Registration No. 333-
(I.R.S. Employer Identification No.)
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions
of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging
growth company” in Rule 12b-2 of the Exchange Act.
If an emerging growth company, indicate by check mark if the
registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards
provided pursuant to Section 7(a)(2)(B) of the Securities Act.
The information included and incorporated
by reference in this Prospectus contains “forward-looking statements,” within the meaning of the federal securities
laws. These statements describe the Company’s plans and beliefs concerning future business conditions and the outlook for
the Company based on currently available information. The Company’s actual results could differ materially from those described
in the forward-looking statements due to a number of risks and uncertainties. These risks and uncertainties include the risks discussed
in our more recent filings with the SEC which are incorporated by reference in this Prospectus. See “Incorporation of Certain
Documents by Reference” below.
Risks Related to Our Business
We operate in a very competitive industry and may not
be able to maintain our revenues and profitability.
Since the 1990s, several international companies
engaged in supplying integrated automation services for the petroleum extraction industry have been qualified in China. These competitors
have significantly greater financial and marketing resources and name recognition than we have. In addition, at least five domestic
private competitors also compete with us, and more competitors may enter the market as Chinese petroleum companies seek to reduce
oil production costs and improve efficiencies. There can be no assurance that we will be able to compete effectively in our industry.
In addition, our competitors may introduce
new systems. If these new systems are more attractive to customers than the systems we currently use or may develop, our customers
may switch to our competitors’ services, and we may lose market share. We believe that competition may become more intense
as more integrated automation service providers, including Chinese/foreign joint ventures, are qualified to conduct business. We
cannot assure you that we will be able to compete successfully against any new or existing competitors, or against any new systems
our competitors may implement. Any of these competitive factors could have a material adverse effect on our revenues and profitability.
We must continually research and develop new technologies
and products to remain competitive.
Because our industry is so competitive,
we will need to continually research, develop and refine new technologies and offer new products to compete effectively. Many factors
may limit our ability to develop and refine new products, including the availability of funds to dedicate to this portion of our
business and access to new products and technologies that we can incorporate into our products, as well as marketplace resistance
to new products and technologies. We believe that the Domestic Companies (defined in the following paragraph) and our products
are able to compete in the marketplace based upon, among other things, our intellectual property. We cannot assure investors that
applications of our and the Domestic Companies’ technologies or those of third parties, if developed, will not be rendered
superfluous or obsolete by research efforts and technological advances by others in these fields.
We control by contract the PRC companies
of Beijing BHD Petroleum Technology Co., Ltd. (“BHD”) and Nanjing Recon Technology Co., Ltd. (“Nanjing Recon”),
collectively, the Domestic Companies. As new technologies are developed, the Domestic Companies and we may need to adapt and change
our products and services, our method of marketing or delivery or alter our current business in ways that may adversely affect
revenue and our ability to achieve our proposed business goals. Accordingly, there is a risk that the Domestic Companies’
and our technology will not support a viable commercial enterprise.
Our financial performance is dependent upon the sale and
implementation of petroleum mining and extraction software and hardware and related services, a single, concentrated group of products.
We derive substantially all of our revenues
from the license and implementation of software applications and hardware innovations for the Chinese petroleum industry. The life
cycle of our products and services is difficult to estimate due in large measure to the potential effect of new software and hardware
applications and enhancements, including those we introduce, and the maturation in both the Chinese petroleum and software/hardware
industries. If we are unable to continually improve our software and hardware to address the changing needs of the Chinese petroleum
industry, we may experience a significant decline in the demand for the Domestic Companies’ and our products and services.
In such a scenario, our revenues may significantly decline.
As a technology-oriented business, our ability to operate
profitably is directly related to our ability to develop and protect our proprietary technology.
We rely on a combination of trademark, trade
secret, nondisclosure, copyright and patent law to protect the Domestic Companies’ and our software and hardware, which may
afford only limited protection.
Although the Chinese government has issued
Nanjing Recon over ten copyrights on software and Nanjing Recon and BHD over forty patents on products, we cannot guarantee that
competitors will be unable to develop technologies that are similar or superior to the Domestic Companies’ and our technology.
Despite our efforts to protect the Domestic Companies’ and our proprietary rights, unauthorized parties, including customers,
may attempt to reverse engineer or copy aspects of the Domestic Companies’ and our products or to obtain and use information
that the Domestic Companies and we regard as proprietary. Furthermore, our competitors may independently develop substantially
equivalent or superior proprietary information and techniques, reverse engineer information and techniques, or otherwise gain access
to our proprietary technology. In the future, we cannot guarantee that others will not use the Domestic Companies’ and our
technology without proper authorization. In addition, under the Chinese intellectual property law, the 50-year protection period
for software copyright and 10-year patent protection period are not subject to renewal upon expiration.
The Domestic Companies and we develop our
software products on third-party middleware software programs that are licensed by our customers from third parties, generally
on a non-exclusive basis. The termination of any such licenses, or the failure of the third-party licensors to adequately maintain
or update their products, could result in delay in our ability to develop, market or ship certain of our products while we seek
to implement technology offered by alternative sources. While it may be necessary or desirable in the future to obtain other licenses,
there can be no assurance that they will be able to do so on commercially reasonable terms or at all.
In addition, the Domestic Companies and
we may initiate claims or litigation against third parties for infringement of our proprietary rights or to establish the validity,
scope or enforceability of our proprietary rights. Any such claims could be time consuming, result in costly litigation, cause
product development or shipment delays or force the Domestic Companies or us to enter into royalty or license agreements rather
than dispute the merits of such claims, thereby impairing our financial performance by requiring the Domestic Companies or us to
pay additional royalties and/or license fees to third parties. There is always a risk that patents, if issued, may be subsequently
invalidated, either in whole or in part and this could diminish or extinguish protection for any technology we may license. In
addition, the laws of China may not protect proprietary rights to the same extent as U.S. law. Therefore, we may be unable to meaningfully
protect our rights in trade secrets, technical know-how and other non-patented technology. Any failure to enforce or protect the
Domestic Companies’ and our rights could cause us to lose the ability to exclude others from issuing technology to develop
or sell competing products.
We may not be able to adequately protect our intellectual
property, which could cause us to be less competitive and negatively impact our business.
We rely on trademark, patent and trade
secret law, as well as confidentiality agreements with certain of our employees to protect our proprietary rights. The product
patents owned by the Company are employee service patents invented by the Company’s key employees. We generally require
the Domestic Companies’ and our employees, consultants, advisors and collaborators to execute appropriate confidentiality
agreements with, as applicable, the respective Domestic Companies and the Company. These agreements typically provide that all
material and confidential information developed or made known to the individual during the course of the individual’s relationship
with the Company is owned by the Company and will be kept confidential and not disclosed to third parties except in specific circumstances.
These agreements may be breached, and in some instances, we may not have an appropriate remedy available for breach of the agreements.
We may be accused of infringing the intellectual property
rights of others.
In the future, the Domestic Companies and
we may receive notices claiming that we are infringing the proprietary rights of third parties. We cannot guarantee that the Domestic
Companies and we will not become the subject of infringement claims or legal proceedings by third parties with respect to the Domestic
Companies’ and our current programs or future software developments. Our standard software license agreements contain an
infringement indemnity clause under which we agree to indemnify and hold harmless our customers and business partners against liability
and damages arising from claims of various copyright or other intellectual property infringement by our products. Neither
the Domestic Companies nor we have been the subject of an intellectual property claim since our formation.
Our software products may contain integration challenges,
design defects or software errors that could be difficult to detect and correct.
Despite extensive testing, we may, from
time to time, discover defects or errors in the Domestic Companies’ and our software only after use by a customer. We may
also experience delays in shipment of our software during the period required to correct such errors. In addition, we may, from
time to time, experience difficulties relating to the integration of the Domestic Companies’ and our software products with
other hardware or software in the customer’s environment that are unrelated to defects in such software products. Such defects,
errors or difficulties may cause future delays in product introductions and shipments, result in increased costs and diversion
of development resources, require design modifications or impair customer satisfaction with the Domestic Companies’ and our
software. Since these software products are used by our customers to perform mission-critical functions related to petroleum mining
and extraction, design defects, software errors, misuse of these products, incorrect data from external sources or other potential
problems within or out of our control that may arise from the use of the Domestic Companies’ and our products could result
in financial or other damages to our customers. We do not maintain product liability insurance. Although our license agreements
with customers contain provisions designed to limit our exposure to potential claims as well as any liabilities arising from such
claims, such provisions may not effectively protect us against such claims and the liability and costs associated therewith. To
the extent we are found liable in a product liability case, we could be required to pay substantial amount of damages to an injured
customer, thereby impairing our financial condition.
We are dependent on the state of the PRC’s economy
as the majority of our business is conducted in the PRC.
Currently, the majority of our business
operations are conducted in the PRC, and most of our customers are also located in the PRC. Accordingly, any significant slowdown
in the PRC economy may cause our customers to reduce expenditures or delay the building of new facilities or projects. This may
in turn lead to a decline in the demand for our products and services. That would have a material adverse effect on our business,
financial condition and results of operations.
Our future success depends on our ability to help our
customers find, develop and acquire petroleum reserves.
To remain competitive in our industry, our
products must help our customers locate and develop or acquire new crude oil reserves to replace those depleted by production.
Without successful exploration or acquisition activities, our customers’ reserves, production and revenues will decline rapidly.
If the Domestic Companies’ and our technology is less well accepted for helping our customers locate additional reserves
than our competitors’ technology, our customers may terminate their relationships with us, which could have a material adverse
effect on our financial condition and future growth prospects.
Our customers are companies engaged in the petroleum industry,
and, consequently, our financial performance is dependent upon the economic conditions of that industry.
We have derived most of our revenues to
date from providing integrated automation services to Chinese petroleum companies at oilfields within China. Our customers’
success is intrinsically linked to economic conditions both in China and in the petroleum industry in general and the volatility
of prices of crude oil and refined products in particular. The petroleum industry, in turn, is subject to intense competitive pressures
and is affected by overall economic conditions. Demand for our services could be harmed by volatility in the petroleum industry.
There can be no assurance that we will be able to continue our historical revenue growth or sustain our profitability on a quarterly
or annual basis or that our results of operations will not be adversely affected by continuing or future volatility in the petroleum
Our revenues are highly dependent on a very limited number
of customers, which subjects our business to high seasonality. Our contracts with such customers may be terminated at any time,
materially and adversely affecting our business.
Historically, we derived the majority of
our revenues from two customers, (i) China National Petroleum Corporation (“CNPC”) and (ii) China Petroleum
and Chemical Corporation (“Sinopec”). Since the fiscal year ended June 30, 2017, Sinopec accounted for less than 5%
of our revenues.
We provide products and services to CNPC
under a series of agreements, each of which is terminable without notice. We first began to provide services to CNPC in 2000. CNPC
accounted for approximately 45%, 72% and 75% of our revenues in the fiscal years ended June 30, 2018, 2017 and 2016, respectively,
and any termination of our business relationships with CNPC would materially harm our operations.
In the fiscal year ended June 30, 2018,
we had a new client of chemical plants, which accounted for approximately 43.29% of our revenues. We also signed a series of contracts
with Shenhua Group Corporation Limited (“Shenhua Group”) and expect to receive significant revenue from it in the fiscal
year 2019. Any termination of our business relationships with CNPC or any other major client would materially harm our operations.
Because we derive such a high percentage
of our revenues from CNPC and a few new clients, our revenue has been subject to high seasonality. We recognize revenue when it
is realized and earned. We consider revenue realized or realizable and earned when (1) we have persuasive evidence of an arrangement,
(2) delivery has occurred, (3) the sales price is fixed or determinable, and (4) collectability is reasonably assured.
Because these matters depend on reaching agreements with these clients, revenue recognition occurs, to a large extent, on their
schedule. Accordingly, revenue recognized in the first quarter is usually the smallest in proportion to that for the whole year,
due to our clients’ budgeting and planning schedules. If these clients were to change its budgeting or planning schedule
our high and low quarters could also shift. This seasonality limits our ability to make accurate long-term predictions about our
performance and makes it difficult to compare our revenues across quarters.
Changes in environmental and regulatory factors may harm
The oil drilling industry in China to date
has not been subject to the type and scope of regulation seen in Europe and the United States. However, the Chinese government
may implement new legislation or regulations or may enforce existing laws more stringently. Either of these scenarios may have
a significant impact on our customers’ mining and extraction operations and may require us or our customers to significantly
change operations or to incur substantial costs. We believe that the Domestic Companies’ and our operations in China are
in compliance with China’s applicable legal and regulatory requirements. However, there can be no assurance that China’s
central or local governments will not impose new, stricter regulations or interpretations of existing regulations that would require
Petroleum reserve degradation and depletion may reduce
our customers’ and our profitability.
Our profitability depends substantially
on our ability to help our customers exploit their oil reserves at competitive costs. Replacement reserves may not be available
to our customers when required or, if available, may not be drilled at costs comparable to those characteristics of the depleting
oilfield. The Domestic Companies’ and our technology may not enable our customers to accurately assess the geological characteristics
of any new reserves, which may adversely affect their decision to use the Domestic Companies’ and our products in the future.
We are heavily dependent upon the services of experienced
personnel who possess skills that are valuable in our industry, and we may have to actively compete for their services.
Our company is much smaller than our main
foreign competitors, including Schlumberger Limited, Honeywell International, Emerson Process Management and Rockwell Automation,
and we compete in large part on the basis of the quality of services we are able to provide our clients. As a result, we are heavily
dependent upon our ability to attract, retain and motivate skilled personnel to serve our clients. Many of our personnel possess
skills that would be valuable to all companies engaged in the integrated automation services industry. Consequently, we expect
that we will have to actively compete for these employees. Some of our competitors may be able to pay our employees more than we
are able to pay to retain them. Our ability to profitably operate is substantially dependent upon our ability to locate, hire,
train and retain our personnel. There can be no assurance that we will be able to retain our current personnel, or that we will
be able to attract or assimilate other personnel in the future. If we are unable to effectively obtain and maintain skilled personnel,
the development and quality of our technological products and the effectiveness of installation and training could be materially
We are substantially dependent upon our key personnel,
particularly Shenping Yin, our Chief Executive Officer, Mr. Chen Guangqiang, our Chief Technology Officer and Ms. Jia
Liu, our Chief Financial Officer.
Our performance is substantially dependent
on the performance of our executive officers and key employees. In particular, we rely on the services of:
Mr. Shenping Yin, Chief Executive Officer;
Mr. Chen Guangqiang, Chief Technology Officer; and
Ms. Jia Liu, Chief Financial Officer.
Each of these individuals would be difficult
to replace. We do not have in place “key person” life insurance policies on any of our employees. The loss of the services
of any of our executive officers or other key employees could substantially impair our ability to successfully develop new systems
and develop new programs and enhancements. In addition, we would need to spend considerable time and other resources to seek suitable
replacements, which might detract from our efforts to develop our business.
Our business is capital intensive and our growth strategy
may require additional capital, which may not be available on favorable terms or at all.
We may require additional cash resources
due to changed business conditions, implementation of our growth strategy or potential investments or acquisitions we may pursue.
To meet our capital needs, we may sell additional equity or debt securities or obtain additional credit facilities. The sale of
additional equity securities or other securities convertible into such equity securities could result in dilution of your holdings.
The incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operating and
financial covenants that would restrict our operations. Financing may not be available in amounts or on terms acceptable to us,
if at all. Any failure by us to raise additional funds on terms favorable to us, or at all, could limit our ability to expand our
business operations and could harm our overall business prospects.
We do not intend to pay dividends in the foreseeable future
and there are certain restrictions on the payment of dividend under PRC laws.
We have not previously paid any cash dividends,
and we do not anticipate paying any dividends on our ordinary shares. As we intend to remain in a growth mode, we intend to
reinvest any profits in the foreseeable future to grow the business. We cannot assure you that our operations will continue to
result in sufficient revenues to enable us to operate at profitable levels or to generate positive cash flows. Furthermore,
there is no assurance our Board of Directors will declare dividends even if we are profitable. Dividend policy is subject
to the discretion of our Board of Directors and will depend on, among other things, our earnings, financial condition, capital
requirements and other factors. If we determine to pay dividends on any of our ordinary shares in the future, we will be dependent,
in large part, on receipt of funds from the Domestic Companies.
We are a holding company with no operations
of our own and substantially all of our operations are conducted through Nanjing Recon and BHD, hereafter referred to as our Domestic
Companies, which are established as variable interest entities (“VIEs”) under the laws of the People’s Republic
of China (“PRC”). Our ability to pay dividends is dependent upon dividends and other distributions from the Domestic
Companies. Chinese legal restrictions permit payment of dividends to us by our Domestic Companies only out of their respective
accumulated net profits, if any, determined in accordance with Chinese accounting standards and regulations. Under Chinese law,
our Domestic Companies are required to set aside a portion (at least 10%) of their after-tax net income (after discharging all
cumulated loss), if any, each year for compulsory statutory reserve until the amount of the reserve reaches 50% of our Domestic
Companies’ registered capital. These funds may be distributed to shareholders at the time of each Domestic Company’s
wind up. Payments of dividends by Domestic Companies to us are also subject to restrictions including primarily the restriction
that foreign invested enterprises may only buy, sell and/or remit foreign currencies at those banks authorized to conduct foreign
exchange business after providing valid commercial documents. There are no such similar foreign exchange restrictions in the Cayman
Our certificates, permits, and license are subject to
governmental control and renewal, and the failure to obtain renewal would cause all or part of our operations to be suspended and
may have a material adverse effect on our financial condition.
We are subject to various PRC laws and regulations
pertaining to automation services for the petroleum extraction industry. We have obtained certain certificates, permits, and licenses
required for the operation of an automation services provider for the petroleum extraction industry and the manufacturing and distribution
of software and hardware products in the PRC.
During the application or renewal process
for our licenses and permits, we will be evaluated and re-evaluated by the appropriate governmental authorities and must comply
with the prevailing standards and regulations, which may change from time to time. In the event that we are not able to obtain
or renew the certificates, permits and licenses, all or part of our operations may be suspended by the government, which would
have a material adverse effect on our business and financial condition. Furthermore, if escalating compliance costs associated
with governmental standards and regulations restrict or prohibit any part of our operations, it may adversely affect our results
of operations and profitability.
Risks Related to Our Corporate Structure
PRC laws and regulations governing our businesses and
the validity of certain of our contractual arrangements are uncertain. In addition, changes in such PRC laws and regulations may
materially and adversely affect our business.
There are substantial uncertainties regarding
the interpretation and application of PRC laws and regulations, including, but not limited to, the laws and regulations governing
our business, and the enforcement and performance of our contractual arrangements with the Domestic Companies and their shareholders.
Recon Technology, Ltd (the “Company”),
Recon Technology Co., Limited (“Recon HK”), Jining Recon Technology Ltd. (“Recon JN”), Recon Investment
Ltd. (“Recon IN”) and Recon Hengda Technology (Beijing) Co., Ltd. (“Recon BJ”) are considered foreign persons
or foreign invested enterprises under PRC law. As a result, the Company, Recon-HK, Recon-JN, Recon-IN and Recon-BJ are subject
to PRC law limitations on foreign ownership of domestic companies. Although the primary business of the Domestic Companies falls
within a category in which foreign investment is currently encouraged, the uncertainty of PRC regulations and governmental policies
affecting foreign ownership may result in the Company being required to hold (or, conversely, being prohibited from holding), directly
or indirectly, a given percentage of the Domestic Companies’ equity interests. Our contractual arrangements with the Domestic
Companies and their shareholders, which allow us to substantially control the Domestic Companies through Recon-JN, are governed
by Chinese law. We cannot assure you, however, that we will be able to enforce these contracts. If we are unable to enforce these
contracts, we could be required to deconsolidate such Domestic Company from our financial results.
In addition, Chinese laws and regulations
limiting foreign ownership of domestic companies are relatively new and may be subject to change, and their official interpretation
and enforcement may involve substantial uncertainty. The effectiveness of newly enacted laws, regulations or amendments may be
delayed, resulting in detrimental reliance by foreign investors. New laws and regulations that affect existing and proposed future
businesses may also be applied retroactively.
The PRC government has broad discretion
in dealing with violations of laws and regulations, including levying fines, revoking business and other licenses and requiring
actions necessary for compliance. In particular, licenses and permits issued or granted to us by relevant governmental bodies may
be revoked at a later time by higher regulatory bodies. We cannot predict the effect of the interpretation of existing or new PRC
laws or regulations on our businesses. We cannot assure you that our current ownership and operating structure would not be found
in violation of any current or future PRC laws or regulations. As a result, we may be subject to sanctions, including fines, and
could be required to restructure our operations or cease to provide certain services. Any of these or similar actions could significantly
disrupt our business operations or restrict us from conducting a substantial portion of our business operations, which could materially
and adversely affect our business, financial condition and results of operations and future growth prospects.
Although we believe we comply and will continue
to comply with current PRC regulations, we cannot assure you that the PRC government would agree that these operating arrangements
comply with PRC licensing, registration or other regulatory requirements, with existing policies or with requirements or policies
that may be adopted in the future. If the PRC government determines that we do not comply with applicable law, it could revoke
our business and operating licenses, require us to discontinue or restrict our operations, restrict our right to collect revenues,
require us to restructure our operations, impose additional conditions or requirements with which we may not be able to comply,
impose restrictions on our business operations or on our customers, or take other regulatory or enforcement actions against us
that could be harmful to our business.
The PRC government may determine that the agreements we
use to control the Domestic Companies are not in compliance with applicable PRC laws, rules and regulations and are therefore unenforceable.
In the PRC, foreign invested enterprises
are forbidden or restricted to engage in certain specified businesses or industries which are sensitive to the economy. The Chinese
government periodically revises its list of encouraged, permitted, restricted, and forbidden industries. As we intend to centralize
our management and operation in the PRC without being restricted to conduct certain business activities which are important for
our current or future business but are restricted or might be restricted in the future, we believe the agreements between Recon-JN
and the Domestic Companies will be essential for our business operation. In order for Recon-JN to manage and operate our business
through the Domestic Companies in the PRC, these agreements were entered into under which almost all the business activities of
the Domestic Companies are managed and operated by Recon-JN and almost all economic benefits and risks arising from the business
of the Domestic Companies are transferred to Recon-JN.
Risks are associated with our operations
under the agreements with the Domestic Companies. If the PRC government determines that these agreements used to control the Domestic
Companies are unenforceable as they circumvent the PRC restrictions relating to foreign investment restrictions, the relevant regulatory
authorities would have broad discretion in dealing with such breach, including:
imposing economic penalties;
discontinuing or restricting our operations;
imposing conditions or requirements in respect of the agreements with the Domestic Companies with which we may not be able to comply;
requiring us to restructure the relevant ownership structure or operations;
taking other regulatory or enforcement actions that could adversely affect our business; and
revoking the business license and/or the licenses or certificates of Recon-JN, and/or voiding the agreements.
Any of these actions could have a material
adverse impact on our business, future operating prospects, financial condition and results of operations.
Our contractual arrangements with the Domestic Companies
and their respective shareholders may not be as effective in providing control over these entities as direct ownership.
We have no equity ownership interest in
the Domestic Companies and rely on contractual arrangements to control and operate such businesses. These contractual arrangements
may not be as effective in providing control over the Domestic Companies as direct ownership. For example, BHD could fail to take
actions required for our business or fail to pay dividends to Recon-JN despite its contractual obligation to do so. If the Domestic
Companies fail to perform under their agreements with us, we may have to rely on legal remedies under PRC law, which may not be
effective. In addition, we cannot assure you that any of the Domestic Companies’ shareholders would always act in our best
Regulations relating to offshore investment activities
by PRC residents may limit our ability to acquire PRC companies and could adversely affect our business.
In July 2014, SAFE promulgated the Circular
on Issues Concerning Foreign Exchange Administration Over the Overseas Investment and Financing and Roundtrip Investment by Domestic
Residents Via Special Purpose Vehicles, or Circular 37, which replaced Relevant Issues Concerning Foreign Exchange
Control on Domestic Residents’ Corporate Financing and Roundtrip Investment through Offshore Special Purpose Vehicles, or
Circular 75. Circular 37 requires PRC residents to register with local branches of SAFE in connection with
their direct establishment or indirect control of an offshore entity, referred to in Circular 37 as a “special
purpose vehicle” for the purpose of holding domestic or offshore assets or interests. Circular 37 further
requires amendment to a PRC resident’s registration in the event of any significant changes with respect to the special purpose
vehicle, such as an increase or decrease in the capital contributed by PRC individuals, share transfer or exchange, merger, division
or other material event. Under these regulations, PRC residents’ failure to comply with specified registration procedures
may result in restrictions being imposed on the foreign exchange activities of the relevant PRC entity, including the payment of
dividends and other distributions to its offshore parent, as well as restrictions on capital inflows from the offshore entity to
the PRC entity, including restrictions on its ability to contribute additional capital to its PRC subsidiaries. Further, failure
to comply with the SAFE registration requirements could result in penalties under PRC law for evasion of foreign exchange regulations.
As Circular 37 is newly-issued,
it is unclear how these regulations will be interpreted and implemented. In addition, different local SAFE branches may have different
views and procedures as to the interpretation and implementation of the SAFE regulations, and it may be difficult for our ultimate
shareholders or beneficial owners who are PRC residents to provide sufficient supporting documents required by the SAFE or to complete
the required registration with the SAFE in a timely manner, or at all. Any failure by any of our shareholders who is a PRC resident,
or is controlled by a PRC resident, to comply with relevant requirements under these regulations could subject us to fines or sanctions
imposed by the PRC government, including restrictions on Recon-JN’s ability to pay dividends or make distributions to us
and on our ability to increase our investment in the Recon-JN.
Under Circular 37, if a non-listed
special purpose vehicle uses its own equity or share option to grant equity incentive awards to directors, supervisors, members
of senior management or employees directly employed by a domestic enterprise that is directly or indirectly controlled by such
special purpose vehicle, or with which such employee has established an employment relationship, any of such directors, supervisors,
members of senior management or employees who is a PRC resident should, prior to exercising their rights, file an application with
the SAFE for foreign exchange registration with respect to such special purpose vehicle. However, in practice, different local
SAFE branches may have different views and procedures as to the interpretation and implementation of the SAFE regulations and,
since Circular 37 was the first regulation to regulate the foreign exchange registration of a non-listed special
purpose vehicle’s equity incentive granted to PRC residents, there remains uncertainty with respect to its implementation.
Our contractual arrangements with the Domestic Companies
may result in adverse tax consequences to us.
As a result of our corporate structure and
contractual arrangements between Recon-JN and the Domestic Companies, we are effectively subject to several PRC taxes on both revenues
generated by Recon-JN’s operations in China and revenues derived from Recon-JN’s contractual arrangements with the
Domestic Companies. Moreover, we would be subject to adverse tax consequences if the PRC tax authorities were to determine that
the contracts between Recon-JN and the Domestic Companies were not on an arm’s length basis and therefore constitute a favorable
transfer pricing. As a result, the PRC tax authorities could request that we adjust our taxable income upward for PRC tax purposes.
If the PRC tax authorities took such action, such authorities would be able to establish in its sole discretion the amount of tax
payable by Recon-JN, so we cannot predict the effect of such action on our company other than the likely effect that our profits
would decrease. Such a pricing adjustment could adversely affect us by:
increasing our tax expenses, which could subject Recon-JN to late payment fees and other penalties for under-payment of taxes; and/or
resulting in Recon-JN’s loss of preferential tax treatment.
The principal shareholders of the Domestic Companies have
potential conflicts of interest with us, which may adversely affect our business.
Shenping Yin, our Chief Executive Officer,
and Chen Guangqiang, our Chief Technology Officer, are significant shareholders in our company. They are also the principal shareholders
of each of the Domestic Companies and collectively control the Domestic Companies. Conflicts of interests between their duties
to our company and the respective Domestic Companies may arise. For example, Mr. Yin and Mr. Chen could cause a Domestic
Company to fail to take actions that are in the best interests of our Company or to fail to pay dividends to Recon-JN despite its
contractual obligation to do so if making such payment would harm the Domestic Company.
As Mr. Yin and Mr. Chen are also
directors and executive officers of our company, they have duties of loyalty and care to us under Cayman Islands law when there
are any potential conflicts of interests between our company and the Domestic Companies. Each of Mr. Yin and Mr. Chen
has executed an irrevocable power of attorney to appoint the individual designated by us to be his attorney-in-fact to vote on
his behalf on all matters related to the Domestic Companies requiring shareholder approval. We cannot assure you, however, that
if conflicts of interest arise, they will act completely in our interests or that conflicts of interests will be resolved in our
favor. In addition, Mr. Yin and Mr. Chen could violate their respective employment agreements with us or their legal
duties by diverting business opportunities from us to others. If we cannot resolve any conflicts of interest between us and Mr. Yin
and Mr. Chen, as applicable, we would have to rely on legal proceedings, which could result in the disruption of our business.
Any deterioration of the relationship between Recon-JN
and the Domestic Companies could materially and adversely affect the overall business operation of our company.
Our relationship with our Domestic Companies
is governed by their agreements with Recon-JN, which are intended to provide us, through our indirect ownership of Recon-JN, with
effective control over the business operations of our Domestic Companies. However, these agreements may not be effective in providing
control over the applications for and maintenance of the licenses required for our business operations. Our Domestic Companies
could violate these agreements, go bankrupt, suffer from difficulties in its business or otherwise become unable to perform its
obligations under these agreements and, as a result, our operations, reputation, business and stock price could be severely harmed.
If Recon-JN exercises its purchase option of the Domestic
Companies’ equity pursuant to the Exclusive Equity Interest Purchase Agreement, payment of the purchase price could materially
and adversely affect our financial position.
Under the Exclusive Equity Interest Purchase
Agreement, Recon-JN holds an option to purchase all or a portion of the equity of the Domestic Companies at a price, based on the
capital paid in by the Domestic Company shareholders. If applicable PRC laws and regulations require an appraisal of the equity
interest or provide other restriction on the purchase price, the purchase price shall be the lowest price permitted under the applicable
PRC laws and regulations. As the Domestic Companies are already contractually controlled affiliates to our company, Recon-JN’s
purchase of the Domestic Companies’ equity would not bring immediate benefits to our company and the exercise of the option
and payment of the purchase prices could adversely affect our financial position and available working capital.
Our classified board structure may prevent a change in
Our board of directors is divided into three
classes of directors. The current terms of the directors expire in 2018, 2019 and 2020. Directors of each class are chosen for
three-year terms upon the expiration of their current terms, and each year one class of directors is elected by the shareholders.
The staggered terms of our directors may reduce the possibility of a tender offer or an attempt at a change in control, even though
a tender offer or change in control might be in the best interest of our shareholders.
Shareholder rights under Cayman Islands law may differ
materially from shareholder rights in the United States, which could adversely affect the ability of us and our shareholders to
protect our and their interests.
Our corporate affairs are governed by our
amended and restated memorandum and articles of association, by the Companies Law (2018 Revision) and the common law of the Cayman
Islands. The rights of shareholders to take action against the directors, 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 in the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from
English common law, the decisions of whose courts are of persuasive authority but are not binding on a court in the Cayman Islands.
In particular, the Cayman Islands has a less developed body of securities laws as compared to the United States, and some states,
such as Delaware, have more fully developed and judicially interpreted bodies of corporate laws. Moreover, our company could be
involved in a corporate combination in which dissenting shareholders would have no rights comparable to appraisal rights which
would otherwise ordinarily be available to dissenting shareholders of United States corporations. However, Cayman Islands statutory
law does provide a mechanism for a dissenting shareholder in a merger or consolidation to apply to the Grand Court for a determination
of the fair value of the dissenter’s shares if it is not possible for the dissenter and the Company to agree a fair price
within the time limits prescribed. Also, our Cayman Islands counsel is not aware of a significant number of reported derivative
actions having been brought in Cayman Islands courts. Class actions are not recognized in the Cayman Islands, but groups of shareholders
with identical interests may bring representative proceedings which are similar. Such actions are ordinarily available in respect
of United States corporations in U.S. courts. Finally, Cayman Islands companies may not have standing to initiate shareholder derivative
action before the federal courts of the United States. As a result, our public shareholders may face different considerations in
protecting their interests in actions against the management, directors or our controlling shareholders than would shareholders
of a corporation incorporated in a jurisdiction in the United States, and our ability to protect our interests may be limited if
we are harmed in a manner that would otherwise enable us to sue in a United States federal court.
As we are a Cayman Islands company and most of our assets
are outside the United States, it will be extremely difficult to acquire jurisdiction and enforce liabilities against us and our
officers, directors and assets based in China.
We are a Cayman Islands exempt company,
and our corporate affairs are governed by our Memorandum and Articles of Association and by the Cayman Islands Companies Law (2018
Revision) and other applicable Cayman Islands laws. Certain of our directors and officers reside outside of the United States.
In addition, the Company’s assets will be located outside the United States. As a result, it may be difficult or impossible
to effect service of process within the United States upon our directors or officers and our subsidiaries, or enforce against any
of them court judgments obtained in United States’ courts, including judgments relating to United States federal securities
laws. In addition, there is uncertainty as to whether the courts of the Cayman Islands and of other offshore jurisdictions would
recognize or enforce judgments of United States’ courts obtained against us predicated upon the civil liability provisions
of the securities laws of the United States or any state thereof on the grounds that such provisions are penal in nature, or be
competent to hear original actions brought in the Cayman Islands or other offshore jurisdictions predicated upon the securities
laws of the United States or any state thereof. Our Cayman Islands’ counsel has advised us that although there is no
statutory enforcement in the Cayman Islands of judgments obtained in the United States, the courts of the Cayman Islands will recognize
and enforce a foreign judgment of a court of competent jurisdiction if such judgment is final, for a liquidated sum, provided it
is not in respect of taxes or a fine or penalty, is not inconsistent with a Cayman Islands’ judgment in respect of the same
matters, and was not obtained in a manner which is contrary to the public policy of the Cayman Islands. A Cayman Islands court
may stay proceedings if concurrent proceedings are being brought elsewhere. Furthermore, because the majority of our assets are
located in China, it would also be extremely difficult to access those assets to satisfy an award entered against us in United
Risks Related to Doing Business in China
Adverse changes in China’s political, economic or
social conditions or government policies could have a material adverse effect on the overall economic growth of China, which could
reduce the demand for our products and materially adversely affect our competitive position.
We conduct substantially all of our operations
and generate most of our revenues in China. Accordingly, our business, financial condition, results of operations and prospects
are affected significantly by economic, political and legal developments in China. The PRC economy differs from the economies of
most developed countries in many respects, including:
the higher level of government involvement;
the early stage of development of the market-oriented sector of the economy;
the relatively rapid growth rate;
the higher level of control over foreign exchange; and
the allocation policies of resources.
While the PRC economy has grown significantly
since the late 1970s, the growth has been uneven, both geographically and among various sectors of the economy. The PRC government
has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures benefit
the overall PRC economy, but may also have a negative effect on our business. For example, our financial condition and results
of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable
The PRC economy has been transitioning from
a planned economy to a more market-oriented economy. The PRC government continues to exercise significant control over economic
growth in China through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary
policy and imposing policies that impact particular industries or companies in different ways.
Uncertainties with respect to the PRC legal system could
limit the legal protections available to you and us.
We conduct substantially all of our business
through our operating subsidiary in the PRC, Recon-JN, which is a wholly foreign owned enterprise in China. The Company also wholly
owns Recon-BJ, which was incorporated under the laws of the PRC, through Recon-IN. Recon-JN and Recon-BJ are generally subject
to laws and regulations applicable to foreign invested enterprises in China and intellectual property protections. The PRC legal
system is based on written statutes, and prior court decisions may be cited for reference but have limited precedential value.
Since the late 1970s, a series of new PRC laws and regulations have significantly enhanced the protections afforded to intellectual
property rights and various forms of foreign investments in China. However, since these laws and regulations are relatively new
and the PRC legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform
and enforcement of these laws, regulations and rules involve uncertainties, which may limit legal protections available to you
and us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management
We do not have business interruption, litigation or natural
The insurance industry in China is still
at an early stage of development. In particular PRC insurance companies offer limited business products. As a result, we do not
have any business liability or disruption insurance coverage for our operations in China. Any business interruption, litigation
or natural disaster may result in our business incurring substantial costs and the diversion of resources.
We may be subject to foreign exchange controls in the
Our PRC subsidiary and affiliates are subject
to PRC rules and regulations on currency conversion. In the PRC, the State Administration for Foreign Exchange (“SAFE”)
regulates the conversion of the RMB into foreign currencies. Currently, foreign investment enterprises (“FIEs”) are
required to apply to SAFE for “Foreign Exchange Registration Certificate for FIEs.” Recon-JN and Recon-BJ are FIEs.
With such registration certifications (which need to be renewed annually), FIEs are allowed to open foreign currency accounts including
the “recurrent account” and the “capital account.” Currently, conversion within the scope of the “recurrent
account” can be effected without requiring the approval of SAFE. However, conversion of currency in the “capital account”
(e.g. for capital items such as direct investments, loans, securities, etc.) still requires the approval of SAFE. Accordingly,
compliance with SAFE requirements may limit how we are able to use our funds, in ways that we would not be limited if we operated
in countries other than China.
Fluctuations in exchange rates could adversely affect
the value of our securities.
Changes in the value of the RMB against
the U.S. dollar and other foreign currencies are affected by, among other things, changes in China’s political and economic
conditions. Any significant revaluation of the RMB may have a material adverse effect on the value of, and any dividends payable
on our shares in U.S. dollar terms. For example, if we decide to convert our RMB into U.S. dollars for the purpose of paying dividends
on our ordinary shares or for other business purposes, appreciation of the U.S. dollar against the RMB would have a negative effect
on the U.S. dollar amount available to us.
Since July 2005, the RMB is no longer pegged
to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant
short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar
in the medium to long term. Moreover, it is possible that in the future PRC authorities may lift restrictions on fluctuations in
the RMB exchange rate and lessen intervention in the foreign exchange market.
Very limited hedging transactions are available
in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions. We do
not plan to enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited,
and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified
by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies.
Recent PRC regulations relating to the establishment of
offshore special purpose vehicles by PRC residents, if applied to us, may subject our PRC resident shareholders to personal liability
and limit our ability to acquire PRC companies or to inject capital into Recon-JN, Recon-HK, Recon-IN and Recon-BJ, limit Recon-JN’s,
Recon-HK’s, Recon-IN’s and Recon-BJ’s ability to distribute profits to us or otherwise materially adversely affect
On October 21, 2005, SAFE issued a public
notice, the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Return Investment Through Special Purpose
Companies by Residents Inside China, or the SAFE notice, which requires PRC residents, including both legal persons and natural
persons, to register with the competent local SAFE branch before establishing or controlling any company outside of China, referred
to as an “offshore special purpose company,” for the purpose of overseas equity financing involving onshore assets
or equity interests held by them. In addition, any PRC resident that is the shareholder of an offshore special purpose company
is required to amend its SAFE registration with the local SAFE branch with respect to that offshore special purpose company in
connection with any increase or decrease of capital, transfer of shares, merger, division, equity investment or creation of any
security interest over any assets located in China. Moreover, if the offshore special purpose company was established and owned
the onshore assets or equity interests before November 1, 2005, a retroactive SAFE registration is required to have been completed
before March 31, 2006. If any PRC shareholder of any offshore special purpose company fails to make the required SAFE registration
and amendment, the PRC subsidiaries of that offshore special purpose company (Recon-JN, Recon-HK, Recon-IN and Recon-BJ for our
company) may be prohibited from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation
to the offshore special purpose company. Moreover, failure to comply with the SAFE registration and amendment requirements described
above could result in liability under PRC laws for evasion of applicable foreign exchange restrictions.
Due to lack of official interpretation,
some of the terms and provisions in the SAFE notice remain unclear and implementation by central SAFE and local SAFE branches of
the SAFE notice has been inconsistent since its adoption. Because of uncertainty over how the SAFE notice will be interpreted and
implemented, we cannot predict how it will affect our business operations or future strategies. For example, Recon-JN’s,
Recon-HK’s, Recon-IN’s, Recon-BJ’s and any prospective PRC subsidiaries’ ability to conduct foreign exchange
activities, such as the remittance of dividends and foreign currency-denominated borrowings, may be subject to compliance with
the SAFE notice by our company’s PRC resident beneficial holders. In addition, such PRC residents may not always be able
to complete the necessary registration procedures required by the SAFE notice. We also have little control over either our present
or prospective direct or indirect shareholders or the outcome of such registration procedures. A failure by our PRC resident beneficial
holders or future PRC resident shareholders to comply with the SAFE notice, if SAFE requires it, could subject us to fines or legal
sanctions, restrict our overseas or cross-border investment activities, limit our subsidiary’s ability to make distributions
or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.
Under the Enterprise Income Tax Law, we may be classified
as a “Resident Enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and
our non-PRC shareholders.
China passed the Enterprise Income Tax Law,
or the EIT Law, and it is implementing rules, both of which became effective on January 1, 2008. Under the EIT Law, an enterprise
established outside of China with “de facto management bodies” within China is considered a “resident enterprise,”
meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. The implementing
rules of the EIT Law define de facto management as “substantial and overall management and control over the production and
operations, personnel, accounting, and properties” of the enterprise.
On April 22, 2009, the State Administration
of Taxation of China, or the SAT, issued the Circular Concerning Relevant Issues Regarding Cognizance of Chinese Investment Controlled
Enterprises Incorporated Offshore as Resident Enterprises pursuant to Criteria of de facto Management Bodies, or the SAT Notice
82, further interpreting the application of the EIT Law and its implementation to offshore entities controlled by a Chinese enterprise
or enterprise group. Pursuant to the SAT Notice 82, an enterprise incorporated in an offshore jurisdiction and controlled by a
Chinese enterprise or enterprise group will be classified as a “non-domestically incorporated resident enterprise”
if (i) its senior management in charge of daily operations reside or perform their duties mainly in China; (ii) its financial or
personnel decisions are made or approved by bodies or persons in China; (iii) its substantial assets and properties, accounting
books, corporate stamps, board and shareholder minutes are kept in China; and (iv) at least half of its directors with voting rights
or senior management often resident in China. After SAT Notice 82, the SAT issued a bulletin, known as SAT Bulletin 45, which took
effect on September 1, 2011, to provide more guidance on the implementation of SAT Notice 82 and clarify the reporting and filing
obligations of such “non-domestically incorporated resident enterprise.” SAT Bulletin 45 provides procedures and administrative
details for the determination of resident status and administration on post-determination matters. On January 29, 2014, the SAT
issued Announcement of the State Administration of Taxation on Recognizing Resident Enterprises Based on the Criteria of de facto
Management Bodies, to further clarify the reporting and filing procedure for offshore entities controlled by a Chinese enterprise
or enterprise group and recognized as a resident enterprise.
The determining criteria set forth in SAT
Notice 82 and SAT Bulletin 45 may reflect the SAT’s general position on how the “de facto management body” test
should be applied in determining the tax resident status of offshore enterprises, regardless of whether they are controlled by
PRC enterprises, PRC enterprise groups or by PRC or foreign individuals. If the PRC tax authorities determine that Recon or its
subsidiaries is a PRC resident enterprise for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences
could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as
PRC enterprise income tax reporting obligations. In our case, this would mean that income such as non-China source income would
be subject to PRC enterprise income tax at a rate of 25%. Currently, we do not have any non-China source income, as we complete
our sales, including export sales, in China. Second, under the EIT Law and its implementing rules, dividends paid to us from our
PRC subsidiaries would be deemed as “qualified investment income between resident enterprises” and therefore qualify
as “tax-exempt income” pursuant to the clause 26 of the EIT Law. Finally, it is possible that future guidance issued
with respect to the new “resident enterprise” classification could result in a situation in which the dividends we
pay with respect to our ordinary shares, or the gain our non-PRC shareholders may realize from the transfer of our ordinary shares,
may be treated as PRC-sourced income and may therefore be subject to a 10% PRC withholding tax. If we are required under the EIT
Law and its implementing regulations to withhold PRC income tax on dividends payable to our non-PRC shareholders, or if non-PRC
shareholders are required to pay PRC income tax on gains on the transfer of their shares of ordinary shares, our business could
be negatively impacted and the value of your investment may be materially reduced. Further, if we were treated as a “resident
enterprise” by PRC tax authorities, we would be subject to taxation in both China and such countries in which we have taxable
income, and our PRC tax may not be creditable against such other taxes.
PRC regulations and potential registration requirements
relating to acquisitions of PRC companies by foreign entities may create regulatory uncertainties that could restrict or limit
our ability to operate.
On August 8, 2006, six PRC regulatory agencies,
including the PRC Ministry of Commerce (“MOC”), the State-owned Assets Supervision and Administration Commission of
the State Council, the State Administration of Taxation, the State Administration for Industry and Commerce, the China Securities
Regulatory Commission (“CSRC”) and SAFE, jointly adopted the Regulations on Mergers and Acquisitions of Domestic
Enterprises by Foreign Investors, or the M&A Rules, which came into effect on September 8, 2006 and was amended on June 22,
2009. The M&A Rules significantly revised China’s regulatory framework governing onshore-to-offshore restructurings
and foreign acquisitions of domestic enterprises. These new rules signify greater PRC government attention to cross-border merger,
acquisition and other investment activities, by confirming MOC as a key regulator for issues related to mergers and acquisitions
in China and requiring MOC approval of a broad range of merger, acquisition and investment transactions. Further, the new rules
establish reporting requirements for acquisition of control by foreigners of companies in key industries and reinforce the ability
of the Chinese government to monitor and prohibit foreign control transactions in key industries.
Among other things, the M&A Rules include
new provisions that purport to require that an offshore SPV, formed for listing purposes and controlled directly or indirectly
by PRC companies or individuals must obtain the approval of the CSRC prior to the listing and trading of such SPV’s securities
on an overseas stock exchange. On September 21, 2006, the CSRC published on its official website procedures specifying documents
and materials required to be submitted to it by SPVs seeking CSRC approval of their overseas listings. However, the application
of this PRC regulation remains unclear with no consensus currently existing among the leading PRC law firms regarding the scope
and applicability of the CSRC approval requirement.
If the PRC regulatory authorities take the
view that the VIE Agreements constitute a reverse merger acquisition or round-trip investment in related party transactions without
the approval of the national offices of MOC, they could invalidate the VIE Agreements. Additionally, the PRC regulatory authorities
may take the view that any public offering plan will require the prior approval of CSRC. If we cannot obtain MOC or CSRC approval
in case we are required to do so, our business and financial performance will be materially adversely affected. We may also face
regulatory actions or other sanctions from the MOC or other PRC regulatory agencies. These regulatory agencies may impose fines
and penalties on our operations in the PRC, limit our operating privileges in the PRC, delay or restrict the repatriation of the
proceeds of this or any other offering into the PRC, or take other actions that could have a material adverse effect on our business,
financial condition, results of operations, reputation and prospects, as well as the trading price of our ordinary shares.
Also, if the CSRC later requires that we
obtain its approval, we may be unable to obtain a waiver of the CSRC approval requirements, if and when procedures are established
to obtain such a waiver. Any uncertainties and/or negative publicity regarding this CSRC approval requirement could have a material
adverse effect on the trading price of our ordinary shares.
PRC registration requirements for stock option plans
of overseas publicly-listed companies may restrict our ability to adopt equity compensation plans for our directors and employees
or otherwise limit our PRC subsidiaries’ ability to distribute profits to us.
In February 2012, SAFE promulgated the Notice
on the Administration of Foreign Exchange Matters for Domestic Individuals Participating in the Stock Incentive Plans of Overseas
Listed Companies, or the Stock Option Notice, which replaced the Application Procedures of Foreign Exchange Administration
for Domestic Individuals Participating in Employee Stock Ownership Plans or Stock Option Plans of Overseas Publicly-Listed Companies
issued by SAFE on March 28, 2007. Under the Stock Option Notice and other relevant rules and regulations, PRC residents who participate
in stock incentive plan in an overseas publicly-listed company are required to register with SAFE or its local branches and complete
certain other procedures. Participants of a stock incentive plan who are PRC residents must collectively retain a qualified PRC
agent, which could be a PRC subsidiary of such overseas publicly listed company or another qualified institution selected by such
PRC subsidiary, to conduct the SAFE registration and other procedures with respect to the stock incentive plan on behalf of its
participants. Such participants must also collectively retain an overseas entrusted institution to handle matters in connection
with their exercise of stock options, the purchase and sale of corresponding stocks or interests and fund transfers. In addition,
the PRC agent is required to amend the SAFE registration with respect to the stock incentive plan if there is any material change
to the stock incentive plan, the PRC agent or the overseas entrusted institution or other material changes. We and our PRC employees
who have been granted stock options are subject to these regulations. Failure of our PRC stock option holders to complete their
SAFE registrations may subject these PRC residents to fines and legal sanctions and may also limit our ability to compensate
our employees and directors through equity compensation, limited our PRC subsidiaries’ ability to distribute dividends
to us, or otherwise materially adversely affect our business.
The Chinese government could change its policies toward
private enterprise or even nationalize or expropriate private enterprises, which could result in the total loss of our investment
in that country.
Our business is subject to significant political
and economic uncertainties and may be adversely affected by political, economic and social developments in China. Over the past
several years, the Chinese government has pursued economic reform policies including the encouragement of private economic activity
and greater economic decentralization. The Chinese government may not continue to pursue these policies or may significantly alter
them to our detriment from time to time with little, if any, prior notice.
Changes in policies, laws and regulations
or in their interpretation or the imposition of confiscatory taxation, restrictions on currency conversion, restrictions or prohibitions
on dividend payments to shareholders, devaluations of currency or the nationalization or other expropriation of private enterprises
could have a material adverse effect on our business. Nationalization or expropriation could even result in the total loss of our
investment in China and in the total loss of your investment in us.
We may be unable to establish and maintain an effective
system of internal control over financial reporting, and as a result we may be unable to accurately report our financial results
or prevent fraud.
The PRC historically has been deficient
in western style management, governance and financial reporting concepts and practices, as well as in modern banking, and other
control systems. Our current management has little experience with western style management, governance and financial reporting
concepts and practices, and we may have difficulty in hiring and retaining a sufficient number of qualified employees to work in
the PRC. As a result of these factors, and especially given that we are a publicly listed company in the U.S. and subject to regulation
as such, we may experience difficulty in establishing management, governance, legal and financial controls, collecting financial
data and preparing financial statements, books of account and corporate records and instituting business practices that meet western
standards. We may have difficulty establishing adequate management, governance, legal and financial controls in the PRC. Therefore,
we may, in turn, experience difficulties in implementing and maintaining adequate internal controls as required under Section 404
of the Sarbanes-Oxley Act of 2002 and other applicable laws, rules and regulations. This may result in significant deficiencies
or material weaknesses in our internal controls which could impact the reliability of our financial statements and prevent us from
complying with SEC rules and regulations and the requirements of the Sarbanes-Oxley Act of 2002. Any such deficiencies, weaknesses
or lack of compliance could have a materially adverse effect on our business and the public announcement of such deficiencies could
adversely impact our stock price.
Risks Related to Our Ordinary Shares
We are a foreign private issuer within the meaning of
the rules under the Exchange Act, and as such we are exempt from certain provisions applicable to United States domestic public
Because we are a foreign private issuer
under the Exchange Act, we are exempt from certain provisions of the securities rules and regulations in the United States that
are applicable to U.S. domestic issuers, including:
the rules under the Exchange Act requiring the filing of quarterly reports on Form 10-Q or current reports on Form 8-K with the SEC;
the sections of the Exchange Act regulating the solicitation of proxies, consents, or authorizations in respect of a security registered under the Exchange Act;
the sections of the Exchange Act requiring insiders to file public reports of their stock ownership and trading activities and liability for insiders who profit from trades made in a short period of time; and
the selective disclosure rules by issuers of material nonpublic information under Regulation FD.
We are required to file an annual report
on Form 20-F within four months of the end of each fiscal year. In addition, we intend to publish our results on a quarterly
basis through press releases, distributed pursuant to the rules and regulations of the NASDAQ Capital Market. Press releases relating
to financial results and material events are also furnished to the SEC on Form 6-K. However, the information we are required
to file with or furnish to the SEC is less extensive and less timely compared to that required to be filed with the SEC by
U.S. domestic issuers. As a result, you may not be afforded the same protections or information, which would be made available
to you, were you investing in a U.S. domestic issuer. As a Cayman Islands company listed on the NASDAQ Capital Market, we are subject
to the NASDAQ Capital Market corporate governance listing standards. However, NASDAQ Capital Market rules permit a foreign private
issuer like us to follow the corporate governance practices of its home country. Certain corporate governance practices in the
Cayman Islands, which is our home country, may differ significantly from the NASDAQ Capital Market corporate governance listing
standards. To the extent that we choose to utilize the home country exemption for corporate governance matters, our shareholders
may be afforded less protection than they otherwise would under the NASDAQ Capital Market corporate governance listing standards
applicable to U.S. domestic issuers. We follow home country practice with respect to annual shareholders meetings
You may experience future dilution as a result of future
In order to raise additional capital, we
may in the future offer additional ordinary shares or other securities convertible into or exchangeable for our ordinary shares
at prices that may not be the same as the price per share you paid. We may sell shares or other securities in any other offering
at a price per share that is less than the price per share paid by existing investors, and investors purchasing shares or other
securities in the future could have rights superior to existing shareholders. The price per share at which we sell additional ordinary
shares, or securities convertible or exchangeable into ordinary shares, in future transactions may be higher or lower than the
price per share paid by existing investors.
We do not intend to pay dividends in the foreseeable future.
We have never paid cash dividends on our
ordinary shares. We currently intend to retain our future earnings, if any, to finance the operation and growth of our business
and currently do not plan to pay any cash dividends in the foreseeable future.
Future sales of a significant number of our ordinary shares
in the public markets, or the perception that such sales could occur, could depress the market price of our ordinary shares.
Future sales of a substantial number of
our ordinary shares in the public markets, or the perception that such sales could occur, could depress the market price of our
ordinary shares and impair our ability to raise capital through the sale of additional equity securities. If any existing shareholder
or shareholders sell a substantial amount of our ordinary shares, the prevailing market price for our ordinary shares could be
adversely affected. In addition, if we pay for our future acquisitions in whole or in part with additionally issued ordinary shares,
your ownership interests in our company would be diluted and this, in turn, could have a material and adverse effect on the price
of our ordinary shares.
The market price for our securities may be volatile, which
could result in substantial losses to investors.
The market price for our ordinary shares
has been, and is likely to remain, volatile and subject to wide fluctuations in response to factors including the following:
actual or anticipated fluctuations in our quarterly operating results;
changes in the Chinese petroleum and energy industries;
changes in the Chinese economy;
announcements by our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments;
future sales of our ordinary shares;
period to period fluctuations in our financial results;
low trading volume of our ordinary shares;
additions or departures of key personnel; or
We expect that any other securities of our
Company are likely to be similarly volatile. In addition, the securities markets have from time to time experienced significant
price and volume fluctuations that are not related to the operating performance of particular companies. As a result, to the extent
shareholders sell our securities in negative market fluctuation, they may not receive a price per share that is based solely upon
our business performance. We cannot guarantee that shareholders will not lose some of their entire investment in our securities.