Form F-1
Table of Contents

As filed with the Securities and Exchange Commission on November 16, 2007

Registration No. 333-            


UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM F-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 


Xinyuan Real Estate Co., Ltd.

(Exact name of registrant as specified in its charter)

Not Applicable

(Translation of Registrant’s name into English)

 


 

Cayman Islands   1520   Not Applicable

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

No. 18 Xinyuan Road

Zhengzhou, Henan 450011

People’s Republic of China

(86) 371 6565 1600

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

 


CT Corporation System

111 Eighth Avenue

New York, New York 10011

(212) 664-1666

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 


Copies to:

 

Scott Clemens, Esq.

Baker & McKenzie LLP

Suite 3401, China World Tower

2, China World Trade Center, 1 Jianguomenwai Dajie, Beijing

100004, PRC

 

Roslyn Tom, Esq.

Baker & McKenzie LLP

1114 Avenue of the Americas

New York, NY 10036

 

Matthew Bersani, Esq.

Shearman & Sterling LLP

12/F, Gloucester Tower

The Landmark

15 Queen’s Road Central

Central Hong Kong, PRC

 


Approximate date of commencement of proposed sale to the public:    As soon as practicable after the effective date of this registration statement.

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨            

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨             

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨             

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earliest effective registration statement for the same offering.  ¨             

 


CALCULATION OF REGISTRATION FEE


Title of each class of

securities to be registered

  

Proposed Maximum
Aggregate

Offering Price(3)

   Amount of
Registration Fee

Common shares, par value $0.0001 per common share(1)(2)

   $ 299,500,000    $ 9,195

(1)   American depositary shares issuable upon deposit of the common shares registered hereby will be registered under a separate registration statement on Form F-6 (Registration No. 333-                     ). Each American depositary share represents                      common shares.
(2)   Includes common shares initially offered and sold outside the United States that may be resold from time to time in the United States either as part of their distribution or within 40 days after the later of the effective date of this registration statement and the date the shares are first bona fide offered to the public, and also includes common shares that may be purchased by the underwriters pursuant to an over-allotment option. These common shares are not being registered for the purpose of sales outside the United States.
(3)   Estimated solely for the purpose of determining the amount of registration fee in accordance with Rule 457(o) under the Securities Act of 1933.

The Registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to such Section 8(a), may determine.

 



Table of Contents

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and we are not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion

Preliminary Prospectus dated                     , 2007

American Depositary Shares

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Xinyuan Real Estate Co., Ltd.

Representing              Common Shares

 


This is our initial public offering. We are offering                      American depositary shares, or ADSs. Each ADS represents
                     of our common shares, par value US$0.0001 per share.

We expect the public offering price to be between US$             and US$             per ADS. Currently no public market exists for the ADSs or our common shares. Our ADSs have been approved for listing on the New York Stock Exchange under the symbol “XIN.”

Investing in the ADSs involves risks that are described in the “ Risk Factors” section beginning on page 11 of this prospectus.

 


 

     Per ADS      Total

Public offering price

   $      $

Underwriting discount

   $      $

Proceeds to us before expenses

   $      $

The underwriters may also purchase up to an additional              ADSs from us at the public offering price, less the underwriting discount, within 30 days from the date of this prospectus to cover over-allotments.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The ADSs will be ready for delivery on or about                     , 2007.

 


Merrill Lynch & Co.

 


 

Deutsche Bank Securities   Allen & Company LLC

The date of this prospectus is                     , 2007.


Table of Contents

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Table of Contents

TABLE OF CONTENTS

      Page

Prospectus Summary

   1

Our Summary Consolidated Financial and Operating Data

   9

Risk Factors

   11

Special Note Regarding Forward-Looking Statements

   32

Use of Proceeds

   33

Dividend Policy

   34

Exchange Rates

   35

Capitalization

   36

Dilution

   38

Selected Consolidated Financial and Operating Data

   40

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   42

Our Industry

   80

Our Corporate History and Structure

   87

Business

   89

Regulation

   110

Management

   124

Principal Shareholders

   133

Related Party Transactions

   135

Description of Share Capital

   139

Description of American Depositary Shares

   145

Shares Eligible for Future Sale

   155

Description of Debt and Equity-Linked Securities

   157

Taxation

   161

Underwriting

   165

Enforceability of Civil Liabilities

   173

Expenses Relating to this Offering

   174

Legal Matters

   174

Experts

   174

Where You Can Find Additional Information

   175

Index to Consolidated Financial Statements

   F-1

 


You should rely only on the information contained in this prospectus. We have not, and the underwriters have not, authorized any other person to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information appearing in this prospectus is accurate only as of the date on the front cover of this prospectus. Our business, financial condition, results of operations and prospects may have changed since that date.

 

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PROSPECTUS SUMMARY

This summary highlights selected information about us and the ADSs that we are offering. It may not contain all of the information that may be important to you. Before investing in the ADSs, you should read this entire prospectus carefully for a more complete understanding of our business and this offering, including our audited consolidated financial statements and the related notes, and the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

Our Business

We are a fast-growing residential real estate developer that focuses on Tier II cities in China, which are a selected group of larger, more developed cities with above average GDP and urban population growth rates. We utilize a standardized and scalable model that emphasizes rapid asset turnover, efficient capital management and strict cost control. We commenced operations in 1997 in Zhengzhou, the provincial capital of Henan Province, and were ranked No. 1 among all property developers in Zhengzhou in terms of contracted sales of residential units for the years 2004, 2005 and 2006, according to statistics prepared by the Bureau of Real Estate Management in Zhengzhou. Since 2006, we have expanded into strategically selected Tier II cities around the country and expect to benefit from the rising residential housing demand in these markets resulting from increasing income levels of consumers and growing populations in these cities. We currently have operations in five Tier II cities, including Chengdu in Sichuan Province, Hefei in Anhui Province, Jinan in Shandong Province, Suzhou in Jiangsu Province and Zhengzhou in Henan Province.

We focus on developing large scale quality residential projects, which typically consist of multiple residential buildings that include multi-layer apartment buildings, sub-high-rise apartment buildings or high-rise apartment buildings, together with auxiliary services and amenities such as retail outlets, leisure and health facilities, kindergartens and schools. We also develop small scale residential properties. Our developments aim at providing middle-income consumers with a comfortable and convenient community life. In addition, we provide property management services for our developments and other real estate-related services to our customers. We acquire our development sites primarily through public auctions of government land involving a transparent bidding process. This acquisition method allows us to obtain unencumbered land use rights to unoccupied land which can be immediately developed without the need for additional demolition, re-settlement or protracted legal processes to obtain title. As a result, we are able to commence construction relatively quickly after we acquire a site for development.

We have expanded our business and operations significantly during the past three years. The number of projects we had under construction increased from three projects with a total gross floor area, or GFA, of 278,868 square meters as of December 31, 2004, to seven projects with a total GFA of 770,781 square meters as of September 30, 2007. We have seven additional projects with total GFA of 1,282,498 square meters under planning as of September 30, 2007. As of September 30, 2007, we have completed 13 projects with total GFA of approximately 939,829 square meters and comprising a total of 8,645 units, 99.6% of which have been sold. For each of the three years ended December 31, 2004, 2005 and 2006, our revenues were US$35.6 million, US$61.9 million and US$142.4 million, respectively, representing a compounded annual growth rate, or CAGR, of 99.9%. Our net income for each of those three years was US$3.9 million, US$9.6 million and US$16.1 million, respectively, representing a CAGR of 102.2%. For the nine months ended September 30, 2006 and 2007, our revenue was US$99.7 million and US$218.3 million, respectively. Our net income for the nine months ended September 30, 2006 and 2007 was US$12.5 million and US$36.0 million, respectively.

We intend to continue our expansion into additional strategically selected Tier II cities as suitable opportunities arise.

 

 

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Our Competitive Strengths

We believe the following strengths allow us to compete effectively in the real estate development industry:

Well Positioned to Capture Attractive Growth Opportunities in Tier II Cities.    Increases in consumer disposable income and urbanization rates have resulted in the emergence of a growing middle-income consumer market, driving demand for quality housing in many cities across China. Since 1997, we have been building large communities of modern, mid-sized residential properties for this market segment and have accumulated substantial knowledge and experience about the residential preferences and demands of these customers.

Standardized and Scalable Business Model.    Our business model focuses on a standardized property development process designed for rapid asset turnover. We segment the process into well-defined stages and closely monitor our costs and development schedules through each stage. We commence our pre-planning and budgeting prior to land acquisition, which enables us to acquire land at costs that meet our pre-set investment target and to immediately begin the development process upon acquisition. We believe that our standardized practices and methodologies, together with our systematic approach to the development process, can be replicated in strategically selected Tier II cities. Since 2006, we have expanded from one to a total of five Tier II cities in China, and from December 31, 2004 to September 30, 2007, our total GFA for projects under construction has grown 176.4%.

Proven Ability to Provide Large Scale Quality Housing for Middle-Income Consumers.    We have a clear focus on China’s emerging middle-income consumers and provide standardized mid-sized units at affordable prices for this market. Our residential units feature modern designs and offer comfortable and convenient community lifestyles. We have a proven track record of building large-scale quality residential communities that appeal to middle-income customers, as demonstrated by the sale of more than 99.0% of units in our completed projects and the growth in our revenue at a CAGR of 99.9% from 2004 to 2006.

Ability to Generate Attractive Investment Returns.    Our standardized processes that emphasize rapid asset turnover allow us to efficiently use capital and generate attractive returns on our investments. We typically acquire land through the government auction system that is ready for development. We do not tie up our capital in idle land banks but instead begin development immediately after land acquisition. We use our working capital efficiently by actively managing and coordinating receivables and expenditures across various projects. We believe that the velocity of our development cycle and our ability to efficiently manage our capital and maintain strict cost control at each stage of development enable us to generate attractive returns on our projects.

Experienced Management Team Supported by Trained and Motivated Workforce.    Our senior managers, most of whom have been working with our company for over five years, have on average over 10 years of experience in the PRC real estate industry and considerable strategic planning and business management expertise. Our Chairman and founder, Mr. Yong Zhang, has more than 20 years of experience in developing residential housing in China. Mr. Zhang was elected in 2004 as one of the Top Ten Rising Entrepreneurs in China’s Real Estate Industry by the China International Real Estate & Archi-tech Fair (CIHAF). Our management and work force are well trained and motivated. To promote effective recruitment, retention and advancement, we provide our management with training and incentive programs that include subsidizing our management’s pursuit of post-secondary degrees and programs.

Relationships with Our Institutional Shareholders.    In 2006, Blue Ridge China and Equity International invested in our company. Blue Ridge China is a China-focused private equity fund and Equity International is a privately-held investment company specializing in real estate investments outside the United States founded and led by Samuel Zell and Gary Garrabrant. Equity International’s portfolio companies include Homex in Mexico and Gafisa in Brazil, both of which are publicly traded in the United States. Both of these shareholders (through their designees on the board of directors) are active in major board-level decisions and contribute their expertise in corporate governance best practices, financial management and accessing global capital.

 

 

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Our Strategies

Our goal is to become the leading residential property developer focused on China’s Tier II cities by implementing the following strategies:

Continue Expanding in Selected Tier II Cities.    We believe that Tier II cities present development opportunities that are well suited for our scalable business model of rapid asset turnover. Many Tier II cities offer a large supply of potential development sites that meet the criteria of our internal pre-set investment target. Furthermore, Tier II cities currently tend to be in an early stage of market maturity and have fewer large national developers. We believe that the fragmented market and relative abundance of land supply in Tier II cities, as compared to Tier I cities, offer opportunities for us to generate attractive margins and believe that our experience in and strategic focus on Tier II cities afford us the opportunity to emerge as a leading developer in these markets. We plan to enter into additional Tier II cities that have increasing population, growing consumer disposable income and sustainable land supply for future developments.

Capitalize on Growth of Middle-Income Population.    The growing middle-income consumer market in China presents an attractive opportunity to continue our business expansion at a rapid pace. We will target this market by continuing to provide quality mid-sized modern residential units in large community developments for middle-income consumers. Our strategy is also consistent with the housing policy of relevant PRC governmental authorities in the context of rising incomes and rapid urbanization to promote the development of more low- and mid-priced housing in China.

Focus on Efficient Land Acquisition.    We constantly seek and assess land acquisition opportunities in selected Tier II cities through the governmental land auction system. To achieve our land acquisition targets, we have established a centralized and efficient system to research land acquisition opportunities. We monitor, plan and budget development costs for potential development sites. We bid for the site through the auction process, if the development opportunity meets our pre-set investment target. We believe that beginning with efficient land acquisition and following through with well-executed development will allow us to expand into Tier II cities successfully and provide sustainable growth for our business.

Maintain Strict Cost Control.    We plan to continue to closely monitor our capital and cash positions and carefully manage our land use rights costs, construction costs and operating expenses. We believe that by adhering to prudent cost management we will be able to more efficiently use our working capital, which will help to maintain our profit margins.

Strengthen our “Xinyuan Brand.    We intend to promote our “Xinyuan” brand in our selected Tier II cities by delivering high quality products and attentive real estate-related services to our customers. At the same time, we will continue to actively promote the “Xinyuan” brand through marketing initiatives in our targeted markets.

Risks Related to Our Business

Our Challenges

We believe that the following are some of the major risks and uncertainties that may materially affect us:

 

  Ÿ  

ability to successfully manage our expansion into Tier II cities;

 

  Ÿ  

availability of capital resources to fund our land use rights acquisition and property developments;

 

 

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  Ÿ  

difficulties to acquire desired development sites at commercially reasonable costs;

 

  Ÿ  

financial and operating covenants contained in our current debt indentures that restrict our ability to pay dividends, raise further debt and take other corporate actions;

 

  Ÿ  

risks associated with the guarantees we provide for the mortgage loans of our customers;

 

  Ÿ  

further measures the PRC government may adopt to curtail the overheating of the property sector; and

 

  Ÿ  

dependence on the performance of the residential property market in China.

Please see “Risk Factors” and other information included in this prospectus for a detailed discussion of these risks and uncertainties.

Our Corporate History and Structure

We are a Cayman Islands holding company and conduct substantially all of our business through our operating subsidiary in the PRC, Xinyuan (China) Real Estate, Ltd., or Xinyuan China. We own 100% of Xinyuan Real Estate, Ltd., or Xinyuan Ltd., a Cayman Islands holding company, which owns 100% of Xinyuan China. Xinyuan China has 11 wholly-owned subsidiaries in the PRC and holds a 45% minority interest in Zhengzhou Jiantou Xinyuan Real Estate Co., Ltd., or Jiantou Xinyuan. The following diagram illustrates our corporate structure as of the date of this prospectus:

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(1)   The other shareholders of Zhengzhou Jiantou Xinyuan Real Estate Co., Ltd. are Zhengzhou General Construction Investment Company (50%) and Zhengzhou Jiantou Project Consulting Co., Ltd. (5%).

We commenced our operations in May 1997 through Henan Xinyuan Real Estate Co., Ltd., one of our wholly-owned subsidiaries in the PRC. We completed a restructuring in April 2007 under which we established our current corporate structure by completing a share exchange in which the existing shareholders of Xinyuan

 

 

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Ltd., our then holding company, exchanged their respective shares for an equivalent number of our shares of the same class.

In April 2007, we issued the following equity and debt securities:

 

  Ÿ  

In connection with the restructuring referred to above and in exchange for Series A preference shares of Xinyuan Ltd. that were issued in August 2006 for cash proceeds of US$25 million, or US$0.81155 per share, we issued an aggregate of 30,805,400 Series A convertible redeemable preference shares, or Series A preference shares, to Blue Ridge China Partners, L.P., or Blue Ridge China, and EI Fund II China, LLC, or Equity International, together with certain warrants. If our cumulative net income for the two years ending December 31, 2008 is less than US$80 million, the holders of the warrants are entitled to purchase up to a maximum of 3,987,009 additional Series A preference shares at an exercise price of US$0.01 per share. If our cumulative net income for such period equals or exceeds US$80 million, or if we consummate a qualified initial public offering prior to March 31, 2008, then these warrants will expire without exercise. We expect these warrants to expire without exercise upon the completion of this offering. The fair value assigned to the warrants as at the date of issuance was US$496,000. The terms of our Series A preference shares contain a contingent conversion option which Blue Ridge China and Equity International waived in November 2007. Due to the waiver, we will recognize a deemed dividend of US$         million to the holders of our Series A preference shares, representing the difference between the fair value of the Series A preference shares immediately after the waiver and the carrying value of the Series A preference shares immediately prior to the waiver. This deemed dividend will not affect our net income or cash flows. It will reduce our net income attributable to common shareholders and retained earnings for the year ending December 31, 2007, each by the amount of US$             million.

 

  Ÿ  

In connection with the restructuring referred to above and in exchange for warrants of Xinyuan Ltd. that were issued in August 2006 in consideration of financial advisory and investment banking services rendered, we issued warrants to Burnham Securities Inc. and Joel B. Gardner, or Burnham warrants, for the issuance of 1,853,172 fully paid common shares at an exercise price of US$0.81155 per share. We assigned a fair value of US$55,595 to these warrants, which was recorded as paid-in capital.

 

  Ÿ  

In connection with the restructuring referred to above and in exchange for common shares of Xinyuan Ltd. that were issued in November 2006 for an aggregate consideration of US$15 million, or US$0.9551 per share, we issued 15,704,379 common shares to Blue Ridge China and Equity International.

 

  Ÿ  

We issued US$75 million principal amount of units, each unit comprising US$100,000 principal amount of secured senior floating rate notes due 2010, or the floating rate notes, and one warrant to subscribe for our common shares. Each warrant entitles the holder to subscribe at the warrant exercise price for the number of common shares equal to the quotient obtained by dividing (i) US$40,000 by (ii) the warrant exercise price, which will be equal to 80% of the price per common share derived from the offering of the ADSs. The fair value assigned to the warrants as at the date of issuance was US$7.36 million.

 

  Ÿ  

We issued US$25 million principal amount of convertible subordinated notes due 2012, or convertible notes. The convertible notes are convertible into common shares at the rate of 38,388.48 common shares per US$100,000 principal amount of convertible notes, or a total of 9,597,120 common shares.

See “Description of Share Capital—History of Share Issuances” with respect to the original issuances of such securities by Xinyuan Ltd.

 

 

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Mr. Yong Zhang and Ms. Yuyan Yang collectively own 55.37% of our outstanding share capital as of the date of this prospectus and will own approximately             % of our outstanding share capital upon completion of this offering. Blue Ridge China owns 25.75% of our outstanding share capital as of the date of this prospectus and will own approximately             % of our outstanding share capital upon completion of this offering. Equity International owns 17.17% of our outstanding share capital as of the date of this prospectus and will own approximately             % of our outstanding share capital upon completion of this offering.

Corporate Information

Our registered address is Ugland House, South Church Street, George Town, Grand Cayman, Cayman Islands. Our principal executive offices are located at No. 18 Xinyuan Road, Zhengzhou, Henan 450011, People’s Republic of China. Our telephone number at this address is (86) 371 6565 1600 and our fax number is (86) 371 6565 1686.

Investor inquiries should be directed to us at the address and telephone number of our principal executive offices set forth above. Our website is www.xyre.com. The information contained on our website does not form part of this prospectus. Our agent for service of process in the United States is CT Corporation System located at 111 Eighth Avenue, New York, New York 10011.

Conventions Used in this Prospectus

Unless the context otherwise requires, in this prospectus:

 

  Ÿ  

“we,” “us,” “our company,” “our” and “Xinyuan” refer to Xinyuan Real Estate Co., Ltd., its predecessor entities and its subsidiaries;

 

  Ÿ  

“shares” or “common shares” refers to our common shares, par value US$0.0001 per share;

 

  Ÿ  

“ADSs” refers to our American depositary shares, each of which represents             of our common shares, and “ADRs” refers to the American depositary receipts that evidence our ADSs;

 

  Ÿ  

“China” or “PRC” refers to the People’s Republic of China, excluding, for the purposes of this prospectus only, Taiwan, Hong Kong and Macau; and

 

  Ÿ  

“RMB” or “Renminbi” refers to the legal currency of China and “US$” or “U.S. dollars” refers to the legal currency of the United States.

At present, there is no uniform standard to categorize the different types and sizes of cities in China. In this prospectus, we refer to certain larger and more developed cities as Tier I and Tier II cities based on the categorization used by the CIHAF Valuation Report on Real Estate Investment in PRC Cities published by China Real Estate Business, or CREB, an authoritative real estate publication in China, YUBO Media and Institute of Finance and Trade Economics of Chinese Academy of Social Sciences. Based on this approach, there are currently four Tier I cities and 35 Tier II cities in China.

 

 

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THE OFFERING

Unless otherwise indicated, information in this prospectus assumes that the underwriters’ over-allotment option is not exercised.

 

Offering price per ADS

We currently estimate that the initial public offering price will be between US$              and US$             per ADS.

 

ADSs offered by us

                     ADSs

 

Common shares outstanding after the offering

                     common shares.

 

The ADSs

Each ADS represents              common shares, par value $0.0001 per share.

 

 

The depositary will be the holder of the common shares underlying the ADSs and you will have the rights of an ADS holder as provided in the deposit agreement among us, the depositary and owners and beneficial owners of ADSs from time to time.

 

 

You may surrender your ADSs to the depositary to withdraw the common shares underlying your ADSs. The depositary will charge you a fee for such an exchange.

 

 

We may amend or terminate the deposit agreement for any reason without your consent. If an amendment becomes effective, you will be bound by the deposit agreement as amended if you continue to hold your ADSs.

 

 

To understand the terms of the ADSs, you should carefully read the section in this prospectus entitled “Description of American Depositary Shares.” We also encourage you to read the deposit agreement, which is an exhibit to the registration statement that includes this prospectus.

 

 

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Use of proceeds

We intend to use approximately US$                 of the net proceeds to acquire land use rights for future property development projects and to use the remaining net proceeds for working capital and other general corporate purposes. See “Use of Proceeds” for additional information.

 

Depositary

JPMorgan Chase Bank, N.A.

 

Option to purchase additional ADSs

We have granted the underwriters an option, exercisable within 30 days from the date of this prospectus, to purchase up to an aggregate of              additional ADSs to cover over-allotments.

 

Risk factors

See “Risk Factors” and other information included in this prospectus for a discussion of factors you should carefully consider before deciding to invest in the ADSs.

 

Lock-up

We, our officers, directors and certain of our shareholders have agreed with the underwriters not to sell, transfer or dispose of any ADSs, common shares or similar securities for a period of 180 days after the date of this prospectus. See “Underwriting.”

 

 

Listing

Our ADSs have been approved for listing on the New York Stock Exchange under the symbol “XIN.” Our common shares will not be listed or quoted for trading on any stock exchange or any automated quotation system.

Throughout this prospectus, the number of our common shares outstanding after this offering includes:

 

  Ÿ  

the 30,805,400 common shares issuable upon the conversion of all of our outstanding Series A preference shares, which will occur at the completion of this offering; and

 

  Ÿ  

the 1,853,172 common shares issuable upon the exercise of the Burnham warrants, which we expect to be exercised prior to the completion of this offering.

Unless otherwise indicated, the information in this prospectus does not reflect:

 

  Ÿ  

6,802,495 common shares underlying options and restricted share awards granted on August 11, 2007;

 

  Ÿ  

2,441,844 common shares underlying the options granted on November 5, 2007;

 

  Ÿ  

9,597,120 common shares issuable upon the conversion of the convertible notes; and

 

  Ÿ  

             common shares underlying the warrants issued to the holders of our floating rate notes, assuming an initial public offering price of US$             per ADS (the mid-point of the price range set forth on the front cover of this prospectus). A US$1.00 increase (decrease) in the assumed initial public offering price of US$             per ADS would decrease (increase) the number of common shares underlying the warrants issued to the holders of our floating rate notes by              shares.

 

 

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OUR SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA

The following summary consolidated statements of operations and other consolidated financial data for the years ended December 31, 2004, 2005 and 2006, other than the earnings per ADS data, and the consolidated balance sheet data as of December 31, 2004, 2005 and 2006 have been derived from our audited consolidated financial statements, which are included elsewhere in this prospectus. Our audited consolidated financial statements have been prepared and presented in accordance with United States generally accepted accounting principles, or U.S. GAAP, and have been audited by Ernst & Young Hua Ming, an independent registered public accounting firm. The summary consolidated statements of operations data for the nine months ended September 30, 2006 and 2007 and the consolidated balance sheet data as of September 30, 2007 have been derived from our unaudited consolidated financial statements, which are included elsewhere in this prospectus. The summary consolidated statements of operations data and the consolidated balance sheet data as of and for the years ended December 31, 2002 and 2003 have been derived from our unaudited consolidated financial statements, which are not included in this prospectus. Our consolidated financial statements have been prepared as if our current corporate structure had been in existence throughout the relevant periods.

You should read the summary consolidated financial data in conjunction with our consolidated financial statements and related notes, “Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. Our historical results do not necessarily indicate our expected results for any future periods.

 

    Year Ended December 31,     Nine Months
Ended September 30,
 
    2002     2003     2004     2005     2006     2006     2007  
    US$     US$     US$     US$     US$     US$     US$  
    (unaudited)                       (unaudited)  
    (in thousands, except share, per share and per ADS data)  

Consolidated Statements of Operations Data(1)

             

Total revenues

  12,807     16,746     35,632     61,942     142,367     99,655     218,301  

Total costs of revenues

  (11,875 )   (11,978 )   (26,376 )   (42,632 )   (108,196 )   (75,613 )   (146,990 )

Selling and distribution expenses

  (493 )   (1,319 )   (1,604 )   (2,175 )   (2,996 )   (1,876 )   (5,957 )

General and administrative expenses

  (537 )   (939 )   (1,004 )   (1,696 )   (3,626 )   (2,095 )   (7,736 )
                                         

Operating income

  (99 )   2,510     6,648     15,439     27,549     20,071     57,618  

Net income before minority interest

  (471 )   1,067     3,943     9,548     16,120     12,493     35,965  

Net income

  (471 )   1,067     3,943     9,563     16,123     12,495     35,965  

Earnings per share

             

- Basic

  (0.01 )   0.02     0.07     0.16     0.21     0.19     0.32  

- Diluted

          0.07     0.16     0.21     0.19     0.30  

Shares used in computation

             

- Basic

  60,000,000     60,000,000     60,000,000     60,000,000     72,694,467     63,038,341     106,509,779  

- Diluted

  60,000,000     60,000,000     60,000,000     60,000,000     72,694,467     63,038,341     114,268,871  

Pro forma earnings per share

             

- Basic (unaudited)(2)

                  0.17         0.34  

- Diluted (unaudited)(2)

                  0.17         0.30  

Pro forma shares used in computation

             

- Basic (unaudited)(2)

                  92,612,479         106,531,892  

- Diluted (unaudited)(2)

                  96,612,479         114,333,967  

Earnings per ADS(3)

             

- Basic

             

- Diluted

             

Other Operating Data

             

Number of projects launched

  2     3     2     2     3     2     5  

Aggregate GFA delivered (m2)

  54,304     53,076     107,455     161,717     370,105     148,654     350,357  

 

 

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     As of December 31,    As of
September 30,
     2002    2003    2004    2005    2006    2007
     US$    US$    US$    US$    US$    US$
    

(unaudited)

        (unaudited)
          (in thousands)     

Consolidated Balance Sheet Data(1)

                 

Cash and cash equivalents

   2,812    2,822    5,249    14,929    34,914    106,410

Restricted cash

   1,432    3,792    11,399    5,385    32,011    41,916

Real estate property under development(4)

   18,091    24,914    47,403    64,857    106,804    308,709

Total current assets

   26,660    38,294    65,121    90,357    174,426    428,576

Total assets

   27,899    43,683    83,004    108,702    204,956    505,017

Total current liabilities

   23,851    32,756    72,855    82,228    118,840    131,518

Long-term bank loans

   3,624    9,001    3,141    7,435    12,806    139,998

Minority interest

            22      

Preference shares

               22,309    24,441

Total shareholders’ equity

   678    1,746    6,896    17,000    46,583    86,757

(1)

 

Our financial information is first prepared in RMB and then translated into U.S. dollars at (i) the following year-end exchange rates for assets and liabilities and (ii) the following average exchange rates for revenues and expenses. Capital accounts are translated at their historical exchange rates when the transactions occurred.

 

    As of and for the year ended December 31,    As of and for the
nine months ended
September 30,
    2002    2003    2004    2005    2006    2006    2007

Period-end RMB : US$ exchange rate

  8.2773    8.2769    8.2765    8.0702    7.8087    7.9087    7.5108

Period average RMB : US$ exchange rate

  8.2770    8.2771    8.2766    8.1734    7.9721    8.0079    7.6659

 

       See “Exchange Rates” and Note 2(d) to our consolidated financial statements.

(2)

 

On August 25, 2006, we issued Series A preference shares that would convert automatically into 30,805,400 common shares upon the completion of an initial public offering. These pro forma amounts assume that the conversion had occurred “on a hypothetical basis” on January 1, 2006. The pro forma shares used in the computation for the nine months ended September 30, 2007 also include:

 

  Ÿ  

1,853,172 common shares issuable upon the exercise of the Burnham warrants, which we expect to be exercised prior to completion of this offering;

 

  Ÿ  

22,113 vested restricted shares, representing a weighted average based on the number of days from vesting to the ending date of the periods presented, and 42,983 unvested restricted shares calculated using the treasury-stock method; and

 

  Ÿ  

5,905,920 common shares issuable upon the conversion of the convertible notes, representing a weighted average based on the number of days from issuance to the ending date of the periods presented.

 

(3)

 

Earnings per ADS is calculated based on each ADS representing                  common shares. See “Description of American Depositary Shares.”

(4)

 

Includes real estate property under development recorded under current assets and non-current assets.

 

 

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RISK FACTORS

An investment in our ADSs involves significant risks. You should consider carefully all the information in this prospectus, including the risks and uncertainties described below, before making an investment in our ADSs. Our business, results of operations, financial condition or prospects could be adversely affected if any of these risks actually occur. As a result, the market price of our ADSs could decline and you could lose all or part of your investment. The risks described below are those known to us and that we currently believe may materially affect us.

Risks Relating to Our Business

If we are unable to successfully manage our expansion into other Tier II cities, we will not be able to execute our business plan.

Historically, our business and operations have been concentrated in Zhengzhou. Since 2006, we have been expanding our residential property development operations into other Tier II cities, including Chengdu in Sichuan Province, Hefei in Anhui Province, Jinan in Shandong Province and Suzhou in Jiangsu Province. We plan to expand into other Tier II cities as suitable opportunities arise. The development of real estate projects outside Zhengzhou will impose significant demands on our management and other operational resources. Moreover, we will face additional competition, and will need to establish brand recognition and market acceptance for our developments, in these new markets. Each of these Tier II cities has its own market conditions, customer requirements and local regulations related to the real estate industry. If we are unable to successfully develop and sell projects outside Zhengzhou, our future growth may be limited and we may not generate adequate returns to cover our investments in these Tier II cities. In addition, as we expand our operations to Tier II cities with higher land prices, our costs may increase, which may lead to a decrease in our profit margin.

We require substantial capital resources to fund our land use rights acquisition and property developments, which may not be available.

Property development is capital intensive. To date, we have funded our projects primarily through bank borrowings, shareholder loans, proceeds from sales and pre-sales of our properties and proceeds from issuance of equity and debt securities. Our ability to secure sufficient financing for land use rights acquisition and property development depends on a number of factors that are beyond our control, including market conditions in the capital markets, investors’ perception of our securities, lenders’ perceptions of our creditworthiness, the PRC economy and the PRC government regulations that affect the availability and cost of financing for real estate companies.

Various PRC regulations restrict our ability to raise capital through external financing and other methods, including, without limitation, the following:

 

  Ÿ  

we cannot pre-sell uncompleted residential units in a project prior to achieving certain development milestones specified in related regulations;

 

  Ÿ  

PRC banks are prohibited from extending loans to real estate companies to fund the purchase of land use rights;

 

  Ÿ  

we cannot borrow from a PRC bank for a particular project unless we fund at least 35% of the total investment amount of that project from our own capital;

 

  Ÿ  

we cannot borrow from a PRC bank for a particular project if we do not obtain the land use rights certificate for that project;

 

  Ÿ  

property developers are strictly restricted from using the proceeds from a loan obtained from a local bank to fund property developments outside the region where that bank is located; and

 

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  Ÿ  

PRC banks are prohibited from accepting properties that have been vacant for more than three years as collateral for loans.

In addition, the People’s Bank of China, or the PBOC, has increased the reserve requirement ratio for commercial banks several times since July 5, 2006, raising it from 7.5% as of that date to the current 12.0%. The reserve requirement ratio refers to the amount of funds that banks must hold in reserve against deposits made by their customers. These increases in the reserve requirement ratio have reduced the amount of commercial bank credit available to businesses in China, including us.

The PRC government may introduce other measures that limit our access to additional capital. For instance, on July 10, 2007, State Administration of Foreign Exchange, or SAFE, issued a circular restricting a foreign invested property developer’s ability to raise capital through foreign debt, if such developer is established after June 1, 2007 or increases its registered capital after June 1, 2007. Under this circular, our ability to utilize the proceeds of this offering to provide funding to our PRC operations is significantly limited. We cannot assure you that we will be able to obtain sufficient funding to finance intended purchases of land use rights, develop future projects or meet other capital needs as and when required at a commercially reasonable cost or at all. Failure to obtain adequate funding at a commercially reasonable cost may limit our ability to commence new projects or to continue the development of existing projects or may increase our borrowing costs.

We may be unable to acquire desired development sites at commercially reasonable costs.

Our revenue depends on the completion and sale of our projects, which in turn depends on our ability to acquire development sites. Our land use rights costs are a major component of our cost of real estate sales and increases in such costs could diminish our gross margin. In China, the PRC government controls the supply of land and regulates land sales and transfers in the secondary market. As a result, the policies of the PRC government, including those related to land supply and urban planning, affect our ability to acquire, and our costs of acquiring, land use rights for our projects. In recent years, the government has introduced various measures in attempts to moderate investment in the property market in China. Although we believe that these measures are generally targeted at the luxury property market and speculative purchases of land and properties, we cannot assure you that the PRC government will not introduce other measures in the future that adversely affect our ability to obtain land for development. We currently acquire our development sites primarily by bidding for government land. Under current regulations, land use rights acquired from government authorities for commercial and residential development purposes must be purchased through a public tender, auction or listing-for-sale. Competition in these bidding processes has resulted in higher land use rights costs for us. Land use rights costs as a percentage of our cost of revenue have increased from 22.8% in 2004 to 30.0% in 2006. In the nine months ended September 30, 2007, land use rights costs as a percentage of our cost of revenue was 37.2%. We expect that our land use rights costs may continue to increase in the future, which may lead to a decrease in our profit margin. In addition, we may not successfully obtain desired development sites due to the increasingly intense competition in the bidding processes. We may also need to acquire land use rights through acquisition, which could increase our costs. Moreover, the supply of potential development sites in any given city will diminish over time and we may find it increasingly difficult to identify and acquire attractive development sites at commercially reasonable costs in the future.

Our level of indebtedness could have an adverse effect on our financial condition, diminish our ability to raise additional capital to fund our operations and limit our ability to explore business opportunities.

As of September 30, 2007, the outstanding balance of our total indebtedness amounted to US$262.8 million. Our level of indebtedness could have an adverse effect on us. For example, it could:

 

  Ÿ  

require us to dedicate a large portion of our cash flow from operations to fund payments on our debt, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate purposes;

 

  Ÿ  

increase our vulnerability to adverse general economic or industry conditions;

 

  Ÿ  

limit our flexibility in planning for, or reacting to, changes in our business or the industry in which we operate;

 

  Ÿ  

limit our ability to raise additional debt or equity capital in the future or increase the cost of such funding;

 

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  Ÿ  

restrict us from making strategic acquisitions or exploring business opportunities; and

 

  Ÿ  

make it more difficult for us to satisfy our obligations with respect to our debt.

Our current debt indentures contain certain financial and operating covenants that restrict our ability to pay dividends, raise further debt and take other corporate actions.

In April 2007, we issued US$75 million of floating rate notes and US$25 million of convertible notes and entered into related indentures. These indentures contain a number of significant restrictive covenants. These covenants restrict, among other things, our ability and the ability of our subsidiaries to incur additional debt or guarantee, make restricted payments, pay dividends or distributions on our or our subsidiaries’ capital stock, repurchase our or our subsidiaries’ capital stock, pay subordinated indebtedness, make or repay inter-company loans or advances or sell or transfer property or assets, sell our subsidiaries’ capital stock, enter into non-ordinary course business transactions, sell assets, make investments, merge or consolidate with another company, and engage in any business other than related businesses. See “Description of Debt and Equity-Linked Securities.”

As a result of the foregoing, our ability to pay dividends or other distributions on our common shares and the ADSs may be limited. These covenants may also restrict our ability to raise additional capital in the future through bank borrowings and debt and equity issuances or to engage in some transactions that we expect to be of benefit to us.

Our floating rate notes and convertible notes are secured by the mortgage of our shares in our wholly owned Cayman subsidiary, which indirectly holds all of our assets and operations in China. If we default under the notes, the holders may enforce their claims against these shares, which could cause us to lose control or ownership of our assets and operations in China. In addition, our floating rate notes and convertible notes are also secured by (i) the pledge of all of the Cayman subsidiary’s shares in Xinyuan (China) Real Estate, Ltd., or the WFOE, which we have submitted to the PRC regulatory authority, and (ii) the pledge of a loan from the Cayman subsidiary to the WFOE.

Our financing costs are subject to changes in interest rates.

The rate of interest payable on our floating rate notes varies according to the six-month LIBOR. In addition, the rates of our long-term bank loans are adjustable based on the range of 95% to 110% of the PBOC benchmark rate. As of September 30, 2007, the principal amount of our aggregate outstanding variable rate debt was US$215 million. A hypothetical 1% increase in annual interest rates would increase our interest expenses by approximately US$2.15 million based on our debt level at September 30, 2007.

We rely on third-party contractors.

Substantially all of our project construction and related work are outsourced to third-party contractors. We are exposed to risks that the performance of our contractors may not meet our standards or specifications. Negligence or poor work quality by any contractors may result in defects in our buildings or residential units, which could in turn cause us to suffer financial losses, harm our reputation or expose us to third-party claims. We work with multiple contractors on different projects and we cannot guarantee that we can effectively monitor their work at all times. Although our construction and other contracts contain provisions designed to protect us, we may be unable to successfully enforce these rights and, even if we are able to successfully enforce these rights, the third-party contractor may not have sufficient financial resources to compensate us. Moreover, the contractors may undertake projects from other property developers, engage in risky undertakings or encounter financial or other difficulties, such as supply shortages, labor disputes or work accidents, which may cause delays in the completion of our property projects or increases in our costs.

We may be unable to complete our property developments on time or at all.

The progress and costs for a development project can be adversely affected by many factors, including, without limitation:

 

  Ÿ  

delays in obtaining necessary licenses, permits or approvals from government agencies or authorities;

 

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  Ÿ  

shortages of materials, equipment, contractors and skilled labor;

 

  Ÿ  

disputes with our third-party contractors;

 

  Ÿ  

failure by our third-party contractors to comply with our designs, specifications or standards;

 

  Ÿ  

difficult geological situations or other geotechnical issues;

 

  Ÿ  

onsite labor disputes or work accidents; and

 

  Ÿ  

natural catastrophes or adverse weather conditions.

Any construction delays, or failure to complete a project according to our planned specifications or budget, may delay our property sales, which could harm our revenues, cash flows and our reputation.

Under PRC laws and regulations and our pre-sale contracts, we are required to compensate purchasers for late delivery or failure to complete our pre-sold units. For the five years ended December 31, 2006, we paid an aggregate amount of RMB1.4 million (US$166,710) of compensation to our customers due to late delivery. If the delay extends beyond the contractually specified period, the purchasers may become entitled to terminate the pre-sale contracts and claim damages. Proceeds from pre-sale of our properties are an important source of financing for our property developments. Under PRC laws, we are not permitted to commence pre-sales until we have completed certain stages of the construction process for a project. Consequently, a significant delay in the construction of a project could restrict our ability to pre-sell our properties, which could extend the recovery period for our capital outlay. This, in turn, could have an adverse effect on our cash flow, business and financial position.

Changes of laws and regulations with respect to pre-sales may adversely affect our cash flow position and performance.

We depend on cash flows from pre-sale of properties as an important source of funding for our property projects and servicing our indebtedness. Under current PRC laws and regulations, property developers must fulfill certain conditions before they can commence pre-sale of the relevant properties and may only use pre-sale proceeds to finance the construction of the specific developments. On August 5, 2005, PBOC issued a report entitled “2004 Real Estate Financing Report,” in which it recommended that the practice of pre-selling uncompleted properties be discontinued because, according to the report, such activity creates significant market risks and generates transactional irregularities. This and other PBOC recommendations have not been adopted by the PRC government and have no enforceability. However, there can be no assurance that the PRC government will not ban the practice of pre-selling uncompleted properties or implement further restrictions on the pre-sale of properties, such as imposing additional conditions for a pre-sale permit or further restrictions on the use of pre-sale proceeds. Any such measure will adversely affect our cash flow position and force us to seek alternative sources of funding for much of our property development business.

We provide guarantees for the mortgage loans of our customers which expose us to risks of default by our customers.

We pre-sell properties before actual completion and, in accordance with industry practice, our customers’ mortgage banks require us to guarantee our customers’ mortgage loans. Typically, we provide guarantees to PRC banks with respect to loans procured by the purchasers of our properties for the total mortgage loan amount until the completion of the registration of the mortgage with the relevant mortgage registration authorities, which generally occurs within six to 12 months after the purchasers take possession of the relevant properties. In line with what we believe to be industry practice, we rely on the credit evaluation conducted by mortgagee banks and do not conduct our own independent credit checks on our customers. The mortgagee banks typically require us to maintain, as restricted cash, 3% to 10% of the mortgage proceeds paid to us as security for our obligations under such guarantees. If a purchaser defaults on its payment obligations during the term of our guarantee, the mortgagee bank may deduct the delinquent mortgage payment from the security deposit. If the delinquent mortgage payments exceed the security deposit, the banks may require us to pay the excess amount. If multiple purchasers default on their payment obligations at around the same time, we will be required to make

 

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significant payments to the banks to satisfy our guarantee obligations. If we are unable to resell the properties underlying defaulted mortgages on a timely basis or at prices higher than the amounts of our guarantees and related expenses, we will suffer financial losses. For the five years ended December 31, 2006, we experienced certain defaults on mortgage loans by our customers in an aggregate principal amount of RMB1.5 million (US$187,542).

As of December 31, 2004, 2005 and 2006 and September 30, 2007, our outstanding guarantees in respect of our customers’ mortgage loans amounted to US$17.8 million, US$37.9 million, US$62.4 million and US$172.5 million, respectively. If substantial defaults by our customers occur and we are called upon to honor our guarantees, our financial condition and results of operations will be materially adversely affected.

Our results of operations may fluctuate from period to period.

Our results of operations tend to fluctuate from period to period. The number of properties that we can develop or complete during any particular period is limited due to the substantial capital required for land acquisition and construction, as well as the lengthy development periods required before positive cash flows may be generated. In addition, several properties that we have developed or that are under development are large scale and are developed in multiple phases over the course of one to several years. The selling prices of the residential units in larger scale property developments tend to change over time, which may impact our sales proceeds and, accordingly, our revenues for any given period.

The recognition of our real estate revenue and costs relies upon our estimation of total project sales value and costs.

We recognize our real estate revenue based on the full accrual method and the percentage of completion method depending on the estimated project construction period. Under both methods, revenue and costs are calculated based on an estimation of total project costs and total project revenue, which are revised on a regular basis as the work progresses. Any material deviation between actual and estimated total project sales and costs may result in an increase, a reduction or an elimination of reported revenues or costs from period to period, which will affect our net income.

We may be required to pay additional corporate income taxes in China.

Based on the current levy method applied by the Zhengzhou local tax bureau, our subsidiaries in Zhengzhou are paying corporate income tax, or CIT, on a deemed profit basis, where taxable income is deemed to be 12% or 14% of cash receipts, regardless of actual income generated in that year. According to PRC tax regulations, the deemed profit basis should only be applicable to companies that are unable to keep accounting books or whose accounts are incomplete and inaccurate. These circumstances do not apply to us and, accordingly, we may be subject to corporate income tax at the rate of 33% on our actual taxable income. We have made provision for the full amount of applicable CIT estimated in accordance with the relevant PRC tax laws and regulations, but we pay CIT each year as required by the local tax authorities. We cannot guarantee that we will not be required to pay additional taxes in accordance with the PRC tax laws and regulations or that our accrued deferred tax liabilities will be sufficient to cover any additional CIT payments we will be required to pay in the future with respect to past financial periods.

The newly enacted PRC Corporate Income Tax Law could affect tax exemptions on dividends received by us and our shareholders and increase our corporate income tax rate.

We are incorporated under the laws of the Cayman Islands. As a foreign legal person, dividends derived from our business operations in the PRC are currently not subject to income tax under PRC law. However, we cannot assure you that such dividends will continue to be exempt from PRC income tax. Under the newly enacted PRC Corporate Income Tax Law which will take effect from January 1, 2008, if we are deemed a non-PRC tax resident enterprise without an office or premises in the PRC, withholding tax at the rate of 20% will be applicable to dividends paid by us, unless the tax is entitled to reduction or elimination in accordance with any future PRC

 

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laws or regulations or an applicable tax treaty between the PRC and the Cayman Islands. As of the date of this prospectus, the Cayman Islands has not entered into any such tax treaties with the PRC. The newly enacted PRC Corporate Income Tax Law is also unclear as to how such tax reduction or elimination would be implemented.

In addition, the newly enacted PRC Corporate Income Tax Law provides that, if an enterprise incorporated outside the PRC has its “de facto management organization” located within the PRC, such enterprise may be recognized as a PRC tax resident enterprise and thus may be subject to corporate income tax at the rate of 25% on its worldwide income. However, the newly enacted PRC Corporate Income Tax Law does not define the term “de facto management organization.” A substantial number of our management are located in the PRC. If a substantial number of our management continue to be located in the PRC after the effective date of the newly enacted PRC Corporate Income Tax Law, we may be deemed a PRC tax resident and therefore subject to a corporate income tax rate of 25% on our worldwide income (including dividend income received from our subsidiaries). The newly enacted PRC Corporate Income Tax Law also provides that dividends received by a qualified PRC tax resident from another PRC tax resident are exempt from corporate income tax. However, given the short history of this law, it remains unclear as to the detailed qualification requirements for such exemption and whether the dividends that we receive from our PRC subsidiaries will be exempt from corporate income tax if we are recognized as a PRC tax resident.

The relevant PRC tax authorities may challenge the basis on which we have been paying our land appreciation tax obligations and our results of operations and cash flows may be affected.

Under PRC laws and regulations, our PRC subsidiaries engaging in property development are subject to land appreciation tax, or LAT, which is levied by the local tax authorities. All taxable gains from the sale or transfer of land use rights, buildings and their attached facilities in the PRC are subject to LAT at progressive rates ranging from 30% to 60%. Exemptions are available for the sale of ordinary residential properties if the appreciation values do not exceed certain thresholds specified in the relevant tax laws. Gains from the sale of commercial properties are not eligible for this exemption.

The Zhengzhou city local tax authority did not impose the LAT on real estate companies until September 2004. Since September 2004, it has levied the LAT at the rates of 0.8% or 1% against total cash receipts from our sales of our residential properties and certain retail premises located in our developments, respectively, rather than according to the progressive rates. Accordingly we recognized LAT in prior years as an expense based on the rate of 0.8% or 1%, as applicable, of cash receipts imposed by the local tax authority. On December 28, 2006, the State Administration of Taxation issued the Notice on Administration of the Settlement of Land Appreciation Tax of Property Development Enterprises, or the LAT Notice, which became effective on February 1, 2007. The LAT Notice sets forth, among other things, methods of calculating LAT and a time frame for settlement of LAT. We have accrued all LAT payable on our property sales and transfers in accordance with the progressive rates specified in relevant tax laws, less amounts previously paid under the levy method applied by relevant local tax authorities. However, provisioning for LAT requires our management to use a significant amount of judgment with respect to, among other things, the anticipated total proceeds to be derived from the sale of the entire phase of the project or the entire project, the total appreciation of land value and the various deductible items. If the LAT provisions we have made are substantially lower than the actual LAT amounts assessed by the tax authorities in the future, our results of operations and cash flows will be materially and adversely affected.

We rely on our key management members.

We depend on the services provided by key management members. Competition for management talent is intense in the property development sector. In particular, we are highly dependent on Mr. Yong Zhang, our founder, Chairman and Chief Executive Officer, and Mr. Longgen Zhang, our Chief Financial Officer. We do not maintain key employee insurance. In the event that we lose the services of any key management member, we may be unable to identify and recruit suitable successors in a timely manner or at all, which will adversely affect our business and operations. Moreover, we need to employ and retain more management personnel to support our

 

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expansion into other Tier II cities on a much larger geographical scale. If we cannot attract and retain suitable human resources, especially at the management level, our business and future growth will be adversely affected.

Grants of employee share options and other share-based compensation could adversely affect our net income.

In August 2007, we adopted an equity incentive plan for our directors, management, employees and consultants under which we granted share options and restricted share awards for the purchase of up to 6,802,495 common shares. In November 2007, we adopted a long term incentive plan for our directors, management and key employees under which we are authorized to grant options, restricted shares, restricted stock units, stock appreciation rights and other stock-based awards for the purchase of up to 10 million common shares. As a result of the grant of options and awards under these plans, we expect to incur share-based compensation expenses in future periods. We may adopt additional equity incentive plans in the future. We have adopted Statement of Financial Accounting Standard No. 123(R) for the accounting treatment of our share-based compensation. We account for compensation costs for all stock-based awards using a fair-value based method and recognize expenses in our consolidated statement of operations in accordance with U.S. GAAP, which may reduce our net income.

Increases in the price of raw materials may increase our cost of sales and reduce our earnings.

Our third-party contractors are responsible for procuring almost all of the raw materials used in our project developments. Our construction contracts typically provide for fixed or capped payments, but the payments are subject to changes in government-suggested steel prices. The increase in steel prices could result in an increase in our construction cost. In 2006, for instance, the average price of steel increased approximately 4%, which in turn increased our cost. In addition, the increases in the price of raw materials, such as cement, concrete blocks and bricks, in the long run could be passed on to us by our contractors, which will increase our construction cost. Any such cost increase could reduce our earnings to the extent we are unable to pass these increased costs to our customers.

If we do not maintain good relationships with our joint venture partners, our results of operations may be adversely affected.

One of our project companies, Jiantou Xinyuan, is a joint venture established under PRC law. We hold a 45% equity interest in Jiantou Xinyuan, with 50% held by Zhengzhou General Construction Investment Company and the remaining 5% held by Zhengzhou Jiantou Project Consulting Co., Ltd. As of September 30, 2007, Jiantou Xinyuan had completed International City Garden I and was in the process of developing International City Garden II, City Mansion and International Plaza. These four projects have an aggregate GFA of 473,895 square meters. We hold only a minority interest in Jiantou Xinyuan and do not have full control over its operations. We may not be able to control the quality of products produced by Jiantou Xinyuan. Under the joint venture contract, we and other shareholders agree to share the profits according to our respective equity interests in Jiantou Xinyuan, but we require the consent of our joint venture partners before we can cause the joint ventures to distribute profits to the shareholders, including us. Furthermore, our joint venture partners and the joint venture themselves may hold different views or have different interests from ours, and therefore may compete in the same market with us, in which case our interest and future development may be materially adversely affected.

If we do not maintain good relationships with our institutional shareholders, our business and operations may be adversely affected.

Our institutional shareholders, Blue Ridge China and Equity International, have substantial ownership of our shares. Blue Ridge China owns 25.75% of our outstanding share capital as of the date of this prospectus and will own approximately         % of our outstanding share capital upon completion of this offering. Equity International owns 17.17% of our outstanding share capital as of the date of this prospectus and will own approximately         % of our outstanding share capital upon completion of this offering. Each of Blue Ridge

 

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China and Equity International has appointed one director to our board. While Blue Ridge China’s and EI’s rights to appoint directors to our board will be terminated upon completion of this offering, the two directors designated by them (Yue (Justin) Tang and Christopher J. Fiegen) will remain our directors until their resignation or removal. If we do not maintain a good relationship with either Blue Ridge China or Equity International, that could have an adverse effect on us.

We are a holding company that depends on dividend payments from our subsidiaries for funding.

We are a holding company established in the Cayman Islands and operate all of our business and operations through our subsidiaries in China. Therefore, our ability to pay dividends to our shareholders and to service our indebtedness depends upon dividends that we receive from our subsidiaries in China. If our subsidiaries incur indebtedness or losses, such indebtedness or loss may impair their ability to pay dividends or other distributions to us. As a result, our ability to pay dividends and to service our indebtedness will be restricted. Regulations in China currently permit payment of dividends only out of accumulated profits as determined in accordance with accounting standards and regulations in China. Each of our PRC subsidiaries, including wholly foreign-owned enterprises and domestic companies, is required to set aside at least 10.0% of its after-tax profit based on PRC accounting standards each year to its general reserves or statutory capital reserve fund until the accumulative amount of such reserves reaches 50.0% of its respective registered capital. As of September 30, 2007, our restricted reserves amounted to US$4.1 million, and our accumulated profits that were unrestricted and were available for distribution amounted to US$57.5 million. On November 13, 2007, we modified the Series A preference shares which resulted in recording a deemed dividend that will eliminate the accumulated profits of US$57.5 million as at September 30, 2007. Our restricted reserves are not distributable as cash dividends. The indentures for our floating rate notes and convertible notes contain restrictions on our subsidiaries’ ability to pay dividends. In addition, restrictive covenants in bank credit facilities, joint venture agreements or other agreements that we or our subsidiaries may enter into in the future may also restrict the ability of our subsidiaries to make contributions to us and our ability to receive distributions. Therefore, these restrictions on the availability and usage of our major source of funding may impact our ability to pay dividends to our shareholders and to service our indebtedness.

Any unauthorized use of our brand or trademark may adversely affect our business.

We own trademarks for “ LOGO”, in the form of Chinese characters and our company logo. We rely on the PRC intellectual property and anti-unfair competition laws and contractual restrictions to protect brand name and trademarks. We believe our brand, trademarks and other intellectual property rights are important to our success. Any unauthorized use of our brand, trademarks and other intellectual property rights could harm our competitive advantages and business. Historically, China has not protected intellectual property rights to the same extent as the United States or the Cayman Islands, and infringement of intellectual property rights continues to pose a serious risk of doing business in China. Monitoring and preventing unauthorized use is difficult. The measures we take to protect our intellectual property rights may not be adequate. Furthermore, the application of laws governing intellectual property rights in China and abroad is uncertain and evolving, and could involve substantial risks to us. If we are unable to adequately protect our brand, trademarks and other intellectual property rights, our reputation may be harmed and our business may be adversely affected.

We may be subject to additional payments of statutory employee benefits.

According to PRC central government and local regulations, we are required to pay various statutory employee benefits, including pensions, housing fund, medical insurance, work-related injury insurance, unemployment insurance and childbearing insurance for all employees, to designated government agents. We pay statutory employee benefits based on the local government pre-set contribution ratio, while we accrue provisions for unpaid employee benefits based on relevant central government regulations. We cannot be certain that such accrued amount will be sufficient to meet any additional employee benefits payments that we are required to pay in the future. In addition, we have underpaid certain employee benefits based on the local government pre-set ratio in the past. We may need to settle the underpaid amount plus late payment interest, and may also be subject to fines or penalties for the underpayment, which may have a material adverse effect on our financial condition.

 

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We do not have insurance to cover potential losses and claims.

We do not have insurance coverage against potential losses or damages with respect to our properties before their delivery to customers, nor do we maintain insurance coverage against liability from tortious acts or other personal injuries on our project sites. Although we require our contractors to carry insurance, we believe most of our contractors do not comply with this requirement. Our contractors may not be sufficiently insured themselves or have the financial ability to absorb any losses that arise with respect to our projects or pay our claims. In addition, there are certain types of losses, such as losses due to earthquakes, which are currently uninsurable in China. While we believe that our practice is in line with the general practice in the PRC property development industry, there may be instances when we will have to internalize losses, damages and liabilities because of the lack of insurance coverage, which may in turn adversely affect our financial condition and results of operations.

We may fail to obtain, or may experience material delays in obtaining necessary government approvals for any major property development, which will adversely affect our business.

The real estate industry is strictly regulated by the PRC government. Property developers in China must abide by various laws and regulations, including implementation rules promulgated by local governments to enforce these laws and regulations. Before commencing, and during the course of, development of a property project, we need to apply for various licenses, permits, certificates and approvals, including land use rights certificates, construction site planning permits, construction work planning permits, construction permits, pre-sale permits and completion acceptance certificates. We need to satisfy various requirements to obtain these certificates and permits. To date, we have not encountered serious delays or difficulties in the process of applying for these certificates and permits, but we cannot guarantee that we will not encounter serious delays or difficulties in the future. In the event that we fail to obtain the necessary governmental approvals for any of our major property projects, or a serious delay occurs in the government’s examination and approval progress, we may not be able to maintain our development schedule and our business and cash flows may be adversely affected.

We may forfeit land to the PRC government if we fail to comply with procedural requirements applicable to land grants from the government or the terms of the land use rights grant contracts.

According to the relevant PRC regulations, if we fail to develop a property project according to the terms of the land use rights grant contract, including those relating to the payment of land premiums, specified use of the land and the time for commencement and completion of the property development, the PRC government may issue a warning, may impose a penalty or may order us to forfeit the land. Specifically, under current PRC law, if we fail to commence development within one year after the commencement date stipulated in the land use rights grant contract, the relevant PRC land bureau may issue a warning notice to us and impose an idle land fee on the land of up to 20% of the land premium. If we fail to commence development within two years, the land will be subject to forfeiture to the PRC government, unless the delay in development is caused by government actions or force majeure. Even if the commencement of the land development is compliant with the land use rights grant contract, if the developed GFA on the land is less than one-third of the total GFA of the project or the total capital invested is less than one-fourth of the total investment of the project and the suspension of the development of the land continues for more than one year without government approval, the land will also be treated as idle land and be subject to penalty or forfeiture. We cannot assure you that circumstances leading to significant delays in our development schedule or forfeiture of land will not arise in the future. If we forfeit land, we will not only lose the opportunity to develop the property projects on such land, but may also lose all past investments in such land, including land premiums paid and development costs incurred.

Any non-compliant GFA of our uncompleted and future property developments will be subject to governmental approval and additional payments.

The local government authorities inspect property developments after their completion and issue the completion acceptance certificates if the developments are in compliance with the relevant laws and regulations.

 

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If the total constructed GFA of a property development exceeds the GFA originally authorized in the relevant land grant contracts or construction permit, or if the completed property contains built-up areas that do not conform with the plan authorized by the construction permit, the property developer may be required to pay additional amounts or take corrective actions with respect to such non-compliant GFA before a completion acceptance certificate can be issued to the property development.

We have obtained completion acceptance certificates for all of our completed properties as of September 30, 2007. However, we cannot be certain that local government authorities will not find the total constructed GFA upon completion of our existing projects under development or any future property developments to exceed the relevant authorized GFA. Any such non-compliance could lead to additional payments or penalty, which would adversely affect our financial condition.

We may not be able to continue obtaining qualification certificates, which will adversely affect our business.

Real estate developers in the PRC must obtain a formal qualification certificate in order to carry on a property development business in the PRC. According to the PRC regulations on qualification of property developers issued in 2000, a newly established property developer must first apply for a temporary qualification certificate with a one-year validity, which can be renewed for not more than two years. If, however, the newly established property developer fails to commence a property development project within the one-year period during which the temporary qualification certificate is in effect, it will not be allowed to renew its temporary qualification certificate. All qualification certificates are subject to renewal on an annual basis. Under government regulations, developers must fulfill all statutory requirements before they may obtain or renew their qualification certificates. In accordance with the provisions of the rules on the administration of qualifications, the real estate developer qualifications are classified into four classes and the approval system for each class is tiered. The approval for Class I Qualification is subject to examination by the construction authority under the State Council, that is, the central government, and the procedure for approval of developers for Class II Qualification or lower qualifications is administered by the construction authorities at the provincial-level of government. A real estate developer may only engage in the development and sale of real estate within its approved scope of business. For instance, a Class I developer is not restricted to the scale of real estate projects to be developed and may undertake real estate development projects anywhere in the country, while a Class II or below developer may undertake projects with construction area of less than 250,000 square meters per project. See “Regulation—Regulations on Qualifications of Developer.”

There can be no assurance that some of our project companies that are in the process of applying for proper qualification certificates will be able to obtain such certificates timely to commence their planned real estate projects development on schedule. There can be no further assurance that we and our project companies will continue to be able to extend or renew the qualification certificates or be able to successfully upgrade the current qualification class to a higher qualification. If we or our project companies are unable to obtain or renew qualification certificates, the PRC government will refuse to issue pre-sale and other permits necessary for the conduct of the property development business, and our results of operations, financial condition and cash flows will be adversely affected.

Our failure to assist our customers in applying for property ownership certificates in a timely manner may lead to compensatory liabilities to our customers.

We are required to meet various requirements within 90 days after delivery of property, or such other period contracted with our customers, in order for our customers to apply for their property ownership certificates, including passing various governmental clearances, formalities and procedures. Under our sales contract, we are liable for any delay in the submission of the required documents as a result of our failure to meet such requirements, and are required to compensate our customers for delays. In the case of serious delays on one or more property projects, we may be required to pay significant compensation to our customers and our reputation may be adversely affected.

 

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We may become involved in legal and other proceedings from time to time and may suffer significant liabilities or other losses as a result.

We have in the past, and may in future, become involved in disputes with various parties relating to the acquisition of land use rights, the development and sale of our properties or other aspects of our business and operations. These disputes may lead to legal or other proceedings and may result in substantial costs and diversion of resources and management’s attention. For example, our acquisition and development of a site in Zhengzhou in 2004 was delayed because the vendor failed to transfer the land use rights to us as agreed under our contract, despite a deposit we paid. We brought legal proceedings against the vendor to enforce our rights, which were finally determined in our favor in November 2006. Disputes and legal and other proceedings may require substantial time and expense to resolve, which could divert valuable resources, such as management time and working capital, delay our planned projects and increase our costs. Third parties that are found liable to us may not have the resources to compensate us for our incurred costs and damages. We could also be required to pay significant costs and damages if we do not prevail in any such disputes or proceedings. In addition, we may have disagreements with regulatory bodies in the course of our operations, which may subject us to administrative proceedings and unfavorable decrees that result in pecuniary liabilities and cause delays to our property developments.

We are subject to potential environmental liability.

We are subject to a variety of laws and regulations concerning the protection of health and the environment. The particular environmental laws and regulations that apply to any given development site vary significantly according to the site’s location and environmental condition, the present and former uses of the site and the nature of the adjoining properties. Environmental laws and conditions may result in delays, may cause us to incur substantial compliance and other costs and can prohibit or severely restrict project development activity in environmentally-sensitive regions or areas. Although the environmental investigations conducted by local environmental authorities have not revealed any environmental liability that we believe would have a material adverse effect on our business, financial condition or results of operations to date, it is possible that these investigations did not reveal all environmental liabilities and that there are material environmental liabilities of which we are unaware. We cannot assure you that future environmental investigations will not reveal material environmental liability. Also, we cannot assure you that the PRC government will not change the existing laws and regulations or impose additional or stricter laws or regulations, the compliance of which may cause us to incur significant capital expenditure. See “Business—Environmental Matters.”

If we fail to maintain an effective system of internal controls over financial reporting, we may not be able to accurately report our financial results or prevent fraud.

We will be subject to reporting obligations under the U.S. securities laws. The Securities and Exchange Commission, or the SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, adopted rules requiring every public company to include a management report on such company’s internal controls over financial reporting in its annual report, which contains management’s assessment of the effectiveness of the company’s internal controls over financial reporting. In addition, an independent registered public accounting firm must attest to and report on the effectiveness of the company’s internal controls over financial reporting. These requirements will first apply to our annual report on Form 20-F for the first full fiscal year subsequent to our listing. Our management may conclude that our internal controls over our financial reporting are not effective. Moreover, even if our management concludes that our internal controls over financial reporting is effective, our independent registered public accounting firm may still issue a report that is qualified or adverse if it believes that the design or implementation of our internal controls is not effective, or if it interprets the relevant requirements differently from us.

Prior to this offering, we have been a private company with limited accounting personnel and other resources with which to address our internal controls and procedures. We have begun the process of improving our internal controls over financial reporting. For example, in the course of auditing our consolidated financial statements as of and for the year ended December 31, 2006, our auditors recommended that our key accounting

 

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personnel be provided with training on the application of U.S. GAAP to improve the quality of our financial reporting. Based on such recommendation, we have hired additional staff with U.S. GAAP experience. We plan to complete a review of our internal controls and remedy any weaknesses or deficiencies in time to meet the deadline imposed by Section 404 of the Sarbanes-Oxley Act. If we fail to timely achieve and maintain the adequacy of our internal controls, we may not be able to conclude that we have effective internal controls over financial reporting. Moreover, effective internal controls over financial reporting are necessary for us to produce reliable financial reports and are important to help prevent fraud. As a result, our failure to achieve and maintain effective internal controls over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the trading price of our ADSs. Furthermore, we anticipate that we will incur considerable costs and devote significant management time and efforts and other resources to comply with Section 404 of the Sarbanes-Oxley Act.

Risk Relating to the Residential Property Industry in China

We are heavily dependent on the performance of the residential property market in China, which is at a relatively early development stage.

The residential property industry in the PRC is still in a relatively early stage of development. Although demand for residential property in the PRC has been growing rapidly in recent years, such growth is often coupled with volatility in market conditions and fluctuation in property prices. It is extremely difficult to predict how much and when demand will develop, as many social, political, economic, legal and other factors, most of which are beyond our control, may affect the development of the market. The level of uncertainty is increased by the limited availability of accurate financial and market information as well as the overall low level of transparency in the PRC, especially in Tier II cities which have lagged in progress in these aspects when compared to Tier I cities.

The lack of a liquid secondary market for residential property may discourage investors from acquiring new properties. The limited amount of property mortgage financing available to PRC individuals may further inhibit demand for residential developments.

We face intense competition from other real estate developers.

The property industry in the PRC is highly competitive. In the Tier II cities we focus on, local and regional property developers are our major competitors, and an increasing number of large state-owned and private national property developers have started entering these markets. Many of our competitors, especially the state-owned and private national property developers, are well capitalized and have greater financial, marketing and other resources than we have. Some also have larger land banks, greater economies of scale, broader name recognition, a longer track record and more established relationships in certain markets. In addition, the PRC government’s recent measures designed to reduce land supply further increased competition for land among property developers.

Competition among property developers may result in increased costs for the acquisition of land for development, increased costs for raw materials, shortages of skilled contractors, oversupply of properties, decrease in property prices in certain parts of the PRC, a slowdown in the rate at which new property developments will be approved and/or reviewed by the relevant government authorities and an increase in administrative costs for hiring or retaining qualified personnel, any of which may adversely affect our business and financial condition. Furthermore, property developers that are better capitalized than we are may be more competitive in acquiring land through the auction process. If we cannot respond to changes in market conditions as promptly and effectively as our competitors, or effectively compete for land acquisition through the auction systems and acquire other factors of production, our business and financial condition will be adversely affected.

In addition, risk of property over-supply is increasing in parts of China, where property investment, trading and speculation have become overly active. We are exposed to the risk that in the event of actual or perceived over-supply, property prices may fall drastically, and our revenue and profitability will be adversely affected.

 

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The PRC government may adopt further measures to curtail the overheating of the property sector.

Along with the economic growth in China, investments in the property sectors have increased significantly in the past few years. In response to concerns over the scale of the increase in property investments, the PRC government has introduced policies to curtail property development. We believe the following regulations, among others, significantly affect the property industry in China.

In May 2006, the Ministry of Construction, National Development and Reform Commission, or the NDRC, PBOC and other relevant PRC government authorities jointly issued the Opinions on Adjusting the Housing Supply Structure and Stabilizing the Property Prices, which introduced measures to limit resources allocated to the luxury residential market. For instances, the new measures require that at least 70% of a residential project must consist of units with a GFA of less than 90 square meters per unit, and the minimum amount of down payment was increased from 20% to 30% of the purchase price of the underlying property if it has a unit GFA of 90 square meters or more. In September 2007, PBOC and China Banking Regulatory Commission issued the Circular on Strengthening the Management of Commercial Real Estate Credit Facilities, which increased the minimum down payment for any purchase of second or subsequent residential property to 40% of the purchase price if the purchaser had obtained a bank loan to finance the purchase of his or her first property.

In July 2006, the Ministry of Construction, the Ministry of Commerce, NDRC, PBOC, the State Administration for Industry and Commerce and SAFE issued Opinions on Regulating the Entry and Administration of Foreign Investment in Real Property Market, which impose significant requirements on foreign investment in the PRC real estate sector. For instance, these opinions set forth requirements of registered capital of a foreign invested real property enterprise as well as thresholds for a foreign invested real property enterprise to borrow domestic or overseas loans. In addition, since June 2007, a foreign invested real property enterprise approved by local authorities is required to register such approvals with the Ministry of Commerce.

The PRC government’s restrictive regulations and measures to curtail the overheating of the property sector could increase our operating costs in adapting to these regulations and measures, limit our access to capital resources or even restrict our business operations. We cannot be certain that the PRC government will not issue additional and more stringent regulations or measures, which could further slow down property development in China and adversely affect our business and prospects.

Our sales will be affected if mortgage financing becomes more costly or otherwise becomes less attractive.

Substantially all purchasers of our residential properties rely on mortgages to fund their purchases. An increase in interest rates may significantly increase the cost of mortgage financing, thus affecting the affordability of residential properties. In 2007, PBOC raised the lending rates five times. The benchmark lending rate for loans with a term of over five years, which affects mortgage rates, has been increased to 7.83%. The PRC government and commercial banks may also increase the down payment requirement, impose other conditions or otherwise change the regulatory framework in a manner that would make mortgage financing unavailable or unattractive to potential property purchasers. Under current PRC laws and regulations, purchasers of residential properties generally must pay at least 20% of the purchase price of the properties before they can finance their purchases through mortgages. In May 2006, the PRC government increased the minimum amount of down payment to 30% of the purchase price of the underlying property if such property has a unit GFA of 90 square meters or more. In September 2007, the minimum down payment for any purchase of second or subsequent residential property was increased to 40% of the purchase price if the purchaser had obtained a bank loan to finance the purchase of his or her first property. Moreover, the interest rate for bank loans of such purchase shall not be less than 110% of the PBOC benchmark rate of the same term and category. For further purchases of properties, there would be upward adjustments on the minimum down payment and interest rate for any bank loan. In addition, mortgagee banks may not lend to any individual borrower if the monthly repayment of the anticipated mortgage loan would exceed 50% of the individual borrower’s monthly income or if the total debt service of the individual borrower would exceed 55% of such individual’s monthly income. If the availability or attractiveness of mortgage financing is reduced or

 

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limited, many of our prospective customers may not be able to purchase our properties and, as a result, our business, liquidity and results of operations could be adversely affected.

In line with industry practice, we provide guarantees to PRC banks with respect to loans procured by the purchasers of our properties for the total amount of mortgage loans. Such guarantees expire upon the completion of the registration of the mortgage with the relevant mortgage registration authorities. If there are changes in laws, regulations, policies and practices that would prohibit property developers from providing guarantees to banks in respect of mortgages offered to property purchasers and as a result, banks would not accept any alternative guarantees by third parties, or if no third party is available or willing in the market to provide such guarantees, it may become more difficult for property purchasers to obtain mortgages from banks and other financial institutions during sales and pre-sales of its properties. Such difficulties in financing could result in a substantially lower rate of sale and pre-sale of our properties, which would adversely affect our cash flow, financial condition and results of operations. We are not aware of any impending changes in laws, regulations, policies or practices which will prohibit such practice in China. However, there can be no assurance that such changes in laws, regulations, policies or practices will not occur in China in the future.

Risks Relating to China

PRC economic, political and social conditions as well as government policies can affect our business.

The PRC economy differs from the economies of most developed countries in many aspects, including:

 

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political structure;

 

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degree of government involvement;

 

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degree of development;

 

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level and control of capital reinvestment;

 

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control of foreign exchange; and

 

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allocation of resources.

The PRC economy has been transitioning from a centrally planned economy to a more market-oriented economy. For more than two decades, the PRC government has implemented economic reform measures emphasizing utilization of market forces in the development of the PRC economy. Although we believe these reforms will have a positive effect on China’s overall and long-term development, we cannot predict whether changes in the PRC economic, political and social conditions, laws, regulations and policies will have any adverse effect on our current or future business, financial condition or results of operations.

Changes in foreign exchange regulations may adversely affect our results of operations.

We currently receive all of our revenues in RMB. The PRC government regulates the conversion between RMB and foreign currencies. Over the years, the government has significantly reduced its control over routine foreign exchange transactions under current accounts, including trade and service related foreign exchange transactions, payment of dividends and service of foreign debt. However, foreign exchange transactions by our PRC subsidiaries under capital accounts continue to be subject to significant foreign exchange controls and require the approval of, or registration with, PRC governmental authorities. There can be no assurance that these PRC laws and regulations on foreign investment will not cast uncertainties on our financing and operating plans in China. Under current foreign exchange regulations in China, subject to the relevant registration at SAFE, we will be able to pay dividends in foreign currencies, without prior approval from SAFE, by complying with certain procedural requirements. However, there can be no assurance that the current PRC foreign exchange policies regarding debt service and payment of dividends in foreign currencies will continue in the future. Changes in PRC foreign exchange policies might have a negative impact on our ability to

 

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service our foreign currency-denominated indebtedness and to distribute dividends to our shareholders in foreign currencies.

Fluctuations in the value of RMB will affect the amount of our non-RMB debt service in RMB terms and affect the value of, and dividends payable on, our ADSs in foreign currency terms.

The value of RMB depends, to a large extent, on China’s domestic and international economic, financial and political developments and government policies, as well as the currency’s supply and demand in the local and international markets. For over 10 years from 1994, the conversion of RMB into foreign currencies, including the U.S. dollar, was based on exchange rates set and published daily by People’s Bank of China in light of the previous day’s inter-bank foreign exchange market rates in China and the then current exchange rates on the global financial markets. The official exchange rate for the conversion of RMB into the U.S. dollar was largely stable until July 2005. On July 21, 2005, People’s Bank of China revalued RMB by reference to a basket of foreign currencies, including the U.S. dollar. As a result, the value of RMB appreciated by 2% on that day. Since then, the PRC central bank has allowed the official RMB exchange rate to float against a basket of foreign currencies. There can be no assurance that such exchange rate will not fluctuate widely against the U.S. dollar or any other foreign currency in the future. Fluctuation of the value of RMB will affect the amount of our non-RMB debt service in RMB terms since we have to convert RMB into non-RMB currencies to service our foreign debt, including our floating rate and convertible notes. Since our income and profits are denominated in RMB, any appreciation of RMB will also increase the value of, and any dividends payable on, our ADSs in foreign currency terms. Conversely, any depreciation of RMB will decrease the value of, and any dividends payable on, our ADSs in foreign currency terms.

Interpretation of PRC laws and regulations involves uncertainty.

Our core business is conducted within China and is governed by PRC laws and regulations. The PRC legal system is based on written statutes, and prior court decisions can only be used as a reference. Since 1979, the PRC government has promulgated laws and regulations in relation to economic matters such as foreign investment, corporate organization and governance, commerce, taxation and trade, with a view to developing a comprehensive system of commercial law, including laws relating to property ownership and development. However, due to the fact that these laws and regulations have not been fully developed, and because of the limited volume of published cases and the non-binding nature of prior court decisions, interpretation of PRC laws and regulations involves a degree of uncertainty. Some of these laws may be changed without being immediately published or may be amended with retroactive effect. Depending on the government agency or how an application or case is presented to such agency, we may receive less favorable interpretations of laws and regulations than our competitors, particularly if a competitor has long been established in the locality of, and has developed a relationship with, such agency. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. All these uncertainties may cause difficulties in the enforcement of our land use rights, entitlements under its permits, and other statutory and contractual rights and interests.

The PRC national and regional economies may be adversely affected by a recurrence of epidemic.

Certain areas of China, including the Tier II cities where we operate, are susceptible to epidemics such as Severe Acute Respiratory Syndrome, or SARS, or avian influenza. A recurrence of SARS, avian influenza or any epidemic in these cities or other areas of China could result in material disruptions to our property developments, which in turn could materially and adversely affect our financial condition and results of operations.

Recent PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident shareholders to personal liability and limit our ability to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute profits to us or otherwise adversely affect us.

SAFE issued a public notice in October 2005, requiring PRC residents to register with the local SAFE branch before establishing or acquiring the control of any company outside of China for the purpose of financing

 

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that offshore company with assets or equity interest in a PRC company. PRC residents that are shareholders of offshore special purpose companies established before November 1, 2005 were required to conduct the overseas investment registration with the local SAFE branch before March 31, 2006, and once the special purpose vehicle has a major capital change event (including overseas equity or convertible bonds financing), the residents must conduct a registration relating to the change within 30 days of occurrence of the event. On May 29, 2007, the SAFE issued an additional notice, clarifying some outstanding issues and providing standard operating procedures for implementing the prior notice. According to the new notice, SAFE sets up seven schedules that track registration requirements for offshore fundraising and roundtrip investments.

We have already urged our shareholders who are PRC residents to make the necessary applications and filings as required under these notices and other related rules. However, as a result of uncertainty concerning the reconciliation of these notices with other approval or registration requirements, it remains unclear how these notices, and any future legislation concerning offshore or cross-border transactions, will be interpreted, amended and implemented by the relevant government authorities. We attempt to comply, and attempt to ensure that our shareholders who are subject to these rules comply, with the relevant requirements. However, we cannot provide any assurances that all of our shareholders who are PRC residents will comply with our request to make or obtain any applicable registrations or comply with other requirements required by these notices or other related rules. The failure or inability of our PRC resident shareholders to make any required registrations or comply with other requirements may subject such shareholders to fines and legal sanctions and may also limit our ability to contribute additional capital into or provide loans to (including using the proceeds from this offering) our PRC subsidiaries, limit our PRC subsidiaries’ ability to pay dividends or otherwise distribute profits to us, or otherwise adversely affect us.

We may face PRC regulatory risks relating to our equity incentive plan and long term incentive plan.

On March 28, 2007, the SAFE promulgated the Application Procedures of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Holding Plan or Stock Option Plan of Overseas-Listed Company, or the Stock Option Rules. Under the Stock Option Rules, PRC citizens who are granted stock options and other types of stock-based awards by an overseas publicly-listed company are required, through an agent of the overseas publicly-listed company, generally its PRC subsidiary or a financial institution, to obtain approval from the local SAFE branch. We and our PRC directors, management employees and consultants who have been granted share options and other awards under our equity incentive plan and our long term incentive plan will be subject to the Stock Option Rules when we become a U.S.-listed company. If we, or any of these persons, fail to comply with the relevant rules or requirements, we may be subject to penalties, such as fines. Furthermore, prior to this offering, we are required to file our equity incentive plan and our long term incentive plan with the relevant foreign exchange authority. If we fail to comply with these rules, we may be subject to the relevant penalties and may become subject to more stringent review and approval processes with respect to our foreign exchange activities, such as our PRC subsidiaries’ dividend payment to us or borrowing foreign currency loans, all of which may adversely affect our business and financial condition.

Risks Relating to our ADSs and this Offering

There has been no public market for our common shares or ADSs prior to this offering, and you may not be able to resell our ADSs at or above the price you paid, or at all.

Prior to this initial public offering, there has been no public market for our common shares or ADSs. Our ADSs have been approved for listing on the New York Stock Exchange. Our common shares will not be listed on any exchange or quoted for trading on any over-the-counter trading system. If an active trading market for our ADSs does not develop after this offering, the market price and liquidity of our ADSs will be materially and adversely affected.

The initial public offering price for our ADSs will be determined by negotiations between us and the underwriters and may bear no relationship to the market price for our ADSs after the initial public offering. An

 

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active trading market for our ADSs may not develop and the market price of our ADSs may decline below the initial public offering price.

The market price for our ADSs may be volatile.

The market price for our ADSs may be volatile and subject to wide fluctuations in response to factors such as actual or anticipated fluctuations in our quarterly operating results, changes in financial estimates by securities research analysts, changes in the economic performance or market valuations of other real estate developers, announcements by us or our competitors of material acquisitions, strategic partnerships, joint ventures or capital commitments, fluctuations of exchange rates between RMB and the U.S. dollar, release of lock-up or other transfer restrictions on our outstanding shares or ADSs, and economic or political conditions in China. In addition, the performance, and fluctuation in market prices, of other companies with business operations located mainly in China that have listed their securities in the United States may affect the volatility in the price of and trading volumes of our ADSs. Furthermore, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our ADSs.

You will experience immediate and substantial dilution in the net tangible book value of ADSs purchased.

The initial public offering price per ADS will be substantially higher than the net tangible book value per ADS prior to the offering. Consequently, when you purchase ADSs in the offering at the assumed initial public offering price of US$            , the midpoint of the estimated range of the initial public offering price, you will incur immediate dilution of US$             per ADS. See “Dilution.” In addition, you may experience further dilution to the extent that additional common shares are issued upon the exercise of options, warrants and further options we may grant from time to time, and the conversion of our convertible notes.

We may raise additional capital through the sale of additional equity or debt securities, which could result in additional dilution to our shareholders, or impose upon us additional financial obligations.

We may require additional cash resources to finance our continued growth or other future developments, including any investments or acquisitions we may decide to pursue. The amount and timing of such additional financing needs will vary principally depending on the timing of our property developments, investments and/or acquisitions, and the amount of cash flow from our operations. If our resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities. The sale of additional equity securities, including additional warrants, could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations, including our ability to pay dividends or redeem stock. We cannot guarantee that financing will be available in amounts or on terms acceptable to us, if at all.

Substantial future sales or the perception of sales of our ADSs in the public market could cause the price of our ADSs to decline.

Sales of our ADSs or common shares in the public market after this offering, or the perception that these sales could occur, could cause the market price of our ADSs to decline. Upon completion of this offering, we will have              common shares outstanding, including              common shares represented by              ADSs, assuming the underwriters do not exercise the over-allotment option. All ADSs sold in this offering will be freely transferable without restriction or additional registration under the Securities Act of 1933, as amended, or the Securities Act. The remaining common shares outstanding after this offering will be available for sale, upon the expiration of the applicable lock-up period beginning from the date of this prospectus, subject to volume and other restrictions as applicable under Rule 144 under the Securities Act. See “Shares Eligible for Future Sale” and “Underwriting” for a detailed description of the lock-up restrictions. Any or all of these shares may be released prior to expiration of the lock-up period at the discretion of the lead underwriter for this offering. To the

 

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extent shares are released before the expiration of the lock-up period and these shares are sold into the market, the market price of our ADSs could decline.

In addition, certain holders of our common shares will have the right to cause us to register the sale of certain number of shares under the Securities Act, subject to a 180-day lock-up period in connection with this offering. Registration of these shares under the Securities Act would result in these shares becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of the registration. Sales of these registered shares in the public market could cause the price of our ADSs to decline.

The interests of our existing shareholders may not be aligned with the interests of our other shareholders.

Mr. Yong Zhang, chairman of our board of directors and chief executive officer, together with his spouse, Ms. Yuyan Yang, who is a shareholder of us, currently beneficially owns 55.37% of our outstanding share capital and will beneficially own approximately             % of our outstanding share capital upon completion of this offering. Accordingly, they have substantial influence over our business, including decisions regarding mergers, consolidations and the sale of all or substantially all of our assets, election of directors and other significant corporate actions. In addition, our institutional shareholders, Blue Ridge China and Equity International, also have substantial ownership of our shares. Blue Ridge China owns 25.75% of our outstanding share capital as of the date of this prospectus and will own approximately             % of our outstanding share capital upon completion of this offering. Equity International owns 17.17% of our outstanding share capital as of the date of this prospectus and will own approximately             % of our outstanding share capital upon completion of this offering. This concentration of ownership may result in actions being taken even if opposed by our other shareholders, including those who purchase ADSs in this offering. In addition, it may discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our ADSs.

Compliance with new rules and regulations applicable to companies publicly listed in the United States is costly and complex and any failure by us to comply with these requirements on an ongoing basis could negatively affect investor confidence in us and cause the market price of our ADSs to decrease.

In addition to Section 404, the Sarbanes-Oxley Act also mandates, among other things, that companies adopt new corporate governance measures, imposes comprehensive reporting and disclosure requirements, sets stricter independence and financial expertise standards for audit committee members, and imposes increased civil and criminal penalties for companies, their chief executive officers, chief financial officers and directors for securities law violations. For example, in response to the Sarbanes-Oxley Act, the New York Stock Exchange has adopted additional comprehensive rules and regulations relating to corporate governance. We expect these new laws, rules and regulations will increase the scope, complexity and cost of our corporate governance and future reporting and disclosure practices. Our current and future compliance efforts will continue to require significant management attention. We are currently evaluating and monitoring developments with respect to these new rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs. In addition, our board members, chief executive officer and chief financial officer could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficulty attracting and retaining qualified board members and executive officers to fill critical positions within our company. Any failure by us to comply with these requirements on an ongoing basis could negatively affect investor confidence in us, cause the market price of our ADSs to decrease or even result in the delisting of our ADSs from the New York Stock Exchange.

You may not have the same voting rights as the holders of our common shares and may not receive voting materials in time to be able to exercise your right to vote.

Except as described in this prospectus and in the deposit agreement, holders of our ADSs will not be able to exercise voting rights attaching to the shares evidenced by our ADSs on an individual basis. Holders of our ADSs will appoint the depositary or its nominee as their representative to exercise the voting rights attaching

 

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to the shares represented by the ADSs. You may not receive voting materials in time to instruct the depositary to vote, and it is possible that you, or persons who hold their ADSs through brokers, dealers or other third parties, will not have the opportunity to exercise a right to vote. As soon as practicable after the depositary receives from us a notice of a shareholders’ meeting, the depositary will distribute to registered holders of ADRs a notice stating (a) such information as is contained in such notice and any solicitation materials, (b) that each registered holder on the record date set for such purpose will, subject to any applicable provisions of Cayman Island law, be entitled to instruct the depositary as to the exercise of the voting rights and (c) the manner in which such instructions may be given, including instructions to give a discretionary proxy to a person designated by us. The depositary will not itself exercise any voting discretion in respect of any shares nor will it provide any instructions with respect to the shares represented by any ADSs for which voting instructions were not timely and properly received. There can be no guarantee that registered holders of ADRs will receive the notice described above with sufficient time to enable them to return any voting instructions to the depositary in a timely manner. To the extent you hold your ADSs through a bank, broker or other nominee, you will be relying upon such institutions with respect to voting matters.

You may not be able to participate in rights offerings and may experience dilution of your holdings as a result.

We may from time to time distribute rights to our shareholders, including rights to acquire our securities. Under the deposit agreement for the ADSs, the depositary will not offer those rights to ADS holders unless both the rights and the underlying securities to be distributed to ADS holders are either registered under the Securities Act or are exempt from registration under the Securities Act with respect to all holders of ADSs. We are under no obligation to file a registration statement with respect to any such rights or underlying securities or to endeavor to cause such a registration statement to be declared effective. In addition, we may not be able to take advantage of any exemptions from registration under the Securities Act. Accordingly, holders of our ADSs may be unable to participate in our rights offerings and may experience dilution in their holdings as a result.

You may be subject to limitations on transfer of your ADSs.

Your ADSs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from time to time when it deems expedient in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers of ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary deem it advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.

Certain judgments obtained against us by our shareholders may not be enforceable.

We are incorporated in the Cayman Islands, and conduct substantially all of our operations in China through our wholly owned subsidiaries and affiliated entities in China. All of our officers reside outside the United States and some or all of the assets of those persons are located outside of 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 Cayman Islands or in China in the event that you believe that your rights have been infringed under the securities laws or otherwise. Even if you are successful in bringing an action of this kind, the respective laws of the Cayman Islands and China may render you unable to enforce a judgment against our assets or the assets of our directors and officers. There is no statutory recognition in the Cayman Islands of judgments obtained in the United States, although the courts of the Cayman Islands will generally recognize and enforce a non-penal judgment of a foreign court of competent jurisdiction without retrial on the merits. For more information regarding the relevant laws of the Cayman Islands and China, see “Enforceability of Civil Liabilities.”

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

Our corporate affairs are governed by our memorandum and articles of association and by the Companies Law (2007 Revision) and common law of the Cayman Islands. The rights of shareholders to take

 

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legal action against our directors and us, actions by minority shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law 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, 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 precedents in the United States. In particular, the Cayman Islands has a less developed body of securities laws as compared to the United States, and provides significantly less protection to investors. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action before the federal courts of the United States.

As a result of all of the above, our public shareholders may have more difficulty in protecting their interests through actions against our management, directors or major shareholders than would shareholders of a corporation incorporated in a jurisdiction in the United States.

You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based on United States or other foreign laws against us or our management named in the prospectus.

We conduct substantially all of our operations in China and all of our assets are located in China. In addition, except for two directors, all of our directors and senior executive officers reside within China. As a result, it may not be possible to effect service of process within the United States or elsewhere outside China upon our directors and senior executive officers, including with respect to matters arising under U.S. federal securities laws or applicable state securities laws. Moreover, our PRC counsel has advised us that the PRC does not have treaties with the United States or many other countries providing for the reciprocal recognition and enforcement of judgment of courts.

Our management will have considerable discretion as to the use of the net proceeds to be received by us from this offering.

Our allocation of the net proceeds to be received by us of this offering is based on current plans and business conditions. The amounts and timing of any expenditure will vary depending on the amount of cash generated by our operations, competitive and market developments and the number and type of new projects, if any, we undertake. Accordingly, our management will have considerable discretion in the application of the net proceeds received by us. You will not have the opportunity, as part of your investment decision, to assess whether proceeds are being used appropriately. You must rely on the judgment of our management regarding the application of the net proceeds of this offering. The net proceeds may be used for corporate purposes that do not improve our efforts to maintain profitability or increase our share price. The net proceeds from this offering may be placed in investments that do not produce income or that lose value.

Our articles of association may contain anti-takeover provisions that could have a material adverse effect on the rights of holders of our common shares and ADSs.

We are considering adopting amended and restated articles of association that will contain provisions to limit the ability of others to acquire control of our company or cause us to engage in change-of-control transactions. These provisions could have the effect of depriving our shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transaction. For example, our board of directors has the authority, without further action by our shareholders, to issue preferred shares in one or more series and to fix their designations, powers, preferences, privileges and relative participating, optional or special rights and their qualifications, limitations or restrictions, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights associated with our common shares, in the form of ADS or otherwise. Preferred shares could be issued quickly with terms calculated to delay or prevent a change in control of our company or make removal of management more difficult. If our

 

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board of directors decides to issue preferred shares, the price of our ADSs may fall and the voting and other rights of the holders of our common shares and ADSs may be materially and adversely affected. As a result, the price of our ADSs may fall.

We may be classified as a passive foreign investment company, which could result in adverse U.S. federal income tax consequences to U.S. holders of our ADSs or common shares.

We do not expect to be considered a “passive foreign investment company,” or PFIC, for U.S. federal income tax purposes for our taxable year ending December 31, 2007. However, the determination of our PFIC status is dependent upon the composition of our income and assets and, in addition, we must make a separate determination at the close of each taxable year as to whether we are a PFIC. Because PFIC status is a factual determination based on actual results for the entire taxable year, our U.S. counsel expresses no opinion with respect to our PFIC status and also expresses no opinion with respect to our expectations contained in this paragraph. A non-U.S. corporation will be considered a PFIC for any taxable year if either (1) at least 75% of its gross income is passive income or (2) at least 50% of the value of its assets is attributable to assets that produce or are held for the production of passive income. The market value of our assets will be determined based on the market price of our ADSs and common shares, which is likely to fluctuate after this offering. In addition, the composition of our income and assets will be affected by how, and how quickly, we spend the cash we raise in this offering. If we were treated as a PFIC for any taxable year during which a U.S. person held an ADS or a common share, certain adverse U.S. federal income tax consequences could apply to such U.S. person. See “Taxation—U.S. Federal Income Taxation—Passive Foreign Investment Company.”

We may be classified as a controlled foreign corporation, which will result in application of special rules to certain of our U.S. holders.

Given our current ownership, there is a possibility that we may be a controlled foreign corporation, or CFC, following the issuance of the ADSs. Because CFC status is a factual determination dependent on the circumstances existing on the relevant date and thereafter, our U.S. counsel expresses no opinion with respect to our CFC status following the issuance of ADSs. If we were treated as a CFC for any taxable year during which a U.S. 10% shareholder held ADSs or common shares, certain adverse U.S. federal income tax consequences could apply to such U.S. 10% shareholder. See “Taxation—U.S. Federal Income Taxation—Controlled Foreign Corporation.”

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that relate to our current expectations and views of future events. The forward-looking statements are contained principally in the sections entitled “Prospectus Summary,” “Risk Factors,” “Use of Proceeds,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, “Our Industry” and “Business.” These statements relate to events that involve known and unknown risks, uncertainties and other factors, including those listed under “Risk Factors,” which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements.

In some cases, these forward-looking statements can be identified by words or phrases such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “potential,” “continue,” “is/are likely to” or other similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements include, among other things, statements relating to:

 

  Ÿ  

our future business development, results of operations and financial condition;

 

  Ÿ  

our expectations with respect to our ability to acquire adequate suitable land use rights for future development;

 

  Ÿ  

our ability to continue to implement our business model successfully;

 

  Ÿ  

our ability to secure adequate financing for our project development;

 

  Ÿ  

our ability to successfully sell or complete our property projects under construction and planning;

 

  Ÿ  

our ability to enter into new geographic markets and expand our operations;

 

  Ÿ  

our ability to maintain strict cost control;

 

  Ÿ  

our ability to obtain permits and licenses to carry on our business;

 

  Ÿ  

competition from other real estate developers;

 

  Ÿ  

our belief with respect to market opportunities in, and growth prospects of, Tier II cities in China;

 

  Ÿ  

the expected growth of the real estate industry in China, particularly Tier II cities; and

 

  Ÿ  

fluctuations in general economic and business conditions in China.

The forward-looking statements made in this prospectus relate only to events or information as of the date on which the statements are made in this prospectus. Except as required by law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, after the date on which the statements are made or to reflect the occurrence of unanticipated events. You should read this prospectus and the documents that we reference in this prospectus and have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect.

 

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USE OF PROCEEDS

We estimate that we will receive net proceeds from this offering of approximately US$             million, after deducting underwriting discounts and commissions and estimated offering expenses payable by us. These estimates are based upon an assumed initial offering price of US$             per ADS, the midpoint of the range shown on the front cover page of this prospectus. A US$1.00 increase (decrease) in the assumed initial public offering price of US$             per ADS would increase (decrease) the net proceeds to us from this offering by US$             million, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us and assuming no exercise of the underwriters’ over-allotment option and no other change to the number of ADSs offered by us as set forth on the cover page of this prospectus.

We intend to use approximately US$             of the net proceeds to acquire land use rights for future property development projects and to use the remaining net proceeds for working capital and other general corporate purposes.

The foregoing use of our net proceeds from this offering represents our current intentions based upon our present plans and business condition. The amounts and timing of any expenditure will vary depending on the amount of cash generated by our operations, competitive and market developments and the number and type of new projects, if any, we undertake. Accordingly, our management will have significant discretion in the allocation of the net proceeds we receive from this offering. Depending on future events and other changes in the business climate, we may determine at a later time to use the net proceeds for different purposes. Pending their use, we intend to place our net proceeds in short-term bank deposits.

In utilizing the proceeds of this offering, as an offshore holding company, we are permitted, under PRC laws and regulations, to provide funding to our existing and any future PRC subsidiaries through capital contributions, subject to satisfaction of applicable government registration and approval requirements. We cannot assure you that we will be able to obtain these government registrations or approvals on a timely basis, if at all. See “Risk Factors—Risks Relating to China—Recent PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident shareholders to personal liability and limit our ability to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute profits to us or otherwise adversely affect us.”

 

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DIVIDEND POLICY

We have never declared or paid dividends, nor do we have any present plan to pay any cash dividends on our common shares in the foreseeable future. We currently intend to retain our available funds and any future earnings to operate and expand our business.

Under our indentures for our floating rates notes and our convertible notes, we may not pay dividends unless our net income or cash flow exceeds specified thresholds and certain other conditions are satisfied. Assuming we are able, in accordance with these contractual arrangements, to pay dividends, any payment of dividends will still be subject to our board of directors’ discretion and the form, frequency and amount of any dividend will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant.

If we pay any dividends, we will pay our ADS holders to the same extent as holders of our common shares, subject to the terms of the deposit agreement, including the fees and expenses payable thereunder. See “Description of American Depositary Shares.” Cash dividends on our common shares, if any, will be paid in U.S. dollars.

 

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EXCHANGE RATES

Our financial statements and other financial data included in this prospectus are presented in U.S. dollars. Our business and operations are primarily conducted in China through our PRC subsidiaries. The functional currency of our PRC subsidiaries is RMB. Their financial statements are translated into United States dollars, using published exchange rates in China, based on (i) year-end exchange rates for assets and liabilities and (ii) average yearly exchange rates for revenues and expenses. Capital accounts are translated at historical exchange rates when the transactions occurred. The effects of foreign currency translation adjustments are included as a component of accumulated other comprehensive income in our shareholders’ equity.

The RMB is not freely convertible into foreign currency. Since January 1, 1994, the PBOC has set and published daily a base exchange rate with reference primarily to the supply and demand of RMB against the U.S. dollar in the market during the prior day. On July 21, 2005, the PBOC announced a reform of its exchange rate system and revalued the RMB to RMB8.11 to US$1.00. Under the reform, the RMB is no longer effectively linked to the U.S. dollar but instead is allowed to fluctuate within a narrow and managed band against a basket of foreign currencies, according to market demand and supply conditions. The PBOC announces the RMB’s closing price each day, and that rate serves as the midpoint of the next day’s trading band.

The following table sets forth, for each of the periods indicated, the low, average, high and period-end noon buying rates in New York City for cable transfers, in RMB per U.S. dollar, as certified for customs purposes by the Federal Reserve Bank of New York.

 

     Noon Buying Rate

Period

   Period
End
   Average(1)    Low    High
     (RMB per US$1.00)

2002

   8.2800    8.2770    8.2800    8.2700

2003

   8.2767    8.2772    8.2800    8.2765

2004

   8.2765    8.2768    8.2774    8.2764

2005

   8.0702    8.1940    8.2765    8.0702

2006

   7.8041    7.9723    8.0702    7.8041

2007

           

April

   7.7090    7.7247    7.7345    7.7090

May

   7.6516    7.6773    7.7065    7.6463

June

   7.6120    7.6333    7.6680    7.6120

July

   7.5720    7.5757    7.6055    7.5580

August

   7.5462    7.5734    7.6181    7.5420

September

   7.4928    7.5196    7.5540    7.4928

October

   7.4682    7.5016    7.5158    7.4682

November (through November 15)

   7.4250    7.4383    7.4582    7.4190

(1)

 

Determined by averaging the rates on the last business day of each month during the relevant period for annual and quarterly periods and each business day for monthly periods or any part thereof.

We make no representation that any RMB or U.S. amounts referred to in this prospectus could have been or could be converted into U.S. dollars or RMB, as the case may be, at any particular rate or at all.

 

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CAPITALIZATION

The following table sets forth our capitalization as of September 30, 2007:

 

  Ÿ  

on an actual basis; and

 

  Ÿ  

on an as adjusted basis to give effect to (i) the deemed dividend of US$             from the common shareholders to the Series A preference shareholders upon the modification of Series A preference shares; (ii) the automatic conversion of all of our outstanding Series A preference shares into 30,805,400 common shares upon completion of this offering; (iii) the issuance of 1,853,172 common shares upon the exercise of the Burnham warrants prior to the completion of this offering; and (iv) the issuance and sale of            common shares in the form of ADSs by us in this offering, assuming an initial public offering price of US$            per ADS, the mid-point of the estimated range of the initial public offering price, after deducting underwriting discounts and commissions and estimated offering expenses payable by us and assuming no exercise of the underwriters’ over-allotment option and no other change to the number of ADSs offered by us as set forth on the cover page of this prospectus.

You should read this table together with our financial statements and the related notes included elsewhere in this prospectus and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

     As of September 30, 2007
     Actual    As Adjusted(1)
     (US$ in thousands)

Long-term debt(2)

   233,130   
         

Series A convertible redeemable preference shares, US$0.0001 par value, 50,000,000 shares authorized; 30,805,400 shares issued and outstanding, actual; 0 shares issued and outstanding, as adjusted

  


24,441

  
         

Shareholders’ equity:

     

Common shares, US$0.0001 par value, 500,000,000 shares authorized; 75,704,379 shares issued and outstanding, actual              shares issued and outstanding, as adjusted

   8   

Additional paid-in capital(3)

   17,181   

Statutory reserves

   4,067   

Retained earnings

   57,477   

Accumulated other comprehensive earnings

   8,025   
         

Total shareholders’ equity(3)

   86,758   
         

Total capitalization(3)

   344,328   
         

(1)

 

Excludes:

  Ÿ  

6,802,495 common shares underlying all of the options and restricted share awards granted on August 11, 2007;

 

  Ÿ  

2,441,844 common shares underlying the options granted on November 5, 2007;

 

  Ÿ  

9,597,120 common shares issuable upon the conversion of the convertible notes; and

 

  Ÿ  

             common shares underlying the warrants issued to the holders of our floating rate notes, assuming an initial public offering price of US$             per ADS (the mid-point of the price range set forth on the front cover of this prospectus). A US$1.00 increase (decrease) in the assumed initial public offering price of US$             per ADS would decrease (increase) the number of common shares underlying the warrants issued to the holders of our floating rate notes by              shares.

 

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(2)

 

Includes long-term bank loans, convertible notes and floating rate notes but excludes fair value of embedded derivatives.

(3)

 

Assuming the number of ADSs offered by us as set forth on the cover page of this prospectus remains the same, and after deduction of underwriting discounts and commissions and the estimated offering expenses payable by us, a US$1.00 increase (decrease) in the assumed initial public offering price of US$             per ADS would increase (decrease) each of additional paid-in capital, total shareholders’ equity and total capitalization by US$             million.

 

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DILUTION

If you invest in our ADSs, your interest will be diluted to the extent of the difference between the initial public offering price per ADS and our net tangible book value per ADS after this offering. Dilution results from the fact that the initial public offering price per common share is substantially in excess of the book value per common share attributable to the existing shareholders for our presently outstanding common shares.

Our net tangible book value as of September 30, 2007 was US$109,438,339, or US$1.03 per common share and US$             per ADS. Net tangible book value represents the amount of our total consolidated tangible assets, minus the amount of our total consolidated liabilities. Without taking into account any other changes in such net tangible book value after September 30, 2007, other than to give effect to (i) the automatic conversion of our Series A preference shares into 30,805,400 common shares upon completion of this offering, (ii) the issuance of 1,853,172 common shares upon the exercise of the Burnham warrants at the completion of this offering; (iii) 9,597,120 common shares issuable upon the conversion of the convertible notes, (iv)              common shares underlying the warrants issued to the holders of our floating rate notes, assuming an initial public offering price of US$             per ADS (the mid-point of the price range set forth on the front cover of this prospectus), and (v) the issuance and sale of              common shares in the form of ADSs by us in this offering, at the assumed initial public offering price of US$             per ADS, the midpoint of the estimated range of the initial public offering price, and after deduction of underwriting discounts and commissions and estimated offering expenses of this offering payable by us, our adjusted net tangible book value as of September 30, 2007 would have increased to US$             million or US$             per common share or US$             per ADS. This represents an immediate increase in net tangible book value of US$             per common share, or US$             per ADS, to the existing shareholders and an immediate dilution in net tangible book value of US$             per common share, or US$             per ADS, to investors purchasing ADSs in this offering. The following table illustrates such per share dilution:

 

Assumed initial public offering price per ADS

  

US$                

Net tangible book value per common share as of September 30, 2007

  

US$1.03

Adjusted net tangible book value per common share after giving effect to this offering and the common share issuances described above

  

US$        

Adjusted net tangible book value per ADS after giving effect to this offering and the common share issuances described above

  

US$        

Amount of dilution in net tangible book value per common share to new investors in this offering

  

US$        

Amount of dilution in net tangible book value per ADS to new investors in this offering

  

US$        


A US$1.00 increase (decrease) in the assumed initial public offering price of US$             per ADS would increase (decrease) our pro forma net tangible book value after giving effect to the offering by US$             million, or by US$             per common share and by US$             per ADS, assuming no change to the number of ADSs offered by us as set forth on the cover page of this prospectus, and after deducting underwriting discounts and commissions and other expenses of this offering.

 

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The following table summarizes, on a pro forma basis as of September 30, 2007, the differences between existing shareholders (including holders of our Series A preference shares and our issued warrants that will be automatically converted into or exercised for our common shares immediately upon the completion of this offering) and the new investors with respect to the number of common shares (in the form of ADSs or shares) purchased from us, the total consideration paid and the average price per common share and per ADS paid before deducting underwriting discounts and commissions and estimated offering expenses, assuming an initial public offering price of US$             per ADS, the midpoint of the estimated range of the initial public offering price. The total number of common shares in the following table does not include common shares underlying the ADSs issuable upon the exercise of the underwriters’ over-allotment option.

 

     Common Shares Purchased    Total Consideration    Average Price Per
Common Share
   Average
Price Per ADS
     Number    Percent    Amount    Percent      

Existing shareholders(1)

                  %    US$                             %    US$                 US$             

New investors

                 
                                 

Total

                  %    US$                  %      

(1)

 

Assumes the automatic conversion of our outstanding Series A preference shares into common shares and the issuance of common shares upon the exercise of our issued warrants at the completion of this offering.

A US$1.00 increase (decrease) in the assumed initial public offering price of US$             per ADS would increase (decrease) total consideration paid by new investors, total consideration paid by all shareholders and the average price per ADS paid by all shareholders by US$             million, US$             million and US$            , respectively, assuming no change in the number of ADSs sold by us as set forth on the cover page of this prospectus and without deducting underwriting discounts and commissions and other expenses of the offering.

The dilution to new investors will be US$             per common share and US$             per ADS, if the underwriters exercise in full their over-allotment option.

The discussion and tables above also assume no exercise of any outstanding share options or awards under our 2007 equity incentive plan and 2007 long term incentive plan. In August 2007, we adopted our 2007 equity incentive plan pursuant to which we granted share options and restricted share awards for 6,802,495 common shares to our directors, management, employees and consultants. In November 2007, we adopted our 2007 long term incentive plan for our directors, management and employees under which we are authorized to grant options, restricted shares, restricted stock units, stock appreciation rights and other stock-based awards for the purchase of up to 10 million common shares. To the extent that any of these options or other awards are exercised, there will be further dilution to new investors.

 

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SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA

The following selected consolidated statements of operations and other consolidated financial data for the years ended December 31, 2004, 2005 and 2006, other than the earnings per ADS data, and the consolidated balance sheet data as of December 31, 2004, 2005 and 2006 have been derived from our audited consolidated financial statements, which are included elsewhere in this prospectus. Our audited consolidated financial statements have been prepared and presented in accordance with United States generally accepted accounting principles, or U.S. GAAP, and have been audited by Ernst & Young Hua Ming, an independent registered public accounting firm. The selected consolidated statements of operations data for the nine months ended September 30, 2006 and 2007 and the consolidated balance sheet data as of September 30, 2007 have been derived from our unaudited consolidated financial statements, which are included elsewhere in this prospectus. The selected consolidated statements of operations data and the consolidated balance sheet data as of and for the years ended December 31, 2002 and 2003 have been derived from our unaudited consolidated financial statements, which are not included in this prospectus. Our consolidated financial statements have been prepared as if our current corporate structure had been in existence throughout the relevant periods.

You should read the selected consolidated financial data in conjunction with our financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. Our historical results do not necessarily indicate our results expected for any future periods.

 

    Year Ended December 31,     Nine Months
Ended September 30,
 
    2002     2003     2004     2005     2006     2006     2007  
    US$    

US$

   

US$

   

US$

   

US$

   

US$

   

US$

 
    (unaudited)                       (unaudited)  
    (in thousands, except share, per share and per ADS data)  

Consolidated Statements of Operations Data(1)

             

Total revenues

  12,807     16,746     35,632     61,942     142,367     99,655     218,301  

Total costs of revenues

  (11,875 )   (11,978 )   (26,376 )   (42,632 )   (108,196 )   (75,613 )   (146,990 )

Selling and distribution expenses

  (493 )   (1,319 )   (1,604 )   (2,175 )   (2,996 )   (1,876 )   (5,957 )

General and administrative expenses

  (537 )   (939 )   (1,004 )   (1,696 )   (3,626 )   (2,095 )   (7,736 )
                                         

Operating income

  (99 )   2,510     6,648     15,439     27,549     20,071     57,618  

Net income before minority interest

  (471 )   1,067     3,943     9,548     16,120     12,493     35,965  

Net income

  (471 )   1,067     3,943     9,563     16,123     12,495     35,965  

Earnings per share

             

- Basic

  (0.01 )   0.02     0.07     0.16     0.21     0.19     0.32  

- Diluted

          0.07     0.16     0.21     0.19     0.30  

Shares used in computation

             

- Basic

  60,000,000     60,000,000     60,000,000     60,000,000     72,694,467     63,038,341     106,509,779  

- Diluted

  60,000,000     60,000,000     60,000,000     60,000,000     72,694,467     63,038,341     114,268,871  

Pro forma earnings per share

             

- Basic (unaudited)(2)

                  0.17         0.34  

- Diluted (unaudited)(2)

                  0.17         0.30  

Pro forma shares used in computation

             

- Basic (unaudited)(2)

                  92,612,479         106,531,892  

- Diluted (unaudited)(2)

                  96,612,479         114,333,967  

Earnings per ADS(3)

             

- Basic

             

- Diluted

             

Other Operating Data

             

Number of projects launched

  2     3     2     2     3     2     5  

Aggregate GFA delivered (m2)

  54,304     53,076     107,455     161,717     370,105     148,654     350,357  

 

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     As of December 31,   As of September 30,
     2002    2003    2004    2005    2006   2007
    

US$

  

US$

  

US$

  

US$

  

US$

 

US$

     (unaudited)              (unaudited)
     (in thousands)

Consolidated Balance Sheet Data(1)

                

Cash and cash equivalents

   2,812    2,822    5,249    14,929    34,914   106,410

Restricted cash

   1,432    3,792    11,399    5,385    32,011   41,916

Real estate property under development(4)

   18,091    24,914    47,403    64,857    106,804   308,709

Total current assets

   26,660    38,294    65,121    90,357    174,426   428,576

Total assets

   27,899    43,683    83,004    108,702    204,956   505,017

Total current liabilities

   23,851    32,756    72,855    82,228    118,840   131,518

Long-term bank loans

   3,624    9,001    3,141    7,435    12,806   139,998

Minority interest

            22     

Preference shares

               22,309   24,441

Total shareholders’ equity

   678    1,746    6,896    17,000    46,583   86,757

(1)

 

Our financial information is first prepared in RMB and then translated into U.S. dollars at (i) the following year-end exchange rates for assets and liabilities and (ii) the following average exchange rates for revenues and expenses. Capital accounts are translated at their historical exchange rates when the transactions occurred.

 

    As of and for the year ended December 31,    As of and for the
nine months ended
September 30,
    2002    2003    2004    2005    2006    2006    2007

Period end RMB : US$ exchange rate

  8.2773    8.2769    8.2765    8.0702    7.8087    7.9087    7.5108

Period average RMB : US$ exchange rate

  8.2770    8.2771    8.2766    8.1734    7.9721    8.0079    7.6659

 

       See “Exchange Rates” and Note 2(d) to our consolidated financial statements.

(2)

 

On August 25, 2006, we issued Series A preference shares that would convert automatically into 30,805,400 common shares upon the completion of an initial public offering. These pro forma amounts assume that the conversion had occurred “on a hypothetical basis” on January 1, 2006. The pro forma shares used in the computation for the nine months ended September 30, 2007 also include:

 

  Ÿ  

1,853,172 common shares issuable upon the exercise of the Burnham warrants, which we expect to be exercised prior to completion of this offering;

 

  Ÿ  

22,113 vested restricted shares, representing a weighted average based on the number of days from vesting to the ending date of the periods presented, and 42,983 unvested restricted shares calculated using the treasury-stock method; and

 

  Ÿ  

5,905,920 common shares issuable upon the conversion of the convertible notes, representing a weighted average based on the number of days from issuance to the ending date of the periods presented.

 

(3)

 

Earnings per ADS is calculated based on each ADS representing                  common shares. See “Description of American Depositary Shares.”

(4)

 

Includes real estate property under development recorded under current assets and non-current assets.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the section entitled “Selected Consolidated Financial and Operating Data” and our consolidated financial statements and related notes included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and elsewhere in this prospectus.

Overview

We are a fast-growing residential real estate developer that focuses on Tier II cities in China. We focus on developing large scale, quality residential projects aimed at providing middle-income consumers with a comfortable and convenient community life. Since our inception in 1997, we have completed 13 projects with total GFA of 939,829 square meters. As of September 30, 2007, we had 14 projects with estimated total GFA of 2,053,279 square meters under construction and planning, of which seven projects with estimated total GFA of 770,781 square meters were under construction.

We commenced operations in 1997 in Zhengzhou, the provincial capital of Henan Province, and we were ranked No. 1 among all property developers in Zhengzhou in terms of contracted sales of residential units in 2004, 2005 and 2006, according to statistics prepared by the Bureau of Real Estate Management in Zhengzhou. Since 2006, we have expanded into certain Tier II cities in China which we strategically selected based on a set of criteria, which include population and urbanization growth rate, general economic condition and growth rate, disposable income and purchasing power of resident consumers, anticipated demand for private residential properties, availability of future land supply and land prices and governmental urban planning and development policies. We have established operations in five Tier II cities in China, including Chengdu in Sichuan Province, Hefei in Anhui Province, Jinan in Shandong Province, Suzhou in Jiangsu Province and Zhengzhou in Henan Province.

Our revenues, derived primarily from sales of residential units, have grown from US$35.6 million in 2004 to US$61.9 million in 2005 and US$142.4 million in 2006, while our net income was US$3.9 million, US$9.6 million and US$16.1 million, respectively, for the same periods. For the nine months ended September 30, 2007, our revenue and net income were US$218.3 million and US$36.0 million, respectively. We have achieved our growth by employing a standardized and scalable business model that emphasizes rapid asset turnover, efficient capital management and strict cost control. We acquire land primarily through auctions of government land. This acquisition method allows us to obtain unoccupied land with unencumbered land use rights, which in turn enable us to avoid the time and expenses associated with demolition and re-settlement and to commence construction relatively quickly.

We hold a 45% minority interest in a joint venture project company, Jiantou Xinyuan, which had one completed project with total GFA of 107,846 square meters and three additional projects under construction with estimated total GFA of 366,049 square meters as of September 30, 2007. All of Jiantou Xinyuan’s projects are located in Zhengzhou.

Principal Factors Affecting Our Results of Operations

Economic growth and demand for residential property in China

Our business and results of operations are significantly affected by trends and developments in the PRC economy, including disposable income levels, urbanization rate, population growth, availability of project and consumer financing, which affect demand for residential properties in China. During the past decade, China has experienced significant economic growth, which has created a favorable operating environment for us in the Tier II cities where we operate. Sales of our residential units have been strong and 99.6% of the units in our completed projects have been sold as of September 30, 2007. We expect continuing economic growth in China,

 

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rising disposable income levels and population growth in Tier II cities to support demand for residential properties, including our residential units, over the next few years, despite recent measures by the PRC government to control overheating in the PRC property market.

PRC government policies and regulations

Our business and results of operations are significantly affected by PRC government policies and regulations, particularly those that relate to land sales and development, project and consumer financing, property sales and transfers, property taxation and residential property prices.

Since 2004, due to concerns that investment in the PRC property market may become excessive, the PRC government has introduced a series of measures to curb speculative investments in the property market, regulate real estate project lending and promote the development of more low- and mid-priced housing. These measures are discussed in more detail under “Regulation.” We believe that these policies have negatively affected our sales to a lesser extent than other property developers that focus on the luxury sector, because our business model focuses on the development of mid-priced housing, which is consistent with these policies. However, these measures will require us to invest greater capital outlay upfront to finance our projects and may increase our bank borrowing costs. As a consequence, we may not be able to expand our operations as rapidly as we could in the absence of these policies.

Moreover, a substantial portion of our customers depend on mortgage financing to purchase our properties. Although government policies have generally fostered the growth of private home ownership, regulations have been adopted in recent years to tighten mortgage lending rules. For example, the minimum down payment required for residential properties of 90 square meters or more was increased from 20% to 30% of the purchase price in 2006. In September 2007, the minimum down payment for any second or subsequent purchase of residential property was increased to 40% of the purchase price where the purchaser had obtained a bank loan to finance the purchase of his or her first property. Moreover, the interest rate for bank loans of such purchase shall not be less than 110% of the PBOC benchmark rate of the same term and category. The pricing and continued availability of mortgage financing are important factors that affect our results of operations.

Number, type and location of our property developments

The amount of revenues we record in any given period is affected by a number of factors, including the number, type and location of properties we have under construction and their stage of completion, whether the completed units have been sold and the realized selling prices for such units. The average selling prices of our projects vary depending on the types and sizes of the units sold and on the location of the projects. As the overall development moves closer to completion, the sales prices tend to increase because a more established residential community is offered to purchasers. The type of property development affects the estimated construction period of the project, which largely determines the revenue recognition method we apply. Revenue recognized in any period under the full accrual method depends on the number, aggregate GFA and average selling prices of units completed and sold during the period. Revenue recognized in any period under the percentage of completion method depends on contracted sales of units in the relevant project and the completion progress of a project (measured by the ratio of cost incurred to total estimated cost). See “—Critical Accounting Policies.” As the completion and sales of our projects are not spread evenly over time, our results of operations may differ significantly from period to period.

Availability and cost of financing

Like other property developers, we require substantial capital investment for the acquisition of land use rights and the construction of our projects. Our ability to secure financing for such purposes affects the number of projects we are able to develop at any time. The cost of our financing also affects our operating results. We typically obtain bank borrowings for up to 65% of our land use rights cost to fund project development after we receive required permits. Interest on our commercial bank borrowings is typically linked to benchmark lending rates published by the People’s Bank of China. In 2007, we issued US$75 million principal amount of floating rate notes, which bear interest at a variable rate based on LIBOR, and US$25 million principal amount of

 

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convertible notes, which bear interest at 2% per annum. We expect our interest costs to fluctuate in future periods as a result of changes in interest rates and our outstanding borrowings.

Acquisition of land use rights in target markets

Our business model depends to a large extent on our ability to acquire land use rights for development sites and proceed quickly with construction to shorten our development cycle. As a consequence, we are frequently surveying the market for attractive development opportunities in our target Tier II cities. Under current regulations and market practice, land use rights for residential development purposes may be acquired from local governments through a competitive auction or other bidding process, in which the minimum reserve price is determined based on the appraised value. Land use rights may also be acquired in the secondary markets. Land use rights prices vary significantly from city to city.

Government land auctions are a transparent and competitive process for bringing development land to market, allowing the developer to acquire clean title and the ability to proceed immediately with development. However, as competition for development sites in Tier II cities increases, the auction mechanism tends to lead to higher market-clearing prices, which has led to increasing land use rights costs. In 2004, 2005, 2006 and the nine months ended September 30, 2006 and 2007, land use rights costs, including auction price and taxes, constituted 22.8%, 23.8%, 30.0%, 28.9% and 37.2%, respectively, of our cost of revenue. We expect that our land use rights costs may continue to increase in the future, especially as we expand our operations to Tier II cities with higher land prices, which may lead to a decrease in our profit margin.

Our business and geographical expansion

We have expanded our business and operations significantly during the past three years and plan to continue this expansion over the next few years. The number of projects we had under construction has increased from three projects with total GFA of 278,868 square meters as of December 31, 2004 to five projects with total GFA of 584,011 square meters as of December 31, 2006 to seven projects with total GFA of 770,781 square meters as of September 30, 2007, and we had another seven projects with total GFA of 1,282,498 square meters under planning as of September 30, 2007. Since 2006, we have expanded our operations outside of Zhengzhou and we are currently developing and planning projects in five Tier II cities. As a result of this expansion, our capital investment and our financing needs have grown. Moreover, our operating expenses have increased as a result of this expansion, particularly because of the need to recruit more personnel and acquire office space as we expand into new cities. We expect our operating expenses, including our general and administrative expenses, to continue to increase as we continue to expand.

As a result of this offering, we will become a public company subject to the rules and regulations of the United States securities laws and the New York Stock Exchange relating to, among other things, corporate governance and internal controls. In preparation for our transition to become a public company, we have recruited additional management, accounting and other personnel. We have also incurred expenses to improve our enterprise resource management system and internal controls, and expect to incur additional associated costs in the near future.

Share-based compensation expenses

We adopted our equity incentive plan for our directors, management, employees and consultants in August 2007. On August 11, 2007, we granted share options and restricted share awards for an aggregate of 6,802,495 common shares at a weighted average exercise price of US$1.08. These options and restricted shares have various vesting periods ranging from 10 to 60 months, and will vest only if the holder is still a director or an employee or an affiliate of our company at the time of the relevant vesting. The share options will begin to vest upon the completion of this offering and they have a catch-up provision, at the discretion of our board of directors, to allow for vesting from the grant date upon completion of this offering. The restricted share awards have a catch-up provision upon the completion of this offering to allow for vesting from the grant date. These share options and restricted share awards will expire no later than August 10, 2017. See “Management—2007 Equity Incentive Plan.”

 

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The share options and restricted share awards granted are performance-based and do not begin vesting until the consummation of this offering. As a result, no compensation expense had been recognized during the nine months ended September 30, 2007.

In November 2007, we adopted our 2007 long term incentive plan for our directors, management and key employees under which we are authorized to grant options, restricted shares, restricted stock units, stock appreciation rights and other stock-based awards for the purchase of up to 10 million common shares at prevailing market prices. On November 5, 2007, we granted options for an aggregate of 2,441,844 common shares at the exercise price that will be equal to the initial public offering price of the ADSs as set forth on the cover of this prospectus. These options have vesting periods of up to 36 months, starting at the listing date of this offering and will expire no later than the 10th anniversary of the date of grant. See “Management — 2007 Long Term Incentive Plan.”

Critical Accounting Policies

We prepare our consolidated financial statements in accordance with U.S. GAAP, which requires us to make judgments, estimates and assumptions that affect (i) the reported amounts of our assets and liabilities, (ii) the disclosure of our contingent assets and liabilities at the end of each reporting period and (iii) the reported amounts of revenues and expenses during each reporting period. We continually evaluate these estimates based on our own experience, knowledge and assessment of current business and other conditions, our expectations regarding the future based on available information and reasonable assumptions, which together form our basis for making judgments about matters that are inherently uncertain. Since the use of estimates is an integral component of the financial reporting process, our actual results could differ from those estimates. Some of our accounting policies require a higher degree of judgment than others in their application.

When reading our financial statements, you should consider (i) our selection of critical accounting policies, (ii) the judgment and other uncertainties affecting the application of such policies and (iii) the sensitivity of reported results to changes in conditions and assumptions. We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements.

Revenue and cost recognition

We apply either of two different methods for revenue recognition, depending on the expected construction period.

Full accrual method

Revenue from the sale of properties where the construction period (the period from the construction permit award date to the unit delivery date) is expected to be 12 months or less is recognized by the full accrual method when the sale is consummated and the unit has been delivered. A sale is considered to be consummated when the sales price has been paid, any permanent financing for which we are responsible has been arranged, all conditions precedent to closing have been performed, we do not have any substantial continuing involvement with the unit and the usual risks and rewards of ownership have been transferred to the buyer. Costs are recorded based on the ratio of the sales value of the relevant units completed and sold to the estimated total project sales value, multiplied by the estimated total project cost. For these projects, our policy is that cash payments received from the buyer are recorded as a deposit liability and costs are capitalized as incurred, up to when the sale is consummated and the unit has been delivered.

Delivery and closing take place only after the local government has certified that the building is completed and ready for habitation (comparable to a certificate of occupancy in the United States) and the following events have occurred:

 

  Ÿ  

The sales department has determined that the sales contract is signed, the sales tax invoice is properly issued, the purchaser is physically present and the purchasers’ identification cards are checked;

 

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  Ÿ  

All consideration has been paid by the purchaser; and

 

  Ÿ  

The unit has been inspected and accepted by the purchaser.

Percentage of completion method

Revenue from the sale of properties where the construction period is expected to be more than 12 months is recognized by the percentage of completion method on the sale of individual units based on the completion progress of a project, as described below.

We apply the percentage of completion method to projects with an expected construction period of over 12 months, not including any unforeseen delays, or delays beyond our control. For these projects, our policy is that cash payments received from the buyer are initially recorded as customer deposits, and costs are capitalized as incurred.

Revenue and profit from the sale of these development properties are recognized by the percentage of completion method on the sale of individual units when the following conditions are met:

 

  (a)   construction is beyond a preliminary stage;

 

  (b)   the buyer is committed to the extent of being unable to require a refund except for non-delivery of the unit;

 

  (c)   sufficient units have already been sold to assure that the entire property will not revert to rental property;

 

  (d)   sales prices are collectible; and

 

  (e)   aggregate sales proceeds and costs can be reasonably estimated.

Under the percentage of completion method, revenues from units sold and related costs are recognized over the course of the construction period, based on the completion progress of a project. In relation to any project, revenue is determined by calculating the ratio of incurred costs, including land use rights costs and construction costs, to total estimated costs and applying that ratio to the contracted sales amounts. Cost of sales is recognized by determining the ratio of contracted sales during the period to total estimated sales value, and applying that ratio to the incurred costs. Current period amounts are calculated based on the difference between the life-to-date project totals and the previously recognized amounts.

Our significant judgments and estimates related to applying the percentage of completion method include our estimates of the time necessary to complete the project, the total expected revenue and the total expected costs. Fluctuations in sales prices and variances in costs from budgets could change the percentages of completion and affect the amount of revenue and costs recognized. Changes in total estimated project cost or losses, if any, are recognized in the period in which they are determined. Revenue recognized to date in excess of amounts received from customers is classified as current assets under real estate property under development. Amounts received from customers in excess of revenue recognized to date are classified as current liabilities under customer deposits.

Interest capitalization

We obtain loans from banks and shareholders and we issue debt securities to finance projects and provide for working capital. See “—Liquidity and Capital Resources.” We charge the borrowing costs related to working capital loans to interest expense when incurred and capitalize interest costs related to project developments as a component of the project costs.

The interest to be capitalized for a project is based on the amount of borrowings related specifically to such project. Interest for any period is capitalized based on the amounts of accumulated expenditures and the interest rate of the loans. Payments received from the pre-sales of units in the project are deducted in the

 

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computation of the amount of accumulated expenditures during a period. The interest capitalization period begins when expenditures have been incurred and activities necessary to prepare the asset (including administrative activities before construction) have begun, and ends when the project is substantially completed. Interest capitalized is limited to the amount of interest incurred.

The interest rate used in determining the amount of interest capitalized is the weighted average rate applicable to the project-specific borrowings. However, when accumulated expenditures exceed the principal amount of project-specific borrowings, we also capitalize interest on borrowings that are not specifically related to the project, at a weighted average rate of such borrowings.

Our significant judgments and estimates related to interest capitalization include the determination of the appropriate borrowing rates for the calculation, and the point at which capitalization is started and discontinued. Changes in the rates used or the timing of the capitalization period may affect the balance of property under development and the costs of sales recorded.

Income taxes

We have adopted the liability method for financial accounting and reporting for income taxes. We recognize:

 

  Ÿ  

the amount of taxes payable or refundable for the current fiscal year;

 

  Ÿ  

deferred tax assets and liabilities for the future tax consequences of events that have been recognized in our financial statements or tax returns; and

 

  Ÿ  

the difference between the taxes calculated based on our earnings at the statutory rates and the amounts charged by the local tax authorities based on our “deemed earnings.”

Our significant judgments and estimates include the allowability of deductible items for income tax purposes and other tax positions that we may take. Disagreements with the taxing authorities could subject us to additional taxes, and possibly, penalties.

Please see note 13 to our consolidated financial statements.

Impairment of long-lived assets

We review long-lived assets, including real estate projects, whenever events or changes in circumstances indicate that the carrying amount of an asset may no longer be recoverable. When these events occur, we measure impairment by comparing the carrying value of the long-lived assets to the estimated undiscounted future cash flows expected as a result from the use of the assets and their eventual disposition. If the sum of the expected undiscounted cash flow is less than the carrying amount of the assets, we would recognize an impairment loss based on the fair value of the assets.

Our significant judgments and estimates related to impairment include our determination if an event has occurred to warrant an impairment test. If a test is required, other significant judgments and estimates include our expectations of future cash flows, and the calculation of the fair value of the assets impaired.

Share-based payments

Under SFAS No. 123(R), we are required to recognize share-based compensation as compensation expense in our statement of operations based on the fair value of stock options and other equity awards on the date of the grant, with the compensation expense recognized over the period in which the recipient is required to provide services to us in exchange for the equity award. However, the options granted under the 2007 Equity Incentive Plan are performance-based and do not begin vesting until the consummation of our initial public offering. Due to the performance condition in the awards, no compensation expense has been recognized during the nine months ended September 30, 2007.

 

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Since August 25, 2006, we have issued instruments convertible into or exercisable for common shares to investors, employees and directors as set forth in the following table.

 

Type of instrument

  Issue Date/ Grant
Date
  No. of
shares /
warrant /
option
issued /
granted
 

Conversion
price /
Exercise price

  Fair Value of Instrument at
Issue/Grant Date
  Fair
Value of
Common
Equity
  Type of
Valuation
 
        Per unit     Aggregate    
            US$   US$     US$   US$      

Series A Convertible Redeemable Preference Shares

  August 25, 2006   30,805,400   0.81 Note(1)   0.80 Note(2)     24,504,000   0.53   (a )

Series A Convertible Redeemable Preference Shares associated warrants

  August 25, 2006   3,987,009   0.01   0.12     496,000   0.53   (a )

Burnham warrants

  August 25, 2006   1,853,172   0.81   0.03     55,595   0.53   (c )

Floating rate note warrants

  April 13, 2007   750   Note(3)   9,812.00     7,359,000   1.45   (a )

Convertible notes

  April 13, 2007   9,597,120   2.60 Note(1)   2.60     25,000,000   1.45   (a )

Stock Option Plan I

  August 11, 2007   3,604,078   0.0001   3.25     11,713,254   3.25   (b )

Stock Option Plan II

  August 11, 2007   400,000   0.81   2.69     1,076,000   3.25   (b )

Stock Option Plan III

  August 11, 2007   2,798,417   2.50   1.98     5,540,866   3.25   (b )

Stock Option Plan IV

  November 5, 2007   2,441,844   price of this
offering
  Note (4)       (d )

(a)   Retrospective valuation of common equity by American Appraisal China Limited, an independent third party appraisal firm.
(b)   Contemporaneous valuation of common equity by American Appraisal China Limited.
(c)   Valuation based on the value of services provided.
(d)   Valuation of common shares by management based on an assumed initial offering price of US$            , the mid-point of the indicative price range for the offering, adjusted for a 5% lack of marketability discount.

 

Note  (1):   Amount represents the original issuance price times the conversion rate at which these securities are convertible into common shares.
Note  (2):   Valuation based on negotiated price between independent third parties at arm’s length. A retrospective valuation of the preference shares by American Appraisal China Limited indicated a fair value of US$1.26.
Note  (3):   The exercise price for each warrant share is 80% of price per common share at an initial public offering. Total number of common shares to be purchased is quotient of US$30 million divided by exercise price.
Note  (4):   The fair value of each option is estimated on the date of grant using the Dividend Adjusted Black-Scholes option-pricing model that uses such assumptions: average risk-free rate of return of 4.61%; expected term of 5.8 years; volatility rate of 46.5%; and no dividend yield.

We have engaged American Appraisal China Limited, or American Appraisal, an independent third party appraisal firm, to assist in our determination of the fair value of our common shares as of each relevant grant date or issuance date of the preference shares, warrants and options on August 25, 2006, April 13, 2007 and August 11, 2007, respectively. Valuations on August 25, 2006 and April 13, 2007 have been performed retrospectively and the valuation on August 11, 2007 was performed contemporaneously.

American Appraisal used a combination of (i) the discounted cash flow, method of the income approach and (ii) the market approach to assess the fair value of common shares underlying the warrants and options we granted in 2006 and 2007. The determination of the fair value of our common shares requires complex and subjective judgments to be made regarding our projected financial and operating results, our unique business risks, the liquidity of our shares and our operating history and prospects at the time of each grant.

The major assumptions used in calculating the fair value of common shares include:

 

  Ÿ  

Weighting of discounted cash flow and market multiples. American Appraisal assigned a 50% weight to the discounted cash flow approach and 50% weight to the market multiple approach.

 

  Ÿ  

Weighted average cost of capital. Weighted average cost of capital of between 17.5% and 22.0% was used. This was the combined result of the change in risk-free rate, industry average beta, our increased use of leverage and the decrease in our company-specific risk as we continued to grow and meet important milestones.

 

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  Ÿ  

Comparable companies. In deriving discount rates and market multiples, American Appraisal selected nine companies in the real estate industry whose shares are publicly traded on securities markets in China and Hong Kong for reference as our guideline companies. These companies have longer trading history on the public market and therefore more meaningful records from a volatility perspective.

 

  Ÿ  

Capital market valuation multiples. American Appraisal obtained and assessed updated capital market data of the selected comparable companies and used multiples of enterprise value to earnings before interest, taxes, depreciation and amortization or EV/EBITDA, for its valuations.

 

  Ÿ  

Discount for lack of marketability, or the DLOM. American Appraisal quantified discount for lack of marketability using the Black-Scholes option-pricing model. This option pricing method is one of the methods commonly used in estimating DLOM as it takes into consideration factors such as timing of liquidity event (e.g. this offering) and estimated volatility of our shares. This method treats the right to sell a company’s shares freely before a liquidity event as a put option. The further the valuation date is from an expected liquidation event and the higher the estimated volatility of our share, the higher the put option value and thus the higher the implied discount would be. Discounts for lack of marketability of between 13% and 20% were used in our valuations.

We estimated the volatility of our shares based on the stock price volatilities of our comparable companies. As at August 11, 2007, the average share price volatility of our comparable companies for a comparable period to the time of the expected date of this offering was 57%. Based on this information, American Appraisal used the option-pricing model to reach a DLOM of approximately 13%. As the amount of time until the expected date of this offering decreases, the DLOM will decrease and ultimately fall to zero. If the DLOM decreases by 1%, for example, from 13% to 12%, additional compensation expense of US$244,000 would be recognized over the vesting period of the options and restricted shares granted on August 11, 2007.

We summarized below the key assumptions used in the valuations of common shares underlying the instruments as at each issue date.

 

Issue Date

  

Weighted
average
cost of
capital

    Volatility used
for allocating
equity value
    Discount for
lack of
marketability
   

EV/EBITDA
of comparable

companies

(before
adjustment)

   EV/EBITDA
used in valuation
(adjusted)

August 25, 2006

   22.0 %   49.8 %   20 %   7.2 - 38.6    3.9

April 13, 2007

   21.0 %   52.2 %   18 %   4.2 - 24.8    4.5

August 11, 2007

   17.5 %   57.3 %   13 %   6.0 - 49.9    9.3

The income approach involves applying appropriate discount rates to estimated cash flows that are based on earnings forecasts developed by us. The assumptions used in deriving the fair values are consistent with our business plan at the time of respective valuations. These assumptions include: no material changes in the existing political, legal and economic conditions in China; no material changes in our ability to retain competent management, key personnel and staff to support our ongoing operations; and no material deviation in market conditions from economic forecasts. These assumptions are inherently uncertain. The risks associated with achieving our forecasts were assessed by selecting the appropriate discount rates, which ranged from 21% to 22%.

The discount rates have been determined by American Appraisal using weighted average cost of capital, weighted at a long-term debt level of between 20% to 30%. After-tax cost of debt is estimated at between 5% to 8% and cost of equity at between 22% to 26%.

 

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The cost of debt as at each issuance date was determined by a consideration of the interest rates of our existing bank loans and the best lending rates in China. The cost of equity was determined by American Appraisal, using the Capital Asset Pricing Model, based on a consideration of the factors like risk-free rate, comparative industry risk, equity risk premium, small-company premium and company-specific factors. The decrease in weighted average cost of capital from 22.0% on August 25, 2006 to 17.5% on August 11, 2007 was the combined result of (i) the continuous growth of our business and company size, (ii) increased financial leverage of our company and (iii) the likely lower cost of equity when becoming a public company.

Under the market approach, enterprise value to earnings before interest, taxes, depreciation and amortization or EV/EBITDA multiples of comparable companies were calculated and analyzed. The trading multiples of the comparable companies vary but in general, the companies with higher projected growth, higher profit margin and lower business risk (manifested as lower required cost of capital and larger market capitalization) would lead to a higher multiple. As no single public company is similar to us in all aspects, American Appraisal compared each individual company to us and derived the adjusted multiples applicable to us based on the above factors. American Appraisal took the average of the adjusted multiples, and multiplied that by the forecast EBITDA of our company to come up with an enterprise value on a minority and freely tradable basis. To reflect the fact that we were a private company, a discount for lack of marketability has also been considered.

Due to the facts that (i) we were a small company and our cost of capital was higher than those of the public companies and (ii) our land reserves are less than many of the comparable companies, which increases the risk and uncertainty in realizing our projected profits, the EV/EBITDA multiples used in the valuations were lower than or on the low end of the range of the comparable companies.

American Appraisal used the option-pricing method to allocate enterprise value to preference and common shares, taking into account the guidance prescribed by the AICPA Audit and Accounting Practice Aid “Valuation of Privately-Held-Company Equity Securities Issued as Compensation,” or the Practice Aid. The method treats common stock and preferred stock as call options on the enterprise’s value, with exercise prices based on the liquidation preference of the preferred stock. Under this method, the common stock has value only if the funds available for distribution to shareholders exceed the value of the liquidation preference at the time of a liquidity event.

This method involves making estimates of the anticipated timing of a potential liquidity event, such as a sale of our company or an initial public offering, and estimates of the volatility of our equity securities. The anticipated timing is based on the plans of our board and management. Estimating the volatility of the share price of a privately held company is complex because there is no readily available market for the shares. American Appraisal estimated the volatility of our shares based on historical volatility of comparable companies’ shares. Volatilities of between 50% and 60% have been used. Had we used different estimates of volatility, the allocations between preferred and common shares would have been different.

As at the issue date, as retrospectively determined by American Appraisal, the fair value of the Series A Convertible Redeemable Preference Shares, or the Series A preference shares, was US$1.26 and the fair value of common share was US$0.53. As the Series A preference shares have rights, privileges and preferences that common shares do not have, value of the preferred share is normally higher than that of the common share. The difference in value between the common share and the Series A preference share will decrease as the value of our company grows.

The key factors that cause the difference in values between the preference share and the common share include (i) the Series A preference shares are redeemable five years after issuance at issue price plus accrued interests at an annual compound rate of 10%, (ii) the preference shares rank senior to the common shares in all respects as to rights of payment and distribution and (iii) on a winding-up, the holders of Series A preference shares shall be entitled to receive, prior and in preference to any distribution of any of the assets or surplus funds

 

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of us to holders of the common shares by reason of their ownership of such shares, for each Series A preference share, the amount per share, or the Series A Preference Amount, equals to two (2) times the sum of (x) US$0.81155 and (y) an accreted annual amount of 10% on the original Series A issue price, compounded annually from the date of issuance of such Series A preference shares to the date of payment hereunder. After the payment in full has been made to the holders of Series A preference shares, the holders of the Series A preference shares shall be entitled to share pro rata in all remaining assets and funds to be distributed.

On November 5, 2007, we granted options exercisable for 2,441,844 common shares. These options vest over a period of three years, starting at the listing date of this offering, and have an exercise price that will be equal to the initial public offering price of the ADSs as set forth on the cover of this prospectus.

We have applied a 5% discount to an assumed initial offering price of US$            , the mid-point of the indicative price range for the offering, to arrive at a fair value of US$             for each common share. In calculating the discount, we have accounted for adjustments due to the residual price risk of the common shareholders before the offering and have assumed that the offering will be consummated prior to year end.

The fair value of each option is estimated on the date of grant using the Dividend Adjusted Black-Scholes option-pricing model that uses the assumptions noted below:

 

Average risk-free rate of return

   4.61%

Expected term

   5.8 years

Volatility rate

   46.5%

Dividend yield

   0%

The risk-free rate for periods within the expected life of the option is based on the implied yield rates of China International Bond denominated in U.S. dollar as of the valuation date. The expected life of options represents the period of time the granted options are expected to be outstanding. Since we have not previously granted options that have vested, no historical exercising pattern could be followed in estimating the expected life. Therefore, the expected life is estimated as the average of the contractual term and the vesting period. We have not paid dividends in the past nor do we expect to pay dividends in the foreseeable future, therefore the dividend yield is set as zero. Since our shares are not publicly tradable at the moment, the expected volatility we used in our calculations was based on the historical volatilities of comparable publicly traded companies engaged in similar business.

Selected Statement of Operations Items

Revenues

Our revenues are derived mainly from the development and sale of real estate. In addition, we generate a small percentage of revenue from leasing ancillary facilities and residential units in certain of our residential developments, as well as from the provision of related services, including property management and real estate agency services.

The following table sets forth a breakdown of our revenues for the periods indicated.

 

    Year Ended December 31,   Nine Months Ended September 30,
    2004   2005   2006   2006   2007
    US$   %   US$   %   US$   %   US$   %   US$   %
    (US$ in thousands, except for percentages)

Real estate sales

  35,320.6   99.1   61,769.4   99.7   141,577.7   99.5   99,341.0   99.7   215,908.3   98.9

Real estate leasing

  143.9   0.4   132.1   0.2   204.4   0.1   171.2   0.2   165.5   0.1

Other revenue

  168.0   0.5   40.5   0.1   585.1   0.4   142.9   0.1   2,227.0   1.0
                                       

Total revenues

  35,632.5   100.0   61,942.0   100.0   142,367.2   100.0   99,655.1   100.0   218,300.8   100.0
                                       

 

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Real Estate Sales

Real estate sales represent revenues from the sales of residential properties we develop. Throughout this prospectus, real estate sales are stated net of sales tax levied on the relevant contracted sales value. Sales tax is a one-time tariff which consists of a business tax at the rate of 5%, an urban construction tax at the rate of 0.35% and an education surcharge at the rate of 0.15%. Total sales tax amounted to US$2.1 million, US$3.6 million and US$8.3 million, for 2004, 2005, and 2006, respectively. Total sales tax amounted to US$5.8 million and US$12.7 million for the nine months ended September 30, 2006 and 2007, respectively.

Historically we recognized most of our projects under the full accrual method. In 2004 and 2005, we recognized revenues from one project, Zhengzhou Xinyuan Splendid Haojingge, under the percentage of completion method. In 2006, we recognized revenues from two additional projects, Zhengzhou Central Garden-East and Zhengzhou Central Garden-West, under the percentage of completion method. In the nine months ended September 30, 2007, we recognized revenues from five additional projects, Suzhou Lake Splendid, Jinan Elegant Scenery, Zhengzhou Commercial Plaza, Suzhou Colorful Garden and Hefei Wangjiang Garden, under the percentage of completion method. The full accrual method was applied to the remainder of our projects. See “—Critical Accounting Policies—Revenue and cost recognition.”

Real Estate Leasing

Real estate leasing revenues represent the income from the rental of ancillary facilities, including kindergarten, elementary school, clubhouse and parking facilities, in a number of our developments. We also lease a small number of residential units owned by us.

Other Revenue

Other revenue consists primarily of fees received for our property management services, real estate agency services and other real estate related services that we provided to residents and purchasers of our residential units. We acquired these operations from Mr. Yong Zhang and Ms. Yuyan Yang in August 2006 for an aggregate consideration of US$2.1 million.

Also included in other revenues are discounts given by suppliers with respect to expenses incurred in prior years, penalties paid by tenants of our leased properties for late payment and penalties paid by our contractors for delays in their contract performance.

Cost of Revenues

The following table sets forth a breakdown of our cost of revenues for the periods indicated.

 

    Year Ended December 31,  

Nine Months Ended

September 30,

    2004   2005   2006   2006   2007
    US$   %   US$   %   US$   %   US$   %   US$   %
    (US$ in thousands, except for percentages)

Costs of real estate sales

                   

Land use rights costs

  6,005.5   22.8   10,148.4   23.8   32,439.0   30.0   21,889.8   28.9   54,608.2   37.2

Construction costs

  20,118.5   76.3   32,051.1   75.2   74,828.4   69.2   53,210.8   70.4   90,423.2   61.5
                                       

Total

  26,124.0   99.1   42,199.5   99.0   107,267.4   99.2   75,100.6   99.3   145,031.4   98.7

Costs of real estate leasing

  252.1   0.9   432.8   1.0   442.0   0.4   347.3   0.5   319.8   0.2

Other costs

          486.3   0.4   164.5   0.2   1,638.6   1.1
                                       

Total costs of revenues

  26,376.1   100.0   42,632.3   100.0   108,195.7   100.0   75,612.4   100.0   146,989.8   100.0
                                       

 

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Costs of Real Estate Sales

Costs of real estate sales consist primarily of land use rights costs and construction costs. Costs of real estate sales are capitalized and allocated to development projects using the specific identification method. When the full accrual method of revenue recognition is applied, costs are recorded based on the ratio of the sales value of the relevant units completed and sold to the estimated total project sales value, multiplied by the estimated total project costs. When the percentage of completion method of revenue recognition is applied, capitalized costs are released to our statement of operations based on the completion progress of a project. See “—Critical Accounting Policies—Revenue and cost recognition.”

Land use rights costs.    Land use rights costs include the land premium we pay to acquire land use rights for our property development sites, plus taxes. We acquire our development sites mainly by competitive bidding at public auctions of government land. Our land use rights costs for different projects vary according to the size and location of the site and the minimum land premium set for the site, all of which are influenced by government policies, as well as prevailing market conditions. Our land use rights costs have increased in the past few years due to rising property prices in Zhengzhou and increased competition from other bidders at government land auctions.

Construction costs.    We outsource the construction of all of our projects to third party contractors, whom we select through a competitive tender process. Our construction contracts provide for fixed or capped payments which cover substantially all labor, materials, fittings and equipment costs, subject to adjustments for some types of excess, such as design changes during construction or changes in government-suggested steel prices. Our construction costs consist primarily of the payments to our third-party contractors, which are paid over the construction period based on specified milestones. In addition, we purchase and supply a limited range of fittings and equipment, including elevators, window frames and door frames. Our construction costs also include capitalized interest costs.

Costs of Real Estate Leasing

Our costs of real estate leasing consist primarily of depreciation expenses and maintenance expenses associated with the leased properties. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Estimated useful lives of our properties held for lease are 20 years.

Other Costs

Other costs represent costs incurred in connection with the property management services, real estate agency services and other property related services that we provide to residents and purchasers of our developments.

Selling and Distribution Expenses

Our selling and distribution expenses include:

 

  Ÿ  

advertising and promotion expenses, such as print advertisement costs, billboard and other display advertising costs, and costs associated with our showrooms and model apartments;

 

  Ÿ  

staff costs, which consist primarily of salaries and sales commissions of approximately 0.45% of contracted sales of our sales personnel; and

 

  Ÿ  

other related expenses.

As of September 30, 2007, we employed 160 full time sales and marketing personnel. We expect our selling and marketing expense to increase in the near future as we increase our sales efforts, launch more projects and target new markets to expand our operations.

General and Administrative Expenses

General and administrative expenses principally include:

 

  Ÿ  

staff salaries and benefits;

 

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  Ÿ  

travelling and entertainment expenses;

 

  Ÿ  

professional fees, such as audit and legal fees; and

 

  Ÿ  

other expenses.

We expect that general and administrative expenses will increase as we expand our business and operations. In addition, as a result of this offering, we will become a public company subject to the rules and regulations of United States securities laws and the New York Stock Exchange relating to, among other things, corporate governance and internal controls. In preparation for our transition to become a public company, we have recruited additional management and accounting personnel, and we believe that we will need to hire more personnel as our business continues to grow. We have also incurred expenses to improve our enterprise resource management system and internal controls, and we believe that we will need to incur additional such costs in the near future.

Interest Income

Interest income represents interest earned on our bank balances.

Interest Expenses

Interest expenses include (i) interest paid on our bank borrowings and other indebtedness, including our floating rate notes and convertible notes issued in April 2007, (ii) amortization of warrants and debt issuance cost, (iii) accretion of fair value of embedded derivatives and (iv) change in fair value of embedded derivatives. The floating rate notes bear interest at the adjustable annual rate of six-month LIBOR plus 6.8%, while the convertible notes bear interest at the fixed annual rate of 2%. The rates of interest payable on our floating rate notes and convertible notes are subject to adjustment under some circumstances which are described in more detail under “Description of Debt and Equity-Linked Securities.” Interest rates on our bank borrowings, all of which are granted by PRC commercial banks and denominated in RMB, are typically linked to benchmark rates published by PBOC. As of the date of this prospectus, the PBOC benchmark rate for one-year loan is 7.29% per annum and those for loans of more than one year range from 7.47% to 7.83% per annum.

Share of Income (Loss) in Equity Investee

Share of income (loss) in equity investee represents profit or loss associated with our 45% equity interest in Jiantou Xinyuan. Under the relevant joint venture agreement, we share the profit or loss of Jiantou Xinyuan according to our equity interest percentage. Jiantou Xinyuan recorded a loss in the nine months ended September 30, 2006, due to the start-up of its development activities. Jiantou Xinyuan launched Zhengzhou International City Garden Phase I in March 2006 and completed this project in January 2007. Jiantou Xinyuan also launched three projects in 2007. See “Business—Jiantou Xinyuan’s Projects.” Jiantou Xinyuan recorded a net income of US$13.0 million in the nine months ended September 30, 2007.

Change in Fair Value of Derivative Liabilities

We have issued warrants to Series A preference shareholders and our floating rate notes holders, which are accounted for as derivative liabilities. Under our amended warrant agreement dated as of August 28, 2007, the Series A preference shares warrants, entitling the Series A preference shareholders to purchase additional preference shares, shall terminate if we meet our earnings target in the warrant agreement or if we consummate a qualified initial public offering prior to March 31, 2008. During the nine months ended September 30, 2007, the fair value of Series A preference shares warrants decreased as a result of the amendment to the warrant agreement and primarily due to our performance relative to our earnings target. The warrants issued to our floating rate notes holders entitle them to purchase our common shares at 80% of the price per common share sold to the public pursuant to an initial public offering. During the nine months ended September 30, 2007, the fair value of such warrants has decreased as the likelihood of such offering has improved.

 

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The change in fair value is measured (i) in the case of the Series A preference shares warrants, against fair value as of December 31, 2006, and (ii) in the case of the warrants issued with floating rate notes, against fair value as of the date of their issuance.

Income Taxes

The following table sets forth the components of income taxes for the periods indicated.

 

    Year Ended December 31,   Nine Months Ended September 30,
    2004     2005   2006   2006   2007
    US$     %     US$   %   US$   %   US$   %   US$   %
    (in thousands, except for percentages)

Corporate income tax

  2,011.7     103.0     2,949.8   56.2   6,193.6   57.8   4,127.2   59.4   3,604.8   17.5

Land appreciation tax

  10.1     0.5     418.5   8.0   2,003.0   18.7   396.1   5.7   3,848.6   18.7

Tax uncertainty benefit

                      8,810.1   42.8

Deferred tax (benefit) expense

  (69.6 )   (3.5 )   1,879.5   35.8   2,520.7   23.5   2,425.3   34.9   4,320.7   21.0
                                           

Income taxes

  1,952.2     100.0     5,247.8   100.0   10,717.3   100.0   6,948.6   100.0   20,584.2   100.0
                                           

Corporate Income Tax, Tax Uncertainty Benefit and Deferred Tax Expense

As a Cayman Islands exempted company, we are not subject to income tax in the Cayman Islands.

Our PRC subsidiaries are subject to income tax at a statutory rate of 33% (30% state income tax plus 3% local income tax) on their taxable income. This tax rate will be reduced to 25% according to the PRC’s new Corporate Income Tax Law which will take effect from January 1, 2008. In 2004, 2005, 2006 and the nine months ended September 30, 2006 and 2007, in accordance with local provisional tax regulations in Henan province, the local tax authority in Zhengzhou determined that the taxable income of our PRC subsidiaries in Henan province should be deemed at 12% or 14% of their total cash receipts from sales of residential units. Total cash receipts include cash receipts proceeds from pre-sales of our properties that are recorded as customer deposits, which partly comprise mortgage loan proceeds received in our account from mortgage lending banks. The Zhengzhou local tax authority has provisionally confirmed that it will apply the same levy method to our PRC subsidiaries located in Henan province for the year ending December 31, 2007. For our subsidiaries located in Shandong, Jiangsu, Anhui and Sichuan provinces, the relevant local tax authorities levy income tax similarly at the rate of 33% on a deemed taxable income basis by applying a taxable margin rate to cash receipts from our sales, including pre-sales, of real estate properties located in those jurisdictions, net of applicable business tax, surcharges and costs.

The Zhengzhou and other local tax authorities are entitled to re-examine taxes paid in prior years under the levy method described above; however, they have not indicated whether they will do so. We have made full provision for the corporate income tax payable by our PRC subsidiaries based on the statutory 33% income tax rate after appropriate adjustments to our taxable income used in the calculation. Prior to January 1, 2007, the difference between tax payable on our actual taxable income and tax levied on the deemed taxable income basis has been treated as a temporary difference, giving rise to deferred tax balances. We believe this is appropriate due to the possibility of reinterpretation of the application of the tax regulations by higher tax authorities in the PRC, as the local authorities have indicated that they will apply the regulation in the same manner in 2007. The deferred tax balances have been classified as non-current.

On January 1, 2007, we adopted the Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN 48”). There was no cumulative effect adjustment to beginning retained earnings resulting from the adoption of FIN 48. The total liability for cumulative unrecognized tax uncertainty benefit as of January 1, 2007 was US$2.7 million. As of the date of adoption, no interest and penalties have been recognized under FIN 48.

 

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Since the adoption of FIN 48 on January 1, 2007, our total unrecognised tax uncertainty benefit increased by US$8.8 million, and the balance at September 30, 2007 is US$11.8 million. The provision for deferred tax arising from the difference between tax payable on our actual taxable income and tax levied on the deemed taxable income basis has been reclassified to unrecognized tax uncertainty benefit.

Land Appreciation Tax

Under PRC laws and regulations, our PRC subsidiaries engaging in property development are subject to land appreciation tax, or LAT, which is levied by the local tax authorities upon the “appreciation value” as defined in the relevant tax laws. All taxable gains from the sale or transfer of land use rights, buildings and related facilities in China are subject to LAT at progressive rates that range from 30% to 60%. Certain exemptions are allowed for sales of ordinary residential properties if the appreciation value does not exceed a threshold specified in the relevant tax laws. Gains from sales of commercial properties are not eligible for this exemption. Whether a property qualifies for the ordinary residential property exemption is determined by the local government taking into consideration the property’s plot ratio, aggregate GFA and sales price.

The Zhengzhou local tax authority did not impose the LAT on real estate companies until September 2004. Since September 2004, it has levied LAT at fixed rates of 0.8% and 1% on total cash receipts from sales, including pre-sales, of our residential units and commercial properties (which comprised certain retail space within our residential developments), respectively, rather than applying the progressive rates to the appreciation value. On December 28, 2006, the State Administration of Taxation issued the Notice on the Administration of the Settlement of Land Appreciation Tax of Property Development Enterprises, which came into effect on February 1, 2007. Such notice provides further clarification on the payment and settlement of LAT.

We have responded to this Notice by making provision for LAT on all projects completed since the date of incorporation. We have accrued all LAT payable on our property sales and transfers in accordance with the progressive rates specified in relevant tax laws, less amounts previously paid under the levy method applied by relevant local tax authorities. Provision for LAT on projects completed in prior years is charged as income tax in year 2006. In prior years, we recognized LAT as an expense upon completion of our projects based on the rate of 0.8% or 1%, as applicable, of cash receipts imposed by the local tax authority. As of December 31, 2004 and 2005 our prepaid LAT balances of US$134,411 and US$284,028, which represent amounts we had paid to local tax authorities based on cash receipts associated with the properties pre-sold during those periods, were included in other deposits and prepayments in our consolidated balance sheets, before the relevant projects were completed. Once the projects were completed, the relevant prepaid LAT balances were recorded as income tax expense.

 

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Results of Operations

The following table presents a summary of our consolidated statements of operations by amount and as a percentage of our total revenues during the periods indicated. Our historical results presented below are not necessarily indicative of the results that may be expected for any other future period.

 

    Year Ended December 31,     Nine Months Ended September 30,  
    2004     2005     2006     2006     2007  
    US$   %     US$     %     US$     %     US$     %     US$     %  
    (in thousands, except for percentages)     (unaudited)  

Revenues

  35,632.5   100.0     61,942.0     100.0     142,367.2     100.0     99,655.1     100.0     218,300.7     100.0  

Cost of revenues

  (26,376.1)   (74.0 )   (42,632.3 )   (68.8 )   (108,195.7 )   (76.0 )   (75,612.5 )   (75.9 )   (146,989.7 )   (67.3 )
                                                         

Gross profit

  9,256.4   26.0     19,309.7     31.2     34,171.5     24.0     24,042.6     24.1     71,311.0     32.7  

Selling and distribution expenses

  (1,604.0)   (4.5 )   (2,175.1 )   (3.5 )   (2,996.2 )   (2.1 )   (1,876.1 )   (1.9 )   (5,956.7 )   (2.7 )

General and administrative expenses

  (1,004.1)   (2.8 )   (1,695.4 )   (2.7 )   (3,625.8 )   (2.5 )   (2,095.9 )   (2.1 )   (7,736.0 )   (3.5 )
                                                         

Operating income

  6,648.3   18.7     15,439.2     24.9     27,549.5     19.4     20,070.6     20.1     57,618.3     26.5  

Interest income

  66.9   0.2     191.0     0.3     461.3     0.3     124.4     0.1     735.5     0.3  

Interest expenses

  (820.1)   (2.3 )   (834.5 )   (1.3 )   (727.0 )   (0.5 )   (307.2 )   (0.3 )   (1,438.6 )   (0.7 )

Share of income (loss) in equity investee

                (446.1 )   (0.3 )   446.1     (0.4 )   5,819.7     2.7  

Change in fair value of derivative liabilities

                                (6,186.0 )   (2.8 )
                                                         

Income from operations before income taxes

  5,895.1   16.5     14,795.7     23.9     26,837.7     18.9     19,441.7     19.5     56,548.9     26.0  

Income taxes

  (1,952.1)   (5.5 )   (5,247.8 )   (8.5 )   (10,717.3 )   (7.5 )   (6,948.6 )   (7.0 )   (20,584.2 )   (9.4 )

Minority interest

        14.9     0.0     2.6     0.0     2.2     0.0          
                                                         

Net income

  3,943.0   11.1     9,562.8     15.4     16,123.0     11.3     12,495.3     12.5     35,964.7     16.6  

Accretion of Series A convertible redeemable preference shares

                        (235.6 )   (0.2 )   (2,167.4 )   (1.0 )
                                                         

Net income attributable to ordinary shareholders

  3,940.0   11.1     9,562.8     15.4     16,123.0     11.3     12,259.7     12.3     33,797.3     15.6  
                                                         

 

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Nine Months Ended September 30, 2007 Compared to Nine Months Ended September 30, 2006

Revenues

Revenues increased by US$118.6 million, or 119.1%, to US$218.3 million for the nine months ended September 30, 2007 from US$99.7 million for the nine months ended September 30, 2006.

Real estate sales.    Revenues from real estate sales increased by US$116.6 million, or 117.3%, to US$215.9 million for the nine months ended September 30, 2007 from US$99.3 million for the nine months ended September 30, 2006, primarily as a result of increased residential unit sales and increased selling prices of those residential units. In the nine months ended September 30, 2007, we recognized revenues from Zhengzhou Central Garden-East, Zhengzhou Central Garden-West, Suzhou Lake Splendid, Jinan Elegant Scenery, Zhengzhou Commercial Plaza, Suzhou Colorful Garden and Hefei Wangjiang Garden under the percentage of completion method, while revenues from other projects were recognized under the full accrual method. In the nine months ended September 30, 2006, we recognized revenues from Zhengzhou Xinyuan Splendid Haojingge, Zhengzhou Central Garden-East and Zhengzhou Central Garden-West under the percentage of completion method, while revenues from other projects were recognized under the full accrual method. The increase was also attributable to the increase of average selling price of units we sold from RMB3,125 per square meter in the nine months ended September 30, 2006 to RMB4,820 per square meter in the nine months ended September 30, 2007.

Full accrual method revenues

The following table sets forth for the nine months ended September 30, 2006 and 2007 the aggregate GFA and the related revenues recognized under the full accrual method by project:

Project

  

Total
GFA(1)

   GFA delivered for
nine months ended
September 30,
   Percentage of total
GFA delivered(2) as
of
September 30,
  

Revenues recognized for nine months ended

September 30,

      2007     2006    2007    2006    2007    2006
     m2    m2     m2    %    %    US$     %(3)    US$    %(3)

Zhengzhou Xinyuan Splendid 1A

   62,623    884     56    97.8    96.2    857,339     0.4    73,153    0.1

Zhengzhou Xinyuan Splendid 2B

   27,041           100.0    100.0    23,838     0.0      

Zhengzhou Xinyuan Splendid 3A3B3C

   114,774    225     1,942    100.0    99.4    125,459     0.1    909,693    0.9

Zhengzhou Xinyuan Splendid City Homestead

   45,378    645     1,279    100.0    98.2    404,391     0.2    694,463    0.7

Other

                   62,074     0.0    955,902    1.0
                                              

Zhengzhou Xinyuan Splendid Subtotal

   249,816    1,754     3,277          1,473,101     0.7    2,633,211    2.7

Zhengzhou City Family

   39,226    5,968        92.1    0.0    3,392,758     1.6      

Zhengzhou City Manor(4)

   118,716    (105 )   118,716    99.9    100.0    (34,550 )   0.0    37,624,101    37.9
                                          

Total

   407,758    7,617     121,993          4,831,309     2.3    40,257,312    40.6
                                          

 


(1)   The amount for “total GFA” in this table and elsewhere in this prospectus are the amounts of total saleable residential GFA and are derived on the following basis:

 

  Ÿ  

for properties that are sold, the stated GFA is based on the sale contracts relating to such property;

 

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  Ÿ  

for unsold properties that are completed or under construction, the stated GFA is calculated based on the detailed construction blueprint and the calculation method approved by the PRC government for saleable GFA, after necessary adjustments; and

 

  Ÿ  

for properties that are under planning, the stated GFA is based on the land grant contract and our internal projection.

 

(2)   Percentage of total GFA delivered is the total GFA delivered as of a period end divided by the project’s total GFA.
(3)   Percentage of all real estate sales revenues for the relevant period, including revenues recognized under full accrual method and under percentage of completion method.
(4)   During the nine months ended September 30, 2007, we purchased one unit from one of our customers to use for property management purposes.

Percentage of completion method revenues

The following table sets forth the percentage of completion, the percentage sold and related revenues for our projects recognized under the percentage of completion method in the nine months ended September 30, 2006 and 2007.

 

Project

  

Total
GFA(1)

   Percentage of
Completion(2)
as of
September 30,
   Percentage
Sold(3) -
Accumulated as
of
September 30,
  

Revenues recognized for nine months ended

September 30,

      2007    2006    2007    2006    2007    2006
     m2    %    %    %    %    US$    %(4)    US$    %(4)

Zhengzhou Xinyuan Splendid Haojingge

   31,089    100.0    100.0    100.0    100.0          1,236,419    1.2

Zhengzhou Central Garden-East

   165,206    100.0    57.0    100.0    79.0    32,702,607    15.1    29,945,203    30.1

Zhengzhou Central Garden-West

   190,384    100.0    53.0    100.0    71.0    40,977,706    19.0    27,902,110    28.1

Zhengzhou Commercial Plaza

   67,578    49.1       61.0       12,750,809    5.9      

Suzhou Lake Splendid

   197,179    66.4       79.1       73,245,679    33.9      

Suzhou Colorful Garden

   81,131    69.2       2.2       1,106,624    0.5      

Jinan Elegant Scenery

   99,777    76.7       65.2       32,397,132    15.0      

Hefei Wangjiang Garden

   145,452    48.8       49.8       17,896,411    8.3      
                                    

Total

   977,796                211,076,968    97.7    59,083,732    59.4
                                    

(1)   The amounts for “total GFA” in this table and elsewhere in this prospectus are the amounts of total saleable residential GFA and are derived on the following basis:

 

  Ÿ  

for properties that are sold, the stated GFA is based on the sale contracts relating to such property;

 

  Ÿ  

for unsold properties that are completed or under construction, the stated GFA is calculated based on the detailed construction blueprint and the calculation method approved by the PRC government for saleable GFA, after necessary adjustments; and

 

  Ÿ  

for properties that are under planning, the stated GFA is based on the land grant contract and our internal projection.

 

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(2)   Percentage of completion is calculated by dividing total costs incurred by total estimated costs for the relevant project.
(3)   Percentage sold is calculated by dividing contracted sales value from property sales by total estimated sales value of the relevant project.
(4)   Percentage of all real estates sales revenues for the relevant period, including revenues recognized under full accrual method and under percentage of completion method.

Real estate leasing.    Real estate leasing income decreased by US$5,636 to US$165,514 for the nine months ended September 30, 2007 from US$171,150 for the nine months ended September 30, 2006, because we did not lease out our club house after we transferred it to fixed assets in 2007.

Other revenue.    Other revenue increased to US$2.2 million for the nine months ended September 30, 2007 from US$142,871 for the nine months ended September 30, 2006. This increase primarily resulted from revenue for real estate related services from operations which we acquired in August 2006, including, among others, property management service fees and consulting service and agency service fees in the amount of US$1.4 million and US$0.8 million, respectively, in the nine months ended September 30, 2007, as compared to US$93,505 and US$49,366 in the nine months ended September 30, 2006.

Cost of Revenue

Cost of revenue increased by US$71.4 million, or 94.4%, to US$147.0 million for the nine months ended September 30, 2007 from US$75.6 million for the nine months ended September 30, 2006.

Cost of real estate sales

Cost of real estate sales increased by US$69.9 million, or 93.1%, to US$145.0 million for the nine months ended September 30, 2007 from US$75.1 million for the nine months ended September 30, 2006, due to the launch of new projects in the nine months ended September 30, 2007. The land use right costs increased to US$54.6 million for the nine months ended September 30, 2007 from US$21.9 million for the nine months ended September 30, 2006. The construction costs increased to US$90.4 million for nine months ended September 30, 2007 from US$53.2 million for nine months ended September 30, 2006.

Cost of real estate leasing

Cost of real estate leasing decreased by US$27,591, or 7.9%, to US$319,750 for the nine months ended September 30, 2007 from US$347,341 for the nine months ended September 30, 2006. The decrease was mainly because the depreciation of a clubhouse was recorded as general and administrative expense after we ceased leasing it out in 2007.

Other costs

Other costs were US$1.6 million for the nine months ended September 30, 2007, compared to US$164,543 for the nine months ended September 30, 2006. Other costs represent costs incurred in connection with the property management services, real estate agency services and other property related services we provided.

Gross Profit

Gross profit increased by US$47.3 million, or 197.1%, to US$71.3 million for the nine months ended September 30, 2007 from US$24.0 million for the nine months ended September 30, 2006, due to the cumulative effect of the foregoing factors. The gross margin of our projects is normally in the range of 20% to 30%. However, our gross margin increased to 32.7% for the nine months ended September 30, 2007 from 24.1% for

 

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the nine months ended September 30, 2006. The increase was due primarily to the higher gross margin in the nine months ended September 30, 2007 than in the nine months ended September 30, 2006 of Zhengzhou Central Garden-East, Zhengzhou Central Garden-West and Zhengzhou Commercial Plaza whose revenue represented 40.1% of our revenue for the nine months ended September 30, 2007. During the nine months ended September 30, 2007, the selling price of the units of Zhengzhou Central Garden increased significantly as its construction approached completion, while its actual costs decreased from the estimation mainly because the Zhengzhou Municipal Government reduced the heat installation tariff from US$7.12 per square meter in 2006 to US$5.70 per square meter in 2007 and we also achieved significant cost reduction in property exterior decoration. Zhengzhou Commercial Plaza, a property newly launched in 2007, enjoyed a relatively high gross margin because the land for this project was acquired at a relative lower cost than other projects.

Selling and Distribution Expenses

Selling and distribution expenses increased by US$4.1 million, or 215.8%, to US$6.0 million for the nine months ended September 30, 2007 from US$1.9 million for the nine months ended September 30, 2006. The increase was primarily due to the launch of more projects as well as the increased level of marketing activities as we entered into new markets in the nine months ended September 30, 2007. As a percentage of revenue, selling and distribution expenses increased to 2.7% in the nine months ended September 30, 2007 from 1.9% in the nine months ended September 30, 2006.

General and Administrative Expenses

General and administrative expenses increased by US$5.6 million, or 266.7%, to US$7.7 million for the nine months ended September 30, 2007 from US$2.1 million for the nine months ended September 30, 2006. The increase was primarily due to the opening and expansion of our operations in Suzhou, Jinan, Hefei and Chengdu. As a percentage of revenue, general and administrative expenses increased to 3.5% in the nine months ended September 30, 2007 from 2.1% in the nine months ended September 30, 2006.

Interest Income

Interest income increased by US$610,925, or 490.9%, to US$735,376 for the nine months ended September 30, 2007 from US$124,451 for the nine months ended September 30, 2006. The increase was due primarily to an increase in our bank balances resulting from increased cash receipts from property sales and financing activities.

Interest Expenses

Interest expenses, net of interest capitalized, increased by US$1.1 million, or 366.7%, to US$1.4 million for the nine months ended September 30, 2007 from US$0.3 million for the nine months ended September 30, 2006. The gross interest expense for the nine months ended September 30, 2007 consisted of US$12.7 million of interest on loans, US$1.9 million of accretion of discount arising from warrants and amortization of debt issuance cost, US$0.8 million of accretion of fair value of embedded derivatives and a US$5.9 million income from the change in fair value of embedded derivatives. In the nine months ended September 30, 2006, the interest expenses consisted solely of interest on loans.

Total interest costs incurred amounted to US$12.7 million for the nine months ended September 30, 2007, including US$4.7 million interest on our floating rate notes and convertible notes issued in April 2007, from US$1.4 million for the nine months ended September 30, 2006. Total interest expense capitalized as part of the construction cost for the nine months ended September 30, 2007 and 2006 amounted to US$8.1 million and US$1.1 million, respectively.

Share of Income (Loss) in an Equity Investee

We recorded income of US$5.8 million for the nine months ended September 30, 2007, compared to a loss of US$0.4 million for the nine months ended September 30, 2006. Our equity investee, Jiantou Xinyuan,

 

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recognized net income of US$13.0 million during the nine months ended September 30, 2007, as it began to generate revenues from the completed project, Zhengzhou International City Garden Phase I, and from Zhengzhou City Mansion under the percentage of completion method.

Change in Fair Value of Derivative Liabilities

For the nine months ended September 30, 2007, we recorded US$6.2 million of net expenses due to changes in fair value of derivative liabilities, resulting from a decrease of US$420,000 in the fair value of our Series A preference shares warrants and an increase of US$6.6 million in the fair value of the warrants issued with floating rate notes.

Income Taxes

Income taxes increased by US$13.7 million, or 198.6%, to US$20.6 million for the nine months ended September 30, 2007 from US$6.9 million for the nine months ended September 30, 2006. The increase was consistent with the increase of our pre-tax income and partly due to the increase of LAT. Our effective tax rate decreased from 35.7% for the nine months ended September 30, 2006 to 36.4% for the nine months ended September 30, 2007. See “— Components of results of operation - Income Taxes.”

Minority Interest

Minority interest for the nine months ended September 30, 2007 was nil, as compared to US$2,223 for the nine months ended September 30, 2006. This decrease was due to the fact that Beijing Xinyuan Jinhe Investment & Development Co., Ltd., a company 99% owned by us, was dissolved in November 2006.

Net Income

Net income increased by US$23.5 million, or 188%, to US$36.0 million for the nine months ended September 30, 2007 from US$12.5 million for the nine months ended September 30, 2006.

Accretion expense of Series A convertible redeemable preference shares

Our Series A preference shares are redeemable, if not previously converted, upon the earlier occurrence of the date on which Mr. Zhang ceases to serve as the chairman of our board or the fifth anniversary of the issuance date. The redemption price is determined at a per share price in cash equal to the sum of the original issue price of US$0.81155 per share and an accreted amount of 10% of the original issue price, compounded annually to the date of redemption. For the nine months ended September 30, 2007 and 2006, we recorded an accretion expense of US$2.2 million and US$0.2 million, respectively, based on the net proceeds from our Series A preference shares issuance multiplied by an effective annual accretion rate.

2006 Compared to 2005

Revenues

Revenues increased by US$80.5 million, or 129.8%, to US$142.4 million for 2006 from US$61.9 million for 2005.

Real estate sales.    Revenues from real estate sales increased by US$79.8 million, or 129.2%, to US$141.6 million for 2006 from US$61.8 million for 2005 primarily as a result of increased residential unit sales in 2006 as compared to 2005. In 2006, we recognized revenues from Zhengzhou Xinyuan Splendid Haojingge, Zhengzhou Central Garden-East and Zhengzhou Central Garden-West under the percentage of completion method, while revenues from Xinyuan Splendid (except Zhengzhou Xinyuan Splendid Haojingge), Zhengzhou City Family and Zhengzhou City Manor Projects were recognized under the full accrual method. In 2005, we

 

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recognized all revenues under the full accrual method, except for those of Zhengzhou Xinyuan Splendid Haojingge.

Full accrual method revenues

The following table sets forth for the years 2005 and 2006 the aggregate GFA sold and the related revenues recognized under the full accrual method by project:

 

                    Project                     

  Total
GFA(1)
  GFA delivered for
the year ended
December 31,
  Percentage of
total GFA
delivered(2)
as of
December 31,
  Revenues recognized for the year ended
December 31,
    2006   2005   2006   2005   2006   2005
    m2   m2   m2   %   %   US$   %(3)   US$   %(3)

Zhengzhou Xinyuan
Splendid 1A

  62,623   205   516   96.4   96.1   225,247   0.2     150,634     0.2

Zhengzhou Xinyuan
Splendid 1B

  43,673     255   100.0   100.0         78,752     0.1

Zhengzhou Xinyuan
Splendid 2A

  39,996     116   100.0   100.0         35,572     0.1

Zhengzhou Xinyuan
Splendid 2B

  27,041     593   100.0   100.0         238,411     0.4

Zhengzhou Xinyuan
Splendid 2C

  21,748     311   100.0   100.0         114,072     0.2

Zhengzhou Xinyuan
Splendid 3A3B3C

  114,774   2,369   109,087   99.8   97.7   1,266,807   0.9     43,425,320     70.2

Zhengzhou Xinyuan
Splendid City Homestead

  45,378   1,453   43,280   98.6   95.4   824,757   0.6     14,262,549     23.1

Other

            972,780   0.7     528,008     0.9
                                       

Zhengzhou Xinyuan Splendid Subtotal

  355,233   4,027   154,158   99.1   98.0   3,289,591   2.4     58,833,318     95.2

Zhengzhou City Family

  39,226   30,175     76.9     13,768,566   9.7        

Zhengzhou City Manor

  118,716   118,716     100.0     37,773,234   26.6        
                                   

Total

  513,175   152,918   154,158       54,831,391   38.7     58,833,318     95.2
                                   

 


(1)   The amounts for ‘‘total GFA’’ in this table and elsewhere in this prospectus are the amounts of total saleable residential GFA and are derived on the following basis:

 

  Ÿ  

for properties that are sold, the stated GFA is based on the sale contracts relating to such property;

 

  Ÿ  

for unsold properties that are completed or under construction, the stated GFA is calculated based on the detailed construction blueprint and the calculation method approved by the PRC government for saleable GFA, after necessary adjustments; and

 

  Ÿ  

for properties that are under planning, the stated GFA is based on the land grant contract and our internal projection.

 

(2)   Percentage of total GFA delivered is the total GFA delivered as of a period end divided by the project’s total GFA.

 

(3)   Percentage of all real estate sales revenues for the financial year, including revenues recognized under full accrual method and under percentage of completion method.

 

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Percentage of completion method revenues

The following table sets forth the percentage of completion, the percentage sold and related revenues recognized for our Zhengzhou Xinyuan Splendid Haojingge, Zhengzhou Central Garden-East and Zhengzhou Central Garden-West projects in 2005 and 2006:

 

Project

  Total
GFA(1)
  Percentage of
Completion(2) as of
December 31,
  Percentage Sold(3)
–Accumulated as
of December 31,
 

Revenues recognized for the year ended

December 31,

      2006       2005       2006       2005     2006   2005
    m2   %   %   %   %   US$   %(4)   US$     %(4)

Zhengzhou Xinyuan Splendid Haojingge

  31,089   100.0   100.0   100.0   87.7   1,241,320   0.9   2,936,118     4.8

Zhengzhou Central Garden-East

  165,206   71.1   21.0   82.6   20.8   42,474,231   30.0   (5)  

Zhengzhou Central Garden-West

  190,384   68.6   18.7   80.5     43,030,796   30.4      
                             

Total

  386,679           86,746,347   61.3   2,936,118     4.8
                             

(1)   The amounts for ‘‘total GFA’’ in this table and elsewhere in this prospectus are the amounts of total saleable residential GFA and are derived on the following basis:

 

  Ÿ  

for properties that are sold, the stated GFA is based on the sale contracts relating to such property;

 

  Ÿ  

for unsold properties that are completed or under construction, the stated GFA is calculated based on the detailed construction blueprint and the calculation method approved by the PRC government for saleable GFA, after necessary adjustments; and

 

  Ÿ  

for properties that are under planning, the stated GFA is based on the land grant contract and our internal projection.

 

(2)   Percentage of completion is calculated by dividing total costs incurred by total estimated costs for the relevant project.
(3)   Percentage sold is calculated by dividing contracted sales value from property sales by total estimated sales value of the relevant project.
(4)   Percentage of all real estates sales revenues for the financial year, including revenues recognized under full accrual method and under percentage of completion method.
(5)   As of December 31, 2005, construction on Zhengzhou Central Garden-East was not beyond the preliminary stage, hence no revenues were recognized for the period ended on that date.

Real estate leasing.    Real estate leasing income increased by US$72,284, or 54.7%, to US$204,411 for 2006 from US$132,127 for 2005. The increase was due primarily to an increase in the rental of parking facilities in 2006.

Other revenue.    Other revenue increased by US$544,585 to US$585,072 for 2006 from US$40,487 for 2005. The increase represents fees for property related services that we provided. We acquired these operations in August 2006 and, consequently, did not record any other revenue in 2005.

Cost of Revenue

Cost of revenue increased by US$65.6 million, or 153.8%, to US$108.2 million for 2006 from US$42.6 million for 2005.

 

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Cost of real estate sales

Cost of real estate sales increased by US$65.1 million, or 154.2%, to US$107.3 million for 2006 from US$42.2 million for 2005. This increase was due primarily to the increase in units completed and sold and higher land use rights costs associated with the projects for which revenues were recognized during the period. Our land use rights costs increased by US$22.3 million, or 219.6%, to US$32.4 million for 2006 from US$10.1 million for 2005. Our revenues in 2005 were derived solely from our Xinyuan Splendid projects, which are built on land acquired in 2001, when land use rights were available for relatively lower costs.

Cost of real estate leasing

Cost of real estate leasing increased by US$9,172, or 2.1%, to US$442,020 for 2006 from US$432,848 for 2005.

Other cost

Other cost was US$486,307 for 2006.

Gross Profit

Gross profit increased by US$14.9 million, or 77.0%, to US$34.2 million for 2006 from US$19.3 million for 2005 due to the cumulative effect of the foregoing factors. Our gross margin decreased from 31.2% in 2005 to 24.0% in 2006. Our gross margin in 2005 benefited from the relatively lower land use rights costs associated with our Xinyuan Splendid projects.

Selling and Distribution Expenses

Selling and distribution expenses increased by US$0.8 million, or 37.7%, to US$3.0 million for 2006 from US$2.2 million for 2005, as a result of the launch of three new projects in 2006, including our Zhengzhou Central Garden (East and West) and Jinan City Family. Our advertising and marketing campaign for Zhengzhou Central Garden and Jinan City Family was on a larger scale than our other property launches. As a percentage of revenue, selling and distribution expenses declined from 3.5% in 2005 to 2.1% in 2006.

General and Administrative Expenses

General and administrative expenses increased by US$1.9 million, or 113.9%, to US$3.6 million for 2006 from US$1.7 million for 2005, primarily as a result of our expansion into Jinan, Suzhou and Hefei, which involved establishing local offices, and the recruitment of additional staff in those cities and additional administrative staff to support our expansion. In addition, we incurred US$432,329 of professional fees in 2006. As a percentage of revenue, general and administrative expenses declined from 2.7% in 2005 to 2.5% in 2006.

Interest Income

Interest income increased by US$270,335, or 141.5%, to US$461,335 for 2006 from US$191,000 for 2005. The increase was due primarily to an increase in our bank balances resulting from increased cash receipts from our property sales.

Interest Expense

Interest expense decreased by US$107,428, or 12.9%, to US$727,041 for 2006 from US$834,469 for 2005. The decrease was due primarily to interest capitalization in relation to a larger volume of construction in

 

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progress in 2006 compared to 2005. Total interest costs incurred amounted to US$2,209,340 for 2006 and US$1,725,090 for 2005. Total interest expense capitalized as part of the construction costs for the year ended December 31, 2006 and 2005 amounted to US$1,482,299 and US$890,621, respectively.

Share of Income (Loss) in Equity Investee

Share of loss in equity investee was US$446,086 for 2006 compared to nil for 2005. This amount is attributable to our investment in Jiantou Xinyuan. In 2005, Jiantou Xinyuan had not commenced its operations, and in 2006 it incurred losses related to the start-up of its development activities, without generating any revenue during the period. The first project of Jiantou Xinyuan was completed in January 2007.

Income Taxes

Income taxes increased by US$5.5 million, or 104.2%, to US$10.7 million for 2006 from US$5.2 million for 2005. The increase was primarily due to increased corporate income tax liabilities related to higher taxable income incurred in 2006. The increase is also due to higher LAT related to the higher sales revenues recognized in 2006 and provision for LAT in respect of projects completed in prior years. As a result, our effective tax rate increased from 35.5% in 2005 to 39.9% in 2006. See “—Components of results of operations—Income Taxes.”

Minority Interest

Share of loss by minority interest decreased by US$12,319, or 82.7%, to US$2,572 for 2006 from US$14,891 for 2005. The decrease was due to smaller loss incurred by a 99% subsidiary which was dissolved as of December 31, 2006.

Net Income

Net income increased by US$6.6 million, or 68.6%, to US$16.1 million for 2006 from US$9.6 million for 2005.

2005 Compared to 2004

Revenues

Revenues increased by US$26.3 million, or 73.8%, to US$61.9 million for 2005 from US$35.6 million for 2004.

Real estate sales.    Revenue from real estate sales increased by US$26.4 million, or 74.9%, to US$61.8 million for 2005 from US$35.3 million for 2004. The increase was primarily attributable to an increase in the number and aggregate GFA of units completed and sold from 107,455 square meters in 2004 to 161,717 square meters, an increase of 50.5%. In 2005, our revenues derived primarily from sales of Xinyuan Splendid Phase Three and Xinyuan Splendid City Homestead, and in 2004 our revenues derived primarily from sales of Xinyuan Splendid Phases One and Two.

 

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Full accrual method revenues

The following table sets forth for the years 2004 and 2005 the aggregate GFA completed and sold and the related revenues recognized under the full accrual method by project:

 

Project

  Total
GFA(1)
  GFA delivered
for the year
ended December
31,
  Percentage
of total GFA
delivered(2)
as of
December 31,
  Revenues recognized for the year ended
December 31,
    2005   2004   2005   2004   2005   2004
    m2   m2   m2   %   %   US$   %(3)   US$   %(3)

Zhengzhou Xinyuan Splendid 1A

  62,623   516   902   96.1   95.3   150,634   0.2     284,447   0.8

Zhengzhou Xinyuan Splendid 1B

  43,673   255   43,418   100.0   99.4   78,752   0.1     15,088,754   42.7

Zhengzhou Xinyuan Splendid 2A

  39,996   116   1,877   100.0   99.7   35,572   0.1     636,821   1.8

Zhengzhou Xinyuan Splendid 2B

  27,041   593   15,817   100.0   97.8   238,411   0.4     6,193,456   17.5

Zhengzhou Xinyuan Splendid 2C

  21,748   311   21,437   100.0   98.6   114,072   0.2     7,705,168   21.8

Zhengzhou Xinyuan Splendid 3A3B3C

  114,774   109,087   3,093   97.7   2.7   43,425,320   70.2     1,118,458   3.2

Zhengzhou Xinyuan Splendid City Homestead

  45,378   43,280     95.4     14,262,549   23.1      

Other

            528,008   0.9      
                                 

Total

  355,233   154,158   86,544       58,833,318   95.2     31,027,104   87.8
                                 

(1)   The amounts for ‘‘total GFA’’ in this table and elsewhere in this prospectus are the amounts of total saleable residential GFA and are derived on the following basis:

 

  Ÿ  

for properties that are sold, the stated GFA is based on the sale contracts relating to such property;

 

  Ÿ  

for unsold properties that are completed or under construction, the stated GFA is calculated based on the detailed construction blueprint and the calculation method approved by the PRC government for saleable GFA, after necessary adjustments; and

 

  Ÿ  

for properties that are under planning, the stated GFA is based on the land grant contract and our internal projection.

 

(2)   Percentage of total GFA delivered is the total GFA delivered as of a period end divided by the project’s total GFA.

 

(3)   Percentage of all real estates sales revenues for the financial year, including revenues recognized under full accrual method and under percentage of completion method.

Percentage of completion method revenues

The following table sets forth the percentage of completion, percentage sold and related revenues recognized for our Zhengzhou Xinyuan Splendid Haojingge project in 2004 and 2005.

 

Project

   Total
GFA
   Percentage of
completion as of
December 31,
   Percentage
Sold-
Accumulated
as of
December 31,
   Revenues Recognized for the year ended
December 31,
      2005    2004    2005    2004    2005    2004
     m2    %    %    %    %    US$    %    US$    %

Zhengzhou Xinyuan Splendid Haojingge

   31,089    100.0    100.0    87.7    67.2    2,936,118    4.8    4,293,481    12.2
                                            

 

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Real estate leasing.    Real estate leasing decreased by US$11,781, or 8.2%, to US$132,127 for 2005 from US$143,908 for 2004.

Other Revenue

Other revenue decreased by US$127,530, or 75.9%, to US$40,487 for 2005 from US$168,017 for 2004. Late payment penalties paid by tenants in our real estate lease business and penalties paid by contractors for delay in contract performance in 2004 were substantially reduced in 2005.

Cost of Revenue

Cost of revenue increased by US$16.3 million, or 61.6%, to US$42.6 million for 2005 from US$26.4 million for 2004.

Cost of real estate sales.    Cost of real estate sales increased by US$16.1 million, or 61.5%, to US$42.2 million for 2005 from US$26.1 million for 2004. This increase was due primarily to the increase in units completed and sold during the period.

Cost of real estate leasing.    Cost of real estate leasing increased by US$180,705, or 71.7%, to US$432,848 for 2005 from US$252,143 for 2004. This increase was due primarily to depreciation expenses associated with certain parking and clubhouse facilities completed in 2005.

Gross Profit

Gross profit increased by US$10.1 million, or 108.6%, to US$19.3 million for 2005 from US$9.3 million for 2004. Our gross margin increased from 26.0% in 2004 to 31.2% in 2005. This increase in gross margin in 2005 was primarily due to the increase in sales while the land use rights costs remained stable.

Selling and Distribution Expenses

Selling and distribution expenses increased by US$0.6 million, or 35.6%, to US$2.2 million for 2005 from US$1.6 million for 2004. The increase was attributable to the launch of additional projects within the Xinyuan Splendid development. As a percentage of revenue, selling and distribution expenses declined from 4.5% in 2004 to 3.5% in 2005.

General and Administrative Expenses

General and administrative expenses increased by US$0.7 million, or 68.8%, to US$1.7 million for 2005 from US$1.0 million for 2004. The increase was primarily attributable to increases in, among others, staff costs, traveling and entertainment costs, depreciation and consultants’ fees, in line with the growth of our business. As a percentage of revenue, general and administrative expenses declined from 2.8% in 2004 to 2.7% in 2005.

Interest Income

Interest income increased by US$124,045, or 185.3%, to US$191,000 for 2005 from US$66,955 for 2004. The increase was due primarily to an increase in bank balances resulting from increased cash receipts generated by increased property sales.

Interest Expense

Interest expense increased by US$14,320 to US$834,469 for 2005 from US$820,149 for 2004. Total interest costs incurred amounted to US$1,725,090 for 2005 and US$1,302,126 for 2004. Total interest expense capitalized as part of the construction costs for the year ended December 31, 2005 and 2004 amounted to US$890,621 and US$481,977, respectively.

 

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Income Taxes

Income taxes increased by US$3.3 million, or 168.8%, to US$5.2 million for 2005 from US$2.0 million for 2004 due to increased property sales. Our effective tax rate increased from 33.1% in 2004 to 35.5% in 2005 due to an increase in non-deductible expenses. See Note 12 to consolidated financial statements.

Minority Interest

Share of loss by minority interest of US$14,891 in 2005 was due to loss incurred by a 99% subsidiary that was established in April 2005.

Net Income

Net income increased by US$5.6 million, or 142.5%, to US$9.6 million for 2005 from US$3.9 million for 2004.

Business Segments

We consider each of our individual property developments as a discrete operating segment. As presentation of segment information for each property development would not be meaningful, we have aggregated our segments into the following reporting segments: (i) property developments in Zhengzhou, Henan Province, (ii) property developments in Jinan, Shandong Province, (iii) property developments in Suzhou, Jiangsu Province, (iv) property developments in Hefei, Anhui Province, (v) property developments in Chengdu, Sichuan Province and (vi) property management services and other real estate-related services we provide.

 

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The table below sets forth selected information of our reporting segments for the periods indicated:

     For Nine Months Ended September 30,  
     2007     2006  
    

(US$ in thousands, except for percentages)

 

Zhengzhou, Henan

    

Total revenue

   91,359.2           99,512.2  

Total cost of revenues

   (46,085.1 )   (75,448.0 )

Gross profit

   45,274.1     24,064.2  

Gross margin

   49.6 %   24.2 %

Operating income (loss)

   40,603.6     20,370.7  

Jinan, Shandong

    

Total revenue

   32,422.0     0.7  

Total cost of revenues

   (26,524.7 )    

Gross profit

   5,897.3     0.7  

Gross margin

   18.2 %    

Operating income (loss)

   3,508.4     (223.7 )

Suzhou, Jiangsu

    

Total revenue

   74,397.3      

Total cost of revenues

   (58,342.7 )    

Gross profit

   16,054.6      

Gross margin

   21.6 %    

Operating income (loss)

   13,187.7      

Hefei, Anhui

    

Total revenue

   17,909.6      

Total cost of revenues

   (14,398.7 )    

Gross profit

   3,510.9      

Gross margin

   19.6 %    

Operating income (loss)

   2,219.7      

Chengdu, Sichuan

    

Total revenue

   0.0      

Total cost of revenues

        

Gross profit

   0.0      

Gross margin

        

Operating income (loss)

   (383.9 )    

Others

    

Total revenue

   2,212.7     142.2  

Total cost of revenues

   (1,638.6 )   (164.5 )

Gross profit

   574.1     (22.3 )

Gross margin

   26.0 %   (15.7 )%

Operating income (loss)

   (1,517.1 )   (76.4 )

 

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Selected Quarterly Results of Operations

The following table sets forth our unaudited consolidated selected quarterly results of operations for the seven fiscal quarters ended September 30, 2007. You should read the following table in conjunction with our audited and unaudited financial statements and related notes included elsewhere in this prospectus. We have prepared the unaudited consolidated selected quarterly financial information on the same basis as our audited and unaudited consolidated financial statements. The unaudited consolidated financial information includes all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the quarters presented.

 

    Three Months Ended  
    March 31,
2006
    June 30,
2006
    September 30,
2006
    December 31,
2006
    March 31,
2007
    June 30,
2007
    September 30,
2007
 
    (US$ in thousands)  

Revenues

  51,458.3     23,022.0     25,174.8     42,712.1     22,876.8     74,828.9     120,595.0  

Costs of revenues

  (39,069.8 )   (17,547.7 )   (18,995.0 )   (32,583.2 )   (10,225.9 )   (47,832.8 )   (88,931.1 )
                                         

Gross profit

  12,388.5     5,474.3     6,179.8     10,128.9     12,650.9     26,996.2     31,664.0  

Selling and distribution expenses

  (594.8 )   (733.2 )   (548.1 )   (1,120.1 )   (1,018.3 )   (2,172.0 )   (2,766.4 )

General and administrative expenses

  (437.0 )   (789.9 )   (869.0 )   (1,529.9 )   (1,892.3 )   (2,864.8 )   (2,978.9 )
                                         

Operating income

  11,356.7     3,951.2     4,762.7     7,478.9     9,740.3     21,959.3     25,918.7  

Interest income

  30.0     38.6     55.8     336.9     165.1     151.0     419.4  

Interest expenses

  (11.7 )   (108.2 )   (187.3 )   (419.8 )   (174.3 )   492.8     (1,757.1 )

Share of income (loss) in equity investee

      (406.4 )   (39.7 )           3,599.3     2,220.4  

Change in fair value of derivative liabilities

                  476.0     (4,822.0 )   (1,840.0 )
                                         

Income from operations before income taxes

  11,375.0     3,475.2     4,591.5     7,396.0     10,207.1     21,380.4     24,961.4  
                                         

Net income

  6,836.4     2,736.6     2,922.3     3,627.7     6,867.0     13,846.7     15,251.0  
                                         

Our quarterly revenues have primarily been affected by the GFA and the selling price of the properties we sold. Our quarterly cost of revenues and selling, general and administrative expenses experienced less fluctuation than our quarterly revenues as a portion of our cost of revenues and selling, general and administrative expenses are fixed in nature and do not vary in proportion with revenues from quarter to quarter.

Both seasonal fluctuations in real estate transactions and real estate industry cyclicality have affected, and are likely to continue to affect, our business and our quarterly results of operations. We generally experience relatively low volume of real estate transactions in the first quarter due to the cold weather and the Chinese New Year holiday, while the fourth quarter is typically the strongest period for our real estate sales activities.

Liquidity and Capital Resources

To date, we have financed our operations primarily through cash flows from operations, borrowings from banks and proceeds from issuances of equity and debt securities.

 

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Cash Flows

The following table presents selected cash flow data from our cash flow statements for the periods indicated.

 

     Year Ended December 31,     Nine Months Ended
September 30,
 
     2004     2005     2006     2006     2007  
     (US$ in thousands)     (unaudited)  

Net cash provided by (used in) operating activities

   (2,249.9 )   12,555.4     (27,679.2 )   2,213.0     (109,415.0 )

Net cash provided by (used in) investing activities

   (103.1 )   (666.2 )   (3,021.9 )   (1,911.5 )   (1,614.9 )

Net cash provided by (used in) financing activities

   4,780.0     (2,474.3 )   49,295.0     4,403.3     179,740.0  
                              

Net increase in cash and cash equivalents

   2,427.0     9,414.9     18,593.9     4,704.8     68,710.1  

Effect of exchange rate changes on cash and cash equivalents

   (0.2 )   264.6     1,391.6     1,017.2     2,786.1  

Cash and cash equivalents at beginning of year/period

   2,822.4     5,249.2     14,928.7     14,928.7     34,914.2  
                              

Cash and cash equivalents at end of year/period

   5,249.2     14,928.7     34,914.2     20,650.7     106,410.4  
                              

Operating Activities

Net cash used in operating activities was US$109.4 million in the nine months ended September 30, 2007, primarily attributable to cash paid to acquire land use rights in our real estate property under development, an increase in accounts receivable, an increase in other deposits and prepayments, and a decrease in income tax payable. The increase in cash used in operating activities was partly offset by an increase in our accounts payable, customer deposits, other payables and accrued liabilities, and payroll and welfare payable. The increase in our customer deposits was attributable to increased cash receipts from sales of real estate properties in the nine months ended September 30, 2007. The increase in accounts payable was mainly due to increased payables to engineering and construction service providers, reflecting the increased number of, and investments in, real estate properties under construction in the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006.

Net cash used in operating activities in 2006 reflected substantial increases in projects under construction during the period. Net cash used in operating activities was US$27.7 million in 2006, primarily attributable to cash paid to acquire land use rights in our real estate property under development, a decrease in our customer deposits and increases in advances to suppliers and deposits and prepayments. The decrease in customer deposits was attributable to recognition of the related amounts as revenues after meeting all conditions of revenue recognition method. The increase in cash used in our operating activities was partly offset by corresponding increases in our net income and deferred taxation expenses associated with the properties completed and delivered, as well as increases in our other payables and accrued liabilities and accounts payable.

Net cash provided by operating activities was US$12.6 million in 2005, primarily attributable to increases in our net income and deferred taxation expenses associated with properties completed and sold, and a corresponding decrease in property development completed. Customer deposits also increased, as a result of pre-sales of properties under construction. An increase in accounts payable also contributed to cash provided by operating activities. The increase was partially offset by increases in real estate property under development, reflecting properties under construction, as well as related advances to suppliers, other deposits and prepayments.

Net cash used in operating activities was US$2.2 million in 2004, primarily attributable to an increase in real estate property under development and in related advances to suppliers, other deposits and prepayments. The increase in cash used in operating activities was partially offset by increases in customer deposits resulting from

 

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pre-sales of properties under construction, and by increases in accounts payable and income taxes payable. Our net income increased and real estate property development completed decreased as a result of the completion and sale of properties.

Proceeds from pre-sales of our properties under development are an important source of cash flow for our operations. PRC law allows us to pre-sell properties before their completion upon satisfaction of certain requirements and requires us to use the pre-sales proceeds to develop the particular project pre-sold. The amount and timing of cash flows from pre-sales are affected by a number of factors, including restrictions on pre-sales imposed by PRC law, market demand for our properties subject to pre-sales, prices at which we can pre-sell and the number of properties we have available for pre-sale. Any pre-sales payments we receive before we recognize revenue are recorded as current liabilities under customer deposits. At December 31, 2004, 2005 and 2006 and September 30, 2007, we recorded current liabilities consisting of customer deposits of US$31.0 million, US$43.8 million, US$25.5 million and US$44.2 million, respectively. We actively market pre-sales of our properties in accordance with regulations to accelerate cash flows to the extent possible.

Investing Activities

Net cash used in investing activities was US$1.6 million in the nine months ended September 30, 2007, primarily attributable to US$1.3 million we used in purchasing property and equipment.

Net cash used in investing activities was US$3.0 million in 2006, primarily attributable to US$1.6 million we paid in consideration for the acquisition from Mr. Yong Zhang and Ms. Yuyan Yang of four subsidiaries providing real estate-related services, net of cash acquired.

Net cash used in investing activities was US$0.7 million in 2005, primarily attributable to the investments in Jiantou Xinyuan and Henan Xinyuan Real Estate Agency Co., Ltd.

Net cash used in investing activities was US$103,145 in 2004, due to purchases of plant and equipment.

Financing Activities

Net cash provided by financing activities was US$179.8 million in the nine months ended September 30, 2007, primarily attributable to proceeds in the amount of US$141.1 million from long-term bank loans, proceeds in the amount of US$17.3 million from short-term bank loans and net proceeds in the amount of US$94.9 million from the issue of our floating rate notes and convertible notes, partly offset by US$35.0 million repayment of shareholders’ loans, a US$8.5 million increase of restricted cash, US$11.3 million repayment of short-term bank loans and US$17.0 million repayment of long-term bank loans.

Net cash provided by financing activities was US$49.3 million in 2006, primarily attributable to proceeds in the amount of US$36.5 million from issuances of common and Series A preference shares, a US$35.0 million bridge loan from shareholders and US$28.5 million proceeds from short- and long-term bank borrowings, partially offset by an increase of US$26.6 million in restricted cash, reflecting the increase in real estate sales, and US$24.8 million repayment of short-term bank loans.

Net cash used in financing activities was US$2.5 million in 2005, primarily attributable to the proceeds of short- and long-term bank loans in the aggregate of US$34.7 million and a decrease in restricted cash of US$6.2 million, largely offset by repayment of short-term bank loans in the amount of US$37.0 million and loans to related parties of US$5.6 million.

Net cash provided by financing activities was US$4.8 million in 2004, primarily attributable to proceeds from short-term bank loans of US$20.5 million, partially offset by increase in restricted cash of US$7.6 million, repayments of long-term bank loans of US$5.9 million and repayment of borrowings from employees of US$3.0

 

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million. These borrowings from employees were used for our real property developments, and were fully repaid as of September 30, 2007.

Debt and Equity-Linked Securities

See “Description of Debt and Equity-Linked Securities” for a description of warrants, floating rate notes and convertible notes that we have issued.

Bank Borrowings

Bank borrowing is an important source of funding for our property developments. Our borrowings as of December 31, 2004, 2005, 2006 and September 30, 2007, respectively, were as follows.

 

     As of December 31,   

As of September 30,

2007

     2004    2005    2006   
     US$    US$    US$    US$

Short-term bank loans

   30,145,593    24,410,795    22,667,025    29,690,579

Long-term bank loans

   3,141,425    7,434,760    12,806,229    139,998,402
                   

Total

   33,287,018    31,845,555    35,473,254    169,688,981
                   

As of December 31, 2004, 2005 and 2006 and September 30, 2007, the weighted average interest rate on our short-term bank loans was 6.31%, 7.31%, 7.05% and 6.99%, respectively. As of December 31, 2004, 2005 and 2006 and September 30, 2007, our short-term bank loans were all denominated in Renminbi and are secured by our land use rights, real estate under development, certain property certificates and certain bank deposits.

As of December 31, 2004, 2005 and 2006 and September 30, 2007, the weighted average interest rate on our long-term bank loans was 6.30%, 6.62%, 6.93% and 7.77%, respectively. As of December 31, 2004, 2005 and 2006 and September 30, 2007, our long-term bank loans were all denominated in Renminbi and are secured by our land use rights and real estate under development.

Since June 2003, commercial banks have been prohibited under PBOC guidelines from advancing loans to fund the payment of land premium. In addition, the PRC government also encourages property developers to use internal funds to develop their property projects. Under guidelines jointly issued by the Ministry of Construction and other PRC government authorities in August 2004, commercial banks in China are not permitted to lend funds to property developers with an internal capital ratio, calculated by dividing the internal funds available by the total capital required for the project, of less than 35%, an increase of five percentage points from 30% as previously required. Such increase in internal capital ratio has limited the amount of bank financing that property developers, including us, are able to obtain.

Shareholders’ loan

On December 7, 2006, we borrowed a bridge loan in the principal amount of US$35 million from Blue Ridge China and Equity International, holders of our Series A preference shares and common shares. This loan bore interest at the rate of 12.5% per annum. In April 2007, we repaid the bridge loan using a portion of the net proceeds from the issuance and sale of floating rate notes.

Capital Expenditures

Our capital expenditures were US$103,145, US$174,245, US$1,540,874 and US$1,614,897 in 2004, 2005, 2006 and the nine months ended September 30, 2007, respectively. Our capital expenditures in 2004, 2005, 2006 and the nine months ended September 30, 2007 were mainly used for building improvements and to

 

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purchase vehicles, fixtures and furniture and equipment. We expect to incur capital expenditures of approximately US$0.4 million in the last quarter of 2007, which will be used primarily to purchase vehicles, computers and other equipment for our newly established subsidiaries. The source of our capital expenditures is primarily the cash flow generated from operating activities.

Recent Development

The terms of our Series A preference shares contain a contingent conversion option that allows holders to receive additional common shares if the value of our common shares in connection with this offering is less than two times the original Series A preference shares issuance price of US$0.81155, plus an accreted amount of 10% compounded annually to the date of the offering. On November 13, 2007, in order to provide more clarity with respect to accounting treatment of the Series A preference shares in our financial statements, we requested that Blue Ridge China and Equity International, the only holders of the Series A preference shares waive this option. They agreed in writing to the waiver on the belief that the option condition will be satisfied and therefore not triggered. Accordingly, we expect to issue 30,805,400 common shares upon the conversion of all of our Series A preference shares at the completion of this offering. We will recognize a deemed dividend to the holders of the Series A preference shares in connection with this waiver of the contingent conversion option. This deemed dividend will not affect our net income or cash flows, however, it will reduce our net income attributable to ordinary shareholders and earnings per share (ADS) for the year ending December 31, 2007. The dividend will be calculated based on the difference between the fair value of the Series A preference shares immediately after the waiver of the contingent conversion option and the carrying value of the Series A preference shares immediately prior to the waiver. The carrying value of the Series A preference shares immediately prior to the waiver was US$24,785,612. We have determined that on November 13, 2007, a 4% marketability discount be applied to an assumed initial offering price of US$            , the mid-point of the indicative price range for the offering, to arrive at a fair value of US$             for each Series A preference share. At this estimated fair value, we will record the modified Series A preference shares at an amount of approximately US$             million and the deemed dividend to the Series A preference shareholders at approximately US$             million, which will reduce the net income attributable to ordinary shareholders and retained earnings by the same amount of US$             million for the year ending December 31, 2007.

Contractual Obligations

As of September 30, 2007, our contractual obligations amounted to US$432.0 million, primarily arising from contracted construction costs or other capital commitments for future property developments and debt obligations. The following table sets forth our contractual obligations for the periods indicated.

 

     Payments due by period

Contractual Obligations

   Total    less than
1 year
   1-3 years    3-5
years
   more than
5 years
     (US$ in thousands)

Long-term debt obligations:

              

— long-term bank loans

   139,998       139,998      

— interest on long-term bank loans(1)

   18,114    10,234    7,880      

— convertible notes

   25,000          25,000   

— interest on convertible notes(2)

   2,300    508    1,521    271   

— floating rate notes

   75,000       75,000      

— interest on floating rate notes(3)

   23,109    9,122    13,987      

Short-term debt obligations

   29,691    29,691         

— interest on short-term debt obligations(4)

   1,099    1,099         

Operating lease obligations

   186    168    18      

Non-cancellable construction contract obligations

   117,484    117,484         

Contracted land use rights obligations

   163,084    163,084         
                        

Total

   595,065    331,390    238,404    25,271   
                        

 

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(1)   Our long-term bank loans bear variable interest at rates adjustable based on the PBOC benchmark rate. Interest on long-term loans is calculated based on the current interest rate of each loan, ranging from 5.99% to 8.217% per annum, using the PBOC benchmark rate of 7.47% as of September 30, 2007.
(2)   Interest on convertible notes is calculated at a rate of 2% per annum, assuming that we will complete an initial public offering prior to October 15, 2009.
(3)   Interest on floating rate notes is calculated at 6-month LIBOR as of September 30, 2007 plus 6.8% per annum. The applicable LIBOR rate was 5.3625% as of September 30, 2007.
(4)   Interest on short-term loans is calculated based on the fixed interest rates for relevant loans, ranging from 6.41% to 7.344% per annum.

This table does not include a liability of US$11.8 million for unrecognized tax benefits.

Off-Balance Sheet Arrangements

As is customary in the property industry in China, we provide guarantees to commercial banks in respect of the mortgage loans they extend to our customers prior to the issuance of their property ownership certificates. These guarantees remain outstanding until the completion of the registration of the mortgage with the relevant mortgage registration authorities. In most cases, guarantees for mortgages on residential properties are discharged when we submit the individual property ownership certificates and certificates of other interests in the property to the mortgagee bank. In our experience, the application for and issuance of the individual property ownership certificates typically takes six to 12 months, so the guarantee periods typically last for up to six to 12 months after we deliver the related property.

As of December 31, 2004, 2005 and 2006 and September 30, 2007, we guaranteed mortgage loans in the aggregate outstanding amounts of US$17.8 million, US$37.9 million, US$62.4 million and US$172.5 million, respectively.

Except for the contingent liabilities set forth above, we have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any transactions with unconsolidated entities, derivative contracts that are indexed to our shares and classified as shareholders’ equity, or that are not reflected in our consolidated financial statements.

Inflation

Inflation has not had a significant effect on our business during the past three years. According to the National Bureau of Statistics of China, China’s overall national inflation rate, as represented by the general consumer price index, was approximately 3.9%, 1.8%, 1.5% and 4.1% in 2004, 2005, 2006 and the nine months ended September 30, 2007, respectively. Deflation could negatively affect our business as it would be a disincentive for prospective property buyers to make a purchase. As of the date of this prospectus, we have not been materially affected by any inflation or deflation.

Quantitative and Qualitative Disclosure about Market Risks

Market risk is the risk of loss related to adverse changes in market prices, including interest rate and foreign exchange rates of financial instruments. We are exposed to various types of market risks, in the normal course of business. We have not in the past used derivatives to manage our exposure to market interest rate risk or foreign exchange risk. The following discussion and analysis, which constitute “forward-looking statements” that involve risk and uncertainties, summarize our exposure to different market risks.

 

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Foreign Exchange Risk

All of our revenues are denominated in RMB. However, we have substantial U.S. dollar denominated obligations, including the redemption obligation relating to the Series A preference shares and the obligation to pay interest and principal on the floating rate notes and convertible notes. Accordingly, any significant fluctuation between the RMB and the U.S. dollar could expose us to foreign exchange risk. We do not currently hedge our exchange rate exposure. We evaluate such risk from time to time and may consider engaging in hedging activities in the future to the extent we deem appropriate. Such hedging arrangements may require us to pledge or transfer cash and other collateral to secure our obligations under the agreements, and the amount of collateral required may increase as a result of mark-to-market adjustments.

The Renminbi 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. The conversion of Renminbi into foreign currencies, including U.S. dollars, has been based on rates set by the People’s Bank of China. On July 21, 2005, the PRC government changed its previous policy of pegging the value of the Renminbi to the U.S. dollar. Under the new policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. Since July 21, 2005, this change in policy has resulted in an approximately 7.98% appreciation of the Renminbi against the U.S. dollar by September 30, 2007. There remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the Renminbi against the U.S. dollar. To the extent that we need to convert U.S. dollars we receive from this offering into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount we receive from the conversion. Any appreciation of the Renminbi against the U.S. dollar or any other foreign currencies would make any new RMB-denominated investments or expenditures more costly to us, to the extent that we need to convert foreign currencies into Renminbi for such purposes. Any significant depreciation in the exchange rates of the Renminbi against the U.S. dollar could adversely affect the value of our dividends, which would be funded by Renminbi but paid in U.S. dollars. There can be no assurance that any future movements in the exchange rate of the Renminbi against the U.S. dollar or other foreign currencies will not adversely affect our results of operations and financial condition (including our ability to pay dividends). A significant depreciation in the Renminbi against major foreign currencies may have a material adverse impact on our results of operations, financial condition and share price because our reporting currency is U.S. dollars and our ADSs are expected to be quoted in U.S. dollars, whereas our revenues, costs and expenses are denominated in RMB.

Interest Rate Risk

We are subject to market risks due to fluctuations in interest rates and refinancing of short-term debt. Our cost of financing is sensitive to fluctuations in interest rates. Our bank borrowings and the floating rate notes bear interest at variable rates, and an increase in interest rates would increase our costs thereunder. Our net income is affected by changes in interest rates as a result of the impact such changes have on interest income from, and interest expense on, short-term deposits and other interest-bearing financial assets and liabilities. In addition, our sales are also sensitive to fluctuations in interest rates. An increase in interest rates would adversely affect our prospective purchasers’ ability to obtain financing and depress the overall housing demand. Higher interest rates, therefore, may adversely affect our revenues, gross profits and net income, and our ability to raise and service debt and to finance our developments.

Our indebtedness consists primarily of short- and long-term bank borrowings, the floating rate notes and the convertible notes. As of September 30, 2007, we had US$29.7 million of short-term bank borrowings, all of which are denominated in Renminbi and bear interest at fixed rates ranging from 6.41% per annum to 7.344% per annum, with a weighted average interest rate at such date of 6.99%. As of September 30, 2007, we had outstanding long-term bank loans of US$140.0 million that bore interest rates ranging from 5.99% per annum to 8.22% in the first contract years, with a weighted average interest rate at such date of 7.77%, which should be adjusted based on the PBOC benchmark rate in the range of 95% to 110% in the following years. The PBOC

 

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regulates the interest rates of our Renminbi-denominated borrowings. The PBOC-published benchmark one-year lending rates in China, which directly affect the property mortgage rates offered by commercial banks in China, as at December 31, 2004, 2005 and 2006 and September 30, 2007 were 5.58%, 5.58%, 6.12% and 7.29%, respectively. The floating rate notes and the convertible notes are denominated in U.S. dollars. The floating rate notes bear interest at a floating rate based on six-month LIBOR plus 6.8%. The convertible notes bear interest at 2% per annum, adjustable to 8% from October 15, 2009 to maturity if an initial public offering does not occur prior to October 15, 2009.

Credit Risk

We provide guarantees to mortgage lending banks in respect of the mortgage loans provided to the purchasers of our properties up until completion of the registration of the mortgage with the relevant authorities, which generally occurs within six to 12 months after the purchasers take possession of the relevant properties. If a purchaser defaults under the loan while our guarantee is in effect and we repay all debt owed by the purchaser to the mortgagee bank under the loan, the mortgagee bank must assign its rights under the loan and the mortgage to us and, after the registration of the mortgage, we will have full recourse to the property. In line with what we believe is industry practice, we do not conduct independent credit checks on our customers but rely on the credit checks conducted by the mortgagee banks.

As of September 30, 2007, we had guaranteed mortgages in the principal amount of US$172.5 million. If a purchaser defaults on the payment of its mortgage during the term of the guarantee, the mortgage lending bank may require us to repay the outstanding amount under the loan plus any accrued interest. In this event, although we are able to retain the customer’s deposit and sell the property to recover any amounts paid by us to the bank, there can be no assurance that we would be able to sell the property at a price equal to or greater than the amount necessary to pay off the defaulting purchaser’s outstanding loan amount and any accrued interest thereon.

Recent Accounting Pronouncements

In September 2006, the EITF issued EITF Issue No. 06-8, “Applicability of the Assessment of a Buyer’s Continuing Investment under SFAS No. 66 for the Sale of Condominiums” (“EITF 06-8”). EITF 06-8 states that in assessing the collectibility of the sales price pursuant to paragraph 37(d) of SFAS 66, an entity should evaluate the adequacy of the buyer’s initial and continuing investment to conclude that the sales price is collectible. If an entity is unable to meet the criteria of paragraph 37, including an assessment of collectibility using the initial and continuing investment tests described in paragraphs 8-12 of SFAS 66, then the entity should apply the deposit method as described in paragraphs 65-67 of SFAS 66. EITF 06-8 is effective for fiscal years beginning after March 15, 2007. In November 2006, the FASB ratified the EITF’s recommendation. The application of the continuing investment criteria on the collectibility of the sales price will limit our ability to recognize revenue and costs using the percentage of completion accounting method. Although we will continue to evaluate the application of EITF 06-8, we do not foresee that the adoption will have a material impact on the revenue or costs reported under percentage of completion accounting in fiscal 2004-2006. The effect of a change resulting from adoption of this consensus will be recognized as a cumulative-effect adjustment.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 establishes a framework for measuring fair value in generally accepted accounting principles, clarifies the definition of fair value within that framework, and expands disclosures about the use of fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The provisions are to be applied prospectively as of the beginning of the fiscal year in which SFAS No. 157 is initially applied, except as it pertains to a change in accounting principles related to (i) large positions previously accounted for using a block discount and (ii) financial instruments (including derivatives and hybrids) that were initially measured at fair value using the transaction price in accordance with guidance in footnote 3 of EITF No. 02-3 or similar guidance in SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements

 

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No. 133 and 140”. For these transactions, differences between the amounts recognized in the statement of financial position prior to the adoption of SFAS No. 157 and the amounts recognized after adoption should be accounted for as a cumulative-effect adjustment to the opening balance of retained earnings in the year of adoption. We are currently assessing the impact, if any, of this new standard on our financial statements, however, management does not currently foresee that the adoption will have a material impact on our results of operations or financial position.

In February 2007, the FASB issued SFAS No.159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No.115”. SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently assessing the impact of this new standard on our financial statements, however, management does not currently foresee that the adoption will have a material impact on our results of operations or financial position.

In March 2007, the FASB EITF released Topic No. D-109, “Determining the Nature of a Host Contract Related to a Hybrid Financial Instrument Issued in the Form of a Share under FASB Statement No. 133.” EITF Topic D-109 provides guidance that the determination of the nature of the host contract for a hybrid financial instrument (that is, whether the nature of the host contract is more akin to debt or to equity) issued in the form of a share should be based on a consideration of economic characteristics and risks. The SEC believes that the consideration of the economic characteristics and risks of the host contract should be based on all the stated and implied substantive terms and features of the hybrid financial instrument. EITF Topic D-109 is effective at the beginning of the first fiscal quarter beginning after June 15, 2007. Although we will continue to evaluate the application of EITF Topic No. D-109, management does not currently foresee that the adoption will have a material impact on our results of operations or financial position.

 

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OUR INDUSTRY

General

Since early 1990s, the real estate industry in China, including its residential property market, has been transitioning from a planned system controlled by the PRC government into a more market-oriented system. At present, although the PRC government still owns all urban land in China, long term land use rights with terms of up to 70 years can be granted to, and owned or leased by, private individuals and companies. A large and active market in the private sector has developed for sales and transfers of land use rights initially granted by the PRC government and property units built by private developers on such land. This has fostered the development of real estate-related businesses, such as property development, property management and real estate agencies.

The real estate industry in China, like elsewhere, is highly influenced by the domestic macroeconomic environment. The PRC economy has experienced significant growth during the past decade, which has led to a significant expansion of its real estate industry. This expansion has been supported by other factors, including increasing urbanization, growing personal affluence, as well as the emergence of the mortgage lending market. The following table sets forth selected statistics for the real estate industry in China for the periods indicated.

 

     For the year ended December 31,   

2001-2005
CAGR

 
     2001    2002    2003    2004    2005   

Investment in real estate development (RMB in billions)

   634.4    779.1    1,015.4    1,315.8    1,590.9    25.8 %

Total GFA sold (square meters in millions)

   224.1    268.1    337.2    382.3    554.9    25.4 %

Average price of properties sold (RMB per square meter)

   2,170    2,250    2,359    2,778    3,168    9.9 %

Source:   China Statistical Yearbook

Under a recently-enacted PRC Property Rights Law, which became effective on October 1, 2007, the term of the land use rights for residential land may be automatically renewed upon expiration. We expect this new law to encourage further growth in the PRC residential property market.

Growth in the PRC Economy

According to the 11th Five-year Plan for National Economic and Social Development, the PRC government expects the country to achieve GDP growth of approximately 7.5% per annum from 2006 to 2010. The table below sets forth selected PRC economic statistics for the periods indicated.

 

     For the year ended December 31,   

2001-2005
CAGR

 
     2001    2002    2003    2004    2005   

Nominal GDP (RMB in billions)

   10,965.5    12,033.3    13,582.3    15,987.8    18,308.5    13.7 %

Per capita GDP (RMB)

   8,622    9,398    10,542    12,336    14,040    13.0 %

Real GDP growth rate (%)

   8.3    9.1    10.0    10.1    10.2    N/A  

Source:   China Statistical Yearbook

 

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Increasing Urbanization in China

The urban population in China has grown significantly in the past 10 years, creating higher demand for housing in many cities. The following table sets forth China’s urban population, total population and urbanization rates for the periods indicated.

 

     For the year ended December 31,   

2001-2005
CAGR

 
     2001    2002    2003    2004    2005   

Urban population (in millions)

   480.6    502.1    523.8    542.8    562.1    4.0 %

Total population (in millions)

   1,276.3    1,284.5    1,292.3    1,299.9    1,307.6    0.6 %

Urbanization rate (%)

   37.7    39.1    40.5    41.8    43.0    N/A  

Source:   China Statistical Yearbook

Growing Personal Affluence

Demand for housing in major cities has also grown significantly as a result of growing personal affluence, particularly among urban residents. The following table sets forth China’s per capita disposable income for urban households and aggregate personal savings for the periods indicated:

 

     For the year ended December 31,    2001-2005
CAGR
 
     2001    2002    2003    2004    2005   

Aggregate personal savings (RMB in billions)

   7,376.2    8,691.1    10,361.8    11,955.5    14,105.1    17.6 %

Per capita disposable income for urban households (RMB)

   6,860    7,703    8,472    9,422    10,493    11.2 %

Source:   National Bureau of Statistics of China; China Statistical Yearbook

Emergence of mortgage lending in China

Financing for property purchases effectively began in 1994 when the PRC government promulgated rules which required companies to establish housing purchase benefit plans for their employees in urban areas. These plans were jointly funded by both employers and employees and provided substantial financial assistance for home purchases. The PRC government ended its practice of allocating housing units in urban areas in 1998. In 1999, commercial banks in China began to offer mortgage loans for up to 80% of the purchase price to individual property purchasers with maximum terms of 30 years. According to the National Bureau of Statistics of China, the aggregate balance of outstanding mortgage loans for residential properties in China increased from approximately RMB560 billion in 2001 to approximately RMB1,840 billion in 2005. The increased availability in property financing fostered the growth in private property purchases.

 

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The Residential Property Market in China

The following table sets forth selected statistics regarding the residential property market in China for the periods indicated.

 

    For the year ended December 31,  

2001-2005
CAGR

 
    2001   2002   2003   2004   2005  

Investment in real estate development in residential properties (RMB in billions)

  421.7   522.8   677.7   883.7   1,086.1   26.7 %

GFA of residential properties sold (square meters in millions)

  199.4   237.0   297.8   338.2   495.9   25.6 %

Average price of residential properties (RMB per square meter)

  2,017   2,092   2,197   2,608   2,937   9.8 %

Source:   China Statistical Yearbook

As a result of the growing demand and increased prices for residential properties, total residential property sales in China increased from approximately RMB402.1 billion in 2001 to approximately RMB1,456.4 billion in 2005, according to China Statistical Yearbook.

At present, there is no uniform standard to categorize the different types and sizes of cities in China. In this prospectus, we refer to certain larger and more developed cities in China as Tier I and Tier II cities based on the categorization used by the CIHAF Valuation Report on Real Estate Investment in PRC Cities published by China Real Estate Business, or CREB, an authoritative real estate publication in China, YUBO Media and Institute of Finance and Trade Economics of Chinese Academy of Social Sciences. According to this report, four cities in China, namely Beijing, Shanghai, Shenzhen and Guangzhou, are currently considered Tier I cities due to their higher economic output and relatively more mature real estate market development. Another 35 cities are currently considered Tier II cities based on their economic growth and real estate development and investment growth potential.

We see a higher demand potential in the real estate market of the Tier II cities compared to the Tier I cities. The Tier II cities have a total population of 215.1 million and nominal GDP of RMB5,563.0 billion as of December 31, 2005. These represent a 16.4% of China’s total population and 30.4% of China’s total nominal GDP, compared to 2.7% of China’s total population and 14.3% of China’s total nominal GDP in the Tier I cities.

Also, we expect a more robust growth in the real estate market of the Tier II cities, given a more rapid urbanization in the Tier II cities compared to Tier I cities. The Tier II cities have an average urbanization rate of 52.7%, which is lower than the 82.0% rate in the Tier I cities, as of December 31, 2005. However, the urban population in Tier II cities has grown at a CAGR of 6.1% from 2001 to 2005, which is higher than a CAGR of 4.0% in Tier I cities in such period. We believe that the increasing urbanization rates in many Tier II cities are among the factors that have contributed to the growth in their residential housing demand and that the lower urbanization rates in these cities, compared to Tier I cities, are an indication of their capacity for further urban population growth.

In addition, Tier II cities have displayed a higher economic growth. In 2005, Tier II cities grew at a weighted average real GDP growth of 14.5%, which is higher than the 12.4% growth in Tier I cities. We expect continuing economic growth in many Tier II cities and improved intercity transportation infrastructure to encourage growth in the urban populations and residential housing demand of these cities.

 

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The following sets forth an overview of the Tier II cities in which we currently operate:

Chengdu, Sichuan Province

Chengdu is the capital city of Sichuan Province, which is located in Southwest China. According to the China City Statistical Yearbook, Chengdu had a population of 10.8 million as of December 31, 2005, making it the second largest Tier II city in China. The table below sets forth selected economic statistics and real estate industry data for Chengdu for the periods indicated.

 

     For the year ended December 31,
         2001            2002            2003            2004            2005    

Population (in millions)

   10.2    10.3    10.4    10.6    10.8

Nominal GDP (RMB in billions)

   149.2    166.7    187.1    218.6    237.1

Real GDP growth rate (%)

   13.1    13.1    13.0    13.6    13.5

Per capita disposable income for urban households (RMB)

   8,128    8,972    9,641    10,394    11,359

Residential real estate investments (RMB in billions)

   12.3    14.9    18.9    18.6    29.4

Residential GFA completed (square meters in millions)

   7.2    7.8    9.0    7.0    5.0

Residential GFA sold (square meters in millions)

   6.4    7.4    9.0    6.8    4.9

Average price of residential property per square meter (RMB)

   1,648    1,775    1,908    2,224    2,308

Source:   China City Statistical Yearbook; China Real Estate Statistics Yearbook; Chengdu Statistical Yearbook

Hefei, Anhui Province

Hefei is the capital city of Anhui Province, which is located in Eastern China. According to the China City Statistical Yearbook, Hefei had a population of 4.6 million as of December 31, 2005, making it the 24th largest Tier II city in China. The table below sets forth selected economic statistics and real estate industry data for Hefei during the periods indicated.

 

     For the year ended December 31,
         2001            2002            2003            2004            2005    

Population (in millions)

   4.4    4.5    4.6    4.4