We file reports with
the Securities and Exchange Commission (“SEC” or “Commission”). We make available on our website (http://www.andatee.com)
free of charge our public reports filed pursuant to the Exchange Act and amendments to those reports as soon as reasonably practicable
after we electronically file such materials with or furnish them to the SEC. Information appearing at our website is not a part
of this Annual Report on Form 10-K. You can also read and copy any materials we file with the Commission at its Public Reference
Room at 100 F Street, NE, Washington, DC 20549. You can obtain additional information about the operation of the Public Reference
Room by calling the Commission at 1-800-SEC-0330. In addition, the Commission maintains an Internet site (www.sec.gov) that contains
reports, proxy and information statements, and other information regarding issuers that file electronically with the Commission,
including our reports.
Our fiscal year begins on January 1, and
ends on December 31, and any references herein to “Fiscal 2013” mean the year ended December 31, 2013, and references
to other “Fiscal” years mean the year ending December 31, of the year indicated.
We obtained statistical
data, market data and other industry data and forecasts used in this Form 10-K from publicly available information. While we believe
that the statistical data, industry data, forecasts and market research are reliable, we have not independently verified the data,
and we do not make any representation as to the accuracy of that information.
Except where the context otherwise requires
and for purposes of this Annual Report:
• the
terms “we,” “us,” “our company,” “our” refer to Andatee China Marine Fuel Services
Corporation, a Delaware corporation, its subsidiaries Goodwill Rich International Limited and Dalian Fusheng Consulting Co. Ltd.,
its subsidiaries, Dalian Xifa Petrochemical Company, Ltd., Shandong Xifa Prochemical Company, Ltd., Shanghai Fusheng Petrochemical
Company, Donggang Xingyuan Marine Bunker Company Ltd., Rongcheng Xinfa Petroleum Company Ltd., Rongcheng Mashan Xingyuan Marine
Bunker Co. Ltd., Rongcheng Zhuoda Trading Co.Ltd, Suzhou Fusheng Petrol Co. Ltd., Wujiang Xinlang Petrol Co. Ltd, Lianyungang
Fusheng Petrochemical Company, Ltd., and its previous variable interest entity (VIE), Dalian Xingyuan Marine Bunker Co. Ltd.,
through which entity we conducted all of our business operations and since we have transferred most of them under the direct control
of Dalian Fusheng Petrol Co. Ltd. , and only two subsidiaries of the VIE, which is Xiangshan Yongshi Nanlian Petrol Company Ltd.;
and Lianyungang Xingyuan Marine Bunker Co., Ltd.;
• the
term “Andatee” refers to Andatee China Marine Fuel Services Corporation, the parent company;
• the
term Goodwill’’ refers to Goodwill Rich International Limited, a subsidiary of Andatee, which for financial reporting
purposes is the predecessor to Andatee; and
• “China”
and “PRC” refer to the People’s Republic of China, and for the purpose of this Annual Report only, excluding
Taiwan, Hong Kong and Macau.
The standard barrel
of 42 US gallons is used in the United States as a measure of crude oil, and the producers of other petroleum products as reported
on the US commodities or stock exchanges tend to convert their production volumes into barrels for global reporting purposes.
Elsewhere in the world, oil is commonly measured in liters or cubic meters (1,000 liters equals one cubic meter, and 159 liters
equals one US 42 gallon barrel) or in tons (the latter customarily used by European oil companies). The fuel oils produced by
the company, however, are qualitatively different products from crude oil. In its essence, they are types of heavy oil, with densities
ranging from 0.82 to 0.95, thus, making it impracticable to use US barrels for measuring and reporting purposes. In addition,
all of the company supply, vendor and client contracts are executed in tons, not in barrels.
The conversion chart below illustrates
the conversions between barrels or liters and tons, as applied to our product line:
This Annual Report
contains translations of certain Renminbi, or RMB, the legal currency of China, amounts into U.S. dollars at the rate of RMB 6.1104
to $1.00, the noon buying rate in effect on December 31, 2013 in New York City for cable transfers of Renminbi as certified for
customs purposes by the Federal Reserve Bank of New York. We make no representation that the Renminbi or U.S. dollar amounts referred
to in this Annual Report could have been or can be converted into U.S. dollars or Renminbi, as the case may be, at any particular
rate or at all. On March 19, 2014, the exchange rate was approximately RMB6.1933 to $1.00.
Company Overview
We carry out all of
our business through our Hong Kong subsidiary, Goodwill Rich, its wholly-owned Chinese subsidiary, Fusheng, and Fusheng’s
directly controlled subsidiaries, previous were Dalian Xingyuan’s subsidiaries and Fusheng’s variable interest entity
(VIE), Dalian Xingyuan, and Dalian Xingyuan’s subsidiaries (Dalian Xingyuan and its subsidiaries being collectively referred
to as the VIE entities). Through both directly controlled subsidiaries and VIE entities, we are engaged in the production, storage,
distribution and wholesale purchases and sales of blended marine fuel oil for cargo and fishing vessels with operations mainly
in Liaoning, Shandong, Jiangsu and Zhejiang Provinces in People’s Republic of China (PRC). We compete by providing our customers
value added benefits, including single-supplier convenience, competitive pricing, logistical support and fuel quality control.
Our sales of marine
oil for fishing boats represented approximately 81% of our total revenue for the period of 2013 as compared with the sale of marine
oil for cargo vessels which represented the remaining 19% of our total revenue for the same periods. Currently, we sell approximately
88% of our products through distributors and remaining 12% to retail customers. Our products are substitutes for diesel used throughout
east China fishing industry by small to medium sized cargo vessels. Our core facilities include as storage tanks, berths (the
space allotted to a vessel at the wharf), marine fuel pumps, blending facilities and tankers. Our sales network covers major depots
along the towns of Dalian, Dandong, Lianyungang, Shidao Shipu, Suzhou and Shanghai along the east coast of China.
Our operations in
China are conducted through our Wholly-Owned Foreign Enterprise ("WOFE"), Dalian Fusheng Petrochemical Company and its
subsidiaries: Dalian Xifa Petrochemical Company, Ltd. (located in Dalian City, Liaoning Province, and established on August 26,
2010), Hailong Petrochemical Co., Limited (established in Tianjin City, on April 23, 2001), Donggang Xingyuan Marine Bunker Company,
Ltd. (located in Dandong City, Liaoning Province, and established in April 2008 under the laws of the PRC), Rongcheng Xinfa Petrol
Company, Ltd. (located in Rongcheng City, Shandong Province, and established in September 2007 under the laws of the PRC), and
Rongcheng Mashan Marine Bunker Company (established in Rongcheng City, Shandong province, on March 12, 2010), Shandong Xifa Petrochemical
Company, Ltd. (located in Zibo City, Shandong Province, and established on December 2, 2010), Rongcheng Zhuoda Trading Co. acquired
in Dec, 31, 2011 (located in Rongcheng city, Shandong Province, and established in Sep, 18, 2009), Suzhou Fusheng Petrochemical
Company, acquired in Dec, 21, 2011 (located in Suzhou city, Jiangsu Province and established in June, 8, 2011), Wujiang Xinlang
Petrochemical Company, acquired in Dec, 7, 2011(located in Wujiang city, Jiangsu Province and established in Apr 28, 1998), Shanghai
Fusheng Petrochemical Company, Ltd. (located in Shanghai city and established on April 6, 2012), Lianyungang Fusheng Petrochemical
Co., Ltd. (located in Lianyungang City, Jiangsu Province, and established on April 27, 2013) and our VIE, Dalian Xingyuan Marine
Bunker Company, Ltd and its subsidiaries: Xiangshan Yongsh Nanlian Petrol Company, Ltd. (located in Xiangshan City, Zhejiang Province,
and established in May 1997 under the laws of the PRC) and Lianyungang Xingyuan Marine Bunker Co., Ltd, (located in Lianyungang
City, Jiangsu Province, and established on April 27, 2013).
Our marine fuel for
cargo vessels is classified as CST180 and CST120; our marine fuel for fishing boats/vessels, #1 fuel (for engines with 2,000 rpm
capacity), #2 fuel (for engines with 1,800 rpm capacity), #3 fuel (for engines with 1,600 rpm capacity) and #4 fuel (for engines
with 1,400 rpm capacity). We also produce blended marine fuel according to customer specifications using our proprietary blending
technology. Our own blend of Marine Diesel Oil, #3 fuel and #4 fuel are substitutes for the traditional diesel oil, commonly known
as #0 diesel oil, used by most small to medium vessels. We generate virtually all of our revenues from our own brands of blended
oil products.
Andatee China Marine
Fuel Services Corporation is a Delaware corporation. Our executive offices are located at Unit C, No. 68 of West Binhai Road,
Xigang District, Dalian, P.R. of China; telephone number is 011 (86411) 8240 8939. Our website address is http://www.andatee.com.
Organizational Structure and Corporate History
Our WOFE, Dalian Fusheng
Petrochemical Company, was incorporated on March 22, 2009 with registered capital of $19.33 million invested by Goodwill Rich.
Fusheng has the following subsidiaries: Dalian Xifa Petrochemical CompanY, Ltd., Hailong Petrochemical Co., Limited (established
in Tianjin City, on April 23, 2001), Donggang Xingyuan Marine Bunker Company, Ltd., Rongcheng Xinfa Petrol Company, Ltd., and
Rongcheng Mashan Marine Bunker Company, Shandong Xifa Petrochemical Company, Ltd., Rongcheng Zhuoda Trading Co., Suzhou Fusheng
Petrochemical Company, Wujiang Xinlang Petrochemical Company, Shanghai Fusheng Petrochemical Company, Ltd. and Lianyungang Fusheng
Petrochemical Co., Ltd.
Our VIE operating
entity, Dalian Xingyuan, currently has two subsidiaries: Xiangshan Yongshinanlian Petrol Company Ltd. and Lianyungang Xingyuan
Marine Bunker Co., Ltd,, Dalian Xingyuan and its subsidiaries are collectively referred to as the ‘‘VIE’’.
Dalian Xingyuan was established in September 2001 with an initial registered capital of RMB 30 million (approximate to $4.8 million).
Its registered capital was increased to RMB 60.1 million (or $9.5 million) in 2008. Upon the October 28, 2008 incorporation of
Goodwill, Goodwill and the shareholders of Dalian Xingyuan had entered into a series of separate agreements under which Goodwill
and Dalian Xingyuan were deemed, until March 2009, to be under the common control of the shareholders of Dalian Xingyuan. The
reason that we registered our VIE’s subsidiaries under the control of our WOFE was that we think it will be more appropriate
all of our operating facilities are wholly controlled by our WOFE instead of VIE (control through contracts).
On March 26, 2009,
Fusheng entered into a series of variable interest entity agreements (the “VIE Agreements”) with Dalian Xingyuan.
Under these agreements (including the Consulting Services Agreement, the Operating Agreement, the Equity Pledge Agreement, the
Option Agreement and the Proxy and Voting Agreement), Xingyuan entered into these agreements with Fusheng because of the PRC laws
and regulations restricting the ability of offshore entities to acquire or dispose of ownership of domestic companies. These agreements
ensure that the original minority shareholders of Xingyuan will regain their respective pro rata ownership upon triggering of
the conditions set forth in the agreements. Under these agreements, the Company obtained the ability to direct the operations
of Xingyuan and its subsidiaries and to obtain the economic benefit of their operations. Therefore, management determined that
Xingyuan became a variable interest entity and the Company was determined to be the primary beneficiary of Xingyuan and its subsidiaries.
Accordingly, beginning March 26, 2009, the Company has consolidated the assets, liabilities, results of operations and cash flows
of Xingyuan and its subsidiaries its financial statements.
In August 2009, Andatee
entered into a share exchange agreement (the “Exchange Agreement”) with all of the shareholders of Goodwill Rich International
Limited, a Hong Kong company (“Goodwill”). Pursuant to the Exchange Agreement, Andatee agreed to issue 6,000,000 shares
of its common stock in exchange for all of the issued and outstanding securities of Goodwill (”Share Exchange”). The
Goodwill shareholders included Star Blessing Enterprise Limited (“SBE”), a company organized under the laws of the
British Virgin Islands, (i) Growing Sincere Limited (“GSL”) a company organized under the laws of the British Virgin
Islands, (ii) White Bright Limited (“WBL”), a company organized under the laws of the British Virgin Islands, and
(iii) Shining Joy Group Limited (“SJG”) a company organized under the laws of the British Virgin Islands. Prior to
the Share Exchange, SBE, GSL, WBL and SJG beneficially owned 89.04%, 4%, 3% and 3.96% of equity securities in Goodwill, respectively.
The Share Exchange closed on October 16, 2009. Andatee did not issue any fractional shares in connection with the Share Exchange.
Upon the closing of the Share Exchange, Andatee (i) became the 100% parent of Goodwill, and its wholly-owned subsidiary, Dalian
Fusheng Consulting Co., Ltd., and (ii) assumed the operations of Goodwill and its subsidiaries. The transactions contemplated
by the Exchange Agreement, as amended, were intended to be a ‘‘tax-free’’ incorporation pursuant to the
provisions of Section 351 of the Internal Revenue Code of 1986, as amended. The organization of Andatee and its acquisition of
Goodwill Rich did nothing more than to change the name of Goodwill Rich to Andatee, change its place of incorporation/organization,
and change its capital structure from 10,000 shares outstanding to 8,000,000 shares outstanding (prior to the October 2009 reverse
stock split). For financial reporting purposes, the Share Exchange will be accounted for as a recapitalization of Goodwill affected
through a combination of companies (Andatee and Goodwill) under common control, which will be recorded at historical cost. As
a result, Goodwill is deemed to be the predecessor of Andatee for financial reporting purposes, and the historical financial statements
of Goodwill presented in this report will become the historical financial statements of Andatee (after being adjusted to retroactively
reflect the effects of the recapitalization to 6,000,000 issued and outstanding common shares) at such time as Andatee issues
financial statements for the period that includes October 16, 2009.
On October 16, 2009,
our Board approved a reverse split in the 1-for-1.333334 ratio. Following shareholder approval of the split, we effected the split
on October 19, 2009. Immediately following the reverse stock split, all outstanding shares of our common stock was exchanged for
the newly issued shares of common stock on the basis of the reverse split ratio. The par value of common stock was not affected
by the split. As a result of the split, the number of shares available for future issuances has increased and the number of currently
outstanding shares of our common stock decreased. The purpose of the split was to recapitalize all of our outstanding shares of
capital stock into shares of the same class of common stock to be sold in the January 2010 initial public offering.
In May 2010, we entered
into an agreement with shareholder of Mashan Xingyuan Marine Fuel Co., Ltd ("MashanXingyuan"), which is located in Rongcheng
City, Shandong Province, PRC. Under the terms of the agreement, we acquired 52% of MashanXingyuan for a cash payment of RMB 3.64
million (approximately US$ 0.54 million). Through the acquisition, Andatee gained control of MashanXingyuan's assets, which include
three 1,000 cubic meter storage tanks, three 500 cubic meter storage tanks, equipment and facilities, as well as 3,600 square
meters of land use rights, along with the assumption of RMB 0.54 million (approximately US$ 0.08 million). MashanXingyuan was
founded in Rongcheng, Shandong province and is an important blended marine fuel retail outlet in the region.
In July 2010, we entered
into an agreement with shareholders of Hailong Petrochemical Co., Ltd ("Hailong"), which is located in Tianjin City
engaged in retail and wholesale of fuel oil and petrochemical products. Under the terms of the agreement, we acquired 52% of Hailong's
equity for a cash payment of RMB 3.64 million (approximately US$ 0.54 million). Pursuant to Board resolutions of Tianjin Hailong
dated on January 18, 2013, Dalian Fusheng approved to sale its 51.952% ownership interest in Tianjin Hailong to Tianjin Hailong's
two individual shareholders Mr. Niu Jinfu and Mr.Zhao Guohua for RMB 5.46 million (about $0.86 million). After such sale, Tianjin
Hailong’s operations will no longer be consolidated. The formal sale agreement has not been completed as of December 31,
2013.
In December 2011,
we entered into an agreement with shareholders of Wujiang Xinlang Petrochemical Company (“Xinlang”), which is a river
pump station, located in Wujiang City, Jiangsu Province engaged in retail and wholesale of fuel oil for small cargo boats. Under
the terms of agreement, we acquired 90% of Xinlang’s equity for a cash payment of RMB 2.36 million (approximately US$ 0.37
million).
In December 2011,
we entered into an agreement with shareholders of Suzhou Fusheng Petrochemical Company (“Suzhou Fusheng”), which includes
several storage tanks total volume of 16.5 thousand cubic meters and a river pump station. Under the terms of the agreement, we
acquired 61% of the equity for a cash payment of RMB12.2 million (approximately US$1.93million). We will cooperate with Suzhou
Fusheng on business development in the local market.
In December 2011,
we entered into an agreement with shareholders of Rongcheng Zhuoda Trading Co. (“Zhuoda”), which owned 13,000 cubic
meters tanks, which is located in Rongcheng City, Shandong Province engaged in retail and wholesale of marine fuel oil for fishing
boats. Under the terms of agreement, we acquired 100% of Zhuoda equity for a cash payment of RMB 13 million (approximately US$2
million).
On April 27, 2013,
Dalian Fusheng formed a new subsidiary Lianyungang Fusheng Petrochemical Co., Ltd. (“Lianyungang Fusheng”) in the
city of Lianyungang under the laws of the PRC with initial registered capital of RMB 29.0 million (approximately $4.7 million).
Based upon the Board Resolutions, Dalian Fusheng increased the registered and paid in capital of Lianyungang Fusheng to RMB 53.7
million (approximately $8.8 million) on November 1, 2013 and then increased to RMB 153.7 million (approximately $25.2 million)
on December 27, 2013.
On April 27, 2013,
Dalian Xingyuan formed a new subsidiary Lianyungang Xingyuan Marine Bunker Co., Ltd. (“Lianyungang Xingyuan”) in the
city of Lianyungang under the laws of the PRC with registered capital of RMB 21,000,000 (approximately $3.4 million).
During the third quarter
of 2013, Dalian Xingyuan acquired 37% capital shares from Xiangshan Nanlian’s minority shareholder Mr. Chen Wenwei for a
cash consideration of RMB 11.2 million (approximately $1.83 million). After the acquisition, Xiangshan Nanlian became the 100%
controlled subsidiary of Dalian Xingyuan. The acquisition was treated as a related party transaction because formal minority shareholder
Mr. Chen Weiwen still serves as the legal representative of Xiangshan Nanlian after the acquisition.
On December 31, 2013,
Dalian Fusheng, Dalian Xingyuan and Dalian Xifa jointly formed a new subsidiary Xinniu Development Co., Ltd. (“Xinniu”)
in the city of Dalian under the laws of the PRC with registered capital of RMB 200 million (approximately $32.7 million).
The following diagram illustrates our corporate
structure:
Industry Overview
The Company’s
main line of business is providing various kinds of fuel oils for marine fishing industry. According to statistics, as of December
2013, there are about 20 million various marine fishing boats in China, with an annual marine fuel oil consumption demand of about
7.9 million metric tons. Total volume of the marine fishing industry is estimated to be $7.8 billion (RMB 47.4 billion) In 2013,
global warming and previous over-fishing activities has brought certain negative impact on the marine ecosystem and water temperature,
causing immeasurable harm to inshore fishing resources. As a result, marine fishing boats have to travel to more remote offshore
sea areas for fishing.
Our Products and Services
We blend and supply
marine fuel as an alternative fuel for Chinese cargo and fishing vessels. Our sales of marine oil for fishing boats represented
approximately 81% and 94% of our total revenue for fiscal 2013 and 2012, respectively, as compared with the sale of marine oil
for cargo vessels which represented the remaining 19% and 6% of our total revenue for the same periods. Our cargo vessel fuel
is designated as CST180 and CST120; fishing boat/vessel fuel #1 fuel (for engines with 2,000 rpm capacity), #2 fuel (for engines
with 1,800 rpm capacity), #3 fuel (for engines with 1600 rpm capacity) and #4 fuel (for engines with 1400 rpm capacity). We also
blend fuel to specific customer specifications using our proprietary blending technology. Our own blend of Marine Diesel Oil,
#1, #2, #3 fuel oil and #4 fuel oil are able to replace the traditional diesel oil, commonly known as #0 diesel oil, used by most
small to medium vessels and boats. Currently, we sell approximately 88% of our products through distributors and approximately
12% of our products to retail customers. Fuel is classified into 6 classes, numbered 1 through 6, each according to its boiling
point, composition and purpose. The boiling point, in the range of 175 − 600°C, and carbon chain length, in the range
of 20 − 70 atoms, of the fuel increases with fuel number, i.e. the higher the class number, the higher the boiling point
and the carbon chain length as well as oil’s viscosity. Price of oil, on the other hand, usually decreases as the fuel number
increases since higher number fuel must be heated to overcome its viscosity.
The following table
represents the description of our sales organized by product and geographical markets for the periods 2011-2013:
|
|
2013
|
|
|
|
|
|
2012
|
|
|
|
|
|
2011
|
|
|
|
|
|
|
Tons
|
|
|
%
|
|
|
Tons
|
|
|
%
|
|
|
Tons
|
|
|
%
|
|
|
|
(in thousands)
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
Products
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1#
|
|
|
127.4
|
|
|
|
23.8
|
%
|
|
|
21.99
|
|
|
|
7.42
|
%
|
|
|
32.10
|
|
|
|
10.74
|
%
|
2#
|
|
|
37.7
|
|
|
|
10.5
|
%
|
|
|
28.81
|
|
|
|
9.71
|
%
|
|
|
35.33
|
|
|
|
11.82
|
%
|
3#
|
|
|
32.2
|
|
|
|
9.4
|
%
|
|
|
43.76
|
|
|
|
14.76
|
%
|
|
|
35.55
|
|
|
|
11.89
|
%
|
4#
|
|
|
125.2
|
|
|
|
37.5
|
%
|
|
|
185.19
|
|
|
|
62.45
|
%
|
|
|
152.64
|
|
|
|
51.05
|
%
|
180CST
|
|
|
53.6
|
|
|
|
15.9
|
%
|
|
|
12.03
|
|
|
|
4.06
|
%
|
|
|
23.53
|
|
|
|
7.87
|
%
|
120CST
|
|
|
11.0
|
|
|
|
2.9
|
%
|
|
|
4.78
|
|
|
|
1.61
|
%
|
|
|
19.84
|
|
|
|
6.64
|
%
|
|
|
|
387.37
|
|
|
|
|
|
|
|
296.56
|
|
|
|
|
|
|
|
298.99
|
|
|
|
|
|
Areas
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dalian
|
|
|
128.8
|
|
|
|
37.2
|
%
|
|
|
272.51
|
|
|
|
91.89
|
%
|
|
|
166.37
|
|
|
|
55.64
|
%
|
Shandong
|
|
|
44.7
|
|
|
|
13.1
|
%
|
|
|
14.43
|
|
|
|
4.87
|
%
|
|
|
86.73
|
|
|
|
29.01
|
%
|
Shanghai
|
|
|
202.2
|
|
|
|
46.0
|
%
|
|
|
4.56
|
|
|
|
1.54
|
%
|
|
|
21.74
|
|
|
|
7.27
|
%
|
Zhejiang
|
|
|
11.6
|
|
|
|
3.7
|
%
|
|
|
5.06
|
|
|
|
1.71
|
%
|
|
|
24.17
|
|
|
|
8.08
|
%
|
Our Competitive Strengths
Our business objective
is to become the premium ‘‘one-stop’’ marine service provider for cargo, fishing and other vessels in
China through our integrated distribution networks. We believe that our business model offers competitive advantages over our
current market competition through:
|
·
|
Product Superiority and Price Competitiveness
- our blended
marine fuel is price competitive as compared with various brands of diesel oil available in the local PRC market. In 2013,
we re-assessed our business goals and started to diversify our purchase channels, such as import the fuel oil from overseas
market to lower the costs. In fact, based on 2013 price data, our blended fuel (#4), while maintaining the same fuel efficiency,
is, on average, US$20 per ton cheaper than the leading diesel fuel brand.
|
|
·
|
Brand Recognition
- our consistent and superior product
quality over the years has resulted in our dominance in the fishing boat and vessel market in the provinces where we maintain
our operations. Through our VIE entities, we are the largest privately owned company engaged in marine fuel industry in northern
China. We intend to take advantage of our brand to increase our customer base and to leverage our brand and build an integrated
distribution system for our range of related oil products and services. We believe our strong branding has allowed us to develop
a broad base of end-user customers, expand our sales channels and facilitate more rapid acceptance of our new products.
|
|
·
|
Reliability of Our Supplies of Raw Materials
- We have
stable and reliable raw material suppliers for our production. Our relationships with upstream suppliers enables us to be
a low cost producer. We have a long-standing relationship with China Petroleum which provided almost 25% of all
raw materials we required for 2013. For the year ended December 31, 2013, other major suppliers are Panjin Liaohe Oil Field
Dali Group Petrochemical Co., Ltd and Liaoyang Petroleum Fiber Company Yifang Industrial Co., Ltd., which provide us 11.1%
and 10.4% of our raw materials. Together with other suppliers, including Dalian Mingyuan Petrochemical Co., Ltd., Dalian Jingtian
Shipping Service Co., Ltd., and Shanghai Longyu, etc., providing the remaining of our need for raw materials. In second half
of 2013, we also started to import fuel oil from overseas market, such as from the Middle East and Russia. We will continue
to explore new suppliers to reduce supply risk as needed
.
|
|
·
|
Extensive Sales and Distribution Network
- Our distribution
consists of approximately distributors throughout China in six provinces, we believe our distribution network is one of the
largest among marine fuel suppliers in China. We are acquiring and building new facilities, which consist of blending plants,
storage tanks, and fueling ports, close to some of our end customers or to a particular market in order to improve our product
distribution capacity. We focus on timely delivery and good customer service. In addition our storage facilities are located
close to our customers, enabling us to sell directly to them resulting in lower logistics costs. It also allows us to provide
better after sales service and to maintain a close relationship with our key distributors through regular meetings, discussions
and customer visits. Among our distributors, in 2013, Shanghai Lonyer Fuels Co., Ltd and Dalian Ocean Fishery Group of Corporations
represent 16% and 4.8% of our sales, respectively.
|
|
·
|
Innovation and R&D capabilities
- We strive to identify
market trends and developments in the marine fuel industry and use our blending technology to produce quality oils to satisfy
the market demand. We operate several dedicated research and development facilities with 49 professionals and collaborate
with universities and institutes, including Dalian University of Technology and Shandong Petrol University. We believe our
investment in research and development has enabled us to continuously expand our product offerings and proactively anticipate
market changes in our industry. Those R&D efforts continued in 2013.
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Stringent Quality Control
- We have stringent quality
control systems at all stages of the blending process. Our periodic quality tests of our blended products are conducted by
the team of trained scientific personnel which represent the area’s leading technical institutes and universities. We
test the consistency and quality of our blended products and adjust the various components on an ‘‘as needed’’
basis. In addition, the quality of our testing process is periodically and independently verified by the governmental agencies
in charge of overseeing quality and safety standards of the oil products supplied in the marketplace.
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Strong Management Team
- We have key management staff
that has extensive experience and technical skills in oil processing, refining and blending technology.
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Our Strategies
Our strategy is to
capitalize on our competitive strengths to expand our current market penetration. We plan to grow our business by pursuing the
following strategies:
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Expand our Product Offerings
- We are focused on becoming
a ‘‘one-stop’’ product supplier for our end-user customers. We plan to continue expanding our product
offerings to increase the customization of marine fuels and address the key elements of our end-user customers’ needs
for lower prices, easier access to fuel and a wide variety of complementary services. We believe offering these integrated
systems will promote higher end-user customer satisfaction, higher margins, the establishment of long-term service contracts
to maintain the systems and increased barriers to entry for potential competitors.
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Focus on Advanced Technologies
- We are currently utilizing
our research and development capabilities to develop new blending processes and applications. We believe there will be a growing
demand for products possessing such features as governments, businesses and consumers become increasingly focused on sustainable
economic growth and environmental issues. We follow advanced project selection procedures prior to the development of new
products, including the use of detailed market and technological analyses. All new products are subject to rigorous testing
at our facilities prior to production and sample products are often delivered to end-user customers for their trial use. We
begin manufacturing new products only after the sample product from a trial production passes internal inspection and achieves
customer satisfaction. This integrated approach allows us to identify potential difficulties in commercializing our product
and make adjustments as necessary to develop cost-efficient manufacturing processes prior to mass production. We recognize
the importance of customer satisfaction for our newly-developed products and continue to seek feedback from our end-user customers
even after the formal launch of a product.
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Terminate Certain Subsidiaries
with unsatisfactory Operating Performance –
Since we moved the headquarters from Shanghai back to Dalian in
late 2012, we have been undergoing an internal re-organization which, away other things, included discontinuing several
subsidiaries as a result of unsatisfactory operating performance. On January 7, 2013, the Company filed application with
local government authority to terminate the operation of its subsidiary, Shandong Shengfu. The application was approved
by local government on March 7, 2013. In addition, pursuant to a Board Resolution of Tianjin Hailong dated on January
18, 2013, Dalian Fusheng transferred its 51.952% ownership interest in Tianjin Hailong to Tianjin Hailong's two individual
shareholders Mr. Niu Jinfu and Mr.Zhao Guohua for RMB 5.46 million (about $0.86 million).After such transfer, Tianjin
Hailong’s operations will not be consolidated. The formal sale agreement has not been completed as of December 31,
2013. As of December 31, 2013, Tianjin Hailong’s total assets was $2.4 million, accounting for only 0.8% of the
Company’s consolidated total assets; and total liabilities was approximately $1.9 million, accounting for only 0.8%
of the Company’s consolidated total liabilities. There was no revenue and net income reported for the year ended
December 31, 2013. The assets were not reported as discontinued operations due to immateriality. In 2014, we plan to terminate
additional subsidiaries, such as Wujiang Xinlang and Mashan Xingyuan, among possible others.
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Pursue Selective Strategic Acquisitions -
While we have
experienced substantial organic growth, we plan to pursue a disciplined and targeted acquisition strategy to accelerate our
growth. Our strategy will focus on obtaining complementary product offerings and locations, product line extensions, research
and development capabilities and access to new markets and customers. We seek vertical growth through the acquisition of retail
facilities which increase revenue line by having these newly acquired facilities to purchase more goods from parent and enjoying
the profit margin on wholesale and retail distribution. Our acquisitions have historically enabled us to increase our product
and service offerings and expand into other geographies. We may continue to acquire companies that provide us with storage
capacities, customer and distribution network access. We expect that our acquisition targets will have the same core expertise
as we do, maintain suitable storage facilities/berth locations, an established customer base to market our existing line of
products and services. We anticipate that this strategy will enhance our time to market and our customer base, and will reduce
local market entry risk. We intend to target profitable companies with proper location and currently under poor operation
and management. After our acquisition, we will utilize our strength, operation and low cost product to occupy the market.
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Increase Our Market Share in China
- We plan to continue
to expand our market share of the industry in China. To do so, we are developing additional advanced products across our comprehensive
product lines, which will further create cross-selling opportunities and production and marketing synergies. We also intend
to increase our marketing activities and are actively seeking to increase the number of distributors carrying our products,
specifically new distributors that will provide us with greater access to a wider range of end-user customers.
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Expand Our Blending Capacity and Increase In-house Production
- We currently plan to build new manufacturing and blending facilities and production lines to produce new brands of marine
fuel products. In December 31, 2013, we started to construct a new chemical and fuel oil blending project in Lianyungang city
after we obtained a land use right in October 2013. Total estimated contract price for this new project is approximately
$41 million (or RMB 250 million). We prepaid $16 million (equivalent to RMB 100 million) to the general contracting firm in
charge of building the facility to start the project in December 2013. We also plan to improve and upgrade our
existing manufacturing facilities and production lines to enhance our quality control and to meet increasing demand for our
current products. With the increased manufacturing capacity, we also expect to bring additional production steps in-house
and increase the in-house manufacturing of certain core components to further improve our cost structure, the protection of
our intellectual property, the quality and performance of our products and our operational efficiencies.
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Sales & Marketing
Our main customers
are located in Liaoning, Shandong, Jiangsu, Shanghai Guangdong and Zhejiang Provinces. Currently, we have 100 full-time sales
and marketing personnel responsible for promoting our products and services to our customers and distributors. We maintain close
relationships with our key customers through regular meetings and discussions to keep them updated on the variety of products
and services we offer. In addition, we maintain strong relationships in our local communities and government for favorable business
expansion in each individual geographical area. Our sales and marketing approach varies depending on the peculiarities of a particular
market.
Supply of Raw Materials
Although we intend
to diversify our raw material supplies by engaging international sources, presently, we purchase all of our raw materials only
from Chinese suppliers. Our operating companies, Xingyuan and Fusheng, maintain a contractual relationship with Panjin Liaohe
Oil Field Dali Group Petrochemical Co., Ltd. (“Panjin”) for purchases of wax fuel oil, which we commenced in October
2005, which provides over 20% of all raw materials as we need every year. These contracts are renewed on a monthly basis whereby
the quantities of oil purchased vary from period to period at then prevailing market prices. Xingyuan also purchases, at market
prices, rubber filling oil from PetroChina Dalian Petrochemical Company in amounts of 3,000 − 5,000 tons per month, respectively,
which provides over 25% of all raw materials as we need every year. These contracts are also renewed on a monthly basis whereby
the quantities of oil purchased vary from period to period at then prevailing market prices. Similarly, Xingyuan maintains a contractual
relationship with Qingdao Anbang Refining and Chemical Co., Ltd. (“Qingdao”) for our needs of catalytic diesel oil.
These contracts are also renewed on a rolling monthly basis whereby the quantities of oil purchased vary from period to period
at then prevailing market prices. The use of domestic, local suppliers in close proximity to our facilities enables us to closely
monitor the quality of the raw supplies obtained from such suppliers, provide technical training relating to our raw material
requirements and suggest technical improvements. We obtain raw materials and components from suppliers through non-exclusive purchase
orders and supply contracts. The purchase order or contract specifies the price for the raw material. Although we allow for adjustments
in the price for certain raw materials under extraordinary circumstances, the prices for our materials are generally fixed for
the effective term of the purchase agreement. Our contracts with our suppliers are generally renewable on an annual basis, but
the price is not fixed and remains flexible and reflective of the prevailing market conditions. We typically negotiate with our
suppliers to renew supply contracts at the beginning of each year, taking into account the quality and consistency of the materials
and services provided. We maintain multiple supply sources for each of our key raw materials so as to minimize any potential disruption
of our operations and maintain sourcing stability.
In fiscal year 2013,
our purchases from our largest supplier PetroChina Dalian Petrochemical Company accounted for about 25.1% of our total purchases.
In fiscal 2013 and 2012, purchases from Panjin Liaohe Oil Field Dali Group Petrochemical Co., Ltd, accounted for 11.1% and 19.46%,
respectively, of our total purchases of raw materials. For the same periods, our ten largest suppliers combined accounted for
65.8% and 71%, respectively, of our total purchases of raw materials. The raw materials required for our products are low value
crude oil refinement byproducts which conventionally are disposed of by the major oil producing and refining companies. We negotiate
prices for our raw material supplies on a monthly basis to accommodate for our short-term production requirements.
We maintain a procurement
team that has established relationships with various raw material suppliers to ensure constant and reliable supply. In addition,
we have successfully employed and continue to employ a number of methods to hedge against the risks of fluctuations in the raw
material prices. Namely, we:
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Shorten our production cycle;
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Review raw material price agreements
on a weekly basis;
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Reduce purchase amounts, or
buy on an ‘‘as needed’’ basis;
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Place our blending facilities
in close proximity to our customers to reduce delivery time;
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Increase the proportion of
direct sales to end users by building more infrastructure to reduce reliance on distributors;
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Leverage our brand, i.e. seek
customers who are willing to pay quality and brand premium.
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Quality Control
We have implemented
a rigid quality control system and devote significant attention to quality control procedures at every stage of our process. We
monitor our manufacturing process closely and conduct performance and reliability testing to ensure our products meet our end-user
customer expectations. Our quality control group as of December 31, 2013 included 5 employees that implement various management
systems to improve product quality programs. We inspect our raw materials to ensure compliance with quality standards. We also
evaluate the quality and delivery performance of each supplier periodically and adjust quantity allocations accordingly. We also
monitor in-process and outgoing stages of our processes.
Seasonality
The Chinese government
prohibits fishing boats and vessels from fishing from June 15th to September 15th of each year, the breeding season for many varieties
of fish, in order to protect marine resources and prevent overfishing. In addition, we are also subject to the reduced commercial
activity during the Chinese New Year, the most important of the traditional Chinese holidays. During this time, both cargo and
fishing traffic decrease and we expect the demand for our products to decrease accordingly.
Research & Development
As of December 31,
2013, we had 49 professionals in our research and development group. Our research and development activities are based in our
research and development center located in the City of Dalian and Zibo City, Shandong Province, where we maintain 4 laboratories,
including one at the Dalian University of Technology. Each of our laboratories is staffed with several support personnel and is
headed by an experienced member of the faculty with whom we enter into contractual arrangements to provide research and development
services to the Company. We own all rights, title and interest in any proprietary information resulting from the research work
at our R & D facilities. In addition to improving our existing product offerings, our research and development efforts focus
on the development of new products, as well as the development of new production methodologies to improve our manufacturing processes.
Competition
The market for oil
for small and medium size vessels, i.e. less than 3,000 tons, is very fragmented with no discernible market leader. We estimate
the total value of this market to be approximately US$7.8 billion as of December 31, 2013. It is characterized by intense price
competition, uneven product and service quality and is dominated by many small fuel trading companies. Most of these trading companies
do not have stable supply sources or a strong working capital to withstand market risk, which may lead to chronic shortages of
oil in the market. Boat and vessel operators are at high risk when oil merchants market them poor quality oil or counterfeit products
that have insufficient energy efficiency or cause damage to engines. Therefore, our experience and market research have consistently
shown that boat and vessel operators are willing to pay a premium for consistent quality products and services. High barriers
of entry for new entrants into this industry include heavy regulatory hurdles, scarcity of suitable operation and storage sites,
capital intensity and skilled management. Most of the operational, business and other activities in the storage, refining and
producing industries are heavily regulated and require layers of governmental consents and approvals. In addition, storage hubs
must be located on sufficiently large sites in strategic locations with close proximity to industrial ports and harbors with deep
water access. Most of the infrastructure requires significant upfront capital expenditures. Thus, we believe all of the foregoing
factors fortify our competitive positions in the industry.
Our industry is characterized
by the major national oil companies controlling the upstream refineries and supplying the end products to the downstream. In particular
for marine fuel oil, China Marine Bunker (China Petrol) Co., Ltd. is a major participant in the market. In the downstream, there
are many traders selling marine fuel oil in all the provinces feeding from the 1st tier manufacturers. There are only a limited
number of credible manufacturers that have blending capability of and direct access to raw materials from national refineries.
Our competitors are numerous, ranging from large multinational corporations, which have significantly greater capital resources,
to relatively small and specialized firms. In addition to competing with fuel resellers, we also compete with the major oil producers
that market fuel directly to the large shipping companies. Such major oil producers do not include the PRC oil companies since
under the PRC laws, petroleum producers are precluded from blending oil and oil products. Our business could be adversely affected
because of increased competition from the larger oil companies who may choose to directly market to shipping companies, or to
provide less advantageous price and credit terms to us than our fuel reseller competitors.
We believe we have
no significant competition in the fuel market for small and medium vessels. Potential competitors could include major domestic
oil producing and refining companies, including as Sinopec, China Petrol and CNOOC, none of which are currently active in this
marketplace or legally permitted to blend oil. However, we believe it is unlikely they would enter into this segment of the market
in the near future since the entry opportunities diminish as we develop our integrated distribution system through acquiring resources
and sites and strengthening our market position, thus creating high barriers to entry, including regulatory and compliance hurdles
capital and storage scarcity, shortage of skilled management.
Insurance
The insurance industry
in China is still at an early state of its development. Insurance companies in China offer limited business insurance products
or offer them at a high price. Business interruption or similar types of insurance are not customary in China. We currently maintain
insurance coverage with China People’s Insurance Company Limited of China, which, as of December 31, 2013, was approximately
RMB14.3 million (US$2.33 million) on our property and facilities and approximately RMB36.5 million (US$5.9 million) on our inventory.
We do not carry any third party liability insurance to cover claims in respect of personal injury, property or environmental damage
arising from accidents on our property or relating to our operations other than on our transportation vehicles. We have not had
a third party liability claim filed against us during the last five years.
Business, Ownership, Environmental
and Other Regulations
Petroleum and Refining Industry Regulations
Although the Chinese
government is liberalizing its control over the petroleum and petrochemical industries, significant government regulations remain.
Central government agencies and their local or provincial level counterparts do not own or directly control our production facilities.
However, they exercise significant control over the petrochemical industry in areas such as production quotas, quality standards,
allocation of raw materials and finished products, allocation of foreign exchange and Renminbi loans for capital construction
projects. Since 2003, at the national level, our operations are subject to the supervision and industrial oversight, to various
extent, by the State Assets Regulatory and Management Commission, by the Ministry of Commerce and the National Development and
Reform Committee. At the local level, we are subject to the supervision and oversight by the provincial branches of these national
agencies as well as local governments and agencies.
Foreign Exchange and Dividend Distribution
Regulations
The principal regulations
governing foreign currency exchange in China are the Foreign Exchange Control Regulations (1996), as amended. Under these regulations,
the Renminbi is convertible for current account items, including the distribution of dividends, interest payments, trade and service-related
foreign exchange transactions. Conversion of the Renminbi for capital account items, such as direct investment, loans, repatriation
of investment and investment in securities outside China, however, is still subject to the approval of the SAFE or its competent
local branch. The dividends paid by a subsidiary to its shareholder are deemed income of the shareholder and are taxable in China.
Pursuant to the Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996), foreign-invested enterprises
in China may purchase or remit foreign exchange, subject to a cap approved by the SAFE, for settlement of current account transactions
without the approval of the SAFE.
The principal regulations
governing distribution of dividends of foreign holding companies include the Foreign Investment Enterprise Law (1986), as amended,
and the Administrative Rules under the Foreign Investment Enterprise Law (2001). Under these regulations, foreign-invested enterprises
in China may pay dividends only out of their accumulated profits, if any, determined in accordance with Chinese accounting standards
and regulations. In addition, foreign-invested enterprises in China are required to allocate at least 10% of their respective
accumulated profits each year, if any, to fund certain reserve funds unless these reserves have reached 50% of the registered
capital of the enterprises. These reserves are not distributable as cash dividends. Our Chinese VIE’s and one PRC subsidiary,
Fusheng, which are all foreign-invested enterprises, are restricted from distributing any dividends to us until they have met
these requirements set out in the regulations.
According to the new
EIT law and the implementation rules on the new EIT law, if a foreign legal person is not deemed to be a resident enterprise for
Chinese tax purposes, dividends generated after January 1, 2008 and paid to this foreign legal person from business operations
in China will be subject to a 10% withholding tax, unless such foreign legal person’s jurisdiction of incorporation has
a tax treaty with the PRC that provides for a different withholding arrangement. Under the new EIT law and its implementation
rules, if an enterprise incorporated outside China has its ‘‘de facto management organization’’ located
within China, such enterprise would be classified as a resident enterprise and thus would be subject to an enterprise income tax
rate of 25% on all of its income on a worldwide basis, with the possible exclusion of dividends received directly from another
Chinese tax resident.
On December 25, 2006,
the People’s Bank of China, or PBOC, issued the Administration Measures on Individual Foreign Exchange Control, and the
corresponding Implementation Rules were issued by SAFE on January 5, 2007. Both of these regulations became effective on February
1, 2007. According to these regulations, all foreign exchange matters relating to employee stock holding plans, share option plans
or similar plans in which PRC citizens’ participation require approval from the SAFE or its authorized branch. On March
28, 2007, SAFE promulgated the Application Procedure of Foreign Exchange Administration for Domestic Individuals Participating
in Employee Stock Option Holding Plan or Stock Option Plan of Overseas Listed Company, or the Stock Option Rule. The purpose of
the Stock Option Rule is to regulate foreign exchange administration of Chinese citizens who participate in employee stock holding
plans and share option plans of offshore listed companies. According to the Stock Option Rule, if a Chinese citizen participates
in any employee stock holding plans or share option plans of an offshore listed company, a Chinese domestic agent or the Chinese
subsidiary of the offshore listed company is required to file, on behalf of the individual, an application with the SAFE to obtain
approval for an annual allowance with respect to the purchase of foreign exchange in connection with stock holding or share option
exercises. This restriction exists because a Chinese citizen may not directly use offshore funds to purchase stock or exercise
share options. Concurrent with the filing of the required application with the SAFE, the Chinese domestic agent or the Chinese
subsidiary must obtain approval from the SAFE to open a special foreign exchange account at a Chinese domestic bank to hold the
funds required in connection with the stock purchase or option exercise, any returned principal profits upon sales of stock, any
dividends issued on the stock and any other income or expenditures approved by the SAFE. The Chinese domestic agent or the Chinese
subsidiary also is required to obtain approval from the SAFE to open an offshore special foreign exchange account at an offshore
trust bank to hold offshore funds used in connection with any employee stock holding plans. All proceeds obtained by a Chinese
citizen from dividends acquired from the offshore listed company through employee stock holding plans or share option plans, or
sales of the offshore listed company’s stock acquired through other methods, must be remitted back to China after relevant
offshore expenses are deducted. The foreign exchange proceeds from these sales can be converted into Renminbi or transferred to
the individuals’ foreign exchange savings account after the proceeds have been remitted back to the special foreign exchange
account opened at a Chinese bank. If share options are exercised in a cashless exercise, the Chinese individuals exercising them
are required to remit the proceeds to the special foreign exchange account. Although the Stock Option Rule has been promulgated
recently and many issues require further interpretation, we and our Chinese employees who have been or will be granted share options
or shares will be subject to the Stock Option Rule, as an offshore listed company.
Employee Stock Option Regulations
Under SAFE Notice
No. 106, employee stock holding plans of offshore special purpose companies must be filed with the SAFE, and employee share option
plans of offshore special purpose companies must be filed with the SAFE while applying for the registration for the establishment
of the offshore special purpose company. After the employees exercise their options, they must apply for the amendment to the
registration for the offshore special purpose company with the SAFE. If we or our Chinese employees fail to comply with the Stock
Option Rule, we and/or our Chinese employees may face sanctions imposed by foreign exchange authority or any other Chinese government
authorities.
On August 8, 2006,
six Chinese regulatory agencies, including the Ministry of Commerce, the State Assets Supervision and Administration Commission,
the State Administration for Taxation, the State Administration for Industry and Commerce, the CSRC and the SAFE, jointly issued
the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the New M&A Rule, which became
effective on September 8, 2006. Under the New M&A Rule, equity or assets merger and acquisition of Chinese enterprises by
foreign investors will be subject to the approval from the Ministry of Commerce or its competent local branches. This regulation
also includes provisions that purport to require special purpose companies formed for purposes of offshore listing of equity interests
in Chinese companies to obtain the approval of the CSRC prior to the listing and trading of their securities on any offshore stock
exchange. As defined in the New M&A Rule, a special purpose vehicle is an offshore company that is directly or indirectly
established or controlled by Chinese entities or individuals for the purposes of an overseas listing.
The CSRC approval
procedures require the filing of a number of documents with the CSRC and it would take several months to complete the approval
process. The application of the New M&A Rule with respect to offshore listings of special purpose companies remains unclear
with no consensus currently existing among leading Chinese law firms regarding the scope of the applicability of the CSRC approval
requirement. A loan made by foreign investors as shareholders in a foreign-invested enterprise is considered to be foreign debt
in China and subject to several Chinese laws and regulations, including the Foreign Exchange Control Regulations of 1997, the
Interim Measures on Foreign Debts of 2003, or the Interim Measures, the Statistical Monitoring of Foreign Debts Tentative Provisions
of 1987 and its Implementing Rules of 1998, the Administration of the Settlement, Sale and Payment of Foreign Exchange Provisions
of 1996, and the Notice of the SAFE in Respect of Perfection of Issues Relating Foreign Debts, dated October 21, 2005. Under these
regulations, a shareholder loan in the form of foreign debt made to a Chinese entity does not require the prior approval of the
SAFE. However, such foreign debt must be registered with and recorded by the SAFE or its local branch in accordance with relevant
Chinese laws and regulations. Our Chinese VIE’s and our PRC subsidiary can legally borrow foreign exchange loans up to their
borrowing limits, which is defined as the difference between the amount of their respective ‘‘total investment’’
and “registered capital” as approved by the Ministry of Commerce, or its local counterparts. Interest payments, if
any, on the loans are subject to 10% withholding tax unless any such foreign shareholders’ jurisdiction of incorporation
has a tax treaty with China that provides for a different withholding agreement. Pursuant to Article 18 of the Interim Measures,
if the amount of foreign exchange debt of our Chinese VIE’s and our PRC subsidiary exceed their respective borrowing limits,
we are required to apply to the relevant Chinese authorities to increase the total investment amount and registered capital to
allow the excess foreign exchange debt to be registered with the SAFE.
Environmental Regulations
China’s rapid
economic growth over the last two decades has also brought with it several energy related environmental problems. Environmental
pollution from fossil fuel combustion is damaging human health, air and water quality, agriculture, and ultimately the economy.
Many of China’s cities are among the most polluted in the world. China is the world’s second-largest source of carbon
dioxide emissions behind the United States. EIA forecasts predict that China will experience the largest growth in carbon dioxide
emissions between now and the year 2030. The Chinese government has taken several steps to improve environmental conditions in
the country. Chief among these is the new Law on Renewable Energy, which took effect on January 1, 2006. The new law seeks to
promote cleaner energy technologies, with a stated goal of increasing the use of renewable energy to 10% of the country’s
electricity consumption by 2010 (up from roughly 3% in 2003).
We are subject to
national and local environmental protection regulations, which currently impose a graduated schedule of fees for the discharge
of waste substances, require the payment of fines for pollution and provide for the forced closure of any facility that fails
to comply with orders requiring it to cease or cure certain environmentally damaging practices. We have established environmental
protection systems which consist of pollution control facilities to treat certain of our waste materials and to safeguard against
accidents. We believe our environmental protection facilities and systems are adequate for the existing national and local environmental
protection regulations.
Employees
As of December 31,
2013, we had 189 employees, 9 of which are engaged in management, 31 of which are engaged in administration and related areas,
49 of which are engaged in research and development activities, and the remaining 100 (primarily sales and marketing personnel)
are engaged in operations at various local sites throughout the east of China. None of our employees are represented by a labor
union or collective bargaining agreements. We consider our employee relations to be good.
Intellectual Property
We rely on trademark
and copyright laws, trade secret protection, non-competition and confidentiality and/or licensing agreements with our executive
officers, clients, contractors, research and development personnel and others to protect our intellectual property rights. We
do not possess any licenses to use third-party intellectual property rights nor do we license to third-parties any intellectual
property rights we own. The protection afforded by our intellectual property may be inadequate. It may be possible for third parties
to obtain and use, without our consent, intellectual property that we own or are licensed to use. Unauthorized use of our intellectual
property by third parties, and the expenses incurred in protecting our intellectual property rights, may adversely affect our
business. We may also be subject to litigation involving claims of violation of intellectual property rights of third parties.
The Company faces
many risks. The risks described below may not be the only risks the Company faces. Additional risks not yet known or currently
believed to be immaterial may also impair the Company’s business. If any of the events or circumstances described in the
following risks actually occurs, the Company’s business, financial condition or results of operations could suffer, and
the trading price of its common stock could decline. You should consider the following risks, together with all of the other information
in this Annual Report on Form 10-K, before making an investment decision with respect to the Company’s securities.
Risks Relating to Our Operations
Our limited operating history makes
evaluation of our business difficult
We have a limited
operating history and have encountered and expect to continue to encounter many of the difficulties and uncertainties often faced
by early stage companies. Our limited operating history makes it difficult to evaluate our future prospects, including our ability
to develop a wide customer and distribution network for our services, expand our operations to include additional services and
control raw material costs, all of which are critical to our success. We may encounter unanticipated problems, expenses and delays
in developing and marketing our services and securing additional blending and storage facilities. We may not be able to successfully
address these risks. If we are unable to address these risks, our business may not grow, our stock price may suffer, and we may
be unable to stay in business.
If the fuel we blend fails to meet
the specifications we have agreed to supply to our customers, our relationship with our customers could be adversely affected
We blend marine fuel
to meet customer specifications. If the fuel fails to meet the specifications we have agreed to supply to our customers, our relationship
with our customers could be adversely affected, and we could be subject to claims and other liabilities which could have a material
adverse effect on our business, financial condition and results of operations.
Our historical sales to significant
customers have been concentrated
For the year ended
December 31, 2013, one customer accounted for approximately 16% of our total revenues. For the fiscal year ended December 31,
2012, two customers accounted for approximately 33.08% and 10.53% of our total revenues. No other customer contributed greater
than 10% of the revenues.
Our operations may be adversely
affected by the cyclical nature of the petroleum and petrochemical market and by the volatility of prices of crude oil and petrochemical
products
Almost all of our
revenues are attributable to petrochemical products, which have historically been cyclical and sensitive to the availability and
price of raw materials and general economic conditions. Markets for many of our products are sensitive to changes in industry
capacity and output levels, cyclical changes in regional and global economic conditions, the price and availability of substitute
products and changes in consumer demand, which from time to time have had a significant impact on product prices in the regional
and global markets. Historically, the markets for these products have experienced alternating periods of tight supply, causing
prices and margins to increase, followed by periods of capacity additions, finally resulting in oversupply and declining prices
and margins. As tariffs and other import restrictions are reduced and the control of product pricing is relaxed in China, the
markets for many of our products have become increasingly subject to the cyclicality of regional and global markets. For example,
in 2008, abrupt changes occurred in the domestic demand for petrochemical products. In the first half of the year, the prices
of petrochemical products continued to rise in conjunction with substantial rises in international oil prices. However, in the
second half, there was a fall in both sales volume and prices of petrochemical products triggered by the global economic downturn.
The sales volume and prices of our petrochemical products also declined, and may remain at the current levels for a sustained
period of time, or even decline further from such levels. Historically, international prices of crude oil have fluctuated widely
due to many factors beyond our control. For example, international crude oil prices increased significantly in the first half
of 2008 but decreased significantly in the second half. After hitting successive record highs, crude oil prices began to fall
rapidly, and hit a new, 3-year record low in December 2008. We expect that the volatility and uncertainty of the prices of crude
oil and petrochemical products will continue. Increasing crude oil prices and declines in prices of petrochemical products may
adversely affect our business and results of operations and financial condition.
Some of our major products are subject
to government price controls, and we are not able to pass on all cost increases from rising crude oil prices through higher product
prices
We require large amounts
of crude oil to manufacture our products. Our ability to pass on increased crude oil costs to our customers is dependent on market
conditions and government regulations, particularly government regulation with respect to the price of certain of our fuel products.
In particular, gasoline, diesel and jet fuel, and liquefied petroleum gas are subject to government price controls. In 2013 and
2012, no sales were from such products subject to price control. Although the Chinese government has adopted a new pricing mechanism
for domestic refined oil products that indirectly links the prices of these products to international crude oil prices, such pricing
mechanism is still nontransparent. Moreover, the Chinese government controls the distribution of many petroleum products in China.
For instance, some of our petroleum products are required to be sold to designated distributors (such as the subsidiaries of China
Petroleum & Chemical Corporation). Because we cannot freely sell our fuel products to take advantage of opportunities for
higher prices and because the formula for the new pricing mechanism set by the Chinese government is not transparent, in periods
of high crude oil prices, we may not be able to fully cover increases in crude oil prices by increases in the sale prices of our
products, which has had and will continue to have a material adverse effect on our financial condition, results of operations
and cash flows.
Our development plans have significant
capital expenditure and financing requirements, which are subject to a number of risks and uncertainties
The
petrochemical business is a capital intensive business. Our ability to maintain and increase our revenues, net income and
cash flows depends upon continued capital spending. Our current business strategy contemplates capital expenditures for 2014
of approximately RMB 150 million (US$24.6 million), which will be provided through financing activities, and use of our own
capital. Our actual capital expenditures may vary significantly from these planned amounts due to our ability to generate
sufficient cash flows from operations, investments and other factors that may be beyond our control. In addition, there can
be no assurance as to whether, or at what cost, our capital projects will be completed or the success of these projects if
completed. Our ability to obtain external financing in the future is subject to a variety of uncertainties, including:
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our future results of operations, financial condition and
cash flows;
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the condition of the economy in China and the markets for
our products;
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the cost of financing and the condition of financial markets;
and
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the issuance of relevant government
approvals and other project risks associated with the development of infrastructure in
China.
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If we fail to obtain
sufficient funding for our operations or development plans, our business, results of operations and financial condition could
be adversely affected.
Material disruptions in the availability
or supply of fuel would adversely affect our business
The success of our
business depends on our ability to purchase, sell and coordinate delivery of fuel and related services to our customers. In the
past, we experienced difficulties in securing supplies of certain components for blending process. We have addressed that concern
by diversifying our raw material supplies and strengthening our relationships with our existing suppliers. Our business would
be adversely affected to the extent that political instability, natural disasters, terrorist activity, military action or other
conditions disrupt the availability or supply of fuel.
Our earnings will be adversely affected
by seasonality of the fishing business
The Chinese government
prohibits fishing vessels from fishing from June 15th to September 15th of each year, the breeding season for many varieties of
fish, in order to protect marine resources and prevent overfishing. As a result, the demand for our blended fuel drops by approximately
15% during this period, which, in turn, has an adverse effect on our operations in the 3rd fiscal quarter of each calendar year.
In addition, we are also subject to the reduced commercial activity during the Chinese New Year which takes place during the 1st
quarter and lasts about 2 weeks. During this time, both cargo and fishing traffic decreases and we expect the demand for our products
to decrease accordingly by approximately the same amount as the decrease in the 3rd quarter.
Adverse conditions in the shipping
and fishing industries may have an adverse effect on our business
Our business is focused
on the marketing of fuel and fuel-related services to the shipping and fishing industries. Therefore, any adverse economic conditions
in these industries may have an adverse effect on our business. In addition, any political instability, natural disasters, terrorist
activity or military action that disrupts shipping or flight operations will adversely affect our customers and may reduce the
demand for our products and services. Our business also could be adversely affected by increased merger activity in such industries,
which may reduce the number of customers that purchase our products and services, as well as the prices we are able to charge
for such products and services.
Insurance coverage for some of our
operations may be insufficient to cover losses
The insurance industry
in China is still at an early state of its development. Insurance companies in China offer limited business insurance products
or offer them at a high price. We do not maintain insurance coverage for various risks, including environmental claims. A significant
uninsured claim against us would have a material adverse effect on our financial position and results of operations.
Failure to attract and retain highly
qualified personnel could have a material negative impact on our business
Implementation of
our business strategy is predominantly dependent on the efforts of Mr. Wang Hao, our Chairman and Chief Executive Officer. If
we were to lose his services, our business and operations would be severely affected. Competition for highly qualified personnel
is intense, and we have very limited resources. The loss of any executive officer or key employee or the failure to attract and
retain other skilled employees could have a material adverse impact upon our business, operations or financial condition.
We may be unable to protect our
trademark or other proprietary intellectual property rights
We rely on trademark
and copyright laws, trade secret protection, non-competition and confidentiality and/or licensing agreements with our executive
officers, clients, contractors, research and development personnel and others to protect our intellectual property rights. We
do not possess any licenses to use third-party intellectual property rights nor do we license to third-parties any intellectual
property rights we own. The protection afforded by our intellectual property may be inadequate. It may be possible for third parties
to obtain and use, without our consent, intellectual property that we own or are licensed to use. Unauthorized use of our intellectual
property by third parties, and the expenses incurred in protecting our intellectual property rights, may adversely affect our
business. We may also be subject to litigation involving claims of violation of intellectual property rights of third parties.
In order to protect or enforce our intellectual property rights, we may initiate litigation against third parties. In addition,
we may become subject to inference, cancellation, or opposition proceedings conducted in trademark offices or the courts to determine
the priority of rights in our marks. The defense of intellectual property rights, interference, cancellation, or opposition proceedings,
and other legal and administrative proceedings, would be costly and divert our technical and management personnel from their normal
responsibilities. Furthermore, because of the substantial amount of discovery required in connection with intellectual property
litigation, there is a risk that some of our confidential information could be compromised by disclosure during this type of litigation
which disclosure could substantially diminish our competitive advantages, thus, resulting in decrease revenues and possible losses.
We face competition and, if we are
not able to effectively compete in our markets, our revenues and profits may decrease
Competitive pressures
in our markets could adversely affect our competitive position, leading to a possible loss of market share or a decrease in prices,
either of which could result in decreased revenues and profits. Our competitors are numerous, ranging from large multinational
corporations, which have significantly greater capital resources, to relatively small and specialized firms. In addition to competing
with fuel resellers, we also compete with the major oil producers that market fuel directly to the large commercial airlines and
shipping companies. Such major oil producers do not include the PRC oil companies since under the PRC laws, petroleum producers
are precluded from blending oil and oil products. Our business could be adversely affected because of increased competition from
the larger oil companies who may choose to directly market to smaller airlines and shipping companies, or to provide less advantageous
price and credit terms to us than our fuel reseller competitors.
We rely on few significant providers
for our raw material supplies
Currently, we purchase
most of our raw materials from Chinese suppliers. In fiscal year 2013, our purchases from our largest supplier PetroChina Dalian
Petrochemical Company accounted for about 25.1% of our total purchases. In addition, our operating company, Fusheng and Xingyuan,
maintain a contractual relationship with Panjin Liaohe Oil Field Dali Group Petrochemical Co., Ltd. (“Panjin”) for
purchases of wax fuel oil, which we commenced in October 2005, provided 11.1% and 19.46% of our purchase of raw materials for
years ended December 31, 2013 and 2012, respectively. Another major supplier for the year 2013 is Liaoyang Petroleum Fiber Company
Yifang Industrial Co., Ltd. which provided 10.4% of raw materials as we need this year. Our ten largest suppliers combined accounted
for 65.8% and 71% of our total purchase for the year ended December 31, 2013 and 2012, respectively. If our supply arrangements
are disrupted or terminated, our business operations would suffer. Economic conditions and growth trends in our industry could
materially and adversely affect our ability to maintain an adequate supply of raw materials necessary to maintain our operations.
We may not be able to integrate
profits from future acquisitions
Acquisitions of local
providers of marine oil and other similar products and services in various cities along the eastern shore of China are a part
of our growth strategy. Such growth path would present a number of challenges to us, including, without limitation, needs to integrate
management teams, local infrastructure, profits, etc. of such companies. We provide no assurance that we will be able to successfully
acquire any such business or that we would be able to integrate profits from such acquired companies.
We are subject to
a variety of environmental laws and regulations related to our refining, blending and storage operations. Our failure to comply
with environmental laws and regulations may have a material adverse effect on our business and results of operations
We are subject to
various environmental laws and regulations that require us to obtain environmental permits for our operations. If we fail to comply
with the provisions of our permit, we could be subject to fines, criminal charges or other sanctions by regulators, including
the suspension or termination of our operations. We are required to comply with extensive and complex environmental laws and regulations
at various levels in the PRC relating to, among other things:
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the handling of fuel and fuel
products;
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the operation of bulk fuel
storage facilities;
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fuel spillage or seepage;
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environmental damage; and
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hazardous waste disposal.
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If we are involved
in a spill or other accident involving hazardous substances, if there are releases of fuel and fuel products we own, or if we
are found to be in violation of environmental laws or regulations, we could be subject to liabilities that could have a material
adverse effect on our business, financial condition and results of operations. If we should fail to comply with applicable environmental
regulations, we could be subject to substantial fines or penalties and to civil and criminal liability. We cannot assure you that
at all times we will be in compliance with environmental laws and regulations or our environmental permits or that we will not
be required to expend significant funds to comply with, or discharge liabilities arising under, environmental laws, regulations
and permits.
We will continue incur significant
costs as a result of being a public company
In January 2010, we
completed our initial public offering and became an Exchange Act reporting company and, thus, expect to continue to incur significant
legal, accounting and other expenses that we did not incur as a private company. Moreover, the Sarbanes-Oxley Act of 2002, as
well as new rules subsequently implemented by the Securities and Exchange Commission and the Nasdaq Stock Market, have imposed
additional requirements on corporate governance practices of public companies. We expect these new rules and regulations to increase
our legal and financial compliance costs and to make some corporate activities more time-consuming and costly. We will also incur
additional costs associated with our public company reporting requirements. It may also be difficult for us to attract and retain
qualified persons to serve on our board of directors due to increased risks of liability to our directors under the new rules
and regulations. We are currently evaluating and monitoring developments with respect to these new rules and regulations, and
we cannot predict or estimate with any degree of certainty the amount or timing of additional costs we may incur. Our results
of operations, cash flows and financial condition reflected in our consolidated financial statements may not be indicative of
the results of operations that we would have achieved had we operated as a public entity for all periods presented or of future
results that we may achieve as a publicly traded company with our current holding company structure. Such variations may be material
to our business.
If we fail to maintain an effective
system of internal controls, we may not be able to accurately report our financial results or prevent fraud. As a result, current
and potential shareholders could lose confidence in our financial reporting, which would harm our business and the trading price
of our stock
Effective internal
controls are necessary for us to provide reliable financial reports and effectively prevent fraud. As directed by Section 404
of the Sarbanes-Oxley Act of 2002, or SOX 404, the Securities and Exchange Commission adopted rules requiring public companies
to include a report of management on the Company’s internal controls over financial reporting in their annual reports. As
of December 31, 2013, our certifying officers concluded that our disclosure controls and procedures were not effective. We have
been and continue to undertake a number of stages to address these issues. If we cannot provide financial reports or prevent fraud,
our business reputation and operating results could be harmed. Inferior internal controls also could cause investors to lose confidence
in our reported financial information, which could have a negative effect on the trading price of our stock.
Risks Related to our Corporate Structure
and Doing Business in China
The laws of the PRC may adversely
affect the rights of shareholders and their ability to prosecute claims against us, our officers and our directors, and may expose
our Company to substantial litigation risk
Shareholders generally
have the right under the applicable law of the state of Delaware to inspect certain books and records of the Company. There are
laws governing business secrets and state secrets in the PRC that may significantly limit the scope and nature of those books
and records that might be available to shareholders, and may impede the ability of our shareholders to investigate or to prosecute
claims against our Company, our officers and our directors. Those same laws may also preclude us from producing information required
to be produced by us pursuant to subpoena, court order or other legal process, which could in turn expose us to financial and
equitable sanctions, and even to the entry of default judgments. Violation of the PRC secrecy laws can result in fines, revocation
of business licenses and imprisonment. The laws of the PRC also protect the files of independent auditing firms and intermediaries
involved in the securities offering diligence process from producing or delivering their records to a foreign country (such as
the United States), or to an agency, instrumentality or court of a foreign country. These laws could also substantially impair
our shareholders abilities to investigate and prosecute claims against our Company, our officers and our directors.
Chinese laws and regulations governing
our businesses and the validity of certain of our contractual arrangements are uncertain. If we are found to be in violation,
we could be subject to sanctions. In addition, changes in such Chinese laws and regulations may materially and adversely affect
our business
There are substantial
uncertainties regarding the interpretation and application of Chinese laws and regulations, including, but not limited to, the
laws and regulations governing our business, or the enforcement and performance of our contractual arrangements with our VIE entity,
Xingyuan, and its stockholders. We are considered a foreign person or foreign invested enterprise under Chinese law. These laws
and regulations are relatively new and may be subject to change, and their official interpretation and enforcement may involve
substantial uncertainty. The effectiveness of newly enacted laws, regulations or amendments may be delayed, resulting in detrimental
reliance by foreign investors. New laws and regulations that affect existing and proposed future businesses may also be applied
retroactively.
The Chinese government
has broad discretion in dealing with violations of laws and regulations, including levying fines, revoking business and other
licenses and requiring actions necessary for compliance. In particular, licenses and permits issued or granted to us by relevant
governmental bodies may be revoked at a later time by higher regulatory bodies. We cannot predict the effect on our business of
the interpretation of existing or new Chinese laws or regulations. We cannot assure you that our current ownership and operating
structure would not be found in violation of any current or future Chinese laws or regulations. As a result, we may be subject
to sanctions, including fines, and could be required to restructure our operations or cease to provide certain services.
If the relevant authorities
find us in violation of PRC laws or regulations, they would have broad discretion in dealing with such a violation, including,
without limitation:
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revoking our business license, other licenses or authorities;
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requiring that we restructure our ownership or operations;
and
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requiring that we discontinue any portion or all of our
business.
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Any of these or similar
actions could significantly disrupt our business operations or restrict us from conducting a substantial portion of our business
operations, which could materially and adversely affect our business, financial condition and results of operations.
The contractual arrangements with
Xingyuan and its shareholders may not be as effective in providing control over Xingyuan as direct ownership of Xingyuan and the
shareholders of Xingyuan may have potential conflicts of interest with us
We have no ownership
interest in Xingyuan and we conduct substantially all of our operations and generate substantially all of our revenues through
contractual arrangements that our subsidiary, Fusheng, had entered into with Xingyuan and its shareholders, and such contractual
arrangements in 2011 are designed to provide us with effective control over Xingyuan. As a result, we moved most of subsidiaries
of Xingyuan to Fusheng in order to reduce this conflict.
We believe that these
contractual arrangements are valid, binding and enforceable, and will not result in any violation of PRC laws or regulations currently
in effect. If we had direct ownership of Xingyuan, we would be able to exercise our rights as a shareholder to effect changes
in the board of directors of Xingyuan, which in turn could effect changes, subject to any applicable fiduciary obligations, at
the management level. Due to our VIE structure, we have to rely on contractual rights to effect control and management of Xingyuan,
which exposes us to the risk of potential breach of contract by the shareholders of Xingyuan. In addition, as Xingyuan is jointly
owned by its shareholders, it may be difficult for us to change our corporate structure if such shareholders refuse to cooperate
with us.
Xingyuan shareholders may have potential
conflict of interest with us
The shareholders of
Xingyuan may breach, or cause Xingyuan to breach, the contracts for a number of reasons. For example, their interests as shareholders
of Xingyuan and the interests of our company may conflict and we may fail to resolve such conflicts; the shareholders may believe
that breaching the contracts will lead to greater economic benefit for them; or the shareholders may otherwise act in bad faith.
If any of the foregoing were to occur, we may have to rely on legal or arbitral proceedings to enforce our contractual rights,
including specific performance or injunctive relief, and claiming damages. Such arbitration and legal proceedings may cost us
substantial financial and other resources, and result in disruption of our business, and we cannot assure you of a favorable outcome.
In addition, as all
of these contractual arrangements are governed by PRC law and provide for the resolution of disputes through either arbitration
or litigation in the PRC, they would be interpreted in accordance with PRC law and any disputes would be resolved in accordance
with PRC legal procedures. The legal environment in the PRC is not as developed as in other jurisdictions, such as the United
States. As a result, uncertainties in the PRC legal system could further limit our ability to enforce these contractual arrangements.
Furthermore, these contracts may not be enforceable in China if PRC government authorities or courts take a view that such contracts
contravene PRC laws and regulations or are otherwise not enforceable for public policy reasons. In the event we are unable to
enforce these contractual arrangements, we may not be able to exert effective control over Xingyuan, and our ability to conduct
our business may be materially and adversely affected.
Xingyuan’s termination of
its consulting services agreement with Fusheng may adversely affect our business and operations
Under the terms of
the exclusive consulting services agreement by and between Fusheng and Xingyuan, Fusheng has the exclusive right to provide to
Xingyuan business consulting and related services in connection with the production and sale of marine bunker. Under this agreement,
Fusheng owns the intellectual property rights arising from the performance of these services, including, but not limited to, any
trade secrets, copyrights, patents, know-how, unpatented methods and processes and otherwise, whether developed by Fusheng or
Xingyuan based on Fusheng’s provision of such services under the agreement. Xingyuan pays quarterly consulting service fees
to Fusheng that are equal 50% of Xingyuan’s total net profit for such quarter. The consulting services agreement is in effect
for a term of 10 years starting from March 26, 2009 unless terminated earlier by (a) Xingyuan upon 6 months’ prior written
notice and payment to Fusheng of RMB 2,000,000 and all of Fusheng’s losses resulting from such early termination; (b) Fusheng
upon Xingyuan’s breach of the agreement; or (c) Fusheng at any time upon 30 days’ prior written notice to Xingyuan.
Due to the substantial expenses and time involved in finding a suitable replacement for this relationship, in the event such termination,
our business and operations would be adversely affected.
All of our assets are located in
the PRC and all of our revenues are derived from our operations in China, and changes in the political and economic policies of
the PRC government or uncertainties with respect to the PRC legal system could have a significant impact upon the business we
may be able to conduct in the PRC and accordingly, on the results of our operations and financial condition
Our business operations
may be adversely affected by the current and future political environment in the PRC. The Chinese government exerts substantial
influence and control over the manner in which we must conduct our business activities. Our ability to operate in China may be
adversely affected by changes in Chinese laws and regulations, including those relating to taxation, import and export tariffs,
raw material environmental regulations, land use rights, property and other matters. Under the current government leadership,
the government of the PRC has been pursuing economic reform policies that encourage private economic activity and greater economic
decentralization. There is no assurance, however, that the government of the PRC will continue to pursue these policies, or that
it will not significantly alter these policies from time to time without notice.
Since 1979, the Chinese
government has promulgated many new laws and regulations covering general economic matters. Despite this activity to develop a
legal system, China’s system of laws is not yet complete. Even where adequate law exists in China, enforcement of existing
laws or contracts based on existing law may be uncertain or sporadic, and it may be difficult to obtain swift and equitable enforcement
or to obtain enforcement of a judgment by a court of another jurisdiction. The relative inexperience of China’s judiciary,
in many cases, creates additional uncertainty as to the outcome of any litigation. In addition, interpretation of statutes and
regulations may be subject to government policies reflecting domestic political changes. Our activities in China will also be
subject to administrative review and approval by various national and local agencies of China’s government. Because of the
changes occurring in China’s legal and regulatory structure, we may not be able to secure the requisite governmental approval
for our activities. Although we have obtained all required governmental approval to operate our business as currently conducted,
to the extent we are unable to maintain required governmental approvals, the Chinese government may, in its sole discretion prohibit
us from conducting our business.
The Chinese legal
system is based on written statutes, and prior court decisions may be cited for reference, but have limited precedential value.
Since 1979, a series of new Chinese laws and regulations have significantly enhanced the protections afforded to various forms
of foreign investments in China. Since the Chinese legal system continues to rapidly evolve, the interpretations of many laws,
regulations and rules are not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which
may limit legal protections available to you and us.
Investors may not be able to serve
process or enforce judgments on us or our related parties
Some of our directors,
including our agent for service of process, are residents of China and not of the United States, and substantially all the assets
of these Chinese persons are located outside the United States. As a result, it could be difficult for investors to effect service
of process in the United States or to enforce a judgment obtained in the United States against our Chinese officers, directors
and other related parties. There is also uncertainty as to whether the courts in China would enforce judgments of United States
courts against us or our directors and officers based on the civil liabilities provisions of the securities laws of the United
States or any other state, or adjudicate an original action brought in China based upon the securities laws of the United States
or any other state.
The contractual arrangements
entered into between our Chinese VIE’s or between us and one of our Chinese VIE’s entities may be subject to audit
or challenge by the Chinese tax authorities. A finding that we owe additional taxes could substantially reduce our net earnings
and the value of your investment.
Under Chinese laws
and regulations, arrangements and transactions among affiliated parties may be subject to audit or challenge by the Chinese tax
authorities. We could face material and adverse tax and financial consequences if the Chinese tax authorities determine that the
contractual arrangements between our Chinese VIE’s or between us and one of our Chinese VIE’s or those arrangements
entered into between us or one of our Chinese VIE’s and an entity affiliated with us do not represent arm’s-length
prices. As a result of such a determination, the Chinese tax authorities could adjust any of the income in the form of a transfer
pricing adjustment. A transfer pricing adjustment could, among other things, result in a reduction of expense deductions for Chinese
tax purposes recorded by us or our Chinese VIE’s or an increase in taxable income, all of which could increase our tax liabilities.
In addition, the Chinese tax authorities may impose late payment fees and other penalties on us or our Chinese VIE’s for
under-paid taxes. Part of our revenues are generated through Xingyuan, and we partially rely on payments made by Xingyuan to Fusheng,
our subsidiary, pursuant to contractual arrangements to transfer any such revenues to Fusheng. Any restriction on such payments
and any increase in the amount of PRC taxes applicable to such payments may materially and adversely affect our business and our
ability to pay dividends to our shareholders.
We conduct partially
some of our operations through Xingyuan, which generates part of our revenues. Fusheng, our subsidiary in China, entered into
a number of contracts with Xingyuan, pursuant to which Xingyuan pays Fusheng for certain services that Fusheng provides to Xingyuan.
However, depending on the nature of services provided, certain of these payments are subject to PRC taxes at different rates,
including business taxes and VATs, which effectively reduce the amount that Fusheng receives from Xingyuan. We cannot assure you
that the PRC government will not impose restrictions on such payments or change the tax rates applicable to such payments. Any
such restrictions on such payment or increases in the applicable tax rates may materially and adversely affect our ability to
receive payments from Xingyuan or the amount of such payments, and may in turn materially and adversely affect our business, our
net income and our ability to pay dividends to our shareholders.
The Chinese government exerts substantial
influence over the manner in which we must conduct our business activities
The Chinese government
has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation
and state ownership. Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating
to taxation, import and export tariffs, environmental regulations, land-use-rights, property and other matters. We believe that
our operations in China are in material compliance with all applicable legal and regulatory requirements. The central or local
governments of the jurisdictions in which we operate 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 China’s economic reforms
and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies,
could have a significant effect on economic conditions in China or particular regions thereof and could require us to divest ourselves
of any interest we then hold in Chinese properties or joint ventures.
Under the terms of the Circular
No. 698, recently promulgated by the PRC State Administration of Taxation, a future sale or transfer of Goodwill Rich’s
securities may subject us to tax liability and filing requirements in the PRC
On December 11, 2009,
the PRC State Administration of Taxation (“SAT”) issued Circular No. 698 (the “Circular”), entitled Notice
on Strengthening the Management of Enterprise Income Tax Collection of Proceeds from Equity Transfers by Non-resident Enterprises,
indicating SAT’s intention to target off-shore transactions involving the indirect transfer of Chinese enterprises. Under
the Circular, a sale of securities of an offshore entity may give rise to a tax liability in the PRC for the Chinese resident
proposing the sale if SAT were to treat the transaction as a transfer of a PRC resident enterprise by a non-resident enterprise
and that such offshore entity had no reasonable business purpose. Although the Circular does not contain any guidance on the precise
meaning of the term “reasonable business purpose,” Article 120 of the Implementing Regulations of the Enterprise Income
Tax Law defines the expression “not having a reasonable business purpose” as an activity for the purpose of reducing,
avoiding or deferring the payment of taxes. If we were to transfer all or some of our securities holdings in Goodwill Rich and
the SAT were to determine that Goodwill Rich had no reasonable business purpose, the PRC tax authorities, on approval of the SAT,
may re-characterize the transaction, causing the existence of Goodwill Rich to be ignored, thus, treating the proposed transfer
as a transfer by us of our wholly-owned onshore subsidiary, Dalian Fusheng. In such a circumstance, we would be required to make
certain disclosures and tax filings with the appropriate Chinese tax authorities within seven days commencing from the agreed
date of the share transfer, or from the date when we actually received the purchase price paid prior to the agreed transfer date.
In addition to the tax liability, we may be required to provide SAT with various information, including documentation with respect
to the relationship between us and Goodwill Rich, the business purpose of Goodwill Rich, and financial information of Goodwill
Rich and our Company.
The Circular is a
notice issued by SAT, and, as such, does not have the legal effect of a rule or regulation. Although, under the PRC laws, SAT
already had the legal authority to enforce the tax, it is not being enforced by SAT and tax forms to be filed by the PRC target
enterprise in connection with a proposed transfer are not specified. SAT will need to provide additional rules and regulations
to outline and clarify the application of the Circular. Therefore, based on the limited and imprecise nature of the regulatory
interpretations, it is difficult for us to assess the likelihood, effect upon our operations, if any, and the extent of any tax
liability in the event we determined to sell or otherwise dispose of any of the securities of our Goodwill Rich.
The scope of our business license
in China is limited, and we may not expand or continue our business without government approval and renewal, respectively
Xingyuan is our principal
operating Variable Interest Entity, and Fusheng is a wholly foreign-owned enterprise, commonly known as a WFOE. A WFOE can only
conduct business within its approved business scope, which ultimately appears on its business license. The scope of its business
license includes consulting services in corporate, investment and corporate marketing areas as well as in commercial marketing.
Any amendment or expansion to the scope of its business requires further application and government approval. Any changes to the
scope of business license require application and review with the regulatory authorities. In the event such approval is not granted,
our business may be adversely affected. Currently, Xingyuan and its subsidiaries maintain all necessary permits and approvals
to carry out its business plan and, therefore, the scope of Fusheng’s business license has no practical limitation on the
scope of business engaged in by Xingyuan or its respective subsidiaries. We cannot assure investors that Xingyuan will be able
to obtain the necessary government approval for any change or expansion of its business.
We may be subject to fines and legal
sanctions imposed by SAFE or other Chinese government authorities if we or our Chinese employees fail to comply with recent Chinese
regulations relating to employee share options or shares granted by offshore special purpose companies or offshore listed companies
to Chinese citizens
On December 25, 2006,
the People’s Bank of China, or PBOC, issued the Administration Measures on Individual Foreign Exchange Control, and the
corresponding Implementation Rules were issued by the PRC State Administration of Foreign Exchange, or “SAFE,” on
January 5, 2007. Both of these regulations became effective on February 1, 2007. According to these regulations, all foreign exchange
matters relating to employee stock holding plans, share option plans or similar plans with PRC citizens’ participation require
approval from the SAFE or its authorized branch. On March 28, 2007, the SAFE issued the Application Procedure of Foreign Exchange
Administration for Domestic Individuals Participating in Employee Stock Holding Plan or Stock Option Plan of Overseas-Listed Company,
or the Stock Option Rule. Under the Stock Option Rule, Chinese citizens who are granted share options or shares by an offshore
listed company are required, through a Chinese agent or Chinese subsidiary of the offshore listed company, to register with the
SAFE and complete certain other procedures. We and our Chinese employees who may be granted share options or shares will be subject
to the Stock Option Rule when we become an offshore listed company. If we or our Chinese employees fail to comply with these regulations,
we or our Chinese employees may be subject to fines or other legal sanctions imposed by the SAFE or other Chinese government authorities.
Recent PRC regulations relating
to acquisitions of PRC companies by foreign entities may create regulatory uncertainties that could restrict or limit our ability
to operate, including our ability to pay dividends. Our failure to obtain the prior approval of the China Securities Regulatory
Commission, or the CSRC, for any offering and the listing and trading of our common stock could have a material adverse effect
on our business, operating results, reputation and trading price of our common stock
The SAFE issued a
public notice in November 2005, known as Circular 75, concerning the use of offshore holding companies in mergers and acquisitions
in China. The public notice provides that if an offshore company controlled by PRC residents intends to acquire a PRC company,
such acquisition will be subject to registration with the relevant foreign exchange authorities. The public notice also suggests
that registration with the relevant foreign exchange authorities is required for any sale or transfer by the PRC residents of
shares in an offshore holding company that owns an onshore company. The PRC residents must each submit a registration form to
the local SAFE branch with respect to their ownership interests in the offshore company, and must also file an amendment to such
registration if the offshore company experiences material events, such as changes in the share capital, share transfer, mergers
and acquisitions, spin-off transactions or use of assets in China to guarantee offshore obligations. If any PRC resident stockholder
of an offshore holding company fails to make the required SAFE registration and amended registration, the onshore PRC subsidiaries
of that offshore company may be prohibited from distributing their profits and the proceeds from any reduction in capital, share
transfer or liquidation to the offshore entity. Failure to comply with the SAFE registration and amendment requirements described
above could result in liability under PRC laws for evasion of applicable foreign exchange restrictions. Because of uncertainty
in how the SAFE notice will be interpreted and enforced, we cannot be sure how it will affect our business operations or future
plans. For example, Fusheng’s ability to conduct foreign exchange activities, such as the remittance of dividends and foreign
currency denominated borrowings, may be subject to compliance with the SAFE notice by our PRC resident beneficial holders. Failure
by our PRC resident beneficial holders could subject these PRC resident beneficial holders to fines or legal sanctions, restrict
our overseas or cross-border investment activities, limit Xingyuan’s ability to make distributions or pay dividends or affect
our ownership structure, which could adversely affect our business and prospects.
On August 8, 2006,
the PRC Ministry of Commerce (“MOFCOM”), joined by the State-owned Assets Supervision and Administration Commission
of the State Council, the State Administration of Taxation, the State Administration for Industry and Commerce, the China Securities
Regulatory Commission and the SAFE, released a substantially amended version of the Provisions for Foreign Investors to Merge
with or Acquire Domestic Enterprises (the “Revised M&A Regulations”), which took effect September 8, 2006. These
new rules significantly revised China’s regulatory framework governing onshore-to-offshore restructurings and foreign acquisitions
of domestic enterprises. These new rules signify greater PRC government attention to cross-border merger, acquisition and other
investment activities, by confirming MOFCOM as a key regulator for issues related to mergers and acquisitions in China and requiring
MOFCOM approval of a broad range of merger, acquisition and investment transactions. Further, the new rules establish reporting
requirements for acquisition of control by foreigners of companies in key industries, and reinforce the ability of the Chinese
government to monitor and prohibit foreign control transactions in key industries. Among other things, the revised M&A Regulations
include new provisions that purport to require that an offshore special purpose vehicle, or SPV, formed for listing purposes and
controlled directly or indirectly by PRC companies or individuals must obtain the approval of the CSRC prior to the listing and
trading of such SPV’s securities on an overseas stock exchange. On September 21, 2006, the CSRC published on its official
website procedures specifying documents and materials required to be submitted to it by SPVs seeking CSRC approval of their overseas
listings. However, the application of this PRC regulation remains unclear with no consensus currently existing among the leading
PRC law firms regarding the scope and applicability of the CSRC approval requirement. If the CSRC or another PRC regulatory agency
subsequently determines that CSRC approval was required, we may face regulatory actions or other sanctions from the CSRC or other
PRC regulatory agencies. These regulatory agencies may impose fines and penalties on our operations in the PRC, limit our operating
privileges in the PRC, delay or restrict the repatriation of the proceeds from an offering of securities into the PRC, or take
other actions that could have a material adverse effect on our business, financial condition, results of operations, reputation
and prospects, as well as the trading price of our common stock. The CSRC or other PRC regulatory agencies also may take actions
requiring us, or making it advisable for us, to halt any offering before settlement and delivery of the securities offered. Consequently,
if investors engage in market trading or other activities in anticipation of and prior to settlement and delivery, they do so
at the risk that settlement and delivery may not occur. Also, if later the CSRC requires that we obtain its approval, we may be
unable to obtain a waiver of the CSRC approval requirements, if and when procedures are established to obtain such a waiver. Any
uncertainties and/or negative publicity regarding this CSRC approval requirement could have a material adverse effect on the trading
price of our common stock. Furthermore, published news reports in China recently indicated that the CSRC may have curtailed or
suspended overseas listings for Chinese private companies. These news reports have created further uncertainty regarding the approach
that the CSRC and other PRC regulators may take with respect to us. It is uncertain how our business operations or future strategy
will be affected by the interpretations and implementation of Circular 75 and the Revised M&A Regulations. It is anticipated
that application of the new rules will be subject to significant administrative interpretation, and we will need to closely monitor
how MOFCOM and other ministries apply the rules to ensure that our domestic and offshore activities continue to comply with PRC
law. Given the uncertainties regarding interpretation and application of the new rules, we may need to expend significant time
and resources to maintain compliance.
Our corporate structure together
with applicable law impede shareholders from asserting claims against the Company and its principles
All of our operations
and records, and most of our senior management are located in the People’s Republic of China. Shareholders of companies
such as ours have limited ability to assert and collect on claims in litigation against such companies and their principals. In
addition our operations are located in VIEs, which are entities owned by third parties and not by the Company but which are controlled
by the Company by virtue of contractual relationships. The VIE structure could further impede the ability of a person to prove
a claim or collect on a judgment against the Company. Finally, China has very restrictive secrecy laws that prohibit the delivery
of many of the financial records maintained by a business located in China to third parties absent Chinese government approval.
Since discovery is an important part of proving a claim in litigation, and since most if not all of the Company’s records
are in China, Chinese secrecy laws could frustrate efforts to prove a claim against the Company or its management.
In order to commence
litigation in the United States against an individual such as an officer or director, that individual must be served. While directors
and officers of a Delaware corporation such as ours may be easily served for purposes of a suit against them in Delaware for breach
of fiduciary duty and there are means of serving individuals who reside outside the United States in other litigation, generally
service requires the cooperation of the country in which a defendant resides. China has a history of failing to cooperate in efforts
to effect such service upon Chinese citizens in China.
SAFE rules and regulations may limit
our ability to transfer the proceeds from future capital raising and other similar activities to Xingyuan, our VIE in the PRC,
which may adversely affect the business expansion of Xingyuan
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. The use of such Renminbi capital may not be changed without SAFE’s approval, and may not in any case be used
to repay Renminbi loans if the proceeds of such loans have not been used. Violations of Circular 142 will result in severe penalties,
such as heavy fines. As a result, Circular 142 may adversely affect the business expansion of Xingyuan.
The foreign currency exchange rate
between U.S. Dollars and Renminbi could adversely affect our financial condition
To the extent that
we need to convert U.S. Dollars into Renminbi for our operational needs, our financial position and the price of our common stock
may be adversely affected should the Renminbi appreciate against the U.S. Dollar at that time. Conversely, if we decide to convert
our Renminbi into U.S. Dollars for the operational needs or paying dividends on our common stock, the dollar equivalent of our
earnings from our VIE’s in China would be reduced should the dollar appreciate against the Renminbi. Until 1994, the Renminbi
experienced a gradual but significant devaluation against most major currencies, including dollars, and there was a significant
devaluation of the Renminbi on January 1, 1994 in connection with the replacement of the dual exchange rate system with a unified
managed floating rate foreign exchange system. Since 1994, the value of the Renminbi relative to the U.S. Dollar has remained
stable and has appreciated slightly against the U.S. Dollar. Countries, including the United States, have argued that the Renminbi
is artificially undervalued due to China’s current monetary policies and have pressured China to allow the Renminbi to float
freely in world markets. In July 2005, the PRC government changed its policy of pegging the value of the Renminbi to the dollar.
Under the new policy the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of designated foreign
currencies. While the international reaction to the Renminbi revaluation has generally been positive, there remains significant
international pressure on the PRC government to adopt an even more flexible currency policy, which could result in further and
more significant appreciation of the Renminbi against the dollar.
Very limited hedging
transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any
hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may enter into hedging transactions
in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully
hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by Chinese exchange control regulations
that restrict our ability to convert Renminbi into foreign currencies.
Governmental control of currency
conversion may affect the value of your investment
The PRC government
imposes controls on the convertibility of the Renminbi into foreign currencies and, in certain cases, the remittance of currency
out of China. We receive the majority of our revenues in Renminbi. Shortages in the availability of foreign currency may restrict
the ability of our affiliated entities to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise
satisfy its foreign currency denominated obligations. Under existing PRC foreign exchange regulations, payments of current account
items, including profit distributions, interest payments and expenditures from trade-related transactions, can be made in foreign
currencies without prior approval from the PRC State Administration of Foreign Exchange by complying with certain procedural requirements.
However, approval from appropriate government authorities is required where Renminbi is to be converted into foreign currency
and remitted out of China to pay capital expenses such as the repayment of bank loans denominated in foreign currencies. The PRC
government may also at its discretion restrict access in the future to foreign currencies for current account transactions. If
the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we
may not be able to pay dividends, if any, in foreign currencies to our shareholders.
Inflation in the PRC could negatively
affect our profitability and growth
While the PRC economy
has experienced rapid growth, such growth has been uneven among various sectors of the economy and in different geographical areas
of the country. Rapid economic growth can lead to growth in the money supply and rising inflation. During the past decade, the
rate of inflation in China has been as high as approximately 20% and China has experienced deflation as low as approximately minus
2%. If prices for our products and services rise at a rate that is insufficient to compensate for the rise in the costs of supplies
such as raw materials, it may have an adverse effect on our profitability. In order to control inflation in the past, the PRC
government has imposed controls on bank credits, limits on loans for fixed assets and restrictions on state bank lending. The
implementation of such policies may impede economic growth. In October 2004, the People’s Bank of China, the PRC’s
central bank, raised interest rates for the first time in nearly a decade and indicated in a statement that the measure was prompted
by inflationary concerns in the Chinese economy. In April 2006, the People’s Bank of China raised the interest rate again.
Repeated rises in interest rates by the central bank would likely slow economic activity in China which could, in turn, materially
increase our costs and also reduce demand for our products and services. On March 18, 2008, China’s central bank, the People’s
Bank of China, announced that the bank reserve ratio would rise half of a percentage point to 15.5% effective March 25, 2008 in
an effort to reduce inflation pressures hours after Premier Wen Jiabao highlighted inflation as a major concern for the government.
China’s consumer price index growth rate reached 8.7% year over year in 2008.
Failure to comply with the United
States Foreign Corrupt Practices Act could subject us to penalties and other adverse consequences
As our ultimate holding
company is a Delaware corporation, we are subject to the United States Foreign Corrupt Practices Act, which generally prohibits
United States companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining
or retaining business. Foreign companies, including some that may compete with us, are not subject to these prohibitions. Corruption,
extortion, bribery, pay-offs, theft and other fraudulent practices may occur from time-to-time in the PRC. We can make no assurance,
however, that our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees
or other agents are found to have engaged in such practices, we could suffer severe penalties and other consequences that may
have a material adverse effect on our business, financial condition and results of operations.
If we make equity compensation grants
to persons who are PRC citizens, they may be required to register with the State Administration of Foreign Exchange of the PRC,
or SAFE. We may also face regulatory uncertainties that could restrict our ability to adopt an equity compensation plan for our
directors and employees and other parties under PRC law
On April 6, 2007,
SAFE issued the “Operating Procedures for Administration of Domestic Individuals Participating in the Employee Stock Ownership
Plan or Stock Option Plan of An Overseas Listed Company, also known as “Circular 78.’’ It is not clear whether
Circular 78 covers all forms of equity compensation plans or only those which provide for the granting of stock options. For any
plans which are so covered and are adopted by a non-PRC listed company after April 6, 2007, Circular 78 requires all participants
who are PRC citizens to register with and obtain approvals from SAFE prior to their participation in the plan. In addition, Circular
78 also requires PRC citizens to register with SAFE and make the necessary applications and filings if they participated in an
overseas listed company’s covered equity compensation plan prior to April 6, 2007. We intend to adopt an equity compensation
plan in the future and make option grants to our officers and directors, most of who are PRC citizens. Circular 78 may require
our officers and directors who receive option grants and are PRC citizens to register with SAFE. We believe that the registration
and approval requirements contemplated in Circular 78 will be burdensome and time consuming. If it is determined that any of our
equity compensation plans are subject to Circular 78, failure to comply with such provisions may subject us and participants of
our equity incentive plan who are PRC citizens to fines and legal sanctions and prevent us from being able to grant equity compensation
to our PRC employees. In that case, our ability to compensate our employees and directors through equity compensation would be
hindered and our business operations may be adversely affected.
Any recurrence of Severe Acute Respiratory
Syndrome (SARS), Avian Flu, or another widespread public health problem, in the PRC could adversely affect our operations
A renewed outbreak
of SARS, Avian Flu or another widespread public health problem in China, where all of our manufacturing facilities are located
and where all of our sales occur, could have a negative effect on our operations. Our business is dependent upon our ability to
continue to manufacture products. Such an outbreak could have an impact on our operations as a result of:
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quarantines or closures of some of our manufacturing facilities,
which would severely disrupt our operations,
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the sickness or death of our key officers and employees,
and
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a general slowdown in the Chinese economy.
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Any of the foregoing
events or other unforeseen consequences of public health problems could adversely affect our operations.
Adverse changes in political and
economic policies of the PRC government could have a material and adverse effect on the overall economic growth of China, which
could reduce the demand for our products
Most of our business
operations are conducted in China and most of our revenues are generated in China. Accordingly, our business, financial condition,
results of operations and prospects are affected significantly by economic, political and legal developments in China. The Chinese
economy differs from the economies of most developed countries in many respects, including the amount of government involvement,
the level of development, the growth rate, the control of foreign exchange, and the allocation of resources.
While the Chinese
economy has grown significantly in the past 30 years, the growth has been uneven geographically among various sectors of the economy,
and during different periods. We cannot assure you that the Chinese economy will continue to grow, or that if there is growth,
such growth will be steady and uniform, or that if there is a slowdown, such slowdown will not have a negative effect on our business.
For example, the Chinese economy experienced high inflation in the second half of 2007 and the first half of 2008. China’s
consumer price index soared 7.9% during the six months ended June 30, 2008 as compared to the same period in 2007. To combat inflation
and prevent the economy from overheating, the PRC government adopted a number of tightening macroeconomic measures and monetary
policies, including increasing interest rates, raising statutory reserve rates for banks and controlling bank lending to certain
industries or economic sectors. However, due in part to the impact of the global crisis in financial services and credit markets
and other factors, the growth rate of China’s gross domestic product has decreased to 6.8% in the fourth quarter of 2008,
down from 11.9% reached in the second quarter of 2007. As a result, beginning in September 2008, among other measures, the PRC
government began to loosen macroeconomic measures and monetary policies by reducing interest rates and decreasing the statutory
reserve rates for banks. In addition, in November 2008 the PRC government announced an economic stimulus package in the amount
of $586 billion. We cannot assure you that the various macroeconomic measures, monetary policies and economic stimulus package
adopted by the PRC government to guide economic growth and the allocation of resources will be effective in sustaining the fast
growth rate of the Chinese economy. In addition, such measures, even if they benefit the overall Chinese economy in the long-term,
may adversely affect us.
A downturn in the economy of the
PRC may slow our growth and profitability
The Chinese economy
has grown at an approximately 9% annual rate for more than 25 years, making it the fastest growing major economy in recorded history.
In 2007, China’s economy grew by 11.4%, the fastest pace in 11 years, according to the National Bureau of Statistics. We
cannot assure you that growth of the Chinese economy will be steady, that inflation will be controllable or that any slowdown
in the economy or uncontrolled inflation will not have a negative effect on our business. Several years ago, the Chinese economy
experienced deflation, which may recur in the future. More recently, the Chinese government announced its intention to continuously
use macroeconomic tools and regulations to slow the rate of growth of the Chinese economy, the results of which are difficult
to predict. Adverse changes in the Chinese economy will likely impact the financial performance of a variety of industries in
China that use or would be candidates to use our products. If such adverse changes were to occur, our customers and potential
customers could reduce spending on our products and services.
Contract drafting, interpretation
and enforcement in China involves significant uncertainty
We have entered into
numerous contracts governed by PRC law, many of which are material to our business. As compared with contracts in the United States,
contracts governed by PRC law tend to contain less detail and are not as comprehensive in defining contracting parties’
rights and obligations. As a result, contracts in China are more vulnerable to disputes and legal challenges. In addition, contract
interpretation and enforcement in China is not as developed as in the United States, and the result of any contract dispute is
subject to significant uncertainties. Therefore, we cannot assure you that we will not be subject to disputes under our material
contracts, and if such disputes arise, we cannot assure you that we will prevail.
Because our business is located
in the PRC, we may have difficulty establishing adequate management, legal and financial controls, which it is required to do
in order to comply with U.S. securities laws
PRC companies have
historically not adopted a Western style of management and financial reporting concepts and practices, which includes strong corporate
governance, internal controls and, computer, financial and other control systems. Most of our middle and top management staff
are not educated and trained in the Western system, and we may have difficulty hiring new employees in the PRC with such training.
In addition, we may have difficulty in hiring and retaining a sufficient number of qualified employees to work in the PRC. As
a result of these factors, 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. Therefore, we may, in turn, experience difficulties in implementing and maintaining adequate internal controls as required
under Section 404 of the Sarbanes-Oxley Act of 2002. This may result in significant deficiencies or material weaknesses in our
internal controls which could impact the reliability of our financial statements and prevent us from complying with SEC rules
and regulations and the requirements of the Sarbanes-Oxley Act of 2002. Any such deficiencies, weaknesses or lack of compliance
could have a materially adverse effect on our business.
Risks Related to the Common Stock
Techniques employed by manipulative
short sellers in Chinese small cap stocks may drive down the market price of our common stock
Short selling is the
practice of selling securities that the seller does not own but rather has, supposedly, borrowed from a third party with the intention
of buying identical securities back at a later date to return to the lender. The short seller hopes to profit from a decline in
the value of the securities between the sale of the borrowed securities and the purchase of the replacement shares, as the short
seller expects to pay less in that purchase than it received in the sale. As it is therefore in the short seller’s best interests
for the price of the stock to decline, many short sellers (sometime known as “disclosed shorts”) publish, or arrange
for the publication of, negative opinions regarding the relevant issuer and its business prospects in order to create negative
market momentum and generate profits for themselves after selling a stock short. While traditionally these disclosed shorts were
limited in their ability to access mainstream business media or to otherwise create negative market rumors, the rise of the Internet
and technological advancements regarding document creation, videotaping and publication by weblog (“blogging”) have
allowed many disclosed shorts to publicly attack a company’s credibility, strategy and veracity by means of so-called research
reports that mimic the type of investment analysis performed by large Wall Street firms and independent research analysts. These
short attacks have, in the past, led to selling of shares in the market, on occasion in large scale and broad base. Issuers with
business operations based in the PRC and who have limited trading volumes and are susceptible to higher volatility levels than
U.S. domestic large-cap stocks, can be particularly vulnerable to such short attacks.
These short seller
publications are not regulated by any governmental, self-regulatory organization or other official authority in the U.S., are not
subject to the certification requirements imposed by the Securities and Exchange Commission in Regulation AC (Regulation Analyst
Certification) and, accordingly, the opinions they express may be based on distortions of actual facts or, in some cases, fabrications
of facts. In light of the limited risks involved in publishing such information, and the enormous profit that can be made from
running just one successful short attack, unless the short sellers become subject to significant penalties, it is more likely than
not that disclosed shorts will continue to issue such reports. While we intend to strongly defend our public filings against any
such short seller attacks, often times we are constrained, either by principles of freedom of speech, applicable state law (often
called “Anti-SLAPP statutes”), or issues of commercial confidentiality, in the manner in which we can proceed against
the relevant short seller. You should be aware that in light of the relative freedom to operate that such persons enjoy oftentimes
blogging from outside the U.S. with little or no assets or identity requirements – should we be targeted for such an attack,
our stock will likely suffer from a temporary, or possibly long term, decline in market price should the rumors created not be
dismissed by market participants.
The market price for our securities may be subject to
wide fluctuations
The securities of a number of Chinese companies
and companies with substantial operations in China have experienced wide fluctuations in their stock price. Among the factors that
could affect the price of our common stock are risk factors described in this section and other factors, including:
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announcements of competitive developments, by our competitors;
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regulatory developments of our industry affecting us,
our customers or our competitors;
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actual or anticipated fluctuations in our quarterly operating
results;
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failure of our quarterly financial and operating results
to meet market expectations or failure to meet our previously announced guidance, if any;
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changes in financial estimates by securities research
analysts;
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changes in the economic performance or market valuations
of our competitors;
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additions or departures of our executive officers and
other key personnel;
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announcements regarding litigation (or potential litigation)
involving us or any of our directors and officers; and
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fluctuations in the exchange rates between the U.S. dollar
and the Renminbi.
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In addition, the securities
markets have from time to time experienced significant price and volume fluctuations that are not related to the operating performance
of particular industries or companies. These market fluctuations may also have a material adverse effect on the market price of
our securities.
We may need additional capital and
may sell additional securities or other equity securities or incur indebtedness, which could result in additional dilution to our
shareholders or increase our debt service obligations.
We may require additional
cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may
decide to pursue. If our cash resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity
or debt securities or obtain a credit facility. The sale of additional equity securities or equity-linked debt securities could
result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations
and could result in operating and financing covenants that would restrict our operations. We cannot assure you that financing will
be available in amounts or on terms acceptable to us, if at all.
Substantial future sales of our securities in the public
market, or the perception that these sales could occur, could cause the price of our securities to decline.
Additional sales of
our securities in the public market or the perception that these sales could occur, could cause the market price of our securities
to decline. We may grant or sell additional options, restricted shares or other share-based awards in the future under our share
incentive plan to our management, employees and other persons, the settlement and sale of which may further dilute our shares and
drive down the price of our securities.
If NASDAQ were to delist our securities
from trading on its exchange, such action could limit investors’ ability to make transactions in our securities and subject
us to additional trading restrictions.
Our common stock is
currently listed on the NASDAQ Capital Market. We cannot assure you that our securities will meet the continued listing requirements
be listed on NASDAQ in the future. If NASDAQ delists our common stock from trading on its exchange, we could face significant material
adverse consequences including:
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a limited availability of market quotations for our securities;
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a determination that our common stock is a “penny
stock” which will require brokers trading in our common stock to adhere to more stringent rules and possibly resulting in
a reduced level of trading activity in the secondary trading market for our common stock;
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a
limited amount of news and analyst coverage for our company; and
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a
decreased ability to issue additional securities or obtain additional financing in the future.
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If our shares of common stock become
subject to the SEC’s penny stock rules, broker-dealers may experience difficulty in completing customer transactions and
trading activity in our securities may be adversely affected.
If our common stock
were removed from listing with the NASDAQ Capital Market, it may be subject to the so-called “penny stock” rules. The
SEC has adopted regulations that define a “penny stock” to be any equity security that has a market price per share
of less than $5.00, subject to certain exceptions, such as any securities listed on a national securities exchange. For any transaction
involving a “penny stock,” unless exempt, the rules impose additional sales practice requirements on broker-dealers,
subject to certain exceptions. If our common stock were delisted and determined to be a “penny stock,” a broker-dealer
may find it more difficult to trade our common stock and an investor may find it more difficult to acquire or dispose of our common
stock on the secondary market. Investors in penny stocks should be prepared for the possibility that they may lose their whole
investment.