UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
OR
For the Fiscal Year Ended
OR
☐ TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
Date of event requiring this shell company report _________
For the transition period from _________ to __________
Commission file number
(Exact Name of registrant as specified in its charter)
Not Applicable
(Translation of Registrant’s name into English)
(Jurisdiction of incorporation or organization)
(Address of principal executive offices)
(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||
| The |
Securities registered or to be registered pursuant to Section 12(g) of the Act:
None
(Title of Class)
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
None
(Title of Class)
Indicate the number of outstanding
shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report: as
of December 31, 2022,
Indicate by check mark if
the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐
If this report is an annual
or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934. Yes ☐
Note - Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.
Indicate by check mark whether
the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Indicate by check mark whether
the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T
(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit
such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or an emerging growth company. See definition of “large accelerated filer,” accelerated filer,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer ☐ | Accelerated filer ☐ | Emerging growth company |
If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards † provided pursuant to Section 13(a) of the Exchange Act. ☐
†The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.
Indicate by check mark whether
the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control
over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that
prepared or issued its audit report. ☐ Yes
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐
Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐
| International Financial Reporting Standards as issued | Other ☐ | |
| By the International Accounting Standards Board ☐ |
If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.
Item 17 ☐ Item 18 ☐
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐ No
(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. ☐ Yes ☐ No
Table of Contents
i
CERTAIN TERMS AND CONVENTIONS
Except where the context otherwise requires and for purposes of this annual report on Form 20-F only:
| ● | “Act” refers to The BVI Business Companies Act, 2004 (as amended); | |
| ● | “Beijing REIT” refers to Beijing REIT Technology Development Co., Ltd., a PRC limited liability company; | |
| ● | “Beijing REIT Ecological” refers to Beijing REIT Ecological Engineering Technology Co., Ltd., a PRC limited liability company; |
| ● | “BVI” refers to the British Virgin Islands; |
| ● | “China” or the “PRC” refers to the People’s Republic of China and the term “Chinese” has a correlative meaning for the purpose of this annual report; |
| ● | “Common Shares” refers to common shares of par value $0.001 per share issued in ReTo; |
| ● | “CSRC” refers to the China Securities Regulatory Commission; | |
| ● | “Exchange Act” refers to the Securities Exchange Act of 1934, as amended; | |
| ● | “FINRA” refers to the Financial Industry Regulatory Authority, Inc.; |
| ● | “Hainan Coconut” refers to Hainan Coconut Network Freight Co., Ltd., a limited liability company incorporated in mainland China and subsidiary of Yangpu Fangyuyuan; | |
| ● | “Hainan Kunneng” refers to Hainan Kunneng Direct Supply Chain Management Co., Ltd., a limited liability company incorporated in mainland China and subsidiary of Yangpu Fangyuyuan; | |
| ● | “Hainan Yile IoT” refers to Hainan Yile IoT Technology Co., Ltd, a PRC limited liability company and subsidiary of REIT Mingde; | |
| ● | “Hong Kong” refers to the Hong Kong Special Administrative Region of the PRC; | |
| ● | “IoV Technology Research” refers to Hainan Yile IoV Technology Research Institute Co., Ltd., a limited liability company incorporated in mainland China and subsidiary of Hainan Yile IoT; | |
| ● | “JOBS Act” refers to the Jumpstart Our Business Startups Act, enacted in April 2012; |
| ● | “M&A” refers to the amended and restated memorandum and articles of association of ReTo, currently in effect and as amended from time to time; | |
| ● | “Macau” refers to the Macao Special Administrative Region of the PRC; | |
| ● | “mainland China” refers to the People’s Republic of China, excluding, for the purpose of this annual report, Taiwan, Hong Kong and Macau; | |
| ● | “MOFCOM” refers to China’s Ministry of Commerce; | |
| ● | “PCAOB” refers to the Public Company Accounting Oversight Board of the United States; | |
| ● | “PRC subsidiaries” refers to the Company’s subsidiaries that were incorporated in mainland China; |
| ● | “REIT Changjiang” refers to REIT MingSheng Environment Protection Construction Materials (Changjiang) Co., Ltd., a PRC limited liability company, which was disposed in December 2021; |
| ● | “REIT Construction” refers to Hainan REIT Construction Engineering Co., Ltd., a PRC limited liability company, which was dissolved on February 9, 2023; |
| ● | “REIT Holdings” refers to REIT Holdings (China) Limited, a Hong Kong limited company and a wholly owned subsidiary of ReTo; |
| ● | “REIT Mingde” refers to Hainan REIT Mingde Investment Holding Co., Ltd., a PRC limited liability company and a wholly owned subsidiary of REIT Technology Development Co., Ltd.; |
ii
| ● | “REIT Ordos” Refers to REIT Ecological Technology Co., Ltd., a limited liability company incorporated in mainland China and a wholly owned subsidiary of REIT Holdings; |
| ● | “REIT Technology” refers to REIT Technology Development Co., Ltd., a PRC limited liability company and subsidiary of REIT Holdings; |
| ● | “Renminbi” or “RMB” refers to the legal currency of the People’s Republic of China; |
| ● | “ReTo” refers to ReTo Eco-Solutions, Inc., a BVI business company (registered in the BVI with company number 1885527); |
| ● | “SAFE” refers to China’s State Administration of Foreign Exchange; | |
| ● | “SEC” refers to the U.S. Securities and Exchange Commission; | |
| ● | “Securities Act” refers to the Securities Act of 1933, as amended; | |
| ● | “Xinyi REIT” refers to REIT New Materials Xinyi Co., Ltd, a joint venture established by Beijing REIT; | |
| ● | “Yangpu Fangyuyuan” refers to Yangpu Fangyuyuan United Logistics Co., Ltd., a limited liability company incorporated in mainland China and a subsidiary of REIT Mingde; |
| ● | “U.S. dollars”, “US$” and “$” refer to the legal currency of the United States; and |
| ● | “We”, “us”, “our”, or the “Company” refers to ReTo Eco-Solutions, Inc. and its subsidiaries, unless the context requires otherwise. |
For the sake of clarity, this annual report follows the English naming convention of first name followed by last name, regardless of whether an individual’s name is Chinese or English. For example, the name of our chief executive officer will be presented as “Hengfang Li”, even though, in Chinese, his name would be presented as “Li Hengfang”.
Our reporting and functional currency is the Renminbi. Solely for the convenience of the reader, this annual report contains translations of some RMB amounts into U.S. dollars, at specified rates. Except as otherwise stated in this annual report, all translations from RMB to U.S. dollars are made at RMB6.8972 to US$1.00, the rate published by the Federal Reserve Board on December 31, 2022. No representation is made that the RMB amounts referred to in this annual report could have been or could be converted into U.S. dollars at such rate.
Our fiscal year end is December 31. References to a particular “fiscal year” are to our fiscal year ended December 31 of that calendar year.
We own or have rights to trademarks or trade names that we use in connection with the operation of our business, including our corporate names, logos and website names. In addition, we own or have the rights to copyrights, trade secrets and other proprietary rights that protect the content of our products. This annual report may also contain trademarks, service marks and trade names of other companies, which are the property of their respective owners. Our use or display of third parties’ trademarks, service marks, trade names or products in this annual report is not intended to, and should not be read to, imply a relationship with or endorsement or sponsorship of us. Solely for convenience, some of the copyrights, trade names and trademarks referred to in this annual report or the documents incorporated by reference herein are listed without their ©, ® and ™ symbols, but we will assert, to the fullest extent under applicable law, our rights to our copyrights, trade names and trademarks. All other trademarks are the property of their respective owners.
iii
FORWARD-LOOKING STATEMENTS
This annual report contains forward-looking statements. All statements contained in this annual report other than statements of historical fact, including statements regarding our future results of operations and financial position, our business strategy and plans, and our objectives for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect,” and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements include statements relating to:
| ● | the potential impact on our business of the economic, political and social conditions of the PRC; | |
| ● | any changes in the laws of the PRC or local province that may affect our operations; | |
| ● | the impact of COVID-19 on our operations; | |
| ● | our ability to operate as a going concern; | |
| ● | the liquidity of our securities; | |
| ● | inflation and fluctuations in foreign currency exchange rates; | |
| ● | the ability to realize benefits of the acquisition of REIT Mingde and integrate and expand its businesses into our existing business and grow and manage growth profitably; | |
| ● | the ability to navigate geographic market risks of our eco-friendly constructions materials; | |
| ● | the ability to maintain a reserve for warranty or defective products and installation claims; | |
| ● | our on-going ability to obtain all mandatory and voluntary government and other industry certifications, approvals, and/or licenses to conduct our business; | |
| ● | our ability to maintain effective supply chain of raw materials and our products; | |
| ● | slowdown or contraction in industries in China in which we operate; | |
| ● | our ability to maintain or increase our market share in the competitive markets in which we do business; | |
| ● | our ability to diversify our product and service offerings and capture new market opportunities; | |
| ● | our estimates of expenses, capital requirements and needs for additional financing and our ability to fund our current and future operations; | |
| ● | the costs we may incur in the future from complying with current and future laws and regulations and the impact of any changes in the regulations on our operations; and | |
| ● | the loss of key members of our senior management. |
These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in the “Risk Factors,” “Operating and Financial Review and Prospects,” and elsewhere in this annual report. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this annual report may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.
You should not rely upon forward-looking statements as predictions of future events. The events and circumstances reflected in the forward-looking statements may not be achieved or occur. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. We are under no duty to update any of these forward-looking statements after the date of this annual report or to conform these statements to actual results or revised expectations.
iv
PART I
Item 1. Identity of Directors, Senior Management and Advisers
Not applicable.
Item 2. Offer Statistics and Expected Timetable
Not applicable.
Item 3. Key Information
Holding Company Structure
ReTo Eco-Solutions, Inc. (“ReTo”, collectively with its consolidated subsidiaries, the “Company,” “we,” “us”, “our” or similar terminology) is a holding company and a business company incorporated in the British Virgin Islands (“BVI”) with no material operations of its own. We conduct substantially all of our operations through our subsidiaries established in mainland China. Our equity structure is a direct holding structure, that is, ReTo, the BVI entity listed in the U.S., controls Beijing REIT and other PRC operating entities through REIT Holdings. See “Item 4. Information on the Company - A. History and development of the company” For more details.
We face various risks and uncertainties relating to doing business in China. Our business operations are primarily conducted in China, and we are subject to complex and evolving PRC laws and regulations. For example, we face risks associated with regulatory approvals on offshore offerings, anti-monopoly regulatory actions, and oversight on cybersecurity and data privacy, which may impact our ability to conduct certain businesses, accept foreign investments, or list and conduct offerings on a United States or other foreign exchange. These risks could result in a material adverse change in our operations and the value of our Common Shares, significantly limit or completely hinder our ability to continue to offer securities to investors, or cause the value of such securities to significantly decline. For a detailed description of risks relating to doing business in China, see “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in China.”
The PRC government’s significant discretion and authority in regulating our operations and its oversight and control over offerings conducted overseas by, and foreign investment in, China-based issuers could significantly limit or completely hinder our ability to offer or continue to offer securities to investors. Implementation of industry-wide regulations in this nature may cause the value of our securities to significantly decline or become worthless. For more details, see “Item 3. Key Information—D. Risk Factors—Risks Relating to Doing Business in China— The PRC government’s significant oversight and discretion over the conduct of our business and may intervene or influence our operations at any time which could result in a material adverse change in our operation and/or the value of our Common Shares.”
Risks and uncertainties arising from the legal system in China, including risks and uncertainties regarding the enforcement of laws and quickly evolving rules and regulations in China, could result in a material adverse change in our operations and cause our Common Shares to decrease in value or become worthless. For more details, see “Item 3. Key Information—D. Risk Factors—Risks Relating to Doing Business in China— There are uncertainties regarding the interpretation and enforcement of PRC laws, rules and regulations. The rules and regulations in China can change quickly with little advance notice and uncertainties in the interpretation and enforcement of PRC laws, rules and regulations could limit the legal protections available to you and us.”
1
Cash and Other Assets Transfers between the Holding Company and Its Subsidiaries
Upon the closing of ReTo’s initial public offering (“IPO”) in November 2017, ReTo received net proceeds of approximately $14.3 million. In March 2021, ReTo issued a convertible debenture to an institutional investor in the principal amount of $2,300,000 and received net proceeds of $1,476,915. In July 2021, ReTo issued a convertible debenture to an institutional investor in the principal amount of $2,500,000 and received net proceeds of $2,189,256. In March 2022, ReTo issued the Note (as defined below) in the principal amount of $3,415,500 and received net proceeds of $3,000,000. On May 25, 2022, ReTo issued 5,970,000 Common Shares to Hainan Tashanshi Digital Information Co. Ltd. (“Hainan Tashanshi”) at $0.60 per share for aggregate gross proceeds of $3,582,000 (the “Private Placement”), RMB19.6 million (approximately $2.9 million) of which was transferred to Beijing REIT as a shareholder loan and approximately RMB4.4 million (approximately $0.6 million) of which was transferred to Beijing REIT Ecological as a shareholder loan. As of the date of this annual report, with respect to the net proceeds from the IPO, the convertible debentures, the Note and the Private Placement, ReTo had transferred an aggregate of approximately $21.4 million to Beijing REIT through REIT Holdings via shareholder loans and capital contribution and approximately $0.6 million to Beijing REIT Ecological via shareholder loans.
Other than the IPO, the convertible debentures, the Note and the Private Placement, ReTo has not raised funds from investors as of the date of this annual report, nor has it transferred any other funds to its subsidiaries. To date, there have not been any dividends or other distributions from our PRC subsidiaries to REIT Holdings and ReTo, both of which are located outside of mainland China. ReTo, as a BVI holding company, may rely on dividends and other distributions on equity paid by its PRC subsidiaries for its cash and financing requirements, including the funds necessary to pay dividends and other cash distributions to its shareholders, subject to ReTo’s M&A and the Act or to service any expenses and other obligations it may incur.
Within our direct holding structure, the cross-border transfer of funds from ReTo to its PRC subsidiaries is permitted under laws and regulations of the PRC currently in effect. Specifically, ReTo is permitted to provide funding to its PRC subsidiaries in the form of shareholder loans or capital contributions, subject to satisfaction of applicable government registration, approval and filing requirements in China. There are no quantity limits on ReTo’s ability to make capital contributions to its PRC subsidiaries under the PRC law and regulations. However, the PRC subsidiaries may only procure shareholder loans from REIT Holding in an amount equal to the difference between their respective registered capital and total investment amount as recorded in the Chinese Foreign Investment Comprehensive Management Information System or 2.5 times of its net assets, at the discretion of such PRC subsidiary.
For additional information, see “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in China — PRC regulation on loans to, and direct investment in, PRC entities by offshore holding companies and governmental control in currency conversion may delay or prevent us from using the proceeds of our offerings to make loans to or make additional capital contributions to our PRC subsidiaries, which could materially and adversely affect our liquidity and our ability to fund and expand our business.”
2
Subject to the passive foreign investment company rules, the requirements of ReTo’s M&A and the Act, the gross amount of any distribution that we make to investors with respect to our securities (including any amounts withheld to reflect PRC withholding taxes) will be taxable as a dividend, to the extent paid out of our current or accumulated earnings and profits, as determined under United States federal income tax principles. Any proposed dividend would be subject to ReTo’s M&A and the Act; specifically, ReTo may only pay a dividend if ReTo’s directors are satisfied, on reasonable grounds, that, immediately after the dividend is paid, the value of its assets will exceed its liabilities and it will be able to pay its debts as they fall due.
The PRC Enterprise Income Tax Law (the “EIT Law”) and its implementation rules provide that a withholding tax at a rate of 10% will be applicable to dividends payable by PRC companies to non-PRC-resident enterprises unless reduced under treaties or arrangements between the PRC central government and the governments of other countries or regions where the non-PRC resident enterprises are tax resident. Pursuant to the tax agreement between mainland China and the Hong Kong Special Administrative Region, the withholding tax rate in respect to the payment of dividends by a PRC enterprise to a Hong Kong enterprise may be reduced to 5% from a standard rate of 10%. However, if the relevant tax authorities determine that our transactions or arrangements are for the primary purpose of enjoying a favorable tax treatment, the relevant tax authorities may adjust the favorable withholding tax in the future. Accordingly, there is no assurance that the reduced 5% withholding rate will apply to dividends received by our Hong Kong subsidiary from our PRC subsidiaries. This withholding tax will reduce the amount of dividends we may receive from our PRC subsidiaries.
We maintain bank accounts in China, including cash in Renminbi in the amount of RMB672,792 and cash in USD in the amount of US$97,554 as of December 31, 2022. Funds are transferred between ReTo and its subsidiaries for their daily operation purposes. The transfer of funds between our PRC subsidiaries are subject to the Provisions of the Supreme People’s Court on Several Issues Concerning the Application of Law in the Trial of Private Lending Cases (2020 Second Revision, the “Provisions on Private Lending Cases”), which was implemented on January 1, 2021 to regulate the financing activities between natural persons, legal persons and unincorporated organizations. The Provisions on Private Lending Cases set forth that private lending contracts will be upheld as invalid under the circumstance that (i) the lender swindles loans from financial institutions for relending; (ii) the lender relends the funds obtained by means of a loan from another profit-making legal person, raising funds from its employees, illegally taking deposits from the public; (iii) the lender who has not obtained the lending qualification according to the law lends money to any unspecified object of the society for the purpose of making profits; (iv) the lender lends funds to a borrower when the lender knows or should have known that the borrower intended to use the borrowed funds for illegal or criminal purposes; (v) the lending is in violation of public orders or good morals; or (vi) the lending is in violation of mandatory provisions of laws or administrative regulations. We have relied on the opinion of our PRC counsel, Yuan Tai Law Offices, that the Provisions on Private Lending Cases does not prohibit using cash generated from one subsidiary to fund another subsidiary’s operations. We have not been notified of any other restriction which could limit our PRC subsidiaries’ ability to transfer cash between subsidiaries. As of the date of this annual report, we have not adopted any cash management policies that dictate how funds are transferred between our holding company and our subsidiaries.
There is no assurance that the PRC government will not intervene or impose restrictions on the ability of us or our subsidiaries to transfer cash. Most of our cash is in Renminbi, and the PRC government could prevent the cash maintained in our bank accounts in mainland China from leaving mainland China, could restrict deployment of the cash into the business of our subsidiaries and restrict the ability to pay dividends. For details regarding the restrictions on our ability to transfer cash between us, and our subsidiaries, see “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in China — The PRC government could prevent the cash maintained in our bank accounts in mainland China from leaving mainland China, restrict deployment of the cash into the business of its subsidiaries and restrict the ability to pay dividends to U.S. investors, which could materially adversely affect our operations.” We currently do not have cash management policies that dictate how funds are transferred between our BVI holding company and our subsidiaries.
Restrictions on Our Ability to Transfer Cash Out of China and to U.S. Investors
Our PRC subsidiaries’ ability to distribute dividends is based upon their distributable earnings. Current PRC regulations permit our PRC subsidiaries to pay dividends to their respective shareholders only out of their accumulated profits, if any, as determined in accordance with PRC accounting standards and regulations. In addition, under PRC law, each of our PRC subsidiaries is required to set aside at least 10% of its after-tax profits each year, if any, to fund certain statutory reserve funds until such reserve funds reach 50% of its registered capital. These reserves are not distributable as cash dividends. If any of our PRC subsidiaries incurs debt on its own behalf in the future, the instruments governing such debt may restrict its ability to pay dividends to ReTo.
3
To address persistent capital outflows and the RMB’s depreciation against the U.S. dollar in the fourth quarter of 2016, the People’s Bank of China and the State Administration of Foreign Exchange, or SAFE, implemented a series of capital control measures in the subsequent months, including stricter vetting procedures for China-based companies to remit foreign currency for overseas acquisitions, dividend payments and shareholder loan repayments. The PRC government may continue to strengthen its capital controls and our PRC subsidiaries’ dividends and other distributions may be subject to tightened scrutiny in the future. The PRC government also imposes controls on the conversion of RMB into foreign currencies and the remittance of currencies out of mainland China. Therefore, we may experience difficulties in completing the administrative procedures necessary to obtain and remit foreign currency for the payment of dividends from our profits, if any.
Effect of The Holding Foreign Companies Accountable Act
The Holding Foreign Companies Accountable Act (the “HFCAA”), which was signed into law on December 18, 2020, requires a foreign company to submit that it is not owned or manipulated by a foreign government or disclose the ownership of governmental entities and certain additional information, if the PCAOB is unable to inspect completely a foreign auditor that signs the company’s financial statements. If the PCAOB is unable to inspect the Company’s auditors for three consecutive years, the Company’s securities will be prohibited from trading on a national exchange. The Accelerating Holding Foreign Companies Accountable Act, which was enacted on December 29, 2022, has decreased the number of non-inspection years from three years to two, thus reducing the time period before our Common Shares may be prohibited from trading or delisted.
On December 16, 2021, the PCAOB issued its determination that the PCAOB is unable to inspect or investigate completely PCAOB-registered public accounting firms headquartered in mainland China and in Hong Kong, because of positions taken by PRC authorities in those jurisdictions, and the PCAOB included in the report of its determination a list of the accounting firms that are headquartered in mainland China or Hong Kong. This list did not include YCM CPA Inc., our current auditor. Our auditor, as an auditor of companies that are traded publicly in the United States and a firm registered with the PCAOB, is subject to laws in the United States pursuant to which the PCAOB conducts regular inspections to assess its compliance with the applicable professional standards. On August 26, 2022, the PCAOB signed a Statement of Protocol with the CSRC and MOF, taking the first step toward opening access for the PCAOB to inspect and investigate registered public accounting firms headquartered in mainland China and Hong Kong without any limitations on scope. However, uncertainties exist with respect to the implementation of this framework and there is no assurance that the PCAOB will be able to execute, in a timely manner, its future inspections and investigations in a manner that satisfies the Statement of Protocol. On December 15, 2022, the PCAOB determined that the PCAOB was able to secure complete access to inspect and investigate registered public accounting firms headquartered in mainland China and Hong Kong and voted to vacate its previous determinations to the contrary.
These developments could add uncertainties to the trading of our securities, including the possibility that the SEC may prohibit trading in our securities if the PCAOB cannot fully inspect or investigate our auditor and we fail to appoint a new auditor that is accessible to the PCAOB and that Nasdaq can delist our Common Shares.
If it is later determined that the PCAOB is unable to inspect or investigate our auditor completely, investors may be deprived of the benefits of such inspection. Any audit reports not issued by auditors that are completely inspected by the PCAOB, or a lack of PCAOB inspections of audit work undertaken in China that prevents the PCAOB from regularly evaluating our auditors’ audits and their quality control procedures, could result in a lack of assurance that our financial statements and disclosures are adequate and accurate, then such lack of inspection could cause our securities to be delisted from the stock exchange.
On December 2, 2021, the SEC adopted final amendments to its rules implementing the HFCAA. Such final rules establish procedures that the SEC will follow in (i) determining whether a registrant is a “Commission-Identified Issuer” (a registrant identified by the SEC as having filed an annual report with an audit report issued by a registered public accounting firm that is located in a foreign jurisdiction and that the PCAOB is unable to inspect or investigate completely because of a position taken by an authority in that jurisdiction) and (ii) prohibiting the trading of an issuer that is a Commission-Identified Issuer for three consecutive years under the HFCAA. The SEC began identifying Commission-Identified Issuers for the fiscal years beginning after December 18, 2020. A Commission-Identified Issuer is required to comply with the submission and disclosure requirements in the annual report for each year in which it was identified. If a registrant is identified as a Commission-Identified Issuer based on its annual report for the fiscal year ended, for example, September 30, 2021, the registrant will be required to comply with the submission or disclosure requirements in its annual report filing covering the fiscal year ended September 30, 2022.
4
For details on the effects of HFCAA on us, see “Item 3. Key Information—D. Risk Factors — Risks Related to Doing Business in China — Our Common Shares may be delisted under the Holding Foreign Companies Accountable Act if the PCAOB is unable to inspect our auditors. The delisting of our Common Shares, or the threat of their being delisted, may materially and adversely affect the value of your investment. Additionally, the inability of the PCAOB to conduct inspections deprives our investors with the benefits of such inspections. Furthermore, on December 29, 2022, the Accelerating Holding Foreign Companies Accountable Act was enacted, which amends the HFCAA and requires the SEC to prohibit an issuer’s securities from trading on any U.S. stock exchanges if its auditor is not subject to PCAOB inspections for two consecutive years instead of three.”
Regulatory Permissions and Developments
We have been advised by our PRC Counsel, Yuan Tai Law Offices, that pursuant to the relevant laws and regulations in China, none of our PRC subsidiaries’ currently engaged business is stipulated on the Special Administrative Measures for the Access of Foreign Investment (Negative List) (2021 Version) (the “2021 Negative List”) promulgated by the Ministry of Commerce (the “MOFCOM”) and the National Development and Reform Commission of the People’s Republic of China (“NDRC”) which entered into force on January 1, 2022. Therefore, our PRC subsidiaries are able to conduct their business without being subject to restrictions imposed by the foreign investment laws and regulations of the PRC. Certain of the business scope of our PRC subsidiaries are listed on the 2021 Negative List, such as value-added telecommunication business, which the ratio of investment by foreign investors in a foreign-invested telecommunication enterprise that engages in the operation of a value-added telecommunication business (except e-commerce, domestic multi-party communication, storage and forwarding class and call center) shall not exceed 50%. Based on the confirmation of the PRC subsidiaries, these subsidiaries have not been actually engaged in such business activities.
Certain of the business stated on the business license of our PRC subsidiaries are subject to additional licenses and permits, such as value-added telecommunication certification and construction enterprise qualifications. Based on the confirmation of the PRC subsidiaries, these subsidiaries have not been actually engaged in business activities those require special licenses or permits and they will only carry out business activities after obtaining corresponding licenses or permits. Currently, none of our PRC subsidiaries is required to obtain additional licenses or permits beyond a regular business license for their operations currently being conducted. Each of our PRC subsidiaries is required to obtain a regular business license from the local branch of the State Administration for Market Regulation (“SAMR”). Each of our PRC subsidiaries has obtained a valid business license for its respective business scope, and no application for any such license has been denied.
As of the date of this annual report, ReTo and its PRC subsidiaries are not subject to permission requirements from the CSRC, the Cyberspace Administration of China (the “CAC”) or any other entity that is required to approve of its PRC subsidiaries’ operations. Recently, the PRC government initiated a series of regulatory actions and made a number of public statements on the regulation of business operations in China with little advance notice, including cracking down on illegal activities in the securities market, enhancing supervision over China-based companies listed overseas, adopting new measures to extend the scope of cybersecurity reviews, and expanding efforts in anti-monopoly enforcement.
Among other things, the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (the “M&A Rules”) and Anti-Monopoly Law of the People’s Republic of China promulgated by the Standing Committee of the National People’s Congress (the “SCNPC”) which became effective in 2008 and amended and put into effect as from August 1, 2022 (the “Anti-Monopoly Law”), established additional procedures and requirements that could make merger and acquisition activities by foreign investors more time-consuming and complex. Such regulation requires, among other things, that the MOFCOM be notified in advance of any change-of-control transaction in which a foreign investor acquires control of a PRC domestic enterprise or a foreign company with substantial PRC operations, if certain thresholds under the Provisions of the State Council on the Standard for Declaration of Concentration of Business Operators, issued by the State Council in 2008 and amended on September 19, 2018, are triggered. Moreover, the Anti-Monopoly Law requires that transactions which involve the national security, the examination on the national security shall also be conducted according to the relevant provisions of the State Council. In addition, the PRC Measures for the Security Review of Foreign Investment which became effective in January 2021 require acquisitions by foreign investors of PRC companies engaged in military-related or certain other industries that are crucial to national security be subject to security review before consummation of any such acquisition.
5
On July 6, 2021, the relevant PRC governmental authorities made public the Opinions on Strictly Cracking Down Illegal Securities Activities in Accordance with the Law. These opinions emphasized the need to strengthen the administration over illegal securities activities and the supervision on overseas listings by China-based companies and proposed to take effective measures, such as promoting the construction of relevant regulatory systems to deal with the risks and incidents faced by China-based overseas-listed companies. As these opinions are recently issued, official guidance and related implementation rules have not been issued yet and the interpretation of these opinions remains unclear at this stage. Given the current PRC regulatory environment, it is uncertain when and whether ReTo, REIT Holdings or any of our PRC subsidiaries will be required to obtain permission from the PRC government to list on U.S. exchanges in the future, and even when such permission is obtained, whether it will be denied or rescinded. See “Item 3. Key Information—D. Risk Factors—Risks Relating to Doing Business in China—The approval and/or other requirements of the CSRC or other PRC governmental authorities may be required in connection with an offering under PRC rules, regulations or policies, and, if required, we cannot predict whether or how soon we will be able to obtain such approval.” As of the date of this annual report, we have not received any inquiry, notice, warning, or sanctions regarding offshore offering from the CSRC or any other PRC governmental authorities.
On July 10, 2021, the CAC published the Measures for Cybersecurity Review (Revised Draft for Comments), or the Measures, for public comments, which propose to authorize the relevant government authorities to conduct cybersecurity review on a range of activities that affect or may affect national security, including listings in foreign countries by companies that possess the personal data of more than one million users. On December 28, 2021, the Measures for Cybersecurity Review (2021 Version) was promulgated and became effective on February 15, 2022, which iterates that any “online platform operators” controlling personal information of more than one million users which seeks to list in a foreign stock exchange should also be subject to cybersecurity review. The Measures for Cybersecurity Review (2021 Version), further elaborates the factors to be considered when assessing the national security risks of the relevant activities, including, among others, (i) the risk of core data, important data or a large amount of personal information being stolen, leaked, destroyed, and illegally used or exited the country; and (ii) the risk of critical information infrastructure, core data, important data or a large amount of personal information being affected, controlled, or maliciously used by foreign governments after listing abroad. We have relied on the opinion of our PRC counsel, Yuan Tai Law Offices, that as a result of: (i) we do not hold personal information on more than one million users in our business operations; and (ii) data processed in our business does not have a bearing on national security and thus may not be classified as core or important data by the authorities, we are not required to apply for a cybersecurity review under the Measures for Cybersecurity Review (2021 Version).
As advised by our PRC legal counsel, Yuan Tai Law Offices, the PRC governmental authorities may have wide discretion in the interpretation and enforcement of these laws, including the interpretation of the scope of “critical information infrastructure operators”. In anticipation of the strengthened implementation of cybersecurity laws and regulations and the continued expansion of our business, we may face challenges in addressing its requirements and make necessary changes to our internal policies and practices in data processing. As of the date of this annual report, we have not been involved in any investigations on cybersecurity review made by the CAC on such basis, and we have not received any inquiry, notice, warning, or sanctions in such respect.
On August 20, 2021, the SCNPC promulgated the Personal Information Protection Law, which integrates the scattered rules with respect to personal information rights and privacy protection and took effect on November 1, 2021. Personal information refers to information related to identified or identifiable natural persons which is recorded by electronic or other means and excluding anonymized information. The Personal Information Protection Law provides that a personal information processor could process personal information only under prescribed circumstances such as with the consent of the individual concerned and where it is necessary for the conclusion or performance of a contract to which such individual is a party to the contract. If a personal information processor shall provide personal information to overseas parties, various conditions shall be met, which includes security evaluation by the national network department and personal information protection certification by professional institutions. The Personal Information Protection Law raises the protection requirements for processing personal information, and many specific requirements of the Personal Information Protection Law remain to be clarified by the CAC, other regulatory authorities, and courts in practice. We may be required to make further adjustments to our business practices to comply with the personal information protection laws and regulations.
6
None of our PRC subsidiaries currently operates in an industry that prohibits or limits foreign investment. As a result, as advised by our PRC counsel, Yuan Tai Law Offices, other than those requisite for a domestic company in mainland China to engage in the businesses similar to those of our PRC subsidiaries, none of our PRC subsidiaries is required to obtain any permission from Chinese authorities, including the CSRC, the CAC, or any other governmental agency that is required to approve its current operations. However, if our PRC subsidiaries do not receive or maintain the approvals, or we inadvertently conclude that such approvals are not required, or applicable laws, regulations, or interpretations change such that our PRC subsidiaries are required to obtain approval in the future, we may be subject to investigations by competent regulators, fines or penalties, ordered to suspend our PRC subsidiaries’ relevant operations and rectify any non-compliance, prohibited from engaging in relevant business or conducting any offering, and these risks could result in a material adverse change in our PRC subsidiaries’ operations, significantly limit or completely hinder our ability to offer or continue to offer securities to investors, or cause such securities to significantly decline in value or become worthless. As of the date of this annual report, we and our PRC subsidiaries have received from PRC authorities all requisite licenses, permissions, or approvals needed to engage in the businesses currently conducted in China, and no permission or approval has been denied.
CSRC released the Tentative Measures for Administration of the Overseas Issuance and Listing of Securities by Domestic Enterprises (the “Tentative Measures”) on February 17, 2023, which became effective on March 31, 2023. The Tentative Measures lay out the filing regulation arrangement for both direct and indirect overseas listing by PRC domestic companies, and clarify the determination criteria for indirect overseas listing in overseas markets. Any future securities offerings and listings outside of mainland China by our Company, including but not limited to, follow-on offerings, secondary listings and going private transactions, will be subject to the filing requirements with the CSRC under the Tentative Measures, and we cannot assure you that we will be able to comply with such filing requirements in a timely manner, or at all. As of the date of this annual report, we have not received any formal inquiry, notice, warning, sanction, or objection from the CSRC or any other PRC governmental authorities with respect to our listing on Nasdaq. As the Tentative Measures were newly published and there is uncertainty with respect to the filing requirements and their implementation, if we are required to submit to the CSRC and complete the filing procedure, we cannot be sure that we will be able to complete such filings in a timely manner, or at all. Any failure or perceived failure of us to fully comply with such new regulatory requirements could significantly limit or completely hinder our ability to offer or continue to offer securities to investors, cause significant disruption to our business operations, and severely damage our reputation, which could materially and adversely affect our financial condition and results of operations and could cause the value of our securities to significantly decline or be worthless.
Except as disclosed above, in connection with our issuance of securities to foreign investors, under current PRC laws, regulations and regulatory rules, as of the date of this annual report, we and our PRC subsidiaries, (i) are not required to obtain permissions from the PRC authorities, including the CSRC or the CAC, and (ii) have not received or were denied such permissions by any PRC authority. We are subject to the risks of uncertainty of any future actions of the PRC government in this regard including the risk that we inadvertently conclude that the permission or approvals discussed here are not required, that applicable laws, regulations or interpretations change such that we and our PRC subsidiaries are required to obtain approvals in the future.
| A. | [Reserved] |
| B. | Capitalization and indebtedness. |
Not applicable.
7
| C. | Reasons for the offer and use of proceeds. |
Not applicable.
| D. | Risk factors. |
Summary of Risk Factors
Below please find a summary of the principal risks we face, organized under relevant headings.
Risks Related to Doing Business in China
We face risks and uncertainties related to doing business in China in general, including, but not limited to, the following:
| ● | Changes in China’s economic, political or social conditions or government policies or in relations between China and the United States; | |
|
●
● |
The impact on our operations and value of our Common Shares by PRC government’s significant oversight, control, intervention and/or influence over our business operation;
The complex and evolving laws and regulations regarding privacy and data protection, including China’s new Data Security Law, Cybersecurity Review Measures, Personal Information Protection Law, that our business is subject to; |
| ● | Uncertainties regarding the interpretation and enforcement of PRC laws, rules and regulations; | |
| ● | The risks of delisting or the threat of being delisted under the HFCAA if the PCAOB is unable to inspect our auditor; | |
| ● | The approval of the CSRC, CAC or other Chinese regulatory agencies which may be required in connection with our offshore offerings under Chinese law and, if required, our inability to obtain such approval or complete such filing; | |
|
●
|
The potential treatment as a resident enterprise for PRC tax purposes under the EIT Law and the risk of being subject to PRC income tax on our global income; | |
| ● |
Foreign exchange controls in China, which could limit our use of funds that would be raised in future offerings, which could have a material adverse effect on our business;
| |
| ● | The complex procedures under the PRC laws and regulation in connection with certain acquisitions of China-based companies by foreign investors; |
| ● | PRC regulation of loans to, and direct investment in, PRC entities by offshore holding companies and governmental control of currency conversion, which may restrict or prevent ReTo from making additional capital contributions or loans to its PRC subsidiaries; | |
| ● | Any limitation on the ability of our PRC subsidiaries to make payments to us; | |
| ● | Fluctuations in exchange rates; | |
| ● | The adverse impact on our business by the war in Ukraine; | |
| ● | The potential supply chain disruptions; and | |
| ● | Any severe or prolonged downturn in the global or Chinese economy. |
8
Risks Related to Our Business and Industry
We are subject to risks and uncertainties related to our business and industry, including, but not limited to, the following:
| ● | The potential slowdown of the industries in which our customers operate; |
| ● | Any decline in the availability or increase in the cost of raw materials; |
| ● | Any disruption in the supply chain of raw materials and our products; |
| ● | Wage increases in China; |
| ● | Our reliance on a limited number of vendors and the potential loss of any significant vendor; |
| ● | Certain risks in collecting our accounts receivable; |
| ● | Failure to protect our intellectual property rights; |
| ● | The substantial doubt about our ability to continue as a going concern in the report of our independent registered public accounting firm on our financial statements for the years ended December 31, 2022, 2021 and 2020; |
| ● | Failure to maintain a reserve for warranty or defective products and installation claims; |
| ● | Product defects and unanticipated use or inadequate disclosure with respect to our products; |
| ● | Inability to deliver our backlog on time; |
| ● | Various hazards that may cause personal injury or property damage and increase our operating costs, which may exceed the coverage of our insurance; |
| ● | Any material costs and losses as a result of claims our products do not meet regulatory requirements or contractual specifications; |
| ● | Substantial liabilities to comply with environmental laws and regulations; |
| ● | Inability to implement and maintain effective internal control over financial reporting; |
| ● | The integration of newly acquired businesses; |
| ● | Our continued investing in technology, resources, and new business capabilities; |
| ● | Any failure to offer high quality services and support; |
| ● | The competitiveness of the software and information technology service market in which we participate; |
| ● | Reliance of Hainan Yile IoT on a limited number of customers; |
| ● | Security incidents and attacks on our products or solutions; |
| ● | Limited business insurance coverage; | |
| ● | The benefits we have received from certain government subsidies and incentives; |
| ● | Changes in practices of insurance companies in the markets; |
| ● | Defects or errors in our products or solutions; |
| ● | Our reliance on the stable performance of servers, and any disruption to our servers due to internal and external factors; and |
| ● |
Our use of open source or third-party software. |
9
Risks Related to Our Common Shares
We face risks and uncertainties related to our Common Shares, including, but not limited to, the following:
| ● | The volatility of trading prices of our Common Shares; |
| ● | Any negative reports by securities or industry analysts publish about our business; | |
| ● | Failure to meet the continued listing requirements of Nasdaq; and |
| ● | Substantial future sales or perceived sales of our Common Shares in the public market. |
Risks Related to Doing Business in China
Changes in the political and economic policies of the PRC government or in relations between China and the United States may materially and adversely affect our business, financial condition and results of operations and may result in our inability to sustain our growth and expansion strategies.
Substantially all of our operations are conducted in mainland China and substantially all of our revenues is sourced from mainland China. Accordingly, our financial condition and results of operations are affected to a significant extent by economic, political and legal developments in the PRC or changes in government relations between China and the United States or other governments. There is significant uncertainty about the future relationship between the United States and China with respect to trade policies, treaties, government regulations and tariffs.
The PRC economy differs from the economies of most developed countries in many respects, including the extent of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. Although the PRC government has implemented measures emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets, and the establishment of improved corporate governance in business enterprises, a substantial portion of productive assets in China is still owned by the government. In addition, the PRC government continues to play a significant role in regulating industry development by imposing industrial policies. The PRC government also exercises significant control over China’s economic growth by allocating resources, controlling payment of foreign currency-denominated obligations, setting monetary policy, regulating financial services and institutions and providing preferential treatment to particular industries or companies.
While the PRC economy has experienced significant growth in the past four decades, growth has been uneven, both geographically and among various sectors of the economy. The PRC government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures may benefit the overall PRC economy, but may also have a negative effect on us. Our financial condition and results of operation could be materially and adversely affected by government control over capital investments or changes in tax regulations that are applicable to us. In addition, the PRC government has implemented in the past certain measures, including interest rate increases, to control the pace of economic growth. These measures may cause decreased economic activity.
In July 2021, the Chinese government provided new guidance on China-based companies raising capital outside of China. In light of such developments, the SEC has imposed enhanced disclosure requirements on China-based companies seeking to register securities with the SEC. As substantially all of our operations are based in China, any future Chinese, U.S. or other rules and regulations that place restrictions on capital raising or other activities by China based companies could adversely affect our business and results of operations. If the business environment in China deteriorates from the perspective of domestic or international investment, or if relations between China and the United States or other governments deteriorate, our operations in China as well as the market price of our Common Shares may be adversely affected.
10
Our business is subject to complex and evolving laws and regulations regarding privacy and data protection. Compliance with China’s new Data Security Law, Cybersecurity Review Measures, Personal Information Protection Law, as well as additional laws, regulations and guidelines that the Chinese government promulgates in the future may entail significant expenses and could materially affect our business.
Regulatory authorities in China have implemented and are considering further legislative and regulatory proposals concerning data protection. China’s new Data Security Law went into effect on September 1, 2021. The Data Security Law provides that the data processing activities must be conducted based on “data classification and hierarchical protection system” for the purpose of data protection and prohibits entities in China from transferring data stored in China to foreign law enforcement agencies or judicial authorities without prior approval by the Chinese government. The Data Security Law sets forth the legal liabilities of entities and individuals found to be in violation of their data protection obligations, including rectification order, warning, fines of up to RMB5 million, suspension of relevant business, and revocation of business permits or licenses.
In addition, the PRC Cybersecurity Law provides that personal information and important data collected and generated by operators of critical information infrastructure in the course of their operations in the PRC should be stored in the PRC, and the law imposes heightened regulation and additional security obligations on operators of critical information infrastructure. According to the Cybersecurity Review Measures promulgated by the CAC and certain other PRC regulatory authorities in April 2020, which became effective in June 2020, operators of critical information infrastructure must pass a cybersecurity review when purchasing network products and services which do or may affect national security. Any failure or delay in the completion of the cybersecurity review procedures may prevent the critical information infrastructure operator from using or providing certain network products and services, and may result in fines of up to ten times the purchase price of such network products and services. The PRC government recently launched cybersecurity reviews against a number of mobile apps operated by several U.S.-listed Chinese companies and prohibiting these apps from registering new users during the review periods. We do not believe that we constitute a critical information infrastructure operator under the Cybersecurity Review Measures.
On July 10, 2021, the CAC issued the Cybersecurity Review Measures (revised draft for public comments), which proposed to authorize the relevant government authorities to conduct cybersecurity review on a range of activities that affect or may affect national security. The PRC National Security Law covers various types of national security, including technology security and information security. The Cybersecurity Review Measures (2021 Version) took effect on February 15, 2022. The Cybersecurity Review Measures (2021 Version) expand the cybersecurity review to data processing operators in possession of personal information of over 1 million users if the operators intend to list their securities in a foreign country. Under the Cybersecurity Review Measures (2021 Version), the scope of entities required to undergo cybersecurity review to assess national security risks that arise from data processing activities would be expanded to include all critical information infrastructure operators who purchase network products and services and all data processors carrying out data processing activities that affect or may affect national security. In addition, such reviews would focus on the potential risk of core data, important data, or a large amount of personal information being stolen, leaked, destroyed, illegally used or exported out of China, or critical information infrastructure being affected, controlled or maliciously used by foreign governments after such a listing. An operator that violates these measures shall be dealt with in accordance with the provisions of the PRC Cybersecurity Law and the PRC Data Security Law.
According to the Cybersecurity Review Measures (2021 Version), cybersecurity review will be required when (i) operators of critical information infrastructure purchasing network products and services or online platform operators carry out data processing activities which do or may affect national security; and (ii) any online platform operator controlling personal information of more than one million users which seeks to list in a foreign stock exchange. The factors to be considered when assessing the national security risks of the relevant activities, including, among others, (i) the risk of core data, important data or a large amount of personal information being stolen, leaked, destroyed, and illegally used or exited the country; and (ii) the risk of critical information infrastructure, core data, important data or a large amount of personal information being affected, controlled, or maliciously used by foreign governments after listing abroad. The CAC has said that under the new rules companies holding data of more than 1,000,000 users must now apply for cybersecurity approval when seeking listings in other nations because of the risk that such data and personal information could be “affected, controlled, and maliciously exploited by foreign governments.” The cybersecurity review will also look into the potential national security risks from overseas initial public offerings. As advised our PRC legal counsel , because (i) none of our PRC subsidiaries collecting personal information or processing data in actual operation, and (ii) none of our PRC subsidiaries is an “online platform operator holding more than one million users’ personal information”, we believe the cybersecurity review requirement is not applicable us. However, there remains uncertainty as to the interpretation and implementation of the revised Cybersecurity Review Measures and we cannot assure you that the CAC will reach the same conclusion as our PRC counsel. As advised by our PRC legal counsel, the PRC governmental authorities may have wide discretion in the interpretation and enforcement of these laws, including the interpretation of the scope of “critical information infrastructure operators.” If the Company or any of its PRC subsidiaries is deemed as a critical information infrastructure operator under the PRC cybersecurity laws and regulations, we and our PRC subsidiaries must fulfill certain obligations as required under the PRC cybersecurity laws and regulations, including, among others, storing personal information and important data collected and produced within the PRC territory during our operations in China, which we and our PRC subsidiaries have fulfilled in our business, and we and our PRC subsidiaries may be subject to review when purchasing internet products and services. We and our PRC subsidiaries may be subject to review when conducting data processing activities, and may face challenges in addressing its requirements and make necessary changes to our internal policies and practices in data processing. As of the date of this annual report, we and our PRC subsidiaries have not been involved in any investigations on cybersecurity review made by the CAC on such basis, and we and our PRC subsidiaries have not received any inquiry, notice, warning, or sanctions in such respect.
11
On November 14, 2021, the CAC released the Regulations on Network Data Security (draft for public comments) and accepted public comments until December 13, 2021. The draft Regulations on Network Data Security provide more detailed guidance on how to implement the general legal requirements under legislations such as the Cybersecurity Law, Data Security Law and the Personal Information Protection Law. The draft Regulations on Network Data Security follow the principle that the state will regulate based on a data classification and multi-level protection scheme. We believe that we or any of our PRC subsidiaries do not constitute an online platform operator under the draft Regulations on Network Data Security as proposed, which is defined as a platform that provides information publishing, social network, online transaction, online payment and online audio/video services. None of our PRC subsidiaries is an online platform operator themselves, nor is any of them required to obtain an ICP license for their current operations.
On August 20, 2021, the SCNPC promulgated the Personal Information Protection Law which became effective on November 1, 2021. The Personal Information Protection Law provides a comprehensive set of data privacy and protection requirements that apply to the processing of personal information and expands data protection compliance obligations to cover the processing of personal information of persons by organizations and individuals in China, and the processing of personal information of persons in China outside of China if such processing is for purposes of providing products and services to, or analyzing and evaluating the behavior of, persons in China. The Personal Information Protection Law also provides that critical information infrastructure operators and personal information processing entities who process personal information meeting a volume threshold to be set by Chinese cyberspace regulators are also required to store in China personal information generated or collected in China, and to pass a security assessment administered by Chinese cyberspace regulators for any export of such personal information. Lastly, the Personal Information Protection Law contains proposals for significant fines for serious violations of up to RMB 50 million or 5% of annual revenues from the prior year and may also be ordered to suspend any related activity by competent authorities. We have access to certain information of our customers in providing services and may be required to further adjust our business practice to comply with new regulatory requirements.
Interpretation, application and enforcement of these laws, rules and regulations evolve from time to time and their scope may continually change, through new legislation, amendments to existing legislation or changes in enforcement. Compliance with the PRC Cybersecurity Law and the PRC Data Security Law could significantly increase the cost to us of providing our service offerings, require significant changes to our operations or even prevent us from providing certain service offerings in jurisdictions in which we currently operate or in which we may operate in the future. Despite our efforts to comply with applicable laws, regulations and other obligations relating to privacy, data protection and information security, it is possible that our practices or service offerings could fail to meet all of the requirements imposed on us by the PRC Cybersecurity Law, the PRC Data Security Law and/or related implementing regulations. Any failure on our part to comply with such law or regulations or any other obligations relating to privacy, data protection or information security, or any compromise of security that results in unauthorized access, use or release of personally identifiable information or other data, or the perception or allegation that any of the foregoing types of failure or compromise has occurred, could damage our reputation, discourage new and existing counterparties from contracting with us or result in investigations, fines, suspension or other penalties by Chinese government authorities and private claims or litigation, any of which could materially adversely affect our business, financial condition and results of operations. Even if our practices are not subject to legal challenge, the perception of privacy concerns, whether or not valid, may harm our reputation and brand and adversely affect our business, financial condition and results of operations. Moreover, the legal uncertainty created by the Data Security Law and the recent Chinese government actions could materially adversely affect our ability, on favorable terms, to raise capital, including engaging in follow-on offerings of our securities in the U.S. market.
12
There are uncertainties regarding the interpretation and enforcement of PRC laws, rules and regulations. The rules and regulations in China can change quickly with little advance notice and uncertainties in the interpretation and enforcement of PRC laws, rules and regulations could limit the legal protections available to you and us.
Substantially all of our operations are conducted in mainland China, and are governed by PRC laws, rules and regulations. Our PRC subsidiaries are subject to laws, rules and regulations applicable to foreign investment in China. The PRC legal system is a civil law system based on written statutes. Unlike the common law system, prior court decisions may be cited for reference but have limited precedential value. In 1979, the PRC government began to promulgate a comprehensive system of laws, rules and regulations governing economic matters in general. The overall effect of legislation over the past three decades has significantly enhanced the protections afforded to various forms of foreign investment in China. However, China has not developed a fully integrated legal system, and recently enacted laws, rules and regulations may not sufficiently cover all aspects of economic activities in China or may be subject to significant degrees of interpretation by PRC regulatory agencies. In particular, because these laws, rules and regulations, especially those relating to the internet, are relatively new, and because of the limited number of published decisions and the nonbinding nature of such decisions, and because the laws, rules and regulations often give the relevant regulator significant discretion in how to enforce them, the interpretation and enforcement of these laws, rules and regulations involve uncertainties and can be inconsistent and unpredictable. In addition, the PRC legal system is based in part on government policies and internal rules, some of which are not published on a timely basis or at all, and 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. Any administrative and court proceedings in China may be protracted, resulting in substantial costs and diversion of resources and management attention. The rules and regulations in China can change quickly with little advance notice and uncertainties in the interpretation and enforcement of PRC laws, rules and regulations could limit the legal protections available to you and us.
The PRC government has recently announced its plans to enhance its regulatory oversight of Chinese companies listing overseas. The Opinions on Strictly Cracking Down on Illegal Securities Activities issued on July 6, 2021 called for:
| ● | tightening oversight of data security, cross-border data flow and administration of classified information, as well as amendments to relevant regulation to specify responsibilities of overseas listed Chinese companies with respect to data security and information security; |
| ● | enhanced oversight of overseas listed companies as well as overseas equity fundraising and listing by Chinese companies; and |
| ● | extraterritorial application of China’s securities laws. |
As the Opinions on Strictly Cracking Down on Illegal Securities Activities were recently issued, there are great uncertainties as to how soon legislative or administrative regulation making bodies will respond and what existing or new laws or regulations or detailed implementations and interpretations will be modified or promulgated, if any, and the potential impact such modified or new laws and regulations will have on companies like us, but among other things, our ability and the ability of our subsidiaries to obtain external financing through the issuance of equity securities overseas could be negatively affected.
CSRC released the Tentative Measures and five supporting guidelines on February 17, 2023, which became effective on March 31, 2023. The Tentative Measures lay out the filing regulation arrangement for both direct and indirect overseas listing by PRC domestic companies, and clarify the determination criteria for indirect overseas listing in overseas markets. Any future securities offerings and listings outside of mainland China by our Company, including but not limited to follow-on offerings, secondary listings and going private transactions, will be subject to the filing requirements with the CSRC under the Tentative Measures, and we cannot assure you that we will be able to comply with such filing requirements in a timely manner, or at all.
13
The PRC government’s significant oversight and discretion over the conduct of our business and may intervene or influence our operations at any time which could result in a material adverse change in our operation and/or the value of our Common Shares.
We conduct our business in mainland China primarily through our PRC subsidiaries. Our operations in mainland China are governed by PRC laws and regulations. The PRC government’s significant oversight and discretion over the conduct of our business and may intervene or influence our operations at any time which could result in a material adverse change in our operation and/or the value of our Common Shares. Also, the PRC government has recently indicated an intent to exert more oversight over offerings that are conducted overseas and/or foreign investment in China-based issuers. Any such action could significantly limit or completely hinder our ability to offer or continue to offer securities to investors. In addition, implementation of industry-wide regulations directly targeting our operations could cause our securities to significantly decline in value or become worthless. Therefore, investors of ReTo face potential uncertainty from actions taken by the PRC government affecting our business.
The CSRC has published the Tentative Measures for filing regulation arrangement for both direct and indirect overseas listing, including but not limited to initial public offering, follow-on offerings, and secondary listings, which could significantly limit or completely hinder our ability to offer or continue to offer our Common Shares to investors and could cause the value of our Common Shares to significantly decline or become worthless.
On February 17, 2023, the CSRC published the Tentative Measures, which became effective on March 31, 2023. The Tentative Measures lay out the filing regulation arrangement for both direct and indirect overseas listing, and clarify the determination criteria for indirect overseas listing in overseas markets. Among other things, if a domestic enterprise intends to indirectly offer and list securities in an overseas market, the record-filing obligation is with a major operating entity incorporated in mainland China appointed by the issuer and such filing obligation shall be completed within three business days after the overseas listing application is submitted. The required filing materials for an initial public offering and listing should include at least the following: report, commitment from issuer and securities company, the resolutions, shareholding structure chart and control structure chart, the information of issuer and intermediary project team members, Chinese legal opinion and commitment of Chinese counsel, the Prospectus, approval and other documents issued by competent regulatory authorities of relevant industries (if applicable); and security assessment opinion issued by relevant regulatory authorities (if applicable).
In addition, an overseas offering and listing is prohibited under any of the following circumstances: (1) if the intended securities offering and listing is specifically prohibited by national laws and regulations and relevant provisions; (2) if the intended securities offering and listing may constitute a threat to or endangers national security as reviewed and determined by competent authorities under the State Council in accordance with law; (3) if, in the past three years, the domestic enterprise or its controlling shareholders or actual controllers have committed corruption, bribery, embezzlement, misappropriation of property, or other criminal offenses disruptive to the order of the socialist market economy, or are currently under judicial investigation for suspicion of criminal offenses, or are under investigation for suspicion of major violations; (4) if, the domestic enterprise is being investigated according to law due to suspected crimes or major violations of laws and regulations, and there is no clear conclusion; (5) if there are material ownership disputes over the equity of the controlling shareholder or shareholders controlled by controlling shareholders and actual controllers. The Tentative Measures defines the legal liabilities of breaches such as failure in fulfilling filing obligations or fraudulent filing conducts, imposing a fine between RMB 1 million and RMB 10 million, and in cases of severe violations, a parallel order to suspend relevant business or halt operation for rectification, revoke relevant business permits or operational license.
Any future securities offerings and listings outside of mainland China by our Company, including but not limited to follow-on offerings, secondary listings, and going private transactions, will be subject to the filing requirements with the CSRC under the Tentative Measures, and we cannot assure you that we will be able to comply with such filing requirements in a timely manner, or at all. Any failure of us to fully comply with new regulatory requirements may significantly limit or completely hinder our ability to offer or continue to offer our Common Shares, cause significant disruption to our business operations, and severely damage our reputation, which would materially and adversely affect our financial condition and results of operations and cause our Common Shares to significantly decline in value or become worthless.
14
Restrictions on currency exchange or outbound capital flows may limit our ability to utilize our PRC revenue effectively.
Substantially all of our revenue is denominated in Renminbi. The Renminbi is currently convertible under the “current account,” which includes dividends, trade and service-related foreign exchange transactions, but requires approval from or registration with appropriate government authorities or designated banks under the “capital account,” which includes foreign direct investment and loans, such as loans we may secure from our onshore subsidiaries. Currently, our PRC subsidiaries, a foreign invested enterprise, may purchase foreign currency for settlement of “current account transactions,” including payment of dividends to us, without the approval of the SAFE by complying with certain procedural requirements. However, the relevant PRC governmental authorities may limit or eliminate our ability to purchase foreign currencies in the future for current account transactions.
Since 2016, PRC governmental authorities have imposed more stringent restrictions on outbound capital flows, including heightened scrutiny over “irrational” overseas investments for certain industries, as well as over four kinds of “abnormal” offshore investments, which are:
| ● | investments through enterprises established for only a few months without substantive operation; |
| ● | investments with amounts far exceeding the registered capital of onshore parent and not supported by its business performance shown on financial statements; |
| ● | investments in targets that are not related to onshore parent’s main business; and |
| ● | investments with abnormal sources of Renminbi funding suspected to be involved in illegal transfer of assets or illegal operation of underground banking. |
On January 26, 2017, SAFE promulgated the Circular on Further Improving Reform of Foreign Exchange Administration and Optimizing Genuineness and Compliance Verification, which tightened the authenticity and compliance verification of cross-border transactions and cross-border capital flow. In addition, the Outbound Investment Sensitive Industry Catalogue (2018) lists certain sensitive industries that are subject to NDRC pre-approval requirements prior to remitting investment funds offshore, which subjects us to increased approval requirements and restrictions with respect to our overseas investment activity. Since a significant amount of our PRC revenue is denominated in Renminbi, any existing and future restrictions on currency exchange or outbound capital flows may limit our ability to utilize revenue generated in Renminbi to fund our business activities outside of mainland China, make investments, service any debt we may incur outside of mainland China or pay dividends in foreign currencies to our shareholders, including holders of our Common Shares.
PRC regulation on loans to, and direct investment in, PRC entities by offshore holding companies and governmental control in currency conversion may delay or prevent us from using the proceeds of our offerings to make loans to or make additional capital contributions to our PRC subsidiaries, which could materially and adversely affect our liquidity and our ability to fund and expand our business.
ReTo is a company incorporated in the BVI structured as a holding company conducting its operations in mainland China through its PRC subsidiaries. As permitted under PRC laws and regulations, in utilizing the proceeds of its offerings, ReTo may make loans to its PRC subsidiaries subject to the approval from governmental authorities and limitation of amount, or ReTo may make additional capital contributions to its PRC subsidiaries. Furthermore, loans by ReTo to its PRC subsidiaries to finance their activities cannot exceed the difference between their respective total project investment amount and registered capital or 2.5 times of their net worth and capital contributions to its PRC subsidiaries are subject to the requirement of making necessary filings in the Foreign Investment Comprehensive Management Information System and registration with other governmental authorities in China.
15
The SAFE promulgated the Notice of the State Administration of Foreign Exchange on Reforming the Administration of Foreign Exchange Settlement of Capital of Foreign-invested Enterprises, or SAFE Circular 19, effective on June 1, 2015, in replacement of the Circular on the Relevant Operating Issues Concerning the Improvement of the Administration of the Payment and Settlement of Foreign Currency Capital of Foreign-Invested Enterprises, the Notice from the State Administration of Foreign Exchange on Relevant Issues Concerning Strengthening the Administration of Foreign Exchange Businesses, and the Circular on Further Clarification and Regulation of the Issues Concerning the Administration of Certain Capital Account Foreign Exchange Businesses. According to SAFE Circular 19, the flow and use of the RMB capital converted from foreign currency-denominated registered capital of a foreign-invested company is regulated such that RMB capital may not be used for the issuance of RMB entrusted loans, the repayment of inter-enterprise loans or the repayment of bank loans that have been transferred to a third party. Although SAFE Circular 19 allows RMB capital converted from foreign currency-denominated registered capital of a foreign-invested enterprise to be used for equity investments within mainland China, it also reiterates the principle that RMB converted from the foreign currency-denominated capital of a foreign-invested company may not be directly or indirectly used for purposes beyond its business scope. Thus, it is unclear whether the SAFE will permit such capital to be used for equity investments in mainland China in actual practice. The SAFE promulgated the Notice of the State Administration of Foreign Exchange on Reforming and Standardizing the Foreign Exchange Settlement Management Policy of Capital Account, or SAFE Circular 16, effective on June 9, 2016, which reiterates some of the rules set forth in SAFE Circular 19, but changes the prohibition against using RMB capital converted from foreign currency-denominated registered capital of a foreign-invested company to issue RMB entrusted loans to a prohibition against using such capital to grant loans to non-associated enterprises. Violations of SAFE Circular 19 and SAFE Circular 16 could result in administrative penalties. SAFE Circular 19 and SAFE Circular 16 may significantly limit our ability to transfer any foreign currency we hold, including the net proceeds from our follow-on offering, to our PRC subsidiaries, which may adversely affect our liquidity and our ability to fund and expand our business in mainland China.
In light of the various requirements imposed by PRC regulations on loans to, and direct investment in, PRC entities by offshore holding companies, we cannot assure you that we will be able to complete the necessary government registrations or obtain the necessary government approvals on a timely basis, if at all, with respect to future loans by us to our PRC subsidiaries or with respect to future capital contributions by us to our PRC subsidiaries. If we fail to complete such registrations or obtain such approvals, our ability to use the proceeds from our offerings and to capitalize or otherwise fund our PRC operations may be negatively affected, which could materially and adversely affect our liquidity and our ability to fund and expand our business.
The PRC government could prevent the cash maintained in our bank accounts in mainland China from leaving mainland China, restrict deployment of the cash into the business of its subsidiaries and restrict the ability to pay dividends to U.S. investors, which could materially adversely affect our operations.
The PRC government controls the conversion of Renminbi into foreign currencies and the remittance of currencies out of mainland China. We receive substantially all of our revenues in Renminbi, and most of our cash is in Renminbi. Under our corporate structure, ReTo, a BVI holding company, primarily relies on dividend payments from our PRC subsidiaries to fund any cash and financing requirements it may have. Under the existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and trade- and-service-related foreign exchange transactions, can be made in foreign currencies without prior approval from the SAFE by complying with certain procedural requirements. As such, under the existing exchange restrictions, cash generated from the operations of our PRC subsidiaries is able to be paid as dividends in foreign currencies to ReTo without prior approval from the SAFE by complying with certain procedural requirements. However, approval from or registration with appropriate government authorities is required where Renminbi is to be converted into foreign currency and remitted out of mainland China to pay capital expenses such as the repayment of loans denominated in foreign currencies. The PRC government may also at its discretion in the future restrict access to foreign currencies for current account transactions. There is no assurance that the PRC government will not intervene or impose restrictions on the ability of us, our subsidiaries to transfer cash. If the foreign exchange control system prevents us from obtaining sufficient foreign currencies to satisfy our foreign currency demands, we may not be able to pay dividends in foreign currencies from the PRC subsidiaries to the offshore subsidiaries, across borders, and to our shareholders, including the U.S. investors. These foreign exchange restrictions and limitations could prevent the cash maintained from leaving mainland China, and restrict our ability to pay dividends to ReTo and the U.S. investors.
16
There are limitations on our PRC subsidiaries’ ability to distribute earnings to their respective shareholders. On the one hand, under the current PRC laws and regulations, our PRC subsidiaries may pay dividends only out of their accumulated profits. In addition, our PRC subsidiaries are required to set aside at least 10% of their accumulated after-tax profits each year, if any, to fund certain statutory reserve funds, until the aggregate amount of such fund reaches 50% of their registered capital. Our PRC subsidiaries may at their discretion allocate a portion of their after-tax profits to staff welfare and bonus funds in accordance with relevant PRC rules and regulations. These reserve funds and staff welfare and bonus funds cannot be distributed as cash dividends. Moreover, if the PRC subsidiaries incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability to pay dividends or make other distributions to us.
In addition, any transfer of funds by ReTo to our PRC subsidiaries, either as a shareholder loan or as an increase in the registered capital, is subject to a series of procedural requirements imposed by SAFE or its local counterparts. This may hinder or delay our deployment of cash into our subsidiaries’ business, which could result in a material and adverse effect on our operations.
Our Common Shares may be delisted under the HFCAA if the PCAOB is unable to inspect our auditors. The delisting of our Common Shares, or the threat of their being delisted, may materially and adversely affect the value of your investment. Furthermore, on December 29, 2022, the Accelerating Holding Foreign Companies Accountable Act was enacted, which amends the HFCAA and requires the SEC to prohibit an issuer’s securities from trading on any U.S. stock exchanges if its auditor is not subject to PCAOB inspections for two consecutive years instead of three.
The HFCAA was enacted on December 18, 2020. The HFCAA states if the SEC determines that we have filed audit reports issued by a registered public accounting firm that has not been subject to inspection by the PCAOB for three consecutive years, the SEC shall prohibit our Common Shares from being traded on a national securities exchange or in the over the counter trading market in the U.S.
On March 24, 2021, the SEC adopted interim final rules relating to the implementation of certain disclosure and documentation requirements of the HFCAA. We will be required to comply with these rules if the SEC identifies us as having a “non-inspection” year under a process to be subsequently established by the SEC. The SEC is assessing how to implement other requirements of the HFCAA, including the listing and trading prohibition requirements described above. On September 22, 2021, the PCAOB adopted a final rule implementing the HFCAA, which provides a framework for the PCAOB to use when determining, as contemplated under the HFCAA, whether the PCAOB is unable to inspect or investigate completely registered public accounting firms located in a foreign jurisdiction because of a position taken by one or more authorities in that jurisdiction.
On December 2, 2021, the SEC adopted final amendments to its rules implementing the HFCAA. Such final rules establish procedures that the SEC will follow in (i) determining whether a registrant is a “Commission-Identified Issuer” (a registrant identified by the SEC as having filed an annual report with an audit report issued by a registered public accounting firm that is located in a foreign jurisdiction and that the PCAOB is unable to inspect or investigate completely because of a position taken by an authority in that jurisdiction) and (ii) prohibiting the trading of an issuer that is a Commission-Identified Issuer for three consecutive years under the HFCAA. The SEC began identifying Commission-Identified Issuers for the fiscal years beginning after December 18, 2020. A Commission-Identified Issuer is required to comply with the submission and disclosure requirements in the annual report for each year in which it was identified. If a registrant is identified as a Commission-Identified Issuer based on its annual report for the fiscal year ended, for example, September 30, 2021, the registrant will be required to comply with the submission or disclosure requirements in its annual report filing covering the fiscal year ended September 30, 2022.
Furthermore, on December 29, 2022, the Accelerating Holding Foreign Companies Accountable Act was enacted, which amends the HFCAA and requires the SEC to prohibit an issuer’s securities from trading on any U.S. stock exchanges if its auditor is not subject to PCAOB inspections for two consecutive years instead of three.
17
On December 16, 2021, the PCAOB issued its determination that the PCAOB is unable to inspect or investigate completely PCAOB-registered public accounting firms headquartered in mainland China and in Hong Kong, because of positions taken by PRC authorities in those jurisdictions, and the PCAOB included in the report of its determination a list of the accounting firms that are headquartered in mainland China or Hong Kong. This list does not include, YCM CPA Inc.
Our independent registered public accounting firm, as an auditor of companies that are traded publicly in the United States and a firm registered with the PCAOB, is subject to laws in the United States pursuant to which the PCAOB conducts regular inspections to assess its compliance with the applicable professional standards. Our auditor is currently registered under the PCAOB and subject to PCAOB inspections. However, the recent developments would add uncertainties to our offering and we cannot assure you whether Nasdaq or regulatory authorities would apply additional and more stringent criteria to us after considering the effectiveness of our auditor’s audit procedures and quality control procedures, adequacy of personnel and training, or sufficiency of resources, geographic reach or experience as it relates to the audit of our financial statements.
On August 26, 2022, the PCAOB signed the Protocol with the CSRC and MOF, taking the first step toward opening access for the PCAOB to inspect and investigate registered public accounting firms headquartered in mainland China and Hong Kong without any limitations on scope. However, uncertainties exist with respect to the implementation of this framework and there is no assurance that the PCAOB will be able to execute, in a timely manner, its future inspections and investigations in a manner that satisfies the Protocol.
The SEC may propose additional rules or guidance that could impact us if our auditor is not subject to PCAOB inspection. For example, on August 6, 2020, the President’s Working Group on Financial Markets, or the PWG, issued the Report on Protecting United States Investors from Significant Risks from Chinese Companies to the then President of the United States. This report recommended the SEC implement five recommendations to address companies from jurisdictions that do not provide the PCAOB with sufficient access to fulfil its statutory mandate. Some of the concepts of these recommendations were implemented with the enactment of the HFCAA. However, some of the recommendations were more stringent than the HFCAA. For example, if a company’s auditor was not subject to PCAOB inspection, the report recommended that the transition period before a company would be delisted would end on January 1, 2022.
On December 15, 2022, the PCAOB determined that the PCAOB was able to secure complete access to inspect and investigate registered public accounting firms headquartered in mainland China and Hong Kong and voted to vacate its previous determinations to the contrary. However, should PRC authorities obstruct or otherwise fail to facilitate the PCAOB’s access in the future, the PCAOB will consider the need to issue a new determination.
The SEC has announced that the SEC staff is preparing a consolidated proposal for the rules regarding the implementation of the HFCAA and to address the recommendations in the PWG report. It is unclear when the SEC will complete its rulemaking and when such rules will become effective and what, if any, of the PWG recommendations will be adopted. The implications of this possible regulation in addition to the requirements of the HFCAA are uncertain. Such uncertainty could cause the market price of our Common Shares to be materially and adversely affected, and our securities could be delisted or prohibited from being traded “over-the-counter” earlier than would be required by the HFCAA. If our securities are unable to be listed on another securities exchange by then, such a delisting would substantially impair your ability to sell or purchase our Common Shares when you wish to do so, and the risk and uncertainty associated with a potential delisting would have a negative impact on the price of our Common Shares.
We may be treated as a resident enterprise for PRC tax purposes under the EIT Law, and we may therefore be subject to PRC income tax on our global income.
China passed an Enterprise Income Tax Law (the “EIT Law”) and implementing rules, both of which became effective on January 1, 2008, EIT Law was subsequently amended by the SCNPC and became effective on February 24, 2017. Under the EIT Law, resident enterprises pay income tax at the rate of 25% for their worldwide income while non-resident enterprises pay 20% for their income generated from China and income generated overseas but are substantially related to the entities established in China by the non-resident enterprises. As far as the definition of resident enterprises, according to the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise.” The implementing rules of the EIT Law define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise.
18
On April 22, 2009, the State Administration of Taxation of China issued Circular on Issues Concerning the Identification of Chinese-Controlled Overseas Registered Enterprises as Resident Enterprises with the Actual Standards of Organizational Management, or Circular 82, further interpreting the application of the EIT Law and its implementation to offshore entities controlled by a Chinese enterprise or group. Pursuant to the Circular 82, an enterprise incorporated in an offshore jurisdiction and controlled by a Chinese enterprise or group will be classified as a “resident enterprise” with its “de facto management body” located within China if (i) the place where the senior management and core management departments that are in charge of its daily operations perform their duties is mainly located in China; (ii) its financial and human resources decisions are made by or are subject to approval by persons or bodies in China; (iii) its major assets, accounting books, company seals, and minutes and files of its board and shareholders’ meetings are located or kept in China; and (iv) at least half of the enterprise’s directors or senior management with voting rights frequently reside in China. A resident enterprise would have to pay a withholding tax at a rate of 10% when paying dividends to its non-mainland-China stockholders.
Given that ReTo does not have a mainland China individual or a mainland China enterprise or group, but a Hong Kong enterprise, as its primary controlling shareholder, we believe Circular 82 will not apply to us. However, Circular 82 did mention that the facts-oriented recognition is more important than format in the case of recognizing “de facto management”. Although we have never been determined by any competent tax authorities to be a “resident enterprise”, and we have not seen any corporations with similar structures to ours to be determined as a “resident enterprise”, whether or not we will be recognized as a “resident enterprise” is subject to the PRC tax authorities’ discretion and their interpretation of the term “de facto management body”.
As for our Hong Kong business, we do not believe that we meet some of the conditions outlined. As a holding company, the key assets and records of REIT Holdings, including the resolutions and meeting minutes of our board of directors and the resolutions and meeting minutes of our shareholders, are located and maintained outside mainland China. Accordingly, we believe that REIT Holdings should not be treated as a “resident enterprise” for PRC tax purposes if the criteria for “de facto management body” as set forth in Circular 82 were deemed applicable to us. However, as the tax residency status of an enterprise is subject to determination by the PRC tax authorities and uncertainties remain with respect to the interpretation of the term “de facto management body” as applicable to our offshore entities, we will continue to monitor our tax status.
If the PRC tax authorities determine that we are a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. In our case, this would mean that income such as non-mainland-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second, under the EIT Law and its implementing rules, dividends paid to us from our PRC subsidiaries would qualify as “tax-exempt income.” Finally, it is possible that future guidance issued with respect to the new “resident enterprise” classification could result in a situation in which a 10% withholding tax is imposed on dividends we pay to our non-PRC stockholders and with respect to gains derived by our non-PRC stockholders from transferring our shares.
Fluctuations in exchange rates could result in foreign currency exchange losses to us and may reduce the value of, and amount in U.S. Dollars of dividends payable on, our shares in foreign currency terms.
Changes in the value of the RMB against the U.S. dollar, Euro and other foreign currencies are affected by, among other things, changes in China’s political and economic conditions. Any significant revaluation of the RMB may have a material adverse effect on our revenues and financial condition, and the value of, and any dividends payable on our shares in U.S. dollar terms. Although we use the United States dollar for financial reporting purposes, all of the transactions effected by our PRC subsidiaries are denominated in China’s currency, the RMB. The value of the RMB fluctuates and is subject to changes in China’s political and economic conditions. We do not currently engage in hedging activities to protect against foreign currency risks. Even if we choose to engage in such hedging activities, we may not be able to do so effectively. Future movements in the exchange rate of the RMB could adversely affect our financial condition as we may suffer financial losses when transferring money raised outside of China into the country or paying vendors for services performed outside of China. For example, to the extent that we need to convert U.S. dollars into RMB for our operations, appreciation of the RMB against the U.S. dollar would have an adverse effect on RMB amount we would receive from the conversion. Conversely, if we decide to convert our RMB into U.S. dollars for the purpose of paying dividends on our Common Shares or for other business purposes, appreciation of the U.S. dollar against the RMB would have a negative effect on the U.S. dollar amount available to us. In addition, fluctuations of the RMB against other currencies may increase or decrease the cost of imports and exports, and thus affect the price-competitiveness of our products against products of foreign manufacturers or products relying on foreign inputs.
19
Since July 2005, the RMB is no longer pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future Chinese authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.
We reflect the impact of currency translation adjustments in our financial statements under the heading “Foreign currency translation gain (loss).” For the years ended December 31, 2022, 2021 and 2020, we had a negative adjustment of $1,183,819, a positive adjustment of $493,769 and a positive adjustment of $1,923,316, respectively, for foreign currency translations. 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. 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 China exchange control regulations that restrict our ability to convert RMB into foreign currencies.
Besides, Fluctuation of the Renminbi could materially affect our financial condition and results of operations. The value of the Renminbi 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 Renminbi to the U.S. dollar. Under the new policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in an appreciation of the Renminbi against the U.S. dollar. While the international reaction to the Renminbi revaluation has generally been positive, there remains international pressure on the Chinese government to adopt an even more flexible currency policy, which could result in a further and more rapid appreciation of the Renminbi against the U.S. dollar. Any material revaluation of Renminbi may materially and adversely affect our cash flows, revenues, earnings and financial position, and the value of, and any dividends payable on, our Common Shares in U.S. dollars. For example, an appreciation of Renminbi against the U.S. dollar would make any new Renminbi denominated investments or expenditures more costly to us, to the extent that we need to convert U.S. dollars into Renminbi for such purposes.
We may be subject to foreign exchange controls in China, which could limit our use of funds that would be raised in future offerings, which could have a material adverse effect on our business.
Beijing REIT, REIT Technology and REIT Ordos are subject to Chinese rules and regulations on currency conversion. In China, SAFE regulates the conversion of the RMB into foreign currencies. Currently, FIEs are required to apply to SAFE for “Registration of Establishment as FIEs”. Beijing REIT, REIT Technology and REIT Ordos are FIEs. With such registration, Beijing REIT, REIT Technology and REIT Ordos are allowed to open foreign currency accounts including the “current account” and the “capital account”. Currently, conversion within the scope of the “current account” and general “capital account” can be effected without requiring the approval of SAFE. However, conversion of currency in some restricted “capital account” (e.g. for capital items such as direct investments, loans, securities, etc.) still requires the approval of SAFE.
In particular, if Beijing REIT, REIT Technology or REIT Ordos borrow foreign currency through loans from ReTo or other foreign lenders, these loans must be registered with SAFE. If Beijing REIT, REIT Technology or REIT Ordos are financed by means of additional capital contributions, reporting to or filings with certain Chinese government authorities, including MOFCOM, or the local counterparts of SAFE and SAMR or its local counterparts, in respect of these capital contributions. These restrictions could limit our use of funds which would be raised in our future offerings, which could have an adverse effect on our business.
20
If we fail to comply with PRC regulations regarding the registration requirements for employee stock ownership plans or share option plans, the PRC plan participants or we could be subject to fines and other legal or administrative sanctions.
In February 2012, SAFE promulgated the Notices on Issues Concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly Listed Company (the “SAFE Circular 7). Pursuant to SAFE Circular 7, directors, supervisors, senior management and other employees participating in any stock incentive plan of an overseas publicly listed company who are PRC citizens or who are non-PRC citizens residing in China for a continuous period of not less than one year, are required to register with SAFE through a domestic qualified agent, which could be the PRC subsidiary of such overseas-listed company, and complete certain other procedures, unless certain exceptions are available. In addition, an overseas-entrusted institution must be retained to handle matters in connection with the exercise or sale of stock options and the purchase or sale of shares and interests. We and our executive officers and other employees who are PRC citizens or non-PRC citizens living in China for a continuous period of not less than one year and have been granted options are subject to these regulations as our company has become an overseas-listed company. Failure to complete SAFE registrations may subject them to fines of up to RMB50,000 for individuals and may also limit our ability to contribute additional capital into our WFOE and our WFOE’ ability to distribute dividends to us. If any unapproved outflow or inflow of capital occurs and constitutes foreign exchange evasion or arbitrage, the amount of fine will be higher.
In addition, the Ministry of Finance and the State Administration of Taxation have issued certain circulars concerning employee share options and restricted shares. Under these circulars, our employees working in China who exercise share options or are granted restricted shares will be subject to PRC individual income tax. Our relevant PRC subsidiary has obligations to file documents related to employee share options or restricted shares with relevant tax authorities and to withhold individual income taxes of those employees who exercise their share options or are granted restricted share. If our employees fail to pay or we fail to withhold their income taxes according to relevant laws and regulations, we may face sanctions imposed by the tax authorities or other PRC government authorities.
PRC regulations relating to investments in offshore companies by PRC residents may subject our PRC-resident beneficial owners or our PRC subsidiaries to liability or penalties, limit our ability to inject capital into our PRC subsidiaries or limit our PRC subsidiaries’ ability to increase their registered capital or distribute profits.
SAFE promulgated the Circular on Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Offshore Investment and Financing and Roundtrip Investment through Special Purpose Vehicles, or the SAFE Circular 37, on July 4, 2014, which replaced the former circular commonly known as “SAFE Circular 75” promulgated by SAFE on October 21, 2005. SAFE Circular 37 requires PRC residents to register with local branches of SAFE in connection with their direct establishment or indirect control of an offshore entity, for the purpose of overseas investment and financing, with such PRC residents’ legally owned assets or equity interests in domestic enterprises or offshore assets or interests, referred to in SAFE Circular 37 as a “special purpose vehicle”. SAFE Circular 37 further requires amendment to the registration in the event of any significant changes with respect to the special purpose vehicle, such as increase or decrease of capital contributed by PRC individuals, share transfer or exchange, merger, division or other material event. In the event that a PRC shareholder holding interests in a special purpose vehicle fails to fulfill the required SAFE registration, the PRC subsidiaries of that special purpose vehicle may be prohibited from making profit distributions to the offshore parent and from carrying out subsequent cross-border foreign exchange activities, and the special purpose vehicle may be restricted in its ability to contribute additional capital into its PRC subsidiary. Moreover, failure to comply with the various SAFE registration requirements described above could result in liability under PRC law for evasion of foreign exchange controls.
We have notified substantial beneficial owners of Common Shares who we know are PRC residents of their filing obligation, and are aware that all substantial beneficial owners have completed the necessary registration with the local SAFE branch or qualified banks as required by SAFE Circular 37. However, we may not at all times be aware of the identities of all of our beneficial owners who are PRC residents. We do not have control over our beneficial owners and cannot assure you that all of our PRC-resident beneficial owners will comply with SAFE Circular 37 and subsequent implementation rules. The failure of our beneficial owners who are PRC residents to register or amend their SAFE registrations in a timely manner pursuant to SAFE Circular 37 and subsequent implementation rules, or the failure of future beneficial owners of our company who are PRC residents to comply with the registration procedures set forth in SAFE Circular 37 and subsequent implementation rules, may subject such beneficial owners or our PRC subsidiaries to fines and legal sanctions. Furthermore, since SAFE Circular 37 was recently promulgated and it is unclear how this regulation, and any future regulation concerning offshore or cross-border transactions, will be interpreted, amended and implemented by the relevant PRC government authorities, we cannot predict how these regulations will affect our business operations or future strategy. Failure to register or comply with relevant requirements may also limit our ability to contribute additional capital to our PRC subsidiaries and limit our PRC subsidiaries’ ability to distribute dividends to our company. These risks may have a material adverse effect on our business, financial condition and results of operations.
21
Failure to comply with the Individual Foreign Exchange Rules relating to the overseas direct investment or the engagement in the issuance or trading of securities overseas by our Chinese resident stockholders may subject such stockholders to fines or other liabilities.
Other than Circular 37, our ability to conduct foreign exchange activities in China may be subject to the interpretation and enforcement of the Implementation Rules of the Administrative Measures for Individual Foreign Exchange promulgated by SAFE in January 2007 (as amended and supplemented, the “Individual Foreign Exchange Rules”). Under the Individual Foreign Exchange Rules, any Chinese individual seeking to make a direct investment overseas or engage in the issuance or trading of negotiable securities or derivatives overseas must make the appropriate registrations in accordance with SAFE provisions. Chinese individuals who fail to make such registrations may be subject to warnings, fines or other liabilities.
We may not be fully informed of the identities of all our beneficial owners who are Chinese residents. For example, because the investment in or trading of our shares will happen in an overseas public or secondary market where shares are often held with brokers in brokerage accounts, it is unlikely that we will know the identity of all of our beneficial owners who are Chinese residents. Furthermore, we have no control over any of our future beneficial owners and we cannot assure you that such Chinese residents will be able to complete the necessary approval and registration procedures required by the Individual Foreign Exchange Rules.
It is uncertain how the Individual Foreign Exchange Rules will be interpreted or enforced and whether such interpretation or enforcement will affect our ability to conduct foreign exchange transactions. Because of this uncertainty, we cannot be sure whether the failure by any of our Chinese resident stockholders to make the required registration will subject our subsidiaries to fines or legal sanctions on their operations, restriction on remittance of dividends or other punitive actions that would have a material adverse effect on our business, results of operations and financial condition.
You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing actions in China against us or our management named in the annual report based on foreign laws.
Our holding company is a company incorporated under the laws of the British Virgin Islands, but we conduct substantially all of our operations in China and substantially most of our assets are located in China. In addition, most of our senior executive officers are PRC nationals and reside within China for a significant portion of the time. As a result, it may be difficult for you to effect service of process upon us or those persons inside mainland China. It may also be difficult for you to enforce in U.S. courts judgments obtained in U.S. courts based on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors who reside and whose assets are located outside the United States. In addition, there is uncertainty as to whether the courts of the British Virgin Islands or the PRC would recognize or enforce judgments of U.S. courts against us or such persons predicated upon the civil liability provisions of the securities laws of the United States or any state.
The recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedures Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based either on treaties between China and the country where the judgment is made or on principles of reciprocity between jurisdictions. China does not have any treaties or other forms of reciprocity with the United States that provide for the reciprocal recognition and enforcement of foreign judgments. In addition, according to the PRC Civil Procedures Law, the PRC courts will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates the basic principles of PRC laws or national sovereignty, security or public interest. As a result, it is uncertain whether and on what basis a PRC court would enforce a judgment rendered by a court in the United States.
22
Shareholder claims that are common in the United States, including securities law class actions and fraud claims, generally are difficult to pursue as a matter of law or practicality in China. For example, in China, there are significant legal and other obstacles to obtaining information needed for shareholder investigations or litigation outside China or otherwise with respect to foreign entities. Although the local authorities in China may establish a regulatory cooperation mechanism with the securities regulatory authorities of another country or region to implement cross-border supervision and administration, such regulatory cooperation with the securities regulatory authorities in the Unities States have not been efficient in the absence of mutual and practical cooperation mechanism. According to Article 177 of the PRC Securities Law which took effect in March 2020, no overseas securities regulator is allowed to directly conduct investigation or evidence collection activities within the territory of the PRC. Accordingly, without the consent of the competent PRC securities regulators and relevant authorities, no organization or individual may provide the documents and materials relating to securities business activities to overseas parties.
The war in Ukraine could materially and adversely affect our business and results of operations.
In February 2022, the Russian Federation commenced a military invasion of Ukraine, and as a result, the United States, the European Union, the United Kingdom and other jurisdictions have imposed sanctions on certain Russian and Ukrainian persons and entities, including certain Russian banks, energy companies and defense companies, and have imposed restrictions on exports of various items to Russia and certain regions of Ukraine (including the self-proclaimed Donetsk People’s Republic and Luhansk People’s Republic and Crimea). Moreover, on February 22, 2022, the Office of Foreign Assets Control of the United States issued sanctions aimed at limiting Russia’s ability to raise funds through sovereign debt.
The war in Ukraine has already affected global economic markets, including a dramatic increase in the price of oil and gas, and the uncertain resolution of this conflict could result in protracted and/or severe damage to the global economy. Russia’s invasion of Ukraine has led to, and may continue to lead to, additional sanctions being levied by the United States, European Union and other countries against Russia. Russia’s military incursion and the resulting sanctions could adversely affect global energy and financial markets and thus could affect the global markets, our customers or suppliers’ businesses and potentially our business, even though we do not conduct any business in Russia or Ukraine.
As of the date of this annual report, we do not have any business, operation or assets in Russia or Ukraine, nor do we have any direct or indirect business or contracts with any Russian or Ukraine entity as a supplier or customer. Additionally, we do not have any knowledge as to whether our customers or suppliers have any business, operation or assets in Russia or Ukraine, or have any direct or indirect business or contracts with any Russian or Ukraine entity as a supplier or customer. However, our operations, especially the supply chain, could be adversely impacted as a result of the dramatic fuel cost increases or delay to international shipping, in particular marine freight, that may be caused by the war.
The extent and duration of the military action, sanctions and resulting market disruptions of the war in Ukraine are impossible to predict, but could be substantial. Any such disruptions caused by Russian military actions or resulting sanctions may magnify the impact of other risks described in this section. We cannot predict the progress or outcome of the situation in Ukraine, as the conflict and governmental reactions are rapidly developing and beyond our control. Prolonged unrest, intensified military activities or more extensive sanctions impacting the region could have a material adverse effect on the global economy, and such effect could in turn have a material adverse effect on our business, financial condition, results of operations and prospects.
We may be subject to supply chain disruptions, which could have a material adverse effect on our business, financial condition and results of operations.
Our operations, in particular sales of construction materials and equipment, are subject to supply chain disruptions. We have not experienced any suspension of production, purchase or sale of our products and equipment; however, we have experienced some disruption to our supply chain during the PRC government mandated lockdown due to the COVID-19 pandemic, including but not limited to, restrictions or suspensions of logistics and shipping services in certain areas of China and increase in raw material costs.
While all of our major suppliers are currently fully operational, any future disruption in their operations would impact our ability to produce and deliver our products to customers. In addition, reductions in commercial airline and cargo flights, disruptions to ports and other shipping infrastructure resulting from the COVID-19 pandemic are resulting in increased transport times to deliver our products to customers. This has limited our ability to fulfill orders and we may be unable to satisfy all of the demand for our products and equipment in a timely manner, which has adversely affected our relationships with our customers. As a result, the supply chain disruptions have materially affected our operations and may impact our outlook or business goals.
23
We have also experienced higher costs of raw materials for manufacture and sale of our equipment, primarily steel and certain electronic parts due to limited availability or increased commodity prices caused by the COVID -19 pandemic. We have expanded our supplier network in order to control the procurement costs, diversify supply of our raw materials and ensure timely fulfillment of customer orders. As a result, we believe we can still supply products and equipment at competitive prices amid the COVID-19 impact.
As a result of Russia’s military invasion of Ukraine, the United States, the European Union, the United Kingdom and other jurisdictions have imposed sanctions on certain Russian and Ukrainian persons and entities, including certain Russian banks, energy companies and defense companies, and have imposed restrictions on exports of various items to Russian and certain regions of Ukraine. These geopolitical issues have resulted in increasing global trading uncertainties and thus could potentially affect our supply chain, even though we do not have any business, operation or assets in Russia or Ukraine, nor do we have any direct or indirect business or contracts with any Russian or Ukraine entity as a supplier or customer. See ” – The war in Ukraine could materially and adversely affect our business and results of operations.”
Our management has analyzed the current and future international and domestic political and economic situations and formulated different development strategies and measures for each of our business segments, with a goal to reduce the existing and potential impact of supply chain disruptions. For the equipment and construction materials businesses, we have made market development efforts to expand sales and have strengthened the management of raw material procurement by adding backup suppliers. Moreover, we have focused on production design and processing processes to improve quality and efficiency as well as reduce costs. We also plan to focus more on the growth of our software development and RSA services, which are generally less prone to any supply chain disruptions. However, there is no assurance that our efforts to mitigate the impact of supply chain disruptions will be successful. If our efforts were not successful, our business, financial condition and results of operations could be materially adversely affected.
Wage increases in China may prevent us from sustaining our competitive advantage and could reduce our profit margins.
Labor costs in China have increased with China’s economic development. Rising inflation in China is also putting pressure on wages. Wage costs for our employees form a significant part of our costs. For instance, for the years ended December 31, 2022, 2021 and 2020, our compensation and benefit costs for our employees were approximately $2.9 million, $3.3 million and $3.4 million, respectively. In addition, we are required by PRC laws and regulations to pay various statutory employee benefits, including pensions, housing funds, medical insurance, work-related injury insurance, unemployment insurance and maternity insurance to designated governmental agencies for the benefit of our employees. We expect that our labor costs, including wages and employee benefits, will continue to increase, particularly as we seek to expand our operations. In addition, the future issuance of equity-based compensation to our professional staff and other employees would also result in additional stock dilution for our shareholders. Unless we are able to pass on these increased labor costs to our customers by increasing prices for our products, services and projects, our profitability and results of operations may be materially and adversely affected. Furthermore, the PRC government has promulgated new laws and regulations to enhance labor protections in recent years, such as the Labor Contract Law and the Social Insurance Law. As the interpretation and implementation of these new laws and regulations are still evolving, our employment practice may not at all times be deemed in compliance with the new laws and regulations. If we are subject to penalties or incur significant liabilities in connection with labor disputes or investigation, our business and profitability may be adversely affected.
24
We face risks related to natural disasters, health epidemics and other outbreaks, such as the COVID-19 pandemic, which could significantly disrupt our operations.
In recent years, there have been outbreaks of epidemics in China and globally, including the outbreak of COVID-19. In March 2020, the World Health Organization declared the COVID-19 a pandemic. COVID-19 has resulted in quarantines, travel restrictions, and the temporary closure of businesses and facilities in China and worldwide.
The worldwide outbreak of COVID-19 pandemic has resulted in significant disruptions in the global economy. To contain the spread of COVID-19, the Chinese government has taken certain emergency measures, including extension of the Lunar New Year holidays, implementation of travel bans, blockade of certain roads and closure of factories and businesses, and encouragement of remote working arrangements and cancellation of public activities. Recently, there has been a recurrence of COVID-19 outbreaks in certain provinces of China, including Shanghai, due to the Delta and Omicron variants. As a result, the Chinese government has implemented similar emergency measures to contain further spread of COVID-19.
As it has historically, the COVID-19 pandemic may continue to, among other things, (i) disrupt our supply chain, delay our ability to timely fulfill our customer orders and lead to higher fulfilment expenses, (ii) reduce or curtail our customers’ expenditures and overall demand for our products or services, and increase the volatility of their purchase patterns from period-to-period, (iii) cause delays in production and collection of accounts receivable, and (iv) require us to take the initiatives in response to COVID-19 and many other efforts to leverage our technology, products and services to help contain the pandemic, all of which could have a material adverse effect on our business, financial condition and results of operations.
Our operations are not located in affected regions, which could however reduce the capacity and efficiency of our operations and negatively impact normal business operations. Our other measures taken to reduce the impact of this epidemic outbreak included upgrading our telecommuting system, monitoring our employees’ health on a daily basis and optimizing our technology system to support potential growth in user traffic. We continue to monitor the evolving situation and guidance from government and public health authorities and may take additional actions based on their recommendations.
There remains uncertainty around the severity and duration of the COVID-19 pandemic and the measures taken, or may be taken, in response to the COVID-19 pandemic, which will depend on numerous factors, including, among others, the emergence of new cases of COVID-19 and its variants, hospitalization and mortality rates, and the availability and distribution of safe and effective treatments and vaccines.
We are also vulnerable to natural disasters and other calamities. Although we have servers that are hosted in an offsite location and our backup system is able to capture data on a real-time basis, we may still be unable to recover certain data in the event of a server failure. We cannot assure you that any backup systems will be adequate to protect us from the effects of fire, floods, typhoons, earthquakes, power loss, telecommunications failures, break-ins, war, riots, terrorist attacks or similar events. Any of the foregoing events may give rise to server interruptions, breakdowns, system failures, technology platform failures or internet failures, which could cause the loss or corruption of data or malfunctions of software or hardware as well as adversely affect our ability to operate or provide services to our customers.
Any future outbreak of contagious diseases, extreme unexpected bad weather or natural disasters would adversely affect our operations and delivery of our products, services and projects. If there is a recurrence of an outbreak of certain contagious diseases or natural disasters, our operations may materially be affected and the delivery of our products services and projects may be delayed, which may have a material adverse effect on our business and operating results.
Our revenue will decrease if the industries in which our customers operate experience a protracted slowdown.
Our customers generally operate in the construction industry. Therefore, we are subject to general changes in economic conditions impacting this segment of the economy. If the construction industry does not grow or if there is a contraction in this industry, demand for our business would decrease. Demand for our business is typically affected by a number of overarching economic factors, including interest rates, environmental laws and regulations, the availability and magnitude of private and governmental investment in infrastructure projects and the health of the overall economy. If there is a decline in economic activity in China or the other markets in which we operate, or there is a protracted slowdown in industries upon which we rely for our sales, demand for our projects and products and our revenue would likewise decrease, which could have a materially adverse effect on our business.
25
Any decline in the availability or increase in the cost of raw materials could materially impact our earnings.
Our construction material products, manufacturing equipment and projects depend heavily on the ready availability of various raw materials. The availability of raw materials may decline, and their prices may fluctuate greatly. If our suppliers are unable or unwilling to provide us with raw materials on terms favorable to us, we may be unable to produce certain products, equipment or complete projects. The inability to produce certain products or projects for customers could result in a decrease in profit and damage to our corporate reputation. In the event our raw material costs increase, we may not be able to pass these higher costs on to our customers in full or at all.
We rely on a limited number of vendors, and the loss of any significant vendor could harm our business, and the loss of any one of such vendors could have a material adverse effect on our business.
We consider our major vendors to be those vendors that accounted for more than 10% of overall purchases in any given fiscal period. For the years ended December 31, 2022, 2021 and 2020, the Company purchased approximately 19%, 53% and 43% of its raw materials from one major supplier, respectively. We have not entered into long-term contracts with all of our significant vendors and instead rely on individual contracts with such vendors. Although we believe that we can locate replacement vendors readily on the market for prevailing prices, any difficulty in replacing a vendor on terms acceptable to us could negatively affect our company’s performance to the extent it results in higher prices or a slower supply chain.
We face substantial inventory risk, which if not addressed could have a material adverse effect on our business.
We must order materials for our products and projects and build inventory in advance of production. We typically acquire materials through a combination of purchase orders, supplier contracts and open orders, in each case based on projected demand.
As of December 31, 2022, our inventory from continuing operations was $337,798. Inventory turnover associated with our continuing operations for the fiscal year ended December 31, 2022 was 24 days. As our markets are competitive and subject to rapid technology and price changes, there is a risk that we will forecast incorrectly and order or produce incorrect amounts of products or not fully utilize firm purchase commitments. If we were unsuccessful in accurately quantifying appropriate levels of inventory, our business, financial condition and results of operation may be materially and adversely affected.
Any disruption in the supply chain of raw materials and our products could adversely impact our ability to produce and deliver products, which could have a material adverse effect on our business.
In order to optimize our product manufacturing, we must manage our supply chain for raw materials and delivery of our products. Supply chain fragmentation and local protectionism within China further increase supply chain disruption risks. Local administrative bodies and physical infrastructure built to protect local interests may pose transportation challenges for raw material transportation as well as product delivery. In addition, profitability and volume could be negatively impacted by limitations inherent within the supply chain, including competitive, governmental, legal, natural disasters, and other events that could impact both supply and price. Any of these occurrences could cause significant disruptions to our supply chain, manufacturing capability and distribution system that could adversely impact our ability to produce and deliver products. If we are unsuccessful in maintaining efficient operation of our supply chain, our business, financial condition and results of operation may be materially and adversely affected.
We do not maintain a reserve for warranty or defective products and installation claims. Our costs could increase if we experience a significant number of claims, which could have a material adverse effect on our business.
We generally obtain customers’ acceptance when we deliver products, equipment or projects. In practice, we allow our customers to reserve approximately 5-20% of the agreed purchase or installation price as a security retention for a period of one or two years after we deliver or implement a solution. We consider this one or two year term to be a warranty period for our products or projects sold. Historically, we have not experienced significant customer complaints concerning our products or projects, and none of our customers have claimed damages for any loss incurred due to quality problems. In addition to our one to two year reserve, China’s Product Quality Law generally allows customers two years to seek compensation for damages caused by product quality deficiencies in cases in which a product lacks an expiration period.
26
We expect our customer support teams and our quality assurance and manufacturing monitoring procedures to continue to keep claims at a level that does not support a need for a financial reserve. However, if we experience significant increases in claims or customers’ failure to pay the final 5-20% of a purchase/installation price as a result of quality concerns, our financial results could be adversely affected.
We face certain risks in collecting our accounts receivable, the failure to collect could have a material adverse effect on our business.
As of December 31, 2022, 2021 and 2020, our net accounts receivable associated with our continuing operations were $2,234,186 (including accounts receivable from third party customers of $2,150,450 and accounts receivable from related party customers of $83,736), $535,292 (including accounts receivable from third party customers of $441,703 and accounts receivable from related party customers of $93,589) and $3,056,104 (including accounts receivable from third party customers of $2,856,105 and accounts receivable from related party customers of approximately $199,999), respectively. These amounts represented 35%, 15% and 37% of our total revenues from continuing operations in 2022, 2021 and 2020, respectively. For the years ended December 31, 2022, 2021 and 2020, our accounts receivable turnover associated with our continuing operations was 154 days, 182 days and 222 days, respectively.
Although we believe that we have developed a robust receivables management system and have not incurred a situation where an account receivable has become uncollectable, as our business continues to scale, we believe that our accounts receivable balance will continue to grow. This, in turn, increases our risks for bad debts and uncollectible receivables. To the extent we incur additional bad debts and/or uncollectible receivables, our business, financial condition and results of operation may be materially and adversely affected.
Our return on investment in client projects may be different from our projections.
Our return on investment in client projects will take some time to materialize. At the initial stages of project investment and construction, the depreciation of newly added materials and fixed assets will negatively affect our operating results. In addition, the projects may be subject to changes in market conditions during the installation and implementation phases. Changes in industry policy, the progress of the projects, project management, raw materials supply, market conditions and other variables may affect the profitability and the time in which we profit on projects, which may be different from our initial forecast, thus affecting the actual return on investment of the projects.
The sales of our eco-friendly construction materials are subject to geographic market risks, which could adversely affect our revenues and profitability.
Currently, our eco-friendly construction materials are sold in China. Accordingly, we are subject to risks related to the economy of China. In addition to economic conditions, the geographic concentration suggests that regional specific legislation, taxes and disasters such as earthquakes could disproportionately affect us and our financial performance. For example, a downturn in the demand for eco-friendly construction materials or economic conditions in Hainan Province could result in a material decline in our business, financial condition and results of operation.
The report of our independent registered public accounting firm on our financial statements for the years ended December 31, 2022, 2021 and 2020 includes an explanatory paragraph that expresses substantial doubt about our ability to continue as a going concern, and if our business is unable to continue it is likely investors will lose all of their investment.
As discussed in Note 3 to the consolidated financial statements to this annual report, we have suffered significant losses from operations and has a significant decrease in working capital that raises substantial doubt about our ability to continue as a going concern. Our auditor, YCM CPA Inc., has indicated in their report on our financial statements for the fiscal year ended December 31, 2022 that there is a substantial doubt about our ability to continue as a going concern for the next 12 months from the issuance of the consolidated financial statements. A “going concern” opinion could impair our ability to finance our operations through the sale of equity, incurring debt, or other financing alternatives.
27
Management’s plan to alleviate the substantial doubt about our ability to continue as a going concern include working to improve our liquidity and capital sources mainly through cash flow from its operations, renewal of bank borrowings, equity or debt offering and borrowing from related parties. In order to fully implement its business plan and recover from continuing losses, we may also seek equity financing from outside investors. At the present time, however, we do not have commitments of funds from any potential investors. There can be no assurance that additional financing, if required, would be available on favorable terms or at all and/or that these plans and arrangements will be sufficient to fund our ongoing capital expenditures, working capital, and other requirements. If we are unable to achieve these goals, our business will be jeopardized and we may not be able to continue. If we ceased operations, it is likely that all of our investors will lose their investment.
We cannot assure you that our growth strategy will be successful, which may result in a negative impact on our growth, financial condition, results of operations and cash flow.
We intend to grow by expanding our business, increasing market penetration of our existing products, developing new products and increasing our targeting of domestic and international markets. However, many obstacles to this expansion exist, including increased competition from similar businesses, our ability to improve our products and product mix to realize the benefits of our research and development efforts, unexpected costs and costs associated with marketing efforts. As such, we cannot assure you that we will be able to successfully overcome these potential challenges and establish our business in additional markets. Our inability to implement this growth strategy successfully may have a negative impact on our growth, future financial condition, and results of operations or cash flows.
If we fail to protect our intellectual property rights, it could harm our business and competitive position.
We own an aggregate of 123 patents (ten of which are owned jointly with Luoyang Water-Conservancy Surveying & Design Co., Ltd. (“Luoyang”), an independent third party), three of which were awarded Gold and Silver Prize of International Exhibition of Inventions of Geneva. We also have 73 pending patent applications in China. In addition, we own 25 software copyrights in China. We rely on a combination of patent, trademark and trade secret laws and non-disclosure agreements and other methods to protect our intellectual property rights.
The process of seeking patent protection on future patents can be lengthy and expensive, our patent applications may fail to result in patents being issued, and our existing and future patents may be insufficient to provide us with meaningful protection or commercial advantage. Our patents and patent applications may also be challenged, invalidated or circumvented.
Implementation of Chinese intellectual property-related laws have historically been lacking, primarily because of ambiguities in PRC laws and enforcement difficulties. Accordingly, intellectual property rights and confidentiality protections in China may not be as effective as in the United States or other western countries. Furthermore, policing unauthorized use of proprietary technology is difficult and expensive, and we may need to resort to litigation to enforce or defend patents issued to us or to determine the enforceability, scope and validity of our proprietary rights or those of others. Such litigation and an adverse determination in any such litigation, if any, could result in substantial costs and diversion of resources and management attention, which could harm our business and competitive position.
28
We may be exposed to intellectual property infringement and other claims by third parties which, if successful, could disrupt our business and have a material adverse effect on our financial condition and results of operations.
Our success depends, in large part, on our ability to use and develop our technology and know-how without infringing third party intellectual property rights. We face a high risk of being the subject of claims for intellectual property infringement, invalidity or indemnification relating to other parties’ proprietary rights because we sell our products and manufacturing equipment internationally and litigation is becoming more common in China. Our current or potential competitors, many of which have substantial resources and have made substantial investments in competing technologies, may have or may obtain patents that will prevent, limit or interfere with our ability to make, use or sell our branded products in either China or other countries, including the United States and other countries in Asia. In addition, the defense of intellectual property suits, including patent infringement suits, and related legal and administrative proceedings can be costly, time consuming and may significantly divert the efforts and resources of our technical and management personnel. Furthermore, an adverse determination in any such litigation or proceedings to which we may become a party could cause us to:
| ● | pay damage awards; |
| ● | seek licenses from third parties; |
| ● | pay ongoing royalties; |
| ● | redesign our branded products; or |
| ● | be restricted by injunctions. |
Each of these events could effectively prevent us from pursuing some or all of our business and result in our customers or potential customers deferring or limiting their purchase or use of our branded products, which could have a material adverse effect on our financial condition and results of operations.
Confidentiality agreements with employees and third parties may not prevent unauthorized disclosure of proprietary information and trade secrets.
In addition to patents, we rely on confidentiality agreements to protect our technical know-how and other proprietary information. In addition, our officers and each of our main technical and management employees have signed a confidentiality agreement. Nevertheless, there can be no guarantee that an employee or a third party will not make an unauthorized disclosure of our proprietary confidential information. This might happen intentionally or inadvertently. It is possible that a competitor will make use of such information, and that our competitive position will be compromised, in spite of any legal action we might take against persons making such unauthorized disclosures.
The use of unqualified individual subcontractors may result in substantial liability.
Beijing REIT Ecological Engineering Technology Co., Ltd. (“Beijing REIT Ecological”) subcontracts portions of its projects to third parties. According to Construction Law and Qualification Standard for Labor Subcontracting in Construction Business of China, individual contractors are not in a position to obtain any qualification of labor subcontracting. Accordingly, contracts subcontracted out by Beijing REIT Ecological to individual contractors may be declared void and unenforceable by applicable courts. Article 29 of the Construction Law requires that “the overall contractors and subcontractors shall bear joint responsibilities to project owners for the subcontracted projects”. It is possible that Beijing REIT Ecological may subcontract projects to individuals or parties without required qualifications. If the construction completed by unqualified individual subcontractors does not meet required quality standards and an accident occurs, we may jointly bear the consequences pursuant to Article 67 of the Construction Law. Also, according to Article 54 of the Regulation on the Quality Management of Construction Projects, the liabilities for the consequences could be indemnifying the damages and paying a penalty ranging from RMB 500,000 (approximately $72,000) up to RMB 1.0 million (approximately $144,000).
If we experience a significant disruption in, or a breach in security of, our information technology systems or if we fail to implement, manage or integrate new systems, software and technologies successfully, it could harm our business.
Our information technology (“IT”) systems are an integral part of our business. We depend on our IT systems to process transactions, manage logistics, keep financial records, prepare our financial reporting and operate other critical functions. Security breaches, cyber-attacks or other serious disruptions of our IT systems can create systemic disruptions, shutdowns or unauthorized disclosure of confidential information. If we are unable to prevent or adequately respond to such breaches, attacks or other disruptions, our operations could be adversely affected or we may suffer financial or reputational damage.
29
In addition, our ability to effectively implement our business plan in a rapidly evolving market requires effective planning, reporting and analytical processes and systems. We are improving and expect that we will need to continue to improve and further integrate our IT systems, reporting systems and operating procedures on an ongoing basis. If we fail to do so effectively, it could adversely affect our ability to achieve our objectives.
Product defects and unanticipated use or inadequate disclosure with respect to our products could adversely affect our business, reputation and financial performance.
Manufacturing or design defects (including in products or components that we source from third parties), unanticipated use of, or inadequate disclosure of risks relating to, the use of products or equipment that we make and sell may lead to personal injury, death or property damage. These events could lead to recalls or alerts relating to our products, result in the removal of a product or equipment from the market or result in product liability claims being brought against us. Product and equipment recalls, removals and liability claims can lead to significant costs, as well as negative publicity and damage to our reputation that could reduce demand for our products and equipment.
Outstanding bank loans may reduce our available funds.
We had approximately $1.3 million in bank loans loan outstanding as of December 31, 2022 (all short-term bank loans). The loans are held at multiple banks, and all of the debt is guaranteed by third-party guaranty companies and certain company officers. There can be no guarantee that we will be able to pay all amounts when due or refinance the amounts on terms that are acceptable to us or at all. If we are unable to make our payments when due or to refinance such amounts, our property could be foreclosed and our business could be negatively affected.
A financial intermediary may have acquired investment funds from investors to invest in our Company’s business before reaching a final mutual agreement with us to obtain such investments, which may subject us to on-going or future litigation, which could have a material adverse effect on our financial condition.
In 2018, a financial intermediary and REIT New Materials Xinyi Co., Ltd. (“Xinyi REIT”) began negotiations towards a potential cooperation where the financial intermediary would introduce potential investors to facilitate investment in Xinyi REIT’s business. In December 2018, an investor invested RMB1,000,000 (approximately $0.15 million) in Xinyi REIT through this financial intermediary. Xinyi REIT rejected this investment and returned the total investment funds it received to the investor and informed the financial intermediary to cease facilitating investments from other investors. In addition, despite there not being a final mutual agreement between the parties, it appears the financial intermediary may have acquired investment funds in the aggregate amount of RMB15,450,000 (approximately $2.15 million) from certain investors, and Xinyi REIT did not receive any funds from these investments.
Mr. Hengfang Li, the Company’s Chief Executive Officer and Chairman, has agreed to assume full responsibility for liabilities, if any, and assume the creditor’s rights for these claims on behalf of the Company for any legal claims or lawsuits against the Company due to these investments. In May 2020, Mr. Li paid RMB 300,000 (approximately $44,000) to an investor in a lawsuit against Xinyi REIT to return the investment funds. In 2022 and 2023, a few other investors brought legal actions against Xinyi REIT for the same claim and judgments were rendered in their favor. Subsequently, Xinyi REIT appealed these judgments, and the appeals are still pending in higher courts as of the date of this annual report. The Company does not believes that any liability resulting from the outcome of such proceedings, if any, will have a material adverse effect on the Company’s consolidated financial position or results of operations or liquidity.
However, in the event that Mr. Li personally fails to satisfy any losses related to the investments on our behalf, the Company may be required to repay related liabilities, which although is remote, could have a material adverse effect on our financial condition.
Our future growth depends on new products, environmental solutions and new technology innovation, and failure to invent and innovate could adversely impact our business prospects.
Our future growth depends in part on maintaining our competitive advantage with current products in new and existing markets, as well as our ability to develop new products, and technologies to serve such markets. To the extent that competitors develop competitive products, and technologies, or new products, or technologies that achieve higher customer satisfaction, our business prospects could be adversely impacted. In addition, regulatory approvals for new products, equipment or technologies may be required, and these approvals may not be obtained in a timely or cost-effective manner, which could adversely impact our business prospects.
30
Changes in demand for our products, equipment and business relationships with key customers and suppliers may negatively affect operating results.
To achieve our objectives, we must develop and sell products and equipment that are subject to the demands of our customers. This is dependent on many factors, including managing and maintaining relationships with key customers, responding to the rapid pace of technological change and obsolescence, which may require increased investment by us or result in greater pressure to commercialize developments rapidly or at prices that may not fully recover the associated investment, and the effect on demand resulting from customers’ research and development, capital expenditure plans and capacity utilization. If we are unable to keep up with our customers’ demands, our sales, earnings and operating results may be negatively affected.
We may be unable to deliver our backlog on time, which could affect future sales and profitability and our relationships with customers.
Our ability to meet customer delivery schedules for backlog is dependent on a number of factors including sufficient manufacturing plant capacity, adequate supply channel access to raw materials and other inventory required for production, an adequately trained and capable workforce, project engineering expertise for certain large projects and appropriate planning and scheduling of manufacturing resources. Many of the contracts we enter into with our customers require long manufacturing lead times. Failure to deliver in accordance with customer expectations could subject us to contract cancellations and financial penalties, and may result in damage to existing customer relationships and could have a material adverse effect on our business, financial condition and results of operations. We cannot assure you that our backlog will result in revenue on a timely basis or at all, or that any cancelled contracts will be replaced.
Our operations are subject to various hazards that may cause personal injury or property damage and increase our operating costs, and which may exceed the coverage of our insurance.
There are inherent risks to our operations. Our workers are subject to the usual hazards associated with providing services on construction sites, while our plant personnel are subject to the hazards associated with moving and storing large quantities of heavy raw materials and finished products. Operating hazards can cause personal injury and loss of life, damage to or destruction of property, plant and equipment and environmental damage. Although we conduct training programs designed to reduce these risks, we cannot eliminate these risks. We rely on state mandated social insurance for work-related injuries of our employees. However, any claim that exceeds the scope of our insurance coverage, if successful and of sufficient magnitude, could result in the incurrence of substantial costs and the diversion of resources, which could have a material adverse effect on us. In addition, we do not have any business liability, disruption, litigation or property insurance coverage for our operations. Any uninsured occurrence of loss or damage to property, or litigation or business disruption may also materially and adversely affect our ability to operate.
We may incur material costs and losses as a result of claims our products do not meet regulatory requirements or contractual specifications.
Our operations involve providing products that must meet building code or other regulatory requirements and contractual specifications for durability, stress-level capacity, weight-bearing capacity and other characteristics. If we fail or are unable to provide products meeting these requirements and specifications, we may face economic penalties, including price adjustments, rejection of deliveries and/or termination of contracts, and our reputation could be damaged. If a significant product-related claim or claims are made and resolved against us in the future, such resolution may have a material adverse effect on our business, financial condition, results of operations and cash flows.
31
Our operations may incur substantial liabilities to comply with environmental laws and regulations.
Our construction materials manufacturing operations are subject to laws and regulations relating to the release or disposal of materials into the environment or otherwise relating to environmental protection. Our failure to have complied with the applicable laws may result in the assessment of administrative, civil and criminal penalties, the incurrence of investigatory or remedial obligations and the imposition of injunctive relief. Resolution of these matters may require considerable management time and expense. In addition, changes in environmental laws and regulations occur frequently and any changes that result in more stringent or costly manufacturing, storage, transport, disposal or cleanup requirements could require us to make significant expenditures to reach and maintain compliance and may otherwise have a material adverse effect on our industry in general and on our own results of operations, competitive position or financial condition.
We depend on our key personnel, and our business and growth prospects may be severely disrupted if we lose their services.
Our future success depends heavily upon the continued service of our key executives. In particular, we rely on the expertise and experience of Hengfang Li, our founder, Chairman and Chief Executive Officer. We rely on his industry expertise and experience in our business operations, and in particular, his business vision, management skills, and working relationship with our employees, our other major shareholders, the regulatory authorities, and many of our clients. If he became unable or unwilling to continue in his present position, or if he joined a competitor or formed a competing company in violation of his employment agreement, we may not be able to replace him easily, our business may be significantly disrupted and our financial condition and results of operations may be materially adversely affected.
We do not maintain key man life insurance on any of our senior management or key personnel. The loss of any one of them would have a material adverse effect on our business and operations. Competition for senior management and our other key personnel is intense and the pool of suitable candidates is limited. We may be unable to locate a suitable replacement for any senior management or key personnel that we lose. In addition, if any member of our senior management or key personnel joins a competitor or forms a competing company, they may compete with us for customers, business partners and other key professionals and staff members of our Company. Although each of our senior management and key personnel has signed a confidentiality and non-competition agreement in connection with his or her employment with us, we cannot assure that we will be able to successfully enforce these provisions in the event of a dispute between us and any member of our senior management or key personnel.
In addition, we compete for qualified personnel with other industry competitors, and we face competition in attracting skilled personnel and retaining the members of our senior management team. These personnel possess technical and business capabilities, including expertise relevant to the construction materials industry, which are difficult to replace. There is intense competition for experienced senior management with technical and industry expertise in the construction materials industry, and we may not be able to retain our key personnel. Intense competition for these personnel could cause our compensation costs to increase, which could have a material adverse effect on our results of operations. Our future success and ability to grow our business will depend in part on the continued service of these individuals and our ability to identify, hire and retain additional qualified personnel. If we are unable to attract and retain qualified employees, we may be unable to meet our business and financial goals.
We have limited business insurance coverage. Any future business liability, disruption or litigation we experience might divert management focus from our business and could significantly impact our financial results.
Availability of business insurance products and coverage in China is limited, and most such products are expensive in relation to the coverage offered. We have determined that the risks of disruption, cost of such insurance and the difficulties associated with acquiring such insurances on commercially reasonable terms make it impractical for us to maintain such insurances. As a result, we do not have any business liability, disruption or litigation insurance coverage for our operations in China. Accordingly, a business disruption, litigation or natural disaster may result in substantial costs and divert management’s attention from our business, which would have an adverse effect on our results of operations and financial condition.
32
We may require additional financing in the future and our operations could be curtailed if we are unable to obtain required additional financing when needed.
We may need to obtain additional debt or equity financing to fund future capital expenditures. Any additional equity financing may result in dilution to the holders of our outstanding shares of capital stock. Additional debt financing may put us in situations that would restrict our freedom to operate our business, such as situations that:
| ● | limit our ability to pay dividends or require us to seek consent for the payment of dividends; |
| ● | increase our vulnerability to general adverse economic and industry conditions; |
| ● | require us to dedicate a portion of our cash flow from operations to payments on our debt, thereby reducing the availability of our cash flow to fund capital expenditures, working capital and other general corporate purposes; and |
| ● | limit our flexibility in planning for, or reacting to, changes in our business and our industry. |
We cannot guarantee that we will be able to obtain additional financing on terms that are acceptable to us, or any financing at all, and the failure to obtain sufficient financing could adversely affect our business operations.
Potential disruptions in the capital and credit markets may adversely affect our business, including the availability and cost of short-term funds for liquidity requirements, which could adversely affect our results of operations, cash flows and financial condition.
Potential changes in the global economy may affect the availability of business and consumer credit. We may need to rely on the credit markets, particularly for short-term borrowings from banks in China, as well as the capital markets, to meet our financial commitments and short-term liquidity needs if internal funds from our operations are not available to be allocated to such purposes. Disruptions in the credit and capital markets could adversely affect our ability to draw on such short-term bank facilities. Our access to funds under such credit facilities is dependent on the ability of the banks that are parties to those facilities to meet their funding commitments, which may be dependent on governmental economic policies in China. Those banks may not be able to meet their funding commitments to us if they experience shortages of capital and liquidity or if they experience excessive volumes of borrowing requests from us and other borrowers within a short period of time.
Long-term disruptions in the credit and capital markets could result from uncertainty, changing or increased regulations, reduced alternatives or failures of financial institutions could adversely affect our access to the liquidity needed for our business. Any disruption could require us to take measures to conserve cash until the markets stabilize or until alternative credit arrangements or other funding for our business needs can be arranged. Such measures may include deferring capital expenditures, and reducing or eliminating discretionary uses of cash. These events would adversely impact our results of operations, cash flows and financial position.
Changes in China’s environmental laws and policies may affect our financial condition.
Our eco-friendly construction materials are primarily used in the construction industry. Our business is in line with China’s current focus on environmental protection policies, specifically the 14th Five-Year Plan (2021-2025). However, should China alter its environmental policies towards less regulation, we believe demand for our eco-friendly construction materials and equipment will decrease, adversely impacting our results of operations, cash flows and financial position.
Our business benefits from certain government subsidies and incentives. Expiration, reduction or discontinuation of, or changes to, these incentives will increase our burden and reduce our net income, which could have a material adverse effect on our business and operations.
We have received subsidies from some governmental agencies after meeting certain conditions, such as developing certain technologies, which are chosen as annual key research and development, or obtaining certain technological certifications. For the years ended December 31, 2022, 2021 and 2020, we included government subsidies of $235,084, $261,197 and $269,061, respectively, in other income.
33
Beijing REIT obtained the High-New Technology Enterprise (“HNTE”) Certificate and is entitled to a preferential income tax rate of 15% for the three years from December 2020 to December 2022. Such HNTE Certificate has been renewed for another three years from December 2022 to December 2025. Hainan Yile IoT obtained an HNTE Certificate and is entitled to a preferential income tax rate of 15% for the three years from October 2020 to October 2023. Hainan Yile IoV Technology Research Institute Co., Ltd. (“IoV Technology Research”) obtained an HNTE Certificate and is entitled to a preferential income tax rate of 15% for the three years from October 2022 to October 2025. The 15% tax rate is less than the standard 25% income tax rate in China. The estimated tax savings as a result of the Company’s tax benefits for the years ended December 31, 2022, 2021 and 2020 amounted to nil, nil and $164,071, respectively. In the event any of Beijing REIT, Hainan Yile IoT or IoV Technology Research is unable to renew its HNTE status, its applicable tax rate will increase from 15% to 25%, the standard business income tax rate in China. In addition, the termination of any one-time subsidies for eco-friendly construction materials could increase the burden of manufacturing and selling these materials in the future. The reduction or discontinuation of any of these economic incentives could negatively affect our business and operations.
Failure to make adequate contributions to certain employee benefit plans as required by PRC regulations may subject us to penalties.
We are required under PRC law to participate in various government sponsored employee benefit plans, including social security insurance, housing provident funds and other welfare-oriented payments, and contribute to the plans in amounts equal to certain percentages of salaries, including bonuses and allowances, of our employees up to a maximum amount specified by the local government from time to time at locations where we operate our businesses. We have not made adequate employee benefit payments to the housing provident fund. We may be required to pay the shortage of our contributions. If we are subject to late fees or fines in relation to the underpaid employee benefits, our financial condition and results of operations may be adversely affected.
Since the majority of our operations and assets are located in China, shareholders may find it difficult to enforce a U.S. judgment against the assets of our Company, our directors and executive officers.
Other than REIT India, our operations and assets are located in China. In addition, a majority of our executive officers and directors are non-residents of the U.S., and substantially all the assets of such persons are located outside the U.S. As a result, it could be difficult for investors to effect service of process in the U.S., or to enforce a judgment obtained in the U.S. against us or any of these persons.
Substantial uncertainties exist with respect to the interpretation and implementation of the framework rules of the PRC Foreign Investment Law, and its application may require further rules to be issued by the PRC government, which may incur and increase our compliance costs and expenses and accordingly our financial condition and operation will be adversely affected.
On Mach 15, 2019, the National People’s Congress of China promulgated the Foreign Investment Law of the PRC aiming to replace the major existing laws governing foreign investment in China. The Foreign Investment Law became effective on January 1, 2020. The Foreign Investment Law applies to PRC enterprises established, acquired or otherwise invested wholly or partially by foreign investors in a manner prescribed under applicable PRC laws and regulations. It also governs investment projects and activities in China by foreign investors. Accordingly, as our company qualifies as a “foreign investor” for these purposes, our PRC subsidiaries are subject to the Foreign Investment Law.
Under the Foreign Investment Law, a “negative list’ promulgated or approved by the State Council will set forth industries that are prohibited industries and restricted industries. A foreign investor is prohibited to invest in any prohibited industry included therein. If a foreign investor is found to invest in any prohibited industry set forth under the “negative list”, such foreign investor may be required to, among other aspects, cease its investment activities, dispose of its equity interests in or assets of the “foreign-invested enterprise” (“FIE”) and have its income confiscated. A foreign investor may be permitted to invest in a FIE that is in a restricted industry set forth in the “negative list”, provided that relevant conditions are satisfied and certain approvals are acquired from relevant PRC governmental authorities. With respect to industries in which foreign investment is not prohibited or restricted, domestic and foreign investors will be equally treated. On December 27, 2021, the MOFCOM and the NDRC jointly issued the latest version of Negative List (Edition 2021). Currently, our business falls within the permitted category. However, we cannot assure you that our current operations or any newly-developed business in the future will still deemed to be “permitted” in the “negative list”, which may be promulgated or be amended from time to time by the MOFCOM and the NDRC.
34
Some of our PRC subsidiaries are as FIEs. Once an entity is determined to be a FIE and its business operations fall within a restricted industry under the “negative list”, in order for a foreign investor to invest in the FIE, such entity will be required to obtain entry clearance and approvals from the MOFCOM or its local counterparts and other relevant PRC government agencies. Our main products currently manufactured by us, including eco-friendly construction materials and equipment used for the production of these eco-friendly construction materials, the RSA services and software products and solutions services do not fall in the prohibited or restricted industries under “negative list” that is currently effective.
The Foreign Investment Law also requires that the entity form, main organizations and business activities of an FIE established before the enactment of the Foreign Investment Law and in accordance with the Chinese-Foreign Equity Joint Venture Enterprise Law, the Chinese-Foreign Cooperative Joint Venture Enterprise Law or the Wholly Foreign-Owned Enterprise Law comply with the PRC Company Law, the PRC Partnership Law and other laws (as the case might be) and there is a five-year transition period from January 1, 2020 for FIEs to fully comply with such requirements.
The relevant business carried out by our PRC subsidiaries and our investment in the PRC subsidiaries currently are not subject to the national security review under applicable PRC laws and regulations. However, if our future business operations or potential mergers and acquisitions we enter into in the PRC are related to national security sensitive areas or industries involving certain key technologies, national security review requirements will likely apply and the review result that is in compliance with PRC laws should be definitive. It remains unclear when the specific implementation measures of the Foreign Investment Law will be issued by the State Council. Given the uncertainties exist with respect to the interpretation and implementation of the Foreign Investment Law, its application may require further rules to be issued by PRC government, which may incur and increase our compliance costs and expenses and accordingly our financial condition and operation will be adversely affected.
The integration of newly acquired businesses may not provide the benefits anticipated at the time of acquisition.
In line with our strategy to expand our operations and services in markets in which we currently operate as well as into new and emerging markets, leveraging our existing know-how and infrastructure, in December 2021, we acquired REIT Mingde, and we may make future acquisitions. We are required to devote management attention and resources to integrating business practices and operations of REIT Mingde. Potential difficulties we may encounter in the integration process include the following:
| ● | the inability to successfully integrate the businesses, including operations, technologies, products and services, in a manner that permits us to achieve the anticipated cost savings, revenue synergies and business growth, which could result in the anticipated benefits of the Acquisition not being realized partly or wholly in the time frame currently anticipated or at all; |
| ● | lost sales and customers as a result of certain customers of any of the businesses deciding not to do business with us, or deciding to decrease their amount of business in order to reduce their reliance on a single company; |
| ● | the necessity of coordinating geographically separated organizations, systems and facilities; |
| ● | potential unknown liabilities and unforeseen increased expenses, delays or regulatory conditions following the Acquisition; |
| ● | integrating personnel with diverse business backgrounds and business cultures, while maintaining focus on providing consistent, high-quality products and services; |
| ● | consolidating and rationalizing information technology platforms and administrative infrastructures as well as accounting systems and related financial reporting activities and difficulty implementing effective internal controls over financial reporting and disclosure controls and procedures in particular; and |
| ● | preserving important relationships of the Company and REIT Mingde and resolving potential conflicts that may arise. |
35
Furthermore, it is possible that the integration process could result in the loss of key employees or skilled workers of REIT Mingde. The loss of key employees and skilled workers could adversely affect our ability to successfully conduct the newly acquired business because of their experience and knowledge of REIT Mingde’s businesses. In addition, we could be adversely affected by the diversion of management’s attention and any delays or difficulties encountered in connection with the integration of REIT Mingde’s businesses. The process of integrating operations could cause an interruption of, or loss of momentum in, the activities of one or more of our operations. If we experience difficulties with the integration process, the anticipated benefits of the Acquisition may not be realized fully or at all, or may take longer to realize than expected. These integration matters could have an adverse effect on our business, results of operations, financial condition or prospects during this transition period and for an undetermined period after completion of the Acquisition.
We have a limited operating history in the newly acquired businesses and may be unable to achieve or sustain profitability or accurately predict the future results of such businesses.
Hainan Yile IoT commenced the RSA services operations in 2020 and the development and sales of software solutions in May 2019. Because its businesses and the market for its services are both new and evolving, evaluating the current business and its future performance is difficult and based upon limited historical data, a changing market, and its ability to influence the market. This applies to predictions of both revenue and expenses.
Building its businesses to date, Hainan Yile IoT has accumulated losses. The continued investment in new technology and services will add to its operating expenses. We cannot assure you that Hainan Yile IoT will be profitable, that it will be able to sustain profitability, or of the magnitude of its profitability. Our financial performance may be adversely impacted if we fail to address the “Risk Factors” described in this section, or any other risks and challenges that we may face. If its assumptions for addressing the risks that Hainan Yile IoT has identified and other business conditions are incorrect, our plans for operating the business may be impacted and it may not achieve our planned and expected results.
Growing the newly acquired businesses requires us to continue investing in technology, resources, and new business capabilities; these investments may contribute to losses, and we cannot guarantee that any will be successful or contribute to profitability.
Our plans for operating the newly acquired businesses and leading further growth of its RSA services and software solution offerings. These plans include developing new products and services. These investments could contribute to losses, and we cannot guarantee whether or when any of the new products and services will become operational, be successful with customers, or whether they will be profitable.
Any failure to offer high quality services and support may adversely affect our relationships with our customers and prospective customers, and adversely affect our business, results of operations and financial condition.
Our software solutions clients depend on our customer support team to assist them in deploying the solutions effectively, to help them to resolve post-deployment issues quickly, and to provide ongoing support. If we do not devote sufficient resources or are otherwise unsuccessful in assisting our customers effectively, it could adversely affect our ability to retain existing customers and could discourage prospective customer from purchasing and using our software solutions. We may be unable to respond quickly enough to accommodate short-term increases in demand for customer support. We also may be unable to modify the nature, scope and delivery of our customer support to compete with changes in the support services provided by our competitors. Increased demand for customer support, without corresponding revenue, could increase costs and adversely affect our business, results of operations and financial condition. Any failure to maintain high quality customer support, or a market perception that we do not maintain high quality customer support, could erode customer trust and adversely affect our reputation, business, results of operations and financial condition.
36
The software and information technology service market in which we participate is competitive, and if we do not compete effectively, our business, results of operations and financial condition could be harmed.
The software and information technology service market is competitive and rapidly evolving. The principal competitive factors in our market include completeness of product offerings, level of customization of solutions, credibility with developers, global reach, ease of integration and programmability, product features, platform scalability, reliability, security and performance, brand awareness and reputation, the strength of sales and marketing efforts, customer support, as well as the cost of deploying and using our products.
Some of our existing competitors and potential competitors have larger scale, greater brand name recognition, longer operating histories, more established customer relationships and greater resources than we do. As a result, our competitors may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards or customer requirements. In addition, some competitors may offer products, solutions or services that address one or a limited number of functions at lower prices, with greater depth than our products or in different geographies. Our current and potential competitors may develop and market new products, solutions and services with comparable functionality to ours, and this could force us to decrease prices in order to remain competitive. With the introduction of new products, solutions and services and new market entrants, we expect competition to intensify in the future. In addition, some of our customers may choose to use our products and solutions and our competitors’ products and solutions at the same time.
Hainan Yile IoT receives a substantial portion of its revenues from a limited number of customers, and the loss of, or a significant reduction in usage by, one or more of its customers would result in lower revenues and could harm our business.
Our future success is dependent on establishing and maintaining successful relationships with a diverse set of customers. Hainan Yile IoT currently receives a substantial portion of its revenues from a limited number of customers, i.e. four insurance companies. In the years ended December 31, 2022, 2021 and 2020, total revenues generated from the four insurance company customers accounted for 42%, 54.3% and 8.5% of the total revenues of Hainan Yile IoT in the same periods, respectively. It is likely that we will continue to be dependent upon a limited number of customers for a significant portion of our revenues for the foreseeable future and, in some cases, the portion of our revenues attributable to one single customer may increase in the future. The loss of one or more significant customers or a reduction in usage by any significant customers would reduce our revenues. If we fail to maintain existing customers or develop relationships with new customers, our business would be harmed.
We operate in an emerging and evolving market. If our market does not grow as we expect, or if we fail to adapt and respond effectively to rapidly changing technology, evolving industry standards, changing regulations, and changing customer needs, requirements or preferences, our products and solutions may become less competitive.
The software and information technology service market in China is at an early stage of development. There are uncertainties over the size and rate at which this market will grow, as well as whether our solutions and products will be widely adopted. Moreover, the industry is subject to rapid technological change, evolving industry standards, changing regulations, as well as changing customer needs, requirements and preferences. The success of our business will depend, in part, on our ability to adapt and respond effectively to these changes on a timely basis. If we are unable to develop new solutions and products that satisfy our customers and provide enhancements and new features for our existing products that keep pace with rapid technological and industry change, our business, results of operations and financial condition could be adversely affected. If new technologies emerge that are able to deliver competitive products and services at lower prices, more efficiently, more conveniently or more securely, such technologies could adversely impact our ability to compete effectively.
Our solutions must also integrate with a variety of network, hardware, software platforms and technologies, and we need to continuously modify and enhance our products and solutions to adapt to changes and innovation. For example, if customers adopt new software platforms or infrastructure, we may be required to develop new versions of our products to be compatible with those new software platforms or infrastructure. This development effort may require significant resources, which would adversely affect our business, results of operations and financial condition. Any failure of our products and solutions to operate effectively with evolving or new software platforms and technologies could reduce the demand for our products and solutions. If we are unable to respond to these changes in a cost-effective manner, our products and solutions may become less marketable and less competitive or obsolete, and our business, results of operations and financial condition could be adversely affected.
37
Security incidents and attacks on our products or solutions could lead to significant costs and disruptions that could harm our business, financial results, and reputation.
Our business is dependent on providing our customers with safe, reliable and high-quality software solutions. Maintaining the security and availability of our systems, network, and the security of information we hold is a critical issue for us and our customers. Attacks on our customers and our own network are frequent and take a variety of forms. Malicious actors can attempt to fraudulently induce employees or suppliers to disclose sensitive information through spamming, phishing, or other tactics. We may be subject to cyber-attacks from third parties. If attacks like these were to occur in the future and if we do not have the systems and processes in place to respond to them, our business could be harmed.
The costs incurred by us to avoid or alleviate cyber or other security problems and vulnerabilities may be significant. However, our efforts to address these problems and vulnerabilities may not be successful. Any significant breach of our security measures could:
| ● | lead to the dissemination of proprietary information or sensitive, personal, or confidential data about us, our employees, or our customers—including personally identifiable information of individuals involved with our customers and their end-users; |
| ● | lead to interruptions or degradation of performance in our products and solutions; |
| ● | threaten our ability to provide our customers with access to our products and solutions, and negatively affect our abilities to retain existing customers; |
| ● | generate negative publicity about us; |
| ● | result in litigation and increased legal liability or fines; or |
| ● | lead to governmental inquiry or oversight. |
The occurrence of any of these events could harm our business or damage our brand and reputation, lead to customer credits, loss of customers, higher expenses, and possibly impede our present and future success in retaining and attracting new customers. Security incidents or attacks on our infrastructure would be damaging to our reputation and could harm our business.
Similar security risks exist with respect to our business partners and our third-party suppliers for information technology support services and administrative functions. As a result, we are subject to the risk that cyber-attacks on our business partners and third-party suppliers may adversely affect our business even if an attack or breach does not directly impact our systems. It is also possible that security breaches sustained by our competitors could result in negative publicity for our entire industry that indirectly harms our reputation and diminishes demand for our platform.
A significant portion of our RSA service revenues were derived from customers in the insurance industry. The intensifying competition, change in sector trend and landscape and government policies may have a direct impact on the insurance industry and negatively affect the stability of our clients, which may subsequently have negative impact on our business.
A significant portion of our RSA service revenues were derived from insurance companies in Hainan province. Any change in the competitive landscape, market trend or user behaviors in such sector may have a negative impact on our customers, thus harm their ability to make payments and maintain and increase the usage of our services. In addition, the insurance industry in China is highly regulated by the PRC government and numerous regulatory authorities of the central PRC government are empowered to issue and implement regulations governing various aspects of the industry. As the laws and regulations are evolving and some of them are relatively new, changes to the current laws and regulations may harm our business and results of operation. In addition, interpretation and enforcement of such laws and regulations involve significant uncertainty. As a result, in certain circumstances it may be difficult to determine what actions or omissions may be deemed to be in violations of applicable laws and regulations. If these laws and regulations or the uncertainty associated with their interpretation negatively impact the insurance industry where our customers operate, our business may be adversely affected as well.
38
Changes in practices of insurance companies in the markets in which we provide, and sell, our RSA services could adversely affect our revenues and growth potential.
We depend on the practices of insurance companies in the markets in which we provide our RSA services. The majority of our RSA customers are insurance companies, which in turn sell our RSA services to their policy holders as policy benefits. Other customers of our RSA services are drivers without any insurance coverage for RSA services. Therefore, we rely on insurance companies’ continued practice of offering RSA services as benefits under its policies and accepting our RSA services.
If any of these policies or practices change, for regulatory or commercial reasons, or if market prices for these services fall, revenues from our RSA services could decline, which could adversely affect our revenues and growth potential.
Defects or errors in our products or solutions could diminish demand for our products or solutions, harm our business and results of operations and subject us to liability.
Our customers use our products or solutions for important aspects of their businesses, and any errors, defects or disruptions to our products and solutions and any other performance problems with our products or solutions could damage our customers’ businesses and, in turn, hurt our brand and reputation. We provide regular updates to our products or solutions, which have in the past contained, and may in the future contain, undetected errors, failures, vulnerabilities and bugs when first introduced or released. Real or perceived errors, failures or bugs in our products or solutions could result in negative publicity, loss of or delay in market acceptance of our products or solutions, loss of competitive position, lower customer retention or claims by customers for losses sustained by them. In such an event, we may be required, or may choose, for customer relations or other reasons, to expend additional resources in order to help correct the problem. In addition, we do not carry insurance to compensate us for any losses that may result from claims arising from defects or disruptions in our products. As a result, our reputation and our brand could be harmed, and our business, results of operations and financial condition may be adversely affected.
In addition, our solutions and products must interoperate with our customers’ existing internal networks and infrastructure. These complex internal systems are developed, delivered, and maintained by the customer and a myriad of vendors and service providers. As a result, the components of our customers’ infrastructure have different specifications, rapidly evolve, utilize multiple protocol standards, include multiple versions and generations of products, and may be highly customized. We must be able to interoperate and provide products to customers with highly complex and customized internal networks, which requires careful planning and execution between our customers, our customer support teams and, in some cases, our channel partners. Further, when new or updated elements of our customers’ infrastructure or new industry standards or protocols are introduced, we may have to update or enhance our technologies and infrastructure to allow us to continue to provide our products or solutions to customers. Our competitors or other vendors may refuse to work with us to allow their products to interoperate with our products and solutions, which could make it difficult for our products and solutions to function properly in customer internal networks and infrastructures that include these third-party products.
We may not deliver or maintain interoperability quickly or cost-effectively, or at all. These efforts require capital investment and engineering resources. If we fail to maintain compatibility of our solutions and products with our customers’ internal networks and infrastructures, our customers may not be able to fully utilize our solutions and products, and we may, among other consequences, lose or fail to increase our market share and experience reduced demand for our products or solutions which would materially harm our business, results of operations, and financial condition.
A severe or prolonged downturn in the global or Chinese economy could materially and adversely affect our business and our financial condition.
The Chinese economy has slowed down since 2012 and such slowdown may continue. There is considerable uncertainty over the long-term effects of the expansionary monetary and fiscal policies adopted by the central banks and financial authorities of some of the world’s leading economies, including the United States and China. There have been concerns over unrest and terrorist threats in the Middle East, Europe and Africa, which have resulted in volatility in oil and other markets, and over the conflicts involving Ukraine and Syria. There have also been concerns on the relationship among China and other Asian countries, which may result in or intensify potential conflicts in relation to territorial disputes. Economic conditions in China are sensitive to global economic conditions, as well as changes in domestic economic and political policies and the expected or perceived overall economic growth rate in China.
39
Due to the impact of the COVID-19 pandemic, the global economy has slowed down, especially in infrastructure construction. Therefore, in the past two years, the market and sales of our equipment and building materials have declined and we have experienced declines in demand of our products and services. Entering into 2022, with the weakening of the pandemic situation, we expect that the international and domestic demand for equipment will gradually resume.
Any severe or prolonged slowdown in the global or Chinese economy may materially and adversely affect our business, results of operations and financial condition. In addition, continued turbulence in the international markets may adversely affect our ability to access capital markets to meet liquidity needs.
We face challenges from the evolving regulatory environment and user attitude toward data privacy and protection. Actual or alleged failure to comply with data privacy and protection laws and regulations could materially and adversely affect our business and results of operations.
We operate in a regulatory environment in which data privacy and protection is evolving. We cannot assure you that relevant governmental authorities will not interpret or implement the laws or regulations in ways that negatively affect the software and information technology service industry, our clients and us. Regulatory investigations, restrictions, penalties and sanctions, whether targeted at us or not, may negatively affect the market environment in which we operate, our existing or potential clients, and our products and services, which may in turn have a material adverse effect on our business, results of operations and financial condition. It is also possible that we may become subject to additional or new laws and regulations regarding data privacy and protection in connection with the data we have access to and the data products and services we provide to our clients. Moreover, we may become subject to regulatory requirements as a result of utilization of our products and services by residents of, or travelers who visit, certain jurisdictions, such as the General Data Protection Regulation of the European Union, or the GDPR. Complying with additional or new regulatory requirements could force us to incur substantial costs or require us to change our business practices. Moreover, if a high-profile security breach occurs with respect to our competitors, people may lose trust in the security of software solutions providers generally, including us, which could damage the reputation of the industry, result in heightened regulation and strengthened regulatory enforcement and adversely affect our business and results of operations.
Our business partners and customers may be subject to regulations related to the handling and transfer of certain types of sensitive and confidential information. Any failure of our partners or customers to comply with applicable laws and regulations would harm our business, results of operations and financial condition.
Our business partners and customers that use our products may be subject to privacy- and data protection-related laws and regulations that impose obligations in connection with the collection, processing and use of personal data, financial data, health data or other similar data.
Any failure or perceived failure by our business partners or customers to comply with applicable laws and regulations could result in their reputational damage or governmental investigations, inquiries, enforcement actions and prosecutions, private litigation, fines and penalties or adverse publicity, which may harm our business partnership and have a negative impact on our business.
We could be harmed by data loss or other security breaches.
Because we process, store, and transmit data, including personal information, failure to prevent or mitigate risks of data loss or other security breaches, including breaches of our vendors’ or customers’ technology and systems, could expose us or our customers to a risk of loss or misuse of such information, adversely affect our operating results, result in litigation or potential liability for us, deter customers from using our products and services, and otherwise harm our business and reputation. We use third-party technology and systems for a variety of reasons, including, without limitation, encryption and authentication technology, employee email, content delivery to customers, back-office support, and other functions. Some of our systems have experienced past security breaches, and, although they did not have a material adverse effect on our operating results, there can be no assurance of a similar result in the future. Although we have developed systems and processes that are designed to protect customer information and prevent data loss and other security breaches, including systems and processes designed to reduce the impact of a security breach at a third-party vendor or customer, such measures cannot provide absolute security. Moreover, in the event of a major system disruption, hardware malfunction or damages to data centers and servers caused by technologies failures, natural disasters or man-made problems, we may experience significant loss of data which would materially and adversely affect our business, financial condition and results of operations.
40
Changes in laws and regulations related to the internet or changes in the internet infrastructure itself may diminish the demand for our products and solutions, and could adversely affect our business, results of operations and financial condition.
The future success of our business depends upon the continued use of the internet as a primary medium for commerce, communications and business applications. PRC or foreign government bodies or agencies have in the past adopted, and may in the future adopt, laws or regulations affecting the use of the internet as a commercial medium. Changes in these laws or regulations could require us to modify our products and solutions in order to comply with these changes. In addition, government agencies or private organizations have imposed and may impose additional taxes, fees or other charges for accessing the internet or commerce conducted via the internet. These laws or charges could limit the growth of internet-related commerce or communications generally, or result in reductions in the demand for internet-based products and services such as our products and solutions. In addition, the use of the internet as a business tool could be adversely affected due to delays in the development or adoption of new standards and protocols to handle increased demands of internet activity, security, reliability, cost, ease-of-use, accessibility and quality of service. The performance of the internet and its acceptance as a business tool has been adversely affected by “viruses,” “worms,” and similar malicious programs. If the use of the internet is reduced as a result of these or other issues, then demand for our products or solutions could decline, which could adversely affect our business, results of operations and financial condition.
Our services rely on the stable performance of servers, and any disruption to our servers due to internal and external factors could diminish demand for our products or solutions, harm our business, our reputation and results of operations and subject us to liability.
We rely in part upon the stable performance of our servers for provision of our solutions, products and services. Any disruption to our servers may happen due to internal and external factors, such as inappropriate maintenance, defects in the servers, cyber-attacks targeted at us, occurrence of catastrophic events or human errors. Such disruption could result in negative publicity, loss of or delay in market acceptance of our solutions and products, loss of competitive position, lower customer retention or claims by customers for losses sustained by them. In such an event, we may need to expend additional resources to help with recovering. In addition, we may not carry insurance to compensate us for any losses that may result from claims arising from disruption in servers. As a result, our reputation and our brand could be harmed, and our business, results of operations and financial condition may be adversely affected.
Our use of open source or third-party software could negatively affect our ability to sell our products and solutions, and subject us to possible litigation.
Our products and solutions incorporate open-source software, and we expect to continue to incorporate open source software in our products and solutions in the future. Courts have interpreted few of the licenses applicable to open source software, and there is a risk that these licenses could be construed in a manner that could impose unanticipated conditions or restrictions on our ability to commercialize our products and solutions. Moreover, although we have implemented policies to regulate the use and incorporation of open source software into our products and solutions, we cannot be certain that we have not incorporated open source software in our products or solutions in a manner that is inconsistent with such policies. If we or our employees fail to comply with open source licenses, we may be subject to certain requirements, including requirements that we offer our products that incorporate the open source software for no cost, that we make available source code for modifications or derivative works we create based upon, incorporating or using the open source software and that we license such modifications or derivative works under the terms of applicable open source licenses. If an author or other third party that distributes such open source software were to allege that we had not complied with the conditions of one or more of these licenses, we could be required to incur significant legal expenses defending against such allegations and could be subject to significant damages, enjoined from generating revenues from customers using products that contained the open source software and required to comply with onerous conditions or restrictions on these products. In any of these events, we and our customers could be required to seek licenses from third parties in order to continue offering our products and solutions and to re-engineer our products or solutions or discontinue offering our products to customers in the event re-engineering cannot be accomplished on a timely basis. Any of the foregoing could require us to devote additional research and development resources to re-engineer our products or solutions, could result in customer dissatisfaction and may adversely affect our business, results of operations and financial condition.
41
We could incur substantial costs in protecting or defending our intellectual property rights, and any failure to protect our intellectual property could adversely affect our business, results of operations and financial condition.
Our success depends, in part, on our ability to protect our brand and the proprietary methods and technologies that we develop under patent and other intellectual property laws in China so that we can prevent others from using our inventions and proprietary information. As of the date of this annual report, we have registered 123 patents, 73 pending patent applications, 39 trademarks, 25 software copyrights, and 10 domain names in China related to our newly acquired businesses. There can be no assurance that any patents that have been issued or that may be issued in the future will provide significant protection for our intellectual property. If we fail to protect our intellectual property rights adequately, our competitors might gain access to our technology and our business, results of operations and financial condition may be adversely affected. There can be no assurance that the particular forms of intellectual property protection that we seek, including business decisions about when to file trademark applications and patent applications, will be adequate to protect our business. We may have to spend significant resources to monitor and protect our intellectual property rights. Litigation may be necessary in the future to enforce our intellectual property rights, determine the validity and scope of our proprietary rights or those of others, or defend against claims of infringement or invalidity. Such litigation could be costly, time-consuming and distracting to management, result in a diversion of significant resources, the narrowing or invalidation of portions of our intellectual property and have an adverse effect on our business, results of operations and financial condition. Our efforts to enforce our intellectual property rights may be met with defenses, counterclaims and countersuits attacking the validity and enforceability of our intellectual property rights or alleging that we infringe the counterclaimant’s own intellectual property. Any of our patents, copyrights, trademarks or other intellectual property rights could be challenged by others or invalidated through administrative process or litigation.
We also rely, in part, on confidentiality agreements and non-compete agreements with our business partners, employees, consultants, advisors, customers and others in our efforts to protect our proprietary technology, processes and methods. These agreements may not effectively prevent disclosure of our confidential information, and it may be possible for unauthorized parties to copy our software or other proprietary technology or information, or to develop similar software independently with us lacking an adequate remedy for unauthorized use or disclosure of our confidential information. In addition, others may independently discover our trade secrets and proprietary information, and in these cases, we would not be able to assert any trade secret rights against those parties. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive business position. In addition, to the extent we expand our international activities, our exposure to unauthorized copying, transfer and use of our proprietary technology or information may increase.
We cannot be certain that our means of protecting our intellectual property and proprietary rights will be adequate or that our competitors will not independently develop similar technology. If we fail to meaningfully protect our intellectual property and proprietary rights, our business, results of operations and financial condition could be adversely affected.
42
Risks Related to Our Common Shares
The market price of our Common Shares has recently declined significantly, and our Common Shares could be delisted from the Nasdaq or trading could be suspended.
The listing of our Common Shares on the Nasdaq Capital Market is contingent on our compliance with the Nasdaq Capital Market’s conditions for continued listing. On June 9, 2022, we announced that we received written notification, or the Notification Letter, from the Nasdaq Stock Market LLC on June 3, 2022 that we were not in compliance with the minimum bid price requirement of US$1.00 per share under the Nasdaq Listing Rules. In accordance with Nasdaq Listing Rules, we must regain compliance within 180 calendar days, or by November 30, 2022. To regain compliance, our Common Shares need to have a closing bid price of at least US$1.00 for a minimum of 10 consecutive business days. In the event we do not regain compliance by November 30, 2022, we could be eligible for additional time to regain compliance or may face delisting.
We have also received a written notification from the Nasdaq on December 1, 2022, notifying us that we are eligible for an additional 180 calendar day period, or until May 30, 2023, to regain compliance with Nasdaq’s continued listing requirement to maintain a minimum bid price of US$1.00 per share. During the second 180-day extension period, we intend to monitor the price of our Common Shares, and intend to effect a reverse share split of our Common Shares at a ratio which will be sufficient to increase the price of our Common Shares above $1.00. We plan to effect the reverse share split in a timely manner, only if the closing bid price of our Common Shares does not increase above a minimum bid price of at least $1.00 per share for 10 consecutive trading days prior to the end of the second 180-day extension period. There can be no assurance that we will be able to regain compliance with the minimum bid price requirement, without having to effect a reverse share split, or maintain compliance with the minimum bid price requirement, after we have regained compliance, even if we implement a reverse share split.
We cannot assure you that we will be able to regain compliance with the minimum bid price requirement under the Nasdaq Listing Rules, or that we will not receive other deficiency notifications from Nasdaq in the future. A decline in the closing price of our Common Shares could result in a breach of the requirements for listing on the Nasdaq Capital Market. If we do not maintain compliance, Nasdaq could commence suspension or delisting procedures in respect of our Common Shares. The commencement of suspension or delisting procedures by an exchange remains at the discretion of such exchange and would be publicly announced by the exchange. If a suspension or delisting were to occur, there would be significantly less liquidity in the suspended or delisted securities. In addition, our ability to raise additional necessary capital through equity or debt financing would be greatly impaired. Furthermore, with respect to any suspended or delisted Common Shares, we would expect decreases in institutional and other investor demand, analyst coverage, market making activity and information available concerning trading prices and volume, and fewer broker-dealers would be willing to execute trades with respect to such Common Shares. A suspension or delisting would likely decrease the attractiveness of our Common Shares to investors and cause the trading volume of our Common Shares to decline, which could result in a further decline in the market price of our Common Shares.
In the event that our Common Shares are delisted from Nasdaq, U.S. broker-dealers may be discouraged from effecting transactions in our Common Shares because they may be considered penny stocks and thus be subject to the penny stock rules.
The SEC has adopted a number of rules to regulate “penny stock” that restricts transactions involving stock which is deemed to be penny stock. Such rules include Rules 3a51-1, 15g-1, 15g-2, 15g-3, 15g-4, 15g-5, 15g-6, 15g-7, and 15g-9 under the Exchange Act. These rules may have the effect of reducing the liquidity of penny stocks. “Penny stocks” generally are equity securities with a price of less than $5.00 per share (other than securities registered on certain national securities exchanges or quoted on Nasdaq if current price and volume information with respect to transactions in such securities is provided by the exchange or system). Our Common Shares could be considered to be a “penny stock” within the meaning of the rules. The additional sales practice and disclosure requirements imposed upon U.S. broker-dealers may discourage such broker-dealers from effecting transactions in shares of our Common Shares, which could severely limit the market liquidity of such Common Shares and impede their sale in the secondary market.
A U.S. broker-dealer selling a penny stock to anyone other than an established customer or “accredited investor” (generally, an individual with a net worth in excess of $1,000,000 or an annual income exceeding $200,000, or $300,000 together with his or her spouse) must make a special suitability determination for the purchaser and must receive the purchaser’s written consent to the transaction prior to sale, unless the broker-dealer or the transaction is otherwise exempt. In addition, the “penny stock” regulations require the U.S. broker-dealer to deliver, prior to any transaction involving a “penny stock”, a disclosure schedule prepared in accordance with SEC standards relating to the “penny stock” market, unless the broker-dealer or the transaction is otherwise exempt. A U.S. broker-dealer is also required to disclose commissions payable to the U.S. broker-dealer and the registered representative and current quotations for the securities. Finally, a U.S. broker-dealer is required to submit monthly statements disclosing recent price information with respect to the “penny stock” held in a customer’s account and information with respect to the limited market in “penny stocks”.
43
The market for “penny stocks” has suffered in recent years from patterns of fraud and abuse. Such patterns include (i) control of the market for the security by one or a few broker-dealers that are often related to the promoter or issuer; (ii) manipulation of prices through prearranged matching of purchases and sales and false and misleading press releases; (iii) “boiler room” practices involving high-pressure sales tactics and unrealistic price projections by inexperienced sales persons; (iv) excessive and undisclosed bid-ask differentials and markups by selling broker-dealers; and (v) the wholesale dumping of the same securities by promoters and broker-dealers after prices have been manipulated to a desired level, resulting in investor losses. Our management is aware of the abuses that have occurred historically in the penny stock market. Although we do not expect to be in a position to dictate the behavior of the market or of broker-dealers who participate in the market, management will strive within the confines of practical limitations to prevent the described patterns from being established with respect to our securities.
If we are classified as a passive foreign investment company, United States taxpayers who own our Common Shares may have adverse United States federal income tax consequences.
Based on the nature of our business activities, we may be classified as a passive foreign investment company (“PFIC”), by the U.S. Internal Revenue Service (“IRS”), for U.S. federal income tax purposes. Such characterization could result in adverse U.S. tax consequences to you if you are a U.S. investor. For example, if we are a PFIC, a U.S. investor will become subject to burdensome reporting requirements. The determination of whether or not we are a PFIC is made on an annual basis and will depend on the composition of our income and assets from time to time. Specifically, we will be classified as a PFIC for U.S. tax purposes if either:
| ● | 75% or more of our gross income in a taxable year is passive income; or |
| ● | the average percentage of our assets by value in a taxable year that produce or are held for the production of passive income (which includes cash) is at least 50%. |
The calculation of the value of our assets is based, in part, on the then market value of our Common Shares, which is subject to change. In addition, the composition of our income and assets will be affected by how, and how quickly, we spend the cash we raised in our prior public offerings. We cannot assure that we will not be a PFIC for any taxable year. See “Taxation – Material United States Federal Income Tax Considerations – Passive Foreign Investment Company.”
Securities analysts may not publish favorable research or reports about our business or may publish no information at all, which could cause our stock price or trading volume to decline.
If a trading market for our Common Shares develops, the trading market will be influenced to some extent by the research and reports that industry or financial analysts publish about us and our business. We do not control these analysts. As a young public company, we may be slow to attract research coverage and the analysts who publish information about our Common Shares will have had relatively little experience with us or our industry, which could affect their ability to accurately forecast our results and could make it more likely that we fail to meet their estimates. In the event any of the analysts who cover us provide inaccurate or unfavorable research or issue an adverse opinion regarding our stock price, our stock price could decline. If one or more of these analysts cease coverage of us or fail to publish reports covering us regularly, we could lose visibility in the market, which in turn could cause our stock price or trading volume to decline and result in the loss of all or a part of your investment in us.
44
We have identified material weaknesses in our internal control over financial reporting. If we are unable to implement and maintain effective internal control over financial reporting, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our Common Shares may decline.
As a public company, we are required to maintain internal control over financial reporting and to report any material weaknesses in such internal control. In addition, we are required to furnish a report by management on the effectiveness of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act. Our independent registered public accounting firm has not conducted an audit of our internal control over financial reporting. However, in preparing our consolidated financial statements in connection with this annual report, we identified material weaknesses in our internal control over financial reporting, as defined in the standards established by the Public Company Accounting Oversight Board of the United States, or PCAOB, and other control deficiencies. The material weaknesses identified relate to (i) a lack of full-time accounting and financial reporting personnel with appropriate knowledge of U.S. GAAP and SEC reporting and compliance requirements; and (ii) a lack of an effective review by management for the year ended accounting close and reporting. As a result, our management has concluded that our internal control was not effective as of December 31, 2022.
Following the identification of the material weaknesses and control deficiencies, we have taken remedial measures, including (i) hiring external financial consultants with experience in U.S. GAAP and SEC reporting obligations; and (ii) implementing regular and continuous U.S. GAAP accounting and financial reporting training programs for our accounting and financial reporting personnel. We plan to continue implementing the above remedial initiatives including engaging more qualified accounting personnel and consultants with relevant U.S. GAAP and SEC reporting experience and qualifications to strengthen the financial reporting and U.S. GAAP training and to set up a financial and system control framework. See “Item 15. Controls and Procedures.”
However, the implementation of these measures may not fully address the material weaknesses in our internal control over financial reporting. Our failure to correct the material weaknesses or our failure to discover and address any other material weaknesses or control deficiencies could result in inaccuracies in our financial statements and could also impair our ability to comply with applicable financial reporting requirements and related regulatory filings on a timely basis. Moreover, ineffective internal control over financial reporting significantly hinders our ability to prevent fraud.
Our independent registered public accounting firm is required to attest to the effectiveness of our internal control over financial reporting in this annual report on Form 20-F as we are no longer an “emerging growth company.” However, as long as we remain a “smaller reporting company” as defined in Rule 10(f)(1) of Regulation S-K, we are not required to comply with the independent registered public accounting firm attestation requirement on our internal control over financial reporting. If we are unable to implement and maintain effective internal control over financial reporting, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our Common Shares could be negatively affected, and we could become subject to investigations by the stock exchange on which our securities are listed, the SEC, or other regulatory authorities, which could require additional financial and management resources.
General Risk Factors
Our disclosure controls and procedures may not prevent or detect all errors or acts of fraud.
Our disclosure controls and procedures must provide reasonable assurance that information we are required to disclose in reports we file or submit under the Exchange Act is accumulated and communicated to management, and recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. We believe that any disclosure controls and procedures, no matter how well-conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.
These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by an unauthorized override of the controls. Accordingly, because of the inherent limitations in our control system, misstatements due to error or fraud may occur and not be detected.
45
Our classified board structure may prevent a change in control of our Company.
Our board of directors is divided into three classes of directors. Class B directors hold office for a term expiring at the 2024 annual meeting of shareholders, Class C directors hold office for a term expiring at the 2025 annual meeting of shareholders and Class A directors hold office for a term expiring at the 2023 annual meeting of shareholders. Directors of each class are elected for three-year terms upon the expiration of their current terms. The staggered terms of our directors may reduce the possibility of a tender offer or an attempt at a change in control, even though a tender offer or change in control might be in the best interest of our shareholders.
Shares eligible for future sale may adversely affect the market price of our Common Shares, as the future sale of a substantial amount of outstanding Common Shares in the public marketplace could cause the price of our Common Shares to decrease.
The market price of our shares could decline as a result of sales of substantial amounts of our shares in the public market, or the perception that these sales could occur. In addition, these factors could make it more difficult for us to raise funds through future offerings of our Common Shares.
As the rights of stockholders under British Virgin Islands law differ from those under U.S. law, you may have fewer protections as a shareholder.
Our corporate affairs are governed by (among other things) our constitutional documents (consisting of our M&A) and the British Virgin Island’s primary corporate legislation, the British Virgin Islands Business Companies Act, 2004 (as amended) (the “BVI Act”). The British Virgin Islands has a common law legal system based on the English model, comprising statute law and binding case precedents influenced by the laws of England and other Commonwealth jurisdictions, with a right of final appeal to the Privy Council in London. The rights of shareholders to take legal action against our directors, actions by minority stockholders and the fiduciary responsibilities and duties of our directors under British Virgin Islands law are to a large extent found under common law and the BVI Act. While decisions of the BVI courts are treated as precedents in the usual way, reference often needs to be made to decided cases in other jurisdictions. While the common law of England is recognised in the jurisdiction by way of statutory enactment, this is subject to local conditions that give the court a degree of flexibility. However, in practice, the courts ordinarily treat English judgments as highly persuasive (although in certain cases, the BVI courts have declined to follow English precedents, which is normally justified by distinguishing on the basis that the position is modified in the BVI by statute). The BVI forms part of the wider jurisdiction of the Eastern Caribbean Supreme Court, so judgments from other courts in the same jurisdiction are normally persuasive, even though they are not technically binding upon the court. Judgments from other leading Commonwealth jurisdictions, particularly Australia and Hong Kong, are also often considered by the BVI courts. The rights of our shareholders and the fiduciary responsibilities of our directors under British Virgin Islands law may not be as clearly established as they would be under statutes or judicial precedents in some jurisdictions in the United States. In particular, the British Virgin Islands may have a less developed body of securities laws as compared to the United States, and some states (such as Delaware) have more fully developed and judicially interpreted bodies of corporate law.
British Virgin Islands companies may not be able to initiate shareholder derivative actions in a federal court of the United States and may have to proceed with such action in the British Virgin Islands, thereby limiting shareholders’ ability to protect their interests.
Whether a British Virgin Islands company has standing to initiate a shareholder derivative action in a federal court of the United States is a matter of United States law and in such case, that company may have to proceed with such action in the British Virgin Islands. Permission is required from the BVI Court in order for a shareholder of a BVI company to bring a derivative action in the BVI. The circumstances in which any such action may be brought, and the procedures and defenses that may be available with respect to any such action, may result in the rights of shareholders of a British Virgin Islands company being more limited than those of shareholders of a company organized in the United States. Accordingly, shareholders may have fewer alternatives available to them if they believe that corporate wrongdoing has occurred. The British Virgin Islands courts are also unlikely to recognize or enforce against us judgments of courts in the United States based on certain liability provisions of U.S. securities law; and to impose liabilities against us, in original actions brought in the British Virgin Islands, based on certain liability provisions of U.S. securities laws that are penal in nature. There is no statutory recognition in the British Virgin Islands of judgments obtained in the United States, although the courts of the British Virgin Islands will generally recognize and enforce the non-penal monetary judgment of a foreign court of competent jurisdiction without retrial on the merits.
46
The laws of the British Virgin Islands provide little protection for minority shareholders, so minority shareholders will have little or no recourse if the shareholders are dissatisfied with the conduct of our affairs.
Under the law of the British Virgin Islands, there is little statutory law for the protection of minority shareholders other than the provisions of the BVI Act dealing with shareholder remedies. The principal protection under statutory law is that shareholders may bring an action to enforce the constituent documents of the corporation, in our case, our M&A. Shareholders are entitled to have the affairs of the Company conducted in accordance with the general law and the Memorandum and Articles.
We are a “foreign private issuer,” and our disclosure obligations differ from those of U.S. domestic reporting companies. As a result, we may not provide you the same information as U.S. domestic reporting companies or we may provide information at different times, which may make it more difficult for you to evaluate our performance and prospects.
We are a foreign private issuer and, as a result, we are not subject to the same requirements as U.S. domestic issuers. Under the Exchange Act, we are subject to reporting obligations that, to some extent, are more lenient and less frequent than those of U.S. domestic reporting companies. For example, we are not required to issue quarterly reports or proxy statements and we do not intend to file quarterly reports. We are not required to disclose detailed individual executive compensation information and we do not intend to disclose detailed executive compensation information. Furthermore, our directors and executive officers are not required to report equity holdings under Section 16 of the Exchange Act and are not subject to the insider short-swing profit disclosure and recovery regime and we do not intend to file Section 16 reports for officers and directors.
As a foreign private issuer, we are also exempt from the requirements of Regulation FD (Fair Disclosure) which, generally, are meant to ensure that select groups of investors are not privy to specific information about an issuer before other investors. However, we do plan to disclose material information to all investors at this time. In addition, we are still subject to the anti-fraud and anti-manipulation rules of the SEC, such as Rule 10b-5 under the Exchange Act. Since many of the disclosure obligations imposed on us as a foreign private issuer differ from those imposed on U.S. domestic reporting companies, you should not expect to receive the same information about us and at the same time as the information provided by U.S. domestic reporting companies.
We are subject to changing law and regulations regarding regulatory matters, corporate governance and public disclosure that have increased both our costs and the risk of non-compliance.
We are subject to rules and regulations by various governing bodies, including, for example, the SEC, which are charged with the protection of investors and the oversight of companies whose securities are publicly traded, and to new and evolving regulatory measures under applicable law, including the laws of the BVI. Our efforts to comply with new and changing laws and regulations have resulted in and are likely to continue to result in, increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities.
Moreover, because these laws, regulations and standards are subject to varying interpretations, their application in practice may evolve over time as new guidance becomes available. This evolution may result in continuing uncertainty regarding compliance matters and additional costs necessitated by ongoing revisions to our disclosure and governance practices. If we fail to address and comply with these regulations and any subsequent changes, we may be subject to penalty and our business may be harmed.
Mail addressed to the Company at its registered office may be delayed due to forwarding practice.
Mail addressed to the Company and received at its registered office will be forwarded unopened to the forwarding address supplied by the Company to be dealt with. None of the Company, its directors, officers, advisors or service providers (including the organization which provides registered office services in the BVI) will bear any responsibility for any delay howsoever caused in mail reaching the forwarding address.
47
Item 4. Information on the Company
| A. | History and development of the company. |
Corporate History
ReTo is a BVI business company with limited liability, established under the laws of the BVI on August 7, 2015 as a holding company to develop business opportunities in China.
On November 29, 2017, ReTo completed its IPO of 3,220,000 Common Shares at a public offering price of $5.00 per share. In connection with the IPO, the Company’s Common Shares began trading on the Nasdaq Capital Market beginning on November 29, 2017 under the symbol “RETO.”
ReTo owns 100% equity interest of REIT Holdings, a limited liability company established in Hong Kong. Beijing REIT was established on May 12, 1999 under the laws of PRC. Over the years, Beijing REIT established four subsidiaries consisting of: Gu’an REIT Machinery Manufacturing Co., Ltd. (“Gu’an REIT”), which was incorporated on May 12, 2008; Beijing REIT Ecological, which was incorporated on April 24, 2014; Langfang Ruirong Mechanical and Electrical Equipment Co., Ltd., which was incorporated on May 12, 2014 and was subsequently dissolved in 2021; and REIT Technology Development (America), Inc., a California corporation, which was incorporated on February 27, 2014 and was dissolved in March 2022.
On February 7, 2016, Beijing REIT and its individual original shareholders entered into an equity transfer agreement, pursuant to which these shareholders agreed to transfer all of their ownership interests in Beijing REIT with a carrying value of RMB 24 million (or $3,466,260) to REIT Holdings. After this equity transfer, Beijing REIT became a wholly foreign-owned enterprise and amended the registration with the State Administration of Market Regulation on March 21, 2016.
REIT Changjiang was incorporated in Hainan Province, China, on November 22, 2011 with the original registered capital of RMB 100 million (approximately $15.7 million). REIT Changjiang was engaged in hauling and processing construction and mining waste, with which it produces recycled aggregates and bricks for environmental-friendly uses prior to the disposition of REIT Changjiang in December 2021.
On June 1, 2015, REIT Construction was incorporated as a wholly owned subsidiary of REIT Changjiang.
On July 15, 2015, Beijing REIT established a joint venture, Xinyi REIT, together with Xinyi City Transportation Investment Co., Ltd. (“Xinyi TI”), a third party. Beijing REIT owns 70% equity interest of Xinyi REIT, with the remaining 30% owned by Xinyi TI.
On September 20, 2015, Beijing REIT acquired 100% of the equity interest of Nanjing Dingxuan Environment Protection Technology Development Co., Ltd. (“Nanjing Dingxuan”) from a third party for no consideration given the company’s registered capital was not paid and had no assets or operations. Nanjing Dingxuan was engaged in providing technical support and consulting services for environmental protection projects but its operation was suspended in 2021 and the company was further dissolved on August 30, 2022.
In February 2016, Beijing REIT established a joint venture, REIT Q GREEN Machines Private Limited (“REIT India”), together with an Indian company, Q Green Techcon Private Limited (“Q Green”). Beijing REIT owns 51% equity interest of REIT India with the remaining 49% owned by Q Green.
On October 22, 2018, REIT Ordos was incorporated as a wholly owned subsidiary of REIT Holdings.
On August 29, 2019, Datong Ruisheng Environmental Engineering Co., Ltd. (“Datong Ruisheng”) was incorporated as a wholly owned subsidiary of Beijing REIT. Datong Ruisheng is engaged in potential ecological restoration projects in Datong, Shanxi Province.
48
On November 11, 2019, Yangbi Litu Ecological Technology Co., Ltd. (“Yangbi Litu”) was jointly established by REIT Ordos and Yunnan Litu Technology Development Co., Ltd. (“Yunnan Litu”). REIT Ordos owned 55% of the ownership interest in Yangbi Litu, with the remaining 45% equity interest owned by Yunnan Litu. Because the Company’s ownership interest in Yunnan Litu was 55%, the Company held an aggregate 79.75% equity interest in Yangbi Litu, directly and indirectly. Yangbi Litu will be engaged in providing services in comprehensive ecological restoration and sales of environmentally friendly equipment and new materials. On July 13, 2020, REIT Ordos transferred its 55% equity interest in Yunnan Litu to a third-party individual and two third-party companies for a nominal price. As a result, the Company’s equity ownership interest in Yangbi Litu decreased from 79.75% to 55%. On July 13, 2020, ReTo transferred its 55% equity interests in Yunnan Litu to third parties for a nominal price given the inactivity of Yunnan Litu’s business operations since its inception and ReTo’s ongoing focus on its own organic business growth.
On January 2, 2020, Beijing REIT signed a share transfer agreement with third party, Hebei Huishitong Techonology Inc. (“Huishitong”) and sold 100% of its ownership interest in Gu’an REIT to Huishitong for total consideration of RMB 39.9 million (approximately $5.7 million).
On September 7, 2020, Beijing REIT entered into a share transfer agreement with the original shareholder of Shexian Ruibo Environmental Science and Technology Co., Ltd. (“Shexian Ruibo”) for the acquisition of 41.67% of the equity interests in Shexian Ruibo for a total consideration of $3.6 million (RMB 25 million), including a cash payment of $2.7 million (RMB 18.5 million) and non-cash contribution of six patents valued at $0.9 million (RMB 6.5 million). Beijing REIT made cash payment of $2.7 million (RMB 18.5 million) on October 20, 2020 and the six patents had been transferred to Shexian Ruibo prior to September 15, 2020.
In December 2020, we incorporated Guangling REIT Ecological Cultural Tourism Co., Ltd. (“Guangling REIT”) in mainland China as a wholly owned subsidiary of REIT Ordos. Guangling REIT will be engaged in the business of ecological restoration and management, and construction and operation of health and cultural tourism projects.
On November 12, 2021, Beijing REIT and REIT Holdings entered into an equity transfer agreement to sell 100% equity interest in REIT Changjiang to the purchasers, in exchange for a total consideration of RMB 60,000,000 (approximately $9.4 million) in cash. The purchasers have issued to Beijing REIT and REIT Holdings a promissory note in the principal amount of RMB 60,000,000, reflecting the purchase price to be paid in accordance with the equity transfer agreement. As of December 31, 2022, we received a total of RMB 53.5 million (approximately US$7.76 million) from the purchasers with the remaining RMB 7.4 million (approximately US$1.1 million) expected to be paid by the purchasers by June 30, 2024. In December 2021, we completed the disposition of REIT Changjiang following the approval of our shareholders and board of directors.
On December 27, 2021, REIT Technology acquired 100% equity interest of REIT Mingde, as more fully described under the heading “Recent Developments” below. As a result of this acquisition, the Company also acquired, indirectly through RETI Mingde, 100% of the equity interest of Yangpu Fangyuyuan and 61.548% of the equity interest of Hainan Yile IoT, which, in turn, owns 90% of the equity interest of IoV Technology Research, 85% of the equity interest of Shanxi Global Travel Co., Ltd. and 45% of the equity interest of Hainan Beiqi Yinjian Yile Smart Travel Technology Co., Ltd. Yangpu Fangyuyuan is engaged in facilitating logistic services through its cloud based platform in China. IoV Technology Research provides RSA services in Hainan Province, China.
On December 27, 2021, Yangpu Fangyuyuan and Shanghai Ruida Fenghe Management Consulting Partnership (Limited Partnership) incorporated Hainan Kunneng as a limited liability company to engage in the development of an international commodity trading platform for the Hainan International Trade Zone, using digital supply chain technologies. Yangpu Fangyuyuan owns 51% of Hainan Kunneng’s equity interest while Shanghai Ruida Fenghe Management Consulting Partnership (Limited Partnership) owns 49%. Hainan Kunneng commenced operations in January 2022.
On August 24, 2022, due to the addition of a new shareholder, REIT Mingde became a 90% owner of Yangpu Fangyuyuan’s equity interest.
49
On August 25, 2022, Hainan Coconut was incorporated as a wholly owned subsidiary of Yangpu Fangyuyuan. Hainan Coconut plans to build an online freight and logistics platform to provide logistics and transportation services. As of the date of this annual report, Hainan Coconut has not commenced its operations.
On September 30, 2022, Gansu Ruishi Tongda Ecological Management Co., Ltd. was incorporated as a limited liability company in mainland China and REIT Ecological owns 70% of its equity interest. Its business scope includes project management, project investment and financing, and other ecological management projects. It was dissolved on March 7, 2023.
On November 29, 2022, Honghe REIT Ecological Technology Co., Ltd. was incorporated as an operating limited liability company in mainland China and a wholly-owned subsidiary of REIT Ordos. Its business scope includes EOD projects and related ecological restoration projects.
On February 9, 2023, REIT Construction was dissolved.
Corporate Structure
The chart below summarizes our corporate structure as of the date of this report:
50
| B. | Business overview. |
Overview
We, through our operating subsidiaries in China, are engaged in the manufacture and distribution of eco-friendly construction materials (aggregates, bricks, pavers and tiles), made from mining waste (iron tailings), as well as equipment used for the production of these eco-friendly construction materials. In addition, we provide consultation, design, project implementation and construction of urban ecological protection projects through our operating subsidiaries in China. We also provide parts, engineering support, consulting, technical advice and service, and other project-related solutions for our manufacturing equipment and environmental protection projects. As more fully described below under the heading “Our Products and Services,” through the newly acquired subsidiaries, we expand our product and service offerings to include RSA services, and software development services and solutions utilizing Internet of Things (“IoT”) technologies.
We currently provide a full spectrum of products and services related to recycling and reuse of solid wastes, from producing eco-friendly construction materials and manufacturing equipment used to produce construction materials, to project installation. We differentiate us from our competitors through strong research and development capabilities and advanced technologies and systems.
Our products are eco-friendly, as they contain approximately 70% of reclaimed iron tailings in place of traditional cement. The use of reclaimed iron tailings assists in the protection of the environment by saving space in landfills used for the disposal of these materials, and assisting in the remediation and reclamation of abandoned or closed mining sites. In addition, we believe less energy is consumed when manufacturing our eco-friendly construction materials as compared with other traditional building materials. We believe our eco-friendly construction materials, with superior water permeability and competitive prices, are in greater demand than traditional materials as governments and others increase their focus on reducing the environmental impact of their activities.
Due to China’s recent emphasis on environmental protection, we believe there is a unique opportunity to grow our company, which we expect will be driven by demand for our eco-friendly construction materials and equipment used to produce these materials as well as our project construction expertise. We believe our technological know-how, production capacity, reputation and offerings of products and services will enable us to seize this opportunity.
Our clients are located throughout mainland China, and internationally in Middle East, Southeastern Asia, Africa, Europe and North America. We are actively pursuing additional clients for our products, equipment and projects, internationally in the Bangladesh, North America and in additional provinces of China. We seek to establish long-term relationships with our clients by producing and delivering high-quality products and equipment and then providing technical support and consulting services after equipment is delivered and projects are completed.
Recent Developments
Spinoff of REIT Changjiang
On November 12, 2021, Beijing REIT and REIT Holdings entered into an equity transfer agreement to sell 100% equity interest in REIT Changjiang to Zhixin Group (Hong Kong) Co., Ltd. and Xiamen Zhixin Building Materials Co., Ltd. (collectively, the “Purchasers”) in exchange for a total consideration of RMB 60,000,000 (approximately $9.4 million) in cash. The Purchasers have issued to Beijing REIT and REIT Holdings a promissory note in the principal amount of RMB 60,000,000, reflecting the purchase price to be paid in accordance with the equity transfer agreement. The parties entered into a supplemental agreement on December 24, 2021, providing for a revised payment schedule for the purchase price. As of December 31, 2022, we received a total of RMB 53.5 million (approximately US$7.76 million) from the purchasers with the remaining RMB 7.4 million (approximately US$1.1 million) expected to be paid by the purchasers by June 30, 2024. On December 17, 2021, we completed the disposition of REIT Changjiang following the approval of our shareholders and board of directors.
51
Acquisition of REIT Mingde
On December 27, 2021, REIT Technology entered into an Equity Transfer Agreement (the “Agreement”) with REIT Mingde, Xiaoping Li and Jing Peng, former shareholders of REIT Mingde and owning 99% and 1% of the equity interest of REIT Mingde prior to the Acquisition (as defined below), respectively, and together with Hainan Yile IoT, a limited liability company incorporated in mainland China and subsidiary of REIT Mingde, and Yangpu Fangyuyuan United Logistics Co., Ltd., a limited liability company incorporated in mainland China and subsidiary of REIT Mingde (“Yangpu Fangyuyuan”). REIT Mingde owned 90% of the equity interest of Yangpu Fangyuyuan and 61.55% of the equity interest of Hainan Yile IoT.
Pursuant to the Agreement, among other things, REIT Technology acquired 100% of the equity interest of REIT Mingde for a total consideration of RMB10,000,000 (approximately US$1.6 million) in cash or cash equivalents (the “Acquisition”). After the closing of the Acquisition, Xiaoping Li, who is also the legal representative of REIT Mingde, will be appointed as a director and Executive Vice President of ReTo.
On February 22, 2022, ReTo issued an aggregate of 2,580,000 Common Shares to Xiaoping Li and Jing Peng (and/or their designees), at $0.61 per share, in lieu of the cash payment of an aggregate of RMB 10 million payable to Xiaoping Li and Jing Peng under the Acquisition. The 2,580,000 Common Shares represented approximately 8.45% of the issued and outstanding Common Shares of ReTo immediately prior to the issuance.
Convertible Note Financing
On March 10, 2022, ReTo entered into a Securities Purchase Agreement pursuant to which ReTo issued an unsecured convertible promissory note (the “Note”) to Streeterville Capital, LLC, an institutional accredited investor (the “Investor”). The Note will mature 12 months after the purchase price of the Note is delivered from the Investor to ReTo (the “Purchase Price Date”). The Note has an original principal amount of $3,105,000 and Investor gave consideration of $3,000,000, reflecting an original issue discount of $90,000 and $15,000 for Investor’s fees, costs and other transaction expenses incurred in connection with the purchase and sale of the Note. The transaction contemplated under the Securities Purchase Agreement was closed on March 11, 2022 and the Company anticipates using the proceeds for general working capital purposes.
On March 28, 2022, ReTo and Investor entered into an amendment to the Note, pursuant to which ReTo has agreed to satisfy any conversion request from Investor by making a cash payment equal to 110% of any converted amount if, at the time of the conversion, the Floor Price (as defined in the Note) is higher than the then current conversion price.
On October 13, 2022, the Company entered into a standstill agreement with the Investor. Pursuant to the standstill agreement, the Investor agreed not to seek to convert any portion of the Note until December 10, 2022 (the “Standstill Period”). Balance of the Note was increased by $310,500 (the “Standstill Fee”) as of the date of the standstill agreement. The parties have agreed to extend the Note and are in the process of negotiating the terms of the extension as of the date of this annual report.
Industry and Market Opportunities
Construction and Construction Materials Markets
From 2011 to 2020, the total output value of China’s construction industry showed an upward trend year by year. Although China’s economic growth has slowed in recent years, it is believed China is, and will continue to be, the world’s largest construction market for a number of years despite the decline of its share of the global construction industry.
The slowdown in China’s urbanization process since 2020 has a significant impact on the construction industry. However, we believe our eco-friendly construction materials will be in greater demand than traditional materials as the PRC construction market continues to grow and the PRC government increases its focus on reducing the environmental impact of construction activities, which includes, among other things, recent environmental initiatives.
52
Sponge city. The concept of the “sponge city” proposed by PRC scientists and politicians is equivalent to the “Sustainable Drainage Systems” (SuDS) in the United Kingdom as well as the “Low Impact Development” in the United States. Sponge cities are being constructed nationwide in China, not only in new urban (town) areas, but also in the transformation of existing urban (town) areas. In the “14th Five-Year Plan” (2021-2025) announced by China in March 2021, “sponge city construction” will remain one of the PRC government’s investment focuses for the next few years, which will not only lead to changes in materials for municipal pavement, pond slope protection and other construction purposes, but also create an ongoing need for these materials.
Water ecological restoration and high-standard farmland construction. In China’s 14th Five-Year Plan, water conservation continues to be the top priority of the national infrastructure network, with emphases on water resource management, water ecological restoration and environmental water protection. In 2021, the Ministry of Agriculture and Rural Affairs of China issued the National High-standard Farmland Construction Plan (2021-2030), and provide for some specific indicators for the farmlands, water and roads. We believe this will create higher demands for construction projects such as ecological slope protection (retaining walls), dry barrier walls (SRWs), and drainage trenches and thereby bring us new market from molding equipment and small precast concrete products.
“Rural revitalization” and “urban renewal”. In January 2022, the Opinions of the Central Committee of the Communist Party of China and the State Council on Doing a Good Job in Comprehensively Promoting the Key Work of Rural Revitalization in 2022 was issued by the Central Committee of the Communist Party of China and the State Council. Also known as “Document No. 1,” the Opinions is the first official policy document issued by the PRC government in the new year that traditionally focuses on rural issues with this year’s focus on the advancement of rural revitalization. Rural revitalization calls for high standard farmland construction, advancement of agricultural infrastructure, and improvement of the implementation of rural conduction system, among other things.
In addition, in November 2021, the General Office of the Ministry of Housing and Urban-Rural Development of the PRC issued the Notice on Launching the First Batch of Urban Renewal Pilot Work, and decided to carry out the first batch of urban renewal pilot work in a two-year period in 21 cities (districts) including Beijing. The connotation of “urban renewal” is to “promote the optimization of urban structure, function improvement and quality improvement”. It is believed that “Urban renewal” is fundamentally different from the previous “old city renovation” and includes the renovation of the old city, with a higher level and a wider scope, including house renovation (demolition) and road renovation, as well as preservation of urban culture and customs, and division of functional areas. We believe the rural revitalization and urban renewal policies of the PRC government will create demand for construction materials, in particular in the concrete blocks (bricks) industry, which will bring opportunities to increase product value and competition for product differentiation, optimize product structures and improve the equipment functionalities.
Eco-friendly raw materials and low carbon products. The current Industrial Structure Adjustment Guidance Catalogue (2019 Version) issued by the National Development and Reform Commission of the PRC, list pavement bricks (boards), pavement permeable bricks (boards), square permeable bricks (boards), decorative bricks (blocks), antique bricks, slope protection ecological bricks (blocks), hydraulic ecological bricks (blocks) and other green building materials in the Encouraged Category: Building Materials. The catalogue proposes in “Encouraged Categories: Environmental protection and comprehensive utilization of resource conservation, the comprehensive utilization of tailings, waste residues and other resources and the manufacture of supporting equipment” as well as the “construction waste recycling project and industrialization.” As China aims to achieve peak carbon dioxide emission before 2030 and achieve carbon neutrality before 2060, certification of green buildings in China continues to advance. The government commitment and related policies to support green buildings development will create growth opportunities for eco-friendly construction materials, including the concrete blocks (bricks) which are one of our main products.
53
As a result of the above government initiatives and market trends, we expect the demand for equipment for manufacturing eco-friendly building materials to recover and increase. In response, we have improved our existing equipment and technologies to meet the market demands. Specifically, we have improved the degree of automation of our equipment, further optimized the technology to use solid waste, realized timely customer services through use of Internet technology and developed production lines with a larger output. We plan to leverage our advanced production and advanced research and development research capabilities to take advantages of the opportunities created by these government initiatives and market demands and provide high quality eco-friendly construction materials.
Automotive After-Sales Market
According to the data reported by Xinhua News Agency in 2020, the automotive after-sales market continues to recover and was estimated to exceed a total consumption amount of RMB one trillion (approximately $157.1 billion ) for 2020. The automotive after-sales refers to the transactions or services during the use of sold cars. In the automotive after-sales market, fuel is the largest segment with an average annual market size of RMB 2.6 trillion (approximately $408.5 billion ) from 2019 to 2021, and insurance is the second largest segment with an average annual market size of about RMB 800 billion (approximately $125.7 billion ), which is our targeted segment.
In September 2020, the China Banking and Insurance Regulatory Commission formulated and issued the Guiding Opinions on Implementing Comprehensive Reform of Auto Insurance, requiring insurance companies to achieve the reform goals of “reducing prices, increasing coverage and improving quality” of auto insurance. The Guiding Opinion also call for development of new insurance products, including the vehicle mileage insurance. As a result, it is expected that the growth of the segment will slow down and market size will decrease in the near future.
With the explosive growth of new energy vehicle production and sales, traditional auto insurance no longer meets the demand, and relevant insurance companies have launched corresponding new energy vehicle insurance. The initial market size is expected to be RMB 17 billion (approximately $2.8 billion). According to the “New Energy Vehicle Industry Development Plan (2021-2035)” issued by Ministry of Industry and Information Technology, by 2025, China sets the goal to have its new energy vehicle sales account for about 20% of the total vehicle sales. New energy vehicle insurance market in China is therefore expected to expand further.
However, after years of expansion, China’s auto insurance market has started to experience a significant slowdown in the increase in premiums, as a result of the reform and saturation of the auto insurance market and the resulting decrease in average premium per policy and increase marketization of auto insurance. Auto insurance premiums in China showed an increasing growth trend during 2013 to 2020 and reached an aggregate of RMB 824.5 billion (approximately $129.6 million) in 2020, representing an increase of 0.7% from the prior year. During the first three quarters of 2021, China’s auto insurance premiums were RMB562.2 billion (approximately $88.3 million), showing a cumulative decrease of 9.44% as compared to the same period in the prior year.
According to the s data released by the Hainan Insurance Industry Association, there was a total of approximately 108,100 and 120,500 car accidents (involving solely the mandatory liability insurance cases that occurred and closed during the relevant year, excluding single-vehicle accidents) in Hainan province, representing an average of approximately 296 and 330 accident per day, respectively.
Software and Information Technology Service Industry
In recent years, with the rapid expansion of China’s software and information technology service industry and the significant advancement in technologies, the industry has become an important part of the strategic emerging industries. According to the 14th Five-Year Plan Software and Information Technology Service Industry Development Plan, during the 13th Five-Year Plan period, the revenue of the software and information technology service industry increased from RMB4.28 trillion (approximately $672.5 billion) in 2015 to RMB8.16 trillion (approximately $128.2 billion) in 2020, with an average annual growth rate of 13.8%, and its share of the information industry has increased from 28% in 2015 to 40% in 2020. The total profit of the software and information technology service industry has increased from RMB576.6 billion (approximately $90.6 billion) in 2015 to RMB1,067.6 billion (approximately $16.7 billion) in 2020, with an average annual growth rate of 13.1% and its share of the information industry has increased from 51% in 2015 to 64% in 2020. The information technology services revenue increased from 51.2% of the information technology in 2015 to 61.1% in 2020. Emerging platform software, industrial application software, and embedded software has developed rapidly while revenue from basic software and industrial software products has continued to grow. According to the Analysis Report on Market Prospects and Investment Strategic Planning of China’s Software Industry released by the Prospective Industry Research Institute, in 2021, there were more than 40,000 enterprises above designated size in the software and information technology service industries in China, and the accumulated software business revenue was RMB9,499.4 billion (approximately $149.3 billion), representing a year-on-year increase of 17.7%. The 14th Five-Year Plan for Software and Information Technology Service Industry Development Plan sets out the development goals, i.e., the software business revenue of enterprises above designated size will exceed RMB14 trillion (approximately $220 billion), with an average annual growth rate of more than 12%.
54
Our Competitive Strengths
We believe the following competitive strengths differentiate us from our competitors and contribute to our ongoing success.
Eco-friendly products. Unlike many of our competitors, who still use traditional materials, we use reclaimed iron tailings to manufacture our construction materials. In doing so, we help reduce environmental waste. In addition, the equipment we used to produce construction materials can recycle disposed building materials, including, without limitation, waste clay bricks and waste concrete, to manufacture construction materials.
Effective operational management. The consistent quality of our products and manufacturing equipment is achievable only through effective management in all aspects of our operations, from purchasing to production and sales. In every step, we have fully trained, experienced and skilled employees to ensure the quality of our construction materials and manufacturing equipment. In addition, we have a committed and qualified management team who fully understand our corporate culture and effectively implement our business strategy.
Proprietary technologies and strong research and development capabilities. We have developed key technologies and knowhow in the manufacture of various types of construction materials and manufacturing equipment. We own an aggregate of 123 PRC patents (ten of which are owned jointly with Luoyang Water-Conservancy Surveying & Design Co., Ltd. (“Luoyang”), an independent third party), including 31 design patents, 82 utility model patents and ten invention patents. Three of our patents were awarded Gold and Silver Prize of International Exhibition of Inventions of Geneva. In addition, we own 25 software copyrights in China.
We are committed to the research and development of new construction materials and the equipment used to produce these materials. As of the date of this annual report, our research and development team consists of an aggregate of 41 staff, accounting for approximately 40% of our total employees. Of all our research and development staff, 25 hold bachelor’s degree or higher degrees. Our team has an average of five years of experience in research and development in relevant industries.
Full range of eco-friendly project solutions. We are able to provide consultation, design and implementation of projects such as sponge city and hydraulic ecological projects for customers, in addition to manufacturing and sales of eco-friendly construction materials and equipment. Our one-stop solution allows us to capture revenue from all stages of a project and serve more types of customers, such as municipalities and governments.
Experienced management team and work force. Our management team, led by Hengfang Li, our Chief Executive Officer, who has extensive industry experience, deep knowledge of our business and a demonstrated track record of managing costs, adapting to changing market conditions, and developing new products. In addition, Mr. Li has a vast network and understating of the market. In addition, following the acquisition of REIT Mingde, we expect to leverage the expertise of Mr. Li Xiaoping, Chairman of REIT Mingde, in the field of mobile communication and IoT and his extensive experience in business management and operations, to grow and expand our businesses related to the application of the IoT technologies. Mr. Li has more than 20 years of experience in the communication and IoT industry. He worked and held senior positions at Nokia Corporation Asia Pacific, and Huawei Technology Services Co., Ltd. successively before he founded his own businesses, including Hainan Yile IoT, among others.
We also maintain a well-trained workforce that is highly skilled and capable to address complex and individualized client issues.
55
Our Strategies
Our objective is to become the leading provider of eco-friendly construction materials and equipment. Following our acquisition of REIT Mingde, we also aim to expand the application of our IoT solutions and products for commercial use vehicles, build smart environmental protection solutions and logistics and supply chain services. To achieve these goals, we are pursuing the following strategies:
Market Opportunity. China’s 14th Five-Year Plan (2021-2025) promotes a cleaner and greener economy, with strong commitments to environmental management and protection, clean energy and emissions controls, ecological protection and security, and the development of renewable energy industry. This demonstrates a clear focus on charting a sustainable course for the economy in the long-term. The 14th Five-Year Plan offers opportunities for the private sector to support China’s environmental goals of water resource management, water ecology remediation and environmental protection of water, such as through the construction of sponge cities and the use of eco-friendly construction materials. Presently, we are able to serve all facets of sponge city construction through our construction materials that are used in construction, our equipment that can produce the construction materials and our general contracting expertise.
The 14th Five-Year Plan also calls for the strengthening of the innovation and application of key digital technologies, the acceleration of digitalization development in China and the promotion of transition of industry digitalization. The plan lists the IoT industry as one of the key industries of a digital economy. We plan to take advantages of the resources and support available under the 14th Five-Year Plan and promote the in-depth integration of the IoT technologies with the equipment manufacturing industry, the ecological restoration market and the automotive after-sales market based our existing experience and expertise in the IoT technologies and RSA services.
Expand our remediation projects in mining regions. We believe there are thousands of former mining locations in China that need to be remediated and reclaimed. Abandoned ore mines contain tailings and abandoned or closed mines are normally associated with environmental concerns such as contaminated water and soil. As part of the remediation and reclamation process, we are able to assist mining companies with the disposal of tailings, and municipalities creating viable villages in former mining areas. For example, in 2015, we completed a sponge city project in Hainan Province where a village located in a former mining area was built with our eco-friendly construction materials made from iron tailings. We will continue to focus on using iron tailings in our eco-friendly construction materials and seek reclamation projects in former mining areas.
Continue to develop new products. We are committed to the research and development of new products for specific customer needs. We plan to develop advanced technologies and devices for our equipment and innovate the new type of the construction products for sponge cities, water ecological restoration and high-standard farmland construction. We believe scientific and technological innovations will help our Company achieve its long-term strategic objectives.
Increase our revenue and market share by expanding our business network internationally. In order to expand our international market share, we plan to add four to five distributors in America, Southeast Asia, and the Middle East. We plan to change our advertising strategies to reach new customers through new methods, such as digital marketing. We also plan to participate in targeted international marketing events, such as seminars, workshops, and trade shows, where we can meet potential customers, promote our products and deepen our network to further expand our sales.
Take advantage of the Hainan Free Trade Port policy. Hainan province government recently promulgated the Hainan Province’s Three-Year Action Plan to Win the Battle of Science and Technology Innovation by Extraordinary Means (2021-2023) (Qiong Fu Ban [2021] No. 24) and the Hainan Province Science and Technology Planning System Optimization and Reform Plan (Qionke [2021] No. 250)in an aim to promote the technology innovation-driven development of enterprises. The government is promoting the establishment of the Haikou City Research and Development Center for Internet of Things Digitalization Application Engineering and Technology” and gathers resources for and renovation and development of high technologies. The government offers subsidies, tax incentives as well as support for introducing talents to the province, such as housing subsidies and bonuses. We plan to take advantages of the government resources and support of the Hainan Free Trade Port to further the development of our technologies and our business operations.
56
Pursue Strategic Acquisitions. We intend to continue to pursue expansion opportunities in existing and new markets, as well as in core and adjacent categories through strategic acquisitions. Specifically, we are seeking to acquire construction material or construction material manufacturing equipment companies in areas of China with more established economies. We believe the demand for eco-friendly construction materials and manufacturing equipment used to produce these materials are and will continue to be in greater demand in these established economies.
Our Products and Services
Eco-Friendly Construction Materials
We manufacture eco-friendly construction materials (aggregates, bricks, pavers and tiles) through our subsidiary, Xinyi REIT, which operates our plant in Xinyi, Jiangsu Province. We refer to our construction materials as eco-friendly because we produce them from reclaimed iron mine tailings. Tailings are the materials left over after the process of separating the valuable fraction from the worthless fraction of an ore. Iron ore tailings generally consist of hard rock and sand. Waste rock and tailings constitute the largest (by volume) industrial solid waste generated in the mining process. Xinyi REIT has utilized construction and demolition waste (which is the disposed bricks and/or concrete after the old building is dismantled) as the raw materials to produce the products. By recycling iron tailings and utilizing the construction and demolition waste, we believe that our construction materials manufacturing process is a viable and environmentally friendly solution to disposal problems associated with these materials.
Traditional bricks in China consist primarily of clay, which is mixed with water and silt, pressed into a mold for shaping, then fired in a kiln, or furnace. We use reclaimed iron tailings or construction and demolition waste primarily as a substitute for rocks. Through vibration technology, with these raw materials inputted, the finished products can come out with different shape and types. Since the whole production is cured without fire, this process has the benefits of less space required for production and less pollution generated to the environment. We believe iron tailings or construction and demolition waste reduce both the density and heat conductivity of our construction materials without sacrificing their durability and strength. Our construction materials’ density and strength meet or exceed China national standards. In addition, because we use iron tailings or construction and demolition waste in the manufacturing process, we believe our construction materials are consistent with China’s recent environmental protection policies, such as energy conservation included in the 2016 China’s 14th Five-Year Plan (2021-2025).
In addition to iron tailings and construction and demolition waste, our construction materials contain river sand and granite. Our eco-friendly construction materials are produced on a fully automatic production line primarily based upon our proprietary technology.
Our eco-friendly construction materials include, without limitation, the following:
| ● | Ground works materials. Essential materials for sponge cities to assist in water absorption, flood control and water retention. These construction materials can be used for urban roads, pedestrian streets and sidewalks, city squares, landmarks, parking lots, and docks. |
| ● | Landscape retaining materials. These construction materials are mainly used for gardens, roads, bridges, city squares, retaining walls and slope construction. |
| ● | Hydraulic engineering materials. Construction material for sponge city construction, they can be used for hydraulic ecological projects such as slope protection and river transformation. |
| ● | Wall materials. These construction materials are used for insulation, decoration, and for building walls. |
57
Eco-friendly Construction Materials Manufacturing Equipment
We produce manufacturing equipment used to create eco-friendly construction materials. We sell our equipment to customers in China, South Asia, North America, the Middle East, North Africa and Southeast Asia. The equipment consists of large-scale fully automated production equipment with hydraulic integration. The equipment can be used to produce various types of eco-friendly construction materials that can be used for a variety of projects such as ground works, hydraulic engineering, landscape retention and wall projects.
Our equipment used to manufacture construction materials include, without limitation, the following:
| ● | REIT-Classic RT9A, RT9B, RT15A, RT15B. These are fully automated block production lines and can be universally used for the manufacture of bricks, tiles, pavers with and without face mix, curbstones, hollow blocks and similar construction materials. | |
| ● | REITRT10 Series Equipment. REITRT10 series equipment is used to produce bricks, tiles, pavers with and without face mix, curbstones, hollow blocks and similar construction materials. |
| ● | Horizontal Pull Holes Device. Horizontal Pull Holes Device is used to produce interlocking bricks, water conservancy blocks and slope protection blocks. |
| ● | REIT-I Concrete Block Splitter. Synchronized concrete block cutting machine with four blades. The blades are guided by ultra-wear resistant guide leads and driven by a large bore hydraulic drive, which lowers the operating pressure of the hydraulic unit and increases the splitting force. |
| ● | REIT Foam Insert Device. This device is used to insert a foam plate into the mold and produce thermal insulation blocks.
| |
| ● | Gravity Separator for Iron Mine. Gravity separator is used to collect iron from the mine. |
Roadside Assistance Services
Following the acquisition of REIT Mingde, we, through Hainan Yile IoT, provide RSA services to drivers within Hainan Province, China, through our network of RSA services providers of tow providers and automotive repair services. Our RSA services include towing, jump start, tire change, automobile repair services, and other services. We do not directly provide the RSA services but coordinate with our contracted RSA service providers who are licensed to provide such services. Our RSA services area covers the entire island of Hainan province, including 18 cities and counties. Upon receipt of a request for RSA services, we will contact our tow providers and other RSA service providers in close proximity to the vehicles and arrange the vehicles to be towed or repaired. We operate a proprietary platform, which connects insurance companies, tow providers, automobile repair services, and other service providers as well as the drivers. The platform is accessible to users via web interface and mobile applications, consisting of a central management system, a mobile application for RSA service providers to accept orders and dispatch service teams, a mobile application for drivers to send requests and monitor status, and a mobile application for insurance companies to monitor and review the request status.
Our RSA services are available to insured drivers and uninsured drivers. Our services to insured drivers are based on the type of insurance policy they have with their insurance company as well as the terms of our service contract with their insurance companies. Uninsured drivers pay our services fee based our prevailing rates at the time of services. We maintain a 24/7 service team to ensure timely responses to RSA services requests.
Our RSA services commenced in 2020 and we have established a network of an aggregate of 38 RSA services providers. Hainan Yile IoT has signed written agreements with all of its RSA services providers and settles payments to these service providers on a periodical basis.
We are paid by the drivers receiving RSA services or if they are insured, by their insurance companies. Hainan Yile IoT has entered into annual agreements with four major insurance companies in China, including, without limitation, China Life Property & Casualty Insurance Company Limited and China Pacific Insurance (Group) Co., Ltd. Pursuant to these agreements, we agree to provide RSA services to the insured drivers of these insurance companies upon requests and receive fees based on the services provided.
58
Software Solutions
Through Hainan Yile IoT, we are also engaged in the design, development and sales of customized software solutions based on the client specifications. We have developed the following software solutions for our clients during the fiscal years ended December 31, 2022, 2021 and 2020:
| - | Logistics management system – comprehensive software solutions for the management of multimodal logistics, encompassing functions including customer management, supplier management, order management, and vehicle management. |
| - | Retail management system - comprehensive software solutions for retail management, including functions such as invoicing, reporting, data statistics, online marketing. |
| - | Fleet management system – comprehensive software solutions providing client with capabilities to manage its fleet including functions such as vehicle management, vehicle application, vehicle alarm, and location control. |
| - | Vehicle rental management system - comprehensive software solutions providing client with capabilities to manage its car rental services, including functions such as vehicle management, vehicle rental (rental renewal), and remote fuel and electricity disconnection. |
In connection with the sales of software solutions, we also include hardware sales and/or service subscriptions based on the clients’ requirements, which are charged separately.
Our Projects
We have acted as general contractor and consultant for the construction of sponge cities since 2014 And as general contractor for ecological restoration projects since 2019. We are also responsible for the planning, construction and design of such projects.
Representative Projects
Sponge City – Changjiang County, Hainan Province
We were the general contractor for a sponge city project where an entire village was relocated and constructed in a former mining area. The project took 16 months to complete resulting in revenue of approximately RMB 14 million ($2.2 million) for us. We made all construction materials out of recycled iron tailings. A total of 86 single-family homes were built with a total construction area of 9,400 square meters (101,000 square feet). An estimated 1,810,000 pieces of bricks were used for walls, 90,000 roof tiles, and 4,200 square meters (approximately 45,000 square feet) of ground was covered with our construction materials. The completed project has won recognitions at various government levels in Hainan Province, and has been designated as a demonstration or model project for promotion of sponge city construction.
Sponge City – Haikou City, Hainan Province
We acted as a consultant for a sponge city project in Haikou City, Hainan Province. We also paved 50,000 square meters for this project. To assist with the nationwide efforts to promote pilot cities in sponge city construction, we will collaborate with international institutions in sponge city construction such as Jude Technology Corporation located in Germany. By gradually increasing our efforts, and expanding the scale in the planning, design and construction of sponge cities, we aim to become a key enterprise in sponge city construction.
59
Ecological Restoration Projects – Datong City, Shanxi Province
Pursuant to a strategic cooperation agreement entered into with Hunyuan County People’s Government, we have acted as the general contractor in connection with the restoration of abandoned coal mines and disposal of solid wastes in Hunyuan County, Datong City, Shanxi Province. We commenced the project in November 2019 and are in charge of the project feasibility study, design, implementation and supervision of the project. This project covers several affected villages and has an aggregate area of approximately 386 acres. We expect to complete this project by the end of 2023. We believe the completion of the project is expected to enable the local government to complete geological disaster prevention and control of an area of approximately 329 acres and reclaim land for agricultural use of approximately 133 acres, among other restoration to the environment. Upon completion of the project, we will be paid our fees upon receipt of proceeds from the sale of restored lands.
Customers
Our eco-friendly construction materials are sold only in China. Sales of construction materials accounted for $0.8 million, $1.7 million and $1.8 million of our total revenues for the years ended December 31, 2022, 2021 and 2020, respectively.
Our primary customers for software development services are state-owned petroleum companies and telecommunications companies. The primary customers for RSA services are insurance companies with the rest being individual customers. The majority of our customers for software development services and RSA services are located in Hainan Province.
We have international customers located in Asia, India, the Middle East, North Africa and North America for our manufacturing equipment. The following is a summary of our total revenues from our continuing operations by geographic market for each of the last three years for our manufacturing equipment used to produce construction materials.
| Region | 2022 | 2021 | 2020 | |||||||||
| Middle East | $ | 556,867 | $ | 50,573 | $ | - | ||||||
| India | 261,922 | 491,192 | 2,120,381 | |||||||||
| Pakistan | 837 | 12,457 | - | |||||||||
| China | 3,458,528 | 1,212,824 | 3,603,587 | |||||||||
| Malaysia | - | 20,656 | - | |||||||||
| Maldives | 20,495 | - | 804,112 | |||||||||
| Total | $ | 4,298,649 | $ | 1,787,702 | $ | 6,528,080 | ||||||
For the year ended December 31, 2022, one customer accounted for 21% of the Company’s total revenue. For the year ended December 31, 2021, one customer accounted for 11% of the Company’s total revenue. For the year ended December 31, 2020, no single customer accounted for more than 10% of the Company’s total revenue.
Sales and Marketing
We are increasing our marketing and sales efforts, including a directed focus on online marketing. Online marketing allows us to efficiently educate prospective customers about the products and services we have to offer and assists us in expanding the reach of our market, both in China and internationally. We will also participate in exhibitions, trade shows, conferences to introduce our equipment and machineries in China and internationally.
In order to expand our international market, we plan to add four to five distributors in the Americas, Southeast Asia, and the Middle East by the end of 2023. We will transform our advertising strategies to reach new and existing customers through new methods, such as digital marketing. We also plan to participate in targeted international marketing events, such as seminars, workshops, and trade shows, where we can meet potential customers, promote our products and deepen our network to further expand our sales.
We have obtained new customers by word-of-mouth referrals and have found that satisfied customers are loyal customers. We believe quality products and excellent services are a good marketing tool to retain and expand our customer base and as such we will improve the performance and quality of our equipment and combine the internet technology to our equipment to improve our after-sale services and satisfy the customers’ needs. In addition, the introduction of new products, such as permeable floor tiles for sponge city construction and slope and damn protection blocks in water conservancy construction have helped open new markets. In addition, we have developed the equipment to reuse waste rock wool products for manufacturing of construction materials. We believe that this approach has been crucial in winning and retaining clients and increasing our ability to withstand competition.
Our current market for software development and RSA services is Hainan Province. We plan to expand our offering of those services to other provinces in China through client referrals and targeted marketing.
60
Competition
We face significant competition in both our manufacturing equipment and construction materials markets. We have both domestic and international competitors in our manufacturing equipment market. In the international market for our manufacturing equipment our main competition is from German made manufacturing equipment. We believe our competitive strength against these competitors is the lower cost of our equipment with the same technical standards and high-quality service. Our disadvantage is that the German-made equipment has a better aesthetic appearance as compared to the equipment we manufacture. To improve the appearance of our equipment, we have collaborated with Tsinghua University and have jointly developed an aesthetic one-piece soundproof cover on our equipment and obtained patents for the design.
Our construction materials are manufactured by Xinyi REIT, which is located in Xuzhou City, the transportation hub connecting five neighboring provinces. The main competitors of our building materials are the small workshops in the region, who primarily rely on low-price competition to seize the market. However, we believe we can effectively compete with them based on large-scale automatic production lines, wide recognition by local governments and customers and strong research and development capabilities.
Our main competitors in the PRC market for our manufacturing equipment are small PRC companies located in Fujian Province. We believe our competitive strength against these competitors is the quality of our equipment while our competitive disadvantage is the higher cost of our equipment. There is an increased demand for fully automated construction materials production lines due to the increase of PRC labor costs. We are positioned to take advantage of the increased demand for fully automated construction lines due to our current ability to manufacture such equipment.
In both the domestic and international markets we are increasing our research and development of technology for construction materials manufacturing equipment. In addition, we are researching a variety of construction materials that can be made with our manufacturing equipment. We believe that a continued focus on a broad array of products and product designs coupled with our engineering and manufacturing expertise will enable us to provide customers with differentiated product performance and customer support.
In Hainan, our primary competitors for providing RSA services are the tow providers and other RSA service providers who may also be our contracted service providers. We believe we effectively compete with other RSA service providers in the following aspects:
| ● | Proprietary platform that can be customized and offered to different customers, enabling broader outreach to potential customers; |
| ● | Streamlined service process fully supported by our operation, technology and customer support teams; |
| ● | Efficiency and responsiveness of service requests; and |
| ● | Province wide service coverage. |
61
The rapidly evolving market for our software solutions is competitive and highly fragmented in certain of our regions, particularly by geography and customer segment. We compete with other developers of software solutions and services locally in Hainan and nationwide in China, such as Digital Hainan Co., Ltd., Inspur Group Co., Ltd., and Neusoft Group Co., Ltd. Some of our actual and potential competitors may enjoy competitive advantages over us, such as greater name recognition, longer operating histories, more varied services, and larger marketing budgets, as well as greater financial, technical, and other resources. We believe that the key competitive factors in our market include:
| ● | ease of onboarding, initial setup and use; |
| ● | platform functionality, performance and reliability (speed and stability); |
| ● | relevant features that best meet the needs of clients’ operators; |
| ● | business intelligence capabilities; |
| ● | technology architecture scalability; and |
| ● | cost. |
We believe that our patented technologies, focus on segments with high demand as well as dedication to customers in Hainan province enable us to compete effectively in Hainan province.
Research and Development
Soon after its establishment, we set up a research and development center in Xi’an. We believe scientific and technological innovation will help our Company achieve its long-term strategic objectives. We conduct research and development in the following areas:
| ● | Manufacturing equipment; | |
| ● | Recycling and utilization of solid wastes; | |
| ● | New construction materials; and | |
| ● | Urban ecological construction (sponge cities). |
We conduct our research and development according to strategic objectives, the market and customer needs. Combining application research and advanced research, we will not only improve current products, but also develop future strategic products, realizing technology development in line with the market demand.
Our research and development activities mainly focus on solid waste utilization and recycling, ecological environmental friendly construction materials, technology and equipment, thermal insulation products and related production equipment.
We accounted for the payments as research and development expenses in accordance with ASC 730-20 for the related periods. For the years ended December 31, 2022, 2021, and 2020, we spent $960,598, $346,951 and $334,904, respectively, on research and development associated with our continuing operations. We expect to increase our allocation of research and development funds in the future in an effort to enhance our core competence.
Quality control is an important aspect of our research and development department’s work and ensuring quality at every stage of the process has been as key driver in maintaining and developing our brand value. We have set up a separate research and development division to account for our investment in research and development. As of December 31, 2022, we employed 41 professionals in research and technology development. We expect to increase our allocation of research and development funds in an effort to enhance its core competence.
Sample research and development projects from 2020 to 2022 include the following:
Year 2020
| ● | A automatic palletizing system |
62
Year 2021
| ● | A servo control system for cubing plant V1.0 | |
| ● | A control system V1.0 for finger cart | |
| ● | An environmentally friendly permeable concrete PC brick | |
| ● | A porous sound-absorbing and noise-reducing PC brick | |
| ● | A production, processing, positioning and cutting device for PC bricks | |
| ● | A weather-resistant PC brick | |
| ● | A permeable PC brick surface layer and chamfer grinding device | |
| ● | A self-compensating shrink PC brick |
Year 2022
| ● | A squirrel cage concrete product turning machine | |
| ● | An extra-thick surface layer bulk concrete product forming device | |
| ● | A control system and software for 3D printing V1.0 |
| ● | REITRT10 Series equipment | |
| ● | Gravity separator for iron mine |
Sources of Raw Materials
Our primary raw materials are steel for our manufacturing equipment and iron tailings, fly-ash and cement for our construction materials. We purchase from a variety of suppliers and believe these raw materials are widely available.
We have efficient access to all of the raw materials necessary for the production of our manufacturing equipment and construction materials. We believe our relationships with the suppliers of these raw materials are strong. We do not expect the prices of such raw materials to vary greatly from their current prices, as there has traditionally been little price volatility for such materials.
For the years ended December 31, 2022, 2021, and 2020, the Company purchased approximately 19%, 53%, and 43%, respectively, of its raw materials from one major supplier. If we are unable to purchase from this supplier, we do not expect we would face difficulties in locating other suppliers at substantially the same prices because alternative suppliers are readily available on the market.
Intellectual Property
We regard our patents, copyrights, trademarks, domain names, know-how, proprietary technologies and similar intellectual property as critical to our businesses, and we rely on patent, copyrights, trademark and trade secret law and confidentiality, invention assignment and non-compete agreements with our employees and others to protect our proprietary rights. However, we do not believe that our business, as a whole, is dependent on, or that its profitability would be materially affected by the revocation, termination, expiration or infringement upon any particular patent. We own an aggregate of 123 PRC patents (ten of which are owned jointly with Luoyang Water-Conservancy Surveying & Design Co., Ltd. (“Luoyang”), an independent third party), including 31 design patents, 82 utility model patents and ten invention patents. Three of our patents were awarded Gold and Silver Prize of International Exhibition of Inventions of Geneva. In addition, we own 25 software copyrights in China.
Pursuant to Article 15 of Patent Law of China if there is any agreement between the joint owners of the right to apply for a patent or a patent right regarding the exercise of the relevant right, the agreement shall be followed. If there is no such agreement, any of the joint owners may exploit the patent independently or license others to exploit the patent by means of ordinary license. In the case of licensing to others to exploit the patent, royalties charged shall be distributed among the joint owners.
In order to minimize our liabilities or loss from the seven joint patents referenced above, Beijing REIT entered into an agreement with Luoyang on January 7, 2017, regarding the use, licensing, and transfer rights for the joint patents. The agreement, among other terms, provides Beijing REIT with sole use and exclusive right of licensing of the joint patents and prohibits Luoyang and Beijing REIT from transferring the joint patents to any other third parties without each parties’ consent. Subsidiaries of Beijing REIT also have the right to use the joint patents under the agreement. In addition, the parties will share any fees generated from any licensing of the joint patents.
63
REGULATION
Regulations Relating to the Manufacturing Industry
Our manufacturing activities are regulated by the Law of China on Work Safety, or the Work Safety Law, which was adopted in 2002 and latest amended in 2021. The State Administration of Work Safety is responsible for the supervision and administration of work safety nationwide. Pursuant to the Work Safety Law, production units which are engaged in producing and operating activities in China shall meet the conditions of work safety stipulated by relative law and regulations or national standards or industry standards; otherwise, those production units are not allowed to undertake manufacturing activities in China.
Our major products are regulated by the Law of China on Product Quality, which was promulgated in 1993 and latest amended in 2018, which require our products to comply with national standards and industry standards during the process of manufacturing and selling. Our products will be defined as defective products if they fail to comply with such standards. Meanwhile if our products cause personal injuries or other product damages, we shall be responsible for applicable compensation. The statute of limitation of legal proceedings for injuries or damages caused by defective products will be two years, commencing from the date of awareness of injuries or damages. Our products are mainly divided into two categories, which are eco-friendly construction materials and equipment used to produce construction materials, respectively. Under the Law of China on Product Quality, our products manufacturing shall be in compliance with five national standards and four industry standards, including but not limited to the GB/T 8533-2008 (national standard) and the JC/T 920-2011 (industry standard) for our manufacturing equipment, and the GB/T 21144-2007 (national standard) and the NY/T 1253-2006 (industry standard) for our construction materials.
Regulations Relating to Foreign Investment
The Foreign Investment Law
On March 15, 2019, the National People’s Congress approved the Foreign Investment Law, which took effect on January 1, 2020 and replaced three existing laws on foreign investments in China, namely, the PRC Sino-foreign Equity Joint Venture Law, the PRC Sino-foreign Cooperative Joint Venture Law and the PRC Wholly Foreign-owned Enterprise Law, together with their implementation rules and ancillary regulations. On December 26, 2019, the Regulation on the Implementation of the Foreign Investment Law of the People’s Republic of China, was issued by the State Council and came into force on January 1, 2020. The organization form, organization and activities of foreign-invested enterprises shall be governed, among others, by the PRC Company Law and the PRC Partnership Enterprise Law. Foreign-invested enterprises established before the implementation of this Law may retain the original business organization and so on within five years after the implementation of this Law. The Foreign Investment Law embodies an expected PRC regulatory trend to rationalize its foreign investment regulatory regime in line with prevailing international practice and the legislative efforts to unify the corporate legal requirements for both foreign and domestic invested enterprises in China. The Foreign Investment Law establishes the basic framework for the access to, and the promotion, protection and administration of foreign investments in view of investment protection and fair competition.
According to the Foreign Investment Law, “foreign investment” refers to investment activities directly or indirectly conducted by one or more natural persons, business entities, or otherwise organizations of a foreign country (collectively referred to as “foreign investor”) within China, and the investment activities include the following situations: (i) a foreign investor, individually or collectively with other investors establishes a foreign-invested enterprise within China; (ii) a foreign investor acquires stock shares, equity shares, shares in assets, or other like rights and interests of an enterprise within China; (iii) a foreign investor, individually or collectively with other investors, invests and establishes new projects within China; and (iv) a foreign investor invests through other approaches as stipulated by laws, administrative regulations, or otherwise regulated by the State Council.
According to the Foreign Investment Law, the State Council will publish or approve to publish the “negative list” for special administrative measures concerning foreign investment. The Foreign Investment Law grants national treatment to foreign-invested entities, or FIEs, except for those FIEs that operate in industries deemed to be either “restricted” or “prohibited” in the “negative list”. The Foreign Investment Law provides that FIEs operating in foreign restricted or prohibited industries will require market entry clearance and other approvals from relevant PRC governmental authorities. If a foreign investor is found to invest in any prohibited industry in the “negative list”, such foreign investor may be required to, among other aspects, cease its investment activities, dispose of its equity interests or assets within a prescribed time limit and have its income confiscated. If the investment activity of a foreign investor is in breach of any special administrative measure for restrictive access provided for in the “negative list”, the relevant competent department shall order the foreign investor to make corrections and take necessary measures to meet the requirements of the special administrative measure for restrictive access. On December 27, 2021, MOFCOM and NDRC jointly issued the latest version of Negative List (Edition 2021). See “Item 4. Information on the Company – B. Business Overview – Regulation — Regulations relating to Foreign Investment — The Guidance Catalogue of Industries for Foreign Investment.”
64
Besides, the PRC government will establish a foreign investment information reporting system, according to which foreign investors or foreign-invested enterprises shall submit investment information to the competent department for commerce concerned through the enterprise registration system and the enterprise credit information publicity system, and a security review system under which the security review shall be conducted for foreign investment affecting or likely affecting the state security.
Furthermore, the Foreign Investment Law provides that foreign invested enterprises established according to the existing laws regulating foreign investment may maintain their structure and corporate governance within five years after the implementing of the Foreign Investment Law.
In addition, the Foreign Investment Law also provides several protective rules and principles for foreign investors and their investments in the PRC, including, among others, that a foreign investor may freely transfer into or out of China, in Renminbi or a foreign currency, its contributions, profits, capital gains, income from disposition of assets, royalties of intellectual property rights, indemnity or compensation lawfully acquired, and income from liquidation, among others, within China; local governments shall abide by their commitments to the foreign investors; governments at all levels and their departments shall enact local normative documents concerning foreign investment in compliance with laws and regulations and shall not impair legitimate rights and interests, impose additional obligations onto FIEs, set market access restrictions and exit conditions, or intervene with the normal production and operation activities of FIEs; except for special circumstances, in which case statutory procedures shall be followed and fair and reasonable compensation shall be made in a timely manner, expropriation or requisition of the investment of foreign investors is prohibited; and mandatory technology transfer is prohibited.
The Guidance Catalogue of Industries for Foreign Investment
Investment activities in the PRC by foreign investors are subject to the Catalogue for the Guidance of Foreign Investment Industry, or the Catalogue, which was promulgated and is amended from time to time by the MOFCOM and the NDRC. The Foreign Investment Catalogue which was promulgated jointly by MOFCOM and the NDRC, on June 28, 2017 and became effective on July 28, 2017, classifies industries into three categories with regard to foreign investment: (1) “encouraged”, (2) “restricted”, and (3) “prohibited”. The latter two categories are included in a negative list, which was first introduced into the Foreign Investment Catalog in 2017 and specified the restrictive measures for the entry of foreign investment.
On June 28, 2018, MOFCOM and NDRC jointly promulgated the Special Administrative Measures (Negative List) for Foreign Investment Access, or the Negative List (Edition 2018), which replaced the negative list attached to the Foreign Investment Catalogue in 2017. On June 30, 2019, MOFCOM and NDRC jointly issued the Special Administrative Measures (Negative List) for Foreign Investment Access, or the Negative List (Edition 2019), which replaced the Negative List (Edition 2018), and the Catalogue of Industries for Encouraging Foreign Investment (Edition 2019), or the Encouraging Catalogue (Edition 2019), which replaced the encouraged list attached to the Foreign Investment Catalogue in 2017. On June 23, 2020, MOFCOM and NDRC jointly issued the Special Administrative Measures (Negative List) for Foreign Investment Access, or the Negative List (Edition 2020), which replaced the Negative List (Edition 2019). On December 27, 2021, MOFCOM and NDRC jointly issued the Special Administrative Measures (Negative List) for Foreign Investment Access, or the Negative List (Edition 2021), which replaced the Negative List (Edition 2020).
65
Pursuant to the Negative List (Edition 2021) effective on January 1, 2022, any industry that is not listed in any of the restricted or prohibited categories is classified as a permitted industry for foreign investment. Establishment of wholly foreign-owned enterprises is generally allowed for industries outside of the Negative List. For the restricted industries within the Negative List, some are limited to equity or contractual joint ventures, while in some cases PRC partners are required to hold the majority interests in such joint ventures. In addition, restricted category projects are subject to higher-level government approvals and certain special requirements. Foreign investors are not allowed to invest in industries in the prohibited category. Industries not listed in the Negative List are generally open to foreign investment unless specifically restricted by other PRC regulations.
The Encouraging Catalogue (Edition 2022) effective on January 1, 2023, is divided into two parts, namely the Nationwide Catalogue of Encouraged Industries for Foreign Investment and the Catalogue of Priority Industries for Foreign Investment in Central and Western China. The Nationwide Catalogue of Encouraged Industries for Foreign Investment lists a total of 519 industry sectors that encourage foreign investments; the Catalogue of Priority Industries for Foreign Investment in Central and Western China lists industry sectors that each province and city wish to introduce.
In October 2016, the MOFCOM issued the Interim Measures for Record-filing Administration of the Establishment and Change of Foreign-invested Enterprises or FIE Record-filing Interim Measures, which was revised in June 2018. Pursuant to FIE Record-filing Interim Measures, the establishment and change of FIE are subject to record-filing procedures, instead of prior approval requirements, provided that the establishment or change does not involve special entry administration measures. If the establishment or change of FIE matters involves the special entry administration measures, the approval of the MOFCOM or its local counterparts is still required. Pursuant to the Announcement [2016] No. 22 of the NDRC and the MOFCOM dated October 8, 2016, the special entry administration measures for foreign investment apply to restricted and prohibited categories specified in the Catalogue, and the encouraged categories are subject to certain requirements relating to equity ownership and senior management under the special entry administration measures.
On January 1, 2020, the Foreign-invested Information Reporting Measures or FIE Reporting Measures came into force which replaced the FIE Record-filing Interim Measures. Pursuant to FIE Reporting Measures, foreign investors or FIEs are required to submit initial report, change report, deregistration report and annual report through enterprises registration system.
Currently, our business falls within the permitted category.
Company Law
Pursuant to the PRC Company Law, promulgated by the SCNPC on December 29, 1993, effective as of July 1, 1994, and as revised on December 25, 1999, August 28, 2004, October 27, 2005, December 28, 2013 and October 26, 2018, the establishment, operation and management of corporate entities in the PRC are governed by the PRC Company Law. The PRC Company Law defines two types of companies: limited liability companies and companies limited by shares.
Each of our PRC subsidiaries is a limited liability company. Unless otherwise stipulated in the related laws on foreign investment, foreign invested companies are also required to comply with the provisions of the PRC Company Law.
Regulations on Tax
See “Item 10. Additional Information —E. Taxation—People’s Republic of China Taxation.”
Regulation of Foreign Currency Exchange and Dividend Distribution
Foreign Currency Exchange. The principal regulations governing foreign currency exchange in China are the Foreign Exchange Administration Regulations (1996), as amended on August 5, 2008, the Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996) and the Measures on Administration of Foreign Debts Registration (2013). Under these regulations, Renminbi are freely convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions, but not for most capital account items, such as direct investment, loans, repatriation of investment and investment in securities outside China, unless the prior approval of SAFE or its local counterparts is obtained. In addition, any loans to an operating subsidiary in China that is a foreign invested enterprise, cannot, in the aggregate, exceed the difference between its respective approved total investment amount and its respective approved registered capital amount or 2.5 times of its net assets, at the discretion of such company.
66
Any increase in the amount of the total investment and registered capital must be reported to and filed with the China Ministry of Commerce or its local counterpart and SAMS or its local counterparts. We may not be able to report to or file with these government authorities on a timely basis, if at all, which could result in a delay in the process of making these loans.
Pursuant to the Circular of the State Administration of Foreign Exchange on Further Simplifying and Improving the Direct Investment-related Foreign Exchange Administration Policies, or the SAFE Notice 13, which was promulgated on February 13, 2015 and with effect from June 1, 2015, the foreign exchange registration under domestic direct investment and the foreign exchange registration under overseas direct investment is directly reviewed and handled by banks in accordance with the SAFE Notice 13, and the SAFE and its branches shall perform indirect regulation over the foreign exchange registration via banks.
Dividend Distribution. According to the PRC Company Law and Foreign Investment Law, enterprises in China may pay dividends only out of their retained profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, enterprises in China are required to allocate at least 10% of their respective retained 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, and an enterprise is not permitted to distribute any profits until losses from prior fiscal years have been offset. Furthermore, under the Enterprise Income Tax Law, or the EIT Law, which became effective in January 2008 and latest amended in 2018, the maximum tax rate for the withholding tax imposed on dividend payments from PRC foreign invested companies to their overseas investors that are not regarded as “resident” for tax purposes is 20%. The rate was reduced to 10% under the Implementing Regulations for the EIT Law issued by the State Council. However, a lower withholding tax rate might be applied if there is a tax treaty between China and the jurisdiction of the foreign holding companies, such as tax rate of 5% in the case of Hong Kong companies that holds at least 25% of the equity interests in the foreign-invested enterprise, and certain requirements specified by PRC tax authorities are satisfied.
Circular 37. On July 4, 2014, SAFE issued Notice on Relevant Issues concerning Foreign Exchange Administration for Domestic Residents Engaging in Overseas Financing and Investing through Round-Trip Investment via Special Purpose Companies, or Circular 37, which became effective as of July 4, 2014. According to Circular 37, PRC residents shall apply to SAFE and its branches for going through the procedures for foreign exchange registration of overseas investments before contributing the domestic assets or interests to a SPV. An amendment to registration or filing with the local SAFE branch by such PRC resident is also required if the registered overseas SPV’s basic information such as domestic individual resident shareholder, name, operating period, or major events such as domestic individual resident capital increase, capital reduction, share transfer or exchange, merger or division has changed. Although the change of overseas funds raised by overseas SPV, overseas investment exercised by overseas SPV and non-cross-border capital flow are not included in Circular 37, we may be required to make foreign exchange registration if required by SAFE and its branches.
Moreover, Circular 37 applies retroactively. As a result, PRC residents who have contributed domestic assets or interests to a SPV, but failed to complete foreign exchange registration of overseas investments as required prior to implementation of Circular 37, are required to send a letter to SAFE and its branches for explanation. Under the relevant rules, failure to comply with the registration procedures set forth in Circular 37 may result in receiving a warning from SAFE and its branches, and may result in a fine of up to RMB 300,000 (approximately $46,000) for an organization or up to RMB 50,000 (approximately $8,000) for an individual.
PRC residents who control our Company are required to register with SAFE in connection with their investments in us. If we use our equity interest to purchase the assets or equity interest of a PRC company owned by PRC residents in the future, such PRC residents will be subject to the registration procedures described in Circular 37.
Circular 19 & Circular 16. On March 30, 2015, SAFE issued the Circular Concerning the Reform of the Administration of the Settlement of Foreign Currency Capital of Foreign-Invested Enterprises, or Circular 19, which became effective on June 1, 2015. Circular 19 regulates the conversion of foreign currency capital funds into RMB by a foreign-invested enterprise, and limits how the converted RMB may be used.
67
Furthermore, SAFE promulgated a circular on June 9, 2016, Circular on Reforming and Regulating Policies on the Administration over Foreign Exchange Settlement under Capital Accounts, or Circular 16, which further revises several clauses in Circular 19. Both Circular 19 and Circular 16 regulate that foreign exchange incomes of a domestic enterprise under their capital account shall not be used in the ways stated below:
| ● | For expenditures that are forbidden by relevant laws and regulations, or for purposes which are not included in the business scope approved by relevant government authority; | |
| ● | For direct or indirect securities investments within China, or for any other kinds of investments except banks’ principal-guaranteed wealth-management products, unless otherwise prescribed by other laws and regulations; | |
| ● | For issuing RMB entrusted loans directly or indirectly (except those included in the business scope), or for repaying inter-enterprise loans (including advances by the third party), or for repaying bank loans which has been lent to third parties; | |
| ● | For issuing RMB loans to non-affiliated enterprises, unless expressly permitted in the business scope; | |
| ● | For purchasing or constructing real estate which is not for personal use, in addition to those real estate enterprises. |
In addition, SAFE supervises the flow and use of those RMB capital converted from foreign currency capital funds of a foreign-invested company by further focusing on ex post facto supervisions and violations, and the use of the net proceeds from our initial public offering to invest in or acquire any other PRC companies in China is subject to the provisions under both Circular 19 and Circular 16.
M&A Regulations and Overseas Listings
On August 8, 2006, six PRC regulatory agencies, including the MOFCOM, the State Assets Supervision and Administration Commission, the State Administration for Taxation, the State Administration for Industry and Commerce, CSRC and 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 and was amended on June 22, 2009. This New M&A Rule, among other things, includes provisions that purport to require that an offshore special purpose vehicle formed for purposes of overseas listing of equity interests in PRC companies and controlled directly or indirectly by PRC companies or individuals should obtain the approval of CSRC prior to the listing and trading of such special purpose vehicle’s securities on an overseas stock exchange.
On September 21, 2006, CSRC published on its official website the Provisions on Indirect Issuance of Securities Overseas by a Domestic Enterprise or Overseas Listing of Its Securities for Trading, which specify procedures regarding CSRC’s approval for overseas listings by special purpose vehicles. 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 this new PRC regulation remains unclear with no consensus currently existing among leading PRC law firms regarding the scope of the applicability of the CSRC approval requirement.
In addition, according to the Notice on Establishing the Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors issued by the General Office of the State Council on February 3, 2011 and which became effective 30 days thereafter, the Rules on Implementation of Security Review System for the Merger and Acquisition of Domestic Enterprises by Foreign Investors issued by the MOFCOM on August 25, 2011 and which became effective on September 1, 2011, mergers and acquisitions by foreign investors that raise “national defense and security” concerns and mergers and acquisitions through which foreign investors may acquire de facto control over domestic enterprises that raise “national security” concerns are subject to strict review by the MOFCOM, and the regulations prohibit any activities attempting to bypass such security review, including by structuring the transaction through a proxy or contractual control arrangement.
68
On July 6, 2021, the State Council and General Office of the CPC Central Committee issued Opinions on Strictly Cracking Down Illegal Securities Activities in Accordance with the Law. The opinions emphasized the need to strengthen the administration over illegal securities activities and the supervision on overseas listings by China-based companies and proposed to take effective measures, such as promoting the construction of relevant regulatory systems to deal with the risks and incidents faced by China-based overseas-listed companies.
In December 2019, the newly revised Securities Law of the PRC clarified that direct and indirect overseas issuances and listings should comply with the relevant regulations of the State Council.
On February 17, 2023, the CSRC published the Tentative Measures and five supporting guidelines, which became effective on March 31, 2023. The Tentative Measures lay out the filing regulation arrangement for both direct and indirect overseas listing, and clarify the determination criteria for indirect overseas listing in overseas markets. Among other things, if a domestic enterprise intends to indirectly offer and list securities in an overseas market, the record-filing obligation is with a major operating entity incorporated in mainland China which appointed by the issuer and such filing obligation shall be completed within three business days after the overseas listing application is submitted. The required filing materials for an initial public offering and stock exchange listing shall include, but are not limited to: record-filing report and related undertakings; regulatory opinions, record-filing, approval and other documents issued by competent regulatory authorities of relevant industries (if applicable); security assessment opinion issued by relevant regulatory authorities (if applicable); PRC legal opinion; and prospectus. In addition, an overseas offering and listing is prohibited under any of the following circumstances: (1) if the intended securities offering and listing is specifically prohibited by national laws and regulations and relevant provisions; (2) if the intended securities offering and listing may constitute a threat to or endangers national security as reviewed and determined by competent authorities under the State Council in accordance with law; (3) if, in the past three years, the domestic enterprise or its controlling shareholders or actual controllers have committed corruption, bribery, embezzlement, misappropriation of property, or other criminal offenses disruptive to the order of the socialist market economy, or are currently under judicial investigation for suspicion of criminal offenses, or are under investigation for suspicion of major violations; (4) if, the domestic enterprise is being investigated according to law due to suspected crimes or major violations of laws and regulations, and there is no clear conclusion; or (5) if there are material ownership disputes over the equity of the controlling shareholder or shareholders controlled by controlling shareholders and actual controllers. The Tentative Measures provide directional guidance to the PRC’s reform plan for the supervision of overseas listings. The Tentative Measures adopt an “ex-post filing mechanism” where the filer completes its filing obligation within three business days after it submits its listing application to the regulator in the place of intended listing. With respect to the domestic enterprises, non-compliance with the Tentative Measures or an overseas listing completed in breach of it may result in a warning or a fine ranging from RMB 1 million to RMB10 million. Furthermore, the directly responsible executives and other directly responsible personnel of the domestic enterprises may be warned, or fined between RMB 500,000 and RMB 5 million and the controlling shareholder, actual controllers, and other legally appointed persons of the domestic enterprises may be warned, or fined between RMB 1 million and RMB 10 million. If, during the filing process, the domestic enterprises conceal important factors or the content is materially false, and securities are not issued, they are subject to a fine of RMB1 million to RMB10 million. With respect to the directly responsible executives and other directly responsible personnel of the domestic enterprises, they are subject to a warning and fine between RMB 500,000 and RMB 5 million, and with respect to the controlling shareholder, actual controllers, and other legally appointed persons of the domestic enterprises, they are subject to a warning and fine between RMB 1 million and RMB 10 million.
On February 24, 2023, the CSRC published the Provisions on Strengthening the Confidentiality and Archives Administration Related to the Overseas Securities Offering and Listing by Domestic Enterprises, or the Confidentiality and Archives Administration, and, which became effective on March 31, 2023. The Confidentiality and Archives Administration requires that, in the process of overseas issuance and listing of securities by domestic entities, the domestic entities, and securities companies and securities service institutions that provide relevant securities service shall strictly implement the provisions of relevant laws and regulations and the requirements of these provisions, establish and improve rules on confidentiality and archives administration. Where the domestic entities provide with or publicly disclose documents, materials or other items related to the state secrets and government work secrets to the relevant securities companies, securities service institutions, overseas regulatory authorities, or other entities or individuals, the companies shall apply for approval of competent departments with the authority of examination and approval in accordance with law and report the matter to the secrecy administrative departments at the same level for record filing. Where there is unclear or controversial whether or not the concerned materials are related to state secrets, the materials shall be reported to the relevant secrecy administrative departments for determination.
69
Regulations on Offshore Parent Holding Companies’ Direct Investment in and Loans to Their PRC Subsidiaries
An offshore company may invest equity in a PRC company, which will become the PRC subsidiary of the offshore holding company after investment. Such equity investment is subject to a series of laws and regulations generally applicable to any foreign-invested enterprise in China, which include Foreign Investment Law of the People’s Republic of China, Implementation Regulations for the Foreign Investment Law of the People’s Republic of China, the Administrative Provisions on Foreign Exchange in Domestic Direct Investment by Foreign Investors; and the Notice of the State Administration on Foreign Exchange on Further Improving and Adjusting Foreign Exchange Administration Policies for Direct Investment.
Under the aforesaid laws and regulations, the increase of the registered capital of a foreign-invested enterprise is subject to prior approval by or filing with the original approval authority of its establishment. In addition, the increase of registered capital and total investment amount shall both be registered with SAMS or its local counterpart, report to Ministry of Commerce and a local bank authorized by the SAFE.
Shareholder loans made by offshore parent holding companies to their PRC subsidiaries are regarded as foreign debts in China for regulatory purpose, which is subject to a number of PRC laws and regulations, including the PRC Foreign Exchange Administration Regulations, Measures on Administration on Foreign Debts, the Tentative Provisions on the Statistics Monitoring of Foreign Debts and its implementation rules, and the Administration Rules on the Settlement, Sale and Payment of Foreign Exchange.
Under these regulations, the shareholder loans made by offshore parent holding companies to their PRC subsidiaries shall be registered with a local bank authorized by the SAFE. Furthermore, the total amount of foreign debts that can be borrowed by such PRC subsidiaries, including any shareholder loans, shall not exceed the difference between the total investment amount and the registered capital amount of the PRC subsidiaries, both of which are subject to the governmental approval or 2.5 times of the net assets of such subsidiary.
Regulations Relating to Intellectual Property Rights
Patent. Patents in China are principally protected under the Patent Law of China, which was promulgated by the SCNPC in 1984 and latest amended on October 17, 2020. The duration of a patent right is either 10 years (utility model), 15 years (design) or 20 years (invention) from the date of application, depending on the type of patent right.
Copyright. Copyright in China, including software copyright, is principally protected under the Copyright Law of China which was issued by the Standing Committee of the NPC in 1990 and latest amended on November 11, 2020, and its related rules and regulations. Under the Copyright Law, for a company, the term of protection for copyright is 50 years from the first publication of its work.
Trademark. Registered trademarks are protected under the Trademark Law of China promulgated by the Standing Committee of the NPC in 1982 and latest amended on April 23, 2019, and its related rules and regulations. Trademarks are registered with the Trademark Office of the State Administration for Industry and Commerce. Where registration is sought for a trademark that is identical or similar to another trademark that has already been registered or given preliminary examination and approval for use in the same or similar category of commodities or services, the application for registration of such trademark could be rejected. Trademark registrations are effective for a renewable ten-year period, unless otherwise revoked.
Domain names. Domain names are protected under the Administrative Measures on the Internet Domain Names promulgated by the MIIT on April 24, 2017 (effective as of November 1, 2017) and the Registration Implementing Measures on the Domain Names promulgated by the CNNIC. The MIIT is the major regulatory body responsible for the administration of the PRC Internet domain names, under supervision of which the CNNIC is responsible for the daily administration of .cn domain names and PRC domain names. MIIT adopts the “first to file” principle with respect to the registration of domain names.
70
Employee Stock Option Plans
In February 2012, SAFE promulgated the Notices on Issues concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly-Listed Company, replacing earlier rules promulgated in March 2007, to regulate the foreign exchange administration of PRC citizens and non-PRC citizens who reside in China for a continuous period of not less than one year, with a few exceptions, who participate in stock incentive plans of overseas publicly-listed companies. Pursuant to these rules, these individuals who participate in any stock incentive plan of an overseas publicly-listed company, are required to register with SAFE through a domestic qualified agent, which could be the PRC subsidiaries of such overseas listed company, and complete certain other procedures.
Regulations Relating to Labor
Pursuant to the China Labor Law, which first took effect on January 1, 1995 and was most recently amended on December 29, 2018, and the China Labor Contract Law, which became effective on January 1, 2008 and amended in 2012, a written labor contract is required when an employment relationship is established between an employer and an employee. The China Labor Law stipulates the maximum number of working hours per day and per week while other labor-related regulations and rules of China stipulate the minimum wages. An employer is required to set up occupational safety and sanitation systems, implement the national occupational safety and sanitation rules and standards, educate employees on occupational safety and sanitation, prevent accidents at work and reduce occupational hazards.
An employer is obligated to sign an indefinite term labor contract with an employee if the employer continues to employ the employee after two consecutive fixed-term labor contracts, with certain exceptions. The employer also has to pay compensation to the employee if the employer terminates an indefinite term labor contract, with certain exceptions. Except where the employer proposes to renew a labor contract by maintaining or raising the conditions of the labor contract and the employee is not agreeable to the renewal, an employer is required to compensate the employee when a definite term labor contract expires. Furthermore, under the Regulations on Paid Annual Leave for Employees issued by the State Council in December 2007 and effective as of January 2008, an employee who has served an employer for more than one year and less than ten years is entitled to a 5-day paid vacation, those whose service period ranges from 10 to 20 years are entitled to a 10-day paid vacation, and those who have served for more than 20 years are entitled to a 15-day paid vacation. An employee who does not use such vacation time at the request of the employer must be compensated at three times their normal daily salaries for each waived vacation day.
Regulations Relating to Environmental Protection
The Environmental Protection Law, which was adopted in 1989 and amended in 2015, effectively established the legal framework for environment protection in China. The Environmental Protection Law requires the Ministry of Environmental Protection (the “MEP”), to implement uniform supervision and administration of environmental protection work nationwide and establishes national environmental quality standards and pollutants discharge standards. Enterprises producing environmental contamination and other public hazards must incorporate environmental protection work into their planning and establish environmental protection systems.
Through the adoption of the Environmental Impact Assessment Law of China in 2003 and last amended in 2018 and the Classification Lists for Environmental Impact Assessment of Construction Projects (latest 2021 Version), the PRC government established a system to appraise the environmental impact of construction projects and classify the appraisal based on the degree of environmental impact caused by the construction project.
Pursuant to the Order on Ecosystem by The Ministry of Ecology and Environment, which was issued on July 28, 2017 and most recently amended on December 20, 2019, The Ministry of Ecology and Environment implements a classification-based management on the environmental impact assessment, or EIA, of pollutants according to pollutant amount and the impact of the pollutants on the environment as below:
| ● | For those pollutant discharge units with large amount of pollutants and significant environmental impacts, the key management on a pollutant discharge permit is required; |
71
| ● | For those pollutant discharge units with small amount of pollutants and small environmental impacts, the simplified management on a pollutant discharge permit is required; and |
| ● | For those pollutant discharge units with very small amount of pollutants and very small environmental impacts, the pollutant discharge registration form is required. |
| C. | Organizational structure. |
Please refer to “Item 4. Information on the Company– A. History and Development of the Company – Corporate Structure.”
| D. | Property, plants and equipment. |
Our headquarters is located at X-702, Runfengdeshangyuan, 60 Anli Road, Chaoyang District, Beijing City, People’s Republic of China. We own and lease properties for our operations in China. We believe our facilities are adequate for our current needs and we do not believe we will encounter any disputes of property rights or any difficulty in extending the terms of the leases by which we occupy our respective premises. A summary description of our leased and owned properties is as follows:
| Office | Address | Term | Ownership | Space (m2) | ||||||
| Office of Beijing REIT | X-702, Runfengdeshangyuan, No. 60 Anli Road, Chaoyang District, Beijing City | April 2023-December 2023 | Leased | 322.24 | ||||||
| Office for the R&D department of Beijing REIT | Room 2304, 5 Building, Luxury Times City, 168 Jixiang Road, Yanta District, Xi’an City | April 2022-March 2025 | Leased | 126 | ||||||
| Office for the R&D department of Beijing REIT | Units 12001-12002, No. 1 Building, West-side of South 2nd Ring Road, Beilin District, Xi’an City | Owned | 245.38 | |||||||
| Office of REIT | 22nd Floor, Xinheng Building, No. 123-8, Binhai Avenue, Longhua District, Haikou City, Hainan Province | February 2022 - January 2025 | Leased | 1,279.66 | ||||||
| Land Owned by Xinyi REIT | West Area of Jizheng Avenue, North Area of Tanggang Road, Economic and Technical Development Zone, Xinyi City, Jiangsu Province | February 2017 - February 2067 | Owned | 74,254.61 | ||||||
| Staff dormitory of Beijing REIT | Unit 601, Unit 1, Building 207, Huizhong Beili, Chaoyang District, Beijing City | July 2022-July 2023 | Leased | 68.74 | ||||||
| Staff dormitory of REIT Ordos | Room 401, Unit 1, Building 4, Longxi County Plaza | May 2022-May 2023 | Leased | 94.95 | ||||||
| Office of Hainan Kunneng Direct Supply Chain Management Co., Ltd. | Room 309, 3rd Floor, No. 211 Guoyao Road, Pudong New Area, Shanghai City | February 2022-August 2023 | Leased | 150 | ||||||
| Staff dormitory of Beijing REIT | 601, 3rd Floor, Building 216, Datunli, Chaoyang District, Beijing City | October 2022-October 2023 | Leased | 95.59 | ||||||
| Staff dormitory of REIT Ordos | Room 1701, Building 11, Ruijing Famous Garden | October 2022-October 2023 | Leased | 126.01 | ||||||
| Office of Beijing REIT | Room 1611, No.1 Building, No.208, Second Block, Lize Zhongyuan, Wangjing Xinxing Industrial Area, Chaoyang District, Beijing City | January 2023 - January 2024 | Leased | 42.42 | ||||||
72
Item 4A. Unresolved Staff Comments
Not applicable.
Item 5. Operating and Financial Review and Prospects
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes that appear in this annual report. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this annual report, particularly in “Risk Factors.”
| A. | Operating Results |
Overview
Our business consists of four business segments, including machinery and equipment sales, construction materials sales, municipal construction projects and technological consulting and other services, which accounted for 67%, 12%, 8% and 13% of our total revenue from our continuing operations for the year ended December 31, 2022, respectively, for 50%, 46%, 4% and 0% of our total revenue from our continuing operations for the year ended December 31, 2021, respectively, and 77%, 21%, 1% and 0% of our total revenue from our continuing operations for the year ended December 31, 2020, respectively. Our technological consulting and other services include the RSA services and software development services conducted by REIT Mingde which was acquired by us in December 2021.
Our domestic customers are throughout China and our international customers are mainly located in Asia, the Middle East, North Africa and North America. Sales to customers in China and internationally from our continuing operations accounted for approximately 91% and 9%, respectively, of our total sales for the year ended December 31, 2022, approximately 84% and 16%, respectively, of our total sales for the year ended December31, 2021, and approximately 67% and 33%, respectively, of our total sales for the year ended December 31, 2020. As of December 31, 2022, our equipment and machinery were sold in five countries.
Impact of COVID-19
The Company’s operations are affected by the recent and ongoing outbreak and spread of the COVID-19 which was declared a pandemic by the World Health Organization in March 2020. The COVID-19 pandemic is causing lockdowns, travel restrictions, and closures of businesses in China and globally. Our business has been, and may continue to be, materially adversely impacted by the COVID-19 pandemic.
73
From late January 2020 through March 2020, the Company had to temporarily suspend the manufacturing activities due to government restrictions. During the temporary business closure period, employees had very limited access to our manufacturing facilities and the shipping services were not available and as a result, the Company experienced difficulty in delivering the products to customers on a timely basis. In addition, due to the COVID-19, some of the Company’s customers or suppliers experienced financial distress, delayed or defaulted on their payments, reduced the scale of their business, or suffered disruptions in their business. Our production and sales activities returned to normal after the spread of COVID-19 had been substantially controlled in China in late 2020. However, since 2021, there has been a resurgence of COVID-19 cases caused by new variants such as Delta and Omicron in multiple cities in China, as well as across the world. Restrictions have been re-imposed in certain cities to combat such outbreaks and emerging variants of the virus. The COVID-19 pandemic has had a significant impact on the construction sector, which is sensitive to economic cycles. The nature of the impacts and extent of the ramifications are in large part dependent upon the location of the underlying projects. Direct impacts have ranged from a slowdown of available materials and labor to suspensions and, in some instances, deferral and suspension of entire projects.
On December 7, 2022, China announced new rules that constitute a relaxation of almost all of its stringent COVID-19 pandemic control measures. Subsequently, local governments also lifted additional mobility restrictions. While such measures have effectively reopened business within China, COVID-19’s continued existence may have significant impacts on our industry. The impact of the COVID-19 pandemic on the Company’s future financial results will depend on various factors, such as the length and severity of the crisis, potential resurgences, future government responses and the overall impact of the COVID-19 pandemic on the global economy and capital markets, among others, all of which remain highly uncertain and unpredictable. Therefore, the Company is currently unable to quantify the expected impact of the COVID-19 pandemic on its future operations, financial condition, liquidity and results of operations if the current situation continues.
Despite the on-going impact of COVID-19, our revenue increased by 80%, or approximately $2.9 million, from approximately $3.6 million for the year ended December 31, 2021 to approximately $6.5 million for the year ended December 31, 2022 due to higher machinery and equipment sales resulted from large contracts for gravity separators and revenue from RSA services and software development services which were acquired in December 2021.
Results of Operations from Our Continuing Operations
Comparison of Operation Results for the Years Ended December 31, 2022, 2021 and 2020
The following table summarizes the results of our continuing operations during the fiscal years ended December 31, 2022, 2021 and 2020, and provides information regarding the dollar and percentage increase or (decrease) during such years.
(All amounts, other than percentages, in thousands of U.S. dollars)
| 2022 | 2021 | |||||||||||||||||||||||
| Statements of Income Data: | Amount | As % of Sales | Amount | As % of Sales | Amount Increase (Decrease) | Percentage Increase (Decrease) | ||||||||||||||||||
| Revenues- third party customers | $ | 6,169 | 95 | % | $ | 3,318 | 92 | % | $ | 2,851 | 86 | % | ||||||||||||
| Revenue- related party customers | 305 | 5 | % | 282 | 8 | % | 23 | 8 | % | |||||||||||||||
| Total revenues | 6,474 | 100 | % | 3,600 | 100 | % | 2,874 | 80 | % | |||||||||||||||
| Cost of revenues- third party customers | 5,195 | 80 | % | 3,039 | 84 | % | 2,156 | 71 | % | |||||||||||||||
| Cost of revenues – related parties | 472 | 7 | % | 175 | 5 | % | 297 | 170 | % | |||||||||||||||
| Total cost of revenues | 5,667 | 88 | % | 3,214 | 89 | % | 2,453 | 76 | % | |||||||||||||||
| Gross profit | 807 | 12 | % | 386 | 11 | % | 421 | 109 | % | |||||||||||||||
| Operating expenses: | ||||||||||||||||||||||||
| Selling expenses | 3,775 | 58 | % | 826 | 23 | % | 2,949 | 357 | % | |||||||||||||||
| General and administrative expenses | 8,593 | 133 | % | 4,619 | 128 | % | 3,974 | 86 | % | |||||||||||||||
| Bad debt expenses | 1,711 | 26 | % | 2,250 | 63 | % | (539 | ) | (24 | )% | ||||||||||||||
| Impairment of long-lived assets | - | - | % | 4,344 | 121 | % | (4,344 | ) | (100 | )% | ||||||||||||||
| Impairment of goodwill | 1,019 | 16 | % | - | - | 1,091 | - | |||||||||||||||||
| Research and development expense | 961 | 15 | % | 347 | 10 | % | 614 | 177 | % | |||||||||||||||
| Total operating expenses | 16,059 | 248 | % | 12,387 | 344 | % | 3,672 | 30 | % | |||||||||||||||
| Loss from operations | (15,252 | ) | (236 | )% | (12,001 | ) | (333 | )% | (3,251 | ) | 27 | % | ||||||||||||
| Other income (expenses) | ||||||||||||||||||||||||
| Interest expense, net | (322 | ) | (5 | )% | (103 | ) | (3 | )% | (219 | ) | 211 | % | ||||||||||||
| Interest income | 3 | - | % | 2 | - | % | 1 | 70 | % | |||||||||||||||
| Other income (expense), net | 178 | 3 | % | (27 | ) | (1 | )% | 205 | (759 | )% | ||||||||||||||
| change in fair value in convertible debt | (467 | ) | (7.2 | )% | (1,909 | ) | 53 | % | 1,441 | (76 | )% | |||||||||||||
| Loss from disposal of REIT Changjiang | - | - | % | (6,293 | ) | (175 | )% | 6,293 | (100 | )% | ||||||||||||||
| Gain from dissolution of subsidiaries | 508 | 8 | % | - | - | 508 | - | % | ||||||||||||||||
| Share of losses in equity method investments | (46 | ) | (1 | )% | (143 | ) | (4 | )% | 97 | (68 | )% | |||||||||||||
| Total other expenses, net | (146 | ) | (2 | )% | (8,473 | ) | (235 | )% | 8,327 | (98 | )% | |||||||||||||
| Loss before income taxes | (15,398 | ) | (238 | )% | (20,474 | ) | (569 | )% | 5,076 | (25 | )% | |||||||||||||
| Income taxes provision (benefit) | (18 | ) | - | % | 3 | - | % | (21 | ) | (606 | )% | |||||||||||||
| Net loss from continuing operations | $ | (15,380 | ) | (238 | )% | $ | (20,478 | ) | (569 | )% | $ | 5,098 | (25 | )% | ||||||||||
| Net loss from discontinued operations, net of taxes | - | - | (1,596 | ) | (44 | )% | 1,596 | (100 | )% | |||||||||||||||
| Net loss | $ | (15,380 | ) | (238 | )% | $ | (22,074 | ) | (613 | )% | $ | 6,694 | (30 | )% | ||||||||||
74
| 2021 | 2020 | |||||||||||||||||||||||
| Statements of Income Data: | Amount | As % of Sales | Amount | As % of Sales | Amount Increase (Decrease) | Percentage Increase (Decrease) | ||||||||||||||||||
| Revenues- third party customers | $ | 3,318 | 92 | % | $ | 8,111 | 97 | % | $ | (4,793 | ) | (59 | )% | |||||||||||
| Revenue- related party customers | 282 | 8 | % | 228 | 3 | % | 54 | 24 | % | |||||||||||||||
| Total revenues | 3,600 | 100 | % | 8,339 | 100 | % | (4,739 | ) | (57 | )% | ||||||||||||||
| Cost of revenues- third party customers | 3,039 | 84 | % | 6,194 | 74 | % | (3,154 | ) | (51 | )% | ||||||||||||||
| Cost of revenues – related parties | 175 | 5 | % | 148 | 2 | % | 27 | 18 | % | |||||||||||||||
| Total cost of revenues | 3,214 | 89 | % | 6,342 | 76 | % | (3,127 | ) | (49 | )% | ||||||||||||||
| Gross profit | 386 | 11 | % | 1,998 | 24 | % | (1,612 | ) | (81 | )% | ||||||||||||||
| Operating expenses: | ||||||||||||||||||||||||
| Selling expenses | 826 | 23 | % | 1,086 | 13 | % | (259 | ) | (24 | )% | ||||||||||||||
| General and administrative expenses | 4,619 | 128 | % | 3,971 | 48 | % | 647 | 16 | % | |||||||||||||||
| Bad debt expenses | 2,250 | 63 | % | 910 | 11 | % | 1,340 | 147 | % | |||||||||||||||
| Impairment of long-lived assets | 4,344 | 121 | % | 2,267 | 27 | % | 2,077 | 92 | % | |||||||||||||||
| Research and development expense | 347 | 10 | % | 335 | 4 | % | 12 | 4 | % | |||||||||||||||
| Total operating expenses | 12,387 | 344 | % | 8,569 | 103 | % | 3,818 | 45 | % | |||||||||||||||
| Loss from operations | (12,001 | ) | (333 | )% | (6,572 | ) | (79 | )% | (5,429 | ) | 83 | % | ||||||||||||
| Other income (expenses) | ||||||||||||||||||||||||
| Interest expense, net | (103 | ) | (3 | )% | (858 | ) | (10 | )% | 754 | (88 | )% | |||||||||||||
| Interest income | 2 | - | % | 1 | - | % | 1 | 100 | % | |||||||||||||||
| Other income (expense), net | (27 | ) | (1 | )% | 480 | 6 | % | (507 | ) | (106 | )% | |||||||||||||
| change in fair value in convertible debt | (1,909 | ) | (53 | )% | - | - | % | (1,909 | ) | - | % | |||||||||||||
| Loss from disposal of REIT Changjiang | (6,293 | ) | (175 | )% | - | - | % | (6,293 | ) | - | % | |||||||||||||
| Gain from disposal of Gu’an REIT | - | - | 2,231 | 27 | % | (2,231 | ) | (100 | )% | |||||||||||||||
| Share of losses in equity method investments | (143 | ) | (4 | )% | - | - | % | (143 | ) | - | % | |||||||||||||
| Total other Income (expenses), net | (8,473 | ) | (235 | )% | 1,854 | 22 | % | (10,327 | ) | (557 | )% | |||||||||||||
| Loss before income taxes | (20,474 | ) | (569 | )% | (4,718 | ) | (57 | )% | (15,756 | ) | 334 | % | ||||||||||||
| Provision for income taxes | 3 | - | % | 570 | 7 | % | (567 | ) | (99 | )% | ||||||||||||||
| Net loss from continuing operations | $ | (20,478 | ) | (569 | )% | $ | (5,288 | ) | (63 | )% | $ | (15,190 | ) | 287 | % | |||||||||
| Net loss from discontinued operations | (1,596 | ) | (44 | )% | (7,613 | ) | (91 | )% | 6,016 | (79 | )% | |||||||||||||
| Net loss | $ | (22,074 | ) | (613 | )% | $ | (12,901 | ) | (155 | )% | $ | (9,173 | ) | 71 | % | |||||||||
(All amounts, other than percentages, in thousands of U.S. dollars)
75
Revenues
Our total revenues from continuing operations increased by approximately $2.9 million, or 80%, to approximately $6.5 million for the year ended December 31, 2022 from approximately $3.6 million for the year ended December 31, 2021. Among our total revenue, revenue from third party customers increased by approximately $2.9 million or 86% from approximately $3.3 million for the year ended December 31, 2021 to approximately $6.2 million for the year ended December 31, 2022, while revenue from related party customers increased by $23,091 or 8% from $281,784 for the year ended December 31, 2021 to $304,875 for the year ended December 31, 2022. The significant increase in our total revenue in the year ended December 31 2022 compared to the year ended December 31, 2021 was mainly due to higher machinery and equipment sales resulted from large contracts for gravity separators and revenue from RSA services and software development services which were acquired in December 2021.
Our total revenues decreased by approximately $4.7 million, or 57%, to approximately $3.6 million for the year ended December 31, 2021 from approximately $8.3 million for the year ended December 31, 2020. Among our total revenue, revenue from third party customers decreased by approximately $4.8 million or 59% from approximately $8.1 million in 2020 to approximately $3.3 million in 2021, while revenue from related party customers increased by $52,970 or 23% from $228,814 in 2020 to $281,784 in 2021. The significant decrease in our total revenue in fiscal 2021 as compared to fiscal 2020 was mainly due to slowdown of construction industry due to financial tightness. Real estate companies in China faced challenges rolling over their debts and some went bankrupt. Construction investments were cut or delayed due to financial tightness and market pessimism. Continuous impact of COVID-19 also caused disruption in our supply chains and less demand for our products. However, we believe our eco-friendly construction materials will be in greater demand than traditional construction materials as the PRC construction market continues to grow and the PRC government increases its focus on reducing the environmental impact of construction activities, which includes, among other things, recent environmental initiatives.
The following table summarizes the results of revenues from our continuing operations by business segments for the fiscal years ended December 31, 2022, 2021 and 2020:
Revenue by Business Segment
(All amounts, other than percentages, in thousands of U.S. dollars)
| December 31, 2022 | December 31, 2021 | Variance | ||||||||||||||||||||||
| Amount | % of Sales | Amount | % of Sales | Amount Increase (Decrease) | Percentage Increase (Decrease) | |||||||||||||||||||
| Machinery and equipment | $ | 4,299 | 67 | % | $ | 1,800 | 50 | % | $ | 2,499 | 139 | % | ||||||||||||
| Construction materials | 806 | 12 | % | 1,658 | 46 | % | (852 | ) | (51 | )% | ||||||||||||||
| Municipal construction | 527 | 8 | % | 142 | 4 | % | 385 | 271 | % | |||||||||||||||
| Technological consulting and other services | 842 | 13 | % | - | - | 842 | - | % | ||||||||||||||||
| Total | $ | 6,474 | 100 | % | $ | 3,600 | 100 | % | $ | 2,874 | 80 | % | ||||||||||||
| December 31, 2021 | December 31, 2020 | Variance | ||||||||||||||||||||||
| Amount | % of Sales | Amount | % of Sales | Amount Increase (Decrease) | Percentage Increase (Decrease) | |||||||||||||||||||
| Machinery and equipment | $ | 1,800 | 50 | % | $ | 6,456 | 77 | % | $ | (4,656 | ) | (72 | )% | |||||||||||
| Construction materials | 1,658 | 46 | % | 1,777 | 21 | % | (119 | ) | (7 | )% | ||||||||||||||
| Municipal construction | 142 | 4 | % | 107 | 1 | % | 35 | 33 | % | |||||||||||||||
| Total | $ | 3,600 | 100 | % | $ | 8,340 | 100 | % | $ | (4,740 | ) | (57 | )% | |||||||||||
76
Machinery and Equipment
Revenue from machinery and equipment sales increased by approximately $2.5 million, or 139%, from approximately $1.8 million for the year ended December 31, 2021 to approximately $4.3 million for the year ended December 31, 2022. The increase is mainly due to increased sales from large contracts for gravity separators.
Revenue from machinery and equipment sales in our continuing operations decreased by approximately $4.7 million, or 72%, from approximately $6.5 million for the year ended December 31, 2020 to approximately $1.8 million for the year ended December 31, 2021. The decrease is mainly due to slowdown of the construction industry disruption in our supply chains and less demand for our products.
Construction Materials
Sales of our environmental-friendly construction materials decreased by approximately $0.9 million or 51% to approximately $0.8 million for the year ended December 31, 2022 as compared to the year ended December 31, 2021 due to the decrease in demand resulting from the downturn of the national construction market under the impact of COVID-19.
Sales of our environmental-friendly construction materials in our continuing operations decreased by approximately $0.1 million or 7% for the year ended December 31, 2021 as compared to the year ended December 31, 2020.
Municipal Construction
Municipal construction includes such projects known as sponge city projects. Our environmental-friendly construction materials such as brick and block may be used in these municipal construction projects as required by local governments. Revenue from municipal construction projects in our continuing operations increased by approximately $0.4 million or 271% in the year ended December 31, 2022 as compared to the year ended December 31 2021. The increase is due to overall economy recover in 2022. Revenue from municipal construction projects in our continuing operations increased by approximately $35,000 in the year ended December 31 2021 as compared to the year ended December 31 2020.
Technological Consulting and Other Services
Revenue from technological consulting and other services was approximately $0.8 million for the year ended December 31, 2022, which was generated by our newly acquired subsidiary, Hainan Yile IoT Technology Co., Ltd, a PRC limited liability company (“Hainan Yile IoT”). Hainan Yile IoT provides RSA services to drivers within Hainan Province, China, through our network of RSA services providers of tow providers and automotive repair services. Through Hainan Yile IoT, we are also engaged in the design, development and sales of customized software solutions based on the client specifications.
Cost of Revenues
Our total cost of revenues increased by approximately $2.5 million or 76% to approximately $5.7 million for the year ended December 31, 2022 from approximately $3.2 million for the year ended December 31, 2021. Cost of revenues from third party customers increased by approximately $2.2 million or 71% from approximately $3.0 million in the year ended December 31, 2021 to approximately $5.2 million in the year ended December 31, 2022, while cost of revenues from related party customers increased by approximately $0.3 million or 170% from approximately $0.2 million in the year ended December 31, 2021 to approximately $0.5 million in the year ended December 31, 2022. The increase in our total cost of revenue was in line with the increase in revenue. As a percentage of revenues, the cost of revenues decreased to 88% in the year ended December 31, 2022 from 89% in the year ended December 31, 2021.
Our total cost of revenues decreased by approximately $3.1 million or 49% to approximately $3.2 million for the year ended December 31, 2021 from approximately $6.3 million for the year ended December 31, 2020. Cost of revenues from third party customers decreased by approximately $3.2 million or 51% from approximately $6.2 million in the year ended December 31, 2020 to approximately $3.0 million in the year ended December 31, 2021, while cost of revenues from related party customers increased by $27,019 or 18% from $148,034 in the year ended December 31, 2020 to $175,053 in the year ended December 31, 2021. The decrease in our total cost of revenue was in line with the decrease in revenue. As a percentage of revenues, the cost of revenues increased to 89% in the year ended December 31, 2021 from 76% in the year ended December 31, 2020 due to increase in purchase price of raw materials and labor costs.
77
Cost of Revenues by Business Segment
(All amounts, other than percentages, in thousands of U.S. dollars)
| For the Year Ended December 31, | Variance | |||||||||||||||||||||||
| 2022 | 2021 | Amount | Percentage | |||||||||||||||||||||
| Amount | % of Costs | Amount | % of Costs | Increase (Decrease) | Increase (Decrease) | |||||||||||||||||||
| Machinery and Equipment | $ | 3,931 | 69 | % | $ | 1,501 | 47 | % | $ | 2,430 | 162 | % | ||||||||||||
| Construction materials | 905 | 16 | % | 1,563 | 49 | % | (658 | ) | (42 | )% | ||||||||||||||
| Municipal construction | 486 | 9 | % | 150 | 4 | % | 336 | 224 | % | |||||||||||||||
| Other services | 346 | 6 | % | - | - | % | 346 | - | % | |||||||||||||||
| Total | $ | 5,668 | 100 | % | $ | 3,214 | 100 | % | $ | 2,454 | 76 | % | ||||||||||||
| For the Year Ended December 31, | Variance | |||||||||||||||||||||||
| 2021 | 2020 | Amount | Percentage | |||||||||||||||||||||
| Amount | % of Costs | Amount | % of Costs | Increase (Decrease) | Increase (Decrease) | |||||||||||||||||||
| Machinery and Equipment | $ | 1,501 | 47 | % | $ | 4,430 | 70 | % | $ | (2,929 | ) | (66 | )% | |||||||||||
| Construction materials | 1,563 | 49 | % | 1,901 | 30 | % | (338 | ) | (18 | )% | ||||||||||||||
| Municipal construction | 150 | 4 | % | 11 | - | % | 139 | 1,264 | % | |||||||||||||||
| Total | $ | 3,214 | 100 | % | $ | 6,342 | 100 | % | $ | (3,128 | ) | (49 | )% | |||||||||||
Machinery and Equipment
Cost of revenues for machinery and equipment sales increased by approximately $2.4 million, or 162%, from approximately $1.5 million for the year ended December 31, 2021 to approximately $3.9 million for the year ended December 31, 2022. The increase was primarily due to the increase in production volume, as well as increase in costs of raw materials and labor in 2022.
Cost of revenues for machinery and equipment sales decreased by approximately $2.9 million, or 66%, from approximately $4.4 million for the year ended December 31, 2020 to approximately $1.5 million for the year ended December 31, 2021. The decrease was primarily due to the decrease in production volume.
Construction Materials
Cost of revenues for sales of our environmental-friendly construction materials decreased by approximately $0.7 million, or 42%, from approximately $1.6 million for the year ended December 31, 2021 to approximately $0.9 million for the year ended December 31, 2022. The decrease was due to decrease in sales volume for construction materials sold in the downturn of the national construction market. Since we had fixed costs which did not change as a result of the change in sales, the decrease in our cost of revenues is not as significant as the decrease in the sales of construction materials.
Cost of revenues for sales of our environmental-friendly construction materials decreased by approximately $0.3 million, or 18%, from approximately $1.9 million for the year ended December 31, 2020 to approximately $1.6 million for the year ended December 31, 2021. The decrease was due to decrease in sales volume for construction materials sold in downturn of the national construction market.
Municipal Construction
Cost of revenues for sales of municipal construction projects increased by approximately $0.3 million, or 224%, from approximately $0.2 million for the year ended December 31, 2021 to approximately $0.5 million for the year ended December 31, 2022.
78
Cost of revenues for sales of municipal construction projects in our continuing operations amounted to approximately $150,000 and approximately $11,000 for the years ended December 31, 2021 and 2020, respectively.
Technological Consulting and Other services
Cost of revenues for technological consulting and other services amounted to approximately $0.3 million for the year ended December 31, 2022. There was no cost of technological consulting and other services for the years ended December 31, 2021 and 2020.
Gross Profit
Our gross profit increased by approximately $0.4 million, or 109%, to approximately $0.8 million for the year ended December 31, 2022 from approximately $0.4 million for the year ended December 31, 2021. Gross profit margin for our continuing operations was 12% for the year ended December 31, 2022, as compared with 11% for the year ended December 31, 2021.
Our gross profit decreased by approximately $1.6 million, or 81%, to approximately $0.4 million for the year ended December 31, 2021 from approximately $2.0 million for the year ended December 31, 2020. Gross profit margin for our continuing operations was 11% for fiscal 2021, as compared with 24% for fiscal 2020. The decrease in gross profit margin from our continuing operations was primarily attributable to significant decrease in gross profit in machinery and equipment segment due to the challenging market environment resulting from the COVID-19 pandemic which resulted in financial tightness and slowdown of the construction industry and thereby reduced demand for our products. We had to offer more competitive prices to maintain and win new customers/projects. In addition, the COVID-19 pandemic caused disruption in our supply chain, impacted our ability to timely fulfill our customer orders and led to higher fulfilment expenses.
Our gross profit and gross margin by segments are as follows:
(All amounts, other than percentages, in thousands of U.S. dollars)
| 2022 | 2021 | Variance | ||||||||||||||||||||||
| Gross Profit | Gross Profit% | Gross Profit | Gross Profit% | Gross Profit Increase (Decrease) | Gross Profit% Increase (Decrease) | |||||||||||||||||||
| Machinery and equipment | $ | 368 | 9 | % | $ | 298 | 17 | % | $ | 70 | 23 | % | ||||||||||||
| Construction materials | (99 | ) | (12 | )% | 96 | 6 | % | (194 | ) | (204 | )% | |||||||||||||
| Municipal construction | 41 | 8 | % | (8 | ) | (6 | )% | 49 | (612 | )% | ||||||||||||||
| Technological consulting and other services | 497 | 59 | % | - | - | 497 | - | % | ||||||||||||||||
| Total | $ | 807 | 12 | % | $ | 386 | 11 | % | $ | 422 | 109 | % | ||||||||||||
| 2021 | 2020 | Variance | ||||||||||||||||||||||
| Gross Profit | Gross Profit% | Gross Profit | Gross Profit% | Gross Profit Increase (Decrease) | Gross Profit% Increase (Decrease) | |||||||||||||||||||
| Machinery and equipment | $ | 298 | 17 | % | $ | 2,026 | 31 | % | $ | (1,728 | ) | (85 | )% | |||||||||||
| Construction materials | 96 | 6 | % | (124 | ) | (7 | )% | 220 | (177 | )% | ||||||||||||||
| Municipal construction | (8 | ) | (6 | )% | 96 | 90 | % | (104 | ) | (108 | )% | |||||||||||||
| Total | $ | 386 | 11 | % | $ | 1,998 | 24 | % | $ | (1,612 | ) | (81 | )% | |||||||||||
79
Machinery and Equipment
Gross profit for sales of machinery and equipment products increased by approximately $70,000 to approximately $0.4 million for the year ended December 31, 2022 as compared to approximately $0.3 million for the year ended December 31, 2021. Gross profit margin for this segment was 9% and 17%, respectively, for the years ended December 31, 2022 and 2021. The decrease in gross profit margin was mainly due to the fact that we had to offer more competitive prices for our products in the challenging market environment resulting from the COVID-19 pandemic which resulted in financial tightness and slowdown of the construction industry and thereby reduced demand for our products. In addition, the COVID-19 pandemic caused disruption in our supply chain, impacted our ability to timely fulfill our customer orders and led to higher fulfilment expenses.
Gross profit for machinery and equipment products decreased by approximately $1.7 million to approximately $0.3 million for the year ended December 31, 2021 as compared to $2.0 million for the year ended December 31, 2020. Gross profit margin for this segment was 17% and 31%, respectively, for the years ended December 31, 2021 and 2020. The decrease in gross profit margin was mainly due to the fact that we had to offer more competitive prices for our products in the challenging market environment resulting from the COVID-19 pandemic which resulted in financial tightness and slowdown of the construction industry and thereby reduced demand for our products. In addition, the COVID-19 pandemic caused disruption in our supply chain, impacted our ability to timely fulfill our customer orders and led to higher fulfilment expenses.
Construction Materials
Gross loss for construction materials was approximately $0.1 million for the year ended December 31, 2022 compared to a gross profit of approximately $0.1 million for the year ended December 31, 2021. The gross profit (loss) margin for this segment was approximately (12)% for the year ended December 31, 2022 as compared to 6% for the year ended December 31, 2021.We had fixed costs which did not decrease proportionately with the revenue decrease, and thus resulted in a gross loss.
Gross profit for construction materials was approximately $0.1 million for the year ended December 31, 2021 compared to a gross loss of approximately $0.1 million for the year ended December 31, 2020. The gross profit margin for this segment was approximately 6% for the year ended December 31, 2021 as compared to (7%) for the year ended December 31, 2020. The increase in gross margin was mainly due to the reverse of approximately $0.1 million in inventory valuation, which caused decrease in our cost of revenue.
Municipal Construction
Gross profit (loss) for the municipal construction project segment was approximately $0.04 million, $(0.01) million and $0.1million for the years ended December 31, 2022, 2021 and 2020, respectively.
Technological Consulting and Other Services
Gross profit for technological consulting and other services was approximately $0.5 million for the year ended December 31, 2022. The gross profit margin for this segment was approximately 59% for the year ended December 31, 2022. There was no technological consulting and other services offered during the years ended December 31, 2021 and 2020.
Selling Expenses
For the year ended December 31, 2022, our selling expenses were approximately $3.8 million, representing a 357% increase from approximately $0.8 million in the year ended December 31, 2021. As a percentage of sales, our selling expenses were 58% and 23% for the years ended December 31, 2022 and 2021, respectively. The increase was mainly due to more marketing activities and shipping and handling fees associated with increased sales in the year ended December 31, 2022.
80
For fiscal 2021, our selling expenses were approximately $0.8 million, representing a 24% decrease from approximately $1.1 million in the year ended December 31, 2020. As a percentage of sales, our selling expenses were 23% and 13% for the years ended December 31, 2021 and 2020, respectively. The decrease was mainly due to fewer marketing activities and shipping and handling fees associated with decreased sales in the year ended December 31, 2021.
General and Administrative Expenses
For the year ended December 31, 2022, our general and administrative expenses were approximately $8.6 million, representing an increase of approximately $4.0 million compared to approximately $4.6 million in the year ended December 31, 2021. The increase in general and administrative expenses was mainly due to an increase of share-based compensation for services and consulting and professional fees of $4.0 million. As a percentage of revenues, general and administrative expenses were 133% and 129% of our total revenues for the years ended December 31, 2022 and 2021, respectively.
For the year ended December 31, 2021, our general and administrative expenses were approximately $4.6 million, representing an increase of approximately $0.7 million compared to approximately $4.0 million in the year ended December 31, 2020. The increase in general and administrative expenses was mainly due to an increase of share-based compensation for services and consulting and professional fees of $1.9 million, offset by decreases in other general administrative expenses. As a percentage of revenues, general and administrative expenses were 129% and 48% of our total revenues for the years ended December 31, 2021 and 2020, respectively.
Bad Debt Expenses
For the year ended December 31, 2022, our bad debt expenses were approximately $1.7 million, representing a decrease of approximately $0.5 million as compared to approximately $2.3 million in the year ended December 31, 2021. We incurred significant bad debt expenses on uncollectible accounts receivable and advance payments for fiscal 2022 and 2021, however, in fiscal 2022, the impact of COVID-19 on our customers alleviated. As a percentage of revenues, bad debt expenses were 26% and 63% of our total revenues for the years ended December 31, 2022 and 2021, respectively.
For the year ended December 31, 2021, our bad debt expenses were approximately $2.3 million, representing an increase of approximately $1.4 million as compared to approximately $0.9 million in the year ended December 31, 2020. We incurred significant bad debt expenses on uncollectible accounts receivable and advance payments due to slower or delayed payments from customers and delayed fulfillment of suppliers who were adversely affected by the COVID-19 pandemic and faced shortage in working capital. As a percentage of revenues, bad debt expenses were 63% and 11% of our total revenues for the years ended December 31, 2021 and 2020, respectively.
Research and Development Expenses
Our research and development (“R&D”) expenses were approximately $1.0 million, $0.3 million and $0.3 million for the years ended December 31, 2022, 2021 and 2020, respectively. The increase in R&D expenses in the year ended December 31, 2022 was due to more R&D projects conducted by Beijing REIT.
Impairment of Long-lived Assets
During the years ended December 31, 2022, 2021 and 2020, due to the Company’s reoccurring loss, the Company further assessed that the expected future cash flows may not cover the carrying value of the Company’s fixed asset equipment and machinery. As a result, the Company recorded an additional impairment of approximately $nil, $4.3 million and $2.3 million on its fixed assets for the year ended December 31, 2022, 2021 and 2020, respectively.
81
Impairment of Goodwill
For the year ended December 31, 2022, due to the slow development of REIT Mingde and its subsidiaries, the Company performed the two-step test for the REIT Mingde and its subsidiaries. In accordance with ASC 350-20, the Company recorded an impairment loss of $1,018,870 for the year ended December 31, 2022.
Interest Expense
Our interest expenses were approximately $0.3 million, $0.1 million and $0.9 million for the years ended December 31, 2022, 2021 and 2020, respectively. The increase in interest expenses for fiscal 2022 as compared to fiscal 2021 was because of a higher loan balance in 2022 as compared to that in 2021. The decrease in interest expenses for the year ended December 31, 2021 as compared to the year ended December 31, 2020 was because of a lower loan balance in 2021 as compared to that in 2020.
Other Income (Expense)
Other income amounted to approximately $0.2 million in the year ended December 31, 2022, mainly representing government subsidy. We had other expense of approximately $26,991 in the year ended December 31, 2021, mainly representing acquired inventory loss related to Hainan Yile IoT. We had other income of approximately $0.5 million from our continuing operations in fiscal 2020, mainly due to approximately $0.3 million in government subsidy and recognition of certain balances over three years in customer advance as other income.
Change in Fair Value in Convertible Debt
During the years ended December 31, 2022 and 2021, change in fair value in convertible debt amounted to approximately $0.5 million and $1.9 million, respectively. There was no change in fair value of convertible debt in year ended December 31, 2020.
Share of Losses in Equity Method Investments
For the years ended December 31, 2022 and 2021, share of losses in equity method investments for Shexian Ruibo amounted to approximately $0.05 million and $0.1 million, respectively. There was no share of losses in equity method investments in the year ended December 31, 2020.
Gain (loss) from Disposal and Dissolution of Subsidiaries
The Company recognized a gain from dissolving subsidiaries of approximately $0.5 million in the year ended December 31, 2022. The Company recognized a loss from disposal of REIT Changjiang of approximately $6.3 million in the year ended December 31, 2021. The Company recognized a gain from disposal of Gu’an REIT of approximately $2.2 million in the year ended December 31, 2020.
Loss before Income Taxes
Our loss before income taxes was approximately $15.4 million for the year ended December 31, 2022, a decrease of approximately $5.1 million as compared to loss before income taxes of approximately $20.5 million for the year ended December 31, 2021. The decrease in our loss before income taxes for the fiscal year 2022 was primarily attributable to the increase in revenues and decrease in other expenses, partially offset by increased costs and operating expenses as discussed above.
Our loss before income taxes was approximately $20.5 million for the year ended December 31, 2021, an increase of approximately $15.8 million as compared to loss before income taxes of approximately $4.7 million for the year ended December 31, 2020. The increase in our loss before income taxes for the year ended December 31, 2021 was primarily attributable to the significant decrease in revenues and increased costs and expenses as discussed above.
82
Provision for Income Taxes
The Company’s PRC subsidiaries are subject to PRC income tax, which is computed according to the relevant laws and regulations in the PRC. Under the EIT Law, the corporate income tax rate applicable to all companies, including both domestic and foreign-invested companies, is 25%. However, each of Beijing REIT and Hainan Yile IoT is recognized as a HNTE by PRC government and subject to a favorable income tax rate of 15%.
The following table reconciles the income tax expense by statutory rate to the Company’s actual income tax expense from our continuing operations:
| For the Years Ended December 31, | ||||||||||||
| 2022 | 2021 | 2020 | ||||||||||
| Income tax expense computed based on PRC statutory income tax rate | $ | (3,849,305 | ) | $ | (5,118,519 | ) | $ | (1,179,508 | ) | |||
| Effect of favorable income tax rate in certain entity in PRC | 181,088 | 889,716 | (164,071 | ) | ||||||||
| Non-PRC entities not subject to PRC tax | 1,749,333 | 1,564,644 | 401,488 | |||||||||
| Research & Development (“R&D”) tax credit | (240,150 | ) | (260,213 | ) | (251,178 | ) | ||||||
| Non-deductible expenses - permanent difference | 171,393 | 588,191 | 826,034 | |||||||||
| Change in valuation allowance | 1,970,079 | 2,339,650 | 937,209 | |||||||||
| Income tax expenses | $ | (17,562 | ) | $ | 3,469 | $ | 569,974 | |||||
Net Loss
Our net loss from continuing operations amounted to approximately $15.4 million, $20.5 million and $5.3 million for the years ended December 31, 2022, 2021 and 2020, respectively. Our net loss from discontinued operations amounted to approximately $nil, $1.6 million and $7.6 million for the years ended December 31, 2022, 2021 and 2020, respectively. Total net loss amounted to approximately $15.4 million, $22.1 million and $12.9 million for the years ended December 31, 2022, 2021 and 2020, respectively.
| B. | Liquidity and Going Concern |
We are a holding company incorporated in the British Virgin Islands. REIT Holdings, our wholly owned subsidiary established in Hong Kong, directly owns Beijing REIT, REIT Technology and REIT Technology, which in turn own our assets through their respective subsidiaries in China, India and the United States. We may need dividends and other distributions in equity from our subsidiaries, including our PRC subsidiaries to satisfy our liquidity requirements. Current PRC regulations permit our PRC subsidiaries to pay dividends to us only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, our PRC subsidiaries are required to set aside at least 10% of their respective accumulated profits each year, if any, to fund certain reserve funds until the total amount set aside reaches 50% of their respective registered capital. Our PRC subsidiaries may also allocate a portion of their after-tax profits based on PRC accounting standards to employee welfare and bonus funds at their discretion. These reserves are not distributable as cash dividends. We have primarily relied on direct payments of expenses by our subsidiaries (which generate revenues), to meet our obligations to date.
Substantially all of our operations are conducted in China and are denominated in RMB, which is subject to the exchange control regulation in China, and, as a result, we may have difficulty distributing any dividends outside of China due to PRC exchange control regulations that restrict the ability to convert RMB into U.S. Dollars.
Under applicable PRC regulations, foreign-invested enterprises in China may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, a foreign-invested enterprise in China is required to set aside at least 10% of its after-tax profit based on PRC accounting standards each year to its general reserves until the accumulative amount of such reserves reaches 50% of its registered capital. These reserves are not distributable as cash dividends. The board of directors of a foreign-invested enterprise has the discretion to allocate a portion of its after-tax profits to staff welfare and bonus funds, which may not be distributed to equity owners except in the event of liquidation. Under PRC law, RMB is currently convertible into U.S. Dollars under a company’s “current account,” which includes dividends, trade and service-related foreign exchange transactions, without prior approval of the SAFE, not from a company’s “capital account,” which includes foreign direct investments and loans, without the prior approval of the SAFE.
83
We have historically funded our working capital needs from operations, advance payments from customers, bank borrowings, equity and debt offering, capital contributions from shareholders and related-party loans. Presently, our principal sources of liquidity are generated from our operations, proceeds from our shareholders’ contributions, and loans and notes from commercial banks. Our working capital requirements are influenced by the level of our operations, the numerical volume and dollar value of our sales contracts, the progress of execution on our customer contracts, and the timing of accounts receivable collections.
As reflected in the Company’s consolidated financial statements for the year ended December 31, 2022, the Company reported a net loss of approximately $15.4 million. As of December 31, 2022, the Company had a working capital deficit of approximately of $10.1 million.
As of December 31, 2022, the Company had outstanding bank loans of approximately $1.3 million from a PRC bank. If the Company cannot renew existing loans or borrow additional loans from banks, the Company’s working capital may be further negatively impacted.
As of December 31, 2022, the Company had cash of approximately $0.1 million. In addition, the Company had outstanding accounts receivable of approximately $2.2 million (including accounts receivable from third-party customers of $2.1 million and accounts receivable from related party customers of approximately $0.1 million), of which approximately $0.3 million, or 7.7%, had been subsequently collected between January and April 2022, and became available for use as working capital. As of December 31, 2022, the Company had outstanding bank loans of approximately $1.3 million from a PRC bank.
Management expects that it would be able to renew all of its existing bank loans upon their maturity based on past experience and the Company’s good credit history. Currently, the Company is working to improve its liquidity and capital source mainly through cash flow from its operations, renewal of bank borrowings, and borrowing from related parties. In order to fully implement its business plan and sustain continued growth, the Company may also seek equity financing from outside investors. At the present time, however, the Company does not have commitments of funds from any potential investors. No assurance can be given that additional financing, if required, would be available on favorable terms or at all.
Based on the reasons above, there is a substantial doubt about the Company’s ability to continue as a going concern for the next 12 months from the issuance of the consolidated financial statements.
Cash Flows for Years Ended December 31, 2022, 2021 and 2020
The following table sets forth summary of our cash flows for the periods indicated:
(All amounts in thousands of U.S. dollars)
December 31, 2022 | December 31, 2021 | December 31, 2020 | ||||||||||
| Net cash (used in) provided by operating activities | $ | (9,962 | ) | $ | (2,764 | ) | $ | 248 | ||||
| Net cash provided by (used in) investing activities | 4,243 | (1,743 | ) | 944 | ||||||||
| Net cash provided by (used in) financing activities | 4,756 | 4,048 | (1,178 | ) | ||||||||
| Effect of exchange rate changes on cash and cash equivalents | 620 | (204 | ) | 121 | ||||||||
| Net (decrease) increase in cash and cash equivalents | (344 | ) | (663 | ) | 135 | |||||||
| Cash and restricted cash, beginning of the year | 457 | 1,121 | 986 | |||||||||
| Cash and restricted cash, end of the year | 114 | $ | 458 | $ | 1,121 | |||||||
| Less: cash and cash equivalents, restricted cash of discounted operations at end of period | - | - | 63 | |||||||||
| Cash and cash equivalents, restricted cash of continued operation, at end of period | $ | 114 | $ | 458 | $ | 1,058 | ||||||
84
Operating Activities
Net cash used in operating activities was approximately $10.0 million in the year ended December 31, 2022. Net cash used in operating activities in the year ended December 31, 2022 mainly consisted of net loss from continuing operation of approximately $15.4 million, adjustments of non-cash items of approximately $8.3 million, an increase of approximately $2.7 million in accounts receivable, a decrease of approximately $0.1 million in inventories, an increase of approximately $0.7 million in advance from customers, an increase of approximately $0.7 million in accounts payable, a decrease of approximately $0.2 million in accrued expenses and other liabilities, and a decrease of approximately $0.6 million in taxes payable.
Net cash used in operating activities was approximately $2.8 million in the year ended December 31, 2021. Net cash provided by operating activities in the year ended December 31, 2021 mainly consisted of net loss from continuing operation of approximately $20.5 million, adjustments of non-cash items of approximately $18.2 million, a decrease of approximately $0.7 million in accounts receivable, a decrease of approximately $1.2 million in advance to suppliers, a decrease of approximately $1.4 million in advance from customers, an increase of approximately $1.1 million in accounts payable, an increase of approximately $1.0 million in accrued expenses and other liabilities, and a decrease of approximately $0.2 million in deferred grants. Net cash provided by discontinued operating activities was approximately $2.7 million.
Net cash provided by operating activities was approximately $0.2 million in the year ended December 31, 2020. Net cash provided by operating activities in the year ended December 31, 2020 mainly consisted of net loss of approximately $5.3 million, adjustments of non-cash items of approximately $3.0 million, a decrease of approximately $3.9 million in accounts receivable, an increase of approximately $0.4 million in advance from customers, an increase of approximately $1.1 million in accrued expenses and other liabilities, an increase of approximately $0.7 million in tax payable, offset by an increase of approximately $1.2 million in advance to suppliers, a decrease of approximately $1.8 million in accounts payable and, and an increase of approximately $0.7 million in prepayments and other assets. Net cash provided by discontinued operating activities was $6,990.
Investing Activities
Net cash provided by investing activities was approximately $4.2 million for the year ended December 31, 2022. During the year ended December 31, 2022, the Company paid approximately $1.3 million on software and received proceeds from disposal of subsidiaries of approximately $5.7 million.
Net cash used in investing activities was approximately $1.7 million for the year ended December 31, 2021. During the year ended December 31, 2021, the Company paid approximately $2.6 million on the construction in progress (“CIP”) and received proceeds from disposal of subsidiaries of approximately $2.6 million. Net cash used in discontinued investing activities was approximately $1.8 million.
Net cash provided by investing activities was approximately $0.9 million for the year ended December 31, 2020. During the year ended December 31, 2020, we paid approximately $2.6 million for the acquisition of a 41.67% ownership interest in Shexian Ruibo and received approximately $3.8 million for disposition of Gu’an REIT. Net cash used in discontinued investing activities was approximately $0.2 million.
Financing Activities
Net cash provided by financing activities was approximately $4.8 million for the year ended December 31, 2022, including proceeds from bank loans of approximately $0.7 million, proceeds of approximately $3.0 million from issuance of a convertible note, proceeds from third-party loans of approximately $1.8 million, proceeds received from share issuance of approximately $3.6 million, offset by repayment of bank loans of approximately $1.5 million, net loan payment to related parties of approximately $1.3 million, payments to non-controlling shareholders of approximately $1.9 million for purchasing non-controlling interest of a subsidiary, and repayment of third-party loans of approximately $1.0 million.
85
Net cash provided by financing activities was approximately $4.0 million for the year ended December 31, 2021, including proceeds from bank loans of approximately $2.3 million and proceeds of approximately $3.7 million from issuing convertible loans, proceeds from third party loans of approximately $0.8 million, offset by repayment of bank loans of approximately $7.2 million and net loan payment to related parties of approximately $0.3 million. Net cash provided by discontinued financing activities was approximately $4.7 million.
Net cash used in financing activities was approximately $1.9 million for the year ended December 31, 2020, including proceeds from bank loans of approximately $11.0 million, offset by repayment of bank loans of approximately $13.2 million and net repayment to related parties of $38,835. Net cash provided by discontinued financing activities was approximately $0.4 million.
Statutory Reserves
The Company is required to make appropriations to certain reserve funds, comprising the statutory surplus reserve and the discretionary surplus reserve, based on after-tax net income determined in accordance with generally accepted accounting principles of the PRC (“PRC GAAP”). Appropriations to the statutory surplus reserve are required to be at least 10% of the after-tax net income determined in accordance with PRC GAAP until the reserve is equal to 50% of the entity’s registered capital. Appropriations to the discretionary surplus reserve are made at the discretion of the Board of Directors. The restricted amounts as determined pursuant to PRC statutory laws totaled $1,066,554 and $1,230,387 as of December 31, 2022 and 2021, respectively.
Capital Expenditures
We had capital expenditures of approximately $1.5 million, $2.6 million, and $0.1 million for the years ended December 31, 2022, 2021 and 2020, respectively, for purchases of equipment and intangible assets in connection with our business activities.
Recent Accounting Pronouncements
A list of recent relevant accounting pronouncements is included in Note 2 “Summary of Principal Accounting Policies” of our consolidated financial statements included elsewhere in this annual report.
| C. | Research and Development, Patent and Licenses, etc. |
Please refer to “Item 4. Information on the Company—B. Business Overview—Research and Development” and “—Intellectual Property.”
| D. | Trend Information. |
Other than as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demands, commitments or events that are reasonably likely to have a material effect on our net revenues, income from continuing operations, profitability, liquidity or capital resources, or that would cause reported financial information not necessarily to be indicative of future operating results or financial condition.
| E. | Critical Accounting Estimates. |
We prepare our financial statements in conformity with accounting principles generally accepted by the United States of America (“U.S. GAAP”), which requires us to make judgments, estimates and assumptions that affect our reported amount of assets, liabilities, revenue, costs and expenses, and any related disclosures. Although there were no material changes made to the accounting estimates and assumptions in the past years, we continually evaluate these estimates and assumptions based on the most recently available information, our own historical experience and various other assumptions that we believe to be reasonable under the circumstances. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from our expectations as a result of changes in our estimates.
86
We believe that the following accounting policies involve a higher degree of judgment and complexity in their application and require us to make significant accounting estimates. Accordingly, these are the policies we believe are the most critical to understanding and evaluating our consolidated financial condition and results of operations.
Accounts Receivable, Net
Accounts receivable is recognized and carried at original invoiced amount less an estimated allowance for uncollectible accounts. The Company usually grants credit to customers with good credit standing with a maximum of 180 days and determines the adequacy of reserves for doubtful accounts based on individual account analysis and historical collection trends. The Company establishes a provision for doubtful receivables when there is objective evidence that the Company may not be able to collect amounts due. The allowance is based on management’s best estimates of specific losses on individual exposures, as well as a provision on historical trends of collections. Based on the assessment of customers’ credit and ongoing relationships, the Company’s payment terms typically range from 90 days to 1 year. The provision is recorded against accounts receivables balances, with a corresponding charge recorded in the consolidated statements of income and comprehensive income. Actual amounts received may differ from management’s estimate of credit worthiness and the economic environment. Delinquent account balances are written-off against the allowance for doubtful accounts after management has determined that the likelihood of collection is not probable. As affected by the ongoing COVID-19 pandemic and spread, the Company’s accounts receivable collection was negatively affected. Based on subsequent collection analysis, the Company accrued increased bad debt reserve for the outstanding accounts receivable as of December 31, 2021. As a result, allowance for uncollectible balances amounted to $1,771,761 and $904,052 as of December 31, 2022 and 2021, respectively.
Impairment of Long-lived Assets
The Company reviews long-lived assets, including definitive-lived intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the estimated cash flows from the use of the asset and its eventual disposition are below the asset’s carrying value, then the asset is deemed to be impaired and written down to its fair value. During the year ended December 31, 2019, the Company disposed of approximately $0.2 million of outdated and fully depreciated equipment and machinery. Given the Company’s net loss position in fiscal 2022, 2021 and 2020, the Company further assessed that the expected future cash flow generated from its machinery, equipment, and other long-lived assets would not recover their carrying value and as a result, the Company recorded an impairment of approximately $nil, $4.3 million and $2.3 million on these fixed assets for the year ended December 31, 2022, 2021 and 2020, respectively, based on the fair value assessment provided by the third party valuation firm using the significant unobservable inputs.
Revenue Recognition
The Company adopted ASC Topic 606 Revenue from Contracts with Customers (“ASC 606”) on January 1, 2018 using the modified retrospective approach. Under ASC 606, revenue is recognized when control of promised goods or services is transferred to the Company’s customers in an amount of consideration to which an entity expects to be entitled to in exchange for those goods or services.
To determine revenue recognition for contracts with customers, the Company performs the following five steps: (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, including variable consideration to the extent that it is probable that a significant future reversal will not occur, (iv) allocate the transaction price to the respective performance obligations in the contract, and (v) recognize revenue when (or as) the Company satisfies the performance obligation.
The Company’s revenues are primarily derived from the following sources:
| ● | Revenue from machinery and equipment sales |
The Company recognizes revenue when the machinery and equipment is delivered and control is transferred. The Company generally provide a warranty for a period of 12 months after the customers receive the equipment. The Company determines that such product warranty is not a separated performance obligation because the nature of warranty is to provide assurance that a product will function as expected and in accordance with customer’s specification and the Company has not sold the warranty separately. From its past experience, the Company has not experienced any material warranty costs and, therefore, the Company does not believe an accrual for warranty cost is necessary for the years ended December 31, 2022, 2021 and 2020.
87
| ● | Revenue from construction materials sales |
The Company recognizes revenue, net of sales taxes and estimated sales returns, when the construction materials are shipped to, delivered to or picked up by customers and control is transferred.
| ● | Revenue from municipal construction projects |
The Company provides municipal construction services, also known as sponge city projects. The Company recognizes revenue associated with these contracts over time as service is performed and the transfer of control occurs, based on a percentage-of-completion method using cost-to-cost input methods as a measure of progress. When the percentage-of-completion method is used, the Company estimates the costs to complete individual contracts and records as revenue that portion of the total contract price that is considered complete based on the relationship of costs incurred to date to total anticipated costs (the cost-to-cost approach).
Under the cost-to-cost approach, the use of estimated costs to complete each contract is a significant variable in the process of determining recognized revenue, requires judgment and can change throughout the duration of a contract due to contract modifications and other factors impacting job completion. The costs of earned revenue include all direct material and labor costs and those indirect costs related to contract performance, such as indirect labor, supplies, tools and repairs. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined.
| ● | Revenue from technological consulting and other services |
The Company recognizes revenue when technological consulting and other services are rendered and accepted by the customers.
Contract Assets and Liabilities
Payment terms are established on the Company’s pre-established credit requirements based upon an evaluation of customers’ credit quality. Contact assets are recognized for in related accounts receivable. Contract liabilities are recognized for contracts where payment has been received in advance of delivery. The contract liability balance can vary significantly depending on the timing of when an order is placed and when shipment or delivery occurs.
As of December 31, 2022 and 2021, other than accounts receivable and advances from customers, the Company had no other material contract assets, contract liabilities or deferred contract costs recorded on its consolidated balance sheet. Costs of fulfilling customers’ purchase orders, such as shipping, handling and delivery, which occur prior to the transfer of control, are recognized in selling, general and administrative expense when incurred.
Stock-based Compensation
The Company accounts for share-based compensation in accordance with ASC 718, Compensation — Stock Compensation (“ASC 718”). In accordance with ASC 718, the Company determines whether an award should be classified and accounted for as a liability award or an equity award. All the Company’s share-based awards were classified as equity awards and are recognized in the consolidated financial statements based on their grant date fair values.
88
The Company has elected to recognize share-based compensation using the straight-line method for all share-based awards granted with graded vesting based on service conditions. The Company uses the accelerated method for all awards granted with graded vesting. The Company accounts for forfeitures as they occur in accordance with ASU No. 2016-09, Compensation — Stock Compensation (Topic 718): Improvement to Employee Share-based Payment Accounting. The Company, with the assistance of an independent third-party valuation firm, determined the fair value of the stock options granted to employees. The binomial option pricing model and Black-Scholes Model were applied in determining the estimated fair value of the options granted to employees and non-employees.
Income Taxes
The Company accounts for income taxes under ASC 740. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period including the enactment date. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.
The provisions of ASC 740-10-25, “Accounting for Uncertainty in Income Taxes,” prescribe a more-likely-than-not threshold for consolidated financial statement recognition and measurement of a tax position taken (or expected to be taken) in a tax return. This interpretation also provides guidance on the recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and related disclosures. The Company records a liability for uncertain tax positions when it is probable that a loss has been incurred and the amount can be reasonably estimated.
To the extent applicable, the Company records interest and penalties as a general and administrative expense. The Company’s subsidiaries in China and Hong Kong are subject to the income tax laws of the PRC and Hong Kong. No significant taxable income was generated outside the PRC for the years ended December 31, 2022, 2021 and 2020. As of December 31, 2022, the tax years ended December 31, 2018 through December 31, 2022 for the Company’s PRC subsidiaries remain open for statutory examination by PRC tax authorities.
Item 6. Directors, Senior Management and Employees
| A. | Directors and senior management. |
The following table sets forth information regarding directors and our executive officers as of the date of this annual report.
| Name (1) | Age | Position | ||||
| Hengfang Li (2) | 60 | Chief Executive Officer and Chairman of the Board | ||||
| Guangfeng Dai (2) | 62 | President, Chief Operating Officer and Director | ||||
| Zhizhong Hu (2) | 60 | Chief Technology Officer and Director | ||||
| Degang Hou | 61 | Chief Internal Control Officer | ||||
| Yue Hu | 33 | Chief Financial Officer | ||||
| Tonglong Liu (3) (5) (6) (7) | 59 | Director | ||||
| Baoqing Sun (3) (5) (6) (7) | 60 | Director | ||||
| Lidong Liu (4) (5) | 51 | Director | ||||
| Austin Huang (4) (6) (7) | 65 | Director | ||||
| (1) | Each individual’s business address is c/o Beijing REIT Technology Development Co., Ltd., Building X-702, 60 Anli Road, Chaoyang District, Beijing China. |
| (2) | Class C director, whose term will expire at the 2025 annual meeting of shareholders. |
89
| (3) | Class B director, whose term will expire at the 2024 annual meeting of shareholders. |
| (4) | Class A director, whose term will expire at the 2023 annual meeting of shareholders. |
| (5) | Member of audit committee. |
| (6) | Member of compensation committee. |
| (7) | Member of nominating committee. |
Hengfang Li. Mr. Li has served as the Chief Executive Officer and Chairman of ReTo since April 2016. Mr. Li founded Beijing REIT in 1999 and has served as Beijing REIT’s Chief Executive Officer and Chairman since 1999. Mr. Li served as the chief representative in China of the German Hess Group from 1995 until 1999. From 1988 through 1995, Mr. Li was an engineer, senior engineer and then branch director at China North Vehicle Engine Research Center. Mr. Li holds a Master degree in Engine Studies from Beijing Institute of Technology.
Guangfeng Dai. Mr. Dai became the President of ReTo in 2020. Previously Mr. Dai served as the Chief Operating Officer and of ReTo and has served as a Director since November 2016. Mr. Dai has served as Beijing REIT’s Chief Operating Officer and Director since 2000. Mr. Dai served as the deputy representative in China for Hess Mechanical Engineering Co., Ltd. of Germany from 1997 until 2000. From 1995 through 1997, Mr. Dai was a senior engineer at Yanxing Corporation of China. From 1992 through 1994, Mr. Dai was a senior engineer at China North Industries Group Corporation. Mr. Dai received his Master degree in Automobile Engineering from Beijing Institute of Technology.
Zhizhong Hu. Mr. Hu has served as the Chief Technology Officer and Director of ReTo since November 2016. Mr. Hu has served as Beijing REIT’s Chief Technology Officer and Director since 2000. Mr. Hu served as the general manager and executive director of Yichang Hayes Building Materials Co., Ltd. from 1997 through 2000. From 1996 through 1997, Mr. Hu served as the business representative for Hayes Mechanical Engineering Co., Ltd. of Germany. Mr. Hu received his Bachelor’s Degree in Mechanical Engineering from Nanjing University of Science and Technology.
Degang Hou. Mr. Hou has served as the Chief Internal Control Officer of ReTo since February 2020. From 1983 through 1999, he was an engineer and senior engineer of North Vehicle Research Institute, State Weaponry Equipment Corporation. From 1999 through 2020 he was the deputy general manager for Beijing REIT. He graduated in Ship Internal Combustion Engine Direction from Dalian University of Technology in 1983.
Yue Hu. Ms. Hu has served as Chief Financial Officer of ReTo since August 2022. She has worked in Beijing REIT Technology Development Co., Ltd., a wholly owned subsidiary of ReTo, as an assistant to the management since May 2019, and has assisted with preparation and filing of periodic reports of the Company to the Securities and Exchange Commission. From March 2015 to December 2016, Ms. Hu worked in Gu’an REIT Machinery Manufacturing Co., Ltd., a former wholly owned subsidiary of the Company, as a procurement specialist, in charge of purchasing accessories needed for production and processing. Ms. Hu received her Bachelor’s degree in Accounting from Xi’an Siyuan University.
90
Tonglong Liu. Mr. Liu has served as an independent director of the Company since November 2022. Mr. Liu has also served as the Chief Executive Officer and Chairman of Beike Huizhi Software Technology Co., Ltd., a private company, since June 2018. From December 2012 to June 2018, he served as the Vice President of Great China of Dassault Systèmes S.A., a software solutions provider. Mr. Liu was with PTC, Inc. (formerly Parametric Technology Corporation) (China), a computer software and services company, from March 1993 to November 2012, where he served as the Application Engineer from March 1993 to March 1995, Sale Representative from March 1995 to September 1996, District Manager of North China from September 1996 to September 1999, Reginal Director of North China from September 1999 to September 2002, Senior Regional Director of North China from September 2002 to September 2005, Area Vice President of China from September 2005 to September 2008, and Senior Vice President of China from September 2008 to September 2012. Prior to that, Mr. Liu worked at Computer Application Research Institute, NORICO Group from February 1988 to February 1993 where, he served as Engineer from February 1988 to February 1990 and as the Deputy Director of Computer Aided Design software research division from February 1990 to February 1993. Mr. Liu received his master’s degree and bachelor’s degree from the Department of Vehicle Engineering of Beijing Institute of Technology.
Baoqing Sun. Mr. Sun has served as an independent director of the Company since November 2022. Before retiring in 2014, Mr. Sun served as the Deputy Director of Gu’an County Transportation Bureau from March 2003 to April 2014, where he was responsible for political and administration affairs, matters regarding transportation technology, transportation combat readiness, and highway stations. He was also responsible for construction and maintenance of national and provincial main lines and local highways. Prior to that, Mr. Sun served as the Director of Economic Commission, Deputy Secretary of the Committee, Secretary of the Disciplinary Committee, and Deputy Mayor of Gu’an Town, Gu’an County, from March 2001 to March 2003, from June 2000 to March 2001, from December 1999 to June 2000, and from December 1999 to April 1995, respectively, where he was mainly handling town affairs such as town enterprises, taxation, or market development. From April 1995 to May 1996, he was the Deputy General Manager of Langfang Sanhe Food Co., Ltd. Mr. Sun served as the Clerk of Gu’an County Labor and Personnel Bureau from June 1984 to April 1995 and worked in Gu’an County Transportation Bureau Second Automobile Team Overhaul Workshop from July 1983 to June 1984. Mr. Sun obtained a bachelor’s degree in mechanical engineering automotive from Hebei Institute of Technology.
Lidong Liu. Ms. Liu has served as the Chief Financial Officer since November 2015 for Jilin Yiyatong Deep Supply Chain Management Co., Ltd, a supply chain management company. From January 2011 to September 2015, she served as the Chief Financial Officer for Sinopharm Holding (Jilin) Co., Ltd, a pharmaceuticals company. In addition, between January 2002 and December 2010, Ms. Liu was the Chief Financial Officer for Changchun Yongxin Dirui Pharmaceutical Co., Ltd., a pharmaceuticals company. Ms. Liu is a member of China Certified Public Accountants and a seasoned executive with professional experience in auditing and financial reporting. Ms. Liu holds a bachelor’s degree in Accounting from Ji Lin University of Finance and Economics, and an MBA from Changchun University of Science and Technology.
Austin Huang. Dr. Huang has served as an independent director of ReTo since November 2016. Dr. Huang has served as the President and Principal Engineer for Merit Engineering, Inc., a geotechnical, environmental, and civil engineering services company, since 1993. Among other awards, Mr. Huang has received the Diplomat of Geotechnical Engineering by the Academy of Geoprofessionals in 2011 and named a Fellow, ACCE (American Society of Civil engineering) in 2007. Dr. Huang served as an expert witness on geo-retaining wall design issues. In addition, he has presented two papers in the area of slope stability and pile foundations with socket in bedrock in international conferences. He holds 19 research publications including six in leading research journals. Dr. Huang holds a Master’s Degree and Ph.D. in Geotechnical Engineering from University of Wisconsin.
91
Family Relationship
There are no family relations among any of our officers or directors, except that Yue Hu is Zhizhong Hu’s daughter. There are no other arrangements or understandings pursuant to which our directors are selected or nominated.
Board Diversity
The table below provides certain information regarding the diversity of our board of directors as of the date of this annual report.
| Board Diversity Matrix | ||||
| Country of Principal Executive Offices: | China | |||
| Foreign Private Issuer | Yes | |||
| Disclosure Prohibited under Home Country Law | No | |||
| Total Number of Directors | 7 | |||
| Female | Male |
Non- Binary |
Did Not Disclose Gender | |
| Part I: Gender Identity | ||||
| Directors | 1 | 6 | 0 | 0 |
| Part II: Demographic Background | ||||
| Underrepresented Individual in Home Country Jurisdiction | 0 | |||
| LGBTQ+ | 0 | |||
| Did Not Disclose Demographic Background | 0 | |||
| B. | Compensation. |
Executive Compensation
Our board of directors has not adopted or established a formal policy or procedure for determining the amount of compensation paid to our executive officers. Currently, our board of directors determines the compensation to be paid to our executive officers based on our financial and operating performance and prospects, and contributions made by the officers to our success. Each of our named executive officers is measured by a series of performance criteria by the board of directors, or the compensation committee on a yearly basis. Such criteria are set forth based on certain objective parameters such as job characteristics, required professionalism, management skills, interpersonal skills, related experience, personal performance and overall corporate performance. The board of directors will make an independent evaluation of appropriate compensation to key employees, with input from management. The board of directors has oversight of executive compensation plans, policies and programs.
In 2022, we expensed an aggregate of approximately $479,235 as salaries to our senior officers named in this annual report. Other than salaries, fees and share incentives, we do not otherwise provide pension, retirement or similar benefits to our officers and directors.
Employment Agreements
Employment Agreement of Hengfang Li
The Company entered into an employment agreement with Mr. Li on December 31, 2021 (the “Li Employment Agreement”), pursuant to which Mr. Li serves as Chairman and Chief Executive Officer of the Company and Beijing REIT for a term from January 1, 2022 and shall terminate on December 31, 2023. Pursuant to the Li Employment Agreement, Mr. Li is entitled to an annual compensation of RMB 800,000 (approximately $117,000) and social insurance and other employee benefits (including health insurance, vacation and expense reimbursement), each in accordance with PRC law and the Company’s policies.
Employment Agreement of Guangfeng Dai
The Company entered into an employment agreement with Mr. Dai on December 31, 2021, (the “Dai Employment Agreement”) pursuant to which Mr. Dai serves as the President of the Company and Beijing REIT for a term from January 1, 2022 and shall terminate on December 31, 2023. Pursuant to the Dai Employment Agreement, Mr. Dai is entitled to annual compensation of RMB 750,000 (approximately $109,000) and social insurance and other employee benefits (including health insurance, vacation and expense reimbursement), each in accordance with PRC law and the Company’s policy.
92
Employment Agreement of Zhizhong Hu
The Company entered into an employment agreement with Mr. Hu on December 31, 2021 (the “Hu Employment Agreement”), pursuant to which Mr. Hu serves as the Chief Technology Officer of the Company and Beijing REIT for a term from January 1, 2022 and shall terminate on December 31, 2023. Pursuant to the Hu Employment Agreement, Mr. Hu is entitled to annual compensation of RMB 700,000 (approximately $102,000) and social insurance and other employee benefits (including health insurance, vacation and expense reimbursement), each in accordance with PRC law and the Company’s policy.
Employment Agreement of Degang Hou
The Company entered into an employment agreement with Mr. Hou on December 31, 2021 (the “Hou Employment Agreement”), pursuant to which Mr. Hou serves as the Chief Internal Control Officer of the Company and Beijing REIT for a term from January 1, 2022 and shall terminate on December 31, 2023. Pursuant to the Hou Employment Agreement, Mr. Hou is entitled to annual compensation of RMB 700,000 (approximately $102,000) and social insurance and other employee benefits (including health insurance, vacation and expense reimbursement), each in accordance with PRC law and the Company’s policy.
Employment Agreement with Yue Hu
The Company entered into an employment agreement with Ms. Hu on August 15, 2022 providing for Ms. Hu to serve as the Company’s Chief Financial Officer (the “Hu Employment Agreement”) for a term from August 15, 2022 to August 14, 2025. Pursuant to the terms of the Hu Employment Agreement, Ms. Hu will be entitled to an annual compensation of RMB180,000 (approximately $26,500) and social insurance and other employee benefits (including health insurance, vacation and expense reimbursement), each in accordance with laws in the People’s Republic of China and the Company’s policy. The Hu Employment Agreement may be terminated in accordance with the PRC Labor Contract Law and relevant local regulations in Beijing.
Director Compensation
Officers are elected by and serve at the discretion of the Board of Directors. Employee directors do not receive any compensation for their services on the Board of Directors. Non-employee directors are entitled to receive $10,000 per year for serving as directors and may receive stock grants pursuant to our share incentive plans. In addition, non-employee directors are entitled to receive compensation for their actual travel expenses for each Board of Directors meeting attended, up to a maximum of $2,000 per meeting and $4,000 per year.
During the fiscal year ended December 31, 2022, 1,025,000 Common Shares were issued pursuant to the 2018 Share Incentive Plan, and 3,000,000 Common Shares were issued pursuant to the 2021 Share Incentive Plan.
See Item 6.E for a description of our 2018 Share Incentive Plan, 2021 Share Incentive Plan and the 2022 Share Incentive Plan.
| C. | Board Practices. |
See information provided in response to Item 6.A. above as to the current directors.
Composition of Board
Our board of directors currently consists of seven directors. The directors are divided into three classes, as nearly equal in number as the then total number of directors permits. All directors hold office until the next annual meeting of shareholders at which their respective class of directors is re-elected and until their successors have been duly elected and qualified. Officers are elected by and serve at the discretion of the board of directors. Class A directors shall face re-election at our 2023 annual general meeting of shareholders and shall face reelection every three years thereafter. Class B directors faced re-election at our 2024 annual general meeting of shareholders and every three years thereafter. Class C directors shall face re-election at our 2025 annual general meeting of shareholders and every three years thereafter.
93
If the number of directors changes, any increase or decrease will be apportioned among the classes so as to maintain the number of directors in each class as nearly as possible. Any additional director of a class elected to fill a vacancy resulting from an increase in such class will hold office for a term that coincides with the remaining term of that class. Decreases in the number of directors will not shorten the term of any incumbent director. These board provisions could make it more difficult for third parties to gain control of our Company by making it difficult to replace members of the board of directors.
There are no membership qualifications for directors. Further, there are no share ownership qualifications for directors unless so fixed by us in a general meeting.
The board of directors maintains a majority of independent directors who are deemed to be independent under the definition of independence under Rule 5605(c)(2) of the Nasdaq Stock Market Rules and meet the independence standards under Rule 10A-3 under the Exchange Act, as amended. Baoqing Sun, Tonglong Liu, Lidong Liu and Austin Huang are our independent directors.
There are no other arrangements or understandings pursuant to which our directors are selected or nominated. We do not have any service contacts with our directors that provide benefits upon termination of employment.
Our board of directors plays a significant role in our risk oversight. The board of directors makes all relevant company decisions. As such, it is important for us to have both our Chief Executive Officer and President to serve on the Board as they play key roles in the risk oversight or the Company. As a smaller reporting company with a small board of directors, we believe it is appropriate to have the involvement and input of all of our directors in risk oversight matters.
Committees of the Board of Directors
Currently, three committees have been established under the board: the audit committee, the compensation committee and the nominating committee. The audit committee is responsible for overseeing the accounting and financial reporting processes of the Company and audits of the financial statements of the Company, including the appointment, compensation and oversight of the work of our independent auditors. The compensation committee of the board of directors reviews and makes recommendations to the board regarding our compensation policies for our officers and all forms of compensation, and also administers our incentive compensation plans and equity-based plans (but our board retains the authority to interpret those plans). The nominating committee of the board of directors is responsible for the assessment of the performance of the board, considering and making recommendations to the board with respect to the nominations or elections of directors and other governance issues. The nominating committee considers diversity of opinion and experience when nominating directors.
Baoqing Sun and Tonglong Liu serve on all three Committees, Austin Huang serves on the Nominating Committee and Compensation Committee, Lidong Liu serves on the Audit Committee. Austin Huang chairs the Nominating Committee and the Compensation Committee and Lidong Liu chairs the Audit Committee. Lidong Liu qualifies as an “audit committee financial expert” as that term is defined by the applicable SEC regulations and Nasdaq Capital Market corporate governance requirements.
Duties of Directors
Under BVI law, our directors have a duty to act honestly, in good faith and with a view to our best interests. Our directors also have a duty to exercise the care, diligence and skills that a reasonably prudent person would exercise in comparable circumstances. In fulfilling their duty of care to us, our directors must ensure compliance with our M&A. Shareholders shall have the right to seek damages if a duty owed by our directors is breached.
The functions and powers of our board of directors include, among others:
| ● | having all the powers necessary for managing and for directing and supervising, the business and affairs for the Company |
| ● | appointing officers and determining the term of office of the officers; |
94
| ● | fixing the emoluments of officers; |
| ● | exercising all powers of the Company to incur indebtedness, liabilities or obligations and to secure indebtedness, liabilities or obligations whether of the Company or of any third party; |
| ● | designating committees of directors; |
| ● | executing checks, promissory notes, drafts, bills of exchange and other negotiable instruments on behalf of the Company; and |
| ● | determining that any sale, transfer, lease, exchange, or other disposition is in the usual or regular course of the business carried on by the Company and such determination is, in the absence of fraud, conclusive. |
Interested Transactions
A director may vote, attend a board meeting or sign a document on our behalf with respect to any contract or transaction in which he or she is interested. A director must promptly disclose the interest to all other directors after becoming aware of the fact that he or she is interested in a transaction we have entered into or are to enter into. A general notice or disclosure to the board or otherwise contained in the minutes of a meeting or a written resolution of the board or any committee of the board that a director is a shareholder, director, officer or trustee of any specified firm or company and is to be regarded as interested in any transaction with such firm or company will be sufficient disclosure, and, after such general notice, it will not be necessary to give special notice relating to any particular transaction. A director may be counted for a quorum upon a motion in respect of any contract or arrangement which he shall make with our Company, or in which he is so interested and may vote on such motion.
Remuneration and Borrowing
The directors may receive such remuneration as our board of directors may determine from time to time. Each director is entitled to be repaid or prepaid for all traveling, hotel and incidental expenses reasonably incurred or expected to be incurred in attending meetings of our board of directors or committees of our board of directors or shareholder meetings or otherwise in connection with the discharge of his or her duties as a director. The compensation committee will assist the directors in reviewing and approving the compensation structure for the directors.
Our board of directors may exercise all the powers of the Company to borrow money and to mortgage or charge our undertakings and property or any part thereof, to issue debentures, debenture stock and other securities whenever money is borrowed or as security for any debt, liability or obligation of the Company or of any third party.
Qualification
A director is not required to hold shares as a qualification to office.
Limitation on Liability and Other Indemnification Matters
Under British Virgin Islands law, each of our directors and officers, in performing his or her functions, is required to act honestly and in good faith with a view to our best interests. Our M&A provide that, to the fullest extent permitted by British Virgin Islands law or any other applicable laws, our directors will not be personally liable to us or our shareholders for any acts or omissions in the performance of their duties. Such limitation of liability does not affect the availability of equitable remedies such as injunctive relief or rescission. These provisions will not limit the liability of directors under United States federal securities laws.
95
We may indemnify any of our directors or anyone serving at our request as a director of another entity against all expenses, including legal fees, and against all judgments, fines and amounts paid in settlement and reasonably incurred in connection with legal, administrative or investigative proceedings. We may only indemnify a director if he or she acted honestly and in good faith with the view to our best interests and, in the case of criminal proceedings, the director had no reasonable cause to believe that his or her conduct was unlawful. The decision of our board of directors as to whether the director acted honestly and in good faith with a view to our best interests and as to whether the director had no reasonable cause to believe that his or her conduct was unlawful, is in the absence of fraud sufficient for the purposes of indemnification, unless a question of law is involved. The termination of any proceedings by any judgment, order, settlement, conviction or the entry of no plea does not, by itself, create a presumption that a director did not act honestly and in good faith and with a view to our best interests or that the director had reasonable cause to believe that his or her conduct was unlawful. If a director to be indemnified has been successful in defense of any proceedings referred to above, the director is entitled to be indemnified against all expenses, including legal fees, and against all judgments, fines and amounts paid in settlement and reasonably incurred by the director or officer in connection with the proceedings.
We may purchase and maintain insurance in relation to any of our directors or officers against any liability asserted against the directors or officers and incurred by the directors or officers in that capacity, whether or not we have or would have had the power to indemnify the directors or officers against the liability as provided in our M&A.
Insofar as indemnification for liabilities arising under the Securities Act may be permitted for our directors or officers under the foregoing provisions, we have been informed that in the opinion of the SEC, such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable as a matter of United States law.
| D. | Employees. |
As of December 31, 2022, we had a total of 116 full-time employees. Among these employees, we had 35 employees in management, 22 employees in sales and marketing, 41 employees in research and development, 14 employees in manufacturing and installation and four employees in administration. All of these employees were located at our facilities in Beijing, Hainan and Xinyi, China. We had a total of 115 and 139 full-time employees as of December 31, 2021 and 2020, respectively. We did not hire any part-time employees during the fiscal years ended December 31, 2022, 2021 and 2020. Our employees are not represented by a labor organization or covered by a collective bargaining agreement.
We participate in various employee social security plans that are organized by municipal and provincial governments, including housing, pension, medical insurance and unemployment insurance, as required by laws and regulations in China. We are required under PRC law to make contributions to employee benefit plans at specified percentages of the salaries, bonuses and certain allowances of our employees, up to a maximum amount specified by the local government from time to time.
We typically enter into standard labor contracts with our employees. We also enter into standard confidentiality and non-compete agreements with our senior management and research and development personnel. These contracts involve a covenant that prohibits them from engaging in any activities that compete with our business within certain agreed period after the termination of their employment with us, and during such non-competition period. We believe we maintain a good working relationship with our employees, and we have not experienced any material labor disputes or any difficulty in recruiting staff for our operations.
| E. | Share ownership. |
The following tables set forth certain information with respect to the beneficial ownership of our Common Shares as of April 28, 2023, for:
| ● | each of our directors and named executive officers; and |
| ● | all of our directors and executive officers as a group. |
We have determined beneficial ownership in accordance with the rules of the SEC. Except as indicated by the footnotes below, we believe, based on the information furnished to us, that the persons and entities named in the table below have sole voting and investment power or the power to receive the economic benefit with respect to all Common Shares that they beneficially own, subject to applicable community property laws.
96
Applicable percentage ownership prior is based on 53,787,689 Common Shares outstanding as of the date of this annual report. Unless otherwise indicated, the address of each beneficial owner listed in the table below is c/o ReTo Eco-Solutions, Inc., Building X-702, 60 Anli Road, Beijing, People’s Republic of China 100101.
| Beneficial Ownership | ||||||||
| Name of Beneficial Owner | Common Shares | Percentage | ||||||
| Directors and Executive Officers | ||||||||
| Hengfang Li(1) | 2,646,264 | 4.9 | % | |||||
| Guangfeng Dai(2) | 1,620,632 | 3.0 | % | |||||
| Zhizhong Hu(3) | 1,355,632 | 2.5 | % | |||||
| Degang Hou(4) | 1,155,632 | 2.1 | % | |||||
| Yue Hu(5) | 25,000 | * | ||||||
| Tonglong Liu | - | - | ||||||
| Baoqing Sun | - | - | ||||||
| Lidong Liu(5) | 10,000 | * | ||||||
| Austin Huang(6) | 40,000 | * | ||||||
| All directors and executive officers as a group (nine persons) | 6,853,161 | 12.7 | % | |||||
| Other 5% or greater beneficial owners | ||||||||
| REIT International Development (Group) Co., Limited | 3,903,161 | 7.3 | % | |||||
| * | Less than 1%. |
| (1) | Represents (i) approximately 1,561,264 Common Shares held through REIT International Development (Group) Co, a Hong Kong limited liability company (“REIT International”). Mr. Li holds a 40% ownership of REIT International and has the voting and investment power with respect to 40% of the 3,903,161 Common Shares held by REIT International; (ii) 10,000 Common Shares held through Soothie Holdings Limited, a British Virgin Islands company, controlled by Mr. Li; (iii) 225,000 Common Shares held by Mr. Li directly; (iv) 600,000 Common Shares granted to Mr. Li under the 2021 Share Incentive Plan; and (v) 250,000 shares granted to Mr. Li under the 2022 Share Incentive Plan. |
| (2) | Represents (i) approximately 780,632 Common Shares held through REIT International. Mr. Dai holds a 20% ownership of REIT International and has the voting and investment power with respect to 20% of the 3,903,161 Common Shares held by REIT International; (ii) 150,000 Common Shares held by Mr. Dai directly; (iii) 440,000 Common Shares granted to Mr. Dai under the 2021 Share Incentive Plan; and (iv) 250,000 shares granted to Mr. Dai under the 2022 Share Incentive Plan. |
| (3) | Represents (i) approximately 780,632 Common Shares held through REIT International. Mr. Hu holds a 20% ownership of REIT International and has the voting and investment power with respect to 20% of the 3,903,161 Common Shares held by REIT International; (ii) 125,000 Common Shares held by Mr. Hu directly; (iii) 300,000 Common Shares granted to Mr. Hu under the 2021 Share Incentive Plan; and (iv) 150,000 Common Shares granted to Mr. Hu under the 2022 Share Incentive Plan. |
| (4) | Represents (i) approximately 780,632 Common Shares held through REIT International. Mr. Hou holds a 20% ownership of REIT International and has the voting and investment power with respect to 20% of the 3,903,161 Common Shares held by REIT International; (ii) 125,000 Common Shares held by Mr. Hou directly; and (iii) 200,000 Common Shares granted to Mr. Hou under the 2021 Share Incentive Plan; and (iv) 50,000 Common Shares granted to Mr. Hou under the 2022 Share Incentive Plan. |
| (5) | Represents Common Shares granted under the 2022 Share Incentive Plan. |
| (6) | Represents (i) 30,000 Common Shares held by Mr. Huang directly; and (ii) 10,000 Common Shares granted to Mr. Huang under the 2022 Share Incentive Plan. |
97
2018 Share Incentive Plan
On November 6, 2018, the Company’s shareholders approved the 2018 Share Incentive Plan, which allows for issuance of up to 2,000,000 Common Shares to employees, non-employee directors, officers and consultants for services rendered to the Company.
On April 22, 2022, the Company’s board of directors approved the issuance of an aggregate of 1,025,000 Common Shares to its employees for their services.
The Company issued an aggregate of 975,000 Common Shares under the 2018 Share Incentive Plan as of December 31, 2021. The Company issued an aggregate of 2,000,000 Common Shares under the 2018 Share Incentive Plan as of December 31, 2022. As of April 28, 2023, there were no shares available for issuance under the 2018 Incentive Plan.
The following is a summary of the principal terms of the 2018 Share Incentive Plan.
Administration
The 2018 Share Incentive Plan is administered by the Compensation Committee of the Board of Directors. The 2018 Share Incentive Plan provides the Compensation Committee with flexibility to design compensatory awards that are responsive to the company’s needs. Subject to the terms of the 2018 Share Incentive Plan, the Compensation Committee has the discretion to determine the terms of each award.
Amount of Awards
The maximum number of Common Shares as to which awards may be granted under the 2018 Share Incentive Plan is 2,000,000 shares.
Types of Awards
Awards under the 2018 Share Incentive Plan may be in the form of incentive stock options, non-statutory stock options or restricted stock awards. An option is the right to purchase shares of Common Shares at a price and on a schedule set by the Compensation Committee. The option price will be no less than the fair market value of the shares on the option grant date.
Participants
Employees of the Company, executive officers, employee and non-employee directors, consultants, independent contractors and advisors may all be selected by the Compensation Committee to receive awards under the 2018 Share Incentive Plan. The benefits or amounts that may be received by or allocated to participants under the 2018 Share Incentive Plan will be determined at the discretion of the Compensation Committee and are not presently determinable.
Termination and Amendment
The Compensation Committee may terminate the 2018 Share Incentive Plan at any time. If not sooner terminated by the Board of Directors, the 2018 Share Incentive Plan will terminate on the tenth anniversary of its effective date.
The 2018 Share Incentive Plan may be amended by the Board of Directors, but without further approval by the shareholders of the Company, the Board shall not amend the 2018 Share Incentive Plan in any manner that requires shareholder approval. The Board may condition any amendment on the approval of the shareholders if such approval is necessary or deemed advisable with respect to the applicable listing or other requirements of a national securities exchange or other applicable laws, policies or regulations.
98
2021 Share Incentive Plan
On November 24, 2021, the Company’s shareholders approved the 2021 Share Incentive Plan, which allows for issuance of up to 3,000,000 Common Shares to employees, non-employee directors, officers and consultants for services rendered to the Company.
The Company did not issue any Common Shares under the 2021 Share Incentive Plan as of December 31, 2021. On April 22, 2022, the Company’s board of directors approved the issuance of an aggregate of 3,000,000 Common Shares to its employees, officers and directors for their services. The Company issued an aggregate of 3,000,000 Common Shares under the 2021 Share Incentive Plan as of December 31, 2022. As of April 28, 2023, there were no shares available for issuance under the 2021 Incentive Plan.
The following is a summary of the principal terms of the 2021 Share Incentive Plan.
Administration
The 2021 Share Incentive Plan is administered by the Compensation Committee of the Board of Directors. The 2021 Share Incentive Plan provides the Compensation Committee with flexibility to design compensatory awards that are responsive to the company’s needs. Subject to the terms of the 2021 Share Incentive Plan, the Compensation Committee has the discretion to determine the terms of each award.
Amount of Awards
The maximum number of Common Shares as to which awards may be granted under the 2021 Share Incentive Plan was 3,000,000 shares.
Types of Awards
Awards under the 2021 Share Incentive Plan may be in the form of incentive stock options, non-statutory stock options or restricted stock awards. An option is the right to purchase shares of Common Shares at a price and on a schedule set by the Compensation Committee. The option price will be no less than the fair market value of the shares on the option grant date.
Participants
Employees of the Company, executive officers, employee and non-employee directors, consultants, independent contractors and advisors may all be selected by the Compensation Committee to receive awards under the 2021 Share Incentive Plan. The benefits or amounts that may be received by or allocated to participants under the 2021 Share Incentive Plan will be determined at the discretion of the Compensation Committee and are not presently determinable.
Termination and Amendment
The Compensation Committee may terminate the 2021 Share Incentive Plan at any time. If not sooner terminated by the Board of Directors, the 2021 Share Incentive Plan will terminate on the tenth anniversary of its effective date.
The 2021 Share Incentive Plan may be amended by the Board of Directors, but without further approval by the shareholders of the Company, the Board shall not amend the 2021 Share Incentive Plan in any manner that requires shareholder approval. The Board may condition any amendment on the approval of the shareholders if such approval is necessary or deemed advisable with respect to the applicable listing or other requirements of a national securities exchange or other applicable laws, policies or regulations.
2022 Share Incentive Plan
On December 6, 2022, the Company’s shareholders approved the 2022 Share Incentive Plan, which initially allowed for issuance of up to 5,000,000 Common Shares to employees, non-employee directors, officers and consultants for services rendered to the Company, with an automatic share reserve increase by a number equal to the lesser of (i) 5% of the total number of Common Shares issued and outstanding on December 31 of the calendar year immediately preceding the date of such increase and (ii) a number of = Common Shares determined by the Compensation Committee.
99
The Company did not issue any Common Shares under the 2022 Share Incentive Plan as of December 31, 2022. On March 8, 2023, the Company’s board of directors approved the issuance of an aggregate of 5,000,000 Common Shares to its employees, officers and directors for their services. As of April 28, 2023, there were 2,169,944 shares available for issuance under the 2022 Incentive Plan.
The following is a summary of the principal terms of the 2022 Share Incentive Plan.
Administration
The 2022 Share Incentive Plan is administered by the Compensation Committee of the Board of Directors. The 2022 Share Incentive Plan provides the Compensation Committee with flexibility to design compensatory awards that are responsive to the company’s needs. Subject to the terms of the 2022 Share Incentive Plan, the Compensation Committee has the discretion to determine the terms of each award.
Amount of Awards
The maximum number of Common Shares as to which awards may be granted under the 2022 Share Incentive Plan is 5,000,000 shares. The 2022 Share Incentive Plan provides for an automatic share reserve increase feature, whereby the share reserve will be increased automatically on the first day of each fiscal year beginning with the 2023 fiscal year, in an amount equal to the lesser of (i) a number equal to 5% of the aggregate number of Common Shares outstanding on the last day of the immediately preceding fiscal year and (ii) such smaller number of shares as is determined by the compensation committee. The automatic share reserve feature and any provisions that are or would create a “formula” plan for purposes of Nasdaq listing requirements will operate only until the ten-year anniversary of the earlier of the initial adoption of the 2022 Share Incentive Plan by the Board or the approval of the 2022 Share Incentive Plan by our shareholders, and therefore no automatic share reserve increase will be added after the increase on the first day of our 2032 fiscal year.
Types of Awards
Awards under the 2022 Share Incentive Plan may be in the form of incentive stock options, non-statutory stock options or restricted stock awards. An option is the right to purchase shares of the Company’s Common Shares at a price and on a schedule set by the Compensation Committee. The option price will be no less than the fair market value of the shares on the option grant date.
Participants
Employees of the Company, executive officers, non-employee directors and consultants may all be selected by the Compensation Committee to receive awards under the 2022 Share Incentive Plan. The benefits or amounts that may be received by or allocated to participants under the 2022 Share Incentive Plan will be determined at the discretion of the Compensation Committee and are not presently determinable.
Termination and Amendment
The Compensation Committee may terminate the 2022 Share Incentive Plan at any time. If not sooner terminated by the Board of Directors, the 2022 Share Incentive Plan will terminate on the tenth anniversary of its effective date.
The 2022 Share Incentive Plan may be amended by the Board of Directors, but without further approval by the shareholders of the Company, the Board shall not amend the 2022 Share Incentive Plan in any manner that requires shareholder approval. The Board may condition any amendment on the approval of the shareholders if such approval is necessary or deemed advisable with respect to the applicable listing or other requirements of a national securities exchange or other applicable laws, policies or regulations.
100
Item 7. Major Shareholders and Related Party Transactions
| A. | Major shareholders. |
Please refer to “Item 6. Directors, Senior Management and Employees—E. Share Ownership.”
| B. | Related party transactions. |
The related party transactions for the years ended December 31, 2022, 2021 and 2020 are identified as follows:
| (1) | Related parties relationships |
| Name of Related Party | Relationship to the Company | |
| Mr. Hengfang Li | Chief Executive Officer and Chairman of the Board of Directors | |
| Q Green Techcon Private Limited | Owned by the minority shareholder of REIT India | |
| Shexian Ruibo | The Company owns 41.67% ownership interest in Shexian Ruibo | |
| Zhongrong Honghe Eco Construction Materials Co., Ltd | An entity controlled by Ms. Hong Ma | |
| Hunyuan Baiyang Food Co., Ltd. | An entity controlled by Mr. Hengfang Li | |
| Bei Qi Yin Jian Yi Le (Haikou) Smart Move Science Technology Co., Ltd. | Hainan Yile IoT owns 45% ownership interest in this company | |
| Zhongtou REIT Information Service (Beijing) Co., Ltd | An entity controlled by Mr. Xinyang Li and Ms. Xinran Li, children of Mr. Hengfang Li | |
| Handan Ruisheng Construction Material Technology Co., Ltd. | An entity controlled by Shexian Ruibo |
| (2) | Due to related parties |
The balance of due to related parties were as follows:
December 31, 2022 | December 31, 2021 | December 31, 2020 | ||||||||||
| Mr. Hengfang Li | $ | 208,225 | $ | 472,439 | $ | 1,019,469 | ||||||
| (3) | Accounts receivable from related parties |
Accounts receivable from related parties consisted of the following:
December 31, 2022 | December 31, 2021 | December 31, 2020 | ||||||||||
| Accounts receivable – related party | ||||||||||||
| REIT International Trading Co. Ltd | $ | - | $ | - | $ | 199,999 | ||||||
| Q Green Techcon Private Limited | - | 2,981 | - | |||||||||
| Hunyuan Baiyang Food Co., Ltd. | 37,048 | 40,088 | - | |||||||||
| Bei Qi Yin Jian Yi Le (Haikou) Smart Move Science Technology Co., Ltd. | 46,688 | 50,520 | - | |||||||||
| Total accounts receivable from related party | $ | 83,736 | $ | 93,589 | $ | 199,999 | ||||||
The Company fully collected the accounts receivable as of December 31, 2022 from related parties as of the date of this annual report.
101
| (4) | Advance to suppliers, related party |
Advance to suppliers, related party, consisted of the following:
December 31, 2022 | December 31, 2021 | December 31, 2020 | ||||||||||
| Q Green Techcon Private Limited | $ | 15,310 | $ | 174,099 | $ | 162,014 | ||||||
| Shexian Ruibo Environmental Science and Technology Co., Ltd.* | 3,769,138 | 3,656,118 | 3,872,110 | |||||||||
| Handan Ruisheng Construction Material Technology Co., Ltd. | 2,588 | 12,403 | - | |||||||||
| Total | $ | 3,787,036 | $ | 3,832,421 | $ | 4,034,124 | ||||||
| * | The balance represents the Company’s purchase advances for eco-friendly materials and equipment supplied by Shexian Ruibo. |
| (5) | Accounts payable to related parties |
Accounts payables to related parties consisted of the following:
December 31, 2022 | December 31, 2021 | December 31, 2020 | ||||||||||
| Shexian Ruibo Environmental Science and Technology Co., Ltd. | $ | - | $ | - | $ | 153,344 | ||||||
| Zhongtou REIT Information Service (Beijing) Co., Ltd | - | 10,199 | - | |||||||||
| Total | $ | - | $ | 10,199 | $ | 153,344 | ||||||
| (6) | Sales to related parties |
Sales to related parties consisted of the following:
| For the Years Ended December 31, | ||||||||||||
| 2022 | 2021 | 2020 | ||||||||||
| Changjiang Zhongrong Hengde Environmental Protection Co., Ltd. | $ | 215,693 | $ | - | $ | - | ||||||
| Shexian Ruibo | 82,453 | 61,177 | 228,814 | |||||||||
| Q Green Techcon Private Limited | 6,729 | 220,607 | - | |||||||||
| Total | $ | 304,875 | $ | 281,784 | $ | 228,814 | ||||||
Cost of revenue associated with the sales to these related parties amounted to $471,849, $175,053 and $148,034 for the years ended December 31, 2022, 2021 and 2020, respectively.
102
| (7) | Purchases from related parties |
Purchases from related parties consisted of the following:
| For the Years Ended December 31, | ||||||||||||
| 2022 | 2021 | 2020 | ||||||||||
| Q Green Techcon Private Limited | $ | 266,544 | $ | 228,838 | $ | 1,039,152 | ||||||
| Shexian Ruibo | 1,141,377 | 235,946 | 1,837,841 | |||||||||
| Total | $ | 1,407,921 | $ | 464,784 | $ | 2,876,993 | ||||||
| (8) | Other related party transactions |
On September 7, 2020, Beijing REIT entered into a share transfer agreement with the original shareholder of Shexian Ruibo for the acquisition of a 41.67% ownership interest in Shexian Ruibo for a total consideration of $3.6 million (RMB 25 million), including a cash payment of $2.8 million (RMB 18.5 million) and a non-cash contribution of six patents valued at $0.9 million (RMB 6.5 million). The cash consideration was fully paid for the year ended December 31, 2020.
| C. | Interests of Experts and Counsel |
Not applicable.
Item 8. Financial Information
| A. | Consolidated Statements and Other Financial Information. |
The financial statements required by this item may be found at the end of this report on 20-F, beginning on page F-1.
Legal and Administrative Proceedings
In the ordinary course of business, the Company is from time to time involved in legal proceedings and litigation that are generally contractual in nature.
In 2018, a financial intermediary and Xinyi REIT began negotiations towards a potential cooperation where the financial intermediary would introduce potential investors to facilitate investment in Xinyi REIT’s business. In December 2018, an investor invested RMB 1,000,000 (approximately $0.15 million) in Xinyi REIT through this financial intermediary. Xinyi REIT rejected this investment and returned the total investment funds it received to the investor and informed the financial intermediary to cease facilitating investments from other investors. In addition, despite there not being a final mutual agreement between the parties, it appears the financial intermediary may have acquired investment funds in the aggregate amount of RMB 15,450,000 (approximately $2.15 million) from certain investors, and Xinyi REIT did not receive any funds from these investments.
Mr. Hengfang Li, the Company’s Chief Executive Officer and Chairman, has agreed to assume full responsibility for liabilities, if any, and assume the creditor’s rights for these claims on behalf of the Company for any legal claims or lawsuits against the Company due to these investments. In May 2020, Mr. Li paid RMB 300,000 (approximately $44,000) to an investor in a lawsuit against Xinyi REIT to return the investment funds. In 2022 and 2023, a few other investors brought legal actions against Xinyi REIT for the same claim and judgments were rendered in their favor. Subsequently, Xinyi REIT appealed these judgments, and the appeals are still pending in higher courts as of the date of this annual report. The Company does not believes that any liability resulting from the outcome of such proceedings, if any, will have a material adverse effect on the Company’s consolidated financial position or results of operations or liquidity.
On April 8, 2022, Beijing REIT reached a settlement with the minority shareholder of Xinyi REIT for the lawsuit filed by the minority shareholder of Xinyi REIT in respect of the buy-back of the 30% equity interest of Xinyi REIT held by the minority shareholder. Pursuant to the settlement, Beijing REIT agreed to pay an aggregate amount of RMB18 million to purchase the 30% equity interest. The purchase price is payable in four installments of RMB 4 million, RMB 4 million, RMB 5 million, and RMB 5 million, due by April 19, 2022, June 30, 2022, September 30, 2022, and December 31, 2022, respectively. The Company had paid RMB 13 million (approximately $1.9 million) as of December 31, 2022. As of December 31, 2022, the balance amounted to RMB 5 million (approximately $0.7 million). The Company further paid RMB 3 million (approximately $0.4 million) in 2023. However, as of the date of this annual report, the remaining balance of RMB 2 million (approximately $0.3 million) is due by Beijing REIT.
103
On April 11, 2023, a local court order was issued to Beijing REIT and its legal representative to restrict them from frivolous spending. We are actively negotiating the settlement with the party who initiated the court order and we do not believe this matter will have a material adverse effect on the Company’s consolidated financial position or results of operations.
Except as disclosed above, we are currently not a party to any material legal or administrative proceedings and we are not aware of any material legal or administrative proceedings threatened against us. We may from time to time be subject to various legal or administrative proceedings arising in the ordinary course of business.
Dividend Policy
We have never declared or paid any cash dividends on our Common Shares. We anticipate that we will retain any earnings to support operations and to finance the growth and development of our business. Therefore, we do not expect to pay cash dividends in the foreseeable future. Any future determination relating to our dividend policy will be made at the discretion of our board of directors and will depend on a number of factors, including future earnings, capital requirements, financial conditions and future prospects and other factors the board of directors may deem relevant.
Under British Virgin Islands law, we may only pay dividends from surplus (the excess, if any, at the time of the determination of the total assets of our company over the sum of our liabilities, as shown in our books of account, plus our capital), and we must be solvent before and after the dividend payment in the sense that we will be able to satisfy our liabilities as they become due in the ordinary course of business; and the realizable value of assets of our company will not be less than the sum of our total liabilities, other than deferred taxes as shown on our books of account, and our capital.
If we determine to pay dividends on any of our Common Shares in the future, as a holding company, we will be dependent on receipt of funds from our PRC subsidiaries. Current PRC regulations permit our PRC subsidiaries to pay dividends to REIT Holdings only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. Further, loan governing part of the current debts incurred by Beijing REIT has restrictions on its ability to pay dividends, and any future financing arrangements may impose such restrictions as well. In addition, each of our subsidiaries in China is required to set aside at least 10% of its after-tax profits each year, if any, to fund a statutory reserve until such reserve reaches 50% of its registered capital. Our PRC subsidiaries are also required to further set aside a portion of its after-tax profits to fund the employee welfare fund, although the amount to be set aside, if any, is determined at the discretion of its board of directors. Although the statutory reserves can be used, among other ways, to increase the registered capital and eliminate future losses in excess of retained earnings of the respective companies, the reserve funds are not distributable as cash dividends except in the event of liquidation. Our subsidiaries in China are required to set aside statutory reserves and have done so.
In addition, pursuant to the EIT Law and its implementation rules, dividends generated after January 1, 2008 and distributed to us by Beijing REIT, REIT Technology and REIT Ordos are subject to withholding tax at a rate of 10% unless otherwise exempted or reduced according to treaties or arrangements between the PRC central government and governments of other countries or regions where the non-PRC-resident enterprises are incorporated.
Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and trade and service-related foreign exchange transactions, can be made in foreign currencies without prior approval of the State Administration of Foreign Exchange, or SAFE, by complying with certain procedural requirements. Specifically, under the existing exchange restrictions, without prior approval of SAFE, cash generated from the operations in China may be used to pay dividends to our company. See “Item 4. Information on the Company – B. Business Overview – Regulation – Regulation of Foreign Currency Exchange and Dividend Distribution.”
104
| B. | Significant Changes. |
Except as otherwise disclosed in this annual report, we have not experienced any significant changes since the date of our audited consolidated financial statements included herein.
Item 9. The Offer and Listing
| A. | Offer and listing details. |
Our Common Shares have been listed on the Nasdaq Capital Market since November 29, 2017 under the symbol “RETO.”
| B. | Plan of distribution. |
Not applicable.
| C. | Markets. |
Our Common Shares are listed on the Nasdaq Capital Market under the symbol “RETO.”
| D. | Selling shareholders. |
Not applicable.
| E. | Dilution. |
Not applicable.
| F. | Expenses of the issue. |
Not applicable.
Item 10. Additional Information
| A. | Share capital. |
Not applicable.
| B. | Memorandum and articles of association. |
We incorporate by reference the description of our M&A, as currently in effect in the British Virgin Islands, set forth in our registration statement on Form F-1, as amended, declared effective on November 28, 2017 (File No. 333-219709).
| C. | Material contracts. |
Securities Purchase Agreement dated March 1, 2021
On March 1, 2021, the Company entered into a securities purchase agreement with an accredited investor (the “Debenture Holder”) for the issuance of a Convertible Debenture (the “March Debenture”) in the aggregate principal amount of up to $2,300,000 with a maturity date of twelve months after the issuance thereof, provided that in case of an event of default, the March Debenture may become at the Debenture Holder’s election immediately due and payable. In addition, the Company paid to an affiliate of the March Debenture Holder a fee equal to 3.5% of the amount of the Debenture and a one-time due diligence and structuring fee of $10,000 at the closing.
105
The Debenture Holder may convert the March Debenture in its sole discretion to Company’s Common Shares at any time at the lower of $2.50 or 95% of the average of the two lowest daily VWAPs during the ten consecutive trading days immediately preceding the conversion date, provided that the conversion price may not be less than $0.50 (the “March Debenture Floor Price”). The Debenture Holder may not convert any portion of a Debenture if such conversion would result in the Debenture Holder beneficially owning more than 4.99% of Company’s then issued and Common Shares, provided that such limitation may be waived by the Debenture Holder with a 65 days’ notice. Any time after the issuance of the March Debenture that the daily VWAP is less than the March Debenture Floor Price for a period of 10 consecutive trading days (each such occurrence, a “March Debenture Triggering Event”) and only for so long as such conditions exist after a March Debenture Triggering Event, the Company shall make monthly payments beginning on the 30th day after the date of the March Debenture Triggering Event. Each monthly payment shall be in an amount equal to the sum of (i) the principal amount outstanding as of the date of the March Debenture Triggering Event divided by the number of such monthly payments until maturity, (ii) a redemption premium of 20% of such principal amount and (iii) accrued and unpaid interest hereunder as of each payment date.
The Company has elected to recognize the March Debenture at fair value and therefore there was no further evaluation of embedded features for bifurcation. The March Debenture was fully converted into 2,369,501 Common Shares of the Company for the year ended December 31, 2022.
Securities Purchase Agreement dated July 6, 2021
On July 6, 2021, the Company entered into another securities purchase with the Debenture Holder for the issuance of a Convertible Debenture (the “July Debenture”) in the aggregate principal amount of up to $2,500,000 with a maturity date of twelve months after the issuance thereof, provided that in case of an event of default, the July Debenture may become at the Debenture Holder’s election immediately due and payable. In addition, the Company paid to an affiliate of the Debenture Holder a fee equal to 3.5% of the amount of the July Debenture and a one-time due diligence and structuring fee of $5,000 at the closing.
The Debenture Holder may convert the July Debenture in its sole discretion to Company’s Common Shares at any time at the lower of $1.50 or 95% of the average of the two lowest daily VWAPs during the ten consecutive trading days immediately preceding the conversion date, provided that the conversion price may not be less than $0.50 (the “July Debenture Floor Price”). The Debenture Holder may not convert any portion of the July Debenture if such conversion would result in the Debenture Holder beneficially owning more than 4.99% of Company’s then issued and Common Shares, provided that such limitation may be waived by the Debenture Holder with a 65 days’ notice. Any time after the issuance of the July Debenture that the daily VWAP is less than the July Debenture Floor Price for a period of 10 consecutive trading days (each such occurrence, a “July Debenture Triggering Event”) and only for so long as such conditions exist after a July Debenture Triggering Event, the Company shall make monthly payments beginning on the 30th day after the date of the July Debenture Triggering Event. Each monthly payment shall be in an amount equal to the sum of (i) the principal amount outstanding as of the date of the July Debenture Triggering Event divided by the number of such monthly payments until maturity, (ii) a redemption premium of 20% of such principal amount and (iii) accrued and unpaid interest hereunder as of each payment date. The principal balance of $1,130,000 of the July Debenture was converted into 1,385,533 Common Shares of the Company for the year ended December 31, 2021. The remaining balance of $1,370,000 of the July Debenture was converted into 1,068,078 Common Shares of the Company during the year ended December 31, 2022.
Securities Purchase Agreement dated March 10, 2022
On March 10, 2022, ReTo entered into a Securities Purchase Agreement pursuant to which ReTo issued Note to the Investor. The Note will mature 12 months after the purchase price of the Note is delivered from the Investor to ReTo (the “Purchase Price Date”). The Note has an original principal amount of $3,105,000 and Investor gave consideration of $3,000,000, reflecting an original issue discount of $90,000 and $15,000 for Investor’s fees, costs and other transaction expenses incurred in connection with the purchase and sale of the Note. The transaction contemplated under the Securities Purchase Agreement was closed on March 11, 2022 and the Company anticipates using the proceeds for general working capital purposes.
On March 28, 2022, ReTo and Investor entered into an amendment to the Note, pursuant to which ReTo has agreed to satisfy any conversion request from Investor by making a cash payment equal to 110% of any converted amount if, at the time of the conversion, the Floor Price (as defined in the Note) is higher than the then current conversion price.
106
On October 13, 2022, the Company entered into a standstill agreement with the Investor. Pursuant to the standstill agreement, the Investor agreed not to seek to convert any portion of the Note During the Standstill Period. Balance of the Note was increased by $310,500 as of the date of the standstill agreement.
The principal balance of $10,000 of the Note was converted into 290,773 Common Shares of the Company on December 20, 2022. Subsequently from February to April 2023, the principal balance of $350,000 of the Note was converted into 1,388,804 Common Shares of the Company. The parties have agreed to extend the Note and are in the process of negotiating the terms of the extension as of the date of this annual report.
Equity Transfer Agreement dated December 27, 2021
For a description of the terms of this agreement, see “Item 4. Information on the Company—B. Business Overview—Recent Development —Acquisition of REIT Mingde.”
Consulting Agreement
On April 21, 2021, the Company entered into that certain three-year consulting agreement (the “Consulting Agreement”) with Geniusland International Capital Ltd. (the “Geniusland”) in connection with Company’s corporate strategy on the Nasdaq Stock Market. Pursuant to the agreement, the Company issued an aggregate of 1,000,000 Common Shares to Geniusland and its designees for services rendered. The Consulting Agreement was superseded by the Supplemental Consulting Agreement described below.
Supplemental Consulting Agreement
On December 29, 2021, the Company entered into a Supplemental Consulting Agreement with Geniusland (the “Supplemental Agreement”) which superseded the Consulting Agreement. Pursuant to the Supplemental Agreement, Geniusland provided corporate strategies in connection with the Company’s listing on the Nasdaq Stock Market for a term from December 29, 2021 to March 28, 2022. In consideration of the services rendered by Geniusland, upon execution of the Supplemental Agreement, the Company issued 500,000 restricted Common Shares to Geniusland, in lieu of cash, valued at 70% of the closing price on the day before the signing date of the Supplemental Agreement. Such shares are subject to a 6-month lock-up.
Lease Agreement
On November 25, 2021, REIT Technology entered into a lease agreement (“Lease”) with Hainan Nuclear Power Co., Ltd. (“Hainan Nuclear Power”) to lease an office space of 1,279.66 square meters, located at the 22nd Floor, Xinheng Building, No. 123-8, Binhai Avenue, Longhua District, Haikou City, Hainan Province, China. The Lease has a term of three years from February 1, 2022 to January 31, 2025. If REIT Technology intends to renew the Lease, REIT shall notify Hainan Nuclear Power two months earlier in writing. Hainan Nuclear Power shall notify REIT Technology of its intention to sell the leased property at least 90 business days in advance, under which circumstances, REIT Technology shall have the priority right to purchase the leased property, If Hainan Nuclear terminates the Lease earlier without cause, it shall notify REIT Technology 60 days in advance and refund REIT Technology with the balance of the paid rent and security deposit and pay a liquidated damage equal to 100% of the security deposit to REIT Technology. If REIT Technology terminates the Lease earlier, it shall notify Hainan Nuclear Power at least 60 days in advance and forfeit the paid rent and the security deposit.
Settlement Agreement
For a description of the terms of this agreement, see “Item 8. Financial Information – A. Consolidated Statements and Other Financial Information – Legal and Administrative Proceedings.”
107
Hainan Tashanshi Agreement
On May 25, 2022, the Company entered into a securities purchase agreement with Hainan Tashanshi, pursuant to which the Company agreed to sell to Hainan Tashanshi an aggregate of 5,970,000 Common Shares at $0.60 per share, for aggregate gross proceeds of $3,582,000. The transaction was closed on May 25, 2022 and the Company issued 5,970,000 Common Shares to the designees of Hainan Tashanshi.
2023 Consulting Agreements
On February 27, 2023, the Company entered into a consulting service agreement with Express Transportation Ltd. (“ETL”). Pursuant to the agreement, ETL has agreed to provide feasibility, analysis and risk management services on investment project in mainland China in exchange for 2,000,000 Common Shares, which were issued on March 8, 2023.
On February 27, 2023, the Company entered into a consulting service agreement with Maxleed Investment Holding Ltd. (“MIHL”). Pursuant to the agreement, MIHL has agreed to provide strategy, due diligence, business expansion and optimization services in exchange for 2,000,000 Common Shares, which were issued on March 8, 2023.
Other than those set forth above and those described elsewhere in this annual report, we did not have any other material contracts.
| D. | Exchange controls. |
Foreign Currency Exchange
The principal regulations governing foreign currency exchange in China are the Foreign Exchange Administration Regulations (1996), as amended on August 5, 2008, the Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996) and the Interim Measures on Administration on Foreign Debts (2003), as amended on July 26, 2022. Under these regulations, Renminbi is freely convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions, but not for most capital account items, such as direct investment, loans, repatriation of investment and investment in securities outside China, unless the prior approval of SAFE or its local counterparts is obtained. In addition, any loans to an operating subsidiary in China that is a foreign invested enterprise, cannot, in the aggregate, exceed the difference between its respective approved total investment amount and its respective approved registered capital amount. Furthermore, any foreign loan must be registered with SAFE or its local counterparts for the loan to be effective. Any increase in the amount of the total investment and registered capital must be approved by the MOFCOM or its local counterpart. We may not be able to obtain these government approvals or registrations on a timely basis, if at all, which could result in a delay in the process of making these loans.
The dividends paid by the subsidiary to its shareholder are deemed shareholder income and are taxable in mainland 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 SAFE, for settlement of current account transactions without the approval of SAFE. Foreign exchange transactions under the capital account are still subject to limitations and require approvals from, or registration with, SAFE and other relevant PRC governmental authorities.
On August 29, 2008, SAFE issued the Circular on the Relevant Operating Issues Concerning the Improvement of the Administration of the Payment and Settlement of Foreign Currency Capital of Foreign-Invested Enterprises, or SAFE Circular 142, regulating the conversion by a foreign-invested enterprise of foreign currency-registered capital into RMB by restricting how the converted RMB may be used. SAFE Circular 142 provides that the RMB capital converted from foreign currency registered capital of a foreign-invested enterprise may only be used for purposes within the business scope approved by the applicable government authority and may not be used for equity investments within China. SAFE also strengthened its oversight of the flow and use of the RMB capital converted from foreign currency registered capital of foreign-invested enterprises. The use of such RMB capital may not be changed without SAFE’s approval, and such RMB capital may not in any case be used to repay RMB loans if the proceeds of such loans have not been used. On March 30, 2015, SAFE issued SAFE Circular 19, which took effective and replaced SAFE Circular 142 on June 1, 2015. Although SAFE Circular 19 allows for the use of RMB converted from the foreign currency-denominated capital for equity investments in China, the restrictions continue to apply as to foreign-invested enterprises’ use of the converted RMB for purposes beyond the business scope, for entrusted loans or for inter-company RMB loans. SAFE promulgated the Notice of the State Administration of Foreign Exchange on Reforming and Standardizing the Foreign Exchange Settlement Management Policy of Capital Account, or SAFE Circular 16, effective on June 9, 2016, which reiterates some of the rules set forth in SAFE Circular 19, but changes the prohibition against using RMB capital converted from foreign currency-denominated registered capital of a foreign-invested company to issue RMB entrusted loans to a prohibition against using such capital to issue loans to non-associated enterprises. Violations of SAFE Circular 19 or SAFE Circular 16 could result in administrative penalties.
108
On November 19, 2012, SAFE promulgated the Circular of Further Improving and Adjusting Foreign Exchange Administration Policies on Foreign Direct Investment which substantially amends and simplifies the current foreign exchange procedure. Pursuant to this circular, the opening of various special purpose foreign exchange accounts (e.g., pre-establishment expenses accounts, foreign exchange capital accounts and guarantee accounts), the reinvestment of lawful incomes derived by foreign investors in China (e.g. profit, proceeds of equity transfer, capital reduction, liquidation and early repatriation of investment), and purchase and remittance of foreign exchange as a result of capital reduction, liquidation, early repatriation or share transfer in a foreign-invested enterprise no longer require SAFE approval, and multiple capital accounts for the same entity may be opened in different provinces, which was not possible before. In addition, SAFE promulgated the Circular on Printing and Distributing the Provisions on Foreign Exchange Administration over Domestic Direct Investment by Foreign Investors and the Supporting Documents in May 2013, which specifies that the administration by SAFE or its local departments over direct investment by foreign investors in the PRC shall be conducted by way of registration and banks shall process foreign exchange business relating to the direct investment in China based on the registration information provided by SAFE and its local departments.
On February 13, 2015, SAFE promulgated the Circular on Further Simplifying and Improving the Policies Concerning Foreign Exchange Control on Direct Investment, or SAFE Circular 13, which took effect on June 1, 2015. SAFE Circular 13 delegates the authority to enforce the foreign exchange registration in connection with the inbound and outbound direct investment under relevant SAFE rules to certain banks and therefore further simplifies the foreign exchange registration procedures for inbound and outbound direct investment.
Circular 37
On July 4, 2014, SAFE issued Circular 37, which became effective as of July 4, 2014. According to Circular 37, PRC residents shall apply to SAFE and its branches for going through the procedures for foreign exchange registration of overseas investments before contributing the domestic assets or interests to a SPV. An amendment to registration or filing with the local SAFE branch by such PRC resident is also required if the registered overseas SPV’s basic information such as domestic individual resident shareholder, name, operating period, or major events such as domestic individual resident capital increase, capital reduction, share transfer or exchange, merger or division has changed. Although the change of overseas funds raised by overseas SPV, overseas investment exercised by overseas SPV and non-cross-border capital flow are not included in Circular 37, we may be required to make foreign exchange registration if required by SAFE and its branches.
Moreover, Circular 37 applies retroactively. As a result, PRC residents who have contributed domestic assets or interests to a SPV, but failed to complete foreign exchange registration of overseas investments as required prior to implementation of Circular 37, are required to send a letter to SAFE and its branches for explanation. Under the relevant rules, failure to comply with the registration procedures set forth in Circular 37 may result in receiving a warning from SAFE and its branches, and may result in a fine of up to RMB 300,000 for an organization or up to RMB 50,000 for an individual. In the event of failing to register, if capital outflow occurred, a fine up to 30% of the illegal amount may be assessed.
PRC residents who control our Company are required to register with SAFE in connection with their investments in us. If we use our equity interest to purchase the assets or equity interest of a PRC company owned by PRC residents in the future, such PRC residents will be subject to the registration procedures described in Circular 37.
Regulations on Offshore Parent Holding Companies’ Direct Investment in and Loans to Their PRC Subsidiaries
According to the Interim Regulations on Statistics and Supervision of Foreign Debt promulgated by the State Council and latest amended on November 29, 2020, and the Interim Provisions on the Management of Foreign Debts promulgated by SAFE, the NDRC and the MOFCOM and effective from March 1, 2003 and latest amended on July 26, 2022, loans by foreign companies to their subsidiaries in China, which accordingly are FIEs, are considered foreign debt, and such loans must be registered with the local branches of the SAFE. Under the provisions, the total amount of accumulated medium-term and long-term foreign debt and the balance of short-term debt borrowed by a FIE is limited to the difference between the total investment and the registered capital of the foreign-invested enterprise.
109
On January 12, 2017, the People’s Bank of China promulgated the Circular of the People’s Bank of China on Matters relating to the Macro-prudential Management of Comprehensive Cross-border Financing, or PBOC Circular 9, which took effect on the same date. The PBOC Circular 9 established a capital or net assets-based constraint mechanism for cross-border financing. Under such mechanism, a company may carry out cross-border financing in Renminbi or foreign currencies at their own discretion. The total cross-border financing of a company shall be calculated using a risk-weighted approach and shall not exceed an upper limit. The upper limit is calculated as capital or assets multiplied by a cross-border financing leverage ratio and multiplied by a macro-prudential regulation parameter.
In addition, according to PBOC Circular 9, as of the date of the promulgation of PBOC Circular 9, a transition period of one year is set for foreign-invested enterprises and during such transition period, FIEs may apply either the current cross-border financing management mode, namely the mode provided by Implementation Rules for the Provisional Regulations on Statistics and Supervision of Foreign Debt and the Interim Provisions on the Management of Foreign Debts, or the mode in this PBOC Circular 9 at its sole discretion. After the end of the transition period, the cross-border financing management mode for FIEs will be determined by the People’s Bank of China and SAFE after assessment based on the overall implementation of this PBOC Circular 9.
According to applicable PRC regulations on FIEs, capital contributions from a foreign holding company to its PRC subsidiaries, which are considered FIEs, may only be made when approval by or registration with the MOFCOM or its local counterpart is obtained.
Regulation of Dividend Distribution
The principal regulations governing the distribution of dividends by foreign holding companies include the Company Law of China (1993), as amended in 2018.
Under these regulations, enterprises in China may pay dividends only out of their retained profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, enterprises in China are required to allocate at least 10% of their respective retained 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, and an enterprise is not permitted to distribute any profits until losses from prior fiscal years have been offset.
| E. | Taxation. |
The following sets forth the material British Virgin Islands, PRC and U.S. federal income tax matters related to an investment in our Common Shares. It is directed to U.S. Holders (as defined below) of our Common Shares and is based on laws and relevant interpretations thereof in effect as of the date of this annual report, all of which are subject to change. This description does not deal with all possible tax consequences relating to an investment in our Common Shares, such as the tax consequences under state, local and other tax laws.
The following brief description applies only to U.S. Holders (defined below) that hold Common Shares as capital assets and that have the U.S. dollar as their functional currency. This brief description is based on the tax laws of the United States in effect as of the date of this annual report and on U.S. Treasury regulations in effect or, in some cases, proposed, as of the date of this annual report, as well as judicial and administrative interpretations thereof available on or before such date. All of the foregoing authorities are subject to change, which change could apply retroactively and could affect the tax consequences described below.
The brief description below of the U.S. federal income tax consequences to “U.S. Holders” will apply to you if you are a beneficial owner of shares and you are, for U.S. federal income tax purposes,
| ● | an individual who is a citizen or resident of the United States; |
| ● | a corporation (or other entity taxable as a corporation for U.S. federal income tax purposes) organized under the laws of the United States, any state thereof or the District of Columbia; |
| ● | an estate whose income is subject to U.S. federal income taxation regardless of its source; or |
| ● | a trust that (1) is subject to the primary supervision of a court within the United States and the control of one or more U.S. persons for all substantial decisions or (2) has a valid election in effect under applicable U.S. Treasury regulations to be treated as a U.S. person. |
110
WE URGE POTENTIAL PURCHASERS OF OUR SHARES TO CONSULT THEIR OWN TAX ADVISORS CONCERNING THE U.S. FEDERAL, STATE, LOCAL AND NON-U.S. TAX CONSEQUENCES OF PURCHASING, OWNING AND DISPOSING OF OUR SHARES.
PRC Enterprise Income Tax
According to the EIT Law, which was promulgated by the SCNPC on March 16, 2007 (effective as of January 1, 2008 and was last amended on February 24, 2017 (effective on the same day) and on December 29, 2018 (effective on the same day), respectively. The income tax for both domestic and foreign-invested enterprises on their global income is at a uniform rate of 25%, unless they qualify for certain exceptions. The Regulation on the Implementation of Enterprise Income Tax Law of China (the “EIT Rules”) was promulgated by the State Council on December 6, 2007 and became effective on January 1, 2008 and partly amended on April 23, 2019 further clarifies the calculation of the income tax on different types of incomes and permit certain HNTEs strongly supported by the state” that independently own core intellectual property and meet statutory criteria, to enjoy a reduced 15% enterprise income tax rate.
On January 29, 2016, the PRC Ministry of Science and Technology, Ministry of Finance and State Administration of Taxation enacted the Administrative Measures for Certifying High and New Technology Enterprises (2016 Version) (the “Certifying Measures”), which retroactively became effective on January 1, 2016. Under the EIT Law and the Certifying Measures, certain qualified high-tech companies may benefit from a preferential tax rate of 15% if they own their core intellectual properties and are classified into certain industries strongly supported by the PRC government and set forth by certain departments of the PRC State Council. Beijing REIT, Hainan Yile IoT and IoV Technology Research were granted the HNTE qualifications valid until December 2025, October 2023 and October 2025, respectively. There can be no assurance, however, that Beijing REIT and Hainan Yile IoT will continue to meet the qualifications for such a reduced tax rate. In addition, there can be no guaranty that relevant governmental authorities will not revoke the “HNTE” status of Beijing REIT, Hainan Yile IoT or IoV Technology Research in the future.
Pursuant to Circular of the State Administration of Taxation on Printing and Distributing the Implementing Measures for Special Tax Adjustments (for Trial Implementation), effective on January 1, 2008, enterprises shall adopt a reasonable transfer pricing method when conducting transactions with their affiliates. Tax authorities have the power to assess whether related transactions conform to the principle of equity and make adjustments accordingly. Therefore, the invested enterprise should faithfully report relevant information of its related transactions. Pursuant to the Announcement of the State Administration of Taxation on Issuing the Administrative Measures for Special Tax Adjustment and Investigation and Mutual Consultation Procedures, effective on May 1, 2017, an enterprise may adjust and pay taxes at its own discretion when it receives a special tax adjustment risk warning or identifies its own special tax adjustment risks, and the tax authorities may also carry out special tax investigation and adjustment in accordance with the relevant provisions in regard to enterprises that adjust and pay taxes at their own discretion.
In January 2009, the SAT promulgated the Provisional Measures for the Administration of Withholding of Enterprise Income Tax for Non-resident Enterprises, or the Non-resident Enterprises Measures, which was repealed by Announcement of the State Administration of Taxation on Issues Relating to Withholding at Source of Income Tax of Non-resident Enterprises in December 2017. According to the new announcement, it shall apply to handling of matters relating to withholding at source of income tax of non-resident enterprises pursuant to the provisions of Article 37, Article 39 and Article 40 of the EIT Law. According to Article 37, Article 39 of the EIT Law, income tax over non-resident enterprise income pursuant to the provisions of the third paragraph of Article 3 shall be subject to withholding at the source, where the payer shall act as the withholding agent. The tax amount for each payment made or due shall be withheld by the withholding agent from the amount paid or payable. Where a withholding agent fails to withhold tax or perform tax withholding obligations pursuant to the provisions of Article 37, the taxpayer shall pay tax at the place where the income is derived. Where the taxpayer fails to pay tax pursuant to law, the tax authorities may demand payment of the tax amount payable, from a payer of the taxpayer with payable tax amounts from other taxable income items in China.
111
On April 30, 2009, the MOFCOM and the SAT jointly issued the Circular on Issues Concerning Treatment of Enterprise Income Tax in Enterprise Restructuring Business, or Circular 59, which became effective retroactively as of January 1, 2008 and was partially revised on January 1, 2014. By promulgating and implementing this circular, the PRC tax authorities have enhanced their scrutiny over the direct or indirect transfer of equity interests in a PRC resident enterprise by a Non-resident Enterprise.
On February 3, 2015, the SAT issued the Announcement of the State Administration of Taxation on Several Issues Relating to Enterprise Income Tax of Transfers of Assets between Non-resident Enterprises, or SAT Bulletin 7, which was partially abolished on December 29, 2017. SAT Bulletin 7 extends its tax jurisdiction to transactions involving transfer of immovable property in China and assets held under the establishment, and placement in China, of a foreign company through the offshore transfer of a foreign intermediate holding company. SAT Bulletin 7 also addresses transfer of the equity interest in a foreign intermediate holding company broadly. In addition, SAT Bulletin 7 introduces safe harbor scenarios applicable to internal group restructurings. However, it also brings challenges to both the foreign transferor and transferee of the Indirect Transfer as they have to assess whether the transaction should be subject to PRC tax and to file or withhold the PRC tax accordingly.
On October 17, 2017, the SAT issued the Announcement of the State Administration of Taxation on Issues Concerning the Withholding of Non-resident Enterprise Income Tax at Source, or SAT Bulletin 37, which came into effect on December 1, 2017 and was revised on June 15, 2018. The SAT Bulletin 37 further clarifies the practice and procedure of withholding of non-resident enterprise income tax.
If non-resident investors were involved in our private equity financing, if such transactions were determined by the tax authorities to lack reasonable commercial purpose, we and our non-resident investors may be at risk of being required to file a return and be taxed under SAT Bulletin 7 and we may be required to expend valuable resources to comply with SAT Bulletin 7 or to establish that we should not be held liable for any obligations under SAT Bulletin 7.
Uncertainties exist with respect to how the EIT Law applies to the tax residence status of ReTo and our offshore subsidiaries. Under the EIT Law, an enterprise established outside of China with a “de facto management body” within China is considered a “resident enterprise”, which means that it is treated in a manner similar to a PRC enterprise for enterprise income tax purposes. Although the EIT Rules define “de facto management body” as a managing body that exercises substantive and overall management and control over the production and business, personnel, accounting books and assets of an enterprise, the only official guidance for this definition currently available is set forth in Circular 82 issued by the State Administration of Taxation, on April 22, 2009 which provides that a foreign enterprise controlled by a PRC company or a PRC company group will be classified as a “resident enterprise” with its “de facto management bodies” located within China if all of the following criteria are satisfied:
| ● | the place where the senior management and core management departments that are in charge of its daily operations perform their duties is mainly located in China; |
| ● | its financial and human resources decisions are made by or are subject to approval by persons or bodies in China; |
| ● | its major assets, accounting books, company seals, and minutes and files of its board and shareholders’ meetings are located or kept in China; and |
| ● | half or more than half of the enterprise’s directors or senior management with voting rights frequently reside in China. |
We do not believe that we meet the conditions outlined in the preceding paragraph since ReTo does not have a PRC enterprise or enterprise group as our primary controlling shareholder. In addition, we are not aware of any offshore holding companies with a corporate structure similar to the Company that has been deemed a China “resident enterprise” by the PRC tax authorities.
If we are deemed a China resident enterprise, we may be subject to the EIT at the rate of 25% on our global income, except that the dividends we receive from our PRC subsidiaries may be exempt from the EIT to the extent such dividends are deemed dividends among qualified resident enterprises. If we are considered a resident enterprise and earn income other than dividends from our PRC subsidiaries, a 25% EIT on our global income could significantly increase our tax burden and materially and adversely affect our cash flow and profitability.
112
PRC Value-Added Tax
The Provisional Regulations of the PRC on Value-added Tax were promulgated by the State Council on December 13, 1993 and came into effect on January 1, 1994, which were subsequently amended on November 10, 2008 and came into effect on January 1, 2009 and most recently amended on November 19, 2017. The Detailed Rules for the Implementation of the Provisional Regulations of the PRC on Value-added Tax was promulgated by the Ministry of Finance on December 25, 1993 and subsequently amended on December 15, 2008 and October 28, 2011, or collectively, VAT Law. On November 19, 2017, the State Council promulgated the Decisions on Abolishing the Provisional Regulations of the PRC on Business Tax and Amending the Provisional Regulations of the PRC on Value-added Tax, or Order 691. According to the VAT Law and Order 691, all enterprises and individuals in China engaging in the sale of goods, the provision of processing, repair and assembly services, sales of services, intangible assets, real property and the importation of goods within the territory of the PRC are the taxpayers of VAT. On April 4, 2018, Ministry of Finance and State Administration of Taxation collectively promulgated the Circular of the Ministry of Finance and the State Administration of Taxation on Adjusting Value-added Tax Rates, the implementation of which began on May 1, 2018, pursuant to which a taxpayer engaging in a taxable sales activity for the value-added tax purpose or imports of goods, the previous applicable 17% and 11% tax rates are adjusted to 16% and 10% respectively, and exported goods originally subject to 17% and 11% tax rates and export rebate rate, will be subject to 16% and 10% tax rate and export rebate rate. From April 1, 2019, the 16% and 10% tax rates were reduced to 13% and 9%, respectively. The VAT tax rates generally applicable are simplified as 17%, 11%, 6% and 0%, and the VAT tax rate applicable to the small-scale taxpayers is 3%. The amount of VAT payable is calculated as “output VAT” minus “input VAT” and the rate of VAT for the China PRC subsidiaries ranges from 3% to 13%.
China Dividend Withholding Tax
Under the PRC tax laws effective prior to January 1, 2008, dividends paid to foreign investors by foreign-invested enterprises were exempt from PRC withholding tax. Pursuant to the EIT Law and the Implementation Rules, dividends generated after January 1, 2008 and payable by a foreign-invested enterprise in China to its foreign enterprise investors are subject to a 10% withholding tax, unless any such foreign investor’s jurisdiction of incorporation has a tax treaty with China that provides for a different withholding arrangement.
Pursuant to an Arrangement Between the Mainland of China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and Tax Evasion on Income, or the Double Tax Avoidance Arrangement came into effect on December 8, 2006, and other applicable PRC laws and regulations, if a Hong Kong resident enterprise is determined by the competent PRC tax authority to have satisfied the relevant conditions and requirements under such Double Tax Avoidance Arrangement and other applicable laws and regulations, the 10% withholding tax on the dividends the Hong Kong resident enterprise receives from a PRC resident enterprise may be reduced to 5%. According to the Announcement of the SAT on Issuing the Measures for the Administration of Non-resident Taxpayers’ Enjoyment of Treaty Benefits effective on January 1, 2020, non-resident taxpayers can enjoy tax treaty benefits via the “self-assessment of eligibility, claiming treaty benefits, retaining documents for inspection” mechanism. Non-resident taxpayers who have self-assessed that they are eligible for the treaty benefits can claim such tax treaty benefits accordingly provided that they have collected and retained relevant supporting documents for inspection by the tax authorities in their post-filing administration process. Pursuant to the Announcement on Certain Issues with Respect to the “Beneficial Owner” in Tax Treaties, issued by the SAT on February 3, 2018, and effective on April 1, 2018, when determining an applicant’s “beneficial owner” status regarding tax treatments in connection with dividends, interests or royalties in tax treaties, several factors set forth below will be taken into account, although the actual analysis will be fact-specific: (i) whether the applicant is obligated to pay more than 50% of his or her income in 12 months to residents in a third country or region; (ii) whether the business operated by the applicant constitutes a substantial business operation; and (iii) whether the counterparty country or region to the tax treaties does not levy any tax or grant tax exemption on relevant incomes or levy tax at an extremely low rate. The applicant must submit relevant documents to the competent tax authorities to prove his or her “beneficial owner” status.
113
British Virgin Islands Taxation
All dividends paid by ReTo to holders of Common Shares who are not persons resident in the BVI are exempt from the provisions of the British Virgin Islands Income Tax Act, and any capital gains realized with respect to any Common Shares by persons who are not persons resident in the BVI are exempt from all forms of taxation in the BVI.
No estate, inheritance, succession, or gift tax, rate, duty, levy, or other charge is payable by persons who are not persons resident in the BVI with respect to Common Shares.
All instruments relating to transfers of property (except in the case of real estate situated in the BVI) to or by ReTo and all instruments relating to transactions in respect of Common Shares are exempt from the payment of stamp duty in the BVI.
There is no income tax treaty or convention currently in effect between the United States and the British Virgin Islands or between China and the British Virgin Islands.
Material United States Federal Income Tax Considerations
The following does not address the tax consequences to any particular investor or to persons in special tax situations such as:
| ● | a dealer in securities or currencies; |
| ● | a person whose “functional currency” is not the United States dollar; |
| ● | banks; |
| ● | financial institutions; |
| ● | insurance companies; |
| ● | regulated investment companies; |
| ● | real estate investment trusts; |
| ● | broker-dealers; |
| ● | traders that elect to mark-to-market; |
| ● | U.S. expatriates; |
| ● | tax-exempt entities; |
| ● | persons liable for alternative minimum tax; |
| ● | persons holding our Common Shares as part of a straddle, hedging, conversion or integrated transaction; |
| ● | persons that actually or constructively own 10% or more of our voting shares; |
| ● | personsthat are subject to the applicable financial statement accounting rules under Section 451(b) of the Code; |
| ● | persons who acquired our Common Shares pursuant to the exercise of any employee share option or otherwise as consideration; or |
| ● | persons holding our Common Shares through partnerships or other pass-through entities. |
Prospective purchasers are urged to consult their tax advisors about the application of the U.S. Federal tax rules to their particular circumstances as well as the state, local, foreign and other tax consequences to them of the purchase, ownership and disposition of our Common Shares.
114
Taxation of Dividends and Other Distributions on our Common Shares
Subject to the passive foreign investment company rules discussed below, the gross amount of distributions made by us to you with respect to the Common Shares (including the amount of any taxes withheld therefrom) will generally be includable in your gross income as dividend income on the date of receipt by you, but only to the extent that the distribution is paid out of our current or accumulated earnings and profits (as determined under U.S. federal income tax principles). The dividends will not be eligible for the dividends-received deduction allowed to corporations in respect of dividends received from other U.S. corporations.
With respect to non-corporate U.S. Holders, including individual U.S. Holders, dividends will be taxed at the lower capital gains rate applicable to qualified dividend income, provided that (1) the Common Shares are readily tradable on an established securities market in the United States, or in the event we are deemed to be a PRC “resident enterprise” under the China tax law, we are eligible for the benefits of an approved qualifying income tax treaty with the United States that includes an exchange of information program, (2) we are not a passive foreign investment company (as discussed below) for either our taxable year in which the dividend is paid or the preceding taxable year, and (3) certain holding period requirements are met. Under U.S. Internal Revenue Service authority, Common Shares are considered for purpose of clause (1) above to be readily tradable on an established securities market in the United States if they are listed on the Nasdaq Capital Market. You are urged to consult your tax advisors regarding the availability of the lower rate for dividends paid with respect to our Common Shares, including the effects of any change in law after the date of this annual report.
Dividends will constitute foreign source income for foreign tax credit limitation purposes. If the dividends are taxed as qualified dividend income (as discussed above), the amount of the dividend taken into account for purposes of calculating the foreign tax credit limitation will be limited to the gross amount of the dividend, multiplied by the reduced rate divided by the highest rate of tax normally applicable to dividends. The limitation on foreign taxes eligible for credit is calculated separately with respect to specific classes of income. For this purpose, dividends distributed by us with respect to our Common Shares will constitute “passive category income” but could, in the case of certain U.S. Holders, constitute “general category income.”
To the extent that the amount of the distribution exceeds our current and accumulated earnings and profits (as determined under U.S. federal income tax principles), it will be treated first as a tax-free return of your tax basis in your Common Shares, and to the extent the amount of the distribution exceeds your tax basis, the excess will be taxed as capital gain. We do not intend to calculate our earnings and profits under U.S. federal income tax principles. Therefore, a U.S. Holder should expect that a distribution will be treated as a dividend even if that distribution would otherwise be treated as a non-taxable return of capital or as capital gain under the rules described above.
Taxation of Dispositions of Common Shares
Subject to the passive foreign investment company rules discussed below, you will recognize taxable gain or loss on any sale, exchange or other taxable disposition of a share equal to the difference between the amount realized (in U.S. dollars) for the share and your tax basis (in U.S. dollars) in the Common Shares. The gain or loss will generally be capital gain or loss. Capital gains are generally subject to United States federal income tax at the same rate as ordinary income, except that non-corporate U.S. Holders who have held Common Shares for more than one year may be eligible for reduced rates of taxation. The deductibility of capital losses is subject to limitations. Any such gain or loss that you recognize will generally be treated as United States source income or loss for foreign tax credit limitation purposes.
115
Passive Foreign Investment Company
Based on our current and anticipated operations and the composition of our income and assets, we do not expect to be a passive foreign investment company, or PFIC, for U.S. federal income tax purposes for our current taxable year ending December 31, 2023. Our actual PFIC status for the current taxable years ending December 31, 2023 will not be determinable until after the close of such taxable years and, accordingly, there is no guarantee that we will not be a PFIC for the current taxable year. PFIC status is a factual determination for each taxable year which cannot be made until the close of the taxable year. A non-U.S. corporation is considered a PFIC for any taxable year if either:
| ● | at least 75% of its gross income is passive income; or |
| ● | at least 50% of the value of its assets (based on an average of the quarterly values of the assets during a taxable year) is attributable to assets that produce or are held for the production of passive income (the “asset test”). |
We will be treated as owning our proportionate share of the assets and earning our proportionate share of the income of any other corporation in which we own, directly or indirectly, at least 25% (by value) of the stock.
We must make a separate determination each year as to whether we are a PFIC. As a result, our PFIC status may change. In particular, because the value of our assets for purposes of the asset test will generally be determined based on the market price of our Common Shares, our PFIC status will depend in large part on the market price of our Common Shares. Accordingly, fluctuations in the market price of the Common Shares may cause us to become a PFIC. In addition, the application of the PFIC rules is subject to uncertainty in several respects and the composition of our income and assets will be affected by how, and how quickly, we spend the cash we raised in our IPO. If we are a PFIC for any year during which you hold Common Shares, we will continue to be treated as a PFIC for all succeeding years during which you hold Common Shares. However, if we cease to be a PFIC, you may avoid some of the adverse effects of the PFIC regime by making a “deemed sale” election with respect to the Common Shares.
If we are a PFIC for any taxable year during which you hold Common Shares, you will be subject to special tax rules with respect to any “excess distribution” that you receive and any gain you realize from a sale or other disposition (including a pledge) of the Common Shares, unless you make a “mark-to-market” election as discussed below. Distributions you receive in a taxable year that are greater than 125% of the average annual distributions you received during the shorter of the three preceding taxable years or your holding period for the Common Shares will be treated as an excess distribution. Under these special tax rules:
| ● | the excess distribution or gain will be allocated ratably over your holding period for the Common Shares; |
| ● | the amount allocated to the current taxable year, and any taxable year prior to the first taxable year in which we were a PFIC, will be treated as ordinary income, and |
| ● | the amount allocated to each other year will be subject to the highest tax rate in effect for that year and the interest charge generally applicable to underpayments of tax will be imposed on the resulting tax attributable to each such year. |
The tax liability for amounts allocated to years prior to the year of disposition or “excess distribution” cannot be offset by any net operating losses for such years, and gains (but not losses) realized on the sale or other disposition of the Common Shares cannot be treated as capital, even if you hold the Common Shares as capital assets.
A U.S. Holder of “marketable stock” (as defined below) in a PFIC may make a mark-to-market election for such stock to elect out of the tax treatment discussed above. If you make a mark-to-market election for the Common Shares, you will include in ordinary income each year an amount equal to the excess, if any, of the fair market value of the Common Shares as of the close of your taxable year over your adjusted tax basis in such Common Shares. You are allowed a deduction for the excess, if any, of the adjusted tax basis of the Common Shares over their fair market value as of the close of the taxable year. However, deductions are allowable only to the extent of any net mark-to-market gains on the Common Shares included in your income for prior taxable years. Amounts included in your income under a mark-to-market election, as well as gain on the actual sale or other disposition of the Common Shares, are treated as ordinary income. Ordinary loss treatment also applies to the deductible portion of any mark-to-market loss on the Common Shares, as well as to any loss realized on the actual sale or disposition of the Common Shares, to the extent that the amount of such loss does not exceed the net mark-to-market gains previously included for such Common Shares. Your tax basis in the Common Shares will be adjusted to reflect any such income or loss amounts. If you make a valid mark-to-market election, the tax rules that apply to distributions by corporations which are not PFICs would apply to distributions by us, except that the lower applicable capital gains rate for qualified dividend income discussed above under “—Taxation of Dividends and Other Distributions on our Common Shares” generally would not apply.
116
The mark-to-market election is available only for “marketable stock”, which is stock that is traded in other than de minimis quantities on at least 15 days during each calendar quarter (“regularly traded”) on a qualified exchange or other market (as defined in applicable U.S. Treasury regulations), including the Nasdaq Capital Market. If the Common Shares are regularly traded on the Nasdaq Capital Market and if you are a holder of Common Shares, the mark-to-market election would be available to you were we to be or become a PFIC.
Alternatively, a U.S. Holder of stock in a PFIC may make a “qualified electing fund” election with respect to such PFIC to elect out of the tax treatment discussed above. A U.S. Holder who makes a valid qualified electing fund election with respect to a PFIC will generally include in gross income for a taxable year such holder’s pro rata share of the corporation’s earnings and profits for the taxable year. However, the qualified electing fund election is available only if such PFIC provides such U.S. Holder with certain information regarding its earnings and profits as required under applicable U.S. Treasury regulations. We do not currently intend to prepare or provide the information that would enable you to make a qualified electing fund election. If you hold Common Shares in any year in which we are a PFIC, you will generally be required to file U.S. Internal Revenue Service Form 8621 to report your ownership of our Common Shares as well as distributions received on the Common Shares, any gain realized on the disposition of the Common Shares, any PFIC elections you would like to make in regard to the Common Shares, and any information required to be reported pursuant to such an election.
You are urged to consult your tax advisors regarding the application of the PFIC rules to your investment in our Common Shares and the elections discussed above.
Information Reporting and Backup Withholding
Dividend payments with respect to our Common Shares and proceeds from the sale, exchange or redemption of our Common Shares may be subject to information reporting to the U.S. Internal Revenue Service and possible U.S. backup withholding at a current rate of 24%. Backup withholding will not apply, however, to a U.S. Holder who furnishes a correct taxpayer identification number and makes any other required certification on U.S. Internal Revenue Service Form W-9 or who is otherwise exempt from backup withholding. U.S. Holders who are required to establish their exempt status generally must provide such certification on U.S. Internal Revenue Service Form W-9. U.S. Holders are urged to consult their tax advisors regarding the application of the U.S. information reporting and backup withholding rules.
Backup withholding is not an additional tax. Amounts withheld as backup withholding may be credited against your U.S. federal income tax liability, and you may obtain a refund of any excess amounts withheld under the backup withholding rules by filing the appropriate claim for refund with the U.S. Internal Revenue Service and furnishing any required information. We do not intend to withhold taxes for individual shareholders.
Under the Hiring Incentives to Restore Employment Act of 2010, certain United States Holders are required to report information relating to Common Shares, subject to certain exceptions (including an exception for shares held in accounts maintained by certain financial institutions), by attaching a complete Internal Revenue Service Form 8938, Statement of Specified Foreign Financial Assets, with their tax return for each year in which they hold shares. U.S. Holders are urged to consult their own tax advisors regarding the application of the U.S. information reporting and backup withholding rules.
A Non-U.S. Holder generally may eliminate the requirement for information reporting and backup withholding by providing certification of its foreign status to the payor, under penalties of perjury, on the applicable IRS Form W-8BEN.
117
| F. | Dividends and paying agents. |
Not applicable.
| G. | Statement by experts. |
Not applicable.
| H. | Documents on display. |
We are subject to periodic reporting and other informational requirements of the Exchange Act as applicable to foreign private issuers, and are required to file reports and other information with the SEC. Specifically, we are required to file annually an annual report on Form 20-F within four months after the end of each fiscal year, which is December 31. All information filed with the SEC can be obtained over the internet at the SEC’s website at www.sec.gov. As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing the furnishing and content of quarterly reports and proxy statements, and officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in Section 16 of the Exchange Act.
In accordance with Nasdaq Stock Market Rule 5250(d), we will post this annual report on Form 20-F on our website at www.retoeco.com. In addition, we will provide hard copies of our annual report free of charge to shareholders upon request.
| I. | Subsidiary information. |
Not applicable.
| J. | Annual Report to Security Holders. |
Not applicable.
Item 11. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
Our main interest rate exposure relates to bank borrowings. We manage our interest rate exposure with a focus on reducing our overall cost of debt and exposure to changes in interest rates.
As of December 31, 2022, we had $1.3 million in outstanding debt borrowings, with effective interest rates between 5.50% and 7.3590%. As of December 31, 2021, we had $2.4 million in outstanding debt borrowings, with effective interest rates between 4.55% and 8.5%. As of December 31, 2020, we had $15.9 million in outstanding debt borrowings, with effective interest rates ranging from 5.0025% to 19.2%.
As of December 31, 2022, if interest rates change by 1%, with all other variables having remained constant, and assuming the amount of bank borrowings outstanding at the end of the year was outstanding for the entire year, profit attributable to equity owners of our Company would have been RMB51,603 ($7,668) lower/higher, respectively, mainly as a result of higher/lower interest expenses incurred on the outstanding debt borrowings.
As of December 31, 2021, if interest rates increased/decreased by 1%, with all other variables having remained constant, and assuming the amount of bank borrowings outstanding at the end of the year was outstanding for the entire year, profit attributable to equity owners of our Company would have been RMB151,820 ($23,535) lower/higher, respectively, mainly as a result of higher/lower interest expenses incurred on the outstanding debt borrowings.
As of December 31, 2020, if interest rates increased/decreased by 1%, with all other variables having remained constant, and assuming the amount of bank borrowings outstanding at the end of the year was outstanding for the entire year, profit attributable to equity owners of our Company would have been RMB 1,095,297 ($158,599) lower/higher, respectively, mainly as a result of higher/lower interest expenses incurred on the outstanding debt borrowings.
118
Foreign Exchange Risk
Our functional currency is the RMB, and our financial statements are presented in U.S. dollars. China’s currency has gradually depreciated against most foreign currencies over the last few years. The average exchange rate for US$ against Chinese RMB has changed from US$1.00 for RMB6.4508 in fiscal 2021 to US $1.00 for RMB6.7290 in fiscal 2022. The exchange rate was US$1.00 for RMB6.8972 as of December 31, 2022. The change in the value of RMB relative to the U.S. dollar may affect our financial results reported in the U.S. dollar terms without giving effect to any underlying change in our business or results of operation. If using the average exchange rate of fiscal 2021, our revenue, cost of revenue and total expenses, including selling expenses, general administrative expenses, bad debt expense and research and development expenses, for the year ended December 31, 2022 would decrease by approximately $280,000, $245,000 and $694,000, respectively.
Currently, our assets, liabilities, revenues and costs are denominated in RMB and in U.S. dollars, our exposure to foreign exchange risk will primarily relate to those financial assets denominated in U.S. dollars. Any significant revaluation of RMB against U.S. dollar may materially affect our earnings and financial position, and the value of, and any dividends payable on, our Common Shares in U.S. dollars in the future. See “Item 3. Key Information- D. Risk Factors — Risks Related to Doing Business in China — Fluctuations in exchange rates could result in foreign currency exchange losses to us and may reduce the value of, and amount in U.S. Dollars of dividends payable on, our shares in foreign currency terms.”
Credit Risk
As of December 31, 2022, we had cash and cash equivalents of $0.1 million. Our cash and cash equivalents are invested primarily in savings and deposit accounts with original maturities of three months or less. Savings and deposit accounts generate a small amount of interest income.
Inflation Risk
Inflationary factors such as increases in the cost of our product and overhead costs may adversely affect our operating results. Although we do not believe that inflation has had a material effect on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of gross profit and selling, general and administrative expenses as a percentage of net sales if the selling prices of our products do not increase with these increased costs.
Commodity Risk
As a developer and manufacturer of construction materials and equipment, our Company is exposed to the risk of an increase in the price of raw materials. We historically have been able to pass on price increases to customers by virtue of pricing terms that vary with changes in raw material prices such as steel and cement, but we have not entered into any contract to hedge any specific commodity risk. Moreover, our Company does not purchase or trade on commodity instruments or positions; instead, it purchases commodities for use.
Item 12. Description of Securities Other Than Equity Securities
A. Debt Securities
Not applicable.
B. Warrants and Rights
Not applicable.
C. Other Securities
Not applicable.
D. American Depositary Shares
Not applicable.
119
PART II
Item 13. Defaults, Dividends Arrearages and Delinquencies
None.
Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds
Material Modifications to the Rights of Security Holders
See “Item 10. Additional Information – B. Memorandum and Articles of Association” for a description of the rights of securities holders, which remain unchanged.
Use of Proceeds
Not applicable.
Item 15. Controls and Procedures
| (a) | Disclosure Controls and Procedures. |
As of December 31, 2022 (the “Evaluation Date”), the Company carried out an evaluation, under the supervision of and with the participation of management, including the Company’s chief executive officer and chief financial officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on the foregoing, the chief executive officer and chief financial officer concluded that as of the Evaluation Date the Company’s disclosure controls and procedures were not effective due to the material weaknesses identified below.
| (b) | Management’s Annual Report on Internal Control over Financial Reporting. |
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is a process designed under the supervision of our chief executive officer and chief financial officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our consolidated financial statements for external reporting purpose in accordance with U.S. generally accepted accounting principles.
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2022. In making this assessment, management used the framework set forth in the report Internal Control – Integrated framework issued in 2013 by the Committee of Sponsoring Organization of the Treadway Commission, or COSO. The COSO framework summarizes each of the components of a company’s internal control system, including (1) the control environment, (2) risk assessment, (3) control activities, (4) information and communication and (5) monitoring.
Based on that evaluation, management concluded that these controls were ineffective at December 31, 2022 due to material weaknesses relating to (i) a lack of full-time accounting and financial reporting personnel with appropriate knowledge of U.S. GAAP and SEC reporting and compliance requirements; and (ii) a lack of an effective review by management for the year ended accounting close and reporting.
Remediation Activities and Plans
The Company is in the process of designing and implementing measures to improve our internal control over financial reporting to remediate the material weaknesses that have we identified, including (i) hiring external financial consultants with experience in U.S. GAAP and SEC reporting obligations; (ii) implementing regular and continuous U.S. GAAP accounting and financial reporting training programs for our accounting and financial reporting personnel; iii) implementing new policies and procedures to standardize relevant processes, and (iv) enhancing our internal recordkeeping.
Since initially identifying the material weaknesses, we have improved our internal control environment in the following ways:
| (i) | Management engaged certain qualified consultants with relevant U.S. GAAP and SEC reporting experience and qualification to strengthen the Company’s financial reporting and U.S. GAAP and SEC reporting training; and |
| (ii) | Management strengthened the application of critical accounting policies and implemented new critical accounting policies to support the financial reporting and disclosure. |
| (c) | Attestation report of the registered public accounting firm. |
Not applicable.
120
| (d) | Changes in Internal Control over Financial Reporting. |
Other than as described above, there were no changes in our internal controls over financial reporting that occurred during the period covered by this annual report on Form 20-F that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 16. [Reserved]
Item 16A. Audit committee financial expert
The Company’s Board of Directors has determined that Ms. Lidong Liu qualifies as an “audit committee financial expert” in accordance with applicable Nasdaq standards. The Company’s Board of Directors has also determined that Ms. Liu and the other members of the Audit Committee are all “independent” in accordance with the applicable Nasdaq standards.
Item 16B. Code of Ethics
Our board of directors has adopted a code of business conduct and ethics that applies to all of our directors, executive officers and employees. We have filed our code of business conduct and ethics as an exhibit to our registration statement on Form F-1, declared effective on July 27, 2017 (File No. 333-217355). The code is also available on our official website under the investor relations section at www.retoeco.com.
Item 16C. Principal Accountant Fees
The following table sets forth the aggregate fees by categories specified below in connection with certain professional services rendered and billed by YCM CPA Inc., our independent registered public accounting firm, for the periods indicated.
December 31, 2022 | December 31, 2021 | |||||||
| Audit fees(1) | $ | 190,000 | $ | 190,000 | ||||
| Audit-Related fees | - | - | ||||||
| Tax fees | - | - | ||||||
| All other fees(2) | - | - | ||||||
| Total | $ | 190,000 | $ | 190,000 | ||||
| (1) | Audit fees include the aggregate fees billed for each of the fiscal years for professional services rendered by our independent registered public accounting firm for the audit of our annual financial statements and review of the interim financial statements. |
| (2) | All other fees include the aggregate fees billed in each of the fiscal years for products and services provided by our independent registered public accounting firm other than the services reported under audit fees, audit-related fees, and tax fees. |
The policy of our audit committee is to pre-approve all audit and non-audit services provided by YCM CPA Inc., our independent registered public accounting firm, including audit services, audit-related services, tax services, and other services as described above.
121
Item 16D. Exemptions form the Listing Standards for Audit Committees
Not Applicable.
Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers
None.
Item 16F. Change in Registrant’s Certifying Accountant
(1) Previous Independent Registered Public Accounting Firm
(i) On March 15, 2021, the Company dismissed its independent registered public accounting firm, Friedman LLP (“Friedman”).
(ii) The report of Friedman on the financial statements of the Company for the fiscal years ended December 31, 2019, and the related statements of operations and comprehensive income (loss), changes in shareholders’ equity (deficit), and cash flows for the fiscal years ended December 31, 2019 did not contain an adverse opinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles, except that the audit report on the financial statements of the Company for the year ended December 31, 2019 contained an uncertainty about the Company’s ability to continue as a going concern.
(iii) The decision to change the independent registered public accounting firm was recommended and approved by the Audit Committee of the Company.
(iv) During the fiscal years ended December 31, 2019 and 2020 and the subsequent interim period from January 1, 2021 through March 15, 2021, the date of dismissal, (a) there were no disagreements with Friedman on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Friedman, would have caused it to make reference thereto in its reports on the financial statements for such years and (b) there were no “reportable events” as described in Item 304(a)(1)(v) of Regulation S-K.
(v) On March 15, 2021, the Company provided Friedman with a copy of the Current Report 6-K which was filed on March 15, 2020 and had requested that it furnished the Company with a letter addressed to the U.S. Securities and Exchange Commission stating whether it agreed with the above statements. A copy of such letter was filed as an Exhibit 16.1 to the Company’s Current Report on Form 6-K filed on March 15, 2021 and was incorporated herein for reference in this report.
(2) New Independent Registered Public Accounting Firm
On March 15, 2021, the Audit Committee approved the appointment of YCM CPA Inc. (“YCM”) as its new independent registered public accounting firm to undertake the Company’s audit for the financial year ending December 31, 2020. YCM also conducted the audit for the financial year ending December 31, 2021.
During the two fiscal years ended December 31, 2020 and December 31, 2019 and the subsequent interim period from January 1, 2021 through March 15, 2021, prior to the engagement of YCM, neither the Company, nor someone on its behalf, has consulted YCM regarding:
(i) either: the application of accounting principles to a specified transaction, either completed or proposed; or the type of audit opinion that might be rendered on the Company’s consolidated financial statements, and either a written report was provided to the Company or oral advice was provided that the new independent registered public accounting firm concluded was an important factor considered by the Company in reaching a decision as to the accounting, auditing or financial reporting issue; or
(ii) any matter that was either the subject of a disagreement as defined in paragraph 304(a)(1)(iv) of Regulation S-K or a reportable event as described in paragraph 304(a)(1)(v) of Regulation S-K.
122
Item 16G. Corporate Governance
Our Common Shares are listed on the Nasdaq Capital Market. As such, we are subject to corporate governance requirements imposed by Nasdaq. Under Nasdaq rules, listed non-US companies such as ourselves may, in general, follow their home country corporate governance practices in lieu of some of the Nasdaq corporate governance requirements.
Certain corporate governance practices in the BVI, which is our home country, may differ significantly from the Nasdaq corporate governance listing standards. The following summarizes some significant ways in which our corporate governance practices differ from those followed by domestic companies under the listing standards of the Nasdaq:
Pursuant to the home country rule exemption set forth under Nasdaq Listing Rule 5615(a)(3)(A), which provides (with certain exceptions not relevant to the conclusions expressed herein) that a foreign private issuer may follow its home country practice in lieu of the requirements of the Nasdaq Marketplace Rule 5600 Series, we elected to be exempt from the requirements as follows:
| (a) | Nasdaq Marketplace Rule 5620 which provides that (with certain exceptions not relevant to the conclusions expressed herein) each company listing common stock or voting preferred stock, and their equivalents, shall hold an annual meeting of shareholders no later than one year after the end of the company’s fiscal year-end; and |
| (b) | Nasdaq Marketplace Rule 5635 which sets forth the circumstances under which shareholder approval is required prior to an issuance of securities in connection with: (i) the acquisition of the stock or assets of another company; (ii) equity-based compensation of officers, directors, employees or consultants; (iii) a change of control; and (iv) transactions other than public offerings. |
We currently intend to comply with the Nasdaq corporate governance practices and do not rely on the home country rule exemption and except for the foregoing, there is no significant difference between our corporate governance practices and what the Nasdaq requires of domestic U.S. companies.
Item 16H. Mine Safety Disclosure
Not applicable.
Item 16I. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections
Not applicable.
123
PART III
Item 17. Financial Statements
We have elected to provide financial statements pursuant to Item 18.
Item 18. Financial Statements
The consolidated financial statements of ReTo Eco-Solutions, Inc. are included at the end of this annual report, beginning with page F-1.
Item 19. Exhibits
124
125
| 13.1** | Certification of the Chief Executive Officer of ReTo Eco-Solutions, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
| 13.2** | Certification of the Chief Financial Officer of ReTo Eco-Solutions, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
| 15.1* | Consent of YCM CPA Inc. | |
| 101. INS* | Inline XBRL Instance Document. | |
| 101. SCH* | Inline XBRL Taxonomy Extension Schema Document. | |
| 101. CAL* | Inline XBRL Taxonomy Extension Calculation Linkbase Document. | |
| 101. DEF* | Inline XBRL Taxonomy Extension Definition Linkbase Document. | |
| 101. LAB* | Inline XBRL Taxonomy Extension Label Linkbase Document. | |
| 101. PRE* | Inline XBRL Taxonomy Extension Presentation Linkbase Document. | |
| 104* | Cover Page Interactive Data File (embedded within the Inline XBRL document) |
| * | Filed herewith. |
| ** | Furnished herewith. |
126
SIGNATURES
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.
| RETO ECO-SOLUTIONS, INC. | ||
| By: | /s/ Hengfang Li | |
| Hengfang Li | ||
| Chief Executive Officer | ||
| (Principal Executive Officer) | ||
Date: May 1, 2023
127
RETO ECO-SOLUTIONS INC. AND SUBSIDIARIES
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
ReTo Eco-solutions, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of ReTo Eco-solutions, Inc. and subsidiaries (collectively, the “Company”) as of December 31, 2022 and 2021, and the related consolidated statements of operations and comprehensive income (loss), changes in stockholders’ equity, and cash flows for the years ended December 31, 2022, 2021 and 2020, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for the years ended December 31, 2022, 2021 and 2020, in conformity with accounting principles generally accepted in the United States of America.
Going Concern
The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 3 to the consolidated financial statements, the Company records an accumulated deficit as of December 31, 2022, and the Company currently has net working capital deficit, continued net losses and negative cash flows from operations. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regards to these matters are also described in Note 3. These consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.
F-2
Critical Audit Matters
The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Impairment of goodwill - Mingde Reporting Unit — Refer to Notes 2, and 5 to the financial statements
Critical Audit Matter Description
Goodwill represents the excess of the cost of an acquisition over the fair value of the identifiable assets acquired less liabilities assumed of an acquired business. The Group’s goodwill at December 31, 2021 arose from its business acquisition of REIT Mingde and its subsidiaries. Goodwill acquired in a business combination is not amortized, but instead tested for impairment at least annually, or more frequently if certain circumstances indicate a possible impairment may exist. In accordance with ASC 350-20, Intangibles-Goodwill and Other, Goodwill, (“ASC 350-20”) the Group has assigned and assessed goodwill for impairment at the reporting unit level. A reporting unit is an operating segment or one level below the operating segment. The Group has determined that it has one reporting unit, which is also its only reportable segment. For the year ended December 31, 2022, due to the slow development of REIT Mingde and its subsidiaries, the Company performed the two-step test for the REIT Mingde and its subsidiaries. In accordance with ASC 350-20, the Company recorded an impairment loss of $1,018,870 for the year ended December 31, 2022.
We identified goodwill impairment as a critical audit matter because the determination of the estimated future cash flows requires significant management judgment, specifically forecasting future sales, gross profits and general expenses. Changes in these estimates could have a significant impact on whether goodwill should be further evaluated for impairment and could have a significant impact on the measurement of the resulting impairment charge. This required a high degree of auditor judgment and an increased extent of effort when performing audit procedures to evaluate the reasonableness of the Company’s judgments used in these estimates.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to management’s judgments regarding the estimated future cash flows, specifically projection of future sales, gross margin and general expense growth assumptions included the following, among others:
| (1) | We evaluated management’s ability to accurately estimate future cash flows by comparing actual results to management’s historical forecasts and internal communications regarding the Company’s business plan and strategy. |
| (2) | We evaluated the reasonableness of management’s estimated future cash flows by comparing the projections to historical operating results, performed independent analysis, and exercised professional judgment during our evaluation process. |
/s/
We have served as the Company’s auditor since 2021.
PCAOB ID
May 01, 2023
F-3
RETO ECO-SOLUTIONS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
| December 31, | December 31, | |||||||
| 2022 | 2021 | |||||||
| ASSETS | ||||||||
| Current Assets: | ||||||||
| Cash and cash equivalents | $ | $ | ||||||
| Accounts receivable, net | ||||||||
| Accounts receivable, net - related party | ||||||||
| Advances to suppliers, net | ||||||||
| Advances to suppliers, net - related party | ||||||||
| Inventories, net | ||||||||
| Prepayments and other current assets | ||||||||
| Due from related parties | ||||||||
| Receivable from disposition - current | ||||||||
| Total Current Assets | ||||||||
| Property, plant and equipment, net | ||||||||
| Intangible assets, net | ||||||||
| Long-term investment in equity investee | ||||||||
| Right-of-use assets | ||||||||
| Goodwill | ||||||||
| Total Assets | $ | $ | ||||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
| Current Liabilities: | ||||||||
| Short-term loans | $ | |||||||
| Convertible debt | ||||||||
| Advances from customers | ||||||||
| Due to a minority shareholder | ||||||||
| Deferred grants - current | ||||||||
| Accounts payable | ||||||||
| Accounts payable - related party | ||||||||
| Accrued and other liabilities | ||||||||
| Loans from third parties | ||||||||
| Taxes payable | ||||||||
| Due to related parties | ||||||||
| Operating lease liabilities, current | ||||||||
| Deferred tax liability | ||||||||
| Total Current Liabilities | ||||||||
| Loans from third parties-noncurrent | ||||||||
| Operating lease liabilities - noncurrent | ||||||||
| Total Liabilities | ||||||||
| Commitments and Contingencies | ||||||||
| Shareholders’ Equity: | ||||||||
| Common Share, $ | ||||||||
| Additional paid-in capital | ||||||||
| Statutory reserve | ||||||||
| Accumulated deficit | ( | ) | ( | ) | ||||
| Accumulated other comprehensive loss | ( | ) | ( | ) | ||||
| Total Shareholders’ Equity Attributable to ReTo Eco-Solutions Inc. | ||||||||
| Noncontrolling interest | ||||||||
| Total Shareholders’ Equity | ||||||||
| Total Liabilities and Shareholders’ Equity | $ | |||||||
The accompanying notes are an integral part of these consolidated financial statements.
F-4
RETO ECO-SOLUTIONS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
For the Years Ended December 31, | ||||||||||||
| 2022 | 2021 | 2020 | ||||||||||
| Revenues | $ | $ | $ | |||||||||
| Revenues – related parties | ||||||||||||
| Total Revenues | ||||||||||||
| Cost of revenues | ||||||||||||
| Cost of revenues – related parties | ||||||||||||
| Total cost of revenues | ||||||||||||
| Gross Profit | ||||||||||||
| Operating Expenses: | ||||||||||||
| Selling expenses | ||||||||||||
| General and administrative expenses | ||||||||||||
| Bad debt expenses | ||||||||||||
| Impairment of long-lived assets | ||||||||||||
| Impairment of goodwill | ||||||||||||
| Research and development expenses | ||||||||||||
| Total Operating Expenses | ||||||||||||
| Loss from Operations | ( | ) | ( | ) | ( | ) | ||||||
| Other Income (Expenses): | ||||||||||||
| Interest expense | ( | ) | ( | ) | ( | ) | ||||||
| Interest income | ( | ) | ||||||||||
| Other income (expenses), net | ( | ) | ||||||||||
| Loss from disposal of REIT Changjiang | ( | ) | ||||||||||
| Gain from dissolution of subsidiaries | ||||||||||||
| Gain from disposal of Gu’an REIT | ||||||||||||
| Share of losses in equity method investments | ( | ) | ( | ) | ||||||||
| Change in fair value convertible debt | ( | ) | ( | ) | ||||||||
| Total Other Income (Expenses), net | ( | ) | ( | ) | ||||||||
| Loss before provision for income taxes | ( | ) | ( | ) | ( | ) | ||||||
| Income taxes provision (benefit) | ( | ) | ||||||||||
| Net loss from continuing operations | ( | ) | ( | ) | ( | ) | ||||||
| Net loss from discontinued operations, net of taxes | ( | ) | ( | ) | ||||||||
| Net Loss | ( | ) | ( | ) | ( | ) | ||||||
| Less: net loss attributable to noncontrolling interest | ( | ) | ( | ) | ( | ) | ||||||
| Net loss attributable to ReTo Eco-Solutions, Inc. | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
| Comprehensive Loss: | ||||||||||||
| Net Loss | $ | ( | ) | ( | ) | ( | ) | |||||
| Other Comprehensive income (loss): | ||||||||||||
| Foreign currency translation adjustments | ( | ) | ||||||||||
| Comprehensive Loss | ( | ) | ( | ) | ( | ) | ||||||
| Less: comprehensive loss attributable to noncontrolling interest | ( | ) | ( | ) | ( | ) | ||||||
| Comprehensive loss attributable to ReTo Eco-Solutions, Inc. | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
| Net loss attributable to ReTo Eco-Solutions, Inc. | ||||||||||||
| Continuing operations | ( | ) | ( | ) | ( | ) | ||||||
| Discontinued operations | ( | ) | ( | ) | ||||||||
| Total | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
| Basic and Diluted Loss Per Share Attributable to ReTo Eco-Solutions, Inc. | ||||||||||||
| Continuing operations | ( | ) | ( | ) | ( | ) | ||||||
| Discontinued operations | ( | ) | ( | ) | ||||||||
| Total | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
| Weighted average number of shares | ||||||||||||
The accompanying notes are an integral part of these consolidated financial statements
F-5
RETO ECO-SOLUTIONS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2022, 2021 AND 2020
| Additional | Retained Earnings | Accumulated Other | |||||||||||||||||||||||||||||||
| Common Shares | Paid-in | Statutory | (Accumulated | Comprehensive | Noncontrolling | Total | |||||||||||||||||||||||||||
| Shares | Amount | Capital | Reserve | Deficit) | Income (Loss) | Interest | Equity | ||||||||||||||||||||||||||
| Balance at December 31, 2019 | $ | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | $ | |||||||||||||||||||||
| Net loss | - | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||||
| Issuance of common shares for services | |||||||||||||||||||||||||||||||||
| Issuance of common shares for services | |||||||||||||||||||||||||||||||||
| Change in statutory reserve related to disposal of Gu’an REIT | - | ( | ) | ||||||||||||||||||||||||||||||
| Appropriation to statutory reserve | - | ( | ) | ||||||||||||||||||||||||||||||
| Foreign currency translation adjustments | - | ( | ) | ||||||||||||||||||||||||||||||
| Balance at December 31, 2020 | $ | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | $ | |||||||||||||||||||||
| Net loss | ( | ) | ( | ) | ( | ) | |||||||||||||||||||||||||||
| Common shares issued for conversion of debt | |||||||||||||||||||||||||||||||||
| Issuance of common shares for services | |||||||||||||||||||||||||||||||||
| Appropriation to statutory reserve | - | ( | ) | ||||||||||||||||||||||||||||||
| Change in capital related to disposal of REIT Changjiang | - | ( | ) | ||||||||||||||||||||||||||||||
| Change statutory related to disposal of REIT Changjiang | - | ( | ) | ||||||||||||||||||||||||||||||
| Change in non-controlling interest related to acquisition subsidiaries of REIT Mingde | - | ||||||||||||||||||||||||||||||||
| Share to be issued | - | ||||||||||||||||||||||||||||||||
| Foreign currency translation adjustments | - | ||||||||||||||||||||||||||||||||
| Balance at December 31, 2021 | $ | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | $ | |||||||||||||||||||||
| Net loss | - | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||||
| Conversion of convertible debt | |||||||||||||||||||||||||||||||||
| Issuance of common shares for acquisition of REIT Mingde | ( | ) | |||||||||||||||||||||||||||||||
| Issuance of common shares in private placements | |||||||||||||||||||||||||||||||||
| Issuance of common shares for services | |||||||||||||||||||||||||||||||||
| Share-based compensation | |||||||||||||||||||||||||||||||||
| Appropriation to statutory reserve | - | ( | ) | ||||||||||||||||||||||||||||||
| Shareholders’ contribution | - | ||||||||||||||||||||||||||||||||
| Purchase of | - | ( | ) | ( | ) | ||||||||||||||||||||||||||||
| Change in equity related to dissolution of Dingxuan and REIT Xong’an | - | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||||
| Foreign currency translation adjustment | - | ( | ) | ( | ) | ||||||||||||||||||||||||||||
| Balance at December 31, 2022 | $ | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | $ | |||||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
F-6
RETO ECO-SOLUTIONS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, | ||||||||||||
| 2022 | 2021 | 2020 | ||||||||||
| CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||||||
| Net loss | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
| Less: net loss from discontinued operations | - | |||||||||||
| Net loss from continuing operations | ( | ) | ( | ) | ( | ) | ||||||
| Adjustments to reconcile net loss to net cash provided by (used in) operating activities: | ||||||||||||
| Loss from disposal of property and equipment | - | |||||||||||
| Deferred tax provision (benefit) | ( | ) | - | |||||||||
| Depreciation and amortization | ||||||||||||
| Change in fair value in convertible debt | ||||||||||||
| Convertible debt issuance cost | - | - | ||||||||||
| Accrued interest for convertible debt | ||||||||||||
| Impairment of long-lived assets | - | |||||||||||
| Stock-based compensation | ||||||||||||
| Change in bad debt allowances | ||||||||||||
| Change in inventory reserve | ( | ) | ||||||||||
| Impairment of good will | - | - | ||||||||||
| (Gain) loss from disposal of subsidiary | - | ( | ) | |||||||||
| Gain from dissolution of a subsidiary | ( | ) | ||||||||||
| Shares of losses in equity method investments | ||||||||||||
| Amortization of operating lease right-of-use assets | ||||||||||||
| Changes in operating assets: | ||||||||||||
| Accounts receivable | ( | ) | ||||||||||
| Accounts receivable - related party | ||||||||||||
| Advances to suppliers | ||||||||||||
| Advances to suppliers - related party | ( | ) | ( | ) | ||||||||
| Inventories | ( | ) | ||||||||||
| Prepayments and other current assets | ( | ) | ( | ) | ( | ) | ||||||
| Changes in operating liabilities: | ||||||||||||
| Advances from customers | ( | ) | ||||||||||
| Advances from customers - related party | - | ( | ) | |||||||||
| Deferred revenue | ( | ) | ( | ) | ||||||||
| Deferred grants | ( | ) | ||||||||||
| Accounts payable | ( | ) | ||||||||||
| Accounts payable - related party | ( | ) | ( | ) | ( | ) | ||||||
| Accrued and other liabilities | ( | ) | ) | |||||||||
| Taxes payable | ( | ) | ||||||||||
| Operating lease liability | ( | ) | ( | ) | ( | ) | ||||||
| Net cash (used in) provided by operating activities from continuing operations | ( | ) | ( | ) | ||||||||
| Net cash provided by (used in) operating activities from discontinued operations | - | ( | ) | |||||||||
| Net cash provided by (used in) operating activities | ( | ) | ( | ) | ||||||||
| CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||||||
| Proceeds from disposal of subsidiaries | ||||||||||||
| Addition of property and equipment | ( | ) | ( | ) | ( | ) | ||||||
| Addition of intangible assets | ( | ) | - | - | ||||||||
| Investment in equity method investment | - | ( | ) | |||||||||
| Prepayment on CIP | - | ( | ) | - | ||||||||
| Net cash from acquisition of REIT Mingde | - | |||||||||||
| Net cash provided by investing activities from continuing operations | ||||||||||||
| Net cash used in investing activities from discontinued operations | - | ( | ) | ( | ) | |||||||
| Net cash provided by (used in) investing activities | ( | ) | ||||||||||
| CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||||||
| Proceeds from short-term bank loans | ||||||||||||
| Repayment of short-term bank loans | ( | ) | ( | ) | ( | ) | ||||||
| Repayment of long-term bank loans | - | ( | ) | ( | ) | |||||||
| Proceeds received from share issuance | - | - | ||||||||||
| Proceeds from third-party loans | ||||||||||||
| Repayment of third-party loans | ( | ) | - | - | ||||||||
| Shareholder contribution | - | - | ||||||||||
| Proceeds from issuance of convertible debt | ||||||||||||
| Payments to non-controlling shareholders | ( | ) | - | - | ||||||||
| Proceeds from related party loans | ||||||||||||
| Repayment of related party loans | ( | ) | ( | ) | ( | ) | ||||||
| Net cash provided by (used in) financing activities from continuing operations | ( | ) | ( | ) | ||||||||
| Net cash provided by financing activities from discontinued operations | - | |||||||||||
| Net cash provided by (used in) financing activities | ( | ) | ||||||||||
| EFFECT OF EXCHANGE RATE CHANGES ON CASH | ( | ) | ||||||||||
| NET INCREASE (DECREASE) IN CASH | ( | ) | ( | ) | ||||||||
| CASH, BEGINNING OF YEAR | ||||||||||||
| CASH, END OF YEAR | $ | $ | $ | |||||||||
| Less: cash and cash equivalents, restricted cash of discontinued operations at end of period | - | |||||||||||
| Cash and cash equivalents, restricted cash of continued operation, at end of period | $ | $ | $ | |||||||||
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: | ||||||||||||
| Interest paid | $ | $ | $ | |||||||||
| Income tax paid | $ | - | $ | $ | - | |||||||
| Non-Cash Investing Activities | ||||||||||||
| Right-of-use assets obtained in exchange for operating lease obligations | $ | $ | $ | |||||||||
| Right-of-use assets offset with operating lease obligations due to lease cancellation | $ | $ | $ | |||||||||
| Purchase of | $ | $ | $ | |||||||||
| Addition to account receivable from disposal of REIT Changjiang | $ | $ | $ | |||||||||
| Common shares issued for conversion of debt | $ | $ | $ | |||||||||
| Withdrawal of capital by original minority shareholder in Xinyi REIT | $ | $ | $ | |||||||||
| Share to be issued for acquisition of REIT Mingde | $ | - | $ | $ | ||||||||
The accompanying notes are an integral part of these consolidated financial statements.
F-7
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – ORGANIZATION AND DESCRIPTION OF BUSINESS
ReTo Eco-Solutions, Inc. (“ReTo”) is a business company established under the laws of the British Virgin Islands on August 7, 2015 as a holding company to develop business opportunities in the People’s Republic of China (the “PRC” or “China”). ReTo and its subsidiaries are collectively referred to as the Company. ReTo, through its subsidiaries, is engaged in (i) manufacture and distribution of eco-friendly construction materials and equipment used for the production of these eco-friendly construction materials and related consultation and technological services; (ii) consultation, design, project implementation and construction of urban ecological protection projects; (iii) roadside assistance services; and (iv) software development services.
As of December 31, 2022, the accompanying consolidated financial statements of the Company reflected the principal activities of the entities listed below. All inter-company balances and transactions have been eliminated upon consolidation.
| Name of the Entity | Place of Incorporation | Ownership Percentage | ||||
| ReTo Eco-Solutions, Inc. | ||||||
| REIT Holdings (China) Limited (“REIT Holdings”) | ||||||
| Beijing REIT Technology Development Co., Ltd. (“Beijing REIT”) | ||||||
| Beijing REIT Ecological Engineering Technology Co., Ltd. (“Beijing REIT Ecological”) | ||||||
| Hainan REIT Construction Engineering Co., Ltd. (“REIT Construction”)** | ||||||
| REIT New Materials Xinyi Co., Ltd. (“Xinyi REIT”) | ||||||
| Nanjing Dingxuan Environmental Protection Technology Development Co., Ltd. (“Dingxuan”)** | % | |||||
| REIT Q GREEN Machines Private Ltd (“REIT India”) | ||||||
| REIT Ecological Technology Co., Ltd. (“REIT Ordos”)* | ||||||
| Datong Ruisheng Environmental Engineering Co., Ltd. (“Datong Ruisheng”) | ||||||
| Guangling REIT Ecological Cultural Tourism Co., Ltd. | ||||||
| REIT (Xiong’an, Hebei) Eco Technology Co., Ltd. (“REIT Xiong’an”)** | % | |||||
| REIT Technology Development Co., Ltd (“REIT Technology”) | ||||||
| Hainan REIT Mingde Investment Holding Co., Ltd (“REIT Mingde”) | ||||||
| Yangpu Fangyuyuan United Logistics Co., Ltd. (“Fangyuyuan”) | ||||||
| Hainan Kunneng Direct Supply Chain Management Co., Ltd. | ||||||
| Hainan Yile IoT Technology Co., Ltd (“Hainan Yile IoT”) | ||||||
| Hainan Yile IoV Technology Research Institute Co., Ltd, (“IoV Technology Research”) | ||||||
| Ruishi Tongda Ecological Management Co., Ltd.** | ||||||
| Honghe Ruitu Ecological Technology Co., Ltd. | ||||||
| Hainan Coconut Network Freight Co., Ltd. | ||||||
| * | |
| ** |
F-8
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates are based on information as of the date of the consolidated financial statements.
Significant estimates required to be made by management include, but are not limited to, the valuation of accounts receivable, inventories, advances to suppliers, useful lives of property, plant and equipment, intangible assets, the recoverability of long-lived assets, provision necessary for contingent liabilities, revenue recognition under the input method, and realization of deferred tax assets. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents represent cash on hand
and cash deposited in major third-party payment processing platform such as Alipay. In addition, highly liquid investments which have
original maturities of three months or less when purchased are classified as cash equivalents. The Company maintains most of the bank
accounts in the PRC. On May 1, 2015, the PRC’s new Deposit Insurance Regulation came into effect, pursuant to which banking financial
institutions, such as commercial banks, established in the PRC are required to purchase deposit insurance for deposits in RMB and in foreign
currency placed with them. Such Deposit Insurance Regulation would not be effective in providing complete protection for the Company’s
accounts, as its aggregate deposits are much higher than the compensation limit, which is RMB
Accounts Receivable, net
Accounts receivable are recognized and carried
at original invoiced amount less an estimated allowance for uncollectible accounts. The Company usually grants credit to customers with
good credit standing with a maximum of 180 days and determines the adequacy of reserves for doubtful accounts based on individual account
analysis and historical collection trends. The Company establishes a provision for doubtful receivables when there is objective evidence
that the Company may not be able to collect amounts due. The allowance is based on management’s best estimates of specific losses
on individual exposures, as well as a provision on historical trends of collections. Based on the assessment of customers’ credit
and ongoing relationships, the Company’s payment terms typically range from 90 days to 1 year. The provision is recorded against
accounts receivables balances, with a corresponding charge recorded in the consolidated statements of income and comprehensive income.
Actual amounts received may differ from management’s estimate of credit worthiness and the economic environment. Delinquent account
balances are written-off against the allowance for doubtful accounts after management has determined that the likelihood of collection
is not probable. As affected by the ongoing COVID-19 pandemic, the Company’s accounts receivable collection was negatively affected.
Based on subsequent collection analysis, the Company accrued increased bad debt reserve for the outstanding accounts receivable as of
December 31, 2022. As a result, allowance for uncollectible balances amounted to $
Inventories
Inventories are stated at the lower of cost or net realizable value. Costs include the cost of raw materials, freight, direct labor and related production overhead. The cost of inventories is calculated using the weighted average method. Any excess of the cost over the net realizable value of each item of inventories is recognized as a provision for diminution in the value of inventories.
Net realizable value is the estimated selling
price in the normal course of business less any costs to complete and sell products. The Company evaluates inventories on a quarterly
basis for its net realizable value adjustments, and reduces the carrying value of those inventories that are obsolete or in excess of
the forecasted usage to their estimated net realizable value based on various factors including aging and future demand of each type of
inventories. The Company recorded an inventory reserve of $
Advances to Suppliers, net
Advances to suppliers consist of balances paid
to suppliers for services and materials that have not been provided or received. Advances to suppliers for service and material are short-term
in nature. Advances to Suppliers are reviewed periodically to determine whether their carrying value has become impaired. The Company
considers the assets to be impaired if the collectability of the advance becomes doubtful. The Company uses the aging method to estimate
the allowance for uncollectible balances. In addition, at each reporting date, the Company generally determines the adequacy of allowance
for doubtful accounts by evaluating all available information, and then records specific allowances for those advances based on the specific
facts and circumstances. Allowance for uncollectible balances from the continuing operations amounted to $
F-9
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Property, Plant and Equipment
Property and equipment are stated at cost. The straight-line depreciation method is used to compute depreciation over the estimated useful lives of the assets, as follows:
| Useful life | ||
| Property and buildings | ||
| Machinery equipment | ||
| Transportation vehicles | ||
| Office and electronic equipment |
Expenditures for maintenance and repairs, which do not materially extend the useful lives of the assets, are charged to expense as incurred. Expenditures for major renewals and betterments which substantially extend the useful life of assets are capitalized. The cost and related accumulated depreciation of assets retired or sold are removed from the respective accounts, and any gain or loss is recognized in the consolidated statements of income and other comprehensive income in other income or expenses.
Construction-in-Progress (“CIP”)
Construction-in-progress represents property and buildings under construction and consists of construction expenditures, equipment procurement, and other direct costs attributable to the construction. Construction-in-progress is not depreciated. Upon completion and ready for intended use, construction-in-progress is reclassified to the appropriate category within property, plant and equipment.
Intangible Assets
Intangible assets consist primarily of land use rights and software. Under the PRC law, all land in the PRC is owned by the government and cannot be sold to an individual or company. The government grants individuals and companies the right to use parcels of land for specified periods of time. These land use rights are sometimes referred to informally as “ownership”. Land use rights are stated at cost less accumulated amortization. Intangible assets are amortized using the straight-line method with the following estimated useful lives:
| Items | Useful life | |
| Land use rights | ||
| Software |
Goodwill
Goodwill represents the excess of the cost of an acquisition over the fair value of the identifiable assets acquired less liabilities assumed of an acquired business. The Group’s goodwill at December 31, 2021 arose from its business acquisition of REIT Mingde and its subsidiaries. Goodwill acquired in a business combination is not amortized, but instead tested for impairment at least annually, or more frequently if certain circumstances indicate a possible impairment may exist.
In accordance with ASC 350-20, Intangibles-Goodwill and Other, Goodwill, (“ASC 350-20”) the Group has assigned and assessed goodwill for impairment at the reporting unit level. A reporting unit is an operating segment or one level below the operating segment. The Group has determined that it has one reporting unit, which is also its only reportable segment. The Group has the option to first assess qualitative factors to determine whether it is necessary to perform the two-step test in accordance with ASC 350-20. If the Group believes, as a result of the qualitative assessment, that it is more-likely-than-not that the fair value of the reporting unit is less than its carrying amount, the two-step quantitative impairment test described below is required. Otherwise, no further testing is required. In the qualitative assessment, the Group considers primary factors such as industry and market considerations, overall financial performance of the reporting unit, and other specific information related to the operations. In performing the two-step quantitative impairment test, the first step compares the carrying amount of the reporting unit to the fair value of the reporting unit based on either quoted market prices of the ordinary shares or estimated fair value using a combination of the income approach and the market approach. If the fair value of the reporting unit exceeds the carrying value of the reporting unit, goodwill is not impaired, and the Group is not required to perform further testing. If the carrying value of the reporting unit exceeds the fair value of the reporting unit, then the Group must perform the second step of the impairment test in order to determine the implied fair value of the reporting unit’s goodwill. The fair value of the reporting unit is allocated to its assets and liabilities in a manner similar to a purchase price allocation in order to determine the implied fair value of the reporting unit goodwill. If the carrying amount of the goodwill is greater than its implied fair value, the excess is recognized as an impairment loss.
For the year ended December 31, 2022, due to the
slow development of REIT Mingde and its subsidiaries, the Group performed the two-step test for the reporting unit. In accordance with
ASC 350-20, the Group recorded an impairment loss of $
F-10
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Impairment of Long-lived Assets
The Company reviews long-lived assets, including
definitive-lived intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. If the estimated cash flows from the use of the asset and its eventual disposition are below the asset’s
carrying value, then the asset is deemed to be impaired and written down to its fair value. Given the Company’s net loss position
in fiscal 2022, 2021 and 2020, the Company further assessed that the expected future cash flow generated from its machinery, equipment,
and other long-lived assets would not recover their carrying value and as a result, the Company recorded an impairment of approximately
$, $
Long-term investment in Equity Investee
The Company’s long-term investments include equity method investments and equity investments without readily determinable fair values.
Investments in entities in which the Company can exercise significant influence but does not own a majority equity interest or control are accounted for using the equity method of accounting in accordance with ASC 323, Investments-Equity Method and Joint Ventures (“ASC 323”). Under the equity method, the Company initially records its investment at cost and the difference between the cost of the equity investee and the amount of the underlying equity in the net assets of the equity investee is accounted for as if the investee were a consolidated subsidiary. The share of earnings or losses of the investee are recognized in the consolidated statements of comprehensive loss. Equity method adjustments include the Company’s proportionate share of investee income or loss, adjustments to recognize certain differences between the Company’s carrying value and its equity in net assets of the investee at the date of investment, impairments, and other adjustments required by the equity method. The Company assesses its equity investment for other-than-temporary impairment by considering factors as well as all relevant and available information including, but not limited to, current economic and market conditions, the operating performance of the investees including current earnings trends, the general market conditions in the investee’s industry or geographic area, factors related to the investee’s ability to remain in business, such as the investee’s liquidity, debt ratios, and cash burn rate and other company-specific information.
Investments in equity securities without readily determinable fair values are measured at cost minus impairment adjusted by observable price changes in orderly transactions for the identical or a similar investment of the same issuer. These investments are measured at fair value on a nonrecurring basis when there are events or changes in circumstances that may have a significant adverse effect. An impairment loss is recognized in the consolidated statements of comprehensive loss equal to the amount by which the carrying value exceeds the fair value of the investment. Prior to the adoption of ASU 2016-01 on January 1, 2019, these investments were accounted for using the cost method of accounting, measured at cost less other-than-temporary impairment.
As of December 31, 2022 and December 31, 2021,
the Company’s long-term investment in equity investee balance represents its $
The Company continually reviews its investments in equity investees to determine whether a decline in fair value below the carrying value is other-than-temporary. The primary factors the Company considers in its determination include the financial condition, operating performance and the prospects of the equity investee; other company specific information such as recent financing rounds; the geographic region, market and industry in which the equity investee operates; and the length of time that the fair value of the investment is below its carrying value. If the decline in fair value is deemed to be other-than-temporary, the carrying value of the equity investee is written down to fair value. As of December 31, 2022 and December 31, 2021, the Company did not recognize any impairment on its equity investment.
F-11
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Leases
The Company adopted ASU No. 2016-02—Leases (Topic 842) on January 1, 2019 using the modified retrospective transition method permitted under ASU No. 2018-11. This transition approach provides a method for recording existing leases only at the date of adoption and does not require previously reported balances to be adjusted. In addition, we elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allowed us to carry forward the historical lease classification. The standard did not materially impact our consolidated net earnings and cash flows.
Fair Value of Financial Instruments
ASC 825-10 requires certain disclosures regarding the fair value of financial instruments. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A three-level fair value hierarchy prioritizes the inputs used to measure fair value. The hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:
| ● | Level 1 - Quoted prices in active markets for identical assets and liabilities. |
| ● | Level 2 - Quoted prices in active markets for similar assets and liabilities, or other inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. |
| ● | Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets and liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs. |
The Company considers the recorded value of its financial assets and liabilities, which consist primarily of cash and cash equivalents, accounts receivable, advance to suppliers, accounts payable, accrued and other liabilities, advances from customers, deferred revenue, taxes payable and due to related parties to approximate the fair value of the respective assets and liabilities at December31, 2022 and 2021, based upon the short-term nature of the assets and liabilities.
The Company believes that the carrying amount of the short-term and long-term borrowings approximates fair value at December31, 2022 and 2021 based on the terms of the borrowings and current market rates as the rates of the borrowings are reflective of the current market rates.
The Company elected the fair value option to account
for its convertible loans. The Company engaged an independent valuation firm to perform the valuation. The fair value of the convertible
loans included in short term debts as of December 31, 2022 was $
As the inputs used in developing the fair value for level 3 instruments are unobservable, and require significant management estimate, a change in these inputs could result in a significant change in the fair value measurement.
The following is a reconciliation of the beginning and ending balances for convertible loans measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as of December 31, 2022:
December 31, 2022 | ||||
| Opening balance | $ | |||
| New convertible loans issued | ||||
| Accrued interest | ||||
| Loss on change in fair value of convertible loan | ||||
| Conversion of convertible loans | ( | ) | ||
| Total | $ | |||
F-12
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Revenue Recognition
The Company adopted ASC Topic 606 Revenue from Contracts with Customers (“ASC 606”) on January 1, 2018 using the modified retrospective approach. Under ASC 606, revenue is recognized when control of promised goods or services is transferred to the Company’s customers in an amount of consideration to which an entity expects to be entitled to in exchange for those goods or services.
To determine revenue recognition for contracts with customers, the Company performs the following five steps: (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, including variable consideration to the extent that it is probable that a significant future reversal will not occur, (iv) allocate the transaction price to the respective performance obligations in the contract, and (v) recognize revenue when (or as) the Company satisfies the performance obligation.
The Company’s revenues are primarily derived from the following sources:
| ● | Revenue from machinery and equipment sales |
The Company recognizes revenue when the machinery and equipment is delivered and control is transferred. The Company generally provide a warranty for a period of 12 months after the customers receive the equipment. The Company determines that such product warranty is not a separated performance obligation because the nature of warranty is to provide assurance that a product will function as expected and in accordance with customer’s specification and the Company has not sold the warranty separately. From its past experience, the Company has not experienced any material warranty costs and, therefore, the Company does not believe an accrual for warranty cost is necessary for the years ended December 31, 2022, 2021 and 2020.
| ● | Revenue from construction materials sales |
The Company recognizes revenue, net of sales taxes and estimated sales returns, when the construction materials are shipped to, delivered to or picked up by customers and control is transferred.
| ● | Revenue from municipal construction projects |
The Company provides municipal construction services, also known as sponge city projects. The Company recognizes revenue associated with these contracts over time as service is performed and the transfer of control occurs, based on a percentage-of-completion method using cost-to-cost input methods as a measure of progress. When the percentage-of-completion method is used, the Company estimates the costs to complete individual contracts and records as revenue that portion of the total contract price that is considered complete based on the relationship of costs incurred to date to total anticipated costs (the cost-to-cost approach).
F-13
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Revenue Recognition (continued)
Under the cost-to-cost approach, the use of estimated costs to complete each contract is a significant variable in the process of determining recognized revenue, requires judgment and can change throughout the duration of a contract due to contract modifications and other factors impacting job completion. The costs of earned revenue include all direct material and labor costs and those indirect costs related to contract performance, such as indirect labor, supplies, tools and repairs. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined.
| ● | Revenue from technological consulting and other services |
The Company recognizes revenue when technological consulting and other services are rendered and accepted by the customers.
Contract assets and liabilities
Payment terms are established on the Company’s pre-established credit requirements based upon an evaluation of customers’ credit quality. Contact assets are recognized for in related accounts receivable. Contract liabilities are recognized for contracts where payment has been received in advance of delivery. The contract liability balance can vary significantly depending on the timing of when an order is placed and when shipment or delivery occurs.
As of December 31, 2022 and 2021, other than accounts receivable and advances from customers, the Company had no other material contract assets, contract liabilities or deferred contract costs recorded on its consolidated balance sheet. Costs of fulfilling customers’ purchase orders, such as shipping, handling and delivery, which occur prior to the transfer of control, are recognized in selling, general and administrative expense when incurred.
Disaggregation of Revenues
The Company disaggregates its revenue from contracts by products and services, as we believe it best depicts how the nature, amount, timing and uncertainty of the revenue and cash flows are affected by economic factors. The Company’s disaggregation of revenues for the years ended December 31, 2022, 2021 and 2020 is disclosed in Note 21.
Shipping and Handling
Shipping and handling costs are expensed as incurred
and are included in operating expenses, as a part of selling, and general and administrative expenses, in the Company’s consolidated
statements of income and comprehensive income. Shipping and handling costs associated with the Company’s continuing operations were
$
Government grants
Government grants represent cash subsidies received
from PRC government or related institutions. Cash subsidies which have no defined rules and regulations to govern the criteria necessary
for companies to enjoy the benefits are recognized as other income, net when received. Specific subsidies that local government has provided
for a specific purpose, such as research and development are recorded as other non-current liabilities when received and recognized as
other income or reduction of related expense when the specific performance is meet. As of December 31, 2020, the Company received related
grants of $
F-14
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Stock-based compensation
The Company accounts for share-based compensation in accordance with ASC 718, Compensation — Stock Compensation (“ASC 718”). In accordance with ASC 718, the Group determines whether an award should be classified and accounted for as a liability award or an equity award. All the Company’s share-based awards were classified as equity awards and are recognized in the consolidated financial statements based on their grant date fair values.
The Company has elected to recognize share-based compensation using the straight-line method for all share-based awards granted with graded vesting based on service conditions. The Company uses the accelerated method for all awards granted with graded vesting. The Company accounts for forfeitures as they occur in accordance with ASU No. 2016-09, Compensation — Stock Compensation (Topic 718): Improvement to Employee Share-based Payment Accounting. The Company, with the assistance of an independent third-party valuation firm, determined the fair value of the stock options granted to employees. The binomial option pricing model and Black-Scholes Model were applied in determining the estimated fair value of the options granted to employees and non-employees.
Income Taxes
The Company accounts for income taxes under ASC 740. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period including the enactment date. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.
The provisions of ASC 740-10-25, “Accounting for Uncertainty in Income Taxes,” prescribe a more-likely-than-not threshold for consolidated financial statement recognition and measurement of a tax position taken (or expected to be taken) in a tax return. This interpretation also provides guidance on the recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and related disclosures. The Company records a liability for uncertain tax positions when it is probable that a loss has been incurred and the amount can be reasonably estimated.
To the extent applicable, the Company records interest and penalties as a general and administrative expense. The Company’s subsidiaries in China and Hong Kong are subject to the income tax laws of the PRC and Hong Kong. No significant taxable income was generated outside the PRC for the years ended December 31, 2022, 2021 and 2020. As of December 31, 2022, the tax years ended December 31, 2018 through December 31, 2022 for the Company’s PRC subsidiaries remain open for statutory examination by PRC tax authorities.
Value Added Tax (“VAT”)
Sales revenue represents the invoiced value of
goods, net of VAT. The VAT is based on gross sales price and VAT rates range up to
Earnings (Loss) per Share
The Company computes earnings (loss) per share (“EPS”) in accordance with ASC 260, “Earnings per Share” (“ASC 260”). ASC 260 requires companies with complex capital structures to present basic and diluted EPS. Basic EPS is measured as net income (loss) divided by the weighted average common shares outstanding for the period. Diluted EPS is similar to basic EPS but presents the dilutive effect on a per share basis of potential common shares (e.g., convertible securities, options and warrants) as if they had been converted at the beginning of the periods presented, or issuance date, if later. Potential common shares that have an anti-dilutive effect (i.e., those that increase income per share or decrease loss per share) are excluded from the calculation of diluted EPS. For the years ended December 31, 2022, 2021 and 2020, the Company had no dilutive security outstanding that could potentially dilute EPS in the future.
F-15
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Foreign Currency Translation
The Company’s principal country of operations is the PRC. The financial position and results of its operations located in PRC are determined using RMB, the local currency, as the functional currency. ReTo, REIT US and REIT Holdings use U.S. Dollars as their functional currency, while REIT India uses Indian rupee as the functional currency. The Company’s financial statements are reported using U.S. Dollars. The results of operations and the consolidated statements of cash flows denominated in foreign currency are translated at the average rate of exchange during the reporting period. Assets and liabilities denominated in foreign currencies at the balance sheet date are translated at the applicable rates of exchange in effect at that date. The equity denominated in the functional currency is translated at the historical rate of exchange at the time of capital contribution. Because cash flows are translated based on the average translation rate, amounts related to assets and liabilities reported on the consolidated statements of cash flows will not necessarily agree with changes in the corresponding balances on the consolidated balance sheets. Translation adjustments arising from the use of different exchange rates from period to period are included as a separate component of accumulated other comprehensive income (loss). Gains and losses from foreign currency transactions are included in the results of operations.
The value of RMB against US$ and other currencies may fluctuate and is affected by, among other things, changes in the PRC’s political and economic conditions. Any significant revaluation of RMB may materially affect the Company’s financial condition in terms of US$ reporting. The following table outlines the currency exchange rates that were used in creating the consolidated financial statements in this report:
|
December 31, 2022 |
December 31, 2021 |
December 31, 2020 | ||||
| Year-end spot rate | US$ |
US$ |
US$ | |||
| Average rate | US$ |
US$ |
US$ |
Risks and Uncertainties
The main operation of the Company is located in the PRC. Accordingly, the Company’s business, financial condition, and results of operations may be influenced by political, economic, and legal environments in the PRC, as well as by the general state of the PRC economy. The Company’s results may be adversely affected by changes in the political, regulatory and social conditions in the PRC. Although the Company has not experienced losses from these situations and believes that it is in compliance with existing laws and regulations including its organization and structure disclosed in Note 1, this may not be indicative of future results.
The coronavirus disease 2019 (“COVID-19”) pandemic has, and continues to have, a severe and negative impact on the PRC and the global economy. The Company’s business has been negatively impacted by the COVID-19 pandemic.
From late January 2020 through March 2020, the Company had to temporarily suspend the manufacturing activities due to government restrictions. During the temporary business closure period, employees had very limited access to its manufacturing facilities and the shipping companies were not available and as a result, the Company experienced difficulty delivering the products to customers on a timely basis. In addition, due to the COVID-19 outbreak, some of the Company’s customers or suppliers experienced financial distress, delayed or defaulted on their payments, reduced the scale of their business, or suffered disruptions in their business due to the outbreak. Any increased difficulty in collecting accounts receivable, delayed raw materials supply, bankruptcy of small and medium businesses, or early termination of agreements due to deterioration in economic conditions could negatively impact its results of operations. The Company’s production and sales activities from its continuing operations returned to normal after the spread of COVID-19 had been substantially controlled in China in late 2020. However, since 2021, there has been a resurgence of COVID-19 cases caused by new variants such as Delta and Omicron in multiple cities in China, as well as across the world. Restrictions have been re-imposed in certain cities to combat such outbreaks and emerging variants of the virus. The COVID-19 pandemic has had a significant impact on the construction sector, which is sensitive to economic cycles. The nature of the impacts and extent of the ramifications are in large part dependent upon the location of the underlying projects. Direct impacts have ranged from a slowdown of available materials and labor through to suspensions and, in some instances, deferral and suspension of entire projects. COVID-19 had a significant impact on the Company’s financial results for the years ended December 31, 2022 and 2021. On December 7, 2022, China announced 10 new rules that constitute a relaxation of almost all of its stringent COVID-19 pandemic control measures. Shortly after their announcement, additional mobility restrictions issued by local governments were also scrapped. While such measures effectively reopened business within China, COVID-19’s continued existence may have significant and still not well-understood impacts on our industry. The extent of the impact on the Company’s future financial results will be dependent on future developments such as the length and severity of the crisis, the potential resurgence of the crisis, future government actions in response to the crisis and the overall impact of the COVID-19 pandemic on the global economy and capital markets, among many other factors, all of which remain highly uncertain and unpredictable. Given this uncertainty, the Company is currently unable to quantify the expected impact of the COVID-19 pandemic on its future operations, financial condition, liquidity and results of operations if the current situation continues.
F-16
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Reclassifications
In connection with the discontinued operations of a business, certain prior-year amounts have been reclassified for consistency with the current-year presentation. These reclassifications had no effect on the reported results of operations. The assets and liabilities related to the discontinued operations are classified as assets/liabilities held for sale as of December 31, 2022 and 2021, while results of operations related to the discontinued operations, including comparatives, were reported as losses from discontinued operations. Certain prior-year balance sheet accounts have been reclassified to conform to the current-year presentation.
Concentrations and Credit Risk
A majority of the Company’s transactions are denominated in RMB and a significant portion of the Company and its subsidiaries’ assets and liabilities are denominated in RMB. RMB is not freely convertible into foreign currencies. In the PRC, certain foreign exchange transactions are required by law to be transacted only by authorized financial institutions at exchange rates set by the People’s Bank of China (“PBOC”). Remittances in currencies other than RMB by the Company in China must be processed through the PBOC or other China foreign exchange regulatory bodies which require certain supporting documentation in order to affect the remittance.
As of December 31, 2022 and 2021, $
For the year ended December 31, 2022, one customer
accounted for
As of December 31, 2022, three customers
accounted for
For the years ended December 31, 2022, 2021 and
2020, the Company purchased approximately
As of December 31, 2022, two suppliers accounted
for
F-17
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Recent Accounting Pronouncements
The Company considers the applicability and impact of all accounting standards updates (“ASUs”). Management periodically reviews new accounting standards that are issued.
In June 2016, the Financial Accounting Standards Board (the “FASB”) issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326) (“ASU 2016-13”), which requires entities to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. This ASU replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost. ASU 2016-13 was subsequently amended by Accounting Standards Update 2018-19, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Accounting Standards Update 2019-04 Codification Improvements to Topic 326, Financial Instruments — Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, and Accounting Standards Update 2019-05, Targeted Transition Relief. For public entities, ASU 2016-13 and its amendments are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. For all other entities, this guidance and its amendments will be effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Early application will be permitted for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. As an emerging growth company, the Company adopted this guidance effective January 1, 2023. The adoption did not have significant impact on the Company’s consolidated financial statements.
In January 2020, the FASB issued ASU 2020-01, Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) (“ASU 2020-01”), which is intended to clarify the interaction of the accounting for equity securities under Topic 321 and investments accounted for under the equity method of accounting in Topic 323 and the accounting for certain forward contracts and purchased options accounted for under Topic 815. ASU 2020-01 is effective for the Company beginning January 1, 2021. The adoption did not impact the Company’s financial position.
In August 2020, the FASB issued ASU 2020-06, “Debt — Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging — Contracts in Entity’s Own Equity (Subtopic 815-40)”. This ASU reduces the number of accounting models for convertible debt instruments and convertible preferred stock. As well as amend the guidance for the derivatives scope exception for contracts in an entity’s own equity to reduce form-over-substance-based accounting conclusions. In addition, this ASU improves and amends the related EPS guidance. This standard became effective for the Company on January 1, 2022. The ASU did not have a significant impact on the Company’s consolidated financial statements.
In October 2021, the FASB issued ASU No. 2021-08, “‘Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers” (“ASU 2021-08”). This ASU requires entities to apply Topic 606 to recognize and measure contract assets and contract liabilities in a business combination. The amendments improve comparability after the business combination by providing consistent recognition and measurement guidance for revenue contracts with customers acquired in a business combination and revenue contracts with customers not acquired in a business combination. The amendments are effective for the Company beginning after December 15, 2023, and are applied prospectively to business combinations that occur after the effective date. The Company does not expect the adoption of ASU 2021-04 will have a material effect on the consolidated financial statements.
In November 2021, the FASB issued Accounting Standards Update No 2021-10, Government Assistance (Topic 832) — Disclosures by Business Entities about Government Assistance (“ASU 2021-10”). ASU 2021-10 requires additional disclosures regarding the nature of government assistance, the related accounting policy used to account for assistance, the affected line items and applicable amounts within the consolidated financial position and results of operations, and significant terms and conditions related to the assistance. Government assistance within the scope of ASC 832 includes assistance that is administered by domestic, foreign, local, state, national governments, as well as departments, independent agencies and intergovernmental organizations. The updated guidance increases transparency of government assistance including, 1) the type of assistance, 2) the entity’s accounting for assistance, and 3) the effect of assistance on the entity’s financial statements. The new standard is effective for fiscal years beginning after December 15, 2021. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.
Except for the above-mentioned pronouncements, there are no recently issued accounting standards that will have a material impact on the audited consolidated financial position, statements of operations, and cash flows of the Company.
F-18
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 – GOING CONCERN
As reflected in the Company’s consolidated financial statements
for the year ended December 31, 2022, the Company’s revenue increased by approximately $
In addition, the Company had large bank borrowings as of December 31, 2022 and some of the bank loans will mature and need to be repaid within the next 12 months. If the Company cannot renew existing loans or borrow additional loans from banks, the Company’s working capital may be further negatively impacted.
As of December 31, 2022, the Company had cash
of approximately $
Management expects that it would be able to renew all of its existing bank loans upon their maturity based on past experience and the Company’s good credit history. Currently, the Company is working to improve its liquidity and capital source mainly through cash flow from its operations, renewal of bank borrowings, and borrowing from related parties. In order to fully implement its business plan and sustain continued growth, the Company may also seek equity financing from outside investors. At the present time, however, the Company does not have commitments of funds from any potential investors. No assurance can be given that additional financing, if required, would be available on favorable terms or at all.
Based on above reasons, there is a substantial doubt about the Company’s ability to continue as a going concern for the next 12 months from the issuance of the consolidated financial statements.
F-19
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 – DISCONTINUED OPERATION
The Company’s
subsidiary Gu’an REIT was primarily engaged in manufacturing and distribution of machinery and equipment used for environmental-friendly
construction materials production. On January 2, 2020, Beijing REIT signed a share transfer agreement with a third party - Hebei
Huishitong Techonology Inc. (“Huishitong”) to sell
The Company’s subsidiary, REIT Changjiang
was primarily engaged in solid waste processing business. On November 12, 2021, the Company signed a share transfer agreement with Zhixin
Group (Hong Kong) Co., Ltd. and Xiamen Zhixin Building Materials Co., Ltd. (collectively, “Zhixin”) to sell
The discontinued operation represents a strategic shift that has a major effect on the Company’s operations and financial results, which trigger discontinued operations accounting in accordance with ASC 205-20-45. The results of operations related to the discontinued operations for the years ended December 31, 2021 and 2020 were reported as loss from discontinued operations.
The results of discontinued operations of REIT Changjiang for years ended December 31, 2022, 2021 and 2020 are as follows:
| For the Years Ended December 31, | ||||||||||||
| 2022 | 2021 | 2020 | ||||||||||
| Revenue | $ | $ | ||||||||||
| Cost of revenues | ||||||||||||
| Gross loss | ( | ) | ( | ) | ||||||||
| Operating expenses | ||||||||||||
| Loss from discontinued operations | ( | ) | ( | ) | ||||||||
| Other income (expense), net | ( | ) | ||||||||||
| Loss before tax | ( | ) | ( | ) | ||||||||
| Income tax provision | ||||||||||||
| Net loss from discontinued operations | $ | $ | ( | ) | ( | ) | ||||||
F-20
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 – ACQUISITION
On December 27, 2021, the Company entered into
an acquisition agreement to acquire
The acquisition was accounted for as business
combinations in accordance with ASC 805. The purchase price was RMB
| Amount | ||||
| Cash acquired | $ | |||
| Other current assets | ||||
| Total current assets | ||||
| Property and equipment | ||||
| Intangible assets, net | ||||
| Goodwill | ||||
| Total assets | ||||
| Current liabilities | ||||
| Deferred tax liability | ||||
| Total liabilities | ||||
| Non-controlling interest | ||||
| Total consideration | $ | |||
Goodwill is mainly attributable to the excess of the consideration paid over the fair value of the net assets acquired that cannot be recognized separately as identifiable assets, and comprise (a) the assembled work force and (b) the expected but unidentifiable business growth as a result of the synergy resulting from the acquisition. None of the goodwill is expected to be deductible for income tax purposes. For the year ended December 31, 2022, the Company fully impaired the goodwill related to the acquisition of REIT Mingde and its subsidiaries.
F-21
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 – ACCOUNTS RECEIVABLE, NET
Accounts receivable consisted of the following:
December 31, 2022 | December 31, 2021 | |||||||
| Trade accounts receivable from third-part customers | $ | $ | ||||||
| Less: allowances for doubtful accounts | ( | ) | ( | ) | ||||
| Total accounts receivable from third-party customers, net | ||||||||
| Add: accounts receivable, net, related parties | ||||||||
| Accounts receivable, net | $ | $ | ||||||
Due to a change in market conditions as affected by the COVID-19 outbreak
and spread, the Company’s collection efforts did not result in a favorable outcome as compared to prior years. Out of the Company’s
accounts receivable balance from third party customers as of December 31, 2022, approximately $
Allowance for doubtful accounts movement is as follows:
December 31, 2022 | December 31, 2021 | |||||||
| Beginning balance | $ | $ | ||||||
| Bad debt provision | ||||||||
| Write off | ( | ) | ( | ) | ||||
| Reduction due to divestitures | - | ( | ) | |||||
| Foreign exchange translation | ( | ) | ||||||
| Ending balance | $ | $ | ||||||
Below is the aging schedule of accounts receivable as of December 31, 2022 and 2021:
December 31, 2022 | December 31, 2021 | |||||||
| Accounts Receivable Aging: | ||||||||
| Less than 3 months | $ | $ | ||||||
| From 4 to 6 months | ||||||||
| From 7 to 9 months | ||||||||
| From 10 to 12 months | ||||||||
| Over 1 year | ||||||||
| Bad debt reserve | ( | ) | ( | ) | ||||
| Accounts Receivable, net | $ | $ | ||||||
F-22
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 – ADVANCES TO SUPPLIERS, NET
Advances to suppliers include prepayments for raw materials used for production of construction materials for the Company’s construction projects, which consisted of the following:
December 31, 2022 | December 31, 2021 | |||||||
| Raw material prepayments for equipment production | $ | $ | ||||||
| Land reclamation prepayments | ||||||||
| Advances to construction subcontractors | ||||||||
| Total: | ||||||||
| Less: allowances for doubtful accounts | ( | ) | ( | ) | ||||
| Advances to suppliers, net, third parties | $ | $ | ||||||
Our suppliers generally require refundable prepayments
from us before delivery of goods or service.
The changes of allowance for doubtful accounts for the years ended December 31, 2022 and 2021 are as follow:
December 31, 2022 | December 31, 2021 | |||||||
| Beginning balance | $ | $ | ||||||
| Bad debt provision | ( | ) | ||||||
| Write off | ( | ) | ||||||
| Foreign exchange translation | ( | ) | ||||||
| Ending balance | $ | $ | ||||||
NOTE 8 – INVENTORIES, NET
Inventories, net, consisted of the following:
December 31, 2022 | December 31, 2021 | |||||||
| Raw materials | $ | $ | ||||||
| Finished goods | ||||||||
| Subtotal | ||||||||
| Less: Inventory allowance | ( | ) | ( | ) | ||||
| Inventories, net | $ | $ | ||||||
Inventories include raw material and finished goods. Finished goods include direct material costs, direct labor costs and manufacturing overhead.
For the years ended December31, 2022, 2021 and
2020, the Company provided an inventory allowance (reversion) of $
NOTE 9 – PREPAYMENTS AND OTHER CURRENT ASSETS
The Company’s prepaid expenses and other current assets are as follows:
December 31, 2022 | December 31, 2021 | |||||||
| Other receivable, net (1) | $ | $ | ||||||
| Value added tax receivable | ||||||||
| Total | $ | $ | ||||||
| (1) |
F-23
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 – LEASE
The Company has several operating leases for manufacturing
facilities and offices. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive
covenants. Rent expense for the years ended December 31, 2022, 2021 and 2020 was $
The Company’s operating leases primarily
include leases for office space and manufacturing facilities. The current portion of operating lease liabilities and the non-current portion
of operating lease liabilities are presented on the consolidated balance sheet. Total lease expense amounted to $
December 31, 2022 | ||||
| Right-of-use assets | $ | |||
| Operating lease liabilities – current | $ | |||
| Operating lease liabilities - non-current | ||||
| Total operating lease liabilities | $ | |||
The weighted average remaining lease terms and discount rates for all of operating leases were as follows as of December 31, 2022:
| Remaining lease term and discount rate: | ||||
| Weighted average remaining lease term (years) | ||||
| Weighted average discount rate | % | |||
The following is a schedule of maturities of lease liabilities as of December 31, 2022:
| 2023 | $ | |||
| 2024 | ||||
| Total lease payments | ||||
| Less: imputed interest | ||||
| Present value of lease liabilities | $ |
F-24
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 – PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment, net consisted of the following:
December 31, 2022 | December 31, 2021 | |||||||
| Property and buildings | $ | $ | ||||||
| Machinery and equipment | ||||||||
| Transportation vehicles | ||||||||
| Office and electronic equipment | ||||||||
| Leasehold improvement | ||||||||
| Subtotal | ||||||||
| Construction in progress (“CIP”) | ||||||||
| Less: accumulated depreciation | ( | ) | ( | ) | ||||
| Impairment of fixed assets | ( | ) | ( | ) | ||||
| Property, plant and equipment, net | $ | $ | ||||||
Given the Company’s net loss position, the
Company assessed that the expected future cash flows may not cover the carrying value of the Company’s fixed asset equipment and
machinery. As a result, the Company recorded an impairment of approximately $, $
As of December 31, 2021, the Company’s properties
with an aggregate carrying value of approximately $
Depreciation expense was $
F-25
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 – INTANGIBLE ASSETS, NET
Intangible assets, net consisted of the following:
December 31, 2022 | December 31, 2021 | |||||||
| Land use rights | $ | $ | ||||||
| Software | ||||||||
| Others | ||||||||
| Patent | ||||||||
| Total | ||||||||
| Less: accumulated amortization | ( | ) | ( | ) | ||||
| Intangible assets, net | $ | $ | ||||||
As of December 31, 2022 and 2021, land use rights
of
Amortization expense was $
Estimated future amortization expense is as follows:
| Twelve months ending December 31, | Amortization expense | |||
| 2023 | $ | |||
| 2024 | ||||
| 2025 | ||||
| 2026 | ||||
| 2027 | ||||
| 2028 and Thereafter | ||||
| $ | ||||
NOTE 13–CONVERTIBLE LOANS
March Debenture
On March 1, 2021, the Company entered into a securities
purchase agreement with an accredited investor (the “Debenture Holder”) for the issuance of a Convertible Debenture (the “March
Debenture”) in the aggregate principal amount of up to $
F-26
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13–CONVERTIBLE LOANS (continued)
The Debenture Holder may convert the March Debenture
in its sole discretion to Company’s common shares at any time at the lower of $
The Company has elected to recognize the March
Debenture at fair value and therefore there was no further evaluation of embedded features for bifurcation. The March Debenture was fully
converted into
July Debenture
On July 6, 2021, the Company entered into another
securities purchase with the Debenture Holder for the issuance of a Convertible Debenture (the “July Debenture”) in the aggregate
principal amount of up to $
The Debenture Holder may convert the July Debenture
in its sole discretion to Company’s common shares at any time at the lower of $
The principal balance of $
2022 March Debenture
On March 10, 2022, the Company entered into a
securities purchase agreement with an accredited investor for the issuance of a Convertible Promissory Note (the “Note”) in
the aggregate principal amount of $
The principal balance of $
For the years ended December 31, 2022 and 2021,
due to change in fair value of convertible debentures, the Company recorded an unrealized loss of $
F-27
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14–SHORT-TERM LOANS
Short-term loans consisted of the following:
| December 31, 2022 | December 31, 2021 | |||||||
| Hunyuan Rural Credit Cooperative Association (1) | $ | $ | ||||||
| Bank of Jiangsu (2) | ||||||||
| Huaxia Bank (3) | ||||||||
| Total | $ | $ | ||||||
| (1) | |
| (2) | |
| (3) |
For the years ended December 31, 2022, 2021 and
2020, interest expense on all short-term loans amounted to $
NOTE 15–LONG TERM LOAN
December 31, 2022 | December 31, 2021 | |||||||
| Long-term loans | ||||||||
| Jiangsu Yuantong Municipal Projects Construction Co., Ltd. (1) | $ | $ | ||||||
| Total | $ | $ | ||||||
| (1) |
For the years ended December 31, 2022, 2021 and
2020 interest on the Company’s long-term loans amounted to $, $ and $ $
F-28
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16–LOANS FROM THIRD PARTIES
| Loans from third parties | December 31, 2022 | December 31, 2021 | ||||||
| Sanya Guohong Municipal Projects Construction Co., Ltd. | $ | $ | ||||||
| Changshu Tongjiang Engineering Co., Ltd. | ||||||||
| Zhang Miao | ||||||||
| Pen Jing | ||||||||
| Chen Guo | ||||||||
| Chai Guirong | ||||||||
| Hainan Boxinda Science Technology Partnership | ||||||||
| Yu Zhanfeng | ||||||||
| (Qinhua) Beijing Dingji Rubik’s Cube Model Technology Co. LTD | ||||||||
| Xinyi Xinshuo Concrete Co., LTD | ||||||||
| Chen Gang | ||||||||
| Total | $ | $ | ||||||
On May 9, 2021, Beijing REIT obtained a working
capital loan of $
On July 29, 2021, Beijing REIT obtained a working
capital loan of $
On February 8, 2021, Beijing REIT obtained a working
capital loan of $
On August 1, 2021, Hainan Yile IoT obtained a
working capital loan of $
On October 21, 2021, Hainan Yile IoT obtained
a working capital loan of $
On August 2, 2021, Hainan Yile IoT obtained a
working capital loan of $
On July 4, 2021, Yile Vehicles obtained a working
capital loan of $
On July 29, 2022, Beijing REIT obtained three
working capital loans of $
On May 9, 2022, Beijing REIT obtained a working
capital loan of $
On September 18, 2022, Beijing REIT obtained a
working capital loan of $
On September 19, 2022, Beijing REIT obtained a
working capital loan of $
F-29
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17–TAXES
| (a) | Corporate income taxes |
The Company is subject to income taxes on an entity basis on income arising in or derived from the location in which each entity is domiciled.
ReTo was incorporated in the British Virgin Islands and is exempt from paying income tax. REIT Holdings is registered in Hong Kong as a holding company.
The Company’s operating subsidiaries were
all incorporated in the PRC and are subject to PRC income tax, which is computed according to the relevant laws and regulations in the
PRC. Under the Enterprise Income Tax Law of PRC, the corporate income tax rate applicable to all companies, including both domestic and
foreign-invested companies, is
The following table reconciles income tax expense by statutory rate to the Company’s actual income tax expense:
| For the Years Ended December 31, | ||||||||||||
| 2022 | 2021 | 2020 | ||||||||||
| Income tax benefit computed based on PRC statutory income tax rate | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
| Effect of favorable income tax rate in certain entity in PRC | ( | ) | ||||||||||
| Non-PRC entities not subject to PRC tax (1) | ||||||||||||
| Research & Development (“R&D”) tax credit (2) | ( | ) | ( | ) | ( | ) | ||||||
| Non-deductible expenses - permanent difference (3) | ||||||||||||
| Change in valuation allowance | ||||||||||||
| Effective tax (benefit) expense | $ | ( | ) | $ | $ | |||||||
| (1) | |
| (2) | |
| (3) |
The breakdown of the Company’s income (loss) before income tax provision is as follows:
| For the Years Ended December 31, | ||||||||||||
| 2022 | 2021 | 2020 | ||||||||||
| Loss before income tax expense from China | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
| Loss before income tax expense from outside of China | ( | ) | ( | ) | ( | ) | ||||||
| Total loss before income tax provision | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
F-30
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17–TAXES (continued)
| (a) | Corporate income taxes (continued) |
Loss before income tax expense from outside of China represents the losses incurred in ReTo, REIT Holdings, REIT India and REIT US, which are mainly holding companies incorporated outside of China.
The income tax provision (benefit) for the years ended December 31, 2022, 2021 and 2020 was as follows:
| For the Years ended December 31, | ||||||||||||
| 2022 | 2021 | 2020 | ||||||||||
| Current | $ | $ | $ | |||||||||
| Deferred | ( | ) | ||||||||||
| Total | $ | ( | ) | $ | $ | |||||||
Deferred income taxes reflect the net effects of temporary difference between the carrying amounts of assets and liabilities for financial statement purposes and the amounts used for income tax purposes. The Company periodically evaluates the likelihood of the realization of deferred tax assets and reduces the carrying amount of the deferred tax assets by a valuation allowance to the extent it believes a portion will not be realized. Due to continuous losses incurred, the Company provided full allowance on the deferred tax assets as of December 31, 2022 and 2021.
| Deferred tax asset | December 31 2022 | December 31 2021 | ||||||
| Provision of doubtful accounts | $ | $ | ||||||
| Tax loss carried forwards | ||||||||
| Valuation allowance on tax losses | ( | ) | ( | ) | ||||
| $ | $ | |||||||
| (b) | VAT |
The Company is subject to VAT for selling products
in China.
| (c) | Taxes Payable |
The Company’s taxes payable consists of the following:
| December 31, | December 31, | |||||||
| 2022 | 2021 | |||||||
| VAT tax payable | $ | $ | ||||||
| Corporate income tax payable | ||||||||
| Land use tax and other taxes payable | ||||||||
| Total | $ | $ | ||||||
As of December 31, 2022 and 2021, the Company
had tax payables of approximately $
F-31
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18–COMMITMENTS AND CONTIGENCIES
Contingencies
From time to time, the Company is a party to various legal actions arising in the ordinary course of business. The majority of these claims and proceedings are related to, or arise from, lease disputes, commercial disputes, worker compensation complaints, default on guaranteeing third-party lease obligations, and default on loans. The Company first determines whether a loss from a claim is probable, and if it is reasonable to estimate the potential loss, the loss will be accrued. The Company discloses a range of possible losses, if a loss from a claim is probable but the amount of loss cannot be reasonably estimated.
Contractual commitments
As of December 31, 2022, the Company’s contractual obligations consisted of the following:
| Contractual Obligations | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | |||||||||||||||
| Operating lease commitment | $ | $ | $ | $ | $ | |||||||||||||||
| Repayment of bank loans | ||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | |||||||||||||||
NOTE 19–RELATED PARTY TRANSACTIONS
The Company records transactions with various related parties. These related party balances as of December 31, 2022 and 2021 and transactions for the years ended December 31, 2022, 2021 and 2020 are identified as follows:
| (1) | Related parties with transactions and related party relationships |
| Name of Related Party | Relationship to the Company | |
| Mr. Hengfang Li | ||
| Q Green Techcon Private Limited | ||
| Shexian Ruibo | ||
| Zhongrong Honghe Eco Construction Materials Co., Ltd | ||
| Hunyuan Baiyang Food Co., Ltd. | ||
| Bei Qi Yin Jian Yi Le (Haikou) Smart Move Science Technology Co., Ltd. | ||
| Zhongtou REIT Information Service (Beijing) Co., Ltd | ||
| Handan Ruisheng Construction Material Technology Co., Ltd. |
| (2) | Due to related parties |
As of December 31, 2022 and 2021, the balance of due to related parties was as follows:
December 31, 2022 | December 31, 2021 | |||||||
| Mr. Hengfang Li | $ | $ | ||||||
Mr. Hengfang Li is the Chief Executive Officer and major shareholder of the Company. Mr. Li periodically provides working capital loans to support the Company’s operations when needed. Such advances were non-interest bearing and due on demand.
| (3) | Accounts receivable from related parties |
Accounts receivable from related parties consisted of the following:
December 31, 2022 | December 31, 2021 | |||||||
| Accounts receivable from– related parties | ||||||||
| Q Green Techcon Private Limited | $ | $ | ||||||
| Hunyuan Baiyang Food Co., Ltd. | ||||||||
| Bei Qi Yin Jian Yi Le (Haikou) Smart Move Science Technology Co., Ltd. | ||||||||
| Total accounts receivable from related party | $ | $ | ||||||
The Company fully collected the accounts receivable as of December 31, 2022 from related parties as of the date herein.
F-32
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 19–RELATED PARTY TRANSACTIONS (continued)
| (4) | Advance to suppliers, related party |
Advance to suppliers, related party, consisted of the following:
December 31, 2022 | December 31, 2021 | |||||||
| Advance to supplier – related party | ||||||||
| Shexian Ruibo* | $ | $ | ||||||
| Q Green Techcon Private Limited | ||||||||
| Handan Ruisheng Construction Material Technology Co., Ltd. | ||||||||
| Total | $ | $ | ||||||
| * |
| (5) | Accounts payable to related parties |
Accounts payables to related parties consisted of the following:
December 31, 2022 | December 31, 2021 | |||||||
| Accounts payable – related part | ||||||||
| - Zhongtou Ruitu Information Service (Beijing) Co., Ltd | $ | $ | ||||||
| Total | $ | $ | ||||||
| (6) | Sales to related parties |
Sales to related parties consisted of the following:
| For the Years Ended December 31, | ||||||||||||
| 2022 | 2021 | 2020 | ||||||||||
| Sales to related parties | ||||||||||||
| Changjiang Zhongrong Hengde Environmental Protection Co., LTD | $ | $ | $ | |||||||||
| Shexian Ruibo | ||||||||||||
| Q Green Techcon Private Limited | ||||||||||||
| Total | $ | $ | $ | |||||||||
Cost of revenue associated with the sales to these
related parties amounted to $
| (7) | Purchases from related parties |
Purchases from related parties consisted of the following:
| For the years ended December 31, | ||||||||||||
| 2022 | 2021 | 2020 | ||||||||||
| Purchase from a relate party | ||||||||||||
| Q Green Techcon Private Limited. | $ | $ | $ | |||||||||
| Shexian Ruibo | ||||||||||||
| Total | $ | $ | $ | |||||||||
F-33
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20–SHAREHOLDERS’ EQUITY
Statutory reserve
The Company is required to make appropriations
to certain reserve funds, comprising the statutory surplus reserve and the discretionary surplus reserve, based on after-tax net income
determined in accordance with generally accepted accounting principles of the PRC (“PRC GAAP”).
Shares issuances
The Company is a company limited by shares established
under the laws of the British Virgin Islands with
On September 5, 2019, the Company entered into
a consulting service agreement with FirstTrust Group, Inc. (“FirstTrust”), pursuant to which FirstTrust would assist the Company
with strategic initiatives over the service period from August 16, 2019 to August 15, 2020. The Company issued
Pursuant to the Company’s 2018 Share Incentive
Plan, on January 22, 2020, the Company’s board of directors approved the issuance of an aggregate of
In addition, on February 3, 2020, the Company’s
board of directors further approved the issuance of
In April 2021, the Company entered into a consulting
service agreement with Geniusland International Capital Ltd., (“Geniusland”) Pursuant to the agreement, Geniusland will assist
the Company with strategic initiatives over the service period between January 23, 2021 to January 24, 2024. For the first-year service,
the Company issued
In January 2022, the Company revised the consulting
service agreement with Geniusland International Capital Ltd., (“Geniusland”). Pursuant to the new agreement, the service will
cease on March 28, 2022. For the service provided between December 29, 2021 to March 28, 2022. The Company issued
Number of shares | Weighted average grant date value | |||||||
| Nonvested as of December 31, 2021 | $ | $ | ||||||
| Granted | ||||||||
| Vested | ||||||||
| Nonvested as of December 31, 2021 | $ | $ | ||||||
F-34
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20–SHAREHOLDERS’ EQUITY (continued)
On May 11, 2021, the Company issued
On December
27, 2021, the Company entered into an acquisition agreement to acquire
On April
22, 2022, the Company’s board of directors approved the issuance of an aggregate of
On May 25,
2022, the Company issued
On March 8, 2023, the Company’s board of
directors approved the issuance of an aggregate of
On February 27, 2023, the Company entered into
a consulting service agreement with Express Transportation Ltd. (“ETL”). Pursuant to the agreement, ETL has agreed to provide
feasibility, analysis and risk management services on investment project in mainland China in exchange for
On February 27, 2023, the Company entered into
a consulting service agreement with Maxleed Investment Holding Ltd. (“MIHL”). Pursuant to the agreement, MIHL has agreed to
provide strategy, due diligence, business expansion and optimization services in exchange for
Conversion of convertible debentures
For the year ended December 31, 2022, the Company
issued an aggregate of
For the
year ended December 31, 2021, the Company issued an aggregate of
Purchase of non-controlling interest in Xinyi REIT
On
April 8, 2022, the Company signed an agreement with the minority shareholder of Xinyi REIT. Pursuant to the agreement, the Company agreed
to purchase the minority shareholder’s
Non-controlling shareholder contribution
On April
6, 2022, Hainan Shi Yuan Tong Da Ye Feng Private Equity Partnership (Limited Partnership) signed an investment agreement with REIT
Mingde to invest RMB
F-35
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21–SEGMENT REPORTING
ASC 280, “Segment Reporting”, establishes standards for reporting information about operating segments on a basis consistent with the Company’s internal organizational structure as well as information about geographical areas, business segments and major customers in financial statements for details on the Company’s business segments. The Company uses the “management approach” in determining reportable operating segments. The management approach considers the internal organization and reporting used by the Company’s chief operating decision maker for making operating decisions and assessing performance as the source for determining the Company’s reportable segments. Management, including the chief operating decision maker, reviews operation results by the revenue of different products or services. Based on management’s assessment, the Company has determined that it has four operating segments as defined by ASC 280, including machinery and equipment, construction material, municipal construction projects, and technology consulting and other services.
Construction material segment manufactures and sells eco-friendly construction material. Machinery and equipment segment manufactures and sells machinery and equipment used to manufacture construction material. Construction service segment generates revenue from contracting municipal construction projects. Technological consulting service segment generates revenue from providing environmental-protection related consulting services to customers.
The following table presents summary information by segments for the Company’s continuing operations for the years ended December 31, 2022, 2021 and 2020, respectively:
| For the Year Ended December 31, 2022 | ||||||||||||||||||||
| Machinery
and Equipment sales | Construction materials sales | Municipal construction projects | Technological consulting and other services | Total | ||||||||||||||||
| Revenues | $ | $ | $ | $ | $ | |||||||||||||||
| Cost of goods sold | ||||||||||||||||||||
| Gross profit | ( | ) | ||||||||||||||||||
| Interest expense and charges | ||||||||||||||||||||
| Interest income | ( | ) | ||||||||||||||||||
| Depreciation and amortization | ( | ) | ||||||||||||||||||
| Capital expenditures | ( | ) | ||||||||||||||||||
| Income tax benefit | - | - | - | ( | ) | ( | ) | |||||||||||||
| Segment loss | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||
| Segment assets | $ | $ | $ | ( | ) | $ | $ | |||||||||||||
F-36
RETO ECO-SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21–SEGMENT REPORTING (continued)
| For the Year Ended December 31, 2021 | ||||||||||||||||||||
| Machinery and Equipment sales | Construction materials sales | Municipal construction projects | Technological consulting and other services | Total | ||||||||||||||||
| Revenues | $ | $ | $ | $ | - | $ | ||||||||||||||
| Cost of goods sold | - | |||||||||||||||||||
| Gross profit | ( | ) | ||||||||||||||||||
| Interest expense and charges | ( | ) | ||||||||||||||||||
| Depreciation and amortization | - | |||||||||||||||||||
| Capital expenditures | - | - | ||||||||||||||||||
| Income tax expenses | - | - | - | |||||||||||||||||
| Segment loss | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||
| Segment assets | $ | $ | $ | $ | $ | |||||||||||||||
| For the Year Ended December 31, 2020 | ||||||||||||||||||||
Machinery and Equipment sales | Construction materials sales | Municipal construction projects | Technological consulting and other services | Total | ||||||||||||||||
| Revenues | $ | $ | $ | $ | $ | |||||||||||||||
| Cost of goods sold | ||||||||||||||||||||
| Gross profit | ( | ) | - | |||||||||||||||||
| Interest expense and charges | ||||||||||||||||||||
| Depreciation and amortization | ||||||||||||||||||||
| Capital expenditures | ||||||||||||||||||||
| Income tax expenses | ||||||||||||||||||||
| Segment loss | ( | ) | ( | ) | ( | ) | - | ( | ) | |||||||||||
| Segment assets | $ | $ | $ | $ | $ | |||||||||||||||
NOTE 22–SUBSEQUENT EVENTS
On March 13, 2023, REIT New Materials Xinyi Co.,
Ltd. and Weiying Zhou were named as defendants in a lawsuit. The complaint demanded for a repayment of a loan of RMB
On March 23, 2023, REIT New Materials Xinyi Co.,
Ltd. was named as defendants in a lawsuit. The complaint demanded for a repayment of a loan of RMB
In addition, the Company is regularly subject to claims and litigation. The outcomes of our legal proceedings and other contingencies are inherently unpredictable, subject to significant uncertainties, and could be material to our operating results and cash flows for a particular period. The Company evaluates, on a regular basis, developments in its legal proceedings and other contingencies that could affect the amount of liability, including amounts in excess of any previous accruals and reasonably possible losses disclosed, and make adjustments and changes to the accruals and disclosures as appropriate. For the matters the Company discloses that does not include an estimate of the amount of loss or range of losses, such an estimate is not possible or is immaterial, and the Company may be unable to estimate the possible loss or range of losses that could potentially result from the application of non-monetary remedies. Until the final resolution of such matters, if any of the Company’s estimates and assumptions change or prove to have been incorrect, the Company may experience losses in excess of the amounts recorded, which could have a material effect on the Company’s business, consolidated financial position, results of operations, or cash flows.
F-37