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Project Shaanxi Due Diligence Report – UPDATE 3
September 2, 2010 Strictly Private and Confidential


TABLE OF CONTENTS SCOPE AND PROCESS.........................................................................................................................................4 SECTION 1 - BACKGROUND ................................................................................................................................5 SECTION 2 - KEY ISSUES.....................................................................................................................................6 SECTION 3 - RECOMMENDATION .....................................................................................................................21 APPENDIX ONE - CONTRACT ............................................................................................................................22 APPENDIX TWO - INFORMATION SOURCES ...................................................................................................23 APPENDIX THREE - SITE VISIT PHOTOS..........................................................................................................24


Scope and Process
For the purpose of this report, we visited CGA’s greenhouse facilities located near Xi’an, Shaanxi province, as well as its manufacturing plant in Yangling, Shaanxi, followed by telephone calls and discussions with management. We had discussions with, and obtained information from other employees, customers, suppliers and competitors of CGA, as well as industry analysts, experts and consultants. Our information was obtained primarily from 3rd party sources known by us to be reliable, the management of CGA, SEC filings, together with other information obtained through our conversations with CGA employees, customers and other public sources. CGA engaged an accounting firm, Kabani & Company, Inc, to perform an audit of the consolidated financial statements for FY08 and FY09, and reviews of the FY10 Q1, Q2, Q3 financial statements on which our analysis was based. We have not carried out anything in the nature of an audit nor, unless explicitly stated, have we subjected financial or other information contained in this report to checking or verification procedures. Accordingly, we assume no responsibility and make no representations with respect to the accuracy or completeness of the information in our report. The sufficiency of the work we performed is solely the addressee’s responsibility and we make no representations regarding the sufficiency of our work either for the purpose for which this report has been requested or for any other purpose. Per your request, we have not shown a draft of this report to the management of CGA nor have we discussed with them the findings and conclusions we submitted in this report.

Due diligence process

Access to information

External auditor

Significant scope matters

Management representations


Section 1 Background



Section 2 Key Issues


CGA management continues to be unable to explain large discrepancies between the VAT payables presented in their audited financials filed with the SEC and records obtained from the PRC State Administration of Taxation
Chinese companies report and pay VAT and corporate income taxes to the State Administration of Taxation (SAT), the equivalent of the IRS in the United States. To conduct our investigation we obtained certified copies of CGA Jinong’s SAT payment records from 3rd party sources known by us to be reliable. SAT records are the only reliable and definitive source of tax payment records in China. On yesterday’s conference call, CEO Tao Li confirmed our assertion that CGA is exempt from paying VAT on most of its products. He said the exemption was granted on September 1, 2009. He also stated that the VAT accrued on CGA’s balance sheet filed with the SEC was all paid to the SAT and that the records we obtained were “incomplete”. Of course we disagree and insist that the records we obtained are in fact correct. We have found no evidence that CGA’s subsidiaries have ever paid any material amount of VAT. Nor has CGA offered any such proof of paying VAT. 1) Value Added Tax (VAT). CGA’s quarterly and annual audited financial statements filed with the SEC on forms 10-Q and 10-K disclose VAT payable at the end of each period. These amounts according to PRC law are payable within 30 days. Few if any extensions are granted and late penalties are severe. The following table summarizes these amounts. Date 2010.3.31 VAT Payable $12,073 2009.12.31 $4,536 2009.9.30 $2,191,772 2009.6.30 $1,216,191 2009.3.31 $582,925 2008.12.31 $1,009,242 2008.9.30 $5,476,791 2008.6.30 $4,495,140

As the table above shows, CGA historically accrued large VAT payables up until September 2009 after which management claimed they received an exemption in accordance with SAT 2008 Taxation Notice #56, “Exemption of VAT for Organic Fertilizer Products”. However, the large historical accruals were in fact never paid according to SAT records of CGA’s main subsidiary, Shaanxi TechTeam Jinong Humic Acid Product Co., Ltd. (“Jinong”):1


Original tax records from PRC State Administration of Taxation in Appendix Two at the end of this report.

SAT Tax record Tax period VAT payment 2010.4 ¥127,976 2010.3 ¥120,906 2010.2 ¥3,784 2010.1 ¥0 2009.12 ¥19,536 2009.11 ¥0 2009.10 ¥41,291 2009.9 ¥16,329 2009.8 ¥14,921 2009.7 ¥35,539 2009.6 ¥11,869 2009.5 ¥23,761 2009.4 ¥0 2009.3 ¥8,337 2009.2 ¥0 2009.1 ¥0 2008.12 ¥0 2008.11 ¥4,630 2008.10 ¥4,467 2008.9 ¥4,453 2008.8 ¥17,623 2008.7 ¥13,577 Total ¥469,000 Total $67,971

SEC filings Date VAT Payable 2010.3.31 $12,073 2009.12.31 2009.9.30 2009.6.30 2009.3.31 2008.12.31 2008.9.30 2008.6.30 Total $4,536 $2,191,772 $1,216,191 $582,925 $1,009,242 $5,476,791 $4,495,140 $14,988,670

According to SAT records, from July 2008 through April 2010 Jinong paid VAT of only 469,000 RMB (about $67,971). This small amount is completely inconsistent with the large amounts reported on CGA’s balance sheet each quarter as shown above. The difference is nearly $15 million (assuming each quarter ending balance payable was in fact paid according to the regulation, which only gives companies 30 days to pay before serious penalties are applied). We have repeatedly asked CGA management to provide an accounting of this huge shortfall. Where did these funds go? To date management has refused to respond other than stating on their conference call that the records we obtained were “incomplete”. 8

2) Corporate Income Tax. CGA’s annual audited financial statements filed with the SEC on form 10-K disclose income tax paid. Based on the cumulative amounts disclosed in the quarterly 10-Q cash flow statements we calculated the amount of income tax paid in calendar year 2009 on a cash basis to be as follows: Fiscal Period Q2E 12.31.09 Q1E 9.30.09 Q4E 6.30.09 Q3E 3.31.09 2009 Total Income Tax Paid $$$(621,367) $3,355,719 $2,734,352

However, according to SAT records there is no record of Jinong paying corporate income tax in 2009.2 There are several troubling implications: • If indeed Jinong did not pay income tax in 2009 as indicated by the SAT record then the net profit of $17,208,332 of the fertilizer division (Jinong) reported in its SEC filings as shown below must be significantly overstated.
Fiscal Period Q2E 12.31.09 Q1E 9.30.09 Q4E 6.30.09 Q3E 3.31.09 Total Jinong Net Income $4,213,250 $5,159,879 $4,369,862 $3,465,341 $17,208,332

If Jinong did not pay the $2,734,352 tax as reported, then according to PRC law the failure to pay is a serious criminal offense with significant penalties.


Ibid. 9

If Jinong did not pay the $2,734,352 tax as reported, where did these funds go? Management to date has completely refused to respond to this question other than stating on their conference call that the records we obtained are incomplete.


The actual cost of the September 2009 Hu County 88 acre greenhouse land purchase was indeed less than ¼ the price CGA reported in its SEC filings and to investors in yesterday’s conference call
Yesterday, CEO Tao Li claimed on the conference call that the evidence we collected regarding the greenhouse land purchase was, similar to the tax records, “incomplete”. He asserted that in addition to our well-documented costs there was another 54.8 million RMB land use rights transfer payment to an undisclosed SOE. Tao Li did not offer any proof of this payment nor do we think any valid proof exists. From a review of the extensive evidence and PRC law: 1. It is clearly stated in the land use right transfer agreement that CGA subsidiary Yuxing (Yuxing) acquired the land use right from Hu County government's Land and Resource Bureau. There is no possibility of payment made to a 3rd party. The agreement is titled "State-Owned Land Use Right Transfer Agreement" and it clearly stated the seller is the Land and Resource Bureau of Hu County, Xi'an, Shaanxi. In the Notice of Approval of the Land Use Right Sale issued by Hu County People's Government, file number - Notice #16 (2009), it is clearly stated that, on April 3rd 2009, the local government had already taken back the ownership of the Land Use Right that was subsequently sold to Yuxing. The document also indicated the land use right was granted to Yuxing by the Hu County government according to the 26th and 60th meeting by its standing committee. There clearly was no 3rd party involved in this transaction. 2. The same notice clearly pointed out the specified usage of the land is for agriculture (农田). Agricultural use land is much lower price than industrial use land. In fact the “comparable” prices quoted by CGA management on the conference call were for land sold for industrial purposes, a much higher cost use. We are preparing a table of real comparable sales and will circulate in a subsequent update. 3. The designated receipts issued for the payment in the sale each indicate the seller is the government, not the farm that previously owned the land. 4. Calculation of the Deed Tax does not support management’s inflated claim because regardless of whether the land use right was purchased from a 3rd party or the government, deed taxes are required to be calculated and paid based on total sale price. In this case, the deed tax receipt and proof of completion from the Land and Resource Bureau shows the 3% deed tax is applied only to the RMB17.35M recorded purchase price not the RMB73.2M inflated purchase price claimed by CGA management. 11

5. Finally, the sale price of the land use right was the result of an appraisal by a 3rd party appraisal firm and approved by the Land and Resource Bureau. In the official Confirmation Report of Land Appraisal issued by the Land and Resource Bureau (confirmation file #14 dated August 5, 2009), the bureau acknowledged the appraised value of RMB17.33M properly reflects the real value of the land. We therefore strongly continue to believe that multiple government agencies records accurately and correctly show the actual purchase price was only RMB 17.35 million or $2,540,433. The government agency that granted the land use right was the Land & Resources Bureau (LRB) in Hu County, the local branch of the Ministry of Land and Resources of the PRC government. An overview of the key functions and responsibilities of the LRB can be found on its website13. For the purpose of verifying the purchase cost of land use rights, we obtained a number of official documents from the LRB including the following14:
a. A written, stamped confirmation report (Hu County LRB confirmation [2009] #14) issued by the Land Resource Bureau of Hu County for the valuation of the land, showing an appraised value of RMB 17,338,684 for the land. b. Land Use Right Certificate issued and stamped by Hu County People’s Government and LRB. c. Land Use Right Transfer Agreement provided by Hu County LRB, showing a transfer price of RMB 5,201,605.29. The agreement was signed by Xi’an Yuxing Agricultural Science and Technology Development Co., Ltd. d. Land Compensation Agreement provided by the Land Resource Bureau of County Hu, which is signed with Xi’an Yuxing Agricultural Science and Technology Development Co., Ltd, outlining the compensation cost needed to pay for the acquisition of the land and its attached assets of RMB 12,149,554. e. Three receipts showing the total purchase price of the land use right, totaling RMB 17,351,159.29. The receipts are issued and stamped by Agricultural Tax Collection Office of Hu County. f. The deed tax invoice provided by the LRB of Hu County. This invoice shows the actual sales price of RMB 17,351,159.29 for this land use right. g. Notice of Approval of the Land Use Right Sale issued by Hu County People’s Government, file number – Notice #16 (2009)


Ministry of Land and Resources of People’s Republic of China website: Original documents are attached in Appendix Two at the end of the report.


A direct comparison of the land cost disclosed by CGA and the government records reveals:
CGA disclosed purchase price $10,721,805 Government records RMB 17.35 million or $2,540,433 Discrepancy $8,181,372

In this case, the overwhelming evidence strongly contradicts CGA’s disclosed purchase price. The difference of $8,181,372 cannot be account for. CGA management has still not provided any valid explanation or proof otherwise. And seriously, 88 Chinese acres (“mu”) equals about 14.5 U.S. acres or 5.9 hectares of farmland. Who has ever paid over $1.8 million per hectare for undeveloped farmland? Where did the money really go?


Large discrepancies in revenues and net income reported in CGA’s filings with the SEC compared to those reported to its local State Administration of Industry and Commerce (SAIC) have not been explained by Management
On yesterday’s conference call, CEO Tao Li and CFO Ken Ren asserted that the amounts reported to the SEC are correct and that all the SAIC records are “incomplete”. This combined with all the other claims by management that their PRC records are supposedly “incomplete” is nonsense. We remind investors that management signed off on all these records and has yet to offer any additional records to supplement those we collected from reliable sources. We clearly do not believe such records exist, though management might certainly be trying to create some right now in response to our repeated challenges. The State Administration of Industry and Commerce is the official regulatory agency of private businesses in China. Its function is similar to the Commerce Department in the United States. Each year companies are required by law to submit their financial statements to their local branch of the SAIC. For the purpose of verifying CGA’s reported revenues and net income, we obtained the Annual Joint Inspection Reports for 2007 and 2008 from the local SAIC branch in the city of Xi’an. The reports are stamped by both SAIC and Jinong, as well as signed by CGA’s Chairman, Mr. Tao Li15. Comparison  of  Jinong  Revenue  and  Net  Income  reported  to  SEC  and  SAIC   Calendar  Year  2007   Calendar  Year  2008   SEC   SAIC   Variance   SEC   SAIC   Variance   USD   USD   RMB   USD   USD   USD   RMB   USD    $14,790,590     $6,646,166   ¥50,218,096   122.54%    $22,896,632      $7,793,689     ¥55,078,779   193.78%    $7,054,892     $1,116,664   ¥8,437,454   531.78%    $9,700,758      $1,273,983     ¥9,003,364   661.45%  

      Revenue   Net  Income  

Exchange  rates  used  to  translate  the  revenues/net  incomes  are  7.56  in  2007  and  7.07  in  2008.  

As shown in the table above, Jinong’s Sales and Net Income figures reported in CGA’s SEC filings are dramatically higher than the amounts Jinong reported to the SAIC. For 2008, the Net Income variance is over six times (661%). Considering CGA Chairman Li signed both SEC and SAIC filings, we question how such a large discrepancy could exist without his express approval.

Original SAIC Annual Joint Inspection Report submitted by Jinong, including the annual financial statements in 2007 and 2008.


We are uncomfortable with the company’s selection of Kabani & Company as auditor
We find it quite unusual for an NYSE listed company with more than $250 million market capitalization not to have a “Big Four” or at least a top ten ranked accounting firm as its auditor. A list of current/past Chinese clients of Kabani & Company screened from SEC filings is shown below. From the table, the only considerable sized client Kabani audits (measured by daily dollar trading volume) is L&L Energy (NASDAQ: LLEN), a company that recently upgraded to NASDAQ. At worst, Kabani used to audit a company called Bodisen Biotech Inc (OTCBB: BBCZ), another Chinese organic fertilizer company whose stock went from $10 to $0.57. Curiously, both Bodisen and CGA’s factories are located in the same small town of Yangling in the Yang Ling Agriculture High-tech Demonstration Zone. However, we could find no connection between the companies. Given the large amount of cash it has raised in the past and currently has on hand, CGA could easily afford the engagement of a “Big Four” auditor. So we question why CGA has waited so long? Ticker LLEN FFHL SGTI.OB CVDT.OB BBCZ.OB ORS SRRY.OB AMGY.PK TONJ.OB ARUZ.OB AWSH.OB CYXN.OB SGLA.OB CVPH.OB NTYN.OB HXTH.PK HRCT.OB Name L & L Energy, Inc. Fuwei Films (Holdings) Co., Ltd SHENGTAI PHARMACEUTICAL, INC. CHINA VOIP & DIGITAL Bodisen Biotech Inc Orsus Xelent Technolgies, Inc. Sancon Resources Recovery Inc American Metal & Technology, Inc TONGJI HEALTHCARE GP AURASOUND INC AMERICAN WENSHEN STL CHINA YONGXIN PHARMA SINO GREEN LAND CORP CHINA VITUP HEALTH NEW TAOHUAYUAN CULTR HXT HLDGS INC HARTCOURT COS INC Price $11.34 $1.38 $1.43 $0.47 $0.62 $0.24 $0.36 $0.19 $0.21 $1.80 $1.01 $3.86 $0.30 $1.06 $0.01 $1.08 $Volume 816,200 37,457 12,855 21,650 14,786 29,486 6,300 317 172 14 15 0 0 0 0 0 Dollar Volume $9,255,708 $51,690 $18,382 $10,175 $9,463 $7,076 $2,268 $60 $36 $25 $15 $$$$$$15

The acquisition price CGA paid for Beijing Gufeng was too high. CFO Ken Ren admitted Gufeng’s 2009 earnings quality was low. Gufeng’s audited financials completely contradict its results filed with the PRC State Administration of Industry and Commerce (SAIC)
In the 8-K filed with the SEC on July 7 2010, CGA disclosed the details of its acquisition of Beijing Gufeng Chemical Products Co., Ltd. (Gufeng). According to the 8-K, CGA acquired 100% of the equity interests in Gufeng for a combination of RMB 60 million (approximately $8.8 million) in cash plus the issuance of 2,275,931 shares of CGA common stock to Gufeng shareholders. Based on the closing stock price of $10.81 on August 13, 2010 the total purchase price was $33.38 million. However, the extra $14.7 million advanced to Gufeng to cover its working capital shortfall brings the total cost of the acquisition to $48 million.

CGA appears to be significantly overpaying for this acquisition
1. Gufeng net assets are worth far less than the purchase price CGA disclosed Gufeng has fertilizer production capacity of 300,000 metric tons/year with a current utilization rate of 60%. Our survey of fertilizer industry experts concluded that the cost to construct a brand new state of the art facility of similar capacity should not exceed $15 million. In the latest audited financial statements of Gufeng disclosed in the 8-K/A on August 13, 2010, Gufeng had Plant, Property and Equipment of $10,127,221 as of March 31, 2010, an amount less than 1/3 of the reported purchase price. After deducting all Liabilities from Total Assets, the net asset value of Gufeng is merely $4.2 million, meaning approximately $29 million of the purchase price will be allocated to “goodwill”. In addition, Gufeng’s financial position prior to the acquisition was very weak judging from the lack of cash resources on the balance sheet and lack of cash flow historically. In fact, CGA’s July 7th 8-K admitted CGA will: “…contribute RMB 100 million (approximately $ 14.7 million) to Gufeng following the Closing Date for working capital.”


Accounting for this $14.7 million additional cash advance from CGA to make up Gufeng’s working capital shortfall, the total acquisition cost rises to $48 million. Considering the less-than-stellar historical performance of Gufeng and the fact that the same management team is going to stay to manage the business, we failed to see any reason to pay a premium price for Gufeng. 2. Gufeng’s audited financials are of low quality and are inconsistent with SAIC records According to the Income Statements disclosed in the 8-K/A on August 13 2010, Gufeng had a net loss of $2,946,701 in 2008 and a net income of $3,755,409 in 2009, with its revenue growing 30% year over year. However, the financial statements filed with SAIC show very little profit made in calendar years 2007-2008 and Gufeng actually had a loss of RMB 7.98 million in 2009, as shown in the table below.
Beijing Gufeng Financial Information Unit: RMB '000 SAIC Audited Financials* 2007 2008 2009 2007 2008 2009 296,485 340,568 177,997 N/A 281,795 369,000 182 131 (7,980) N/A (20,097) 25,649

Source Calendar Year Revenue Net Profit

*Audited financials provided by CGA were converted with the exchange rate of 6.82 in 2008 and 6.83 in 2009.

We obtained Gufeng’s original annual financial statements filed with the SAIC directly from local SAIC branch in Beijing. The document was stamped by the company and also signed by Gufeng’s CEO Qingxin Jiang and financial manager Cunxin Guo.21


Original Beijing Gufeng’s financial statements filed with the SAIC and signed by CEO QingXin Jiang


Another sign of low earnings quality is the unusually large changes in Inventory and Unearned Revenue between 2008 and 2009:


When companies delay or hold off the recognition of revenues, Inventory and Unearned Revenue tend to go up. When revenues are subsequently recognized on the Income Statements, the Inventory becomes Cost of Revenue and Unearned Revenue becomes Revenue. In Gufeng’s case, this is evidenced by the record high levels of Inventory and Unearned Revenue on the 2008 year-end Balance Sheet followed by sharp decreases of $11.88 million in Inventory and $13.62 million in Unearned revenue at 2009 year-end. Furthermore, Gufeng moved from stable operating cash flow of $3.8 million in 2008 to a total lack of operating cash flow in 2009. In sharp contrast, most Shanghai and Shenzhen listed fertilizer companies reported significantly better results in 2008 than 2009 (see the table below).


Ticker 000792 000830 600423 000731 002170 000912 600227

Company 盐湖钾肥 鲁西化工 柳化股份 四川美丰 芭田股份 泸天化 赤天化

2008 Operating Income RMB 000 2,671,789 316,781 102,628 226,204 66,618 468,647 190,737

2009 Operating Income RMB 000 2,050,988 160,550 19,594 92,529 5,218 59,239 166,931

Year over Year Change -23% -49% -81% -59% -92% -87% -12%

When queried on yesterday’s conference call, CFO Ken Ren agreed that Gufeng’s 2009 earnings quality was “low”. So we ask: Did Gufeng intentionally shift some revenue from 2008 to 2009? How does Gufeng explain the opposing trends in earnings and cash flow from 2008 to 2009? What value can investors place on these low quality earnings? Most importantly, why would CGA pay such a huge purchase price and where is this money really going? To date management has provided no meaningful response. Finally, what was the point of acquiring Gufeng when CGA's own facility is at merely 40% utilization? And why is management, in addition to retooling Gufeng, spending $7 million to add another 200k tons per annum production line? And if it only costs $7 million to build 200ktpa capacity why did they value Gufeng’s existing, admittedly outdated, 300ktpa plant at $33M purchase price +$14.7M working capital infusion?


Section 3 Recommendations



Appendix One Contract



Appendix Two Information Sources

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Appendix Three Site Visit Photos

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