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EX-2.1 - KAIBO FOODS Co Ltd | v199698_ex2-1.htm |
EX-99.1 - KAIBO FOODS Co Ltd | v199698_ex99-1.htm |
EX-99.2 - KAIBO FOODS Co Ltd | v199698_ex99-2.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
8-K
CURRENT
REPORT
Pursuant
to Section 13 or 15(d) of The Securities Exchange Act of 1934
Date of
Report(Date of Earliest Event Reported): October 21, 2010
CFO
CONSULTANTS, INC.
(Exact
name of registrant as specified in its charter)
Nevada
(State or
other jurisdiction of incorporation)
333-149294
|
42-1749358
|
(Commission
File Number)
|
(IRS
Employer Identification No.)
|
Rm. 2102
F & G, Nan Fung Centre, 264-298 Castle Peak Rd.,
Tsuen
Wan, N.T., Hong Kong
+852 2412 2208
(Registrant's
telephone number including area code)
73726
Alessandro Dr. Suite 103, Palm Desert, CA 92260
(Registrant's
former name or former address, if changed since last report)
Check the
appropriate box below if the Form 8-K filing is intended to simultaneously
satisfy the filing obligation of registrant under any of the following
provisions:
¨ Written
communications pursuant to Rule 425 under the Securities Act (17 CFR
230.425)
¨ Soliciting
material pursuant to Rule 14a-12(b) under the Exchange Act (17 CFR
240.14a-12(b))
¨ Pre-commencement
communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR
240.14d-2(b))
¨ Pre-commencement
communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR
240.13e-4(c))
Forward
Looking Statements
This Form
8-K and other reports filed by CFO Consultants, Inc. from time to time with the
Securities and Exchange Commission (collectively the “Filings”) contain or may
contain forward looking statements and information that is based upon beliefs
of, and information currently available to, CFO Consultants, Inc’s management as
well as estimates and assumptions made by management. When used in
the Filings the words “anticipate”, “believe”, “estimate”, “expect”, “future”,
“intend”, “plan” or the negative of these terms and similar expressions as they
relate to us or our management identify forward looking statements. Such
statements reflect our current view with respect to future events and are
subject to risks, uncertainties, assumptions and other factors (including the
risks contained in the section of this report entitled “Risk Factors”) relating
to industry, our operations and results of operations. Should one or more of
these risks or uncertainties materialize, or should underlying assumptions prove
incorrect, actual results may differ significantly from those anticipated,
believed, estimated, expected, intended or planned.
Except as
required by applicable law, including the securities laws of the United States,
we do not intend to update any of the forward-looking statements to conform
these statements to actual results. The following discussion should
be read in conjunction with the audited consolidated financial statements of
Hong Kong Wai Bo International Limited as of December 31, 2008 and 2009 and for
the years ended December 31, 2007, 2008 and 2009 and the related notes thereto,
and the unaudited interim consolidated financial statements as of June 30, 2010
and for the six months ended June 30, 2009 and 2010 and the related notes
thereto filed as exhibits to this Form 8-K.
In this
Form 8-K, references to “we,” “our,” “us,” or the “Company” refer to CFO
Consultants, Inc., a Nevada corporation.
Item 1.01 Entry Into A Material Definitive
Agreement
On
October 21, 2010, we acquired Hong Kong Wai Bo International Limited, a Hong
Kong corporation (“Waibo”) that, through its operating subsidiaries in the
People’s Republic of China (the “PRC” or “China”), is in the business of
producing potato starch.
On
October 21, 2010, the (“Closing Date”), pursuant to the terms of an Agreement
and Plan of Reorganization dated as of October 21, 2010 (the “Exchange
Agreement”) by and among the Company, Waibo, the holders of all outstanding
shares of Waibo (the “Waibo Shareholders”) and Orion Investment Inc. (the
Company's Principal Shareholder”), we acquired all of the outstanding
shares of Waibo (the “Waibo Shares”) from the Waibo Shareholders and the Waibo
Shareholders transferred all of the Waibo Shares to us. In exchange, we agreed
to issue to the Waibo Shareholders or their designee, an aggregate of
361,920,000 shares of our common stock (the “Exchange Shares”), equal to 96% of
all (collectively, the “Amendment
Issuances”)
our outstanding shares, after giving effect to the conversion of an
outstanding convertible note of the Company held by Millennium Capital, Inc., in
the principal amount of $25,000 (the “Convertible Note”), which such note is
convertible into 9,441,667 shares of our common stock, and the planned amendment
of our Articles of Incorporation. On the Closing Date, we did
not have sufficient authorized shares to complete the issuance of the entire
amount of Exchange Shares and shares issuable pursuant to the Convertible Note,
so only 38,000,000 shares were issued to the designee of the Waibo Shareholders
at the closing, and no shares were issued to the holder of the Convertible Note.
As soon as practicable after the Company effectuates an amendment to its
Articles of Incorporation to increase its authorized shares, the Company will
issue the remaining 323,920,000 shares to the Waibo Shareholders, as well as
9,441,667 shares to the holder of the Convertible Note. As a result
of the transactions contemplated by the Exchange Agreement, Waibo became our
wholly owned subsidiary.
2
A copy of
the Exchange Agreement is included as Exhibit 2.1 to this Current Report on Form
8-K and is hereby incorporated by reference. All references to the Exchange
Agreement and other exhibits to this Current Report are qualified, in their
entirety, by the text of such exhibits.
Item 2.01 Completion of Acquisition or
Disposition of Assets
Closing
of Exchange Agreement
On the
Closing Date, we entered into an agreement to acquire Waibo, a Hong Kong
corporation that, through its operating subsidiaries in the PRC, is in the
business of producing potato starch. Pursuant to the terms of the
Exchange Agreement, the Waibo Shareholders transferred and contributed all of
the Waibo Shares to us and in exchange, we agreed to issue to the designee of
the Waibo Shareholders, the Exchange Shares, equal to 96% of all of our shares
after giving effect to the conversion of the Convertible Note. On the Closing
Date, we did not have sufficient authorized shares to complete the issuance of
the entire amount of Exchange Shares and shares issuable pursuant to the
Convertible Note, so only 38,000,000 shares were issued to the Waibo
Shareholders on the Closing Date and no shares were issued to the holder of the
Convertible Note. As soon as practicable after we effectuate an amendment to our
Articles of Incorporation to increase our authorized shares, we will issue the
remaining 323,920,000 shares to the Waibo Shareholders, as well as 9,441,667
shares to the holder of the Convertible Note.
Prior to
the Closing Date, we were a “shell company” (as such term is defined in Rule
12b-2 under the Securities Exchange Act of 1934, as amended (the “Exchange
Act”)). Accordingly, pursuant to the requirements of Item 2.01(a)(f)
of Form 8-K, set forth below is the information that would be required if we
were filing a general form for registration of securities on Form 10 under the
Exchange Act regarding our common stock.
3
Our
current corporate structure is set forth below:
Description
of Business
We are a
leading PRC producer of high quality potato starch, a value added and functional
ingredient in many different types of packaged and processed
foods. Our corporate headquarters are in Hong Kong and our
operational headquarters are in Kunming city, Yunnan province. Our factories are
in Yunnan, Guizhou and Gansu provinces in China. Our potato starch is
sold under the “Wei Bao” and “Jiabao” brands and we believe that our
products are well known for their consistency, purity, quality and white
color.
4
Potato
starch is a functional food additive, offering strong adhesion without
chemicals. Potato starch is also a cost effective thickener, which does not
interfere with taste. In addition, our premium potato starch is white in color
and thus can be added to many foods without affecting product color. Our potato
starch is used by makers of noodles, instant noodles, dumplings, fishballs,
shrimp balls, meatballs, and many other mainstream Chinese foods.
We
believe that we are among the top five makers of premium native potato
starch in the PRC and that our manufacturing presence in Yunnan, Guizhou and
Gansu makes us the single largest producer in these provinces. Our
current overall production capacity is 111,500 metric tons per
year. Our native potato starch has consistently received the
government’s highest rating, which affords it a premium price in the PRC market
place. We sell our products to distributors and food processing companies.
In 2009 we sold to more than 50 customers, with only one
customer comprising more than 5% of our annual total sales.
China’s
modernization has brought about significant changes to its food industry. With
increasing urbanization, the use of supermarkets and consumption of prepared and
processed foods have grown rapidly. According to a July 2010 report of the
United States Department of Agriculture, the PRC now has over 500,000
manufacturers of frozen and processed foods, with a total annual output of RMB
4.5 trillion in 2009. The potato starch market in the PRC is currently
estimated at over 900,000 metric tons (China Potato Starch-Specialized Society
2009).
We
benefit from favorable government policies in the PRC. We currently enjoy
no income taxes for most of our business due to government policies aimed at
providing extra incentive to rural food businesses involved in China’s primary
food supply. In addition we have a successful track record at working
with local governments to increase rural income levels through increased potato
production. This is important to our business because obtaining high
and steady quantities of premium potato resource is the key challenge facing
large scale potato starch production.
We
provide farmer education and assistance to enable better yields and higher
starch potatoes, and we were selected in 2009 by the Ministry of Agriculture to
establish the National R&D Center for Potato Processing. We are
building new production lines that will expand our business into whole potato
starch, which is used in the fast food industry, as well as modified potato
starch, which is used in non food industries including paper, textiles, and
building materials.
Industry
Overview
Starch is
a carbohydrate consisting of a large number of glucose units joined together by
glycosidic bonds. This polysaccharide is produced by all green plants as an
energy store. It is the most important carbohydrate in the human diet and is
contained in such staple foods as potatoes, wheat, maize (corn) and rice. Potato
starch is starch extracted from potatoes and is a very refined starch,
containing minimal amount of protein or fat. Native potato starch is a white
powder with a neutral taste and high adhesive properties. This functional
additive is widely used in many types of Chinese processed foods including
instant noodles, dumplings, sauces, meatballs and sausages.
5
Market
Overview
The
potato starch industry in China is relatively young. According to an
August 2010 report of the United States Department of Agriculture, approximately
90% of the potato starch factories categorized in China are characterized as
small. We believe that Waibo, with 111,500 metric tons of annual
capacity, already ranks among the top 5 producers in the PRC. We
believe that premium potato starch usage will grow in step with the overall
growth in processed and prepared foods. In addition, we expect that
premium potato starch will increasingly be used as a value added substitute for
corn starch as well as chemical thickeners and stabilizers. We
believe that all natural additives like premium potato starch will be more
sought after by food makers that are increasingly concerned about the use of
chemical stabilizers and additives and by consumers who prefer more nutritious
ingredients.
Increased
Urbanization and Consumer Purchasing Power
Over the
last thirty years, China has experienced rapid urbanization due to the
increasingly limited capacity of rural areas to provide adequate economic
support for a large agrarian population, the increasing disparity in disposable
incomes between rural and urban dwellers and the easing of restrictions, which
historically limited rural to urban migration from rural areas to towns and
cities. According to the Annual Report on Urban Development of China in 2009,
the population of Chinese cities by the end of 2009 exceeded 621 million people,
representing an increase of 410 million since 1982. It is further
estimated that China’s urban population will expand to 926 million by 2025 and
hit the one billion mark by 2030.
Per
capita incomes in urban centers have risen greatly in recently decades, from RMB
1,516 in 1990 to RMB 16,180 in 2008. As of 2008, there were over
34,000 (The National Bureau of Statistics of China Yearbook 2009) supermarkets
in the PRC. By comparison, the US has over 35,000 supermarkets (U.S.
Census Bureau, Food Marketing Institute 2009).
Increased
demand for prepared and processed foods
Consumption
of prepared and processed foods in the PRC has grown in step with the country’s
urbanization trend. As people’s lives become busier, the traditional
custom of making daily purchases of fresh raw produce from small farmers’
markets has increasingly given way to less frequent visits to supermarkets to
buy prepared, packaged and processed foods. According to a July 2010 report of
the United States Department of Agriculture, the prepared and processed food
industry in China reached RMB 4.5 trillion (2009), representing a 20% increase
from 2008. The industry remains highly fragmented with many thousands
of different food makers and tens of thousands of products. The instant noodle
market towers over most with demand reaching RMB 59 billion in 2009 (Noodles in
China, Euromonitor, 2009).
Advantage
Over Corn Starch
Corn
starch is also used as a thickening agent, stabilizer, and
emulsifier. Corn starch is approximately half the cost of potato
starch and currently in greater supply in the PRC. According to a May 2009
report of the United States Department of Agriculture, there are over 160
corn-processing companies in China, with annual processing capacity estimated at
63.93 million metric tons. However, as food producers become more
concerned about food-safety, potato starch is increasingly viewed as a superior
alternative. Corn starch also has a lower melting point than potato
starch and it can affect product color. It must therefore receive significant
bleaching and modification to match the whiteness and temperature attributes of
potato starch.
6
Raw
Material Sourcing
Many
potato starch manufacturers are beset with inconsistent potato supply channels.
They typically find that potatoes cannot be bought in sufficient quantities from
major farms or farmers’ markets to run a large potato starch production factory.
Moreover, potato strains have been adapted to various soil and climate
conditions over centuries of cultivation. These differences will produce varying
degrees of starch content and whiteness.
The high
fragmentation and disparities in product quality place a premium on locating
potato starch factories in the high end regions around a concentration of small
growers and soliciting active local government support.
Additional
Potato Starch Varieties and Usages
Modified
potato starch, which is similar to native potato starch in appearance, is
composed mainly of native potato starch and other starch
varieties. It is primarily used in many non-food industries, the
largest which is the paper industry. A typical sheet of copy paper
may have as much as 8% starch content (North Carolina State University report).
Modified potato starch is also used for corrugated board adhesives as well as
glue products used in a wide variety of applications including bookbinding, wall
paper, paper sacks and other forms of paper bonding. Potato starch is
also used in the construction products industry for gypsum board. Furthermore,
modified potato starch is applied for biotechnical raw material, fabrics and
textiles, pharmaceuticals and cosmetics and detergents.
Whole
potato starch is the dehydrated part of fresh potatoes, except the potato skins.
It is typically used in products such as French fries and processed mashed
potatoes. It is used to add both texture and flavor to processed
foods. Approximately 90% of our native potato starch is used by the
food industry, while the rest is used in a variety of different food related
industries.
Competitive
Strengths
We
believe we have the following competitive advantages:
Factories
Built in Top Potato Producing Regions
We have
located our factories in regions of China with moderate temperatures and long
growing seasons, where potatoes can be grown to large sizes with smooth skins
that are less contaminated with impregnated soil and gravel. In
addition, we build our factories in rural regions where potato farming can bring
important added benefit to low-income rural populations. Many of our
competitors are state-owned and have positioned their production facilities
primarily to serve local growers without much consideration to starch content or
product quality.
Strong
Brand Equity known for High Quality Product
Our “Wei
Bao” and “Jiabao” brands are strongly associated with our commitment to quality,
which has been supported over the years with numerous awards and
certifications. The General Administration of Quality Supervision,
Inspection and Quarantine of the PRC issues grades for the quality of potato
starch: passed, first grade and excellent. Approximately 99% of our
products received the “excellent” rating and approximately 1% the “first grade”
rating.
Our
production facilities have implemented stringent quality control procedures,
from the procurement of raw materials to the delivery of our finished products.
This includes active supervision and training assistance provided to our local
farm suppliers.
7
Positioned
in High Growth Industry Segment
In 2009,
the food processing industry recorded a record high output of $662 billion (July
2010 report of the United States Department of Agriculture). We believe there
are significant opportunities to increase sales of premium potato starch for
processed foods, given its many benefits versus traditional food additives.
Participants in many non-food industries are now actively using or exploring the
use of potato starch. These include paper, bio-plastic, biotechnical raw
materials, fabrics and textiles, pharmaceuticals and cosmetics and
detergents.
Potato
Starch Industry is the Beneficiary of Strong Government Support
Two main
policy goals are to better assist rural low-income populations while developing
and improving the country’s massive food needs. Our production
facilities in Yunnan, Gansu and Guizhou provinces are beneficiaries of these
initiatives. For example, in 2007 China implemented a 5-year anti-dumping tax on
EU imports of potato starch of 17%, 18% or 35% depending on the original
manufacturer (PRC Ministry of Commerce). The Ministry of Finance and State
Administration of Taxation has also implemented beneficial tax policies to spur
development of both agriculture and the downstream food-processing industry. We
have successfully obtained a full exemption on Enterprise Income Tax (“EIT”)
since 2008.
Business
Strategies
We plan
to increase our market presence and build on our core competitive strengths by
implementing the following strategies:
Increase
Production Capacity in Existing and New Locations
We plan
to increase our production capacity by building facilities in strategic
locations as well as pursuing mergers and acquisitions for growth. We are
currently building a modified starch factory with an annual production capacity
of 20,000 metric tons in Zhaotong City, Yunnan province and expect this to be
completed by June 2011.
Our
current expansion strategy is to build 4 new production facilities in the next 3
years, with an aggregate capacity of 123,000 metric tons of a variety of potato
starch products. We plan to build native potato starch factories in
Guizhou and Sichuan provinces. The Guizhou facility is expected to
have a production capacity of 38,000 metric tons and we expect it to be
operational by January 2012. The Sichuan facility will have a
production capacity of 40,000 metric tons and should be operational by March
2013.
We plan
to build a whole potato starch facility in Guizhou, with a production capacity
of approximately 15,000 metric tons, which we expect to be operational by
January 2012. We also plan to build a modified potato starch factory in Yunnan,
with a production capacity of approximately 30,000 metric tons which we plan to
be operational by August 2013. We evaluate facility locations based on land
fertility, water availability and railway proximity. We also aim to
identify those areas with adequate farm acreage that are amenable to our quality
standards.
We also
believe there are opportunities to acquire existing state-owned potato-starch
production facilities by leveraging our reputation for operating successful
facilities and producing a premium product.
8
Penetrate
New Markets with Expanded Product Offerings
We
currently produce native potato starch and plan to begin production of modified
potato starch by March 2011. Modified potato starch is used in various
industries such as food processing, paper manufacturing, medical supplies,
industrial chemicals and wood and furniture production. Modified starch tends to
have higher profit margins and wider usages than native potato
starch.
We also
plan to produce whole potato starch, which is primarily used for food
processing. Whole potato starch is the dehydrated part of fresh potatoes, except
the potato skins. Popular
products such as French fries are typically made using whole potato starch. It
is used to add both texture and flavor to processed foods.
Maintain
and Expand Our Customer Base
We plan
to continue to build on our current customer relationships as well as enter new
markets. We believe our diverse and wide customer base provides us beneficial
word of mouth exposure, in addition to stabilizing product demand. Our customer
base also gives us built in product demand as we increase our production
capabilities. We intend to continue to increase our customer base to
allow us to gain increased market presence in new and emerging markets in
China.
R&D
efforts
In 2009,
we were chosen by The Ministry of Agriculture to be the National R&D Center for Potato
Processing. This cooperation with the government promotes open
exchange of cultivation techniques and production technologies. Currently, the
government provides minimal financial support for this
award. However, we believe that our cooperation with the government
gives us early access to the government’s most recent R&D achievements in
our industry. We also anticipate the government will increase funding
with the increasing significance of processed potato products in the PRC. We
believe that it is important to have excellent R&D capabilities and have
plans to build a new R&D center in Kunming in 2013. We believe this facility
can serve as a center for innovation and new ideas that promotes us as a market
leader.
Brands
and Products
Product
brand
We market
our products using the “Wei Bao” and “Jiabao” brand names. Our Wei
Bao brand is used primarily in the food processing industry while our Jiabao
brand is used in the restaurant industry. The two separate brands
allow us to better focus on two segments’ different purchasing
criteria. We focus on building brand names known for high
quality. In 2006, we registered our trademark for the Wei Bao brand
name and in 2010 we registered our trademark for the Jiabao brand
name. These trademarks are effective for 10 years and are typically
renewable.
In 2009,
approximately 95% of our revenue came from products sold under Wei Bao brand
name and the ““ logo.
9
The
Jiaobao brand is represented by the “ ” logo and
accounted for approximately 5% of our revenue in 2009.
Products
We
produce native potato starch, which is primarily used in the food processing
industry. The following table provides the specifications for our
current products. Native potato starch is known for its thickening, adhesive and
emulsifying properties, used in many processed foods including include ham,
sausage, frozen foods, meatballs, prawn balls, starch strips, instant noodles,
jelly, biscuits, cake, ice cream, yogurt, canned foods and candy. It
is manufactured as white colored powder and has a shelf life of up to two
years.
We plan
to expand our product offerings to include modified starch and whole potato
starch. We are currently building a production facility for modified
starch factory in Zhaotong city, Yunnan province with a production capacity of
approximately 20,000 tons. We anticipate this factory to be completed by June
2011. We anticipate our modified starch will be suitable for food
processing, paper manufacturing, medical supplies and industrial
chemicals. We also plan to produce whole potato
starch. This type of starch typically used for food processing and
adds flavor and the body for the processed food it is used for.
Research
and Development
Our
research and development center was established in 2003 in Yunnan province. In
2009, we were chosen by The Ministry of Agriculture to be the National R&D
Center for Potato Processing. We collaborate with the government on developing
new species of potatoes, increasing the crop yield of potatoes, raising starch
content and developing potatoes resistant to diseases and pests. We
receive minimum funding from the government as result of being selected for this
position. However, we believe this cooperation gives us early access
to recent governmental R&D developments, allowing us early implementation
of the most current agricultural techniques and potato
varieties.
We also
have informal cooperation with the Agricultural Technology University and the
Research Institute of Agriculture both of which are located in Kunming
city. We plan to build a new research and development center in
Kunming by 2013. The focus of this center will be on developing
different types of modified starch.
Production
Process
We
manufacture potato starch at four different production facilities in
China. In 2009, we produced 25,337, 25,259 and 41,787 metric tons of
starch at our production faculties located in Yunnan (1 facility), Guizhou (1
facility) and Gansu (2 facilities) respectively. By June 2011, we
anticipate completion of a fifth facility in Zhaotong City, Yunnan Province,
capable of annually producing 20,000 metric tons of modified potato starch. Our
total annual production capacity as of June 30, 2010 was 111,500 metric tons of
native potato starch.
10
Native
Potato Starch Processing
Our
purchasing department buys potatoes from farmers located near our production
facilities. We establish potato quality requirements at the outset
and closely examine them for weight and texture. We have designated potato
storage areas with man-made water channels in the center. High-pressure water
guns push our potatoes into the water channels, which transports the naturally
buoyant potatoes into our production facilities while beginning the cleansing
process.
The
potatoes enter our production facility and first undergo
cleaning. They enter our tumbling machine which uses high-pressure
water to remove dirt and any other unwanted particles. The clean
potatoes are then transferred to a temporary storage container before the
grinding process.
The
grinding machines turn the potatoes into a pulp-like sludge, which results in
dissolution of the potato cells and the release of the potato starch
content. We separate the potato dreg, which is procured from the
potato sludge using an extrication filter. The result is a thick,
milky potato paste.
The
potato paste is transferred into a high-speed centrifugal sieve to remove the
potato fiber. The paste passes through a series of filters to remove tiny sand
particles and water. The end result of this process is unfiltered
starch. This starch is then run through an 18-layer filter device to
further remove impurities and then placed into a refining container. The
concentration of the potato starch is measured during this process.
The
starch is then taken from the refining container and run through a vacuum
hydro-extractor to reduce the water content to 40%. The starch then undergoes
hot air drying and sterilization at temperatures of 140°C and gradually cooled to
approximately 45-50°C. This process
reduces the water content to 18-20%. We send this air-dried potato
starch to cyclonic silos to separate the air from the starch. The
potato starch powder is then sent to a vibrating sifter to produce a more
refined and consistent product - high quality, pure white starch powder. We then
package and store the finished potato starch product for
delivery.
11
Production
process chart
The
following diagram illustrates the production process for potato
starch.
Procurement
The
primary raw material is potatoes, which we procure from more than 100,000 mostly
small-sized local farms. We typically go to nearby villages and come to an oral
agreement with the leading potato farmer in that region. This particular farmer
acts as our main supplier and will coordinate with the other potato farmers in
his village and collect their potatoes. We currently have a total of
270 such main suppliers
Our
production facility in Yunnan province has arrangements with 98 suppliers for a
total of 154,000 tons of potatoes. Our production facility in Guizhou
has arrangements with 83 suppliers, for approximately 155,000 tons of potatoes
and our production facilities in Gansu have arrangements with 89 suppliers for
approximately 266,000 tons of potatoes.
We have
strict selection criteria for our raw material suppliers. First and
foremost, they need to be located in ideal potato cultivating areas with high
crop yields and long harvest seasons. Generally, the local government
will help the farmers select the ideal potato types for regional
production.
Typically,
potatoes have one growing season that starts in March. The potatoes
are harvested from July to December. We also set the quality requirements for
our potatoes such as the starch content.
Potato
farmers are highly fragmented with limited production
capabilities. We typically rely on current market trends and
historical prices during supplier negotiations. Prices are generally
stable from year to year. We do not sign a formal contract with our
suppliers. We negotiate prices yearly and pay cash on
delivery.
12
Inventory
Control and Management
We
typically maintain raw material inventory equal to 3-5 days of production to
maintain freshness. Towards the end of harvesting season, we can preserve the
potatoes by storing them in cellars, extending their usability for several
months.
The raw
materials are weighed upon delivery to confirm the ordered amount before
settling with cash. Because we are currently producing at near full capacity, we
tend to make daily orders of constant quantities. Our finished goods warehouses
hold approximately 200-300 metric tons of products, which are weighed before
storage. We typically ship our finished goods within 1-3 days.
Quality
Control
We have
received all necessary governmental licenses and permits for potato processing,
which include the Food Hygiene License, National Industrial Product Manufacture
License and an “excellent” rating from the General Administration of Quality
Supervision, Inspection and Quarantine. We have also obtained ISO
9001:2000 Quality Management System certification, ISO 22000:2005 Food Safety
Management System certification, and Hazard Analysis and Critical Control Points
certification (HACCP).
Raw
materials quality control
We set
potato quality standards with our suppliers before ordering, foremost of which
is a minimum 15% starch content. Most potato species can only be cultivated for
approximately 3 years before their starch content lowers to unacceptable
levels. However, we know of more than 100 different suitable species
that our nearby potato farmers could use, thus ensuring a constant
supply. The local government agricultural bureau also works with the
farmers to help pick the species of potatoes consistent with our product quality
specifications.
During
the cultivation process, we send quality assurance teams to selected farms in
our potato producing regions to perform a visual inspection on site and test a
random sample of potatoes for starch content. Only if the potatoes
meet our requirements will we accept delivery. Additional visual
examinations and tests for starch content are performed upon
delivery.
Production
process quality control
We pay
particular attention to four key steps in the production process that will
largely determine the quality of the finished product: grinding, centrifugal
sieving, 18-layer filtering and hot air drying.
Finished
products quality control
We
perform a visual inspection, a smell test and laboratory testing on our finished
goods. The General Administration of Quality Supervision, Inspection
and Quarantine of the PRC performs a national standard test on our finished
goods, which entails examinations of the chemical and physical properties every
six months. Our quality assurance staff ensures that our potato
starch meets the national standard every ten minutes during the production
process. The finished goods also undergo semi-annual testing by the Measure for
Quality Supervision and Administration of Food. This department is
entrusted with upholding the national food safety standards and grants us the
right to use a “Quality Safety Label” (QS label) on our
products.
13
Sales
and Customer Relations
Each of
our sales offices in Kunming, Yunnan province has two sales
staff. This is sufficient for present capacity levels to maintain
customer relationships and process customer orders and will be expanded as
required.
We have
approximately 54 customers in industries such as food processing, food
distribution and retail food sales. We select our customers based on
creditworthiness, market share in respective industry, growth potential and
product demand. We have grown a diversified customer base with evenly
distributed sales patterns to reduce concentration risk and provide leverage
during pricing negotiations.
Our
customers are located in 12 provinces and four municipalities in China. We have
a strong market share in Guangdong, Fujian and Shandong provinces.
The
following map illustrates the geographical coverage of our sales and
distribution network in the PRC:
14
Our
customers use our potato starch in hundreds of different processed foods,
including ham, sausage, frozen foods, meatballs, prawn balls, starch strips,
instant noodles, jelly, biscuits, cake, ice cream, yogurt, canned foods, and
candy.
Our
customers sign bi-annual sales contracts for fixed product
volumes. We deliver our products to our customers on a regular basis
as defined by the sales contracts. We typically accumulate orders of
shipment amounts up to shipment amounts of 60 tons, the capacity of a single
rail car, for economical delivery. We typically only pay for transferring our
goods to a railway station located near our facilities. We extend
credit terms of up to 90 days from delivery for our top customers.
Seasonality
We
typically stop our production process from May through July for our Yunnan and
Guizhou production facilities. The potato-planting season typically begins in
March and the potatoes are delivered to our facilities from August until the end
of December. The harvested potatoes can typically be stored up to 4 months in
cellars allowing us to expand our production period to April.
Our
factories in Gansu are in a colder region in China and typically halt production
from January to February. During these months, we store potatoes for
production from March through May. Our Gansu factory will then close
for production from June to July and resume
production in August. During the off-season, we spend time performing
routine production line maintenance.
Pricing
We price
our products based on market trends, raw material costs and competitors’ prices.
Our raw materials constitute approximately 80% of production costs. The prices
for potatoes have increased in step with the price of potato
starch. The prices of potatoes have increased by 27% over the
past 5 years. Whereas, the market price for potato starch has increased by 26%
over the past 5 years. The following table shows our price trends for
potatoes and potato starch for the past five years.
Average price of potatoes
(per ton)
|
Average selling price of potato starch
(per ton) (with VAT)
|
||||||||
Year
|
Price (RMB)
|
Calendar Year
|
Price (RMB)
|
||||||
2005
|
330 |
2005
|
4,380 | ||||||
2006
|
370 |
2006
|
4,450 | ||||||
2007
|
455 |
2007
|
5,650 | ||||||
2008
|
450 |
2008
|
5,850 | ||||||
2009
|
420 |
2009
|
5,540 |
Competition
The
potato starch market is highly fragmented, with more than 50 medium-sized
enterprises and more than 1,000 small-sized enterprises. According to
the CPSSS, in 2007, there were 11 enterprises with an annual capacity of 10,000
- 28,200 metric tons, 20 enterprises with an annual capacity of 2,000-8,000
metric tons, and 10 enterprises with an annual capacity of 300 - 1,800 metric
tons.
We
believe we are one of the top 5 potato starch producers in the PRC. Our main
competitors include the following:
15
·
|
China
Essence Group Ltd (China Essence) headquartered in Beijing and listed on
the Singapore Exchange in 2006. It is one of the largest producers of
potato-related products in the PRC with five potato-processing facilities
and a total of 17 production lines. China Essence has locations in
Heilongjiang province and Inner Mongolia. It produces a wide range of
products including vermicelli, starch strips and five-grain noodles,
potato starch, modified starch and potato by-products. Its distribution
network covers 48 cities in the
PRC.
|
·
|
Yunnan
Run Kai Industry Co Ltd (Run Kai) is based in Yunnan Province and has a
potato starch annual production capacity of 30,000 metric
tons. It has a well-known brand called, “Run Kai.” Run Kai also
exports to foreign countries such as Japan, Korea, Hong Kong, Singapore
and Indonesia.
|
·
|
Qinghai
Weisidun Co., Ltd (Weisidun) is based in Qinghai and has an annual
production capacity of 77,000 metric tons of potato starch. It
has 5 production lines - 1 for modified starch, 2 for instant vermicelli,
1 for crystal vermicelli and 1 that produces a microbiologic
agent.
|
·
|
Heilongjiang
Beidahuang Potato Industry Group (Beidahuang) produces potato starch and
has an annual production capacity of 100,000 metric tons. The group has
expanded its businesses into modified starch, potato biological feed,
ethanol and other by-products.
|
Employees
Our
production staff operates the production lines 24 hours a day in three
eight-hour shifts, 6 days a week. All of our staff are full-time
employees. The chart below describes the number of employees per
department as of June 30, 2010.
Department
|
Total
|
|||
Senior
Executive Management
|
3 | |||
Senior
Management
|
17 | |||
HR
|
9 | |||
Administration
|
62 | |||
Financial
Staff
|
13 | |||
Sales
people
|
6 | |||
Quality
Control
|
21 | |||
R&D
|
4 | |||
Manufacturing
Managers
|
63 | |||
Manufacturing
Workers
|
276 | |||
Total
|
474 |
We have
made employee retirement fund contributions. We believe we are in material
compliance with all applicable labor and safety laws and regulations in the PRC,
including the PRC Labor Contract Law, the PRC Production Safety Law, the PRC
Regulation for Insurance for Labor Injury, the PRC Unemployment Insurance Law,
the PRC Provisional Insurance Measures for Maternity of Employees, PRC Interim
Provisions on Registration of Social Insurance, the PRC Interim Regulation on
the Collection and Payment of Social Insurance Premiums and other related
regulations, as well as rules and provisions issued by the relevant governmental
authorities from time to time.
16
According
to the PRC Labor Contract Law, we are required to enter into labor contracts
with our employees. We are required to pay no less than local minimum wages to
our employees. We are also required to provide employees with labor safety and
sanitation conditions meeting PRC government laws and regulations and carry out
regular health examinations of our employees engaged in hazardous
occupations.
Intellectual
Property Rights
We
registered the “Wei Bao” and “Jiabao” brand trademarks on August 14, 2006 and
January 21, 2010 respectively. These trademarks are effective and renewable
after 10 years. We have a registered PRC design patent for package bags under
the patent number ZL 200930129068.x with a valid term of ten years commencing
from September 29, 2009.
Property
All land
in the PRC is owned by the government and cannot be sold to any individual or
entity. The government alternatively grants or allocates landholders a “land use
right.” There are four ways of acquiring land use rights in the
PRC:
|
·
|
Grant
of the right to use land;
|
|
·
|
Assignment
of the right to use land;
|
|
·
|
Lease
of the right to use land; and
|
|
·
|
Allocation
of the right to use land.
|
Granted
land use rights are provided by the government in exchange for a grant fee, and
carry the rights to pledge, mortgage, lease and transfer the land within the
term of the grant. Land is granted for a fixed term, generally 70 years for
residential use, 50 years for industrial use, and 40 years for commercial and
other use. The term is renewable in theory. Unlike in western nations, granted
land must be used for the specific purpose for which it was
granted.
Allocated
land use rights are generally provided by the government for an indefinite
period (usually to state-owned entities) and cannot be pledged, mortgaged,
leased, or transferred by the user unless otherwise approved by the competent
government authorities. Allocated land can be reclaimed by the government at any
time. Allocated land use rights may be converted into granted land use rights
upon the payment of a grant fee to the government.
We have
land use rights for two of our factories, one of our factories is on leased land
without land use right and we lease one additional factory in Gansu
province.
We lease
our headquarters in Hong Kong for HK$19,000 per month on a 2-year lease
term. We have leased this office since 2008.
17
The
following chart provides details for our PRC-based properties:
Company
Name
|
Property
Area
(Sq.
meters)
|
Ownership
|
Land Area
(Sq. meters)
|
Ownership
|
Building Address
|
Principal Uses of
Building
|
||||||
Yunnan
Zhaoyang Weili Starch Co., Ltd. (“Yunnan WeiLi”),
|
5,852.3
|
Self-owned
|
47,694
|
Land
use right owned
|
Zhaotong
City Zhaoyang District of Yunnan Province Leju Village
|
Company:
Production Department, Warehouse, Office Building and Apartment
Building
|
||||||
Guizhou
Province Weining Weili Starch Co., Ltd. (“Guizhou WeiLi”)
|
5,500
|
Self-owned
|
70,000
|
Leased
|
Guizhou
Province Wainong County Caohai Town Tongxin Village
|
Company:
Production Department, Warehouse, Office Building and Apartment
Building
|
||||||
Gansu
Weibao Starch Co., Ltd.
(“Gansu
WeiBao”)
|
6,003
|
Self-owned
|
43,630
|
Land
use right owned
|
Gansu
Province Jishishan County Town ship Enterprises Park
|
Company:
Production Department, Warehouse, Office Building and Apartment
Building
|
||||||
Guanghe
branch of Gansu Weibao
|
6,187.4
|
Lease
|
17,487
|
Leased
|
Gansu
Province Guanghe County
Sanjiaji
Town Lingyuan Park
|
Company:
Production Department, Warehouse, Office Building and Apartment
Building
|
||||||
Hong
Kong Wai Bo International Ltd.
|
478.19
|
Lease
|
—
|
——
|
Yunnan
Province Kunming Youth Road No. 389 Zhiyuan Building 28 Floor Room
A
|
Operational
Headquarters
|
||||||
Total
|
24,020.89
|
|
808,811
|
|
|
|
Insurance
We
believe that we maintain insurance in line with industry standards. Our
insurance covers 100% of the net book value of our
property, plant and equipment and inventories.
Legal
Proceedings
We are
not engaged in any material litigation, arbitration or claim, and no material
litigation, arbitration or claim is known by our management to be pending or
threatened by or against us that would have a material adverse effect on our
results from operations or financial condition.
PRC
Government Regulations
Our
operations are subject to numerous laws, regulations, rules and
specifications of the PRC relating to various aspects. We are in compliance in
all material respects with such laws, regulations, rules, specifications
and have obtained all material permits, approvals and registrations relating to
human health and safety, the environment, taxation, foreign exchange
administration, financial and auditing, and labor and employments. We make capital
expenditures from time to time to stay in compliance with applicable laws and
regulations. Below we set forth a summary of the most significant PRC
regulations or requirements that may affect our business activities operated in
the PRC or our shareholders’ right to receive dividends and other distributions
of profits from our PRC subsidiaries.
18
Business
license
Any
company that conducts business in the PRC must have a business license that
covers a particular type of work. The business license of each of our PRC
subsidiaries covers its present business of production and deep processing of
potato starch. Prior to expanding any of our PRC subsidiaries’ business beyond
that of its business license, we are required to apply and receive approval from
the PRC government.
Annual
Inspection
In
accordance with relevant PRC laws, all types of enterprises incorporated under
the PRC laws are required to conduct annual inspections with the State
Administration for Industry and Commerce of the PRC or its local
branches. In addition, foreign-invested enterprises are also subject to annual
inspections conducted by PRC government authorities. In order to reduce
enterprises’ burden of submitting inspection documentation to different
government authorities, the Measures on Implementing Joint
Annual Inspection issued by the PRC Ministry of Commerce together with
other six ministries in 1998 stipulated that foreign-invested enterprises shall
participate in a joint annual inspection jointly conducted by all relevant PRC
government authorities. Our PRC subsidiaries, as foreign-invested enterprises,
have participated and passed all such annual inspections since their
establishment.
Employment
laws
We are
subject to laws and regulations governing our relationship with our employees,
including: wage and hour requirements, working and safety conditions,
citizenship requirements, work permits and travel restrictions. These
include local labor laws and regulations, which may require substantial
resources for compliance.
China’s National Labor Law,
which became effective on January 1, 1995, and China’s National Labor Contract
Law, which became effective on January 1, 2008, permit workers in both
state and private enterprises in China to bargain collectively. The National Labor Law and the
National Labor Contract
Law provide for collective contracts to be developed through
collaboration between the labor union (or worker representatives in the absence
of a union) and management that specify such matters as working conditions, wage
scales, and hours of work. The laws also permit workers and employers in all
types of enterprises to sign individual contracts, which are to be drawn up in
accordance with the collective contract.
Foreign
Investment in PRC Operating Companies
The Catalogue for the Guidance of
Foreign Investment Industries jointly issued by the Ministry of Commerce,
or the MOFCOM, and the National Development and Reform Commission, or the NDRC,
in 2007 classified various industries/businesses into three different
categories: (i) encouraged for foreign investment; (ii) restricted to foreign
investment; and (iii) prohibited from foreign investment. For any
industry/business not covered by any of these three categories, they will be
deemed industries/businesses permitted to have foreign investment. Except for
those expressly provided restrictions, encouraged and permitted
industries/businesses are usually 100% open to foreign investment and ownership.
With regard to those industries/businesses restricted to or prohibited from
foreign investment, there is always a limitation on foreign investment and
ownership. Our PRC subsidiaries’ business does not fall under the industry
categories that are restricted to, or prohibited from foreign investment and is
not subject to limitation on foreign investment and ownership.
19
Regulation
of Foreign Currency Exchange
Foreign
currency exchange in the PRC is governed by a series of regulations, including
the Foreign Currency
Administrative Rules (1996), as amended, and the Administrative Regulations Regarding
Settlement, Sale and Payment of Foreign Exchange (1996), as amended.
Under these regulations, the Renminbi is freely convertible for trade and
service-related foreign exchange transactions, but not for direct investment,
loans or investments in securities outside the PRC without the prior approval of
the State Administration of Foreign Exchange, or SAFE. Pursuant to the Administrative Regulations Regarding
Settlement, Sale and Payment of Foreign Exchange (1996), Foreign Invested
Enterprises, or FIEs, may purchase foreign exchange without the approval of the
SAFE for trade and service-related foreign exchange transactions by providing
commercial documents evidencing these transactions. They may also retain foreign
exchange, subject to a cap approved by SAFE, to satisfy foreign exchange
liabilities or to pay dividends. However, the relevant Chinese government
authorities may limit or eliminate the ability of FIEs to purchase and retain
foreign currencies in the future. In addition, foreign exchange transactions for
direct investment, loan and investment in securities outside the PRC are still
subject to limitations and require approvals from the SAFE.
Regulation
of FIEs’ Dividend Distribution
The
principal laws and regulations in the PRC governing distribution of dividends by
FIEs include:
|
(i)
|
The
Sino-foreign Equity Joint Venture Law (1979), as amended, and the
Regulations for the Implementation of the Sino-foreign Equity Joint
Venture Law (1983), as amended;
|
|
(ii)
|
The
Sino-foreign Cooperative Enterprise Law (1988), as amended, and the
Detailed Rules for the Implementation of the Sino-foreign Cooperative
Enterprise Law (1995), as amended;
|
|
(iii)
|
The
Foreign Investment Enterprise Law (1986), as amended, and the Regulations
of Implementation of the Foreign Investment Enterprise Law (1990), as
amended.
|
Under
these regulations, FIEs in the PRC may pay dividends only out of their
accumulated profits, if any, determined in accordance with Chinese accounting
standards and regulations. In addition, foreign-invested enterprises in the PRC
are required to set aside at least 10% of their respective accumulated profits
each year, if any, to fund certain reserve funds unless such reserve funds have
reached 50% of their respective registered capital. These reserves are not
distributable as cash dividends. The board of directors of a FIE has the
discretion to allocate a portion of its after-tax profits to staff welfare and
bonus funds, which may not be distributed to equity owners except in the event
of liquidation.
Regulation
of a Foreign Currency’s Conversion into RMB and Investment by FIEs
On August
29, 2008, the SAFE issued a Notice of the General Affairs Department of the
State Administration of Foreign Exchange on the Relevant Operating Issues
concerning the Improvement of the Administration of Payment and Settlement of
Foreign Currency Capital of Foreign-Invested Enterprises or Notice 142, to
further regulate the foreign exchange of FIEs. According to the Notice 142, FIEs
shall obtain a verification report from a local accounting firm before
converting its registered capital of foreign currency into Renminbi, and the
converted Renminbi shall be used for the business within its permitted business
scope. The Notice 142 explicitly prohibits FIEs from using RMB converted from
foreign capital to make equity investments in the PRC, unless the domestic
equity investment is within the approved business scope of the FIE and has been
approved by SAFE in advance.
20
Regulation
of Foreign Exchange in Certain Onshore and Offshore Transactions
In
October 2005, the SAFE issued the Notice on Issues Relating to the
Administration of Foreign Exchange in Fund-raising and Return Investment
Activities of Domestic Residents Conducted via Offshore Special Purpose
Companies, or SAFE Notice 75, which became effective as of November 1, 2005, and
was further supplemented by two implementation notices issued by the SAFE on
November 24, 2005 and May 29, 2007, respectively. SAFE Notice 75 states that PRC
residents, whether natural or legal persons, must register with the relevant
local SAFE branch prior to establishing or taking control of an offshore entity
established for the purpose of overseas equity financing involving onshore
assets or equity interests held by them. The term “PRC legal person residents”
as used in SAFE Notice 75 refers to those entities with legal person status or
other economic organizations established within the territory of the PRC. The
term “PRC natural person residents” as used in SAFE Notice 75 includes all PRC
citizens and all other natural persons, including foreigners, who habitually
reside in the PRC for economic benefit. The SAFE implementation notice of
November 24, 2005 further clarifies that the term “PRC natural person residents”
as used under SAFE Notice 75 refers to those “PRC natural person residents”
defined under the relevant PRC tax laws and those natural persons who hold any
interests in domestic entities that are classified as “domestic-funding”
interests.
PRC
residents are required to complete amended registrations with the local SAFE
branch upon: (i) injection of equity interests or assets of an onshore
enterprise to the offshore entity, or (ii) subsequent overseas equity financing
by such offshore entity. PRC residents are also required to complete amended
registrations or filing with the local SAFE branch within 30 days of any
material change in the shareholding or capital of the offshore entity, such as
changes in share capital, share transfers and long-term equity or debt
investments or, providing security, and these changes do not relate to return
investment activities. PRC residents who have already organized or gained
control of offshore entities that have made onshore investments in the PRC
before SAFE Notice 75 was promulgated must register their shareholdings in the
offshore entities with the local SAFE branch on or before March 31,
2006.
Under
SAFE Notice 75, PRC residents are further required to repatriate into the PRC
all of their dividends, profits or capital gains obtained from their
shareholdings in the offshore entity within 180 days of their receipt of such
dividends, profits or capital gains. The registration and filing procedures
under SAFE Notice 75 are prerequisites for other approval and registration
procedures necessary for capital inflow from the offshore entity, such as
inbound investments or shareholders loans, or capital outflow to the offshore
entity, such as the payment of profits or dividends, liquidating distributions,
equity sale proceeds, or the return of funds upon a capital
reduction.
Government
Regulations Relating to Taxation
On March
16, 2007, the National People’s Congress or the NPC, approved and promulgated
the PRC Enterprise Income Tax
Law, which we refer to as the New EIT Law. The New EIT Law took effect on
January 1, 2008. Under the New EIT Law, FIEs and domestic companies are subject
to a uniform tax rate of 25%. The New EIT Law provides a five-year transition
period starting from its effective date for those enterprises which were
established before the promulgation date of the New EIT Law and which were
entitled to a preferential lower tax rate under the then-effective tax laws or
regulations.
21
On
December 26, 2007, the State Council issued a Notice on Implementing Transitional
Measures for Enterprise Income Tax, or the Notice, providing that the
enterprises that have been approved to enjoy a low tax rate prior to the
promulgation of the New EIT Law will be eligible for a five-year transition
period since January 1, 2008, during which time the tax rate will be increased
step by step to the 25% unified tax rate set out in the New EIT Law. From
January 1, 2008, for the enterprises whose applicable tax rate was 15% before
the promulgation of the New EIT Law , the tax rate will be increased to 18% for
year 2008, 20% for year 2009, 22% for year 2010, 24% for year 2011, 25% for year
2012. For the enterprises whose applicable tax rate was 24%, the tax rate will
be changed to 25% from January 1, 2008.
The New
EIT Law provides that an income tax rate of 20% may be applicable to dividends
payable to non-PRC investors that are “non-resident enterprises”. Non-resident
enterprises refer to enterprises which do not have an establishment or place of
business in the PRC, or which have such establishment or place of business in
the PRC but the relevant income is not effectively connected with the
establishment or place of business, to the extent such dividends are derived
from sources within the PRC. The income tax for non-resident enterprises shall
be subject to withholding at the income source, with the payor acting as the
obligatory withholder under the New EIT Law, and therefore such income taxes
generally called withholding tax in practice. The State Council of the PRC has
reduced the withholding tax rate from 20% to 10% through the Implementation
Rules of the New EIT Law. It is currently unclear in what circumstances a source
will be considered as located within the PRC. We are a U.S. holding company and
substantially all of our income is derived from dividends we receive from our
subsidiaries located in the PRC. Thus, if we are considered as a “non-resident
enterprise” under the New EIT Law and the dividends paid to us by our subsidiary
in the PRC are considered income sourced within the PRC, such dividends may be
subject to a 10% withholding tax.
Such
income tax may be exempted or reduced by the State Council of the PRC or
pursuant to a tax treaty between the PRC and the jurisdictions in which our
non-PRC shareholders reside. For example, the 10% withholding tax is reduced to
5% pursuant to the Double Tax
Avoidance Agreement Between Hong Kong and Mainland China if the
beneficial owner in Hong Kong owns more than 25% of the registered capital in a
company in the PRC.
The new
tax law provides only a framework of the enterprise tax provisions, leaving many
details on the definitions of numerous terms as well as the interpretation and
specific applications of various provisions unclear and unspecified. Any
increase in the combined company’s tax rate in the future could have a material
adverse effect on its financial conditions and results of
operations.
In
addition, according to the circular entitled Scope of Preliminary Processing of
Agricultural Products Entitled to Preferential Enterprise Income Tax Policies
(Trial Implementation) published by Ministry of Finance (“MOF”) and State
Administrative of Taxation (“SAT”), our PRC subsidiaries are entitled to full
exemption from the PRC corporate income tax beginning January 1,
2008. The exemption currently is not subject to any
limitations.
22
Regulations
of Overseas Investments and Listings
On August
8, 2006, six PRC regulatory agencies, including the MOFCOM, the China Securities
Regulatory Commission or the CSRC, the State Asset Supervision and
Administration Commission or the SASAC, the State Administration of Taxation, or
the SAT, the State Administration for Industry and Commerce or the SAIC and
SAFE, amended and released the New M&A Rule, which took effect as of
September 8, 2006. This regulation, among other things, includes provisions that
purport to require that an offshore special purpose vehicle (SPV) formed for
purposes of overseas listing of equity interest in PRC companies and controlled
directly or indirectly by PRC companies or individuals obtain the approval of
the CSRC prior to the listing and trading of such SPV’s securities on an
overseas stock exchange.
On
September 21, 2006, the CSRC published on its official website procedures
regarding its approval of overseas listings by SPVs. The CSRC approval
procedures require the filing of a number of documents with the CSRC. The
application of the New M&A Rule with respect to overseas listings of SPVs
remains unclear with no consensus currently existing among the leading PRC law
firms regarding the scope of the applicability of the CSRC approval
requirement.
Environmental
Protection
Our
manufacturing operations are subject to PRC environmental laws and regulations
on air emission, solid waste emission, sewage and waste water, discharge of
waste and pollutants, and noise pollution. These laws and regulations include
Law of the PRC on Environmental Protection, Law of the PRC on the Prevention and
Control of Water Pollution, Law of the PRC on the Prevention and Control of
Atmospheric Pollution, Law of the PRC on the Prevention and Control of Pollution
from Environmental Noise and Law of the PRC on the Prevention and Control of
Environmental Pollution of Solid Waste. We are also subject to periodic
monitoring by relevant local government environmental protection
authorities.
According
to these environmental laws and regulations, all business operations that may
cause environmental pollution and other public hazards are required to
incorporate environmental protection measures into their operations and
establish a reliable system for environmental protection. Such a system must
adopt effective measures to prevent and control pollution levels and harm caused
to the environment in the form of waste gas, waste water and solid waste, dust,
malodorous gas, radioactive substance, noise, vibration and electromagnetic
radiation generated in the course of production, construction or other
activities. Companies in the PRC are also required to carry out an environment
impact assessment before commencing construction of production facilities and
the installation of pollution treatment facilities that meet the relevant
environmental standards and treat pollutants before discharge. We carried out
the required environment impact assessment before commencing construction of our
production facilities and have obtained all the required permits and
environmental approvals for our production facilities.
The main
environmental impact from our operations is the generation of wastewater and
noise pollution from the operation of production machinery. In order to comply
with the relevant environmental protection laws and regulations, we have
implemented an environmental protection system to ensure the emissions from
production operations meet the pollution indicators. In addition, our production
plant is located in an open area, away from residential areas and equipped with
an appropriate convection and ventilation system. In order to reduce the impact
on the environment, we have enhanced the convection and ventilation system at
our production facilities to improve air quality and adopted various measures to
prevent and minimize the noise pollution from our production
operations.
23
Health
and Safety Matters
The PRC
Production Safety Law (the “Production Safety Law”) requires that we maintain
safe working conditions under the Production Safety Law and other relevant laws,
administrative regulations, national standards and industrial standards. We are
required to offer education and training programs to our employees regarding
production safety. The design, manufacture, installation, use and maintenance of
our safety equipment are required to conform to applicable national and
industrial standards. In addition, we are required to provide employees with
safety and protective equipment that meet national and industrial standards and
to supervise and educate them to wear or use such equipment according to the
prescribed rules.
We
consider the safety of our employees to be a priority. We have implemented
internal health and safety policies in the work place, available through our
handbook on production safety and security procedures, which incorporate safety
laws and regulations in the PRC. We have implemented safety guidelines on
production procedures for the safe operation of production equipment and
machinery during each stage of the production process. We require our employees
to attend occupational safety education training courses on our safety policies
and procedures to enhance their awareness of safety issues. We provide and
require our employees to wear suitable protective devices to ensure their
safety. We also provide employees with free annual medical
check-ups.
As
required under the Regulation of Insurance for Labor Injury, Provisional
Insurance Measures for Maternity of Employees, Interim Regulation on the
Collection and Payment of Social Insurance Premiums and Interim Provisions on
Registration of Social Insurance, we provide our employees in the PRC with
welfare schemes covering pension insurance, unemployment insurance, maternity
insurance, injury insurance and medical insurance.
We
believe that we were in compliance with all applicable labor and safety laws and
regulations in all-material respects, and implemented internal safety guidelines
and operating procedures.
We
believe that we are in compliance with the new PRC Labor Contract Law, which
came into effect on January 1, 2008, in all respects, and do not believe this
new law will have any impact on our business and operations. Since the
commencement of our business, none of our employees has been involved in any
major accident in the course of their employment and we have never been subject
to disciplinary actions with respect to the labor protection
issues.
Food
Safety Regulations and Production Permit
Under
previous legal regime, food producers and food processing companies are required
to obtain both the food hygiene permit and food production permit for their
operations. The New Food Safety Law (“Food Safety Law”) issued by the
Standing Committee of the National Peoples’ Congress (“NPC”) on February 28,
2009 repealed the Food Hygiene Law (issued by the Standing Committee of NPC in
1995) and as a result the producers engaged in the production or processing of
food-related products are only required to obtain the production permits issued
by the local office of the PRC General Administration of Quality Supervision,
Inspection and Quarantine for their operations.
The PRC
General Administration of Quality Supervision, Inspection and Quarantine issued
the Measures for Quality Supervision and Administration of the Food Production
and Processing Enterprises (the “Measures”). According to the Measures, China
establishes Food Safety and Market Entry System. Any food processing enterprises
shall guarantee food safety and maintain requisite manufacturing conditions.
Industrial Product Manufacture Licensing Certificate shall be obtained prior to
the production of food and its entering into the market. The PRC General
Administration of Quality Supervision, Inspection and Quarantine is responsible
for issuance of examination rules for the Product Manufacture Licensing
Certificate for different kinds of food as well as the issuance of Food Product
Manufacture Licensing Certificate.
24
The
Examination Rules for Product Manufacture Licensing Certificate of Starch and
Starch-Based Products issued by the PRC General Administration of Quality
Supervision, Inspection and Quarantine further specified that the Product
Manufacture Licensing Certificate is required for the production of starch and
starch-based products.
25
RISK
FACTORS
Risks
Relating to Our Business
Our
plans to build new production facilities may be delayed which would affect our
business and financial performance
Our plans
to build new production facilities in the near future could be delayed hurting
our financial performance. We may not be able to raise enough money in our
financing to execute our expansion plans, resulting in a delay in building new
production facilities. In addition, market volatility could limit our
working capital, delaying us from building new production facilities.
These delays could have a significant effect on our financial
performance.
Fluctuations
in supply and commodity prices of potatoes may affect our earnings.
Currently,
all our raw materials are procured in China. Profitability in the potato starch
industry is materially affected by the need to maintain a sufficient supply of
potatoes at stable prices from farmers. These commodity prices are determined by
supply and demand. While the potato starch industry has historically not been
subject to wide fluctuations and cycles, we cannot eliminate the risk of
increased operating costs from potato price increases, and it is very difficult
to predict when and if price spiral cycles will occur.
Various
factors can affect the supply of potatoes. In particular, climate patterns and
soil conditions, the level of supply inventories and demand, and the
agricultural policies of the Chinese government affect the supply of potatoes.
Deteriorations in any of the above factors could result in increases in the
price of potatoes which would affect our profitability if we are unable to pass
such increases onto our customers.
Natural
disasters and outbreaks of disease affecting potato cultivation may occur,
which can significantly restrict our ability to conduct our
operations.
Events
beyond our control, such as the occurrence of droughts, floods, earthquakes or
other natural disasters could result in a material potato shortage and may have
an adverse effect on our business and results of operations. Similarly, an
outbreak of disease may result in government restrictions on the sale of
potatoes and therefore potato starch. This may result in the cancellation of
orders by our customers and create adverse publicity that may have a material
adverse effect on our business, reputation and prospects.
26
Our
failure to compete with other potato starch companies, especially companies with
greater resources, may adversely affect our business, financial condition and
results of operations.
The
Chinese potato starch industry is highly competitive. In general, competitive
factors in the industry include price, product quality, brand identification,
breadth of product line and customer service. Our success depends in part on our
ability to manage costs and be efficient in the highly competitive potato starch
industry. Some of our competitors have greater financial and marketing
resources. As a result, we may not be able to successfully increase our market
penetration or our overall share in the potato starch market.
Increased
competition may result in price reductions, increased sales incentive offerings,
lower gross margins, sales expenses, marketing programs and expenditures to
expand channels to market. Our competitors may offer products with better market
acceptance, better price or better quality. Our business may be adversely
affected if we are unable to maintain current product cost reductions, or
achieve future product cost reductions. If we fail to address these competitive
challenges, there may be a material adverse effect upon our business,
consolidated results of operations and financial condition.
Our
sales revenue may be adversely affected by various factors, including demand for
our products, sales price and general market conditions.
Demand
for our products is highly affected by a number of factors, including the
general demand for the products in the end markets that we serve and the sales
prices of our products. A vast majority of our sales is derived directly or
indirectly from customers who are manufacturers of processed food. Any
significant decrease in the demand for processed food may result in a decrease
in our revenues and earnings. A variety of factors, including urbanization,
consumer spending power and taste preferences may contribute to a slowdown in
the demand for processed food.
Our
potato supply is subject to various risks from the farmers who supply the
potatoes.
We have
steady relations with local farmers to ensure a constant supply of potatoes at
our required quality standards. There is no assurance that we will be able to
continue to renew such agreements with the farmers who may determine to use the
land for other cash crops or to sell their potatoes to other parties who can
offer a higher price. In such event, our business and results of operations will
be adversely affected.
Failure
to retain the services of key personnel or to hire and retain suitably
experienced executives will affect our business and financial
performance.
Our
success to date is largely attributable to the contribution and experience of
our key management personnel who are familiar with our business and understand
our customers’ needs and requirements. In particular, our Chairman, Joanny Kwok
having 7 years of experience in the potato starch industry. Chairman Kwok
is responsible for formulating and implementing our overall business strategy
and corporate development and, together with our management team, has steered
our growth and expansion. Our continued success is therefore dependent, to a
large extent, on our ability to retain and motivate the services of our key
management and operational personnel. The loss of the services of certain of our
key management personnel, who may be affected by health or other reasons,
without suitable and timely replacement will affect our business and results of
operations.
27
We
currently have no employment agreement with Ms. Kwok and Ms. Kwok is not
obligated to devote any specified number of hours to working for us. There
can be no assurance that we will be able to reach an agreement with either Ms.
Kwok on terms favorable to us, if at all. If she ceases to be employed by
us, we may have difficulty finding a suitable replacement with equal leadership
and industry experience, and our business would suffer because we will not have
the leadership needed to capitalize on market opportunities and to direct our
growth, leading to a possible decrease in revenues and inappropriate capital
investments in projects that may not benefit our long-term growth. We do
not maintain key-person insurance on any of our executive officers.
We
may need additional capital and we may not be able to obtain it at acceptable
terms, or at all, which could adversely affect our liquidity and financial
position.
We may
need additional cash resources due to changed business conditions or other
future developments. If these sources are insufficient to satisfy our cash
requirements, we may seek to sell additional equity or debt securities or obtain
a credit facility. The incurrence of indebtedness would result in increased debt
service obligations and could result in operating and financing covenants that
would restrict our operations and liquidity.
Our
ability to obtain additional capital on acceptable terms is subject to a variety
of uncertainties, including, but not limited to:
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investors’
perception of, and demand for, securities of similar potato starch
companies in China;
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conditions
of the U.S. and other capital markets in which we may seek to raise
funds;
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our
future results of operations, financial condition and cash
flow;
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PRC
governmental regulation of foreign investment in oil and gas equipment and
services/clean technology companies in
China;
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economic,
political and other conditions in China;
and
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PRC
governmental policies relating to foreign currency
borrowings.
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We
may face difficulties in protecting our intellectual property
We have
two trademarks and one design patent registered in the PRC (Please refer to the
section entitled “Intellectual Property Rights” of this Current
Report). Although these intellectual properties are protected through
registration, enforcement of measures for the protection of intellectual
property rights in the PRC is currently not as certain or effective as compared
to some developed countries. We believe our trademarks are critical to our
success and that the success of our business depends in part upon our continued
ability to use or to further develop and increase brand awareness. The
infringement of our trademarks would diminish the value of our brand and its
market acceptance, as well as our competitive advantages.
Monitoring
and preventing the unauthorized use of our intellectual property is difficult.
The measures we take to protect our brand, trade names, copyrights and other
intellectual property rights may not be adequate to prevent their unauthorized
use by third parties. Furthermore, application of laws governing intellectual
property rights in China and abroad is uncertain and evolving, and could involve
substantial risks to us. If we are unable to adequately protect our brand,
trademarks and other intellectual property rights, we may lose these rights and
our business, results of operations, financial condition and prospects could be
materially and adversely affected.
28
We
may be adversely affected by any failure to maintain our existing or obtain
future licenses, permits or approvals.
On July
18, 2003, the PRC General Administration of Quality Supervision, Inspection and
Quarantine issued the Measure for Quality Supervision and Administration of the
Food Production and Processing Enterprises (the “Measure”). The Measure
established the rules on the market access of the food industry. According to
the Measure, food production enterprises shall pass the examination before mass
production, and all finished product shall pass the requisite inspection before
entering into the market. All finished products, which have passed the
inspection, shall be attached with a “Quality Safety Label” (QS Label). On
December 23, 2004, the General Administration of Quality Supervision, Inspection
and Quarantine issued a notice which required 13 more categories of food
including starch and starch related products to obtain the Food Production
Certificate (the “Certificate”) before it may enter the market. Accordingly, our
products, namely our potato starch and potato starch-based products are required
to comply with the notice and obtain the Certificate. However, the deadline for
the application for the Certificate has not been determined by the authorities.
We have made an application for the Certificate and approval from the local
government is currently pending. When and if a deadline is imposed and if we
fail to obtain the Certificate before such deadline, the Administration of
Quality Supervision, Inspection and Quarantine may require us to cease our
production and sales. In addition, we will be fined between 100% to 300% of the
value of all the products we have produced after the deadline (including all
sold and unsold products). All revenue earned from the sale of such products
will also be confiscated.
Any
failure to maintain our existing or obtain future licenses, permits or approvals
may have a material adverse effect on our operations.
Disruptions
to our production facilities will affect our financial conditions and results of
operations.
Our
business will be affected by disruptions to our production facilities, such as
water supply, fire, machine down time or the occurrence of power failure or
power surge, which would result in damage to our production equipment and
facilities, or result in suspension of production or delay in our production
process. In addition, our business may be interrupted or otherwise affected by
natural disasters, such as floods, droughts and earthquakes, which could cause
damage to our production facilities. In August 2010, a serious mud-rock flow
broke out at Gongshan and Zhouqu in Yunnan and Gansu Provinces respectively,
near where our production facilities are located. We were not affected by the
mud-rock flow in Yunnan and Gansu, but we cannot assure you that we would not be
adversely affected by a similar natural disaster in the future. Any major
disruption to our production facilities such as the foregoing could have a
material adverse effect on our financial condition and results of
operations.
Our
industry may be affected by the introduction of a potato-starch substitute
product with similar or superior functionality at an attractive price
point.
The main
raw material for the production of our potato starch is potatoes, and potatoes
are not the only
source of starch. Other alternative sources of starch include corn and tapioca.
If new technologies are developed, which can significantly increase starch
output of alternative sources, or if the quality of alternative sources of
starch allows for a higher rate of production than that of starch and
starch-based products which compete with our products, or if new production
technologies are developed which render our production facilities obsolete, our
business operations, profitability and prospects may be adversely affected.
Similarly, alternative products may be developed which may render our products
uncompetitive. The production of such alternative products will adversely affect
our business operations, financial performance and prospects.
29
Our
business is subject to environmental protection laws and
regulations.
We are
required to comply with the environmental protection laws and regulations
promulgated by the state and local governments of the PRC and the prescribed
standards relating to the discharge of waste water, solid wastes, effluent and
gases. These regulations empower local governments to impose penalties on those
companies, which do not comply with these laws and regulations. The nature of
our business is such that waste water and materials are regularly discharged
from our production processes.
We have
installed waste treatment facilities on certain of our production facilities to
treat such discharges. However, there can be no assurance that we will at all
times be in full compliance with the laws and regulations promulgated by the
state and local governments of the PRC. Any failure by us to discharge the waste
generated from our production processes in accordance with the relevant laws and
regulations could subject us to warnings, fines or other penalties imposed by
the environmental protection administration or the relevant government
department with power to conduct environmental supervision and management in the
PRC. The amount of such fines to be imposed is at the discretion of the
environmental protection administration or the relevant government department
with power to conduct environmental supervision and management in the PRC, who
will determine such amount by taking into account factors such as the extent and
seriousness of the pollution. Should the environmental protection administration
or the relevant government department with power to conduct environmental
supervision and management in the PRC determine that the pollution caused is
very severe, criminal penalties, such as a jail term, may also be
imposed.
If our
business operations result in environmental pollution, we will also be obliged
to rectify the harm caused to the environment and pay compensation to the entity
or individual that suffered direct losses as a result of the pollution. Further,
should our production facilities fail to meet other applicable environmental
protection requirements from time to time, we may be subject to fines and be
required to take remedial measures. This may have a negative effect on our
business.
In
addition to the above, the promulgation of any new environmental laws or
regulations, which require us to acquire equipment or incur additional capital
expenditures would inevitably increase our costs and affect the profitability
and prospects of our business.
If
we are unable to establish appropriate internal financial reporting controls and
procedures, it could cause us to fail to meet our reporting obligations, result
in the restatement of our financial statements, harm our operating results,
subject us to regulatory scrutiny and sanction, cause investors to lose
confidence in our reported financial information and have a negative effect on
the market price for shares of our common stock.
Effective
internal controls are necessary for us to provide reliable financial reports and
effectively prevent fraud. We maintain a system of internal control over
financial reporting, which is defined as a process designed by, or under the
supervision of, our principal executive officer and principal financial officer,
or persons performing similar functions, and effected by our board of directors,
management and other personnel, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with accounting principles generally
accepted in the United States of America.
30
As a
public company, we will have significant additional requirements for enhanced
financial reporting and internal controls. We will be required to document and
test our internal control procedures in order to satisfy the requirements of
Section 404 of the Sarbanes-Oxley Act of 2002, which requires annual management
assessments of the effectiveness of our internal controls over financial
reporting and a report by our independent registered public accounting firm
addressing these assessments. The process of designing and implementing
effective internal controls is a continuous effort that requires us to
anticipate and react to changes in our business and the economic and regulatory
environments and to expend significant resources to maintain a system of
internal controls that is adequate to satisfy our reporting obligations as a
public company.
We cannot
assure you that we will not, in the future, identify areas requiring improvement
in our internal control over financial reporting. We cannot assure you that the
measures we may take to remediate any areas in need of improvement will be
successful or that we will implement and maintain adequate controls over our
financial processes and reporting in the future as we continue our growth. If we
are unable to establish appropriate internal financial reporting controls and
procedures, it could cause us to fail to meet our reporting obligations, result
in the restatement of our financial statements, harm our operating results,
subject us to regulatory scrutiny and sanction, cause investors to lose
confidence in our reported financial information and have a negative effect on
the market price for shares of our common stock.
Lack
of experience as officers of publicly-traded companies of our management team
may hinder our ability to comply with the Sarbanes-Oxley Act.
It may be
time consuming, difficult and costly for us to develop and implement the
internal controls and reporting procedures required by the Sarbanes-Oxley Act.
We may need to hire additional financial reporting, internal control and other
finance staff in order to develop and implement appropriate internal controls
and reporting procedures. If we are unable to comply with the Sarbanes-Oxley
Act’s internal control requirements, we may not be able to obtain the report on
internal control over financial reporting from our independent registered public
accounting firm that the Sarbanes-Oxley Act requires publicly-traded companies
to obtain.
We
will incur increased costs as a result of being a public company.
As a
public company, we will incur significant legal, accounting and other expenses
that we did not incur as a private company. In addition, the Sarbanes-Oxley Act
of 2002, as well as new rules subsequently implemented by the SEC, have 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 incur additional costs associated with our
public company reporting requirements. We are currently evaluating and
monitoring developments with respect to these new rules, and we cannot predict
or estimate the amount of additional costs we may incur or the timing of such
costs.
Risks
Associated with Doing Business in the PRC
Changes
in political, economic and legal developments in China may adversely affect our
business.
As we
derive substantially all of our revenues in China and substantially all of our
assets and operations are in China, our continued growth would depend heavily on
China’s general economic condition. The Chinese economy has grown significantly
in recent years, especially after China’s accession to the World Trade
Organization in 2001. We, however, cannot assure you that the Chinese economy
will continue to grow, or that such growth will be steady or in geographic
regions or economic sectors that will benefit us. A downturn in China’s economic
growth or a decline in economic condition may have material adverse effects on
our results of operations.
31
Further,
we will continue to be affected by the political, social and legal developments
of China. Since the late 1970s, the PRC government has introduced a series of
economic and political reforms, including measures designed to effectuate the
country’s transitioning from a planned economy to a more market-oriented
economy. During such economic and political reforms, a comprehensive system of
laws were promulgated, including many new laws and regulations seeking to
provide general guidance on economic and business practices in China and to
regulate foreign investment. Although the Chinese economy has been transitioning
from a planned economy to a more market-oriented economy, a substantial portion
of the productive assets in China are still owned by the PRC government. The
continued control of these assets and other aspects of the national economy by
the Chinese government could materially and adversely affect our
business.
In the
past twenty years, the growth of the Chinese economy has been uneven across
different geographic regions and different economic sectors. In order to
stabilize national economic growth, the PRC government adopted a series of
macroeconomic policies. These policies include measures that restricted
excessive growth and investment in specific sectors of the economy. More
recently, on the other hand, the PRC government has implemented stimulus
responses to the global financial crisis. We cannot predict the future direction
of economic reforms or the effects that any such measures may have on our
business, financial condition or results of operations.
The
PRC government exerts substantial influence over the manner in which we must
conduct our business activities.
China
only recently has permitted provincial and local economic autonomy and private
economic activities. The Chinese government has exercised and continues to
exercise substantial control over virtually every sector of the Chinese economy
through regulation and state ownership. Our ability to operate in China may be
harmed by changes in its laws and regulations, including those relating to
taxation, import and export tariffs, environmental regulations, land use rights,
property and other matters. We believe that our operations in China are in
material compliance with all applicable legal and regulatory requirements.
However, the central or local governments of these jurisdictions may impose new,
stricter regulations or interpretations of existing regulations that would
require additional expenditures and efforts on our part to ensure our compliance
with such regulations or interpretations.
Accordingly,
government actions in the future, including any decision not to continue to
support recent economic reforms and to return to a more centrally planned
economy or regional or local variations in the implementation of economic
policies, could have a significant effect on economic conditions in China or
particular regions thereof, and could require us to divest ourselves of any
interest we then hold in Chinese properties or joint ventures.
Most
of our revenues are denominated in Renminbi, which is not freely convertible for
capital account transactions and may be subject to exchange rate
volatility.
We are
exposed to the risks associated with foreign exchange controls and restrictions
in China, as our revenues are primarily denominated in Renminbi, which is
currently not freely exchangeable. The PRC government imposes control over the
convertibility between Renminbi and foreign currencies. Under the PRC foreign
exchange regulations, payments for “current account” transactions, including
remittance of foreign currencies for payment of dividends, profit distributions,
interest and operation-related expenditures, may be made without prior approval
but are subject to procedural requirements. Strict foreign exchange control
continues to apply to “capital account” transactions, such as direct foreign
investment and foreign currency loans. These capital account transactions must
be approved by or registered with the PRC State Administration of Foreign
Exchange, or “SAFE.” Further, any capital contribution by an offshore
shareholder to its PRC subsidiaries should be approved by the Ministry of
Commerce, “MOFCOM,” in China or its local counterparts. We cannot assure you
that we are able to meet all of our foreign currency obligations to remit
profits out of China or to fund operations in China.
32
On August
29, 2008, SAFE promulgated the Circular on the Relevant Operating Issues
concerning the Improvement of the Administration of Payment and Settlement of
Foreign Currency Capital of Foreign-invested Enterprises, or “Circular 142”, to
regulate the conversion by foreign invested enterprises, or FIEs, of foreign
currency into Renminbi by restricting how the converted Renminbi may be used.
Circular 142 requires that Renminbi converted from the foreign
currency-dominated capital of a FIE may only be used for purposes within the
business scope approved by the applicable government authority and may not be
used for equity investments within the PRC unless specifically provided for
otherwise. In addition, SAFE strengthened its oversight over the flow and use of
Renminbi funds converted from the foreign currency-dominated capital of a FIE.
The use of such Renminbi may not be changed without approval from SAFE, and may
not be used to repay Renminbi loans if the proceeds of such loans have not yet
been used.
We
rely principally on dividends and other distributions on equity paid by our PRC
subsidiaries, and limitations on its ability to pay dividends to us could have a
material adverse effect on our business and results of operations.
We are a
holding company and we rely principally on dividends and other distributions on
equity paid by our PRC subsidiaries, for our cash and financing requirements,
including the funds necessary to pay dividends and other cash distributions to
our shareholders, service any debt we may incur and pay our operating expenses.
If our PRC subsidiaries incur debt on their own behalf in the future, the
instruments governing the debt may restrict their ability to pay dividends or
make other distributions to us.
As an
entity established in China, our PRC subsidiaries are subject to certain
limitations with respect to dividend payments. PRC regulations currently permit
payment of dividends only out of accumulated profits as determined in accordance
with accounting standards and regulations in China. Our PRC subsidiaries, as
wholly foreign owned enterprises, may not distribute their after-tax profits to
us if they have not already made contributions to their reserve fund, enterprise
development fund and employee bonus and welfare fund at percentages that are
decided by its board of directors. We had no restricted net assets as of
December 31, 2009. In addition, if any of our PRC subsidiaries incurs any debt
on its own behalf in the future, the instruments governing the debt may restrict
their ability to pay dividends or make other distributions to us. Limitations on
the ability of our PRC subsidiaries to pay dividends to us could adversely limit
our ability to grow, make investments or acquisitions that could be beneficial
to our businesses, pay dividends, or otherwise fund and conduct our business.
Accordingly, if for any of the above or other reasons, we do not receive
dividends from our PRC subsidiaries, our liquidity, financial condition and
ability to make dividend distributions to our shareholders will be materially
and adversely affected.
33
Fluctuation
in the value of the Renminbi and of the U.S. dollar may have a material adverse
effect on investments in our ordinary shares.
Any
significant revaluation of the Renminbi may have a material adverse effect on
the U.S. dollar equivalent amount of our revenues and financial condition as
well as on the value of, and any dividends payable on, our ordinary shares in
foreign currency terms. For instance, a decrease in the value of Renminbi
against the U.S. dollar could reduce the U.S. dollar equivalent amounts of our
financial results, the value of your investment in our ordinary shares and the
dividends we may pay in the future, if any, all of which may have a material
adverse effect on the prices of our ordinary shares. As of December 31, 2009, we
had cash denominated in U.S. dollars of approximately $22,131,000 USD. Any
further appreciation of Renminbi against U.S. dollars may result in significant
exchange losses.
Prior to
1994, Renminbi experienced a significant net devaluation against most major
currencies, and there was significant volatility in the exchange rate during
certain periods. Upon the execution of the unitary managed floating rate system
in 1994, the Renminbi was devalued by 50% against the U.S. dollar. Since 1994,
the Renminbi to U.S. dollar exchange rate has largely stabilized. On July 21,
2005, the People’s Bank of China announced that the exchange rate of U.S. dollar
to Renminbi would be adjusted from $1 to RMB8.27 to $1 to RMB8.11, and it ceased
to peg the Renminbi to the U.S. dollar. Instead, the Renminbi would be pegged to
a basket of currencies, whose components would be adjusted based on changes in
market supply and demand under a set of systematic principles. On September 23,
2005, the PRC government widened the daily trading band for Renminbi against
non-U.S. dollar currencies from 1.5% to 3.0% to improve the flexibility of the
new foreign exchange system. Since the adoption of these measures, the value of
Renminbi against the U.S. dollar has fluctuated on a daily basis within narrow
ranges, but overall has further strengthened against the U.S. dollar. There
remains significant international pressure on the PRC government to further
liberalize its currency policy, which could result in a further and more
significant appreciation in the value of the Renminbi against the U.S. dollar.
The Renminbi may be revalued further against the U.S. dollar or other
currencies, or may be permitted to enter into a full or limited free float,
which may result in an appreciation or depreciation in the value of the Renminbi
against the U.S. dollar or other currencies.
Adverse
changes in PRC economic and political policies could have a material adverse
effect on the overall economic growth of China and that could increase
inflation, which may reduce the demand for our products and materially and
adversely affect our business.
Our PRC
subsidiaries are based in China. As such, our business, financial condition,
results of operations and prospects are affected significantly by economic,
political and legal developments in China. China’s economy differs from the
economies of most developed countries in many aspects, including:
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the
level of government involvement;
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the
level of development;
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the
growth rate;
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the
level and control of capital investment;
and
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the
control of foreign exchange.
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34
While the
Chinese economy has grown significantly in the past two decades, the growth has
been uneven geographically, among various sectors of the economy and during
different periods. We cannot assure you that the Chinese economy will continue
to grow or to do so at the pace that has prevailed in recent years, or that if
there is growth, such growth will be steady and uniform. In addition, if there
is a slowdown, such slowdown could have a negative effect on our business. For
example, the Chinese economy experienced high inflation in the second half of
2007 and the first half of 2008. China’s consumer price index increased by 7.0%
during the nine months ended September 30, 2008 as compared to the same period
in 2007. To combat inflation and prevent the economy from overheating, the PRC
government adopted a number of tightening macroeconomic measures and monetary
policies. Due in part to the impact of the global crisis in financial services
and credit markets and other factors, the growth rate of China’s gross domestic
product as measured against the same period of the previous year decreased to
7.1% in the first half of 2009, down from 10.4% in the first half of 2008.
Beginning in September 2008, among other measures, the PRC government began to
loosen macroeconomic measures and monetary policies, including reducing interest
rates and decreasing the statutory reserve rates for banks. In addition, in
November 2008 the PRC government announced an economic stimulus package in the
amount of $586 billion. It is uncertain whether the various macroeconomic
measures, monetary policies and economic stimulus packages adopted by the PRC
government will be effective in restoring or sustaining the fast growth rate of
the Chinese economy. In addition, such measures, even if they benefit the
overall Chinese economy in the long term, may have a negative effect on us. For
example, our financial condition and results of operations may be materially and
adversely affected by government control over capital investments.
China’s
legal system is different from those in most other countries.
China is
a civil law jurisdiction. Under the civil law system, prior court decisions may
be cited as persuasive authority but do not have binding precedential effect.
Although progress has been made in the promulgation of laws and regulations
dealing with economic matters, such as corporate organization and governance,
foreign investment, commerce, taxation and trade, China’s legal system remains
less developed than the legal systems in many other countries. Furthermore,
because many laws, regulations and legal requirements have been recently
adopted, their interpretation and enforcement by the courts and administrative
agencies may involve uncertainties. Sometimes, different government departments
may have different interpretations. Licenses and permits issued or granted by
one government authority may be revoked by a higher government authority at a
later time. Government authorities may decline to take action against unlicensed
operators, which may work to the disadvantage of licensed operators, including
us. The PRC legal system is based in part on government policies and internal
rules (some of which may not be published on a timely manner or at all) that may
have a retroactive effect. We may even not be aware of our violation of these
policies and rules until sometime after the violation. Changes in China’s legal
and regulatory framework, the promulgation of new laws and possible conflicts
between national and provincial regulations could adversely affect our financial
condition and results of operations. In addition, any litigation in China may
result in substantial costs and diversion of resources and management
attention.
Because
our funds are held in banks in the PRC that do not provide insurance, the
failure of any bank in which we deposit our funds could affect our ability to
continue in business.
Banks and
other financial institutions in the PRC do not provide insurance for funds held
on deposit. A significant portion of our assets are in the form of cash
deposited with banks in the PRC, and in the event of a bank failure, we may not
have access to our funds on deposit. Depending upon the amount of money we
maintain in a bank that fails, our inability to have access to our cash could
impair our operations, and, if we are not able to access funds to pay our
suppliers, employees and other creditors, we may be unable to continue in
business.
35
PRC
regulations relating to the establishment of offshore companies by PRC residents
may subject our PRC resident shareholders to personal liability and limit our
ability to inject capital into the PRC subsidiaries, limiting our PRC
subsidiaries ability to distribute profits to us or otherwise adversely affect
us.
SAFE
issued the Notice on Issues Relating to the Administration of Foreign Exchange
in Fund-raising and Reverse Investment Activities of Domestic Residents
Conducted via Offshore Special Purpose Companies, or “Notice 75,” on October 21,
2005, which became effective as of November 1, 2005 and the operating procedures
in May 2007, collectively the SAFE Rules. According to the SAFE Rules, prior
registration with the local SAFE branch is required for PRC residents to
establish or to control an offshore company for the purposes of financing that
offshore company with assets or equity interests in an onshore enterprise
located in the PRC. An amendment to registration or filing with the local SAFE
branch by such PRC resident is also required for the injection of equity
interests or assets of an onshore enterprise in the offshore company or overseas
funds raised by such offshore company, or any other material change involving a
change in the capital of the offshore company. Moreover, the SAFE Rules have
retroactive effect. As a result, PRC residents who had established or acquired
control of offshore companies that had made onshore investments in the PRC
before promulgation of the SAFE Rules were required to complete the relevant
registration procedures with the local SAFE branch by March 31, 2006. The SAFE
rules define “PRC residents” to include both legal persons and natural persons
who either hold legal PRC identification documents, or who habitually reside in
China due to economic interests or needs. If any PRC resident fails to file its
SAFE registration for an existing offshore enterprise, any dividends remitted by
the onshore enterprise to its overseas parent after October 21, 2005 will be
considered to be an evasion of foreign exchange purchase rules, and the payment
of the dividend will be illegal. As a result, both the onshore enterprise and
its actual controlling persons can be fined. In addition, failure to comply with
the registration procedures may result in restrictions on the relevant onshore
enterprise, including prohibitions on the payment of dividends and other
distributions to its offshore parent or affiliate and capital inflow from the
offshore enterprise. The PRC resident shareholders of the offshore enterprise
may also be subject to penalties under Chinese foreign exchange administration
regulations.
Our
ultimate shareholders are all non PRC citizens; however, it is not clear whether
any of our ultimate shareholders will be defined as PRC resident under the
Circular 75 and hence be required to complete the individual SAFE
registration. To date, we have not received any communications from, or
had contact with, the PRC government with respect to SAFE Rules. However, we
cannot provide any assurance that whether any of our beneficial shareholders
will be required by SAFE in the future to complete the SAFE registration and, if
we are so requested, whether all of our shareholders and beneficial owners will
comply with the request to make or obtain any applicable registrations or comply
with other requirements required by SAFE Rules. The failure or inability of our
PRC resident shareholders or beneficial owners to make any required
registrations or comply with other requirements may subject such shareholders or
beneficial owners to fines and legal sanctions and may also limit our ability to
contribute additional capital into or provide loans to our PRC subsidiaries,
limit the ability of our PRC subsidiaries to pay dividends or otherwise
distribute profits to us, or otherwise adversely affect us.
36
In
January 2007, SAFE promulgated the Detailed Rules for the Implementation of the
Measures for the Administration of Individual Foreign Exchange, and the
Operating Rules on the Foreign Exchange Administration of the Evolvement of
Domestic Individuals in the Employee Stock Ownership Plans and Share Option
Schemes of Overseas Listed Companies, or “Circular 78.” Under Circular 78, where
PRC domestic individuals are involved in the employee stock ownership plans or
share option schemes of overseas listed companies, such plans or schemes must be
submitted to competent foreign exchange administration authorities for approval,
and the PRC employees shall entrust its agent or the affiliates or branches of
the overseas listed company to apply to competent authorities for purchasing
certain amount of foreign exchange at certain times each year, in order to
purchase the stock or exercise its option right under the employee stock
ownership plans or the share option schemes within the amounts approved by the
authorities. In addition, the PRC employees involved must declare the progress
of such plans or schemes to the administration authorities periodically. All the
proceeds obtained by such employees from the overseas listed company through the
employee stock ownership plans or the share option schemes, or from sale of the
shares of such overseas listed company, after deducting relevant fees and costs
incurred overseas, shall be remitted to the domestic account of the employees in
full amount. As of the date of this Annual Report, no employee share option has
been granted and is outstanding under the current share option scheme. All the
options for the shares of our Company to be granted to and all the stock
ownership plans to be made for our PRC employees in the future, including
exercise of the option rights and performance of such plans, would be subject to
Circular 78 since we become an overseas listed company. If we or our PRC
employees fail to comply with the provisions of Circular 78, we and/or our PRC
employees may be subject to fines and legal sanctions imposed by the SAFE or
other PRC government authorities. If our PRC employees fail to obtain the
approval from or make relevant registrations with SAFE or its local branches, it
will prevent us from conducting the share option schemes or the stock ownership
plans for our PRC employees. In addition, it may impose cost on us for obtaining
the approval from SAFE or its local branches in connection with the foreign
exchange registration.
In
addition, the PRC employees involved in the Incentive Plan must be subject to
approval by the competent foreign exchange administration authorities and make
the registrations as required under Circular 78. We cannot assure you that the
administration authorities would approve the Incentive Plan, or permit such PRC
employees to go through the registration procedures. If this occurs, the
management, operations and financial conditions of the listed company may be
adversely affected.
We
may have limited legal recourse under PRC laws if disputes arise under our
contracts with third parties.
The
Chinese government has enacted laws and regulations dealing with matters such as
corporate organization and governance, foreign investment, commerce, taxation
and trade. However, precedent and experience in implementing, interpreting and
enforcing these laws and regulations is limited, and our ability to enforce
commercial claims or to resolve commercial disputes is unpredictable. If our new
business ventures are unsuccessful, or other adverse circumstances arise from
these transactions, we face the risk that the parties to these ventures may seek
ways to terminate the transactions, or, may hinder or prevent us from accessing
important information regarding the financial and business operations of these
acquired companies. The resolution of these matters may be subject to the
exercise of considerable discretion by agencies of the Chinese government, and
forces unrelated to the legal merits of a particular matter or dispute may
influence their determination. Any rights we may have to specific performance,
or to seek an injunction under PRC law, in either of these cases, are severely
limited, and without a means of recourse by virtue of the Chinese legal system,
we may be unable to prevent these situations from occurring. The occurrence of
any such events could have a material adverse effect on our business, financial
condition and results of operations.
We
must comply with the Foreign Corrupt Practices Act while many of our competitors
do not.
We are
required to comply with the United States Foreign Corrupt Practices Act, which
prohibits U.S. companies from engaging in bribery or other prohibited payments
to foreign officials for the purpose of obtaining or retaining business. Foreign
companies, including some of our competitors, are not subject to these
prohibitions. Corruption, extortion, bribery, pay-offs, theft and other
fraudulent practices occur from time-to-time in mainland China. If our
competitors engage in these practices, they may receive preferential treatment
from personnel of some companies, giving our competitors an advantage in
securing business or from government officials who might give them priority in
obtaining new licenses, which would put us at a disadvantage. Although we inform
our personnel that such practices are illegal, we cannot assure you that our
employees or other agents will not engage in such conduct for which we might be
held responsible. If our employees or other agents are found to have engaged in
such practices, we could suffer severe penalties.
37
We
may not continue to receive the preferential tax treatment we currently enjoy
under PRC law, and dividends paid to us from our operations in China may become
subject to income tax under PRC law.
The rate
of income tax on companies in China may vary depending on the availability of
preferential tax treatment or subsidies based on their industry or
location. Based on the circular entitled Scope of Preliminary Processing of
Agricultural Products Entitled to Preferential Enterprise Income Tax Policies
(Trial Implementation) published by Ministry of Finance (“MOF”) and State
Administrative of Taxation (“SAT”), our PRC subsidiaries are entitled to full
exemption from the PRC corporate income tax beginning January 1, 2008. The
exemption currently is not subject to any limitations. We do not know how long
this preferential tax treatment will continue or if any new law may change the
preferential treatment granted to us. Any loss or substantial reduction of the
tax benefits enjoyed by us would reduce our net profit.
Under
the EIT Law, we and/or our HK holding company may be classified as a “resident
enterprise” of the PRC. Such classification could result in PRC tax consequences
to us and our non-PRC shareholders and/or HK holding company.
Under the
Enterprise Income Tax Law of the PRC (“EIT Law”), which became effective on
January 1, 2008, an enterprise established outside of China with “de facto
management bodies” within China is considered a “resident enterprise,” meaning
that it can be treated in a manner similar to a Chinese enterprise for
enterprise income tax purposes, although the dividends paid to one resident
enterprise from another may qualify as “tax-exempt income.” 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. The EIT Law and its implementing
rules are relatively new and ambiguous in terms of some definitions,
requirements and detailed procedures, and currently no official interpretation
or application of this new “resident enterprise” classification is available;
therefore, it is unclear how tax authorities will determine tax residency based
on the facts of each case.
If HK
holding company were treated as a PRC “non-resident enterprise” under the EIT
Law, then dividends that HK holding company receives from any of our PRC
subsidiaries (assuming such dividends were considered sourced within the PRC)
(i) may be subject to a 5% PRC withholding tax, provided that HK holding company
owns more than 25% of the registered capital of such PRC subsidiary continuously
within 12 months immediately prior to obtaining such dividend from such PRC
subsidiary, and the Arrangement between the Mainland of China and the Hong Kong
Special Administrative Region for the Avoidance of Double Taxation and the
Prevention of Fiscal Evasion with Respect to Taxes on Income, or the “PRC-Hong
Kong Tax Treaty,” were otherwise applicable, or (ii) if such treaty does not
apply (i.e., because the PRC tax authorities may deem HK holding company to be a
conduit not entitled to treaty benefits), may be subject to a 10% PRC
withholding tax. Similarly, if US holding company were treated as a
“non-resident enterprise” under the EIT Law and HK holding company were treated
as a “resident enterprise” under the EIT Law, then dividends US holding company
receives from HK holding company (assuming such dividends were considered
sourced within the PRC) may be subject to a 10% PRC withholding
tax.
38
If US
holding company is determined to be a “resident enterprise” under the EIT Law,
this could result in a situation in which a 10% PRC tax is imposed on dividends
CFO Consultants, Inc. pays to its enterprise, but not individual, investors that
are not tax residents of the PRC, or “non-resident investors” and gains derived
by them from transferring US holding company’s shares or warrants, if such
income is considered PRC-sourced income by the relevant PRC tax authorities. In
such event, US holding company may be required to withhold a 10% PRC tax on any
dividends paid to its non-resident investors. US holding company’s non-resident
investors also may be responsible for paying PRC tax at a rate of 10% on any
gain derived by such investors from the sale or transfer of its shares or
warrants in certain circumstances.
In
January 2009, the State Administration of Taxation promulgated the Provisional
Measures for the Administration of Withholding of Enterprise Income Tax for
Non-resident Enterprises (“Measures”). Entities which have the direct obligation
to make the following types of payments to a non-resident enterprise will be the
relevant tax withholders for such a non-resident enterprise: income from equity
investment (including dividends and other return on investment), interest, rent,
royalties, and income from assignment of property as well as other income
subject to enterprise income taxes received by non-resident enterprises in the
PRC. Further, the Measures provide that in the case of an equity transfer
between two non-resident enterprises outside of the PRC, the non-resident
enterprise which receives the equity transfer payment shall file a tax
declaration with the PRC tax authority located at the place of the PRC company
whose equity has been transferred, and the PRC company whose equity has been
transferred shall assist the tax authorities to collect taxes from the relevant
non-resident enterprise. However, it is unclear whether the Measures cover
equity transfers of a non-resident enterprise, which is a direct, or an indirect
shareholder of a PRC company. Given these Measures, there is a possibility that
we may have an obligation to withhold income tax in respect of the dividends
paid to non-resident enterprise investors.
Changes
in PRC government policy on foreign investment in China may adversely affect our
business and results of operations.
Our PRC
subsidiary is a foreign invested enterprise. As we conduct a significant portion
of our businesses through a foreign investment enterprise in the PRC, we are
subject to restrictions on foreign investment policies imposed by the PRC law
from time to time. Generally, foreign invested enterprises enjoy more favorable
tax treatment in the form of tax incentives and other preferential policies but
are subject to more stringent restrictions in their business operations. If we
cannot obtain approval from relevant approval authorities to engage in
businesses that become restricted or prohibited for foreign investors, we may be
forced to sell or restructure the businesses that have become restricted or
prohibited for foreign investment. If we are forced to adjust our business
portfolio as a result of changes in government policy on foreign investment, our
business, financial condition and results of operations would likely be
materially adversely affected.
Changes
in PRC laws and regulations on labor and employee benefits may adversely affect
our business and results of operations.
As we
conduct a significant portion of our business through our PRC subsidiaries, we
are subject to PRC laws and regulations on labor and employee benefits. In
recent years, the PRC government has implemented policies to strengthen the
protection of employees and obligate employers to provide more benefits to their
employees. In addition, an employment contract law came into effect in the
PRC on January 1, 2008. The PRC employment contract law and related
legislation require more benefits to be provided to employees, such as an
increase in pay or compensation for termination of employment contracts. As a
result, we expect to incur higher labor costs, which would have an adverse
impact on our business and results of operations.
39
We
may be unable to complete a business combination transaction efficiently or on
favorable terms due to complicated merger and acquisition regulations that
became effective on September 8, 2006.
On August
8, 2006, six PRC regulatory agencies promulgated the Regulation on Mergers and
Acquisitions of Domestic Companies by Foreign Investors, which became effective
on September 8, 2006. This new regulation, among other things, governs the
approval process by which a PRC company may participate in an acquisition of
assets or equity interests. Depending on the structure of the transaction, the
new regulation will require the PRC parties to make a series of applications and
supplemental applications to the government agencies. In some instances, the
application process may require the presentation of economic data concerning a
transaction, including appraisals of the target business and evaluations of the
acquirer, which are designed to allow the government to assess the transaction.
Government approvals will have expiration dates by which a transaction must be
completed and reported to the government agencies. Compliance with the new
regulations is likely to be more time consuming and expensive than in the past
and the government can now exert more control over the combination of two
businesses. Accordingly, due to the new regulation, our ability to engage in
business combination transactions has become significantly more complicated,
time consuming and expensive, and we may not be able to negotiate a transaction
that is acceptable to our shareholders or sufficiently protect their interests
in a transaction.
The new
regulation allows PRC government agencies to assess the economic terms of a
business combination transaction. Parties to a business combination transaction
may have to submit to MOFCOM and other relevant government agencies an appraisal
report, an evaluation report and the acquisition agreement, all of which form
part of the application for approval, depending on the structure of the
transaction. The regulations also prohibit a transaction at an acquisition price
obviously lower than the appraised value of the PRC business or assets and in
certain transaction structures, require that consideration must be paid within
defined periods, generally not in excess of a year. The regulation also limits
our ability to negotiate various terms of the acquisition, including aspects of
the initial consideration, contingent consideration, holdback provisions,
indemnification provisions and provisions relating to the assumption and
allocation of assets and liabilities. Transaction structures involving trusts,
nominees and similar entities are prohibited. Therefore, such regulation may
impede our ability to negotiate and complete a business combination transaction
on financial terms that satisfy our investors and protect our shareholders’
economic interests.
The
approval of the China Securities Regulatory Commission may be required in
connection with an offering of our securities under PRC regulations, and, if
required, we cannot currently predict whether we would be able to obtain such
approval.
On August
8, 2006, six PRC regulatory agencies, including the China Securities Regulatory
Commission, or “CSRC,” MOFCOM the State-Owned Assets Supervision and
Administration Commission, or “SASAC”, the State Administration of Taxation, or
“SAT”, the State Administration for Industry and Commerce, or “SAIC” and SAFE
jointly promulgated the Regulation on Mergers and Acquisitions of Domestic
Companies by Foreign Investors, which became effective on September 8, 2006 and
was amended on June 22, 2009 (the “M&A Regulation”). This M&A
Regulation, among other things, has certain provisions that purport to require
offshore special purpose vehicles, or “SPVs”, formed for the purpose of listing
of the equity interests in the PRC Companies on an overseas stock exchange and
directly or indirectly controlled by PRC individuals or companies to obtain
approval from the CSRC prior to listing their securities on an overseas stock
exchange. We have been advised by our PRC counsel, since our PRC subsidiaries
were established as greenfield foreign-invested companies rather than by taking
over existing PRC domestic companies, the M&A Regulation is not applicable
to the formation of our PRC subsidiaries. However, the application of this
M&A Regulation remains unclear with no consensus currently existing among
the leading PRC law firms regarding the scope and applicability of the CSRC
approval requirement. If the CSRC or another PRC regulatory agency subsequently
were to determine that the CSRC approval is required for an offering, we could
face sanctions by the CSRC or other PRC regulatory agencies. If this happens,
these regulatory agencies may impose fines and penalties on our operations in
the PRC, limit our operating privileges in the PRC, delay or restrict the
repatriation of the proceeds from this transaction into the PRC, restrict or
prohibit payment or remittance of dividends by its PRC subsidiaries, or take
other actions that could have a material adverse effect on our business,
financial condition, results of operations, reputation and prospects, as well as
the trading price of our ordinary shares. The CSRC or other PRC regulatory
agencies may also take actions requiring or advising us to halt such an
offering.
40
If
there are any adverse public health developments in China, our business and
operations may be severely disrupted.
Any
prolonged occurrence of avian flu, severe acute respiratory syndrome, or “SARS,”
swine flu, or other adverse public health developments in China or other regions
where we have an operation or presence may have a material adverse effect on our
business operations. These could include the ability of our personnel to travel
or to promote our services within China or at other regions where we have an
operation or presence, as well as temporary closure of our facilities. In
particular, there have been reports of occurrences of avian flu and swine flu in
various parts of China in recent years, including confirmed human cases. In
response, the PRC government has authorized local governments to impose
quarantine and other restrictions on movements of people and goods in the event
of an epidemic. Any closures or travel or other operational restrictions would
severely disrupt our business operations and adversely affect our results of
operations. We have not adopted any written preventive measures or contingency
plans to combat any future outbreak of avian flu, SARS, swine flu, or any other
epidemic.
You
may experience difficulties in effecting service of legal process, enforcing
foreign judgments or bringing original actions in China based on United States
or other foreign laws against us, our management or the experts named in this
Annual Report.
We
conduct substantially all of our operations in China and substantially all of
our assets are located in China. In addition, most of our directors and
executive officers reside within China. As a result, it may not be possible to
affect service of process within the United States or elsewhere outside China
upon some of our directors and senior executive officers, including with respect
to matters arising under U.S. federal securities laws or applicable state
securities laws. It would also be difficult for investors to bring an original
lawsuit against us or our directors or executive officers before a Chinese court
based on U.S. federal securities laws or otherwise. Moreover, our PRC legal
counsel has advised us that the PRC does not have treaties with the United
States or many other countries providing for the reciprocal recognition and
enforcement of judgment of courts. As such, recognition and enforcement in China
of judgments against us, our directors, executive officers or the experts named
in this Current Report obtained from a court in any of those jurisdictions may
be difficult or impossible to enforce.
41
The
Chinese government could change its policies toward private enterprise or even
nationalize or expropriate private enterprises, which could result in the total
loss of our investment in that country.
Our
business is subject to significant political and economic uncertainties and may
be adversely affected by political, economic and social developments in China.
Over the past several years, the Chinese government has pursued economic reform
policies including the encouragement of private economic activity and greater
economic decentralization. The Chinese government may not continue to pursue
these policies or may significantly alter them to our detriment from time to
time with little, if any, prior notice.
Changes
in policies, laws and regulations or in their interpretation or the imposition
of confiscatory taxation, restrictions on currency conversion, restrictions or
prohibitions on dividend payments to shareholders, devaluations of currency or
the nationalization or other expropriation of private enterprises could have a
material adverse effect on our business. Nationalization or expropriation could
even result in the total loss of our investment in China and in the total loss
of your investment in us.
Contract
drafting, interpretation and enforcement in China involves significant
uncertainty, which could leave us vulnerable to legal disputes and challenges
related to our contracts.
We have
entered into numerous contracts governed by PRC law, many of which are material
to our business. As compared with contracts in the United States, contracts
governed by PRC law tend to contain less detail and are not as comprehensive in
defining contracting parties’ rights and obligations. As a result, contracts in
China are more vulnerable to disputes and legal challenges. In addition,
contract interpretation and enforcement in China is not as developed as in the
United States, and the result of any contract dispute is subject to significant
uncertainties. Therefore, we cannot assure you that we will not be subject to
disputes under our material contracts, and if such disputes arise, we cannot
assure you that we will prevail.
If
our land use rights are revoked, we would have no operational
capabilities.
Under
Chinese law land is owned by the state or rural collective economic
organizations. The state issues to the land users the land use right
certificate. Land use rights can be revoked and the land users forced to vacate
at any time when redevelopment of the land is in the public interest. The public
interest rationale is interpreted quite broadly and the process of land
appropriation may be less than transparent. Each of our facilities rely on these
land use rights as the cornerstone of their operations, and the loss of such
rights would have a material adverse effect on our company.
We
could be liable for damages for defects in our products pursuant to the Tort
Liability Law of the PRC.
The Tort
Liability Law of the People’s Republic of China, which was passed during the
12th Session of the Standing Committee of the 11th National People’s Congress on
December 26, 2009, states that manufacturers are liable for damages caused by
defects in their products and sellers are liable for damages attributable to
their fault. If the defects are caused by the fault of third parties such as the
transporter or storekeeper, manufacturers and sellers are entitled to claim for
compensation from these third parties after paying the compensation
amount.
42
We
face uncertainty from China’s Circular on Strengthening the Administration of
Enterprise Income Tax on Non-Resident Enterprises’ Share Transfer that was
released in December 2009 with retroactive effect from January 1,
2008.
The
Chinese State Administration of Taxation, or “SAT,” released a circular
(Guoshuihan No. 698, or “Circular 698”) on December 10, 2009 that addresses the
transfer of shares by nonresident companies. Circular 698, which is
effective retroactively to January 1, 2008, may have a significant impact on
many companies that use offshore holding companies to invest in China.
Circular 698, which provides parties with a short period of time to comply with
its requirements, indirectly taxes foreign (non-PRC) companies, or foreign
investors, on gains derived from the indirect sale of a Chinese company.
Where a foreign investor indirectly transfers equity interests in a Chinese
resident enterprise by selling the shares in an offshore holding company, and
the latter is located in a country or jurisdiction where the actual tax burden
is less than 12.5% or where the offshore income of its residents is not taxable,
the foreign investor is required to provide the tax authority in charge of that
Chinese resident enterprise with certain relevant information within 30 days of
the execution of the equity transfer agreement. Moreover, where a foreign
investor indirectly transfers equity interests in a Chinese resident enterprise
through an abuse of form of organization and there are no reasonable commercial
purposes such that the corporate income tax liability is avoided, the PRC tax
authority will have the power to re-assess the nature of the equity transfer in
accordance with PRC’s “substance-over-form” principle and deny the existence of
the offshore holding company that is used for tax planning
purposes.
There is
uncertainty as to the application of Circular 698. For example, while the
term “indirectly transfer” is not defined, it is understood that the relevant
PRC tax authorities have jurisdiction regarding requests for information over a
wide range of foreign entities having no direct contact with China. Moreover,
the relevant PRC taxing authority has not yet promulgated any formal provisions
or formally declared or stated how to calculate the actual tax burden in the
country or jurisdiction of the offshore holding company and the extent of the
disclosure to the tax authority in charge of the Chinese resident enterprise (or
the process by which such disclosure should be made). In addition, there
are not any formal declarations with regard to how to decide “abuse of form of
organization” and “reasonable commercial purpose,” which can be utilized by us
to determine if our company complies with Circular 698. As a result, we
(or a foreign investor in us) may become at risk of being taxed under Circular
698 and we (or such foreign investor) may be required to expend valuable
resources to comply with Circular 698 or to establish that we (or such foreign
investor) should not be taxed under Circular 698, which could have a material
adverse effect on our financial condition and results of operations (or such
foreign investor’s investment in us).
Because
we may rely on dividends and other distributions on equity paid by our current
and future Chinese subsidiaries for our cash requirements, restrictions under
Chinese law on their ability to make such payments could materially and
adversely affect our ability to grow, make investments or acquisitions that
could benefit our business, pay dividends to you, and otherwise fund and conduct
our businesses.
We have
adopted a holding company structure, and our holding companies may rely on
dividends and other distributions on equity paid by our current and future PRC
subsidiaries for their cash requirements, including the funds necessary to
service any debt we may incur or financing we may need for operations other than
through our PRC subsidiaries. PRC legal restrictions permit payments of
dividends by our PRC subsidiaries only out of their accumulated after-tax
profits, if any, determined in accordance with PRC GAAP. Our PRC subsidiaries
are also required under PRC laws and regulations to allocate at least 10% of
their after-tax profits determined in accordance with PRC GAAP to statutory
reserves until such reserves reach 50% of the company’s registered capital.
Allocations to these statutory reserves and funds can only be used for specific
purposes and are not transferable to us in the form of loans, advances or cash
dividends. Any limitation on the ability of our current or future PRC
subsidiaries to transfer funds to us could materially and adversely limit our
ability to grow, make investments or acquisitions that could be beneficial to
our business, pay dividends and otherwise fund and conduct our
business.
43
Our
payments to the Employee Social Insurance and Housing Funds may be considered
insufficient by the PRC government and further payments could be
required
According
to PRC law and Chinese regulations for social insurance and housing funds, our
PRC subsidiaries are required to make contributions to the social insurance,
including (i) pension; (ii) medical insurance; (iii) unemployment insurance;
(iv) work related injury insurance; (v) maternity insurance, and to the housing
funds of its employees. From its establishment, each of our PRC subsidiaries has
started to make the contribution for the required statutory social insurance for
its employees. However, we cannot assure you that the local social
insurance administrative authority will consider our social insurance payments
as adequate and no further payments will be required.
Our PRC
subsidiaries have not made contributions for the employee housing funds.
If requested by the local housing fund administration authority, our PRC
subsidiary shall make up the housing funds contributions for their employees for
previous periods and may be subject to certain administrative fines
Risks
Related to our Securities
Insiders
have substantial control over us, and they could delay or prevent a change in
our corporate control even if our other stockholders wanted it to
occur.
Our
executive officers, directors, and principal stockholders hold approximately a
large majority of our outstanding Common Stock. Accordingly, these stockholders
are able to control all matters requiring stockholder approval, including the
election of directors and approval of significant corporate transactions. This
could delay or prevent an outside party from acquiring or merging with us even
if our other stockholders wanted it to occur.
We
cannot assure you that the Common Stock will become liquid or that it will be
listed on a securities exchange.
Currently,
we are eligible to be quoted on the OTC Bulletin Board, where an investor may
find it difficult to obtain accurate quotations as to the market value of the
Common Stock. In addition, if we fail to meet the criteria set forth in SEC
regulations, by law, various requirements would be imposed on broker-dealers who
sell its securities to persons other than established customers and accredited
investors. Consequently, such regulations may deter broker-dealers from
recommending or selling our Common Stock, which may further affect its
liquidity.
There
may not be sufficient liquidity in the market for our securities in order for
investors to sell their securities.
There is
currently only a limited public market for our Common Stock and there can be no
assurance that a trading market will develop further or be maintained in the
future.
In
order to raise sufficient funds to expand our operations, we may have to issue
additional securities at prices, which may result in substantial dilution to our
shareholders.
If we
raise additional funds through the sale of equity or convertible debt, our
current stockholders’ percentage ownership will be reduced. In addition, these
transactions may dilute the value of our securities outstanding. We may have to
issue securities that may have rights, preferences and privileges senior to our
common stock. We cannot provide assurance that we will be able to raise
additional funds on terms acceptable to us, if at all. If future financing is
not available or is not available on acceptable terms, we may not be able to
fund our future needs, which would have a material adverse effect on our
business plans, prospects, results of operations and financial
condition.
44
The
market price of our Common Stock may be volatile.
The
market price of our Common Stock has been and will likely continue to be highly
volatile, as is the stock market in general, and the market for OTC Bulletin
Board quoted stocks in particular. Some of the factors that may materially
affect the market price of our Common Stock are beyond our control, such as
changes in financial estimates by industry and securities analysts, conditions
or trends in the industry in which we operate or sales of our Common Stock.
These factors may materially and adversely affect the market price of our Common
Stock, regardless of our performance. In addition, the public stock markets have
experienced extreme price and trading volume volatility. This volatility has
significantly affected the market prices of securities of many companies for
reasons frequently unrelated to the operating performance of the specific
companies. These broad market fluctuations may adversely affect the market price
of our Common Stock.
Because
we became a public company by means of a reverse merger, it may not be able to
attract the attention of major brokerage firms.
Additional
risks may exist since we became public through a “reverse takeover.” Securities
analysts of major brokerage firms may not provide coverage of our securities
since there is little incentive to brokerage firms to recommend the purchase of
our Common Stock. No assurance can be given that brokerage firms will want to
conduct any secondary offerings on our behalf in the future.
If
we fail to maintain an effective system of internal control over financial
reporting, we may not be able to accurately report our financial results. As a
result, current and potential investors could lose confidence in our financial
reporting, which could harm our business and have an adverse effect on our stock
price.
Pursuant
to Section 404 of the Sarbanes-Oxley Act of 2002, we are required to
annually furnish a report by our management on our internal control over
financial reporting. Such report must contain, among other matters, an
assessment by our principal executive officer and our principal financial
officer on the effectiveness of our internal control over financial reporting,
including a statement as to whether or not our internal control over financial
reporting is effective as of the end of our fiscal year. This assessment must
include disclosure of any material weakness in our internal control over
financial reporting identified by management. In addition, under current SEC
rules, we will be required to obtain an attestation from our independent
registered public accounting firm as to our internal control over financial
reporting for our annual report on Form 10-K covering out next fiscal year.
Performing the system and process documentation and evaluation needed to comply
with Section 404 is both costly and challenging. During the course of our
testing we may identify deficiencies which we may not be able to remediate in
time to meet the deadline imposed by the Sarbanes-Oxley Act of 2002 for
compliance with the requirements of Section 404. In addition, if we fail to
maintain the adequacy of our internal controls, as such standards are modified,
supplemented or amended from time to time, we may not be able to ensure that we
can conclude on an ongoing basis that we have effective internal controls over
financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of
2002. Failure to achieve and maintain an effective internal control environment
could also cause investors to lose confidence in our reported financial
information, which could have a material adverse effect on the price of our
Common Stock.
45
Our
Common Stock is considered “penny stock.”
The SEC
has adopted regulations, which generally define “penny stock” to be an equity
security that has a market price of less than $5.00 per share, subject to
specific exemptions. The market price of the Common Stock is currently less than
$5.00 per share and therefore may be a “penny stock.” Brokers and dealers
effecting transactions in “penny stock” must disclose certain information
concerning the transaction, obtain a written agreement from the purchaser and
determine that the purchaser is reasonably suitable to purchase the securities.
These rules may restrict the ability of brokers or dealers to sell the Common
Stock and may affect your ability to sell shares.
The
market for penny stocks has experienced numerous frauds and abuses, which could
adversely impact investors in our stock.
OTCBB
securities are frequent targets of fraud or market manipulation, both because of
their generally low prices and because OTCBB reporting requirements are less
stringent than those of the stock exchanges or NASDAQ.
Patterns
of fraud and abuse include:
|
·
|
Control
of the market for the security by one or a few broker-dealers that are
often related to the promoter or
issuer;
|
|
·
|
Manipulation
of prices through prearranged matching of purchases and sales and false
and misleading press releases;
|
|
·
|
“Boiler
room” practices involving high pressure sales tactics and unrealistic
price projections by inexperienced sales
persons;
|
|
·
|
Excessive
and undisclosed bid-ask differentials and markups by selling
broker-dealers; and
|
|
·
|
Wholesale
dumping of the same securities by promoters and broker-dealers after
prices have been manipulated to a desired level, along with the inevitable
collapse of those prices with consequent investor
losses.
|
Our
management is aware of the abuses that have occurred historically in the penny
stock market.
46
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION, RESULTS OF OPERATIONS AND
PROSPECTS
Disclaimer
Regarding Forward-Looking Statements
This
Current Report on Form 8-K contains forward-looking statements within the
meaning of the federal securities laws. These include statements about our
expectations, beliefs, intentions or strategies for the future, which we
indicate by words or phrases such as “anticipate,” “expect,” “intend,” “plan,”
“will,” “we believe,” “believes,” “management believes” and similar
language. Except for the historical information contained herein, the
matters discussed in this “Management’s Discussion and Analysis of Financial
Condition and Results of Operations,” and elsewhere in this report are
forward-looking statements that involve risks and uncertainties. The factors
listed in the section captioned “Risk Factors,” as well as any cautionary
language in this report, provide examples of risks, uncertainties and events
that may cause our actual results to differ materially from those projected.
Except as may be required by law, we undertake no obligation to update any
forward-looking statement to reflect events after the date of this Form
8-K.
Overview
We are a
premium native potato starch manufacturer in the PRC. Our corporate
headquarters is based in Hong Kong and our operational headquarters is based in
Kunming city, Yunnan province. We began operations in 2004 and have factories
located in Yunnan, Guizhou and Gansu provinces of China.
We
primarily sell our products to distributors and food processing companies in the
PRC, which represented 42.6% and 57.4% of sales respectively for the year ended
December 31, 2009.
Our
products are currently sold under the “Wei Bao” and “Jiabao” brand names.
The Wei Bao brand is targeted primarily to food processors and our Jiabao brand
is targeted to food service operators. We believe that our company is one of the
top 5 premium starch potato processors in the PRC, with a production capacity of
111,500 metric tons per year. In 2008, we received the “China’s Potato Starch
Industry Top Ten Best Selling Products”, “China’s Potato Starch Industry Top Ten
Customer Satisfaction Product” and “China’s Potato Starch Industry Top Ten Best
Brands” awards. Our Jiabao brand created in 2007 is gaining the acceptance
of our target customers.
Sales
We
normally enter into six-month agreements with our customers. The agreement
specifies the quantity that the customer believes they will buy during the
forthcoming six months and the negotiated price per metric ton. Our
customers are not charged a penalty for failing to purchase the quantities set
forth in our contracts. However, historically our customers have purchased the
set amount in the contracts. In the event the market price exceeds the 10%
of the price stipulated in the contract, the agreed price stated on the
agreement will be adjusted to the reflect the current market price.
Historically,
the market price has been within 6% of the contract, not exceeding the 10%
stipulation. We sell premium quality native potato starch, which is usually sold
for 5-10% more than the average market price.
We have
established an extensive distribution network in the PRC. During the year ended
December 31, 2009, 42.6% and 57.4% of our products were sold to manufacturers
and distributors respectively.
47
Revenue
from sales of our native potato starch is recognized upon delivery of our
products to the railway station nearest to our respective factories at which
time the significant risks and rewards of ownership of our products are
transferred to the customers.
Our
revenue has increased from $33.1 million in 2007 to $ 64.5 million in 2009,
representing a compounded annual growth rate of 39.6%. This was
mainly due to the increase in demand for our products from existing and new
customers supported by the increase in our production capacity. We believe
that greater acceptance of our Wei Bao and Jiabao brands in the PRC and our
commitment to continuously improving the quality of our products was also a
contributing factor.
The main
factors that affect our revenue include the following:
(a)
|
Competition
|
We expect
to face competition from potato starch producers with more than 20,000 metric
tons annual production capacity and new entrants. Our future revenue growth
depends on our ability to compete effectively against such competitors on key
considerations including the price and quality of our products. If we are
unable to retain existing customers and secure new ones, or fail to develop new
products to meet the needs of our customers, our revenue and profitability may
be adversely affected.
(b)
|
Stable
supply of raw materials
|
Profitability
in the potato starch industry is materially affected by the need to maintain a
sufficient supply of potatoes at stable prices from farmers. These commodity
prices are determined by supply and demand. While the potato starch industry has
historically not been subject to wide fluctuations and cycles, we cannot
eliminate the risk of increased operating costs from potato price increases, and
it is very difficult to predict when and if price spiral cycles will
occur.
(c)
|
Alternative
raw materials or production
technology
|
If a new
source of starch is discovered as a substitute to native potato starch or new
production technologies are developed that render our production facilities
obsolete, our revenue and profitability may be adversely affected.
(d)
|
Our
production capacity
|
We
currently have a production capacity of 111,500 metric tons per year for native
potato starch. As of June 30, 2010, our production capacity utilization was 87%.
We plan to establish new production lines for native potato starch, modified
potato starch and whole potato starch. We plan to increase our production
capacity to 184,500 metric tons by 2012. Should we able to increase our
production capacity in time to meet any increase in demand, future growth of our
revenue will be significantly improved.
(e)
|
Growth
of native potato starch industry
|
The PRC
continues to experience exponential economic and population growth. The per
capita usage of potato starch in the PRC is mere 0.8kg per annum, compared to
10kg in developed regions such as Europe and Japan. With the increase in
disposable income of the population and the per capita usage of potato starch,
we believe that the demand for our products will continue to rise and improve
our revenue and profitability.
Please
refer to the section “Risk Factors” herein for further information on other
factors that may affect our revenue.
48
Cost
of sales
Our
cost of sales comprises cost of raw material, direct labor and production
overhead, which accounted for 84.4%, 2.1% and 13.5% of our cost of sales
respectively for each of the years ended December 31, 2009.
Potatoes
are a key raw material and we source them from farmers in Yunnan, Gansu and
Guizhou provinces in the PRC.
Direct
labor includes salaries, wages and staff related costs of plant operators and
those who are directly involved in the production of our products. Overhead
consists mainly of depreciation charges on machinery, utilities (water and
electricity) and other factory related costs.
In
addition to the volume of production, our costs of sales are affected by, (i)
factors affecting the costs of raw materials, namely, the market demand and
supply conditions for potatoes, and harvesting conditions; (ii) factors
affecting labor costs, namely demand and supply of labor, general wage levels,
and government regulations; as well as (iii) factors affecting general
manufacturing overhead, namely, our depreciation expense resulting from capital
expenditures and general prices of utilities charges.
Operating
expenses
Our
operating expenses consist of selling and distribution costs and administrative
expenses.
Our
selling and distribution costs consist of transportation costs, salaries and
staff welfare expenses of sales personnel, entertainment expenses and
telecommunication expenses incurred by our sales personnel. Our facilities are
strategically located near railways, which we use as the main method of
transporting our products. We only pay for shipment of our products
to the railway station. Our customers pay for the railway transfer
fee. Transportation costs accounted for an average of 79.5% of our
selling and distribution costs incurred during 2007 through 2009.
Our
administrative and other expenses consist of salaries and staff related expenses
for administrative personnel, depreciation charges, entertainment expenses and
other office related expenses. The major components of administrative and other
expenses include salaries and depreciation, which accounted for an average of
30.0% and 20.0% of our administrative expenses incurred during 2007 through 2009
respectively.
Other
non-operating income
Other
non-operating income consists of government subsidies, bank interest income and
other items. All of our PRC subsidiaries are accredited with “Leading
Enterprise” status, which has entitled them to receive various forms of
preferential treatment from the local and state governments including government
subsidies and infrastructural assistance. The subsidies received related to
agriculture land development fund contributions, commitment to produce high
quality native potato starch and our contribution to rural agriculture
development.
Interest
expense
Our
interest expense consists mainly of interest on bank borrowings, which were
incurred for working capital purposes.
49
Income
tax expenses
The PRC
has enacted a tax policy that entitles a foreign corporation to a full exemption
from both PRC state and local corporate income tax for the first two profitable
calendar years of its operations and thereafter a 50% relief from the PRC state
corporate income tax and full exemption from local corporate income tax for the
following three calendar years. Our PRC subsidiaries, namely Yunnan
WeiLi, Guizhou WeiLi and Gansu WeiBao, qualify for such tax exemptions. The
circular entitled “Scope of Preliminary Processing of Agricultural Products
Entitled to Preferential Enterprise Income Tax Policies (Trial Implementation)”
published by Ministry of Finance and State Administrative of Taxation, entitled
us to a full exemption from PRC corporate income tax since January 1, 2008. Our
native potato starch qualifies for this exemption and as a result none of
our subsidiaries are subject to PRC corporate income tax.
Pursuant
to the New Tax Law, dividends declared by our PRC subsidiaries to their parent
company incorporated in Hong Kong are subject to withholding tax of 5% or
10%. In accordance with Caishui (2008) No. 1 issued by State Tax
Authorities, undistributed profits from our PRC subsidiaries up to December 31,
2007 will be exempt from withholding tax when they are distributed in the
future. As a result, a provision for dividend withholding tax has
been made starting January 1, 2008. As a United States public
company, we do not intend to pay such dividends.
Seasonality
From May
through July, we typically halt our production process at our facilities located
in Yunnan and Guizhou provinces. The potato-planting season typically
begins in March and the potatoes are delivered to our facilities from August
until December. The farmers store remaining unsold potatoes in
cellars for up to four months, which allows us to expand our production
period until April.
Our Gansu
factory is in one of the colder regions in China and typically halts
production during January and February and resumes production from
March to May. It typically shuts down again during June and
July and resumes production in August. During the off-season, we spend time
performing routine maintenance.
CRITICAL
ACCOUNTING POLICIES AND ESTIMATES
We have
identified certain accounting policies that are significant to the preparation
of the financial statements. Critical accounting policies are those that are
both most important to the portrayal of our results of operations and financial
condition and require management’s most difficult, subjective, or complex
judgment, often as a result of the need to make estimates about the effect of
matters that are inherently uncertain and may change in subsequent
periods. Certain accounting estimates are particularly sensitive because
of their significance to financial statements and because of the possibility
that future events affecting the estimate may differ significantly from
management’s current judgments. We believe the following critical
accounting policies involve the most significant estimates and judgments used in
the preparation of the financial statements.
Property,
plant and equipment
Property,
plant and equipment are stated at cost less accumulated depreciation.
Expenditures for routine repairs and maintenance are expensed as
incurred.
50
Depreciation
is calculated on the straight-line basis over each asset’s estimated useful life
down to the estimated residual value of each asset. Estimated useful lives are
as follows:
Land
use rights
|
|
52-55
years
|
Buildings
|
|
20
years
|
Motor
vehicles
|
5
years
|
|
Plant
and machinery
|
10
years
|
|
Other
equipment
|
5
years
|
Revenue
recognition
We
generate our revenues from the selling of native potato starch
products. Revenues from product sales are recognized only when
persuasive evidence of an arrangement exists; delivery has occurred and the
customers' acceptance has been received; the price to the customer is fixed or
determinable; and collectability is reasonably assured. Generally,
these criteria are met upon shipment of products and transfer of title to
customers.
Inventories
Inventory
is stated at the lower of cost or market. Inventory is valued using the weighted
average method, which approximates actual cost. Capitalized costs include
materials, labor and manufacturing overhead related to the purchase and
production of inventories. Excess and obsolete inventory reserves are
established based upon the our evaluation of the quantity of inventory on hand
relative to demand. The total reserve for obsolete inventory was zero
as of December 31, 2008 and 2009.
Allowance
for Doubtful Accounts
An
allowance for doubtful accounts is provided based on an evaluation of the
collectability of accounts receivable, and other receivables. An allowance for
doubtful accounts is provided, when considered necessary, primarily consisting
of an analysis based on current information available about the customer or
borrower. Receivable losses are charged against the allowance when our
management believes the uncollectability of the receivable is confirmed.
Subsequent recoveries, if any, are credited to the allowance. Total allowance
for doubtful accounts was zero as of December 31, 2008 and 2009.
RECENTLY
ISSUED ACCOUNTING GUIDANCE
In
January 2010, the Financial Accounting Standards Board (the “FASB”) issued
additional disclosure requirements for fair value measurements. In accordance
with the new guidance, the fair value hierarchy disclosures are to be further
disaggregated by class of assets and liabilities. A class is often a subset of
assets or liabilities within a line item in the balance sheet. In addition,
significant transfers between Levels 1 and 2 of the fair value hierarchy will be
required to be disclosed. These additional requirements are effective for the
Company on January 1, 2010. These amendments will not have a material
impact on the consolidated financial statements; however they will require
additional disclosures. In addition, the guidance requires more detailed
disclosures of the changes in Level 3 instruments. These changes will be
effective for the Company on January 1, 2011 and are not expected to have a
material impact on the consolidated financial statements.
In June
2009, the FASB approved its Accounting Standards Codification (the “ASC” or
“Codification”) as the single source of authoritative United States accounting
and reporting standards applicable for all nongovernmental entities, with the
exception of the Securities and Exchange Commission (the “SEC”) and its staff.
The Codification, which changes the referencing of financial standards, was
effective for interim or annual financial periods ending after September 15,
2009. Therefore, beginning in the third quarter of fiscal year 2009, all
references made to US GAAP use the new Codification numbering system prescribed
by the FASB. As the Codification is not intended to change or alter existing US
GAAP, it did not have any impact on the Company’s consolidated financial
statements.
51
In
May 2009, the FASB issued guidelines on subsequent event accounting which
set forth: 1) the period after the balance sheet date during which management of
a reporting entity should evaluate events or transactions that may occur for
potential recognition or disclosure in the financial statements; 2) the
circumstances under which an entity should recognize events or transactions
occurring after the balance sheet date in its financial statements; and 3) the
disclosures that an entity should make about events or transactions that
occurred after the balance sheet date. These guidelines were effective for
annual periods ending after June 15, 2009. In
February 2010, the FASB amended this standard whereby companies that file
with the SEC are required to evaluate subsequent events through the date the
financial statements are issued, but are no longer required to disclose in the
financial statements that they have done so or disclose the date through which
subsequent events have been evaluated. Management evaluates all subsequent
events through the date of the issuance of the Company’s consolidated financial
statements.
Results
of Operations
The
Fiscal Years Ended December 31, 2009 and 2008
Sales
Our Wei
Bao and Jiabao brands continued to receive encouraging response from local
customers in 2009. Our sales increased by 21.5% from $53.1 million in 2008 to
$64.5 million in 2009 primarily due to increase in demand from our existing and
new customers. To cope with this increasing demand, we began leasing
a factory in Guanghe, Gansu with a total native potato starch production
capacity of 20,000 metric tons in 2009. Total sales quantity
increased by 25.9% from 73,353 metric tons in 2008 to 92,382 metric tons in
2009.
Cost
of sales
Our cost
of sales increased by 19.5% from $30.5 million in 2008 to $36.5 million in 2009,
primarily due to the corresponding increase in sales.
Gross
profit and gross profit margin
Our gross
profit increased by 24.2% from $22.6 million in 2008 to $28.0 million in 2009 as
a result of the increase in sales. The gross profit margin remained
stable at approximately 43.0% in both 2008 and 2009.
Operating
expenses
Operating
expenses increased by 35.1% from $2.6 million in 2008 to $3.5 million in 2009,
as a result of an increase in distribution expenses, which was attributable to
the increase in sales, resulting in an an increase in staff salaries and office
expenses.
Income
tax expense
Income
tax expense increased by 155.8% from $1.0 million in 2008 to $2.6 million in
2009. The PRC subsidiaries have been entitled to full exemption on
enterprise income tax in the PRC since January 1, 2008. The increase
was attributable to the increase of dividend withholding tax from 5% to 10% on
dividends declared by the PRC subsidiaries to their parent company incorporated
in Hong Kong.
52
The
Fiscal Years Ended December 31, 2008 and 2007
Sales
Our sales
increased by 60.3% from $33.1 million in 2007 to $53.1 million in 2008 as a
result of our effort in promoting our Wei Bao and Jiabao brands. The
sales quantity increased by 40.8% from 52,090 metric tons in 2008 to 73,353
metric tons in 2009.
Cost
of sales
Our cost
of sales increased by 55.6% from $19.6 million in 2007 to $30.5 million in 2008,
primarily due to the corresponding increase in sales.
Gross
profit and gross profit margin
Our gross
profit increased by 67.1% from $13.5 million in 2007 to $22.6 million in 2008 as
a result of the increase in sales. The gross profit margin was 42.5%
in 2008, which is slightly higher than that of 40.8% in 2007 due to the increase
of our selling prices in 2008.
Operating
expenses
Operating
expenses increased by 73.8% from $1.5 million in 2007 to $2.6 million in 2008 as
a result of an increase in distribution expenses, which was primarily
attributable to the increase in sales, resulting in an increase in staff
salaries and office expenses.
Income
tax expense
Income
tax expense increased by 63.4% from $0.6 million in 2007 to $1.0 million in
2008. The PRC subsidiaries have been entitled to full exemption on
enterprise income tax in the PRC since January 1, 2008. The increase
was attributable to a 5% withholding tax on dividends declared by the PRC
subsidiaries to their parent company incorporated in Hong Kong.
53
Six
months ended June 30, 2010 compared to six months ended June 30,
2009
Sales
Our sales
increased by 27.2% from $22.8 million in 2009 to $29.0 million in 2010 as a
result of our effort in promoting our Wei Bao and Jiabao brands and an increase
in our selling prices. We were able to accommodate the increased
volume by leasing a 20,000 metric ton production facility in Gansu that was only
utilized at approximately 66% of its capacity in 2009 and fully utilized during
the first six months of 2010. These factors have contributed to our increase in
sales volume of 8.5% from 35,666 metric tons in 2009 to 38,715 metric tons in
2010.
Cost
of sales
Our cost
of sales increased by 23.2% from $13.5 million in 2009 to $16.6 million in 2010,
primarily due to the corresponding increase in sales.
Gross
profit and gross profit margin
Our gross
profit increased by 32.9% from $9.3 million in 2009 to $12.4 million in 2010 as
a result of the increase in sales. The gross profit margin was 42.7%
in 2010, which is slightly higher than that of 40.1% in 2009 due to the increase
of our selling prices in 2010.
Operating
expenses
Operating
expenses increased by 31.9% from $1.4 million in 2009 to $1.9 million in 2010 as
a result of an increase in distribution expenses which was primarily
attributable to the increase in sales, staff salaries and office
expenses.
Income
tax expense
Income
tax expense increased by 39.8% from $0.8 million in 2009 to $1.1 million in
2010. The PRC subsidiaries have been entitled to full exemption on
enterprise income tax in the PRC since January 1, 2008. The increase
was attributable to a 10% withholding tax on undistributed profits earned by the
PRC subsidiaries, which was higher in 2010 due to the increase in profit over
the six months ended June 30, 2009.
54
LIQUIDITY
AND CAPITAL RESOURCES
We
have historically financed operations primarily through internally generated
cash, loans borrowed from banks and advances from shareholders. Going forward,
we believe our sources of liquidity will be satisfied by using a combination of
cash provided by our operating activities and proceeds from future offerings
after the reverse merger.
The
following table sets out a summary of our cash flow during 2007 to
2009:
Year Ended
December 31,
|
||||||||||||
2007
|
2008
|
2009
|
||||||||||
(Dollars
in thousands)
|
||||||||||||
Net
cash generated by operating activities
|
$ | 7,415 | $ | 19,030 | $ | 19,835 | ||||||
Net
cash used in investing activities
|
(1,089 | ) | (79 | ) | (11 | ) | ||||||
Net
cash used in financing activities
|
(5,237 | ) | (18,729 | ) | (2,075 | ) | ||||||
Net
increase in cash and cash equivalents
|
1,089 | 222 | 17,749 | |||||||||
Effect
of foreign exchange rates on changes in cash and cash
equivalents
|
456 | 846 | (6 | ) | ||||||||
Cash
and cash equivalents at beginning of year
|
1,775 | 3,320 | 4,388 | |||||||||
Cash
and cash equivalents at end of year
|
$ | 3,320 | $ | 4,388 | $ | 22,131 |
Cash
flow from operating activities
We
derived our cash flow from operating activities principally from receipt of
payments for sales of our products. Our cash outflow from operating
activities is principally from purchases of raw materials.
For 2009,
we had net cash generated from operating activities of $19.8 million, which was
primarily contributed by operating profit before working capital changes of
$21.8 million. The cash inflow was partially offset by cash outflow
due to an increase
in trade accounts receivable of $3.9 million. The increase in trade
accounts receivable was primarily due to our sales growth.
For 2008,
we had net cash generated from operating activities of $19.0 million, which was
primarily contributed by operating profit before working capital changes of 18.9
million. The cash inflow was partially offset by cash outflow due to
an increase in trade accounts receivable of $1.8 million. The
increase in trade accounts receivable was primarily due to our sales
growth.
For 2007,
we had net cash generated from operating activities of $7.4 million, which was
primarily contributed by operating profit before working capital changes of 11.3
million. The cash inflow was partially offset by cash outflow due to
an increase in trade accounts receivable of $5.2 million. The
increase in trade accounts receivable was primarily due to our sales
growth.
55
Cash
flow from investing activities
Our cash
outflow for investing activities is principally for purchases of property, plant
and equipment from 2007 to 2009.
Cash
flow from financing activities
We
derived our cash inflow from financing activities principally from bank
borrowings and advances from shareholders. Our cash outflow from
financing activities relates primarily to the repayment of debts, repayments
of advances from
shareholders and the payment of dividends.
For 2009,
the Group had net cash used in financing activities of $2.1 million, which was
primarily due to the net cash outflow used to repay advances to shareholders of
$2.1 million.
For 2008,
the Group had net cash used in financing activities of $18.7 million, which was
primarily due to the cash outflow used to pay dividends of $19.1 million, net
repayment of debt of $1.0 million offset by net advances received from
shareholders of $1.4 million.
For 2007,
the Group had net cash used in financing activities of $5.2 million, which was
primarily due to the cash outflow used to pay dividends of $8.2 million offset
by net proceeds from debt of $2.3 million and net advances received from
shareholders of $0.6 million.
NET
CURRENT ASSETS/LIABILITIES
The
following table sets out our current assets and current liabilities as at the
dates indicated:
December 31,
|
June 30,
|
|||||||||||
2008
|
2009
|
2010
|
||||||||||
(Dollars
in thousands)
|
||||||||||||
Current
assets:
|
||||||||||||
Cash
and cash equivalents
|
$ | 4,388 | $ | 22,131 | $ | 28,639 | ||||||
Trade
accounts receivable, net
|
14,196 | 18,117 | - | |||||||||
Inventories
|
1,370 | 1,199 | 208 | |||||||||
Prepayments
and other receivables
|
38 | 405 | 88 | |||||||||
19,992 | 41,852 | 28,935 | ||||||||||
Current
liabilities:
|
||||||||||||
Trade
accounts payable
|
166 | 14 | - | |||||||||
Accruals
and other payables
|
2,094 | 1,800 | 632 | |||||||||
Income
taxes payable
|
1,026 | 2,623 | 2,419 | |||||||||
Current
portion of long-term debt
|
2,932 | 3,631 | 3,658 | |||||||||
Dividends
payable
|
- | 22,809 | - | |||||||||
Due
to shareholders
|
9,964 | 596 | 1,515 | |||||||||
16,182 | 31,473 | 8,224 | ||||||||||
Net
current assets
|
$ | 3,810 | $ | 10,379 | $ | 20,711 |
We had
net current assets of $3.8 million, $10.4 million and $20.7 million as of
December 31, 2008 and 2009 and June 30, 2010 respectively. The
significant improvement in net current assets as of June 30, 2010 of $10.3
million was primarily due to the decrease in dividends payable of $22.8
million.
56
Trade
accounts receivable
Our trade
accounts receivable represent receivables from customers for sales of products.
We had trade accounts receivable of $14.2 million, $18.1 million and zero as of
December 31, 2008 and 2009 and June 30, 2010 respectively. The
increase in trade accounts receivable as of December 31, 2008 and 2009 was
primarily due to the increase in sales near year end. We did not have
any sales of native potato starch to our customers during the period from May to
June 2010 due to seasonality of potato growth and supply, which resulted
in zero trade accounts receivable as of June 30, 2010.
The table
below sets out our trade accounts receivable turnover days for the periods
indicated:
Years
Ended
|
Six
Months
Ended
|
|||||||||||
December 31,
|
June 30,
|
|||||||||||
2008
|
2009
|
2010
|
||||||||||
Trade
accounts receivable turnover days (note)
|
89 | 91 | 57 |
Note:
|
Trade
accounts receivable turnover days is equal to the average trade accounts
receivable divided by sales and multiplied by 365 days. Average trade
accounts receivable are equal to trade accounts receivable at the
beginning of the year plus trade accounts receivable at the end of the
year and divided by two.
|
The trade
accounts receivable turnover days remained stable for December 31, 2008 and
2009. The significant drop in trade accounts receivable turnover days
in 2010 to 57 days was as a result of zero trade accounts receivable being
outstanding as of June 30, 2010 due to seasonality.
Inventories
Our
inventories amounted to $1.4 million, $1.2 million and $0.2 million as of
December 31, 2008 and 2009 and June 30, 2010 respectively.
57
The
following table sets out the summary of our inventories as of the dates
indicated:
December 31,
|
June 30,
|
|||||||||||
2008
|
2009
|
2010
|
||||||||||
(Dollars
in thousands)
|
||||||||||||
Raw
materials
|
$ | 567 | $ | 364 | $ | 202 | ||||||
Finished
goods
|
803 | 835 | 6 | |||||||||
$ | 1,370 | $ | 1,199 | $ | 208 |
The
following table sets out the inventory turnover days for the
periods indicated:
Years
Ended
|
Six
Months
Ended
|
||||||||
December 31,
|
June 30,
|
||||||||
2008
|
2009
|
2010
|
|||||||
Inventory
turnover days (note)
|
15
|
13
|
8
|
Note:
|
The
calculation of inventory turnover days is based on the average inventory
balances divided by cost of goods sold and multiplied by 365 days for the
year (163 days to the June 30, 2010 period). Average inventory
balances are equal to inventory balance at the beginning of the year plus
inventory balances at the end of the year and divided by
two.
|
The
inventory turnover days remained stable for December 31, 2008 and
2009. The significant drop in the inventory turnover days for
the six months ended June 30, 2010 was as a result of the suspension of our
production process during May to June 2010 because of seasonality.
Trade
accounts payable
Our trade
accounts payable primarily represented the amount we owed to our suppliers for
the purchase of raw materials, mainly potatoes, packaging materials and
coal.
58
Due
to shareholders
The
balances of amounts due to shareholders of $10.0 million, $0.6 million and $1.5
million as of December 31, 2008 and 2009 and June 30, 2010 are unsecured,
non-interest bearing and have no fixed terms of repayment.
Property,
plant and equipment
Net plant
and machinery and other office equipment, amounted to $9.2 million, $8.2 million
and $7.9 million as of December 31, 2008 and 2009 and June 30 2010
respectively. We had no significant additions to property, plant and
equipment during the periods presented.
Capital
Expenditures
The
following table sets out the historical capital expenditures during the periods
indicated:
Years
Ended
|
Six
Months
Ended
|
|||||||||||
December 31,
|
June 30,
|
|||||||||||
2008
|
2009
|
2010
|
||||||||||
(Dollars
in thousands)
|
||||||||||||
Furniture,
fixtures and office equipment
|
$ | 79 | $ | 11 | $ | 133 | ||||||
Construction
in progress
|
- | - | - | |||||||||
$ | 79 | $ | 11 | $ | 133 |
The
following table sets out our projected capital expenditures for the three years
ending December 31:
December 31,
|
||||||||||||
2010
|
2011
|
2012
|
||||||||||
(Dollars
in thousands)
|
||||||||||||
Land
use rights
|
$ | 4,399 | $ | 8,798 | $ | 34,164 | ||||||
Buildings
|
- | 13,137 | 7,871 | |||||||||
Plant
and machinery
|
- | 20,528 | 7,966 | |||||||||
$ | 4,399 | $ | 42,463 | $ | 50,001 |
We expect
that the capital expenditures for the three years ending December 31 will be
primarily used for land use rights, buildings, and plant and machinery to
establish new production lines for native potato starch, modified potato starch
and whole potato starch.
We expect
to finance our projected capital expenditures mainly by the net proceeds from
future offerings after the reverse merger and cash generated from operating
activities.
COMMITMENTS
AND CONTINGENCIES
|
Capital
commitments
|
As of
June 30, 2010, the Group had entered into agreements with the People’s
Government of the Zhaoyang District, Yunnan Province to purchase property, plant
and equipment totaling approximately $19 million related to the construction of
two production facilities.
59
(b)
|
Lease
commitments
|
Operating
lease commitments include commitments under non-cancellable lease agreements for
our office premises, as well as a land lease. The leases expire
from July 2011 through October 2042. The yearly future minimum rental
payments required as of June 30, 2010 were as follows:
(Dollars
in thousands)
|
||||
2011
|
$ | 519 | ||
2012
|
61 | |||
2013
|
22 | |||
2014
|
22 | |||
2015
|
22 | |||
Thereafter
|
605 | |||
$ | 1,251 |
DESCRIPTION
OF CAPITAL STOCK
General
We are
authorized to issue 75,000,000 shares of common stock, par value $0.001 per
share. Holders of common stock are entitled to one vote per share and to receive
dividends or other distributions when and if declared by the Board of Directors.
As of October 21, 2010, there were 43,655,000 shares of common stock
outstanding. Prior to the closing of our purchase of Waibo, we had 5,655,000
shares issued and outstanding. Pursuant to the Exchange Agreement, we issued
38,000,000 shares to the Waibo Shareholders, and further, as soon as practical
after amending our Articles of Incorporation to increase the amount of our
authorized shares of Common Stock, we are obligated to issue an additional (i)
323,920,000 shares of Common Stock to the Waibo Shareholders and (ii) 9,441,667
shares of Common Stock to the holder of an outstanding convertible promissory
note of the Company in the principal amount of $25,000. Following the
amendment to our Articles of Incorporation to increase the amount of our
authorized shares of Common Stock and after giving effect to all of the
issuances above, we will have 377,016,667 shares
outstanding.
Our
common stock does not have preemptive rights, meaning that our common
stockholders' ownership interest would be diluted if additional shares of common
stock are subsequently issued and the existing stockholders are not granted the
right, in the discretion of the Board of Directors, to maintain their percentage
ownership interest in us. This lack of protection from dilution to minority
shareholders could allow our Board of Directors to issue additional shares of
our common stock to persons friendly with our existing management, thus
preventing any change in control of us.
Upon any
liquidation, dissolution or winding-up of us, our assets, after the payment of
debts and liabilities and any liquidation preferences of, and unpaid dividends
on, any class of preferred stock then outstanding, will be distributed pro-rata
to the holders of the common stock. The holders of the common stock have no
right to require us to redeem or purchase their shares.
The
holders of common stock are entitled to share equally in dividends, if and when
declared by our Board of Directors, out of funds legally available therefore,
subject to the priorities given to any class of preferred stock which may be
issued.
No Cumulative
Voting
Holders
of shares of our common stock do not have cumulative voting rights, which means
that the holders of more than 50% of the outstanding shares, voting for the
election of directors, can elect all of the directors to be elected, if they so
choose, and, in that event, the holders of the remaining shares will not be able
to elect any of our directors.
60
Dividend
Policy
To date,
we have not paid any dividends. The payment of dividends, if any, on our common
stock in the future is within the sole discretion of our Board of Directors and
will depend upon our earnings, capital requirements, financial condition, and
other relevant factors. We have no present intention to declare any dividends on
the common stock in the foreseeable future.
Transfer
Agent
We will
use Action Stock Transfer Corp. 7069 S. Highland Dr., Suite 300 Salt Lake City,
UT 84121 as our transfer agent.
MARKET
PRICE OF AND DIVIDENDS ON COMMON EQUITY AND OTHER SHAREHOLDER
MATTERS
Market
Information
There is
no established public trading market for our Common Stock, however our Common
Stock is quoted on the Over-the-Counter Bulletin Board under the symbol “CFOS.”
The following table sets forth the high and low bid information for our Common
Stock for the period from March 25, 2009, the first day for which quotation
information is available, through October 21, 2010. The Over-the-Counter
Bulletin Board quotations reflect inter-dealer prices, are without retail
markup, markdowns or commissions, and may not represent actual
transactions.
Common Stock
|
||||||||
High
|
Low
|
|||||||
March
25-30, 2009
|
$
|
0.01
|
$
|
0.01
|
||||
Second
quarter 2009
|
$
|
0.01
|
$
|
0.01
|
||||
Third
quarter 2009
|
$
|
0.02
|
$
|
0.02
|
||||
Fourth
quarter 2009
|
$
|
1.01
|
$
|
0.51
|
||||
First
quarter 2010
|
$
|
1.01
|
$
|
1.01
|
||||
Second
quarter 2010
|
$ |
0.10
|
$ |
0.0025
|
||||
Third
Quarter 2010
|
$ |
0.05
|
$ |
0.025
|
||||
Fourth
Quarter 2010 through October 21, 2010
|
$ |
0.03
|
$ |
0.03
|
Holders
of Common Stock
As of
October 21, 2010, there were of record 37 holders of our Common
Stock.
Dividend
Policy
We
currently intend to retain all available funds and any future earnings for use
in the operation and expansion of our business and do not anticipate paying any
cash dividends on our Common Stock for the foreseeable future.
61
Future
cash dividends, if any, will be at the discretion of our Board of Directors and
will depend upon our future operations and earnings, capital requirements and
surplus, general financial condition, contractual restrictions and other factors
as our Board of Directors may deem relevant. We can pay dividends only out of
our profits or other distributable reserves and dividends or distribution will
only be paid or made if we are able to pay our debts as they fall due in the
ordinary course of business.
Indemnification
of Directors and Officers
Our
officers and directors are indemnified as provided by the Nevada Revised
Statutes (the “NRS”) and our bylaws.
Under the
NRS, director immunity from liability to a company or its shareholders for
monetary liabilities applies automatically unless it is specifically limited by
a company’s articles of incorporation that is not the case with our articles of
incorporation. Excepted from that immunity are:
(1) a
willful failure to deal fairly with the company or its shareholders in
connection with a matter in which the director has a material conflict of
interest;
(2) a
violation of criminal law (unless the director had reasonable cause to believe
that his or her conduct was lawful or no reasonable cause to believe that his or
her conduct was unlawful);
(3) a
transaction from which the director derived an improper personal profit;
and
(4) willful
misconduct.
Our
bylaws provide that we will indemnify our directors and officers to the fullest
extent not prohibited by Nevada law. Our bylaws provide that we will advance all
expenses incurred to any person who was or is a party or is threatened to be
made a party to any threatened, pending or completed action, suit or proceeding,
whether civil, criminal, administrative or investigative, by reason of the fact
that he is or was our director or officer, or is or was serving at our request
as a director or executive officer of another company, partnership, joint
venture, trust or other enterprise, prior to the final disposition of the
proceeding, promptly following request. This advance of expenses is to be made
upon receipt of an undertaking by or on behalf of such person to repay said
amounts should it be ultimately determined that the person was not entitled to
be indemnified under our bylaws or otherwise.
62
SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The
following table sets forth certain information regarding beneficial ownership of
our common stock as of October 21, 2010 by (i) each person (or group of
affiliated persons) who is known by us to own more than five percent of the
outstanding shares of our common stock, (ii) each director, and named executive
officer, and (iii) all of our directors and executive officers as a
group.
Beneficial
ownership is determined in accordance with SEC rules and generally includes
voting or investment power with respect to securities.
We had
43,655,000 shares of common stock outstanding on October 21, 2010, however, we
anticipate that within the next 60 days that we will have amended our Articles
of Incorporation to effect an increase of our authorized shares of common stock
and will have issued an additional 333,361,667 shares of Common Stock
immediately after such amendment. Therefore, displays both our
current beneficial ownership structure and the effect of such amendment and
issuance.
Names and Addresses of Beneficial
Owners
|
Amount and Nature
of Beneficial
Ownership on
October 21, 2010
(1)
|
% of Class
|
Amount and Nature
of Beneficial
Ownership assuming
issuance of
333,361,667 shares of
common stock as
described above (1)
|
% of Class
|
||||||||||||
Kai
Bo Holdings Limited(3)
|
38,000,000 | 87 | 361,920,000 | 96 | ||||||||||||
Joanny
Kwok, Chief Executive Officer and Chairperson of the Board(3)
|
38,000,000 | 87 | 361,920,000 | 96 | ||||||||||||
Jacky
Kwok, Director(3)
|
38,000,000 | 87 | 361,920,000 | 96 | ||||||||||||
Lam
Yukang(3)
|
38,000,000 | 87 | 361,920,000 | 96 | ||||||||||||
Ken
Tsang, Chief Financial Officer
|
0 | 0 | 0 | 0 | ||||||||||||
Norman
LaBoeuf, Director
|
160,000 | 0 | 160,000 | 0 | ||||||||||||
Guohua
Zheng, Chief Operating Officer and Director
|
0 | 0 | 0 | 0 | ||||||||||||
All
Directors and Officers as a Group (5 Persons)
|
38,160,000 | 87 | 362,080,000 | 96 |
(1)
|
Beneficial
ownership is determined in accordance with the rules of the SEC and
generally includes voting or investment power with respect to securities.
Shares of common stock subject to securities anticipated to be exercisable
or convertible at or within 60 days of the date hereof, are deemed
outstanding for computing the percentage of the person holding such option
or warrant but are not deemed outstanding for computing the percentage of
any other person. The indication herein that shares are anticipated to be
beneficially owned is not an admission on the part of the listed
stockholder that he, she or it is or will be a direct or indirect
beneficial owner of those shares.
|
(2)
|
Based
on 43,655,000 shares of common stock outstanding on October 21,
2010.
|
(3)
|
Kai
Bo Holdings Limited is a Bermuda company with a principal address at: Rm
2102 F&G, Nan Fung Centre, 264-298 Castle Peak Rd, Tsuen Wan, New
Territories, Hong Kong Joanny
Kwok, Jacky Kwok, Lam Yukang are principals of Kai Bo Holdings Limited and
share beneficial ownership of our shares held by Kai Bo Holdings
Limited.
|
63
Item
4.01 Changes in Registrant’s Certifying Accountant.
(a)
Dismissal of Previous Independent Registered Public Accounting
Firm.
On October 21, 2010, we made the
decision to dismiss Sam Kan & Company as our independent registered public
accounting firm. The Board of Directors of the Company approved such dismissal
on October 22, 2010. Our Board of Directors participated in and
approved the decision to change our independent registered public accounting
firm. Sam Kan & Company’s reports on our financial statements of for the
years ended December 31, 2009 and 2008 did not contain an adverse opinion or a
disclaimer of opinion, nor were they qualified or modified as to uncertainty,
audit scope, or accounting principles other than with respect to our ability to
continue as a going concern.
In connection with the audit and review
of our financial statements through October 21, 2010, there were no
disagreements with Sam Kan & Company on any matter of accounting principles
or practices, financial statement disclosures, or auditing scope or procedures,
which disagreements if not resolved to their satisfaction would have caused them
to make reference to the subject matter of the disagreement in connection with
their report.
In connection with our audited
financial statements for the years ended December 31, 2009 and 2008 and through
October 21, 2010, there have been no reportable events with the Company as set
forth in Item 304(a)(1)(v) of Regulation S-K.
We
provided Sam Kan & Company with a copy of this Current Report on Form 8-K
and requested that Sam Kan & Company furnish us with a letter addressed to
the SEC stating whether or not they agree with the above statements. We have
received the requested letter from Sam Kan & Company, and a copy of such
letter will be filed as Exhibit 16.1 to an amended Current
Report on Form 8-K/A.
(b)
Engagement of New Independent Registered Public Accounting Firm.
On October 21, 2010, we made the
decision to appoint GHP Horwath, P.C. (“GHP”) as our new independent
registered public accounting firm. The decision to engage GHP was approved by
our Board of Directors on October 22, 2010.
Prior to October 21, 2010, we did not
consult with GHP regarding (1) the application of accounting principles to a
specified transactions, (2) the type of audit opinion that might be rendered on
our financial statements, (3) written or oral advice was provided that would be
an important factor considered by us in reaching a decision as to an accounting,
auditing or financial reporting issues, or (4) any matter that was the subject
of a disagreement between us and our predecessor auditor as described in Item
304(a)(1)(iv) or a reportable event as described in Item 304(a)(1)(v) of
Regulation S-K.
The Company has authorized Sam Kan & Company to respond fully to
GHP concerning our financial statements.
64
Item
5.01 Changes In Control of the Registrant
On the
Closing Date, pursuant to the terms of the Exchange Agreement, the Waibo
Shareholders transferred all of the Waibo Shares to us and in exchange, we
issued their designee 38,000,000 shares of our Common Stock (or 86% of our
outstanding Common Stock after giving effect to the issuance), and agreed to
issue to their designee an additional 323,920,000 shares, which will in the
aggregate equal 96% of all of our shares after giving effect to such issuance
and the conversion of the Convertible Note into 9,441,667 shares of our Common
Stock. On the Closing Date, we did not have sufficient authorized shares to
complete the issuance of 323,920,000 of the Exchange Shares and shares issuable
pursuant to the Convertible Note, so only 38,000,000 shares were issued to the
Waibo Shareholders on the Closing Date and no shares were issued to the holder
of the Convertible Note. As soon as practicable after we effectuate an amendment
to our Articles of Incorporation to increase our authorized shares, we will
issue the remaining 323,920,000 shares to the Waibo Shareholders, as well as
9,441,667 shares to the holder of the Convertible Note.
Other
than the transactions and agreements disclosed in this Form 8-K, we know of no
arrangements, which may result in a change in control at a subsequent
date.
Item
5.02 Departure of Directors or Principal
Officers; Election of Directors; Appointment of Principal
Officers.
On
October 21, 2010, upon the closing of the Share Exchange, all prior directors
and officers of CFO Consultants, Inc. resigned from their positions, and prior
to their resignation, Joanny Kwok, Jacky Kwok and Guohua Zheng were appointed to
serve as directors, provided, however, that the resignation of Norman LeBoeuf as
director shall be effective on the tenth day following the filing by the Company
of an Information Statement on Schedule 14F-1 with the Securities and Exchange
Commission (the “SEC”) and provided further, however, that the election of Jacky
Kwok and Guohua Zheng as directors shall be effective on the tenth day following
the filing by the Company of an Information Statement on Schedule 14F-1 with the
SEC.
All
former executive officers of CFO Consultants, Inc. resigned on and closing date
Joanny Kwok, Guohua Zheng and Ken Tsang were appointed to serve as our Chief
Executive Officer, Chief Operating Officer and Chief Financial Officer,
respectively.
All
executive officers are elected annually by the Board of Directors for a one-year
term until the election and qualification of their successors. Jacky Kwok
is Joanny Kwok’s brother.
Set forth
below is information regarding our current directors and executive
officers:
Name
|
Age
|
Position
|
||
Joanny
Kwok
|
32
|
Chairman,
CEO, Director
|
||
Guohua
Zheng
|
56
|
Chief
Operating Officer, Director(1)
|
||
Ken
Tsang
|
30
|
Chief
Financial Officer
|
||
Jacky
Kwok
|
30
|
Director(1)
|
||
Norman
LeBoeuf
|
81
|
Director(2)
|
(1)
|
Appointed
as a member of our board of directors on October 21, 2010, effective as of
the tenth day after the filing of an Information Statement on Schedule
14F-1 with the SEC.
|
(2)
|
Resigned
from our board of directors on October 21, 2010, effective as of the tenth
day after the filing of an Information Statement on Schedule 14F-1 with
the SEC.
|
Joanny Kwok, age 32, is
chairman of the board and chief executive officer since October 21,
2010. Ms. Kwok is the co-founder of Hong Kong Wai Bo International
Ltd. and has been the CEO and Chairman of the Board since it was founded
2005. In 2006, Ms. Kwok founded Gansu Weibao Starch Co., Ltd. through
Hong Kong Waibo International Ltd. Prior to that, Ms. Kwok founded Ever Flow
International Ltd. in 2002, which was acquired by Hong Kong Wai Bo International
Ltd. in 2008. In 2003, Ms. Kwok founded Yunnan Zhaoyang Weili Starch
Co., Ltd. and Guizhou Weining Starch Co., Ltd. through Ever Flow International
Ltd.. Ms. Kwok is responsible for our corporate direction, strategies
and business development. Ms. Kwok also is vice president of China
Potato Starch-Specialized Society (CPSSS), a national trade organization focused
on research and communication in the potato starch industry. Ms. Kwok graduated
from the University of Technology, Sydney (UTS) with a B.A. in International
Trade and Finance in 2002.
65
Guohua Zheng, age 56, is our
chief operating officer since October 21, 2010 and was appointed as a member of
our board of directors on October 21, 2010, effective as of the tenth day after
the filing of an Information Statement on Schedule 14F-1 with the
SEC. Mr. Zheng has served as the vice-president of Hong Kong Wai Bo
International Limited. since July 2010. Prior to that, Mr. Zheng was General
Manager of Gansu Weibao Starch Co., Ltd from 2006 to July 2010. Mr.
Zheng graduated from Yunnan College of Finance and Economics, with a diploma in
Corporate Finance Management in 1983.
Ken Tsang, age 30, is our
chief financial officer since October 21, 2010 and the Chief Financial Office of
Hong Kong Wai Bo International Limited since 2010. He is responsible for the
implementation of our internal controls and corporate governance practice as
well as liaising with external parties and regulatory bodies in respect of
financial matters. Prior to joining us, he was an audit manager for RSM
Nelson Wheeler, an
international auditing firm, from 2003 to 2010, where Mr. Tsang was in charge of
audit work, internal control review and due diligence projects. He
graduated from the Hong Kong University of Science and Technology in 2002 with a
Bachelor’s Degree in Accounting. He is a CPA member of the Hong Kong
Institute of Certified Public Accountants.
Jacky Kwok, age 30, was
appointed as a member of our board of directors on October 21, 2010, effective
as of the tenth day after the filing of an Information Statement on Schedule
14F-1 with the SEC. Mr. Kwok is the co-founder of Hong Kong Wai Bo
International Limited. and is the vice chairman and vice president since it was
founded in 2005. Mr. Kwok is responsible for overseeing the manufacturing
process and raw material procurement. Mr. Kwok graduated from Central
Queensland University Australia, with a Bachelors Degree in Business
Administration in 2005.
Norman LeBoeuf, age 81, served as our
President, Chief Executive Officer, Chief Financial Officer and
Secretary until October 21, 2010. Mr. LeBoeuf is still a member of
the Board of Directors, but has tendered his resignation from the Board,
effective as of the tenth day after the filing of an Information Statement on
Schedule 14F-1 with the SEC. Mr. LeBoeuf has been responsible for the accounting
and tax functions for many companies. Mr. LeBoeuf's professional career includes
three years in the U.S. Marine Corps Legal and Administrative functions
(1952-1955) and forty years in all areas of accounting for small, medium and
large (Fortune 500 Companies) in Electronics, Manufacturing and
Aerospace.
Involvement in Certain Legal Proceedings
There
have been no events under any bankruptcy act, no criminal proceedings and no
judgments, injunctions, orders or decrees material to the evaluation of the
ability and integrity of any director, executive officer, promoter or control
person of our Company during the past ten years.
Executive
Compensation
The
following table sets forth the compensation paid or accrued by us to our Chief
Executive Officer and Chief Financial Officer for each of the Company’s last two
completed fiscal years, no other officer’s compensation exceeded $100,000 in
each year.
66
Summary
Compensation Table
Name and Principal Position
|
Year
|
Salary
|
Other
|
Total
|
||||||||||
Joanny
Kwok
|
2009
|
$ | 65,981 | - | $ | 65,981 | ||||||||
CEO
and President
|
||||||||||||||
2008
|
$ | 33,303 | - | $ | 33,303 | |||||||||
Ken
Tsang
|
2009
|
$ | 0 | - | $ | 0 | ||||||||
Chief
Financial Officer
|
||||||||||||||
2008
|
$ | 0 | - | $ | 0 |
Employment Agreements with Executive
Officers
We do not
have any employment agreements with our executive officers.
Director
Compensation
Currently
our directors serve without compensation.
Certain
Relationships and Related Transactions, and Director Independence
Director
Independence
Currently,
the Company does not have any independent directors. Since the Company’s Common
Stock is not currently listed on a national securities exchange, we have
used the definition of “independence” of The NASDAQ Stock Market to make
this determination.
Under
NASDAQ Listing Rule 5605(a)(2), an "independent director" is a "person other
than an officer or employee of the company or any other individual having a
relationship which, in the opinion of the company's board of directors, would
interfere with the exercise of independent judgment in carrying out the
responsibilities of a director."
We do not
currently have a separately designated audit, nominating or compensation
committee. However, we do intend to comply with the independent
director and committee composition requirements in the future.
Transactions
with Related Persons
The
majority shareholder of American Smooth Wave Inc. and Western Lucrative Inc.
owned more than 5% of our common stock at December 31, 2009 and 2008. For the
year ended December 31, 2008, the Company paid consulting and professional fee
of $12,900 through American Smooth Wave Inc and Western Lucrative Inc. The
reimbursements of these consulting fees were made in August, 2008 and September,
2008. There was no balance due to these affiliates at December 31, 2009
and December 31, 2008.
67
Item
5.06. Change in Shell
Company Status
As
described in Item 1.01 of this Current Report on Form 8-K, on the Closing Date,
we acquired Waibo, a Hong Kong corporation that, through its operating
subsidiaries in the PRC, is in the business of producing potato
starch. Pursuant to the terms of the Exchange Agreement, the Waibo
Shareholders transferred and contributed all of the Waibo Shares to us and in
exchange, we issued their designee 38,000,000 shares of our Common Stock, and
agreed to issue to their designee an additional 323,920,000 shares, which will
in the aggregate equal 96% of all of our shares after giving effect to the
conversion of the Convertible Note. On the Closing Date, we did not have
sufficient authorized shares to complete the issuance of 323,920,000 of the
Exchange Shares and shares issuable pursuant to the Convertible Note, so only
38,000,000 shares were issued to the Waibo Shareholders on the Closing Date and
no shares were issued to the holder of the Convertible Note. As soon as
practicable after we effectuate an amendment to our Articles of Incorporation to
increase our authorized shares, we will issue the remaining 323,920,000 shares
to the Waibo Shareholders, as well as 9,441,667 shares to the holder of the
Convertible Note.
As the
result of the consummation of the Share Exchange, we are no longer a shell
company as that term is defined in Rule 12b-2 of the Securities Exchange Act of
1934, as amended.
Item 9.01 Financial Statement and
Exhibits.
(a)
Financial Statements of Business Acquired.
The
Audited Consolidated Financial Statements of Waibo as of December 31, 2009 and
2008 and for the years ended December 31, 2009, 2008 and 2007 are filed as
Exhibit 99.1 to this current report and are incorporated herein by
reference.
The
Unaudited Consolidated Financial Statements of Waibo as of June 30, 2010 and for
the six months ended June 30, 2010 and 2009 are filed as Exhibit 99.2 to this
current report and are incorporated herein by reference.
(b)
Pro Forma Financial Information.
Except as
set forth in the paragraph below relating to pro forma per share information, a
pro-forma statement of operations of the Company for the years ended December
31, 2007, 2008 and 2009 and for the six months ended June 30, 2009 and 2010 are
not presented, as pro-forma financial information for the periods would be
virtually identical to the historical statement of operations of Hong Kong Wai
Bo International Limited for each period.
Pro-forma
income per share for the years ended December 31, 2007, 2008 and 2009 and for
the six months ended June 30, 2009 and 2010 (considering the retroactive
restatement to reflect the new capital structure as a result of the reverse
acquisition) would be $0.03, $0.05, $0.06, $0.02 and $0.03, respectively, per
share; the pro forma weighted average number of common shares outstanding would
be 377,016,667 for each period presented.
Pro-forma
financial information as of June 30, 2010 is not presented as pro forma
financial information would be virtually identical to the historical
consolidated balance sheet of Hong Kong Wai Bo International Limited as of June
30, 2010.
68
(c)
Shell Company Transactions.
Reference
is made to Items 9.01(a) and 9.01(b) and the exhibits referred to therein
which are incorporated herein by reference.
(d)
Exhibits.
Exhibit
No.
|
|
Description
|
2.1
|
Share
Exchange Agreement dated October 21, 2010
|
|
99.1
|
The
Audited Consolidated Financial Statements of Waibo as of December 31, 2009
and 2008 and for the years ended December 31, 2009, 2008 and
2007
|
|
99.2
|
The
Unaudited Interim Consolidated Financial Statements of Waibo as of June
30, 2010 and for the six months ended June 30, 2010 and
2009
|
69
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
CFO
CONSULTANTS, INC.
|
|
By:
|
/s/ Joanny
Kwok
|
Name
|
Joanny
Kwok
|
Title:
|
Chief
Executive Officer
|
Dated:
October 22, 2010
70