Item 1. Description of Business
Overview
Our goal is to become one of Chinas leading wholesale distribution and direct sales enterprises predominantly in the womens fashion apparel industry by leveraging our full range of design, production management, sourcing, media/marketing and technological capabilities. Commencing April 2007, we began to operate primarily as an outsourced brand management and production center for foreign apparel brands mainly in the womens apparel industry through William Brand Administer Co. Ltd., our core operating subsidiary. William Brand contracts with apparel manufacturers and wholesalers, predominately in the United States, to manage the full apparel design, production and export operations. The business accounts for approximately 83% of our total revenues for the six month period ended September 30, 2007.
In addition to our core
ladies'
apparel business, we possess a portfolio of media, marketing and database assets that we intend to leverage in order to expand into online brand management and e-commerce sectors for womens apparel products. In the coming fiscal year, we plan to
increase
our business-to-business revenues by adding new womens apparel clients and to develop business-to-consumer revenue by creating our own apparel brands and marketing these products through new and traditional media using our existing media/marketing resources.
In 2008, we also plan to leverage our current apparel brand management capabilities to develop an integrated online-offline direct sales platform for our
ladies'
apparel business. The key initiatives of this direct sales strategy include: (1) expanding our sales channels to include offline mail-order catalogues and TV-shopping of our own private label and third party brands; (2) launching our own
ladies'
apparel product line under the
Peeress
brand, and (3) partnering with offline shopping malls in China to create online shopping sites that will carry numerous leading domestic/global fashion brands, including our
Peeress
brand.
We created our existing business through the ongoing acquisition of various entities and assets. In September 2005, we acquired Sun New Media Group Limited in a reverse acquisition transaction. Since that time, we completed other acquisitions that have enabled us to serve the apparel, handheld electronics verticals and beverage verticals. During the first half of calendar 2007, we re-focused our business operation by divesting our interests in the handheld electronic and beverage vertical markets and concentrated on the development our business in the womens apparel vertical market.
We were originally incorporated under the laws of Minnesota in 1972 and were previously known as SE Global Equity. In September 2005, we acquired 100% of the issued and outstanding share capital of Sun New Media Group Limited and changed the company name to Sun New Media, Inc. The acquisition was treated as a reverse acquisition for accounting purposes, and we adopted the September 30 fiscal year of the accounting acquirer Sun New Media Group Limited. In February 2006, we changed our fiscal year-end date from September 30th to March 31st.
In May 2007, we reincorporated into the State of Delaware and changed our name to NextMart, Inc. On October 10, 2007, we changed our fiscal year end from March 31 to September 30.
Background
The People's Republic of China ("China")
has experienced rapid economic growth over the past decade. Chinas central bank estimates that economic growth for 2008 at 9.8 percent this year. Furthermore, Chinas entry into the World Trade Organization, accompanied by a proliferation of private businesses and an increase in the number of foreign multinational companies in China, has led to increased market liberalization and competition. In this competitive environment, companies in China are increasingly recognizing the need for improved methods of doing business.
As a result of economic growth and liberalization, the number of business entities operating in China has increased significantly. These new businesses are competing in an economy traditionally dominated by state owned or controlled enterprises at one end and serviced by millions of small local businesses on the other end. These dynamics have generally led to a very stratified market with inefficient systems for channel marketing, sales and distribution. A significant opportunity exists to leverage internet-based technologies to create direct sales channels and efficient distribution networks across Mainland China. The opportunity is particularly salient in industries characterized by multiple-layers of fragmented distribution systems like the apparel industry.
Corporate Strategy
Our goal is to become one of Chinas leading wholesale distribution and direct sales enterprises predominantly in the
ladies'
fashion apparel industry. We believe we have the full range of production design and management, material and services sourcing,
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media/marketing and technological capabilities necessary to achieve our goal. Our current growth initiatives include growing our business-to-business platform by adding new clients domestically and abroad and developing a business-to-consumer platform through direct sales of our private label operations in Mainland China.
Services
The Company is divided into two principal divisions: the Transactional Services Division and the Marketing & Information Services Division. In fiscal year ended September 30, 2007, the Transaction Services Division accounted for 83.4% of revenues and the Marketing & Information Services Division accounted for 16.6% of revenues.
The
Transactional Services Division
. This division is operated by our wholly-owned subsidiary in the womens apparel vertical, William Brand Administer Co., Ltd. William Brand contracts with apparel manufacturers and wholesalers, predominately in the United States, to manage the full apparel design, production and export operations. We help companies efficiently produce branded apparel by taking advantage of Chinas global advantages of low-cost labor and high quality apparel production capabilities. During the fiscal period ended September 30, 2007, the division has predominantly focused on servicing its foreign business clients. Going forward, the division intends to grow revenues by selling womens apparel product in Mainland China. (See Strategy for Fiscal 2008 below).
The
Marketing & Information Services Division
. This division generates revenue through the provision of business information services/products such as digital E-Magazines, sale of advertising, and media consulting services. The division maintains a partnership with Chinas leading online media community Her Village (Chinas largest multimedia womens community) for the purpose of building loyal consumer communities and selling them apparel product through our Transactional Services Division.
In fiscal 2008, we plan to expand these operations to include direct sales of womens apparel to urban professional women throughout Mainland China. (See Strategy for Fiscal 2008 below). .
Strategy for Fiscal 2008
In fiscal 2008, our growth strategy is to develop an integrated online-offline direct sales platform for the
ladies'
apparel sector in China. To achieve this, we will leverage our full portfolio of assets and capabilities ranging from fashion design, and brand and apparel production management, to export operations. The key initiatives of this direct sales strategy include: (1) Expanding our sales channels to include offline mail-order catalogues and TV-shopping; (2) Launching sales of our private label apparel brand
Peeress
; and (3) Partnering with offline shopping malls in China to create online shopping sites that will carry numerous leading domestic/global fashion brands.
Our rationale for pursuing an integrated direct sales strategy is two-fold. First, we expect to achieve higher profit margins by selling
ladies'
apparel directly to consumers rather than selling through high cost, inefficient third-party distribution channels. Second, we already maintain the operational assets and marketing partnerships necessary to realize direct sales distribution. We maintain fashion design and apparel production operations, with a database of several thousand
ladies'
clothing designs. We also have strategic marketing and sales partnerships with Her Village, Chinas leading multimedia
ladies'
community with over 40 million web visits and e-magazine downloads, including over 10 million unique visitors, per month. It also has a strategic sales partnership with Shanghai Guifuren Garment, a well-known women's apparel chain with 49 retail points in China.
We plan to execute this direct sales strategy by reorganizing our operations into the following three enhanced business units:
(1)
Integrated Direct Sales.
We will focus on selling
ladies'
apparel to urban female consumers through three online and offline direct sales channels: (1) Digital E-catalogues/E-Magazines; (2) Print Mail-Order Catalogues; and (3) TV shopping programs.
For (1) Digital E-catalogues/E-Magazines, the company will leverage its existing marketing and sales
relationship
with Her Village. This marketing/sales
relationship
gives us marketing space within Her Villages e-magazine properties in exchange for a 10% commission on sales paid to Her Village. In addition to selling product through Her Villages media products, we are developing our own
NextMart E-Shopping Catalogues
to sell apparel to Her Villages online consumer community.
For (2) Print Mail-Order Catalogues and (3) TV-Shopping, we intend to partner with leading mail-order catalogue and TV-shopping partners in Mainland China. We are currently in discussions with partners for strategic partnership or acquisition. Strategic partnerships would entail our providing low-cost
ladies'
wear to its partners in exchange for ongoing marketing and sales access to Chinese female customers. The parties would split revenue according to a pre-negotiated percentage.
(2) Private Labels.
We will leverage our existing fashion design and apparel production capabilities to launch private labels for sale in China and abroad. Our first brand,
Peeress
, targets mature professional women in Chinas leading cities.
Peeress
already has
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several thousand
ladies'
apparel designs, which include dresses, business suits, evening wear and lingerie.
In 2008, we plan to launch sales of
Peeress
by leveraging our own direct sales network and partnering with retail chains in Mainland China. Internationally, we will work with our current US business
affiliations
to sell product in well known retail chains such as
Sears
. Domestically, we plan to sell product through two leading Chinese retail chains: Shanghai Guifuren Garment Co., a leading
ladies'
apparel chain with 49 stores in Mainland China, and Shanghai 1
st
Department stores, one of Chinas leading department store chains.
(3) E-Commerce
Relationships
.
We will
associate
with leading offline shopping malls to create e-commerce sites that sell
ladies'
clothing of several well-known domestic and international fashion brands. The division will provide e-commerce and technical services in exchange for a commission on e-commerce sales. The division will focus mainly on large-scale projects in order to best utilize its resources and capture scalable business opportunities.
Investments in Media and Marketing Companies
As of September 30, 2007, we maintain investments in consumer media and marketing companies that we believe will allow us to offer our customers one-stop-shop interactive marketing solutions that reach directly to Chinas key consumer groups. We own 33,642,508 shares, representing a 6% interest in CEC Unet plc (f.k.a. Sun 3C Media)(AIM:CECU), an Irish company listed on the Alternative Investment Market in London. These shares have been placed in escrow since July, 2006 pursuant to an escrow agreement by and among various parties including Sun 3C Media and us.
According to the escrow agreement, our shares can be released subject to the orderly market arrangements in place, which state that any decision to sell these ordinary shares within 12 months of their release must be approved by Blue Oar Securities Plc, our agent. The shares are eligible for release in two tranches; 50% of the 33,642,508 shares on June 30, 2007 and 50% of the 33,642,508 on June 30, 2008. As of September 30, 2007, we have 22,633,233 shares, of which the 14,811,979 shares are free and 7,821,254 shares are restricted before Jun 30, 2008.
We also own 1,000,000 shares, representing a 2.07% interest in Validian Corp. (OTCBB: VLDI), a Canadian-based company listed on the OTCBB.
Competition
Presently, a substantial portion of our business involves the offline apparel market, and we intend to compete in the online wholesale distribution and retail shopping market in the area of ladies' fashion. In our core apparel market, we face competition from large-scale apparel groups such as Li & Fung, HK Yida Apparel Co. Ltd, PPG Apparel Co. and smaller apparel manufacturers, design centers and distributors that service foreign brand clients. Many of these competitors have longer histories and larger client bases than we do. In the online space, we expect to face competition from B2B and B2C e-commerce providers that sell fashion and apparel products. Some of these competitors may be horizontal service providers such as Alibaba.com, Hui Cong, Taobao.com and Global Sources and others may be apparel specialists such as Li & Fung Online.
In the media and information sector, the main competitors in the industry continue to be state-owned media groups, industry associations, and government agencies. In the private sector, our principal competitor is Hui Cong, an information services and business search company focused on the domestic market. We face indirect competition from Global Sources, a business information service companies that are primarily focused on the import-export marketplace.
We also face competition from traditional advertising media, such as newspapers, magazines, yellow pages, billboards and other forms of outdoor media, television and radio. Most large companies in China allocate and will likely continue to allocate the bulk of their marketing budgets to traditional advertising media and only a small portion of their budgets to online marketing. If these companies do not devote a larger portion of their marketing budgets to online marketing services provided by us, or if our existing customers reduce the amount they spend on online marketing, our results of operations and future growth prospects could be adversely affected.
Most of our existing and potential competitors have significantly greater financial resources than we do. They also have longer operating histories and more experience in attracting and retaining users and managing customers than we do. They may use their experience and resources to compete with us in a variety of ways, including by competing more heavily for users, customers, distributors and networks of third-party websites, investing more heavily in research and development and making acquisitions.
Proprietary Rights
We regard our intellectual property rights, such as copyrights, trademarks, trade secrets, practices and tools, as important to the success of our business. To protect our intellectual property rights, we intend to rely on a combination of trademark and copyright law, trade secret protection, confidentiality agreements and other contractual arrangements with our employees, affiliates, clients,
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strategic partners, acquisition targets and others. Effective trademark, copyright and trade secret protection may not be available in every country in which we intend to offer our services. And the steps we take to protect our intellectual property rights may not be adequate. Third parties may infringe or misappropriate our intellectual property rights or we may not be able to detect unauthorized use and take appropriate steps to enforce our rights. In addition, other parties may assert infringement claims against us. Such claims, regardless of merit, could result in the expenditure of significant financial and managerial resources. Future patents may limit our ability to use processes covered by such patents or expose us to claims of patent infringement or otherwise require us to obtain related licenses. Such licenses may not be available on acceptable terms. The failure to obtain such licenses on acceptable terms could have a negative effect on our businesses.
Governmental Regulation
All television broadcast media in China are government-controlled networks. The television and broadcasting industry in China operates under a legal regime that consists of the State Council, which is the highest authority of the executive branch of the Chinese central government, and the various ministries and agencies under its leadership. These ministries and agencies mainly include:
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the Ministry of Culture;
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the Ministry of Information Industry;
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the State Press and Publications Administration;
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the State Copyright Bureau;
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the State Administration for Industry and Commerce;
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the Ministry of Public Security; and
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the Bureau of State Secrecy.
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The State Council and these ministries and agencies have issued a series of rules that regulate a number of different substantive areas of our proposed businesses. We believe we have all necessary governmental approvals to conduct our interactive marketing and sales services businesses.
In compliance with China's foreign investment restrictions on media industry and other laws and regulations, we conduct all our media services in China via the following significant domestic Variable Interest Entities (VIEs):
·
Sun China Media (Beijing) Technology Co., Ltd., a Chinese company controlled through us by contract and is owned equally by Qiong Zhou and Jacob Di, both of whom are non-executive employees of the Company.
·
Suizhou Focus Trading Development Co., Ltd., a Chinese company controlled by us by contract and is engaged in marketing, information and technology services to beverage and electronic device distributors. It is 60% owned by Qi Yang, one of our officers and 25% and 15% owned by Bingwei Wu and Quanyi Mao respectively, two non-executive employees of the Company.
·
Shanghai Shengji Technology Co., Ltd, a Chinese company controlled by us by contract, and is engaged in wireless mobile services. It is 40% owned by Hui Yan, 40% owned by Min Lin and 20% owned by Kezhou Luan, each a non-executive employee of the Company.
·
Sun China Media (Beijing) International Advertising Co. Ltd, a Chinese company controlled by us by contract which is engaged in the advertising business. It is 70% owned by Qiong Zhou, and 30% owned by Guosheng Wang, both of whom are non-executive employees of the Company.
·
Dragon List Co. Ltd, a Chinese company controlled by us by contract and is engaged in digital publishing business. It is 70% owned by Qiong Zhou, and 30% owned by Jacob Di, both of whom are non-executive employees of the Company.
·
Sun Trade Media (Beijing) Co. Ltd, a Chinese company controlled by us by contract and is engaged in digital publishing business. It is 70% owned by Qiong Zhou, and 30% owned by Jacob Di, both of whom are non-executive employees of the Company.
·
Sun Asia (Beijing) Investments Consultants Ltd, a Chinese company controlled by us by contract and is engaged in the provision of consultancy services. It is 60% owned by Qiong Zhou, and 40% owned by Bryan Li, both of whom are non-executive employees of the Company.
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·
NextMart Technology (Beijing) Co. Ltd, a Chinese company controlled by us by contract and is engaged in software development. It is 70% owned by Qiong Zhou, and 30% owned by Jacob Di, both of whom are non-executive employees of the Company.
·
Wuhan Xinda Weiye Trade and Development Co. Ltd, a Chinese company controlled by us by contract and engaged in trading. It is 40% owned by Jin Liu, 30% owned by Wanzhi Zhu and 30% owned by Mingde Jiang, all of whom are non-executive employees of the Company.
·
Beijing Trans Global Logistics, a Chinese company 80% by us by contract and engaged in trading. It is 80% owned by Qiong Zhou, 10% owned by Yong Li and 10% owned by Mianchun Wang, Qiong Zhou is a non-executive employees of the Company.
·
Naixiu Exhibition (Beijing) Co. Ltd, a Chinese company that is controlled by us and owned 50% Li Yong and 50% by Wang Jinghchun. Li Yong and Wang Jingchun are non-executive employees of the Company.
The capital investment in these VIEs is funded by the Company and transferred to the VIEs via contractual agreements between the Company (or its non- Chinese subsidiary) and the Chinese employees who own the VIEs. As of September 30, 2007, the total amount of capital investment that was transferred to the VIEs listed above was US$3,451,000. Under various contractual agreements, employee shareholders of the VIEs are required to transfer their ownership in these entities to our subsidiaries in China when permitted by Chinese laws and regulations or to our designees at any time for the outstanding amount of injected capital investment, and all voting rights of the VIEs are assigned to us. We have the power to appoint all directors and senior management personnel of the VIEs. Through our wholly-owned subsidiaries in China, we have also entered into exclusive technical agreements and other service agreements with the VIEs, under which these subsidiaries provide technical services.
Employees
As of December 21, 2007, we had 44 employees. Of our employees, 8 were in management; 19 in finance, legal & administration; 5 in business development and research & development and 12 in sales and marketing.
Recent Developments
On October 10, 2007, we changed the fiscal year from March 31 to September 30 in order to better reflect the results of our restructuring initiatives during the period ended September 30, 2007.
Disclosure Regarding Forward Looking and Cautionary Statements.
Forward Looking Statements
. Certain of the statements contained in this Annual Report on Form 10-KSB includes "forward looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended ("Exchange Act"). All statements other than statements of historical facts included in this Form 10-KSB regarding the Company's financial position, business strategy, and plans and objectives of management for future operations and capital expenditures, and other matters, are forward looking statements. These forward-looking statements are based upon management's expectations of future events. Although we believe the expectations reflected in such forward looking statements are reasonable, there can be no assurances that such expectations will prove to be correct. Additional statements concerning important factors that could cause actual results to differ materially from our expectations ("Cautionary Statements") are disclosed below in the Cautionary Statements section and elsewhere in this Form 10-KSB. All written and oral forward looking statements attributable to us or persons acting on our behalf subsequent to the date of this Form 10-KSB are expressly qualified in their entirety by the Cautionary Statements.
Cautionary Statements
. Certain risks and uncertainties are inherent in the Company's business. In addition to other information contained in this Form 10-KSB, the following Cautionary Statements should be considered when evaluating the forward looking statements contained in this Form 10-KSB:
Risks Related to Our Business
Our short operating history and rapidly evolving business makes it difficult for us to accurately forecast revenues and expenses.
During the last two quarters of the fiscal year ended March 31, 2007, we changed our business focus to the ladies' apparel vertical, through the acquisition of new businesses, including Williams Brand Ltd, and entered into related joint ventures. As a component of our restructuring, we also divested ourselves of certain non core assets and operations. These divested assets and operations contributed significantly to our operations for the 2007 and 2006 fiscal years. In light of these changes, one should consider the future prospects of our new business endeavors keeping in mind the risks and uncertainties experienced by early stage companies in evolving industries in China. As a result, it will be difficult for us to predict future revenues and operating expenses with a great deal of certainty. We have based our expense levels in part on our expectations of future revenues from these transactions. If our
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interactive Marketing and Information service business develops slower than we expect, our losses may be higher than anticipated, which may adversely impact our business.
Some of the other risks and uncertainties of our business relate to our ability to:
·
offer new and innovative products and services to attract and retain a larger consumer base;
·
attract customers;
·
increase awareness of our brand and continue to develop consumer and customer loyalty;
·
respond to competitive market conditions;
·
respond to changes in our regulatory environment;
·
manage risks associated with intellectual property rights;
·
maintain effective control of our costs and expenses;
·
raise sufficient capital to sustain and expand our business;
·
attract, retain and motivate qualified personnel; and
·
upgrade our technology to support increased traffic and expanded services.
If we are unsuccessful in addressing any of these risks and uncertainties, our business may be materially and adversely affected.
The development of our business is dependent upon the completion and integration of acquisitions and other transactions that have only recently or not yet closed.
In September 2006, we acquired Williams Brand, a ladies' apparel manufacturer, which is presently our core business. During August 2007, we also acquired other businesses, assets and entered into joint ventures complimentary to our core business. If we are unable to successfully operate and integrate the businesses we acquire, our business will not be successful. We expect to continually look for new businesses to acquire to maintain and sustain our operations. If we fail to identify such businesses, are unable to acquire such businesses on reasonable terms, or fail to successfully integrate such businesses, our operating results and prospects could be harmed.
If the Internet and, in particular, interactive marketing are not broadly adopted in China, our ability to increase revenue and sustain profitability could be materially and adversely affected.
The use of the Internet as a marketing channel is at an early stage in China. Internet and broadband penetration rates in China are both relatively low compared to those in most developed countries. Many of our existing and potential customers have limited experience with the Internet as a marketing channel, and historically have not devoted a significant portion of their marketing budgets to online marketing and promotion. As a result, they may not consider the Internet effective in promoting their products and services as compared to traditional print and broadcast media. Our ability to generate significant revenues may be negatively impacted by a number of factors, many of which are beyond our control, including:
·
difficulties associated with developing a larger consumer base with demographic characteristics attractive to customers;
·
increased competition and potential downward pressure on online marketing prices;
·
ineffectiveness of our online marketing delivery, tracking and reporting systems; and
·
lack of increase in Internet usage in China.
We face significant competition and may suffer from a loss of users and customers as a result.
We expect to face significant competition in our interactive marketing and sales services business, particularly from other companies that seek to provide online marketing services. Our main competitors include Sohu.com, Alibaba.com, Tom Online, Beijing Media in China and Next Media Group in Hong Kong. Many of these competitors have significantly greater financial resources than we do. They also have longer operating histories and more experience in attracting and retaining users and managing customers than we do. They may use their experience and resources to compete with us in a variety of ways, including by competing more heavily for users, customers, distributors and networks of third-party websites, investing more heavily in research and development and making
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acquisitions.
We may also face competition from traditional advertising media, such as newspapers, magazines, yellow pages, billboards and other forms of outdoor media, television and radio. Most large companies in China allocate, and will likely continue to allocate, the bulk of their marketing budgets to traditional advertising media and only a small portion of their budgets to online marketing. If these companies do not devote a larger portion of their marketing budgets to online marketing services provided by us, or if our existing customers reduce the amount they spend on online marketing, our results of operations and future growth prospects could be adversely affected.
Our business depends on a strong brand, and if we are not able to maintain and enhance our brand, our business and operating results may be harmed.
We believe that recognition of our brand will contribute significantly to the success of our business. We also believe that maintaining and enhancing our brand is critical to expanding our base of consumers and customers. As our market becomes increasingly competitive, maintaining and enhancing our brand will depend largely on our ability to remain as an Internet marketing leader in China, which may be increasingly difficult and expensive.
If we fail to continue to innovate and provide relevant services, we may not be able to generate sufficient user traffic levels to remain competitive.
We must continue to invest significant resources in research and development to enhance services and introduce additional high quality services to attract and retain consumers. If we are unable to anticipate consumer preferences or industry changes, or if we are unable to modify our services on a timely basis, we may lose consumers and customers. Our operating results would also suffer if our innovations do not respond to the needs of our consumers and customers, are not appropriately timed with market opportunities or are not effectively brought to market.
If we fail to keep up with rapid technological changes, our future success may be adversely affected.
The online marketing industry is subject to rapid technological changes. Our future success will depend on our ability to respond to rapidly changing technologies, adapt our services to evolving industry standards and improve the performance and reliability of our services. Our failure to adapt to such changes could harm our business. New marketing media could also adversely affect us. For example, the number of people accessing the Internet through devices other than personal computers, including mobile telephones and hand-held devices, has increased in recent years. If we are slow to develop products and technologies that are more compatible with non-PC communications devices, we may not be successful in capturing a significant share of this increasingly important market for media and other services. In addition, the widespread adoption of new Internet, networking or telecommunications technologies or other technological changes could require substantial expenditures to modify or adapt our products, services or infrastructure. If we fail to keep up with rapid technological changes to remain competitive in our rapidly evolving industry, our future success may be adversely affected.
We may face intellectual property infringement claims and other related claims that could be time-consuming and costly to defend and may result in our inability to continue providing certain existing services.
Internet, technology and media companies are frequently involved in litigation based on allegations of infringement of intellectual property rights, unfair competition, invasion of privacy, defamation and other violations of third-party rights. The validity, enforceability and scope of protection of intellectual property in Internet-related industries, particularly in China, are uncertain and still evolving. In addition, many parties are actively developing and seeking protection for Internet-related technologies, including seeking patent protection. There may be patents issued or pending held by others that cover significant aspects of our technologies, products, business methods or services. As we face increasing competition and as litigation becomes more common in China for resolving commercial disputes, we face a higher risk of being the subject of intellectual property infringement claims.
Intellectual property litigation is expensive and time consuming and could divert resources and management attention from the operations of our businesses. If there is a successful claim of infringement, we may be required to pay substantial fines and damages or enter into royalty or license agreements that may not be available on commercially acceptable terms, if at all. Our failure to obtain a license of the rights on a timely basis could harm our business. Any intellectual property litigation could have a material adverse effect on our business, financial condition or results of operations.
We may not be able to prevent others from unauthorized use of our intellectual property, which could harm our business and competitive position.
We rely on a combination of copyright, trademark and trade secret laws, as well as nondisclosure agreements and other methods to protect our intellectual property rights. The protection of intellectual property rights in China may not be as effective as those in the United States or other countries. The steps we have taken may be inadequate to prevent the misappropriation of our technology.
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Reverse engineering, unauthorized copying or other misappropriation of our technologies could enable third parties to benefit from our technologies without paying us. From time to time, we may have to enforce our intellectual property rights through litigation. Such litigation may result in substantial costs and diversion of resources and management attention.
If we fail to attract customers for our online marketing services, our business and growth prospects could be seriously harmed.
Our online marketing customers will not maintain a business relationship with us if their investment does not generate sales leads and ultimately consumers. Failure to retain our existing online marketing customers or attract new customers for our online marketing services could seriously harm our business and growth prospects.
Because we primarily rely on distributors in providing our e-marketing services, our failure to retain key distributors or attract additional distributors could materially and adversely affect our business.
Online sales and marketing is at an early stage of development in China and is not as widely accepted by or available to businesses as in the United States. As a result, we rely heavily on a nationwide distribution network of third-party distributors for our sales to, and collection of payment from, our corporate and consumer customers. If our distributors do not provide quality services to our customers or otherwise breach their contracts with our customers, we may lose customers and our results of operations may be materially and adversely affected. We do not have long-term agreements with any of our distributors, including our key distributors, and cannot assure that we will continue to maintain favorable relationships with them. Our distribution arrangements are non-exclusive. Furthermore, some of our distributors may have contracts with our competitors or potential competitors and may not renew their distribution agreements with us. In addition, as new methods for accessing the Internet, including the use of wireless devices, become available, we may need to expand our distribution network to cater to the new technologies. If we fail to retain our key distributors or attract additional distributors on terms that are commercially reasonable, our business and operations could be materially and adversely affected.
Our strategy of acquiring complementary businesses, assets and technologies may fail.
As part of our business strategy, we have pursued, and intend to continue to pursue, selective strategic acquisitions of businesses, assets and technologies that complement our existing business. Our acquisitions involve uncertainties and risks, including:
·
potential ongoing financial obligations and unforeseen or hidden liabilities;
·
failure to achieve intended objectives, benefits or revenue-enhancing opportunities;
·
costs and difficulties of integrating acquired businesses and managing a larger business; and
·
diversion of resources and management attention.
Our failure to address these risks successfully may have a material adverse effect on our financial condition and results of operations. Any such acquisition may require a significant amount of capital investment, which would decrease the amount of cash available for working capital or capital expenditures. In addition, if we use our equity securities to pay for acquisitions, we may dilute the value of our common stock. If we borrow funds to finance acquisitions, such debt instruments may contain restrictive covenants that could, among other things, restrict us from distributing dividends. Such acquisitions may also generate significant amortization expense related to intangible assets.
We may not be able to manage our expanding operations effectively.
We anticipate significant continued expansion of our business as we address growth in our consumer and customer base and market opportunities. To manage the potential growth of our operations and personnel, we will be required to improve operational and financial systems, procedures and controls, and expand, train and manage our growing employee base. Furthermore, our management will be required to maintain and expand our relationships with other websites, Internet companies, and other third parties. We cannot assure you that our current and planned personnel, systems, procedures and controls will be adequate to support our future operations.
Our operating results may fluctuate, which makes our results difficult to predict and could cause our results to fall short of expectations.
Our operating results may fluctuate as a result of a number of factors, many of which are outside of our control. For these reasons, comparing our operating results on a period-to-period basis may not be meaningful, thus one should not rely on our past results as an indication of our future performance. Our quarterly and annual revenues and costs and expenses as a percentage of our revenues may be significantly different from our historical or projected rates. Our operating results in future quarters may fall below expectations. Any of these events could cause the price of our common stock to fall. Any of the risk factors listed in this Risk Factors section, and in particular, the following risk factors, could cause our operating results to fluctuate from quarter to quarter:
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·
general economic conditions in China and economic conditions specific to the Internet, Internet search and online marketing;
·
our ability to attract additional customers;
·
the announcement or introduction of new or enhanced products and services by us or our competitors;
·
the amount and timing of operating costs and capital expenditures related to the maintenance and expansion of our businesses, operations and infrastructure;
·
the results of our acquisitions of, or investments in, other businesses or assets;
· Chinese regulations or actions pertaining to activities on the Internet, including gambling, online games and other forms of entertainment; and
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geopolitical events or natural disasters such as war, threat of war, Severe Acute Respiratory Syndrome, or SARS, or other epidemics.
Because of our limited operating history and our rapidly growing business, our historical operating results may not be useful in predicting our future operating results. Advertising spending in China has historically been cyclical, reflecting overall economic conditions as well as budgeting and buying patterns. Our rapid growth has lessened the impact of the cyclicality and seasonality of our business. As we continue to grow, we expect that the cyclicality and seasonality in our business may cause our operating results to fluctuate.
The successful operation of our business depends upon the performance and reliability of the Internet infrastructure and fixed telecommunications networks in China.
Our business depends on the performance and reliability of the Internet infrastructure in China. Almost all access to the Internet is maintained through state-owned telecommunication operators under the administrative control and regulatory supervision of the Ministry of Information Industry of China. In addition, the national networks in China are connected to the Internet through international gateways controlled by the Chinese government. These international gateways are the only channels through which a domestic user can connect to the Internet. We cannot assure you that a more sophisticated Internet infrastructure will be developed in China. We may not have access to alternative networks in the event of disruptions, failures or other problems with Chinas Internet infrastructure. In addition, the Internet infrastructure in China may not support the demands associated with continued growth in Internet usage.
Our success depends on the continuing efforts of our senior management team and other key personnel and our business may be harmed if we lose their services.
Our future success depends heavily upon the continuing services of the members of our senior management team, in particular our chairman Dr. Bruno Wu. If one or more of our senior executives or other key personnel are unable or unwilling to continue in their present positions, we may not be able to replace them easily or at all, and our business may be disrupted and our financial condition and results of operations may be materially and adversely affected. Competition for senior management and key personnel is intense, the pool of qualified candidates is very limited, and we may not be able to retain the services of our senior executives or key personnel, or attract and retain high-quality senior executives or key personnel in the future.
In addition, if any member of our senior management team or any of our other key personnel joins a competitor or forms a competing company, we may lose customers, distributors, know-how and key professionals and staff members. Each of our executive officers and key employees has entered into an employment agreement with us, which contains confidentiality and non-competition provisions. If any disputes arise between any of our senior executives or key personnel and us, we cannot assure you the extent to which any of these agreements may be enforced.
We rely on highly skilled personnel and if we are unable to retain or motivate key personnel or hire qualified personnel, we may not be able to grow effectively.
Our performance and future success depends on the talents and efforts of highly skilled individuals. We will need to continue to identify, hire, develop, motivate and retain highly skilled personnel for all areas of our organization. Competition in our industry for qualified employees is intense. Our continued ability to compete effectively depends on our ability to attract new employees and to retain and motivate our existing employees.
As competition in our industry intensifies, it may be more difficult for us to hire, motivate and retain highly skilled personnel. If we do not succeed in attracting additional highly skilled personnel or retaining or motivating our existing personnel, we may be unable to grow effectively.
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Interruption or failure of our information technology and communications systems could impair our ability to effectively provide our products and services, which could damage our reputation and harm our operating results.
Our ability to provide our Marketing & Information services depends on the continuing operation of our information technology and communications systems. Any damage to or failure of our systems could interrupt our service. Service interruptions could reduce our revenues and profits, and damage our brand if our system is perceived to be unreliable. Our systems are vulnerable to damage or interruption as a result of terrorist attacks, war, earthquakes, floods, fires, power loss, telecommunications failures, computer viruses, interruptions in access to our websites through the use of denial of service or similar attacks, hacking or other attempts to harm our systems, and similar events. Our servers, which are hosted at third-party Internet data centers, are also vulnerable to break-ins, sabotage and vandalism. Some of our systems are not fully redundant, and our disaster recovery planning does not account for all possible scenarios. The occurrence of a natural disaster or a closure of an Internet data center by a third-party provider without adequate notice could result in lengthy service interruptions.
Our business could be adversely affected if our software contains bugs.
Our Marketing & Information systems, including our websites, and other software applications and products, could contain undetected errors or bugs that could adversely affect their performance. We regularly update and enhance our websites and our other online systems and introduce new versions of our software products and applications. The occurrence of errors in any of these may cause us to lose market share, damage our reputation and brand name, and materially and adversely affect our business.
Concerns about the security of electronic commerce transactions and confidentiality of information on the Internet may reduce use of our network and impede our growth.
A significant barrier to electronic commerce and communications over the Internet in general has been public concern over security and privacy, including the transmission of confidential information. If these concerns are not adequately addressed, they may inhibit the growth of the Internet and other online services generally, especially as a means of conducting commercial transactions. If a well-publicized Internet breach of security were to occur, general Internet usage could decline, which could reduce traffic to our destination websites and impede our growth.
We have limited business insurance coverage.
The insurance industry in China is still at an early stage of development. Insurance companies in China offer limited business insurance products. We do not have any business liability or disruption insurance coverage for our operations in China. Any business disruption, litigation or natural disaster may result in our incurring substantial costs and the diversion of our resources.
Fluctuation and impairment of marketable securities will materially impact our net income
We own securities in a number of public companies. These marketable securities are carried at fair market value, fluctuation of market price of those securities could adversely impact net income and earnings per share.
Any change of the indefinite status of any of our intangible assets may require us to record additional amortization expenses
Some of our intangible assets are characterized as indefinite intangible assets and therefore are not required to be amortized. Any changes of the conditions upon which we based categorization of these intangible assets as indefinite will likely require us to amortize these intangible assets over their economic life. Such additional amortization cost could adversely impact our net income and earnings per share.
Risks Related to Our Corporate Structure
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.
Although we are a Delaware corporation, all of our operations and employees are located in the China. As such, 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 certain of our affiliated Chinese entities. We are considered foreign persons or foreign invested enterprises under Chinese law. As a result, we are subject to Chinese law limitations on foreign ownership of Internet and advertising companies. 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.
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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 of the interpretation of existing or new Chinese laws or regulations on our businesses. 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. 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.
Our corporate actions are substantially controlled by our principal shareholders and affiliated entities.
As of September 30, 2007, our principal shareholders and their affiliated entities own approximately
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% of our outstanding common stock. These shareholders, acting individually or as a group, could exert substantial influence over matters such as electing directors and approving mergers or other business combination transactions. This concentration of ownership may also discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our common stock. These actions may be taken even if they are opposed by our other shareholders.
There are certain inter-locking relationships and potential conflicts of interest with our Chairman, His Spouse, and a Significant Shareholder.
Dr. Bruno Wu, our Chairman, is also the Chairman and Director of Sun Media Investment Holdings Limited (SMIH), one of our significant shareholders. Dr. Wus wife is the majority shareholder of SMIH. We also have entered into several transactions involving SMIH or entities controlled by SMIH, including a recent transaction with Her Village Co., Ltd. In addition, the parties may enter into future arrangements, including modifications to existing agreements, which have not been determined at this time. Although our management believes that each of these past transactions were entered into in our best interests (and for future transactions our management will endeavor at all times to maintain our best interests in any such transaction(s)), they were not the product of any arms length negotiations between the parties, nor did we obtain an independent fairness opinion with respect to these transactions. Therefore, conflicts of interest between such parties and us have existed in the past and may continue in the future and may have an adverse impact on our business.
Our officers and directors may allocate their time and efforts to other businesses thereby causing conflicts of interest in their determination as to whether or not to present business opportunities to the Company and as to how much time to devote to our affairs.
Our officers and directors, including Dr. Wu, are not required to commit their full time to our affairs, which may result in a conflict of interest in allocating their time between our operations and other businesses. All of our executive officers are engaged in several other business endeavours and are not obligated to contribute any specific number of hours to our affairs. If our executive officers other business affairs require them to devote more substantial amounts of time to such affairs, it could have a negative impact on our financial condition, results of operations and future business prospects.
We intend to protect our interests in having these officers and directors remain part of the Company and prioritize their time and resources in such a way that will benefit interests, although no assurances thereof can be given.
Our officers and directors may become aware of business opportunities which may be appropriate for presentation to us as well as the other entities to which they owe fiduciary duties. Accordingly, they may have conflicts of interest in determining to which entity a particular business opportunity should be presented. The Company intends to protect its interests in having these officers and directors remain part of the Company and prioritize their time and resources in such a way that will benefit the Company, although no assurances thereof can be given.
Risks Related to Doing Business in China
Adverse changes in economic and political policies of the Chinese government could have a material adverse effect on the overall economic growth of China, which could adversely affect our business.
As our interactive Marketing & Information services business expands, we expect an increasing portion of our business operations to be conducted in China. Accordingly, our results of operations, financial condition and prospects are subject to a significant degree to economic, political and legal developments in China. Chinas economy differs from the economies of most developed countries in
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many respects, including the amount of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. While Chinas economy has experienced significant growth in the past 20 years, growth has been uneven across different regions and among various economic sectors of China. The Chinese government has implemented various measures to encourage economic development and guide the allocation of resources. Some of these measures benefit the overall Chinese economy, but may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by governmental control over capital investments or changes in tax regulations that may be applicable to us. Since early 2004, the Chinese government has implemented certain measures to control the pace of economic growth. Such measures may cause a decrease in the level of economic activity in China, which in turn could adversely affect our results of operations and financial condition.
Our subsidiaries and affiliates are subject to restrictions on paying dividends and making other payments to us.
Our operations are conducted through contractual arrangements between our wholly owned subsidiaries and operating entities located in China. As such, we expect to increasingly rely on dividends payments from our subsidiaries who in turn receive their revenues through the affiliated operating entities in China. However, Chinese regulations currently permit payment of dividends only out of accumulated profits, as determined in accordance with Chinese accounting standards and regulations. Our subsidiaries and affiliated entities in China are also required to set aside a portion of their after-tax profits according to Chinese accounting standards and regulations for certain reserve funds. The Chinese government also imposes controls on the conversion of RMB into foreign currencies and the remittance of currencies out of China. We may experience difficulties in completing the administrative procedures necessary to obtain and remit foreign currency. Furthermore, if our subsidiaries or affiliated entities in China incur debt on their own in the future, the instruments governing the debt may restrict their ability to pay dividends or make other payments. If either ourselves or our subsidiaries are unable to receive all of the revenues from our operations through these contractual or dividend arrangements, we may be unable to fund our overhead of our non- Chinese entities or declare dividends on our common stock.
Uncertainties with respect to the
Chinese
legal system could adversely affect us.
We conduct a substantial and increasing portion our business through subsidiaries and affiliated entities based in China. Our operations in China are governed by Chinese laws and regulations. Our subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to wholly foreign-owned enterprises. The China legal system is based on written statutes. Prior court decisions may be cited for reference but have limited precedent value.
Since 1979, Chinese legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, China has not developed a fully integrated legal system and recently-enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, because these laws and regulations are relatively new, and because of the limited published decisions and their non-binding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. In addition, the Chinese legal system is based in part on governmental policies and internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until after the occurrence of the violation. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.
We may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based on United States or other foreign laws against us or our management.
We conduct all of our operations in China and all of our assets are located in China. In addition, all of our senior executive officers reside within China. As a result, it may not be possible to effect service of process within the United States or elsewhere outside China on our senior executive officers, including matters arising under U.S. federal securities laws or applicable state securities laws. Moreover, our Chinese counsel has advised us that China does not have treaties with the United States or many other countries providing for the reciprocal recognition and enforcement of judgment of courts.
Governmental control of currency conversion may affect the value of your investment.
The Chinese government imposes controls on the conversion of RMB to foreign currencies and, in certain cases, the remittance of currencies out of China. As our domestic sales operations expand, we expect to derive an increasing percentage of our revenues in RMB. Under our current structure, we expect our income will be primarily derived from dividend payments from our Chinese subsidiaries. Shortages in the availability of foreign currency may restrict the ability of our Chinese subsidiaries and our affiliated entities to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy their foreign currency denominated obligations. Under existing Chinese foreign exchange regulations, payments of current account items, including profit distributions, interest and principal payments on outstanding notes (including our recently completed convertible note financing) and expenditures from trade-related transactions, can be made in foreign currencies without prior approval from the People's Republic of China State Administration of Foreign Exchange by complying with certain procedural requirements. However, approval from appropriate government authorities is required when RMB is to be converted into foreign currency and remitted out of China to pay
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capital expenses such as the repayment of bank loans denominated in foreign currencies. The Chinese government at its discretion also may 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 demands, we may not be able to pay dividends in foreign currencies to our shareholders, including holders of our common stock.
Fluctuation in the value of RMB may have a material adverse effect on your investment.
The value of RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions. On July 21, 2005, the Chinese government changed its decade-old policy of pegging the value of the RMB to the U.S. dollar. Under the new policy, the RMB is permitted to fluctuate within a narrow and managed band against a basket of foreign currencies. This change in policy has resulted in an approximately 7.9% appreciation of the RMB against the U.S. dollar. While the international reaction to the RMB revaluation has generally been positive, there remains significant international pressure on the Chinese government to adopt a more flexible currency policy, which could result in a further and significant appreciation of the RMB against the U.S. dollar. As our interactive marketing and sales services business continues to grow, a greater portion of our revenues and costs will be denominated in RMB, while a significant portion of our financial assets may be denominated in U.S. dollars. We expect to rely significantly on dividends and other fees paid to us by our subsidiaries and affiliated entities in China. Any significant revaluation of RMB may materially and adversely affect our cash flows, revenues, earnings and financial position, and the value of, and any dividends payable on, our common stock in U.S. dollars. For example, an appreciation of RMB against the U.S. dollar would make any new RMB denominated investments or expenditures more costly to us, to the extent that we need to convert U.S. dollars into RMB for such purposes.
We may not be able to consolidate the financial results of some of our affiliated companies or such consolidation could materially adversely affect our operating results and financial condition.
For Chinese regulatory reasons, all of our operations are conducted through contractual arrangements with China operating companies which for accounting purposes currently are considered variable interest entities (VIEs) of us. We are considered the primary beneficiary of such entities, and as such, are required to consolidate their respective financial results in our consolidated financial statements. In the event that in the future a company we hold as a VIE would no longer meet the definition of a VIE, or we are deemed not to be the primary beneficiary for any reason, we would not be able to consolidate line by line that entitys financial results in our consolidated financial statements. Also, in the future it is possible that other companies, due to contractual obligations, may become our VIE and thus we would be the primary beneficiary. In such an event, we would be required to include that entitys financial results in our consolidated financial statements. If such entitys financial results were negative, this could have a corresponding negative impact on our operating results.
We may lose control over our VIE entities which could materially adversely affect our operating results and financial condition.
As mentioned elsewhere herein, under Chinese law, we are not allowed to own the Chinese operating entities. Instead, through our subsidiaries, we have contractual arrangement with the Chinese operating entities pursuant to which we receive a substantial portion of the operating revenues of these Chinese companies. If these Chinese companies fail to uphold the operating agreement or if for any reason, these arrangements are deemed unenforceable, we would lose control over such entities which would cause a material adverse impact on our business and operations.
We face risks related to health epidemics and other outbreaks.
Our business could be adversely affected by the effects of SARS or another epidemic or outbreak. China reported a number of cases of SARS in April 2004. Any prolonged recurrence of SARS or other adverse public health developments in China may have a material adverse effect on our business operations. For instance, health or other governmental regulations adopted in response may require temporary closure of Internet cafes, which is one of the avenues where users could access our websites, or of our offices. Such closures would severely disrupt our business operations and adversely affect our results of operations. We have not adopted any written preventive measures or contingency plans to combat any future outbreak of SARS or any other epidemic.
Rapidly developing Chinese tax laws could negatively affect our businesses.
On March 16 2007, the Chinese government produced a new set of revised tax laws. In these tax laws, income tax for companies located in China was reduced from 33% to 25%, resulting in a corresponding increase in net income for our Chinese company. However, given Chinas rapidly changing tax laws and the difference between national tax policy and local tax policy, we could and likely will be exposed to other fluctuations in income associated with these taxes, including but not limited to business taxes, VAT, income taxes, and other taxes.
Risks Related to Our Common Stock
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There has been only a limited public market for our common stock to date.
To date, there has been only a limited public market for our common stock on the Over-the-Counter Bulletin Board. Our common stock is currently not listed on any exchange. If an active trading market for our common stock does not develop, the market price and liquidity of our common stock will be materially and adversely affected.
The market price for our common stock may be volatile.
The market price for our common stock may be volatile and subject to wide fluctuations in response to factors including the following:
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actual or anticipated fluctuations in our quarterly operating results;
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changes in financial estimates by securities research analysts, if any;
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conditions in the China consumer goods and online marketing markets;
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changes in the economic performance or market valuations of other U.S. public companies with substantial operations in China;
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announcements by us or our competitors of new products, acquisitions, strategic partnerships, joint ventures or capital commitments;
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addition or departure of key personnel;
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fluctuations of exchange rates between RMB and the U.S. dollar;
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intellectual property litigation; and
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general economic or political conditions in China.
In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our Common stock.
We will need additional capital, and the sale of additional common stock or other equity securities could result in additional dilution to our shareholders.
We expect to require additional cash resources to fund our operations, as well as investments or acquisitions which we may decide to pursue. To satisfy our cash requirements, we may seek to sell additional equity or debt securities (in addition to our recently completed financing or obtain a credit facility. The sale of additional equity 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 or the perception of sales of our common stock in the public market could cause the price of our common stock to decline.
Sales of our common stock in the public market or the perception that these sales could occur, could cause the market price of our common stock to decline. As of December 20, 2007, approximately 43,886,984 shares, or 50.3% of our outstanding shares will be freely transferable without restriction or additional registration under the Securities Act of 1933, as amended, or are subject to a pending registration statement. The remaining common stock outstanding as of such date will be available for sale, subject to volume and other restrictions as applicable under Rule 144 under the Securities Act.
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud.
We are subject to reporting obligations under the U.S. securities laws. The Securities and Exchange Commission, or the SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring every public company to include a management report on such companys internal controls over financial reporting in its annual report, which contains managements assessment of the effectiveness of the companys internal controls over financial reporting. In addition, an independent registered public accounting firm must attest to and report on managements assessment of the effectiveness of the companys internal controls over financial reporting.
These requirements first apply to our annual report on Form 10-KSB for the fiscal year ending September 30, 2008. Our
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management may conclude that our internal controls over our financial reporting are not effective. Moreover, even if our management concludes that our internal controls over financial reporting are effective, our independent registered public accounting firm may still decline to attest to our managements assessment or may issue a report that is qualified if they are not satisfied with our controls or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us. Our reporting obligations as a public company will place a significant strain on our management, operational and financial resources and systems for the foreseeable future. We are a young company with limited accounting personnel and other resources with which to address our internal controls and procedures. If we fail to timely achieve and maintain the adequacy of our internal controls, we may not be able to conclude that we have effective internal controls over financial reporting at a reasonable assurance level. Moreover, effective internal controls over financial reporting are necessary for us to produce reliable financial reports and are important to help prevent fraud. As a result, our failure to achieve and maintain effective internal controls over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the trading price of our common stock. Furthermore, we anticipate that we will incur considerable costs and use significant management time and other resources in an effort to comply with Section 404 and other requirements of the Sarbanes-Oxley Act.
We will incur increased costs as a result of being a public company.
As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act, as well as rules subsequently implemented by SEC has required changes in corporate governance practices of public companies. We expect these new rules and regulations to increase our legal, accounting and financial compliance costs and make certain corporate activities more time-consuming and costly. In addition, we will incur additional costs associated with our public company reporting requirements. We are currently evaluating and monitoring developments with respect to these new rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.
There is a limited public float of our common stock, which can result in increased volatility in our stock price and prevent the realization of a profit on resale of the Companys common stock
There is a limited public float of our common stock. The term public float refers to shares freely and actively tradable on the Over-the-Counter Bulletin Board System and not owned by officers, directors or affiliates, as defined under the Securities Act. Due to our relatively small public float and the limited trading volume of our common stock, purchases and sales of relatively small amounts of our common stock can have a disproportionate effect on the market price for our common stock. As a result, the market price of our common stock can have increased volatility which may affect a stockholders ability to sell our shares in a timely manner.
Our common stock is subject to restrictions on sales by broker-dealers and penny stock rules, which may be detrimental to investors.
Our common stock is subject to Rules 15g-1 through 15g-9 under the Exchange Act, which impose certain sales practice requirements on broker-dealers who sell our common stock to persons other than established customers and accredited investors (as defined in Rule 501(c) of the Securities Act). For transactions covered by this rule, a broker-dealer must make a special suitability determination for the purchaser and have received the purchasers written consent to the transaction prior to the sale. This rule adversely affects the ability of broker-dealers to sell our common stock and purchasers of our common stock to sell their shares of our common stock.
Additionally, our common stock is subject to SEC regulations applicable to penny stock. Penny stock includes any non-Nasdaq equity security that has a market price of less than $5.00 per share, subject to certain exceptions. The regulations require that prior to any non-exempt buy/sell transaction in a penny stock, a disclosure schedule proscribed by the SEC relating to the penny stock market must be delivered by a broker-dealer to the purchaser of such penny stock. This disclosure must include the amount of commissions payable to both the broker-dealer and the registered representative and current price quotations for our common stock. The regulations also require that monthly statements be sent to holders of penny stock that disclose recent price information for the penny stock and information of the limited market for penny stocks. These requirements adversely affect the market liquidity of our common stock.
When we account for employee share options using the fair value method, such accounting treatment could significantly reduce our net income.
On December 16, 2004, the Financial Accounting Standard Board, or FASB, issued FASB Statement No. 123(R), Share-Based Payment, which requires a public company to recognize as an expense, the fair value of stock options and other share-based compensation to employees at the first fiscal year that begins on or after June 15, 2005. Currently, we record share-based compensation to the extent that the fair value of the shares on the date of grant exceeds the exercise price of the option. We recognize compensation expense over the related vesting periods. For the periods after December 31, 2005, we could have ongoing accounting charges significantly greater than those we would have recorded under our current method of accounting for share options. See
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Managements Discussion and Analysis of Financial Conditions and Results of OperationsCritical Accounting Policies for a more detailed presentation of accounting for share-based compensation plans.