ITEM 1. BUSINESS
Overview of Our Business
We are a holding company that only operates through our
indirect Chinese subsidiaries Beijing SOD and Chongqing SOD. Through our Chinese
subsidiaries, we develop, manufacture and market our SOD products in China. SOD
is a naturally occurring enzyme which may act as a potent antioxidant defense in
cells that are exposed to oxygen. Certain research has shown that under certain
biological conditions, SOD revitalizes cells and reduces the rate of cell
destruction. It neutralizes the most common free radicalsuperoxide radicalby
converting it into hydrogen peroxide and water. Because superoxide is harmful to
human cells, and certain forms of SOD exist naturally in most humans, many
studies show that SOD is valuable in protecting human cells from the harmful
effects of superoxide. SOD is thought to be more powerful than antioxidant
vitamins as it activates the body's productions of its own antioxidants. As a
result, SOD is referred to as the enzyme of life. Commercially, SOD has a wide
range of applications and is widely applied in foods, drinks, skin care
productions, pharmaceuticals, to combat ailments ranging from sunburn to
rheumatoid arthritis.
History and Corporate Structure
We are a New York corporation that was incorporated on February
29, 1996, as United Network Technologies, Inc. and we changed our name to
Panagra International Corporation on October 2, 1998. From our inception until
2001, we were relatively inactive with limited operations. On August 2, 2001 we
changed our name to Minghua Group International Holdings Limited and at that
time we also increased the authorized common shares of our common stock from
40,000,000 shares to 200,000,000 shares. On October 16, 2007, we effectuated a
1-for-20 reverse stock split of all our issued and outstanding shares of common
stock, or the Reverse Split, and changed our name to China Longyi Group
International Holdings Limited.
The following chart reflects our organizational structure as of
the date of this report.
Our Industry
The health supplements industry in China is currently made up
of many small- and medium-sized companies that manufacture and distribute
products generally intended to, or marketed for the purpose of maintaining, and
sometimes improving, the bodys health and general well being. China is one of
the fastest growing health supplements markets in the world. With rapid economic
growth and continued improvement of its peoples livelihoods, the demand for
health supplements from Chinas 1.4 billion people has expanded tremendously
over the last 20 years. Today the Chinese health supplements industry is
estimated to be worth approximately $6 billion in annual sales, according to the
China Health Care Association, which is an association attached to China's
Ministry of Health. Given Chinas current annual per capita consumption of
health supplements is approximately $10which is far below that of many western
countries.
2
Ever since American scientists Joe McCord and Irwin Fridovich
discovered SOD in cattle erythrocytes in 1969 and hypothesized that it can
protect life molecules from oxygenation and retrogradation, experts in the
fields of biology and medicine and many entrepreneurs and industrialists have
been engaged in research, study, development, application and transformation of
SOD into products that we believe will provide human beings with certain health
and longevity benefits.
Research into the functions and applications of SOD in China
began in the late 1970s. Since then, various centers of research in China,
including universities, the military and private companies, have researched
food, medicinal, and cosmetic applications for SOD. In the 1990s, SOD foods
began to be sold in China, including SOD soy milk, SOD dairy milk, and SOD beer.
Due to technical problems with these first-generation SOD food products and
limited public knowledge of the health benefits of SOD, many were discontinued.
Technical difficulties relating to the commercialization of SOD products in
China have included: (1) lack of methods for efficient harvesting of SOD from
animal and human blood and plants; (2) problems with the maintenance and
stabilization of harvested SOD, the longest shelf life so far being only two
years in China; and (3) technical problems in the effectiveness of SOD in
products, particularly food and other products to be consumed orally. More
recently, however, various SOD food products have reappeared in China, including
SOD milk, SOD wine, and SOD vegetables and fruits. We believe that these and
other types of SOD products will become extremely popular due in part to
innovations in the SOD industry; recognition of SOD technologies as proprietary
intellectual property; government policies encouraging healthier food; the
higher awareness of consumers in China of the health benefits of consuming
products containing SOD; and the growth of the spending power of Chinese
citizens.
In addition, China Science and Technology Institute has
recognized that SOD product technologies are proprietary intellectual property.
SOD companies, including us, have instituted strict measures to protect their
SOD product technologies from being misappropriated. As such, the SOD product
technologies may be protected by Chinese intellectual property law even if they
are not patented. As a result, companies are encouraged to develop and
commercialize SOD technologies.
The growing wealth of the Chinese public and its related
greater interest in better health and nutrition are also trends in SOD
industrys favor. SOD production and distribution companies have been working
hard to develop innovations to best exploit the commercial potential of SOD,
including our subsidiary, Chongqing SOD. Since 1993, various types of SOD
products have been sold in China, such as Beijing Dabao SOD skin care series,
Wuhan Jiutouniao SOD liquid nutrition drink series, Guizhou Laolaifu SOD liquid
nutrition drink series, Zhejiang SOD beer, SOD toothpaste, SOD soy milk. We
believe that the SOD industry in China should expand as Chinese consumers grow
more able and willing to purchase SOD products.
Our Products
Historically we manufactured one product, which was Jiuzhou SOD
plant wine which we marketed under the name Jiuzhou Holy Wine. Our Jiuzhou SOD
plant wine was a product developed from the zymolysis of natural wide berries
with an alcohol level of 21%. We currently produce and sell SOD Lifeblood, the
mixture of SOD and Enzymes (natural plant extract essence) as an antioxidant.
Our SOD Lifeblood is an important source of SOD, vitamins and trace elements,
all the raw materials of which are extracted from the wild plants and fruits
grown on the mountains at elevations between 1,000 and 4,000 meters in south and
southwest China. Our SOD Lifeblood is particularly rich in amino acids, several
trace elements and Vitamin C, E, D, B1, B2, B12 and A. It is believed that the
product is also an excellent source of polysaccharides, flavonoids, glycosides,
phenolics, lysozyme, polyphenols, allicin and monophosphate. All of the raw
materials of our fruit enzyme are extracted from the wild plants and fruits of
the south Taihang Mountain with at least 3-5 years brewing. The fruit sugars are
converted into enzymes with two procedures of anaerobic fermentation and aerobic
fermentation without additives. In 2008, we received the certificate of China
Spark Program issued by the Ministry of National Science and Technology for our
SOD Lifeblood. Our SOD Lifeblood also passed the cordial test conducted by
National Sports Bureau in 2014.
Sales & Marketing Strategy
Our sales and marketing department currently consists of 8
employees. We are developing a diversified sales network which allows us to
effectively market products and services to our customers. In addition to sales
efforts conducted directly by our internal sales team and other employees, we
also use sales agents. Currently we have 15 sales agents selling our products.
In terms of geographic area, our sales network covers 21 cities
in China. Our SOD Lifeblood has been listed on the governmental procurement list
of Chongqing City, which will grant us a priority to sell our SOD products to
various governmental agencies in Chongqing City. We also expect that our SOD
products will be listed on the governmental procurement list of Beijing City. We plan to expand our sales
network to cover more Chinese cities, including Shenzhen, Guangzhou, Nanjing,
Shanghai, Shijiazhuang, Lhasa and Nanchang.
3
We also plan to employ an online order system, which will cover
four major metropolitan areas, such as Beijing, Chengdu, Kunming and Chongqing,
within the next 12 months. Through our website
http://www.jiuzhoushengjiu.com/index.asp, we will be able to offer a complete
line of our products to our customers 24 hours a day, seven days a week. This
additional sales channel will enable us to market and sell our products in
regions where we do not have retail operations or have limited operations.
Competition
The health supplementary business both within China and
globally is highly fragmented and intensely competitive. Many of our
competitors, both domestic and international, have significant research and
development capabilities and financial, scientific, manufacturing, marketing and
sales resources. Although our marketing and sales efforts of SOD products are
very limited, we believe that we will compete with our competitors based upon
the price and quality of our products, ability to produce a diverse range of
products and customer services.
In China, we compete principally with Chengdu New Asia
Bioengineering Co., Ltd., Zhuhai Zixing Biological Engineering Co., Ltd. and
Liaoyuan Jinchang Bioengineering Co., Ltd.
We believe that our SOD Lifeblood, made from more than 10 kinds
of wild plants, is more efficient to remove superoxide free radicals than SOD
liquid products made by our competitors. In addition, we believe that our SOD
plant compound enzyme can be stored under the normal atmospheric temperature for
more than 10 years, much longer than the life span of many other SOD products
made from animal blood or a single plant.
Intellectual Property
In 2009 we registered patent relating to our SOD Lifeblood
products. Furthermore, we have registered a trademark for our SOD products which
we sell under the name Longyi Lifeblood.
In addition, we protect our know how technologies through
confidentiality agreements we entered into with our employees in our production
department.
Research and Development
We did not incur expenditures for research and development
for the years ended December 31, 2016 and 2015.
Regulation
Based on different potential uses, SOD products in China are
classified into three types under the Chinese law and accordingly are subject to
different Chinese laws and regulations.
If the SOD products are sold for manufacturing food, they are
considered as food additives. Under current Chinese law, a company may not
produce SOD products for food additives use without two licenses, the Food
Hygiene License issued by the provincial Administration of Health, or AOH, and
the Food Production License issued by the provincial Administration of Quality
Supervision, Inspection and Quarantine, or AQSIQ. If the SOD products are sold
as raw materials for drugs, the Company should first obtain the Pharmaceutical
Producer License from the provincial AOH and the approval from the provincial
Food and Drug Administration, or FDA.
We have already obtained both the Food Hygiene License issued
by the Chongqing AOH and the Food Production License issued by the local AQSIQ.
Since we also plan to produce and sell SOD medicines and skin care products, we
plan to apply for the Pharmaceutical Producer License from the provincial AOH
and the approval from the provincial FDA.
In addition, we are also subject to PRCs foreign currency
regulations. The PRC government has control over RMB reserves through, among
other things, direct regulation of the conversion or RMB into other foreign
currencies. Although foreign currencies which are required for current account
transactions can be bought freely at authorized Chinese banks, the proper
procedural requirements prescribed by Chinese law must be met. At the same time,
Chinese companies are also required to sell their foreign exchange earnings to
authorized Chinese banks and the purchase of foreign currencies for capital
account transactions still requires prior approval of the Chinese government.
4
Employees
As of December 31, 2016, we had a total of 47 full-time
employees. The following table illustrates the allocation of these employees
among the various job functions conducted at our Company.
Department
|
|
Number of Employees
|
|
|
|
Sales
|
|
8
|
|
|
|
Administration
|
|
10
|
|
|
|
Finance
|
|
8
|
|
|
|
SOD Production Center
|
|
6
|
|
|
|
Research and Development
|
|
15
|
|
|
|
Total
|
|
47
|
We believe that our relationship with our employees is good.
The remuneration payable to employees includes basic salaries and allowances. We
have not experienced any significant problems or disruption to our operations
due to labor disputes, nor have we experienced any difficulties in recruitment
and retention of experienced staff.
As required by applicable Chinese laws, we have entered into
employment contracts with all of our officers, managers and employees.
Our employees in China participate in a state pension scheme
organized by Chinese municipal and provincial governments. We are required to
contribute to the scheme at a rate of 28% of the average monthly salary. In
addition, we are required by Chinese laws to cover employees in China with
various types of social insurance. We have purchased social insurances for all
of our employees.
ITEM 1A. RISK FACTORS
You should carefully consider the risks described below,
which constitute all of the material risks facing us. If any of the following
risks actually occur, our business could be harmed. You should also refer to the
other information about us contained in this report, including our financial
statements and related notes.
RISKS RELATED TO OUR BUSINESS
Our independent registered auditors have expressed
substantial doubt about our ability to continue as a going concern.
Our audited consolidated financial statements included in this
report include an explanatory paragraph that indicates that they were prepared
assuming that we would continue as a going concern. As discussed in Note 1 to
the consolidated financial statements included with this report, we had a
working capital deficiency, accumulated deficit from recurring net losses
incurred for the current and prior years as of December 31, 2016. These
conditions raise substantial doubt about our ability to continue as a going
concern.
We have earned only insignificant revenues and it is
uncertain whether we will earn any revenues in the future or whether we will
ultimately be profitable.
We only started generating meaningful amount of revenues
recently and our future operations are subject to all of the risks inherent in
the establishment of a new business enterprise. The likelihood of our success
must be considered in light of the problems, expenses, difficulties,
complications and delays frequently encountered in connection with the
development of SOD products, the utilization of unproven technology and the
competitive environment in which we operate. There can be no assurance that we
will be able to develop, manufacture or market any products in the future, that
future revenues will be significant, that any sales will be profitable or that
we will have sufficient funds available to complete our marketing and
development programs or to market any products which we may develop. In
addition, as a result of our limited operating history even though we do
currently have a marketable product, we expect to incur substantial operating
losses until we can generate sufficient revenues from the sales of our SOD
products to cover our operating costs. We currently have limited sources of potential operating revenue and there can be no
assurance that we will be able to develop revenue sources or that our operations
will ever become profitable.
5
Our industry is highly fragmented and competitive, and
increased competition could reduce our operating income.
The health supplement business both within China and globally
is highly fragmented and intensely competitive. We compete with a number of
domestic and international manufacturers and distributors that are producing and
marketing products in China that are similar to our products. We may not be able
to effectively compete against them because our existing or potential
competitors may have superior financial, technical, distribution, marketing,
sales and other resources, as well as more significant name recognition and
established positions in the market we serve. Increased competition could force
us to lower our prices or offer services at a higher cost to us, which could
reduce our operating income.
Our products could be subject to product liability claims
by consumers, which would adversely affect our profit margins, results from
operations and stockholder value.
We are exposed to risks inherent in the packaging and
distribution of health supplement products, such as with respect to adequacy of
warnings, mislabeling and contamination. As a result, there is a risk that
someone using our products may experience significant negative side effects
which may permanently harm them and we could be subject to claims for damages
based on theories of product liability and other legal theories. The costs and
resources to defend such claims could be substantial and, if such claims are
successful, we could be responsible for paying some or all of the damages. Also,
our reputation could be adversely affected, regardless of whether such claims
are successful. We currently intend to obtain product liability insurance at the
appropriate time; however, there can be no assurance that we will be able to
obtain or maintain insurance on acceptable terms for our products or that such
insurance would be sufficient to cover any potential product liability claim or
recall. Any of these results would adversely affect our profit margins, results
from operations and stockholder value.
We may not be able to adequately protect our proprietary
intellectual property and technology, which may harm our competitive position
and result in increased expenses incurred to enforce our rights.
We rely on a combination of copyright, trademark and trade
secret laws, non-disclosure agreements and other confidentiality procedures and
contractual provisions to establish, protect and maintain our proprietary
intellectual property and technology and other confidential information. Some of
these technologies, especially the technology to extract SOD and SOD related
enzyme from wild plants, are important to our business and are not protected by
patents. Despite our efforts, the steps we have taken to protect our proprietary
intellectual property and technology and other confidential information may not
be adequate to preclude misappropriation of our proprietary information or
infringement of our intellectual property rights. Protecting against the
unauthorized use of our products, trademarks and other proprietary rights is
also expensive, difficult and, in some cases, impossible. Litigation may be
necessary in the future to enforce or defend our intellectual property rights,
to protect our trade secrets or to determine the validity and scope of the
proprietary rights of others. Such litigation could result in substantial costs
and diversion of management resources, either of which could harm our business,
operating results and financial condition.
Compliance with environmental regulations can be
expensive, and our failure to comply with these regulations may result in
adverse publicity and may have a material adverse effect on our business.
As a manufacturer, we are subject to various Chinese
environmental laws and regulations on air emission, waste water discharge, solid
wastes and noise. Although we believe that our operations are in substantial
compliance with current environmental laws and regulations, we may not be able
to comply with these regulations at all times as the Chinese environmental legal
regime is evolving and becoming more stringent. Therefore, if the Chinese
government imposes more stringent regulations in the future, we will have to
incur additional and potentially substantial costs and expenses in order to
comply with new regulations, which may negatively affect our results of
operations. If we fail to comply with any of the present or future environmental
regulations in any material aspects, we may suffer from negative publicity and
may be required to pay substantial fines, suspend or even cease operations.
Failure to comply with Chinese environmental laws and regulations may materially
and adversely affect our business, financial condition and results of
operations.
We depend heavily on key personnel, and turnover of key
employees and senior management could harm our business.
Our future business and results of operations depend in
significant part upon the continued contributions of our key technical and
senior management personnel, including Jie Chen, our Chief Executive Officer and
Xinmin Pan, our Chief Financial Officer. They also depend in significant part
upon our ability to attract and retain additional qualified management,
technical, marketing and sales and support personnel for our operations. If we
lose a key employee or if a key employee fails to perform in his or her current position, or if we are not able to
attract and retain skilled employees as needed, our business could suffer.
Significant turnover in our senior management could significantly deplete our
institutional knowledge held by our existing senior management team. We depend
on the skills and abilities of these key employees in managing the
manufacturing, technical, marketing and sales aspects of our business, any part
of which could be harmed by further turnover.
6
We may be exposed to potential risks relating to our
internal controls over financial reporting and our ability to have the
operating effectiveness of our internal controls attested to by our
independent auditors.
As directed by Section 404 of the Sarbanes-Oxley Act of 2002,
or SOX 404, the SEC adopted rules requiring public companies to include a report
of management on the Companys internal controls over financial reporting in
their annual reports on Form 10-K. We are subject to this requirement commencing
with our fiscal year ended December 31, 2008 and a report of our management is
included under Item 9A of this Annual Report on Form 10-K. In the event we
identify significant deficiencies or material weaknesses in our internal
controls that we cannot remediate in a timely manner, investors and others may
lose confidence in the reliability of our financial statements.
Our holding company structure may limit the payment of
dividends to our stockholders.
We have no direct business operations, other than our ownership
of our subsidiaries. While we have no current intention of paying dividends,
should we decide in the future to do so, as a holding company, our ability to
pay dividends and meet other obligations depends upon the receipt of dividends
or other payments from our operating subsidiaries and other holdings and
investments. In addition, our operating subsidiaries, from time to time, may be
subject to restrictions on their ability to make distributions to us, including
as a result of restrictive covenants in loan agreements, restrictions on the
conversion of local currency into U.S. dollars or other hard currency and other
regulatory restrictions as discussed below. If future dividends are paid in RMB,
fluctuations in the exchange rate for the conversion of RMB into U.S. dollars
may reduce the amount received by U.S. stockholders upon conversion of the
dividend payment into U.S. dollars.
Chinese regulations currently permit the payment of dividends
only out of accumulated profits as determined in accordance with Chinese
accounting standards and regulations. Our subsidiaries in China are also
required to set aside a portion of their after tax profits according to Chinese
accounting standards and regulations to fund certain reserve funds. Currently,
our subsidiaries in China are the only sources of revenues or investment
holdings for the payment of dividends. If they do not accumulate sufficient
profits under Chinese accounting standards and regulations to first fund certain
reserve funds as required by Chinese accounting standards, we will be unable to
pay any dividends.
RISKS RELATED TO DOING BUSINESS IN CHINA
Changes in the economic and political policies of the PRC
government could have a material and adverse effect on our business and
operations.
We conduct substantially all our business operations in China.
Accordingly, our results of operations, financial condition and prospects are
significantly dependent on economic and political developments in China. Chinas
economy differs from the economies of developed countries in many aspects,
including the level of development, growth rate and degree of government control
over foreign exchange and allocation of resources. While Chinas economy has
experienced significant growth in the past 30 years, the growth has been uneven
across different regions and periods and among various economic sectors in
China. We cannot assure you that Chinas economy will continue to grow, or that
if there is growth, such growth will be steady and uniform, or that if there is
a slowdown, such slowdown will not have a negative effect on its business and
results of operations.
The PRC government exercises significant control over Chinas
economic growth through the allocation of resources, control over payment of
foreign currency-denominated obligations, implementation of monetary policy, and
preferential treatment of particular industries or companies. Certain measures
adopted by the PRC government may restrict loans to certain industries, such as
changes in the statutory deposit reserve ratio and lending guidelines for
commercial banks by the Peoples Bank of China, or PBOC. These current and
future government actions could materially affect our liquidity, access to
capital, and ability to operate our business.
The global financial markets experienced significant
disruptions in 2008 and the United States, Europe and other economies went into
recession. Since 2012, growth of the Chinese economy has slowed down. The PRC
government has implemented various measures to encourage economic growth and
guide the allocation of resources. Some of these measures may benefit the
overall PRC economy but may also have a negative effect on us. Our financial
condition and results of operation could be materially and adversely affected by
government control over capital investments or changes in tax regulations that
are applicable to us. In addition, any stimulus measures designed
to boost the Chinese economy, may contribute to higher inflation, which could
adversely affect our results of operations and financial condition..
7
Our business is largely subject to the uncertain legal
environment in China and your legal protection could be limited.
The Chinese legal system is a civil law system based on written
statutes. Unlike common law systems, it is a system in which precedents set in
earlier legal cases are not generally used. The overall effect of legislation
enacted over the past 20 years has been to enhance the protections afforded to
foreign invested enterprises in China. However, these laws, regulations and
legal requirements are relatively recent and are evolving rapidly, and their
interpretation and enforcement involve uncertainties. These uncertainties could
limit the legal protections available to foreign investors, such as the right of
foreign invested enterprises to hold licenses and permits such as requisite
business licenses. In addition, all of our executive officers are residents of
China and not of the U.S., and substantially all the assets of these persons are
located outside the U.S. As a result, it could be difficult for investors to
effect service of process in the U.S., or to enforce a judgment obtained in the
U.S. against us or any of these persons.
The Chinese government exerts substantial influence over
the manner in which we must conduct our business activities.
China only recently has permitted provincial and local economic
autonomy and private economic activities. The 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, import and export tariffs, 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 or joint
ventures.
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 highly fluctuating rates of inflation. During the past ten
years, the rate of inflation in China has been as high as 3% and as low as -0.7%
. 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 and our company.
If consumer spending power in China declines, our ability
to market SOD products may weaken.
The success of our SOD products relies in part on the
perception of consumers of the relative necessity of SOD, which is largely
dependent on Chinese consumers financial ability to afford SOD-enriched
products. If Chinese consumers spending power declines, whether because of the
reversal of Chinas economic growth or other causes, then our SOD products may
become less profitable if companies that use its product to enrich their
products stop ordering it.
If health problems relating to SOD products made in China
emerge, then SOD sales may fall or be banned entirely.
In light of recent news pieces about the health problems and
risks of products made in China, the global market and foreign and Chinese
health authorities may be especially sensitive about health problems caused by
or relating to SOD products made in China. If health problems relating to SOD
products made in China become evident, then the market demand for Chinese SOD
producers may be particularly susceptible to a fall. Likewise, such problems
become evident, foreign or Chinese health authorities may ban or impose other
controls or regulations on such SOD products that could harm or eliminate SOD
product sales. As a producer of a SOD product in China, we would be subject to
these risks.
Restrictions on currency exchange may limit our ability
to receive and use our revenues effectively.
The majority of our revenue will be settled in RMB and U.S.
Dollars, and any future restrictions on currency exchanges may limit our ability
to use revenue generated in RMB to fund any future business activities outside
China or to make dividend or other payments in U.S. dollars. Although the Chinese government
introduced regulations in 1996 to allow greater convertibility of the RMB for
current account transactions, significant restrictions still remain, including
primarily the restriction that foreign-invested enterprises may only buy, sell
or remit foreign currencies after providing valid commercial documents at those
banks in China authorized to conduct foreign exchange business. In addition,
conversion of RMB for capital account items, including direct investment and
loans, is subject to governmental approval in China, and companies are required
to open and maintain separate foreign exchange accounts for capital account
items. We cannot be certain that the Chinese regulatory authorities will not
impose more stringent restrictions on the convertibility of the RMB.
8
We may be unable to complete a business combination
transaction efficiently or on favorable terms due to complicated merger and
acquisition regulations which became effective on September 8, 2006.
On August 8, 2006, six PRC regulatory agencies, including the
CSRC, promulgated the Regulation on Mergers and Acquisitions of Domestic
Companies by Foreign Investors, which became effective on September 8, 2006.
This new regulation, among other things, governs the approval process by which a
PRC company may participate in an acquisition of assets or equity interests.
Depending on the structure of the transaction, the new regulation will require
the PRC parties to make a series of applications and supplemental applications
to the government agencies. In some instances, the application process may
require the presentation of economic data concerning a transaction, including
appraisals of the target business and evaluations of the acquirer, which are
designed to allow the government to assess the transaction. Government approvals
will have expiration dates by which a transaction must be completed and reported
to the government agencies. Compliance with the new regulations is likely to be
more time consuming and expensive than in the past and the government can now
exert more control over the combination of two businesses. Accordingly, due to
the new regulation, our ability to engage in business combination transactions
has become significantly more complicated, time consuming and expensive, and we
may not be able to negotiate a transaction that is acceptable to our
stockholders or sufficiently protect their interests in a transaction.
The new regulation allows PRC government agencies to assess the
economic terms of a business combination transaction. Parties to a business
combination transaction may have to submit to the Ministry of Commerce and other
relevant government agencies an appraisal report, an evaluation report and the
acquisition agreement, all of which form part of the application for approval,
depending on the structure of the transaction. The regulations also prohibit a
transaction at an acquisition price obviously lower than the appraised value of
the PRC business or assets and in certain transaction structures, require that
consideration must be paid within defined periods, generally not in excess of a
year. The regulation also limits our ability to negotiate various terms of the
acquisition, including aspects of the initial consideration, contingent
consideration, holdback provisions, indemnification provisions and provisions
relating to the assumption and allocation of assets and liabilities. Transaction
structures involving trusts, nominees and similar entities are prohibited.
Therefore, such regulation may impede our ability to negotiate and complete a
business combination transaction on financial terms that satisfy our investors
and protect our stockholders economic interests.
Failure to comply with PRC regulations relating to the
investment in offshore special purpose companies by PRC residents may subject
our PRC resident stockholders to personal liability, limit our ability to
acquire PRC companies or to inject capital into our PRC subsidiaries, limit our
PRC subsidiaries ability to distribute profits to us or otherwise materially
adversely affect us.
On July 14, 2014, SAFE issued the Circular on Relevant Issues
Relating to Domestic Residents Investment and Financing and Roundtrip
Investment through Special Purpose Vehicles, or Circular 37, which replaced the
Circular 75, promulgated by SAFE on October 21, 2005. Circular 37 requires PRC
residents to register with local branches of SAFE in connection with their
direct establishment or indirect control of an offshore entity, for the purpose
of overseas investment and financing, with such PRC residents legally owned
assets or equity interests in domestic enterprises or offshore assets or
interests, referred to in Circular 37 as a special purpose vehicle.
We have notified substantial beneficial owners of our company
who we know are PRC residents to comply with the registration obligation.
However, we may not be aware of the identities of all our beneficial owners who
are PRC residents. In addition, we do not have control over our beneficial
owners and cannot assure you that all of our PRC resident beneficial owners will
comply with Circular 37. The failure of our beneficial owners who are PRC
residents to register or amend their SAFE registrations in a timely manner
pursuant to Circular 37 or the failure of future beneficial owners of our
company who are PRC residents to comply with the registration procedures set
forth in Circular 37 may subject such beneficial owners or our PRC subsidiaries
to fines and legal sanctions. Failure to register or amend the registration may
also limit our ability to contribute additional capital to our PRC subsidiaries
or receive dividends or other distributions from our PRC subsidiaries or other
proceeds from disposal of our PRC subsidiaries, or we may be penalized by SAFE.
These risks may have a material adverse effect on our business, financial
condition and results of operations.
9
The value of our securities will be affected by the
foreign exchange rate between U.S. dollars and RMB.
The value of our common stock will be affected by the foreign
exchange rate between U.S. dollars and RMB, and between those currencies and
other currencies in which our sales may be denominated. Currently, RMB is
stronger than U.S. Dollars. For example, to the extent that we need to convert
U.S. dollars into RMB for our operational needs and should RMB appreciate
against the U.S. dollar at that time, our financial position, the business of
the Company, and the price of our common stock may be harmed. Conversely, if we
decide to convert our RMB into U.S. dollars for the purpose of declaring
dividends on our common stock or for other business purposes and the U.S. dollar
appreciates against RMB, the U.S. dollar equivalent of our earnings from our
subsidiaries in China would be reduced.
The Security Review Rules may make it more difficult for
us to make future acquisitions or dispositions of our business operations or
assets in China.
The Security Review Rules, effective as of September 1, 2011,
provides that when deciding whether a specific merger or acquisition of a
domestic enterprise by foreign investors is subject to the national security
review by MOFCOM, the principle of substance-over-form should be applied and
foreign investors are prohibited from circumventing the national security review
requirement by structuring transactions through proxies, trusts, indirect
investments, leases, loans, control through contractual arrangements or offshore
transactions. If the business of any target company that we plan to acquire
falls within the scope subject to national security review, we may not be able
to successfully acquire such company by equity or asset acquisition, capital
increase or even through any contractual arrangement.
Under the Enterprise Income Tax Law, we may be classified
as a resident enterprise of China. Such classification will likely result in
unfavorable tax consequences to us and our non-PRC shareholders.
On March 16, 2007, the National Peoples Congress of China
passed a new Enterprise Income Tax Law, or the EIT Law, and on November 28,
2007, the State Council of China passed its implementing rules, which took
effect on January 1, 2008. Under the EIT Law, an enterprise established outside
of China with de facto management bodies within China is considered a
resident enterprise, meaning that it can be treated in a manner similar to a
Chinese enterprise for enterprise income tax purposes. The implementing rules of
the EIT Law define de facto management as substantial and overall management
and control over the production and operations, personnel, accounting, and
properties of the enterprise.
On April 22, 2009, the State Administration of Taxation issued
the Notice Concerning Relevant Issues Regarding Cognizance of Chinese Investment
Controlled Enterprises Incorporated Offshore as Resident Enterprises pursuant to
Criteria of de facto Management Bodies, or the Notice, further interpreting the
application of the EIT Law and its implementation non-Chinese enterprise or
group controlled offshore entities. Pursuant to the Notice, an enterprise
incorporated in an offshore jurisdiction and controlled by a Chinese enterprise
or group will be classified as a non-domestically incorporated resident
enterprise if (i) its senior management in charge of daily operations reside or
perform their duties mainly in China; (ii) its financial or personnel decisions
are made or approved by bodies or persons in China; (iii) its substantial assets
and properties, accounting books, corporate chops, board and shareholder minutes
are kept in China; and (iv) at least half of its directors with voting rights or
senior management often resident in China. A resident enterprise would be
subject to an enterprise income tax rate of 25% on its worldwide income and must
pay a withholding tax at a rate of 10% when paying dividends to its non-PRC
shareholders. However, it remains unclear as to whether the Notice is applicable
to an offshore enterprise incorporated by a Chinese natural person. Nor are
detailed measures on imposition of tax from non-domestically incorporated
resident enterprises are available. Therefore, it is unclear how tax authorities
will determine tax residency based on the facts of each case.
We may be deemed to be a resident enterprise by Chinese tax
authorities. If the PRC tax authorities determine that we are a resident
enterprise for PRC enterprise income tax purposes, a number of unfavorable PRC
tax consequences could follow. First, we may be subject to the enterprise income
tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise
income tax reporting obligations. In our case, this would mean that income such
as interest on financing proceeds and non-China source income would be subject
to PRC enterprise income tax at a rate of 25%. Second, although under the EIT
Law and its implementing rules dividends paid to us 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, as the PRC foreign exchange
control authorities, which enforce the withholding tax, have not yet issued
guidance with respect to the processing of outbound remittances to entities that
are treated as resident enterprises for PRC enterprise income tax purposes.
Finally, it is possible that future guidance issued with respect to the new
resident enterprise classification could result in a situation in which a 10%
withholding tax is imposed on dividends we pay to our non-PRC shareholders and
with respect to gains derived by our non-PRC stockholders from transferring our
shares.
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 creditable against our U.S. tax.
10
We face uncertainty from Chinas Circular on
Strengthening the Administration of Enterprise Income Tax on NonResident
Enterprises Share Transfer that was released in December 2009 with retroactive
effect from January 1, 2008.
The Chinese State Administration of Taxation, or SAT, released
a circular on December 15, 2009 that addresses the transfer of shares by
nonresident companies, generally referred to as Circular 698. 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.
Circular 698, which provides parties with a short period of
time to comply with its requirements, indirectly taxes foreign companies on
gains derived from the indirect sale of a Chinese company. 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 PRCs
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 not any 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.
We may be exposed to liabilities under the Foreign
Corrupt Practices Act and Chinese anti-corruption laws, and any determination
that we violated these laws could have a material adverse effect on our
business.
We are subject to the Foreign Corrupt Practice Act, or FCPA,
and other laws that prohibit improper payments or offers of payments to foreign
governments and their officials and political parties by U.S. persons and
issuers as defined by the statute, for the purpose of obtaining or retaining
business. We have operations, agreements with third parties, and make most of
our sales in China. The PRC also strictly prohibits bribery of government
officials. Our activities in China create the risk of unauthorized payments or
offers of payments by the employees, consultants, sales agents, or distributors
of our Company, even though they may not always be subject to our control. It is
our policy to implement safeguards to discourage these practices by our
employees. However, our existing safeguards and any future improvements may
prove to be less than effective, and the employees, consultants, sales agents,
or distributors of our Company may engage in conduct for which we might be held
responsible. Violations of the FCPA or Chinese anti-corruption laws may result
in severe criminal or civil sanctions, and we may be subject to other
liabilities, which could negatively affect our business, operating results and
financial condition. In addition, the U.S. government may seek to hold our
Company liable for successor liability FCPA violations committed by companies in
which we invest or that we acquire.
If we become directly subject to the recent scrutiny,
criticism and negative publicity involving U.S.-listed Chinese companies, we may
have to expend significant resources to investigate and resolve the matter which
could harm our business operations, stock price and reputation and could result
in a loss of your investment in our stock, especially if such matter cannot be
addressed and resolved favorably.
Recently, U.S. public companies that have substantially all of
their operations in China, particularly companies like us which have completed
so-called reverse merger transactions, have been the subject of intense
scrutiny, criticism and negative publicity by investors, financial commentators
and regulatory agencies, such as the SEC. Much of the scrutiny, criticism and
negative publicity has centered around financial and accounting irregularities
and mistakes, a lack of effective internal controls over financial accounting,
inadequate corporate governance policies or a lack of adherence thereto and, in
many cases, allegations of fraud. As a result of the scrutiny, criticism and
negative publicity, the publicly traded stock of many U.S. listed Chinese
companies has sharply decreased in value and, in some cases, has become
virtually worthless. Many of these companies are now subject to shareholder
lawsuits and SEC enforcement actions and are conducting internal and external
investigations into the allegations. It is not clear what effect this
sector-wide scrutiny, criticism and negative publicity will have on our Company,
our business and our stock price. If we become the subject of any unfavorable
allegations, whether such allegations are proven to be true or untrue, we will have
to expend significant resources to investigate such allegations and/or defend
our company. This situation will be costly and time consuming and distract our
management from growing our company.
11
The disclosures in our reports and other filings with the
SEC and our other public pronouncements are not subject to the scrutiny of any
regulatory bodies in the PRC. Accordingly, our public disclosure should be
reviewed in light of the fact that no governmental agency that is located in
China where substantially all of our operations and business are located have
conducted any due diligence on our operations or reviewed or cleared any of our
disclosure.
We are regulated by the SEC and our reports and other filings
with the SEC are subject to SEC review in accordance with the rules and
regulations promulgated by the SEC under the Securities Act and the Exchange
Act. Unlike public reporting companies whose operations are located primarily in
the United States, however, substantially all of our operations are located in
China. Since substantially all of our operations and business takes place in
China, it may be more difficult for the staff of the SEC to overcome the
geographic and cultural obstacles that are present when reviewing our
disclosure. These same obstacles are not present for similar companies whose
operations or business take place entirely or primarily in the United States.
Furthermore, our SEC reports and other disclosure and public pronouncements are
not subject to the review or scrutiny of any PRC regulatory authority. For
example, the disclosure in our SEC reports and other filings are not subject to
the review of the China Securities Regulatory Commission, a PRC regulator that
is tasked with oversight of the capital markets in China. Accordingly, you
should review our SEC reports, filings and our other public pronouncements with
the understanding that no local regulator has done any due diligence on our
company and with the understanding that none of our SEC reports, other filings
or any of our other public pronouncements has been reviewed or otherwise been
scrutinized by any local regulator.
RISKS RELATED TO THE MARKET FOR OUR STOCK
Our common stock is quoted on the OTC Market which may
have an unfavorable impact on our stock price and liquidity.
Our common stock is quoted on the OTC Market. The OTC Market is
a significantly more limited market than the New York Stock Exchange or Nasdaq
system. The quotation of our shares on the OTC Market may result in a less
liquid market available for existing and potential stockholders to trade shares
of our common stock, could depress the trading price of our common stock and
could have a long-term adverse impact on our ability to raise capital in the
future.
We are subject to penny stock regulations and
restrictions and you may have difficulty selling shares of our common
stock.
The SEC has adopted regulations which generally define
so-called penny stocks to be an equity security that has a market price less
than $5.00 per share or an exercise price of less than $5.00 per share, subject
to certain exemptions. Our common stock is a penny stock and as a result, we
may become subject to Rule 15g-9 under the Exchange Act, or the Penny Stock
Rule. This rule imposes additional sales practice requirements on
broker-dealers that sell such securities to persons other than established
customers and accredited investors (generally, individuals with a net worth in
excess of $1,000,000 or annual incomes exceeding $200,000, or $300,000 together
with their spouses). For transactions covered by Rule 15g-9, a broker-dealer
must make a special suitability determination for the purchaser and have
received the purchasers written consent to the transaction prior to sale. As a
result, this rule may affect the ability of broker-dealers to sell our
securities and may affect the ability of purchasers to sell any of our
securities in the secondary market.
For any transaction involving a penny stock, unless exempt, the
rules require delivery, prior to any transaction in a penny stock, of a
disclosure schedule prepared by the SEC relating to the penny stock market.
Disclosure is also required to be made about sales commissions payable to both
the broker-dealer and the registered representative and current quotations for
the securities. Finally, monthly statements are required to be sent disclosing
recent price information for the penny stock held in the account and information
on the limited market in penny stock.
There can be no assurance that our common stock will qualify
for exemption from the Penny Stock Rule. In any event, even if our common stock
were exempt from the Penny Stock Rule, we would remain subject to Section
15(b)(6) of the Exchange Act, which gives the SEC the authority to restrict any
person from participating in a distribution of penny stock, if the SEC finds
that such a restriction would be in the public interest.
12
Our controlling stockholder, Wei Wang, holds a
significant percentage of our outstanding voting securities and accordingly may
make decisions regarding our daily operations, significant corporate
transactions and other matters that other stockholders may believe are not in
their best interests.
Ms. Wei Wang, our Director, is the beneficial owner of
approximately 80.81% of our outstanding voting securities. As a result, she
possesses significant influence over the election of our Board of Directors and
significant corporate transactions. Her ownership may also have the effect of
delaying or preventing a future change in control, impeding a merger,
consolidation, takeover or other business combination or discourage a potential
acquirer from making a tender offer. Other stockholders may believe that these
future decisions made by Ms. Wang are not in their best interests.