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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 20-F

 

(Mark One)

 

o

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 December 31, 2019.

 

 

OR

 

 

o

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

 

 

OR

 

 

o

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 . . . . . . . . . . . . . . . . . . .

 

For the transition period from                       to                        

 

Commission file number 001-39167

 

Molecular Data Inc.

(Exact name of Registrant as specified in its charter)

 

N/A

(Translation of Registrant’s name into English)

 

Cayman Islands

(Jurisdiction of incorporation or organization)

 

5/F, Building 12, 1001 North Qinzhou Road, Xuhui
District

Shanghai 201109
People’s Republic of China

(Address of principal executive offices)

 

Zhaohong Li, Chief Financial Officer

5/F, Building 12, 1001 North Qinzhou Road, Xuhui
District

Shanghai 201109
People’s Republic of China
Phone: +86 21-5436-5166
Email: investor@molbase.com

(Name, Telephone, Email and/or Facsimile number and Address of Company Contact Person)

 

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

 

Title of each class:

 

Trading Symbol(s)

 

Name of each exchange on which registered

American depositary shares, each representing three Class A ordinary shares

 

MKD

 

The Nasdaq Stock Market LLC

(The Nasdaq Capital Market)

Class A ordinary shares, par value US$0.00005 per share*

 

* Not for trading, but only in connection with the listing on the Nasdaq Capital Market of American depositary shares.

 

 

 

 

 

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

 

None

(Title of Class)

 


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Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

 

None

(Title of Class)

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:

 

As of December 31, 2019, there were 310,627,023 ordinary shares outstanding, par value of US$0.00005 per share, being the sum of 255,807,290 Class A ordinary shares, par value of US$0.00005 per share and 54,819,733 Class B ordinary shares, par value of US$0.00005 per share, assuming the completion of Share Distribution at that time. The Share Distribution was completed as of the date of this annual report, effective June 30, 2020.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

o Yes   x No

 

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.

o Yes   x No

 

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.

x Yes   o No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

x Yes   o No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

 

Accelerated filer o

 

Non-accelerated filer x

 

Emerging growth company o

 

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. o

 

†The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

 

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. o

 

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

 

U.S. GAAP x

 

International Financial Reporting Standards as issued
by the International Accounting Standards Board
o

 

Other o

 

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.

o Item 17   o 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).

o Yes   x No

 

(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)

 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.

 

o Yes   o No

 


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TABLE OF CONTENTS

 

INTRODUCTION

1

FORWARD-LOOKING STATEMENTS

3

PART I

5

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

5

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

5

ITEM 3. KEY INFORMATION

5

ITEM 4. INFORMATION ON THE COMPANY

51

ITEM 4A. UNRESOLVED STAFF COMMENTS

87

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

87

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

103

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

113

ITEM 8. FINANCIAL INFORMATION

115

ITEM 9. THE OFFER AND LISTING

116

ITEM 10. ADDITIONAL INFORMATION

117

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

127

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

128

PART II.

131

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

131

ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

131

ITEM 15. CONTROLS AND PROCEDURES

131

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

132

ITEM 16B. CODE OF ETHICS

132

ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

133

ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

133

ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

133

ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

133

ITEM 16G. CORPORATE GOVERNANCE

133

ITEM 16H. MINE SAFETY DISCLOSURE

133

PART III.

134

ITEM 17. FINANCIAL STATEMENTS

134

ITEM 18. FINANCIAL STATEMENTS

134

ITEM 19. EXHIBITS

134

 


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INTRODUCTION

 

Unless otherwise indicated and except where the context otherwise requires, references in this annual report on Form 20-F to:

 

·                  “ADRs” are to the American depositary receipts that evidence the ADSs;

 

·                  “ADSs” are to the American depositary shares, each of which represents three Class A ordinary shares;

 

·                  “China” or the “PRC” are to the People’s Republic of China, excluding, for the purposes of this annual report only, Hong Kong, Macau and Taiwan;

 

·                  “Class A ordinary shares” are to our Class A ordinary shares, par value US$0.00005 per share;

 

·                  “Class B ordinary shares” are to our Class B ordinary shares, par value US$0.00005 per share;

 

·                  “MOLBASE group” are to MOLBASE Inc., a Cayman Islands exempted company, its subsidiaries and its VIEs, but excluding, Molecular Data Inc., its subsidiaries and its VIEs;

 

·                  “we,” “us,” “our company” and “our” are to Molecular Data Inc., our Cayman Islands holding company and its subsidiaries and, its VIEs and the subsidiary of the VIEs;

 

·                  “Restructuring” are to the establishment of Molecular Data Inc., its subsidiaries and its VIEs and the transfer of our business from the MOLBASE group to the subsidiaries and VIEs of Molecular Data Inc.;

 

·                  “RMB” and “Renminbi” are to the legal currency of China;

 

·                  “shares” or “ordinary shares” are to our Class A and Class B ordinary shares, par value US$0.00005 per share;

 

·                  “Share Distribution” are to a shareholding change effective on June 30, 2020, subsequent to the completion of which the existing shareholders of MOLBASE Inc. became our shareholders through a distribution of our shares in proportion to MOLBASE Inc.’s then shareholding structure and the remaining one Class B ordinary share held by MOLBASE Inc. was surrendered;

 

·                  “US$,” “U.S. dollars,” “$,” and “dollars” are to the legal currency of the United States;

 

·                  “VIEs” are to Shanghai MOLBASE Technology Co., Ltd. and Jiaxing MOLBASE Information Technology Co., Ltd.;

 

·                  “customers” are to the users who placed at least one order at our Online Platform;

 

·                  “suppliers” are to the users who posted their chemicals for sale at our Online Platform;

 

·                  “GMV” are to gross merchandise value of the transaction orders placed by customers under the direct sales model or the gross merchandise value of the transaction orders we facilitate between customers and suppliers under the marketplace model during the specified period; under the direct sales model, the GMV does not include discounts or returns by the customers and may include the shipping fees in some cases; under the marketplace model, the GMV does not include shipping fees or discounts, regardless of whether the chemicals are actually delivered or returned;

 

·                  “transacting customers” for a certain period are to customers who complete at least one chemicals transaction under either direct sales model or marketplace model on our Online Platform during that period; a transacting customer who completes at least one chemicals transaction under both direct sales model and marketplace model in such period is calculated as one transacting customer;

 

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·                  “transacting suppliers” for a certain period are to suppliers who complete at least one chemicals transaction under either direct sales model or marketplace model on our Online Platform during that period; a transacting supplier who completes at least one chemicals transaction under both direct sales model and marketplace model in such period is calculated as one transacting supplier;

 

·                  “average monthly transacting users” for a certain period are to the monthly average number of transacting customers and suppliers during that period, calculated by dividing (i) the total number of transacting customers and suppliers (eliminating duplicates) in each month of such period by (ii) the number of months in the same period;

 

·                  “transaction orders” are to the total number of orders for chemicals placed under the direct sales model or we facilitate under the marketplace model on our Online Platform, regardless of whether the chemicals are actually sold, delivered or returned;

 

·                  “MOLBASE Online Mall” are to the chemical e-commerce platform located at molbase.cn and molbase.com;

 

·                  “user” are to any participant who uses our Online Platform; and

 

·                  “Series E-1 Warrant” are to the warrant issued by MOLBASE Inc. in December 2019 to an investor for a consideration of US$2.0 million to purchase 1,394,052 Series E-1 preferred shares of MOLBASE Inc. at an exercise price of approximately US$1.4 per share, exercisable no later than the earlier of (i) three months after our IPO, or (ii) March 31, 2020; subsequent to the exercise of Series E-1 Warrant, the Series E-1 Warrant holder would become our shareholder through the Share Distribution. The expiration date of the Series E-1 Warrant was extended to June 30, 2020, as amended by MOLBASE Inc. and the Series E-1 Warrant holder on March 31, 2020. The warrant was exercised as of the date of this annual report, and we plan to enter into agreement with the Series E-1 Warrant holder to issue certain number of our Class A ordinary shares.

 

Unless otherwise noted, all translations from Renminbi to U.S. dollars and from U.S. dollars to Renminbi in this annual report are made at a rate of RMB6.9618 to US$1.00, the exchange rate in effect as of December 31, 2019 as set forth in the H.10 statistical release of The Board of Governors of the Federal Reserve System. We make no representation that any Renminbi or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or Renminbi, as the case may be, at any particular rate, or at all.

 

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FORWARD-LOOKING STATEMENTS

 

This annual report contains forward-looking statements that reflect our current expectations and views of future events. The forward-looking statements are contained principally in the sections entitled “Item 3. Key Information—D. Risk Factors” “Item 4. Information on the Company—B. Business Overview” and “Item 5. Operating and Financial Review and Prospects.” 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.

 

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:

 

·                  our mission, goals and strategies;

 

·                  our future business development, financial conditions and results of operations;

 

·                  the expected growth of chemical e-commerce industry in China;

 

·                   the potential impact of the COVID-19 to our business operations and the economy in China and elsewhere generally;

 

·                  our expectations regarding demand for and market acceptance of our platform and services;

 

·                  our expectations regarding our relationships with our users/customers, suppliers, strategic partners and other stakeholders;

 

·                  competition in our industry; and

 

·                  relevant government policies and regulations relating to our industry.

 

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. Important risks and factors that could cause our actual results to be materially different from our expectations are generally set forth in “Item 3. Key Information—D. Risk Factors” “Item 4. Information on the Company—B. Business Overview” and “Item 5. Operating and Financial Review and Prospects” and other sections in this annual report. 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 and worse than what we expect. We qualify all of our forward-looking statements by these cautionary statements.

 

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Reliance on SEC Order Granting Conditional Exemptions due to Circumstances Related to COVID-19

 

In accordance with an order issued by the Securities and Exchange Commission (the “SEC”) on March 25, 2020 under Section 36 of the Securities and Exchange Act of 1934, as amended (the “Exchange Act;” such order, the “Release No. 34-88465”), we filed a current report on Form 6-K on April 29, 2020 stating that we are relying on the Release No. 34-88465 to extend the due date for the filing of this annual report on Form 20-F to no later than 45 days after April 30, 2020. Starting from early 2020, in response to intensifying efforts to contain the spread of COVID-19, the Chinese government took a number of actions, which included extending the Chinese New Year holiday, quarantining individuals infected with or suspected of having COVID-19, restricting residents from travel, encouraging employees of enterprises to work remotely from home and cancelling public activities, among others. We have taken a series of measures in response to the outbreak to protect our employees, including, among others, temporary office closure for most of days in February, remote working arrangements for our employees and travel restrictions or suspension. These measures have reduced the capacity and efficiency of our operations, including delay on our internal accounting procedures. In addition, we generally commenced our annual closing and audit preparation work in January, which includes, among other things, preliminary and then final closing of our ledger, preparation of consolidated financial statements, as well as reconciliation of account balances and/or transaction amounts with suppliers, customers and commercial banks. However, due to control measures having been put in place by the local government of different cities in China, some of our suppliers and customers did not fully resume operations and had limited staff to respond to the reconciliation process for the year end closing process. As a result of the above, the preparation of our annual report has been delayed. Considering the lack of time for the compilation, dissemination and review of the information required to be presented, and the importance of investors receiving materially accurate information in the annual report, we decided to rely on the Release No. 34-88465.

 

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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 following tables present the selected consolidated financial information for our company. The selected consolidated statements of operations data for the years ended December 31, 2017, 2018 and 2019, selected consolidated balance sheets data as of December 31, 2018 and 2019 and selected consolidated cash flows data for the years ended December 31, 2017, 2018 and 2019 have been derived from our audited consolidated financial statements, which are included in this annual report beginning on page F-1. The selected consolidated statements of operations data for the years ended December 31, 2016, selected consolidated balance sheets data as of December 31, 2017 and selected consolidated cash flows data for the years ended December 31, 2016, have been derived from our audited consolidated financial statements not included in this annual report. Our historical results do not necessarily indicate results expected for any future periods. The selected consolidated financial data should be read in conjunction with, and are qualified in their entirety by reference to, our audited consolidated financial statements and related notes and “Item 5. Operating and Financial Review and Prospects.” Our consolidated financial statements are prepared and presented in accordance with U.S. GAAP.

 

 

 

For the Year Ended December 31,

 

 

 

2016

 

2017

 

2018

 

2019

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

(in thousands, except for per share data)

 

Summary Consolidated Statements of Comprehensive Loss Data:

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

3,206,079

 

4,201,907

 

9,053,266

 

13,207,315

 

1,897,112

 

Chemical trading—direct sales model

 

3,203,742

 

4,199,661

 

9,045,458

 

13,167,719

 

1,891,424

 

Chemical trading—marketplace model

 

1,560

 

972

 

4,387

 

26,513

 

3,808

 

Online membership service

 

777

 

1,274

 

3,421

 

10,650

 

1,530

 

Financial service

 

 

 

 

917

 

132

 

Others

 

 

 

 

1,516

 

218

 

Cost of revenues

 

(3,179,961

)

(4,151,673

)

(8,973,097

)

(13,106,542

)

(1,882,637

)

Gross profit

 

26,118

 

50,234

 

80,169

 

100,773

 

14,475

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing expenses(1) 

 

(59,160

)

(64,962

)

(103,293

)

(108,858

)

(15,636

)

General and administrative expenses(1) 

 

(41,801

)

(41,718

)

(173,872

)

(104,471

)

(15,007

)

Research and development expenses(1) 

 

(20,067

)

(18,608

)

(36,889

)

(45,038

)

(6,469

)

Allowance for doubtful accounts

 

(10,863

)

(14,677

)

(1,907

)

(34,618

)

(4,972

)

Impairment for long-term investment

 

 

(1,450

)

 

 

 

Total operating expenses

 

(131,891

)

(141,415

)

(315,961

)

(292,985

)

(42,084

)

Operating loss

 

(105,773

)

(91,181

)

(235,792

)

(192,212

)

(27,609

)

Interest expenses, net

 

(8,436

)

(16,828

)

(19,049

)

(4,367

)

(627

)

Foreign exchange (loss) gain

 

(1,057

)

(552

)

(3,033

)

185

 

27

 

Other income, net

 

1,330

 

754

 

3,235

 

3,311

 

475

 

Loss before income tax

 

(113,936

)

(107,807

)

(254,639

)

(193,083

)

(27,734

)

Income tax expense

 

 

 

 

(465

)

(67

)

Net loss

 

(113,936

)

(107,807

)

(254,639

)

(193,548

)

(27,801

)

Net loss attributable to Molecular Data Inc.

 

(113,936

)

(107,807

)

(254,639

)

(193,548

)

(27,801

)

Loss per share

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

(0.37

)

(0.35

)

(0.82

)

(0.62

)

(0.09

)

Weighted average shares outstanding

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

310,627,024

 

310,627,024

 

310,627,024

 

310,627,024

 

310,627,024

 

Other comprehensive income, net of tax of nil

 

 

 

 

316

 

45

 

Comprehensive loss

 

(113,936

)

(107,807

)

(254,639

)

(193,232

)

(27,756

)

Comprehensive loss attributable to Molecular Data Inc.

 

(113,936

)

(107,807

)

(254,639

)

(193,232

)

(27,756

)

 

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Note:

 

(1)         Including share-based compensation expenses as follows:

 

 

 

For the Year Ended December 31,

 

 

 

2016

 

2017

 

2018

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

(in thousands)

 

Sales and marketing expenses

 

 

 

7,942

 

6,860

 

985

 

General and administrative expenses

 

 

 

109,956

 

28,773

 

4,133

 

Research and development expenses

 

 

 

6,124

 

3,359

 

483

 

Total

 

 

 

124,022

 

38,992

 

5,601

 

 

The following table presents our selected consolidated balance sheets data as of December 31, 2017, 2018 and 2019.

 

 

 

As of December 31,

 

 

 

2017

 

2018

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

(in thousands)

 

Summary Consolidated Balance Sheets Data:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

38,522

 

6,477

 

15,156

 

2,177

 

Restricted cash

 

67,500

 

 

42,518

 

6,107

 

Accounts receivable, net

 

53,928

 

40,730

 

20,424

 

2,934

 

Unbilled receivables

 

31,155

 

12,813

 

62,529

 

89,82

 

Notes receivable

 

12,445

 

2,075

 

124,176

 

17,837

 

Prepayments and other current assets

 

153,606

 

295,985

 

216,850

 

31,148

 

Total current assets

 

376,456

 

367,702

 

486,832

 

69,929

 

Total assets

 

381,148

 

371,598

 

492,717

 

70,774

 

Total current liabilities

 

299,855

 

255,417

 

675,761

 

97,067

 

Total liabilities

 

375,247

 

433,223

 

709,214

 

101,872

 

Total shareholders’ equity (deficit)

 

5,901

 

(61,625

)

(216,497

)

(31,098

)

 

The following table presents our selected consolidated cash flows data for the years presented:

 

 

 

For the Year Ended December 31,

 

 

 

2016

 

2017

 

2018

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

(in thousands)

 

Summary Consolidated Cash Flows Data:

 

 

 

 

 

 

 

 

 

 

 

Net cash used in operating activities

 

(145,592

)

(186,703

)

(134,636

)

(95,821

)

(13,764

)

Net cash used in investing activities

 

(2,645

)

(3,982

)

(2,242

)

(1,820

)

(262

)

Net cash generated from financing activities

 

173,302

 

262,849

 

37,333

 

149,399

 

21,460

 

Effect of foreign exchange rate changes on cash, cash equivalents and restricted cash

 

 

 

 

(561

)

(80

)

Net increase/(decrease) in cash and cash equivalents and restricted cash

 

25,065

 

72,164

 

(99,545

)

51,197

 

7,354

 

Cash, cash equivalents and restricted cash at beginning of the year

 

8,793

 

33,858

 

106,022

 

6,477

 

930

 

Cash, cash equivalents and restricted cash at end of the year

 

33,858

 

106,022

 

6,477

 

57,674

 

8,284

 

 

B.                                    Capitalization and Indebtedness

 

Not applicable.

 

C.                                    Reasons for the Offer and Use of Proceeds

 

Not applicable.

 

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D.                                    Risk Factors

 

Risks Related to Our Business and Industry

 

The proper functioning of our IT systems and technology infrastructure is essential to our business. Any disruption to our IT systems and technology infrastructure could materially affect our ability to maintain the satisfactory performance of our platform and deliver consistent services to our users.

 

Our IT systems mainly include technology infrastructure supporting the user interface of our Online Platform, consisting of both PC end and mobile end, as well as our knowledge and AI engines, SaaS, financial solutions, and warehousing and logistics solutions. The reliability, availability and satisfactory performance of our IT systems are critical to our success, our ability to attract and retain customers and our ability to maintain a satisfactory user experience and customer service. Our servers may be vulnerable to computer viruses, traffic spike that exceeds the capacity of our servers, electricity power interruptions, physical or electronic break-ins and similar disruptions, which could lead to system interruptions, website slowdown and unavailability, delays in transaction processing, loss of data, and the inability to accept and fulfill customer orders. We have experienced four minor technical system interruptions over the past three years. Even though such technical system interruptions did not cause any material impact to our operation, we can provide no assurance that we will not experience unexpected interruptions in the future and whether such future interruptions will have material impact on our operation. We can provide no assurance that our current security mechanisms will be sufficient to protect our IT systems and technology infrastructure from any third-party intrusions, electricity power interruptions, viruses and hacker attacks, information and data theft, and other similar activities. Any such future occurrences could damage our reputation, impact our operational and financial results, and result in a material decrease in our revenue.

 

Additionally, we are constantly upgrading our internet platform to provide increased scale, improved performance, additional built-in functionality and additional capacity. Maintaining and upgrading our technology infrastructure require significant investment of time and resources, including adding new hardware, updating software, and recruiting and training new engineering personnel. During updates, our systems may experience interruptions, and the new technologies and infrastructures may not be fully integrated with the existing systems timely, or at all. Any failure to maintain and improve our technology infrastructure could result in unanticipated system disruptions, slower response times, impaired quality of user experience and delays in reporting accurate operating and financial information, which in turn, could materially and adversely affect our business, financial condition and results of operations.

 

We have incurred, and in the future may continue to incur, net losses.

 

We have incurred significant losses in the past. We incurred net losses of RMB107.8 million in 2017, RMB254.6 million in 2018 and RMB193.5 million (US$27.8 million) in 2019, respectively. We cannot assure you that we will be able to generate net profits in the future. Our ability to achieve profitability will depend primarily on our ability to increase our operating margin, either by growing our revenues at a rate faster than our cost of revenues increase or by reducing our cost of revenues or operating expenses as a percentage of our net revenues. There can be no assurance that we will achieve this goal, and we may continue to experience losses in the future. We also had negative operating cash flow in the past. To the extent that we have negative operating cash flow in future periods, we may need to allocate a portion of our cash reserves to fund our operations, including repayment of the Restructuring consideration. We may also be required to raise additional funds through the issuance of equity or debt securities. There can be no assurance that we will be able to generate a positive cash flow from our operations, that additional capital or other types of financing will be available when needed or that these financings will be on terms favorable to our company.

 

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Any harm to our brand, failure to maintain and enhance our brand recognition, or failure to do so in a cost-effective manner may materially and adversely affect our business and results of operations.

 

We believe that the recognition and reputation of our MOLBASE brand among our customers, suppliers and other participants in the chemical industry have contributed significantly to the growth and success of our business. Maintaining and enhancing the recognition and reputation of our brand are critical to our business and competitiveness. Many factors, some of which are beyond our control, are important to maintain and enhance our brand. These factors include our abilities to:

 

·                  provide compelling transaction experience to customers;

 

·                  maintain the popularity, quality and authenticity of the chemicals we offer;

 

·                  maintain the efficiency, safety, reliability and quality of our warehousing and logistics solutions;

 

·                  maintain or improve customers’ satisfaction with our customer services;

 

·                  increase brand awareness through marketing and brand promotion activities;

 

·                  preserve our reputation and goodwill in the event of any negative publicity on customer service, internet security, product quality, price or authenticity, or other issues affecting us or other e-commerce business in China; and

 

·                  maintain our cooperative relationships with suppliers and third-party service providers.

 

If we are unable to maintain our reputation, enhance our brand recognition or increase positive awareness of our Online Platform, the chemicals we sell, and our services, it may be difficult to maintain and grow our customer base, and our business and growth prospects may be materially and adversely affected.

 

Furthermore, if we are unable to conduct our branding and marketing activities cost-effectively, our financial condition and results of operations may be materially and adversely affected. We have incurred expenses on a variety of different sales and marketing promotion efforts designed to enhance our brand recognition and increase sales of chemicals and our services. Our marketing and promotional activities may not be well received by customers and may not result in the levels of sales of chemicals and services that we anticipate. We incurred sales and marketing expenses of RMB65.0 million, RMB103.3 million and RMB108.9 million (US$15.6 million) in 2017, 2018 and 2019, respectively, representing 1.5%, 1.1% and 0.8% of total net revenues in the corresponding periods. Marketing approaches and tools in the consumer products market in China are evolving. This further requires us to enhance our marketing approaches and experiment with new marketing methods to keep pace with industry developments and consumer preferences, which may not be as cost-effective as our marketing activities in the past and may lead to significantly higher marketing expenses in the future. Failure to refine our existing marketing approaches or to introduce new effective marketing approaches in a cost-effective manner could impact our revenues and profitability.

 

We are exposed to fluctuations in the supply of, or demand for, chemicals, along with the conditions underlying such fluctuations, which could adversely affect chemicals transaction volume and price.

 

The volumes of supply and demand for chemicals vary from time to time resulting from changes in resource availability, government policies and regulations, costs of production, demand in end markets for chemicals. As we currently derive our revenues mainly from a limited number of chemical categories, any event that adversely affects the supply and demand for the chemicals in those chemical categories may harm our growth strategies and business prospects. As we expand our business into global markets, we are exposed to risks related to fluctuations in global production capacity and demand levels for chemicals, credit markets, chemicals transaction volume in other key export regions, such as the United States, India, Korea, Netherland, Germany, the United Kingdom, Canada, France, Russia, and Australia, as well as global and regional economic conditions.

 

Changes in the fluctuation conditions may also adversely impact our results of operations and financial performance. For example, a decline in economic and global financial conditions or in a specific country, region or sector may cause decline in the supply of or demand for chemicals in such country, region or sector, thus negatively affecting our business, results of operations, and earnings. Other examples of conditions which might result in fluctuations in the supply of, or demand for, chemicals include that: (i) the insolvency of key suppliers, particularly those with whom we have long-term supply agreements, could result in supply chain difficulties, unmatched chemicals price exposure and/or a reduction in chemicals available for our Online Platform; (ii) a significant reduction or increase in commodity prices could result in customers or suppliers, as the case may be, being unwilling or unable to honor their contractual commitments to purchase or sell chemicals on pre-agreed pricing terms; and (iii) a decline in the value of inventories may result in write-downs.

 

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Due to the lack of information transparency and inefficient supply chain management in the chemical industry, there has long been an industry-wide oversupply of chemicals in China, which has caused substantial declines in prices of certain low-tech chemicals and related raw materials. If the price of certain chemicals continues to decrease, the lower selling price may cause lower benefits for us to sell chemicals under direct sales model and for us to collect commissions and service fees for suppliers conducting transactions under marketplace model on our Online Platform, as a result of which, our financial performance may be adversely affected. Under our direct sales model, we generally acquire chemicals from suppliers after the customers place an order and sell directly to customers, and we manage our inventory of chemicals so as to fulfill customer orders in a timely fashion. Therefore, in the event that the supply of chemicals decreases so that price of chemicals increases, and that we are unable to pass on the entirety or a majority of such increase in costs to our customers, our financial performance may be adversely affected.

 

We are reliant on chemical logistics service providers and warehouses across China to meet the growing demands of our customers.

 

To better serve our customers, we cooperate with third-party service providers of warehousing and logistics solutions and rely on them to provide supporting services across our value chain. We believe we have a good business relationship with such service providers; however, there can be no assurance that we will be able to maintain a good relationship with them or renew our agreements with them on commercially reasonable terms, if at all. If we fail to continue our cooperation with such service providers, or if their business or operations are interrupted or fail, and we fail to find comparable alternatives on reasonable terms, our business may be materially and adversely affected.

 

We believe that providing better warehousing and logistics solutions that cover a wider range of geographical areas is essential to improve customer experience and maximize our future growth. As of December 31, 2019, we operated warehouses, all of which are leased properties, in 10 cities across China. We hired third-party delivery services providers to deliver chemicals sold on our Online Platform. As our Online Platform connects to an increasing number of suppliers and customers, and marketplace model becomes increasingly significant to our business, more types of chemicals will need to be delivered to more areas across China. Our current leased warehouses and third-party logistic service providers will not be able to meet such growing demands of our customers.

 

We plan to establish more warehouses in additional locations, including those smaller and less developed areas, to keep providing warehousing services to customers efficiently. We also plan to introduce more warehousing service providers to join our Chemicals Cloud Warehousing Project that matches customers’ and suppliers’ orders with available warehousing service providers. However, we cannot guarantee that we will be able to locate more warehousing resources in the abovementioned ways. If we fail to locate more warehouses either by leasing or purchasing more properties, by strategic alliance or investment in enterprises who own warehouses and required licenses, or by attracting more warehousing service providers to join Chemicals Cloud Warehousing Project, our warehousing services will not meet the demand of our customers. In addition, we need more logistics service resources to meet the growing demand for logistics solutions of our suppliers and customers. We plan to find more logistics solutions and attract more logistics service providers to register on our Chemical Community App that automatically connects logistics service providers to suppliers in need of logistics solutions. If we fail to do so either by hiring and attracting new logistics service providers, or by obtaining required licenses and operating our own vehicles, our logistics solutions will disappoint our customers, and may reduce their interest in keeping using our Online Platform. Failure to expand warehouses or logistics solutions will cause our business to be materially and adversely affected.

 

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If we cannot manage the growth of our business or execute our strategies effectively, our business and prospects may be materially and adversely affected.

 

We have experienced rapid growth since our inception. Our net revenues was RMB4.2 billion, RMB9.1 billion and RMB13.2 billion (US$1.9 billion) in 2017, 2018 and 2019, respectively. The number of our suppliers and customers increased from 31,171 and 65,983 as of December 31, 2017 to 33,752 and 94,373 as of December 31, 2018, respectively. As of December 31, 2019, the number of our suppliers and customers reached 35,456 and 116,291, respectively. However, our historical growth rates may not be indicative of our future growth. We cannot assure you that we will be able to achieve similar results or grow at the same rate as we did in the past.

 

Our business and prospects may be materially and adversely affected if we fail to manage our growth or execute our strategies to attract and retain a critical mass of customers on our Online Platform. Our business has become increasingly complex as the scale, diversity and geographic coverage of our business and our workforce continue to grow. We are still in the process of integrating various business functions and establishing synergies. We also anticipate further expansion in the global markets. Such expansion will increase the complexity of our operations and place a significant strain on our management, operational and financial resources. We will be exposed to political, social or economic instability in foreign markets or regions in which we operate, and such tensions may impact our successful expansion into the global market.

 

Moreover, our current and planned staffing, systems, policies, procedures and controls may not be adequate to support our future operations. To effectively manage the expected growth of our operations and personnel, we will need to continue to improve our transaction processing, operational and financial systems, policies, procedures and internal controls, which could be particularly challenging if we start new business operations in new business sectors or geographic areas. These efforts will require significant managerial, financial and human resources. The emergence of new disruptive business models and technology could also impose risks on our future growth. We may fail to compete effectively with such new models or technology. We cannot assure you that we will be able to effectively manage our growth or to implement all these systems, procedures, control measures, business models and technological developments successfully. If we are not able to manage our growth effectively, our business and prospects may be materially and adversely affected.

 

We have a limited operating history in the new and dynamic chemical e-commerce industry, which makes it difficult for investors to evaluate our future prospects, and we cannot guarantee that our current or future strategies will be successfully implemented or will generate sustainable profit.

 

The chemical e-commerce industry is a nascent industry that emerged very recently, which may not develop into the stage and scale that we expect. We can learn from very few past experiences of other industry participants’ or of ourselves’. Besides, the long-term viability and prospects of the chemical e-commerce industry in China remain untested and are subject to significant uncertainty. We commenced our operations in March 2013 and have a limited operating history. We have limited experience in operating under direct sales and marketplace models, as they were first launched in 2014. In addition, we have limited experience in providing supporting solutions such as financial solutions, and warehousing and logistics solutions to our customers and suppliers. As our business grows or in response to fierce competition, we may continue to introduce new services, adjust our existing services, or adjust our business operations in general. For example, we may seek advancement in the cloud-based transport and storage management system, which may incur considerable costs. We may also seek to purchase properties and vehicles to develop our own warehousing and logistics solutions, which may result in additional costs and expenses. Furthermore, we rely on banks and other non-bank financial institutions we cooperate with, to provide financial solutions to our customers and suppliers. Our ability to continuously attract financing providers on reasonable terms is critical to our business. Any significant change to our business model that does not achieve expected results may have a material and adverse impact on our financial condition and results of operations.

 

You should consider our business and prospects in light of the risks and challenges that we encounter or may encounter given the rapidly evolving market in which we operate and our limited operating history. These risks and challenges include our abilities to, among other things:

 

·                  sustain and improve the quality of chemicals on our Online Platform and provide satisfactory customer experience;

 

·                  maintain and enhance our relationship and business collaboration with our business partners, including suppliers, warehousing and logistics service providers, and financing providers;

 

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·                  develop sufficient, diversified, cost-efficient and reliable financing sources;

 

·                  expand our prospective customer base further, to include customers from overseas market;

 

·                  enhance our technology infrastructure to support the growth of our business and maintain the security of our system;

 

·                  navigate the complex and evolving regulatory environment in China, and geopolitical tensions in global markets;

 

·                  withstand fluctuations in the supply and demand of chemicals and related raw materials;

 

·                  manage our strategic investments and alliances in auxiliary services and sectors;

 

·                  respond to macroeconomic conditions and fluctuations; and

 

·                  defend ourselves against legal and regulatory actions, such as actions involving intellectual property.

 

Our business has been and is likely to continue to be materially adversely affected by the outbreak of COVID-19 in China.

 

In recent years, there have been outbreaks of epidemics in China and globally. In early 2020, in response to intensifying efforts to contain the spread of COVID-19, the Chinese government took a number of actions, which included extending the Chinese New Year holiday, quarantining individuals infected with or suspected of having COVID-19, prohibiting residents from free travel, encouraging employees of enterprises to work remotely from home and cancelling public activities, among others.

 

We have taken a series of measures in response to the outbreak to protect our employees, including, among others, temporary closure of our offices, remote working arrangements for our employees and travel restrictions or suspension. These measures have reduced the capacity and efficiency of our operations which in turn have negatively affected our results of operations. Our business in first quarter of 2020 was adversely affected. For example, our revenues in the first quarter of 2020 decreased compared to the same period in 2019, mainly due to the decrease of net revenues from direct sales model caused by our temporary office closure in February and early March. Our operating profit decreased in the first quarter of 2020 as well. In addition, we have adjusted cash collection and payment schedule with our suppliers and customers, which will increase the amount of accounts receivable and will require us to record additional allowances for doubtful accounts, write-off of bad debts, or reduction of profits.

 

In order to maintain our liquidity and to improve our operating cash flows under such circumstances, our board of directors has authorized to grant restricted shares pursuant to our 2019 Share Incentive Plan to some of our employees, including our senior management members, in replacement of a portion of their cash salaries for a certain period of time commencing from February 2020. We have been delaying our salary payments since March 2020. Salary payments for March 2020 were distributed in June 2020, while salary payments for April and May 2020 have not been distributed as of the date of this annual report. We also plan to optimize our employee structure and may implement a temporary layoff plan. Moreover, we have entered into several credit facility agreements with banks in the first half of 2020 to improve our liquidity.

 

The global spread of COVID-l9 pandemic in a significant number of countries around the world has resulted in, and may intensify, global economic distress, and the duration and extent of the impact of COVID-19 outbreak cannot be reasonably estimated at this time. The extent to which it may affect our results of operations, financial condition and cash flow will depend on the future developments of the outbreak and various factors, including but not limited to the following:

 

·                  given the slowdown in China’s domestic market as well as the negative impact of the COVID-19 outbreak on the chemical industry, we cannot assure that our revenues and operating cashflow will not experience fluctuation or that we can maintain the growth rate we have experienced;

 

·                  temporary closure of offices had affected and may continue to affect our normal business operations. For instance, our headquarters in Shanghai was shut down for the most of days in February. No employee could come to the office to perform business related operations, including signing business contracts, verifying and collecting business paying vouchers and shipping statements, and effectively communicating with our suppliers and customers during the shut-down;

 

·                  the stringent 14-day quarantine measures, travel restrictions or suspension implemented by the Chinese government have affected and may continue to affect our work efficiency as the number of employees that can work in the offices are severely limited;

 

·                  temporary closure of offices, travel restrictions or suspension of operations of our customers have negatively affected, and could continue to negatively affect, the demand for our products and services;

 

·                  any disruption of our supply chain, logistics providers or customers could adversely impact our business and results of operations, including causing us or our suppliers to cease manufacturing chemicals for a period of time or materially delay delivery to customers, which may also lead to loss of customers, as well as reputational, competitive and business harm to us;

 

·                  many business operations in China were halted and factories were temporarily closed for a period of time, which would materially and negatively affect our overall financial results and cashflow position in the first quarter of 2020. Depending on the global progression of the outbreak, our ability to obtain chemicals and deliver chemicals to customers may be partly or completely disrupted not only in our Chinese facilities but globally;

 

·                  some of our customers, suppliers and other partners are small and medium-sized enterprises (SMEs), which may not have strong cash flows or be well capitalized, and may be vulnerable to an epidemic outbreak and slowing macroeconomic conditions. If the SMEs that we work with cannot weather the COVID-19 and the resulting economic impact, or cannot resume business as usual after a prolonged outbreak, our revenues and business operations may be materially and adversely impacted;

 

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·                  our suppliers and customers may require additional time to pay us or fail to pay us at all, which could increase the amount of accounts receivable and require us to record additional allowances for doubtful accounts, write-off of bad debts, or reduction of recognized revenues and profits;

 

·                  our business operations could be disrupted if any of our employees are suspected of having the COVID-19, since it could require our employees to be quarantined and/or our offices to be disinfected;

 

·                  this outbreak of COVID-19 has caused, and may continue to cause, companies in China, including us and certain of our suppliers and customers, to implement temporary adjustment of work schemes allowing employees to work from home and collaborate remotely. We have taken measures to reduce the impact of the epidemic outbreak, including, upgrading our telecommuting system, monitoring our employees’ health on a daily basis and optimizing our technology system to support remote working. However, we may still experience lower work efficiency and productivity, which may adversely affect our service quality; and

 

·                  geopolitical risk and the potential deterioration of international trading relationships between China and the rest of world as a result of the evolving COVID-19 outbreak will impact international chemical business and hence our business.

 

In addition, the COVID-19 outbreak may further adversely affect our financial condition and operating results for the remaining 2020, including but not limited to, negative impact to our total revenues, cashflow options and operating results. While many of the restrictions on movement within China have been relaxed as of the date of this annual report, there is great uncertainty as to the future progress of the disease. Currently, there is no vaccine or specific anti-viral treatment for COVID-19. Relaxation of restrictions on economic and social life may lead to new cases which may lead to the reintroduction of restrictions. Because of the uncertainties surrounding the COVID-19 outbreak, the extent of the business disruption and the related financial impact cannot be reasonably estimated at the time of this annual report.

 

We are reliant on suppliers for our supply of chemicals under direct sales model. If we fail to maintain good relationship with them, or find alternatives on reasonable terms, our business and financial performance may be materially and adversely affected.

 

We source the chemicals we sell under direct sales model from suppliers. Our business, results of operations, financial condition and prospects could be materially and adversely impacted if we are unable to continue sourcing sufficient volumes of quality chemicals from current suppliers or expand our sourcing network to include new suppliers on reasonable terms and prices. We have entered into supply agreements with each of these suppliers. We cannot assure you that we will be able to maintain our existing relationships with these suppliers and continue to be able to source chemicals in stable quantities and at a reasonable price or at all. If we fail to maintain or renew these agreements on reasonable terms or enter into comparable agreements with other suppliers as substitutes, our business and operation could be materially and adversely affected.

 

Additionally, if our supply of chemicals is interrupted for whatever reason or there are significant increases in the prices, our business, financial condition, results of operations and prospects may be materially and adversely affected. Changes in business conditions, force majeure, governmental changes and other factors beyond our control or that we do not presently anticipate could also affect our suppliers’ ability to deliver chemicals to us on a timely basis. Any of the foregoing could materially and adversely affect our results of operations, financial condition and prospects.

 

We are reliant on third-party suppliers to sell their chemicals on our Online Platform under marketplace model. If we fail to keep providing satisfying services to these third-party suppliers or retain them in using our Online Platform, our business and financial performance may be materially and adversely affected.

 

Certain third-party suppliers sell their chemicals on our Online Platform, both through our websites, molbase.cn and molbase.com, Moku Data, one of our Weixin subscription accounts, and Chemical Business Secretary, a Weixin mini program. We rely on these third-party suppliers to provide a wide variety of chemicals that may not be available under direct sales model to customers on our Online Platform, and to enlarge our user base. We previously enabled suppliers to post information of the chemicals they sell on our Online Platform and use our intelligent matching services to connect to customers for free, and only charged service fees to certain suppliers who use value-added services on our website. As our business grows, we plan to charge suppliers higher service fees or commissions with regard to each transaction completed through our Online Platform. We believe we have good relationships with third-party suppliers both on our website and on Moku Data, but we cannot guarantee that we will be able to keep providing satisfactory services to them, especially when we start generating revenues by increasing their cost in using our services. If we fail to keep third-party suppliers using our Online Platform, we may lose certain customers, and our business and financial performance may be adversely impacted. Furthermore, in order for our marketplace model to be successful, we may need to continue to identify and attract new suppliers, and we may not be successful in this regard.

 

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Our business is subject to intense competition, and we may fail to compete successfully against existing or new competitors, including certain matured large-scale enterprises, which may reduce demand for our services and chemicals we sell, reduce operating margins, and result in loss of market share, departures of qualified employees and increased capital expenditures.

 

The chemical e-commerce industry in China is intensely competitive. Our current or potential competitors include other chemical e-commerce platforms, major e-commerce companies in China that offer a wide range of general merchandise product categories, and traditional chemical manufactures in China that are moving into online retailing.

 

We face a variety of competitive challenges with respect to sourcing chemicals efficiently, pricing chemicals competitively, anticipating and quickly responding to changes in customer demands, maintaining favorable brand recognition and providing quality services, finding sources of warehousing and logistics solutions of good quality, and other potential challenges. If we cannot properly address these competitive challenges, our business and prospects would be materially and adversely affected.

 

Some of our current and potential competitors, especially major e-commerce companies in China that offer a wide range of product categories, have significantly greater financial, marketing and other resources. Certain competitors may be able to secure products from suppliers on more favorable terms, devote greater resources to marketing and promotional campaigns, adopt more aggressive pricing or inventory policies, and devote substantially more resources to website and system development. Increased competition may reduce our operating margins, market share and brand recognition, or force us to incur losses. There can be no assurance that we will be able to successfully compete against current and future competitors, and competitive pressures may have a material adverse effect on our business, prospects, financial condition and results of operations.

 

The sophisticated and innovative technologies we use for the operation of our business are new and require time to prove their reliability and effectiveness. We cannot assure you that the performance of these technologies will be stable enough to support our business.

 

We regard technology as critical to our ability to provide high-quality customer services. We have invested substantial resources in developing the sophisticated and innovative technology systems that we use for our daily operations. We expect these technologies to support the smooth performance of certain key functions in our Online Platform, such as searching for chemicals, making orders online, finding suitable sources of financing services, settling payments, and obtaining recommendations for warehousing and logistics solutions. We also expect our technologies to facilitate our customers’ retrieval of timely and accurate chemical industry related information, and the new cloud-based transport management system to improve customer experience. However, as we have been continuously upgrading our technology system, it will take time to gain reputation of reliability and effectiveness among our customers, suppliers, and other participants in the chemical industry. Furthermore, to adapt to evolving and increasingly demanding customers’ and suppliers’ requirements and emerging industry standards, we may need to develop other new technologies or upgrade our Online Platform, mobile applications and systems. If our efforts to invest in the development of new technologies are unsuccessful, our business, financial condition and results of operation may be materially and adversely affected.

 

In addition, the maintenance and processing of various operating and financial data are essential to the day-to-day operation of our business and formulation of our development strategies. Therefore, our business operations and growth prospects depend, in part, on our ability to maintain and make timely and cost-effective enhancement and upgrade to our technology and introduce innovative functions which can meet changing operational needs. Failure to do so could put us at a disadvantage to our competitors and cause economic losses. We can provide no assurance that we will be able to keep up with technological improvements or that the technology developed by others will not render our services less competitive or attractive.

 

As the technologies we use for the operation of our business are relatively new, we may need time to prove their stability, and we can provide no assurance that we will be able to adequately defend against or timely remedy interruptions caused by telecommunications or electricity power failures, computer viruses, hacking or other attempts to harm our systems, or other events beyond our control. The resultant unavailability or slowdown of our systems could have an immediate adverse impact on the services we provide, and our reputation and results of operations could accordingly be materially and adversely impacted.

 

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Any quality issues of the chemicals offered by our suppliers or any negative publicity with respect to us, our suppliers and other partners, as well as the chemical industry in general, may materially and adversely affect our business and results of operations.

 

Our track record in providing all-rounded value propositions for chemicals transactions and a comprehensive suite of services in chemical e-commerce industry has established “MOLBASE ( 摩贝)” as a leading brand in the industry. The risk management system we operate to demand authenticity and quality of the chemicals our suppliers provide has performed well and gained us trust among our customers. We believe that market recognition is key to our future success. As we continue our growth in size, broaden the scope of our services, and expand into foreign markets, however, it will be increasingly difficult to control the quality of chemicals sold on our Online Platform, and to maintain the efficiency and quality of our services, failure of which may negatively impact our market reputation. The failure to maintain and to further enhance our market recognition and corporate reputation may materially and adversely affect our business, financial condition and results of operations.

 

Many factors, some of which are beyond our control, may negatively impact our corporate reputation if not properly managed. These factors include our ability to provide superior services to our customers, successfully conduct marketing and promotional activities, manage relationships with and among suppliers and warehousing and logistics service providers, control quality of the chemicals sold on our Online Platform, monitor the quality of services provided by third-party warehousing and logistics service providers, deal with complaints timely, manage negative publicity of us as well as of suppliers and warehousing and logistics service providers on our Online Platform, and maintain a positive perception of our company, our peers and the chemical e-commerce industry in general. Any actual or perceived deterioration of our service quality, which is based on an array of factors including product quality, customer satisfaction, rate of complaints or rate of accidents, could subject us to damages such as loss of important customers. Any negative publicity directed against us, the chemical e-commerce industry in general or our business partners could cause damages to our corporate reputation and lead to further changes to government policies and the regulatory environment. If we are unable to promote our market recognition and protect our corporate reputation, we may not be able to maintain and grow our customer base, and our business and growth prospects may be adversely affected.

 

Failure to obtain, renew, or retain licenses, permits or approvals may affect our ability to conduct or expand our business.

 

We are required to hold a number of licenses, permits and approvals in connection with our business operation. Our business is subject to governmental supervision and regulation by relevant PRC governmental authorities, including, among others, the Ministry of Commerce of the People’s Republic of China, or MOFCOM, the Ministry of Industry and Information Technology, or MIIT, the Ministry of Emergency Management (formerly known as the State Administration of Work Safety), or MEM. Such government authorities promulgate and enforce laws and regulations that cover a variety of business activities that our operations concern, such as hazardous chemicals business, provision of internet information, provision of chemical e-commerce platform, financial solutions, and internet advertisement. These regulations in general regulate the entry process, the permitted scope, as well as approvals, of licenses and permits for the relevant business activities. We are required to hold a number of licenses and permits in connection with our business operation, including, among other, the Hazardous Chemical Operation License, Value-Added Telecommunication License, or the VATS License, for internet information service and online data processing and transaction processing businesses. We currently hold all such licenses. However, if we fail to maintain or renew the requisite licenses, our business, financial condition and results of operations may be significantly and adversely affected.

 

We provide printed materials containing professional articles, comments, data analysis, industry reports and other chemical industry related information for free to our users who subscribe for this value-added service. We also provide digital version of similar materials online to our users for free. Under PRC laws and regulations related to online publication, enterprises who publish periodicals are required to obtain a Periodical Publication Permit; enterprises who issue publications online are required to obtain an Online Publishing Service License. We believe that our printed or digital materials do not fall within the scope of periodicals that require such license or permit. However, we cannot assure you that the governmental authorities would agree to our conclusion. If the materials we provide are deemed as periodicals or online publication by the relevant governmental authorities, we may not be able to obtain the licenses in a timely manner, or at all, which will reduce the attractiveness of our Online Platform for our users, and thereby negatively affect our results of operations.

 

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As of December 31, 2019, we had not received any notice of warning or been subject to penalties or other disciplinary actions from the relevant governmental authorities regarding our business without the above mentioned approvals and permits. However, we cannot assure you that we will not be subject to any penalties in the future. As the chemical e-commerce industry is constantly evolving in China, new laws and regulations may be adopted from time to time that require additional licenses and permits other than those we currently have, and address new issues that may arise from time to time. As a result, substantial uncertainties exist regarding the interpretation and implementation of current and any future PRC laws and regulations applicable to the chemical e-commerce industry.

 

We have limited experience in providing financial solutions, which plays a substantial role in attracting customers and suppliers to use our Online Platform. Failure to accurately evaluate our customers’ or suppliers’ credit risks, to renew our agreements with banks and other financial institutions on reasonable terms or to find comparable alternatives, or regulatory changes related to the internet finance industry, may have a material adverse effect on our business and results of operations.

 

We started to offer financial solutions in China in 2014. We provide financial solutions to customers and suppliers of our Online Platform, and we were the pioneer and leader among chemical e-commerce platforms to offer financial solutions, which makes our Online Platform more appealing compared with our competitors. Expansion in this business area involves new risks and challenges. Our lack of familiarity with the finance business may make it difficult for us to anticipate the demand and preferences in the market and cooperate with financing providers to offer financial solutions on terms that meet our customers’ and suppliers’ requirements and preferences.

 

Our financial solutions may also face operational risks with respect to illegal or fraudulent activities, such as our customers or supplier providing false credit applications, credit information, or other financially related false information to us or to financing providers, or creating fictitious transactions with collaborators. Significant increases in illegal or fraudulent activities could negatively impact our relationship with financing providers we cooperate with, as well as our brand and reputation. Our failure to accurately evaluate our customers’ or suppliers’ credit risk could lead us to encounter bad debt, and negatively impact our financial solutions. Furthermore, as we put our own capital in providing guarantees for our customers and suppliers under certain circumstances, their failure to fulfill repayment obligation in time would trigger us losing a respective amount of our deposit, equivalent to the defaulted amount of the loan, immediately, therefore negatively affect our business and financial performance. Although we have devoted substantial resources in collecting necessary information to assess the creditworthiness of our customers and suppliers, we are still exposed to the potential risk of inaccurate information and failure to assess our customers or suppliers accurately.

 

We rely on financing providers, including banks and non-bank financial institutions, to provide financings required for financing products under commercially favorable terms and conditions. We believe we have good business relationships with such financing providers; however, there can be no assurance that we will be able to maintain good relationships with them or renew our agreements with them on commercially reasonable terms, if at all. If we fail to continue our cooperation with such financing providers, or if their business or operations are interrupted or fail, and we fail to find comparable alternatives on reasonable terms, our financial solutions may be materially and adversely affected.

 

In addition, PRC laws and regulations concerning the financial solutions and internet finance industry are evolving rapidly. Although we have taken measures to ensure that the financing providers we cooperate with comply with the laws and regulations applicable to the financing products, PRC governmental authorities may promulgate new laws and regulations regulating the internet finance industry in the future. We cannot assure you that any of the financial solutions we present to our customers and suppliers would not be deemed violation to any PRC laws or regulations. In addition, we cannot assure you that the financing providers we cooperate with have obtained or will continue to hold valid licenses and permits required under the applicable laws and regulations. In the event that such financing providers fail to hold, renew or obtain valid and effective licenses and permits required by the applicable laws and regulations, our financial solutions business, our results of operation and financial condition may be adversely affected and may in turn increase our credit risks. Furthermore, we provide deposit or other types of guarantee for our customers and suppliers who use our financial solutions to the financing providers. We cannot assure you that such guarantee will not be deemed as unlicensed financial guarantee business by the relevant PRC government authority, and may subject us to fines, termination of operation, or even criminal liability of our employees. Moreover, developments in the financial solutions and internet finance industry may lead to changes in PRC laws, regulations and policies or the interpretation and application of existing laws, regulations and policies that may limit or restrict financial solutions like those we offer, which could materially and adversely affect our financial solutions and operations.

 

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If we fail to manage our chemical inventory effectively under direct sales model, our operations and financial condition may be materially and adversely affected.

 

Although for a substantial majority of chemicals sold on our Online Platform, the whole transaction process only takes a few days at most, we still bear inventory risk, and we are required to manage our inventory effectively. We depend on our internal business analysis to make purchase decisions and to manage our inventory. Demand for chemicals, however, can change between the time inventory is ordered and the date by which we expect to sell it. Demand may be affected by seasonality, development of new types of chemicals, changes in production cycles and pricing, defects, changes in customer needs with respect to our chemicals and other factors, and our customers may not order chemicals in the quantities that we expect. We are not entitled to return unsold chemicals to suppliers. In addition, when we begin to sell a new type of chemicals, it may be difficult to establish supplier relationships, determine appropriate chemical category, and accurately forecast demand.

 

If we fail to manage our inventory effectively, we may be subject to a heightened risk of inventory obsolescence, a decline in inventory value, and significant inventory write-downs or write-offs. In addition, we may be required to lower sale prices in order to reduce inventory level, which may lead to lower gross margins. High inventory level may require us to commit substantial capital resources, preventing us from using the capital for other important purposes. On the other hand, if we underestimate demand for chemicals we sell, or if our suppliers fail to supply chemicals in a timely manner, we may experience inventory shortage, which might result in missed sales, diminished brand loyalty and lost revenues, any of which could harm our business and reputation. Any of the above may materially and adversely affect our results of operations and financial condition.

 

We rely on several online payment platforms developed and supported by third-party financial institutions to process a portion of payments on our Online Platform. If services of these payment platforms are limited, restricted, curtailed or degraded in any way or become unavailable to us or to our customers for any reasons, our business may be adversely affected.

 

We cooperated with Ping’an Bank to develop third-party online payment platform to support payments on our Online Platform. Under its agreement with us, Ping’an Bank launched Mo Yi Fu as an independent payment platform to provide convenient payment processing to customers who make purchases on our Online Platform. As of December 31, 2019, 189 customers had set up Mo Yi Fu accounts. Although only a small portion of transactions on our Online Platform are processed through Mo Yi Fu, the limitation, restriction, curtailment, or reduction of services of Mo Yi Fu may negatively affect our customers’ transaction experience, and their trust in our services and our brand name.

 

These third-party payment platforms are subject to a number of risks that could materially and adversely affect their ability to provide payment services to us, including, among others, changes to laws and regulations with regard to online payment platforms; dissatisfaction with their services or lower use of these payment platforms by customers and suppliers; changes to rules or practices applicable to online banks and payment systems that link to these payment platforms; breach of customers’ personal information and concerns over the use and security of information collected from customers; adaption to our Online Platform and customers’ payment habits; and failure to manage funds accurately or loss of funds, whether due to employee fraud, security breaches, technical errors or otherwise.

 

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In addition, the wide variety of payment methods that we offer subjects us to third-party payment processing-related risks. We accept payments using a variety of methods, including payment on delivery, bank transfers, payment platforms developed by banks who cooperate with us, such as Mo Yi Fu, online payments through third-party online payment platforms, such as Alipay, Weixin Pay and UnionPay. For certain payment methods, we pay interchange and other fees, which may increase over time and raise our operating costs and lower our profit margins. We may also be subject to fraud and other illegal activities in connection with the various payment methods we offer, including online payment and cash on logistics options. Moreover, we are subject to various rules, regulations and requirements, regulatory or otherwise, governing electronic funds transfers, which could change or be reinterpreted to make it difficult or impossible for us to comply. If we fail to comply with these rules or requirements, we may be subject to fines and higher transaction fees and lose our ability to accept credit and debit card payments from our customers, process electronic funds transfers or facilitate other types of online payments, and our business, financial condition and results of operations could be materially and adversely affected.

 

We are subject to risks relating to the warehousing and logistics of chemicals. If any of these risks materializes, our business, our results of operations and financial condition could be materially and adversely affected.

 

We hire third-party service providers, whom we have no direct control over, to provide warehousing and logistics solutions. We rely on third-party carriers to transport and deliver chemicals. Interruptions to or failures in logistics services could prevent or deter the timely or successful delivery of our chemicals. These interruptions or failures may be due to unforeseen events that are beyond our control or the control of carriers, such as inclement weather, natural disasters or labor unrest. If chemicals sold on our Online Platform are not delivered on time or are delivered in a damaged state, customers may refuse to accept chemicals and hold less confidence in us. Furthermore, the logistics personnel of carriers act on our behalf and interact with our customers personally. Any failure to provide high-quality service to our customers may negatively impact the transaction experience of our customers, damage our reputation, and cause us to lose customers.

 

We rely on third-party warehousing service providers to store chemicals we sell under direct sales model on MOLBASE Online Mall. Any increase in the price charged by such warehousing service providers, any safety accidents or mishandling of chemicals, or any service disruption experienced by such warehouses could have an adverse effect on our business operations.

 

The storage and transportation of chemicals involve inherent safety risks. We handle a large volume of chemicals, and face challenges with respect to the protection and examination of these chemicals. Chemicals we manage may be stolen, damaged, or lost for various reasons, and we and our warehousing and logistics service providers may be perceived to be or found liable for such incidents. Although we hold licenses and permits to manage hazardous chemicals, we cannot assure you that our risk management system will eliminate all possibilities of hazardous chemical diffusions, combustions, and other types of hazardous chemical accidents. In addition, vehicles and personnel of third-party logistics service providers we hire may be involved in transportation accidents, and the chemicals carried by them may be lost, damaged, destroyed, or may cause safety accidents in the case of hazardous chemicals. In addition, friction or disputes may occasionally arise from direct interactions between logistics service providers’ pickup and logistics personnel with chemical senders and recipients. Personal injuries or property damages may arise if such incidents escalate.

 

Moreover, as we implement the Chemicals Transportation Community Project and the Chemicals Cloud Warehousing Project, we connect third-party warehousing and logistics service providers that do not have long-term cooperation agreements with us to our customers, and let these service providers fulfill orders on our Online Platform and directly serve our customers. Under this model, we have even less control over the quality of services offered to our customers, and we bear higher risks of being negatively impacted due to third-party warehousing and logistics solutions. We and third-party warehousing and logistics service providers may face claims and incur serious liabilities if found liable or partially liable for any injuries, damages or losses. Claims against us may exceed the amount of our insurance coverage, or may not be covered by insurance at all. Governmental authorities may also impose serious fines on us or require us to adopt costly preventive measures. Furthermore, if our services are perceived to be unsafe by our customers, our transaction volume may be seriously reduced, and our business, financial condition, and results of operations may be materially and adversely affected.

 

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We require substantial capital to expand our business and to sustain our growth, and we cannot assure you that we will be able to obtain sufficient capital on acceptable terms, or at all.

 

We require substantial capital to maintain and upgrade our integrated suite of solutions in response to fierce competition, technological developments, and changing laws and regulations in the industry. For example, we need substantial capital to expand our logistics and warehousing solutions, upgrade our IT system to meet the growing needs of our Online Platform users, and recruit qualified personnel to keep our innovative development. Moreover, our expansion into global markets, and the pursuit of strategic acquisitions, investments and alliances or other business opportunities may require a significant amount of capital. Our expected sources of capital include both equity and debt financing. However, financing might not be available to us in a timely manner or on terms that are acceptable, or at all.

 

Our ability to obtain the necessary financing to carry out our business plan is subject to a number of factors, including general market conditions and investor acceptance of our business plan. These factors may make the timing, amount, terms and conditions of such financing unattractive or unavailable to us. If we are unable to raise sufficient funds, we will have to significantly reduce our spending, delay or cancel our planned activities or substantially change our current corporate structure. We might not be able to obtain any funding, and we might not have sufficient resources to conduct our business as projected, both of which could mean that we would be forced to curtail or discontinue our operations.

 

Our expansion into global market may expose us to new challenges and more risks, and we may fail to expand effectively. If we fail to overcome the challenges presented by our global operations, our business, financial condition and results of operations may suffer material and adverse impact.

 

As we expand our global and cross-border business into an increasing number of global markets, we will face risks associated with expanding into markets in which we have limited or no experience of, and in which we may be less well-known. We may be unable to attract a sufficient number of customers and business partners, fail to anticipate competitive conditions or face difficulties in operating effectively in these new markets. The expansion of our global and cross-border business will also expose us to risks inherent in operating business globally, including but not limited to:

 

·                  inability to recruit international and local talent and deal with challenges in replicating or adapting our company policies and procedures to operating environments different than those of China;

 

·                  lack of acceptance of our chemicals and service offerings;

 

·                  exposure to lawsuits and regulatory investigations;

 

·                  trade wars;

 

·                  geopolitical tensions, political instability and general economic or political conditions in particular countries or regions;

 

·                  challenges and increased expenses associated with staffing and managing global and cross-border operations and managing an organization spread over multiple jurisdictions;

 

·                  trade barriers, such as import and export restrictions, tariff, customs duties and other taxes, competition law regimes and other trade restrictions, as well as other protectionist policies;

 

·                  differing and potentially adverse tax consequences;

 

·                  increased and conflicting regulatory compliance requirements;

 

·                  adaption to industry practices in different markets;

 

·                  challenges caused by distance, language and cultural differences;

 

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·                  increased costs to protect the security and stability of our information technology systems, intellectual property and personal data, including compliance costs related to data localization laws;

 

·                  availability and reliability of global and cross-border payment systems and logistics infrastructure; and

 

·                  exchange rate fluctuations.

 

As we expand further into new regions and markets, these risks could intensify, and efforts we make to expand our global and cross-border business and operations may not be successful. Failure to expand our global and cross-border business and operations could materially and adversely affect our business, financial condition and results of operation.

 

Our business, financial condition and results of operations may be materially and adversely affected if we are unable to maintain satisfactory customer experience or provide customer service of high quality to retain our existing customers, or fail to acquire new customers in a cost-effective manner.

 

The success of our business hinges on our ability to provide superior customer experience to retain existing customers, which in turn depends on a variety of factors. These factors include our abilities to continue to offer high quality chemicals and effective supporting services at competitive prices, to find sources of timely and reliable warehousing and logistics solutions, financial solutions, and to provide superior after-sales service. Our sales may decrease if our Online Platform services are severely interrupted or otherwise fail to meet customers’ expectations. For example, should we or our logistics service providers fail to provide our chemicals delivery and return services in a convenient or reliable manner, or if our customers are not satisfied with the quality of chemicals received, our reputation and customer loyalty could be adversely affected.

 

We also depend on our call center and online customer service representatives to provide live or timely assistance to our customers. If our call center or online customer service representatives fail to satisfy the individual needs of customers, our reputation and customer loyalty could be adversely affected and we may lose potential or existing customers and experience a decrease in sales. As a result, if we are unable to continue to maintain our customer experience and provide high quality customer service, we may not be able to retain existing customers or attract new customers, which could materially and adversely affect our business, financial condition and results of operations.

 

In addition, some of our suppliers may use their own logistic services and other supporting services, which we have no control over, to serve customers making purchases on our Online Platform. If such suppliers fail to provide satisfactory service to our customers, or fail to control the quality of their chemicals properly, and we fail to deal with such defects effectively, then the experience of our customers may be adversely impacted, and consequently we may face claims raised by our customers that we should be held liable for any losses and damages arising therefrom. As a result, our reputation, business, financial condition, and results of operations might suffer significantly.

 

Furthermore, our future growth depends on our ability to continue to attract new customers. Our efforts to enhance our brand recognition and conduct marketing activities may cause us to incur significant expenses. These efforts may not result in increased user traffic and revenues in the immediate future or at all. Even if they do, any increases in revenues may not offset the expenses incurred. If we fail to successfully promote our services and attract customers while incurring substantial expenses, our results of operations and financial condition would be adversely affected, which may impair our business growth. On the other hand, if we fail to devote adequate resources in maintaining our reputation, enhancing our brand recognition, or increasing positive awareness of our Online Platform and our services, it may be difficult to grow our customer base, and our business and growth prospects may be materially and adversely affected.

 

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Failure to deal effectively with any fraud perpetrated and fictitious transactions conducted on our platform could harm our business.

 

We face risks with respect to fraudulent activities on our Online Platform under marketplace model. Although we take steps to verify the identity of suppliers, we cannot guarantee that all suppliers registered on our Online Platform are duly established legal entities and individuals, and all of the transactions they conduct with customers are real and commercially fair. There may be suppliers on our Online Platform who conduct fake transactions, accept customers’ payments and refuse to deliver respective chemicals, and customers who have received chemicals but refuse to pay suppliers. Although we have implemented various measures to detect and reduce the occurrence of fraudulent activities on our Online Platform, there can be no assurance that these measures will be effective in combating fraudulent transactions or improving overall satisfaction among our suppliers and consumers.

 

In addition, illegal, fraudulent or collusive activities by our employees could also subject us to liability and negative publicity. We have discovered four cases in which our employees conducted fraudulent activities, such as accepting payments from suppliers in order to bypass our Online Platform and to complete offline transactions, disclosing customers’ information to suppliers for personal gains, or applying for fake reimbursement. Although we have dismissed the employees responsible for these incidents, we cannot assure you that similar incidents will not occur in the future. Any illegal, fraudulent or collusive activity could severely damage our brand and reputation as an operator of a trusted online platform, which could adversely affect our business, financial condition and results of operations.

 

We face risks associated with the Restructuring and the subsequent operation of our business.

 

We undertook a Restructuring in 2018 in order to operate our Online Platform as a standalone business. For more details, see “Item 4. Information on the Company — A. History and Development of the Company.” We expect the Restructuring to enhance our brand image as an independent chemical e-commerce platform that provides a comprehensive suite of services, thereby attracting more users to our Online Platform. However, there can be no assurance that the Restructuring will deliver such benefits. For example, existing contracts signed with the MOLBASE group may need extra time or efforts to be transferred to our company. If the resources transferred from the MOLBASE group to our company were inadequate, or if we were unable to enhance the quality of our Online Platform after the Restructuring, our business, financial condition and results of operations would be materially and adversely affected.

 

If we fail to implement and maintain an effective system of internal controls to remediate our material weaknesses over financial reporting, we may be unable to accurately report our results of operations, meet our reporting obligations or prevent fraud, and investor confidence and the market price of the ADSs may be materially and adversely affected.

 

Prior to our IPO, we were a private company with limited accounting personnel and other resources with which to address our internal controls and procedures. Our independent registered public accounting firm has not conducted an audit of our internal control over financial reporting. However, in connection with the audit of our consolidated financial statements as of and for the fiscal years ended December 31, 2016, 2017 and 2018, we and our independent registered public accounting firm identified material weaknesses in our internal control over financial reporting as well as other control deficiencies. As defined in the standards established by the Public Company Accounting Oversight Board of the United States (PCAOB), a “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The material weaknesses identified are the Company’s (i) lack of sufficient accounting and financial reporting personnel with requisite knowledge and experience in application of U.S. GAAP and SEC financial reporting expertise, and (ii) lack of formalized financial reporting policies and procedures that are commensurate with U.S. GAAP and SEC reporting and compliance requirements.

 

We have begun to implement measures to address the material weakness. See “Item 15. Controls and Procedures—Internal Control Over Financial Reporting.” However, the implementation of these measures may not fully address the material weakness in our internal control over financial reporting, and our management concluded that the material weakness still existed as of December 31, 2019. Our failure to correct the material weakness or our failure to discover and address any other control deficiencies could result in inaccuracies in our financial statements and impair our ability to comply with applicable financial reporting requirements and related regulatory filings on a timely basis. As a result, our business, financial condition, results of operations and prospects, as well as the trading price of our ADSs, may be materially and adversely affected. Moreover, ineffective internal control over financial reporting could significantly hinder our ability to prevent fraud.

 

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Furthermore, our independent registered public accounting firm has not conducted an audit of our internal control over financial reporting. It is possible that, had our independent registered public accounting firm conducted an audit of our internal control over financial reporting, such accountant might have identified additional material weaknesses and deficiencies. We are now a public company in the United States subject to the Sarbanes-Oxley Act of 2002. Section 404 of the Sarbanes-Oxley Act of 2002 requires that we include a report of management on our internal control over financial reporting in our annual report on Form 20-F beginning with our annual report for the fiscal year ending December 31, 2020. In addition, our independent registered public accounting firm must attest to and report on the effectiveness of our internal control over financial reporting. Our management may conclude that our internal control over financial reporting is not effective. Moreover, even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm, after conducting its own independent testing, may issue a report that is qualified if it is not satisfied with our internal controls or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us. In addition, as we are now a public company, our reporting obligations may place a significant strain on our management, operational and financial resources and systems for the foreseeable future. We may be unable to timely complete our evaluation testing and any required remediation.

 

During the course of documenting and testing our internal control procedures, in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, we may identify other weaknesses and deficiencies in our internal control over financial reporting. In addition, if we fail to maintain the adequacy of our internal control over financial reporting, as these standards are modified, supplemented or amended from time to time, we may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002. We may not be able to anticipate and identify accounting issues, or other risks critical to financial reporting that could materially impact the consolidated financial statements. Generally, if we fail to achieve and maintain an effective internal control environment, we could suffer material misstatements in our financial statements and fail to meet our reporting obligations, which would likely cause investors to lose confidence in our reported financial information. This could in turn limit our access to capital markets, harm our results of operations, and lead to a decline in the trading price of our ADSs. Additionally, ineffective internal control over financial reporting could expose us to increased risk of fraud or misuse of corporate assets and subject us to potential delisting from the stock exchange on which we list, regulatory investigations and civil or criminal sanctions.

 

Our success depends on the continuing efforts of our key employees, including but not limited to our senior management members, and our corporate culture. If we fail to hire, retain and motivate our key employees, or maintain our corporate culture as we grow, we could lose the innovation, collaboration and focus that contribute to our business.

 

Our future success is significantly dependent upon the continued service of our key executives and other key employees, who have contributed significantly to our current achievements. If we lose the services of any member of management or other key personnel, we may not be able to locate suitable or qualified replacements and may incur additional expenses to recruit and train new staff, which could severely disrupt our business, growth, and our corporate culture. Competition for talents in the Chinese chemical e-commerce industry is intense, and the availability of suitable and qualified candidates in China is limited. Competition for these individuals could cause us to offer higher compensation and other benefits to attract and retain them.

 

Even if we were to offer higher compensation and other benefits such as stock-based incentives, there is no assurance that these individuals will choose to join or continue to work for us. Any failure to attract or retain key management and personnel could severely disrupt our business, growth, and our corporate culture. In addition, if any dispute arises regarding the agreements between our current or former key employees and us, we may have to incur substantial costs and expenses in order to enforce the agreements in China or we may be unable to enforce them at all. We also commit significant time and other resources to training our employees, which increases their value to competitors if they subsequently leave us for our competitors.

 

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We believe that a critical component for our success is our corporate culture, that we put our users first, foster innovation, remain data-driven and encourage teamwork. As we develop the infrastructure of a public company and continue to grow, we may find it difficult to maintain these valuable aspects of our corporate culture. Any failure to preserve our culture could negatively impact our future success, including our ability to attract and retain employees, encourage innovation and teamwork and effectively focus on and pursue our long-term objectives.

 

If we are unable to recruit, train and retain qualified personnel or sufficient workforce, our business may be materially and adversely affected.

 

Our continued growth and success are largely dependent on the experience, abilities and dedication of our personnel and workforce. As we expand into global markets with comprehensive value-added services, we would need additional qualified personnel and sufficient workforce. Therefore, we must continue to hire, train and effectively manage new employees. If our new hires perform poorly or if we are unsuccessful in hiring, training, managing and integrating new employees, our business, financial condition and results of operations may be materially harmed.

 

One of the directors of our consolidated controlled entities may have potential conflicts of interest with us, and if any such conflicts of interest are not resolved in our favor, our business may be materially and adversely affected.

 

PRC laws and regulations provide that a director owes a fiduciary duty to the company to which he or she acts as a director. Dr. Dongliang Chang, one of the directors of our VIEs, must act in good faith and in the best interests of the VIEs and must not use his respective position for personal gains. On the other hand, as the chairman of the board of the directors of our company, Dr. Dongliang Chang has a duty of care and loyalty to our company and to our shareholders as a whole under the Cayman Islands law. We control our VIEs through contractual arrangements, and the business and operations of our VIEs are closely integrated with our subsidiaries’ business and operations. Nevertheless, conflicts of interest for Dr. Dongliang Chang may arise due to his dual roles both as director of the VIEs and as chairman of the board of the directors of our company.

 

We cannot assure you that should any conflicts of interest arise, Dr. Dongliang Chang, or any other similarly situated shareholders, directors or executive officers 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. If we cannot resolve any conflicts of interest or disputes between us and these shareholders, we would have to rely on legal proceedings, which could result in disruption of our business and subject us to substantial uncertainty as to the outcome of any such legal proceedings.

 

Any failure to protect our intellectual property could harm our business and competitive position.

 

We rely on a combination of trademark, patent, copyright and trade secret protection laws in China and other jurisdictions, as well as confidentiality procedures and contractual provisions, to protect our intellectual property rights. We also enter into confidentiality agreements with our employees and any third parties who may access our proprietary information, and we rigorously control access to our proprietary technology and information.

 

Intellectual property protection may not be sufficient in China or other countries in which we operate. Confidentiality agreements may be breached by counterparties, and there may not be adequate remedies available to us for any such breach. Accordingly, we may not be able to effectively protect our intellectual property rights or to enforce our contractual rights in China or elsewhere. In addition, policing any unauthorized use of our intellectual property is difficult, time-consuming, and costly, and the steps we have taken may be inadequate to prevent the misappropriation of our intellectual property. In the event that we resort to litigation to enforce our intellectual property rights, such litigation could result in substantial costs and a diversion of our managerial and financial resources. We can provide no assurance that we will prevail in such litigation. In addition, our trade secrets may be leaked or otherwise become available to, or be independently discovered by, our competitors. Any failure in protecting or enforcing our intellectual property rights could have a material adverse effect on our business, financial condition and results of operations.

 

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We may be subject to intellectual property infringement claims, which may be expensive to defend and may disrupt our business and operations.

 

We cannot be certain that our operations or any aspects of our business do not or will not infringe upon or otherwise violate patents, copyrights or other intellectual property rights held by third parties. We may, and from time to time in the future be, subject to legal proceedings and claims relating to the intellectual property rights of others. In addition, there may be other third-party intellectual property that is infringed by chemicals sold on our Online Platform, services or other aspects of our business. There could also be existing patents of which we are not aware that we may inadvertently infringe. We cannot assure you that holders of patents purportedly relating to some aspect of our technology or business, if any such holders exist, would not seek to enforce such patents against us in China or any other jurisdictions. Further, the application and interpretation of China’s patent laws and the procedures and standards for granting patents in China are still evolving and are uncertain, and we cannot assure you that PRC courts or regulatory authorities would agree with our analysis. If we are found to have violated the intellectual property rights of others, we may be subject to liability for our infringement activities or may be prohibited from using such intellectual property, and we may incur licensing fees or be forced to develop alternatives of our own. In addition, we may incur significant expenses, and may be forced to divert management’s time and other resources from our business and operations to defend against these third-party infringement claims, regardless of their merits.

 

Our operations depend on the performance of the internet infrastructure and telecommunications networks in China and in other countries.

 

Our business depends on the performance and reliability of the internet infrastructure in China and other countries in which we operate. Substantially all of our computer hardware and a majority of our leased cloud computing servers are currently located in China. Almost all access to the internet in China is offered through China Mobile, China Unicom and China Telecom, the state-owned telecommunication operators, operating under the administrative control and regulatory supervision of the MIIT. In addition, the national networks in China are connected to the internet through state-owned international gateways, which are the only channels through which a domestic user can connect to the internet outside of China. We may face similar or other limitations in other countries in which we operate. We may not have access to alternative networks in the event of disruptions, failures or other problems with the internet infrastructure in China or elsewhere. In addition, the internet infrastructure in the countries in which we operate may not support the demands associated with continued growth in internet usage.

 

The failure of telecommunications network operators to provide us with the requisite bandwidth could also interfere with the speed and availability of our websites and mobile applications. We have no control over the costs of the services provided by the telecommunications operators. If the prices that we pay for telecommunications and internet services rise significantly, our gross margins could be adversely affected. In addition, if internet access fees or other charges to internet users increase, our user traffic may decrease, which in turn may significantly decrease our revenues.

 

If we fail to prevent security breaches, improper access to or disclosure of our data or user data, or other hacking and attacks, we may lose users, and our business, reputation, financial condition and results of operations may be materially and adversely affected.

 

Although we have employed significant resources to develop our security measures against breaches, our cybersecurity measures may not detect, prevent or control all attempts to compromise our systems, including distributed denial-of-service attacks, viruses, malicious software, break-ins, phishing attacks, social engineering, security breaches or other attacks and similar disruptions that may jeopardize the security of information stored in and transmitted by our systems or that we otherwise maintain. Breaches of our cybersecurity measures could result in unauthorized access to our systems, misappropriation of information or data, deletion or modification of customer information, or a denial-of-service or other interruption to our business operations. As techniques used to obtain unauthorized access to or sabotage systems change frequently and may not be known until launched against us or our supporting service providers, we may be unable to anticipate, or implement adequate measures to protect against, these attacks.

 

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We are likely in the future to be subject to these types of attacks. If we are unable to avert these attacks and security breaches, we could be subject to significant legal and financial liabilities, our reputation would be harmed and we could sustain substantial revenue loss from lost sales and customer dissatisfaction. We may not have the resources or technical sophistication to anticipate or prevent rapidly evolving types of cyber-attacks. Cyber-attacks may target us, our suppliers, customers or other participants, or the internet infrastructure on which we depend. Actual or anticipated attacks and risks may cause us to incur significantly higher costs, including costs to deploy additional personnel and network protection technologies, train employees, and engage third-party experts and consultants. As we do not carry cybersecurity insurance, we will not be able to mitigate such risks to any third party. Cybersecurity breaches would not only harm our reputation and business, but also could materially decrease our revenue and net income.

 

Our business generates and processes a large amount of data, our failure to protect the confidential information of our users or the improper use or disclose of such data may subject us to the liabilities imposed by data privacy and protection laws and regulations, negatively impact our reputation and deter our users from using our Online Platform.

 

We generate, collect, store and process a large amount of personal, transactional, statistical and behavioral data, including certain personal and other sensitive data from our customers. We face risks inherent in handling large volumes of data and in securing and protecting such data. In particular, we face a number of data-related challenges related to our business operations, including:

 

·                  protecting the data in and hosted on our system, including against attacks on our system by external parties or fraudulent behavior by our employees;

 

·                  addressing concerns related to privacy and sharing, safety, security and other factors; and

 

·                  complying with applicable laws, rules and regulations relating to the collection, use, disclosure or security of personal information, including any requests from regulatory and government authorities relating to such data.

 

Although we have taken steps to protect such data, our security measures could be breached. As techniques used to sabotage or obtain unauthorized access to systems change frequently and generally are not recognized until they are launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. Any accidental or willful security breaches or other unauthorized access to our system could cause confidential customer information to be stolen and used for illegal purposes. Security breaches or unauthorized access to confidential information could also expose us to liability related to the loss of the information, time-consuming and expensive litigation and negative publicity. If security measures are breached because of third-party action, employee error, malfeasance or otherwise, or if design flaws in our technology infrastructure are exposed and exploited, our relationships with customers or suppliers could be severely damaged, we could incur significant liability, and our business and operations could be adversely affected.

 

In addition, PRC government authorities have enacted a series of laws and regulations in regard of the protection of personal information, under which telecommunication business operators, internet service providers and other value chain operators are required to comply with the principles of legality, justification and necessity, to clearly indicate the purposes, methods and scope of any information collection and usage, to obtain the consent of users, and to keep collected personal information confidential, as well as to establish user information protection system with appropriate remedial measures. However, there is uncertainty as to the interpretation and application of such laws which may be interpreted and applied in a manner inconsistent with our current policies and practices or require changes to the features of our system. We cannot assure you that our existing user information protection system and technical measures will be considered sufficient under applicable laws and regulations. If we are unable to address any information protection concerns, or to comply with the then applicable laws and regulations, we may incur additional costs and liability and our reputation, business and operations might be adversely affected.

 

We have obtained the consents from our customers to use their information within the scope of authorization, and we have taken technical measures to ensure the security of such information and prevent the information from being divulged, damaged or lost. However, since the Cyber Security Law and relevant regulations, rules and measures are relatively new, there are uncertainties as to the interpretation and application of these laws and regulations, and it is possible that our data protection practices are or will be inconsistent with regulatory requirements. Any violation of the provisions and requirements under the Cyber Security Law and other relevant regulations, rules and measures may subject us to warnings, fines, confiscation of illegal gains, revocation of licenses, suspension of business, shutting down of websites or even criminal liabilities. Complying with such requirements could cause us to incur substantial expenses or to alter or change our practice in a manner that could harm our business. Any systems failure or security breach or lapse that results in the unauthorized release of our user data could harm our reputation and brand and, consequently, our business, in addition to exposing us to potential legal liability.

 

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We plan to grant options, restricted share units and other types of awards under our share option plan, which may result in increased share-based compensation expenses.

 

As part of the Restructuring, we adopted the 2018 Share Plan on November 27, 2018 to grant share-based compensation awards to employees, outside directors and consultants to incentivize their performance and align their interests with ours. In October 2019, we adopted the 2019 Share Incentive Plan, or the 2019 Plan, effective on December 27, 2019, for the same purpose. Under our 2018 Share Plan, we are authorized to grant shares, options and restricted share units. The maximum aggregate number of shares which may be issued under the 2018 Share Plan is 48,676,179. Under our 2019 Plan, the maximum aggregate number of shares was initially 10,353,810, subject to automatic annual increase. See “Item 6. Directors, Senior Management and Employees—B. Compensation of Directors and Executive Officers—Share Incentive Plans.” We believe the granting of share-based compensation is of significant importance to our ability to attract and retain key personnel and employees, and we will continue to grant share-based compensation to employees in the future. In order to maintain our liquidity and to improve our operating cash flows under such circumstances, our board of directors has authorized to grant restricted shares pursuant to our 2019 Share Incentive Plan to some of our employees, including our senior management members, in replacement of a portion of their cash salaries for a certain period of time commencing from February 2020.  As a result, our expenses associated with share-based compensation may increase, which may have an adverse effect on our results of operations.

 

Acquisitions, strategic alliances and investments could be difficult to integrate, which may disrupt our business, and lower our results of operations and the value of your investment.

 

We may enter into selected strategic alliances and potential strategic acquisitions that are complementary to our business and operations, including opportunities that can help us further expand our logistics service offerings and improve our technology system. These strategic alliances with third parties could subject us to a number of risks, including risks associated with sharing proprietary information, non-performance or default by counterparties, and increased expenses in establishing these new alliances, any of which may materially and adversely affect our business. We may have limited ability to control or monitor the actions of our strategic partners. To the extent a strategic partner suffers any negative publicity as a result of its business operations, our reputation may be negatively affected by virtue of our association with such party.

 

In the past, we invested in Zhejiang Moke Biotechnology Co., Ltd., which was dissolved in December 2018. Provided suitable opportunities, we may pursue strategic alliances and investments in the future. Strategic acquisitions and subsequent integrations of newly acquired businesses would require significant managerial and financial resources and could result in a diversion of resources from our existing business, which in turn could have an adverse effect on our growth and business operations. Acquired businesses or assets may not generate expected financial results immediately, or at all, and may incur losses. The cost and duration of integrating newly acquired businesses could also materially exceed our expectations. Any such negative developments could have a material adverse effect on our business, financial condition and results of operations.

 

We will be a “controlled company” within the meaning of the Nasdaq Stock Market Rules if MOLBASE Inc. continues to beneficially own more than 50% of our outstanding ordinary shares.

 

We undertook the Restructuring in 2018, after which MOLBASE Inc. held 100% of our then outstanding ordinary shares. After the completion of the Share Distribution, the existing shareholders of MOLBASE Inc. became our shareholders. However, we are still a “controlled company” as defined under the Nasdaq Stock Market Rules because Dr. Dongliang Chang beneficially owned approximately 15.9% equity interests or 65.3% voting power of our total outstanding share capital as of March 31, 2020, assuming the completion of Share Distribution at that time. For so long as we remain a controlled company under that definition, we are permitted to elect to rely, and will rely, on certain exemptions from corporate governance rules, including an exemption from the rule that a majority of our board of directors must be independent directors. As a result, you will not have the same protection afforded to shareholders of companies that are subject to these corporate governance requirements.

 

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Our current risk management system may not be able to exhaustively assess or mitigate all risks to which we are exposed. If we fail to develop and maintain an effective system of internal control, our business operation might be negatively affected.

 

We have established risk management, quality control and internal control systems, consisting of policies and procedures, that we believe are appropriate for our business. However, the implementation of such policies and procedures may involve human error and mistakes. Moreover, we may be exposed to fraud or other misconduct committed by our employees, or other third parties, including but not limited to our customers and suppliers, or other events that are out of our control, that could adversely affect our product quality and reputation and subject us to financial losses and sanctions imposed by government authorities. As a result, despite our efforts to improve the aforementioned systems, we cannot assure you that our risk management, quality control and internal control systems are able to completely eliminate non-compliance matters or product defects.

 

Our insurance coverage may not be adequate, which could expose us to significant costs and business disruptions.

 

We have obtained insurance to cover certain potential risks and liabilities, such as domestic trade credit insurance, and casualty insurance for our employees. However, insurance companies in China and other jurisdictions in which we operate may offer only limited types of business insurance products. As a result, we may not be able to acquire any insurance for all types of risks we face in our operations in China and elsewhere, and our coverage may not be adequate to compensate for all losses that may occur, particularly with respect to loss of business or operations. For example, we do not maintain business interruption insurance, nor do we maintain key-man life insurance. In addition, we do not maintain insurance for the chemicals in our custody at the warehouse ourselves but rely on the insurance coverage maintained by our warehousing service providers that meet with our standards and the contractual arrangements with our warehousing service providers relating to reimbursement for our loss in the event that our chemicals are damaged, tainted or missing due to failure of their obligations. Even though we have required such warehousing service providers to take safety measures and maintain insurance that meet our standards during their ordinary course of operations, we cannot assure you that these warehousing service providers will provide their services properly. In the event that these warehousing service providers fail to provide their services properly or adequately and the chemicals in our custody suffer damages or losses, we cannot assure you that we may be able to obtain compensation from the warehousing service providers for all losses that may occur. Any business disruption, litigation, regulatory action, outbreak of epidemic disease or natural disaster could also expose us to substantial costs and diversion of resources. We cannot assure you that our insurance coverage is sufficient to prevent us from any loss or that we will be able to successfully claim our losses under our current insurance policy on a timely basis, or at all. If we incur any loss that is not covered by our insurance policies, or the compensated amount is significantly less than our actual loss, our business, financial condition and results of operations could be materially and adversely affected.

 

Failure to renew our current leases or locate desirable alternatives for our facilities could materially and adversely affect our business.

 

We lease properties for our company registry, offices, and warehouses. We may not be able to successfully extend or renew such leases upon expiration of the current term on commercially reasonable terms or at all and may therefore be forced to relocate the affected operations. This could disrupt our operations and result in significant relocation expenses, which could adversely affect our business, financial condition and results of operations. In addition, we compete with other businesses for premises at certain locations or of desirable sizes. As a result, even though we could extend or renew our leases, rental payments may significantly increase as a result of the high demand for the leased properties. In addition, we may not be able to locate desirable alternative sites for our facilities as our business continues to grow, and failure in relocating our affected operations could adversely affect our business and operations.

 

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Our use of some leased properties could be challenged by third parties or government authorities, which may cause interruptions to our business operations.

 

As of December 31, 2019, some lessors of our leased offices had not provided us with their property ownership certificates or any other documentation proving their right to lease those properties to us. If our lessors are not the owners of the properties and they have not obtained consents from the owners or their lessors or permits from the competent government authorities, our leases could be invalidated. If this occurs, we may have to renegotiate the leases with the owners or the parties who have the right to lease the properties, and the terms of the new leases may be less favorable to us.

 

In addition, none of our leasehold interests in leased properties have been registered with the competent PRC government authorities as required by PRC laws and regulations, which may expose us to administrative fines of up to RMB10,000 if we fail to remediate after receiving any notice from the competent PRC government authorities.

 

As of December 31, 2019, we were not aware of any material claims or actions being contemplated or initiated by government authorities, property owners or any other third parties with respect to our leasehold interests in or use of such properties. However, we cannot assure you that our use of such leased properties will not be challenged. In the event that our use of properties is successfully challenged, we may be subject to fines and forced to relocate the affected operations. In addition, we may become involved in disputes with the property owners or third parties who otherwise have rights to or interests in our leased properties. We can provide no assurance that we will be able to find suitable replacement sites on terms acceptable to us on a timely basis, or at all, or that we will not be subject to material liability resulting from third parties’ challenges on our use of such properties. As a result, our business, financial condition and results of operations may be materially and adversely affected.

 

We may be subject to legal proceedings in the ordinary course of our business. If the outcomes of these proceedings are adverse to us, they could have a material adverse effect on our business, results of operations and financial condition. Contractual disputes could be costly and time-consuming, and may harm our reputation.

 

From time to time, we have become and may in the future become a party to various legal or administrative proceedings arising in the ordinary course of our business, including actions with respect to labor and employment claims, breach of contract claims, anti-competition claims and other matters. Although such proceedings are inherently uncertain and their results cannot be predicted with certainty, we believe that the resolution of our current pending matters will not have a material adverse effect on our business, consolidated financial position, results of operations or cash flow. Regardless of the outcome and merit of such proceedings, however, any legal action can have an adverse impact on us because of defense costs, negative publicity, diversion of management’s attention and other factors. In addition, it is possible that an unfavorable resolution of one or more legal or administrative proceedings, whether in China or in another jurisdiction, could materially and adversely affect our financial position, results of operations, or cash flows in a particular period, or damage our reputation.

 

We face risks related to natural disasters, health epidemics and other outbreaks, which could significantly disrupt our operations.

 

Our business could be materially and adversely affected by natural disasters, such as snowstorms, earthquakes, fires or floods, the outbreak of a widespread health epidemic, such as swine flu, avian influenza, severe acute respiratory syndrome, or SARS, Ebola, Zika, COVID-19 or other events, such as wars, acts of terrorism, environmental accidents, power shortage or communication interruptions. The occurrence of such a disaster or prolonged outbreak of an epidemic illness or other adverse public health developments in the PRC or elsewhere could materially disrupt our business and operations. Such events could also significantly affect our industry and cause a temporary closure of the facilities we use for our operations, which would severely disrupt our operations and have a material adverse effect on our business, financial condition and results of operations. In addition, our revenue and profitability could be materially reduced to the extent that a natural disaster, health epidemic or other outbreak harms the global or PRC economy in general. Our operations could also be severely disrupted if our customers, suppliers or other participants were affected by such natural disasters, health epidemics or other outbreaks.

 

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We are reliant on the innovative development of the whole Chinese chemical industry, which is currently far behind the global leading standard in research and development, technology support, and application of information technology.

 

Although China has become the largest manufacturing country of chemicals and the largest chemicals consuming market in the world, the whole Chinese chemical industry is still relatively underdeveloped, especially in developing and producing high-tech chemicals. The lack of application of information technology in chemical industry, while offering us broader opportunities in obtaining market share in China, may also bring us disadvantages in competing with our competitors outside China and other world-wide chemical e-commerce industry participants.

 

An important part of our business model is to deliver a proprietary and comprehensive SaaS suite to participants in the chemical industry value chain. We are at the initial stage of charging fees for using our SaaS suite, and we also invest in research and development, and marketing and sales to strengthen the monetization of SaaS suite and other technology-enabled services. However, we cannot guarantee that the participants in Chinese chemical industry are willing to pay for our SaaS suite and other technology-enabled services. Failure to effectively monetize our SaaS suite and other technology-enabled services may have an adverse effect on our business, financial condition or results of operations.

 

The underdevelopment of Chinese chemical industry, which we have little control over, can negatively impact our results of operations in various aspects of our business, including, but not limited to, shortage of manufacture and supply of high-technology chemicals, less attraction to qualified personnel in the chemical industry, and difficulties in obtaining transportation and warehousing resources competing with other consumer goods industries. While we seek to implement our business strategy and new technology to connect all parties to all types of chemicals and information in the chemical industry, we cannot guarantee how much our efforts can actually improve the standard of the whole Chinese chemical industry, and any of the abovementioned challenges may result in potential underperformance of our business.

 

The chemical industry faces considerable challenges due to the higher level of scrutiny in terms of environmental protection and work safety as related laws and regulations are being established and implemented, which may increase cost and create restrictions to our business.

 

Our business is subject to a higher level of scrutiny from PRC laws and regulations relating to environmental protection, work safety and occupational health matters. Under these laws and regulations, we are required to limit environmental pollution to a certain standard and protect the occupational safety of our employees.

 

The storage and transportation process of chemicals bears an inherent risk of damaging the environment by discharging pollutants and certain chemical wastes, and the storage and transporting of chemicals. While we have taken measures to ensure us meeting the requirements of current environmental protection laws and regulations, we cannot assure you that all situations that will give rise to material environmental liabilities will be discovered and addressed immediately. If we are found liable for any environmental protection laws and regulation breaches, we will be subject to fines and other forms of punishments. Should the PRC government impose stricter environmental protection standards and regulations in the future, the cost of participants in the chemical industry to comply with such standards will generally increase, causing a negative impact of our operations. Moreover, we cannot assure you that we will be able to comply with such new regulations at reasonable costs, or at all. Any increase in production costs resulting from the implementation of additional environmental protection measures and/or failure to comply with new environmental laws or regulations may have a material adverse effect on our business, financial condition or results of operations.

 

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In addition, the storage and transportation of chemicals inherently require relevant personnel to be exposed to chemicals, therefore bearing risks of accidents and occupational diseases. While we have conducted periodic inspections of our operating facilities and carried out equipment maintenance on a regular basis to ensure that our operations are in compliance with applicable work safety related laws and regulations, we cannot assure you that we will not experience any material accidents, worker injuries or occupational health problems in the course of our operation in the future. Any work safety laws and regulations implemented in the future may materially increase costs of our business, and negatively affect our operation results.

 

Uncertainties regarding the growth and continuous profitability of e-commerce in China could adversely affect our revenues and business prospects. A severe or prolonged downturn in the Chinese or global economy, or any global systemic economic and financial crisis, could materially and adversely affect our business and financial condition, given that our business is highly dependent on Chinese and global commodity and e-commerce markets.

 

A substantial portion of our revenue is generated through our online direct sales and marketplace model. As the chemical e-commerce business emerged in China in recent years, only a limited number of market participants have become profitable. The long-term viability and prospects of the chemical e-commerce industry in China remain untested and are subject to significant uncertainty. Our business, financial condition and results of operations will depend on numerous factors affecting the chemical e-commerce business in China, which may be beyond our control. These factors include general economic conditions inside and outside China, the growth of internet usage, confidence in e-commerce and making purchase online, the emergence of alternative trade channels or business models, the success of marketing and brand building efforts by chemical e-commerce companies, and the development of payment, warehousing and logistics, knowledge engine and business intelligence services, and other supporting services.

 

COVID-19 had a severe and negative impact on the Chinese and the global economy in the first quarter of 2020. Whether this will lead to a prolonged downturn in the economy is still unknown. Even before the outbreak of COVID-19, the global macroeconomic environment was facing numerous challenges. The growth rate of the Chinese economy had already been slowing since 2010. There is considerable uncertainty over the long-term effects of the expansionary monetary and fiscal policies which had been adopted by the central banks and financial authorities of some of the world’s leading economies, including the United States and China, even before 2020. Unrest, terrorist threats and the potential for war in the Middle East and elsewhere may increase market volatility across the globe. There have also been concerns about the relationship between China and other countries, including the surrounding Asian countries, which may potentially have economic effects. In particular, there is significant uncertainty about the future relationship between the United States and China with respect to trade policies, treaties, government regulations and tariffs. Economic conditions in China are sensitive to global economic conditions, as well as changes in domestic economic and political policies and the expected or perceived overall economic growth rate in China. Any severe or prolonged slowdown in the global or Chinese economy may materially and adversely affect our business, results of operations and financial condition.

 

Our business and results of operations are subject to seasonal fluctuations and unexpected interruptions of chemical e-commerce industry in China.

 

The chemical e-commerce industry in China is subject to seasonal fluctuations, which may cause our revenues to fluctuate from quarter to quarter. We generally experience less user traffic and purchase orders during national holidays in China, particularly during the Chinese New Year holiday season in the first quarter of each year. Consequently, the first quarter of each calendar year generally contributes the smallest portion of our annual revenues. Furthermore, as we are substantially dependent on online sales of chemicals, our quarterly revenues and results of operations are likely to be affected by:

 

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·                  seasonality of the chemical market and customers’ purchasing patterns;

 

·                  our ability to retain existing customers and attract new customers for our e-commerce services;

 

·                  our ability to successfully introduce new service offerings on our Online Platform;

 

·                  the amount and timing of our operating expenses and capital expenditures;

 

·                  the adoption of new, or changes to existing, governmental regulations;

 

·                  a shortfall in our revenues relative to our forecasts and a decline in our operating results; and

 

·                  economic conditions in general and specific to the chemical e-commerce industry and to China.

 

As our revenues have grown rapidly in recent years, these factors are difficult to discern based on our historical results, which, therefore, should not be relied on to predict our future performance. Our financial condition and results of operations for future periods may continue to fluctuate. As a result, the trading price of our ADSs may fluctuate from time to time due to seasonality.

 

Risks Related to Our Corporate Structure

 

If the PRC government deems that the contractual arrangements in relation to our VIEs and their subsidiary do not comply with PRC regulatory restrictions on foreign investment in the relevant industries, or if these regulations or the 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.

 

Foreign ownership of internet-based businesses, such as provision of online information and other value-added telecommunication services, are subject to restrictions under current PRC laws and regulations. For example, foreign investors are generally not allowed to own more than 50% of the equity interests in a value-added telecommunication service provider with the exception relating to e-commerce business, and any such foreign investor must have experience in providing value-added telecommunications services overseas and maintain a good track record.

 

To comply with PRC laws and regulations, Shanghai MOHUA Information Technology Co., Ltd., or our WFOE has entered into a series of contractual arrangements with our VIEs and their shareholders, which enable us to (i) exercise effective control over our VIEs, (ii) receive substantially all of the economic benefits of our VIEs, and (iii) have an exclusive option to purchase all or part of the equity interests and assets in our VIEs when and to the extent permitted by PRC law. As a result of these contractual arrangements, we have control over and are the primary beneficiary of our VIEs and hence consolidate their financial results into our consolidated financial statements under U.S. GAAP. See “Corporate History and Structure” for further details.

 

In the opinion of our PRC legal counsel, Global Law Office, (i) the ownership structure of our VIEs in China and our WFOE currently complies with PRC Laws in any material respect; and (ii) the contractual arrangements among our WFOE, our VIEs and their shareholders governed by PRC law constitute legal, valid and binding obligations of all the parties therein, and are enforceable against all the parties therein, and will not result in any violation of applicable PRC laws. However, our PRC legal counsel has also advised us that there are substantial uncertainties regarding the interpretation and application of current and future PRC laws, regulations and rules. Accordingly, the PRC regulatory authorities may take a view that is contrary to the opinion of our PRC legal counsel. It is uncertain whether any new PRC laws or regulations relating to VIE structures will be adopted or, if adopted, what they would provide. If we or our VIEs are found to be in violation of any existing or future PRC laws or regulations, or fail to obtain or maintain any of the required permits or approvals, the relevant PRC regulatory authorities would have broad discretion to take action in dealing with such violations or failures, including:

 

·                  revoking or suspending the business licenses or operating licenses of our WFOE or our VIEs;

 

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·                  discontinuing or placing restrictions or onerous conditions on our operations through any transactions between our WFOE and our VIEs;

 

·                  requiring us to restructure our ownership structure or operations, including terminating the contractual arrangements with our VIEs and deregistering the equity pledges of our VIEs, which in turn would affect our ability to consolidate, derive economic interests from or exert effective control over our VIEs;

 

·                  levying fines or confiscating our income or the income of our WFOE or our VIEs, or imposing other requirements with which we or our VIEs may not be able to comply;

 

·                  restricting or prohibiting our use of the proceeds of our IPO to finance our business and operations in China; and

 

·                  taking other regulatory or enforcement actions that could be harmful to our business.

 

The imposition of any of these penalties would result in a material and adverse effect on our ability to conduct our business. In addition, it is unclear what impact the PRC government actions would have on us and on our ability to consolidate the financial results of our VIEs in our consolidated financial statements, if the PRC government authorities were to find our legal structure and contractual arrangements to be in violation of PRC laws and regulations. If the imposition of any of these government actions causes us to lose our right to direct the activities of our VIEs or our right to receive substantially all the economic benefits and residual returns from our VIEs and we are not able to restructure our ownership structure and operations in a satisfactory manner, we would no longer be able to consolidate the financial results of our VIEs in our consolidated financial statements. Either of these results, or any other significant penalties that might be imposed on us in this event, would have a material adverse effect on our financial condition and results of operations.

 

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

 

On March 15, 2019, the National People’s Congress, or the NPC, approved the Foreign Investment Law, which came into effect on January 1, 2020 and replaced the trio of laws regulating foreign investment in China, namely, the Sino-foreign Equity Joint Venture Enterprise Law, the Sino-foreign Cooperative Joint Venture Enterprise Law and the Wholly Foreign-owned Enterprise Law, together with their implementation rules and ancillary regulations. The Foreign Investment Law embodies an expected PRC regulatory trend to rationalize its foreign investment regulatory regime in line with prevailing international practice and the legislative efforts to unify the corporate legal requirements for both foreign and domestic investments. However, since it is relatively new, uncertainties still exist in relation to its interpretation and implementation. For instance, under the Foreign Investment Law, “foreign investment” refers to the investment activities directly or indirectly conducted by foreign individuals, enterprises or other entities in China. Though it does not explicitly classify contractual arrangements as a form of foreign investment, there is no assurance that foreign investment via contractual arrangement would not be interpreted as a type of indirect foreign investment activities under the definition in the future. In addition, the definition contains a catch-all provision which includes investments made by foreign investors through means stipulated in laws or administrative regulations or other methods prescribed by the State Council. Therefore, it still leaves leeway for future laws, administrative regulations or provisions promulgated by the State Council to provide for contractual arrangements as a form of foreign investment. In any of these cases, it will be uncertain whether our contractual arrangements will be deemed to be in violation of the market access requirements for foreign investment under the PRC laws and regulations. Furthermore, if future laws, administrative regulations or provisions prescribed by the State Council mandate further actions to be taken by companies with respect to existing contractual arrangements, we may face substantial uncertainties as to whether we can complete such actions in a timely manner, or at all. Failure to take timely and appropriate measures to cope with any of these or similar regulatory compliance challenges could materially and adversely affect our current corporate structure, corporate governance and business operations.

 

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We rely on contractual arrangements with our VIEs and their shareholders for a significant portion of our business operations, which may not be as effective as direct ownership in providing operational control.

 

We have relied on and expect to continue to rely on contractual arrangements with our VIEs and their shareholders to conduct our business through Jiaxing MOLBASE, Shanghai MOLBASE and Shaanxi MOLBASE. See “Item 4. Information on the Company—C. Organizational Structure.” These contractual arrangements may not be as effective as direct ownership in providing us with control over our VIEs and their subsidiary. For example, our VIEs and their shareholders could breach their contractual arrangements with us by, among other things, failing to conduct their operations in an acceptable manner or taking other actions that are detrimental to our interests.

 

If we had direct ownership of our VIEs, we would be able to exercise our rights as a shareholder to effect changes in the board of directors of our VIEs, which in turn could implement changes, subject to any applicable fiduciary obligations, at the management and operational level. However, under the current contractual arrangements, we rely on the performance by our VIEs and their shareholders of their obligations under the contracts to exercise control over our VIEs and their subsidiary. The shareholders of our VIEs may not act in the best interests of our company or may not perform their obligations under these contracts. Such risks exist throughout the period in which we intend to operate our business through the contractual arrangements with our VIEs. If any disputes relating to these contracts remains unresolved, we will have to enforce our rights under these contracts through the operations of PRC law and arbitration, litigation and other legal proceedings and therefore will be subject to uncertainties in the PRC legal system. Therefore, our contractual arrangements with our VIEs and their shareholders may not be as effective in ensuring our control over the relevant portion of our business operations as direct ownership would be.

 

Any failure by our VIEs or their respective shareholders to perform their obligations under our contractual arrangements with them would have a material adverse effect on our business.

 

We refer to the shareholders of our VIEs as their nominee shareholders because although they remain the holders of equity interests on record in our VIEs, pursuant to the terms of the relevant shareholder voting proxy agreements, each such shareholder has irrevocably authorized any person designated by our WFOE to exercise the rights as a shareholder of the VIEs. However, if our VIEs or their shareholders fail to perform their respective obligations under the contractual arrangements, we may have to incur substantial costs and expend additional resources to enforce such arrangements. We may also have to rely on legal remedies under PRC law, including seeking specific performance or injunctive relief, and claiming damages, which we cannot assure will be effective under PRC law. For example, if the shareholders of our VIEs refuse to transfer their equity interest in our VIEs to us or our designee if we exercise the purchase option pursuant to these contractual arrangements, or if they otherwise act in bad faith toward us, then we may have to take legal actions to compel them to perform their contractual obligations.

 

All of the agreements under our contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration in China. Accordingly, these contracts would be interpreted in accordance with PRC law, and any disputes arising from these contracts would be resolved in accordance with PRC legal procedures. The legal system 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. See “—Risks Related to Doing Business in China—Uncertainties with respect to the PRC legal system and changes in laws and regulations in China could adversely affect us.” Meanwhile, there are little formal guidance as to how contractual arrangements in the context of VIEs should be interpreted or enforced under PRC law. There remain significant uncertainties regarding the ultimate outcome of such arbitration should legal actions become necessary. In addition, under PRC law, rulings by arbitrators are final, which means parties cannot appeal the arbitration results in courts, and if the losing parties fail to carry out the arbitration awards within a prescribed time limit, the prevailing parties may only enforce the arbitration awards in PRC courts through arbitration award recognition proceedings, which would require additional expenses and delay. In the event we are unable to enforce these contractual arrangements, or if we suffer significant delays or other obstacles in the process of enforcing these contractual arrangements, we may not be able to exert effective control over our VIEs and their subsidiary, and our ability to conduct our business may be negatively affected.

 

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Contractual arrangements in relation to our VIEs may be subject to scrutiny by the PRC tax authorities and they may determine that we, or our VIEs and their subsidiary, owe additional taxes, which could negatively affect our financial condition 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. We could face material and adverse tax consequences if the PRC tax authorities determine that the contractual arrangements by and among us, VIEs and their shareholders 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 the income of our VIEs 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 our VIEs for PRC tax purposes, which could in turn increase their tax liabilities without reducing our WFOE’s tax expenses. In addition, the PRC tax authorities may impose late-payment fees and other penalties on our VIEs for the adjusted but unpaid taxes according to the applicable regulations. Our financial position could be materially and adversely affected if our VIEs’ tax liabilities increase or if they are required to pay late payment fees and other penalties.

 

We may lose the ability to use and benefit from assets held by our VIEs and their subsidiary that are material to the operation of our business if our VIEs or their subsidiary declare bankruptcy or become subject to a dissolution or liquidation proceeding.

 

Our VIEs and their subsidiary hold a majority of our assets, some of which are material to the operation of our business. If our VIEs or their subsidiary declares bankruptcy, and all or part of their 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. Under the contractual arrangements, our VIEs may not, in any manner, sell, transfer, mortgage or dispose of any of their material assets outside the ordinary course of operation or equity interests in the business operation without our prior consent. If our VIEs or their subsidiary undergoes voluntary or involuntary liquidation proceedings, independent 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.

 

If the chops of our PRC subsidiaries, our VIEs or their subsidiaries are not kept safely, are stolen or are used by unauthorized persons or for unauthorized purposes, the corporate governance of these entities could be severely and adversely compromised.

 

In China, a company chop or seal serves as the legal representation of the company towards third parties even when unaccompanied by a signature. Each legally registered company in China is required to maintain a company chop, which must be registered with the local Public Security Bureau. In addition to this mandatory company chop, companies may have several other chops that can be used for specific purposes. The chops of our PRC subsidiaries, VIEs and their subsidiary are generally held securely by personnel we designated or approved in accordance with our internal control procedures. To the extent those chops are not kept safely, are stolen or are used by unauthorized persons or for unauthorized purposes, the corporate governance of these entities could be severely and adversely compromised and those corporate entities may be bound to abide by the terms of any documents so chopped, even if they were chopped by an individual who lacked the requisite power and authority to do so. In addition, if the chops are misused by unauthorized persons, 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 while distracting management from our operations.

 

Risks Related to Doing Business in China

 

Changes in China’s economic, political or social conditions or government policies could have a material adverse effect on our business and results of operations.

 

A majority of our assets and operations are located in China. Accordingly, our business, financial condition, results of operations and prospects may be influenced to a significant degree by political, economic and social conditions in China generally. The Chinese economy differs from the economies of most developed countries in many respects, including the level of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. Although the Chinese government has implemented measures emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets and the establishment of improved corporate governance in business enterprises, a substantial portion of productive assets in China is still owned or controlled by the government. In addition, the Chinese government continues to play a significant role in regulating industry development by imposing industrial policies. The Chinese government also exercises significant control over China’s economic growth through allocating resources, controlling payment of foreign currency denominated obligations, setting monetary policy, and providing preferential treatment to particular industries or companies.

 

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While the Chinese economy has experienced significant growth over the past decades, growth has been uneven, both geographically and among various sectors of the economy, and the rate of growth has been slowing down since 2012. Any adverse changes in economic conditions in China, in the policies of the Chinese government or in the laws and regulations in China could have a material adverse effect on the overall economic growth of China. Such developments could adversely affect our business and operating results, lead to reduction in demand for our products and adversely affect our competitive position. The Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures may benefit the overall Chinese economy but may have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations. In addition, in the past the Chinese government has implemented certain measures, including interest rate adjustment, to control the pace of economic growth. These measures may cause decreased economic activity in China, which may adversely affect our business and operating results.

 

Uncertainties with respect to the PRC legal system and changes in laws and regulations in China could adversely affect us.

 

We conduct our business through our PRC subsidiaries, and our VIEs and their subsidiary in China. Our operations in China are governed by PRC laws and regulations. Our PRC subsidiaries are subject to laws and regulations applicable to foreign investment in China. The PRC legal system is a civil law system based on written statutes. Unlike the common law system, prior court decisions under the civil law system may be cited for reference but have limited precedential value. In addition, any new or changes in PRC laws and regulations related to foreign investment in China could affect the business environment and our ability to operate our business in China.

 

The VIE structure has been adopted by many PRC-based companies, including us, to conduct business in the industries that are currently subject to foreign investment restrictions in China. Under the discussion draft of the Foreign Investment Law for public review and comment published by MOFCOM in January 2015, or the 2015 Draft Foreign Investment Law, a VIE that is controlled via contractual arrangements would also be deemed as a foreign invested enterprise, or FIE, if it is ultimately “controlled” by foreign investors. The Foreign Investment Law published by NPC on March 15, 2019 and the Implementing Regulations of the Foreign Investment Law published by State Council on December 26, 2019 do not touch upon the concept and regulatory regimes of “de facto control” or “variable interest entity structure.” However, there are still substantial uncertainties regarding the interpretation and application of the Foreign Investment Law and the regulatory regimes. See “—Uncertainties exist with respect to the interpretation and implementation of the newly enacted PRC Foreign Investment Law and how it may impact the viability of our current corporate structure, corporate governance and business operations.” It is uncertain whether any new PRC laws or regulations relating to variable interest entity structures will be adopted or if adopted, what they would provide. If our VIEs are deemed as FIEs and the business operation of such VIE falls within the industry catalogue of special management measures, or the Negative List, amended by the MOFCOM and the NDRC in the future, the existing VIE structure may be scrutinized and subject to foreign investment restrictions and approval from the MOFCOM and other supervising authorities such as the MIIT. Our corporate governance practice may be materially impacted and our compliance costs could increase if our VIEs are deemed as FIEs by such supervising authorities.

 

From time to time, we may have to resort to administrative and court proceedings to enforce our legal rights. Any administrative and court proceedings in China may be protracted, resulting in substantial costs and diversion of resources and management attention. Since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory provisions and contractual terms, it may be more difficult to evaluate the outcome of administrative and court proceedings and the level of legal protection we enjoy than in more developed legal systems. These uncertainties may impede our ability to enforce the contracts we have entered into and could materially and adversely affect our business and results of operations.

 

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Furthermore, the PRC legal system is based in part on government policies and internal rules, some of which are not published on a timely basis or at all and may have a retroactive effect. As a result, we may not be aware of our violation of any of these policies and rules until sometime after the violation. Such unpredictability towards our contractual, property and procedural rights could adversely affect our business and impede our ability to continue our operations.

 

We may be adversely affected by the complexity, uncertainties and changes in PRC regulation of chemical industry and internet-related businesses, and any lack of requisite approvals, licenses or permits applicable to our business may have a material adverse effect on our business and results of operations.

 

Our business is subject to governmental supervision and regulation by the relevant PRC governmental authorities, including but not limited to the MOFCOM, MIIT, State Administration for Market Regulation, Ministry of Emergency Management and their counterparts. Together, these government authorities promulgate and enforce regulations that cover many aspects of the operation of transaction, storage and transportation of chemicals, and internet-related business, including foreign ownership of, and the licensing and permit requirements pertaining to, companies in such business. The laws and regulations related to transaction, storage and transportation of chemicals, and internet-related business are evolving rapidly, and their interpretation and enforcement involve significant uncertainties. As a result, in certain circumstances it may be difficult to determine what actions or omissions may be deemed to be in violation of applicable laws and regulations. Under PRC laws, an entity must obtain the Hazardous Chemical Operation License from the Ministry of Emergency Management or its counterpart for conducting transaction, storage and transportation of hazardous chemicals, operation license or record-filing from the National Medical Products Administration or its counterpart for conducting transaction, storage and transportation of medical devices, the value-added telecommunication service operating licenses from the MIIT or its counterpart for either online information services or e-commerce platform operation. We have made great efforts to obtain all applicable licenses and permits necessary to our business.

 

However, the interpretation and application of existing PRC laws, regulations and policies and possible new laws, regulations or policies relating to the transaction, storage and transportation of chemicals, and internet-related business have created substantial uncertainties regarding the legality of existing and future foreign investments in, and the businesses and activities of, transaction, storage and transportation of chemicals, and internet-related business in China, including our business, we cannot assure you that we have obtained all the permits or licenses required for conducting our business or will be able to maintain our existing licenses or obtain new ones. If the PRC government considers that we were operating without the proper approvals, licenses or permits or promulgates new laws and regulations that require additional approvals or licenses or imposes additional restrictions on the operation of any part of our business, it has the power, among other things, to levy fines, confiscate our income, revoke our business licenses, and require us to discontinue our relevant business or impose restrictions on the affected portion of our business. Any of these actions by the PRC government may have a material adverse effect on our business and results of operations.

 

We may rely on dividends paid by our PRC subsidiaries to fund any cash and financing requirements we may have. Any limitation on the ability of our PRC subsidiaries to pay dividends to us could have a material adverse effect on our ability to conduct our business and to pay dividends to holders of the ADSs and our ordinary shares.

 

We are a holding company, and we may rely on dividends to be paid by our PRC subsidiaries for our cash and financing requirements, including the funds necessary to pay dividends and other cash distributions to the holders of the ADSs and our ordinary shares and service any debt we may incur. If our PRC subsidiaries incur debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other distributions to us.

 

Under PRC laws and regulations, wholly foreign-owned enterprises in the PRC, such as our WFOE, may pay dividends only out of its accumulated profits as determined in accordance with PRC accounting standards and regulations. In addition, a wholly foreign-owned enterprise is required to set aside at least 10% of its after-tax profits each year, after making up previous years’ accumulated losses, if any, to fund certain statutory reserve funds, until the aggregate amount of such a fund reaches 50% of its registered capital. The reserve funds are not distributable as cash dividends. Any limitation on the ability of our PRC subsidiaries to pay dividends or make other distributions to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends or otherwise fund and conduct our business.

 

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PRC regulation of loans to and direct investment in PRC entities by offshore holding companies and governmental control of currency conversion may delay or prevent us from using the proceeds of our IPO to make loans to or make additional capital contributions to our PRC subsidiaries, which could materially and adversely affect our liquidity and our ability to fund and expand our business.

 

We are an offshore holding company conducting our operations in China through our PRC subsidiaries, and our VIEs and their subsidiaries. We may make loans to our PRC subsidiaries and VIEs subject to the approval from governmental authorities and limitation of amount, or we may make additional capital contributions to our PRC subsidiaries in China.

 

Any funds we transfer to our PRC subsidiaries, either as a shareholder loan or as an increase in registered capital, are subject to filing or registration with the relevant governmental authorities in China. According to the relevant PRC regulations on foreign-invested enterprises in China, capital contributions to our PRC subsidiaries are subject to the requirement of making necessary filings and registration with other governmental authorities in China. In addition, (a) any foreign loan procured by our PRC subsidiaries is required to be registered with State Administration of Foreign Exchange, or SAFE, or its local branches, and (b) each of our PRC subsidiaries may not procure loans which exceed the statutory limit. Any medium or long-term loan that we are to provide to our VIEs must be recorded and registered by the NDRC and SAFE, or its local branches. We may not complete such recording or registrations on a timely basis, if at all, with respect to future capital contributions or foreign loans from us to our PRC subsidiaries. If we fail to complete such recording or registration, our ability to use the proceeds of our IPO and to capitalize our PRC operations may be negatively affected, which could adversely affect our liquidity and our ability to fund and expand our business.

 

In 2008, SAFE promulgated the Notice of the General Affairs Department of the State Administration of Foreign Exchange on the Relevant Operating Issues concerning the Improvement of the Administration of Payment and Settlement of Foreign Currency Capital of Foreign-invested Enterprises, or Circular 142, which used to regulate the conversion by foreign-invested enterprises of foreign currency into Renminbi by restricting the usage of converted Renminbi. In March 2015, SAFE promulgated the Notice of the State Administration of Foreign Exchange on Reforming the Administrative Approach Regarding the Settlement of the Foreign Exchange Capitals of Foreign-invested Enterprises, or Circular 19. Circular 19 took effect as of June 1, 2015 and superseded Circular 142 on the same date. Circular 19 launched a nationwide reform of the administration of the settlement of the foreign exchange capitals of foreign-invested enterprises and allows foreign-invested enterprises to settle their foreign exchange capital at their discretion, but continues to prohibit foreign-invested enterprises from using the Renminbi fund converted from their foreign exchange capitals for expenditures beyond their business scopes. In June 2016, SAFE promulgated the Notice of the State Administration of Foreign Exchange on Reforming and Standardizing the Administrative Provisions on Capital Account Foreign Exchange Settlement, or Circular 16. Circular 16 continues to prohibit foreign-invested enterprises from, among other things, using the Renminbi fund converted from its foreign exchange capitals for expenditure beyond its business scope, investment and financing (except for guarantee products issued by a bank or otherwise permitted by laws), providing loans to non-affiliated enterprises or constructing or purchasing real estate not for self-use (except for real estate enterprise). Circular 19 and Circular 16 may significantly limit our ability to transfer to and use in China the net proceeds from our IPO, which may adversely affect our business, financial condition and results of operations.

 

Fluctuations in exchange rates could have a material adverse effect on our results of operations and the value of your investment.

 

The conversion of Renminbi into foreign currencies, including U.S. dollars, is based on rates set by the People’s Bank of China. The Renminbi has fluctuated against the U.S. dollar, at times significantly and unpredictably. The value of Renminbi against the U.S. dollar and other currencies is affected by changes in China’s political and economic conditions and by China’s foreign exchange policies, among other things. We cannot assure you that Renminbi will not appreciate or depreciate significantly in value against the U.S. dollar in the future. It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange rate between Renminbi and the U.S. dollar in the future.

 

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Any significant appreciation or depreciation of Renminbi may materially and adversely affect our revenues, earnings and financial position, and the value of, and any dividends payable on, our ADSs in U.S. dollars. For example, to the extent that we need to convert U.S. dollars we receive into Renminbi to pay our operating expenses, appreciation of Renminbi against the U.S. dollar would have an adverse effect on the RMB amount we would receive from the conversion. Conversely, a significant depreciation of Renminbi against the U.S. dollar may significantly reduce the U.S. dollar equivalent of our earnings, which in turn could adversely affect the price of our ADSs

 

Very limited hedging options are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may decide to enter into hedging transactions in the future, the availability and effectiveness of these hedges may be limited and we may not be able to adequately hedge our exposure or at all. In addition, our currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert Renminbi into foreign currency. As a result, fluctuations in exchange rates may have a material adverse effect on your investment.

 

Governmental control of currency conversion may limit our ability to utilize our operating revenue effectively and may affect the value of your investment.

 

The PRC government imposes controls on the convertibility of the Renminbi into foreign currencies and, in certain cases, the remittance of currency out of China. We receive substantially all of our net revenues in Renminbi. Under our current corporate structure, our Cayman Islands holding company primarily relies on dividend payments from our PRC subsidiaries to fund any cash and financing requirements we may have. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and trade and service-related foreign exchange transactions, can be made in foreign currencies without prior approval of SAFE by complying with certain procedural requirements. Specifically, under the existing exchange restrictions, without prior approval of SAFE, cash generated from the operations of our PRC subsidiaries in China may be used to pay dividends to our company. However, approval from or registration with appropriate government authorities is required where Renminbi is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of loans denominated in foreign currencies. As a result, we need to obtain SAFE approval to use cash generated from the operations of our PRC subsidiaries, and our VIEs and their subsidiaries to pay off their respective debt in a currency other than Renminbi owed to entities outside China, or to make other capital expenditure payments outside China in a currency other than Renminbi. The PRC government may at its discretion restrict access to foreign currencies for current account transactions in the future. If the foreign exchange control system prevents us from obtaining sufficient foreign currencies to satisfy our foreign currency demands, we may not be able to pay dividends in foreign currencies to our shareholders, including holders of our ADSs.

 

Failure to make adequate contributions to various employee benefit plans and withhold individual income tax on employees’ salaries as required by PRC regulations may subject us to penalties.

 

Companies operating in China are required to participate in various government-mandated employee benefit contribution plans, including certain social insurance, housing funds and other welfare-oriented payment obligations, and contribute to the plans in amounts equal to certain percentages of salaries, including bonuses and allowances, of our employees up to a maximum amount specified by the local government from time to time at locations where we operate our businesses. The requirement of employee benefit contribution plans has not been implemented consistently by the local governments in China given the different levels of economic development in different locations. Companies operating in China are also required to withhold individual income tax on employees’ salaries based on the actual salary of each employee upon payment. We may be subject to late fees and fines in relation to the underpaid employee benefits and under-withheld individual income tax, our financial condition and results of operations may be adversely affected.

 

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The M&A Rules and certain other PRC regulations establish complex procedures for some acquisitions of Chinese companies by foreign investors, which could make it more difficult for us to pursue growth through acquisitions in China.

 

The Regulations on Mergers and Acquisitions of Domestic Companies by Foreign Investors, or the M&A Rules, adopted by six PRC regulatory agencies in 2006 and amended in 2009, and some other regulations and rules concerning mergers and acquisitions established additional procedures and requirements that could make merger and acquisition activities by foreign investors more time consuming and complex, including requirements in some instances that the MOFCOM be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise. Moreover, the Anti-Monopoly Law requires that the MOFCOM shall be notified in advance of any concentration of undertaking if certain thresholds are triggered. In addition, the security review rules issued by the MOFCOM that became effective in September 2011 specify that mergers and acquisitions by foreign investors that raise “national defense and security” concerns and mergers and acquisitions through which foreign investors may acquire de facto control over domestic enterprises that raise “national security” concerns are subject to strict review by the MOFCOM, and the rules prohibit any activities attempting to bypass a security review, including by structuring the transaction through a proxy or contractual control arrangement. In the future, we may grow our business by acquiring complementary businesses. Complying with the requirements of the above-mentioned regulations and other relevant rules to complete such transactions could be time consuming, and any required approval processes, including obtaining approval from the MOFCOM or its local counterparts may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.

 

PRC regulations relating to offshore investment activities by PRC residents may limit our PRC subsidiaries’ ability to increase their registered capital or distribute profits to us or otherwise expose us or our PRC resident beneficial owners to liability and penalties under PRC law.

 

In October 2005, the SAFE issued a circular on relevant issues relating to foreign exchange administration in fund financing and roundtrip investment by domestic residents via offshore special purpose vehicles, or Circular 75, requiring PRC residents, including individuals and entities, to register with the relevant local branch of SAFE before establishing or controlling any company outside of China, referred to as an offshore special purpose company, for the purpose of raising funds from overseas to acquire or exchange assets of, or acquiring equity interest in, PRC companies held by such PRC residents.

 

In July 2014, the SAFE issued a circular on foreign exchange administration involved in overseas investment, financing and roundtrip investment conducted by PRC residents via offshore special purpose vehicles, or Circular 37, which replaced Circular 75 and further requires PRC residents or entities to register with SAFE or its local branch in connection with their establishment or control of an offshore entity established for the purpose of overseas investment or financing by either onshore or offshore assets or equity legally held by such PRC residents. In February 2015, SAFE released the Notice of the State Administration of Foreign Exchange on Further Simplifying and Improving the Policies of Foreign Exchange Administration Applicable to Direct Investment, or Circular 13, which further clarified that offshore individuals who have foreign identification and use their offshore assets or equity to make contributions into an offshore special purpose vehicle are not subject to the registration under Circular 37.

 

If our shareholders who are PRC residents or entities do not complete their registration as required, our PRC subsidiaries may be prohibited from distributing their profits and proceeds from any reduction in capital, share transfer or liquidation to us, and we may be restricted in our ability to contribute additional capital to our PRC subsidiaries. Moreover, failure to comply with the SAFE registration described above could result in liability under PRC laws for evasion of applicable foreign exchange restrictions.

 

We may not be informed of the identities of all PRC residents holding direct or indirect interest in our company, nor can we compel our beneficial owners to comply with the requirements of Circular 37. As a result, we cannot assure you that all of our shareholders or beneficial owners who are PRC residents or entities have complied with, and will in the future make or obtain any applicable registrations or approvals required by, Circular 37 or other PRC applicable law and regulations related to outbound investment. Failure by such shareholders or beneficial owners to comply with Circular 37, or failure by us to amend the foreign exchange registrations of our PRC subsidiaries, could subject us to fines or legal sanctions, restrict our overseas or cross-border investment activities and limit our PRC subsidiaries’ ability to make distributions or pay dividends to us or affect our ownership structure, which could adversely affect our business and prospects.

 

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Any failure to comply with PRC regulations regarding the registration requirements for employee stock incentive plans may subject the PRC plan participants or us to fines and other legal or administrative sanctions.

 

In February 2012, SAFE promulgated the Notice on Issues Concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly Listed Company, replacing earlier rules promulgated in 2007. Pursuant to these rules, PRC citizens and non-PRC citizens who reside in China for a continuous period of not less than one year who participate in any stock incentive plan of an overseas publicly listed company, subject to a few exceptions, are required to register with SAFE or its local branches through a domestic qualified agent, which could be the PRC subsidiary of such overseas-listed company, and complete certain other procedures. In addition, an overseas-entrusted institution must be retained to handle matters in connection with the exercise or sale of stock options and the purchase or sale of shares and interests. We and our executive officers and other employees who are PRC citizens or who reside in the PRC for a continuous period of not less than one year and who have been granted share-based awards are subject to these regulations. Failure to complete SAFE registrations may subject them to fines of up to RMB300,000 for entities and up to RMB50,000 for individuals, and legal sanctions and may also limit our ability to contribute additional capital into our PRC subsidiaries and limit our PRC subsidiaries’ ability to distribute dividends to us. We also face regulatory uncertainties that could restrict our ability to adopt additional incentive plans for our directors, executive officers and employees under PRC law. See “Item 4. Information on the Company—B. Business Overview—Regulation—Regulations on Labor Protection in the PRC—Employee Stock Incentive Plan.”

 

In addition, the State Administration of Taxation, or SAT, has issued the Notice of the State Administration of Taxation on Relevant Issues of Individual Income Tax Relating to Equity Incentive, or Notice 461 and relevant circulars concerning employee stock options and restricted shares. Under these circulars, our employees working in China who exercise stock options or are granted restricted shares will be subject to PRC individual income tax. Our PRC subsidiaries have obligations to file documents related to employee stock options or restricted shares with relevant tax authorities and to withhold individual income taxes of those employees who exercise their share options or are granted with restricted shares. If our employees fail to pay or we fail to withhold their income taxes according to relevant laws and regulations, we may face sanctions imposed by the tax authorities or other PRC governmental authorities.

 

U.S. regulatory bodies may be limited in their ability to conduct investigations or inspections of our operations in China.

 

Any disclosure of documents or information located in China by foreign agencies may be subject to jurisdiction constraints and must comply with China’s state secrecy laws, which broadly define the scope of “state secrets” to include matters involving economic interests and technologies. There is no guarantee that requests from U.S. federal or state regulators or agencies to investigate or inspect our operations will be honored by us, by entities who provide services to us or with whom we associate, without violating PRC legal requirements, especially as those entities are located in China. Furthermore, under the current PRC laws, an on-site inspection of our facilities by any of these regulators may be limited or prohibited.

 

If we are classified as a PRC resident enterprise for PRC income tax purposes, such classification could result in unfavorable tax consequences to us and our non-PRC shareholders or ADS holders.

 

Under the PRC Enterprise Income Tax Law and its implementation rules, an enterprise established outside of the PRC with a “de facto management body” within the PRC is considered a “resident enterprise” and will be subject to the enterprise income tax on its global income at the rate of 25%. The implementation rules define the term “de facto management body” as the body that exercises full and substantial control over and overall and substantial management of the business, productions, personnel, accounts and properties of an enterprise. In 2009, the SAT issued a circular known as SAT Circular 82, which provides certain specific criteria for determining whether the “de facto management body” of a PRC-controlled enterprise that is incorporated offshore is located in China. Although this circular only applies to offshore enterprises controlled by PRC enterprises or PRC enterprise groups, not those controlled by PRC individuals or foreigners, the criteria set forth in the circular may reflect the SAT’s general position on how the “de facto management body” test should be applied in determining the tax resident status of all offshore enterprises. According to SAT Circular 82, an offshore incorporated enterprise controlled by a PRC enterprise or a PRC enterprise group will be regarded as a PRC tax resident by virtue of having its “de facto management body” in China and will be subject to PRC enterprise income tax on its global income only if all of the following conditions are met: (i) the primary location where senior management personnel and departments that are responsible for the day-to-day operational management is in the PRC; (ii) decisions relating to the enterprise’s financial and human resource matters are made or are subject to approval by organizations or personnel in the PRC; (iii) the enterprise’s primary assets, accounting books and records, company seals, and board and shareholder resolutions are located or maintained in the PRC; and (iv) at least 50% of voting board members or senior executives habitually reside in the PRC.

 

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We believe that we are not a PRC resident enterprise for PRC tax purposes. However, the tax resident status of an enterprise is subject to determination by the PRC tax authorities and uncertainties remain with respect to the interpretation of the term “de facto management body.” If the PRC tax authorities determine that we are a PRC resident enterprise for enterprise income tax purposes, we may be required to withhold a 10% withholding tax, from dividends we pay to our shareholders that are non-resident enterprises, including the holders of our ADSs. In addition, non-resident enterprise shareholders (including our ADS holders) may be subject to PRC tax at a rate of 10% on gains realized on the sale or other disposition of ADSs or ordinary shares, if such income is treated as sourced from within the PRC. Furthermore, if we are deemed a PRC resident enterprise, dividends payable to our non-PRC individual shareholders (including our ADS holders) and any gain realized on the transfer of ADSs or ordinary shares by such shareholders may be subject to PRC tax at a rate of 20%, which, in the case of dividends, we may withhold at source, unless a reduced rate is available under an applicable tax treaty. However, it is unclear whether non-PRC shareholders of our company would be able to claim the benefits of any tax treaties between their country of tax residence and the PRC in the event that we are treated as a PRC resident enterprise. Any such tax may reduce the returns on your investment in the ADSs or ordinary shares.

 

Discontinuation of any of the government subsidies or imposition of any additional taxes and surcharges could adversely affect our financial condition and results of operations.

 

Our VIEs have received various financial subsidies from PRC local government authorities. The financial subsidies result from discretionary incentives and policies adopted by PRC local government authorities. Local governments may decide to change or discontinue such financial subsidies at any time. The discontinuation of such financial subsidies or imposition of any additional taxes could adversely affect our financial condition and results of operations.

 

We may not be able to obtain certain benefits under the relevant tax treaty on dividends paid by our PRC subsidiaries to us through our Hong Kong subsidiary.

 

Pursuant to the Enterprise Income Tax Law and its implementation rules, if a non-resident enterprise has not set up an organization or establishment in the PRC, or has set up an organization or establishment but the income derived has no actual connection with such organization or establishment, it will be subject to a withholding tax on its PRC-sourced income at a rate of 10%. Pursuant to the Arrangement between Mainland China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and Tax Evasion on Income, or the Double Taxation Arrangement, the withholding tax rate in respect to the payment of dividends by a PRC enterprise to a Hong Kong enterprise is reduced to 5% from a standard rate of 10% if the Hong Kong enterprise directly holds at least 25% of the PRC enterprise. There are also other conditions for enjoying the reduced withholding tax rate according to other relevant tax rules and regulations.

 

In February 2009, SAT issued SAT Notice No. 81, pursuant to which an enterprise must be the “beneficial owner” of the relevant dividend income in order to enjoy the preferential withholding tax rates on dividend. If, however, such enterprise otherwise qualifies for such preferential withholding tax rates through any transaction or arrangement, whose main purpose is to qualify for such preferential withholding tax rates, the enterprise nevertheless cannot enjoy the preferential withholding tax rates and the competent tax authority has the power to adjust the applicable withholding tax rates if it so determines. The SAT Notice No. 9 issued by SAT that took effect in April 2018 indicated that “beneficial owner” refers to a person who has ownership and disposal rights to the income or any rights and assets arising from such income, and the tax authority has discretion to determine whether or not an enterprise is determined as a “beneficial owner.” However, since the SAT Notice No. 9 is newly issued, it remains unclear how the PRC tax authorities will implement SAT Notice No. 9 in practice and to what extent they will affect the dividend withholding tax rates for dividends distributed by our PRC subsidiaries to our Hong Kong subsidiary. If the relevant tax authority determines that our Hong Kong subsidiary is a conduit company and does not qualify as the “beneficial owner” of the dividend income it receives from our PRC subsidiaries, the higher 10% withholding tax rate will apply to such dividends.

 

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Therefore, we cannot assure you that our determination regarding our qualification to enjoy the preferential tax treatment will not be challenged by the relevant PRC tax authority or we will be able to complete the necessary filings with the relevant PRC tax authority and enjoy the preferential withholding tax rate of 5% under the Double Taxation Arrangement with respect to dividends to be paid by our PRC subsidiaries to Molecular Data HK.

 

We face uncertainty with respect to indirect transfers of equity interests in PRC resident enterprises by their non-PRC holding companies.

 

We face uncertainties regarding the reporting on and consequences of previous private equity financing transactions involving the transfer and exchange of shares in our company by non-PRC resident investors, and ongoing restructuring where PRC taxable assets are involved.

 

According to the Notice on Strengthening Administration of Enterprise Income Tax for Share Transfers by Non-PRC Resident Enterprises issued by SAT on December 10, 2009, or SAT Circular 698, where a non-PRC resident enterprise transfers the equity interests in a PRC resident enterprise indirectly through a disposition of equity interests in an offshore holding company (other than the sale on a public stock market of shares of an offshore enterprise purchased on a public stock market), or an Indirect Transfer, the non-PRC resident enterprise, as the seller, may be subject to PRC enterprise income tax of up to 10% of the gains derived from the Indirect Transfer in certain circumstances.

 

On February 3, 2015, the SAT issued the Announcement on Several Issues Concerning the Enterprise Income Tax on Indirect Property Transfers by Non-PRC Resident Enterprises, or SAT Notice No. 7, to supersede the existing tax rules in relation to the tax treatment of the Indirect Transfer, while the other provisions of SAT Circular 698 are irrelevant to the Indirect Transfer remain in force. SAT Notice No. 7 introduces a new tax regime that is significantly different from that under a notice issued by SAT Circular 698. It extends SAT’s tax jurisdiction to capture not only the Indirect Transfer as set forth under SAT Circular 698 but also transactions involving indirect transfer of (i) real properties in China and (ii) assets of an “establishment or place” situated in China, by a non-PRC resident enterprise through a disposition of equity interests in an offshore holding company. SAT Notice No. 7 also extends the interpretation with respect to the disposition of equity interests in an offshore holding company broadly. In addition, SAT Notice No. 7 further clarifies how to assess reasonable commercial purposes and introduces safe harbors applicable to internal group restructurings. However, it also brings challenges to both offshore transferor and transferee as they are required to make self-assessments on whether an Indirect Transfer or similar transaction should be subject to PRC tax and whether they should file or withhold any tax payment accordingly. On October 17, 2017, the SAT issued a Notice Concerning Withholding Income Tax of Non-Resident Enterprise, or SAT Notice No. 37, which abolishes SAT Circular 698 and certain provisions of SAT Notice 7. SAT Notice No. 37 further reduces the burden of the withholding obligator, such as revocation of contract filing requirements and tax liquidation procedures, strengthens the cooperation of tax authorities in different places, and clarifies the calculation of tax payable and mechanism of foreign exchange.

 

There is uncertainty as to the application of SAT Notice No. 7 and SAT Notice No. 37. In the event that non-PRC resident investors were involved in our private equity financing transactions and such transactions were determined by the competent tax authorities as lacking reasonable commercial purposes, we and our non-PRC resident investors may become at risk of being taxed under SAT Notice No. 7 and SAT Notice No. 37 and may be required to expend costly resources to comply with SAT Notice No. 7 and SAT Notice No. 37, or to establish a case to be tax exempt under SAT Notice No. 7 and SAT Notice No. 37, which may cause us to incur additional costs and may have a negative impact on the value of your investment in us.

 

The PRC tax authorities have discretion under SAT Notice No. 7 and SAT Notice No. 37 to adjust the taxable capital gains based on the difference between the fair value of the transferred equity interests and the investment cost. We may pursue acquisitions in the future that may involve complex corporate structures. If we are deemed as a non-PRC resident enterprise under the Enterprise Income Tax Law and if the PRC tax authorities adjust the taxable income of the transactions under SAT Notice No. 7 and SAT Notice No. 37, our income tax expenses associated with such potential acquisitions will increase, which may have an adverse effect on our financial condition and results of operations.

 

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The audit report included in this annual report is prepared by an auditor who is not inspected by the Public Company Accounting Oversight Board and, as such, our investors are deprived of the benefits of such inspection.

 

Our independent registered public accounting firm that issues the audit reports included in our annual report filed with the U.S. Securities and Exchange Commission, as auditors of companies that are traded publicly in the United States and a firm registered with the U.S. Public Company Accounting Oversight Board (United States), or the PCAOB, is required by the laws of the United States to undergo regular inspections by the PCAOB to assess its compliance with the laws of the United States and professional standards. Because our auditors are located in the Peoples’ Republic of China, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of the Chinese authorities, our auditors are not currently inspected by the PCAOB. On May 24, 2013, PCAOB announced that it had entered into a Memorandum of Understanding on Enforcement Cooperation with China Securities Regulatory Commission, or CSRC, and the Ministry of Finance which establishes a cooperative framework between the parties for the production and exchange of audit documents relevant to investigations in the United States and China. PCAOB continues to be in discussions with the CSRC and the Ministry of Finance to permit joint inspections in the PRC of audit firms that are registered with the 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, the SEC and the PCAOB issued another joint statement reiterating the greater risk that disclosures will be insufficient in many emerging markets, including China, compared to those made by U.S. domestic companies. In discussing the specific issues related to the greater risk, the statement again highlights the PCAOB’s inability to inspect audit work paper and practices of accounting firms in China, with respect to their audit work of U.S. reporting companies. On June 4, 2020, the U.S. President issued a memorandum ordering the President’s Working Group on Financial Markets 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. However, it remains unclear what further actions the U.S. executive branch, the SEC and PCAOB will take to address the problem.

 

Inspections of other firms that the PCAOB has conducted outside of China have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality. This lack of PCAOB inspections in China prevents the PCAOB from regularly evaluating our auditor’s audits and its quality control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections.

 

The inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of our auditor’s audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections. Investors may lose confidence in our reported financial information and procedures and the quality of our financial statements.

 

As part of a continued regulatory focus in the United States on access to audit and other information currently protected by national law, in particular China’s, in June 2019, a bipartisan group of lawmakers introduced bills in both houses of the U.S. Congress that would require the SEC to maintain a list of issuers for which PCAOB is not able to inspect or investigate an auditor report issued by a foreign public accounting firm. The Ensuring Quality Information and Transparency for Abroad-Based Listings on our Exchanges (EQUITABLE) Act prescribes increased disclosure requirements for these issuers and, beginning in 2025, the delisting from U.S. national securities exchanges such as the New York Stock Exchange of issuers included on the SEC’s list for three consecutive years. On May 20, 2020, the U.S. Senate passed S. 945, the Holding Foreign Companies Accountable Act (the “Kennedy Bill”).  If passed by the U.S. House of Representatives and signed by the U.S. President,  the Kennedy Bill would amend the Sarbanes-Oxley Act of 2002 to direct the SEC to prohibit securities of any registrant from being listed on any of the U.S. securities exchanges or traded “over-the-counter” if the auditor of the registrant’s financial statements is not subject to PCAOB inspection for three consecutive years after the law becomes effective.  Enactment of any of such legislations or other efforts to increase U.S. regulatory access to audit information could cause investor uncertainty for affected issuers, including us, the market price of our ADSs could be adversely affected, and we could be delisted if we are unable to cure the situation to meet the PCAOB inspection requirement in time. It is unclear if and when any of such proposed legislations will be enacted. Furthermore, there have been recent media reports on deliberations within the U.S. government regarding potentially limiting or restricting China-based companies from accessing U.S. capital markets. If any such deliberations were to materialize, the resulting legislation may have material and adverse impact on the stock performance of China-based issuers listed in the United States.

 

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Proceedings instituted by the SEC against the “big four” PRC-based accounting firms, including our independent registered public accounting firm, could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act.

 

Starting in 2011, the Chinese affiliates of the “big four” accounting firms, including our independent registered public accounting firm, were affected by a conflict between U.S. and Chinese law. Specifically, for certain U.S.-listed companies operating and audited in mainland China, the SEC and the PCAOB sought to obtain from the Chinese firms access to their audit work papers and related documents. The firms were, however, advised and directed that under Chinese law, they could not respond directly to the U.S. regulators on those requests, and that requests by foreign regulators for access to such papers in China had to be channeled through the CSRC.

 

In late 2012, this impasse led the SEC to commence administrative proceedings under Rule 102(e) of its Rules of Practice and also under the Sarbanes-Oxley Act of 2002 against the Chinese accounting firms, including our independent registered public accounting firm. A first instance trial of the proceedings in July 2013 in the SEC’s internal administrative court resulted in an adverse judgment against the firms. The administrative law judge proposed penalties on the firms including a temporary suspension of their right to practice before the SEC, although that proposed penalty did not take effect pending review by the Commissioners of the SEC. On February 6, 2015, before a review by the Commissioner had taken place, the firms reached a settlement with the SEC. Under the settlement, the SEC accepts that future requests by the SEC for the production of documents will normally be made to the CSRC. The firms will receive matching Section 106 requests, and are required to abide by a detailed set of procedures with respect to such requests, which in substance require them to facilitate production via the CSRC. If they fail to meet specified criteria, the SEC retains authority to impose a variety of additional remedial measures on the firms depending on the nature of the failure. Remedies for any future noncompliance could include, as appropriate, an automatic six-month bar on a single firm’s performance of certain audit work, commencement of a new proceeding against a firm, or in extreme cases the resumption of the current proceeding against all four firms. If additional remedial measures are imposed on the Chinese affiliates of the “big four” accounting firms, including our independent registered public accounting firm, in administrative proceedings brought by the SEC alleging the firms’ failure to meet specific criteria set by the SEC with respect to requests for the production of documents, we could be unable to timely file future financial statements in compliance with the requirements of the Exchange Act.

 

In the event that the SEC restarts the administrative proceedings, depending upon the final outcome, listed companies in the United States with major PRC operations may find it difficult or impossible to retain auditors in respect of their operations in the PRC, which could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act, including possible delisting. Moreover, any negative news about any such future proceedings against these audit firms may cause investor uncertainty regarding China-based, U.S.-listed companies and the market price of our common stock may be adversely affected.

 

If our independent registered public accounting firm was denied, even temporarily, the ability to practice before the SEC and we were unable to timely find another registered public accounting firm to audit and issue an opinion on our financial statements, our financial statements could be determined not to be in compliance with the requirements of the Exchange Act. Such a determination could ultimately lead to the delisting of our ADSs from Nasdaq Stock Market or deregistration from the SEC, or both, which would substantially reduce or effectively terminate the trading of our ADSs in the United States.

 

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Risks Related to the ADSs

 

The trading price for the ADSs may be volatile, which could result in substantial losses to investors.

 

The trading price of our ADSs may 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. In addition to market and industry factors, the price and trading volume for our ADSs may be volatile for factors specific to our own operations, including the following:

 

·                  variations in our net revenues, earnings and cash flow;

 

·                  our or our competitors’ announcements of new investments, acquisitions, strategic partnerships, or joint ventures;

 

·                  our or our competitors’ announcements of new products and services and expansions;

 

·                  changes in financial estimates by securities analysts;

 

·                  failure on our part to realize monetization opportunities as expected;

 

·                  additions or departures of key personnel;

 

·                  release of lock-up or other transfer restrictions on our outstanding equity securities or sales of additional equity securities;

 

·                  detrimental negative publicity about us, our management, our competitors or our industry;

 

·                  regulatory developments affecting us or our industry; and

 

·                  actual or potential litigation or regulatory investigations.

 

Any of these factors may result in large and sudden changes in the trading volume and price of the ADSs.

 

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.

 

Our dual-class share structure with different voting rights limits your ability to influence corporate matters and could discourage others from pursuing any change of control transactions that holders of our Class A ordinary shares and ADSs may view as beneficial.

 

We have a dual-class share structure such that our ordinary shares consist of Class A ordinary shares and Class B ordinary shares. In respect of matters requiring the votes of shareholders, holders of Class A ordinary shares are entitled to one vote per share, while holders of Class B ordinary shares are entitled to ten votes per share based on our dual-class share structure. Each Class B ordinary share is convertible into one Class A ordinary share at any time by the holder thereof, while Class A ordinary shares are not convertible into Class B ordinary shares under any circumstances. Upon any sale, transfer, assignment or disposition of any Class B ordinary share by MOLBASE Inc. to any person who is not our founder, Dr. Dongliang Chang, or his affiliate, or the change of ultimate beneficial ownership of any Class B ordinary shares from MOLBASE Inc. to any person who is not our founder, Dr. Dongliang Chang, or his affiliate, each of such Class B ordinary share shall be automatically and immediately converted into one Class A ordinary share. Upon any sale, transfer, assignment or disposition of any Class B ordinary share by our founder, Dr. Dongliang Chang, to any person who is not his affiliate, or upon a change of ultimate beneficial ownership of any Class B ordinary share from our founder, Dr. Dongliang Chang to any person who is not his affiliate, each of such Class B ordinary share shall be automatically and immediately converted into one Class A ordinary share.

 

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We have completed the Share Distribution as of the date of this annual report, effective June 30, 2020. The existing shareholders of MOLBASE Inc. became holders of Class A ordinary shares of our company except for our founder, Dr. Dongliang Chang, who became beneficial owner of 54,819,733 Class B ordinary shares. The Class B ordinary shares beneficially owned by Dr. Dongliang Chang represented approximately 15.9% equity interests or 65.3% voting power of our total issued and outstanding share capital as of March 31, 2020, assuming the completion of the Share Distribution at that time. As a result of the dual-class share structure and the concentration of ownership, holders of our Class B ordinary shares have considerable influence over matters such as decisions regarding mergers, consolidations and the sale of all or substantially all of our assets, election of directors and other significant corporate actions. They may take actions that are not in the best interest of us or our other shareholders. This concentration of ownership may discourage, delay or prevent a change in control of our company, which could have the effect of depriving our other shareholders of the opportunity to receive a premium for their shares as part of a sale of our company and may reduce the price of our ADSs. This concentrated control will limit your ability to influence corporate matters and could discourage others from pursuing any potential merger, takeover or other change of control transactions that holders of Class A ordinary shares and ADSs may view as beneficial. In addition, we may incur incremental compensation expenses to the holders of Class B ordinary share as a result of their becoming entitled to high votes on each Class B ordinary share.

 

The dual-class structure of our ordinary shares may adversely affect the trading market for our ADSs.

 

S&P Dow Jones and FTSE Russell have changed their eligibility criteria for inclusion of shares of public companies on certain indices, including the S&P 500, to exclude companies with multiple classes of shares and companies whose public shareholders hold no more than 5% of total voting power from being added to such indices. In addition, several shareholder advisory firms have announced their opposition to the use of multiple class structures. As a result, the dual class structure of our ordinary shares may prevent the inclusion of our ADSs representing Class A ordinary shares in such indices and may cause shareholder advisory firms to publish negative commentary about our corporate governance practices or otherwise seek to cause us to change our capital structure. Any such exclusion from indices could result in a less active trading market for our ADSs. Any actions or publications by shareholder advisory firms critical of our corporate governance practices or capital structure could also adversely affect the value of our ADSs.

 

Because we do not expect to pay dividends in the foreseeable future, you must rely on price appreciation of the ADSs for return on your investment.

 

We currently intend to retain most, if not all, of our available funds and any future earnings to fund the development and growth of our business. As a result, we do not expect to pay any cash dividends in the foreseeable future. Therefore, you should not rely on an investment in our ADSs as a source for any future dividend income.

 

Pursuant to our amended and restated memorandum and articles of association, our board of directors has complete discretion as to whether to distribute dividends. In addition, our shareholders may by ordinary resolution declare a dividend, but no dividend may exceed the amount recommended by our board of directors. In either case, all dividends are subject to certain restrictions under Cayman Islands law, namely that a Cayman Islands company may pay a dividend either out of profits or share premium account, and provided that in no circumstances may a dividend be paid if this would result in the company being unable to pay its debts as it falls due in the ordinary course of business. Even if our board of directors decides to declare and pay dividends, the timing, amount and form of future dividends, if any, will depend on, among other things, our future results of operations and cash flow, our capital requirements and surplus, the amount of distributions, if any, we receive from our PRC subsidiaries, our financial condition, contractual restrictions and other factors deemed relevant by our board of directors. Accordingly, the return on your investment in our ADSs will likely depend entirely upon any future price appreciation of our ADSs. There is no guarantee that our ADSs will appreciate in value or even maintain the price at which you purchased the ADSs. You may not realize a return on your investment in our ADSs and you may even lose your entire investment in our ADSs.

 

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The sale or availability for sale of substantial amounts of the ADSs could adversely affect their market price.

 

Sales of substantial amounts of our ADSs in the public market, or the perception that these sales could occur, could adversely affect the market price of our ADSs and could materially impair our ability to raise capital through equity offerings in the future. As of March 31, 2020, we had 345,632,784 ordinary shares outstanding, comprising of (i) 290,813,051 Class A ordinary shares (excluding treasury shares), and (ii) 54,819,733 Class B ordinary shares, assuming the completion of Share Distribution at that time. Among these shares, 35,005,761 Class A ordinary shares are in the form of ADSs, which are freely tradable without restriction or further registration under the Securities Act. The remaining Class A ordinary shares outstanding and the Class B ordinary shares may also be sold in the public market in the future subject to the restrictions in Rule 144 and Rule 701 under the Securities Act and the applicable lock-up agreements. In connection with our IPO, we, our directors and executive officers, the existing shareholders of MOLBASE Inc. and Series E-1 Warrant holder have agreed not to sell any ordinary shares or ADSs for 180 days after December 27, 2019 without the prior written consent of the representatives of underwriters, subject to certain exceptions. In addition, we have agreed to instruct the depositary not to accept any shares for deposit for the issuance of ADSs for 180 days after December 27, 2019 (other than in connection with our IPO), without prior written consent from the representatives of the underwriters. However, the underwriters may release these securities from these restrictions at any time, subject to applicable regulations of the Financial Industry Regulatory Authority, Inc. We cannot predict what effect, if any, market sales of securities held by our significant shareholders or any other shareholder or the availability of these securities for future sale will have on the market price of our ADSs.

 

The voting rights of holders of ADSs are limited by the terms of the deposit agreement, and you may not be able to exercise your right to direct the voting of the underlying ordinary shares which are represented by your ADSs.

 

Holders of ADSs do not have the same rights as our registered shareholders. As a holder of our ADSs, you will not have any direct right to attend general meetings of our shareholders or to cast any votes at such meetings. You will only be able to exercise the voting rights which are carried by the underlying Class A ordinary shares represented by your ADSs indirectly by giving, or deemed to be giving, voting instructions to the depositary in accordance with the provisions of the deposit agreement. Upon receipt of your voting instructions, the depositary will try, as far as is practicable, to vote the underlying Class A ordinary shares represented by your ADSs in accordance with your instructions. If we ask for your instructions, then upon receipt of your voting instructions, the depositary will try to vote the underlying Class A ordinary shares in accordance with these instructions. If we do not instruct the depositary to ask for your instructions, the depositary may still vote in accordance with instructions you give, but it is not required to do so. You will not be able to directly exercise your right to vote with respect to the underlying Class A ordinary shares unless you withdraw the shares and become the registered holder of such shares prior to the record date for the general meeting. When a general meeting is convened, you may not receive sufficient advance notice of the meeting to withdraw the Class A ordinary shares represented by your ADSs and become the registered holder of such shares to allow you to attend the general meeting and to vote directly with respect to any specific matter or resolution to be considered and voted upon at the general meeting.

 

In addition, under our memorandum and articles of association, for the purposes of determining those shareholders who are entitled to attend and vote at any general meeting, our directors may close our register of members and/or fix in advance a record date for such meeting, and such closure of our register of members or the setting of such a record date may prevent you from withdrawing the underlying Class A ordinary shares represented by your ADSs and becoming the registered holder of such shares prior to the record date, so that you would not be able to attend the general meeting or to vote directly. If we ask for your instructions, the depositary will notify you of the upcoming vote and will arrange to deliver our voting materials to you. We have agreed to give the depositary at least 30 days’ prior notice of shareholder meetings. Nevertheless, we cannot assure you that you will receive the voting materials in time to ensure that you can instruct the depositary to vote the underlying Class A ordinary shares represented by your ADSs. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions or for their manner of carrying out your voting instructions. This means that you may not be able to exercise your right to direct how the underlying Class A ordinary shares represented by your ADSs are voted and you may have no legal remedy if the underlying Class A ordinary shares represented by your ADSs are not voted as you requested. In addition, in your capacity as an ADS holder, you will not be able to call a shareholders’ meeting.

 

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Your right to participate in any future rights offerings may be limited, which may cause dilution to your holdings.

 

We may, from time to time, distribute rights to our shareholders, including rights to acquire securities. Under the deposit agreement, the depositary will not distribute rights to holders of ADSs unless the distribution and sale of rights and the securities to which these rights relate are either exempt from registration under the Securities Act with respect to all holders of ADSs, or are registered under the provisions of the Securities Act. The depositary may, but is not required to, attempt to sell these undistributed rights to third parties, and may allow the rights to lapse. We may be unable to establish an exemption from registration under the Securities Act, and we are under no obligation to file a registration statement with respect to these rights or underlying securities or to endeavor to have a registration statement declared effective. Accordingly, holders of ADSs may be unable to participate in our rights offerings and may experience dilution of their holdings as a result.

 

We and the depository are entitled to amend the deposit agreement and to change the rights of ADS holders under the terms of such agreement, and we may terminate the deposit agreement, without the prior consent of the ADS holders.

 

We and the depository are entitled to amend the deposit agreement and to change the rights of the ADS holders under the terms of such agreement, without the prior consent of the ADS holders. We and the depositary may agree to amend the deposit agreement in any way we decide is necessary or advantageous to us. Amendments may reflect, among other things, operational changes in the ADS program, legal developments affecting ADSs or changes in the terms of our business relationship with the depositary. In the event that the terms of an amendment are disadvantageous to ADS holders, ADS holders will only receive 30 days’ advance notice of the amendment, and no prior consent of the ADS holders is required under the deposit agreement.

 

Furthermore, we may decide to terminate the ADS facility at any time for any reason. For example, terminations may occur when we decide to list our shares on a non-U.S. securities exchange and determine not to continue to sponsor an ADS facility or when we become the subject of a takeover or a going-private transaction. If the ADS facility will terminate, ADS holders will receive at least 30 days’ prior notice, but no prior consent is required from them. Under the circumstances that we decide to make an amendment to the deposit agreement that is disadvantageous to ADS holders or terminate the deposit agreement, the ADS holders may choose to sell their ADSs or surrender their ADSs and become direct holders of the underlying Class A ordinary shares, but will have no right to any compensation whatsoever.

 

ADSs holders may not be entitled to a jury trial with respect to claims arising under the deposit agreement, which could result in less favorable outcomes to the plaintiff(s) in any such action.

 

The deposit agreement governing the ADSs representing our Class A ordinary shares provides that, subject to the depositary’s right to require a claim to be submitted to arbitration in New York or Hong Kong, to the fullest extent permitted by applicable law, ADS holders irrevocably waive the right to a jury trial of any claim that they may have against us or the depositary arising out of or relating to our ordinary shares, the ADSs or the deposit agreement, including any claim under the U.S. federal securities laws.

 

If we or the depositary opposed a jury trial demand based on the waiver, the court would determine whether the waiver was enforceable based on the facts and circumstances of that case in accordance with the applicable state and federal law. To our knowledge, the enforceability of a contractual pre-dispute jury trial waiver in connection with claims arising under the federal securities laws has not been finally adjudicated by the United States Supreme Court. However, we believe that a contractual pre-dispute jury trial waiver provision is generally enforceable, including under the laws of the State of New York, which govern the deposit agreement, by a federal or state court in the City of New York, which has non-exclusive jurisdiction over matters arising under the deposit agreement. In determining whether to enforce a contractual pre-dispute jury trial waiver provision, courts will generally consider whether a party knowingly, intelligently and voluntarily waived the right to a jury trial. We believe that this is the case with respect to the deposit agreement and the ADSs. It is advisable that you consult legal counsel regarding the jury waiver provision before entering into the deposit agreement.

 

If you or any other holders or beneficial owners of ADSs bring a claim against us or the depositary in connection with matters arising under the deposit agreement or the ADSs, including claims under federal securities laws, you or such other holder or beneficial owner may not be entitled to a jury trial with respect to such claims, which may have the effect of limiting and discouraging lawsuits against us or the depositary. If a lawsuit is brought against us or the depositary under the deposit agreement, it may be heard only by a judge or justice of the applicable trial court, which would be conducted according to different civil procedures and may result in different outcomes than a trial by jury would have had, including results that could be less favorable to the plaintiff(s) in any such action.

 

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Nevertheless, if this jury trial waiver provision is not permitted by applicable law, an action could proceed under the terms of the deposit agreement with a jury trial. No condition, stipulation or provision of the deposit agreement or ADSs serves as a waiver by any holder or beneficial owner of ADSs or by us or the depositary of compliance with any substantive provision of the U.S. federal securities laws and the rules and regulations promulgated thereunder.

 

You may be subject to limitations on transfer of your ADSs.

 

Your ADSs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from time to time when it deems expedient in connection with the performance of its duties. The depositary may close its books from time to time for a number of reasons, including in connection with corporate events such as a rights offering, during which time the depositary needs to maintain an exact number of ADS holders on its books for a specified period. The depositary may also close its books in emergencies, and on weekends and public holidays. In addition, the depositary may refuse to deliver, transfer or register transfers of ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary deems it advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.

 

If securities or industry analysts do not publish research or publishes inaccurate or unfavorable research about our business, or if they adversely change their recommendations regarding the ADSs, the market price of our ADSs and trading volume could be affected.

 

The trading market for the ADSs will be influenced by research or reports that industry or securities analysts publish about our business. If one or more analysts who cover us downgrade the ADSs, the market price for the ADSs would likely decline. If one or more of these analysts cease to cover us or fail to regularly publish reports on us, we could lose visibility in the financial markets, which, in turn, could cause the market price or trading volume for the ADSs to decline.

 

We may need additional capital and may sell additional ADSs or other equity securities or incur indebtedness, which could result in additional dilution to our shareholders or increase our debt service obligations.

 

We may require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If our cash resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity securities or equity-linked debt securities could result in additional dilution to our shareholders. The incurrence of indebtedness would result in debt service obligations and could result in operating and financing covenants that would restrict our operations. We cannot assure you that financing will be available in amounts or terms acceptable to us, if at all.

 

You may not receive dividends or other distributions on our ordinary shares and you may not receive any value for them, if it is illegal or impractical to make them available to you.

 

The depositary of the ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian receives on ordinary shares or other deposited securities underlying the ADSs, after deducting its fees and expenses. You will receive these distributions in proportion to the number of Class A ordinary shares your ADSs represent. However, the depositary is not responsible if it decides that it is unlawful or impractical to make a distribution available to any holders of ADSs. For example, it would be unlawful to make a distribution to a holder of ADSs if it consists of securities that require registration under the Securities Act of 1933 but that are not properly registered or distributed under an applicable exemption from registration. The depositary may also determine that it is not feasible to distribute certain property through the mail. Additionally, the value of certain distributions may be less than the cost of mailing them. In these cases, the depositary may determine not to distribute such property. We have no obligation to register under U.S. securities laws any ADSs, ordinary shares, rights or other securities received through such distributions. We also have no obligation to take any other action to permit the distribution of ADSs, ordinary shares, rights or anything else to holders of ADSs. This means that you may not receive distributions we make on our ordinary shares or any value for them if it is illegal or impractical for us to make them available to you. These restrictions may cause a material decline in the value of the ADSs.

 

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Certain judgments obtained against us by our shareholders may not be enforceable.

 

We are a Cayman Islands exempted company and substantially all of our assets are located outside of the United States. Our current operations are mainly conducted in China. In addition, A majority of our current directors and officers are nationals and residents of countries other than the United States. A majority of the assets of these persons are located outside the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the United States in the event that you believe that your rights have been infringed under the U.S. federal securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands and of China may render you unable to enforce a judgment against our assets or the assets of our directors and officers.

 

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.

 

We are an exempted company limited by shares incorporated under the laws of the Cayman Islands. Our corporate affairs are governed by our memorandum and articles of association, the Companies Law (2020 Revision) of the Cayman Islands and the common law of the Cayman Islands. The rights of shareholders to take action against the directors, actions by minority shareholders and the fiduciary duties owed to us by our directors under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from the common law of England, the decisions of whose courts are of persuasive authority, but are not binding, on a court in the Cayman Islands. The rights of our shareholders and the fiduciary duties owed to us by our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedent in some jurisdictions in the United States. In particular, the Cayman Islands has a less developed body of securities laws than 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 or to obtain copies of lists of shareholders of these companies. Our directors have discretion under our post-offering memorandum and 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 our shareholders to obtain the information needed to establish any facts necessary for them to motion or to solicit proxies from other shareholders in connection with a proxy contest.

 

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 our board of directors or controlling shareholders than they would as public shareholders of a company incorporated in the United States.

 

Our memorandum and articles of association contain anti-takeover provisions that could discourage a third party from acquiring us and adversely affect the rights of holders of our ordinary shares and the ADSs.

 

Our current memorandum and articles of association contain certain provisions that could limit the ability of others to acquire control of our company, including a provision that grants authority to our board of directors to establish and issue from time to time one or more series of preferred shares without action by our shareholders and to determine, with respect to any series of preferred shares, the terms and rights of that series. These provisions could have the effect of depriving our shareholders and holders of the ADSs of the opportunity to sell their shares or ADSs at a premium over the prevailing market price by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transactions.

 

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As an exempted company incorporated in the Cayman Islands, we are permitted to adopt certain home country practices in relation to corporate governance matters that differ significantly from the Nasdaq Stock Market corporate governance listing standards; these practices may afford less protection to shareholders than they would enjoy if we complied fully with the Nasdaq Stock Market corporate governance listing standards.

 

As a Cayman Islands exempted company listed on the Nasdaq Stock Market, we are subject to the Nasdaq Stock Market corporate governance listing standards. However, Nasdaq Stock Market rules permit a foreign private issuer like us to follow the corporate governance practices of its home country. Certain corporate governance practices in the Cayman Islands, which is our home country, may differ significantly from the Nasdaq Stock Market corporate governance listing standards. Currently we are not relying on the home country exemption for corporate governance matters, but we may rely on the exemption in the future. If we choose to follow home country practice in the future, our shareholders may be afforded less protection than they would otherwise enjoy under the Nasdaq Stock Market governance listing standards applicable to U.S. domestic issuers.

 

We are a foreign private issuer within the meaning of the rules under the Exchange Act, and as such we are exempt from certain provisions applicable to United States domestic public companies.

 

Because we are 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: (i) the rules under the Exchange Act requiring the filing of quarterly reports on Form 10-Q or current reports on Form 8-K with the SEC; (ii) the sections of the Exchange Act regulating the solicitation of proxies, consents, or authorizations in respect of a security registered under the Exchange Act; (iii) the sections of the Exchange Act requiring insiders to file public reports of their stock ownership and trading activities and liability for insiders who profit from trades made in a short period of time; and (iv) the selective disclosure rules by issuers of material nonpublic information under Regulation FD.

 

We are required to file an annual report on Form 20-F within four months of the end of each fiscal year. In addition, we publish our results on a quarterly basis through press releases, distributed pursuant to the rules and regulations of Nasdaq Stock Market LLC. Press releases relating to financial results and material events are also furnished to the SEC on Form 6-K. However, the information we are required to file with or furnish to the SEC is 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, which would be made available to you, were you investing in a U.S. domestic issuer.

 

There can be no assurance that we will not be a passive foreign investment company, or PFIC, for U.S. federal income tax purposes for any taxable year, which could result in adverse U.S. federal income tax consequences to U.S. investors of our ADSs or ordinary shares.

 

A non-U.S. corporation will be a passive foreign investment company, or PFIC, for any taxable year if either (1) at least 75% of its gross income for such year consists of certain types of “passive” income; or (2) at least 50% of the value of its assets (generally based on an average of the quarterly values of the assets) during such year is attributable to assets that produce passive income or are held for the production of passive income. Although the law in this regard is unclear, we intend to treat our VIEs (and their subsidiaries) as being owned by us for United States federal income tax purposes, not only because we exercise effective control over the operations of such entities but also because we are entitled to substantially all of their economic benefits, and, as a result, we consolidate their results of operations in our consolidated financial statements. Assuming that we are the owner of our VIEs (and their subsidiaries) for United States federal income tax purposes, and based upon our current and expected income and assets and the market price of the ADSs, we do not believe we were a PFIC for the taxable year ended December 31, 2019 and we do not presently expect to be a PFIC for the current taxable year or the foreseeable future.

 

While we do not expect to be or become a PFIC, because the value of our assets for purposes of the asset test may be determined by reference to the market price of the ADSs, fluctuations in the market price of the ADSs may cause us to become a PFIC for the current or subsequent taxable years. If we determine not to deploy significant amounts of cash for active purposes or if it were determined that we do not own the stock of our VIEs for United States federal income tax purposes, our risk of becoming a PFIC may substantially increase. Because PFIC status is a factual determination made annually after the close of each taxable year, there can be no assurance that we will not be a PFIC for the current taxable year or any future taxable year.

 

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If we were to be or become a PFIC for any taxable year during which a U.S. investor holds our ADSs or ordinary shares, certain adverse U.S. federal income tax consequences could apply to such U.S. investor. See “Item 10. Additional Information—E. Taxation—United States Federal Income Tax Considerations—Passive Foreign Investment Company Rules.”

 

We will incur increased costs as a result of being a public company.

 

We are a public company and incur significant legal, accounting and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the SEC and the Nasdaq Stock Market, impose various requirements on the corporate governance practices of public companies, including Section 404 of the Sarbanes-Oxley Act of 2002 relating to internal control over financial reporting.

 

We expect these rules and regulations to increase our legal and financial compliance costs and to make some corporate activities more time-consuming and costly. For example, as a result of being a public company, we need to increase the number of independent directors and adopt policies regarding internal controls and disclosure controls and procedures. We also expect that operating as a public company will make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. In addition, we will incur additional costs associated with our public company reporting requirements. It may also be more difficult for us to find qualified persons to serve on our board of directors or as executive officers. We are currently evaluating and monitoring developments with respect to these rules and regulations, and we cannot predict or estimate with any degree of certainty the amount of additional costs we may incur or the timing of such costs.

 

ITEM 4. INFORMATION ON THE COMPANY

 

A.                                    History and Development of the Company

 

We commenced our operations in 2013, when Jiaxing MOLBASE Information Technology Co., Ltd. was established in preparation for the launch of our Online Platform.

 

MOLBASE Inc. was established in February 2014 as the offshore holding company for our business. MOLBASE Inc. established MOLBASE (HK) Limited in February 2014 as its intermediary holding company. MOLBASE (HK) Limited subsequently established MOLBASE (Shanghai) Biotechnology Co., Ltd., or Shanghai Biotech, a wholly owned subsidiary in China, in May 2014.

 

We established following entities in China to operate our PRC business:

 

·                  In March 2013, we established Jiaxing MOLBASE Information Technology Co., Ltd., or Jiaxing MOLBASE, to operate chemical e-commerce business, financial solutions, and logistics solutions.

 

·                  In January 2014, we established Shanghai MOLBASE Technology Co., Ltd., or Shanghai MOLBASE, to manage our knowledge engine and business intelligence services, and operate our websites.

 

·                  In August 2017, Shanghai Biotech established Shaanxi MOLBASE Biotechnology Co., Ltd., or Shaanxi MOLBASE, a wholly owned subsidiary of Shanghai Biotech, to operate hazardous chemicals transaction business.

 

MOLBASE Inc. obtained control and became the primary beneficiary of Jiaxing MOLBASE and Shanghai MOLBASE through our WFOE’s entering into a series of contractual arrangements with Jiaxing MOLBASE, Shanghai MOLBASE and their shareholders. Due to the PRC legal restrictions on foreign ownership of internet-based businesses, MOLBASE Inc. has relied on these contractual arrangements to conduct its internet-based operations in China.

 

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We refer to MOLBASE Inc., MOLBASE (HK) Limited and its subsidiaries, and VIEs, excluding Molecular Data Inc. and its subsidiaries, in this annual report as the MOLBASE group.

 

We have been operating our business through the MOLBASE group since 2013. Through the MOLBASE group, we launched our knowledge engine in September 2013, and developed our comprehensive knowledge engine and business intelligence services therefrom. We subsequently started operating our chemical e-commerce business in March 2014, and we started offering warehousing and logistics solutions as a supplement to our chemical e-commerce business. In 2014, we started offering financial solutions.

 

In addition to our business, the MOLBASE group started operating commercial factoring business and investment in chemical industry, or Separate Business, through MOXIN Commercial Factoring (Shenzhen) Co., Ltd., MOLBASE (Tianjin) Biotechnology Co., Ltd. and Hele (Tianjin) Investment Management Co., Ltd.. After the Restructuring is completed, the MOLBASE group will keep operating the Separate Business as a supplement to our business.

 

We undertook a corporate restructuring in 2018, as referred to as “Restructuring” in this annual report, in order to operate our Online Platform as a standalone business and thus enhance our brand image as an independent open platform and attract more chemical industry participants to our platform.

 

On February 28, 2018, MOLBASE Inc. established a wholly owned subsidiary, Molecular Data Inc., in the Cayman Islands in anticipation of the offering. On March 14, 2018, Molecular Data Inc. established a wholly owned subsidiary, Molecular Data (HK) Limited, or Molecular Data HK, in Hong Kong. Shanghai MOHUA Information Technology Co., Ltd., or our WFOE, was established on July 27, 2018 as a wholly owned PRC subsidiary of Molecular Data HK. On October 14, 2018, Shanghai MOLBASE acquired 100% equity interest in Shaanxi MOLBASE. On December 21, 2018, we terminated the previous series of contractual arrangements between Shanghai Biotech and Jiaxing MOLBASE and its shareholders as well as the contractual arrangements between Shanghai Biotech and Shanghai MOLBASE and its shareholders. Immediately after termination of such VIE agreements, our WFOE entered into a series of contractual arrangements with Jiaxing MOLBASE, Shanghai MOLBASE and their shareholders. As a result of these contractual arrangements, we are currently the primary beneficiary of Jiaxing MOLBASE and Shanghai MOLBASE, and we accordingly treat them as our VIEs under U.S. GAAP. We consolidate the financial results of Jiaxing MOLBASE, Shanghai MOLBASE and their subsidiary in our consolidated financial statements in accordance with U.S. GAAP.

 

We entered into a series of business and assets transfer agreements on December 21, 2018 with the MOLBASE group, pursuant to which the MOLBASE group transferred all operating assets and liabilities relating to our business to us. We are liable to pay consideration to MOLBASE group for assets and liabilities that it incurred for the development of our business. This liability was presented as amount due to MOLBASE (Shanghai) Biotechnology Co., Ltd. in our consolidated balance sheets. Any actual funding provided by the MOLBASE group for our business before or during the Restructuring in excess of this consideration amount will be settled by the MOLBASE group and deemed as a contribution to us.

 

As a result of the foregoing, Molecular Data Inc. has become our holding company in the Cayman Islands, and it is wholly owned by MOLBASE Inc. For as long as MOLBASE Inc. remains our parent company, we will be a “controlled company” as defined under the Nasdaq Stock Market Rules because MOLBASE Inc. held 89.9% of our outstanding ordinary shares as of March 31, 2020. We completed the Share Distribution, effective June 30, 2020. The existing shareholders of MOLBASE Inc. became our shareholders through a distribution of our shares in proportion to MOLBASE Inc.’s then shareholding structure, and MOLBASE Inc. ceased to be our parent company. However, we are still a "controlled company" as defined under the Nasdaq Stock Market Rules after the Share Distribution because Dr. Dongliang Chang beneficially owned approximately 15.9% equity interests or 65.3% voting power of our total issued and outstanding share capital as of March 31, 2020, assuming the completion of the Share Distribution at that time. A wholly owned subsidiary of Molecular Data Inc., Molecular Data HK, is our intermediary holding company in Hong Kong. Shanghai MOHUA is a wholly owned subsidiary of Molecular Data HK. Shanghai MOKAI and Shanghai MOCHUANG are wholly owned subsidiaries of Shanghai MOHUA. After the Restructuring, we expect to rely on the operations of Shanghai MOKAI and Shanghai MOCHUANG, and our contractual arrangements with Jiaxing MOLBASE, Shanghai MOLBASE (including its wholly owned subsidiary, Shaanxi MOLBASE) and their shareholders, to conduct all of our operations in China.

 

Due to the PRC legal restrictions on foreign ownership of internet-based businesses, we conduct all of our internet-based operations in China through our VIEs and their subsidiary after the Restructuring. We have entered into a series of contractual arrangements, including exclusive option agreements, equity pledge agreements, shareholders’ voting rights proxy agreements and exclusive technical support and services agreements, with our VIEs and their shareholders.

 

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These contractual arrangements allow us to exercise effective control over our VIEs, receive substantially all of the economic benefits of VIEs, and have an exclusive option to purchase all or part of the equity interests in VIEs when and to the extent permitted by PRC law. As a result of these contractual arrangements, we are the primary beneficiary of our VIEs, and we accordingly treat them as our VIEs under U.S. GAAP. We consolidate the financial results of our VIEs and their subsidiaries in our consolidated financial statements in accordance with U.S. GAAP.

 

Shanghai MOLBASE, Jiaxing MOLBASE and their shareholders have all entered into a series of contractual arrangements with our WFOE, and the terms and conditions of the two sets of agreements are substantially identical.

 

On December 30, 2019, the ADSs representing our Class A ordinary shares commenced trading on Nasdaq under the symbol “MKD.” We raised from our initial public offering US$55.4 million in net proceeds after deducting underwriting commissions and discounts and the offering expenses payable by us.

 

Our principal executive offices are located at 5/F, Building 12, 1001 North Qinzhou Road, Xuhui District, Shanghai 201109, People’s Republic of China. Our telephone number at this address is +86 21-5436-5166. Our registered office in the Cayman Islands is located at Maples Corporate Services Limited, PO Box 309, Ugland House, Grand Cayman, KY1-1104, Cayman Islands. Our agent for service of process in the United States is Cogency Global Inc., located at 122 East 42nd Street, 18th Floor, New York, NY 10168. Our main websites are www.molbase.cn and www.molbase.com.

 

B.                                    Business Overview

 

Overview

 

We are a technology-driven platform in China’s chemical industry, connecting participants along the chemical value chain through our integrated solutions. Built upon our core knowledge engine and supported by our artificial intelligence (AI) engine and software-as-a-service (SaaS) suite, we offer e-commerce solutions, financial solutions, and warehousing and logistics solutions to all participants across the chemical value chain. Our e-commerce solutions are mainly delivered through our online platform, consisting of our two websites, molbase.com and molbase.cn, Moku Data Weixin account, Chemical Community App and other ancillary platforms, or, collectively, our Online Platform.

 

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The following chart summarizes the key participants in our ecosystem and the interactions among them:

 

GRAPHIC

 

Our knowledge engine. Our business is built upon our chemicals knowledge engine, which serves as the fundamental infrastructure for our comprehensive services and solutions. We have accumulated chemicals and transaction data to build MOLBASE Encyclopedia. As the entry point of our Online Platform, users may search for chemicals based on molecular structures. We subsequently provide search results covering the synthetic routes of the searched chemicals, along with pricing and supplier information.

 

Our technology services. Leveraging our MOLBASE Encyclopedia knowledge engine and deep understanding on how to transform the traditional chemical value chain, we provide our suppliers and customers with information services empowered by our AI engine, which primarily consist of intelligent matching systems and MOLBASE Intelligent Chemical Industry Maps, as well as a comprehensive SaaS suite.

 

·                  AI engine: our intelligent matching systems recommend information on chemicals to our customers, and match orders among suppliers and customers by identifying chemicals on the synthetic routes and structurally similar chemicals. Built upon the transaction data accumulated on our platform, our MOLBASE Intelligent Chemical Industry Maps provide visualizations of the industry participants for particular chemicals and their relationships, allowing suppliers and customers to locate each other efficiently.

 

·                  SaaS suite: we have developed a SaaS suite enabling suppliers and customers to optimize and digitalize their business operations. Our SaaS suite includes online store maintenance, orders and client relationship management, online payment solutions, instant messages, and promotional and marketing services.

 

Our e-commerce solutions. We offer our chemical e-commerce solutions through direct sales and marketplace models. Our direct sales model involves acquiring chemicals from suppliers at customers’ requests in most cases and selling them directly to customers, generating revenues from the sale of chemicals. In our marketplace model, we connect suppliers and customers and currently charge commissions on only a small portion of transactions in order to attract and encourage users to transact on our platform.

 

Our financial solutions. We cooperate with banks and other non-bank financial institutions to introduce low-cost financing opportunities for chemical industry participants. We may provide guarantees for selected users requesting financial solutions, based on our review of their historical performance, credit records, and transaction history on our platform.

 

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Our warehousing and logistics solutions. We have developed warehousing and logistics solutions to facilitate order fulfillment on our Online Platform. Our platform enables suppliers and customers to find warehousing and logistics service providers and track the location and status of their goods.

 

Knowledge Engine and Business Intelligence

 

Leveraging the knowledge and data we possess on chemicals and transactions, we have developed our MOLBASE Encyclopedia knowledge engine and provide our users with business intelligence and capabilities. Supported and maintained by our research and development team, MOLBASE Encyclopedia is offered on our Online Platform. Our knowledge engine is the entry point for our Online Platform, and also serves as a fundamental data infrastructure and driving force in connecting various participants of the chemical industry within our ecosystem.

 

Enabled by our knowledge engine, we provide chemical business intelligence to our users through our MOLBASE Industry Trend Reports and the Mol’s Vision industry journal. With the help of MOLBASE Encyclopedia, we compile, aggregate and analyze our sales data to discover purchase. With our customer base and transactions conducted via our Online Platform, we are able to extract raw data, conduct analysis, and publish results in Industry Trend Reports and Mol’s Vision.

 

·                  Industry Trend Reports. Hosted on our Online Platform, our reports cover analysis on chemicals and various business subsectors in the chemical field targeting all participants in the chemical industry. In addition, we present industry-related news weekly and monthly, and provide predictions of products’ price changes.

 

·                  Mol’s Vision. This is our professional journal on chemistry, chemical engineering, and biological chemistry that is viewable on both PCs and smart phones, targeting all participants in the chemical industry.

 

We also connect with other companies in the chemical industry by integrating our knowledge and data intelligence systems with their own infrastructure and backend systems. Such integrations will enable these companies to get access to the information on MOLBASE Encyclopedia and MOLBASE Intelligent Chemical Industry Maps and achieve data synchronization. They can also customize their own data and business intelligence systems based on our underlying infrastructure. We charge such companies service fees.

 

AI Engine and SaaS Suite

 

AI Engine

 

Leveraging our MOLBASE Encyclopedia knowledge engine, we have developed our AI engine which collects and connects data along the chemical value chain and matches demand and supply. This in turn enables us to deliver our intelligent matching system and MOLBASE Intelligent Chemical Industry Maps, as well as our SaaS suite.

 

Our intelligent matching system facilitates matchings between potential customers and suppliers and directs the associated demand and supply among the chemicals e-commerce value chain and related ancillary services. Our intelligent matching system is integrated into our websites and Moku Data.

 

We launched MOLBASE Intelligent Chemical Industry Maps on both our website and mobile end in January 2019. Each MOLBASE Intelligent Chemical Industry Map presents a structured and searchable visual of chemical-specific supplier network and allows customers and suppliers to locate each other.

 

SaaS Suite

 

In addition to our AI engine, we have developed our SaaS suite for our Online Platform users with access to various functions, including online store maintenance, orders and client relationship management, accounting tools, instant messenger, advertising and marketing services and logistics and warehousing facilitation. We design and offer multiple SaaS suite packages on a subscription basis for companies of different sizes and we charge membership fees accordingly. The majority of our SaaS suite users are small-to-medium sized chemicals companies.

 

We also partner with reputable and large-scale brands in the chemical industry to enable them to open their flagship stores on our Online Platform. For all flagship stores, customers place orders on our Online Platform, and suppliers deliver chemicals directly to customers. We do not take inventory, nor do we bear any inventory risk. We charge a one-time management fee plus commission for each order completed through flagship stores.

 

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Moreover, we are continuously exploring partnership opportunities with large chemicals companies. We have managed to connect the internal databases and inventory management systems of several large chemicals companies with our platform through our SaaS suite, so that their internal demand and supply records can be synchronized to our Online Platform.

 

We launched our operations optimization services in June 2019. These services are designed to empower other companies in the chemical industry to manage and gain access to specific industry updates and price fluctuation trends, analyze market movements, and provide market rankings based on certain filters. We have developed a suite of solutions based on our knowledge engine and AI engine to help traditional offline chemical companies to digitalize certain aspects of their business operations. Our operations optimization services are scenario-based and are designed to address the operating needs and demands for various chemical companies. These services are delivered as a standalone SaaS package through customized systems, apps, or mini programs and can work with existing infrastructure. We currently charge development and consulting fees for our operations optimization services.

 

Our Online Platform and E-commerce Solutions

 

Our Online Platform empowers us to conduct our core e-commerce business, primarily proving our e-commerce solutions. Our Online Platform primarily consists of the following components:

 

Our Websites

 

We offer our chemical e-commerce solutions through two websites, molbase.cn that targets domestic customers, and molbase.com that focuses on international customers. Our websites offer a broad selection of chemicals and easy navigation, containing the following information and features:

 

·                  Finding products: Customers can get access to the products they intend to purchase by clicking on the “Finding Products” button on the home page and entering either the CAS number or the name of a compound as keywords. The suppliers of such products appear in a list, with associated information on the location of the supplier, product purity, quantity, specification, delivery period, and price. After locating certain products, customers can opt to obtain quotations from particular suppliers, or to purchase such products directly in MOLBASE Online Mall, if available.

 

·                  Placing orders: For products available on MOLBASE Online Mall, customers can submit their orders directly on molbase.cn.

 

·                  Payment: Our customers can pay via the following methods: Weixin Payment, Alipay, Paypal, credit cards, banks’ online payment, and Mo Yi Fu.

 

·                  Delivery: Our customers can select logistics services when they place and check out orders on MOLBASE Online Mall under the direct sales model or by using our Chemical Community App.

 

·                  Data services: Users of molbase.cn can search in the MOLBASE Encyclopedia section, and view Industry Trend Reports and Mol’s Vision from links on our home page.

 

·                  Customer service: At any time during business hours, our customers may contact customer service by means of online chat and telephone for assistance with all aspects of the transaction.

 

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Direct Sales

 

Direct Sales via MOLBASE Online Mall

 

We post and sell chemicals in our MOLBASE Online Mall directly to our customers, including, among others, biochemical and pharmaceutical chemicals, agrochemicals, dyes and pigments, household chemicals, commodity chemicals, natural products and extracts, and paints and coatings.

 

We provide access to MOLBASE Online Mall from both PCs and mobile devices. In MOLBASE Online Mall, customers can search for chemicals using chemicals names, CAS numbers, molecular formulas or molecular structures of chemicals, and find products with price, specification and logistics information. Once customers find chemicals they intend to purchase, they can place orders directly in MOLBASE Online Mall, choose among various payment and logistics methods, and provide their shipping address and invoice information.

 

For a substantial majority of transactions on MOLBASE Online Mall, we generally purchase chemicals from the suppliers after we receive and confirm orders from customers. Under this model, the requested chemicals are transported directly from the suppliers’ warehouses to customer-specified locations. The whole transaction process takes from a few hours to a few days.

 

For the rest of transactions that take place on MOLBASE Online Mall, we purchase chemicals from the suppliers, hold the inventory in our warehouses, and hire third-party logistics service providers to deliver the chemicals to customers from our warehouses once the customers place their orders. We accommodate for such transactions primarily for repeat customers with relatively stable and predictable demand of large quantity orders based on our transaction data, and includes but is not limited to, the types and quantities of chemicals purchased routinely.

 

Direct Sales via Intelligent Matching

 

Complementary to MOLBASE Online Mall, we also sell chemicals directly to customers through our intelligent matching system on molbase.cn. Empowered by AI technology, we have developed an intelligent matching system accessible on molbase.cn through which we can connect suppliers and customers. After we receive the customers’ posts of their purchase needs, we look for the most suitable supplier in our supplier base via our intelligent matching system. When a customer places an order, we purchase chemicals from a suitable supplier, and then arrange delivery from the supplier to the customer.

 

Direct sales via intelligent matching systems are typically for transactions involving basic chemicals with frequent pricing changes. For direct sales conducted via our intelligent matching systems, we generally do not hold inventory for each particular order.

 

Marketplace on molbase.cn

 

Suppliers can establish online stores to directly post and sell chemicals through the marketplace on molbase.cn, after passing our certifications review process. Suppliers can upload their chemicals catalogues to the website and showcase product information, including chemicals name, CAS number, purity, catalog number, region, stock, and package information. Suppliers can also set geographical restrictions, limit purchases to registered website customers, or put restraints on product specifications for certain customers. Customers can search for chemicals through the “Finding Products” link on molbase.cn, and the website will present a list of suppliers that sell such chemicals. Customers can then contact suppliers directly for specific quotations and place orders.

 

For the three years ended December 31, 2019, we collected commission from a portion of suppliers and customers for transactions completed through our marketplace on molbase.cn.

 

Our Mobile Platforms

 

We developed Moku Data, Chemical Community App, MOLBASE Weixin subscription account, and our Weixin mini program as part of our mobile platform offerings.

 

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Marketplace on Moku Data

 

We launched Moku Data in January 2018. Moku Data is the mobile platform embedded in Weixin where customers and suppliers are linked together through our intelligent matching system. On Moku Data, we present chemicals pricing information and provide a marketplace for our suppliers and customers to complete chemicals transactions using our intelligent matching system. Based on the price ranges, suppliers post their supply availability of particular chemicals with the chemicals name, asking price, quantity, and brand information. At the same time, customers post their purchase requests with name of chemicals being sought, asking price, quantity, and brand preferences. Through monitoring posts from suppliers and customers, the system runs an algorithm and automatically generates recommendations for proper “matches” between suppliers and customers based on the chemicals of interest, intended purchase price, and geographical regions. The matched supplier and customer are further invited by our customer service personnel to form a Weixin chat group and allows the two parties to directly negotiate the details of the transaction.

 

We initially did not charge any fees to users of Moku Data. Instead, we selectively charged certain commissions for orders completed through Moku Data. However, we may charge suppliers a service fee for using our intelligent matching service, and furthermore, a portion of payment as commission for each order completed through our intelligent matching services on Moku Data in the future.

 

Chemical Community App

 

We launched our Chemical Community App in November 2017. Chemical Community App combines chemicals transaction, information posting, and social functionality. The design of our Chemical Community App is based on our underlying knowledge engine, user generated content, behavioral data, and the multi-dimensional relationship between suppliers and customers.

 

Users of our Chemical Community App are required to use their real name, employer’s name, job title, and specific sector within the chemical industry to register themselves on the app. Upon registration, users receive recommendations for professional networks that are generated based on their locations and business sectors they work in. Furthermore, in the “Activities” tab, users can post their recent professional updates, purchase requests, delivery requests, and chemicals supply information with supporting text and graphics, and view other users’ posts as well. Chemical Community App offers functionality related to online chemical e-commerce, similar to molbase.cn. MOLBASE Encyclopedia and Mol’s Vision are available in the “Discovery” tab of the app.

 

Chemical Community App supports our internal operations and ground marketing activities. These internal features cover client management, chemicals price search, company search, chemicals supply and demand management, logistics tracking, and payment records management. Authorized employees can also browse information related to customers’ and suppliers’ financial solutions information, such as the approval status, credit assessment, interest rate, contact person, and loan term.

 

Chemical Business Secretary

 

We launched our Chemical Business Secretary mini program based on the Weixin infrastructure in 2018. Users of our Chemical Business Secretary mini program can search for product information, post purchase requests, and place orders directly on the Chemical Business Secretary mini program. We initiated the new membership version in June 2019 and charge our mini program users membership fees.

 

Financial Solutions

 

We started providing our financial solutions in 2014. We negotiate with financing providers, including banks and non-bank financial institutions, on financing options for our customers and suppliers. In providing these financial solutions, we serve as the information intermediary between customers or suppliers and financing providers. We separately charge for our financial solutions starting from July 2019.

 

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We are parties to multiple agreements with banks or non-bank financial institutions that provide financing support to our customers and suppliers. Pursuant to those agreements, we recommend qualified customers who meet the standards determined by those financing providers and are in need of financial support. The financing providers run their independent credit assessment process and have the sole discretion on whether to approve the financing requests from those qualified customers. The financing providers may set an upper limit for aggregate facility amount and amount for each draw-down, and such loan shall only be used for transactions on our Online Platform. We provide guarantees for the loans and a predetermined deposit is deposited by us per the request of the financing providers. From late July 2019, we started to request our new customers to provide deposit to us to cover our guarantee obligation. The financing providers have the right to terminate the agreements with us in the event that certain credit risk metrics and/or operating metrics reach predetermined thresholds.

 

Upon receiving online financing requests from our customers or suppliers, our customer service personnel would contact such customers or suppliers who made the requests, introduce our products that are available to them, and help them choose the most suitable products. For certain financing products, we provide our customers or suppliers with guarantees that we will pay a specified amount of the loans if they become overdue to our customers’ or suppliers’ financing providers.

 

As part of our financial solutions, we cooperate with banks to develop our online payment platform. When placing orders, customers can choose from various payment methods, including an online direct payment channel that banks specifically customize for us. We use a secure infrastructure, encrypt communications between financial institutions and our platform, and require signature verification. In addition, we compile logs for user actions and transaction data for backtracking purposes.

 

We have developed a credit assessment model and a risk-management system. For those customers or suppliers who apply for financing, we require proof of their ongoing business, such as business certificates and licenses, and we conduct online investigations regarding their credit records. In addition, we prioritize customers and suppliers who previously had transaction history on our Online Platform and hold clean transaction records when assessing their credit records. Moreover, we pay close attention to the repayment schedule of customers and suppliers and arrange for our employees to remind them several days before each repayment date. As a result of these efforts above, as of December 31, 2019, substantially all of our customers and suppliers fulfilled their obligations under relevant agreements, and the number of customers and suppliers who breached their obligations has been decreasing due to our rigorous risk management system.

 

Warehousing and Logistics Solutions

 

We provide facilitation services and access to warehousing and logistics solutions to our customers that purchase chemicals under both our direct sales model and marketplace model.

 

For warehousing solutions, as of December 31, 2019, we had leased warehouses in cities across China, including Shanghai, Tianjin, Guangzhou, Chengdu, Qingdao, Zibo, Zhenjiang, Changzhou, Xiamen and Zhengzhou, to hold inventory under the direct sales model. We launched our Chemicals Cloud Warehousing Project that operates on our Online Platform and is dedicated to providing warehousing services. We match customers’ and suppliers’ orders with licensed and qualified warehousing service providers in their vicinity and have available warehouse capacity to hold the chemicals.

 

For our logistics solutions, we arrange third-party logistics service providers to deliver products sold on MOLBASE Online Mall under our direct sales model. We select logistics service providers based on a set of criteria, including qualifications, cost, reputation, equipment, processing capability and location. We have entered into long-term framework agreements with logistics services providers that we have selected to serve our customers. Although the durations of our agreements vary, our agreements with logistics service providers typically include the material terms of price, freight risk, payments, and insurance. After purchasing chemicals from the MOLBASE Online Mall, customers can make a request to us for logistics solutions, after which we would engage a third-party logistics service provider to fulfill product delivery. From the customers’ perspective, they only need to place a request for logistics solutions during check-out and will be provided with a proposed scope of work and price quotes based on our available resources.

 

To engage more logistics service providers and match parties who need logistics solutions with the logistics service providers, we launched our Chemicals Transportation Community Project in November 2017. This project relies on Chemicals Transporters website and Chemicals Transporters App. Chemicals Transporters website provides an open platform to match suppliers with third-party logistics service providers, including those who do not necessarily operate under existing logistics service agreements with us. When a supplier needs logistics service, it posts a delivery request either on the Chemicals Transporters website or the Chemicals Transporters App, and our system generates recommendations and displays contact information of available delivery service providers directly to the supplier. Logistics services providers use Chemicals Transportation for Drivers App to receive order information, take orders, and complete orders upon delivery. Logistics tracking information will be collected via the Chemicals Transportation for Drivers App and uploaded and provided to our customers and suppliers.

 

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Our Customers

 

Our Online Platform has been able to scale quickly after accumulating a sizable customer base. We provide high-quality services to encourage repeat purchases by our customers. We take measures to retain our customers, including attractive price points and promotional activities, financial solutions, smart deliveries, data analysis, and market reports.

 

Compelling Transaction Experience

 

We believe that providing compelling transaction experience is critical to attracting new customers and retaining existing users in our ecosystem. We have moved away from the traditional inefficient and opaque chemical e-commerce model, and we are capable of facilitating transactions and serving all participants in the chemical industry. We provide product and pricing information, data on the entire industry, warehousing and logistics solutions, and financing support.

 

Pricing Policy

 

We set our price based on data collected from our websites, comparisons with our competitors, market surveys, and premiums from additional online services.

 

Under our direct sales model, we price chemicals based on real-time market conditions. Under our marketplace model, we sell a portion of our chemicals based on a guiding settlement price set by suppliers on a daily basis. We develop our sales strategy based on this guiding settlement price and then sell to customers. We make payments to suppliers based on this settlement price after the sale. Under our marketplace model, suppliers determine the prices for chemicals at their full discretion.

 

Customer Services

 

·                  Ground marketing and service team: Our ground marketing and service team provide customers with face-to-face customer service in relevant geographic areas. These marketing efforts target clusters of customers in industrial parks, gathering information on customers’ needs, advertising our Online Platform and our products sold on MOLBASE Online Mall, assisting customers in their registration on MOLBASE Online Mall and their online purchase, following up on the delivery and receipt of goods, and on-site evaluation of credit risk.

 

·                  After-sale service: Our customer service center provides real-time assistance to our customers. Customers can access our sales and after-sales service phone hotlines and online representatives during business hours. We offer, among other services, a return policy within a maximum of seven days of delivery covering for product defects and damages during transportation.

 

·                  Consultation service: We offer phone hotline support and online consultation for customers to reach us for information regarding products or orders, or for providing us with general feedback. Our customer service center is located in Shanghai, China. We train our customer service representatives to answer customer inquiries, educate potential customers on our chemicals and transaction platform, and promptly resolve customer complaints. Each representative is required to complete mandatory training conducted by experienced managers on chemicals knowledge, complaint handling and communication skills.

 

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Our Suppliers

 

We have been building a network of suppliers since our inception. We have managed to foster a supplier community by accumulating suppliers from multiple channels over the past few years. Our suppliers are located throughout the world.

 

Supplier Selection

 

We have established a supplier selection process for potential suppliers. We use standardized criteria and qualifications for the selection of our suppliers on the basis of product quality, reputation, scale of production, price and ability to deliver products or services on time. We perform a three-step background check on each potential supplier by examining: (i) their business license and their product qualification certificates and production facilities, (ii) corporate’s authorized verification to establish a store on MOLBASE Online Mall, and (iii) a security check on the store and chemicals information.

 

We conduct a thorough online review after the suppliers register and submit their products to us before we list any of their products by: (i) verifying the corporate license of the registered companies, (ii) verifying the accuracy of information relating to the online store, (iii) assessing product quality, and (iv) monitoring supplier performance. We have established an internal risk alert system that monitors the credit status of our suppliers. Our supplier database is updated from time to time based on our continuing evaluation.

 

Relationship with Our Suppliers

 

We usually enter into long-term procurement agreements with suppliers under our direct sales model, setting forth the annual procurement amount and pricing policies for relevant products under the direct sales model. Payment terms granted by our suppliers vary depending on a number of factors, including our relationship with the supplier and transaction size. We normally settle our trade payables by bank transfer or credit notes.

 

We provide our suppliers with value-added services under our marketplace model.

 

·                  Customer acquisition. Compared with the traditional chemicals transactions, our Online Platform enables suppliers to sell their products not only within a certain geographical area but also across China and globally. This reduces transaction cost for suppliers as well as for customers.

 

·                  Support services. We offer customer matching, promotion and marketing, and logistics services to our suppliers. Our support services improve the transaction efficiency of our suppliers on our Online Platform.

 

·                  SaaS services. We offer SaaS services to suppliers who establish online stores in the marketplace on molbase.cn, including but not limited to online store maintenance, orders and client relationship management, instant messages, as well as promotional and marketing services.

 

Inventory Management

 

We keep inventory of chemicals for our direct sales model. Our inventory control policy requires us to monitor our inventory level and to manage obsolete inventory. Risk is passed to our customers (or to delivery service providers) upon the delivery of chemicals to our customers. For a substantial majority of chemicals sold through our Online Platform, the whole transaction process takes from a few hours to a few days, thus our inventory risk is limited. For a small portion of our transactions under direct sales model, we hold inventories for repeating customers with relatively stable demands of large quantity based on our transaction data. We analyze historical sales data and days in inventory to establish inventory management plans. We monitor our real-time inventory volume and adjust our inventory management plans based on factors such as fluctuations in supply and prices, seasonality, and sales of a particular product. Our inventory optimization model uses algorithms to help determine the replenishment schedules of chemicals. We also monitor the shelf life of our chemicals by conducting periodic reviews, and either design promotional events or conduct inventory write-downs depending on the status of the inventory.

 

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Quality Control

 

We believe that high quality and standards are key to our success and we administer quality control measures throughout our business operations. We have set up internal control systems to monitor the quality of chemicals. We undertake evaluations of our suppliers in both our direct sales model and marketplace model to meet our standards for authenticity and reliability on a monthly basis based upon a wide range of factors, including, among others, level of stock, associated sales volume, associated profits, quality related complaints, promptness in issuing invoices and legal risks.

 

Marketing

 

Our marketing strategy revolves around promoting brand recognition, increasing user traffic, attracting new users, building strong user loyalty and developing incremental revenue opportunities. We conduct both online and offline marketing and other promotional activities.

 

·                  Online marketing and user acquisition channels. We have established a marketing strategy since our inception through online marketing, such as search engines, social media platform, Weixin subscription accounts and Mol’s Vision industry journal. Our collaboration with search engines is mainly through paid search, whereby we purchase key words and brand-linked products. We have established core partnerships with leading online search companies such as Google and Baidu to conduct precise marketing globally. With the help of social media, our Weixin subscription accounts are able to publish our products and industry information regularly, targeting both customers and suppliers. Additionally, Mol’s Vision, our online industry journal, fulfills portions of our online marketing needs. Mol’s Vision features chemical and pharmaceutical industry landscape, market trend, product and our industry insights, which not only promote our products and services, but also our MOLBASE brand.

 

·                  Offline business development and customer relationship management. We conduct offline marketing primarily in the form of ground marketing, industry summit conferences, MOLBASE industry forum, exhibitions and other promotional activities.

 

We believe that customer and supplier satisfaction engenders word-of-mouth referrals, additional purchases by customers, and increased willingness by suppliers to sell on MOLBASE Online Mall. Unlike customers that purchase consumer goods on generic e-commerce platforms, customers in the chemical e-commerce industry display rational purchase behaviors. Accordingly, we do not focus exclusively on marketing campaigns. We focus on providing better service to our suppliers and customers, not only through our core online chemical e-commerce business, but also through our value-added services.

 

Technology and Infrastructure

 

Technology is the key to our success in achieving efficiency for our business, improving customer and supplier experience, and enabling active transactions and cooperation. Our technology platform supports our processing capacity requirements, provides us with information collected through our operation value chain, and enables insightful data analytics. From our websites, the primary customer interface, to back-end management support systems, our technology platform facilitates executions.

 

Big Data Technology

 

We have developed a data collection and analytics platform that can handle big data analytics tasks. Powered by data on users’ transaction behaviors and usage patterns, we have developed big data analytics and artificial intelligence technology to enhance the accuracy of user behavior predictions and user profiling to improve the user experience, facilitate transaction process and targeted marketing.

 

Our algorithms are embedded in many operational areas. Our engineers understand the computational needs and requirements from different business segments, and are therefore capable of providing technological support to address needs in operating our business.

 

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Artificial Intelligence

 

We have developed two intelligent matching systems using artificial intelligence technology, one on our website, molbase.cn, and the other on Moku Data, one of our Weixin subscription accounts. The intelligent matching system on molbase.cn is based on our Neuron System, which recommends chemicals for our customers based on patterns and similarities in our chemical database. The intelligent matching system on Moku Data is based on the Bayesian model.

 

Both systems rely on large amounts of data accumulated from the transactions completed on our Online Platform as well as pricing information which we update weekly. In addition, both systems provide matches between customers in need of certain chemicals and suppliers selling such chemicals, and between suppliers in need of logistics solutions and logistics service providers who are available within the relevant period of time. The two intelligent matching systems support both our direct sales model and our marketplace model for our chemical e-commerce business, and our warehousing and logistics facilitation services.

 

Security and Data Privacy

 

The security and data privacy measures we undertake include:

 

·                  Operations and maintenance: Our operations are logged and audited, enabling immediate interruptions of abnormal operations during emergencies. We constantly monitor key documents and indicators to ensure timely notifications when abnormalities occur.

 

·                  Firewall: We have developed a anti-crawler system to prevent malicious access and attacks, suspicious data requests, and data leakage. We close unused ports on our servers and leave the service ports open only to whitelist IPs. Additionally, we deploy a three-layer firewall to protect against common types of attacks.

 

·                  System development security review: We have developed and implemented a set of development specifications and quality standards, ensuring robust code review, version protection, and code vulnerability scanning.

 

·                  System sign in authority control: We pay particular attention to make sure that only authorized personnel have access to our system. Anyone who applies for system authority needs to go through a review and recording process. In addition, we maintain regular employee safety awareness trainings to educate our employees to protect their account information, and to clear login information immediately after logging in on third-party online platforms. Upon employees’ leaving the company, their accounts and login authority are closed immediately.

 

IT Infrastructure

 

Our cloud-hosting server room is equipped with additional electricity facilities and an emergency power supply vehicle, which provides over two hours of power supply in the case of an electricity breakdown. Our cloud host ensures the stability and elasticity of our network operation in the database. In emergency situations where our service is disrupted, our cloud host is able to continue its service without human intervention. Furthermore, our server is adjustable and can expand quickly to meet the demand of our business growth.

 

Research and Development

 

As of December 31, 2019, we had a total of 82 research and development staff, focusing on product development, systems maintenance and data analysis. For the year ended December 31, 2017, 2018 and 2019, we incurred research and development expense of RMB18.6 million, RMB36.9 million and RMB45.0 million (US$6.5 million), respectively.

 

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Risk Management and Internal Control

 

We have adopted and implemented various policies and procedures to ensure rigorous risk management and internal controls. Our risk management and internal control policies and procedures cover various aspects of our business operations such as product safety and quality, regulatory risk management, government affairs and regulatory compliance.

 

Fraud Prevention

 

Our fraud prevention system uses a detection process to identify both individual and collusive frauds. We use existing fraud databases, including credit blacklists maintained by us or our business partners. We continuously update our fraud database with new information from similar customers or suppliers.

 

Additionally, we have established an internal risk alert system and constantly monitor the credit status of our suppliers, ensuring that we can take appropriate and timely steps when risks arise. Our supplier database is updated from time to time based on our continuing evaluation.

 

Product Quality and Safety

 

We conduct random quality inspections of the chemicals we procure and reject shipments that fail to meet our quality standards. Our quality control department rigorously implements quality control procedures.

 

Information and Data Safety

 

Sufficient maintenance, storage and protection of user data and other related information is critical to our success. We have implemented relevant internal procedures and controls to ensure that user data is protected and that leakage and loss of such data could be prevented. We comply with laws and regulations and do not distribute or sell our users’ personal data for any purpose. We encrypt user data in network transmissions and in backend storage to ensure confidentiality. We conduct regular data backup and data recovery tests. Our database can only be accessed by certain designated and authorized personnel after assessment and approval procedures, whose actions are thoroughly recorded and monitored.

 

Regulatory Compliance

 

We have designed and adopted internal procedures to ensure compliance to our business operations with relevant laws and regulations and have established a code of conduct to regulate employees’ behavior and activities. In addition, we continually review the implementation of our risk-management policies and measures to ensure our policies and implementation are effective and sufficient.

 

We work closely with relevant government agencies that have jurisdiction over our business, and we maintain frequent communications with industrial associations. Industrial associations, such as Hazardous Chemicals Logistics Association and China E-Commerce Association, rely on our comprehensive database and invite our comments when formulating and implementing new business initiatives.

 

As part of our risk management and internal control measures, we have adopted a series of internal regulations against corruption and fraudulent activities, which include measures against receiving bribes and kickbacks, and misuse of company assets. We have anti-corruption and anti-bribery clauses in a majority of our major business contracts, and we require our suppliers and other third parties who cooperate with us to comply with relevant laws and regulations.

 

Competition

 

We face competition against other online e-commerce platforms which list commercial chemical products, for example, 1688.com. We also compete with other chemical information platforms, and numerous chemical retail companies and traditional chemical distributors.

 

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We believe we compete primarily on the basis of our chemical knowledge engine and business intelligence capabilities, our ability to provide a one-stop comprehensive suite of services in the chemical e-commerce industry, our ability to develop innovative big data and AI technologies, our ability to provide favorable financial solutions and our quality standards, and our reputation among customers, suppliers and other users of our Online Platform.

 

As our business continues to grow rapidly, we face significant competition for highly skilled personnel, including management, engineers, and risk-management personnel. Our growth depends in part on our ability to retain existing personnel and recruit additional highly skilled employees. Meanwhile, as the chemical industry is the most complex industrial ecology in e-commerce with the longest business chain, the barrier to enter the market remains high. We believe our leading market position and our sophisticated knowledge engine and management capabilities enable us to compete effectively against our existing and potential competitors.

 

Intellectual Property

 

We regard our trademarks, copyrights, patents, domain names, know-how, proprietary technologies, and similar intellectual property as critical to our success, and we rely on copyright, trademark and patent law and confidentiality, invention assignment and non-compete agreements with our employees and others to protect our proprietary rights. As of December 31, 2019, we had four patents, 13 patent applications, 123 registered computer software copyrights, 76 registered domain names, including but not limited to molbase.cn and molbase.com, and 132 registered trademarks.

 

Regulations

 

This section sets forth a summary of the most significant rules and regulations that affect our business activities in China or our shareholders’ rights to receive dividends and other distributions from us.

 

Regulations on Foreign Investment

 

Guidance Catalogue of Industries for Foreign Investment

 

Investment activities in the PRC by foreign investors are principally governed by the Guidance Catalogue of Industries for Foreign Investment, or the Catalogue, which was promulgated and is amended from time to time jointly by the Ministry of Commerce, or MOFCOM, and the National Development and Reform Commission, or NDRC. The Special Administrative Measures for Access of Foreign Investment (the Negative List for Access of Foreign Investment) under the Foreign Investment Catalogue was replaced by the Special Administrative Measures for Access of Foreign Investment (the Negative List), or the Negative List, which was jointly promulgated by the MOFCOM and NDRC on June 28, 2018 and took effect on July 28, 2018 and subsequently amended on June 30, 2019 and became effective on July 30, 2019, and the encouraged foreign-invested industries list under the Foreign Investment Catalogue was replaced by the Encouraged Foreign Investment Catalogue (2019 version) which was promulgated by the MOFCOM and NDRC on June 30, 2019 and took effect on July 30, 2019. The Negative List narrows the scope of the industries restricted on the ownership requirements, requirements for senior executives and other special administrative measures for the access of foreign investment, which stipulates that, except for e-commerce, domestic multi-party communication, store-and-forward, and call center, the foreign stake in a value-added telecommunication service may not exceed 50%.

 

On December 30, 2019, MOFCOM and State Administration for Market Regulation, or the SAMR, have jointly issued the Measures for Reporting of Information on Foreign Investment which took effect on January 1, 2020, or the Information Reporting Measures. Pursuant to the Information Reporting Measures, foreign investor or FIE shall report investment information including the initial report, report of changes, report of deregistration and annual report to the competent authorities in charge of commerce through the enterprise registration system and the enterprise credit information publicity system. If the establishment, change or deregistration of foreign-invested enterprises involves the approval from competent authorities as prescribed in the laws and regulations, foreign investor or foreign-invested enterprise shall at the time of application for registration submit the relevant approval documents to the registration authority.

 

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To comply with PRC laws and regulations, we have relied on contractual arrangements with our VIEs to operate our Online Platform. For further information, see “Item 3. Key Information—D. Risk Factors—Risks Related to Our Corporate Structure—We rely on contractual arrangements with our VIEs and their shareholders, for a significant portion of our business operations, which may not be as effective as direct ownership in providing operational control.”

 

Foreign Investment Law

 

In January 2015, MOFCOM published a draft Foreign Investment Law for public comment, or 2015 Draft Foreign Investment Law, which purports to replace the case-by-case approval system for foreign investment with “limited permission plus comprehensive reporting” access management system by means of pre-access national treatment and negative lists.

 

MOFCOM suggests both registration and approval as potential options for the regulation of variable interest entity structures, depending on whether they are “Chinese-controlled” or “foreign-controlled.” One of the core concepts of the 2015 draft Foreign Investment Law is “de facto control,” which is broadly defined and includes cases where (i) the party directly or indirectly holds 50% or more of the shares, equity, property shares, voting rights or other similar rights and interests of the enterprise; (ii) the party directly or indirectly holds less than 50% of the shares, equity, property shares, voting rights or other similar rights and interests of the enterprise, but is entitled to secure at least 50% of the seats on the board of directors or other equivalent decision-making bodies, or having the voting power to exert material influence on the shareholders’ meeting over the board of directors or other equivalent decision-making bodies; or (iii) the party has the power to exert a decisive influence on the operations, finance, personnel, technology, etc. of the enterprise through contract, trust or other means. The 2015 Draft Foreign Investment Law specifically provides that entities established in China but ultimately “controlled” by foreign investors, such as via contracts or trusts, will be treated as foreign-invested enterprises, or FIEs. If a foreign-invested enterprise proposes to conduct business in a restricted industry, the foreign-invested enterprise shall go through the market entry clearance by MOFCOM before being established.

 

The 2015 Draft Foreign Investment Law also emphasizes on the national security review requirements and imposes stringent ad hoc and periodic information reporting requirements on foreign investors and the applicable FIEs. Any company found to be non-compliant with these information reporting requirements may potentially be subject to fines and/or administrative or criminal liabilities, and the persons directly responsible for non-compliance may be subject to criminal liabilities.

 

On March 15, 2019, the Foreign Investment Law, or the FIL, was issued and took effect on January 1, 2020. The State Council promulgated the Regulation for the Implementation of Foreign Investment Law which was also effective on January 1, 2020. The FIL and its implementation regulations apply to PRC enterprises established, acquired or otherwise invested wholly or partially by foreign investors in a manner prescribed under applicable PRC laws and regulations.

 

The FIL has removed all references to the definitions of “de facto control” or “variable interest entity structure” included under the 2015 Draft Foreign Investment Law, and has further specified that all “foreign investments” shall be conducted pursuant to the negative list issued or approved to be issued by the State Council. If a foreign investor is found to invest in any prohibited industry in the “negative list,” such foreign investor may be required to, among other aspects, suspend its investment activities, dispose of its equity interests or assets in the target companies and forfeit its income. In addition, if a foreign investor is found to invest in any restricted industry in the negative list, the relevant competent department shall require the foreign investor to take the measures to correct itself.

 

There are substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations, and whether any new PRC laws or regulations relating to variable interest entity structures will be adopted or if adopted, what they would provide, it is still possible that relevant PRC government agencies will not hold the view that the contractual arrangements with our VIEs under which we operate our online chemical e-commerce business should be treated as a domestic investment. For further information, please see “Item 3. Key Information—D. Risk Factors—Risks Related to Our Corporate Structure—Uncertainties exist with respect to the interpretation and implementation of the newly enacted PRC Foreign Investment Law and how it may impact the viability of our current corporate structure, corporate governance and business operations.”

 

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Regulations on Chemical Industry

 

Regulations on the Safety Management of Hazardous Chemicals

 

In accordance with Regulations on the Safety Management of Hazardous Chemicals, promulgated by the State Council on January 26, 2002, and recently revised on December 7, 2013, enterprises engaged in production, storage, usage, operation and transportation of hazardous chemicals are required to meet the safety conditions set out by relevant laws, administrative regulations, national standards and industrial standards and obtain relevant permits. For example, enterprises shall obtain an operation license for hazardous chemicals before engaging in operations related to hazardous chemicals. A hazardous chemical operation enterprise may not purchase hazardous chemicals from any enterprise which is unlawfully engaged in the production or business operations of hazardous chemicals, or operate hazardous chemicals without the chemical safety technical instructions or chemical safety labels. And in the process of selling highly toxic chemicals or hazardous chemicals which can be used to produce explosives, a hazardous chemical operation enterprise shall check the purchasers’ permits or evidentiary materials required under the regulation. It is prohibited to sell highly toxic chemicals or hazardous chemicals which can be used to produce explosives to the enterprise that do not have the required permits or certificates. Those who have a permit to purchase highly toxic chemicals shall, when purchasing highly toxic chemicals, stick to the category and quantity of highly toxic chemicals as indicated in the permit.

 

Regulations on the Operation Permit of Hazardous Chemicals

 

According to the Administrative Measures of the Operation Permit of Hazardous Chemicals issued by the State Administration of Work Safety (now known as the Ministry of Emergency Management), or the MOEM, on July 17, 2012, and amended on May 27, 2015, an enterprise engaged in the business operation of hazardous chemicals shall obtain a permit for the business operation of hazardous chemicals (hereinafter referred to as the “operation permit”). Without an operation permit, no enterprise or individual may engage in the business operation of hazardous chemicals. To obtain an operation permit, the hazardous chemical operation enterprises should meet all the statutory requirements on business premises, staff training, regulatory system, rescue equipment and other aspects. When an enterprise that has obtained an operation permit modifies the enterprise name, principal person in charge, registered address or hazardous chemical storage facilities and monitoring measures, it shall, within 20 workdays from the date of modification, file a written application for modification with the permit-issuing agency and submit the relevant documents and materials.

 

To comply with these laws and regulations, Jiaxing MOLBASE has obtained an operation permit of hazardous chemicals from Jiaxing Administration of Work Safety in April 2018 which remains valid until April 2021. Shaanxi MOLBASE has obtained an operation permit of hazardous chemicals from Administration of Work Safety in Yaozhou District Tongchuan City which remains valid until May 2021. Shanghai MOKAI has obtained an operation permit of hazardous chemicals from Administration of Work Safety in Jiading District Shanghai which remains valid until February 2022. Shanghai MOCHUANG has obtained an operation permit of hazardous chemicals from Shanghai Jiading Emergency Administration Bureau which remains valid until September 2022.

 

Regulations on the Operation of Precursor Chemicals

 

According to the Regulation on the Administration of Precursor Chemicals adopted by the State Council on August 26, 2005, and most recently amended on September 18, 2018, the PRC government implements the classified administration and licensing or filing system for production, distribution, purchase, transportation and import and export of precursor chemicals. The precursor chemicals are classified into three categories based on the Catalog of Classification and Types of Precursor Chemicals. Category I refers to the major materials that may be used to produce narcotic drugs. Categories II and III refer to the chemical auxiliary substances that may be used to produce narcotic drugs. An application for operating the precursor chemicals under the item of pharmaceuticals and non-pharmaceuticals in Category I shall be subject to the examination and approval of the Drug Administration and the MOEM respectively of all provinces, autonomous regions and municipalities. An enterprise that operates the chemicals which are used to produce chemicals in Category II shall, within 30 days as of operation, report such information as variety, quantity and major flow to the local municipal work safety administration for archival filing. An enterprise that operates the chemicals which are used to produce chemicals in Category III shall, within 30 days as of operation, report such information as variety, quantity and major flow to the local county work safety administration for archival filing. Shanghai MOKAI has obtained an operation permit of non-pharmaceutical precursor chemicals from Shanghai Emergency Administration Bureau which remains valid until June 2022. Shanghai MOCHUANG has obtained an operation permit of non-pharmaceutical precursor chemicals in Category II from Shanghai Emergency Administration Bureau which remains valid until November 2022, and another operation permit of non-pharmaceutical precursor chemicals in Category III from Shanghai Jiading Emergency Administration Bureau which remains valid until November 2022.

 

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Regulations on the Operation of Non-Pharmaceutical Precursor Chemicals

 

According to the Measures for the Licensing for Production and Operation of Non-Pharmaceutical Precursor Chemicals promulgated by the MOEM on April 5, 2006, and effective on April 15, 2006, whoever intends to produce or operate a non-pharmaceutical precursor chemical of Catalogue II or Catalogue III must file for its production and operation of non-pharmaceutical precursor chemicals. If an enterprise produces or operates non-pharmaceutical precursor chemicals without licensing or filing, the relevant work safety administrative department may impose a fine to the enterprise, confiscate its illegal income, or cause its business license revoked by the administrative department for industry and commerce. If the said act constitutes a crime, the concerned party could be subject to criminal liability according to law; and the relevant agencies would not accept its application for licensing or filing for production and operation of non-pharmaceutical precursor chemicals within three years after the decision of administrative penalty made by the relevant agencies. Shanghai MOKAI has obtained an operation permit of non-pharmaceutical precursor chemicals from Shanghai Emergency Administration Bureau which remains valid until June 2022. Shanghai MOCHUANG has obtained an operation permit of non-pharmaceutical precursor chemicals in Category II from Shanghai Emergency Administration Bureau which remains valid until November 2022, and another operation permit of non-pharmaceutical precursor chemicals in Category III from Shanghai Jiading Emergency Administration Bureau which remains valid until November 2022.

 

Regulations on the Medical Device Operation

 

According to the Regulations on the Supervision and Administration of Medical Devices, which was promulgated by the State Council on January 4, 2000 and amended on March 7, 2014 and May 4, 2017, respectively, and the Measures on the Supervision and Administration of the Business Operations of Medical Devices, which was promulgated by the State Food and Drug Administration, or the SFDA, the predecessor of the National Medical Products Administration, or the NMPA, on July 20, 2004, and amended on July 30, 2014 and November 17, 2017 and other relevant laws and regulations, business operations of medical devices are regulated based on the degree of risks involving the medical devices, which are divided into three categories. Operation of Class I medical devices does not require a license or record-filing, while operations of Class II medical devices and Class III medical devices are subject to record-filing and licensing requirements, respectively. An entity engaging in the operation of medical devices shall meet certain requirements with respect to its management system, personnel, facilities etc., and shall apply for approval to operate Class III medical devices and make record-filing with relevant governmental authority to operate Class II medical devices. The valid term of medical devices operation permit is five years. Shanghai MOCHUANG has obtained a Class II medical device operation record-filing certificate from Shanghai Jiading Market Supervision Administration on February 21, 2020. Shanghai MOKAI has obtained a Class II medical device operation record-filing certificate from Shanghai Jiading Market Supervision Administration on March 18, 2020. Shaanxi MOLBASE has obtained a Class II medical device operation record-filing certificate from Shaanxi Tongchuan City Administrative Examination and Approval Service Bureau on April 17, 2020.

 

Regulations on the Import and Export of Commodity

 

Regulations on Record-Filing and Registration of Foreign Trade Operators

 

According to the Foreign Trade Law of the PRC which was promulgated by the SCNPC on May 12, 1994, and most recently amended on November 7, 2016, and the Measures for the Record-Filing and Registration of Foreign Trade Operators promulgated by the MOFCOM on June 25, 2004, and most recently amended on November 11, 2019 and November 30, 2019, foreign trade operators that engage in the import and export of goods shall go through the formalities for record-filing and registration with the MOFCOM or an agency authorized by the MOFCOM, unless laws, administrative regulations and rules of the MOFCOM provide that it is unnecessary to go through such formalities. If foreign trade operators fail to go through the formalities for record-filing and registration in accordance with relevant provisions, the PRC customs agency shall refuse to handle the declaration and clearance formalities of their imports and exports.

 

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Pursuant to the PRC Law on Import and Export Commodity Inspection which was promulgated by the SCNPC on February 21, 1989, and most recently amended on December 29, 2018, and the Regulations for the Implementation of the PRC Law on Import and Export Commodity Inspection, which was promulgated by the former State Bureau of Import and Export Commodities Inspection on October 23, 1992, and promulgated by the State Council on August 31, 2005, and most recently amended on March 2, 2019, the consignees or consigners of import and export commodities may go through formalities of application for inspection by themselves, or may entrust an inspection application agency to go through such formalities, provided that they shall file a record with the entry and exit inspection and quarantine agency in both cases. If anyone exports without permission any export commodity subject to statutory inspection without applying for inspection or without having the commodity inspected, or exports without permission any export commodity without applying for export checking as required, the entry and exit inspection and quarantine agency shall confiscate the entity’s illegal gains and impose a fine upon the entity. If a crime is committed, the entity shall be subject to criminal liabilities.

 

Regulations on Import and Export Duties

 

Pursuant to the Regulations on Import and Export Duties of the PRC recently amended by the State Council on the March 1, 2017, the PRC Customs is the PRC agency in charge of the collection of customs duties. Customs duties of import and export goods may be levied by means of ad valorem, specific duties, or other means specified by the PRC government. In calculating duties, import and export commodities shall be classified under applicable tax items in accordance with the Category Provisions of the Customs Import and Export Tariff and shall be taxed at relevant tax rates.

 

Regulations on the Registration of Customs Declaration Entities

 

Customs Law of the PRC, which was promulgated by the SCNPC on January 22, 1987, and most recently amended on November 4, 2017 and became effective on November 5, 2017, stipulates that all import and export goods, except for otherwise stipulated, must be declared and have duties on them paid by their consigner or consignee or by representatives entrusted by the sender or receiver and approved by and register with the customs. To fulfill customs declaration formalities, the consignees or consigners for imported or exported goods and the customs declaration enterprises must legally register with the customs offices. Engaging in customs declaration without such registration shall be prohibited. Besides, the consignee of import goods and the consigner of export goods are obliged to make an accurate declaration and submit the import or export license and relevant papers to the customs office for examination. In the absence of an import or export license, goods are not permitted to be released for importation or exportation.

 

Provisions of the Customs of the PRC on the Administration of Registration of Customs Declaration Entities adopted by General Administration of Customs on March 31, 2005, and most recently amended on May 29, 2018 and became effective on July 1, 2018, set forth that the registration of customs declaration entities includes the registration of customs declaration enterprises and the registration of the consignees or consignors of imported or exported goods. Enterprises may complete declaration business after obtaining the registration license from the local customs directly under the General Administration of Customs or the subordinate customs authorized thereby, and the consignee or consignor of imported or exported goods may go through the registration procedure directly at the local customs office.

 

To comply with these laws and regulations, Jiaxing MOLBASE, Shanghai MOLBASE and Shaanxi MOLBASE have obtained long-term effective Registration Certificates of the Customs of the PRC for Customs Declaration Entities (Shipper & Consignee as Declaration Entity) or Registration Certificate of Shipper and Consignee as Customs Declaration Entity respectively from the subordinate customs.

 

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Regulations on Value-Added Telecommunication Service Business Operating Licenses

 

The Telecommunications Regulations of the PRC, or the Telecom Regulations, were issued by the State Council in September 2000 and amended in February 2016 as the primary governing law on telecommunication services. The Telecom Regulations set out the general framework for the provision of telecommunication services by PRC companies. Under the Telecom Regulations, telecommunications service providers are required to procure operating licenses prior to their commencement of operations. The Telecom Regulations draw a distinction between “basic telecommunication services” and “value-added telecommunication services.” In December 2015, the Ministry of Industry and Information Technology, or the MIIT, released the Catalog of Telecommunication Business (2015 Revision), or the Telecom Catalog, which was recently amended and became effective on June 6, 2019. Under the Telecom Catalog, both the online data processing and transaction processing business (i.e., operating e-commerce business) and information service business provided via public communication networks, continue to be categorized as value-added telecommunication services, and the information service business as defined under the Telecom Catalog includes information release platform and delivery services, information search and query services, information community platform services, information real-time interactive services, and information protection and processing services.

 

In March 2009, MIIT issued the Administrative Measures for Telecommunications Business Operating Permit, or the Telecom Permit Measures, effective in April 2009 and most recently amended in July 2017. The Telecom Permit Measures set out that there are two types of telecommunication operating licenses for operators in China, namely, licenses for basic telecommunication services and licenses for value-added telecommunication services. The license specifies permitted activities of the enterprise to which it is granted. An approved telecommunication services operator shall conduct its business in accordance with the specifications recorded on its value-added telecommunication business operating licenses, or VATS Licenses. In addition, a VATS License holder is required to obtain approval from the original license-issuing agency in respect of any change to its shareholders or business scope. In February 2015, the State Council has issued the Decisions on Cancelling and Adjusting a Batch of Administrative Approval Items, which, among others, replaced the prior approval requirement for telecommunications business with post-registration regulation.

 

Regulations on Foreign Investment in Value-Added Telecommunication Services

 

Pursuant to the Provisions on Administration of Foreign-Invested Telecommunications Enterprises promulgated by the State Council in December 2001 and most recently amended in February 2016, or the FITE Regulations, the ultimate proportion of contribution from the foreign investors in a foreign-funded telecommunication enterprise that is engaged in the value-added services shall not exceed 50%. Besides, the major foreign investor of a foreign-funded telecommunication enterprise that is engaged in the value-added telecommunication businesses shall have good performances and operation experience in managing the value-added telecommunication businesses. Moreover, foreign investors qualified in the aforesaid requirements must obtain approvals from the MIIT and MOFCOM or their authorized local counterparts, which retain considerable discretion in granting approvals. MIIT issued the Circular on Strengthening the Administration of Foreign Investment in and Operation of Value-added Telecommunication Business, or the MIIT Circular, in July 2006. A foreign investor investing in the telecommunications services within the Chinese territory shall comply with the requirements of the Provisions strictly, apply for the establishment of a foreign-funded telecommunications enterprise as well as a license for telecommunications business. Absence of any aforesaid procedures, the foreign investor shall be forbidden to invest in the telecommunications business in China. Under the MIIT Circular, a domestic company that holds a telecommunications business operating license is prohibited from leasing, transferring or selling the license to foreign investors in any form, and from providing any assistance, including providing resources, sites or facilities, to foreign investors that conduct value-added telecommunication business illegally in China.

 

In June 2015, MIIT issued the Circular on Removing the Restrictions on Equity Ratio Held by Foreign Investors in Online Data Processing and Transaction Processing (Operating E-Commerce) Business, which removes the restrictions on foreign equity ratios in online data processing and transaction processing (operating e-commerce) business across the country, allowing the foreign equity ratios to be increased to 100%. However, other requirements provided by the FITE Regulations (such as good performances and operation experiences for a major foreign investor) still apply, and foreign investors are still prohibited from holding more than 50% of equity interest in a provider of other subcategories of value-added telecommunication services.

 

Shanghai MOLBASE, as our value-added telecommunication service provider, has obtained a VATS License covering both internet information service and online data processing and transaction processing businesses, which remains valid until July 3, 2024.

 

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Regulations on Publishing Information of Hazardous Chemicals

 

On February 5, 2015, the Ministry of Public Security of the PRC, or the MPS, the State Internet Information Office, the MIIT, the Ministry of Environmental Protection, the State Administration for Industry and Commerce (now known as SAMR), and the MOEM jointly issued Regulations on the Administration of the Release of Dangerous Goods Information on the Internet. According to this Regulation, the Internet access providers shall sign an agreement with the dangerous goods business entities or confirm the provision of services, and shall not provide Internet access for the dangerous goods business entities that have not obtained the VATS License for Internet Information Service, or the ICP License, or have not completed the non-profit-making Internet information service filing procedures. The Internet access provider shall not provide Internet access services to any entity or individual other than the dangerous goods operating entities to publish dangerous goods information.

 

Shanghai MOLBASE, as our online chemical e-commerce platform service provider, has obtained an ICP License from the Shanghai Administration of Telecommunications, which remains valid until July 3, 2024. And the Internet access provider has confirmed the provision of services to Shanghai MOLBASE.

 

Regulations on Internet Information Service

 

On September 25, 2000, the State Council promulgated the Administrative Measures on Internet Information Services, or the Internet Measures, which was amended in January 2011. Under the Internet Measures, profit-making Internet information services operators shall obtain an ICP License, with the relevant telecommunication administrative agency before engaging in any profit-making Internet information services in China.

 

Under the Telecom Catalog, Internet information services, or ICP service and online data processing and transaction processing services, or EDI Service are classified as value-added telecommunications services, and the provider of ICP Service and EDI Service shall obtain ICP License and EDI Licenses from the MIIT, or its provincial branches, prior to the provision of ICP Services or EDI Services. If a service operator fails to obtain EDI License, it may be subject to various penalties, such as confiscation of the net revenues that were generated through the unlicensed internet activities, the imposition of fines and the termination or restriction of its operations.

 

Pursuant to the Internet Measures, the PRC government may shut down the websites of ICP License holders and revoke their ICP Licenses if they produce, reproduce, disseminate or broadcast internet information content that is prohibited by laws or administrative regulations. Profit-making internet information services operators are also required to supervise their websites. They may not post or disseminate any content that falls within the prohibited categories, and must remove any such content from their websites, retain the relevant records and report to the relevant governmental agencies if there is such information.

 

Shanghai MOLBASE has obtained a VATS License covering both internet information service and online data processing and transaction processing businesses, which remains valid until July 3, 2024.

 

Regulations on Information Services of Mobile Internet Application Programs

 

On June 28, 2016, the State Internet Information Office promulgated the Administrative Provisions on Information Services of Mobile Internet Application Programs, or the Mobile Application Administrative Provisions which became effective on August 1, 2016, to strengthen the regulation of the mobile application information services. Pursuant to the Mobile Application Administrative Provisions, an internet application program provider must verify a user’s mobile phone number and other identity information under the principle of mandatory real name registration at the back-end and voluntary real name display at the front-end. An internet application program provider shall protect user information, and obtain the consent of users while collecting and using users’ personal information in a lawful and proper manner and adopt proper measures such as warning, limiting functions, suspending updates, and closing accounts, to prevent releasing illegal information content, keep records and report to the competent department. An internet application program provider shall not enable functions that can collect a user’s geographical location information, access a user’s contacts, activate the camera or recorder of the user’s mobile smart device or other functions irrelevant to its services, nor shall it conduct bundle installations of irrelevant application programs, unless it has clearly indicated to the user and obtained the user’s consent on enabling such functions and application programs.

 

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Regulations on E-Commerce

 

In January 2014, the SAMR adopted the Administrative Measures for Online Trading, or the Online Trading Measures, which took effect in March 2014. Under the Online Trading Measures, e-commerce platform operators shall examine and register the identity information of the merchants applying for access to their platforms, and such information shall be kept verified and updated regularly. It is further provided that e-commerce platform operators shall make available to public the link to or the information contained in the business licenses of such merchants (in the case of business entities) or a label confirming the verified identity of the merchants (in the case of individuals).

 

In August 2018, the SCNPC issued E-Commerce Law, which came into force as of January 1, 2019. Under the E-commerce Law, “e-commerce businesses” mean natural persons, legal persons or organizations without the status of legal person that engage in the business activities of selling commodities, or providing services, through the Internet or any other information network, including e-commerce platform businesses, in-platform businesses, and e-commerce businesses that sell commodities or provide services through a self-built website or any other network services. The E-commerce Law proposes a series of requirements on e-commerce operators including individuals and entities carrying out business online, e-commerce platform operators and merchants within the platform. For example, e-commerce platform operators are required to (i) take necessary actions or report to relevant competent government agencies when such operators notice any illegal production or services provided by merchants on the e-commerce platforms; (ii) verify the identity of the business operators on the platforms; (iii) provide identity and tax related information of merchants to local branches of SAMR and tax bureaus; (iv) record and preserve goods and service information and transaction information on the e-commerce platform; and (v) respect and equally protect consumers’ legitimate rights and provide options to consumers without targeting their personal characteristics. The E-Commerce Law also specifically stipulates that e-commerce platform operators shall not impose unreasonable restrictions or conditions on the transactions of their business operators on the platforms. According to the E-Commerce Law, e-commerce platform operators who fail to take necessary actions when they know or should have known that the merchants on the platform infringe others’ intellectual property rights or the products or services provided by the merchants do not meet the requirements for personal and property security, or otherwise infringe upon consumers’ legitimate rights, will be imposed joint liability with the merchants. With respect to the products or services affecting consumers’ life and health, the e-commerce platform operators will be held jointly liable with the merchants if they fail to review the qualifications of merchants or fail to safeguard the interests of the consumers. According to the E-Commerce Law, failures to comply with these requirements may subject the e-commerce platform operators to administrative penalties, fines and/or suspension of business.

 

In March 2016, the State Administration of Taxation, or the SAT, the Ministry of Finance, or the MOF and the General Administration of Customs jointly issued the Notice of the Ministry of Finance, the General Administration of Customs and the State Administration of Taxation on the Tax Policies on Cross-Border E-Commerce Retail Imports, effective in April 2016. Pursuant to this notice, the imported commodities in cross-border e-commerce retail shall be subject to tariffs, import value-added tax (“VAT”) and consumption tax as goods. Individuals purchasing any goods imported through cross-border e-commerce retail are taxable, and e-commerce companies, companies operating e-commerce transaction platforms or logistic companies are required to withhold the taxes. In November 29, 2018, the SAT, the MOF and the General Administration of Customs jointly issued the Notice of the Ministry of Finance, the General Administration of Customs and the State Administration of Taxation on Improving the Tax Policies on Cross-Border E-Commerce Retail Imports, or the Amended Notice, which came into force as of January 1, 2019. Pursuant to this Amended Notice, some of the regulations are amended, including but not limited to purchased e-commerce imports which fall under end-user products used by consumer individuals that shall not be resold in domestic market, and that in principle, bonded imports purchased online shall not be allowed to adopt the “online purchase of bonded goods plus offline self-collection” outside the customs special supervision area. The other requirements under the notice issued in March 2016, which have not been amended in the Amended Notice, shall still apply.

 

Regulations on Internet Information Security and Privacy Protection

 

The National People’s Congress, or the NPC, has enacted the Decisions on Preserving Internet Security in December 2000 and amended in August 2009, which subject violators to potential criminal punishment in China for any attempt to: (i) gain improper entry into a computer or system of strategic importance; (ii) disseminate politically disruptive information; (iii) leak state secrets; (iv) spread false commercial information; or (v) infringe intellectual property rights. The MPS has promulgated measures that prohibit use of the internet in ways which, among other things, result in a leak of state secrets or a spread of socially destabilizing content. If an internet information service provider violates these measures, the MPS and its local branches may revoke its operating license and shut down its websites.

 

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PRC governmental agencies have enacted laws and regulations on internet use to protect personal information from any unauthorized disclosure. In December 2012, the SCNPC promulgated the Decision on Strengthening Network Information Protection to enhance the legal protection of information security and privacy on the internet. In July 2013, the MIIT promulgated the Provisions on Protection of Personal Information of Telecommunication and Internet Users, or Personal Information Protection Rule, to regulate the collection and use of users’ personal information in the provision of telecommunication services and internet information services in China. Telecommunication business operators and internet service providers are required to establish its own rules for collecting and using of users’ information and cannot collect or use users’ information without users’ consent. Telecommunication business operators and internet service providers are prohibited from disclosing, tampering with, damaging, selling or illegally providing others with collected personal information. Moreover, pursuant to the Ninth Amendment to the Criminal Law issued by the SCNPC in August 2015 which became effective in November 2015, any internet service provider that fails to fulfill the obligations related to internet information security administration as required by applicable laws and refuses to rectify upon orders, shall be subject to criminal penalty for the result of (i) any dissemination of illegal information in large scale; (ii) any severe effect due to the leakage of the client’s information; (iii) any serious loss of criminal evidence; or (iv) other severe situation. Any individual or entity that (i) sells or provides personal information to others in a way violating the applicable law, or (ii) steals or illegally obtains any personal information, shall be subject to criminal penalty in severe situation. In addition, the Interpretations of the Supreme People’s Court and the Supreme People’s Procuratorate of the PRC on Several Issues Concerning the Application of Law in Handling Criminal Cases of Infringing Personal Information, issued in May 2017 and effective in June 2017, clarified certain standards for the conviction and sentencing of the criminals in relation to personal information infringement. Furthermore, the NPC promulgated a new National Security Law, effective July 2015, to replace the former National Security Law and covers various types of national security including technology security and information security.

 

Under the Several Provisions on Regulating the Market Order of Internet Information Services, issued by the MIIT in December 2011 and effective March 2012, an internet information service provider may not collect any user’s personal information or provide any such information to third parties without the consent of the user. In addition, an internet information service provider must expressly inform the users of the method, content and purpose of the collection and processing of such user’s personal information and may only collect such information necessary for the provision of its services. An internet information service provider shall ensure that the personal information of users is properly kept. When the personal information of users it keeps is divulged or may be divulged, it shall immediately take remedial measures. Where serious consequences are caused or may be caused, internet information service provider shall immediately report to the telecommunications administrative agencies which approved the internet information service licensing or filing, and shall cooperate with the relevant department in carrying out investigation and handling.

 

In November 2016, the SCNPC promulgated the Cyber Security Law of the PRC, or the Cyber Security Law, effective June 2017, to protect cyberspace security and order. The Cyber Security Law requires that a network operator, which includes, among others, internet information services providers, takes technical measures and other necessary measures in accordance with applicable laws and regulations and the compulsory requirements of the national and industrial standards to safeguard the safe and stable operation of its networks. The Cyber Security Law sets forth various security protection obligations for network operators, which are defined as “owners and administrators of networks and network service providers,” including, among others, complying with a series of requirements of tiered cyber protection systems, identifying users’ real identity, localizing the personal information and important data gathered and produced by key information infrastructure operators during operations within the PRC, and providing assistance and support to government agencies where necessary for protecting national security and investigating crimes. Any violation of the Cyber Security Law may subject the internet information service provider to warnings, fines, confiscation of illegal gains, revocation of licenses, cancellation of filings, shutdown of websites or criminal liabilities.

 

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Furthermore, Personal Information Protection Rule, effective September 2013, contain detailed requirements on the use and collection of personal information as well as security measures required to be taken by telecommunications business operators and internet information service providers.

 

To comply with these laws and regulations, we have required our users to consent to our collecting and using their personal information, and have established information security systems to protect our Internet information security and user’s privacy. For further information, see “Item 3. Key Information—D. Risk Factors—Risks Related to Our Business and Industry—Our business generates and processes a large amount of data, our failure to protect the confidential information of our users or the improper use or disclose of such data may subject us to the liabilities imposed by data privacy and protection laws and regulations, negatively impact our reputation and deter our users from using our Online Platform.”

 

Regulations on Internet Advertising Business

 

In July 2016, SAMR issued the Interim Measures for the Administration of Internet Advertising to regulate internet advertising activities, which became effective in September 2016, defining internet advertising as any commercial advertising that directly or indirectly promotes goods or services through websites, webpages, internet applications and other internet media in the forms of words, picture, audio, video or others, including promotion through emails, texts, images, video with embedded links and paid-for search results. According to these measures, no advertisement of any medical treatment, medicines, food for special medical purpose, medical apparatuses, pesticides, veterinary medicines, dietary supplement or other special commodities or services subject to examination by an advertising examination agency as stipulated by laws and regulations may be published unless the advertisement has passed such examination. In addition, no entity or individual may publish any advertisement of over-the-counter medicines or tobacco on the internet. An internet advertisement must be identifiable and clearly identified as an “advertisement” to the consumers. Paid search advertisements are required to be clearly distinguished from natural search results. In addition, the following internet advertising activities are prohibited: providing or using any applications or hardware to intercept, filter, cover, fast forward or otherwise restrict any authorized advertisement of other persons; using network pathways, network equipment or applications to disrupt the normal data transmission of advertisements, alter or block authorized advertisements of other persons or load advertisements without authorization; or using fraudulent statistical data, transmission effect or matrices relating to online marketing performance to induce incorrect quotations, seek undue interests or harm the interests of others. Internet advertisement publishers are required to verify relevant supporting documents and check the content of the advertisement and are prohibited from publishing any advertisement with unverified content or without all the necessary qualifications. Internet information service providers that are not involved in internet advertising business activities but simply provide information services are required to block any attempt to publish an illegal advisement that they are aware of or should reasonably be aware of through their information services.

 

Regulations on the Financing Guarantee

 

Pursuant to the Reply of the Enterprise Registration Bureau of the State Administration for Industry and Commerce to the Request for Instructions on Whether Prior Examination and Approval Is Needed for Establishing Financial Guarantee Enterprise issued by the SAMR, on July 8, 1999, the Enterprise Registration Bureau of the SAMR affirms that financing guarantee institutions are not financial institutions, therefore, the establishment of financing and non-financing guarantee enterprises shall not be examined and approved by the People’s Bank of China, or the PBOC. However, since such institutions are not financial institutions, they shall not engage in financial business as well. Registration of such institutions shall be proceeded pursuant to the Regulations on the Administration of the Registration of Enterprise Legal Persons, the Regulations on the Administration of the Registration of Companies and the Guarantee Law of the PRC.

 

In March 2010, China Banking Regulatory Commission (now known as China Banking and Insurance Regulatory Commission), or the CBIRC, NDRC, MIIT, MOFCOM, PBOC, SAMR and MOF promulgated the Interim Regulations for Financing Guarantee Companies, which require an entity or individual to obtain a prior approval from the relevant regulatory body to engage in the financing guarantee business, and define “financing guarantee” as an activity whereby the guarantor and the creditor, such as a financial institution in the banking sector, agree that the guarantor shall bear the guarantee obligations in the event that the secured party fails to perform its financing debt owed to the creditor. According to the Interim Regulations for Financing Guarantee Companies, a financing guarantee company shall set aside 50% of the security fee income of the year as reserve for non-matured obligations and set aside no less than 1% of the security obligation balance as of year-end as security compensation reserve. If the security compensation reserve accumulates to 10% of the security obligation balance of the year, the difference of the amount shall be set aside.

 

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In August 2017, the State Council promulgated the Regulations on the Supervision and Administration of Financing Guarantee Companies, or the Financing Guarantee Regulations, effective on October 1, 2017, which stipulate that the departments designated by the people’s governments of all provinces, autonomous regions and municipalities directly under the State Council shall be responsible for the supervision and administration of financing guarantee companies in their respective regions. Moreover, the establishment of a financing guarantee company or engagement in the financing guarantee business without approval may result in several penalties, including but not limited to banning, an order to cease business operation, confiscation of illegal gains, fines of up to RMB 1,000,000 and criminal liabilities.

 

Concerning the operation of a financing guarantee company, Financing Guarantee Regulations set out that in addition to financing guarantee business such as guarantee of borrowings and guarantee of bond issuance, a financing guarantee company with stable operations and a favorable financial position may also engage in non-financing guarantee business such as guarantee of bid submission, guarantee of project performance and guarantee of litigation preservation, as well as consulting and other services related to guarantee business. A financing guarantee company shall not engage in taking deposits directly or in any disguised form, proprietary lending or entrusted lending business, or making investment upon entrustment. Besides, the Financing Guarantee Regulations also set forth that the outstanding guarantee liabilities of a financing guarantee company shall not exceed ten times of its net assets, and that the outstanding guarantee liabilities of a financing guarantee company vis-à-vis the same guaranteed party shall not exceed 10% of the net assets of the financing guarantee company, while the outstanding guarantee liabilities of a financing guarantee company vis-à-vis the same guaranteed party and its affiliated parties shall not exceed 15% of its net assets.

 

The disclosure obligation of a financing guarantee company, as stipulated in the Notice on Issuing the Guidelines for Information Disclosure of Financing Guarantee Companies promulgated by the CBIRC and effective on November 25, 2010, includes annual reports, temporary reports on material incidents and other information required by the laws, regulations, rules and the relevant regulatory agency.

 

In October 2019, the CBIRC, the NDRC, and seven other regulatory authorities jointly issued the Supplementary Provisions on the Supervision and Administration of Financing Guarantee Companies, according to which any institution that provides money lending services such as customer recommendation and credit evaluation is not allowed to, directly or indirectly, provide financing guarantee services without governmental approval. Regulatory authorities should terminate the business of entities that are providing financing guarantee services without licenses.

 

Regulations on Foreign Investment in Financing Guarantee Business

 

The Guidelines for Approval of Foreign Investors to Invest in the Guarantee Industry issued by the MOFCOM on February 25, 2009, allow foreign investors to set up limited liability companies engaged in guarantee operating business in forms of wholly-owned enterprises or joint ventures founded with Chinese investors. In addition, the foreign investors shall have good credit, with necessary economic strength to set up guarantee companies, and their total net assets shall be no less than USD50,000,000 in the year previous to the application. If the guarantee company is established in the form of joint venture, the Chinese investors shall have good credit, and the net assets of the investors shall be no less than RMB50,000,000 in the year previous to the application. Where there are more than two foreign investors or more than two Chinese investors applying for establishment of the guarantee company, at least one of the investors who hold larger percentage of shares shall meet the conditions above. The basic requirements for establishing guarantee enterprises are that: (i) the registered capital shall be no less than USD10,000,000 and all paid in monetary form; (ii) there are senior management staff with qualifications of guarantee agencies and qualified practitioners who are familiar with guiding business; and (iii) there are comprehensive organizational structures, internal management systems and risk control systems.

 

According to the Guidelines for Approval of Foreign Investors to Invest in the Guarantee Industry, the application for investment in financing guarantee business shall be preliminarily examined and approved by the commercial agencies in the project location and ultimately approved by the provincial commercial agencies. The changes in guarantee companies such as increase of business scope, stock right transfer and increase or decrease in registered capital shall be reported and approved by the original examination and approval agencies.

 

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As a value-added service in our financial solutions business, we provide deposit or other types of guarantee for the benefit of our customers and suppliers strictly limited to their transactions conducted on our Online Platform. We believe that this value-added service is an integrated part of our financial solutions rather than a separate financing guarantee business, but we cannot assure you that the relevant PRC government authority would not deem our guarantee service as unlicensed financial guarantee business which may subject us to fines, order to terminate the guarantee service, as well as other legal liabilities. See “Item 3. Key Information—D. Risk Factors—Risks Related to Our Business and Industry—We have limited experience in providing financial solutions, which plays a substantial role in attracting customers and suppliers to use our Online Platform. Failure to accurately evaluate our customers’ or suppliers’ credit risks, to renew our agreements with banks and other financial institutions on reasonable terms or to find comparable alternatives, or regulatory changes related to the internet finance industry, may have a material adverse effect on our business and results of operations.”

 

Regulations on Illegal Financing

 

Illegal financing is banned in accordance with Measures Banning Illegal Financial Institutions and Illegal Financial Business Activities promulgated by the State Council on July 13, 1998, and amended on January 8, 2011, and Notice on Punishing Illegal Financing of the State Council. The “illegal financial” activities mean the following activities conducted without the approval of the PBOC: (i) illegally taking public deposits or taking public deposits in any disguised form; (ii) without obtaining approval in accordance with the law, illegally raising funds from unspecific investors in any name; (iii) illegally granting loans, settling funds, discounting bills, lending funds, making trust investment, engaging in financial lease, providing financing guarantee, or trading foreign exchange; and (iv) Other illegal financial activities as specified by the PBOC.

 

Regulations on Anti-Money Laundering

 

The PRC Anti-money Laundering Law, effective in January 2007, sets forth the principal anti-money laundering requirements applicable to financial institutions as well as non-financial institutions with anti-money laundering obligations, including the adoption of precautionary and supervisory measures, establishment of various systems for client identification, retention of clients’ identification information and transactions records, and reports on large transactions and suspicious transactions. Financial institutions that are subject to the PRC Anti-Money Laundering Law include banks, credit unions, trust investment companies, stock brokerage companies, futures brokerage companies, insurance companies and other financial institutions as listed and published by the State Council. The PBOC and other governmental agencies issued a series of administrative rules and regulations to specify the anti-money laundering obligations of financial institutions and certain non-financial institutions, such as payment institutions. However, the State Council has not promulgated a list of the non-financial institutions subject to anti-money laundering obligations.

 

Regulations on Publication

 

Restrictions on Offline Distribution

 

According to Regulation on the Administration of Publication promulgated by the State Council on December 25, 2001, and most recently revised on February 6, 2016, “publishing activities” mean the publication, print/reproduction, import and distribution of publications; “publishing entity” includes newspaper offices, periodical offices, book publishing houses, audio and video product publishing houses and electronic publication publishing houses, etc.; “publications” mean the newspapers, periodicals, books, audio and video products and electronic publications, which shall, according to the relevant provisions of the state, state the names and addresses of the author, publisher, typographer/reproducer or distributor, the book number, serial number/version number, data on catalogue in publication, the publication date, issue and other relevant items. Besides, prohibited from being included in any publication are contents that: (i) object to the basic principles determined in the Constitution; (ii) endanger the unity of the nation, sovereignty or territorial integrity; (iii) divulge secrets of the State, endanger national security or damage the honor or benefits of the State; (iv) incite the national hatred or discrimination, undermine the solidarity of the nations, or infringe upon national customs and habits; (v) propagate evil cults or superstition; (vi) disturb the public order or destroy the public stability; (vii) propagate obscenity, gambling, violence or instigate crimes; (viii) insult or slander others, or infringe upon the lawful rights and interests of others; (ix) endanger public ethics or the fine folk cultural traditions; and (x) otherwise prohibited by laws, administrative regulations or provisions of the State.

 

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On June 28, 2012, the General Administration of Press and Publication (one of the predecessors of the General Administration of Press, Publication, Radio, Film and Television, now known as National Radio and Television Administration), or the NRTA, promulgated the Implementing Rules of the General Administration of Press and Publication for Supporting Private Capital’s Participation in Publishing Operation Activities, pursuant to which, NRTA, among other things, (i) continuously supports private capital to invest in the establishment of enterprises of publication issuance, wholesale, retailing and chain operation to engage in the issuance and operation activities of publication products, such as books, newspaper, periodicals, video and audio products and electronic publications; and (ii) continuously supports private capital to invest in the establishment of Internet digital publishing enterprises, including online game publishing, mobile publishing, e-book publishing and content software development to engage in publishing and operation activities.

 

The Administrative Provisions on the Publication Market, or the New Administrative Provisions were jointly issued by the NRTA and MOFCOM on May 31, 2016, and became effective on June 1, 2016. The New Administrative Provisions, which superseded the previous Administrative Provisions on the Publication Market promulgated on March 25, 2011, regulate the activities of publication distribution, including wholesale or retail publication activities, which shall be carried out with the publication operation license. Without licensing, such entity or individual may be ordered to cease illegal acts by the competent administrative department of publication, given a warning, and concurrently subject to a fine.

 

Regulations on Periodical Publication

 

Provisions on the Administration of Periodical Publication promulgated by the NRTA on September 30, 2005, and most recently amended on December 11, 2017, or Periodical Regulation, stipulate that periodicals shall be published by lawfully established periodical publication entities. A periodical publication entity shall, when publishing any periodical, seek the approval of the NRTA, hold a CN Serial Number and obtain a License for Periodical Publication. The NRTA shall, after receiving the application for starting a periodical and establishing a periodical publication entity, make a decision on granting approval or not, and notify the sponsor directly or indirectly via the administrative department of press and publication of the province, autonomous region, or municipality directly under the Central Government. Moreover, a periodical publication entity is prohibited to sell, lease, or transfer the name of its own entity, the serial number or title of the periodical or any section of the periodical it publishes, nor shall it lend, transfer, lease or sell the License for Periodical Publication.

 

Besides, there are several conditions which shall be met for starting a periodical or establishing a periodical publication entity, including: (i) having a fixed name that does not conflict with that of any existing periodical; (ii) having the name and the articles of associations of the periodical publication entity; (iii) having the competent entity in charge and the sponsor that comply with the conditions as determined by the NRTA; (iv) having a clear scope of business for periodical publication; (v) having a registered capital of RMB 300,000 or more; (vi) having an organization that meets the needs of the periodical publication activities and the professional editing personnel that comply with the qualification conditions as prescribed by the state; (vii) having a fixed work place that is situated in the same administrative district as the sponsor; (viii) having a definite legal representative or person-in-charge and the legal representative or the person-in-charge shall be the Chinese citizen who lives permanently within the territory of China; and (ix) other conditions as prescribed by any law or administrative regulations.

 

In addition to the approval formalities, in case any periodical publishes any content involving national security or social stability or other major selected topics, it shall go through the formalities for archival filing in light of the provisions on the administration of archival filing on major selected topics.

 

We provide printed materials containing professional articles, comments, data analysis, industry reports and other chemical industry related information to our users who subscribe for this value-added service for free. We do not think our printed materials fall within the scope of periodicals under the Periodical Regulation which are subject to the requirement of Periodical Publication Permit. However, we cannot assure you that the governmental authorities would agree to our conclusion. If our materials are deemed as periodicals and we are required to obtain the relevant license, we may not be able to obtain the licenses in a timely manner, or at all, and we would conduct our publication business by cooperation with qualified third parties who have already obtained such license and having such third party to publish the printed materials. See “Item 3. Key Information—D. Risk Factors—Risks Related to Our Business and Industry—Failure to obtain, renew, or retain licenses, permits or approvals may affect our ability to conduct or expand our business.”

 

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Regulations on Internet Publication

 

On February 4, 2016, the NRTA and MIIT issued the Provisions on the Administration of Online Publishing Services, which took effect on March 10, 2016, or Online Publication Regulation. According to the Provisions on the Administration of Online Publishing Services, the provision of online publishing services must be subject to the approval of the publication administrative department in accordance with the law, and an Online Publishing Service License shall be obtained. Moreover, there are several specific conditions for entities (except for book, audiovisual, electronic, newspaper and periodical publishers) engaged in Internet publication services to meet, including: (i) having definite website domains, intelligent terminal applications and other publishing platforms for online publishing business; (ii) having a definite scope of Internet publication services; (iii) having technical equipment necessary for engaging in Internet publication services, provided that the relevant servers and storage devices must be located within the territory of the PRC; (iv) having the name and the articles of association for the online publishing service provider, and the name is definite and different from any of those of other publishers; (v) having a legal representative and main responsible person in compliance with the requirements of the PRC, which means that the legal representative must be a Chinese citizen with full civil capacity and permanently residing in the territory of PRC, and that either the legal representative or the main responsible person should have vocational qualifications for technicians engaged in the profession of publishing at or above the intermediate level; (vi) in addition to the legal representative and the main responsible person, having at least eight full-time editorial and publishing employees with technical and vocational qualifications for the profession of publishing and other related professions as approved by the NRTA that can meet the needs within the scope of online publishing services, of which there are at least three employees with professional qualifications at or above the intermediate level; (vii) having a content review system required for online publishing services; (viii) having a fixed work place; and (ix) other conditions as provided by laws, administrative regulations and the NRTA.

 

If any entity arbitrarily engages in Internet publication services without approval, it might be banned by the competent publication administrative department and the administrative department for industry and commerce with statutory agency and a fine up to ten times the illegal operating income may be imposed.

 

In addition, based on the Provisions on the Administration of Online Publishing Services, an annual verification system shall apply to Internet publishing service providers and shall be carried out once every year. The competent administrative departments shall carry out the annual verification of Internet publishing service providers within their respective administrative regions and report relevant information to the NRTA.

 

Regulations on Foreign Investment in Internet Publication

 

On July 6, 2005, the Ministry of Culture (now known as Ministry of Culture and Tourism, or the MOCT), the NRTA, the NDRC, and the MOFCOM jointly adopted the Several Opinions on Canvassing Foreign Investment into the Cultural Sector, or the Opinion on Canvassing Foreign Investment. According to the Opinion on Canvassing Foreign Investment, foreign investors are prohibited from engaging in such business as the Internet publication and offline publication.

 

According to the Provisions on the Administration of Online Publishing Services, the NRTA and its local branches are responsible for the approval, supervision and administration of the Internet publication services nationwide, and any Internet publication service and Internet publication item, or publication of Internet publication item via the Internet is required to obtain an Internet publishing service license. Pursuant to the Internet Publication Measures, Sino-foreign equity joint ventures, Sino-foreign cooperative ventures and foreign invested entities shall not engage in Internet publication services.

 

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We provide digital materials including professional articles, comments, data analysis, industry reports and other chemical industry related information online to our users for free. We do not think our digital materials fall within the scope of online publication as defined under the Online Publication Regulations which requires the service provider to hold an Online Publishing Service License. However, we cannot assure you that the governmental authorities would agree with our conclusion. If our materials are deemed as online publication and we are required to obtain the relevant licenses, we may not be able to obtain the licenses in a timely manner, or at all, and we would conduct our publication business by cooperation with qualified third parties who have already obtained such license and having such third parties to publish the digital materials. See “Item 3. Key Information—D. Risk Factors—Risks Related to Our Business and Industry—Failure to obtain, renew, or retain licenses, permits or approvals may affect our ability to conduct or expand our business.”

 

Regulations on Intellectual Property in the PRC

 

Copyright and Software Products

 

Pursuant to the Copyright Law of the PRC, as amended in 2010, copyrights include personal rights such as the right of publication, the right of attribution, and property rights such as the right of production and right of distribution. Reproducing, distributing, performing, projecting, broadcasting or compiling a work or communicating the same to the public via an information network without permission from the owner of the copyright therein, unless otherwise provided in the Copyright Law of the PRC, shall constitute infringement of copyrights. The infringer shall, according to the circumstances of the case, undertake to cease the infringement, take remedial action, offer an apology, and pay damages, etc.

 

In order to further implement the Regulations for the Protection of Computer Software promulgated by the State Council on December 20, 2001, and amended on January 30, 2013, the National Copyright Administration of the PRC issued the Computer Software Copyright Registration Measures on February 20, 2002, which is applicable to software copyright registration, license contract registration and transfer contract registration. We have registered 123 computer software copyrights as of December 31, 2019.

 

Trademark

 

Pursuant to the Trademark Law of the PRC, as amended in 1993, 2001, 2013 and 2019, and the Implementing Regulations of the Trademark Law of the PRC, issued by the State Council in 2002 and amended on April 29, 2014, the right to exclusive use of a registered trademark shall be limited to trademarks which have been approved for registration and to goods where the use of such trademark has been approved. The period of validity of a registered trademark shall be ten years, counted from the day the registration is approved. According to this law, using a trademark that is identical to or similar to a registered trademark in connection with the same or similar goods without the authorization of the owner of the registered trademark constitutes an infringement of the exclusive right to use a registered trademark. The Trademark Law of the PRC has adopted a “first-to-file” principle with respect to trademark registration. For goods or services that are identical or similar, if the trademark to be applied is identical or similar to another trademark that has already been registered or been used following a preliminary examination and approval, then the application for registration of such trademark may be rejected. An application for trademark registration shall not prejudice any pre-existing right of others. It is prohibited to forestall the registration, through any improper means, of a trademark that is already used by another party and has produced a certain influence. The infringer shall, in accordance with the regulations, undertake to cease the infringement, take remedial action, and pay damages, etc. To date, we have not received any third-party claims against our trademarks or trademark applications.

 

Patent

 

Pursuant to the Patent Law of the PRC, as amended in 2008, after the grant of the patent right for an invention or utility model, except where otherwise provided for in the Patent Law, no entity or individual may, without the authorization of the patent owner, exploit the patent, that is, make, use, offer to sell, sell or import the patented product, or use the patented process, or use, offer to sell, sell or import any product which is a direct result of the use of the patented process, for production or business purposes. The Chinese patent system adopts a first-to-file principle, which means that when more than one person file different patent applications for the same invention, only the person who files the application first is entitled to obtain a patent of the invention. To be patentable, an invention or a utility model must meet three criteria: novelty, inventiveness and practicability. A patent is valid for twenty years in the case of an invention and ten years for a utility model and a design. Once the infringement of patent is confirmed, the infringer shall, in accordance with the regulations, undertake to cease the infringement, take remedial action, and pay damages, etc. To date, we have not received any third-party claims against our patents or patent applications.

 

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Domain Name

 

Pursuant to the Measures on Administration of Internet Domain Names promulgated in November 2004 and effective December 2004, or the 2004 Domain Names Measures, and the Measures for the Administration of Internet Domain Names promulgated in August 2017 and effective November 2017 to replace the 2004 Domain Names Measures, “domain name” shall refer to the character mark of hierarchical structure, which identifies and locates a computer on the internet and corresponds to the internet protocol (IP) address of that computer. The principle of first-to-file is followed for the domain name registration service. The applicants will become the holder of such domain names upon the completion of the registration procedure. Any organization or individual may file an application for settlement with the domain names dispute resolution institution or file a lawsuit in the people’s court in accordance with the law, if such organization or individual consider its/his legal rights and interests to be infringed by domain names registered or used by others. As of December 31, 2019, we have registered 76 domain names.

 

Regulations on Labor Protection in the PRC

 

Labor Law

 

Pursuant to the Labor Law of the PRC promulgated on July 5, 1994, and amended on August 27, 2009 and December 29, 2018, the Labor Contract Law of the PRC promulgated on June 29, 2007, and amended on December 28, 2012, and the Regulations on Implementation of the Labor Contract Law of the PRC promulgated on September 18, 2008, labor relationships between employers and employees shall be specified in written form. Wages shall not be lower than the local standards of minimum wages. Employers must establish and perfect their systems of labor safety and health, strictly implement the State’s rules and standards for labor safety and health, provide education on labor safety and health to laborers. It is stipulated by the Labor Contract Law and the Implementation Regulations on Labor Contract Law that a labor contract must be made in writing. An employer and an employee may enter into a fixed-term labor contract, an un-fixed term labor contract, or a labor contract that agrees upon the completion of certain work assignments, after reaching agreement upon due negotiations. An employer may legally terminate a labor contract and dismiss its employees after reaching agreement upon due negotiations with the employee or by fulfilling the statutory conditions. Labor contracts signed prior to the enactment of the Labor Contract Law and subsisting within the validity period thereof shall continue to be honored. With respect to the circumstance where a labor relationship has already been established but no formal contract has been entered into, a written labor contract shall be entered into within one month from the effective date of the Labor Contract Law.

 

Social Insurance and Housing Fund

 

As required under the Regulation of Insurance for Labor Injury implemented on January 1, 2004, and amended in 2010, the Provisional Measures for Maternity Insurance of Employees of Corporations implemented on January 1, 1995, the Decisions on the Establishment of a Unified Program for Old-Aged Pension Insurance of the State Council issued on July 16, 1997, the Decisions on the Establishment of the Medical Insurance Program for Urban Workers of the State Council promulgated on December 14, 1998, the Unemployment Insurance Measures promulgated on January 22, 1999, and the Social Insurance Law of the PRC implemented on July 1, 2011, and amended in 2018, employers are required to provide their employees in the PRC with welfare benefits covering pension insurance, unemployment insurance, maternity insurance, labor injury insurance and medical insurance. These insurance payments shall be made to local administrative agencies. Any employer that fails to make social insurance contributions may be ordered to rectify the non-compliance and pay the required contributions within a prescribed time limit and be subject to a late fee. If the employer still fails to make the relevant contributions within the prescribed time, it may be subject to a fine ranging from one to three times the amount overdue.

 

In accordance with the Regulations on the Management of Housing Fund, which was promulgated by the State Council in 1999 and amended in 2002 and 2019, employers must register at the designated administrative centers and open bank accounts for depositing employees’ housing funds. Employers and employees are required to pay and deposit housing funds, with an amount no less than 5% of the average monthly salary of the employee in the preceding year in full and on time. The employer shall timely pay up and deposit housing provident fund contributions in full amount and late or insufficient payments shall be prohibited.

 

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Employee Stock Incentive Plan

 

Pursuant to the Notice of Issues Related to the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Listed Company, or Circular 7, which was issued by the State Administration of Foreign Exchange, or the SAFE on February 15, 2012, employees, directors, supervisors, and other senior management who participate in any stock incentive plan of a publicly-listed overseas company and who are PRC citizens or non-PRC citizens residing in China for a continuous period of no less than one year, subject to a few exceptions, are required to register with SAFE or its local branches through a qualified domestic agent, which may be a PRC subsidiary of such overseas listed company, and complete certain other procedures.

 

In addition, the SAT has issued the Notice of the State Administration of Taxation on Relevant Issues of Individual Income Tax Relating to Equity Incentive, or Notice 461 and relevant circulars concerning employee stock options and restricted shares. Under these circulars, employees working in the PRC who exercise stock options or are granted restricted shares shall be subject to PRC individual income tax. The PRC subsidiaries of an overseas listed company are required to file documents related to employee stock options and restricted shares with relevant tax agencies and to withhold individual income taxes of employees who exercise their stock option or purchase restricted shares. If the employees fail to pay or the PRC subsidiaries fail to withhold income tax in accordance with relevant laws and regulations, the PRC subsidiaries may face sanctions imposed by the tax agencies or other PRC governmental agencies. See “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in China—Any failure to comply with PRC regulations regarding the registration requirements for employee stock incentive plans may subject the PRC plan participants or us to fines and other legal or administrative sanctions.”

 

Regulations on Tax in the PRC

 

Enterprise Income Tax

 

On March 16, 2007, the SCNPC promulgated the Enterprise Income Tax Law of the PRC, which was amended on February 24, 2017 and December 29, 2018, and the State Council enacted the Regulations for the Implementation of the Enterprise Income Tax Law, or collectively, the EIT Law. The EIT Law came into effect on January 1, 2008 and was amended on April 23, 2019. Under the EIT Law, both resident enterprises and non-resident enterprises are subject to tax in the PRC. Resident enterprises are defined as enterprises that are established in China in accordance with PRC laws, or that are established in accordance with the laws of foreign countries but are actually or in effect controlled from within the PRC. Non-resident enterprises are defined as enterprises that are organized under the laws of foreign countries and whose actual management is conducted outside the PRC, but have established institutions or premises in the PRC, or have no such established institutions or premises but have income generated from inside the PRC. Under the EIT Law and relevant implementing regulations, a uniform corporate income tax rate of 25% is applied. However, if non-resident enterprises have not formed permanent establishments or premises in the PRC, or if they have formed permanent establishment or premises in the PRC but there is no actual relationship between the relevant income derived in the PRC and the established institutions or premises set up by them, enterprise income tax is set at the rate of 10% with respect to their income from the PRC sources.

 

Value-added Tax

 

The Provisional Regulations of the PRC on Value-added Tax were promulgated by the State Council on December 13, 1993 and came into effective January 1, 1994, which were subsequently amended on November 10, 2008, came into effect on January 1, 2009, and most recently amended on November 19, 2017. The Detailed Rules for the Implementation of the Provisional Regulations of the PRC on Value-added Tax (Revised in 2011) was promulgated by the MOF on December 25, 1993 and subsequently amended on December 15, 2008, and October 28, 2011, or collectively, VAT Law. On November 19, 2017, the State Council promulgated the Decisions on Abolishing the Provisional Regulations of the PRC on Business Tax and Amending the Provisional Regulations of the PRC on Value-added Tax, or the Order 691. In March 2019, MOF, SAT and the General Administration of Customs jointly issued the Circular on Relevant Policies for Deepening the Value-Added Tax Reform, or the Circular 39, effective on April 1, 2019. According to the Provisional Regulations of the PRC on Value-added Tax and the Circular 39, all enterprises and individuals engaged in the sale of goods, the provision of processing, repair and replacement services, sales of services, intangible assets, real property and the importation of goods within the territory of the PRC are the taxpayers of VAT. The VAT tax rates generally applicable are simplified as 13%, 9%, 6%, 0% and the VAT tax rate applicable to the small-scale taxpayers is 5% and 3%.

 

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Dividend Withholding Tax

 

The EIT Law provides that since January 1, 2008, an income tax rate of 10% will normally be applicable to dividends declared to non-PRC resident investors who do not have an establishment or place of business in the PRC, or who 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, or the Double Tax Avoidance Arrangement, and other applicable PRC laws, if a Hong Kong resident enterprise is determined by the competent PRC tax agency 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, or the SAT Circular 81, issued on February 20, 2009, by the 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 agencies 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 effective on April 1, 2018, when determining the applicant’s status as a “beneficial owner” regarding tax treatments in connection with dividends, interest 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 income or levy tax at an extremely low rate, will be taken into account, and they 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 as 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 issued by the SAT on August 27, 2015 and amended on June 15, 2018 which has been further replaced by the Announcement on Issuing the Administrative Measures for Non-Resident Taxpayer’s Enjoyment of the Treatment under Agreements issued by SAT on October 14, 2019 and came into effect on January 1, 2020.

 

Tax on Indirect Transfer

 

On February 3, 2015, the SAT issued the Circular on Issues of Enterprise Income Tax on Indirect Transfers of Assets by Non-PRC Resident Enterprises, or Circular 7. Pursuant to Circular 7, an “indirect transfer” of assets, including equity interests in a PRC resident enterprise, by non-PRC resident enterprises, may be recharacterized and treated as a direct transfer of PRC taxable assets, if such arrangement does not have a reasonable commercial purpose and was established for the purpose of avoiding payment of PRC enterprise income tax. As a result, gains derived from such indirect transfer may be subject to PRC enterprise income tax. When determining whether there is a “reasonable commercial purpose” of the transaction arrangement, factors to be taken into consideration include, inter alia, whether the main value of the equity interest of the relevant offshore enterprise derives directly or indirectly from PRC taxable assets; whether the assets of the relevant offshore enterprise mainly consist of direct or indirect investment in China or if its income is mainly derived from China; and whether the offshore enterprise and its subsidiaries directly or indirectly holding PRC taxable assets have real commercial nature that is evidenced by their actual function and risk exposure. The Circular 7 does not apply to transactions of sale of shares by investors through a public stock exchange where such shares were acquired on a public stock exchange. On October 17, 2017, the SAT issued the Circular on Issues of Tax Withholding regarding Non-PRC Resident Enterprise Income Tax, or SAT Circular 37, which further elaborates on the relevant implemental rules regarding the calculation, reporting and payment obligations of the withholding tax by the non-resident enterprises. Nonetheless, there remain uncertainties as to the interpretation and application of the SAT Circular 7. The SAT Circular 7 may be determined by the tax agencies to be applicable to our offshore transactions or sale of our shares or those of our offshore subsidiaries where non-resident enterprises, being the transferors, were involved.

 

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Regulations on Dividend Distributions

 

The principal regulations governing the distribution of dividends paid by foreign-invested enterprises include the Company Law of PRC issued in 1993 and most recently amended in 2018.  Pursuant to the law above, domestic foreign-invested enterprises shall not distribute any profits as dividend until any losses from prior fiscal years have been offset, if any, as determined in accordance with PRC accounting standards and regulations. Moreover, a PRC company is required to set aside as statutory reserve funds at least 10% of its after-tax profit, until the cumulative amount of such reserve funds reaches 50% of its registered capital unless laws regarding foreign investment provide otherwise. However, these reserve funds may not be distributed as cash dividends.

 

Regulations on Foreign Exchange

 

Regulations on Foreign Currency Exchange

 

Under the PRC Foreign Currency Administration Rules promulgated on January 29, 1996 and most recently amended on August 5, 2008, Renminbi is convertible into other currencies for current account transactions, including dividends distribution, interest payments, trade and service-related foreign exchange transactions, but not for capital account transactions, such as direct investments, loans, repatriation of investments and investments in securities outside of China, unless prior approval is obtained from SAFE and the formalities for registration is made with SAFE.

 

SAFE promulgated the Notice on Reforming the Mode of Management of Settlement of Foreign Exchange Capital of Foreign-Funded Enterprises, or Circular 19, in March 2015 and effective June 2015 and the Notice of the State Administration of Foreign Exchange on Reforming and Standardizing the Administrative Provisions on Capital Account Foreign Exchange Settlement, or Circular 16, in June 2016, which came into effect simultaneously. Under Circular 16, domestic enterprises (including Chinese-funded enterprises and foreign-funded enterprises, but excluding financial institutions) may go through foreign exchange settlement procedures for their external debts at their discretion. According to Circular 19 and Notice 16, the flow and use of the RMB capital converted from registered foreign currency capital of a foreign-invested company are under control. Unless otherwise permitted under its business scope, such RMB capital shall not be directly or indirectly used for transactions beyond its business scope or for providing loans to persons other than affiliates.

 

In February 2015, SAFE promulgated the Notice of the State Administration of Foreign Exchange on Further Simplifying and Improving the Policies of Foreign Exchange Administration Applicable to Direct Investment, or Circular 13, effective on June 1, 2015, which delegates the power to enforce the foreign exchange registration related to inbound and outbound direct investments under relevant SAFE rules from branches of SAFE to banks, thereby further simplifying the procedure of foreign exchange registration for inbound and outbound direct investments.

 

In January 2017, SAFE promulgated the Notice of the State Administration of Foreign Exchange on Further Promoting the Reform of Foreign Exchange Administration and Improving the Examination of Authenticity and Compliance, or Circular 3, effective simultaneously. Circular 3 sets out various capital control measures to tighten authenticity and compliance verification of cross-border transactions and cross-border capital flow, which include, without limitation, requiring banks to verify resolution of the board of directors on distribution of profits (or resolution of partners on distribution of profits), original tax recordation form, and audited financial statements relating to the outward remittance before conducting the outward remittance of profits above US$50,000, and making up for losses in previous years with profits pursuant to the law before it is allowed to remit the profits overseas.

 

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Regulations on Foreign Exchange Registration of Overseas Investment by PRC Residents

 

Notice of the State Administration of Foreign Exchange on Issues concerning Foreign Exchange Administration of the Overseas Investment and Financing and the Round-tripping Investment Made by Domestic Residents through Special-Purpose Companies, or Circular 37, issued and effective in July 2014, regulates foreign exchange matters where PRC residents or entities seek offshore investment and financing and conduct round tripping investment in China via special purpose vehicles, or SPVs. As mentioned in Circular 37, a SPV refers to an overseas enterprise directly formed or indirectly controlled for investment or financing purposes by a domestic resident (domestic institution or domestic resident individual) with the assets or interests it legally holds in a domestic enterprise, or with the overseas assets and interests it legally holds. “Round tripping investment” refers to the direct investments made in China by domestic residents directly or indirectly through SPV, namely, the behavior of establishing foreign-funded enterprises or projects, in which case PRC residents or entities are required to complete foreign exchange registration with SAFE or its local branch. Circular 13 as mentioned above allows Chinese residents or entities to register with qualified banks in connection with their establishment or control of an offshore entity established for the purpose of overseas investment or financing. In addition, such Chinese residents or entities shall update their SAFE registrations when the offshore SPV undergoes material matters relating to any change of basic information (including changes of its Mainland resident individual shareholder, its name, operating period), increase or decrease in contribution by the Mainland resident individual, the transfer or replacement of equity, or merger or division into an SPV. Circular 37 further provides that option or equity incentives owners of a non-listed SPV shall conduct registration with SAFE before exercising their right of option or equity incentives.

 

Under the relevant rules, failure to comply with the registration procedures set forth in the Circular 37 may result in bans on the foreign exchange activities of the relevant onshore company, including the payment of dividends and other distributions to its offshore parent or affiliates, and may also subject relevant PRC residents to penalties under PRC foreign exchange administration regulations.

 

As of December 31, 2019, our PRC resident shareholder Dr. Dongliang Chang has completed required registration with the local counterpart of SAFE in relation to his investment in our company, but Mr. Hao Wang has not yet filed for such registration. For further information, see “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in China—PRC regulations relating to offshore investment activities by PRC residents may limit our PRC subsidiaries’ ability to increase their registered capital or distribute profits to us or otherwise expose us or our PRC resident beneficial owners to liability and penalties under PRC law.”

 

Regulations on M&A and Overseas Listings

 

On August 8, 2006, the MOFCOM, SAMR, SAT, SAFE, the State-owned Assets Supervision and Administration Commission of the State Council and the China Securities Regulatory Commission, or the CSRC, promulgated the Provisions of the Ministry of Commerce on M&A of a Domestic Enterprise by Foreign Investors, or the M&A Rules, effective on September 8, 2006, and amended on June 22, 2009, regulating the mergers and acquisitions of a domestic enterprise by foreign investors. The M&A Rules set out that whenever a domestic company, enterprise or natural person merges its affiliated domestic company in the name of a company legally established or controlled by the aforesaid domestic company, enterprise or natural person in foreign countries or regions, it shall be subject to the approval of the MOFCOM. The M&A Rules also stipulate that where a SPV is to be listed overseas, the listing shall be approved by the CSRC prior to overseas listing and trading of such SPV’s securities on an overseas stock exchange.

 

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C.                                    Organizational Structure

 

The following chart illustrates our corporate structure, including our significant subsidiaries and consolidated variable interest entity as of the date of this annual report on Form 20-F:

 

GRAPHIC

 


Notes:

 

(1)         Dr. Dongliang Chang, Mr. Zhengyu Wu and Zhejiang Xingke Technology Development Investment Co., Ltd. hold 76%, 19% and 5% equity interests in Jiaxing MOLBASE, respectively.

 

(2)         Dr. Dongliang Chang and Mr. Zhengyu Wu hold 80% and 20% equity interests in Shanghai MOLBASE, respectively.

 

The following is a summary of the currently effective contractual arrangements by and among our WFOE, our VIEs and their shareholders.

 

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Agreements that provide us with effective control over the VIEs

 

Shareholders’ Voting Rights Proxy Agreements. On December 21, 2018, our WFOE entered into shareholders’ voting rights proxy agreements with our VIEs and their shareholders. Pursuant to the shareholders’ voting rights proxy agreements, each shareholder of Shanghai MOLBASE and Jiaxing MOLBASE irrevocably authorized our WFOE to act as his or its attorney-in-fact to exercise all of his or its rights as a shareholder of the respective VIE, including, but not limited to, the right to convene and attend shareholders’ meetings, vote on any resolution that requires a shareholder vote, such as the appointment of legal representative, directors, and officers, as well as other shareholders’ voting rights permitted by the articles of association of the VIEs. The shareholders’ voting rights proxy agreement will remain effective, as long as the shareholders of the VIEs remain as registered shareholders of the VIEs, unless otherwise instructed by our WFOE in writing.

 

Equity Pledge Agreements. On December 21 2018, our WFOE entered into equity pledge agreements with our VIEs and their shareholders. Pursuant to the equity pledge agreements, the shareholders of the VIEs have pledged 100% equity interests in the VIEs to our WFOE to guarantee performance by the shareholders of their obligations under the respective exclusive technical support and services agreement, exclusive option agreement and shareholders’ voting rights proxy agreement, or together referred to as the “Master Agreements.” In the event of a breach by the VIEs or any of their shareholders of contractual obligations under the Master Agreements or the equity pledge agreement, our WFOE, as pledgee, will be entitled to dispose of the pledged equity. The VIEs and their shareholders also undertake that, without the prior written consent of our WFOE, the shareholders of the VIEs will not dispose of, create or allow any encumbrance on the pledged equity interests. The equity pledge agreements will remain effective until our VIEs and their shareholders discharge all their obligations under the Master Agreements. We have registered such equity pledges with relevant governmental authority.

 

Agreement that allows us to receive economic benefits from the VIEs

 

Exclusive Technical Support and Services Agreements. On December 21, 2018, our WFOE and our VIEs entered into exclusive technical support and services agreements. Pursuant to the exclusive technical support and services agreements, our WFOE has the exclusive right to provide the VIEs with comprehensive technology and business support as well as the relevant consultations services required by the business of the VIEs, or to appoint a third party to provide the VIEs with such services. Without our WFOE’s prior written consent, the VIEs may not directly or indirectly accept any services that are identical or similar to the services provided by our WFOE under the respective exclusive technical support and services agreement from any third party. The VIEs agree to pay our WFOE a quarterly service fee, which is at our WFOE’s discretion. Our WFOE has the exclusive ownership of all the intellectual property rights created as a result of the performance of the exclusive technical support and services agreement to the extent permitted by applicable PRC law. During the term of the agreements, the VIEs shall not accept any consultations and/or services provided by any third party and shall not cooperate with any third party for the provision of identical or similar services without prior consent of our WFOE. The exclusive technical support and services agreements will remain effective for ten years and will be renewed thereafter upon the written confirmation of our WFOE.

 

Agreement that provides us with the option to purchase the equity interests in and assets of the VIEs

 

Exclusive Option Agreements. On December 21, 2018, our WFOE entered into exclusive option agreements with our VIEs and their shareholders. Pursuant to the exclusive option agreements, each of the shareholders of the VIEs has irrevocably granted our WFOE an exclusive option to purchase, or have its designated third party to purchase, at its discretion, to the extent permitted under PRC law, all or part of his or its equity interests in the VIEs. Our WFOE or any third party designated by our WFOE may exercise such options at the price of RMB1.0, or such other price as agreed by WFOE and the VIE shareholders based on the then appraised value, if required by PRC Laws. Any proceeds received by the nominee shareholders from the exercise of the options shall be remitted to the WFOE or its designated party, to the extent permitted by the PRC law. The VIEs undertake that, without our WFOE’s prior written consent, they will not, among other things, (i) change their registered capital or shareholding structure, (ii) amend their articles of association, (iii) create any pledge or encumbrance on any of their assets, (iv) undertake any debt or enter into any material contract with an aggregate value (except in the ordinary course of business), or (v) merge with any other entity. In addition, the shareholders of the VIEs undertake that, without our WFOE’s prior written consent, they will not create any pledge or encumbrance on their equity interests in the VIEs, or transfer or otherwise dispose of their equity interests in the VIEs. The exclusive option agreements will remain effective until all equity interests in the VIEs have been transferred to our WFOE or its designated third party.

 

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In the opinion of Global Law Office, our PRC legal counsel:

 

·                  the ownership structures of our VIEs in China and our WFOE are not in violation of applicable PRC laws and regulations currently in effect; and

 

·                  the contractual arrangements between our Company, our WFOE, our VIEs and their shareholders governed by PRC law are valid, binding and enforceable, and will not result in any violation of applicable PRC laws and regulations currently in effect.

 

However, our PRC legal counsel has also advised us that there are substantial uncertainties regarding the interpretation and application of current and future PRC laws, regulations and rules. Accordingly, the PRC regulatory authorities may take a view that is contrary to the opinion of our PRC legal counsel. It is uncertain whether any new PRC laws or regulations relating to VIE structures will be adopted or if adopted, what they would provide. If we or any of our VIEs are found to be in violation of any existing or future PRC laws or regulations, or fail to obtain or maintain any of the required permits or approvals, the relevant PRC regulatory authorities would have broad discretion to take action in dealing with such violations or failures. See “Item 3. Key Information—D. Risk Factors—Risks Related to Our Corporate Structure—If the PRC government deems that the contractual arrangements in relation to our VIEs and their subsidiary do not comply with PRC regulatory restrictions on foreign investment in the relevant industries, or if these regulations or the 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.”

 

D.                                    Property, Plant and Equipment

 

Our corporate headquarter is located in Shanghai, China. We lease an aggregate of approximately 7,040 square meters of office spaces in Shanghai, Jiaxing and Shaanxi from unrelated third parties under operating lease agreements, with a lease term from one year to three years. We do not hold any facilities of our own. We believe that our existing facilities are generally adequate to meet our current needs, but we expect to seek additional space as needed to accommodate future growth.

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included elsewhere in this annual report on Form 20-F. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Item 3. Key Information—D. Risk Factors” or in other parts of this annual report on Form 20-F.

 

A.                                    Operating Results

 

Key Factors Affecting Our Results of Operations

 

Our results of operations and financial condition are affected by the general factors driving China’s chemical e-commerce industry, including, among others, (i) China’s overall economic growth, (ii) continued demand and price trends for chemicals and related products, (iii) business prospects of our customers and suppliers, (iv) growth of e-commerce, internet usage and the chemical e-commerce market penetration rate, (v) governmental policies and initiatives affecting the chemical industry and the e-commerce industry, and (vi) regulation on data collection and internet, as well as the other general factors affecting the chemical e-commerce industry in domestic and overseas markets. Unfavorable changes in any of these general industry conditions could negatively affect demand for our products and services and materially and adversely affect our results of operations.

 

The outbreak of COVID-19 has adversely affected our business operations and financial conditions. See “Item 3. Key Information—D. Risk Factors—Risks Related to Our Business and Industry— Our business has been and is likely to continue to be materially adversely affected by the outbreak of COVID-19 in China.”

 

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While our business is influenced by these general factors, our results of operations are more directly affected by company-specific factors, including the following major factors:

 

·                  Our ability to attract, maintain and expand our user base and user activity;

 

·                  Our ability to diversify and grow chemicals portfolio and services;

 

·                  Our ability to establish and maintain relationships with suppliers and service providers;

 

·                  Our ability to create value for participants in our ecosystem and increase monetization;

 

·                  Our ability to develop and leverage our technology capacities in a cost-effective manner;

 

·                  Our ability to control costs and expenses and improve efficiency; and

 

·                  Our ability to manage working capital.

 

Our ability to attract, maintain and expand our user base and user activity

 

We generate our profits primarily from the price difference between the purchase price and the sales price of the chemicals from our e-commerce business under our direct sales model. Therefore, the size and characteristics of our user base on our platform and the GMV the customers and suppliers generate significantly affect our revenue and results of operations. We monitor GMV under both direct sales and marketplace models as the indicator for the scale of each model and our Online Platform as well as the engagement of our customers and suppliers. Our user base has been expanding over the past few years. Our registered users increased from 132,869 by December 31, 2017 to 178,220 by December 31, 2018, and further increased to 229,980 by December 31, 2019. Our accumulated customers and suppliers increased from 65,983 and 31,171 by December 31, 2017 to 94,373 and 33,752 by December 31, 2018, and further increased to 116,291 and 35,456 by December 31, 2019, respectively. We need to continue to maintain a large and active customer and supplier base that conduct chemicals transactions on our Online Platform and use our comprehensive value-added services to improve our results of operations and monetization.

 

We devoted considerable resources to marketing activities and user traffic acquisition as we have grown our business. To achieve profitability, we must be able to retain and expand our user base and user activity in a cost-effective manner.

 

Our ability to diversify and grow chemicals portfolio and services

 

Our operation results are affected by the mix of chemicals and value-added services that we offer on our Online Platform. We currently derive our revenues primarily from the sale of chemicals on our Online Platform. We also earn commission fee from marketplace customers or suppliers who request our chemicals transaction services if the transaction we help match is completed. In addition, we have started to charge users of our SaaS suite to improve profitability and diversify our revenue stream.

 

Different products and services have different cost structures. The revenue contributions from our direct sales model, our marketplace model, our online membership services and the initiatives we recently launched have a major influence on our profitability. We plan to better manage the mix of our chemicals portfolio and service offerings in order to improve our profitability.

 

Our ability to establish and maintain relationships with suppliers and service providers

 

We rely on suppliers for sourcing chemicals and third-party service providers for value-added services. Our relationship with suppliers and service providers are essential to our e-commerce solutions. Our ability to provide a broad selection of chemicals and value-added services on our Online Platform at competitive and transparent prices depends on our ability to maintain good relationships with them. As we expand our business scale, we must maintain our strong relationships with suppliers and service providers to ensure chemicals and services supply.

 

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Our ability to create value for participants in our ecosystem and increase monetization

 

Our operation results depend on our ability to create value for participants in our ecosystem and offer more monetization opportunities for them. We draw customers, suppliers and other service providers to our Online Platform because our ecosystem has established a closed-loop value chain driven by our intelligent matching systems, creating value for all participants in the ecosystem. Within such closed-loop ecosystem, we are able to utilize the resources of its participants and effectively direct demands and supplies, thus performing as a supply chain management hub to create a compelling value proposition to the participants.

 

As transaction volume continues to increase, our warehousing and logistics service providers and financing providers can execute more transactions in a timely and cost-effective manner, whereas our customers can have access to comprehensive services with competitive costs. We must achieve and increase monetization of our value-added services, including, among others, business intelligence services, financial solutions, and warehousing and logistics solutions. As we further enhance our technologies, we aim to create more value for the ecosystem participants, increasing their engagement and connection in our ecosystem, which we anticipate will create additional monetization venues for us to drive our revenue growth.

 

Our ability to leverage our technology capabilities in a cost-effective manner

 

We have incurred significant expenses in building our platform and developing capabilities in data analytics and AI technology. Our ability to leverage our technology capabilities to develop and enhance our platform and services in a cost-effective manner affects our revenue and results of operations. We expect to continue investing in research and development as we continue to develop and enhance our data analytics and AI technology capabilities, whereas we expect that such expenses will not increase sharply either in absolute terms or as a percentage of our total revenue as we leverage our knowledge engine and achieve more economies of scale.

 

Our ability to control costs and expenses and improve efficiency

 

Our cost of revenues represents primarily the purchase price of chemicals. As our business further grows in scale, we expect to obtain more favorable terms from suppliers, including pricing terms, credit period and volume-based rebates. In addition, we aim to create value for our suppliers, especially chemical companies, by providing an effective and transparent channel for selling of their products on our Online Platform and by offering them valuable business intelligence on market demand, customer preferences and supply chain information. We believe this value proposition will also help us deepen our relationships with suppliers, obtain favorable terms and reduce our procurement costs.

 

Our sales and marketing expenses are a significant contributor to our operating costs and expenses, and they primarily consist of salaries and travel expenses for sales and marketing personnel and advertising costs. We expect our sales and marketing expenses to remain substantial as we implement new business initiatives.

 

Our ability to manage working capital

 

Our ability to effectively control our working capital has affected and will continue to affect our cash flow from operations. We actively manage our trade receivables and our trade payables. We leverage our scale to negotiate attractive contractual terms with our customers, merchants and suppliers.

 

Key Line Items and Specific Factors Affecting Our Results of Operations

 

Net revenues

 

Our net revenues are primarily generated from sales of chemicals under direct sales model, provision of chemical trading matching service under marketplace model and provision of online membership services. Currently, substantially all of our net revenues are derived from sales of chemicals under direct sales model. Under direct sales model, we generally acquire chemicals from suppliers after the customers place an order and sell them directly to customers primarily through our Online Platform. We also generate revenues from chemical trading under marketplace model, online membership service and recently financial solutions, which represented immaterial portion of our net revenues for the years ended December 31, 2017, 2018 and 2019.

 

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The following table sets forth the components of our net revenues by amounts and percentages of our total revenues for the periods presented:

 

 

 

For the Year Ended December 31,

 

 

 

2017

 

2018

 

2019

 

 

 

RMB

 

%

 

RMB

 

%

 

RMB

 

US$

 

%

 

 

 

(in thousands, except for percentages)

 

Net Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Chemical trading—direct sales model

 

4,199,661

 

99.9

 

9,045,458

 

99.9

 

13,167,719

 

1,891,424

 

99.7

 

Chemical trading—marketplace model

 

972

 

0.0

 

4,387

 

0.1

 

26,513

 

3,808

 

0.2

 

Online membership service

 

1,274

 

0.1

 

3,421

 

0.0

 

10,650

 

1,530

 

0.1

 

Financial service

 

 

 

 

 

917

 

132

 

0.0

 

Others

 

 

 

 

 

1,516

 

218

 

0.0

 

Total revenues

 

4,201,907

 

100.0

 

9,053,266

 

100.0

 

13,207,315

 

1,897,112

 

100.0

 

 

Chemical trading—direct sales model. We generate a substantial majority of our net revenues from chemical trading under our direct sales model. We generally acquire chemicals from suppliers after the customers place an order and sell them directly to customers primarily through our Online Platform as well as handle the delivery of the chemicals.

 

Chemical trading—marketplace model. Our chemical trading under marketplace model provide an integrated supplier-customer matching system, directing demands and supplies in a cost-effective manner. We generate revenue by charging commission fees, the amount of which is at our discretion for the periods presented, upon the completion of our matching services.

 

Online membership service. We generate revenue from the service fees charged to our online members in relation to the membership services, including advertising services and market updates. The service provided to the online members are unique and member-specific with no other alternative use. We typically charge a fixed amount for the service subscribed over the membership term.

 

Financial service. We cooperate with banks and non-bank financial institutions to provide financial solutions to certain customers and suppliers who use our Online Platform. We charge a fixed fee for the facilitation service provided among the customers, suppliers and the banks and non-bank financial institutions and the guarantees provided on the loan repayments as stipulated in the purchase agreements for the underlying chemicals transactions.

 

We expect our business to be affected by COVID-19 and its impact on economic climate and business conditions, although we are unable to provide an accurate account of its effect as of the date of this annual report. See “Item 3. Key Information—D. Risk Factors—Risks Related to Our Business and Industry— Our business has been and is likely to continue to be materially adversely affected by the outbreak of COVID-19 in China.”

 

Costs of revenues

 

Our costs of revenues represent the cost of chemicals that we sold.

 

Gross margin

 

Our gross margin is mainly affected by the selling price, chemical sales volume and the cost of chemicals. The following table sets forth our gross profit and gross margin for each of the periods presented:

 

 

 

For the Year Ended December 31,

 

 

 

2017

 

2018

 

2019

 

 

 

(RMB in thousands, except for percentage data)

 

Gross profit

 

50,234

 

80,169

 

100,773

 

Gross margin

 

1.2

%

0.9

%

0.8

%

 

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Operating expenses

 

Our operating expenses consist of sales and marketing expenses, general and administrative expenses, research and development expenses, allowance for doubtful accounts and impairment for long-term investment. The following table sets forth the components of our operating expenses by amounts and percentages of operating expenses for the periods presented:

 

 

 

For the Year Ended December 31,

 

 

 

2017

 

2018

 

2019

 

 

 

RMB

 

%

 

RMB

 

%

 

RMB

 

US$

 

%

 

 

 

(in thousands, except for percentages)

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing expenses

 

(64,962

)

45.9

 

(103,293

)

32.7

 

(108,858

)

(15,636

)

37.1

 

General and administrative expenses

 

(41,718

)

29.5

 

(173,872

)

55.0

 

(104,471

)

(15,007

)

35.7

 

Research and development expenses

 

(18,608

)

13.2

 

(36,889

)

11.7

 

(45,038

)

(6,469

)

15.4

 

Allowance for doubtful accounts

 

(14,677

)

10.4

 

(1,907

)

0.6

 

(34,618

)

(4,972

)

11.8

 

Impairment for long-term investment

 

(1,450

)

1.0

 

 

 

 

 

 

Total operating expenses

 

(141,415

)

100.0

 

(315,961

)

100.0

 

(292,985

)

(42