Shenguan : Malicious and Groundless Allegations and Comments in Emerson Analytics' Report - Clarification Announcement Issued to Refute Point by Point To Ensure a Correct Understanding of the Group

Allegation in the Report

Response from the Company

The Report questioned the reliability of the financial statistics of the Group and profit overstated

(1) There were hidden raw material costs, and the total raw material costs and the total cost of sales of the Group for each of 2012 and 2013 should be much higher than the figures disclosed.

• The Report's estimation lacked any factual basis and was overstated. The Group recorded revenue growth of 9.8% and stable gross margins, it is arithmetically impossible to have achieved a 25% growth in its sales volume.

• The sales volume of approximately 4.274 billion meters for 2013 as stated in the Report lacked any factual basis. According to the Group's sales records, the sales volume for 2012 and

2013 was approximately 3.8 billion meters and

3.9 billion meters, respectively.

• The rate of conversion per ton of cattle inner skin for the Group is more than 80,000 meters, which is substantially higher than 60,000-

70,000 meters estimated by the Report. The high rate of conversion has resulted from the Group's experienced management and production team, economies of scale, the attainment of 31 patents and high efficient production technology.

(2) The EBIT margin is irrationally high. The Report stated that Shenguan has reported very high EBIT margins that averaged 53% in the last few years, much higher than the 18% or so enjoyed by two foreign companies, Viscofan Group and Devro PLC. Its gross margin at 55-60% was also a lot higher than the

25-40% reported by Liuzhou Honsen, a smaller Chinese manufacturer.

• The Directors are unable to have an in-depth understanding of, and make comment on, the EBIT margin of foreign companies due to their different product categories and production locations.

• The Directors are of the view that the high EBIT margin achieved by the Group is mainly attributable to factors such as economies of scale, centralized production base, direct sales, effective energy saving, production automation and information system automation.

• The Directors are of the view that the five companies in China as stated in the Report are not comparable to the Group in terms of experience, financial strength and scale of operation. (For more information of these five companies, please refer to the Announcement.)

(3) The controlling Shareholders

• The Group received no subsidy from, and

subsidized the Group with the dividends, the proceeds from their sale of the Shares and the proceeds from their sale of Wuzhou Xiansheng, to conceal the costs.

provided no subsidy recovery to, the controlling shareholders. Such allegation is a complete fabrication.

• The allegations defy commercial practice and no cost was hidden by the Group. The Report has not taken into account the costs to the controlling Shareholders such as enterprise income tax, dividend withholding tax, and personal income tax, and the fact that the controlling Shareholders do not hold 100% equity interest in the Company.

• The Company has not conducted any placement of new Shares after its listing.

• The Group utilized its internal funds to satisfy the payments of dividends and maintained at a net cash position since IPO. This allegation is logically fallacious.

The Report alleged that the Group had irregularities in its accounts.

(1) The Report accused Ernst & Young ("EY") of not auditing the accounts of the Group's subsidiaries established in China.

• EY has been sending its team every year to the Group's major operating subsidiaries in China to carry out auditing procedures during annual audit.

The Company has discussed with EY on the allegations of the Report and this Announcement. EY is currently of the view that there is no change to their audit opinions issued for the listing of the Company and annual audits.

• The information presented in the Report is misleading and based on an incomplete understanding of the practice of companies listed on The Stock Exchange of Hong Kong Limited.

(2) The Group's average monthly wages per staff dropped in 2012 and 2013.

• The Report has not taken into account the changes in the regulations relating to the arrangements of employees welfare fund, as well as provision of year-end bonus in China.

• Average monthly wages per staff in 2013 (RMB3,287) were higher than those of 2012 (RMB2,903) and 2011 (RMB 2,955). The average monthly wages per staff increased in

2013 by 13.2%, which was in line with the general market condition in China.

(3) The Report stated that the R&D cost

• The Directors would like to clarify that the R&D

ratios for 2010, 2011 and 2012 were higher than those of other companies, and cast doubt over the accounting treatment for the R&D cost in the financial statements.

costs as described in the prospectus of the Company, published annual reports and in this announcement mainly represent the production costs of New Products. The Directors have confirmed with EY that such expenditures do not fall into the definition of R&D expenses as defined by Hong Kong Accounting Standard 38

Intangible Assets.

• To record all related production expenses incurred for the production of New Products during the addition or improvement of production lines, the enhancement of energy

system and improvement of formulae, the Group has used a separate account (i.e. R&D costs) to record those expenses.

• The purpose of this account is to better monitor and accurately trace the production cost for the New Products for internal management use.

• The production costs of the New Products will be transferred to the cost inventory when the production is completed. When the New Products are sold and shipped to a customer, the Group will record the sales revenue and the corresponding cost of the New Products will be recorded. The cost is not shown as a single item but is further broken down into different categories of costs incurred during the production, such as raw materials costs, utilities costs, direct labour costs and factory

overheads.

• EY confirmed that the accounting treatment as described above does not have any impact on the financial indicators such as cost and profits as presented in the Group's financial statements.

• The Group had incurred a substantial amount of production cost for the New Products which was recorded in the "R&D costs" account in 2012 as a result of the increased production lines, the investment in improving the applicability of existing products and the development of the fourth generation heat energy system in 2012.

Other allegations in the Report

(1) The consideration for acquiring

• At the time of the acquisition of Wuzhou

Wuzhou Xiansheng was too high and the financial performance of Wuzhou Xiansheng was in decline in 2010.

Xiansheng, Wuzhou Xiansheng was a shareholder holding a 3% equity interest in Wuzhou Shenguan. As almost all the Group's business is carried out through Wuzhou Shenguan and its subsidiaries, the market value of the Company is a reasonable estimate of the market value of Wuzhou Shenguan. Wuzhou Xiansheng had no other business at that time.

• The shareholders of Wuzhou Xiansheng had offered a discount of approximately 15% for the acquisition to the Company.

• The declining financial result of Wuzhou Xiansheng was due to the drop in its shareholding in Wuzhou Shenguan from 21.7% to 3% in May 2009 and the decrease in dividends paid to Wuzhou Xiansheng by Wuzhou Shenguan.

(2) The Company charged its major clients at a premium.

• There are various types, models and standards as well as selling prices for the Group's products. For instance, the Group's products can be generally categorized into Western-style casing and Chinese-style casing.

• Major clients of the Group mainly purchased

Western-style products from the Group.

• During 2006-2008, the average selling price of Western-style products was 32% higher than the average selling price of Chinese-style products.

• According to normal business practice, the biggest client purchased product of the same type and standard at a lower price as compared to other clients.

(3) The Group had phony sales with

Zhongshan Defu from 2006 to 2008.

• During the preparation of the prospectus, the Group extracted the sales revenue generated by Zhongshan Defu from its sales accounts, which were supported by relevant invoices and goods delivery notes.

• The Group has no authority to verify or comment on the discrepancies between the Company's records and those filed by Zhongshan Defu.