We are a holding company that conducts our
primary businesses through our PRC subsidiaries and operating entities (the “VIEs”). We primarily operate a one-stop
services for our clients on our Omni-channel advertising, precision marketing and data analysis system.
We derive our revenue principally by:
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l
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distributing the right to use search engine marketing service we purchased from key search engines to increase the sales lead
conversion rate for our clients’ business promotion on both mobile and PC searches;
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l
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selling Internet advertising space on our advertising portals and providing related data service to our clients through the
Internet advertising management systems developed and managed by us;
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l
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selling effective sales lead information; and
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l
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providing other related value-added technical services.
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We generated total revenues of US$58.1
million for the year ended December 31, 2019, compared with US$57.1 million in 2018. Net
loss attributable to our stockholders decreased significantly to approximately US$1.26 million for the year ended December 31,
2019, compared with a net loss attributable to our stockholders of US$14.0 million in 2018.
In early 2018, we commenced to expand our business into the blockchain industry and the related
technology. In January 2018, we announced our strategic partnership with Wuxi Jingtum Network Technology ("Jingtum”),
the credible blockchain ecology builder. This strategic partnership with Jingtum is focused on blockchain technology to build a
credible, fair and transparent platform for business opportunities and transactions. We aim to build a credible, traceable, and
highly secured blockchain application infrastructure platform and develop effective business applications, including both mobile
and web applications, to meet the large demand from the small and medium enterprises (“SMEs”). We believe that the
applications of blockchain in the field of business development and marketing can help SMEs build a new business ecosystem based
on algorithmic trust. With the introduction of blockchain technology, we will gradually shift our platform-centric services in
the past towards decentralizing services, solving trust issues in business cooperation and services and enhancing user vitality
and loyalties. We also plan to gradually shift from providing information services to providing transaction services for business
opportunities so as to create a multi-industry and cross-chain value-based internet sharing business.
For the years ended December 31, 2019 and
2018, as initiating our Business Opportunity Social Ecosystem (“BOSE”), we were in the process of developing two blockchain-technology
powered platform applications named BO!News and OMG, respectively. Our blockchain-powered platform together with the applications
aim to build a social community which facilitates various types of users, such as business owners, entrepreneurs, suppliers and
customers or any individual who is interested in starting up a business, to share business opportunities and related information
and allows users to conduct certain business transactions that can be recorded and verified through the blockchain-technology applied
by our applications. In return, our platform will use a reward point mechanism generated on blockchain in the form of token to
keep track and award the users for their contributions to our platform applications. These reward points are not associated with
any cryptocurrency and will not be listed in any crypto exchange can only be used within our BOSE, such as, exchange for our advertising
and marketing services.
In July 2018, BO!News,
our social network-based news/media mobile application on the blockchain platform was put into preliminary trial stage and downloadable
on the app store in China, and currently only the user behavior information is stored on the blockchain platform. No Martingale
Bonus Point, or “MBP” or “reward points” in form of token has been officially issued to the public and
was only issued to internal testing team for trial and error correction purposes during the trial operation. As we are
still in the early stages of researching and developing our blockchain-infrastructure platform, we continue our efforts to further
develop and adjust our blockchain-powered applications on the blockchain infrastructure platform, which is simultaneously developing
and optimizing, to meet our overall business strategy of blockchain technology, and make it a better synergism with our current
business and client base in 2020. Currently, BO!News is under major adjustments and upgrades,
and thus has not been commercially available. During the trial period, BO!News has generated no revenue. We expect to migrate
the underlying database of BO!News with OMG, our B2B2C blockchain-powered software application that is developed for data exchange,
data recording and data proof of transactions for public trust, with both functions of CRM plus, advertising and marketing. We
had originally scheduled to complete adjustments and upgrades of BO!News, to launch the OMG for trial by the end of May 2020,
and to complete the integration of BO!News and OMG for commercial release by the end of 2020. However, due to the COVID-19 outbreak
in China during the first fiscal quarter of 2020, we currently anticipate that the releasing schedule will likely be postponed
for 1 to 2 months. An updated timeline will be further communicated with the public after
it has become available.
We have engaged RedRun
Limited (“RedRun”) and Beijing Shengshi Kaida Technical Service Co., Ltd. (“Shengshi Kaida”) for the development
of OMG and Bo!News, respectively. Total contract amounts for OMG and Bo!News is US$4.5 million and US$0.43 million, respectively.
The following table summarized the material remaining development costs of these blockchain-powered
applications as of December 31, 2019.
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Total
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Paid in
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Estimated Payment Schedule
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Amount
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Q1 2020
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Q3 2020
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Q4 2020
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(Amounts expressed in thousands of US dollar)
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Remaining development costs under RedRun Agreement:
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965
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300
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440
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225
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Remaining development costs under Shengshi Kaida Agreement
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85
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-
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85
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-
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Total Remaining Development Costs:
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1,050
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300
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525
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225
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Our platform will support
two blockchain-powered Apps: BO!News and OMG.
Our users will use BO!News
on account of that we publish it as an App for life and entrepreneurial social interaction app, which enables its future users
an much easier access to daily news, social medias and social information associating with daily life events and entrepreneurship.
In chorus, they can contribute and share their own experiences by generating their personal contents in writing, forwarding from
other medias, streaming or short videos. In return, they would be rewarded with MBP in form of token, which are recorded on the
blockchain for a transparent and creditable proof with a fixed value (which value is not finally determined yet). The MBP, i.e.
the reward points in form of token issued by the BO!News App, are not associated with cryptocurrency and will not be listed in
any crypto exchange. These reward points are also not transferrable and can only be used to exchange goods or products within
our ecosystem, i.e. the BOSE, of ChinaNet. For example, to exchange for advertising service, or other gifts offered on the App,
which will be further identified to the public when the DAU (“Daily Active User”) of BO!News App reaches sustainable
level. With the anticipated sustainable level of DAU on the App, we would also be able to introduce BO!News as a new marketing
channel for our existing client base, as well as acquisition of new clients, and to generate additional recurring internet advertising
revenues accordingly.
OMG is developed for a
larger business scope than BO!News, and is similar to an App called StorCard in Germany, but with more functions. OMG App will
enable users (consumers and merchants) to integrate other stores’ reward/loyalty point cards into OMG point consolidation
and exchange system built on the blockchain infrastructure platform. OMG will be also featured with its blockchain-powered CRM
plus and Advertising sharing system that combines with all previous advertising technology we have developed and sourced throughout
years. It will provide both consumers and merchants a very easy in-and-cross store spending experience through a combined reward
card, which will help consumers managing all of their different reward/loyalty points cards in a single way. Merchants will also
get benefit of using it as a marketing platform to push their advertising or promotion to their and non-competitors’ customer
bases. For example: Merchant A and B are both OMG App’s participating merchants, as a result, their customers’ loyalty
points databases are connected to OMG through secured API system. User X is a customer of both Merchant A and Merchant B, who
wants to redeem a gift card with Merchant B’s loyalty/reward points, however, he does not have enough Merchant B’s
loyalty/reward points. Through the OMG App, User X makes an offer of exchange Merchant A’s loyalty/reward points for Merchant
B’s loyalty/reward points, and the OMG App matching system has found User Y, who wants to exchange Merchant B’s loyalty/reward
points for Merchant A’s points for redeeming a reward gift in Merchant A. User X and Y are then acknowledged by the OMG
App interactively, and then are able to exchange the loyalty/reward points for their specific needs based on their own negotiated
exchange rate between Merchant A and Merchant B’s loyalty/reward points. Their transaction will be executed by the agreed
terms input onto smart contract through the OMG App and recorded on the public chain for transaction authentication and verification.
In addition, this transaction activity will be recorded by the OMG App, and User X and Y will also be rewarded with the loyalty
points issued by OMG for conducting this transaction on OMG, which will be recorded and stored on our hyperledger blockchain in
the form of token.
Hence, all the behaviors,
including the merchants’ reward/loyalty points exchange transaction mentioned previously, conducted both personal or business-oriented
within OMG will be rewarded with points issued by the platform in form of token (“OMG reward points”). Same as the
points rewarded to the users of the BO!News App, the OMG reward points issued in form of token are also not associated with cryptocurrency,
and will not be listed in any crypto exchange. These reward points will grant privileges on higher sales discount, better point
consumption rate, credit rating, faster matching and so forth, which rules will be finalized before our final commercial release
of the OMG App, and will only be used for the business or consumption purposes within the BOSE of ChinaNet. Our final blockchain
platform has been designed and is developing to adopt both hyperledger and public chains in a hybrid structure.
We anticipant to generate
service revenues from our participating merchants for using our blockchain-powered OMG application. With sustainable level of DAU
on this App, we also anticipant to generate additional recurring internet advertising service revenues on OMG application from
our existing client base, as well as from new customers in future periods.
We have been building our
blockchain infrastructure platform on Ethereum platform, and is now integrating with hyperledger solution to ensure the openness
and easiness of the blockchain platform. The risks involved in our blockchain platform including but not exclusive to, the security
risk, infrastructure risk, transition (blackhole) risk and so forth. As such, any malfunction, breakdown, divergence or abandonment
of the Ethereum platform may have an adverse effect on the our blockchain-powered platform. As a result, we are in the process
of testing and integrating with hyperledger and other public cross-chain solution, to minimize related risks and challenges.
As in our planning, we intend
to issue reward points in the form of token for user interactions within our Apps and it is NOT officially implemented yet. As
previously mentioned, when users of our Apps (i.e. BO!News or OMG) post and share some contents, or conduct a transaction within
the App, they can get some rewards in the form of token as a proof recorded on the blockchain. The reward points will also be given
to the users when their article attracts internet traffics (i.e. clicks and viewings) and interactions (i.e. messages or the click
on the ads within the content). The reason of using blockchain is to improve the social credibility of activities recorded and
transactions conducted. All the points received by the users are stored in the wallet of the Apps on the hyperledger chain, which
is in a closed environment. If a person mobile phone got stolen and his password of the mobile phone and App got cracked, then
his or her points will likely be stolen. But as these points can only be used within our BOSE ecosystem, hence it means zero value
outside of this ecosystem, and if we got informed in advance, we can manage to cancel the points and reissue the points to them
to prevent the owner’s possible losses. Finally, as stated previously, the reward point issued in form of token is not equivalent
to any cryptocurrency and will not be listed on any exchange.
We
appointed a new Chief Technology Officer in December 2019 and a Chief Business Officer in February 2020 to advance our development
of blockchain technology, explore new business opportunities in healthcare industry advertising, and facilitate the integration
of data analytics with artificial intelligence (“AI”). Moreover, to enhance the reliability of our future blockchain
services and optimize location for client proximity, we are in the process of expanding our corporate business and technology headquarters
to the city of Guangzhou in Southern China. We expect to officially open our new Guangzhou headquarters in either June or July
of 2020.
In
response to COVID-19, we are currently in the process of using our blockchain capabilities to launch a simple blockchain-powered
web application. This blockchain-powered web application is designed to help people better understand their current health status
and thus improve their decision making process regarding the choice to either stay at home or go to work. By better understanding
the potential risks, people will be able to go about their daily lives with fewer complications and respond to related concerns
more appropriately. In addition, other functions will be added to enhance people’s understanding of their own health status
as it relates to locations, workspaces, communities as well as friends and families. We plan to make the initial release free in
order to help people around the world understand whether or not they have the symptoms of COVID-19. This web application will be
released in multiple languages, including English, Italian, Spanish and Indonesian. We currently project the initial release date
for this web application to be early in the third quarter of 2020.
In
light of the Chinese government’s favorable policy towards the development of blockchain technology, we will continue focusing
on developing and promoting our blockchain-based platform services and products in the second half of 2020 as planned. We anticipate
that this will help us to not only cultivate more sources of recurring revenue, but also bolster our preparations for the expansion
into the Southeast Asian market in the near future.
Our Subsidiaries, Variable Interest Entities (VIEs) and
Ownership Interest Investment Affiliates
As of December 31, 2019, our corporate structure
is set forth below:
We were incorporated in the State of Texas
in April 2006 and re-domiciled to become a Nevada corporation in October 2006. On June 26, 2009, we consummated a share exchange
transaction with China Net Online Media Group Limited (“China Net BVI”) (the
“Share Exchange”). As a result of the Share Exchange, China Net BVI became
a wholly owned subsidiary of ours and we are now a holding company, which, through certain contractual arrangements with operating
companies in the People’s Republic of China (the “PRC”), is primarily engaged in providing advertising, precision
marketing, online to offline sales channel expansion and the related data and technical services to SMEs in the PRC.
Our subsidiaries and our VIE Structure
Our direct wholly owned subsidiary, China
Net BVI, was incorporated in the British Virgin Islands on August 13, 2007. On April 11, 2008, China Net BVI became the parent
holding company of a group of companies comprised of CNET Online Technology Co. Limited, a Hong Kong company (“China Net
HK”), which established, and is the parent company of, Rise King Century Technology Development (Beijing) Co., Ltd., a wholly
foreign-owned enterprise (“WFOE”) established in the PRC (“Rise King WFOE”). In October 2008, Rise King
WFOE acquired control over Business Opportunity Online (Beijing) Network Technology Co., Ltd. (“Business Opportunity Online”)
and Beijing CNET Online Advertising Co., Ltd. (“Beijing CNET Online”) (collectively the “PRC Operating Entities”
or the “VIEs”) by entering into a series of contracts (the “Contractual Agreements” or the “VIE Agreements”),
which enabled Rise King WFOE to operate the business and manage the affairs of the PRC Operating Entities.
The Special Administrative Measures for
Entrance of Foreign Investment (Negative List) (2019 Version), promulgated jointly by the Ministry of Commerce (“MOFCOM”)
and the National Development and Reform Commission on June 30, 2019 came into effective on July 30, 2019 (the “2019 Negative
List”). The 2019 Negative List classified various industries/business into three different categories: (i) encouraged for
foreign investment, (ii) restricted to foreign investment and (iii) prohibited from foreign investment. For any industry/business
not covered by any of these three categories, they will be deemed to be industries/business permitted to have foreign investment.
Except for those expressly provided restrictions, encouraged and permitted industries/businesses are usually open to foreign investment
and ownership. With regard to those industries/businesses restricted to or prohibited from foreign investment, there is always
a limitation on foreign investment and ownership.
The business of the PRC Operating Entities
falls under the class of a business that provides Internet content or information services, a type of value-added telecommunication
services, for which restrictions upon foreign ownership apply. The 2019 Negative List retains the restrictions on foreign ownership
related to value-added telecommunication services. As a result, Rise King WFOE is not allowed to conduct the business the PRC Operating
Entities companies are currently pursuing. Advertising business is open to foreign investment but used to require that the foreign
investors of a WFOE should have been carrying out advertising business for over three years pursuant to the Foreign Investment
Advertising Measures as amended by MOFCOM and the State Administration of Industry and Commerce (“SAIC”, currently
known as the State Administration for Market Regulations, (“SAMR”)) on August 22, 2008, which was repealed in June
29, 2015. Before June 29, 2015, Rise King WFOE was not allowed to engage in the advertising business because its shareholder, China
Net HK, did not meet such requirements. As a result, in order to control the business and operations of the PRC Operating Entities
and consolidate the financial results of the two companies in a manner that does not violate the related PRC laws, Rise King WFOE
executed the Contractual Agreements with the PRC Shareholders and each of the PRC Operating Entities.
Summary of the material terms of the VIE Agreements:
Exclusive Business Cooperation Agreements:
Pursuant to the Exclusive Business Cooperation
Agreements entered into by and between Rise King WFOE and each of the PRC Operating Entities, Rise King WFOE has the exclusive
right provide to the PRC Operating Entities complete technical support, business support and related consulting services during
the term of these agreements, which includes but is not limited to technical services, business consultations, equipment or property
leasing, marketing consultancy, system integration, product research and development, and system maintenance. In exchange for such
services, each PRC Operating Entity has agreed to pay a service fee consisting of a management fee and a fee for services provided,
to Rise King WFOE, which shall be determined by Rise King WFOE according to the following factors: the complexity and difficulty
of the services, seniority of and time consumed by the employees, specific contents, scope and value of the services, market price
of the same type of services, and operation conditions of the PRC Operating Entities. Each agreement shall remain effective unless
terminated in accordance with the provisions thereof or terminated in writing by Rise King WFOE.
Exclusive Option Agreements:
Under the Exclusive Option Agreements entered
into by and among Rise King WFOE, each of the PRC Shareholders irrevocably granted to Rise King WFOE, or its designated person,
an exclusive option to purchase, to the extent permitted by PRC law, a portion or all of their respective equity interest in any
PRC Operating Entities for a purchase price of RMB10, or a purchase price to be adjusted to be in compliance with applicable PRC
laws and regulations. Rise King WFOE, or its designated person, has the sole discretion to decide when to exercise the option,
whether in part or in full. Each of these agreements shall become effective upon execution and remain effective until all equity
interests held by the relevant PRC Shareholder(s) in the PRC Operating Entities have been transferred or assigned to Rise King
WFOE and/or any other person designated by Rise King WFOE.
Equity Pledge Agreements:
Under the Equity Pledge Agreements entered
into by and among Rise King WFOE, the PRC Operating Entities and each of the PRC Shareholders, the PRC Shareholders pledged all
of their equity interests in the PRC Operating Entities to guarantee the PRC Operating Entities’ and the PRC Shareholders’
performance of the relevant obligations under the Exclusive Business Cooperation Agreements and other Contractual Agreements. If
the PRC Operating Entities or any of the PRC Shareholders breaches its/his/her respective contractual obligations under these agreements,
or upon the occurrence of one of the events regarded as an event of default under each such agreement, Rise King WFOE, as pledgee,
will be entitled to certain rights, including the right to dispose of the pledged equity interests. The PRC Shareholders of the
PRC Operating Entities agreed not to dispose of the pledged equity interests or take any actions that would prejudice Rise King
WFOE's interest, and to notify Rise King WFOE of any events or upon receipt of any notices which may affect Rise King WFOE's interest
in the pledge. Each of the equity pledge agreements will be valid until all the obligations under the Exclusive Business Cooperation
Agreements and other Contractual Agreements have been fulfilled, including the service fee payments related to the Exclusive Business
Cooperation Agreement are paid in full.
Irrevocable Powers of Attorney:
The PRC Shareholders have each executed
an irrevocable power of attorney to appoint Rise King WFOE as their exclusive attorneys-in-fact to vote on their behalf on all
PRC Operating Entities matters requiring shareholder approval. The term of each power of attorney is valid so long as such shareholder
is a shareholder of the respective PRC Operating Entity.
As a result of these Contractual Agreements,
we through our wholly-owned subsidiary, Rise King WFOE, were granted with unconstrained decision making rights and power over key
strategic and operational functions that would significantly impact the PRC Operating Entities or the VIEs’ economic performance,
which includes, but is not limited to, the development and execution of the overall business strategy; important and material decision
making; decision making for merger and acquisition targets and execution of merger and acquisition plans; business partnership
strategy development and execution; government liaison; operation management and review; and human resources recruitment and compensation
and incentive strategy development and execution. Rise King WFOE also provides comprehensive services to the VIEs for their daily
operations, such as operational technical support, office administration technical support, accounting support, general administration
support and technical support for products and services. As a result of the Exclusive Business Cooperation Agreements, the Equity
Pledge Agreements and the Exclusive Option Agreements, we will bear all of the VIEs’ operating costs in exchange for the
net income of the VIEs. Under these agreements, we have the absolute and exclusive right to enjoy economic benefits similar to
equity ownership through the VIE Agreements with our PRC Operating Entities and their shareholders. Due to the fact that Rise King
WFOE and its indirect parent are the sole interest holders of the VIEs, we included the assets, liabilities, revenues and expenses
of the VIEs in our consolidated financial statements, which is consistent with the provisions of FASB Accounting Standards Codification
("ASC") Topic 810 “Consolidation”, subtopic 10.
Please refer to the discussion of uncertainties
and risks in relation to our VIE Structure on page 13 under Business-Government Regulation contained in Item 1 and page 23 under
Risk Factors-Risks Relating to Regulation of Our Business and to Our Structure contained in Item 1A of this Annual Report.
As of December 31, 2019, besides China Net
BVI, China Net HK and Rise King WFOE, as discussed above, we also have three other indirectly wholly-owned investment holding companies,
ChinaNet Investment Holding Ltd, a British Virgin Islands company (“ChinaNet Investment BVI”), Grandon Investments
Limited, a British Virgin Islands company (“Grandon BVI”) and ChinaNet Online Holdings Co., Ltd., a PRC company (“ChinaNet
Online PRC”). ChinaNet Investment BVI co-incorporated ChinaNet Online Holdings Korea, a Korean company (“ChinaNet Korea”)
with four unaffiliated individuals and beneficially owns 15% equity interest in ChinaNet Korea. ChinaNet Online PRC co-incorporated
ChinaNet Chuang Tou (Shenzhen) Co., Ltd., a PRC company (“ChinaNet Chuang Tou”) with two unaffiliated individuals and
beneficially owns 19% equity interest in ChinaNet Chuang Tou. The business activities of ChinaNet Chuang Tou and ChinaNet Korea
are currently dormant. ChinaNet Online PRC also co-incorporated a majority-owned subsidiary, Business Opportunity Chain (Beijing)
Technology Development Co., Ltd., a PRC company (“Business Opportunity Chain”) with three unrelated parties, of which
ChinaNet Online PRC owns 51% equity interest. Business Opportunity Chain was established to perform research and develop and provide
other technical support for our blockchain business unit.
Our VIEs, VIEs’ subsidiaries and other ownership
interest investment affiliates
As discussed above, through Rise King WFOE,
we beneficially own two VIEs: Business Opportunities Online and Beijing CNET Online. Business Opportunities Online is primarily
engaged in providing Internet advertising, online to offline (O2O) precision marketing and related data service to the SMEs. Beijing
CNET Online is primarily engaged in providing TV advertising and other value-added technical services to the SMEs.
As of December 31, 2019, Business Opportunity
Online has the following directly or indirectly wholly-owned subsidiaries in PRC: Beijing Chuang Fu Tian Xia Network Technology
Co., Ltd. (“Beijing Chuang Fu Tian Xia”), Business Opportunity Online (Hubei) Network Technology Co., Ltd. (“Business
Opportunity Online Hubei”), Hubei CNET Advertising Media Co., Ltd. (“Hubei CNET”), Sheng Tian Network Technology
(Hubei) Co., Ltd. (“Sheng Tian Hubei”), Beijing Chuang Shi Xin Qi Advertising Media Co., Ltd. (“Beijing Chuang
Shi Xin Qi”), Beijing Hong Da Shi Xing Network Technology Co., Ltd. (“Beijing Hong Da Shi Xing”) and Beijing
Shi Ji Cheng Yuan Advertising Media Co., Ltd. (“Beijing Shi Ji Cheng Yuan”). Except Hubei CNET and Sheng Tian Hubei,
which are currently dormant, the rest subsidiaries of Business Opportunity Online are all engaged in providing Internet advertising,
O2O precision marketing and related data service to the SMEs.
As of December 31, 2019, except for Local
Chain Xi’an Information Technology Co., Ltd. (“Local Chain Xi’an), in which we beneficially own a 4.9% equity
interest, the business activities of all other equity ownership interest investee entities of Business Opportunities Online and
Beijing CNET Online (except for those that result in consolidation) as indicated in our organization chart above are currently
dormant.
Industry and Market Overview
Overview of the Advertising Market in
China
According to the advertising spend forecasts
of Dentsu Aegis Network published in March 2020, the global advertising spend will reach US$615.4 billion, with an estimated growth
rate of 3.9% in 2020. Although the global coronavirus pandemic has aggravated the uncertainty of the global economic and advertising
industry, there is still a strong possibility that the virus spread could be constrained in the coming months, allowing for an
economy rebound in the second half of 2020.
China’s advertising market is slowing
in step with its economy and was also adversely affected by the COVID-19 outbreak in the first fiscal quarter of 2020, however,
still remains one of the key drivers of global growth of advertising. Dentsu Aegis Network forecasts that China’s total advertising
spend will grow by 3.9% and 5.4% in 2020 and 2021, respectively.
The growth of China’s advertising
market is driven by a number of factors, including the sustained economic growth and increases in disposable income and consumption
in China. China was the second largest economy in the world in terms of gross domestic product (“GDP”), which amounted
to approximately US$14.3 trillion in 2019. According to the National Bureau of Statistics of China, the annual disposable income
per capita in urban households increased to RMB42,359 in 2019, adjusted by the price factors, the actual increase was 5.0%.
Overview of the Internet Advertising
Industry
According to the advertising spend forecasts
of Dentsu Aegis Network published in March 2020, global ad-spend growth continues to be dominated by digital channels, which is
expected to grow 10.5% to reach approximately US$276 billion and 45% of the total ad-spend in 2020, and the share of mobile ad-spend
will exceed that of TV ad-spend in 2020.
In China, the Internet advertising market
growth is expected to stem primarily from a higher internet penetration rate of just 64.5% by the end of March 2020, compared with
59.6% by the end of 2018. Total internet users reached to approximately 904 million people by the end of March 2020, increased
by approximately 75.1 million people, compared with that as of December 31, 2018. (Please refer to the 45th China Internet Network
Development Statistical Report issued by China Internet Network Information Center (the “CNNIC”) in April 2020). According
to the 45th CNNIC report, as of March 2020, the mobile internet user reached to 897 million people, compared with 817 million people
as of December 2018, which accounted for 99.3% of the total internet users, as compared with 98.6% as of December 2018.
According to a report of iResearch Global
Group published in June 2019, online advertising revenue in China reached RMB484.4 billion Yuan (approximately US$70.2 billion)
in 2018 and was estimated to hit RMB625.5 billion Yuan (approximately US$90.7 billion) in 2019, up 29% year-over-year. Its growth
is forecasted to slow in step with its economy in the next few years. Mobile devices have become an indispensable part of people's
lives. At the same time, along with the mobile advertising industry chain keeps improving, driving the rapid growth of online advertising
revenue.
The diagram below depicts the Market Scale
of China’s Online Advertising from 2015 to 2021 and the industry trend in the next three years:
High Demand for the Internet Advertising from SMEs and O2O
Business in China
We believe that the Internet advertising
market in China has significant potential for future growth due to high demand from the rapid development of SMEs and O2O business.
The development of the SME market is still
in its early stages in China. Since their sales channels and distribution networks are still underdeveloped, they are driven to
search for new participants by utilizing Internet advertising and precision marketing. The SMEs tend to be smaller, less-developed
brands primarily focused on restaurants, garments, building materials, home appliances, and entertainment with low start-up costs.
The Chinese government has promulgated a series of laws and regulations to protect and promote the development of SMEs which appeals
to entrepreneurs looking to benefit from the central government’s support of increased domestic demand. SMEs are now
responsible for about 50% of China’s tax revenues, 60% of China’s GDP and employment of approximately 80% of the urban
Chinese workforce. SMEs are creating new urban jobs, and they are the main destination for new graduates entering the workforce
and workers laid-off from state-owned enterprises (SOEs) that re-enter the workforce.
In recent years, the capital market, Internet
giants and traditional offline services business in China have all accelerated their O2O business arrangement and development.
With the advent of the mobile Internet era, the innovation of user needs, and applications have become the main trend of the Internet,
including online payments, location-based services, online and offline interaction and more. Due to the slowdown of China’s
economy growth in recent years, the competitive market pressure within the local life services industry has increased. Under these
circumstances, more and more traditional offline service providers started to use the Internet-based tools (PC, tablet and mobile)
to market and promote their products and services. The rapid development of social media and tools, such as: WeChat and Weibo,
also have had a very important influence on the development of the O2O market, and using social media and tools to promote brands
and maintain customer relationships has become an important adverting and marketing trend for all offline business.
Our Principal Products and Services
Internet Advertising, Precision Marketing
and Related Data Services
Founded in 2003 and 2011, respectively,
28.com and liansuo.com are two of the leading Internet portals for information relating to small business opportunities in China,
and 28.com is one of the earliest entrants in this sector. In the past few years, we further developed and upgraded the system
and tools of our advertising portals, including customer user interface, and integrated our mobile functions. Besides our advertising
portals, we also have established solid partnership relations with key search engines in China which entitle us to the distribution
of the right to use their search engine marketing service which allows our customers to invest in their online advertising and
marketing campaign through multi-channel to maximize market exposure and effectiveness.
Our Internet advertising, precision marketing
and related data services provide advertisers with tools to build sales channels directly in the form of franchisees, sales agents,
distributors, and/or resellers, and have the following features which enable them to be attractive to the advertisers:
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Allowing potential entrepreneurs interested in inexpensive franchise and other business ventures
to find in-depth details about these businesses in various industries and business categories, with real-time and online assistance
through an instant messenger;
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Providing one-stop integrated Internet marketing and advertising services for SMEs by offering
customized services and advertisement placement on various communication channels through intelligent based promotion systems;
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Generating effective sales leads information; and
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Bundling with advanced traffic generation techniques, search-engine optimization and marketing
and other Internet advertising management tools to assist our clients with monitoring, analyzing and managing their advertising
and data collected on our web portal.
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We typically charge our clients a fixed
monthly fee for the Internet advertising and related data services that we provide on our ad portals. For distribution of the right
to use the search engine marketing service, revenue is recognized on a monthly basis and at a gross amount, based on the direct
cost consumed through search engines for providing such services with a premium, which typically is 3%-8%. A certain group of our
clients also purchase effective sales lead information collected by our online advertising system, and we charge a fixed fee, which
varies for different business types, for each effective sales lead information delivered to clients. For the year ended December
31, 2019, we had approximately 1,100 clients who used our Internet advertising, marketing and data services, compared with 800
clients for the year ended December 31, 2018. We achieved approximately US$56.9 million and US$57.0 million of Internet advertising,
precision marketing and related data and technical services revenues for the years ended December 31, 2019 and 2018, respectively.
The overall gross profit margin of this business segment increased to 8% for the year ended December 31, 2019 from 4% for the year
ended December 31, 2018.
Television Advertising
As part of our advertising and marketing services,
we distributed television shows that were comprised of advertisements similar to infomercials. The shows are distributed during
airtime we purchased from provincial satellite television stations. Due to the rapid development of Internet and mobile advertising
and the further restriction on content, air time and duration of these infomercials imposed by the State Administration of Press,
Publication, Radio, Film and Television of the PRC in recent years, the demands of our TV advertising service decreased accordingly.
For the year ended December 31, 2019, we did not generate any TV advertising revenues, as we did not finalize any advertising resources
contracts with suppliers during the year. For the year ended December 31, 2018, we recognized approximately US$0.12 million TV
advertising revenues. We will continue to monitor our clients’ needs of this service. In consideration of the sustained and
steady development of Internet advertising and the rapid development in mobile advertising, we expect future revenues contributed
from this segment will be insignificant.
Sales and Marketing
For the year ended December 31, 2019, we
derived 97.9% of total net revenues from our Internet advertising and the provision of related data and technical services, compared
with 99.8% for the year ended December 31, 2018.
We employ experienced advertising sales
people and provide in-house education and training to our sales people to ensure that they provide our current and prospective
clients with comprehensive information about our services, the benefits of using our advertising, marketing and data services and
relevant information regarding the advertising industry. We also market our advertising services from time to time by placing advertisements
on television and other well-known portals in China, participating in domestic and international franchise exhibitions in China
and other countries and acting as a sponsor to third-party programming and shows.
Suppliers
Our suppliers are major search engines,
Internet gateways, other advertising resources suppliers and regional television stations. Among these suppliers, for the year
ended December 31, 2019, resources purchased from two of the largest search engines in China counted for approximately 89%
and 3% of our search engine resource cost, respectively, compared with 85% and 11% for the year ended December 31, 2018, respectively.
For television, we had one provincial satellite television station which supplied us with television advertising airtime slots
in 2018.
Research and Development
We plan to increase expenditures to enhance
the safety of our hardware and server that we depend on to support our network and manage and monitor programs on the network in
future years. Whether we continue to further deploy newer technology will depend upon cost and network security. We also focus
on enhancing related software systems enabling us to track and monitor advertiser demands and the related data collection and analysis.
In the next few years, we intend to move our research and development efforts to mobile-based application system and data collection
and analysis tools, and our new blockchain-technology powered Business Opportunity Social Ecosystem.
Intellectual Property
As of December 31, 2019, we had twenty-four
software copyright certificates issued by the State Copyright Office of the PRC (“SCO”), including, but not limited
to, software systems covering monitor and management platforms on Internet advertising effects, analysis systems on Internet traffic
statistics and Internet user behavior, analysis systems on log-based visit hotspot and browsing trails, analysis systems on mobile
advertising platform and cloud-compute technology.
Competition
We compete with other Internet advertising
companies for business opportunities in China, including companies that also distribute the right to use the search engine marketing
services provide by key search engines in China, such as: Media Linkage Technology (Beijing) Co., Ltd., Guangzhou Jiuxing Hudong
Technology Co., Ltd., and Guangzhou Chengzhi Mingyuan Network Technology Co., Ltd, and companies that operate Internet advertising
portals, such as u88.cn, 3158.cn and 78.cn. We compete for clients primarily on the basis of network size and coverage, location,
price, the range of services that we offer and our brand name. We also compete for overall advertising spending with other alternative
advertising media companies, such as wireless telecommunications, street furniture, billboards, frame and public transport advertising
companies, and with traditional advertising media, such as newspapers, magazines and radio.
Government Regulation
The PRC government imposes extensive controls
and regulations over the media industry, including on internet, television, radio, newspapers, magazines, advertising, media content
production, and the market research industry. This section summarizes the principal PRC regulations that are relevant to our lines
of business.
Regulations on the Value-added Telecommunication
Services and Advertising Industry in China
Foreign Investments in Value-added Telecommunication
Services
The Foreign Investment Industrial Guidance
Catalogue restricts foreign investments in value-added telecommunication services, including providing Internet information services
(“ICP”). In accordance with the Regulations for the Administration of Foreign-Invested Telecommunications Enterprises
(“FITE Regulations”), which were issued by the State Council of the PRC on December 11, 2001, became effective
on January 1, 2002 and was subsequently amended on September 10, 2008 and February 6, 2016, respectively. The FITE
Regulations stipulate that foreign invested telecommunications enterprises in the PRC (“FITEs”) must be established
as Sino-foreign equity joint ventures. Under the FITE Regulations and in accordance with WTO-related agreements, the foreign party
to a FITE engaging in value-added telecommunications services may hold up to 50% of the equity of the FITE, with no geographic
restrictions on the FITE’s operations. On June 30, 2016, the MIIT issued an Announcement of the Ministry of Industry
and Information Technology (the “MIIT”) on Issues concerning the Provision of Telecommunication Services in the Mainland
by Service Providers from Hong Kong and Macao, which provides that investors from Hong Kong and Macau may hold more than 50% of
the equity in FITEs engaging in certain specified categories of value-added telecommunications services.
For a FITE to acquire any equity interest
in a value-added telecommunications business in China, it must satisfy a number of stringent performance and operational experience
requirements, including demonstrating a track record and experience in operating a value-added telecommunications business overseas.
FITEs that meet these requirements must obtain approvals from the MIIT and the MOFCOM or their authorized local counterparts, which
retain considerable discretion in granting approvals.
On July 13, 2006, the Notice of the
Ministry of Information Industry on Intensifying the Administration of Foreign Investment in Value-added Telecommunications Services
(the “MIIT Notice”), which reiterates certain provisions of the FITE Regulations, was issued. Under the MIIT Notice,
if a FITE intends to invest in a PRC value-added telecommunications business, the FITE must be established and must apply for a
telecommunications business license applicable to the business. Under the MIIT Notice, a domestic company that holds a license
for the provision of Internet content services, or an ICP license, is considered to be a type of value-added telecommunications
business in China, and is prohibited from leasing, transferring or selling the license to foreign investors in any form, and from
providing any assistance, including providing resources, sites or facilities, to foreign investors to conduct value-added telecommunications
businesses illegally in China. Trademarks and domain names that are used in the provision of Internet content services must be
owned by the ICP license holder or its shareholders. On November 27, 2017, the MIIT promulgated the Notice Regulating the
Use of Domain Names in the Provision of Internet-based Information Services, or the Domain Names Notice, which became effective
on January 1, 2018. Under the Domain Names Notice, a domain name used by a provider of Internet-based information services
must be registered and owned by the provider or, if the provider is an entity, by a shareholder or senior management of the provider.
Foreign Investments in Advertising
In accordance with the Administrative Provision
on Foreign Investment in the Advertising Industry, jointly promulgated by the SAIC (currently known as the SAMR) and MOFCOM on
August 22, 2008 and became effective on October 1, 2008, foreign investors can invest in PRC advertising companies either through
wholly owned enterprises or joint ventures with Chinese parties. However, the foreign investor must have at least three years of
direct operations outside China in the advertising industry as its core business. This requirement was reduced to two years if
foreign investment in the advertising company is in the form of a joint venture. The Administrative Provision on Foreign Investment
in the Advertising Industry was subsequently repealed by the SAIC (currently known as the SAMR) and MOFCOM on June 29, 2015.
In consideration of the above discussed
restrictions on foreign investments in ICP and advertising business, our whole-owned subsidiary in China, Rise King WFOE, is ineligible
to apply for the required licenses for providing Internet information services and was ineligible to apply for the required licenses
for providing advertising services in China before June 29, 2015. Our ICP business and advertising business are operated by Business
Opportunity Online and Beijing CNET Online in China. We have been, and are expected to continue to be, dependent on these companies
to operate our ICP business and advertising business. We do not have any equity interest in our PRC Operating Entities, but Rise
King WFOE receives the economic benefits of the same through the Contractual Arrangements.
We have been advised by our PRC counsel,
as of the date hereof, our current contractual arrangements with our VIEs and their respective shareholders are valid, binding
and enforceable. However, there exist substantial uncertainties regarding the application, interpretation and enforcement of current
and future PRC laws and regulations and their potential effect on our corporate structure and contractual arrangements.
On
March 15, 2019, the National People’s Congress of the PRC approved the Foreign Investment Law, which came into effect on
January 1, 2020, replaced the trio of existing laws regulating foreign investment in China, namely, the Sino-foreign Equity
Joint Venture Enterprise Law, the Sino-foreign Cooperative Joint Venture Enterprise Law and the Wholly Foreign-invested Enterprise
Law, together with their implementation rules and ancillary regulations. The Foreign Investment Law embodies an expected PRC regulatory
trend to rationalize its foreign investment regulatory regime in line with prevailing international practice and the legislative
efforts to unify the corporate legal requirements for both foreign and domestic investments. However, since it is relatively new,
uncertainties still exist in relation to its interpretation and implementation. For instance, under the Foreign Investment Law,
“foreign investment” refers to the investment activities directly or indirectly conducted by foreign individuals, enterprises
or other entities in China. Though it does not explicitly classify contractual arrangements as a form of foreign investment, there
is no assurance that foreign investment via contractual arrangements would not be interpreted as a type of indirect foreign investment
activities under the definition in the future. In addition, the definition contains a catch-all provision which includes investments
made by foreign investors through means stipulated in laws or administrative regulations or other methods prescribed by the State
Council. Therefore, it still leaves leeway for future laws, administrative regulations or provisions promulgated by the State Council
to provide for contractual arrangements as a form of foreign investment. In any of these cases, it will be uncertain whether our
contractual arrangements will be deemed to be in violation of the market access requirements for foreign investment under the PRC
laws and regulations. Furthermore, if future laws, administrative regulations or provisions prescribed by the State Council mandate
further actions to be taken by companies with respect to existing contractual arrangements, we may face substantial uncertainties
as to whether we can complete such actions in a timely manner, or at all. Failure to take timely and appropriate measures to cope
with any of these or similar regulatory compliance challenges could materially and adversely affect our current corporate structure,
corporate governance and business operations.
Business License and permits for ICP and Advertising
Companies
All PRC legal entities may commence operations
only upon obtaining a business license from the relevant local branch of the SAIC (currently known as the SAMR).
On October 27, 1994, the Tenth Session of
the Standing Committee of the Eighth National People’s Congress adopted the Advertising Law, which became effective on February
1, 1995, and was subsequently amended on April 24, 2015 by the Fourteenth Session of the Standing Committee of the Twelfth National
People’s Congress, and on October 26, 2018 by the Sixth Session of the Standing Committee of the Thirteenth National People’s
Congress, respectively. The latest Revised Advertising Law became effective on October 26, 2018. According to the Revised Advertising
Law and its various implementing rules, companies engaging in advertising activities must obtain from the SAIC (currently known
as the SAMR) or its local branches a business license which specifically includes within its scope the operation of an advertising
business. Companies conducting advertising activities without such a license may be subject to penalties, including fines, confiscation
of advertising income and orders to cease advertising operations. The business license of an advertising company is valid for the
duration of its existence, unless the license is suspended or revoked due to a violation of any relevant law or regulation. We
have obtained such a business license from the local branches of the SAIC (currently known as the SAMR) as required by existing
PRC regulations. We do not expect to encounter any difficulties in maintaining the business license. However, if we seriously violate
the relevant advertising laws and regulations, the SAIC (currently known as the SAMR) or its local branches may revoke our business
licenses.
On September 25, 2000, the State Council
issued the Measures for the Administration of Internet Information Services (“ICP Measures”). Under the ICP Measures,
entities that provide information to online users on the Internet, or ICPs, are obliged to obtain an operating permit from the
“MIIT or its local branch. ICP permits are subject to annual inspection. Our PRC operating VIEs engaged in ICP business have
obtained their respective ICP permits and comply with the annual inspection and other related provisions. We do not expect to encounter
any difficulties in maintaining the ICP operating permits. However, if we seriously violate the relevant ICP laws and regulations,
the SAIC (currently known as the SAMR) or its local branches may revoke our permits.
Advertising Content
PRC advertising laws, rules and regulations
set forth certain content requirements for advertisements in China including, among other things, prohibitions on false or misleading
content, superlative wording, socially destabilizing content or content involving obscenities, superstition, violence, discrimination
or infringement of the public interest. Advertisements for anesthetic, psychotropic, toxic or radioactive drugs are prohibited.
There are also specific restrictions and requirements regarding advertisements that relate to matters such as patented products
or processes, pharmaceutical products, medical procedures, alcohol, tobacco, and cosmetics. In addition, all advertisements relating
to pharmaceuticals, medical instruments, agrochemicals and veterinary pharmaceuticals, together with any other advertisements which
are subject to censorship by administrative authorities according to relevant laws or regulations, must be submitted to relevant
authorities for content approval prior to dissemination.
Advertisers, advertising operators, including
advertising agencies, and advertising distributors are required by PRC advertising laws and regulations to ensure that the content
of the advertisements they prepare or distribute is true and in full compliance with applicable laws. In providing advertising
services, advertising operators and advertising distributors must review the supporting documents provided by advertisers for advertisements
and verify that the content of the advertisements complies with applicable PRC laws, rules and regulations. Prior to distributing
advertisements that are subject to government censorship and approval, advertising distributors are obligated to verify that such
censorship has been performed and approval has been obtained. Violation of these regulations may result in penalties, including
fines, confiscation of advertising income, orders to cease dissemination of the advertisements and orders to publish an advertisement
correcting the misleading information. In circumstances involving serious violations, the SAIC (currently known as the SAMR) or
its local branches may revoke violators’ licenses or permits for their advertising business operations. Furthermore, advertisers,
advertising operators or advertising distributors may be subject to civil liability if they infringe on the legal rights and interests
of third parties in the course of their advertising business.
In October 2013, the SARFT issued a notice
to enhance the management of TV shopping infomercials broadcasted in provincial satellite television stations, which further restricts
the contents, air time and duration of these infomercials. These restrictions have had and may continue to have a negative impact
on our TV advertising business.
We do not believe that advertisements containing
content subject to restriction or censorship comprise a material portion of the advertisements displayed on our media network.
However, there can be no assurance that each advertisement displayed on our network complies with relevant PRC advertising laws
and regulations. Failure to comply with PRC laws and regulations relating to advertisement content restrictions governing the advertising
industry in China may result in severe penalties.
Regulation on Intellectual Property
Regulation on Trademark
The Trademark Law of the PRC was adopted
at the 24th meeting of the Standing Committee of the Fifth National People’s Congress on August 23, 1982 and amended on February
22, 1993, October 27, 2001, August 30, 2013 and November April 23, 2019, respectively. The Trademark Law sets out the guidelines
on administration of trademarks and protection of the exclusive rights of trademark owners. In order to enjoy an exclusive right
to use a trademark, one must register the trademark with the Trademark Bureau of the SAIC (currently known as the SAMR) and obtain
a registration certificate.
Regulation on Patents
The Patent Law of the PRC was adopted at
the 4th Meeting of the Standing Committee of the Sixth National People’s Congress on March 12, 1984 and subsequently amended
in 1992 and 2000 and 2008. The Patent Law extends protection to three kinds of patents: invention patents, utility patents and
design patents. According to the Implementing Regulations of the Patent Law, promulgated by the State Council of the PRC on June
15, 2001, and subsequently amended in December 28, 2002 and January 9, 2010, respectively, an invention patent refers to a new
technical solution relating to a product, a process or improvement. When compared to existing technology, an invention patent has
prominent substantive features and represents notable progress. A utility patent refers to any new technical solution relating
to the shape, the structure, or their combination, of a product. Utility patents are granted for products only, not processes.
A design patent (or industrial design) refers to any new design of the shape, pattern or color of a product or their combinations,
which creates an aesthetic feeling and are suitable for industrial application. Inventors or designers must register with the State
Intellectual Property Office to obtain patent protection. The term of protection is twenty years for invention patents and ten
years for utility patents and design patents. Unauthorized use of patent constitutes an infringement and the patent holders are
entitled to claims of damages, including royalties, to the extent reasonable, and lost profits.
Regulation on Copyright
The Copyright Law of the PRC was adopted
at the 15th Meeting of the Standing Committee of the Seventh National People’s Congress on September 7, 1990 and amended
on October 27, 2001and February 26, 2010, respectively. Unlike patent and trademark protection, copyrighted works do not require
registration for protection in China. However, copyright owners may wish to voluntarily register with China’s National Copyright
Administration to establish evidence of ownership in the event enforcement actions become necessary. Consent from the copyright
owners and payment of royalties are required for the use of copyrighted works. Copyrights of movies or other audio or video works
usually expire fifty years after their first publication. The amended Copyright Law extends copyright protection to Internet activities,
products disseminated over the Internet and software products. The amended Copyright Law also requires registration of the pledge
of a copyright.
Regulations on Foreign Currency Exchange
Foreign Currency Exchange
Pursuant to the Foreign Currency Administration
Rules promulgated in1996 and most recently amended in August 2008 and various regulations issued by SAFE and other relevant PRC
government authorities, the Renminbi is freely convertible only to the extent of current account items, such as trade-related receipts
and payments, interest and dividends. Capital account items, such as direct equity investments, loans and repatriation of investment,
unless expressly exempted by laws and regulations, require the prior approval from SAFE or its local branch for conversion of the
Renminbi into a foreign currency, such as U.S. dollars, and remittance of the foreign currency outside the PRC.
Payments for transactions that take place
within the PRC must be made in Renminbi. Domestic companies or individuals can repatriate foreign currency payments received from
abroad or deposit these payments abroad subject to applicable regulations that expressly require repatriation within certain period.
Foreign-invested enterprises may retain foreign exchange in accounts with designated foreign exchange banks subject to a cap set
by SAFE or its local branch. Foreign currencies received under current account items can be either retained or sold to financial
institutions engaged in the foreign exchange settlement or sales business without prior approval from SAFE by complying with relevant
regulations. Foreign exchange income under capital account can be retained or sold to financial institutions engaged in foreign
exchange settlement and sales business, with prior approval from SAFE unless otherwise provided.
After a Notice on Further Simplifying and
Improving Foreign Exchange Administration Policy on Direct Investment, or SAFE Notice 13, became effective on June 1, 2015,
instead of applying for approvals regarding foreign exchange registrations of foreign direct investment and overseas direct investment
from SAFE, entities and individuals will be required to apply for such foreign exchange registrations from qualified banks. The
qualified banks, under the supervision of SAFE, directly examine the applications and conduct the registration. On October 23,
2019, SAFE issued the Circular on Further Promoting Cross-border Trade and Investment Facilitation, or SAFE Circular 28. Among
others, SAFE Circular 28 relaxes the prior restrictions and allows the foreign-invested enterprises without equity investment as
in their approved business scope to use their capital obtained from foreign exchange settlement to make domestic equity investment
as long as the investments are real and in compliance with the foreign investment-related laws and regulations. In addition, SAFE
Circular 28 stipulates that qualified enterprises in certain pilot areas may use their capital income from registered capital,
foreign debt and overseas listing, for the purpose of domestic payments without providing authenticity certifications to the relevant
banks in advance for those domestic payments.
Our business operations, which are subject
to the foreign currency exchange regulations, have all been implemented in accordance with these regulations. We will take steps
to ensure that our future operations comply with these regulations.
Dividend Distribution
The principal laws, rules and regulations
governing dividends paid by PRC operating subsidiaries and VIEs include the Company Law of the PRC (1993), as amended in 2018 and
the Foreign Investment Law and its Implementation Rules (2019). Under these laws and
regulations, PRC subsidiaries and VIEs, including wholly owned foreign enterprises, or WFOEs, and domestic companies in China,
may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations.
In addition, its PRC significant subsidiaries and VIEs, including WFOEs and domestic companies, are required to set aside at least
10% of their after-tax profit based on PRC accounting standards each year to their statutory capital reserve fund until the cumulative
amount of such reserve reaches 50% of their respective registered capital. These reserves are not distributable as cash dividends.
Tax
On March 16, 2007, the Fifth Session of
the Tenth National People’s Congress of PRC passed the Enterprise Income Tax Law of the People’s Republic of China,
or EIT Law, which became effective on January 1, 2008 and was subsequently amended on February 24, 2017 and December 29, 2018,
respectively. On November 28, 2007, the State Council at the 197th Executive Meeting passed the Regulation on the Implementation
of the Income Tax Law of the People’s Republic of China, which became effective on January 1, 2008 and was subsequently amended
on April 23, 2019. The EIT Law adopted a uniform tax rate of 25% for all enterprises (including foreign-invested enterprises)
and revoked the existing tax exemption, reduction and preferential treatments applicable to foreign-invested enterprises.
Under the EIT Law, enterprises are classified
as either “resident enterprises” or “non-resident enterprises.” Pursuant to the EIT Law and the Implementation
Rules, enterprises established under PRC laws, or enterprises established outside China whose “de facto management bodies”
are located in China, are considered “resident enterprises” and subject to the uniform 25% enterprise income tax rate
for their global income. According to the Implementation Rules, “de facto management body” refers to a managing body
that in practice exercises overall management and control over the production and business, personnel, accounting and assets of
an enterprise. Our management is currently based in China and is expected to remain in China in the future. In addition, although
the EIT Law provides that “dividends, bonuses and other equity investment proceeds between qualified resident enterprises”
is exempted income, and the Implementation Rules refer to “dividends, bonuses and other equity investment proceeds between
qualified resident enterprises” as the investment proceeds obtained by a resident enterprise from its direct investment in
another resident enterprise, however, it is unclear whether our circumstance is eligible for exemption.
Furthermore, the EIT Law and Implementation
Rules provide that the “non-resident enterprises” are subject to the enterprise income tax rate of 10% on their income
sourced from China, if such “non-resident enterprises” (i) do not have establishments or premises of business in China
or (ii) have establishments or premises of business in China, but the relevant income does not have actual connection with their
establishments or premises of business in China. Such income tax may be exempted or reduced by the State Council of the PRC or
pursuant to a tax treaty between China and the jurisdictions in which its non-PRC shareholders reside. Under the Double Tax Avoidance
Arrangement between Hong Kong and Mainland China, if the Hong Kong resident enterprise owns more than 25% of the equity interest
in a company in China, the 10% withholding tax on the dividends the Hong Kong resident enterprise received from such company in
China is reduced to 5%. If China Net HK is considered to be a Hong Kong resident enterprise under the Double Tax Avoidance Arrangement
and is considered to be a “non-resident enterprise” under the EIT Law, the dividends paid to us by Rise King WFOE may
be subject to the reduced income tax rate of 5% under the Double Tax Avoidance Arrangement. However, based on the Notice on Certain
Issues with Respect to the Enforcement of Dividend Provisions in Tax Treaties, issued on February 20, 2009 by the State Administration
of Taxation, if the relevant PRC tax authorities determine, in their discretion, that a company benefits from such reduced income
tax rate due to a structure or arrangement that is primarily tax-driven, such PRC tax authorities may adjust the preferential tax
treatment.
Provisions Regarding Mergers and Acquisitions
of Domestic Enterprises by Foreign Investors
On August 8, 2006, six PRC regulatory agencies,
including CSRC, MOC, SAT, SASAC, SAIC (currently known as the SAMR) and SAFE, jointly promulgated the M&A Rules, which became
effective on September 8, 2006, and was subsequently amended on June 22, 2009, to regulate foreign investment in PRC domestic
enterprises. The M&A Rules provide that the MOC must be notified in advance of any change-of-control transaction in which a
foreign investor takes control of a PRC domestic enterprise and any of the following situations exist: (i) the transaction involves
an important industry in China; (ii) the transaction may affect national “economic security”; or (iii) the PRC domestic
enterprise has a well-known trademark or historical Chinese trade name in China. The M&A Rules also contain a provision requiring
offshore SPVs formed for the purpose of the overseas listing of equity interests in PRC companies and controlled directly or indirectly
by PRC companies or individuals, to obtain the approval of the CSRC prior to publicly listing their securities on an overseas stock
exchange. On September 21, 2006, the CSRC issued a clarification that sets forth the criteria and procedures for obtaining any
required approval from the CSRC.
To date, the application of the M&A
Rules is unclear. Our PRC counsel has advised us that:
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the CSRC approval requirement applies to SPVs that acquire equity interests in PRC companies through share exchanges and cash,
and seek overseas listings; and
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based on their understanding of the current PRC laws, rules and regulations and the M&A Rules, unless there are new PRC
laws and regulations or clear requirements from the CSRC in any form that require the prior approval of the CSRC for the listing
and trading of any overseas SPV’s securities on an overseas stock exchange, the M&A Rules do not require that we obtain
prior CSRC approval because: (i) the Share Exchange is a purely foreign related transaction governed by foreign laws,
not subject to the jurisdiction of PRC laws and regulations; (ii) we are not a special purpose vehicle formed or controlled by
PRC companies or PRC individuals; and (iii) we are owned or substantively controlled by foreigners.
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However, the interpretation and application
of the M&A Rules remain unclear, and the PRC government authorities have the sole discretion to determine whether the transaction
is subject to the approval of the CSRC, especially when taking into consideration of the performance-based incentive option arrangement
by way of the Share Transfer Agreements. If the CSRC or another PRC regulatory agency subsequently determines that CSRC approval
is required for the transaction, we cannot predict how long it would take to obtain the approval. In addition, we may need to apply
for a remedial approval from the CSRC and may be subject to certain administrative or other sanctions from these regulatory agencies.
Further, new rules and regulations or relevant
interpretations may be issued from time to time that may require us to obtain retroactive approval from the CSRC in connection
with the business combination. If this were to occur, our failure to obtain or delay in obtaining the CSRC approval for the business
combination would subject us to sanctions imposed by the CSRC and other PRC regulatory agencies. These sanctions could include
fines and penalties on our operations in China, restrictions or limitations on our ability to pay dividends outside of China, and
other forms of sanctions that may materially and adversely affect our business, results of operations and financial condition.
If the CSRC or another PRC regulatory agency
subsequently determines that CSRC approval is required for the business combination, we may need to apply for a remedial approval
from the CSRC and may be subject to certain administrative punishments or other sanctions from these regulatory agencies. New rules
and regulations or relevant interpretations may require that we retroactively obtain approval from the CSRC in connection with
the business combination. If this were to occur, our failure to obtain or delay in obtaining the CSRC approval for the transaction
would subject us to sanctions imposed by the CSRC and other PRC regulatory agencies. These sanctions could include fines and penalties
on our operations in China, restrictions or limitations on our ability to pay dividends outside of China, and other forms of sanctions
that may materially and adversely affect our business, results of operations and financial condition.
The M&A Rules also established additional
procedures and requirements expected to make merger and acquisition activities in China by foreign investors more time-consuming
and complex, including requirements in some instances that the MOC be notified in advance of any change-of-control transaction
in which a foreign investor takes control of a PRC domestic enterprise. These rules may also require the approval from the MOC
where overseas companies established or controlled by PRC enterprises or residents acquire affiliated domestic companies. Complying
with the requirements of the new regulations to complete such transactions could be time-consuming, and any required approval processes,
including MOC approval, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand
our business.
Employees
As of December 31, 2019, we had 148 full-time
employees, 21 of whom are in sales and marketing, 69 of whom are in operations and support, 39 of whom are in management and administration
and 19 of whom are in technology support and R&D.
We are compliant with local prevailing wage,
contractor licensing and insurance regulations, and have good relations with our employees.
As required by PRC regulations, we participate
in various employee benefit plans that are organized by municipal and provincial governments, including pension, work-related injury
benefits, maternity insurance, medical and unemployment benefit plans. We are required under PRC laws to make contributions to
the employee benefit plans at specified percentages of the salaries, bonuses and certain allowances of our employees, up to a maximum
amount specified by the local government from time to time. Members of the retirement plan are entitled to a pension equal to a
fixed proportion of the salary prevailing at the member’s retirement date.
Generally, we enter into a standard employment
contract with our officers and managers for a set period of years and a standard employment contract with other employees for a
set period of years. According to these contracts, all of our employees are prohibited from engaging in any activities that
compete with our business during the period of their employment with us. Furthermore, the employment contracts with officers
or managers include a covenant that prohibits officers or managers from engaging in any activities that compete with our business
for two years after the period of employment.
Corporation Information
Our principal executive offices are located
at No. 9 South Min Zhuang Road, Haidian District, Beijing, PRC. Our telephone number at this address is (86 10) 60846616 and
our fax number is (86 10) 88857816. For more information, see our corporate website at www.chinanet-online.com.
In addition to the other information
in this Form 10-K, readers should carefully consider the following important factors. These factors, among others, in some cases
have affected, and in the future could affect, our financial condition and results of operations and could cause our future results
to differ materially from those expressed or implied in any forward-looking statements that appear in this on Form 10-K or that
we have made or will make elsewhere.
Risks Related to Our Business
We are susceptible to general economic
conditions, natural catastrophic events and public health crises, and a potential downturn in advertising and marketing spending
by advertisers could adversely affect our operating results in the near future.
Our business is subject to the impact of
natural catastrophic events, such as earthquakes, or floods, public health crisis, such as disease outbreaks, epidemics, or pandemics
in China, and all these could result in a decrease or sharp downturn of economies, including our markets and business locations
in the current and future periods. The outbreak of the coronavirus (COVID-19) pandemic in China resulted in increased
travel restrictions, and shutdown of businesses, which has caused slower recovery of the China economy. We may experience
impact from quarantines, market downturns and changes in customer behavior related to pandemic fears and impact on our workforce
if the virus continues to spread. COVID-19 affected a significant number of our workforce employed in our operations, and as a
result we are experiencing a slow resumption of operations and may experience delays or the inability to delivery our service on
a timely basis. In addition, one or more of our customers, partners, service providers or suppliers may experience financial distress,
delayed or defaults on payment, file for bankruptcy protection, sharp diminishing of business, or suffer disruptions in their business
due to the outbreak. The extent to which the COVID-19 pandemic impacts our results will depend on future developments and reactions
in China, which are highly uncertain and will include emerging information concerning the severity of the COVID-19 pandemic and
the actions taken by governments and private businesses to attempt to contain the coronavirus. The COVID-19 situation is likely
to result in a potential material adverse impact on our business, results of operations and financial condition in the short run
if it has come worse in China. Wider-spread COVID-19 in China and globally could prolong the deterioration in economic conditions
and could cause decreases in or delays in advertising spending and reduce and/or negatively impact our short-term ability to grow
our revenues. Any decreased collectability of accounts receivable, bankruptcy of small and medium businesses, or early termination
of agreements due to deterioration in economic conditions could negatively impact our results of operations.
We may be subject to, and may expend significant resources
in defending against, government actions and civil suits based on the content and services we provide through our Internet advertising
and data service platforms.
PRC advertising laws and regulations require
advertisers, advertising operators and advertising distributors, including businesses such as ours, to ensure that the content
of the advertisements they prepare or distribute is fair, accurate and in full compliance with applicable laws, rules and regulations.
Although we comply with the requirements by reviewing the business licenses and the profiles of our clients, clients may post advertisements
about business opportunities that are not legitimate and over which we have no control. On April 24, 2015, the Fourteenth Session
of the Standing Committee of the Twelfth National People’s Congress adopted the Revised Advertising Law, which became effective
on September 1, 2015 and was further amended on October 26, 2018. The Revised Advertising Law further established the advertisement
standards and restrictions of certain industries, such as: medical instruments, education and training, franchise and investments;
defined separate standards and restrictions for Internet advertisements and reinforced the regulatory responsibilities of the related
competent authorities. We cannot assure you that our operating entities will be fully in compliance with these new rules during
normal course of business. Violation of these laws, rules or regulations may result in penalties, including fines, confiscation
of advertising fees, orders to cease dissemination of the advertisements and orders to publish an advertisement correcting the
misleading information. In circumstances involving serious violations, the PRC government may revoke a violator’s license
for its advertising business operations.
We operate in the advertising and data service industry,
which is particularly sensitive to changes in economic conditions and advertising trends.
Advertising and data service spending by
our clients is particularly sensitive to changes in general economic conditions. For example, advertising and data service expenditures
typically decrease during periods of economic downturn. Advertisers may reduce the amount of money they spend to advertise and
obtain precision marketing data and data analysis on/from our advertising and data service platforms for a number of reasons, including:
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a general decline in economic conditions;
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a decline in economic conditions in the particular cities where we conduct business;
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a decision to shift advertising and marketing expenditures to other available less expensive advertising media; and
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a decline in advertising and marketing spending in general.
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A decrease in the demand for advertising
media in general, and for our advertising and marketing services in particular, would materially and adversely affect our ability
to generate revenues, and have a material adverse effect on our financial condition and results of operations.
We face significant competition, and if we do not compete
successfully against new and existing competitors, we may lose our market share, and our profitability may be adversely affected.
Increased competition could reduce our profitability
and result in a loss of market share. Some of our existing and potential competitors may have competitive advantages, such as significantly
greater financial, marketing or other resources, and may successfully mimic and adopt our business models. Moreover, increased
competition will provide advertisers with a wider range of media and advertising and marketing service alternatives, which could
lead to lower prices and decreased revenues, gross margins and profits. We cannot assure you that we will be able to successfully
compete against new or existing competitors.
Key employees are essential to growing our business.
Handong Cheng, our chief executive officer
and president, Mark Li, our chief financial officer and George K. Chu, our chief operating officer are essential to our ability
to continue to grow our business. They have established relationships within the industries in which we operate. If they were to
leave us, our growth strategy might be hindered, which could limit our ability to increase revenue.
In addition, we face competition for attracting
skilled personnel with increasing labor cost. If we fail to attract and retain qualified personnel to meet current and future needs,
this could slow our ability to grow our business, which could result in a decrease in market share.
We may need additional capital and we may not be able to
obtain it at acceptable terms, or at all, which could adversely affect our liquidity and financial position.
In Note 3 (b) to our Consolidated Financial
Statements included herewith, we disclosed that there is substantial doubt about our ability to continue as a going concern within
one year after the date that the financial statements are issued. We intend to improve our cashflow status through improving gross
profit margin, strengthen receivables collection management. If the implementation of these plans cannot provide sufficient cash
to satisfy our requirements, we may seek to sell additional equity or debt securities or obtain more credit facilities. The incurrence
of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would
restrict our operations and liquidity.
Our ability to obtain additional capital
on acceptable terms is subject to a variety of uncertainties, including:
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investors’ perception of, and demand for, securities of alternative advertising media companies;
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conditions of the U.S. and other capital markets in which we may seek to raise funds;
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our future results of operations, financial condition and cash flow;
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PRC governmental regulation of foreign investment in advertising service companies in China;
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economic, political and other conditions in China; and
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PRC governmental policies relating to foreign currency borrowings.
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Our failure to protect our intellectual property rights
could have a negative impact on our business.
We believe our brand, trade name, copyrights,
domain name and other intellectual property are critical to our success. The success of our business depends in part upon our continued
ability to use our brand, trade names and copyrights to further develop and increase brand awareness. The infringement of our trade
names and copyrights could diminish the value of our brand and its market acceptance, competitive advantages or goodwill. In addition,
our information and operational systems, which have not been patented or otherwise registered as our property, are a key component
of our competitive advantage and our growth strategy.
Monitoring and preventing the unauthorized
use of our intellectual property is difficult. The measures we take to protect our brand, trade names, copyrights, domain name
and other intellectual property rights may not be adequate to prevent their unauthorized use by third parties. Furthermore, 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, trade names, copyrights, domain name and other intellectual property rights,
we may lose these rights and our business may suffer materially. Further, unauthorized use of our brand, domain name or trade names
could cause brand confusion among advertisers and harm our reputation. If our brand recognition decreases, we may lose advertisers
and fail in our expansion strategies, and our business, results of operations, financial condition and prospects could be materially
and adversely affected.
We rely on computer software and hardware systems in managing
our operations, the failure of which could adversely affect our business, financial condition and results of operations.
We are dependent upon our computer software
and hardware systems in supporting our network and managing and monitoring programs on the network. In addition, we rely on our
computer hardware for the storage, delivery and transmission of the data on our network. Any system failure that interrupts the
input, retrieval and transmission of data or increases the service time could disrupt our normal operation. Any failure in our
computer software or hardware systems could decrease our revenues and harm our relationships with advertisers and consumers, which
in turn could have a material adverse effect on our business, financial condition and results of operations.
Any failure or interruptions in the internet infrastructure,
bandwidth providers, data center providers, other third parties or our own systems for providing our solutions to customers could
negatively impact our business.
Our ability
to deliver our solutions is dependent on the development and maintenance of the internet and other telecommunications services
by third parties. Such services include maintenance of a reliable network backbone with the necessary speed, data capacity and
security for providing reliable internet access and services and reliable telecommunications systems that connect our operations.
While our solutions are designed to operate without interruption, we may experience interruptions and delays in services and availability
from time to time. We rely on systems as well as third-party vendors, including data center, bandwidth, and telecommunications
equipment providers, to provide our solutions. We do not maintain redundant systems or facilities for some of these services. In
the event of a catastrophic event with respect to one or more of these systems or facilities, we may experience an extended period
of system unavailability, which could negatively impact our relationship with our customers.
Privacy and data security concerns, laws, or other regulations
could expose us to liability or impair our operations.
Privacy and
data security are rapidly evolving areas of concern and regulation. Changes in laws restricting or otherwise governing data and
transfer thereof could be difficult to comply with, result in increased costs, or impair our operations. Security measures that
we implement may fail due to third-party attack, employee error or sabotage, or other causes. Hacking techniques change frequently
and therefore can be difficult to prevent. In addition, service providers could suffer security breaches or data losses that affect
our customers’ information. A security breach could damage our reputation, resulting in loss of customers or reluctance of
potential customers to try our platform, or civil or criminal liability.
If we are unable to maintain appropriate internal financial
reporting controls and procedures, it could cause us to fail to meet our reporting obligations, result in the restatement of our
financial statements, harm our operating results, subject us to regulatory scrutiny and sanction, cause investors to lose confidence
in our reported financial information and have a negative effect on the market price for shares of our Common Stock.
Effective internal controls are necessary
for us to provide reliable financial reports and effectively prevent fraud. We maintain a system of internal control over financial
reporting, which is defined as a process designed by, or under the supervision of, our principal executive officer and principal
financial officer, or persons performing similar functions, and effected by our board of directors, management and other personnel,
to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles.
As a public company, we have significant
additional requirements for enhanced financial reporting and internal controls. We are required to document and test
our internal control procedures in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, which requires
annual management assessments of the effectiveness of our internal controls over financial reporting. The process of designing
and implementing effective internal controls is a continuous effort that requires us to anticipate and react to changes in our
business and the economic and regulatory environments and to expend significant resources to maintain a system of internal controls
that is adequate to satisfy our reporting obligations as a public company.
Our management will continue to evaluate
the effectiveness of our overall control environment and will continue to refine existing controls as they, in conjunction with
the Audit Committee of our Board of Directors, chief executive officer and chief financial officer, consider necessary. We cannot
assure you that we will not, in the future, identify areas requiring improvement in our internal control over financial reporting. We
cannot assure you that the measures we will take to remediate any areas in need of improvement will be successful or that we will
implement and maintain adequate controls over our financial processes and reporting in the future as we continue our growth.
If we are unable to maintain appropriate internal financial reporting controls and procedures, it could cause us to fail to meet
our reporting obligations, result in the restatement of our financial statements, harm our operating results, subject us to regulatory
scrutiny and sanction, cause investors to lose confidence in our reported financial information and have a negative effect on the
market price for shares of our Common Stock.
Our blockchain business is at an early stage and the PRC
laws and regulations may have a potential effect.
As
an initiation of our Business Opportunity Social Ecosystem, we are in the process of developing our Business Opportunity
Chain platform based on the blockchain technology to facilitate our company’s business. The laws and regulations governing
the blockchain in China are developing and evolving and subject to changes.
The PRC government adopts a positive attitude
to the blockchain technology and it has been mentioned several times in the national strategy reports. However, for the initial
coin offering (the “ICO”) which may appear in the most blockchain projects, the PRC government authorities have strictly
prohibited the ICO and any similar activities within the PRC by issuing the Announcement of the People's Bank of China, the Office
of the Central Leading Group for Cyberspace Affairs, the Ministry of Industry and Information Technology and Other Departments
on Preventing the Financing Risks of Initial Coin Offerings on September 4, 2017. The Banking and Insurance Regulatory Commission,
the Office of the Central Cyberspace Affairs Commission, the Ministry of Public Security, the People's Bank of China and the State
Administration for Market Regulation also issued the Risk Warning for Preventing Illegal Fundraising in the Name of "Virtual
Currency" or "Blockchain" on August 24, 2018. The Internet Finance Association of China also issued a series of
notices to remind the potential risks of ICO and the cryptocurrency trading to the PRC residents, including the Risk Warning on
Guarding against the "Virtual Currency" such as Bitcoin on September 13, 2017, Risk Warning on Guarding against the Disguised
Initial Coin Offering Activities on January 12, 2018 and Risk Warning on Guarding against the Offshore Initial Coin Offering Activities
and the Cryptocurrency Trading on January 26, 2018.
We do not plan to initiate any ICO in China
or any other jurisdictions. We have been advised by our PRC counsel, as long as we do not issue any virtual currency coins, we
only need to record filing as required by the Cyberspace Administration of China's Regulations on the Management of Blockchain
Information Services that went into effect on February 15, 2019. We do not believe that such record filing procedure will have
a material effect on our blockchain-powered platform. However, as the laws and regulations governing the blockchain in China are
developing and evolving and subject to changes, we cannot assure you that that our blockchain technology related business will
continue to be compliance with the PRC law. If our practice is deemed to have violated any PRC law or regulations, our blockchain
related business would be materially and adversely affected.
Given the continuing changing of the regulation
regime and the government policy of this area in the PRC, an overall limited industry experiences in developing and operating a
blockchain-powered platform, and our lack of operating history to serve as an transaction facilitation and verification services
provider, our ability to generate substantial revenue from the blockchain-powered platform upon its launch remains unproven. It
may be difficult for you to evaluate its performance and prospects.
Risks Relating to Regulation of
Our Business and to Our Structure
If the PRC government finds that the agreements that establish
the structure for operating our China business do not comply with PRC governmental restrictions on foreign investment in the advertising
industry, we could be subject to severe penalties.
Our operations are substantially conducted
through our PRC Operating Entities, or VIEs, and through our contractual agreements with each of our PRC Operating Entities in
China. PRC regulations restrict foreign investments in value-added telecommunication services, including providing Internet information
services (“ICP”) and used to have restrictions on foreign investments in advertising business, which was lifted on
June 29, 2015. In consideration of the restrictions on foreign investments in ICP and advertising business, our whole-owned subsidiary
in China, Rise King WFOE, is ineligible to apply for the required licenses for providing Internet information services and was
ineligible to apply for the required licenses for providing advertising services in China before June 29, 2015. Our PRC Operating
Entities hold the requisite licenses and permits to provide Internet information services and advertising services in China. We
have been and are expected to continue to be dependent on these PRC Operating Entities to operate our ICP and advertising business
for the foreseeable future. We have entered into Contractual Agreements with the PRC Operating Entities, pursuant to which we,
through Rise King WFOE, provide technical support and consulting services to the PRC Operating Entities. In addition, we have entered
into agreements with our PRC Operating Entities and each of their shareholders which provide us with the substantial ability to
control these affiliates.
As discussed above, the Foreign Investment
Law, which came into effect on January 1, 2020, replaced the trio of existing laws regulating foreign investment in China, together
with their implementation rules and ancillary regulations. The Foreign Investment Law stipulates three forms of foreign investment
but does not explicitly stipulate the contractual arrangements under the VIE structure as a form of foreign investment. The Foreign
Investment Law also stipulates that foreign investment includes “foreign investors invest in China through any other methods
under laws, administrative regulations, or provisions prescribed by the State Council.”
Since the Foreign Investment Law is relatively
new, uncertainties still exist in relation to its interpretation and implementation. There is no assurance that foreign investment
via contractual arrangements would not be interpreted as a type of indirect foreign investment activities under the Foreign Investment
Law in the future.
If our contractual arrangements will be
deemed to be in violation of the market access requirements for foreign investment under the PRC laws and regulations, or furthermore
we will fail to complete any actions to be taken by companies with respect to existing contractual arrangements as mandated by
future laws, administrative regulations or provisions prescribed by the State Council in a timely manner, or at all, the relevant
PRC regulatory authorities, including the State Administration for Industry and Commerce, or SAIC, (currently known as SAMR), the
Ministry of Industry and Information Technology, Or MIIT, which regulates ICP and advertising companies, would have broad discretion
in dealing with such violations, including:
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revoking the business and operating licenses of Rise King WFOE and/or the PRC Operating Entities;
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discontinuing or restricting the operations of Rise King WFOE and/or the PRC Operating Entities;
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imposing conditions or requirements with which we, Rise King WFOE and/or our PRC Operating Entities may not be able to comply;
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requiring us or Rise King WFOE and/or PRC Operating Entities to restructure the relevant ownership structure or operations.
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The imposition of any of these penalties
would result in a material and adverse effect on our ability to conduct our business and would have a material adverse impact on
our cash flows, financial position and operating performance.
We rely on contractual arrangements with the PRC Operating
Entities and their shareholders for our China operations, which may not be as effective in providing operational control as direct
ownership.
We rely on contractual arrangements with
our PRC Operating Entities and their shareholders to operate our ICP and advertising business. These contractual arrangements may
not be as effective in providing us with control over the PRC Operating Entities as direct ownership. If we had direct ownership
of the PRC Operating Entities, we would be able to exercise our rights as a shareholder to effect changes in the board of directors
of those companies, which in turn could affect changes, subject to any applicable fiduciary obligations, at the management level.
However, under the current contractual arrangements, as a legal matter, if the PRC Operating Entities or any of their subsidiaries
and shareholders fail to perform its or their respective obligations under these contractual arrangements, we may have to incur
substantial costs and resources to enforce such arrangements, and rely on legal remedies under PRC laws, including seeking specific
performance or injunctive relief, and claiming damages, which we cannot assure you to be effective. Accordingly, it may be difficult
for us to change our corporate structure or to bring claims against the PRC Operating Entities if they do not perform their obligations
under its contracts with us or if any of the PRC citizens who hold the equity interest in the PRC Operating Entities do not cooperate
with any such actions.
Many of these contractual arrangements are
governed by PRC laws and provide for the resolution of disputes through either arbitration or litigation in the PRC. Accordingly,
these contracts would be interpreted in accordance with PRC laws and any disputes would be resolved in accordance with PRC legal
procedures. The legal environment in the PRC is not as developed as in other jurisdictions, such as the United States. As a result,
uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements. In the event we are unable
to enforce these contractual arrangements, we may not be able to exert effective control over our operating entities, and our ability
to conduct our business may be negatively affected. In addition, a PRC court or arbitration tribunal may refuse to enforce the
contractual arrangements on the grounds that they are designed to circumvent PRC foreign investment restrictions and therefore
are against PRC public policy.
Contractual arrangements we have entered into among the
PRC Operating Entities may be subject to scrutiny by the PRC tax authorities and a finding that we owe additional taxes or are
ineligible for our tax exemption, or both, could substantially increase our taxes owed, and reduce our net income and the value
of your investment.
Under PRC law, arrangements and transactions
among related parties may be subject to audit or challenge by the PRC tax authorities. If any of the transactions we have entered
into among our subsidiaries and affiliated entities are found not to be on an arm’s-length basis, or to result in an unreasonable
reduction in tax under PRC law, the PRC tax authorities have the authority to disallow our tax savings, adjust the profits and
losses of our respective PRC entities and assess late payment interest and penalties.
If any of our PRC Operating Entities incurs
debt on its own behalf in the future, the instruments governing the debt may restrict their ability to pay dividends or make other
distributions to us. In addition, the PRC tax authorities may require us to adjust our taxable income under the contractual arrangements
with the PRC Operating Entities we currently have in place in a manner that would materially and adversely affect the PRC Operating
Entities’ ability to pay dividends and other distributions to us. Furthermore, relevant PRC laws and regulations permit payments
of dividends by the PRC Operating Entities only out of their retained earnings, if any, determined in accordance with PRC accounting
standards and regulations. Under PRC laws and regulations, each of the PRC Operating Entities is also required to set aside a portion
of its net income each year to fund specific reserve funds. These reserves are not distributable as cash dividends. In addition,
subject to certain cumulative limits, the statutory general reserve fund requires annual appropriations of 10% of after-tax income
to be set aside prior to payment of dividends. As a result of these PRC laws and regulations, the PRC Operating Entities are restricted
in their ability to transfer a portion of their net assets to us whether in the form of dividends, loans or advances. Any limitation
on the ability of the PRC Operating Entities to pay dividends to us could materially and adversely limit our ability to grow, make
investments or acquisitions that could be beneficial to our businesses, pay dividends, or otherwise fund and conduct our business.
Risks Associated With Doing Business
In China
There are substantial risks associated with doing business in
China, as set forth in the following risk factors.
Our operations and assets in China are subject to significant
political and economic uncertainties.
Changes in PRC laws and regulations, or
their interpretation, or the imposition of confiscatory taxation, restrictions on currency conversion, imports and sources of supply,
devaluations of currency or the nationalization or other expropriation of private enterprises could have a material adverse effect
on our business, results of operations and financial condition. Under its current leadership, the Chinese government has been pursuing
economic reform policies that encourage private economic activity and greater economic decentralization. There is no assurance,
however, that the Chinese government will continue to pursue these policies, or that it will not significantly alter these policies
from time to time without notice.
We derive a substantial portion of our sales from China.
We derive a substantially portion of our
sales from China. We anticipate that sales of our services in China will continue to represent a substantial proportion of our
total sales in the near future. Any significant decline in the condition of the PRC economy could adversely affect consumer demand
of our services, among other things, which in turn would have a material adverse effect on our business and financial condition.
Currency fluctuations and restrictions on currency exchange
may adversely affect our business, including limiting our ability to convert Chinese Renminbi into foreign currencies and, if Chinese
Renminbi were to decline in value, reducing our revenue in U.S. dollar terms.
Our reporting currency is the U.S. dollar
and our operations in China use the local currency as their functional currencies. We are subject to the effects of exchange rate
fluctuations with respect to any of these currencies. For example, the value of the Renminbi depends to a large extent on Chinese
government policies and China’s domestic and international economic and political developments, as well as supply and demand
in the local market. On July 21, 2005, the Chinese government changed its policy of pegging the value of Chinese Renminbi to the
U.S. dollar. Under the new policy, Chinese Renminbi may fluctuate within a narrow and managed band against a basket of certain
foreign currencies. It is possible that the Chinese government could adopt a more flexible currency policy, which could result
in more significant fluctuation of Chinese Renminbi against the U.S. dollar. We can offer no assurance that Chinese Renminbi will
be stable against the U.S. dollar or any other foreign currency.
The income statements of our operations
are translated into U.S. dollars at the average exchange rates in each applicable period. To the extent the U.S. dollar strengthens
against foreign currencies, the translation of these foreign currencies denominated transactions results in reduced revenue, operating
expenses and net income for our international operations. Similarly, to the extent the U.S. dollar weakens against foreign currencies,
the translation of these foreign currency denominated transactions results in increased revenue, operating expenses and net income
for our international operations. We are also exposed to foreign exchange rate fluctuations as we convert the financial statements
of our foreign operating subsidiaries and VIEs into U.S. dollars in consolidation. If there is a change in foreign currency exchange
rates, the conversion of the foreign subsidiaries and VIEs’ financial statements into U.S. dollars will lead to a translation
gain or loss which is recorded as a component of other comprehensive income. In addition, we have certain assets and liabilities
that are denominated in currencies other than the relevant entity’s functional currency. Changes in the functional currency
value of these assets and liabilities create fluctuations that will lead to a transaction gain or loss. We have not entered
into agreements or purchased instruments to hedge our exchange rate risks, although we may do so in the future. The availability
and effectiveness of any hedging transaction may be limited and we may not be able to successfully hedge our exchange rate risks.
Although Chinese governmental policies were
introduced in 1996 to allow the convertibility of Chinese Renminbi into foreign currency for current account items, conversion
of Chinese Renminbi into foreign exchange for capital items, such as foreign direct investment, loans or securities, requires the
approval of the State Administration of Foreign Exchange, or SAFE, which is under the authority of the People’s Bank of China.
These approvals, however, do not guarantee the availability of foreign currency conversion. We cannot be sure that we will be able
to obtain all required conversion approvals for our operations or those Chinese regulatory authorities will not impose greater
restrictions on the convertibility of Chinese Renminbi in the future. Because a significant amount of our future revenue may be
in the form of Chinese Renminbi, our inability to obtain the requisite approvals or any future restrictions on currency exchanges
could limit our ability to utilize revenue generated in Chinese Renminbi to fund our business activities outside of China, or to
repay foreign currency obligations, including our debt obligations, which would have a material adverse effect on our financial
condition and results of operations.
We may have limited legal recourse under PRC laws if disputes
arise under our contracts with third parties.
The Chinese government has enacted laws
and regulations dealing with matters such as corporate organization and governance, foreign investment, commerce, taxation and
trade. However, their experience in implementing, interpreting and enforcing these laws and regulations is limited, and our ability
to enforce commercial claims or to resolve commercial disputes is unpredictable. If our new business ventures are unsuccessful,
or other adverse circumstances arise from these transactions, we face the risk that the parties to these ventures may seek ways
to terminate the transactions, or, may hinder or prevent us from accessing important information regarding the financial and business
operations of these acquired companies. The resolution of these matters may be subject to the exercise of considerable discretion
by agencies of the Chinese government, and forces unrelated to the legal merits of a particular matter or dispute may influence
their determination. Any rights we may have to specific performance, or to seek an injunction under PRC law, in either of these
cases, are severely limited, and without a means of recourse by virtue of the Chinese legal system, we may be unable to prevent
these situations from occurring. The occurrence of any such events could have a material adverse effect on our business, financial
condition and results of operations.
We must comply with the Foreign Corrupt Practices Act.
We are required to comply with the United
States Foreign Corrupt Practices Act, which prohibits U.S. companies from engaging in bribery or other prohibited payments to foreign
officials for the purpose of obtaining or retaining business. Foreign companies, including some of our competitors, are not subject
to these prohibitions. If our competitors engage in these practices, they may receive preferential treatment from personnel of
some companies, giving our competitors an advantage in securing business or from government officials who might give them priority
in obtaining new licenses, which would put us at a disadvantage. Although we inform our personnel that such practices are illegal,
we cannot assure you that our employees or other agents will not engage in such conduct for which we might be held responsible.
If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties.
Changes in foreign exchange regulations in the PRC may
affect our ability to pay dividends in foreign currency or conduct other foreign exchange business.
The Renminbi is not a freely convertible
currency, and the restrictions on currency exchanges may limit our ability to use revenues generated in Renminbi to fund our business
activities outside the PRC or to make dividends or other payments in United States dollars. The PRC government strictly regulates
conversion of Renminbi into foreign currencies. Over the years, foreign exchange regulations in the PRC have significantly reduced
the government’s control over routine foreign exchange transactions under current accounts. In the PRC, the State Administration
for Foreign Exchange, or the SAFE, regulates the conversion of the Renminbi into foreign currencies. Pursuant to applicable PRC
laws and regulations, foreign invested enterprises incorporated in the PRC are required to apply for foreign exchange registration
certificates. Currently, conversion within the scope of the “current account” (e.g. remittance of foreign currencies
for payment of dividends, etc.) 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.
PRC regulations relating to mergers and acquisitions of
domestic enterprises by foreign investors may increase the administrative burden we face and create regulatory uncertainties.
On August 8, 2006, the Ministry of Commerce
(the “MOC”), joined by the China Securities Regulatory Commission (the “CSRC”), State-owned Assets Supervision
and Administration Commission of the State Council (the “SASAC”), the State Administration of Taxation (the “SAT”),
the State Administration of Industry and Commerce (the “SAIC”, currently known as the SAMR), and SAFE, jointly promulgated
a rule entitled the Provisions Regarding Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (the “M&A
Rules”), which took effect as of September 8, 2006 and was subsequently amended on June 22, 2009. This regulation,
among other things, has certain provisions that require special purpose vehicles, or SPVs, formed for the purpose of acquiring
PRC domestic companies and controlled by PRC individuals, to obtain the approval of the CSRC prior to publicly listing their securities
on an overseas stock market. However, the regulation does not expressly provide that approval from the CSRC is required for the
offshore listing of the SPV which acquires, directly or indirectly, equity interest or shares of domestic PRC entities held by
domestic companies or individuals by cash payment, nor does it expressly provide that approval from CSRC is not required for the
offshore listing of a SPV which has fully completed its acquisition of equity interest of domestic PRC equity prior to September
8, 2006. On September 21, 2006, the CSRC published on its official website a notice specifying the documents and materials that
are required to be submitted for obtaining CSRC approval.
It is not clear whether the provisions in
the regulation regarding the offshore listing and trading of the securities of a SPV applies to an offshore company such as us
which owns controlling contractual interest in the PRC Operating Entities. We believe that the M&A Rules and the CSRC approval
are not required in the context of the share exchange under our transaction because (i) such share exchange is a purely foreign
related transaction governed by foreign laws, not subject to the jurisdiction of PRC laws and regulations; (ii) we are not a SPV
formed or controlled by PRC companies or PRC individuals; and (iii) we are owned or substantively controlled by foreigners. However,
we cannot be certain that the relevant PRC government agencies, including the CSRC, would reach the same conclusion, and we still
cannot rule out the possibility that CSRC may deem that the transactions effected by the share exchange circumvented the M&A
rules, the PRC Securities Law and other rules and notices.
If the CSRC or another PRC regulatory agency
subsequently determines that the CSRC’s approval is required for the transaction, we may face sanctions by the CSRC or another
PRC regulatory agency. If this happens, 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 from this offering into the PRC,
restrict or prohibit payment or remittance of dividends to us 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 shares.
The CSRC or other PRC regulatory agencies may also take actions requiring us, or making it advisable for us, to delay or cancel
the transaction.
The M&A Rules, along with foreign exchange
regulations discussed in the above subsection, will be interpreted or implemented by the relevant government authorities in connection
with our future offshore financings or acquisitions, and we cannot predict how they will affect our acquisition strategy. For example,
our operating companies’ ability to remit dividends to us, or to engage in foreign-currency-denominated borrowings, may be
conditioned upon compliance with the SAFE registration requirements by such Chinese domestic residents, over whom we may have no
control. In addition, such Chinese domestic residents may be unable to complete the necessary approval and registration procedures
required by the SAFE regulations. Such uncertainties may restrict our ability to implement our acquisition strategy and adversely
affect our business and prospects.
Future inflation in China may inhibit our activity to conduct
business in China.
In recent years, the Chinese economy has
experienced periods of rapid expansion and high rates of inflation. These factors have led to the adoption by Chinese government,
from time to time, of various corrective measures designed to restrict the availability of credit or regulate growth and contain
inflation. High inflation may in the future cause Chinese government to impose controls on credit and/or prices, or to take
other action, which could inhibit economic activity in China, and thereby harm the market for our services.
The enforcement of the PRC Labor Contract Law and other
labor-related regulations in the PRC may adversely affect our business and results of operations.
The Standing Committee of the National People’s
Congress enacted the Labor Contract Law on January 2008 and amended it on December 28, 2012. The Labor Contract Law introduced
specific provisions related to fixed-term employment contracts, part-time employment, probationary periods, consultation with labor
unions and employee assemblies, employment without a written contract, dismissal of employees, severance, and collective bargaining
to enhance previous PRC labor laws. Under the Labor Contract Law, an employer is obligated to sign an unlimited-term labor contract
with any employee who has worked for the employer for ten consecutive years. Further, if an employee requests or agrees to renew
a fixed-term labor contract that has already been entered into twice consecutively, the resulting contract, with certain exceptions,
must have an unlimited term. With certain exceptions, an employer must pay severance to an employee where a labor contract is terminated
or expires. In addition, PRC governmental authorities have continued to introduce various new labor-related regulations since the
effectiveness of the Labor Contract Law.
Under the PRC Social Insurance Law and the
Administrative Measures on Housing Fund, employees are required to participate in pension insurance, work-related injury insurance,
medical insurance, unemployment insurance, maternity insurance and housing funds and employers are required, together with their
employees or separately, to pay the social insurance premiums and housing funds for their employees.
These laws designed to enhance labor protection
tend to increase our labor costs. In addition, as the interpretation and implementation of these regulations are still evolving,
our employment practices may not be at all times be deemed in compliance with the regulations. As a result, we could be subject
to penalties or incur significant liabilities in connection with labor disputes or investigations, which could have a material
adverse effect on our results of operations and financial condition.
We may have difficulty establishing adequate management,
legal and financial controls in the PRC.
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, we may experience difficulty
in establishing management, 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, legal and financial controls in the PRC.
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 and our management.
We conduct a substantial portion of our
operations in China and a substantial portion of our assets are located in China. In addition, some of our directors and 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 some of our directors and senior executive officers, including with respect to matters arising under U.S. federal
securities laws or applicable state securities laws. It would also be difficult for investors to bring an original lawsuit against
us or our directors or executive officers before a Chinese court based on U.S. federal securities laws or otherwise. Moreover,
China does not have treaties with the United States or many other countries providing for the reciprocal recognition and enforcement
of judgment of courts.
PRC enterprise income tax law could adversely affect our
business and our net income.
On March 16, 2007, the National People’s
Congress of the PRC passed the revised Enterprise Income Tax Law (or EIT Law), which took effect on of January 1, 2008 and was
subsequently amended on February 24, 2017 and December 29, 2018, respectively. The EIT Law imposes a unified income tax rate of
25% on all companies established in China. Under the EIT Law, an enterprise established outside of the PRC with “de facto
management bodies” within the PRC is considered as a resident enterprise and will normally be subject to the enterprise income
tax at the rate of 25% on its global income. The EIT Law, however, does not define the term “de facto management bodies.”
If the PRC tax authorities subsequently determine that we should be classified as a resident enterprise, then our global income
will be subject to PRC income tax at a tax rate of 25%.
With the introduction of the EIT Law, China
has resumed imposition of a withholding tax (10% in the absence of a bilateral tax treaty or new domestic regulation reducing such
withholding tax rate to a lower rate). Per the Double Tax Avoidance Arrangement between Hong Kong and Mainland China, a Hong
Kong company as the investor, which is considered a “non-resident enterprise” under the EIT Law, may enjoy the reduced
withholding tax rate of 5% if it holds more than 25% equity interest in its PRC subsidiary. As China Net HK is the sole shareholder
of Rise King WFOE, substantially all of our income will derive from dividends we receive from Rise King WFOE through China Net
HK. When we declare dividends from the income in the PRC, we cannot assure whether such dividends may be taxed at a reduced
withholding tax rate of 5% per the Double Tax Avoidance Arrangement between Hong Kong and Mainland China as the PRC tax authorities
may regard our China Net HK as a shell company formed only for tax purposes and still deem Rise King WFOE in the PRC as the subsidiary
directly owned by us. Based on the Notice on Certain Issues with respect to the Enforcement of Dividend Provisions in Tax Treaties,
issued on February 20, 2009 by the State Administration of Taxation, if the relevant PRC tax authorities determine, in their discretion,
that a company benefits from such reduced income tax rate due to a structure or arrangement that is primarily tax-driven, such
PRC tax authorities may adjust the preferential tax treatment.
Investors should note that the EIT Law provides
only a framework of the enterprise tax provisions, leaving many details on the definitions of numerous terms as well as the interpretation
and specific applications of various provisions unclear and unspecified. Any increase in our tax rate in the future could
have a material adverse effect on our financial conditions and results of operations.
Under the EIT Law, we may be classified as a “resident
enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and holders of our securities.
Under the EIT Law, an enterprise established
outside of China with its “de facto management body” in China is considered a “resident enterprise,” meaning
that it can be treated the same as a Chinese enterprise for enterprise income tax purposes. The implementing rules of the EIT Law
defines “de facto management body” as an organization that exercises “substantial and overall management and
control over the production and operations, personnel, accounting, and properties” of an enterprise. Currently no interpretation
or application of the EIT Law and its implementing rules is available, therefore it is unclear how tax authorities will determine
tax residency based on the facts of each case.
If the PRC tax authorities determine that
China Net is a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences
could follow. First, we will be subject to enterprise income tax at a rate of 25% on our worldwide income as well as PRC enterprise
income tax reporting obligations. This would mean that income such as interest on offering proceeds and other non-China source
income would be subject to PRC enterprise income tax at a rate of 25%. Second, although under the EIT Law and its implementing
rules dividends paid to us by our PRC subsidiaries would qualify as “tax-exempt income,” we cannot guarantee that such
dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding
tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident
enterprises for PRC enterprise income tax purposes. Finally, a 10% withholding tax will be imposed on dividends we pay to our non-PRC
shareholders.
Our Chinese operating companies are obligated to withhold
and pay PRC individual income tax in respect of the salaries and other income received by their employees who are subject to PRC
individual income tax. If they fail to withhold or pay such individual income tax in accordance with applicable PRC regulations,
they may be subject to certain sanctions and other penalties, which could have a material adverse impact on our business.
Under PRC laws, Rise King WFOE and the PRC
Operating Entities will be obligated to withhold and pay individual income tax in respect of the salaries and other income received
by their employees who are subject to PRC individual income tax. Such companies may be subject to certain sanctions and other liabilities
under PRC laws in case of failure to withhold and pay individual income taxes for its employees in accordance with the applicable
laws.
In addition, the SAT has issued several
circulars concerning employee stock options. Under these circulars, employees working in the PRC (which could include both PRC
employees and expatriate employees subject to PRC individual income tax) are required to pay PRC individual income tax in respect
of their income derived from exercising or otherwise disposing of their stock options. Our PRC entities will be obligated to file
documents related to employee stock options with relevant tax authorities and withhold and pay individual income taxes for those
employees who exercise their stock options. While tax authorities may advise us that our policy is compliant, they may change their
policy, and we could be subject to sanctions.
Because Chinese laws will govern almost all of our business’
material agreements, we may not be able to enforce our rights within the PRC or elsewhere, which could result in a significant
loss of business, business opportunities or capital.
The Chinese legal system is similar to a
civil law system based on written statutes. Unlike common law systems, it is a system in which decided legal cases have little
precedential value. Although legislation in the PRC over the past 40 years has significantly improved the protection afforded to
various forms of foreign investment and contractual arrangements in the PRC, these laws, regulations and legal requirements are
relatively new. Due to the limited volume of published judicial decisions, their non-binding nature, the short history since their
enactments, the discrete understanding of the judges or government agencies of the same legal provision, inconsistent professional
abilities of the judicators, and the inclination to protect local interest in the court rooms, interpretation and enforcement of
PRC laws and regulations involve uncertainties, which could limit the legal protection available to us, and foreign investors,
including you. The inability to enforce or obtain a remedy under any of our future agreements could result in a significant loss
of business, business opportunities or capital and could have a material adverse impact on our business, prospects, financial condition,
and results of operations. In addition, the PRC legal system is based in part on government policies and internal rules (some of
which are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware of our
violation of these policies and rules until a period of time after the violation. In addition, any litigation in the PRC, regardless
of outcome, may be protracted and result in substantial costs and diversion of resources and management attention.
The non-U.S. activities of our non-U.S. subsidiaries and
VIEs may be subject to U.S. taxation.
We conduct a substantial portion of our
business through our operating subsidiaries and VIEs in China and are subject to income tax in the PRC. ChinaNet Online Holdings,
Inc. is a Nevada corporation and is subject to income tax in the United States. New U.S. federal tax legislation, commonly referred
to as the Tax Cuts and Jobs Act (the “U.S. Tax Reform”), was signed into law on December 22, 2017. The U.S. Tax
Reform significantly modified the U.S. Internal Revenue Code by, among other things, reducing the statutory U.S. federal corporate
income tax rate from 35% to 21% for taxable years beginning after December 31, 2017; limiting and/or eliminating many business
deductions; migrating the U.S. to a territorial tax system with a one-time transition tax on a mandatory deemed repatriation of
previously deferred foreign earnings of certain foreign subsidiaries; subject to certain limitations, generally eliminating U.S.
corporate income tax on dividends from foreign subsidiaries; and providing for new taxes on certain foreign earnings.
The U.S. Tax Reform includes provisions
for a new tax on global intangible low-taxed income (“GILTI”) effective for tax years of non-U.S. corporations beginning
after December 31, 2017. The GILTI provisions impose a tax on foreign income in excess of a deemed return on tangible assets
of controlled foreign corporations (“CFCs”), subject to the possible use of foreign tax credits and a deduction equal
to 50 percent to offset the income tax liability, subject to some limitations. The new GILTI tax would be imposed on us when
our subsidiaries and VIEs that are CFCs generate income that is subject to Subpart F of the U.S. Internal Revenue Code beginning
after December 31, 2017, and any such resulting U.S. corporate income tax imposed on us would reduce our consolidated net income.
Risks Related to our Securities
Insiders have substantial control over us, and they could
delay or prevent a change in our corporate control even if our other stockholders wanted it to occur.
Our executive officers, directors, and principal
stockholders hold approximately 27% of our outstanding Common Stock. Accordingly, these stockholders are able to exert substantial
influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate
transactions. This could delay or prevent an outside party from acquiring or merging with us even if our other stockholders
wanted it to occur.
There may not be sufficient liquidity in the market for
our securities in order for investors to sell their securities.
There is currently only a limited public
market for our Common Stock and there can be no assurance that a trading market will develop further or be maintained in the future. As
of May 25, 2020, the closing trade price of our Common Stock was $0.92 per share. As of May 25, 2020,
we had approximately 660 shareholders of record of our Common Stock, not including shares held in street name. In addition,
during the past two fiscal years our Common Stock has had a trading range with a low price of $1.06 per share and a high price
of $9.34 per share.
The market price of our Common Stock may be volatile.
The market price of our Common Stock has
been and will likely continue to be highly volatile, as is the stock market in general. Some of the factors that may materially
affect the market price of our Common Stock are beyond our control, such as changes in financial estimates by industry and securities
analysts, conditions or trends in the industry in which we operate or sales of our common stock. These factors may materially adversely
affect the market price of our Common Stock, regardless of our performance. In addition, the public stock markets have experienced
extreme price and trading volume volatility particularly for companies whose primary operations are located in the PRC. This volatility
has significantly affected the market prices of securities of many companies for reasons frequently unrelated to the operating
performance of the specific companies. These broad market fluctuations may adversely affect the market price of our Common Stock.
The outstanding options and warrants may adversely affect
us in the future and cause dilution to existing stockholders.
We currently have common stock purchase
options outstanding to purchase up to 755,216 shares of our Common Stock in the aggregate issued to our management, executive directors
and employees, subject to forfeiture upon an employee's cessation of employment at the discretion of the Company. The exercise
prices of these options range from $2.10 to $3.00 per share, of which 277,976 shares of common stock purchase options will expire
on November 29, 2021, and the remaining 477,240 shares of common stock purchase options will expire on September 14, 2020. We also
have warrants outstanding to purchase up to 774,000 shares of our Common Stock, of which 645,000 warrants will expire on July 17,
2020 and the remaining 129,000 warrants will expire on January 17, 2021. The exercise price of these warrants is $1.4927 per share,
subject to adjustment in certain circumstances. Exercise of these options and warrants may cause dilution in the interests of other
stockholders as a result of the additional Common Stock that would be issued upon exercise. In addition, sales of the shares of
our Common Stock issuable upon exercise of these options and warrants could have a depressive effect on the price of our stock,
particularly if there is not a coinciding increase in demand by purchasers of our Common Stock. Further, the terms on which we
may obtain additional financing during the period any of these options and warrants remain outstanding may be adversely affected
by the existence of these options and warrants as well.
We may need additional capital and may sell additional
securities or other equity securities or incur indebtedness, which could result in additional dilution to our shareholders or increase
our debt service obligations.
We may require additional cash resources
due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue.
If our cash resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities
or obtain a credit facility. The sale of additional equity securities or equity-linked debt securities 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. We cannot assure you that financing will be available
in amounts or on terms acceptable to us, if at all.
We have not paid dividends in the past and do not expect
to pay dividends in the future, and any return on investment may be limited to the value of our stock.
We have never paid any cash dividends on
our Common Stock and do not anticipate paying any cash dividends on our common stock in the foreseeable future and any return on
investment may be limited to the value of our stock. We plan to retain any future earning to finance growth.
Techniques employed by manipulative short sellers in Chinese
small cap stocks may drive down the market price of our common stock.
Short selling is the practice of selling
securities that the seller does not own but rather has, supposedly, borrowed from a third party with the intention of buying identical
securities back at a later date to return to the lender. The short seller hopes to profit from a decline in the value of the securities
between the sale of the borrowed securities and the purchase of the replacement shares, as the short seller expects to
pay less in that purchase than it received in the sale. As it is therefore in the short seller’s best interests for
the price of the stock to decline, many short sellers (sometime known as “disclosed shorts”) publish, or arrange for
the publication of, negative opinions regarding the relevant issuer and its business prospects in order to create negative market
momentum and generate profits for themselves after selling a stock short. While traditionally these disclosed shorts were
limited in their ability to access mainstream business media or to otherwise create negative market rumors, the rise of the Internet
and technological advancements regarding document creation, videotaping and publication by weblog (“blogging”) have
allowed many disclosed shorts to publicly attack a company’s credibility, strategy and veracity by means of so-called research
reports that mimic the type of investment analysis performed by large Wall Street firm and independent research analysts.
These short attacks have, in the past, led to selling of shares in the market, on occasion in large scale and broad base.
Issuers with business operations based in China and who have limited trading volumes and are susceptible to higher volatility levels
than U.S. domestic large-cap stocks, can be particularly vulnerable to such short attacks.
These short seller publications are not
regulated by any governmental, self-regulatory organization or other official authority in the U.S., are not subject to the certification
requirements imposed by the Securities and Exchange Commission in Regulation AC (Regulation Analyst Certification) and, accordingly,
the opinions they express may be based on distortions of actual facts or, in some cases, fabrications of facts. In light
of the limited risks involved in publishing such information, and the enormous profit that can be made from running just one successful
short attack, unless the short sellers become subject to significant penalties, it is more likely than not that disclosed shorts
will continue to issue such reports.
While we intend to strongly defend our public
filings against any such short seller attacks, oftentimes we are constrained, either by principles of freedom of speech, applicable
state law (often called “Anti-SLAPP statutes”), or issues of commercial confidentiality, in the manner in which we
can proceed against the relevant short seller. You should be aware that in light of the relative freedom to operate that such
persons enjoy – oftentimes blogging from outside the U.S. with little or no assets or identity requirements – should
we be targeted for such an attack, our stock will likely suffer from a temporary, or possibly long term, decline in market price
should the rumors created not be dismissed by market participants.
The NASDAQ may delist our securities from quotation on
its exchange which could limit investors’ ability to make transactions in our securities and subject us to additional trading
restrictions.
Our Common Stock is traded on the Nasdaq
Stock Market LLC (“NASDAQ”), a national securities exchange. On April 21, 2020, we received a notice (the “Notice”)
from The Nasdaq indicating that its common stock (the “Common Stock”), fails to comply with the $1.00 minimum bid price
required for continued listing on The Nasdaq Capital Market under Nasdaq Listing Rule 5550(a)(2) based upon the closing bid price
of the Common Stock for the 30 consecutive business days prior to the date of the Notice. The Nasdaq rules provide us a compliance
period of 180 calendar days in which to regain compliance with Rule 5550(a)(2) which would have been by October 18, 2020. The Notice
also states that, due to current market conditions, Nasdaq has determined to toll the commencement of the compliance period for
the minimum bid price requirement through June 30, 2020. As a result, the date by which we have to regain compliance with the minimum
bid price requirement was extended to December 28, 2020. To regain compliance, the minimum bid price of the Common Stock must meet
or exceed $1.00 per share for a minimum ten consecutive business days at any point prior to December 28, 2020, at which point Nasdaq
would provide written confirmation to us and close the matter. Our failure to regain compliance prior to December 28, 2020 could
result in delisting of our Common Stock from the NASDAQ.
We are presently evaluating various courses
of action to regain compliance. There can be no assurance that we will be able to regain compliance with Nasdaq’s rule or
will otherwise be in compliance with other NASDAQ listing criteria. If NASDAQ delists our Common Stock from trading on its exchange,
we could face significant material adverse consequences including:
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a limited availability of market quotations for our securities;
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a determination that our Common Stock is a “penny stock” which will require brokers trading in our Common Stock
to adhere to more stringent rules and possibly resulting in a reduced level of trading activity in the secondary trading market
for our Common Stock;
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a limited amount of news and analyst coverage for our company; and
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a decreased ability to issue additional securities or obtain additional financing in the future.
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The audit report included in this annual report is prepared
by an auditor who is not inspected by the Public Company Accounting Oversight Board and, as such, you may be deprived of the benefits
of such inspection.
Our independent registered public accounting
firm that issues the audit reports included in our annual reports filed with the U.S. Securities and Exchange Commission (the “SEC”),
as auditors of companies that are traded publicly in the United States and a firm registered with the Public Company Accounting
Oversight Board (United States) (the “PCAOB”), is required by the laws of the United States to undergo regular inspections
by the PCAOB to assess its compliance with the applicable laws of the United States and professional standards. Because our auditor
is located in the People’s Republic of China, a jurisdiction where the PCAOB is currently unable to conduct inspections and
access critical accounting records without the approval of the Chinese authorities, our auditor is not currently inspected by the
PCAOB. Inspections conducted by the PCAOB outside of China have identified deficiencies in those firms’ audit procedures
and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality and prevent
accounting irregularities. This lack of PCAOB inspections in China prevents the PCAOB from regularly evaluating audit documentation
located in China and its related quality control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections.
In a joint public statement on April 21, 2020, the Chairman of the SEC, the Chairman of the PCAOB, SEC Chief Accountant and Directors
of the SEC Divisions of Corporation Finance and Investment Management reminded market participants that this inability of the PCAOB
to inspect the audit work and practices of PCAOB-registered accounting firms in China (including Hong Kong, to the extent their
audit clients have operations in China) represented a significant risk to both investors and finance professionals.