Item 1. Business.
Introduction
China Shianyun Group Corp., Ltd, a Nevada Corporation, was incorporated on August 17, 2006, with a fiscal year end of June 30 under the name of Glance, Inc. Until December 2008, the Company was involved in development and production of organic body-care lotions. At that time, the Company had a change in ownership via a private stock sale of a majority of the common stock of the Company. We changed our name to China Green Creative on January 21, 2009 and changed our fiscal year end to December 31 in 2009. On July 26, 2013, we purchased one hundred shares of common stock of China Shianyun Group Corp., Ltd, a Nevada corporation, representing all of its authorized shares, for $1,354, causing China Shianyun Group Corp., Ltd to become a wholly owned subsidiary of the Company (“Merger Sub”). Immediately following the acquisition, Merger Sub was merged with and into us, effective as of July 26, 2013. As a result of the merger, our corporate name was changed to “China Shianyun Group Corp., Ltd.” Prior to the merger, Merger Sub had no liabilities and nominal assets and, as a result of the merger, the separate existence of the Merger Sub ceased. We are the surviving corporation in the merger and, except for the name change, there was no change in our directors, officers, capital structure or business.
We are currently formulating and distributing consumer goods such as herbal teas and beverage, health liquors, meal replacement products, eggs and cured meat produced by ecologically breeding methods in China. In order to satisfy our customer demands for high quality products, we enter into contracts with factories in China to produce the products with our design, formula, standards and distribute those products under our registered brand names. All our registered brands have obtained nation-wide product certifications. During the past fiscal year, we mainly used “GEN + ME” for our own product lines and used various sub brands under “GEN+ME” for our different product lines. We sell products under our registered brand name primarily through our regional independent third-party distributors in the PRC to customers.
To keep up in such a competitive industry, we constantly adjust our manufacture and distribution strategies in China according to current economic conditions, consumer preference, government policy and social climate in the marketplace. With the improved living condition in China, people pay more and more attention to healthy and natural products. In 2013, our top sale products include red wine using grape grown in original ecological environment in Xinjiang province, natural eggs, cured meat and noodle with extracted tomato carotenes.
We sell products under our registered brand name primarily through our regional independent third-party distributors in the PRC to customers mainly in Zhejiang, Beijing, Shandong, Fujian and Guangdong Provinces. In addition to the sales of consumer products through distributors, we grant regional distribution rights for the use of our trademarks and provide continuing support services to our distributors.
In an effort to stay competitive, as an adjustment of our distribution strategy, we started developing direct sales via internet and other electronic mediums in 2012. With the expansion of our online platform and a major consumer goods producer and distributor joining our online platform in 2013, we plan to use combined brand name for consumer goods distributed via our online platform in 2014. The combined brand name will be “GEN +Me + joined third party brand”.
During 2012, we were authorized by China National Food Industry Association to host the 1st China Food Customization and Safety Care Expo from November 1 to 3, 2012. The Expo was to introduce and promote the new concept of custom food in China. With the recent expansion of China's economy and extensive improvements in living conditions in China, people in the PRC have been paying more attention to food safety and quality than the past. We expect our business will develop rapidly along with the acceptance and recognition of custom food by the market in China. We originally planned to host the Expo annually, but after assessing the effect and cost of the Expo, we decided to host the Expo in every 3 years.
On September 18, 2009, we entered into a share exchange agreement, pursuant to which we acquired 100% of the equity ownership of Plenty Fame, a British Virgin Islands company in exchange for 277,785,000 newly-issued shares of its common stock (the “Share Exchange”).
Plenty Fame is the 100% owner of Prospect Hong Kong Development Limited (
“Prospect”
), an investment holding company incorporated in Hong Kong. Prospect is the 100% owner of Jiangxi Jien Industries Limited (
“Jiangxi Jien”
), a company incorporated in the People’s Republic of China (
“China”
or the
“PRC”
) which principally engaged in distribution of consumer goods in the PRC . In April 2009, Jiangxi Jien formed Shenzhen Jien Electronic Commerce Company Limited (
“Shenzhen Jien”
), a PRC company which is principally engaged in the distribution of consumer goods and electronic products in the PRC.
Immediate after the completion of the Share Exchange, Plenty Fame’s business became our major business and its shareholder became our majority shareholder
As of December 31, 2013, the details of the Company’s subsidiaries are summarized as follows:
Name
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Domicile and date of incorporation
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Paid-in capital
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Effective ownership
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Principal activities
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Plenty Fame Holding, Limited (“Plenty Fame”)
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British Virgin Islands (the “BVI”)
January 18, 2008
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$50,000
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100%
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Investment holding
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Prospect Hong Kong Development Limited (“Prospect”)
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Hong Kong Special Administrative Region (“HKSAR”)
October 17, 2008
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HK$10,000
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100%
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Investment holding
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Jiangxi Jien Industries Limited
(“Jiangxi Jien”)
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The PRC
April 8, 1997
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RMB16,000,000
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100%
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Sale of consumer products in the PRC.
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Shenzhen Jien Electronic Commerce Company Limited (“Shenzhen Jien”)
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The PRC
April 13, 2009
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RMB3,000,000
|
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100%
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Management of regional distribution rights and provision of related services
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On July 23, 2012, we affected a reverse stock split at 1:60 to reduce our issued and outstanding shares of common stock from 300,000,000 to approximately 5,000,052 including rounded up fractional shares. The reverse split was approved by a majority of our shareholders and is retroactively reflected in the interim report on Form 10-Q for the period ended September 30, 2012 which was filed on August 20, 2012.
On October 15, 2013, our Board of Directors authorized and a majority of our shareholders approved a reverse stock split at a ratio of 1:200, reducing the number of outstanding shares of our common stock from 155,350,052 shares to 776,837 shares. The reverse split went effective on November 20, 2013, at which time a new CUSIP number, 16952X 200, applied to our common stock.
On September 19, 2012, we closed an offering ( the “Reg. S Offering”) of $1,503,500 in which we issued a total of 150,350,000 shares of our common stock , par value $0.001 per share (“Common Stock”) to 236 investors at a purchase price of $0.01 per share in reliance upon the exemption from securities registration afforded by Regulation S (“Regulation S”) as promulgated under the Securities Act of 1933. Pursuant to the purchase agreement in the Reg. S Offering, the investors agree not to offer, sell, contract to sell, assign, transfer, hypothecate, gift, pledge or grant a security interest in, or otherwise dispose of, or enter into any transaction which is designed to, or might reasonably be expected to, result in the disposition of (whether by actual disposition or effective economic disposition due to cash settlement or otherwise, directly or indirectly) (each, a “Transfer”), any of the shares until a date that is two years following the closing date.
The investors in the Reg. S Offering except Han Sing Investment Incorporated (“Han Sing”) are individuals and regional independent third-party distributors of the Company. None of these individual distributors held any shares of the Company prior to the Closing Date or was issued more than 5% of the shares of the Company in the Reg. S offering. Han Sing is a Cayman company wholly owned by Mr. Xinghua Chen. Mr. Chen is a director of the Company and is actively involved in the Company’s daily operation and management. Prior to the Reg. S. Offering, Han Sing held approximately 245,417 shares of our Common Stock, representing 4.9% of the shares of issued and outstand Common Stock before the closing of the Reg. S Offering. Han Sing purchased 88,450,000 shares of our Common Stock in the Reg. S Offering, resulting in its holding of approximately 57.1% of our Common Stock. Through his ownership of Han Sing, Mr. Xinghua Chen became a controlling shareholder of the Company.
On July 26, 2013, we purchased one hundred shares of common stock of China Shianyun Group Corp., Ltd, a Nevada corporation, representing all of its authorized shares, for $1,354, causing China Shianyun Group Corp., Ltd to become a wholly owned subsidiary of the Company (“Merger Sub”). Immediately following the acquisition, Merger Sub was merged with and into us, effective as of July 26, 2013. As a result of the merger, our corporate name was changed to “China Shianyun Group Corp., Ltd.” We are the surviving corporation in the merger and, except for the name change; there was no change in our directors, officers, capital structure or business.
In 2013, in order to adapt to the rapid changes in the market, we determined to change the strategic direction of our product mix and marketing in order to sell food produced in original ecologic environment including red wine, eggs, cured meat and vegetables and fruits. Natural food is perceived to be more nutritious and safer than conventional food because it is grown and prepared in a greener and original ecologic environment. We identified this new opportunity for our business and proactively shifted our major resources to this market. The impact of the sales strategies modification has initially caused a reduction in our revenue and net income but we believe that it will, in the longer term, lead to improved sales results following the introduction of our new products. The business of ecological food started to generated income in the third quarter of 2013.
Online shopping, as one mode of E-commerce, is accepted by more and more customers in China, especially by younger people. Observing the potential opportunity of the huge market for online shopping in China, as a part of our new business strategies, we established the “Shianyun” platform (
http://www.shianyun.com/V2/Index2/Index.aspx
and
http://www.shianyunjituan.com
) based on our existing internet platform to develop the online-to-offline commerce, link up the online sales and offline stores and embed our internal production system and logistics management. The application of the new platform greatly optimizes our online sales and delivery system. In the forth quarter of 2013, a leading consumer goods producer and distributor in China joined our online platform and we together plan to develop combined brands for kitchen supplies, dinning tables and coffee tables in 2014.
We expect to continue to invest primarily in marketing and in recruiting new regional distributors. We believe this will not only expand our regional distribution network but increase our market acceptance and customer satisfaction.
General Description of Business
The Company is principally engaged in the production and distribution of consumer goods in the PRC.
Business Overview
We source our selected products from factories in China and distribute them through our regional independent third-party distributors according to market demand. Further, in an effort to stay competitive, we adjust our product portfolio and distribution strategies in China annually according to economic conditions, consumer preference, government policy and social climate in the marketplace. During 2013, our core competencies consist of red wine using grape grown in original ecological environment in Xinjiang province, natural eggs, cured meat and noodle with extracted tomato carotenes. To keep up in such a competitive industry and to satisfy our customer demands for high quality products, as part of our marketing strategy, we register various sub brand names for our products under our general brand name. All these registered brands have obtained nation-wide product certifications. Our general brand is “GEN +ME” and we currently have approximately 100 sub brands under “GEN + ME” for our products. With the expansion of our online platform and a major consumer goods producer and distributor joining our online platform in the last quarter of 2013, we plan to use combined brand name for consumer goods distributed via our online platform in 2014. The combined brand name will be “GEN +Me + joined third party brand”.
Product Supplies
Due to high demand for healthy food and products in the Chinese marketplace, we focus our distribution on consumer products which has allowed us to gain market share and achieve favorable profit margins. Product selection is made only after our market research team conducts appropriate due diligence related to market demand and, after working with our regional independent third-party distributors, determines the best strategy for moving forward. Upon selection of each product type, we source each product from the respective producers within the region. Criteria for choosing producers include, but are not limited to the following: reputation, product quality, price, trustworthiness, business track record, and expertise related to their production of the chosen product. We also impose a quality control metric that ensures product safety in accordance with all required government standards. Further, as an integral part of our products department, our product design team works to ensure the highest innovation and quality in our packaging, logos and product descriptions. For example, we introduced red wine made by grape produced in green environment in Xinjiang province and natural eggs in 2013 which were popular among our customers.
Regional Independent Third-party Distributors
Regional independent third-party distributors are the downstream component in our value chain. They act as our buyers and resell our products directly to the consumer. We value our relationship with our distributors as they have their fingers on the pulse of the market, and best understand the consumer. However, while the distributors are our clients, we also work closely with them as partners in an effort to obtain valuable market information that assists us in our supply chain management. In our expansion efforts, we are constantly seeking out new distributors who can help us break into untapped markets that are sound business opportunities. We rely heavily on our research department, vendors, business associates, customers and friends to locate and invite regional independent third-party distributors to build our distribution network. Further, we choose our regional independent third-party distributors based on a number of criteria, including:
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The size of the distributor’s network in their immediate market,
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The distributor’s ability to market new brands and products within that market,
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The distributor’s operating and logistical strength within the market,
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The distributor’s core competencies and types of products they are already distributing,
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The distributor’s financial strength.
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Product Delivery
To save time, transportation and storage costs, we instruct our suppliers to ship most of our products directly to our regional independent third-party distributors. Through negotiation with our suppliers and the consignment agreements with our distributors, we hold legal title to these inventories as these inventories are considered to be in our physical possession. In a case where there is a product return or defect, the regional distributors return the goods upon our confirmation and approval. Meanwhile, we also keep some level of raw materials and finished goods on hand to meet urgent demand. For revenue recognition policy, we recognize gross revenue instead of net revenues based on the following analysis:
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Products are designed by the Company,
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We provide product specifications to suppliers for their production,
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The Company negotiates the price with customers and bears all credit risks.
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We are in the process of building our own delivery system to handle shipping and we started to ship partial products from our logistics center to our regional distributor directly by ourselves commencing from the beginning of 2013.
Marketing and Sales
We rely heavily on our regional independent third-party distributors to market and promote both our brands and our products. Our distributors deliver our products directly to the local retail shops, and we monitor our sales performance and market information through our distributor’s activities. We typically conduct focused promotion activities when we introduce our new product to the market. Occasionally, we conduct our regional product advertising and promotional campaigns directly through our distributors.
Online platform for customer and regional distributor
In 2011, we began a trial run of a self-developed online customer service platform for our regional distributors to increase our future sales revenue and improve customer satisfaction. The online platform offers one-stop services to our regional distributors, including distributor profile management, consumption statistics, order processing and delivery arrangements. Regional distributors are able to manage their own online stores and real stores through the platform. It also provides advertising opportunities for our new products.
In 2012, in an effort to stay competitive, as an adjustment of our distribution strategy, we updated our online platform to include direct sales to end use customers. Our current online platform offers a range of online activities including shopping, processing and business managing for our distributors and enables end use customers to purchase products distributed by us directly through the internet. In 2013, our online platform received improved customer awareness and a larger customer base, we expect this platform will increase our internet sales revenue in the future.
Production facilities
In 2009, Jiangxi Jien acquired the land use rights to a parcel of land (6.3 acres) up to year 2069, on which we expect to develop a manufacturing base in Anyi County, Jiangxi Province, China. In consideration of the surrounding environment of the land and lack of funds, we revised our plan to develop a storage and logistic base in 2011. Our storage and logistic base mainly comprises warehouse areas, an administration office, a reconstructed processing workshop and a wine cellar. We are planning to improve our site environment and introduce some advanced facilities to our storage and logistic base. Currently, two warehouses have been in service and the remaining construction of the base has been temporarily suspended. The completion of the project, however, relies on our obtaining sufficient funds in the future, of which there can be no guarantee. Jiangxi Jien currently sells locally grown farm products, mainly meat and vegetables, to explore the local food market.
Competition
We are in a highly competitive industry. We compete with other distributors in our region, and also complete with vendors who sell similar products direct in China.
We compete with other distributors and vendors in following areas:
Product Quality and Cost
The Chinese consumer products market is a very price sensitive market. As products are similar and information flow is efficient, product quality and associated costs often dictate the lifespan of a product. We compete with our competitors in sourcing good and cost efficient suppliers, quality control, keeping costs to a minimum, and in the safety precautions taken to keep employees and customers safe. In order to increase market share, we are cultivating our distributors to promote our products through online stores and real stores.
We compete with other players in the industry for the number of retail shops and for market share within the distribution network. The larger the number of retail shops, the higher the penetration of the market and brand awareness. We need to ensure our regional independent third-party distributors have a sizeable distribution network in each region so we can maintain our market share, penetration and exposure. Further, we work with our distributors to ensure adequate and timely delivery to each region in which we are selling our products in order to maintain a competitive market position.
The Chinese consumer is a brand-name consumer. As such, we are constantly competing primarily on a brand recognition basis. Maintaining brand recognition and awareness is vital to our short term strategy and long term survival. We have produced various advertising videos (including anime) to enhance the reputation through the enormous influence of mass media. Our current online platform enables us to sell products directly to end customers and to expand our customer base. With nationally recognized distributors joining our online platform in 2013, we plan to use combined brand “GEN+ME+ third part brand” to further improve our brand awareness.
Growth Strategies
To ensure our continuous success, we plan to implement the following strategies:
Currently we sell our products through our distributors to customers mainly in Beijing, Zhejiang, Shandong, Fujian and Guangdong Provinces of the PRC. We plan to expand our distribution network into more provinces by assigning distributors into every one to two provinces in China, including distributors at provincial/city/county levels. By working with more regional independent third-party distributors, we can expand our geographic coverage to grow our customer base. The larger customer base will increase both our product offerings and our revenues. Further, larger order quantities from distributors will increase our profit margin from wholesale and the increase in order quantities with suppliers will cut our operating costs significantly due to discounts from the larger order quantities.
In addition to our traditional distribution network, we plan to implement a direct sales channel through internet sales. By implementing an online direct sales channel, we can sell our products into regions not yet covered by our distributors. Also, we can secure our sales in the areas in case of distributor non-performance. We believe our online distribution strategy will help us hedge against the risks of distributor failure and further grow our customer base in China.
Our
online sales and offline stores together expand our customer base and increase the sales and profits of our products. In the third quarter of 2013, we upgraded our online platform with cloud-based data management system. We will continue our efforts to reform the traditional operational model of Chinese food producer and distributor and to improve the food safety in China.
In the past, we have relied heavily on our distributors to market our products and build brand awareness. Going forward, building brand awareness will be vital to our success in building our distribution network and in expanding our customer base. Accordingly, we plan to put more time, effort and money into our research and development in an effort to improve product packaging, design, brand management and advertising. In 2014, we plan to use combined brand as “GEN+ME+ joined third party brand” to further expand our customer base and decrease the costs.
Intellectual Property
We are in possession of registered trademark “GEN+ME” for our products and various registered sub trademarks for our different products lines under “GEN+ME”.
Government Regulation
Regarding distribution of consumer goods, the Chinese government and PRC laws do not require any special and/or additional approvals, permissions or any other qualifications except for the relevant business license.
However, for some of our product offerings, the Chinese government may impose certain regulations on the production, distribution and sales. As such, we will only select suppliers and distributors who are in compliance with all laws and regulations as required by the Chinese government, and who possess all required licenses, permits and approvals as is necessary and required to do business in China.
In an effort to stay competitive, as an adjustment of our distribution strategy, we started developing direct sales via internet and other electronic mediums. We have been advised that certain PRC regulatory restrictions over foreign invested internet content providers may apply to our business. As a result, we have been communicating with our PRC legal advisor to explore the appropriate approach to adjust or restructure our operating businesses in China to accommodate our business development. As we are currently evaluating the feasibility and costs of such adjustment, we are not yet able to estimate the timeline and costs related to the process or whether we will be able to obtain all necessary governmental approvals in order to complete such adjustment or restructure.
Foreign Investment in PRC Operating Companies
The
Foreign Investment Industrial Catalogue
jointly issued by China's Ministry of Commerce (MOFCOM) and NDRC in 2007 classified various industries/businesses 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 industries/businesses permitted for foreign investment. Except for those expressly provided with restrictions, encouraged and permitted industries/businesses are usually 100% open to foreign investment and ownership. With regard to those industries/businesses restricted to foreign investment, there is always a limitation on foreign investment and ownership. Foreign investment is prohibited in prohibited industries/business. The PRC subsidiary’s business does not fall under the industry categories that are restricted to, or prohibited from foreign investment and is not subject to limitation on foreign investment and ownership.
Regulation of Foreign Currency Exchange
Foreign currency exchange in the PRC is governed by a series of regulations, including the
Foreign Currency Administrative Rules
(1996), as amended, and the
Administrative Regulations Regarding Settlement, Sale and Payment of Foreign Exchange
(1996), as amended. Under these regulations, the Renminbi is freely convertible for trade and service-related foreign exchange transactions, but not for direct investment, loans or investments in securities outside the PRC without the prior approval of State Administration of Foreign Exchange (SAFE). Pursuant to the
Administrative Regulations Regarding Settlement, Sale and Payment of Foreign Exchange
(1996), foreign investment enterprises, or FIEs may purchase foreign exchange without the approval of SAFE for trade and service-related foreign exchange transactions by providing commercial documents evidencing these transactions. They may also retain foreign exchange, subject to a cap approved by SAFE, to satisfy foreign exchange liabilities or to pay dividends. However, the relevant Chinese government authorities may limit or eliminate the ability of FIEs to purchase and retain foreign currencies in the future. In addition, foreign exchange transactions for direct investment, loan and investment in securities outside the PRC are still subject to limitations and require approvals from SAFE.
Regulation of FIEs’ Dividend Distribution
The principal laws and regulations in the PRC governing distribution of dividends by FIEs include:
(i)
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The
Sino-foreign Equity Joint Venture Law
(1979), as amended, and the
Regulations for the Implementation of the Sino-foreign Equity Joint Venture Law
(1983), as amended;
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(ii)
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The
Sino-foreign Cooperative Enterprise Law
(1988), as amended, and the
Detailed Rules for the Implementation of the Sino-foreign Cooperative Enterprise Law
(1995), as amended;
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(iii)
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The
Foreign Investment Enterprise Law
(1986), as amended, and the
Regulations of Implementation of the Foreign Investment Enterprise Law
(1990), as amended.
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Under these regulations, FIEs in the PRC may pay dividends only out of their accumulated profits, if any, determined in accordance with Chinese accounting standards and regulations. In addition, the wholly-owned foreign enterprises in the PRC are required to set aside at least 10% of their respective accumulated profits each year, if any, to fund certain reserve funds unless such reserve funds have reached 50% of their respective registered capital. These reserves are not distributable as cash dividends.
Regulation of a Foreign Currency’s Conversion into RMB and Investment by FIEs
On August 29, 2008, SAFE issued a
Notice of the General Affairs Department of the State Administration of Foreign Exchange on the Relevant Operating Issues concerning the Improvement of the Administration of Payment and Settlement of Foreign Currency Capital of Foreign-Invested Enterprises
or Notice 142, to further regulate the foreign exchange of FIEs. According to Notice 142, FIEs shall obtain a verification report from a local accounting firm before converting its registered capital in foreign currency into Renminbi, and the converted Renminbi shall be used for the business within its permitted business scope. Notice 142 explicitly prohibits FIEs from using RMB converted from foreign capital to make equity investments in the PRC, unless the domestic equity investment is within the approved business scope of the FIE and has been approved by SAFE in advance. In addition, SAFE strengthened its oversight over the flow and use of Renminbi funds converted from the foreign currency-dominated capital of a FIE. The use of such Renminbi may not be changed without approval from SAFE, and may not be used to repay Renminbi loans if the proceeds of such loans have not yet been used. Violations of Notice 142 may result in severe penalties, including substantial fines as set forth in the SAFE rules.
Regulation of Foreign Exchange in Certain Onshore and Offshore Transactions
In October 2005, SAFE issued the
Notice on Issues Relating to the Administration of Foreign Exchange in Fund-raising and Return Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies
, or SAFE Notice 75, which became effective as of November 1, 2005. SAFE has also issued implemented rules to SAFE Notice 75. SAFE Notice 75 and its implementation rules require PRC residents (including both corporate entities and natural persons) to register with SAFE or its competent local branch in connection with their direct or indirect shareholding in any company outside of China referred to as an “offshore special purpose company” established for the purpose of raising fund from overseas to acquire assets of, or equity interests in, PRC companies. Under SAFE Notice 75, a “special purpose vehicle”, or SPV, refers to an offshore entity established or controlled, directly or indirectly, by PRC residents for the purpose of seeking offshore equity financing using assets or interests owned by such PRC residents in onshore companies. In addition, any PRC resident that is the shareholder of an offshore special purpose company is required to amend his or her SAFE registration with the SAFE or its competent local branch, with respect to that offshore special purpose company in connection with any of its increase or decrease of capital, transfer of shares, merger, division, equity investment or creation of any security interest over any assets located in China. The SAFE regulations require retroactive approval and registration of direct or indirect investments previously made by PRC residents in offshore special purpose companies. PRC subsidiaries of an offshore special purpose company are required to coordinate and supervise the filing of SAFE registrations by the offshore holding company’s shareholders who are PRC residents in a timely manner. In the event that a PRC resident shareholder with a direct or indirect investment in an offshore parent company fails to obtain the required SAFE approval and make the required registration, the PRC subsidiaries of such offshore parent company may be prohibited from making distributions of profit to the offshore parent and from paying the offshore parent proceeds from any reduction in capital, share transfer or liquidation in respect of the PRC subsidiaries. Further, failure to comply with the various SAFE approval and registration requirements described above, as currently drafted, could result in liability under PRC law for foreign exchange evasion.
There still remain uncertainties as to how certain procedures and requirements under the aforesaid SAFE regulations will be enforced, and it remains unclear how these existing regulations, and any future legislation concerning offshore or cross-border transactions, will be interpreted, amended and implemented by the relevant government authorities. Although we have requested PRC residents who, to our knowledge, hold direct or indirect interests in our Company to make the necessary applications, filings and amendments as required under the SAFE Notice 75 and other related rules, our PRC resident beneficial holders have not completed such approvals and registrations required by the SAFE regulations. We will attempt to comply, and attempt to ensure that all of our shareholders subject to these rules comply with the relevant requirements. We cannot, however, assure the compliance of all of our China-resident shareholders. Any current or future failure to comply with the relevant requirements could subject us to fines or sanctions imposed by the Chinese government, including restrictions on certain of our subsidiaries’ ability to pay dividends or hinder our investment in those subsidiaries or affect our ownership structure, which could adversely affect our business and prospects.
Regulations on Employee Stock Option Plans
In December 2006, the People’s Bank of China promulgated the Administrative Measures of Foreign Exchange Matters for Individuals, which set forth the respective requirements for foreign exchange transactions by individuals (both PRC or non-PRC citizens) under either the current account or the capital account. In January 2007, SAFE issued implementing rules for the Administrative Measures of Foreign Exchange Matters for Individuals, which, among other things, specified approval requirements for certain capital account transactions such as a PRC citizen’s participation in the employee stock ownership plans or stock option plans of an overseas publicly-listed company. In March 2007, SAFE promulgated the Application Procedures of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Ownership Plan or Stock Option Plan of Overseas-Listed Company, or the Stock Option Rules. Under these rules, PRC citizens who participate in an employee stock ownership plan or a stock option plan in an overseas publicly-listed company are required to register with SAFE or its local branch and complete certain other procedures. For participants of an employee stock ownership plan, an overseas custodian bank should be retained by the PRC agent, which could be the PRC subsidiary of such overseas publicly-listed company, to hold on trusteeship all overseas assets held by such participants under the employee share ownership plan. In the case of a stock option plan, the PRC agent is required to retain a financial institution with stock brokerage qualification at the place where the overseas publicly-listed company is listed or a qualified institution designated by the overseas publicly-listed company to handle matters in connection with the exercise or sale of stock options for the stock option plan participants. For participants who had already participated in an employee stock ownership plan or stock option plan before the date of the Stock Option Rules, the Stock Option Rules require their PRC employers or PRC agents to complete the relevant formalities within three months of the date of this rule.
Further, a notice concerning the individual income tax on earnings from employee share options jointly issued by Ministry of Finance, or the MOF, and the State Administration of Taxation, or the SAT, and its implementing rules, provide that domestic companies that implement employee share option programs shall (a) file the employee share option plans and other relevant documents to the local tax authorities having jurisdiction over them before implementing such employee share option plans; (b) file share option exercise notices and other relevant documents with the local tax authorities having jurisdiction over them before exercise by the employees of the share options, and clarify whether the shares issuable under the employee share options mentioned in the notice are the shares of publicly listed companies; and (c) withhold taxes from the PRC employees in connection with the PRC individual income tax.
We and our PRC citizen employees who participate in the employee stock incentive plan, which we adopted in 2010, will be subject to these regulations. We and our PRC option grantees have not completed the registrations under these regulations. We cannot assure you that we and our PRC option grantees will be able to complete the required registrations. Any current or future failure to comply with the relevant requirements could subject us to fines or sanctions imposed by the Chinese government, which could adversely affect our business and prospects.
Government Regulations Relating to Taxation
On March 16, 2007, the National People’s Congress or NPC, approved and promulgated the
PRC Enterprise Income Tax Law
, which we refer to as the New EIT Law. The New EIT Law took effect on January 1, 2008. Under the New EIT Law, FIEs and domestic companies are subject to a uniform tax rate of 25%. The New EIT Law provides a five-year transition period starting from its effective date for those enterprises which were established before the promulgation date of the New EIT Law and which were entitled to a preferential lower tax rate under the then-effective tax laws or regulations.
On December 26, 2007, the State Council issued a
Notice on Implementing Transitional Measures for Enterprise Income Tax
, or the Notice, providing that the enterprises that have been approved to enjoy a low tax rate prior to the promulgation of the New EIT Law will be eligible for a five-year transition period beginning January 1, 2008, during which time the tax rate will be increased step by step to the 25% unified tax rate set out in the New EIT Law. From January 1, 2008, for the enterprises whose applicable tax rate was 15% before the promulgation of the New EIT Law, the tax rate will be increased to 18% for 2008, 20% for 2009, 22% for 2010, 24% for 2011, and 25% for 2012. For the enterprises whose applicable tax rate was 24%, the tax rate will be changed to 25% from January 1, 2008.
The New EIT Law and Implementation Rules of the New EIT Law provide that an income tax rate of 10% may be applicable to dividends payable to non-PRC investors that are “non-resident enterprises”, which (i) do not have an establishment or place of business in the PRC, or (ii) have such establishment or place of business in the PRC but the relevant income is not effectively connected with the establishment or place of business, to the extent such dividends are derived from sources within the PRC. The income tax for non-resident enterprises shall be subject to withholding at the income source, with the payor acting as the obligatory withholder under the New EIT Law, and therefore such income taxes generally called withholding tax in practice. Such income tax may be exempted or reduced by the State Council of the PRC or pursuant to a tax treaty between the PRC and the jurisdictions in which our non-PRC shareholders reside. For example, the 10% withholding tax is reduced to 5% pursuant to the Double Tax Avoidance Agreement Between Hong Kong and Mainland China if a Hong Kong resident enterprise owns more than 25% of the registered capital in a company in the PRC and is determined by the competent PRC tax authority to have satisfied the other conditions and requirements under such Double Tax Avoidance Agreement Between Hong Kong and Mainland China and other applicable laws. We are a U.S. holding company and substantially all of our income is derived from dividends we receive from our subsidiaries located in the PRC. Thus, if Prospect is considered as a “non-resident enterprise” under the New EIT Law and the dividends paid to Prospect by our subsidiaries in the PRC are considered income sourced within the PRC, such dividends may be subject to a withholding tax at a rate up to 10%.
The new tax 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 the combined Company’s tax rate in the future could have a material adverse effect on our financial condition and results of operations.
Research and Development
Development focus.
Our research and development effort currently focuses on creating culture concepts for our products such as healthy food for younger generations.
Research team.
We have an experienced and multi-disciplined research and development team, including food processing technology development team and food concept and culture development team.
Description of Property
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Address
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Size
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Leased/Owned/Granted
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Function
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1.
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18/F., Development Centre Building.,
South of Renmin Rd. LuoHu District,
Shenzhen, Guangdong Province, China
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500 sq.
meters
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Leased
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Headquarter
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2.
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No. 9 Zhongduan, Fenghuang Mountain
Development Zone,
Anyi County, Jiangxi Province, China
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25,639 sq.
meters
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Granted use rights
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Land
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3.
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No. 9 Zhongduan, Fenghuang Mountain
Development Zone,
Anyi County, Jiangxi Province, China
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1,521 sq.
meters
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Owned
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Storage and logistic center
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4.
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No. 9 Zhongduan, Fenghuang Mountain
Development Zone,
Anyi County, Jiangxi Province, China
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1,482 sq.
meters
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Owned
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Factory
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5.
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No. 9 Zhongduan, Fenghuang Mountain
Development Zone,
Anyi County, Jiangxi Province, China
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1,276 sq.
meters
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Owned
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Office building
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Employees
As of December 31, 2013, we had 47 employees in five functional departments, supply department, finance and accounting, logistics, market research (including Research and Development team) and administration departments.
All of the employees have signed labor contracts with us and receive monthly salaries as well as other social benefits including pension insurance, unemployment insurance, accidental insurance, medical insurance and housing funds, etc. We constantly hire part time contract workers when we are in need of additional works for production.
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, and 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.
Executive Offices
Our offices are located at 18/F., Development Centre Building., South of Renmin Rd. LuoHu District, Shenzhen, Guangdong Province, China
FOR ADDITIONAL INFORMATION
We are a reporting company and file annual, quarterly and current reports, proxy statements and other information with the SEC. For further information with respect to the Company, you may read and copy its reports, proxy statements and other information, at the SEC public reference rooms at 100 F. Street, N.E., Washington, D.C. 20549. You can request copies of these documents by writing to the SEC and paying a fee for the copying cost. Please call the SEC at 1-800-SEC-0330 for more information about the operation of the public reference rooms. The Company’s SEC filings are also available at the SEC’s web site at
http://www.sec.gov
.
Copies of Company’s Annual Reports on Form 10K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are all available free of charge, within a week after we file same with the SEC by sending a request for a paper copy to our outside securities counsel: Hunter Taubman Weiss LLP, c/o China Shianyun Group Corp., Ltd., 130 W 42nd Street, New York, NY 10036.
THE FOLLOWING MATTERS MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, FINANCIAL CONDITION, LIQUIDITY, RESULTS OF OPERATIONS OR PROSPECTS, FINANCIAL OR OTHERWISE. REFERENCE TO THIS CAUTIONARY STATEMENT IN THE CONTEXT OF A FORWARD-LOOKING STATEMENT OR STATEMENTS SHALL BE DEEMED TO BE A STATEMENT THAT ANY ONE OR MORE OF THE FOLLOWING FACTORS MAY CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN SUCH FORWARD-LOOKING STATEMENT OR STATEMENTS.
Risks Related to our Business
To maximize our potential for future growth and achieve our expected revenues, we need to manage growth in our current operations.
In order to maximize potential growth in our current and potential markets, we believe that we must expand our sourcing, market research and marketing operations. This expansion will place a significant strain on our management and on our operational, accounting, and information systems. We expect that as we continue to grow we will need to improve our financial controls, operating procedures, and management information systems to handle increased operations. We will also need to effectively train, motivate, and manage our employees. Failure to manage our growth could disrupt our operations and ultimately prevent us from generating the revenues we expect.
We cannot guarantee that our organic growth strategy will be successful.
One of our growth strategies is to grow organically by increasing the distribution and sales of our products in new provinces and regions within China. However, many obstacles to entering new provinces exist, such as the costs associated with entering into new markets, developing and implementing effective marketing efforts, cultural differences and differences in provincial government policies. We cannot, therefore, assure you that we will be able to successfully overcome such obstacles and establish our products in any additional markets. Our inability to successfully implement our organic growth strategy may have a negative impact on our growth strategy and on our future financial condition, results of operations or cash flows.
We cannot assure you that our acquisition growth strategy will be successful.
In addition to our organic growth strategy we also expect to grow through strategic acquisitions. We cannot assure you that our acquisitions will be successful or that we will have the funds to pursue any acquisitions. Further, even if we are able to complete strategic acquisitions, as expected, we will face challenges such as integration of systems, personnel and corporate culture that may impact our ability to successfully integrate acquired businesses into our overall corporate structure, which would negatively impact our business, operations and financial performance.
If we are not able to implement our strategies to achieve our business objectives, our business operations and financial performance may be adversely affected.
Our business plan and growth strategy is based on currently prevailing circumstances and the assumption that certain circumstances will or will not occur, as well as the inherent risks and uncertainties involved in various stages of development. However, there is no assurance that we will be successful in implementing our strategies or that our strategies, even if implemented, will lead to the successful achievement of our objectives. If we are not able to successfully implement our strategies, our business operations and financial performance may be adversely affected.
If we need additional capital to fund our growing operations, we may not be able to obtain sufficient capital and may be forced to limit the scope of our operations.
As we implement our growth strategies, we may experience increased capital needs and we may not have enough capital to fund future operations without additional capital investments. Our capital needs will depend on numerous factors, including (1) our profitability; (2) the release of competitive products by our competition; (3) the level of our investment in marketing research and development; and (4) the amount of our capital expenditures. We cannot assure you that we will be able to obtain capital in the future to meet our needs.
If we cannot obtain additional funding, we may be required to:
· reduce our investments in marketing research;
·
limit our marketing efforts; and
·
decrease or eliminate capital expenditures
Such reductions could have a material adverse affect on our business and our ability to compete. Even if we do find sources of additional capital, we may not be able to negotiate acceptable terms and conditions for receiving the additional capital. Any future capital investments could dilute or otherwise materially and adversely affect the holdings or rights of our existing shareholders. In addition, new equity or debt securities issued by us to obtain financing could have rights, preferences and privileges senior to our common stock. We cannot give you any assurance that any additional financing will be available to us, or if available, will be on terms favorable to us
We depend on third parties to supply products; any adverse changes in such supply or the costs of products may adversely affect our operations.
We currently obtain our products from third parties. The supply of these products can be adversely affected by any material change in the economic and political conditions in China, which may, in turn, result in increased costs to purchase these products.
We depend on third parties to supply products, and any failure of our products to comply with safety requirements set by government may adversely affect our results from operations.
We currently obtain our products from third parties. We may fail to ensure the supplied goods to be compliance with safety regulation and rules set by government, which may, in turn, results in losing our customers and region distributors which would adversely affect our revenues and stockholder value.
We rely heavily on our regional independent third-party distributors to market and promote our brands and products, which could negatively impact our business, operating results and financial condition.
We rely heavily on our regional independent third-party distributors to market and promote both our brands and our products. Our distributors deliver our products directly to the local retail shops, and we monitor our sales performance and market information through our distributor’s activities. Though we have we started developing direct sales via internet and other electronic mediums, there is no guaranty that our direct sales via internet and other electronic mediums will be successful in the future. Currently, we are dependent on third-party distributors to market and promote our brands and products.
Intense competition from existing and new entities may adversely affect our revenues and profitability.
We compete with other companies, many of whom are developing, or can be expected to develop, strategies similar to ours. Some of our competitors are more established than we are, and have significantly greater financial, technical, marketing and other resources than we presently possess. Some of our competitors have greater name recognition and a larger customer base. These competitors may be able to respond more quickly to new or changing opportunities and customer requirements and may be able to undertake more extensive promotional activities, offer more attractive terms to customers, and adopt more aggressive pricing policies. We intend to create greater brand awareness for our brand name so that we can successfully compete with our competitors. We cannot guarantee that we will be able to compete effectively with current or future competitors or that the competitive pressures we face will not harm our business.
We depend on our key management personnel and the loss of their services could adversely affect our business.
Our future success is dependent upon the continued service of our management. We rely on their industry expertise and experience in our business operations, and in particular, their business vision, management skills, and working relationships with our employees, many of our regional distributors and suppliers in our network. We do not maintain key-man life insurance for our management. If our management is unable or unwilling to continue in their present positions or if they join a competitor or form a competing company, we may not be able to replace them easily or at all. As a result, our business and growth prospects may be severely disrupted if we lose any of our management’s services.
We may incur significant costs to ensure compliance with U.S. corporate governance and accounting requirements.
We may incur significant costs associated with our public company reporting requirements, costs associated with newly applicable corporate governance requirements, including requirements under the Sarbanes-Oxley Act of 2002 and other rules implemented by the Securities and Exchange Commission and the OTCBB. We expect all of these applicable rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly. We also expect that these applicable rules and regulations may make it more difficult and more expensive for us to obtain director and officer liability insurance and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as executive officers. We are currently evaluating and monitoring developments with respect to these newly applicable rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs
We may be exposed to risks relating to our disclosure controls and our internal controls, and may need to incur significant costs to comply with applicable requirements.
Effective internal controls are necessary for us to provide reliable financial reports and to effectively prevent fraud. We maintain a system of internal controls 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.
We have identified certain material weakness during the 12 months ended December 31, 2013. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis, please refer to Item 9A Controls and Procedures herein after. In order to correct the foregoing material weakness, we engaged consultants and added in additional accounting staff who are familiar with PRC GAAP and US GAAP to assist us in the preparation of financial statements in accordance with US GAAP, and, once our cash flows from operations improve to a level where we are able to, we intend to recruit experienced professionals to augment our financial staff with regard to US GAAP and financial reporting, which would improve our controls and procedures, with the regard to the financial statements preparation; and improve the knowledge of U.S. accounting standards for our current accounting staff.
Due to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible. However, to the extent possible, we intend to implement procedures to assure that the initiation of transactions, the custody of assets and the recording of transactions will be performed by separate individuals.
Notwithstanding the foregoing corrective actions, we cannot currently ensure that our controls and procedures will be effective at any time in the immediate future. Moreover, in order to improve our controls and procedures we anticipate that we will continue to incur significant costs. Failure to properly improve our controls and procedures could result in our failure to meet our reporting obligations, result in the restatement of our past financial statements, cause harm to 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, all of which present significant risk to our investors.
Insurance coverage for some of our operations may be insufficient to cover losses.
The insurance industry in China is still at an early stage of its development. Insurance companies in China offer limited business insurance products or offer them at a high price. We do not maintain insurance coverage for various risks. A significant uninsured claim against us would have a material adverse effect on our financial position and results of operations.
Risks Relating to Regulation of Our Business
Uncertainties with respect to the governing regulations could have a material and adverse effect on us.
There are substantial uncertainties regarding the interpretation and application of the PRC laws and regulations, including, but not limited to, the laws and regulations governing our business and our ownership of the equity interests in our PRC subsidiaries, both of which are wholly foreign owned enterprise under the PRC laws. These laws and regulations are relatively new and may be subject to change, and their official interpretation and enforcement may involve substantial uncertainty. The effectiveness of newly enacted laws, regulations or amendments may be delayed, resulting in detrimental reliance by foreign investors. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively.
The PRC government has broad discretion in dealing with violations of laws and regulations, including levying fines, revoking business permits and other licenses and requiring actions necessary for compliance. In particular, licenses and permits issued or granted to the PRC subsidiary by relevant governmental bodies may be revoked at a later time by higher regulatory bodies. We cannot predict the effect of the interpretation of existing or new PRC laws or regulations on our businesses. We cannot assure you that our current ownership and operating structure would not be found to be in violation of any current or future PRC laws or regulations. As a result, we may be subject to sanctions, including fines, and could be required to restructure our operations or cease to provide certain services. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. Any of these or similar actions could significantly disrupt our business operations or restrict us from conducting a substantial portion of our business operations, which could materially and adversely affect our business, financial condition and results of operations.
Our PRC subsidiaries will be subject to restrictions on dividend payments.
We conduct all of our business through our consolidated subsidiaries incorporated in the PRC. We rely on dividends paid by these consolidated subsidiaries for our cash needs, including the funds necessary to pay any dividends and other cash distributions to our stockholders, to service any debt we may incur and to pay our operating expenses. The payment of dividends by entities established in the PRC is subject to limitations. Current regulations in the PRC would permit the PRC subsidiary to pay dividends to us only out of its accumulated distributable profits, if any, determined in accordance with Chinese accounting standards and regulations. In addition, our PRC subsidiaries will be required to set aside at least 10% (up to an aggregate amount equal to half of its registered capital) of its accumulated profits each year. Such cash reserve may not be distributed as cash dividends. In addition,
if the PRC subsidiary incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other payments to us. Under U.S. GAAP (Financial Accounting Standard Board (“FASB”) Accounting Standard Codification (“ASC”) Topic 740-30), no deferred tax expense is required to be recorded on the earnings of foreign subsidiaries when the parent company establishes that the earnings will be permanently reinvested outside the U.S. If dividend payments are made by our subsidiaries to the US parent, additional U.S. tax could become due in future years. At the time of the repatriation or investment in U.S. property, the U.S. will tax the foreign earnings as a dividend and will allow a foreign tax credit for any foreign taxes previously paid on the earnings. To the extent that dividend payments are made by our PRC subsidiaries to our US Parent additional tax may be due.
PRC regulations on loans and direct investments by overseas holding companies in PRC entities may delay or prevent us to make overseas loans or additional capital contributions to our PRC subsidiary.
Under the PRC laws, foreign investors may make loans to their PRC subsidiaries or foreign investors may make additional capital contributions to their PRC subsidiaries. Any loans to such PRC subsidiaries are subject to the PRC regulations and foreign exchange loan registrations, i.e. loans by foreign investors to their PRC subsidiaries to finance their activities cannot exceed statutory limits and must be registered with the State Administration of Foreign Exchange (the “SAFE”), or its local branch. Foreign investors may also decide to finance their PRC subsidiaries by means of additional capital contributions. These capital contributions must be examined and approved by the Ministry of Commerce of the People’s Republic of China (the “MOFCOM”), or its local branch in advance.
Under the PRC Enterprise Income Tax Law, we may be classified as a “resident enterprise” of China, and such classification would likely result in unfavorable tax consequences to us and our non-PRC stockholders.
On March 16, 2007, the National People’s Congress (the “NPC”), approved and promulgated the PRC Enterprise Income Tax Law (herein referred as the “New EIT Law”). The New EIT Law took effect on January 1, 2008. Under the New EIT Law, Foreign Investment Enterprises (“FIEs”), and domestic companies are subject to a uniform tax rate of 25%. In addition, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise” which means that we may be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes.
Under the New EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. The implementing rules of the New EIT Law define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise. On April 22, 2009, the State Administration of Taxation, or the SAT, issued a circular, or SAT Circular 82, which provides certain specific criteria for determining whether the “de facto management body” of a PRC-controlled enterprise that is incorporated offshore is located in China, which include all of the following conditions: (a) the location where senior management members responsible for an enterprise’s daily operations discharge their duties; (b) the location where financial and human resource decisions are made or approved by organizations or persons; (c) the location where the major assets and corporate documents are kept; and (d) the location where more than half (inclusive) of all directors with voting rights or senior management have their habitual residence. Although the SAT Circular 82 only applies to offshore enterprises controlled by PRC enterprises or PRC enterprise groups, not those controlled by PRC individuals or foreigners, the determining criteria set forth in the SAT Circular 82 may reflect the SAT’s general position on how the “de facto management body” text should be applied in determining the tax resident status of all offshore enterprises, regardless of whether they are controlled by PRC enterprises or individuals. Due to the short history of the New EIT Law and lack of applicable legal precedents, it remains unclear how the PRC tax authorities will determine the PRC tax resident treatment of a foreign company controlled by individuals like us.
If the PRC tax authorities determine that we are “resident enterprises” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. In our case, this would mean that income such as interest on offering proceeds and non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second, although under the New EIT Law and its implementing rules, dividends paid to us from our PRC subsidiaries would qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax Finally, it is possible that “resident enterprise” classification could result in a situation in which a 10% withholding tax is imposed on dividends we pay to our non-PRC enterprise stockholders and with respect to gains derived by our non-PRC enterprise stockholders from transferring our shares and a 20% withholding tax is imposed on dividends we pay to our non-PRC individual stockholders and with respect to gains derived by our non-PRC individual stockholders from transferring our shares.. We are actively monitoring the possibility of “resident enterprise” treatment for the applicable tax years and are evaluating appropriate organizational changes to avoid this treatment, to the extent possible.
If we were treated as a “resident enterprise” by PRC tax authorities, we would be subject to taxation in both the U.S. and China, and our PRC tax may not be credited against our U.S. tax.
If we receive any dividends from our PRC subsidiaries in the future, the dividends may be subject to PRC withholding tax.
The New EIT Law and the Implementation Rules of the New EIT Law provides that an income tax rate of 10% may be applicable to dividends payable to non-PRC investors that are “non-resident enterprises”, which (i) do not have an establishment or place of business in the PRC, or (ii) have such establishment or place of business in the PRC but the relevant income is not effectively connected with the establishment or place of business, to the extent such dividends are derived from sources within the PRC. The income tax for non-resident enterprises shall be subject to withholding at the income source, with the payer acting as the obligatory withholder under the New EIT Law, and therefore such income taxes are generally called withholding tax in practice. It is currently unclear in what circumstances a source will be considered as located within the PRC. We are an offshore holding company. Thus, if Prospect is considered as a “non-resident enterprise” under the New EIT Law and the dividends paid to us by our subsidiaries in the PRC are considered income sourced within the PRC, such dividends may be subject to a withholding tax at a rate up to 10%.
In January 2009, the State Administration of Taxation, or SAT, promulgated the Provisional Measures for the Administration of Withholding of Enterprise Income Tax for Non-resident Enterprises (“Measures”), pursuant to which, the entities which have the direct obligation to make the following payment to a non-resident enterprise shall be the relevant tax withholders for such non-resident enterprise, and such payment includes: incomes from equity investment (including dividends and other return on investment), interests, rents, royalties, and incomes from assignment of property as well as other incomes subject to enterprise income tax received by non-resident enterprises in China. Given these Measures, our PRC subsidiaries have an obligation to withhold income tax in respect of the dividends paid to non-resident enterprise investors.
The new tax 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 the combined company’s tax rate in the future could have a material adverse effect on our financial conditions and results of operations.
We face uncertainty from China’s Circular on Strengthening the Administration of Enterprise Income Tax on Non-Resident Enterprises' Share Transfer (Circular 698 that was released in December 2009 with retroactive effect from January 1, 2008.)
The Chinese State Administration of Taxation released a circular (“Circular 698”) on December 10, 2009 that addresses the transfer of shares by nonresident companies. Circular 698, which is effective retroactively to January 1, 2008, may have a significant impact on many companies that use offshore holding companies to invest in China. Pursuant to Circular 698, where the withholding agent does not withhold in accordance with laws or can’t perform the withholding obligation, the non-resident enterprises shall file a tax declaration with the PRC tax authority located at the place of the resident enterprise whose equity has been transferred, within seven days agree the date of the equity transfer provided under the contracts.
Where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise by selling the shares in an offshore holding company, and the latter is located in a country or jurisdiction where the effective tax burden is less than 12.5% or where the offshore income of his, her, or its residents is not taxable, the foreign investor is required to provide the tax authority in charge of that Chinese resident enterprise with the relevant information within 30 days of the transfers. Moreover, where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise through an abuse of form of organization and there are no reasonable commercial purposes such that the corporate income tax liability is avoided, the PRC tax authority will have the power to re-assess the nature of the equity transfer in accordance with PRC’s “substance-over-form” principle and deny the existence of the offshore holding company that is used for tax planning purposes.
There is uncertainty as to the application of Circular 698. For example, while the term "indirectly transfer" is not defined, it is understood that the relevant PRC tax authorities have jurisdiction regarding requests for information over a wide range of foreign entities having no direct contact with China. Moreover, the relevant authority has not yet promulgated any formal provisions or formally declared or stated how to calculate the effective tax in the country or jurisdiction and to what extent and the process of the disclosure to the tax authority in charge of that Chinese resident enterprise. In addition, there are no formal declarations with regard to how to decide abuse of form of organization and reasonable commercial purpose, which can be utilized by us to balance if our company complies with the Circular 698. As a result, we may become at risk of being taxed under Circular 698 and we may be required to expend valuable resources to comply with Circular 698 or to establish that we should not be taxed under Circular 698, which could have a material adverse effect on our financial condition and results of operations.
Our PRC subsidiaries are obligated to withhold and pay PRC individual income tax on behalf of our employees who are subject to PRC individual income tax. If we fail to withhold or pay such individual income tax in accordance with applicable PRC regulations, we may be subject to certain sanctions and other penalties and may become subject to liability under PRC laws.
Under PRC laws, our PRC subsidiaries are obligated to withhold and pay individual income tax on behalf of our employees who are subject to PRC individual income tax. If any PRC subsidiary fails to withhold and/or pay such individual income tax in accordance with PRC laws, it may be subject to certain sanctions and other penalties and may become subject to liability under PRC laws.
In addition, the SAT has issued several circulars concerning employee stock options. Under these circulars, our employees working in the PRC (which could include both PRC employees and expatriate employees subject to PRC individual income tax) who exercise stock options will be subject to PRC individual income tax. Our PRC subsidiaries have obligations 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
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 all of our sales from China.
Substantially all of our sales are generated from China. We anticipate that sales of our products 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 products, 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 their local currency as their functional currencies. Substantially all of our revenue and expenses are in Chinese Renminbi. 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. Since 1994, the official exchange rate for the conversion of Renminbi to the U.S. dollar had generally been stable and the Renminbi had appreciated slightly against the U.S. dollar. However, 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. As a result of this policy change, Chinese Renminbi depreciated approximately 0.06% against the U.S. dollar in 2009 and appreciated approximately 3.57% in 2010. Chinese Renminbi further appreciated approximately 4.86% in 2011. 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 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 currency denominated transactions could result 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 could result 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 subsidiaries into U.S. dollars in consolidation. If there is a change in foreign currency exchange rates, the conversion of the foreign subsidiaries’ 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 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 that 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.
Because our funds are held in banks in uninsured PRC bank accounts, the failure of any bank in which we deposit our funds could affect our ability to continue our business.
Funds on deposit at banks and other financial institutions in the PRC are often uninsured. A significant portion of our assets are in the form of cash deposited with banks in the PRC, and in the event of a bank failure, we may not have access to our funds on deposit. Depending upon the amount of money we maintain in a bank that fails, our inability to have access to our cash could impair our operations, and, if we are not able to access funds to pay our suppliers, employees and other creditors, we may be unable to continue in business.
Our business could be severely harmed if the Chinese government changes its policies, laws, regulations, tax structure or its current interpretations of its laws, rules and regulations, relating to our operations in China.
Our business is located in China and virtually all of our assets are located in China. We generate our sales revenue only from customers located in China. Our results of operations, financial state of affairs and future growth are, to a significant degree, subject to China’s economic, political and legal development and related uncertainties. Our operations and results could be materially affected by a number of factors, including, but not limited to:
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Changes in policies by the Chinese government resulting in changes in laws or regulations or the interpretation of laws or regulations,
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changes in taxation,
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changes in employment restrictions,
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import duties, and
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currency revaluation.
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Over the past several years, the Chinese government has pursued economic reform policies including the encouragement of private economic activities and greater economic decentralization. If the Chinese government does not continue to pursue its present policies that encourage foreign investment and operations in China, or if these policies are either not successful or are significantly altered, then our business could be harmed. Following the Chinese government’s policy of privatizing many state-owned enterprises, the Chinese government has attempted to augment its revenues through increased tax collection. It also exercises significant control over China’s economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. Continued efforts to increase tax revenues could result in increased taxation expenses being incurred by us. Economic development may be limited as well by the imposition of austerity measures intended to reduce inflation, the inadequate development of infrastructure and the potential unavailability of adequate power and water supplies, transportation and communications. In addition, the Chinese government continues to play a significant role in regulating industry by imposing industrial policies.
Failure to comply with the U.S. foreign corrupt practices act and Chinese anti-corruption laws could subject us to penalties and other adverse consequences.
Our executive officers, employees and other agents are subject to anti-corruption and anti-bribery laws including China’s anti-corruption laws and the U.S. Foreign Corrupt Practices Act, or the FCPA, which generally prohibits United States companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. In addition, we are required to maintain records that accurately and fairly represent our transactions and have an adequate system of internal accounting controls. Foreign companies, including some that may compete with us, are not subject to these prohibitions, and therefore may have a competitive advantage over us. The PRC also strictly prohibits bribery of government officials. However, corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in the PRC.
While we intend to implement measures to ensure compliance with the FCPA and China’s anti-corruption laws by all individuals involved with our company, our employees or other agents may engage in such conduct for which we might be held responsible. Since we became a U.S. public company, we have implemented strict requirements to preclude payments to government officials and limits on the amount employees can spend on gifts and entertaining clients. Although prior to our becoming a U.S public company we had given culturally traditional gifts to government officials during Spring Festival and other Chinese traditional holidays, we believe the amounts of such gifts are below the amounts that generally trigger criminal liability under PRC law. The gifts were not made with the intent to bribe or wrongfully influence any such officials. However, if our employees or other agents are found to have engaged in practices that violate either U.S or PRC laws, we could suffer severe penalties and other consequences that may have a material adverse effect on our business, financial condition and results of operations. In addition, our brand and reputation, our sales activities or our stock price could be adversely affected if we become the target of any negative publicity as a result of actions taken by our employees or other agents.
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 currently, 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, 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.
The Chinese government exerts substantial influence over the manner in which we must conduct our business activities.
China has only recently permitted provincial and local economic autonomy and private economic activities, and, as a result, we are dependent on our relationship with the local government in the province in which we operate our business. Chinese government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, environmental regulations, land use rights, property and other matters. We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of these jurisdictions may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations. Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof, and could require us to divest ourselves of any interest we then hold in Chinese properties.
PRC employment contract law and increases in the labor costs in China may hurt our business and profitability.
A Chinese employment contract law that became effective on January 1, 2008, imposes more stringent requirements on employers in relation to entry into fixed-term employment contracts, recruitment of temporary employees and dismissal of employees. In addition, under the Regulations on Paid Annual Leave for Employees, which also became effective on January 1, 2008, employees who have worked continuously for more than one year are entitled to a paid vacation ranging from 5 to 15 days, depending on the length of the employee’s service. Employees who waive such vacation entitlements at the request of the employer will be compensated for three times their normal daily salaries for each vacation day so waived. As a result of the new law and regulations, our labor costs may increase. There is no assurance that disputes, work stoppages or strikes will not arise in the future.
Increases in the labor costs or future disputes with our employees could damage our business, financial condition or operating results. According to PRC labor laws, the employer shall be responsible to deal with and pay social insurances and housing funds for all of its employees based on the actual salary of the employees. In addition, 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. There is no guarantee that we and our subsidiaries will be able to comply with the relevant requirements. Failure to comply with the various PRC Labor Laws and regulation requirements described above could result in liability under PRC law.
Future inflation in China may inhibit our ability 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 the 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 the 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 products.
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, 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. Please refer to Item 9A. Controls and Procedures on page 44 for additional information on this matter.
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 substantially all of our operations in China and substantially all 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.
Because Chinese laws 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 26 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 room, 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 some 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.
Risks Related to Corporate and Stock Matters
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.
On September 19, 2012, we issued a total of 150,350,000 shares of our common stock at a total consideration of $1,503,500 in the Reg. S Offering. The investors in this Reg. S Offering except Han Sing are individuals and regional independent third-party distributors of the Company. None of these individual distributors held any shares of the Company prior to the closing of Reg. S Offering or was issued more than 5% of the shares of the Company in the Reg. S offering. Han Sing is a Cayman company wholly owned by Mr. Chen Xinghua. Mr. Chen is a director of the Company and is actively involved in the Company’s daily operation and management. Prior to the Reg. S. Offering, Han Sing held approximately 245,417 shares of our Common Stock, representing 4.9% of the shares of issued and outstand Common Stock before the closing of Reg. S offering on September 19, 2012. Han Sing purchased 88,450,000 shares of our Common Stock in the Reg. S Offering, resulting in its holding of approximately 57.1% of our Common Stock. Through his ownership of Han Sing, Mr. Chen became a controlling shareholder of the Company. Accordingly, Mr. Chen is able to control 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 stockers 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.
The limited trading volume in our stock may cause volatility in the market price of our common stock.
Our common stock is currently traded on a limited basis on the OTCBB and the OTCQB under the symbol
"SAYC".
The quotation of our common stock on the OTC does not assure that a meaningful, consistent and liquid trading market currently exists, and in recent years, such market has experienced extreme price and volume fluctuations that have particularly affected the market prices of many smaller companies like us. Our common stock is thus subject to volatility. In the absence of an active trading market:
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investors may have difficulty buying and selling or obtaining market quotations;
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market visibility for our common stock may be limited; and
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a lack of visibility for our common stock may have a depressive effect on the market for our common stock.
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Our stock is a penny stock. Trading of our stock may be restricted by the SEC’s penny stock regulations which may limit a stockholder’s ability to buy and sell our stock.
Our stock is a penny stock. The SEC has adopted Rule 15g-9 which generally defines
"penny stock"
to be any equity security that has a market price (as defined) less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. Our securities are covered by the penny stock rules, which impose additional sales practice requirements on broker-dealers who sell to persons other than established customers and
"accredited investors"
. The term
"accredited investor"
refers generally to institutions with assets in excess of $5,000,000 or individuals with a net worth in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 jointly with their spouse. The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document in a form prepared by the SEC which provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction and monthly account statements showing the market value of each penny stock held in the customer's account. The bid and offer quotations, and the broker-dealer and salesperson compensation information, must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing before or with the customer's confirmation. In addition, the penny stock rules require that prior to a transaction in a penny stock not otherwise exempt from these rules; the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser's written agreement to the transaction. These disclosure requirements may have the effect of reducing the level of trading activity in the secondary market for the stock that is subject to these penny stock rules. Consequently, these penny stock rules may affect the ability of broker-dealers to trade our securities. We believe that the penny stock rules discourage investor interest in and limit the marketability of our common stock.
FINRA sales practice requirements may also limit a stockholder’s ability to buy and sell our stock.
Section 15(g) of the Securities Exchange Act of 1934, as amended, and Rule 15g-2 promulgated thereunder by the SEC require broker-dealers dealing in penny stocks to provide potential investors with a document disclosing the risks of penny stocks and to obtain a manually signed and dated written receipt of the document before effecting any transaction in a penny stock for the investor's account.
Potential investors in our common stock are urged to obtain and read such disclosure carefully before purchasing any shares that are deemed to be
"penny stock."
Moreover, Rule 15g-9 requires broker-dealers in penny stocks to approve the account of any investor for transactions in such stocks before selling any penny stock to that investor. This procedure requires the broker-dealer to (i) obtain from the investor information concerning his or her financial situation, investment experience and investment objectives; (ii)reasonably determine, based on that information, that transactions in penny stocks are suitable for the investor and that the investor has sufficient knowledge and experience as to be reasonably capable of evaluating the risks of penny stock transactions; (iii) provide the investor with a written statement setting forth the basis on which the broker-dealer made the determination in (ii) above; and (iv) receive a signed and dated copy of such statement from the investor, confirming that it accurately reflects the investor's financial situation, investment experience and investment objectives. Compliance with these requirements may make it more difficult for holders of our common stock to resell their shares to third parties or to otherwise dispose of them in the market or otherwise.
Because we became public by means of a reverse merger, we may not be able to attract the attention of major brokerage firms.
Since we became public through a “reverse merger,” the newly-issued common shares issued in connection with the “reverse merger” and the private placement are restricted shares. As a result, our common stock will continue to be very thinly traded after the reverse merger, until a considerable number of such shares are registered in an effective registration statement or become sellable under Rule 144 if all of the conditions in Rule 144(i)(2) are satisfied at the time of the proposed sale. Therefore, securities analysts of major brokerage firms may not provide coverage of our Company since there is little incentive to brokerage firms to recommend the purchase of our common stock. No assurance can be given that brokerage firms will want to conduct any secondary offerings on behalf of the Company in the future.
We may have difficulty raising necessary capital to fund operations as a result of market price volatility of our shares of common stock.
If our growth strategies are successful, we may require additional financing to continue to develop and to expand into new markets. Our growth, therefore, may be dependent upon our ability to obtain equity financing through debt and equity or other means. In recent years, the securities markets in the United States have experienced a high level of price and volume volatility, and the market price of securities of many companies have experienced wide fluctuations that have not necessarily been related to the operations, performance, underlying asset values or prospects of such companies.
For these reasons, our shares of common stock can also be expected to be subject to volatility resulting from purely market forces over which we will have no control. Such volatility may make it more difficult to find investors willing to invest in our common stock, or to negotiate equity financing on terms that are acceptable to us.