Item
3. Key Information
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A.
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Selected
Financial Data.
|
In the table below, we provide the summary
financial data of our company. The selected consolidated statements of income and comprehensive income data for the years ended
December 31, 2018, 2017 and 2016, and the selected consolidated balance sheets data as of December 31, 2018 and 2017 are derived
from our audited consolidated financial statements, which are included elsewhere in this annual report. The selected consolidated
statement of income and comprehensive income data for the years ended December 31, 2015 and 2014 and the selected consolidated
balance sheets data as of December 31, 2016, 2015 and 2014 are derived from our audited consolidated financial statements, which
are not included in this annual report. Historical results are not necessarily indicative of the results that may be expected for
any future period. When you read this historical selected financial data, it is important that you read it along with the historical
statements and notes.
|
|
For the years ended December 31,
|
|
|
|
2018
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenues
|
|
$
|
25,973,963
|
|
|
$
|
16,192,503
|
|
|
$
|
6,425,338
|
|
|
$
|
6,978,254
|
|
|
$
|
1,033,086
|
|
Net revenues from related parties
|
|
|
21,066,741
|
|
|
|
9,146,994
|
|
|
|
5,854,383
|
|
|
|
-
|
|
|
|
-
|
|
Subtotal of revenues
|
|
|
47,040,704
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|
|
|
25,339,497
|
|
|
|
12,279,721
|
|
|
|
6,978,254
|
|
|
|
1,033,086
|
|
Cost of revenues
|
|
|
20,474,072
|
|
|
|
17,199,866
|
|
|
|
7,182,081
|
|
|
|
3,763,871
|
|
|
|
670,739
|
|
Cost of revenues from related parties
|
|
|
5,669,252
|
|
|
|
-
|
|
|
|
556,692
|
|
|
|
-
|
|
|
|
-
|
|
Subtotal of cost of revenues
|
|
|
26,143,324
|
|
|
|
17,199,866
|
|
|
|
7,738,773
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|
|
|
3,763,871
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|
|
|
670,739
|
|
Gross profit
|
|
|
20,897,380
|
|
|
|
8,139,631
|
|
|
|
4,540,948
|
|
|
|
3,214,383
|
|
|
|
362,347
|
|
Total operating expenses
|
|
|
12,025,924
|
|
|
|
5,452,349
|
|
|
|
3,146,521
|
|
|
|
1,643,313
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|
|
|
361,166
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Income from operations
|
|
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8,871,456
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|
|
|
2,687,282
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|
|
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1,394,427
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|
|
|
1,571,070
|
|
|
|
1,181
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Government grants
|
|
|
(627,748
|
)
|
|
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(513,538
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)
|
|
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(1,750,726
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)
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|
|
-
|
|
|
|
-
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Interest income
|
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(26,632
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)
|
|
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(112,592
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)
|
|
|
(5,091
|
)
|
|
|
(2,612
|
)
|
|
|
-
|
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Interest expenses
|
|
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658,290
|
|
|
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242,707
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|
|
|
155,553
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|
|
|
164,613
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|
|
|
-
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Other expenses (income)
|
|
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(1,162
|
)
|
|
|
3,956
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|
|
|
12,534
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|
|
|
10,642
|
|
|
|
-
|
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Total other expense (income)
|
|
|
2,748
|
|
|
|
(379,467
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)
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|
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(1,587,730
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)
|
|
|
172,643
|
|
|
|
-
|
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Income before provision for income taxes
|
|
|
8,868,708
|
|
|
|
3,066,749
|
|
|
|
2,982,157
|
|
|
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1,398,427
|
|
|
|
1,181
|
|
Income tax provisions
|
|
|
1,657,279
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|
|
|
475,818
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|
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548,437
|
|
|
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452,850
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|
|
|
2,774
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Net income (loss)
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|
$
|
7,211,429
|
|
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$
|
2,590,931
|
|
|
$
|
2,433,720
|
|
|
$
|
945,577
|
|
|
$
|
(1,593
|
)
|
Earnings (loss) per shares
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Basic
|
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$
|
0.67
|
|
|
$
|
0.26
|
|
|
$
|
0.28
|
|
|
$
|
0.12
|
|
|
$
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(0.00
|
)
|
Diluted
|
|
$
|
0.67
|
|
|
$
|
0.26
|
|
|
$
|
0.28
|
|
|
$
|
0.10
|
|
|
$
|
(0.00
|
)
|
Selected Balance Sheet Data
|
|
|
|
As of December 31,
|
|
|
|
2018
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
Cash and cash equivalents
|
|
$
|
2,461,501
|
|
|
$
|
3,118,080
|
|
|
$
|
1,484,762
|
|
|
$
|
152
|
|
|
$
|
36,758
|
|
Total current assets
|
|
|
39,535,357
|
|
|
|
31,634,747
|
|
|
|
14,063,217
|
|
|
|
9,200,052
|
|
|
|
1,817,485
|
|
Total non-current assets
|
|
|
22,216,775
|
|
|
|
13,710,900
|
|
|
|
3,528,207
|
|
|
|
1,461,572
|
|
|
|
404,546
|
|
Total assets
|
|
|
61,752,132
|
|
|
|
45,345,647
|
|
|
|
17,591,424
|
|
|
|
10,661,624
|
|
|
|
2,222,031
|
|
Total current liabilities
|
|
|
30,258,610
|
|
|
|
24,343,309
|
|
|
|
6,838,202
|
|
|
|
6,877,885
|
|
|
|
1,461,124
|
|
Total non-current liabilities
|
|
|
4,449,889
|
|
|
|
11,050
|
|
|
|
-
|
|
|
|
30,808
|
|
|
|
-
|
|
Total liabilities
|
|
|
34,708,499
|
|
|
|
24,354,359
|
|
|
|
6,838,202
|
|
|
|
6,908,693
|
|
|
|
1,461,124
|
|
Total shareholders’ equity
|
|
|
27,043,633
|
|
|
|
20,991,288
|
|
|
|
10,753,222
|
|
|
|
3,752,931
|
|
|
|
760,907
|
|
Total liabilities and shareholders’ equity
|
|
$
|
61,752,132
|
|
|
$
|
45,345,647
|
|
|
$
|
17,591,424
|
|
|
$
|
10,661,624
|
|
|
$
|
2,222,031
|
|
Exchange Rate Information
Our business is conducted in China, and
the financial records of Jinzheng are maintained in RMB, its functional currency. However, we use the U.S. dollar as our reporting
currency; therefore, periodic reports made to shareholders will include current period amounts translated into U.S. dollars using
the then-current exchange rates. Our financial statements have been translated into U.S. dollars in accordance with Accounting
Standards Codification (“ASC”) 830-10, “Foreign Currency Matters.” We have translated our asset and liability
accounts using the exchange rate in effect at the balance sheet date. We translated our statements of operations using the average
exchange rate for the period. We reported the resulting translation adjustments under other comprehensive income (loss). The consolidated
balance sheet amounts, with the exception of equity at December 31, 2018 and 2017 were translated at RMB 6.8764 and RMB 6.5064
to $1.00, respectively. The equity accounts were stated at their historical rate. The average translation rates applied to consolidated
statements of income and comprehensive income and cash flows for the years ended December 31, 2018, 2017 and 2016 were RMB 6.6146,
RMB 6.7570 and RMB 6.6441 to $1.00, respectively.
We make no representation that any RMB or
U.S. dollar amounts could have been, or could be, converted into U.S. dollars or RMB, as the case may be, at any particular rate,
or at all. The Chinese government imposes control over its foreign currency reserves in part through direct regulation of the conversion
of RMB into foreign exchange and through restrictions on foreign trade.
|
B.
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Capitalization
and indebtedness.
|
Not
applicable for annual reports on Form 20-F.
|
C.
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Reasons for
Offer and use of Proceeds.
|
Not
applicable for annual reports on Form 20-F.
Risks
Related to Our Business
Our
limited operating history makes it difficult to evaluate our future prospects and results of operations, and we face certain risks
and uncertainties as an early stage company, which, if we are unsuccessful in addressing such risks, could have a material adverse
effect on our business.
Jinzheng was established in 2012. Newater Technology
and Newater HK were established in 2015.
As our operating
history is not lengthy and the environment protection industry in China is still developing, it is difficult to evaluate our business
and future prospects. We cannot assure that we will maintain our profitability or that we will not incur net losses in the future.
Any failure to achieve targeted sales could result in our revenue growth to slow or even operating losses. Accordingly, you should
consider our future prospects in light of the risks and uncertainties experienced by developing companies in the evolving Chinese
markets for water treatment. In addition, we face numerous risks, uncertainties, expenses and difficulties frequently encountered
by companies at an early stage of development. We will continue to encounter risks and difficulties in implementing our business
model, including potential failure to
:
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increase our revenue
and market share by targeting specific markets;
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|
|
|
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●
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expand our operations
and business to other regions in China and internationally;
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|
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attract additional
customers and increase spending per customer;
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attract a wider client
base;
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increase visibility
of our brand and maintain customer loyalty;
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●
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respond to competitive
market conditions;
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●
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anticipate and adapt
to changing conditions in the markets in which we operate as well as changes in government regulations, mergers and acquisitions
involving our competitors, technological developments and other significant competitive and market dynamics;
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●
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manage risks associated
with intellectual property rights;
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|
|
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●
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maintain effective
control of our costs and expenses;
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|
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●
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raise sufficient capital
to sustain and expand our business;
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|
|
●
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attract, train, retain
and motivate qualified personnel, continue to train, motivate and retain our existing employees, attract and integrate new
employees, including into our senior management; and
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|
|
|
|
●
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upgrade our technology
to support additional research and development of new water treatment filtration products.
|
We
cannot predict whether we will be successful in addressing any or all of these risks. If we were unsuccessful in addressing these
risks and uncertainties, our business, financial condition and results of operation may be materially and adversely affected.
Wage
increases in China may prevent us from sustaining our competitive advantage and could reduce our profit margins.
Labor costs in China have increased with
China’s economic development, including Yantai where our offices are based. Rising inflation in China is also putting pressure
on wages. Wage costs for our employees form a significant part of our costs. For instance, in 2018, 2017 and 2016, our compensation
and benefit costs for our employees were $6.8 million, $2.5 million and $1.2 million, respectively. These amounts accounted for
14%, 10% and 10% of our total revenues for the years ended December 31, 2018, 2017 and 2016, respectively. In addition, we are
required by Chinese laws and regulations to pay various statutory employee benefits, including pensions, housing funds, medical
insurance, work-related injury insurance, unemployment insurance and maternity insurance to designated governmental agencies for
the benefit of our employees. We expect that our labor costs, including wages and employee benefits, will continue to increase,
particularly as we seek to remain competitive in retaining the quality and number of employees that our business requires. In addition,
the future issuance of equity-based compensation to our professional staff and other employees would also result in additional
stock dilution for our shareholders. Unless we are able to pass on these increased labor costs to our customers by increasing prices
for our products, projects and services, our profitability and results of operations may be materially and adversely affected.
Furthermore, the Chinese government has promulgated new laws and regulations to enhance labor protections in recent years, such
as the Labor Contract Law and the Social Insurance Law. As the interpretation and implementation of these new laws and regulations
are still evolving, our employment practice may not at all times be deemed in compliance with the new laws and regulations. If
we are subject to penalties or incur significant liabilities in connection with labor disputes or investigation, our business and
profitability may be adversely affected.
Our
revenue will decrease if the industries in which our customers operate experience a protracted slowdown.
Our customers generally operate in the waste
(garbage), chemical and energy industries. Therefore, we are subject to general changes in economic conditions impacting these
industry segments of the economy. If these industries do not grow or if there is a contraction in these industries, demand for
our business will decrease. Our revenue will also be affected by factors such as interest rates, environmental laws and regulations,
private and public investment in infrastructure projects and health of the overall Chinese economy.
Any
decline in the availability or increase in the cost of raw materials could materially impact our earnings.
Revenues from our products, projects and
service depend heavily on the availability of various raw materials. Raw materials may become unavailable from time to time, and
their prices may fluctuate significantly. If our suppliers are unable or unwilling to provide us with raw materials, we may be
unable to produce certain products, which could adversely impact our projects and services. This could result in a decrease in
revenue, damage to our corporate reputation and even financial loss. In the event our raw material costs increase, we may not be
able to pass these higher costs on to our customers in full or at all.
We rely on a limited number of suppliers, and the loss
of any supplier could harm our business, and the loss of any significant supplier could have a material adverse effect on our business.
We have not entered into a long-term contract
with our suppliers and instead rely on individual contracts. Although we believe that we can locate a replacement supplier readily
on the market for prevailing prices, any difficulty in securing the replacement supplier could negatively affect our company’s
performance to the extent it results in higher prices or a slower supply chain.
Decline in sales to related parties may adversely impact
our revenue, which could have a material adverse impact on our business.
In 2018, 45% of our sales revenues or $21,066,741
was generated from related parties. In the event the related parties do not purchase our products to the same extent as in 2018
our revenues will likely decrease, and our business, financial condition and results of operation may be materially and adversely
affected.
Collectability of our accounts receivable has adversely
impacted our operating cash flow, and may continue to do so.
We reported cash flow used in operations
in the amounts of $2,456,777, $3,189,701 and $663,655 for the years ended December 31, 2018, 2017 and 2016, respectively. Improvement
in cash flow from operations in 2018, 2017 and 2016 was partly due to the increase in net income. As of December 31, 2018 and 2017,
the balance of net accounts receivable from third parties were $10,064,847 and $5,442,520, respectively; and the net accounts receivable
from related parties as of December 31, 2018 and 2017 were $1,948,009 and $607,975, respectively. If the accounts receivable cannot
be collected on time, or at all, a significant amount of bad debt expense will occur, and our business, financial condition and
results of operation may be materially and adversely affected.
We face substantial inventory risk, which if such risk
is not addressed could have a material adverse effect on our business.
We typically acquire materials through
a combination of purchase orders, supplier contracts and open orders, based on projected demand. As part of our business strategy,
we order materials for our products, projects and services and build inventory in advance. This strategy has enabled us to complete
customer orders in a short amount of time as compared to months of lead time for our competitors. This strategy has proven to
be effective and given us the competitive advantage since certain customers require expedited order production and shipment. .
Our inventory includes raw materials, work-in progress products and finished goods. As of December 31,
2018, our inventory was $13,762,959. Inventory turnover for the year ended December 31, 2018 was
168
days. As our markets are competitive and subject to rapid technology and price changes, there is a risk that we will project demands
incorrectly and order or produce incorrect amounts of inventories or not fully utilize our purchase commitments. If we fail to
accurately project demands and build inventories, our business, financial condition and results of operation may be materially
and adversely affected.
Any disruption in the supply chain of raw materials and
our products could adversely impact our ability to produce and deliver products, which could have a material adverse effect on
our business.
In order to optimize our production process,
we must manage our supply chain for raw materials and delivery of our products. Supply chain fragmentation and local protectionism
within China further complicates supply chain management. Local administrative bodies and physical infrastructure built to protect
local interests may pose transportation challenges for raw material transportation as well as product delivery. In addition, government
actions, legal enforcements, natural disasters, and other events could impact our supply chain. Any of these events could cause
significant disruptions to our supply chain, production capacity and distribution. If we were unsuccessful in managing our supply
chain, our business, financial condition and results of operation may be materially and adversely affected.
Based on our current operation results,
we rely on our manufacturing inspection, quality testing and customer support teams, to keep repair and maintenance claims at
a level that does not require a financial reserve. However, if we experience any significant increases in claims or customers
refusing to pay the final 5-20% of the price due to product quality, our financial results could be adversely affected.
Our operations are subject to geographic market risks,
which could adversely affect our revenues and profitability.
In 2018, approximately 90% of our revenues
were realized from three geographic markets, with approximately 43%, 33%, and 14% of our revenues from clients located in the Shandong
Province, Beijing City and Inner Mongolia Autonomous Region, respectively. Accordingly, we are subject to risks related to the
economies of these geographic markets. In addition, the geographic concentration of our primary clients suggests that region-specific
legislations, taxation and natural disasters such as earthquakes could adversely affect us and our financial performance. A slowdown in wastewater treatment demand or economic growth in these regions could result in a material decline in our business, financial
condition and results of operation.
We face certain risks in collecting our accounts receivable
and we have a small number of customers who account for a significant amount of our revenues, the failure to collect could have
a material adverse effect on our business.
With the recent expansion of our
business, our accounts receivable has increased. At the end of 2018 and 2017, our net accounts receivable from both third
parties and related parties were $12,
012,856 and
$6,050,495, respectively. These amounts represented 26% of our total revenues in 2018 and 24% of our total revenues in 2017.
In 2018, accounts receivable turnover was 70 days, and in 2017, it was 70 days.
Although we believe that we have developed
a robust receivables management system and have not incurred a situation where an accounts receivable has become uncollectable,
as our business continues to scale, we believe that our accounts receivable balance will continue to grow. This, in turn, increases
our risks for bad debts and uncollectible receivables. To the extent we incur additional bad debts and/or uncollectible receivables,
our business, financial condition and results of operation may be materially and adversely affected.
We
have experienced rapid growth in recent periods. If we fail to manage our growth effectively, we may be unable to execute our
business plan and address competitive challenges, which could have a material adverse effect on our business.
We increased our number of full-time employees from 75 at December 31, 2015, to 203 at December 31, 2018,
and our total revenues from $7 million in 2015, to $
47
million in 2018. This expansion has resulted, and will continue to result, in substantial demands on our managerial, administrative,
operational, financial and other resources. Furthermore, we intend to grow by expanding our business reach, penetrating markets
with our existing products, developing new products and expand our targeted markets such as industrial park wastewater treatment,
municipality wastewater recycling, and seawater desalination. To cope with this growth, we must improve our existing administration,
adopt new systems, enhance our financial oversight and management controls and further grow, train and manage our work force.
As we continue these efforts, we may incur
substantial costs and expend substantial resources due to, among other things, different technology standards, legal considerations
and cultural differences. We will be required to dedicate additional financial resources and personnel to optimize our operational
infrastructure and to recruit more personnel to train and manage our growing employee base. If we cannot successfully implement
these measures efficiently and cost-effectively, we will be unable to satisfy the demand for our products, projects and services,
which will impair our revenue growth and hurt our overall financial performance.
We cannot assure you that our growth strategy will be
successful, which may result in a negative impact on our growth, financial condition, results of operations and cash flow.
We plan to grow by expanding our business
reach, penetrating markets with our existing products, developing new products and grow our targeted markets such as industrial
park wastewater treatment, municipality wastewater recycling, and seawater desalination. However, many risks to this plan exist,
including results of marketing campaigns, competition from similar businesses, and results outcome of our research and development
investments. We cannot, therefore, assure you that we will be able to successfully overcome such risks and grow our business as
planned. Failure in our growth strategy may have a negative impact on our growth, future financial condition, and results of operations
or cash flows.
If we fail to compete successfully against new and existing
competitors, we may not be able to increase our market share, and our profitability may be adversely affected.
We do and will continue to face significant
competition in China in the wastewater treatment business. Currently, our competitive advantages include our brand reputation,
price, quick production and shipment time, and the range of our products and services. Our existing and potential competitors may
have competitive advantages, such as financial resources, marketing campaigns or other resources. We cannot assure that we will
be able to successfully compete with those competitors. If we fail to maintain our competitive advantages and respond to our competitors’
actions, customers demand for our products, projects and services could decline.
If
we fail to protect our intellectual property rights, it could harm our business and competitive position.
We own 23 patents in China covering our
wastewater treatment technology, and we rely on a combination of patent, computer software copyrights, trademark and trade secret
laws and non-disclosure agreements and other methods to protect our intellectual property rights.
The process of seeking patent protection
on future patents can be lengthy and expensive, our patent applications may be rejected, and our existing and future patents may
be insufficient to provide us with sufficient protection or commercial advantage. Our patents and patent applications may also
be challenged, invalidated or circumvented.
Implementation of Chinese intellectual property-related
laws has historically been ineffective, primarily due to ambiguities in Chinese laws and enforcement difficulties. Accordingly,
intellectual property rights and confidentiality protections in China may not be as effective as those in the United States or
other developed countries. Furthermore, indemnifying unauthorized use of proprietary technology is difficult and expensive, and
we may need to resort to litigation to enforce or defend our patents. Such litigations and its results could cause substantial
costs and diversion of resources and management attention, which could harm our business and growth.
We may be exposed to intellectual property infringement
and other claims by third parties which, if successful, could disrupt our business and have a material adverse effect on our financial
condition and results of operations.
Our success depends, in a large part, on
our ability to use and develop our technology and know-how without infringing third party intellectual property rights. With global
expansion of our products, and increased amount of business activities we are exposed to a higher litigation risk for intellectual
property infringement, invalidity and indemnification relating to other parties’ proprietary rights. Our current or potential
competitors, many of which have substantial resources and have made substantial investments in competing technologies, may have
obtained or going to obtain patents that will prevent, limit or interfere with our products in either China or other countries.
The defense of the potential suits, including patent infringement suits, and related legal and administrative proceedings can be
both costly and time consuming and may significantly divert the efforts and resources of our technical and management personnel.
Furthermore, an adverse determination in any such litigation or proceedings to which we may become a party could cause us to:
|
●
|
pay damages;
|
|
|
|
|
●
|
seek licenses from third parties;
|
|
|
|
|
●
|
pay ongoing royalties;
|
|
|
|
|
●
|
redesign our existing products; or
|
|
|
|
|
●
|
be restricted by injunctions.
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Any of these events could prevent us from
expanding to new markets, maintaining our current customer base and obtaining new customers, which could have a material adverse
effect on our financial condition and results of operations.
Confidentiality
agreements with employees and third parties may not prevent unauthorized disclosure of proprietary information and trade secrets.
In
addition to patents, we rely on confidentiality agreements to protect our technical know-how and other proprietary information.
Confidentiality agreements are used, for example, when we talk to potential clients, consultants, contractors and vendors. In
addition, our scientists and each of our research and development and manufacturing employees have signed a confidentiality agreement.
Nevertheless, there can be no guarantee that an employee or a third party will not make an unauthorized disclosure of our proprietary
confidential information. This might happen intentionally or inadvertently. It is possible that a competitor will make use of
such information, and that our competitive position will be compromised, in spite of any legal action we might take against persons
making such unauthorized disclosures.
If
we experience a significant disruption in, or a breach in security of, our information technology systems or if we fail to implement,
manage or integrate new systems, software and technologies successfully, it could harm our business.
Our
information technology (“IT”) systems are an integral part of our business. We depend on our IT systems to process
transactions, manage logistics, keep financial records, prepare our financial reporting and operate other critical functions.
Security breaches, cyber-attacks or other serious disruptions of our IT systems can create systemic disruptions, shutdowns or
unauthorized disclosure of confidential information. If we are unable to prevent or adequately respond to such breaches, attacks
or other disruptions, our operations could be adversely affected or we may suffer financial or reputational damage.
In
addition, our ability to effectively implement our business plan in a rapidly evolving market requires effective planning, reporting
and analytical processes and systems. We are improving and expect that we will need to continue to improve and further integrate
our IT systems, reporting systems and operating procedures on an ongoing basis. If we fail to do so effectively, it could adversely
affect our ability to achieve our objectives.
Product
defects and unanticipated use or inadequate disclosure with respect to our products could adversely affect our business, reputation
and financial performance.
Manufacturing
or design defects (including in products or components that we source from third parties), unanticipated use of, or inadequate
disclosure of risks relating to, the use of products that we make and sell may lead to personal injury, death or property damage.
These events could lead to recalls or alerts relating to our products, result in the removal of a product from the market or result
in product liability claims being brought against us. Product recalls, removals and liability claims can lead to significant costs,
as well as negative publicity and damage to our reputation that could reduce demand for our products.
Our
future growth depends on new products and new technology innovation, and failure to invent and innovate could adversely impact
our business prospects.
Our
future growth depends in part on maintaining our competitive advantage with current products in new and existing markets, as well
as our ability to develop new products and technologies to serve such markets. To the extent that competitors develop competitive
products and technologies, or new products or technologies that achieve higher customer satisfaction, our business prospects could
be adversely impacted. In addition, regulatory approvals for new products or technologies may be required and these approvals
may not be obtained in a timely or cost effective manner, adversely impacting our business prospects.
Changes
in demand for our products and business relationships with key customers and suppliers may negatively affect operating results.
To
achieve our objectives, we must develop and sell products that are subject to the demands of our customers. This is dependent
on many factors, including managing and maintaining relationships with key customers, responding to the rapid pace of technological
change and obsolescence, which may require increased investment by us or result in greater pressure to commercialize developments
rapidly or at prices that may not fully recover the associated investment, and the effect on demand resulting from customers’
research and development, capital expenditure plans and capacity utilization. If we are unable to keep up with our customers’
demands, our sales, earnings and operating results may be negatively affected.
We
may be unable to deliver our backlog on time, which could affect future sales and profitability and our relationships with customers.
Our
ability to meet customer delivery schedules for backlog is dependent on a number of factors including sufficient manufacturing
plant capacity, adequate supply channel access to raw materials and other inventory required for production, an adequately trained
and capable workforce, project engineering expertise for certain large projects and appropriate planning and scheduling of manufacturing
resources. Many of the contracts we enter into with our customers require long manufacturing lead times. Failure to deliver in
accordance with customer expectations could subject us to contract cancellations and financial penalties, and may result in damage
to existing customer relationships and could have a material adverse effect on our business, financial condition and results of
operations.
We
depend on our key personnel, and our business and growth prospects may be severely disrupted if we lose their services.
Our
future success depends heavily upon the continued service of our key executives. In particular, we rely on the expertise and experience
of Yuebiao Li, our founder, Chairman and Chief Executive Officer. We rely on his industry expertise and experience in our business
operations, and in particular, his business vision, management skills, and working relationship with our employees, our other
major shareholders, the regulatory authorities, and many of our clients. If he became unable or unwilling to continue in his present
position, or if he joined a competitor or formed a competing company in violation of his employment agreement, we may not be able
to replace him easily, our business may be significantly disrupted and our financial condition and results of operations may be
materially adversely affected.
We
do not maintain key man life insurance on any of our senior management or key personnel. The loss of any one of them would have
a material adverse effect on our business and operations. Competition for senior management and our other key personnel is intense
and the pool of suitable candidates is limited. We may be unable to locate a suitable replacement for any senior management or
key personnel that we lose. In addition, if any member of our senior management or key personnel joins a competitor or forms a
competing company, they may compete with us for customers, business partners and other key professionals and staff members of
our Company. Although each of our senior management and key personnel has signed a confidentiality and non-competition agreement
in connection with his or her employment with us, we cannot assure that we will be able to successfully enforce these provisions
in the event of a dispute between us and any member of our senior management or key personnel.
In
addition, we compete for qualified personnel with other water treatment companies, and we face competition in attracting skilled
personnel and retaining the members of our senior management team. These personnel possess technical and business capabilities,
including expertise relevant to the water treatment market, which are difficult to replace. There is intense competition for experienced
senior management with technical and industry expertise in the water treatment industry, and we may not be able to retain our
key personnel. Intense competition for these personnel could cause our compensation costs to increase, which could have a material
adverse effect on our results of operations. Our future success and ability to grow our business will depend in part on the continued
service of these individuals and our ability to identify, hire and retain additional qualified personnel. If we are unable to
attract and retain qualified employees, we may be unable to meet our business and financial goals.
Our
senior management lacks experience in managing a public company and complying with laws applicable to operating as a U.S. public
company domiciled in the British Virgin Islands and failure to comply with such obligations could have a material adverse effect
on our business.
Prior to the completion of our initial public
offering, Jinzheng operated as a private company located in China. In connection with our initial public offering, we formed Newater
Technology in the British Virgin Islands, Newater HK Limited in Hong Kong and restructured Jinzheng a Newater subsidiary in China.
In the process of taking these steps to prepare our company for the initial public offering, Jinzheng’s senior management
became the senior management of Newater Technology. None of Newater Technology’s senior management has experience managing
a public company or managing a British Virgin Islands company.
As a result of our initial public offering,
our company became subject to laws, regulations and obligations that did not previously apply to it, and our senior management
had no experience in complying with such laws, regulations and obligations. For example, Newater Technology needs to comply with
the British Virgin Islands laws applicable to companies that are domiciled in that country. The senior management was only experienced
in operating the business of Jinzheng in compliance with Chinese laws. Similarly, by virtue of our initial public offering, Newater
Technology is required to file annual and current reports in compliance with U.S. securities and other laws. These obligations
can be burdensome and complicated, and failure to comply with such obligations could have a material adverse effect on Newater.
In addition, we expect that the process of learning about such new obligations as a public company in the United States will require
our senior management to devote time and resources to such efforts that might otherwise be spent on the operation of our water
treatment business.
We
have limited business insurance coverage. Any future business liability, disruption or litigation we experience might divert management
focus from our business and could significantly impact our financial results.
Availability
of business insurance products and coverage in China is limited, and most such products are expensive in relation to the coverage
offered. We have determined that the risks of disruption, cost of such insurance and the difficulties associated with acquiring
such insurances on commercially reasonable terms make it impractical for us to maintain such insurances. As a result, we do not
have any business liability, disruption or litigation insurance coverage for our operations in China. Accordingly, a business
disruption, litigation or natural disaster may result in substantial costs and divert management’s attention from our business,
which would have an adverse effect on our results of operations and financial condition.
We
may require additional financing in the future and our operations could be curtailed if we are unable to obtain required additional
financing when needed.
We
may need to obtain additional debt or equity financing to fund future capital expenditures. Any additional equity financing may result in dilution to the holders of our outstanding
shares of capital stock. Additional debt financing may impose affirmative and negative covenants that restrict our freedom to
operate our business, including covenants that:
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limit our ability
to pay dividends or require us to seek consent for the payment of dividends;
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increase our vulnerability
to general adverse economic and industry conditions;
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require us to dedicate
a portion of our cash flow from operations to payments on our debt, thereby reducing the availability of our cash flow to
fund capital expenditures, working capital and other general corporate purposes; and
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limit our flexibility
in planning for, or reacting to, changes in our business and our industry.
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We cannot guaranty that we will be able to obtain additional financing on terms that are acceptable to
us, or any financing at all, and the failure to obtain sufficient financing could adversely affect our business operations.
Potential
disruptions in the capital and credit markets may adversely affect our business, including the availability and cost of short-term
funds for liquidity requirements, which could adversely affect our results of operations, cash flows and financial condition.
Potential
changes in the global economy may affect the availability of business and consumer credit. We may need to rely on the credit markets,
particularly for short-term borrowings from banks in China, as well as the capital markets, to meet our financial commitments
and short-term liquidity needs if internal funds from our operations are not available to be allocated to such purposes. Disruptions
in the credit and capital markets could adversely affect our ability to draw on such short-term bank facilities. Our access to
funds under such credit facilities is dependent on the ability of the banks that are parties to those facilities to meet their
funding commitments, which may be dependent on governmental economic policies in China. Those banks may not be able to meet their
funding commitments to us if they experience shortages of capital and liquidity or if they experience excessive volumes of borrowing
requests from us and other borrowers within a short period of time.
Long-term
disruptions in the credit and capital markets could result from uncertainty, changing or increased regulations, reduced alternatives
or failures of financial institutions could adversely affect our access to the liquidity needed for our business. Any disruption
could require us to take measures to conserve cash until the markets stabilize or until alternative credit arrangements or other
funding for our business needs can be arranged. Such measures may include deferring capital expenditures, and reducing or eliminating
discretionary uses of cash. These events would adversely impact our results of operations, cash flows and financial position.
We
rely on short-term borrowings for our liquidity and we may not be able to continue to obtain financing on favorable terms, if
at all.
Our liquidity relies significantly on short-term borrowings. For the years ended December 31, 2018,
2017 and 2016, cash provided by borrowings from third-parties was
$11,493,557,
$8,805,683 and $11,613,289, respectively. Financing may not be available to us on favorable terms, if at all. If we are unable
to obtain short-term financing in an amount sufficient to support our operations, it may be necessary, to suspend or curtail our
operations, which would have a material adverse effect on our business and financial condition. In that event, current stockholders
would likely experience a loss of most of or all of their investment.
Our
bank accounts are not insured or protected against loss.
Jinzheng
maintains cash accounts with various banks located in China. Such cash accounts are not insured or otherwise protected. Should
any bank holding such cash deposits become insolvent, or if Jinzheng is otherwise unable to withdraw funds, Jinzheng would lose
the cash on deposit with that particular bank.
Changes
in China’s environmental laws and policies may affect our financial condition.
Our products, projects and services are
mainly used in the fields of municipal and industrial wastewater treatment and reuse, water purification and desalination. Our
business is in line with China’s current focus on environmental protection policies, specifically the Water Ten Plan and
the 13
th
Five Year Plan (2016-2020). However, should China alter its environmental policies towards less regulation,
we believe demand for our products will decrease, adversely impacting our results of operations, cash flows and financial position.
Risks
Relating to Our Corporate Structure
We
will likely not pay dividends in the foreseeable future.
We
have not previously paid any cash dividends, and we do not anticipate paying any dividends on our common shares in the foreseeable
future. Although we have achieved net profitability in 2018, we cannot assure that our operations will continue to result
in sufficient revenues to enable us to operate at profitable levels or to generate positive cash flows from operating activities. Furthermore,
there is no assurance that our Board of Directors will declare dividends even if we are profitable. Dividend policy is subject
to the discretion of our Board of Directors and will depend on, among other things, our earnings, financial condition, capital
requirements and other factors. If we determine to pay dividends on any of our common shares in the future, we will be dependent,
in large part, on receipt of funds from Jinzheng for our cash needs, including the funds necessary to pay dividends and other
cash distributions, if any, to our shareholders, to service any debt we may incur and to pay our operating expenses. The payment
of dividends by entities organized in China is subject to limitations as described herein. Under British Virgin Islands law, we
may only pay dividends from surplus (the excess, if any, at the time of the determination of the total assets of our Company over
the sum of our liabilities, as shown in our books of account, plus our capital), and we must be solvent before and after the dividend
payment in the sense that we will be able to satisfy our liabilities as they become due in the ordinary course of business; and
the realizable value of assets of our Company will not be less than the sum of our total liabilities, other than deferred taxes
as shown on our books of account, and our capital. If we determine to pay dividends on any of our common shares in the future,
as a holding company, we will be dependent on receipt of funds from Jinzheng. See “Dividend Policy.”
Pursuant
to the Chinese enterprise income tax law, dividends payable by a foreign investment entity to its foreign investors are subject
to a withholding tax of 10%. Similarly, dividends payable by a foreign investment entity to its Hong Kong investor who owns 25%
or more of the equity of the foreign investment entity is subject to a withholding tax of 5%.
The
payment of dividends by entities organized in China is subject to limitations, procedures and formalities. Regulations in China
currently permit payment of dividends only out of accumulated profits as determined in accordance with accounting standards and
regulations in China. Jinzheng is also required to set aside at least 10% of its after-tax profit based on Chinese accounting
standards each year to its compulsory reserves fund until the accumulative amount of such reserves reaches 50% of its registered
capital.
The transfer to this reserve must be made
before distribution of any dividend to shareholders. The surplus reserve fund is non-distributable other than during liquidation
and can be used to fund previous years’ losses, if any, and may be utilized for business expansion or converted into registered
capital, provided that the remaining reserve balance after such issue is not less than 25% of the registered capital. As of December 31,
2018 and 2017, the accumulated appropriations to statutory reserves amounted to $1,765,711 and $705,698, respectively.
Because we do
not anticipate paying any cash dividends on our capital stock in the foreseeable future, capital appreciation, if any, will be
your sole source of gain.
We have never declared
or paid cash dividends. We currently intend to retain all of our future earnings, if any, to finance the growth and development
of our business. As a result, capital appreciation, if any, of our ordinary shares will be your sole source of gain for the foreseeable
future.
Our
business may be materially and adversely affected if any of our Chinese subsidiaries declare bankruptcy or become subject to a
dissolution or liquidation proceeding.
The
Enterprise Bankruptcy Law of China provides that an enterprise may be liquidated if the enterprise fails to settle its debts as
and when they fall due and if the enterprise’s assets are, or are demonstrably, insufficient to clear such debts.
Our
Chinese subsidiaries hold certain assets that are important to our business operations. If any of our Chinese subsidiaries undergoes
a voluntary or involuntary liquidation proceeding, unrelated third-party creditors may claim rights to some or all of these assets,
thereby hindering our ability to operate our business, which could materially and adversely affect our business, financial condition
and results of operations.
Jinzheng
is required to allocate a portion of its after-tax profits, to the statutory reserve fund, and as determined by its board of directors,
to the staff welfare and bonus funds, which may not be distributed to equity owners.
Pursuant to Company Law of P.R. China (2018
Revision), Wholly Foreign-Owned Enterprise Law of the P.R. China (2016 Revision) and Implementing Rules for the Law of the People’s
Republic of China on Wholly Foreign Owned Enterprises (2014 Revision), Jinzheng is required to allocate a portion of its after-tax
profits, to the statutory reserve fund, and in its discretion, to the staff welfare and bonus funds. No lower than 10% of an enterprise’s
after tax-profits should be allocated to the statutory reserve fund. When the statutory reserve fund account balance is equal to
or greater than 50% of the Jinzheng’s registered capital, no further allocation to the statutory reserve fund account is
required. Jinzheng determines, in its own discretion, the amount contributed to the staff welfare and bonus funds. The staff welfare
and bonus fund is used for the collective welfare of the staff of Jinzheng. These reserves represent appropriations of retained
earnings determined according to Chinese law.
As
of the date of this annual report, the amounts of staff welfare and bonus funds have not yet been determined, and we have not
committed to establishing such amounts at this time. Under current Chinese laws, Jinzheng is required to set aside staff welfare
and bonus funds amounts, but has not yet done so. Jinzheng has not done so because Chinese authorities grant companies flexibility
in making a determination. Chinese law requires such a determination to be made in accordance with the company’s organizational
documents and Jinzheng’s organizational documents do not require the determination to be made within a particular timeframe.
Although we have not yet been required by Chinese authorities to make such determinations or set aside such amounts, Chinese authorities
may require Jinzheng to rectify its noncompliance and we may be fined if we fail to do so after receiving a warning within its
set time period.
Additionally,
Chinese law provides that a Chinese company must allocate a portion of after-tax profits to the statutory reserve fund and the
staff welfare and bonus funds reserve prior to the retention of profits or the distribution of profits to foreign invested companies.
Therefore, if for any reason, the dividends from Jinzheng cannot be repatriated to us or not in time, our cash flow may be adversely
impacted or we may become insolvent.
Our failure to obtain prior approval of the China Securities
Regulatory Commission (“CSRC”) for the listing and trading of our common shares on a foreign stock exchange could
have a material adverse effect upon our business, operating results, reputation and trading price of our common shares.
On August 8, 2006, six Chinese regulatory
agencies, including the Ministry of Commerce of the People’s Republic of China (“MOFCOM”), jointly issued the
Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, which was subsequently revised on June 22,
2009 (the New “M&A Rule”). The New M&A Rule contains provisions that require that an offshore special purpose
vehicle (“SPV”) formed for overseas listing purposes and controlled directly or indirectly by Chinese companies or
individuals shall obtain the approval of the CSRC prior to the listing and trading of such SPV’s securities on an overseas
stock exchange.
However, the application of the New
M&A Rule remains unclear with no consensus currently existing among leading Chinese law firms regarding the scope and
applicability of the CSRC approval requirement. Our Chinese counsel, GFE Law Firm, has given us the following advice, based
on their understanding of current Chinese laws and regulations:
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At the time of our
equity interest acquisition, as the acquiree, Jinzheng was not related to or connected with the acquirer, Newater HK. Accordingly,
we did not need the approval from MOFCOM. In addition, we have received all relevant approvals and certificates required for
the acquisition; and
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the CSRC approval under the New M&A Rule only applies to overseas listings of SPVs that have used their existing or newly issued equity interest to acquire existing or newly issued equity interest in Chinese domestic companies, or the SPV-domestic company share swap, due to the fact there has not been any SPV-domestic company share swap in our corporate history, Newater Technology does not constitute a SPV that is required to obtain approval from the CSRC for overseas listing under the New M&A Rule.
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In spite of the lack of clarity on this issue,
the CSRC has not issued any definitive rule or interpretation regarding whether offerings like our initial public offering
are subject to the New M&A Rule.
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The CSRC has not issued any such
definitive rule or interpretation, and we have not chosen to voluntarily request approval under the New M&A Rule. We did
not obtain CSRC approval prior to our initial public offering. If prior CSRC approval was required, we may face regulatory
actions or other sanctions from the CSRC or other Chinese regulatory authorities. These authorities may impose fines and
penalties upon our operations in China, limit our operating privileges in China, or take other actions that could have a
material adverse effect upon our business, financial condition, results of operations, reputation and prospects, as well as
the trading price of our common shares.
Risks
Related to Doing Business in China
Under the Enterprise Income Tax Law,
we may be classified as a “Resident Enterprise” of China. Such classification will likely result in unfavorable tax
consequences to us and our non-PRC shareholders.
China passed an Enterprise Income Tax Law
(the “EIT Law”) and implementing rules, both of which became effective on January 1, 2008, and amended from time
to time. Under the EIT Law, resident enterprises pay income tax at the rate of 25% for their worldwide income while non-resident
enterprises pay 20% for their income generated from China. As far as the definition of resident enterprises, according to the EIT
Law, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident
enterprise.” The implementing rules of the EIT Law define de facto management as “substantial and overall management
and control over the production and operations, personnel, accounting, and properties” of the enterprise.
On April 22, 2009, the State Administration
of Taxation of China (the “SAT”) issued the Circular 82 Concerning Relevant Issues Regarding Cognizance of Chinese
Investment Controlled Enterprises Incorporated Offshore as Resident Enterprises pursuant to Criteria of De Facto Management Bodies
(“Circular 82”) further interpreting the application of the EIT Law and its implementation to offshore entities controlled
by a Chinese enterprise or group. Pursuant to the Circular 82, 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
stamps, board and stockholder minutes are kept in China; and (iv) at least half of its directors with voting rights or senior management
are often resident in China. The SAT issued a Bulletin Concerning on the Administration Measures on Resident Enterprise Income
Tax for Oversea Incorporated Enterprises Controlled by Chinese Enterprise or Enterprise Group on July 27, 2011 or Bulletin 45,
which provides more guidance on the implementation of Circular 82. Bulletin 45 clarifies certain matters relating to resident status
determination, post-determination administration, competent tax authorities, tax registration administration and tax reporting
obligations. In addition, the SAT issued a Bulletin Concerning the Accreditation of Resident Enterprises Based on the Criteria
of De Factor Management Bodies on January 29, 2014, or Bulletin 9, which further provides that, among other things, an entity that
is classified as a “resident enterprise” in accordance with Circular 82 shall file the application for classifying
its status of residential enterprise with the local tax authorities where its main domestic investors are registered. From the
year in which the entity is determined to be a “resident enterprise,” any dividend, profit and other equity investment
gain shall be taxed in accordance with the EIT law and its implementing rules. A resident enterprise would have to pay a withholding
tax at a rate of 10% when paying dividends to its non-PRC stockholders.
We believe that neither Newater Technology
nor Newater HK meet all the conditions outlined in the preceding paragraph to be classified as a PRC “resident enterprise.” Newater Technology does not have a PRC enterprise or enterprise group as its primary controlling shareholder,
and we are not aware of any offshore company with a corporate structure similar to the company that has been deemed a PRC “resident
enterprise” by the PRC tax authorities. However, as the tax resident status of an enterprise is subject to determination
by the PRC tax authorities and uncertainties remain with respect to the interpretation of the term “de facto management body,”
we cannot guarantee that the relevant authorities will not make a contrary conclusion to ours. 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. In our case,
this would mean that income such as non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second,
tax reporting obligations would follow if we are deemed a resident enterprise. Finally, it is possible that future guidance issued
with respect to the “resident enterprise” classification could result in a situation in which a 10% withholding tax
is imposed on dividends we pay to our non-PRC stockholders and with respect to gains derived by our non-PRC stockholders from transferring
our shares. In addition to the uncertainty in how the resident enterprise classification could apply, it is also possible that
the rules may change in the future, possibly with retroactive effect. If we are required under the Enterprise Income Tax law to
withhold PRC income tax on our dividends payable to our foreign shareholders, or if we are required to pay PRC income tax on the
transfer of our shares under the circumstances mentioned above, the value of your investment in our shares or ADSs may be materially
and adversely affected. It is unclear whether, if we are considered as a PRC resident enterprise, holders of our shares would be
able to claim the benefit of income tax treaties or agreements entered into between China and other countries or areas.
We may be exposed to liabilities
under the Foreign Corrupt Practices Act and Chinese anti-corruption law.
In connection with
our initial public offering, we became subject to the U.S. Foreign Corrupt Practices Act (“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 are also subject to the Anti-Unfair
Competition Law of the PRC and the relevant anti-bribery provisions in the Criminal Law of the PRC, or together, the “PRC
Anti-Bribery Laws.” The current PRC Anti-Bribery Laws prohibit the payment of bribes to government officials, private companies
or individuals in a commercial transaction or their agents. We have operations, agreements with third parties, and make sales in
China, which may experience corruption. Our activities in China create the risk of unauthorized payments or offers of payments
by one of the employees, consultants or distributors of our company, because these parties are not always subject to our control.
We are in process of implementing an anticorruption program, which prohibits the offering or giving of anything of value to foreign
officials, directly or indirectly, for the purpose of obtaining or retaining business. The anticorruption program also requires
that clauses mandating compliance with our policy be included in all contracts with foreign sales agents, sales consultants and
distributors and that they certify their compliance with our policy annually. It further requires all hospitality involving promotion
of sales to foreign governments and government-owned or controlled entities to be in accordance with specified guidelines. In the
meantime, we believe to date we have complied in all material respects with the provisions of the FCPA and the PRC Anti-Bribery
Laws.
However, our existing
safeguards and any future improvements may prove to be less than effective, and the employees, consultants or distributors of our
Company may engage in conduct for which we might be held responsible. Violations of the FCPA or PRC Anti-Bribery Laws may result
in severe criminal or administrative sanctions, and we may be subject to other liabilities, which could negatively affect our business,
operating results and financial condition. In addition, the government may seek to hold our Company liable for successor liability
FCPA violations committed by companies in which we invest or that we acquire.
Our subsidiaries’ financial
statements are prepared under different accounting standards than our consolidated financial statements.
We prepare the financial statements for each of our subsidiaries that are PRC legal entities in accordance
with the requirements of generally accepted accounting principles in China, or PRC GAAP. These financial statements drive how we
calculate the taxes payable for operations of these subsidiaries. By contrast, we prepare the consolidated financial statements
for Newater Technology in accordance with generally accepted accounting principles in the United States, or U.S. GAAP. The process
of consolidating the financial statements and changing from PRC GAAP to U.S. GAAP requires us to make certain adjustments on consolidation.
This can result in some discrepancies between the financial statements used to prepare our tax filings in China and the financial
statements audited by our independent registered accounting firm and subsequently filed with the SEC. To the extent the discrepancies
between PRC GAAP and U.S. GAAP are material, we could find, for example, that a PRC subsidiary shows taxable income for which payment
of taxes is due, while our U.S. GAAP-audited financial statements show taxable loss.
If we become directly subject to the recent scrutiny,
criticism and negative publicity involving U.S.-listed China-based companies, we may have to expend significant resources to investigate
and resolve the matter which could harm our business operations and our reputation and could result in a loss of your investment
in our shares, especially if such matter cannot be addressed and resolved favorably.
Recently, U.S. public companies that have
substantially all of their operations in China, 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 on financial and accounting irregularities, a lack of effective internal controls over financial accounting, inadequate
corporate governance policies or a lack of adherence thereto and, in some 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 and our business. 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 the Company. This situation may be a major distraction to our management. If such allegations are
not proven to be groundless, our Company and business operations will be severely hampered and your investment in our shares could
be rendered worthless.
We
are dependent on the state of China’s economy as all of our business is conducted in China and a decline would have a material
adverse effect on our business, financial condition and results of operations.
Currently,
all of our business operations are conducted in China, and all of our customers are also located in China. Accordingly,
any material slowdown in the China’s economy may cause our customers to reduce expenditures or delay the building of
new facilities or projects. This may in turn lead to a decline in the demand for the products, projects and services we
provide. Any such decline would have a material adverse effect on our business, financial condition and results of
operations.
Since
our operations and assets are located in China, shareholders may find it difficult to enforce a U.S. judgment against the assets
of our Company, our directors and executive officers.
Our
operations and assets are located in China. In addition, our executive officers and directors are non-residents of the U.S., and
substantially all the assets of such 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. See “Enforceability
of Civil Liabilities.”
Although
we do not import goods into or export goods out of China, fluctuation of the RMB may indirectly affect our financial condition
by affecting the volume of cross-border money flow.
Although
we use the United States dollar for financial reporting purposes, all of the transactions effected by Jinzheng are denominated
in China’s currency, the RMB. The value of the RMB fluctuates and is subject to changes in China’s political and economic
conditions. We do not currently engage in hedging activities to protect against foreign currency risks. Even if we choose to engage
in such hedging activities, we may not be able to do so effectively. Future movements in the exchange rate of the RMB could adversely
affect our financial condition as we may suffer financial losses when transferring money raised outside of China into the country
or paying vendors for services performed outside of China.
If
any dividend is declared in the future and paid in a foreign currency, you may be taxed on a larger amount in U.S. dollars than
the U.S. dollar amount that you will actually ultimately receive.
In
the event we pay dividends in the future, you will be taxed on the U.S. dollar value of your dividends, if any, at the time you
receive them, even if you actually receive a smaller amount of U.S. dollars when the payment is in fact converted into U.S. dollars.
Specifically, if a dividend is declared and paid in a foreign currency, the amount of the dividend distribution that you must
include in your income as a U.S. holder will be the U.S. dollar value of the payments made in the foreign currency, determined
at the spot rate of the foreign currency to the U.S. dollar on the date the dividend distribution is includible in your income,
regardless of whether the payment is in fact converted into U.S. dollars. Thus, if the value of the foreign currency decreases
before you actually convert the currency into U.S. dollars, you may be taxed on a larger amount in U.S. dollars than the U.S.
dollar amount that you will actually ultimately receive.
We
may become a passive foreign investment company, which could result in adverse U.S. tax consequences to U.S. investors.
Based
on the nature of our business activities, we may be classified as a passive foreign investment company (“PFIC”), by
the U.S. Internal Revenue Service (“IRS”), for U.S. federal income tax purposes. Such characterization could result
in adverse U.S. tax consequences to you if you are a U.S. investor. For example, if we are a PFIC, a U.S. investor will become
subject to burdensome reporting requirements. The determination of whether or not we are a PFIC is made on an annual basis and
will depend on the composition of our income and assets from time to time. Specifically, we will be classified as a PFIC for U.S.
tax purposes if either:
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75% or more of our
gross income in a taxable year is passive income; or
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the average percentage
of our assets by value in a taxable year that produce or are held for the production of passive income (which includes cash)
is at least 50%.
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The calculation of the value of our assets is based, in part, on the then market value of our common shares,
which is subject to change. In addition, the composition of our income and assets will be affected by how, and how quickly, we
spend the cash we raised in our initial public offering. We cannot assure that we will not be a PFIC for any taxable year. See
“Taxation – United States Federal Income Taxation-Passive Foreign Investment Company.”
Introduction
of new laws or changes to existing laws by the Chinese government may adversely affect our business.
The
Chinese legal system is a codified legal system made up of written laws, regulations, circulars, administrative directives and
internal guidelines. Unlike common law jurisdictions such as the U.S., decided cases (which may be taken as reference) do not
form part of the legal structure of China and thus have no binding effect. Furthermore, in line with its transformation from a
centrally planned economy to a more market-oriented economy, the Chinese government is still in the process of developing a comprehensive
set of laws and regulations. As the legal system in China is still evolving, laws and regulations or their interpretation may
be subject to further changes. Such uncertainty and prospective changes to the Chinese legal system could adversely affect our
results of operations and financial condition.
We
may be subject to foreign exchange controls in China, which could limit our use of funds raised in our initial public offering,
which could have a material adverse effect on our business.
Jinzheng
is subject to Chinese rules and regulations on currency conversion. In China, SAFE regulates the conversion of the RMB into foreign
currencies. Currently, foreign investment enterprises (“FIEs”) are required to apply to SAFE for “Registration
of Establishment as FIEs”. Jinzheng is a FIE, with such registration, Jinzheng is allowed to open foreign currency accounts
including the “current account” and the “capital account”. Currently, conversion within the scope of the
“current account” and general “capital account” can be effected without requiring the approval of SAFE.
However, conversion of currency in some restricted “capital account” (e.g. for capital items such as direct investments,
loans, securities, etc.) still requires the approval of SAFE.
In particular, if Jinzheng borrows foreign
currency through loans from Newater Technology or other foreign lenders, these loans must be registered with SAFE. If Jinzheng
is financed by means of additional capital contributions, certain Chinese government authorities, including MOFCOM, or the local
counterparts of SAFE and MOFCOM, must approve these capital contributions. These restrictions could limit our use of funds raised
in our initial public offering which could have an adverse effect on our business.
Governmental
control of currency conversion may affect the value of your investment.
The
Chinese government imposes controls on the convertibility of the Renminbi into foreign currencies and, in certain cases, the remittance
of currency out of China, which may take as long as six months in the ordinary course. We receive the majority of our revenues
in Renminbi. Under our current corporate structure, our income is derived from payments from Jinzheng. Shortages in
the availability of foreign currency may restrict the ability of Jinzheng to remit sufficient foreign currency to pay dividends
or other payments to us, or otherwise satisfy their foreign currency denominated obligations. Under existing Chinese foreign
exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from
trade-related transactions, can be made in foreign currencies without prior approval from SAFE by complying with certain procedural
requirements. However, approval from appropriate government authorities is required where Renminbi is to be converted into
foreign currency and remitted out of China to pay capital expenses such as the repayment of bank loans denominated in foreign
currencies. The Chinese government may also at its discretion restrict access in the future to foreign currencies for current
account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy
our currency demands, we may not be able to pay dividends in foreign currencies to our shareholders. See “Our Business
– Regulations on Foreign Currency Exchange and Dividend Distribution.”
Fluctuation
of the Renminbi could materially affect our financial condition and results of operations.
The
value of the Renminbi against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes
in political and economic conditions. On July 21, 2005, the Chinese government changed its decade-old policy of pegging the
value of the Renminbi to the U.S. dollar. Under the new policy, the Renminbi is permitted to fluctuate within a narrow and managed
band against a basket of certain foreign currencies. This change in policy has resulted in an appreciation of the Renminbi against
the U.S. dollar. While the international reaction to the Renminbi revaluation has generally been positive, there remains international
pressure on the Chinese government to adopt an even more flexible currency policy, which could result in a further and more rapid
appreciation of the Renminbi against the U.S. dollar. Any material revaluation of Renminbi may materially and adversely affect
our cash flows, revenues, earnings and financial position, and the value of, and any dividends payable on, our common shares in
U.S. dollars. For example, an appreciation of Renminbi against the U.S. dollar would make any new Renminbi denominated investments
or expenditures more costly to us, to the extent that we need to convert U.S. dollars into Renminbi for such purposes. See “Exchange
Rate Information.”
Recent
changes in China’s labor law restrict our ability to reduce our workforce in China in the event of an economic downturn
and may increase our production costs which could have a material adverse effect on our business.
To
clarify certain details in connection with the implementation of the Labor Contract Law, the China State Council promulgated the
Implementing Rules for the Labor Contract Law on September 18, 2008, which came into effect immediately. The legislation
formalized workers’ rights concerning overtime hours, pensions, layoffs, employment contracts and the role of trade unions.
Among other things, this new law provides for specific standards and procedures for the termination of an employment contract
and places the burden of proof on the employer. In addition, the law requires the payment of a statutory severance pay upon the
termination of an employment contract in most cases, including the case of the expiration of a fixed-term employment contract.
Further, the law requires an employer to conclude an “employment contract without a fixed-term” with any employee
who either has worked for the same employer for 10 consecutive years or more or has had two consecutive fixed-term contracts with
the same employer. An “employment contract without a fixed term” can no longer be terminated on the ground of the
expiration of the contract, although it can still be terminated pursuant to the standards and procedures set forth under the new
law. Because of the lack of precedent for the enforcement of such a law, the standards and procedures set forth under the law
in relation to the termination of an employment contract have raised concerns among foreign investment enterprises in China that
such an “employment contract without a fixed term” might in fact become a “lifetime, permanent employment contract.”
Finally, under the new law, downsizing of either more than 20 people or more than 10% of the workforce may occur only under specified
circumstances, such as a restructuring undertaken pursuant to China’s Enterprise Bankruptcy Law, or where a company suffers
serious difficulties in production and/or business operations, or where there has been a material change in the objective economic
circumstances relied upon by the parties at the time of the conclusion of the employment contract, thereby making the performance
of such employment contract not possible. To date, there has been very little guidance or precedent as to how such specified circumstances
for downsizing will be interpreted and enforced by the relevant Chinese authorities. All of our employees working for us exclusively
within China are covered by the new law and thus, our ability to adjust the size of our operations when necessary in periods of
recession or less severe economic downturns may be curtailed. Accordingly, if we face future periods of decline in business activity
generally or adverse economic periods specific to our business, this new law can be expected to exacerbate the adverse effect
of the economic environment on our results of operations and financial condition.
Our
business benefits from certain government subsidies and incentives. Expiration, reduction or discontinuation of, or changes to,
these incentives will increase our burden and reduce our net income which could have a material adverse effect on our business
and operations.
Jinzheng
received the following subsidies in 2016:
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RMB 500,000 as Jinzheng
successfully applied for the subsidy of university-industry cooperation and international cooperation projects (“RMB
500K Subsidy”). The recognition requirements for the RMB 500K Subsidy include research and development projects completed
with higher education institutions and collaboration with foreign companies with advanced technologies.
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RMB 1,200,000 as Jinzheng
successfully applied for the subsidy of special membrane project (“RMB 1.2M Subsidy”). The recognition requirements
for the RMB 1.2M Subsidy include the commencement of special membrane project in Laishan District Economic Development Area
in 2016 and tax payment of certain amount in the same year.
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RMB 9,732,000 as Jinzheng
successfully applied for the high technology subsidy (“RMB 9.7M Subsidy”). Due to its encouragement and incentive
nature to invest in local economic development, there is no specific requirement for the RMB 9.7M Subsidy. The RMB 9.7M Subsidy
was granted by the Management Committee of Laishan District Economic Development Area. The grant’s purpose is to encourage
the Company to invest in researching and developing new products and expanding production scale, which will contribute to
the local economic development by bringing more job opportunities and generating more tax revenues.
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The
requirements of the above subsidies totaling RMB 11,432,000 received in 2016 were fully fulfilled and the subsidies were recognized
as other income in consolidated statements of income and comprehensive income for the year ended December 31, 2016.
Jinzheng received the following subsidies in 2017:
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RMB 300,000 as Jinzheng successfully applied for the subsidy of innovation-driven development (“RMB 300K Subsidy”).
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RMB 2,594,000 as Jinzheng successfully applied for the subsidy of special membrane project (“RMB 2.6M Subsidy”).
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RMB 200,000 as Jinzheng was chosen as one of the Provincial Industrial Design Centers in Shandong Province.
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RMB 100,000 as Jinzheng was chosen as the City DTRO Membrane Engineering Lab of Yantai City in Shandong Province.
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RMB 95,975 as Jinzheng successfully applied for the subsidy
on interest expense incurred by the Company for loans obtained.
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The requirements of the above subsidies totaling RMB 3,289,975
received in 2017 were fully fulfilled and the subsidies were recognized as government grant in consolidated statements of income
and comprehensive income for the year ended December 31, 2017.
Jinzheng
received the following subsidies in 2018:
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RMB 3,300,000
as Jinzheng successfully applied for the subsidy of research and development (“RMB 3.3M Subsidy”).
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RMB 200,000 as Jinzheng’s
research and development plan was chosen as one of the annual key plans of Shandong Province. (“RMB 200K Subsidy”)
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RMB 600,000 as Jinzheng successfully
applied for the subsidy from local government of being listed in Nasdaq Security Market. (“RMB 600K Subsidy”)
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For the years ended December 31, 2018,
2017 and 2016, the Company recognized government grants approximately $628,000 (RMB 4,100,000), $514,000 (RMB 3,469,975) and
$1,751,000 (RMB11,632,000) in the consolidated statements of income and comprehensive income, respectively.
In addition, Jinzheng obtained the Hi-Tech
Enterprise certificate and is entitled to a preferential income tax rate of 15% for 2018 and 2017. The 15% tax rate is less than
the standard 25% income tax rate in China. The local Chinese government authorities may reduce or eliminate these incentives through
new legislation at any time in the future. In the event Jinzheng is no longer exempt from lowered income taxation, its applicable
tax rate would increase from 15% to up to 25%, the standard business income tax rate in China. In addition, the termination of
one-time subsidies for water treatment equipment business development could increase the burden of manufacturing and selling water
treatment equipment in the future. The reduction or discontinuation of any of these economic incentives could negatively affect
our business and operations.
Labor
laws in China may adversely affect our results of operations.
On
June 29, 2007, the Chinese government promulgated the Labor Contract Law of China, which became effective
on January 1, 2008, which was further amended on December 28, 2012 (effective July 1, 2013). The Labor Contract Law imposes greater
liabilities on employers and significantly affects the cost of an employer’s decision to reduce its workforce. Further,
it requires certain terminations be based upon seniority and not merit. In the event we decide to significantly change or decrease
our workforce, the Labor Contract Law could adversely affect our ability to enact such changes in a manner that is most advantageous
to our business or in a timely and cost-effective manner, thus materially and adversely affecting our financial condition and
results of operations. The Labor Contract Law also mandates that employers provide social welfare packages to all employees, increasing
our labor costs. To the extent competitors from outside China are not affected by such requirements, we could be at a comparative
disadvantage.
Chinese
regulations relating to the establishment of offshore special purpose companies by Chinese residents may subject our Chinese resident
shareholders to personal liability and limit our ability to inject capital into our Chinese subsidiaries, limit our subsidiaries’
ability to increase its registered capital, distribute profits to us, or otherwise adversely affect us.
On
July 4, 2014, China’s SAFE issued the Circular of the State Administration of Foreign Exchange on Issues concerning
Foreign Exchange Administration over the Overseas Investment and Financing and Round-trip Investment by Domestic Residents via
Special Purpose Vehicles, or Circular 37, which became effective as of July 4, 2014. According to Circular 37, prior
registration with the local SAFE branch is required for Chinese residents to contribute domestic assets or interests to offshore
companies, known as SPVs. Moreover, Circular 37 applies retroactively. As a result, Chinese residents who have contributed domestic
assets or interests to a SPV, but failed to complete foreign exchange registration of overseas investments as required before
July 4, 2014 shall send a letter to SAFE and its branches for explanation. SAFE and its branches shall, under the principle
of legality and legitimacy, conduct supplementary registration, and impose administrative punishment on those in violation of
the administrative provisions on the foreign exchange pursuant to the law.
We have requested our shareholders who are
Chinese residents to make the necessary applications, filings and amendments as required under Circular 37 and other related rules.
We attempt to comply and attempt to ensure that our shareholders who are subject to these rules comply, with the relevant requirements.
However, we cannot provide any assurances that all of our shareholders who are Chinese residents will comply with our request to
make or obtain any applicable registrations or comply with other requirements required by Circular 37 or other related rules. The
failure or inability of our Chinese resident shareholders to make any required registrations or comply with other requirements
may subject such shareholders to fines and legal sanctions and may also limit our ability to contribute additional capital into
or provide loans to (including using the proceeds from our initial public offering) Jinzheng, limiting Jinzheng’s ability
to pay dividends or otherwise distributing profits to us.
Failure
to comply with the Individual Foreign Exchange Rules relating to the overseas direct investment or the engagement in the issuance
or trading of securities overseas by our Chinese resident stockholders may subject such stockholders to fines or other liabilities.
Other than Circular
37, our ability to conduct foreign exchange activities in China may be subject to the interpretation and enforcement of the Administrative
Measures for Individual Foreign Exchange and its implementation rules, which promulgated by the People’s Bank of China and
the SAFE in December 2006 and January 2007, respectively (as amended and supplemented, the “Individual Foreign Exchange Rules”).
Under the Individual Foreign Exchange Rules, any Chinese individual seeking to make a direct investment overseas or engage in the
issuance or trading of negotiable securities or derivatives overseas must make the appropriate registrations in accordance with
SAFE provisions. Chinese individuals who fail to make such registrations may be subject to warnings, fines or other liabilities.
We
may not be fully informed of the identities of all our beneficial owners who are Chinese residents. For example, because the investment
in or trading of our shares will happen in an overseas public or secondary market where shares are often held with brokers in
brokerage accounts, it is unlikely that we will know the identity of all of our beneficial owners who are Chinese residents. Furthermore,
we have no control over any of our future beneficial owners and we cannot assure you that such Chinese residents will be able
to complete the necessary approval and registration procedures required by the Individual Foreign Exchange Rules.
It
is uncertain how the Individual Foreign Exchange Rules will be interpreted or enforced and whether such interpretation or enforcement
will affect our ability to conduct foreign exchange transactions. Because of this uncertainty, we cannot be sure whether the failure
by any of our Chinese resident stockholders to make the required registration will subject our subsidiaries to fines or legal
sanctions on their operations, restriction on
remittance of dividends or other punitive actions that would have a material adverse effect on our business, results of operations
and financial condition.
Changes
in China’s political and economic policies could harm our business.
Substantially
all of our business operations are conducted in China. Accordingly, our results of operations, financial condition and prospects
are subject to economic, political and legal developments in China. China’s economy differs from the economies of most developed
countries in many respects, including with respect to the amount of government involvement, level of development, growth rate,
control of foreign exchange and allocation of resources.
The
Chinese economy has historically been a planned economy subject to governmental plans and quotas and has, in certain aspects,
been transitioning to a more market-oriented economy. Although we believe that the economic reform and the macroeconomic
measures adopted by the Chinese government have had a positive effect on the economic development China, we cannot predict the
future direction of these economic reforms or the effects these measures may have on our business, financial position or results
of operations. In addition, the Chinese economy differs from the economies of most countries belonging to the Organization
for Economic Cooperation and Development (“OECD”). These differences include, without limitation:
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economic structure;
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level of government
involvement in the economy;
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level of development;
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level of capital reinvestment;
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control of foreign
exchange;
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methods of allocating
resources; and
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balance of payments
position.
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As
a result of these differences, our business may not develop in the same way or at the same rate as might be expected if the Chinese
economy were similar to those of the OECD member countries. See “Our Business – Industry and Market Background.”
Since
1979, the Chinese government has promulgated many new laws and regulations covering general economic matters. Despite these
efforts to develop a legal system, China’s system of laws is not yet complete. Even where adequate law exists in China,
enforcement of existing laws or contracts based on existing law may be uncertain or sporadic, and it may be difficult to obtain
swift and equitable enforcement or to obtain enforcement of a judgment by a court of another jurisdiction. The relative inexperience
of China’s judiciary, in many cases, creates additional uncertainty as to the outcome of any lawsuit. In addition,
interpretation of statutes and regulations may be subject to government policies reflecting domestic political changes. Our activities
in China will also be subject to administration review and approval by various national and local agencies of the Chinese government. Because
of the changes occurring in China’s legal and regulatory structure, we may not be able to secure the requisite governmental
approval for our activities. Although we have obtained all required governmental approvals to operate our business as currently
conducted, to the extent we are unable to obtain or maintain required governmental approvals, the Chinese government may, in its
sole discretion, prohibit us from conducting our business.
If
relations between the United States and China worsen, our share price may decrease and we may have difficulty accessing U.S. capital
markets.
At
various times during recent years, the United States and China have had disagreements over political and economic issues. Controversies
may arise in the future between these two countries. Any political or trade controversy between the United States and China could
adversely affect the market price of our common shares and our ability to access U.S. capital markets.
The
Chinese government could change its policies toward private enterprise or even nationalize or expropriate private enterprises,
which could result in the total loss of our investment in that country.
Our
business is subject to political and economic uncertainties and may be adversely affected by political, economic and social developments
in China. Over the past several years, the Chinese government has pursued economic reform policies including the encouragement
of private economic activity and greater economic decentralization. The Chinese government may not continue to pursue these
policies or may alter them to our detriment from time to time with little, if any, prior notice.
Changes
in policies, laws and regulations or in their interpretation or the imposition of confiscatory taxation, restrictions on currency
conversion, restrictions or prohibitions on dividend payments to shareholders, devaluations of currency or the nationalization
or other expropriation of private enterprises could have a material adverse effect on our business. Nationalization or expropriation
could even result in the total loss of our investment in China and in the total loss of any investment in us.
Because
our operations are located in China, information about our operations is not readily available from independent third-party sources.
Because
Jinzheng is based in China, our shareholders may have greater difficulty in obtaining information about them on a timely basis
than would shareholders of a U.S.-based company. Its operations will continue to be conducted in China and shareholders may have
difficulty in obtaining information about them from sources other than the company itself. Information available from newspapers,
trade journals, or local, regional or national regulatory agencies such as issuance of construction permits and contract awards
for development projects will not be readily available to shareholders and, where available, will likely be available only in
Chinese. Shareholders will be dependent upon management for reports of their progress, development, activities and expenditure
of proceeds.
Chinese
economic growth slowdown may cause negative effect to our business.
Since 2010, the annual growth rate of the
Chinese economy has declined, from approximately 11% gross domestic product in 2010 to 6.6% in 2018. This situation has impacted
many types of service industries, such as restaurant and tourism, and some manufacturing industries. Our business operations in
China rely primarily on the waste (garbage), chemical and energy industries that are less influenced by economic growth slowdown
than service industries. However, if China’s economic growth continues to slow down, then our business could be adversely
affected if slow expansion or shrinkage of the industries we serve occurs.
Risks Associated with Ownership of Our Common Shares
The market price for our common shares may be volatile,
which could result in substantial losses to investors.
The trading prices for our common shares
have fluctuated since we first listed our common shares. Since our common shares became listed on the NASDAQ on July 28, 2017,
the trading price of our common shares has ranged from $5.01 to $29.38 per common share, and the last reported trading price
on April 29, 2019 was $8.27 per common share. The market price of our common shares may fluctuate significantly in response to
numerous factors, many of which are beyond our control, including:
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actual or anticipated
fluctuations in our revenue and other operating results;
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the financial projections
we may provide to the public, any changes in these projections or our failure to meet these projections;
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actions of securities
analysts who initiate or maintain coverage of us, changes in financial estimates by any securities analysts who follow our
company, or our failure to meet these estimates or the expectations of investors;
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announcements by us
or our competitors of significant products or features, technical innovations, acquisitions, strategic partnerships, joint
ventures, or capital commitments;
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price and volume fluctuations
in the overall stock market, including as a result of trends in the economy as a whole;
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lawsuits threatened
or filed against us;
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price and volume fluctuations
in the overall stock market, including as a result of trends in the economy as a whole; and
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other events or factors,
including those resulting from war or incidents of terrorism, or responses to these events
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In
addition, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the
market prices of equity securities of many companies. Stock prices of many companies have fluctuated in a manner unrelated or
disproportionate to the operating performance of those companies. In the past, stockholders have filed securities class action
litigation following periods of market volatility. If we were to become involved in securities litigation, it could subject us
to substantial costs, divert resources and the attention of management from our business, and adversely affect our business.
Securities analysts
may not publish favorable research or reports about our business or may publish no information at all, which could cause our stock
price or trading volume to decline.
If a trading market
for our common shares develops, the trading market will be influenced to some extent by the research and reports that industry
or financial analysts publish about us and our business. We do not control these analysts. As a young public company, we may be
slow to attract research coverage and the analysts who publish information about our common shares will have had relatively little
experience with us or our industry, which could affect their ability to accurately forecast our results and could make it more
likely that we fail to meet their estimates. In the event any of the analysts who cover us provide inaccurate or unfavorable research
or issue an adverse opinion regarding our stock price, our stock price could decline. If one or more of these analysts cease coverage
of us or fail to publish reports covering us regularly, we could lose visibility in the market, which in turn could cause our stock
price or trading volume to decline and result in the loss of all or a part of your investment in us.
We
are an “emerging growth company,” and we cannot be certain if choosing to elect the reduced reporting requirements
applicable to emerging growth companies will make our common shares less attractive to investors.
We
are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act, or the JOBS Act. For as long
as we continue to be an emerging growth company, we may take advantage of exemptions from various reporting requirements that
are applicable to other public companies that are not emerging growth companies, including not being required to comply with the
auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive
compensation in our periodic reports and proxy statements and exemptions from the requirements of holding a nonbinding advisory
vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We could be
an emerging growth company for up to five years, although we could lose that status sooner if our revenues exceed $1 billion,
if we issue more than $1 billion in non-convertible debt in a three year period, or if the market value of our common shares held
by non-affiliates exceeds $700 million as of any June 30 before that time, in which case we would no longer be an emerging growth
company as of the following December 31. We cannot predict if investors will find our common shares less attractive because we
may rely on these exemptions. If some investors find our common shares less attractive as a result, there may be a less active
trading market for our common shares and our stock price may be more volatile.
If
we are unable to implement and maintain effective internal control over financial reporting in the future, investors may lose
confidence in the accuracy and completeness of our financial reports and the market price of our common shares may decline.
As a public company, we are required to
maintain internal control over financial reporting and to report any material weaknesses in such internal control. We are in the
process of designing, implementing, and testing the internal control over financial reporting required to comply with this obligation,
which process is time consuming, costly, and complicated. In addition, our independent registered public accounting firm is required
to attest to the effectiveness of our internal control over financial reporting beginning with our annual report on Form 20-F
following the date on which we are no longer an “emerging growth company,” which may be up to five full years following
the date of our initial public offering. If we identify material weaknesses in our internal control over financial reporting, if
we are unable to comply with the requirements of Section 404 in a timely manner or assert that our internal control over financial
reporting is effective, or if our independent registered public accounting firm is unable to express an opinion as to the effectiveness
of our internal control over financial reporting when required, investors may lose confidence in the accuracy and completeness
of our financial reports and the market price of our common shares could be negatively affected, and we could become subject to
investigations by the stock exchange on which our securities are listed, the Securities and Exchange Commission, or the SEC, or
other regulatory authorities, which could require additional financial and management resources.
In connection with the audits of our consolidated financial
statements as of and for the years ended December 31, 2018, our independent registered public accounting firm identified
a material weakness in our internal control over financial reporting. If we fail to develop and maintain an effective system of
internal control over financial reporting, we may be unable to accurately report our financial results or prevent fraud.
In connection with the audits of our consolidated financial statements included in this annual report,
our independent registered public accounting firm identified a material weakness in our internal control over financial reporting.
As defined in the standards established by the U.S. Public Company Accounting Oversight Board, 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 annual or interim financial statements will not be prevented or detected on a timely
basis.
The material
weakness that has been identified relates to internal controls failing to identify related party transactions. The material weakness,
if not timely remedied, may lead to material misstatements in our consolidated financial statements in the future. Our independent
registered public accounting firm did not undertake a comprehensive assessment of our internal control for purposes of identifying
and reporting material weaknesses and other control deficiencies in
our internal control
over financial reporting. Had our independent registered public accounting firm performed an audit of our internal control over
financial reporting, additional deficiencies may have been identified.
Following the
identification of this material weakness, we have taken measures and plan to continue to take measures to remedy this control deficiencies.
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Internal Control Over
Financial Reporting.” However, the implementation of these measures may not fully address these deficiencies in our internal
control over financial reporting, and we cannot conclude that they have been fully remedied. Our failure to correct these control
deficiencies or our failure to discover and address any other control deficiencies could result in inaccuracies in our financial
statements and impair our ability to comply with applicable financial reporting requirements and related regulatory filings on
a timely basis. Moreover, ineffective internal control over financial reporting could significantly hinder our ability to prevent
fraud.
Our disclosure
controls and procedures may not prevent or detect all errors or acts of fraud.
Our disclosure controls
and procedures must provide reasonable assurance that information we are required to disclose in reports we file or submit under
the Exchange Act is accumulated and communicated to management, and recorded, processed, summarized and reported within the time
periods specified in the rules and forms of the SEC. We believe that any disclosure controls and procedures, no matter how well-conceived
and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.
These inherent limitations
include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or
mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people
or by an unauthorized override of the controls. Accordingly, because of the inherent limitations in our control system, misstatements
due to error or fraud may occur and not be detected.
If
our financial condition deteriorates, we may not meet continued listing standards on the NASDAQ Capital Market.
The
NASDAQ Capital Market also requires companies to fulfill specific requirements in order for their shares to continue to be listed.
In order to qualify for continued listing on the NASDAQ Capital Market, we must meet the following criteria:
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Our shareholders’
equity must be at least $2,500,000; or the market value of our listed securities must be at least $35,000,000; or our net
income from continuing operations in our last fiscal year (or two of the last three fiscal years) must have been at least
$500,000;
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The market value of
our shares must be at least $1,000,000;
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The minimum bid price
for our shares must be at least $1.00 per share;
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We must have at least
300 shareholders;
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We must have at least
2 market makers; and
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We must have adopted
NASDAQ-mandated corporate governance measures, including a Board of Directors comprised of a majority of independent directors,
an Audit Committee comprised solely of independent directors and the adoption of a code of ethics among other items.
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If
our shares are delisted from the NASDAQ Capital Market at some later date, our shareholders could find it difficult to sell our
shares. In addition, if our common shares are delisted from the NASDAQ Capital Market at some later date, we may apply to have
our common shares quoted on the Bulletin Board or in the “pink sheets” maintained by the National Quotation Bureau,
Inc. The Bulletin Board and the “pink sheets” are generally considered to be less efficient markets than the NASDAQ
Capital Market. In addition, if our common shares are not so listed or are delisted at some later date, our common shares may
be subject to the “penny stock” regulations. These rules impose additional sales practice requirements on broker-dealers
that sell low-priced securities to persons other than established customers and institutional accredited investors and require
the delivery of a disclosure schedule explaining the nature and risks of the penny stock market. As a result, the ability or willingness
of broker-dealers to sell or make a market in our common shares might decline. If our common shares are delisted from the NASDAQ
Capital Market at some later date or become subject to the penny stock regulations, it is likely that the price of our shares
would decline and that our shareholders would find it difficult to sell their shares.
We
will incur increased costs as a result of being a public company, which could have a material adverse effect on our profitability.
As a public company, we incur legal, accounting
and other expenses that we did not incur as a private company. For example, we must now engage U.S. securities law counsel and
U.S. GAAP auditors that we did not need prior to our initial public offering, and we will continue to have annual payments to
remain listed on the Nasdaq Capital Market. In addition, the Sarbanes-Oxley Act, as well as new rules subsequently implemented
by the SEC and NASDAQ, has required changes in corporate governance practices of public companies. We expect these new rules
and regulations to increase our legal, accounting and financial compliance costs and to make certain corporate activities more
time-consuming and costly. In addition, we will continue to incur additional costs associated with our public company reporting
requirements. Added costs of this nature will naturally reduce our profitability and could have a material adverse effect on our
business.
The
requirements of being a public company may strain our resources and divert management’s attention, which could have a material
adverse effect on our business.
As
a public company, we are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange
Act, the Sarbanes-Oxley Act, the Dodd-Frank Act, the listing requirements of the securities exchange on which we list, and other
applicable securities rules and regulations. Despite recent reforms made possible by the JOBS Act, compliance with these rules
and regulations will nonetheless increase our legal and financial compliance costs, make some activities more difficult, time-consuming
or costly and increase demand on our systems and resources, particularly after we are no longer an “emerging growth company.”
The Exchange Act requires, among other things, that we file annual, and current reports with respect to our business and operating
results.
As a result of disclosure of information
in filings required of a public company, our business and financial condition are more visible, which we believe may result in
threatened or actual litigation, including by competitors and other third parties. If such claims are successful, our business
and operating results could be harmed, and even if the claims do not result in litigation or are resolved in our favor, these claims,
and the time and resources necessary to resolve them, could divert the resources of our management and adversely affect our business,
brand and reputation and results of operations.
We
also expect that being a public company and these new rules and regulations will make it more expensive for us to obtain director
and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain
coverage. These factors could also make it more difficult for us to attract and retain qualified members of our board of directors,
particularly to serve on our audit committee and compensation committee, and qualified executive officers.
The
obligation to disclose information publicly may put us at a disadvantage to competitors that are private companies which could
have an adverse effect on our results of operations.
As a reporting company in the United States,
we are required to file periodic reports with the Securities and Exchange Commission upon the occurrence of matters that are material
to our Company and shareholders. In some cases, we will need to disclose material agreements or results of financial operations
that we would not be required to disclose if we were a private company. Our competitors may have access to this information, which
would otherwise be confidential. This may give them advantages in competing with our Company. Similarly, as a U.S.-listed public
company, we are governed by U.S. laws that our competitors, which are mostly private Chinese companies, are not required to follow.
To the extent compliance with U.S. laws increases our expenses or decreases our competitiveness against such companies, our public
listing could affect our results of operations.
Our
classified board structure may prevent a change in control of our Company.
Our
board of directors is divided into three classes of directors. Class A directors hold office for a term expiring at the 2020
annual meeting of shareholders, Class B directors hold office for a term expiring at the 2021 annual meeting of shareholders and
Class C directors hold office for a term expiring as the 2019 annual meeting of shareholders. Directors of each class are
chosen for three-year terms upon the expiration of their current terms. The staggered terms of our directors may reduce the possibility
of a tender offer or an attempt at a change in control, even though a tender offer or change in control might be in the best interest
of our shareholders. See “Management – Board of Directors and Board Committees.”
Shares
eligible for future sale may adversely affect the market price of our common shares, as the future sale of a substantial amount
of outstanding common shares in the public marketplace could cause the price of our common shares.
The
market price of our shares could decline as a result of sales of substantial amounts of our shares in the public market, or the
perception that these sales could occur. In addition, these factors could make it more difficult for us to raise funds through
future offerings of our common shares. An aggregate of 10,809,000 of our shares are currently outstanding. The 1,610,000
shares sold in our initial public offering are freely transferable without restriction or further registration under the Securities
Act. The remaining 9,199,000 shares are “restricted securities” as defined in Rule 144. These shares may
be sold in the future without registration under the Securities Act to the extent permitted by Rule 144 or other exemptions under
the Securities Act.
Our
employees, officers and/or directors will control a sizeable amount of our common shares, decreasing your influence on shareholder
decisions.
Our employees, officers and/or directors
will, in the aggregate, beneficially own approximately 44.4% of our outstanding shares. As a result, our employees, officers
and directors possess substantial ability to impact our management and affairs and the outcome of matters submitted to shareholders
for approval. These shareholders, acting individually or as a group, could exert substantial influence over matters such as
electing directors and approving mergers or other business combination transactions. This concentration of ownership and voting
power may also discourage, delay or prevent a change in control of our Company, which could deprive our shareholders of an opportunity
to receive a premium for their shares as part of a sale of our Company and might reduce the price of our common shares. These actions
may be taken even if they are opposed by our other shareholders, including those who purchased shares in our initial public offering. See
“Principal Stockholders.”
As
the rights of stockholders under British Virgin Islands law differ from those under U.S. law, you may have fewer protections as
a shareholder
.
Our corporate affairs are governed by our
amended and restated memorandum and articles of association, the British Virgin Islands Business Companies Act, 2004 (the “BVI
Act”), and the common law of the British Virgin Islands. The rights of shareholders to take legal action against our directors,
actions by minority stockholders and the fiduciary responsibilities of our directors under British Virgin Islands law are to a
large extent governed by the common law of the British Virgin Islands and by the BVI Act. The common law of the British Virgin
Islands is derived in part from comparatively limited judicial precedent in the British Virgin Islands as well as from English
common law, which has persuasive, but not binding, authority on a court in the British Virgin Islands. The rights of our shareholders
and the fiduciary responsibilities of our directors under British Virgin Islands law are not as clearly established as they would
be under statutes or judicial precedents in some jurisdictions in the United States. In particular, the British Virgin Islands
has a less developed body of securities laws as compared to the United States, and some states (such as Delaware) have more fully
developed and judicially interpreted bodies of corporate law.
As
a result of all of the above, holders of our shares may have more difficulty protecting their interests through actions against
our management, directors or major shareholders than they would as shareholders of a U.S. company. For a discussion of material
differences between the provisions of the BVI Act and the laws applicable to companies incorporated in the United States and their
shareholders, see “Description of Share Capital – Differences in Corporate Law.”
British
Virgin Islands companies may not be able to initiate shareholder derivative actions in a federal court of the United States and
may have to proceed with such action in the British Virgin Islands, thereby limiting shareholders’ ability to protect their
interests
.
British
Virgin Islands companies may not have standing to initiate a shareholder derivative action in a federal court of the United States
and may have to proceed with such action in the British Virgin Islands. The circumstances in which any such action may be brought,
and the procedures and defenses that may be available with respect to any such action, may result in the rights of shareholders
of a British Virgin Islands company being more limited than those of shareholders of a company organized in the United States.
Accordingly, shareholders may have fewer alternatives available to them if they believe that corporate wrongdoing has occurred.
The British Virgin Islands courts are also unlikely to recognize or enforce against us judgments of courts in the United States
based on certain liability provisions of U.S. securities law; and to impose liabilities against us, in original actions brought
in the British Virgin Islands, based on certain liability provisions of U.S. securities laws that are penal in nature. There is
no statutory recognition in the British Virgin Islands of judgments obtained in the United States, although the courts of the
British Virgin Islands will generally recognize and enforce the non-penal judgment of a foreign court of competent jurisdiction
without retrial on the merits. This means that even if shareholders were to sue us successfully, they may not be able to recover
anything to make up for the losses suffered.
The
laws of the British Virgin Islands provide little protection for minority shareholders, so minority shareholders will have little
or no recourse if the shareholders are dissatisfied with the conduct of our affairs
.
Under
the law of the British Virgin Islands, there is little statutory law for the protection of minority shareholders other than the
provisions of the BVI Act dealing with shareholder remedies. The principal protection under statutory law is that shareholders
may bring an action to enforce the constituent documents of the corporation, in our case, our Memorandum and Articles of Association.
Shareholders are entitled to have the affairs of the company conducted in accordance with the general law and the Memorandum and
Articles.
There
are common law rights for the protection of shareholders that may be invoked, largely dependent on English company law, since
the common law of the British Virgin Islands for business companies is limited. Under the general rule pursuant to English company
law known as the rule in
Foss v. Harbottle
, a court will generally refuse to interfere with the management of a company
at the insistence of a minority of its shareholders who express dissatisfaction with the conduct of the company’s affairs
by the majority or the board of directors. However, every shareholder is entitled to have the affairs of the company conducted
properly according to law and the constituent documents of the corporation. As such, if those who control the company have persistently
disregarded the requirements of company law or the provisions of the company’s memorandum and articles of association, then
the courts will grant relief. Generally, the areas in which the courts will intervene are the following: (1) an act complained
of which is outside the scope of the authorized business or is illegal or not capable of ratification by the majority; (2) acts
that constitute fraud on the minority where the wrongdoers control the company; (3) acts that infringe on the personal rights
of the shareholders, such as the right to vote; and (4) where the company has not complied with provisions requiring approval
of a special or extraordinary majority of shareholders, which are more limited than the rights afforded minority shareholders
under the laws of many states in the United States.
We
are a “foreign private issuer,” and our disclosure obligations differ from those of U.S. domestic reporting companies.
As a result, we may not provide you the same information as U.S. domestic reporting companies or we may provide information at
different times, which may make it more difficult for you to evaluate our performance and prospects.
We are a foreign private issuer and, as
a result, we are not subject to the same requirements as U.S. domestic issuers. Under the Exchange Act, we are subject to reporting
obligations that, to some extent, are more lenient and less frequent than those of U.S. domestic reporting companies. For example,
we are required to issue quarterly reports or proxy statements and we do not intend to file quarterly reports. We are not required
to disclose detailed individual executive compensation information and we do not intend to disclose detailed executive compensation
information. Furthermore, our directors and executive officers are not required to report equity holdings under Section 16 of the
Exchange Act and we are not subject to the insider short-swing profit disclosure and recovery regime and we do not intend to file
Section 16 reports for officers and directors.
As a foreign private issuer, we are also
be exempt from the requirements of Regulation FD (Fair Disclosure) which, generally, are meant to ensure that select groups of
investors are not privy to specific information about an issuer before other investors. However, we do plan to disclose material
information to all investors at this time
.
In addition, we are still subject to the anti-fraud and anti-manipulation rules
of the SEC, such as Rule 10b-5 under the Exchange Act. Since many of the disclosure obligations imposed on us as a foreign private
issuer differ from those imposed on U.S. domestic reporting companies, you should not expect to receive the same information about
us and at the same time as the information provided by U.S. domestic reporting companies.
We may lose
our foreign private issuer status in the future, which could result in significant additional costs and expenses.
As discussed above,
we are a foreign private issuer, and therefore, we are not required to comply with all of the periodic disclosure and current
reporting requirements of the Exchange Act. The determination of foreign private issuer status is made annually on the last business
day of an issuer’s most recently completed second fiscal quarter. We would lose our foreign private issuer status if, for
example, more than 50% of our common shares are directly or indirectly held by residents of the United States and we fail to meet
additional requirements necessary to maintain our foreign private issuer status. If we lose our foreign private issuer status
on this date, we will be required to file with the SEC periodic reports and registration statements on U.S. domestic issuer forms,
which are more detailed and extensive than the forms available to a foreign private issuer. We will also have to mandatorily comply
with U.S. federal proxy requirements, and our officers, directors and principal shareholders will become subject to the short-swing
profit disclosure and recovery provisions of Section 16 of the Exchange Act. In addition, we will lose our ability to rely upon
exemptions from certain corporate governance requirements under the Nasdaq rules. As a U.S. listed public company that is not
a foreign private issuer, we will incur significant additional legal, accounting and other expenses that we will not incur as
a foreign private issuer, and accounting, reporting and other expenses in order to maintain a listing on a U.S. securities exchange.