Filed pursuant to Rule 424 (b)(4)
Registration No. 333-234460
5,000,000 Ordinary Shares
Qilian International Holding Group Limited
We are offering 5,000,000 ordinary shares, par value $0.00166667 per share (“Ordinary Shares”). This is the initial public offering of our Ordinary Shares. The offering price of our Ordinary Shares in this offering is US $5.00 per Ordinary Share. Prior to this offering, there has been no public market for our Ordinary Shares.
We have received the approval letter from the Nasdaq Stock Market LLC (“Nasdaq”) to have our Ordinary Shares on the Nasdaq Global Market under the symbol “QLI”.
Investing in our Ordinary Shares involves a high degree of risk. Before buying any Ordinary Shares, you should carefully read the discussion of material risks of investing in our Ordinary Shares in “Risk Factors” beginning on page 14 of this prospectus.
We are an “emerging growth company” as defined under federal securities laws and, as such, will be subject to reduced public company reporting requirements. See “Prospectus Summary— Implications of Being an Emerging Growth Company and a Foreign Private Issuer” for additional information.
Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.
| PER SHARE | TOTAL (4) | |||||||
| Initial public offering price(1) | $ | 5.00 | $ | 25,000,000 | ||||
| Underwriting discounts(2) | $ | 0.35 | $ | 1,750,000 | ||||
| Proceeds, before expenses, to us(3) | $ | 4.65 | $ | 23,250,000 | ||||
(1) Initial public offering price per share is $5.00 per share.
(2) We have agreed to pay the underwriters a discount equal to (i) 7% of the gross proceeds of the offering for investors introduced to us by the underwriters and (ii) 4% to 1% of the gross proceeds for investors sourced by the Company. All investors are introduced to us by the underwriters. We have agreed to sell to the underwriters, on the applicable closing date of this offering, warrants (the “Underwriters’ Warrants”) in an amount equal to 6% of the aggregate number of Ordinary Shares sold by us in this offering (not including over-allotment shares). For a description of other terms of the Underwriters’ Warrants and a description of the other compensation to be received by the underwriters, see “Underwriting” beginning on page 121.
(3) Excludes fees and expenses payable to the underwriters. The total amount of underwriters’ expenses related to this offering is set forth in the section entitled “Underwriting.”
(4) Assumes that the underwriters do not exercise any portion of their over-allotment option.
We expect our total cash expenses for this offering (including cash expenses payable to our underwriters for their out-of-pocket expenses) to be approximately $1,031,541, exclusive of the above discounts. In addition, we will pay additional items of value in connection with this offering that are viewed by the Financial Industry Regulatory Authority, or FINRA, as underwriting compensation. These payments will further reduce proceeds available to us before expenses. See “Underwriting” beginning on page 121.
This offering is being conducted on a firm commitment basis. Univest Securities, LLC, the representative of the underwriters, is obligated to take and pay for all of the Ordinary Shares if any such Ordinary Shares are taken. We have granted the underwriters an option for a period of 45 days after the closing of this offering to purchase up to 15% of the total number of our Ordinary Shares to be offered by us pursuant to this offering (excluding Ordinary Shares subject to this option), solely for the purpose of covering over-allotments, at the initial public offering price less the underwriting discounts. If the underwriters exercise their option in full, the total underwriting discounts payable will be $2,012,500 based on the offering price of $5.00 per Ordinary Share, and the total gross proceeds to us, before underwriting discounts and expenses, will be $28,750,000. If we complete this offering, net proceeds will be delivered to us on the applicable closing date. We will not be able to use such proceeds in China, however, until we complete capital contribution procedures that require prior approval from each of the respective local counterparts of China’s Ministry of Commerce, the State Administration for Industry and Commerce, and the State Administration of Foreign Exchange. See remittance procedures in the section titled “Use of Proceeds” beginning on page 34.
The underwriters expect to deliver the Ordinary Shares against payment as set forth under “Underwriting”, on or about January 14, 2021.
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Prospectus dated January 11, 2021.
TABLE OF CONTENTS
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About this Prospectus
We and the underwriters have not authorized anyone to provide any information or to make any representations other than those contained in this prospectus or in any free writing prospectuses prepared by us or on our behalf or to which we have referred you and which we have filed with the U.S. Securities and Exchange Commission (the “SEC”). We take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. This prospectus is an offer to sell only the Ordinary Shares offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. We are not making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted or where the person making the offer or sale is not qualified to do so or to any person to whom it is not permitted to make such offer or sale. For the avoidance of doubt, no offer or invitation to subscribe for Ordinary Shares is made to the public in the Cayman Islands. The information contained in this prospectus is current only as of the date on the front cover of the prospectus. Our business, financial condition, results of operations and prospects may have changed since that date.
Other Pertinent Information
Unless otherwise indicated or the context requires otherwise, references in this prospectus to:
| · | “Affiliated Entities” are to our subsidiaries and Gansu QLS, our VIE, and its subsidiaries; | |
| · | “Ahan” are to Jiuquan Ahan Biotechnology Co., Ltd., a limited liability company organized under the laws of the PRC, which is 100% owned by Gansu QLS; | |
| · | “Ahan® Antibacterial Paste” are to a disinfection paste made from a mixture of 11 traditional Chinese herbal ingredients used to treat refractory chronic skin diseases; | |
| · | “APIs” are to Active Pharmaceutical Ingredients, which refer to any substance or mixture of substances intended to be used in the manufacture of a drug (medicinal) product and that, when used in the production of a drug, becomes an active ingredient of the drug product; | |
| · | “Cangmen” are to Tibet Cangmen trading Co., Ltd., a limited liability company organized under the laws of the PRC, which is 100% owned by Gansu QLS; | |
| · | “Chengdu QLS” are to Chengdu Qilianshan Biotechnology Co., Ltd., a limited liability company organized under the laws of the PRC, which is 71.75% owned by Gansu QLS; | |
| · | “China” or the “PRC” are to the People’s Republic of China, excluding Taiwan and the special administrative regions of Hong Kong and Macau for the purposes of this prospectus only; | |
| · | “Gan Di Xin®” are to an innovative antitussive and expectorant medicine made from raw licorice materials; | |
| · | “Gansu QLS” are to Gansu Qilianshan Pharmaceutical Co. Ltd., a limited liability company organized under the laws of the PRC, which we control via a series of contractual arrangements between WFOE and Gansu QLS; | |
| · | “Heparin Sodium Preparation” are to a primary ingredient for pharmaceutical companies to produce medications used in treating cardiovascular diseases, cerebrovascular diseases, and hemodialysis; | |
| · | “Ordinary Shares” are to the ordinary shares, par value US$0.00166667 per, share issued by the Company; | |
| · | “Qilian HK” are to Qilian International’s wholly owned subsidiary, Qilian International (Hong Kong) Holdings Limited, a Hong Kong corporation; | |
| · | “Qilian International” are to Qilian International Holding Group Limited, an exempted company with limited liability incorporated under the laws of the Cayman Islands; | |
| · | “Qilian Shan® Licorice Extract” are to a primary ingredient for pharmaceutical companies to manufacture traditional licorice tablets; | |
| · | “Qilian Shan® Licorice Liquid Extract” are to a primary ingredient for medical preparation companies to produce compound licorice oral solutions; | |
| · | “Qilian Shan® Oxytetracycline APIs” are to an active ingredient used by pharmaceutical companies in the manufacturing of medications that use oxytetracycline; | |
| · | “Qilian Shan® Oxytetracycline Tablets” are to tablets used to prevent and treat a wide range of diseases in chickens, turkeys, cattle, swine, and human; | |
| · | “Qiming” are to Jiuquan Qiming Biotechnology Co., Ltd., a limited liability company organized under the laws of the PRC, which is 100% owned by Gansu QLS; | |
| · | “Rugao” are to Rugao Tianlu Animal Products Co., Ltd., a limited liability company organized under the laws of the PRC, which is 100% owned by Chengdu QLS; | |
| · | “Samen” are to Tibet Samen Trading Co., Ltd., a limited liability company organized under the laws of the PRC, which is 100% owned by Gansu QLS; | |
| · | “TCM” are to Traditional Chinese Medicine, a style of traditional medicine built on a foundation of more than 2,500 years of Chinese medical practice that includes various forms of herbal medicine, acupuncture, massage (tui na), exercise (qigong), and dietary therapy; | |
| · | “TCMD” are to Traditional Chinese Medicine Derivatives, a type of product derived from TCM that has been prepared through modern medicine manufacturing procedures to be ready for use; | |
| · | “VIE” are to variable interest entity; | |
| · | “VIE Agreements” are to a series of contractual arrangements, including the Exclusive Service Agreement, as amended on August 27, 2019, the Call Option Agreement, the Equity Pledge Agreement, the Shareholders’ Voting Rights Proxy Agreement and Powers of Attorney, and the Spousal Consents; | |
| · | “we,” “us,” or “the Company” are to one or more of Qilian International, and its subsidiaries, as the case may be; | |
| · | “WFOE” or “Chengdu Trading” are to Chengdu Qilian Trading Co., Ltd., a limited liability company organized under the laws of the PRC, which is wholly-owned by Qilian International (Hong Kong) Holdings Limited, a limited liability company organized under the laws of Hong Kong; | |
| · | “Xiongguan® Organic Fertilizer” are to a fertilizer product designed to improve crop yield, increase soil’s chemical properties, and reduce soil compaction; | |
| · | “Xiongguan® Organic-Inorganic Compound Fertilizer” are to a fertilizer product made from both organic materials and traditional chemical fertilizer and is designed to increased plant growth; and | |
| · | “Zhu Xiaochang® Sausage Casings” are to an all-natural food product used for culinary purposes. |
Our business is conducted by Gansu QLS, our VIE in the PRC, and its subsidiaries, using RMB, the currency of China. Our consolidated financial statements are presented in United States dollars. In this prospectus, we refer to assets, obligations, commitments and liabilities in our consolidated financial statements in United States dollars. These dollar references are based on the exchange rate of RMB to United States dollars, determined as of a specific date or for a specific period. Changes in the exchange rate will affect the amount of our obligations and the value of our assets in terms of United States dollars which may result in an increase or decrease in the amount of our obligations (expressed in dollars) and the value of our assets, including accounts receivable (expressed in dollars).
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The following summary is qualified in its entirety by, and should be read in conjunction with, the more detailed information and financial statements included elsewhere in this prospectus. In addition to this summary, we urge you to read the entire prospectus carefully, especially the risks of investing in our Ordinary Shares, discussed under “Risk Factors,” before deciding whether to buy our Ordinary Shares.
Unless otherwise indicated, all information in this amendment reflects a 1-for-1.66667 reverse split of our issued and outstanding Ordinary Shares, effected on October 16, 2019.
Overview
We are a pharmaceutical and chemical company based in China that focuses on the development, manufacture, marketing, and sale of licorice products, oxytetracycline products, traditional Chinese medicine derivatives (“TCMD”) product, heparin product, sausage casings, and fertilizers. We independently developed Gan Di Xin® and Ahan® Antibacterial Paste within our research and development department. Our products are sold in more than 20 provinces in China.
COVID-19
The outbreak of the novel coronavirus, commonly referred to as “COVID-19”, significantly affected the economic and business activities within China for the most part of 2020. To attempt to contain the COVID-19 outbreak, the Chinese government had adopted restrictive measures such as city lockdowns, travel restrictions, and closures of business activities since late January 2020. With such measures, China has gradually resumed businesses as government officials started to ease the restrictive measures. As of the date of this prospectus, the COVID-19 outbreak in China appears to be generally under control.
The COVID-19 outbreak has negatively impacted our businesses in the following ways:
| · | Our manufacturing activities depend on a wide array of raw materials such as soybeans, corn starch, glycyrrhiza glabra plant, pig intestines, and many others. We have experienced substantive diminutions in raw material supplies due to the COVID-19 outbreak and ensuing lockdowns. In addition, for the nine months ended June 30, 2020 the price of these raw materials has increased by approximately 4%-8% as compared to the same period of the last fiscal year. Our overall gross margin decreased from approximately 25% for the nine months ended June 30, 2019 to approximately 18% for the nine months ended June 30, 2020. | |
| · | Our sales for the three months ended June 30, 2020 decreased by approximately 31% as compared to the same period in 2019, due to the combined effect of (i) the decreased demand of our licorice and TCMD products, (ii) substantive drop in oxytetracycline products prices in April and May 2020, and (iii) our strategic decision to suspend the sales of heparin products. Due to governmental mandates during the COVID-19 outbreak, the general Chinese population was encouraged to receive examinations and treatments in hospitals instead of resorting to over the counter medicines, which include our licorice and TCMD products. Further, the substantive decrease in market price of our oxytetracycline products was caused by border controls and closures in foreign countries, which resulted in general excess supplies of oxytetracycline products. In addition, we strategically suspended the sales of heparin products because of a significant increase in the price of pig small intestine and we predicted that we would incur loss from selling heparin products. We decided to put our sales of heparin products on hold starting in the quarter ended June 30, 2020 until the market price rebounded. In the quarter ended September 30, 2020, we resumed selling heparin products. |
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Considering the global development of the COVID-19 outbreak and the changes in market conditions that followed, we expect the following to occur for the fiscal year ended September 30,2020:
| · | For the year ended September 30, 2020, our net revenue is estimated to increase by 5% to 8% compared to the year ended September 30, 2019, due to the increase in net revenue in the first six months ended March 31, 2020 and rebounding market conditions in the quarter ended September 30, 2020. |
| · | The COVID-19 outbreak has increased the cost of raw materials for our oxytetracycline, licorice and TCMD products. In addition to the COVID-19 impact, soy bean prices has increased due to the Trade friction between China and US. We expect our cost of production to increase. |
| · | We expect our account receivable collections to slow down due to the Company’s recent extended credit policy, which excludes our customers for oxytetracycline products. We have extended credit terms for certain customers with scrutiny. We expect our account receivable turnover rate to be lower compared to that of the pre-outbreak period. The Company does not expect significant bad debt increase for our fiscal quarter ended September 30, 2020 due to the Company’s credit scrutiny policy and careful credit monitoring procedures. |
| · | The Company will continue funding its capital requirements primarily by cash flow from operations, bank loans, and equity contribution from shareholders. |
Products
| · | Our licorice products include Gan Di Xin®, Qilian Shan® Licorice Extract, and Qilian Shan® Licorice Liquid Extract. Our Gan Di Xin® is an innovative antitussive and expectorant medicine made from raw licorice materials. Our Qilian Shan® Licorice Extract is a primary ingredient for pharmaceutical companies to manufacture traditional licorice tablets. Our Qilian Shan® Licorice Liquid Extract is the primary ingredient for medical preparation companies to produce compound licorice oral solutions. |
| · | Our oxytetracycline products include Qilian Shan® Oxytetracycline Tablets and Qilian Shan® Oxytetracycline Active Pharmaceutical Ingredients (“API”). Our Qilian Shan® Oxytetracycline Tablets are used to prevent and treat a wide range of diseases in chickens, turkeys, cattle, swine, and human. Our Qilian Shan® Oxytetracycline APIs are used by pharmaceutical companies in the manufacturing of medications that use oxytetracycline as an active ingredient. |
| · | Our TCMD product includes Ahan® antibacterial paste, which is made from a mixture of 11 traditional Chinese herbal ingredients. It is used to treat refractory chronic skin diseases. |
| · | Our heparin product includes Heparin Sodium Preparations. It is a primary ingredient for pharmaceutical companies to produce medications used in treating cardiovascular diseases, cerebrovascular diseases, and hemodialysis. |
| · | Our sausage casings include Zhu Xiaochang® Sausage Casings, which are all-natural food products used for culinary purposes. |
| · | Our fertilizer products include Xiongguan® Organic Fertilizer and Xiongguan® Organic-Inorganic Compound Fertilizer. Our Xiongguan® Organic Fertilizer is designed to improve crop yield, increase soil’s chemical properties, and reduce soil compaction. Our Xiongguan® Organic-Inorganic Compound Fertilizer is made from both organic materials and traditional chemical fertilizer and is designed to increased plant growth. |
Our Competitive Advantages
We believe our principal competitive strengths are as follows:
Recognized Brand Name
With over 50 years of history, “Qilian Shan (祁连山)” is a well-known medical and chemical industrial brand in China. We have received many awards from government agencies such as the Gansu Province “Specialized New Technology” Enterprise Status granted by Gansu Provincial Industry and Information Technology Commission in November 2017. Please see “Business—Honors, Awards, and Qualifications” for more detailed information regarding the awards we have received in the past years and selective criteria for each award. In addition, our TCMD products have been available in hospitals and drug stores for years and have received positive feedback from our customers over time. Our fertilizer products have been well received in China for years with individual farmers as well as farm owners. In addition, as Chinese consumers are becoming better informed and more aware of the environmental impact of consumer products, we have actively cultivated a positive sustainability brand image through our operating subsidiary Qiming which uses oxytetracycline waste materials to produce fertilizer, saving resources, protecting our environment and promoting the sustainable development of the fertilizer industry.
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Unique Geographical Location And Beneficial National Policy
Gansu GLS, our operating subsidiary, enjoys unique business and policy advantages as a result of the Belt and Road Initiative, which is a Chinese government’s international infrastructure development and investment strategy that has a particular focus on Western China. Such advantages include exemptions for land transaction fees, exemptions for newly added construction land users’ fees, exemptions for enterprise income tax, and priorities in using certain public lands. In addition, our PRC operating entities, in general, enjoy high quality, low cost, and abundant local resources due to their locations in remote Western China, which enables them to allocate more financial resources on improving production technologies, advancing research and development, and guaranteeing quality control procedures.
Strong Research And Development Capability
We believe that our research and development (“R&D”) capabilities allow us to respond to our customers’ evolving needs. Our R&D team has demonstrated its success in using sophisticated methods and technologies to develop innovative products that we believe give us an edge over our major competitors. We have a strong technical team of 70 highly qualified individuals, amongst whom we have 14 individuals dedicated to the Company’s R&D projects. There are 17 engineers, 2 senior engineer and 18 individuals with bachelor’s and advanced degrees in our technical team. Our R&D personnel have successfully developed two innovative products, Gan Di Xin® and Ahan® Antibacterial Paste, both of which have been commercialized.
High Production Capacity
Our Company has a maximum annual production capacity of 4,000 tons of oxytetracycline APIs, 3 billion oxytetracycline tablets, 1,000 tons of licorice extracts and liquid extracts, 5 tons of Heparin Sodium Preparations, 4 million sausage casings and 100,000 tons of fertilizers. We believe that such production capacity of antibiotic raw materials gives us an advantage over our competitors in China. In addition, we have the largest fermentation and extraction manufacturing units in the country, which we believe offers us a distinctive advantage over our competitors.
Experienced And Accomplished Leadership Team With a Proven Track Record
We have an experienced management team, and most of its members possess more than a decade of pharmaceutical, biomedical, chemical and related industry experience. We believe that our leadership team is well-positioned to lead us through development, regulatory approval and commercialization of our future products. In addition, our management team has extensive R&D, manufacturing and product commercialization experience in the Chinese biomedical and chemical industry.
Our Business Strategies
Our overall strategy is to leverage our considerable industry experience, our deep understanding of PRC market and our R&D expertise to capture additional shares of the PRC markets. We plan to fulfill increasing medical and agricultural needs in the Chinese market with our Gan Di Xin®, Qilian Shan® Oxytetracycline API, Xiongguan® Organic Fertilizer, and Heparin Sodium Preparation. According to the Frost & Sullivan Report, the total output volume of chemical medicines in the PRC is expected to reach 3,797 thousand tons in 2024, with a CAGR of approximately 7.4% from 2020, according to the National Bureau of Statistic of China and the Frost & Sullivan Report. The pharmaceutical market in the PRC started to play an increasingly large role in the global market supply, particularly in relation to APIs. It is expected that the revenue from the manufacturing of APIs will reach RMB1,074.8 billion in 2024, representing a CAGR of approximately 9.9%. According to the Frost & Sullivan Report, the pharmaceutical market in the PRC is highly fragmented with more than 4,000 pharmaceutical companies and a total market size of RMB2,614.7 billion in terms of sales in 2019. In 2019, the top 20 pharmaceutical companies accounted for over 20% of the total pharmaceutical market in the PRC. The market alternatives for Gan Di Xin®, Qilian Shan® Oxytetracycline API, Xiongguan® Organic Fertilizer, and Heparin Sodium Preparation are widely available. In particular, major market participants in the oxytetracycline, compound licorice and heparin sodium markets are small and medium companies with no particular market leader with significant market share to dominate or influence the market.
Our product-specific business strategy is as follows:
Our Business Strategies For Gan Di Xin®
We plan to further enhance market awareness of the Gan Di Xin® brand in the PRC markets. Our Company’s Gan Di Xin® has been included in the National Essential Medicines Category and Gansu Province’s Essential Medicines Category, which are pharmaceutical prescription guidances for medical institutions in the PRC and Gansu Province. Gan Di Xin® has also been enrolled in Gansu Province’s Class B Medical Insurance Coverage Program, which allows Gan Di Xin® to enter insurance-covered pharmacies in Gansu Province. Our branding strategy is to conduct a pilot marketing program in Gansu Province, and then reach a larger customer base in other provinces with wider insurance coverage product offerings by enrolling Gan Di Xin® in the National Medical Insurance Coverage Program. The process of enrolling Gan Di Xin® in the National Medical Insurance Coverage Program is relatively straight forward— we will submit the application materials required by the National Medical Insurance Bureau to Jiuquan City Level Insurance Bureau. Once approved, we will then submit the application to the Gansu Provincial Insurance Bureau, which will further review our application. With Gansu Provincial Insurance Bureau’s approval, we will submit our application further to the National Insurance Bureau, which will have the final say on Gan Di Xin®’s enrollment into the National Medical Insurance Coverage Program. We will amend our application materials if any level of the insurance bureau has any questions regarding our products and applications. Such enrollment will allow Gan Di Xin® to enter medical institutions and insurance-covered pharmacies on a national level. The review for such enrollment is still in progress, and we cannot guarantee that the enrollment application will be approved.
As of the date of this prospectus, Gan Di Xin has been approved to be enrolled into the National Essential Medicines Category (2018 Edition), which was promulgated by the PRC National Health Commission and the National Administration of Traditional Chinese Medicine. In addition, we have applied with the competent authorities for Gan Di Xin to be included in the National Medical Insurance Coverage Program. As of the date of this prospectus, the Administration of Healthcare Security and the Administration of Human Resources and Social Security of Gansu Province have filed a request to the National Administration of Healthcare Security and the PRC Ministry of Human Resources and Social Security respectively for Gan Di Xin’s enrollment. There are no express rules or provisions in China regarding the minimum or maximum period required to obtain any approval for the enrollment process. The Company intends to submit all required information and handle the application process internally, and therefore does not expect to incur any ongoing expenses with respect to such application. In addition, under the Provisional Administration Rules on Drugs for Basic Medical Insurance for Urban Workers, there are no administrative or other application expenses required to be paid for the approval process, nor are there any ongoing expenses required to maintain the enrollment status.
We believe that our existing production capacity for Gan Di Xin will be able to meet our future business objectives and that there is no need to further invest in facility and production line expansion. Rather, we intend to invest more on our marketing efforts for Gan Di Xin and we estimate that we will spend approximately $118,000 annually on marketing expenses in the near future.
Our Business Strategies For Qilian Shan® Oxytetracycline API
We plan to increase our oxytetracycline API production capabilities and hire more experienced marketing specialists in order to carry out our strategic expansions into additional geographical locations in China which we believe would result in us acquiring a bigger share of the Chinese market for this product. We are committed to prioritizing investment in our infrastructure capabilities in order to support the strategic expansions into additional geographical markets in China. We plan to relocate our current oxytetracycline API production facilities and purchase additional state-of-the-art manufacturing facilities to further increase our production capacity. We plan to increase our production capacity to 10,000 tons by 2024 and we estimate that our fixed assets investment will be approximately $18 million. We will focus on hiring more experienced professionals in our sales, marketing, and production departments to support our continued market growth while reducing costs.
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Our Business Strategies For Xiongguan® Organic Fertilizer
We believe our current production equipment and components are adequate to meet current demand and limited future demand. However, to meet the demand anticipated in 2021 and beyond, we will need to move to a larger production capacity in order to reap substantial business benefits from a Chinese government proposal of “Zero Growth of Chemical Fertilizer and Pesticide Use by 2020”. Our plan is to build an organic waste treatment facility that will allow us to increase fertilizer production capacity through turning waste into high quality production materials. We believe this strategy will reduce the cost of our organic fertilizer production while increasing the efficiency of our organic fertilizer production each year. We expect to invest approximately $1.28 million in this project.
Our Business Strategies For Heparin Sodium Preparation
We intend to implement two primary strategies to expand and grow the production capacity of our Heparin Sodium Preparation: (i) upgrade the production efficiency of our existing manufacturing facilities, and (ii) increase the amount of Heparin Sodium Preparation our production lines can produce. While we have earned our reputation through the consistent quality of our products, we believe that sustained improvements in the production efficiency and increasing production lines are vital to maintaining such reputation and acquire more shares in the Chinese heparin sodium markets. We expect to invest approximately $128,000 in implementing these two strategies.
Summary of Risk Factors
Investing in our Ordinary Shares involves significant risks. You should carefully consider all of the information in this prospectus before making an investment in our Ordinary Shares. Below please find a summary of the principal risks we face, organized under relevant headings. These risks are discussed more fully in the section titled “Risk Factors.”
Risks Related to our Business
Risks and uncertainties related to our business include, but are not limited to, the following:
| • | We face significant competition in industries experiencing rapid technological change, and there is a possibility that our competitors may achieve regulatory approval and develop new product candidates before us, which may harm our financial condition and our ability to successfully market or commercialize any of our product candidates. | |
| • | Our pharmaceutical business is subject to inherent risks relating to product liability and personal injury claims. | |
| • | Our business requires a number of permits and licenses. We cannot assure you that we can maintain all required licenses, permits and certifications to carry on our business at all times. | |
| • | A significant portion of our revenue is concentrated on a few large customers, and we do not have long-term agreements with our key customers and rely upon our longstanding relationship with them. If we lose one or more of our customers, our results of operations may be adversely and materially impacted. | |
| • | We source our raw materials used for manufacturing from a limited number of suppliers. If we lose one or more of the suppliers, our operation may be disrupted, and our results of operations may be adversely and materially impacted. | |
| • | If we fail to increase our brand name recognition, we may face difficulty in obtaining new customers. | |
| • | Any disruption in the supply chain of raw materials and our products could adversely impact our ability to produce and deliver products. |
Risks Related to our Corporate Structure
We are also subject to risks and uncertainties related to our corporate structure, including, but not limited to, the following:
| • | If the PRC government deems that our contractual arrangements with our VIE do not comply with PRC regulatory restrictions on foreign investment in the relevant industries, or if these regulations or the interpretation of existing regulations change in the future, we could be subject to severe penalties or be forced to relinquish our interests in those operations. | |
| • | We rely on contractual arrangements with our variable interest entity and its subsidiaries in China for our business operations, which may not be as effective in providing operational control or enabling us to derive economic benefits as through ownership of controlling equity interests. | |
| • | Contractual arrangements in relation to our variable interest entity may be subject to scrutiny by the PRC tax authorities and they may determine that we or our PRC variable interest entity owe additional taxes, which could negatively affect our results of operations and the value of your investment. |
Risks Related to the Offering and Our Ordinary Shares
Risks and uncertainties related to our Ordinary Shares and this offering include, but are not limited to, the following:
| • | The initial public offering price of our Ordinary Shares may not be indicative of the market price of our Ordinary Shares after this offering. In addition, an active, liquid and orderly trading market for our Ordinary Shares may not develop or be maintained, and our stock price may be volatile. | |
| • | Since our Directors and Executive Officers will own at least 58.66% of our Ordinary Shares following the initial public offering, they will have the ability to elect directors and approve matters requiring shareholder approval by way of resolution of members. | |
| • | As a foreign private issuer, we are not subject to certain U.S. securities law disclosure requirements that apply to a domestic U.S. issuer, which may limit the information publicly available to our shareholders. |
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Risks Related to Doing Business in China
| • | Adverse changes in political and economic policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could reduce the demand for our products and materially and adversely affect our competitive position. | |
| • | Uncertainties with respect to the PRC legal system could adversely affect us. | |
| • | Recent joint statement by the SEC and PCAOB, proposed rule changes submitted by Nasdaq, and an act passed by the US Senate all call for additional and more stringent criteria to be applied to emerging market companies upon assessing the qualification of their auditors, especially the non-U.S. auditors who are not inspected by the PCAOB. These developments could add uncertainties to our offering. | |
| • | Substantial uncertainties exist with respect to the interpretation of the PRC Foreign Investment Law and how it may impact the viability of our current corporate structure, corporate governance and business operations. |
Reverse Split And Increase Authorized Shares
On October 16, 2019, our shareholders approved and effected a reverse split of our outstanding Ordinary Shares at a ratio of 1-for-1.66667 shares. In addition, on October 16, 2019, our shareholders approved and effected an increase of the Company’s authorized share capital from US$50,000 consisting of 50,000,000 Ordinary Shares of US$0.001 par value to US$166,667 consisting of 100,000,000 Ordinary Shares of US$0.00166667 par value. All references to Ordinary Shares, share data, per share data, and related information have been retroactively adjusted, where applicable, in this prospectus to reflect the reverse split of our issued and outstanding Ordinary Shares and increase of our authorized Ordinary Shares as if these events had occurred at the beginning of the earliest period presented.
Our History And Corporate Structure
Qilian International Holding Group Limited is a Cayman Islands exempted company with limited liability incorporated on February 7, 2019. Exempted companies are Cayman Islands companies conducting business mainly outside the Cayman Islands and, as such, are exempted from complying with certain provisions of the Companies Law (2018 Revision).
Mr. Zhanchang Xin, our Chairman of the Board of Directors and Chief Executive Officer, is currently the beneficial owner of 46.13% of our outstanding Ordinary Shares, of which 6.13% are directly held by Ahanzhai Development Co., Ltd., an entity 100% owned by Mr. Xin. Ms. Haiping Shi, our Chief Financial Officer and Director Appointee, is currently the beneficial owner of 23.77% of our outstanding Ordinary Shares through Zhijiu Holdings Ltd., an entity 100% owned by Ms. Shi. If we complete the initial public offering of our Ordinary Shares, excluding any Ordinary Shares issuable upon the exercise of the over-allotment option granted to the underwriters, Mr.Xin and Ms. Shi will collectively have the right to vote 59.91% of the Ordinary Shares. Mr. Xin and Ms. Shi will collectively have the right to vote 58.66% of the issued and outstanding Ordinary Shares if taking into account of over-allotment shares issued. They will have the ability to elect directors and approve matters requiring shareholder approval by way of resolution of members. Please see “Risk Factors—Risks Related to the Offering and Our Ordinary Shares—Since our Directors and Executive Officers will own at least 58.66% of our Ordinary Shares following the initial public offering, they will have the ability to elect directors and approve matters requiring shareholder approval by way of resolution of members.”
Qilian International (Hong Kong) Holdings Limited, which we refer to as Qilian HK, our wholly-owned subsidiary, was incorporated in Hong Kong on January 30, 2019. Chengdu Qilian Trading Co., Ltd., which we refer to as WFOE, Qilian HK’s wholly owned subsidiary, was incorporated pursuant to PRC laws on May 15, 2019. Our variable interest entity, Gansu Qilianshan Pharmaceutical Co. Ltd., which we refer to as Gansu QLS, was established in August 30, 2006, as a result of Gansu State-operated Qilianshan Pharmaceutical Factory, which was incorporated in July 1969 in Jiuquan, Gansu Province, PRC pursuant to PRC laws. Gansu QLS’ shareholders include certain PRC residents and corporate entities controlled by PRC residents.
Pursuant to PRC laws, each entity formed under PRC laws shall have certain business scope approved by the Administration of Industry and Commerce or its local counterpart. As such, WFOE’s business scope is to primarily engage in business development, technology service, technology consulting, intellectual property service and business management consulting. Since the sole business of WFOE is to provide Gansu QLS with technical support, consulting services and other management services relating to its day-to-day business operations and management in exchange for a consulting fee, which is at WFOE’s discretion and can be the net income of Gansu QLS, such business scope is necessary and appropriate under the PRC laws. Gansu QLS, on the other hand, has been granted its own business scope, different from WFOE, to enable it to develop, manufacture, market and sale its products.
We control Gansu QLS through contractual agreements, which are described under “Business — Contractual Agreements between WFOE and Gansu QLS.”
Qilian International is a holding company with no business operation other than holding the shares in Qilian HK and Qilian HK is a pass-through entity with no business operation.
WFOE is exclusively engaged in the business of managing the operation of Gansu QLS.
We have asked our shareholders who are PRC residents to make the necessary applications and filings as required under PRC SAFE Circular 37 (“Circular 37”). We cannot assure you that each of our shareholders who are PRC residents will in the future complete the registration process as required by Circular 37. Shareholders of offshore SPV who are PRC residents and who have not completed their registrations in accordance with Circular 37 are subject to certain absolute restrictions, under which they cannot contribute any registered or additional capital to such SPV for offshore financing purposes. In addition, these shareholders cannot repatriate any profits and dividends from the SPV to China either. Please see “Risk Factors—Risks Related to Doing Business in China—Part of our shareholders are not in compliance with the PRC’s regulations relating to offshore investment activities by PRC residents, and as a result, the shareholders may be subject to penalties if we are not able to remediate the non-compliance.”
In addition, even if any shareholder who is a PRC resident (as determined by Circular 37) holds any interest in WFOE and fails to fulfil the required foreign exchange registration with the local SAFE branches, Qilian International and Qilian HK are not restricted in their ability to contribute additional capital to WFOE. Since Gansu QLS and its subsidiaries are only controlled by WFOE through contractual arrangements, and since WFOE is not a shareholder of Gansu QLS, neither Gansu QLS nor any of its subsidiaries have any obligations to contribute capital to WFOE, nor have they any rights to receive distributions or dividends from WFOE. WFOE is not prohibited from distributing its profits and dividends to Qilian International or Qilian HK or from carrying out other subsequent cross-border foreign exchange activities because WFOE has completed the foreign exchange registration formalities as required upon its establishment. Only capital contributions to a special purpose vehicle by its shareholders failing to comply with Circular 37, as well as the repatriation of profits and dividends derived from such special purpose vehicle to China by its shareholders are limited.
Shareholders who have completed the Circular 37 registration would not be adversely affected and are allowed to contribute assets into the offshore special purpose vehicle and repatriate profits and dividends from them. Since WFOE has completed its foreign exchange registration as a foreign investment enterprise, its ability to receive capital contribution, make distributions and pay dividends is not restricted.
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On April 17, 2020, Rugao Tianlu Animal Products Co., Ltd. was incorporated under the laws of the People’s Republic of China (“Rugao”). Rugao is the 100% owned subsidiary of Chengdu QLS. We aim to use it as procurement and manufacturing assistance entity for Chengdu QLS and as a point of expansion for our sausage casings business in Jiangsu Province.
The following diagram illustrates our corporate structure as of the date of this prospectus and upon completion of the Offering based on 5,000,000 Ordinary Shares being offered, assuming that the underwriters do not exercise their over-allotment option:
Corporate Information
Our principal executive offices are located at at Jiuquan Economic and Technological Development Zone (formerly named No. 2 Dadeli Road, Nanjiao Industrial Park), Jiuquan City, Gansu, China, and our phone number is +86-0937-2689523. We maintain a corporate website at http://www.qlsyy.net/. The information contained in, or accessible from, our website or any other website does not constitute a part of this prospectus.
Implications of Being an Emerging Growth Company and a Foreign Private Issuer
As a company with less than $1.07 billion in revenue during our last fiscal year, we qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act, or JOBS Act, enacted in April 2012, and may take advantage of reduced reporting requirements that are otherwise applicable to public companies. These provisions include, but are not limited to:
| · | being permitted to present only two years of audited financial statements and only two years of related Management’s Discussion and Analysis of Financial Condition and Results of Operations in our filings with the SEC; | |
| · | not being required to comply with the auditor attestation requirements in the assessment of our internal control over financial reporting; | |
| · | reduced disclosure obligations regarding executive compensation in periodic reports, proxy statements and registration statements; and | |
| · | exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. |
We may take advantage of these provisions until the last day of our fiscal year following the fifth anniversary of the date of the first sale of our ordinary shares pursuant to this offering. However, if certain events occur before the end of such five-year period, including if we become a “large accelerated filer,” our annual gross revenues exceed $1.07 billion or we issue more than $1.0 billion of non-convertible debt in any three-year period, we will cease to be an emerging growth company before the end of such five-year period.
In addition, Section 107 of the JOBS Act provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933, as amended, or the Securities Act, for complying with new or revised accounting standards. We have elected to take advantage of the extended transition period for complying with new or revised accounting standards and acknowledge such election is irrevocable pursuant to Section 107 of the JOBS Act.
We are a foreign private issuer within the meaning of the rules under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). As such, we are exempt from certain provisions applicable to United States domestic public companies. For example:
| ● | we are not required to provide as many Exchange Act reports, or as frequently, as a U.S. domestic public company; | |
| ● | for interim reporting, we are permitted to comply solely with our home country requirements, which are less rigorous than the rules that apply to domestic public companies; | |
| ● | we are not required to provide the same level of disclosure on certain issues, such as executive compensation; | |
| ● | we are exempt from provisions of Regulation FD aimed at preventing issuers from making selective disclosures of material information; | |
| ● | we are not required to comply with the sections of the Exchange Act regulating the solicitation of proxies, consents, or authorizations in respect of a security registered under the Exchange Act; and | |
| ● | we are not required to comply with Section 16 of the Exchange Act requiring insiders to file public reports of their share ownership and trading activities and establishing insider liability for profits realized from any “short-swing” trading transaction. |
We intend to comply with the Nasdaq Global Market corporate governance rules applicable to foreign private issuers, which permit us to follow certain corporate governance rules that conform to the Cayman Islands requirements in lieu of many of the Nasdaq Global Market corporate governance rules applicable to U.S. companies. As a result, our corporate governance practices may differ from those you might otherwise expect from a U.S. company listed on Nasdaq Global Market.
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| Shares Offered | 5,000,000 Ordinary Shares (or 5,750,000 Ordinary Shares assuming that the underwriters exercise their over-allotment option in full) | |
| Over-allotment Option | We have granted the underwriters an option exercisable up to 45 days after the closing of this offering to purchase up to an additional 15% of the Ordinary Shares sold in this offering on the same terms as the other Ordinary Shares being purchased by the underwriters from us. | |
| Ordinary Shares outstanding prior to completion of this offering | 30,000,000 Ordinary Shares | |
| Ordinary Shares outstanding immediately after this offering | 35,000,000 Ordinary Shares (or 35,750,000 Ordinary Shares assuming that the underwriters exercise their over-allotment option in full) | |
| Use of Proceeds | We estimate that our net proceeds from this offering will be approximately $22,218,459, based on an initial public offering price of $5.00 per Ordinary Share and after deducting estimated underwriting discounts and advisory fee and estimated offering expenses and assuming no exercise of the over-allotment option granted to the underwriters. We intend to use the net proceeds from this offering for production capacities expansion, marketing purposes, and acquisition of upstream and downstream companies manufacturing traditional Chinese medicine pieces. See “Use of Proceeds” for more information. | |
| Representative of the Underwriters | Univest Securities, LLC | |
| Underwriters’ Warrants | We have agreed to sell to Univest Securities, LLC, the representative of the underwriters, warrants (the “Underwriters’ Warrants”) to purchase up to a total of 300,000 Ordinary Shares (equal to 6% of the aggregate number of Ordinary Shares sold in the offering) at a price equal to 110% of the price of our Ordinary Shares offered hereby. The underwriters will not receive any Underwriters’ Warrants for the Ordinary Shares sold pursuant to the over-allotment option. | |
| Nasdaq Global Market symbol | “QLI” | |
| Transfer Agent | VStock Transfer, LLC. | |
| Risk Factors | Investing in these securities involves a high degree of risk. As an investor, you should be able to bear a complete loss of your investment. You should carefully consider the information set forth in the “Risk Factors” section of, and elsewhere in, this prospectus before deciding to invest in our Ordinary Shares. | |
| Lock-Up | We, our directors and executive officers, and our existing beneficial owners of 5% or more of our outstanding Ordinary Shares have agreed with the underwriters, subject to certain exceptions, not to sell, transfer or otherwise dispose of any Ordinary Shares for a period ending 180 days after the commencement of the trading of the Ordinary Shares. See “Underwriting” for more information. |
Unless otherwise indicated, all information in this amendment reflects a 1-for-1.66667 reverse split of our issued and outstanding Ordinary Shares, effected on October 16, 2019, and the corresponding adjustment of proposed maximum offering price per share of our Ordinary Shares.
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The following tables set forth selected historical statements of operations and balance sheet data for the six months ended March 31, 2020 and 2019, and for the fiscal years ended September 30, 2019, and 2018, which have been derived from our audited financial statements for those periods. Our historical results are not necessarily indicative of the results that may be expected in the future. You should read this data together with our consolidated financial statements and related notes appearing elsewhere in this prospectus as well as “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” appearing elsewhere in the prospectus.
Selected Statements of Operations Information:
Qilian International Holding Group Limited and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Amounts in US$, except shares)
| For the six months ended March 31 | ||||||||
| 2020 | 2019 | |||||||
| NET REVENUE | $ | 27,758,814 | $ | 27,160,302 | ||||
| COST OF REVENUE | 21,530,973 | 19,772,589 | ||||||
| GROSS PROFIT | 6,227,841 | 7,387,713 | ||||||
| SELLING, GENERAL AND ADMINISTRATIVE EXPENSES | 1,434,898 | 1,732,288 | ||||||
| INCOME FROM OPERATIONS | 4,792,943 | 5,655,425 | ||||||
| Other Income (Expenses) | ||||||||
| Interest expense | (110,251 | ) | (104,282 | ) | ||||
| Other income | 215,788 | 354,884 | ||||||
| Total Other income (expense) | 105,537 | 250,602 | ||||||
| INCOME BEFORE INCOME TAX PROVISION | 4,898,480 | 5,906,027 | ||||||
| PROVISION FOR INCOME TAXES | 715,101 | 881,726 | ||||||
| NET INCOME | 4,183,379 | 5,024,301 | ||||||
| Less: net income attributable to non-controlling interest | 325,249 | 732,190 | ||||||
| NET INCOME ATTRIBUTABLE TO QILIAN INTERNATIONAL HOLDING GROUP LIMITED | $ | 3,858,130 | $ | 4,292,111 | ||||
| OTHER COMPREHENSIVE INCOME | ||||||||
| Foreign currency translation adjustment | 110,067 | 525,626 | ||||||
| COMPREHENSIVE INCOME | 4,293,446 | 5,549,927 | ||||||
| Less: comprehensive income attributable to non - controlling interests | 340,536 | 828,230 | ||||||
| COMPREHENSIVE INCOME ATTRIBUTABLE TO QILIAN INTERNATIONAL HOLDING GROUP LIMITED | $ | 3,952,910 | $ | 4,721,697 | ||||
| Earnings per common share - basic and diluted | $ | 0.13 | $ | 0.14 | ||||
| Weighted average shares - basic and diluted | 30,000,000 | 30,000,000 | ||||||
Qilian International Holding Group Limited
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Amounts in US$, except shares)
| For the years ended September 30, | ||||||||
| 2019 | 2018 | |||||||
| NET REVENUE | $ | 46,096,684 | $ | 50,369,013 | ||||
| COST OF REVENUE | 36,416,772 | 42,236,773 | ||||||
| GROSS PROFIT | 9,679,912 | 8,132,240 | ||||||
| SELLING, GENERAL AND ADMINISTRATIVE EXPENSES | 3,501,374 | 2,160,873 | ||||||
| INCOME FROM OPERATIONS | 6,178,538 | 5,971,367 | ||||||
| Other Income (Expenses) | ||||||||
| Interest expense | (223,657 | ) | (216,187 | ) | ||||
| Other income | 987,038 | 390,792 | ||||||
| Total Other income (expense) | 763,381 | 174,605 | ||||||
| INCOME BEFORE INCOME TAX PROVISION | 6,941,919 | 6,145,972 | ||||||
| PROVISION FOR INCOME TAXES | 1,033,440 | 943,363 | ||||||
| NET INCOME | 5,908,479 | 5,202,609 | ||||||
| Less: net income attributable to non-controlling interest | 576,161 | 33,102 | ||||||
| NET INCOME ATTRIBUTABLE TO QILIAN INTERNATIONAL HOLDING GROUP LIMITED | $ | 5,332,318 | $ | 5,169,507 | ||||
| OTHER COMPREHENSIVE INCOME | ||||||||
| Foreign currency translation adjustment | (858,337 | ) | (652,232 | ) | ||||
| COMPREHENSIVE INCOME | 5,050,142 | 4,550,377 | ||||||
| Less: comprehensive income attributable to non - controlling interests | 478,722 | (35,398 | ) | |||||
| COMPREHENSIVE INCOME ATTRIBUTABLE TO QILIAN INTERNATIONAL HOLDING GROUP LIMITED | $ | 4,571,420 | $ | 4,585,775 | ||||
| Earnings per ordinary share - basic and diluted | $ | 0.18 | $ | 0.17 | ||||
| Weighted average shares - basic and diluted | 30,000,000 | 30,000,000 | ||||||
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Selected Balance Sheet Information:
Qilian International Holding Group Limited and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(Amounts in US$, except shares)
| As of | ||||||||
| March 31 | September 30 | |||||||
| 2020 | 2019 | |||||||
| ASSETS | ||||||||
| CURRENT ASSETS: | ||||||||
| Cash | $ | 11,811,937 | $ | 4,594,440 | ||||
| Accounts receivable, net | 2,957,586 | 603,760 | ||||||
| Accounts receivable - related parties, net | 9,133 | - | ||||||
| Bank notes receivable | 3,587,334 | 5,476,707 | ||||||
| Inventories, net | 10,473,104 | 12,522,884 | ||||||
| Advances to suppliers, net | 1,727,232 | 958,005 | ||||||
| Other current assets | 914,640 | 813,932 | ||||||
| TOTAL CURRENT ASSETS | 31,480,966 | 24,969,728 | ||||||
| Property and equipment, net | 7,384,553 | 7,665,322 | ||||||
| Intangible assets, net | 1,830,618 | 1,834,130 | ||||||
| Long term investment | 486,442 | 539,680 | ||||||
| Right of use assets-lease | 135,727 | - | ||||||
| Deferred tax assets | 228,711 | 259,384 | ||||||
| TOTAL ASSETS | $ | 41,547,017 | $ | 35,268,244 | ||||
| CURRENT LIABILITIES: | ||||||||
| Bank loans | $ | 7,052,584 | $ | 4,903,128 | ||||
| Accounts payable | 3,608,300 | 3,570,148 | ||||||
| Advance from customers | 244,500 | 1,911,748 | ||||||
| Advance from customers - related parties | - | 2,171 | ||||||
| Deferred government grants-current | 385,013 | 391,142 | ||||||
| Taxes payable | 1,897,100 | 347,930 | ||||||
| Operating lease liabilities, current | 56,125 | - | ||||||
| Accrued expenses and other payables | 523,459 | 531,713 | ||||||
| TOTAL CURRENT LIABILITIES | 13,767,081 | 11,657,980 | ||||||
| LONG TERM LIABILITIES | ||||||||
| Operating lease liabilities, long term | 59,291 | - | ||||||
| Deferred government grants - noncurrent | 789,273 | 972,338 | ||||||
| TOTAL LIABILITIES | 14,615,645 | 12,630,318 | ||||||
| Commitments and contingencies | ||||||||
| SHAREHOLDERS' EQUITY: | ||||||||
| Ordinary Shares, $0.00166667 par value, 100,000,000 shares authorized, 30,000,000
Ordinary Shares issued and outstanding as of March 31, 2020 and September 30, 2019 , respectively |
50,000 | 50,000 | ||||||
| Additional paid-in capital | 12,252,077 | 12,252,077 | ||||||
| Statutory Reserve | 2,200,488 | 1,773,817 | ||||||
| Retained earnings | 10,992,090 | 7,560,631 | ||||||
| Accumulated other comprehensive loss | (1,648,395 | ) | (1,743,175 | ) | ||||
| Total shareholders’ equity attributable to Qilian International | 23,846,260 | 19,893,350 | ||||||
| Non-controlling interest | 3,085,112 | 2,744,576 | ||||||
| TOTAL SHAREHOLDERS' EQUITY | 26,931,372 | 22,637,926 | ||||||
| TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY | $ | 41,547,017 | 35,268,244 | |||||
Qilian International Holding Group Limited
CONSOLIDATED BALANCE SHEET
(Amounts in US$, except shares)
| As of | ||||||||
| September 30, | September 30, | |||||||
| 2019 | 2018 | |||||||
| ASSETS | ||||||||
| CURRENT ASSETS: | ||||||||
| Cash | $ | 4,594,440 | $ | 5,260,788 | ||||
| Restricted cash | - | 363,991 | ||||||
| Accounts receivable, net | 603,760 | 1,321,085 | ||||||
| Accounts receivable - related parties, net | - | 6,185 | ||||||
| Bank notes receivable | 5,476,707 | 3,518,047 | ||||||
| Inventories, net | 12,522,884 | 9,586,360 | ||||||
| Advances to suppliers, net | 958,005 | 1,649,492 | ||||||
| Advances to suppliers – related parties, net | - | - | ||||||
| Other current assets | 813,932 | 463,218 | ||||||
| TOTAL CURRENT ASSETS | 24,969,728 | 22,169,166 | ||||||
| Property and equipment, net | 7,665,322 | 8,488,726 | ||||||
| Intangible assets, net | 1,834,130 | 1,956,008 | ||||||
| Long term investment | 539,680 | 407,345 | ||||||
| Deferred tax assets | 259,384 | 318,296 | ||||||
| TOTAL ASSETS | $ | 35,268,244 | $ | 33,339,541 | ||||
| CURRENT LIABILITIES: | ||||||||
| Bank loans | $ | 4,903,128 | $ | 3,639,911 | ||||
| Accounts payable | 3,570,148 | 3,757,550 | ||||||
| Accounts payable - related parties | - | 3,046 | ||||||
| Advance from customers | 1,911,748 | 4,222,490 | ||||||
| Advance from customers - related parties | 2,171 | - | ||||||
| Bank notes payable | - | 582,386 | ||||||
| Deferred government grants-current | 391,142 | 407,003 | ||||||
| Taxes payable | 347,930 | 1,196,811 | ||||||
| Accrued expenses and other payables | 531,713 | 478,557 | ||||||
| TOTAL CURRENT LIABILITIES | 11,657,980 | 14,287,754 | ||||||
| LONG-TERM LIABILITIES | ||||||||
| Deferred government grants - noncurrent | 972,338 | 1,330,451 | ||||||
| TOTAL LIABILITIES | 12,630,318 | 15,618,205 | ||||||
| Commitments and contingencies | ||||||||
| SHAREHOLDERS' EQUITY: | ||||||||
| Ordinary Shares, $0.00166667 par value, 100,000,000 shares authorized, 30,000,000 Ordinary Shares issued and outstanding as of September 30, 2019 and 2018, respectively | 50,000 | 50,000 | ||||||
| Additional paid-in capital | 12,252,077 | 12,252,077 | ||||||
| Statutory Reserve | 1,773,817 | 1,132,636 | ||||||
| Retained earnings | 7,560,631 | 2,869,494 | ||||||
| Accumulated other comprehensive loss | (1,743,175 | ) | (982,277 | ) | ||||
| Total shareholders’ equity attributable to Qilian International | 19,893,350 | 15,321,930 | ||||||
| Non-controlling interest | 2,744,576 | 2,399,406 | ||||||
| TOTAL SHAREHOLDERS' EQUITY | 22,637,926 | 17,721,336 | ||||||
| TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY | $ | 35,268,244 | 33,339,541 | |||||
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An investment in our Ordinary Shares involves a high degree of risk. Before deciding whether to invest in our Ordinary Shares, you should consider carefully the risks described below, together with all of the other information set forth in this prospectus, including the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes. If any of these risks actually occurs, our business, financial condition, results of operations or cash flow could be materially and adversely affected, which could cause the trading price of our Ordinary Shares to decline, resulting in a loss of all or part of your investment. The risks described below and in the documents referenced above are not the only ones that we face. Additional risks not presently known to us or that we currently deem immaterial may also affect our business. You should only consider investing in our Ordinary Shares if you can bear the risk of loss of your entire investment.
Risks Related to Our Business
We face significant competition in industries experiencing rapid technological change, and there is a possibility that our competitors may achieve regulatory approval and develop new product candidates before us, which may harm our financial condition and our ability to successfully market or commercialize any of our product candidates.
The development and commercialization of new pharmaceutical products and fertilizers is highly competitive, and both industries currently are characterized by rapidly changing technologies, significant competition and a strong emphasis on intellectual property. We will face competition with respect to our current and future pharmaceutical and fertilizer product candidates from major pharmaceutical and chemical companies in China. Potential competitors also include academic institutions, government agencies and other public and private research organizations that conduct research, seek patent protection and establish collaborative arrangements for research, development, manufacturing and commercialization of pharmaceutical and fertilizer products. For example, competition for improving oxytetracycline strains comes from conventional and advanced breeding techniques. Other potentially competitive sources of improvement in oxytetracycline yields include improvements in specific biotechnology areas and information management.
We have competitors in China that manufacture products similar to ours. These companies sell similar products as ours and some of them may have more assets, resources and a larger market share. We believe we are able to compete with these competitors because of our geographical location in Western China, our unique combination of products and our products’ lower prices.
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Some of our current or potential competitors may have significantly greater financial resources and expertise in research and development, manufacturing, product testing, obtaining regulatory approvals and marketing approved products than we do. Mergers and acquisitions in the pharmaceutical, chemical and agricultural industries may result in even more resources being concentrated among a smaller number of our competitors. Smaller or early-stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies. These competitors also compete with us in recruiting and retaining qualified scientific and management personnel, as well as in acquiring technologies complementary to, or necessary for, our R&D projects. Our commercial opportunity could be reduced or eliminated if our competitors develop and commercialize products that are more effective, more convenient or are less expensive than any products we develop alone or with collaborators or that would render any such products obsolete or non-competitive. Our competitors also may obtain regulatory approval for their products more rapidly than we may obtain approval for any that we develop, which could result in our competitors establishing a strong market position before our new products are able to enter the market. Additionally, technologies developed by our competitors may render our product candidates uneconomical or obsolete, and we or our collaborators may not be successful in marketing any product candidates we may develop against competitors. The availability of our competitors’ products could limit the demand, and the price we are able to charge, for any products that we develop alone or with collaborators.
Our pharmaceutical business is subject to inherent risks relating to product liability and personal injury claims.
We, as a pharmaceutical company, are exposed to risks inherent in the manufacturing and distribution of pharmaceutical products, such as with respect to improper filling of prescriptions, labeling of prescriptions, adequacy of warnings, and unintentional distribution of counterfeit drugs. In addition, product liability claims may be asserted against us with respect to any of the products we sell and as a distributor, we are required to pay for damages for any successful product liability claim against us, although we may have the right under applicable PRC laws, rules and regulations to recover from the relevant manufacturer or distributors for compensation we paid to our customers in connection with a product liability claim. We may also be obligated to recall affected products. If we are found liable for product liability claims, we could be required to pay substantial monetary damages. Furthermore, even if we successfully defend ourselves against this type of claim, we could be required to spend significant management, financial and other resources, which could disrupt our business, and our reputation as well as our brand name may also suffer. We, like many other similar companies in China, do not carry product liability insurance. As a result, any imposition of product liability could materially harm our business, financial condition and results of operations. In addition, we do not have any business interruption insurance due to the limited coverage of any available business interruption insurance in China, and as a result, any business disruption or natural disaster could severely disrupt our business and operations and significantly decrease our revenue and profitability.
We have limited sources of working capital and will need substantial additional financing.
The working capital required to implement our business plan and R&D efforts will most likely be provided by funds obtained through offerings of our equity, debt, debt-linked securities, and/or equity-linked securities, and revenues generated by us. No assurance can be given that we will have revenues sufficient to sustain our operations or that we would be able to obtain equity/debt financing in the current economic environment. If we do not have sufficient working capital and are unable to generate sufficient revenues or raise additional funds, we may delay the completion of or significantly reduce the scope of our current business plan; delay some of our development and clinical or marketing efforts; postpone the hiring of new personnel; or, under certain dire financial circumstances, substantially curtail or cease our operations.
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We need sufficient financing to implement our business plan, which includes expanding the marketing efforts for Gan Di Xin® and increasing the manufacturing capacities for our oxytetracycline products, fertilizer products and Heparin Sodium Preparations. We will also need sufficient financing to materialize our future plan of acquiring traditional Chinese medicine enterprises. We estimate that carrying out these business projects will require at least $26 million. Our inability to obtain sufficient additional financing would have a material adverse effect on our ability to implement our business plan and, as a result, could require us to significantly curtail or potentially cease our operations. As of March 31, 2020, we had cash and cash equivalents of approximately $11,811,937, total current assets of $31,480,966 and total current liabilities of $13,767,081. We will need to engage in capital-raising transactions in the near future. Such financing transactions may well cause substantial dilution to our shareholders and could involve the issuance of securities with rights senior to the outstanding shares. Our ability to complete additional financings depends on, among other things, the state of the capital markets at the time of any proposed offering, market reception of the Company and the likelihood of the success of its business model and offering terms. There is no assurance that we will be able to obtain any such additional capital through asset sales, equity or debt financing, or any combination thereof, on satisfactory terms or at all. Additionally, no assurance can be given that any such financing, if obtained, will be adequate to meet our capital needs and to support our operations. If we do not obtain adequate capital on a timely basis and on satisfactory terms, our revenues and operations and the value of our Ordinary Shares and Ordinary Share equivalents would be materially negatively impacted and we may cease our operations.
We depend on certain key personnel and loss of these key personnel could have a material adverse effect on our business, financial condition and results of operations.
Our success is, to a certain extent, attributable to the management, sales and marketing, and research and development expertise of key personnel. We depend upon the services of Mr. Zhanchang Xin, our President, Chief Executive Officer, Chairman of the Board, for the continued growth and operation of our Company, due to his industry experience, technical expertise, as well as his personal and business contacts in the PRC. Additionally, Mr. Zhanchang Xin, performs key functions in the operation of our business as our Chief Scientific Officer and Chief Operations Officer. We may not be able to retain Mr. Zhanchang Xin for any given period of time. Although we have no reason to believe that Mr. Zhanchang Xin will discontinue his services with us or Gansu QLS, the interruption or loss of his services would adversely affect our ability to effectively run our business and pursue our business strategy as well as our results of operations. We do not carry key man life insurance for any of our key personnel, nor do we foresee purchasing such insurance to protect against the loss of key personnel.
We may not be able to hire and retain qualified personnel to support our growth and if we are unable to retain or hire these personnel in the future, our ability to improve our products and implement our business objectives could be adversely affected.
We must attract, recruit and retain a sizeable workforce of technically competent employees. Competition for senior management and personnel in the PRC is intense and the pool of qualified candidates in the PRC is limited. We may not be able to retain the services of our senior executives or personnel, or attract and retain high-quality senior executives or personnel in the future. This failure could materially and adversely affect our future growth and financial condition.
A significant portion of our revenue is concentrated on a few large customers, and we do not have long-term agreements with our key customers and rely upon our longstanding relationship with them. If we lose one or more of our customers, our results of operations may be adversely and materially impacted.
Our customers consist of qualified distributors, dealers and corporate customers. We have several large customers with whom we generated substantial revenue each year, and the composition of our largest customers has changed from year to year. For the six months ended March 31, 2020, three customers represented approximately 22%, 11% and 11% of the Company’s sales, respectively. For the fiscal year ended September 30, 2019, one customer represented approximately 15.3% of the Company’s sales. For the fiscal year ended September 30, 2018, three customers represented approximately 18.8%, 14.7% and 13.7% of the Company’s sales, respectively. Since we do not have long-term customer supply agreements with such large customers and rely primarily upon our goodwill and reputation to sustain the business relationship, our results of operations may be adversely and materially impacted if one or more of these customers stop purchasing from us.
We source our raw materials used for manufacturing from a limited number of suppliers. If we lose one or more of the suppliers, our operation may be disrupted, and our results of operations may be adversely and materially impacted.
For the six months ended March 31, 2020, one of our suppliers accounted for 13 % of the total purchases. For the year ended September 30, 2019, two of our suppliers accounted for 12.9% and 9.5% of the total purchases, respectively. For the fiscal year ended September 30, 2018, three of our suppliers accounted for 19.2%, 14.1%, and 9.4% of the total purchases, respectively. If we lose suppliers and are unable to swiftly engage new suppliers, our operations may be disrupted or suspended, and we may not be able to deliver hardware products to our customers on time. We may also have to pay a higher price to source from a different supplier on short notice. While we are actively searching for and negotiating with new suppliers, there is no guarantee that we will be able to locate appropriate new suppliers or supplier merger targets in our desired timeline. As such, our results of operations may be adversely and materially impacted.
If we fail to increase our brand name recognition, we may face difficulty in obtaining new customers.
Although our brand is well-respected in the Chinese pharmaceutical and chemical industry, we still believe that maintaining and enhancing our brand name recognition in a cost-effective manner is critical to achieving widespread acceptance of our current and future products and services and is an important element in our effort to increase our customer base. Successful promotion of our brand name will depend largely on our marketing efforts and ability to provide reliable and quality products at competitive prices. Brand promotion activities may not necessarily yield increased revenue, and even if they do, any increased revenue may not offset the expenses we will incur in marketing activities. If we fail to successfully promote and maintain our brand, or if we incur substantial expenses in an unsuccessful attempt to promote and maintain our brand, we may fail to attract new customers or retain our existing customers, in which case our business, operating results and financial condition, would be materially adversely affected.
Any disruption in the supply chain of raw materials and our products could adversely impact our ability to produce and deliver products.
Some products we manufacture are resource-based products. Thus, we must manage our supply chain for raw materials and delivery of our products competently. Even though Chengdu QLS enjoy considerable advantages resulting from high quality, low cost, and abundant local resources, supply chain fragmentation and local protectionism within China may cause disruption risks for some of our other VIE operating entities. Local administrative bodies and physical infrastructure built to protect local interests pose transportation challenges for raw material transportation as well as product delivery throughout China. In addition, profitability and volume could be negatively impacted by limitations inherent within the supply chain, including competitive, governmental, legal, natural disasters, and other events that could affect both supply and price. Any of these occurrences could cause significant disruptions to our supply chain, manufacturing capability and distribution system that could adversely affect our ability to produce and deliver some of our products.
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Additionally, some of the raw materials we use are procured from farmers, who are usually subject to environmental risks outside of their control. Thus, they may not have the ability to supply continuously and stably if environmental and climate change adversely affect their business.
Our success depends on our ability to protect our intellectual property.
Our success depends on our ability to obtain and maintain patent protection for products developed utilizing our technologies, in the PRC and in other countries, and to enforce these patents. There is no assurance that any of our existing and future patents will be held valid and enforceable against third-party infringement or that our products will not infringe any third-party patent or intellectual property. Although we have owned eight valid patents and filed an additional patent application with the Patent Administration Department of the PRC, there is no assurance that they will be granted.
Any patents relating to our technologies may not be sufficiently broad to protect our products. In addition, our patents may be challenged, potentially invalidated or potentially circumvented. Our patents may not afford us protection against competitors with similar technology or permit the commercialization of our products without infringing third-party patents or other intellectual property rights.
We also rely on or intend to rely on our trademarks, trade names and brand names to distinguish our products from the products of our competitors, and have registered or will apply to register a number of these trademarks. However, third parties may oppose our trademark applications or otherwise challenge our use of the trademarks. In the event that our trademarks are successfully challenged, we could be forced to rebrand our products, which could result in loss of brand recognition and could require us to devote resources to advertising and marketing these new brands. Further, our competitors may infringe our trademarks, or we may not have adequate resources to enforce our trademarks.
In addition, we also have trade secrets, non-patented proprietary expertise and continuing technological innovation that we shall seek to protect, in part, by entering into confidentiality agreements with licensees, suppliers, employees and consultants. These agreements may be breached and there may not be adequate remedies in the event of a breach. Disputes may arise concerning the ownership of intellectual property or the applicability of confidentiality agreements. Moreover, our trade secrets and proprietary technology may otherwise become known or be independently developed by our competitors. If patents are not issued with respect to products arising from research, we may not be able to maintain the confidentiality of information relating to these products.
Implementation and enforcement of PRC laws relating to intellectual property have historically been deficient and ineffective. Accordingly, protection of intellectual property rights in China may not be as effective as in the United States or other developed countries. Furthermore, policing unauthorized use of proprietary technology is difficult and expensive. We rely on a combination of patent, copyright, trademark, and trade secret laws and restrictions on disclosure to protect our intellectual property rights. Despite our efforts to protect our proprietary rights, third parties may attempt to copy or otherwise obtain and use our intellectual property or seek court declarations that they do not infringe upon our intellectual property rights. Monitoring unauthorized use of our intellectual property is difficult and costly, and we cannot assure you that the steps we have taken or will take will prevent misappropriation of our intellectual property. From time to time, we may have to resort to litigation to enforce our intellectual property rights, which could result in substantial costs and diversion of our resources.
We face risks related to research and the ability to develop new pharmaceutical and chemical products.
Our growth and survival depend on our ability to consistently discover, develop and commercialize new products and find new and improved technology. As such, if we fail to make sufficient investments in research, be attentive to unmet consumer needs or focus on advancing pharmaceutical and chemical product technology, our current and future products could be surpassed by more effective or advanced products of other companies.
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Our business requires a number of permits and licenses. We cannot assure you that we can maintain all required licenses, permits and certifications to carry on our business at all times.
Pharmaceutical companies in China are required to obtain certain permits and licenses from various PRC governmental authorities, including Pharmaceutical Product Permits.
We have obtained certificates, permits, and licenses required for the operation of a pharmaceutical enterprise and the manufacturing of pharmaceutical products in the PRC. The latest amended Drug Administration Law took effect on December 1, 2019 and has vacated the GMP certificate requirements for pharmaceutical companies. We do not need to renew our current GMP certificates. However, we cannot assure you that we can maintain all the other required licenses, permits and certifications to carry on our business at all times, and in the past from time to time we may have not been in compliance with all such required licenses, permits and certifications. Moreover, these licenses, permits and certifications are subject to periodic renewal and/or reassessment by the relevant PRC governmental authorities and the standards of such renewal or reassessment may change from time to time. We intend to apply for the renewal of these licenses, permits and certifications when required by then applicable laws and regulations. Any failure by us to obtain and maintain all licenses, permits and certifications necessary to carry on our business at any time could have a material adverse effect on our business, financial condition and results of operations. In addition, any inability to renew these licenses, permits and certifications could severely disrupt our business and prevent us from continuing to carry on our business. Any changes in the standards used by governmental authorities in considering whether to renew or reassess our business licenses, permits and certifications, as well as any enactment of new regulations that may restrict the conduct of our business, may also decrease our revenue and/or increase our costs and materially reduce our profitability and prospects. Furthermore, if the interpretation or implementation of existing laws and regulations changes or if new regulations come into effect requiring us to obtain any additional licenses, permits or certifications that were previously not required to operate our existing businesses, we cannot assure you that we will successfully obtain such licenses, permits or certifications.
Our innovative Gan Di Xin® in China is subject to continuing regulation by the National Medical Products Administration (the “NMPA”). Our innovative Ahan® Antibacterial Paste is subject to continuing regulation by the National Health and Family Planning Commission. If the labeling or manufacturing process of an approved pharmaceutical product is significantly modified, the NMPA may require that we obtain a new pre-market approval.
Adverse publicity associated with our products, ingredients or network marketing program, or those of similar companies, could harm our financial condition and operating results.
The results of our operations may be significantly affected by the public’s perception of our product and similar companies. This perception depends upon opinions concerning:
| • | the safety and quality of our products and ingredients; |
| • | the safety and quality of similar products and ingredients distributed by other companies; and |
| • | our downstream distributors and sales forces. |
Adverse publicity concerning any actual or purported failure to comply with applicable laws and regulations regarding product claims and advertising, good manufacturing practices, or other aspects of our business, whether or not resulting in enforcement actions or the imposition of penalties, could have an adverse effect on our goodwill and could negatively affect our sales and ability to generate revenue. In addition, our consumers’ perception of the safety and quality of products and ingredients as well as similar products and ingredients distributed by other companies can be significantly influenced by media attention, publicized scientific research or findings, widespread product liability claims and other publicity concerning our products or ingredients or similar products and ingredients distributed by other companies. Adverse publicity, whether or not accurate or resulting from consumers’ use or misuse of our products, that associates consumption of our products or ingredients or any similar products or ingredients with illness or other adverse effects, questions the benefits of our or similar products or claims that any such products are ineffective, inappropriately labeled or have inaccurate instructions as to their use, could negatively impact our reputation or the market demand for our products.
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We face risks related to natural disasters, extreme weather conditions, health epidemics and other catastrophic incidents, which could significantly disrupt our operations.
In the past, China has experienced significant natural disasters, including earthquakes, extreme weather conditions, as well as health scares related to epidemics, and any similar event could materially impact our business in the future. If a disaster or other disruption were to occur in the future that affects the regions where we operate our business, our operations could be materially and adversely affected due to loss of personnel, damages to our manufacturing facilities and volatile Chinese markets. Even if we are not directly affected, such a disaster or disruption could affect the operations or financial condition of our ecosystem participants such as suppliers and distributors, which could harm our results of operations.
In general, our business could be affected by public health epidemics. If any of our employees or staff members who operates manufacturing facilities or conduct R&D activities is suspected of having contracted a contagious disease, we may be required to apply quarantines to our facilities or suspend our manufacturing operations entirely. Furthermore, any future outbreak may restrict economic activities in affected regions and beyond, resulting in reduced business volume, temporary closure of our factories or other disruptions of our business operations and adversely affect our results of operations.
The outbreak of COVID-19 significantly affected business and manufacturing activities within China for the most part of 2020, including travel restrictions, widespread mandatory quarantines, and suspension of business activities within China. These measures caused severe business disruptions to our customers and suppliers, and led to postponement of payment from these parties. Accordingly, our business, results of operations and financial condition were adversely affected. As of the date of this prospectus, the virus seems to be under control within China.
More specifically, the COVID-19 outbreak has negatively impacted our businesses in the following ways:
| · | Our manufacturing activities depend on a wide array of raw materials such as soybeans, corn starch, glycyrrhiza glabra plant, pig intestines, and many others. We have experienced substantive diminutions in raw material supplies due to the COVID-19 outbreak and ensuing lockdowns, and for the nine months ended June 30, 2020, the price of these raw materials has increased by approximately 4%-8% as compared to the same period of last fiscal year. Our overall gross margin decreased from approximately 25% for the nine months ended June 30, 2019 to approximately 18% for the nine months ended June 30, 2020; |
| · | Our sales for the three months ended June 30, 2020 decreased by approximately 31% as compared to the same period in 2019, due to the combined effect of (i) the decreased demand of our licorice and TCMD products, (ii) substantive drop in oxytetracycline products prices in April and May 2020, and (iii) our strategic decision to suspend the sales of heparin products. Due to governmental mandates during the COVID-19 outbreak, the general Chinese population was encouraged to receive examinations and treatments in hospitals instead of resorting to over the counter medicines, which include our licorice and TCMD products. Further, the substantive decrease in market price of our oxytetracycline products was caused by border controls and closures in foreign countries, which resulted in general excess supplies of oxytetracycline products. In addition, we strategically suspended the sales of heparin products because of a significant increase in the price of pig small intestine and we predicted that we would incur loss from selling heparin products. We decided to put our sales of heparin products on hold starting in the quarter ended June 30, 2020 until the market price rebounded. In the quarter ended September 30, 2020, we resumed selling heparin products. |
Risks Related to Our Corporate Structure
If the PRC government deems that our contractual arrangements with our VIE do not comply with PRC regulatory restrictions on foreign investment in the relevant industries, or if these regulations or interpretation of existing regulations change in the future, we could be subject to severe penalties or be forced to relinquish our interests in those operations.
Current PRC laws and regulations place certain restrictions on foreign ownership of certain areas of businesses. In accordance with the Special Administrative Measures on Access of Foreign Investment, promulgated in June 2020 and effective in July 2020, or the Negative List, foreign investors are not prohibited nor restricted from investing in our current operations and production. See “Regulations—PRC Laws and Regulations on Foreign Investment.”
We are a Cayman Islands company and the WFOE are considered foreign invested enterprises, or FIEs. To comply with the applicable PRC laws and regulations, we conduct certain operations in China through certain PRC entities. For a detailed description of these contractual arrangements, see “Business—Our History and Corporate Structure.”
We believe that our corporate structure and contractual arrangements enable us to: (i) be the exclusive provider of business support, technical and consulting services in exchange for a fee; (ii) receive substantially all of the economic benefits and bear the obligation to absorb substantially all of the losses of our VIE; (iii) have an irrevocable and exclusive right to purchase, or to designate one or more persons to purchase, from the registered shareholders all or any part of their equity interests in our VIE at any time and from time to time in our absolute discretion to the extent permitted by PRC laws; (iv) have an irrevocable and exclusive right to purchase, or to designate one or more persons to purchase, from our VIE all or any part of its assets at any time and from time to time in our absolute discretion to the extent permitted by PRC laws; (v) appoint us, any person authorized by us (except the shareholders of our VIE), as exclusive agent and attorney to act on behalf of the shareholders of our VIE on all matters concerning our VIE and to exercise all their rights as a registered shareholder of our VIE in accordance with PRC laws and the articles of our VIE; and (vi) pledge as first-ranking charge all of the equity interests in our VIE to us as collateral security for any and all of the guaranteed debt under the contractual arrangements and to secure performance of the obligations under the contractual arrangements. The contractual arrangements allow the results of operations and assets and liabilities of our VIE and its subsidiaries to be consolidated into our results of operations and assets and liabilities under U.S. GAAP as if they were subsidiaries of our Company.
Our PRC counsel, Dentons Law Offices, LLP, is of the opinion that (i) the ownership structure of WFOE and our VIE does not violate applicable PRC laws and regulations currently in effect, and (ii) the contractual arrangements are valid, binding and enforceable in accordance with the applicable PRC laws or regulations currently in effect. However, there can be no assurance that the PRC government authorities will take a view that is not contrary to or otherwise different from the opinion of our PRC counsel stated above. There is also the possibility that the PRC government authorities may adopt new laws, regulations and interpretations that may invalidate the contractual arrangements. If the PRC government determines that we are in violation of PRC laws or regulations or lack the necessary permits or licenses to operate our business, the relevant PRC regulatory authorities, including the PRC National Health Commission, or the NHC, would have broad discretion in dealing with such violations or failures, and measures may include, but are not limited to:
| • | revoking our business and operating licenses; | |
| • | discontinuing or restricting our operations; | |
| • | imposing conditions or requirements with which we or WFOE and our VIE may not be able to comply; | |
| • | requiring us, WFOE and our VIE to restructure the relevant ownership structure or operations; | |
| • | restricting or prohibiting our use of the proceeds from our initial public offering and the concurrent private placement or other of our financing activities to finance the business and operations of our VIE and its subsidiaries; or | |
| • | taking other regulatory or enforcement actions that could be harmful to our business. |
Any of these actions could cause significant disruption to our business operations, and may adversely affect our business, financial condition and results of operations. In addition, if the PRC governmental authorities find our legal structure and contractual arrangements to be in violation of PRC laws and regulations, it is unclear what impact these actions would have on us and on our ability to consolidate the financial results of our VIE and its subsidiaries in our consolidated financial statements. If any penalty results in our inability to direct the activities of our VIE and its subsidiaries and such a penalty significantly impacts their economic performance and/or our ability to receive economic benefits from our VIE and its subsidiaries, we may not be able to consolidate our VIE and its subsidiaries into our consolidated financial statements in accordance with U.S. GAAP.
We rely on contractual arrangements with our variable interest entity and its subsidiaries in China for our business operations, which may not be as effective in providing operational control or enabling us to derive economic benefits as through ownership of controlling equity interests.
We rely on and expect to continue to rely on our wholly owned PRC subsidiary’s contractual arrangements with Gansu QLS and its shareholders to operate our business. These contractual arrangements may not be as effective in providing us with control over Gansu QLS as ownership of controlling equity interests would be in providing us with control over, or enabling us to derive economic benefits from the operations of Gansu QLS. Under the current contractual arrangements, as a legal matter, if Gansu QLS or any of its shareholders executing the VIE Agreements fails to perform its, his or her respective obligations under these contractual arrangements, we may have to incur substantial costs and resources to enforce such arrangements, and rely on legal remedies available under PRC laws, including seeking specific performance or injunctive relief, and claiming damages, which we cannot assure you will be effective. For example, if shareholders of a variable interest entity were to refuse to transfer their equity interests in such variable interest entity to us or our designated persons when we exercise the purchase option pursuant to these contractual arrangements, we may have to take a legal action to compel them to fulfill their contractual obligations.
If (i) the applicable PRC authorities invalidate these contractual arrangements for violation of PRC laws, rules and regulations, (ii) any variable interest entity or its shareholders terminate the contractual arrangements or (iii) any variable interest entity or its shareholders fail to perform their obligations under these contractual arrangements, our business operations in China would be materially and adversely affected, and the value of your shares would substantially decrease. Further, if we fail to renew these contractual arrangements upon their expiration, we would not be able to continue our business operations unless the then current PRC law allows us to directly operate businesses in China.
In addition, if any variable interest entity or all or part of its assets become subject to liens or rights of third-party creditors, we may be unable to continue some or all of our business activities, which could materially and adversely affect our business, financial condition and results of operations. If any of the variable interest entities undergoes a voluntary or involuntary liquidation proceeding, its shareholders or unrelated third-party creditors may claim rights to some or all of these assets, thereby hindering our ability to operate our business, which could materially and adversely affect our business and our ability to generate revenues.
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All of these contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration in the PRC. The legal environment in the PRC is not as developed as in some other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements. In the event we are unable to enforce these contractual arrangements, we may not be able to exert effective control over our operating entities and we may be precluded from operating our business, which would have a material adverse effect on our financial condition and results of operations.
Gansu QLS’s shareholders may have potential conflicts of interest with us, which may materially and adversely affect our business and financial condition.
The equity interests of Gansu QLS are held by a total of 151 shareholders. Their interests may differ from the interests of our Company as a whole. They may breach, or cause Gansu QLS to breach, or refuse to renew the existing contractual arrangements we have with Gansu QLS, which would have a material adverse effect on our ability to effectively control Gansu QLS and receive economic benefits from them. For example, the shareholders may be able to cause our agreements with Gansu QLS to be performed in a manner adverse to us by, among other things, failing to remit payments due under the contractual arrangements to us on a timely basis. We cannot assure you that when conflicts of interest arise, any or all of these shareholders will act in the best interests of our Company or such conflicts will be resolved in our favor.
Currently, we do not have any arrangements to address potential conflicts of interest between these shareholders and our Company, except that we could exercise our purchase option under the exclusive option agreement with these shareholders to request them to transfer all of their equity interests in Gansu QLS to a PRC entity or individual designated by us, to the extent permitted by PRC laws. If we cannot resolve any conflict of interest or dispute between us and the shareholders of Gansu QLS, we would have to rely on legal proceedings, which could result in the disruption of our business and subject us to substantial uncertainty as to the outcome of any such legal proceedings.
Contractual arrangements in relation to our variable interest entity may be subject to scrutiny by the PRC tax authorities and they may determine that we or our PRC variable interest entity owe additional taxes, which could negatively affect our results of operations and the value of your investment.
Under applicable PRC laws and regulations, arrangements and transactions among related parties may be subject to audit or challenge by the PRC tax authorities within ten years after the taxable year when the transactions are conducted. The PRC enterprise income tax law requires every enterprise in China to submit its annual enterprise income tax return together with a report on transactions with its related parties to the relevant tax authorities. The tax authorities may impose reasonable adjustments on taxation if they have identified any related party transactions that are inconsistent with arm’s length principles. We may face material and adverse tax consequences if the PRC tax authorities determine that the contractual arrangements between our WFOE, our variable interest entity Gansu QLS and the shareholders of Gansu QLS were not entered into on an arm’s length basis in such a way as to result in an impermissible reduction in taxes under applicable PRC laws, rules and regulations, and adjust Gansu QLS’s income in the form of a transfer pricing adjustment. A transfer pricing adjustment could, among other things, result in a reduction of expense deductions recorded by Gansu QLS for PRC tax purposes, which could in turn increase their tax liabilities without reducing WFOE’s tax expenses. In addition, if WFOE requests the shareholders of Gansu QLS to transfer their equity interests in Gansu QLS at nominal or no value pursuant to these contractual arrangements, such transfer could be viewed as a gift and subject WFOE to PRC income tax. Furthermore, the PRC tax authorities may impose late payment fees and other penalties on Gansu QLS for the adjusted but unpaid taxes according to the applicable regulations. Our results of operations could be materially and adversely affected if Gansu QLS’s tax liabilities increase or if they are required to pay late payment fees and other penalties.
If we exercise the option to acquire equity ownership of Gansu QLS, the ownership transfer may subject us to certain limitation and substantial costs.
Pursuant to the contractual arrangements, WFOE has the exclusive right to purchase all or any part of the equity interests in Gansu QLS from Gansu QLS’s shareholders for a nominal price, unless the relevant government authorities or then applicable PRC laws request that a minimum price amount be used as the purchase price, in such case the purchase price shall be the lowest amount under such request. The shareholders of Gansu QLS will be subject to PRC individual income tax on the difference between the equity transfer price and the then current registered capital of Gansu QLS. Additionally, if such a transfer takes place, the competent tax authority may require WFOE to pay enterprise income tax for ownership transfer income with reference to the market value, in which case the amount of tax could be substantial.
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Risks Related to the Offering and Our Ordinary Shares
The initial public offering price of our Ordinary Shares may not be indicative of the market price of our Ordinary Shares after this offering. In addition, an active, liquid and orderly trading market for our Ordinary Shares may not develop or be maintained, and our stock price may be volatile.
Prior to this offering, our Ordinary Shares were not traded on any market. An active, liquid and orderly trading market for our Ordinary Shares may not develop or be maintained after this offering. Active, liquid and orderly trading markets usually result in less price volatility and more efficiency in carrying out investors’ purchase and sale orders. The market price of our Ordinary Shares could vary significantly as a result of a number of factors, some of which are beyond our control. In the event of a drop in the market price of our Ordinary Shares, you could lose a substantial part or all of your investment in our Ordinary Shares. The initial public offering price will be determined by us, based on numerous factors and may not be indicative of the market price of our Ordinary Shares after this offering. Consequently, you may not be able to sell our Ordinary Shares at prices equal to or greater than the price paid by you in this offering.
The following factors could affect our share price:
| • | our operating and financial performance; |
| • | quarterly variations in the rate of growth of our financial indicators, such as net income per share, net income and revenues; |
| • | the public reaction to our press releases, our other public announcements and our filings with the SEC; |
| • | strategic actions by our competitors; |
| • | changes in revenue or earnings estimates, or changes in recommendations or withdrawal of research coverage, by equity research analysts; |
| • | speculation in the press or investment community; |
| • | the failure of research analysts to cover our Ordinary Shares; |
| • | sales of our Ordinary Shares by us or other shareholders, or the perception that such sales may occur; |
| • | changes in accounting principles, policies, guidance, interpretations or standards; |
| • | additions or departures of key management personnel; |
| • | actions by our shareholders; |
| • | domestic and international economic, legal and regulatory factors unrelated to our performance; and |
| • | the realization of any risks described under this “Risk Factors” section. |
The stock markets in general have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the trading price of our Ordinary Shares. Securities class action litigation has often been instituted against companies following periods of volatility in the overall market and in the market price of a company’s securities. Such litigation, if instituted against us, could result in very substantial costs, divert our management’s attention and resources and harm our business, operating results and financial condition.
Since our Directors and Executive Officers will own at least 58.66% of our Ordinary Shares following the initial public offering, they will have the ability to elect directors and approve matters requiring shareholder approval by way of resolution of members.
Mr. Zhanchang Xin, our Chairman of the Board of Directors and Chief Executive Officer, is currently the beneficial owner of 13,839,000, or 46.13% of our outstanding Ordinary Shares, of which 6.13% are directly held by Ahanzhai Development Co., Ltd., an entity 100% owned by Mr. Xin. Ms. Haiping Shi, our Chief Financial Officer and Director Appointee, is currently the beneficial owner of 7,131,000, or 23.77% of our outstanding Ordinary Shares through Zhijiu Holdings Ltd., an entity 100% owned by Ms. Shi. If we complete the initial public offering of our Ordinary Shares, excluding any Ordinary Shares issuable upon the exercise of the over-allotment option granted to the underwriters, Mr. Xin and Ms. Shi will collectively have the right to vote 59.91% of the issued and outstanding Ordinary Shares. Mr. Xin and Ms. Shi will collectively have the right to vote 58.66% of the issued and outstanding Ordinary Shares if taking into account of over-allotment shares issued. They are expected to have the power to elect all directors and approve all matters requiring shareholder approval without the votes of any other shareholder. They are expected to have significant influence over a decision to enter into any corporate transaction and have the ability to prevent any transaction that requires the approval of shareholders, regardless of whether or not our other shareholders believe that such transaction is in our best interests. Such concentration of voting power could have the effect of delaying, deterring, or preventing a change of control or other business combination, which could, in turn, have an adverse effect on the market price of our Ordinary Shares or prevent our shareholders from realizing a premium over the then-prevailing market price for their Ordinary Shares.
For as long as we are an emerging growth company, we will not be required to comply with certain reporting requirements, including those relating to accounting standards and disclosure about our executive compensation, that apply to other public companies.
In April 2012, President Obama signed into law the JOBS Act. We are classified as an “emerging growth company” under the JOBS Act. For as long as we are an emerging growth company, which may be up to five full fiscal years, unlike other public companies, we will not be required to, among other things, (i) provide an auditor’s attestation report on management’s assessment of the effectiveness of our system of internal control over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act, (ii) comply with any new requirements adopted by the PCAOB requiring mandatory audit firm rotation or a supplement to the auditor’s report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer, (iii) provide certain disclosure regarding executive compensation required of larger public companies or (iv) hold nonbinding advisory votes on executive compensation. We will remain an emerging growth company for up to five years, although we will lose that status sooner if we have more than $1.07 billion of revenues in a fiscal year, have more than $700 million in market value of our Ordinary Shares held by non-affiliates, or issue more than $1.0 billion of non-convertible debt over a three-year period.
To the extent that we rely on any of the exemptions available to emerging growth companies, you will receive less information about our executive compensation and internal control over financial reporting than issuers that are not emerging growth companies. If some investors find our Ordinary Shares to be less attractive as a result, there may be a less active trading market for our Ordinary Shares and our stock price may be more volatile.
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If we fail to establish and maintain proper internal financial reporting controls, our ability to produce accurate financial statements or comply with applicable regulations could be impaired.
Pursuant to Section 404 of the Sarbanes-Oxley Act, we will be required to file a report by our management on our internal control over financial reporting, including an attestation report on internal control over financial reporting issued by our independent registered public accounting firm. However, while we remain an emerging growth company, we will not be required to include an attestation report on internal control over financial reporting issued by our independent registered public accounting firm. The presence of material weaknesses in internal control over financial reporting could result in financial statement errors which, in turn, could lead to errors in our financial reports and/or delays in our financial reporting, which could require us to restate our operating results. We might not identify one or more material weaknesses in our internal controls in connection with evaluating our compliance with Section 404 of the Sarbanes-Oxley Act. In order to maintain and improve the effectiveness of our disclosure controls and procedures and internal controls over financial reporting, we will need to expend significant resources and provide significant management oversight. Implementing any appropriate changes to our internal controls may require specific compliance training of our directors and employees, entail substantial costs in order to modify our existing accounting systems, take a significant period of time to complete and divert management’s attention from other business concerns. These changes may not, however, be effective in maintaining the adequacy of our internal control.
If we are unable to conclude that we have effective internal controls over financial reporting, investors may lose confidence in our operating results, the price of the Ordinary Shares could decline and we may be subject to litigation or regulatory enforcement actions. In addition, if we are unable to meet the requirements of Section 404 of the Sarbanes-Oxley Act, the Ordinary Shares may not be able to remain listed on Nasdaq Global Market.
As a foreign private issuer, we are not subject to certain U.S. securities law disclosure requirements that apply to a domestic U.S. issuer, which may limit the information publicly available to our shareholders.
Because we qualify as a foreign private issuer under the Exchange Act, we are exempt from certain provisions of the securities rules and regulations in the United States that are applicable to U.S. domestic issuers, including:
| • | the rules under the Exchange Act requiring the filing with the SEC of quarterly reports on Form 10-Q or current reports on Form 8-K; | |
| • | the sections of the Exchange Act regulating the solicitation of proxies, consents, or authorizations in respect of a security registered under the Exchange Act; | |
| • | the sections of the Exchange Act requiring insiders to file public reports of their stock ownership and trading activities and liability for insiders who profit from trades made in a short period of time; | |
| • | the selective disclosure rules by issuers of material nonpublic information under Regulation FD; and | |
| • | certain audit committee independence requirements in Rule 10A-3 of the Exchange Act. |
We will be required to file an annual report on Form 20-F within four months of the end of each fiscal year. However, the information we are required to file with or furnish to the SEC will be less extensive and less timely compared to that required to be filed with the SEC by U.S. domestic issuers. As a result, you may not be afforded the same protections or information that would be made available to you were you investing in a U.S. domestic issuer.
Because we are a foreign private issuer and are exempt from certain Nasdaq corporate governance standards applicable to U.S. issuers, you will have less protection than you would have if we were a domestic issuer.
The Nasdaq Listing Rules requires listed companies to have, among other things, a majority of its board members be independent. As a foreign private issuer, however, we are permitted to, and we may follow home country practice in lieu of the above requirements, or we may choose to comply with the above requirement within one year of listing. The corporate governance practice in our home country, the Cayman Islands, does not require a majority of our board to consist of independent directors. Thus, although a director must act in the best interests of the Company, it is possible that fewer board members will be exercising independent judgment and the level of board oversight on the management of our company may decrease as a result. In addition, the Nasdaq Listing Rules also requires U.S. domestic issuers to have a compensation committee, a nominating/corporate governance committee composed entirely of independent directors, and an audit committee with a minimum of three members. We, as a foreign private issuer, may not be subject to all these requirements. The Nasdaq Listing Rules may require shareholder approval for certain corporate matters, such as requiring that shareholders be given the opportunity to vote on all equity compensation plans and material revisions to those plans, certain ordinary share issuances. We intend to comply with the requirements of the Nasdaq Listing Rules in determining whether shareholder approval is required on such matters and to appoint a nominating and corporate governance committee. However, we may consider following home country practice in lieu of the requirements under the Nasdaq Listing Rules with respect to certain corporate governance standards which may afford less protection to investors.
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We may lose our foreign private issuer status in the future, which could result in significant additional costs and expenses.
As discussed above, we are a foreign private issuer, and therefore, we are not required to comply with all of the periodic disclosure and current reporting requirements of the Exchange Act. The determination of foreign private issuer status is made annually on the last business day of an issuer’s most recently completed second fiscal quarter, and, accordingly, the next determination with respect to our status will be made on March 31, 2021. We would lose our foreign private issuer status if, for example, more than 50% of our Ordinary Shares are directly or indirectly held by residents of the U.S. and we fail to meet additional requirements necessary to maintain our foreign private issuer status. If we lose our foreign private issuer status on this date, we will be required to file with the SEC periodic reports and registration statements on U.S. domestic issuer forms beginning on March 31, 2021, which are more detailed and extensive than the forms available to a foreign private issuer. We will also have to mandatorily comply with U.S. federal proxy requirements, and our officers, directors and principal shareholders will become subject to the short-swing profit disclosure and recovery provisions of Section 16 of the Exchange Act. In addition, we will lose our ability to rely upon exemptions from certain corporate governance requirements under the Nasdaq Listing Rules. As a U.S. listed public company that is not a foreign private issuer, we will incur significant additional legal, accounting and other expenses that we will not incur as a foreign private issuer, and accounting, reporting and other expenses in order to maintain a listing on a U.S. securities exchange.
The requirements of being a public company may strain our resources and divert management’s attention.
As a public company, we will be subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act, the Sarbanes-Oxley Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act, the listing requirements of the securities exchange on which we list, and other applicable securities rules and regulations. Despite recent reforms made possible by the JOBS Act, compliance with these rules and regulations will nonetheless increase our legal, accounting, and financial compliance costs and investor relations and public relations costs, make some activities more difficult, time-consuming or costly and increase demand on our systems and resources, particularly after we are no longer an “emerging growth company.” The Exchange Act requires, among other things, that we file annual, quarterly, and current reports with respect to our business and operating results as well as proxy statements.
As a result of disclosure of information in this prospectus and in filings required of a public company, our business and financial condition will become more visible, which we believe may result in threatened or actual litigation, including by competitors and other third parties. If such claims are successful, our business and operating results could be harmed, and even if the claims do not result in litigation or are resolved in our favor, these claims, and the time and resources necessary to resolve them, could divert the resources of our management and adversely affect our business, brand and reputation and results of operations.
We also expect that being a public company and these new rules and regulations will make it more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These factors could also make it more difficult for us to attract and retain qualified members of our board of directors, particularly to serve on our audit committee and compensation committee, and qualified executive officers.
We have broad discretion in the use of the net proceeds from our initial public offering and may not use them effectively.
To the extent (i) we raise more money than required for the purposes explained in the section titled “Use of Proceeds” or (ii) we determine that the proposed uses set forth in that section are not no longer in the best interests of our Company, we cannot specify with any certainty the particular uses of such net proceeds that we will receive from our initial public offering. Our management will have broad discretion in the application of such net proceeds, including working capital, possible acquisitions, and other general corporate purposes, and we may spend or invest these proceeds in a way with which our shareholders disagree. The failure by our management to apply these funds effectively could harm our business and financial condition. Pending their use, we may invest the net proceeds from our initial public offering in a manner that does not produce income or that loses value.
We do not intend to pay dividends for the foreseeable future.
We currently intend to retain any future earnings to finance the operation and expansion of our business. We do not expect to declare or pay any dividends in the foreseeable future. As a result, you may only receive a return on your investment in our Ordinary Shares if we are successfully listed and the market price of our Ordinary Shares increases.
The price of the Ordinary Shares and other terms of this offering have been determined by us along with our underwriters.
If you purchase our Ordinary Shares in this offering, you will pay a price that was not established in a competitive market. Rather, you will pay a price that was determined by us along with our underwriters. The offering price for our Ordinary Shares may bear no relationship to our assets, book value, historical results of operations or any other established criterion of value. The trading price, if any, of the Ordinary Shares that may prevail in any market that may develop in the future, for which there can be no assurance, may be higher or lower than the price you paid for our Ordinary Shares.
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There may not be an active, liquid trading market for our Ordinary Shares.
Prior to this offering, there has been no public market for our Ordinary Shares. An active trading market for our Ordinary Shares may not develop or be sustained following this offering. You may not be able to sell your shares at the market price if trading in our shares is not active. The initial public offering price was determined by negotiations between us and our advisors based upon a number of factors. The initial public offering price may not be indicative of prices that will prevail in the trading market.
The obligation to disclose information publicly may put us at a disadvantage to competitors that are private companies.
We have become a public company in the United States. As a public company, we are required to file periodic reports with the Securities and Exchange Commission upon the occurrence of matters that are material to our Company and shareholders. Although we may be able to attain confidential treatment of some of our developments, in some cases, we will need to disclose material agreements or results of financial operations that we would not be required to disclose if we were a private company. Our competitors may have access to this information, which would otherwise be confidential. This may give them advantages in competing with our Company. Similarly, as a U.S. public company, we will be governed by U.S. laws that our competitors, which are mostly private Chinese companies, are not required to follow. To the extent compliance with U.S. laws increases our expenses or decreases our competitiveness against such companies, our public Company status could affect our results of operations.
Shares eligible for future sale may adversely affect the market price of our Ordinary Shares if the shares are successfully listed on Nasdaq or other stock markets, as the future sale of a substantial amount of outstanding Ordinary Shares in the public marketplace could reduce the price of our Ordinary Shares.
The market price of our shares could decline as a result of sales of substantial amounts of our shares in the public market, or the perception that these sales could occur. In addition, these factors could make it more difficult for us to raise funds through future offerings of our Ordinary Shares. An aggregate of 30,000,000 Ordinary Shares will be outstanding before the consummation of this offering all of which, except those held by management, are freely tradable. All of the Ordinary Shares sold in the offering will be freely transferable without restriction or further registration under the Securities Act. The remaining Ordinary Shares will be “restricted securities” as defined in Rule 144. These Ordinary Shares may be sold without registration under the Securities Act to the extent permitted by Rule 144 or other exemptions under the Securities Act. See “Shares Eligible for Future Sale.”
If you purchase our Ordinary Shares in this offering, you will incur immediate and substantial dilution in the book value of your shares.
Investors purchasing our Ordinary Shares in this offering will pay a price per share that substantially exceeds the pro forma as adjusted net tangible book value per share. As a result, investors purchasing Ordinary Shares in this offering will incur immediate dilution of $3.60 per share (or $3.53 per share if the over-allotment option is exercised in full), representing the difference between our initial public offering price of $5.00 per share and our pro forma as adjusted net tangible book value per share as of March 31, 2020. For more information on the dilution you may experience as a result of investing in this offering, see the section of this prospectus entitled “Dilution.”
A sale or perceived sale of a substantial number of our Ordinary Shares may cause the price of our Ordinary Shares to decline.
All of our executive officers and directors and all of our shareholders have agreed not to sell our Ordinary Shares for a period of six months following this offering, subject to extension under specified circumstances. See “Underwriting—Lock-Up Agreement.” Ordinary shares subject to these lock-up agreements will become eligible for sale in the public market upon expiration of these lock-up agreements, subject to limitations imposed by Rule 144 under the Securities Act of 1933, as amended. If our shareholders sell substantial amounts of our Ordinary Shares in the public market, the market price of our Ordinary Shares could fall. Moreover, the perceived risk of this potential dilution could cause shareholders to attempt to sell their Ordinary Shares and investors to short our Ordinary Shares. These sales also may make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem reasonable or appropriate.
The laws of the Cayman Islands may not provide our shareholders with benefits comparable to those provided to shareholders of corporations incorporated in the United States. For instance, you may face difficulties in protecting your interests, and your ability to protect your rights through U.S. courts may be limited, because we are incorporated under Cayman Islands law.
Our corporate affairs are governed by our amended and restated memorandum and articles of association, by the Companies Law (2020 Revision) of the Cayman Islands and by the common law of the Cayman Islands. The rights of shareholders to take action against our directors, actions by minority shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law in the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands and from English common law. Decisions of the Privy Council (which is the final Court of Appeal for British Overseas Territories such as the Cayman Islands) are binding on a court in the Cayman Islands. Decisions of the English courts, and particularly the Supreme Court and the Court of Appeal are generally of persuasive authority but are not binding in the courts of the Cayman Islands. Decisions of courts in other Commonwealth jurisdictions are similarly of persuasive but not binding authority. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in the United States. In particular, the Cayman Islands has a less developed body of securities laws relative to the United States. Some U.S. states, such as Delaware, have more fully developed and judicially interpreted bodies of corporate law than the Cayman Islands. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action in a federal court of the United States.
Shareholders of Cayman Islands exempted companies like us have no general rights under Cayman Islands law to inspect corporate records (other than copies of the memorandum and articles of association, the register of mortgages and charges, and any special resolutions passed by the shareholders) or to obtain copies of lists of shareholders of these companies. Our directors have discretion under our articles of association to determine whether or not, and under what conditions, our corporate records may be inspected by our shareholders, but are not obliged to make them available to our shareholders. This may make it more difficult for you to obtain the information needed to establish any facts necessary for a shareholder motion or to solicit proxies from other shareholders in connection with a proxy contest.
Certain corporate governance practices in the Cayman Islands, which is our home country, differ significantly from requirements for companies incorporated in other jurisdictions such as the United States. If we choose to follow home country practice in the future, our shareholders may be afforded less protection than they otherwise would under rules and regulations applicable to U.S. domestic issuers.
As a result of all of the above, our public shareholders may have more difficulty in protecting their interests in the face of actions taken by management, members of the board of directors or controlling shareholders than they would as public shareholders of a company incorporated in the United States. For a discussion of significant differences between the provisions of the Companies Law of the Cayman Islands and the laws applicable to companies incorporated in the United States and their shareholders, see "Description of Share Capital—Differences in Corporate Law."
You may be unable to present proposals before annual general meetings or extraordinary general meetings not called by shareholders.
Cayman Islands law provides shareholders with only limited rights to requisition a general meeting, and does not provide shareholders with any right to put any proposal before a general meeting. These rights, however, may be provided in a company’s articles of association. Our articles of association allow our shareholders holding shares representing in aggregate not less than 10% of our voting share capital in issue, to requisition a general meeting of our shareholders, in which case our directors are obliged to call such meeting. Advance notice of at least twenty-one clear days is required for the convening of our annual general shareholders’ meeting and at least 14 clear days’ notice any other general meeting of our shareholders. A quorum required for a meeting of shareholders consists of at least one shareholder present or by proxy, representing not less than one-third of the total issued shares carrying the right to vote at a general meeting of the Company.
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Risks Related to Doing Business in China
PRC regulation of loans to, and direct investments in, PRC entities by offshore holding companies may delay or prevent us from using proceeds from this offering and/or future financing activities to make loans or additional capital contributions to our PRC operating subsidiaries.
As an offshore holding company with PRC subsidiaries, we may transfer funds to our PRC subsidiaries or finance our operating entity by means of loans or capital contributions. Any capital contributions or loans that we, as an offshore entity, make to our Company’s PRC subsidiaries, including from the proceeds of this offering, are subject to PRC regulations. Any loans to our PRC subsidiaries, which are foreign-invested enterprises, cannot exceed statutory limits based on the difference between the amount of our investments and registered capital in such subsidiaries, and shall be registered with China’s State Administration of Foreign Exchange (“SAFE”), or its local counterparts. Furthermore, any capital increase contributions we make to our PRC subsidiaries, which are foreign-invested enterprises, shall be approved by China’s Ministry of Commerce (“MOFCOM”), or its local counterparts. We may not be able to obtain these government registrations or approvals on a timely basis, if at all. If we fail to obtain such approvals or make such registration, our ability to make equity contributions or provide loans to our Company’s PRC subsidiaries or to fund their operations may be negatively affected, which may adversely affect their liquidity and ability to fund their working capital and expansion projects and meet their obligations and commitments. As a result, our liquidity and our ability to fund and expand our business may be negatively affected.
We must remit the offering proceeds to China before they may be used to benefit our business in China, and this process may take several months to complete.
The process for sending the proceeds from this offering back to China may take as long as six months after the closing of this offering. In utilizing the proceeds of this offering in the manner described in “Use of Proceeds,” as an offshore holding company of our PRC operating subsidiaries, we may make loans to our PRC subsidiaries, or we may make additional capital contributions to our PRC subsidiaries. Any loans to our PRC subsidiaries are subject to PRC regulations. For example, loans by us to our subsidiaries in China, which are foreign-invested enterprises, to finance their activities cannot exceed statutory limits and must be registered with SAFE.
To remit the proceeds of the offering, we must take the following steps:
| • | First, we will open a special foreign exchange account for capital account transactions. To open this account, we must submit to SAFE certain application forms, identity documents, transaction documents, form of foreign exchange registration of overseas investments of the domestic residents, and foreign exchange registration certificate of the invested company. As of the date of this prospectus, we have already opened a special foreign exchange account for capital account transactions. |
| • | Second, we will remit the offering proceeds into this special foreign exchange account. |
| • | Third, we will apply for settlement of the foreign exchange. In order to do so, we must submit to SAFE certain application forms, identity documents, payment order to a designated person, and a tax certificate. |
The timing of the process is difficult to estimate because the efficiencies of different SAFE branches can vary significantly. Ordinarily the process takes several months but is required by law to be accomplished within 180 days of application.
We may also decide to finance our subsidiaries by means of capital contributions. These capital contributions must be approved by MOFCOM or its local counterpart. We cannot assure you that we will be able to obtain these government approvals on a timely basis, if at all, with respect to future capital contributions by us to our subsidiaries. If we fail to receive such approvals, our ability to use the proceeds of this offering and to capitalize our Chinese operations may be negatively affected, which could adversely affect our liquidity and our ability to fund and expand our business. If we fail to receive such approvals, our ability to use the proceeds of this offering and to capitalize our Chinese operations may be negatively affected, which could adversely affect our liquidity and our ability to fund and expand our business.
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Adverse changes in political and economic policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could reduce the demand for our products and materially and adversely affect our competitive position.
Substantially all of our business operations are conducted in China. Accordingly, our business, results of operations, financial condition and prospects are subject to economic, political and legal developments in China. Although the Chinese economy is no longer a planned economy, the PRC government continues to exercise significant control over China’s economic growth through direct allocation of resources, monetary and tax policies, and a host of other government policies such as those that encourage or restrict investment in certain industries by foreign investors, control the exchange between RMB and foreign currencies, and regulate the growth of the general or specific market. These government involvements have been instrumental in China’s significant growth in the past 30 years. In response to the recent global and Chinese economic downturn, the PRC government has adopted policy measures aimed at stimulating the economic growth in China. If the PRC government’s current or future policies fail to help the Chinese economy achieve further growth or if any aspect of the PRC government’s policies limits the growth of our industry or otherwise negatively affects our business, our growth rate or strategy, our results of operations could be adversely affected as a result.
Under the Enterprise Income Tax Law, we may be classified as a “Resident Enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.
China passed the Enterprise Income Tax Law, or the EIT Law, which effective on 29 December, 2018, and its implementing rules, which became effective on 23 April, 2019. Under the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes, which is subject to an EIT rate of 25.0% on its global 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.
On April 22, 2009, the State Administration of Taxation of China issued the Notice Concerning Relevant Issues Regarding Cognizance of Chinese Investment Controlled Enterprises Incorporated Offshore as Resident Enterprises pursuant to Criteria of de facto Management Bodies, or the Notice, further interpreting the application of the EIT Law and its implementation to offshore entities controlled by a Chinese enterprise or group. Pursuant to the Notice, an enterprise incorporated in an offshore jurisdiction and controlled by a Chinese enterprise or group will be classified as a “non-domestically incorporated resident enterprise” if (i) its senior management in charge of daily operations reside or perform their duties mainly in China; (ii) its financial or personnel decisions are made or approved by bodies or persons in China; (iii) its substantial assets and properties, accounting books, corporate stamps, board and stockholder minutes are kept in China; and (iv) over half of its directors with voting rights or senior management reside in China. A resident enterprise would be subject to an enterprise income tax rate of 25% on its worldwide income and must pay a withholding tax at a rate of 10% when paying dividends to its non-PRC stockholders. Because substantially all of our operations and senior management are located within the PRC and are expected to remain so for the foreseeable future, we may be considered a PRC resident enterprise for enterprise income tax purposes and therefore subject to the PRC enterprise income tax at the rate of 25% on its worldwide income. However, it remains unclear as to whether the Notice is applicable to an offshore enterprise controlled by a Chinese natural person. Therefore, it is unclear how tax authorities will determine tax residency based on the facts of each case.
If the PRC tax authorities determine that we are a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. In our case, this would mean that income such as non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Currently, we do not have any non-China source income, as we conduct our sales in China. However, under the EIT Law and its implementing rules, dividends paid to us from our PRC subsidiaries would be deemed as “qualified investment income between resident enterprises” and therefore qualify as “tax-exempt income” pursuant to clause 26 of the EIT Law. Second, it is possible that future guidance issued with respect to the new “resident enterprise” classification could result in a situation in which the dividends we pay with respect to our Ordinary Shares, or the gain our non-PRC stockholders may realize from the transfer of our Ordinary Shares, may be treated as PRC-sourced income and may therefore be subject to a 10% PRC withholding tax. The EIT Law and its implementing regulations are, however, relatively new and ambiguities exist with respect to the interpretation and identification of PRC-sourced income, and the application and assessment of withholding taxes. If we are required under the EIT Law and its implementing regulations to withhold PRC income tax on dividends payable to our non-PRC stockholders, or if non-PRC stockholders are required to pay PRC income tax on gains on the transfer of their Ordinary Shares, our business could be negatively impacted and the value of your investment may be materially reduced. Further, if we were treated as a “resident enterprise” by PRC tax authorities, we would be subject to taxation in both China and such countries in which we have taxable income, and our PRC tax may not be creditable against such other taxes.
We may be exposed to liabilities under the Foreign Corrupt Practices Act and Chinese anti-corruption law.
In connection with this offering, we will become subject to the U.S. Foreign Corrupt Practices Act (the “FCPA”), and other laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. persons and issuers as defined by the statute for the purpose of obtaining or retaining business. We are also subject to Chinese anti-corruption laws, which strictly prohibit the payment of bribes to government officials. We have operations, agreements with third parties, and make sales in China, which may experience corruption. Our activities in China create the risk of unauthorized payments or offers of payments by one of the employees, consultants or distributors of our Company, because these parties are not always subject to our control.
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Although we believe to date we have complied in all material respects with the provisions of the FCPA and Chinese anti-corruption law, our existing safeguards and any future improvements may prove to be less than effective, and the employees, consultants or distributors of our Company may engage in conduct for which we might be held responsible. Violations of the FCPA or Chinese anti-corruption law may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could negatively affect our business, operating results and financial condition. In addition, the government may seek to hold our Company liable for successor liability FCPA violations committed by companies in which we invest or that we acquire.
Uncertainties with respect to the PRC legal system could adversely affect us.
We conduct all of our business through our subsidiaries and variable interests entities in China. Our operations in China are governed by PRC laws and regulations. Our PRC subsidiaries and variable interests entities are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws and regulations applicable to wholly foreign-owned enterprises. The PRC legal system is a civil law system based on statutes. Prior court decisions may be cited for reference but have limited precedential value. The PRC legal system is evolving rapidly, and the interpretations of many laws, regulations and rules may contain inconsistencies and enforcement of these laws, regulations and rules involves uncertainties.
Since 1979, PRC legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, China has not developed a fully integrated legal system and recently enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, because these laws and regulations are relatively new, and because of the limited volume of published decisions and their nonbinding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. In addition, the PRC legal system is based in part on government policies and internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until sometime after the violation. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. Such unpredictability towards our contractual, property (including intellectual property) and procedural rights could adversely affect our business and impede our ability to continue our operations.
PRC regulation of loans and direct investment by offshore holding companies to PRC entities may delay or prevent us from using the proceeds of this offering to make loans or additional capital contributions to our PRC subsidiaries, which could materially and adversely affect our liquidity and our ability to fund and expand our business.
In utilizing the proceeds of this offering in the manner described in “Use of Proceeds,” as an offshore holding company of our PRC operating subsidiaries, we may make loans to our PRC subsidiaries, or we may make additional capital contributions to our PRC subsidiaries.
Any loans to our PRC subsidiaries are subject to PRC regulations. For example, loans by us to our subsidiaries in China, which are FIEs, to finance their activities cannot exceed statutory limits and must be registered with SAFE. On March 30, 2015, SAFE promulgated Hui Fa [2015] No.19, which last amended on 30 December,2019, a notice regulating the conversion by a foreign-invested company of foreign currency into RMB. The foreign exchange capital, for which the monetary contribution has been confirmed by the foreign exchange authorities (or for which the monetary contribution has been registered for account entry) in the capital account of a foreign-invested enterprise may be settled at a bank as required by the enterprise’s actual management needs. Foreign-funded equity investment enterprises with investment as their main business (including foreign-funded investment companies, foreign-funded venture capital enterprises and foreign-funded equity investment enterprises) are allowed to directly settle foreign exchange capital or transfer the RMB funds in the account for settled foreign exchange to be paid to the investee's account according to the actual investment scale under the premise that the domestic projects funded by them are true and comply with the relevant regulations.
On May 11, 2013, SAFE released Circular 21, which came into effect on May 13, 2013. According to Circular 21, SAFE has simplified the foreign exchange administration procedures with respect to the registration, account openings and conversions, settlements of FDI-related foreign exchange, as well as fund remittances.
Circular 21 may significantly limit our ability to convert, transfer and use the net proceeds from this offering and any offering of additional equity securities in China, which may adversely affect our liquidity and our ability to fund and expand our business in the PRC.
We may also decide to finance our subsidiaries by means of capital contributions. These capital contributions must be approved by MOFCOM or its local counterpart, which usually takes no more than 30 working days to complete. We may not be able to obtain these government approvals on a timely basis, if at all, with respect to future capital contributions by us to our PRC subsidiaries. If we fail to receive such approvals, we will not be able to capitalize our PRC operations, which could adversely affect our liquidity and our ability to fund and expand our business.
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Governmental control of currency conversion may affect the value of your investment.
The PRC government imposes controls on the convertibility of the RMB into foreign currencies and, in certain cases, the remittance of currency out of China. We receive substantially all of our revenues in RMB. Under our current corporate structure, our income is primarily derived from dividend payments from our PRC subsidiaries. Shortages in the availability of foreign currency may restrict the ability of our PRC subsidiaries to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy their foreign currency denominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from trade-related transactions can be made in foreign currencies without prior approval from SAFE by complying with certain procedural requirements. However, approval from appropriate government authorities is required where RMB is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of loans denominated in foreign currencies. The PRC government may also at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay dividends in foreign currencies to our security-holders.
We are a holding company and we rely for funding on dividend payments from our subsidiaries, which are subject to restrictions under PRC laws.
We are a holding company incorporated in the Cayman Islands, and we operate our core businesses through our VIE and its subsidiaries in the PRC. Therefore, the availability of funds for us to pay dividends to our shareholders and to service our indebtedness depends upon dividends received from our VIE and its subsidiaries. If our VIE and its subsidiaries incur debt or losses, their ability to pay dividends or other distributions to us may be impaired. As a result, our ability to pay dividends and to repay our indebtedness will be restricted. PRC laws require that dividends be paid only out of the after-tax profit of our PRC subsidiaries calculated according to PRC accounting principles, which differ in many aspects from generally accepted accounting principles in other jurisdictions. PRC laws also require enterprises established in the PRC to set aside part of their after-tax profits as statutory reserves. These statutory reserves are not available for distribution as cash dividends. In addition, restrictive covenants in bank credit facilities or other agreements that we or our subsidiaries may enter into in the future may also restrict the ability of our subsidiaries to pay dividends to us. These restrictions on the availability of our funding may impact our ability to pay dividends to our shareholders and to service our indebtedness.
Our business may be materially and adversely affected if any of our PRC subsidiaries declare bankruptcy or become subject to a dissolution or liquidation proceeding.
The Enterprise Bankruptcy Law of the PRC, or the Bankruptcy Law, came into effect on June 1, 2007. The Bankruptcy Law provides that an enterprise will be liquidated if the enterprise fails to settle its debts as and when they fall due and if the enterprise’s assets are, or are demonstrably, insufficient to clear such debts.
Our PRC subsidiaries hold certain assets that are important to our business operations. If any of our PRC subsidiaries undergoes a voluntary or involuntary liquidation proceeding, unrelated third-party creditors may claim rights to some or all of these assets, thereby hindering our ability to operate our business, which could materially and adversely affect our business, financial condition and results of operations.
According to SAFE’s Notice of the State Administration of Foreign Exchange on Further Improving and Adjusting Foreign Exchange Administration Policies for Direct Investment, promogulated on 19 Novemver,2012 and amended on 4 May,2015, and the Provisions on the Foreign Exchange Administration of Domestic Direct Investment of Foreign Investors, effective on May 13, 2013, if any of our PRC subsidiaries undergoes a voluntary or involuntary liquidation proceeding, prior approval from SAFE for remittance of foreign exchange to our shareholders abroad is no longer required, but we still need to conduct a registration process with the SAFE local branch. It is not clear whether “registration” is a mere formality or involves the kind of substantive review process undertaken by SAFE and its relevant branches in the past.
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Recent joint statement by the SEC and PCAOB, proposed rule changes submitted by Nasdaq, and an act passed by the US Senate all call for additional and more stringent criteria to be applied to emerging market companies upon assessing the qualification of their auditors, especially the non-U.S. auditors who are not inspected by the PCAOB. These developments could add uncertainties to our offering.
In May 2013, the PCAOB announced that it had entered into a Memorandum of Understanding on Enforcement Cooperation with the China Securities Regulatory Commission, or the CSRC, and the PRC Ministry of Finance, which establishes a cooperative framework between the parties for the production and exchange of audit documents relevant to investigations undertaken by the PCAOB, the CSRC or the PRC Ministry of Finance in the United States and the PRC, respectively. The PCAOB continues to be in discussions with the CSRC, and the PRC Ministry of Finance to permit joint inspections in the PRC of audit firms that are registered with PCAOB and audit Chinese companies that trade on U.S. exchanges.
On December 7, 2018, the SEC and the PCAOB issued a joint statement highlighting continued challenges faced by the U.S. regulators in their oversight of financial statement audits of U.S.-listed companies with significant operations in China. The joint statement reflects a heightened interest in an issue that has vexed U.S. regulators in recent years.
On April 21, 2020, SEC Chairman Jay Clayton and PCAOB Chairman William D. Duhnke III, along with other senior SEC staff, released a joint statement highlighting the risks associated with investing in companies based in or have substantial operations in emerging markets including China. The joint statement emphasized the risks associated with lack of access for the PCAOB to inspect auditors and audit work papers in China and higher risks of fraud in emerging markets.
On June 4, 2020, the U.S. President issued a memorandum ordering the President’s Working Group on Financial Markets, or the PWG, to submit a report to the President within 60 days of the memorandum that includes recommendations for actions that can be taken by the executive branch and by the SEC or PCAOB on Chinese companies listed on U.S. stock exchanges and their audit firms, in an effort to protect investors in the U.S.
On August 6, 2020, the PWG released a report recommending that the SEC take steps to implement the five recommendations outlined in the report. In particular, to address companies from jurisdictions that do not provide the PCAOB with sufficient access to fulfill its statutory mandate, or NCJs, the PWG recommends enhanced listing standards on U.S. stock exchanges. This would require, as a condition to initial and continued exchange listing, PCAOB access to work papers of the principal audit firm for the audit of the listed company. Companies unable to satisfy this standard as a result of governmental restrictions on access to audit work papers and practices in NCJs may satisfy this standard by providing a co-audit from an audit firm with comparable resources and experience where the PCAOB determines it has sufficient access to audit work papers and practices to conduct an appropriate inspection of the co-audit firm. There is currently no legal process under which such a co-audit may be performed in China. The report permits the new listing standards to provide for a transition period until January 1, 2022 for listed companies, but would apply immediately to new listings once the necessary rulemakings and/or standard-setting are effective. The measures in the PWG Report are presumably subject to the standard SEC rulemaking process before becoming effective. On August 10, 2020, the SEC announced that SEC Chairman had directed the SEC staff to prepare proposals in response to the PWG Report, and that the SEC was soliciting public comments and information with respect to these proposals. Since we are listed on the Nasdaq Global Market, if we fail to meet the new listing standards before the deadline specified thereunder due to factors beyond our control, we could face possible de-listing from the Nasdaq Stock Market, deregistration from the SEC and/or other risks, which may materially and adversely affect, or effectively terminate, our Ordinary Shares trading in the United States.
The lack of access to the PCAOB inspection in China prevents the PCAOB from fully evaluating audits and quality control procedures of the auditors based in China. As a result, the investors may be deprived of the benefits of such PCAOB inspections. The inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of these accounting firms’ audit procedures or quality control procedures as compared to auditors outside of China that are subject to the PCAOB inspections, which could cause existing and potential investors in our stock to lose confidence in our audit procedures and reported financial information and the quality of our financial statements.
Our auditor, the independent registered public accounting firm that issues the audit report included elsewhere in this prospectus, as an auditor of companies that are traded publicly in the United States and a firm registered with the PCAOB, is subject to laws in the United States pursuant to which the PCAOB conducts regular inspections to assess its compliance with the applicable professional standards. Our auditor is headquartered in Manhattan, New York, and has been inspected by the PCAOB on a regular basis with the last inspection in May 2018 and an ongoing inspection that started in October 2020. The recent developments would add uncertainties to our offering and we cannot assure you whether the national securities exchange we apply to for listing or regulatory authorities would apply additional and more stringent criteria to us after considering the effectiveness of our auditor’s audit procedures and quality control procedures, adequacy of personnel and training, or sufficiency of resources, geographic reach, or experience as it relates to our audit.
Substantial uncertainties exist with respect to the interpretation of the PRC Foreign Investment Law and how it may impact the viability of our current corporate structure, corporate governance and business operations.
The Ministry of Commerce published a discussion draft of the proposed Foreign Investment Law in January 2015, or the 2015 FIL Draft, which expands the definition of foreign investment and introduces the principle of “actual control” in determining whether a company is considered a foreign-invested enterprise, or an FIE. Under the 2015 FIL Draft, VIEs that are controlled via contractual arrangement would also be deemed as foreign invested enterprises, if they are ultimately “controlled” by foreign investors.
On March 15, 2019, the National People’s Congress approved the Foreign Investment Law of the PRC, or the FIL, which came into effect on January 1, 2020, repealing simultaneously the Law of the PRC on Chinese-foreign Equity Joint Ventures, the Law of the PRC on Wholly Foreign-owned Enterprises and the Law of the PRC on Chinese-foreign Cooperative Joint Ventures, together with their implementation rules and ancillary regulations. Pursuant to the FIL, foreign investment refers to any investment activity within China directly or indirectly carried out by foreign natural persons, enterprises, or other organizations, including investment in new construction project, establishment of foreign funded enterprise or increase of investment within China alone or jointly with any other investor, merger and acquisition, and investment in any other way stipulated under laws, administrative regulations, or provisions of the State Council. Although the FIL has deleted the particular reference to the concept of “actual control” and contractual arrangements compared to the 2015 FIL Draft, there is no assurance that foreign investment via contractual arrangement would not be interpreted as a type of indirect foreign investment activities in the future. In addition, the definition contains a catch-all provision providing that investments made by foreign investors through other methods specified in laws or administrative regulations or other methods prescribed by the State Council, which leaves leeway for future laws, administrative regulations or provisions promulgated by the State Council to provide for contractual arrangements as a method of foreign investment. Given the foregoing, it is uncertain whether our contractual arrangements will be deemed to be in violation of the market entry clearance requirements for foreign investment under the PRC laws and regulations.
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Even if our VIE were to be identified as a FIE in the future, we believe that our current business would not be adversely affected. However, if we were to engage in any business conduct involving third parties identified as prohibited or restricted on the Negative List, our VIE as well as Gansu QLS and its subsidiaries may be subject to laws and regulations on foreign investment. Such might be the case for Gansu QLS’s proposed acquisition of enterprises manufacturing traditional Chinese medicine pieces. In addition, our shareholders would also be prohibited or restricted to invest in certain sectors on the Negative List. However, even if our VIE were to be identified as a FIE, the validity of our contractual arrangements with Gansu QLS and its shareholders as well as our corporate structure would not be adversely affected. We would still be able to receive benefits from our VIE in accordance with the contractual agreements. In addition, as the Chinese government has been updating the Negative List in recent years and reducing the sectors prohibited or restricted for foreign investment, it is probable in the future that, even if our VIE is identified as a FIE, it is still allowed to acquire or hold equity of enterprises in sectors currently prohibited or restricted for foreign investment.
It may be difficult for overseas regulators to conduct investigation or collect evidence within China.
Shareholder claims or regulatory investigation that are common in the United States generally are difficult to pursue as a matter of law or practicality in China. For example, in China, there are significant legal and other obstacles to providing information needed for regulatory investigations or litigations initiated outside China. Although the authorities in China may establish a regulatory cooperation mechanism with the securities regulatory authorities of another country or region to implement cross-border supervision and administration, such cooperation with the securities regulatory authorities in the Unities States may not be efficient in the absence of mutual and practical cooperation mechanism. Furthermore, according to Article 177 of the PRC Securities Law, which became effective in March 2020, no overseas securities regulator is allowed to directly conduct investigation or evidence collection activities within the PRC territory. While detailed interpretation of or implementation rules under Article 177 have yet to be promulgated, the inability for an overseas securities regulator to directly conduct investigation or evidence collection activities within China may further increase the difficulties you face in protecting your interests. See also "—Risks Related to the Offering and Our Ordinary Shares— The laws of the Cayman Islands may not provide our shareholders with benefits comparable to those provided to shareholders of corporations incorporated in the United States. For instance, you may face difficulties in protecting your interests, and your ability to protect your rights through U.S. courts may be limited, because we are incorporated under Cayman Islands law." for risks associated with investing in us as a Cayman Islands company.
You may experience difficulties in effecting services of legal process, enforcing foreign judgments or bringing actions in China against us or our management named in the prospectus based on foreign laws.
We are an exempted company incorporated under the laws of the Cayman Islands; however, we conduct all of our operations in China and most of our assets are located in China. In addition, all of our directors and executive officers are nationals or residents of the PRC and most of their assets are located outside the United States. As a result, it may be difficult for you to effect service of process upon us or our management named in the prospectus inside mainland China. It may also be difficult for you to enforce in U.S. courts of the judgments obtained in U.S. courts based on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors. In addition, there is uncertainty as to whether the courts of the Cayman Islands or the PRC would recognize or enforce judgments of U.S. courts against us or such persons predicated upon the civil liability provisions of the securities laws of the United States or any state.
The recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedures Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based either on treaties between China and the country where the judgment is made or on principles of reciprocity between jurisdictions. China does not have any treaties or other forms of written arrangement with the United States that provide for the reciprocal recognition and enforcement of foreign judgments. In addition, according to the PRC Civil Procedures Law, the PRC courts will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates the basic principles of PRC laws or national sovereignty, security or public interest. As a result, it is uncertain whether and on what basis a PRC court would enforce a judgment rendered by a court in the United States.
The custodians or authorized users of our controlling non-tangible assets, including chops and seals, may fail to fulfill their responsibilities, or misappropriate or misuse these assets.
Under the PRC law, legal documents for corporate transactions, including agreements and contracts are executed using the chop or seal of the signing entity or with the signature of a legal representative whose designation is registered and filed with relevant PRC market regulation administrative authorities.
In order to secure the use of our chops and seals, we have established internal control procedures and rules for using these chops and seals. In any event that the chops and seals are intended to be used, the responsible personnel will submit an application and the application will be verified and approved by authorized employees in accordance with our internal control procedures and rules. In addition, in order to maintain the physical security of our chops, we generally have them stored in secured locations accessible only to authorized employees. Although we monitor such authorized employees, the procedures may not be sufficient to prevent all instances of abuse or negligence. There is a risk that our employees could abuse their authority, for example, by entering into a contract not approved by us or seeking to gain control of one of our subsidiaries or our VIEs or their subsidiaries. If any employee obtains, misuses or misappropriates our chops and seals or other controlling non-tangible assets for whatever reason, we could experience disruption to our normal business operations. We may have to take corporate or legal action, which could involve significant time and resources to resolve and divert management from our operations.
Fluctuations in exchange rates could adversely affect our business and the value of our securities.
Changes in the value of the RMB against the U.S. dollar, Euro and other foreign currencies are affected by, among other things, changes in China’s political and economic conditions. Any significant revaluation of the RMB may have a material adverse effect on our revenues and financial condition, and the value of, and any dividends payable on our shares in U.S. dollar terms. For example, to the extent that we need to convert U.S. dollars we receive from our initial public offering into RMB for our operations, appreciation of the RMB against the U.S. dollar would have an adverse effect on RMB amount we would receive from the conversion. Conversely, if we decide to convert our RMB into U.S. dollars for the purpose of paying dividends on our Ordinary Shares or for other business purposes, appreciation of the U.S. dollar against the RMB would have a negative effect on the U.S. dollar amount available to us. In addition, fluctuations of the RMB against other currencies may increase or decrease the cost of imports and exports, and thus affect the price-competitiveness of our products against products of foreign manufacturers or products relying on foreign inputs.
Since July 2005, the RMB is no longer pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future PRC authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.
Increases in labor costs in the PRC may adversely affect our business and results of operations.
The currently effective PRC Labor Contract Law, or the Labor Contract Law was first adopted on June 29, 2007, later amended on December 28, 2012 and effective on 1 July,2013. The PRC Labor Contract Law has reinforced the protection of employees who, under the Labor Contract Law, have the right, among others, to have written employment contracts, to enter into employment contracts with no fixed term under certain circumstances, to receive overtime wages and to terminate or alter terms in labor contracts. Furthermore, the Labor Contract Law sets forth additional restrictions and increases the costs involved with dismissing employees. To the extent that we need to significantly reduce our workforce, the Labor Contract Law could adversely affect our ability to do so in a timely and cost-effective manner, and our results of operations could be adversely affected. In addition, for employees whose employment contracts include non-competition terms, the Labor Contract Law requires us to pay monthly economic compensation after such employment is terminated, which will increase our operating expenses.
We expect that our labor costs, including wages and employee benefits, will continue to increase. Unless we are able to pass on these increased labor costs to our customers by increasing the prices of our products and services, our financial conditions and results of operations would be materially and adversely affected.
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Part of our shareholders are not in compliance with the PRC’s regulations relating to offshore investment activities by PRC residents, and as a result, the shareholders may be subject to penalties if we are not able to remediate the non-compliance.
In July 2014, the State Administration of Foreign Exchange promulgated the Circular on Issues Concerning Foreign Exchange Administration over the Overseas Investment and Financing and Roundtrip Investment by Domestic Residents via Special Purpose Vehicles, or “Circular 37”. According to Circular 37, prior registration with the local SAFE branch is required for Chinese residents to contribute domestic assets or interests to offshore companies, known as special purpose vehicles, or SPVs. Circular 37 further requires amendment to a PRC resident’s registration in the event of any significant changes with respect to the SPV, such as an increase or decrease in the capital contributed by PRC individuals, share transfer or exchange, merger, division, or other material event. Further, foreign investment enterprises established by way of round-tripping shall complete the relevant foreign exchange registration formalities pursuant to the prevailing foreign exchange control provisions for direct investments by foreign investors, and disclose the relevant information such as actual controlling party of the shareholders truthfully.
There are a total of 151 Gansu QLS shareholders, who are PRC residents. Amongst them, 121 have signed the VIE agreements, but only 81 have completed the Circular 37 Registration. The remaining 40 shareholders who have yet to complete the Circular 37 Registration hold a total of 4.5% of shares of Gansu QLS. We have asked our shareholders who are Chinese residents to make the necessary applications and filings as required by Circular 37. We attempt to comply, and attempt to ensure that our shareholders who are subject to these rules comply, with the relevant requirements. We cannot, however, provide any assurances that all of our shareholders who are Chinese residents will comply with our request to make or obtain any applicable registration or comply with other requirements required by Circular 37 or other related rules. The Chinese resident shareholders’ failure to comply with Circular 37 registration would not impose penalties on our company, while it may result in restrictions being imposed on part of foreign exchange activities of the offshore special purpose vehicles, including restrictions on its ability to receive registered capital as well as additional capital from Chinese resident shareholders who fail to complete Circular 37 registration; and repatriation of profits and dividends derived from special purpose vehicles to China, by the Chinese resident shareholders who fail to complete Circular 37 registration, are also illegal. In addition, the failure of the Chinese resident shareholders to complete Circular 37 registration may subject each of the shareholders to fines less than RMB50,000. We cannot assure you that each of our Chinese resident shareholders will in the future complete the registration process as required by Circular 37.
We are not in compliance with the PRC’s regulations relating to employee’s social insurance and housing funds, and as a result, Gansu QLS and its subsidiaries may be subject to penalties if we are not able to remediate the non-compliance.
Pursuant to the Social Security Law of the PRC, or the Social Security Law, which was promulgated by the SCNPC on October 28, 2010 and amended on December 29, 2018, employers shall pay the basic pension insurance, medical insurance, work-related injury insurance, unemployment insurance and maternity insurance for employees. Gansu QLS has not deposited social security premium for part of employees in accordance with the Social Security Law. Although Gansu QLS has failed to deposit social security premiums in full, we believes that no additional amount is required to be paid by Gansu QLS since (i) some of the employees of Gansu QLS are over the age limit to be paid social insurance fees, and some chose to waive receiving social insurance fees deposited by Gansu QLS and decided to participate in their own voluntary social insurance plans instead; and (ii) pursuant to the Emergency Notice on Practicing Principles of the State Council Executive Meeting and Stabilizing Work on Collecting Social Insurance Premiums promulgated by the Ministry of Human Resources and Social Security on 21 September 2018, local authorities are prohibited from recovering the unpaid social insurance premiums from enterprises. Thus, it is unlikely that the overdue social insurance premiums would be ordered to be repaid by Gansu QLS.
In accordance with the Regulation on Management of Housing Provident Fund (the “Regulations of HPF”), which were promulgated by the PRC State Council on April 3, 1999, and last amended on March 24, 2019, employers must register at the designated administrative centers and open bank accounts for employees’ housing funds deposits. Employers and employees are also required to pay and deposit housing funds in an amount no less than 5% of the monthly average salary of each of the employees in the preceding year in full and on time. Gansu QLS had not opened such bank accounts or deposited its employees’ housing funds until August 2019. On the basis that: (i) Gansu QLS has opened the account for housing funds and deposited housing funds for staff since August 2019; and (ii) according to the interview with local housing fund administration authorities by our PRC Legal Counsel, the local authorities had not taken enforceable measures to collect housing funds from local enterprises; we think it is unlikely that the overdue unpaid housing fund would be ordered to be recovered from Gansu QLS. However, Chengdu QLS has not opened bank accounts for its employees’ housing funds deposits, nor has it deposited employees’ housing funds in accordance with the Regulations of HPF. Thus, Chengdu QLS may be ordered by PRC authorities to open a housing funds account, make the payment, and deposit an amount required by the PRC authorities within a prescribed time limit. Chengdu QLS may be required to pay an aggregate amount of RMB 92,874 (as of March 31, 2020) for its failure to deposit housing funds. If Chengdu QLS fails to comply to PRC authorities’ order within the prescribed time limit, a court ordered compulsory enforcement may be adopted and a fine of no less than RMB10,000 but no more than RMB50,000 shall be imposed.
Since we failed to make adequate social insurance and housing fund contributions, we may be subject to fines and legal sanctions, and our business, financial condition and results of operations may be adversely affected.
If we become directly subject to the recent scrutiny, criticism and negative publicity involving U.S.-listed Chinese companies, we may have to expend significant resources to investigate and resolve the matter which could harm our business operations, this offering and our reputation and could result in a loss of your investment in our stock, especially if such matter cannot be addressed and resolved favorably.
Recently, U.S. public companies that have substantially all of their operations in China, have been the subject of intense scrutiny, criticism and negative publicity by investors, financial commentators and regulatory agencies, such as the SEC. Much of the scrutiny, criticism and negative publicity has centered around financial and accounting irregularities, a lack of effective internal controls over financial accounting, inadequate corporate governance policies or a lack of adherence thereto and, in many cases, allegations of fraud. As a result of the scrutiny, criticism and negative publicity, the publicly traded stock of many U.S. listed Chinese companies has sharply decreased in value and, in some cases, has become virtually worthless. Many of these companies are now subject to shareholder lawsuits and SEC enforcement actions and are conducting internal and external investigations into the allegations. It is not clear what effect this sector-wide scrutiny, criticism and negative publicity will have on our Company, our business and this offering. If we become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, we will have to expend significant resources to investigate such allegations and/or defend the Company. This situation may be a major distraction to our management. If such allegations are not proven to be groundless, our Company and business operations will be severely hampered and your investment in our stock could be rendered worthless.
You may face difficulties in protecting your interests and exercising your rights as a stockholder since we conduct substantially all of our operations in China, and almost all of our officers and directors reside outside the U.S.
Although we are incorporated in the Cayman Islands, we conduct substantially all of our operations in China. All of our current officers and almost all of our directors reside outside the U.S. and substantially all of the assets of those persons are located outside of the U.S. It may be difficult for you to conduct due diligence on the Company or such directors in your election of the directors and attend shareholders meeting if the meeting is held in China. We plan to have one shareholder meeting each year at a location to be determined, potentially in China. As a result of all of the above, our public shareholders may have more difficulty in protecting their interests through actions against our management, directors or major shareholders than would shareholders of a corporation doing business entirely or predominantly within the U.S.
If we are classified as a passive foreign investment company, United States taxpayers who own our Ordinary Shares may have adverse United States federal income tax consequences.
A non-U.S. corporation such as ourselves will be classified as a passive foreign investment company, which is known as a PFIC, for any taxable year if, for such year, either:
| ● | At least 75% of our gross income for the year is passive income; or | |
| ● | The average percentage of our assets (determined at the end of each quarter) during the taxable year which produce passive income or which are held for the production of passive income is at least 50%. |
Passive income generally includes dividends, interest, rents and royalties (other than rents or royalties derived from the active conduct of a trade or business), and gains from the disposition of passive assets.
If we are determined to be a PFIC for any taxable year (or portion thereof) that is included in the holding period of a U.S. taxpayer who holds our Ordinary Shares, the U.S. taxpayer may be subject to increased U.S. federal income tax liability and may be subject to additional reporting requirements.
Depending on the amount of cash we raise in this offering, together with any other assets held for the production of passive income, it is possible that, for our 2021 taxable year or for any subsequent year, more than 50% of our assets may be assets which produce passive income, in which case we would be deemed a PFIC, which could have adverse US federal income tax consequences for US taxpayers who are shareholders. We will make this determination following the end of any particular tax year.
Although the law in this regard is unclear, we treat our consolidated affiliated entities as being owned by us for United States federal income tax purposes, not only because we exercise effective control over the operation of such entities but also because we are entitled to substantially all of their economic benefits, and, as a result, we consolidate their operating results in our consolidated financial statements. For purposes of the PFIC analysis, in general, a non-U.S. corporation is deemed to own its pro rata share of the gross income and assets of any entity in which it is considered to own at least 25% of the equity by value.
For a more detailed discussion of the application of the PFIC rules to us and the consequences to U.S. taxpayers if we were or are determined to be a PFIC, see “Taxation—United States Federal Income Taxation—Passive Foreign Investment Company.”
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements that reflect our current expectations and views of future events, all of which are subject to risks and uncertainties. Forward-looking statements give our current expectations or forecasts of future events. You can identify these statements by the fact that they do not relate strictly to historical or current facts. You can find many (but not all) of these statements by the use of words such as “approximates,” “believes,” “hopes,” “expects,” “anticipates,” “estimates,” “projects,” “intends,” “plans,” “will,” “would,” “should,” “could,” “may” or other similar expressions in this prospectus. These statements are likely to address our growth strategy, financial results and product and development programs. You must carefully consider any such statements and should understand that many factors could cause actual results to differ from our forward-looking statements. These factors may include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:
| · | future financial and operating results, including revenues, income, expenditures, cash balances and other financial items; |
| · | our ability to execute our growth and expansion, including our ability to meet our goals; |
| · | current and future economic and political conditions; |
| · | our ability to compete in an industry with low barriers to entry; |
| · | our ability to continue to operate through our VIE structure; |
| · | our capital requirements and our ability to raise any additional financing which we may require; |
| · | our ability to attract clients, win primary agency sale bids, and further enhance our brand recognition; and |
| · | our ability to hire and retain qualified management personnel and key employees in order to enable us to develop our business; |
| · | our ability to retain the services of Mr. Zhanchang Xin, our chief executive officer; |
| · | trends and competition in the Chinese chemical and pharmaceutical industries; |
| · | uncertainty about the spread of the COVID-19 virus and the impact it may have on the Company’s operations, the demand for the Company’s products, global supply chains, and economic activity in general; and |
| · | other assumptions described in this prospectus underlying or relating to any forward-looking statements. |
We describe material risks, uncertainties and assumptions that could affect our business, including our financial condition and results of operations, under “Risk Factors.” We base our forward-looking statements on our management’s beliefs and assumptions based on information available to our management at the time the statements are made. We caution you that actual outcomes and results may, and are likely to, differ materially from what is expressed, implied or forecast by our forward-looking statements. Accordingly, you should be careful about relying on any forward-looking statements. Except as required under the federal securities laws, we do not have any intention or obligation to update publicly any forward-looking statements after the distribution of this prospectus, whether as a result of new information, future events, changes in assumptions, or otherwise.
Industry Data and Forecasts
This prospectus contains data related to the pharmaceutical and chemical industries in China. These industry data include projections that are based on a number of assumptions which have been derived from industry and government sources which we believe to be reasonable. The pharmaceutical and chemical industries may not grow at the rate projected by industry data, or at all. The failure of this industry to grow as anticipated is likely to have a material adverse effect on our business and the market price of our Ordinary Shares. In addition, the rapidly changing nature of the Chinese chemical and pharmaceutical industries subjects any projections or estimates relating to the growth prospects or future condition of our industry to significant uncertainties. Furthermore, if any one or more of the assumptions underlying the industry data turns out to be incorrect, actual results may, and are likely to, differ from the projections based on these assumptions.
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ENFORCEABILITY OF CIVIL LIABILITIES
We are incorporated under the laws of the Cayman Islands as an exempted company with limited liability since February 7, 2019. We are incorporated under the laws of the Cayman Islands because of certain benefits associated with being a Cayman Islands company, such as political and economic stability, an effective judicial system, a favorable tax system, the absence of foreign exchange control or currency restrictions and the availability of professional and support services. However, the Cayman Islands have a less developed body of securities laws as compared to the United States and provide significantly less protection for investors than the United States. Additionally, Cayman Islands companies may not have standing to sue before the Federal courts of the United States.
Substantially all of our assets are located in the PRC. In addition, all of our directors and officers are nationals or residents of the PRC and all or a substantial portion of their assets are located outside the United States. As a result, it may be difficult for investors to effect service of process within the United States upon us or these persons or to enforce against us or them judgments obtained in United States courts, including judgments predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States.
We have appointed Cogency Global Inc. at 122 East 42nd Street, 18th Floor, New York, NY 10168 as our agent to receive service of process with respect to any action brought against us in the United States District Court for the Southern District of New York under the federal securities laws of the United States or of any state in the United States or any action brought against us in the Supreme Court of the State of New York in the County of New York under the securities laws of the State of New York.
Ogier, our counsel with respect to the laws of the Cayman Islands, and Dentons Law Offices, LLP, our counsel with respect to PRC law, have advised us that there is uncertainty as to whether the courts of the Cayman Islands or the PRC would (i) recognize or enforce judgments of United States courts obtained against us or our directors or officers predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States or (ii) entertain original actions brought in the Cayman Islands or the PRC against us or our directors or officers predicated upon the securities laws of the United States or any state in the United States.
Ogier has further advised us that there is currently no statutory enforcement or treaty between the United States and the Cayman Islands providing for enforcement of judgments. A judgment obtained in the United States, however, may be recognized and enforced in the courts of the Cayman Islands at common law, without any re-examination on the merits of the underlying dispute, by an action commenced on the foreign judgment debt in the Grand Court of the Cayman Islands, provided such judgment: (i) is given by a foreign court of competent jurisdiction; (ii) is final; (iii) is not in respect of taxes, a fine or a penalty; and (iv) was not obtained in a manner and is not of a kind the enforcement of which is contrary to natural justice or public policy of the Cayman Islands. Furthermore, it is uncertain that the Cayman Islands courts would enforce: (1) judgments of U.S. courts obtained in actions against us or other persons that are predicated upon the civil liability provisions of the U.S. federal securities laws; or (2) original actions brought against us or other persons predicated upon the Securities Act. Ogier has informed us that there is uncertainty with regard to Cayman Islands law relating to whether a judgment obtained from the U.S. courts under civil liability provisions of the securities laws will be determined by the courts of the Cayman Islands as penal or punitive in nature.
Dentons Law Offices, LLP has further advised us that the recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedure Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedure Law based either on treaties between China and the country where the judgment is made or on reciprocity between jurisdictions. Dentons Law Offices, LLP has advised us further that there are no treaties or other forms of reciprocity between China and the United States for the mutual recognition and enforcement of court judgments, thus making the recognition and enforcement of a U.S. court judgment in China difficult.
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We estimate that the net proceeds from the sale of 5,000,000 Ordinary Shares in this offering will be approximately $22,218,459, after deducting the underwriting discounts, estimated offering expenses payable by us, based on the initial public offering price of $5.00 per Ordinary Share. If the underwriters exercise their over-allotment option in full, we estimate that the net proceeds to us from this offering will be approximately $25,705,959, after deducting the underwriting discounts and estimated offering expenses payable by us.
The primary purposes of this offering are to create a public market for our shares for the benefit of all shareholders and obtain additional capital. We intend to use the net proceeds of this offering as follows, and we have ordered the specific uses of proceeds in order of priority:
| • | approximately 90.0% for fixed asset investment in Oxytetracycline API production facilities; | |
| • | approximately 6.4% for construction of an organic-waste treatment facility; | |
| • | approximately 0.6% for fixed asset investment in Heparin Sodium Preparation facilities; and | |
| • | approximately 3.0% for marketing expenses for Gan Di Xin. |
This expected use of the net proceeds from this offering represents our intentions based upon our current plans and prevailing business conditions, which could change in the future as our plans and prevailing business conditions evolve. Predicting the cost necessary to develop product candidates can be difficult and the amounts and timing of our actual expenditures may vary significantly depending on numerous factors, including the progress of our development, the status of and results from clinical trials, any collaborations that we may enter into with third parties for our product candidates and any unforeseen cash needs. As a result, our management will retain broad discretion over the allocation of the net proceeds from this offering.
Regarding our use of the proceeds from this initial public offering, we will use the majority of proceeds received in expanding the manufacturing capacity for our oxytetracycline products, our fertilizer products, and our Heparin Sodium Preparations. We will also use the proceeds to support our planned marketing efforts for Gan Di Xin®.
More specifically, for our Qilian Shan® Oxytetracycline API, we plan to increase our oxytetracycline API production capabilities and hire more experienced marketing specialists in order to carry out our strategic expansions into additional geographical locations in China, which we believe would result in us acquiring a bigger share of the Chinese market for this product. We are committed to prioritizing investment in our infrastructure capabilities in order to support the strategic expansions into additional geographical markets in China. We plan to relocate our current oxytetracycline API production facilities and purchase additional state-of-the-art manufacturing facilities to further increase our production capacity. We plan to increase our production capacity to 10,000 tons by 2024, and we estimate that our fixed assets investment will be approximately $18 million. We will focus on hiring more experienced professionals in our sales, marketing, and production departments to support our continued market growth while reducing costs.
For our Xiongguan® Organic Fertilizer, we plan to build an organic waste treatment facility that will allow us to increase fertilizer production capacity through turning waste into high quality production materials. We believe this strategy will reduce the cost of our organic fertilizer production while increasing the efficiency of our organic fertilizer production each year. We expect to invest approximately $1.28 million in this project.
For our Heparin Sodium Preparation, we intend to implement two primary strategies to expand and grow the production capacity of our Heparin Sodium Preparation: (i) upgrade the production efficiency of our existing manufacturing facilities, and (ii) increase our production lines for Heparin Sodium Preparation. While we have earned our reputation through the consistent quality of our products, we believe that sustained improvements in the production efficiency and increasing production lines are vital to maintaining such reputation and acquire more shares in the Chinese heparin sodium markets. We expect to invest approximately $128,000 in implementing these two strategies.
For our Gan Di Xin®, we plan to reach a larger customer base beyond Gansu Province by enrolling in the National Medical Insurance Coverage Program, which will allow Gan Di Xin® to enter medical institutions and insurance-covered pharmacies on national level. We also plan to invest more on our marketing efforts for Gan Di Xin®, and we estimate that we will spend approximately $118,000 annually on marketing expenses in the near future.
For acquiring traditional Chinese medicine enterprises in the future, the Company will adopt non-cash acquisition methods and it currently does not have any commitments or agreements to acquire any specific traditional Chinese medicine enterprises.
Pending any use described above, we plan to invest the net proceeds in short-term, interest-bearing, debt instruments.
The net proceeds from this offering must be remitted to China before we will be able to use the funds to grow our business. The procedure to remit funds may take several months after completion of this offering, and we will be unable to use the offering proceeds in China until remittance is completed. See “Risk Factors” for further information.
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We intend to keep any future earnings to finance the expansion of our business. We do not anticipate that any cash dividends will be paid in the foreseeable future.
Under Cayman Islands law, a Cayman Islands company may pay a dividend on its shares out of either profit or share premium amount, provided that in no circumstances may a dividend be paid if this would result in the company being unable to pay its debts due in the ordinary course of business.
If we determine to pay dividends on any of our Ordinary Shares in the future, as a holding company, we will depend on receipt of funds from our Hong Kong subsidiary, Qilian HK.
Current PRC regulations permit our indirect PRC subsidiaries to pay dividends to Qilian HK only out of their accumulated profits, if any, determined in accordance with Chinese accounting standards and regulations. In addition, each of our subsidiaries in China is required to set aside at least 10% of its after-tax profits each year, if any, to fund a statutory reserve until such reserve reaches 50% of its registered capital. Although the statutory reserves can be used, among other ways, to increase the registered capital and eliminate future losses in excess of retained earnings of the respective companies, the reserve funds are not distributable as cash dividends except in the event of liquidation.
The PRC government also imposes controls on the conversion of RMB into foreign currencies and the remittance of currencies out of the PRC. Therefore, we may experience difficulties in completing the administrative procedures necessary to obtain and remit foreign currency for the payment of dividends from our profits, if any. Furthermore, if our subsidiaries and affiliates in the PRC incur debt on their own in the future, the instruments governing the debt may restrict their ability to pay dividends or make other payments. If we or our subsidiaries are unable to receive all of the revenues from our operations through the current contractual arrangements, we may be unable to pay dividends on our Ordinary Shares.
Cash dividends, if any, on our Ordinary Shares will be paid in U.S. dollars. Qilian HK may be considered a non-resident enterprise for tax purposes, so that any dividends WFOE pays to Qilian HK may be regarded as China-sourced income and as a result may be subject to PRC withholding tax at a rate of up to 10%. See “Taxation—People’s Republic of China Enterprise Taxation.”
In order for us to pay dividends to our shareholders, we will rely on payments made from Gansu QLS to WFOE, pursuant to contractual arrangements between them, and the distribution of such payments to Qilian HK as dividends from WFOE. Certain payments from our Gansu QLS to WFOE are subject to PRC taxes, including VAT, urban maintenance and construction tax, educational surcharges. In addition, if Gansu QLS or its subsidiaries or branches incur debt on their own behalves in the future, the instruments governing the debt may restrict its ability to pay dividends or make other distributions to us.
Pursuant to the Arrangement between Mainland China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and Tax Evasion on Income, or the Double Tax Avoidance Arrangement, the 10% withholding tax rate may be lowered to 5% if a Hong Kong resident enterprise owns no less than 25% of a PRC project. However, the 5% withholding tax rate does not automatically apply and certain requirements must be satisfied, including without limitation that (a) the Hong Kong project must be the beneficial owner of the relevant dividends; and (b) the Hong Kong project must directly hold no less than 25% share ownership in the PRC project during the 12 consecutive months preceding its receipt of the dividends.
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The following table sets forth our capitalization as of March 31, 2020 on:
The following table sets forth our capitalization as of March 31, 2020 on:
| • | an actual basis; and | |
| • | a pro forma as adjusted basis to give effect to the sale of 5,000,000 Ordinary Shares in this offering at the initial public offering price of $5.00 per Ordinary Share after deducting the underwriting discounts and estimated offering expenses payable by us. |
You should read this information together with our audited consolidated financial statements appearing elsewhere in this prospectus and the information set forth under the sections titled “Selected Consolidated Financial Data,” “Use of Proceeds” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
| As of March 31, 2020 | ||||||||
| Actual | Pro Forma As Adjusted (1) (2) | |||||||
| US$ | US$ | |||||||
| Shareholders’ Equity | ||||||||
| Ordinary shares, $0.00166667 par value: 100,000,000 shares authorized; 30,000,000 shares issued and outstanding; 35,000,000 shares issued and outstanding pro forma | 50,000 | 58,333 | ||||||
| Additional paid-in capital | 12,252,077 | 34,462,203 | ||||||
| Statutory reserves | 2,200,488 | 2,200,488 | ||||||
| Retained earnings | 10,992,090 | 10,992,090 | ||||||
| Accumulated other comprehensive loss | (1,648,395 | ) | (1,648,395 | ) | ||||
| Noncontrolling interest | 3,085,112 | 3,085,112 | ||||||
| Total shareholders’ equity | 26,931,372 | 49,149,831 | ||||||
| Total capitalization | 26,931,372 | 49,149,831 | ||||||
(1) Reflects the sale of Ordinary Shares in this offering (excluding any Ordinary Shares that may be sold as a result of the underwriters exercising their over-allotment option) at the initial public offering price of $5.00 per share, and after deducting the estimated underwriting discounts and estimated offering expenses payable by us. Additional paid-in capital reflects the net proceeds we expect to receive, after deducting the underwriting discounts, estimated offering expenses payable by us and advisory fees. We estimate that such net proceeds will be approximately $22,218,459.
(2) Assuming the underwriters do not exercise their over-allotment option.
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If you invest in our Ordinary Shares in this offering, your interest will be immediately diluted to the extent of the difference between the initial public offering price per Ordinary Share in this offering and the net tangible book value per Ordinary Share after this offering. Dilution results from the fact that the initial public offering price per Ordinary Share is substantially in excess of the net tangible book value per Ordinary Share. As of March 31, 2020, we had a historical net tangible book value of $26,931,372, or $0.9 per Ordinary Share. Our net tangible book value per share represents total tangible assets less total liabilities, all divided by the number of Ordinary Shares outstanding on March 31, 2020.
After giving effect to the sale of 5,000,000 Ordinary Shares in this offering at the initial public offering price of $5.00 per Ordinary Share and after deducting the underwriting discounts and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value at March 31, 2020 would have been $49,149,831, or $1.40 per Ordinary Share. This represents an immediate increase in pro forma as adjusted net tangible book value of $0.50 per Ordinary Share to existing investors and immediate dilution of $3.60 per Ordinary Share to new investors. The following table illustrates this dilution to new investors purchasing Ordinary Shares in this offering:
| Offering without Over-allotment Option | Offering with Full Exercise of Over- allotment Option | |||||||
| Initial public offering price per Ordinary Share | $ | 5.00 | $ | 5.00 | ||||
| Net tangible book value per Ordinary Share as of March 31, 2020 | $ | 0.90 | $ | 0.90 | ||||
| Increase in pro forma as adjusted net tangible book value per Ordinary Share attributable to new investors purchasing Ordinary Shares in this offering | $ | 0.50 | $ | 0.57 | ||||
| Pro forma as adjusted net tangible book value per Ordinary Share after this offering | $ | 1.40 | $ | 1.47 | ||||
| Dilution per Ordinary Share to new investors in this offering | $ | 3.60 | $ | 3.53 | ||||
If the underwriters exercise their over-allotment option in full, the pro forma as adjusted net tangible book value per Ordinary Share after the offering would be $1.47 the increase in net tangible book value per Ordinary Share to existing shareholders would be $0.57 and the immediate dilution in net tangible book value per Ordinary Share to new investors in this offering would be $3.53
The following table summarizes, on a pro forma as adjusted basis as of March 31, 2020, the differences between existing shareholders and the new investors with respect to the number of Ordinary Shares purchased from us, the total consideration paid and the average price per Ordinary Share before deducting the estimated discounts to the underwriters and the estimated offering expenses payable by us.
| Ordinary Shares purchased |
Total consideration | Average price per Ordinary |
||||||||||||||||||
| Number | Percent | Amount | Percent | Share | ||||||||||||||||
| ($) | ||||||||||||||||||||
| Existing shareholders (1) | 30,000,000 | 85.71 | % | $ | 12,302,077 | 29.08 | % | $ | 0.41 | |||||||||||
| New investors | 5,000,000 | 14.29 | % | $ | 30,000,000 | 70.92 | % | $ | 6.00 | |||||||||||
| Total | 35,000,000 | 100 | % | $ | 42,302,077 | 100 | % | $ | 1.21 | |||||||||||
(1) Not including over-allotment shares
The pro forma as adjusted information as discussed above is illustrative only. Our net tangible book value following the completion of this offering is subject to adjustment based on the actual initial public offering price of our Ordinary Shares and other terms of this offering determined at the pricing.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS OF QILIAN INTERNATIONAL HOLDING GROUP LIMITED
You should read the following description of Qilian International Holding Group Limited’s results of operations and financial condition in conjunction with its consolidated audited financial statements for the years ended September 30, 2019 and 2018 and condensed financial statements for the six months ended March 31, 2020 and 2019.
Overview
Qilian International Holding Group Limited (the “Company”) is engaged in the research, development, and production of licorice products, oxytetracycline products, traditional Chinese medicine derivatives (“TCMD”) product, heparin product, sausage casings, and fertilizers.
The Company was originally incorporated in the Cayman Islands on February 7, 2019. Our business is conducted by Gansu Qilianshan Pharmaceutical Co. Ltd. (“Gansu QLS”), our variable interest entity (“VIE”) in the PRC, and its subsidiaries, using RMB, the currency of China.
On May 20, 2019, the Company, through its wholly foreign-owned entity Chengdu Qilian Trading Co., Ltd (“WFOE” or “Chengdu Trading”), entered into a series of contractual agreements with Gansu QLS, which include an Exclusive Service Agreement, an Equity Pledge Agreement, a Call Option Agreement, a Shareholders’ Voting Rights Proxy Agreement and Powers of Attorney (together, the “VIE agreements”). Pursuant to the VIE agreements, WFOE provides Gansu QLS with technical support, consulting services and other management services and is entitled to receive 98.297% of Gansu QLS’ net profits, this percentage being the number of shares of Gansu QLS held by shareholders having signed the VIE Agreements over the total issued and outstanding shares of Gansu QLS. In addition, Gansu QLS’s shareholders have pledged 98.297% of their equity interests in Gansu QLS to WFOE, irrevocably granted WFOE an exclusive option to purchase, to the extent permitted under PRC law, all or part of the equity interests in Gansu QLS, and agreed to entrust all the rights to exercise their voting power to the person(s) appointed by WFOE. Through the VIE agreements, Qilian Chengdu holds all the variable interests of Gansu QLS. Therefore, Qilian Chengdu is the primary beneficiary of Gansu QLS.
Based on the VIE arrangements, Gansu QLS is considered a VIE of Qilian Chengdu under U.S. GAAP. As the above entities were under common control before and after the execution of the VIE agreements, the restructuring was accounted for as a reorganization of entities under common control and consolidated financial statements were prepared as if the reorganization occurred at the beginning of the first period presented. Thus, the financial results presented here include those of VIEs from the first period presented.
As of the date of this prospectus, there are 30,000,000 Ordinary Shares issued and outstanding.
Outlook
We plan to continue developing our business by expanding our marketing network and investing in pharmaceutical and chemical facilities, which depend heavily on sufficient capital. If we are not able to obtain equity or debt financing, we may not be able to execute our development and expansion plans, which could have material adverse effect on our future business performance and operating results.
The Company’s net revenue for the six months ended March 31, 2020 was $27.8 million, representing an increase of $0.6 million, or 2%, from $27.2 million for the six months ended March 31, 2019. Net income attributable to the Company’s shareholders for the six months ended March 31, 2020 was $3.9 million, representing a decrease of $0.4 million, or 10%, from $4.3 million for the six months ended March 31, 2019. Non-GAAP EBITDA for the six months ended March 31, 2020 was $5.6 million, representing a decrease of $1 million, or 15%, from $6.6 million for the six months ended March 31, 2019. For additional information on EBITDA, please see the subsection “Management’s Discussion and Analysis of Financial Condition and Results of Operations—EBITDA” below.
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How to Assess the Company’s Performance
In assessing performance, the Company considers a variety of performance and financial measures, including principal growth in net revenue, gross profit, distribution, general and administrative expenses, net income from operations, and EBITDA (Non-GAAP). The key measures that we use to evaluate the performance of the Company’s business are set forth below:
Net Revenue
Net revenue is equal to gross sales minus sales returns and sales incentives that the Company offers to its customers, such as discounts that are offset to gross sales. The Company’s net sales are driven by changes in the number of customers, product varieties, selling price, and mix of products sold.
Gross Profit
Gross profit is equal to net sales minus cost of goods sold. Cost of goods sold primarily includes inventory costs (net of supplier consideration), inbound freight, custom clearance fees, and other miscellaneous expenses. Cost of goods sold generally changes as the Company incurs higher or lower costs from suppliers and as the customer and product mix changes.
Selling, General and Administrative Expenses
Selling, general and administrative expenses primarily consist of salaries and benefits for employees, shipping expense, utilities, maintenance and repairs expenses, insurance expense, depreciation and amortization expenses, selling and marketing expenses, professional fees, and other operating expenses.
Non-GAAP Financial Measures-EBITDA
Management uses certain financial measures to evaluate our operating performance which is calculated and presented on the basis of methodologies other than in accordance with GAAP (“Non-GAAP”). These measures should not be considered a substitute for, or superior to, measures of financial performance prepared in accordance with GAAP, and our calculations thereof may not be comparable to similarly entitled measures reported by other companies. The Company believes that EBITDA is a useful performance measure and can be used to facilitate a comparison of the Company’s operating performance on a consistent basis from period to period and to provide for a more complete understanding of factors and trends affecting the Company’s business than GAAP measures alone can provide. The Company’s management believes that EBITDA is less susceptible to variances in actual performance resulting from depreciation, amortization and other non-cash charges and more reflective of other factors that affect its operating performance. The Company’s management believes that the use of these Non-GAAP financial measures provides an additional tool for investors to use in evaluating ongoing operating results and trends and in comparing the company’s financial measures with the companies in the same industry, many of which present similar Non-GAAP financial measures to investors. The Company presents EBITDA in order to provide supplemental information that Management considers relevant for the readers of its consolidated financial statements included elsewhere in this Filing, and such information is not meant to replace or supersede U.S. GAAP measures.
The Company’s management defines EBITDA as net income (loss) before interest expense, income taxes, and depreciation and amortization. EBITDA is not defined under U.S. GAAP and is subject to important limitations as analytical tools, you should not consider them in isolation or as substitutes for analysis of the Company results as reported under U.S. GAAP. For example, EBITDA:
| ● | excludes certain tax payments that may represent a reduction in cash available to the Company; | |
| ● | does not reflect any cash capital expenditure requirements for the assets being depreciated and amortized that may have to be replaced in the future; | |
| ● | does not reflect changes in, or cash requirements for, the Company’ working capital needs; and | |
| ● | does not reflect the significant interest expense, or the cash requirements, necessary to service the Company’s debt. |
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COVID-19
The outbreak of the novel coronavirus, commonly referred to as “COVID-19”, significantly affected the economic and business activities within China for the most part of 2020. To attempt to contain the COVID-19 outbreak, the Chinese government had adopted restrictive measures such as city lockdowns, travel restrictions, and closures of business activities since late January 2020. With such measures, China has gradually resumed businesses as government officials started to ease the restrictive measures. As of the date of this prospectus, the COVID-19 outbreak in China appears to be generally under control.
The COVID-19 outbreak has negatively impacted our businesses in the following ways:
| · | Our manufacturing activities depend on a wide array of raw materials such as soybeans, corn starch, glycyrrhiza glabra plant, pig intestines, and many others. We have experienced substantive diminutions in raw material supplies due to the COVID-19 outbreak and ensuing lockdowns. In addition, for the nine months ended June 30, 2020 the price of these raw materials has increased by approximately 4%-8% as compared to the same period of the last fiscal year. Our overall gross margin decreased from approximately 25% for the nine months ended June 30, 2019 to approximately 18% for the nine months ended June 30, 2020; | |
| · | Our sales for the three months ended June 30, 2020 decreased by approximately 31% as compared to the same period in 2019, due to the combined effect of (i) the decreased demand of our licorice and TCMD products, (ii) substantive drop in oxytetracycline products prices in April and May 2020, and (iii) our strategic decision to suspend the sales of heparin products. Due to governmental mandates during the COVID-19 outbreak, the general Chinese population was encouraged to receive examinations and treatments in hospitals instead of resorting to over the counter medicines, which include our licorice and TCMD products. Further, the substantive decrease in market price of our oxytetracycline products was caused by border controls and closures in foreign countries, which resulted in general excess supplies of oxytetracycline products. In addition, we strategically suspended the sales of heparin products because of a significant increase in the price of pig small intestine and we predicted that we would incur loss from selling heparin products. We decided to put our sales of heparin products on hold starting in the quarter ended June 30, 2020 until the market price rebounded. In the quarter ended September 30, 2020, we resumed selling heparin products. |
Considering the global development of the COVID-19 outbreak and the changes in market conditions that followed, we expect the following to occur for the fiscal year ended September 30, 2020:
| · | For the year ended September 30, 2020, our net revenue is estimated to increase by 5% to 8% compared to the year ended September 30, 2019, due to the increase in net revenue in the first six months ended March 31, 2020 and rebounding market conditions in the quarter ended September 30, 2020 |
| · | The COVID-19 outbreak has increased the cost of raw materials for our oxytetracycline, licorice and TCMD products. In addition to the COVID-19 impact, soy bean prices has increased due to the Trade friction between China and US. We expect our cost of production to increase. |
| · | We expect our account receivable collections to slow down due to the Company’s recent extended credit policy, which excludes our customers for oxytetracycline products. We have extended credit terms for certain customers with scrutiny. We expect our account receivable turnover rate to be lower compared to that of the pre-outbreak period. The Company does not expect significant bad debt increase for our fiscal quarter ended September 30, 2020 due to the Company’s credit scrutiny policy and careful credit monitoring procedures. |
| · | The Company will continue funding its capital requirements primarily by cash flow from operations, bank loans, and equity contribution from shareholders. |
Results of Operations for the six months ended March 31, 2020 and 2019
The following table sets forth a summary of the Company’s consolidated results of operations for the six months ended March 31, 2020 and 2019. The historical results presented below are not necessarily indicative of the results that may be expected for any future period.
| For the six months ended | ||||||||||||||||
| March 31 | Changes | |||||||||||||||
| 2020 | 2019 | Amount | % | |||||||||||||
| Net revenue | $ | 27,758,814 | $ | 27,160,302 | $ | 598,512 | 2 | % | ||||||||
| Cost of revenue | 21,530,973 | 19,772,589 | 1,758,384 | 9 | % | |||||||||||
| Gross profit | 6,227,841 | 7,387,713 | (1,159,872) | (16) | % | |||||||||||
| Selling, general and administrative expenses | 1,434,898 | 1,732,288 | (297,390) | (17) | % | |||||||||||
| Income from operations | 4,792,943 | 5,655,425 | (862,482) | (15) | % | |||||||||||
| Interest expense | (110,251 | ) | (104,282 | ) | (5,969) | 6 | % | |||||||||
| Other income | 215,788 | 354,884 | (139,096) | (39) | % | |||||||||||
| Income before income tax provision | 4,898,480 | 5,906,027 | (1,007,547) | (17) | % | |||||||||||
| Provision for income taxes | 715,101 | 881,726 | (166,625) | (19) | % | |||||||||||
| Net income | 4,183,379 | 5,024,301 | (840,922) | (17) | % | |||||||||||
| Less: net income attributable to noncontrolling interest | 325,249 | 732,190 | (406,941) | (56) | % | |||||||||||
| Net income attributable to Qilian International Holding Group Limited | $ | 3,858,130 | $ | 4,292,111 | $ | (433,981) | (10) | % | ||||||||
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Net Revenue
The following table sets forth the breakdowns of the Company’s net revenue:
| For the six months ended March 31, | ||||||||||||||||||||||||
| 2020 | 2019 | Changes | ||||||||||||||||||||||
| Amount | % | Amount | % | Amount | % | |||||||||||||||||||
| Net revenue | ||||||||||||||||||||||||
| Oxytetracycline & Licorice products and TCMD | $ | 16,753,161 | 60 | % | $ | 16,305,675 | 60 | % | $ | 447,486 | 3 | % | ||||||||||||
| Heparin products and Sausage casing | $ | 10,671,831 | 39 | % | $ | 10,615,044 | 39 | % | $ | 56,787 | 1 | % | ||||||||||||
| Fertilizer | $ | 333,822 | 1 | % | $ | 239,583 | 1 | % | $ | 94,239 | 39 | % | ||||||||||||
| Total | $ | 27,758,814 | 100.0 | % | $ | 27,160,302 | 100 | % | $ | 598,512 | 2 | % | ||||||||||||
Compared with net revenue for the six months ended March 31, 2019, the Company’s net revenue increased by $0.6 million, or a 2% increase, for the six months ended March 31, 2020, which was primarily attributable to a $0.4 million sales increase from oxytetracycline and licorice products.
Oxytetracycline & Licorice products and TCMD
Our sales for oxytetracycline products, licorice products and TCMD increased by approximately $0.4 million, or 3%, from approximately $16.3 million for the six months ended March 31, 2019 to approximately $16.8 million for the six months ended March 31, 2020. The sales of oxytetracycline products, licorice products, and TCMD accounted for 94.3%, 4.8%, and 0.9% of this segment’s total sales for the six months ended March 31, 2020, and 93.9%, 6.0%, and 0.1% of such segment’s total sales for the six months ended March 31, 2019. The increase in sales of this segment is due to the following reasons: (1) sales from oxytetracycline products have increased by $0.4 million due to the increased quantity sold. During the six months ended March 31, 2020, we developed 17 new customers mainly located in Yunnan and Sichuan provinces. As a result, sales in these two provinces increased by 90%, or $0.5 million, as compared to the same period in in 2019; and (2) during the COVID-19 outbreak in China, We switched part of our production lines to manufacture disinfection products in light of a shortage of such products , which contributed $145,000 in sales for the six months ended March 31, 2020. Further, the sales increase in this segment was offset to a certain degree by a decrease in sales of licorice products. The COVID-19 outbreak in China during January to March had a significant impact on the sales of our licorice products. The sales volume of our licorice products decreased by 41% due to the logistics restraint and delays caused by China’s national lockdown during the COVID-19 outbreak. However, the market price of our licorice products had increased by 45% compared to same period in the last year due to the market’s high demand. Overall, the sales from our licorice products decreased by $0.2 million during the six months ended March 31, 2020, as compared to the same period in 2019.
Heparin products and Sausage casings
Sales from heparin products increased by approximately $57,000, or a 1% increase, from $10.6 million for the six months ended March 31, 2019 to $10.7 million for the six months ended March 31, 2020. The slight increase of sales from heparin products was due to a combined effect of a decrease in quantity sold and an increase in market price for the six months ended March 31, 2020. Due to the ongoing African swine fever in China since November 2018, the pig population China has experienced substantial decrease, which in turn has caused dwindling raw material supplies for our heparin products and sausage casings. Our production quantities of heparin products and sausage casings decreased by 17% and 35%, respectively, for the six months ended March 31, 2020, as compared to the same period in 2019. Such decrease in production quantities have caused the market price of heparin products to increase by 77% for the six months ended March 31, 2020, as compared to the same period in 2019. The market price of sausage casings remained consistent for the six months ended March 31, 2020 and six months ended March 31, 2019.
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Fertilizer
Sales from our fertilizer products increased by $0.1 million, or a 39% increase, from $0.2 million for the six months ended March 31, 2019 to $0.3 million for the six months ended March 31, 2020. Sales quantity of our fertilizer products increased by 12% and market price increased by 31% during the six months ended March 31, 2020, as compared to the same period in 2019. The increase in our sales of fertilizer products was due to our newly developed customers and increased government purchase of our products. Further, the market prices of our fertilizer products had increased in the past three months due to the logistics restraint and delays caused by China’s national lockdown during the COVID-19 outbreak.
Cost of Revenue and Gross Profit
The following tables set forth the calculation of gross profit and gross margin for the each of the Company’s segments:
| For the six months ended March 31, | Changes | |||||||||||||||
| 2020 | 2019 | Amount | % | |||||||||||||
| Oxytetracycline & Licorice products and TCMD | ||||||||||||||||
| Net revenue | $ | 16,753,161 | $ | 16,305,675 | $ | 447,486 | 3 | % | ||||||||
| Cost of revenue | 12,062,310 | 11,045,694 | 1,016,616 | 9 | % | |||||||||||
| Gross profit | $ | 4,690,851 | $ | 5,259,981 | $ | (569,130) | (11) | % | ||||||||
| Gross Margin | 28.0 | % | 32.3 | % | (4.3) | % | ||||||||||
| Heparin products and Sausage casing | ||||||||||||||||
| Net revenue | $ | 10,671,831 | $ | 10,615,044 | $ | 56,787 | 1 | % | ||||||||
| Cost of revenue | 9,318,555 | 8,657,866 | 660,689 | 8 | % | |||||||||||
| Gross profit | $ | 1,353,276 | $ | 1,957,178 | $ | (603,902) | (31) | % | ||||||||
| Gross Margin | 12.7 | % | 18.4 | % | (5.7) | % | ||||||||||
| Fertilizer | ||||||||||||||||
| Net revenue | $ | 333,822 | $ | 239,583 | $ | 94,239 | 39 | % | ||||||||
| Cost of revenue | 150,108 | 69,029 | 81,079 | 117 | % | |||||||||||
| Gross profit | $ | 183,714 | $ | 170,554 | $ | 13,160 | 8 | % | ||||||||
| Gross Margin | 55.0 | % | 71.2 | % | (16.2 | )% | ||||||||||
| Total | ||||||||||||||||
| Net revenue | $ | 27,758,814 | $ | 27,160,302 | $ | 598,512 | 2 | % | ||||||||
| Cost of revenue | 21,530,973 | 19,772,589 | 1,758,384 | 9 | % | |||||||||||
| Gross profit | $ | 6,227,841 | $ | 7,387,713 | $ | (1,159,872) | (16) | % | ||||||||
| Gross Margin | 22.4 | % | 27.2 | % | (4.8) | % | ||||||||||
Oxytetracycline & Licorice products and TCMD
Cost of revenue was $12.1 million for the six months ended March 31, 2020, representing an increase of $1.0 million, or 9%, from $11 million for the six months ended March 31, 2019. With oxytetracycline products accounting for approximately 94.3% of the total sales of this entire segment, the increase in cost of revenue was primarily attributable to the significant increase in our oxytetracycline products’ production costs. The cost per unit for oxytetracycline products had increased by 10%, which was caused by a 2% increase in raw material price and 5% increase in labor cost during the six months ended March 31, 2020. The gross margin of this segment decreased from 27.2% for the six months ended March 31, 2019, to 22.4% for the six months ended March 31, 2020. Such a decrease in gross margin is primarily attributable to the increased production costs for our oxytetracycline products during the six months ended March 31, 2020.
Heparin products and Sausage casings
Cost of revenue was $9.3 million for the six months ended March 31, 2020, representing an increase of $0.7 million, or 7.6%, from $8.7 million for the six months ended March 31, 2019. This increase in cost of revenue was primarily attributable to a combined effect of a decrease in sales quantity and an increase in unit cost of our heparin products and sausage casings. Due to the combined effect of COVID-19 outbreak and African Swine fever in China, the general decrease in pig population and raw material supplies had caused a substantive increase in the unit cost of our heparin products and sausage casings. The Company’s market price for heparin products and sausage casings increased by 77% and 0%, respectively, during the six months ended March 31, 2020, as compared to the same period in 2019. The cost of revenue per unit for heparin products and sausage casings increased by 71% and 51%, respectively, during the six months ended March 31, 2020, as compared to the same period in 2019. The combined effect of a significant decrease in sausage casings’ margin and a substantive decrease in quantity sold from heparin products have led to a general decrease in gross margin of this segment from 18.4% during the six months ended March 31, 2019 to 12.7% during the same period in 2020.
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Fertilizer
Cost of revenue for our fertilizer products was approximately $150,000 for the six months ended March 31, 2020, representing an increase of approximately $81,000, or 117%, from approximately $69,000 for the six months ended March 31, 2019. The increase in cost of revenue was mainly due to an increased quantity in sales and increased cost of sales per unit for our fertilizer products. Average cost of sales per unit for our fertilizer products had increased by 77% for the six months ended March 31, 2020, as compared to the same period in 2019. Such increase was primarily attributable to significantly decreased supply of raw materials during the COVID-19 outbreak. Gross margin decreased by 16.2% from 71.2% for the six months ended March 31, 2019 to 55.0% for the six months ended March 31, 2020. During the six months ended March 31, 2020, the market prices of our fertilizer products increased by 30% while cost per unit increased by 77%, and the combined effect of market price increase and cost per unit increase had resulted a decrease in gross margin of our fertilizer products from 71.2% to 59%, as compared to the six months ended March 31, 2019.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $1.4 million for the six months ended March 31, 2020, representing a decrease of approximately $0.3 million, or 17%, from $1.7 million for the six months ended March 31, 2019. The decrease was mainly attributable to a decrease of $0.3 million in consulting and professional fees related to the Company’s initial public offering in the United States, which were not allowed to be capitalized according to U.S. GAAP, and a decrease of $0.1 million in advertising and promotion expenses during the COVID-19 outbreak.
Interest Expenses and Bank Charges
Interest expenses and bank charges are primarily generated from bank borrowings, including bank loans and banknotes payable. Interest expenses were approximately $110,000 and $104,000 for the six months ended March 31, 2020 and 2019, respectively.
Other Income (expense)
Other income (expense) is a netted account, which primarily consists of government grants, donations and contributions, and other non-operating incomes. Other income (expense) was $0.2 million for the six months ended March 31, 2020, as compared to $0.4 million for the six months ended March 31, 2019. Such decrease was due to a $0.2 million donation made during the COVID-19 outbreak.
Income taxes Provision
The income taxes provision decreased by $0.2 million, or 19%, from $0.9 million for the six months ended March 31, 2019 to that of $0.7 million for the same period in 2020 as a result of the Company’s decreased income before income tax provision. Income before income tax provision was $4.9 million for the six months ended March 31, 2020, as compared to $5.9 million for the six months ended March 31, 2019.
Net Income Attributable to Noncontrolling Interest
Net income attributable to non-controlling interest decreased by approximately $0.4 million, or 56%, from approximately $732,000 for the six months ended March 31, 2019 to approximately $325,000 for the six months ended March 31, 2020. Such decrease was attributable to a decrease in net income of Chengdu QLS, which is partially owned by non-controlling interest holders. Chengdu QLS’ net income decreased from $1.4 million for the six months ended March 31, 2019 to $0.9 million for the six months ended March 31, 2020. Chengdu QLS manufactures our heparin products and sausage casings. As discussed in the net revenue and gross profit sections, gross margin for Chengdu QLS decreased from 18.4% to 12.7% and was primarily attributable to the increased production cost of the Company’s heparin products. Such decrease in the gross margin had caused a decrease in Chengdu QLS’ net income.
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Net Income Attributable to the Company’s Shareholders
As a result of the various factors discussed in the “Net Income Attributable to Non-controlling Interest” section, the Company’s net income attributable to the Company’s shareholders decreased by $0.4 million, or 10%, from $4.3 million for the six months ended March 31, 2019 to $3.9 million for the six months ended March 31, 2020.
EBITDA
The following table sets forth of the calculation of the Company’s EBITDA:
| For the six months ended March 31, | Changes | |||||||||||||||
| 2020 | 2019 | Amount | % | |||||||||||||
| Net income | $ | 4,183,379 | $ | 5,024,301 | $ | (840,922 | ) | (17) | % | |||||||
| Interest expense | 110,251 | 104,282 | 5,969 | 6 | % | |||||||||||
| Income tax provision | 715,101 | 881,726 | (166,625 | ) | (19 | )% | ||||||||||
| Depreciation & Amortization | 577,860 | 600,119 | (22,259 | ) | (4 | )% | ||||||||||
| EBITDA | $ | 5,586,591 | $ | 6,610,428 | $ | (1,023,837 | ) | (15) | % | |||||||
| Percentage of EBITDA to revenue | 20.1 | % | 24.3 | % | (4.2 | )% | ||||||||||
The Company’s EBITDA was $5.6 million for the six months ended March 31, 2020, representing a decrease of $1.0 million, or 15%, from that of $6.6 million for the six months ended March 31, 2019. This was due to a decrease in net income caused by the Company’s decreased gross profit, which outweighs a decrease in income tax liability. The percentage of EBITDA to revenue was 20.1% and 24.3% for the six months ended March 31, 2020 and 2019, respectively.
Results of Operations for the years ended September 30, 2019 and 2018
The following table sets forth a summary of the Company’s consolidated results of operations for the years ended September 30, 2019 and 2018. The historical results presented below are not necessarily indicative of the results that may be expected for any future period.
| For the years ended | ||||||||||||||||
| September 30, | Changes | |||||||||||||||
| 2019 | 2018 | Amount | % | |||||||||||||
| Net revenue | $ | 46,096,684 | $ | 50,369,013 | $ | (4,272,329 | ) | (8 | )% | |||||||
| Cost of revenue | 36,416,772 | 42,236,773 | (5,820,001 | ) | (14 | )% | ||||||||||
| Gross profit | 9,679,912 | 8,132,240 | 1,547,672 | 19 | % | |||||||||||
| Selling, general and administrative expenses | 3,501,374 | 2,160,873 | 1,340,501 | 62 | % | |||||||||||
| Income from operations | 6,178,538 | 5,971,367 | 207,171 | 3 | % | |||||||||||
| Interest expense | (223,657 | ) | (216,187 | ) | (7,470 | ) | 3 | % | ||||||||
| Other income | 987,038 | 390,792 | 596,246 | 153 | % | |||||||||||
| Income before income tax provision | 6,941,919 | 6,145,972 | 795,947 | 13 | % | |||||||||||
| Provision for income taxes | 1,033,440 | 943,363 | 90,077 | 10 | % | |||||||||||
| Net income | 5,908,479 | 5,202,609 | 705,870 | 14 | % | |||||||||||
| Less: net income attributable to noncontrolling interest | 576,161 | 33,102 | 543,059 | 1,641 | % | |||||||||||
| Net income attributable to Qilian International Holding Group Limited | $ | 5,332,318 | $ | 5,169,507 | $ | 162,811 | 3 | % | ||||||||
Net Revenue
The following table sets forth the breakdown of the Company’s net revenue:
| For the years ended September 30, | ||||||||||||||||||||||||
| 2019 | 2018 | Changes | ||||||||||||||||||||||
| Amount | % | Amount | % | Amount | % | |||||||||||||||||||
| Net revenue | ||||||||||||||||||||||||
| Oxytetracycline & Licorice products and TCMD | $ | 30,149,950 | 65 | % | $ | 33,429,330 | 66 | % | $ | (3,279,380 | ) | (10 | )% | |||||||||||
| Heparin products and Sausage casing | $ | 15,397,503 | 33 | % | $ | 16,225,787 | 32 | % | $ | (828,285 | ) | (5 | )% | |||||||||||
| Fertilizer | $ | 549,231 | 2 | % | $ | 713,896 | 2 | % | $ | (164,664 | ) | (23 | )% | |||||||||||
| Total | $ | 46,096,684 | 100.0 | % | $ | 50,369,013 | 100.0 | % | $ | (4,272,329 | ) | (8 | )% | |||||||||||
Compared with net revenue for the year ended September 30, 2018, the Company’s net revenue decreased by $4.3 million, or an 8% decrease, for the year ended September 30, 2019, which was primarily attributable to a $3.3 million decrease in sales from oxytetracycline products and licorice products, and a $0.8 million decrease in sales from heparin products and sausage casings.
44
Oxytetracycline & Licorice products and TCMD
For the year ended September 30, 2019, our sales for oxytetracycline products, licorice products and TCMD decreased by approximately $3.3 million, or 10%, from approximately $33.4 million for the year ended September 30, 2018 to approximately $30.1 million for the year ended September 30, 2019. The sales of oxytetracycline products, licorice products and TCMD accounted for 96%, 4% and 0%, respectively, of this segment’s total sales for the year ended September 30, 2019, and 96.1%, 3.8% and 0.1%, respectively, of such segment’s total sales for the year ended September 30, 2018. The decrease in sales in this segment is due to the following reasons: first, the exchange rate of the RMB against the US dollar decreased from 6.54 in 2018 to 6.87 in 2019, causing the sales denominated in US dollar to decrease by approximately $1.7 million; second, the Company conducted its scheduled facility maintenance from July 2019 to September 2019, which resulted in reduced oxytetracycline production by approximately 360 tons (a 19% decrease from that of fiscal year 2018). However, such decrease in production was partially offset by a 12% increase in the sale price of our oxytetracycline products as compared to fiscal year 2018. As a result, the sales revenues of our oxytetracycline products for the fiscal year ended June 30, 2019 decreased by approximately $1.6 million as compared to fiscal year ended June 30, 2018. Our sales for licorice products decreased by approximately $0.16 million, or 16.7%, from approximately $0.96 million for the year ended September 30, 2018 to approximately $0.8 million for the year ended September 30, 2019. Our sales for TCMD products decreased by $6,589, or 16.7%, from $11,735 for the year ended September 30, 2018 to $5,146 for the year ended September 30, 2019.
Heparin products and Sausage casings
Sales from heparin products decreased by $0.8 million, or a 5% decrease, from $16.2 million for the year ended September 30, 2018, to $15.4 million for the year ended September 30, 2019. The decrease of $0.76 was mainly caused by the exchange rate of the RMB against the US dollar decreasing from 6.54 in 2018 to 6.87 in 2019. The sales denominated in RMB for these periods were stable. Due to the outbreak and ongoing spread of African Swine fever in China since November 2018, the decrease of pig population caused a dramatic decrease in our production quantity of Heparin products and sausage casings while the price of these products increased dramatically. As a result, although the sales quantity of heparin product and sausage casing for the year ended September 30, 2019 decreased by 54% and 15%, respectively, from the year ended September 30, 2018, the fluctuation of total revenue denominated in RMB was insignificant as the price of these products increased by 84% and 42%, respectively.
Fertilizer
Sales from fertilizer decreased by $0.2 million, or a 23% decrease, from $0.7 million for the year ended September 30, 2018 to $0.5 million for the year ended September 30, 2019. Sales quantity has decreased by 8% and sales price decreased by 12%. The decrease in our fertilizers’ sales was due to unusual weather conditions in Tibet, where a majority of our customers of fertilizer products are located. More specifically, Tibet experienced the coldest days in 19 years from December 2018 to February 2019 while the average precipitations during that time were the highest in 39 years. Such unusual weather conditions significantly interfered with Tibetan’s local cultivation activities and caused the area’s demand for fertilizer products to decrease in general during the Company’s 2019 fiscal year.
Cost of Revenue and Gross Profit
The following tables set forth the calculation of gross profit and gross margin for the each of the Company’s segments:
| For the years ended September 30, | Changes | |||||||||||||||
| 2019 | 2018 | Amount | % | |||||||||||||
| Oxytetracycline & Licorice products and TCMD | ||||||||||||||||
| Net revenue | $ | 30,149,950 | $ | 33,429,330 | $ | (3,279,380 | ) | (10 | )% | |||||||
| Cost of revenue | 22,324,422 | 26,159,584 | (3,835,162 | ) | (15 | )% | ||||||||||
| Gross profit | $ | 7,825,528 | $ | 7,269,746 | $ | 555,782 | 8 | % | ||||||||
| Gross Margin | 26.0 | % | 21.7 | % | 4.3 | % | ||||||||||
| Heparin products and Sausage casing | ||||||||||||||||
| Net revenue | $ | 15,397,503 | $ | 16,225,787 | $ | (828,284 | ) | (5 | )% | |||||||
| Cost of revenue | 13,905,846 | 15,841,870 | (1,936,024 | ) | (12 | )% | ||||||||||
| Gross profit | $ | 1,491,657 | $ | 383,917 | $ | 1,107,740 | 289 | % | ||||||||
| Gross Margin | 9.7 | % | 2.4 | % | 7.3 | % | ||||||||||
| Fertilizer | ||||||||||||||||
| Net revenue | $ | 549,231 | $ | 713,896 | $ | (164,665 | ) | (23 | )% | |||||||
| Cost of revenue | 186,504 | 235,319 | (48,815 | ) | (21 | )% | ||||||||||
| Gross profit | $ | 362,727 | $ | 478,577 | $ | (115,850 | ) | (24 | )% | |||||||
| Gross Margin | 66.0 | % | 67.0 | % | (1.0 | )% | ||||||||||
| Total | ||||||||||||||||
| Net revenue | $ | 46,096,684 | $ | 50,369,013 | $ | (4,272,329 | ) | (8 | )% | |||||||
| Cost of revenue | 36,416,772 | 42,236,773 | (5,820,001 | ) | (14 | )% | ||||||||||
| Gross profit | $ | 9,679,912 | $ | 8,132,240 | $ | 1,547,672 | 19 | % | ||||||||
| Gross Margin | 21.0 | % | 16.1 | % | 4.9 | % | ||||||||||
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Oxytetracycline & Licorice products and TCMD
Cost of revenue was $22.3 million for the year ended September 30, 2019, a decrease of $3.9 million, or 15%, from $26.2 million for the year ended September 30, 2018, which was primarily attributable to a $3.3 million, or 10%, decrease in sales for this segment. Gross margin increased from 21.7% to 26.0% primarily due to the increased market price of oxytetracycline products in 2019. Due to local governments’ increasingly strict enforcement of environmental regulations, manufacturers in general are gradually upgrading manufacturing facilities to better comply with environmental regulations and we observed a significant decrease in supply from 2018 to 2019. As our oxytetracycline sales price increased by 13% compared to 2018, the overall gross margin of this segment increased to 26.0%.
Heparin products and Sausage casings
Cost of revenue was $13.9 million for the year ended September 30, 2019, a decrease of $1.9 million, or 12%, from $15.8 million for the year ended September 30, 2018. This was primarily attributable to a combined effect of a decrease in sales quantity and an increase in unit cost of our Heparin products and sausage casings. Due to the outbreak and ongoing spread of African Swine fever in China since November 2018, the decrease of pig population caused an increase in the unit cost of our Heparin products and sausage casings while the price of these products increased dramatically. The Company’s sales price for heparin products and sausage casing increased by 84% and 42%, while the cost of revenue per unit only increased by 82% and 16%, respectively. Since the increase in the selling price of heparin products and sausage casings was higher than the increase in the cost of revenue per unit, the gross margin of heparin products and sausage casings increased from 2.4% to 9.7%.
Fertilizer
Cost of revenue for our fertilizer products was approximately $187,000 for the year ended September 30, 2019, a decrease of approximately $49,000, or 21%, from approximately $235,000 for the year ended September 30, 2018. The decrease in cost of revenue was mainly due to our decreased sales quantity in fertilizer products and relatively consistent cost of sales per unit. Gross margin decreased by 1% from 67% for the year ended September 30, 2018 to that of 66% for the year ended September 30, 2019. The decrease in gross margin was mainly due to a 12% decrease in selling price and a relatively consistent cost of sales per unit. The Company’s fertilizer customers are individual customers located in Tibet. Tibet experienced the coldest days in 19 years from December 2018 to February 2019 while the average precipitations during that time were the highest in 39 years. Such unusual weather conditions significantly interfered with Tibetan’s local cultivation activities and caused the area’s demand for fertilizer products to decrease in general during the Company’s 2019 fiscal year.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $3.5 million for the year ended September 30, 2019, an increase of approximately $1.3 million, or 62%, from $2.2 million for the year ended September 30, 2018. The increase was mainly attributable to: (a) an increase of approximately $1.0 million in consulting and professional fees related to the Company’s effort to go public which were not allowed to be capitalized in accordance with the U.S. GAAP, and (b) an increase of $0.3 million in advertising and promotion expenses for our sales.
Interest Expenses and Bank Charges
Interest expenses and bank charges are primarily generated from bank borrowings including bank loans and banknotes payable. Interest expenses were approximately $224,000 and $216,000 for the years ended September 30, 2019 and 2018, respectively.
46
Other Income
Other income primarily consists of government grants and other non-operating incomes. Other income was $1.0 million for the year ended September 30, 2019 as compared to $0.4 million for the year ended September 30, 2018, representing an increase of $0.4 million in government grants, an increase of $0.1 million in investment income attributable to equity investment, and a decrease in loss of approximately $0.1 million from marketable securities incurred in 2018 from marketable securities which were sold.
Income taxes Provision
Provision for income taxes increased by $0.1 million, or 10%, from $0.9 million for the year ended September 30, 2018 to $1.0 million for the year ended September 30, 2019, as a result of the increased income before income tax provision. Income before income tax provision was $6.9 million for the year ended September 30, 2019, compared to $6.1 million for the year ended September 30, 2018.
Net Income Attributable to Non-controlling interest
Net income attributable to non-controlling interest increased by approximately $0.5 million, or 1,641%, from approximately $33,000 for the year ended September 30, 2018 to approximately $576,000 for the year ended September 30, 2019, as a result of the increase of net income of Chengdu QLS, which is partially owned by non-controlling interest holders. Chengdu QLS experienced a net loss of approximately $90,000 for the year ended September 30, 2018; and it experienced a net income of approximately $1.0 million for the year ended September 30, 2019. Its non-controlling shareholders’ ownership decreased from 48.57% as of September 30, 2018 to 28.25% starting from March 21, 2019. Chengdu QLS manufactures our heparin products and sausage casings. As discussed in the net revenue and gross profit sections, due to the increased sales price and decreased sales quantity of our heparin products and sausage casings, revenue from heparin products and sausage casing remained stable and their gross margin increased from 2.4% to 9.7%. Therefore, Chengdu QLS turned from net loss in 2018 into net income in 2019.
Net Income Attributable to the Company’s Shareholders
As a result of the above, the Company’s net income attributable to the Company’s shareholders increased by $0.1 million, or 3%, from $5.2 million for the year ended September 30, 2018 to $5.3 million for the year ended September 30, 2019.
EBITDA
The following table sets forth of the calculation of the Company’s EBITDA:
| For the years
ended September 30, | Changes | |||||||||||||||
| 2019 | 2018 | Amount | % | |||||||||||||
| Net income | $ | 5,908,479 | $ | 5,202,609 | $ | 705,870 | 14 | % | ||||||||
| Interest expense | 223,657 | 216,187 | 7,470 | 3 | % | |||||||||||
| Income tax provision | 1,033,440 | 943,363 | 90,077 | 10 | % | |||||||||||
| Depreciation & Amortization | 1,188,173 | 1,254,098 | (65,925 | ) | (5 | )% | ||||||||||
| EBITDA | $ | 8,353,749 | $ | 7,616,257 | $ | 737,492 | 10 | % | ||||||||
| Percentage of EBITDA to revenue | 18.1 | % | 15.1 | % | 3 | % | ||||||||||
The Company’s EBITDA was $8.4 million for the year ended September 30, 2019, an increase of $0.7 million, or 10%, compared to $7.6 million for the year ended September 30, 2018. This was mainly due to an increase in net income resulting from increased gross profit and an increase in other income, offset by an increase in selling and administrative expenses. The percentage of EBITDA to revenue was 18.1% and 15.1% for the years ended September 30, 2019 and 2018, respectively.
47
Liquidity and Capital Resources
As of March 31, 2020, the Company had cash of approximately $11.8 million. The Company has funded its working capital and other capital requirements primarily by equity contribution from shareholders, cash flow from operations, and bank loans. Cash was used to pay for inventory, salaries, selling expenses, rental expenses, income taxes, other operating expenses, and repay debts.
Although the Company’s management believes that the cash generated from operations will be sufficient to meet its normal working capital needs for at least the next twelve months, its ability to repay its current obligations will depend on the future realization of its current assets. The Company’s management has considered the historical experience, the economy, trends in the pharmaceutical industry, the expected collectability of accounts receivable and the realization of the inventories as of March 31, 2020. Based on these considerations, the Company’s management believes that the Company has sufficient funds to meet its working capital requirements and debt obligations as they become due for at least the next twelve months from the financial reporting release date. However, there is no assurance that management will be successful in their plan. There are a number of factors that could potentially arise and result in shortfalls to the Company’s plan, such as the demand for its products, economic conditions, the competitive pricing in the industry and its banks and suppliers being able to provide continued supports. If the future cash flow from operations and other capital resources are insufficient to fund its liquidity needs, the Company may be forced to reduce or delay its expected acquisition plan, sell assets, obtain additional debt or equity capital or refinance all or a portion of its debt.
The following table summarizes the Company’s cash flow data for the six months ended March 31, 2020 and 2019:
| For the six months ended March 31, | ||||||||
| 2020 | 2019 | |||||||
| Net cash provided by (used in) operating activities | $ | 5,293,283 | $ | (2,173,232) | ||||
| Net cash used in investing activities | (167,446 | ) | (577,366 | ) | ||||
| Net cash provided by financing activities | 2,139,007 | 159,132 | ||||||
| Effect of exchange rate on cash | (47,347 | ) | 108,421 | |||||
| Net increase (decrease) in cash and cash equivalents | $ | 7,217,497 | $ | (2,483,045 | ) | |||
Operating Activities
Net cash provided by operating activities consists primarily of net income adjusted for non-cash items, including depreciation and amortization, accounts receivable and inventory reserve, and adjusted for the effect of working capital changes. Net cash provided by operating activities was approximately $5.3 million for the six months ended March 31, 2020, an increase of $7.5 million cash provided by operating activities, or 344%, compared to net cash used in operating activities of $2.2 million for the year six months ended March 31, 2019. The increase was a result of increase in working capital from inventory for $3.9 million, advance from customers for $1.6 million, bank notes receivable of $2.4 million, and tax payable of $0.8 million, offset by decrease of net income of $0.8 million and change of working capital mainly resulting from the change in accrued expense of $0.5 million and advances to supplies of $0.3 million.
Investing Activities
Net cash used in investing activities was approximately $0.2 million for the six months ended March 31, 2020, a decrease of $0.4 million, or 71%, compared to $0.6 million net cash used in investing activities for the six months ended March 31, 2019. The decrease was mainly due to the decrease of cash paid for the purchase of property and equipment of $0.3 million.
Financing Activities
Net cash provided by financing activities was approximately $2.1 million for the six months ended March 31, 2020, an increase of $1.9 million, or 1244%, compared to $0.2 million for the six months ended March 31, 2019. The increase was a result of a $2.1 million increase in bank loan proceeds, offset by a $0.3 million decrease in notes payable payment.
The following table summarizes the Company’s cash flow data for the years ended September 30, 2019 and 2018:
| For the years
ended September 30, | ||||||||
| 2019 | 2018 | |||||||
| Net cash (used in) provided by operating activities | $ | (580,197 | ) | $ | 4,438,015 | |||
| Net cash used in investing activities | (666,629 | ) | (1,386,080 | ) | ||||
| Net cash provided by (used in) financing activities | 373,650 | (3,116,213 | ) | |||||
| Effect of exchange rate on cash | (157,163 | ) | (181,798 | ) | ||||
| Net decrease in cash and cash equivalents | $ | (1,030,339 | ) | $ | (246,076 | ) | ||
Operating Activities
Net cash provided by operating activities consists primarily of net income adjusted for non-cash items, including depreciation and amortization, accounts receivable and inventory reserve, and adjusted for the effect of working capital changes. Net cash used in operating activities was approximately $0.6 million for the year ended September 30, 2019, a decrease of $5.0 million cash provided by operating activities, or 113%, compared to net cash provided by operating activities of $4.4 million for the year ended September 30, 2018. The decrease was a result of decrease in working capital from inventory for $6.3 million, advance from customers for $2.0 million, and tax payable of $1.5 million, offset by $4.7 million from increase of net income of $0.7 million and change of working capital mainly resulting from the change in accounts receivable of $1.8 million, bank notes receivable of $0.8 million, accounts payable of $0.8 million and advances to supplies of $0.6 million.
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Investing Activities
Net cash used in investing activities was approximately $0.7 million for the year ended September 30, 2019, a decrease of $0.7 million, or 52%, compared to $1.4 million net cash used in investing activities for the year ended September 30, 2018. The decrease was mainly due to the decrease of cash paid for the purchase of property and equipment of $0.5 million and payment made for long-term investment of $0.2 million.
Financing Activities
Net cash provided by financing activities was approximately $0.4 million for the year ended September 30, 2019, an increase of $3.5 million, or 112%, compared to $3.1 million for the year ended September 30, 2018. The increase was a combined result of a $3.0 million increase in bank loan proceeds, a $0.5 million decrease in notes payable payment, and a $0.7 million decrease in payment made for the cash dividend to shareholders, offset by a $0.2 million decrease in capital contribution from shareholders, and an increase of $0.1 million in cash payment for acquisition of noncontrolling interest for $0.1 million.
Commitments and Contractual Obligations
The following table presents the company’s material contractual obligations as of March 31, 2020:
| Contractual Obligations | Total | Less
than 1 year | 1-3 years | 3-5 years | More than | |||||||||||||||
| Bank loans | $ | 7,052,584 | $ | 7,052,584 | $ | — | $ | — | $ | — | ||||||||||
| Operating lease | $ | 121,868 | $ | 60,934 | $ | 60,934 | $ | — | $ | — | ||||||||||
| Total | $ | 7,174,452 | $ | 7,113,518 | $ | 60,934 | $ | — | $ | — | ||||||||||
Off -balance Sheet Arrangements
The Company is not a party to any off -balance sheet arrangements.
Critical Accounting Policies
The discussion and analysis of the Company’s financial condition and results of operations are based upon its financial statements, which have been prepared in accordance with GAAP. These principles require the Company’s management to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, cash flow and related disclosure of contingent assets and liabilities. The estimates include, but are not limited to, accounts receivable, revenue recognition, inventory realization, impairment of long-lived assets and income taxes. The Company bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances. Actual results may differ from these estimates. To the extent that there are material differences between these estimates and the actual results, future financial statements will be affected.
The Company’s management believes that among their significant accounting policies, which are described in Note 2 to the audited consolidated financial statements of the Company included in this prospectus, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, the Company’s management believes these are the most critical to fully understand and evaluate its financial condition and results of operations.
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Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions. Such estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company’s critical accounting estimates included, but are not limited to: allowance for estimated uncollectible receivables, inventory valuations, impairment of long-lived assets, impairment of intangible assets, and income taxes. Actual results could differ from those estimates.
Accounts receivable, net
Accounts receivable are recognized and carried at original invoiced amount less an estimated allowance for uncollectible accounts. The Company usually grants credit to customers with good credit standing with a maximum of 90 days and determines the adequacy of reserves for doubtful accounts based on individual account analysis and historical collection trends. The Company establishes a provision for doubtful receivables when there is objective evidence that the Company may not be able to collect amounts due. The allowance is based on management’s best estimates of specific losses on individual exposures, as well as a provision on historical trends of collections. The provision is recorded against accounts receivables balances, with a corresponding charge recorded in the consolidated statements of income and comprehensive income. Actual amounts received may differ from management’s estimate of credit worthiness and the economic environment. Delinquent account balances are written-off against the allowance for doubtful accounts after management has determined that the likelihood of collection is not probable. As of March 31, 2020 and September 30, 2019, the allowances for doubtful accounts were $16,288 and $10,796, respectively.
Inventories, net
Inventories are stated at the lower of cost or market value. Costs include the cost of raw materials, freight, direct labor and related production overhead. The cost of inventories is calculated using the weighted average method. Any excess of the cost over the net realizable value of each item of inventories is recognized as a provision for diminution in the value of inventories. Net realizable value is the estimated selling price in the normal course of business less any costs to complete and sell products.
Revenue recognition
On October 1, 2018, the Company adopted Accounting Standards Update (“ASU”) 2014-09 Revenue from Contracts with Customers (FASB ASC Topic 606) using the modified retrospective method for contracts that were not completed as of October 1, 2018. The results of applying Topic 606 using the modified retrospective approach were insignificant and did not have a material impact on our consolidated balance sheets, statement of income, cash flows, business process, controls or systems.
The core principle underlying the revenue recognition ASU is that the Company will recognize revenue to represent the transfer of goods and services to customers in an amount that reflects the consideration to which the Company expects to be entitled in such exchange. This will require the Company to identify contractual performance obligations and determine whether revenue should be recognized at a point in time or over time, based on when control of goods and services transfers to a customer. The majority of our contracts have one single performance obligation as the promise to transfer the individual goods is not separately identifiable from other promises in the contracts and is, therefore, not distinct. The Company’s revenue streams are recognized at a point in time when title and risk of loss passes and the customer accepts the goods, which generally occurs at delivery. Our products is sold with no right of return and we do not provide other credits or sales incentive, which are accounted for as variable consideration. Sales taxes invoiced to customers and remitted to government authorities are excluded from net sales.
The contract assets and contract liabilities are recorded on the consolidated balance sheets as accounts receivable and advance from customers as of March 31, 2020 and September 30, 2019. For the six months ended March 31, 2020 and 2019, revenue recognized from performance obligations related to prior periods was insignificant.
Impairment of Long-lived Assets
The Company assesses its long-lived assets such as property and equipment for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Factors which may indicate potential impairment include a significant underperformance related to the historical or projected future operating results or a significant negative industry or economic trend. Recoverability of these assets is measured by comparison of their carrying amounts to future undiscounted cash flows the assets are expected to generate. If property and equipment are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the assets exceeds their fair value.
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Income taxes
The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, we determine deferred tax assets and liabilities on the basis of the differences between the financial statement and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.
The Company recognizes deferred tax assets to the extent that we believe that these assets are more likely than not to be realized. In making such a determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of recent operations. If we determine that we would be able to realize our deferred tax assets in the future in excess of their net recorded amount, we would make an adjustment to the deferred tax asset valuation allowance, which would reduce the provision for income taxes.
The Company records uncertain tax positions in accordance with ASC 740 on the basis of a two-step process in which (1) we determine whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority. The Company does not believe that there was any uncertain tax position at March 31, 2020 and September 30, 2019.
Recent accounting pronouncements
In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 requires companies to measure credit losses utilizing a methodology that reflects expected credit losses and requires a consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including those interim periods within those fiscal years. The Company is currently assessing the impact of adopting this standard, but based on a preliminary assessment, does not expect the adoption of this guidance to have a material impact on its condensed consolidated financial statements.
In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement,” to improve the effectiveness of disclosures in the notes to financial statements related to recurring or nonrecurring fair value measurements by removing amounts and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, policies for timing of transfers between different levels for fair value measurements, and the valuation processes for Level 3 fair value measurements. The new standard requires disclosure of the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The amendments in this update are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company does not expect that the adoption of this ASU will have a material impact on its financial statements.
Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
We are exposed to interest rate risk while we have short-term bank loans outstanding. Although interest rates for our short-term loans are typically fixed for the terms of the loans, the terms are typically twelve months and interest rates are subject to change upon renewal.
Credit Risk
Credit risk is controlled by the application of credit approvals, limits and monitoring procedures. We manage credit risk through in-house research and analysis of the Chinese economy and the underlying obligors and transaction structures. We identify credit risk collectively based on industry, geography and customer type. In measuring the credit risk of our sales to our customers, we mainly reflect the “probability of default” by the customer on its contractual obligations and consider the current financial position of the customer and the current and likely future exposures to the customer.
Liquidity Risk
We are also exposed to liquidity risk which is risk that it we will be unable to provide sufficient capital resources and liquidity to meet our commitments and business needs. Liquidity risk is controlled by the application of financial position analysis and monitoring procedures. When necessary, we will turn to other financial institutions and related parties to obtain short-term funding to cover any liquidity shortage.
Foreign Exchange Risk
While our reporting currency is the U.S. dollar, almost all of our consolidated revenues and consolidated costs and expenses are denominated in RMB. All of our assets are denominated in RMB. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between the U.S. dollar and RMB. If the RMB depreciates against the U.S. dollar, the value of our RMB revenues, earnings and assets as expressed in our U.S. dollar financial statements will decline. We have not entered into any hedging transactions in an effort to reduce our exposure to foreign exchange risk.
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Unless otherwise noted, all the information and data presented in this section have been derived from an August 2020 industry report from Frost & Sullivan (Beijing) Inc., Shanghai Branch Co. (“Frost & Sullivan”) entitled “The PRC Pharmaceutical Industry Independent Market Research” (the “Frost & Sullivan Report”). Frost & Sullivan has advised us that the statistical and graphical information contained herein is drawn from its database and other sources. The following discussion projections for future growth, which may not occur at the rates that are projected or at all.
OVERVIEW OF THE MACROECONOMIC ENVIRONMENT IN THE PRC
Nominal GDP and Nominal GDP per Capita
Source: International Monetary Fund, National Bureau of Statistics of China, Frost & Sullivan Report
According to the International Monetary Fund, during the past five years, total nominal gross domestic product (“GDP”) in the PRC rose from RMB64.7 trillion in 2014 to RMB98.9 trillion in 2019, representing a compound annual growth rate (“CAGR”) of approximately 8.8%. The growth was mainly due to the favorable government policies stimulating the development of the domestic economy. Further, with the economic reform from an investment-driven economy to a consumption-driven economy, the nominal GDP in the PRC is expected to increase with a CAGR of approximately 7.6% from 2020 to 2024. In line with the rapid growth of the nominal GDP, nominal GDP per capita in the PRC was RMB70,892.0 in 2019, representing a CAGR of 8.4% from 2014.
Population and Urbanization Rate
Source: National Bureau of Statistics of China, Frost & Sullivan Report
According to the National Bureau of Statistics of China, rapid economic growth in the PRC has supported the urbanization process from 2014 to 2018. The urban population rose from 742.7 million in 2014 to 848.5 million in 2019, with a CAGR of approximately 2.7%. The urbanization rate increased from 54.3% to 60.6% during the same period. With the issue of “The National Plan of New-type Urbanization (2014-2020)” in 2014, the urbanization is expected to rise further from 2020 to 2024. The increasing population implies steady demand for pharmaceutical products in the PRC, which will further stimulate the growth of the market.
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Population Aged 65 years or Older
Source: National Bureau of Statistics of China, Frost & Sullivan Report
With the increasing life expectancy and “One Child Policy” from 1980 to 2016 in the PRC, population is aging rapidly with people aged 65 or above reaching 176.0 million in 2019 with a CAGR of approximately 5.1% from 2014, per the National Bureau of Statistics of China. It is expected that the population aged 65 or above will grow at a CAGR of approximately 5.2% to 226.6 million by the end of 2024, accounting for 15.9% of the total population in the PRC. As a result, it is expected that the aging society will support the demand for pharmaceutical products including oxytetracycline products and compound licorice products in the PRC.
OVERVIEW OF THE PHARMACEUTICAL MARKET IN THE PRC
Manufacturing Process of Pharmaceutical Products
Source: Frost & Sullivan Report
Major raw materials for pharmaceutical manufacturing include chemicals, animal and plant tissues, which will be used to derive pharmaceutical intermediates. The production of pharmaceutical intermediates will employ natural and biochemical processes, including fermentation, synthesis and extraction. Afterwards, pharmaceutical intermediates will be purified and concentrated to active pharmaceutical ingredients (API), which will be used to produce final pharmaceutical products through proportioning and packaging approved and registered with National Medical Products Administration (NMPA).
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Value Chain Analysis
Note: The Company is a vertically integrated pharmaceutical and chemical company supplying both API and pharmaceutical products.
Source: Frost & Sullivan Report
The value chain of the pharmaceutical market in the PRC consists of upstream, midstream and downstream participants. The upstream of the pharmaceutical market in the PRC mainly involves suppliers of chemicals, animal and plant tissues and etc., and API manufacturers who produce and sell active pharmaceutical ingredients (APIs). Pharmaceutical manufacturers and pharmaceutical product distributors, as being the midstream along the value chain, manufacture and distribute final pharmaceutical products to downstream consumers. Downstream healthcare consumers can purchase pharmaceutical products from medical service providers including hospitals, clinics and etc.
Market Size Analysis
Note: Oxytetracycline and compound licorice are categorized as chemical medicines.
Source: National Bureau of Statistics of China, Frost & Sullivan Report
In October 25 2016, the State Council of the PRC issued the “Health China 2030 Planning Outline”, as a guideline for the PRC government to establish universal health care (UHC). From 2014 to 2018, the total output volume of chemical medicines in the PRC rose from 3,034.0 thousand tons in 2014 to 3,554.4 thousand tons in 2017. Total output volume experienced a fall in both 2018 and 2019, reaching 2,523.0 thousand tons by the end of 2019. The fall was primarily due to the increasingly stringent regulations on environmental protection and pollution management. Looking forward, with a series of supportive government policies including the Belt and Road Initiative and rising demand for pharmaceutical products driven by the outbreak of COVID-19 and aging population, the total output volume of chemical medicines in the PRC is expected to reach 3,797.0 thousand tons in 2024, with a CAGR of approximately 7.4% from 2020, according to the National Bureau of Statistic of China and the Frost & Sullivan Report.
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Source: Ministry of Industry and Information Technology of China, Frost & Sullivan Report
The pharmaceutical market in the PRC started to play an increasingly large role in the global market supply, particularly in relation to active pharmaceutical ingredients (APIs). Attributed to the lower cost structure for rent, labor, materials and equipment, and the easy access to a wide variety of intermediates and chemicals, the API market in the PRC grew significantly during the past five years. According to the Ministry of Industry and Information Technology of China, during the period from 2014 to 2018, revenue generated from manufacturing of active pharmaceutical ingredients grew with a CAGR of approximately 10.7% from RMB424.0 billion in 2014 to RMB669.4 billion in 2019. With the increasing demand from downstream manufacturers of chemical medicines, it is expected that the revenue from the manufacturing of active pharmaceutical ingredients) will reach RMB1,074.8billion in 2024, representing a CAGR of approximately 9.9%.
Overview of Compound Licorice Products
Licorice is the root of the Glycyrrhiza glabra plant and a type of traditional Chinese medicine which is widely accepted by Chinese people. Its main functions consist of expelling heat from the body, detoxifying, and relieving cough. It has been used in traditional Chinese medicine and food preparation through procedures including drying, slicing, grinding and extracting. Compound licorice product is a type of Chinse medicine and has been frequently used as an antitussive and expectorant medicine with wide applications in clinics for years. Compound licorice products on the market are usually sold in liquid or solid forms. Compound licorice tablet is favored by a number of Chinese patients given its curative effectiveness and low price.
Growing areas for Glycyrrhiza glabra in the PRC are mainly located in the northwestern arid regions of the PRC, such as Xinjiang, Inner Mongolia, Ningxia, Gansu and Shanxi. The supply of licorice from these regions is relatively stable with increasing yield over the past few years, which is expected to support the continuous development of compound licorice in the PRC in the next five years.
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Source: Frost & Sullivan Report
Supported by the stable market demand, the issue of Development Plan for Traditional Chinese Medicine under Belt and Road Initiative (《中医药“一带一路”发展规划( 2016-2020) 》) and the problem of an aging population, according to Frost & Sullivan Report, production volume of compound licorice products recorded 8.0 thousand tons in 2019 with a CAGR of approximately 3.7% from 2014. In the next five years, with the expansion of the National Medical Insurance Coverage Program to cover additional compound licorice products, the market demand for compound licorice products is expected to grow continuously. It is expected that the production volume of compound licorice products will grow at a CAGR of approximately 4.5% from 8.5 thousand tons in 2020 to 10.1 thousand tons in 2024.
Overview of Oxytetracycline Products
Oxytetracycline (C22H24N2O9), a tetracycline derivative generated by streptomyces rimosus, is a broad-spectrum antibiotic designed to prevent infections that occur due to bacterial invasion in the body. It is widely used in human and animal medicine, and as a pesticide. Oxytetracycline can be used as an antibacterial medicine for human diseases to treat a host of bacterial infections, including acute otitis media infection, pharyngitis, pneumonia, skin infection, trachoma, and etc. The use of oxytetracycline in stock farming for preventing and controlling bacterial pathogens including gram-positive and gram-negative bacteria, eperythrozoon, chlamydia, mycoplasma, rickettsia, spirochete, actinobacteria, vibrio, and etc. is frequent in the PRC. Meanwhile, the byproducts generated during the fermentation of Oxytetracycline can also be used as raw materials for the production of organic fertilizers.
Source: Frost & Sullivan Report
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The rising number of people aged 65 or above and the end of “One Child Policy” in 2016 have stimulated the market demand for oxytetracycline products in the PRC. According to the Frost & Sullivan Report, production volume of oxytetracycline has increased from 25.4 thousand tons in 2014 to 28.5 thousand tons in 2019, representing a CAGR of approximately 2.3%. Given the low price of oxytetracycline products, its effectiveness in enhancing disease resistance and preventing pathogens, and its use as an environmentally-friendly raw material for organic fertilizer, it is expected that the demand for oxytetracycline product will rise, driving the steady growth of the production volume of oxytetracycline in the PRC. It is forecasted that the production volume of oxytetracycline will attain 32.7 thousand tons by the end of 2024, representing a CAGR of approximately 2.8% from 2020.
Raw material used to produce oxytetracycline refers to corn starch which is the starch derived from corn. According the National Bureau of Statistics of China (NBS), from 2014 to 2019, producer price index for corn in the PRC decreased from 100.0 in 2014 to 87.2 in 2019, representing a CAGR of approximately -2.7% during the period. There was a slight increase in the price of corn from 81.3 in 2017 to 87.2 in 2019. The rise from 2017 to 2019 was mainly due to policy control on corn planting and imbalance between supply and demand in the PRC.
Source: National Bureau of Statistics of China, Frost & Sullivan Report
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Overview of Heparin Sodium Products
Heparin is one of the most widely used anticoagulants to prevent and treat thrombosis, and is usually used in the treatment of heart attack and unstable angina. Standard heparin has been commonly used for the prevention and treatment of venous thromboembolism (VTE). Various heparin products are manufactured and marketed in the PRC, including heparin calcium, heparin sodium, and etc. Heparin sodium, among all heparin products, is used in preventing conditions caused by blood coagulation and widely used in the world.
Pharmaceutical-grade heparin is usually obtained from mucosal tissues, such as pig intestines and cow lungs. Pig intestine mucosa is currently the most accepted or even the only approved raw material for producing heparin in most of the world. The PRC is one of the largest countries for the production and consumption of pigs. According to National Bureau of Statistics, in 2019, total number of pigs slaughtered and number of pig stock reached 544.2 million and 310.4 million respectively. Benefiting from the abundant supply of raw materials for the production of heparin in the PRC, it is expected that the overall heparin market in the PRC will maintain steady growth in the future.
The manufacturing process of crude heparin sodium can be roughly divided into five stages which are illustrated in the following diagram.
Source: Frost & Sullivan Report
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Market Drivers
Rising healthcare awareness. Due to the continuous economic growth and the increasing number of aging population, a larger number of consumers in the PRC are paying closer attention to healthcare and pharmaceutical products. With the rise in total expenditure in healthcare and better access to pharmaceutical products in the PRC, the pharmaceutical market in the PRC kept expanding during the past few years. Further, with the healthcare reform and the implementation of the 13th Five-Year Plan, healthcare expenditure in the PRC is expected to grow continuously in the next five years.
Supportive governmental policies. Recently, the implementation of supportive governmental policies has been stimulating the sales growth of the pharmaceutical market in the PRC. As stated in the “State Council’s opinion on consolidation of basic medical insurance systems for residents in urban and rural areas” (国务院关于整合城乡居民基本医疗保险制度的意见) in 2016, the number of pharmaceutical products that can be reimbursed in rural public medical insurance programs match those in urban public medical insurance programs by 2017. The reimbursement provided by the PRC government is expected to support the future development of pharmaceutical market. Further, manufacturing of oxytetracycline product and compound licorice is expected to grow continuously, supported by the Outline for the Strategic Development of Chinese Medicine (2016-2030) (《中医药发展战略规划纲要( 2016-2030) 》) and the Outline of the 13th Five-Year Plan for the National Economic and Social Development of the People’s Republic of China (《中华人民共和国国民经济和社会发展第十三个五年规划纲要》) which highlight the importance of chemical medicine and traditional Chinese medicine in the pharmaceutical market in the PRC.
Expanding aging population. According to the National Bureau Statistics of China, China has entered an aging society with the aging population growing at a CAGR of approximately 5.1% during the period from 2014 to 2019. The aging population will create higher market demand for healthcare services and healthcare products, as they usually have weaker immune systems and increased chances of becoming ill. It is expected that this rising demand will contribute to the solid growth of pharmaceutical market and the manufacturing of oxytetracycline product and compound licorice in the next five years.
Improving regulation system. Starting from 2016, with the issue of Notice of the General Office of the States Council on Issuing the Plan for the Pilot Program of the System of the Holders of Drug Marketing Licenses (“国务院关于印发药品上市许可持有人制度试点方案的通知”), the PRC government has been trying to improve the regulation system of the pharmaceutical market in the PRC. Further in 2019, the Notice by the General Office of the State Council of Issuing the Pilot Program of the Centralized Procurement and Use Drugs Organized by the State (“国务院办公厅关于印发国家组织药品集中采购和使用试点方案的通知”) is expected to deepen the reform of pharmaceutical and healthcare systems in the PRC, improve the pricing mechanism of pharmaceutical products, and support the continuous development of pharmaceutical market in the PRC.
OVERVIEW OF ORGANIC FERTILIZER MARKET IN THE PRC
According to Frost & Sullivan Report, from 2014 to 2019, total volume of effective component of chemical fertilizer used in the PRC decreased from 60.0 million tons in 2014 to 54.0 million tons in 2019, representing a CAGR of approximately -2.1%. The trend is mainly due to the fall in volumes of effective component of nitrogenous, phosphate and potash fertilizers. Compound fertilizer, on the other hand, has rose from 21.2 million tons in 2014 to 22.0 million tons in 2019, with a CAGR of approximately 0.8%. Looking forward, with the implementation of government policies targeting zero growth in the use of chemical fertilizer by 2020, the total consumption of chemical fertilizer in the PRC is expected to decrease further, implying opportunities for the market of compound fertilizer and organic fertilizer in the PRC. It is expected that the market size of organic fertilizer will grow with a CAGR of approximately 8.0% from 2019 to 2024.
Source: National Bureau of Statistics of China, Frost & Sullivan Report
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Market Drivers
Improving crop yields. The PRC is one of the largest agricultural producers in the world with limited arable area to support around 20% of the world’s population. Moreover, according to the Frost & Sullivan Report, the decline of arable land has added to the pressure of producing increased yield per area to feed to the growing population. This increasing demand for food emphasizes the importance of increasing crop yields by using fertilizer in more efficient ways. Benefiting form a series of measures taken by the PRC government which increased the incomes of farmers and investment in agriculture, it is expected that organic and compound fertilizer consumption in the PRC would experience steady growth.
Favorable government policies. Agriculture in the PRC has been growing rapidly on a limited area with heavy inputs of fertilizers since 1980s when chemical fertilizers were developed and produced heavily to boost crop yields and scale up agricultural production. With limited arable land and growing population, protecting China’s polluted and artificially fertilized soil remains a major concern to the government. Therefore, the PRC government is targeting zero growth in the use of chemical fertilizers and pesticides by 2020 and encouraging the use of compound fertilizer instead of straight fertilizer, as stated in the Action Plan of Zero Growth on Chemical Fertilizer by 2020 (《到2020年化肥施用量零增长行动方案》). In addition, in 2018, the Ministry of Agriculture announced policies stimulating the development of organic fertilizer market in the PRC, including providing rewards and subsidies to the manufacturers and consumers of organic fertilizer. These policies have created opportunities for organic fertilizer market since compared to chemical fertilizers, organic fertilizer usually contains comprehensive nutrients and are more environmentally friendly. Therefore, the penetration of organic fertilizer is expected to increase with the government policies and the incentive to improve fertilizer performance.
COMPETITIVE LANDSCAPE OF PHARMACEUTICAL MARKET IN THE PRC
Overview of Competitive Landscape
According to the Frost & Sullivan Report, the pharmaceutical market in the PRC is highly fragmented with more than 4,000 pharmaceutical companies and a total market size of RMB2,614.7 billion in terms of sales in 2019. In 2019, top 20 pharmaceutical companies accounted for over 20% of the total pharmaceutical market in the PRC. In particular, major market participants in oxytetracycline, compound licorice and heparin sodium market are small and medium companies with no particular market leader with significant market share to dominate or influence the market. With the structural reform on the supply side of pharmaceutical industry implemented by the PRC government, the improvements on regulations and standards for environment protection, and the advancements in production technologies, it is expected that pharmaceutical companies with competitive products, well-established business relationship and distribution networks, and access to industry professionals will expand market share and become leading market participants in the pharmaceutical market in the PRC.
Entry Barrier Analysis
Access to industry professionals. The pharmaceutical market in the PRC relies heavily on professionals and talents for medicine research, development and production. Well-established and sizable market participants are more likely to acquire and retain professionals with extensive knowledge and expertise in pharmaceutical research, development and production. Therefore, access to industry professionals serve as a key entry barrier for new market entrants without tracking records and the ability to attract professionals.
Established business relationship. Business relationship with stakeholders becomes a key entry barrier for new entrants, as extensive distribution network and stable supply of raw materials are essential for market participants in the pharmaceutical market in the PRC. Established market participants generally possess good business relationship with their upstream suppliers and downstream customers, which enable them to source raw materials and provide desired products and services, and even obtain information on recent market trends.
Significant capital investment. Pharmaceutical companies generally require significant investment in the research and development of new products, expanding along the industry value chain, upgrading of manufacturing and production facilities, and recruiting industry professionals and talents. Established market participants tend to have sufficient capital investment and a good track record to raise funds, which in contrast will hinder the development of new market entrants.
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Overview
Through our wholly owned indirect subsidiaries and the contractual arrangements described below, we are a pharmaceutical and chemical company based in China that focuses on the development, manufacture, marketing, and sale of oxytetracycline products, licorice products, traditional Chinese medicine derivatives (“TCMD”) product, heparin product, sausage casings, and fertilizers. We independently developed Gan Di Xin® and Ahan® Antibacterial Paste within our research and development department. Our products are sold in more than 20 provinces in China.
| · | Our licorice products include Gan Di Xin®, Qilian Shan® Licorice Extract, and Qilian Shan® Licorice Liquid Extract. Our Gan Di Xin® is an innovative antitussive and expectorant medicine made from raw licorice materials. Our Qilian Shan® Licorice Extract is a primary ingredient for pharmaceutical companies to manufacture traditional licorice tablets. Our Qilian Shan® Licorice Liquid Extract is the primary ingredient for medical preparation companies to produce compound licorice oral solutions. |
| · | Our oxytetracycline products include Qilian Shan® Oxytetracycline Tablets and Qilian Shan® Oxytetracycline Active Pharmaceutical Ingredients (“API”). Our Qilian Shan® Oxytetracycline Tablets are used to prevent and treat a wide range of diseases in chickens, turkeys, cattle, swine, and human. Our Qilian Shan® Oxytetracycline APIs are used by pharmaceutical companies in the manufacturing of medications that use oxytetracycline as an active ingredient. |
| · | Our TCMD product includes Ahan® antibacterial paste, which is made from a mixture of 11 traditional Chinese herbal ingredients. It is used to treat refractory chronic skin diseases. |
| · | Our heparin product includes Heparin Sodium Preparation. It is a primary ingredient for pharmaceutical companies to produce medications used in treating cardiovascular diseases, cerebrovascular diseases, and hemodialysis. |
| · | Our sausage casings include Zhu Xiaochang® Sausage Casings, which are all-natural food products used for culinary purposes. |
| · | Our fertilizer products include Xiongguan® Organic Fertilizer and Xiongguan® Organic-Inorganic Compound Fertilizer. Our Xiongguan® Organic Fertilizer is designed to improve crop yield, increase soil’s chemical properties, and reduce soil compaction. Our Xiongguan® Organic-Inorganic Compound Fertilizer is made from both organic materials and traditional chemical fertilizer, and is designed to increased plant growth. |
Our History and Corporate Structure
Qilian International Holding Group Limited is a Cayman Islands exempted company with limited liability incorporated on February 7, 2019. Qilian International (Hong Kong) Holdings Limited., which we refer to as “Qilian HK”, our wholly-owned subsidiary, was incorporated in Hong Kong on January 30, 2019. Chengdu Qilian Trading Co., Ltd., which we refer to as “WFOE”, Qilian HK’s wholly owned subsidiary, was organized pursuant to PRC laws on May 15, 2019 Our variable interest entity, Gansu Qilianshan Pharmaceutical Co. Ltd., which we refer to as Gansu QLS, was established in August 30, 2006, as a result of restructuring from Gansu State-operated Qilianshan Pharmaceutical Factory, which was incorporated in July 1969 in Jiuquan, Gansu Province, PRC pursuant to PRC laws. Gansu QLS’ shareholders include certain PRC residents and corporate entities controlled by PRC residents.
Pursuant to PRC laws, each entity formed under PRC law shall have certain business scope approved by the Administration of Industry and Commerce or its local counterpart. As such, WFOE’s business scope is to primarily engage in business development, technology service, technology consulting, intellectual property service and business management consulting. Since the sole business of WFOE is to provide Gansu QLS with technical support, consulting services and other management services relating to its day-to-day business operations and management in exchange for a consulting fee, which is at WFOE’s discretion and can be the net income of Gansu QLS, such business scope is necessary and appropriate under the PRC laws. Gansu QLS, on the other hand, has been granted a business scope different from WFOE to enable it to develop, manufacture, market and sell its products.
Since we intend to acquire upstream and downstream companies manufacturing traditional Chinese medicine pieces, which is prohibited to be invested in by foreign investors, our WFOE cannot hold equity of Gansu QLS. We control Gansu QLS through contractual agreements, which are described under “Business — Contractual Agreements between WFOE and Gansu QLS”. Qilian International is a holding company with no business operation other than holding the shares in Qilian HK and Qilian HK is a pass-through entity with no business operation. WFOE is exclusively engaged in the business of managing the operation of Gansu QLS and its subsidiaries.
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Gansu QLS, our VIE, was established in August 30, 2006, by restructuring from Gansu State-operated Qilianshan Pharmaceutical Factory, which was incorporated in July 1969 in Jiuquan, Gansu Province, PRC pursuant to PRC laws.
On April 17, 2020, Rugao Tianlu Animal Products Co., Ltd. was incorporated under the laws of the People’s Republic of China (“Rugao”). Rugao is the 100% owned subsidiary of Chengdu QLS. We aim to use it as procurement and manufacturing assistance entity for Chengdu QLS and as a point of expansion for our sausage casings business in Jiangsu Province.
The following diagram illustrates our corporate structure as of the date of this prospectus and upon completion of the Offering based on 5,000,000 Ordinary Shares being offered, assuming that the underwriters do not exercise their over-allotment option:
Contractual Arrangements between WFOE and Gansu QLS
Due to PRC legal restrictions on foreign ownership in the pharmaceutical sector, neither we nor our subsidiaries own any equity interest in Gansu QLS. Instead, we control and receive the economic benefits of Gansu QLS’s business operation through a series of contractual arrangements. WFOE, Gansu QLS and its shareholders entered into a series of contractual arrangements, also known as VIE Agreements, on May 20, 2019. The VIE agreements are designed to provide WFOE with the power, rights and obligations equivalent in all material respects to those it would possess as the sole equity holder of Gansu QLS, including absolute control rights and the rights to the assets, property and revenue of Gansu GLS.
Each of the VIE Agreements is described in detail below:
Exclusive Service Agreement
Pursuant to the Exclusive Service Agreement between Gansu QLS and WFOE, WFOE provides Gansu QLS with technical support, consulting services and other management services relating to its day-to-day business operations and management, on an exclusive basis, utilizing its advantages in technology, business management and information. For services rendered to Gansu QLS by WFOE under this agreement, WFOE is entitled to collect a service fee that shall be equal to 98.297% of the net profits of Gansu QLS, as reflected in the “ARTICLE 3 - SERVICE FEES” of the Amended Exclusive Service Agreement executed on August 27, 2019. This percentage represents the number of shares of Gansu QLS held by shareholders having signed the VIE Agreements over the total number of issued and outstanding shares of Gansu QLS.
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The Exclusive Service Agreement shall remain in effect for ten years unless earlier terminated upon written confirmation from both WFOE and Gansu QLS before expiration. Otherwise, this agreement shall be extended by another ten years automatically. Gansu QLS does not have the right to terminate the agreement unilaterally.
WFOE is currently managing Gansu QLS pursuant to the terms of the Exclusive Service Agreement. WFOE has absolute authority relating to the management of Gansu QLS, including but not limited to decisions with regard to expenses, salary raises and bonuses, hiring, firing and other operational functions. The Exclusive Service Agreement does not prohibit related party transactions. Upon establishment of the audit committee at the consummation of this offering, the audit committee of the registrant will be required to review and approve in advance any related party transactions, including transactions involving WFOE or Gansu QLS.
Equity Pledge Agreement
Under the Equity Pledge Agreement between WFOE and certain shareholders of Gansu QLS together holding 75,492,128 shares, or 98.297% of the total issued and outstanding shares, of Gansu QLS (“Gansu QLS Shareholders”), the Gansu QLS Shareholders pledged all of their equity interests in Gansu QLS to WFOE to guarantee the performance of Gansu QLS’ obligations under the Exclusive Service Agreement. Under the terms of the Equity Pledge Agreement, in the event that Gansu QLS breaches its contractual obligations under the Exclusive Service Agreement, WFOE, as pledgee, will be entitled to certain rights, including, but not limited to, the right to collect dividends generated by the pledged equity interests. The Gansu QLS Shareholders also agreed that upon occurrence of any event of default, as set forth in the Equity Pledge Agreement, WFOE is entitled to dispose of the pledged equity interest in accordance with applicable PRC laws. The Gansu QLS Shareholders further agree not to dispose of the pledged equity interests or take any actions that would prejudice WFOE’s interest.
The Equity Pledge Agreement shall be effective until the latest date of the following: (1) the secured debt in the scope of pledge is cleared off; (2) WFOE exercises its pledge rights pursuant to provisions and conditions of the Equity Pledge Agreement; and (3) the Gansu QL Shareholders transfer all the pledged equity interests to WFOE according to the Call Option Agreement, or other entity or individual designated by it.
The purposes of the Equity Pledge Agreement are to (1) guarantee the performance of Gansu QLS’s obligations under the Exclusive Service Agreement, (2) ensure the Gansu QLS Shareholders do not transfer or assign the pledged equity interests, or create or allow any encumbrance that would prejudice WFOE’s interests without WFOE’s prior written consent and (3) provide WFOE control over Gansu QLS. Under the Call Option Agreement, WFOE may be able to acquire the equity interests or the assets in Gansu QLS any time to the extent permitted by the PRC Law. In the event Gansu QLS breaches its contractual obligations under the Exclusive Service Agreement, WFOE will be entitled to foreclose on the Gansu QLS Shareholders’ equity interests in Gansu QLS and may (1) exercise its option to purchase or designate third parties to purchase part or all of their equity interests or the assets in Gansu QLS and in this situation, WFOE may terminate the Exclusive Service Agreement, Equity Pledge Agreement and Call Option Agreement after acquisition of all equity interests or assets in Gansu QLS or form new VIE structure with the third parties designated by WFOE; or (2) dispose the pledged equity interests or assets and be paid in priority out of proceed from the disposal in which case the VIE structure will be terminated.
Call Option Agreement
Under the Call Option Agreement, the Gansu QLS Shareholders irrevocably granted WFOE (or its designee) an exclusive right to purchase, to the extent permitted under PRC law, once or at multiple times, at any time, a portion or whole of the equity interests or assets in Gansu QLS held by the Gansu QLS Shareholders. The purchase price should be no more than $1.00 subject to any appraisal or restrictions required by applicable PRC laws and regulations.
The agreement remains effective till all the transferred equity or transferred asset of Gansu QLS is legally transferred under the name of WFOE and/or other entity or individual designated by it.
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Shareholders’ Voting Rights Proxy Agreement and Powers of Attorney
Under the Shareholders’ Voting Rights Proxy Agreement and each Power of Attorney, each Gansu QLS Shareholder authorizes WFOE to act on their behalf as their exclusive agent and attorney with respect to all rights as shareholders, including but not limited to: (a) the attendance of the shareholder’s meeting and the execution of relative Shareholder Resolution(s) of Gansu QLS; (b) exercising all the shareholder’s rights, including voting, that shareholders are entitled to under the laws of China and the Articles of Association, including but not limited to the sale or transfer or pledge or disposition of shares in part or in whole; and (c) designating and appointing on behalf of shareholders the legal representative, the executive director, supervisor, the chief executive officer and other senior management members of Gansu QLS.
Each Power of Attorney is coupled with an interest and shall be irrevocable and continuously valid from the date of its execution, so long as the relevant Gansu QLS Shareholder is a shareholder of Gansu QLS.
Spousal Consent
The spouses of the Gansu QLS Shareholders agreed, via a spousal consent, to the execution of the “Transaction Documents” including: (a) the Call Option Agreement entered into with WFOE and Gansu QLS; (b) the Shareholders’ Voting Rights Proxy Agreement entered into with WFOE and Gansu QLS; (c) the Equity Pledge Agreement entered into with WFOE; and (d) the Power of Attorney executed by each Gansu QLS Shareholder , and the disposal of the equity interests of Gansu QLS held by each Gansu QLS Shareholder and registered in his/her name.
The spouses further undertake not to make any assertions in connection with the equity interests of Gansu QLS which are held by the Gansu QLS Shareholders. They confirm that the Gansu QLS Shareholders can perform, amend, or terminate the Transaction Documents without their authorization or consent. They undertake to execute all necessary documents and take all necessary actions to ensure appropriate performance of the agreements.
Our Business Strategies
Our overall strategy is to leverage our considerable industry experience, our deep understanding of PRC markets and our R&D expertise to capture additional shares of the PRC markets. We plan to fulfill increasing medical and agricultural needs in the Chinese market with our Gan Di Xin®, Qilian Shan® Oxytetracycline API, Xiongguan® Organic Fertilizer, and Heparin Sodium Preparation. According to the Frost & Sullivan Report, the total output volume of chemical medicines in the PRC is expected to reach 3,797.0 thousand tons in 2024, with a CAGR of approximately 7.4% from 2020, according to the National Bureau of Statistic of China and the Frost & Sullivan Report. The pharmaceutical market in the PRC started to play an increasingly large role in the global market supply, particularly in relation to APIs. It is expected that the revenue from the manufacturing of APIs will reach RMB1,074.8 billion in 2024, representing a CAGR of approximately 9.9%. According to the Frost & Sullivan Report, the pharmaceutical market in the PRC is highly fragmented with more than 4,000 pharmaceutical companies and a total market size of RMB2,614.7 billion in terms of sales in 2019. In 2019, top 20 pharmaceutical companies accounted for over 20% of the total pharmaceutical market in the PRC. The market alternatives for Gan Di Xin®, Qilian Shan® Oxytetracycline API, Xiongguan® Organic Fertilizer, and Heparin Sodium Preparation are widely available. In particular, major market participants in oxytetracycline, compound licorice and heparin sodium market are small and medium companies with no particular market leader with significant market share to dominate or influence the market.
In addition, we have an experienced management team with significant industry and regulatory knowledge. With combined scientific and business expertise, we expect our management team to lead us through future development and commercialization of our products. Our product-specific business strategy is as follows:
Our Business Strategies for Gan Di Xin®
We plan to further enhance market awareness of Gan Di Xin® brand in the PRC markets. Our Company’s Gan Di Xin® has been included in the National Essential Medicines Category and Gansu Province’s Essential Medicines Category, which are pharmaceutical prescription guidances for medical institutions in the scope of PRC and Gansu Province. Gan Di Xin® has also been enrolled in Gansu Province’s Class B Medical Insurance Coverage Program, which allows Gan Di Xin® to enter insurance-covered pharmacies in Gansu Province. Our branding strategy is to conduct a pilot marketing program in Gansu Province, and then reach a larger customer base in other provinces with wider insurance coverage product offerings by enrolling Gan Di Xin® in the National Medical Insurance Coverage Program. The process of enrolling Gan Di Xin® in the National Medical Insurance Coverage Program is relatively straight forward— we will submit the application materials required by the National Medical Insurance Bureau to Jiuquan City Level Insurance Bureau. Once approved, we will then submit the application to the Gansu Provincial Insurance Bureau, which will further review our application. With Gansu Provincial Insurance Bureau’s approval, we will submit our application further to the National Insurance Bureau, which will have the final say on Gan Di Xin®’s enrollment into the National Medical Insurance Coverage Program. We will amend our application materials if any level of the insurance bureau has any questions regarding our products and applications. Such enrollment will allow Gan Di Xin® to enter medical institutions and insurance-covered pharmacies on a national level. The review for such enrollment is still in progress, and we cannot guarantee that the enrollment application will be approved.
As of the date of this prospectus, Gan Di Xin® has been approved to be enrolled into the National Essential Medicines Category (2018 Edition), which was promulgated by the PRC National Health Commission and the National Administration of Traditional Chinese Medicine. In addition, we have applied with the competent authorities for Gan Di Xin® to be included in the National Medical Insurance Coverage Program. As of the date of this prospectus, the Administration of Healthcare Security and the Administration of Human Resources and Social Security of Gansu Province have filed a request to the National Administration of Healthcare Security and the PRC Ministry of Human Resources and Social Security respectively for Gan Di Xin’s enrollment. There are no express rules or provisions in China regarding the minimum or maximum period required to obtain any approval for the enrollment process. The Company intends to submit all required information and handle the application process internally, and therefore does not expect to incur any ongoing expenses with respect to such application. In addition, under the Provisional Administration Rules on Drugs for Basic Medical Insurance for Urban Workers, there are no administrative or other application expenses required to be paid for the approval process, nor are there any ongoing expenses required to maintain the enrollment status.
We believe that our existing production capacity for Gan Di Xin® will be able to meet our future business objectives and that there is no need to further invest in facility and production line expansion. Rather, we intend to invest more on our marketing efforts for Gan Di Xin® and we estimate that we will spend approximately $118,000 annually on marketing expenses in the near future.
Our Business Strategies For Qilian Shan® Oxytetracycline API
We plan to increase our oxytetracycline API production capabilities and hire more experienced marketing specialists in order to carry out our strategic expansions into additional geographical locations in China, which we believe would result in us acquiring a bigger share of the Chinese market for this product. We are committed to prioritizing investment in our infrastructure and marketing capabilities in order to support the strategic expansions into additional geographical markets in China. We are committed to prioritizing investment in our infrastructure capabilities in order to support our strategic expansions into additional geographical markets in China. We plan to relocate our current oxytetracycline API production facilities and purchase additional state-of-the-art manufacturing facilities to further increase our production capacity. We plan to increase our production capacity to 10,000 tons by 2024 and we estimate that our fixed assets investment will be approximately $18 million. We will focus on hiring more experienced professionals in our sales, marketing, and production departments to support our continued market growth while reducing costs.
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Our Business Strategies For Xiongguan® Organic Fertilizer
We believe our current production equipment and components are adequate to meet current demand and limited future demand. However, to meet the demand anticipated in 2020 and beyond according to the “Zero Growth of Chemical Fertilizer and Pesticide Use by 2020” proposed by Ministry of Agriculture and Rural Affairs of the People’s Republic of China, we will need to move to a larger production capacity in order to reap substantial business benefits from this Chinese government proposal. Our plan is to build an organic waste treatment facility with the capability to process 36,000 tons of oxytetracycline slags, 1,400 tons of sludge, 68,000 tons of livestock and poultry manure, 54,000 tons of straw wastes, and 7,000 tons of vegetable wastes every year. This organic waste treatment facility will allow us to increase fertilizer production capacity through turning waste into high quality production materials, which will reduce the cost of our organic fertilizer production while increasing the efficiency of our organic fertilizer production each year. We anticipate to complete building our new organic waste treatment facility by 2021. We expect to invest approximately $1.28 million in this project.
Our Business Strategies For Heparin Sodium Preparation
We intend to implement two primary strategies to expand and grow the production capacity of our Heparin Sodium Preparation: (i) upgrade the production efficiency of our existing manufacturing facilities, and (ii) increase our production lines for Heparin Sodium Preparation. While we have earned our reputation through the consistent quality of our products, we believe that sustained improvements in the production efficiency and increasing production lines are vital to maintaining such reputation and acquire more shares in the Chinese heparin sodium markets.
For upgrading the production technology of our existing manufacturing facilities, we plan to improve staff trainings with respect to production, maintenance and quality control procedures in order to increase production speed while lowering production costs. We plan to make equipment and production upgrades to take advantage of quality and cost improvements that new technologies can offer in order to stay ahead of competition. On the other hand, we also plan to improve our information gathering capability to fully understand current market and customer information, which in turn can help better our marketing positioning. Our goal is to increase our heparin sodium preparation’s production capacity to 5 tons per year in three years.
We expect to invest approximately $128,000 in implementing these two strategies.
Our Products
The Company currently manufactures ten products. We independently developed Gan Di Xin® and Ahan® Antibacterial Paste within our research and development department. Our products are sold in more than 20 provinces in China. The following list outlines the Company’s current products under six categories— oxytetracycline products, licorice products, TCMD product, heparin product, sausage casings, and fertilizers.
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| Product Category | Product Name | Intended Use | Government Agency Approval | |||
| Licorice Products | Gan Di Xin® (1) | Used orally as antitussive and expectorant medicine. | Pharmaceutical Manufacturing Permit approved by Gansu Food and Drug Administration on August 14, 2018
GMP Certificate approved by Gansu Food and Drug Administration on August 20, 2015;
Re-registration approved by the Gansu Provincial Food and Drug Administration on February 7, 2020, May 14, 2015 and April 30, 2004. | |||
| Qilian Shan® Licorice Exact (1) | Used for treating bronchitis, pharyngitis, bronchial asthma and chronic adrenal insufficiency. | Pharmaceutical Manufacturing Permit approved by Gansu Food and Drug Administration on August 14, 2018;
GMP Certificate approved by Gansu Food and Drug Administration on August 20, 2015;
Re-registration approved by Gansu Food and Drug Administration on May 14, 2015. The Company filed for record with Drug-related Information Filing Platform in July 2019, which removed any further need for re-registration according to Article 11 of the Notice of the NMPA on Strengthening the Supervision and Administration of Extracts and Extracts in the Production of Chinese Medicine. | ||||
Qilian Shan® Licorice Liquid Extract (1)
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Used for treating bronchitis, pharyngitis, bronchial asthma and chronic adrenal insufficiency. | Pharmaceutical Manufacturing Permit approved by Gansu Food and Drug Administration on August 14, 2018 GMP Certificate approved by Gansu Food and Drug Administration on August 20, 2015; Re-registration approved by the Gansu Provincial Food and Drug Administration on May 14, 2015 and April 30, 2004. The Company filed for record with Drug-related Information Filing Platform in July 2019, which removed any further need for re-registration according to Article 11 of the Notice of the NMPA on Strengthening the Supervision and Administration of Extracts and Extracts in the Production of Chinese Medicine. | ||||
| Oxytetracycline Products | Qilian Shan® Oxytetracycline API (1) | Used for treating following diseases: Rickettsia, Mycoplasma infection, Chlamydia infection, Regression fever, Brucellosis cholera, Rabbit fever and Plague. | Pharmaceutical Manufacturing Permit approved by Gansu Food and Drug Administration on August 14, 2018; GMP Certificate approved by Gansu Food and Drug Administration on March 2, 2015; Re-registration approved by Gansu Food and Drug Administration on May 14, 2015. The Company filed for record with Drug-related Information Filing Platform in July 2019, which removed any further need for re-registration according to Article 11 of the Notice of the NMPA on Strengthening the Supervision and Administration of Extracts and Extracts in the Production of Chinese Medicine. | |||
| Qilian Shan® Oxytetracycline Tablets (1) | Used orally for treating the following diseases: Rickettsia, Mycoplasma infection, Chlamydia infection, Regression fever, Brucellosis cholera, Rabbit fever and Plague. | Pharmaceutical Manufacturing Permit approved by Gansu Food and Drug Administration on August 14, 2018; GMP Certificate approved by Gansu Food and Drug Administration on August 20, 2015; Re-registration approved by Gansu Provincial Food and Drug Administration on February 7, 2020, May 14, 2015 and September 19, 2010. | ||||
| TCMD Product | Ahan® Antibacterial Paste (2) | Designed as a rubbing ointment to kill Staphylococcus aureus, Candida albicans and Escherichia coli. It treats psoriasis, various dermatitis and eczema, mites, onychomycosis, and genital itching. | Sanitary License for Manufactures of Disinfectant Products approved by Health and Family Planning Commission of Gansu Province and Shaanxi Provincial Center for Disease Control and Prevention on June 1, 2017. | |||
| Heparin Product | Heparin Sodium Preparations (3) | Designed for the prevention of thrombosis and embolism; treatment of diffuse intravascular coagulation (DIC) caused by various causes; and other anticoagulation purposes. | Business license issued by Chengdu Administration for Industry and Commerce on June 23, 2014 | |||
| Sausage Casings | Zhu Xiaochang® Sausage Casing (3) | Used for culinary purposes. | Business license issued by Chengdu Administration for Industry and Commerce on June 23, 2014 | |||
| Fertilizers | Xiongguan® Organic Fertilizer (4) | Designed as a base application fertilizer. It is used to improve soil quality, increases crop yield and improves agricultural products’ quality. | National Manufacturing License for Industrial Products approved by Gansu Provincial Agriculture and Animal Husbandry on August 5, 2016. Fertilizer Registration Certificate of The People’s Republic of China approved by PRC Ministry of Agriculture on May 19, 2020. | |||
| Xiongguan® Organic-Inorganic compound Fertilizer (4) | Designed as a base and top application fertilizer. It is used to improve soil structure, prevents soil compaction, increases soil’s water retention capacity, improves crops’ drought/cold weather resistance, and enhances crops’ rooting. | National Manufacturing License for Industrial Products approved by Gansu Provincial Quality Inspection Bureau and Gansu Provincial Agriculture and Animal Husbandry on August 5, 2016. Fertilizer Registration Certificate of The People‘s Republic of China approved by PRC Ministry of Agriculture on May 19, 2020. |
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| (1) | This product is manufactured by our operating subsidiary, Gansu GLS. |
| (2) | This product is manufactured by our operating subsidiary, Ahan. |
| (3) | This product is manufactured by our operating subsidiary, Chengdu QLS. |
| (4) | This product is manufactured by our operating subsidiary, Qiming. |
The following is a detailed description of the Company’s current products and products in development.
Our Licorice Products
Gan Di Xin®- As an enhanced type of compound licorice tablet, Gan Di Xin is an antitussive and expectorant medicine made from raw licorice materials. We have independently researched and developed Gan Di Xin using our patented purification, thin-film coating and inclusion technology (the “3-in-1 technology”, Patent Number ZL 200410030776.4, issued on October 25, 2006). The effective medical ingredients in compound licorice tablets become active only when they are absorbed by the bloodstream. However, traditional licorice tablets’ efficacy is drastically reduced when the effective medical ingredients are swallowed and enter the gastrointestinal tract. Rather than being absorbed by the bloodstream directly, the effective medical ingredients go through the liver’s metabolism process first, which renders the ingredients ineffective. Such phenomenon is called “first pass effect”. Our-3-in-1 technology has helped our Gan Di Xin bypass the so called “first pass effect” by allowing our Gan Di Xi to be dissolved slowly in patients’ mouths, whereby the active ingredients are absorbed through oral mucosa, enabling them to enter blood circulation directly rather than being metabolized by the liver. In this way, Gan Di Xin’s effectiveness can be preserved.
Gan Di Xin is currently categorized as a chemical medicine that falls under China’s State Category V New Drug. According to the New Drug Approval Methods promulgated in July 1985 and revised in April 1999 by the State Drug Administration of PRC, claims of new indications for marketed chemical drugs shall be categorized as a V Category New Drug in the application for approval. Since we applied to have Gan Di Xin approved as a marketed drug reducing dosages, thus adding new indications to already marketed drugs, when Gan Di Xin was approved, it was approved as a Category V New Drug. The application and approval procedures for Category V New Drugs are divided into two stages: clinical research and production and sale. The application for a Category V New Drug is pre-examined by the provincial branches of the National Medical Products Administration, and re-examined by the National Medical Products Administration. Gan Di Xin was issued the National New Drug Certificate (No. H20040463) on April 30, 2004 with Drug Registration Approval (No. 20040640). As a pharmaceutical manufacturer, Gansu QLS is subject to the national medicine quality standard of WS1-(X-001)-2015Z for product registration and manufacturing.
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Our Gan Di Xin® is innovative in terms of its unconventional administration methods, taste, and efficacy. Our unique manufacturing process, the abundance of local source materials and our geographical location are crucial elements contributing to the success our Gan Di Xin®.
We introduced Gan Di Xin® to the Chinese market in 2004. Gan Di Xin® has enjoyed growing popularity in recent years due to its easy administration method, strong efficacy, and soothing taste. We sold approximately 108 million pieces in 2017, and 310 million pieces in 2018, and 163 million pieces in 2019. Gan Di Xin® was awarded “Famous Trademark of Gansu Province” in 2011 by the Gansu Famous Brand Strategy Promotion Committee of the Gansu government. Gan Di Xin® was also awarded “China Chemical and Pharmaceutical Industry’s Excellent Product Brand” in 2013 by the China Chemical Pharmaceutical Industry Association, China Pharmaceutical Business Association, China Non-Prescription Drug Association, and China Pharmaceutical Enterprise Development and Promotion Association. Currently, we sell Gan Di Xin® in more than 20 provinces in China.
Qilian Shan® Licorice Extract and Qilian Shan® Licorice Liquid Extract — Our licorice extract is a type of API made from processed high quality licorice. Our licorice liquid extract is a type of API made from fluid extract of further processed licorice extract. Our licorice extract is the primary product for pharmaceutical companies to manufacture traditional licorice tablets. Our licorice liquid extract is the primary product for medical preparation companies to produce compound licorice oral solutions. Both the traditional compound licorice tablets and compound licorice oral solutions are prescriptive palliatives that help to relieve the symptoms of mucosa irritations and gastrointestinal smooth muscle spasms; they are also used in treating bronchitis, bronchial asthma, throat inflammation and chronic adrenal insufficiency.
Our Oxytetracycline Products
Qilian Shan® Oxytetracycline Tablets – Oxytetracycline is a yellow crystalline broad-spectrum antibiotic C22H24N2O9, which is active against a wide variety of bacteria. Oxytetracycline works by interfering with the ability of bacteria to produce essential proteins. Without these proteins, the bacteria cannot grow, multiply and increase in numbers. Oxytetracycline therefore stops the spread of the infection and the remaining bacteria are killed by the immune system or eventually die.
The Company uses the active ingredient oxytetracycline to manufacture oxytetracycline tablets. Our Qilian Shan® Oxytetracycline Tablets are used to prevent and treat a wide range of diseases in chickens, turkeys, cattle, swine, and human. We sell our Qilian Shan® Oxytetracycline tablets in more than 20 provinces. Most of the customers who purchase our oxytetracycline tablets are pharmaceutical companies.
Qilian Shan® Oxytetracycline APIs— Pharmaceutical companies use our oxytetracycline APIs in the manufacture of other medications that use oxytetracycline as an active ingredient in such pharmaceutical products.
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Our Company is the only producer in China manufacturing both oxytetracycline tablets and oxytetracycline APIs. Both Qilian Shan® Oxytetracycline tablets and Qilian Shan® Oxytetracycline APIs are certified by the State Food and Drug Administration (“CFDA”), which has been superseded as National Medical Products Administration (“NMPA”). Our operating subsidiary, Gansu QLS, has obtained the Pharmaceutical Production License, the Good Manufacturing Practice (“GMP”) Standard Certificate, and the re-registration approval for the production of our oxytetracycline products. All registrations and qualifications for production are within their validity period.
While our domestic competitors’ oxytetracycline products are certified for veterinary use only by the Chinese Ministry of Agriculture (“CMA”), our products are also qualified for human consumption by the CFDA. The Company relies on an established production system as well as a quality control process for its product manufacturing process. Our key productions indicators such as fermentation unit, fermentation yield, and bacterial infection rate have given our Company distinctive advantages over our competitors, such as excellent per unit production rate, stable and premium quality of products, or large scale production capability.
Our TCMD Product
Ahan® Antibacterial Paste— Categorized as a disinfecting product under the Law of the PRC on Prevention and Treatment of Infectious Disease, Ahan® antibacterial paste is made from a mixture of 11 traditional Chinese herbal ingredients including Scutellariae Radix, Phellodendri Chinensis Cortex, Rhei Radix Et Rhizoma, Cnidii Fructus and Dictamni Cortex. It is used to treat refractory chronic skin diseases caused by Staphylococcus aureus, Moniliaalbican, and Escherichia coli. It is also prescribed for people suffering from skin infections such as psoriasis, eczema and onychomycosis. Since its introduction to the Chinese public in November 2017, Ahan® antibacterial paste has been praised by Chinese customers for its curative effect and soothing relief according to online product rating, offline surveys and personal interviews by the Company.
Our Heparin Product
Heparin Sodium Preparations- Heparin sodium is a prescription drug that has multiple biological and medical functions such as anticoagulation, antithrombotic, hypolipidemic and anti-atherosclerosis. It is used in treating cardiovascular diseases, cerebrovascular diseases, and hemodialysis. Heparin sodium decreases the risk of coagulation, which is the formation of blood clots in the blood vessels. Heparin sodium is used in preventing blood clotting during open-heart surgery, bypass surgery, kidney dialysis, and blood transfusions. In low doses, it can help prevent and reduce coagulation in certain patients, especially those who underwent surgeries or must remain in bed for a long time. Heparin sodium is also valuable in diagnosing and treating disseminated intravascular coagulation, a serious blood condition in which increased clotting depletes the clotting factors needed to control bleeding, causing excessive bleeding. Heparin sodium has been one of the most effective and most widely used anticoagulants in the world since its first use in 1935.
Chengdu QLS, a subsidiary of the Company, purchases healthy, locally raised pigs and extracts heparin-rich organic materials from their small intestinal mucosa. Chengdu QLS then processes extracted heparin materials into heparin crude products, which are then sent to manufacturers of heparin sodium raw material for further preparations. Our crude heparin is intended for use as a component of other drugs in the Chinese biochemical and medical industry such as Enoxaparin Sodium Injection and Nadroparin Calcium Injection.
Our Sausage Casings
Zhu Xiaochang® Sausage Casings – Our sausage casings are soft cylindrical containers made from small intestines of locally raised pigs. They can be used to contain sausage mixes or for certain medical uses. Our all-natural sausage casings are strong and flexible enough to resist the pressure produced by filling them with sausage mix and are permeable to water vapor and gases. Our sausage casings offer resistance at low or high temperatures and under customary culinary or medical preparations.
Our Heparin Sodium Preparations and Zhu Xiaochang® sausage casings are resource-based products. Chengdu QLS enjoys high quality, low cost, and abundant local resources, which enables it to focus on production technologies and quality control procedures.
Our Fertilizers
Xiongguan® Organic Fertilizer— Our organic fertilizer combines functional microorganisms and composites of organic materials such as animal and plant residues. In addition to its high nutrient efficiency, our organic fertilizer is designed to improve crop yield, increase soil’s chemical properties, and reduce soil compaction.
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Xiongguan® Organic-Inorganic Compound Fertilizer— Primarily sold in six Western Chinese provinces, our organic-inorganic compound fertilizer contains both organic materials and composites from traditional chemical fertilizer. The organic materials are a mixture of animal feces and peat moss, which are then treated by microbial fermentation process. The organic materials are further mixed with composites from traditional chemical fertilizer, along with humic acid, amino acid and beneficial microbial bacteria. The final product is a granulated nutritious blend designed to increased plant growth.
Products Currently in Development
Microbial Fertilizer — Microbial fertilizer is a type of multi-element fertilizer containing various strains of living microorganisms. It is a mixture of peat, cow dung, sheep manure carefully cultivated with beneficial bacteria such as lactobacillus, photosynthetic bacteria, and Bacillus. It is a compound bacterial fertilizer rich in various antioxidant substances, amino acids, and digestive enzymes. Microbial fertilizer’s bio-mechanism is creating positive influence upon crops and plants through solubilization of phosphorus, nitrogen fixation, production of plant nutrients and phytohormones, protection from pathogens and recovery from stressful environmental conditions. Functionally, microbial fertilizer enhances crops and plants’ resilience against pests, diseases, and harsh environmental conditions, thus reducing yield loss over time. In addition to providing essential nutrients for crops, it stimulates the growth of roots through chemical substances released by living microorganisms, creating a virtuous cycle of nutrients accumulation that increases crop yields.
Bio-organic Fertilizer — bio-organic fertilizer is a combination of functional microorganisms and organic materials mainly composed of animal and plant residues (such as mixtures of livestock manure and straws). Manufactured through environmental-friendly processes, our product is expected to have the following benefits— high nutrient utilization efficiency, the capability to improve crop yield and quality, and the ability to improve soil’s physical and chemical properties.
Our two products in development must be registered with the PRC Ministry of Agriculture before they can be produced, sold, or advertised. We have applied for the registration of our new fertilizers with the Agriculture Administration of Gansu Province and the Agriculture Administration of Gansu Province has finished its preliminary examination on our microbial fertilizer and the bio-organic fertilizer. We believe that the Agriculture Administration of Gansu Province has submitted our reviewed application to the PRC Ministry of Agriculture in October 2019. It may take about 3 months for the PRC Ministry of Agriculture to complete its final review process. The Company has obtained the Fertilizer Registration Certificate of The People’s Republic of China approved by PRC Ministry of Agriculture on May 19, 2020.
Manufacturing Process
The following is a brief description of the manufacturing process of the Company’s current products.
Our Licorice Products
Gan Di Xin® — Our facilities produce licorice tablets by combining Licorice Extract, hydrochloric acid, and diluted ammonia. The resulting paste-like mixture is then dried and pulverized into fine powder. That powder is then mixed with camphor extract, star anise oil, and betacyclodextrin. The mixture is further stirred, refrigerated, filtered, dried, combined with more ingredients before final granulation, pressure forming and packaging processes.
Qilian Shan® Licorice Extract and Qilian Shan® Licorice Liquid Extract— To make Licorice Extract, we boil and purify a mixture of water and licorice raw materials. We then extract the clear liquid lying above solid licorice residue after precipitation and process the clear liquid into a thick, paste-like solid concentration called Licorice Extract.
To make Licorice Liquid Extract, we first apply heat to a mixture of water and Licorice Extract Power. We then add ethanol to the heated solutions, stir, let stand overnight, and extract the clear liquid lying above solid residue. Such procedures are repeated three times before mixing all the clear liquid that was extracted. After removing the residues and ethanol content in the clear liquid, we then add other chemicals to the clear liquid mixture to ensure that the content of glycyrrhizic acid and alcohol in the clear liquid mixture is in compliance with relevant industry regulations. Our facilities then purify the clear liquid mixture before packaging.
Our Oxytetracycline Products
Qilian Shan® Oxytetracycline Tablets— we mix oxytetracycline and starch evenly, producing a soft material that later goes through granulation and drying procedures. We then add magnesium stearate to the mixture as a “flow agent”, which prevents the ingredients in each individual tablet from sticking to each other. Then we pressure form, sugar-coat and finally package the tablets.
Qilian Shan® Oxytetracycline APIs— we carefully cultivate and reproduce Streptomyces Rimosus under specific conditions. Antibiotic materials are produced and accumulated during this fermentation process. We extract antibiotic materials from the fermentation products. We then purify and refine the extractions before finally formulating and packaging the product.
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Our TCMD Product
Ahan® Antibacterial Paste— We produce Ahan Antibacterial Paste by mixing water and various Chinese herbal medicine. We then prepare an herbal decoction by heating, purifying and concentrating the mixture. After emulsification, the final products are packaged.
Our Heparin Product
Heparin Sodium Preparations- We scrape cleaned pigs’ intestines and collect intestinal mucosa. We then heat the intestinal mucosa with water and filter the solution, which is then further processed and dried before packaging.
Our Sausage Casings
Zhu Xiaochang® Sausage Casings – We salt, dry and package scraped clean pigs’ intestines.
Our Fertilizers
Xiongguan® Organic Fertilizer and Xiongguan® Organic-Inorganic Compound Fertilizer— We start with processing and crushing a mixture of compost and chemical materials. We then granulate the crushed composted materials and dry the granulated pellet, use coating machines to add a protection layer on the surface of the pellets and finally package our fertilizer products.
Quality Control and Assurance
In China, each pharmaceutical manufacturer is required to comply with the Good Manufacturing Practice (“GMP”) standards and obtain Pharmaceutical Manufacturing Permits and GMP Certificates granted by the NMPA or its local branches before it engages in any pharmaceutical manufacturing and distribution. GMP standards regulate whole processes and procedures in generating pharmaceutical products to ensure the quality in China.
We are a GMP-certified company and have obtained the Pharmaceutical Manufacturing Permit with the product manufacturing scopes covering our licorice products and oxytetracycline products. We have obtained the National Manufacturing License for Industrial Products that covers the manufacturing of our fertilizer products. The Company has also obtained a Fertilizer Registration Certificate of The People’s Republic of China, which was approved by the PRC Ministry of Agriculture on May 19, 2020. We have obtained the Sanitary License for Manufactures of Disinfectant Products that allows us to manufacture our antibacterial paste. The Chinese authorities currently do not require the Company to obtain specific qualification or licenses for our sausage casings manufacturing. We have well-qualified and trained professional employees for manufacturing and quality control procedures. Our quality control starts with procurement and continues in our manufacturing, packaging, storage capabilities, and cost competitiveness to ensure that all of our products meet the requirements.
Distribution and Marketing of Products
Our Company’s products are sold in more than 20 provinces nationwide to our qualified distributors, dealers and corporate customers. Currently, we have 13 corporate customers buying our heparin product throughout China; we have 15 corporate customers buying our sausage casings throughout China; we have 30 distributors and seven dealers buying our fertilizer products throughout China; we have 31 distributors and two dealers buying our oxytetracycline API throughout China; and we have 86 distributors and one dealer buying our oxytetracycline tablets and licorice products throughout China. A qualified distributor is a merchant with a pharmaceutical business qualification certificate, awarded and authorized by the NMPA. We intend to engage more qualified distributors and dealers in order to strengthen our distribution network.
We understand the importance of branding and packaging. Packed in unique packaging, our products bear distinctive trademarks that help them stand out in the market. Our Company designs packaging for our products and engages third-party manufacturers to produce the packaging.
We conduct marketing activities to publicize and enhance our image and brand name. Our marketing efforts are concentrated on attending national meetings, seminars, symposiums, exhibitions for veterinary healthcare and medical industries and other related industries where we can showcase our brand and products.
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Customers
Our customers are consisted of qualified distributors, dealers and corporate customers. We have several large customers with whom we generated substantial revenue each year, and the composition of our largest customers has changed from year to year. For the six months ended March 31, 2020, three customers represented approximately 22%, 11%, and 11% of the Company’s sales, respectively. For the year ended September 30, 2019, one of our customers represented approximately 15.3% of the Company’s sales. For the year ended September 30, 2018, three customers represented approximately 18.8%, 14.7% and 13.7% of the Company’s sales, respectively. While we believe that one or more of our major customers could account for a significant portion of our sales for the foreseeable future, we anticipate that our customer base will continue to expand and that we will become less dependent on major customers.
Suppliers; Sources and Availability of Raw Materials
We research, design and manufacture our products at our manufacturing facilities located at Jiuquan City of Gansu Province and Qionglai City of Sichuan Province in China. Our principal raw materials include various chemical and biological materials including, but not limited to, starch, pig intestine, oxalic acid, liquid alkali, liquid ammonia, sodium ferrocyanide, and defoamer agent. None of our current products requires any raw materials that are scarce, and our raw materials in general are readily available from a wide range of local sources. Accordingly, we do not have any continuing or long-term supply agreements with any of these suppliers. We purchase our raw materials from our suppliers on a per purchase order basis. The prices for these raw materials are nevertheless subject to market forces largely beyond our control, including energy costs, organic chemical feedstock, market demand, and freight costs. The prices for these raw materials have varied significantly in the past and may vary significantly in the future.
For the six months ended March 31, 2020, one of our suppliers accounted for 13% of the total purchases. For the year ended September 30, 2019, two of our suppliers accounted for 12.9% and 9.5% of the total purchases, respectively. For the year ended September 30, 2018, three of our suppliers accounted for 19.2%, 14.1%, and 9.4% of the total purchases, respectively.
Competition
We have competitors in China that manufacture products similar to ours. These companies sell products similar to ours and some of them may have more assets, resources and a larger market share. We believe we are able to compete with these competitors because of our geographical location in West China, our unique combination of products and our products’ lower prices.
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| Products | Competitors | |
| Compound Licorice Tablets (a pharmaceutical product that has similar medical efficacy compared to our award winning Gan Di Xin®) | Jiangxi Pharmaceutical Co., Ltd. (the only company in China that manufacture compound licorice tablets) | |
| Oxytetracycline Tablets | Shanxi Datong Tongxing Antibiotics Co., Ltd.; Chifeng Pharmaceutical Co., Ltd.; Hebei Shengxue Dacheng Pharmaceutical Co., Ltd. | |
| Oxytetracycline APIs | Yunnan Baiyao Group Co., Ltd.; Kunming Pharmaceutical Group Co., Ltd.; Hunan Jianlang Pharmaceutical Co., Ltd.; Hainan Pharmaceutical Factory Co., Ltd. No. 2 Pharmaceutical Factory; Anhui Fengyuan Pharmaceutical Co., Ltd. | |
| Licorice Extract and Liquid Extract | Baoji Jinsen Pharmaceutical Co., Ltd.; Xinjiang Tarim Agricultural Comprehensive Development Co., Ltd.; Jiangxi Jin Furong Pharmaceutical Co., Ltd.; Fuzhou Haiwang Jinxiang Chinese Medicine Pharmaceutical Co., Ltd.; Xinjiang Sinopharm Group Co., Ltd. | |
| Organic Fertilizer | Gansu Shikefeng New Fertilizer Co., Ltd.; Beijing Century Arms Biotechnology Co., Ltd.; Ningxia Yipin Biotechnology Co., Ltd.; Shijiazhuang Golden Sun Bio-organic Fertilizer Co., Ltd.; Ningxia Beite Fertilizer Co., Ltd. | |
| Organic-Inorganic Compound Fertilizer | Gansu Shikefeng New Fertilizer Co., Ltd.; Gansu Jinhua Group Corporation; Jinzhengda Ecological Engineering Group Co., Ltd.; Stanley Fertilizer Co., Ltd.; Hubei Xinyangfeng Fertilizer Co., Ltd. | |
| Heparin Sodium Preparations | Chengdu Shenrui Animal Products Co., Ltd.; Guanghan Jinghuang Meat Food Co., Ltd.; Sichuan Xinkang Green Food Co., Ltd.; Yibin Lihao Biotechnology Co., Ltd. | |
| Sausage Casings | Chengdu Shenrui Animal Products Co., Ltd.; Guanghan Jinghuang Meat Food Co., Ltd.; Sichuan Xinkang Green Food Co., Ltd.; Yibin Lihao Biotechnology Co., Ltd. | |
| Chinese Herbal Anti-bacterial Paste | Wuhan Laowantong Biotechnology Co., Ltd.; Wuhan Runhe Biomedical Co., Ltd.; Jiangxi Jiarun Biotechnology Co., Ltd.; Jiangxi Cihetang Biotechnology Co., Ltd.; Jiangxi Jianyuantang Biotechnology Co., Ltd. |
Our Competitive Advantages
We believe our principal competitive strengths are as follows:
Recognized Brand Name
With over 50 years of history, “Qilian Shan (祁连山)” is a well-known medical and chemical product brand in China. We have received many awards from government agencies such as the Gansu Province “Specialized New Technology” Enterprise Status granted by Gansu Provincial Industry and Information Technology Commission in November 2017. Please see “Business—Honors, Awards, and Qualifications” for more detailed information regarding the awards we have received in the past years and selective criteria for each award. In addition, our TCMD product have been available in hospitals and drug stores for years and have received positive feedback from our customers over time.
Our fertilizer products enjoy customer loyalty and goodwill because they are designed to significantly increase soil organic matter contents, improve soil physical and chemical properties and enhance soil fertility, thereby increasing crop yields and yield quality. Our fertilizer products have been well received in China for years and individual farmers as well as farm owners have well received them. In addition, as Chinese consumers are becoming better informed and more aware of the environmental impact of consumer products, we have actively cultivated a positive sustainability brand image through our operating subsidiary Qiming which uses oxytetracycline waste materials to produce fertilizer, saving resources, protecting our environment and promoting the sustainable development of the fertilizer industry.
Unique Geographical Location And Beneficial National Policy
Situated in one of the most important cities of the ancient Silk Road, Jiuquan City of Gansu Province, Gansu QLS enjoys unique business and policy advantages bestowed by the Belt and Road Initiative, which is a Chinese government’s international infrastructure development and investment strategy that has a particular focus on Western China. Such advantages include exemptions for land transaction fees, exemptions for newly added construction land users’ fees, exemptions for enterprise income tax, and priorities in using certain public lands. Spearheaded by the Chinese government since President Xi Jinping first announced this initiative in 2013, the Belt and Road Initiative aims to recreate the ancient Silk Road geopolitical economy, reshaping global economic through trading coverage of more than 65 countries, half of the world’s population, and about one-third of global GDP. In addition, Gansu QLS and its operating subsidiaries enjoy high quality, low cost, and abundant local resources due to their locations in remote Western China, which enables them to allocate more financial resources on improving production technologies, advancing research and development, and guaranteeing quality control procedures.
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Strong Research And Development Capability
We believe that our research and development capabilities allow us to respond to our customers’ evolving needs. Our research and development team has demonstrated its success in using sophisticated research methods and modern technologies to develop innovative TCMD products that we believe give us certain advantage. We have a strong technical team of 70 highly qualified individuals, amongst whom we have 14 individuals dedicated to the Company’s research and development projects. There are 17 engineers, two senior engineers, and 18 individuals with bachelor’s and advanced degrees in our technical team. Our research and development personnel have successfully developed two innovative TCMD products (Gan Di Xin® and Ahan® Antibacterial Paste), both of which have been fully commercialized. We have received a Pharmaceutical Manufacturing Permit, a Pharmaceutical Good Manufacturing Practices Certificate (“GMP Certificate”) and national drug registration approval from Gansu Provincial Food and Drug Administration for Gan Di Xin®. We have also obtained the Sanitary License for Manufactures of Disinfectant Products for the production of our Ahan® Antibacterial Paste.
High Production Capacity
Our Company has a maximum annual production capacity of 4,000 tons of oxytetracycline APIs, 3 billion oxytetracycline tablets, 1,000 tons of licorice APIs, 5,000 kilograms of heparin sodium, 4 million sausage casings and 100,000 tons of fertilizers. We believe that such production capacity of antibiotic raw materials gives us an advantage over our competitors in China. In addition, we believe that we have the largest fermentation and extraction manufacturing units in the country, which we believe offers a distinctive advantage over our competitors.
Experienced And Accomplished Leadership Team With a Proven Track Record
We have an experienced management team, and a majority of our members possess more than a decade of pharmaceutical, biomedical, chemical and related industry experience. We believe that our leadership team is well-positioned to lead us through development, regulatory approval and commercialization of our future products. Collectively, our management team has extensive experience in R&D, manufacturing and commercialization in Chinese biomedical and chemical industry. Our success in our current products reflects the significant experience that members of our management team have in their respective fields of expertise and their in-depth knowledge in the Chinese biomedical and chemical business.
Honors, Awards, and Qualifications
Honors
| Honors | Individual
or Entity Honored |
Agency | Date | |||
| Vice Presiding Entity of Northwestern Natural Herbal Medicine Technology Innovation Strategical Alliance | Gansu QLS | Northwestern Natural Herbal Medicine Technology Innovation Strategical Alliance | August 2010 | |||
| Vice Presiding Entity for Gansu Province Medical Industry Association | Gansu QLS | Gansu Province Medical Industry Association | May 2013 | |||
| The 3rd Governing Entity of China Narcotics Association | Gansu GLS | China Association of Narcotic Drugs | October 2014 | |||
| Vice Presiding Entity for Jiuquan City Environmental Protection Industrial Association | Gansu QLS | Jiuquan City Environmental Protection Industrial Association | March 2015 |
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Awards
| Awards | Individual
or Entity Awarded |
Agency | Date | |||
| Gansu Provincial Excellent Engineering Consulting Award (awarded to our CEO) | Zhanchang Xin, our CEO. | Gansu Provincial Development and Reform Commission | August 2010 | |||
| Gansu Province’s Famous Brand | Gansu QLS | Gansu Famous Brand Strategy Promotion Committee | December 2011 | |||
| Suzhou District Science and Technology Progress Award | Gansu QLS | Government of Suzhou District, Jiuquan City | August 2012 | |||
| 2013 China Chemical and Pharmaceutical Industry’s Excellent Product Brand (awarded to our Gan Di Xin® product) | Gansu QLS | China Chemical Pharmaceutical Industry Association, China Pharmaceutical Business Association, China Non-Prescription Drug Association, China Pharmaceutical Enterprise Development and Promotion Association | November 2013 | |||
| Famous Trademark of Gansu Province (awarded to our trademark Qilian Shan®) | Gansu QLS | Gansu Provincial Administration for Industry and Commerce | November 2014 | |||
| Gansu Province Circular Economy Exemplar Enterprise | Gansu QLS | Gansu Provincial Industry and Information Technology Commission | July 2015 | |||
| Nationally Recognized Enterprise Technology Center Status, Provincial Level | Gansu QLS | Gansu Provincial Industry and Information Commission, Gansu Provincial Development and Reform Commission, Gansu Provincial Science and Technology Department, Gansu Provincial Finance Department, Gansu Provincial State Taxation Bureau, Gansu Provincial Local Taxation Bureau | December 2015 | |||
| Famous Trademark of Gansu Province (awarded to our Gan Di Xin® product) | Gansu QLS | Gansu Provincial Administration for Industry and Commerce | December 2015 | |||
| Excellent Entrepreneur Award (awarded to our CEO) | Zhanchang Xin | China Petroleum and Chemical Industry Committee | July 2016 | |||
| Gansu Province “Specialized New Technology” Enterprise | Gansu QLS | Gansu Provincial Industry and Information Technology Commission | November 2017 | |||
| Strategic Emerging Growth Exemplar Enterprise | Gansu QLS | Gansu Provincial Development and Reform Commission | December 2018 | |||
| Little Giant Enterprise of Chengdu City | Chengdu QLS | Sichuan Provincial Economic and Information Commission, Sichuan Provincial SME Bureau, Chengdu City Economic and Information Commission | December 2018 | |||
| Petroleum and Chemical Industry “Specialized and Innovative” Small to Medium Enterprises (the “SME”) Award | Gansu QLS | China Petroleum and Chemical Industry Federation and China SME Development Committee | November 2019 | |||
| Chengdu City’s Unicorn Enterprise Award | Chengdu QLS | Chengdu City Municipal New Economy Commission | June 2019 | |||
| Sichuan Province “Specialized and Innovative” SME Award | Chengdu QLS | Sichuan Province Economic and Information Technology Commission | March 2020 | |||
| Sichuan Province “High-growth” SME Award | Chengdu QLS | Sichuan Province Economic and Information Technology Commission | March 2020 | |||
| Suzhou District “Tax Contribution Award” for 2019 | Gansu QLS | Suzhou District Committee and District Government of Jiuquan City |
March 2020 | |||
| 2020 Gansu Provincial Technology Innovation Model Enterprise | Gansu QLS | Gansu Province Industry and Information Technology Commission, Gansu Province Department of Finance | August 2020 | |||
| “Specialized and Innovative” Little Giant Enterprise of China | Gansu QLS | Ministry of Industry and Information Technology |
Approved* |
| * | On November 23, 2020, the publicity period for the award ended. Currently, we are waiting to receive the award certificate. |
Selective Criteria for the Awards
Gansu Provincial Excellent Engineering Consulting Award (awarded to our CEO Mr. Zhanchang Xin)
The Gansu Provincial Excellent Engineering Consulting Award is awarded by the Gansu Provincial Development and Reform Commission based on the comprehensive evaluation of the engineering consulting achievements accomplished by the applicant and such recognition is only awarded to engineering projects that have reached high level of ingenuity and economic potential within certain industry. Our “Gan Di Xin Industrialization Project” was recognized as such engineering project and Mr. Zhanchang Xin was recognized as having made outstanding contributions to the project during its establishment, implementation and completion stages.
Gansu Province’s Famous Brand
Gansu Province’s Famous Brand is awarded by Gansu Famous Brand Strategy Promotion Committee in accordance with the “Product Quality Law of the People’s Republic of China”, the “Quality Control Guideline of the State Council” and the “Quality Control Implementation Plan of Gansu Province”. In an effort to promote and cultivate excellent local brand of Gansu province, Gansu Famous Brand Strategy Promotion Committee carefully evaluates the applicant’s qualifications based on the following guidelines, which include but not limited to: brand-name strategy, products quality control, market share, customer satisfaction, annual profit and tax contribution, production cost and annual profit, applicant’s technological innovation and product development capabilities, and customer service.
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Suzhou District Science and Technology Progress Award
In August 2012, the Company’s project “Research and development of oxalic acid extracted from oxytetracycline raw material production waste liquid” was awarded the first prize of “Science and Technology Progress” by the People’s Government of Suzhou County, Jiuquan City. The award is given by the local people’s government after comprehensive evaluation of our project’s key quantitative and qualitative indicators such as technological innovation, project scale, overall technical difficulties involved, economic benefits conferred, and the promotion of scientific and technological progress in related industrial fields.
2013 China Chemical and Pharmaceutical Industry’s Excellent Product Brand (awarded to our Gan Di Xin®)
The Company’s product, Gan Di Xin®, was awarded “2013 China Chemical and Pharmaceutical Industry’s Excellent Product Brand” after a joint review process conducted by the China Chemical Pharmaceutical Industry Association, the China Pharmaceutical Business Association, and the China Pharmaceutical Enterprise Development Promotion Association. The review process was based on the following qualifications, which include but are not limited to, the Company’s R&D capabilities, marketing capabilities, technological innovation, and production scale.
Famous Trademark of Gansu Province (awarded to our trademark Qilian Shan®)
According to the “Trademark Law of the People’s Republic of China”, the “Regulations on the Implementation of the Trademark Law of the People’s Republic of China” and other laws and administrative regulations, the Gansu Provincial Administration for Industry and Commerce is authorized to award the “Famous Trademark of Gansu Province” title to eligible applicants based on the following qualifications, which include but not limited to: whether the trademark is publicly recognized and legally owned by the applicant, whether the trademark has high reputation/credibility and is well-known to the general public, whether the product behind the trademark is of superior quality than its competitors, and whether the customer service is satisfactory. The Gansu Provincial Administration for Industry and Commerce also evaluate the applicant’s key business indicators such as sales volume, local tax contribution, and annual profit increase in the past three years.
Gansu Province Circular Economy Exemplar Enterprise
According to the “Management Measures for the Identification and Assessment of Key Enterprises in Strategic Emerging Industries in Gansu Province” provided by the Provincial Development and Reform Commission, the Commission has the authority to award the Strategic Emerging Growth Exemplar Enterprise status to local enterprises with the following qualifications, which include but not limited to: well-known brand name within certain industry, high business growth, high contribution to local tax revenue, market competitiveness, and future development potential.
Nationally Recognized Enterprise Technology Center Status, Provincial Level
According to the “Gansu Provincial Level Nationally Recognized Enterprise Technology Center Recognition Measures”, Gansu Provincial Department of Industry and Information Technology, together with Gansu Provincial Development and Reform Commission, Gansu Provincial Department of Finance, State Taxation Bureau, and Gansu Provincial Taxation Bureau commissioned certain third-party institutions to conduct a comprehensive review of the applicant’s qualifications based on the following criteria, which include but not limited to: annual sales revenue, net profit, capitalization, production scales, competitive strength such as technological innovation, research and development capabilities, and ownership of intellectual property rights.
Famous Trademark of Gansu Province (awarded to our Gan Di Xin®)
According to the “Trademark Law of the People’s Republic of China”, the “Regulations on the Implementation of the Trademark Law of the People’s Republic of China” and other laws and administrative regulations, the Gansu Provincial Administration for Industry and Commerce is authorized to award the “Famous Trademark of Gansu Province” title to eligible applicants based on the following qualifications, which include but not limited to: whether the trademark is publicly recognized and legally owned by the applicant, whether the trademark has high reputation/credibility and is well-known to the general public, whether the product behind the trademark is of superior quality than its competitors, and whether the customer service is satisfactory. The Gansu Provincial Administration for Industry and Commerce also evaluate the applicant’s key business indicators such as sales volume, local tax contribution, and annual profit increase in the past three years.
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Excellent Entrepreneur Award (awarded to our CEO, Mr. Zhanchang Xin)
China National Petroleum Corporation and China Chemical Industry Federation jointly reviewed the qualification of Mr. Zhanchang Xin based on the following standards, which include but not limited to: the Company’s R&D capacity, the Company’s annual profit increase in the past five years, the Company’s major products, and the Company’s local and national tax contributions.
Gansu Province “Specialized New Technology” Enterprise
According to the “Guiding Opinions on Promoting the Development of Specialized New Technology Enterprises” and “Plans on Promoting the Development of Small and Medium-sized Enterprises” provided by the Ministry of Industry and Information Technology, the Gansu Provincial Department of Industry and Information Technology has the authority to award the “Specialized New Technology Enterprise” status to enterprises with the following qualifications, which include but not limited to: good operating status, complete and organized financial management system, high-tech industrial products encouraged by the local and central governments, high average annual growth rate of net profit (no less than 10%), low asset-liability ratio (less than 70%), high level of proficiency in business operation and management, high R&D capacity, high product quality, safe manufacturing environment, high financial credit, and high social credit.
Strategic Emerging Growth Exemplar Enterprise
According to the “Management Measures for the Identification and Assessment of Key Enterprises in Strategic Emerging Industries in Gansu Province” provided by the Provincial Development and Reform Commission, the Commission has the authority to award the Strategic Emerging Growth Exemplar Enterprise status to local enterprises with the following qualifications, which include but not limited to: well-known brand name within certain industry, high business growth, high contribution to local tax revenue, market competitiveness, and future development potential.
Little Giant Enterprise of Chengdu City Award
According to the “Notice for Carrying out the Cultivation of High-Growth SMEs and Small Giant Enterprises in 2018” (Enterprise Division of Sichuan Provincial Economic and Information Commission [2018] No. 136) issued by the Sichuan Provincial Economic and Information Commission and Sichuan Provincial SME Bureau, the Chengdu City Economic and Information Commission is authorized to award the “Little Giant Enterprise of Chengdu City” Award according to the following qualifications, which include but not limited to: sizes of the applicants’ manufacturing capabilities, annual profits, tax contributions, and annual business income.
Petroleum and Chemical Industry “Specialized and Innovative” Small to Medium Enterprises (the “SME”) Award
According to the “Measures for the Recognition of Petroleum and Chemical Industry “Specialized and Innovative” SMEs Award” and “Opinions on Promoting the Healthy Development of SMEs” issued by the General Office of the CPC Central Committee and General Office of the State Council, the China Petroleum and Chemical Industry Federation and China SME Development Committee are authorized to award Petroleum and Chemical Industry “Specialized and Innovative” SME Enterprises Award according to the following qualifications, which include but not limited to: well-known brand name within petroleum and chemical industry, strong R&D capacities, specialization and expertise in certain market segments, market competitiveness, ownership of certain highly competitive IPs, and management efficiencies.
Chengdu City’s Unicorn Enterprise Award
According to the "Notice of the Chengdu City Municipal New Economy Committee on Cultivating New Economic Enterprise 2018" (Chengdu City Municipal New Economy Development Committee [2018] No. 247) issued by the Chengdu City Municipal New Economy Committee, the Chengdu City Municipal New Economy Committee, with the help of qualified industrial experts and financial experts, is authorized to award the “Chengdu City’s Unicorn Enterprise”. Such award is based on, without limitation, investment qualifications, market capital estimation, and annual net income.
Sichuan Province “Specialized and Innovative” SME Award
According to the "Proposal on Cultivating Specialized and Innovative SMEs” and the “Notice on Carrying Out the Proposal of Cultivating Specialized and Innovative SMEs”, Sichuan Province Economic and Information Technology Commission is authorized to award the Sichuan Province “Specialized and Innovative” SME Award according to the following qualifications, which include but are not limited to: annual business income, annual profits, tax contributions, accounting credibility, social credits, and bank credits.
Sichuan Province “High-growth” SME Award
Sichuan Province Economic and Information Technology Commission is authorized to award the Sichuan Province “High-growth” SME Award based on the applicant’s annual business income in the past two years.
Suzhou District “Tax Contribution Award” for 2019
Suzhou District Committee and District Government of Jiuquan City are authorized to award the Suzhou District “Tax Contribution Award” for 2019 based on the applicant’s overall tax contributions in 2019.
2020 Gansu Provincial Technology Innovation Model Enterprise
Gansu Province Industry and Information Technology Commission and Gansu Province Department of Finance are authorized to award “2020 Gansu Provincial Technology Innovation Model Enterprise” based on the applicant’s annual business income, contribution to innovation evidenced by commercial application, credit worthiness, production scales, and others.
“Specialized and Innovative” Little Giant Enterprise of China
Following the guidance of the “Guiding Opinions on Promoting the Healthy Development of Small and Medium-Sized Enterprises” co-issued by the General Office of the Chinese Communist Party and the General Office of the State Council, and according to the “Notice of the Ministry of Industry and Information Technology on Cultivating the Second Round of ‘Specialized and Innovative’ Little Giant Enterprises of China,” the Small and Medium Sized Enterprises Bureau of the Ministry of Industry and Information Technology (the “MIIT”) is authorized to award the “Specialized and Innovative” Little Giant Enterprise of China to an enterprise according to certain criteria, including but are not limited to: financial conditions and results of operations, specialization and expertise in certain market segments, strong research and development capabilities, substantial market share, ownership of certain highly competitive intellectual properties, and management efficiency. Gansu QLS was included in the second batch of Little Giant Enterprises publicity list determined by the Small and Medium Sized Enterprises Bureau of the MIIT. During the publicity period, a list of prospective recipients was published on the official website of the MIIT, and anyone intending to raise objections against any prospective recipient of the award could file their objections with the MITT. On November 23, 2020, the publicity period ended, and no objection was filed against Gansu QLS. As of the date of this prospectus, we are waiting to receive the award certificate.
Qualifications
| Qualifications | Individual
or Entity Qualified |
Agency | Issue Date | Expiration Date | |||
| GMP Certificate for our Oxytetracycline Products | Gansu QLS | Gansu Provincial Food and Drug Administration | March 2015 | March 1, 2020* | |||
| GMP Certificate for our Licorice Products | Gansu QLS | Gansu Provincial Food and Drug Administration | August 2015 | August 19, 2020* | |||
| National Permit for Industrial Products Manufacturers | Qiming | Gansu Provincial Bureau of Quality and Technical Supervision | January 2018 | September 20, 2021 | |||
| Production Permit for Disinfection Product Manufacturers | Ahan | Gansu Provincial Health and Family Planning Commission | June 2017 | May 31, 2021 | |||
| China’s High-tech Enterprise Certificate | Gansu QLS | Gansu Provincial Department of Science and Technology, Gansu Provincial Department of Finance, Gansu Provincial Department of Taxation, Gansu Provincial Local Taxation Bureau | November 2017 | November 2023 (1) | |||
| Pollutant Discharge Permits | Gansu QLS | Jiuquan City Environmental Protection Bureau | December 2017 | December 28, 2020(2) | |||
| Gansu Province Fertilizer Official Registration Certificate | Qiming | Gansu Provincial Agriculture and Animal Husbandry | December 2017 | December 31, 2022 | |||
| Pharmaceutical Production License | Gansu QLS | Gansu Provincial Food and Drug Administration | August 2018 | February 17, 2021(3) | |||
| Fertilizer Registration Certificate for Xiongguan® Organic Fertilizer | Qiming | Ministry of Agriculture and Rural Affairs | May 2020 | May 2025 | |||
| Fertilizer Registration Certificate for Xiongguan® Organic-Inorganic Compound Fertilizer | Qiming | Ministry of Agriculture and Rural Affairs | May 2020 | May 2025 |
| Notes: | ||
| * | The Good Manufacturing Practice certification was cancelled pursuant to the Drug Administration Law, as amended on August 26, 2019 and effective from December 1, 2019. | |
| (1) | The certificate was valid for three years. Our renewal request was approved in September 2020. | |
| (2) | Our renewal application was under review as of December 2020. | |
| (3) | We have submitted our renewal application. As of December 2020, our renewal application was under review. |
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Regulations, Certificates and Permits
All pharmaceutical manufacturers, including TCMD and API manufacturers, must obtain pharmaceutical manufacturing permits from the NMPA’s relevant provincial branch. This permit is valid for five years and is renewable for an additional five-year period upon its expiration. Our current pharmaceutical manufacturing permit, issued by the CFDA, will expire on February 17, 2021. We will file a renewal request six months before the expiration date. In general, as long as a business entity operates legally and in good standing, its renewal request will be approved. We submitted the application materials for renewal of our pharmaceutical manufacturing permit to the competent authorities in August 2020 and completed the required on-site inspection process on November 13, 2020. We expect to obtain a renewed pharmaceutical manufacturing permit prior to the expiration of the current permit.
Good Manufacturing Practice (“GMP”) Standard — A pharmaceutical manufacturer must meet the GMP standards for each of its production facilities in China for each form of pharmaceutical product it produces. GMP standards include staff qualifications, production premises and facilities, equipment, raw materials, environmental hygiene, production management, quality control and customer complaint administration. If a manufacturer meets the GMP standards, the NMPA will issue to the manufacturer a GMP certificate with a five-year validity period. The New GMP Standards became effective on March 1, 2011 and pharmaceutical manufacturers (except manufacturers of injectables, blood products or vaccines, which have a three-year grace period) had a five-year grace period to upgrade existing facilities to comply with the new standards.
We have obtained all necessary GMP certificates for our manufacturing facilities to produce our products. The latest amended Drug Administration Law took effect on December 1, 2019 and has vacated the GMP certificate requirements for pharmaceutical companies. The current amended Drug Administration Law does not otherwise impose new regulatory requirements for pharmaceutical manufacturers and we do not need to renew our current GMP certificates. See “Regulations—PRC Laws and Regulations on Pharmaceutical Manufacture—GMP Certificates”.
In China, Category I Fertilizers are those fertilizers that have been used for many years domestically and have been established with national or industrial product executive standard. Category I Fertilizers are exempted from registration. These fertilizers include a vast majority of traditional chemical fertilizers such as ammonia sulfate, urea, calcium cyanimide, ammonium phosphate (mono and di), phosphor nitrate, superphosphate, potassium chloride, potassium sulfate and many others. Category II Fertilizers need to be registered with provincial agricultural department, which include: compound fertilizer; formula fertilizer (no foliar fertilizer), refined organic fertilizer and soil acid regulating agents. Fertilizers that do not fit in the above mentioned two categories should be registered with the Ministry of Agriculture of the People’s Republic of China, or the MoA.
Our Xiongguan® Organic-Inorganic Compound Fertilizer is a Category I fertilizer and our Xiongguan® Organic Fertilizer is a Category II fertilizer. We have obtained Gansu Province Fertilizer Official Registration Certificates on January 1, 2018, which are valid until December 2022, and National Manufacturing License for Industrial Products on August 5, 2016, which is valid until September 2021. We have also obtained a Fertilizer Registration Certificate of The People’s Republic of China, which was approved by the PRC Ministry of Agriculture on May 19, 2020 and valid until May 2025. The certificates and license enable us to legally manufacture our fertilizer products.
Intellectual Property
Protection of our intellectual property is a strategic priority for our business. We rely on a combination of patent, trademark and trade secret laws, as well as confidentiality agreements, to establish and protect our proprietary rights. We do not rely on third-party licenses of intellectual property for use in our business.
Through Gansu QLS, we currently hold ten Chinese patents. Gansu QLS’s current Chinese issued patents expire at various times from 2026 through 2027. Gansu QLS currently has two Chinese patent applications pending. Ahan currently has one Chinese patent application pending. Qiming currently has three Chinese patent applications pending. We have exclusive rights to utilize the processes issued patent rights within the valid term. As for other products of us and the related manufacturing processes, since the technology information has been published to public domain by national or local product standard, we are able to utilize such technology information without need to obtain any patent license. And we do not violate existing patent rights of any other party.
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The following table sets forth a brief description of the Company’s issued Chinese patents, including their respective publication numbers, application filing date, issue date, expiration date and title.
| Patent Number | File Date | Issue Date | Expiration
Date* |
Title | Status | |||||
| ZL 200410030776.4 | April 9, 2004 | October 25, 2006 | October 25, 2026 | Purification, thin-film coating and inclusion technology for the manufacturing of Gan Di Xin®. | Effective | |||||
| ZL 201521133480.5 | December 30, 2015 | June 22, 2016 | June 22, 2026 | A dust removal process. | Effective | |||||
| ZL 201521133504.7 | December 30, 2015 | August 24, 2016 | August 24, 2026 | A device for processing oxytetracycline residue. | Effective | |||||
| ZL 201521129906.X | December 31, 2015 | June 29, 2016 | June 29, 2026 | A treatment system for waste-water residues. | Effective | |||||
| ZL 201521133522.5 | December 30, 2015 | August 10, 2016 | August 10, 2026 | Double-effect concentrator. | Effective | |||||
| ZL 201621459387.8 | December 28, 2016 | July 7, 2017 | July 7, 2027 | A new type of oxytetracycline fermenter. | Effective | |||||
| ZL 201621454988.X | December 28, 2016 | July 7, 2017 | July 7, 2027 | A traditional Chinese medicine extracting device for ulcerative colitis treatments. | Effective | |||||
| ZL 201621464545.9 | December 28, 2016 | August 25, 2017 | August 25, 2027 | An insecticide spraying device for vegetables. | Effective | |||||
| 201822114750.8** | December 17, 2018 | December 6, 2019 | December 6, 2028 | An oxytetracycline residue neutralizer. | Effective | |||||
| 201822114757.x** | December 17, 2018 | December 6, 2019 | December 6, 2028 | An oxytetracycline crystallization mother liquor retriever. | Effective | |||||
| ZL 201920537937.0 | April 19, 2019 | March 10, 2020 | April 19, 2029 | A Chinese medicine extraction device | Effective | |||||
| ZL 201920726585.3 | May 12, 2019 | March 10, 2020 | May 21, 2029 | A medicine grinding machine | Effective | |||||
| ZL 201921243962.4** | August 2, 2019 | April 14, 2020 | August 2, 2029 | An air dying system for oxytetracycline production | Effective | |||||
| ZL 201921244754.6** | August 2, 2019 | April 14, 2020 | August 2, 2029 | A dryer for organic fertilizers production | Effective | |||||
| 201810214947.0 | March 15, 2018 | A production process of traditional Chinese herb based antibacterial cream. | PENDING | |||||||
| 201822121674.3 | December 18, 2018 | A sterilization filter for oxytetracycline fermentation liquid. | PENDING | |||||||
| 201910713025.9 | August 2, 2019 | Processing technology for bio-organic fertilizer. | PENDING | |||||||
| 201910713063.4 | August 2, 2019 | Processing technology for potassium humate flush fertilizers | PENDING | |||||||
| 201910712340.X | August 2, 2019 | Processing technology for sunflower organic fertilizers. | PENDING | |||||||
| 201921244766.9 | August 2, 2019 | A filter for producing liquor rice extract. | PENDING |
*Patent expiration dates are routinely subject to dispute in patent infringement actions. No assurance can be given that third parties infringing our patents will not dispute the expiration dates of our patents or that we will be successful in defending against such disputes.
** Utility model patents
Through Gansu QLS, we currently have nine Chinese trademarks. Gansu QLS’s current Chinese issued trademarks expire at various times from 2020 through 2028. Gansu QLS currently does not have any Chinese trademarks applications pending.
| Trademark Number | Issue Date | Expiration Date* | Trademark Title | |||
| 6084468 | February 14, 2010 | February 13, 2020 | 祁连山 (Qilian Shan)** | |||
| 3792776 | March 14, 2006 | March 13, 2026 | 甘帝欣 (Gan Di Xin) | |||
| 13679211 | March 7, 2015 | March 6, 2025 | 沙门果 (Shamen Guo) | |||
| 13679213 | March 7, 2015 | March 6, 2025 | 甘帝康 (Gan Di Kang) | |||
| 13679212 | March 7, 2015 | March 6, 2025 | 阿含 (Ahan) | |||
| 22534753 | April 7, 2018 | April 6, 2028 | 阿含斋 (Ahan Zhai) | |||
| 20810590 | September 21, 2017 | September 20, 2027 | 陌上发 (Moshangfa) | |||
| 10336012 | February 28, 2013 | February 27, 2023 | 雄关 (Xiongguan) | |||
| 27770670 | November 14, 2018 | November 13, 2028 | 猪小常 (Zhuxiaochang) | |||
| 37873604 | March 7, 2020 | March 6, 2030 | 祁連國際 (Qilian Guoji) |
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*Trademark expiration dates are routinely subject to dispute in trademark infringement actions. No assurance can be given that third parties infringing our trademark will not dispute the expiration dates of our trademarks or that we will be successful in defending against such disputes.
** The Company submitted a trademark renewal request for 祁连山 (Qilian Shan) to the China National Intellectual Property Administration (“CNIPA”) in July 2019. On February 14, 2020, the CNIP approved the renewal request for 祁连山 (Qilian Shan) and the Company obtained a registration certificate for the renewal of such trademark.
Research and Development
Our Company established a research and development department in 2015, with its Nationally Recognized Enterprise Technology Center status assessed and approved by the Gansu Provincial Industry and Information Commission, the Gansu Provincial Development and Reform Commission, the Gansu Provincial Science and Technology Department, Gansu Provincial Finance Department, the Gansu Provincial State Taxation Bureau, and the Gansu Provincial Local Taxation Bureau in December 2015. The Nationally Recognized Enterprise Technology Center status is a competitive honor awarded by Chinese government agencies, such recognition reflects the Company’s comprehensive strength in technological innovation and robust research and development (“R&D”) activities. After years of continued development, our R&D department has become the core of the Company’s technological innovation efforts, dramatically improving the Company’s R&D capabilities, enhancing the Company’s industry competitiveness, and, we believe, improving the Company’s overall business outlook.
R&D Achievements
Our research and development activities are project based and the number of projects we work on varies annually. As of October 31, 2020, we had 14 research and development professionals, three of whom have advanced degrees in Medicine and Traditional Medicine. The Director of our R&D department, Mr. Zhanchang Xin, is also the chairman and legal representative of Gansu QLS. Under Mr. Zhanchang Xin’s leadership, our R&D department contributed to the following recent accomplishments:
In the beginning of October 2016, Ahan established a TCMD research project borrowing ideas from medicines of Chinese Dai ethnicities. This research project created our innovative Ahan® antibacterial paste for the treatment of psoriasis, neurodermatitis and other skin ailments. The Company has completed all necessary filing procedure as required by PRC laws and the Ahan® Antibacterial Paste has been on the Chinese market since November 2017. We have filed a patent application on March 15, 2018 under patent number 201810214947.0, and the application is currently in the stage of substantive examination as of the date of this prospectus.
Gansu QLS has invested approximately RMB 1,000,000 for its mutational breeding experiment of oxytetracycline-producing bacteria. Currently, the Company has selected and bred superior strains and has successfully increased the average fermentation unit of oxytetracycline from 32000 U/ml to 35000 U/ml and beyond, thereby greatly improving our oxytetracycline product yield while reducing our production cost.
R&D Development Plan
The Company intends to continue focusing on R&D to improve the quality of its products. The Company also intends to develop new products and exploit unmet market demand in the near future.
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With the aid of advanced production technology and manufacturing facilities, our production capacity of oxytetracycline has reached its industrial upper limit. After thorough research and investigation, our R&D department has concluded that only through improving the quality of oxytetracycline strains can we lead to industrial break-through of oxytetracycline production capacity.
Regarding our fertilizer, our operating subsidiary Qiming will continue utilizing its advantage of abundant local raw material sources and expect to develop liquid-flushing fertilizer, crops fertilizer and pharmaceutical fertilizer that fulfills the agricultural production demands of various crops.
Our R&D department will further develop our Ahan® antibacterial paste to suit different skin types of our customers and appeal to customers from different ethnic and cultural regions in China. In addition, we will create more products so as to provide our customers with more choices. Pursuant to the Regulations on Sanitary and Safety Evaluation of Disinfectant Products issued by the National Health and Family Planning Committee on June 27, 2014, the Company shall file the sanitary and safety evaluation reports of its modified Ahan® antibacterial paste to the provincial health administrative branch before such product can be introduced to the Chinese market. The local authorities shall publish the filing information excluding commercial secrets. The Company’s filing procedures do not involve approval from the relevant authorities, and enterprises are not required to obtain any certificate in order to complete the filing procedure. We have completed the required filing process for our current version of Ahan® antibacterial paste in May 2017. We will also update the sanitary and safety evaluation report and file the updated report to the competent authorities for any modified Ahan antibacterial paste in the future.
Employees
We had 288, 280, 292, and 279 employees in total as of October 31, 2020 and September 30, 2019, 2018 and 2017, respectively. There are 227 employees in Gansu QLS, 17 employees in Qiming, and 44 employees in Chengdu QLS and they work in the following capacities: management, administration, supplement, production, quality control, R&D, strain cultivation, chemical residue cleaning, ingredient combination, disinfection, tablet making, drug preparation, packaging, equipment operator, plate framing, boiler management, bottle making, biochemistry monitoring, powder making, crystalizing, decolorization, docking, product loading, facility repair, air compressor management, water pump management, water treatment, plumbing, welding, hygiene, intestine cleaning, salting, salt disintegration, vehicle management and financial management.
As of October 31, 2020, our employees were located in Jiuquan City, Chengdu City and Qionglai City, China.
The following table sets forth a breakdown of employees by activity in Jiuquan City and Qionlai City for Gansu QLS, Qiming and Chengdu QLS as of October 31, 2020:
| Gansu QLS | Number of Employees |
||
| General Management | 20 | ||
| Manufacturing Management | 5 | ||
| Facility Management | 5 | ||
| Financial Management | 5 | ||
| Warehouse Management | 3 | ||
| Operators | 106 | ||
| Assay and Quality Control Department | 15 | ||
| Logistics Department | 6 | ||
| Laboratory and Facilities | 47 | ||
| Facility Maintenance | 6 | ||
| Sales Department | 5 | ||
| Procurement | 4 | ||
| Total | 227 | ||
| Qiming | Number of Employees |
||
| General Management | 4 | ||
| Sales Department | 1 | ||
| Statistics | 1 | ||
| Drivers | 4 | ||
| Facility Management | 1 | ||
| Operators | 6 | ||
| Total | 17 | ||
| Chengdu QLS | Number of Employees | ||
| General Management | 9 | ||
| Financial Department | 2 | ||
| Warehouse Management | 2 | ||
| Assay and Quality Control Department | 4 | ||
| Operators | 26 | ||
| Driver | 1 | ||
| Total | 44 |