(2) A Chinese subsidiary of the registrant, Kanghui Agricultural, as the WFOE, could acquire the operating company. Generally, Chinese law allows for a WFOE to acquire a Chinese operating company, which is not conducting business in a limited or prohibited industry under the
Catalogue of Industries for Guiding Foreign Investment
(the “Catalogue”), without the approval from the foreign investment authority in China. However, if the acquisition of a Chinese domestic company (even though the Chinese domestic company is not in a limited or prohibited industry under the Catalogue) by a WFOE is immediately after the establishment of the WOFE, the relevant foreign investment authority may challenge such acquisition for its possible intention of bypassing the New M&A Rules and may request that the WFOE go through the regulatory approval procedure. Generally, no further approval from the foreign investment authority is required for a WOFE that has been in operation for more than two years and the acquisition involves a Chinese domestic company which is not in a limited or prohibited industry under the Catalogue. In this instance, Kanghui Agricultural did not exist for two years prior to the transaction.
Payment of Cash for Capital Stock of Guangzhou Tanke
Under the direct equity structure, we would be required to pay the Tanke Shareholders cash for the capital stock of Guangzhou Tanke because stock-for-stock acquisitions are not permitted under Chinese law. It is stipulated in Article 29 of the New M&A Rules that if the equity of a foreign company is intended to be used as consideration in a stock-for-stock acquisition, such foreign company shall have been listed in an overseas market (excluding over-the-counter market) with a stable stock price for one year. If such foreign company is not a listed company, it has to be a “special purpose vehicle.” Under the New M&A Rules, the Company does not fall within definition of a “special purpose vehicle” because it is not directly or indirectly controlled by a Chinese company or natural person (Article 39 of the New M&A Rules). Further, the foreign investor which intends to adopt the stock-for-stock acquisition must also apply to the Ministry of Commerce, or MOFCOM. Currently, there is no successful precedent regarding MOFCOM approval of such stock-for-stock acquisition.
Tax Reasons
The structure provided by the VIE Agreements is tax-free to the Tanke Shareholders under applicable PRC law. Under the direct equity structure, the price for the equity of the operating company is based on the valuation by a qualified asset appraisal institution (Article 14 of the New M&A Rules). The income tax is based on the difference between the valued price and the actual selling price. A VIE structure will not trigger the shareholders of the operating company to pay income tax which will be otherwise applied in case of direct equity structure. We are unable to calculate the actual tax savings benefit because we did not have an appraisal of the operating company completed for the transaction.
Share Exchange
On February 9, 2011, pursuant to a Share Exchange Agreement, dated January 3, 2011 (the “Share Exchange Agreement”), between Greyhound, Golden Genesis and China Flying, the Company closed the Share Exchange and acquired all of the outstanding equity securities of China Flying from Golden Genesis, which was the sole shareholder of China Flying immediately prior to the closing of the Share Exchange. In exchange, we issued to Golden Genesis 10,758,000 newly issued shares of our common stock. In addition, pursuant to the terms of the Share Exchange Agreement, the Company effected a 1 for 8.512 reverse stock split to modify the Company’s capital structure to accommodate the transactions contemplated by the Share Exchange and the Private Placement and to put in place an appropriate capital structure for the Company following the closing of the Share Exchange and the Private Placement. Such securities were not registered under the Securities Act of 1933, as amended (the “Securities Act”). These securities qualified for exemption under Section 4(2) of the Securities Act since the issuance of securities by us did not involve a public offering. All references to number of shares and per share amounts included in this prospectus give effect to the 1 for 8.512 reverse stock split.
We consummated the Share Exchange in order to acquire China Flying and Kanghui Agricultural. Pursuant to the terms of the VIE Agreements, the Share Exchange also resulted in us acquiring control of the business and operations of Guangzhou Tanke.
Private Placement
On February 9, 2011, we entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with certain accredited investors who are selling stockholders in this offering (each, including their respective successors and assigns, an “Investor” and collectively, the “Investors”) and, with respect to certain sections of the Securities Purchaser Agreement, Euro Pacific Capital, Inc. (“Euro Pacific”) and Newbridge Securities Corporation, relating to the Private Placement of 6,669,627 Units at a purchase price of $1.15 per Unit. Each Unit consisted of a $1.15 principal amount 8% Senior Convertible Note and a Common Stock Purchase Warrant to purchase one share of the Company’s common stock, with an exercise price of $1.40 per share. We sold 6,669,627 Units in the Private Placement, for gross proceeds of $7,670,071.50. In addition, in connection with the Private Placement, we also issued to certain affiliates of Euro Pacific, our lead placement agent in the Private Placement, three-year warrants (the “Agent Warrants”) to purchase an aggregate of 666,963 shares of our common stock at an exercise price of $1.15 per share. The Private Placement met the requirements to qualify for exemption under Regulation D promulgated under the Securities Act.
The Notes are convertible into shares of our common stock at a price of $1.15 per share (subject to customary weighted average and stock based anti-dilution protection) and are payable 24 months from the date of their issuance with an interest rate of 8% per annum payable semiannually in arrears. Each three-year Warrant entitles the holder to purchase one share of our common stock, with an exercise price of $1.40 per share (subject to customary weighted average and stock based anti-dilution protection). We also issued to certain affiliates of Euro Pacific, our lead placement agent in the Private Placement, three-year Agent Warrants to purchase an aggregate of 666,963 shares of common stock at an exercise price of $1.15 per share. The Agent Warrants also contain a cashless exercise option. The issuance of the Notes and the Warrants was not registered under the Securities Act as such issuance was exempt from registration under Section 4(2) of the Securities Act and Regulation D. The issuance of the Agent Warrants was exempt from registration under Section 4(2) of the Securities Act.
In connection with the closing of the Private Placement, we also entered into the following additional agreements:
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Registration Rights Agreement
. We entered into a Registration Rights Agreement (the “Registration Rights Agreement”) with the Investors which sets forth the rights of the Investors to have the shares of common stock underlying the Notes and Warrants registered with the SEC for public resale. The filing of the registration statement of which this prospectus is a part is intended to satisfy certain of our obligations under the terms of the Registration Rights Agreement. We also entered into a Registration Rights Agreement with the Investors.
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Pursuant to the Registration Rights Agreement, we agreed to file, no later than April 11, 2011, a registration statement to register the shares underlying the Notes and the Warrants and to have such registration statement effective no later than September 18, 2011. If the registration statement was not filed by April 11, 2011 (the “Filing Failure”), is not effective by September 18, 2011 (the “Effectiveness Failure”) or if, after the effective date, sales of securities included in the registration statement cannot be made (including, without limitation, because of a failure to keep the registration statement effective, to disclose such information as is necessary for sales to be made pursuant to the registration statement, to register a sufficient number of shares of Common Stock or to maintain the listing of the Common Stock) (a “Maintenance Failure”) then, as liquidated damages (and in complete satisfaction and to the exclusion of any claims or remedies inuring to any holder of the securities) the Company is required to pay an amount in cash equal to 1% of the aggregate purchase price paid by the Investors on each of the following dates: (i) 20 days following the date of a Filing Failure; (ii) 30 days following the initial day of a Maintenance Failure; (iii) on every thirtieth day thereafter (pro-rated for periods totaling less than thirty days) until such failure is cured; (iv) on every thirtieth day after the day of an Effectiveness Failure and thereafter (pro rated for periods totaling less than thirty days) until such Effectiveness Failure is cured; (v) on every thirtieth day after the initial day of a Maintenance Failure and thereafter (pro rated for periods totaling less than thirty days) until such Maintenance Failure is cured. The payments to be made by the Company are limited to a maximum of 6% of the aggregate amount paid by the Investors ($460,204.29). As of March 30, 2012, we accrued the maximum amount of $460,206 for registration delay penalty.
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Interest Escrow Agreement
. We entered into an Escrow Agreement (the “Interest Escrow Agreement”) with Euro Pacific and Escrow, LLC (the “Escrow Agent”), as escrow agent, pursuant to which the Company deposited into escrow an amount of proceeds of the Private Placement equal to one semi-annual interest payment on the Notes to secure prompt interest payments under the Notes. Until such time as 75% of the Notes are converted into shares of common stock, if such escrow is depleted in order to make interest payments, the Company has agreed to promptly replenish such escrow amount.
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Securities Escrow Agreement
. We entered into a Securities Escrow Agreement (the “Securities Escrow Agreement”) with Euro Pacific, as representative of the Investors, Golden Genesis and the Escrow Agent, as escrow agent, pursuant to which Golden Genesis placed in escrow 2,000,000 shares of common stock, to be disbursed to either the Investors on a pro rata basis or to Golden Genesis based on the financial performance of Guangzhou Tanke, our principal operating business, for the fiscal years ending December 31, 2011 and 2012.
We did not achieve the Adjusted Income of $4,652,410 for the year ended December 31, 2011, therefore 1,000,000 shares of common stock placed in escrow have been distributed to the Investors on a pro rata basis, pursuant to the terms of the Securities Escrow Agreement.
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Corporate Name Change
On February 8, 2011, in connection with the closing of the Share Exchange and Private Placement, we filed a Certificate of Amendment to our Articles of Incorporation with the Secretary of State of the State of Nevada to change our corporate name from “Greyhound Commissary, Inc.” to “Tanke Biosciences Corporation”, a name that more accurately reflects the business operations of the Company following the closing of the Share Exchange. The name change was effective as of February 10, 2011.
Our Organizational Structure
Our organization structure is illustrated below:
Mr. Guixiong Qiu is the sole director of the Company and Golden Genesis, the Company’s largest stockholder. Other than Mr. Qiu, Golden Genesis does not have other directors or officers. Ms. Wong Kwai Ho is the sole director of China Flying. Ms. Wu Chun Rui is the sole director of Kanghui Agricultural and the legal representative who is authorized to sign corporate documents on behalf of Kanghui Agricultural. Mr. Guixiong Qiu, Mr. Bi Gao, Mr. Xugang Shu, and Ms. Xiuzhen Liang are the directors and officers of Guangzhou Tanke and its subsidiaries, Guangzhou Tanke Bio-Tech Co., Ltd., Guangzhou Jenyi Bio-Tech Co., Ltd., and Guangzhou Tanke Animal Health Co.
Implications of Being an Emerging Growth Company
We qualify as an emerging growth company as that term is used in the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other burdens that are otherwise applicable generally to public companies. These provisions include:
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A requirement to have only two years of audited financial statements and only two years of related MD&A;
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Exemption from the auditor attestation requirement in the assessment of the emerging growth company’s internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002;
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Reduced disclosure about the emerging growth company’s executive compensation arrangements; and
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No non-binding advisory votes on executive compensation or golden parachute arrangements.
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We have already taken advantage of these reduced reporting burdens in this prospectus, which are also available to us as a smaller reporting company as defined under Rule 12b-2 of the Exchange Act.
In addition, Section 107 of the JOBS Act also 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 for complying with new or revised accounting standards. We have elected to use the extended transition period provided above and therefore our financial statements may not be comparable to companies that comply with public company effective dates.
We could remain an emerging growth company for up to five years, or until the earliest of (i) the last day of the first fiscal year in which our annual gross revenues exceed $1 billion, (ii) the date that we become a “large accelerated filer” as defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended, which would occur if the market value of our common stock that is held by non-affiliates exceeds $700 million as of the last business day of our most recently completed second fiscal quarter, or (iii) the date on which we have issued more than $1 billion in non-convertible debt during the preceding three year period.
The Offering
Common stock outstanding immediately before this offering:
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13,324,083 shares
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Common stock offered by the selling stockholders:
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Up to 16,173,130 shares underlying securities held by the selling stockholders
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Common stock outstanding immediately after this offering:
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Up to 27,330,300 shares, assuming full conversion of the principal on the Notes and exercise of the Warrants, but no conversion of any interest accrued on the Notes.
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OTCBB Symbol:
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TNBI (formerly GHND). No active market for our common stock presently exists.
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Use of proceeds:
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We will not receive any proceeds from the sale of the common stock offered hereby. However, we may receive up to a maximum of $17,007,548.85 of proceeds from the conversion of Notes and exercise of Warrants by certain selling stockholders, which proceeds we would expect to use for general working capital. No assurances can be given, however, that all or any portion of such warrants will ever be exercised.
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Risk Factors:
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Investing in our 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 section of this prospectus entitled “Risk Factors.”
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RISK FACTORS
Our business, as well as our common stock, are highly speculative in nature and involve a high degree of risk. Our securities should be purchased only by persons who can afford to lose their entire investment. Accordingly, prospective investors should carefully consider, along with other matters referred to herein, the following risk factors in evaluating our business before purchasing any of our common stock.
Risks Related to Our Business
We may not possess all the licenses required to operate our business, or may fail to maintain the licenses we currently hold. This could subject us to fines and other penalties, which could have a material adverse effect on our results of operations.
We are required to hold a variety of permits, licenses and certificates to conduct our business in China and we may not possess all of the permits, licenses and certificates required for our business. We entered into a Land Lease Agreement valid from May 20, 2006 to May 20, 2021 with the government of Huaqiao Town, Huadu District, Guangzhou under which the Government of Huaqiao Town granted us a land use right covering the land where our manufacturing facility currently stands. This lease will be superseded by a Land Use Right Certificate and will be automatically terminated once we obtain such certificate. Due to changes in the relevant PRC regulations, we have not been granted such certificate for this land. Therefore, pursuant to applicable PRC law, we are not permitted to operate our manufacturing facility without such certificate and as a result, there is a risk that the PRC government may declare our Land Lease Agreement invalid.
We are currently negotiating with the local government to obtain a Land Use Right Certificate, which would permit us to operate our business as it is currently conducted. Without the Land Use Right Certificate, we are unable to apply for a Property Ownership Certificate for our manufacturing facilities. Until we obtain the Land Use Right Certificate, the PRC government may evict our personnel from the premises and remove our manufacturing facilities that we built on the premises. Such action would have a very significant and negative impact on our operations and business.
In addition, there may be other circumstances under which the approvals, permits, licenses or certificates granted by the governmental agencies are subject to change without substantial advance notice, and it is possible that we could fail to obtain the approvals, permits, licenses or certificates that are required to expand our business as we intend. If we fail to obtain or to maintain such permits, licenses or certificates, or renewals are granted with onerous conditions, we could be subject to fines and other penalties and be limited in the number or the quality of the products that we would be able to offer. As a result, our business, result of operations and financial condition could be materially and adversely affected.
Concerns with the safety and quality of agricultural feed additive products could cause customers to avoid our products.
We could be adversely affected if our customers and the ultimate consumers of our feed additive products lose confidence in the safety and quality of various feed additive products. Adverse publicity about these types of concerns may discourage our customers from buying our products or cause production and delivery disruptions. Any negative change in customer perceptions about the safety and quality of our feed additive products could adversely affect our business and financial condition.
If our feed additive products become adulterated or misbranded, we would need to recall those items and may experience product liability claims if consumers are injured as a result.
Animal feed products occasionally contain contaminants due to inherent defects in those products or improper storage or handling. Under adverse circumstances, animal feed manufacturers may need to recall some of their products if they become adulterated or misbranded, and may also be liable if the consumption of any of their products causes injury. A widespread product recall could result in changes to one or more of our business processes, product shortages, loss of customer confidence in our products or other adverse effects on our business. If we are required to defend against a product liability claim, whether or not we are found liable under the claim, we could incur substantial costs, our reputation could suffer and our customers might substantially reduce their existing or future orders from us.
We face significant competition in the sales of our agricultural feed additive products.
Competition in the feed additive industry, especially with companies with greater resources, may make us unable to compete successfully, which could adversely affect our business.
In general, the competitive factors in the feed additive industry in China include:
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price;
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product quality;
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brand identification;
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breadth of product line; and
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customer service.
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To the extent that our products and services do not exhibit these qualities, our ability to compete will be hindered.
The markets in which we operate are highly competitive and fragmented and we may not be able to maintain market share.
We operate in highly competitive markets and compete with numerous local Chinese feed additive manufacturers. We expect competition to persist and intensify in the future. Our domestic competitors are mainly leaders in the feed additive markets in China. Our small local competitors may have better access in certain local markets to customers and prospects, an enhanced ability to customize products to a particular region or locality and more established local distribution channels within a small region. We also compete with large Chinese national and multi-national competitors who may have competitive advantages over us in certain areas such as access to capital, technology, product quality, economies of scale and brand recognition and may also be better positioned than us to develop superior product features and technological innovations and to exploit and adapt to market trends. Due to the lack of publicly available information about our competitors and industry, we may not be able to conduct in-depth research and analysis on our current or new markets. Therefore, we may not be able to determine our direct competitors, such competitors' revenues or market share.
In addition, China’s entry into the World Trade Organization may lead to increased foreign competition for us. International producers and traders import products into China that generally are of higher quality than those produced in the local Chinese market. We may face additional competition if these products are considered to be better than the type of feed additives we produce. If we are not successful in our marketing and advertising efforts to increase awareness of our brands, our revenues could decline, which could have a material adverse effect on our business, financial condition, results of operations and share price. We may not be able to compete successfully against existing or new competition in our markets.
We may not be able to fully implement our current business strategy if we are unable to develop a second manufacturing facility.
As part of our current business strategy, we intend to continue to increase our production volume in order to gain additional market share. In connection with that strategy, we plan to build a second manufacturing facility that would double our organic trace mineral production capacity. There is a risk that we may be unable to finish construction of the new facility, or operate it at a profit. If we are unable to achieve any or all of the foregoing it could have a material adverse effect on our business and results of operations.
We cannot be certain that our feed additive product innovations and marketing achievements to date will continue.
We believe that our past performance has been based on, and our future prospects will depend upon, in large part, our ability to continue to improve our existing feed additive products or develop new feed products. We may not be successful in introducing, marketing and producing any new feed products or feed additive product innovations, or that we will develop and introduce, in a timely manner, innovations to our existing products which satisfy customer needs or achieve market acceptance. Our failure to develop new feed additive products and introduce them successfully and in a timely manner could harm our ability to grow our business and could have a material adverse effect on our business, results of operations and financial condition.
We purchase many commodities that we use for raw materials and packaging; price changes for such commodities may adversely affect our profitability.
The raw materials used in our feed additive business are largely commodities that experience price fluctuations caused by external conditions and changes in governmental agricultural programs that we cannot control. As a result, we try to recover our commodity cost increases by increasing prices, promoting a higher-margin product mix and creating additional operating efficiencies. Substantial increases in the prices of packaging materials, such as corrugated cardboard, aluminum products, films and plastics, or higher prices of our raw materials could adversely affect our operating performance and financial results. Any substantial fluctuation in the prices of raw materials, if not offset by increases in our sales prices, could adversely affect our profitability.
Outbreaks of livestock disease can adversely affect sales of our products.
Outbreaks of livestock diseases can significantly affect demand for our feed additive products and could result in governmental restrictions on the sale of livestock products to or from customers, or require our customers to destroy their feeds. This could result in the cancellation of orders of feed additive products by our customers and create adverse publicity that may have a material adverse effect on the agricultural products industry and our ability to market our products successfully.
We do not typically have long-term sales contracts with our customers and our customers could at any time reduce purchases of, or entirely cease purchasing, our products, harming our operating results and business.
We typically do not have long-term volume sales contracts with our customers. Accordingly, our customers could reduce their purchases from us or cease purchasing our products altogether when a particular contract expires. A variety of factors, including economic, health, regulatory, political and social instability, could contribute to a slowdown in the demand or a reduction in the market price for our products because poultry demand and pricing is highly correlated with general economic activities. If any of our customers experience serious financial difficulties, it may lead to a decline in sales and write-offs of accounts receivable, which could harm our results of operations.
The cessation of tax exemptions and deductions by the Chinese government may affect our profitability.
On March 16, 2007, the National People’s Congress of China enacted a new tax law, or the New Tax Law, whereby both foreign investment enterprises, or FIEs, and domestic companies will be subject to a uniform income tax rate of 25%. On November 28, 2007
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the State Council of China promulgated the Implementation Rules of the New Tax Law, the “Implementation Rules”. Both the New Tax Law and the Implementation Rules have become effective on January 1, 2008. Both the New Tax Law and the Implementation Rules provide tax exemption treatment for enterprises engaged in agricultural industries, such as farming, foresting, fishing and animal husbandry. We have been informed that certain of our Chinese subsidiaries are eligible for relevant preferential tax treatment, including tax reduction and exemption, and certain of our products are exempted from value added tax. In the future, if the relevant tax authorities determine that Guangzhou Tanke, our principal operating business, is not eligible for tax exemption treatment it may materially and adversely affect our profits, business and financial performance.
Potential environmental liability could have a material adverse effect on our operations and financial condition.
As a manufacturer, we are subject to various Chinese environmental laws and regulations on air emission, waste water discharge, solid wastes and noise. The Environmental Protection Bureau of Huadu District, Guangzhou issued the Opinion on the Environmental Impact Statement regarding the Construction Project of Tanke Group on February 16, 2004. To date, we have not obtained any documentation of environment appraisal and acceptance inspection with respect to the completion of projects of the factory buildings and the production lines, because we have not obtained a Land Use Right Certificate for such site nor have we been granted Property Ownership Certificate. We are in the process of applying for a Land Use Right Certificate, which will enable us to obtain an environmental appraisal and acceptance inspection with respect to our facilities. Following our receipt of a Land Use Right Certificate, we anticipate that we will be able to obtain the necessary environmental approvals, but there can be no assurance in this regard. We may not be able to comply with environmental regulations at all times as the Chinese environmental legal regime is evolving and becoming more stringent. Therefore, if the Chinese government imposes more stringent regulations in future, we may have to incur additional and potentially substantial costs and expenses in order to comply with new regulations, which may negatively affect our results of operations. Furthermore, no assurance can be given that all potential environmental liabilities have been identified or properly quantified or that any prior owner, operator, or tenant has not created an environmental condition unknown to us. If we fail to obtain our Land Use Right Certificate or to comply with any of the present or future environmental regulations in any material aspects, we may suffer from negative publicity and be subject to claims for damages that may require us to pay substantial fines or have our operations suspended or even be forced to cease operations.
We do not presently maintain business disruption insurance and any disruption of the operations in our production facility would damage our business.
All of our feed additive products are currently manufactured in our production facility in the Huadu Economic Development Zone near the capital city of Guangzhou in the province of Guangdong, China. Our operations could be interrupted by fire, flood, earthquake and other events beyond our control. Any disruption of the operations in our production facility would have a significant negative impact on our ability to manufacture and deliver products as we would likely be unable to outsource our production on terms favorable to us, if at all. Failure to replace any lost production capability would cause a potential reduction in sales, the cancellation of orders, loss of valuable employees, damage to our reputation and potential lawsuits.
Our products and processes can expose us to product liability claims.
Product liability claims or product recalls can adversely affect our business reputation and expose us to increased scrutiny by local, provincial, and central governmental regulators. The packaging, marketing and distribution of agricultural feed additive products entail an inherent risk of product liability and product recall and the resultant adverse publicity. We may be subject to significant liability if the consumption of any of our products causes injury, illness or death of livestock, other animals or humans. We could be required to recall certain of our feed additive products in the event of contamination or damage to the products. In addition to the risks of product liability or product recall due to deficiencies caused by our production or processing operations, we may encounter the same risks if any third party tampers with our feed additive products. We may be required to perform product recalls, or that product liability claims will be asserted against us in the future. Any claims that may be made may create adverse publicity that would have a material adverse effect on our ability to market our feed additive products successfully or on our business, reputation, prospects, financial condition and results of operations. A successful product liability claim in excess of our insurance coverage could have a material adverse effect on us and could prevent us from obtaining adequate product liability insurance in the future on commercially reasonable terms.
Our current and future operations substantially depend on our management team and other key personnel, the loss of any of whom could disrupt our business operations.
Our business does and will depend in substantial part on the continued service of our senior management and founder, including but not limited to Guixiong Qiu, Xugang Shu and Bo Jun. The loss of the services of one or more of our key personnel could impede implementation and execution of our business strategy and result in the failure to reach our goals. We do not carry key person life insurance for any of our officers or employees. Our future success will also depend on the continued ability to attract, retain and motivate highly qualified personnel in the diverse areas required for continuing our operations. The rapid growth of the economy in China has caused intense competition for qualified personnel. We may not be able to retain our key personnel or that we will be able to attract, train or retain qualified personnel in the future.
Volatile energy prices could adversely affect our operating results.
In the last few years, energy prices have risen dramatically and are now volatile, which has resulted in increased and unpredictable increases for our raw materials costs. Continued or volatile increases in energy prices could adversely affect demand for our feed products and increase our operating costs, both of which would reduce our operating income.
If we need additional financing, we may not be available to find such financing on satisfactory terms or at all. The cost of obtaining additional financing may adversely affect our stockholders or the financial interests of the Company.
Our capital requirements may be accelerated as a result of many factors, including the growth and timing of our business development activities, budget shortfalls, unanticipated expenses or capital expenditures, future product opportunities, future licensing opportunities and future business combinations. Consequently, we may need to seek additional debt or equity financing, which may not be available on favorable terms, if at all, and which may be dilutive to our stockholders.
We may seek to raise additional capital through public or private equity offerings, debt financings or additional corporate collaboration and licensing arrangements. To the extent we raise additional capital by issuing equity securities, our stockholders may experience dilution. To the extent that we raise additional capital by issuing debt securities, we may incur substantial interest obligations, may be required to pledge assets as security for the debt and may be constrained by restrictive financial and/or operational covenants. Any provider of debt financing would also be superior position to our stockholders’ interest in the event of a bankruptcy or liquidation. To the extent we raise additional funds through collaboration and licensing arrangements, it may be necessary to relinquish some rights to our technologies or product candidates, or grant licenses on unfavorable terms.
We face risks associated with currency exchange rate fluctuations; any adverse fluctuation may adversely affect our operating margins
Almost all
of our revenues are denominated in Renminbi. Conducting business in currencies other than US dollars subjects us to fluctuations in currency exchange rates that could have a negative impact on our reported operating results. Fluctuations in the value of the US dollar relative to other currencies impact our revenues, cost of revenues and operating margins and result in foreign currency translation gains and losses. If the exchange rate of the Renminbi is affected by lowering its value as against the US dollar, our reported profitability when stated in US dollars will decrease. Historically, we have not engaged in exchange rate hedging activities and have no current intention of doing so.
We may not be able to adequately protect and maintain our intellectual property, trademark, and brand names.
Our business has and will depend on our ability to continue to develop and market feed additive products. We currently own two patents and have entered into an exclusive licensing agreement with respect to two other patents covering aspects of the manufacturing and production of feed additives. We have filed applications for five additional patents. Our inability to protect our rights to this intellectual property may adversely affect our ability to prevent competitors from using our products and developments.
Intellectual property rights in China are still developing, and there are uncertainties involved in the protection and the enforcement of such rights. We will need to pay special attention to protecting our intellectual property and trade secrets. Failure to do so could lead to the loss of a competitive advantage that could not be compensated by our damages award.
We have elected to use the extended transition period for complying with new or revised accounting standards under Section 102(b)(2)(b) of the JOBS Act and therefore our financial statements may not be comparable to companies that comply with public company effective dates.
We have elected to use the extended transition period for complying with new or revised accounting standards under Section 102(b)(2)(b) of the JOBS Act allowing us to delay the adoption of new or revised accounting standards that have different effective dates for public and private companies and therefore our financial statements may not be comparable to companies that comply with public company effective dates.
Risks Related to Our Corporate Structure
The Chinese government may determine that the VIE Agreements which we utilize to operate Guangzhou Tanke are not in compliance with applicable Chinese laws, rules and regulations and that they are therefore unenforceable.
In China it is widely understood that foreign investment enterprises, or FIEs, are forbidden or restricted from engaging in certain businesses or industries which are sensitive to the economy. As we intend to centralize our management and operation in China without being restricted to conduct certain business activities which are important for our current or future business but are restricted or might be restricted in the future, we believe our VIE Agreements will be essential for our business operation.
A WFOE that operates for certain period of time is allowed to further acquire or invest in a Chinese domestic company, which is not in a limited or prohibited industry under the Catalogue, without approval from the Chinese foreign investment authority. Assuming that the WFOE, Kanghui Agricultural, has been operating for a certain period of time, the acquisition of the operating company (as being in the encouraged industry) by the WFOE will need no approval from foreign investment authority. However, after acquisition by WFOE, if the operating company intends to expand or invest in another Chinese domestic company (which is a limited or prohibited industry under the Catalogue) in the future, such acquisition or investment may need further approval from the foreign investment authority or may be rejected in case of prohibited industry because of its direct foreign investment background, such further acquisition or investment by the operating company may raise the concern of the foreign investment authority for its possible intention of bypassing the restrictions imposed under the Catalogue regarding the limited and prohibited industry for foreign investment.
Under the VIE structure, the operating company has no foreign investment background. Its future business expansion or investment will not be subject to the restrictions imposed under the Catalogue for foreign investment.
Pursuant to the terms of the VIE Agreement, almost all of our business activities in China are managed and operated by China Flying though Kanghui Agricultural, and almost all economic benefits and risks arising from the business of Guangzhou Tanke are transferred to China Flying and Kanghui Agricultural.
There are risks involved with the operation of Guangzhou Tanke under the VIE Agreements. We received an opinion, dated January 4, 2011, from Martin Hu & Partners, our PRC legal counsel, that if the Chinese government determines the VIE Agreement used to control the operating company to be unenforceable as they circumvent the Chinese restrictions relating to foreign investment restrictions, the relevant regulatory authorities would have broad discretion in dealing with such breach, including:
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imposing economic penalties;
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discontinuing or restricting the operations of China Flying, Kanghui Agricultural or Guangzhou Tanke;
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imposing conditions or requirements in respect of the VIE Agreements with which Kanghui Agricultural or Guangzhou Tanke may not be able to comply;
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requiring us to restructure the relevant ownership structure or operations;
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taking other regulatory or enforcement actions that could adversely affect our business; and
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revoking the business license and/or the licenses or certificates of China Flying or Kanghui Agricultural, Guangzhou Tanke, and/or voiding the VIE Agreements.
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Any of these actions could have a material adverse impact on our business, financial condition and results of operations. Under PRC law the feed additive industry is not currently prohibited from receiving direct foreign investments. We implemented the VIE Agreements in order to ensure that if PRC law changes in the future that it will not adversely affect us.
We depend upon the VIE Agreements in conducting our operations in China, which may not be as effective as direct ownership.
We conduct our business through our Chinese operating subsidiaries and generate the revenues through the VIE Agreements. The VIE Agreements may not be as effective as direct ownership in providing us with control over Guangzhou Tanke. Under the VIE structure, if the parties breach or terminate any one of the VIE agreements, the WFOE (namely, Kanghui Agricultural) may not be able to receive the agreed benefits or profits from the operating company, which will in turn have an impact on distributing funds to the registrant.
The VIE Agreements are governed by Chinese laws and provide for the resolution of disputes through arbitration proceedings pursuant to Chinese laws. Accordingly, the VIE Agreements will be interpreted in accordance with Chinese laws. If Guangzhou Tanke or its shareholders fail to perform the obligations under the VIE Agreements, we may have to rely on legal remedies under Chinese laws, including seeking specific performance or injunctive relief, and claiming damages, and there is a risk that we may be unable to obtain these remedies. The legal environment in China is not as developed as in other jurisdictions. As a result, uncertainties in the Chinese legal system could limit our ability to enforce the VIE Agreements.
The pricing arrangement under the VIE Agreements may be challenged by Chinese tax authorities.
We could face adverse tax consequences if Chinese tax authorities determine that the VIE Agreements were not entered into based on arm’s length negotiations. If the Chinese tax authorities determine that the VIE Agreements were not entered into on an arm’s length basis, they may adjust the income and expenses of our company for Chinese tax purposes which could result in higher tax liability.
Any deterioration of the relationship between Kanghui Agricultur al and Guangzhou Tanke could materially and adversely affect the overall business operation of our company.
Our relationship with Guangzhou Tanke is governed by the VIE Agreements, which are intended to provide us, through our ownership of China Flying and indirect ownership of Kanghui Agricultural, with effective control over the business operations of Guangzhou Tanke. Guangzhou Tanke could violate the VIE Agreements, go bankrupt, suffer from difficulties in its business, fail to renew necessary permits and certifications or otherwise become unable to perform its obligations under the VIE Agreements and, as a result, our operations, reputation, business and stock price could be severely harmed.
If Kanghui Agricultural exercises the purchase options over Guangzhou Tanke’s equity pursuant to the VIE Agreements, the payment of purchase prices could materially and adversely affect our financial position.
Under the VIE Agreements, China Flying, through its ownership of Kanghui Agricultural, holds an option to purchase all or a portion of the equity of Guangzhou Tanke at a price, pro rata in case of not all, based on the capital paid in by the Tanke Shareholders ($1,147,704 or 9.5 million RMB). If applicable Chinese laws and regulations require an appraisal of the equity interest or provide other restrictions on the purchase price, the purchase price shall be the lowest price permitted under the applicable Chinese laws and regulations. As Guangzhou Tanke is already a contractually controlled affiliate to our company, Kanghui Agricultural’s purchase of Guangzhou Tanke’s equity would not bring immediate benefits to us. Due to the existence of the VIE Agreements, we currently receive all of the revenue of Guangzhou Tanke, after the payment of taxes. Therefore, even if we own Guangzhou Tanke, we will not have a stronger claim to its revenue. In addition, payment of the option price would significantly decrease our cash and this reduction of cash would have a material adverse impact on our financial position.
If the consulting service agreement between Kanghui Agricultural and Guangzhou Tanke is terminated, it could materially and adversely affect the business operation of our company.
Either Guangzhou Tanke or Kanghui Agricultural may terminate the consulting service agreement entered into by and between them as part of the VIE agreements if circumstances arise that could materially and adversely affect the performance of the objectives of this agreement. We may close our control over the operations of Guangzhou Tanke if the consulting service agreement is terminated.
Risks Associated With Doing Business in China
If Guangzhou Tanke’s land use rights are revoked, we would have no operational capabilities.
Under Chinese law, land is owned by the state or rural collective economic organizations. The rural collective economic organizations issue to tenants the rights to use rural land. Use rights can be revoked and the tenants forced to vacate at any time when redevelopment of the land is in the public interest. The public interest rationale is interpreted quite broadly and the process of land appropriation may be less than transparent. We rely heavily on Guangzhou Tanke’s land use rights for our operations, and the loss of such rights would have a material adverse effect on our business.
We entered into a Land Use Right Grant Agreement with the government of Huaqiao Town, Huadu District, Guangzhou under which the Government of Huaqiao Town granted us certain land use rights for an area of approximately 60 mu where our manufacturing facility is built. The land use right of such parcel of land is owned collectively by local farmers. However, we currently do not maintain a Land Use Right Certificate for such parcel of land. Having no use right certificate of our land would have a material adverse effect on us as we would be required to relocate our facilities and obtain new land use rights, and there is a risk that we would not be able to accomplish such a relocation with reasonable cost or at all.
In addition, we currently do not maintain a building ownership certificate for our manufacturing facility. Because Guangzhou Tanke does not have land use right certificate on this parcel of land, it neither applied for nor will be granted a building ownership certificate for the manufacturing facility it built on this parcel of land. We may not be able to eventually obtain the building ownership certificate for the foresaid land with reasonable cost.
Economic, political and social conditions in China are subject to significant uncertainty and could affect our business.
All of our operations are located in China and our business is subject to political and economic uncertainties in China. The economy of China differs from the economies of most developed countries in many respects, including the level of government involvement, the level of development, control of foreign exchange, and methods for allocating resources. A substantial portion of productive assets in China are owned by the Chinese government. Changes in Chinese policies, laws and regulations, or in their interpretation or the imposition of confiscatory taxation, restrictions on currency conversion, restrictions or prohibitions on imports, restrictions or prohibitions on dividend payments to stockholders, devaluations of currency or the nationalization or other expropriation of private enterprises may occur from time to time without notice and could have a material adverse effect on our business. Nationalization or expropriation could result in the total loss of our investment in China. We have no control over most of these risks and may be unable to anticipate changes in Chinese economic and political conditions.
The Chinese government exerts substantial influence over the manner in which we must conduct our business activities.
We are dependent on our relationship with the local government in the province in which we operate our business. Chinese government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, environmental regulations, land use rights, property and other matters. The Chinese central or local governments may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations. Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof, and could require us to divest ourselves of any interest we then hold in Chinese properties.
Future inflation in China may inhibit our ability to conduct business in China. In recent years, the Chinese economy has experienced periods of rapid expansion and high rates of inflation. Rapid economic growth can lead to growth in the money supply and rising inflation. If prices for our products rise at a rate that is insufficient to compensate for the rise in the costs of supplies, it may have an adverse effect on profitability. These factors have led to the adoption by Chinese government, from time to time, of various corrective measures designed to restrict the availability of credit or regulate growth and contain inflation. High inflation may in the future cause Chinese government to impose controls on credit and/or prices, or to take other action, which could inhibit economic activity in China, and thereby harm the market for our products.
If relations between the United States and China worsen, our share price may decrease and we may have difficulty accessing U.S. capital markets.
At various times during recent years, the United States and China have had disagreements over political and economic issues. Any political or trade controversies between the United States and China in the future could adversely affect the market price of our common stock and our ability to access U.S. capital markets.
In the fiscal year ended December 31, 2011, we derived approximately 99% of our sales in China. A slowdown or other adverse developments in China’s economy may materially and adversely affect our customers, demand for our products and our business.
During the fiscal year ended December 31, 2011, we generated 99% of our sales in China. We continue to focus our growth of business primarily in China in the next few years simply due to the market growth potential and the cost of doing business is still relatively low comparing with selling overseas. However, the significant growth of China’s economy in recent years may not continue. The industry which we are involved in China is relatively new and growing, but we do not know how sensitive we are to a slowdown in economic growth or other adverse changes in the Chinese economy which may affect demand for our products. In addition, the Chinese government also exercises significant control over Chinese economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. Although we are in one of the industries the Chinese government highly supports – agriculture, and receive certain preferential treatment, we are uncertain how significant an overall economic slowdown or recession in China will reduce the demand of our products and adversely affect our business.
We may have limited legal recourse under Chinese laws if disputes arise under our contracts with third parties.
The Chinese government has enacted some laws and regulations dealing with matters such as corporate organization and governance, foreign investment, commerce, taxation and trade. However, their experience in implementing, interpreting and enforcing these laws and regulations is limited, and our ability to enforce commercial claims or to resolve commercial disputes is unpredictable. If our new business ventures are unsuccessful, or other adverse circumstances arise from these transactions, we face the risk that the parties to these ventures may seek ways to terminate the transactions, or, may hinder or prevent us from accessing important information regarding the financial and business operations of these acquired companies. The resolution of these matters may be subject to the exercise of considerable discretion by agencies of the Chinese government, and forces unrelated to the legal merits of a particular matter or dispute may influence their determination. Any rights we may have to specific performance, or to seek an injunction under Chinese laws, in either of these cases, are severely limited, and without a means of recourse by virtue of the Chinese legal system, we may be unable to prevent these situations from occurring. In addition, the inability to enforce or obtain a remedy under any of our future agreements could result in a significant loss of business, business opportunities or capital and could have a material adverse impact on our operations business and financial condition.
Because our principal assets are located outside of the United States and our sole director and officer and all of our key employees reside in China, outside of the United States, it may be difficult for you to enforce your rights based on the United States federal securities laws against us and our officers and directors in the United States or to enforce judgments of United States courts against us or them in China.
Our sole director and officer and all of our key employees
reside in China, outside of the United States. In addition, our principal operating business is located in China and all of our assets are located outside of the United States. China does not have a treaty with United States providing for the reciprocal recognition and enforcement of judgments of courts. It may therefore be difficult for investors in the United States to enforce their legal rights based on the civil liability provisions of the United States federal securities laws against us in the courts of either the United States or China and, even if civil judgments are obtained in courts of the United States, to enforce such judgments in Chinese courts. Further, it is unclear if extradition treaties now in effect between the United States and Chinese would permit effective enforcement against us or our officers and directors of criminal penalties, under the United States federal securities laws or otherwise.
We may have difficulty establishing adequate management, legal and financial controls in China, which could impair our planning processes and make it difficult to provide accurate reports of our operating results.
China historically has been deficient in Western style management and financial reporting concepts and practices, as well as in modern banking, and other control systems. We may have difficulty in hiring and retaining a sufficient number of qualified employees familiar with these concepts, practices and systems to work in China. As a result of these factors, and especially given that we expect to be a publicly listed company in the U.S. and subject to regulation as such, we may experience difficulty in establishing management, legal and financial controls, collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet Western standards. We may have difficulty establishing adequate management, legal and financial controls in China.
Currency fluctuations and restrictions on currency exchange may adversely affect our business, including limiting our ability to convert Chinese Renminbi into foreign currencies and, if Chinese Renminbi were to decline in value, reducing our revenue in U.S. dollar terms.
Our reporting currency is the U.S. dollar and our operations in China use their local currency as their functional currency. Substantially all of our revenue and expenses are in Chinese Renminbi. We are subject to the effects of exchange rate fluctuations with respect to any of these currencies. For example, the value of the Renminbi depends to a large extent on Chinese government policies and China’s domestic and international economic and political developments, as well as supply and demand in the local market. Since 1994, the official exchange rate for the conversion of Renminbi to the U.S. dollar had generally been stable and the Renminbi had appreciated slightly against the U.S. dollar. However, on July 21, 2005, the Chinese government changed its policy of pegging the value of Chinese Renminbi to the U.S. dollar. Under the new policy, Chinese Renminbi may fluctuate within a narrow and managed band against a basket of certain foreign currencies. It is possible that the Chinese government could adopt a more flexible currency policy, which could result in more significant fluctuation of Chinese Renminbi against the U.S. dollar. We can offer no assurance that Chinese Renminbi will be stable against the U.S. dollar or any other foreign currency.
Our financial statements are translated into U.S. dollars at the average exchange rates in each applicable period. To the extent the U.S. dollar strengthens against foreign currencies, the translation of these foreign currencies denominated transactions results in reduced revenue, operating expenses and net income for our international operations. Similarly, to the extent the U.S. dollar weakens against foreign currencies, the translation of these foreign currency denominated transactions results in increased revenue, operating expenses and net income for our international operations. We are also exposed to foreign exchange rate fluctuations as we convert the financial statements of our foreign consolidated subsidiaries into U.S. dollars in consolidation. If there is a change in foreign currency exchange rates, the conversion of the foreign consolidated subsidiaries’ financial statements into U.S. dollars will lead to a translation gain or loss which is recorded as a component of other comprehensive income. In addition, we have certain assets and liabilities that are denominated in currencies other than the relevant entity’s functional currency. Changes in the functional currency value of these assets and liabilities create fluctuations that will lead to a transaction gain or loss. We have not entered into agreements or purchased instruments to hedge our exchange rate risks. The availability and effectiveness of any hedging transaction may be limited and we may not be able to hedge our exchange rate risks.
The application of Chinese regulations relating to the overseas listing of Chinese domestic companies is uncertain, we may be subject to penalties for failing to request approval of the Chinese authorities prior to listing our shares in the U.S. and we may be subject to additional approval requirements for Kanghui Agricultural’s acquisition of Guangzhou Tanke.
On August 8, 2006, six Chinese government agencies, namely, the Ministry of Commerce, or MOFCOM, the State Administration for Industry and Commerce, or SAIC, the China Securities Regulatory Commission, or CSRC, the State Administration of Foreign Exchange, or SAFE, the State Assets Supervision and Administration Commission, or SASAC, and the State Administration for Taxation, or SAT, jointly issued the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, which we refer to as the “New M&A Rules”, which became effective on September 8, 2006. The New M&A Rules purport, among other things, to require offshore “special purpose vehicles,” that are (1) formed for the purpose of overseas listing of the equity interests of Chinese companies via acquisition and (2) are controlled directly or indirectly by Chinese companies and/or Chinese individuals, to obtain the approval of the CSRC prior to the listing and trading of their securities on overseas stock exchanges.
There are substantial uncertainties regarding the interpretation, application and enforcement of the New M&A Rules and CSRC has yet to promulgate any written provisions or formally declare or state whether the overseas listing of a China-related company structured similar to ours is subject to the approval of CSRC. Any violation of these rules could result in fines and other penalties on our operations in China, restrictions or limitations on remitting dividends outside of China, and other forms of sanctions that may cause a material and adverse effect to our business, operations and financial conditions.
The new mergers and acquisitions regulations also established additional procedures and requirements that are expected to make merger and acquisition activities by foreign investors more time-consuming and complex, including requirements in some instances that the Ministry of Commerce be notified in advance of any change-of-control transaction in which a foreign investor takes control of a Chinese domestic enterprise that owns well-known trademarks or China’s traditional brands. If within two years, the relevant PRC authority determines that Kanghui Agricultural lacks a business in the ordinary course, Kanghui Agricultural may be considered as a wholly foreign owned holding company and therefore Kanghui Agricultural’s acquisition of Guangzhou Tanke may be subject to additional approvals that are required under the new M&A Rule. Complying with the requirements of the new mergers and acquisitions regulations in completing this type of transactions could be time-consuming, and any required approval processes, including CSRC approval, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.
Recent Chinese regulations relating to the establishment of offshore special purpose companies by Chinese residents may subject our Chinese resident shareholders to penalties in certain circumstance. After exercising their rights under the Call Option Agreement, the Tanke Shareholders will need to register with SAFE according to Circular 75. Circular 75 affects the Tanke Shareholders and does not apply to
us, our subsidiaries including Guangzhou Tanke, or
any shareholders who are not PRC residents.
The SAFE issued a public notice in October 2005, or the SAFE Circular No. 75 (“Circular 75”), requiring Chinese residents to register with the local SAFE branch before establishing or controlling any company outside of China for the purpose of capital financing with assets or equities of Chinese companies, referred to in the Circular 75 as special purpose vehicles, or SPVs. Chinese residents who are shareholders of SPVs established before November 1, 2005 were required to register with the local SAFE branch before June 30, 2006. Further, Chinese residents are required to file amendments to their registrations with the local SAFE branch if their SPVs undergo a material event involving changes in capital, such as changes in share capital, mergers and acquisitions, share transfers or exchanges, spin-off transactions or long-term equity or debt investments.
To date, the Chinese residents who are shareholders of Guangzhou Tanke do not own any equity in the Company, and for such reason they do not need to file registrations with the foreign exchange authority pursuant to Circular 75. The ground for this statement is Article 2 of Circular 75, according to which a Chinese resident is required to file the registration under Circular 75 only when it is to directly establish or indirectly control an offshore special purpose vehicle. Strictly speaking, by executing the Call Option Agreement alone, Tanke Shareholders shall not be deemed to own any shares in the Company and therefore will not trigger the registration of Circular 75. Unless and until Tanke Shareholders intend to exercise the call option to own the shares of the Company, they will not be required to complete the registration under Circular 75.
Pursuant to the vesting schedule set forth in the Call Option Agreement, the Tanke Shareholders are permitted to exercise their options for shares of common stock in the Company. When exercising their right to acquire Option Shares, the Tanke Shareholders will need to file registrations with SAFE. Any failure by the Tanke Shareholders to file their registration with SAFE will restrict and prohibit such individuals from transferring the proceeds from a sale of common stock to China. If such sales proceeds are transferred to China without SAFE registration, any individual in violation thereof could be subject to a fine imposed by the PRC foreign exchange control agency in an amount of approximately 30% of the sales price as well as criminal liabilities. See “Business—Government Regulation – Foreign Exchange Regulation”.
Under applicable PRC laws, a Chinese domestic resident legal person or natural person (collectively, the “Resident Person”) shall register with SAFE if such Resident Person “directly establishes or indirectly controls” a Special Purpose Vehicle in another country. The aforementioned “directly establish or indirectly controls” could be by an individual Resident Person or by several Resident Persons collectively.
The Special Purpose Vehicle means a foreign enterprise established for the purpose of an equity financing (including convertible bond financing) outside of China by using the assets or interests held by such individual or several Resident Persons in the Chinese enterprise. In this regard, if the Tanke Shareholders exercise their right under the Call Option Agreement and, therefore, individually or collectively control us, under applicable PRC law, we will be deemed to be a Special Purpose Vehicle because we are controlled by a Resident Person and our interests in Guangzhou Tanke, through the VIE Agreements, was used in connection with our equity financing in the US.
Before exercising their rights under the Call Option Agreement, none of the Tanke Shareholders may obtain shares in us and, therefore, shall not be deemed to be controlling us. In this regard, Circular 75 will not apply. After exercising their rights under the Call Option Agreement, the Tanke Shareholders (all of them are Chinese residents and, therefore, fall into the definition of Resident Person) will be deemed as individually or collectively controlling us. Therefore, the Tanke Shareholders will need to register with SAFE according to Circular 75. Circular 75 affects the Tanke Shareholders and does not apply to any shareholders who are not PRC residents.
It is expressly stated in the Article 1 of Circular 75 that Circular 75 only applies to Chinese residents (including the natural person holding Chinese identity card or passport; the natural person habitually residing in China for economic or other benefit ties without holding Chinese identity card or passport; and the company, institution or other economic entity incorporated in China) who directly establish or indirectly control the special purpose vehicle. Therefore, under Circular 75, only a Chinese resident who directly establishes or indirectly controls the special purpose vehicle is liable for registration with local foreign exchange authority. Circular 75 does not extend its application to any non-Chinese resident, such as the Company, or any non-Chinese shareholders of the Company. As to Kanghui Agricultural, although it is a Chinese resident, it does not engage in any activity within the scope of “directly establishing or indirectly controlling the special purpose vehicle”, and therefore is not within the application of Circular 75
For such reason, the Company, the non-Chinese shareholders of the Company, and the subsidiaries of the Company (including Kanghui Agricultural) will not be subject to any administrative or criminal liabilities due to Tanke Shareholders failure of complying with Circular 75.
The uncertainty regarding the interpretation and implementation of Circular 75 that may have impact on the Company is the definition of "Control" stipulated in Article 1 of Circular 75. Circular 75 applies only to Chinese residents who intend to directly establish or INDIRECTLY CONTROL an offshore purpose vehicle for the purpose of raising capital overseas. It is stipulated in Circular 75 that "Control" shall refer to "the behavior that a Chinese resident obtains the rights to carry out business operation of, to gain proceeds from or to make decisions for a special purpose vehicle by means of acquisition, trusteeship, holding shares on behalf of others, voting rights, repurchase, convertible bonds, etc."
Mr. Qiu Guixiong, one of the Tanke shareholders, is the sole director of the Company and therefore has the decisive power to the operation of the Company. However, he obtains the control over the Company by means of directorship in the Company rather than any of the means expressly set out in Circular 75 (i.e., acquisition, trusteeship, holding shares on behalf of others, voting rights, repurchase, convertible bonds).
Strictly speaking, the Call Option Agreement placed a condition on exercising of the voting power by Golden Genesis (the “Grantor”). It is expressly stated in Article 2.8 of the Call Option Agreement that the Grantor “agrees not to exercise any of its voting rights with respect to the Option Shares……on behalf of the Grantees without the prior written consent of the Grantees,……before all of the Grantor’s shares are transferred to the Grantee,…”. This arrangement does not directly grant the voting power to the Grantees (which includes Mr. Qiu), rather limiting the voting power of the Grantor. Such condition placed cannot be strictly equivalent to the “voting power” mentioned in Circular 75 because that, under the Chinese law perspective, the voting power is attached to the equity and Tanke Shareholders do not have the title of the Option Shares before exercising the option right. To date, there is no further interpretation regarding the “voting power” under the Circular 75.
Circular 75 remains unclear on whether the control gained through the directorship should be deemed “Control” within its application. To date, there is no further amendment or detailed interpretation regarding the definition of "Control" of Circular 75. Our informal consultation with some officials of foreign exchange authorities confirmed that the control over a special purpose vehicle through the position of directorship does not belong to the scope of the “Control” under Circular 75. We are therefore of the opinion that, in absence of further amendments or detailed regulations regarding the definition of "Control" in Circular 75, the chance that Mr. Qiu Guixiong's position will be definitely determined as "control" over the Company is rare.
However, if the Chinese local foreign exchange authority determines under its own discretion that Mr. Qiu Guixiong is a de facto controller of the Company and his control over the Company should be deemed to be within the scope of Notice 75, Mr. Qiu Guixiong may be required to finish the registration under Circular 75, even before he exercises the call option right on the shares of the Company. Under such circumstance, Mr. Qiu’s non-compliance under Circular 75 will not affect Kanghui Agricultural to distribute funds to us because that, as being mentioned before, Tanke Shareholders’ failure of complying with the Circular 75 will not trigger Kanghui Agricultural or us to be subject to any administrative or criminal liabilities.
Under Chinese law, Mr. Qiu’s failure of complying with Circular 75 will not affect his ability to serve as the registrant’s chief executive officer and sole director because the Circular 75 only regulates the matters relating to the administration of foreign exchange.
We face uncertainty from the Circular on Strengthening the Administration of Enterprise Income Tax on Non-resident Enterprises' Share Transfer, or Circular 698, released in December 2009 by China's State Administration of Taxation, or the SAT, effective as of January 1, 2010.
Pursuant to the Circular 698 effective on January 1, 2010, where a foreign investor transfers the equity interests of a Chinese resident enterprise indirectly via disposing of the equity interests of an overseas holding company, which we refer to as an Indirect Transfer, and such overseas holding company is located in a tax jurisdiction that: (i) has an effective tax rate less than 12.5% or (ii) does not tax foreign income of its residents, the foreign investor shall report such Indirect Transfer to the competent tax authority of the Chinese resident enterprise. The Chinese tax authority will examine the true nature of the Indirect Transfer, and if the tax authority considers that the foreign investor has adopted an abusive arrangement in order to avoid Chinese tax, they will disregard the existence of the overseas holding company and re-characterize the Indirect Transfer and as a result, gains derived from such Indirect Transfer may be subject to Chinese withholding tax at the rate of up to 10%. Circular 698 also provides that, where a non-Chinese resident enterprise transfers its equity interests in a Chinese resident enterprise to its related parties at a price lower than the fair market value, the competent tax authority has the power to make a reasonable adjustment to the taxable income of the transaction.
Wong Kwai Ho’s transfer of her 100% shareholding interest in China Flying to Golden Genesis may be deemed an indirect disposal of equity interest of Guangzhou Tanke, a Chinese resident enterprise, through China Flying. This transfer may be subject to examination by Chinese tax authorities and could be subject to Wong Kwai Ho been required to pay a withholding tax of 10%.
SAFE rules and regulations may limit our ability to transfer the net proceeds from future offerings to Guangzhou Tanke, which may adversely affect the business expansion of Guangzhou Tanke.
On August 29, 2008, SAFE promulgated Circular 142, a notice regulating the conversion by a foreign-invested company of foreign currency into Renminbi by restricting how the converted Renminbi may be used. The notice requires that the registered capital of a foreign-invested company settled in Renminbi converted from foreign currencies may only be used for purposes within the business scope approved by the applicable governmental authority and may not be used for equity investments within the PRC. In addition, SAFE strengthened its oversight of the flow and use of the registered capital of a foreign-invested company settled in Renminbi converted from foreign currencies. Violations of Circular 142 will result in severe penalties, such as heavy fines. As a result, Circular 142 may significantly limit our ability to transfer the net proceeds from future offerings.
We may be considered a resident enterprise of the PRC, and if so, the Enterprise Income Tax Law of PRC relating to PRC taxation on resident enterprise may subject us or our Shareholders to penalties, limit our ability to distribute dividend to our shareholders or otherwise adversely affect us.
The Enterprise Income Tax Law (the “EIT Law”) of the PRC and its implementing rules provide that enterprises established outside China whose “de facto management bodies” are located in China are considered “resident enterprises” and subject to the uniform 25% enterprise income tax rate on global income. Our management is substantially based in the PRC and expects to be based in the PRC in the future. It is unclear and uncertain how the PRC tax authorities would interpret and implement the EIT Law and its implementing rules and it remains uncertain whether the PRC tax authorities would determine that we are a “resident enterprise” or a “non-resident enterprise”. If we are deemed as resident enterprise, we will be subject to a 25% enterprise income tax rate. If we are deemed as resident enterprise, any failure to pay the enterprise income tax may result in a fine imposed by relevant PRC tax authorities in an amount from RMB2,000 to RMB10,000, and any failure to pay the income tax within a limited period of time as requested by the PRC tax authorities may result in a fine in amount from 50% to 500% of the taxes unpaid or underpaid.
Due to various restrictions under Chinese laws on the distribution of dividends by our Chinese operating companies, we may not be able to pay dividends to our stockholders.
The Wholly-Foreign Owned Enterprise Law (1986), as amended, the Wholly-Foreign Owned Enterprise Law Implementing Rules (1990), as amended and the Company Law of China (2006) contain the principal regulations governing dividend distributions by wholly foreign-owned enterprises. Under these regulations, wholly foreign-owned enterprises may pay dividends only out of their accumulated profits, if any, determined in accordance with Chinese accounting standards and regulations. Additionally, prior to the distribution of the dividend, wholly foreign-owned enterprises are required to set aside 10% of their annual net income as certain company statutory reserves, until the total amount of such reserves reach to 50% of the registered capital of the foreign-owned enterprises. These reserves can only be utilized to make up the loss or be converted to the registered capital of the foreign-owned enterprises and are not distributable as cash dividends except in the event of liquidation.
In accordance with these regulations, Kanghui Agriculture is required to remain 10% of its net income annually, as determined in accordance with the PRC’s accounting rules and regulations, as the statutory reserve fund until the amount of such statutory reserve reaches 50% of its registered capital. Such statutory reserve cannot be distributed in cash to China Flying and in turn to our common stock shareholders, until and unless Kanghui Agriculture is liquidated. To date, we have segregated $373,406 related to the statutory reserve requirements.
Additionally, the Circular 75 requires Chinese residents to register with the local SAFE branch before establishing or controlling any company outside of China for the purpose of capital financing with assets or equities of Chinese companies, referred to in the Circular 75 as special purpose vehicles, or SPVs. Chinese residents who are shareholders of SPVs established before November 1, 2005 were required to register with the local SAFE branch before June 30, 2006. Further, Chinese residents are required to file amendments to their registrations with the local SAFE branch if their SPVs undergo a material event involving changes in capital, such as changes in share capital, mergers and acquisitions, share transfers or exchanges, spin-off transactions or long-term equity or debt investments.
To date, the Chinese residents who are shareholders of Guangzhou Tanke do not own any equity in the Company, and for such reason such Chinese residents currently do not need to file registrations with SAFE pursuant to Circular 75. When the Chinese residents exercise their options in the future to receive any share of the Company pursuant to the Call Option Agreement, they will need to file registrations with SAFE. In that case, before the Chinese residents complete the registration with SAFE, Kanghui Agriculture cannot remit out of China its dividend and, as a result, we may experience delay or difficulty in paying the dividends on our common stock.
The Chinese government also imposes controls on the conversion of RMB into foreign currencies and the remittance of currencies out of China. We may experience difficulties in completing the administrative procedures necessary to obtain and remit foreign currency for the payment of dividends from the profits of Guangzhou Tanke. Furthermore, if our subsidiaries in China 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 unable to receive all of the revenues from our operations through these contractual or dividend arrangements, we may be unable to pay dividends on our common stock.
The State Administration of Foreign Exchange restrictions or changes in foreign exchange regulations in China may affect our ability to pay dividends in foreign currency or conduct other foreign exchange business.
We receive substantially all of our revenues in RMB, which is currently not a freely convertible currency. The restrictions on currency exchanges may limit our ability to use revenues generated in RMB to make dividends or other payments in United States dollars. The Chinese government strictly regulates conversion of RMB into foreign currencies. Over the years, foreign exchange regulations in China have significantly reduced the government’s control over routine foreign exchange transactions under current accounts. In China, SAFE regulates the conversion of the RMB into foreign currencies. Pursuant to applicable Chinese laws and regulations, foreign invested enterprises incorporated in China are required to apply for “Foreign Exchange Registration Certificates.” Currently, conversion within the scope of the “current account” (e.g. remittance of foreign currencies for payment of dividends, trade and service-related foreign exchange transactions, etc.) can be effected without requiring the approval of SAFE, instead, need to be registered with the SAFE. However, conversion of currency in the “capital account” (e.g. for capital items such as direct investments, loans, securities, etc.) still requires the approval of SAFE. In addition, failure to obtain approval from SAFE for currency conversion on the capital account may adversely impact our capital expenditure plans and our ability to expand in accordance with our desired objectives.
All of our income is derived from the consulting fees we receive from Guangzhou Tanke through the VIE Agreements. SAFE restrictions may delay the payment of dividends, since we have to comply with certain procedural requirement and we may experience difficulties in completing the administrative procedures necessary to obtain and remit foreign currency for the payment of dividends from the profits of Kanghui Agricultural, and it thus may delay our payment of dividend to the equity holders.
Foreign exchange transactions by Chinese operating subsidiaries under the capital account continue to be subject to significant foreign exchange controls and require the approval of and need to register with Chinese government authorities, including SAFE. In particular, if Guangzhou Tanke, which we control via the VIE Agreement, borrows foreign currency through loans from us or other foreign lenders, these loans must be registered with SAFE, and if we finance Guangzhou Tanke by means of additional capital contributions, these capital contributions must be approved by certain government authorities, including the Ministry of Commerce, or their respective local counterparts. These limitations could affect Guangzhou Tanke’s ability to obtain foreign exchange through debt or equity financing.
The Chinese government may also at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining foreign currency, we may be unable to pay dividends or meet obligations that may be incurred in the future that require payment in foreign currency.
We are subject to Chinese environmental laws that adversely affect our results of operations.
We are subject to multiple Chinese environmental laws, including the Law on Environmental Protection of China and the Law of Prevention of Effluent Pollution of China and other environmental regulation governing the classification and disposal of waste. We expect that national, provincial and local governmental agencies will adopt stricter pollution controls in the future. Our production process may produce waste which may be harmful to the environment. There can be no assurance that future changes in environmental laws and regulations will not impose costly compliance requirements on us or otherwise subject us to future liabilities. Our profitability may be adversely affected if additional or modified environmental control regulations are imposed upon us.
Our failure to fully comply with Chinese labor laws, including laws relating to social insurance, may expose us to potential liability and increased costs.
Companies operating in China must comply with a variety of labor laws, including the Labor Contract Law of China enacted in June 2007, or the New Labor Contract Law, and laws requiring us to make social insurance (including unemployment insurance, medical insurance, and pension) and other staff welfare-oriented payments (such as housing funds). Our failure to comply with these laws could have a material adverse effect on our business. The New Labor Contract Law, which became effective on January 1, 2008, imposes stricter obligations on employers including a requirement that employers execute written labor contracts with all of their employees. Among our 165 employees, we have paid social insurance for 151 of our employees and 14 employees participated in commercial insurance due to the fact that they are transferred to the Company from other companies who have paid their social insurance. Our failure to remain in compliance with Chinese labor laws including social insurance requirements in the future could adversely impact our results of operations.
Furthermore, the New Labor Contract Law governs standard terms and conditions for employment, including termination and lay-off rights, contract requirements, compensation levels and consultation with labor unions, among other topics. In addition, the law limits non-competition agreements with senior management and other employees who have access to confidential information to two years and imposes restrictions or geographical limits. This new labor contract law will increase our labor costs, which could adversely impact our results of operations.
We must comply with the Foreign Corrupt Practices Act.
We are required to comply with the United States Foreign Corrupt Practices Act, which prohibits U.S. companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. Foreign companies, including some of our competitors, are not subject to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in mainland China. If our competitors engage in these practices, they may receive preferential treatment from personnel of some companies, giving our competitors an advantage in securing business or from government officials who might give them priority in obtaining new licenses, which would put us at a disadvantage. We have no formal policies in place to prevent our employees or other agents from engaging in such conduct. If such conduct is undertaken, we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties, which could adversely impact our business and results of operations.
Risks Related to Our Common Stock
An active and visible trading market for our common stock may not develop.
We cannot predict whether an active market for shares of our common stock will develop in the future. In the absence of an active trading market:
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Investors may have difficulty buying and selling or obtaining market quotations;
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Market visibility for shares of our common stock may be limited; and
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A lack of visibility for shares of our common stock may have a depressive effect on the market price for shares of our common stock.
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The OTCBB is an unorganized, inter-dealer, over-the-counter market that provides significantly less liquidity than NASDAQ or the NYSE AMEX. The trading price of our common stock is expected to be subject to significant fluctuations in response to variations in quarterly operating results, changes in analysts’ earnings estimates, announcements of innovations by us or our competitors, general conditions in the industry in which we operate and other factors. These fluctuations, as well as general economic and market conditions, may have a material or adverse effect on the market price of shares of our common stock.
The market price for shares of our common stock may be volatile.
The market price for shares of our common stock may be volatile and subject to wide fluctuations in response to factors including the following:
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actual or anticipated fluctuations in our quarterly operating results;
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changes in financial estimates by securities research analysts;
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conditions in commodities markets;
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changes in the economic performance or market valuations of other feed additive technology companies;
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announcements by us or our competitors of new products, acquisitions, strategic partnerships, joint ventures or capital commitments;
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addition or departure of key personnel;
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fluctuations of exchange rates between RMB and the U.S. dollar;
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intellectual property litigation; and
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general economic or political conditions in China.
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In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of shares of our common stock.
We do not anticipate paying cash dividends in the foreseeable future and, as a result, our investors’ sole source of gain, if any, will depend on capital appreciation, if any.
We do not plan to declare or pay any cash dividends on our shares of common stock in the foreseeable future and currently intend to retain any future earnings for funding growth. As a result, investors should not rely on an investment in our securities if they require the investment to produce dividend income. Capital appreciation, if any, of our shares may be investors’ sole source of gain for the foreseeable future. Moreover, investors may not be able to resell their shares of common stock at or above the price they paid for them.
We have considerable discretion in the use of proceeds from the selling stockholders’ conversion of the Notes and exercise of the Warrants, and we may use these proceeds in ways with which you may not agree.
Our Board of Directors and our management will have considerable discretion in the application of the net proceeds received by us from the selling stockholders’ conversion of the Notes and exercise of the Warrants. You will not have the opportunity, as part of your investment decision, to assess whether proceeds are being used appropriately. You must rely on the judgment of our Board of Directors and our management regarding the application of the net proceeds of this offering. The net proceeds may be used for corporate purposes that do not improve our efforts to maintain profitability or increase the price of our securities. The net proceeds from this offering may be placed in investments that do not produce income or that lose value. See “Use of Proceeds.”
Shares eligible for future sale may adversely affect the market price of our common stock, as the future sale of a substantial amount of outstanding stock in the public marketplace could reduce the price of our common stock.
The former shareholders of Guangzhou Tanke are eligible to sell all or some of their shares of our common stock by means of ordinary brokerage transactions in the open market pursuant to Rule 144 promulgated under the Securities Act (“Rule 144”), subject to certain limitations. In general, pursuant to Rule 144, a stockholder (or stockholders whose shares are aggregated) who has satisfied an one-year holding period may, under certain circumstances, sell within any three-month period a number of securities which does not exceed the greater of 1% of the then outstanding shares of common stock or the average weekly trading volume of the class during the four calendar weeks prior to such sale. As of the closing of the Private Placement, 1% of our issued and outstanding shares of common stock equals approximately 133,241 shares (without giving effect to any conversion of Notes or exercise of Warrants or Agent Warrants). Rule 144 also permits, under certain circumstances, the sale of securities, without any limitations, by a non-affiliate that has satisfied a one-year holding period. Any substantial sale of common stock pursuant to any resale prospectus or Rule 144 may have an adverse effect on the market price of our common stock by creating an excessive supply. A stockholder that is not an affiliate of the Company, and that acquired shares of common stock pursuant to its conversion of the Notes or its exercise of the Warrants, shall be permitted to sell its shares of common stock pursuant to Rule 144(i) on or after February 10, 2012.
We will incur increased costs as a result of being a public company.
As a public company, we will incur significant legal, accounting and other expenses, in excess of $100,000, that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the SEC, has required changes in corporate governance practices and internal control and procedures of public companies. We expect these new rules and regulations to increase our legal, accounting and financial compliance costs and to make certain corporate activities more time-consuming and costly. In addition, we will incur additional costs associated with our public company reporting requirements. We are currently evaluating and monitoring developments with respect to these new rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.
We have determined that our internal control over financial reporting is currently not effective. The lack of effective internal controls could materially adversely affect our financial condition and ability to carry out our business plan.
Our management team for financial reporting, under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, conducted an evaluation of the effectiveness of the design and operation of our internal controls. At December 31, 2011, we concluded that our internal control over financial reporting was not effective because we (1) lack of controls designed or implemented over financial reporting process as well as lack of qualified staff to effectively carry out the activities over financial reporting process, (2) lack of policies over comingling Company funds with personal bank accounts and policies over cash transactions, (3) Incomplete and inappropriate accounting records keeping, and (4) lack of U.S. GAAP expertise to identify and assess unusual or complex accounting transactions. Until we have been able to test the operating effectiveness of remediated internal controls, any material weaknesses may materially adversely affect our ability to report accurately our financial condition and results of operations in the future in a timely and reliable manner. In addition, although we continually review and evaluate internal control systems to allow management to report on the sufficiency of our internal controls, we cannot assure you that we will not discover additional weaknesses in our internal control over financial reporting. Any such additional weakness or failure to remediate the existing weakness could materially adversely affect our financial condition or ability to comply with applicable financial reporting requirements and the requirements of the Company’s various financing agreements.
Our common stock may be considered a “penny stock,” and thereby be subject to additional sale and trading regulations that may make it more difficult to sell.
Our common stock, which is currently and will be quoted for trading on OTCBB, may be considered to be a “penny stock” if it does not qualify for one of the exemptions from the definition of “penny stock” under Section 3a51-1 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Our common stock may be a “penny stock” if it meets one or more of the following conditions: (i) the stock trades at a price less than $5.00 per share; (ii) it is not traded on a “recognized” national exchange; (iii) it is not quoted on the Nasdaq Capital Market, or even if so, has a price less than $5.00 per share; or (iv) is issued by a company that has been in business less than three years with net tangible assets less than $5 million. The principal result or effect of being designated a “penny stock” is that securities broker-dealers participating in sales of our common stock will be subject to the “penny stock” regulations set forth in Rules 15-2 through 15g-9 promulgated under the Exchange Act. For example, Rule 15g-2 requires broker-dealers dealing in penny stocks to provide potential investors with a document disclosing the risks of penny stocks and to obtain a manually signed and dated written receipt of the document at least two business days before effecting any transaction in a penny stock for the investor’s account. Moreover, Rule 15g-9 requires broker-dealers in penny stocks to approve the account of any investor for transactions in such stocks before selling any penny stock to that investor. This procedure requires the broker-dealer to: (i) obtain from the investor information concerning his or her financial situation, investment experience and investment objectives; (ii) reasonably determine, based on that information, that transactions in penny stocks are suitable for the investor and that the investor has sufficient knowledge and experience as to be reasonably capable of evaluating the risks of penny stock transactions; (iii) provide the investor with a written statement setting forth the basis on which the broker-dealer made the determination in (ii) above; and (iv) receive a signed and dated copy of such statement from the investor, confirming that it accurately reflects the investor’s financial situation, investment experience and investment objectives. Compliance with these requirements may make it more difficult and time consuming for holders of our common stock to resell their shares to third parties or to otherwise dispose of them in the market or otherwise.
Our majority stockholder and its affiliates will control the outcome of matters requiring stockholder approval.
Golden Genesis is our majority stockholder and beneficially owns 10,011,469 shares of common stock, or approximately 75.14% of the issued and outstanding shares of common stock (without giving effect to any conversion of Notes or exercise of Warrants or Agent Warrants). Golden Genesis is controlled (and will be majority owned, upon consummation of the transactions contemplated in the Call Option Agreement described herein) by our Chairman and Chief Executive Officer, Mr. Qiu. Consequently, Golden Genesis and Mr. Qiu will have the ability, when acting alone or with others, to control the election of our directors and the outcome of corporate actions requiring stockholder approval, such as changes to our Articles of Incorporation and Bylaws and a merger or a sale of our company or a sale of all or substantially all of our assets. This concentration of voting power and control could have a significant effect in delaying, deferring or preventing an action that might otherwise be beneficial to our other stockholders and be disadvantageous to our stockholders with interests different from those of our officers, directors and affiliates. Golden Genesis and Mr. Qiu also have significant control over our business, policies and affairs. Additionally, this significant concentration of share ownership may adversely affect the trading price for our common stock because investors often perceive disadvantages in owning stock in companies with controlling stockholders.
Provisions in our Bylaws could discourage, delay or prevent a change of control of our company and may result in an entrenchment of management and diminish the value of our common stock.
Our Bylaws provide that, unless otherwise prescribed by statute, special meetings of the stockholders can only be called by the Chairman of our Board of Directors, our President, or by the Board of Directors, or in their absence or disability, by any Vice President; and can be called by the President or, in his or her absence or disability, by a Vice President or by the Secretary upon the written request of the holders of not less than 15% of all the shares entitled to vote at the meeting. These provisions may discourage, delay or prevent a merger, acquisition or other change of control that our stockholders may consider favorable. Such provisions could impede the ability of our common stockholders to benefit from a change of control and, as a result, could materially adversely affect the market price of our common stock and your ability to realize any potential change-in-control premium.
Provisions in our Bylaws limit the rights of dissenting stockholders in transactions involving the purchase by a third party of a controlling equity interest in the Company and may result in dissenting stockholders in such transactions not obtaining payment of the fair market value of its shares.
Pursuant to our By-Laws, we have elected to limit the rights, under Chapter 78 of the Nevada Revised Statutes, of dissenting stockholders in transactions involving the purchase by a third party of a controlling equity interest in the Company. Under Nevada law, following the acquisition of a controlling interest of a company by an acquiring person, a stockholder whose shares are not voted in favor of authorizing voting rights for the control shares may dissent, and obtain payment of the fair value of his or her shares. The Company has elected not to be governed by this provision. As a result of not being able to dissent in such transactions under Nevada law, the dissenting stockholder may not be able to obtain payment of the fair market value of its shares.
Our employees and management do not have significant experience in the preparation or supervising the preparation of our financial statements in accordance with US GAAP.
Prior to the completion of this offering, Guangzhou Tanke operated as a private company located in China. In connection with the completion of the offering the Company acquired control of Guangzhou Tanke by virtue of VIE agreements. In the process of taking these steps to prepare our company for this offering, Guangzhou Tanke’s senior management became the senior management of the Company. Guangzhou Tanke’s senior management has limited experience managing a public company in the U.S. or complying with such U.S. laws, regulations and obligations. These obligations can be burdensome and complicated, and failure to comply with such obligations could have a material adverse effect on the Company. In addition, we expect that the process of learning about such new obligations as a public company in the United States will require senior management to devote time and resources to such efforts that might otherwise be spent on the operation of the business of the Company.
Historically our operations have been in China, and we have prepared our financial statements and maintained our books and records in accordance with China GAAP and have not previously been required to comply with U.S. GAAP. We recently hired a new Chief Financial Officer that is familiar with U.S. GAAP. In addition, we have engaged outside consultants who have significant experience with U.S. GAAP to prepare the conversion from China GAAP into U.S. GAAP. Furthermore, our financial statements are audited by our independent registered public accounting firm for compliance with U.S. GAAP standards. Yet, we cannot assure that our management has identified or fully remedied all material weaknesses in our internal controls of financial reporting pursuant to U.S. GAAP. If deficiencies go undetected or unremedied, our financial statements may not accurately reflect our financial condition as required by U.S. GAAP. We will evaluate these risk factors that impact our ability to prepare financial statements and maintain our books and records in accordance with U.S. GAAP in the future in concluding on the effectiveness of disclosure controls and procedures under Item 307 of Regulation S-K and internal control over financial reporting under Item 308 of Regulation S-K.
CAUTIONARY NOTE ON FORWARD LOOKING STATEMENTS
The information contained in this prospectus, includes some statements that are not purely historical and that are forward-looking statements. Such forward-looking statements herein which are not historical reflect our current expectations and projections about the Company’s future results, performance, liquidity, financial condition, prospects and opportunities and are based upon information currently available to the Company and our management and their interpretation of what is believed to be significant factors affecting the businesses, including many assumptions regarding future events. Such forward-looking statements include statements regarding, among other things:
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our ability to produce, market and generate sales of our products;
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our ability to develop, acquire and/or introduce new products;
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our projected future sales, profitability and other financial metrics;
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our future financing plans;
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our plans for expansion of our facilities;
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our anticipated needs for working capital;
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the anticipated trends in our industry;
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our ability to expand our sales and marketing capability;
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acquisitions of other companies or assets that we might undertake in the future;
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our operations in China and the regulatory, economic and political conditions in China;
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our ability as a U.S. company to operate our business in China through an indirect wholly-owned subsidiary; and
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competition existing today or that will likely arise in the future.
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Forward-looking statements, which involve assumptions and describe our future plans, strategies and expectations, are generally identifiable by use of the words “may,” “should,” “expect,” “anticipate,” “estimate,” “believe,” “intend,” “seek,” or “project” or the negative of these words or other variations on these words or comparable terminology. Actual results, performance, liquidity, financial condition and results of operations, prospects and opportunities could differ materially from those expressed in, or implied by, these forward-looking statements as a result of various risks, uncertainties and other factors, including the ability to raise sufficient capital to continue the Company’s operations. Actual events or results may differ materially from those discussed in forward-looking statements as a result of various factors, including, without limitation, the risks outlined under “Risk Factors” and matters described in this prospectus generally. In light of these risks and uncertainties, there can be no assurance that the forward-looking statements contained in this prospectus will in fact occur. Potential investors should not place undue reliance on any forward-looking statements. Except as expressly required by the federal securities laws, there is no undertaking to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances or any other reason.
Potential investors should not place undue reliance on any forward-looking statements. Except as expressly required by the federal securities laws, there is no undertaking to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances or any other reason.
The specific discussions in this prospectus about the Company include financial projections and future estimates and expectations about the Company’s business. The projections, estimates and expectations are presented in this prospectus only as a guide about future possibilities and do not represent actual amounts or assured events. All the projections and estimates are based exclusively on the Company management’s own assessment of our business, the industry in which it works and the economy at large and other operational factors, including capital resources and liquidity, financial condition, fulfillment of contracts and opportunities. The actual results may differ significantly from the projections.
Potential investors should not make an investment decision based solely on the Company’s projections, estimates or expectations.
USE OF PROCEEDS
The selling security holders will receive all of the proceeds from the sale of shares of common stock pursuant to this prospectus. We will not receive any proceeds from the sale of the shares of common stock offered by the selling security holders to the public. However, we will receive proceeds from the conversion of the Notes and exercise of the Warrants. If all of the Notes are converted and Warrants are exercised, then we will receive gross proceeds of $17,007,548.85. Any such proceeds will be used for working capital and general corporate purposes of the Company. No assurance can be given, however, that all or any portion of such Notes will be converted or all or any portion of such Warrants will be exercised.
DETERMINATION OF OFFERING PRICE
The selling stockholders may sell these shares in the over-the-counter market or otherwise, at market prices prevailing at the time of sale, at prices related to the prevailing market price, or at negotiated prices. We will not receive any proceeds from the sale of shares by the selling stockholders but we may receive proceeds upon the conversion or exercise, if any, of the Notes and the Warrants.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with our financial statements and the related notes. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties, such as its plans, objectives, expectations and intentions. Its actual results and the timing of certain events could differ materially from those anticipated in these forward-looking statements. As a result of the Share Exchange and the VIE Agreements, the Company, through Kanghui Agricultural, its indirect wholly owned subsidiary, assumed management of the business activities of Guangzhou Tanke and has the right to appoint all executives and senior management and the members of the board of directors of Guangzhou Tanke. As used in this section, the terms “we”, “our”, “us” and the “Company” refer to the Company, our direct and indirect subsidiaries and Guangzhou Tanke, our principal operating business.
Overview
We are one of the leading animal nutrition and feed additive providers in China and in 2001 were designated a certified high-tech company by the Guangzhou City Commission of Science and Technology as recognition for new technology developed by us in the agriculture industry. Our products optimize the growth and health of livestock such as pigs and cattle, as well as farmed fish, and seek to capitalize on China’s growing demand for safe and reasonably priced food. Feed additives are utilized in China at less than half the rate of the United States and Europe, and we have a significant growth opportunity as Chinese farmers and ranchers include a greater amount of increasingly sophisticated additive to their feed.
We have more than 165 employees, with 40 engaged in sale or sales-related activities. Our headquarters and manufacturing facilities are in a state-of-the-art 34,000 square-meter facility in the capital city of Guangzhou, in Guangdong province. We currently produce 22 branded feed additives, with each brand available in seven different mixes that correspond to different states of an animal’s life cycle.
Our major products address most key market categories within China’s animal feed additive industry including: Organic Trace Mineral Additives, which account for approximately 86% of our revenue, Functional regulation, which account for approximately 11% of our revenue, and Herbal Medicinal Additives, which account for approximately 1% of our revenue. Our extensive distribution network reaches China’s top 10 feed producers and the 500 largest animal farming operations. We currently market 22 different brands of feed additives at various price points to meet the demands of existing and prospective customers. Within each brand there are seven different mixes that correspond to the different growth stages of an animal’s life cycle. While the majority of our sales are domestic, international sales, mainly in Southeast Asia, Latin American and other developing countries, currently account for approximately 1% of our total sales.
Critical Accounting Policies
While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements, we believe that the following accounting policies are the most critical to aid you in fully understanding and evaluating this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Basis of Preparation
The Company’s consolidated financial statements have been stated in US dollars and prepared in accordance with generally accepted accounting principles in the United States of America ("US GAAP") and have been consistently applied.
Basis of consolidation
These consolidated financial statements include the financial statements of the Company, its subsidiaries and its VIE-Guangzhou Tanke (the “Group''). All significant inter-company balances and transactions within the Group have been eliminated.
Use of Estimates
In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. These accounts and estimates include, but are not limited to, the valuation of the amount due from related parties, the net realizable value of inventories, the estimation of useful lives of property and equipment and intangible assets, allowance of bad debt and the value of warrants. Actual results could differ from those estimates.
Concentrations of Credit Risk
Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of cash and cash equivalents, restricted cash, accounts receivable and amounts due from related parties. The Company places its cash with financial institutions with high-credit ratings and quality. The Company maintains bank accounts in the PRC only. In addition, the Company conducts periodic reviews of the related party financial conditions and payment practices.
Approximately 99% of the Company’s revenue is generated from buyers in mainland China.
Concentrations of Suppliers
All the Company’s suppliers are located in mainland China.
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Cash and Cash Equivalents
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The Company considers all highly liquid investments with initial maturities of three months or less to be cash equivalents.
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Restricted Cash
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Deposits that are restricted in use are classified as restricted cash.
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The Company periodically assesses its accounts receivable for collectability on a specific identification basis. If collectability of an account becomes unlikely, an allowance is recorded for that doubtful account. Once collection efforts have been exhausted, the account receivable is written off against the allowance. The Company does not require collateral for trade or other accounts receivable.
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Inventories are stated at the lower of cost or net realizable value. Cost is determined using the weighted average method. The cost of inventories includes the purchase cost and other costs incurred in bringing the inventories to their present location and condition. Net realizable value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and the estimated costs necessary to make the sale.
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Property and equipment are stated at cost less accumulated depreciation. Cost represents the purchase price of the asset and other costs incurred to bring the asset into its existing use.
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Depreciation of property and equipment is calculated using the straight-line method over their estimated useful lives. The estimated useful lives are as follows:
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Buildings
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15-20 years
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Plant and machinery
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3-20 years
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Motor vehicle
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10 years
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Office equipment
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3-10 years
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Expenditures for additions, major renewals and betterments are capitalized and expenditures for maintenance and repairs are charged to expense as incurred.
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