Textile Industry Co., Ltd. and Lanxi Tianxianfang Linen Co., Ltd., dated November 15, 2010

(8)10.3

Off-Shore Employment Agreement with Jodie Zheng Wehner, dated September 7, 2010

(7)10.4

Agreement, dated April 15,2010 between Mr. Gao and Creation International Development Investments Limited

(9)11.1

Code of Ethics – Chief Executive Officer

(1)11.2

Code of Ethics – Chief Financial Officer

(1)11.3

Code of Ethics – Directors and Officers

(1)12.1

Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

*12.2

Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

*13.1

Certification Pursuant to 18 U.S.C. Section 1350, as Adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

*15.1

Letter, dated August 17, 2010, from UHY HK to the Securities and Exchange Commission

*





*
Filed herewith.




(1)
Previously filed with the Registration Statement on Form 20FR12G filed with the SEC on November 16, 2005.


(2)
Previously filed with the Annual Report on Form 20F filed with the SEC on July 10, 2008 for the period ended December 31, 2008.


(3)
Previously filed with the Current Report on Form 6-K filed with the SEC on July 16, 2010.


(4)
Previously filed with the Annual Report on Form 20F filed with the SEC on August 18, 2010 for the period ended December 31, 2009.


(5)
Previously filed with Current Report on Form 6-K filed with the SEC on November 5, 2010.


(6)
Previously filed with Current Report on Form 6-K filed with the SEC on September 3, 2010.


(7)
Previously filed with Current Report on Form 6-K filed with the SEC on September 10, 2010.


(8)
Previously filed with the Registration Statement on Form F-1 filed with the SEC on December 17, 2010.


(9)
Previously filed with the Registration Statement on Form F-1/A filed with the SEC on March 18, 2011.


(10)
Previously filed with the Current Report on Form 6-K filed with the SEC on March 29, 2011.





77




SIGNATURES





The Registrant hereby certifies that it meets all of the requirements for filing on Form 20-F/A and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.





CHINA LINEN TEXTIL INDUSTRY, LTD.By:
/s/ Gao RenGao RenChief Executive Officer and ChairmanApril 6, 2011





78




CHINA LINEN TEXTILE INDUSTRY, LTD.


AUDITED CONSOLIDATED FINANCIAL STATEMENTS


Years ended December 31, 2010 and 2009




F-1


CHINA LINEN TEXTILE INDUSTRY, LTD.





TABLE OF CONTENTS





PageReport of Independent Registered Public Accounting Firm

F-3Financial StatementsConsolidated Balance Sheets

F-4Consolidated Statements of Operations and Other Comprehensive Income

F-5Consolidated Statements of Changes in Shareholders’ Equity

F-6Consolidated Statements of Cash Flows

F-7 - F-8Notes to Consolidated Financial Statements

F-9 - F-48




F-2


暉誼(香港)會計師事務所有限公司PARKER RANDALL CF (H.K.) CPA LIMITEDRoom 201, 2/F., Two Grand Tower, 625 Nathan Road, Kowloon.Tel : 3576 3455 Fax : 2625 1263





REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the Shareholders and Board of Directors of


China Linen Textile Industry, Ltd.





We have audited the accompanying consolidated balance sheets of China Linen Textile Industry, Ltd. (the “Company”) and its subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of operations and other comprehensive income, changes in shareholders’ equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.





We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (PCAOB) of United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits include consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.





In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company, Ltd. and its subsidiaries as of December 31, 2010 and 2009, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.







/s/ Parker Randall CF





Parker Randall CF (H.K.) CPA Limited





Certified Public Accountants, Hong Kong





March 29, 2011




F-3


CHINA LINEN TEXTILE INDUSTRY, LTD.





CONSOLIDATED BALANCE SHEETS


December 31, 2010 and 2009


(Stated in US Dollars)





Notes

2010

2009$

$ASSETSCurrent assetsCash




4,162,069


2,320,656Bank checks and commercial paper




-


1,921,610Accounts receivable, net

3


13,310,770


8,762,516Inventory

4


9,908,789


4,862,855Prepaid expenses

5


984,960


2,183,219Other receivables




201,896


100,165Due from related parties

6


79,879


2,576,579Deferred assets

7


577,667


-Governmental subsidy receivable

8


2,890,197


1,449,331Deferred tax assets

20


113,440


228,794Total current assets




32,229,667


24,405,725Non-current assetsProperty, plant and equipment, net

9


16,153,577


9,195,907Land use right, net

10


872,324


408,134Governmental subsidy receivable, non-current

8


1,918,212


1,882,593Deferred tax assets, non-current

20


473,470


238,600TOTAL ASSETS




51,647,250


36,130,959LIABILITIES AND STOCKHOLDERS' EQUITYCurrent LiabilitiesBank loans

11


3,623,900


4,048,583Accounts payable




3,510,701


2,565,188Accrued expenses and other payables

12


920,535


1,101,571Taxes payable

13


1,186,208


3,729,506Deferred revenue




202,709


423,153Deferred governmental subsidy

14


91,608


88,995Due to related parties

15


-


74,888Deferred tax liabilities

20


722,549


362,333Total current liabilities




10,258,210


12,394,217Non-current liabilitiesDeferred governmental subsidy, non-current

14


1,753,516


1,792,482Deferred tax liabilities, non-current

20


479,553


470,648Convertible notes payable, net

21


6,991,439


-TOTAL LIABILITIES




19,482,718


14,657,347STOCKHOLDER’S EQUITYCommon stock$0.002 par value, 500,000,000 shares authorized; 20,412,203 shares and 20,200,003 shares issued and outstanding as of December 31, 2010 and 2009

22


42,698


42,274Additional paid-in capital




3,437,264


3,093,816Statutory reserves




2,768,269


1,593,559Retained earnings




23,450,326


15,060,004Accumulated other comprehensive income




2,465,975


1,683,959TOTAL STOCKHOLDER’S EQUITY




32,164,532


21,473,612TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY




51,647,250


36,130,959


See notes to consolidated financial statements.




F-4


CHINA LINEN TEXTILE INDUSTRY, LTD.





CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE INCOME


For the Years Ended December 31, 2010 and 2009


(Stated in US Dollars)





Notes


2010


2009$


$RevenuesNet sales





49,090,643



29,386,131Costs of goods sold





33,880,012



20,675,443Gross profit





15,210,631



8,710,688Operating expensesSelling expenses





439,259



615,176General and administrative expenses





3,304,364



1,019,025Total operating expenses





3,743,623



1,634,201Operating income





11,467,008



7,076,487Other incomeInterest income





314,489



252,355Interest expense





(447,889
)


(314,898
)Government subsidies


16



1,708,698



863,436Other income/(expense)






25,473



(5,177
)Total other income






1,600,771



795,716Income before tax






13,067,779



7,872,203Income tax


20



3,502,747



2,141,684Net income






9,565,032



5,730,519Other comprehensive incomeEffects of foreign currency conversion






782,016



32,149Comprehensive income






10,347,048



5,762,668Basic earnings per share


19



0.47



0.28Diluted earnings per share


19



0.46



0.28Pro forma basic earnings per share


19



1.65



1.0Pro forma diluted earnings per share


19



1.61



1.0





See notes to consolidated financial statements




F-5


CHINA LINEN TEXTILE INDUSTRY, LTD.





CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY


For the Years Ended December 31, 2010 and 2009


(Stated in US Dollars)


Common Stock











AccumulatedNumber
of shares


Amount


AdditionalPaid-inCapital


StatutoryReserve


RetainedEarnings


Other
Comprehensive Income


Total$



$



$



$



$



$Balances at January 1, 2009


20,100,003



42,074



2,986,212



1,019,595



9,903,449



1,651,810



15,603,140Shares contributed by shareholders as consideration for advisory services


100,000



200



107,604



-



-



-



107,804Net income


-



-



-



-



5,730,519



-



5,730,519Appropriation to statutory reserves


-



-



-



573,964



(573,964
)


-



-Other comprehensive incomeeffects of foreign currency Conversion


-



-



-



-



-



32,149



32,149Balances at December 31, 2009


20,200,003



42,274



3,093,816



1,593,559



15,060,004



1,683,959



21,473,612Common stock issued for services and compensation


112,200



224



113,800



-



-



-



114,000Share compensation for an independent director


100,000



200



171,820



-



-



-



172,044Net income


-



-



-



-



9,565,032



-



9,565,032Appropriation to statutory reserves


-



-



-



1,174,710



(1,174,710
)


-



-Issuance of convertible notes


-



-



57,828



-



-



-



57,828Other comprehensive incomeeffects of foreign currency Conversion


-



-



-



-



-



782,016



782,016Balances at December 31, 2010


20,412,203



42,698



3,437,264



2,768,269



23,450,326



2,465,975



32,164,532




See notes to consolidated financial statements




F-6


CHINA LINEN TEXTILE INDUSTRY, LTD.





CONSOLIDATED STATEMENTS OF CASH FLOWS


For the Years Ended December 31, 2010 and 2009


(Stated in US Dollars)


2010


2009$



$Cash Flows from Operating ActivitiesNet income


9,565,032



5,730,519Adjustments to reconcile net income to net cashprovided by operating activities:Bad debt (recoveries)/expenses


660,640



(31,313
)Impairment loss on property, plant and equipment


-



4,081Depreciation


693,045



506,434Amortization


10,191



8,795Deferred income taxes


235,411



(15,290
)Deferred government subsidy


(90,283
)


-Fair value of contributed common stock for advisory services


211,571



8,984Interest expense on convertible notes


4,267



-Changes in assets and liabilities:Decrease/(increase) in bank checks and commercial paper


1,949,419



(351,798
)Decrease/(increase) in accounts receivable


(3,983,248
)


884,956Decrease/(increase) in inventory


(4,371,691
)


3,484,721Decrease/(increase) in prepaid expenses


1,264,985



(620,250
)Decrease in other receivables


58,830



244,367Increase ingovernmental subsidy, net


(1,358,679
)


(484,093
)Decrease/(increase) in due from/to related parties


2,459,171



(1,048,002
)Increase/(decrease) in accounts payable


857,584



(149,159
)Decrease in accrued expenses and other payables


(263,792
)


(548,092
)Increase/(decrease) in taxes payable


(2,253,455
)


(4,310,506
)Increase/(decrease) in deferred revenue


(259,140
)


162,204Net cash provided by operating activities


5,389,858



3,476,558





See notes to consolidated financial statements.




F-7




CHINA LINEN TEXTILE INDUSTRY, LTD.





CONSOLIDATED STATEMENTS OF CASH FLOWS


For the Years Ended December 31, 2010 and 2009


(Stated in US Dollars)





2010


2009$



$Cash Flows from Investing ActivitiesAcquisition of investment in subsidiaries, net of cash acquired


(6,607,413
)


-Net cash inflow from acquisition of a subsidiary


482



-Purchase of property, plant and equipment


(2,862,895
)


(872,962
)Net cash used in investing activities


(9,469,826
)


(872,962
)Cash Flows from Financing ActivitiesProceeds from bank loans


5,480,286



4,043,601Payments on bank loans


(6,069,920
)


(4,043,601
)Payments on loans from local government


-



(295,321
)Gross proceeds from issue of convertible notes


6,418,293



-Net cash used in financing activities


5,828,659



(295,321
)Net increase in cash and cash equivalents


1,748,691



2,308,275Effects of foreign currency conversion on cash


92,722



1,707Cash and cash equivalents – beginning of year/period


2,320,656



10,674Cash and cash equivalents – end of year/period


4,162,069



2,320,656Supplemental Disclosures of Cash Flow InformationCash paid during the year for:Interest paid on convertible bonds


48,273



-Interest paid on bank loans


180,062



310,895Income taxes


5,481,979



1,526,428




See notes to consolidated financial statements.




F-8




CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





1.
ORGANIZATION AND PRINCIPAL ACTIVITIES





The Company is currently principally engaged in the business of production and distribution of various types of linen products, such as linen yarn, linen fabric, and blending linen, etc. The Company is also involved in the consultation, research and development related to of linen technology and linen products.





The Company was incorporated under the laws of the Cayman Islands B.W.I. on February 3, 2000 as Aquasol Envirotech, Ltd. The Company was formed to engage in the business of developing, acquiring and marketing water and waste water technology solutions. The Company built a pilot facility in Squamish, British Columbia, Canada in 2001 and conducted limited operations to test its Bio Trap system for wastewater treatment and reuse. The pilot facility was closed in 2001 after completion of the test, the Company ceased operations and became a shell company.





The Company entered into a share exchange transaction on July 9, 2008 as detailed below which resulted in a change of control of the Company. This transaction was accounted for as a reverse merger whereby the historical financial statements and operations of the accounting acquirer are included in the financial statements of the Company.





Business Acquisition


On August 5, 2007, the owners of Heilongjiang Lanxi Sunrise Linen Textile Industry Co., Ltd. (“Lanxi Sunrise”) entered into a Share Purchase Agreement (the “Agreement”) with Bright International Group Co., Ltd. (“Bright”). Pursuant to the Agreement, the owners of Lanxi Sunrise agreed to transfer their 95% equity ownership interest to Bright for a cash consideration of $750,000 (RMB 5,700,000). The remaining 5% equity ownership interest was kept by Mr. Ren Gao, CEO of Lanxi Sunrise. On April 8, 2008, the local government approved the transaction as indicated on the Lanxi Sunrise's new business license. Upon completion of the acquisition, Lanxi Sunrise became an enterprise with foreign investment in PRC and a 95% owned subsidiary of Bright.




F-9




CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





NOTE 1 — ORGANIZATION AND PRINCIPAL ACTIVITIES(Continued)





Acquisition of Lanxi Tianxianfang Linen Co., Ltd.


On November 15, 2010, we, through our indirect 95% owned subsidiary, Lanxi Sunrise, entered into a Share Acquisition Agreement (the “Acquisition Agreement”) with Lanxi Tianxianfang Linen Co., Ltd. ( “Lanxi Tianxianfang”, “Target”) and Shufan Wang (“Wang”) and Lijie Fu (“Fu”), the two shareholders of the Target. Pursuant to the Acquisition Agreement, Lanxi Sunrise has purchased all of the equity of the Target for a price of RMB 44,401,485 (approximately $6.7 million) (the “Purchase Price”), which Purchase Price was based on an appraisal report of the Target’s assets, liabilities and net assets as of March 31, 2010 by Heilongjiang Zhongming Guolin Asset Appraisal Co., Ltd.





The Purchase Price was paid in one installment by Lanxi Sunrise to Wang and Fu on November 16, 2010. Wang and Fu deposited RMB 22,750,642 (approximately $3.4 million) into a bank account of the Target for the repayment of the sum of the debts of the Target outstanding on March 31, 2010, which funds will be distributed by the Company in accordance with a payment schedule for such debts. According to the Acquisition Agreement, the acquisition date was November 16, 2010.





On November 24, 2010, the equity transfer was officially completed upon the effectiveness of the change in registration of the equity interest from Wang and Fu to Lanxi Sunrise with the relevant PRC authority.




F-10




CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





NOTE 1 — ORGANIZATION AND PRINCIPAL ACTIVITIES(Continued)





Reverse Acquisition


On July 9, 2008, the Company entered into a share exchange transaction with Bright in which the Company acquired all the issued and outstanding capital stock of Bright in return for the issuance of 18,963,005 shares of the Company’s common stock. As a result of the reverse merger, the Company effectively issued 1,136,998 shares (post split) of common stock on July 9, 2008. As a result of the transaction, Bright became a wholly owned subsidiary of the Company. The transaction was accounted for as a reverse acquisition from accounting perspective since Bright has become the controlling shareholder of the Company after the share exchange transaction. For accounting purpose, Bright is regarded as the accounting acquirer while the Company before the reverse acquisition is deemed to have been acquired by Bright. As a result, these consolidated financial statements have been prepared as a continuation of the consolidated financial statements of Bright. In anticipation of completion of the Reverse Acquisition, the Company changed its name to China Linen Textile Industry, Ltd.





Share Split


On June 30, 2008, prior to completion of the Share Exchange transaction, the Company completed a 1:2 reverse split of its issued and outstanding common stock, thereby reducing the number of issued and outstanding shares from 2,273,995 to approximately 1,136,998.





The Company conducts all of its business activities through its wholly owned subsidiary, Lanxi Sunrise, which was incorporated in Lanxi County, Heilongjiang Province, the People's Republic of China (the "PRC") on June 11, 2002, as a state-owned holding company under the Company Law of PRC and changed into a privately owned business enterprise in June 2007. Lanxi Sunrise manufacturing facility is located in Lanxi County, Heilongjiang Province.





Bright, incorporated in the Republic of Vanuatu on July 4, 2007, is an investment holding company with 95% equity ownership interest in Lanxi Sunrise.




F-11




CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





2.
SIGNIFICANT ACCOUNTING POLICIES





Basis of Presentation


The financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("US GAAP").





Basis of Consolidation


The accompanying consolidated financial statements include the accounts of the Company, Bright, Lanxi Sunrise and Lanxi Tianxianfang (hereafter, collectively referred to as “the Group”). All significant intercompany accounts and transactions have been eliminated in consolidation.





Statement of Cash Flows


In accordance with SFAS No. 95, “Statement of Cash Flows,” cash flows from the Group’s operations is calculated based upon the functional currency. As a result, amounts related to assets and liabilities reported on the statement of cash flows may not necessarily agree with changes in the corresponding balances on the balance sheets.





Economic and Political Risks


The Group’s operations are conducted solely in the PRC. There are significant risks associated with doing business in the PRC, among others, political, economic, legal and foreign currency exchange risks. The Group’s results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation, among other things.





Use of Estimates


In preparing the consolidated financial statements in conformity with US GAAP, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. These accounts and estimates include, but are not limited to, the valuation of accounts receivable, inventories, deferred income taxes and the estimation on useful lives of plant and machinery. Actual results could differ from those estimates.




F-12




CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





2.
SIGNIFICANT ACCOUNTING POLICIES(Continued)





Cash and Cash Equivalents


Cash and cash equivalents include cash on hand, deposits in banks with maturities of three months or less, and all highly liquid investments which are unrestricted as to withdrawal or use, and which have original maturities of three months or less at the time of purchase. As of December 31, 2010 and 2009, there were cash and cash equivalents of $4,162,069 and $2,320,656 respectively.





Bank Checks and Commercial Paper


Bank checks and commercial paper include bank checks and commercial paper with original maturities of approximately 180 days or less at the time of issuance. Book value approximates fair value because of the short maturity of those instruments. The Group receives these financial instruments as payments from its customers in the ordinary course of business.





Accounts Receivable


Accounts receivable consists of amounts due from customers. The Group extends unsecured credit to its customers in the ordinary course of business but mitigates the associated risks by performing credit checks and actively pursuing past due accounts. An allowance for doubtful accounts is established and determined based on management’s assessment of known requirements, aging of receivables, payment history, the customer’s current credit worthiness and the economic environment.





Concentrations of Credit Risk


The Group sells its products to domestic and international customers. For PRC domestic customers, credit is extended based on an evaluation of the customer's financial condition. As of December 31, 2010 and 2009, five customers accounted for approximately 48.1% and 99.2% of its accounts receivable balances. Due to the longstanding nature of its relationships with these customers and contractual obligations, the Group is confident that it will recover these amounts. The Group establishes an allowance for doubtful accounts based on factors surrounding the credit risk of specific customers and other information.





The Group maintains its cash and cash equivalents with high-quality institutions. Deposits held with banks in PRC may not be insured or exceed the amount of insurance provided on such deposits.




F-13


CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





2.
SIGNIFICANT ACCOUNTING POLICIES(Continued)





Inventories


Inventories are stated at the lower of cost or market value. Actual cost is used to value raw materials and supplies. Finished goods and work-in-progress are valued on the weighted-average cost method. Elements of costs in finished goods and work-in-progress include raw materials, direct labor, and manufacturing overhead. In assessing the ultimate realization of inventories, the management makes judgments as to future demand requirements compared to current or committed inventory levels. The Group’s reserve requirements generally increase/decrease due to management projected demand requirements, market conditions and product life cycle changes. As of December 31, 2010 and 2009, the Group did not make any allowance for slow-moving or defective inventories.





Fair value of Financial Instruments


The carrying values of the Group’s financial instruments, including cash and cash equivalents, accounts receivables, other receivables and prepayments, short-term borrowings, accounts payables, derivative instruments, and other accrued liabilities are at their fair values due to the maturity of such instruments.





Other Receivables


Other receivables principally include advances to employees who are working on projects on behalf of the Group. After the work is finished, they will submit expense reports with supporting documents to the accounting department. Upon being properly approved, the expenses are debited into the relevant accounts and the advances are credited out. Cash flows from these activities are classified as cash flows from operating activities.





Property, plant and equipment


Property, plant and equipment, other than construction in progress, are stated at cost less depreciation and amortization and accumulated impairment loss. Cost represents the purchase price of the asset and other costs incurred to bring the asset into its existing use. Maintenance, repairs and betterments, including replacement of minor items, are charged to expense; major additions to physical properties are capitalized.





When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in income in the reporting period of disposition.




F-14





CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





2.
SIGNIFICANT ACCOUNTING POLICIES(Continued)





Property, plant and equipment(Continued)


Depreciation of property, plant and equipment is calculated to written off the cost, less their estimated residual value, if any, using the straight-line method over their estimated useful lives. The principal annual rates are as follows:





Leasehold improvement and buildings
20~40 yearsMachinery
10~18 yearsMotor vehicles
5 yearsOffice equipment
5 years





Upon sale or disposition, the applicable amounts of asset cost and accumulated depreciation are removed from the accounts and the net amount less proceeds from disposal is charged or credited to income.





Construction in progress mainly represents expenditures in respect of the Group’s corporate campus and machinery under construction, which the campus was completed and at which production began in 2009. Assets under construction are not depreciated until the construction is completed and the assets are ready for their intended use.





Accounting for the Impairment of Long-Lived Assets


The Group adopted Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Live Assets” (“SFAS 144”), which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. The Group periodically evaluates the carrying value of long-lived assets to be held and used in accordance with SFAS 144. SFAS 144 requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amounts. In that event, a loss is recognized based on the amount by which the carrying amount exceeds the fair market value of the long-lived assets. Loss on long-lived assets to be disposed of is determined in a similar manner, except that fair market values are reduced for the cost of disposal. Based on its review, the Group believes that, as of December 31, 2010 and 2009, there were no significant impairments of its long-lived assets.




F-15





CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





2.
SIGNIFICANT ACCOUNTING POLICIES(Continued)





Land Use Right


All land is owned by the Government in the PRC. Enterprises and individuals can pay the State a fee to obtain a right to use land for commercial purposes for an initial period of 50 years. The land use right can be sold, purchased, and exchanged in the market. The successor owner of the land use right will reduce the amount of time which has been consumed by the predecessor owner.





(1)
Land Use Right – Town East Street





In August 2006, Lanxi Sunrise obtained the land use right of a piece of land, approximately 11 acres, located in the Lanxi County, Heilongjiang Province for $333,321 (RMB 2,600,000). The land use right is for commercial use purposes with a 50-year period ended August 15, 2056. The cost of this land use right is amortized over its prospective beneficial period, using the straight-line method. Most of Lanxi Sunrise’s production facilities and headquarters are located on this land. The local government refunded the full amount of the purchase price of $333,321 (RMB 2,600,000) to Lanxi Sunrise, which recorded the amount as deferred governmental subsidy to be recognized over the land use right's amortization period.





(2)
Land Use Right – Lixin Street





In January 2005, Lanxi Sunrise obtained the land use right of two adjacent pieces of land, approximately 2 acres, also located in Lanxi County, Heilongjiang Province for $49,600 (RMB 400,000). The land use right is for commercial use purposes with a 50-year period ended December 29, 2054. The cost of this land use right is amortized over its prospective beneficial period, using the straight-line method. A portion of Lanxi Sunrise’s production facilities are located in these two pieces of land.





In January 2005, the local government also granted the buildings attached to these two pieces of land to Lanxi Sunrise as a governmental subsidy, as more fully disclosed in the "Governmental Subsidies" section of this note. Lanxi Sunrise pledged the use rights of the two pieces of land and the buildings attached, as collateral to provide a guarantee for a related party through April 10, 2008 to receive an import letter of credit, as more fully disclosed in the "Related Party Transaction" of this note.




F-16


CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





2.
SIGNIFICANT ACCOUNTING POLICIES(Continued)





Governmental Subsidies


The Company’s subsidiary, Lanxi Sunrise, is considered to be a leading manufacture enterprise by the local government, Lanxi Government ("Lanxi Government"), which has a long-term desire to encourage Lanxi Sunrise to expand its production capacity and to create more job opportunities for local residents. For that purpose, the local government has granted various subsidies to Lanxi Sunrise as follows:





(1)
Income Tax Refund Grant


On May 19, 2006, the local government ran an incentive program exclusively for Lanxi Sunrise. Among other things, the program provided Lanxi Sunrise to receive government grants equal to Lanxi Sunrise's income taxes for the years 2006, 2007, and 2008, and 40% of the local income taxes for the years 2009 and 2010. To be eligible for the grants, Lanxi Sunrise needs to pay income taxes to the tax authority as required by tax laws and regulation, and then submits the proof of payment to Lanxi Government, which will deposit the grants to Lanxi Sunrise's bank account. The Lanxi Government further granted Lanxi Sunrise the deferral of income tax payments for 2006, 2007 and 2008 until 2009, 2010 and 2011, respectively.





Lanxi Sunrise records the present value of income tax refund grant as governmental subsidies receivable and governmental subsidy revenue at the same time when the income taxes payable are recorded. For the year ended December 31, 2009, Lanxi Sunrise has received the refund of income tax payment from the local government for the year of 2006 amounted to $1,320,000 (RMB 8,991,000).





(2)
Land Subsidy


Included in the incentive program described in the preceding paragraph, the local government provided $333,321 (RMB 2,600,000) subsidy for Lanxi Sunrise to purchase a land use right. Lanxi Sunrise purchased the land use right in August 2006 for $333,321 (RMB 2,600,000), as more fully disclosed in the "Land Use Right" section of this note. The local government refunded the full amount of the purchase price to Lanxi Sunrise, which recorded the amount as deferred governmental subsidy to be recognized over the land use right's amortization period.




F-17


CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





2.
SIGNIFICANT ACCOUNTING POLICIES(Continued)





Governmental Subsidies (Continued)


(3)
Building Subsidy


In January 2005, the local government granted the buildings attached to two adjacent pieces of land to Lanxi Sunrise as government subsidy, as more fully disclosed in the "Land Use Right" section of this note. Lanxi Sunrise obtained the title documents of these buildings on February 2, 2006. Management estimated the fair value of these buildings at $794,345 (RMB 5,793,572.), based on an appraisal report issued by an independent appraiser certified by the local government. Lanxi Sunrise treated the full amount as deferred governmental subsidy, and began to recognize governmental subsidy revenue when Lanxi Sunrise complied with all conditions attached to the grant in December 2007, over these buildings' estimated useful life of 20 years.





(4)
Sewage Facilities Improvement Subsidy


In December 2008, the local government granted $776,045 (RMB 5,300,000) to Lanxi Sunrise for sewage facilities improvement. This subsidy is regarded as deferred government subsidy whose primary condition for qualification is to improve the sewage facilities of the production plant by acquiring certain long-term assets. The government grant is recognized as income over the periods necessary to match them with the related costs of the assets purchased which they are intended to compensate over the periods and in the proportions in which depreciation on those assets is charged. Subsidy income of $39,435 and $16,185 was recognized for the year ended December 31, 2010 and 2009.





(5) Monetary Grant


The local government granted various funds to Lanxi Sunrise, such as leading enterprise fund and financial supporting fund. Lanxi Sunrise recorded these funds as liabilities upon receipt. Government subsidy revenue is recognized only when there is reasonable assurance that Lanxi Sunrise has complied with all conditions attached to the grant.




F-18


CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





2.
SIGNIFICANT ACCOUNTING POLICIES(Continued)





Foreign Currency Translation


The Company and Bright maintain its books and accounting records in the United States Dollar ("USD"), which is determined as the functional currency. However, the functional currency of the Company’s subsidiary, Lanxi Sunrise, is in PRC currency “Renminbi” (“RMB”). Transactions denominated in currencies other than RMB are translated into RMB at the exchange rates quoted by the People’s Bank of China (“PBOC”) prevailing at the date of the transactions. Monetary assets and liabilities denominated in currencies other than RMB are translated into RMB using the applicable exchange rates quoted by the PBOC at the balance sheet dates. Gain and losses resulting from foreign currency transactions are included in operations.





For financial reporting purposes, the financial statements of the Group which are prepared using the functional currency have been translated into United States dollars. Assets and liabilities are translated at the exchange rates at the balance sheet dates and revenue and expenses are translated at the average exchange rates and stockholders’ equity is translated at historical exchange rates. Any translation adjustments resulting are not included in determining net income but are included in foreign exchange adjustment to other comprehensive income, a component of stockholders’ equity.


2010


2009Year end US$: RMB exchange rate


6.6227



6.8172Average periodic US$: RMB exchange rate


6.7200



6.8221





RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into US$ at the rates used in translation.





Revenue Recognition


Revenue represents the invoiced value of goods sold recognized upon the delivery of goods to customers. Revenue is recognized when all of the following criteria are met:


l
Persuasive evidence of an arrangement exists;


l
Delivery has occurred or services have been rendered;


l
The seller’s price to the buyer is fixed or determinable; and


l
Collectability is reasonably assured. Payments have been established.




F-19




CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





2.
SIGNIFICANT ACCOUNTING POLICIES(Continued)





Revenue Recognition (Continued)


The return policy of goods is recognized in actual basis when the goods sold were being returned by customer then the closing balance of the period/year is actually deducted by the increment of relevant cost of sales. As the sales return rate is low and immaterial, no such provision is required to be made.





Deferred Revenue


Deferred revenue consists of prepayments to the Group for products that have not yet been delivered to the customers. Payments received prior to satisfying the Group’s revenue recognition criteria are recorded as deferred revenue.





Research and Development Costs


Research and development costs relating to the development of new products and processes, including significant improvements and refinements to existing products, are expensed when incurred. The major components of these research and development costs include experimental materials and labor costs. Research and development costs were immaterial for the Group in the years ended December 31, 2010 and 2009, respectively, and are included in general and administration expenses.





Comprehensive Income


The Group has adopted ASC 220 “Comprehensive Income” which establishes the rules for the reporting of comprehensive income and its components. Comprehensive income is defined to include all changes in equity except those resulting from investments by owners and distributions to owners. Among other disclosures, all items that are required to be recognized under current accounting standards as components of comprehensive income are required to be reported in a consolidated financial statement that is presented with the same prominence as other financial statements. The Group’s current components of other comprehensive income are the foreign currency translation adjustment.





Value-added Tax (VAT)


Sales revenue represents the invoiced value of goods, net of value-added tax (VAT). All of the Group’s products that are sold in PRC are subject to Chinese value-added tax at a rate of 17% of the gross sales price or at a rate approved by the Chinese local government. This VAT may be offset by VAT paid on purchases of raw materials included in the cost of producing the finished goods.




F-20


CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





2.
SIGNIFICANT ACCOUNTING POLICIES(Continued)





Advertising Costs


Advertising costs are expensed as incurred and included as part of selling and marketing expenses. Advertising costs were immaterial for the Group in the years ended December 31, 2010 and 2009, respectively.





Pension and Employee Benefits


Full time employees of the PRC entities participate in a government mandated multi-employer defined contribution plan pursuant to which certain pension benefits, medical care, unemployment insurance, employee housing fund and other welfare benefits are provided to employees. Chinese labor regulations require the PRC entities to accrue for these benefits based on certain percentages of the employees' salaries. Management believes full time employees who have passed the probation period are entitled to such benefits. The total employee pension expenses were $726,935 and $398,742 for the years ended December 31, 2010 and 2009, respectively.





Share-based compensation


The issuance of the Company’s common stock for non-cash consideration have been assigned a per share amount equaling the fair value. The fair value is determined by the management by reference to the market price of the Company’s shares on the measurement date. The non-cash consideration received pertains to services rendered by the consultant and salary compensation.





The Company accounts for equity instruments issued to the consultant in exchange for services in accordance with the provisions of EITF Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling Goods or Services, and EITF Issue No. 00-18, Accounting Recognition for Certain Transactions Involving Equity Instruments Granted to Other than Employees. The measurement date for the fair value of the equity instruments issued is determined at the earlier of (i) the date at which a commitment for performance by the consultant is reached or (ii) the date at which the consultant’s performance is complete. In the case of equity instruments issued to consultants, the fair value of the equity instrument is recognized over the term of the consulting agreement.




F-21


CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





2.
SIGNIFICANT ACCOUNTING POLICIES(Continued)





Share-based compensation(Continued)





The Company accounts for equity instruments issued to the employee in exchange for compensation in accordance with the provisions of FASB Statement NO.123, Accounting For Stock-Based Compensation.The fair value of shares or stock options granted should be measured at the grant date, based on market prices if available, taking into account the terms and conditions upon which those shares or stock options were granted.





The Company records the fair value of the fully vested, non-forfeitable common stock issued for future consulting services as prepaid consulting in its consolidated balance sheet.





Statutory Reserves


Pursuant to the applicable laws in PRC, PRC entities are required to make appropriations to three non-distributable reserve funds, the statutory surplus reserve, statutory public welfare fund, and discretionary surplus reserve, based on after-tax net earnings as determined in accordance with the PRC GAAP, after offsetting any prior years’ losses. Appropriation to the statutory surplus reserve should be at least 10% of the after-tax net earnings until the reserve is equal to 50% of the entity's registered capital.





The Group has passed a resolution in January 2010 whereby Lanxi Sunrise will continue to allocate 10% of the after-tax net earnings to statutory surplus reserve despite the reserve having reached 50% of Lanxi Sunrise’s registered capital.





Appropriation to the statutory public welfare fund is 5% to 10% of the after-tax net earnings. The statutory public welfare fund is established for the purpose of providing employee facilities and other collective benefits to the employees and is non-distributable other than in liquidation. Beginning January 1, 2006, the Group has no further requirements to make appropriations to the statutory public welfare fund. The Group does not make appropriations to the discretionary surplus reserve fund.




F-22


CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





2.
SIGNIFICANT ACCOUNTING POLICIES(Continued)





Statutory Reserves(Continued)





The Group contributed $1,174,710 and $573,966 to the statutory surplus reserve fund in 2010 and 2009 respectively. Statutory reserves consist of the followings:





Statutory


Statutory


TotalSurplus


Welfare


StatutoryReserve


Reserve


ReservesBalance on January 1, 2009

$
877,260


$
142,335


$
1,019,595Contribution in 2009


573,964



-



573,964Balance on December 31, 2009

$
1,451,224


$
142,335


$
1,593,559Contribution in 2010


1,174,710



-



1,174,710Balance on December 31, 2010

$
2,625,934


$
142,335


$
2,768,269




Related Party Transactions


For the purposes of these financial statements, parties are considered to be related if one party has the ability, directly or indirectly, to control the party or exercise significant influence over the party in making financial and operating decisions, or vice versa, or where the Group and the party are subject to common control or common significant influence. Related parties may be individuals or other entities. The Group’s relationships with related parties are described as follows:





Name

RelationshipRen Gao

CEO and Chairman of the GroupHarbin Zhongyi Sunshine Linen Co., Ltd.

Under common control by Ren GaoHarbin Sunshine Linen Textile Co., Ltd.

Under the control by Jun Gao*





*Jun Gao, the elder brother of Ren Gao, is considered as a related party of the Group.




F-23


CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





2.
SIGNIFICANT ACCOUNTING POLICIES(Continued)





Related Party Transactions(Continued)


(1) Due from/to related parties





The Group purchases some raw materials from, and sells some finished goods to related parties. In addition, Harbin Zhongyi Sunshine Linen Co., Ltd and Harbin Sunshine Linen Textile Co., Ltd., at times act as the Group’s agents in importing raw materials and exporting products on similar terms with unrelated parties. Due from/to related parties derived from such transactions are disclosed separately from arm's length trading accounts receivable and payable. Cash flows from these activities are classified as cash flows from operating activities.





(2) Loans from Related Parties





Loans from related parties are interest-free short-term loans from the related parties to finance the Group’s operation. Cash flows from these activities are classified as cash flows from financing activities. As at December 31, 2010 and 2009, the loans from related parties of the Group were $0 and $74,888.




F-24


CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





2.
SIGNIFICANT ACCOUNTING POLICIES(Continued)





Income Taxes


The Group accounts for income taxes under ASC 740 “Income Taxes”, which method are called the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets are reduced by a valuation allowance to the extent management concludes it is more likely than not that the assets will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statements of income and comprehensive income in the periods that includes the enactment date.





Commitments and Contingencies


Liabilities for loss contingencies arising from claims, assessments, litigation, fines and penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated.





Fair Value Measurements


In August 2009, the FASB issued Accounting Standards Update “ASU” 2009-5 “Measuring Liabilities at Fair Value”. This ASU provides amendments to ASC 820-10 “Fair Value Measurements and Disclosures” to address concerns regarding the determination of the fair value of liabilities. Because liabilities are often not “traded”, due to restrictions placed on their transferability, there is typically a very limited amount of trades (if any) from which to draw market participant data. As such, many entities have had to determine the fair value of a liability through the use of a hypothetical transaction. This ASU clarifies the valuation techniques that must be used when the liability subject to the fair value determination is not traded as an asset in an active market.




F-25


CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





2.
SIGNIFICANT ACCOUNTING POLICIES(Continued)





Fair Value Measurements(Continued)


The Company adopted the guidance of Accounting Standards Codification (“ASC”) 820 for fair value measurements which clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:





Level 1 - Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.





Level 2 - Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other then quoted prices that are observable, and inputs derived from or corroborated by observable market data.





Level 3 - Inputs are unobservable inputs which reflect the reporting entity’s own assumptions on what assumptions the market participants would use in pricing the asset or liability based on the best available information.





The carrying amounts reported in the balance sheets for cash, accounts receivable, other receivables, short-term borrowings, accounts payable and accrued expenses, customer advances, and amounts due from related parties approximate their fair market value based on the short-term maturity of these instruments.





ASC 825-10 “Financial Instruments,” allows entities to voluntarily choose to measure certain financial assets and liabilities at fair value (fair value option). The fair value option may be elected on an instrument-by-instrument basis and is irrevocable, unless a new election date occurs. If the fair value option is elected for an instrument, unrealized gains and losses for that instrument should be reported in earnings at each subsequent reporting date. The Company uses Level 3 inputs to value its derivative liabilities.




F-26


CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





2.
SIGNIFICANT ACCOUNTING POLICIES(Continued)





Fair Value Measurements(Continued)


In April 2009, the FASB issued ASC 820-10-65-4 (formerly FSP No. 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset and Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly”). This standard emphasizes that even if there has been a significant decrease in the volume and level of activity, the objective of a fair value measurement remains the same. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants. This standard provides a number of factors to consider when evaluating whether there has been a significant decrease in the volume and level of activity for an asset or liability in relation to normal market activity.





In addition, when transactions or quoted prices are not considered orderly, adjustments to those prices based on the weight of available information may be needed to determine the appropriate fair value. This standard is effective for interim and annual reporting periods ending after June 15, 2009, and shall be applied prospectively. Early adoption is permitted for periods ending after March 15, 2009. The adoption of this standard did not have a material effect on our consolidated financial statements.





Earnings Per Share


The Company reports basic earnings per share in accordance with ASC Topic 260, “Earnings Per Share”. Basic earnings/(loss) per share is computed by dividing net income/ (loss) by weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during the period. As of November 3, 2010, the Company had 4,634,869 common stock shares from convertible notes that could potentially dilute future earnings per share.


F-27


CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





2.
SIGNIFICANT ACCOUNTING POLICIES(Continued)





Recent Accounting Pronouncements


In January 2010, the FASB issued ASU No. 2010-02 “Accounting and Reporting for Decrease in Ownership of a subsidiary – a Scope Clarification”. The update provides amendments to subtopic 810-10 and related guidance within US GAAP to clarify that the scope of the decrease in ownership provisions of the Subtopic and related guidance applies to three cases. The amendments in this Update also clarify that the decrease in ownership guidance in Subtopic 810-10 does not apply to the sales of in substance real estate and conveyances of oil and gas mineral rights transactions even if they involve businesses. If a decrease in ownership occurs in a subsidiary that is not a business or nonprofit activity, and entity first needs to consider whether the substance of the transaction causing the decrease in ownership in addressed in other U.S.GAAP, such as transfers of financial assets, revenue recognition, exchanges of nonmonetary assets, sales of in substance real estate, or conveyances of oil and gas mineral rights, and apply that guidance as applicable. If no other guidance exists, an entity should apply the guidance in Subtopic 810-10. The amendments in this Update also expand the disclosure about the deconsolidation of a subsidiary or derecognition of a group of assets within the scope of Subtopic 810-10. None of the new pronouncements has current application to the Company.





In January 2010, the FASB issued ASU No. 2010-06 “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements”. This update provides amendments to Subtopic 820-10 that required new disclosures for 2 situations. i) A report entity should disclose separately the amount of significant transfer in and out of Level 1 and 2 fair value measurements and describe the reasons for the transfers. ii) In the reconciliation for fair value measurements using significant unobservable inputs (Level 3), a reporting entity should present separately information about purchases, sales, issuance, and settlements. None of the new pronouncements has current application to the Company.




F-28


CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





2.
SIGNIFICANT ACCOUNTING POLICIES(Continued)





Recent Accounting Pronouncements(Continued)


In February 2010, the FASB issued ASU No. 2010-09 “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements”. This Update provides amendments to i)An entity that either (a) is an SEC filer or (b) is a conduit bond obligor for conduit debt securities that are traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local or regional markets) is required to evaluate subsequent events through the date that the financial statements are issued. If an entity meets neither of those criteria, then it should evaluate subsequent events through the date the financial statements are available to be issued. ii)The glossary of Topic 855 is amended to include the definition of SEC filer. iii)An entity that is an SEC filer is not required to disclose the date through which subsequent events have been evaluated. iv)The glossary of Topic 855 is amended to remove the definition of public entity. v)The scope of the reissuance disclosure requirements is refined to include revised financial statements only. None of the new pronouncements has current application to the Company.





In May 2010, the FASB issued ASU No. 2010-19 “Foreign Currency (Topic 830): Foreign Currency Issues: Multiple Foreign Currency Exchange Rates (SEC Update)”. The purpose of this Update is to codify the SEC Staff Announcement made at the March 18, 2010 meeting of the FASB Emerging Issues Task Force (EITF) by the SEC Observer to the EITF. The Staff Announcement provides the SEC staff’s view on certain foreign currency issues related to investments in Venezuela. None of the new pronouncements has current application to the Company.





In December 2010, the FASB issued ASU No. 2010-29 “Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations (a consensus of the FASB Emerging Issues Task Force)”. The amendments in this Update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments in this Update also expand the supplemental pro forma disclosures under Topic 805 to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. None of the new pronouncements has current application to the Company.




F-29


CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





3.
ACCOUNTS RECEIVABLE


Accounts receivable consist of the following:





December 31,


December 31,2010


2009Accounts receivable

$
14,576,559


$
9,238,460Less: Allowance for doubtful accounts


(1,265,789
)


(475,944
)Accounts receivable, net

$
13,310,770


$
8,762,516





There was bad debt expense of $777,819 charged to operations for the year ended December 31, 2010.


There was reversal of bad debt expense of $245,755 credited to operations for the years ended December 31, 2009.





4.
INVENTORY


Inventory consists of the followings:





December 31,


December 31,2010


2009Finished goods

$
2,540,407


$
2,443,517Work-in-progress


433,489



406,297Raw materials


5,519,497



1,994,074Subcontract stocks


1,395,873



-Supplies and low-value materials


19,523



18,967$
9,908,789


$
4,862,855





No allowance for inventories was provided at December 31, 2010 and 2009.




F-30




CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





5.
PREPAID EXPENSES


Prepaid expenses consist of the followings:





December 31,


December 31,2010


2009Raw materials and supplies

$
811,667


$
1,756,565Advance to contractors


-



315,137Others


173,293



111,517$
984,960


$
2,183,219





There were bad debt expense of $49,658 and $206,136 charged to operations for the year ended December 31, 2010 and 2009.





6.
DUE FROM RELATED PARTIES


Due from related parties consist of the followings:





Name of related parties

December 31,


December 31,2010


2009Harbin Sunshine Linen Textile Co., Ltd.

$
79,879


$
515,479Harbin Zhongyi Sunshine Linen Co., Ltd.


-



2,061,100$
79,879


$
2,576,579





7.
DEFERRED ASSETS


Deferred assets consist of the followings:





December 31,


December 31,2010


2009Issuance cost capitalized for equity component

$
5,144


$
-Issuance cost capitalized for liability component


572,523



-$
577,667


$
-




F-31


CHINA LINEN TEXTILE INDUSTRY, LTD.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





8.
GOVERNMENTAL SUBSIDY RECEIVABLE


Governmental subsidy receivable consists of the following:





(1)
Current Portion





Name of Governmental Subsidy

December 31,


December 31,2010


2009Income Tax Subsidy-2007

$
1,289,546


$
1,252,755Income Tax Subsidy-2007 for interest imputed


315,137



196,576Income Tax Subsidy-2008


1,157,166



-Income Tax Subsidy-2008 for interest imputed


128,348



-$
2,890,197


$
1,449,331





(2)
Non-current Portion





Name of Governmental Subsidy

December 31,


December 31,2010


2009Income Tax Subsidy-2008

$
-


$
1,044,683Income Tax Subsidy-2008 for interest imputed


-



60,704Income Tax Subsidy-2009


759,043



777,206Income Tax Subsidy-2009 for interest imputed


40,987



-Income Tax Subsidy-2010


1,118,182



-$
1,918,212


$
1,882,593




F-32


CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





9.
PROPERTY, PLANT AND EQUIPMENT


The following is a summary of property, plant and equipment:





December 31,


December 31,2010


2009CostBuilding and warehouses

$
8,901,351


$
4,161,061Machinery and equipment


10,781,186



7,651,155Office equipment and furniture


191,475



141,953Motor vehicles


45,178



8,831Leasehold improvement


1,023,495



-Total

$
20,942,685


$
11,963,000Accumulated depreciation


(4,857,648
)


(2,841,436
)Idle fixed assets


68,540



66,964Fixed assets to be disposed


-



7,379Property, plant and equipment, net

$
16,153,577


$
9,195,907





Depreciation expense charged to operations was $693,045 and $506,434 for the years ended December 31, 2010 and 2009, respectively.





10.
LAND USE RIGHT


The following is a summary of land use right, less amortization:





December 31,


December 31,2010


2009Land use right

$
947,540


$
440,063Less: Amortization


(75,216
)


(31,929
)Land use right, net

$
872,324


$
408,134





Amortization expense charged to operations was $10,191 and $8,795 for the years ended December 31, 2010 and 2009, respectively.




F-33




CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





11.
BANK LOANS


Bank loans consist of the following as of December 31, 2010:




Loan from Financial Institutions

Annual

Interest

Rate


Loan period

Loan

Amount

CollateralLanxi Branch of Agriculture Bank of China


6.903
%

2/24/2010 – 2/23/2011

$
2,264,938

The Group'sLanxi Branch of Agriculture Bank of China


6.903
%

3/22/2010 – 3/21/2011


1,358,962

equipment andTotal







$
3,623,900

buildings





Interest expense charged to operations for these bank loans was $180,062 for the year ended December 31, 2010.





Bank loans consist of the following as of December 31, 2009:


Loan from Financial Institutions

Annual

Interest

Rate


Loan period


Loan

Amount

CollateralLanxi Branch of Agriculture Bank of China


6.903
%

3/18/2009 – 3/17/2010


$
968,139Lanxi Branch of Agriculture Bank of China


6.903
%

3/18/2009 – 3/17/2010



440,063Lanxi Branch of Agriculture Bank of China


6.903
%

3/20/2009 – 3/19/2010



440,063

The Group'sLanxi Branch of Agriculture Bank of China


6.903
%

3/23/2009 – 3/22/2010



1,320,190

equipment andLanxi Branch of Agriculture Bank of China


6.903
%

3/25/2009 – 3/24/2010



880,128

buildingsTotal








$
4,048,583




Interest expense charged to operations for these bank loans was $310,895 for the year ended December 31, 2009. There was no default of bank loan or interest payments during the year. All the bank loans were settled in March, 2010.




F-34


CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





12.
ACCRUED EXPENSES AND OTHER PAYABLES


Accrued expenses and other payables consist of the followings:





December 31,


December 31,2010


2009Accrued payroll

$
302,090


$
262,153Accrued employee benefits


212,437



265,886Accrued pension expenses


-



102,957Other accrued expenses


70,000



246,473Interest payable for convertible notes


35,386



-Other payables


300,622



224,102$
920,535


$
1,101,571





13.
TAXES PAYABLE


Taxes payable consist of the followings:





December 31,


December 31,2010


2009Income taxes payable

$
1,267,227


$
3,414,122Sales-related taxes payable


-



23,080VAT payable


(124,771
)


288,496Other taxes payable


43,752



3,808$
1,186,208


$
3,729,506





The deductible VAT payable was brought forward from Lanxi Tianxianfang as of the acquisition date of November 16, 2010.




F-35


CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





14.
DEFERRED GOVERNMENTAL SUBSIDIES


Deferred governmental subsidies consist of the following:


(1)
Current Portion


December 31,


December 31,Name of Governmental Subsidy

2010


2009Land subsidy

$
7,852


$
7,628Building subsidy


43,743



42,495Sewage facilities improvement subsidy


40,013



38,872$
91,608


$
88,995





(2)
Non-current Portion


December 31,


December 31,Name of Governmental Subsidy

2010


2009Land subsidy

$
350,059


$
362,954Building subsidy


699,880



764,901Sewage facilities improvement subsidy


703,577



664,627$
1,753,516


$
1,792,482




15.
DUE TO RELATED PARTIES


Due to related parties consist of the followings:


December 31,


December 31,Name of related parties

2010


2009Ren Gao

$
-


$
45,672Songyuan Qianan Sunshine Linen Co., Ltd.


-



29,216$
-


$
74,888




F-36


CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





16.
GOVERNMENTAL SUBSIDY INCOME


Governmental subsidy income consists of the followings:





December 31,


December 31,Name of Governmental Subsidy

2010


2009Income tax refund subsidy

$
1,142,222


$
776,643Land use right subsidy


7,738



7,622Building subsidy


43,109



42,464Sewage subsidy


39,435



16,185Financial support grants


476,194



20,522$
1,708,698


$
863,436





17.
RELATED PARTY TRANSACTIONS


December 31,


December 31,2010


2009Transactions

Amount


Percentage of

Total Similar

Transactions


Amount


Percentage of

Total Similar

Transactions(a)
Selling finished goods to

Harbin Sunshine Linen Textile Co., Ltd.

$
186,162



0.4
%

$
4,169,833



14.2
%Purchasing raw materials from

Harbin Sunshine Linen Textile Co., Ltd.

$
-



0
%

$
41,337



1.05
%(b)
Selling finished goods to

Harbin Zhongyi Sunshine Linen Co., Ltd

$
2,931,298



6.0
%

$
7,289,137



24.8
%Purchasing raw materials from

Harbin Zhongyi Sunshine Linen Co., Ltd

$
4,809,323



25.0
%

$
1,382,827



35.2
%




F-37


CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





18.
CONCENTRATION





Geographic Areas Information


All of the Group's assets exist mainly in the PRC, and its revenues are substantially derived from its operations therein.





Major Customers


There were six major customers each of which made sales over 5% of the Group’s total sales in 2010 as compared to five major customers each of which made sales over 5% of the Group’s total sales in 2009 as summarized in the following:




December 31,2010Major Customers

Revenue


Percentage of
Total RevenueHarbin Zhongyi Sunshine Linen Co., Ltd.

$
2,931,298



6.0
%Five unrelated customers


23,136,455



47.1
%Total

$
26,067,753



53.1
%




December 31,2009Major Customers

Revenue


Percentage of
Total RevenueHarbin Sunshine Linen Textile Co., Ltd.

$
4,169,833



14.2
%Harbin Zhongyi Sunshine Linen Co., Ltd.


7,289,137



24.8
%Three unrelated customers


16,299,625



55.5
%Total

$
27,758,595



94.5
%




F-38





CHINA LINEN TEXTILE INDUSTRY, LTD.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





18.
CONCENTRATION(Continued)





Major Suppliers


The Group has a diversified supplier line. There were a few major suppliers from each of which the Group purchased over 5% of the Group’s total purchase, as summarized in the following:




December 31,


December 31,2010


2009Major Suppliers

Purchase


Percentage of

Total Purchase


Purchase


Percentage of

Total PurchaseHarbin Zhongyi Sunshine Linen Co., Ltd.

$
4,809,323



25.0
%

$
1,382,827



11.7
%Two unrelated suppliers


5,002,799



26.1
%


5,236,901



44.4
%Total

$
9,812,122



51.1
%

$
6,619,728



56.1
%




19.
EARNINGS PER SHARE





December 31,


December 31,2010


2009Net income for basic earnings per share

$
9,565,032


$
5,730,519Weighted average number of shares


20,251,490



20,108,333Basic earnings per share

$
0.47


$
0.28





December 31,


December 31,2010


2009Net income for diluted earnings per share

$
9,652,958


$
5,730,519Weighted average number of shares


20,987,990



20,108,333Diluted earnings per share

$
0.46


$
0.28




F-39





CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





19.
EARNINGS PER SHARE(Continued)


As of March 23, 2011, the Company filed an Amended and Restated Memorandum of Association of the Company, which consolidates the share capital of the Company at a ratio of 3.5:1 by increasing the par value of the Company’s share capital from US$0.002 par value each to US$0.007 par value each, thereby reducing the number of authorized shares from US$1,000,000 divided into 500,000,000 ordinary shares of US$0.002 par value each to US$1,000,000 divided into 142,857,142.86 ordinary shares of US$0.007 par value each (the “Share Consolidation”). The market date of effectiveness of the Share Consolidation is March 30, 2011.


The pro forma earnings per share assuming the share consolidation occurred as of December 31, 2010 and 2009 consist of the followings:





December 31,


December 31,2010


2009Net income for basic earnings per share

$
9,565,032


$
5,730,519Pro forma weighted average number of shares


5,786,140



5,745,238Pro forma basic earnings per share

$
1.65


$
1.0





December 31,


December 31,2010


2009Net income for diluted earnings per share

$
9,652,958


$
5,730,519Pro forma weighted average number of shares


5,996,569



5,745,238Pro forma diluted earnings per share

$
1.61


$
1.0





F-40





CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





20.
INCOME TAX


The Group is subject to income taxes on an entity basis, that is, on income arising in or derived from the tax jurisdiction in which the entity is domiciled.





The income tax on consolidated statements of operation and other comprehensive income represented the provision of income taxes for the operating subsidiary, Lanxi Sunrise only. No provision for the Company and Bright has been made as both companies have no operation nor assessable profits for the year ended December 31, 2010 and 2009.





All Chinese enterprises are governed by the PRC Income Tax Law and various local income tax laws, pursuant to which a company generally is subject to an income tax at an effective rate of 25% on income as reported in its statutory financial statements after appropriate tax adjustments.


The provision for income taxes consists of the followings:





December 31,


December 31,2010


2009Current Income Tax

$
3,267,336


$
2,156,974Deferred Income Tax


235,411



(15,290
)Income Tax

$
3,502,747


$
2,141,684





F-41





CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





20.
INCOME TAX(Continued)


The components of net deferred tax liabilities are as follows:





December 31,


December 31,2010


2009Deferred tax assets:Accrued Pension

$
-


$
25,739Accrued Expenses


-



17,950Bad Debt Allowance


90,538



175,387Fixed assets provision


35,091



34,090Deferred Subsidy Income


461,281



214,228Total deferred tax assets

$
586,910


$
467,394Deferred tax liabilities:Subsidy Receivable

$
(1,202,102
)

$
(832,981
)Net deferred tax liabilities

$
(615,192
)

$
(365,587
)Reported as:Current deferred tax assets

$
113,440


$
228,794Current deferred tax liabilities


(722,549
)


(362,333
)Non-current deferred tax assets


473,470



238,600Non-current deferred tax liabilities


(479,553
)


(470,648
)Net deferred taxes

$
(615,192
)

$
(365,587
)





F-42





CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





20.
INCOME TAX(Continued)


The effective tax rate differed from the statutory income tax rate is as follows:





December 31,


December 31,2010


2009China statutory income tax rate


25
%


25
%Effect of:Non-deductible expenses


(3.57
)%


1.23
%Change in income tax rate and others






-Effective Tax Rate


21.43
%


26.23
%





21.
CONVERTIBLE NOTES


On November 3, 2010, the Company entered into a securities purchase agreement (the “Purchase Agreement”), with certain institutional and accredited investors (the “Investors”) for the issuance and sale of an aggregate of approximately $7,045,000 of 7.5% notes (the “Notes”) that are convertible into the Company’s ordinary shares, par value $.002 per share (the “Ordinary Shares”) for aggregate net proceeds of $6,418,293.





The Notes carry a fixed conversion price of $1.52, which is equal to 115% of the 10-day volume weighted average price prior to November 3, 2010, and have a two-year repayment term during which interest payments are due quarterly. The conversion price of the Notes is subject to adjustment in the event that the Company issues or sells Ordinary Shares for a price less than the conversion price in effect at the time of such issuance or sales, to such lower issuance or sale price. The principal and accrued interest under the Notes may be converted into Ordinary Shares at any time after the closing date, subject to certain limitations described in the Notes. At any time after the one-year anniversary of the closing date, the Company may elect to redeem all or any portion of the outstanding amount due under the Notes for a sum equal to 107% of such outstanding amount, plus any accrued and unpaid interest and other charges due on such amount.





F-43





CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





21.
CONVERTIBLE NOTES(Continued)


In the event of a change in control of the Company, a majority of the holders of the aggregate principal amount of the Notes then outstanding may require the Company to redeem all or any portion of the then-outstanding amounts due under the Notes, on a pro-rata basis among holders of the Notes, in cash at a price equal to the greater of (a) 110% of such amount, plus any accrued and unpaid interest and other charges due on such amount (the “Conversion Amount”), and (b) the product of (i) the Conversion Amount being redeemed multiplied by (ii) the quotient determined by dividing (x) the greatest closing sale price of the Ordinary Shares during the period beginning on the date immediately preceding the earlier to occur of (1) the consummation of the change of control of the Company and (2) the public announcement of such change of control of the Company, and ending on the date the holder delivers the change of control redemption notice by (y) the conversion price then in effect.





In connection with the Offering, the Company entered into a registration rights agreement (the “Registration Rights Agreement”) with the Investors. Pursuant to the Registration Rights Agreement, the Company has file a registration statement (the “Registration Statement”) with the U.S. Securities and Exchange Commission (the “SEC”) to register for resale the Ordinary Shares issuable under the Notes within 60 calendar days of the closing date of the Offering, and the filing is currently under review by the SEC.





As of November 3, 2010, the fair value of the Notes was evaluated as $8,580,000 by Roma Appraisals Limited, a Hong Kong professional appraisal and consulting firm. The effective interest rate of the Notes was 7.948% per annum and the liabilities on straight bond were $6,987,000.The embedded conversion option and call option of the Notes was $1,654,000 and ($61,000).





F-44





CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





21.
CONVERTIBLE NOTES(Continued)


December 31,2010Convertible notes payable:-par value

$
7,045,000-discount on liabilities


(57,828
)-interest adjustment


4,267$
6,991,439


Interest expense for the year ended December 31, 2010 was $87,926.





22.
COMMON STOCK ISSUED FOR SERVICES AND SALARY COMPENSATION


Lanxi Sunrise entered into an Advisory Agreement with Mid-Continental Securities Corp. on March 30, 2007. Pursuant to that agreement, Mid-Continental Securities Corp, or its designees, were entitled to receive a total of 804,000 shares of the Company as compensation for services after the reverse merger. Such shares were transferred to Mid-Continental Securities Corp. by some shareholders of the Company in 2008. The Company has accounted for this as a contribution of capital by its shareholders and recorded a charge to operations as general and administrative expense in the amount of $844,200 for the year ended December 31, 2008. Such shares were valued based on the closing market price of $1.05 per share at the date of transfer.





On November 16, 2009, the Board of Directors authorized the issuance of 100,000 shares of common stock to an independent party pursuant to a consultancy agreement dated on November 14, 2010 for financial advisory services to be provided to the Company from November 16, 2009 through November 15, 2010. The shares were valued at $107,804 and during the year ended December 31, 2009, the Company recorded general and administrative expense of approximately $9,000 related to the agreement.





On February 23, 2010, the Board of Directors authorized the issuance of 15,000 shares of common stock to the above investor relations company pursuant to the supplement agreement of the above one dated November 14, 2009. The shares were valued at $25,800 and during the period ended March 31, 2010, the Company recorded it in general and administrative expense.





F-45





CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





22.
COMMON STOCK ISSUED FOR SERVICES AND SALARY COMPENSATION(Continued)





The Company and Mr. Qi entered into a Severance Agreement dated August 28, 2010. Pursuant to the terms of the Severance Agreement, Mr. Qi will receive 30,000 restricted ordinary shares of the Company, par value $0.002 per share. On December 3, 2010, the Company issued 30,000 Ordinary Shares to Mr. Qi.The value of the shares issued to Mr. Qi was $44,100.





The Company entered into an Investor Relations Consulting Agreement on May 5, 2010 (the “Agreement”) with Hayden Communications International, Inc. (“HCI”) (the “Agreement”) for the provision of certain investor relations services, dated as of May 5, 2010, which was subsequently as supplemented and amended by the Amendment to Investor Relations Consulting Agreement entered into between the Company and HCI dated as of October 13, 2010. In partial consideration for the provision of such investor relations services, the Company had agreed to issue to Hayden Communications International, Inc. HCI and/or its designees 67,200 restricted ordinary shares on the terms and conditions set forth in the Agreement and the Amendment to Investor Relations Consulting Agreement. On December 6, 2010, the Company issued 52,800, 9,600 and 4,800 Ordinary Shares to HCI and its designees, Feng Peng and Scott Powell, respectively.The value of the shares issued to HCI was $102,144.





Stephen Monticelli entered into an employment agreement with the Company on August 30, 2010 to serve as an independent director of the Company. In consideration for his services as director, the Company had agreed to issue Mr. Monticelli 100,000 shares of restricted ordinary shares. On December 6, 2010, the Company issued 100,000 Ordinary Shares to Stephen Monticelli.The value of the shares issued to Stephen Monticelli was $114,000.




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CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





23.
ASSET RETIREMENT OBLIGATIONS





The Group operates within the requirements of numerous regulations at the local, province, and national levels regarding issues such as the handling and disposal of hazardous chemicals, wastewater treatment and effluent and emissions limitations among others. From a practical standpoint, certain environmental contamination cannot be reasonably determined until a facility or asset is retired or an event occurs that otherwise requires the facility to be tested and monitored. In the absence of such requirements to test for environmental contamination prior to an asset or facility retirement, the Group has concluded that it cannot reasonably estimate the cost associated with such environmental-related asset retirement obligations (“ARO”).





In addition, the Group anticipates operating its manufacturing facilities indefinitely into the future thereby rendering the potential range of settlement dates as indeterminate. Therefore, the Group has not recorded any AROs to recognize legal obligations associated with the retirement of tangible long-lived assets.





24.
COMMITMENTS AND CONTINGENCIES





PRC’s Political and Economic System


The Group faces a number of risks and challenges not typically associated with companies in North America and Western Europe, since its assets exist mainly in the PRC, and its revenues are derived from its operations therein. The PRC is a developing country with an early stage market economic system, overshadowed by the state. Its political and economic systems are very different from the more developed countries and are in a state of change. The PRC also faces many social, economic and political challenges that may produce major shocks and instabilities and even crises, in both its domestic arena and in its relationships with other countries, including the United States. Such shocks, instabilities and crises may in turn significantly and negatively affect the Group’s performance.





Environmental


In the ordinary course of its business, the Group is subject to numerous environmental laws and regulations covering compliance matters or imposing liability for the costs of, and damages resulting from, cleaning up sites, past spills, disposals and other releases of hazardous substances. Currently, the Group's environmental compliance costs principally include the routine inspection fees paid to the local environmental department. These amounts are immaterial to the Group's operating costs. However, future extension of its production line or changes in the environmental laws and regulations may significantly increase its environmental compliance costs and therefore have a material adverse effect on the Group’s financial position and results of operations.





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CHINA LINEN TEXTILE INDUSTRY, LTD.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2010 and 2009


(Stated in US Dollars)





24.
COMMITMENTS AND CONTINGENCIES (Continued)





Environmental(Continued)


Also, any failure by the Group to adequately comply with such laws and regulations could subject the Group to significant future liabilities.





Governmental Control of Currency Conversion


The PRC government imposes controls on the convertibility of Renminbi into foreign currencies and, in certain cases, the remittance of currency out of the PRC. The Group receives most of its revenues in Renminbi, which is currently not a freely convertible currency. Shortages in the availability of foreign currency may restrict the Group’s ability to remit sufficient foreign currency to satisfy foreign currency dominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from the transaction, can be made in foreign currencies without prior approval from the PRC State Administration of Foreign Exchange by complying with certain procedural requirements. However, approval from appropriate governmental authorities is required where Renminbi is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of bank loans denominated in foreign currencies.





The PRC government may also at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents the Group from obtaining sufficient foreign currency to satisfy its currency demands, the Group may not be able to pay certain of its expenses as they come due.





Capital Commitment


Contractual commitments for capital expenditure approximated $0 and $889,000 (RMB 6,060,000) relating to the construction of sewage facilities and acquisition of equipment as of December 31, 2010 and 2009.





25.
SUBSEQUENT EVENTS





As of March 23, 2011, the Company filed an Amended and Restated Memorandum of Association of the Company, which consolidates the share capital of the Company at a ratio of 3.5:1 by increasing the par value of the Company’s share capital from US$0.002 par value each to US$0.007 par value each, thereby reducing the number of authorized shares from US$1,000,000 divided into 500,000,000 ordinary shares of US$0.002 par value each to US$1,000,000 divided into 142,857,142.86 ordinary shares of US$0.007 par value each (the “Share Consolidation”). The market date of effectiveness of the Share Consolidation is March 30, 2011.




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