UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549


_____________________________




FORM
20-F


_____________________________




 ̈
            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 September 30, 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 event requiring this shell company report:




Commission
file number




Lizhan
Environmental Corporation


(Exact
name of Registrant as Specified in its Charter)




Cayman
Islands


(Jurisdiction
of Incorporation or Organization)




No. 716,
Qifu Road, Wutong Street, Tongxiang


Zhejiang
Province, 314500, People’s Republic of China


(Address
of Principal Executive Offices)





Tel: (86)
573-88986299 Fax: (86)-573-88986399


(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
      RegisteredCommon
      shares, par value US$0.32 per share
              Nasdaq
      Global Market





Securities
registered or to be registered pursuant to Section 12(g) of the
Act:




None


(Title of
Class)




Securities
for which there is a reporting obligation pursuant to Section 15(d) of the
Act:




None


(Title of
Class)




The
number of outstanding shares of each of the issuer’s classes of capital or
common stock as of February 1, 2011 was: 13,643,750 ordinary shares, par value
$0.32 per share.




Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.




Yes  ̈ No
x




If this
report is 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.




Yes  ̈ No
x




Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days:




Yes  ̈ No
x




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  ̈
    Non-accelerated filer x




Indicate
by check mark which basis of accounting the registrant has used to prepare the
financial statements included in this filing:




ý U.S. GAAP o International Financial
Reporting Standards as issued by the International Accounting


Standards Board
 ̈  Other
 ̈




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  ̈ No
x





LIZHAN
ENVIRONMENTAL CORPORATION


FORM
20-F ANNUAL REPORT


TABLE
OF CONTENTS




PagePART
      IItem
      1.
              Identity
      of Directors, Senior Management and Advisors
              1Item
      2.
              Offer
      Statistics and Expected Timetable
              1Item
      3.
              Key
      Information
              2Item
      4.
              Information
      on the Company
              21Item
      4A.
              Unresolved
      Staff Comments
              40Item
      5.
              Operating
      and Financial Review and Prospects
              40Item
      6.
              Directors,
      Senior Management, and Employees
              54Item
      7.
              Major
      Shareholders and Related Party Transactions
              61Item
      8.
              Financial
      Information
              63Item
      9.
              The
      Offer and Listing
              64Item
      10.
              Additional
      Information
              64Item
      11.
              Quantitative
      and Qualitative Disclosures About Market Risk
              74Item
      12.
              Description
      of Securities Other Than Equity Securities
              75PART
      IIItem
      13.
              Defaults,
      Dividend Arrearages and Delinquencies
              75Item
      14.
              Material
      Modifications to the Rights of Security Holders and Use of
      Proceeds
              75Item
      15.
              Controls
      and Procedures
              75Item
      16.
              Reserved
              76Item
      16A.
              Audit
      Committee Financial Expert
              76Item
      16B.
              Code
      of Ethics
              76Item
      16C.
              Principal
      Accounting Fees and Services
              76Item
      16D.
              Exemptions
      from the Listing Standards for Audit Committees
              77Item
      16E.
              Purchases
      of Equity Securities by the Issuer and Affiliated
    Purchasers
              77Item
      16F.
              Change
      in Registrant’s Certifying Accountant
              77Item
      16G.
              Corporate
      Governance
              77







PART
      IIIItem
      17.
              Financial
      Statements
              78Item
      18.
              Financial
      Statements
              78Item
      19.
              Exhibits
              78





CERTAIN
INFORMATION




In this
annual  report on Form 20-F, unless otherwise indicated, “we,” “us,”
“our,” the “Company” and “Lizhan Environmental” refer to Lizhan Environmental
Corporation, a company organized in the Cayman Islands, its predecessor entities
and its subsidiaries.




Unless
the context indicates otherwise, all references to “China” and the “PRC” refer
to the People’s Republic of China.  All references to “Renminbi” or
“RMB” are to the legal currency of the People’s Republic of China and all
references to “U.S. dollars,” “dollars” and “$” are to the legal currency of the
United States. This annual report contains translations of Renminbi amounts into
U.S. dollars at specified rates solely for the convenience of the reader. We
make no representation that the Renminbi or U.S. dollar amounts referred to in
this report could have been or could be converted into U.S. dollars or Renminbi,
as the case may be, at any particular rate or at all. On January 31, 2011, the
cash buying rate announced by the People’s Bank of China was RMB 6.6017 to
$1.00.




FORWARD-LOOKING
STATEMENTS




This
report contains “forward-looking statements” for purposes of the safe harbor provisions of the
Private Securities Litigation ReformAct of
1995that represent our beliefs, projections and predictions about
future events. All statements other than statements of historical fact are
“forward-looking statements,” including any projections of earnings, revenue or
other financial items, any statements of the plans, strategies and objectives of
management for future operations, any statements concerning proposed new
projects or other developments, any statements regarding future economic
conditions or performance, any statements of management’s beliefs, goals,
strategies, intentions and objectives, and any statements of assumptions
underlying any of the foregoing. Words such as “may”, “will”, “should”, “could”,
“would”, “predicts”, “potential”, “continue”, “expects”, “anticipates”,
“future”, “intends”, “plans”, “believes”, “estimates” and similar expressions,
as well as statements in the future tense, identify forward-looking
statements.




These
statements are necessarily subjective and involve known and unknown risks,
uncertainties and other important factors that could cause our actual results,
performance or achievements, or industry results, to differ materially from any
future results, performance or achievements described in or implied by such
statements. Actual results may differ materially from expected results described
in our forward-looking statements, including with respect to correct measurement
and identification of factors affecting our business or the extent of their
likely impact, and the accuracy and completeness of the publicly available
information with respect to the factors upon which our business strategy is
based or the success of our business.




Forward-looking
statements should not be read as a guarantee of future performance or results,
and will not necessarily be accurate indications of whether, or the times by
which, our performance or results may be achieved. Forward-looking statements
are based on information available at the time those statements are made and
management’s belief as of that time with respect to future events, and are
subject to risks and uncertainties that could cause actual performance or
results to differ materially from those expressed in or suggested by the
forward-looking statements. Important factors that could cause such differences
include, but are not limited to, those factors discussed under the headings
“Risk Factors”, “Operating and Financial Review and Prospects,” and elsewhere in
this report.




ITEM
      1.
            IDENTITY
      OF DIRECTORS, SENIOR MANAGEMENT AND
ADVISORS




1.A.  Directors
and Senior Management




Not
Applicable.




1.B.  Advisors




Not
Applicable.




1.C.  Auditors




Not
Applicable.




ITEM
      2.
            OFFER
      STATISTICS AND EXPECTED
TIMETABLE


Not
Applicable.




1




ITEM
      3.
            KEY
      INFORMATION




3.A.  Selected
Financial Data




The
following selected financial information should be read in connection with, and
is qualified by reference to, our consolidated financial statements and their
related notes and the section entitled “Operating and Financial Review and
Prospects” included elsewhere in this annual report. The consolidated statements
of income data for the fiscal years ended September 30, 2009 and 2010 and the
balance sheet data as of September 30, 2009 and 2010 are derived from audited
consolidated financial statements included elsewhere in this annual report. The
consolidated statement of income data for the fiscal year ended September 30,
2008 and the balance sheet data as of September 30, 2008 have been derived from
audited financial statements that are not included in this annual report. The
consolidated statement of income data for the fiscal years ended September 30,
2006 and 2007 and the balance sheet data as of September 30, 2006 and 2007 have
been derived from unaudited financial statements that are not included in this
annual report. The consolidated income and balance sheet data as of, and for the
year ended, September 30, 2006 reflect our operations and financial condition
from December 6, 2005, which was the date Lizhan Textile (Zhejiang) Co., Ltd.,
or Lizhan Textile, was formed, through September 30, 2006. Until production
activities commenced in November 2007, Lizhan Textile was engaged in research
and development activities. The consolidated income and balance sheet data as
of, and for the fiscal year ended, September 30, 2005 has been omitted because
such information is not applicable. Our historical results for any prior period
are not necessarily indicative of results to be expected in any future
period.




For the Year Ended September
      30,2010
                    (Audited)
                  
                  
                  2009
                    (Audited)
                  
                  
                  2008
                    (Audited)
                  
                  
                  2007
                    (Unaudited)
                  
                  
                  2006
                    (Unaudited)Net
      Sales
                  
                  $
                  46,321,225
                  
                  
                  $
                  21,612,541
                  
                  
                  $
                  13,124,439
                  
                  
                  $
                  —
                  
                  
                  $
                  —Cost
      of sales
                  
                  
                  (35,042,898
                  )
                  
                  
                  (17,868,408
                  )
                  
                  
                  (10,628,938
                  )
                  
                  
                  —
                  
                  
                  
                  —Gross
      profit
                  
                  
                  11,278,327
                  
                  
                  
                  3,744,133
                  
                  
                  
                  2,495,501
                  
                  
                  
                  —
                  
                  
                  
                  —Operating
      expensesGeneral
      and administrative expenses
                  
                  
                  (2,110,506
                  )
                  
                  
                  (1,053,752
                  )
                  
                  
                  (590,132
                  )
                  
                  
                  (50,465
                  )
                  
                  
                  (8,707
                  )Research
      and development expenses
                  
                  
                  (136,398
                  )
                  
                  
                  (64,991
                  )
                  
                  
                  (32,186
                  )
                  
                  
                  —
                  
                  
                  
                  —Selling
      and marketing expenses
                  
                  
                  (634,544
                  )
                  
                  
                  (322,133
                  )
                  
                  
                  (260,290
                  )
                  
                  
                  —
                  
                  
                  
                  —Total
      Operating Expenses
                  
                  
                  (2,881,448
                  )
                  
                  
                  (1,440,876
                  )
                  
                  
                  (882,608
                  )
                  
                  
                  (50,465
                  )
                  
                  
                  (8,707
                  )Operating
      income/(loss)
                  
                  
                  8,396,879
                  
                  
                  
                  2,303,257
                  
                  
                  
                  1,612,893
                  
                  
                  
                  (50,465
                  )
                  
                  
                  (8,707
                  )Other
      income and (expense):Other
      income
                  
                  
                  1,139,445
                  
                  
                  
                  610,548
                  
                  
                  
                  9,393
                  
                  
                  
                  —
                  
                  
                  
                  —Exchange
      loss
                  
                  
                  (49,788
                  )
                  
                  
                  (24,963
                  )
                  
                  
                  (20,950
                  )
                  
                  
                  —
                  
                  
                  
                  —Interest
      income
                  
                  
                  26,721
                  
                  
                  
                  19,972
                  
                  
                  
                  17,103
                  
                  
                  
                  —
                  
                  
                  
                  —Interest
      expense
                  
                  
                  (300,609
                  )
                  
                  
                  (166,186
                  )
                  
                  
                  (123,199
                  )
                  
                  
                  —
                  
                  
                  
                  —Other
      expenses, net
                  
                  
                  (142,419
                  )
                  
                  
                  (11,330
                  )
                  
                  
                  (9,095
                  )
                  
                  
                  (16,367
                  )
                  
                  
                  —Total
      other income (expenses), net
                  
                  
                  673,350
                  
                  
                  
                  428,041
                  
                  
                  
                  (126,748
                  )
                  
                  
                  (16,367
                  )
                  
                  
                  —Income/(loss)
      before income taxes
                  
                  
                  9,070,229
                  
                  
                  
                  2,731,298
                  
                  
                  
                  1,486,145
                  
                  
                  
                  (66,832
                  )
                  
                  
                  (8,707
                  )Income
      tax expenses
                  
                  
                  (912,249
                  )
                  
                  
                  —
                  
                  
                  
                  (1,010
                  )
                  
                  
                  —
                  
                  
                  
                  —Net
      income/(loss)
                  
                  
                  8,157,980
                  
                  
                  
                  2,731,298
                  
                  
                  
                  1,485,135
                  
                  
                  
                  (66,832
                  )
                  
                  
                  (8,707
                  )Net
      loss attributable to non—controlling interest
                  
                  
                  28,127
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Net
      income attributable to the Company
                  
                  
                  8,186,107
                  
                  
                  
                  2,731,298
                  
                  
                  
                  1,485,135
                  
                  
                  
                  (66,832
                  )
                  
                  
                  (8,707
                  )Other
      comprehensive income (loss)Foreign
      currency translation adjustment
                  
                  
                  422,497
                  
                  
                  
                  (6,026
                  )
                  
                  
                  362,789
                  
                  
                  
                  94,638
                  
                  
                  
                  14,635Less:
      Foreign currency translation adjustments attributable to non—controlling
      interest
                  
                  
                  (1,906
                  )
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Comprehensive
      Income
                  
                  $
                  8,606,698
                  
                  
                  $
                  2,725,272
                  
                  
                  $
                  1,847,924
                  
                  
                  $
                  27,806
                  
                  
                  $
                  5,928Earnings
      per common share — Basic and fully diluted
                  
                  $
                  0.74
                  
                  
                  $
                  0.25
                  
                  
                  $
                  0.14
                  
                  
                  $
                  —
                  
                  
                  $
                  —


2




Balance
      Sheet Data (at end of year)
                  
                  September
      30,(in U.S. Dollars)
                  
                  2010
                  
                  
                  2009
                  
                  
                  2008
                  
                  
                  2007
                  
                  
                  2006Audited
                  
                  
                  Audited
                  
                  
                  Audited
                  
                  
                  Unaudited
                  
                  
                  UnauditedCash
      and cash equivalents
                  
                  $
                  2,597,366
                  
                  
                  $
                  864,162
                  
                  
                  $
                  706,459
                  
                  
                  $
                  112,639
                  
                  
                  $
                  159,200Total
      current assets
                  
                  
                  18,127,675
                  
                  
                  
                  11,400,067
                  
                  
                  
                  6,508,672
                  
                  
                  
                  708,505
                  
                  
                  
                  181,125Total
      other assets
                  
                  
                  26,558,839
                  
                  
                  
                  9,526,249
                  
                  
                  
                  7,583,781
                  
                  
                  
                  2,475,246
                  
                  
                  
                  732,367Total
      assets
                  
                  
                  44,686,514
                  
                  
                  
                  20,926,316
                  
                  
                  
                  14,092,453
                  
                  
                  
                  3,183,751
                  
                  
                  
                  913,492Total
      liabilities
                  
                  
                  26,341,222
                  
                  
                  
                  12,803,407
                  
                  
                  
                  9,385,368
                  
                  
                  
                  700,445
                  
                  
                  
                  95,212Total
      stockholders’ equity
                  
                  
                  18,345,292
                  
                  
                  
                  8,122,909
                  
                  
                  
                  4,707,085
                  
                  
                  
                  2,483,306
                  
                  
                  
                  818,280Total
      liabilities and stockholders’ equity
                  
                  $
                  44,686,514
                  
                  
                  $
                  20,926,316
                  
                  
                  $
                  14,092,453
                  
                  
                  $
                  3,183,751
                  
                  
                  $
                  913,492




3.A.3.  Exchange
Rates




Not
Applicable.




3.B.  Capitalization
and Indebtedness




Not
Applicable.




3.C.  Reasons
For The Offer And Use Of Proceeds




Not
Applicable.


3


3.D.  Risk
Factors




You
should carefully consider the risks described below in evaluating our business.
If any of the following risks were to occur, our business, results of operations
and financial condition could be harmed. In that case, you might lose all or
part of your investment in our ordinary shares. You should also refer to the
other information set forth in this annual report, including our consolidated
financial statements and the related notes and the section entitled “Operating
and Financial Review and Prospects.”




Risks
Related to Our Business and Our Industry




We
have a limited operating history which provides limited reference for you to
evaluate our ability to achieve our business objectives.




We were
formed in August 2009 as a Cayman Islands exempted limited liability company.
One of our operating subsidiaries, Lizhan Textile, was formed in the PRC as a
limited liability company on December 6, 2005 and our other operating
subsidiary, Hongzhan (Zhejiang) New Material Co. Ltd., or Hongzhan, was formed
in the PRC as a wholly foreign owned enterprise on December 8, 2009. Lizhan
Textile did not generate significant revenues prior to our 2008 fiscal year and
Hongzhan has not generated any revenue to date. Our financial condition, results
of operations and future success will depend on our ability to continue to
operate and expand our business profitably and to achieve significant economies
of scale. Our company has a limited operating history, is subject to the risks
and uncertainties associated with early stage companies and prior to our 2008
fiscal year operated at a loss. Accordingly, you will have a limited basis on
which to evaluate our ability to achieve our business objectives. We cannot
assure you that we will be able to operate our expanded business profitably. If
we fail to achieve our business objectives, then we may not be able to realize
our expected revenue growth, maintain our existing revenue levels or operate at
a profit. Even if we do realize our business objectives, our business may not be
profitable in the future.




Our
operations are cash intensive, and our business could be adversely affected if
we fail to maintain sufficient levels of liquidity and working
capital.




During
the past two fiscal years, we spent a significant amount of cash on our
operational and investment activities, principally to procure raw materials for
our products, to construct our Evergreen Product facilities and to acquire
capital equipment. We financed operational and investment activities mainly from
cash generated from operations, short-term bank loans and proceeds from bank
acceptance notes payable. Subsequent to September 30, 2010, we converted a portion of our short-term loans tolong-term loans, as discussed below under the heading “Operating
and Financial Review as Prospects.” If we fail to generate sufficient cash flow
from these sources, we may not have sufficient liquidity to fund our operating
costs and our business could be adversely affected.




Our
short-term and long-term loans are from Chinese banks and are generally secured
by our buildings, land use rights, and guarantees provided by our Chairman Mr.
Liu and other unrelated parties. The term of all short-term loans is one year or
less. Historically, we have rolled over such loans on an annual basis. However,
we may not have sufficient funds available to pay all of our borrowings upon
maturity. Failure to roll over our short-term borrowings at maturity or to
service our debt could result in the imposition of penalties, including
increases in interest rates, legal actions against us by our creditors, or even
insolvency.




Management
anticipates that our existing capital resources and cash flows from operations
and current and expected bank loans, bank facilities and lines of credit will be
adequate to satisfy our liquidity requirements for the next twelve months.
However, if available liquidity is not sufficient to meet our operating and loan
obligations as they come due, our plans include considering pursuing alternative
financing arrangements, reducing expenditures as necessary, or limiting our
plans for expansion to meet our cash requirements. However, there is no
assurance that, if required, we will be able to raise additional capital, reduce
discretionary spending or efficiently limit our expansion to provide the
required liquidity. Currently, the capital markets for small capitalization
companies are extremely difficult and banking institutions have become stringent
in their lending requirements. Accordingly, we cannot be sure of the
availability or terms of any third party financing. If we are unable to raise
additional financing, we may be unable to implement our long-term business plan,
develop or enhance our products, take advantage of future opportunities or
respond to competitive pressures on a timely basis, if at all. In addition, a
lack of additional financing could force us to substantially curtail or cease
operations.




The
capital we recently raised is insufficient to meet our capital needs, and we may
be required to curtail or significantly reduce our expansion plans.




In
November 2010, we raised $10.0 million in an initial public offering. We will
use the proceeds of such offering to install Evergreen Product production lines.
However, the capital we raised in our initial public offering is insufficient to
meet our capital needs for this expansion.  Consequently, we require
additional capital to expand the production capacity of our Evergreen Products
and develop a distribution network for our Evergreen Products. There can be no
assurance that financing will be available in amounts or on terms acceptable to
us, if at all. The inability to obtain additional capital may reduce our ability
to develop our business. If we are unable to obtain additional financing, we
will likely be required to curtail or significantly reduce our expansion plans.
Further, in the event that we were to raise equity in the future to finance
future growth, any such additional equity financing may involve substantial
dilution to our then existing shareholders.


4


Price
inflation in China could affect our results of operation if we are unable to
pass along raw material price increases to our customers.




Inflation
in China has recently increased. Recent reports indicate that inflation in China
increased to a 28-month high in November 2010. Because we purchase raw materials
from suppliers in China, price inflation has recently caused an increase in the
cost of our raw materials.  Price inflation could affect our results
of operation if we are unable to pass along raw material price increases to
customers.  Similarly, the cost of the recent construction of our
Evergreen Products facilities and the installation of our first Evergreen
Product production line increased to an aggregate of approximately $13.0 million
because of recent inflationary trends, and we currently anticipate that the
installation of Evergreen Product production lines 2, 3 and 4 will cost
approximately $12.0 million in the aggregate.  In addition, if
inflationary trends continue in China, China could lose its competitive
advantage as a low-cost manufacturing venue, which could in turn lessen some of
the competitive advantages of our being based in China. Accordingly, inflation
in China may weaken our competitiveness domestically or in international
markets.




Our
inability to manage our growth may have a material adverse effect on our
business, results of operations and financial condition.




We have
experienced significant growth since we began operations in November 2007. Our
revenues have grown from approximately $13.1 million for the year ended
September 30, 2008 to approximately $46.3 million for the year ended September
30, 2010. The total number of our employees has grown from approximately 242 as
of September 30, 2008 to 371 as of September 30, 2010. In addition, we recently
completed the testing of the first of our Evergreen Product production lines and
expect to begin mass production in mid-February. We intend to add a second
Evergreen Product production line in May 2011.  We expect our future
growth to place significant demands on both our management and our resources.
This will require us to continuously evolve and improve our operational,
financial and internal controls across our organization. In particular,
continued expansion increases the challenges we face in:




·      recruiting,
training and retaining sufficient skilled technical, sales and management
personnel;




·      adhering
to our high quality and process execution standards;




·      maintaining
high levels of customer satisfaction;




·      creating
and managing economies of scale;




·      maintaining
and managing costs to correspond with timeliness of revenue recognition;
and




·
            developing
      and improving our internal administrative infrastructure, including our
      financial, operational and communication systems, processes and
      controls.




Any
inability to manage our growth may have a material adverse effect on our
business, results of operations and financial condition.




In
the event that we encounter difficulties in developing or selling our Evergreen
Products, or if our customers are not satisfied with our Evergreen Products, our
business and financial condition may be materially and adversely
affected.




Outside
of research and developments testing, we have never mass produced or sold our
Evergreen Products. In the event that we encounter difficulties in, or failures
with respect to, the installation of machinery and personnel, the manufacture or
sale of these products or the development of a new nationwide distribution
network, our business and financial condition may be materially and adversely
affected. With respect to our first Evergreen Product production line, we
initially anticipated that mass production would begin in late November 2010 and
the second production line in February 2011. However, we decided to delay mass
production of our first production line to mid-February in order to make certain
technical modifications to parts of the manufacturing equipment to ensure that
the quality of the new Evergreen Products meets our standards and the standards
of our customers, and further delays in the mass production or sales of
these products are possible. We now expect the second
production line to begin operating by May 2011 as a result of these
modifications, although further delays are possible.  Further, even if
we do not encounter such difficulties, our customers may not be satisfied with
our Evergreen Products or a market for the Evergreen Products may never develop.
Any such difficulties or failures could result in financial losses that could
have a material adverse effect on our business, cause the price of our ordinary
shares to decline and delay or prevent the production or sale of our new
Evergreen Products.


5


If
we fail to offer products that our customers or consumers find attractive, the
demand for our products may be limited.




In order
for our business to be successful, our product offerings must be useful to
consumers, well made and affordable. We may not be successful in offering
products that meet these requirements in the future. If our products become less
popular with our customers or consumers, or if new products do not become
popular with our customers or consumers, or if demand generally for products
such as ours decreases or fails to grow, our sales may decline or we may be
required to offer our products at lower prices. If customers buy fewer of our
products, or if we have to reduce our prices, our net sales would decline and
our operating results would be affected adversely.




We
believe that our future growth will be substantially dependent on the continued
increase in sales growth of existing core products, such as our ultrasuede and
synthetic leather powder products and our new Evergreen Products,
while at the same time maintaining or increasing our current gross margin rates.
During fiscal year 2009, we launched, and increased rapidly, the production and
sales of our recycled leather flocked fabric products, whichconsist of
fabrics that are flocked with recycledleatherpowder
that improve the texture of the fabric. Our
recycled leather flocked fabric products are higher margin products and are more
environmentally friendly than other purely chemical-based products.We
recently completed the testing of the first of our Evergreen Product production
lines and intend to begin large scale production in mid-February. We also intend
to install a second Evergreen Product production line in May 2011. The genuine
leather content and
profit margins of these Evergreen Products are expected to be even greater than
our recycled leather flocked fabric products. However, we may not be able to
increase the growth of existing core products or successfully introduce our
Evergreen Products or
other new products, or to maintain or increase our gross margin rates in future
periods. Failure to do so may adversely affect our
business.




Moreover,
in order to meet our strategic goals, we must successfully identify, obtain
supplies of, and offer our customers high quality products on a continuous
basis. These products must appeal to a wide range of residential and commercial
consumers whose preferences may change in the future. If we misjudge either the
market for our products or our customers’ or consumers’ purchasing habits, we
may be faced with significant excess inventories for some products and missed
opportunities for products we choose not to stock. In addition, our sales may
decline or we may be required to sell our products at lower prices. This would
adversely affect our business.




We
intend to install additional Evergreen Product production lines, which, among
other things, may continue to divert our resources and may cause our margins to
suffer.




Our goal
over the next several years will be to increase production and sales of our new
Evergreen Products. This process has diverted, and could continue to divert,
resources, including the focus of our management, from the operation of our
business. In addition, our recent initial public offering, and attention to our
new obligations as a U.S. reporting company, have diverted, and may in the
future divert the focus of our management from the operation of our business and
from the installation of our Evergreen Product production lines. The anticipated
expansion of our Evergreen Products capabilities will increase our costs and
potentially decrease operating margins before mass production is initiated and
revenue is generated, which could, individually or in the aggregate, negatively
impact our business, financial condition and results of operations.




Our
plans to develop a nationwide network for our new Evergreen Products in the
future entail numerous risks which could materially and adversely affect our
business and financial condition.




Currently,
many of our domestic customers are located in close proximity to our facilities.
We deliver our products directly to the manufacturing facilities of these
customers. However, our long-term business strategy relies in large part on
establishing a nationwide distribution network throughout the PRC for our new
Evergreen Products. Risks affecting our expansion include challenges caused by
geographic distance, cultural differences, compliance with regulations which
differ from those to which we are accustomed, expertise and performance of
potential distributors and the inability to effectively enforce contractual or
other legal rights. These risks could result in increased and unbudgeted costs
associated with servicing new markets, which could in turn materially and
adversely affect our business and financial condition.


6


Our
revenues and profitability could be impacted because of our dependence on cost
efficient raw materials.





The
principal raw materials that we use to produce our fabrics are leather waste and
chemical fiber based materials. Our ability to continue to obtain raw materials
is subject to the continued reliability and viability of our suppliers. We
launched the production of recycled leather flocked fabric in fiscal year 2009,
which are flocked with recycled leather
waste, a lower cost material. Our Evergreen Products will also be manufactured
from recycled leather waste.  The number of recycled leather waste
suppliers that we use is currently relatively small.  As we expand our
Evergreen Product production over the next several years, we are unable to
obtain adequate or timely deliveries of required raw materials from these
suppliers, we may be unable to find a replacement that is capable of
manufacturing sufficient quantities of our products on a timely basis and at a
reasonable cost. This could cause us to lose sales, incur additional costs,
delay new product introductions or suffer harm to our reputation and could
negatively impact our revenues. Furthermore, if we are unable to obtain our raw
materials, and in particular leather waste, at cost efficient levels, our
ability to generate profits may be harmed.


We
are subject to various risks and uncertainties that might affect our ability to
procure quality raw materials.




Our
performance depends on our ability to procure low cost, high quality raw
materials, including leather waste, PU, ultrasuede grey cloth, backing fabric
and resin, on a timely basis from our suppliers. Our supplies are subject to
certain risks, including availability of raw materials, labor disputes,
inclement weather, natural disasters, and general economic and political
conditions, which might limit the ability of our suppliers to provide us with
low cost, high quality merchandise on a timely basis. Furthermore, for these or
other reasons, one or more of our suppliers might not adhere to our quality
control standards, and we might not identify the deficiency before the materials
are shipped to us or our customers. Our suppliers’ failure to supply quality
materials at a reasonable cost on a timely basis could reduce our net sales,
damage our reputation and have an adverse effect on our financial
condition.




We may
have to increase the number of our suppliers of raw materials in the future to
meet growing production demands. Despite our efforts to control our supply of
raw materials and maintain good relationships with our suppliers, we could lose
one or more of our suppliers at any time. The loss of one or more key suppliers
could increase our reliance on higher cost or lower quality supplies, which
could negatively affect our profitability. In addition, if we have to increase
the number of our suppliers in the future to meet growing production demands, we
may not be able to locate new suppliers who could provide us with sufficient
materials to meet our needs. Any interruptions to, or decline in, the amount or
quality of our raw materials supply could materially disrupt our production and
adversely affect our business and financial condition and financial
prospects.




Because
our sales and profitability fluctuate on a seasonal basis, our results of
operations may fluctuate from quarter to quarter.




Our
production and sales slow considerably during and around the Chinese New Year,
which usually occurs during the quarter ended March 31, as a result of the
closing of our facilities and the facilities of many of our customers for the
New Year’s celebration, as well as the shutting down of our steamers for an
annual inspection by local authorities. In addition, our sales volume declines
during summer due to the slow demand from the international markets while
consumer spending is generally slower for furniture and
garments.  Consequently, our results of operations may fluctuate from
quarter to quarter.  In addition, any significantdecrease
in sales during the remainder of the year would have a material adverse effect
on our business, our financial condition and our results of
operations.




We
face intense competition, and if we are unable to compete effectively we may not
be able to maintain profitability.




The
synthetic leather industry is highly fragmented but highly competitive. We
compete with many other companies located in the PRC and internationally that
manufacture fabrics similar to ours. Many of our competitors are larger
companies with greater financial resources than us. In addition, we expect that
as demand in the PRC and in other foreign countries for high quality, low cost
synthetic leather and other fabric products continue to grow, new competitors
will enter the market. In light of the many competitive challenges facing us, we
may not be able to compete successfully. Increased competition could adversely
affect our net sales in the future. Moreover, increased competition may result
in potential or actual litigation between us and our competitors relating to
such activities as competitive sales practices, relationships with key suppliers
and customers or other matters. As a result, increased competition may adversely
affect our future financial performance or reputation.


7


Any
loss or limitations on our rights to use intellectual property licensed from
third parties could have a material adverse effect on our business, operating
results and financial condition.




We
currently have an exclusive long-term license to use the key patents and patent
applications which protects the technology to be used in the manufacture of our
new Evergreen Products. We are, and will continue to be, reliant upon the owner
of this patent to protect his intellectual property rights to this technology.
While we are not aware of any disputes between the patent owner and us or any
third party, the patent owner may determine not to protect his intellectual
property rights that we license from him and we may be unable defend such
intellectual property rights on our own or we may have to undertake costly
litigation to defend the intellectual property rights of the patent owner. Upon
the termination of the license agreement for this patent, we may no longer
continue to have proprietary rights to the intellectual property that we license
from the patent owner. Any loss or limitations on our right to use the
intellectual property licensed from the patent owner could have a material
adverse effect on our business, operating results and financial condition. In
addition, in many countries, the patent owner may be limited to monetary relief
and may be unable to enjoin infringement, which could materially diminish the
value of the patent.




We
are subject to third party claims of intellectual property infringement, which
could have a material adverse effect on our business, results of operations and
financial condition.




From time
to time in the course of our business, we are subject to claims of patent
infringement or other intellectual property infringement. Additional
infringement claims may be asserted against us in the future. We may also be
required to change our methodologies so as not to use any allegedly infringed
intellectual property, which may not be technically or commercially feasible and
may cause us to expend significant resources. Any claims or litigation relating
to intellectual property infringement, whether we ultimately win or lose, could
be time-consuming and costly and/or injure our reputation, which could have a
material adverse effect on our business, results of operations and financial
condition.




We
may lose our competitive advantage, and our operations may suffer, if we fail to
prevent the loss, misappropriation of, or disputes over, our intellectual
property.




We rely
on a combination of patents, trademarks, trade secrets and confidentiality
agreements to protect our intellectual property rights. Our manufacturing
processes are based on technology developed primarily in-house by our research
and development and engineering personnel. While we are not aware of any
infringement on our intellectual property, our ability to compete successfully
and to achieve future revenue growth will depend, in significant part on our
ability to protect our proprietary technology and operate without infringing
upon the intellectual property rights of others. The legal regime in China for
the protection of intellectual property rights is still in an early stage of
development. Intellectual property protection became a national effort in China
in 1979 when China adopted its first statute on the protection of trademarks.
Since then, China has adopted its Patent Law, Trademark Law and Copyright Law
and promulgated related regulations. China has also acceded to various
international treaties and conventions in this area, such as the Paris
Convention for the Protection of Industrial Property, Patent Cooperation Treaty,
Madrid Agreement and its Protocol Concerning the International Registration of
Marks. In addition, when China became a party to the World Trade Organization in
2001, China amended many of its laws and regulations to comply with the
Agreement on Trade-Related Aspects of Intellectual Property Rights. Despite many
laws and regulations promulgated, and other efforts made, by China over the past
several years in an attempt to protect intellectual property rights,
intellectual property rights may not be as expansive or certain in China as they
would in many Western countries, including the United States. Furthermore,
enforcement of such laws and regulations in China has not been fully developed.
Neither the administrative agencies nor the court systems in China are equipped
as their counterparts in developed countries to deal with violations or handle
the nuances and complexities between compliant technological innovation and
non-compliant infringement.




Our
revenues are highly dependent on a limited number of customers and the loss of
any one of our major customers could materially and adversely affect our growth
and our revenues.




During
the years ended September 30, 2008, and 2009 and 2010, our five largest
customers contributed approximately 75.4%, 74.9% and 79.1% of our total sales,
respectively, while one of our single largest customers accounted for 26.5%,
32.6%, and 30.4% of our total sales, respectively. As a result of our reliance
on a limited number of customers, we may face pricing and other competitive
pressures which may have a material adverse effect on our growth and our
revenues. The volume of work performed for specific customers is likely to vary
from year to year, especially since we are not the exclusive provider for many
of our customers, including all of our automobile upholstery customers.
Furthermore, we do not have an exclusivity arrangement with any of our
customers. In addition, there are a number of factors, other than our
performance, that could cause the loss of a customer or a substantial reduction
in the products that we provide to any customer and that may not be predictable.
For example, our customers may decide to reduce spending on our products. The
loss of any one of our major customers, a decrease in the volume of sales to
these customers or a decrease in the price at which we sell our products to them
could materially adversely affect our growth and our revenues and harm our
reputation in the industry. Moreover, the loss of any one of our major customers
could require us to initiate involuntary attrition, which in turn could have a
material adverse effect on our attrition rate and make it more difficult for us
to attract and retain professionals in the future, which could further
materially adversely affect our growth and our revenues. In addition, this
customer concentration may subject us to perceived or actual leverage that our
customers may have given their relative size and importance to us. If our
customers seek to negotiate their agreements on terms less favorable to us and
we accept such unfavorable terms, such unfavorable terms may have a material
adverse effect on our business, financial condition and results of operations.
Accordingly, unless and until we diversify and expand our customer base, our
future success will significantly depend upon the timing and volume of business
from our largest customers and the financial and operational success of these
customers.


8


Our
customers may decide to discontinue purchasing our products, which could
materially and adversely affect our growth and our revenues.




Our
customers typically retain us through non-exclusive contracts or purchase
orders. These agreements typically do not include any commitment by our
customers to give us a specific volume of business beyond the particular
transaction set forth in the agreement. In addition, the purchase orders that we
enter into, including the advance sale purchase orders that we entered into in
August 2010 with respect to our Evergreen Products, generally provide that the
customer is not required to purchase the products specified in the purchase
order if the products do not meet the customers’ quality requirements or other
specifications. Our business is dependent on the decisions and actions of our
customers, which are outside our control. Decisions by existing customers to
refuse to purchase our Evergreen Products or existing products due to the
failure of such products to meet the customer’s demands, or discontinue
purchasing our products, even temporarily, could materially and adversely affect
our growth and our revenues.




Our
customers operate in a limited number of industries. Factors that adversely
affect these industries may materially and adversely affect our business,
results of operations and financial condition.




We derive
a large portion of our revenues from customers which operate in a limited number
of industries. For example, in fiscal years 2008, 2009, and 2010, we derived
approximately 94%, 97% and 98% of our revenues from our customers in the
furniture and garment manufacturing industries. We also sell our products to
customers in the upholstery fabric and furniture manufacturing industries and
are currently developing nylon taffeta to enable us to sell our products to the
apparel industry. Any significant decrease in spending for our products by
customers in these industries or in the other industries from which we derive
significant revenues in the future may reduce the demand for our products. For
instance, if economic conditions weaken in any of these industries, our clients
may reduce or postpone their spending for our products significantly which may
negatively affect our revenue and profitability. The loss of, or any significant
decline in business from, one or more of our major customers would lead to a
significant decline in our revenue and gross profit, particularly if we are
unable to make corresponding reductions in our expenses in the event of any such
loss or decline. Further, any significant decrease in the growth of the
industries into which we intend to expand, or significant consolidation in those
industries, or any decrease in growth or consolidation in other industry
segments in which we operate, may reduce the demand for our products, which may
materially and adversely affect our business, results of operations and
financial condition.




If
our customers’ businesses are not successful, the volume of purchases and the
prices that they are willing to pay for our products may diminish, which could
harm our business, results of operations and financial condition.




The
success of our business depends on the success of our customers’ businesses. If
our customers are not successful, for any reason, the amount of volume of
purchases and the prices that they are willing to pay for our products may
diminish. Our customers’ decisions about how much money to budget for our
products is directly impacted by their own financial success and forecasts of
their own customers’ needs. If our customers’ products or services are not
sufficiently utilized by their own customers, they may choose to reduce the
volume of purchases of our products, which could cause our revenue to decline,
which could in turn harm our business, results of operations and financial
condition.


9


If
our customers experience financial difficulties, we could have difficulty
recovering amounts owed to us from these customers.




We sell
our products to customers that have in the past, and may in the future,
experience financial difficulties, particularly in light of the recent global
economic downturn. If our customers experience financial difficulties, we could
have difficulty recovering amounts owed to us from these customers. While we
perform credit evaluations and adjust credit limits based upon each customer’s
payment history and credit worthiness, such programs may not be effective in
reducing our exposure to credit risk. We evaluate the collectability of accounts
receivable, and based on these evaluations may need to make adjustments, to the
allowance for doubtful accounts for expected losses. Actual bad debt write-offs
may differ from our estimates, which may have a material adverse effect on our
financial condition, operating results and cash flows. Our suppliers may also
experience financial difficulties, which could result in our having difficulty
sourcing the materials and components we use in producing our products. If we
encounter such difficulties, we may not be able to produce our products for our
customers in a timely fashion which could have an adverse effect on our results
of operations, financial condition and cash flows.




Public
perception that products developed from our materials may be marketed as genuine
leather or that our processing is not environmentally friendly, whether
justified or not, could have a material adverse effect on our business,
financial condition and results of operations.




Our
products are not genuine leather but are designed to look and feel like leather.
We and, to our knowledge, our customers, do not market our fabrics or the end
products developed from our fabrics as genuine leather. However, we cannot be
certain that all manufacturers and marketers of products made from our fibers
will refrain from marketing such products as genuine leather. In addition,
certain of our products are manufactured from recycled materials and certain of
our manufacturing processes are conducted using environmentally friendly
methods. Public perception that products developed from our materials are being
marketed as genuine leather or that our processing is not environmentally
friendly, whether justified or not, could lead to reduced demand for our
products, impair our reputation, involve us in litigation, damage our brand
names and otherwise have a material adverse effect on our business, financial
condition and results of operations.




Our
revenues, expenses and profits are difficult to predict and can vary
significantly from quarter to quarter. This could cause the trading price of our
ordinary shares to decline.




Our
quarterly operating results may vary significantly from quarter to quarter.
Therefore, we believe that period-to-period comparisons of our results of
operations are not necessarily meaningful and should not be relied upon as an
indication of our future performance. It is possible that in the future some of
our quarterly results of operations may be below the expectations of market
analysts and our investors, which could lead to a significant decline in the
trading price of our ordinary shares.




As a
large part of our revenues in any quarter are derived from existing customers,
revenue growth can vary due to project starts and stops and customer specific
situations. Factors which affect the fluctuation of our revenues, expenses and
profits include:




·
            changes
      in prices of our raw materials, with higher prices leading to reduced
      operating income;




·
            variations,
      expected or unexpected, in the duration, size, timing and scope of
      purchase orders, particularly with our key
  customers;




·
            the
      effect of facility closings during and around the Chinese New
      Year;




·
            changes
      in our pricing policies or those of our customers or
      competitors;




·
            unanticipated
      cancellations, non-renewal of our contracts by our customers, contract
      terminations or deferrals of
deliveries;




·
            the
      effect of hiring patterns, unanticipated attrition and the time required
      to train and productively utilize our new
  employees;




·
            changes
      in compensation, which may reduce our gross profit for the quarter in
      which they are effected;




·
            the
      size and timing of expansion of our facilities and opening new
      facilities;




·
            our
      inability to manage costs, including those related to our raw materials,
      personnel, infrastructure and
facilities;


10


·
            exchange
      rate fluctuations; and




·
            general
      economic conditions.




A portion
of our expenses, particularly those related to personnel and facilities, are
fixed in advance of any particular quarter. As a result, unanticipated
variations in the number and timing of our purchase orders or prices of our raw
materials may cause significant variations in our operating results in any
particular quarter. There are also a number of factors besides our performance
that are not within our control that could cause significant fluctuations in our
operating results from quarter to quarter.




We
expect to undertake strategic acquisitions, joint ventures and alliances, which
may prove to be difficult to integrate and manage or may not be successful, and
may result in increased expenses or write-offs.




We expect
over time to pursue strategic acquisitions, joint ventures and alliances to
enhance our capabilities and expand our industry expertise, technical expertise
and geographic coverage. It is possible that we may not identify suitable
acquisition candidates or alliance or joint venture partners, or if we do
identify suitable candidates or partners, we may not complete those transactions
on terms commercially acceptable to us or at all. The inability to identify
suitable acquisition targets, joint ventures or alliances, or our inability to
complete such transactions, may adversely affect our ability to compete and
grow.




These
types of transactions involve numerous risks, including:




·       difficulties
in integrating operations, systems, technologies, accounting methods and
personnel;




·       difficulties
in supporting and transitioning clients of our acquired companies or strategic
partners;




·       disruption
of our ongoing business;




·       diversion
of financial and management resources from existing operations;




·       risks
of entering new markets;




·       potential
loss of key employees; and




·       inability
to generate sufficient revenue to offset transaction costs and
expenses.




Further,
any such transaction that we attempt, whether or not completed, or any media
reports or rumors with respect to any such transactions, may materially and
adversely affect the value of our ordinary shares.




We may
finance future transactions through debt financing or the issuance of our equity
securities or a combination of the foregoing. Acquisitions financed with the
issuance of our equity securities could be dilutive, which could affect the
market price of our ordinary shares. Acquisitions financed with debt could
require us to dedicate a substantial portion of our cash flow to principal and
interest payments and could subject us to restrictive covenants. Acquisitions
also frequently result in the recording of goodwill and other intangible assets
that are subject to potential impairments in the future that could harm our
financial results. Our inability to identify suitable acquisition targets,
strategic investments or partnership or alliance candidates, or to complete such
transactions, may negatively affect our competitiveness and growth prospects.
Moreover, if we fail to properly evaluate acquisitions, alliances or
investments, we may not achieve the anticipated benefits of those transactions,
and we may incur costs in excess of what we had anticipated.




Our
success depends in large part upon our senior management and key personnel. Our
inability to attract and retain these individuals could materially and adversely
affect our business, results of operations and financial condition.




We are
highly dependent on our senior management and other key employees, including Mr.
Jianfeng Liu and Mr. Liwen Zhang. Mr. Liu is the founder of our company and has
more than 20 years of experience in our industry. Mr. Zhang, our Chief
Scientist, is the lead researcher responsible for our new Evergreen Products.
The skills, knowledge and experience of these individuals, as well as other
members of our senior management team, are critical to the growth of our
company. Our future performance will be dependent upon the continued service of
members of our senior management and key employees. We do not maintain key man
life insurance for any of the members of our management team or other key
personnel. Competition for senior management in our industry is intense, and we
may not be able to retain our senior management and key personnel or attract and
retain new senior management and key personnel in the future, which could
materially and adversely affect our business, results of operations and
financial condition.


11


Because
we have not yet procured business or product liability insurance, and we may not
be able to procure business or product liability insurance in the future, we may
not be protected from certain risks that are customarily covered by business or
product liability insurance in the United States.




We have
not procured product liability or general liability insurance for our business
because the insurance industry in China is still in the early stages of its
development. To the extent that we suffer a loss of a type which would normally
be covered by product liability or general liability insurance in the United
States, we would incur significant expenses in defending any action against us
and in paying any claims that result from a settlement or judgment against us.
Product liability claims and product recalls may divert the attention of our
management and could have a material adverse effect on the demand for our
products and on our business, goodwill and reputation. Furthermore, adverse
publicity could result in a loss of consumer confidence in our
products.




Risks
Related to Doing Business in China




China’s
energy policies could have an adverse impact on our operations.




The
Chinese authorities reduce energy usage from time to time, such as during the
summer months when the usage of electricity is high. Chinese authorities
mandated a significant reduction of energy usage at the end of 2010 in an effort
to meet the targets for energy consumption and emissions set by the 11th Five
Year Plan, which plan concluded on December 31, 2010. As a result, we were
restricted from using electrical power in our original facility for several days
in November 2010. In response to this policy, we obtained a power generator to
provide us with the energy needed to run our original facility when electrical
power is restricted. Additional energy use restrictions could be imposed in the
future. Any additional restrictions could adversely impact our results of
operations in future periods.




Our
operations and assets in China are subject to significant political and economic
uncertainties.




Changes
in PRC laws and regulations, or their interpretations, or the imposition of
confiscatory taxation, restrictions on currency conversion, imports and sources
of supply, devaluations of currency or the nationalization of other
expropriation of private enterprises could have a material adverse effect on our
business, results of operations and financial condition. Under the current
political leadership in the PRC, the Chinese government has been pursuing
economic reform policies that encourage private economic activity and greater
economic decentralization in many industries, including ours. There is no
assurance, however, that the Chinese government will continue to pursue these
policies with respect to the Chinese economy generally or our industry in
particular, or that it will not significantly alter these policies from time to
time without notice.




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 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.


12


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. Compliance with Circular 142 may delay or inhibit our ability to
complete such transactions, which could affect our ability to expand
business.




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 common shares. All of our revenues are
denominated in Renminbi. 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. In June
2010, the Chinese government announced its intention to allow the Renminbi to
fluctuate within the 2005 parameters. 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.




China’s
legal system is different from those in some 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 result in fines, the
revocation of a business or other license, the restructuring of our ownership or
the discontinuation of all, or a portion, of our business. In addition, any
litigation in China may result in substantial costs and diversion of resources
and management attention.


13


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 subsidiaries, limiting our subsidiaries’
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. 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,
the required filings pursuant to SAFE Rules are underway for shareholders of
Lizhan Environmental. Mr. Liu has completed his SAFE filing procedure. 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.




In March
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. We have adopted the Lizhan Environmental Corporation 2010 Stock Option
Plan. However, as of the date of this annual report, no employee share option
has been granted. 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.




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.




Prior to
January 1, 2008, the basic enterprise income tax rate for foreign invested
enterprises in the PRC was 33.0%, while the PRC government provided various
incentives, including reduced tax rates, to foreign-invested enterprises and
domestic companies operating in a national level economic and technological
development zone. In addition, Lizhan Textile qualifies for a tax holiday during
which it is entitled to an exemption from enterprise income tax for two years
commencing from its first profit-making year of operation and a 50% reduction of
enterprise income tax for the following three calendar years. In connection
therewith, Lizhan Textile was fully exempt from income tax in each of the years
ended December 31, 2008 and 2009 and has been subject to enterprise income tax
at a reduced rate of 12.5% since the year ended December 31, 2009. The tax
holiday expires on December 31, 2012.


14


On March
16, 2007, the National People’s Congress approved and promulgated a new tax law,
the PRC Enterprise Income Tax Law, or “EIT Law,” which took effect on January 1,
2008. Under the new tax law, foreign-invested enterprises and domestic companies
are subject to a uniform tax rate of 25%. On December 26, 2007, the State
Council issued the Notice of the State Council Concerning Implementation of
Transitional Rules for Enterprise Income Tax Incentives, or “Circular 39.” Based
on Circular 39, enterprises that enjoyed a preferential tax rate of 15% in
accordance with previous laws, regulations and relevant regulatory documents are
eligible for a graduated rate increase to 25% over a five-year transition period
beginning January 1, 2008. For those enterprises which currently enjoy tax
holidays, such tax holidays will continue until their expiration in accordance
with previous tax laws, regulations and relevant regulatory documents. While the
new tax law equalizes the tax rates for foreign-invested enterprises and
domestic companies, preferential tax treatment would continue to be given to
companies in certain encouraged sectors and to those classified as high and new
technology enterprises enjoying special support from the state.




We may
not be able to continue receiving this preferential tax treatment after the tax
holiday expires on December 31, 2012, which may cause an increase in our income
tax expense, thereby reducing our net income and adversely affect our results of
operations.




Under
the EIT Law, we may be classified as a “resident enterprise” of the PRC. Such
classification could result in unfavorable tax consequences to us and our
non-PRC shareholders.




Under the
EIT Law, 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.




If the
PRC tax authorities determine that we are a “resident enterprise” for PRC
enterprise income tax purposes, a number of unfavorable PRC tax consequences
could follow. First, we 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 subsidiaries through our sub-holding companies
may qualify as “tax-exempt income,” we cannot guarantee that such dividends will
not be subject to withholding tax. Finally, the new “resident enterprise”
classification 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.




Our PRC
subsidiaries are held directly by Resources, which is an entity organized under
the law of Hong Kong. According to Article 10 of the arrangement between
Mainland China and the Hong Kong Special Administrative Region, or HKSAR, on the
Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect
to Taxes on Income, when a Hong Kong resident enterprise holds more than 25%
percent of the shares of a company, the Hong Kong resident enterprise pays
income tax amounting to 5% of the dividends paid. When a Hong Kong resident
enterprise holds 25% or less of the shares of a company, the Hong Kong resident
enterprise pays income tax amounting to no more than 10% of the dividends
paid.




If any
such PRC taxes apply to our non-PRC shareholders, a non-PRC shareholder may be
entitled to a reduced rate of PRC taxes under an applicable income tax treaty
and/or a foreign tax credit 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 foreign tax
credits.




Changes
in PRC government policy on foreign investment in China may adversely affect our
business and results of operations.




Both of
our PRC subsidiaries are foreign investment enterprises. As foreign invested
enterprises, our wholly owned subsidiaries are subject to restrictions on
foreign investment imposed by PRC laws from time to time. For instance, under
the Foreign Investment Industrial Guidance Catalogue, some industries are
categorized as sectors which are encouraged, restricted or prohibited for
foreign investment. According to the latest version of this Catalogue, our
business does not belong to the prohibited or the restricted category. As this
Catalogue is updated every few years, there can be no assurance that the PRC
government will not change its policies in a manner that would cause part or all
of our business to fall within the restricted or prohibited categories. If any
of our business activities become prohibited, or if we cannot obtain approval
from relevant approval authorities to engage in business activities which become
restricted for foreign investors, we may be forced to sell or restructure our
business activities which have become restricted or prohibited for foreign
investment. If we are forced to adjust our corporate structure or business line
as a result of changes in government policy on foreign investment, our business,
financial condition and results of operations may be materially and adversely
affected.


15


Restrictions
on currency exchange may limit our ability to receive and use our revenues
effectively, which could materially and adversely affect our business and
financial condition.




Substantially
all of our revenues and operating expenses are denominated in Renminbi. The
Renminbi is currently freely convertible under the “current account,” which
includes dividends, trade and service-related foreign exchange transactions, but
not under the “capital account,” which includes foreign direct investment and
loans. Currently, our PRC subsidiaries may purchase foreign exchange for
settlement of “current account transactions,” including payment of dividends to
Resources, without the approval of the SAFE. Our PRC subsidiaries may also
retain foreign exchange in its current account, subject to a ceiling approved by
the SAFE, to satisfy foreign exchange liabilities or to pay dividends. However,
we cannot assure you that the relevant PRC governmental authorities will not
limit or eliminate our PRC subsidiaries’ abilities to purchase and retain
foreign currencies in the future. Since a significant amount of our future
revenues will be denominated in Renminbi, the existing and any future
restrictions on currency exchange may limit our ability to utilize capital
generated in Renminbi to fund our business activities outside of China, if we
were to have any in the future, or expenditures denominated in foreign
currencies. Foreign exchange transactions under the capital account are subject
to limitations and require registration with or approval by the relevant PRC
governmental authorities. In particular, if we finance our PRC subsidiaries by
foreign currency loans, those loans cannot exceed certain statutory limits and
must be registered with the SAFE, and if we finance our PRC subsidiaries by
capital contributions using, for instance, proceeds from our initial public
offering, those capital contributions must be approved by the local authority,
such as Tongxiang Foreign Trade and Economic Cooperation Bureau and Zhejiang
Foreign Trade and Economic Cooperation Bureau. In addition, because of the
regulatory issues related to foreign currency loans to, and foreign investment
in, domestic PRC enterprises, we may not be able to finance our PRC operating
companies’ operations by loans or capital contributions. We cannot assure you
that we can obtain these governmental registrations or approvals on a timely
basis, if at all. These limitations could affect the ability of these entities
to obtain foreign exchange through debt or equity financing, and could adversely
affect our business and financial conditions.




China’s
regulation of loans and direct investment by non-Chinese holding companies to
Chinese entities may delay or prevent us from using the proceeds of our recent
initial public offering to make loans or additional capital contributions to our
Chinese operating subsidiaries, which could materially and adversely affect our
business and financial condition.




In
utilizing the proceeds of our recent initial public offering, as a non-Chinese
holding company of Chinese operating subsidiaries, we may make loans to our
Chinese subsidiaries, or we may make additional capital contributions to our
Chinese subsidiaries. Any loans we make to our Chinese subsidiaries are subject
to regulations in China. For example, loans by us to our Chinese subsidiaries,
which are foreign-invested enterprises, to finance their activities cannot
exceed statutory limits and must be registered with SAFE or its local
counterparts.




We may
also decide to finance our subsidiaries by means of capital contributions. These
capital contributions must be approved by China’s Ministry of Commerce or its
local counterpart. We may not be able to obtain these government approvals on a
timely basis, if at all, with respect to future capital contributions by us to
our Chinese subsidiaries. If we fail to receive such approvals, our ability to
use the proceeds of the offering and to capitalize our operations in China may
be negatively affected, which could adversely affect our business, results of
operations and financial condition.




Any
failure to comply with PRC environmental laws may require us to incur
significant costs.




We carry
on our business in an industry that is subject to PRC environmental protection
laws and regulations. These laws and regulations require enterprises engaged in
manufacturing and construction that may cause environmental waste to adopt
effective measures to control such waste. In addition, such enterprises are
required to pay fines, or to cease operations entirely under extreme
circumstances, should they discharge waste substances. The Chinese government
may also change the existing laws or regulations or impose additional or
stricter laws or regulations, compliance with which may cause us to incur
significant capital expenditures, which we may be unable to pass on to our
customers through higher prices for our products.


16


We
must comply with the Foreign Corrupt Practices Act.




We are
required to comply with the United States Foreign Corrupt Practices Act, which
prohibits companies whose shares are listed on a U.S. securities exchange from
making prohibited payments to foreign officials for the purpose of obtaining or
retaining business. Corruption, extortion, bribery, pay-offs, theft and other
fraudulent practices occur from time to time in mainland China. If any of our
non-US listed competitors that are not subject to the Foreign Corrupt Practices
Act engage in these practices, they may receive preferential treatment and
secure business from government officials in a way that is unavailable to us.
Furthermore, although we inform our personnel that such practices are illegal,
we cannot assure you that our employees or other agents will not engage in
illegal conduct for which we might be held responsible under US law. If our
employees or other agents are found to have engaged in such practices, we could
suffer severe penalties.




Because
our funds are held in banks 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. As a result, in the event of a bank failure, we may not have access
to 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.




The
Chinese government exerts substantial influence over the manner in which we must
conduct our business activities.




The
Chinese central government and local governments have exercised, and continue 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 national or local laws and regulations, including those
relating to taxation, the environment, labor and employee benefits and land use
rights. The central or local governments may impose stricter regulations or
stricter 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, 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 hold in
Chinese properties. In addition, if the PRC government were to eliminate export
processing zones, restrict the transportation of goods in and out of the
country, adopt policies favoring competitors or impose other restrictions on our
operations, the impact may be significant. A reversal of current liberalizations
of foreign exchange controls by the Chinese government could be disruptive and
costly to our export sales.




If
relations between the United States and China worsen, investors may be unwilling
to hold or buy our stock and our stock price may decrease.




At
various times during recent years, the United States and China have had
significant disagreements over political and economic issues. Controversies may
arise in the future between these two countries. Any political or trade
controversies between the United States and China, whether or not directly
related to our business, could reduce the price of our ordinary
shares.




Risks
Related to Our Ordinary Shares




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 various factors, including the
following:




·
            actual
      or anticipated fluctuations in our quarterly operating results and
      revisions to our expected results;




·
            changes
      in financial estimates by securities research
  analysts;




·
            conditions
      in the markets for our
products;


17


·
            changes
      in the economic performance or market valuations of companies specializing
      in our industry or our customers or their
  industries;




·
            announcements
      by us or our competitors of new products, acquisitions, strategic
      relationships, joint ventures or capital
  commitments;




·
            addition
      or departure of our senior management and key
  personnel;




·
            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, and to an even greater
degree since the last quarter of 2007, 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. Furthermore, 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.




We
are a Cayman Islands Company and because judicial precedent regarding the rights
of shareholders is more limited under Cayman Islands law than U.S. law, you may
have less protection of your shareholders rights than you would under U.S.
law.




We are
incorporated under the laws of the Cayman Islands. Our corporate affairs are
governed by our memorandum and articles of association, the Companies Law (2010
Revision) of the Cayman Islands (as amended from time to time) 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 comparatively limited 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. The
rights of our shareholders and the fiduciary responsibilities of our directors
under Cayman Islands law are not as clearly established as they would be 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. In addition, some U.S. jurisdictions, such as Delaware, have
more fully developed and judicially interpreted bodies of corporate law than the
Cayman Islands. Furthermore, shareholders of Cayman Islands companies may not
have standing to initiate a shareholder derivative action in a federal court in
the United States. As a result, our public shareholders may have more
difficulties in protecting their interests based on actions taken by management,
members of the board of directors or controlling shareholders than they would as
shareholders of a U.S. company.




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.




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 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. For more information regarding the relevant
laws of the Cayman Islands and the PRC, see “Enforceability of Civil
Liabilities.”


18


If
we fail to maintain an effective system of internal controls, we may 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
affected.




Our
reporting obligations as a public company place a significant strain on our
management, operational and financial resources and systems for the foreseeable
future. 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 need to further develop
accounting and financial capabilities, including the establishment of an
internal audit function and development of documentation related to internal
control policies and procedures. Failure to quickly establish the necessary
controls and procedures would make it difficult to comply with SEC rules and
regulations with respect to internal control and financial reporting. We need to
take further actions to continue to improve our internal controls. If we are
unable to implement solutions to any weaknesses in our existing internal
controls and procedures, or if we fail to maintain an effective system of
internal controls in the future, we may 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 may also engage external Sarbanes-Oxley consultants 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.




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
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, subject to the
approval of our shareholders, and will depend upon our results of operations,
our cash flows, our financial condition, the payment of our subsidiaries of cash
dividends to us, our capital needs, future prospects and other factors that our
directors may deem appropriate. You should refer to the “Dividend Policy”
section in this annual report for additional information regarding our current
dividend policy for additional legal restrictions on the ability of our PRC
subsidiaries to pay dividends to us.




We
incur increased costs as a result of being a public company in the United
States, which could reduce our profits.




We are
subject to the reporting obligations of the SEC, which many consider to be more
stringent, rigorous and expensive than operating a privately held company. In
particular:




·
            We
      incur additional costs in order to comply with U.S. corporate governance
      requirements, including requirements under the Sarbanes-Oxley Act of 2002,
      as well as new rules implemented by the SEC and the Financial Industry
      Regulatory Authority, or FINRA. We expect these requirements will increase
      our legal compliance costs and will make some compliance activities more
      time consuming and costly.


19


·
            We
      incur additional costs in implementing and verifying internal control
      procedures as required by section 404 of the Sarbanes-Oxley Act of 2002
      and the rules and regulations thereunder. We expect these requirements
      will increase our accounting and financial
  costs.




·
            We
      are required under U.S. rules and regulations to retain our independent
      directors that serve on our board of directors. We may encounter
      difficulty in retaining, or in the future attracting, qualified
      independent directors to serve on our board of directors and our audit
      committee, in particular. We will also incur substantial costs to maintain
      directors and officers insurance.




If we
fail to retain, or attract as necessary, independent directors, we may be
subject to SEC enforcement proceedings and delisting by the securities exchange
on which our ordinary shares are listed at the time. As a result, we will incur
greater costs for legal, accounting and other services and, in turn, will
increase our operating expenses and reduce our profits.




Mr.
Liu, our Chairman, has the ability to exercise significant control over us, and
whose interests may conflict with your interests as a shareholder.




Mr.
Jianfeng Liu, who is our Chairman, President and Chief Executive Officer,
beneficially owns 62.5% of our outstanding ordinary shares. As a result, Mr. Liu
has the ability to exercise significant influence over our management, including
over matters requiring shareholder approval or approval by our Board of
Directors. This could delay, defer or prevent a change in control, impede a
merger, consolidation, take-over or other business combination involving us, or
discourage a potential acquirer from making a tender offer or otherwise
attempting to obtain control of us. In addition, Mr. Liu has entered into
several related party transactions with our company, including guaranteeing our
banks loans, transferring patents to us, purchasing our ordinary shares and
selling materials to us. See Item 7 below. Conflicts of interest between these
dual relationships may arise. We cannot assure you that when conflicts of
interest arise, Mr. Liu will act in the best interests of our company or that
conflicts of interest will be resolved in our favor.




If
we are classified as a passive foreign investment company, our U.S. shareholders
may suffer adverse tax consequences.




Generally,
if for any taxable year, after applying certain look-through rules, 75% or more
of our gross income is passive income, or at least 50% of our assets are held
for the production of, or produce, passive income, we may be characterized as a
passive foreign investment company, or PFIC, for U.S. federal income tax
purposes. This characterization could result in adverse U.S. tax consequences to
our shareholders who are U.S. taxpayers, including gain realized on the
disposition of our ordinary shares being treated as ordinary income rather than
capital gain income and in punitive interest charges being applied to such sales
proceeds. Rules similar to those applicable to dispositions apply to amounts
treated as “excess distributions.”




We do not
believe that we were a PFIC for the years ended September 30, 2009 or September
30, 2010 and currently anticipate that we will not be a PFIC for the current
fiscal year based upon our estimates of the values of our assets. However,
because PFIC status is based on the composition of our income and assets for the
entire taxable year, it is not possible to determine whether we will become a
PFIC for the current year until after the close of the year. Therefore, we may
become a PFIC for the year ending September 30, 2011 or in any future taxable
year. U.S. shareholders should consult with their own U.S. tax advisors with
respect to the U.S. tax consequences of investing in our ordinary shares. See
“Taxation — U.S. Taxation — Tax Consequences if We Are a Passive Foreign
Investment Company.”




If
equity research analysts do not publish research or reports about our company or
if they issue unfavorable commentary or downgrade our ordinary shares, the price
of our ordinary shares could decline.




The
trading market for our ordinary shares will rely in part on the research and
reports that equity research analysts publish about us and our company. We do
not control these analysts. The price of our ordinary shares could decline if
one or more equity analysts downgrade our ordinary shares or if they issue other
unfavorable commentary, or cease publishing reports, about us or our
company.


20


ITEM
      4.
            INFORMATION
      ON THE COMPANY




4A.  History
and Development of the Company




Lizhan
Textile




Our
wholly owned subsidiary, Lizhan Textile (Zhejiang) Co., Ltd., or Lizhan Textile,
is an operating company whose principal activities are the manufacture,
distribution and marketing of synthetic leather and other fabrics. Lizhan
Textile was established as a wholly foreign-owned enterprise in the PRC on
December 6, 2005. We conduct all of our current operations through Lizhan
Textile.




Until
2009, when our company underwent a corporate restructuring prior to of our
initial public offering in November 2010, Lizhan Textile was wholly owned by
Illigate Development Limited, or Illigate, a company incorporated in the British
Virgin Islands on September 26, 2005. Illigate is wholly owned by Mr. Jianfeng
Liu, our Chief Executive Officer and Chairman.




Corporate
Restructuring




Prior to
our initial public offering, we underwent a corporate restructuring in the
second half of 2009 and early 2010, as follows:




Li Zhan
Resources Recycling Technology Development Company Limited, or Resources, was
incorporated on September 3, 2009 as a limited liability company in Hong Kong.
Resources was initially wholly owned by Mr. Liu. On September 15, 2009,
Resources acquired 100% of the equity interests in Lizhan Textile from Illigate
in exchange for approximately $3.6 million. This change in ownership of Lizhan
Textile was approved by the local PRC government on October 12, 2009.
Consequently, Resources is an intermediate holding company that directly owns
100% of Lizhan Textile.




Lizhan
Environmental Corporation was incorporated on August 31, 2009 as a limited
liability company in the Cayman Islands. Lizhan Environmental was initially
incorporated under the name Illigate Environment Resources Technology Company
Limited and on January 12, 2010, we changed its name to Lizhan Environmental
Corporation. On August 31, 2009, Lizhan Environmental issued 10,937,500 ordinary
shares to Mr. Jianfeng Liu, which represented 100% of the issued and outstanding
shares of Lizhan Environmental, in exchange for $3.5 million.




On
November 9, 2009, Lizhan Environmental acquired 100% of the equity interest in
Resources from Mr. Liu in exchange for nominal consideration. Consequently,
Lizhan Environmental owns 100% of Resources directly and 100% of Lizhan Textile
indirectly through Resources.




Hongzhan




On
December 8, 2009, Resources established a new wholly-owned subsidiary named
Hongzhan (Zhejiang) New Material Co. Ltd., or Hongzhan, which is a wholly
foreign owned enterprise in the PRC. Hongzhan will engage in the manufacture and
selling of our new Evergreen Products. On February 8, 2010, Resources entered
into a share transfer agreement with an entity named Eminent Benefit Holdings
Limited, or Eminent, which is wholly owned by Liwen Zhang, a key employee of
ours since February 2010. Pursuant to this agreement, as amended on February 10,
2010, Resources transferred a 13% equity interest in Hongzhan to Eminent. In
exchange for the 13% interest in Hongzhan, valued at $650,000 (13% of the
registered capital of Hongzhan), Liwen Zhang transferred to Resources and
Hongzhan two patents and one patent application related to our new Evergreen
Products in satisfaction of the $650,000 payment owed by Mr. Zhang pursuant to
the share transfer agreement. These patents were subsequently transferred to
Lizhan Textile in August 2010 subject to the approval by the local State
Intellectual Property Office of the PRC or SIPO. Lizhan Textile has licensed the
use of the patents to Hongzhan for no consideration. The license to Hongzhan is
subject to approval by the local SIPO. Following the share transfer, Resources
owns 87% of the outstanding shares of Hongzhan and Eminent owns the remaining
13%.




Our
Shareholders




From the
date of our inception until December 14, 2009, Mr. Liu, our chairman, owned all
of the issued and outstanding ordinary shares of Lizhan
Environmental.


21


On
December 14, 2009, Mr. Liu transferred 1,562,500 ordinary shares of Lizhan
Environmental to Infinite Harvest International Limited, for no consideration.
Infinite Harvest International Limited is a company formed under the laws of the
British Virgin Islands. Liu Yang, son of Mr. Jianfeng Liu, owns 60% of the
outstanding shares of Infinite. The remaining 40% of the outstanding shares of
Infinite is held by two PRC residents that are unaffiliated with our company or
any of our directors and officers. In addition, on December 14, 2009, Mr. Liu
transferred 218,750 ordinary shares to Mr. Liu’s son, Liu Yang, and 125,000
ordinary shares to Mr. Liu’s son, Liu Hai, for no consideration.




On
January 12, 2010, we issued 206,250 shares to Mr. Liu for a purchase price of
approximately $4.80 per share.




On
January 12, 2010, Mr. Liu transferred 6,612,500 ordinary shares of Lizhan
Environmental to Illigate, a BVI company wholly owned by Mr. Liu, for no
consideration. In addition, in December 2009 and January 2010, Mr. Liu
transferred an aggregate of 2,625,000 ordinary shares of Lizhan Environmental to
unaffiliated third parties that reside in the PRC, Hong Kong and BVI for an
aggregate purchase price of $4.2 million, which purchase price was paid in
January 2009. These individuals, together with Liu Yang and Liu Hai, are
collectively referred to as “other shareholders” in the organization chart on
page 6 below.




Reverse
Stock Split




On
September 14, 2010, we effectuated a consolidation of every 1.6 ordinary shares
in our authorized share capital into one ordinary share. Upon the consolidation,
every 1.6 ordinary shares were consolidated into one ordinary share. As a
result, the number of our authorized shares comprising our authorized share
capital of $10,000,000 was reduced from 50,000,000 to 31,250,000, the number of
outstanding ordinary shares was reduced from 17,830,000 to 11,143,750 in the
aggregate, the par value of our ordinary shares was increased from $0.20 per
share to $0.32 per share and the number of ordinary shares available under our
stock option plan was reduced from 3,000,000 to 1,875,000. Any fractional share
issued as a result of the reverse split was rounded up.


22


Organizational
Structure Chart




The
following chart reflects our organizational structure as of December 31,
2010:









Capital
Expenditures




We
incurred capital expenditures of approximately $16.6 million, $1.2 million and
$3.8 million for the years ended September 30, 2010, 2009 and 2008,
respectively, primarily in connection with purchases of land use rights,
property, plant and equipment and construction of our facilities, leasehold
improvements and investment in equipment, technology and operating systems.
These capital expenditures were financed by the cash flow generated by our
operations and from bank financing. The capital expenditures incurred in the
twelve months ended September 30, 2009 exclude machinery valued at $1,294,186
which we received pursuant to an asset transfer contract with one of our largest
customers. See a description of this arrangement under the heading “— Results of
Operations” below.




We
believe that our capital expenditures in fiscal year 2011 will be incurred
primarily in connection with the construction of our Evergreen Products
facility. We expect to finance these capital expenditures by using cash on hand,
internal cash flow to be generated by operations, short-term bank borrowings and
bank facilities and net proceeds from our recent initial public
offering.




Registered
office




The
address of our registered office in the Cayman Islands is: Scotia Centre, 4th Floor,
P.O. BOX 2804, George Town, Grand Cayman KY1-112, Cayman Islands. The telephone
number of the registered office is (284) 494-4840.


23


4B.  Business
Overview




Overview




We
manufacture, distribute and market synthetic leather and other fabrics from
recycled leather waste, among other materials. Our production facilities are
strategically located in Tongxiang, Zhejiang Province, which is in close
proximity to many leather product manufacturers whose production facilities are
located in Tongxiang, Haining and Wenzhou, all of which are situated in Zhejiang
Province, which collectively are considered as one of the most important
leather industry clusters in China. We believe that we are one of only a few
Chinese synthetic fabric manufacturers that own an extensive range of finishing
processes to manufacture synthetic leather and other fabrics, ranging from
products which are manufactured entirely from chemical-based materials, such as
our microfiber fabrics, to products such as recycled leather flocked fabric,
which are flocked with recycled genuine
leather waste. Recycled leather flocked products accounted for approximately
73.9% of our revenue in the twelve months ended September 30,
2010.  In November 2010 we closed our initial public offering,
pursuant to which issued 2,500,000 ordinary shares at a price of $4.00 per
share.  We received net proceeds of approximately $7.5 million from
the offering.






Our
products are used in various consumer applications, as we sell our products to
furniture, automotive upholstery and garment manufacturers, as well as fabric
distributors. In fiscal years 2008, 2009 and 2010, we derived approximately 94%,
97% and 98% of our revenues from our customers in the furniture and garment
manufacturing industries. We sell domestically in China and export to the US and
other countries, including Nicaragua, Germany, Belgium, France and South Korea.
During the twelve months ended September 30, 2010, 2009 and 2008, approximately
22.9%, 37.3% and 27.0% of our revenues, respectively, were generated from export
sales. The solid reputation that we believe our management team has developed
over the past ten years in the synthetic leather industry in China, including an
established track record for consistently providing quality products at
competitive prices, has enabled us to develop and expand our customer base.
However, our company has a limited operating history and you will have a limited
basis on which to evaluate our ability to achieve our business objectives. In
addition, we expect our future growth to place significant demands on our
management and resources.




Our
primary raw materials are leather waste, ultrasuede grey cloth, backing fabric,
polyurethane (commonly referred to as PU) and resin, which we acquire almost
entirely from local suppliers. The manufacturing process of each of our products
generally involves various steps, including stamping, PU dry coating, embossing,
printing, recycled leather powder electrostatic flocking and
tufting.




We
believe that we have been able to harness our technology and know-how to develop
a distinct competitive advantage by recycling leather waste to produce eco green
fabrics which are more similar to genuine leather in quality than our existing
products, at lower production costs than genuine leather products.
Specifically:




·
            We
      use innovative production technology, for which we have filed an invention
      patent application in the PRC, to manufacture fabric productsthat are flocked with materials made from
      leather waste. We have been selling these products since fiscal year 2009,
      and these products accounted for approximately 73.9% of our revenue in the
      twelve months ended September 30,
2010.




·
            We
      own and lease innovative patented production technologies that we use to
      manufacture a new product, reconstituted Evergreen LZ collagen fiber
      leather, or Evergreen Products. We believe these technologies will enable
      us to generate imitation leather products that look and feel more similar
      to genuine leather. We expect to initially sell these new products to
      furniture manufacturers and to manufacturers of automotive upholstery
      applications for environmentally clean vehicles that are being developed
      for the Chinese market.




·
            We
      currently own five design patents and three new utility model patents
      relating to our existing products, seven of which were acquired from Mr.
      Jianfeng Liu, who is our Chairman, President and Chief Executive Officer,
      and one pending patent application. In addition, we recently acquired from
      Mr. Liwen Zhang, who is our Chief Scientist, ownership rights to two
      invention patents, one patent application and a license to use a fourth
      patent owned by Mr. Zhang, which are related to the technology to be
      utilized in the manufacture of the Evergreen Products. In September 2010,
      we submitted an application to obtain an invention patent in the PRC
      pursuant to the Patent Cooperation Treaty, related to the process of our
      Evergreen Products.


24


Presently,
natural fiber sources are limited by nature, with natural fibers having high
cost and relatively low abrasion resistance and tensile strength. On the other
hand, synthetic fibers are poor water-absorbents, flame-retardants, and provide
only low comfort.




The
Licensed Patents are directed to an invention to provide a yarn of collagen
fiber of animal leather, and a manufacturing process thereof in that yarn is
manufactured by using animal skins or leathers and leftover materials thereof as
well as wasted leathers. The present invention provides for the textile industry
a yarn having higher tensile strength and better resistance to abrasion than
those of the natural fiber yarns, and having higher water absorption, greater
comfort, and better flame-retardant properties than those of synthetic fiber
yarns. This technology that is most essential to the front-end manufacturing
process of our Evergreen Products has been patented in eighteen countries,
including China, Canada, South Africa, Germany and the United Kingdom.
Applications for patent protection with respect to this key technology have also
been submitted in eight other countries, including the United States. The
eighteen patents and eight patent applications relating to this key technology,
which we also refer to throughout this annual report as the Licensed Patents,
have been licensed to us exclusively until 2024. The Licensed Patents are
intended to protect the technologies, including machinery and processes,
developed by Liwen Zhang’s team, to produce collagen fiber from animal leather.
We believe that the patents that we own and the Licensed Patents differentiate
our new Evergreen Products as an environmentally friendly and economical
alternative to existing synthetic and genuine leather fabrics.




We have
experienced substantial growth since we launched our commercial production in
November 2007. Our aggregate annual production capacity was 15 million meters as
at September 30, 2010. We produced and sold approximately 5.1 million, 8.0
million and 14.0 million meters of fabric during the twelve months ended
September 30, 2008, 2009 and 2010, respectively. Our revenues and net income
increased substantially during the same period. Specifically, we generated
revenues of $13.1 million, $21.6 million and $46.3 million and achieved net
income of $1.5 million, $2.7 million and $8.2 million during the twelve months
ended September 30, 2008, 2009 and 2010, respectively.




We
recently completed the testing of the first of our Evergreen Product production
lines and expect to begin mass production in mid-February. In addition, we plan
to launch mass production of the second of our Evergreen Product production
lines by May 2011, provided that there is sufficient demand for our Evergreen
Products at that time. We plan to begin installing production lines 3 and 4 in
fiscal year 2011 and to utilize these production lines for production of
Evergreen Products beginning in November 2011 and April 2012, respectively,
provided that there is sufficient demand for our Evergreen Products at that
time. As a result, our aggregate production capacity is expected to be 21.4
million meters of fabric (including 6.4 million meters of Evergreen Products)
and 27.8 million meters of fabric (including 12.8 million meters of Evergreen
Products) as of September 30, 2011 and 2012, respectively.




Our
Strengths




We
believe that the following factors have contributed to our growth to
date:




A
track record of rapid growth




Our
revenues and net income increased substantially since we began our operations in
November 2007. Specifically, we generated revenues of $13.1 million, $21.6
million and $46.3 million and achieved net income of $1.5 million, $2.7 million
and $8.2 million during the twelve months ended September 30, 2008, 2009 and
2010, respectively.




High
Quality, Eco-Friendly “Green Leather” Products Produced from Recycling Leather
Waste




According
to a 2009 report issued by the China Investment Consulting Company, which report
we refer to throughout this section as the OCN report, the development of
environmentally friendly technology has been an important focus of the synthetic
leather industry. Since our inception, we have continually pursued technological
innovations in our manufacturing methods and processes. We believe that we are
one of only a few Chinese synthetic fabric manufacturers which manufactures
products that are flocked with recycled
genuine leather, which results in higher quality products with higher profit
margins. Furthermore, we believe that the patented technologies that have been
developed to manufacture our new Evergreen Products will enable us to generate
imitation leather products that look and feel more similar to genuine leather.
The Evergreen Products are expected to generate higher margins than our existing
products as a result of higher sales prices at which we expect to charge our
customers without a proportionate increase in cost of sales, and are
environmentally friendly. Based on our market feasibility study and discussions
with long-term customers who have entered into market co-development agreements
with us, we believe that we may price Evergreen Products at approximately two to
three times the average selling price of our existing products. However, outside
of research and development testing, we have never mass produced or sold any
Evergreen Products. There is no assurance that we will be successful in
developing and selling these products or in growing this line of
business.




25


An
Extensive Intellectual Property Portfolio




We have
accumulated an extensive portfolio of intellectual property that is not
typically seen in the industrial manufacturing sector in China. Our key
intellectual properties include one trademark, one trademark application, ten
Chinese patents, two new patents under application in China, and a long-term
exclusive license to one Chinese patent, seventeen international patents and
eight international patent applications related to the same production
technology that is critical to the manufacture of the Evergreen Products. The
proprietary production technologies related to our patents enable us to produce
higher-value synthetic materials and to use lower-cost recycled materials,
particularly leather waste.




An
extensive range of finishing production processes and technologies




We
believe that we are one of only a few Chinese synthetic fabric manufacturers
that own an extensive range of finishing processes to manufacture synthetic
leather and other fabrics, ranging from purely chemical-based products, such as
our microfiber fabrics, to products such as synthetic powder leather, which are
manufactured from recycled genuine leather. Our finishing processes include
stamping, PU dry coating, embossing, printing, recycled leather powder
electrostatic flocking, and tufting.




Strong
Recognition from Domestic and International Customers




The solid
reputation that we believe our management team has developed over the past ten
years in the synthetic leather industry in China and in other countries such as
Nicaragua, the United States, Germany and Belgium, including an established
track record for consistently providing quality products at competitive prices,
has enabled us to develop a strong customer base which includes several
reputable domestic and multinational fabric and furniture
manufacturers.




Reliable
Supplier Network for Low-Cost Raw Materials




Many of
our current suppliers have had longstanding relationships with us. We believe
that these long-standing supplier relationships provide us with a competitive
advantage in China. However, as we increase the scale of our production, we may
need to establish a more diverse supplier network while attempting to continue
to leverage our purchasing power to obtain favorable pricing and delivery terms.
We also purchase leather waste in bulk quantities from leather manufacturers.
There is an incentive for the leather manufacturers to sell leather waste to us,
as we provide them with an environmentally friendly and commercially viable
channel for the disposal of these waste products. Consequently, we have been
able to obtain these products in sufficient amounts and at competitive
prices.




Rigorous
Quality Control Standards




Consistent
with our continuing commitment to quality, we impose rigorous quality control
standards at various stages of our production process. We strictly comply with
various national quality standards with respect to the manufacture of furniture
leather, PU dry-coating artificial leather and PU artificial leather, as well as
the national general safety technical code for textile products, all of which
have been established by the General Administration of Quality Supervision,
Inspection and Quarantine of China, a government body in China in charge of
national quality, metrology, entry-exit commodity inspection, entry-exit health
quarantine, entry-exit animal and plant quarantine, import-export food safety,
certification and accreditation, standardization, as well as administrative law
enforcement.




Experienced
Management and Operational Teams with Domestic PRC Market Knowledge




Our
senior management team and key operating personnel have extensive management
skills, relevant operating experience and domestic PRC industry knowledge. In
particular, Mr. Jianfeng Liu, our founder Chairman, President and Chief
Executive Officer, has managed and operated businesses in the synthetic leather
and textile industries in the PRC for over 20 years. Mr. Liwen Zhang, an
experienced researcher and developer in our industry who joined our company in
February 2010, is also a key member of our team. We believe that our management
team’s experience and in-depth knowledge of the market in China will enable us
to continue to successfully execute our expansion strategies. In addition, we
believe our management team’s strong track record will enable us to continue to
take advantage of market opportunities that may arise.


26


We
are Taking Advantage of Industry Trends




According
to the OCN report, in recent years, production of synthetic fabric in developed
countries has declined. This decline has been attributed to the increasing labor
costs and operational costs incurred in the manufacture of these products in
these countries. Consequently, manufacturers in these countries are relying more
on imported synthetic leather fabric products. Our strategy is to take advantage
of this trend.




Our
Growth Strategy




Our goal
is to strive to be one of the leading Chinese manufacturers of a broad range of
synthetic leather and other fabrics using cost efficient and eco-friendly
products and technologies and to become a leading eco-green material
manufacturer that provides high quality recycled and affordable products for
China’s rapidly growing consumer market by pursuing the following growth
strategies:




Increasing
our production capacity and developing new higher margin products.




As of
September 30, 2010, we had an aggregate annual production capacity of
approximately 15 million meters. We intend to launch the production of our
Evergreen Products production lines in fiscal year 2011, and we expect to
achieve an annual production capacity of 6.4 million meters of fabric of
Evergreen Products during fiscal year 2011. These new Evergreen Products, as
well as recycled leather flocked fabric products, which we began producing in
fiscal year 2009, carry higher price and profit margins, and are environmentally
friendly products manufactured from leather waste. We believe that the expansion
of our product offerings will enable us to benefit from the continued growth in
overall demand for synthetic leather and chemical fiber industry in
China.




Building
an international “Green Leather” brand and promoting the benefits of our
eco-friendly Evergreen Products




We
believe our Evergreen Products are innovative in the international market place.
By launching and expanding the distribution of Evergreen products initially in
China for furniture applications and automotive upholstery applications in clean
vehicles and subsequently across the world in upholstery, apparel and other
applications, we intend to establish our reputation in the international market
as a manufacturer and distributor of “Green Leather”. We also intend to
extensively promote the benefits of, and develop new applications for, Evergreen
Products.




Strengthening
our relationships with key customers and diversifying our customer
base.




We intend
to strengthen our relationships with key customers while further expanding our
customer base. We plan to continue providing high-quality and cost-competitive
products to our existing customers and to use our existing customer network and
strong industry reputation to expand into new regions within the PRC, beyond the
local regions into which we currently sell our products, and internationally.
Specifically, we plan to develop a nationwide distribution network in all major
provinces in the PRC for the sale of our new Evergreen Products. In addition, we
plan to expand into complimentary markets that would use our products for new
applications. Specifically, we are currently developing nylon taffeta, a new
artificial leather material that is used for the manufacture of lightweight
waterproof apparel. We intend to continue to use customer feedback to improve
the quality of our products and to strengthen our long-term base of domestic and
international customers.




Developing
new technologies, new products and new application markets




We intend
to develop and introduce new, higher value-added products that are expected to
expand margins and meet the increasing demands of new and existing customers. We
will continually strive to broaden our research and development efforts, to
develop and manufacture high quality recycled leather products to meet customer
demand and to develop new application markets for our new products.




Pursuing
strategic relationships and acquisition opportunities




We intend
to evaluate and pursue acquisition opportunities and strategic partner
relationships which could enhance our product offerings, customer base or
geographic reach, or which could allow us to achieve economies of scale and
operating efficiencies. We currently have no plans, agreements or commitments
with respect to any material acquisitions or strategic
relationships.


27


Seasonality




Our
production and sales slow considerably during and around the Chinese New Year,
which usually occurs during the quarter ended March 31, as a result of the
closing of our facilities and the facilities of many of our customers for the
New Year’s celebration, as well as the shutting down of our steamers for an
annual inspection by local authorities. In addition, our sales volume declines
during summer due to the slow demand from the international markets while
consumer spending is generally slower for furniture and
garments.  Consequently, our results of operations may fluctuate from
quarter to quarter.  In addition, any significantdecrease
in sales during the remainder of the year would have a material adverse effect
on our business, our financial condition and our results of
operations.




Our
Products




We
currently manufacture and sell the following types of products:




·       Synthetic
leather fabrics, which consist of ultrasuede and recycled leather flocked
fabric; and




·       Other
fabrics, which consist of microfiber towel and tufted fabrics.




The
following table provides a breakdown of the revenues generated by each of our
product types during the twelve months ended September 30, 2009 and 2010,
respectively, expressed in US dollars and as a percentage of total
revenues:




For the Year Ended September
      30,2009
                  
                  
                  2010$
                  
                  
                  %
                  
                  
                  $
                  
                  
                  %Synthetic
      Leather FabricUltrasuede
                  
                  $
                  8,616,807
                  
                  
                  
                  39.9
                  %
                  
                  $
                  9,201,596
                  
                  
                  
                  19.9
                  %Recycled
      leather flocked fabric
                  
                  
                  11,740,691
                  
                  
                  
                  54.3
                  %
                  
                  
                  34,209,667
                  
                  
                  
                  73.9
                  %Other
      FabricMicrofiber
      towel
                  
                  
                  408,354
                  
                  
                  
                  1.9
                  %
                  
                  
                  558,408
                  
                  
                  
                  1.2
                  %Tufted
      fabrics
                  
                  
                  115,866
                  
                  
                  
                  0.5
                  %
                  
                  
                  1,692,669
                  
                  
                  
                  3.7
                  %Other
      fabrics
                  
                  
                  730,823
                  
                  
                  
                  3.4
                  %
                  
                  
                  658,885
                  
                  
                  
                  1.3
                  %Total
                  
                  $
                  21,612,541
                  
                  
                  
                  100.0
                  %
                  
                  $
                  46,321,225
                  
                  
                  
                  100.0
                  %




Synthetic
Leather Fabric Products




We
currently produce the following types of synthetic leather fabric
products:




·
            Ultrasuede
      products, which consist of non-woven fabric embedded with tiny polyester
      fibers and which have a soft and lush surface resembling suede
      leather.




·
            Recycled
      leather flocked fabric products, which consist of fabrics that are flocked
      with recycled leather powder that improve the texture of the
      fabric.


28


Recycled
Leather Flocked Fabric Products




Leather
waste, functioning as the reinforcing filler, is flocked into the PU fabric to
create this thermoplastic polymer composite. The resulting fabric has better
tensile strength and the aesthetic appearance of genuine leather. The fabric is
a higher margin product and is more environmentally friendly than other purely
chemical-based products.




During
fiscal year 2009, we launched, and increased rapidly, the production and sales
of our recycled leather flocked fabric products, which consist of fabrics that are flocked with recycled leather powder that improve the texture of the fabric. We
continued this growth trend and expect this product to continue to grow in
fiscal year 2011. Our recycled leather flocked fabric products are higher margin
products and are more environmentally friendly than other purely chemical-based
products.




Compared
to chemical based synthetic leather, recycled leather has better vapor
permeability and a more comfortable handle because the leather powder contained
in these products has the same macrostructure and microstructure as natural
leather. Recycled leather is also more biodegradable and as a result is more
environmentally friendly.




Reconstituted
New Evergreen LZ Collagen Fiber Leather Products




We
manufacture Evergreen Products using a new leather processing technology which
utilizes genuine leather and its scraps to generate a new class of imitation
leather derived from natural fiber. The technology enables dissembling collagen
fibers and recomposing or weaving the collagen fiber bundles according to the
natural leather structure. These products are expected to be suitable for
applications in automotive textile, furniture, shoes, eco-fashion apparel,
radiation proof clothing and luggage and bags. We expect to initially sell these
new products to furniture manufacturers and to manufacturers of automobile
upholstery applications for environmentally clean vehicles that are being
developed for the Chinese market.




Compared
to genuine leather, the reconstituted leather of the Evergreen Products is
produced according to industrialized specifications in thickness and size, and
will therefore be homogenous and consistent in density. Thus, it may result in a
much lower cut scrap rate. Produced from leather waste, Evergreen Products will
have a compelling cost structure and value proposition as well as environmental
friendliness.




Compared
to chemical based synthetic leather, Evergreen Products do not contain any
adhesive. Rather, its mechanical properties are derived from collagen fiber.
Evergreen Products are resistant to fire, tearing and cracking, and have better
vapor permeability and handling. Evergreen Products are expected to be superior
to synthetic leathers because synthetic leathers imitate the surface appearance
of leather only, without achieving the leather quality.




We
recently completed the construction of our Evergreen Product facility and the
testing of the first production line in that facility. Evergreen Products are
manufactured from collagen fibers extracted from leather waste and reconstructed
into a fibrous web by an air laid system to form the fabric. We believe that our
process of collagen fiber extraction is innovative, as it involves a simple and
environmentally clean physical process. Samples of our new Evergreen Products
have been tested by Intertek Services, a global product testing, certification
and inspection company. Our products passed various measures related to product
safety and eco-friendliness. We anticipate launching large scale production of
the first Evergreen Product line in mid-February 2011.




We own
two patents and one pending patent application related to these new technologies
and have a long-term exclusive license to eighteen patents (including a Chinese
patent and seventeen international patents) and eight international patent
applications related to production technology that is critical to the
manufacture of the Evergreen Products. We believe that these patents
differentiate our new Evergreen Products as an environmentally friendly and
economical alternative to existing synthetic and genuine leather
fabrics.




Our
process of collagen fiber extraction is innovative as it involves a simple and
environmentally clean physical production process. We believe chemical processes
of fiber separation are more prevalent in the industry’s research and
development efforts and are inferior due to the negative environmental impact.
In addition, compared to leather powder, leather fiber can form fabric which
carries higher leather content and a closer look and feel to genuine leather in
the subsequent step.


29


Other
fabrics




We
currently produce the following types of other fabric products:




·
            Microfiber
      towel products, which consist of fine synthetic fibers that are woven into
      textiles whose texture and drape resemble that of natural fiber cloth
      materials. These products are more advantageous than natural fiber cloth
      materials because of their enhanced washability, breathability, and water
      repellency.




·
            Tufted
      fabrics, which consist of fabrics with elongated
  strands.




Our
Raw Materials and Supply




Raw
Materials




Our raw
materials consist primarily of leather waste and chemical fiber based materials,
including ultrasuede grey cloth, PU and resin.




Leather
Waste




For the
production of recycled leather flocked fabric, we mainly source the leather
waste formed after the tanning processing and prior to the coating process from
leather manufacturers. For the production of the Evergreen Products,
technically, we may use any form of leather waste sourced from either leather or
leather goods manufacturers.




The
leather waste which we recycle comes from a variety of sources, and our
suppliers include individuals and private enterprises in the PRC engaged in the
business of collecting leather waste and manufacturers of leather and leather
products.




Our
production facilities are strategically located in Tongxiang, Zhejiang Province,
which is in close proximity to many leather product manufacturers whose
production facilities are located in Tongxiang, Haining and Wenzhou, all of
which are situated in Zhejiang Province. Consequently, leather waste is readily
available to us in large supplies. Leather manufacturers prefer to recycle,
rather than dispose of, their leather waste because recycling is more
environmentally friendly and less costly to leather manufacturers.




Manufacturing
synthetic and imitation leather products from leather waste is a relatively new
development in our industry. In fiscal year 2009, we began manufacturing our
recycled leather flocked fabric products. The new Evergreen Products that we
intend to produce and sell on a large scale in 2011 is manufactured from
collagen fibers extracted from leather waste. Other products that we produce,
including ultrasuede and other fabric products, are purely synthetic and are not
produced from leather waste.




The
quality of products manufactured from leather waste is higher than pure chemical
fabrics. Consequently, consumers are willing to pay more for these products,
resulting in higher margins. In addition, the costs associated with the
manufacture of products manufactured from leather waste is significantly lower
than the costs associated with the manufacture of genuine leather products.
Furthermore, these products are considered more environmentally friendly because
they are manufactured from recycled leather waste.




Our
Supply Sources




Our
business depends on obtaining a reliable supply of the raw materials described
above. Because of the diversity of available sources of these raw materials, we
believe that our raw materials are in adequate supply and will continue to be so
in the future. We purchased almost all of our raw materials from Chinese
suppliers in the years ended September 30, 2009 and 2010, respectively. Other
than resin, which we procure from third party distributors, we generally procure
our raw materials directly from chemical or fabric manufacturers.




We
generally enter into non-exclusive contracts or purchase orders with suppliers
and do not have long-term agreements with them. We negotiate pricing with our
suppliers on an arm’s length basis prior to the delivery of these supplies to
us, based upon the prevailing market prices at such time. We generally make
payments to our suppliers within sixty days following the date of delivery. As
we increase the scale of our production, we may need to establish a more diverse
supplier network while attempting to continue to leverage our purchasing power
to obtain favorable pricing and delivery and payment terms.


30


During
the fiscal years ended September 30, 2009 and 2010, payments made to our five
largest suppliers accounted for 49.8% and 41.8% of our total cost of supplies,
respectively, and our single largest supplier accounted for 15.9% and 12.5% of
our total cost of supplies, respectively.




Our major
suppliers for the year ended September 30, 2009 included the
following:




Name
      of Supplier
                          
                          Total
                              purchases
                          
                          Percent
      of
                              cost
                              of
      suppliesHangzhou
      Yongsheng Haiyi Chemical Textile Co Ltd.
                          
                          $
                          2,447,327
                          
                          
                          15.9
                          %Hangzhou
      Huiweishi Yongsheng Textile Dying and Finishing Co Ltd.
                          
                          
                          1,717,104
                          
                          
                          11.2
                          %Zhejiang
      Huifeng Weaving Co Ltd.
                          
                          
                          1,277,333
                          
                          
                          8.3
                          %Jiashan
      Haifeng Textile Co Ltd.
                          
                          
                          1,189,913
                          
                          
                          7.7
                          %Shaoxing
      Libo Textile Co Ltd.
                          
                          
                          1,030,852
                          
                          
                          6.7
                          %




Our major
suppliers for the year ended September 30, 2010 included the
following:




Name
      of Supplier
                              
                              Total
                                  purchases
                              
                              
                              Percent
      of
                                  cost
                                  of
      suppliesZhejiang
      Huifeng Weaving Co Ltd.
                              
                              $
                              4,367,796
                              
                              
                              
                              12.5
                              %Hangzhou
      Yongsheng Haiyi Chemical Textile Co Ltd.
                              
                              
                              4,283,958
                              
                              
                              
                              12.2
                              %Kunshan
      Xiexing Textile Co. Ltd.
                              
                              
                              2,463,766
                              
                              
                              
                              7.0
                              %Hangzhou
      Huiweishi Yongsheng Textile Dying and Finishing Co Ltd.
                              
                              
                              2,173,431
                              
                              
                              
                              6.2
                              %Ningbo
      Guanxiong Fabric Co Ltd.
                              
                              
                              1,355,840
                              
                              
                              
                              3.9
                              %




Manufacturing




We
currently manufacture our products in our original facility, and we are in the
process of completing the construction of a new facility for the production of
our Evergreen Products, both of which are located in Tongxiang County, Zhejiang
Province, China.




Production
Process


The
manufacturing process of each of our products generally involves various steps,
including:




·
            Stamping,
      which is the process through which images are transferred to the fabric by
      means of a chemically treated transfer paper, combined with heat and
      pressure. Stamping is a more environmental friendly process than
      conventional printing.




·
            PU
      dry coating, which is the process through which images are coated onto the
      release paper by using non-water-soluble resin before being transferred to
      the fabric.


·
            Embossing,
      which is the process through which a design is heat-pressed onto the
      surface of the fabric to create a series of raised
  marks.




31




·
            Printing,
      which is the process that dyes the fabric with the engraved roller being
      pressed onto the fabric.




·
            Recycled
      leather powder electrostatic flocking. In this process, the embedded
      materials of leather powder flock, which is a powder that is produced from
      leather waste, are applied to the backing fabric as an adhesive
      layer.




·       Tufting,
which is the process that furnishes the fabric with a short cluster of elongated
strands.




The
technology and procedures used in the above processes vary amongst the different
products that we manufacture and depend upon the product specifications
prescribed by a particular customer. In addition, since our inception, our
production facilities have included recycling technologies to capture, treat and
recycle air, waste water and dimethyl formamide (DMF), which are produced during
the manufacturing process.




The
manufacturing process of our new Evergreen Products will involve various steps,
including the formation of collagen fiber from leather waste and the
construction of the fiber into web in order to form fabric.




We have
acquired three Chinese patents, and have entered into an exclusive 15-year
licensing agreement for the rights to a fourth Chinese patent, as well as
seventeen international patents and eight patent applications to protect our
rights to the technologies used in the production of our new Evergreen
Products.




Quality
Control




Consistent
with our continuing commitment to quality, we impose rigorous quality control
standards at various stages in the production process. Since May 2010, our
facility has maintained the following certifications:




·
            ISO9001:2008
      certification in quality management systems granted by the China Quality
      Mark Certification Group, a comprehensive certification and training body
      providing certification, training and other conformity assessment;
      and


·
            ISO14001:2004
      certification in environmental management granted by the International
      Certification Network (IQNet and CQM), an organization dedicated to the
      creation of standards and offers certification services around the world,
      with respect to the design and production of synthetic sofa fabrics,
      genuine flocked leather and stamping fabrics and the production of tufted
      fabrics, as well as related management activities;
  and




We have
also been certified by the International Organization of Standardization. In
addition, we set our own production standards based on certain international
industry standards, including the American Four-Point Standards, and the
National Light Diesel Standard. In addition, we strictly comply with various PRC
national quality standards with respect to the manufacture of furniture leather,
PU dry coating process for artificial leather, and the national general safety
technical code for textile products, all of which have been established by the
General Administration of Quality Supervision, Inspection and Quarantine of
China.




Facilities




Historically,
we manufactured all of our products in our original Tongxiang County facility,
for which we have been granted land use rights. From time to time our building
and land use rights are pledged as collateral for short-term bank loans. We have
land use rights for our original facility, an aggregate of 26,290 square meters
of land. We also have land use rights for a second facility, an aggregate of
17,200 square meters of land. The construction of this second facility was
completed in January 2011 and we use it as our Evergreen Product facility. In
addition, since December 2010, we have been leasing an additional property near
the two facilities that we own in order to accommodate our current and
planned growth. The monthly rent pursuant to the lease agreement is
approximately $46,723 and the term of this agreement expires in November 2020.
We use our facilities for the following functions: executive and administrative
space, production and research and development and living quarters.




The
operations at our original facility commenced in November 2007. At that time,
the designed capacity for our facility produced 12 million meters of materials
annually. We gradually increased our utilization over time.


32


Our
short-term goal is to increase the production and sales of our new Evergreen
Products in our newly constructed facility and to achieve production capacity of
6.4 million meters of fabric during the year ending September 30, 2011. Our
long-term goal is to achieve production capacity of 12.8 million meters of
fabric during the year ending September 30, 2012.




The
following table provides information about (1) our original facility, in which
we manufacture our existing products, (2) the Evergreen Product production line
(production line 1) which we have installed in our newly constructed Evergreen
Product facility, (3) the installation of an Evergreen Product production line
(production line 2) in our Evergreen Product facility and (4) future plans for
the installation of two additional production lines (production lines 3 and 4)
in our Evergreen Product facility.




Original
      Facility
              
              Evergreen
      Production
                  Facility(2)
              
              CombinedLocation
              Tongxiang,
      Zhejiang
              
              Tongxiang,
      Zhejiang
              
              
              —Product
      Type
              Existing
      Products
              
              Evergreen
      Products
              
              
              —Construction
      began
              December
      2005
              
              January
      2010
              
              
              —Construction
      completed
              July
      2007
              
              January
      2011
              
              
              —Mass
      production began / Production expected to begin
              November
      2007
              
              February
      2011
              
              
              —Capacity
      / Expected Capacity at:(1)September
      30, 2009 (actual) (Meters)
              15,000,000
              
              —
              
              
              15,000,000September
      30, 2010 (actual) (Meters)
              15,000,000
              
              —
              
              
              15,000,000September
      30, 2011 (expected) (Meters)
              15,000,000
              
              6,400,000
              
              
              21,400,000September
      30, 2012 (expected) (Meters)
              15,000,000
              
              12,800,000
              
              
              27,800,000Manufacturing
      Space (Sq M)(3)
              30,000
              
              30,000
              
              
              60,000Site
      Area (Sq M)(4)
              26,290
              
              17,200
              
              
              43,490




(1)
            Capacity
      refers to the maximum annual amount that we can concurrently produce with
      respect to our key production processes when we operate at full production
      and our standard fabric products are generally at the width of
      140cm.




(2)
            Each
      Evergreen Product production line is expected to have an annual production
      capacity of 3.2 million meters.




(3)
            Manufacturing
      space refers to the number of square meters of floor space, including
      floor space on multiple stories, that we use to manufacture our
      products.




(4)
            Site
      area refers to the number of square meters of land on which the facility
      is located.




In the
event that we encounter difficulties in, or failures with respect to, the
manufacture or sale of our Evergreen Products, the development of a new
nationwide distribution network or the installation of machinery and personnel,
our business and financial condition may be materially and adversely affected.
Further, even if we do not encounter such difficulties, our customers may not be
satisfied with our Evergreen Products or a market for the Evergreen Products may
never develop. Any such difficulties or failures could result in financial
losses that could have a material adverse effect on our business, cause the
price of our ordinary shares to decline and delay or prevent the production or
sale of our new Evergreen Products.


33


Equipment
Suppliers




Our
production facilities use innovative equipment and machinery manufactured by
international and domestic equipment vendors. We seek to ensure the quality of
our equipment and machinery, and safeguard our technical know-how, by utilizing
a small number of equipment vendors. Our management team has had long-term
business relationships with many of these equipment vendors and we are satisfied
with the quality of their equipment.




In June
2008, one of our largest customers provided us with tufting equipment valued at
approximately $1.3 million in exchange for a two-year supply agreement for our
products. Pursuant to this agreement, we agreed not to sell tufted fabrics to
any other customers in the United States until March 2011.




Our
Customers




We sell
domestically in China and we export to distributors and manufacturers in the US
and other foreign countries. Our products are sold directly or indirectly to
manufacturers of garments, such as synthetic shoes, furniture, such as synthetic
couches, and automobile upholstery, such as synthetic car seats. Our goal is to
penetrate the apparel industry, particularly manufacturers of hand bags and
luggage, in the near future. Our domestic customers are generally furniture and
garment manufacturers. Approximately 22.9% of the revenues that we generated in
fiscal year 2010 were generated by sales to distributors, or resellers, located
outside of China that sell our products to fabric manufacturers and the
remaining 77.1% were generated by sales to manufacturers and resellers located
in China. Some of our domestic customers manufacture furniture or upholstery
fabric in China and then export their products to the United States and other
international markets.




The
following table sets forth the percentage of revenues generated from sales to
our domestic Chinese and export customers for the periods
indicated:




For
      the year ended
                    September
      30,2010
                
                2009Domestic
      Chinese customers
                
                
                77.1
                %
                
                
                62.7
                %Export
      customers
                
                
                22.9
                %
                
                
                37.3
                %




According
to the OCN report, in recent years, production of synthetic leather fabric,
microfiber and tufted fabric products in the US and other developed countries
has declined. This decline has been attributed to the increasing labor costs and
operational costs incurred in the manufacture of these products in these
countries. Consequently, manufacturers in these countries are relying more on
imported synthetic leather fabric products. In an attempt to take advantage of
this trend, we have broadened our customer base over time, both in the PRC, and,
more notably, in the international markets.




We
generally obtain sales orders from customers three to four weeks in advance of
delivery. The total sales volume, pricing, product specifications, delivery
schedule and method of delivery are provided in these sales orders. Generally,
our customers are required to pay us on 60 to 90 day credit terms, depending on
our business relationship with the customer, the customer’s credit history and
prevailing market conditions.




We
usually enter into non-exclusive contracts or purchase orders with customers and
do not have long-term agreements with them.




Our
production facilities are strategically located in Tongxiang, Zhejiang Province,
which is in close proximity to many leather product manufacturers whose
production facilities are located in Tongxiang, Haining and Wenzhou, all of
which are situated in Zhejiang Province. The majority of our domestic customers
are located in these regions. For our domestic customers, we ship our products
directly from our production facilities to the customers’ manufacturing
facilities or, in the case of customers that distribute our products to
manufacturers, to the customers’ distribution facilities. For our export
customers, we ship our goods on the Free On Board (FOB) term from major ports in
China to the customers’ respective destinations.


34


During
the fiscal years ended September 30, 2009 and 2010, sales made to our five
largest customers accounted for 74.9% and 79.1% of our total sales,
respectively, and our two largest customers accounted for 32.6% and 28.2% of our
total sales during fiscal year 2009, respectively, and our three largest
customers accounted for 30.4%, 17.3% and 15.6% of our total sales during fiscal
year 2010, respectively.




Sales
and Marketing




We seek
to expand our customer base by:




·       direct
sales communications with our largest customers;




·       sales
through distributors to new customer bases;




·       referrals
from existing customers; and




·       participation
in domestic and international trade shows and conferences.




Historically,
we have not spent a significant amount of capital on advertising.




We have
an internal sales team of 12 employees located in our Tongxiang facility. Our
sales personnel regularly contact our customers and visit them in person to
obtain feedback on our products, to gather additional relevant market
information and to build long-term relationships with our existing
customers.




Our
long-term plan is to increase our marketing and distribution activities for our
synthetic and imitation leather fabrics and other fabrics, as well as to
increase public awareness of recycled leather as an eco-friendly alternative to
chemical fiber-based and leather fabrics using various methods, including
advertising and media outlets. In the near future, as we expand our customer
base to include manufacturers of apparel, we intend to hire additional sales
representatives to market our fabric to this customer base.




For the
Evergreen Products, we have entered into a letter of intent that contemplates an
exclusive sales agency relationship with one of our largest customers for the
launch and distribution of this new product in the North America market. We have
also entered into a letter of intent with other potential customers to
distribute the Evergreen Products for automotive and upholstery applications. We
expect to initially focus on furniture applications and automotive upholstery
applications in clean vehicles developed for the Chinese market. We plan to
develop a nationwide distribution network comprising external sales agents in
all major provinces in the PRC to expand the customer base of our new Evergreen
Products beyond the local regions into which we currently sell our existing
products.




Hongzhan
has entered into purchase orders with five customers, each located in the PRC,
for the sale of our Evergreen Products.  We renegotiated the term of
these purchase orders because the commencement of the production of our
Evergreen Products has been delayed until mid-February.  As a result,
Hongzhan agreed to sell an aggregate of 2.9 million meters of materials for an
aggregate purchase price of approximately $32.5 million between March 2011 and
February 2012, subject to the customers’ inspection of, and satisfaction with,
the quality of the materials and other customary conditions. See the risk factor
entitled “Our customers may decide to discontinue purchasing our products, which
could materially and adversely affect our growth and our revenues” above
regarding some of the material risks inherent in these
arrangements.




Research
and Development Activities




We have
15 full-time professionals in our research and development division that have
developed innovative technology that is instrumental in controlling our
production costs, increasing our operational efficiency and enhancing our
ability to develop eco-friendly production processes. Our combination
proprietary production technology enables us to use lower-cost materials,
including leather waste, in place of the higher-value and non-recyclable
chemical fiber based materials.




One of
our key employees, Mr. Liwen Zhang, who is also a minority shareholder of our
Hongzhan operating subsidiary, is the original owner of four Chinese patents,
seventeen international patents and eight international patent applications
related to technologies utilized in the manufacture of our Evergreen Products.
Three of the Chinese patents have been transferred to us and the remaining
patents and patent applications, all of which are related to the technologies
that are critical to the production of the Evergreen Products, have been
licensed to us for our exclusive use until 2024. Mr. Zhang has managed the
research and development process on these patents and related production
technologies since 2003. Mr. Zhang and four other researchers joined our company
in February 2010.


35


We plan
to continue our research and development efforts to strengthen our leading
position in our industry. For example, we are currently developing nylon
taffeta, a new PU leather material that is used for apparel manufacturing
purposes.




We will
focus our research and development efforts primarily on our new Evergreen
Products going forward. We entered into a three-year joint research and
development agreement with Sichuang University in China, under which we will
establish a genuine leather fiber research lab to focus on developing the
applications and products for our Evergreen Products. All research results that
are jointly developed pursuant to this relationship will belong to both parties.
We will have the exclusive right to produce, sell and export products based on
these results. However, we will be obligated to pay a percentage of any sales of
any of these products to Sichuang University.




Intellectual
Property




General




We rely
on a combination of patents, trademarks, trade secrets and confidentiality
agreements to protect our intellectual property rights. Our manufacturing
processes are based on technology developed primarily in-house by our research
and development and engineering personnel.




With
respect to proprietary know-how that is not patentable and processes for which
patents are difficult to enforce, we rely on, among other things, trade secret
protection and confidentiality agreements to safeguard our interests. All of our
research and development personnel have entered into confidentiality and
proprietary information agreements with us. These agreements address
intellectual property protection issues and require our associates to assign to
us all of the inventions, designs and technologies they develop during the
course of employment with us. We are not aware of any material infringement of
our intellectual property rights.




Patents
— Ownership Rights




We
currently own five design patents and three new utility model patents relating
to our existing products, seven of which were acquired from Mr. Jianfeng Liu,
who is our Chairman, President and Chief Executive Officer, and one pending
patent application.




Actual
examination times for design patent applications in China vary, but examinations
of patents similar to those currently under examination have taken approximately
one year. The following table describes the patents and patent applications
relating to our existing products:




Description
            
            Type
            
            Registration
            
            Grant
      Date
            
            Expiration
                Date1
            
            Fabric
            
            Design
            
            ZL
      2006 3 0105432.5
            
            2007.2.7
            
            2016.3.92
            
            Fabric
            
            Design
            
            ZL
      2006 3 0105433.X
            
            2007.2.7
            
            2016.3.93
            
            Fabric
            
            Design
            
            ZL
      2006 3 0105434.4
            
            2007.2.7
            
            2016.3.94
            
            Fabric
            
            Design
            
            ZL
      2006 3 0105435.9
            
            2007.2.7
            
            2016.3.95
            
            Fabric
            
            Design
            
            ZL
      2006 3 0105436.3
            
            2007.2.7
            
            2016.3.96
            
            Fabric
            
            New
      Utility Model
            
            ZL
      2009 2 0116292.X
            
            2010.1.13
            
            2019.3.247
            
            Ultrasoft
      * fabric
            
            New
      Utility Model
            
            ZL200820162614.X
            
            2009.5.20
            
            2018.8.78
            
            Synthetic
      leather with leather fiber
            
            New
      Utility Model
            
            ZL200920116291.5
            
            2010.3.31
            
            2019.3.24


36




Patents
      Under Application
              
              Type
              
              Application
      Number
              
              Application
                  Date1
              
              Recycled
      leather powder electrostatic flocking and the process
    thereof
              
              Invention
              
              2008100634571
              
              2008.8.7




In
February 2010, we acquired a five-person research and development team led by
Liwen Zhang, as well as ownership rights to the following two Chinese invention
patents and one patent application which had been granted to Liwen Zhang,
relating to the production of the new Evergreen Products:




Description
              
              Type
              
              Registration
              
              Grant
      Date
              
              Expiration
                  Date1
              
              A
      Liquid Opener
              
              Invention
              
              200610035347.5
              
              2007.10.31
              
              2026.4.302
              
              Collagen
      Fiber Synthetic Leather Substrate and process thereof
              
              Invention
              
              200410097268.8
              
              2006.5.31
              
              2024.11.20




Patents
      Under Application
              
              Type
              
              Application
      Number
              
              Application
                  Date1
              
              A
      spun lace fabric and process method thereof
              
              Invention
              
              200710003092.9
              
              2007.1.31




In
September 2010 we submitted an application to obtain the following invention
patent in the PRC pursuant to the Patent Cooperation Treaty, related to the
process of our Evergreen Products:




Patents
      Under Application
              
              Type
              
              Application
      Number
              
              Application
                  Date1
              
              Recycled
      leather and the composition process method thereof
              
              Invention
              
              PCT/CN2010/077501
              
              2010.9.30




Patents
— Licensing Rights




Presently,
natural fiber sources are limited by nature, with natural fibers having high
cost and relatively low abrasion resistance and tensile strength. On the other
hand, synthetic fibers are poor water-absorbents, flame-retardants, and provide
only low comfort.




The
Licensed Patents are directed to an invention to provide a yarn of collagen
fiber of animal leather, and a manufacturing process thereof in that yarn is
manufactured by using animal skins or leathers and leftover materials thereof as
well as wasted leathers. The present invention provides for the textile industry
a yarn having higher tensile strength and better resistance to abrasion than
those of the natural fiber yarns, and having higher water absorption, greater
comfort, and better flame-retardant properties than those of synthetic fiber
yarns. This technology that is most essential to the front-end manufacturing
process of our Evergreen Products has been patented in eighteen countries,
including China, Canada, South Africa, Germany and the United Kingdom.
Applications for patent protection with respect to this key technology have also
been submitted in eight other countries, including the United States. The
Licensed Patents have been licensed to us exclusively until 2024. See Item 7
below.




The
Licensed Patents are intended to protect the technologies, including machinery
and processes, developed by Liwen Zhang’s team, to produce collagen fiber from
animal leather, which is the most essential front-end manufacturing process in
the production of our new Evergreen Products. We believe that the patents that
we own and the Licensed Patents differentiate our new Evergreen Products as an
environmentally friendly and economical alternative to existing synthetic and
genuine leather fabrics.


37


Trademarks




We
currently use the registered trademark “Illigate”.




We are in
the process of obtaining the trademark “Evergreen LZ” for our new Evergreen
Products.




Competition




We
believe that the principal competitive factors needed to compete in the
synthetic fabric industry in China are as follows:




·
            Cost control and
      pricing. Manufacturers must have the ability to control the costs
      of raw materials and other operational expenses in order to control the
      pricing of their products. Consequently, manufacturers must have the
      ability to use economies of scale to secure competitive pricing from
      suppliers of raw materials.




·
            Technology.
      Manufacturers must have the ability to install eco-friendly technology
      that allows them to produce their fabrics from low-cost raw materials such
      as leather waste.




·
            Barriers to entry.
      Manufacturers must have the technical knowledge, local market knowledge
      and established relationships with suppliers and customers to support the
      development of new products and the growth of commercially viable
      production facilities.




·
            Logistics and services.
      A manufacturer’s ability to compete is dependent upon the geographic
      location of its production facilities in relation to the manufacturing
      facilities of customers and suppliers, and the ability to manage the
      logistics and delivery of its
products.




The
synthetic fabric industry in China is very large and fragmented. Our ability to
compete against other national and international enterprises is, to a
significant extent, dependent on our ability to distinguish our products from
those of our competitors by providing large volumes of high quality products
that appeal to consumers’ preferences at competitive prices. Our local
competitors generally consist of small-scale manufacturers, many of whom develop
a range of finishing processes which is not as broad as ours and utilize
production technology which is not as advanced as some of our patented
technology. Some of our competitors have been in business longer than we have
and are more established. Our competitors may provide products comparable or
superior to those we provide, and our competitors may adapt more quickly than we
do to evolving industry trends or changing market requirements.




China
represents a potentially lucrative market for international competitors, many of
whom may seek to enter the PRC market in the future. However, to date, potential
international competitors have purchased products from domestic Chinese
manufacturers such as ours and have little or no presence of their own in the
PRC market.




Insurance




We
maintain various insurance policies to safeguard against risks and unexpected
events. We provide social security insurance, including pension insurance,
unemployment insurance, work related injury insurance, maternity insurance and
medical insurance to approximately 26.6% of our employees, in accordance with
PRC regulations. We also maintain insurance for our plants, machinery,
equipment, inventories and motor vehicles. However, we do not maintain product
liability insurance for our products.




Governmental
Regulations




Environmental
Matters




Our
manufacturing facilities are subject to various pollution control regulations
with respect to noise, water and air pollution and the disposal of waste and
hazardous materials. We are also subject to periodic inspections by local
environmental protection authorities.


38


The major
environmental regulations applicable to us include:




·       the
Environmental Protection Law of the PRC;




·       the
Law of PRC on the Prevention and Control of Water Pollution;




·       Implementation
Rules of the Law of PRC on the Prevention and Control of Water
Pollution;




·       the
Law of PRC on the Prevention and Control of Air Pollution;




·       Implementation
Rules of the Law of PRC on the Prevention and Control of Air
Pollution;




·       the
Law of PRC on the Prevention and Control of Solid Waste Pollution;
and




·       the
Law of PRC on the Prevention and Control of Noise Pollution.




We are
periodically inspected by local environmental protection authorities. Our
operating subsidiaries have received certifications from the relevant PRC
government agencies in charge of environmental protection indicating that their
business operations are in material compliance with the relevant PRC
environmental laws and regulations. We are not currently subject to any pending
actions alleging any violations of applicable PRC environmental laws. To date,
the Company’s cost of compliance has been insignificant. The Company does not
believe the existence of these environmental laws, as currently written and
interpreted, will materially hinder or adversely affect the Company’s business
operations; however, there can be no assurances of future events or changes in
laws, or the interpretation of laws, governing our industry.




The
Chinese authorities have recently mandated a significant reduction of energy
usage in an effort to meet the targets for energy consumption and emissions set
by the 11th Five Year Plan, which plan concludes on December 31, 2010. As a
result, we were instructed by local government officials in mid-November that we
will be restricted from using electrical power in our original facility for
approximately eight days during the remainder of November 2010, although our new
Evergreen Product facility will be unaffected because it has been designated as
a priority project by the local government. In response to this policy, we have
obtained a power generator to provide us with the energy needed to run our
original facility when electrical power is restricted. If this power generator
is unable to generate sufficient energy for our facility when electrical power
is restricted, the results of our operations would be affected during that time.
It is currently unclear whether the electrical power restriction will be in
place during December 2010. In addition, while we believe that the current
restrictions will be eliminated with the implementation of China’s 12th Five
Year Plan on January 1, 2011, additional energy use restrictions could be
imposed in the future. Any additional restrictions could adversely impact our
results of operations in future periods.




Circular
75 Compliance and Approval




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. 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.


39


To date,
the required filings pursuant to SAFE Rules are underway for shareholders of
Lizhan Environmental. Mr. Liu has completed his SAFE filing procedure. 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. It is our understanding that these
shareholders are in the process of making the required filings. 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.




4C.  Organizational
Structure




See
“—History and Development of the Company” above in subsection A of Item 4 for a
description of our organizational structure.




4D.  Property,
Plants and Equipment




Lizhan
Textile owns 3 factory buildings with total area of 18,967 square meters; 1
office building with total area of 2,568 square meters; 1 staff dormitory and
canteen buildingof4,632
square meters. The above-mentioned properties were put into service since 2007.
The comprehensive design production capacity of the existing production lines
for Lizhan Textile is 15 million meters. Our annual production output has
reached 14.8 million meters, or 99% of the production capacity. Our production
capacity could be increased to 17 million meters to meet market demands under
current conditions without additional capital investment and without extending
the working hours of the equipment. For the production of Evergreen products,
Hongzhan has 3 factory buildings with a total area of 30,000 square meters. In
addition, our newly leased facility has a total area of 32,301 square
meters, including 10,800 square meters for the buildings
located at the facility.




ITEM
      4A.
            UNRESOLVED
      STAFF COMMENTS




Not
Applicable




ITEM
      5.
            OPERATING
      AND FINANCIAL REVIEW AND PROSPECTS




The
following discussion and analysis should be read in conjunction with our
consolidated financial statements, the notes to those financial statements and
other financial data that appear elsewhere in this annual report. In addition to
historical information, the following discussion contains forward-looking
statements based on current expectations that involve risks and uncertainties.
Actual results and the timing of certain events may differ significantly from
those projected in such forward-looking statements due to a number of factors,
including those set forth in “Risk Factors” and elsewhere in this report. Our
consolidated financial statements are prepared in conformity with U.S.
GAAP.




5A.  Operating
Results




Overview




General




Lizhan
Environmental Corporation is an innovative green materials manufacturer that
designs high quality recycled leather and synthetic leather in China. Our
products are utilized worldwide in industries such as furniture, automotive
upholstery and other consumer goods. Lizhan owns and exclusively licenses a
broad range of patents for its recycled leather products and its other synthetic
leather products. Our soon to be marketed Evergreen Products have been patented
in eighteen countries, including China, Canada, South Africa, Germany and the
United Kingdom.  Our production facilities are strategically located
in Tongxiang, Zhejiang Province, which is in close proximity to many leather
product manufacturers whose production facilities are located in Tongxiang,
Haining and Wenzhou, all of which are situated in Zhejiang Province, which
collectively are considered as one of the most important leather industry
clusters in China. We believe that we are one of only a few Chinese synthetic
fabric manufacturers that own an extensive range of finishing processes to
manufacture synthetic leather and other fabrics, ranging from products which are
manufactured entirely from chemical-based materials, such as our microfiber
fabrics, to products such as recycled leather flocked fabric, which are
flocked with recycled genuine leather
waste. Recycled leather flocked fabric products accounted for approximately
73.9% of our revenue in the year ended September 30, 2010.




40


Our
business depends on obtaining a reliable supply of various raw materials,
including leather waste, ultrasuede grey cloth, polyurethane, which we also
refer to as PU, backing fabric, and resin. Because of the diversity of available
sources of these raw materials, we believe that our raw materials are in
adequate supply and will continue to be so in the future. To minimize purchasing
costs, we use fewer than five primary suppliers for each of our raw materials.
However, as we expand our operations and require greater supplies of leather
waste products, we may not be able to procure a sufficient supply of these
materials at a competitive price, which could have an adverse effect on our
results of operations, financial condition and cash flows.




Our
products are used in various consumer applications, as we sell our products to
furniture, automotive upholstery and garment manufacturers, as well as fabric
distributors. We sell domestically in China and export to the US and other
countries, including Nicaragua, Germany and Belgium. During the twelve months
ended September 2010 and 2009, approximately 22.9% and 37.3% of our revenues,
respectively, were generated from export sales. The solid reputation that our
management team has developed over the past ten years in the synthetic leather
industry in China, including an established track record for consistently
providing quality products at competitive prices, has enabled us to develop and
expand our customer base. However, our company has a limited operating history
and you will have a limited basis on which to evaluate our ability to achieve
our business objectives. In addition, we expect our future growth to place
significant demands on our management and resources.




We have
experienced substantial growth since we launched our commercial production in
November 2007. Our aggregate annual production capacity was 15 million meters as
of September 30, 2010. We produced and sold approximately 8.0 million and 14.0
million meters of fabric during the twelve months ended September 30, 2009 and
2010, respectively. Our revenues and net income increased substantially during
these periods. Specifically, we generated revenues of $21.6 million and $46.3
million and achieved net income of $2.7 million and $8.2 million during the
twelve months ended September 30, 2009 and 2010, respectively. We believe that
the growth which we have achieved reflects our success in addressing customer
needs, strategically expanding our production lines, increasing market
penetration and enhancing the quality of our products.




We
recently completed the testing of the first of our Evergreen Product production
lines and expect to begin mass production in mid-February. In addition, we plan
to launch mass production of the second of our Evergreen Product production
lines by May 2011, provided that there is sufficient demand for our Evergreen
Products at that time. We plan to begin installing production lines 3 and 4 in
fiscal year 2011 and to utilize these production lines for production of
Evergreen Products beginning in November 2011 and April 2012, respectively,
provided that there is sufficient demand for our Evergreen Products at that
time. To accommodate this increase in production, we will require additional
capital to meet a significant portion of our anticipated growing working capital
requirements. The capital that we recently raised in our initial public offering
is insufficient to meet our capital needs, and there can be no assurance that
additional financing will be available in amounts or on terms acceptable to us,
if at all.




According
to a 2009 report issued by the China Investment Consulting Company (the OCN
Report), in recent years, production of synthetic fabric in developed countries
has declined. This decline has been attributed to the increasing labor costs and
operational costs incurred in the manufacture of these products in these
countries. Consequently, manufacturers in these countries are relying more on
imported synthetic leather fabric products. In an attempt to take advantage of
this trend, we have broadened our customer base over time, both in the PRC and
in the international markets. Compared to the year ended September 30, 2009,
sales to domestic PRC customers and to international customers increased by
approximately 163.6% from $13.6 million to $35.7 million and by 31.5% from $8.1
million to $10.6 million, respectively, during the years ended September 30,
2009 and 2010.




We
believe that we have been able to harness our technology and know-how to develop
a distinct competitive advantage by recycling leather waste to produce eco green
fabrics which are more similar to genuine leather in quality than our existing
products, at lower production costs than genuine leather products.
Specifically:




·
            We
      use innovative production technology, for which we have filed an invention
      patent application in the PRC, to manufacture recycled leather flocked
      fabric products. We have been selling these products since fiscal year
      2009, and these products accounted for approximately 73.9% of our revenue
      in the year ended September 30,
2010.




·
            We
      own and lease innovative patented production technologies that we use to
      manufacture new Evergreen Products. We believe these technologies will
      enable us to generate imitation leather products that look and feel more
      similar to genuine leather. We expect to initially sell these new products
      to furniture manufacturers and to manufacturers of automotive upholstery
      applications for environmentally clean vehicles that are being developed
      for the Chinese market.


41


We
believe that the Evergreen Products, which are environmentally friendly, will
generate higher margins than our existing products, as a result of higher sales
prices without a proportionate increase in cost of sales. Based on our market
feasibility study and discussions with long-term customers who have entered into
market co-development agreements with us, we believe that we may be able to sell
our Evergreen Products at approximately two to three times the average selling
price of our existing products. However, outside of research and development
testing, we have never produced or sold any Evergreen Product and there is no
assurance that we will be successful in developing and selling these products or
in growing this line of business.




Important
Factors Affecting our Results of Operations




We
believe that the significant factors that affect our financial condition and
results of operations are as follows:




·
            Expansion of our production
      capacity and increase of production volume. Our revenues largely
      depend on our production capacity and production volume. The operations at
      our original facility commenced in November 2007 and have expanded over
      time. As of September 30, 2010, our original facility had the design
      capacity to produce 15 million meters of fabrics annually. We produced and
      sold approximately 8.0 million and 14.0 million meters of fabric during
      the twelve months ended September 30, 2009 and 2010, respectively. Our
      revenues and net income increased substantially during the past period.
      Specifically, we generated revenues of $21.6 million and $46.3 million,
      and achieved net income of $2.7 million and $8.2 million during the twelve
      months ended September 30, 2009 and 2010, respectively. We recently
      completed the construction of our Evergreen Products facility and intend
      to begin mass production using the first Evergreen Product production line
      in mid-February.




·
            Introduction of new
      products. In fiscal year 2009, we launched the production and sales
      of our recycled leather flocked fabric products which are flocked withleather waste. We have
      seen a rapid increase in the demand of this product from our customers,
      and anticipate that this product will continue expanding and account for
      an increasingly significant percentage of our total revenues in fiscal
      year 2010. During fiscal year 2009 and the year ended September 30, 2010,
      this product accounted for 54.3% and 73.9% of total revenue, respectively.
      In addition, as we have gotten more experienced in the production and
      sales of this product, our gross margin has increased as a result of
      higher average selling price and better production yield. During fiscal
      year 2009 and the year ended September 30, 2010, our gross margin for this
      product was 19% and 28%,
respectively.




·
            Product mix and effect on
      gross margin. Our gross margin in any given period will be directly
      impacted by our product mix. We believe that we are one of only a few
      Chinese synthetic fabric manufacturers that own an extensive range of
      finishing processes to manufacture synthetic leather and other fabrics,
      ranging from purely chemical-based products, such as our microfiber
      fabrics, to products such as recycled leather flocked fabric, which are
      flocked with recycled genuine leather. We manufacture products based on
      customer orders. Order may have unique specifications and may vary on
      selling prices, production costs and gross margins. Our selling price and
      gross margin may decline if our competitors lower their prices and we
      respond by reducing prices to compete more effectively. Alternatively, we
      may increase our selling price and gross margin when we introduce new or
      enhanced products or when there are products which few manufacturers can
      produce. As a result, new products, such as recycled leather flocked
      material, generally generate higher selling prices and profit margins. We
      expect our new Evergreen Products will generate even higher selling prices
      and profit margins. Mature products such as ultrasuede generate lower
      selling prices and gross margins. Our increased revenue exposure from new
      products will lead to higher overall gross margin. During the years ended
      September 30, 2009 and 2010, our gross margin was 17.3% and 24.3%,
      respectively. The gross margin increased during fiscal 2010 mainly as a
      result of the higher proportion of recycled leather products
      sold.


42


·
            Raw materials prices.
      Raw material is the most important aspect of our production cost. During
      fiscal years 2009 and 2010, direct material costs accounted for
      approximately 88% and 91% of our total cost of sales, respectively. As a
      result, price fluctuations in raw materials impact our gross profits and
      results of operations. Our production requires substantial quantities of
      various raw materials. The market for certain of our principal raw
      materials, in particular PU base and microfiber cloth, may fluctuate over
      time based on market conditions. For instance, the cost of our raw
      materials increased significantly during the three months ended December
      31, 2010 and this trend may continue in the near future unless the PRC
      government is successful in implementing measures to slow recent increases
      in inflation. In addition, we outsource when we foresee capacity
      constraint or on certain processes which are required by the customers
      that we don’t yet handle in-house. Our material costs increase as we
      increase the level of outsourcing. During a period of volatile material
      costs, it is industry practice for manufacturers to place advanced orders
      with a committed quantity and price to ensure an ample supply of raw
      materials within an expected pricing range, and to pass onto customers a
      portion of the cost fluctuations, which practice we have adopted. We
      account for inventory for raw materials at cost and any adjustment
      required to value inventory at the lower of cost or market is made at the
      year-end and not at interim periods. However, because we keep inventory on
      hand for relatively short periods of time, we believe that differences
      between cost and market are not
significant.




·
            Adequate supply of raw
      materials. Many of our current suppliers have longstanding
      relationships with us. These long-standing supplier relationships provide
      us with a competitive advantage in China. Many of our current suppliers
      are located in Zhejiang Province, PRC, in close proximity to our
      facilities. We also purchase leather waste, which is a lower cost
      material, in bulk quantities from leather manufacturers. To date, we have
      been able to obtain these products in sufficient amounts and at
      competitive prices. During the year ended September 30, 2010, we procured
      raw materials from over 100 suppliers overall. During the year ended
      September 30, 2010, our largest supplier accounted for 12.5% of our total
      raw material purchases, and our top five largest suppliers accounted for
      41.8% of our total raw material purchases
  collectively.




Seasonality




Our
production and sales slow considerably during and around the Chinese New Year,
which usually occurs during the quarter ended March 31, as a result of the
closing of our facilities and the facilities of many of our customers for the
New Year’s celebration, as well as the shutting down of our steamers for an
annual inspection by local authorities. In addition, our sales volume declines
during summer due to the slow demand from the international markets while
consumer spending is generally slower for furniture and
garments.  Consequently, our results of operations may fluctuate from
quarter to quarter.  In addition, any significantdecrease
in sales during the remainder of the year would have a material adverse effect
on our business, our financial condition and our results of
operations.




Taxation




Under the
current laws of the Cayman Islands, we are not subject to any income or capital
gains tax, and any dividend payments we may make are not subject to any
withholding. Under the prevailing laws of Hong Kong, there is no tax on capital
gains and dividend payments by our Hong Kong subsidiary are not subject to any
withholding tax. Hong Kong profits tax will only apply if our Hong Kong
subsidiary carries on business in Hong Kong and derives a Hong Kong sourced
profit from such business. Our operating subsidiaries in the PRC are subject to
the PRC enterprise income tax, or EIT. Each of our operating subsidiaries files
its own separate tax return on a calendar year basis.




According
to the relevant laws and regulations in the PRC, foreign invested enterprises
established prior to January 1, 2008 were entitled to full exemption from income
tax for two years beginning from the first year when the enterprises become
profitable and have accumulative profits, and a 50% income tax reduction for the
subsequent three years. Lizhan Textile was entitled to the EIT exemption in the
company fiscal years ended September 30, 2008 and 2009, and is subject to 50%
income tax reduction during the period from January 1, 2010 to September 30,
2012. Hongzhan is subject to a uniformed tax rate of 25% beginning in
2010.


43


Set out
in the following table are the EIT rates for our two PRC Operating Companies
from 2008 to 2013:




2008
                
                
                2009
                
                
                2010
                
                
                2011
                
                
                2012
                
                
                2013Lizhan
      Textile
                
                
                —
                
                
                
                —
                
                
                
                12.5
                %
                
                
                12.5
                %
                
                
                12.5
                %
                
                
                25
                %Hongzhan
                
                
                —
                
                
                
                —
                
                
                
                25
                %
                
                
                25
                %
                
                
                25
                %
                
                
                25
                %




Foreign
Currency Translation




Our
financial statements are expressed in US dollars but the functional currency of
our operating subsidiary is RMB. Our results of operations are translated at
average exchange rates during the relevant financial reporting periods, assets
and liabilities are translated at the unified exchange rate at the end of these
periods and equity is translated at historical exchange rates. Adjustments
resulting from the process of translating the local currency financial
statements into US dollars are included in determining comprehensive
income.




Results
of Operations




The
following tables set forth key components of our results of operations for the
periods indicated, in dollars and as a percentage of revenue.




For
      the Year Ended September 30,2010
                
                
                2009(Audited)USD
                
                
                %
      of
                    Revenue
                
                
                USD
                
                
                %
      of
                    RevenueNet
      Sales
                
                $
                46,321,225
                
                
                
                100.0
                %
                
                $
                21,612,541
                
                
                
                100.0
                %Cost
      of Sales
                
                
                (35,042,898
                )
                
                
                (75.7
                )%
                
                
                (17,868,408
                )
                
                
                (82.7
                )%Gross
      profit
                
                
                11,278,327
                
                
                
                24.3
                %
                
                
                3,744,133
                
                
                
                17.3
                %General
      and administrative expenses
                
                
                (2,110,506
                )
                
                
                (4.6
                )%
                
                
                (1,053,752
                )
                
                
                (4.9
                )%Research
      and development expenses
                
                
                (136,398
                )
                
                
                (0.3
                )%
                
                
                (64,991
                )
                
                
                (0.3
                )%Selling
      and marketing expenses
                
                
                (634,544
                )
                
                
                (1.4
                )%
                
                
                (322,133
                )
                
                
                (1.5
                )%Operating
      Income
                
                
                8,396,879
                
                
                
                18.1
                %
                
                
                2,303,257
                
                
                
                10.7
                %Other
      income/(expenses), net
                
                
                673,350
                
                
                
                1.5
                %
                
                
                428,041
                
                
                
                2.0
                %Income
      before taxes
                
                
                9,070,229
                
                
                
                19.6
                %
                
                
                2,731,298
                
                
                
                12.6
                %Income
      tax expense
                
                
                (912,249
                )
                
                
                (2.0
                )%
                
                
                —
                
                
                
                —Net
      income
                
                
                8,157,980
                
                
                
                17.6
                %
                
                
                2,731,298
                
                
                
                12.6
                %Net
      loss attributable to non-controlling interest
                
                
                28,127
                
                
                
                —
                
                
                
                —
                
                
                
                —Net
      income attributable to the Company
                
                
                8,186,107
                
                
                
                17.7
                %
                
                
                2,731,298
                
                
                
                12.6
                %Foreign
      currency translationadjustment
                
                
                422,497
                
                
                
                1.0
                %
                
                
                (6,026
                )
                
                
                —Foreign
      currency translation adjustment attributable to non-controlling
      interest
                
                
                (1,906
                )
                
                
                —
                
                
                
                —
                
                
                
                —Comprehensive
      income
                
                $
                8,606,698
                
                
                
                18.6
                %
                
                $
                2,725,272
                
                
                
                12.6
                %


44


Comparison
of Year Ended September 30, 2010 and September 30, 2009




Net Sales. We generate
revenues from sales of our synthetic leather and other fabrics. During the year
ended September 30, 2010, we had revenues of approximately $46.3 million as
compared to revenues of approximately $21.6 million during year ended September
30, 2009, an increase of approximately $24.7 million, or 114.3%. The growth in
our revenues during the year ended September 30, 2010 was attributable to a
significant increase of volume sold during such period as compared to the year
ended September 30, 2009. We produced and sold 8.0 million and 14.0 million
meters of fabrics during the years ended September 30, 2009 and 2010,
respectively.




The
following table provides a breakdown of revenues of each of our product types
during the years September 30, 2010 and 2009:




Year
      ended September 30,2010
                
                
                2009
                
                
                Growth
      from the same
                    period
      last year$
                
                
                %
      of Total
                    Revenue
                
                
                $
                
                
                %
      or Total
                    Revenue
                
                
                $
                
                
                %Products:Ultrasuede
                
                
                9,201,596
                
                
                
                19.9
                %
                
                
                8,616,807
                
                
                
                39.9
                %
                
                
                584,789
                
                
                
                6.8
                %Recycled
      leather flocked fabric
                
                
                34,209,667
                
                
                
                73.9
                %
                
                
                11,740,691
                
                
                
                54.3
                %
                
                
                22,468,976
                
                
                
                191.4
                %Microfiber
      towel
                
                
                558,408
                
                
                
                1.2
                %
                
                
                408,354
                
                
                
                1.9
                %
                
                
                150,054
                
                
                
                36.7
                %Tufted
      fabrics
                
                
                1,692,669
                
                
                
                3.7
                %
                
                
                115,866
                
                
                
                0.5
                %
                
                
                1,576,803
                
                
                
                1,360.9
                %Other
      fabrics
                
                
                658,885
                
                
                
                1.3
                %
                
                
                730,823
                
                
                
                3.4
                %
                
                
                (71,938
                )
                
                
                (9.8
                )%Total
                
                
                46,321,225
                
                
                
                100.0
                %
                
                
                21,612,541
                
                
                
                100.0
                %
                
                
                24,708,684
                
                
                
                114.3
                %







We
generated revenues of approximately $34.2 million from sales of our recycled
leather flocked fabric products in the year ended September 30, 2010, the
production of which we launched during the fiscal year ended September 30, 2009.
This product is flocked with genuine leather and the quality of these products
is better than purely chemical-based synthetic products. As a result, the price
that customers are willing to pay for this product is higher, resulting in
higher revenues and gross margins. In addition, the production of these products
is more environmentally friendly than the production of products made from
non-recycled raw materials.




The
following table sets forth the percentage of revenues generated from sales to
our domestic Chinese and export customers for the periods
indicated:


45




For
      the year ended September 30,2010
                  
                  
                  2009
                  
                  
                  Growth
      from the sameperiod
      last year%
      of
                  
                  
                  
                  
                  
                  %
      of$
                  
                  
                  Revenue
                  
                  
                  $
                  
                  
                  Revenue
                  
                  
                  $
                  
                  
                  %CustomerDomestic
      Chinese customers
                  
                  
                  35,720,935
                  
                  
                  
                  77.1
                  %
                  
                  
                  13,550,142
                  
                  
                  
                  62.7
                  %
                  
                  
                  22,170,793
                  
                  
                  
                  163.6
                  %Export
      customers
                  
                  
                  10,600,290
                  
                  
                  
                  22.9
                  %
                  
                  
                  8,062,399
                  
                  
                  
                  37.3
                  %
                  
                  
                  2,537,891
                  
                  
                  
                  31.5
                  %




During
the year ended September 30, 2010, our customer base expanded. We had 27
international customers and 189 domestic customers, increased from 14
international and 79 domestic customers from the year ended September 30,
2009.




While
sales to domestic PRC customers increased by approximately 163.6% during the
year ended September 30, 2010, sales to international customers increased by
approximately 31.5% during the year ended September 30, 2010. We expect our
revenues in the domestic and international markets to continue to
grow.




Cost of Sales. Cost of sales
was approximately $35.0 million during the year ended September 30, 2010, as
compared to approximately $17.9 million during the year ended September 30,
2009, representing an increase of 96.1% or approximately $17.2 million. This
increase resulted from the increase in volume sold during this period. In
addition, our depreciation expenses for our plants and machinery increased to
approximately $0.7 million in the year ended September 30, 2010 from
approximately $0.5 million in the year ended September 30, 2009 as a result of
new equipment purchased for our original facility. As a percentage of net
revenues, cost of revenue decreased from 82.7% to 75.7% during the year ended
September 30, 2010.




Gross Profit and Gross
Margin. Our gross profit increased 201.2% to approximately $11.3 million
during the year ended September 30, 2010, from approximately $3.7 million for
the same period in 2009. The increase was primarily attributable to increased
sales and change of product mix. For the years ended September 30, 2010 and
2009, our gross margin was 24.3% and 17.3%, respectively. The rise of gross
profit margin in 2010 is due to the maturity of our production technique for our
recycled leather flocked products, which resulted in increased product yield and
decreased costs. In addition, the sales price of the recycled leather flocked
material has increased. However, during the third and forth quarters, we
experienced an increase in the costs of producing these materials as a result of
increased prices for raw materials.




General and Administrative
Expenses. General and administrative expenses totaled approximately $2.1
million for the year ended September 30, 2010, as compared to approximately $1.1
million for the year ended September 30, 2009, representing an increase of
100.3%. This increase was primarily attributable to expenses incurred in
connection with the retention and payment of advisors in connection with our
listing as a US public company, in addition to the increased payment of salaries
and related expenses to our employees as a result of new hires in fiscal year
2010.


Research and Development
Expenses. Research and development expenses totaled $136,398 for the year
ended September 30, 2010, as compared to $64,991 for year ended September 30,
2009, an increase of 109.9%. This increase was attributable to the payment of
salaries and related expenses to additional employees during the year ended
September 30, 2010, as we expanded the size of our research and development
staff efforts during that time.




Selling and Marketing
Expenses. Selling and marketing expenses totaled $634,544 for the year
ended September 30, 2010, as compared to $322,133 for the year ended September
30, 2009, an increase of 97.0%. This increase was attributable primarily to
increased advertising and promotion activities, staffing costs and other costs
relating to selling and marketing activities.


46




Operating Income. As a result
of the foregoing, operating income for the year ended September 30, 2010 was
approximately $8.4 million, an increase of 264.6% as compared to approximately
$2.3 million for the same period in 2009.




Other Income (expenses), net.
Our other income (expenses), net for the year ended September 30, 2010 totaled
$673,350, compared to other expenses of $428,041 for the previous year. Other
income (expenses), net for the year ended September 30, 2010 comprise revenue of
$649,484 from an exclusive distribution rights arrangement with one of our
largest customers, government grants of $440,826 which were awarded to us by the
local PRC government as an incentive to increase our exports, scrap sales of
$14,034, other miscellaneous income of $35,101, exchange loss of $49,788,
interest income of $26,721, interest expense of $300,609 and other expenses of
$142,419. Our other income and expenses for the year ended September 30, 2009
comprise revenue of $539,244 from an exclusive distribution rights arrangement
with one of our largest customers, government grants of $26,367 which were
awarded to us by the local PRC government as an incentive to increase our
exports, scrap sales of $44,937, the exchange loss of $24,963, interest income
of $19,972 and interest expenses of $166,186 and other expenses of
$11,330.




We
recognized $539,244 of the value of the machines we received as revenue for the
year ended September 30, 2009.




Provision for Income Taxes.
We incurred income tax expenses of $912,249 and $0 in fiscal years ended
September 30, 2010 and 2009, respectively. Beginning in calendar year 2010,
Lizhan Textile became subject to an income tax rate of 12.5%.




Net Income. As a result of
the foregoing, our net income totaled approximately $8.2 million for the year
ended September 30, 2010, as compared to approximately $2.7 million for the year
ended September 30, 2009, an increase of 199.7%.




5.B.  Liquidity
and Capital Resources




General




Our
primary capital needs have been, and we expect will continue to be, to fund the
working capital requirements necessitated by our sales growth, including
purchasing raw materials from suppliers, adding new products and completing
construction of our Evergreen Products facility. Our primary sources of
financing have been cash generated from operations, short-term loans, long-term
loans, lines of credit from banks in China, proceeds from bank acceptance notes
and proceeds from our recent initial public offering. We expect to continue to
finance our operations and working capital needs in 2011 from these
sources.




We have
not experienced any difficulties in the acquisition and rollover of the
short-term bank loans that fund our daily operations. We anticipate rollovers of
all current facilities that are set to mature in fiscal year 2011 and do not
foresee a reduction in the availability of bank credit to fund our operations
and meet our growth objectives. We expect that anticipated cash flows from
operations, short-term bank loans, bank acceptance notes and lines of credit
will be sufficient to fund our current operations and growth plans through at
least the next twelve months.




The
recent construction of our Evergreen Products facility and the installation of
production line 1 cost approximately $13.0 million in the aggregate, $12.0
million of which has been due and paid from our revolving lines of credit and
cash generated from operations. The installation of production lines 2, 3 and 4
are expected to cost approximately $12.0 million in the aggregate. We intend to
use the proceeds from our initial public offering and long-term loans to meet
this capital requirement.




On
October 28, and 29, 2010, we repaid our short-term loans in the aggregate amount
of approximately $9.5 million. In addition, during that period, we entered into
new long-term loans, which are due between May to December 2012, in the
aggregate amount of $9.5 million. As a result, our short-term loans as at
September 30, 2010 amounted to $4.2 million in the aggregate and long-term loans
currently amounted to $9.5 million in the aggregate at the end of October 2010.
Additionally, in October 2010, we also obtained one short term loan of
approximately $747,000 and a one-year line of credit with Shanghai Pudong
Development Bank with an availability of up to approximately $4.9
million.




We
believe that these events enhance our working capital position in the near
future and will give us greater flexibility in managing the growth of our
company, including investment in our new Evergreen Product facility and first
production line. We anticipate repaying our newly obtained long-term loans by
using cash generated from our operations.


47


If
available liquidity is not sufficient to meet our operating and loan obligations
as they come due or to fund our growth plans, our plans include pursuing
alternative financing arrangements or reducing expenditures as necessary to meet
our cash requirements. However, there is no assurance that we will be able to
raise additional capital or reduce discretionary spending to provide required
liquidity. Currently, the capital markets for small capitalization companies are
extremely difficult. Accordingly, we cannot be sure of the availability or terms
of any alternative financing arrangements.




Cash
and Restricted Cash




The
following table sets forth a summary of cash and restricted cash at the end of
the periods indicated:




September
      30,2010
                
                
                2009(Audited)
                
                
                (Audited)Cash
                
                $
                2,597,366
                
                
                $
                864,162Restricted
      cash
                
                
                1,072,416
                
                
                
                1,972,470




Restricted
cash represents bank deposits held as collateral for bank acceptance notes, and
will be released at the expiration date of the bank acceptance notes. The bank
acceptance notes generally mature in periods ranging from three to six months
and bear bank charges calculated as 0.05% of the face value of the notes, which
are generally at a lower rate than the banks’ interest rate. As security for the
bank acceptance notes, we have been required to place deposits equal to 40% to
50% of the note amounts with the banks and other pledge and
guarantee.




Restricted
cash fluctuated during these periods in proportion to the balance of the bank
acceptance notes.




Cash
Flow




The
following table sets forth a summary of our net cash flow information for the
periods indicated:




Year
      Ended September 30,2010
                
                
                2009(Audited)
                
                
                (Audited)Net
      cash provided by operating activities
                
                $
                7,558,625
                
                
                $
                473,578Net
      cash used in investing activities
                
                
                (15,737,840
                )
                
                
                (2,219,103
                )Net
      cash provided by financing activities
                
                
                9,922,302
                
                
                
                1,903,745


48


Operating
Activities




Net cash
provided by operating activities was approximately $7.6 million and $0.5 million
for the years ended September 30, 2010 and 2009, respectively. We experienced a
substantial increase in net income, to $8.1 million in the year ended September
30, 2010 compared to $2.7 million in the year ended September 30, 2009, and an
increase in accounts payable, income tax payable and value added tax and less
increase in inventory, partially offset by deferred income related to our
exclusive distribution arrangement with one of our largest customers and an
increase in accounts receivable, an increase in inventories and a decrease in
prepaid expenses as a result of our growth in fiscal year 2010.




In
addition to our growth, which has driven the increase of cash provided by our
operating activities in 2010, a primary factor affecting our operating cash flow
is the timing of cash receipts from product sales and payments for purchase of
materials in the ordinary course of business. A majority of our cash receipts
are collected with a credit period of 60 to 90 days. We generally pay our
suppliers in 60 days and, from time to time, with 3-month bank acceptance notes.
Going forward, we expect cash provided from operating activities to continue to
be a major source of liquidity for us, and we expect the future trend to
continue to be affected by the factors described above.




Our
accounts receivable balances as of September 30, 2009 and 2010 were $4.3 million
and $7.3 million, respectively. Our accounts receivable increased during these
periods as a result of the significant increase in sales with credit terms of
generally 60 to 90 days. The accounts receivable turnover days, which we define
as our average receivable balances during the period divided by sales and
multiplied by the number of days in the period, were 62 and 46 days,
respectively, in fiscal years 2009 and 2010. Average accounts receivable days
decreased over time as a result of our stricter collection efforts. Our credit
period granted to customers is generally 60 to 90 days, depending on our
business relationship with the customer, the customer’s credit history and
prevailing market conditions.




Our
inventory balances as of September 30, 2009 and 2010 were $3.5 million and $4.7
million, respectively, among which raw material inventory was $1.2 million and
$1.5 million, respectively. The increase in 2010 resulted from increased sales
in the same year. We generally keep a raw material inventory of one month at
hand for the production planning purposes. The number of inventory days, which
we define as the average inventory balances during the period divided by cost of
goods sold and multiplied by the number of days in the period, decreased from 51
days in 2009 to 42 days in 2010. The decrease of inventory turnover in days is
due to the rise of sales volume through the year while the raw materials in
stock are subject to the influence of price hike.




Our
accounts payable and bank acceptance notes payable, collectively, as of
September 30, 2009 and 2010, were $8.9 million and $10.3 million, respectively.
Both items are derived from our trade related procurement. Notes payable refers
to the balance of bank acceptance notes which finance the purchase of our raw
materials and is commonly used by Chinese companies to obtain bank financing
with a lower financing cost. We generally make payments to our suppliers within
sixty days following the date of delivery either in cash or with 3-month bank
acceptance notes. The increase in 2010 resulted from the increased levels of
bank acceptance notes needed to finance our operations. Our days payables, which
we define as the average payable balances during the period divided by cost of
goods sold and multiplied by the number of days in the period, increased from 83
days in 2009 to 67 days in 2010.




Investing
Activities




For the
year ended September 30, 2010, approximately $15.7 million was used in investing
activities as compared to approximately $2.2 million used in investing
activities for the same period in 2009, reflecting an increase in payments for
the purchase of plants and equipment and the purchase of land use
rights.




The
purchases of property, plant and equipment were primarily made in connection
with the expansion of our manufacturing facilities. We expect investing
activities over the next several years to increase significantly from previous
levels as we execute our plan to install new production lines for our Evergreen
Products. See “Capital Expenditures” below.




Financing
Activities




Net cash
provided by financing activities for the year ended September 30, 2010 was
approximately $9.9 million as compared to approximately $1.9 million in the same
period in 2009. The increase in cash provided by financing activities was
primarily due to increased proceeds from short-term bank loans and bank
acceptance notes, partially offset by the repayment of bank acceptance notes and
an increase in repayments of short-term bank loans.




As of
September 30, 2010, we maintained working capital facilities of $14.7 million
with various banks in China. We are generally not subject to any operational or
financial covenants under these working capital facilities.  However,
our loan from China Construction Bank in the amount of $5.0 million provides
that our debt-to-asset ratio may not exceed 70% for more than three months, our
debt-to-equity ratio may not exceed 50% and any investment in another company
may not exceed 20% of our shareholders’ equity. As of September 30, 2010, we had
applied $13.4 million of the credit facilities for production facilities on
existing products and the new project related to Evergreen
Products.


49


Capital
Expenditures




We
incurred capital expenditures of approximately $16.7 million and $1.2 million
for and the years ended September 30, 2010 and 2009, respectively, primarily in
connection with purchases of land use rights, property, plant and equipment and
construction of our facilities, leasehold improvements and investment in
equipment, technology and operating systems. These capital expenditures were
financed by the cash flow generated by our operations and from bank
financing.




We
believe that our capital expenditures in 2011 will be incurred primarily in
connection with the construction of our Evergreen Products
facility.




We expect
to finance these capital expenditures by using cash on hand, internal cash flow
to be generated by operations, short-term and long-term bank borrowings, bank
facilities and net proceeds from our recent initial public
offering.




Loan
Facilities




As of
September 30, 2010, our outstanding bank loans which are all classified as
current, were as follows:




Payable
      to:China
      Construction Bank
                  
                  $
                  5,007,100China
      Citic Bank
                  
                  
                  448,397Hang
      Zhou Bank
                  
                  
                  747,328Jiaxing
      City Commercial Bank
                  
                  
                  7,473,283Total
                  
                  $
                  13,676,108




In
connection with these loans, we have pledged our buildings and land use rights,
and Mr. Jianfeng Liu has provided a personal guaranty. Generally, our loan
amounts are denominated in RMB with fixed interest rates which range from 5.31%
to 6.107%.




On
October 28, and 29, 2010, we repaid our short-term loans in the aggregate amount
of approximately $9.5 million. In addition, during that period, we entered into
new long-term loans, which are due between May to December 2012, in the
aggregate amount of $9.5 million. As a result, our short-term loans as at
September 30, 2010 amounted to $4.2 million in the aggregate and long-term loans
currently amounted to $9.5 million in the aggregate at the end of October 2010.
Additionally, in October 2010, we also obtained one short term loan of
approximately $747,000 and a one-year line of credit with Shanghai Pudong
Development Bank with an availability of up to approximately $4.9 million. We
believe that these events enhance our working capital position in the near
future and will give us greater flexibility in managing the growth of our
company, including investment in our new Evergreen Product facility and first
production line. We anticipate repaying our newly obtained long-term loans by
using cash generated from our operations.




Critical
Accounting Policies and Estimates




Management’s
discussion and analysis of its financial condition and results of operations are
based upon our consolidated financial statements, which have been prepared in
accordance with U.S. GAAP. Our financial statements reflect the selection and
application of accounting policies, which require management to make significant
estimates and judgments. See Note 2 to our consolidated financial statements,
“Summary of Significant Accounting Policies.” We believe that the following
paragraphs reflect the more critical accounting policies that currently affect
our financial condition and results of operations.


50


Impairment




We
account for impairment of long-lived assets including property, plant and
equipment, and amortizable intangible assets in accordance with ASC 360-10-35,
“Impairment and Disposal of ASC 360-10-35,” “Impairment or Disposal of
Long-Lived Assets Subsections”, which requires an impairment loss to be
recognized when the carrying amount of a long-lived asset or asset group exceeds
its fair value and is not recoverable (when carrying amount exceeds the gross,
undiscounted cash flows from use and disposition). The impairment loss is
measured as the excess of the carrying amount over the assets (or asset group’s)
fair value.




Revenue
recognition




Our
revenues consist of sales of synthetic leather and other fabrics which are used
in the production of residential and office furniture, garments and automotive
upholstery products. Sales are recognized in accordance with Securities and
Exchange Commission (“SEC”) Staff Accounting Bulletin (“SAB”) No. 104, when the
following four revenue criteria are met: persuasive evidence of an arrangement
exists, delivery has occurred, the selling price is fixed or determinable, and
collectability is reasonably assured. Revenues are presented net of value added
tax (VAT). No return allowance is made as products are normally not returnable
upon acceptance by the customers.




Foreign
currency translation




Our
reporting currency of the Company is United States Dollars. All assets and
liabilities accounts have been translated into United States Dollars using the
current exchange rate at the balance sheet date. Capital stock is recorded at
historical rates. Revenue and expenses are translated using the average exchange
rate in the year. The resulting gain and loss has been reported as other
comprehensive income (loss) within the shareholder’s equity.




Use
of estimates




The
preparation of consolidated financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Because of the use of estimates inherent in the financial
reporting process, actual results could differ from those estimates. Significant
estimates include estimates of accruals and determination of fair values for
assets disposal.




Recently
issued accounting pronouncements




Effective
January 1, 2010, the Company adopted the provisions in ASU 2010-06, “Fair Value
Measurements and Disclosures (ASC Topic 820): Improving Disclosures about Fair
Value Measurements, which requires new disclosures related to transfers in and
out of levels 1 and 2 and activity in level 3 fair value measurements, as well
as amends existing disclosure requirements on level of disaggregation and inputs
and valuation techniques. The adoption of the provisions in ASU 2010-06 did not
have an impact on the Company’s consolidated financial statements.




In
February 2010, the Financial Accounting Standards Board (“FASB”) issued
authoritative guidance that amends the disclosure requirements related to
subsequent events. This guidance includes the definition of a Securities and
Exchange Commission filer, removes the definition of a public entity, redefines
the reissuance disclosure requirements and allows public companies to omit the
disclosure of the date through which subsequent events have been evaluated. This
guidance is effective for financial statements issued for interim and annual
periods ending after February 2010. This guidance did not materially impact the
Company’s results of operations or financial position, but did require changes
to the Company’s disclosures in its financial statements.




In April
2010, the FASB issued ASU No. 2010-13 — Compensation — Stock Compensation (Topic
718), which addresses the classification of an employee share-based payment
award with an exercise price denominated in the currency of a market in which
the underlying equity security trades. This Update provides amendments to Topic
718 to clarify that an employee share-based payment award with an exercise price
denominated in the currency of a market in which a substantial portion of the
entity’s equity securities trades should not be considered to contain a
condition that is not a market, performance, or service condition. Therefore, an
entity would not classify such an award as a liability if it otherwise qualifies
as equity. The amendments in this Update are effective for fiscal years, and
interim periods within those fiscal years, beginning on or after December 15,
2010. The Company expects that the adoption of the amendments in this Update
will not have any significant impact on its financial position and results of
operations.


51


Other
accounting standards that have been issued or proposed by the FASB or other
standards-setting bodies that do not require adoption until a future date are
not expected to have a material impact on the Company’s Consolidated Financial
Statements upon adoption.




Other
recent accounting pronouncements issued by the FASB (including its Emerging
Issues Task Force), the AICPA, and the SEC did not or are not believed by
management to have a material impact on the Company’s present or future
consolidated financial statements.




Governmental
Regulations




See the
discussion under the heading “Governmental Regulations” in Item 4 above for a
discussion of governmental policies or factors that could materially affect our
business.




5.C.  Research
and Development, Patents and Licenses, etc.




Research
and Development




We have
15 full-time professionals in our research and development division that have
developed innovative technology that is instrumental in controlling our
production costs, increasing our operational efficiency and enhancing our
ability to develop eco-friendly production processes. Our combination
proprietary production technology enables us to use lower-cost materials,
including leather waste, in place of the higher-value and non-recyclable
chemical fiber based materials.




One of
our key employees, Mr. Liwen Zhang, who is also a minority shareholder of our
Hongzhan operating subsidiary, is the original owner of four Chinese patents,
seventeen international patents and eight international patent applications
related to technologies utilized in the manufacture of our Evergreen Products.
Three of the Chinese patents have been transferred to us and the remaining
patents and patent applications, all of which are related to the technologies
that are critical to the production of the Evergreen Products, have been
licensed to us for our exclusive use until 2024. Mr. Zhang has managed the
research and development process on these patents and related production
technologies since 2003. Mr. Zhang and four other researchers joined our company
in February 2010.




We plan
to continue our research and development efforts to strengthen our leading
position in our industry. For example, we are currently developing nylon
taffeta, a new PU leather material that is used for apparel manufacturing
purposes.




We will
focus our research and development efforts primarily on our new Evergreen
Products going forward. We entered into a three-year joint research and
development agreement with Sichuang University in China, under which we will
establish a genuine leather fiber research lab to focus on developing the
applications and products for our Evergreen Products. All research results that
are jointly developed pursuant to this relationship will belong to both parties.
We will have the exclusive right to produce, sell and export products based on
these results. However, we will be obligated to pay a percentage of any sales of
any of these products to Sichuang University.




5.D.  Trend
Information




See
discussion in Parts A and B of this item.




5.E.  Off-Balance
Sheet Arrangements




We do not
have any off-balance sheet arrangements that have, or are reasonably likely to
have, a current or future effect on our financial condition, changes in
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that is material to our
investors.


52


5.F.  Tabular
Disclosure of Contractual Obligations




Our
contractual obligations consist of short-term debt obligations and operating
lease obligation.  The following table sets forth a breakdown of our
contractual obligations as of September 30, 2010:




Payments due by periodCONTRACTUAL
      OBLIGATIONS
                      
                      Total
                      
                      
                      Less than
                        1 year
                      
                      
                      1-3 years
                      
                      
                      3-5 years
                      
                      
                      More than
                        5 yearsShort-term
      debt obligations (1)
                      
                      
                      13,676,108
                      
                      
                      
                      13,676,108
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Operating
      lease obligations
                      
                      
                      6,234,553
                      
                      
                      
                      590,573
                      
                      
                      
                      1,816,559
                      
                      
                      
                      1,816,559
                      
                      
                      
                      2,010,862Total
                      
                      
                      19,910,661
                      
                      
                      
                      14,266,681
                      
                      
                      
                      1,816,559
                      
                      
                      
                      1,816,559
                      
                      
                      
                      2,010,862


________________


(1)
Attributable to short-term bank loans.


53


ITEM
      6.
            DIRECTORS,
      SENIOR MANAGEMENT, AND EMPLOYEES




6.A.  Directors
and Senior Management




The following table sets forth the
name, age, positions and a brief description of the business experience of each
of our directors, executive officers and key employees as of the date of this
annual report.




Name
            
            Positions
            
            AgeJianfeng
      Liu
            
            President,
      Chief Executive Officer and Chairman of the Board and
    Director
            
            46Angell
      Chang
            
            Chief
      Financial Officer
            
            40Jianfu
      Ma
            
            Finance
      Controller and Director
            
            41Jianrong
      You
            
            Director
            
            39Zhenyuan
      Feng
            
            Director
            
            44Jianlun
      Tu
            
            Director
            
            46Johnson
      Lau
            
            Director
            
            37Jiancheng
      Sun
            
            Director
            
            41Liwen
      Zhang
            
            Chief
      Scientist
            
            46




There are
no family relationships among our directors, executive officers and key
employees. The address of each of our directors, executive officers and key
employees is c/o Lizhan Environmental Corporation, No. 716, Qifu Road, Wutong
Street, Tongxiang, Zhejiang Province, 314500, People’s Republic of
China.




Executive
Officers, Directors and Key Employees




Mr. Jianfeng Liuis the
founder and Chief Executive Officer of our Company and has served as Chairman of
our Board of Directors since August 2009. He has more than 20 years of
experience in corporate strategy, business management, business development and
industrial analysis in the synthetic fabric and textile industries. Prior to
founding our Company, from 2004 until 2005, Mr. Liu was the General Manager of
Haining Jianfeng Textile Co., Ltd., which produces and sells cloth. From June
1998 until December 2003, Mr. Liu was General Manager of Shanghai Xiangcheng
Textile Material Co., Ltd., which was a leather and cloth processing company.
From May 1993 until May 1998, Mr. Liu was Factory Director of Shanghai Ruilian
Composite Fabrics Co., Ltd., which is a leather and cloth processing company.
From July 1987 until 1993, Mr. Liu was Factory Director of Guangdong Nanhai Dayi
Shoes Material Factory., which is a leather and cloth processing company. Mr.
Liu taught at Chengbu Wei Xi Xiang Jiang Middle School from 1985 until June
1987. Mr. Liu completed the U.S. Excellerated Business School for Entrepreneurs
program.




Ms. Angell Changhas been our
Chief Financial Officer since June 2010. Ms. Chang graduated from Montclair
State University with a BS in accounting. Ms. Chang is a certified public
accountant (CPA) licensed in the State of New Jersey. Ms. Chang has extensive
work experience with public trading companies, such as Wyndham Worldwide,
Pfizer, and Polo Ralph Lauren. Before joining our company, Ms. Chang was
employed by Wyndham Worldwide from 2006 to 2010, where she was in charge of
consolidation and internal reporting, which involved auditing related experience
and frequent communication with the company’s auditors. At Pfizer, from 2003 to
2006, Ms. Chang was a senior SEC analyst. Ms. Chang is a native Chinese speaker
and has lived in the United States for approximated twenty
years.


54


Mr. Jianfu Mawas the Chief
Financial Officer of our company from 2008 until June 2010. Since June 2010, Mr.
Ma has been our Finance Controller. Mr. Ma has also been a director since March
2010. He has extensive experience in financial, taxation and investment advisory
services. Before joining our company in 2008, Mr. Ma was Chief Auditor of
Tongxiang Materials Bureau from 1990 until 1995. From 1995 until 1996, Mr. Ma
was General Manager of Tongxiang Wuzhen Materials Corporation. From 2000 until
2007, Mr. Ma was Senior Business Manager of Jiaxing Xinge Tax Agents Firm. From
1996 until 2003, Mr. Ma was General Manager of Zhongcheng Finance and Taxation
Co., Ltd. Mr. Ma studied Accounting at Hunan University Network School and he
studied Finance Management at Zhejiang University of Finance and Economics. Mr.
Ma holds a bachelor degree. He also has the professional titles of China
Certified Tax Agent and China Certified PublicAccountant.




Mr. Jianrong Youhas been
General Manager of Lizhan Textile (Zhejiang) Co., Ltd. since July 2009, and has
worked at the company since 2006, during which time he also held the position of
Vice General Manager. He has more than 10 years of experience in corporate
management, market operations and research and development. He has a depth of
knowledge of the textile industry and valuable insight into market trends and
products. Mr. You completed the Executives Seminar for Growth-Oriented
Enterprises program at Zhejiang University.




Mr. Zhenyuan Fenghas served
as one of our directors since March 2010. He has more than 20 years of
experience as a lawyer. He is currently a Partner, Chair and Director of
Zhejiang Bai Jia Law Firm. Before working at Zhejiang Bai Jia Law Firm, Mr. Feng
worked at Tongxiang City law firm from 1984 until 1995. Mr. Feng studied at East
China University of Politics and Law, Southwest University of Political Science,
postgraduate courses of Procedural Law (Civil Action Procedure
direction).




Mr. Jianlun Tuhas served as
one of our directors since March 2010. Mr. Tu has participated in large and
medium state-owned enterprises and private enterprises restructuring,
reorganization, mergers and acquisitions, debt issuance and auditing. He is
currently head of Tong Xiang Fang Lian Accounting Firm. From 1995 until 1999 he
was GAO chief in Tongxiang City, and head of Tong Xiang Shenda Accounting Firm.
Mr. Tu received a bachelors degree. He also has the professional title of
Chinese Certified Public Accountant.






Mr. Johnson Lauhas served as one of
our directors since June 2010. Mr. Lau has been the Chief Financial Officer of
AutoChina Group Inc. since October 2008 and subsequently became the Director of
Finance of AutoChina International Limited (NASDAQ: AUTC) on July 15, 2010.
Starting from December 2010, he became an independent director of China Green
Material Technologies, Inc. (OTC: CAGM), which
manufactures starch-based biodegradable containers, tableware and packaging
materials. From March 2006 to October 2008, he was the Chief Financial
Officer of Haike Chemical Group Ltd., a petrochemical and specialty chemical
company. Mr. Lau served as the Chief Operating Officer of Kiwa Bio-Tech Products
Group Corp. (OTC: KWBT.OB), which engaged in bio-technological products for
agriculture products, from January 2005 to March 2006. Mr. Lau served on the
Board of Directors of Haike Chemical Group Ltd. (AIM: HAIK) from January 2006 to
January 2010. From May 1997 to August 2004, Mr. Lau worked for Deloitte Touche
Tohmatsu in Hong Kong and Beijing. Mr. Lau received a Bachelor of Commerce
degree from Monash University.




Mr. Jiancheng Sunhas served
as one of our directors since March 2010. Mr. Sun is currently Deputy
Secretary-General of Chongfu Fur of China Association. Mr. Sun was the Chief of
Construction and a member of the management committee of Chongfu Fur Market. Mr.
Sun received his bachelor’s degree from Northeast China University of
Finance.




Mr. Liwen Zhanghas extensive
experience in the research and development of technology for which he has sought
multiple patents. Mr. Zhang began research on collagen fiber in 2004. In 2009,
Mr. Zhang founded Eminent Benefit Holdings Limited, which acquired 13% of
Hongzhan in February 2010. Mr. Zhang became our Chief Scientist in February
2010, following the acquisition of shares of Hongzhan by Eminent. From 2001
until 2004 he worked at Guangzhou Zhongyu Co., Ltd. From 1999 until 2003, Mr.
Zhang researched and filed 22 applications for invention patents and a patent
for a new utility model in connection with down fiber. Mr. Zhang began his
research on the Evergreen Products in 2003.




6.B.  Compensation




For the year ended September 30, 2010,
the aggregate cash compensation that we paid to our executive officers and
directors was approximately $217,640. There are no service contracts between us
and any of our directors, except for those directors who are also our executive
officers. Pursuant to PRC law, 25% of our executive officers’ salaries have been
set aside for pension and retirement.


55


Employment
Agreements




We have entered into employment
agreements with each of our executive officers. Under these agreements, each of
our executive officers, other than Ms. Chang, is employed for a time period
ranging from between one and three years. We have adopted several internal
regulations which have to be strictly followed by our management and other
employees. We may terminate the employment of each of our executive officers,
other than Ms. Chang, as permitted by the Law of the People’s Republic of China
on Employment Contracts, or the Employment Contract Law. Under the Employment
Contract Law, we may terminate an employee for cause, at any time, without
remuneration, for certain acts of the employee, including but not limited to a
conviction or plea of guilty to a felony, willful dishonesty to us and willful
and continued failure to perform substantially all his agreed-to duties after a
reasonable opportunity to cure the failure. An executive officer may terminate
his employment permitted by the Employment Contract Law, at any time without
penalty if there is any failure by us to comply with any material provisions of
the employment agreement.




We have entered into an employment
agreement with Ms. Angell Chang. Ms. Chang is employed as our Chief Financial
Officer. The term of Ms. Chang’s agreement is from July 1, 2010 until July 1,
2012, which term is renewable upon expiration. We will compensate Ms. Chang at
an annual rate of $150,000. Ms. Chang will be provided with living arrangements
and transportation during the term of her employment. However, as described
above, Ms. Chang has informed us of her intention to resign in the near
future.




We may not terminate Ms. Chang’s
agreement during the first twelve months of the term of the agreement without
cause. After the initial twelve month period, we may terminate the agreement
with three months written notice without cause. Ms. Chang may terminate the
agreement with three months written notice without cause. If we terminate the
agreement without cause during the initial twelve month period, within 30 days
of termination, we will pay Ms. Chang in a lump sum, any unpaid bonus awards,
reimbursable expenses and benefits owed through the day her employment was
terminated. Within 30 days of termination, we will also pay Ms. Chang a lump sum
equal to her unpaid base salary for the twelve months. If the agreement is
terminated for cause by us, or for any reason by Ms. Chang, we will pay in a
lump sum, any unpaid portion of base salary proportional to the number of months
employed, any unpaid bonus awards, reimbursable expenses and benefits owed to
Ms. Chang though the date of termination of employment.




Each executive officer and key employee
has agreed to hold in confidence and not to use in competition against us,
except as required in the performance of his or her duties in connection with
the employment, any confidential information relating to the business of our
company, affiliates or customers. Our executive officers have also agreed to
disclose to us all inventions, designs and trade secrets which they conceive,
develop or reduce to practice during the employment and to assign all right,
title and interest in them to us.




6.C.  Board
Practices




Our Board of Directors currently has
seven directors.  Under our amended and restated memorandum and
articles of association, our Board of Directors may not consist of more than ten
directors. Our directors will be elected by the holders of our ordinary shares
or by the directors. There are no agreements or understandings between any of
our executive officers or directors and any other person pursuant to which such
executive officer or director was selected to serve as a director or executive
officer of our company. Directors shall hold office until they are removed by
special resolution of the shareholders, or until the director becomes bankrupt
or makes any arrangement or composition with his creditors, dies or is found to
become of unsound mind, resigns his office by notice in writing to the company,
or without special leave of absence from the Board is absent from meetings of
the Board for three consecutive meetings and the Board resolves that his office
be vacated. There are no provisions relating to retirement of directors upon
reaching any age limit. Committees of the Board of DirectorsOur
directors are not required to hold any shares in our company by way of
qualification. Under our memorandum and articles of association, subject to any
separate requirement for audit committee approval under the applicable Nasdaq
rules, a director may vote with respect to any contract, proposed contract or
arrangement in which he or she is interested, so long as the director discloses
the nature of his or her interest in such contract, proposed contract or
arrangement, and may be counted in the quorum at such meeting. The board of
directors may exercise all the powers of the company to borrow money, mortgage
its undertakings, property and uncalled capital, and issue debentures, debenture
stock and other securities whenever money is borrowed or pledged as security for
any obligation of the company or of any third party.


56


Nasdaq
Requirements for Director Independence




Under the Nasdaq rules, a majority of
our directors must meet the definition of “independence” contained in those
rules within one year of our listing on the Nasdaq Global Market. Our Board has
determined that Johnson Lau, Zhenyuan Feng, Jianlun Tu and Jiancheng Sun meet
the independence standards contained in the Nasdaq rules. We do not believe that
any of these directors have any relationships that would preclude a finding of
independence under these rules and, in reaching its determination, our Board
determined that any other relationships that these directors have with us do not
and would not impair their independence.




Committees
of the Board of Directors




We have established three committees of
the Board of Directors: an audit committee, a compensation committee and a
corporate governance and nominating committee. In addition, our board of
directors has determined that Johnson Lau is qualified as an audit committee
financial expert within the meaning of SEC regulations. In compliance with Rule
5605 of the Marketplace Rules of the Nasdaq Stock Market, which we refer to as
the Nasdaq rules, a majority of the members of our audit committee will be
required to be independent directors during the 90 day transition period after
our ordinary shares are listed on the Nasdaq Global Market, and all of the
members of our audit committee will be required to be independent directors
within one year of listing. We have adopted a charter for each of the three
committees. Each committee’s members and functions are described below. In
addition, since we are a foreign private issuer, the Nasdaq Marketplace Rules
will generally permit us, with certain exceptions, to follow our home country
rules in lieu of certain requirements.




Audit Committee.  Our audit
committee consists of Johnson Lau, Jianlun Tu and Jiancheng Sun, each of whom
satisfies the independence requirements of Rule 10A-3 under the Securities
Exchange Act of 1934, as amended, which we refer to as the Exchange Act, and
Rule 5605 of the Nasdaq rules. The audit committee will oversee our accounting
and financial reporting processes and audits of the financial statements of our
company. The audit committee will be responsible for, among other
things:




•
            selecting
      our independent auditors and pre-approving all audit and non-audit
      services permitted to be performed by our independent
      auditors;


•
            reviewing
      with our independent auditors any audit problems or difficulties and
      management’s response;


•
            reviewing
      and approving all proposed related party transactions, as defined in Item
      404 of Regulation S-K;


•
            discussing
      our annual audited financial statements with management and our
      independent auditors;


•
            reviewing
      major issues as to the adequacy of our internal controls and any special
      audit steps adopted in light of material control deficiencies;
      and


•
            meeting
      separately and periodically with management and our independent
      auditors.


Compensation
      Committee.




Our compensation committee consists of
Jianlun Tu, Jiancheng Sun and Zhenyuan Feng, each of whom satisfies the
independence requirements of Rule 5605 of the Nasdaq rules. The compensation
committee will assist the Board in reviewing and approving the compensation
structure, including all forms of compensation relating to our directors and
executive officers. Our Chief Executive Officer may not be present at any
committee meeting during which his compensation is deliberated. The compensation
committee will be responsible for, among other things:




•
            reviewing
      and approving the total compensation package for our senior executives;
      and


•
            reviewing
      periodically, and approving, any long-term incentive compensation or
      equity plans, programs or similar arrangements, annual bonuses, employee
      pension and welfare benefit
plans.


57


Corporate Governance and Nominating
Committee.  Our corporate governance and nominating committee consists
of Zhenyuan Feng, Jianlun Tu and Jiancheng Sun, each of whom satisfies the
independence requirements of Rule 5605 of the Nasdaq rules. The corporate
governance and nominating committee will assist the Board in selecting
individuals qualified to become members of our Board and in determining the
composition of the Board and its committees. The corporate governance and
nominating committee will be responsible for, among other things:




•
            identifying
      and recommending to the board qualified candidates to be nominated for the
      election or re-election to the board of directors and committees of the
      board of directors, or for appointment to fill any
  vacancy;


•
            reviewing
      annually with the board of directors the current composition of the board
      of directors with regards to characteristics such as independence, age,
      skills, experience and availability of service to us;
  and


•
            advising
      the board of directors periodically with regard to significant
      developments in the law and practice of corporate governance as well as
      our compliance with these laws and practices, and making recommendations
      to the board of directors on all matters of corporate governance and on
      any remedial actions to be taken, if
needed.




Duties
of Directors




Under Cayman Islands law, our directors
owe a fiduciary duty to the Company to act honestly in good faith with a view to
our best interests. Our directors also have a duty to exercise the skill they
actually possess with the care and diligence that a reasonably prudent person
would exercise in comparable circumstances. In fulfilling their duty of care to
us, our directors must ensure compliance with our memorandum and articles of
association. A shareholder has the right to seek damages if a duty owed by any
of our directors is breached.




Under our amended and restated
memorandum and articles of association, subject to any separate requirement for
audit committee approval under applicable Nasdaq rules, a director may vote with
respect to any contract, proposed contract or arrangement in which he or she is
interested, so long as the director discloses the nature of his or her interest
in such contract, proposed contract or arrangement, and may be counted in the
quorum at such meeting.




Terms
of Directors and Officers




Except as otherwise provided by law,
vacancies on our board may be filled by the affirmative vote of a majority of
the directors then in office, or by our shareholders.




6.D.  Employees




We had
371 and 382 employees as of September 30, 2010 and 2009, respectively. The
following table shows a breakdown of our employees by function as of September
30, 2009 and 2010, respectively:




Number
      of
                    employees2010
                  
                  
                  2009Manufacturing
                  
                  
                  250
                  
                  
                  
                  258Sales
      and Marketing
                  
                  
                  12
                  
                  
                  
                  13General
      Administration, Purchasing and Logistics
                  
                  
                  64
                  
                  
                  
                  72Quality
      Control, Technology and Research & Development
                  
                  
                  45
                  
                  
                  
                  39Total
                  
                  
                  371
                  
                  
                  
                  382


58


From time
to time, we also employ third-party consultants for the research and development
of our products. We have not experienced any significant labor disputes and
consider our relationship with our employees to be good.




6.E.  Share
Ownership




As of
January 28, 2011, 13,643,750 of our ordinary shares were outstanding. Holders of
our ordinary shares are entitled to vote together as a single class on all
matters submitted to shareholders for approval. No holder of ordinary shares has
different voting rights from other any other holders of ordinary shares. We are
not aware of any arrangement that may, at a subsequent date, result in a change
of control of our company. As of  September 30, 2010, no ordinary
shares were held by record holders in the United States.




Beneficial
ownership is determined in accordance with the rules and regulations of the SEC.
The percentages of shares beneficially owned in the table below are based on
13,643,750 ordinary shares outstanding as of January 28, 2011.




The
following table sets forth information with respect to the beneficial ownership
of our common shares as of January 28, 2011 by:




·       each
of our directors and executive officers; and




·       each
person known to us to beneficially own more than 5% of our outstanding ordinary
shares.




Except as
otherwise noted, the business address of each person listed in the table is No.
716, Qifu Road, Wutong Street, Tongxiang, Zhejiang Province, 314500, People’s
Republic of China




Name
                  
                  Number
                  
                  
                  PercentDirectors
      and Executive OfficersJianfeng
      Liu (2)
                  
                  
                  8,518,750
                  
                  
                  
                  62.4Angell
      Chang
                  
                  
                  —
                  
                  
                  
                  —Jianfu
      Ma
                  
                  
                  —
                  
                  
                  
                  —Jianrong
      You
                  
                  
                  —
                  
                  
                  
                  —Zhenyuan
      Feng
                  
                  
                  —
                  
                  
                  
                  —Jianlun
      Tu
                  
                  
                  —
                  
                  
                  
                  —Johnson
      Lau
                  
                  
                  —
                  
                  
                  
                  —Jiancheng
      Sun
                  
                  
                  —
                  
                  
                  
                  —Liwen
      Zhang
                  
                  
                  —
                  
                  
                  
                  —All
      Directors and Executive Officers as a Group (3)
                  
                  
                  8,518,750
                  
                  
                  
                  62.4Principal
      Shareholders:Illigate
      Development Limited (4)
                  
                  
                  6,612,500
                  
                  
                  
                  48.5Infinite
      Harvest International Limited (5)
                  
                  
                  1,562,500
                  
                  
                  
                  11.5China
      Growth Equity Investment Limited (6)
                  
                  
                  937,500
                  
                  
                  
                  6.9Liu
      Hai (7)
                  
                  
                  8,518,750
                  
                  
                  
                  62.4Liu
      Yang (8)
                  
                  
                  8,518,750
                  
                  
                  
                  62.4


59




*
            Less
      than 1%.




(1)
            Beneficial
      ownership is determined in accordance with the rules and regulations of
      the SEC. Percentage of beneficial ownership of each listed person is based
      on ordinary shares outstanding as of January 28, 2011, including ordinary
      shares convertible from all outstanding preferred shares, and the ordinary
      shares underlying any options and warrants exercisable by such person
      within 60 days of January 28, 2011.




(2)
            Includes
      6,612,500 ordinary shares held by Illigate Development Limited, which is
      wholly owned by Mr. Liu, 1,562,500 ordinary shares held by Infinite
      Harvest International Limited, 60% of which is held by Mr. Liu’s son, Liu
      Yang (see footnote 5 below), 218,750 ordinary shares held by Mr. Liu’s
      son, Liu Yang, and 125,000 ordinary shares held by Mr. Liu’s son, Liu Hai.
      Under SEC rules and regulations, Mr. Liu may be deemed to beneficially own
      the shares held by his sons, either directly or through Infinite. Mr. Liu
      disclaims beneficial ownership of the shares held by his sons, either
      directly or through Infinite.




(3)
            Includes
      ordinary shares held by all of our directors and executive officers as a
      group.




(4)
            These
      shares are beneficially owned by Jianfeng Liu, who is the sole shareholder
      of Illigate Development Limited. The mailing address of Illigate
      Development Limited is Palm Grove House, P.O. Box 438, Road Town, Tortola,
      British Virgin Islands.




(5)
            Infinite
      Harvest International Limited is a company formed under the laws of the
      British Virgin Islands. Liu Yang, son of Mr. Jianfeng Liu, owns 60% of the
      outstanding shares of Infinite. The remaining 40% is held in the aggregate
      by two PRC residents that are unaffiliated with our company or any of our
      directors and officers. The mailing address of Infinite Harvest
      International Limited is No. 716, Qifu Road, Wutong Street, Tongxiang
      City, Zhejiang, China.




(6)
            China
      Growth Equity Investment Limited, or China Growth, is a company formed
      under the laws of the British Virgin Islands. Li Xulin owns 60% of the
      outstanding shares of China Growth and Wong Xiaobing owns the remaining
      40% of China Growth. The mailing address of China Growth is ATC Trustees
      (BVI) Limited, 2 nd
      Floor, Abbott Building, Road Town, Tortola, British Virgin
      Islands.




(7)
            Includes
      6,612,500 ordinary shares held by Illigate Development Limited, 1,562,500
      ordinary shares held by Infinite Harvest International Limited and 218,750
      ordinary shares held by Mr. Liu Hai’s brother, Liu Yang. Under SEC rules
      and regulations, Mr. Liu Hai may be deemed to beneficially own the shares
      held by his father, Mr. Jianfeng Liu, through Illigate and the shares held
      by his brother. Mr. Liu Hai disclaims beneficial ownership of the shares
      held by his father and the shares held by his brother. The mailing address
      for Mr. Liu Hai is Room 401, No. 716, Qifu Road, Wutong Street, Tongxiang,
      Zhejiang Province, 314500, People’s Republic of
  China.




(8)
            Includes
      6,612,500 ordinary shares held by Illigate Development Limited, 1,562,500
      ordinary shares held by Infinite Harvest International Limited and 125,000
      ordinary shares held by Mr. Liu Yang’s brother, Liu Hai. Under SEC rules
      and regulations, Mr. Liu Yang may be deemed to beneficially own the shares
      held by his father, Mr. Jianfeng Liu, through Illigate and the shares held
      by his brother. Mr. Liu Yang disclaims beneficial ownership of the shares
      held by his father and the shares held by his brother. The mailing address
      for Mr. Liu Yang is Room 401, No. 716, Qifu Road, Wutong Street,
      Tongxiang, Zhejiang Province, 314500, People’s Republic of
      China.


60




Stock
Options




Stock
Option Plan




On March 1, 2010, our Board of
Directors adopted the Lizhan Environmental Corporation 2010 Stock Option Plan,
or the 2010 Plan. We are authorized to issue up to 1,875,000 ordinary shares
under the 2010 Plan. No shares have been issued under the 2010 Plan to date. The
2010 Plan allows us to grant stock options to our officers, directors, and
executive, managerial, professional or administrative employees of ours or our
subsidiaries or joint ventures, and to our consultants. We refer to these
individuals collectively as key persons. Up to ten percent of our outstanding
ordinary shares may be issued under the 2010 Plan. The purpose of the 2010 Plan
is to provide certain key persons, on whose initiative and efforts the
successful conduct of our business depends, with incentives to: (a) enter into
and remain in our service, (b) acquire a proprietary interest in our success,
(c) maximize their performance and (d) enhance our long-term performance
(whether directly or indirectly through enhancing the long-term performance of a
subsidiary, joint venture or consultant.




The administrator of the 2010 Plan is
the compensation committee of our Board of Directors, or may be any other
committee appointed by the Board of Directors for that purpose. The
administrator has full power and authority to administer, construe and interpret
the 2010 Plan. Grants under the 2010 Plan will be governed by individualized
grant agreements and may be subject to either time-based or performance-based
vesting provisions.




The administrator establishes the terms
of stock options, subject to certain parameters set forth in the 2010 Plan. The
following are the general terms of stock options:




•The
exercise price must be at least equal to the par value of shares.




•The term
of a stock option may not exceed ten years from the date of grant.




•Unless
the administrator determines otherwise, if an option holder terminates
employment, his or her unvested options expire immediately and vested options
may be exercised during the three-month period following termination, after
which they will expire. If the employee terminates employment due to death or
disability, the three month period is extended to one year.




•Stock
options generally may not be transferred, except to immediate family
members.




•The 2010
Plan will automatically terminate on the fifth anniversary of the 2010 Plan’s
adoption. However,outstanding stock options will continue to be effective after
the 2010 Plan’s termination.




•Our
board of directors has the authority to amend, alter, suspend or terminate the
2010 Plan or any outstanding stock option. The consent of an option holder is
necessary for any amendment that would adversely affect an outstanding
option.




ITEM
      7.
            MAJOR
      SHAREHOLDERS AND RELATED PARTY
TRANSACTIONS




7.A.  Major
Shareholders




See Item
6.E., “Share Ownership,” for a description of our major
shareholders.




7.B.  Related
Party Transactions




Loans
Made by Related Parties




In April 2006, the company borrowed
$109,998 from Mr. Liu for settling the start-up expenses of the company. This
borrowing was repaid during April 2009. During the year ended September 30 2008,
the company borrowed $373,425 from Haining Jianfeng Textile Co., Ltd., a then
affiliate of ours that was owned and controlled by Mr. Liu, our Chairman and
Chief Executive Officer, for the purposes of settling the start-up expenses.
This borrowing was repaid in November and December of 2008.


61


In July 2009, Lizhan Textile borrowed
$51,252 from Mr. Liu, our Chairman and Chief Executive Officer, pursuant to an
interest free unsecured loan, for the purpose of settling a payable for purchase
of production equipment. The repayment was made in December 2009.




In September 2009, we borrowed $80,000
from Illigate, an entity that owns 59.4% of our outstanding shares and which is
wholly owned by Mr. Liu, our Chairman and Chief Executive Officer, pursuant to
an interest free unsecured loan, for the purpose of completing the
Reorganization of the Company in preparation for its proposed listing in the
U.S. The repayment was made in March 2010.




Purchase
from the Related Parties




In April 2008, Lizhan Textile purchased
certain materials at $47,486 from Haining Jianfeng Textile Co., Ltd., a then
affiliate of our company that was owned and controlled by Mr. Liu, our Chairman
and Chief Executive Officer. The trade payment was settled during the same
month.




Guarantees




During November 2009, we obtained two
loans aggregating $735,294 (RMB 5,000,000) from local banks. Mr. Liu, our
Chairman and Chief Executive Officer, has provided a personal guaranty for each
of these loans. The purpose of these loans is to fund our working capital and
construction and expansion. Local banks have required this personal guaranty
pursuant to their standard regulations. The annualized interest rate on these
loans was 5.589%. The term of these loans was five and six months respectively.
The loans were repaid in April and May 2010, respectively.




In May 2010, we obtained one loan in
the amount of $448,397 (RMB 3,000,000) from the same local bank. Mr. Liu
provided a personal guaranty for this loan. The local bank has required this
personal guaranty pursuant to its standard regulations. The annualized interest
rate on this loan was 6.1065%. The term of this loan was eight and one half
months.




Patent
Transfer




We
recently acquired from Mr. Liu seven Chinese patents. See “Business —
Intellectual Property” above.




Transfer
of 13% Interest in Hongzhan




On February 8, 2010, our subsidiary,
Resources, entered into a share transfer agreement with Eminent, which is wholly
owned by Liwen Zhang, a key employee of ours. Pursuant to this agreement, as
amended on February 10, 2010, Resources transferred a 13% equity interest in
Hongzhan to Eminent. In exchange for the 13% interest in Hongzhan, valued at
$650,000 (13% of the registered capital of Hongzhan), Liwen Zhang transferred to
Resources and Hongzhan two patents and one patent application related to our new
Evergreen Products in satisfaction of the $650,000 payment owed by Mr. Zhang
pursuant to the share transfer agreement. These patents were subsequently
transferred to Lizhan Textile in August 2010 subject to the approval by the
local State Intellectual Property Office of the PRC or SIPO. Lizhan Textile has
licensed the use of the patents to Hongzhan for no consideration. The license to
Hongzhan is subject to approval by the local SIPO.




Long
term exclusive license




On December 29, 2009, Hongzhan entered
into an exclusive long-term license agreement with Mr. Liwen Zhang, our Chief
Scientist and the sole owner of Eminent. Pursuant to the license agreement, Mr.
Liwen Zhang has licensed the Licensed Patents to us exclusively until 2024 in
exchange for license fees of RMB100,000 (or $14,650) for the first year,
RMB200,000 (or $29,300) for the second year, and RMB300,000 (or $43,950) for
each subsequent year. During the twelve months ended September 30, 2010, we
recognized a license fee expense of $11,021, which is included under our general
and administrative expenses.


62


Issuances
and Transfers of Ordinary Shares




On August 31, 2009, we issued
10,937,500 ordinary shares to Jianfeng Liu, our Chairman, for consideration of
approximately $3.5 million, which represented 100% of the total issued and
outstanding shares of the Company.




In December 2009 and January 2010, Mr.
Liu transferred all of these shares. See “Corporate Structure and Organization —
Our Shareholders” above.




On January 12, 2010, we issued 206,250
shares to Mr. Liu for a purchase price of approximately $4.80 per
share.




On September 14, 2010, we effectuated a
consolidation of every 1.6 ordinary shares in our authorized share capital into
one ordinary share. Upon the consolidation, every 1.6 ordinary shares were
consolidated into one ordinary share. As a result, the number of our authorized
shares comprising our authorized share capital of $10,000,000 was reduced from
50,000,000 to 31,250,000, the number of outstanding ordinary shares was reduced
from 17,830,000 to 11,143,750 in the aggregate, the par value of our ordinary
shares was increased from $0.20 per share to $0.32 per share and the number of
ordinary shares available under our stock option plan was reduced from 3,000,000
to 1,875,000. Any fractional share issued as a result of the reverse split was
rounded up.




On
November 19, 2010, we issued 2,500,000 ordinary shares pursuant to our
initial public offering at a price of $4.00 per share.  We received
net proceeds of approximately $7.5 million from the offering.




Transfers
of Shares in Connection with our Restructuring




On September 15, 2009, in connection
with our restructuring, Resources acquired 100% of the outstanding shares of
Lizhan Textile from Illigate for approximately $3.6 million. Resources and
Illigate are wholly owned by Mr. Liu.




Subsequently, on November 9, 2009,
Lizhan Environmental acquired 100% of the equity interest in Resources from Mr.
Liu in exchange for nominal consideration. As a result, Lizhan Environmental
owns 100% of Resources directly and 100% of Lizhan Textile indirectly thought
Resources.




7.C.  Interests
of Experts and Counsel




Not
applicable.




ITEM
      8.
            FINANCIAL
      INFORMATION




Consolidated
Statements and Other Financial Information




The
financial statements required by this item may be found at the end of this
report on 20-F.




Legal
Proceedings




We are not currently a party to any
material legal or administrative proceedings. We are not aware of any material
legal or administrative proceedings threatened against us. From time to time, we
are subject to various legal or administrative proceedings arising in the
ordinary course of our business.




Dividends




We have
never declared or paid any dividend on our ordinary shares and we do not
anticipate paying any dividends on our ordinary shares in the
future.  We currently intend to retain all future earnings to finance
our operations and to expand our business.


63


No
Significant Changes




No
significant changes to our financial condition have occurred since the date of
the annual financial statements contained herein.




ITEM
      9.
            THE
      OFFER AND LISTING




9.A.  Offer
and Listing Details




Our
ordinary shares are listed for trading on the Nasdaq global market under the
symbol “LZEN.”  The shares were began trading at $4.00 per ordinary
share on November 19, 2010.  The trading price for the ordinary shares
was $3.16 on January 28, 2011.




9.B.  Plan
of Distribution




Not
Applicable.




9.C.  Markets




Our
ordinary shares are currently traded on the Nasdaq Global Market.




9.D.
Selling Shareholders




Not
Applicable.




9.E.
Dilution




Not
Applicable.




9.F.
Expenses of the Issuer




Not
Applicable.




ITEM
      10.
            ADDITIONAL
      INFORMATION




10.A.  Share
Capital




Authorized/Issued
Capital and History of Share Capital




Not
Applicable.




Shares
Not Representing Capital




Not
Applicable.




Shares
Held By Company




Not
Applicable.




Resolutions/Authorizations/Approvals




Not
Applicable.


64


10.B.  Memorandum
and Articles of Association




Ordinary
Shares




General




Certificates
representing our ordinary shares are issued in registered form. Our shareholders
who are nonresidents of the Cayman Islands may freely hold and vote their
shares. We are currently authorized to issue 31,250,000 ordinary shares. We do
not have the power to issue bearer shares.




Meetings
of Shareholders




As an
exempted company incorporated in the Cayman Islands, the Company is not
obligated to hold an annual general meeting. The Company may in each year hold a
general meeting as its annual general meeting and shall specify the meeting as
such in the notices calling it. The annual general meeting shall be held as such
time and place as may be determined by the Directors.




The
directors may, and shall on the requisition of shareholders holding at least
10.0% of the issued shares of our company carrying voting rights at general
meetings, proceed to convene a general meeting of such shareholders. If the
directors do not within 21 days from the deposit of the requisition duly proceed
to convene a general meeting, which will be held within a further period of 21
days, the requisitioning shareholders, or any of them holding more than 50% of
the total voting rights of all of the requisitioning shareholders, may
themselves convene a general meeting. Any such general meeting must be convened
within three months after the expiration of such 21-day period.




Each
holder of ordinary shares is entitled to one vote on all matters upon which the
ordinary shares are entitled to vote on a show of hands or, on a poll, each
holder is entitled to have one vote for each share registered in his name on the
register of members. Voting at any meeting of shareholders is by show of hands
unless a poll is demanded. A poll may be demanded by the chairman of our board
of directors or by any shareholder present in person or by proxy.




A quorum
required for a meeting of shareholders consists of shareholders who hold at
least one-third of our ordinary shares in issue at the meeting present in person
or by proxy or, if a corporation or other non-natural person, by its duly
authorized representative. Shareholders’ meetings may be held annually and may
be convened by our board of directors on its own initiative or upon a request to
the directors by shareholders holding in aggregate at least 10.0% of the issued
shares of the Company as at the date of the deposit of the requisition carrying
the right of voting at general meetings of the Company. Advance notice of at
least 21 days is required for the convening of our annual general meeting and
other shareholders meetings.




An
ordinary resolution to be passed by the shareholders requires the affirmative
vote of a simple majority of the votes attaching to the ordinary shares cast in
a general meeting, while a special resolution requires the affirmative vote of
no less than two-thirds of the votes cast attaching to the ordinary shares. A
special resolution will be required for important matters such as a change of
name or making changes to our memorandum and articles of
association.




Dividends




The
holders of our ordinary shares are entitled to such dividends as may be declared
by our board of directors subject to the Companies Law.




According
to Article 19 of PRC law on Foreign-Funded Enterprises, dividends can be
remitted to holders of our ordinary shares abroad. Moreover, the new tax law
provides that an income tax rate of 20% will normally be applicable to dividends
payable to non-PRC investors, which are derived from sources within the PRC.
However, our PRC subsidiaries are held directly by Resources, and the treaty
between Hong Kong and Mainland China will apply. Pursuant to Article 10 of the
Arrangement between the Mainland China and the Hong Kong Special Administrative
Region for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion
with respect to Taxes on Income, dividends paid by a foreign-invested enterprise
in the Mainland China to a corporate shareholder in Hong Kong will only be
subject to withholding tax at a rate of 5% provided that such Hong Kong
corporate shareholder directly owns not less than 25% of the equity interests in
the foreign-invested enterprise distributing the dividends.


Transfer
of Shares




Subject
to the restrictions of our articles of association, as applicable, any of our
shareholders may transfer all or any of his or her ordinary shares by an
instrument of transfer in the usual form or common form or such other form
approved by the Board of Directors.


65




Our board
of directors may, in its absolute discretion, decline to register any transfer
of any ordinary share.




Our board
of directors may also decline to register any transfer of any ordinary share
unless:




•
            the
      instrument of transfer is lodged with us, accompanied by the certificate
      for the ordinary shares to which it relates and such other evidence as our
      board of directors may reasonably require to show the right of the
      transferor to make the transfer;




•
            the
      instrument of transfer is with respect to only one class of ordinary
      shares;




•
            the
      instrument of transfer is properly stamped, if
  required;




•
            in
      the case of a transfer to joint holders, the number of joint holders to
      whom the ordinary share is to be transferred does not exceed four;
      and




•
            the
      ordinary shares transferred are free of any lien in favor of
      us.




If our
directors refuse to register a transfer they shall, within two months after the
date on which the instrument of transfer was lodged, send to each of the
transferor and the transferee notice of such refusal.




The
registration of transfers may, on 14 days’ notice being given by advertisement
in such one or more newspapers or by electronic means, be suspended and the
register closed at such times and for such periods as our board of directors may
from time to time determine, provided, however, that the registration of
transfers shall not be suspended nor the register closed for more than 30 days
in any year.




Calls
on Shares




Our board
of directors may from time to time make calls upon shareholders for any amounts
unpaid on their shares in a notice served to such shareholders at least 14 days
prior to the specified time and place of payment. If a sum which has been called
is not paid before or on the appointed date, the persons subject to the call
shall pay interest upon the sum at the rate of eight percent per annum, but the
directors may waive the payment of interest either wholly or in part. The shares
that have been called and remain unpaid on the specified time of the notice are
subject to forfeiture.




Forfeiture
of Shares




Upon the
failure of payment of a call or installment of a call, our board of directors
may give notice of the unpaid call along with interest. Such notice shall name a
future day for payment of the call, which must be not earlier than the
expiration of fourteen days from the date of the notice. The notice shall state
that in the event of non-payment on or before the date stated in the notice, the
shares are liable to be forfeited. If the requirements of the notice are not met
by the shareholder, the share may be forfeited by a resolution of the directors
to that effect. A person whose shares have been forfeited shall cease to be a
holder of the shares, but shall continue to remain liable to pay to the Company
all monies which at the date of forfeiture were payable by him to the company in
respect of the shares forfeited. The shareholder’s liability shall cease if and
when the Company receives full payment of the amount unpaid on the shares
forfeited.




Redemption
of Shares




Subject
to the provisions of the Companies Law and our memorandum and articles of
association, we may issue shares on terms that they are subject to redemption at
our option or at the option of the holders, on such terms and in such manner as
may be determined before the issue of such shares by either the Board or by the
shareholders by Special Resolution.


66


Variations
of Rights of Shares




All or
any of the special rights attached to any class of shares may, subject to the
provisions of the Companies Law, be varied with the consent in writing of the
holders of not less than two-thirds of the issued shares of that class, or with
the sanction of a resolution passed at a general meeting of the holders of the
shares of that class by a majority of two-thirds of the votes cast at such a
meeting.




The
rights which are conferred upon the holders of any class of shares with
preferred or other rights shall not, subject to any rights or restrictions for
the time being attached to the shares of that class, be deemed to be varied by
the creation or issue of further shares ranking pari passu with the class of
shares.




Lien
on Shares




We shall
have a first and paramount lien on all shares for all amounts payable at a fixed
time or called in respect of that share. The board of directors may declare a
share to be wholly or partially exempt from a lien.




History
of Securities Issuances




Ordinary
Shares




On August
31, 2009, we issued 10,937,500 ordinary shares to Jianfeng Liu, our Chairman,
for consideration of approximately $3.5 million, which represented 100% of the
total issued and outstanding shares of the Company.




On
January 12, 2010, we issued 206,250 shares to Mr. Liu for a purchase price of
approximately $4.80 per share.




In
December 2009 and January 2010, Mr. Liu transferred all of these shares. See
“Corporate Structure and Organization — Our Shareholders”
above.




Material
Differences Between U.S. Corporate Law and Cayman Islands Corporate
Law




The
Companies Law differs from laws applicable to U.S. corporations and their
shareholders. Set forth below is a summary of the material differences between
the provisions of the Companies Law applicable to us and the laws applicable to
companies incorporated in the United States and their shareholders.




On
November 19, 2010, we issued 2,500,000 ordinary shares pursuant to our
initial public offering at a price of $4.00 per share.  We received
net proceeds of approximately $7.5 million from the offering.




Mergers
and Similar Arrangements




The
Companies Law permits mergers and consolidations between Cayman Islands
companies and between Cayman Islands companies and non-Cayman Islands companies.
For these purposes, (a) “merger” means the merging of two or more constituent
companies and the vesting of their undertaking, property and liabilities in one
of such companies as the surviving company and (b) a “consolidation” means the
combination of two or more constituent companies into a consolidated company and
the vesting of the undertaking, property and liabilities of such companies to
the consolidated company. In order to effect such a merger or consolidation, the
directors of each constituent company must approve a written plan of merger or
consolidation (a “Plan”), which must then be authorized by either:




(a)
            a
      special resolution of the shareholders of each constituent company voting
      together as one class if the shares to be issued to each shareholder in
      the consolidated or surviving company will have the same rights and
      economic value as the shares held in the relevant constituent company,
      or




(b)
            a
      shareholder resolution of each constituent company passed by a majority in
      number representing 75% in value of the shareholders voting together as
      one class.




The Plan
must be filed with the Registrar of Companies together with a declaration as to
the solvency of the consolidated or surviving company, a list of the assets and
liabilities of each constituent company and an undertaking that a copy of the
certificate of merger or consolidation will be given to the members and
creditors of each constituent company and published in the Cayman Islands
Gazette.


67


Dissenting
shareholders have the right to be paid the fair value of their shares (which, if
not agreed between the parties, will be determined by the Cayman Islands court)
if they follow the required procedures, subject to certain
exceptions.




Court
approval is not required for a merger or consolidation which is effected in
compliance with these statutory procedures.




There are
statutory provisions that facilitate the reconstruction and amalgamation of
companies, provided that the arrangement is approved by a majority in number of
each class of shareholders and creditors with whom the arrangement is to be
made, and who must in addition represent three-fourths in value of each such
class of shareholders or creditors, as the case may be, that are present and
voting either in person or by proxy at a meeting, or meetings, convened for that
purpose. The convening of the meetings and subsequently the arrangement must be
sanctioned by the Grand Court of the Cayman Islands. While a dissenting
shareholder has the right to express to the court the view that the transaction
ought not to be approved, the court can be expected to approve the arrangement
if it determines that:




•
            the
      company is not proposing to act illegally or beyond the scope of its
      authority and the statutory provisions as to the dual majority vote have
      been complied with;




•
            the
      shareholders have been fairly represented at the meeting in
      question;




•
            the
      arrangement is such that a businessman would reasonably approve;
      and




•
            the
      arrangement is not one that would more properly be sanctioned under some
      other provision of the Companies Law or that would amount to a “fraud on
      the minority.”




When a
take-over offer is made and accepted by holders of 90% of the shares within four
months, the offeror may, within a two-month period, require the holders of the
remaining shares to transfer such shares on the terms of the offer. An objection
can be made to the Grand Court of the Cayman Islands but this is unlikely to
succeed unless there is evidence of fraud, bad faith or collusion.




If the
arrangement and reconstruction are thus approved, the dissenting shareholder
would have no rights comparable to appraisal rights, which would otherwise
ordinarily be available to dissenting shareholders of U.S. corporations,
providing rights to receive payment in cash for the judicially determined value
of the shares.




Corporate
Governance




Cayman
Islands law does not restrict transactions with directors, requiring only that
directors exercise a duty of care and owe a fiduciary duty to the companies for
which they serve. Under our amended and restated memorandum and articles of
association, subject to any separate requirement for audit committee approval
under the applicable rules of the exchange on which we are listed, or unless
disqualified by the chairman of the relevant board meeting, so long as one of
our directors discloses the nature of his or her interest in any contract or
arrangement in which that director is interested, that director may vote in
respect of any contract or proposed contract or arrangement in which the
director is interested and may be counted in the quorum at such
meeting.




Shareholders’
Suits




The
Cayman Islands courts can be expected to follow English case law
precedents.




The
common law principles (namely the rule in Foss v. Harbottle and the exceptions
thereto) which permit a minority shareholder to commence a class action against
or derivative actions in the name of the Company to challenge:




•
            an
      act which is ultra vires the Company or
illegal,




•
            an
      act which constitutes a fraud against the minority where the wrongdoers
      are themselves in control of the Company,
and


68


•
            an
      action which requires a resolution with a qualified (or special) majority
      which has not been obtained) have been applied and followed by the courts
      in the Cayman Islands.




Exempted
Companies




The
Companies Law distinguishes between ordinary resident companies and exempted
companies. Any company that is registered in the Cayman Islands but conducts
business mainly outside of the Cayman Islands may apply to be registered as an
exempted company. The requirements for an exempted company are essentially the
same as for an ordinary company except for the exemptions and privileges listed
below:




•
            an
      exempted company does not have to file an annual return of its
      shareholders with the Registrar of
Companies;




•
            an
      exempted company is not required to open its register of members for
      inspection;




•
            an
      exempted company does not have to hold an annual general
      meeting;




•
            an
      exempted company may in certain circumstances issue negotiable or bearer
      shares or shares with no par value;




•
            an
      exempted company may obtain an undertaking against the imposition of any
      future taxation (such undertakings are usually given for twenty years in
      the first instance);




•
            an
      exempted company may register by way of continuation in another
      jurisdiction and be deregistered in the Cayman
  Islands;




•
            an
      exempted company may register as a limited duration company;
      and




•
            an
      exempted company may register as a segregated portfolio
      company.




10.C.  Material
Contracts




Employment
Agreements




We have
entered into an employment agreement with Jianfeng Liu, Angell Chang and Jianfu
Ma.  See Item 6.B - Compensation for a description of the employment
agreements.




10.D.  Exchange
Controls




Cayman
Islands




There are
no exchange control regulations imposed on us or our shareholders under Cayman
Islands law.




The
PRC




China
regulates foreign currency exchanges primarily through the following rules and
regulations:




·       Foreign
Currency Administration Rules of 1996, as amended; and




·       Administrative
Rules of the Settlement, Sale and Payment of Foreign Exchange of
1996.




As we
disclosed in the risk factors above, Renminbi is not a freely convertible
currency at present. Under the current PRC regulations, conversion of Renminbi
is permitted in China for routine current-account foreign exchange transactions,
including trade and service related foreign exchange transactions, payment of
dividends and service of foreign debts. Conversion of Renminbi for most
capital-account items, such as direct investments, investments in PRC securities
markets and repatriation of investments, however, is still subject to the
approval of SAFE.


69


Pursuant
to the above-mentioned administrative rules, foreign-invested enterprises may
buy, sell and/or remit foreign currencies for current account transactions at
banks in China with authority to conduct foreign exchange business by complying
with certain procedural requirements, such as presentment of valid commercial
documents. For capital-account transactions involving foreign direct investment,
foreign debts and outbound investment in securities and derivatives, approval
from SAFE is a pre-condition. Capital investments by foreign-invested
enterprises outside China are subject to limitations and requirements in China,
such as prior approvals from the PRC Ministry of Commerce or SAFE.




10.E.  Taxation




The
following summary of the material Cayman Islands, PRC and U.S. tax consequences
of an investment in our ordinary shares is based upon laws and relevant
interpretations thereof in effect as of the date of this annual report, all of
which are subject to change, possibly with retroactive effect. The discussion is
based on information provided to us by our legal counsel, whose legal opinions
have been filed as exhibits to the registration statement of which this
prospectus forms a part. The discussion is not intended to be, nor should it be
construed as, legal or tax advice to any prospective purchaser and is not
exhaustive of all possible tax considerations. This summary does not deal with
all possible tax consequences relating to an investment in our shares, such as
the tax consequences under state, local, non-U.S., non-PRC, and non-Cayman
Islands tax laws. You should consult your own tax advisors with respect to the
consequences of the acquisition, ownership and disposition of our
shares.




To the
extent that the discussion relates to matters of Cayman Islands tax law, it
represents the opinion of Maples and Calder, our Cayman Islands counsel. Based
on the facts and subject to the limitations set forth herein, the statements of
law or legal conclusions under the caption “— U.S. Federal Income Taxation”
constitute the opinion of Kramer Levin Naftalis & Frankel LLP, our special
U.S. counsel, as to the material U.S. federal income tax consequences of an
investment in our ordinary shares. Based on the facts and subject to the
limitations set forth herein, the statements of law or legal conclusions under
“— People’s Republic of China Taxation” constitute the opinion of Allbright Law,
our special PRC counsel, as to the material PRC tax consequences of an
investment in our ordinary shares.




Cayman
Islands Taxation




The
Cayman Islands currently levies no taxes on individuals or corporations based
upon profits, income, gains or appreciation and there is no taxation in the
nature of inheritance tax or estate duty. There are no other taxes likely to be
material to the company or its shareholders levied by the Government of the
Cayman Islands except for stamp duties which may be applicable on instruments
executed in, or brought within the jurisdiction of the Cayman Islands. The
Cayman Islands is not party to any double tax treaties that are applicable to
any payments made to or by the Company. There are no exchange control
regulations or currency restrictions in the Cayman Islands.




People’s
Republic of China Taxation




On March
16, 2007, the National People’s Congress approved and promulgated a new tax law
named “Enterprise Income Tax Law,” which took effect beginning January 1, 2008.
Under the Enterprise Income Tax Law, enterprises established under the laws of
non-PRC jurisdictions but whose “de facto management body” is located in the PRC
are treated as resident enterprises for PRC tax purposes. It is currently
unclear in which situation a non-PRC enterprise’s “de facto management body” is
deemed to be located in the PRC. Substantially all of our management is
currently based in the PRC, and may remain in the PRC after the effectiveness of
the new tax law. If we are treated as a resident enterprise for PRC tax
purposes, we will be subject to PRC tax on our worldwide income at a uniform tax
rate of 25%, which will include the dividend income we receive from our
subsidiaries. Although the new tax law provides that dividend income between
qualified resident enterprises is exempted income, it is unclear what is
considered to be a qualified resident enterprise under the new tax
law.




The
profit generated before January 1, 2008 and which is derived by a foreign
investor from a Chinese enterprise with foreign investment is exempted from
withholding tax in China according to the relevant Chinese laws and regulations.
The profit generated on and after January 1, 2008 and which is derived by a
foreign investor from a Chinese enterprise with foreign investment shall be
subject to a 10% withholding tax according to the relevant Chinese laws and
regulations. However, such withholding tax may be reduced as provided by any
applicable double taxation treaty.




The
Enterprise Income Tax Law provides that enterprise income tax shall be exempted
for dividends obtained by a resident enterprise from another resident enterprise
and dividends obtained by a non-resident enterprise from a resident enterprise
if the dividends are obtained in connection with a presence maintained by such
non-resident enterprise in China.


70


Our PRC
subsidiaries are held directly by Resources, and the tax arrangement between
Hong Kong and Mainland China will apply to dividends received by Resources from
our PRC subsidiaries. Pursuant to Article 10 of the Arrangement between the
Mainland China and the Hong Kong Special Administrative Region for the Avoidance
of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on
Income, dividends paid by a foreign-invested enterprise in the Mainland China to
a corporate shareholder in Hong Kong will only be subject to withholding tax at
a rate of 5% provided that such Hong Kong corporate shareholder directly owns
not less than 25% of the equity interests in the foreign-invested enterprise
distributing the dividends.




U.S.
Federal Income Taxation




The
following is a discussion of the material U.S. federal income tax considerations
relevant to an investment decision by a U.S. Holder or a Non-U.S. Holder, as
defined below, with respect to our ordinary shares. This discussion does not
purport to deal with the tax consequences of owning our ordinary shares to all
categories of investors, some of which (such as financial institutions,
regulated investment companies, real estate investment trusts, tax-exempt
organizations, insurance companies, persons holding our ordinary shares as part
of a hedging, integrated, conversion or constructive sale transaction or a
straddle, traders in securities that have elected the mark-to-market method of
accounting for their securities, persons liable for alternative minimum tax,
persons who are investors in pass-through entities, persons who own, actually or
under applicable constructive ownership rules, 10% or more of our ordinary
shares, U.S. expatriates, dealers in securities or currencies and investors
whose functional currency is not the U.S. dollar) may be subject to special
rules. This discussion deals only with holders who purchase ordinary shares and
hold the ordinary shares as a capital asset. Moreover, this discussion is based
on laws, regulations and other authorities in effect as of the date of this
report, all of which are subject to change, possibly with retroactive effect.
You are encouraged to consult your own tax advisors concerning the overall tax
consequences arising in your own particular situation under U.S. federal, state,
local or foreign law of the ownership of our ordinary shares.




For
purposes of this discussion, the term “U.S. Holder” means a beneficial owner of
our ordinary shares that is, for United States federal income tax purposes, (i)
an individual U.S. citizen or resident, (ii) a U.S. corporation or other U.S.
entity taxable as a corporation, (iii) an estate the income of which is subject
to U.S. federal income taxation regardless of its source, or (iv) a trust if
either (x) a court within the United States is able to exercise primary
jurisdiction over the administration of the trust and one or more U.S. persons
have the authority to control all substantial decisions of the trust, or (y) the
trust has a valid election in effect under applicable Treasury Regulations to be
treated as a U.S. person. If a U.S. partnership, or an entity treated for U.S.
federal income tax purposes as a partnership, such as a U.S. limited liability
company, holds ordinary shares, the tax treatment of a partner will depend on
the status of the partner and upon the activities of the partnership. If you are
a partner in such a partnership holding our ordinary shares, you are encouraged
to consult your tax advisor. A beneficial owner of our ordinary shares (other
than a partnership) that is not a U.S. Holder is referred to below as a
“Non-U.S. Holder.”




U.S.
Federal Income Taxation of U.S. Holders




Distributions




Subject
to the discussion of PFICs below, any distributions (other than certain
distributions of our ordinary shares or warrants to purchase our ordinary
shares) made by us with respect to our ordinary shares to a U.S. Holder will
constitute dividends to the extent of our current or accumulated earnings and
profits, as determined under U.S. federal income tax principles. Distributions
in excess of those earnings and profits will be treated first as a nontaxable
return of capital to the extent of the U.S. Holder’s tax basis in our ordinary
shares, and thereafter as capital gain. Because we are not a U.S. corporation,
U.S. Holders that are corporations will not be entitled to claim a
dividends-received deduction with respect to any distributions they receive from
us. Amounts taxable as dividends will be treated as foreign source “passive
income” for U.S. foreign tax credit purposes.




Dividends
paid on our ordinary shares to a U.S. Holder who is an individual, trust or
estate (a “U.S. Non-Corporate Holder”) will be treated as “qualified dividend
income” that is taxable to such U.S. Non-Corporate Holder at preferential tax
rates through 2010, provided that (1) our ordinary shares are readily tradable
on an established securities market in the United States (such as the Nasdaq
Global Market, on which we expect our ordinary shares will be traded); (2) we
are not a PFIC for the taxable year during which the dividend is paid or the
immediately preceding taxable year (which, as discussed below, we do not believe
will be the case); (3) the U.S. Non-Corporate Holder’s holding period of the
ordinary shares includes more than 60 days in the 121-day period beginning 60
days before the date on which the ordinary shares becomes ex-dividend; and (4)
the U.S. Non-Corporate Holder is not under an obligation to make related
payments with respect to positions in substantially similar or related property.
There is no assurance that (i) any dividends paid on our ordinary shares will be
eligible for these preferential rates in the hands of a U.S. Non-Corporate
Holder, or (ii) the preferential rate on dividends will not be repealed prior to
the scheduled expiration date or expire on such date. Any dividends we pay out
of earnings and profits which are not eligible for these preferential rates will
be taxed as ordinary income to a U.S. Non-Corporate Holder.


71


Special
rules apply to any “extraordinary dividend” — a dividend in an amount
which is equal to or in excess of 10% of a shareholder’s adjusted basis (or fair
market value in certain circumstances) in a share of our ordinary
shares — paid by us. If we pay an “extraordinary dividend” on our
ordinary shares that is treated as “qualified dividend income,” then,
notwithstanding the period during which the shares were held, any loss derived
by a U.S. Non-Corporate Holder from the sale or exchange of such ordinary shares
will be treated as long-term capital loss to the extent of such
dividend.




Impact
of New Legislation on Ownership and Disposition of Ordinary Shares




Newly
enacted legislation requires certain U.S. Holders that are individuals, estates
or trusts to pay an additional 3.8% tax on, among other things, dividends on and
capital gains from the sale or other disposition of stock for taxable years
beginning after December 31, 2012. U.S. Holders should consult their tax
advisors regarding the effect, if any, of this legislation on their ownership
and disposition of our ordinary shares.




Sale,
Exchange or Other Disposition of Ordinary Shares




Subject
to the discussion of PFICs below, a U.S. Holder will recognize taxable gain or
loss upon a sale, exchange or other taxable disposition of our ordinary shares
in an amount equal to the difference between the amount realized by the U.S.
Holder from such disposition and the U.S. Holder’s tax basis in such stock. Such
gain or loss will be treated as long-term capital gain or loss if the U.S.
Holder’s holding period is greater than one year at the time of the disposition.
Such capital gain or loss will generally be treated as U.S. source income or
loss, as applicable, for U.S. foreign tax credit purposes. Long-term capital
gains of U.S. Non-Corporate Holders are eligible for reduced rates of taxation.
A U.S. Holder’s ability to deduct capital losses is subject to certain
limitations.




Passive
Foreign Investment Company Status and Significant Tax Consequences




We will
be a passive foreign investment company (a “PFIC”) if either:




•
            75%
      or more of our gross income in a taxable year consists of “passive income”
      (including dividends, interest, gains from the sale or exchange of
      investment property and rents and royalties other than rents and royalties
      which are received from unrelated parties in connection with the active
      conduct of a trade or business, as defined in applicable Treasury
      regulations); or




•
            at
      least 50% of our assets in a taxable year (averaged over the year and
      generally determined based upon value) produce or are held for the
      production of passive income.




We do not
believe that we were a PFIC for the years ended September 30, 2009 or September
30, 2010 nor do we currently anticipate that we will be a PFIC for the current
fiscal year based upon our estimates of the values of our assets. However,
because PFIC status is based on the composition of our income and assets for the
entire taxable year, it is not possible to determine whether we will become a
PFIC for the current year until after the close of the year. Therefore, we may
become a PFIC for the year ending September 30, 2011 or in any future taxable
year.




If we
were to be treated as a PFIC for any taxable year (and regardless of whether we
remain a PFIC for subsequent taxable years), each U.S. Holder who is treated as
owning our stock for purposes of the PFIC rules would be liable to pay U.S.
federal income tax at the highest applicable income tax rates on ordinary income
upon the receipt of excess distributions (i.e., the portion of any distributions
received by the U.S.




Holder on
our ordinary shares in a taxable year in excess of 125 percent of the average
annual distributions received by the U.S. Holder in the three preceding taxable
years, or, if shorter, the U.S. Holder’s holding period for the ordinary shares)
and on any gain from the disposition of our ordinary shares, plus interest on
such amounts, as if such excess distributions or gain had been recognized
ratably over the U.S. Holder’s holding period of our ordinary
shares.




The above
rules relating to the taxation of excess distributions and dispositions will not
apply to a U.S. Holder who has made a timely “qualified electing fund” (“QEF”)
election for all taxable years that the holder has held our ordinary shares and
we were a PFIC. Instead, each U.S. Holder who has made a timely QEF election is
required for each taxable year to include in income a pro rata share of our
ordinary earnings as ordinary income and a pro rata share of our net capital
gain as long term capital gain, regardless of whether we have made any
distributions of the earnings or gain. The U.S. Holder’s basis in our ordinary
shares will be increased to reflect taxed but undistributed income.
Distributions of income that had been previously taxed will result in a
corresponding reduction in the basis of the ordinary shares and will not be
taxed again once distributed. A U.S. Holder making a QEF election would
recognize capital gain or loss on the sale, exchange or other disposition of our
ordinary shares. If we determine that we are a PFIC for any taxable year, we may
provide each U.S. Holder with all necessary information in order to make the QEF
election described above.


72


Alternatively,
if we were to be treated as a PFIC for any taxable year and provided that our
ordinary shares is treated as “marketable,” which we believe will be the case, a
U.S. Holder may make a mark-to-market election. Under a mark-to-market election,
any excess of the fair market value of the ordinary shares at the close of any
taxable year over the U.S. Holder’s adjusted tax basis in the ordinary shares is
included in the U.S. Holder’s income as ordinary income. In addition, the
excess, if any, of the U.S. Holder’s adjusted tax basis at the close of any
taxable year over the fair market value of the ordinary shares is deductible in
an amount equal to the lesser of the amount of the excess or the amount of the
net mark-to-market gains that the U.S. Holder included in income in prior years.
A U.S. Holder’s tax basis in its ordinary shares would be adjusted to reflect
any such income or loss. Gain realized on the sale, exchange or other
disposition of our ordinary shares would be treated as ordinary income, and any
loss realized on the sale, exchange or other disposition of the ordinary shares
would be treated as ordinary loss to the extent that such loss does not exceed
the net mark-to-market gains previously included by the U.S.
Holder.




A U.S.
Holder who holds our ordinary shares during a period when we are a PFIC will be
subject to the foregoing rules for that taxable year and all subsequent taxable
years with respect to that U.S. Holder’s holding of our ordinary shares, even if
we cease to be a PFIC, subject to certain exceptions for U.S. Holders who made a
mark-to-market or QEF election. U.S. Holders are urged to consult their tax
advisors regarding the PFIC rules, including as to the advisability of choosing
to make a QEF or mark-to-market election.




U.S.
Federal Income Taxation of Non-U.S. Holders




Non-U.S.
Holders will not be subject to U.S. federal income tax or withholding tax on
dividends received from us on our ordinary shares unless the income is
effectively connected with the conduct by the Non-U.S. Holder of a trade or
business in the United States (“effectively connected income”) (and, if an
income tax treaty applies, the income is attributable to a permanent
establishment maintained by the Non-U.S. Holder in the United
States).




Non-U.S.
Holders will not be subject to U.S. federal income tax or withholding tax on any
gain realized upon the sale, exchange or other disposition of our ordinary
shares, unless either:




•
            the
      gain is effectively connected income (and, if a treaty applies, the gain
      is attributable to a permanent establishment maintained by the Non-U.S.
      Holder in the United States); or




•
            the
      Non-U.S. Holder is an individual who is present in the United States for
      183 days or more during the taxable year of disposition and certain other
      conditions are met.




Effectively
connected income will be subject to regular U.S. federal income tax in the same
manner as discussed in the section above relating to the taxation of U.S.
Holders, unless exempt under an applicable income tax treaty. In addition,
earnings and profits of a corporate Non-U.S. Holder that are attributable to
such income, as determined after allowance for certain adjustments, may be
subject to an additional branch profits tax at a rate of 30%, or at a lower rate
as may be specified by an applicable income tax treaty.




Non-U.S.
Holders may be subject to tax in jurisdictions other than the United States on
dividends received from us on our ordinary shares and on any gain realized upon
the sale, exchange or other disposition of our ordinary shares.




Backup
Withholding and Information Reporting




Payments
of distributions on, and the proceeds of a disposition of, our ordinary shares
will be subject to U.S. federal income tax information reporting requirements if
you are a Non-Corporate U.S. Holder. We will also be required to withhold U.S.
federal backup withholding tax from such payments if you are a Non-Corporate
U.S. Holder and you:




•
            fail
      to provide us with an accurate taxpayer identification
    number;




•
            are
      notified by the IRS that you have failed to report all interest or
      dividends required to be shown on your federal income tax returns;
      or




•
            fail
      to comply with applicable certification
  requirements.


73


Non-U.S.
Holders will be subject to information reporting with respect to distributions
on our ordinary shares. Non-U.S. Holders who are not otherwise exempt will be
required to establish their exemption from information reporting on proceeds of
a disposition of our ordinary shares and from backup withholding by certifying
their status on IRS Form W-8BEN, W-8ECI or W-8IMY, as applicable.




Backup
withholding tax is not an additional tax. Rather, you may obtain a refund of any
amounts withheld under backup withholding rules that exceed your income tax
liability by timely filing a refund claim with the IRS in accordance with
applicable requirements.




Stamp
Taxes




If you
purchase our ordinary shares offered in this prospectus, you may be required to
pay stamp taxes and other charges under the laws and practices of the country of
purchase, in addition to the offering price listed on the cover page of this
prospectus.




10.F.  Dividends
and Paying Agents




The
Company has no current plans to pay dividends. The Company does not currently
have a paying agent.




10.G.  Statement
by Experts




The
consolidated financial statements of the Company as of September 30, 2010, and
2009 and for the fiscal periods ended September 30, 2010, and 2009, included
herein, have been audited by UHY Vocation HK CPA Limited independent registered
public accounting firm, as stated in their report appearing herein, and is
included in reliance upon the report of such firm given upon their authority as
experts in accounting and auditing and their consent and
authorization.




10.H.  Documents
on Display




The Company’s documents can be viewed
at its headquarters, located at No. 716, Qifu Road, Wutong Street, Tongxiang
Zhejiang Province, 314500, People’s Republic of China. The Company is subject to
the informational requirements of the Securities Exchange Act of 1934, as
amended, and will file reports, registration statements and other information
with the SEC. The Company’s reports, registration statements and other
information can be inspected on the SEC’s website at www.sec.gov and such
information can also be inspected and copies ordered at the public reference
facilities maintained by the SEC at the following location: 100 F Street NE,
Washington, D.C.  20549.





10.I.
Subsidiary Information




Not
Applicable.




ITEM
      11.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK




Financial instruments that expose us to
concentrations of credit risk primarily consist of cash and accounts
receivables. The maximum amount of loss due to credit risk in the event of other
parties failing to perform their obligations is represented by the carrying
amount of each financial asset as stated in our consolidated balance
sheets.





As of September 30, 2010 and 2009,
substantially all of our cash included bank deposits in accounts maintained
within the PRC where there is currently no rule or regulation in place for
obligatory insurance to cover bank deposits in the event of bank failure.
However, we have not experienced any losses in such accounts and we believe we
are not exposed to any significant risks on our cash in bank
accounts.





We are exposed to various types of
market risks, including changes in foreign exchange rates, commodity prices and
inflation in the normal course of business.


74


Interest
rate risk





We are subject to risks resulting from
fluctuations in interest rates on our bank balances. A substantial portion of
our cash is held in China in interest bearing bank deposits and denominated in
RMB. To the extent that we may need to raise debt financing in the future,
upward fluctuations in interest rates would increase the cost of new debt. We do
not currently use any derivative instruments to manage our interest rate
risk.





Commodity
price risk





Certain raw materials used by us are
subject to price volatility caused by supply conditions, political and economic
variables and other unpredictable factors. The primary purpose of our commodity
price management activities is to manage the volatility associated with
purchases of commodities in the normal course of business. We do not speculate
on commodity prices.





Foreign
exchange risk





We carry out most of our transactions
in RMB. Therefore, we have limited exposure to foreign exchange fluctuations.
The RMB is not a freely convertible currency. The PRC government may take
actions that could cause future exchange rates to vary significantly from
current or historical exchange rates. Fluctuations in exchange rates may
adversely affect the value of any dividends we declare.





Very limited hedging transactions are
available in China to reduce our exposure to exchange rate fluctuations. To
date, we have not entered into any hedging transactions in an effort to reduce
our exposure to foreign currency exchange risk. While we may enter into hedging
transactions in the future, the availability and effectiveness of these
transactions may be limited, and we may not be able to successfully hedge our
exposure at all. In addition, our foreign currency exchange losses may be
magnified by PRC exchange control regulations that restrict our ability to
convert RMB into foreign currencies.





Inflation
risk





In recent years, China has not
experienced significant inflation or deflation and thus inflation and deflation
have not had a significant effect on our business during the past three years.
According to the National Bureau of Statistics of China, inflation as measured
by the consumer price index in China was 1.5%, 4.8%, 5.9% and (0.1)% and 2.2% in
2006, 2007, 2008 and 2009, respectively. Inflationary factors such as increases
in the cost of our products and overhead costs may adversely affect our
operating results. A high rate of inflation in the future may have an adverse
effect on our ability to maintain current levels of gross margin and selling,
general and administrative expenses as a percentage of net revenues if the
selling prices of our products do not increase proportionately with these
increased costs. However, subsequent to September 30, 2010, China has
experienced inflation, which may have an effect on our future
results.





ITEM
      12.
            DESCRIPTION
      OF SECURITIES OTHER THAN EQUITY
SECURITIES




Not
Applicable.




ITEM
      13.
            DEFAULTS,
      DIVIDEND ARREARAGES AND
DELINQUENCIES




Not
Applicable.




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




Not
Applicable.




ITEM
      15.
            CONTROLS
      AND PROCEDURES




(a)           Disclosure
Controls and Procedures


75




The
Company performed an evaluation of the effectiveness of its disclosure controls
and procedures that are designed to ensure that the material financial and
non-financial information required to be disclosed to the SEC is recorded,
processed, summarized and reported timely. Based on the Company’s evaluation,
the Company’s management, including the CEO and CFO, has concluded that the
Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) of the Securities Exchange Act of 1934, as amended) as of the end of
the period covered by this report are effective. Notwithstanding the foregoing,
there can be no assurance that the Company’s disclosure controls and procedures
will detect or uncover all failures of persons within the Company to disclose
material information otherwise required to be set forth in the Company’s
reports.




(b)           Management’s
Report on Internal Control Over Financial Reporting




This
annual report does not include a report of management’s assessment regarding
internal control over financial reporting or an attestation report of the
company’s registered public accounting firm due to a transition period
established by rules of the Securities and Exchange Commission for newly public
companies.




ITEM
      16.
            RESERVED




ITEM
      16A.
            AUDIT
      COMMITTEE FINANCIAL EXPERT




Our audit committee consists of Johnson
Lau, Jianlun Tu and Jiancheng Sun. Our board of directors has determined that
Johnson Lau, Jianlun Tu and Jiancheng Sun are “independent directors” within the
meaning of Nasdaq Stock Market Rule 5605(a)(2) and meet the criteria for
independence set




forth in
Rule 10A−3(b) of the Exchange Act. Johnson Lau meets the criteria of an audit
committee financial expert as set forth under the applicable rules of the
SEC.




ITEM
      16B.
            CODE
      OF ETHICS




Our board
of directors has adopted a code of business conduct and ethics. Our code of
business conduct and ethics are publicly available on our website at http://www.lzencorp.com.




ITEM
16C.          PRINCIPAL
ACCOUNTING FEES AND SERVICES





Year Ended
                                September 30, 2010Audit
      fees(1)
                              
                              $
                              95,000Audit-related
      fees(2)
                              
                              $
                              235,000Tax
      fees(3)
                              
                              
                              —





(1)
            “Audit
      fees” means the aggregate fees billed in each of the fiscal years listed
      for professional services rendered by our principal auditors for the
      audits of our annual financial statements in
  2010.




(2)
            “Audit-related
      fees” means the aggregate fees billed in each of the fiscal years listed
      for assurance and related services by our principal auditors that are
      reasonably related to the performance of the audit or review of our
      financial statements and are not reported under “Audit Fees.” Services
      comprising the fees disclosed under the category of “Audit-Related Fees”
      in 2010 involve principally the issue of comfort lettersand the rendering of listing advice in
      connection with our initial public offering,
      including the audit or review of financial statements from 2007 to 2009,
      the review of SEC filings and the review of interim financial
      statements.




(3)
            “Tax
      fees” means the fees billed for tax compliance services, including the
      preparation of tax returns and tax consultations, such as tax advice
      related to employee share-based
compensation.




The
policy of our audit committee and our board of directors is to pre-approve all
audit and non-audit services provided by UHY Vocation HK CPA Limited, including
audit services, audit-related services, and other services as described above,
other than those for de minimis services which are approved by the audit
committee or our board of directors prior to the completion of the
services.




76





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




Not
Applicable.




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




Not
Applicable.




ITEM
      16F.
            CHANGE
      IN REGISTRANT’S CERTIFYING
ACCOUNTANT




Not
Applicable.




ITEM
      16G.
            CORPORATE
      GOVERNANCE




Our
ordinary shares are listed on the Nasdaq Global Market, or Nasdaq. As such, we
are subject to corporate governance requirements imposed by the Nasdaq. Under
Nasdaq rules, listed non-US companies such as ourselves may, in general, follow
their home country corporate governance practices in lieu of some of the Nasdaq
corporate governance requirements. A Nasdaq-listed non-US company is simply
required to provide a general summary of the significant differences to its US
investors either on the company website or in its annual report distributed to
its US investors. We are committed to a high standard of corporate governance.
As such, we endeavor to comply with the Nasdaq corporate governance practices
and there is no significant difference between our corporate governance
practices and what the Nasdaq requires of domestic U.S. companies.




77




PART
III




ITEM
      17.
            FINANCIAL
      STATEMENTS




Not
applicable.




ITEM
      18.
            FINANCIAL
      STATEMENTS




The
consolidated financial statements and related notes required by this item are
contained on pages F-1 through F-34.




ITEM
      19.
            EXHIBITS




Exhibit
                  Number
                
                Description of Documents1.1
                
                Amended
      and Restated Memorandum and Articles of Association (2)2.1
                
                Form
      of Underwriter’s Warrant (2)2.2
                
                Form
      of Ordinary Share Certificate (2)4.1
                
                Lizhan
      Environmental Corporation 2010 Stock Option Plan (2)4.2
                
                Share
      Transfer Agreement, dated February 8, 2010, between Resources and Eminent.
      (2)4.3
                
                Patent
      Transfer Agreement, dated February 10, 2010, between Liwen Zhang and
      Resources with respect to the Share Transfer Agreement (2)4.4
                
                Equipment
      Transfer Agreement, dated June 26, 2008 (2)4.5
                
                Employment
      Agreement entered into by the Company and Jianfeng Liu (2)4.6
                
                Employment
      Agreement entered into by the Company and Jianfu Ma (2)4.7
                
                Employment
      Agreement entered into by the Company and Jianrong You (2)4.8
                
                Patent
      Rights Transfer Agreement, dated March 9, 2010, between Jianfeng Liu and
      the Company (2)4.9
                
                Equity
      Transfer Agreement, dated September 15, 2009, between Illigate Development
      Ltd. and Li Zhan Resources Recycling Technology Development Co., Ltd.
      (2)4.10
                
                Amended
      and Restated Employment Agreement dated September 15, 2010, entered into
      by the Company and Angell Chang (2)4.11
                
                Sales
      Agreement, dated August 20, 2010, between Hongzhan and Zhejiang Miluo
      Furniture Co., Ltd. (2)4.12
                
                Sales
      Agreement, dated August 20, 2010 (2)4.13
                
                Sales
      Agreement, dated August 20, 2010 (2)4.14
                
                Sales
      Agreement, dated August 20, 2010 (2)4.15
                
                Sales
      Agreement, dated August 20, 2010 (2)8.1
                
                Subsidiaries
      of the Registrant (2)12.1
                
                Sarbanes-Oxley
      Section 302 Certification for Chief Executive Officer (1)12.2
                
                Sarbanes-Oxley
      Section 302 Certification for Chief Financial Officer (1)13.1
                
                Sarbanes-Oxley
      Section 906 Certification for Chief Executive Officer (1)13.2
                
                Sarbanes-Oxley
      Section 906 Certification for Chief Financial Officer (1)




(1)
            Attached
      hereto.




(2)
            Incorporated
      by reference to the registrant’s registration statement filed with the
      U.S. Securities and Exchange Commission on August 19, 2010, as
      amended.


78


SIGNATURES




The
registrant hereby certifies that it meets all of the requirements for filing on
Form 20-F and that it has duly caused and authorized the undersigned to sign
this registration statementon its
behalf.




LIZHAN
      ENVIRONMENTAL CORPORATION/s/  Jianfeng
  LiuName:
      Jiangfeng LiuTitle:
      Chief Executive Officer


Date:
February 1, 2011


79


LIZHAN
ENVIRONMENTAL CORPORATION




INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS




PageReport
      of Independent Registered Public Accounting Firm
                  F-2Consolidated
      Balance Sheets as of September 30, 2010 and 2009
                  F-3Consolidated
      Statements of Income and Comprehensive Income for the Years Ended
      September 30, 2010 and 2009
                  F-4Consolidated
      Statement of Changes in Stockholders’ Equity for the Years Ended September
      30, 2010 and 2009
                  F-5Consolidated
      Statements of Cash Flows for the Years Ended September 30, 2010 and
      2009
                  F-6Notes
      to the Consolidated Financial Statements
                  F-7
      to F-34


F-1




REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM




TO THE
STOCKHOLDERS AND BOARD OF DIRECTORS OF


LIZHAN
ENVIRONMENTAL CORPORATION




We have
audited the accompanying consolidated balance sheets of Lizhan Environmental
Corporation and Subsidiaries (collectively the “Company”) as of September 30,
2010 and 2009, and the related consolidated statements of income and
comprehensive income, changes in stockholders’ equity and cash flows for the two
years then ended. These consolidated financial statements are the responsibility
of the Company’s management. Our responsibility is to express an opinion on
these financial statements based on our audits.




We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the 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 included 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 includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
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 consolidated financial positions of Lizhan
Environmental Corporation and Subsidiaries as of September 30, 2010 and 2009,
the consolidated results of its operations and its consolidated cash flows for
the two years then ended, in conformity with accounting principles generally
accepted in the United States of America.




UHY
VOCATION HK CPA LIMITED


Certified
Public Accountants




Hong
Kong, the People’s Republic of China,


January
31, 2011


F-2


LIZHAN
ENVIRONMENTAL CORPORATION




CONSOLIDATED
BALANCE SHEETS




(IN
U.S. DOLLARS)




As
      of September 30,2010
                            
                            
                            2009AssetsCurrent
      assetsCash
                            
                            $
                            2,597,366
                            
                            
                            $
                            864,162Restricted
      cash
                            
                            
                            1,072,416
                            
                            
                            
                            1,972,470Accounts
      receivable, net
                            
                            
                            7,310,194
                            
                            
                            
                            4,327,232Inventories
                            
                            
                            4,666,496
                            
                            
                            
                            3,472,276Amounts
      due from directors
                            
                            
                            1,497
                            
                            
                            
                            -Value
      added tax receivable
                            
                            
                            37,586
                            
                            
                            
                            372,094Prepaid
      expenses and other current assets
                            
                            
                            2,442,120
                            
                            
                            
                            391,833Total
      current assets
                            
                            
                            18,127,675
                            
                            
                            
                            11,400,067Other
      assetsProperty,
      plant and equipment, net
                            
                            
                            12,906,655
                            
                            
                            
                            8,392,188Land
      use rights
                            
                            
                            1,638,248
                            
                            
                            
                            1,013,311Intangible
      assets, net
                            
                            
                            628,333
                            
                            
                            
                            -Deposits
      for plant and equipment
                            
                            
                            11,385,603
                            
                            
                            
                            120,750Total
      other assets
                            
                            
                            26,558,839
                            
                            
                            
                            9,526,249Total
      assets
                            
                            $
                            44,686,514
                            
                            
                            $
                            20,926,316Liabilities
      and stockholders' equityCurrent
      liabilitiesAccounts
      payable
                            
                            $
                            8,158,461
                            
                            
                            $
                            4,765,776Bank
      acceptance notes payable
                            
                            
                            2,144,832
                            
                            
                            
                            4,198,272Short-term
      loans
                            
                            
                            13,676,108
                            
                            
                            
                            2,342,949Accrued
      expenses and other payables
                            
                            
                            1,251,849
                            
                            
                            
                            313,778Payable
      for construction of building and machinery
                            
                            
                            297,153
                            
                            
                            
                            296,267Due
      to a stockholder and director
                            
                            
                            -
                            
                            
                            
                            51,252Amount
      due to related companies
                            
                            
                            -
                            
                            
                            
                            80,000Income
      taxes payable
                            
                            
                            702,713
                            
                            
                            
                            -Deferred
      income
                            
                            
                            110,106
                            
                            
                            
                            755,113Total
      current liabilities
                            
                            
                            26,341,222
                            
                            
                            
                            12,803,407Total
      liabilities
                            
                            
                            26,341,222
                            
                            
                            
                            12,803,407Stockholders'
      equityCommon
      stock, $0.32 par; 31,250,000 shares authorized, 11,143,750 shares and10,937,500
      shares issued and outstanding as at September 30, 2010 and 2009,
      respectively
                            
                            
                            3,566,000
                            
                            
                            
                            3,500,000Additional
      paid-in capital
                            
                            
                            924,000
                            
                            
                            
                            -Statutory
      reserves
                            
                            
                            1,289,475
                            
                            
                            
                            422,321Retained
      earnings
                            
                            
                            11,053,506
                            
                            
                            
                            3,734,553Accumulated
      other comprehensive income
                            
                            
                            888,532
                            
                            
                            
                            466,035Total
      Lizhan stockholders’ equity
                            
                            
                            17,721,513
                            
                            
                            
                            8,122,909Non-controlling
      interest
                            
                            
                            623,779
                            
                            
                            
                            -Total
      equity
                            
                            
                            18,345,292
                            
                            
                            
                            8,122,909Total
      liabilities and stockholders' equity
                            
                            $
                            44,686,514
                            
                            
                            $
                            20,926,316




See
accompanying notes to consolidated financial statements.


F-3


LIZHAN
ENVIRONMENTAL CORPORATION




CONSOLIDATED
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME




(IN
U.S. DOLLARS)




For
      the Year Ended September 30,2010
                
                
                2009NET
      SALES
                
                $
                46,321,225
                
                
                $
                21,612,541Cost
      of sales
                
                
                (35,042,898
                )
                
                
                (17,868,408
                )Gross
      profit
                
                
                11,278,327
                
                
                
                3,744,133Operating
      expenses:General
      and administrative expenses
                
                
                (2,110,506
                )
                
                
                (1,053,752
                )Research
      and development expenses
                
                
                (136,398
                )
                
                
                (64,991
                )Selling
      and marketing expenses
                
                
                (634,544
                )
                
                
                (322,133
                )Total
      operating expenses
                
                
                (2,881,448
                )
                
                
                (1,440,876
                )Operating
      income
                
                
                8,396,879
                
                
                
                2,303,257Other
      income (expenses):Other
      income
                
                
                1,139,445
                
                
                
                610,548Exchange
      loss
                
                
                (49,788
                )
                
                
                (24,963
                )Interest
      income
                
                
                26,721
                
                
                
                19,972Interest
      expense
                
                
                (300,609
                )
                
                
                (166,186
                )Other
      expenses, net
                
                
                (142,419
                )
                
                
                (11,330
                )Total
      other income , net
                
                
                673,350
                
                
                
                428,041Income
      before income taxes
                
                
                9,070,229
                
                
                
                2,731,298Income
      tax expense
                
                
                (912,249
                )
                
                
                -Net
      income before allocation of non-controlling interest
                
                
                8,157,980
                
                
                
                2,731,298Net
      loss attributable to non-controlling interest
                
                
                28,127
                
                
                
                -Net
      income attributable to the Company
                
                
                8,186,107
                
                
                
                2,731,298Other
      comprehensive income (loss)Foreign
      currency translation adjustment
                
                
                422,497
                
                
                
                (6,026
                )8,608,604
                
                
                
                2,725,272Less:
      Foreign currency translation adjustments attributable to
      non-controlling interest
                
                
                (1,906
                )
                
                
                -Comprehensive
      income
                
                $
                8,606,698
                
                
                $
                2,725,272Earnings
      per common share-
      Basic and fully diluted
                
                $
                0.74
                
                
                $
                0.25Weighted
      average number of common shares outstanding-
      Basic and fully diluted
                
                
                11,084,983
                
                
                
                10,937,500




See
accompanying notes to consolidated financial statements.


F-4


LIZHAN
ENVIRONMENTAL CORPORATION




CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY




FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(IN
U.S. DOLLARS)




(Accumulated
                          
                          
                          AccumulatedAdditional
                          
                          
                          
                          
                          
                          
                          
                          
                          Losses)
                          
                          
                          Other
                          
                          
                          Non-Common
      stock
                          
                          
                          Paid-in
                          
                          
                          Subscription
                          
                          
                          Statutory
                          
                          
                          Retained
                          
                          
                          Comprehensive
                          
                          
                          ControllingNumber
                          
                          
                          Amount
                          
                          
                          Capital
                          
                          
                          Receivable
                          
                          
                          Reserves
                          
                          
                          Earnings
                          
                          
                          Income
                          
                          
                          Interest
                          
                          
                          TotalBalance
      as of October 1, 2008
                          
                          
                          10,937,500
                          
                          
                          $
                          3,500,000
                          
                          
                          $
                          -
                          
                          
                          $
                          (690,552
                          )
                          
                          $
                          148,514
                          
                          
                          $
                          1,277,062
                          
                          
                          $
                          472,061
                          
                          
                          
                          -
                          
                          
                          $
                          4,707,085Contribution
      of cash by stockholders
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          690,552
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          690,552Net
      income
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          2,731,298
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          2,731,298Foreign
      currency translation adjustment
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          (6,026
                          )
                          
                          
                          -
                          
                          
                          
                          (6,026
                          )Appropriations
      to statutory reserves
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          273,807
                          
                          
                          
                          (273,807
                          )
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -Balance
      as of September 30, 2009
                          
                          
                          10,937,500
                          
                          
                          
                          3,500,000
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          422,321
                          
                          
                          
                          3,734,553
                          
                          
                          
                          466,035
                          
                          
                          
                          -
                          
                          
                          
                          8,122,909Sale
      of 206,250 shares of common stock at $4.80 per share
                          
                          
                          206,250
                          
                          
                          
                          66,000
                          
                          
                          
                          924,000
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          990,000Disposal
      of  13% interest in a subsidiary in exchange for patents pending
      (note 1)
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          650,000
                          
                          
                          
                          650,000Net
      income/ (loss)
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          8,186,107
                          
                          
                          
                          -
                          
                          
                          
                          (28,127
                          )
                          
                          
                          8,157,980Appropriations
      to statutory reserves
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          867,154
                          
                          
                          
                          (867,154
                          )
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -Foreign
      currency translation adjustment
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          422,497
                          
                          
                          
                          1,906
                          
                          
                          
                          424,403Balance
      as of September 30, 2010
                          
                          
                          11,143,750
                          
                          
                          $
                          3,566,000
                          
                          
                          $
                          924,000
                          
                          
                          
                          -
                          
                          
                          $
                          1,289,475
                          
                          
                          $
                          11,053,506
                          
                          
                          $
                          888,532
                          
                          
                          $
                          623,779
                          
                          
                          
                          18,345,292




See
accompanying notes to consolidated financial statements.


F-5


LIZHAN
ENVIRONMENTAL CORPORATION


CONSOLIDATED
STATEMENTS OF CASH FLOWS




(IN
U.S. DOLLARS)




For the Year ended
                  September 30,2010
                
                
                2009Cash
      flows from operating activities:Net
      income
                
                $
                8,157,980
                
                
                $
                2,731,298Less
      net loss attributable to noncontrolling interest
                
                
                28,127
                
                
                
                -Net
      income attributable to the Company
                
                
                8,186,107
                
                
                
                2,731,298Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
      of property, plant and equipment
                
                
                693,653
                
                
                
                505,340Amortization
      of intangible assets
                
                
                21,651
                
                
                
                -Amortization
      of land use right
                
                
                34,343
                
                
                
                22,694Recognition
      of noncash deferred income from exclusive distribution right granted by
      the Company to a customer (Note 10)
                
                
                (649,484
                )
                
                
                (539,244
                )Non-controlling
      interest
                
                
                (28,127
                )
                
                
                -Changes
      in operating assets and liabilities:Accounts
      receivable
                
                
                (2,844,533
                )
                
                
                (1,365,887
                )Inventories
                
                
                (1,103,391
                )
                
                
                (1,923,183
                )Prepaid
      expenses and other current assets
                
                
                (1,900,657
                )
                
                
                (287,496
                )Accounts
      payable
                
                
                3,238,413
                
                
                
                1,423,890Accrued
      expenses and other payables
                
                
                487,940
                
                
                
                39,959Income
      tax payable
                
                
                690,848
                
                
                
                -Value
      added tax
                
                
                731,862
                
                
                
                (133,793
                )Net
      cash provided by operating activities
                
                
                7,558,625
                
                
                
                473,578Cash
      flows from investing activities:(Increase)
      decrease in restricted cash
                
                
                925,001
                
                
                
                (1,031,346
                )Purchase
      of land use rights
                
                
                (628,106
                )
                
                
                -Payment
      for purchase of plant and equipment
                
                
                (16,034,735
                )
                
                
                (1,187,757
                )Net
      cash used in investing activities
                
                
                (15,737,840
                )
                
                
                (2,219,103
                )Cash
      flows from financing activities:Proceeds
      from short term bank loans
                
                
                15,208,511
                
                
                
                2,342,418Repayment
      of short term bank loans
                
                
                (4,114,380
                )
                
                
                (2,708,420
                )Proceeds
      from bank acceptance notes payable
                
                
                5,297,264
                
                
                
                2,733,308Repayment
      to acceptance notes payable
                
                
                (7,401,475
                )
                
                
                -Payment
      of amounts due to contractors for building and machinery
                
                
                (5,158
                )
                
                
                (802,797
                )Capital
      contributions from a stockholder
                
                
                990,439
                
                
                
                690,552(Repayment
      to) advances from a stockholder and director
                
                
                (52,899
                )
                
                
                51,240Repayment
      to related companies
                
                
                -
                
                
                
                (402,556
                )Net
      cash provided by financing activities
                
                
                9,922,302
                
                
                
                1,903,745Effect
      of exchange rate changes on cash
                
                
                (9,883
                )
                
                
                (517
                )Net
      increase in cash
                
                
                1,733,204
                
                
                
                157,703Cash
      at beginning of year
                
                
                864,162
                
                
                
                706,459Cash
      at end of year
                
                $
                2,597,366
                
                
                $
                864,162


Non-cash
      investing and financing transactions:Acquisition
      of machinery in exchange for exclusive distribution right granted to a
      customer (see Note 10)
                    
                    $
                    -
                    
                    
                    $
                    1,294,186Payable
      due to contractors for construction of building and
    machinery
                    
                    $
                    226,331
                    
                    
                    $
                    296,267Exclusive
      use of patents contributed by a principal stockholder as
      capital
                    
                    $
                    87,740
                    
                    
                    $
                    -Acquisition
      of patent and patents pending  in exchange for 13% interest in a
      subsidiary
                    
                    $
                    650,000
                    
                    
                    $
                    -Supplemental
      information:Cash
      paid for income tax
                    
                    $
                    221,400
                    
                    
                    $
                    -Cash
      paid for interest
                    
                    $
                    300,609
                    
                    
                    $
                    166,186




See
accompanying notes to consolidated financial statements.


F-6


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(1)
            DESCRIPTION
      OF BUSINESS AND ORGANIZATION




Nature
of operations


Lizhan
Environmental Corporation (“Lizhan
Environmental”) is a holding company and, through its subsidiaries, primarily
engages in the manufacture, distribution and marketing of synthetic leather and
other fabrics which are used in the production of residential and office
furniture, garments and automotive upholstery products.  Lizhan
Environmental together with its subsidiaries are collectively referred to as the
“Company”.




Reorganization


Lizhan
Environmental was incorporated under the name “Illigate Environment Resources
Technology Company Limited” on August 31, 2009 as a limited liability company in
the Cayman Islands.  During the period from incorporation through the
Reorganization (as defined below), the controlling interest in Lizhan
Environmental was owned by Mr. Jianfeng Liu (“Mr. Liu”), the Chief
Executive Officer (“CEO”) and Chairman of
the Company.




On
January 12, 2010, the Company changed its name from Illigate Environment
Resources Technology Company Limited to Lizhan Environmental
Corporation.




Details
of Lizhan Environmental’s subsidiaries which are included in these consolidated
financial statements are as follows:




Subsidiaries’ names
                  
                  Place and date of
                    incorporation
                  
                  Percentage of
                    ownership by
                    the Company
                  
                  Principal activitiesLi
      Zhan Resources Recycling Technology Development Company Limited (“Resources”)
                  
                  Hong
      Kong
                    September
      3, 2009
                  
                  100%
                  
                  Intermediate
      holding companyLizhan
      Textile (Zhejiang) Co., Ltd. (“Lizhan
      Textile”)
                  
                  People’s
      Republic of China (“PRC”)
                    December
      6, 2005
                  
                  100%
      (through Resources)
                  
                  Manufacture,
      distribution and marketing of synthetic leather and other
      fabricsZhejiang
      Hongzhan New Material Limited (“Hongzhan”)
                  
                  PRC
                    December
      8, 2009
                  
                  87%
      (through Resources)
                  
                  Manufacture
      and selling of a new reconstituted evergreen
  product




Resources
was incorporated as a limited liability company in Hong Kong and had been wholly
owned by Mr. Liu until being acquired by Lizhan Environmental pursuant to a
reorganization (the “Reorganization”) to
prepare for the listing of the Company’s shares on a stock
exchange.




Lizhan
Textile was established as a wholly foreign-owned enterprise in the PRC on
December 6, 2005 and has a registered and paid-up capital of US$3,580,000 as of
September 30, 2010.




Prior to
the Reorganization, Lizhan Textile had been wholly owned by Illigate Development
Limited (“Illigate”), a company
incorporated in the British Virgin Island which in turn is wholly owned by Mr.
Liu.




Pursuant
to a stock transfer agreement dated September 15, 2009, Resources acquired the
entire ownership interests in Lizhan Textile from Illigate. The change in
ownership of Lizhan Textile was approved by the PRC local government on October
12, 2009.




As part
of the Reorganization, on November 9, 2009, Lizhan Environmental acquired 100%
equity interest in Resources from Mr. Liu.


F-7


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009






(1)           DESCRIPTION
OF BUSINESS AND ORGANIZATION – CONTINUED




Reverse
Stock Split


The
Company initiated a 1-for-1.6 reverse stock split effective September 14, 2010.
All shares and per share amounts in these consolidated financial statements and
note thereto have been retroactively adjusted to give effect to the reverse
stock split.




Establishment
of New Subsidiary and Changes in Ownership Interest in the
Subsidiary


In
December 8, 2009, the Company, through its 100% owned subsidiary, Resources,
established a new wholly-owned subsidiary, Hongzhan, with a registered capital
of $5,000,000 in the PRC. Hongzhan will engage in the manufacture and selling of
new reconstituted evergreen products, which are manufactured from collagen
fibers extracted from leather waste and constructed into a fibrous web by an air
laid system.




On
February 8, 2010, Resources entered into a share transfer agreement with Eminent
Benefit Holdings Limited (“Eminent”, which is wholly-owned by Mr. Liwen Zhang, a
key employee of the Company since February 2010) (with no ownership interest in
the Company) to transfer 13% ownership interest in Hongzhan to Eminent for
$650,000. Pursuant to a supplemental agreement, dated February 10, 2010, the
parties agreed that Mr. Liwen Zhang shall transfer one patent and two patents
pending, which are related to the production of evergreen leather products in
satisfaction of the $650,000 payable by Eminent to Resources for the transfer of
13% ownership interest in Hongzhan. As a result, the Company essentially
disposed of 13% ownership interest in Hongzhan in exchange for the patent and
patents pending transferred from Mr. Liwen Zhang. Immediately before this share
transfer agreement, Hongzhan had not commenced any business activities and had
no assets except for the cash it received from the issuance of its
capital.




The
Company has considered the guidance provided in The American Institute of
Certified Public Accountants Practice Aids, “Valuation of Privately-Held Company
Equity Securities Issued as Compensation” for the determination of fair
value at the enterprise level. Hongzhan, being a newly established company and
an early stage enterprise, has not generated any revenue and has no expense
history, both market and income approaches have been considered impracticable or
inappropriate and hence, an asset-based approach has been applied. As of the
date of transfer of the 13% interest, Hongzhan’s only asset comprised cash of
$5,000,000, which amount equaled to its registered capital contributed by
shareholder. As a result, 13% interest of Hongzhan has been valued at 13% of
$5,000,000, being $650,000. On the other hand, the Company has also considered
the estimation of the fair value of the three patents acquired in exchange for
the 13% interest in Hongzhan. Due to the lack of market information for
identical or similar patents in the PRC, the Company has considered that the
income approach would be the only possible method to estimate the fair value of
the three patents. In applying the income approach, the Company would be
required to estimate the cash flows or earnings that it expects to derive
separately from the three patents, discounted to a present value based on its
own assumptions about risk, rate of return, etc.




Based on
the above, the Company has determined that the fair value of $650,000 of 13%
interest in Hongzhan is more clearly evident than the fair value of the three
patents which may only be determined based on unobservable inputs and highly
subjective and has been applied as the basis for accounting for this
transaction.




As a
result, the Company, through Resources owns 87% of the interests in Hongzhan and
Eminent controls the remaining 13%. The transfer of 13% ownership interest in
Hongzhan from Resources to Eminent was approved by the PRC local government on
March 10, 2010.




On
November 19, 2010, the Company issued 2,500,000 ordinary shares at par
value of $0.32 per share in the initial public offering. The public offering
price of the ordinary shares is $4.00 per share.  The Company received net
proceeds of approximately $7.5 million from the offering, after deducting
underwriting discounts, expense payable by the Company.


F-8


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(2)
            SUMMARIES
      OF SIGNIFICANT ACCOUNTING POLICIES




(a)
            Basis
      of presentation and consolidation




The
accompanying audited consolidated financial statements and related notes have
been prepared in conformity with accounting principles generally accepted in the
United States of America (US GAAP).




As
Illigate, Lizhan Environmental, Resources and Lizhan Textile have all been under
common control of Mr. Liu before and after the Reorganization, the
Reorganization has been accounted for as a common control transaction using the
“as if” pooling method of accounting. These consolidated financial statements
have been prepared as if the existing corporate structure had been in existence
throughout the periods presented and as if the Reorganization had occurred as of
the beginning of the earliest period presented.




The
consolidated financial statements include all accounts of the Company and its
subsidiaries. All material inter-company balances and transactions have been
eliminated on consolidation.




In June
2009, the Financial Accounting Standards Board (“FASB”) issued Accounting
Standards Update No. 2009-01, “Generally Accepted Accounting Principles” (ASC
Topic 105) which establishes the FASB Accounting Standards Codification (“the
Codification” or “ASC”) as the official single source of authoritative U.S.
generally accepted accounting principles (“GAAP”).  All existing accounting
standards are superseded.  All other accounting guidance not included in
the Codification will be considered non-authoritative.  The Codification
also includes all relevant Securities and Exchange Commission (“SEC”) guidance
organized using the same topical structure in separate sections within the
Codification.  Following the Codification, the FASB will not issue new
standards in the form of Statements, FASB Staff Positions or Emerging Issues
Task Force Abstracts.  Instead, it will issue Accounting Standards Updates
(“ASU”) which will serve to update the Codification, provide background
information about the guidance and provide the basis for conclusions on the
changes to the Codification.




The
Codification is not intended to change GAAP, but it will change the way GAAP is
organized and presented. The adoption of ASC 105 does not have an impact on the
Group's financial statements.




(b)
            Use
      of estimates




The
preparation of the financial statements in conformity with US generally accepted
accounting principles (“GAAP”) requires management of the Company to make a
number of estimates and assumptions relating to the reported amounts of assets
and liabilities and the disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the years presented. Significant items subject to such estimates
and assumptions include the recoverability of the carrying amount and the
estimated useful lives of long-lived assets; valuation allowances for
receivables, realizable values for inventories. Actual results could differ from
those estimates.




(c)
            Foreign
      currency translation




The
Company uses United States dollars (“U.S. Dollar” or “US$” or “$”) for financial
reporting purposes. The subsidiaries within the Company maintain their books and
records in their respective functional currency, Chinese Renminbi (“RMB”) and
Hong Kong dollars (“HK$”), being the lawful currency in the PRC and Hong Kong,
respectively. Assets and liabilities of the subsidiaries are translated from RMB
or HK$ into U.S. Dollars using the applicable exchange rates prevailing at the
balance sheet date. Items on the statements of income and comprehensive income
and cash flows are translated at average exchange rates during the reporting
period. Equity accounts are translated at historical rates. Adjustments
resulting from the translation of the Company’s financial statements are
recorded as accumulated other comprehensive income.


F-9


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(2)           SUMMARIES
OF SIGNIFICANT ACCOUNTING POLICIES – CONTINUED




(c)
            Foreign
      currency translation - continued




The
exchange rates used to translate amounts in RMB and HK$ into U.S. Dollars for
the purposes of preparing the consolidated financial statements are as
follows:-




2010
                    
                    2009Balance
      sheet items, except for equity accounts
                    
                    RMB6.6905=$1
                      HK7.7599=S1
                    
                    RMB6.8290=$1
                      HK$7.7805=$1Items
      in statements of income and cash flows
                    
                    RMB6.8054=$1
                      HK7.7656=1
                    
                    RMB6.8306=$1
                      HK$7.7890=$1




There is
no assurance that the RMB and HK$ amounts could have been, or could be,
converted into U.S. dollars at the above rates.




(d)
            Cash




Cash
consist of cash on hand and at banks. Substantially all of the Company’s cash
deposits are held with financial institutions located in the PRC. Management
believes that these major financial institutions are of high credit quality.
Restricted cash is excluded from cash and cash equivalents.




(e)
            Accounts
      receivable




Accounts
receivable are recorded at the invoiced amount, net of any allowances for
doubtful accounts.  The Company records an allowance for doubtful accounts
based on specifically identified amounts that the Company believes to be
uncollectible.  The Company reviews the accounts receivable on a periodic
basis and makes allowances where there is doubt as to the collectibility of
individual balances. In evaluating the collectibility of individual receivable
balances, the Company considers many factors, including the age of the balance,
the customer’s payment history and settlement status, its current
credit-worthiness as well as current economic trends.




Based on
the Company’s assessment of collectibility and that no accounts receivable was
past due as of the balance sheet dates, there has been no allowance for doubtful
accounts recognized as of September 30, 2010 and 2009.




Outstanding
account balances are reviewed individually for collectability. Account balances
are charged off against the allowance after all means of collection have been
exhausted and the potential for recovery is considered remote. The Company does
not have any off-balance-sheet credit exposure to its customers.




(f)
            Inventories




Inventories
consist primarily of leather waste (which is used as raw materials for
reconstitution as synthetic leather), ultrasuede grey cloth, polyurethane (“PU”)
base, resin, PU leather and other fabrics, and are stated at the lower of cost
or market. Cost is determined using the weighted average cost method. Costs of
work-in-process and finished goods include raw materials, direct labor and
overhead associated with the manufacturing process. Market value is determined
by reference to selling prices after the balance sheet date or to management’s
estimates based on prevailing market conditions. The management also regularly
evaluates the composition of its inventories to identify slow-moving and
obsolete inventories to determine if valuation allowance is
required.


F-10


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(2)           SUMMARIES
OF SIGNIFICANT ACCOUNTING POLICIES – CONTINUED




(g)
            Property,
      plant and equipment




Property,
plant and equipment are recorded at cost less accumulated depreciation. 
Expenditures for major additions and betterments are capitalized. 
Maintenance and repairs are charged to general and administrative expenses as
incurred. Depreciation of property, plant and equipment is computed by the
straight-line method over the assets’ estimated useful lives. Building
improvements, if any, are amortized on a straight-line basis over the estimated
useful life. Interest costs incurred during the construction period (i.e. the
period of time necessary to bring a constructed fixed asset to the condition and
location necessary for its intended use) is capitalized and amortized over the
useful life of the asset.




Upon sale
or retirement of property, plant and equipment, the related cost and accumulated
depreciation are removed from the accounts and any gain or loss is reflected in
operations.




Construction
in progress represents the costs of property, plant and equipment under
construction or installation. Depreciation commences when the assets are placed
in service. The accumulated costs are reclassified as property, plant and
equipment when installation or construction is completed.




The
estimated useful lives of the assets are as follows:




Buildings
              
              30
      yearsPlant,
      machinery and equipment
              
              5 –
      10 yearsMotor
      vehicles
              
              8
      yearsOffice
      equipment
              
              5
      yearsComputer
      software
              
              3 –
      5 years




(h)
            Intangible
      assets




The
Company’s intangible assets include ten-year exclusive rights to use certain
patents.  The Company accounts for its intangible assets pursuant to FASB
ASC Subtopic 350-30, “General Intangibles Other Than Goodwill”. Under ASC
350-30-35, intangibles with definite lives are amortized on a straight-line
basis over the lesser of their estimated useful lives or contractual terms.
Accordingly, the Company amortizes the exclusive rights to use the patents over
10 years on a straight-line basis.




(i)
            Land
      use right




Land use
rights represent the prepayments for the use of the parcels of land in the PRC
where the Company’s production facilities located, and are charged to expense
over their respective lease periods of 50 years. According to the laws of the
PRC, the government owns all of the land in the PRC. Companies or individuals
are authorized to use the land only through land use rights granted by the PRC
government for a certain period (usually 50 years).


F-11


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(2)           SUMMARIES
OF SIGNIFICANT ACCOUNTING POLICIES – CONTINUED




(j)
            Impairment
      of long-lived assets




Long-lived
assets, including intangible assets with definite lives and property, plant and
equipment, are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to the estimated undiscounted
future cash flows expected to be generated by the asset. If the carrying amount
of an asset exceeds its estimated future cash flows, an impairment charge is
recognized by the amount by which the carrying amount of the asset exceeds the
fair value of the asset.




Based on
the Company’s assessment, there have been no events or changes in circumstances
that would indicate any impairment of long-lived assets as of September 30, 2010
or 2009.




(k)
            Fair
      value measurements




ASC Topic
820, Fair Value Measurement
and Disclosures, defines fair value as the exchange price that would be
received for an asset or paid to transfer a liability (an exit price) in the
principal or most advantageous market for the asset or liability in an orderly
transaction between market participants on the measurement date. This topic also
establishes a fair value hierarchy which requires classification based on
observable and unobservable inputs when measuring fair value. There are three
levels of inputs that may be used to measure fair value:




Level 1-
            Quoted
      prices in active markets for identical assets or
    liabilities.




Level 2-
            Observable
      inputs other than Level 1 prices such as quoted prices for similar assets
      or liabilities; quoted prices in markets that are not active; or other
      inputs that are observable or can be corroborated by observable market
      data for substantially the full term of the assets or
      liabilities.




Level 3-
            Unobservable
      inputs that are supported by little or no market activity and that are
      significant to the fair value of the assets or
  liabilities.




Determining
which category an asset or liability falls within the hierarchy requires
significant judgment. The Company evaluates its hierarchy disclosures each
quarter.




The
carrying values of cash and cash equivalents, trade and other receivables, trade
and other payables, and short-term borrowings approximate fair values due to
their short maturities.




There was
no asset or liability measured at fair value on a non-recurring basis as of
September 30, 2010 and 2009.


F-12


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(2)           SUMMARIES
OF SIGNIFICANT ACCOUNTING POLICIES – CONTINUED




(l)
            Revenue
      recognition




Revenue
is recognized when the following four criteria are met as prescribed by U.S.
Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin
No. 104 (“SAB 104”): (i) persuasive evidence of an arrangement exists,
(ii) product delivery has occurred or the services have been rendered,
(iii) the fees are fixed or determinable, and (iv) collectability is
reasonably assured.




The
Company generates its revenue primarily from the sales of synthetic leather and
other fabrics. Sales of productsare generally
recognized when title transfers and the risks and rewards of ownership have
passed to customers and when the selling price has been fixed and collectability
is reasonably assured. The Company does not provide its customers with the right
of return (except for quality), after-sale warranty or price protection. There
are no customer acceptance provisions associated with the Company’s
products.




The
Company is subject to value added tax at 17% on the revenues earned for products
sold in the PRC. The Company presents its revenue net of value added and other
taxes, sales discounts and returns. There were insignificant product returns for
the two years ended September 30, 2010 and hence no provision has been made for
sales returns as of September 30, 2010 and 2009, respectively.




(m)
            Nonmonetary
      transactions




The
Company accounts for nonmonetary transactions based on the fair value of the
assets (or services) involved in accordance with the requirements of FASB ASC
Topic 845, “Nonmonetary
Transactions”.




(n)
            Advertising
      costs




The
Company expenses advertising costs as incurred. Advertising expenses are
included in selling and marketing expenses and amounted to $24,174 and $40,220
for the years ended September 30, 2010 and 2009, respectively.




(o)
            Shipping
      and handling costs




Shipping
and handling costs are charged to expense when incurred and are included in
selling and marketing expenses. Shipping and handling costs charged to
operations were $ 219,852 and $116,388 for the years ended September 30, 2010
and 2009, respectively.




(p)
            Income
      taxes




The
Company accounts for income taxes under ASC 740 "Income Taxes". Deferred
income tax assets and liabilities are determined based upon differences between
the financial reporting and tax bases of assets and liabilities and are measured
using the enacted tax rates and laws that will be effective when the differences
are expected to reverse.




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 in the period that includes the enactment
date.




ASC 740
prescribes a more-likely-than-not threshold for financial statement recognition
and measurement of a tax position taken in the tax return. This interpretation
also provides guidance on de-recognition of income tax assets and liabilities,
classification of current and deferred income tax assets and liabilities,
accounting for interest and penalties associated with tax positions, accounting
for income taxes in interim periods and income tax disclosures.


F-13


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(2)           SUMMARIES
OF SIGNIFICANT ACCOUNTING POLICIES – CONTINUED




(q)
            Comprehensive
      income




Comprehensive
income is defined as the change in equity of a company during the period from
transactions and other events and circumstances excluding transactions resulting
from investments from owners and distributions to owners. Accumulated other
comprehensive income (loss), as presented on the accompanying consolidated
statements of changes in equity and comprehensive income, consisted of
cumulative foreign currency translation adjustment in each of the two years
ended September 30, 2010 and 2009.




(r)
            Commitments
      and contingencies




The
Company is subject to lawsuits, investigations and other claims related to
operations, product, taxing authorities, environmental and other matters out of
the normal course of business, and is required to assess the likelihood of any
adverse judgments or outcomes to these matters, as well as potential ranges of
probable losses and fees.  A determination of the amount of reserves and
disclosures required, if any, for these contingencies are made after
considerable analysis of each individual issue. The Company accrues for
contingent liabilities when an assessment of the risk of loss is probable and
can be reasonably estimated. The Company discloses contingent liabilities when
the risk of loss is reasonably possible or probable.




(s)
            Pension
      and employee benefits




Full time
employees of the Company’s PRC subsidiary 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.  PRC labor regulations require
the Company to accrue for these benefits based on certain percentages of the
employees' salaries. Costs for pension and employee benefits for the years ended
September 30, 2010 and 2009 were $104,798 and $51,763,
respectively.




(t)
            Government
      grant




Government
grants are recognized initially as deferred income in the balance sheet at fair
value when there is reasonable assurance that they will be received and the
Company will comply with the conditions associated with the grant. Grants that
compensate the Company for expenses incurred are recognized in consolidated
statements of operations as other income on a systematic basis in the same
periods in which the expenses are recognized. Grants that compensate the Company
for the cost of an asset are recognized in consolidated statements of income and
comprehensive income on a systematic basis over the useful life of the
asset.




(u)
            Research
      and development costs




Research
and development costs are charged to expense as incurred. Research and
development costs mainly consist of salary for the research and development
staff and depreciation for plant and machinery. The Company recorded $ $136,398
and $64,991 of research and development costs for the years ended September 30,
2010 and 2009, respectively.


F-14


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(2)           SUMMARIES
OF SIGNIFICANT ACCOUNTING POLICIES – CONTINUED




(v)
            Earnings
      per share




Basic
earnings per share is computed on the basis of the weighted-average number of
shares of the Company’s common stock outstanding during the fiscal years.
Diluted earnings per share is computed on the basis of the weighted-average
number of shares of the common stock plus any effect of dilutive potential
common shares outstanding during the year using the if-converted
method.




(w)
            Stock-based
      compensation




The
Company will recognize all stock-based payments to employees and to non-employee
directors as compensation for service on the Board of Directors as compensation
expense in the consolidated financial statements based on the fair value of such
payments. Stock-based compensation expense recognized in each period is based on
the value of the portion of share-based payment awards that is ultimately
expected to vest during the period.




For
share-based payments to consultants and other third-parties, compensation
expense will be determined at the “measurement date”. The expense will be
recognized over the vesting period of the award. Until the measurement date is
reached, the total amount of compensation expense remains uncertain. The Company
will record compensation expense based on the fair value of the award at the
reporting date. The awards to consultants and other third-parties will then be
revalued, or the total compensation is recalculated based on the then current
fair value, at each subsequent reporting date.




(x)
            Recently
      issued accounting standards




Effective
January 1, 2010, the Company adopted the provisions in ASU 2010-06, “Fair Value
Measurements and Disclosures (ASC Topic 820): Improving Disclosures about Fair
Value Measurements, which requires new disclosures related to transfers in and
out of levels 1 and 2 and activity in level 3 fair value measurements, as well
as amends existing disclosure requirements on level of disaggregation and inputs
and valuation techniques. The adoption of the provisions in ASU 2010-06 did not
have an impact on the Company’s consolidated financial statements.




In
February 2010, the Financial Accounting Standards Board (“FASB”) issued
authoritative guidance that amends the disclosure requirements related to
subsequent events. This guidance includes the definition of a Securities and
Exchange Commission filer, removes the definition of a public entity, redefines
the reissuance disclosure requirements and allows public companies to omit the
disclosure of the date through which subsequent events have been evaluated. This
guidance is effective for financial statements issued for interim and annual
periods ending after February 2010. This guidance did not materially impact the
Company’s results of operations or financial position, but did require changes
to the Company’s disclosures in its financial statements.




In April
2010, the FASB issued ASU No. 2010-13—Compensation—Stock Compensation (Topic
718), which addresses the classification of an employee share-based payment
award with an exercise price denominated in the currency of a market in which
the underlying equity security trades. This Update provides amendments to Topic
718 to clarify that an employee share-based payment award with an exercise price
denominated in the currency of a market in which a substantial portion of the
entity’s equity securities trades should not be considered to contain a
condition that is not a market, performance, or service condition. Therefore, an
entity would not classify such an award as a liability if it otherwise qualifies
as equity. The amendments in this Update are effective for fiscal years, and
interim periods within those fiscal years, beginning on or after December 15,
2010. The Company expects that the adoption of the amendments in this Update
will not have any significant impact on its financial position and results of
operations.


F-15


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(2)           SUMMARIES
OF SIGNIFICANT ACCOUNTING POLICIES – CONTINUED




(y)
              Recently
      issued accounting standards -
continued




Other
accounting standards that have been issued or proposed by the FASB or other
standards-setting bodies that do not require adoption until a future date are
not expected to have a material impact on the Company’s Consolidated Financial
Statements upon adoption.




(3)
            CASH




As at
September 30, 2010 and 2009, substantially all of the Company’s cash included
cash balances deposited with banks located in the PRC.  According to
existing PRC laws and regulations, remittance of these cash balances out of the
PRC is subject to various restrictions imposed by the PRC government (see Note
24).




(4)
            RESTRICTED
      CASH




Restricted
cash represents bank deposits held as collaterals for the bank acceptance notes
payable (see Note 11), and will be released only at the expiration date of the
bank acceptance notes.




(5)
            INVENTORIES




Inventories
consist of the following:




As
      of September 30,2010
                  
                  
                  2009Raw
      materials
                  
                  $
                  1,491,532
                  
                  
                  $
                  1,166,281Work-in-process
                  
                  
                  1,979,247
                  
                  
                  
                  965,222Finished
      goods and consumables
                  
                  
                  1,195,717
                  
                  
                  
                  1,340,773Total
                  
                  $
                  4,666,496
                  
                  
                  $
                  3,472,276




(6)
            PREPAID
      EXPENSES AND OTHER CURRENT ASSETS




Prepaid
expenses and other current assets consist of the following:




As
      of September 30,2010
                  
                  
                  2009Deposits
      for purchase of raw materials and accessories
                  
                  $
                  1,196,436
                  
                  
                  $
                  148,036Prepaid
      operating expenses
                  
                  
                  740,627
                  
                  
                  
                  224,553Other
      deposits
                  
                  
                  475,366
                  
                  
                  
                  -Advances
      to staff for normal business purposes
                  
                  
                  11,883
                  
                  
                  
                  13,670Others
                  
                  
                  17,808
                  
                  
                  
                  5,574Total
                  
                  $
                  2,442,120
                  
                  
                  $
                  391,833


F-16


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(7)
              INTANGIBLE
      ASSETS




Intangible
assets, net consisted of the following:




As
      of September 30,2010
                  
                  
                  2009Patent
      and pending patent applications
                  
                  $
                  650,000
                  
                  
                  $
                  -Less:
      Accumulated amortization
                  
                  
                  (21,667
                  )
                  
                  
                  -Net
      book value
                  
                  $
                  628,333
                  
                  
                  $
                  -





As
discussed in Note 1, one patent and two pending patent applications with an
aggregate cost of $650,000 were acquired essentially in exchange for 13%
ownership interest in the new subsidiary, Hongzhan, in February 2010. These
patent and pending patents applications relate to the production of the
Company’s new evergreen products.




Amortization
expenses were $21,667 and $Nil for the twelve months ended September 30, 2010
and 2009, respectively.  The expected amortization for the next five years
and thereafter is as follows:




Year
      ending September 30, 2011
                  
                  $
                  32,500Year
      ending September 30, 2012
                  
                  
                  32,500Year
      ending September 30, 2013
                  
                  
                  32,500Year
      ending September 30, 2014
                  
                  
                  32,500Year
      ending September 30, 2015
                  
                  
                  32,500Thereafter
                  
                  
                  465,833$
                  628,333


F-17


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(8)
            PROPERTY,
      PLANT AND EQUIPMENT, NET




Property,
plant and equipment consist of the following:




As
      of September 30,2010
                  
                  
                  2009At
      cost:Buildings
                  
                  $
                  4,789,139
                  
                  
                  $
                  4,407,807Plant,
      machinery and equipment
                  
                  
                  5,946,949
                  
                  
                  
                  4,153,370Motor
      vehicles
                  
                  
                  266,596
                  
                  
                  
                  146,134Office
      equipment
                  
                  
                  269,607
                  
                  
                  
                  256,787Computer
      software
                  
                  
                  1,874
                  
                  
                  
                  1,874Construction
      in progress
                  
                  
                  3,013,937
                  
                  
                  
                  88,389Total
                  
                  
                  14,288,102
                  
                  
                  
                  9,054,361Less:
      Accumulated depreciation
                  
                  
                  (1,381,447
                  )
                  
                  
                  (662,173
                  )Net
                  
                  $
                  12,906,655
                  
                  
                  $
                  8,392,188




Depreciation
expense for the years ended September 30, 2010 and 2009 was $693,653 and
$505,340, respectively. Depreciation expense included in cost of sales amounted
to $496,238 and $331,062 for the years ended September 30, 2010 and 2009
respectively. Depreciation expense included in operating expenses amounted to
$197,415 and $174,278 for the years ended September 30, 2010 and 2009
respectively.




Buildings
with net book value of $4,423,733 and $4,185,146 as of September 30, 2010 and
2009 are held as collateral for the bank acceptance notes (see Note 11) and
short-term bank loans (see Note 12).




Construction
in progress as of September 30, 2010 and September 30, 2009 represented
production plant, machinery and equipment which had not been put in use pending
completion of their installation and integration. The estimated cost to complete
their installation and integration is approximately $1,871,928 and insignificant
as of September 30, 2010 and September 30, 2009 respectively. No depreciation
has been provided for construction in progress.


F-18


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(9)
            LAND
      USE RIGHTS




Land use
rights represent prepaid lease payments to the local government in the PRC for
the use of 3 parcels of land where the Company’s production facilities are
located. Land use rights have a 40 to 50-year lives from January 8, 2007 to
January 7, 2057, July 21, 2008 to July 20, 2048 and December 23, 2009 to
December 22, 2059, respectively. See also Note 21 regarding provisions for the
Company to make investment imposed by one of the land use rights.




The
expected amortization expense of the prepaid land use rights for each of the
next five years and thereafter is as follows:




Year
      ending September 30, 2011
                  
                  $
                  35,784Year
      ending September 30, 2012
                  
                  
                  35,784Year
      ending September 30, 2013
                  
                  
                  35,784Year
      ending September 30, 2014
                  
                  
                  35,784Year
      ending September 30, 2015
                  
                  
                  35,784Thereafter
                  
                  
                  1,459,328$
                  1,638,248




The
Company’s land use rights with carrying amount of $1,638,248 as of September 30,
2010 have been held as collaterals for the bank acceptance notes (see Note 11)
and short-term bank loans (see Note 12).




The
Company’s land use rights with carrying amount $1,013,311 as of September 30,
2009 have been held as collateral for the bank acceptance notes (see Note 11)
and short-term bank loans (see Note 12).




(10)
            DEFERRED
      INCOME




On June
26, 2008, the Company entered into an asset transfer contract with an unrelated
customer. Pursuant to the contract, the Company acquired certain used machinery
in exchange for granting an exclusive right to the customer for the distribution
of the Company’s products produced by those machines (i.e. tufted fabrics)
within the United States of America for a period of two years from October 2008
to October 2010. The Company has accounted for this transaction in accordance
with ASC Topic 845, “Nonmonetary
Transactions”.




The
Company has applied the cost approach in measuring the fair values of the
machinery received based on the current quoted prices provided by the machine
supplier, depreciated by reference to generally accepted service lives of
similar machines and adjusted to reflect those machines’ existing physical
condition, functional and economic obsolescence. On the other hand, in order to
arrive at the fair value of the exclusive distribution right surrendered, the
Company would rely on the income approach which would use the Company’s
estimates of future cash flows or earnings to be derived from the distribution
rights, discounted to a present value based on its own assumptions about risk,
rate of return, etc. Therefore, the fair values of the machines having been
determined based on quoted prices for similar assets (Level 2 fair value
hierarchy according to ASC 820-10-35-37) are considered more clearly evident
than the fair value of the distribution rights surrendered, which may only be
determined based on unobservable inputs (Level 3 fair value
hierarchy).


F-19


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(10)
            DEFERRED
      INCOME – CONTINUED




Accordingly,
this transaction has been accounted for based on the aggregate fair value of the
machines received, which amounted to $1,294,186, in accordance with the
requirements of ASC 845-10-30-1.




The
exclusive distribution right granted to the customer has initially been recorded
as deferred income, and subsequently amortized and recognized as revenue on a
straight-line basis over the two-year period of the exclusive distribution
right. Accordingly, $649,484 was recognized as revenue for the year ended
September 30, 2010. The rollforward of the deferred income is as
follows:




Fair
      value of machinery received
                  
                  $
                  1,294,186Recognition
      of revenue from exclusive distribution right for the year ended September
      30, 2009
                  
                  
                  (539,244
                  )Effect
      of exchange rate changes
                  
                  
                  171Deferred
      income included in current liabilities as of September 30,
      2009
                  
                  $
                  755,113Recognition
      of revenue from exclusive distribution right for the year ended September
      30, 2010
                  
                  
                  (649,484
                  )Effect
      of exchange rate changes
                  
                  
                  4,477Deferred
      income included in current liabilities as of September 30,
      2010
                  
                  $
                  110,106




(11)
            BANK
      ACCEPTANCE NOTES PAYABLE




Bank
acceptance notes payable consist of the following:




As
      of September 30,2010
                  
                  
                  2009Bank
      acceptance notes:China
      Citic Bank
                  
                  $
                  896,793
                  
                  
                  $
                  1,159,760Jiaxing
      City Commercial Bank
                  
                  
                  1,248,039
                  
                  
                  
                  3,038,512Total
                  
                  $
                  2,144,832
                  
                  
                  $
                  4,198,272




The bank
acceptance notes generally mature in periods ranging from three to six months
and bear bank charges calculated as 0.05% of the face value of the notes. As
security for the bank acceptance notes, the Company has placed deposits equal to
40% to 50% of the note amounts with the banks (see Note 4 regarding Restricted
Cash), pledged its buildings (see Note 8) and land use rights (see Note 9) in
favor of the banks, and provided the banks with personal guarantee given by Mr.
Liu (the Company’s stockholder, CEO and chairman), related party guarantee by
its subsidiary and third party guarantee. There are no financial covenants
associated with these bank acceptance notes.





Bank
charges on the bank acceptance notes are included in other expenses and amounted
to $3,212 and $6,568 for the years ended September 30, 2010 and 2009,
respectively.


F-20


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(12)
            SHORT-TERM
      LOANS




The
Company has entered into loan agreements with several banks in the PRC to obtain
fixed-rate term loans with maturities not exceeding 12 months, to meet its
working capital needs.  Short-term loans consist of the
following:




As
      of September 30,2010
                    
                    
                    2009Payable
      to:China
      Construction Bank
                    
                    $
                    5,007,100
                    
                    
                    $
                    292,869China
      Citic Bank
                    
                    
                    448,397
                    
                    
                    
                    292,869Jiaxing
      City Commercial Bank
                    
                    
                    7,473,283
                    
                    
                    
                    1,757,211Hangzhou
      Bank
                    
                    
                    747,328
                    
                    
                    
                    -Total
                    
                    $
                    13,676,108
                    
                    
                    $
                    2,342,949Weighted
      average interest rate on borrowings outstanding at year
end
                    
                    
                    5.77
                    %
                    
                    
                    5.40
                    %




The
short-term bank loans are secured by the Company’s buildings (see Note 8) and
land use rights (see Note 9), and guarantees provided by Mr. Liu (the Company’s
stockholder, CEO and chairman), its subsidiary and other unrelated third
parties. The company is in compliance with financial covenants associated with
the short term bank loans.




Interest
expenses on the short-term bank loans amounted to $ 383,734 and $166,186 for the
years ended September 30, 2010 and 2009, respectively of which $83,125 of the
interest expenses is capitalized to construction in progress




(13)
            ACCRUED
      EXPENSES AND OTHER PAYABLES




Accrued
expenses and other payables consist of the following:




As
      of September 30,2010
                    
                    
                    2009Accrued
      operating expenses
                    
                    $
                    455,102
                    
                    
                    $
                    292,676Other
      tax payables
                    
                    
                    402,220
                    
                    
                    
                    -Other
      payables
                    
                    
                    394,527
                    
                    
                    
                    21,102Total
                    
                    $
                    1,251,849
                    
                    
                    $
                    313,778


F-21


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(14)
            STOCKHOLDER’S
      EQUITY




In
January 2010, the Company issued an aggregate of 206,250 ordinary shares to Mr.
Liu, CEO and Chairman and a principal stockholder of the Company, for a purchase
price of approximately $4.80 per share, or $990,000 in aggregate.




(15)
            NON-CONTROLLING
      INTERESTS




Non-controlling
interests arose from the Company’s disposition of 13% interest in Hongzhan in
exchange for certain patents, as further disclosed in Note 1, Non-controlling
interests included in the Company’s consolidated balance sheet as of September
30, 2010 represent the 13% minority shareholder’s share of Hongzhan’s net
assets.




(16)
            STATUTORY
      RESERVES




The
Company’s subsidiary incorporated in the PRC is required on an annual basis to
make appropriations of retained earnings set at certain percentage of after-tax
profit determined in accordance with PRC accounting standards and regulations
(“PRC GAAP”). Lizhan Textile must make appropriations to (i) general
reserve and (ii) enterprise expansion fund in accordance with the Law of
the PRC on Enterprises Operated Exclusively with Foreign Capital.




The
general reserve fund requires annual appropriations of 10% of after-tax profit
(as determined under PRC GAAP at each year-end and after setting off against any
accumulated losses from prior years) until such fund has reached 50% of Lizhan
Textile’s registered capital whereas enterprise expansion fund appropriation is
at its discretion. Appropriation to the general reserve must be made before
distribution of dividends to stockholders. The general reserve fund and
statutory reserve fund can only be used for specific purposes, such as setting
off the accumulated losses, enterprise expansion or increasing the registered
capital. The enterprise expansion fund was mainly used to expand the production
and operation; it also may be used for increasing the registered
capital.




Appropriations
to these funds are classified in the consolidated balance sheets as statutory
reserves. During the years ended September 30, 2010 and 2009, the Company made
total appropriations of $867,154 and $273,807 from retained earnings to these
statutory reserves, respectively.




There are
no legal requirements in the PRC to fund these reserves by transfer of cash to
restricted accounts, and the Company has not done so.




(17)
            OTHER
      INCOME




Other
income consists of the following:




Year
      ended September 30,2010
                  
                  
                  2009Revenue
      from exclusive distribution right (see Note 10)
                  
                  $
                  649,484
                  
                  
                  $
                  539,244Government
      grants
                  
                  
                  440,826
                  
                  
                  
                  26,367Scrap
      sales and others
                  
                  
                  49,135
                  
                  
                  
                  44,937Total
                  
                  $
                  1,139,445
                  
                  
                  $
                  610,548


F-22


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




During
the year ended September 30, 2010, $440,826 was recorded as revenue which was
derived from government grant received. The government grant was unconditional
and awarded to the Company as encouragement to the Company’s export business
development.




(18)
            INCOME
      TAXES




The
entities within the Company file separate tax returns in the respective tax
jurisdictions that they operate.




Cayman
Islands


Lizhan
Environmental, being incorporated in the Cayman Islands as an exempted company,
is not subject to any income tax in the Cayman Islands.




Hong
Kong


Resources
is generally subject to Hong Kong income tax on its taxable income derived from
trade or businesses carried out in Hong Kong at 16.5% for the two years ended
September 30, 2010. However, as Resources has not generated any revenue or
income, no provision for Hong Kong income tax has been made.




PRC


Lizhan
Textile being established in the PRC was subject to the PRC Enterprise Income
Tax (“EIT”) at 33% prior to January 1, 2008. In March 2007, the PRC government
enacted the PRC Enterprise Income Tax Law, or the New EIT Law, and promulgated
related regulation, Implementing Regulations for the PRC Enterprise Income Tax
Law, which became effective from January 1, 2008. The PRC Enterprise Income Tax
Law, among other things, imposes a unified income tax rate of 25% for both
domestic and foreign invested enterprises registered in the PRC. The New EIT Law
provides a grandfathering on tax holidays which were granted under the then
effective tax laws and regulations.




Lizhan
Textile has been approved a “foreign invested enterprise” and granted a
preferential tax treatment – a tax holiday of full exemption from EIT for the
two calendar years ended December 31, 2009 and a 50% reduction on its EIT rate
for the ensuing three calendar years ending December 31, 2012.




The
Company’s income tax expense consists of the following:




Year
      ended September 30,2010
                  
                  
                  2009PRC:-
      current income tax
                  
                  $
                  912,249
                  
                  
                  $
                  --
      deferred income tax
                  
                  
                  -
                  
                  
                  
                  -Total
                  
                  $
                  912,249
                  
                  
                  $
                  -


F-23


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




A
reconciliation of the expected income tax expense to the actual income tax
expense is as follows:




Year
      ended September 30,2010
                  
                  
                  2009Income
      before tax
                  
                  $
                  9,083,891
                  
                  
                  $
                  2,713,258PRC
      statutory income tax rates
                  
                  
                  25
                  %
                  
                  
                  25
                  %Expected
      income tax expense calculated at PRC statutory tax rates
                  
                  
                  2,270,973
                  
                  
                  
                  678,315Tax
      holiday
                  
                  
                  (1,358,724
                  )
                  
                  
                  (678,315
                  )Actual
      income tax expense
                  
                  $
                  912,249
                  
                  
                  $
                  -




The
effect of the tax holiday of Lizhan Textile amounted to $1,358,724 and $678,315
for the years ended September 30, 2010 and 2009, equivalent to basic and diluted
earnings per share amount of $0.12 and $0.06, respectively.




(18)
            INCOME
      TAXES – CONTINUED




As of
September 30, 2010 and 2009, the Company did not have any significant temporary
differences and carryforwards that may result in deferred tax. The Company has
analyzed the tax positions taken or expected to be taken in its tax filings and
has concluded it has no material liability related to uncertain tax positions or
unrecognized tax benefits. The Company classifies interest and/or penalties
related to income tax matters in income tax expense. For the years ended
September 30, 2010 and 2009, the Company has not recognized any amount of
interest and penalties related to uncertain tax positions. The Company does not
anticipate any significant increases or decreases to its liability for
unrecognized tax benefits within the next 12 months.




The New
EIT Law also imposes a withholding tax of 10% unless reduced by a tax treaty,
for dividends distributed by a PRC-resident enterprise to its immediate holding
company outside the PRC for earnings accumulated beginning on January 1, 2008
and undistributed earnings generated prior to January 1, 2008 are exempt from
such withholding tax. The Company has not provided for income taxes on
accumulated earnings of its PRC subsidiary as of September 30, 2010 and
September 30, 2009 because these earnings are intended to be reinvested
indefinitely in the overseas jurisdictions. It is not practicable to estimate
the amount of additional taxes that might be payable on such undistributed
earnings.




According
to the PRC Tax Administration and Collection Law, the statute of limitations is
three years if the underpayment of taxes is due to computational or other errors
made by the taxpayer or the withholding agent.  The statute of limitations
extends to five years under special circumstances. In the case of transfer
pricing issues, the statute of limitations is ten years. There is no statute of
limitations in the case of tax evasion. Accordingly, the income tax returns of
Lizhan Textile for the years ended September 30, 2008 through 2010 are open to
examination by the PRC state and local tax authorities.


F-24


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(19)
            RELATED
      PARTY TRANSACTIONS




Due
from/to related parties




As
      of September 30,2010
                    
                    
                    2009Amount
      due from a stockholder and director-
      Mr. You
                    
                    $
                    1,497
                    
                    
                    
                    -Amount
      due to a stockholder and director-
      Mr. Liu
                    
                    
                    -
                    
                    
                    $
                    51,252Amount
      due to a related company-
      Illigate Development Limited (wholly-owned by Mr. Liu)
                    
                    
                    -
                    
                    
                    $
                    80,000-
      Haining Jianfeng Textile Co., Ltd. (under common control of Mr.
      Liu)
                    
                    
                    -
                    
                    
                    
                    --
                    
                    
                    $
                    80,000




The
amounts due from and to related parties are interest-free, unsecured and without
fixed repayment term.




Related
      party purchase
                  
                  Year
      ended September 30,2010
                  
                  
                  2009Purchase
      from:-
      Haining Jianfeng Textile Co., Ltd. (under common control of Mr.
      Liu)
                  
                  
                  -
                  
                  
                  $
                  --
      Haining Yanfeng Textile Co., Ltd. (under common control of Mr.
      Liu)
                  
                  
                  -
                  
                  
                  
                  1,540Total
                  
                  
                  -
                  
                  
                  $
                  1,540




Guarantees
given by a stockholder and director


As of
September 30, 2010 and 2009, Mr. Liu provided a personal guarantee for the
Company’s bank acceptance notes (Note 11) and short-term bank loans (Note
12).




(20)
            RELATED
      PARTY TRANSACTIONS-CONTINUED




Use
and Transfer of Patents by a Principal Stockholder


Mr. Liu,
CEO and Chairman and a principal stockholder of the Company, has allowed the
Company to use exclusively 7 patents for fabric designs for no consideration. In
June 2010, in order to legalize the Company’s ownership of these patents, Mr.
Liu agreed to transfer their legal titles to the Company for no consideration.
As the historical costs recorded by Mr. Liu regarding these patents were
insignificant, the Company has not recognized these patents in the consolidated
financial statements, in accordance with the guidance within SAB Topic
5:G.




Long
term exclusive license


On
December 29, 2009, the Company’s 87% subsidiary, Hongzhan, entered into an
exclusive long-term license agreement with Mr. Liwen Zhang, the sole owner of
Eminent, which in turn holds 13% interest in Hongzhan, and a key employee of the
Company. Pursuant to the license agreement, Mr. Liwen Zhang has licensed to the
Company the use of certain patents in relation to the key innovative production
technology for the manufacture of the Company’s new evergreen products for
fifteen years, for the license fees of RMB100,000 (or $14,650) for the first
year, RMB200,000 (or $29,300) for the second year, and RMB300,000 (or $43,950)
for the third year and each of the years thereafter.


F-25


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




During
the year ended September 30, 2010, the Company recognized a license fee expense
of $11,021, included under “General and administrative expenses” in the
accompanying interim consolidated income statements. In connection with the
patent license agreement with Mr. Liwen Zhang, the Company is obligated to pay
the license fee for the patents as follows:




Year
      ending September 30, 2011
                  
                  
                  29,893Year
      ending September 30, 2012
                  
                  
                  44,840Year
      ending September 30, 2013
                  
                  
                  44,840Year
      ending September 30, 2014
                  
                  
                  44,840Year
      ending September 30, 2015
                  
                  
                  44,840Thereafter
                  
                  
                  418,503$
                  627,756




(21)
            CAPITAL
      COMMITMENT AND CONTINGENCIES




Capital
Commitments


For the
purposes of expansion of its production facilities, the Company has entered into
a number of contracts for the acquisition and construction of property, plant
and equipment. The related capital commitments which had not been provided for
in the financial statements as of September 30, 2010 amounted to $1,871,928,
which is expected to be disbursed during the next twelve months. In December
2009, the Company’s subsidiary, Hongzhan acquired a 50-year right to use a
parcel of land having an area of 17,200 square meter and located in the PRC. As
of January 31, 2011, Hongzhan has invested RMB 65,830,000 (or approximately
$9,974,242) for the purposes of the development of that land, and complete such
investment, including construction of buildings and facilities and installation
of plant and equipment.




F-26


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(22)
            OPERATING
      LEASE COMMITMENTS




License
fee expense for obligations under operating leases was $11,021 for the year
ended September 30, 2010. In December 2010, the Company entered into an
agreement to lease space for purposes of temporarily storing equipment to be
used in Evergreen Products production lines which the Company anticipated
installing later in 2011.  The monthly rent pursuant to this agreement is
approximately $46,723 and the term of this agreement expires in November
2020.The total future minimum lease payments under non-cancellable operating
leases with respect to premises and licence fee as of September 30, 2010 are
payable as follows:




September
      30,
                  
                  License Fee
                  
                  
                  Premises
                  
                  
                  Total2011
                  
                  
                  29,893
                  
                  
                  
                  420,510
                  
                  
                  
                  450,4032012
                  
                  
                  44,840
                  
                  
                  
                  560,680
                  
                  
                  
                  605,5202013
                  
                  
                  44,840
                  
                  
                  
                  560,680
                  
                  
                  
                  605,5202014
                  
                  
                  44,840
                  
                  
                  
                  560,680
                  
                  
                  
                  605,5202015
                  
                  
                  44,840
                  
                  
                  
                  560,680
                  
                  
                  
                  605,520Over
      five years
                  
                  
                  418,503
                  
                  
                  
                  2,943,567
                  
                  
                  
                  3,362,070$
                  627,756
                  
                  
                  $
                  5,606,797
                  
                  
                  $
                  6,234,553




(23)
            CERTAIN
      RISKS AND CONCENTRATIONS




Credit
risk and major customers


Financial
instruments that expose the Company to concentrations of credit risk primarily
consist of cash and accounts receivables. The maximum amount of loss due to
credit risk in the event of other parties failing to perform their obligations
is represented by the carrying amount of each financial asset as stated in the
consolidated balance sheet.




As of
September 30, 2010 and 2009, substantially all of the Company’s cash included
bank deposits in accounts maintained within the PRC where there is currently no
rule or regulation in place for obligatory insurance to cover bank deposits in
the event of bank failure. However, the Company has not experienced any losses
in such accounts and believes it is not exposed to any significant risks on its
cash in bank accounts.




The
Company performs ongoing credit evaluations of its customers’ financial
condition and historically has not experienced any significant collectibility
problem. As of September 30, 2010, two customers accounted for 22% and 14% of
the Company’s accounts receivable, respectively. As of September 30, 2009, two
customers accounted for 35% and 13% of the Company’s accounts receivable,
respectively.


F-27


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




Customers
accounting for 10% or more of the Company’s net revenue are as
follows:




Year
      ended September 30,2010
                  
                  
                  2009%
                  
                  
                  %Customer
      A
                  
                  
                  30
                  
                  
                  
                  28Customer
      B
                  
                  
                  16
                  
                  
                  
                  33Customer
      C
                  
                  
                  17
                  
                  
                  
                  N/A




Except as
disclosed above, no other single customer accounted for 10% or more of the
Company’s net revenue for the years ended September 30, 2010 and
2009.




(23)        CERTAIN
RISKS AND CONCENTRATIONS-CONTINUED




Concentration
of suppliers


The
Company purchased its raw materials from a few primary suppliers, which expose
the Company to risk of concentration of suppliers. Suppliers accounting for 10%
or more of the Company’s cost of revenue are as follows:




Year
      ended September 30,2010
                  
                  
                  2009%
                  
                  
                  %Supplier
      A
                  
                  
                  N/A
                  
                  
                  
                  11Supplier
      B
                  
                  
                  12
                  
                  
                  
                  16Supplier
      D
                  
                  
                  12
                  
                  
                  
                  N/A


F-28


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




Foreign
Operations





Substantially,
all of the Company’s operations are carried out and its long-lived assets are
located within the PRC. Accordingly, the Company’s business, financial condition
and results of operations may be influenced by the political, economic and legal
environments in the PRC. Among other risks, the Company’s operations in the PRC
are subject to the risks of restrictions on transfer of funds, export duties,
quotas, and embargoes, domestic and international customs and tariffs, changing
taxation policies, foreign exchange restrictions; and political conditions and
governmental regulations.




(24)
            RESTRICTED
      NET ASSETS




All of
the Company’s operations are conducted through Lizhan Textile. Lizhan Textile
may only pay dividend out of its retained earnings determined in accordance with
the accounting standards and regulations in the PRC and after it has met the PRC
requirements for appropriation to statutory reserves (see Note 16).




In
addition, a substantial part of Lizhan Textile’s businesses and assets are
denominated in RMB, which is not freely convertible into foreign currencies. All
foreign exchange transactions take place either through the People’s Bank of
China or other banks authorized to buy and sell foreign currencies at the
exchange rates quoted by the People’s Bank of China. Approval of foreign
currency payments by the People’s Bank of China or other regulatory institutions
requires submitting a payment application form together with suppliers’
invoices, shipping documents and signed contracts. These requirements imposed by
the PRC government authorities may restrict the ability of Lizhan Textile to
transfer its net assets to the Company through loans, advances or cash
dividends, which consisted of paid-up capital, additional paid in capital,
retained earnings and statutory reserves and amounted to approximately $17.2
million (RMB115) million as of September 30, 2010, exceeding 25% of the
Company’s consolidated net assets. Accordingly, condensed parent company
financial statements have been prepared in accordance with Rule 5-04 and Rule
12-04 of SEC Regulation S-X, and set out in Note 27.




(25)
            SEGMENT
      DATA –
      ENTITY-WIDE DISCLOSURE




The
Company follows FASB ASC Topic 280, Segment Reporting, which
requires that companies disclose segment data based on how management makes
decision about allocating resources to segments and evaluating their
performance. The Company operates and manages its business as a single segment
that includes primarily the manufacturing and sales of leather and other
fabrics.


F-29


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




The
following tables sets out the analysis of the Company’s net revenue by product
and geographical location:




Year
      ended September 30,2010
                      
                      
                      2009Products:Polyurethane
      (PU) and ultrasuede leather
                      
                      $
                      9,201,596
                      
                      
                      $
                      8,616,807Recycled
      leather flocked fabric
                      
                      
                      34,209,667
                      
                      
                      
                      11,740,691Microfiber
      towel
                      
                      
                      558,408
                      
                      
                      
                      408,354Tufted
      fabrics
                      
                      
                      1,692,669
                      
                      
                      
                      115,866Other
      fabrics
                      
                      
                      658,885
                      
                      
                      
                      730,823Total
                      
                      $
                      46,321,225
                      
                      
                      $
                      21,612,541Geographical information:PRC
                      
                      $
                      35,720,935
                      
                      
                      $
                      13,550,142United
      States
                      
                      
                      6,363,200
                      
                      
                      
                      5,488,462Nicaragua
                      
                      
                      2,354,356
                      
                      
                      
                      2,093,445Others
                      
                      
                      1,882,734
                      
                      
                      
                      480,492Total
                      
                      $
                      46,321,225
                      
                      
                      $
                      21,612,541




Revenues
are attributed to countries according to the location where the customers take
delivery of the Company’s products.


F-30


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(26)
            ADOPTION
      OF STOCK OPTION PLAN




On March
1, 2010 the Company’s Board of Directors adopted the Lizhan Environmental
Corporation 2010 Stock Option Plan (the “2010 Plan”).  The 2010 Plan allows
the Company to grant stock options to officers, directors (whether or not they
are employed by the Company), executive, managerial, professional or
administrative employees of, and consultants to, the Company, its parent,
subsidiaries and joint ventures (collectively, “key persons”) as the Committee
in its sole discretion shall select. Up to1,875,000 shares of the Company’s
common stock may be issued under the 2010 Plan. The purpose of the 2010 Plan is
to provide certain key individuals with compensation for initiative and
successful efforts.




The
Company has not granted any options under the 2010 Plan up to September 30,
2010.


F-31


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(27)
            CONDENSED
      PARENT COMPANY FINANCIAL INFORMATION OF LIZHAN
    ENVIRONMENTAL




The
Company records its investment in subsidiaries under the equity method of
accounting as prescribed in ASC Topic 323, “Investments – Equity Method and
Joint Ventures”. Such investment and long-term loans to subsidiaries are
presented on the balance sheet as “Investments in subsidiaries” and the income
of the subsidiaries is presented as “Equity in income of subsidiaries” on the
statement of income.




These
supplemental condensed parent company financial statements should be read in
conjunction with the notes to the Company’s Consolidated Financial Statements.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with U.S. GAAP have been condensed or
omitted.




As of
September 30, 2009 and 2010, there were no material contingencies, significant
provisions for long-term obligations, or guarantees of the Company, except as
separately disclosed in the Company’s Consolidated Financial Statements, if
any.




CONDENSED
      BALANCE SHEETS
                    
                    As
      of September 30,2010
                    
                    
                    2009AssetsCash
                    
                    $
                    17,957
                    
                    
                    
                    -Investments
      in subsidiaries
                    
                    
                    18,404,028
                    
                    
                    
                    8,174,989Total
      assets
                    
                    $
                    18,421,985
                    
                    
                    $
                    8,174,989Liabilities
      and Shareholders’ EquityCurrent
      liabilities:Other
      Payable
                    
                    $
                    76,693
                    
                    
                    $
                    -Due
      to a subsidiary
                    
                    
                    -
                    
                    
                    $
                    52,080Total
      liabilities
                    
                    $
                    76,693
                    
                    
                    $
                    52,080Shareholders’
      equityCommon
      stock, $0.32 par; 31,250,000 shares authorized, 11,143,750 shares and
      10,937,500 shares issued and outstanding as at September 30, 2010 and
      2009, respectively
                    
                    
                    3,566,000
                    
                    
                    
                    3,500,000Additional
      paid-in capital
                    
                    
                    924,000
                    
                    
                    
                    -Retained
      earnings
                    
                    
                    12,342,981
                    
                    
                    
                    4,156,874Accumulated
      other comprehensive income
                    
                    
                    888,532
                    
                    
                    
                    466,035Total
      Lizhan’s shareholders’ equity
                    
                    
                    17,721,513
                    
                    
                    
                    8,122,909Noncontrolling
      interest
                    
                    
                    623,779
                    
                    
                    
                    -Total
      equity
                    
                    
                    18,345,292
                    
                    
                    
                    8,122,909Total
      liabilities and shareholders’ equity
                    
                    $
                    18,421,985
                    
                    
                    $
                    8,174,989


F-32


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(27)
            CONDENSED
      PARENT COMPANY FINANCIAL INFORMATION OF LIZHAN
      ENVIRONMENTAL-CONTINUTED




CONDENSED
      STATEMENT OF INCOME
                  
                  Year
      ended September 30,2010
                  
                  
                  2009General
      and administrative expenses
                  
                  $
                  (303,561
                  )
                  
                  $
                  (42,080
                  )Equity
      in income of subsidiaries
                  
                  
                  8,489,668
                  
                  
                  
                  2,773,378Net
      income
                  
                  $
                  8,186,107
                  
                  
                  $
                  2,731,298




CONDENSED
      STATEMENT OF CASH FLOWS
                  
                  Year
      ended September 30,2010
                  
                  
                  2009Net
      cash used in operating activities
                  
                  $
                  -
                  
                  
                  $
                  -Net
      cash used in investing activities
                  
                  
                  (972,482
                  )
                  
                  
                  (690,552
                  )Net
      cash provided by financing activities
                  
                  
                  990,439
                  
                  
                  
                  690,552Cash,
      beginning of year
                  
                  
                  -
                  
                  
                  
                  -Cash,
      end of year
                  
                  $
                  17,957
                  
                  
                  $
                  -


F-33


LIZHAN
ENVIRONMENTAL CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED SEPTEMBER 30, 2010 AND 2009




(28)
            SUBSEQUENT
      EVENT




(i)
            Loan
      & Credit Facility




On
October 28, and 29, 2010, the Company repaid its short-term loans in the
aggregate amount of approximately $9.5 million. In addition, during that period,
the Company entered into new long-term loans, which are due between May to
December 2012, in the aggregate amount of $9.5 million. As a result, the
Company’s short-term loans as at September 30, 2010 amounted to $4.2 million in
the aggregate and long-term loans currently amounted to $9.5 million in the
aggregate at the end of October 2010. Additionally, in October 2010, the Company
also obtained one short term loan of about $747,000 (RMB 5,000,000) and a
one-year line of credit with Shanghai Pudong Development Bank with an
availability of up to $4.9 million (RMB 33,000,000).




(ii)
            Initial
      Public Offerings




On
November 19, 2010, the Company issued 2,500,000 ordinary shares at par
value of $0.32 per share in the initial public offering. The public offering
price of the ordinary shares is $4.00 per share.  The Company received net
proceeds of approximately $7.5 million from the offering, after deducting
underwriting discounts, expense payable by the Company.


F-34