BGM (BGM) 20-F2020 FY Annual report (foreign)

FORM 20-F

¨ REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended September 30, 2020

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________ to _____________.

OR

¨ SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report:

Commission file number: 001-39805

Securities registered or to be registered pursuant to Section 12(b) of the Act:

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.

An aggregate of 35,750,000 ordinary shares, par value $0.00166667 per share, as of February 10, 2021.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨  No x

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 ¨  No x

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. Yes ¨ No x

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted 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 and post such files). Yes x  No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

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. ¨

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

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 x 

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. ¨

TABLE OF CONTENTS

INTRODUCTION

“We,” “us,” “our,” or the “Company” are to Qilian International Holding Group Limited, a Cayman Islands exempted company with limited liability, and its Affiliated Entities, as the case may be. Unless the context otherwise requires, in this annual report on Form 20-F references to:

FORWARD-LOOKING INFORMATION

This annual report on Form 20-F contains ‘forward-looking statements’ within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that involve substantial risks and uncertainties. Known and unknown risks, uncertainties and other factors, including those listed under “Item 3. Key Information—D. Risk Factors,” may cause our actual results, performance or achievements to be materially different from those expressed or implied by the forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from those expressed or implied by the forward-looking statements.

You can identify some of these forward-looking statements by words or phrases such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “is/are likely to,” “potential,” “continue” or other similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements include statements relating to:

These forward-looking statements involve various risks and uncertainties. Although we believe that our expectations expressed in these forward-looking statements are reasonable, our expectations may later be found to be incorrect. Our actual results could be materially different from our expectations. Other sections of this annual report include additional factors that could adversely impact our business and financial performance. Moreover, we operate in an evolving environment. New risk factors and uncertainties emerge from time to time and it is not possible for our management to predict all risk factors and uncertainties, 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. You should read thoroughly this annual report and the documents that we refer to with the understanding that our actual future results may be materially different from, or worse than, what we expect. We qualify all of our forward-looking statements by these cautionary statements.

This annual report contains certain data and information that we obtained from various government and private publications. Statistical data in these publications also include projections based on a number of assumptions. The insurance industry may not grow at the rate projected by market data, or at all. Failure of this market to grow at the projected rate may have a material and adverse effect on our business and the market price of the Ordinary Shares. In addition, the rapidly evolving nature of this industry results in significant uncertainties for any projections or estimates relating to the growth prospects or future condition of our market. Furthermore, if any one or more of the assumptions underlying the market data are later found to be incorrect, actual results may differ from the projections based on these assumptions. You should not place undue reliance on these forward-looking statements.

The forward-looking statements made in this annual report relate only to events or information as of the date on which the statements are made in this annual report. Except as required by law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, after the date on which the statements are made or to reflect the occurrence of unanticipated events. You should read this annual report and the documents that we refer to in this annual report and exhibits to this annual report completely and with the understanding that our actual future results may be materially different from what we expect.

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

A.         Selected Financial Data

The selected consolidated statements of operations data for the fiscal years ended September 30, 2019 and 2020, and balance sheet data as of September 30, 2019 and 2020 have been derived from our audited consolidated financial statements included in this annual report beginning on page F-1. The selected consolidated statements of operations data for the fiscal year ended September 30, 2018 and balance sheet data as of September 30, 2018 are derived from our audited consolidated financial statements not included in this annual report.

Our consolidated financial statements are prepared and presented in accordance with U.S. GAAP. Our historical results are not necessarily indicative of the results for any future periods. You should read the following summary consolidated financial data in conjunction with our consolidated financial statements and the related notes included elsewhere in this annual report and “Item 5. Operating and Financial Review and Prospects.”

Selected Statements of Operations Information

Selected Balance Sheets Information:

B.         Capitalization and Indebtedness

      Not applicable.

C.         Reasons for the Offer and Use of Proceeds

       Not applicable.

D.         Risk Factors

Summary of Risk Factors

Investing in our Ordinary Shares involves significant risks. You should carefully consider all of the information in this prospectus before making an investment in our Ordinary Shares. Below please find a summary of the principal risks we face, organized under relevant headings. These risks are discussed more fully in the section titled “Item 3. Key Information—D. Risk Factors” in this annual report.

Risks Related to our Business

Risks and uncertainties related to our business include, but are not limited to, the following:

Risks Related to our Corporate Structure

We are also subject to risks and uncertainties related to our corporate structure, including, but not limited to, the following:

Risks Related to Our Ordinary Shares

Risks and uncertainties related to our Ordinary Shares include, but are not limited to, the following:

Risks Related to Doing Business in China

Risks Related to Our Business

We face significant competition in industries experiencing rapid technological change, and there is a possibility that our competitors may achieve regulatory approval and develop new product candidates before us, which may harm our financial condition and our ability to successfully market or commercialize any of our product candidates.

The development and commercialization of new pharmaceutical products and fertilizers is highly competitive, and both industries currently are characterized by rapidly changing technologies, significant competition and a strong emphasis on intellectual property. We will face competition with respect to our current and future pharmaceutical and fertilizer product candidates from major pharmaceutical and chemical companies in China. Potential competitors also include academic institutions, government agencies and other public and private research organizations that conduct research, seek patent protection and establish collaborative arrangements for research, development, manufacturing and commercialization of pharmaceutical and fertilizer products. For example, competition for improving oxytetracycline strains comes from conventional and advanced breeding techniques. Other potentially competitive sources of improvement in oxytetracycline yields include improvements in specific biotechnology areas and information management.

We have competitors in China that manufacture products similar to ours. These companies sell similar products as ours and some of them may have more assets, resources and a larger market share. We believe we are able to compete with these competitors because of our geographical location in Western China, our unique combination of products and our products’ lower prices.

Some of our current or potential competitors may have significantly greater financial resources and expertise in research and development, manufacturing, product testing, obtaining regulatory approvals and marketing approved products than we do. Mergers and acquisitions in the pharmaceutical, chemical and agricultural industries may result in even more resources being concentrated among a smaller number of our competitors. Smaller or early-stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies. These competitors also compete with us in recruiting and retaining qualified scientific and management personnel, as well as in acquiring technologies complementary to, or necessary for, our R&D projects. Our commercial opportunity could be reduced or eliminated if our competitors develop and commercialize products that are more effective, more convenient or are less expensive than any products we develop alone or with collaborators or that would render any such products obsolete or non-competitive. Our competitors also may obtain regulatory approval for their products more rapidly than we may obtain approval for any that we develop, which could result in our competitors establishing a strong market position before our new products are able to enter the market. Additionally, technologies developed by our competitors may render our product candidates uneconomical or obsolete, and we or our collaborators may not be successful in marketing any product candidates we may develop against competitors. The availability of our competitors’ products could limit the demand, and the price we are able to charge, for any products that we develop alone or with collaborators.

Our pharmaceutical business is subject to inherent risks relating to product liability and personal injury claims.

We, as a pharmaceutical company, are exposed to risks inherent in the manufacturing and distribution of pharmaceutical products, such as with respect to improper filling of prescriptions, labeling of prescriptions, adequacy of warnings, and unintentional distribution of counterfeit drugs. In addition, product liability claims may be asserted against us with respect to any of the products we sell and as a distributor, we are required to pay for damages for any successful product liability claim against us, although we may have the right under applicable PRC laws, rules and regulations to recover from the relevant manufacturer or distributors for compensation we paid to our customers in connection with a product liability claim. We may also be obligated to recall affected products. If we are found liable for product liability claims, we could be required to pay substantial monetary damages. Furthermore, even if we successfully defend ourselves against this type of claim, we could be required to spend significant management, financial and other resources, which could disrupt our business, and our reputation as well as our brand name may also suffer. We, like many other similar companies in China, do not carry product liability insurance. As a result, any imposition of product liability could materially harm our business, financial condition and results of operations. In addition, we do not have any business interruption insurance due to the limited coverage of any available business interruption insurance in China, and as a result, any business disruption or natural disaster could severely disrupt our business and operations and significantly decrease our revenue and profitability.

We have limited sources of working capital and will need substantial additional financing.

The working capital required to implement our business plan and R&D efforts will most likely be provided by funds obtained through offerings of our equity, debt, debt-linked securities, and/or equity-linked securities, and revenues generated by us. No assurance can be given that we will have revenues sufficient to sustain our operations or that we would be able to obtain equity/debt financing in the current economic environment. If we do not have sufficient working capital and are unable to generate sufficient revenues or raise additional funds, we may delay the completion of or significantly reduce the scope of our current business plan; delay some of our development and clinical or marketing efforts; postpone the hiring of new personnel; or, under certain dire financial circumstances, substantially curtail or cease our operations.

We need sufficient financing to implement our business plan, which includes expanding the marketing efforts for Gan Di Xin^® and increasing the manufacturing capacities for our oxytetracycline products, fertilizer products and Heparin Sodium Preparations. We will also need sufficient financing to materialize our future plan of acquiring traditional Chinese medicine enterprises. We estimate that carrying out these business projects will require at least $26 million. Our inability to obtain sufficient additional financing would have a material adverse effect on our ability to implement our business plan and, as a result, could require us to significantly curtail or potentially cease our operations. As of September 30, 2020, we had cash and cash equivalents of approximately $11,867,130, total current assets of $ 37,517,422 and total current liabilities of $18,423,771. We will need to engage in capital-raising transactions in the near future. Such financing transactions may well cause substantial dilution to our shareholders and could involve the issuance of securities with rights senior to the outstanding shares. Our ability to complete additional financings depends on, among other things, the state of the capital markets at the time of any proposed offering, market reception of the Company and the likelihood of the success of its business model and offering terms. There is no assurance that we will be able to obtain any such additional capital through asset sales, equity or debt financing, or any combination thereof, on satisfactory terms or at all. Additionally, no assurance can be given that any such financing, if obtained, will be adequate to meet our capital needs and to support our operations. If we do not obtain adequate capital on a timely basis and on satisfactory terms, our revenues and operations and the value of our Ordinary Shares and Ordinary Share equivalents would be materially negatively impacted and we may cease our operations.

We depend on certain key personnel and loss of these key personnel could have a material adverse effect on our business, financial condition and results of operations.

Our success is, to a certain extent, attributable to the management, sales and marketing, and research and development expertise of key personnel. We depend upon the services of Mr. Zhanchang Xin, our Chief Executive Officer and Chairman of the Board, for the continued growth and operation of our Company, due to his industry experience, technical expertise, as well as his personal and business contacts in the PRC. Additionally, Mr. Zhanchang Xin, performs key functions in the operation of our business as our Chief Scientific Officer and Chief Operations Officer. We may not be able to retain Mr. Zhanchang Xin for any given period of time. Although we have no reason to believe that Mr. Zhanchang Xin will discontinue his services with us or Gansu QLS, the interruption or loss of his services would adversely affect our ability to effectively run our business and pursue our business strategy as well as our results of operations. We do not carry key man life insurance for any of our key personnel, nor do we foresee purchasing such insurance to protect against the loss of key personnel.

We may not be able to hire and retain qualified personnel to support our growth and if we are unable to retain or hire these personnel in the future, our ability to improve our products and implement our business objectives could be adversely affected.

We must attract, recruit and retain a sizeable workforce of technically competent employees. Competition for senior management and personnel in the PRC is intense and the pool of qualified candidates in the PRC is limited. We may not be able to retain the services of our senior executives or personnel, or attract and retain high-quality senior executives or personnel in the future. This failure could materially and adversely affect our future growth and financial condition.

A significant portion of our revenue is concentrated on a few large customers, and we do not have long-term agreements with our key customers and rely upon our longstanding relationship with them. If we lose one or more of our customers, our results of operations may be adversely and materially impacted.

Our customers consist of qualified distributors, dealers and corporate customers. We have several large customers with whom we generated substantial revenue each year, and the composition of our largest customers has changed from year to year. For the fiscal year ended September 30, 2020, three customers represented approximately 18%, 11% and 10% of the Company’s sales, respectively. For the fiscal year ended September 30, 2019, one customer represented approximately 15.3% of the Company’s sales. For the fiscal year ended September 30, 2018, three customers represented approximately 18.8%, 14.7% and 13.7% of the Company’s sales, respectively. Since we do not have long-term customer supply agreements with such large customers and rely primarily upon our goodwill and reputation to sustain the business relationship, our results of operations may be adversely and materially impacted if one or more of these customers stop purchasing from us.

We source our raw materials used for manufacturing from a limited number of suppliers. If we lose one or more of the suppliers, our operation may be disrupted, and our results of operations may be adversely and materially impacted.

For the fiscal year ended September 30, 2020, two of our suppliers accounted for 11% and 10% of the total purchases, respectively. For the year ended September 30, 2019, two of our suppliers accounted for 12.9% and 9.5% of the total purchases, respectively. For the fiscal year ended September 30, 2018, three of our suppliers accounted for 19.2%, 14.1%, and 9.4% of the total purchases, respectively. If we lose suppliers and are unable to swiftly engage new suppliers, our operations may be disrupted or suspended, and we may not be able to deliver hardware products to our customers on time. We may also have to pay a higher price to source from a different supplier on short notice. While we are actively searching for and negotiating with new suppliers, there is no guarantee that we will be able to locate appropriate new suppliers or supplier merger targets in our desired timeline. As such, our results of operations may be adversely and materially impacted.

If we fail to increase our brand name recognition, we may face difficulty in obtaining new customers.

Although our brand is well-respected in the Chinese pharmaceutical and chemical industry, we still believe that maintaining and enhancing our brand name recognition in a cost-effective manner is critical to achieving widespread acceptance of our current and future products and services and is an important element in our effort to increase our customer base. Successful promotion of our brand name will depend largely on our marketing efforts and ability to provide reliable and quality products at competitive prices. Brand promotion activities may not necessarily yield increased revenue, and even if they do, any increased revenue may not offset the expenses we will incur in marketing activities. If we fail to successfully promote and maintain our brand, or if we incur substantial expenses in an unsuccessful attempt to promote and maintain our brand, we may fail to attract new customers or retain our existing customers, in which case our business, operating results and financial condition, would be materially adversely affected.

Any disruption in the supply chain of raw materials and our products could adversely impact our ability to produce and deliver products.

Some products we manufacture are resource-based products. Thus, we must manage our supply chain for raw materials and delivery of our products competently. Even though Chengdu QLS enjoy considerable advantages resulting from high quality, low cost, and abundant local resources, supply chain fragmentation and local protectionism within China may cause disruption risks for some of our other VIE operating entities. Local administrative bodies and physical infrastructure built to protect local interests pose transportation challenges for raw material transportation as well as product delivery throughout China. In addition, profitability and volume could be negatively impacted by limitations inherent within the supply chain, including competitive, governmental, legal, natural disasters, and other events that could affect both supply and price. Any of these occurrences could cause significant disruptions to our supply chain, manufacturing capability and distribution system that could adversely affect our ability to produce and deliver some of our products.

Additionally, some of the raw materials we use are procured from farmers, who are usually subject to environmental risks outside of their control. Thus, they may not have the ability to supply continuously and stably if environmental and climate change adversely affect their business.

Our success depends on our ability to protect our intellectual property.

Our success depends on our ability to obtain and maintain patent protection for products developed utilizing our technologies, in the PRC and in other countries, and to enforce these patents. There is no assurance that any of our existing and future patents will be held valid and enforceable against third-party infringement or that our products will not infringe any third-party patent or intellectual property. Although we have owned 14 valid patents and filed an additional patent application with the Patent Administration Department of the PRC, there is no assurance that they will be granted.

Any patents relating to our technologies may not be sufficiently broad to protect our products. In addition, our patents may be challenged, potentially invalidated or potentially circumvented. Our patents may not afford us protection against competitors with similar technology or permit the commercialization of our products without infringing third-party patents or other intellectual property rights.

We also rely on or intend to rely on our trademarks, trade names and brand names to distinguish our products from the products of our competitors, and have registered or will apply to register a number of these trademarks. However, third parties may oppose our trademark applications or otherwise challenge our use of the trademarks. In the event that our trademarks are successfully challenged, we could be forced to rebrand our products, which could result in loss of brand recognition and could require us to devote resources to advertising and marketing these new brands. Further, our competitors may infringe our trademarks, or we may not have adequate resources to enforce our trademarks.

In addition, we also have trade secrets, non-patented proprietary expertise and continuing technological innovation that we shall seek to protect, in part, by entering into confidentiality agreements with licensees, suppliers, employees and consultants. These agreements may be breached and there may not be adequate remedies in the event of a breach. Disputes may arise concerning the ownership of intellectual property or the applicability of confidentiality agreements. Moreover, our trade secrets and proprietary technology may otherwise become known or be independently developed by our competitors. If patents are not issued with respect to products arising from research, we may not be able to maintain the confidentiality of information relating to these products.

Implementation and enforcement of PRC laws relating to intellectual property have historically been deficient and ineffective. Accordingly, protection of intellectual property rights in China may not be as effective as in the United States or other developed countries. Furthermore, policing unauthorized use of proprietary technology is difficult and expensive. We rely on a combination of patent, copyright, trademark, and trade secret laws and restrictions on disclosure to protect our intellectual property rights. Despite our efforts to protect our proprietary rights, third parties may attempt to copy or otherwise obtain and use our intellectual property or seek court declarations that they do not infringe upon our intellectual property rights. Monitoring unauthorized use of our intellectual property is difficult and costly, and we cannot assure you that the steps we have taken or will take will prevent misappropriation of our intellectual property. From time to time, we may have to resort to litigation to enforce our intellectual property rights, which could result in substantial costs and diversion of our resources.

We face risks related to research and the ability to develop new pharmaceutical and chemical products.

Our growth and survival depend on our ability to consistently discover, develop and commercialize new products and find new and improved technology. As such, if we fail to make sufficient investments in research, be attentive to unmet consumer needs or focus on advancing pharmaceutical and chemical product technology, our current and future products could be surpassed by more effective or advanced products of other companies.

Our business requires a number of permits and licenses. We cannot assure you that we can maintain all required licenses, permits and certifications to carry on our business at all times.

Pharmaceutical companies in China are required to obtain certain permits and licenses from various PRC governmental authorities, including Pharmaceutical Product Permits.

We have obtained certificates, permits, and licenses required for the operation of a pharmaceutical enterprise and the manufacturing of pharmaceutical products in the PRC. The latest amended Drug Administration Law took effect on December 1, 2019 and has vacated the GMP certificate requirements for pharmaceutical companies. We do not need to renew our current GMP certificates. However, we cannot assure you that we can maintain all the other required licenses, permits and certifications to carry on our business at all times, and in the past from time to time we may have not been in compliance with all such required licenses, permits and certifications. Moreover, these licenses, permits and certifications are subject to periodic renewal and/or reassessment by the relevant PRC governmental authorities and the standards of such renewal or reassessment may change from time to time. We intend to apply for the renewal of these licenses, permits and certifications when required by then applicable laws and regulations. Any failure by us to obtain and maintain all licenses, permits and certifications necessary to carry on our business at any time could have a material adverse effect on our business, financial condition and results of operations. In addition, any inability to renew these licenses, permits and certifications could severely disrupt our business and prevent us from continuing to carry on our business. Any changes in the standards used by governmental authorities in considering whether to renew or reassess our business licenses, permits and certifications, as well as any enactment of new regulations that may restrict the conduct of our business, may also decrease our revenue and/or increase our costs and materially reduce our profitability and prospects. Furthermore, if the interpretation or implementation of existing laws and regulations changes or if new regulations come into effect requiring us to obtain any additional licenses, permits or certifications that were previously not required to operate our existing businesses, we cannot assure you that we will successfully obtain such licenses, permits or certifications.

Our innovative Gan Di Xin^® in China is subject to continuing regulation by the National Medical Products Administration (the “NMPA”). Our innovative Ahan® Antibacterial Paste is subject to continuing regulation by the National Health and Family Planning Commission. If the labeling or manufacturing process of an approved pharmaceutical product is significantly modified, the NMPA may require that we obtain a new pre-market approval.

Adverse publicity associated with our products, ingredients or network marketing program, or those of similar companies, could harm our financial condition and operating results.

The results of our operations may be significantly affected by the public’s perception of our product and similar companies. This perception depends upon opinions concerning:

Adverse publicity concerning any actual or purported failure to comply with applicable laws and regulations regarding product claims and advertising, good manufacturing practices, or other aspects of our business, whether or not resulting in enforcement actions or the imposition of penalties, could have an adverse effect on our goodwill and could negatively affect our sales and ability to generate revenue. In addition, our consumers’ perception of the safety and quality of products and ingredients as well as similar products and ingredients distributed by other companies can be significantly influenced by media attention, publicized scientific research or findings, widespread product liability claims and other publicity concerning our products or ingredients or similar products and ingredients distributed by other companies. Adverse publicity, whether or not accurate or resulting from consumers’ use or misuse of our products, that associates consumption of our products or ingredients or any similar products or ingredients with illness or other adverse effects, questions the benefits of our or similar products or claims that any such products are ineffective, inappropriately labeled or have inaccurate instructions as to their use, could negatively impact our reputation or the market demand for our products.

We face risks related to natural disasters, extreme weather conditions, health epidemics and other catastrophic incidents, which could significantly disrupt our operations.

In the past, China has experienced significant natural disasters, including earthquakes, extreme weather conditions, as well as health scares related to epidemics, and any similar event could materially impact our business in the future. If a disaster or other disruption were to occur in the future that affects the regions where we operate our business, our operations could be materially and adversely affected due to loss of personnel, damages to our manufacturing facilities and volatile Chinese markets. Even if we are not directly affected, such a disaster or disruption could affect the operations or financial condition of our ecosystem participants such as suppliers and distributors, which could harm our results of operations.

In general, our business could be affected by public health epidemics. If any of our employees or staff members who operates manufacturing facilities or conduct R&D activities is suspected of having contracted a contagious disease, we may be required to apply quarantines to our facilities or suspend our manufacturing operations entirely. Furthermore, any future outbreak may restrict economic activities in affected regions and beyond, resulting in reduced business volume, temporary closure of our factories or other disruptions of our business operations and adversely affect our results of operations.

The outbreak of COVID-19 significantly affected business and manufacturing activities within China for the most part of 2020, including travel restrictions, widespread mandatory quarantines, and suspension of business activities within China. These measures caused severe business disruptions to our customers and suppliers, and led to postponement of payment from these parties. Accordingly, our business, results of operations and financial condition were adversely affected.

More specifically, the COVID-19 outbreak has negatively impacted our businesses in the following ways:

Risks Related to Our Corporate Structure

If the PRC government deems that our contractual arrangements with our VIE do not comply with PRC regulatory restrictions on foreign investment in the relevant industries, or if these regulations or interpretation of existing regulations change in the future, we could be subject to severe penalties or be forced to relinquish our interests in those operations.

Current PRC laws and regulations place certain restrictions on foreign ownership of certain areas of businesses. In accordance with the Special Administrative Measures on Access of Foreign Investment, promulgated in June 2020 and effective in July 2020, or the Negative List, foreign investors are not prohibited nor restricted from investing in our current operations and production. See “Item 4. Information on the Company—B. Business Overview—Regulation—PRC Laws and Regulations on Foreign Investment.”

We are a Cayman Islands company and the WFOE are considered foreign invested enterprises, or FIEs. To comply with the applicable PRC laws and regulations, we conduct certain operations in China through certain PRC entities. For a detailed description of these contractual arrangements, see “Item 4. Information on the Company—C. Organizational Structure—Contractual Arrangements between WFOE and Gansu QLS.”

We believe that our corporate structure and contractual arrangements enable us to: (i) be the exclusive provider of business support, technical and consulting services in exchange for a fee; (ii) receive substantially all of the economic benefits and bear the obligation to absorb substantially all of the losses of our VIE; (iii) have an irrevocable and exclusive right to purchase, or to designate one or more persons to purchase, from the registered shareholders all or any part of their equity interests in our VIE at any time and from time to time in our absolute discretion to the extent permitted by PRC laws; (iv) have an irrevocable and exclusive right to purchase, or to designate one or more persons to purchase, from our VIE all or any part of its assets at any time and from time to time in our absolute discretion to the extent permitted by PRC laws; (v) appoint us, any person authorized by us (except the shareholders of our VIE), as exclusive agent and attorney to act on behalf of the shareholders of our VIE on all matters concerning our VIE and to exercise all their rights as a registered shareholder of our VIE in accordance with PRC laws and the articles of our VIE; and (vi) pledge as first-ranking charge all of the equity interests in our VIE to us as collateral security for any and all of the guaranteed debt under the contractual arrangements and to secure performance of the obligations under the contractual arrangements. The contractual arrangements allow the results of operations and assets and liabilities of our VIE and its subsidiaries to be consolidated into our results of operations and assets and liabilities under U.S. GAAP as if they were subsidiaries of our Company.

Our PRC counsel, Gansi Xiongtao Law Firm, is of the opinion that (i) the ownership structure of WFOE and our VIE does not violate applicable PRC laws and regulations currently in effect, and (ii) the contractual arrangements are valid, binding and enforceable in accordance with the applicable PRC laws or regulations currently in effect. However, there can be no assurance that the PRC government authorities will take a view that is not contrary to or otherwise different from the opinion of our PRC counsel stated above. There is also the possibility that the PRC government authorities may adopt new laws, regulations and interpretations that may invalidate the contractual arrangements. If the PRC government determines that we are in violation of PRC laws or regulations or lack the necessary permits or licenses to operate our business, the relevant PRC regulatory authorities, including the PRC National Health Commission, or the NHC, would have broad discretion in dealing with such violations or failures, and measures may include, but are not limited to:

Any of these actions could cause significant disruption to our business operations, and may adversely affect our business, financial condition and results of operations. In addition, if the PRC governmental authorities find our legal structure and contractual arrangements to be in violation of PRC laws and regulations, it is unclear what impact these actions would have on us and on our ability to consolidate the financial results of our VIE and its subsidiaries in our consolidated financial statements. If any penalty results in our inability to direct the activities of our VIE and its subsidiaries and such a penalty significantly impacts their economic performance and/or our ability to receive economic benefits from our VIE and its subsidiaries, we may not be able to consolidate our VIE and its subsidiaries into our consolidated financial statements in accordance with U.S. GAAP.

We rely on contractual arrangements with our variable interest entity and its subsidiaries in China for our business operations, which may not be as effective in providing operational control or enabling us to derive economic benefits as through ownership of controlling equity interests.

We rely on and expect to continue to rely on our wholly owned PRC subsidiary’s contractual arrangements with Gansu QLS and its shareholders to operate our business. These contractual arrangements may not be as effective in providing us with control over Gansu QLS as ownership of controlling equity interests would be in providing us with control over, or enabling us to derive economic benefits from the operations of Gansu QLS. Under the current contractual arrangements, as a legal matter, if Gansu QLS or any of its shareholders executing the VIE Agreements fails to perform its, his or her respective obligations under these contractual arrangements, we may have to incur substantial costs and resources to enforce such arrangements, and rely on legal remedies available under PRC laws, including seeking specific performance or injunctive relief, and claiming damages, which we cannot assure you will be effective. For example, if shareholders of a variable interest entity were to refuse to transfer their equity interests in such variable interest entity to us or our designated persons when we exercise the purchase option pursuant to these contractual arrangements, we may have to take a legal action to compel them to fulfill their contractual obligations.

If (i) the applicable PRC authorities invalidate these contractual arrangements for violation of PRC laws, rules and regulations, (ii) any variable interest entity or its shareholders terminate the contractual arrangements or (iii) any variable interest entity or its shareholders fail to perform their obligations under these contractual arrangements, our business operations in China would be materially and adversely affected, and the value of your shares would substantially decrease. Further, if we fail to renew these contractual arrangements upon their expiration, we would not be able to continue our business operations unless the then current PRC law allows us to directly operate businesses in China.

In addition, if any variable interest entity or all or part of its assets become subject to liens or rights of third-party creditors, we may be unable to continue some or all of our business activities, which could materially and adversely affect our business, financial condition and results of operations. If any of the variable interest entities undergoes a voluntary or involuntary liquidation proceeding, its shareholders or unrelated third-party creditors may claim rights to some or all of these assets, thereby hindering our ability to operate our business, which could materially and adversely affect our business and our ability to generate revenues.

All of these contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration in the PRC. The legal environment in the PRC is not as developed as in some other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements. In the event we are unable to enforce these contractual arrangements, we may not be able to exert effective control over our operating entities and we may be precluded from operating our business, which would have a material adverse effect on our financial condition and results of operations.

Gansu QLS’s shareholders may have potential conflicts of interest with us, which may materially and adversely affect our business and financial condition.

The equity interests of Gansu QLS are held by a total of 151 shareholders. Their interests may differ from the interests of our Company as a whole. They may breach, or cause Gansu QLS to breach, or refuse to renew the existing contractual arrangements we have with Gansu QLS, which would have a material adverse effect on our ability to effectively control Gansu QLS and receive economic benefits from them. For example, the shareholders may be able to cause our agreements with Gansu QLS to be performed in a manner adverse to us by, among other things, failing to remit payments due under the contractual arrangements to us on a timely basis. We cannot assure you that when conflicts of interest arise, any or all of these shareholders will act in the best interests of our Company or such conflicts will be resolved in our favor.

Currently, we do not have any arrangements to address potential conflicts of interest between these shareholders and our Company, except that we could exercise our purchase option under the exclusive option agreement with these shareholders to request them to transfer all of their equity interests in Gansu QLS to a PRC entity or individual designated by us, to the extent permitted by PRC laws. If we cannot resolve any conflict of interest or dispute between us and the shareholders of Gansu QLS, we would have to rely on legal proceedings, which could result in the disruption of our business and subject us to substantial uncertainty as to the outcome of any such legal proceedings.

Contractual arrangements in relation to our variable interest entity may be subject to scrutiny by the PRC tax authorities and they may determine that we or our PRC variable interest entity owe additional taxes, which could negatively affect our results of operations and the value of your investment.

Under applicable PRC laws and regulations, arrangements and transactions among related parties may be subject to audit or challenge by the PRC tax authorities within ten years after the taxable year when the transactions are conducted. The PRC enterprise income tax law requires every enterprise in China to submit its annual enterprise income tax return together with a report on transactions with its related parties to the relevant tax authorities. The tax authorities may impose reasonable adjustments on taxation if they have identified any related party transactions that are inconsistent with arm’s length principles. We may face material and adverse tax consequences if the PRC tax authorities determine that the contractual arrangements between our WFOE, our variable interest entity Gansu QLS and the shareholders of Gansu QLS were not entered into on an arm’s length basis in such a way as to result in an impermissible reduction in taxes under applicable PRC laws, rules and regulations, and adjust Gansu QLS’s income in the form of a transfer pricing adjustment. A transfer pricing adjustment could, among other things, result in a reduction of expense deductions recorded by Gansu QLS for PRC tax purposes, which could in turn increase their tax liabilities without reducing WFOE’s tax expenses. In addition, if WFOE requests the shareholders of Gansu QLS to transfer their equity interests in Gansu QLS at nominal or no value pursuant to these contractual arrangements, such transfer could be viewed as a gift and subject WFOE to PRC income tax. Furthermore, the PRC tax authorities may impose late payment fees and other penalties on Gansu QLS for the adjusted but unpaid taxes according to the applicable regulations. Our results of operations could be materially and adversely affected if Gansu QLS’s tax liabilities increase or if they are required to pay late payment fees and other penalties.

If we exercise the option to acquire equity ownership of Gansu QLS, the ownership transfer may subject us to certain limitation and substantial costs.

Pursuant to the contractual arrangements, WFOE has the exclusive right to purchase all or any part of the equity interests in Gansu QLS from Gansu QLS’s shareholders for a nominal price, unless the relevant government authorities or then applicable PRC laws request that a minimum price amount be used as the purchase price, in such case the purchase price shall be the lowest amount under such request. The shareholders of Gansu QLS will be subject to PRC individual income tax on the difference between the equity transfer price and the then current registered capital of Gansu QLS. Additionally, if such a transfer takes place, the competent tax authority may require WFOE to pay enterprise income tax for ownership transfer income with reference to the market value, in which case the amount of tax could be substantial.

Risks Related to Our Ordinary Shares

The trading price of our Ordinary Shares is likely to be volatile, which could result in substantial losses to our investors.

From the closing of our initial public offering on January 14, 2021 to February 10, 2021, the trading price of our Ordinary Shares has ranged from US$6.72 to US$22.00 per Ordinary Share. The trading price of our Ordinary Shares is likely to continue to be volatile and could fluctuate widely due to factors beyond our control. This may happen because of broad market and industry factors, including the performance and fluctuation of the market prices of other companies with business operations located mainly in China that have listed their securities in the United States. The securities of some of these companies have experienced significant volatility since their initial public offerings, including, in some cases, substantial price declines in their trading prices. The trading performances of other Chinese companies’ securities after their offerings may affect the attitudes of investors toward Chinese companies listed in the United States in general and consequently may impact the trading performance of our Ordinary Shares, regardless of our actual operating performance.

In addition to market and industry factors, the price and trading volume for our Ordinary Shares may be highly volatile for factors specific to our own operations, including the following:

Any of these factors may result in large and sudden changes in the volume and price at which our Ordinary Shares will trade.

In the past, shareholders of public companies have often brought securities class action suits against those companies following periods of instability in the market price of their securities. If we were involved in a class action suit, it could divert a significant amount of our management’s attention and other resources from our business and operations and require us to incur significant expenses to defend the suit, which could harm our results of operations. Any such class action suit, whether or not successful, could harm our reputation and restrict our ability to raise capital in the future. In addition, if a claim is successfully made against us, we may be required to pay significant damages, which could have a material adverse effect on our financial condition and results of operations.

Since our directors and executive officers 58.66% of our Ordinary Shares, they have the ability to elect directors and approve matters requiring shareholder approval by way of resolution of members.

Mr. Zhanchang Xin, our Chairman of the Board of Directors and Chief Executive Officer, is currently the beneficial owner of 13,839,000, or 38.71% of our outstanding Ordinary Shares, of which 5.14% are directly held by Ahanzhai Development Limited, an entity 100% owned by Mr. Xin. Ms. Haiping Shi, our Chief Financial Officer and Director, is currently the beneficial owner of 7,131,000, or 19.95% of our outstanding Ordinary Shares through Zhijiu Holdings Limited, an entity 100% owned by Ms. Shi. They have the power to elect all directors and approve all matters requiring shareholder approval without the votes of any other shareholder. They are expected to have significant influence over a decision to enter into any corporate transaction and have the ability to prevent any transaction that requires the approval of shareholders, regardless of whether or not our other shareholders believe that such transaction is in our best interests. Such concentration of voting power could have the effect of delaying, deterring, or preventing a change of control or other business combination, which could, in turn, have an adverse effect on the market price of our Ordinary Shares or prevent our shareholders from realizing a premium over the then-prevailing market price for their Ordinary Shares.

For as long as we are an emerging growth company, we will not be required to comply with certain reporting requirements, including those relating to accounting standards and disclosure about our executive compensation, that apply to other public companies.

In April 2012, President Obama signed into law the JOBS Act. We are classified as an “emerging growth company” under the JOBS Act. For as long as we are an emerging growth company, which may be up to five full fiscal years, unlike other public companies, we will not be required to, among other things, (i) provide an auditor’s attestation report on management’s assessment of the effectiveness of our system of internal control over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act, (ii) comply with any new requirements adopted by the PCAOB requiring mandatory audit firm rotation or a supplement to the auditor’s report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer, (iii) provide certain disclosure regarding executive compensation required of larger public companies or (iv) hold nonbinding advisory votes on executive compensation. We will remain an emerging growth company for up to five years, although we will lose that status sooner if we have more than $1.07 billion of revenues in a fiscal year, have more than $700 million in market value of our Ordinary Shares held by non-affiliates, or issue more than $1.0 billion of non-convertible debt over a three-year period.

To the extent that we rely on any of the exemptions available to emerging growth companies, you will receive less information about our executive compensation and internal control over financial reporting than issuers that are not emerging growth companies. If some investors find our Ordinary Shares to be less attractive as a result, there may be a less active trading market for our Ordinary Shares and our stock price may be more volatile.

If we fail to establish and maintain proper internal financial reporting controls, our ability to produce accurate financial statements or comply with applicable regulations could be impaired.

Pursuant to Section 404 of the Sarbanes-Oxley Act, we are required to file a report by our management on our internal control over financial reporting, including an attestation report on internal control over financial reporting issued by our independent registered public accounting firm. However, while we remain an emerging growth company, we will not be required to include an attestation report on internal control over financial reporting issued by our independent registered public accounting firm. The presence of material weaknesses in internal control over financial reporting could result in financial statement errors which, in turn, could lead to errors in our financial reports and/or delays in our financial reporting, which could require us to restate our operating results. We might not identify one or more material weaknesses in our internal controls in connection with evaluating our compliance with Section 404 of the Sarbanes-Oxley Act. In order to maintain and improve the effectiveness of our disclosure controls and procedures and internal controls over financial reporting, we need to expend significant resources and provide significant management oversight. Implementing any appropriate changes to our internal controls may require specific compliance training of our directors and employees, entail substantial costs in order to modify our existing accounting systems, take a significant period of time to complete and divert management’s attention from other business concerns. These changes may not, however, be effective in maintaining the adequacy of our internal control.

If we are unable to conclude that we have effective internal controls over financial reporting, investors may lose confidence in our operating results, the price of the Ordinary Shares could decline and we may be subject to litigation or regulatory enforcement actions. In addition, if we are unable to meet the requirements of Section 404 of the Sarbanes-Oxley Act, the Ordinary Shares may not be able to remain listed on Nasdaq Global Market.

As a foreign private issuer, we are not subject to certain U.S. securities law disclosure requirements that apply to a domestic U.S. issuer, which may limit the information publicly available to our shareholders.

Because we qualify as a foreign private issuer under the Exchange Act, we are exempt from certain provisions of the securities rules and regulations in the United States that are applicable to U.S. domestic issuers, including:

We are required to file an annual report on Form 20-F within four months of the end of each fiscal year. However, the information we are required to file with or furnish to the SEC will be less extensive and less timely compared to that required to be filed with the SEC by U.S. domestic issuers. As a result, you may not be afforded the same protections or information that would be made available to you were you investing in a U.S. domestic issuer.

Because we are a foreign private issuer and are exempt from certain Nasdaq corporate governance standards applicable to U.S. issuers, you will have less protection than you would have if we were a domestic issuer.

The Nasdaq Listing Rules requires listed companies to have, among other things, a majority of its board members be independent. As a foreign private issuer, however, we are permitted to, and we may follow home country practice in lieu of the above requirements, or we may choose to comply with the above requirement within one year of listing. The corporate governance practice in our home country, the Cayman Islands, does not require a majority of our board to consist of independent directors. Thus, although a director must act in the best interests of the Company, it is possible that fewer board members will be exercising independent judgment and the level of board oversight on the management of our company may decrease as a result. In addition, the Nasdaq Listing Rules also requires U.S. domestic issuers to have a compensation committee, a nominating/corporate governance committee composed entirely of independent directors, and an audit committee with a minimum of three members. We, as a foreign private issuer, may not be subject to all these requirements. The Nasdaq Listing Rules may require shareholder approval for certain corporate matters, such as requiring that shareholders be given the opportunity to vote on all equity compensation plans and material revisions to those plans, certain ordinary share issuances. We intend to comply with the requirements of the Nasdaq Listing Rules in determining whether shareholder approval is required on such matters and to appoint a nominating and corporate governance committee. However, we may consider following home country practice in lieu of the requirements under the Nasdaq Listing Rules with respect to certain corporate governance standards which may afford less protection to investors.

We may lose our foreign private issuer status in the future, which could result in significant additional costs and expenses.

As discussed above, we are a foreign private issuer, and therefore, we are not required to comply with all of the periodic disclosure and current reporting requirements of the Exchange Act. The determination of foreign private issuer status is made annually on the last business day of an issuer’s most recently completed second fiscal quarter, and, accordingly, the next determination with respect to our status will be made on March 31, 2021. We would lose our foreign private issuer status if, for example, more than 50% of our Ordinary Shares are directly or indirectly held by residents of the U.S. and we fail to meet additional requirements necessary to maintain our foreign private issuer status. If we lose our foreign private issuer status on this date, we will be required to file with the SEC periodic reports and registration statements on U.S. domestic issuer forms beginning on March 31, 2021, which are more detailed and extensive than the forms available to a foreign private issuer. We will also have to mandatorily comply with U.S. federal proxy requirements, and our officers, directors and principal shareholders will become subject to the short-swing profit disclosure and recovery provisions of Section 16 of the Exchange Act. In addition, we will lose our ability to rely upon exemptions from certain corporate governance requirements under the Nasdaq Listing Rules. As a U.S. listed public company that is not a foreign private issuer, we will incur significant additional legal, accounting and other expenses that we will not incur as a foreign private issuer, and accounting, reporting and other expenses in order to maintain a listing on a U.S. securities exchange.

The requirements of being a public company may strain our resources and divert management’s attention.

As a public company, we are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act, the Sarbanes-Oxley Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act, the listing requirements of Nasdaq, and other applicable securities rules and regulations. Despite recent reforms made possible by the JOBS Act, compliance with these rules and regulations will nonetheless increase our legal, accounting, and financial compliance costs and investor relations and public relations costs, make some activities more difficult, time-consuming or costly and increase demand on our systems and resources, particularly after we are no longer an “emerging growth company.” The Exchange Act requires, among other things, that we file annual, quarterly, and current reports with respect to our business and operating results as well as proxy statements.

As a result of disclosure of information in this Form 20-F and in filings required of a public company, our business and financial condition are more visible, which we believe may result in threatened or actual litigation, including by competitors and other third parties. If such claims are successful, our business and operating results could be harmed, and even if the claims do not result in litigation or are resolved in our favor, these claims, and the time and resources necessary to resolve them, could divert the resources of our management and adversely affect our business, brand and reputation and results of operations.

Being a public company and these new rules and regulations will make it more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These factors could also make it more difficult for us to attract and retain qualified members of our board of directors, particularly to serve on our audit committee and compensation committee, and qualified executive officers.

We do not intend to pay dividends for the foreseeable future.

We currently intend to retain any future earnings to finance the operation and expansion of our business. We do not expect to declare or pay any dividends in the foreseeable future. As a result, you may only receive a return on your investment in our Ordinary Shares if we are successfully listed and the market price of our Ordinary Shares increases.

A sale or perceived sale of a substantial number of our Ordinary Shares may cause the price of our Ordinary Shares to decline.

All of our executive officers and directors and 5% shareholders have agreed not to sell our Ordinary Shares for a period of 180 days following the effective date of our registration statement on Form F-1, subject to extension under specified circumstances. Ordinary shares subject to these lock-up agreements will become eligible for sale in the public market upon expiration of these lock-up agreements, subject to limitations imposed by Rule 144 under the Securities Act of 1933, as amended. If our shareholders sell substantial amounts of our Ordinary Shares in the public market, the market price of our Ordinary Shares could fall. Moreover, the perceived risk of this potential dilution could cause shareholders to attempt to sell their Ordinary Shares and investors to short our Ordinary Shares. These sales also may make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem reasonable or appropriate.

The laws of the Cayman Islands may not provide our shareholders with benefits comparable to those provided to shareholders of corporations incorporated in the United States. For instance, you may face difficulties in protecting your interests, and your ability to protect your rights through U.S. courts may be limited, because we are incorporated under Cayman Islands law.

Our corporate affairs are governed by our amended and restated memorandum and articles of association, by the Companies Act (2021 Revision) of the Cayman Islands and by the common law of the Cayman Islands. The rights of shareholders to take action against our directors, actions by minority shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law in the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands and from English common law. Decisions of the Privy Council (which is the final Court of Appeal for British Overseas Territories such as the Cayman Islands) are binding on a court in the Cayman Islands. Decisions of the English courts, and particularly the Supreme Court and the Court of Appeal are generally of persuasive authority but are not binding in the courts of the Cayman Islands. Decisions of courts in other Commonwealth jurisdictions are similarly of persuasive but not binding authority. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in the United States. In particular, the Cayman Islands has a less developed body of securities laws relative to the United States. Some U.S. states, such as Delaware, have more fully developed and judicially interpreted bodies of corporate law than the Cayman Islands. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action in a federal court of the United States.

Shareholders of Cayman Islands exempted companies like us have no general rights under Cayman Islands law to inspect corporate records (other than copies of the memorandum and articles of association, the register of mortgages and charges, and any special resolutions passed by the shareholders) or to obtain copies of lists of shareholders of these companies. Our directors have discretion under our articles of association to determine whether or not, and under what conditions, our corporate records may be inspected by our shareholders, but are not obliged to make them available to our shareholders. This may make it more difficult for you to obtain the information needed to establish any facts necessary for a shareholder motion or to solicit proxies from other shareholders in connection with a proxy contest.

Certain corporate governance practices in the Cayman Islands, which is our home country, differ significantly from requirements for companies incorporated in other jurisdictions such as the United States. If we choose to follow home country practice in the future, our shareholders may be afforded less protection than they otherwise would under rules and regulations applicable to U.S. domestic issuers.

As a result of all of the above, our public shareholders may have more difficulty in protecting their interests in the face of actions taken by management, members of the board of directors or controlling shareholders than they would as public shareholders of a company incorporated in the United States.

Risks Related to Doing Business in China

PRC regulation of loans to, and direct investments in PRC entities by offshore holding companies may delay or prevent us from using proceeds from future financing activities to make loans or additional capital contributions to our PRC subsidiary.

As an offshore holding company with a PRC subsidiary, we may transfer funds to our PRC subsidiary or finance our operating entity by means of loans or capital contributions. Any capital contributions or loans that we, as an offshore entity, make to our Company’s PRC subsidiary, are subject to PRC regulations. Any loans to our PRC subsidiary, which are foreign-invested enterprises, cannot exceed statutory limits based on the difference between the amount of our investments and registered capital in such subsidiary, and shall be registered with China’s State Administration of Foreign Exchange (“SAFE”), or its local counterparts. Furthermore, any capital increase contributions we make to our PRC subsidiary, which are foreign-invested enterprises, shall be approved by China’s Ministry of Commerce (“MOFCOM”), or its local counterparts. We may not be able to obtain these government registrations or approvals on a timely basis, if at all. If we fail to obtain such approvals or make such registration, our ability to make equity contributions or provide loans to our Company’s PRC subsidiary or to fund its operations may be negatively affected, which may adversely affect their liquidity and ability to fund their working capital and expansion projects and meet their obligations and commitments. As a result, our liquidity and our ability to fund and expand our business may be negatively affected.

Adverse changes in political and economic policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could reduce the demand for our products and materially and adversely affect our competitive position.

All of our business operations are conducted in China. Accordingly, our business, results of operations, financial condition and prospects are subject to economic, political and legal developments in China. Although the Chinese economy is no longer a planned economy, the PRC government continues to exercise significant control over China’s economic growth through direct allocation of resources, monetary and tax policies, and a host of other government policies such as those that encourage or restrict investment in certain industries by foreign investors, control the exchange between RMB and foreign currencies, and regulate the growth of the general or specific market. These government involvements have been instrumental in China’s significant growth in the past 30 years. In response to the recent global and Chinese economic downturn, the PRC government has adopted policy measures aimed at stimulating the economic growth in China. If the PRC government’s current or future policies fail to help the Chinese economy achieve further growth or if any aspect of the PRC government’s policies limits the growth of our industry or otherwise negatively affects our business, our growth rate or strategy, our results of operations could be adversely affected as a result.

Under the Enterprise Income Tax Law, we may be classified as a “Resident Enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC shareholders.

China passed the Enterprise Income Tax Law, or the EIT Law, which effective on December 29, 2018, and its implementing rules, which became effective on April 23, 2019. Under the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes, which is subject to an EIT rate of 25.0% on its global income. The implementing rules of the EIT Law define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise.

On April 22, 2009, the State Administration of Taxation of China issued the Notice Concerning Relevant Issues Regarding Cognizance of Chinese Investment Controlled Enterprises Incorporated Offshore as Resident Enterprises pursuant to Criteria of de facto Management Bodies, or the Notice, further interpreting the application of the EIT Law and its implementation to offshore entities controlled by a Chinese enterprise or group. Pursuant to the Notice, an enterprise incorporated in an offshore jurisdiction and controlled by a Chinese enterprise or group will be classified as a “non-domestically incorporated resident enterprise” if (i) its senior management in charge of daily operations reside or perform their duties mainly in China; (ii) its financial or personnel decisions are made or approved by bodies or persons in China; (iii) its substantial assets and properties, accounting books, corporate stamps, board and shareholder minutes are kept in China; and (iv) over half of its directors with voting rights or senior management reside in China. A resident enterprise would be subject to an enterprise income tax rate of 25% on its worldwide income and must pay a withholding tax at a rate of 10% when paying dividends to its non-PRC shareholders. Because substantially all of our operations and senior management are located within the PRC and are expected to remain so for the foreseeable future, we may be considered a PRC resident enterprise for enterprise income tax purposes and therefore subject to the PRC enterprise income tax at the rate of 25% on its worldwide income. However, it remains unclear as to whether the Notice is applicable to an offshore enterprise controlled by a Chinese natural person. Therefore, it is unclear how tax authorities will determine tax residency based on the facts of each case.

If the PRC tax authorities determine that we are a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. In our case, this would mean that income such as non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Currently, we do not have any non-China source income, as we conduct our sales in China. However, under the EIT Law and its implementing rules, dividends paid to us from our PRC subsidiary would be deemed as “qualified investment income between resident enterprises” and therefore qualify as “tax-exempt income” pursuant to clause 26 of the EIT Law. Second, it is possible that future guidance issued with respect to the new “resident enterprise” classification could result in a situation in which the dividends we pay with respect to our Ordinary Shares, or the gain our non-PRC shareholders may realize from the transfer of our Ordinary Shares, may be treated as PRC-sourced income and may therefore be subject to a 10% PRC withholding tax. The EIT Law and its implementing regulations are, however, relatively new and ambiguities exist with respect to the interpretation and identification of PRC-sourced income, and the application and assessment of withholding taxes. If we are required under the EIT Law and its implementing regulations to withhold PRC income tax on dividends payable to our non-PRC shareholders, or if non-PRC shareholders are required to pay PRC income tax on gains on the transfer of their Ordinary Shares, our business could be negatively impacted and the value of your investment may be materially reduced. Further, if we were treated as a “resident enterprise” by PRC tax authorities, we would be subject to taxation in both China and such countries in which we have taxable income, and our PRC tax may not be creditable against such other taxes.

We may be exposed to liabilities under the Foreign Corrupt Practices Act and Chinese anti-corruption law.

We are subject to the U.S. Foreign Corrupt Practices Act (the “FCPA”), and other laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. persons and issuers as defined by the statute for the purpose of obtaining or retaining business. We are also subject to Chinese anti-corruption laws, which strictly prohibit the payment of bribes to government officials. We have operations, agreements with third parties, and make sales in China, which may experience corruption. Our activities in China create the risk of unauthorized payments or offers of payments by one of the employees, consultants or distributors of our Company, because these parties are not always subject to our control.

Although we believe to date we have complied in all material respects with the provisions of the FCPA and Chinese anti-corruption law, our existing safeguards and any future improvements may prove to be less than effective, and the employees, consultants or distributors of our Company may engage in conduct for which we might be held responsible. Violations of the FCPA or Chinese anti-corruption law may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could negatively affect our business, operating results and financial condition. In addition, the government may seek to hold our Company liable for successor liability FCPA violations committed by companies in which we invest or that we acquire.

Uncertainties with respect to the PRC legal system could adversely affect us.

We conduct all of our business through our PRC subsidiary, our VIE and its subsidiaries in China. Our operations in China are governed by PRC laws and regulations. Our PRC subsidiary, our VIE and its subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws and regulations applicable to wholly foreign-owned enterprises. The PRC legal system is a civil law system based on statutes. Prior court decisions may be cited for reference but have limited precedential value. The PRC legal system is evolving rapidly, and the interpretations of many laws, regulations and rules may contain inconsistencies and enforcement of these laws, regulations and rules involves uncertainties.

Since 1979, PRC legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, China has not developed a fully integrated legal system and recently enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, because these laws and regulations are relatively new, and because of the limited volume of published decisions and their nonbinding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. In addition, the PRC legal system is based in part on government policies and internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until sometime after the violation. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. Such unpredictability towards our contractual, property (including intellectual property) and procedural rights could adversely affect our business and impede our ability to continue our operations.

PRC regulation of loans and direct investment by offshore holding companies to PRC entities may delay or prevent us from making loans or additional capital contributions to our PRC subsidiaries, which could materially and adversely affect our liquidity and our ability to fund and expand our business.

Any loans to our PRC subsidiary and Affiliated Entities are subject to PRC regulations. For example, loans by us to our subsidiary or Affiliated Entities in China, which are FIEs, to finance their activities cannot exceed statutory limits and must be registered with SAFE. On March 30, 2015, SAFE promulgated Hui Fa [2015] No.19, which last amended on 30 December,2019, a notice regulating the conversion by a foreign-invested company of foreign currency into RMB. The foreign exchange capital, for which the monetary contribution has been confirmed by the foreign exchange authorities (or for which the monetary contribution has been registered for account entry) in the capital account of a foreign-invested enterprise may be settled at a bank as required by the enterprise’s actual management needs. Foreign-funded equity investment enterprises with investment as their main business (including foreign-funded investment companies, foreign-funded venture capital enterprises and foreign-funded equity investment enterprises) are allowed to directly settle foreign exchange capital or transfer the RMB funds in the account for settled foreign exchange to be paid to the investee's account according to the actual investment scale under the premise that the domestic projects funded by them are true and comply with the relevant regulations.

On May 11, 2013, SAFE released Circular 21, which came into effect on May 13, 2013. According to Circular 21, SAFE has simplified the foreign exchange administration procedures with respect to the registration, account openings and conversions, settlements of FDI-related foreign exchange, as well as fund remittances.

Circular 21 may significantly limit our ability to convert, transfer and use the net proceeds from any offering of additional equity securities in China, which may adversely affect our liquidity and our ability to fund and expand our business in the PRC.

We may also decide to finance our subsidiaries by means of capital contributions. These capital contributions must be approved by MOFCOM or its local counterpart, which usually takes no more than 30 working days to complete. We may not be able to obtain these government approvals on a timely basis, if at all, with respect to future capital contributions by us to our PRC subsidiaries. If we fail to receive such approvals, we will not be able to capitalize our PRC operations, which could adversely affect our liquidity and our ability to fund and expand our business.

Governmental control of currency conversion may affect the value of your investment.

The PRC government imposes controls on the convertibility of the RMB into foreign currencies and, in certain cases, the remittance of currency out of China. We receive substantially all of our revenues in RMB. Under our current corporate structure, our income is primarily derived from dividend payments from our PRC subsidiaries. Shortages in the availability of foreign currency may restrict the ability of our PRC subsidiaries to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy their foreign currency denominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from trade-related transactions can be made in foreign currencies without prior approval from SAFE by complying with certain procedural requirements. However, approval from appropriate government authorities is required where RMB is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of loans denominated in foreign currencies. The PRC government may also at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay dividends in foreign currencies to our security-holders.

We are a holding company and we rely for funding on dividend payments from our subsidiaries, which are subject to restrictions under PRC laws.

We are a holding company incorporated in the Cayman Islands, and we operate our core businesses through our VIE and its subsidiaries in the PRC. Therefore, the availability of funds for us to pay dividends to our shareholders and to service our indebtedness depends upon dividends received from our VIE and its subsidiaries. If our VIE and its subsidiaries incur debt or losses, their ability to pay dividends or other distributions to us may be impaired. As a result, our ability to pay dividends and to repay our indebtedness will be restricted. PRC laws require that dividends be paid only out of the after-tax profit of our PRC subsidiaries calculated according to PRC accounting principles, which differ in many aspects from generally accepted accounting principles in other jurisdictions. PRC laws also require enterprises established in the PRC to set aside part of their after-tax profits as statutory reserves. These statutory reserves are not available for distribution as cash dividends. In addition, restrictive covenants in bank credit facilities or other agreements that we or our subsidiaries may enter into in the future may also restrict the ability of our subsidiaries to pay dividends to us. These restrictions on the availability of our funding may impact our ability to pay dividends to our shareholders and to service our indebtedness.

Our business may be materially and adversely affected if any of our PRC subsidiaries declare bankruptcy or become subject to a dissolution or liquidation proceeding.

The Enterprise Bankruptcy Law of the PRC, or the Bankruptcy Law, came into effect on June 1, 2007. The Bankruptcy Law provides that an enterprise will be liquidated if the enterprise fails to settle its debts as and when they fall due and if the enterprise’s assets are, or are demonstrably, insufficient to clear such debts.

Our PRC subsidiaries hold certain assets that are important to our business operations. If any of our PRC subsidiaries undergoes a voluntary or involuntary liquidation proceeding, unrelated third-party creditors may claim rights to some or all of these assets, thereby hindering our ability to operate our business, which could materially and adversely affect our business, financial condition and results of operations.

According to SAFE’s Notice of the State Administration of Foreign Exchange on Further Improving and Adjusting Foreign Exchange Administration Policies for Direct Investment, promulgated on November 19, 2012 and amended on May 4, 2015, and the Provisions on the Foreign Exchange Administration of Domestic Direct Investment of Foreign Investors, effective on May 13, 2013, if any of our PRC subsidiaries undergoes a voluntary or involuntary liquidation proceeding, prior approval from SAFE for remittance of foreign exchange to our shareholders abroad is no longer required, but we still need to conduct a registration process with the SAFE local branch. It is not clear whether “registration” is a mere formality or involves the kind of substantive review process undertaken by SAFE and its relevant branches in the past.

Recent joint statement by the SEC and PCAOB, proposed rule changes submitted by Nasdaq, and an act passed by the US Senate all call for additional and more stringent criteria to be applied to emerging market companies upon assessing the qualification of their auditors, especially the non-U.S. auditors who are not inspected by the PCAOB. These developments could add uncertainties to our continued listing on Nasdaq in the future.

In May 2013, the PCAOB announced that it had entered into a Memorandum of Understanding on Enforcement Cooperation with the China Securities Regulatory Commission, or the CSRC, and the PRC Ministry of Finance, which establishes a cooperative framework between the parties for the production and exchange of audit documents relevant to investigations undertaken by the PCAOB, the CSRC or the PRC Ministry of Finance in the United States and the PRC, respectively. The PCAOB continues to be in discussions with the CSRC, and the PRC Ministry of Finance to permit joint inspections in the PRC of audit firms that are registered with PCAOB and audit Chinese companies that trade on U.S. exchanges.

On December 7, 2018, the SEC and the PCAOB issued a joint statement highlighting continued challenges faced by the U.S. regulators in their oversight of financial statement audits of U.S.-listed companies with significant operations in China. The joint statement reflects a heightened interest in an issue that has vexed U.S. regulators in recent years.

On April 21, 2020, SEC Chairman Jay Clayton and PCAOB Chairman William D. Duhnke III, along with other senior SEC staff, released a joint statement highlighting the risks associated with investing in companies based in or have substantial operations in emerging markets including China. The joint statement emphasized the risks associated with lack of access for the PCAOB to inspect auditors and audit work papers in China and higher risks of fraud in emerging markets.

On June 4, 2020, the U.S. President issued a memorandum ordering the President’s Working Group on Financial Markets, or the PWG, to submit a report to the President within 60 days of the memorandum that includes recommendations for actions that can be taken by the executive branch and by the SEC or PCAOB on Chinese companies listed on U.S. stock exchanges and their audit firms, in an effort to protect investors in the U.S.

On August 6, 2020, the PWG released a report recommending that the SEC take steps to implement the five recommendations outlined in the report. In particular, to address companies from jurisdictions that do not provide the PCAOB with sufficient access to fulfill its statutory mandate, or NCJs, the PWG recommends enhanced listing standards on U.S. stock exchanges. This would require, as a condition to initial and continued exchange listing, PCAOB access to work papers of the principal audit firm for the audit of the listed company. Companies unable to satisfy this standard as a result of governmental restrictions on access to audit work papers and practices in NCJs may satisfy this standard by providing a co-audit from an audit firm with comparable resources and experience where the PCAOB determines it has sufficient access to audit work papers and practices to conduct an appropriate inspection of the co-audit firm. There is currently no legal process under which such a co-audit may be performed in China. The report permits the new listing standards to provide for a transition period until January 1, 2022 for listed companies, but would apply immediately to new listings once the necessary rulemakings and/or standard-setting are effective. The measures in the PWG Report are presumably subject to the standard SEC rulemaking process before becoming effective. On August 10, 2020, the SEC announced that SEC Chairman had directed the SEC staff to prepare proposals in response to the PWG Report, and that the SEC was soliciting public comments and information with respect to these proposals. Since we are listed on the Nasdaq Global Market, if we fail to meet the new listing standards before the deadline specified thereunder due to factors beyond our control, we could face possible de-listing from the Nasdaq Stock Market, deregistration from the SEC and/or other risks, which may materially and adversely affect, or effectively terminate, our Ordinary Shares trading in the United States.

The lack of access to the PCAOB inspection in China prevents the PCAOB from fully evaluating audits and quality control procedures of the auditors based in China. As a result, the investors may be deprived of the benefits of such PCAOB inspections. The inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of these accounting firms’ audit procedures or quality control procedures as compared to auditors outside of China that are subject to the PCAOB inspections, which could cause existing and potential investors in our stock to lose confidence in our audit procedures and reported financial information and the quality of our financial statements.

Our auditor, the independent registered public accounting firm that issues the audit report included elsewhere in this prospectus, as an auditor of companies that are traded publicly in the United States and a firm registered with the PCAOB, is subject to laws in the United States pursuant to which the PCAOB conducts regular inspections to assess its compliance with the applicable professional standards. Our auditor is headquartered in Manhattan, New York, and has been inspected by the PCAOB on a regular basis with the last inspection in May 2018 and an ongoing inspection that started in October 2020. The recent developments would add uncertainties to our offering and we cannot assure you whether the national securities exchange we apply to for listing or regulatory authorities would apply additional and more stringent criteria to us after considering the effectiveness of our auditor’s audit procedures and quality control procedures, adequacy of personnel and training, or sufficiency of resources, geographic reach, or experience as it relates to our audit.

Substantial uncertainties exist with respect to the interpretation of the PRC Foreign Investment Law and how it may impact the viability of our current corporate structure, corporate governance and business operations.

The Ministry of Commerce published a discussion draft of the proposed Foreign Investment Law in January 2015, or the 2015 FIL Draft, which expands the definition of foreign investment and introduces the principle of “actual control” in determining whether a company is considered a foreign-invested enterprise, or an FIE. Under the 2015 FIL Draft, VIEs that are controlled via contractual arrangement would also be deemed as foreign invested enterprises, if they are ultimately “controlled” by foreign investors.

On March 15, 2019, the National People’s Congress approved the Foreign Investment Law of the PRC, or the FIL, which came into effect on January 1, 2020, repealing simultaneously the Law of the PRC on Chinese-foreign Equity Joint Ventures, the Law of the PRC on Wholly Foreign-owned Enterprises and the Law of the PRC on Chinese-foreign Cooperative Joint Ventures, together with their implementation rules and ancillary regulations. Pursuant to the FIL, foreign investment refers to any investment activity within China directly or indirectly carried out by foreign natural persons, enterprises, or other organizations, including investment in new construction project, establishment of foreign funded enterprise or increase of investment within China alone or jointly with any other investor, merger and acquisition, and investment in any other way stipulated under laws, administrative regulations, or provisions of the State Council. Although the FIL has deleted the particular reference to the concept of “actual control” and contractual arrangements compared to the 2015 FIL Draft, there is no assurance that foreign investment via contractual arrangement would not be interpreted as a type of indirect foreign investment activities in the future. In addition, the definition contains a catch-all provision providing that investments made by foreign investors through other methods specified in laws or administrative regulations or other methods prescribed by the State Council, which leaves leeway for future laws, administrative regulations or provisions promulgated by the State Council to provide for contractual arrangements as a method of foreign investment. Given the foregoing, it is uncertain whether our contractual arrangements will be deemed to be in violation of the market entry clearance requirements for foreign investment under the PRC laws and regulations.

Even if our VIE were to be identified as a FIE in the future, we believe that our current business would not be adversely affected. However, if we were to engage in any business conduct involving third parties identified as prohibited or restricted on the Negative List, our VIE as well as Gansu QLS and its subsidiaries may be subject to laws and regulations on foreign investment. Such might be the case for Gansu QLS’s proposed acquisition of enterprises manufacturing traditional Chinese medicine pieces. In addition, our shareholders would also be prohibited or restricted to invest in certain sectors on the Negative List. However, even if our VIE were to be identified as a FIE, the validity of our contractual arrangements with Gansu QLS and its shareholders as well as our corporate structure would not be adversely affected. We would still be able to receive benefits from our VIE in accordance with the contractual agreements. In addition, as the Chinese government has been updating the Negative List in recent years and reducing the sectors prohibited or restricted for foreign investment, it is probable in the future that, even if our VIE is identified as a FIE, it is still allowed to acquire or hold equity of enterprises in sectors currently prohibited or restricted for foreign investment.

It may be difficult for overseas regulators to conduct investigation or collect evidence within China.

Shareholder claims or regulatory investigation that are common in the United States generally are difficult to pursue as a matter of law or practicality in China. For example, in China, there are significant legal and other obstacles to providing information needed for regulatory investigations or litigations initiated outside China. Although the authorities in China may establish a regulatory cooperation mechanism with the securities regulatory authorities of another country or region to implement cross-border supervision and administration, such cooperation with the securities regulatory authorities in the Unities States may not be efficient in the absence of mutual and practical cooperation mechanism. Furthermore, according to Article 177 of the PRC Securities Law, which became effective in March 2020, no overseas securities regulator is allowed to directly conduct investigation or evidence collection activities within the PRC territory. While detailed interpretation of or implementation rules under Article 177 have yet to be promulgated, the inability for an overseas securities regulator to directly conduct investigation or evidence collection activities within China may further increase the difficulties you face in protecting your interests. See also "—Risks Related to the Offering and Our Ordinary Shares— The laws of the Cayman Islands may not provide our shareholders with benefits comparable to those provided to shareholders of corporations incorporated in the United States. For instance, you may face difficulties in protecting your interests, and your ability to protect your rights through U.S. courts may be limited, because we are incorporated under Cayman Islands law." for risks associated with investing in us as a Cayman Islands company.

You may experience difficulties in effecting services of legal process, enforcing foreign judgments or bringing actions in China against us or our management named in the prospectus based on foreign laws.

We are an exempted company incorporated under the laws of the Cayman Islands; however, we conduct all of our operations in China and most of our assets are located in China. In addition, all of our directors and executive officers are nationals or residents of the PRC and most of their assets are located outside the United States. As a result, it may be difficult for you to effect service of process upon us or our management named in the prospectus inside mainland China. It may also be difficult for you to enforce in U.S. courts of the judgments obtained in U.S. courts based on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors. In addition, there is uncertainty as to whether the courts of the Cayman Islands or the PRC would recognize or enforce judgments of U.S. courts against us or such persons predicated upon the civil liability provisions of the securities laws of the United States or any state.

The recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedures Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based either on treaties between China and the country where the judgment is made or on principles of reciprocity between jurisdictions. China does not have any treaties or other forms of written arrangement with the United States that provide for the reciprocal recognition and enforcement of foreign judgments. In addition, according to the PRC Civil Procedures Law, the PRC courts will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates the basic principles of PRC laws or national sovereignty, security or public interest. As a result, it is uncertain whether and on what basis a PRC court would enforce a judgment rendered by a court in the United States.

The custodians or authorized users of our controlling non-tangible assets, including chops and seals, may fail to fulfill their responsibilities, or misappropriate or misuse these assets.

Under the PRC law, legal documents for corporate transactions, including agreements and contracts are executed using the chop or seal of the signing entity or with the signature of a legal representative whose designation is registered and filed with relevant PRC market regulation administrative authorities.

In order to secure the use of our chops and seals, we have established internal control procedures and rules for using these chops and seals. In any event that the chops and seals are intended to be used, the responsible personnel will submit an application and the application will be verified and approved by authorized employees in accordance with our internal control procedures and rules. In addition, in order to maintain the physical security of our chops, we generally have them stored in secured locations accessible only to authorized employees. Although we monitor such authorized employees, the procedures may not be sufficient to prevent all instances of abuse or negligence. There is a risk that our employees could abuse their authority, for example, by entering into a contract not approved by us or seeking to gain control of one of our subsidiaries or our VIEs or their subsidiaries. If any employee obtains, misuses or misappropriates our chops and seals or other controlling non-tangible assets for whatever reason, we could experience disruption to our normal business operations. We may have to take corporate or legal action, which could involve significant time and resources to resolve and divert management from our operations.

Fluctuations in exchange rates could adversely affect our business and the value of our securities.

Changes in the value of the RMB against the U.S. dollar, Euro and other foreign currencies are affected by, among other things, changes in China’s political and economic conditions. Any significant revaluation of the RMB may have a material adverse effect on our revenues and financial condition, and the value of, and any dividends payable on our shares in U.S. dollar terms. For example, to the extent that we need to convert U.S. dollars we receive from our initial public offering into RMB for our operations, appreciation of the RMB against the U.S. dollar would have an adverse effect on RMB amount we would receive from the conversion. Conversely, if we decide to convert our RMB into U.S. dollars for the purpose of paying dividends on our Ordinary Shares or for other business purposes, appreciation of the U.S. dollar against the RMB would have a negative effect on the U.S. dollar amount available to us. In addition, fluctuations of the RMB against other currencies may increase or decrease the cost of imports and exports, and thus affect the price-competitiveness of our products against products of foreign manufacturers or products relying on foreign inputs.

Since July 2005, the RMB is no longer pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future PRC authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.

Increases in labor costs in the PRC may adversely affect our business and results of operations.

The currently effective PRC Labor Contract Law, or the Labor Contract Law was first adopted on June 29, 2007, later amended on December 28, 2012 and effective on 1 July,2013. The PRC Labor Contract Law has reinforced the protection of employees who, under the Labor Contract Law, have the right, among others, to have written employment contracts, to enter into employment contracts with no fixed term under certain circumstances, to receive overtime wages and to terminate or alter terms in labor contracts. Furthermore, the Labor Contract Law sets forth additional restrictions and increases the costs involved with dismissing employees. To the extent that we need to significantly reduce our workforce, the Labor Contract Law could adversely affect our ability to do so in a timely and cost-effective manner, and our results of operations could be adversely affected. In addition, for employees whose employment contracts include non-competition terms, the Labor Contract Law requires us to pay monthly economic compensation after such employment is terminated, which will increase our operating expenses.

We expect that our labor costs, including wages and employee benefits, will continue to increase. Unless we are able to pass on these increased labor costs to our customers by increasing the prices of our products and services, our financial conditions and results of operations would be materially and adversely affected.

Part of our shareholders are not in compliance with the PRC’s regulations relating to offshore investment activities by PRC residents, and as a result, the shareholders may be subject to penalties if we are not able to remediate the non-compliance.

In July 2014, the State Administration of Foreign Exchange promulgated the Circular on Issues Concerning Foreign Exchange Administration over the Overseas Investment and Financing and Roundtrip Investment by Domestic Residents via Special Purpose Vehicles, or “Circular 37”. According to Circular 37, prior registration with the local SAFE branch is required for Chinese residents to contribute domestic assets or interests to offshore companies, known as special purpose vehicles, or SPVs. Circular 37 further requires amendment to a PRC resident’s registration in the event of any significant changes with respect to the SPV, such as an increase or decrease in the capital contributed by PRC individuals, share transfer or exchange, merger, division, or other material event. Further, foreign investment enterprises established by way of round-tripping shall complete the relevant foreign exchange registration formalities pursuant to the prevailing foreign exchange control provisions for direct investments by foreign investors, and disclose the relevant information such as actual controlling party of the shareholders truthfully.

There are a total of 151 Gansu QLS shareholders, who are PRC residents. Amongst them, 121 have signed the VIE agreements, but only 81 have completed the Circular 37 Registration. The remaining 40 shareholders who have yet to complete the Circular 37 Registration hold a total of 4.5% of shares of Gansu QLS. We have asked our shareholders who are Chinese residents to make the necessary applications and filings as required by Circular 37. We attempt to comply, and attempt to ensure that our shareholders who are subject to these rules comply, with the relevant requirements. We cannot, however, provide any assurances that all of our shareholders who are Chinese residents will comply with our request to make or obtain any applicable registration or comply with other requirements required by Circular 37 or other related rules. The Chinese resident shareholders’ failure to comply with Circular 37 registration would not impose penalties on our company, while it may result in restrictions being imposed on part of foreign exchange activities of the offshore special purpose vehicles, including restrictions on its ability to receive registered capital as well as additional capital from Chinese resident shareholders who fail to complete Circular 37 registration; and repatriation of profits and dividends derived from special purpose vehicles to China, by the Chinese resident shareholders who fail to complete Circular 37 registration, are also illegal. In addition, the failure of the Chinese resident shareholders to complete Circular 37 registration may subject each of the shareholders to fines less than RMB50,000. We cannot assure you that each of our Chinese resident shareholders will in the future complete the registration process as required by Circular 37.

We are not in compliance with the PRC’s regulations relating to employee’s social insurance and housing funds, and as a result, Gansu QLS and its subsidiaries may be subject to penalties if we are not able to remediate the non-compliance.

Pursuant to the Social Security Law of the PRC, or the Social Security Law, which was promulgated by the SCNPC on October 28, 2010 and amended on December 29, 2018, employers shall pay the basic pension insurance, medical insurance, work-related injury insurance, unemployment insurance and maternity insurance for employees. Gansu QLS has not deposited social security premium for part of employees in accordance with the Social Security Law. Although Gansu QLS has failed to deposit social security premiums in full, we believes that no additional amount is required to be paid by Gansu QLS since (i) some of the employees of Gansu QLS are over the age limit to be paid social insurance fees, and some chose to waive receiving social insurance fees deposited by Gansu QLS and decided to participate in their own voluntary social insurance plans instead; and (ii) pursuant to the Emergency Notice on Practicing Principles of the State Council Executive Meeting and Stabilizing Work on Collecting Social Insurance Premiums promulgated by the Ministry of Human Resources and Social Security on September 21, 2018, local authorities are prohibited from recovering the unpaid social insurance premiums from enterprises. Thus, it is unlikely that the overdue social insurance premiums would be ordered to be repaid by Gansu QLS.

In accordance with the Regulation on Management of Housing Provident Fund (the “Regulations of HPF”), which were promulgated by the PRC State Council on April 3, 1999, and last amended on March 24, 2019, employers must register at the designated administrative centers and open bank accounts for employees’ housing funds deposits. Employers and employees are also required to pay and deposit housing funds in an amount no less than 5% of the monthly average salary of each of the employees in the preceding year in full and on time. Gansu QLS had not opened such bank accounts or deposited its employees’ housing funds until August 2019. On the basis that: (i) Gansu QLS has opened the account for housing funds and deposited housing funds for staff since August 2019; and (ii) according to the interview with local housing fund administration authorities by our PRC Legal Counsel, the local authorities had not taken enforceable measures to collect housing funds from local enterprises; we think it is unlikely that the overdue unpaid housing fund would be ordered to be recovered from Gansu QLS. However, Chengdu QLS has not opened bank accounts for its employees’ housing funds deposits, nor has it deposited employees’ housing funds in accordance with the Regulations of HPF. Thus, Chengdu QLS may be ordered by PRC authorities to open a housing funds account, make the payment, and deposit an amount required by the PRC authorities within a prescribed time limit. Chengdu QLS may be required to pay an aggregate amount of RMB 92,874 (as of March 31, 2020) for its failure to deposit housing funds. If Chengdu QLS fails to comply to PRC authorities’ order within the prescribed time limit, a court ordered compulsory enforcement may be adopted and a fine of no less than RMB10,000 but no more than RMB50,000 shall be imposed.

Since we failed to make adequate social insurance and housing fund contributions, we may be subject to fines and legal sanctions, and our business, financial condition and results of operations may be adversely affected.

If we become directly subject to the recent scrutiny, criticism and negative publicity involving U.S.-listed Chinese companies, we may have to expend significant resources to investigate and resolve the matter which could harm our business operations and our reputation and could result in a loss of your investment in our stock, especially if such matter cannot be addressed and resolved favorably.

Recently, U.S. public companies that have substantially all of their operations in China, have been the subject of intense scrutiny, criticism and negative publicity by investors, financial commentators and regulatory agencies, such as the SEC. Much of the scrutiny, criticism and negative publicity has centered around financial and accounting irregularities, a lack of effective internal controls over financial accounting, inadequate corporate governance policies or a lack of adherence thereto and, in many cases, allegations of fraud. As a result of the scrutiny, criticism and negative publicity, the publicly traded stock of many U.S. listed Chinese companies has sharply decreased in value and, in some cases, has become virtually worthless. Many of these companies are now subject to shareholder lawsuits and SEC enforcement actions and are conducting internal and external investigations into the allegations. It is not clear what effect this sector-wide scrutiny, criticism and negative publicity will have on our Company and our business. If we become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, we will have to expend significant resources to investigate such allegations and/or defend the Company. This situation may be a major distraction to our management. If such allegations are not proven to be groundless, our Company and business operations will be severely hampered and your investment in our stock could be rendered worthless.

You may face difficulties in protecting your interests and exercising your rights as a shareholder since we conduct substantially all of our operations in China, and almost all of our officers and directors reside outside the U.S.

Although we are incorporated in the Cayman Islands, we conduct substantially all of our operations in China. All of our current officers and almost all of our directors reside outside the U.S. and substantially all of the assets of those persons are located outside of the U.S. It may be difficult for you to conduct due diligence on the Company or such directors in your election of the directors and attend shareholders meeting if the meeting is held in China. We plan to have one shareholder meeting each year at a location to be determined, potentially in China. As a result of all of the above, our public shareholders may have more difficulty in protecting their interests through actions against our management, directors or major shareholders than would shareholders of a corporation doing business entirely or predominantly within the U.S.

If we are classified as a passive foreign investment company, United States taxpayers who own our Ordinary Shares may have adverse United States federal income tax consequences.

A non-U.S. corporation such as ourselves will be classified as a passive foreign investment company, which is known as a PFIC, for any taxable year if, for such year, either:

Passive income generally includes dividends, interest, rents and royalties (other than rents or royalties derived from the active conduct of a trade or business), and gains from the disposition of passive assets.

If we are determined to be a PFIC for any taxable year (or portion thereof) that is included in the holding period of a U.S. taxpayer who holds our Ordinary Shares, the U.S. taxpayer may be subject to increased U.S. federal income tax liability and may be subject to additional reporting requirements.

Depending on our assets held for the production of passive income, it is possible that, for our 2021 taxable year or for any subsequent year, more than 50% of our assets may be assets which produce passive income, in which case we would be deemed a PFIC, which could have adverse US federal income tax consequences for US taxpayers who are shareholders. We will make this determination following the end of any particular tax year.

Although the law in this regard is unclear, we treat our consolidated affiliated entities as being owned by us for United States federal income tax purposes, not only because we exercise effective control over the operation of such entities but also because we are entitled to substantially all of their economic benefits, and, as a result, we consolidate their operating results in our consolidated financial statements. For purposes of the PFIC analysis, in general, a non-U.S. corporation is deemed to own its pro rata share of the gross income and assets of any entity in which it is considered to own at least 25% of the equity by value. See “Item 10. Additional Information—E. Taxation—United States Federal Income Tax Considerations—Passive Foreign Investment Company Considerations.”

ITEM 4. INFORMATION ON THE COMPANY 

A. History and Development of the Company 

Qilian International Holding Group Limited is a Cayman Islands exempted company with limited liability incorporated on February 7, 2019. Qilian International (Hong Kong) Holdings Limited., which we refer to as “Qilian HK”, our wholly-owned subsidiary, was incorporated in Hong Kong on January 30, 2019. Chengdu Qilian Trading Co., Ltd., which we refer to as “WFOE”, Qilian HK’s wholly owned subsidiary, was organized pursuant to PRC laws on May 15, 2019 Our variable interest entity, Gansu Qilianshan Pharmaceutical Co. Ltd., which we refer to as Gansu QLS, was established in August 30, 2006, as a result of restructuring from Gansu State-operated Qilianshan Pharmaceutical Factory, which was incorporated in July 1969 in Jiuquan, Gansu Province, PRC pursuant to PRC laws. Gansu QLS’ shareholders include certain PRC residents and corporate entities controlled by PRC residents.

Pursuant to PRC laws, each entity formed under PRC law shall have certain business scope approved by the Administration of Industry and Commerce or its local counterpart. As such, WFOE’s business scope is to primarily engage in business development, technology service, technology consulting, intellectual property service and business management consulting. Since the sole business of WFOE is to provide Gansu QLS with technical support, consulting services and other management services relating to its day-to-day business operations and management in exchange for a consulting fee, which is at WFOE’s discretion and can be the net income of Gansu QLS, such business scope is necessary and appropriate under the PRC laws. Gansu QLS, on the other hand, has been granted a business scope different from WFOE to enable it to develop, manufacture, market and sell its products.

Since we intend to acquire upstream and downstream companies manufacturing traditional Chinese medicine pieces, which is prohibited to be invested in by foreign investors, our WFOE cannot hold equity of Gansu QLS. We control Gansu QLS through contractual agreements, which are described under “Business — Contractual Agreements between WFOE and Gansu QLS”. Qilian International is a holding company with no business operation other than holding the shares in Qilian HK and Qilian HK is a pass-through entity with no business operation. WFOE is exclusively engaged in the business of managing the operation of Gansu QLS and its subsidiaries.

Gansu QLS, our VIE, was established in August 30, 2006, by restructuring from Gansu State-operated Qilianshan Pharmaceutical Factory, which was incorporated in July 1969 in Jiuquan, Gansu Province, PRC pursuant to PRC laws.

On April 17, 2020, Rugao Tianlu Animal Products Co., Ltd. was incorporated under the laws of the People’s Republic of China (“Rugao”). Rugao is the 100% owned subsidiary of Chengdu QLS. We aim to use it as procurement and manufacturing assistance entity for Chengdu QLS and as a point of expansion for our sausage casings business in Jiangsu Province.

On January 12, 2021, our Ordinary Shares commenced trading on the Nasdaq Global Market under the symbol “QLI.” We raised approximately US$25,705,959 in net proceeds from our initial public offering after deducting underwriting commissions and the offering expenses payable by us.

Our principal executive offices are located at at Jiuquan Economic and Technological Development Zone (formerly named No. 2 Dadeli Road, Nanjiao Industrial Park), Jiuquan City, Gansu, China. Our telephone at this address is +86-0937-2689523. We maintain a corporate website at http://www.qlsyy.net/. The information contained in our website is not a part of this annual report.

The SEC maintains a website at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC using its EDGAR system.

See “Item 5. Operating and Financial Review and Prospects—B. Liquidity and Capital Resources—Capital Expenditures” for a discussion of our capital expenditures.

B. Business Overview

Through our wholly owned indirect subsidiaries and the contractual arrangements described below, we are a pharmaceutical and chemical company based in China that focuses on the development, manufacture, marketing, and sale of oxytetracycline products, licorice products, traditional Chinese medicine derivatives (“TCMD”) product, heparin product, sausage casings, and fertilizers. We independently developed Gan Di Xin^® and Ahan® Antibacterial Paste within our research and development department. Our products are sold in more than 20 provinces in China.

Our Products

We currently manufacture ten products. We independently developed Gan Di Xin^® and Ahan® Antibacterial Paste within our research and development department. Our products are sold in more than 20 provinces in China. The following list outlines the Company’s current products under six categories— oxytetracycline products, licorice products, TCMD product, heparin product, sausage casings, and fertilizers.

The following is a detailed description of the Company’s current products and products in development.

Our Licorice Products

Gan Di Xin^®- As an enhanced type of compound licorice tablet, Gan Di Xin is an antitussive and expectorant medicine made from raw licorice materials. We have independently researched and developed Gan Di Xin using our patented purification, thin-film coating and inclusion technology (the “3-in-1 technology”, Patent Number ZL 200410030776.4, issued on October 25, 2006). The effective medical ingredients in compound licorice tablets become active only when they are absorbed by the bloodstream. However, traditional licorice tablets’ efficacy is drastically reduced when the effective medical ingredients are swallowed and enter the gastrointestinal tract. Rather than being absorbed by the bloodstream directly, the effective medical ingredients go through the liver’s metabolism process first, which renders the ingredients ineffective. Such phenomenon is called “first pass effect”. Our-3-in-1 technology has helped our Gan Di Xin bypass the so called “first pass effect” by allowing our Gan Di Xi to be dissolved slowly in patients’ mouths, whereby the active ingredients are absorbed through oral mucosa, enabling them to enter blood circulation directly rather than being metabolized by the liver. In this way, Gan Di Xin’s effectiveness can be preserved.

Gan Di Xin is currently categorized as a chemical medicine that falls under China’s State Category V New Drug. According to the New Drug Approval Methods promulgated in July 1985 and revised in April 1999 by the State Drug Administration of PRC, claims of new indications for marketed chemical drugs shall be categorized as a V Category New Drug in the application for approval. Since we applied to have Gan Di Xin approved as a marketed drug reducing dosages, thus adding new indications to already marketed drugs, when Gan Di Xin was approved, it was approved as a Category V New Drug. The application and approval procedures for Category V New Drugs are divided into two stages: clinical research and production and sale. The application for a Category V New Drug is pre-examined by the provincial branches of the National Medical Products Administration, and re-examined by the National Medical Products Administration. Gan Di Xin was issued the National New Drug Certificate (No. H20040463) on April 30, 2004 with Drug Registration Approval (No. 20040640). As a pharmaceutical manufacturer, Gansu QLS is subject to the national medicine quality standard of WS1-(X-001)-2015Z for product registration and manufacturing.

Our Gan Di Xin^® is innovative in terms of its unconventional administration methods, taste, and efficacy. Our unique manufacturing process, the abundance of local source materials and our geographical location are crucial elements contributing to the success our Gan Di Xin^®.

We introduced Gan Di Xin^® to the Chinese market in 2004. Gan Di Xin® has enjoyed growing popularity in recent years due to its easy administration method, strong efficacy, and soothing taste. We sold approximately 108 million pieces in 2017, and 310 million pieces in 2018, and 163 million pieces in 2019. Gan Di Xin^® was awarded “Famous Trademark of Gansu Province” in 2011 by the Gansu Famous Brand Strategy Promotion Committee of the Gansu government. Gan Di Xin^® was also awarded “China Chemical and Pharmaceutical Industry’s Excellent Product Brand” in 2013 by the China Chemical Pharmaceutical Industry Association, China Pharmaceutical Business Association, China Non-Prescription Drug Association, and China Pharmaceutical Enterprise Development and Promotion Association. Currently, we sell Gan Di Xin^® in more than 20 provinces in China.

Qilian Shan^® Licorice Extract and Qilian Shan^® Licorice Liquid Extract — Our licorice extract is a type of API made from processed high quality licorice. Our licorice liquid extract is a type of API made from fluid extract of further processed licorice extract. Our licorice extract is the primary product for pharmaceutical companies to manufacture traditional licorice tablets. Our licorice liquid extract is the primary product for medical preparation companies to produce compound licorice oral solutions. Both the traditional compound licorice tablets and compound licorice oral solutions are prescriptive palliatives that help to relieve the symptoms of mucosa irritations and gastrointestinal smooth muscle spasms; they are also used in treating bronchitis, bronchial asthma, throat inflammation and chronic adrenal insufficiency.

Our Oxytetracycline Products

Qilian Shan^® Oxytetracycline Tablets – Oxytetracycline is a yellow crystalline broad-spectrum antibiotic C22H24N2O9, which is active against a wide variety of bacteria. Oxytetracycline works by interfering with the ability of bacteria to produce essential proteins. Without these proteins, the bacteria cannot grow, multiply and increase in numbers. Oxytetracycline therefore stops the spread of the infection and the remaining bacteria are killed by the immune system or eventually die.

We use the active ingredient oxytetracycline to manufacture oxytetracycline tablets. Our Qilian Shan^® Oxytetracycline Tablets are used to prevent and treat a wide range of diseases in chickens, turkeys, cattle, swine, and human. We sell our Qilian Shan^® Oxytetracycline tablets in more than 20 provinces. Most of the customers who purchase our oxytetracycline tablets are pharmaceutical companies.

Qilian Shan^® Oxytetracycline APIs— Pharmaceutical companies use our oxytetracycline APIs in the manufacture of other medications that use oxytetracycline as an active ingredient in such pharmaceutical products.

Our Company is the only producer in China manufacturing both oxytetracycline tablets and oxytetracycline APIs. Both Qilian Shan^® Oxytetracycline tablets and Qilian Shan^® Oxytetracycline APIs are certified by the State Food and Drug Administration (“CFDA”), which has been superseded as National Medical Products Administration (“NMPA”). Our operating subsidiary, Gansu QLS, has obtained the Pharmaceutical Production License, the Good Manufacturing Practice (“GMP”) Standard Certificate, and the re-registration approval for the production of our oxytetracycline products. All registrations and qualifications for production are within their validity period.

While our domestic competitors’ oxytetracycline products are certified for veterinary use only by the Chinese Ministry of Agriculture (“CMA”), our products are also qualified for human consumption by the CFDA. The Company relies on an established production system as well as a quality control process for its product manufacturing process. Our key productions indicators such as fermentation unit, fermentation yield, and bacterial infection rate have given our Company distinctive advantages over our competitors, such as excellent per unit production rate, stable and premium quality of products, or large scale production capability.

Our TCMD Product

Ahan^® Antibacterial Paste— Categorized as a disinfecting product under the Law of the PRC on Prevention and Treatment of Infectious Disease, Ahan^® antibacterial paste is made from a mixture of 11 traditional Chinese herbal ingredients including Scutellariae Radix, Phellodendri Chinensis Cortex, Rhei Radix Et Rhizoma, Cnidii Fructus and Dictamni Cortex. It is used to treat refractory chronic skin diseases caused by Staphylococcus aureus, Moniliaalbican, and Escherichia coli. It is also prescribed for people suffering from skin infections such as psoriasis, eczema and onychomycosis. Since its introduction to the Chinese public in November 2017, Ahan^® antibacterial paste has been praised by Chinese customers for its curative effect and soothing relief according to online product rating, offline surveys and personal interviews by the Company.

Our Heparin Product

Heparin Sodium Preparations- Heparin sodium is a prescription drug that has multiple biological and medical functions such as anticoagulation, antithrombotic, hypolipidemic and anti-atherosclerosis. It is used in treating cardiovascular diseases, cerebrovascular diseases, and hemodialysis. Heparin sodium decreases the risk of coagulation, which is the formation of blood clots in the blood vessels. Heparin sodium is used in preventing blood clotting during open-heart surgery, bypass surgery, kidney dialysis, and blood transfusions. In low doses, it can help prevent and reduce coagulation in certain patients, especially those who underwent surgeries or must remain in bed for a long time. Heparin sodium is also valuable in diagnosing and treating disseminated intravascular coagulation, a serious blood condition in which increased clotting depletes the clotting factors needed to control bleeding, causing excessive bleeding. Heparin sodium has been one of the most effective and most widely used anticoagulants in the world since its first use in 1935.

Chengdu QLS, a subsidiary of the Company, purchases healthy, locally raised pigs and extracts heparin-rich organic materials from their small intestinal mucosa. Chengdu QLS then processes extracted heparin materials into heparin crude products, which are then sent to manufacturers of heparin sodium raw material for further preparations. Our crude heparin is intended for use as a component of other drugs in the Chinese biochemical and medical industry such as Enoxaparin Sodium Injection and Nadroparin Calcium Injection.

Our Sausage Casings

Zhu Xiaochang^® Sausage Casings – Our sausage casings are soft cylindrical containers made from small intestines of locally raised pigs. They can be used to contain sausage mixes or for certain medical uses. Our all-natural sausage casings are strong and flexible enough to resist the pressure produced by filling them with sausage mix and are permeable to water vapor and gases. Our sausage casings offer resistance at low or high temperatures and under customary culinary or medical preparations.

Our Heparin Sodium Preparations and Zhu Xiaochang^® sausage casings are resource-based products. Chengdu QLS enjoys high quality, low cost, and abundant local resources, which enables it to focus on production technologies and quality control procedures.

Our Fertilizers

Xiongguan^® Organic Fertilizer— Our organic fertilizer combines functional microorganisms and composites of organic materials such as animal and plant residues. In addition to its high nutrient efficiency, our organic fertilizer is designed to improve crop yield, increase soil’s chemical properties, and reduce soil compaction.

Xiongguan^® Organic-Inorganic Compound Fertilizer— Primarily sold in six Western Chinese provinces, our organic-inorganic compound fertilizer contains both organic materials and composites from traditional chemical fertilizer. The organic materials are a mixture of animal feces and peat moss, which are then treated by microbial fermentation process. The organic materials are further mixed with composites from traditional chemical fertilizer, along with humic acid, amino acid and beneficial microbial bacteria. The final product is a granulated nutritious blend designed to increased plant growth.

Products Currently in Development

Microbial Fertilizer — Microbial fertilizer is a type of multi-element fertilizer containing various strains of living microorganisms. It is a mixture of peat, cow dung, sheep manure carefully cultivated with beneficial bacteria such as lactobacillus, photosynthetic bacteria, and Bacillus. It is a compound bacterial fertilizer rich in various antioxidant substances, amino acids, and digestive enzymes. Microbial fertilizer’s bio-mechanism is creating positive influence upon crops and plants through solubilization of phosphorus, nitrogen fixation, production of plant nutrients and phytohormones, protection from pathogens and recovery from stressful environmental conditions. Functionally, microbial fertilizer enhances crops and plants’ resilience against pests, diseases, and harsh environmental conditions, thus reducing yield loss over time. In addition to providing essential nutrients for crops, it stimulates the growth of roots through chemical substances released by living microorganisms, creating a virtuous cycle of nutrients accumulation that increases crop yields.

Bio-organic Fertilizer — bio-organic fertilizer is a combination of functional microorganisms and organic materials mainly composed of animal and plant residues (such as mixtures of livestock manure and straws). Manufactured through environmental-friendly processes, our product is expected to have the following benefits— high nutrient utilization efficiency, the capability to improve crop yield and quality, and the ability to improve soil’s physical and chemical properties.

Our two products in development must be registered with the PRC Ministry of Agriculture before they can be produced, sold, or advertised. We have applied for the registration of our new fertilizers with the Agriculture Administration of Gansu Province and the Agriculture Administration of Gansu Province has finished its preliminary examination on our microbial fertilizer and the bio-organic fertilizer. We believe that the Agriculture Administration of Gansu Province has submitted our reviewed application to the PRC Ministry of Agriculture in October 2019. It may take about 3 months for the PRC Ministry of Agriculture to complete its final review process. We have obtained the Fertilizer Registration Certificate of The People’s Republic of China approved by PRC Ministry of Agriculture on May 19, 2020.

Manufacturing Process

The following is a brief description of the manufacturing process of our current products.

Our Licorice Products

Gan Di Xin^® — Our facilities produce licorice tablets by combining Licorice Extract, hydrochloric acid, and diluted ammonia. The resulting paste-like mixture is then dried and pulverized into fine powder. That powder is then mixed with camphor extract, star anise oil, and betacyclodextrin. The mixture is further stirred, refrigerated, filtered, dried, combined with more ingredients before final granulation, pressure forming and packaging processes.

Qilian Shan^® Licorice Extract and Qilian Shan^® Licorice Liquid Extract — To make Licorice Extract, we boil and purify a mixture of water and licorice raw materials. We then extract the clear liquid lying above solid licorice residue after precipitation and process the clear liquid into a thick, paste-like solid concentration called Licorice Extract.

To make Licorice Liquid Extract, we first apply heat to a mixture of water and Licorice Extract Power. We then add ethanol to the heated solutions, stir, let stand overnight, and extract the clear liquid lying above solid residue. Such procedures are repeated three times before mixing all the clear liquid that was extracted. After removing the residues and ethanol content in the clear liquid, we then add other chemicals to the clear liquid mixture to ensure that the content of glycyrrhizic acid and alcohol in the clear liquid mixture is in compliance with relevant industry regulations. Our facilities then purify the clear liquid mixture before packaging.

Our Oxytetracycline Products

Qilian Shan^® Oxytetracycline Tablets — we mix oxytetracycline and starch evenly, producing a soft material that later goes through granulation and drying procedures. We then add magnesium stearate to the mixture as a “flow agent”, which prevents the ingredients in each individual tablet from sticking to each other. Then we pressure form, sugar-coat and finally package the tablets.

Qilian Shan^® Oxytetracycline APIs — we carefully cultivate and reproduce Streptomyces Rimosus under specific conditions. Antibiotic materials are produced and accumulated during this fermentation process. We extract antibiotic materials from the fermentation products. We then purify and refine the extractions before finally formulating and packaging the product.

Our TCMD Product

Ahan^® Antibacterial Paste — We produce Ahan Antibacterial Paste by mixing water and various Chinese herbal medicine. We then prepare an herbal decoction by heating, purifying and concentrating the mixture. After emulsification, the final products are packaged.

Our Heparin Product

Heparin Sodium Preparations — We scrape cleaned pigs’ intestines and collect intestinal mucosa. We then heat the intestinal mucosa with water and filter the solution, which is then further processed and dried before packaging.

Our Sausage Casings

Zhu Xiaochang^® Sausage Casings — We salt, dry and package scraped clean pigs’ intestines.

Our Fertilizers

Xiongguan^® Organic Fertilizer and Xiongguan^® Organic-Inorganic Compound Fertilizer — We start with processing and crushing a mixture of compost and chemical materials. We then granulate the crushed composted materials and dry the granulated pellet, use coating machines to add a protection layer on the surface of the pellets and finally package our fertilizer products.

Quality Control and Assurance

In China, each pharmaceutical manufacturer is required to comply with the Good Manufacturing Practice (“GMP”) standards and obtain Pharmaceutical Manufacturing Permits and GMP Certificates granted by the NMPA or its local branches before it engages in any pharmaceutical manufacturing and distribution. GMP standards regulate whole processes and procedures in generating pharmaceutical products to ensure the quality in China.

We are a GMP-certified company and have obtained the Pharmaceutical Manufacturing Permit with the product manufacturing scopes covering our licorice products and oxytetracycline products. We have obtained the National Manufacturing License for Industrial Products that covers the manufacturing of our fertilizer products. The Company has also obtained a Fertilizer Registration Certificate of The People’s Republic of China, which was approved by the PRC Ministry of Agriculture on May 19, 2020. We have obtained the Sanitary License for Manufactures of Disinfectant Products that allows us to manufacture our antibacterial paste. The Chinese authorities currently do not require the Company to obtain specific qualification or licenses for our sausage casings manufacturing. We have well-qualified and trained professional employees for manufacturing and quality control procedures. Our quality control starts with procurement and continues in our manufacturing, packaging, storage capabilities, and cost competitiveness to ensure that all of our products meet the requirements.

Distribution and Marketing of Products

Our Company’s products are sold in more than 20 provinces nationwide to our qualified distributors, dealers and corporate customers. Currently, we have 13 corporate customers buying our heparin product throughout China; we have 15 corporate customers buying our sausage casings throughout China; we have 30 distributors and seven dealers buying our fertilizer products throughout China; we have 31 distributors and two dealers buying our oxytetracycline API throughout China; and we have 86 distributors and one dealer buying our oxytetracycline tablets and licorice products throughout China. A qualified distributor is a merchant with a pharmaceutical business qualification certificate, awarded and authorized by the NMPA. We intend to engage more qualified distributors and dealers in order to strengthen our distribution network.

We understand the importance of branding and packaging. Packed in unique packaging, our products bear distinctive trademarks that help them stand out in the market. Our Company designs packaging for our products and engages third-party manufacturers to produce the packaging.

We conduct marketing activities to publicize and enhance our image and brand name. Our marketing efforts are concentrated on attending national meetings, seminars, symposiums, exhibitions for veterinary healthcare and medical industries and other related industries where we can showcase our brand and products.

Customers

Our customers are consisted of qualified distributors, dealers and corporate customers. We have several large customers with whom we generated substantial revenue each year, and the composition of our largest customers has changed from year to year. For the fiscal year ended September 30, 2020, three customers represented approximately 18%, 11%, and 10% of the Company’s sales, respectively. For the year ended September 30, 2019, one of our customers represented approximately 15.3% of the Company’s sales. For the year ended September 30, 2018, three customers represented approximately 18.8%, 14.7% and 13.7% of the Company’s sales, respectively. While we believe that one or more of our major customers could account for a significant portion of our sales for the foreseeable future, we anticipate that our customer base will continue to expand and that we will become less dependent on major customers.

Suppliers; Sources and Availability of Raw Materials

We research, design and manufacture our products at our manufacturing facilities located at Jiuquan City of Gansu Province and Qionglai City of Sichuan Province in China. Our principal raw materials include various chemical and biological materials including, but not limited to, starch, pig intestine, oxalic acid, liquid alkali, liquid ammonia, sodium ferrocyanide, and defoamer agent. None of our current products requires any raw materials that are scarce, and our raw materials in general are readily available from a wide range of local sources. Accordingly, we do not have any continuing or long-term supply agreements with any of these suppliers. We purchase our raw materials from our suppliers on a per purchase order basis. The prices for these raw materials are nevertheless subject to market forces largely beyond our control, including energy costs, organic chemical feedstock, market demand, and freight costs. The prices for these raw materials have varied significantly in the past and may vary significantly in the future.

For the fiscal year ended September 30, 2020, two of our suppliers accounted for 11% and 10% of the total purchases, respectively. For the year ended September 30, 2019, two of our suppliers accounted for 12.9% and 9.5% of the total purchases, respectively. For the year ended September 30, 2018, three of our suppliers accounted for 19.2%, 14.1%, and 9.4% of the total purchases, respectively.

Competition

We have competitors in China that manufacture products similar to ours. These companies sell products similar to ours and some of them may have more assets, resources and a larger market share. We believe we are able to compete with these competitors because of our geographical location in West China, our unique combination of products and our products’ lower prices.

Honors, Awards, and Qualifications

Honors

Selective Criteria for the Awards

Gansu Provincial Excellent Engineering Consulting Award (awarded to our CEO Mr. Zhanchang Xin)

The Gansu Provincial Excellent Engineering Consulting Award is awarded by the Gansu Provincial Development and Reform Commission based on the comprehensive evaluation of the engineering consulting achievements accomplished by the applicant and such recognition is only awarded to engineering projects that have reached high level of ingenuity and economic potential within certain industry. Our “Gan Di Xin Industrialization Project” was recognized as such engineering project and Mr. Zhanchang Xin was recognized as having made outstanding contributions to the project during its establishment, implementation and completion stages.

Gansu Province’s Famous Brand

Gansu Province’s Famous Brand is awarded by Gansu Famous Brand Strategy Promotion Committee in accordance with the “Product Quality Law of the People’s Republic of China”, the “Quality Control Guideline of the State Council” and the “Quality Control Implementation Plan of Gansu Province”. In an effort to promote and cultivate excellent local brand of Gansu province, Gansu Famous Brand Strategy Promotion Committee carefully evaluates the applicant’s qualifications based on the following guidelines, which include but not limited to: brand-name strategy, products quality control, market share, customer satisfaction, annual profit and tax contribution, production cost and annual profit, applicant’s technological innovation and product development capabilities, and customer service.

Suzhou District Science and Technology Progress Award

In August 2012, the Company’s project “Research and development of oxalic acid extracted from oxytetracycline raw material production waste liquid” was awarded the first prize of “Science and Technology Progress” by the People’s Government of Suzhou County, Jiuquan City. The award is given by the local people’s government after comprehensive evaluation of our project’s key quantitative and qualitative indicators such as technological innovation, project scale, overall technical difficulties involved, economic benefits conferred, and the promotion of scientific and technological progress in related industrial fields.

2013 China Chemical and Pharmaceutical Industry’s Excellent Product Brand (awarded to our Gan Di Xin^®)

The Company’s product, Gan Di Xin®, was awarded “2013 China Chemical and Pharmaceutical Industry’s Excellent Product Brand” after a joint review process conducted by the China Chemical Pharmaceutical Industry Association, the China Pharmaceutical Business Association, and the China Pharmaceutical Enterprise Development Promotion Association. The review process was based on the following qualifications, which include but are not limited to, the Company’s R&D capabilities, marketing capabilities, technological innovation, and production scale.

Famous Trademark of Gansu Province (awarded to our trademark Qilian Shan®)

According to the “Trademark Law of the People’s Republic of China”, the “Regulations on the Implementation of the Trademark Law of the People’s Republic of China” and other laws and administrative regulations, the Gansu Provincial Administration for Industry and Commerce is authorized to award the “Famous Trademark of Gansu Province” title to eligible applicants based on the following qualifications, which include but not limited to: whether the trademark is publicly recognized and legally owned by the applicant, whether the trademark has high reputation/credibility and is well-known to the general public, whether the product behind the trademark is of superior quality than its competitors, and whether the customer service is satisfactory. The Gansu Provincial Administration for Industry and Commerce also evaluate the applicant’s key business indicators such as sales volume, local tax contribution, and annual profit increase in the past three years.

Gansu Province Circular Economy Exemplar Enterprise

According to the “Management Measures for the Identification and Assessment of Key Enterprises in Strategic Emerging Industries in Gansu Province” provided by the Provincial Development and Reform Commission, the Commission has the authority to award the Strategic Emerging Growth Exemplar Enterprise status to local enterprises with the following qualifications, which include but not limited to: well-known brand name within certain industry, high business growth, high contribution to local tax revenue, market competitiveness, and future development potential.

Nationally Recognized Enterprise Technology Center Status, Provincial Level

According to the “Gansu Provincial Level Nationally Recognized Enterprise Technology Center Recognition Measures”, Gansu Provincial Department of Industry and Information Technology, together with Gansu Provincial Development and Reform Commission, Gansu Provincial Department of Finance, State Taxation Bureau, and Gansu Provincial Taxation Bureau commissioned certain third-party institutions to conduct a comprehensive review of the applicant’s qualifications based on the following criteria, which include but not limited to: annual sales revenue, net profit, capitalization, production scales, competitive strength such as technological innovation, research and development capabilities, and ownership of intellectual property rights.

Famous Trademark of Gansu Province (awarded to our Gan Di Xin®)

According to the “Trademark Law of the People’s Republic of China”, the “Regulations on the Implementation of the Trademark Law of the People’s Republic of China” and other laws and administrative regulations, the Gansu Provincial Administration for Industry and Commerce is authorized to award the “Famous Trademark of Gansu Province” title to eligible applicants based on the following qualifications, which include but not limited to: whether the trademark is publicly recognized and legally owned by the applicant, whether the trademark has high reputation/credibility and is well-known to the general public, whether the product behind the trademark is of superior quality than its competitors, and whether the customer service is satisfactory. The Gansu Provincial Administration for Industry and Commerce also evaluate the applicant’s key business indicators such as sales volume, local tax contribution, and annual profit increase in the past three years.

Excellent Entrepreneur Award (awarded to our CEO, Mr. Zhanchang Xin)

China National Petroleum Corporation and China Chemical Industry Federation jointly reviewed the qualification of Mr. Zhanchang Xin based on the following standards, which include but not limited to: the Company’s R&D capacity, the Company’s annual profit increase in the past five years, the Company’s major products, and the Company’s local and national tax contributions.

Gansu Province “Specialized New Technology” Enterprise

According to the “Guiding Opinions on Promoting the Development of Specialized New Technology Enterprises” and “Plans on Promoting the Development of Small and Medium-sized Enterprises” provided by the Ministry of Industry and Information Technology, the Gansu Provincial Department of Industry and Information Technology has the authority to award the “Specialized New Technology Enterprise” status to enterprises with the following qualifications, which include but not limited to: good operating status, complete and organized financial management system, high-tech industrial products encouraged by the local and central governments, high average annual growth rate of net profit (no less than 10%), low asset-liability ratio (less than 70%), high level of proficiency in business operation and management, high R&D capacity, high product quality, safe manufacturing environment, high financial credit, and high social credit.

Strategic Emerging Growth Exemplar Enterprise

According to the “Management Measures for the Identification and Assessment of Key Enterprises in Strategic Emerging Industries in Gansu Province” provided by the Provincial Development and Reform Commission, the Commission has the authority to award the Strategic Emerging Growth Exemplar Enterprise status to local enterprises with the following qualifications, which include but not limited to: well-known brand name within certain industry, high business growth, high contribution to local tax revenue, market competitiveness, and future development potential.

Little Giant Enterprise of Chengdu City Award

According to the “Notice for Carrying out the Cultivation of High-Growth SMEs and Small Giant Enterprises in 2018” (Enterprise Division of Sichuan Provincial Economic and Information Commission [2018] No. 136) issued by the Sichuan Provincial Economic and Information Commission and Sichuan Provincial SME Bureau, the Chengdu City Economic and Information Commission is authorized to award the “Little Giant Enterprise of Chengdu City” Award according to the following qualifications, which include but not limited to: sizes of the applicants’ manufacturing capabilities, annual profits, tax contributions, and annual business income.

Petroleum and Chemical Industry “Specialized and Innovative” Small to Medium Enterprises (the “SME”) Award

According to the “Measures for the Recognition of Petroleum and Chemical Industry “Specialized and Innovative” SMEs Award” and “Opinions on Promoting the Healthy Development of SMEs” issued by the General Office of the CPC Central Committee and General Office of the State Council, the China Petroleum and Chemical Industry Federation and China SME Development Committee are authorized to award Petroleum and Chemical Industry “Specialized and Innovative” SME Enterprises Award according to the following qualifications, which include but not limited to: well-known brand name within petroleum and chemical industry, strong R&D capacities, specialization and expertise in certain market segments, market competitiveness, ownership of certain highly competitive IPs, and management efficiencies.

Chengdu City’s Unicorn Enterprise Award

According to the "Notice of the Chengdu City Municipal New Economy Committee on Cultivating New Economic Enterprise 2018" (Chengdu City Municipal New Economy Development Committee [2018] No. 247) issued by the Chengdu City Municipal New Economy Committee, the Chengdu City Municipal New Economy Committee, with the help of qualified industrial experts and financial experts, is authorized to award the “Chengdu City’s Unicorn Enterprise”. Such award is based on, without limitation, investment qualifications, market capital estimation, and annual net income.

Sichuan Province “Specialized and Innovative” SME Award

According to the "Proposal on Cultivating Specialized and Innovative SMEs” and the “Notice on Carrying Out the Proposal of Cultivating Specialized and Innovative SMEs”, Sichuan Province Economic and Information Technology Commission is authorized to award the Sichuan Province “Specialized and Innovative” SME Award according to the following qualifications, which include but are not limited to: annual business income, annual profits, tax contributions, accounting credibility, social credits, and bank credits.

Sichuan Province “High-growth” SME Award

Sichuan Province Economic and Information Technology Commission is authorized to award the Sichuan Province “High-growth” SME Award based on the applicant’s annual business income in the past two years.

Suzhou District “Tax Contribution Award” for 2019

Suzhou District Committee and District Government of Jiuquan City are authorized to award the Suzhou District “Tax Contribution Award” for 2019 based on the applicant’s overall tax contributions in 2019.

2020 Gansu Provincial Technology Innovation Model Enterprise

Gansu Province Industry and Information Technology Commission and Gansu Province Department of Finance are authorized to award “2020 Gansu Provincial Technology Innovation Model Enterprise” based on the applicant’s annual business income, contribution to innovation evidenced by commercial application, credit worthiness, production scales, and others.

Qualifications

Intellectual Property

Protection of our intellectual property is a strategic priority for our business. We rely on a combination of patent, trademark and trade secret laws, as well as confidentiality agreements, to establish and protect our proprietary rights. We do not rely on third-party licenses of intellectual property for use in our business.

Through Gansu QLS, we currently hold 14 Chinese patents. Gansu QLS’s current Chinese issued patents expire at various times from 2026 through 2029. Gansu QLS currently has two Chinese patent applications pending. Ahan currently has one Chinese patent application pending. Qiming currently has three Chinese patent applications pending. We have exclusive rights to utilize the processes issued patent rights within the valid term. As for other products of us and the related manufacturing processes, since the technology information has been published to public domain by national or local product standard, we are able to utilize such technology information without need to obtain any patent license. And we do not violate existing patent rights of any other party.

The following table sets forth a brief description of the Company’s issued Chinese patents, including their respective publication numbers, application filing date, issue date, expiration date and title.

Through Gansu QLS, we currently have ten Chinese trademarks. Gansu QLS’s current Chinese issued trademarks expire at various times from 2020 through 2030. Gansu QLS currently does not have any Chinese trademarks applications pending.

Research and Development

Our Company established a research and development department in 2015, with its Nationally Recognized Enterprise Technology Center status assessed and approved by the Gansu Provincial Industry and Information Commission, the Gansu Provincial Development and Reform Commission, the Gansu Provincial Science and Technology Department, Gansu Provincial Finance Department, the Gansu Provincial State Taxation Bureau, and the Gansu Provincial Local Taxation Bureau in December 2015. The Nationally Recognized Enterprise Technology Center status is a competitive honor awarded by Chinese government agencies, such recognition reflects the Company’s comprehensive strength in technological innovation and robust research and development (“R&D”) activities. After years of continued development, our R&D department has become the core of the Company’s technological innovation efforts, dramatically improving the Company’s R&D capabilities, enhancing the Company’s industry competitiveness, and, we believe, improving the Company’s overall business outlook.

R&D Achievements

Our research and development activities are project based and the number of projects we work on varies annually. As of December 31, 2020, we had 14 research and development professionals, three of whom have advanced degrees in Medicine and Traditional Medicine. The Director of our R&D department, Mr. Zhanchang Xin, is also the chairman and legal representative of Gansu QLS. Under Mr. Zhanchang Xin’s leadership, our R&D department contributed to the following recent accomplishments:

In the beginning of October 2016, Ahan established a TCMD research project borrowing ideas from medicines of Chinese Dai ethnicities. This research project created our innovative Ahan^® antibacterial paste for the treatment of psoriasis, neurodermatitis and other skin ailments. The Company has completed all necessary filing procedure as required by PRC laws and the Ahan^® Antibacterial Paste has been on the Chinese market since November 2017. We have filed a patent application on March 15, 2018 under patent number 201810214947.0, and the application is currently in the stage of substantive examination as of the date of this annual report.

Gansu QLS has invested approximately RMB 1,000,000 for its mutational breeding experiment of oxytetracycline-producing bacteria. Currently, the Company has selected and bred superior strains and has successfully increased the average fermentation unit of oxytetracycline from 32000 U/ml to 35000 U/ml and beyond, thereby greatly improving our oxytetracycline product yield while reducing our production cost.

R&D Development Plan

The Company intends to continue focusing on R&D to improve the quality of its products. The Company also intends to develop new products and exploit unmet market demand in the near future.

With the aid of advanced production technology and manufacturing facilities, our production capacity of oxytetracycline has reached its industrial upper limit. After thorough research and investigation, our R&D department has concluded that only through improving the quality of oxytetracycline strains can we lead to industrial break-through of oxytetracycline production capacity.

Regarding our fertilizer, our operating subsidiary Qiming will continue utilizing its advantage of abundant local raw material sources and expect to develop liquid-flushing fertilizer, crops fertilizer and pharmaceutical fertilizer that fulfills the agricultural production demands of various crops.

Our R&D department will further develop our Ahan^® antibacterial paste to suit different skin types of our customers and appeal to customers from different ethnic and cultural regions in China. In addition, we will create more products so as to provide our customers with more choices. Pursuant to the Regulations on Sanitary and Safety Evaluation of Disinfectant Products issued by the National Health and Family Planning Committee on June 27, 2014, the Company shall file the sanitary and safety evaluation reports of its modified Ahan® antibacterial paste to the provincial health administrative branch before such product can be introduced to the Chinese market. The local authorities shall publish the filing information excluding commercial secrets. The Company’s filing procedures do not involve approval from the relevant authorities, and enterprises are not required to obtain any certificate in order to complete the filing procedure. We have completed the required filing process for our current version of Ahan^® antibacterial paste in May 2017. We will also update the sanitary and safety evaluation report and file the updated report to the competent authorities for any modified Ahan antibacterial paste in the future.

Legal Proceedings 

We are currently not a party to any material legal or administrative proceedings. We may from time to time be subject to various legal or administrative claims and proceedings arising in the ordinary course of business. Litigation or any other legal or administrative proceeding, regardless of the outcome, is likely to result in substantial cost and diversion of our resources, including our management’s time and attention.

Regulation

This section sets forth a summary of the most significant rules and regulations that affect our business activities in China.

PRC Laws and Regulations on Pharmaceutical Manufacture

General Regulations Relating to Pharmaceutical Industry

The pharmaceutical industry in China is highly regulated. We operate our business in China under a legal regime consisting of the National People’s Congress, which is the country’s highest legislative body, the State Council, which is the highest authority of the executive branch of the PRC central government, and several ministries and agencies under its authority, including the State Administration of Market Regulation (“SAMR”), the National Medical Products Administration (“NMPA”), the Ministry of Industry and Information Technology (“MIIT”), and their respective local offices.

As a developer and producer of medicinal products, we are mainly subject to regulation and oversight by the NMPA and its provincial and local branches. These regulations set forth detailed rules with respect to pharmaceutical companies in China. The Drug Administration Law of the PRC, or the Drug Administration Law, which was first promulgated in 1984 and last amended on August 26, 2019, provides the basic legal framework for the administration of the production and sale of pharmaceutical products in China and covers the manufacturing, distribution, packaging, pricing and advertising of pharmaceutical products. We are also subject to other PRC laws and regulations that are applicable to business operators, manufacturers and distributors in general.

Pharmaceutical Marketing Permit Holders

The last amended version of the Drug Administration Law, which was promulgated on August 26, 2019 and took effect on December 1, 2019, adopts the drug marketing authorization holder system and further tightens and expands supervision of drugs to cover the entire processes, including the research and development, production, sale, use and management processes of drugs. Pharmaceutical marketing permit holders shall mean enterprises or pharmaceutical research and development institutes which have obtained a pharmaceutical registration certificate. Pharmaceutical marketing permit holders shall be liable for non-clinical study, clinical trial, manufacturing and business operation, post-market launch study, monitoring, reporting and handling of adverse reactions of the pharmaceuticals. Pharmaceutical marketing permit holders may engage in pharmaceutical manufacturing on their own, and may entrust a pharmaceutical manufacturing enterprise to manufacture. Pharmaceutical marketing permit holders engaging in manufacturing pharmaceutical on their own shall obtain a pharmaceutical manufacturing permit; for entrusted manufacturing, the pharmaceutical marketing permit holder shall entrust a qualified pharmaceutical manufacturing enterprise. The pharmaceutical marketing permit holder and the entrusted manufacturing enterprise shall enter into an entrustment agreement and a quality agreement, and strictly perform the obligations agreed in the agreements. Pharmaceutical marketing permit holders may sell on their own the pharmaceuticals for which they have obtained a pharmaceutical registration certificate, or entrust a pharmaceutical business enterprise to sell. Pharmaceutical marketing permit holders engaging in pharmaceutical retail activities shall obtain a pharmaceutical business permit.

Pharmaceutical Manufacturing Permit

According to the Drug Administration Law and the Implementation Rules, no pharmaceutical products can be produced in the PRC without a Pharmaceutical Manufacturing Permit. A local pharmaceutical manufacturer must obtain a Pharmaceutical Manufacturing Permit from one of the NMPA’s provincial level branches in order to commence production of pharmaceutical products. Prior to granting such license, the relevant government authority will inspect the manufacturer’s production facilities, and decide whether the sanitary conditions, quality assurance system, management structure and manufacturing equipment have met the standards and criteria. Among other things, such a permit sets forth the permit number, the name, legal representative and registered address of the enterprise, the site and scope of production, issuing institution, date of issuance and effective period.

Each Pharmaceutical Manufacturing Permit issued to a pharmaceutical manufacturing enterprise is effective for a period of five years. Any enterprise holding a Pharmaceutical Manufacturing Permit is subject to review by the relevant regulatory authorities on an annual basis. Such enterprise is required to apply for renewal of such permit within six months prior to its expiry and will be subject to re-assessment by the issuing authorities in accordance with the then effective legal and regulatory requirements for the purposes of such renewal.

Our PRC entity Gansu QLS has obtained a Pharmaceutical Manufacturing Permit, which expires on December 29, 2025 and allows us to sell all types of pharmaceutical products we are currently selling.

GMP Certificates

A pharmaceutical manufacturer must meet the Good Manufacturing Practice standards, or GMP standards, for each factor that influence the quality of drugs, in respect of each form of pharmaceutical product it produces. GMP standards include staff qualifications, production premises and facilities, equipment, raw materials, environmental hygiene, production management, quality control and customer complaint administration. If a manufacturer meets the GMP standards, the NMPA will issue to the manufacturer a Good Manufacturing Practice certificate, or a GMP certificate, with a five-year validity period. However, for a newly-established pharmaceutical manufacturer that meets the GMP standards, the NMPA will issue a GMP certificate with only a one-year validity period. The New GMP Standards became effective on March 1, 2011 and pharmaceutical manufacturers (except manufacturers of injectables, blood products or vaccines, which have a three-year grace period) have a five-year grace period to upgrade existing facilities to comply with the revisions. The latest amended Drug Administration Law took effect on December 1, 2019, and has vacated the GMP certificate requirements for pharmaceutical companies. The current amended Drug Administration Law does not otherwise impose new regulatory requirements for pharmaceutical manufacturers.

Gansu QLS obtained the GMP certificates for its quality management system in respect of scope of oxytetracycline products, which was valid until March 1, 2020 and in respect of scope of tablets extract and fluid extract, which was valid until August 19, 2020. As the latest amended Drug Administration Law has vacated the GMP certificate requirements for pharmaceutical companies, we do not need to renew our GMP certificates.

Registration and Approval of Medicine

Pursuant to the PRC Provisions for Drug Registration, a medicine must be registered and approved by the NMPA before it can be manufactured and sold. The registration and approval process requires the manufacturer to submit to the NMPA a registration application containing detailed information concerning the efficacy and quality of the medicine and the manufacturing process and the production facilities the manufacturer expects to use. This process generally takes two to five years and could be longer, depending on the nature of the medicine under review, the quality of the data provided and the workload of the NMPA.

The valid term of a drug approval number is five years. To continue its drug production, the applicant shall submit a re-registration application six months prior to the expiry date. When making re-registration of a drug, the relevant data shall be submitted according to the provisions of the NMPA. If no application for the re-registration of a drug is made upon expiration of the valid term, or the application fails to comply with the provisions on re-registration of the NMPA upon review, the drug approval number shall be withdrawn.

Our variable interest entity, Gansu QLS has obtained the approval numbers for its products and completed the re-registration procedures to ensure each approval number is valid.

National Drug Standard

The national drug standards in China include the Chinese Pharmacopoeia, drug registration standard, and other drug standards published by the NMPA, of which the contents consist of technical requirements, testing methods and manufacturing processes, etc. Pharmaceutical manufacturers shall be subject to the drug registration standard, which refers to the specified specifications of the applied drug approved by the NMPA and shall not be lower than those required by the Chinese Pharmacopoeia.

The Chinese Pharmacopoeia (Latest Version 2015) became effective on December 1, 2015 and has been codified into law with the purpose of providing clear guidance on the pharmaceutical products manufacturing process. The Chinese Pharmacopoeia applies to all aspects of the pharmaceutical products manufacturing process including research and development, production (import), management, use and supervision of pharmaceutical products. It provides standard language that can be used by pharmaceutical companies to draft description, identification, processing, assay, property and flavor, meridian tropism, actions, indications, storage, administration and dosage, precautions and warnings of pharmaceutical products.

Our pharmaceutical products have been issued approval numbers and completed registration procedures, which certifies that our pharmaceutical products comply with the national drug standards.

Continuing NMPA Regulation

Pharmaceutical manufacturers in China are subject to continuing regulation by the NMPA. If the labeling or manufacturing process of an approved medicine is significantly modified, a new pre-market approval or pre-market approval supplement will be required by the NMPA. Pursuant to the Drug Administration Law, we should also be subject to periodic inspection and safety monitoring by the NMPA to determine compliance with regulatory requirements.

If the NMPA approves a medicine, it will issue a new medicine certificate to the manufacturer and impose a monitoring period not more than five years. During the monitoring period, the NMPA will monitor the safety of the new medicine, and will neither accept new medicine certificate applications for an identical medicine by another pharmaceutical company, nor approve the production or import of an identical medicine by other pharmaceutical companies. As a result of these regulations, the holder of a new medicine certificate has the exclusive right to manufacture the new medicine during the monitoring period.

The NMPA has a variety of enforcement actions available to enforce its regulations and rules, including fines and injunctions, recall or seizure of products, the imposition of operating restrictions, partial suspension or complete shutdown of production and criminal prosecution.

PRC Laws and Regulations on Pharmaceutical Product Packages

Insert Sheet and Labels of Products

According to the Provisions for the Administration of the Insert Sheets and Labels of Drugs, which became effective on June 1, 2006, the insert sheets and labels of drugs should be reviewed and approved by the NMPA. A drug insert sheet should include the scientific data, conclusions and information concerning drug safety and efficacy in order to direct the safe and rational use of drugs. The inner label of a drug should bear information such as the drug’s name, indication and function, strength, dose and usage, production date, batch number, expiration date and drug manufacturer; and the outer label of a drug should indicate information such as the drug’s name, ingredients, description, indication or function, strength, dose and usage and adverse event. As our pharmaceutical products have been issued approval numbers and completed registration procedures, the insert sheets and labels of our pharmaceutical products have been reviewed and approved.

Use of Pharmaceutical Product Packages

Pharmaceutical products packages must, in accordance with applicable regulations, be labeled and have an instruction booklet attached to them. The name of the drug, its ingredients, specifications, the manufacturing enterprise, approval number, product batch number, date of production, expiry date, suitability for symptoms or main function, methods of use, dosage, contraindications, side-effects and points to note must be clearly indicated on the label or in the instruction booklet. The labels of narcotic drugs, psychotropic drugs, poisonous drugs, radioactive drugs, drugs for external use only and non-prescription drugs must bear the prescribed mark. Drug packaging must comply with the national and professional standards. If no national or professional standards are available, an enterprise can formulate its own standards and put into implementation after obtaining the approval of the food and drug administration bureau at provincial level. Such enterprise must reapply with the relevant authorities if it needs to change its own packaging standards. Pharmaceuticals that have not developed or received approval for, packing standards must not be sold or traded its drugs in China (except for drugs for the military).

Currently, all of our marketed products meet the packaging requirements.

Drug Packaging Manufacturing

On June 18, 2004, the Ministry of Health promulgated the Administration Rules for Packaging Material and Containers Directly Contacting Drugs, which stipulates that enterprises producing packaging material and containers directly containing drugs shall apply for registration after completion of trial work and re-registration 6 months before the expiration of the registration certificate.

Our PRC entity Qiming has registered for the drug containers it produces and obtained the re-registration certificate.

PRC Laws and Regulations on Advertising of Drug Products

Pursuant to the Measures for the Examination of Drug Advertisements, which came into effect in 2007 and was amended on December 21, 2018, an enterprise seeking to advertise its drugs must apply for an advertisement approval code. The valid term of an advertisement approval code for pharmaceuticals is one year. The content of an approved advertisement may not be altered without prior approval. Where any alteration to the advertisement is needed, a new advertisement approval code shall be obtained. As of the date of this annual report, we have not advertised for our pharmaceutical products, thus not needing to apply for any approval.

PRC Laws and Regulations on Disinfectant Products

The SCNPC promulgated the Law of the PRC on Prevention and Treatment of Infectious Disease on February 21, 1989, which took effect on September 1, 1989, and revised it on August 28, 2004 as well as June 29, 2013. Pursuant to the Law of the PRC on Prevention and Treatment of Infectious Disease, disinfectant products used for prevention and treatment of infectious diseases shall measure up to the sanitary standards and specifications of the State. Manufacturers of disinfectant products and disinfectant products to be manufactured for prevention and treatment of infectious diseases shall be subject to examination and approval by the health administration department under the people’s governments at or above the provincial level. 

Our PRC operating subsidiary, Ahan, has obtained the Sanitary License for Manufactures of Disinfectant Products for the Ahan^® antibacterial paste it produces.

According to the Regulations on Sanitary and Safety Evaluation of Disinfectant Products issued by the National Health and Family Planning Committee on June 27, 2014, our Ahan^® antibacterial paste is categorized as Type II disinfectant, which is an disinfectant product with risks of middle level. Type II disinfectant products’ sanitary and safety evaluation reports shall be filed for record to the provincial health administrative branch before the product firstly be published to market. Pursuant to the Regulations on Sanitary and Safety Evaluation of Disinfectant Products issued by the National Health and Family Planning Committee on June 27, 2014, the Company shall file the sanitary and safety evaluation reports of its modified Ahan® antibacterial paste to the provincial health administrative branch before such product can be introduced to the Chinese market. The local competent authorities shall publish the filing information excluding commercial secrets. The filing procedure does not involve approval from the competent authorities, and enterprises are not required to obtain any certificate in order to complete the filing procedure. We have completed the required filing process for our current version of Ahan^® antibacterial paste in June 2017.

PRC Laws and Regulations on Fertilizer Production and Registration

Fertilizer usually refers to organic, inorganic and microbial substances and mixture of substances which offer, maintain or improve the nutritional status, output, quality and stress tolerance (abiotic) of crops or the physical, chemical and biological performance of soils or plants, increase the output and quality of agricultural produce or increase stress resistance of plants.

Production License

In China, producers of chemical fertilizers (which are covered by the catalog of industrial products issued by the State Council) are required to obtain a production license from the Market Regulation Departments at the provincial level (the “Provincial MRDs”). An application for license renewal should be made with the applicable Provincial MRD within six months before such license expires. Pursuant to a series of decisions regarding amendments to the product license administration process promulgated by the State Council in September 2018 as well as its Implementation Notifications promulgated by the Administration of Market Regulation (the “State MRD”) on October 16, 2018, the Provincial MRDs are authorized to assess the qualification of such applicant after receiving its renewal application. The assessment process includes appointing staff members from the Provincial MRD to conduct on-site due diligence and reviewing qualification test reports on the applicant’s industrial products issued by qualified inspection institutions within the last year (the “QT Reports”). The Provincial MRD would typically inform the applicant of the on-site due diligence results in writing within 30 days after the due diligence process is completed. Such process may be waived if the applicant makes a representation in writing that its production process and manufacturing conditions have not been changed since the license was last granted or renewed. If the applicant successfully passed the on-site due diligence process (or such requirement is effectively waived), the Provincial MRD will subsequently request the applicant to submit the QT Reports for review. The Provincial MRD will make a final decision on the renewal application within 60 days from the day accepting the application. If the Provincial MRD decides to grant the renewal, then a renewed Production License for Industrial Products will be sent to the applicant within 10 days after the date of the Provincial MRD decision. If the Provincial MRD decides not to grant the renewal, then it will notify the applicant in writing.

Our PRC operating entity Qiming currently owns a valid Production License for Industrial Products, which will expire on September 20, 2021. Its Production License for Industrial Products covers our organic-inorganic compound fertilizer, which is subject to the regulations for chemical fertilizers.

Fertilizer Registration

Fertilizers cannot be imported, produced, sold, or advertised without prior registration with the competent authorities at a ministerial or provincial level. From a registration prospective, fertilizers can be divided into 3 types:

Exempted from Registration — Fertilizers that have been used for many years domestically and have been established with national or industrial product executive standard are exempted from registration: ammonia sulfate, urea, calcium cyanamide, ammonium phosphate (mono and di), phosphor nitrate, superphosphate, potassium chloride; potassium sulfate, potassium nitrate ,ammonium chloride ,ammonium bicarbonate, calcium magnesium phosphate, potassium dihydrogen phosphate, single microelement fertilizer, high concentration compound fertilizer;

Registered with provincial agricultural department — compound fertilizer; formula fertilizer (no foliar fertilizer); refined organic fertilizer and soil acid regulating agents should be registered with provincial agricultural department and can be only sold within the administration area of the province. If the producer or distributor files a provincially registered fertilizer to the department at another province, the fertilizer can be sold in that province too.

Other Fertilizers — Fertilizers that do not comply with the above two criteria should be registered with the Chinese Ministry of Agriculture (the “MoA”). Fertilizer-pesticide mixtures and the homemade organic fertilizer produced by the farmers are also beyond the scope of fertilizer registration management. Homemade organic fertilizers are usually for self-use purpose and fertilizer-pesticide mixtures are controlled under China’s pesticide registration system.

MOA Decree No. 32, the Administrative Measures of Fertilizer Registration in China by MOA, was published on June 23, 2006. This decree specifies China fertilizer registration obligations, product types/registration types and data requirements. Fertilizer products are regulated by the Decree. Companies are required to register fertilizer products in China prior to importing, manufacturing, selling and using in China.

On November 30, 2017, the MOA issued Order 8 to abolish and revise a series of existing ministerial regulations, of which two sections are an amendment to the current fertilizer registration: removal of temporary registration and broadened acceptance scope of field trial report. On December 29, 2017, the MOA released Announcement 2636, the Service Guide to the Administrative Approval of MOA (Batch 2: Fertilizer Registration and Pesticide Registration), which standardizes administrative procedures and further clarifies data requirements including qualification of applicant, timeline, list of required documents, means of submission and administration fee. Depending on the market circulation stage, fertilizer registrations can be classified into registration, registration renewal (each 5 years) and registration amendment (only applicable to crop range and administrative information). Domestic products and imported fertilizer are subject to different assessment criteria and approval procedures.

Our Xiongguan^® Organic Fertilizer and Xiongguan^® Organic-Inorganic Compound Fertilizer are Category II fertilizers. We have registered these two products with the provincial agricultural department. We have obtained Gansu Province Fertilizer Official Registration Certificates, which cover the manufacturing of our compound fertilizers and organic fertilizers. We have renewed our Gansu Province Fertilizer Official Registration Certificates once in January 2018, and they will expire in December 2022. Pursuant to the Administrative Measures of Fertilizer Registration, we will apply for another renewal six months before such certificates expire. The Company has obtained Fertilizer Registration Certificates for both our Xiongguan^® Organic Fertilizer and Xiongguan^® Organic-Inorganic Compound Fertilizer, which were approved by the PRC Ministry of Agriculture on May 19, 2020 and are valid until May 2025.

Data Requirements of Fertilizer Registration Application

The registration application materials consist of an application form, credential documents, test reports, position paper/ evaluation form, safety data, product executive standard, label sample, enterprise information and product samples. Field trials and one quality inspection test are performed prior to the application and another quality inspection and safety tests will be organized by the Secretariat afterward. Domestic applicants are subject to additional preliminary review and product executive standard filing formality at their provincial department. For imported fertilizers, qualification/identity of overseas producers and business relationship with its domestic agent are particularly reviewed. Technical data and sample requirements may vary depending on product nature, as summarized in the table.

An enterprise should submit a renewal application of its registration certificate six months before such registration expires. As provided by the Administrative Measures of Fertilizer Registration in China, our Xiongguan^® Organic Fertilizer and Xiongguan^® Organic-Inorganic Compound Fertilizer should also register their renewal with the Gansu Province Administration of Agriculture. According to the instructions on fertilizer registrations published by the Gansu Government Services (http://www.gszwfw.gov.cn/art/2019/12/20/art_412266_8414.html), we are requested by Gansu Province Administration of Agriculture to provide a product quality inspection report issued by a qualified provincial or national inspection institution with China Metrology Accreditation, along with other procedural documents such as application forms. The Gansu Province Administration of Agriculture is responsible for adjudicating the adequacy of our application materials and making final decisions on approval. Qiming submitted all required documentation for renewal and was granted new registration certificates in January 2018. Qiming’s new registration certificates will expire in May 2025.

PRC Laws and Regulations on Natural Sausage Casings

The production of natural sausage casing must comply with the national standard Natural Sausage Casings (GB/T 7740-2006) promulgated by the General Administration of Quality Supervision, Inspection and Quarantine (the “AQSIQ”) and the Standardization Administration of the PRC, which provides the definitions, categories, manufacturing requirements, quarantine methods, labels, packages, preservation and transportation of natural sausage casings. According to the circular of the AQSIQ, natural sausage casings shall not be categorized as food, and Chengdu QLS does not need to apply for the Food Production License.

PRC Laws and Regulations on Environmental Protection

The Ministry of Ecology and Environment is responsible for the uniform supervision and control of environmental protection in the PRC. It formulates national environmental quality and discharge standards and monitors the PRC’s environmental system. Ecology and Environment bureaus at the county level and above are responsible for environmental protection within their areas of jurisdiction.

Pursuant to the Law on Environmental Impact Evaluation of the PRC promulgated on October 28, 2002 and effective from September 1, 2003, and later amended on July 2, 2016 and December 29, 2018, manufacturers must prepare and file an environmental impact report setting forth the impact that the proposed construction project may have on the environment and the measures to prevent or mitigate the impact for approval by the relevant PRC government authority prior to commencement of construction of the relevant project. Gansu QLS and its subsidiaries have obtained approval for their environmental impact reports as required.

Pursuant to the Environmental Protection Law of the PRC, or the Environmental Protection Law, promulgated on December 26, 1989 with immediate effect and last revised on April 24, 2014, the environmental protection department of the State Council is in charge of promulgating national standards for environmental protection. The Environmental Protection Law requires any facility that produces pollutants or other hazards to incorporate environmental protection measures in its operations and establish an environmental protection responsibility system. Any entity that discharges pollution must obtain the Pollution Discharging License from the relevant environmental protection authority. Remedial measures for breaches of the Environmental Protection Law include a warning, payment of damages or imposition of a fine. Criminal liability may be imposed for a material violation of environmental laws and regulations that causes loss of property, personal injuries or death.

Pursuant to the Law of the People's Republic of China on the Prevention and Control of Atmospheric Pollution promulgated by the NPC on September 5, 1987, last amended on October 26, 2018 and effective from September 1, 2000, the environmental protection authorities above the county level are in charge of exercising unified supervision and administration of prevention and control of air pollution. Manufacturers discharging polluted air must comply with applicable national and local standards. Manufacturers discharging polluted air must pay polluted air discharging fees. If a manufacturer emits polluted air exceeding national or local standards, it must correct its action during a prescribed period of time and the manufacturer may be subject to penalties.

Pursuant to the Water Pollution Prevention Law of the PRC, which was originally promulgated by the NPC on May 11, 1984 and amended on May 15, 1996, February 28, 2008 and June 27, 2017, effective from January 1, 2018, manufacturers must discharge water pollutants in accordance with national and local standards. If the water pollutants discharged exceed national or local standards, the manufacturer would be subject to fines amounting between 0.1 million to 1 million RMB. In addition, the environmental protection authority has the right to order such manufacturer to correct their actions by reducing the amount of discharge during a stipulated period of time by restricting or suspending their operations. If the manufacturer fails to correct its action at the expiration of the stipulated period, the environmental protection authority may, subject to approval by the relevant level of the PRC government, shut down the manufacturer.

Gansu QLS has obtained its Pollutant Discharging Permit valid from December 29, 2020 to December 28, 2025, and Chengdu QLS has obtained the Pollutant Discharging Permit valid from May 30, 2019 to May 29, 2022, as required by the Air Pollution Prevention Law of the PRC as well as the Water Pollution Prevention Law of the PRC.

PRC Laws and Regulations on Foreign Investment

Investment in the PRC by foreign investors and foreign-invested enterprises shall comply with the Catalogue for the Guidance of Foreign Investment Industries (2017 Revision) (the “Catalogue”), which was last amended and issued by MOFCOM and NDRC on June 28, 2017 and became effective since July 28, 2017, and the Special Management Measures for Foreign Investment Access (2020 version), or the Negative List, which came into effect on July 23, 2020. The Catalogue and the Negative List contains specific provisions guiding market access for foreign capital and stipulates in detail the industry sectors grouped under the categories of encouraged industries, restricted industries and prohibited industries. Any industry not listed on the Negative List is a permitted industry unless otherwise prohibited or restricted by other PRC laws or regulations. The pharmaceutical industry, except for the production of confidential prescription products of proprietary Chinese medicines and the application of steaming, frying, simmering and calcining and other processing techniques for traditional Chinese medicine pieces, which are prohibited to be invested in by foreign capital, falls within the permitted category in accordance with the Catalogue and the Negative List. As of the date of this prospectus, our current production and operation do not fall within any items on the Negative List. However, we may in the future acquire upstream and downstream companies manufacturing traditional Chinese medicine pieces, and as result it is likely that our production and operation would be subject to the Negative List. As a result, we would not be able to hold any equity of Gansu QLS and its subsidiaries.

On March 15, 2019, the National People’s Congress approved the Foreign Investment Law of the PRC, or the Foreign Investment Law, which came into effect on January 1, 2020, repealing simultaneously the Law of the PRC on Sino-foreign Equity Joint Ventures, the Law of the PRC on Wholly Foreign-owned Enterprises and the Law of the PRC on Sino-foreign Cooperative Joint Ventures. The Foreign Investment Law adopts the management system of pre-establishment national treatment and negative list for foreign investment. Policies in support of enterprises shall apply equally to foreign-funded enterprises according to laws and regulations. Foreign investment enterprises shall be guaranteed that they could equally participate in the setting of standards, and the compulsory standards formulated by the State shall be equally applied. Fair competition for foreign investment enterprises to participate in government procurement activities shall be protected. The Foreign Investment Law also stipulates the protection on intellectual property rights and trade secrets. The State also establishes information reporting system and national security review system according to the Foreign Investment Law.

PRC Laws and Regulations on Wholly Foreign-owned Enterprises

The establishment, operation and management of corporate entities in China are governed by the PRC Company Law, which was promulgated by the SCNPC on December 29, 1993 and became effective on July 1, 1994. It was last amended on October 26, 2018 and the amendments became effective on October 26, 2018. Under the PRC Company Law, companies are generally classified into two categories, namely, limited liability companies and joint stock limited companies. The PRC Company Law also applies to limited liability companies and joint stock limited companies with foreign investors. Where there are otherwise different provisions in any law on foreign investment, such provisions shall prevail.

The Law of the PRC on Wholly Foreign-invested Enterprises was promulgated and became effective on April 12, 1986, and was last amended and became effective on October 1, 2016. The Implementing Regulations of the PRC Law on Foreign-invested Enterprises were promulgated by the State Council on October 28, 1990. They were last amended on February 19, 2014 and the amendments became effective on March 1, 2014. The Provisional Measures on Administration of Filing for Establishment and Change of Foreign Investment Enterprises were promulgated by MOFCOM and became effective on October 8, 2016, and were last amended on June 30, 2018 with immediate effect. The above-mentioned laws form the legal framework for the PRC Government to regulate Foreign-invested Enterprises. These laws and regulations govern the establishment, modification, including changes to registered capital, shareholders, corporate form, merger and split, dissolution and termination of Foreign-invested Enterprises.

According to the above regulations, a Foreign-invested Enterprise should get approval by MOFCOM before its establishment and operation. Chengdu Qilian Trading Co., Ltd. is a Foreign-invested Enterprise since established, and has obtained the approval of the local administration of MOFCOM. Its establishment and operation are in compliance with the above-mentioned laws. Gansu QLS is a PRC domestic company, and it is not subject to the record-filling or examination applicable to Foreign-invested Enterprises.

PRC Laws and Regulations on Intellectual Property Rights

Regulations on Trademarks

The Trademark Law of the PRC was adopted at the 24th meeting of the SCNPC on August 23, 1982. Four amendments were made on February 22, 1993, October 27, 2001, August 30, 2013 and April 23, 2019. The last amendment was implemented on November 1, 2019. The Regulations on the Implementation of the Trademark Law of the PRC were promulgated by the State Council of the People’s Republic of China on August 3, 2002, which took effect on September 15, 2002. It was revised on April 29, 2014 and became effective as of May 1, 2014. According to the Trademark Law and the implementing regulations, a trademark which has been approved and registered by the trademark office is a registered trademark, including a trademark of goods, services, collective trademark and certification trademark. The trademark registrant shall enjoy the exclusive right to use the trademark and shall be protected by law. The trademark law also specifies the scope of registered trademarks, procedures for registration of trademarks and the rights and obligations of trademark owners. We are currently holding 9 registered trademarks in China and enjoy the corresponding rights.

Regulations on Patents

Pursuant to the Patent Law of the PRC, or the Patent Law, promulgated by the SCNPC on March 12, 1984, as latest amended on December 27, 2008, and effective from October 1, 2009 and the Implementation Rules of the Patent Law of the PRC, promulgated by the State Council on June 15, 2001 and latest amended on January 9, 2010, there are three types of patent in the PRC: invention patent, utility model patent and design patent. The protection period is 20 years for invention patent and 10 years for utility model patent and design patent, commencing from their respective application dates. Any individual or entity that utilizes a patent or conducts any other activity in infringement of a patent without prior authorization of the patentee shall pay compensation to the patentee and is subject to a fine imposed by relevant administrative authorities and, if constituting a crime, shall be held criminally liable in accordance with the law. In the event that a patent is owned by two or more co-owners without an agreement regarding the distribution of revenue generated from the exploitation of any co-owner of the patent, such revenue shall be distributed among all the co-owners.

Existing patents can become narrowed, invalid or unenforceable due to a variety of grounds, including lack of novelty, creativity, and deficiencies in patent application. In China, a patent must have novelty, creativity and practical applicability. Under the Patent Law, novelty means that before a patent application is filed, no identical invention or utility model has been publicly disclosed in any publication in China or overseas or has been publicly used or made known to the public by any other means, whether in or outside of China, nor has any other person filed with the patent authority an application that describes an identical invention or utility model and is recorded in patent application documents or patent documents published after the filing date. Creativity means that, compared with existing technology, an invention has prominent substantial features and represents notable progress, and a utility model has substantial features and represents any progress. Practical applicability means an invention or utility model can be manufactured or used and may produce positive results. Patents in China are filed with the State Intellectual Property Office, or SIPO. Normally, the SIPO publishes an application for an invention patent within 18 months after the filing date, which may be shortened at the request of applicant. The applicant must apply to the SIPO for a substantive examination within 3 years from the date of application.

Our variable interest entity, Gansu QLS is currently holding 14 patents in China and enjoying the corresponding rights. In addition, Gansu QLS and Ahan have separately filed 3 and 1 patent applications with the Patent Administration Department of the PRC. We have exclusive rights to manufacture the products and utilize the processes issued patent rights within the valid term. As for other products of us and the related manufacturing processes, since the technology information has been published to public domain by national or local product standard, we are able to utilize such technology information without need to obtain any patent license. To our knowledge, we do not violate the existing patent rights of any third party.

Regulations on Domain Names

The Ministry of Industry and Information Technology of the PRC, or the MIIT, promulgated the Measures on Administration of Internet Domain Names, or the Domain Name Measures, on August 24, 2017, which took effect on November 1, 2017 and replaced the Administrative Measures on China Internet Domain Name promulgated by the MIIT on November 5, 2004. According to the Domain Name Measures, the MIIT is in charge of the administration of PRC internet domain names. The domain name registration follows a first-to-file principle. Applicants for registration of domain names shall provide true, accurate and complete information of their identities to domain name registration service institutions. The applicant will become the holder of such domain names upon completion of the registration procedure. We have completed filing for record for our domain name of “qlsyy.net” as a provider of non-commercial internet-based information services.  

PRC Laws and Regulations on Foreign Exchange

General Administration of Foreign Exchange

The principal regulation governing foreign currency exchange in the PRC is the Administrative Regulations of the PRC on Foreign Exchange (the “Foreign Exchange Regulations”), which were promulgated on January 29, 1996, became effective on April 1, 1996 and were last amended on August 5, 2008. Under these rules, Renminbi is generally freely convertible for payments of current account items, such as trade- and service-related foreign exchange transactions and dividend payments, but not freely convertible for capital account items, such as capital transfer, direct investment, investment in securities, derivative products or loans unless prior approval by competent authorities for the administration of foreign exchange is obtained. Under the Foreign Exchange Regulations, foreign-invested enterprises in the PRC may purchase foreign exchange without the approval of SAFE to pay dividends by providing certain evidentiary documents, including board resolutions, tax certificates, or for trade- and services-related foreign exchange transactions, by providing commercial documents evidencing such transactions.

Registration of Foreign Investment Enterprises

Pursuant to the Notice of State Administration of Foreign Exchange on Promulgation of the Provisions on Foreign Exchange Control on Direct Investments in China by Foreign Investors promulgated by the SAFE, or the Notice, upon establishment of a foreign investment enterprise pursuant to the law, registration formalities shall be completed with the foreign exchange bureau. Upon completion of registration formalities by the entities involved in direct investments in China, the entities may open accounts for direct investments in China such as preliminary expense account, capital fund account and asset realization account, etc. with the bank based on the actual needs. Upon completion of such registration formalities, foreign investment enterprises could also conduct settlement when contributing foreign exchange funds, and remit funds overseas in the event of capital reduction, liquidation, advance recovery of investment, profit distribution, etc.

Our WFOE has completed the foreign exchange registration formalities upon establishment. Consequently, Qilian International (Hong Kong) Holdings Limited, the sole shareholder of WFOE, is able to contribute capital to or receive distributions and dividends from WFOE.

Circular No. 37 and Circular No. 13

Circular 37 was released by SAFE on July 4, 2014 and repealed Circular 75 which had been in effect since November 1, 2005. Pursuant to Circular 37, a PRC resident should apply to SAFE for foreign exchange registration of overseas investments before it makes any capital contribution to a special purpose vehicle, or SPV, using his or her legitimate domestic or offshore assets or interests. SPVs are offshore enterprises directly established or indirectly controlled by domestic residents for the purpose of investment and financing by utilizing domestic or offshore assets or interests they legally hold. Following any significant change in a registered offshore SPV, such as capital increase, reduction, equity transfer or swap, consolidation or division involving domestic resident individuals, the domestic individuals shall amend the registration with SAFE. Where an SPV intends to repatriate funds raised after completion of offshore financing to the PRC, it shall comply with relevant PRC regulations on foreign investment and foreign debt management. A foreign-invested enterprise established through return investment shall complete relevant foreign exchange registration formalities in accordance with the prevailing foreign exchange administration regulations on foreign direct investment and truthfully disclose information on the actual controller of its shareholders.

If any shareholder who is a PRC resident (as determined by Circular No. 37) holds any interest in our SPV and fails to fulfil the required foreign exchange registration with the local SAFE branches, capital contribution to the SPV by the shareholder failing to comply with Circular No. 37, as well as the distribution of profits and dividends derived from the SPV to such shareholder may be prohibited. However, even if such shareholder fails to fulfil the required foreign exchange registration with the local SAFE branches, Qilian International and Qilian HK are not restricted in their ability to contribute additional capital to WFOE. Since Gansu QLS and its subsidiaries are only controlled by WFOE through contractual arrangements, and since WFOE is not a shareholder of Gansu QLS, neither Gansu QLS nor any of its subsidiaries have any obligations to contribute capital to WFOE, nor have they any rights to receive distributions or dividends from WFOE. Only capital contributions to a special purpose vehicle by its shareholders failing to comply with Circular 37, as well as the repatriation of profits and dividends derived from such special purpose vehicle to China by its shareholders are limited. Our WFOE is not prohibited from distributing its profits and dividends to Qilian International or Qilian HK or from carrying out other subsequent cross-border foreign exchange activities because WFOE has completed the foreign exchange registration formalities as required upon its establishment. Where a domestic resident fails to complete relevant foreign exchange registration as required, fails to truthfully disclose information on the actual controller of the enterprise involved in the return investment or otherwise makes false statements, the foreign exchange administration authority may, according to Regulation of the People's Republic of China on Foreign Exchange Administration (2008 Revision) promulgated by the State Council with immediate effect on August 5, 2008, order them to take remedial actions, issue a warning, and impose a fine of less than RMB 300,000 on an institution or less than RMB 50,000 on an individual.

Circular 13 was issued by SAFE on February 13, 2015, became effective on June 1, 2015, and amended on December 30, 2019. Pursuant to Circular 13, a domestic resident who makes a capital contribution to an SPV using his or her legitimate domestic or offshore assets or interests is no longer required to apply to SAFE for foreign exchange registration of his or her overseas investments. Instead, he or she shall register with a bank in the place where the assets or interests of the domestic enterprise in which he or she has interests are located if the domestic resident individually seeks to make a capital contribution to the SPV using his or her legitimate domestic assets or interests; or he or she shall register with a local bank at his or her permanent residence if the domestic resident individually seeks to make a capital contribution to the SPV using his or her legitimate offshore assets or interests.

There are a total of 151 Gansu QLS shareholders, who are PRC residents. Amongst them, 121 have signed the VIE agreements, but only 81 have completed the Circular 37 Registration. The remaining 40 shareholders who have yet to complete the Circular 37 Registration hold a total of 4.5% of shares of Gansu QLS. The failure of our beneficial shareholders to comply with the registration procedures may subject each of our beneficial shareholders to fines of less than RMB 50,000 (approximately US$7,199). Shareholders of offshore SPV who are PRC residents and who have not completed their registrations in accordance with Circular 37 are subject to certain absolute restrictions, under which they cannot contribute any registered or additional capital to such SPV for offshore financing purposes. In addition, these shareholders cannot repatriate any profits and dividends from the SPV to China either.

Shareholders who have completed the Circular 37 registration would not be adversely affected and are allowed to contribute assets into the offshore special purpose vehicle and repatriate profits and dividends from them. Since our WFOE has completed its foreign exchange registration as a foreign investment enterprise, its ability to receive capital contribution, make distributions and pay dividends is not restricted.

Circular 19 and Circular 16

Circular 19 was promulgated by SAFE on March 30, 2015, became effective on June 1, 2015 and last amended on December 30, 2019. According to Circular 19, the foreign exchange capital in the capital account of foreign-invested enterprises, meaning the monetary contribution confirmed by the foreign exchange authorities or the monetary contribution registered for account entry through banks, shall be granted the benefits of Discretional Foreign Exchange Settlement (“Discretional Foreign Exchange Settlement”). With Discretional Foreign Exchange Settlement, foreign capital in the capital account of a foreign-invested enterprise for which the rights and interests of monetary contribution have been confirmed by the local foreign exchange bureau, or for which book-entry registration of monetary contribution has been completed by the bank, can be settled at the bank based on the actual operational needs of the foreign-invested enterprise. The allowed Discretional Foreign Exchange Settlement percentage of the foreign capital of a foreign-invested enterprise has been temporarily set to be 100%. The Renminbi converted from the foreign capital will be kept in a designated account and if a foreign-invested enterprise needs to make any further payment from such account, it will still need to provide supporting documents and to complete the review process with its bank.

Furthermore, Circular 19 stipulates that foreign-invested enterprises shall make bona fide use of their capital for their own needs within their business scopes. The capital of a foreign-invested enterprise and the Renminbi it obtained from foreign exchange settlement shall not be used for the following purposes:

Circular 16 was issued by SAFE on June 9, 2016. Pursuant to Circular 16, enterprises registered in the PRC may also convert their foreign debts from foreign currency to Renminbi on a self-discretionary basis. Circular 16 provides an integrated standard for conversion of foreign exchange capital items (including but not limited to foreign currency capital and foreign debts) on a self-discretionary basis applicable to all enterprises registered in the PRC. Circular 16 reiterates the principle that an enterprise’s Renminbi capital converted from foreign currency-denominated capital may not be directly or indirectly used for purposes beyond its business scope or purposes prohibited by PRC laws or regulations, and such converted Renminbi capital shall not be provided as loans to non-affiliated entities.

PRC Laws and Regulations on Taxation

Enterprise Income Tax

The Enterprise Income Tax Law of the People’s Republic of China (the “EIT Law”) was promulgated by the Standing Committee of the National People’s Congress on March 16, 2007, became effective on January 1, 2008, and was last amended on December 29, 2018. The Implementation Rules of the EIT Law (the “Implementation Rules”) were promulgated by the State Council on December 6, 2007, became effective on January 1, 2008 and last amended on April 23, 2019. According to the EIT Law and the Implementation Rules, enterprises are divided into resident enterprises and non-resident enterprises. Resident enterprises shall pay enterprise income tax on their incomes obtained in and outside the PRC at the rate of 25%. Non-resident enterprises setting up institutions in the PRC shall pay enterprise income tax on the incomes obtained by such institutions in and outside the PRC at the rate of 25%. Non-resident enterprises with no institutions in the PRC, and non-resident enterprises whose incomes having no substantial connection with their institutions in the PRC, shall pay enterprise income tax on their incomes obtained in the PRC at a reduced rate of 10%.

The Arrangement between the PRC and Hong Kong Special Administrative Region for the Avoidance of Double Taxation the Prevention of Fiscal Evasion with respect to Taxes on Income (the “Arrangement”) was promulgated by the State Administration of Taxation (“SAT”) on August 21, 2006, with its fifth protocol coming into effect on December 6, 2019. According to the Arrangement, a company incorporated in Hong Kong will be subject to withholding tax at the lower rate of 5% on dividends it receives from a company incorporated in the PRC if it holds a 25% interest or more in the PRC company. The Notice on the Understanding and Identification of the Beneficial Owners in the Tax Treaty (the “Notice”) was promulgated by SAT and became effective on October 27, 2009. According to the Notice, a beneficial ownership analysis will be used based on a substance-over-form principle to determine whether or not to grant tax treaty benefits.

Gansu GLS and its subsidiaries are resident enterprises and pay EIT tax at the rate of 25% in the PRC. It is more likely than not that the Company and its offshore subsidiary would be treated as a non-resident enterprise for PRC tax purposes.

Value-added Tax

Pursuant to the Provisional Regulations on Value-added Tax of the PRC, or the VAT Regulations, which were promulgated by the State Council on December 13, 1993, took effect on January 1, 1994, and were amended on November 10, 2008, February 6, 2016, and November 19, 2017, respectively, and the Rules for the Implementation of the Provisional Regulations on Value-added Tax of the PRC, which were promulgated by the MOF on December 25, 1993, and were amended on December 15, 2008, and October 28, 2011, respectively, entities and individuals that sell goods or labor services of processing, repair or replacement, sell services, intangible assets, or immovables, or import goods within the territory of the People’s Republic of China are taxpayers of value-added tax. The VAT rate is 17% for taxpayers selling goods, labor services, or tangible movable property leasing services or importing goods, except otherwise specified; 11% for taxpayers selling services of transportation, postal, basic telecommunications, construction and lease of immovable, selling immovable, transferring land use rights, selling and importing other specified goods including fertilizers; 6% for taxpayers selling services or intangible assets.

According to the Notice on the Adjustment to the Value-added Tax Rates issued by the SAT and the MOF on April 4, 2018, where taxpayers make VAT taxable sales or import goods, the applicable tax rates shall be adjusted from 17% to 16% and from 11% to 10%, respectively. Subsequently, the Notice on Policies for Deepening Reform of Value-added Tax was issued by the SAT, the MOF and the General Administration of Customs on March 20, 2019 and took effective on April 1, 2019, which further adjusted the applicable tax rate for taxpayers making VAT taxable sales or importing goods. The applicable tax rates shall be adjusted from 16% to 13% and from 10% to 9%, respectively. 

Currently, Gansu QLS and its subsidiaries are paying VAT at the rate of 13% for pharmaceutical manufacture and sales, health materials and medical consumable products manufacture, soy products manufacture, selling Heparin Sodium Preparations; 9% for lease of immovable, use of land and second-hand buildings, soy products manufacture, pollution disposing, selling of sausage casing; and 6% for human resource services.

Dividend Withholding Tax

The Enterprise Income Tax Law provides that since January 1, 2008, an income tax rate of 20% will normally be applicable to dividends declared to non-PRC resident investors that do not have an establishment or place of business in the PRC, or that have such establishment or place of business but the relevant income is not effectively connected with the establishment or place of business, to the extent such dividends are derived from sources within the PRC.

Pursuant to an Arrangement Between the Mainland of China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Incomes (“Double Tax Avoidance Arrangement”) , with its fifth protocol coming into effect on December 6, 2019,and other applicable PRC laws, 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, the 10% withholding tax on the dividends the Hong Kong resident enterprise receives from a PRC resident enterprise may be reduced to 5%. However, based on the Circular on Certain Issues with Respect to the Enforcement of Dividend Provisions in Tax Treaties (the “SAT Circular 81”) issued on February 20, 2009 by SAT, if the relevant PRC tax authorities determine, in their discretion, that a company benefits from such reduced income tax rate due to a structure or arrangement that is primarily tax-driven, such PRC tax authorities may adjust the preferential tax treatment. According to the Circular on Several Questions regarding the “Beneficial Owner” in Tax Treaties, which was issued on February 3, 2018 by the SAT and took effect on April 1, 2018, when determining the applicant’s status of the “beneficial owner” regarding tax treatments in connection with dividends, interests or royalties in the tax treaties, several factors, including without limitation, whether the applicant is obligated to pay more than 50% of his or her income in twelve months to residents in third country or region, whether the business operated by the applicant constitutes the actual business activities, and 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, will be taken into account, and it will be analyzed according to the actual circumstances of the specific cases. This circular further provides that applicants who intend to prove his or her status of the “beneficial owner” shall submit the relevant documents to the relevant tax bureau according to the Announcement on Issuing the Measures for the Administration of Non-Resident Taxpayers’ Enjoyment of the Treatment under Tax Agreements.

We have not commenced the application process for a Hong Kong tax resident certificate from the relevant Hong Kong tax authority, and there is no assurance that we will be granted such a Hong Kong tax resident certificate. We have not filed required forms or materials with the relevant PRC tax authorities to prove that we should enjoy the 5% PRC withholding tax rate.

PRC Laws and Regulations on Employment and Social Welfare

Labor Law of the PRC

Pursuant to the Labor Law of the PRC, which was promulgated by the Standing Committee of the NPC on July 5, 1994 with an effective date of January 1, 1995 and was last amended on December 29, 2018 and the Labor Contract Law of the PRC, which was promulgated on June 29, 2007, became effective on January 1, 2008 and was last amended on December 28, 2012, with the amendments coming into effect on July 1, 2013, enterprises and institutions shall ensure the safety and hygiene of a workplace, strictly comply with applicable rules and standards on workplace safety and hygiene in China, and educate employees on such rules and standards. Furthermore, employers and employees shall enter into written employment contracts to establish their employment relationships. Employers are required to inform their employees about their job responsibilities, working conditions, occupational hazards, remuneration and other matters with which the employees may be concerned. Employers shall pay remuneration to employees on time and in full accordance with the commitments set forth in their employment contracts and with the relevant PRC laws and regulations. Gansu QLS and its subsidiary company have entered into written employment contracts with all the employees and performed their obligations under the relevant PRC laws and regulations.

Social Insurance and Housing Fund

Pursuant to the Social Insurance Law of the PRC, which was promulgated by the Standing Committee of the NPC on October 28, 2010, became effective on July 1, 2011, and was last amended on December 29, 2018,employers in the PRC shall provide their employees with welfare schemes covering basic pension insurance, basic medical insurance, unemployment insurance, maternity insurance, and occupational injury insurance. Gansu QLS has not deposited the social insurance fees in full for all the employees in compliance with the relevant regulations. Gansu QLS may be ordered by the social security premium collection agency to make or supplement contributions within a stipulated period, and shall be subject to a late payment fine computed from the due date at the rate of 0.05% per day; where payment is not made within the stipulated period, the relevant administrative authorities shall impose a fine ranging from one to three times the amount of the amount in arrears. Gansu QLS has deposited the social insurance fees as required by relevant regulations. See “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in China—We are not in compliance with the PRC’s regulations relating to employee’s social insurance and housing funds, and as a result, Gansu QLS and its subsidiaries may be subject to penalties if we are not able to remediate the non-compliance.”

In accordance with the Regulations on Management of Housing Provident Fund, which were promulgated by the State Council on April 3, 1999 and last amended on March 24, 2019, employers must register at the designated administrative centers and open bank accounts for depositing employees’ housing funds. Employers and employees are also required to pay and deposit housing funds, with an amount no less than 5% of the monthly average salary of the employee in the preceding year in full and on time. Gansu QLS has opened bank accounts and deposited housing provident funds as required since August 2019. However, Chengdu QLS have not opened bank accounts for its employees’ housing funds deposits, or deposited employees’ housing funds, which may be ordered by the relevant PRC authorities to open the housing funds account, make the payment, and deposit within a prescribed time limit. If Chengdu QLS fails to go through the formalities to open the account within the prescribed time limit, a fine of not less than RMB10,000 nor more than RMB50,000 shall be imposed. If Chengdu QLS fails to make the payment and deposit within the prescribed time limit, an application may be made to the people’s court for compulsory enforcement.

C.  Organizational Structure

The following diagram illustrates our current corporate structure, which includes our significant subsidiaries as of the date of this annual report:

Contractual Arrangements between WFOE and Gansu QLS

Due to PRC legal restrictions on foreign ownership in the pharmaceutical sector, neither we nor our subsidiaries own any equity interest in Gansu QLS. Instead, we control and receive the economic benefits of Gansu QLS’s business operation through a series of contractual arrangements. WFOE, Gansu QLS and its shareholders entered into a series of contractual arrangements, also known as VIE Agreements, on May 20, 2019. The VIE agreements are designed to provide WFOE with the power, rights and obligations equivalent in all material respects to those it would possess as the sole equity holder of Gansu QLS, including absolute control rights and the rights to the assets, property and revenue of Gansu GLS.

Each of the VIE Agreements is described in detail below:

Exclusive Service Agreement

Pursuant to the Exclusive Service Agreement between Gansu QLS and WFOE, WFOE provides Gansu QLS with technical support, consulting services and other management services relating to its day-to-day business operations and management, on an exclusive basis, utilizing its advantages in technology, business management and information. For services rendered to Gansu QLS by WFOE under this agreement, WFOE is entitled to collect a service fee that shall be equal to 98.297% of the net profits of Gansu QLS, as reflected in the “ARTICLE 3 - SERVICE FEES” of the Amended Exclusive Service Agreement executed on August 27, 2019. This percentage represents the number of shares of Gansu QLS held by shareholders having signed the VIE Agreements over the total number of issued and outstanding shares of Gansu QLS.

The Exclusive Service Agreement shall remain in effect for ten years unless earlier terminated upon written confirmation from both WFOE and Gansu QLS before expiration. Otherwise, this agreement shall be extended by another ten years automatically. Gansu QLS does not have the right to terminate the agreement unilaterally.

WFOE is currently managing Gansu QLS pursuant to the terms of the Exclusive Service Agreement. WFOE has absolute authority relating to the management of Gansu QLS, including but not limited to decisions with regard to expenses, salary raises and bonuses, hiring, firing and other operational functions. The Exclusive Service Agreement does not prohibit related party transactions. The audit committee of the registrant is required to review and approve in advance any related party transactions, including transactions involving WFOE or Gansu QLS. 

Equity Pledge Agreement

Under the Equity Pledge Agreement between WFOE and certain shareholders of Gansu QLS together holding 75,492,128 shares, or 98.297% of the total issued and outstanding shares, of Gansu QLS (“Gansu QLS Shareholders”), the Gansu QLS Shareholders pledged all of their equity interests in Gansu QLS to WFOE to guarantee the performance of Gansu QLS’ obligations under the Exclusive Service Agreement. Under the terms of the Equity Pledge Agreement, in the event that Gansu QLS breaches its contractual obligations under the Exclusive Service Agreement, WFOE, as pledgee, will be entitled to certain rights, including, but not limited to, the right to collect dividends generated by the pledged equity interests. The Gansu QLS Shareholders also agreed that upon occurrence of any event of default, as set forth in the Equity Pledge Agreement, WFOE is entitled to dispose of the pledged equity interest in accordance with applicable PRC laws. The Gansu QLS Shareholders further agree not to dispose of the pledged equity interests or take any actions that would prejudice WFOE’s interest.

The Equity Pledge Agreement shall be effective until the latest date of the following: (1) the secured debt in the scope of pledge is cleared off; (2) WFOE exercises its pledge rights pursuant to provisions and conditions of the Equity Pledge Agreement; and (3) the Gansu QL Shareholders transfer all the pledged equity interests to WFOE according to the Call Option Agreement, or other entity or individual designated by it.

The purposes of the Equity Pledge Agreement are to (1) guarantee the performance of Gansu QLS’s obligations under the Exclusive Service Agreement, (2) ensure the Gansu QLS Shareholders do not transfer or assign the pledged equity interests, or create or allow any encumbrance that would prejudice WFOE’s interests without WFOE’s prior written consent and (3) provide WFOE control over Gansu QLS. Under the Call Option Agreement, WFOE may be able to acquire the equity interests or the assets in Gansu QLS any time to the extent permitted by the PRC Law. In the event Gansu QLS breaches its contractual obligations under the Exclusive Service Agreement, WFOE will be entitled to foreclose on the Gansu QLS Shareholders’ equity interests in Gansu QLS and may (1) exercise its option to purchase or designate third parties to purchase part or all of their equity interests or the assets in Gansu QLS and in this situation, WFOE may terminate the Exclusive Service Agreement, Equity Pledge Agreement and Call Option Agreement after acquisition of all equity interests or assets in Gansu QLS or form new VIE structure with the third parties designated by WFOE; or (2) dispose the pledged equity interests or assets and be paid in priority out of proceed from the disposal in which case the VIE structure will be terminated.

Call Option Agreement

Under the Call Option Agreement, the Gansu QLS Shareholders irrevocably granted WFOE (or its designee) an exclusive right to purchase, to the extent permitted under PRC law, once or at multiple times, at any time, a portion or whole of the equity interests or assets in Gansu QLS held by the Gansu QLS Shareholders. The purchase price should be no more than $1.00 subject to any appraisal or restrictions required by applicable PRC laws and regulations.

The agreement remains effective till all the transferred equity or transferred asset of Gansu QLS is legally transferred under the name of WFOE and/or other entity or individual designated by it.

Shareholders’ Voting Rights Proxy Agreement and Powers of Attorney

Under the Shareholders’ Voting Rights Proxy Agreement and each Power of Attorney, each Gansu QLS Shareholder authorizes WFOE to act on their behalf as their exclusive agent and attorney with respect to all rights as shareholders, including but not limited to: (a) the attendance of the shareholder’s meeting and the execution of relative Shareholder Resolution(s) of Gansu QLS; (b) exercising all the shareholder’s rights, including voting, that shareholders are entitled to under the laws of China and the Articles of Association, including but not limited to the sale or transfer or pledge or disposition of shares in part or in whole; and (c) designating and appointing on behalf of shareholders the legal representative, the executive director, supervisor, the chief executive officer and other senior management members of Gansu QLS.

Each Power of Attorney is coupled with an interest and shall be irrevocable and continuously valid from the date of its execution, so long as the relevant Gansu QLS Shareholder is a shareholder of Gansu QLS.

Spousal Consent

The spouses of the Gansu QLS Shareholders agreed, via a spousal consent, to the execution of the “Transaction Documents” including: (a) the Call Option Agreement entered into with WFOE and Gansu QLS; (b) the Shareholders’ Voting Rights Proxy Agreement entered into with WFOE and Gansu QLS; (c) the Equity Pledge Agreement entered into with WFOE; and (d) the Power of Attorney executed by each Gansu QLS Shareholder , and the disposal of the equity interests of Gansu QLS held by each Gansu QLS Shareholder and registered in his/her name.

The spouses further undertake not to make any assertions in connection with the equity interests of Gansu QLS which are held by the Gansu QLS Shareholders. They confirm that the Gansu QLS Shareholders can perform, amend, or terminate the Transaction Documents without their authorization or consent. They undertake to execute all necessary documents and take all necessary actions to ensure appropriate performance of the agreements.

D.  Property, Plants and Equipment 

We own our principal executive office, which is located at Jiuquan Economic and Technological Development Zone (formerly named No. 2 Dadeli Road, Nanjiao Industrial Park), Jiuquan City, Gansu, China. We use our principal executive office not only for corporate and administrative purposes, but also for manufacturing our oxytetracycline products and licorice TCMD products.

The Company also currently owns the following land use rights and properties for its operations:

In addition, the Company’s operating subsidiaries in China currently lease four properties as office space and employee dormitories.

Chengdu QLS currently leases from Sichuan Lianjia Real Estate Brokerage Co., Ltd., on an arm’s length basis, for an office space of approximately 78 square meters at No. 180, Building 6, No. 126 of Guanghua West 3rd Road, Qingyang District, Chengdu, Sichuan Province, China under a lease that expires on December 1, 2020 and can be renewed subject to mutual agreements by both parties.

Chengdu QLS also currently leases from Chengdu Dingsheng Jiaye Real Estate Brokerage Co., Ltd., on an arm’s length basis, for a dormitory of approximately 60 square meters at No. P02, Building P, No. 78 of Guanghua East 4th Road, Qingyang District, Chengdu, Sichuan Province, China under a lease that expires on October 18, 2020 and can be renewed subject to mutual agreements by both parties.

Gansu QLS currently leases from Ms. Kunqiong Zeng, on an arm’s length basis, for a dormitory of approximately 79 square meters at No. 1506, Unit 1, Building 8, No. 383 of Chengfei Avenue South Section, Qingyang District, Chengdu, Sichuan Province, China under a lease that expires on October 30, 2020 and can be renewed subject to mutual agreements by both parties.

Gansu QLS also currently leases from Ms. Jing Zhou, on an arm’s length basis, for a dormitory of approximately 84 square meters at No. 505, 5th Floor, Unit 1, Building 3, No. 30 of Guanghua West 3rd Road, Qingyang District, Chengdu, Sichuan Province, China under a lease that expires on November 9, 2020 and can be renewed subject to mutual agreements by both parties.

We believe that our current facilities are adequate and suitable for our operations.

ITEM 4.A. UNRESOLVED STAFF COMMENTS 

None.

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 

The following discussion of our financial condition and results of operations is based upon and should be read in conjunction with our consolidated financial statements and their related notes included elsewhere in this annual report. This annual report contains forward-looking statements. See “Forward-Looking Information” in this annual report. In evaluating our business, you should carefully consider the information provided under the caption “Item 3. Key Information—D. Risk Factors” in this annual report. We caution you that our businesses and financial performance are subject to substantial risks and uncertainties.

A.  Operating Results 

Overview

We are engaged in the research, development, and production of licorice products, oxytetracycline products, TCMD product, heparin product, sausage casings, and fertilizers.

We were originally incorporated in the Cayman Islands on February 7, 2019. Our business is conducted by Gansu QLS, our VIE in the PRC, and its subsidiaries, using RMB, the currency of China.

On May 20, 2019, we, through our wholly foreign-owned entity Chengdu Trading, entered into a series of contractual agreements with Gansu QLS, which include an Exclusive Service Agreement, an Equity Pledge Agreement, a Call Option Agreement, a Shareholders’ Voting Rights Proxy Agreement and Powers of Attorney (together, the “VIE agreements”). Pursuant to the VIE agreements, WFOE provides Gansu QLS with technical support, consulting services and other management services and is entitled to receive 98.297% of Gansu QLS’ net profits, this percentage being the number of shares of Gansu QLS held by shareholders having signed the VIE Agreements over the total issued and outstanding shares of Gansu QLS. In addition, Gansu QLS’s shareholders have pledged 98.297% of their equity interests in Gansu QLS to WFOE, irrevocably granted WFOE an exclusive option to purchase, to the extent permitted under PRC law, all or part of the equity interests in Gansu QLS, and agreed to entrust all the rights to exercise their voting power to the person(s) appointed by WFOE. Through the VIE agreements, Qilian Chengdu holds all the variable interests of Gansu QLS. Therefore, Qilian Chengdu is the primary beneficiary of Gansu QLS.

Based on the VIE arrangements, Gansu QLS is considered a VIE of Qilian Chengdu under U.S. GAAP. As the above entities were under common control before and after the execution of the VIE agreements, the restructuring was accounted for as a reorganization of entities under common control and consolidated financial statements were prepared as if the reorganization occurred at the beginning of the first period presented. Thus, the financial results presented here include those of VIEs from the first period presented.

As of the date of this annual report, there are 35,750,000 Ordinary Shares issued and outstanding.

Outlook

We plan to continue developing our business by expanding our marketing network and investing in pharmaceutical and chemical facilities, which depend heavily on sufficient capital. If we are not able to obtain equity or debt financing, we may not be able to execute our development and expansion plans, which could have material adverse effect on our future business performance and operating results.

Our net revenue for the year ended September 30, 2020 was $50.0 million, representing an increase of $3.9 million, or 9%, from $46.1 million for the year ended September 30, 2019. Net income attributable to our shareholders for the year ended September 30, 2020 was $5.1 million, representing a decrease of $0.2 million, or 5%, from $5.3 million for the year ended September 30, 2019. Non-GAAP EBITDA for the year ended September 30, 2020 was $7.2 million, representing a decrease of $1.2 million, or 14%, from $8.4 million for the year ended September 30, 2019. For additional information on EBITDA, please see the subsection “—EBITDA” below.

How to Assess the Company’s Performance

In assessing performance, we consider a variety of performance and financial measures, including principal growth in net revenue, gross profit, distribution, general and administrative expenses, net income from operations, and EBITDA (Non-GAAP). The key measures that we use to evaluate the performance of our business are set forth below:

Net Revenue

Net revenue is equal to gross sales minus sales returns and sales incentives that we offer to our customers, such as discounts that are offset to gross sales. Our net sales are driven by changes in the number of customers, product varieties, selling price, and mix of products sold.

Gross Profit

Gross profit is equal to net sales minus cost of goods sold. Cost of goods sold primarily includes inventory costs (net of supplier consideration), inbound freight, custom clearance fees, and other miscellaneous expenses. Cost of goods sold generally changes as we incur higher or lower costs from suppliers and as the customer and product mix changes.

Selling, General and Administrative Expenses

Selling, general and administrative expenses primarily consist of salaries and benefits for employees, shipping expense, utilities, maintenance and repairs expenses, insurance expense, depreciation and amortization expenses, selling and marketing expenses, professional fees, and other operating expenses.

Non-GAAP Financial Measures-EBITDA

Management uses certain financial measures to evaluate our operating performance which is calculated and presented on the basis of methodologies other than in accordance with GAAP (“Non-GAAP”). These measures should not be considered a substitute for, or superior to, measures of financial performance prepared in accordance with GAAP, and our calculations thereof may not be comparable to similarly entitled measures reported by other companies. We believe that EBITDA is a useful performance measure and can be used to facilitate a comparison of our operating performance on a consistent basis from period to period and to provide for a more complete understanding of factors and trends affecting our business than GAAP measures alone can provide. Our management believes that EBITDA is less susceptible to variances in actual performance resulting from depreciation, amortization and other non-cash charges and more reflective of other factors that affect its operating performance. Our management believes that the use of these Non-GAAP financial measures provides an additional tool for investors to use in evaluating ongoing operating results and trends and in comparing our financial measures with the companies in the same industry, many of which present similar Non-GAAP financial measures to investors. We present EBITDA in order to provide supplemental information that Management considers relevant for the readers of its consolidated financial statements included elsewhere in this annual report, and such information is not meant to replace or supersede U.S. GAAP measures.

Our management defines EBITDA as net income (loss) before interest expense, income taxes, and depreciation and amortization. EBITDA is not defined under U.S. GAAP and is subject to important limitations as analytical tools, you should not consider them in isolation or as substitutes for analysis of our Company results as reported under U.S. GAAP. For example, EBITDA:

COVID-19

The outbreak of the novel coronavirus, commonly referred to as “COVID-19”, has significantly affected the economic and business activities within China. To contain the COVID-19 outbreak, the Chinese government has adopted restrictive measures such as city lockdowns, travel restrictions, and closures of business activities. As of the date of this prospectus, China has shown signs of COVID-19 slowdown and Chinese industries have gradually resumed businesses as government officials started to ease the restrictive measures since April 2020.

The COVID-19 outbreak has negatively impacted our businesses. Our manufacturing activities depend on a wide array of raw materials such as soybeans, corn starch, glycyrrhiza glabra plant, pig intestines, and many others. We have experienced substantive diminutions in raw material supplies due to the COVID-19 outbreak and ensuing lockdowns, in addition for the year ended September 30, 2020 the price of these raw materials has increased by approximately 4%-8% as compared to the same period of the last fiscal year. Our overall gross margin decreased from 21% for the year ended September 30, 2019 to 15% for the year ended September 30, 2020;

As of the date of this annual report, the COVID-19 coronavirus outbreak in China appears to be under control and majority of business activities have resumed under the guidance and support of the government. We have resumed manufacturing activities since February 27 2020. Most of our production lines have been restored to normal production capacity. However, the extent of future impact to which our operations or those of our third-party vendors and customers, including those customers that distribute to Europe and other jurisdictions outside of mainland China is still considered uncertain as COVID-19 continues to adversely affect the global economy and the potential for resurgences remain. 

Results of Operations for the years ended September 30, 2020 and 2019  

The following table sets forth a summary of our consolidated results of operations for the years ended September 30, 2020 and 2019. The historical results presented below are not necessarily indicative of the results that may be expected for any future period.

Net Revenue

The following table sets forth the breakdown of our net revenue:

Compared with net revenue for the year ended September 30, 2019, our net revenue increased by $3.9 million, or an 9% increase, for the year ended September 30, 2020, which was primarily attributable to a $2.5 million increase in sales from oxytetracycline products and licorice products, and a $1.3 million increase in sales from heparin products and sausage casings.

Oxytetracycline & Licorice products and TCMD

For the year ended September 30, 2020, our sales for oxytetracycline products, licorice products and TCMD increased by approximately $2.5 million, or 8%, from approximately $30.1 million for the year ended September 30, 2019 to approximately $32.6 million for the year ended September 30, 2020. The sales of oxytetracycline products, licorice products and TCMD accounted for 97%, 2% and 1%, respectively, of this segment’s total sales for the year ended September 30, 2020, and 96%, 4% and 0%, respectively, of such segment’s total sales for the year ended September 30, 2019. The increase in sales in this segment is due to the following reasons: 1) we conducted our scheduled facility maintenance from July 2019 to September 2019, which resulted in reduced oxytetracycline production by approximately 386 tons (a 16% decrease compared to that of fiscal year 2020). Although the outbreak of COVID-19 in early 2020 had negative impact of the manufacturing, we resumed production on February 27, 2020. Due to the production suspension in 2019, the quantity sold in 2019 was 16% less than the sales quantity in 2020, which contributed to $3.9 million of increase in sales in 2020. 2) Sales price per unit decreased by 5%, which is considered as normal in the course of business. The sales decreased by $0.6 million due to the price change. 3) during the COVID-19 outbreak in China, we switched part of our production lines to manufacture disinfection products in light of a shortage of such products, which contributed $148,000 in sales for the year ended September 30, 2020; 4) The sales increase in this segment was offset to a certain degree by a decrease in sales of licorice products. The COVID-19 outbreak in China during January to March had a significant impact on the sales of our licorice products. The sales volume of our licorice products decreased by 16% due to the logistics restraint and delays caused by China’s national lockdown during the COVID-19 outbreak. However, the market price of our licorice products had increased by 9% compared to same period in the last year due to the market’s high demand. Overall, the sales from our licorice products decreased by $0.3 million. 5) Due to the exchange rates, the sales for the year ended September 30, 2020 denominated in USD reduced by $0.6 million compared to that for the year ended September 30, 2019.

Heparin products and Sausage casings

Sales from heparin products increased by $1.3 million, or 9%, from $15.4 million for the year ended September 30, 2019, to $16.7 million for the year ended September 30, 2020. The increase of our sales of heparin products was mainly driven by the demand from our two long-term pharmaceutical customers. Due to COVID-19, eruption of the pandemic globally increased the demand for prescription medicines, vaccines and medical devices in pharmaceutical industries. The demand for heparin, a widely used medication also increased significantly during the pandemic. The sales made to our largest pharmaceutical customer in this segment increased by 179%, which contributed to $5.5 million of sales in this segment. Sales from other pharmaceutical customers increased by $0.6 million. However, our sales of sausage casing was decreased by $2.3 million due to the combined effect of COVID-19 outbreak and African Swine fever in China.

Fertilizer

Sales from fertilizer increased by $0.2 million, or a 28% increase, from $0.5 million for the year ended September 30, 2019 to $0.7 million for the year ended September 30, 2020. The increase in our sales of fertilizer products was due to our newly developed customers and regulatory policy of decreasing use of non-organic fertilizer and pesticide. Our fertilizer are mainly organic and more environmental friendly.

Cost of Revenue and Gross Profit

The following tables set forth the calculation of gross profit and gross margin for the each of our segments:

Oxytetracycline & Licorice products and TCMD 

Cost of revenue was $25.0 million for the year ended September 30, 2020, an increase of $2.7 million, or 12%, from $22.3 million for the year ended September 30, 2019, which was primarily attributable to a $2.5 million, or 8%, increase in sales for this segment. Gross margin decreased from 26.0% to 23.3% primarily due to the increased raw material price in 2020. Due to COVID-19 pandemic, the restraint of raw material supply made the cost increased from 4% to 8% for major material we use for the products of this segment. Sales price has increased to absorb the cost increase, but in a smaller percentage.

Heparin products and Sausage casings

Cost of revenue was $17.2 million for the year ended September 30, 2020, an increase of $3.3 million, or 24%, from $13.9 million for the year ended September 30, 2019. This was primarily attributable to a significant increase in unit cost of our heparin products and sausage casings. Due to the combined effect of COVID-19 outbreak and African Swine fever in China, the general decrease in pig population and raw material supplies had caused a substantive increase in the unit cost of our heparin products and sausage casings. Cost of pig small intestine, which is the major material for the products in this segment, increased by 50% in 2020. Our market price for heparin products increased by 6% in the year end September 30, 2020 to reflect the cost increase. However, due to significant decreased demand for sausage casing, the selling price of sausage casing decreased by 11% for the year ended September 30, 2020, compared to selling price for the same period in 2019. The gross margin of sausage casing was (30)% for the year ended September 30, 2020, which lead to (2.7)% gross margin for this segment.

Fertilizer

Cost of revenue for our fertilizer products was approximately $305,000 for the year ended September 30, 2020, an increase of approximately $118,000, or 63%, from approximately $187,000 for the year ended September 30, 2019. The increase in cost of revenue was mainly due to our increased sales in fertilizer products. Gross margin decreased by 9.5% from 66% for the year ended September 30, 2019 to 56.6% for the year ended September 30, 2020. The decrease in gross margin was mainly due to a 34% increase in cost per unit, resulting from significantly decreased supply of raw materials during the COVID-19 outbreak, while a relatively consistent selling price per unit.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $2.7 million for the year ended September 30, 2020, an decrease of approximately $0.8 million, or 22%, from $3.5 million for the year ended September 30, 2019. The decrease was mainly attributable to the decrease of approximately $0.7 million in consulting and professional fees related to our effort to go public which were not eligible to be capitalized in accordance with the U.S. GAAP. As 2019 was the first year we prepared the public listing and filing, the majority filing cost were incurred in 2019.

Interest Expenses

Interest expenses are primarily generated from bank borrowings including bank loans and banknotes payable. Interest expenses were approximately $243,000 and $224,000 for the years ended September 30, 2020 and 2019, respectively.

Other Income

Other income was $1.2 million for the year ended September 30, 2020 as compared to $1.0 million for the year ended September 30, 2019, which was primarily consists of government grants and other non-operating incomes.

Income taxes Provision

Provision for income taxes decreased by $0.2 million, or 16%, from $1.0 million for the year ended September 30, 2019 to $0.8 million for the year ended September 30, 2020, as a result of the decreased income before income tax provision. Income before income tax provision was $5.8 million for the year ended September 30, 2020, compared to $6.9 million for the year ended September 30, 2019.

Net Income (loss) Attributable to Non-controlling interest

Net loss attributable to non-controlling interest was $0.1 million, decreased by $0.7 million or 121%, from approximately $0.6 million of net income attributable to non-controlling interest for the year ended September 30, 2019, The decrease was a result of the decrease of net income of Chengdu QLS, which is partially owned by non-controlling interest holders. Chengdu QLS and Rugao experienced a net loss of approximately $704,000 for the year ended September 30, 2020 and it experienced a net income of approximately $1.0 million for the year ended September 30, 2019. Chengdu QLS manufactures our heparin products and sausage casings. As discussed in the net revenue and gross profit sections, due to the increased cost of heparin products and sausage casings, the gross margin decreased from 9.7% to (2.7)%. Therefore, Chengdu QLS turned from net profit in 2019 into net loss in 2020.

Net Income Attributable to Our Shareholders

As a result of the above, our net income attributable to our shareholders decreased by $0.3 million, or 5%, from $5.3 million for the year ended September 30, 2019 to $5.0 million for the year ended September 30, 2020.

EBITDA

The following table sets forth of the calculation of our EBITDA:

Our EBITDA was $7.2 million for the year ended September 30, 2020, a decrease of $1.2 million, or 14%, compared to $8.4 million for the year ended September 30, 2019. This was mainly due to the decrease in net income resulting from decreased gross profit, offset by the decrease in selling and administrative expenses. The percentage of EBITDA to revenue was 14.3% and 18.1% for the years ended September 30, 2020 and 2019, respectively.

Results of Operations for the years ended September 30, 2019 and 2018  

The following table sets forth a summary of our consolidated results of operations for the years ended September 30, 2019 and 2018. The historical results presented below are not necessarily indicative of the results that may be expected for any future period.

Net Revenue

The following table sets forth the breakdown of our net revenue:

Compared with net revenue for the year ended September 30, 2018, our net revenue decreased by $4.3 million, or an 8% decrease, for the year ended September 30, 2019, which was primarily attributable to a $3.3 million decrease in sales from oxytetracycline products and licorice products, and a $0.8 million decrease in sales from heparin products and sausage casings.

Oxytetracycline & Licorice products and TCMD

For the year ended September 30, 2019, our sales for oxytetracycline products, licorice products and TCMD decreased by approximately $3.3 million, or 10%, from approximately $33.4 million for the year ended September 30, 2018 to approximately $30.1 million for the year ended September 30, 2019. The sales of oxytetracycline products, licorice products and TCMD accounted for 96%, 4% and 0%, respectively, of this segment’s total sales for the year ended September 30, 2019, and 96.1%, 3.8% and 0.1%, respectively, of such segment’s total sales for the year ended September 30, 2018. The decrease in sales in this segment is due to the following reasons: first, the exchange rate of the RMB against the US dollar decreased from 6.54 in 2018 to 6.87 in 2019, causing the sales denominated in US dollar to decrease by approximately $1.7 million; second, we conducted our scheduled facility maintenance from July 2019 to September 2019, which resulted in reduced oxytetracycline production by approximately 360 tons (a 19% decrease from that of fiscal year 2018). However, such decrease in production was partially offset by a 12% increase in the sale price of our oxytetracycline products as compared to fiscal year 2018. As a result, the sales revenues of our oxytetracycline products for the fiscal year ended June 30, 2019 decreased by approximately $1.6 million as compared to fiscal year ended June 30, 2018. Our sales for licorice products decreased by approximately $0.16 million, or 16.7%, from approximately $0.96 million for the year ended September 30, 2018 to approximately $0.8 million for the year ended September 30, 2019. Our sales for TCMD products decreased by $6,589, or 16.7%, from $11,735 for the year ended September 30, 2018 to $5,146 for the year ended September 30, 2019.

Heparin products and Sausage casings

Sales from heparin products decreased by $0.8 million, or a 5% decrease, from $16.2 million for the year ended September 30, 2018, to $15.4 million for the year ended September 30, 2019. The decrease of $0.76 was mainly caused by the exchange rate of the RMB against the US dollar decreasing from 6.54 in 2018 to 6.87 in 2019. The sales denominated in RMB for these periods were stable. Due to the outbreak and ongoing spread of African Swine fever in China since November 2018, the decrease of pig population caused a dramatic decrease in our production quantity of Heparin products and sausage casings while the price of these products increased dramatically. As a result, although the sales quantity of heparin product and sausage casing for the year ended September 30, 2019 decreased by 54% and 15%, respectively, from the year ended September 30, 2018, the fluctuation of total revenue denominated in RMB was insignificant as the price of these products increased by 84% and 42%, respectively.

Fertilizer

Sales from fertilizer decreased by $0.2 million, or a 23% decrease, from $0.7 million for the year ended September 30, 2018 to $0.5 million for the year ended September 30, 2019. Sales quantity has decreased by 8% and sales price decreased by 12%. The decrease in our fertilizers’ sales was due to unusual weather conditions in Tibet, where a majority of our customers of fertilizer products are located. More specifically, Tibet experienced the coldest days in 19 years from December 2018 to February 2019 while the average precipitations during that time were the highest in 39 years. Such unusual weather conditions significantly interfered with Tibetan’s local cultivation activities and caused the area’s demand for fertilizer products to decrease in general during our 2019 fiscal year.

Cost of Revenue and Gross Profit

The following tables set forth the calculation of gross profit and gross margin for the each of our segments:

Oxytetracycline & Licorice products and TCMD 

Cost of revenue was $22.3 million for the year ended September 30, 2019, a decrease of $3.9 million, or 15%, from $26.2 million for the year ended September 30, 2018, which was primarily attributable to a $3.3 million, or 10%, decrease in sales for this segment. Gross margin increased from 21.7% to 26.0% primarily due to the increased market price of oxytetracycline products in 2019. Due to local governments’ increasingly strict enforcement of environmental regulations, manufacturers in general are gradually upgrading manufacturing facilities to better comply with environmental regulations and we observed a significant decrease in supply from 2018 to 2019. As our oxytetracycline sales price increased by 13% compared to 2018, the overall gross margin of this segment increased to 26.0%.

Heparin products and Sausage casings

Cost of revenue was $13.9 million for the year ended September 30, 2019, a decrease of $1.9 million, or 12%, from $15.8 million for the year ended September 30, 2018. This was primarily attributable to a combined effect of a decrease in sales quantity and an increase in unit cost of our Heparin products and sausage casings. Due to the outbreak and ongoing spread of African Swine fever in China since November 2018, the decrease of pig population caused an increase in the unit cost of our Heparin products and sausage casings while the price of these products increased dramatically. The sales price of our heparin products and sausage casing increased by 84% and 42%, while the cost of revenue per unit only increased by 82% and 16%, respectively. Since the increase in the selling price of heparin products and sausage casings was higher than the increase in the cost of revenue per unit, the gross margin of heparin products and sausage casings increased from 2.4% to 9.7%.

Fertilizer

Cost of revenue for our fertilizer products was approximately $187,000 for the year ended September 30, 2019, a decrease of approximately $49,000, or 21%, from approximately $235,000 for the year ended September 30, 2018. The decrease in cost of revenue was mainly due to our decreased sales quantity in fertilizer products and relatively consistent cost of sales per unit. Gross margin decreased by 1% from 67% for the year ended September 30, 2018 to that of 66% for the year ended September 30, 2019. The decrease in gross margin was mainly due to a 12% decrease in selling price and a relatively consistent cost of sales per unit. Customers of our fertilizers are individual customers located in Tibet. Tibet experienced the coldest days in 19 years from December 2018 to February 2019 while the average precipitations during that time were the highest in 39 years. Such unusual weather conditions significantly interfered with Tibetan’s local cultivation activities and caused the area’s demand for fertilizer products to decrease in general during our 2019 fiscal year.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $3.5 million for the year ended September 30, 2019, an increase of approximately $1.3 million, or 62%, from $2.2 million for the year ended September 30, 2018. The increase was mainly attributable to: (a) an increase of approximately $1.0 million in consulting and professional fees related to our effort to go public which were not allowed to be capitalized in accordance with the U.S. GAAP, and (b) an increase of $0.3 million in advertising and promotion expenses for our sales.

Interest Expenses and Bank Charges

Interest expenses and bank charges are primarily generated from bank borrowings including bank loans and banknotes payable. Interest expenses were approximately $224,000 and $216,000 for the years ended September 30, 2019 and 2018, respectively.

Other Income

Other income primarily consists of government grants and other non-operating incomes. Other income was $1.0 million for the year ended September 30, 2019 as compared to $0.4 million for the year ended September 30, 2018, representing an increase of $0.4 million in government grants, an increase of $0.1 million in investment income attributable to equity investment, and a decrease in loss of approximately $0.1 million from marketable securities incurred in 2018 from marketable securities which were sold.

Income taxes Provision

Provision for income taxes increased by $0.1 million, or 10%, from $0.9 million for the year ended September 30, 2018 to $1.0 million for the year ended September 30, 2019, as a result of the increased income before income tax provision. Income before income tax provision was $6.9 million for the year ended September 30, 2019, compared to $6.1 million for the year ended September 30, 2018.

Net Income Attributable to Non-controlling interest

Net income attributable to non-controlling interest increased by approximately $0.5 million, or 1,641%, from approximately $33,000 for the year ended September 30, 2018 to approximately $576,000 for the year ended September 30, 2019, as a result of the increase of net income of Chengdu QLS, which is partially owned by non-controlling interest holders. Chengdu QLS experienced a net loss of approximately $90,000 for the year ended September 30, 2018; and it experienced a net income of approximately $1.0 million for the year ended September 30, 2019. Its non-controlling shareholders’ ownership decreased from 48.57% as of September 30, 2018 to 28.25% starting from March 21, 2019. Chengdu QLS manufactures our heparin products and sausage casings. As discussed in the net revenue and gross profit sections, due to the increased sales price and decreased sales quantity of our heparin products and sausage casings, revenue from heparin products and sausage casing remained stable and their gross margin increased from 2.4% to 9.7%. Therefore, Chengdu QLS turned from net loss in 2018 into net income in 2019.

Net Income Attributable to Our Shareholders

As a result of the above, our net income attributable to our shareholders increased by $0.1 million, or 3%, from $5.2 million for the year ended September 30, 2018 to $5.3 million for the year ended September 30, 2019.

EBITDA

The following table sets forth of the calculation of our EBITDA:

Our EBITDA was $8.4 million for the year ended September 30, 2019, an increase of $0.7 million, or 10%, compared to $7.6 million for the year ended September 30, 2018. This was mainly due to an increase in net income resulting from increased gross profit and an increase in other income, offset by an increase in selling and administrative expenses. The percentage of EBITDA to revenue was 18.1% and 15.1% for the years ended September 30, 2019 and 2018, respectively.

Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. These principles require our management to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, cash flow and related disclosure of contingent assets and liabilities. The estimates include, but are not limited to, accounts receivable, revenue recognition, inventory realization, impairment of long-lived assets and income taxes. We bases our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. To the extent that there are material differences between these estimates and the actual results, future financial statements will be affected.

Our management believes that among their significant accounting policies, which are described in Note 2 to the audited consolidated financial statements of the Company included elsewhere in this annual report, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, our management believes these are the most critical to fully understand and evaluate our financial condition and results of operations.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions. Such estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our critical accounting estimates included, but are not limited to: allowance for estimated uncollectible receivables, inventory valuations, impairment of long-lived assets, impairment of intangible assets, and income taxes. Actual results could differ from those estimates.

Accounts receivable, net

Accounts receivable are recognized and carried at original invoiced amount less an estimated allowance for uncollectible accounts. We usually grant credit to customers with good credit standing with a maximum of 90 days and determines the adequacy of reserves for doubtful accounts based on individual account analysis and historical collection trends. We establish a provision for doubtful receivables when there is objective evidence that we may not be able to collect amounts due. The allowance is based on management’s best estimates of specific losses on individual exposures, as well as a provision on historical trends of collections. The provision is recorded against accounts receivables balances, with a corresponding charge recorded in the consolidated statements of income and comprehensive income. Actual amounts received may differ from management’s estimate of credit worthiness and the economic environment. Delinquent account balances are written-off against the allowance for doubtful accounts after management has determined that the likelihood of collection is not probable. As of September 30, 2020 and September 30, 2019, the allowances for doubtful accounts were $206,856 and $10,796, respectively.

Inventories, net

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.

Revenue recognition

On October 1, 2018, we adopted Accounting Standards Update (“ASU”) 2014-09 Revenue from Contracts with Customers (FASB ASC Topic 606) using the modified retrospective method for contracts that were not completed as of October 1, 2018. The results of applying Topic 606 using the modified retrospective approach were insignificant and did not have a material impact on our consolidated balance sheets, statement of income, cash flows, business process, controls or systems.

The core principle underlying the revenue recognition ASU is that we will recognize revenue to represent the transfer of goods and services to customers in an amount that reflects the consideration to which we expect to be entitled in such exchange. This will require us to identify contractual performance obligations and determine whether revenue should be recognized at a point in time or over time, based on when control of goods and services transfers to a customer. The majority of our contracts have one single performance obligation as the promise to transfer the individual goods is not separately identifiable from other promises in the contracts and is, therefore, not distinct. Our revenue streams are recognized at a point in time when title and risk of loss passes and the customer accepts the goods, which generally occurs at delivery. Our products are sold with no right of return and we do not provide other credits or sales incentive, which are accounted for as variable consideration. Sales taxes invoiced to customers and remitted to government authorities are excluded from net sales. 

The contract assets and contract liabilities are recorded on the consolidated balance sheets as accounts receivable and advance from customers as of September 30, 2020 and 2019. For the year ended September 30, 2020 and 2019, revenue recognized from performance obligations related to prior periods was insignificant.

Impairment of Long-lived Assets

We assess our long-lived assets such as property and equipment for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Factors which may indicate potential impairment include a significant underperformance related to the historical or projected future operating results or a significant negative industry or economic trend. Recoverability of these assets is measured by comparison of their carrying amounts to future undiscounted cash flows the assets are expected to generate. If property and equipment are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the assets exceeds their fair value.

Income taxes

We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, we determine deferred tax assets and liabilities on the basis of the differences between the financial statement and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

We recognize deferred tax assets to the extent that we believe that these assets are more likely than not to be realized. In making such a determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of recent operations. If we determine that we would be able to realize our deferred tax assets in the future in excess of their net recorded amount, we would make an adjustment to the deferred tax asset valuation allowance, which would reduce the provision for income taxes.

We record uncertain tax positions in accordance with ASC 740 on the basis of a two-step process in which (1) we determine whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority. We do not believe that there was any uncertain tax position at September 30, 2020 and 2019.

Recent accounting pronouncements

In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 requires companies to measure credit losses utilizing a methodology that reflects expected credit losses and requires a consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including those interim periods within those fiscal years. We are currently assessing the impact of adopting this standard, but based on a preliminary assessment, do not expect the adoption of this guidance to have a material impact on our condensed consolidated financial statements.

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement,” to improve the effectiveness of disclosures in the notes to financial statements related to recurring or nonrecurring fair value measurements by removing amounts and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, policies for timing of transfers between different levels for fair value measurements, and the valuation processes for Level 3 fair value measurements. The new standard requires disclosure of the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The amendments in this update are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. We do not expect that the adoption of this ASU will have a material impact on our financial statements.

We do not believe other recently issued but not yet effective accounting standards, if currently adopted, would have a material effect on the consolidated financial position, statements of income and cash flows. 

B.  Liquidity and Capital Resources