F-1/A: Zerolimit Technology Files IPO Amendment, Targets Nasdaq Listing Amidst China VIE Risks

Zerolimit Technology Holding Co. Ltd., a Cayman Islands holding company operating through a China-based Variable Interest Entity, filed an amendment to its F-1 registration statement for an initial public offering of up to 2,000,000 ordinary shares at an anticipated price of $4 per share, seeking to list on Nasdaq under the symbol ZDAN.

Summary

• Zerolimit Technology Holding Co. Ltd. is a Cayman Islands holding company that conducts its primary operations through a Variable Interest Entity (VIE), Zhenglian Technology (Shenzhen) Co., Ltd., in China, due to PRC foreign ownership restrictions.
• The company is pursuing an Initial Public Offering (IPO) of up to 2,000,000 Ordinary Shares, with an anticipated initial offering price of $4 per share, aiming to raise approximately $8 million in net proceeds.
• Plans are in place to list Ordinary Shares on the Nasdaq Capital Market under the symbol ZDAN, with the offering conditioned upon successful listing approval.
• The business focuses on providing distributed network infrastructure software products and complementary software development kits for decentralized applications (DApps), addressing security, centralization, and resource limitations of traditional networks.
• For the fiscal year ended September 30, 2024, total revenue reached approximately $5.91 million, a 4% increase from $5.68 million in the fiscal year ended September 30, 2023.
• Net income for the fiscal year ended September 30, 2024, was approximately $2.71 million, up 7% from $2.52 million in the prior fiscal year.
• Gross profit margin remained stable at 74% for both fiscal years ended September 30, 2024 and 2023.
• Research and development (R&D) expenses decreased significantly to $47,909 in FY2024 from $124,100 in FY2023, a 61% reduction, while capitalized R&D also saw a substantial decrease from $593,670 to $12,210.
• The company's revenue is primarily derived from Cloud Data Base Station Node Software (89.90% of total revenue in FY2024) and is entirely generated through a distribution network in China, comprising 35 distributors as of September 30, 2024.
• Key intellectual property includes 2 registered trademarks, 38 registered computer software copyrights, 11 registered patents, and 1 license in China.
• Guangqing Hu, the Chairman and Chief Technology Officer, will retain substantial control, beneficially owning 73.01% of outstanding Ordinary Shares post-offering, making the company a 'controlled company' under Nasdaq rules.

Sentiment

Score: 6

Explanation: The company operates in a high-growth, innovative industry with demonstrated revenue and net income growth and a strong intellectual property portfolio. However, significant risks associated with its VIE structure, the uncertain PRC regulatory environment, high customer/supplier concentration, and a notable decline in R&D investment and cash reserves temper the positive outlook. The IPO is critical for its stated growth plans, but the inherent uncertainties warrant a cautious assessment.

Positives

• Achieved revenue growth of 4% and net income growth of 7% for the fiscal year ended September 30, 2024, demonstrating continued financial performance.
• Maintained a high gross profit margin of 74% for both fiscal years, indicating strong cost management relative to revenue.
• Possesses a robust intellectual property portfolio, including 38 registered computer software copyrights and 11 registered patents, providing a competitive advantage in the decentralized technology industry.
• Identifies as an early entrant and technological leader in the decentralized distributed technology industry, with proprietary technology developed since 2017.
• Has established good relationships with its network of 35 distributors, suppliers, and local government agencies in China, facilitating market penetration across 9 provinces and 11 municipalities.
• Received national high-tech enterprise certification in China in 2022 and specialized and sophisticated SME recognition in April 2023.
• Plans to allocate significant IPO proceeds (40%) to research and development and (25%) to new product production, signaling a commitment to innovation and growth.

Negatives

• Operates through a Variable Interest Entity (VIE) structure in China, which is subject to substantial uncertainties regarding interpretation and application of current and future PRC laws, potentially leading to significant operational changes or loss of investment value.
• Experienced a significant decrease in research and development expenses by 61% to $47,909 in FY2024 from $124,100 in FY2023, and a sharp decline in capitalized R&D from $593,670 to $12,210, which could impact future innovation and competitiveness.
• Faces concentration risk with its top 5 distributors accounting for a significant portion of total revenue (e.g., 34% from top 3 in FY2024), making it vulnerable to the loss of any major customer.
• Relied on a single supplier for 100% of its purchases in FY2024, creating a high supplier concentration risk.
• Does not have long-term contracts with its hardware product suppliers, exposing it to potential supply disruptions or unfavorable terms.
• Identified material weaknesses in internal control over financial reporting, including a lack of accounting staff with U.S. GAAP and SEC reporting knowledge and a lack of formal internal controls over financial closing and reporting processes.
• Management team lacks experience in managing a U.S. publicly-listed company and complying with related laws, posing potential operational and regulatory challenges.
• Cash and cash equivalents decreased substantially from $1,641,922 as of September 30, 2023, to $105,706 as of September 30, 2024, indicating a deteriorating cash position prior to the IPO.
• Net cash used in operating activities increased from $(1,393,210) in FY2023 to $(1,825,252) in FY2024, driven by increases in accounts receivable and prepayments for marketing and IPO costs.

Risks

• Reliance on contractual arrangements with the VIE and VIE Shareholders for business operations, which may not be as effective as direct ownership and could be disallowed by the PRC government.
• Substantial uncertainties regarding the interpretation and enforcement of PRC laws, rules, and regulations related to the VIE Agreements, potentially leading to a material change in operations or significant depreciation of share value.
• The VIE Shareholders may have actual or potential conflicts of interest with the company, which could materially and adversely affect business and financial condition.
• Risk of losing the ability to use and enjoy assets held by the VIE if the entity goes bankrupt or becomes subject to dissolution or liquidation proceedings.
• Contractual arrangements in relation to the VIE may be subject to scrutiny by PRC tax authorities, potentially leading to additional taxes or penalties.
• Uncertainty regarding the enforceability of judgments obtained against the company or its management in China due to differences in legal systems and lack of reciprocal enforcement treaties with the U.S. or Cayman Islands.
• PRC regulatory authorities may require additional approvals or filings (e.g., CSRC, cybersecurity review) for the U.S. listing or future offerings, which may not be obtained or could be rescinded.
• Government control of currency conversion and transfers of funds in China may limit the ability to utilize revenues, remit dividends, or transfer cash effectively, affecting investment value.
• The VIE's operating history may not be indicative of future growth, and the company may not be able to sustain historical growth rates.
• Dependence on proprietary technology and the risk that the VIE cannot maintain technological superiority in a rapidly changing industry.
• The further development and acceptance of decentralized distributed technologies are subject to various difficult-to-evaluate factors, and a slowdown could materially adversely affect the business.
• Changes in other technologies (e.g., hardware, network performance like 5G/6G) or related industries could render products obsolete or require significant adaptation costs.
• High dependence on its largest 5 distributors; the loss of any could cause a significant decline in consolidated revenues.
• Distributor agreements allow customers to reduce quantities or cease purchases with only termination as a consequence, potentially leading to significant revenue declines.
• Success of networks created using proprietary technology depends on maintaining a minimum user base and number of nodes (e.g., below 160 nodes increases application failures).
• The distributed network may face scalability challenges as it expands to a greater number of users, potentially leading to reduced efficacy or reputational harm.
• Issues with the VIE's programming code or damage to a sufficient number of nodes could hurt network functionality and reputation.
• Significant interruption in hardware suppliers could disrupt operations, and the lack of long-term contracts with suppliers exacerbates this risk.
• Inability to build and maintain a sufficient sales and distribution network could impair the ability to execute on business plans.
• Inability to prevent unauthorized use of intellectual property could harm business and competitive position.
• Exposure to pandemics, epidemics, natural disasters, terrorist activities, and political unrest (e.g., COVID-19 impact) could disrupt operations.
• Failure to maintain and enhance brands or effectively expand marketing and sales capabilities could harm customer attraction.
• Failure to comply with data protection laws and regulations could lead to government enforcement actions and significant penalties.
• Changes in laws and regulations related to the internet or changes in the internet infrastructure itself may diminish demand for products.
• Exposure to risks of litigation and arbitration in the course of operations, including a pending contract dispute with a former supplier.
• Potential tax liabilities for historical reporting errors or if classified as a PRC resident enterprise for tax purposes.
• The initial public offering price may not be indicative of the market price after the offering, and an active, liquid, and orderly trading market may not develop or be maintained.
• New investors will experience immediate and substantial dilution due to the difference between the IPO price and the pro forma net tangible book value per share.
• No expectation of paying dividends in the foreseeable future, requiring investors to rely on share price appreciation for returns.
• Potential for the company's Ordinary Shares to be subject to 'penny stock' regulations and restrictions, making them difficult to sell.
• Lack of research or reports from securities or industry analysts could lead to a decline in market price and trading volume.
• Vulnerability to techniques employed by short sellers, which could drive down the market price.
• Risk of being classified as a Passive Foreign Investment Company (PFIC) for U.S. federal income tax purposes, leading to significant adverse tax consequences for U.S. holders.
• As an emerging growth company and foreign private issuer, the company is eligible for reduced public company reporting and corporate governance requirements, which may limit information available to shareholders.
• Management's discretion over the use of net proceeds from the offering may not produce income or increase share price.
• Some members of the management team lack experience in managing a U.S. publicly-listed company and complying with related laws.
• The obligation to disclose information publicly may put the company at a disadvantage to private competitors.
• Cayman Islands economic substance requirements may have an effect on business and operations.

Future Outlook

The company aims to become a leading provider of distributed network solutions by continuously investing in research and development, improving existing products, developing new solutions, expanding its sales and distribution network in the PRC, and enhancing its ability to attract and retain talented professionals. It plans to roll out an expanded product portfolio, including upgraded Enterprise Data Base Station and other decentralized application software, to meet diverse customer demands. The company also intends to pursue strategic acquisitions and investments in selected technologies and businesses within the distributed technology industry to enhance its capabilities.

Management Comments

• Our mission is driving continuous advancement in internet technology.
• Our goal is to become a leading provider of distributed network solutions.
• We hope to continue to increase our investment in the research and development of distributed networks and to continuously educate and spread awareness of the solutions we can provide to address the challenges end-users are encountering in both traditional and current networks.
• We aim to stay up-to-date on technical innovations by maintaining a large talent pool and will continue to invest in research and development to upgrade the software solutions of our subsidiaries and the VIE.

Industry Context

The company operates within the decentralized distributed technology industry, which is characterized by rapid changes and innovations. This industry is still in its early stage of development but is projected to experience rapid growth globally and in China. The global market size reached $1.4 billion in 2020 and is projected to reach $18.95 billion by 2024, with a compound annual growth rate (CAGR) of approximately 48%. The Chinese market reached $600 million in 2021 and is projected to reach $4.28 billion by 2026, with a CAGR of approximately 32%. The company positions itself as a solution provider for the limitations of traditional networks (Web 2.0), such as security, centralization, and resource limitations, by leveraging secure and decentralized distributed technologies. Key application areas for this technology include intellectual property, healthcare, e-commerce, education, and financial services.

Comparison to Industry Standards

• The company claims to be an early entrant into the decentralized distributed technology industry, with its founder leading development since 2017, suggesting a first-mover advantage over newer competitors.
• It highlights its extensive intellectual property portfolio (38 software copyrights, 11 patents) as a competitive strength, implying a stronger proprietary position compared to some industry players.
• The company states its proprietary network and accompanying software solutions offer 'faster innovation, flexible resources and economies of scale' compared to competitors, though specific comparative metrics are not provided.
• While identifying global competitors like Dfinity, Near, Conflux, IBM, Oracle, and Microsoft Azure, and domestic players such as Qulian Technology, Tencent Blockchain, and AntChain, the filing does not offer specific performance benchmarks or market share comparisons against these entities.
• The company's high gross profit margin of 74% could be indicative of strong pricing power or efficient cost of revenue relative to industry peers, though direct industry-wide gross margin data for comparison is not provided.

Management Changes

Corporate Governance

Legal Proceedings

• Zhenglian Shenzhen is involved in a contract dispute with a previous supplier, Shenzhen Youwei Communication Technology Co., Ltd. (Youwei).
• Zhenglian Shenzhen sued Youwei on March 23, 2023, claiming approximately $1.1 million in total compensation for Youwei's failure to provide customized mobile phones as per purchase agreements.
• Youwei filed a counterclaim against Zhenglian Shenzhen in June 2023.
• As of September 30, 2024, the case is still pending the court's judgment.
• Management does not believe this legal proceeding will have a material adverse effect on operations in China.

Related Party Transactions

• Software Licensing Agreements between Zhenglian Technology (Shenzhen) Co, Ltd. (VIE) and ZeroLimit Digital Technology Co., Ltd. (related party) for distributed cloud disk, distributed domain name, Huashengren, and Rushujiazhen software, effective March 1, 2023, to February 29, 2024, with specified authorization and monthly fees.
• A Trademark Authorization Agreement between the VIE and Zerolimit Digital Technology Co., Ltd. for the VIE's free use of trademarks from January 1, 2021, to December 31, 2025.
• An accounts receivable from Liaoning Pulian Suyuan Health Technology Information Consulting Co., LTD (related party due to former director Jian Gang) with an outstanding balance of $1,297,265 as of September 30, 2023, which was fully settled in December 2023.
• Loan received from Zerolimit Digital Technology Co., LTD (related party) of $1,458,321 in FY2023, with $663,669 repaid in the same fiscal year.
• Loan received from Guangqing Hu (Chairman, CTO, and controlling shareholder) of $13,881 in FY2024, which was fully repaid in the same fiscal year.
• Total revenue from related parties was $635,480 for FY2024 and $2,067,626 for FY2023.
• Total purchases from related parties were $23,645 for FY2024 and $17,944 for FY2023.
• Accounts receivable from related parties were $2,781 as of September 30, 2024, down from $152,196 as of September 30, 2023.
• Amounts due to related parties were $244 as of September 30, 2024, down from $4,112 as of September 30, 2023.

Stakeholder Impact

• Shareholders: Will experience immediate and substantial dilution from the IPO. Investment is subject to significant risks related to the VIE structure, PRC regulatory changes, and potential for share price volatility. No dividends are expected in the foreseeable future.
• Employees: The R&D team size decreased from 31 to 23 employees between FY2023 and FY2024. The company plans to enhance its ability to attract, incentivize, and retain talented professionals. Compliance with PRC labor laws, including social insurance contributions, is an ongoing requirement.
• Customers (Distributors): The company relies entirely on its distribution network for sales and after-sales support. There is a concentration risk with a few major distributors, and agreements allow distributors to reduce or cease purchases with only termination as a consequence.
• Suppliers: The company faces supplier concentration risk, relying on a single supplier for 100% of its purchases in FY2024. The lack of long-term contracts with hardware suppliers could lead to supply disruptions.
• Creditors: The company has short-term bank loans and has recently obtained additional borrowings. Its ability to repay these debts depends on its operational cash flows and the success of the IPO.

Next Steps

• Complete the listing process for Ordinary Shares on the Nasdaq Capital Market under the symbol ZDAN.
• Continue to invest in research and development to improve existing software products and create new ones.
• Expand the sales and distribution network to penetrate new geographic markets in the PRC and increase market share in existing ones.
• Enhance the ability to attract, incentivize, and retain talented professionals, including implementing a market-oriented employee compensation structure and a standardized multilevel performance review mechanism.
• Pursue strategic acquisitions and investments in selected technologies and businesses within the distributed technology industry.
• Complete necessary filing procedures with the China Securities Regulatory Commission (CSRC) pursuant to the Trial Administrative Measures of Overseas Securities Offering and Listing by Domestic Companies.

Key Dates

Recommendation

The company operates in the promising decentralized distributed technology sector, demonstrating revenue growth (4%) and net income growth (7%) with a strong 74% gross margin. Its proprietary technology, intellectual property portfolio (38 software copyrights, 11 patents), and early market entry provide competitive advantages. However, the investment carries substantial risks, primarily due to its Variable Interest Entity (VIE) structure in China, which is subject to evolving and uncertain PRC laws and regulations, including potential disallowance by the government. There's also significant customer and supplier concentration risk, a notable decline in R&D investment and capitalized R&D in the most recent fiscal year, and a sharp decrease in cash reserves prior to the IPO. While the IPO aims to raise $8 million for R&D, new product production, and market expansion, the inherent legal and operational uncertainties in China, coupled with the company's status as a controlled company and foreign private issuer, warrant a cautious stance. The stock is speculative given these factors, and a 'hold' is appropriate for investors to monitor how the company navigates these challenges post-IPO.

Keywords

Decentralized Technology, Distributed Networks, Software, Initial Public Offering, China, VIE Structure, Nasdaq, Web3, DApps, Cybersecurity, Intellectual Property, Cloud Data Base Station, Smart Metaverse Box, Enterprise Data Base Station