As filed with the Securities and Exchange Commission on February 5, 2019

Registration No. 333-228510

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

Amendment No. 3 to

FORM F-1

REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933

 

 

 

Puyi Inc.

(Exact Name of Registrant as Specified in its Charter)

 

Cayman Islands   8900   Not applicable
(State or Other Jurisdiction of   (Primary Standard Industrial   (I.R.S. Employer
Incorporation or Organization)   Classification Code Number)   Identification Number)

 

42F, Pearl River Tower

No. 15 Zhujiang West Road, Zhujiang New Town, Tianhe, Guangzhou

Guangdong Province, People’s Republic of China

Tel: +86-020-28381666

(Address, including zip code, and telephone number, including area code, of principal executive offices)

 

Cogency Global Inc.

10 E. 40th Street, 10th Floor,

New York, NY 10016

+1-212-947-7200

(Name, address, including zip code, and telephone number, including areas code, of agent for service)

 

Copies to:

 

Kefei Li, Esq.

Sidley Austin LLP

Suite 608, Tower C2, Oriental Plaza

No. 1 East Chang An Avenue, Dong Cheng District Beijing 100738, People’s Republic of China

Tel: +86-10-5905-5588

 

Fang Liu, Esq.

Mei & Mark LLP

818 18th Street NW, Suite 410

Washington, DC 20006

(202) 567-6417 

 

Approximate date of commencement of proposed sale to the public:

 

As soon as practicable after this Registration Statement becomes effective.

 

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ☒

 

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

 

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

 

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

 

Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933. Emerging growth company. ☒

 

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards † provided pursuant to Section 7(a)(2)(B) of the Securities Act.  ☐

 

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

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 

 

 

 

CALCULATION OF REGISTRATION FEE

 

Title of Each Class of Securities to be Registered

  Proposed
maximum
offering price
per share(1)
   Amount of
registration
fee(3)
 
Ordinary shares, par value $0.001 per share(2)  $40,000,000   $4,848 

 

(1)

The registration fee for securities to be offered by the Registrant is based on an estimate of the Proposed Maximum Aggregate Offering Price of the securities, and such estimate is solely for the purpose of calculating the registration fee pursuant to Rule 457(a).

   
(2)

In accordance with Rule 416(a), the Registrant is also registering an indeterminate number of additional ordinary shares that shall be issuable pursuant to Rule 416 to prevent dilution resulting from share splits, share dividends or similar transactions.

   
(3)

Previously paid.

 

 

  

 

 

 

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and is not soliciting an offer to buy these securities in any state or other jurisdiction where the offer or sale is not permitted.  

SUBJECT TO COMPLETION, DATED February 5, 2019

 

Puyi Inc.

4,000,000 American depositary shares representing 6,000,000 ordinary shares (minimum offering amount)

 

6,666,668 American depositary shares representing 10,000,002 ordinary shares (maximum offering amount)

 

 

 

This is the initial public offering of ADSs, by Puyi Inc. Two ADSs represent three ordinary shares, par value $0.001 per share. We expect that the initial public offering price will be between $6.0 and $7.5 per ADS.

No public market currently exists for our ADSs or ordinary shares. We will apply for list the ADSs on the NASDAQ Global Market. We have reserved the symbol “PUYI” for listing on the NASDAQ Global Market. We believe that upon the completion of the offering contemplated by this prospectus, we will meet the standards for listing on the NASDAQ Global Market.

We are an “emerging growth company” as defined in the Jumpstart Our Business Act of 2012, as amended, and, as such, will be subject to reduced public company reporting requirements.

An investment in our securities is highly speculative, involves a high degree of risk and should be considered only by persons who can afford the loss of their entire investment. See “Risk Factors” beginning on page 11 of this prospectus.  

    Minimum offering amount     Maximum offering amount  
    Per ordinary share     Total     Per ordinary share     Total  
Initial public offering price   US$                   US$                   US$                   US$                
Commissions to the underwriter (7%) for sales to investors introduced by the underwriter(1)   US$                   US$                   US$                   US$                
Proceeds to our company before expenses(1)(2)   US$                   US$                   US$                   US$                

 

(1) We have agreed to pay Network 1 Financial Securities, Inc. (the “Underwriter”) a fee equal to 7% of the gross proceeds of the offering from investors introduced by the Underwriter and a fee equal to 5% of the gross proceeds of the offering from investors introduced by us. The calculation above is based on the assumption that all shares sold in this offering were to investors introduced by the Underwriter. Proceeds to the company will be higher if any shares sold in this offering were to investors introduced by us. See “Underwriting” in this prospectus for more information regarding our arrangements with the Underwriter.
(2) The total estimated expenses related to this offering are set forth in the section entitled “Underwriting - Discounts, Commissions and Expenses.”

 

The underwriter is selling our ADSs in this offering on a best efforts basis. The offering is being made without a firm commitment by the underwriter, which has no obligation or commitment to purchase any securities. The underwriter must sell the minimum number of securities offered (4,000,000 ADSs) if any securities are sold. The underwriter is required to use only its best efforts to sell the securities offered. One of the conditions to our obligation to sell any securities through the underwriter is that, upon the closing of the offering, the ADSs would qualify for listing on the NASDAQ Global Market. 

We do not intend to close this offering unless we sell at least a minimum number of ADS, at the price per ADS set forth above, to result in sufficient proceeds to list our ADSs on the NASDAQ Global Market. Because this is a best efforts offering, the underwriter does not have an obligation to purchase any securities, and, as a result, there is a possibility that we may not be able to sell the minimum offering amount. The offering may close or terminate, as the case may be, on the earlier of (i) any time after the minimum offering amount of our ADSs is raised, or (ii) 90 days from the date of effectiveness of this prospectus (and for a period of up to 90 additional days if extended by agreement between us and the underwriter). The proceeds from the sale of the ADSs in this offering will be deposited in a separate (limited to funds received on behalf of us) non-interest bearing bank account at JP Morgan Chase established by our escrow agent, or the Escrow Account, until the minimum offering amount is raised. If we can successfully raise the minimum offering amount within the offering period, the proceeds from the offering will be released to us. 

If we do not receive a minimum of US$30,000,000 by            , 2019, all funds will be returned to the investors in this offering promptly after the termination of the offering, without charge, deduction or interest. Prior to                 , 2019, in no event will funds be returned to the investors unless the offering is terminated. 

Neither the Securities and Exchange Commission nor any state securities commission nor any other regulatory body has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. 

The underwriter expects to deliver the ADSs through the book-entry facilities of The Depository Trust Company.

Prospectus dated            , 2019

 

 

 

TABLE OF CONTENTS

 

Prospectus Summary 1
The Offering 7
Summary Consolidated Financial Data 9
Risk Factors 11
Special Note Regarding Forward-looking Statements 39
Use of Proceeds 40
Dividend Policy 41
Exchange Rate Information 42
Capitalization 43
Dilution 44
Selected Consolidated Financial Data 46
Management’s Discussion and Analysis of Financial Condition and Results of Operations 48
Industry 70
Corporate History and Structure 80
Business 84
Regulation 100
Management 110
Related Party Transactions 114
Principal Shareholders 115
Description of Share Capital 117
Description of American Depository Shares 125
Shares Eligible for Future Sale 134
Taxation 135
Enforceability of Civil Liabilities 140
Underwriting 141
Expenses Related to This Offering 145
Legal Matters 146
Experts 147
Where You Can Find Additional Information 148
Index to Consolidated Financial Statements F-1

 

Until                   , 2019 (the 25th day after the date of this prospectus), all dealers that buy, sell or trade ADSs, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

You should rely only on the information contained in this prospectus and any free writing prospectus we may authorize to be delivered to you. We have not, and the underwriter has not, authorized anyone to provide you with information different from, or in addition to, that contained in this prospectus and any related free writing prospectus. We and the underwriter take no responsibility for, and can provide no assurances as to the reliability of, any information that others may give you. This prospectus is not an offer to sell, nor is it seeking an offer to buy, these securities in any jurisdiction where the offer or sale is not permitted. The information contained in this prospectus is only accurate as of the date of this prospectus, regardless of the time of delivery of this prospectus and any sale of our ADSs. Our business, financial condition, results of operations and prospects may have changed since that date. 

 

i

 

 

PROSPECTUS SUMMARY

 

This summary highlights information that we present more fully in the rest of this prospectus. This summary does not contain all of the information you should consider before buying our ADSs in this offering. You should read the entire prospectus carefully, including the “Risk Factors” section and the financial statements and the notes to those statements. In addition, this prospectus contains information from a market research report prepared by China Insights Consultancy, or CIC, an independent industry consultant (the “CIC Report”) which was commissioned by us to provide information on our industry and market in China.

 

Our Business

 

Puyi is the largest third-party wealth management services provider in China focusing on mass affluent and emerging middle class population, with a 10.4% market share based on 2017 transaction value, according to CIC. We are also the 21st largest third-party wealth management services provider overall in China based on the same metric, according to the same source.

 

According to CIC, the size of China’s mass affluent and emerging middle class totaled 502.0 million with investable assets of RMB115.3 trillion (US$17.4 trillion) at the end of 2017. Currently, a majority of the mass affluent and emerging middle class population in China rely on wealth management products issued and distributed by commercial banks. In April 2018, China’s banking and securities regulators jointly released the Guidelines on Standardizing Asset Management Businesses of Financial Institutions, or the 2018 Guidelines, which aimed at reining in the banks’ supply of off-balance sheet wealth management products and breaking traditional implicit guarantee of returns on wealth management products. As a result, the number of new products issued by banks have declined significantly. It is expected that the mass affluent and emerging middle class population in China will increasingly turn to third-party wealth management service providers for investment advisory services relating to market-oriented products.

 

We provide wealth management services, corporate finance services and asset management services. Our largest business has been our wealth management services business, under which we distribute wealth management products both online and offline through our branch network. Products distributed online include publicly raised fund products, exchange administered products and asset management plans. Products distributed offline through our branch network are privately raised fund products. (Because we derive revenue from sales commissions paid by product providers of wealth management products, such as fund managers, issuers of exchange administered products and asset management plans, for accounting purposes, we treat these product providers as “customers”. We deem “clients” to be the purchasers of the products we distribute.) For the year ended June 30, 2017 and the year ended June 30, 2018, the aggregate transaction value of the wealth management products we distributed totaled RMB5.6 billion and RMB6.0 billion (US$0.9 billion), respectively. In addition, we have a substantial corporate finance services business, under which we provide corporate borrowers with financing solutions, including product design, identification of sources of funding, compliance and risk management. We also have a newly-established and fast-growing asset management business under which we currently manage two FoFs and in preparation of new FoFs and NPL funds.

 

We adopt a unique social e-commerce sales model to develop our client base. Our approach consists of identifying, fostering and collaborating with seed clients—existing clients who believe in our service capabilities—to actively market our products or services on social media platforms to their families, friends and acquaintances. Our seed clients are supported by our approximately 100 investment advisors, who are responsible for providing seed clients with systematic and continuous professional training on our product offering as well as investment and asset allocation. As of June 30, 2016, 2017 and 2018, the number of our seed clients increased from approximately 16,000 to 25,200 and further to 35,000. Currently we have seed clients in 168 cities in 20 provinces across China. As of June 30, 2018, approximately 20.4% of our total clients were seed clients, but approximately 98% of our total sales for the year ended June 30, 2017 and 2018 were all generated by our seed clients.

 

 

1

 

 

 

We have experienced significant growth in recent years. Our net revenues increased from RMB155.7 million for the year ended June 30, 2017 to RMB165.8 million (US$25.1 million) for the year ended June 30, 2018, primarily due to increases in net revenues from (i) corporate finance services which we began offering at the beginning of 2017; and (ii) asset management services which we launched in 2018. Such increases were partially offset by a decrease in net revenue from our wealth management services, which was primarily due to a combination of (i) an increasing proportion of net revenues derived from distribution of privately raised fund products for which we recognize revenue on a net-commission basis as opposed to a gross-commission basis; and (ii) a decrease in transaction value of exchange administered products as a result of the changing governmental regulatory environment from December 2017 to April 2018. In the foreseeable future, we expect net revenues generated from corporate finance services and asset management services to continue increasing as we continue to expand such services. We also expect the net revenues generated from exchange administered products to increase as we currently do not anticipate further regulatory changes relating to these products. In addition, we expect the total net revenues from distribution of privately raised fund products to continue to increase. However, because our product providers have sole discretion in selecting the sales model (i.e. net commission based or gross commission based), the respective proportion of products offered on a net-commission basis or a gross-commission basis may vary from year to year.

 

Our net income increased from RMB39.6 million for the year ended June 30, 2017 to RMB63.6 million (US$9.6 million) for the year ended June 30, 2018, primarily due to a combination of (i) a decrease in operating costs and expenses primarily as a result of an increasing proportion of net revenues derived from distribution of products for which we recognize revenue on a net-commission basis as described above; (ii) increases in net revenues driven by corporate finance services and asset management services; and (iii) increases in investment income and interest income.

 

Our total assets increased from RMB191.7 million as of June 30, 2017 to RMB225.7 million (US$34.1 million), primarily due to (i) an increase in cash and cash equivalents; (ii) purchase of commercial acceptance notes with a principal amount of RMB11.4 million in May 2018; and (iii) short-term loans receivables as a result of a loan to a third party in June 2018, partially offset by a significant decrease in amount due from related parties.

 

Our Industry

 

According to CIC, the wealth management services market in China is at an early stage of development and is currently highly fragmented. Major types of service providers include (i) commercial banks; (ii) non-bank traditional financial institutions, or non-bank TFI, such as securities firms, fund managers and insurance companies with internal sales arm; (iii) online-based service providers; and (iv) third-party wealth management service providers that are not associated with financial institutions.

 

According to CIC, mass affluent population in China is defined as those with investable assets of between RMB600,000 (US$100,000) to RMB6 million (US$1 million), and the emerging middle class is defined as those with investable assets of between RMB30,000 (US$5,000) to RMB600,000 (US$100,000). Driven by China’s economic growth and accelerated urbanization rates, the size of China’s mass affluent and emerging middle class population has grown rapidly, increasing from 403.7 million in 2013 to 502.0 million in 2017 and is expected to further increase to 642.9 million in 2022, while the percentage of the total population with investable assets increased from 40.6% in 2013 to 48.7% in 2017, and is expected to reach 59.3% in 2022. The amount of investable assets held by such population segments increased from RMB58.2 trillion (US$8.8 trillion) in 2013 to RMB115.3 trillion (US$17.4 trillion) in 2017, and is expected to further increase to RMB192.1 trillion (US$29.0 trillion) in 2022. Despite the vast private wealth held by the emerging middle class and mass affluent population, the current penetration rate of wealth management services in such population segments in China is only less than 25%, which is significantly lower than 50% in the United States, according to CIC. The market size of China’s wealth management services for mass affluent and emerging middle class population in terms of transaction value increased from RMB7.8 trillion (US$1.2 trillion) in 2013 to RMB25.2 trillion (US$3.8 trillion) in 2017, or a CAGR of 34.2%, and is expected to further increase to approximately RMB47.3 trillion (US$7.1 trillion) by 2022, or a CAGR of 13.4% from 2017 to 2022, according to the same source.

 

Compared with the other three types of service providers, third-party wealth management institutions generally have advantages in terms of service capabilities in addition to comprehensive product offering. According to CIC, China’s third-party wealth management services market for the mass affluent and emerging middle class population experienced a CAGR of 42.8% from 2013 to 2017 in terms of transaction value, and is expected to reach RMB2,709.6 billion (US$409.5 billion) in 2022, representing a CAGR of 25.2% from 2017 to 2022. According to the same source, the key market trends and drivers in the third-party wealth management services market for mass affluent and emerging middle class population include (i) strengthening supervision of commercial banks, especially after the release of the 2018 Guidelines; (ii) increasing supply of diversified and market-oriented products due to a shortage of bank-distributed wealth management products; (iii) changes in asset allocation and investment preference of mass affluent and emerging middle class population with increasing investment in market-oriented products; and (iv) increasing complexity of the market.

 

2

 

 

Competitive Strengths

 

We believe that the following competitive strengths differentiate us from our competitors and have contributed to our rapid and significant growth to date:

 

our market position as the largest third-party wealth management services provider focusing on China’s mass affluent and emerging middle class population with growing asset management capabilities;

 

our unique social e-commerce based sales model driven by seed clients;

 

our prudently selected and developed products meeting the specific needs of our client base;

 

our collaboration with diverse and high-quality industry players; and

 

our visionary senior management team and experienced business team.

 

Business Strategy

 

Our business strategy includes the following components:

 

  continue our expansion while focusing on our target client base;

 

strengthen our product offering;

 

continue to invest in our IT infrastructure; and

 

Enhance our brand recognition in our target markets.

 

Our Challenges and Risks

 

Our ability to achieve our goals and execute our strategies is subject to risks and uncertainties, including those associated with:

 

our ability to identify or fully appreciate various risks related to wealth management products we distribute;

 

our ability to maintain or renew existing licenses or to obtain additional licenses and permits necessary to our business;

 

our ability to continue to retain or expand our primary client base targeting the mass affluent and emerging middle class population;

 

our ability to adapt to changes in laws and regulations governing the wealth management industry and asset management industry in China;

 

our ability to recruit and retain qualified seed clients;

 

our ability to collaborate with highly qualified product providers, retain our existing major product providers, or seek alternative or engage new product providers where necessary;

 

the investment performance of wealth management products we distribute and/or manage;

 

fee rates of our services;

 

competition in the wealth management services industry in China; and

 

our use of a variable interest entity, or VIE, to operate our private equity businesses.

 

See “Risk Factors” for a detailed discussion of these and other factors you should consider before making an investment in our ordinary shares.

 

3

 

 

Corporate Information

 

Puyi Inc. was incorporated in the Cayman Islands on August 6, 2018. Our principal executive offices are located at 42F, Pearl River Tower, No. 15 Zhujiang West Road, Zhujiang New Town, Tianhe, Guangzhou, Guangdong Province, People’s Republic of China, 510620. Our telephone number is +86-020-2838-1666. Our registered office in the Cayman Islands is Avalon Trust & Corporate Services Ltd., Landmark Square, 1st Floor, 64 Earth Close, PO Box 715, Grand Cayman KY1 1107, Cayman Islands. Investors should submit any inquiries to the address and telephone number of our principal executive offices.

 

Our main website is www.puyiwm.com. The information contained on our website is not a part of this prospectus. Our agent for service of process in the United States is Cogency Global Inc., located at 10 E. 40th Street, 10th Floor, New York, NY 10016.

 

Corporate History and Structure

 

We commenced our wealth management services business in November 2010 when our founder, chairman of the board and chief executive officer, Mr. Yu Haifeng, founded Fanhua Puyi Investment Management Co., Ltd. (泛华普益投资管理有限公司), or Fanhua Puyi, in November 2010. Fanhua Puyi was renamed Fanhua Puyi Fund Distribution Co., Ltd. (泛华普益基金销售有限公司) in March 2013.

 

In 2018, in preparation for our initial public offering, we completed a number of corporate restructuring steps, including:

 

Establishing offshore holding companies. In August 2018, we incorporated Puyi Inc. as our offshore holding company in the Cayman Islands. In July 2018, we incorporated Puyi Group Limited in the British Virgin Islands, which became the wholly owned subsidiary of Puyi Inc. in August 2018. In July 2018, we incorporated Puyi Holdings (Hong Kong) Limited, or Puyi HK, which became the wholly owned subsidiary of Puyi Group Limited in August 2018.

 

Establishing WFOE. In August 2018, our PRC WFOE, Puyi Enterprises Management Consulting Co., Ltd. (普益企业管理咨询有限公司), or Puyi Consulting, was incorporated in Chengdu, Sichuan, PRC. In December 2018, WFOE acquired 100% equity interest of Shenzhen Baoying Factoring Co., Ltd. (深圳宝盈商业保理有限公司) from Guangdong Puyi Asset Management Co., Ltd (广东普益资产管理有限公司) and a third party.

 

Transferring of operating entities. We transferred a number of entities with related businesses under the control of Mr. Yu Haifeng to become subsidiaries of Chengdu Puyi Bohui Information Technology Co., Ltd. (成都普益博汇信息技术有限公司), or Puyi Bohui, our variable interest entity, or VIE. Puyi Bohui has been primarily engaged in providing information technology services to the financial services industry in China. The entities transferred to Puyi Bohui included the following:

 

Fanhua Puyi, which has been the principal entity engaged in wealth management services business. See above. We initially set up Fanhua Puyi with an 84.59% equity interest with the remaining 15.41% held by Beijing Fanlian Investment Co., Ltd. (北京泛联投资有限公司), or Beijing Fanlian, a third party. On September 3, 2018, we purchased the remaining equity interest from Beijing Fanlian in exchange for (i) a cash consideration of RMB10,028,117; and (ii) new issuance of 4,033,600 ordinary shares of our company to Fanhua Inc. at a consideration of US$1,468,976.8.

 

Guangdong Puyi Asset Management Co., Ltd. (广东普益资产管理有限公司) (previously known as Guangdong Fanhua Puyi Asset Management Co., Ltd.), or Puyi Asset Management, which primarily operates our FoF business. Puyi Asset Management currently has one subsidiary, Shenzhen Qianhai Zhonghui Huiguan Investment Management Co., Ltd. (深圳前海中惠惠冠投资管理有限公司), in which Puyi Asset Management holds 51% interest (acquired in July 2018), which primarily operates our non-performing loan management business.

 

Shenzhen Puyi Zhongxiang Information Technology Co., Ltd. (深圳普益众享信息科技有限公司), which primarily distributes our exchange administered products.

 

Chongqing Fengyi Management Consulting Co., Ltd. (重庆锋毅企业管理咨询有限公司), which primarily operates our corporate finance service business.

 

Due to restrictions imposed by PRC laws and regulations on foreign ownership of companies that engage in asset management, Puyi Consulting entered into a series of contractual arrangements with Puyi Bohui and its shareholders, through which Puyi Consulting has gained full control over the management and receives the economic benefits of Puyi Bohui. See “— Contractual Arrangements.”

 

4

 

 

The following diagram illustrates our corporate structure, including our subsidiaries, interests and consolidated variable interest entities as of the date of this prospectus:

 

 

 

---------►Equity interest

 

◄- - - -►Contractual arrangement, including the exclusive option agreements, the equity interest pledge agreement, the powers of attorney, the spousal consent, the exclusive technical and consulting services agreement.

 

(1)Puyi Bohui is held by Mr. Yu Haifeng as to 99.04% and Ms. Yang Yuanfen as to 0.96% respectively.

  

(2) The remaining 49% of the equity interest is owned by two independent third parties as to 48% and 1%, respectively.

 

Implications of Being an Emerging Growth Company and a Foreign Private Issuer

 

We are an “emerging growth company,” as defined in the JOBS Act, and we are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies” including not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a non-binding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We have not made a decision whether to take advantage of any or all of these exemptions. If we do take advantage of any of these exemptions, we do not know if some investors will find our common shares less attractive as a result. The result may be a less active trading market for our common shares and the price of our common shares may be more volatile.

 

5

 

 

In addition, Section 107 of the JOBS Act also provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933 (the “Securities Act”) for complying with new or revised accounting standards. In other words, an “emerging growth company” can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We are choosing to “opt in” to such extended transition period for complying with new or revised accounting standards under Section 102(b)(2) of the JOBS Act, which allows us to delay the adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies.

 

We will remain an “emerging growth company” until the earliest of (i) the last day of the first fiscal year in which our annual gross revenues exceed US$1.07 billion, (ii) the last day of our fiscal year following the fifth anniversary of the completion of this offering; (iii) the date that we become a “large accelerated filer” as defined in Rule 12b-2 under the Securities Exchange Act of 1934 (the “Exchange Act”), which would occur if the market value of our common shares that is held by non-affiliates exceeds $700 million as of the last business day of our most recently completed second fiscal quarter, or (iv) the date on which we have issued more than $1 billion in non-convertible debt during the preceding three-year period. Once we cease to be an emerging growth company, we will not be entitled to the exemptions provided in the JOBS Act discussed above.

 

We are incorporated in the Cayman Islands, and more than 50 percent of our outstanding voting securities are not directly or indirectly held by residents of the United States. Therefore, we are a “foreign private issuer” as defined in Rule 405 under the Securities Act and Rule 3b-4(c) under the Exchange Act. As a result, we are not subject to the same requirements as U.S. domestic issuers. As a foreign private issuer, we may take advantage of certain provisions in the NASDAQ listing rules that allow us to follow Cayman Islands law for certain corporate governance matters. Under the Exchange Act, we will be subject to reporting obligations that, to some extent, are more lenient and less frequent than those of U.S. domestic reporting companies. For example, we will not be required to issue quarterly reports or proxy statements. We will not be required to disclose detailed individual executive compensation information. Furthermore, our directors and executive officers will not be required to report equity holdings under Section 16 of the Exchange Act and will not be subject to the insider short-swing profit disclosure and recovery regime.

 

Conventions that Apply to this Prospectus

 

Unless otherwise indicated or the context otherwise requires, references in this prospectus to:

 

“CAGR” refers to compound annual growth rate;

 

“China” or the “PRC” refers to the People’s Republic of China, excluding, for the purpose of this prospectus only, Hong Kong special administrative region, Macau special administrative region and Taiwan;

 

“CIC” refers to China Insights Consultancy Limited, the industry consultant;

 

“EIT” refers to PRC enterprise income tax;
   
 

“FoF(s)” refers to fund(s) of funds;

 

“MOFCOM” refers to the Ministry of Commerce of the PRC;

 

“NPL(s)” refers to non-performing loan(s);
   
 “PIPE” refers to private investment in public equity;

 

“Puyi,” “we,” “us,” “our company,” and “our” refer to Puyi Inc. and its subsidiary and consolidated entity;
   
 “QDII” refers to Qualified Domestic Institutional Investor;

 

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

 

“SAFE” refers to the State Administration of Foreign Exchange;
   
 “TMT” refers to the telecommunications, media and technology;

 

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

 

“VIE” refers to variable interest entity.

 

Our reporting currency is in Renminbi because all of our business in conducted in China and all of our revenues are denominated in Renminbi. This prospectus contains translations of Renminbi amounts into U.S. dollars at specific rates solely for the convenience of the reader. The conversion of Renminbi into U.S. dollars in this prospectus is based on the exchange rate set forth in the H.10 statistical release of the Board of Governors of the Federal Reserve System. Unless otherwise noted, all translations from Renminbi to U.S. dollars and from U.S. dollars to Renminbi in this prospectus were made at a rate of RMB6.6171 to US$1.00, the exchange rate on June 29, 2018 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, the rates stated below, or at all. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the conversion of Renminbi into foreign exchange and through restrictions on foreign trade. On January 25, 2019, the exchange rate for Renminbi was RMB6.7748 to US$1.00.

 

6

 

 

The Offering

 

Offering price  

We currently estimate that the initial public offering price will be between $6.0 per ADS and $7.5 per ADS.

     
ADSs offered by us   Minimum of 4,000,000 ADSs and maximum of 6,666,668 ADSs.
     
ADSs outstanding Immediately after this offering   4,000,000 ADSs if the ADSs are offered and sold at the minimum offering amount in this offering, or 6,666,668 ADSs if the ADSs are offered and sold at the maximum offering amount in this offering.
     
Lock-up agreements   We, our directors and officers  named in “Management”, our existing shareholders have agreed with the underwriters not to sell, transfer or dispose of any ADSs or similar securities for a period of 180 days after the date of this prospectus. See “Shares Eligible for Future Sales” and “Underwriting.”
     
Ordinary shares outstanding Immediately before this offering   84,033,600 ordinary shares
     
The ADSs   Two ADSs represent three ordinary shares, par value $0.001 per share. The depositary will hold ordinary shares underlying your ADSs. You will have rights as provided in the deposit agreement among us, the depositary and holders and beneficial owners of ADSs from time to time.   We do not expect to pay dividends in the foreseeable future. If, however, we declare dividends on our ordinary shares, the depositary will pay you the cash dividends and other distributions it receives on our ordinary shares after deducting its fees and expenses in accordance with the terms set forth in the deposit agreement.   You may turn in your ADSs to the depositary in exchange for ordinary shares. The depositary will charge you fees for any exchange.   We may amend or terminate the deposit agreement without your consent. If you continue to hold your ADSs after an amendment to the deposit agreement, you agree to be bound by the deposit agreement as amended.   To better understand the terms of the ADSs, you should carefully read the “Description of American Depositary Shares” section of this prospectus. You should also read the deposit agreement, which is filed as an exhibit to the registration statement that includes this prospectus.
     
Depositary   Deutsche Bank Trust Company Americas

  

Best efforts

 

The underwriter is selling our ADSs on a “best efforts” basis.

 

We do not intend to close this offering unless we sell at least a minimum number of ADSs, at the price per ADS set forth on the cover page of this prospectus, to result in sufficient proceeds to list our ADSs on the NASDAQ Global Market.

We expect that delivery of the ADSs will be made to investors through the book-entry facilities of The Depository Trust Company.

     
Offering period   The ADSs are being offered for a period of 90 days commencing from the date of this prospectus (and for a period of up to 90 additional days if extended by agreement between us and the underwriter). If the minimum offering amount is not raised within 90 days from the date of this prospectus, all subscription funds from the escrow account will be returned to investors promptly without interest (since the funds are being held in a non-interest bearing account) or deduction of fees. The offering may close or terminate, as the case may be, on the earlier of (i) any time after the minimum offering amount of our ADSs is raised, or (ii) 90 days from the date of this prospectus (and for a period of up to 90 additional days if extended by agreement by us and the underwriter). If we can successfully raise the minimum offering amount within the offering period, the proceeds from the offering will be released to us from the escrow account.

 

7

 

 

Escrow account  

The proceeds from the sale of the ADSs in this offering will be payable to “Continental Stock Transfer & Trust AAF Puyi Inc. Escrow Account” and will be deposited in a separate non-interest bearing bank account (limited to funds received on our behalf) until the minimum offering amount is raised. No interest will be available for payment to either us or the investors (since the funds are being held in a non-interest bearing account). All subscription funds will be held in escrow pending the raising of the minimum offering amount and no funds will be released to us until the completion of the offering. Release of the funds to us is based upon the Escrow Agent (defined below) reviewing the records of the depository institution holding the escrow to verify that the funds received have cleared the banking system prior to releasing the funds to us. All subscription information and subscription funds through checks or wire transfers should be delivered to the Escrow Agent. Failure to do so will result in subscription funds being returned to the investor. If we do not receive a minimum of US$30,000,000 by                , 2019, all funds will be returned to the investors in this offering by noon of the next business day after the termination of the offering, without charge, deduction or interest. Prior to , 2018, in no event will funds be returned to the investors unless the offering is terminated. The investors will only be entitled to receive a refund of their subscription price if we do not raise a minimum of US$30,000,000 by                   , 2019. No interest will be paid either to us or to the investors. We have appointed Continental Stock Transfer & Trust Company, an independent third party, as our escrow agent, or the “Escrow Agent”.

 

8

 

 

SUMMARY CONSOLIDATED FINANCIAL DATA

 

The following summary consolidated statements of income data for the year ended June 30, 2017 and 2018, and summary consolidated balance sheet data as of June 30, 2017 and 2018 and summary consolidated cash flow data as of June 30, 2017 and 2018 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. Our consolidated financial statements are prepared and presented in accordance with generally accepted accounting principles in the United States of America, or U.S. GAAP. You should read this Summary Consolidated Financial Data income data section together with our consolidated financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. Our historical results are not necessarily indicative of results expected for future periods.

 

Summary Consolidated Statements of Income data:

 

  

For the year ended June 30,

 
  

2017

  

2018

  

2018

 
   RMB   RMB   US$ 
   (combined, in thousands) 
Net revenues:            
Wealth management services   144,925    140,403    21,218 
Corporate finance services   773    13,710    2,072 
Asset management services   -    103    16 
Information technology services and others   9,993    11,595    1,752 
Total net revenues   155,691    165,811    25,058 
Operating costs and expenses:               
Cost of sales   (53,397)   (28,825)   (4,356)
Selling expenses   (34,969)   (45,470)   (6,872)
General and administrative expenses   (20,088)   (28,623)   (4,326)
Total operating costs and expenses   (108,454)   (102,918)   (15,554)
Income from operations   47,237    62,893    9,504 
Other income, net:               
Investment income   1,715    5,144    777 
Interest income   51   3,640    550 
Interest expenses   (2,311)   -    - 
Others, net   843    201    31 
Income from continuing operations before income taxes and discontinued operations   47,535    71,878    10,862 
Income tax expense   (7,641)   (8,261)   (1,248)
Net income from continuing operations   39,894    63,617    9,614 
Net loss from discontinued operations, net of tax   (254)   -    - 
Net income   39,640    63,617    9,614 
less: net income (loss) attributable to non-controlling interests   1,827    (979)   (148)
Net income attributable to the Company’s shareholders   37,813    64,596    9,762 

 

9

 

 

  

   For the year ended June 30, 
   2017   2018   2018 
   RMB   RMB   US$ 
  

(combined)

 
             
Net income per share:            
Basic and Diluted            
Net income from continuing operations   0.476    0.807    0.122 
Net loss from discontinued operations   (0.003)   -    - 
Net income   0.473    0.807    0.122 
                
Weighted average number of shares used in computation:               
Basic:   80,000,000    80,000,000    80,000,000 
Diluted   80,000,000    80,000,000    80,000,000 

 

Summary Consolidated Balance Sheet Data, Statements of Financial Position

 

   As of June 30, 
   2017   2018   2018 
   RMB
(combined)
   RMB   US$ 
   (in thousands) 
Total current assets   185,127    214,574    32,427 
Total assets   191,663    225,866    34,134 
Total current liabilities   33,113    32,214    4,869 
Total liabilities   33,113    32,214    4,869 
Total equity interest attributable to the company   148,712    184,793    27,927 
Non-controlling interests   9,838    8,859    1,338 

 

Summary Consolidated Statements of Cash Flow Data:

 

   For the year ended June 30, 
   2017   2018   2018 
   RMB   RMB   US$ 
   (combined, in thousands) 
Net cash (used in) provided by operating activities    (23,069)   44,916    6,788 
Net cash provided by investing activities   21,074    10,047    1,518 
Net cash used in financing activities   (26,194)   -    - 
Net (decrease) increase in cash and cash equivalents, and restricted cash   (28,189)   54,963    8,306 
Cash and cash equivalents at beginning of year   85,226    57,037    8,620 
Cash and cash equivalents at end of year   57,037    112,000    16,926 

 

 

10

 

 

RISK FACTORS

 

An investment in our ADSs involves significant risks. You should consider carefully all of the information in this prospectus, including the risks and uncertainties described below, before making an investment in our ADSs. Any of the following risks could have a material adverse effect on our business, financial condition and results of operations. In any such case, the market price of our ADSs could decline, and you may lose all or part of your investment.

 

Risks Related to Our Business and Industry

 

The wealth management products that we distribute involve various risks and our failure to identify or fully appreciate such risks will negatively affect our reputation, client relationships, operations and prospects.

 

Under our wealth management services, we distribute a broad variety of wealth management products. The products we distribute can be divided into products distributed online and those distributed offline. These products often have different structures and involve various risks, including default risks, interest risks, liquidity risks and other risks. Our success in distributing these products depends, in part, on our successful identification and full appreciation of risks associated with such products. Not only must we keep pace with third-party wealth management product providers and prudently select products, but we must also accurately describe the products to, and evaluate them for, our clients. Although we seek to implement strict risk management policies and procedures, our risk management policies and procedures may not be fully effective in mitigating the risk exposure of our clients in all market environments or against all types of risks. Moreover, clients could experience losses on raised capital as a result of poor investment performance by our distributed funds. In addition, in the event that any of the distributed funds under our management were to perform poorly, it would be more difficult for us to raise new capital. If we fail to identify and fully appreciate any of the aforementioned risks associated with products we distribute to our clients, or fail to disclose such risks to our clients, and as a result our clients suffer financial loss or other damages resulting from their purchase of the wealth management products following our wealth management and product recommendations and services, our reputation, client relationships, business and prospects will be materially and adversely affected.

 

If we fail to maintain or renew existing licenses or to obtain additional licenses and permits necessary to conduct our operations in China pursuant to applicable laws and regulations from time to time governing our operations, we may be subject to limitations or uncertainties with respect to our business activities and render our operations non-compliant, and our business would be materially and adversely affected.

 

China’s wealth management marketplace is a relatively new and evolving industry, and the laws and regulations governing our services are still developing. There are substantial uncertainties as to the legal system and the interpretation and implementation of the PRC laws and regulations applicable to the wealth management industry. To date, the PRC government has adopted a unified regulatory framework governing the distribution and management of publicly raised fund products and asset management plans issued by securities companies; however, currently only an interim regulatory framework exists to govern privately raised fund products. In addition, only two regulatory documents issued by the State Council set out the prohibitive provisions regarding local financial assets exchanges and exchange administered products. Exchange administered products are currently mainly subject to the regulation of the local office of finance at the provincial and municipal levels.

 

11

 

 

Currently, a license is required for the distribution of publicly raised fund products and asset management plans issued by securities companies. The distribution of privately raised fund products by non-licensed distributors is not prohibited by the current applicable laws and regulations. Fanhua Puyi has obtained a fund distribution license from CSRC and we entered into a majority of fund distribution agreements with fund managers through this subsidiary. To comply with PRC laws and regulations, for certain privately raised fund products and asset management plans, we may collect distribution commissions in the form of advisory service fees under advisory service agreements with fund managers which is not prohibited by the current applicable laws and regulations.

 

In addition, fund managers managing privately raised funds are required to register with Asset Management Association of China, or AMAC; unregistered individuals or institutions are not permitted to conduct securities investment activities under the names of “funds” or “fund management.” We are in the process of applying for the license to operate as a fund manager for privately raised funds. To comply with PRC laws, we currently collaborate with licensed fund managers and structure our fund management services as advisory services to them. Neither the fund management services under advisory service agreements with fund managers, nor our service fees generated from such agreements are prohibited by the applicable laws and regulations. However, we cannot assure you that the relevant PRC government will agree with our interpretation of the relevant laws and regulations. If the PRC government interprets the relevant rules differently and deems our role in such arrangements requiring the fund management license, it may order us to cease our provision of fund management services until our relevant entities successfully acquire the fund management license. We cannot assure you that our relevant entities will be able to obtain the fund management license promptly, if at all, and any failure to do so would require us to permanently cease such services, which may materially and adversely affect our business.

 

As the wealth management services industry in China is at an early stage of development, new applicable laws and regulations may be adopted to address new issues that arise from time to time or to require additional licenses and permits for distribution of products other than funds such as asset management plans and exchange administered products. As a result, substantial uncertainties exist regarding the evolution of the regulatory system and the interpretation and implementation of current and any future Chinese laws and regulations applicable to the wealth management services industry.

 

We cannot assure you that we will be able to maintain our existing licenses and permits, renew any of them when their current term expires or obtain additional licenses requisite for our future business expansion. If we are unable to maintain and renew one or more of our current licenses and permits, or obtain such renewals or additional licenses requisite for our future business expansion on commercially reasonable terms, our operations and prospects could be materially disrupted. Moreover, new PRC regulations promulgated in the future may require that we obtain additional licenses or permits in order to continue to conduct our business operations; however, we can give no guarantee that we would be able to obtain such licenses or permits in a timely fashion, or at all. If any of the foregoing were to occur, our business, financial condition and prospects would be materially and adversely affected.

 

12

 

 

If certain categories of products currently traded on local financial assets exchanges become restricted or prohibited, or if local financial assets exchanges are prohibited from listing exchange administered products, our business, financial condition and prospects would be materially and adversely affected.

 

Since December 2016, we have collaborated with two local financial assets exchanges, namely, Tianjin Financial Asset Exchange and Guangzhou Financial Asset Exchange, to distribute financial products administered by them. From the fourth quarter of 2018, we started to collaborate with two additional financial assets exchanges based in Guizhou and Xiamen, respectively. Unlike fund products and asset management plans, the PRC government has not adopted a regulatory framework governing such local exchanges or the listing, trading and distribution of exchange administered products. The local financial assets exchanges are established upon approval of the local governments, and the exchange administered products listed and traded on these exchanges are filed with and approved by local financial assets exchanges under the supervision of the offices of finance at the municipal and provincial levels. As a result, the major product types selected for distribution on such exchanges are dependent upon the local regulatory environment and policies. If any significant product types are discouraged by the local government authorities, our product portfolio, distribution services and related revenues may be negatively impacted. For example, historically a significant number of exchange administered products we distributed were for purposes of real estate development financing and local government financing, and many were highly leveraged. Since the end of 2017, as a result of the changing governmental regulatory environment to support industries in the “new economy” and consumption economy, the number of real estate financing products and securities investment products decreased dramatically from December 2017 to April 2018 and adversely affected the transaction value and revenue of our distribution services.

 

In addition, although the local financial exchanges are regulated by the local government subject to the two prohibitive provisions issued by the State Council, we cannot guarantee that they would not be covered by the tightened national financial supervision system. If they are subject to approval or guidance of any national regulatory bodies, such as the People’s Bank of China, China Banking and Insurance Regulatory and Administration Committee, or the CSRC, these financial exchanges may be prohibited from listing certain or all of the products currently traded on such exchanges, or be prohibited from engaging in such listing and trading services. In such circumstances, we may have to change our business model or cease to distribute exchange administered products, and as a result, our business, financial condition and prospects would be materially and adversely affected.

 

We may not be able to continue to retain or expand our primary client base targeting the mass affluent and emerging middle class population or maintain or increase the amount of investment made by our primary clients in the products we distribute.

 

We target China’s large population of mass affluent and emerging middle class individuals as our clients. In light of China’s rapidly-evolving wealth management industry, we cannot assure you that we will be able to maintain and increase the number of our clients or that our existing clients will maintain the same level of investment in the wealth management products that we distribute. As China’s wealth management industry is at an early stage of development and is currently highly fragmented, we face competition from numerous types of market players including commercial banks, non-bank traditional financial institutions and online-based service providers. Moreover, many of our existing and future competitors may be better equipped, adopt better sales and marketing approach to focus on our target clients, and may capture market opportunities to grow their client bases more effectively compared to us. In addition, the evolving regulatory landscape of China’s financial service industry may not affect us and our competitors proportionately with respect to the ability to maintain or grow our client base. We may lose our leading position if we fail to maintain or further grow our client base at the same pace. A decrease in the number of our clients or a decrease in their spending on the products that we distribute may reduce revenues derived from our wealth management services and our asset management services. If we fail to continue to meet our clients’ expectations on the returns from the products we distribute or manage or if they are no longer satisfied with our services, they may leave us for our competitors and our reputation may be damaged by these clients, which may in turn adversely affect our financial condition, results of operations and ability to attract new clients.

 

13

 

 

If we are required to obtain ICP licenses for the operation of our two apps, we may not be able to offer relevant information and transaction processing services and our business and operations may be negatively affected.

 

We have launched two mobile apps, “Puyi Fund” (普益基金) and “Puyitou” (普益投), to facilitate our clients to complete transaction online for publicly raised fund products and exchange administered products, respectively. We do not have any web-based online platforms. According to the Provisions on the Administration of Mobile Internet Application Information Services, or the App Provisions, issued by Cyberspace Administration of China on June 28, 2016, any owner or operator providing information services through a mobile internet application, or an “app,” must obtain the relevant qualification(s) as required by laws and regulations. The App Provisions, however, do not further clarify the scope of “information services,” nor do they specify what “relevant qualification(s)” that an app owner/operator must obtain. In practice, operational activities of a company conducted through an app is currently subject to the supervisions of local departments of the Information Communications Administration, and often, the local departments differentiate the operational activities conducted through websites and through apps. In many cases, standalone apps through which a company provides information services without any web-based online services are not required to obtain ICP licenses. However, the interpretation and enforcement of such laws and regulations are subject to substantial discretion of the local authorities. We cannot rule out the possibility that the local departments of the Information Communications Administration would take the view that the current primary information services and transaction processing services provided by us through the two apps would require an ICP license, or that without such license, we would be prohibited from rendering such services. If such ICP licenses are required for our two apps, our inability to obtain them in a timely manner or at all may have a material adverse effect on our business and operations.

 

If we fail to recruit and retain qualified seed clients, our business could suffer.

 

We rely on our seed clients to market our products or services to potential clients as well as to provide services to and to develop and maintain relationships with our existing clients. As we further grow our business and expand into new cities and regions, our need for high quality seed clients will increase. We have been actively recruiting and will continue to recruit qualified seed clients to join our coverage network. However, there is no assurance that we can recruit and retain a sufficient number of seed clients who meet our high quality requirements to support our further growth. In some of the branch offices that we have recently established or plan to establish, the client pool from which we can recruit seed clients is smaller than in major economic centers such as Shanghai and Beijing. Even if we are able to recruit sufficient seed clients, we may need to incur significant training and administrative related expenses in order to prepare them to market our products or services, which would increase our operating costs and reduce our profitability. In addition, we pay our seed clients commissions as returns. Although such commissions are currently not prohibited by applicable laws and regulations, we cannot assure you that relevant authorities would not deem that our seed clients are distributing products on our behalf and prohibit such commissions in the future. If so, we may be subject to fines and/or may be ordered to cease paying such fees to our seed clients, we may be unable to attract and retain highly productive seed clients, and our business could be materially and adversely affected.

 

14

 

 

We rely on highly qualified product providers that we collaborate with.

 

We view our collaborative relationships as a core asset for developing our wealth management business, product portfolios and professional networks. We source products from quality third-party providers in China, including 17 fund managers, three leading securities firms and four local financial assets exchanges to date. These parties have contributed to a majority of our fund products and all of our asset management plans and exchange administered products. In addition, we also actively seek collaborative opportunities with well-recognised fund managers to manage our FoFs, which can help us to deliver returns to our clients in a cost-effective manner. As such, our business is heavily dependent on our relationships with these third parties. Although we have maintained stable relationships with them, any material deterioration or termination of our relationships with any major product providers, or fund managers, or the failure to further expand our network with such third parties, could inhibit our ability to secure products or manage funds, which in turn would have a material adverse effect on our business, financial condition and growth prospects. In addition, a decline in the financial condition of one or more our third party product providers may expose us to credit losses or defaults, limit our access to liquidity or otherwise disrupt the operations of our businesses. Downgrades in the credit or financial strength ratings assigned to the counterparties with whom we collaborate or other adverse reputational impacts to such counterparties could create the perception that our financial condition will be adversely impacted as a result of potential future defaults by such counterparties, thereby having a negative impact on our business and operating performance as well as on the confidence in our products.

A decline in the investment performance of products distributed or managed by us could negatively impact our revenues and profitability. 

Investment performance is a key competitive factor for products distributed or managed by us. Strong investment performance helps us to retain and expand our client base and helps us to generate new sales of products and services, and therefore is an important element to our goals of maximizing the value of products and services provided to our clients or the assets under management, or AUM. There can be no assurance as to how future investment performance will compare to our competitors or that historical performance will be indicative of future returns. Any drop or perceived drop in investment performance as compared to our competitors could cause a decline in sales of our investment products and services. These impacts may also reduce our aggregate amount of assets under management and management fees. Poor investment performance could also adversely affect our ability to expand the distribution of third-party wealth management products and our self-developed products. 

In addition, the profitability of our growing asset management services depends on, among others, fees charged based on the AUM under management. Any impairment on the assets that we manage, whether caused by fluctuations or downturns in the underlying markets or otherwise, will reduce our revenues generated from asset management business, which in turn may materially and adversely affect our overall financial performance and results of operations. 

Any material change in fund sales models adopted by the fund managers that we collaborate with may have a significant impact on our revenues, cost of sales and results of operations.

Our largest business line is wealth management services, and a significant majority of our wealth management services revenue is derived from privately raised fund products. Currently in China, a product provider (i.e. a fund manager) of privately raised fund products has sole discretion in selecting the sales model of its fund products as under either a direct sales model or distributions on a commission basis model. The sale model selected by the fund manager determines whether we need to pay commissions to seed clients and thereby recognize such commissions as our cost of sales. Under the direct sales model, we generate revenue on net-commission basis. In contrast, we generate revenue on a gross-commission basis under the distribution on commission basis model. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Major Factors Affecting Our Results of Operations - Product Mix.” Moreover, the fund manager can subsequently change the sales model during the term of the relevant fund. Given that the selection of the sales model is at the sole discretion of the fund manager and is outside of our control, the respective proportion of products that we offer on a net-commission basis or a gross-commission basis may vary from year to year, which may lead to fluctuations in our net revenues, cost of sales and gross margin. For the year ended June 30, 2018, as one of our major product providers that previously elected to distribute under the gross-commission model subsequently changed its distribution model to net-commission based, our revenue from fund products under the net commission model increased significantly to RMB51.9 million (US$7.8 million) from RMB5.2 million for the year ended June 30, 2017 while our revenue from fund products under the gross commission model significantly decreased to RMB36.9 million (US$5.6 million) from RMB80.5 million for the year ended June 30, 2017. Our operating costs and expenses as a percentage of our revenue decreased from 69.7% for the our year ended June 30, 2017 to 62.1% for the year June 30, 2018. As a result of the foregoing, any material change in fund sales models adopted by our fund managers may have a significant impact on our revenues, cost of sales and results of operations.

Any material decrease in the fee rates for our services may have an adverse effect on our revenues, cash flow and results of operations. 

We derive a majority of our revenues from distribution commissions and performance-based fees from wealth management services, the management fees and carried interest from the funds that we manage and service fees from our corporate finance services. The relative fee rates are negotiated between us and third-party product providers or the investors or corporate borrowers, and vary from product to product. Although the fee rates within any given category of the products we distribute or manage remained relatively stable during the applicable periods referenced in this prospectus, future fee rates may be subject to change based on the prevailing political, economic, regulatory, taxation and competitive factors that affect product providers or investors. In addition, the fee rates of our corporate finance services depend on complexity of financing needs and designed structure of each deal. These factors, which are not within our control, include the capacity of product providers to place new business and realize profits, client demand and preference for wealth management products and financing services, the availability of comparable products from other product providers at a lower cost and the availability of alternative wealth management products to clients. In addition, the historical volume of wealth management products that we distributed or managed may have a significant impact on our bargaining power with third-party wealth management product providers in relation to the fee rates for future products. Because we do not determine, and cannot predict, the timing or extent of fee rate changes with respect to the wealth management products as well as fund management and corporate finance services, it is difficult for us to assess the effect of any of these changes on our operations. In order to maintain our relationships with the product providers and to enter into contracts for new products, we may have to accept lower distribution commission rates or other less favorable terms, which could reduce our revenues. Furthermore, as we continue to grow our corporate finance business and asset management business, we may face similar fee rates risk in connection with the provision of related services.

 

15

 

 

We depend on a small number of third-party product providers to derive a significant portion of our net revenues and this dependence is likely to continue.

 

We derive a significant portion of our net revenues from a limited number of third-party wealth management product providers. For accounting purposes, we treat these third-party product providers as our customers under our wealth management services. For the fiscal years ended June 30, 2017 and 2018, three of our product providers each accounted for more than 10% of our total net revenues and collectively accounted for 74.3% and 72.5% of our total net revenues, respectively. If we lose any one of our major product providers or any of these product providers significantly reduces its volume of business with us, our net revenues and profitability would be substantially reduced if we are unable seek alternative product providers on a timely basis, or at all. In addition, the product volume we source and distribute from specific product providers may vary from period to period, particularly because we are not the exclusive distributor for any particular product provider. Our high customer concentration may also adversely affect our ability to negotiate fee rates with these product providers, which may in turn materially and adversely affect our results of operations.

 

Our risk management policies and procedures may not be fully effective in identifying or mitigating risk exposure in all market environments or against all types of risk, including employee and seed client misconduct.

 

We have devoted significant resources to developing our risk management policies and procedures and will continue to do so. Nonetheless, our policies and procedures to identify, monitor and manage risks may not be fully effective in mitigating our risk exposure in all market environments or against all types of risk. Many of our risk management policies are based upon observed historical market behavior or statistics based on historical models. During periods of market volatility or due to unforeseen events, the historically derived correlations upon which these methods are based may not be valid. As a result, these methods may not predict future exposures accurately, which could be significantly greater than what our models indicate. This could cause us to incur investment losses or cause our hedging and other risk management strategies to be ineffective. Other risk management methods depend upon the evaluation of information regarding markets, clients, catastrophe occurrence or other matters that are publicly available or otherwise accessible to us, which may not always be accurate, complete, up-to-date or properly evaluated.

 

Moreover, we are subject to the risks of errors and misconduct by our employees and seed clients, which include:

 

engaging in misrepresentation or fraudulent activities when marketing or distributing wealth management products to clients;

 

improperly using or disclosing confidential information of our clients, third-party wealth management product providers or other parties;

 

concealing unauthorized or unsuccessful activities; or

 

otherwise not complying with laws and regulations or our internal policies or procedures

 

Although we have established an internal compliance system to supervise service quality and regulation compliance, these risks may be difficult to detect in advance and deter, and could harm our business, results of operations or financial performance. 

 

In addition, although we perform due diligence on potential clients, we cannot assure you that we will be able to identify all the possible issues based on the information available to us. If certain investors do not meet the relevant qualification requirements for products we distribute or under applicable laws, we may also be deemed in default of the obligations required by law and in our contract with the product providers. Management of operational, legal and regulatory risks requires, among other things, policies and procedures to properly record and verify a large number of transactions and events, and these policies and procedures may not be fully effective in mitigating our risk exposure in all market environments or against all types of risk.

 

Our business is subject to risks related to lawsuits and other claims brought by our clients.

 

We are subject to lawsuits and other claims in the ordinary course of our business. In particular, we may face arbitration claims and lawsuits brought by our clients who have bought wealth management products based on our recommendations which turned out to be unsuitable. We may also encounter complaints alleging misrepresentation on the part of our employees and seed clients or that we have failed to carry out a duty owed to them. This risk may be heightened during periods when credit, equity or other financial markets are deteriorating in value or are volatile, or when clients or investors are experiencing losses. Actions brought against us may result in settlements, awards, injunctions, fines, penalties or other results adverse to us including harm to our reputation. The contracts between ourselves and third-party wealth management product providers do not provide for indemnification of our costs, damages or expenses resulting from such lawsuits. Even if we are successful in defending against these actions, the defense of such matters may result in our incurring significant expenses. Predicting the outcome of such matters is inherently difficult, particularly where claimants seek substantial or unspecified damages, or when arbitration or legal proceedings are at an early stage. A substantial judgment, award, settlement, fine, or penalty could be materially adverse to our operating results or cash flows for a particular future period, depending on our results for that period.

 

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Our reputation and brand recognition are crucial to our business. Any harm to our reputation or failure to enhance our brand recognition may materially and adversely affect our business, financial condition and results of operations.

 

Our reputation and brand recognition, which primarily depends on earning and maintaining the trust and confidence of current or potential clients, is critical to our business. Our reputation and brand are vulnerable to many threats that can be difficult or impossible to control, and costly or impossible to remediate. Regulatory inquiries or investigations, lawsuits initiated by clients or other third parties, employee or seed client misconduct, perceptions of conflicts of interest and rumors, among other things, could substantially damage our reputation, even if they are baseless or satisfactorily addressed. In addition, any perception that the quality of our wealth management and product recommendations and services may not be the same as or better than that of other wealth management advisory firms or wealth management product distributors can also damage our reputation. Moreover, any negative media publicity about the financial service industry in general or product or service quality problems of other firms in the industry, including our competitors, may also negatively impact our reputation and brand. If we are unable to maintain a good reputation or further enhance our brand recognition, our ability to attract and retain clients, wealth management product providers and key employees could be harmed and, as a result, our business and revenues would be materially and adversely affected.

 

We face significant competition in the wealth management services industry, and if we are unable to compete effectively with our existing and potential competitors, we could lose our market share and our results of operations and financial condition may be materially and adversely affected.

 

The wealth management market in China is at an early stage of development and is currently highly fragmented and competitive, and we expect competition to persist and intensify. In distributing wealth management products, we face direct competition primarily from (i) commercial banks, (ii) non-bank traditional financial institutions, such as securities firms, fund managers and insurance companies with internal sales capabilities, (iii) online-based service providers, and (iv) third-party professional wealth management services providers that are not associated with financial institutions. In addition, there is a risk that we may not successfully identify new product and service opportunities or develop and introduce these opportunities in a timely and cost-effective manner. New competitors that are better adapted to the wealth management services industry may emerge, which could cause us to lose market share in key market segments.

 

Our competitors may have greater financial and marketing resources than we do. For example, the commercial banks we compete with tend to enjoy significant competitive advantages due to their nationwide distribution network, established brand and credit, and much larger client base and settlement capabilities. Moreover, many of the wealth management product providers with whom we currently have relationships, such as fund managers or securities firms, are also engaged in, or may in the future engage in, the distribution of wealth management products and they may benefit from their vertical integration of manufacturing and distribution.

 

In addition, the corporate finance services market is highly fragmented and we may face fierce competition. In the asset management services sector, we may also face competition from fund management companies that have emerged or will emerge in the asset management business in China in the foreseeable future.

 

17

 

 

Our failure to respond in a timely and cost-effective manner to rapid product innovation in the financial industry may be have an adverse effect on our business and operating results.

 

The financial industry is increasingly influenced by frequent new product and service introductions and evolving industry standards. We believe that our future success will depend on our ability to continue to anticipate product innovations and to offer additional product and service opportunities that meet evolving standards on a timely and cost-effective basis. There is a risk that we may not successfully identify new product and service opportunities or develop and introduce these opportunities in a timely and cost-effective manner. In addition, product and service opportunities that our competitors develop or introduce may render our products and services noncompetitive. As a result, we can give no assurances that product innovation that may affect our industry in the future will not have a material adverse effect on our business and results of operations.

 

We may not be able to effectively manage our growth or implement our future business strategies, in which case our business and results of operations may be materially and adversely affected.

 

We have experienced a period of rapid growth and expansion that has placed, and continues to place, significant strain on our management and resources. We believe that our continued growth will depend on our ability to effectively implement our business strategy and address the above listed factors that may affect us. In order to strengthen our market position in the wealth management services industry targeting the mass affluent and emerging middle class population in China, we need to allocate substantial resources to enhance our ability to source and distribute third-party wealth management products, design and develop high-quality products and continue to grow our asset management business. Moreover, while our corporate finance services business has expanded rapidly for the year ended June 30, 2018, we only began to offer such services recently and have limited experience in operating such business. Accordingly, our ability to continue expanding our corporate finance services is unproven and subject to uncertainties. We anticipate that we will also need to implement a variety of enhanced and upgraded operational and financial systems, procedures and controls, including the improvement of our accounting and other internal management systems. All of these endeavors involve risks and will require substantial management efforts, attention and skills, and significant additional expenditure. We cannot assure you that our current and planned personnel, systems, procedures and controls will be adequate to support our future operations. In addition, we cannot assure you that we will be able to manage our growth or implement our future business strategies effectively, and failure to do so may materially and adversely affect our business and results of operations.

 

18

 

 

Any significant failure in our information technology systems could have a material adverse effect on our business and profitability.

 

Our business is highly dependent on the ability of our information technology systems to timely process a large amount of information of wealth management products, clients and transactions. The proper functioning of our OA system, finance system, investment advisor platform, operation database client service and other data processing systems, together with the communication systems between our various branch offices and our headquarters in Guangzhou, is critical to our business and to our ability to compete effectively. In particular, we rely on the online service platforms provided through our two apps, Puyitou (普益投) and Puyi Fund (普益基金) to provide our clients with up-to-date product-related information online and a full-scope online transaction processing whereby clients can execute transactions and monitor their investments portfolio. We cannot assure you that our business activities would not be materially disrupted in the event of a partial or complete failure of any of these information technology or communication systems, which could be caused by, among other things, software malfunction, computer virus attacks or conversion errors due to system upgrading. In addition, a prolonged failure of our information technology system could damage our reputation and materially and adversely affect our future prospects and profitability.

 

Any failure to protect our clients’ privacy and confidential information could lead to legal liability, adversely affect our reputation and have a material adverse effect on our business, financial condition or results of operations.

 

Our services involve the exchange, storage and analysis of highly confidential information, including detailed personal and financial information regarding our mass affluent and emerging middle class clients and corporate borrower clients, through a variety of electronic and non-electronic means, and our reputation and business operations are highly dependent on our ability to safeguard the confidential personal data and information of our clients. We rely on a network of process and software controls to protect the confidentiality of data provided to us or stored on our systems. We face various security threats on a regular basis, including cyber-security threats to and attacks on our technology systems that are intended to gain access to our confidential information, destroy data or disable our systems.

 

If we do not take adequate measures to prevent security breaches, maintain adequate internal controls or fail to implement new or improved controls, this data, including personal information, could be misappropriated or confidentiality could otherwise be breached. We could be subject to liability if we fail to prevent security breaches, improper access to, or inappropriate disclosure of, any client’s personal information, or if third parties are able to illegally gain access to any client’s name, address, portfolio holdings, or other personal and confidential information. Although we have developed systems and internal control processes that are designed to prevent or detect security breaches and protect our clients’ data, we cannot assure you that such measures will provide absolute security. Any such failure could subject us to claims for identity theft or other similar fraud claims or claims for other misuses of personal information, such as unauthorized marketing or unauthorized access to personal information. In addition, such events would cause our clients to lose their trust and confidence in us, which may result in a material adverse effect on our business, results of operations and financial condition.

 

19

 

 

We may not be able to prevent unauthorized use of our intellectual property, which could reduce demand for the products that we distribute and our services, adversely affect our revenues and harm our competitive position.

 

We rely primarily on a combination of copyright, trade secret, trademark and anti-unfair competition laws and contractual rights to establish and protect our intellectual property rights. We cannot assure you that the steps we have taken or will take in the future to protect our intellectual property or piracy will prove to be sufficient. For example, although we require our employees, wealth management product providers and seed clients to enter into confidentiality agreements in order to protect our trade secrets, other proprietary information and, most importantly, our client information, these agreements might not effectively prevent disclosure of our trade secrets, know-how or other proprietary information and might not provide an adequate remedy in the event of unauthorized disclosure of such confidential information. In addition, others may independently discover trade secrets and proprietary information, and in such cases we could not assert any trade secret rights against such parties. Implementation of intellectual property-related laws in China has historically been lacking, primarily due to ambiguity in the PRC laws and enforcement difficulties. Accordingly, intellectual property rights and confidentiality protection in China may not be as effective as in the United States or other countries. Current or potential competitors may use our intellectual property without our authorization in the development of products and services that are substantially equivalent or superior to ours, which could reduce demand for our solutions and services, adversely affect our revenues and harm our competitive position. Even if we were to discover evidence of infringement or misappropriation, our recourse against such competitors may be limited or could require us to pursue litigation, which could involve substantial costs and diversion of management’s attention from the operation of our business.

 

We may face intellectual property infringement claims that could be time consuming and costly to defend and may result in the loss of significant rights by us.

 

Although we have not been subject to any litigation, pending or threatened, alleging infringement of third parties’ intellectual property rights, we cannot assure you that such infringement claims will not be asserted against us in the future.

 

Intellectual property litigation is expensive and time-consuming and could divert resources and management attention from the operation of our business. If there is a successful claim of infringement, we may be required to alter our services, cease certain activities, pay substantial royalties and damages to, and obtain one or more licenses from, third parties. We may not be able to obtain those licenses on commercially acceptable terms, or at all. Any of those consequences could cause us to lose revenues, impair our client relationships and harm our reputation.

 

Our future success depends on the continuing efforts to retain our existing management team and other key employees as well as to attract, integrate and retain highly skilled and qualified personnel, and our business may be disrupted if we lose their services.

 

Our future success depends heavily on the continued services of our current executive officers. We also rely on the skills, experience and efforts of other key employees, including management, marketing, support, research and development, technical and services personnel. Qualified employees are in high demand throughout wealth management services industries in China, and our future success depends on our ability to attract, train, motivate and retain highly skilled employees and the ability of our executive officers and other members of senior management to work effectively as a team.

 

If one or more of our executive officers or other key employees are unable or unwilling to continue in their present positions, we may not be able to find replacements easily or at all, which may disrupt our business operations. We do not have key personnel insurance in place. If any of our executive officers or other key employees joins a competitor or forms a competing company, we may lose clients, know-how, key professionals and staff members. Each of our executive officers has entered into a non-competition agreement with us as well as an employment agreement with us which contains confidentiality provisions. However, if any dispute arises between our executive officers and us, we cannot assure you of the extent to which any of these agreements could be enforced in China, where these executive officers reside, because of the uncertainties of China’s legal system. See “— Risks Related to Doing Business in China — Uncertainties with respect to the PRC legal system could adversely affect us.”

 

20

 

 

Our existing shareholders have substantial influence over our company and their interests may not be aligned with the interests of our other shareholders.

 

Currently, Mr. Yu Haifeng, our founder, chairman and chief executive officer, beneficially owns 94.3% of our share capital. Upon the completion of this offering, he will beneficially own an aggregate of 88.0% of our outstanding share capital assuming the minimum offering amount is sold and 84.3% of our outstanding share capital assuming the maximum offering amount is sold. As a result of this high level of shareholding, Mr. Yu has substantial influence over our business, including decisions regarding mergers, consolidations and the sale of all or substantially all of our assets, election of directors and other significant corporate actions. Mr. Yu may take actions that are not in the best interests of us or our other shareholders. This concentration of ownership may discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our ADSs. These actions may be taken even if they are opposed by our other shareholders, including those who purchase ADSs in this offering. See “Principal Shareholders.”

 

Our revenues and operating results can fluctuate from period to period, which could cause the price of our ADSs to fluctuate.

 

Our revenues and operating results have fluctuated in the past and may fluctuate from period to period in the future due to a variety of factors, many of which are beyond our control. Factors relating to our business that may contribute to these fluctuations include the following factors, as well as other factors described elsewhere in this prospectus:

 

a decline or slowdown of the growth in the value of wealth management products, which may reduce the value of products we distribute for wealth management product providers and the products provided by ourselves and therefore our revenues and cash flows;

 

negative public perception and reputation of the wealth management services industry;

 

unanticipated delays of anticipated rollouts of our products or services;

 

unanticipated changes to economic terms in contracts with our wealth management product providers, including renegotiations;

 

changes in laws or regulatory policy that could impact our ability to provide wealth management services and/or asset management services;

 

failure to enter into contracts with new wealth management product providers;

 

cancellations or non-renewal of existing contracts with wealth management product providers; and

 

changes in the number of clients who decide to terminate their relationship with us or who ask us to redeem their investment in our FoF products.

 

As a result of these and other factors, the results of any prior quarterly or annual periods should not be relied upon as indications of our future revenues or operating performance.

 

Fanhua Inc., a shareholder and former employer of one of our officers, has been recently named as a defendant in a securities class action lawsuit; we cannot assure you that we or any of our directors or officers will not be involved in any investigations, proceedings or lawsuits in connection with this lawsuit in the future.

 

Fanhua Inc. (NASDAQ: FANH) is our shareholder and currently holds approximately 4.8% equity interest in our company. See “Corporate History and Structure”. In addition, Mr. Hu Anlin, our executive director and chief financial officer, is an ex-employee of Fanhua Inc. from September 2013 to June 2018, and Mr. Hu Yinan, our director, is the founder and currently a director of Fanhua Inc. In September 2018, a class action lawsuit was filed against Fanhua Inc. and two of its executive officers, Mr. Wang Chunlin and Mr. Ge Peng, and is currently pending in the United States District Court for the Southern District of New York. The complaint alleged that Fanhua Inc. made material false or misleading statements and omissions regarding its business, operational and compliance policies in its annual report filed on Form 20-F for the year ended December 31, 2017 and in its current reports filed on Forms 6-K for the first and second quarters of 2018. Although none of our company, our directors or executive officers have been named as defendant in the complaint in the class action lawsuit to date, we cannot assure you that we or any of our directors or officers will not be involved in any investigations, proceedings or lawsuits in connection with this lawsuit in the future. If any of them does become subject to such investigations, proceedings or lawsuits, our reputation might be substantially damaged, and our business, financial condition and results of operations might be adversely affected.  As a result of any of the foregoing, the price and trading volume of our ADSs may experience significant declines, and you may lose significant value of your investment in our company.

 

We are an emerging growth company within the meaning of the Securities Act and may take advantage of certain reduced reporting requirements, and this could make it more difficult to compare our performance with other public companies.

 

We are an “emerging growth company,” as defined in the JOBS Act, and we may take advantage of certain exemptions from various requirements applicable to other public companies that are not emerging growth companies including, most significantly, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002 so long as we are an emerging growth company. As a result, if we elect not to comply with such auditor attestation requirements, our investors may not have access to certain information they may deem important. In addition, Section 102(b)(1) of the JOBS Act exempts emerging growth companies from being required to comply with new or revised financial accounting standards until private companies (that is, those that have not had a Securities Act registration statement declared effective or do not have a class of securities registered under the Exchange Act) are required to comply with the new or revised financial accounting standards. The JOBS Act provides that a company can elect to opt out of the extended transition period and comply with the requirements that apply to non-emerging growth companies but any such an election to opt out is irrevocable. We have elected to opt in to such extended transition period, which means that when a standard is issued or revised and it has different application dates for public or private companies, we, as an emerging growth company, can delay the adoption of the new or revised standard until private companies adopt the new or revised standard. Accordingly, our financial statements may not be comparable to other public companies that are not emerging growth companies or that are emerging growth companies which have opted out of using the extended transition because of the potential differences in accounting standards used.

 

21

 

 

We are a foreign private issuer within the meaning of the rules under the Exchange Act and are therefore exempt from certain provisions applicable to U.S. domestic issuers.

 

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

 

the rules under the Exchange Act requiring the filing with the SEC of quarterly reports on Form 10-Q or current reports on Form 8-K;
   
the sections of the Exchange Act regulating the solicitation of proxies, consents or authorizations in respect of a security registered under the Exchange Act;
   
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
   
the selective disclosure rules by issuers of material nonpublic information under Regulation FD.

 

We will be required to file an annual report on Form 20-F within four months of the end of each fiscal year. In addition, we intend to publish our results on a quarterly basis as press releases, distributed pursuant to the rules and regulations of the NASDAQ Global Market. Press releases relating to financial results and material events will also be furnished to the SEC on Form 6-K. However, the information we are required to file with or furnish to the SEC will be less extensive and less timely compared to that required to be filed with the SEC by U.S. domestic issuers. As a result, you may not be afforded the same protections or information that would be made available to you were you investing in a U.S. domestic issuer.

 

As a company incorporated in the Cayman Islands, we are permitted to adopt certain home country practices in relation to corporate governance matters in lieu of the corporate governance listing standards applicable to U.S. domestic issuers, which home country practices may afford comparatively less protection to shareholders.

 

As a 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 Global Market corporate governance requirements; these practices may afford less protection to shareholders than they would enjoy if we complied fully with the NASDAQ Global Market corporate governance requirements. For example, as a foreign private issuer, we are not required to: (i) have a majority of the board be independent; (ii) have a compensation committee or a nominating/corporate governance committee consisting entirely of independent directors; or (iii) have regularly scheduled executive sessions with only independent directors each year.

 

We intend to follow home country practice in lieu of the requirements under the NASDAQ Global Market rules with respect to certain corporate governance standards. Accordingly, you may not be provided with the benefits of certain corporate governance requirements of the NASDAQ Global Market rules.

 

If we fail to implement and maintain an effective system of internal control, we may be unable to accurately or timely report our results of operations or prevent fraud, and investor confidence and the market price of the ADSs may be materially and adversely affected.

 

We will be subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act and the rules and regulations of the NASDAQ Global Market after the completion of this offering. Our reporting obligations as a public company will place a significant strain on our management, operational and financial resources and systems for the foreseeable future. Prior to this offering, we have been a private company with limited accounting personnel and other resources with which to address our internal control over financial reporting, and we were never required to evaluate our internal control over financial reporting within a specified period, and, as a result, we may experience difficulty in meeting these reporting requirements in a timely manner. In the course of preparing our consolidated financial statements, we and our independent registered public accounting firm identified one material weakness in our internal control in the course of preparing and auditing our consolidated financial statements for the years ended June 30, 2017 and 2018. As defined in the standards established by the Public Company Accounting Oversight Board of the United States, a “material weakness” is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

 

22

 

 

The material weakness identified is a lack of dedicated resources to take responsibility for the finance and accounting functions and the preparation of financial statements in compliance with U.S. GAAP. Neither we nor our independent registered public accounting firm undertook a comprehensive assessment of our internal control under the Sarbanes-Oxley Act for purposes of identifying and reporting any weakness or significant deficiency in our internal control over financial reporting as we will be required to do once we become a public company and our independent registered public accounting firm may be required to do once we cease to be an emerging growth company. We and they are required to do so only after we become a public company. Had we performed a formal assessment of our internal control over financial reporting or had our independent registered public accounting firm performed an audit of our internal control over financial reporting, additional material weaknesses may have been identified.

 

We have implemented and are continuing to implement a number of measures to address the material weakness identified. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — 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 we cannot conclude that it has been fully remedied. 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 could also 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 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. We may also be required to restate our financial statements from prior periods.

 

Upon completion of this offering, we will become subject to the Sarbanes-Oxley Act of 2002. Section 404 of the Sarbanes-Oxley Act will require that we include a report from management on the effectiveness of our internal control over financial reporting in our annual report on Form 20-F beginning with our annual report for the fiscal year ending June 30, 2019. In addition, once we cease to be an “emerging growth company” as the term is defined in the JOBS Act, our independent registered public accounting firm must attest to and report on the effectiveness of our internal control over financial reporting. If we fail to remedy the problems identified above, our management may conclude that our internal control over financial reporting is not effective. Moreover, even if our management concludes the problems identified above have been remedied, 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 have become 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, 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. 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. We may also be required to restate our financial statements from prior periods.

 

We have limited insurance coverage.

 

Insurance companies in China currently do not offer as extensive an array of insurance products as insurance companies in more developed economies do. Other than casualty insurance on some of our assets, we do not have commercial insurance coverage on our other assets and personnel and we do not have insurance to cover our business or interruption of our business, litigation or product liability. We have determined that the costs of insuring for these risks and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to have such insurance. Any uninsured occurrence of loss or damage to property, litigation or business disruption may result in our incurring substantial costs and the diversion of resources, which could have an adverse effect on our results of operations and financial condition.

 

23

 

 

Risks Related to Our Corporate Structure

 

If the PRC government finds that the agreements that establish the structure for operating our businesses in China do not comply with PRC regulations relating to fund management businesses, 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 certain parts of our businesses including fund management services is subject to restrictions under current PRC laws and regulations. For example, foreign ownership in fund management companies that focus on securities investment funds shall not exceed 51%. Also, any foreign shareholder of a foreign-invested fund management company focusing securities investment funds must be a financial institution approved by the national or regional financial regulatory authority where the foreign investor locates, and such national or regional financial regulatory authority must have signed a memorandum of understanding on bilateral regulatory cooperation with the CSRC or its approved institution. In addition, such foreign-invested fund management company must invest in domestic capital markets.

 

While in December 2018 CSRC announced that it entered into a memorandum of understanding on bilateral regulatory corporation with the Cayman Islands Monetary Authority (“CIMA”), the principal regulator for the financial services industry of the Cayman Island, since currently we are not a financial institution approved by CIMA, we are not eligible to conduct our fund management business by directly establishing a foreign-invested fund management company. To comply with PRC laws and regulations and utilize our ability in providing fund management services, we currently conduct our business activities through our variable interest entity (the “VIE”), Puyi Bohui and its subsidiaries. Through our PRC subsidiary Puyi Consulting, we entered into a series of contractual arrangements with Puyi Bohui and its shareholders, which enable us to (i) exercise effective control over Puyi Bohui, (ii) receive substantially all of the economic benefits of Puyi Bohui, and (iii) have an exclusive option to purchase all or part of the equity interests and assets in Puyi Bohui 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 Puyi Bohui and hence consolidate its financial results and its subsidiaries into our consolidated financial statements under U.S. GAAP. Our consolidated affiliated entities hold the licenses, approvals and key assets that are essential for our operations.

 

In the opinion of our PRC legal counsel, GFE Law Office, based on its understandings of the relevant PRC laws and regulations, (i) the ownership structures of our VIE in China and Puyi Consulting, both currently and immediately after giving effect to this offering, are not in violation of applicable PRC laws and regulations currently in effect; and (ii) each contracts among Puyi Consulting, Puyi Bohui and its shareholders is legal, valid, binding and enforceable in accordance with its terms and applicable PRC laws. However, our PRC legal counsel has also advised us that there are substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations. Accordingly, the PRC regulatory authorities may ultimately take a view contrary to the opinion of our PRC legal counsel. 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 we or our VIE are found to be in violation of any PRC laws or regulations, if the contractual arrangements among Puyi Consulting, our VIE and its shareholders are determined as illegal or invalid by the PRC court, arbitral tribunal or regulatory authorities, or if we or our VIE 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:

 

revoke the business license and/or operating license that such entities currently have or obtain in the further;

 

discontinuing or placing restrictions or onerous conditions on our operations;

 

imposing fines, confiscating the income from Puyi Consulting or our VIE, or imposing other requirements with which we or our VIE may not be able to comply;

 

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

 

restricting or prohibiting our use of the proceeds of this offering to finance our business and operations in China.

 

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 VIE 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 VIE or our right to receive substantially all the economic benefits and residual returns from our VIE 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 VIE 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.

 

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We rely on contractual arrangements with our variable interest entity and its shareholders for a portion of our China operations, which may not be as effective as direct ownership in providing operational control.

 

Due to PRC restrictions on foreign ownership of fund management business in China, we operate our business in China through our VIE and its subsidiaries, or the VIEs, in which we have no ownership interest. We rely on contractual arrangements with our VIE, Puyi Bohui and its shareholders including the Power of Attorney with each of the shareholders, to control and operate business of our consolidated affiliated entities. These contractual arrangements are intended to provide us with effective control over our consolidated affiliated entities and allow us to obtain economic benefits from them. See “Corporate History and Structure—Contractual Arrangements”. In particular, our ability to control the consolidated affiliated entities depends on the Powers of Attorney, pursuant to which our PRC subsidiary Puyi Consulting can vote on all matters requiring shareholder approval in our VIE. We believe these Powers of Attorney are legally enforceable but may not be as effective as direct equity ownership.

 

Although we have been advised by our PRC legal counsel that each of the contracts among Puyi Consulting, our VIE and its shareholders is valid, binding and enforceable under existing PRC laws and regulations, these contractual arrangements may not be as effective as direct ownership in providing us with control over our VIE and its subsidiaries. Under the current contractual arrangements, as a legal matter, if our VIE or its shareholders fail to perform their respective obligations under these contractual arrangements, we may have to incur substantial costs and expend additional resources to enforce our rights under such arrangements. All of these contracts are governed by PRC law and provide for the resolution of disputes through arbitration in the PRC. Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. The legal environment in the PRC is not as developed as in other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements, which may make it difficult to exert effective control over our VIE, and we may lose control over the assets owned by our VIE. As a result, we may be unable to consolidate the financial results of such entities in our consolidated financial statements, our ability to conduct our business may be negatively affected, and our operations could be severely disrupted, which could materially and adversely affect our results of operations and financial condition. See “— Risks Related to Doing Business in China — Uncertainties with respect to the PRC legal system could adversely affect us.” The arbitration provisions under these contractual arrangements have no effect on the rights of our shareholders and do not prevent them from pursuing claims against us under U.S. federal securities laws.

 

The contractual arrangements we have entered into with our VIE and its shareholders, and any other arrangements and transactions among related parties that we currently have or will have in future may be subject to scrutiny by the PRC tax authorities and they may determine that we owe additional taxes, which could substantially reduce our consolidated net income 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 are not able to determine whether the contractual arrangements that we have entered into among Puyi Consulting, our VIE and its shareholders, or any other arrangements and transactions among related parties that we currently have or will have in future will be regarded by the PRC tax authorities as arm’s length transactions. We could face material and adverse tax consequences if the PRC tax authorities determine that our current contractual arrangements or any other arrangements and transactions among related parties are not entered into on an arm’s-length basis, and therefore constitute favorable transfer pricing. As a result, the PRC tax authorities could require us to adjust our taxable income upward for PRC tax purposes, which could increase our VIE’s tax expenses without reducing the tax expenses, subject us to late payment fees and other penalties for under-payment of taxes, and result in the loss of any preferential tax treatment we may have. As a result, our consolidated net income may be adversely affected.

 

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The shareholders of our VIE may have potential conflicts of interest with us, which may materially and adversely affect our business and financial condition.

 

Both of the shareholders of Puyi Bohui, Mr. Yu Haifeng and Ms. Yang Yuanfen are PRC nationals. They may have conflicts of interest with us. Conflicts of interest may arise between the dual roles of them who are both shareholders of our company and shareholders of our variable interest entity. We do not have existing arrangements to address potential conflicts of interest between those individuals and our company and cannot assure you that when conflicts arise, those individuals will act in the best interest of our company or that conflicts will be resolved in our favor. If we cannot resolve any conflicts of interest or disputes between us and those individuals, we would have to rely on legal proceedings, which may materially disrupt our business. There is also substantial uncertainty as to the outcome of any such legal proceeding.

 

We may lose the ability to use and enjoy assets held by our VIE that are material to the operation of certain portion of our business if the VIE goes bankrupt or become subject to a dissolution or liquidation proceeding.

 

As part of our contractual arrangements with our VIE, our VIE and its subsidiaries hold certain assets that are material to the operation of our business, including intellectual property and premise and licenses. If our VIE or any of its subsidiaries goes bankrupt and all or part of its assets become subject to liens or rights of third-party creditors, we may be unable to continue some or all of our business activities, which could materially and adversely affect our business, financial condition and results of operations. Under the contractual arrangements, our VIE may not, in any manner, sell, transfer, mortgage or dispose of their assets or legal or beneficial interests in the business without our prior consent. If our VIE undergoes a voluntary or involuntary liquidation proceeding, 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 we were deemed to be an investment company under the Investment Company Act of 1940, applicable restrictions could make it impractical for us to continue our business as contemplated and could have a material adverse effect on our business and the price of our ordinary shares.

 

An entity will generally be deemed an “investment company” for purposes of the Investment Company Act of 1940, as amended (the “1940 Act”) if: (a) it is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting or trading in securities, or (b) absent an applicable exemption, it owns or proposes to acquire investment securities having a value exceeding 40% of the value of its total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis. We believe that we are engaged primarily in the business of providing wealth management services, corporate finance services and asset management services and not in the business of investing, reinvesting or trading in securities. We hold ourselves out as a third-party wealth management service provider and do not propose to engage primarily in the business of investing, reinvesting or trading in securities. Accordingly, we believe that Puyi Inc. is not an investment company under Section 3(b)(1) of the Investment Company Act, among other things, because it is primarily engaged in a non-investment company business. If one or more of our operating entities ceased to be deemed as a wholly-owned subsidiary of ours, our interests in those subsidiaries could be deemed an ’‘investment security’’ for purposes of the 1940 Act.

 

The 1940 Act and the rules thereunder contain detailed parameters for the organization and operation of investment companies. Among other things, the 1940 Act and the rules thereunder limit or prohibit transactions with affiliates, impose limitations on the issuance of debt and equity securities, generally prohibit the issuance of options and impose certain governance requirements. We intend to conduct our operations so that Puyi Inc. will not be deemed an investment company. However, if we were to be deemed an investment company, restrictions imposed by the 1940 Act, including limitations on our capital structure and our ability to transact business with affiliates, could make it impractical for us to continue our business as currently conducted and would have a material adverse effect on our business, financial condition, results of operations and the price of our ordinary shares. In addition, we may be required to limit the amount of investments that we make as a principal or otherwise conduct our business in a manner that does not subject us to the registration and other requirements on the 1940 Act.

 

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Risks Related to Doing Business in China

 

Adverse changes in the political and economic policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could adversely affect our business.

 

Substantially all of our assets are located in China and substantially all of our revenues are derived from our operations there. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. The Chinese economy differs from the economies of most developed countries in many respects, including amount of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. While the Chinese economy has experienced significant growth in the past 30 years, the growth has been uneven across different periods, regions and among various economic sectors of China, and the rate of growth has been slowing since 2012. We cannot assure you that the Chinese economy will continue to grow. Further, the Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources, some of which may benefit the overall Chinese economy but 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. Also, in the past the Chinese government 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. Accordingly, 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 services and adversely affect our competitive position.

 

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

 

We conduct our business primarily through our PRC subsidiary and variable interest entity and its subsidiaries in China. Our operations in China are governed by PRC laws and regulations. Our PRC subsidiary is a foreign invested enterprise and is subject to laws and regulations applicable to foreign investment in China and, in particular, laws applicable to foreign-invested enterprises. The PRC legal system is a civil law system based on written statutes. Unlike common law system, prior court decisions 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 businesses in China.

 

From time to time, we may have to resort to administrative and court proceedings to enforce our legal rights. However, since PRC judicial and administrative authorities have significant discretion in interpreting and implementing statutory and contractual terms, it may be more difficult to predict the outcome of a judicial or administrative proceeding than in more developed legal systems. In addition, the PRC legal system is based in part on government policies and internal rules, some of which are not published on a timely basis or at all, that may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until some time after the violation. Any administrative and court proceedings in China may be protracted and result in substantial costs and diversion of resources and management attention. However, since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory 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 also impede our ability to enforce the contracts we have entered into, and as a result, could materially adversely affect our business and results of operations.

 

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Fluctuations in exchange rates may have a material adverse effect on your investment.

 

The value of the Renminbi against the U.S. dollar and other currencies is affected by, among other things, changes in China’s political and economic conditions and China’s foreign exchange policies. The conversion of Renminbi into foreign currencies, including U.S. dollars, has been based on exchange rates set by the People’s Bank of China. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the Renminbi solely to the U.S. dollar, and the Renminbi appreciated more than 20% against the U.S. dollar over the following three years. Between July 2008 and June 2010, however, this appreciation halted and the Renminbi was traded within a narrow range against the U.S. dollar. Between July 2010 and November 2015, the Renminbi fluctuated against the U.S. dollar, at times significantly and unpredictably. On November 30, 2015, the Executive Board of IMF completed the regular five-year review of the basket of currencies that make up the Special Drawing Right, or the SDR, and decided that with effect from October 1, 2016, Renminbi is determined to be a freely usable currency and will be included in the SDR basket as a fifth currency, along with the U.S. dollar, the Euro, the Japanese yen and the British pound. In the fourth quarter of 2016, the Renminbi depreciated significantly in the backdrop of a surging U.S. dollar and persistent capital outflows of China. This depreciation halted in 2017, and the RMB appreciated approximately 7% against the U.S. dollar during this one-year period. Since February 2018, the RMB has depreciated significantly, over 8% against the U.S. dollar. With the development of the foreign exchange market and progress towards interest rate liberalization and Renminbi internationalization, the PRC government may in the future announce further changes to the exchange rate system, and we cannot assure you that the 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 the Renminbi and the U.S. dollar in the future.

 

Significant revaluation of the Renminbi may have a material and adverse effect on your investment. For example, to the extent that we need to convert U.S. dollars we receive from this offering into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount we would receive from the conversion. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or ADSs or for other business purposes, appreciation of the U.S. dollar against the Renminbi would have a negative effect on the U.S. dollar amount available to us. The net proceeds from this offering will be denominated in U.S. dollars. Fluctuations in exchange rates, primarily those involving the U.S. dollar, may affect the relative purchasing power of these proceeds. In addition, appreciation or depreciation in the value of the Renminbi relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of earnings from and the value of any U.S. dollar-denominated investments we make in the future.

 

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.

 

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Governmental control of conversion of Renminbi into foreign currencies may limit our ability to utilize our revenues effectively and 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 revenues in Renminbi. Under our current corporate structure, our company may rely on dividend payments from our PRC subsidiary, Puyi Consulting, 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 from SAFE by complying with certain procedural requirements. Therefore, Puyi Consulting is able to pay dividends in foreign currencies to us without prior approval from SAFE by complying with certain procedural requirements. But 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. The PRC government may also at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign 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.

 

The approval of the China Securities Regulatory Commission, or CSRC, may be required in connection with this offering under a regulation adopted in August 2006, and, if required, we cannot predict whether we will be able to obtain such approval.

 

The Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rules, adopted by six PRC regulatory agencies, including the CSRC, requires offshore special purpose vehicles, or SPVs, formed for the purpose of acquiring PRC domestic companies and controlled by PRC companies or individuals, to obtain the approval of the CSRC prior to listing their securities on an overseas stock exchange. See “Regulation—PRC Regulations Relating to Mergers and Acquisitions”. However, the application of this regulation remains unclear. Currently, there is no consensus among the leading PRC law firms regarding the scope and applicability of the CSRC approval requirement. If CSRC approval is required, it is uncertain whether it would be possible for us to obtain the approval, and any failure to obtain or delay in obtaining CSRC approval for this offering would subject us to sanctions imposed by the CSRC and other PRC regulatory agencies.

 

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Our PRC legal counsel, GFE Law Office, has advised us that, based on their understanding of the current PRC laws and regulations as well as the procedures announced in September 2006 by the CSRC, we are not required to submit an application to the CSRC for its approval of the listing and trading of our ADSs on the NASDAQ Global Market, unless we are clearly required to do so by subsequent rules of the CSRC, because (1) the CSRC currently has not issued any definitive rule or interpretation concerning whether offerings like ours under this prospectus are subject to the M&A Rules; (2) we established our PRC subsidiary, Puyi Consulting by means of direct investment other than by merger or acquisition of a PRC domestic company; and (3) no provision in the M&A Rules clearly classifies the contractual arrangements among Puyi Consulting, our VIE and its shareholders as a type of transaction subject to the M&A Rules. However, we cannot assure you that the relevant PRC government agency, including the CSRC, would reach the same conclusion as our PRC legal counsel. Since there has been no official interpretation or clarification of this regulation since its adoption, there is uncertainty as to how this regulation will be interpreted or implemented. If it is determined that the CSRC’s approval is required for this offering, we may face sanctions by the CSRC or other PRC regulatory agencies for failure to seek CSRC’s approval for this offering. These sanctions may include fines and penalties on our operations in the PRC, limitations on our operating privileges in the PRC, delays or restrictions on the repatriation of the proceeds from this offering into the PRC, restrictions on or prohibition of payment or remittance of dividends by our China subsidiary, or other actions that could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our ADSs. The CSRC or other PRC regulatory agencies may also take actions requiring us, or making it advisable to us, to halt this offering before settlement and delivery of the ADSs that we are offering. Consequently, if you engage in market trading or other activities in anticipation of and prior to settlement and delivery of the ADSs we are offering, you would be doing so at the risk that settlement and delivery may not occur.

 

PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident beneficial owners or our PRC subsidiary to liability or penalties, limit our ability to inject capital into our PRC subsidiary, limit our PRC subsidiary’s ability to increase its registered capital or distribute profits to us, or may otherwise adversely affect us.

 

On July 4, 2014, SAFE issued the Circular on Issues Concerning Foreign Exchange Control over the Overseas Investment and Financing and Round-trip Investment by Domestic Residents via Special Purpose Vehicles, or SAFE Circular 37, which became effective as of July 4, 2014. According to SAFE Circular 37, prior registration with the local SAFE branch is required for PRC residents, including PRC individuals and PRC corporate entities as well as foreign individuals that are deemed as PRC residents for foreign exchange administration purpose, in connection with their direct or indirect contribution of domestic assets or interests to offshore companies, known as SPVs. SAFE Circular 37 further requires amendment to the SAFE registrations in the event of any changes with respect to the basic information of the offshore special purpose vehicle, such as change of a PRC individual shareholder, name and operation term, or any significant changes with respect to the offshore special purpose vehicle, such as increase or decrease of capital contribution, share transfer or exchange, or mergers or divisions. SAFE Circular 37 is applicable to our shareholders who are PRC residents and may be applicable to any offshore acquisitions that we make in the future. In February 2015, SAFE promulgated a Notice on Further Simplifying and Improving Foreign Exchange Administration Policy on Direct Investment, or SAFE Notice 13, effective June 2015. Under SAFE Notice 13, applications for foreign exchange registration of inbound foreign direct investments and outbound overseas direct investments, including those required under SAFE Circular 37, will be filed with qualified banks instead of SAFE. The qualified banks will directly examine the applications and accept registrations under the supervision of SAFE.

 

In addition to SAFE Circular 37 and SAFE Notice 13, our ability to conduct foreign exchange activities in China may be subject to the interpretation and enforcement of the Implementation Rules of the Administrative Measures for Individual Foreign Exchange promulgated by SAFE in January 2007 (as amended and supplemented, the “Individual Foreign Exchange Rules”). Under the Individual Foreign Exchange Rules, any PRC individual seeking to make a direct investment overseas or engage in the issuance or trading of negotiable securities or derivatives overseas must make the appropriate registrations in accordance with SAFE provisions, the failure of which may subject such PRC individual to warnings, fines or other liabilities.

  

Our shareholders, Mr. Yu Haifeng and Ms. Yang Yuanfen, who are subject to the SAFE Circular 37 and Individual Foreign Exchange Rules have completed the initial registrations with the qualified banks as required by the regulations. However, we may not be informed of the identities of all the PRC residents holding direct or indirect interest in our company, and we have no control over any of our beneficial owners. Thus, we cannot provide any assurance that our current or future PRC resident beneficial owners will comply with our request to make or obtain any applicable registrations or continuously comply with all registration procedures set forth in these SAFE regulations. Such failure or inability of our PRC residents beneficial owners to comply with these SAFE regulations may subject us or our PRC residents beneficial owners to fines and legal sanctions, restrict our cross-border investment activities, or limit our PRC subsidiary’s ability to distribute dividends to, or obtain foreign-exchange-dominated loans from, our company, or prevent us from being able to make distributions or pay dividends, as a result of which our business operations and our ability to distribute profits to you could be materially adversely affected.

 

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We may rely principally on dividends and other distributions on equity paid by our PRC subsidiary to fund any cash and financing requirements we may have, and any limitation on the ability of our PRC subsidiary to pay dividends to us could have a material adverse effect on our ability to conduct our business.

 

We are a holding company, and we may rely principally on dividends and other distributions on equity paid by Puyi Consulting, our PRC subsidiary, for our cash and financing requirements, including the funds necessary to pay dividends and other cash distributions to our shareholders and service any debt we may incur. If Puyi Consulting incurs 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. In addition, the PRC tax authorities may require us to adjust our taxable income under the contractual arrangements that Puyi Consulting currently has in place with our variable interest entity in a manner that would materially and adversely affect its ability to pay dividends and other distributions to us.

 

Under PRC laws and regulations, Puyi Consulting, as a wholly foreign-owned enterprise in the PRC, 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 such as Puyi Consulting is required to set aside at least 10% of its accumulated after-tax profits each year, if any, to fund certain statutory reserve funds, until the aggregate amount of such fund reaches 50% of its registered capital. At its discretion, it may allocate a portion of its after-tax profits based on PRC accounting standards to staff welfare and bonus funds. These reserve funds and staff welfare and bonus funds are not distributable as cash dividends. Any limitation on the ability of Puyi Consulting 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. See also “— Risks Related to Doing Business in China — The dividends we receive from our PRC subsidiary may be subject to PRC tax under the PRC Enterprise Income Tax Law, which would likely have a material adverse effect on our financial condition and results of operations.”

 

PRC regulation of loans to and direct investment in PRC entities by offshore holding companies and governmental control of conversion of foreign currencies into Renminbi may delay or prevent us from using the proceeds of this offering to make loans to our PRC subsidiary and variable interest entity or to make additional capital contributions to our PRC subsidiary, 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 subsidiary and variable interest entity. We may make loans to our PRC subsidiary and variable interest entity, or we may make additional capital contributions to our PRC subsidiary. Any loans to our PRC subsidiary, which is treated as a foreign invested enterprise under PRC law, are subject to PRC regulations and foreign exchange loan registrations. For example, loans by us to Puyi Consulting to finance its activities cannot exceed statutory limits and must be registered with the local counterpart of the State Administration of Foreign Exchange, or SAFE. We may also decide to finance Puyi Consulting by means of capital contributions, which must be approved by the PRC Ministry of Commerce or its local counterpart. Due to the restrictions imposed on loans in foreign currencies extended to any PRC domestic companies, we are not likely to directly make such loans to our variable interest entity, a PRC domestic company. Meanwhile, we are not likely to finance the activities of our variable interest entity by means of capital contributions because that would result in our VIE being converted into a foreign invested company, while foreign invested companies engaged in fund management industry are subject to more stringent requirements than PRC domestic enterprises.

 

In light of the various requirements imposed by of PRC regulations on loans to and direct investment in PRC entities by offshore holding companies, we cannot assure you that we will be able to complete the necessary government registrations or obtain the necessary government approvals on a timely basis, if at all, with respect to future loans by us to our PRC subsidiary or our variable interest entity or with respect to future capital contributions by us to our PRC subsidiary. If we fail to complete such registrations or obtain such approvals, our ability to use the proceeds we expect to receive from this offering and to capitalize or otherwise fund our PRC operations may be negatively affected, which could materially and adversely affect our liquidity and our ability to fund and expand our business.

 

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

 

Under SAFE regulations, PRC residents who participate in a share incentive plan in an overseas publicly listed company are required to register with SAFE or its local branches and complete certain other procedures. See “Regulations – PRC Regulations Relating to Share Incentive Plan”. We and our PRC resident employees who participate in our share incentive plans will be subject to these regulations when our company becomes publicly listed in the United States. If we or any of these PRC resident employees fail to comply with these regulations, we or such employees may be subject to fines and other legal or administrative sanctions. 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.

 

The dividends we receive from our PRC subsidiary may be subject to PRC tax under the PRC Enterprise Income Tax Law, which would likely have a material adverse effect on our financial condition and results of operations.

 

Pursuant to the Enterprise Income Tax Law (the “EIT Law”) and implementing rules, both of which became effective on January 1, 2008, an enterprise established outside of the PRC with “de facto management bodies” within the PRC is considered as a “resident enterprise” and will pay income tax at the rate of 25% for its global income. The implementing rules of the EIT Law define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise. In 2009, the State Administration of Taxation, or SAT, issued the SAT Circular 82, which further interprets the application of the EIT Law and its implementation to a PRC-controlled offshore enterprise. Pursuant to the SAT Circular 82, an enterprise incorporated in an offshore jurisdiction and controlled by a PRC enterprise or a PRC enterprise group will be classified as a PRC resident enterprise for tax purposes and will be subject to PRC enterprise income tax on its global income, only if  (i) its senior management in charge of daily operations reside or perform their duties mainly in the PRC; (ii) its financial or personnel decisions are made or approved by bodies or persons in the PRC; (iii) its substantial assets and properties, accounting books, corporate stamps, board and shareholder minutes are kept in the PRC; and (iv) at least 50% of its directors with voting rights or senior management habitually reside in the PRC. Such PRC resident enterprise would have to pay a withholding tax at a rate of 10% when paying dividends to its non-PRC shareholders.

 

We believe that we are not a PRC resident enterprise for PRC tax purposes because we do not have a PRC enterprise or a PRC enterprise group as our primary controlling shareholder. In addition, we are not aware of any offshore company with a corporate structure similar to ours that has been deemed a PRC resident enterprise by the PRC tax authorities. However, as the tax residency status of an enterprise is subject to determination by the PRC tax authorities and uncertainties remain with respect to the interpretation of the term “de facto management body”, we will continue to monitor our tax status.

 

If the PRC tax authorities determine that we are a PRC resident enterprise for tax purposes, we could be subject to PRC tax at a rate of 25% on our worldwide income, which could materially reduce our net income, and we may be required to withhold a 10% withholding tax from dividends we pay to our non-PRC shareholders, including the holders of our ADSs. In addition, if such income is treated as sourced from within the PRC, non-resident shareholders including the holders of our ADSs may be subject to PRC tax on gains realized on the sale or other disposition of ADSs or ordinary shares, at a rate of 10% for non-PRC enterprises or a rate of 20% for non-PRC individuals, unless a reduced rate is available under an applicable tax treaty. 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.

 

We may be subject to penalties for failure to make adequate contributions to social security and housing provident fund by some subsidiaries of our VIE pursuant to the relevant PRC laws and regulations.

 

In the past, some subsidiaries of our VIE may not have been in compliance with the relevant PRC laws and regulations to make adequate contributions to social security and housing provident fund. Pursuant to the Social Insurance Law of the PRC promulgated in 2010 and the Regulations on Management of Housing Provident Funds promulgated in 1999 and amended in 2002, an enterprise is required, within a prescribed time limit, to register with the relevant social security authority and housing provident fund management center, and to open the relevant accounts and make timely contributions for their employees; failure to do so may subject the enterprise to order for rectification, and certain fines if the enterprise fails to rectify in time. As of the date of this prospectus, such subsidiaries of our VIE have not received any demand or order from the competent authorities with respect to their social security and housing provident fund contributions. In the event that the relevant authorities determine that we have underpaid, such subsidiaries of our VIE may be required to pay outstanding contributions and penalties to the extent they did not make full contributions to the social security and housing provident funds.

 

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

 

Pursuant to the Notice on Strengthening Administration of Enterprise Income Tax for Share Transfers by Non-PRC Resident Enterprises, or SAT Circular 698, issued by SAT in 2009 with retroactive effect from January 1, 2008, where a non-resident enterprise transfers the equity interests of a PRC resident enterprise indirectly by disposition of the equity interests of an overseas holding company, or an Indirect Transfer, and such overseas holding company is located in a tax jurisdiction that: (i) has an effective tax rate less than 12.5% or (ii) does not tax foreign income of its residents, the non-resident enterprise, being the transferor, shall report to the competent tax authority of the PRC resident enterprise this Indirect Transfer.

 

In February 2015, SAT issued a Public Notice Regarding Certain Corporate Income Tax Matters on Indirect Transfer of Properties by Non-Tax Resident Enterprises, or SAT Circular 7, which supersedes the rules with respect to the Indirect Transfer under SAT Circular 698, but does not touch upon the other provisions of SAT Circular 698, which remain in force. SAT Circular 7 extends its tax jurisdiction to not only Indirect Transfers set forth under SAT Circular 698 but also transactions involving transfer of other taxable assets through offshore transfer of a foreign intermediate holding company. In addition, SAT Circular 7 provides clearer criteria than SAT Circular 698 for assessment of reasonable commercial purposes and has introduced safe harbors for internal group restructurings and the purchase and sale of equity through a public securities market. SAT Circular 7 also brings challenges to both foreign transferor and transferee (or other person who is obligated to pay for the transfer) of taxable assets. Where a non-resident enterprise transfers taxable assets indirectly by disposing of the equity interests of an overseas holding company, which is an Indirect Transfer, the non-resident enterprise as either transferor or transferee, or the PRC entity that directly owns the taxable assets, may report such Indirect Transfer to the relevant tax authority. Using a “substance over form” principle, the PRC tax authority may disregard the existence of the overseas holding company if it lacks a reasonable commercial purpose and was established for the purpose of reducing, avoiding or deferring PRC tax. As a result, gains derived from such Indirect Transfer may be subject to PRC enterprise income tax, and the transferee or other person who is obligated to pay for the transfer is obligated to withhold the applicable taxes, currently at a rate of 10% for the transfer of equity interests in a PRC resident enterprise. Both the transferor and the transferee may be subject to penalties under PRC tax laws if the transferee fails to withhold the taxes and the transferor fails to pay the taxes.

 

In October 2017, SAT issued an Announcement on Issues Relating to Withholding at Source of Income Tax of Non-resident Enterprises, or SAT Circular 37, effective December 2017, which, among others, repealed the Circular 698 and amended certain provisions in SAT Circular 7. According to SAT Circular 37, where the non-resident enterprise fails to declare the tax payable pursuant to Article 39 of the Enterprise Income Tax, the tax authority may order it to pay the tax due within required time limits, and the non-resident enterprise shall declare and pay the tax payable within such time limits specified by the tax authority. However, if the non-resident enterprise voluntarily declares and pays the tax payable before the tax authority orders it to do so within required time limits, it shall be deemed that such enterprise has paid the tax in time.

  

We face uncertainties as to the reporting and other implications of certain past and future transactions where PRC taxable assets are involved, such as offshore restructuring, sale of the shares in our offshore subsidiaries and investments. Our company may be subject to filing obligations or taxed if our company is transferor in such transactions, and may be subject to withholding obligations if our company is transferee in such transactions, under SAT Circular 7 and SAT Circular 37. For transfer of shares in our company by investors who are non-PRC resident enterprises, our PRC subsidiary may be requested to assist in the filing under the SAT circulars. As a result, we may be required to expend valuable resources to comply with the SAT circulars or to request the relevant transferors from whom we purchase taxable assets to comply with these circulars, or to establish that our company should not be taxed under these circulars, which may have a material adverse effect on our financial condition and results of operations.

 

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Risks Related to our ADSs and This Offering

 

There has been no public market for our ADSs or ordinary shares prior to this offering, and you may not be able to resell our ADSs at or above the price you paid, or at all.

 

Prior to this initial public offering, there has been no public market for our ordinary shares. We will apply for listing the ADSs on the NASDAQ Global Market. Our ADSs will not be listed on any exchange or quoted for trading on any over-the-counter trading system. If an active trading market for our ADSs does not develop after this offering, the market price and liquidity of our ADSs will be materially and adversely affected.

 

 Negotiations with the underwriters will determine the initial public offering price for our ADSs which may bear no relationship to their market price after the initial public offering. We cannot assure you that an active trading market for our ADSs will develop or that the market price of our ADSs will not decline below the initial public offering price.

 

The market price for our ADSs may be volatile.

 

The market price for our ADSs is likely to be highly volatile and subject to wide fluctuations in response to factors including the following:

 

regulatory developments in our target markets affecting us, our clients or our competitors;

 

announcements of studies and reports relating to the quality of our products and services or those of our competitors;

 

changes in the economic performance or market valuations of other companies that provide wealth management services;

 

actual or anticipated fluctuations in our quarterly results of operations and changes or revisions of our expected results;

 

changes in financial estimates by securities research analysts;

 

conditions in the wealth management services industry;

 

announcements by us or our competitors of new services, acquisitions, strategic relationships, joint ventures or capital commitments;

 

addition or departure of our senior management;

 

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fluctuations of exchange rates between the Renminbi and the U.S. dollar;

 

release or expiry of lock-up or other transfer restrictions on our outstanding ordinary shares; and

 

sales or perceived potential sales of additional ordinary shares.

 

In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also have a material adverse effect on the market price of our ordinary shares.

 

Because our initial public offering price is substantially higher than our net tangible book value per share, you will experience immediate and substantial dilution.

 

If you purchase ADSs in this offering, you will pay more for each ADS than the corresponding amount paid by existing shareholders for their ordinary shares. As a result, you will experience immediate and substantial dilution of approximately $5.83 per ADS, representing the difference between our net tangible book value per ADS at $0.92 immediately after this offering, after giving effect to this offering and an assumed initial public offering price of $6.75 per ADS (which is the mid-point of the estimated range of the initial public offering price shown on the front cover of this prospectus) and assuming the minimum offering amount is sold, or an immediate and substantial dilution of $5.70 per ADS, representing the difference between our net tangible book value per ADS at $1.05 immediately after this offering, after giving effect to this offering and an assumed initial public offering price of $6.75 per ADS (which is the mid-point of the estimated range of the initial public offering price shown on the front cover of this prospectus) and assuming the maximum offering amount is sold. The dilution calculation has taken into account the total ordinary shares of 84,033,600 before completion of this offering which include 80,000,000 ordinary shares issued on August 6, 2018 and 4,033,600 ordinary shares issued on September 5, 2018. See “Dilution” for a more complete description of how the value of your investment in our ADSs will be diluted upon the completion of this offering.

 

We do not expect to pay dividends in the foreseeable future and you may have to rely on price appreciation of our ADSs for any 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 of future dividend income.

 

Our board of directors has complete discretion as to whether to distribute dividends. 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, received by us from our 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 after this offering 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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Substantial future sales or perceived potential sales of our ADSs in the public market could cause the price of our ADSs to decline.

 

Sales of our ADSs or ordinary shares in the public market after this offering, or the perception that these sales could occur, could cause the market price of our ADSs to decline. All ADSs sold in this offering will be freely transferable without restriction or additional registration under the U.S. Securities Act of 1933, as amended, or the Securities Act. The remaining ordinary shares outstanding after this offering will be available for sale, upon the expiration of the 180-day lock-up period beginning from the date of this prospectus, subject to volume and other restrictions as applicable under Rules 144 and 701 under the Securities Act. Any or all of these shares may be released prior to expiration of the lock-up period at the discretion of the representative. To the extent shares are released before the expiration of the lock-up period and sold into the market, the market price of our ADSs could decline.

 

Upon completion of this offering, certain holders of our ordinary shares will have the right to cause us to register under the Securities Act the sale of their shares, subject to the 180-day lock-up period in connection with this offering. Registration of these shares under the Securities Act would result in ADSs representing these shares becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of the registration. Sales of these registered shares in the form of ADSs, in the public market could cause the price of our ADSs to decline.

 

You may not have the same voting rights as the holders of our ordinary shares and may not receive voting materials in time to be able to exercise your right to vote.

 

Except as described in this prospectus and in the deposit agreement, holders of our ADSs will not be able to exercise voting rights attaching to the shares represented by our ADSs on an individual basis. Holders of our ADSs will appoint the depositary or its nominee as their representative to exercise the voting rights attaching to the shares represented by the ADSs. You may not receive voting materials in time to instruct the depositary to vote, and it is possible that you, or persons who hold their ADSs through brokers, dealers or other third parties, will not have the opportunity to exercise a right to vote. See “Description of Share Capital — Our Post-Offering Memorandum and Articles — Voting Rights” and “Description of American Depositary Shares — Voting Rights.”

 

Your right to participate in any future rights offerings may be limited, which may cause dilution to your holdings and you may not receive cash dividends if it is impractical to make them available to you.

 

We may from time to time distribute rights to our shareholders, including rights to acquire our securities. However, we cannot make rights available to you in the United States unless we register both the rights and the securities to which the rights relate under the Securities Act or an exemption from the registration requirements is available. Under the deposit agreement, the depositary will not make rights available to you unless both the rights and the underlying securities to be distributed to ADSs holders are either registered under the Securities Act or exempt from registration under the Securities Act. We are under no obligation to file a registration statement with respect to any such rights or securities or to endeavor to cause such a registration statement to be declared effective and we may not be able to establish a necessary exemption from registration under the Securities Act. Accordingly, you may be unable to participate in our rights offerings and may experience dilution in your holdings.

 

The depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian receives on our ordinary shares or other deposited securities after deducting its fees and expenses. You will receive these distributions in proportion to the number of ordinary shares your ADSs represent. However, the depositary may, at its discretion, decide that it is inequitable or impractical to make a distribution available to any holders of ADSs. For example, the depositary may determine that it is not practicable to distribute certain property through the mail, or that the value of certain distributions may be less than the cost of mailing them. In these cases, the depositary may decide not to distribute such property to you.

 

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. 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.

 

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Your rights to pursue claims against the depositary as a holder of ADSs are limited by the terms of the deposit agreement.

 

Under the deposit agreement, any action or proceeding against or involving the depositary, arising out of or based upon the deposit agreement or the transactions contemplated thereby or by virtue of owning the ADSs may only be instituted in a state or federal court in New York, New York, and you, as a holder of our ADSs, will have irrevocably waived any objection which you may have to the laying of venue of any such proceeding, and irrevocably submitted to the exclusive jurisdiction of such courts in any such action or proceeding.

 

The depositary may, in its sole discretion, require that any dispute or difference arising from the relationship created by the deposit agreement be referred to and finally settled by an arbitration conducted under the terms described in the deposit agreement, although the arbitration provisions do not preclude you from pursuing claims under the Securities Act or the Exchange Act in federal courts. See “Description of American Depositary Shares” for more information.

 

ADS 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 ordinary shares provides that, subject to the depositary’s right to require a claim to be submitted to arbitration, the federal or state courts in the City of New York have exclusive jurisdiction to hear and determine claims arising under the deposit agreement and in that regard, to the fullest extent permitted by law, ADS holders waive the right to a jury trial of any claim 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. 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 investing in the ADSs.

 

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 and / or the depositary. If a lawsuit is brought against us and/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.

 

Nevertheless, if this jury trial waiver provision is not enforced, to the extent a court action proceeds, it would 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 face difficulties in protecting your interests, and your ability to protect your rights through the U.S. federal courts may be limited because we are incorporated under Cayman Islands law, we conduct substantially all of our operations in China and all of our directors and officers reside outside the United States.

 

We are incorporated in the Cayman Islands, and conduct substantially all of our operations in China through our PRC subsidiary and variable interest entity. All of our directors and officers reside outside the United States and a substantial portion of their assets are located outside of 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 Cayman Islands or in China in the event that you believe that your rights have been infringed under the 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. There is no statutory recognition in the Cayman Islands of judgments obtained in the United States, although the courts of the Cayman Islands will generally recognize and enforce a non-penal judgment of a foreign court of competent jurisdiction without retrial on the merits. For more information regarding the relevant laws of the Cayman Islands and China, see “Enforceability of Civil Liabilities.”

 

Our corporate affairs are governed by our memorandum and articles of association, as amended and restated from time to time, and by the Companies Law (2010 Revision) and common law of the Cayman Islands. The rights of shareholders to take legal action against us and our directors, actions by minority shareholders and the fiduciary responsibilities of our directors 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 English common law, which provides persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in the United States. In particular, the Cayman Islands has a less developed body of securities laws than the United States and provides significantly less protection to investors. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action in U.S. federal courts.

 

As a result, our public shareholders may have more difficulty in protecting their interests through actions against us, our management, our directors or our major shareholders than would shareholders of a corporation incorporated in a jurisdiction in the United States.

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You must rely on the judgment of our management as to the use of the net proceeds from this offering, and such use may not produce income or increase our ADS price.

 

We have not allocated a significant portion of the net proceeds of this offering to any particular purpose. Rather, our management will have considerable discretion in the application of the net proceeds received by us. You will not have the opportunity, as part of your investment decision, to assess whether proceeds are being used appropriately. You must rely on the judgment of our management regarding the application of the net proceeds of this offering. The net proceeds may be used for corporate purposes that do not improve our efforts to maintain profitability or increase our ADSs price. The net proceeds from this offering may be placed in investments that do not produce income or that lose value.

 

Our memorandum and articles of association will contain anti-takeover provisions that could adversely affect the rights of holders of our ADSs.

 

We will adopt amended and restated articles of association that will become effective immediately upon the closing of this offering. Our new memorandum and articles of association will contain certain provisions that could limit the ability of others to acquire control of our company, including a provision that grants to our board of directors the authority 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. The provisions could have the effect of depriving our shareholders of the opportunity to sell their shares 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.

 

We may be classified as a passive foreign investment company under U.S. tax law, which could result in adverse U.S. federal income tax consequences to U.S. holders of our ADSs.

 

Depending upon the value of our assets (based, in part, on the market value of our ADSs) and the nature of our assets and income over time, we could be classified as a passive foreign investment company, or PFIC, for United States federal income tax purposes. Based on our current income and assets and projections as to the value of our ordinary shares and ADSs pursuant to this offering, we do not expect to be classified as a PFIC for the current taxable year. While we do not anticipate becoming a PFIC for the current taxable year, fluctuations in the market price of our ADSs may cause us to become a PFIC for the current or any subsequent taxable year.

 

We will be classified as a PFIC for any taxable year if either (i) at least 75% of our gross income for the taxable year is passive income or (ii) at least 50% of the value of our assets (determined on the basis of a quarterly average) is attributable to assets that produce or are held for the production of passive income. Although the law in this regard is unclear, we intend to treat our VIE (including its subsidiaries) as being owned by us for United States federal income tax purposes and we treat it that way, not only because we exercise effective control over the operation of such entity but also because we are entitled to substantially all of the economic benefits associated with it, and, as a result, we consolidate its operating results in our consolidated, U.S. GAAP financial statements. If it were determined, however, that we are not the owner of our VIE (including its subsidiaries) for U.S. federal income tax purposes, we may be treated as a PFIC for our taxable year ending on December 31, 2018 and any subsequent taxable year. Because of the uncertainties in the application of the relevant rules and PFIC status is a factual determination made annually after the close of each taxable year on the basis of the composition of our income and the value of our active versus passive assets, there can be no assurance that we will not be a PFIC for the taxable year ending on December 31, 2018 or any future taxable year. The overall level of our passive assets will be affected by how, and how quickly, we spend our liquid assets and the cash raised in this offering. Under circumstances where we determine not to deploy significant amounts of cash for active purposes, our risk of becoming classified as a PFIC would substantially increase.

  

If we were to be or become classified as a PFIC, a U.S. holder (as defined in “Taxation — U.S. Federal Income Tax Considerations — General”) may be subject to reporting requirements and may incur significantly increased United States income tax on gain recognized on the sale or other disposition of the ADSs or ordinary shares and on the receipt of distributions on the ADSs or ordinary shares to the extent such gain or distribution is treated as an “excess distribution” under the United States federal income tax rules. Further, if we were a PFIC for any year during which a U.S. holder held our ADSs or ordinary shares, we would continue to be treated as a PFIC for all succeeding years during which such U.S. holder held our ADSs or ordinary shares. You are urged to consult your tax advisor concerning the United States federal income tax consequences of acquiring, holding, and disposing of ADSs or ordinary shares if we are or become classified as a PFIC. See “Taxation — U.S. Federal Income Tax Considerations — Passive Foreign Investment Company Considerations.”

 

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

 

As a public company, we will incur significant accounting, legal and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act, as well as rules subsequently implemented by the SEC and the NASDAQ Global Market, have detailed requirements concerning corporate governance practices of public companies including Section 404 relating to internal controls over financial reporting. We expect these rules and regulations to increase our accounting, legal and financial compliance costs and to make certain corporate activities more time-consuming and costly. In addition, we will incur additional costs associated with our public company reporting requirements. We are currently evaluating and monitoring developments with respect to these new rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.

 

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Special Note Regarding Forward-looking Statements

 

We have made statements in this prospectus, including under “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Business” and elsewhere that constitute forward-looking statements. Forward-looking statements involve risks and uncertainties, such as statements about our plans, objectives, expectations, assumptions or future events. In some cases, you can identify forward-looking statements by terminology such as “anticipate,” “estimate,” “plan,” “project,” “potential,” “continue,” “ongoing,” “expect,” “aim,” “believe,” “intend,” “may,” “should,” “will,” “is/are likely to,” “could” and similar expressions denoting uncertainty or an action that may, will or is expected to occur in the future. These statements involve estimates, assumptions, known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from any future results, performances or achievements expressed or implied by the forward-looking statements.

 

Examples of forward-looking statements include statements relating to:

 

our business strategies, goals and objectives;

 

our future business development, financial condition and results of operations;

 

the expected growth of China’s wealth management services market, corporate finance services market as well as asset management services market;

 

our expectations regarding demand for and market acceptance of our existing and future products and services;

 

projections of revenue, earnings, capital structure and other financial items;

 

the capabilities of our business operations;

 

expected future economic performance;

 

relevant government policies and regulations relating to our industry;

 

competition in the wealth management services industry as well as the asset management services industry; and

 

general economic and business conditions in the markets in which we operate;

 

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 “Prospectus Summary – Our Challenges and Risks,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Business,” “Regulation” and other sections in this prospectus. You should thoroughly read this prospectus 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.

 

This prospectus contains certain data and information that we obtained from various government and private publications as well as a report issued by CIC, a PRC consulting and market research firm. Statistical data in these publications and the report also include projections based on a number of assumptions. The wealth management industry, asset management industry and corporate finance industry may not grow at the rate projected by market data, or at all. Failure of such industries to grow at the projected rate may have a material and adverse effect on our business and the market price of our ADSs. Furthermore, if any one or more of the assumptions underlying the market data are later found to be incorrect, actual results may differ from the projections based on these assumptions. You should not place undue reliance on these forward-looking statements.

 

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

 

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USE OF PROCEEDS

 

We estimate that we will receive net proceeds from the minimum offering amount of approximately US$26.2 million after deducting underwriting discounts and commissions and the estimated offering expenses payable by us, and net proceeds from the maximum offering amount of approximately US$35.5 million after deducting underwriting discounts and commissions and the estimated expenses payable by us. These estimates are based upon an assumed initial public offering price of US$6.75 per ADS, the mid-point of the estimated range of the initial public offering price shown on the front cover of this prospectus. A US$1.00 increase (decrease) in the assumed initial public offering price of US$6.75 per ADS, the mid-point of the estimated range of the initial public offering price shown on the front cover of this prospectus, would increase (decrease) the net proceeds to us from this offering by US$4.1 million if the minimum offering amount is sold, or approximately US$5.5 million if the maximum offering amount is sold, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. 

 

We plan to use the net proceeds of this offering as follows:

 

20% of the net proceeds of this offering to expand our branch network, including expanding branches in tier one and tier two cities in China, developing our base of independent investment advisors and additional seed clients, and hiring additional investment advisors;

 

20% of the net proceeds of this offering to upgrade our IT infrastructure;

 

20% of the net proceeds of this offering to launch additional FoFs and non-performing loan funds under our asset management business; and

 

the remaining 40% for general corporate purposes, including to fund strategic investments and acquisitions.

  

The foregoing represents our current intentions based upon our present plans and business conditions to use and allocate the net proceeds of this offering. Our management, however, will have significant flexibility and discretion to apply the net proceeds of this offering. If an unforeseen event occurs or business conditions change, we may use the proceeds of this offering differently than as described in this prospectus. See “Risk Factors—Risks Related to Our ADSs and This Offering—You must rely on the judgment of our management as to the use of the net proceeds from this offering, and such use may not produce income or increase our ADS price.”

  

In using the net proceeds of this offering, we are permitted under PRC laws and regulations as an offshore holding company to provide funding to our WFOE only through loans or capital contributions and to our VIE only through loans, subject to the satisfaction of applicable government registration, approval and filing requirements. We expect 30% of the net proceeds to be used by us or our offshore intermediate holding companies for general corporate purposes, and the remaining 70% to be immediately remitted to our WFOE and/or our VIE following the completion of this offering to be applied towards our planned use of proceeds. With respect to capital contributions that we can make to our WFOE, as of the date of this prospectus, the maximum amount of capital contributions that we may make to our WFOE is US$200 million, without obtaining approvals from SAFE or other government authorities. The WFOE may increase its registered capital to receive additional capital contributions from us at any time, and currently there is no statutory limit to the amount of registered capital. The relevant filing and registration processes for increasing the cap for capital contributions typically take approximately eight weeks to be completed. With respect to loans, pursuant to relevant PRC regulations, the maximum amount of loans that we may provide to our WFOE equals to the larger amount of (i) the balance between the total investment amount (approved by the Ministry of Commerce or its local counterpart) and the amount of registered capital of our WFOE, or (ii) two times of the amount of the net assets of the WFOE calculated in accordance with PBOC Circular 9; and the maximum amount of loans we may provide to our VIE equals to two times of the amount of the net assets of our VIE calculated in accordance with PBOC Circular 9.Each of the loans to our WFOE or VIE is subject to satisfaction of applicable government registration or approval requirements. The relevant filing and registration processes for such loans typically take approximately four weeks to be completed. See “Regulations—PRC Regulations Relating to Foreign Debt” for details. While we currently see no material obstacles to complete the relevant filing and registration processes with respect to future loans or capital contributions to our WFOE and/or our VIE, we cannot assure you that we will be able to obtain these government registrations or approvals on a timely basis, if at all. See “Risk Factors—Risks Related to Doing Business in China—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 this offering to make loans or additional capital contributions to our PRC subsidiary, which could materially and adversely affect our liquidity and our ability to fund and expand our business.”

 

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Dividend Policy

 

Since inception, we have not declared or paid any dividends on our shares. We do not have any present plan to pay any dividends on our ordinary shares or ADSs in the foreseeable future. We intend to retain most, if not all, of our available funds and any future earnings to operate and expand our business.

 

Any other future determination to pay dividends will be made at the discretion of our board of directors and may be based on a number of factors, including our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant. If we pay any dividends, we will pay our ADS holders to the same extent as holders of our ordinary shares, subject to the terms of the deposit agreement, including the fees and expenses payable thereunder. See “Description of American Depositary Shares—American Depositary Shares.” Cash dividends on our ordinary shares, if any, will be paid in U.S. dollars.

 

We are an exempted company incorporated in the Cayman Islands. In order for us to distribute any dividends to our shareholders and ADS holders, we may rely on dividends distributed by our PRC subsidiary. Certain payments from our PRC subsidiary to us may be subject to PRC withholding income tax. In addition, regulations in the PRC currently permit payment of dividends of a PRC company only out of accumulated distributable after-tax profits as determined in accordance with its articles of association and the accounting standards and regulations in China. Our PRC subsidiary is required to set aside at least 10% of its after-tax profit based on PRC accounting standards every year to a statutory common reserve fund until the aggregate amount of such reserve fund reaches 50% of the registered capital of such subsidiary. Such statutory reserves are not distributable as loans, advances or cash dividends.

 

41

 

 

Exchange Rate Information

 

Our reporting currency is the Renminbi because our business is substantially conducted in China and all of our revenues are denominated in Renminbi. This prospectus contains translations of Renminbi amounts into U.S. dollars at specific rates solely for the convenience of the reader. The conversion of Renminbi into U.S. dollars in this prospectus is based on the exchange rate set forth in the H.10 statistical release of the Board of Governors of the Federal Reserve System. Unless otherwise noted, all translations from Renminbi to U.S. dollars and from U.S. dollars to Renminbi in this prospectus were made at a rate of RMB6.6171 to US$1.00, the exchange rate on June 29, 2018 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, the rates stated below, or at all. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the conversion of Renminbi into foreign exchange and through restrictions on foreign trade. On January 25, 2019, the exchange rate for Renminbi was RMB6.7748 to US$1.00.

 

The following table sets forth information concerning exchange rates between the Renminbi and the U.S. dollar for the periods indicated. These rates are provided solely for your convenience and are not necessarily the exchange rates that we used in this prospectus or will use in the preparation of our periodic reports or any other information to be provided to you.

 

    Exchange Rate  
Period   Period
End
    Average     Low     High  
    (RMB per US$1.00)  
2013     6.0537       6.1412       6.0537       6.2438  
2014     6.2046       6.1704       6.0402       6.2591  
2015     6.4778       6.2869       6.2046       6.4778  
2016     6.9430       6.6400       6.4480       6.9580  
2017     6.5063       6.7350       6.4773       6.9575  
2018     6.8755       6.6090       6.2649       6.9558  
2019                                
January (through January 25)     6.7748       6.8028       6.7448       6.8708  

 

Source: Federal Reserve Statistical Release

 

Note:

 

(1)Annual averages are calculated by using the average of the exchange rates on the last day of each month during the relevant year. Monthly averages are calculated by using the average of the daily rates during the relevant month.

 

42

 

 

Capitalization

 

The following table sets forth our capitalization as of June 30, 2018:

 

On an actual basis; and

 

On a pro forma basis to give effect to the sale of 7,777,779 ordinary shares in the form of ADSs by us in this offering at the assumed initial public offering price of $6.75 per ADS, which is the mid-point of the estimated range of the initial public offering price shown on the front cover of this prospectus, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

 

You should read this table together with our consolidated financial statements and the related notes included elsewhere in this prospectus and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

    As of June 30, 2018  
    Actual    

As Adjusted for IPO

(Minimum offering amount)(1)

   

As Adjusted for IPO

(Maximum offering amount)(1)

 
    RMB     US$     RMB     US$     RMB     US$  
    (in thousands except shares)  
Ordinary shares                                                
Shares(2)     80,000,000       80,000,000       90,700,269       90,700,269       92,922,489       92,922,489  
Par Value Amount     529       80       601       88       616       90  
Call-up Capital                                    
Additional Paid-In Capital     62,705       9,476       244,751       36,582       306,276       45,880  
Statutory reserve     14,152       2,139       14,152       2,139       14,152       2,139  
Retained Earnings     107,407       16,232       107,407       16,232       107,407       16,232  
Accumulated Other Comprehensive Income                                    
Total     184,793       27,927       366,911       55,041       428,451       64,341  

 

(1) We have agreed to pay Network 1 Financial Securities, Inc. (the “Underwriter”) a fee equal to 7% of the gross proceeds of the offering from investors introduced by the Underwriter and a fee equal to 5% of the gross proceeds of the offering from investors introduced by us. The calculation above is based on the assumption that all shares sold in this offering were to investors introduced by the Underwriter. Proceeds to the company will be higher if any shares sold in this offering were to investors introduced by us. We have agreed to pay a corporate finance fee of US$250,000 of the gross proceeds of the offering. See “Underwriting” in this prospectus for more information regarding our arrangements with the Underwriter.

 

(2)The number of shares shown in the first column is the number of shares as of June 30, 2018. On August 6, 2018, we issued an aggregate of 80,000,000 ordinary shares with total consideration of US$80,000, at price of US$0.001 per share on the same day. On September 5, 2018, we issued an aggregate of 4,033,600 ordinary shares with a total consideration of US$1,468,976.8. In accordance with SEC SAB Topic 4, the nominal share issuance was accounted for as a stock split and that all share and per share information has been retrospectively restated to reflect such stock split for all periods presented.

 

43

 

 

Dilution

 

If you invest in our ADSs, your interest will be immediately diluted by US$5.83, representing the difference between our net tangible book value per ADS at US$0.92 as of June 30, 2018 after giving effect to this offering and an assumed initial public offering price of US$6.75 per ADS, which is based on the mid-point of the estimated initial public offering price range set forth on the cover page of this prospectus and assuming the minimum offering amount is sold, or an immediate dilution of US$5.70 per ADS, representing the difference between our net tangible book value per ADS at US$1.05 as of June 30, 2018 after giving effect to this offering and an assumed initial public offering price of US$6.75 per ADS, which is based on the mid-point of the estimated initial public offering price range set forth on the cover page of this prospectus and assuming the maximum offering amount is sold. Dilution results from the fact that the initial public offering price per ordinary share is substantially in excess of the book value per ordinary share attributable to the existing shareholders for our presently outstanding ordinary shares.

 

Dilution to New Investors if the Minimum Offering Amount is Sold

 

Our net tangible book value as of June 30, 2018 was $29.2 million, or $0.35 per ordinary share as of that date and $0.52 per ADS. Net tangible book value represents the amount of our total consolidated assets (excluding intangible assets), less the amount of our total consolidated liabilities. Dilution is determined by subtracting net tangible book value per ordinary share, after giving effect to the additional proceeds we will receive from this offering, from the assumed initial public offering price of $4.5 per ordinary share, which is the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus adjusted to reflect the ADS-to-ordinary share ratio, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us. The dilution calculation has taken into account the total ordinary shares of 84,033,600 before completion of this offering which include 80,000,000 ordinary shares issued on August 6, 2018 and 4,033,600 ordinary shares issued on September 5, 2018.

 

Without taking into account any other changes in net tangible book value after June 30, 2018, other than to give effect to our sale of the ADSs offered in this offering at the assumed initial public offering price of $6.75 per ADS, the midpoint of the estimated range of the initial public offering price, after deduction of the underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of June 30, 2018 would have been $55.5 million, or $0.61 per ordinary share and $0.92 per ADS. This represents an immediate increase in net tangible book value of $0.26 per ordinary share and $0.40 per ADS to the existing shareholders and an immediate dilution in net tangible book value of $3.89 per ordinary share and $5.83 per ADS to investors purchasing ADSs in this offering. The following table illustrates such dilution: 

 

    Per Ordinary Share     Per ADS  
Assumed initial offering price   $ 4.5       6.75  
Net tangible book value as of June 30, 2018   $ 0.35       0.52  
Increase/(decrease) in net tangible book value attributable to the sale of the ADSs   $ 0.26       0.40  
Pro forma as adjusted net tangible book value after the offering   $ 0.61       0.92  
Amount of dilution in net tangible book value to new investors   $ 3.89       5.83  

 

A $1.00 increase (decrease) in the assumed public offering price of $6.75 per ADS would increase (decrease) our pro forma as adjusted net tangible book value after giving effect to this offering by $4.1 million, the pro forma as adjusted net tangible book value per ordinary share and per ADS after giving effect to this offering by $0.05 per ordinary share and $0.07 per ADS and the dilution in pro forma as adjusted net tangible book value per ordinary share and per ADS to new investors in this offering by $0.62 per ordinary share and $0.93 per ADS, assuming no change to the number of ADSs offered by us as set forth on the cover page of this prospectus, and after deducting underwriting discounts and commissions and other offering expenses.

 

The following table summarizes, on a pro forma as adjusted basis as of June 30, 2018, the differences between existing shareholders and the new investors with respect to the minimum number of ordinary shares (in the form of ADSs or shares) purchased from us, the total consideration paid and the average price per ordinary share and per ADS paid before deducting the underwriting discounts and commissions and estimated offering expenses.

 

    Ordinary Shares Purchased     Total Consideration     Average
Price Per
    Average
Price Per
 
    Number     Percent     Amount     Percent     Ordinary Share     ADS  
Existing shareholders     84,033,600       92.6 %   $ 1,548,977       4.9 %   $ 0.02     $ 0.03  
New investors     6,666,669       7.4 %   $ 30,000,011       95.1 %   $ 4.50     $ 6.75  
Total     90,700,269       100 %   $ 31,548,988       100 %            

 

The pro forma as adjusted information discussed above is illustrative only. Our net tangible book value following the completion of this offering is subject to adjustment based on the actual initial public offering price of our ADSs and other terms of this offering determined at pricing.

 

44

 

 

Dilution to New Investors if the Maximum Offering Amount is Sold

 

Our net tangible book value as of June 30, 2018 was $29.2 million, or $0.35 per ordinary share as of that date and $0.52 per ADS. Net tangible book value represents the amount of our total consolidated assets (excluding intangible assets), less the amount of our total consolidated liabilities. Dilution is determined by subtracting net tangible book value per ordinary share, after giving effect to the additional proceeds we will receive from this offering, from the assumed initial public offering price of $4.5 per ordinary share, which is the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus adjusted to reflect the ADS-to-ordinary share ratio, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us. The dilution calculation has taken into account the total ordinary shares of 84,033,600 before completion of this offering which include 80,000,000 ordinary shares issued on August 6, 2018 and 4,033,600 ordinary shares issued on September 5, 2018.

 

Without taking into account any other changes in net tangible book value after June 30, 2018, other than to give effect to our sale of the ADSs offered in this offering at the assumed initial public offering price of $6.75 per ADS, the midpoint of the estimated range of the initial public offering price, after deduction of the underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of June 30, 2018 would have been $64.8 million, or $0.70 per ordinary share and $1.05 per ADS. This represents an immediate increase in net tangible book value of $0.35 per ordinary share and $0.53 per ADS to the existing shareholders and an immediate dilution in net tangible book value of $3.80 per ordinary share and $5.70 per ADS to investors purchasing ADSs in this offering. The following table illustrates such dilution: 

 

    Per Ordinary Share     Per ADS  
Assumed initial offering price   $ 4.5       6.75  
Net tangible book value as of June 30, 2018   $ 0.35       0.52  
Increase/(decrease) in net tangible book value attributable to the sale of the ADSs   $ 0.35       0.53  
Pro forma as adjusted net tangible book value after the offering   $ 0.70       1.05  
Amount of dilution in net tangible book value to new investors   $ 3.80       5.70  

 

A $1.00 increase (decrease) in the assumed public offering price of $6.75 per ADS would increase (decrease) our pro forma as adjusted net tangible book value after giving effect to this offering by $5.5 million, the pro forma as adjusted net tangible book value per ordinary share and per ADS after giving effect to this offering by $0.06 per ordinary share and $0.09 per ADS and the dilution in pro forma as adjusted net tangible book value per ordinary share and per ADS to new investors in this offering by $0.61 per ordinary share and $0.92 per ADS, assuming no change to the number of ADSs offered by us as set forth on the cover page of this prospectus, and after deducting underwriting discounts and commissions and other offering expenses.

   

The following table summarizes, on a pro forma as adjusted basis as of June 30, 2018, the differences between existing shareholders and the new investors with respect to the maximum number of ordinary shares (in the form of ADSs or shares) purchased from us, the total consideration paid and the average price per ordinary share and per ADS paid before deducting the underwriting discounts and commissions and estimated offering expenses.

 

    Ordinary Shares Purchased     Total Consideration     Average
Price Per
    Average
Price Per
 
    Number     Percent     Amount     Percent     Ordinary Share     ADS  
Existing shareholders     84,033,600       90.4 %   $ 1,548,977       3.7 %   $ 0.02     $ 0.03  
New investors     8,888,889       9.6 %   $ 40,000,001       96.3 %   $ 4.50     $ 6.75  
Total     92,922,489       100 %   $ 41,548,978       100 %                

 

The pro forma as adjusted information discussed above is illustrative only. Our net tangible book value following the completion of this offering is subject to adjustment based on the actual initial public offering price of our ADSs and other terms of this offering determined at pricing.

 

45

 

 

Selected Consolidated Financial Data

 

The following summary consolidated statements of operations data for the year ended June 30, 2017 and 2018, and summary consolidated balance sheets data as of June 30, 2017 and 2018 and summary consolidated cash flow data as of June 30, 2017 and 2018 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. Our consolidated financial statements are prepared and presented in accordance with the generally accepted accounting principles in the United States of America, or U.S. GAAP. You should read this Summary Consolidated Financial Data and Summary Operating Data section together with our consolidated financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. Our historical results are not necessarily indicative of results expected for future periods.

 

Selected Consolidated Statements of Income

 

  

For the year ended June 30,

 
  

2017

  

2018

  

2018

 
   RMB
   RMB
   US$
 
  (combined, in thousands) 
Net revenues:            
Wealth management services   144,925    140,403    21,218 
Corporate financing services   773    13,710    2,072 
Asset management services   -    103    16 
Information technology services and others   9,993    11,595    1,752 
Total net revenues   155,691    165,811    25,058 
Operating costs and expenses:               
Cost of sales   (53,397)   (28,825)   (4,356)
Selling expenses   (34,969)   (45,470)   (6,872)
General and administrative expenses   (20,088)   (28,623)   (4,326)
Total operating costs and expenses   (108,454)   (102,918)   (15,554)
Income from operations   47,237    62,893    9,504 
Other income, net:               
Investment income   1,715    5,144    777 
Interest income   51    3,640    550 
Interest expenses   (2,311)   -    - 
Others, net   843    201    31 
Income from continuing operations before income taxes and discontinued operations   47,535    71,878    10,862 
Income tax expense   (7,641)   (8,261)   (1,248)
Net income from continuing operations   39,894    63,617    9,614 
Net loss from discontinued operations, net of tax   (254)   -    - 
Net income   39,640    63,617    9,614 
less: net income (loss) attributable to non-controlling interests   1,827    (979)   (148)
Net  income attributable to the Company’s shareholders   37,813    64,596    9,762 

 

  

For the year ended June 30,

 
   2017   2018   2018 
   RMB   RMB   US$ 
      

(combined)

     
             
Net income per share:            
Basic and Diluted            

Net income from continuing operations

   0.476    0.807    0.122 
Net loss from discontinued operations   (0.003)   -    - 
Net income   0.473    0.807    0.122 
                
Weighted average number of shares used in computation:               

Basic:

   80,000,000    80,000,000    80,000,000 
Diluted   80,000,000    80,000,000    80,000,000 

 

46

 

 

Selected Consolidated Statements of Financial Position

 

   As of June 30, 
   2017   2018   2018 
   RMB
(combined)
   RMB   US$ 
   (in thousands) 
Total current assets   185,127    214,574    32,427 
Total assets   191,663    225,866    34,134 
Total current liabilities   33,113    32,214    4,869 
Total liabilities   33,113    32,214    4,869 
Total equity interest attributable to the company   148,712    184,793    27,927 
Non-controlling interests   9,838    8,859    1,338 

 

Selected Consolidated Statements of Cash Flow:

 

   For the year ended June 30, 
   2017   2018   2018 
   RMB   RMB   US$ 
   (combined, in thousands) 
Net cash (used in) provided by operating activities   (23,069)   44,916    6,788 
Net cash provided by investing activities   21,074    10,047    1,518 
Net cash used in financing activities   (26,194)   -    - 
Net (decrease) increase in cash and cash equivalents, and restricted cash   (28,189)   54,963    8,306 
Cash and cash equivalents at beginning of year   85,226    57,037    8,620 
Cash and cash equivalents at end of year   57,037    112,000    16,926 

 

47

 

 

MANAGEMENTS DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the section entitled Selected Consolidated Financial Dataand our consolidated financial statements and the related notes included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under Risk Factorsand elsewhere in this prospectus.

 

Overview

 

Puyi is the largest third-party wealth management services provider in China focusing on mass affluent and emerging middle class population, with a 10.4% market share based on 2017 transaction value, according to CIC. We are also the 21st largest third-party wealth management services provider in China overall based on the same metric, according to the same source.

 

We provide wealth management services, corporate finance services and asset management services. Our largest business has been our wealth management services business. For the year ended June 30, 2017 and the year ended June 30, 2018, the aggregate transaction value of the wealth management products we distributed totaled RMB5.6 billion and RMB6.0 billion (US$0.9 billion), respectively. Under our wealth management services, we charge all financial product issuers distribution commissions calculated as a percentage of the amount of products distributed by us, and specifically, earn performance-based fees mainly from the issuers of the privately raised fund products that we distribute. In addition, we have a substantial corporate finance services business, under which we provide financing services to corporate borrowers, and generate revenue computed as a percentage of the amount financed. In April 2018, we commenced our asset management services business where we manage FoFs. Under this business, we are entitled to management fees amounting to a percentage of capital committed and a performance-based fees based on the extent of which the fund’s investment performance exceeds a certain threshold at the end of the contract term.

 

We have experienced significant growth in recent years. Our net revenues increased from RMB155.7 million for the year ended June 30, 2017 to RMB165.8 million (US$25.1 million) for the year ended June 30, 2018. Our net income increased from RMB39.6 million for the year ended June 30, 2017 to RMB63.6 million (US$9.6 million) for the year ended June 30, 2018.

 

Major Factors Affecting Our Results of Operations

 

We believe that the major factors affecting our results of operations include the following.

 

Effectiveness of our seed client model

 

To expand our business more quickly and efficiently, we have developed a sales model by collaborating with seed clients—existing clients who believe in our service capabilities—to actively market our products or services on social media platforms to their family, friends and acquaintances. Approximately 98% of our total sales for the year ended June 30, 2017 and all of our 2018 sales were generated by our seed clients. Therefore, the number of our seed clients and their ability to attract more potential clients are vital to the expansion of our business. We define seed clients who bring in at least one new registered user of our apps or one new client during any given period as active seed clients in that same period. Increases in the number of active seed clients and percentage of active seed clients to total seed clients indicate an improvement in sales performance of our seed clients and the expansion of our new client base. As of June 30, 2016, 2017 and 2018, the number of our seed clients increased from approximately 16,000 to 25,200 and further to 35,000. For the years ended June 30, 2017 and 2018, we had 25,014 and 33,922 active seed clients, respectively, accounting for 96.8% and 97.2% of the total seed clients for the same periods, respectively.

 

48

 

 

We expect that the number of seed clients, the number of active seed clients and the number of new clients brought in by seed clients will continue to be a key factor affecting our revenue growth. The number of new clients we may develop is affected by the breadth of our coverage network (including seed clients and branch offices) and the support services we provide. As we expand our coverage network and expand the team of our investment advisors who are responsible for providing support services to seed clients, we will increase our capacity and capability to cultivate and serve new clients, which may result in an increase in the number of seed clients and new clients introduced by them.

 

Business Mix

 

Other than the wealth management services we provided since our inception, we commenced corporate finance services in January 2017 and asset management services in April 2018. From January 2017 to April 2018, we also provided information technology services to third parties. Our revenue, net profit, profit margins and other aspects of our results of operations are affected by the level of success we experience in each of the businesses we operate:

 

Wealth management services. The composition and level of revenues that we derive from wealth management services are affected by the type of products we distribute, as the product type determines the fee rates of one-time commissions we can received from the wealth management products we distribute.

 

In particular, our online sold wealth management products primarily consist of (i) publicly raised fund products, (ii) exchange administered products and (iii) asset management plans. Due to the relatively low fee rate of publicly raised fund products as compared to privately raised fund products, we expect that revenue from such products to continue accounting for a small portion of our total net revenue. In order to increase revenue in our publicly raised fund products, we plan to develop and manage FoF type of products with performance fee-based structures. Since the end of 2017, as a result of the changing governmental regulatory environment to support industries in the “new economy” and consumption economy and disfavors leveraged financing, the number of real estate development financing type and governmental financial type exchange administered products decreased dramatically from December 2017 to April 2018 and adversely affected the transaction volume and revenue of our distribution services. From May 2018, in line with the new regulatory environment, we witnessed a substantial increase in the number of exchange administered products based on supply chain financing and micro- and small businesses working capital loans, which are primary product types we currently offer.

 

Corporate finance services. Under our corporate finance services business, we provide financing services to corporate borrowers, including product structure design, introduction of potential investors, compliance and risk management services. As we charge service fees equal to a percentage of total fund raised by taking into account of complexity of financing needs and designed structure, our revenue from corporate finance services depends on the transaction volume and may fluctuate among periods.

 

Asset management services. We began our asset management services by launching two FoF products. Currently, we are in the preparation of launching more FoFs and NPL funds. See “Business – Our Services – Asset Management Services”. Therefore, we estimate that our revenue from asset management services, as a percentage of total net revenue, to increase in the future.

 

Information technology services. Historically, we provided information technology services to third parties through our VIE, Puyi Bohui and charged our clients a one-time service fee. Since 2018, we have strategically transitioned Puyi Bohui’s function to one of IT support by shifting the focus of Puyi Bohui’s services to meet our internal needs. As a result, we expect that we will no longer generate revenue from such services starting from 2019.

 

Product Mix

 

Our largest business line is wealth management services, and a significant majority of our wealth management services revenue is derived from privately raised fund products. Currently in China, a product provider (i.e. a fund manager) of privately raised fund products is required to identify the sales model of its fund products as under either a direct sales model or distributions on a commission basis model at the time of filing details of the relevant fund product with the AMAC. The fund managers can select either one at their sole discretion and can change subsequently during the term of the relevant funds. See “Regulation – PRC Regulations Relating to Wealth Management Services – Privately Raised Funds”. The sale model chosen determines our fee structure. Under the direct sales model, fund managers bear all the costs and expenses in connection with the fund product distribution including the commissions paid to our seed clients. Accordingly, the revenue we generate from funds under direct sales are net of commission. For these funds, we recognize the distribution commission fees and performance-based fees we receive from fund managers as revenue, and no commissions are paid to seed clients by us or were recognized as cost of sales. In contrast, distributions on a commission basis refers to a gross commission model, where we are responsible for the commissions paid to seed clients. For gross-commission based funds, we recognize distribution commission fees and performance-based fees we receive as revenue for these funds and recognize the commissions paid to seed clients as cost of sales.

 

For the year ended June 30, 2018, one of our major product providers that previously elected to distribute under the gross-commission model subsequently changed its distribution model to net-commission based, which resulted in a significant increase in the number of our privately raised fund products distributed on a net-commission basis. As a result, our revenue from distribution of fund products under the net commission model increased significantly from RMB5.2 million for the year ended June 30, 2017 to RMB51.9 million (US$7.8 million) for the year ended June 30, 2018 while our revenue from distribution of fund products under the gross commission model decreased significantly from RMB80.5 million for the year ended June 30, 2017 to RMB36.9 million (US$5.6 million) for the year ended June 30, 2018. As a result of the foregoing, a significant change in the composition of the type of funds we distribute will affect our revenue, cost of sales and gross margin. Moreover, the fund manager can subsequently change the sales model during the term of relevant fund. Given that the selection of the sales model is at the sole discretion of the fund manager and is outside of our control, the respective proportion of products that we offer on a net-commission basis or a gross-commission basis may vary from year to year, which may lead to fluctuations in our net revenues, cost of sales and gross margin may change from time to time.

 

49

 

 

Operating Costs and Expenses

 

Our operating costs and expenses have a significant impact on our financial results. Total operating costs and expenses as a percentage of our revenue decreased from 69.7% for the year ended June 30, 2017 to 62.1% for the year June 30, 2018. Such decrease was primarily due to (i) a significant decrease in cost of sales of the operating costs and expenses for the year ended June 30, 2018; and (ii) an increase in net revenues from privately raised fund products for the year ended June 30, 2018, both of which were due to the significant increase in the number of privately raised funds distributed on net commission basis as discussed above. Additionally, we expect the continued expansion of our business operations, which would necessarily require us to hire additional personnel and expand our office space, to add to our overall expenses. Moreover, the cost associated with becoming a public company is expected to increase our cost level substantially.

 

Key Components of Results of Operations

 

Net Revenues

 

Our net revenues are total revenues net of business taxes and related surcharges. Historically, we generated revenue primarily from (i) wealth management services, (ii) corporate finance services, (iii) asset management services, and (iv) information technology services. The table below sets forth the components of our net revenues for the period indicated.

 

  

For the year ended June 30,

 
   2017   2018   2018 
   RMB
(in thousand)
   %   RMB
(in thousand)
   %   US$
(in thousand)
 
           (combined)         
                     
Wealth management services   144,925    93.1    140,403    84.7    21,218 
Corporate finance services   773    0.5    13,710    8.2    2,072 
Asset management services   -    -    103    0.1    16 
Information technology services   9,993    6.4    11,595    7.0    1,752 
Total net revenues   155,691    100.0    165,811    100.0    25,058 

 

Wealth Management Services

 

By revenue type

 

Our revenue from wealth management services primarily consists of commissions paid by wealth management product providers. Upon establishment of a financial product, we charge a distribution commission fee against the issuer by multiplying a pre-agreed annualized charge rate with the amount of products distributed through our online platform or offline sales network, prorated by the actual period length of the product. In addition, we receive performance-based fee income mainly for the privately raised funds we distribute, and to a lesser extent, subscription fees for our FoF products. Performance-based fees are calculated based on the extent by which the fund’s investment performance exceeds a certain threshold at the end of the contract term. Performance-based fees are typically calculated and recognized at the end of each contract term when the cumulative return of the fund can be determined, and is not subject to clawback provision.

 

50

 

 

The following table sets forth the components of our revenue from wealth management services by fee type for the period indicated.

 

  

For the year ended June 30,

 
   2017   2018   2018 
  

RMB

(in thousand)

   %  

RMB

(in thousand)

   %  

US$

(in thousand)

 
           (combined)         
                     
Distribution commissions   144,925    100.0    126,843    90.3    19,169 
Performance-based fees   -    -    13,560    9.7    2,049 
                          
Total   144,925    100.0    140,403    100.0    21,218 

 

By product type

 

Our wealth management products can be classified into wealth management products distributed online and wealth management products (i.e. privately raised fund products) distributed offline through our branch network. The following table sets forth the components of our revenue from wealth management services by product type for the period indicated.

 

  

For the year ended June 30,

 
   2017   2018   2018 
  

RMB

(in thousand)

   %  

RMB

(in thousand)

   %  

US$

(in thousand)

 
          

(combined)

         
Wealth management products distributed online                    
Publicly raised fund products   72    0.0    1,101    0.8    166 
Exchange administered products   59,129    40.8    50,056    35.7    7,565 
Asset management products   -    -    484    0.3    73 
Subtotal   59,201    40.8    51,641    36.8    7,804 
Wealth management products distributed offline   85,724    59.2    88,762    63.2    13,414 
Total   144,925    100.0    140,403    100.0    21,218 

 

The following table sets forth the transaction value of the different product categories under our wealth management services for the period indicated.

 

  

For the year ended June 30,

 
   2017   2018   2018 
  

RMB

(in thousand)

   %  

RMB

(in thousand)

   %  

US$

(in thousand)

 
          

(combined)

         
Wealth management products distributed online                    
Publicly raised fund products   12,688    0.2    257,292    4.3    38,883 
Exchange administered products   3,248,621    57.7    1,919,486    31.8    290,080 
Asset management plans   -    -    53,600    0.9    8,100 
Subtotal   3,261,309    57.9    2,230,378    37.0    337,063 
Wealth management products distributed offline                         
Net commission based funds   152,650    2.7    2,778,480    46.1    419,894 
Gross commission based funds   2,220,750    39.4    1,018,010    16.9    153,845 
Subtotal   2,373,400    42.1    3,796,490    63.0    573,739 
Total   5,634,709    100.0    6,026,868    100.0    910,802 

 

Our wealth management products distributed online include (i) publicly raised fund products, (ii) exchange administered products, and (iii) asset management plans. See “- Business – Our Services – Wealth Management Services”.

 

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Net commission model vs. gross commission model

  

All of our wealth management products distributed offline through our branch network are privately raised fund products. Currently in China, a privately raised fund products provider is required to identify its fund products as under either a direct sales model or distribution on a commission based model at the time of filing details of the relevant fund products with the AMAC, which in turn determines the fee structure of privately raised funds distributed by us as either on a net-commission basis or a gross commission basis. Under the net commission model, the commissions paid to our seed clients are borne by providers of the fund products. For these funds, we recognize the distribution commission fees and performance-based fees we receive as revenue, and no commissions are paid to seed clients by us or recognized as cost of sales. In contrast, under the gross commission model, we are responsible for the commissions paid to seed clients. We recognize distribution commission fees and performance-based fees we receive as revenue for these funds and recognize the commissions paid to seed clients as cost of sales.

 

The following table sets forth the breakdown of revenue from wealth management products distributed offline by commission payment model for the periods indicated.

 

  

For the year ended June 30,

 
   2017   2018   2018 
   RMB
(in thousand)
   %   RMB
(in thousand)
   %   US$
(in thousand)
 
           (combined)         
Wealth management products distributed offline                    
Net commission based funds   5,212    3.6    51,866    36.9    7,838 
Gross commission based funds   80,512    55.6    36,896    26.3    5,576 
Total   85,724    59.2    88,762    63.2    13,414 

 

Corporate Finance Services

 

Since January 2017, we have provided corporate finance services by assisting corporate borrowers in their fund raising efforts. Our corporate finance fee charged is generally a percentage of total fund raised by taking into account the complexity of financing needs and product structure. Major corporate borrowers we serve have included consumer finance providers and auto supply chain companies. For a description of the services we provided, see “Business—Our Services—Corporate Finance Services”.

 

The following table sets forth the components of our revenue from corporate finance services by customer and service type for the period indicated.

 

  

For the year ended June 30,

 
   2017   2018   2018 
   RMB
(in thousand)
   %   RMB
(in thousand)
   %   US$
(in thousand)
 
           (combined)         
                     
Auto supply chain service providers   773    100.0    7,692    56.1    1,162 
Consumer finance provider   -    -    6,018    43.9    910 
Total   773    100.0    13,710    100.0    2,072 

 

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Asset Management Services

 

Revenue under asset management services represents the management fees and carried interest from the funds that we manage. (The subscription fees we collect for the funds we manage are recorded as revenue under wealth management services. See “—Wealth Management Services—By revenue type”.) We currently manage two FoFs launched in April 2018. See “Business – Our Services – Asset Management Business”. As we plan to continue launching a number of new FoFs and NPL funds in the future, we expect that we will generate an increasing proportion of our revenue from asset management service business.

 

Information Technology Services

 

Historically, we collected services fees from the information technology services we provided through Puyi Bohui. The services fees were calculated based on the expected labor cost, project management services fee and a certain percentage of gross profit. Revenue from such services was recognized according to completion percentage plus total contract amount. Since 2018, we have strategically transitioned Puyi Bohui’s function to one of IT support by shifting the focus of Puyi Bohui’s services to meet our internal needs. As a result, we expect that we will no longer generate revenue from such services starting from 2019.

 

Operating Costs and Expenses

 

Our operating costs and expenses consist of (i) cost of sales, (ii) selling expenses, and (iii) general and administrative expenses. The following table sets forth the components of our operating costs and expenses for the period indicated.

 

  

For the year ended June 30,

 
   2017   2018   2018 
  

RMB

(in thousand)

   %  

RMB

(in thousand)

   %  

US$

(in thousand)

 
           (combined)         
                     
Cost of sales   53,397    49.2    28,825    27.9    4,356 
Selling expenses   34,969    32.3    45,470    44.3    6,872 
General and administrative   20,088    18.5    28,623    27.8    4,326 
Total operating costs and expenses   108,454    100.0    102,918    100.0    15,554 

 

Cost of Sales

 

Our cost of sales primarily consists of (i) commissions paid to third parties (i.e. our seed clients) on the gross-commission based funds we distribute (all of which are privately raised fund products) as well as on wealth management products distributed online; (ii) payment processing fees paid to third-parties payment platforms; and (iii) others (primarily consisting of fees and expenses paid to suppliers in relation to our IT services business).

 

53

 

 

The following table sets forth the components of our cost of sales for the period indicated.

 

  

For the year ended June 30,

 
   2017   2018   2018 
  

RMB

(in thousand)

   %  

RMB

(in thousand)

   %  

US$

(in thousand)

 
           (combined)         
                     
Commission cost                         
Wealth management products distributed online   14,626    27.5    8,724    30.3    1,319 
Gross-commission-based funds   28,517    53.3    10,099    35.0    1,526 
Subtotal   43,143    80.8    18,823    65.3    2,845 
Payment processing fees   6,291    11.8    3,343    11.6    504 
Others   3,963    7.4    6,659    23.1    1,007 
Total cost of sales   53,397    100.0    28,825    100.0    4,356 

 

Selling Expenses

 

Selling expenses primarily consist of salaries and benefits of our investment advisors and other sales and marketing employees as well as marketing expenses for sales conferences and other promotional activities. We expect our selling expenses to increase in the near future as we intend to hire more investment advisors to support the expansion of our business.

 

General and Administrative Expenses

 

General and administrative expenses primarily consist of (i) salaries and benefits related to our management and administrative employees, (ii) office expenses, (iii) traveling expenses and (iv) amortization of our intangible assets such as software. In the short term, we expect our general and administrative expenses to increase as a result of expenses relating to this offering. In the longer term, we expect our general and administrative expenses to continue to increase in absolute terms as our business expands but remain relatively stable as a percentage of our net revenues.

 

Other income

 

Our other income primarily consists of (i) our investment income from wealth management products we purchased, (ii) interest income from commercial acceptance notes, (iii) interest income from a one-year loan to a real estate developing company with an annual interest rate of 10%, (iii) interest expenses in relation to the convertible bond issued in November 2014 with a principle amount of RMB51.3 million which was redeemed in November 2016, and (iv) grants from local government as incentives for high technology companies.

 

Income from continuing operations before income taxes and discontinued operations

 

As a result of the foregoing, we have income from continuing operations before income taxes and discontinued operations of RMB47.5 million and RMB71.9 million (US$10.9 million) for the year ended June 30, 2017 and 2018, respectively.

 

In December 2016, we disposed two subsidiaries to third parties for a total cash consideration of RMB57.7 million. We recognized a net loss of RMB8.6 million on such disposal, which was determined by the excess of the sales consideration over the net book value of the subsidiary at the time of disposal. These disposals were completed in December 2016.

 

54

 

 

Income Tax Expense

 

The Cayman Islands

 

Puyi Inc. is incorporated in the Cayman Islands. Under the current laws of the Cayman Islands, the Company is not subject to income or capital gains taxes. In addition, dividend payments are not subject to withholdings tax in the Cayman Islands.

 

British Virgin Islands

 

Our subsidiary incorporated in the BVI is not subject to taxation.

 

Hong Kong

 

Puyi HK is located in Hong Kong and is subject to an income tax rate of 16.5% for taxable income earned in Hong Kong.

 

PRC

 

The Group’s PRC subsidiary and VIEs incorporated in PRC are subject to Income Tax in the PRC. Pursuant to the relevant laws and regulations in the PRC, Puyi Bohui is regarded as an accredited software company and a qualified High and New Technology Enterprise (“HNTE”), and thus enjoys preferential tax treatments, including being exempted from PRC Income Tax for two years starting from its first profit-making year, followed by a 50% reduction for the next three years. For Puyi Bohui, tax year 2015 was the first profit-making year and accordingly, Puyi Bohui has made a 12.5% tax provision for its profits from January 1, 2017. Shenzhen Puyi Zhongxiang Information Technology Co., Ltd. is qualified for Shenzhen Qianhai modern services cooperation district entity tax preference and is subject to an income tax rate for 15%. Chongqing Fengyi is qualified for west development taxation preference and is subject to an income tax rate for 15%. Our WFOE and other subsidiaries of our VIE are subject to a standard 25% EIT.

 

Critical Accounting Policies

 

Our consolidated financial statements include the financial statements of our Company, all our majority-owned subsidiaries and those VIEs of which we are the primary beneficiary, from the dates they were acquired or incorporated. We prepare consolidated financial statements in accordance with U.S. GAAP, which requires us to make judgments, estimates and assumptions that affect the reported amounts of our assets and liabilities and the disclosure of our contingent assets and liabilities at the end of each fiscal period and the reported amounts of revenues and expenses during each fiscal period. We continually evaluate these judgments and estimates based on our own historical experience, knowledge and assessment of current business and other conditions, our expectations regarding the future based on available information and assumptions that we believe to be reasonable, which an integral component of the financial reporting process, our actual results could differ from those estimates. Some of our accounting policies require a higher degree of judgment than others in their application.

 

Pursuant to the JOBS Act, as an emerging growth company, we can elect to opt out of the extended transition period for adopting any new or revised accounting standards. We have elected to opt in to such extended transition period, which means that when a standard is issued or revised and it has different application dates for public or private companies, we, as an emerging growth company, can delay the adoption of the new or revised standard until private companies adopt the new or revised standard. This may make it difficult or impossible to compare our financial statements with any other public company that is either not an emerging growth company, or that is an emerging growth company that has opted out of using the extended transition period, because of the potential differences in accounting standards used.

 

The selection of critical accounting policies, the judgments and other uncertainties affecting application of those policies and the sensitivity of reported results to changes in conditions and assumptions are factors that should be considered when reviewing our financial statements. We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements.

 

Investments

 

We invest in debt securities and accounts for the investments based on the nature of the products invested, and our intent and ability to hold the investments to maturity.

 

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Our investments in debt securities include asset management plans and bank financial products which have a stated maturity and normally pay a prospective fixed rate of return and secondary market equity fund products, the underlying assets of which are portfolios of equity investments in listed enterprises. We classify the investments in debt securities as held-to-maturity when it has both the positive intent and ability to hold them until maturity. Held-to-maturity investments are recorded at amortized cost and are classified as long-term or short-term according to their contractual maturity. Long-term investments are reclassified as short-term when their contractual maturity date is less than one year. Investments that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and are reported at fair value with changes in fair value recognized in earnings. Investments that do not meet the criteria of held-to-maturity or trading securities are classified as available-for-sale, and are reported at fair value with changes in fair value deferred in other comprehensive income.

 

We record investments in private equity funds, in which we act as a limited partner with insignificant equity interest, as long-term investments on the consolidated balance sheet under the cost method. Gains or losses are realized when such investments are sold. We review our investments except for those classified as trading securities for other-than-temporary impairment based on the specific identification method and considers available quantitative and qualitative evidence in evaluating potential impairment. If the cost of an investment exceeds the investment’s fair value, we consider, among other factors, general market conditions, government economic plans, the duration and the extent to which the fair value of the investment is less than cost and our intent and ability to hold the investment to determine whether an other-than-temporary impairment has occurred.

 

We recognize other-than-temporary impairment in earnings if it has the intent to sell the investments or if it is more-likely-than-not that it will be required to sell the investments before recovery of its amortized cost basis. Additionally, we evaluate expected cash flows to be received and determines if credit-related losses on debt securities exist, which are considered to be other-than-temporary, should be recognized in earnings.

 

If the investment’s fair value is less than the cost of an investment and we determine the impairment to be other-than-temporary, we recognize an impairment loss based on the fair value of the investment. We have not recorded an other-than-temporary impairment for each of the years ended June 30, 2017 and 2018.

 

Revenue recognition

 

We generate revenues mainly from wealth management, corporate finance, asset management and information technology and others. We recognize revenues when there is persuasive evidence of an arrangement, service has been rendered, the sales price is fixed or determinable and collectability is reasonably assured. Revenues are recorded, net of the related taxes and surcharges.

 

Wealth management

 

Revenue from wealth management mainly includes distribution commissions and performance-based fees, in a typical arrangement in which we serve as distributor.

 

Distribution commissions are primarily generated from (1) online distributions of financial products which include publicly raised fund products, exchange administered products and asset management plans, and (2) products distributed offline, (i.e. privately raised fund products). Performance-based fees are mainly attributable to the privately raised fund products distributed offline. Both types of revenue streams are paid by the corresponding financial product issuers.

 

56

 

 

Distribution commissions

 

We enter into distribution agreements with financial product issuers which specify the key terms and conditions of the arrangement. Such agreements do not include rights of return, credits or discounts, rebates, price protection or other similar privileges. Upon establishment of a financial product, we charge a distribution commission fee against the issuer by multiplying a pre-agreed annualized charge rate with the amount of products distributed through either online platform or offline sales network, prorated by the actual period length of the product.

 

We define the “establishment of a financial product” for its revenue recognition purpose as the time when both of the following two criteria are met: (1) the product purchaser (the “investor”) has entered into a purchase or subscription contract with the relevant product issuer and the investor has transferred the subscription fund to an escrow account designated by the product issuer and (2) the product issuer has issued a formal notice to confirm the establishment of a financial product. Revenue is recorded upon the establishment of the financial products, when the provision of service concludes and the fee becomes fixed and determinable, assuming all other revenue recognition criteria have been met, and there are no future obligations or contingencies.

 

Performance-based fees

 

We earn performance-based fees mainly from the issuers of the privately raised fund products that it distributes, which is dependent on the extent by which the fund’s investment performance exceeds a certain threshold at the end of the contract term. Such performance-based fee is typically recognized and distributed at the end of the contract term when the cumulative return of the fund can be determined, and is not subject to clawback provisions. We did not recognize any performance-based income for the year ended June 30, 2017. We recognized performance-based income of RMB13.6 million (US$2.0 million) for year ended June 30, 2018.

 

Corporate finance

 

We provide comprehensive financing solutions to corporate borrowers, including financing structure design, reference of sources and/or channels of funding, financing compliance and risk management services. Revenue is recognized when the financing fund is transferred to the corporate borrower and is calculated based on certain percentage of the amount financed.

 

Asset management

 

Revenue from asset management service mainly includes management fees and performance-based fees, in a typical arrangement in which we serve as fund manager.

 

Management fees

 

Revenue from asset management services, includes management fee and performance-based fees from the privately raised funds managed by us. Management fees are recognized in the period during which the related services are performed in accordance with the contractual terms of the fund agreements from the established date to the terminated date of the funds. Management fees earned from certain investment funds are based upon range up to 2% of capital committed. By unanimous consent among the fund manager, investors and the trustee, the fund could be terminated earlier than the contract period, and the remaining portion of unamortized management fee shall be returned to the investors.

 

57

 

 

Performance-based fees

 

We are entitled to a performance-based fee based on the extent by which the fund’s investment performance exceeds a certain threshold at the end of the contract term. Such performance-based fee is typically calculated and distributed at the end of the contract term when the cumulative return of the fund can be determined, and is not subject to clawback provisions. We do not record any performance-based revenue until the end of the contract term. There is no carried interest revenue recorded by us for the years ended June 30, 2017 and 2018.

 

Information technology and others

 

Information technology and others mainly represents revenue from the technological support and system development services provided to third parties. The services contract pricing is based on the expected labor cost, project management services fee plus a certain percentage of gross profit. Revenue is recognized according to completion percentage and total contract amount upon the acceptance of the services confirmed by the customers.

 

Results of Operations

 

The following table sets forth a summary of our consolidated results of operations for the periods indicated. The information should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this prospectus. The operating results in any period are not necessarily indicative of results that may be expected for any further period.

 

  

For the year ended June 30,

 
   2017   2018   2018 
  

RMB

(in thousand)

   %  

RMB

(in thousand)

   %  

US$

(in thousand)

 
           (combined)         
                     
Net revenues   155,691    100.0    165,811    100.0    25,058 
Total operating costs and expenses   (108,454)   (69.7)   (102,918)   (62.1)   (15,554)
Income from operations   47,237    30.3    62,893    37.9    9,504 
Other income, net:   298    0.2    8,985    5.4    1,358 
Income from continuing operations before income taxes, share of income of affiliates and discontinued operations   47,535    30.5    71,878    43.3    10,862 
Income tax expense   (7,641)   (4.9)   (8,261)   (5.0)   (1,248)
Net income from continuing operations   39,894    25.6    63,617    38.3    9,614 
Net loss from discontinued operations, net of tax   (254)   0.2    -    -    - 
Net income   39,640    25.5    63,617    38.3    9,614 
less: net income (loss) attributable to non-controlling interests   1,827    1.2    (979)   0.6    (148)
Net income attributable to the Company’s shareholders   37,813    24.3    64,596    38.9    9,762 

 

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Year Ended June 30, 2018 Compared to Year Ended June 30, 2017

 

Net Revenues

 

Our net revenues increased by RMB10.1 million, or 6.5%, from RMB155.7 million for the year ended June 30, 2017 to RMB165.8 million (US$25.1 million) for the year ended June 30, 2018.

 

Wealth management services

 

Revenue from wealth management services decreased by RMB4.5 million, or 3.1%, from RMB144.9 million for the year ended June 30, 2017 to RMB140.4 million (US$21.2 million) for the year ended June 30, 2018.

 

Products distributed online. Our commissions from wealth management products distributed online decreased by RMB7.6 million, or 12.8%, from RMB59.2 million for the year ended June 30, 2017 to RMB51.6 million (US$7.8 million) for the year ended June 30, 2018, primarily due to a decrease in our commissions from exchange administered products. Such decrease, in turn, was primarily due to a significant decrease in the number of real estate development financing products and governmental financial products due to the changes in governmental regulatory environment. See “Business—Our Services—Wealth Management Services—Exchange administered products”.

 

  Products distributed offline. Our revenue from wealth management products distributed offline increased by RMB3.1 million, or 3.5%, from RMB85.7 million for the year ended June 30, 2017 to RMB88.8 million (US$13.4 million) for the year ended June 30, 2018, primarily due to a significant increase of 60.0% in total transaction value in such products from RMB2.4 billion for the year ended June 30, 2017 to RMB3.8 billion (US$573.7 million) for the year ended June 30, 2018. Such increase was due to a significant increase in the transaction value of net-commission based products as one of our major product providers that previously elected to distribute under the gross-commission model subsequently changed its distribution model to net-commission based. However, the increase in our revenue from privately raised funds we distributed was partially offset by changes in the proportion of net-commission based funds vis-a-vis gross-commission based funds. As we do not bear the commissions to seed clients of net commission-based funds, the commission rate range of net-commission based funds is typically lower than that of gross-commission based funds. As a result, any changes in the absolute transaction value of net-commission based funds have less impact on net revenue from net-commission based funds as opposed to gross-commission based funds. As the transaction value of net-commission-based funds, as a percentage of total transaction value of privately raised funds, increased significantly from 6.6% for the year ended June 30, 2017 to 74.6% for the year ended June 30, 2018, our revenue from privately raised funds increased at a lower rate than total transaction value of our privately raised funds.

 

Corporate finance services

 

Our revenue from corporate finance services increased significantly from RMB0.8 million for the year ended June 30, 2017 to RMB13.7 million (US$2.1 million) for the year ended June 30, 2018, primarily reflecting the ramping up in demand for such services, which we began offering in January 2017.

 

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Asset management services

 

We commenced our asset management services by launching two FoFs under our management in April 2018. Accordingly, we recorded RMB0.1 million (US$16,000) for the year ended June 30, 2018 in revenue from such services.

 

Information technology services

 

Our revenue from information technology services increased by RMB1.6 million, or 18.3% from RMB10.0 million for the year ended June 30, 2017 to RMB11.6 million (US$1.8 million) for the year ended June 30, 2018. We began winding down our IT services business in the first half of 2018. See “—Key Components of Results of Operations—Net Revenues—Information Technology Services” and—Major Factors Affecting Our Results of Operations—business Mix.”

 

Operating Costs and Expenses

 

Our total operating costs and expenses decreased by RMB5.5 million, or 5.1%, from RMB108.5 million for the year ended June 30, 2017 to RMB102.9 million (US$15.6 million) for the year ended June 30, 2018.

 

Our cost of sales decreased by RMB24.6 million, or 46.0%, from RMB53.4 million for the year ended June 30, 2017 to RMB28.8 million (US$4.4 million) as of June 30, 2018, primarily due to (i) a RMB18.5 million decrease in our commission cost from offline distributed wealth management products as an increasing proportion of our privately-raised fund products were on a net-commission basis as opposed to a gross-commission basis, where we did recognize the commissions to our clients as cost of sales; and (ii) a RMB5.9 million decrease in our online commission cost, which reflected a decrease in transaction value from exchange administered products. Our cost of sales as a percentage of net revenues decreased from 34.3% for the year ended June 30, 2017 to 17.4% for the year ended June 30, 2018. Our gross profit margin (calculated as the difference between net revenues and the cost of sales divided by the net revenues) increased from 67.5% for the year ended June 30, 2017 to 82.6% for the year ended June 30, 2018. Such changes were primarily due to (i) a significant decrease in cost of sales of the operating costs and expenses for the year ended June 30, 2018; and (ii) an increase in net revenues from privately raised fund products for the year ended June 30, 2018, both of which were due to the significant increase in the number of privately raised funds distributed on a net commission basis as discussed above.

 

Our selling expenses increased by RMB10.5 million, or 30.0% from RMB35.0 million for the year ended June 30, 2017 to RMB45.5 million (US$6.9 million) for the year ended June 30, 2018, primarily due to an increase in hiring of new investment advisors as we expanded our branch network. Our selling expenses as a percentage of net revenues was 22.5% for the year ended June 30, 2017 and 27.4% for the year ended June 30, 2018.

 

Our general and administrative expenses increased by RMB8.5 million or 42.5%, from RMB20.1 million for the year ended June 30, 2017 to RMB28.6 million (US$4.3 million) as of June 30, 2018, primarily due to an increase in the number of our employees and a general increase in their compensation level. Our general and administrative expenses as a percentage of net revenues was 12.9% for the year ended June 30, 2017 and 17.3% for the year ended June 30, 2018.

 

Investment Income

 

Our investment income increased significantly from RMB1.7 million for the year ended June 30, 2017 to RMB5.1 million (US$0.8 million) for the year ended June 30, 2018, primarily due to (i) an increase of RMB2.1 million in our income from investment in exchange administered products and asset management products that we distribute, and (ii) an increase of RMB0.9 million in our income from our investment in the short-term wealth management products issued by banks.

 

Interest Income

 

Our interest income increased significantly from RMB51,000 for the year ended June 30, 2017 to RMB3.6 million (US$0.6 million) for the year ended June 30, 2018, primarily due to (i) an interest income of RMB1.4 million from the loan provided to a real estate developing company for the year ended June 30, 2018, and (ii) an interest income of RMB1.6 million from endorsement of commercial acceptance notes for the year ended June 30, 2018.

 

Interest Expenses

 

We incurred an interest expense of RMB2.3 million for the year ended June 30, 2017, which was primarily in relation to redemption in November 2016 of the convertible bond issued in November 2014 with a principle amount of RMB51.3 million.

 

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Income Tax Expense

 

Income tax expense increased by RMB0.7 million, or 8.1% from RMB7.6 million for the year ended June 30, 2017 to RMB8.3 million (US$1.3 million) for the year ended June 30, 2018, primarily due to our business expansion. Our effective tax rate remained relatively stable at 16.1% in the year ended June 30, 2017 and 11.5% in the year ended June 30, 2018.

 

Net Income

 

As a result of the foregoing, our net income increased by RMB24.0 million, or 60.6% from RMB39.6 million for the year ended June 30, 2017 to RMB63.6 million (US$9.6 million) for the year ended June 30, 2018.

 

Discussion of Certain Balance Sheet Items

 

The following table sets forth selected information from our combined statement of financial position as of June 30, 2017 and 2018. This information should be read together with our combined financial statements and related notes included elsewhere in this prospectus.

 

   As of June 30, 
   2017   2018   2018 
   RMB   RMB   US$ 
   (combined)         
   (in thousand) 
ASSETS:            
Current assets            
Cash and cash equivalents   55,196    103,228    15,600 
Restricted cash   1,841    8,772    1,326 
Accounts receivable, net   23,116    30,757    4,648 
Short-term investments   14,243    5,010    757 
Commercial acceptance notes   -    10,642    1,608 
Other receivables   4,831    5,729    866 
Short-term loans receivable   -    50,356    7,610 
Amount due from related parties   85,900    80    12 
Total current assets   185,127    214,574    32,427 
                
Long-term investments   -    5,000    756 
Property and equipment, net   1,021    890    135 
Intangible assets, net   1,503    700    106 
Long-term prepayments   -    461    70 
Deferred tax assets   4,012    4,241    640 
Total assets   191,663    225,866    34,134 
                
LIABILITIES:               
Current liabilities               
Commission payable   13,133    3,677    556 
Investors’ deposit   1,841    8,772    1,326 
Other payables and accrued expenses   7,752    6,129    926 
Due to shareholder for acquisition of subsidiaries   -    2,116    320 
Income taxes payable   1,687    2,820    426 
Other tax liabilities   8,700    8,700    1,315 
Total current liabilities   33,113    32,214    4,869 
Total liabilities   33,113    32,214    4,869 

 

Accounts Receivable, Net

 

Accounts receivable primarily relate to the amount that we earned from our wealth management services and asset management services. Our accounts receivable increased by RMB7.6 million, or 33.1% from RMB23.1 million as of June 30, 2017 to RMB30.8 million (US$4.6 million) as of June 30, 2018, primarily due to an increase in the commissions receivable from our products providers, which in turn reflected the payment schedule of our contracts with them.

 

Short-term Investments

 

Our short-term investments primarily consist of our investments in debt securities including (i) asset management plans, (ii) bank financial products, and (iii) secondary market equity fund products. Our short-term investments decreased by RMB9.2 million, or 64.8% from RMB14.2 million as of June 30, 2017 to RMB5.0 million (US$0.8 million) as of June 30, 2018, primarily due to a shift in our investment strategy to invest in commercial acceptance notes and private equity funds as a limited partner.

 

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Commercial Acceptance Notes 

On May 18, 2018, we purchased commercial acceptance notes with a principal amount of RMB11.4 million at an annual discount rate of 8.50%. As of June 30, 2018, the carried amount of such notes was RMB10.6 million (US$1.6 million), which represented the principal amount less the amount of discount that has been amortized as interest income as of that date. 

Short-term Loans Receivable 

As of June 30, 2018, our short-term loans receivable primarily consist of a loan of RMB50.0 million to a real estate development company for one year from June 5, 2018 to June 4, 2019, with an annual interest of 10%. In July 2018, such loan was fully repaid. 

Commission Payable 

Commission payable primarily consists of commissions due to our seed clients. Our commission payable decreased by RMB9.5 million, or 72.0%, from RMB13.1 million as of June 30, 2017 to RMB3.7 million (US$0.6 million) as of June 30, 2018, primarily due to a decrease in the commissions in relation to the offline distributed privately-raised fund products as an increasing proportion of such products were registered as net-commission based funds as opposed to gross-commission based funds for the year ended June 30, 2018. 

Investors’ Deposit 

Investors’ deposit primarily consists of the uninvested cash balances that are temporarily deposited in our bank account of the investors of publicly raised fund products. The investors’ deposit increased significantly by RMB6.9 million from RMB1.8 million as of June 30, 2017 to RMB8.8 million (US$1.3 million) as of June 30, 2018, primarily due to a significant increase in the transaction value of the publicly raised fund products that we distributed. 

Other Payables and Accrued Expenses 

The following table sets forth the components of our other payables and accrued expenses as of the date indicated. 

   As of June 30, 
   2017   2018   2018 
   RMB   RMB   US$ 
   (combined)         
   (in thousand) 
     
Payroll payable   3,507    3,229    488 
Promotion expense received from issuers in advance   1,473    -    - 
Value-added tax   1,589    1,900    287 
Individual income tax   482    479    72 
Other miscellaneous taxes   75    143    22 
Others   626    378    57 
Other payables and accrued expenses   7,752    6,129    926 

 

Our other payables and accrued expenses decreased by RMB1.6 million, or 20.9% from RMB7.8 million as of June 30, 2017 to RMB6.1 million (US$0.9 million) as of June 30, 2018, primarily due to a decrease in promotion expense received from issuers in advance from RMB1.5 million as of June 30, 2017 to nil as of June 30, 2018, as we discontinued the promotional activities in the year ended June 30, 2018 as demand for our products increased. 

Liquidity and Capital Resources 

To date, we have financed our operations primarily through cash generated from our operating activities. Our principal uses of cash for the years ended June 30, 2017 and 2018 were for operating activities, primarily including employee compensation and rental expenses. As of June 30, 2017 and 2018, we had cash and cash equivalents, and restricted cash of RMB57.0 million and RMB112.0 million (US$16.9 million), respectively. As of June 30, 2018, we had no bank borrowings. 

We believe that our current cash and anticipated cash flow from operations will be sufficient to meet our anticipated cash needs, including our cash needs for at least the next 12 months. We may, however, need additional capital in the future to fund our continued operations. If we determine that our cash requirements exceed the amount of cash and cash equivalents we have on hand at the time, we may seek to issue equity or debt securities or obtain credit facilities. The issuance and sale of additional equity or convertible loans would result in further dilution to our shareholders. The incurrence of indebtedness would result in increased fixed obligations and could result in operating covenants that might restrict our operations. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all. 

Although we consolidate the results of our consolidated variable interest entity, we only have access to cash balances or future earnings of our consolidated variable interest entity through our contractual arrangements with our variable interest entity. See “Corporate History and Structure”. For restrictions and limitations on liquidity and capital resources as a result of our corporate structure, see “— Holding Company Structure” below. 

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As a Cayman exempted and offshore holding company, we are permitted under PRC laws and regulations to provide funding to our wholly foreign-owned subsidiary in China only through loans or capital contributions, subject to the approval of government authorities and limits on the amount of capital contributions and loans. In addition, our wholly foreign-owned subsidiary in China may provide Renminbi funding to our consolidated VIE only through entrusted loans. See “Risk Factors—Risks Related to Doing Business in China—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 this offering to make loans or additional capital contributions to our PRC subsidiary, which could materially and adversely affect our liquidity and our ability to fund and expand our business.” 

 

The following table sets forth a summary of our cash flows for the period indicated.

 

   For the year ended June 30, 
   2017   2018   2018 
   RMB   RMB   US$ 
   (in thousands) 
Net cash (used in) provided by operating activities:   (23,069)   44,916    6,788 
Net cash provided by investing activities   21,074    10,047    1,518 
Net cash used in financing activities   (26,194)   -    - 
Net (decrease) increase in cash and cash equivalents, and restricted cash   (28,189)   54,963    8,306 
Cash and cash equivalents and restricted cash at beginning of year   85,226    57,037    8,620 
Cash and, cash equivalents and restricted cash at end of year   57,037    112,000    16,926 

 

Operating Activities

 

Net cash generated from operating activities for the year ended June 30, 2018 was RMB44.9 million (US$6.8 million). This reflected the net income of RMB63.6 million (US$9.6 million), as adjusted for non-cash items primarily including (i) investment income of RMB5.1 million (US$0.8 million), (ii) interest income of RMB3.6 million (US$0.6 million), and (iii) amortization of intangible assets of RMB1.3 million (US$0.2 million). This amount was further adjusted by negative changes in working capital including: (i) a decrease in accounts payable of RMB9.5 million, primarily due to an decrease in the distribution commissions payables in relation to an decrease in the sales of exchange administered products and gross commission based funds, and (ii) an increase in accounts receivables of RMB7.6 million, reflecting our business expansion; partially offset by an increase in other payables and accrued expenses of RMB5.3 million, primarily due to an increased in accrued payroll, which in turn reflected our business expansion.

 

Net cash used in operating activities for the year ended June 30, 2017 was RMB23.1 million. This reflected the net income of RMB39.6 million, as adjusted for non-cash items primarily including (i) loss on disposal of Puyi Asset Management (Beijing) Co., Ltd. (普益资产管理 (北京) 有限公司) and Shenzhen Puyi Panshi Asset Management Co., Ltd. (深圳普益磐石资产管理有限公司) of RMB8.6 million, (ii) uncertainty tax provision of RMB2.0 million and amortization of intangible assets of RMB1.2 million; and (iii) investment income of RMB1.7 million. This amount was further adjusted by negative changes in working capital including (i) a decrease in other payables and accrued expenses of RMB201.3 million, irrelevant to borrowing from 3rd party; mostly related to disposal of subsidiary, and (ii) an increase in accounts receivables of RMB20.4 million, primarily due to an increase in receivables in relation to the distribution of privately raised fund products; partially offset by a decrease in other receivables of RMB139.5 million. The decrease in other payables and accrued expenses as well as in other receivables for that year was primarily due to the disposal of the two above-mentioned subsidiaries.

 

Investing Activities

 

Net cash provided by investing activities for the year ended June 30, 2018 was RMB10.0 million (US$1.5 million), primarily attributable to (i) proceeds from disposal of short term investments of RMB1,100.6million (US$166.3 million) in connection with our investments in asset management plans, and (ii) repayment of short-term loans made to related parties of RMB85.8 million; partially offset by purchase of short term investment of RMB1,094.9 million (US$165.5 million).

 

Net cash provided by investing activities for the year ended June 30, 2017 was RMB21.1 million primarily attributable to (i) proceeds from disposal of short term investments of RMB223.7 million in connection with our investments in asset management plans and bank financial products, and (ii) the disposal of Puyi Asset Management (Beijing) Co., Ltd. (普益资产管理 (北京) 有限公司) and Shenzhen Puyi Panshi Asset Management Co., Ltd. (深圳普益磐石资产管理有限公司) in the amount of RMB56.0 million; partially offset by (i) purchase of short term investment of RMB195.4 million, and (ii) short-term loans of RMB74.7 million provided to related parties.

 

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Financing Activities

 

Net cash used in financing activities for the year ended June 30, 2017 was RMB26.2 million. It reflects the repayment of the convertible bond that we issued in November 2014 in the amount of RMB56.2 million, which was offset by capital injection of RMB30 million made to Puyi Asset Management.

 

We did not have any cash inflow or outflow due to financing activities for the year ended June 30, 2018.

 

Capital Expenditures

 

We made capital expenditures of RMB0.7 million and RMB6.4 million (US$1.0 million) for the years ended June 30, 2017 and 2018, respectively, which were primarily related to our long-term receivables, deferred income tax assets, and purchase of office equipment and software.

 

Contractual Obligations and Commitments

 

We have several non-cancelable operating leases, primarily for our office premises.

 

The following table sets forth our minimum future commitments under non-cancelable operating lease agreements as of June 30, 2018:

 

   Minimum Lease Payment   Minimum Lease Payment 
   RMB   US$ 
   (in thousands) 
Year ending June 30:        
2019   4,343    656 
2020   3,033    458 
2021   2,182    330 
2022   1,680    254 
2023   1,489    225 
After 2023   789    120 
Total   13,516    2,043 

 

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Holding Company Structure

 

Puyi, Inc. is a holding company with no material operations of its own. We conduct our operations primarily through our wholly owned subsidiary, our consolidated VIE and its subsidiaries in China. As a result, our ability to pay dividends depends upon dividends paid by our wholly owned subsidiary. If our wholly owned subsidiary or any newly formed subsidiaries incur debt on their own behalf in the future, the instruments governing their debt may restrict their ability to pay dividends to us. In addition, our wholly owned subsidiary in China is permitted to pay dividends to us only out of its retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. Under PRC law, each of our wholly owned subsidiary and our consolidated VIE in China is required to set aside at least 10% of its after-tax profits each year, if any, to fund a statutory reserve until such reserve funds reach 50% of its registered capital. In addition, our wholly foreign-owned subsidiary in China may allocate a portion of its after-tax profits based on PRC accounting standards to enterprise expansion funds and staff bonus and welfare funds at its discretion, and our VIE may allocate a portion of its after-tax profits based on PRC accounting standards to a discretionary surplus fund at its discretion. Although the statutory reserves can be used, among other ways, to increase the registered capital and eliminate future losses in excess of retained earnings of the respective companies, the reserve funds are not distributable as cash dividends. Remittance of dividends by a wholly foreign-owned company out of China is subject to examination by the banks designated by the SAFE. We currently plan to reinvest all earnings from our wholly owned subsidiary in China to its business development and do not plan to request dividend distributions from such subsidiary.

 

Off-Balance Sheet Arrangements

 

We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. In addition, we have not entered into any derivative contracts that are indexed to our own shares and classified as equity, or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. Moreover, we do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.

 

Quantitative and Qualitative Disclosures about Market Risk

 

Risks in relation to the VIE structure

 

We believe that the contractual arrangements with our VIE and the respective shareholders are in compliance with PRC laws and regulations and are legally enforceable. However, uncertainties in the PRC legal system could limit our ability to enforce the contractual arrangements. If the legal structure and contractual arrangements were found to be in violation of PRC laws and regulations, the PRC government could:

 

revoke the business and operating licenses of our PRC subsidiary and VIE;

 

discontinue or restrict the operations of any related-party transactions between our PRC subsidiary and VIE;

 

limit our business expansion in China by way of entering into contractual arrangements;

 

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impose fines or other requirements with which our PRC subsidiary and VIE may not be able to comply;

 

require us or our PRC subsidiary and VIE to restructure the relevant ownership structure or operations; or

 

restrict or prohibit our use of the proceeds of the additional public offering to finance our business and operations in China.

 

Our ability to conduct its asset management business may be negatively affected if the PRC government were to carry out of any of the aforementioned actions. As a result, we may not be able to consolidate our VIE in our consolidated financial statements as we may lose the ability to exert effective control over the VIE and their respective shareholders and we may lose the ability to receive economic benefits from the VIE. We, however, do not believe such actions would result in the liquidation or dissolution of our Company, our PRC subsidiary and VIE.

 

The interests of the shareholders of VIE may diverge from that of our Company and that may potentially increase the risk that they would seek to act contrary to the contractual terms, for example by influencing VIE not to pay the service fees when required to do so. We cannot assure that when conflicts of interest arise, shareholders of VIE will act in the best interests of us or that conflicts of interests will be resolved in our favor. Currently, we do not have existing arrangements to address potential conflicts of interest the shareholders of VIE may encounter in its capacity as beneficial owners and directors of VIE, on the one hand, and as beneficial owners and directors of our Company, on the other hand. We believe the shareholders of VIE will not act contrary to any of the contractual arrangements and the exclusive option agreements provide us with a mechanism to remove the current shareholders of VIE should they act to the detriment of our Company. We rely on certain current shareholders of VIE to fulfill their fiduciary duties and abide by laws of the PRC and act in the best interest of our Company. If we cannot resolve any conflicts of interest or disputes between us and the shareholders of VIE, we would have to rely on legal proceedings, which could result in disruption of its business, and there is substantial uncertainty as to the outcome of any such legal proceedings.

 

Total assets and liabilities presented on our consolidated balance sheets and sales, expense, net income presented on Consolidated Statement of Income as well as the cash flow from operating, investing and financing activities presented on the Consolidated Statement of Cash Flows are substantially the financial position, operation and cash flow of our VIE Puyi Bohui, and its subsidiaries. The following financial statements amounts and balances of the VIE were included in the accompanying consolidated financial statements as of June 30, 2017 and 2018 and for the years ended June 30, 2017 and 2018.

 

   As of June 30, 
   2017   2018   2018 
   RMB   RMB   US$ 
      

(in

thousands)

     
             
Total assets   191,663    225,866    34,134 
Total liabilities   33,113    32,214    4,869 

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For the year ended June 30,

 
   2017   2018   2018 
   RMB   RMB   US$ 
             
Net revenues   155,691    165,811    25,058 
Net income   39,640    63,617    9,614 

 

Concentration risks

 

Details of the customers accounting for 10% or more of total net revenues are as follows:

 

   For the year ended June 30, 
   2017   % of net revenues   2018   2018   % of net revenues 
   RMB
(in thousands)
       RMB
(in thousands)
   US$
(in thousands)
     
Company A   42,618    27.4%   *    *    * 
Company B   40,125    25.8%   *    *    * 
Company C   32,844    21.1%   47,856    7,232    28.9%
Company D   *    *    44,452    6,718    26.8%
Company E   *    *    27,855    4,210    16.8%
    115,587    74.3%   120,163    18,160    72.5%

 

* represented less than 10% of total net revenues for the fiscal year.

 

Details of the customers which accounted for 10% or more of accounts receivable are as follows:

 

   As of June 30, 
   2017   %   2018   2018   % 
   RMB
(in thousands)
       RMB
(in thousands)
   US$
(in thousands)
     
Company C   4,292    18.6%   27,633    4,176    89.8%
Company E   8,273    35.8%   *    *    * 
Company A   5,881    25.4%   *    *    * 
    18,446    79.8%   27,633    4,176    89.8%

 

* represented less than 10% of account receivables as of the year end.

 

Our Group performs ongoing credit evaluations of its customers and generally does not require collateral on accounts receivable.

 

Our Group places its cash and cash equivalents with financial institutions with high-credit ratings and quality.

 

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Internal Control over Financial Reporting

 

Prior to this offering, we have been a private company with limited accounting personnel and other resources to address our internal control over financial reporting. In connection with the preparation and external audit of our consolidated financial statements, we and our independent registered public accounting firm identified one material weakness in our internal control over financial reporting as of and for the years ended June 30, 2017 and 2018. The material weakness identified was the lack of dedicated resources to take responsibility for the finance and accounting functions and the preparation of financial statements in compliance with U.S. GAAP. Neither we nor our independent registered public accounting firm undertook a comprehensive assessment of our internal control under the Sarbanes-Oxley Act for purposes of identifying and reporting any weakness or significant deficiency in our internal control over financial reporting, as we will be required to do once we become a public company and our independent registered public accounting firm may be required to do once we cease to be an emerging growth company. Had we performed a formal assessment of our internal control over financial reporting or had our independent registered public accounting firm performed an audit of our internal control over financial reporting, additional material weaknesses may have been identified.

 

Following the identification of the material weakness, we have taken certain steps and plan to continue to take measures to strengthen our internal control over financial reporting. We have sent our finance personnel to attend external U.S. GAAP training courses organized by professional financial advisory firms, and are in the process of hiring additional qualified finance and accounting staff with working experience in U.S. GAAP and SEC reporting requirements. Furthermore, we plan to implement the following measures: (i) establish a separate department which will be responsible for the reporting process; (ii) further streamline our reporting process to support our business development as necessary; and (iii) engage professional financial advisory firms if necessary to provide ongoing training to our finance and accounting personnel as well as to strengthen our financial reporting expertise and system. We expect that we will incur significant costs in the implementation of such measures. However, the implementation of these measures may not fully address the material weakness identified in our internal control over financial reporting. See “Risk Factors—Risks Related to Our Business and Industry—If we fail to implement and maintain an effective system of internal control, we may be unable to accurately or timely report our results of operations or prevent fraud, and investor confidence and the market price of the ADSs may be materially and adversely affected.”

 

As a company with less than US$1.07 billion in revenue for our last fiscal year, we qualify as an “emerging growth company” pursuant to the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other requirements that are otherwise applicable generally to public companies. These provisions include exemption from the auditor attestation requirement under Section 404 of the Sarbanes-Oxley Act of 2002 in the assessment of the emerging growth company’s internal control over financial reporting.

 

Recently Issued Accounting Standards Not Yet Adopted

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, which was subsequently modified in August 2015 by ASU No. 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date. The core principle of ASU No. 2014-09 is that companies should recognize revenue when the transfer of promised goods or services to customers occurs in an amount that reflects what the company expects to receive. It requires additional disclosures to describe the nature, amount, timing and uncertainty of revenue and cash flows from contracts with customers. In 2016, the FASB issued additional ASUs that clarify the implementation guidance on principal versus agent considerations (ASU 2016-08), on identifying performance obligations and licensing (ASU 2016-10), and on narrow-scope improvements and practical expedients (ASU 2016-12) as well as on the revenue recognition criteria and other technical corrections (ASU 2016-20). These new standards will identify performance obligations and narrow aspects on achieving core principle. We are currently evaluating the impact the adoption of this guidance may have on its financial statements, including with respect to the timing of the recognition of carried interest. We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). Under the JOBS Act, emerging growth companies (“EGCs”) can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. Therefore, we will not be subject to the same new or revised accounting standards as public companies that are not EGCs. The management has not yet selected a transition method. We anticipate adopting this new guidance on July 1, 2019, and plans on giving additional updates on its progress and further conclusions.

 

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In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this update address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The amendments in this update require public business entities that are required to disclose fair value of financial instruments measured at amortized cost on the balance sheet to measure that fair value using the exit price notion consistent with Topic 820, Fair Value Measurement. The amendments in this update require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option. The amendments in this Update require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or in the accompanying notes to the financial statements. In addition, according to ASU No. 2016-01, all equity investments in unconsolidated entities (other than those accounted for using the equity method of accounting) will generally be measured at fair value through earnings. For equity investments without readily determinable fair values, the cost method is also eliminated. However, entities will be able to elect to record equity investments without readily determinable fair values at cost, less impairment, adjusted for subsequent observable price changes. Entities that elect this measurement alternative will report changes in the carrying value of the equity investments in current earnings. This election only applies to equity investments that do not qualify for the net asset value practical expedient. The impairment model for equity investments subject to this election is a single-step model. Under the single-step model, an entity is required to perform a qualitative assessment each reporting period to identify impairment. When a qualitative assessment indicates an impairment exists, the entity would estimate the fair value of the investment and recognize in current earnings an impairment loss equal to the difference between the fair value and the carrying amount of the equity investment. The measurement alternative may be elected separately on an investment by investment basis for each equity investment without a readily determinable fair value. Once elected, it should be applied consistently as long as the investment meets the qualifying criteria.

 

The amendments in this update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. For non-public business entities, early adoption is not permitted. We are currently evaluating the impact of adopting ASU No. 2016-01 on its consolidated financial statements.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230). The update is intended to improve financial reporting in regard to how certain transactions are classified in the statement of cash flows. This update requires that debt extinguishment costs be classified as cash outflows for financing activities and provides additional classification guidance for the statement of cash flows. The update also requires that the classification of cash receipts and payments that have aspects of more than one class of cash flows to be determined by applying specific guidance under generally accepted accounting principles. The update also requires that each separately identifiable source or use within the cash receipts and payments be classified on the basis of their nature in financing, investing or operating activities. The update is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We are still in the process of analyzing the impact of adoption of this guidance on the consolidated financial statement.

 

In February 2017, the FASB issued ASU No. 2017-02, Leases (Topic 842), which requires lessees to recognize most leases on the balance sheet. This ASU requires lessees to recognize a right-of-use asset and lease liability for all leases with terms of more than 12 months. Lessees are permitted to make an accounting policy election to not recognize the asset and liability for leases with a term of twelve months or less. The ASU does not significantly change the lessees’ recognition, measurement and presentation of expenses and cash flows from the previous accounting standard. Lessors’ accounting under the ASC is largely unchanged from the previous accounting standard. In addition, the ASU expands the disclosure requirements of lease arrangements. Lessees and lessors will use a modified retrospective transition approach, which includes a number of practical expedients. The provisions of this guidance are effective for annual periods beginning after December 15, 2018, and interim periods within those years, with early adoption permitted. We are in the process of evaluating the impact of adoption of this guidance on our consolidated financial statements.

  

In June 2017, the FASB issued ASU 2017-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. The ASU requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. We are in the process of evaluating the impact of adoption of this guidance on our consolidated financial statements.

 

Other accounting pronouncements that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on our consolidated financial statements upon adoption.

 

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INDUSTRY

  

China’s Wealth Management Services Market

 

According to CIC, wealth management services in China refer to a combination of distribution of wealth management products and provision of more personalized financial planning services to population with investable assets. The total population with investable assets increased from approximately 994.9 million in 2013 to approximately 1,030.0 million in 2017, and is expected to further increase to 1,085.0 million by 2022. The total private wealth held by such population in terms of investable assets increased from approximately RMB91.0 trillion (US$13.8 trillion) in 2013 to approximately RMB188.4 trillion (US$28.5 trillion) in 2017, and is expected to further increase to RMB321.8 trillion (US$48.6 trillion) in 2022. Despite the vast private wealth, as measured by AUM, the current penetration rate of wealth management services in such population segments in China is only less than 25%, which is significantly lower than 50% in the United States.

 

The wealth management services market in China is at an early stage of development and is currently highly fragmented. Major types of service providers include (i) commercial banks; (ii) non-bank traditional financial institutions, or non-bank TFI, such as securities firms, fund managers and insurance companies with internal sales capabilities; (iii) online-based service providers; and (iv) third-party wealth management service providers that are not associated with financial institutions. The following graph shows the historical and forecast wealth management service market size in China by service provider type: 

 

 

Note: TPWM (Third-party wealth management firms) refer to companies that are engaged to manage the asset to achieve the value maintenance and appreciation of the affluent clients through providing at least three regulated and legitimate financial products such as fixed income products, publicly raised fund and privately raised fund, etc.

 

Source: China Insights Consultancy

 

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Mass Affluent and Emerging Middle Class Population in China

 

Size of Population and Investable Assets

 

China’s population can be categorized into four segments in terms of amount of investable assets: (i) the high net worth individual population (i.e. those with investable assets above RMB6 million (US$1 million), or HNWI; (ii) the mass affluent population (i.e. those with investable assets of between RMB600,000 (US$100,000) to RMB6 million (US$1 million), or MA; (iii) the emerging middle class population (i.e. those with investable assets of between RMB30,000 (US$5,000) to RMB600,000 (US$100,000), or EMC; and (iv) the mass population (i.e. those with investable assets of less than RMB30,000 (US$5,000). “Investable assets” is defined to include cash, deposits, stocks, funds, bonds, insurance and other financial products as well as investment property excluding their primary residence.

 

Driven by China’s economic growth and accelerated urbanization rates, the aggregate population of China’s mass affluent and emerging middle class segments has grown rapidly, increasing from 403.7 million in 2013 to 502.0 million in 2017 and is expected to further increase to 642.9 million in 2022, while the percentage of the total population with investable assets increased from 40.6% in 2013 to 48.7% in 2017, and is expected to reach 59.3% in 2022. The amount of investable assets held by such population segments increased from RMB58.2 trillion (US$8.8 trillion) in 2013 to RMB115.3 trillion (US$17.4 trillion) in 2017, and is expected to further increase to RMB192.1 trillion (US$29.0 trillion) in 2022. The following graphs show the historical and forecast growth of personal investable assets and population by segment for the period indicated.

 

   

 

Source: China Insights Consultancy

 

Investment Preference

 

According to CIC, the mass affluent and emerging middle class population segments are generally more risk adverse than the high net worth population but is able to tolerate a manageable level of risk, and many in these segments of the population do not have significant investment experience and lack of the knowledge to identify and select suitable products on their own. Historically, these segments primarily allocated their investable assets to cash and deposits as well as investment properties, which collectively accounted for approximately 67% of their total investments in 2013. In light of the relatively low interest rates and tightened regulatory restrictions on property investments in China, the mass affluent and emerging middle class population segments have become increasingly receptive to diversified and balanced asset allocation with increasing investments in wealth management products. The following graph shows the assets allocation of mass affluent and emerging middle class population by product type of wealth management products in 2017.

 

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Source: China Insights Consultancy

 

Among the various types of wealth management products, currently the mass affluent and emerging middle class population segments in China prefer fixed income products and publicly raised fund products. According to CIC, more than 60% and more than 30% of the emerging middle class population purchased fixed income products and publicly raised fund products in 2017, and more than 25% of their purchased fixed income products were distributed by banks with implicit guaranteed returns. In addition, more than 75% and more than 70% of the mass affluent population purchased publicly raised fund products and fixed income products, respectively, of which more than 15% and more than 80% were distributed by banks. However, due to the release of the 2018 Guidelines, wealth management products bank issued and distributed especially fixed income products with guaranteed returns have gradually declined. With the increasing supply of more diversified and market-based products, it is expected that the purchases in such products, such as privately raised funds, would increase.

 

Wealth Management Services Market for China’s Mass Affluent and Emerging Middle Class

 

According to CIC, the market size of China’s wealth management services for mass affluent and emerging middle class population segments in terms of transaction value increased from RMB7.8 trillion (US$1.2 trillion) in 2013 to RMB25.2 trillion (US$3.8 trillion) in 2017, with a CAGR of 34.2%, and is expected to further increase to approximately RMB47.3 trillion (US$7.1 trillion) by 2022, or a CAGR of 13.4% from 2017 to 2022. All the major types of wealth management services providers have client coverage within such population segments.

 

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In terms of sales capabilities, products offerings and services capabilities serving the mass affluent and emerging middle class population segments, the differences among these service providers are illustrated below:

 

 

Source: China Insights Consultancy

 

The following is a brief analysis of the advantages and disadvantages of each type of wealth management service providers:

 

Commercial banks. Generally, commercial banks in China have advantages in terms of branch network and full license coverage for distribution. However, the banks are inherently conflicted because their main business is interest-based lending rather than a commission-based business such as wealth management service; therefore they typically do not offer personalized services and lack the independence in providing investment advice.
   
Online-based service providers. Online-based service providers can attract a large client base through their online platforms. However, because they mainly provide automated recommendation and trading services, online-based service providers generally do not offer extensive personalized services that many investors need.
   
Non-bank traditional financial institutions. Non-bank traditional financial institutions such as brokerages, trust companies and insurance companies have advantages on specific product types, particularly product types that they themselves have developed and manage (e.g. trust plans for trust companies). However, they are disadvantaged in terms of product choices, branch network and comprehensive client services, and more and more cooperate with banks and third-party wealth management service providers to distribute their products.

 

Compared with these three types of service providers, third-party wealth management institutions generally have advantages in terms of service capabilities in addition to comprehensive product offering. As a result, third-party wealth management services providers are expected to experience significant growth in China’s wealth management services market for mass affluent and emerging middle class population segments in the future.

 

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Third-Party Wealth Management Services Market for Mass Affluent and Emerging Middle Class in China

 

According to CIC, the third-party wealth management services market for the mass affluent and emerging middle class population segments in China is currently at an early stage of development. China’s market for such services reached RMB879.4 billion (US$132.9 billion) in 2017 in terms of transaction value, and as measured by population, these segments covering less than 10% of the total third-party wealth management services market. The mass affluent and emerging middle class population experienced a CAGR of 42.8% from 2013 to 2017 in terms of transaction value, and is expected to reach RMB2,709.6 billion (US$409.5 billion) in 2022, representing a CAGR of 25.2% from 2017 to 2022, according to the same source. The following graph shows the historical and forecast market size of the third-party wealth management services market for the mass affluent and emerging middle class population segments in China:

 

 

Source: China Insights Consultancy

 

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Market Trends and Drivers

 

According to CIC, key market trends and drivers in third-party wealth management services market for mass affluent and emerging middle class population segments include the following:

 

Strengthening supervision of commercial banks. The continuous strengthening supervision of the banking industry in China is conducive to the development of third-party wealth management market. In April 2018, China’s banking and securities regulators jointly released the Guidelines on Standardizing Asset Management Businesses of Financial Institutions, or the 2018 Guidelines, which aimed at reining in the banks’ supply of off-balance sheet wealth management products and at breaking traditional implicit guarantees of repayment on wealth management products. Such regulation is expected to drive the development of a truly market-based wealth management products and services market.

 

Increasing supply of diversified and market-oriented products. Since the release of the 2018 Guidelines, the number of new products issued by banks declined by 17.0%, and the number of new products offering guaranteed returns declined by 5.3% from March 2018 to June 2018. CIC expects that the shortage of bank-distributed wealth management products will be filled by more diversified and market-oriented products. Because China’s large mass affluent and emerging middle class population historically has primarily purchased products with guaranteed returns distributed by banks, and because a large segment of such population lacks the knowledge and experience to select alternative investment products, the need for third-party wealth management services is expected to be substantial.

 

Changes in assets allocation and investment preference. The ratio of household savings deposit growth to disposable income decreased from 25.4% in 2012 to 12.7% in 2017, indicating that Chinese people are less willing to keep disposable income as savings. The total scale of investable assets held by individuals in China amounted to RMB188.1 trillion (US$28.4 trillion) in 2017, twice the amount held in 2013. Considering the implications of recent regulations such as the 2018 Guidelines, investors are expected to increasingly invest in market-oriented products, leading to increasing need for professional services.

 

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Increasing complexity of the market. China’s financial market is offering a more diverse range of investment products and the market is becoming increasingly complex. It is increasingly difficult for individuals to accurately capture market dynamics and gain insights into market investment opportunities. At the same time, it is difficult for individual investors to have sufficient financial knowledge to conduct detailed investigations to determine higher-yielding products. As a result, it is expected that China’s individual investors will increasingly rely on professional advisors for investment advice.

 

Entry Barriers and Success Factors

 

According to the CIC Report, entry barriers and success factors to the success of third-party wealth management service providers for mass affluent and emerging middle class population in China include:

 

Fund distribution license. China’s wealth management industry is under highly rigorous government supervision. Non-financial institutions that do not hold fund distribution licenses will not be able to conduct fund-based sales. From 2012, the regulatory authorities gradually opened up the application of fund distribution licenses to third parties. Before that, except of the direct sales of fund companies, domestic fund-based sales qualifications were mainly hold by financial institutions such as banks and a part of brokers. While after September 2016, the issuance of domestic third-party fund distribution licenses has almost stagnated. From September 2016 to June 2018, only three non-financial institutions obtained new fund distribution licenses. Therefore, it can be considered that in the future, wealth management companies holding fund distribution licenses will gradually become the engine of wealth management market growth.

 

High quality and comprehensive product portfolio offerings. Third-party wealth management service providers with high quality products and comprehensive service offerings are able to address various types of clients’ investment needs and build continuing relationships with clients. Currently, the industry is still in the initial stage of product sales, with limited high quality product types and serious homogenized competition. It is becoming increasingly important for wealth management service providers not to provide a simple open platform or fund supermarket, but to fully combine its resource endowments in the investment banking and trading markets to design differentiated products and meet the investment and financing needs of clients. Furthermore, with limited high-quality financial products on the market, having the ability to acquire such products is expected to be critical to success.

 

Sales network coverage across China. China’s mass affluent and emerging middle class people are widely distributed in various provinces and cities across the country, which requires wealth management services providers to engage a nationwide sales network for establishing and expanding the client base. As individuals in these two population segments generally prefer face-to-face interaction, branch network, wealth management service providers need to have outlets across the country. In addition, to further tab the vast market, online-based channels become a promising choice. Building a comprehensive sales network with both offline branches and online channels requires substantial investments in time and capital, which represents a significant entry barrier to new market entrants.

 

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Ability to provide personalized services. The ability to identify and validate certificated clients is difficult to all of the third-party wealth management institutions, especially for the mass affluent and emerging middle class population, in addition to the general demand for capital preservation, clients also need personalized financial services, including customized wealth management products, financing needs, and cross-market transactions. These services can bring in much greater and more diverse revenue than traditional management fees. Therefore, securing the promising clients is the best way to secure success.

 

Competitive Landscape

 

According to CIC, in 2017, Puyi ranked 21st among all the third-party wealth management service providers with a fund distribution license, with total transaction value of RMB6.2 billion (US$0.9 billion). Companies that ranked 21st to 50th form a market segment that specifically targets the mass affluent and emerging middle class population segments with market size of approximately RMB600.0 billion(US$90.7 billion), and Puyi was the largest third-party wealth management service provider in this market segment, with a market share of approximately 10.4%. At the same time, Puyi is also extending its target client base to high net worth individuals. The following chart shows competitive landscape of third-party wealth management service market in China in 2017:

 

 

Source: China Insights Consultancy

 

China’s Corporate Finance Services

 

Corporate finance services in China are comprehensive financing solutions to corporate borrowers, including product structure design, introduction of potential investors, compliance and risk management services. Due to the small scale, low proportion of fixed assets, low transparency of financial information and other reasons, small and micro enterprises in China often face challenges in obtaining financing quickly and on reasonable commercial terms. According to China’s State Council, in 2017, more than 60% of the small and micro enterprises in China could not obtain any form of loans and rely entirely on their own funds and retained earnings to operate and develop. Such strong demand for financing represents unprecedented opportunities for financial services providers that have established relationships with a variety of corporate borrowers and accumulated in-depth understanding of their financing needs.

 

In addition, with the development of supply chain finance, corporate financing needs in the supply chain industry or in industries heavily rely on supply chain have grown rapidly, such as the automotive industry and the real estate industry. Therefore, assisting corporate borrowers in the automotive industry, real estate industry and other supply chain related industries to obtain financing services will become a significant driver for the growth of the fixed-income corporate finance industry.

 

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China’s Asset Management Services Market

 

According to CIC, the market size of China’s asset management services in terms of AUM increased from RMB41.7 trillion (US$6.3 trillion) in 2013 to RMB125.7 trillion (US$19.0 trillion) in 2017, representing a CAGR of 31.5%, and is expected to further grow to approximately RMB223.0 trillion (US$33.7 trillion) in 2022, with a CAGR of 12.0%. Privately raised funds are a significant component of the asset management market that utilize a variety of investment strategies to achieve return objectives within certain predefined risk parameters and investment guidelines. Among different types of privately raised funds, FoFs and NPL funds are two of the most popular forms of privately raised funds in recent years.

 

FoFs

 

FoFs in China have only begun to develop on a large scale in recent years, having been officially recognized by regulators in 2014. Characterized by relatively low risk and investment advisory services, privately raised FoFs has become an important form of asset allocation for the mass affluent and emerging middle class. The size of the FoF market, as measured by capital raised, increased from approximately RMB36.2 billion (US$5.5 billion) in 2013 to approximately RMB1,453.1 billion (US$219.6 billion) in 2017, representing a CAGR of 151.7%. As China’s economy continues its growth, capital raised for FoFs is expected to further increase from 2017 to RMB9,596.3 billion (US$1,450.2 billion) in 2022, representing a CAGR of 42.5%. According to CIC, such rapid increase is attributable to supportive policies from government, large capital investment and increasing acceptance in the market. The following chart illustrates the historical and forecast market size of FoFs by capital raised in China for the period indicated.

 

 

Source: Asset Management Association of China; China Insights Consultancy

 

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NPL Funds Market

 

The size of the NPL funds market, as measured by the amount of bank’s NPLs, increased from RMB576.3 billion (US$87.1 billion) in 2013 to RMB1,660.2 billion (US$250.9 billion) in 2017, representing a CAGR of 30.3%. In 2017, the amount of banks’ non-performing loans (NPLs) accounting for more than 90% of the non-performing assets in the financial market, and more than 60% of the total distressed assets in China, respectively. With the enhancement of asset management and disposal capabilities of China’s commercial banks and state-owned asset management companies or AMCs, the methods of NPLs’ disposal are becoming more diversified. Considering the relatively lower cost to acquire and in turn higher returns to dispose NPLs, banks and the four major state-owned AMCs are expected to allocate more resources to the disposal of NPLs. Due to the expanding size of China’s NPLs and the increase in professional investment services, the NPL funds market is expected to further grow from RMB1,660.2 billion (US$250.9 billion) in 2017 to RMB3,518.3 billion (US$531.7 billion) in 2022, representing a CAGR of 16.2%. The following chart illustrate the historical and forecast market size of NPL funds as measured by the amount of non-performing loans of banks in China for the period indicated:

 

 

  

Source: China Banking Regulatory Commission; China Insights Consultancy

 

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Corporate History and Structure

 

We commenced our wealth management service business in November 2010 when our founder, chairman of the and chief executive officer, Mr. Yu Haifeng, founded Fanhua Puyi Investment Management Co., Ltd. (泛华普益投资管理有限公司), or Fanhua Puyi, in November 2010. Fanhua Puyi was renamed Fanhua Puyi Fund Distribution Co., Ltd. (泛华普益基金销售有限公司) in March 2013.

 

In 2018, in preparation for our initial public offering, we completed a number of corporate restructuring steps, including:

 

Establishing offshore holding companies. In August 2018, we incorporated Puyi Inc. as our offshore holding company in the Cayman Islands. In July 2018, we incorporated Puyi Group Limited in the British Virgin Islands, which became the wholly owned subsidiary of Puyi Inc. in August 2018. In July 2018, we incorporated Puyi Holdings (Hong Kong) Limited, or Puyi HK, which became the wholly owned subsidiary of Puyi Group Limited in August 2018.

 

Establishing WFOE. In August 2018, our PRC WFOE, Puyi Enterprises Management Consulting Co., Ltd. (普益企业管理咨询有限公司), or Puyi Consulting, was incorporated in Chengdu, Sichuan, PRC. In December 2018, WFOE acquired 100% equity interest of Shenzhen Baoying Factoring Co., Ltd. (深圳宝盈商业保理有限公司) from Guangdong Puyi Asset Management Co., Ltd (广东普益资产管理有限公司) and a third party.

 

Transferring of operating entities. We transferred a number of entities with related businesses under the control of Mr. Yu Haifeng to become subsidiaries of Chengdu Puyi Bohui Information Technology Co., Ltd. (成都普益博汇信息技术有限公司), or Puyi Bohui, our variable interest entity, or VIE. Puyi Bohui has been primarily engaged in providing information technology services to the financial services industry in China. The entities transferred to Puyi Bohui included the following:

 

oFanhua Puyi, which has been the principal entity engaged in wealth management service business. See above. We initially set up Fanhua Puyi with an 84.59% equity interest with the remaining 15.41% held by Beijing Fanlian Investment Co., Ltd. (北京泛联投资有限公司), or Beijing Fanlian, a third party. On September 3, 2018, we purchased the remaining equity interest from Beijing Fanlian in exchange for (i) a cash consideration of RMB10,028,117; and (ii) new issuance of 4,033,600 ordinary shares of our company to Fanhua Inc. at a consideration of US$1,468,976.8.

 

o Guangdong Puyi Asset Management Co., Ltd. (广东普益资产管理有限公司) (previously known as Guangdong Fanhua Puyi Asset Management Co., Ltd.), or Puyi Asset Management, which primarily operates our FoF business. Puyi Asset Management currently has one subsidiary, Shenzhen Qianhai Zhonghui Huiguan Investment Management Co., Ltd. (深圳前海中惠惠冠投资管理有限公司), in which we hold 51% interest (acquired in July 2018), which primarily operates our non-performing loan management business.

 

oShenzhen Puyi Zhongxiang Information Technology Co., Ltd. (深圳普益众享信息科技有限公司), which primarily distributes our exchange administered products.

 

oChongqing Fengyi Management Consulting Co., Ltd. (重庆锋毅企业管理咨询有限公司), which primarily operates our corporate finance service business.

 

Due to restrictions imposed by PRC laws and regulations on foreign ownership of companies that engage in asset management, Puyi Consulting entered into a series of contractual arrangements with Puyi Bohui and its shareholders, through which Puyi Consulting has gained full control over the management and receives the economic benefits of Puyi Bohui. See “— Contractual Arrangements.”

 

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The following diagram illustrates our corporate structure, including our subsidiaries, interests and consolidated variable interest entities as of the date of this prospectus:

 

 

 

---------►Equity interest

 

◄- - - -►Contractual arrangement, including the exclusive option agreements, the equity interest pledge agreement, the powers of attorney, the spousal consent, the exclusive technical and consulting services agreement.

 

 

 

(1) Puyi Bohui is held by Mr. Yu Haifeng as to 99.04% and Ms. Yang Yuanfen as to 0.96% respectively.

 

(2) The remaining 49% of the equity interest is owned by two third parties as to 48% and 1%, respectively.

 

As of August 6, 2018, we issued 79,232,000 ordinary shares and 768,000 ordinary shares to Worldwide Success Group Limited and Future One Holdings Limited, respectively. On August 31, 2018, Worldwide Success Group Limited, a shareholder transferred 14,400,000 ordinary shares, 13,600,000 ordinary shares and 12,832,000 ordinary shares to Winter Dazzle Limited, Danica Surge Limited and Advance Tycoon Limited, respectively. On September 5, 2018, we entered into a share purchase agreement under which Puyi agreed to issue 4,033,600 ordinary shares to Fanhua Inc. at a consideration of US$1,468,976.8. The issuance was completed on the same day.

 

On September 18, 2018, Winter Dazzle Limited transferred 1,840,500 ordinary shares to Worldwide Success Group Limited at a consideration of US$1,840.5.

 

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Contractual Arrangements

 

We engage in fund management services among other services and in the process of applying for the license as a fund manager. Due to PRC legal restrictions on foreign ownership in business of management of privately raised securities funds, we conduct our business in China through our variable interest entities by way of a series of contractual arrangements.

 

Agreement that Allows Us to Receive Economic Benefits from Puyi Bohui

 

Exclusive Technical and Consulting Services Agreement. On September 6, 2018, Puyi Consulting entered into an Exclusive Technical and Consulting Services Agreement with Puyi Bohui to enable Puyi Consulting to operate and manage substantially all of the assets and business of Puyi Bohui and receive 100% of the net income of Puyi Bohui before corporate income tax. Under this Agreement, Puyi Consulting has the exclusive right to provide Puyi Bohui with comprehensive business support, technical and consulting services and other services in relation to the principal business during the term of this agreement utilizing its own advantages in management consulting and technology and information. Puyi Consulting or any other party designated by Puyi Consulting, may enter into further technical and consulting service agreements with Puyi Bohui which shall provide the specific contents, manner, personnel, and fees for the specific consulting service. This agreement became effective on September 6, 2018 and will remain effective unless otherwise terminated when all of the equity interest in Puyi Bohui held by its shareholders and/or all the assets of Puyi Bohui have been legally transferred to Puyi Consulting and/or its designee upon the approval of the board of directors of Puyi Inc. in accordance with an Exclusive Option Agreement entered among Puyi Consulting, Puyi Bohui and its shareholders.

 

Agreements that Provide Us with Effective Control over Puyi Bohui

 

Powers of Attorney. On September 6, 2018, Mr. Yu Haifeng and Ms. Yang Yuanfen, shareholders of Puyi Bohui, each executed a Power of Attorney to Puyi Consulting and Puyi Bohui, whereby both shareholders of Puyi Bohui irrevocably authorize and constitute Puyi Consulting as their attorney-in-fact to exercise on the shareholders’ behalf any and all rights that shareholders of Puyi Bohui have in respect of their equity interests in Puyi Bohui. These two Power of Attorney documents became effective on September 6, 2018 and will remain irrevocable and continuously effective and valid as long as the original shareholders of Puyi Bohui remain as the shareholders of Puyi Bohui.

 

Equity Interest Pledge Agreement. Under the Equity Interest Pledge Agreement dated September 6, 2018 among Puyi Bohui, each of the shareholders of Puyi Bohui and Puyi Consulting, each shareholder of Puyi Bohui agreed to pledge all of his or her equity interest in Puyi Bohui to Puyi Consulting to secure the performance of Puyi Bohui’s obligations under the Exclusive Technical and Consulting Services Agreement and any such agreements to be entered into in the future. Under the terms of the agreement, in the event that Puyi Bohui or its shareholders breach their respective contractual obligations under the Exclusive Technical and Consulting Services Agreement, Puyi Consulting, as the pledgee, will be entitled to certain rights, including, but not limited to, the right to collect dividends generated by the pledged equity interest. The Puyi Bohui shareholders also agreed that upon occurrence of any event of default, as set forth in the Equity Interest Pledge Agreement, Puyi Consulting is entitled to dispose of the pledged equity interest in accordance with applicable PRC laws. The shareholders of Puyi Bohui agreed not to transfer, sell, pledge, dispose of or otherwise create any encumbrance on their equity interest in Puyi Bohui agreed without the prior written consent of Puyi Consulting. The pledge of each of the shareholders of Puyi Bohui became effective on such date when the pledge of the Equity Interest contemplated herein was registered with relevant administration for industry and commerce and will remain effective until all payments due under the Exclusive Technical and Consulting Agreement have been fulfilled by Puyi Bohui, or upon the transfer of equity interest under the Exclusive Option Agreement entered into among the parties of this agreement.

 

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Spousal Consent Letters. Pursuant to these letters, the spouses of Mr. Yu Haifeng and Ms. Yang Yuanfen, the shareholders of Puyi Bohui irrevocably agreed that the equity interest in Puyi Bohui held by them and registered in their names will be disposed of pursuant to the Equity Interest Pledge Agreement, the Exclusive Option Agreement, and the Powers of Attorney. Each spouse of the shareholders agreed not to assert any rights over the equity interest in Puyi Bohui held by their respective spouses. In addition, in the event that any spouse obtains any equity interest in Puyi Bohui through the respective shareholder for any reason, he or she agreed to be bound by the contractual arrangements.

 

Agreements that Provide Us with the Option to Purchase the Equity Interest in Puyi Bohui

 

Exclusive Option Agreement. Puyi Bohui and its shareholders have entered into an Exclusive Option Agreement with Puyi Consulting on September 6, 2018. Under the Exclusive Option Agreement, the Puyi Bohui shareholders irrevocably granted Puyi Consulting (or its designee) an irrevocable and exclusive option to purchase, to the extent permitted under PRC law, once or at multiple times, at any time, part or all of their equity interests in Puyi Bohui. According to the Exclusive Option Agreement, the purchase price to be paid by Puyi Consulting to each shareholder of the Puyi Bohui will be the RMB10 or certain other amount permitted by applicable PRC Law at the time when such share transfer occurs. The Exclusive Option Agreement became effective on September 6, 2018 and will remain effective permanently.

 

In the opinion of GFE Law Office, our PRC legal counsel, the contractual arrangements among Puyi Consulting, Puyi Bohui and its shareholders, are governed by PRC laws or regulations both currently and immediately after giving effect to this offering are valid, binding and enforceable, and will not result in any violation of PRC laws or regulations currently in effect.

 

However, there are substantial uncertainties regarding the interpretation and application of current and future PRC laws, regulations and rules. Accordingly, the PRC regulatory authorities may in the future take a view that is contrary to or otherwise different from the above 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 the PRC government finds that the agreements that establish the structure for the operation of Puyi Bohui do not comply with PRC government restrictions on foreign investment in any of our businesses when we successfully acquire a license for privately raised fund manager, we could be subject to severe penalties including being prohibited from continuing operations. See “Risk Factors — Risks Related to Our Corporate Structure — If the PRC government finds that the agreements that establish the structure for operating our businesses in China do not comply with PRC regulations relating to fund management business, or if these regulations or the interpretations of existing regulations change in the future, we could be subject to severe penalties or be forced to relinquish our interests in those operation.”

 

The VIE agreements under our contractual arrangements are governed by PRC laws and provide for the resolution of disputes through arbitration in China. For additional information, see “Risk Factors—Risks Related to Our Corporate Structure—We rely on contractual arrangements with our variable interest entity and its shareholders for a portion of our China operations, which may not be as effective as direct ownership in providing operational control.” Such arbitration provisions have no effect on the rights of our shareholders to pursue claims against us under U.S. federal securities laws.

 

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BUSINESS

 

Overview

 

Puyi is the largest third-party wealth management services provider in China focusing on mass affluent and emerging middle class population, with a 10.4% market share based on 2017 transaction value, according to CIC. We are also the 21st largest third-party wealth management services provider overall in China based on the same metric, according to the same source.

 

According to CIC, the size of China’s mass affluent and emerging middle class totaled 502.0 million with investable assets of RMB115.3 trillion (US$17.4 trillion) at the end of 2017. Currently, a majority of the mass affluent and emerging middle class population in China rely on wealth management products issued and distributed by commercial banks. In April 2018, China’s banking and securities regulators jointly released the Guidelines on Standardizing Asset Management Businesses of Financial Institutions, or the 2018 Guidelines, which aimed at reining in the banks’ supply of off-balance sheet wealth management products and breaking traditional implicit guarantee of returns on wealth management products. As a result, the number of new products issued by banks have declined significantly. It is expected that the mass affluent and emerging middle class population in China will increasingly turn to third-party wealth management service providers for investment advisory services relating to market-oriented products.

 

We provide wealth management services, corporate finance services and asset management services. Our largest business has been our wealth management services business, under which we distribute wealth management products both online and offline through our branch network. Products distributed online include publicly raised fund products, exchange administered products and asset management plans. Products distributed offline through our branch network are privately raised fund products. For the year ended June 30, 2017 and the year ended June 30, 2018, the aggregate transaction value of the wealth management products we distributed totaled RMB5.6 billion and RMB6.0 billion (US$0.9 billion), respectively. In addition, we have a substantial corporate finance services business, under which we provide corporate borrowers with financing solutions, including product design, identification of sources of funding, compliance and risk management. We also have a newly-established and fast-growing asset management business under which we currently manage two FoFs and in preparation of new FoFs and NPL funds.

 

We adopt a unique social e-commerce sales model to develop our client base. Our approach consists of identifying, fostering and collaborating with seed clients—existing clients who believe in our service capabilities—to actively market our products or services on social media platforms to their families, friends and acquaintances. Our seed clients are supported by our approximately 100 investment advisors, who are responsible for providing seed clients with systematic and continuous professional training on our product offering as well as investment and asset allocation. As of June 30, 2016, 2017 and 2018, the number of our seed clients increased from approximately 16,000 to 25,200 and further to 35,000. Currently we have seed clients in 168 cities in 20 provinces across China. As of June 30, 2018, approximately 20.4% of our total clients were seed clients, but approximately 98% of our total sales for the year ended June 30, 2017 and 2018 were all generated by our seed clients.

 

We have experienced significant growth in recent years. Our net revenues increased from RMB155.7 million for the year ended June 30, 2017 to RMB165.8 million (US$25.1 million) for the year ended June 30, 2018. Our net income increased from RMB39.6 million for the year ended June 30, 2017 to RMB63.6 million (US$9.6 million) for the year ended June 30, 2018. 

 

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Competitive Strengths

 

Largest third-party wealth management services provider focusing on China’s mass affluent and emerging middle class population

 

Puyi is the largest third-party wealth management services provider in China focusing on mass affluent and emerging middle class population, with a 10.4% market share based on 2017 transaction value, according to CIC. We are also the 21st largest third-party wealth management services provider in China overall based on the same metric, according to the same source. The size of China’s mass affluent and emerging middle class population totaled 502.0 million in 2017 and is expected to further increase to 642.9 million in 2022, while the percentage of China’s total population with investable assets is expected to increase from 48.7% in 2017 to 59.3% in 2022. Currently less than 10% of the mass affluent and emerging middle class population are using third-party wealth management services, as compared to more than 50% in the United States.

 

Currently, a majority of mass affluent and emerging middle class population rely on wealth management products issued and distributed by commercial banks, but the banks are inherently conflicted because their main business is interest-based lending rather than a commission-based business such as wealth management service, therefore they typically do not offer personalized services and lack the independence in providing investment advice. Furthermore, historically, a large number of banks’ wealth management products were issued off-balance sheet with implicit guarantee of returns. In April 2018, China’s banking and securities regulators jointly released the 2018 Guidelines, aimed at reining in the banks’ supply of off-balance sheet wealth management products and breaking traditional implicit guarantee of returns on all types of wealth management products. As a result, the number of new products issued by banks declined by 17.0%, and the number offering guaranteed repayment decreased by 5.3% from March 2018 to June 2018.

 

These regulatory and industry trends are expected to lead to the development of a truly market-oriented wealth management products and services market, which we believe positions us well for rapid future growth.

 

A unique social e-commerce based sales model driven by seed clients

 

According to CIC, we are the first third-party wealth management service provider to successfully adopt an innovative social e-commerce based approach to tap into the vast wealth management market serving the mass affluent and emerging middle class population in China. Our approach consists of identifying, fostering and collaborating with seed clients—existing clients who believe in our service capabilities—to actively market our products or services on social media platforms to their families, friends and acquaintances.

 

The nature of social e-commerce is accepting peer recommendations that consumer trust. As a result, our seed clients are uniquely advantaged to developing potential clients within their social network because they can have greater influence on their investment decisions than our in-house investment advisors. It is also more convenient for our seed clients to manage clients they developed by maintaining regular contact. Our seed clients are supported by our approximately 100 investment advisors, who are responsible for providing them systematic and continuous professional training on products profile as well as investment and assets allocation knowledge. We also educate our seed clients through investment advisors to encourage long-term hold strategy as investment returns of most of our products, especially the ones with underlying investments in securities may vary yearly, but should average out over the long run. Furthermore, as our products portfolio aims to be simple and easy to understand, our seed clients are able to discuss products intelligently and with precision.

 

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Our seed client model transforms seed clients to our distribution channel, and enables us to more quickly strengthen brand awareness and develop a client base without deploying a large and expensive in-house sales force. Furthermore, the model enables our investment advisor team to focus more on enhancing professional advisory and financial planning services capabilities to serve our client base. Because we separate our client relationship management function from our professional service function, we are able to reduce reliance on any particular seed client or investment advisor and increase the stability of our client base.

 

As of June 30, 2016, 2017 and 2018, the number of our seed clients increased from approximately 16,000 to 25,200 and further to 35,000. Currently we have seed clients in 168 cities in 20 provinces across China, covering major tier three and tier four cities where there is a high concentration of emerging middle class as well as selected economically well-developed cities with a large percentage of mass affluent Chinese available for marketing. As of June 30, 2018, approximately 20.4% of our client base consisted of seed clients, while approximately 98% of our total sales for the year ended June 30, 2017 and 2018 were all generated by our seed clients.

 

Prudently selected and developed products meeting the specific needs of our client base

 

We focus on providing wealth management services catering to the mass affluent and emerging middle class population in China. According to CIC, such population segments generally exhibit the following characteristics: they are generally more risk averse than the high net worth population, but are able to tolerate a manageable level of risk, and many do not have significant investment experience, many lack the knowledge to identify and select suitable products on their own. To satisfy their investment needs and risk-return preference, we strive to build and expand our products portfolio with the following features:

 

Simple structure and differentiated products. Our products generally do not have highly-complex structures in terms of fund flow, investment return calculation, underlying investments and contractual obligations. In addition, we do not offer clients a large number of products with similar profiles which may cause confusion, but focus on a select number of differentiated products suitable for different risk appetites. For example, we have different publicly raised fund products in terms of underlying investment, among which money market funds and bonds funds are primarily purchased by the emerging middle class, and securities funds and hybrid funds are often chosen by the mass affluent population. Recently, we have launched three publicly raised fund packaged products for aggressive, moderate and conservative clients, respectively, which combine different funds into packages and further simplify the products choices. We believe that such a product portfolio makes it easier to understand for potential clients and facilitates our efforts to train our seed clients in their marketing efforts. See “—A unique social e-commerce based sales model driven by seed clients” above.

 

Prudent investments with balanced allocation. For our target clients, we have developed a product selection and development process guided by a principal of capital preservation first followed by capital appreciation. The underlying investments of our products primarily include fix income products which have short maturities and stable returns, publicly traded securities which are subject to compliance requirement and public disclosures, and loans and receivables with assets-backed collateral, which we believe are suitable for most prudent investors. In addition, we seek to assist our clients in developing a balanced allocation to their assets. For example, we recently launched in-house developed FoFs which allocate investors’ assets into diversified underlying funds in order to give our clients exposure to additional mix of products at a manageable risk level. Furthermore, the NPL funds that we have distributed and plan to develop adopt a counter cyclical strategy and are designed to help clients to achieve sustainable asset growth through various phases of the economic cycle.

 

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High-quality portfolio. The products we distribute to our clients generally deliver strong performance or demonstrate such potential. For example, as of June 30, 2018, the money market fund product and the medium- and small-cap fund product we sourced from “Yifangda” (易方达), have achieved an accumulated return of 23.81% and 307.6%, respectively, since their launch in November 2013 and July 2015, respectively, surpassing the respective performance of major similar products in China. The non-restricted asset management plan issued by Guotai Junan Securities, achieved five-consecutive-year positive returns with four-year double-digit returns as of December 31, 2017. In addition, our Meihao FoF, which adopts a hedging investment strategy on the stock and futures markets, has generated positive investment return within three months after its launch in 2018, and is expected to achieve satisfactory returns from a long-term holding perspective.

 

Collaboration with diverse and high-quality industry players

 

We have established collaboration with a variety of well-recognized industry players, including:

 

Quality product providers for wealth management services. We source third-party products from product providers with strong performance record and established credit in the industry. A majority of fund managers of our fund products have long-term operating history, large-scale AUM and are top-rated by leading financial institutions, such as Bosera Funds (博时基金), one of the largest domestic fund managers affiliated with China Merchants Securities; China Southern Asset Management (南方基金), one of the first three domestic approved fund manager; and E Fund (易方达), which has generated attractive returns on multiple products over the 15 years operation and received numerous awards for its fund management performance. We also source asset management plans from three leading domestic securities firms, Guotai Junan Securities, GF Securities and Changjiang Securities. In addition, we collaborate with four financial assets exchanges to offer exchange administered products, where we can benefit from pre-screening procedures of products by such exchanges which further reduce clients’ risks and our operating costs.

 

  Well-recognized fund managers for FoF products. We are actively seeking investment opportunities in funds managed by quality domes