Annual and Transition Report (foreign Private Issuer) (20-f)

Date : 05/01/2019 @ 11:29AM
Source : Edgar (US Regulatory)
Stock : Kbs Fashion Grp. Limited (KBSF)
Quote : 2.6901  -0.0566 (-2.06%) @ 4:25PM

Annual and Transition Report (foreign Private Issuer) (20-f)

 

  

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 20-F

 

(Mark One)

 

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

 

OR

 

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

 

For the fiscal year ended December 31, 2018

 

OR

 

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

 

For the transition period from ___________ to ___________

 

OR

 

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

 

Date of event requiring this shell company report:

  

Commission file number: 001-35715

 

KBS Fashion Group Limited

 

(Exact Name of Registrant as Specified in Its Charter)

 

Not Applicable

(Translation of Registrant’s Name Into English)

 

Republic of the Marshall Islands

(Jurisdiction of Incorporation or Organization)

 

Xin Fengge Building

Yupu Industrial Park

Shishi City, Fujian Province 362700

People’s Republic of China

 

(Address of Principal Executive Offices)

 

Mr. Keyan Yan, Chief Executive Officer

Xin Fengge Building

Yupu Industrial Park

Shishi City, Fujian Province 362700

People’s Republic of China

Tel: + (86) 595 8889 6198

Fax: (86) 595 8850 5328

 

(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

 

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

 

Title of Each Class   Name of Each Exchange On Which Registered
Common Stock, $0.0001 par value   NASDAQ Capital Market

  

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

 

Units, Common Stock Purchase Warrants

(Title of Class)

 

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

 

None

(Title of Class)

 

 

 

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report (December 31, 2018): 2,271,299

 

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

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.  Yes No

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes No

 

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

 

Large Accelerated Filer Accelerated Filer    Non-Accelerated Filer Emerging Growth Company  ☐

 

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the Exchange Act.

 

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

 

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

 

U.S. GAAP International Financial Reporting Standards as issued by the International Accounting Standards Board   Other

 

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow. ☐ Item 17 Item 18

 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No

 

 

 

 

 

 

Annual Report on Form 20-F

 

Year Ended December 31, 2018

 

TABLE OF CONTENTS

 

    Page
PART I    
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 2
A. Directors and Senior Management 2
B. Advisors 2
C. Auditors 2
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE 2
A. Offer Statistics 2
B. Method and Expected Timetable 2
ITEM 3. KEY INFORMATION 2
A. Selected Financial Data 2
B. Capitalization and Indebtedness 3
C. Reasons for the Offer and Use of Proceeds 3
D. Risk Factors 3
ITEM 4. INFORMATION ON THE COMPANY 24
A. History and Development of the Company 24
B. Business Overview 26
C. Organizational Structure 42
D. Property, Plants and Equipment 43
ITEM 4A. UNRESOLVED STAFF COMMENTS 44
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 44
A. Principal Factors Affecting Financial Performance 45
B. Liquidity and Capital Resources 50
C. Research and Development, Patents and Licenses, Etc. 51
D. Trend Information 51
E. Off Balance Sheet Arrangements 51
F. Tabular Disclosure of Contractual Obligations 52
G. Safe Harbor 62
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 63
A. Directors and Senior Management 63
B. Compensation 64
C. Board Practices 65
D. Employees 66
E. Share Ownership 66
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 67
A. Major Shareholders 67
B. Related Party Transactions 67
C. Interests of Experts and Counsel 67

 

i

 

ITEM 8. FINANCIAL INFORMATION 67
A. Consolidated Statements and Other Financial Information 67
B. Significant Changes 68
ITEM 9. THE OFFER AND LISTING 68
A. Offer and Listing Details 68
B. Plan of Distribution 68
C. Markets 68
D. Selling Shareholders 68
E. Dilution 68
F. Expenses of the Issue 68
ITEM 10. ADDITIONAL INFORMATION 69
A. Share Capital 69
B. Memorandum and Articles of Association 69
C. Material Contracts 71
D. Exchange Controls 71
E. Taxation 74
F. Dividends and Paying Agents 79
G. Statement by Experts 79
H. Documents on Display 79
I. Subsidiary Information 79
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 79
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES 80
A. Debt Securities 80
B. Warrants and Rights 80
C. Other Securities 80
D. American Depositary Shares 80
PART II    
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 81
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS 81
ITEM 15. CONTROLS AND PROCEDURES 81
A. Disclosure Controls and Procedures 81
B. Management’s Annual Report on Internal Control Over Financial Reporting 81
C. Attestation Report of the Registered Public Accounting Firm 81
D. Changes in Internal Controls over Financial Reporting 82
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT 82
ITEM 16B. CODE OF ETHICS 82
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES 82
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES 82
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS 83
ITEM 16F. CHANGES IN REGISTRANT’S CERTIFYING ACCOUNTANT 83
ITEM 16G. CORPORATE GOVERNANCE 83
ITEM 16H. MINE SAFETY DISCLOSURE 83
PART III    
ITEM 17. FINANCIAL STATEMENTS 84
ITEM 18. FINANCIAL STATEMENTS 84
ITEM 19. EXHIBITS 84

 

ii

 

INTRODUCTORY NOTES

 

Use of Certain Defined Terms

 

Except as otherwise indicated by the context and for the purposes of this report only, references in this report to:

 

“KBS,” “we,” “us,” “our” and the “Company” are to KBS Fashion Group Ltd., a company organized in the Republic of the Marshall Islands;

 

““KBS International,” refers to KBS International Holding Inc., a Nevada corporation, which was dissolved in August 2014;

 

“Hongri PRC,” refers to Hongri (Fujian) Sports Goods Co., Ltd., which is our wholly owned subsidiary organized in the PRC;

 

“Hongri International” are to Hongri International Holdings Limited, which is our wholly owned subsidiary and a company organized in the BVI;

 

“BVI” are to the British Virgin Islands;

 

“Hong Kong” are to the Hong Kong Special Administrative Region of the People’s Republic of China;

 

“PRC” and “China” are to the People’s Republic of China;

 

“SEC” are to the Securities and Exchange Commission;

 

“Exchange Act” are to the Securities Exchange Act of 1934, as amended;

 

“Securities Act” are to the Securities Act of 1933, as amended;

 

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

 

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

 

Forward-Looking Information

 

In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. We use words such as “believe,” “expect,” “anticipate,” “project,” “target,” “plan,” “optimistic,” “intend,” “aim,” “will” or similar expressions which are intended to identify forward-looking statements. Such statements include, among others, those concerning market and industry segment growth and demand and acceptance of new and existing products; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; and any statements regarding future economic conditions or performance, as well as all assumptions, expectations, predictions, intentions or beliefs about future events. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, as well as assumptions, which, if they were to ever materialize or prove incorrect, could cause the results of the Company to differ materially from those expressed or implied by such forward-looking statements. Potential risks and uncertainties include, among other things, the possibility that we may not be able to maintain or increase our net revenues and profits due to our failure to anticipate consumer preferences and develop new menswear products, our failure to execute our business expansion plan, changes in domestic and foreign laws, regulations and taxes, changes in economic conditions, uncertainties related to China’s legal system and economic, political and social events in China, a general economic downturn, a downturn in the securities markets, and other risks and uncertainties which are generally set forth under Item 3 “Key information—D. Risk Factors” and elsewhere in this report.

 

Readers are urged to carefully review and consider the various disclosures made by us in this report and our other filings with the SEC. These reports attempt to advise interested parties of the risks and factors that may affect our business, financial condition and results of operations and prospects. The forward-looking statements made in this report speak only as of the date hereof and we disclaim any obligation, except as required by law, to provide updates, revisions or amendments to any forward-looking statements to reflect changes in our expectations or future events.

 

On February 3, 2017, approved by the shareholders, our Board of Directors approved a one-for-fifteen (1-for-15) reverse stock split of the Company’s issued and outstanding common stock. In addition, in lieu of issuing any fractional share, the Board of Directors decided that shareholders are entitled to receive the number of shares of common stock rounded up to the next whole number. Our common stock began trading on the NASDAQ Stock Market on a split-adjusted basis when the market opened on February 9, 2017. All references in this report to share and per share data have been adjusted, including historical data which have been retroactively adjusted, to give effect to the reverse stock split unless specified otherwise.

 

1

 

PART I

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

A. Directors and Senior Management

 

Not applicable.

 

B. Advisors

 

Not applicable.

 

C. Auditors

 

Not applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

 

A. Offer Statistics

 

Not applicable.

 

B. Method and Expected Timetable

 

Not applicable.

 

ITEM 3. KEY INFORMATION

 

A. Selected Financial Data

 

The following table presents selected financial data regarding our business. It should be read in conjunction with our consolidated financial statements and related notes contained elsewhere in this annual report and the information under Item 5 “Operating and Financial Review and Prospects.” The selected consolidated statements of comprehensive income data for the fiscal years ended December 31, 2018, 2017 and 2016, and the selected consolidated statements of financial position data as of December 31, 2018 and 2017 have been derived from our audited consolidated financial statements that are included in this annual report beginning on page F-1. The selected consolidated statements of comprehensive income data for the fiscal years ended December 31, 2015 and 2014, and the selected consolidated statements of financial position data as of December 31, 2016, 2015 and 2014 have been derived from our audited consolidated financial statements that are not included in this annual report.

 

Our consolidated financial statements were prepared and presented in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”). The selected financial data information is only a summary and should be read in conjunction with the historical consolidated financial statements and related notes contained elsewhere herein. The financial statements contained elsewhere fully represent our financial condition and operations; however, they are not indicative of our future performance.

 

2

   

    Years ended December 31,  
    2018     2017     2016     2015     2014  
Statement of Income Data                              
Total revenue   $ 18,535,116     $ 23,762,536     $ 41,200,205     $ 61,343,681     $ 58,832,481  
Total cost of sales     (20,851,252 )     (35,274,352 )     (39,041,932 )     (46,511,274 )     (39,416,973 )
Gross profit     (2,316,136 )     (11,511,816 )     2,158,272       14,832,407       19,415,508  
Distribution and selling expenses     (2,670,955 )     (3,265,380 )     (3,606,010 )     (6,621,256 )     (7,191,606 )
Administrative expenses     (4,907,020 )     (4,879,397 )     (3,543,993 )     2,798,082       (4,649,229 )
Profit for the year     (17,968,597 )     (14,815,596 )     (11,902,688 )     1,243,670       6,876,982  
Total comprehensive income for the year     (20,040,295 )     (10,004,880 )     (18,028,121 )     (4,801,102 )     6,526,172  
Outstanding shares     2,299,915     1,860,831       1,750,142       1,694,489       1,694,489  
Earnings per share, basic diluted     -8.06     -7.96       -6.80       0.73       4.06  
Balance Sheet Data                                        
Cash and cash equivalents   $ 21,026,103     $ 26,050,456     $ 24,576,341     $ 21,214,080     $ 20,604,583  
Non-current assets     29,837,875       40,966,319       34,754,942       47,221,529       52,929,386  
Current assets     31,328,131       40,343,386       56,343,823       62,098,951       62,093,570  
Working capital     24,463,446       33,060,877       48,647,185       53,598,854       52,704,076  
Total assets     61,166,006       81,309,705       91,098,765       109,310,480       115,022,956  
Current liabilities     6,864,685       7,282,509       7,696,638       8,500,097       9,389,493  
Total liabilities     6,864,685       7,282,509       7,696,638       8,503,506       9,404,880  
Equity     54,301,321       74,027,196       83,402,127       100,816,974       105,618,076  

 

B. Capitalization and Indebtedness

 

Not applicable.

 

C. Reasons for the Offer and Use of Proceeds

 

Not applicable.

 

D. Risk Factors

 

An investment in our capital stock involves a high degree of risk. You should carefully consider the risks described below, together with all of the other information included in this annual report, before making an investment decision. If any of the following risks actually occurs, our business, financial condition or results of operations could suffer. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment.

 

3

 

RISKS RELATED TO OUR BUSINESS

 

General economic conditions, including a prolonged weakness in the economy, may affect consumer discretionary spending, which could adversely affect our business and financial performance.

 

The apparel industry has historically been subject to substantial cyclical variations. Our business and financial performance are dependent on a number of factors impacting consumer discretionary spending, including general economic and business conditions; consumer confidence; wages and employment levels; the housing market; consumer debt levels; availability of consumer credit; credit and interest rates; fuel and energy costs; energy shortages; taxes; general political conditions, both domestic and abroad. Consumer product purchases, including purchases of our products, may decline during recessionary periods. Our ability to access the capital markets may be restricted at a time when we would like, or need, to raise capital, which could impair on our ability to open additional stores or build additional manufacturing lines. In addition, as domestic and international economic conditions change, trends in consumer spending on discretionary items, including our merchandise, become unpredictable and subject to reductions due to economic uncertainties. A prolonged economic recovery or an uncertain outlook in the economy could result in additional declines in consumer discretionary spending, which could materially affect our financial performance.

 

A contraction in apparel sales and production could impair our results of operations and liquidity and jeopardize our supply base.

 

Apparel sales and production are cyclical and depend, among other things, on general economic conditions and consumer spending and preferences. As the volume of apparel production fluctuates, the demand for our products also fluctuates. A contraction in apparel sales could harm our results of operations and liquidity. In addition, our suppliers would also be subject to many of the same consequences which could pressure their results of operations and liquidity. Depending on an individual supplier’s financial condition and access to capital, its viability could be challenged which could impact its ability to perform as we expect and consequently our ability to meet our own commitments.

 

If we are unable to anticipate consumer preferences and develop new menswear products, we may not be able to maintain or increase our net revenues and profits.

 

Our success depends on our ability to identify, originate and define apparel trends as well as to anticipate, gauge and react to changing consumer demands for menswear in a timely manner. Our target market of consumers comprises urban males between the ages of 20 and 40 with moderate-to-high levels of disposable income. Our business is particularly sensitive to their fashion preferences, which cannot be predicted with certainty. Our new products may not receive consumer acceptance as consumer preferences could shift rapidly, and our future success depends in part on our ability to anticipate and respond to these changes. If we fail to anticipate accurately and respond to trends and shifts in consumer preferences by adjusting the mix of existing product offerings, developing new products, designs, styles and categories, we could experience lower sales, excess inventories and lower profit margins. In a distressed economic and retail environment, many of our competitors may engage in aggressive activities, such as markdowns or other promotional sales to dispose of excess, slow-moving inventory, further increasing the need to react appropriately to changing consumer preferences and fashion trends. Failure to do so could adversely affect the level of acceptance of our products, our brand image and our relationship with our distributors, and therefore have a material adverse effect on our financial condition or results of operations.

  

The apparel industry is highly competitive, and if we fail to compete effectively, we could lose our market position.

 

The menswear industry is highly competitive in China and worldwide. We compete with various domestic brands with similar business models and target markets. We also compete with a growing number of international brands trying to expand their market share in China to take advantage of rising consumer spending on casual menswear. Our primary international and domestic competitors include Exceed, Xiniya, Cabbeen, GXG and NQ. Some of our competitors are significantly larger and have greater financial resources than we do. In order to compete effectively, we must: (1) maintain the image of our brands and our reputation for innovation and high quality; (2) be flexible and innovative in responding to rapidly changing market demands on the basis of brand image, style, performance and quality; and (3) offer consumers a wide variety of high quality products at competitive prices.

 

4

 

The purchasing decisions of consumers are highly subjective and can be influenced by many factors, such as brand image, marketing programs and product features. Some of our competitors enjoy competitive advantages, including greater brand recognition and greater financial resources for competitive activities, such as sales, marketing and strategic acquisitions. The number of our direct competitors and the intensity of competition may increase as we expand into other product lines or as other companies expand into our product lines. Our competitors may enter into business combinations or alliances that strengthen their competitive positions or prevent us from taking advantage of such combinations or alliances. Our competitors also may be able to respond more quickly and effectively than we can to new or changing opportunities, standards or consumer preferences. Our results of operations and market position may be adversely impacted by our competitors and the competitive pressures in the menswear industries.

 

Failure to effectively promote or develop our brand could materially and adversely affect our sales and profits.

 

We sell all our products under the KBS brand, from which we derive most of our revenues. Brand image is an important factor that affects a customer’s purchasing decision for menswear products. Our success therefore depends on, among other things, market recognition and acceptance of the KBS brand and the culture, lifestyle, and images associated with the brand, some of which may not be within our control. We have limited control over our distributors that we rely upon to sell our products, which may limit our ability to ensure a consistent brand image. See “Risks Factors Related to Our Business –We have limited control over the ultimate retail sales by our distributors and our image and business may be adversely affected if our distributors fail to adhere to, or fail to cause the third party retail outlet operators to adhere to, our retail policies and standards.” We began designing, promoting, and selling KBS branded products in China in 2006. To effectively promote KBS brand, we need build and maintain the brand image by focusing on a variety of promotional and marketing activities to promote brand awareness, as well as to increase its presence in the markets in which we compete. There is no assurance that we will be able to effectively promote or develop KBS brand, and if we fail to do so, the goodwill of KBS brand may be undermined and our business as well as our financial results may be adversely affected. In addition, negative publicity or disputes regarding KBS brand, products, company, or management could materially and adversely affect public perception of KBS brand. Any impact on our ability to continue to sell KBS brand or any significant damage to KBS brand’s image could materially and adversely affect our sales and profits.

 

Our business depends substantially on the continuing efforts of our senior executives and other key personnel, and our business may be severely disrupted if we lose their services.

 

Our future success heavily depends on the continued service of our senior executives and other key employees. In particular, we rely on the expertise, experience, and business contacts, of Mr. Keyan Yan, our Chairman and Chief Executive Officer, Ms. Lixia Tu, our Director and Chief Financial Officer and Mr. Themis Kalapotharakos, our director. If one or more of our senior executives are unable or unwilling to continue to work for us in their present positions, we may have to spend a considerable amount of time and resources searching, recruiting, and integrating the replacements into our operations, which would substantially divert management’s attention from and severely disrupt the Company business. This may also adversely affect our ability to execute our business strategy. Moreover, if any of our senior executives joins a competitor or forms a competing company, we may lose customers, suppliers and key employees.

 

Failure to execute our business expansion plan could adversely affect our financial condition and results of operations.

 

A large part of our initial growth resulted from an increase in the number of our retail sales outlets, including corporate and franchised stores, and the increased sales volume and profitability provided by these sales outlets. The number of our sales outlets increased from 8 in 2006 to 33 in year 2018.

 

5

 

We have our factory located in Taihu City in Anhui Province, China, consisting of an aggregate of 110,457 square meters of land. Currently the facility there has a production capacity of 2 million pieces of clothes per year and can accommodate 5,000 workers. This production facility mainly produces original equipment manufacturer (OEM) products for online stores, regional apparel brands and overseas orders. The construction commenced in 2011 and takes place in four phases: Phase 1 consists of the construction of a 5-story dormitory; Phase 2 is to add facilities with annual production capacity of five million pieces of clothes. We have completed the construction of facilities of Phase 1 and Phase 2 by the end of 2014. Phase 3 construction of the adjacent facility on the third parcel of land has been delayed because the local government needs additional time to conclude negotiations with local residents over appropriate resettlement terms. Because the time for the government to resolve this matter is uncertain, we wrote off the land use right of the third parcel of land from account balance, according to the international framework reporting standard. Phase 4 includes building production facilities with annual production capacity of 10 million pieces, an office building, staff quarters and living facilities on the third parcel of land. As a result, our commitments to this facility may reduce our liquidity for an indefinite period and until it is completed. We could also indefinitely lose opportunities to expand our sales due to any further delay of our construction.

 

The decision to increase our production capacity was based in part on our projections of market demand for our products and OEM orders from other brand name owners. If actual customer demand does not meet our projections, we will likely suffer overcapacity problems and may have to leave capacity idle or need to contract out our facilities at an unfavorable price, which may reduce our overall profitability and adversely affect our financial condition and results of operations. Our future success depends on our ability to expand the Company’s business to address growth in demand for our current and future products.

 

Our ability to expand the Company’s business is subject to significant risks and uncertainties, including:

 

the unavailability of additional funding to invest more in brand recognition such as advertisement, expand our production capacity, purchase additional fixed assets and purchase raw materials on favorable terms or at all;

 

our inability to manage an online shop, hire qualified personnel and establish distribution methods;

 

conditions in the commercial real estate market existing at the time we seek to expand;

 

delays and cost overruns as a result of a number of factors, many of which may be beyond our control, such as problems with equipment vendors and contract manufacturers;

 

failure to maintain high quality control standards;

 

shortage of raw materials;

 

our inability to obtain, or delays in obtaining, required approvals by relevant government authorities;

 

diversion of significant management attention and other resources; and

 

failure to execute our expansion plan effectively.

 

The expansion of our business may place significant strain on our personnel, management, financial systems and operational infrastructure and may impede our ability to meet any increased demand for our products. To accommodate the Company’s growth, we will need to implement a variety of new and upgraded operational and financial systems, procedures, and controls, including improvements to our accounting and other internal management systems, by dedicating additional resources to our reporting and accounting function and improvements to our record keeping and contract tracking system. We will also need to recruit more personnel and train and manage our growing employee base. Furthermore, we will need to maintain and expand relationships with our current and future customers, suppliers, distributors and other third parties, and there is no guarantee that we will succeed.

 

In the future, we also intend to invest more resources to research and purchase online sales platforms and online stores. We believe that we will have better opportunities to expand by purchasing online sales platforms or online stores. In addition, we will keep on exploring other areas and business models, such as the use of artificial intelligence for brand promotion, learning customer preferences, and identifying shopping trends.

 

If we encounter any of the risks described above or if we are otherwise unable to establish or successfully operate online shops or additional production capacity, we may be unable to grow our business and revenues, reduce our operating costs, maintain our competitiveness or improve our profitability and, consequently, our business, financial condition, results of operations and prospects will be adversely affected.

  

6

 

If we are unable to fund capital expenditures or obtain additional sources of liquidity when we need it, our business may be adversely affected. In addition, if we obtain equity financing, the issuance of our equity securities could cause dilution for our stockholders. To the extent we obtain the financing through the issuance of debt securities, our debt service obligations could increase, and we may become subject to restrictive operating and financial covenants.

 

We anticipate that we will make substantial capital investments to expand our business within the next 3 years. There is no assurance that we will have sufficient cash to fund our anticipated capital expenditures. If we need but are unable to obtain adequate financing with on terms favorable to us, we may be unable to successfully maintain our operations and accomplish our growth strategy. In addition, we may be unable to generate sufficient cash internally or obtain alternative sources of capital to fund our proposed capital expenditures, take advantage of business opportunities or respond to competitive pressures. As a result, we may seek to sell additional equity securities, debt securities, or borrow from lending institutions. Any issuance of equity securities could cause dilution for our stockholders. Any incurrence of indebtedness could increase our debt service obligations and cause us to be subject to restrictive operating and finance covenants. Our ability to obtain external financing in the future is also subject to a number of uncertainties, including:

 

Our future financial condition, results of operations and cash flows;

 

general market conditions for financing activities by companies in our industry;

 

economic, political and other conditions in China and elsewhere; and

 

uncertain economic prospect and tightened credit markets resulting from the recent global economic slowdown and financial market crisis.

 

If we are unable to obtain funding in a timely manner or on commercially acceptable terms, or at all, our growth prospects and future profitability may be materially adversely affected. Adverse changes in the capital markets could make it difficult to obtain capital or obtain it at attractive rates.

 

Our past results may not be indicative of our future performance and evaluating our business and prospects may be difficult.

 

Our business has gone through various stages of the business life cycle in recent years as demonstrated by our growth in net sales, which reached $99.6 million for the year ended December 31, 2013, while in 2014 our net sales decreased by 40% to $58.8 million and in year 2015 net sales went up slightly by 4.3% to $61.3 million, our net sales decreased by 32.8% to $41.2 million in 2016, net sales decreased 42% to $23.8 million in 2017 and net sales further decreased 22% to $18.53 million in 2018. The decrease in sales in 2016, 2017 and 2018 as compared with 2013 was mainly due to the slowdown of the Chinese economic growth and a challenging retail environment. As a result, we cannot assure that we will be able to achieve similar growth in future periods as recent years before 2014, and our historical operating results may not provide a meaningful basis for evaluating our business, financial performance and prospects. Moreover, our ability to achieve satisfactory production results at higher volumes is unproven. Therefore, you should not rely on our past results or our historical rate of growth as an indication of our future performance.

 

We experience fluctuations in operating results.

 

Our annual and quarterly operating results have fluctuated, and are expected to continue to fluctuate. Among the factors that may cause our operating results to fluctuate are customers’ response to merchandise offerings, the timing of the rollout of new sales outlets, seasonal variations in sales, the timing of merchandise receipts, the level of merchandise returns, changes in merchandise mix and presentation, our cost of merchandise, unanticipated operating costs, and other factors beyond our control, such as general economic conditions and actions of competitors.

  

We have historically experienced seasonal fluctuations in our sales. A substantial portion of our revenues are typically earned during the second and fourth quarters and we generally experience lowest revenues during the first and third quarters. If sales during the second and fourth quarters are lower than expected, our operating results would be adversely affected, and it would have a disproportionately large impact on our annual operating results. The sales of our products are also affected by local spending behavior, which are typically affected by seasonal shopping patterns during major Chinese holidays.

 

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As a result of these factors, we believe that period-to-period comparisons of historical and future results will not necessarily be meaningful and should not be relied on as an indication of future performance.

 

Our failure to collect the trade receivables or untimely collection could affect our liquidity.

 

Our distributors place advance purchase orders twice a year. From 2015 to 2018, we typically expect and receive payment within 30-180 days of product delivery. In addition, approximately 83.2% of accounts receivables are within a 180 days credit term. Starting in September 2015, we extended credit to some of our customers to 150-180 days without requiring collaterals. We perform ongoing credit evaluations of the financial condition of our customers and we generally require no collateral from our distributors and authorized retailers to secure their payment obligations. However, our sales going forward may rely more heavily on credit, and if we encounter future problems collecting amounts due from our clients or if we experience delays in the collection of amounts due from our clients, our liquidity could be negatively affected.

 

The Chinese economy experienced a softening of economic growth, and the apparel industry is also facing a downturn. The impact of the current and possible future economic downturn on our distributors cannot be predicted and may be severe, causing a significant impact on their business. As a result, our financial condition and result of operations could be negatively affected. In addition, if they cannot continue their orders of our products due to the failure of paying us for its previous purchases, our brand image and reputation may be materially negatively affected as well.

 

We rely on distributors for a substantial portion of our sales and the loss of any of our large distributors would harm our business. 

 

A substantial portion of our sales are made to distributors that resell our products. For the years ended December 31, 2017 and 2018, distributors accounted for approximately 67% and 73% of our total sales, respectively, and our top five distributors accounted for approximately 23.8% and 34.8% of our total sales, respectively. The marketing efforts of our distributors are critical for our success. If we fail to attract additional distributors, and our existing distributors do not promote our products at the same or at a greater level than the products of our competitors, our business, financial condition and results of operations could be adversely affected.

 

Furthermore, there is no assurance that any of our distributors will satisfy the sales targets set forth in their distribution agreements and we or they may not wish to renew the distribution agreements in future years. Moreover, our distributors are not obliged to continue to place orders with the Company at the same level as before or at all and there is no assurance that we would be able to obtain orders from other distributors to replace any such lost sales on terms satisfactory to us or all. If any of our largest distributors substantially reduces its purchases from us, or otherwise fails to renew its distribution agreement with us, we may suffer a significant loss of sales and our business, results of operations, and financial condition may be materially and adversely affected.

 

We have limited control over the ultimate retail sales by our distributors and our image and business may be adversely affected if our distributors fail to adhere to, or fail to cause the third party retail outlet operators to adhere to, our retail policies and standards.

 

We rely on the contractual obligations set forth in the distribution agreements that we enter into with our distributors, as well as policies and standards we formulate from time to time, to impose our retail policies on these distributors in respect of the franchisee retail outlets. In addition, as we do not enter into any agreements with the third party retail outlet operators, we rely on our distributors to ensure that these franchisee retail outlets operate in accordance with our retail policies. As such, our control over the ultimate retail sales by our distributors and the franchisee retail outlet operators is limited. There is no assurance that our distributors or the third party franchisee retail outlet operators will comply with, or that the distributors will enforce, our retail policies. As a result, we may not be able to effectively manage our sales network or maintain a uniform brand image, and cannot assure you that franchisee retail outlets would continue to offer quality services to consumers.

 

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In addition, if any of the distributors or third party franchisee retail outlet operators experiences difficulties in selling our products in the retail market, they may attempt to disregard our pricing policies and liquidate their excessive inventory buildup through aggressive discounts, which may damage the image and the value of our brand. There is no assurance that we will be able to, in a timely manner, impose penalties on or replace any distributors who consistently fail to comply with, or fail to cause the third party franchisee retail outlet operators appointed by them to comply with, our retail policies in their operation of franchisee retail outlets. In such event, our business, results of operations and financial condition may be materially and adversely affected.

 

We may not be able to accurately track the inventory levels at our distributors, retailers or department store concessions.

 

Our ability to track the sales by our distributors to third-party retailers and the ultimate retail sales by the retailers, and consequently their respective inventory levels, is limited. We implement a policy to require our distributors to provide us with their sales reports on a weekly basis and we carry out random on-site inspections of our distributors to track their inventories. The purpose of tracking the inventory level is mainly to gather information regarding the market acceptance of our products so that we can reflect consumers’ preferences in the design and development of our products for the next season. The tracking of inventory level also helps us to understand the market recognition of our products in a particular region, and thus allows us to adjust our marketing strategy if necessary. The implementation of the policy, however, requires the distributors to accurately report the relevant data to us in a timely manner, which is largely dependent on the cooperation of the Company’s distributors. We may not always obtain the required data in time and the data provided to us by our distributors may be inaccurate or incomplete.

 

Inaccurate, mistaken, incomplete or delayed data regarding inventory levels may mislead the Company to make wrong business judgments for its production, marketing efforts and sales strategies. If that happens, our operations and financial results may be materially adversely affected. In addition, if we cannot manage inventory levels properly, future orders of our products may be reduced, which would materially adversely affect our future business, financial condition, results of operation and prospects.

 

Our operations could be materially adversely affected if we fail to effectively manage our relationships with, or lose the services of, our OEM contract manufacturers.

 

The production of our brand name products are 100% outsourced to PRC-based third-party OEM contract manufacturers. In the years ended December 31, 2018 and 2017 we had 5 and 6 contract manufacturers, respectively. Purchases from our top five OEM contract manufacturers accounted for approximately 92% and 88.6% of our total purchases for the years ended December 31, 2018 and 2017, respectively. As we do not enter into long-term contracts with our OEM contract manufacturers, they may decide not to accept our future OEM orders on the same or similar terms, or at all. If an OEM contract manufacturer decides to substantially reduce its volume of supply to us or to terminate its business relationship with us, we may not be able to find a proper replacement in a timely manner and may be forced to default on the agreements with our distributors that sell our products. This may negatively impact our revenues and adversely affect our reputation and relationships with our distributors that sell our products, causing a material adverse effect on our financial condition, results of operations and prospects.

 

Further, if any of our OEM contract manufacturers fails to provide the required number of products meeting our quality standards, we may have to delay delivery of products to our distributors, become unable to supply products at all, or even recall products previously dispatched. This could cause the Company to lose revenues or market share and damage our reputation, any of which could have a material adverse effect on our business, financial condition, results of operations and prospects. In addition, some OEM contract manufacturers may not fully comply with certain laws, such as labor and environmental laws. If any of our OEM contract manufacturers is found to have violated laws and regulations in the PRC, media reports on such violations may negatively affect our reputation and image, resulting in material adverse impact on our business, financial condition and results of operations.

 

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While we provide the designs of our products to the OEM contract manufacturers, as well as guidance for manufacturing the products ordered by us, we do not have direct control over the OEM contract manufacturers. If any of them is involved in unauthorized production and sale of goods using the KBS brand, our reputation, financial condition and results of operations may be materially adversely affected.

 

As the Company grows, our reliance on OEM contract manufacturers may also grow as our added production capacity may not be sufficient to keep pace with the increased production requirements driven by our growth. We may not be able to find sufficient additional OEM contract manufacturers to produce our products on the same or similar terms as our existing OEM contract manufacturers, and we may not be able to achieve our growth and development goals.

 

Any interruption in our operations could impair our financial performance and negatively affect our brand. 

 

Our operations are complicated and integrated, involving the coordination of third-party OEM contract manufacturers and external distribution processes. While these operations are modified on a regular basis in an effort to improve outsourcing and distribution efficiency and flexibility, we may experience difficulties in coordinating the various aspects of our operations processes, thereby causing downtime and delays. In addition, we may encounter interruption in our operations processes due to a catastrophic loss or events beyond our control, such as fires, explosions, labor disturbances or violent weather conditions. Any interruptions in our operations or capabilities at our facilities could result in our inability to procure our products, which would reduce our net sales and earnings for the affected period. If there are delays in delivery times to our customers, our business and reputation could be severely affected. Any significant delays in deliveries to our customers could lead to increased returns or cancellations and cause the Company to lose future sales. The Company currently does not have business interruption insurance to offset these potential losses, delays and risks so a material interruption of our business operations could severely damage our business.

 

We rely heavily on our management information system for inventory management, distribution and other functions. If our system fail to perform these functions adequately or if we experience an interruption in our operation, our business and results of operations could be materially adversely affected. 

 

The efficient operation of our business is dependent on our management information systems. We rely heavily on our management information systems to manage our order entry, order fulfillment, pricing, point-of-sale and inventory replenishment processes. 

 

We cannot assure you that our management information system will operate properly or without interruption. Any malfunction to any part or all of our management information system for a prolonged period may cause delays in operations or impairment of our overall business efficiency. We also cannot ensure that the level of security currently maintained will be sufficient to protect the system from third party intrusions, viruses, lost or stolen data, or similar situations. Additionally, as part of our growth and development strategy over the next few years, we plan to upgrade and improve our management information system. We cannot assure you that there will be no interruptions to our management information system during the upgrades or that the new management information system will be able to integrate fully with the existing information system. 

 

The failure of our management information system to perform as we anticipate could disrupt our business and could result in decreased revenue, increased overhead costs and excess or out-of-stock inventory levels, causing our business and results of operations to suffer materially. 

 

Failure to protect the integrity, security and use of our customers’ information and media could expose us to litigation and materially damage our standing with our customers. 

 

Increasing costs associated with information security — such as increased investment in technology, the costs of compliance with consumer protection laws and costs resulting from consumer fraud — could cause our business and results of operations to suffer materially. While we have taken significant steps to protect customer and confidential information, including entering into confidentiality agreements with relevant employees and incorporate confidentiality clauses in our policies, there can be no assurance that advances in computer capabilities, new discoveries in the field of cryptography or other developments will prevent the compromise of our customer transaction processing capabilities and personal data. If any such compromise of our security were to occur, it could have a material adverse effect on our reputation, operating results and financial condition. Any such compromise may materially increase the costs we incur to protect against such information security breaches and could subject us to additional legal risk. Procurement specialists and managers are required to sign a confidentiality agreement. 

 

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We have limited insurance coverage in China and may not be able to recover insurance proceeds if we experience uninsured losses. 

 

Operation of our facilities involves many risks, including equipment failures, natural disasters, industrial accidents, power outages, labor disturbances and other business interruptions. We do not carry any business interruption insurance, product recall or third-party liability insurance for our production facilities or with respect to our products to cover claims pertaining to personal injury or property or environmental damage arising from defects in our products, product recalls, accidents on our property or damage relating to our operations. While business interruption insurance and other types of insurance are available to a limited extent in China, we have determined that the risks of interruption, cost of such insurance and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to have such insurance. Therefore, our existing insurance coverage may not be sufficient to cover all risks associated with our business. As a result, we may be required to pay for financial and other losses, damages and liabilities, including those caused by natural disasters and other events beyond our control, out of our own funds, which could have a material adverse effect on our business, financial condition and results of operations. 

 

Our inability to protect our trademarks and other intellectual property rights may prevent us from successfully marketing our products and competing effectively. 

 

We believe our trademarks and other intellectual property rights are important to our success and competitive position and recognize the importance of registering the trademarks related to our KBS brand for protection against infringement. We currently hold two registered trademarks. Failure to protect our intellectual property could harm our brand and our reputation, and adversely affect our ability to compete effectively. Further, enforcing or defending our intellectual property rights, including our trademarks, patents, copyrights and trade secrets, could result in the expenditure of significant financial and managerial resources. We produce, market and sell our products under registered trademarks. We regard our intellectual property, particularly our trademarks and trade secrets to be of considerable value and importance to our business and our success. We rely on a combination of trademark, patent, and trade secrecy laws, and contractual provisions to protect our intellectual property rights. There can be no assurance that the steps taken by us to protect these proprietary rights will be adequate or that third parties will not infringe or misappropriate our trademarks, trade secrets or similar proprietary rights. In addition, there can be no assurance that other parties will not assert infringement claims against us, and we may have to pursue litigation against other parties to assert our rights. Any such claim or litigation could be costly, and we may lack the resources required to defend against such claims. In addition, any event that would jeopardize our proprietary rights or any claims of infringement by third parties could have a material adverse effect on our ability to market or sell our brands, and profitably exploit our products.

 

Environmental regulations impose substantial costs and limitations on our operations. 

 

We use chemicals and produce significant emissions in our manufacturing operations. As such, we are subject to various national and local environmental laws and regulations in China concerning issues such as air emissions, wastewater discharges, and solid waste management and disposal. These laws and regulations can restrict or limit our operations and expose us to liability and penalties for non-compliance. While we believe that our facilities are in material compliance with all applicable environmental laws and regulations, the risks of substantial unanticipated costs and liabilities related to compliance with these laws and regulations are an inherent part of our business. It is possible that future conditions may develop, arise or be discovered that create new environmental compliance or remediation liabilities and costs. While we believe that we can comply with existing environmental legislation and regulatory requirements and that the costs of compliance have been included within budgeted cost estimates, compliance may prove to be more limiting and costly than anticipated.

 

We may be unable to establish and maintain an effective system of internal control over financial reporting, and, as a result, we may be unable to accurately report our financial results or prevent fraud.

 

We are subject to reporting obligations under the U.S. securities law. The SEC as required by Section 404 of the Sarbanes-Oxley Act of 2002 (“SOX 404”), adopted rules requiring every public company to include a management report on such company’s internal control over financial reporting in its annual report, which must also contain management’s assessment of the effectiveness of the company’s internal control over financial reporting. In addition, the independent registered public accounting firm auditing the financial statements of a company that is not a non-accelerated filer under Rule 12b-2 of the Exchange Act must also attest to the operating effectiveness of the company’s internal controls.

 

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Failure to achieve and maintain an effective internal control environment could result in our inability to accurately report our financial results, prevent or detect fraud or provide timely and reliable financial and other information pursuant to the reporting obligations we have as a public company, which could have a material adverse effect on our business, financial condition and results of operations. Further, it could cause our investors to lose confidence in the information we report, which could adversely affect our stock price.

 

RISKS RELATED TO DOING BUSINESS IN CHINA

 

Our business operation may be affected if we are forced to relocate our manufacturing facilities and stores.

 

We leased the premises for our office located in Shishi and one corporate store. However, none of our lease agreements have been registered with the relevant governmental agencies. According to our PRC legal counsel, without registration, our rights to use and occupy the premises may not be secured if any third parties such as other tenants who have registered their lease agreements challenge us under PRC law. Moreover, while we have taken various measures to verify the ownership of property such as checking utility bills and search government records, most of our landlords have declined to confirm whether they possess the property ownership certificates and land use rights certificates for our properties. As a result, we have been unable to verify whether third parties may assert their ownership rights under PRC law against most of our landlords or challenge most of our leases in the future. If our rights to use the premises are challenged, we may be forced to relocate to other premises. We may not be able to relocate to a suitable premise promptly or lease alternative premises on terms at least as favorable as our existing ones. In addition, relocation costs and interruption of production may have a material adverse effect on our business operation and financial performance.

 

Changes in the economic and political policies of the PRC government could have a material and adverse effect on our business and operations.

 

We conduct substantially all our business operations in China. Accordingly, our results of operations, financial condition and prospects are significantly dependent on economic and political developments in China. China’s economy differs from the economies of developed countries in many aspects, including the level of development, growth rate and degree of government control over foreign exchange and allocation of resources. While China’s economy has experienced significant growth in the past 30 years, the growth has been uneven across different regions and periods and among various economic sectors in China. We cannot assure you that China’s economy will continue to grow, or that if there is growth, such growth will be steady and uniform, or that if there is a slowdown, such slowdown will not have a negative effect on its business and results of operations.

 

The PRC government exercises significant control over China’s economic growth through the allocation of resources, control over payment of foreign currency-denominated obligations, implementation of monetary policy, and preferential treatment of particular industries or companies. Certain measures adopted by the PRC government may restrict loans to certain industries, such as changes in the statutory deposit reserve ratio and lending guidelines for commercial banks by the People’s Bank of China, or PBOC. These current and future government actions could materially affect our liquidity, access to capital, and ability to operate our business.

 

The global financial markets experienced significant disruptions in 2008 and the United States, Europe and other economies went into recession. Since 2012, growth of the Chinese economy has slowed. The PRC government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures may benefit the overall PRC economy but may also have a negative effect on us. Our financial condition and results of operation could be materially and adversely affected by government control over capital investments or changes in tax regulations that are applicable to us. In addition, any stimulus measures designed to boost the Chinese economy, may contribute to higher inflation, which could adversely affect our results of operations and financial condition. See “Risks Related to Doing Business in China -Future inflation in China may inhibit our ability to conduct business in China.”

 

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Uncertainties with respect to the PRC legal system could limit the legal protections available to you and us.

 

We conduct substantially all of our business through our operating subsidiaries in the PRC. Our operating subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to foreign-invested enterprises. The PRC legal system is based on written statutes, and prior court decisions may be cited for reference but have limited precedential value. Since 1979, a series of new PRC laws and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since the PRC legal system continues to evolve rapidly, the interpretations of many laws, regulations, and rules are not always uniform, and enforcement of these laws, regulations, and rules involve uncertainties, which may limit legal protections available to you and us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. In addition, most of our executive officers and directors are residents of China and not of the United States, and substantially all the assets of these persons are located outside the United States. As a result, it could be difficult for investors to affect service of process in the United States or to enforce a judgment obtained in the United States against our Chinese operations and subsidiaries.

 

You may have difficulty enforcing judgments against us.

 

Most of our assets are located outside of the United States and most of our current operations are conducted in the PRC. In addition, most of our directors and officers are nationals and residents of countries other than the United States. A substantial portion of the assets of these persons is located outside the United States. As a result, it may be difficult for you to effect service of process within the United States upon these persons. It may also be difficult for you to enforce in U.S. courts judgments on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors, most of whom are not residents in the United States and the substantial majority of whose assets are located outside of the United States. In addition, there is uncertainty as to whether the courts of the PRC would recognize or enforce judgments of U.S. courts. Our counsel as to PRC law has advised us that the recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedures Law. Courts in China may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based on treaties between China and the country where the judgment is made or on reciprocity between jurisdictions. China does not have any treaties or other arrangements that provide for the reciprocal recognition and enforcement of foreign judgments with the United States. In addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates basic principles of PRC law or national sovereignty, security, or the public interest. So, it is uncertain whether a PRC court would enforce a judgment rendered by a court in the United States.

 

The PRC government exerts substantial influence over the manner in which we must conduct our business activities.

 

The PRC government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property, and other matters. We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of the jurisdictions in which we operate may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations.

 

Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures

 

Restrictions on currency exchange may limit our ability to receive and use our sales effectively. 

 

The majority of our sales will be settled in RMB and U.S. dollars, and any future restrictions on currency exchanges may limit our ability to use revenue generated in RMB to fund any future business activities outside China or to make dividend or other payments in U.S. dollars. Although the Chinese government introduced regulations in 1996 to allow greater convertibility of the RMB for current account transactions, significant restrictions still remain, including primarily the restriction that foreign-invested enterprises may only buy, sell or remit foreign currencies after providing valid commercial documents, at those banks in China authorized to conduct foreign exchange business. In addition, conversion of RMB for capital account items, including direct investment and loans, is subject to governmental approval in China, and companies are required to open and maintain separate foreign exchange accounts for capital account items. We cannot be certain that the Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of the RMB in the future.

 

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

 

The value of our securities will be indirectly affected by the foreign exchange rate between the U.S. dollar and RMB and between those currencies and other currencies in which our sales may be denominated. Appreciation or depreciation in the value of the RMB 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 any dividend we issue that will be exchanged into U.S. dollars, as well as earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.

 

Since July 2005, the RMB has no longer been pegged to the U.S. dollar. Since then the RMB has fluctuated against the U.S. dollar, at times significantly and unpredictably, and in recent years the RMB has depreciated significantly 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 there is no guarantee that the RMB 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 RMB and the U.S. dollar in the future.

 

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

 

Restrictions under PRC law on our PRC subsidiaries’ ability to make dividends and other distributions could materially and adversely affect our ability to grow, make investments or acquisitions that could benefit our business, pay dividends to you, and otherwise fund and conduct our business. 

 

Substantially all of our sales are earned by our PRC subsidiaries. However, PRC regulations restrict the ability of our PRC subsidiaries to make dividends and other payments to their offshore parent companies. PRC legal restrictions permit payments of dividends by our PRC subsidiaries only out of their accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations. Our PRC subsidiaries are also required under PRC laws and regulations to allocate at least 10% of their annual after-tax profits determined in accordance with PRC GAAP to a statutory general reserve fund until the amounts in said fund reaches 50% of their registered capital. Allocations to these statutory reserve funds can only be used for specific purposes and are not transferable to us in the form of loans, advances, or cash dividends. Any limitations on the ability of our PRC subsidiaries to transfer funds to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.

 

PRC regulations relating to investments in offshore 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 or limit our PRC subsidiary’s ability to increase their registered capital or distribute profits.

 

SAFE promulgated the Circular on Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Offshore Investment and Financing and Roundtrip Investment through Special Purpose Vehicles, or SAFE Circular 37, on July 4, 2014, which replaced the former circular commonly known as “SAFE Circular 75” promulgated by SAFE on October 21, 2005. SAFE Circular 37 requires PRC residents to register with local branches of the SAFE in connection with their direct establishment or indirect control of an offshore entity, for the purpose of overseas investment and financing, with such PRC residents’ legally owned assets or equity interests in domestic enterprises or offshore assets or interests, referred to in SAFE Circular 37 as a “special purpose vehicle.” SAFE Circular 37 further requires amendment to the registration in the event of any significant changes with respect to the special purpose vehicle, such as increase or decrease of capital contributed by PRC individuals, share transfer or exchange, merger, division or other material event. In the event that a PRC shareholder holding interests in a special purpose vehicle fails to fulfill the required SAFE registration, the PRC subsidiaries of that special purpose vehicle may be prohibited from making profit distributions to the offshore parent and from carrying out subsequent cross-border foreign exchange activities, and the special purpose vehicle may be restricted in its ability to contribute additional capital into its PRC subsidiary. Moreover, failure to comply with the various SAFE registration requirements described above could result in liability under PRC law for evasion of foreign exchange controls. According to the Notice on Further Simplifying and Improving Policies for the Foreign Exchange Administration of Direct Investment released on February 13, 2015 by SAFE, local banks will examine and handle foreign exchange registration for overseas direct investment, including the initial foreign exchange registration and amendment registration, under SAFE Circular 37 from June 1, 2015.

 

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According to SAFE Circular 37, our shareholders or beneficial owners, who are PRC residents, are subject to SAFE Circular 37 or other foreign exchange administrative regulations in respect of their investment in our company. We have notified substantial beneficial owners of ordinary shares who we know are PRC residents of their filing obligations. Nevertheless, we may not be aware of the identities of all of our beneficial owners who are PRC residents. We do not have control over our beneficial owners and there can be no assurance that all of our PRC-resident beneficial owners will comply with SAFE Circular 37 and subsequent implementation rules, and there is no assurance that the registration under SAFE Circular 37 and any amendment will be completed in a timely manner, or will be completed at all. The failure of our beneficial owners who are PRC residents to register or amend their foreign exchange registrations in a timely manner pursuant to SAFE Circular 37 and subsequent implementation rules, or the failure of future beneficial owners of our company who are PRC residents to comply with the registration procedures set forth in SAFE Circular 37 and subsequent implementation rules, may subject such beneficial owners or our PRC subsidiary to fines and legal sanctions. Such failure to register or comply with relevant requirements may also limit our ability to contribute additional capital to our PRC subsidiary and limit our PRC subsidiary’s ability to distribute dividends to our company. These risks may have a material adverse effect on our business, financial condition and results of operations.

 

Furthermore, SAFE Circular 37 is unclear how this regulation, and any future regulation concerning offshore or cross-border transactions, will be interpreted, amended and implemented by the relevant PRC government authorities, and we cannot predict how these regulations will affect our business operations or future strategy. Failure to register or comply with relevant requirements may also limit our ability to contribute additional capital to our PRC subsidiaries and limit our PRC subsidiaries’ ability to distribute dividends to us. These risks could in the future have a material adverse effect on our business, financial condition and results of operations.

 

We may be unable to complete a business combination transaction efficiently or on favorable terms due to complicated merger and acquisition regulations which became effective on September 8, 2006.

 

On August 9, 2006, six PRC regulatory agencies, including the China Securities Regulatory Commission, promulgated the Regulation on Mergers and Acquisitions of Domestic Companies by Foreign Investors, which became effective on September 8, 2006, and was subsequently amended in 2009. This regulation, among other things, governs the approval process of a PRC company’s participation in an acquisition of assets or equity interests. Depending on the structure of the transaction, the regulation requires the PRC parties to make a series of applications and supplemental applications to the government agencies for approval of acquisition of assets or equity interests from other entity. In some instances, the application process may require a presentation of economic data concerning the transaction, including appraisals of the target business and evaluations of the acquirer, which are designed to allow the government to assess viability of the transaction. Government approvals will have expiration dates, by which a transaction must be completed and reported to the government agencies. Compliance with the regulation is likely to be more time consuming and expensive than it was in the past, and provides the government more controls over business combination of two enterprises. As a result, our ability to engage in business combination transactions has become significantly more complicated, time consuming, and expensive. We may not be able to negotiate a transaction that is acceptable to our stockholders or sufficiently protect their interests in a transaction.

 

The regulation allows PRC governmental agencies to assess the economic terms of a business combination transaction. Parties to a business combination transaction may have to submit to MOFCOM and other relevant government agencies an appraisal report, an evaluation report, and the acquisition agreement, all of which were a part of the application for approval, depending on the structure of the transaction. The regulation also prohibits a transaction with an acquisition price obviously lower than the appraised value of the PRC business or assets and in certain transaction structures, and requires consideration being paid within a defined period, generally not in excess of a year. The regulation also limits our ability to negotiate various terms of the acquisition, including the initial consideration, contingent consideration, holdback provisions, indemnification provisions, and provisions related to the assumption and allocation of assets and liabilities. Transaction structures involving trusts, nominees and similar entities are prohibited. Therefore, such regulation may impede our ability to negotiate and complete a business combination transaction on financial terms that satisfy our investors and protect our stockholders’ economic interests.

 

15

 

PRC regulation of loans to, and direct investment in, PRC entities by offshore holding companies and governmental control of currency conversion may restrict or prevent us from using the proceeds of our future financings to make loans to our PRC subsidiaries, or to make additional capital contributions to our PRC subsidiary.

 

We, as an offshore holding company, are permitted under PRC laws and regulations to provide funding to our PRC subsidiary, which are treated as foreign-invested enterprises under PRC laws, through loans or capital contributions. However, loans by us to any PRC subsidiary to finance its activities cannot exceed statutory limits and must be registered with the local counterpart of SAFE and capital contributions to our PRC subsidiary are subject to the requirement of making necessary filings in the Foreign Investment Comprehensive Management Information System, and registration with other governmental authorities in China.

 

SAFE promulgated the Notice of the State Administration of Foreign Exchange on Reforming the Administration of Foreign Exchange Settlement of Capital of Foreign-invested Enterprises, or Circular 19, effective on June 1, 2015, in replacement of the Circular on the Relevant Operating Issues Concerning the Improvement of the Administration of the Payment and Settlement of Foreign Currency Capital of Foreign- Invested Enterprises, or Circular 142, the Notice from the State Administration of Foreign Exchange on Relevant Issues Concerning Strengthening the Administration of Foreign Exchange Businesses, or Circular 59, and the Circular on Further Clarification and Regulation of the Issues Concerning the Administration of Certain Capital Account Foreign Exchange Businesses, or Circular 45. According to Circular 19, the flow and use of the RMB capital converted from foreign currency-denominated registered capital of a foreign-invested company is regulated such that RMB capital may not be used for the issuance of RMB entrusted loans, the repayment of inter-enterprise loans or the repayment of bank loans that have been transferred to a third party. Although Circular 19 allows RMB capital converted from foreign currency-denominated registered capital of a foreign invested enterprise to be used for equity investments within the PRC, it also reiterates the principle that RMB converted from the foreign currency-denominated capital of a foreign-invested company may not be directly or indirectly used for purposes beyond its business scope. Thus, it is unclear whether SAFE will permit such capital to be used for equity investments in the PRC in actual practice. SAFE promulgated the Notice of the State Administration of Foreign Exchange on Reforming and Standardizing the Foreign Exchange Settlement Management Policy of Capital Account, or Circular 16, effective on June 9, 2016, which reiterates some of the rules set forth in Circular 19, but changes the prohibition against using RMB capital converted from foreign currency-denominated registered capital of a foreign-invested company to issue RMB entrusted loans to a prohibition against using such capital to grant loans to non-associated enterprises. Violations of SAFE Circular 19 and Circular 16 could result in administrative penalties. Circular 19 and Circular 16 may significantly limit our ability to transfer any foreign currency we hold, including the net proceeds from our future financings, to our PRC subsidiary, which may adversely affect our liquidity and our ability to fund and expand our business in the PRC.

 

Due to the restrictions imposed on loans in foreign currencies extended to any PRC domestic companies, we are not likely to make such loans to any of our PRC subsidiaries. Meanwhile, we are not likely to finance the activities of our subsidiaries by means of capital contributions given the restrictions on foreign investment in the businesses that are currently conducted by our subsidiaries.

 

In light of the various requirements imposed by PRC regulations on loans to, and direct investment in, PRC entities by offshore holding companies, we cannot assure you that we will be able to complete the necessary government registrations or obtain the necessary government approvals on a timely basis, if at all, with respect to future loans to our PRC subsidiary or any consolidated variable interest entity or future capital contributions by us to our PRC subsidiary. As a result, uncertainties exist as to our ability to provide prompt financial support to our PRC subsidiaries when needed. If we fail to complete such registrations or obtain such approvals, our ability to use foreign currency, including the proceeds we received from our future financings, 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.

 

16

 

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

 

Pursuant to SAFE Circular 37, PRC residents who participate in share incentive plans in overseas non-publicly-listed companies may submit applications to SAFE or its local branches for the foreign exchange registration with respect to offshore special purpose companies. In the meantime, our directors, executive officers and other employees who are PRC citizens or who are non-PRC residents residing in the PRC for a continuous period of not less than one year, subject to limited exceptions, and who have been granted restricted shares, options or restricted share units, or RSUs, by us or our overseas listed subsidiaries may follow the Notice on Issues Concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly Listed Company, issued by SAFE in February 2012, to apply for the foreign exchange registration. According to those regulations, employees, directors and other management members participating in any stock incentive plan of an overseas publicly listed company who are PRC citizens or who are non-PRC citizens residing in China for a continuous period of not less than one year, subject to limited exceptions, are required to register with SAFE through a domestic qualified agent, which may be a PRC subsidiary of the overseas listed company, and complete certain other procedures. Failure to complete the SAFE registrations may subject them to fines and legal sanctions and may also limit their ability to make payment under the relevant equity incentive plans or receive dividends or sales proceeds related thereto in foreign currencies, or our ability to contribute additional capital into our domestic subsidiaries in China and limit our domestic subsidiaries’ ability to distribute dividends to us. We also face regulatory uncertainties under PRC law that could restrict our ability or the ability of our overseas listed subsidiaries to adopt additional equity incentive plans for our directors and employees who are PRC citizens or who are non-PRC residents residing in the PRC for a continuous period of not less than one year, subject to limited exceptions.

 

In addition, the State Administration of Taxation has issued circulars concerning employee share options, restricted shares or RSUs. Under these circulars, employees working in the PRC who exercise share options, or whose restricted shares or RSUs vest, will be subject to PRC individual income tax. The PRC subsidiaries of an overseas listed company have obligations to file documents related to employee share options or restricted shares with relevant tax authorities and to withhold individual income taxes of those employees related to their share options, restricted shares or RSUs. If the employees fail to pay, or the PRC subsidiaries fail to withhold, their income taxes according to relevant laws, rules and regulations, the PRC subsidiaries may face sanctions imposed by the tax authorities.

 

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

 

On March 16, 2007, the National People’s Congress of China passed a new Enterprise Income Tax Law, or the EIT Law. On November 28, 2007, the State Council of China passed its implementing rules, which took effect on January 1, 2008. Under the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. The implementing rules of the EIT Law define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise.

 

On April 22, 2009, the State Administration of Taxation issued the Notice Concerning Relevant Issues Regarding Cognizance of Chinese Investment Controlled Enterprises Incorporated Offshore as Resident Enterprises. According to the Criteria of de facto Management Bodies, or the Notice, further interprets the application of the EIT Law and its implementation non-Chinese enterprise or group controlled offshore entities. Pursuant to the Notice, an enterprise incorporated in an offshore jurisdiction and controlled by a Chinese enterprise or group will be classified as a “non-domestically incorporated resident enterprise” if (i) its senior management in charge of daily operations reside or perform their duties mainly in China; (ii) its financial or personnel decisions are made or approved by bodies or persons in China; (iii) its substantial assets and properties, accounting books, corporate chops, board and shareholder minutes are kept in China; and (iv) at least half of its directors with voting rights or senior management often resident in China. A resident enterprise would be subject to an enterprise income tax rate of 25% on its worldwide income and must pay a withholding tax at a rate of 10%, when paying dividends to its non-PRC shareholders. However, it remains unclear as to whether the Notice is applicable to an offshore enterprise incorporated by a Chinese natural person, nor detailed measures on imposition of tax from non-domestically incorporated resident enterprises are available. Therefore, it is unclear how tax authorities will determine tax residency based on the facts of each case.

 

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We may be deemed to be a resident enterprise by Chinese tax authorities. If the PRC tax authorities determine that we are a “resident enterprise” for the PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. In our case, this would mean that income such as interest on financing proceeds and non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second, although, under the EIT Law and its implementing rules, dividends paid to us from our PRC subsidiaries would qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued a guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for the PRC enterprise income tax purposes. Finally, it is possible that future guidance issued with respect to the new “resident enterprise” classification could result in a situation, which a 10% withholding tax is imposed on dividends we pay to our non-PRC shareholders and with respect to gains derived by our non-PRC stockholders from transferring our shares.

 

Our failure to fully comply with PRC laws relating to social insurance and housing accumulation fund may expose it to potential administrative penalties.  

 

The PRC laws and regulations require all employers in China to fully contribute their own portion to the social insurance and housing accumulation funds for their employees within a certain period of time. Failure to do so may expose the employers to make rectification for the unpaid contributions by the relevant labor authority. 

 

As of the date of this report, Hongri PRC has not paid housing accumulation funds for its employees. In addition, Hongri PRC failed to make contributions to the social insurance in full amount for its employees before 2014. PRC governmental authorities may impose penalties on Hongri PRC for failure to comply. In addition, in the event that any current or former employee files a complaint with the PRC government, Hongri PRC may be subject to making up the contributions to the social insurance and housing accumulation funds as well as paying administrative fines. The total cost of these contributions and any related fines or penalties could be significant and could have a material adverse effect on our working capital. 

 

We may be exposed to liabilities under the Foreign Corrupt Practices Act and Chinese anti-corruption laws, and any determination that we violated these laws could have a material adverse effect on our business. 

 

We are subject to the Foreign Corrupt Practice Act, or FCPA, and other laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. persons and issuers as defined by the statute, for the purpose of obtaining or retaining business. We have operations, agreements with third parties, and make most of our sales in China. The PRC also strictly prohibits bribery of government officials. Our activities in China create the risk of unauthorized payments or offers of payments by the employees, consultants, sales agents, or distributors of our Company, even though they may not always be subject to our control. It is our policy to implement safeguards to discourage these practices by our employees. However, our existing safeguards and any future improvements may prove to be less than effective, and the employees, consultants, sales agents, or distributors of our Company may engage in conduct for which we might be held responsible. Violations of the FCPA or Chinese anti-corruption laws may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could negatively affect our business, operating results and financial condition. In addition, the U.S. government may seek to hold our Company liable for successor liability FCPA violations committed by companies in which we invest or that we acquire. 

 

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

 

In the past few years, U.S. publicly traded companies that have substantially all of their operations in China, particularly companies like us have been the subject of intense scrutiny, criticism, and negative publicity by investors, financial commentators, and regulatory agencies, such as the SEC. Much of the scrutiny, criticism, and negative publicity has centered around financial and accounting irregularities and mistakes, lacking effective internal controls over financial accounting, inadequate corporate governance policies or lacking of adherence thereto and, in many cases, allegations of fraud. As a result of the scrutiny, criticism, and negative publicity, the publicly traded stocks of many U.S. listed Chinese companies have sharply decreased in value and, in some cases, have become virtually worthless. Many of these companies are now subject to shareholder lawsuits and SEC enforcement actions, and are conducting internal and external investigations into the allegations. It is not clear the effect of this sector-wide scrutiny, criticism, and negative publicity will have on our Company, our business, and our stock price. If we become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, we will have to expend significant resources to investigate such allegations defending our Company. This situation will be costly, time consuming, and distract our management from growing our company.

 

18

 

The disclosures in our reports and other filings with the SEC and our other public pronouncements will not be subject to the scrutiny of any regulatory bodies in the PRC. Accordingly, our public disclosure should be reviewed in light of the fact that no governmental agency that is located in China where all of our operations and business are located have conducted any due diligence on our operations or reviewed or cleared any of our disclosure. 

 

Unlike public reporting companies whose operations are located primarily in the United States, however, all of our operations will be located in China. Since all of our operations and business takes place in China, it may be more difficult for the Staff of the SEC to overcome the geographic and cultural obstacles that are present when reviewing our disclosure. These same obstacles are not present for similar companies whose operations or business take place entirely or primarily in the United States. Furthermore, our SEC reports and other disclosure and public pronouncements are not subject to the review or scrutiny of any PRC regulatory authority. For example, the disclosure in our SEC reports and other filings are not subject to the review of the CSRC, a PRC regulator that is tasked with oversight of the capital markets in China. Accordingly, you should review our SEC reports, filings and our other public pronouncements with the understanding that no local regulator has done any due diligence on our company and with the understanding that none of our SEC reports, other filings or any of our other public pronouncements has been reviewed or otherwise been scrutinized by any local regulator. 

 

Proceedings instituted by the SEC against five PRC-based accounting firms could result in financial statements being determined to be not in compliance with the requirements of the Securities Exchange Act of 1934.

 

In December 2012, the SEC instituted proceedings under Rule 102(e)(1)(iii) of the SEC’s Rules of Practice against five PRC-based accounting firms alleging that these firms had violated U.S. securities laws and the SEC’s rules and regulations thereunder by failing to provide to the SEC the firms’ work papers related to their audits of certain PRC-based companies that are publicly traded in the United States. Rule 102(e)(1)(iii) grants to the SEC the authority to deny to any person, temporarily or permanently, the ability to practice before the SEC who is found by the SEC, after notice and opportunity for a hearing, to have willfully violated, or willfully aided and abetted the violation of, any such laws or rules and regulations. On January 22, 2014, an initial administrative law decision was issued, sanctioning four of these accounting firms and suspending them from practicing before the SEC for a period of six months. The sanction will not take effect until there is an order of effectiveness issued by the SEC. In February 2014, four of these PRC-based accounting firms filed a petition for review of the initial decision.  In February 2015, each of these four accounting firms agreed to a censure and to pay fine to the SEC to settle the dispute with the SEC. The settlement stays the current proceeding for four years, during which time the firms are required to follow detailed procedures to seek to provide the SEC with access to Chinese firms’ audit documents via the CSRC. If a firm does not follow the procedures, the SEC would impose penalties such as suspensions, or commence a new, expedited administrative proceeding against the non-compliant firm or it could restart the administrative proceeding against all four firms.

 

If our independent registered public accounting firm were denied, temporarily or permanently, the ability to practice before the SEC, and we are unable to find in a timely manner another registered public accounting firm which can audit and issue a report on our financial statements, our financial statements could be determined to not be in compliance with the requirements for financial statements of public companies with a class of securities registered under the Securities Exchange Act of 1934, as amended, or the Exchange Act. Such a determination could ultimately lead to the SEC’s revocation of the registration of our common stock under the Exchange Act, which would cause the immediate delisting of our common stock from the NASDAQ Capital Market, and the effective termination of the trading market for our common stock in the United States, which would likely have a significant adverse effect on the value of our common stock.

 

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Our holding company structure may limit the payment of dividends.

 

We have no direct business operations, other than our ownership of our subsidiaries. While we have no current intention of paying dividends, should we decide in the future to do so, as a holding company, our ability to pay dividends and meet other obligations depend upon the receipts of dividends or other payments from our operating subsidiaries, other holdings, and investments. In addition, our operating subsidiaries, from time to time, may be subject to restrictions on their ability to make distributions to us, including as a result of restrictive covenants in loan agreements, restrictions on the conversion of local currency into U.S. dollars or other hard currency, and other regulatory restrictions as discussed below. If future dividends are paid in RMB, fluctuations in the exchange rate for conversion of RMB into U.S. dollars may reduce the amount received by the U.S. stockholders upon conversion of dividend payments into U.S. dollars.

 

Chinese regulations currently permit the payment of dividends only out of accumulated profits as determined in accordance with Chinese accounting standards and regulations. Our subsidiaries in China are also required to set aside a portion of their after-tax profits to fund certain reserve funds according to the Chinese accounting standards and regulations. Currently, our subsidiaries in China are the only sources of revenues or investment holdings for the payment of dividends. If they do not accumulate sufficient profits under Chinese accounting standards and regulations to satisfy certain reserve funds as required by the Chinese accounting standards, we will be unable to pay any dividends.

 

After-tax profits/losses with respect to the payment of dividends from accumulated profits and the annual appropriation of after-tax profits as calculated pursuant to the Chinese accounting standards and regulations do not result in significant differences as compared to after-tax earnings as presented in our financial statements. However, there are certain differences between PRC accounting standards and regulations and U.S. GAAP, arising from different treatment of items such as amortization of intangible assets and change in fair value of contingent consideration rising from business combinations.

 

RISKS RELATED TO THIS OFFERING AND THE MARKET FOR OUR SECURITIES GENERALLY

 

If we fail to comply with the continued listing requirements of NASDAQ, we would face possible delisting, which would result in a limited public market for our shares and make obtaining future debt or equity financing more difficult for us.

 

Our common stock is traded and listed on the Nasdaq Capital Market under the symbol “KBSF.” The common stock may be delisted if we fail to maintain certain Nasdaq listing requirements. For instance, companies listed on NASDAQ are subject to delisting for, among other things, failure to maintain a minimum closing bid price per share of $1.00 for 30 consecutive business days. On March 3, 2016, we received a letter from NASDAQ indicating that for the 30 consecutive business days between January 20, 2016 and March 2, 2016, the bid price of our common stock closed below the minimum $1.00 per share requirement pursuant to NASDAQ Listing Rule 5550(a)(2) for continued inclusion on The NASDAQ Capital Market. In accordance with NASDAQ Listing Rule 5810(c)(3)(A), we had an initial grace period of 180 calendar days, or until August 30, 2016, to regain compliance with the minimum bid price requirement. After the Company effectuated a one-for-fifteen reverse stock split of the outstanding common stock, the Company received a letter from Nasdaq on February 27, 2017 stating that because the Company maintained the closing bid price of its common stock at $1.00 per share or greater from February 9 to February 24, 2017, they determined that the Company has regained compliance with the minimum closing bid price requirement.

 

We cannot ensure you that we will continue to comply with the requirements for continued listing on The NASDAQ Capital Market in the future. If our common stock is no longer listed on The NASDAQ Capital Market, our shares would likely trade on the over-the-counter market. If our shares were to trade on the over-the-counter market, selling our shares could be more difficult because smaller quantities of shares would likely be bought and sold, transactions could be delayed, and security analysts’ coverage of us may be reduced. In addition, in the event our shares are delisted, broker-dealers have certain regulatory burdens imposed upon them, which may discourage broker-dealers from effecting transactions in our shares, further limiting the liquidity of our shares. These factors could result in lower prices and larger spreads in the bid and ask prices for our shares. Such delisting from The NASDAQ Capital Market and continued or further declines in our share price could also greatly impair our ability to raise additional necessary capital through equity or debt financing, and could significantly increase the ownership dilution to shareholders caused by our issuing equity in financing or other transactions.

 

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If we were delisted from NASDAQ, we may become subject to the trading complications experienced by “Penny Stocks” in the over-the-counter market.

 

Delisting from NASDAQ may cause our shares of common stock to become the SEC’s “penny stock” rules. The SEC generally defines a penny stock as an equity security that has a market price of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to specific exemptions. One such exemption is to be listed on NASDAQ. The market price of our common stock is currently higher than $1.00 per share. However, because the daily trading volume in our common stock is very low, significant price movement can be caused by the trading in a relatively small number of shares. Therefore, were we to be delisted from NASDAQ, our common stock may become subject to the SEC’s “penny stock” rules. These rules require, among other things, that any broker engaging in a purchase or sale of our securities provide its customers with: (i) a risk disclosure document, (ii) disclosure of market quotations, if any, (iii) disclosure of the compensation of the broker and its salespersons in the transaction and (iv) monthly account statements showing the market values of our securities held in the customer’s accounts. A broker would be required to provide the bid and offer quotations and compensation information before effecting the transaction. This information must be contained on the customer’s confirmation. Generally, brokers are less willing to effect transactions in penny stocks due to these additional delivery requirements. These requirements may make it more difficult for shareholders to purchase or sell our shares. Because the broker, not us, prepares this information, we would not be able to assure that such information is accurate, complete or current.

 

Trading in our shares over the last three months has been very limited, so our stock price is highly volatile, leading to the possibility that you may not be able to sell as much stock as you want at prevailing prices.

 

Because approximately 70% of our then issued and outstanding shares of common stock was tendered in the tender offering closed on July 29, 2014, we currently have a limited amount of shares eligible for public trading. The average daily trading volume in our common stock over the last three months is very limited. If limited trading in our common stock continues, it may be difficult for investors to sell their shares in the public market at any given time at prevailing prices. Moreover, the market price for shares of our common stock may be made more volatile because of the relatively low volume of trading in our common stock. When trading volume is low, significant price movement of our common stock can be caused by the trading in a relatively small number of shares. Volatility in our common stock could cause stockholders to incur substantial losses.

 

Numerous factors, many of which are beyond our control, may cause the market price of our Common Stock to fluctuate significantly.

 

There are numerous additional factors, many of which are beyond our control, may cause the market price of our Common Stock to fluctuate significantly. These factors include:

 

our earnings releases, actual or anticipated changes in our earnings, fluctuations in our operating results or our failure to meet the expectations of financial market analysts and investors;

 

changes in financial estimates by us or by any securities analysts who might cover our shares;

 

speculation about our business in the press or the investment community;

 

significant developments relating to our relationships with our customers or suppliers;

 

  stock market price and volume fluctuations of other publicly traded companies and, in particular, those that are in our industries;

 

customer demand for our products;

 

  investor perceptions of our industry in general and our company in particular;

 

the operating and stock performance of comparable companies;

 

general economic conditions and trends;

 

major catastrophic events;

 

announcements by us or our competitors of new products, significant acquisitions, strategic partnerships or divestitures;

 

changes in accounting standards, policies, guidance, interpretation or principles;

 

loss of external funding sources;

 

sales of our shares, including sales by our directors, officers or significant shareholders; and

 

additions or departures of key personnel.

 

21

 

Securities class action litigation is often instituted against companies following periods of volatility in their share price. This type of litigation could result in substantial costs to us and divert our management’s attention and resources. Moreover, securities markets may from time to time experience significant price and volume fluctuations for reasons unrelated to operating performance of particular companies. For example, in July 2008, the securities markets in the United States, China and other jurisdictions experienced the largest decline in share prices since September 2001. These market fluctuations may adversely affect the price of our shares and other interests in our company at a time when you want to sell your interest in us.

 

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

 

For the foreseeable future, we intend to retain any earnings to finance the development and expansion of our business, and do not anticipate paying any cash dividends on our shares. Accordingly, investors must be prepared to rely on sales of their shares after price appreciation to earn an investment return, which may never occur. Investors seeking cash dividends should not purchase our shares. Any determination to pay dividends in the future will be made at the discretion of our Board of Directors, and will depend on our results of operations, financial condition, contractual restrictions, restrictions imposed by applicable laws, and other factors our board deems relevant.

 

Certain of our shareholders hold a significant percentage of our outstanding voting securities.

 

Mr. Keyan Yan, our Chairman and Chief Executive Officer, is the beneficial owner of approximately 37% of our outstanding voting securities. As a result, he possesses significant influence and can elect a majority of our board of directors and authorize or prevent proposed significant corporate transactions. His ownership and control may also have the effect of delaying or preventing a future change in control, impeding a merger, consolidation, takeover or other business combination or discourage a potential acquirer from making a tender offer.

 

Our outstanding warrants may adversely affect the market price of our shares of common stock.

 

There are currently 393,836 warrants outstanding. Each warrant entitles the holder to purchase one share of common stock at a price of $172.50. The sale or possibility of sale of the shares underlying the warrants could have an adverse effect on the market price for our shares of common stock or our ability to obtain future financing. If and to the extent these warrants are exercised, you may experience dilution to your holdings.

 

You will not be able to exercise your redeemable warrants if we do not have an effective registration statement and a prospectus in place when you desire to do so.

 

No redeemable warrants will be exercisable, and we will not be obligated to issue shares of common stock upon exercise of redeemable warrants by a holder unless, at the time of such exercise, we have a registration statement or post-effective amendment under the Securities Act covering the shares of common stock issuable upon the exercise of the redeemable warrants and a current prospectus relating to shares of common stock. Under the terms of a redeemable warrant agreement between American Stock Transfer & Trust Company as warrant agent, and us, we have agreed to use our best efforts to have a registration statement in effect covering shares of common stock issuable upon exercise of the redeemable warrants from the date the redeemable warrants become exercisable and to maintain a current prospectus relating to shares of common stock until the redeemable warrants expire or are redeemed, and to take such action as is necessary to qualify the shares of common stock issuable upon exercise of the redeemable warrants for sale in those states in which the IPO was initially qualified. However, we cannot assure you that we will be able to do so. We may be unable to have a registration statement in effect covering shares of common stock issuable upon exercise of the redeemable warrants or to maintain a current prospectus relating to such shares of common stock if, for example, we lack the current financial statements necessary to be included in such registration statement or prospectus. We have no obligation to settle the redeemable warrants for cash, in any event, and the redeemable warrants may not be exercised and we will not deliver securities therefor in the absence of an effective registration statement and a prospectus available for use. The redeemable warrants may be deprived of any value, the market for the redeemable warrants may be limited if there is no registration statement in effect covering the shares of common stock issuable upon the exercise of the redeemable warrants or the prospectus relating to the shares of common stock issuable upon the exercise of the redeemable warrants is not current and the redeemable warrants may expire worthless. If you are unable to exercise or sell your redeemable warrants, you will have paid the full unit price for only the shares of common stock underlying the units.

 

22

 

Holders of warrants included in the placement units may exercise these warrants even if an effective registration statement and a prospectus is not in place, which means they may be able to exercise such warrants while public warrants might not be exercisable and may expire worthless.  

 

Unlike the warrants underlying the units issued in connection with our IPO, the warrants included in the placement units will not be restricted from being exercised in the absence of a registration statement under the Securities Act in effect covering the shares of common stock issuable upon the exercise of the such warrants and a current prospectus relating to shares of common stock. Therefore, the holders thereof will be able to exercise such warrants regardless of whether the issuance of the underlying shares of common stock is registered under the Securities Act, while public warrants might not be exercisable and may expire worthless.

 

We are a “foreign private issuer” and have disclosure obligations that are different than those of U.S. domestic reporting companies. Therefore, you should not expect to receive the same information about us as a U.S. domestic reporting company may provide. Furthermore, if we or lose our status as a foreign private issuer, we would be required to fully comply with the reporting requirements of the Exchange Act applicable to U.S. domestic issuers and incur significant operational, administrative, legal, and accounting costs that we would not incur as a foreign private issuer.

 

We are a foreign private issuer. As a result, we are not subject to certain of the requirements imposed upon U.S. domestic issuers by the SEC. For example, we are not required by the SEC or the federal securities laws to issue quarterly reports or file proxy statements with the SEC. We are also allowed to file our annual report with the SEC within four months of our fiscal year end. We are also not required to disclose certain detailed information regarding executive compensation that is required from U.S. domestic issuers. Further, our directors and executive officers are not required to report equity holdings under Section 16 of the Securities Act. As a foreign private issuer, we are also exempt from the requirements of Regulation FD (Fair Disclosure) which, generally, are meant to ensure that select groups of investors are not privy to specific information about an issuer before other investors. We are, however, still subject to the anti-fraud and anti-manipulation rules of the SEC, such as Rule 10b-5. Since many of the disclosure obligations required of us as a foreign private issuer are different than those required by U.S. domestic reporting companies, our shareholders should not expect to receive all of the same types of information about us and at the same time as information is received from, or provided by, U.S. domestic reporting companies. We are liable for violations of the rules and regulations of the SEC, which do apply to us as a foreign private issuer. Violations of these rules could affect our business, results of operations, and financial condition.

 

As a foreign private issuer, we are permitted to rely on exemptions from certain NASDAQ corporate governance standards applicable to domestic U.S. issuers. This may afford less protection to holders of our securities.

 

We are exempted from certain corporate governance requirements of the Nasdaq Stock Market by virtue of being a foreign private issuer. As a foreign private issuer, we are permitted to follow the governance practices of our home country, the Republic of the Marshall Islands in lieu of certain corporate governance requirements of Nasdaq. As result, the standards applicable to us are considerably different than the standards applied to domestic U.S. issuers. For instance, we are not required to:

 

have a compensation committee and a nominating committee to be comprised solely of “independent directors; and

 

hold an annual meeting of shareholders no later than one year after the end of the Company’s fiscal year-end.

 

As a result, you may not have the same protections afforded to shareholders of companies that are subject to all of the Nasdaq corporate governance requirements.

 

Future sales or perceived sales of our shares of common stock could depress our stock price.

 

As of the date of this report, we have 2,591,299 shares of common stock outstanding. Many of these shares will become eligible for sale in the public market, subject to limitations imposed by Rule 144 under the Securities Act. If the holders of these shares were to attempt to sell a substantial amount of their holdings at once, the market price of our common stock could decline. Moreover, the perceived risk of this potential dilution could cause shareholders to attempt to sell their shares and investors to short the common stock, a practice in which an investor sells shares that he or she does not own at prevailing market prices, hoping to purchase shares later at a lower price to cover the sale. As each of these events would cause the number of shares of our common stock being offered for sale to increase, our common stock market price would likely further decline. All of these events could combine to make it very difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate.

 

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Holders of our securities may face difficulties in protecting their interests because we are incorporated under the Republic of the Marshall Islands law.

 

We are a company incorporated under the laws of the Marshall Islands, and almost all of our assets are located outside the United States. In addition, majority of our directors and officers, and their assets, are located outside of the United States. As a result, you may have difficulty serving legal process within the United States upon us or any of these persons. You may also have difficulty enforcing, both in and outside the United States, judgments you may obtain in U.S. courts against us or these persons in any action, including actions based upon the civil liability provisions of U.S. federal or state securities laws. You may also have difficulty bringing an original action in the appropriate court of the Marshall Islands to enforce liabilities against us or any person based upon the U.S. federal securities laws.

 

Provisions of our articles of incorporation may impede a takeover or make it more difficult for shareholders to change the direction or management of the Company, which could reduce shareholders’ opportunity to influence management of the Company.

 

Our articles of incorporation permit our board of directors to issue up to five million shares of preferred stock with a par value of $0.0001 from time to time, with such rights and preferences as they consider appropriate. These terms may include voting rights including the right to vote as a series on particular matters, preferences as to dividends and liquidation, conversion rights and redemption rights provisions. The issuance of any preferred stock could reduce the value of our common stock. In addition, specific rights granted to future holders of preferred stock could be used to restrict our ability to merge with, or sell assets to, a third party. The ability of the board of directors to issue preferred stock could make it more difficult, delay, discourage, prevent or make it more costly to acquire or effect a change-in-control, which in turn could prevent shareholders from recognizing a gain in the event that a favorable offer is extended and could materially and negatively affect the market price of our common stock.

 

ITEM 4. INFORMATION ON THE COMPANY

 

A. History and Development of the Company

 

We are a Republic of the Marshall Islands Company incorporated under the Marshall Islands Business Corporations Act (“BDA”) on January 26, 2012. We were originally organized under the name “Aquasition Corp.” for the purpose of acquiring through a merger, capital stock exchange, asset acquisition, stock purchase, or similar acquisition transaction, one or more operating businesses or assets. The address of the Company’s principal executive office is Xingfengge Building, Baogaiyupu Industrial Park, Shishi City, Fujian Province of china.

 

On March 24, 2014, we entered into a share exchange agreement and plan of liquidation (the “Exchange Agreement”), with KBS International, Hongri International, a then wholly owned subsidiary of KBS International and Cheung So Wa and Chan Sun Keung, each an individual and shareholder of KBS International (each, a “Principal Stockholder”). The Exchange Agreement was subsequently amended on June 21, 2014. The transactions contemplated in the Exchange Agreement (the “Share Exchange”) were closed on August 1, 2014. At the closing, we acquired 100% of the issued and outstanding equity interest in Hongri International from KBS International. In exchange, we issued an aggregate of 1,530,497 shares of common stock of the Company to KBS International. In addition, on July 29, 2014, we completed a tender offer related to the Share Exchange and redeemed the 332,116 shares of common stock validly tendered and not withdrawn. Pursuant to the Exchange Agreement, KBS International was liquidated and dissolved in August 2014 and the 1,530,497 shares of common stock of the Company were distributed to each shareholder of KBS International according to their respective ownership of KBS International. As a result, following the consummation of the Share Exchange, we had a total of 1,694,489 shares of common stock outstanding.

 

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On October 31, 2014, we held a special shareholder meeting and amended our Articles of Incorporation to change our name to KBS Fashion Group Limited.

 

On February 3, 2017, a special shareholder meeting was held at the Company’s headquarters in China and at the meeting, our shareholders approved a proposal to grant discretionary authority to the Board of Directors of the Company to effect a reverse stock split of issued and outstanding shares of common stock at a ratio within the range from one-for-two up to one-for-twenty; and determine whether to pay in cash the fair value of fractions of a share of common stock as of the time when those entitled to receive such fractions are determined, or to entitle shareholders to receive, in lieu of any fractional share, the number of shares of common stock rounded up to the next whole number. On February 3, 2017, after the special shareholder meeting, our Board of Directors approved a one-for-fifteen reverse stock split of the Company’s issued and outstanding common stock. In addition, in lieu of issuing any fractional share, the Board of Directors decided that shareholders are entitled to receive the number of shares of common stock rounded up to the next whole number. Our common stock began trading on the NASDAQ Stock Market on a split-adjusted basis when the market opened on February 9, 2017.

 

On March 29, 2016, we granted an aggregate of 73,334 restricted shares of common stock to certain executive officers and directors of the Company as compensations for their past services in 2015 and future services to be provided in 2016.

 

On July 10, 2017, we granted an aggregate of 215,000 restricted shares of common stock to certain executive officers and directors of the Company as compensations for their services.

 

On February 10, 2018, we granted an aggregate of 285,000 restricted shares of common stock to certain executive officers and directors of the Company as compensations for their services.

 

On March 25, 2019, we granted an aggregate of 305,000 registered shares of common stock pursuant to our 2018 Equity Incentive Plan to our executive officers, directors and certain employees as compensations for their services.

 

On March 29, 2019, our board of directors approved the issuance of 15,000 shares of common stock to our Investor Relationship firm as compensation for their services. The issuance of the shares was made in reliance on the exemption provided by Section 4(a)(2) of the Securities Act of 1933, as amended (the “Act”), for the offer and sale of securities not involving a public offering, and Regulation S promulgated thereunder. None of the shares have been registered under the Act and neither may be offered or sold in the United States absent registration or an applicable exemption from registration requirements.

 

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Corporate Structure

 

All of our business operations are conducted through our PRC subsidiaries. The chart below presents our corporate structure as of the date of this report.   

 

      

The Securities and Exchange Commission, or SEC, maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at http://www.sec.gov.

 

Our web site address is http://www.kbsfashion.com. Information contained on, or that can be accessed through, our website does not constitute a part of this Annual Report.

 

Principal Capital Expenditures and Divestitures

 

For the year ended December 31, 2018, our total capital expenditures and divestitures were $nil. For the years ended December 31, 2017 and 2016, our total capital expenditures and divestitures were $849,199 and $45,445, respectively. Such expenditures were primarily used construction of production facility and purchasing fire protection facility. Our operating cash flow mainly funded these capital expenditures.

 

B. Business Overview

 

We are a leading casual menswear company in China with a demonstrated track record of designing, marketing, and selling our own line of fashion menswear. Our products include men’s apparel, footwear and accessories, primarily targeting urban males between the ages of 20 and 40 in the Tier II and Tier III cities in China. Tier II cities generally refer to major cities located in each province of China other than the capital city of such province. Tier III cities generally refer to county-level cities in China. Tier III cities that we focus on are the national top 100 county cities identified by the State Statistics Bureau of China each year. These cities are characterized by higher GDP, higher disposable income, better education and better infrastructure as compared with other county-level cities.

 

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Our apparel products include outerwear, knitwear, denim, tops, bottoms, accessories and footwear. Since 2006, we have launched 4,056 collections of new products, each year with a different theme to highlight the current trends in menswear for the season.

 

We have established a nationwide distribution network covering 12 of China’s 32 provinces and centrally administered municipalities. As of December 31, 2018, this network was comprised of 1 corporate store owned and operated by the company and 40 franchised stores operated by 14 third party distributors or their sub-distributors. The number of stores has grown from 1 corporate store and 7 franchised stores as of December 31, 2006. In the years ended December 31, 2018, 2017 and 2016, sales through our corporate stores accounted for 13%, 29.4% and 13% of our total revenues respectively, and sales through distributors and whole sellers accounted for 73%, 66.5% and 78% of our revenues, respectively. Total revenue from corporate stores sales for fiscal year 2018 was $2.37 million, compared to $7.0 million for 2017 and $5.53 million for 2016.

 

From 2009 through 2018, total net sales decreased from $28.1 million to $18.53 million while the net profit decreased from $9.0 million to a net loss of -$8 million.

 

Our Competitive Strengths

 

We believe that the following competitive strengths enable us to compete effectively in and capitalize on the growing casual menswear industry in China.

 

There is a sizable market for our products . We believe that we have a sizeable potential market. Our target customers are male middle-class consumers in the 20-40 age range. According to the national census in 2018, the population in China between 16-59 years-old was approximately 900 million. Our target group falls into this category and is estimated to be more than 200 million people. As a result of the growing affluence in the PRC and increased purchasing power of the PRC population, we believe that PRC consumers are becoming more willing and able to purchase casual menswear. In addition, we believe that the purchasing decision of PRC consumers is becoming more predicated upon brand image, product design and style, rather than just price considerations. With rising affluence and improvement in lifestyle, we also believe the overall Chinese population is generally growing more brand name conscious and style oriented and has shown a propensity for increased spending on casual menswear.

 

We have a strong focus on design and product development . We believe that our in-house design and product development capabilities allow us to create unique products that appeal to our customers. We have established a strong in-house design and product development team of 20 employees as of April 26, 2019. Our team identifies new fashion trends by attending fashion shows and exhibitions as well as by drawing from creative ideas in magazines and other media. Each spring and fall, we carefully plan and create a new product line for our fall/winter and spring/summer collections of 727 SKU that encompasses our full range of product offerings, including outerwear, tops, bottoms and accessories. We introduce new design elements into our product lines each season. With our highly skilled and creative team of designers, we have extensive experience in creating unique designs to meet the preferences and needs of our target customer base.

 

Our trademarked brand has earned a following in China . Our brand was developed in 2006. Our marketing concept is “French origin, Korean design and made for Chinese.” Our customers are middle-class consumers in the 20-40 age range. We believe that their products’ concept, marketing, design and packaging fully match with the pro-western attitude and life styles of their target customers. We believe the KBS brand is essential to our success to penetrate to the casual menswear market in China.

 

We have an extensive and well-managed nationwide distribution network . We have an extensive distribution network throughout China. As of December 31, 2018, we had 1 KBS branded corporate stores and 32 franchised stores across 10 of China’s 32 provinces and centrally administered municipalities. The KBS branded corporate stores are required to sell only our products. We have been building up our selected distributor network since 2007. As of December 31, 2018, we had 11 distributors operating 32 franchised stores. All of our distributors have been working with us from 1 to 10 years. We select our distributors based on a number of criteria, including experience in the menswear retail industry, sales channels, business resources, brand promotion capabilities and ability to help us implement our broader business strategies. Our distributors help us respond to changing consumer tastes in a timely manner by providing regular feedback on our products at our semi-annual sales fairs and frequent communications. The financial resources of our distributors allow us to expand our retail network with less working capital investment from us than would be required for establishing direct stores, as our distributors are responsible for the store rentals and cost of inventory in their stores. We sold a substantial amount of our products through our distributors, which have allowed us to distribute our products to a wide geographic area and penetrate markets by leveraging the local market knowledge of our distributors and their sub- distributors. We believe that our distribution network has enabled us to expand our business and increase our sales efficiently and with less operational risk. This model has also minimized our operational risk because we typically start production after we receive orders from our distributors. We believe that using a distribution network to sell a substantial amount of our KBS products has enabled us to devote our resources to our core competitive strengths of design, brand management and product development.

 

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We have an experienced management team . Our management team has extensive R&D, marketing and financial experience, led by our Chief Executive Officer, Mr. Keyan Yan. Mr. Yan has over 27 years of experience in the apparel industry and also has developed a differentiated product by international cooperation with a Korean designer. After working in the garment industry for more than 16 years, Mr. Yan acquired and developed the KBS brand. With his strong understanding of the apparel industry, Mr. Yan has successfully established this brand name in the market. We are committed to attract and retain top management level executives who we believe are and will continue to be the driving force behind our product development and growth.

 

Our Growth Strategy

 

We intend to further strengthen our market position in the casual menswear market in China by implementing the following strategies:

 

We plan to expand our online business and purchase one or more online sales platforms or online stores . Together with the change in consumer trends, online sales is now the most important sales channel in Chinese market and is becoming increasingly important globally. Sales from our stores and distributors have been steadily decreasing, and we are now in the process of identifying the best possible ways to establish and expand our online business. We plan to research and purchase one or more online sales platforms and online stores. We believe that KBS will have better opportunities to expand by purchasing online sales platforms or online stores in year 2019, and the management of KBS will keep on exploring other areas and business models, such as the use of artificial intelligence for brand promotion, learning customer preferences, and identifying shopping trends. We consider that our policy to expand our outreach using new technologies will add significant shareholder value.

 

We plan to expand our OEM sales by attracting more reputable and long-term clients. We just had the renewal of a framework sales contract with two major current customers: Hangzhou Zhi Yin Apparel Clothes Co., Ltd and Hangzhou Yiyuan Apparel Co., Ltd. These two sales contracts are expected to generate approximately RMB 28 million in total, of which RMB 20 million relates to Hangzhou Ziyin of new 450,000 orders and RMB 8 million relates to Hangzhou Yiyuan of new 160,000 orders for this year. We are also expanding our OEM business and to get more clients, especially to focus on online providers, as they have expanded their market share over the past years quickly together with the change in Chinese consumer’s preferences and occupy a large market share. By the time when we start executing the orders, we expect that we can have sustainable and increasing business.

 

We plan to invest in a Greece Based Private Smart Tech Apparel Company. We signed a letter of intent with Tribe, one of the most innovative smart clothing technology companies internationally. If the transaction is consummated, we conceive that this investment will enhance and expand significantly our client network and products offering. The smart clothing market is expected to surpass the 2 trillion US dollars in size in 2019 and we believe we are well positioned to capture a part of this market in the wider region.

 

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We plan to continue to raise the profile of the KBS brand through enhanced advertising and promotional activities . We believe that the strong association of KBS brand with our concept of “French origin, Korean design and made for Chinese” has helped drive our brand positioning and customers’ receptivity to our products. We intend to further build our brand and deliver a consistent brand image from product design to sales and marketing. We seek to promote and enhance our presence in China’s casual menswear market by continuing to adopt proactive marketing strategies and produce high quality, well- designed casual menswear for our target market. In particular, we aim to increase awareness of our brand through: (1) multi-channel advertising strategies through national television, fashion magazines, billboards and other media channels; (2) further assisting our distributors’ regional advertising efforts; (3) distinctive store and product launch campaigns, including special events for new product launches and large-scale grand opening events for new stores, particularly new corporate stores; (4) update of the decoration and layout of a number of existing stores which have been in operation for years to improve the shopping experience; (5) participation in fashion shows; and (6) sponsorships of selected high-impact events. We believe that these advertising and promotional activities will help to further strengthen brand awareness in our target market and enhance customer loyalty.

 

We plan to expand and build upon our design and product development capabilities. We intend to further strengthen our design and product development capabilities by accelerating the commercialization of design concepts, expanding our product offerings and continuing to develop what we believe is unique casual menswear. We plan to further invest in design and product development and expand our design and product development team by attracting talented designers, either domestic or international, and training young graduates from leading fashion design institutes. We believe that combining western fashion design experience with our local designer’s understanding of the China market and aesthetic will enable us to create fashionable yet popular casual menswear for consumers in China. We also intend to cooperate with our suppliers to develop new materials and fabrics which we believe will give customers a unique fashion product and create new market opportunities. We believe that our focus on designing unique and quality casual menswear will allow us to maintain our competitiveness and help to enhance our sales and overall profitability.

 

  We plan to expand our production capacity to expand and diversify our product offerings . Our production facility is located in Taihu City, Anhui Province, China, consisting of total 110,557 square meters of land. Currently this facility has a production capacity of 2 million pieces of clothes per year and can accommodate 5,000 workers. This production facility mainly produces OEM products for famous sportswear producers, some successful online brand stores and fulfill some overseas orders. The construction of our facility commenced in 2011 and takes place in four phases: Phase 1 consists of the construction of a 5-story dormitory; Phase 2 is to add facilities with annual production capacity of five million pieces of clothes. We have completed the construction of facilities for Phase 1 and Phase 2 by the end of 2014. Although we have the designed capacity of 5 million pieces yearly, the facility currently may only produce 2 million pieces per year. Phase 3 construction has been delayed because the local government needs additional time to conclude negotiations with local residents over appropriate resettlement terms. Once the government settles with the local residents, the phase 3 and 4 can be continued. Phase 4 will include production facilities with annual production capacity of 10 million pieces, an office building, staff quarters and living facilities. Upon completion, the new facility is expected to have a production capacity of 20 million pieces and accommodate 5,000 workers. Please see “Production” below for a more complete explanation of our plans for the expansion of our production capacity. We anticipate that the new production facility will allow us to further refine our existing product lines by offering more styles within our existing apparel and accessories categories and to introduce additional, complementary apparel and accessories categories into our product line. We currently introduce 500 to 900 different styles of products each year and intend to increase the number of our product offerings in the future.

 

We plan to expand our international market and attract more orders from overseas. Starting from year 2016, we have been awarded international OEM orders for producing clothes with overseas brands. Such orders are usually large and continuous. Due to the completion of phase 2 construction of our Anhui factory, we have enough production capacity to take on large orders. The current utilization rate of the Anhui factory is still quite low and we expect to invest more in attracting more large orders from overseas.

 

The KBS Brand

 

We are engaged in a highly competitive industry in which brand image and recognition is critical to attracting customers to purchase our products. We have adopted KBS as a uniform brand name and image for all stores in our distribution network and on all products sold in those stores. The KBS brand was created by Ms. Qinghua Ye in 2006 and registered with the trademark administration authority in 2008. Subsequently, Ms. Ye assigned the KBS trademark to Hongri PRC in 2008. In 2009, Hongri PRC transferred this trademark to France Cock, which then licensed such trademark back to Hongri PRC. Based on our sharp rise in revenue since 2006, we believe that the KBS brand has gained a following in the casual menswear market in the cities where our products are sold.

 

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To promote our brand, we have developed and implemented brand management policies in all of our corporate stores and franchised stores. Our brand management policies set out detailed requirements for store decorations and display of products. This enables us to project a consistent brand image. In addition, each season, our design and product development team develops display concepts, including the presentation of our collections in the stores and the color schemes for the backdrops. We also work closely with our distributors to supervise the daily operations of franchised stores through unscheduled visits to ensure that our brand management policies are properly followed.

 

We may suspend the supply of our products or terminate distribution agreements in the event that any of our distributors or their sub-distributors consistently fails to comply with our brand management policies.

 

Our Products

 

Our apparel products include cotton and down jackets, sweaters, shirts, T-shirts, jeans and trousers. Accessories include shoes, bags, socks and caps. In 2018, the suggested retail prices of our products ranged from RMB 15 to RMB1,599 (approximately $2 to $237) for our apparel products and RMB178 to RMB1599 (approximately $26 to $236) for our accessory products. Since 2006, we have launched 4,056 collections of new products, each year with a different theme to highlight the current trends in menswear for the season.

 

Our Design

 

We believe one of our key strengths is our internal design and product development team, which designs products that reinforce our brand image. Major parts of our products are designed by our internal design and product development team with the collaboration of Korean designers. As of December 31, 2018, our design and product development team consisted of 20 members, including one senior designer with over five years of working experience. Final design concepts are approved by Mr. Keyan Yan, who has more than 27 years of experience in the industry. All of the other designers are graduates of professional design schools in China. We believe that our design and product development team is innovative and passionate and that the individual experience of each of our designers helps bring new and exciting products to our customers. Our design and product development team conceptualizes each season’s collections through an interactive process, taking into account our brand strategy, product image and market feedback, drawing inspirations from domestic and international fashion trends and collaborating with both our suppliers and distributors to fine-tune our designs. In particular, we collaborate with our suppliers to develop a variety of materials and fabrics for our products. We also involve distributors in our product selection process to take advantage of their market intelligence, which helps us to adapt to constantly changing customer preferences in local markets. Our designers also attend various domestic and international fashion shows to keep abreast of the latest fashion trends.

 

Starting from year 2015, design of our products comes from three channels. In addition to designing products by our in-house staff, we outsource to certain reputable designers. From time to time, our ODMs also will directly sell their designed products to us.

 

In a typical year, we design and make around 1,500 prototypes. After the initial product selection, internal cost analysis of approved prototypes and final selection by distributors at the sales fairs, we eventually select approximately 750 designs for mass production. Final design of all of our products will be approved by our Chairman, Mr. Yan.

 

Our Distribution Network

 

We have established a nationwide distribution network consisting of corporate stores and franchised stores covering 10 of China’s 32 provinces and centrally administered municipalities.

 

Corporate Stores

 

As of December 31, 2018, we owned and operated 1 corporate store with the floor area of approximately 120 square meters. As part of our corporate strategy, we closed 17 corporate stores in last two years because of the low profitability of certain corporate stores. In the years ended December 31, 2018, 2017 and 2016, sales through our corporate stores accounted for 13%, 29.4% and 13% of our total revenues, respectively.

 

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We directly own and operate our corporate store. This direct control enables us to have closer relationship with our ultimate customers and better understanding of market trends and consumer preferences. Required capital for opening of each store depends on the location and area of the designated store. On average, the renovation cost per store is around $67,000 and the first year of rent payment is around $140,000 including premium paid to the previous owner. Rental period varies from two to five years. The total capital required to open a new store is generally around $207,000 per store. Once negotiation of rent is concluded, it takes one to two months to open up a store. We usually open up stores right before a peak season, such as labor holiday in May, National holiday in October and Chinese New Year in January/February. On average, new stores break even after one to three months of operation.

 

We currently have one standard designs for our corporate stores located in Fujian Province. They were considered as flagship stores for our distributors’ reference. Because in year 2016 and 2015 we closed some corporate stores, the inventories of these stores were cleared through promotion exhibitions we held in the third-tier cities at lower prices.

 

For corporate stores opened in second tier cities, we normally have a higher aesthetic standard compared with corporate stores in third and fourth tier cities. We generally locate our corporate stores at street level to access high pedestrian flow. Normally, we will sell in-season stock in our second-tier city corporate stores. Our second-tier city corporate stores are also designed to showcase our marketability to potential distributors so as to induce them to join our distributorship. For stores opened in the third and fourth tier cities, we normally sell some of our slow-moving or off-season stock at a discount due to our awareness of the generally lesser amount of disposable income available to residents of these cities. During certain times of the year, such as the New Year, Chinese New Year and Labor Day, we will organize promotional discounts together with our franchised stores to attract more customers and increase our stock turnover.

 

Franchised Stores

 

We sell a substantial amount of our products to our franchised distributors who in turn sell them to retail customers through KBS branded retail stores operated by our distributors or their sub-distributors. Since 2013, we have also been selling products to 3 provincial distributors without their own stores, or the no-store distributors, on a trial basis. We do not have any ownership in, or controlling relationship with, these franchised stores, but we have entered into distribution agreements with them in the Company’s standard form, pursuant to which we require distributors and their sub-distributors to sell only KBS products in these stores. Distributors are responsible for selecting and ordering products from us and overseeing the sales in the stores operated by them and their sub-distributors. By selling directly to our distributors, we can recognize revenues upon delivery to our distributors and delegate the distribution responsibilities to our distributors. This allows us to distribute our merchandise to a wide geographic area and penetrate markets by leveraging the local market knowledge of our distributors and their sub-distributors. This also minimizes our inventory and sales risks while allowing us to allocate our resources to our core competitive strengths of design, brand management and product development. We believe that our cooperation with distributors has enabled us to expand our business and accelerate our sales growth at much lower costs and operational risk and achieve brand recognition throughout China.

 

We have been building up our selected franchised distributor network since 2007. As of December 31, 2018, we had 11 franchised distributors who operated 32 retail stores directly or through their sub-distributors, all of which were stand-alone stores, which were typically located in commercial centers, including department stores or shopping malls, in their cities. All these distributors have worked with us for about 1 to 8 years. We have not encountered any material dispute or financial difficulty with our key distributors. The average floor area of each retail store was approximately 78 square meters as of December 2018. The number of retail stores has grown significantly in recent years from 7 as of December 31, 2006, with the aggregate floor area increasing from 560 square meters as of December 31, 2006 to 2,635 square meters as of December 31, 2018. In the years ended December 31, 2018, 2017 and 2016, sales through our distributors accounted for 73%, 63.3% and 78% of our revenues, respectively. 

 

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During each of the fiscal years ended December 31, 2016, 2017 and 2018, we had no customer exceeding 10% of our net sales.

 

Sales generated by our five best-performing franchised distributors accounted for approximately 29.3%, 23.8% and 28.3% of our revenues in the years ended December 31, 2018, 2017 and 2016, respectively. Those top distributors have been with us since 2007 or 2008 and have grown organically with us. At the same time, we are exploring more distributors in other regions including relatively small distributors to grow with their businesses. Although we rely on distributors for the sales and marketing of our products, we believe our business is not substantially dependent on any individual distributor.

 

We are highly selective in appointing distributors. We select our distributors based on a number of criteria, including experience in the menswear retail industry, sales channels, business resources, brand promotion capabilities and ability to help us implement our broader business strategies. We maintain good relationships with many regional or local distributor candidates which we identify through our internal research and external referrals but only appoint a handful of them to become our distributors. We evaluate the relevant experience of the distributor candidates in operating retail stores, their financial condition and sources of funding required for the establishment of a regional distribution network and their ability to develop a network of retail stores in the designated distribution region of a given distributor before we make any appointment.

 

Once appointed, each distributor must enter into a distribution agreement with us. We do not own any interest in any of our distributors, their sub-distributors or the retail stores they operate. The distribution agreements we typically enter into with distributors do not allow us to be involved in the daily operating, financing or other activities of the distributors, except that distributors need to comply with our brand management policies and pricing and store management guidelines. Key terms of our standard distribution agreement include:

 

Product Exclusivity . Our distributors are required to sell only our products at KBS branded retail outlets managed by them or authorized retailers.

 

Geographic Coverage . Distributors are granted exclusive rights to distribute our products (directly and indirectly through their sub-distributors) in the retail stores within the specified geographic area with no overlapping of distributors within our distribution network. However, we retain the right to operate direct stores anywhere regardless of whether we have appointed distributors there.

 

Duration . The distribution agreements generally have an initial term of one year and are renewable at our discretion after taking into account factors such as compliance with our brand management policies and sales performance.

 

Distributor Pricing . Distributors agree to order our products at a discount from our suggested retail prices. The discounted wholesale prices to distributors are classified into the following three categories: provincial distributor at a discount of 35% of retail price, district distributor is 30% of retail price and the wholesale distributor is 25% of retail price.

 

Minimum Purchase Requirement . Each of our distributors is customarily expected to purchase a minimum amount of our products for each trade fair held biannually according to their present and expected distribution network. The minimum is typically RMB800,000 (approximately $110,000) for each store.

 

  Payment and Delivery. Normally, we expect distributors to pay us RMB0.5 million (approximately $74,000) to RMB1 million (approximately $148,148) as a deposit upon placing an order. Upon delivery of the orders, we will deduct amounts on deposit from the purchase price. For new and small district distributors, we normally require them to pay the balance before the delivery of its products. We may also accept payment on credit terms to the extent requested by distributors experiencing working capital difficulties or encouraging them to order more. The amount and duration of credit granted to each distributor will depend on its financial position and creditworthiness. We handle the arrangements for delivery of our products, but the distributors are normally expected to bear the related costs and expenses.

 

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Return of Products . We will only accept product returns from distributors for quality reasons and only if the distributors followed our standard procedures in processing the returned products. So far, we have not experienced any product returns due to expressed quality reasons.

 

Retail Pricing . Other than at times when we launch promotional campaigns or adjust our strategies, distributors must adopt, and are required to procure their sub-distributors to adopt, our suggested retail prices for products. Distributors must obtain our consent before launching any distributor specific special offers.

 

Brand Management . Distributors must comply with our brand management policies and store management guidelines. We may impose penalties, forfeiture of deposit, suspend supply of products and terminate the agreement in the event of any breach of such policies.

 

Termination . We may generally terminate the distribution agreements and seek indemnification in the event of breach by distributors. In the event of some types of breach, we may not terminate the agreement but have other remedies. For example, if a distributor fails to order all products provided for under the distributorship agreement, we may instead impose forfeiture of deposit or withhold certain benefits.

 

When opening new retail stores, our distributors conduct research on the market potential of the proposed retail sites, after which they will provide us with an application for opening a new retail store. In reviewing applications, we consider factors including the store location, store layout, available area, market opportunities, competitors and estimated sales. We conduct selected on-site investigations to verify applications filed by our distributors. Our retail stores are generally located in convenient retail locations in their respective cities and thus benefit from high volumes of pedestrian traffic.

 

Effective monitoring of distributors and their retail stores is critical to our success. We have a team in our marketing, sales and distribution department to monitor our distributors’ and their sub-distributors’ performance, who conduct on-site inspections of selected retail stores each quarter without prior notice to ensure compliance with our store management guidelines. According to the results of our inspections, we, from time to time, make suggestions to our distributors with respect to the opening or closure of their retail stores. Distributors also need to submit to us their annual/ semi-annual plans to estimate their orders for the next season and their plan to improve the performance of existing retail stores or expand by opening new retail stores. This reporting system enables us to access up-to-date sales projections of our distributors and their sub-distributors, which reflects the overall level of retail sales of our products. It also provides us with the expansion plan of each distributor which helps us prepare our overall development plan in a more accurate manner.

 

We invite our distributors, as well as a select number of their sub-distributors and retail store managers, to attend our sales fairs, which are held twice a year. During the sales fairs, we discuss with our distributors and their sub-distributors the upcoming product line. Apart from participating in two sales fairs each year, our distributors visit us from time to time and contact us as necessary, which allows us to have access to updated market information. We also provide training for distributors and their sub-distributors in the areas of sales techniques, customer service and product knowledge, typically prior to the launch of our new collections each year. We believe that these investments help to improve the operations of the sales network and provide additional value-added services to retain our distributors and their sub-distributors.

 

The following table lists by region the number of retail stores operated by distributors and sub-distributors as of December 31, 2018:

 

Location   As of December 31,
2018
 
Fujian   6  
Guangdong   2  
Guangxi   3  
Jiangsu   4  
Anhui   2  
Chongqing   4  
Tianjin   3  
Hebei   4  
Sichuan   4  
Total   32  

 

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Pricing Policy

 

We sell our products to our distributors at uniform discounts from our suggested retail prices. We have a suggested retail price policy that applies to all our stores to help maintain brand image, ensure consistent pricing levels from region to region and prevent price competition among our distributors. In determining our pricing strategies, we take into account market supply and demand, production cost and the prices of our competitors’ similar products. Our sales representatives collect and record the retail prices of our products sold by our retailers. We analyze the information collected and engage in discussions with our distributors to ensure that they follow our pricing policy. See “Franchised Stores” above.

 

Production

 

Originally located in Shishi City in Fujian Province and started production in 2006, our production facility is currently located in Taihu City in Anhui Province, China. The facility currently has a production capacity of 2 million pieces of clothes per year. This production facility mainly produces OEM products for famous sportswear producers. Our production facility was operating at full capacity between 2009 and 2012. In 2014, we produced about 0.39 million units at the operating capacity of 19.5%; while in 2015,we produced about 0.48 million units at the operating capacity of 24%. In 2016, we produced about 0.54 million units at the operating capacity of 27%.

 

In 2017 and 2018, we produced about 0.30 million and 0.49 million units at the operating capacity of 15% and 25%.

 

 Since 2011, we have been negotiating with the local government to acquire land use rights for our current facility consisting of 110,557 square meters. We obtained a portion of such land use rights for two parcels of land of 7,405 square meters and 2,440 square meters in March 2012 and May 2012, respectively, and have finished the construction of 8,572 square meters of staff dormitories and 22,292 square meters as workshop buildings and offices. We started to use the dormitory and factory in year 2015 and moved into the offices at the beginning of 2016. Due to the local government’s need for additional time to conclude negotiations with local residents over appropriate resettlement terms, the construction of the adjacent facility on the third parcel of land has been delayed. While we cannot guarantee when and whether the construction of the adjacent facility on the third parcel of land will be eventually completed, we believe we will be in a better position to schedule our construction plan once we acquire the land use right of the third parcel of land. Once completed, our total production capacity of the facility is expected to increase to 20 million pieces per year from the current capacity of 2 million pieces per year.

 

All of the products produced by our ODM and OEM contract manufacturers bear the brand name KBS. As of December 31, 2018, we had 3 ODM contract manufacturers and 3 OEM contract manufacturers. In the years ended December 31, 2017 and 2016, we had 3 and 6 OEM contract manufacturers, respectively. Our sourcing strategy is based upon the quality of fabrics and workmanship that our customers expect from the KBS brand. The costs of our outsourced production amounted to approximately $8.38 million, $10.94 million and$26.1 million for years ended December 31, 2018, 2017 and 2016, respectively, accounting for approximately 27.3%, 31% and 66.8% of our total cost of sales in the respective periods.

 

As of December 31, 2018, our principal ODM and OEM contract suppliers included the following:

 

No.    
1  

Bai Tian Ni (Fujian) Clothing fabric Co. Ltd

2   Shishi Hua Lai Shi Clothing Co. Ltd
3   Jinjiang City Hongtawanheng trading Co. Ltd
4   Fujian Gumaite Clothing Technology Co. Ltd
5   Shishi Rongpeng Clothing Co. Ltd
6   Hubei Mingyuan Clothing Co. Ltd

 

We are not materially reliant on any single ODM or OEM contract supplier.

 

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Inventory Management

 

We recognize that controlling the level of inventory is important to our overall operational efficiency and cost control. Based on the purchase orders our distributors and the department store chains place at our biannual sales fairs, we are able to anticipate the demand for our products in advance and plan ahead for our own manufacturing and the orders we will be required to place with our ODM and OEM contract manufacturers. We generally plan purchases of raw materials and place manufacturing orders with our ODM and OEM contract manufacturers immediately after each of our two seasonal sales fairs, usually in May for our autumn and winter products and in October for our spring and summer products, where we confirm sales orders with our distributors and department store chains. This enables us and our ODM and OEM contract manufacturers to have sufficient time, ranging from two to eight weeks, to produce the products and provide our products suitable for a specific season to our distributors and department store chains on a just-in-time basis so as to minimize our inventory levels. The alternative way to control cost is when if we have chance to buy materials which the price is much lower than market price, we will buy it in advance and give to OEM contract manufactures use our material to produce.

 

Quality Control

 

Product quality control is a critical aspect of our business. Our dedicated quality control team performs various quality inspection and testing procedures, including random sample testing at different stages of our production process, to ensure that our products meet or exceed the expectations of our consumers. We also perform routine product inspections on every batch of our products and sample testing to ensure consistent quality of our products, including semi-finished and finished products.

 

We have implemented a centralized system for procurement and inspection of raw materials and ancillary components to help ensure a stable and high quality supply. Those materials and components that fail to meet our tests may be returned to the suppliers for replacement. Our quality control team also carries out quality control procedures on the products produced by our ODM and OEM contract manufacturers. We conduct on-site inspections of our ODM and OEM contract manufacturers before we enter into business relationships with them. We also send our in-house quality control staff on-site to our ODM and OEM contract manufacturers to monitor the entire production process. The initial product inspections are performed on-site by our staff before these products are shipped to our headquarters for further inspection and storage in our warehouse. We also provide technical training to ODM and OEM contract manufacturers to assist them with quality control of the production processes and inspect pre-production samples and finished products from ODM and OEM contract manufacturers. We have not encountered any material disruptions to our business as a result of the failure of any of our ODM and OEM contract manufacturers to meet our quality standards.

 

In order to further improve the quality of our products and shorten our delivery cycle, we intend to increase our control over the manufacturing process and production cycle of our ODM and OEM contract manufacturers, primarily by requiring our ODM and OEM contract manufacturers to implement stricter and more comprehensive quality control procedures, which cover each stage of the production process, from raw material selection and procurement to finished products packaging and delivery. We also intend to apply more stringent standards for inspecting products manufactured for us by our ODM and OEM contract manufacturers.

 

Marketing and Advertising

 

We have conducted multi-channel marketing campaigns to advertise our products to our target customers through advertising in newspapers, magazines, the Internet, and billboards, and organizing regular and frequent in-store marketing activities and road shows.

 

We have implemented strict requirements on our distributors with respect to the display and promotion of our products to ensure consistent branding and enhance marketing results. Our distributors are required to ensure that our marketing strategies are implemented at the retail outlets managed or authorized by them, including displaying our products according to our specifications and using our billboard advertisements. We also assign sales representatives to monitor the in-store displays of our products at various retail outlets on a regular basis to help ensure that our retailers have followed our product display policies.

 

In the years ended December 31, 2018, 2017 and 2016 our total advertising and promotional expenses amounted to approximately $1.21 million, $1.59 million and $1.55 million, respectively, which accounted for approximately 6.6%, 7.5% and 3.8% of our revenues in the respective periods.

 

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Competition

 

The menswear industry in China is a fragmented industry. Competition mainly comes from local market players such as Exceed, Xiniya, Zuoan and Cabbeen. We believes that we differentiate ourselves by providing more fashionable, younger-looking and leisure products, and competitive pricing without giving up the casual feel of our products.

 

We compete primarily on the basis of product design, brand recognition, operational efficiency and a low cost structure. Some of our domestic competitors have a stronger customer base, greater resources and more industry expertise than us. However, we believe that we can continue to successfully compete with our local competitors due to our unique product designs.

 

Intellectual Property

 

We currently have the licenses to use two registered trademarks in the PRC.

 

The registered trademarks on which we have licenses are the following:

 

Trademark   Registration No.     Valid Term
KBS     4342760     Jan 1, 2019 - August 28, 2028
             
Ka bi sports     5462336     March 14, 2010 - March 12,2020

 

We believe that these trademarks provide significant value as they are important for marketing and building brand recognition. We are not aware of any third party currently using trademarks similar to our trademarks in the PRC on the same products.

 

Insurance

 

We do not have any business liability, interruption or litigation insurance coverage for our operations in China. Insurance companies in China offer limited business insurance products. While business interruption insurance is available to a limited extent in China, we have determined that the risks of interruption, cost of such insurance and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to have such insurance. Therefore, we are subject to business and product liability exposure. See “Risk Factors—Risks Related to Our Business—We have limited insurance coverage in China and may not be able to recover insurance proceeds if we experience uninsured losses.”

 

Regulation

 

Because our primary operating subsidiaries are located in China, we are subject to China’s national and local laws detailed below. We believe that we are in material compliance with all registrations and requirements for the issuance and maintenance of all licenses required by the governing bodies and that all license fees and filings are current. This section summarizes the major PRC regulations relating to our business.

 

Regulations Relating to Foreign Investment

 

Investment activities in the PRC by foreign investors are mainly governed by the Guidance Catalog of Industries for Foreign Investment (2017 revision), or the Catalog, which was promulgated jointly by MOFCOM and the National Development and Reform Commission, or the NDRC, on June 28, 2017 and entered into force on July 28, 2017. The Catalog divides industries into four categories in terms of foreign investment, which are “encouraged,” “restricted,” and “prohibited,” and all industries that are not listed under one of these categories are deemed to be “permitted.” Establishment of wholly foreign-owned enterprises is generally allowed in encouraged and permitted industries. Some restricted industries are limited to equity or contractual joint ventures, while in some cases Chinese partners are required to hold the majority interests in such joint ventures. In addition, foreign investment in restricted category projects is subject to government approvals. Foreign investors are not allowed to invest in industries in the prohibited category. Industries not listed in the Catalogue are generally open to foreign investment unless specifically restricted by other PRC regulations.

 

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In June 2018, MOFCOM and NDRC promulgated the Special Management Measures (Negative List) for the Access of Foreign Investment, or the Negative List, effective July 2018. The Negative List expands the scope of permitted industries by foreign investment by reducing the number of industries that fall within the Negative List where restrictions on the shareholding percentage or requirements on the composition of board or senior management still exists. Foreign investment in value-added telecommunications services (except for e-commerce) falls within the Negative List.

 

In October 2016, MOFCOM issued the Interim Measures for Record-filing Administration of the Establishment and Change of Foreign-invested Enterprises, or FIE Record-filing Interim Measures, most recently amended in July 2017. Pursuant to FIE Record-filing Interim Measures, the establishment and change of foreign-invested enterprises are subject to record-filing procedures, instead of prior approval requirements, provided that such establishment or change does not involve special entry administration measures. If the establishment or change of foreign-invested enterprises matters involve the special entry administration measures, the approval of the Ministry of Commerce or its local counterparts is still required.

 

Regulations Relating to Product Quality

 

The principal legal provisions governing product liability are set forth in the PRC Product Quality Law, which was promulgated in February 1993 by the SCNPC and amended in July 2000 and August 2009.

 

The PRC Product Quality Law stipulates the responsibilities and obligations of product sellers and producers. Violations of the PRC Product Quality Law may result in the imposition of fines. In addition, the seller or producer may be ordered to suspend its operations, and its business license may be revoked. There may also be criminal liability in serious cases.

 

According to the PRC Product Quality Law, consumers or other victims who suffer injury or property losses due to product defects may demand compensation from the manufacturer as well as the seller. After compensating the consumer, the seller may recover the corresponding amount from the manufacturer if the manufacturer is responsible for the product defects, and vice versa.

 

Regulations Relating to Consumer Protection

 

The principal legal provisions for the protection of consumer interests are set forth in the Law of the PRC on Protection of Consumer Rights and Interests, or the Consumer Protection Law, which was promulgated in October 1993 amended in October 2013. The Consumer Protection Law sets forth standards of behavior that businesses must observe in their dealings with consumers.

 

Violations of the Consumer Protection Law may result in the imposition of fines. In addition, the violating entity may be ordered to suspend its operations, and its business license may be revoked. There may also be criminal liability in serious cases.

 

According to the Consumer Protection Law, if the legal rights and interests of a consumer are violated during the purchase or use of goods, the consumer may seek compensation from the seller. If the manufacturer or an upstream distributor is responsible, after compensating the consumer, the seller may recover the corresponding amount from the manufacturer or the upstream distributor. Consumers or other persons who suffer personal injury or property damages due to defects in products may seek compensation from the manufacturer as well as the seller. After compensating the consumer, the seller may recover the corresponding amount from the manufacturer if the manufacturer is responsible for the product defects, and vice versa.

 

Regulations Related to Trademarks

 

The PRC Trademark Law, adopted in 1982 and revised in 2001 and 2013, protects the proprietary rights to registered trademarks. The Trademark Office under the State Administration of Industry and Commerce handles trademark registration and grants a term of ten years to registered trademarks and another ten years to trademarks as requested upon expiry of the prior term. Trademark license agreements and transfer agreements must be filed with the Trademark Office for record.

 

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Regulations Relating to Environmental Matters

 

Our facilities are subject to various governmental regulations related to environmental protection. We use a myriad of chemicals in our operations and produce emissions that could pose environmental risks. Our manufacturing facilities are subject to various pollution control regulations with respect to noise, water and air pollution and the disposal of waste and hazardous materials, including, China’s Environmental Protection Law, Law of the People’s Republic of China on Appraising of Environment Impacts, China’s Law on the Prevention and Control of Water Pollution and its implementing rules, China’s Law on the Prevention and Control of Air Pollution and its implementing rules, China’s Law on the Prevention and Control of Solid Waste Pollution, and China’s Law on the Prevention and Control of Noise Pollution. We are subject to periodic inspections by local environmental protection authorities.

 

We did not incur material costs in environmental compliance in fiscal years 2018, 2017 and 2016. We believe we are in material compliance with the relevant PRC environmental laws and regulations. We are not currently subject to any pending actions alleging any violations of applicable PRC environmental laws.

 

Regulations Related to Employment

 

The PRC Labor Law and the Labor Contract Law require that employers must execute written employment contracts with full-time employees. All employers must compensate their employees with wages equal to at least the local minimum wage standards. Violations of the PRC Labor Law and the Labor Contract Law may result in the imposition of fines and other administrative sanctions, and serious violations may constitute criminal offences.

 

On December 28, 2012, the PRC Labor Contract Law was amended with effect on July 1, 2013 to impose more stringent requirements on labor dispatch. Under such law, dispatched workers are entitled to pay equal to that of full-time employees for equal work, but the number of dispatched workers that an employer hires may not exceed a certain percentage of its total number of employees as determined by the Ministry of Human Resources and Social Security. Additionally, dispatched workers are only permitted to engage in temporary, auxiliary or substitute work. According to the Interim Provisions on Labor Dispatch promulgated by the Ministry of Human Resources and Social Security on January 24, 2014, which became effective on March 1, 2014, the number of dispatched workers hired by an employer shall not exceed 10% of the total number of its employees (including both directly hired employees and dispatched workers). The Interim Provisions on Labor Dispatch require employers not in compliance with the PRC Labor Contract Law in this regard to reduce the number of its dispatched workers to below 10% of the total number of its employees prior to March 1, 2016.

 

Enterprises in China are required by PRC laws and regulations to participate in certain employee benefit plans, including social insurance funds, namely a pension plan, a medical insurance plan, an unemployment insurance plan, a work-related injury insurance plan and a maternity insurance plan, and a housing provident fund, and contribute to the plans or funds in amounts equal to certain percentages of salaries, including bonuses and allowances, of the employees as specified by the local government from time to time at locations where they operate their businesses or where they are located. The enterprise may be ordered to pay the full amount within a deadline if it fails to make adequate contributions to various employee benefit plans and may be subject to fines and other administrative sanctions.

  

Regulations Relating to Foreign Exchange

 

Regulations on Foreign Currency Exchange

 

Under the PRC Foreign Currency Administration Rules promulgated on January 29, 1996 and last amended on August 5, 2008 and various regulations issued by the State Administration of Foreign Exchange and other relevant PRC government authorities, payment of current account items in foreign currencies, such as trade and service payments, payment of interest and dividends can be made without prior approval from the State Administration of Foreign Exchange by following the appropriate procedural requirements. By contrast, the conversion of RMB into foreign currencies and remittance of the converted foreign currency outside the PRC for the purpose of capital account items, such as direct equity investments, loans and repatriation of investment, requires prior approval from the State Administration of Foreign Exchange or its local office.

 

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On February 13, 2015, the State Administration of Foreign Exchange promulgated the Circular on Simplifying and Improving the Foreign Currency Management Policy on Direct Investment, effective from June 1, 2015, which cancels the requirement for obtaining approvals of foreign exchange registration of foreign direct investment and overseas direct investment from the State Administration of Foreign Exchange. The application for the registration of foreign exchange for the purpose of foreign direct investment and overseas direct investment may be filed with qualified banks, which, under the supervision of the State Administration of Foreign Exchange, may review the application and process the registration.

 

The Circular of the State Administration of Foreign Exchange on Reforming the Management Approach regarding the Settlement of Foreign Capital of Foreign-invested Enterprise was promulgated on March 30, 2015 and became effective on June 1, 2015. According to this Circular, a foreign-invested enterprise may, according to its actual business needs, settle with a bank the portion of the foreign exchange capital in its capital account for which the relevant foreign exchange bureau has confirmed monetary contribution rights and interests (or for which the bank has registered the account-crediting of monetary contribution). For the time being, foreign-invested enterprises are allowed to settle 100% of their foreign exchange capitals on a discretionary basis; a foreign-invested enterprise shall truthfully use its capital for its own operational purposes within the scope of business; where an ordinary foreign-invested enterprise makes domestic equity investment with the amount of foreign exchanges settled, the invested enterprise shall first go through domestic re-investment registration and open a corresponding Account for Foreign Exchange Settlement Pending Payment with the foreign exchange bureau (bank) at the place of registration. The Circular of the State Administration of Foreign Exchange on Reforming and Regulating Policies on the Control over Foreign Exchange Settlement of Capital Accounts was promulgated and became effective on June 9, 2016. According to this Circular, enterprises registered in PRC may also convert their foreign debts from foreign currency into Renminbi on self-discretionary basis. This Circular provides an integrated standard for conversion of foreign exchange under capital account items (including but not limited to foreign currency capital and foreign debts) on self—discretionary basis, which applies to all enterprises registered in the PRC. This Circular reiterates the principle that Renminbi converted from foreign currency-denominated capital of a company may not be directly or indirectly used for purposes beyond its business scope and may not be used for investments in securities or other investment with the exception of bank financial products that can guarantee the principal within the PRC unless otherwise specifically provided. Besides, the converted Renminbi shall not be used to make loans for related enterprises unless it is within the business scope or to build or to purchase any real estate that is not for the enterprise own use with the exception for the real estate enterprise.

 

On January 26, 2017, the State Administration of Foreign Exchange promulgated the Circular on Further Improving Reform of Foreign Exchange Administration and Optimizing Genuineness and Compliance Verification, which stipulates several capital control measures with respect to the outbound remittance of profits from domestic entities to offshore entities, including (i) banks must check whether the transaction is genuine by reviewing board resolutions regarding profit distribution, original copies of tax filing records and audited financial statements, and (ii) domestic entities must retain income to account for previous years’ losses before remitting any profits. Moreover, pursuant to this Circular, domestic entities must explain in detail the sources of capital and how the capital will be used, and provide board resolutions, contracts and other proof as a part of the registration procedure for outbound investment.

 

Regulations on Foreign Exchange Registration of Overseas Investment by PRC Residents

 

The State Administration of Foreign Exchange issued the Circular on Relevant Issues Relating to Domestic Resident’s Investment and Financing and Roundtrip Investment through Special Purpose Vehicles, or Circular 37, which became effective in July 2014, to replace the Circular of the State Administration of Foreign Exchange on Issues Concerning the Regulation of Foreign Exchange in Equity Finance and Roundtrip Investments by Domestic Residents through Offshore Special Purpose Vehicles, to regulate foreign exchange matters in relation to the use of special purpose vehicles by PRC residents or entities to seek offshore investment and financing or conduct round trip investment in China. Circular 37 defines a “special purpose vehicle” as an offshore entity established or controlled, directly or indirectly, by PRC residents or entities for the purpose of seeking offshore financing or making offshore investment, using legitimate onshore or offshore assets or interests, while “round trip investment” is defined as direct investment in China by PRC residents or entities through special purpose vehicles, namely, establishing foreign-invested enterprises to obtain the ownership, control rights and management rights. Circular 37 stipulates that, prior to making contributions into a special purpose vehicle, PRC residents or entities be required to complete foreign exchange registration with the State Administration of Foreign Exchange or its local branch. In addition, the State Administration of Foreign Exchange promulgated the Notice on Further Simplifying and Improving the Administration of the Foreign Exchange Concerning Direct Investment in February 2015, which amended Circular 37 and became effective on June 1, 2015, requiring PRC residents or entities to register with qualified banks rather than the State Administration of Foreign Exchange in connection with their establishment or control of an offshore entity established for the purpose of overseas investment or financing.

 

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PRC residents or entities who had contributed legitimate onshore or offshore interests or assets to special purpose vehicles but had not obtained registration as required before the implementation of the Circular 37 must register their ownership interests or control in the special purpose vehicles with qualified banks. An amendment to the registration is required if there is a material change with respect to the special purpose vehicle registered, such as any change of basic information (including change of the PRC residents, name and operation term), increases or decreases in investment amount, transfers or exchanges of shares, and mergers or divisions. Failure to comply with the registration procedures set forth in Circular 37 and the subsequent notice, or making misrepresentation on or failure to disclose controllers of the foreign-invested enterprise that is established through round-trip investment, may result in restrictions being imposed on the foreign exchange activities of the relevant foreign-invested enterprise, including payment of dividends and other distributions, such as proceeds from any reduction in capital, share transfer or liquidation, to its offshore parent or affiliate, and the capital inflow from the offshore parent, and may also subject relevant PRC residents or entities to penalties under PRC foreign exchange administration regulations. See “Risk Factors—Risks Related to Doing Business in China—PRC regulations relating to investments in offshore 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 or limit our PRC subsidiary’s ability to increase their registered capital or distribute profits.”

 

Regulations on Stock Incentive Plans

 

The State Administration of Foreign Exchange promulgated the Notice on Issues Concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly Listed Company, or the Stock Incentive Plan Notice, in February 2012, replacing the previous rules issued by the State Administration of Foreign Exchange in March 2007. Pursuant to the Stock Incentive Plan Notice and other relevant rules and regulations, PRC residents participating in stock incentive plan in an overseas publicly-listed company are required to register with the State Administration of Foreign Exchange or its local branches and follow certain other procedures. Participants of a stock incentive plan who are PRC residents must conduct the registration and other procedures with respect to the stock incentive plan through a qualified PRC agent, which could be a PRC subsidiary of the overseas publicly listed company or another qualified institution appointed by the PRC subsidiary. In addition, the PRC agent is required to update the relevant registration should there be any material change to the stock incentive plan, the PRC agent or other material changes. The PRC agent must, on behalf of the PRC residents who have the right to exercise the employee stock options, apply to the State Administration of Foreign Exchange or its local branches for an annual quota for the payment of foreign currencies in connection with the PRC residents’ exercise of the employee stock options. The foreign exchange proceeds received by the PRC residents from the sale of shares under the stock incentive plans granted and dividends distributed by the overseas listed companies must be remitted into the bank accounts in the PRC opened by the PRC agents prior to distribution to such PRC residents.

 

We have adopted an equity incentive plan in 2018, under which we will have the discretion to award incentives and rewards to eligible participants. We have advised the recipients of awards under our equity incentive plan to handle relevant foreign exchange matters in accordance with the Stock Incentive Plan Notice. However, we cannot guarantee that all employee awarded equity-based incentives can successfully register with SAFE in full compliance with the Stock Incentive Plan Notice. See “Risk Factors—Risks Related to Doing Business in China—Any failure to comply with PRC regulations regarding employee share incentive plans may subject the PRC plan participants or us to fines and other legal or administrative sanctions.”

 

Regulations on Dividend Distribution

 

Distribution of dividends of foreign investment enterprises are mainly governed by the Foreign Investment Enterprise Law, issued in 1986 and amended in 2000 and 2016, respectively, and the Implementation Rules under the Foreign Investment Enterprise Law, issued in 1990 and amended in 2001 and 2014, respectively. Under these regulations, foreign investment enterprises in the PRC may distribute dividends only out of their accumulative profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, no less than 10% of the accumulated profits of the foreign investment enterprises in the PRC are required to be allocated to fund certain reserve funds each year unless these reserves have reached 50% of the registered capital of the enterprises. A PRC company is not permitted to distribute any profits until any losses from previous fiscal years have been offset. Profits retained from prior fiscal years may be distributed together with distributable profits from the current fiscal year. Under our current corporate structure, our Marshall Islands holding company may rely on dividend payments from Hongri PRC, which is a wholly foreign-owned enterprise incorporated in China, to fund any cash and financing requirements we may have. Limitation on the ability of our other PRC subsidiaries to make remittance to Hongri PRC and on the ability of Hongri PRC to pay dividends to us could limit our ability to access cash generated by the operations of those entities. See “Risk Factors—Risks Related to Doing Business in China—We rely to a significant extent on dividends and other distributions on equity paid by our principal operating subsidiary to fund offshore cash and financing requirements.”

 

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Regulations Relating to Overseas Listings

 

On August 8, 2006, six PRC regulatory agencies, including the Ministry of Commerce, the State-Owned Assets Supervision and Administration Commission, the State Administration of Taxation, the State Administration for Industry and Commerce, the China Securities Regulatory Commission and the State Administration of Foreign Exchange, jointly issued the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, which became effective on September 8, 2006 and was amended on June 22, 2009. These regulations, among other things, require that (i) PRC entities or individuals obtain approval from the Ministry of Commerce before they establish or control a special purpose vehicle overseas, provided that they intend to use the special purpose vehicle to acquire their equity interests in a PRC company at the consideration of newly issued share of the special purpose vehicle, or Share Swap, and list their equity interests in the PRC company overseas by listing the special purpose vehicle in an overseas market; (ii) the special purpose vehicle obtains approval from the Ministry of Commerce before it acquires the equity interests held by the PRC entities or PRC individual in the PRC company by Share Swap; and (iii) the special purpose vehicle obtains China Securities Regulatory Commission approval before it lists overseas. See “Risk Factors—Risks Related to Doing Business in China—The approval of the China Securities Regulatory Commission may be required in connection with this offering under a PRC regulation. The regulation also establishes more complex procedures for acquisitions conducted by foreign investors that could make it more difficult for us to grow through acquisitions.”

 

Regulations Relating to Taxation

 

Dividend Withholding Tax

 

In March 2007, the National People’s Congress enacted the Enterprise Income Tax Law which became effective on January 1, 2008 and amended on February 24, 2017. According to Enterprise Income Tax Law, dividends generated after January 1, 2008 and payable by a foreign-invested enterprise in China to its foreign enterprise investors are subject to a 10% withholding tax, unless any such foreign investor’s jurisdiction of incorporation has a tax treaty with China that provides for a preferential withholding arrangement. Pursuant to the Notice of the State Administration of Taxation on Negotiated Reduction of Dividends and Interest Rates, issued on January 29, 2008 and supplemented and revised on February 29, 2008, and the Arrangement between Mainland China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and Prevention of Fiscal Evasion with Respect to Taxes on Income, which became effective on December 8, 2006 and applicable to income derived in any year of assessment commencing on or after April 1, 2007 in Hong Kong and in any year commencing on or after January 1, 2007 in the PRC, such withholding tax rate may be lowered to 5% if a Hong Kong enterprise is deemed the beneficial owner of any dividend paid by a PRC subsidiary by PRC tax authorities and holds at least 25% of the equity interest in that particular PRC subsidiary at all times within the 12-month period immediately prior to the distribution of the dividends. Furthermore, pursuant to the Announcement on Issues concerning “Beneficial Owners” in Tax Treaties issued on February 3, 2018 by the State Administration of Taxation, when determining the status of “beneficial owners,” a comprehensive analysis may be conducted through materials such as articles of association, financial statements, records of capital flows, minutes of board of directors, resolutions of board of directors, allocation of manpower and material resources, the relevant expenses, functions and risk assumption, loan contracts, royalty contracts or transfer contracts, patent registration certificates and copyright certificates, etc. However, even if an applicant has the status as a “beneficiary owner,” if the competent tax authority finds necessity to apply the principal purpose test clause in the tax treaties or the general anti-tax avoidance rules stipulated in domestic tax laws, the general anti-tax avoidance provisions shall apply.

 

Enterprise Income Tax

 

In December 2007, the State Council promulgated the Implementing Rules of the Enterprise Income Tax Law, which became effective on January 1, 2008. The Enterprise Income Tax Law and its relevant implementing rules (i) impose a uniform 25% enterprise income tax rate, which is applicable to both foreign-invested enterprises and domestic enterprises (ii) permits companies to continue to enjoy their existing tax incentives, subject to certain transitional phase-out rules and (iii) introduces new tax incentives, subject to various qualification criteria.

 

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The Enterprise Income Tax Law also provides that enterprises organized under the laws of jurisdictions outside China with their “de facto management bodies” located within China may be considered PRC resident enterprises and therefore be subject to PRC enterprise income tax at the rate of 25% on their worldwide income. The implementing rules further define the term “de facto management body” as the management body that exercises substantial and overall management and control over the production and operations, personnel, accounts and properties of an enterprise. If an enterprise organized under the laws of jurisdiction outside China is considered a PRC resident enterprise for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, it would be subject to the PRC enterprise income tax at the rate of 25% on its worldwide income. Second, a 10% withholding tax would be imposed on dividends it pays to its non-PRC enterprise shareholders and with respect to gains derived by its non-PRC enterprise shareholders from transfer of its shares.

 

On October 17, 2017, the State Administration of Taxation issued the Bulletin on Issues Concerning the Withholding of Non-PRC Resident Enterprise Income Tax at Source, or Bulletin 37, which replaced the Notice on Strengthening Administration of Enterprise Income Tax for Share Transfers by Non-PRC Resident Enterprises issued by the State Administration of Taxation on December 10, 2009, and partially replaced and supplemented rules under the Bulletin on Issues of Enterprise Income Tax on Indirect Transfers of Assets by Non-PRC Resident Enterprises, or Bulletin 7, issued by the State Administration of Taxation on February 3, 2015. Under Bulletin 7, an “indirect transfer” of assets, including equity interests in a PRC resident enterprise, by non-PRC resident enterprises may be re-characterized and treated as a direct transfer of PRC taxable assets, if such arrangement does not have a reasonable commercial purpose and was established for the purpose of avoiding payment of PRC enterprise income tax. As a result, gains derived from such indirect transfer may be subject to PRC enterprise income tax. In respect of an indirect offshore transfer of assets of a PRC establishment, the relevant gain is to be regarded as effectively connected with the PRC establishment and therefore included in its enterprise income tax filing, and would consequently be subject to PRC enterprise income tax at a rate of 25%. Where the underlying transfer relates to the immoveable properties in China or to equity investments in a PRC resident enterprise, which is not effectively connected to a PRC establishment of a non-resident enterprise, a PRC enterprise income tax at 10% would apply, subject to available preferential tax treatment under applicable tax treaties or similar arrangements, and the party who is obligated to make the transfer payments has the withholding obligation. Pursuant to Bulletin 37, the withholding party shall declare and pay the withheld tax to the competent tax authority in the place where such withholding party is located within seven days from the date of occurrence of the withholding obligation. Both Bulletin 37 and Bulletin 7 do not apply to transactions of sale of shares by investors through a public stock exchange where such shares were acquired from a transaction through a public stock exchange. See “Risk Factors—Risks Related to Doing Business in China—We and our existing shareholders face uncertainties with respect to indirect transfers of equity interests in PRC resident enterprises or other assets attributed to a Chinese establishment of a non-Chinese company, or immovable properties located in China owned by non-Chinese companies.”

 

Value-Added Tax

 

In November 2011, the Ministry of Finance and the State Administration of Taxation promulgated the Pilot Plan for Imposition of Value-Added Tax to Replace Business Tax. In March 2016, the Ministry of Finance and the State Administration of Taxation further promulgated the Notice on Fully Promoting the Pilot Plan for Replacing Business Tax by Value-Added Tax. Pursuant to this Pilot Plan and the relevant notice, value added tax at a rate of 6% is generally imposed, on a nationwide basis, on the revenue generated from the provision of service in lieu of business tax in the modern service industries. Value added tax of a rate of 6% applies to revenue derived from the provision of some modern services. Unlike business tax, a taxpayer is allowed to offset the qualified input value added tax paid on taxable purchases against the output value added tax chargeable on the modern services provided.

 

C. Organizational Structure

 

See “—A. History and Development of the Company—Corporate Structure” above for details of our current organizational structure.

 

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D. Property, Plants and Equipment

 

Our company has established a nationwide distribution network covering 12 of China’s 32 provinces and centrally administered municipalities. As of December 31, 2018, this network was comprised of 1 corporate store owned and operated by us and 32 franchised stores operated by 11 third-party distributors or their sub-distributors.

 

Relocated from Shishi City, Fujian, China in March 2011, our company’s production facility is currently located in Taihu City in Anhui Province, China. The facility has a production capacity of 2 million pieces per year and we move in upon the completion of phase 2 in year 2015. By relocating from the coastal area to Anhui Province, our new facility takes advantage of lower labor costs and a more stable labor supply. We manufacture a variety of menswear products, including, jeans, shirts, suits and socks. Because of its variety and complexity in the production process, these products require special sewing machines and workmanship, which we currently do not possess. As a result, the Company is not yet able to produce KBS branded products and has outsourced its KBS branded product manufacturing to other established ODM and OEM manufacturers in the Fujian and Zhejiang regions. The Company has completed the second phase construction of its new factory at the end of 2014. The second phase has an annual production capacity of 5 million pieces subject to our purchasing additional equipment. Currently Anhui factory mainly produces OEM orders and some international orders.

 

Our production facility consists of total 110,557 square meters of land. We obtained a portion of such land use rights for two parcels of land of 7,405 square meters and 2,440 square meters in May 2012 and have finished the construction of 8,572 square meters of staff dormitories and 22,292 square meters as workshop buildings and offices. We started to use the dormitory and factory in year 2015 and moved into the offices at the beginning of 2016. Due to the local government’s need for additional time to conclude negotiations with local residents over appropriate resettlement terms, the construction of the adjacent facility on the third parcel of land has been delayed. We believe we will be in a better position to schedule our construction plan once we acquire the land use right of the third parcel of land. Once the construction of the new production facilities is completed, our total production capacity of the facility is expected to increase to 20 million pieces per year from the current capacity of 2 million pieces per year.

 

In 2016, we closed 1 corporate store and as of December 31, 2018, we leased the premises for our sole remaining corporate store. We have undertaken various measures to verify the lessees’ rights to the property leased to us in respect of its stores. In China, all land is owned by the State or other governmental bodies, and “ownership” is generally evidenced by a land use rights certificate. We rent some stores that were located in rural areas where land use rights are held collectively by villages and records regarding the ownership of land use rights are frequently not kept. In these cases, the company has confirmed our ability to lease the stores through communications with village authorities, and has reviewed electricity and water bills to confirm utilities are being paid by the parties leasing the premises to us. Based on the results of these efforts, we believe the risk of third party claims against our leases of these stores is relatively small and the measures taken by our company are sufficient to verify the land use rights for all of its stores.

 

In addition, the property used as our head office and corporate store is leased from a related party, whose ownership of the property has been verified by our company. We paid a total of RMB720,000, RMB 720,000, and RMB 720,000, as rental fees for the existing corporate stores during the fiscal years 2016, 2017 and 2018, respectively. The total area of these 2 corporate stores is 158 square meters. The sales of each store and its location are shown below:

 

Area   Sales in fiscal year 2016(USD)     Sales in fiscal year 2017(USD)     Sales in fiscal year 2018(USD)  
Shishi factory     1,240,354.74       772,299       691,431  
Quanzhou Dayang (closed in 2016)     470,280.90       -     -
Total:     1,710,635.64       772,299       691,431  

 

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ITEM 4A. UNRESOLVED STAFF COMMENTS

 

Not required.

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

We are engaged in the design, development, marketing and sale of casual menswear in China, including apparel and accessories, which we market under the KBS brand. The KBS brand was developed in 2006. Before 2012, we were engaged in the design, development, marketing and sale of fashion sportswear in China. Since our products feature a unique and stylish design that is more fashionable than traditional sportswear, as well as quality fabrics and materials and the sportswear market was becoming more and more competitive, in late 2011 we turned our focus on casual menswear market which has higher profit margin. KBS’s apparel products include cotton and down jackets, sweaters, shirts, T-shirts, Jeans and trousers. Accessories include shoes, bags, belts and caps. In 2016, the suggested retail prices of KBS’s products ranged from RMB199 to RMB1,499 for its apparel products and RMB15 to RMB899 for its accessory products. KBS holds new products launch events twice every year, one in spring and the other in autumn. Since 2006, we have launched about 1,500 ,536 collections of new products each year with a different theme to highlight the current trends for the season. KBS’s marketing concept is “French origin, Korean design and made for Chinese.” KBS’s customers are male middle-class consumers in the 20-40 age range, primarily located in tier two and tier three cities in China. The company has adopted “KBS” as a uniform brand name, which stands for “Keep Best Style”, and KBS are designed by us for a uniform look and feel that fits our brand image, with in-store displays that accentuate the quality and style of our products across all stores in our distribution network and on all products sold in those stores. We believe that the KBS brand has become a recognized brand name in the cities where their products are sold.

 

We have established a nationwide distribution network covering 10 of China’s 32 provinces and centrally administered municipalities. As of December 31, 2018, this network was comprised of 1 corporate store owned and operated by us and 32 franchised stores operated by 11 third-party distributors or their sub-distributors. The number of stores grew significantly from 1 corporate store and 7 franchised stores as of December 31, 2006 to 31 corporate stores as of December 31, 2012 and 96 franchised stores as of December 31, 2013, and decreased to 84 stores as of December 31, 2014. Because of the recent softening of economic growing in China and fierce competition from our competitors, online store sales of franchised stores and corporate stores went down in 2015 as compared with the previous year. In 2017 and 2018, the distributors closed 15 and 8 franchised stores, respectively, and we closed 1 corporate store in year 2016. We generate more revenues from OEM in 2018 and intend to generate more in OEM and target area from acquisitions.

 

KBS also acts as an original design manufacturer, or ODM, upon request. Income from such services accounted for 14%, 7.3% and 9% of revenue for the years ended December 31, 2018, 2017 and 2016, respectively.

 

Relocated from Shishi City, Fujian, China in March 2011, KBS’s production facility is currently located in Taihu City in Anhui Province, China. The company believes that the shortage of labor and rising wage expectations in China, especially in the coastal area, could have a material impact on our operations as well as its suppliers’ cost of manufacturing. By relocating from the coastal area to inland Anhui Province, our new facility takes advantage of lower labor costs and a more stable labor supply. Since the company’s original production team was not ready to produce the new style KBS products, KBS has outsourced its product manufacturing to other established ODM manufacturers. As such, KBS’s own production facility in Taihu mainly takes OEM orders from other sportswear companies, like Xtep. Our production facility in Taihu, Anhui Province includes three parcels of land with a total area of 110,557 square meters. We have obtained land use rights for two parcels of land with an area of 9,845 square meters in 2012 and have finished the construction of 8,572 square meters of staff dormitories and 22,292 square meters as workshop buildings and offices. We started to use the dormitory and factory in year 2015 and moved into the offices at the beginning of 2016. Due to the local government’s need for additional time to conclude negotiations with local residents over appropriate resettlement terms, the construction of the adjacent facility on the third parcel of land has been delayed. We believe we will be in a better position to schedule our construction plan once we acquire the land use right of the third parcel of land. Once the government settles with the local residents, the phase 3 and 4 can be continued. Once completed, our total production capacity of the facility is expected to increase to 20 million pieces per year from the current capacity of 2 million pieces per year. We do not necessarily rely on our own production facility to satisfy the demand of our products as we may outsource some or all of the production work to various ODM and OEM manufacturers in China.

 

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A. Principal Factors Affecting Financial Performance

 

Our operating results are primarily affected by the following factors:

 

  Growth of China’s menswear industry . With approximately one-fifth of the world’s population and a fast-growing gross domestic product, China represents a significant growth opportunity for a wide variety of retail goods, including apparel. The enhanced living standards and increased disposable income that has resulted from the vibrant economic growth has driven the rapid development of the men’s apparel market in China in recent years. China is currently one of the world’s largest men’s apparel markets. As a leading provider of casual menswear in China, we believe we are well positioned to capitalize on the favorable economic, demographic and industry trends in this sector.

 

Brand recognition . We derive all of our revenues from sales of the KBS branded products in China, and our success depends on the market perception and acceptance of the KBS brand and the culture, lifestyle and images associated with this brand. Market acceptance of our brand may affect the selling prices and market demand for our products, the profit margin of us can achieve, and our ability to grow.

 

  Ratio of franchised stores to corporate stores in our sales network The ratio of franchised stores to corporate stores in terms of floor area in our sales network affects our results of operations in a given period. The franchised stores operated by our distributors have been and will continue to be the main contributor to our revenue for the foreseeable future. Under the distribution business model, we sell directly to our distributors and recognize revenues upon delivery of our products to them. Such distribution network has enabled us to accelerate sales growth at a much lower cost than opening direct stores and has limited our inventory and sales risks. Corporate stores operated by us, on the other hand, despite incurring more significant capital expenditures as compared with franchised stores, allow us more control over our brand and the consumer’s shopping experience, which are important factors for the overall success of our business. In addition, our corporate store sales generally have a higher gross profit margin than sales to distributors because we are able to sell the products at retail prices directly to the end-consumers and because we recognize expenses relating to our corporate stores as selling and distribution expenses. Therefore, the ratio of franchised stores to corporate stores in our sales network will affect our gross profit margin.

 

Product offering and pricing . Our success depends on our ability to identify, originate and define menswear trends as well as to anticipate, gauge and react to changing consumer demands for menswear in a timely manner. Most of our products are subject to changing consumer preferences and fashion trends that cannot be predicted with certainty. Our new products may not receive consumer acceptance as consumer preferences could shift rapidly, and our future success depends in part on our ability to anticipate and respond to these changes.

 

Fluctuations in raw material supply and prices.  The per unit cost of producing our products depends on the supply and price of raw materials, particularly fabrics such as cotton, wool and polyester, which have experienced volatility in past years. Increases in the price of raw materials would negatively impact our gross margins if we are not able to offset such price increases through increases in our selling price or changes in product offerings and mix.

 

  Financial Statement Presentation

 

Revenue. During the periods covered by this section, we generated revenue from sales of our menswear products.

 

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Cost of sales. During the periods covered by this section, our cost of sales primarily consisted of the costs of our outsourcing cost, raw materials, labor and overhead. We did not have any inward or outward freight charges as these charges are borne by our distributors and suppliers.

 

Gross profit and gross margin. For the periods covered by this section, our gross profit is equal to the difference between our net sales and cost of sales. Our gross margin is equal to the gross profit divided by net sales. Our gross margin may not be comparable to those of other retail entities since some retail entities include all of their distribution network costs in cost of sales and others, like us, include these expenses in another statement of operations line item.

 

Administrative expenses. For the periods covered by this section, general and administrative expenses consisted primarily of compensation and benefits to our general management, finance and administrative staff, professional advisor fees, audit fees and other expenses incurred in connection with general operations.

 

Selling expenses. For the periods covered by this section, our selling and marketing expenses consisted primarily of compensation and benefits to our sales and marketing staff, store rent, business travel, coordination with distributor marketing and promotions, transportation costs and other sales related costs.

 

Comparison of Fiscal Years Ended December 31, 2018, 2017 and 2016

 

The following table sets forth key components of our results of operations, for the years ended December 31, 2018, 2017 and 2016, both in U.S. dollars and as a percentage of or revenue.

 

    Year ended
December 31, 2018
    Year ended
December 31, 2017
    Year ended
December 31, 2016
 
    Amount     % of Sales     Amount     % of Sales     Amount     % of Sales  
                                     
Revenue     18,535,115               23,762,536               41,200,205          
Cost of sales     -20,851,252       -112 %     -35,274,352       -148 %     -39,041,932       -95 %
Gross (loss)/profit     -2,316,137       -12 %     -11,511,816       -48 %     2,158,272       5 %
Operating expenses                                                
Distribution and selling expenses     -2,670,955       -14 %     -3,265,380       -14 %     -3,606,010       -9 %
Administrative expenses     -4,907,020       -26 %     -4,879,397       -21 %     -3,543,993       -9 %
Total operating expenses     -7,577,975       -41 %     -8,144,776       -34 %     -7,150,003       -17 %
Other income     122,139       1 %     461,564       2 %     555,051       1 %
Other gains and losses     -13,522,300       -73 %     -122,244       -1 %     -11,123,767       -27 %
Loss from operations     -23,294,273       -126 %     -19,317,272       -81 %     -15,560,447       -38 %
Finance costs     -96,444       1 %     -96,385       0 %     -71,783       0 %
Change in fair value of warrant liabilities     0       0 %     0       0 %     3,409       0 %
Loss before tax     -23,390,717       -126 %     -19,413,657       -82 %     -15,628,821       -38 %
Income tax     5,422,119       29 %     4,598,061       19 %     3,726,133       9 %
Loss for the year     -17,968,598       -97 %     -14,815,596       -62 %     -11,902,688       -29 %

 

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A breakdown of revenue, percentage of revenue and percentage of gross margin by segment for the respective periods is as follows:

 

By business   Distribution network     Corporate stores     OEM     Consolidated  
   

Year ended December 31,

2018

   

Year ended December 31,

2017

   

Year ended December 31,

2016

   

Year ended December 31,

2018

   

Year ended December 31,

2017

   

Year ended December 31,

2016

   

Year ended December 31,

2018

   

Year ended December 31,

2017

   

Year ended December 31,

2016

   

Year ended December 31,

2018

   

Year ended December 31,

2017

   

Year ended December 31,

2016

 
Sales to external customers     13,584,754       15,034,800       32,127,083       2,375,773       6,983,592       5,529,985       2,574,588       1,744,144       3,543,137       18,535,115       23,762,536       41,200,205  
Segment     13,584,754       15,034,800       32,127,083       2,375,773       6,983,592       5,529,985       2,574,588       1,744,144       3,543,137       18,535,115       23,762,536       41,200,205  
% of Sales     73 %     63 %     78 %     13 %     29 %     13 %     14 %     7 %     9 %     100 %     100 %     100 %
Segments gross margins     2,245,944       2,277,858       6,623,617       -5,402,994       -14,291,680       -5,727,349       845,700       502,007       1,262,005       -2,316,136       -11,511,816       2,158,273  
Gross margin rate     17 %     15 %     21 %     -227 %     -205 %     -104 %     33 %     29 %     36 %     -12 %     -48 %     5 %

 

Segment sales

 

For the year ended December 31, 2018, total revenue decreased by 22% from $23.8 million in 2017 to $18.5 million. Our total revenue of 2017 decreased by 33% from $41.2 million to $23.8 million for the year ended December 31, 2016. The Company reports financial and operating results in three segments: distributor network, corporate stores and OEM.

 

Distributor Network — Revenue from the Company’s distributor network in year 2018 decreased by 10% from $15 million in 2017 to $13 million primarily due to a decrease in sales volume. There was a decrease of revenue from the Company’s distributor network in year 2017 by 53% from $32.1 million in year 2016 primarily due to a decrease in sales volume. The distributor segment accounted for 73% of the total revenue in 2018, compared to 63% and 78% during years 2017 and 2016, respectively.

 

In year 2018, gross profit margin for the company’s distributor network increased to 17% from 15% for year 2017 as the company adjusted the selling price of new products. The sales went down in year 2018 because we suspended sales of new products to some distributors which failed to pay off debts to us due to overstock during previous periods. We also terminated some cooperation with some distributors due to their failure to pay off debts owed to us.

 

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In year 2017, gross profit margin for the company’s distributor network decreased to 15% from 21% for year 2017 as the company adjusted the selling price, and the sales went down in year 2017 because we suspended sales of new products to some distributors which failed to pay off debts to us due to overstock during previous periods. We also terminated some cooperation with some distributors due to their failure to pay off debts owed to us.

  

The Company’s distributor network currently consists of 11 distributors in 12 provinces. Most of these distributors, either directly or through their sub-distributors, operate KBS-branded stores. Some wholesale distributors sold the products to multi-branded stores and online stores. As of December 31, 2018, distributors operated a total of 32 KBS-branded stores, primarily in second and third tier cities. KBS products distributed to the fourth and fifth tier cities are primarily sold in multi-branded department stores.

 

Corporate Stores — Total revenue from corporate store sale for fiscal year 2018 was $2.37 million, compared to $6.98 million for year 2017. In 2018 sales from corporate store decreased as compared to 2017 due to a decrease in promotion sales of repurchased inventory from certain distributors which are unable to pay off the debts owed to us.

 

Total revenue from corporate store sales for fiscal year 2017 was $6.98 million, compared to $5.53 million for year 2016. In 2017 sales from corporate stores increased as compared to 2016 due to an increase in sales volume, which in turn was mainly attributable to the increase in promotion sales on repurchased inventory from certain distributors which are unable to pay off the debts owed to us.

 

As of December 31, 2018, we operated 1 corporate store which located in Fujian. Total revenue from corporate store sales of 2018 decreased as compared to 2017 because of the decrease the promotion sales of repurchased inventory.

 

The corporate store segment contributed 14% of total revenue in 2018, compared to 29% of 2017 and 13% of 2016. Gross profit margin for the Company’s corporate store was -232% in 2018, compared to -205% in 2017 and -104% in 2016. The margin compression from 2016 to 2018 is primarily due to: 1) close of 1 corporate store in 2016 and the sale of its inventory at a lower price; 2) reduction of sale price of our goods in corporate stores to stimulate sales; 3) loss from sales of repurchased inventory from certain distributors which sold at big discounted price in year 2017 and year 2018.

 

OEM The OEM segment is comprised of products that are designed by the customers but manufactured by us. Revenue from the OEM segment increased by $0.83 million to $2.57 million for year ended December 31, 2018, compared to $1.74 million for year ended December 31, 2017. Gross profit margin increased to 33% from 29% of year 2017. Revenue from the OEM segment decreased by $1.79 million to $1.74 million for year ended December 31, 2017, compared to $3.53 million for year ended December 31, 2016. Gross profit margin decreased to 29% from 36% of year 2016. Our revenues from sales of OEM represented 14%, 9% and 9%, respectively of our total revenues for years ended December 31, 2018, 2017 and 2016.

 

  Cost of sales and gross profit rate

 

Cost of sales comprises of purchasing materials, labor costs for personnel employed in production, depreciation of non-current assets used for production purpose, outsourced manufacturing cost, taxes and surcharges and water and electricity.

 

Our cost of sales decreased from $35 million in year 2017 to $21 million in year 2018. The decrease was mainly due to the decrease in repurchased inventory from certain distributors compared to year 2017.

 

The gross profit rate increased from -48% in year 2017 to -12% in year 2018 due to 1) a decrease in the number of promotion sales in repurchased inventory from certain distributors compared to year 2017. We reacquired excess inventory of RMB 55 million from certain distributors and sold at its net realizable value, which caused a loss at RMB 40 million; 2) the higher price of updated new products and improvement of products quality; 3) higher profit margin of OEM segments due to lower amortized fixed fees from big orders from certain customers. In order to keep long-term relationships with our distributors and support their continued operation, we decided to continue to buy back some excessive inventory from certain distributors in 2018 and thereafter.

 

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Our cost of sales decreased from $39 million in year 2016 to $35 million in year 2017. The decrease was consistent with the decrease in our revenue, which resulted in a decrease in purchases by $7 million. The decrease in purchases was mainly due to a challenging retail environment and close of some stores.

 

The gross profit rate decreased from 5% in year 2016 to -48% in year 2017 due to 1) a decrease in the number of our franchised stores from 55 as of December 31, 2016 to 40 as of December 31, 2017; 2)  in order to make more fair and friendly business environment for our all distributors, we adjusted our price policy to have same price to our district distributors and province distributors in 2017, the price sell to the district distributor is lower than before. 3) a slowdown in demand in menswear resulted from competition from online sales and other international brand, which led to an oversupply in recent years and our distributors faced difficulties in selling their products and paying back the balance owed to the company. We reacquired excess inventory of RMB 141.42 million from certain distributors and sold at its net realizable value, which caused a loss at RMB 98.52 million. Although we are not contractually obligated to buy back the excessive inventory from any our distributors, in order to keep long-term relationships with our distributors and support their continued operation, we decided to do same in 2017 to buy back some excessive inventory from certain distributors and we may implement similar plans in the following years.

 

Administrative expenses

 

Administrative expenses increased by $0.02 million or 1% to $4.9 million for year 2018 from $4.88 million for 2017. The change was mainly due to the decrease of outsourcing design expense and the increase of the company’s share-based compensation paid to officers and directors of the company.

 

Administrative expenses increased by $1.34 million or 37% to $4.88 million for year 2017 from $3.54 million for 2016. The increase was mainly due to the increase in design staff expenses and the increase attributable to the company’s share-based compensation paid to officers and directors of the company.

  

Distribution and selling expenses

 

The selling and distribution expenses decreased by $0.59 million or 18% to $2.7 million for the year ended December 31, 2018 from $ 3.2 million in 2017, primarily due to the decrease of advertisement expense, products promotion expenses and entertainment expenses.

 

The selling and distribution expenses decreased by $0.34 million or 9.45% to $3.2 million for the year ended December 31, 2017 from $ 3.6 million in 2016, primarily due to the decrease of advertisement expenses and promotion expense of products including placement order meeting expense.

  

The advertisement expenses of 2018, 2017 and 2016 are relatively even and selling expenses accounted for 6.6%, 7.5% and 9% for 2018, 2017 and 2016, respectively.

 

Other gains and losses

 

Other gains and losses increased by $13.4 million, or 10,875%, to -$13.52 million for the year ended December 31, 2018 from -$0.12 million for year 2017. The increase was mainly due to the impairment on Anhui property due to the decrease of its fair value.

 

Other gains and losses decreased by $11 million, or 98.9%, to -$0.12 million for the year ended December 31, 2017 from -$11.1 million for year 2016. The decrease was mainly due to the fact that there was no additional provision on bad debts from three clients as in 2016.

  

Profit for the year

 

We had a loss of $18 million in 2018 as compared to a loss of $14.81 million for 2017, representing a decrease of profit of $3 million or 21%. Net margin was -97% for the year ended December 31, 2018, compared to -62% for the year ended December 31, 2017.

 

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We had a loss of $14.81 million in 2017 as compared to a loss of $11.9 million for 2016, representing a decrease of profit of $2.91 million or -25%. Net margin was -62% for the year ended December 31, 2017, compared to -29% for the year ended December 31, 2016.

 

Profit for the year decreased from 2018 to 2017 mainly due to the following reasons:(1)the impairment on Anhui property due to the decrease of its fair value (2) the distribution and selling expenses decreased to a small portion of total revenue and the revenue also decreased compared to year ended December 31, 2017; (3) a slowdown in demand in menswear resulted from competition from online sales and other international brands, which led to an oversupply in recent years and our distributors faced difficulties in selling products and paying back the balance owed to us. We reacquired an excess inventory of RMB 55 million from certain distributors and sold at its net realizable value, which caused a loss at RMB 40 million.

 

Profit for the year decreased from 2016 to 2017 mainly due to the following reasons: (1) the administrative expenses increased to a large portion of total revenue; and (2) slowdown in demand in menswear resulted from competition from online sales and other international brand, which led to an oversupply in recent years and our distributors faced difficulties in selling their products and paying back the balance owed to the company. We reacquired an excess inventory of RMB 141.42 million from certain distributors and sold at its net realizable value, which caused a loss at RMB 98.52 million.

 

B. Liquidity and Capital Resources

 

As of December 31, 2018, we had cash and cash equivalents of $21,026,103. Our cash and cash equivalents consist of cash on hand and cash in the banks. We believe that our current levels of cash and cash equivalent and cash flows from operations will be sufficient to meet our anticipated cash needs for at least the next 12 months. To date, we have financed our operations primarily through net cash flow from operations. Our cash flows are driven by key performance indicators including the number of orders placed by distributors, number of outlets that each distributor operates the pricing of our products, sales of our corporate stores, and the collect portion of account receivable. Currently there is only minimal cash held by offshore subsidiaries and there is no need for these subsidiaries to transfer cash to Hongri PRC.

  

The following table provides detailed information about our net cash flow for all financial statement periods presented in this report:

 

    Fiscal Year Ended December 31  
    2018     2017     2016  
Net cash provided by (used in) operating activities   $ (3,703,354 )   $ 1,922,252     $ 3,194,287  
Net cash provided by (used in) investing activities     52,932       (865,365 )     45,445  
Net cash provided by (used in) financing activities     (256,870 )     (1,095,910 )     1,679,509  
Net increase (decrease) in cash and cash equivalents     (3,907,291 )     (39,024 )     4,919,241  
Effects  of exchange rate change in cash     (1,117,062 )     1,513,138       (1,556,980 )
Cash and cash equivalents at beginning of the period     26,050,456       24,576,341       21,214,080  
Cash and cash equivalent at end of the period   $ 21,026,103     $ 26,050,456     $ 24,576,341  

 

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Operating Activities

 

The net cash provided by operating activities consists of profit before tax, as adjusted by finance costs, change in fair value of warrant liabilities, interest income, shared based compensation, bad debt allowance, depreciation of property, plant and equipment, amortization of prepaid lease payment and trademark, amortization of subsidies prepaid to distributors, amortization of prepayment and premiums under operating leases, provision(Reversal) of inventory obsolescence, provision of impairment loss in prepayments, loss(gain) on disposal of property, plant and equipment, deferred income tax, which include trade and other receivables, prepayment and deferred expenses, inventory, trade and other payables.

 

Net cash used in operating activities in fiscal year 2018 was $3.7 million, compared with net cash provided by operating activities of $1.9 million in the year ended December 31, 2017. The change is mainly due to the increase of provision of Anhui property and the increase of deferred tax due to the loss of fiscal year 2018.

 

Net cash provided by operating activities in fiscal year 2017 was $1.9 million, compared with $3.2 million in the year ended December 31, 2016. The change is mainly due to the decrease in the amount of collection of account receivable.

 

Investing Activities

 

Net cash provided by investing activities in fiscal year 2018 was $0.05 million, compared with $0.8 million net cash used in investing activities in 2017. The net cash provided in investing activities in 2018 was interest received from our bank deposits.

 

Net cash used in investing activities in fiscal year 2017 was $0.8 million, compared with $0.04 million net cash provided by investing activities in 2016. The net cash used in investing activities in 2017 was to purchase fire protection facility.

 

Financing Activities

 

Net cash used in financing activities in fiscal year 2018 was $0.26 million, compared with $1.1 million net cash used in financing activities in 2017. It mainly consisted of repayment of bank loans in 2018.

 

Net cash used in financing activities in fiscal year 2017 was $1.1 million, compared with $1.68 million net cash provided by financing activities in 2016. It mainly consisted of interests paid for our bank loans.

 

Loans, Other Commitments, Contingencies

 

As of December 31, 2018, we had bank loans in an amount of $1,092,785. We may, however, in the future, require additional cash resources due to changing business conditions, implementation of our strategy to expand our business or other investments or acquisitions we may decide to pursue. If our own financial resources are insufficient to satisfy the capital requirements, we may seek to sell additional equity or debt securities or obtain additional credit facilities. The sale of additional equity securities could result in dilution to our stockholders. The incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operating and financial covenants that would restrict our operations. Financing may not be available in amounts or on terms acceptable to us, if at all. Any failure by us to raise additional funds on terms favorable to us, or at all, could limit our ability to expand our business operations and could harm our overall business prospects.

 

C. Research and Development, Patents and Licenses, Etc.

 

Our industry is characterized by rapid technological change, evolving industry standards and changing customer demands. These conditions require continuous expenditures on product research and development to enhance existing products create new products and avoid product obsolescence. See Item 3 “Key Information—D. Risk Factors—If we are unable to develop competitive new products and service offerings our future results of operations could be adversely affected,” —“If we are unable to keep pace with the rapid technological changes in our industry, demand for our products and services could decline which would adversely affect our revenue,” and —“Our technology may become obsolete which could materially adversely affect our ability to sell our products and services.” For a detailed analysis of research and development costs, see Item 5.A. “Operating Results—Results of Operations—Research and development expenses”.

 

D. Trend Information

 

Other than as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demands, commitments or events for the year ended December 31, 2018 that are reasonably likely to have a material adverse effect on our net revenues, income, profitability, liquidity or capital resources, or that would cause the disclosed financial information to be not necessarily indicative of future operating results or financial conditions.

 

E. Off Balance Sheet Arrangements

 

We do not have any off balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, sales or expenses, results of operations, liquidity or capital expenditures, or capital resources that are material to an investment in our securities.

 

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F. Tabular Disclosure of Contractual Obligations

 

The table below shows our material contractual obligations as of December 31, 2018.

 

    Payments Due by Period  
    Less than
1 year
    1-3 years     3-5 years     More than
5 years
 
Contractual Obligations                        
Construction Obligations   $ 64,088,236                                                          
Operating Lease Obligations   $ 78,532       146,705       2,225,030      
Total   $ 64,166,768       146,705       2,225,030          

 

Anhui Factory Construction Contract

 

On November 20, 2010, Hongri PRC entered into an agreement with a third party for the construction of a new plant with a total size of 110,557 square meters, at Taihu City, Anhui at a consideration of RMB 690 million (equivalent to approximately $104 million). This is the frame contract for the construction of Anhui factory and round estimation. By December 31, 2016 we had already paid about $37.75 million in total on the phase 1, 2, 3 of construction based on detailed phase contract and the balance of construction cost of the Anui factory need to be determined based on the on-time budget on every phase. The majority of funds for construction expenses came from the cash balance on the account as of December 31, 2018 and the new profit of following year.

 

Anhui Land Use Right Acquisition Contract

 

On September 2, 2010, Hongri PRC entered into an agreement with a third party to acquire a land use right in relation to the development of factories in Taihu City, Anhui Province, at a total consideration of RMB 43 million (approximately $6.3 million). Full consideration was paid in September 2010. There are three parts of the land. The Company has obtained land use rights certificates for the first parcel of land with 7,405 square meters on March 19, 2012, and the second parcel of land with 2,440 square meters on May 26, 2012. The Company is currently in the process of obtaining the land use right certificate for the third parcel of the land with 100,712 square meters.

 

Except as set forth above, we have no other material long-term debt, capital or operating lease or fixed purchase obligations.

 

Inflation

 

Inflation and changing prices have not had a material effect on our business, and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future. However, our management will closely monitor price changes in the Chinese economy and the apparel industry and continually maintain effective cost controls in operations.

 

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Seasonality

 

Our business, like that of many retailers, is seasonal. Historically, we have realized more of our revenue and earnings in the fourth quarter, which includes the majority of the holiday shopping season, than in any other fiscal quarter.

 

Critical Accounting Policies

 

The preparation of financial statements is in conformity with IFRS as issued by the IASB. It requires the Company’s management to make assumptions, estimates and judgments that affect the amounts reported, including the notes thereto, and related disclosures of commitments and contingencies, if any. The Company has identified certain accounting policies that are significant to the preparation of Company’s financial statements. These accounting policies are important for an understanding of the Company’s financial condition and results of operation. Critical accounting policies are those that are most important to the portrayal of the Company’s financial condition and results of operations and require management’s difficult, subjective, or complex judgment, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. Certain accounting estimates are particularly sensitive because of their significance to financial statements and because of the possibility that future events affecting the estimate may differ significantly from management’s current judgments. The Company believes the following critical accounting policies involve the most significant estimates and judgments used in the preparation of the Company’s financial statements.

 

Revenue recognition (applicable from January 1, 2018)

 

Revenue from contracts with customers

 

Revenue from contracts with customers is recognised when control of goods or services is transferred to the customers at an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services.

 

When the consideration in a contract includes a variable amount, the amount of consideration is estimated to which the Company will be entitled in exchange for transferring the goods or services to the customer. The variable consideration is estimated at contract inception and constrained until it is highly probable that a significant revenue reversal in the amount of cumulative revenue recognised will not occur when the associated uncertainty with the variable consideration is subsequently resolved.

 

When the contract contains a financing component which provides the customer a significant benefit of financing the transfer of goods or services to the customer for more than one year, revenue is measured at the present value of the amount receivable, discounted using the discount rate that would be reflected in a separate financing transaction between the Company and the customer at contract inception. When the contract contains a financing component which provides the Company a significant financial benefit for more than one year, revenue recognised under the contract includes the interest expense accreted on the contract liability under the effective interest method. For a contract where the period between the payment by the customer and the transfer of the promised goods or services is one year or less, the transaction price is not adjusted for the effects of a significant financing component, using the practical expedient in IFRS 15.

 

Revenue from the sale of goods is recognised at the point in time when control of the asset is transferred to the customer, generally on delivery of the goods.

 

Other income

 

Interest income is recognised on an accrual basis using the effective interest method by applying the rate that exactly discounts the estimated future cash receipts over the expected life of the financial instrument or a shorter period, when appropriate, to the net carrying amount of the financial asset.

 

Rental income is recognised on a time proportion basis over the lease terms.

 

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Dividend income is recognised when the shareholders’ right to receive payment has been established, it is probable that the economic benefits associated with the dividend will flow to the Company and the amount of the dividend can be measured reliably. 

 

Revenue recognition (applicable before January 1, 2018)

 

Revenue is measured at the fair value of the consideration received or receivable and represents amounts receivable for goods sold in the normal course of business, net of discounts and sales related taxes.

 

The Group’s revenue originates (i) from corporate owned stores, (ii) distributors and (iii) the services performed as an original design manufacturer. Revenue from all above categories is recognized when all the following conditions are satisfied:

 

the Group has transferred to the buyer the significant risks and rewards of ownership of the goods;

 

the Group has fully rendered service to the contract manufacturing customer by shipping the product to the customer;

 

the Group retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;

 

the amount of revenue can be measured reliably;

 

it is probable that the economic benefits associated with the transaction will flow to the Group; and the costs incurred or to be incurred in respect of the transaction can be measured reliably.

 

Specifically, revenue from sale of goods is recognized when the goods are delivered and title has passed.

 

Value added tax (VAT)

 

Output VAT is 16% of product sales and taxable services revenue, according to tax laws. The remaining balance of output VAT, after subtracting the deductible input VAT of the period, is VAT payable.

 

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Borrowing costs

 

Borrowing costs directly attributable to the acquisition, construction or production of qualifying assets, which are assets that necessarily take a substantial period of time to get ready for their intended use or sale, are added to the cost of those assets until such time as the assets are substantially ready for their intended use or sale.

 

All other borrowing costs are recognized in profit or loss in the period in which they are incurred.

 

Retirement benefit costs

 

Pursuant to the relevant regulations of the PRC government, the Group’s subsidiaries located in the PRC participate in a local municipal government retirement benefits scheme (the “Scheme”), whereby they contribute a prescribed percentage of the basic salaries of their employees to the Scheme to fund their retirement benefits. Once the Scheme has been funded via contributions by the Group’s participating subsidiaries, the local municipal government takes responsibility for the retirement benefits obligations of all existing and future retired employees of those subsidiaries located in the PRC; accordingly, the only obligation of the Group with respect to the Scheme is to pay the on-going required contributions as long as the employees maintain employment with the Group. There are no provisions under the Scheme whereby forfeited contributions may be used to reduce future contributions. These plans are considered defined contribution plans. The Group has no legal or constructive obligations to pay further contributions after its payment of the fixed contributions into the pension schemes. Contributions to pension schemes are recognized as an expense in the period in which the related service is performed.

 

Taxation

 

The tax expense for the period comprises current and deferred tax. Tax is recognised in the income statement, except to the extent that it relates to items recognised in other comprehensive income or directly in equity. In this case the tax is also recognised in other comprehensive income or directly in equity, respectively.

 

The current income tax charge is calculated on the basis of the tax laws enacted or substantively enacted at the balance sheet date in the countries where the Group operates and generates taxable income. Management periodically evaluates positions taken in tax returns with respect to situations in which applicable tax regulation is subject to interpretation and establishes provisions where appropriate on the basis of amounts expected to be paid to the tax authorities.

 

Deferred tax is recognized on temporary differences between the carrying amounts of assets and liabilities in the consolidated financial statements and the corresponding tax bases used in the computation of taxable profit. Deferred tax liabilities are generally recognized for all taxable temporary differences. Deferred tax assets are generally recognized for all deductible temporary differences to the extent that it is probable that taxable profits will be available against which those deductible temporary differences can be utilized. Such deferred tax assets and liabilities are not recognized if the temporary difference arises from goodwill or from the initial recognition (other than in a business combination) of other assets and liabilities in a transaction that affects neither the taxable profit nor the accounting profit.

 

Deferred tax liabilities are recognized for taxable temporary differences associated with investments in subsidiaries, except where the Group is able to control the reversal of the temporary difference and it is probable that the temporary difference will not reverse in the foreseeable future. Deferred tax assets arising from deductible temporary differences associated with such investments are only recognized to the extent that it is probable that there will be sufficient taxable profits against which to utilize the benefits of the temporary differences and they are expected to reverse in the foreseeable future.

 

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The carrying amount of deferred tax assets is reviewed at the end of each reporting period and reduced to the extent that it is no longer probable that sufficient taxable profits will be available to allow all or part of the asset to be recovered.

 

Deferred tax assets and liabilities are measured at the tax rates that are expected to apply in the period in which the liability is settled or the asset realized, based on tax rates (and tax laws) that have been enacted or substantively enacted by the end of the reporting period. The measurement of deferred tax liabilities and assets reflects the tax consequences that would follow from the manner in which the Group expects, at the end of the reporting period, to recover or settle the carrying amount of its assets and liabilities.

 

Deferred income tax assets and liabilities are offset when there is a legally enforceable right to offset current tax assets against current tax liabilities and when the deferred income tax assets and liabilities relate to income taxes levied by the same taxation authority on either the taxable entity or different taxable entities where there is an intention to settle the balances on a net basis.

 

Current and deferred tax are recognized in profit or loss, except when they relate to items that are recognized in other comprehensive income or directly in equity, in which case, the current and deferred tax are also recognized in other comprehensive income or directly in equity respectively. Where current tax or deferred tax arises from the initial accounting for a business combination, the tax effect is included in the accounting for the business combination.

 

Store pre-opening cost

 

Store pre-opening cost was the start-up activity costs incurred prior to opening a new store, mainly including leasing, leasehold improvements, payroll and supplies. The accounting policies for leasing and leasehold improvements were as below. Other store pre-opening costs were directly charged to expenses when occurred.

 

Leasing

 

Leases are classified as finance leases whenever the terms of the lease transfer substantially all the risks and rewards of ownership to the lessee. All other leases are classified as operating leases.

 

Leasehold improvements

 

Leasehold improvements, principally comprising costs of office buildings and shops renovation, are held for administrative and selling purposes. Leasehold improvements are initially measured at cost and amortized systematically over its useful life.

 

Property, plant and equipment

 

Property, plant and equipment (“PPE”) including buildings held for use in the production or supply of goods or services, or for administrative purposes other than construction in progress are stated at cost less subsequent accumulated depreciation and accumulated impairment losses.

 

Depreciation is provided to write off the cost of items of property, plant and equipment other than construction in progress over their estimated useful lives and after taking into account of their estimated residual value, using the straight-line method.

 

Construction in progress includes property, plant and equipment in the course of construction for production or for its own use purposes. Construction in progress is carried at cost less any recognized impairment loss. Construction in progress is classified to the appropriate category of property, plant and equipment when completed and ready for intended use. Depreciation of these assets, on the same basis as other property assets, commences when the assets are ready for their intended use.

 

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An item of property, plant and equipment is derecognized upon disposal or when no future economic benefits are expected to arise from the continued use of the asset. Any gain or loss arising on de-recognition of the asset (calculated as the difference between the net disposal proceeds and the carrying amount of the item) is included in profit or loss in the period in which the item is de-recognized.

 

The Group as lessor

 

Rental income from operating leases is recognized in profit or loss on a straight-line basis over the term of the relevant lease.

 

Land use rights

 

Land use rights are stated at cost less accumulated amortization and accumulated impairment losses. Cost represents consideration paid for the rights to use the land on which various plants and buildings are situated for periods varying from 20 to 50 years.

 

Amortization of land use rights is calculated on a straight-line basis over the period of the land use rights.

 

Inventories

 

Inventories are stated at the lower of cost and net realizable value. Costs of inventories are determined using the weighted average method. Net realizable value represents the estimated selling price for inventories less all estimated costs of completion and costs necessary to make the sale.

 

Financial instruments – investments and other financial assets (applicable from January 1, 2018)

 

Initial recognition and measurement

 

Financial assets are classified, at initial recognition, as subsequently measured at amortised cost, fair value through other comprehensive income, and fair value through profit or loss.

 

The classification of financial assets at initial recognition depends on the financial asset’s contractual cash flow characteristics and the Group’s business model for managing them. With the exception of trade receivables that do not contain a significant financing component or for which the Group has applied the practical expedient of not adjusting the effect of a significant financing component, the Group initially measures a financial asset at its fair value, plus in the case of a financial asset not at fair value through profit or loss, transaction costs. Trade receivables that do not contain a significant financing component or for which the Group has applied the practical expedient are measured at the transaction price determined under IFRS 15 in accordance with the policies set out for “Revenue recognition (applicable from January 1, 2018)” below.

 

In order for a financial asset to be classified and measured at amortised cost or fair value through other comprehensive income, it needs to give rise to cash flows that are solely payments of principal and interest (“SPPI”) on the principal amount outstanding.

 

The Group’s business model for managing financial assets refers to how it manages its financial assets in order to generate cash flows. The business model determines whether cash flows will result from collecting contractual cash flows, selling the financial assets, or both.

 

All regular way purchases and sales of financial assets are recognised on the trade date, that is, the date that the Group commits to purchase or sell the asset. Regular way purchases or sales are purchases or sales of financial assets that require delivery of assets within the period generally established by regulation or convention in the marketplace.

 

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Subsequent measurement

 

The subsequent measurement of financial assets depends on their classification as follows:

 

Financial assets at amortised cost (debt instruments)

 

The Group measures financial assets at amortised cost if both of the following conditions are met:

 

  The financial asset is held within a business model with the objective to hold financial assets in order to collect contractual cash flows.

 

  The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.

 

Financial assets at amortised cost are subsequently measured using the effective interest method and are subject to impairment. Gains and losses are recognised in the income statement when the asset is derecognised, modified or impaired.

 

Financial assets at fair value through other comprehensive income (debt instruments)

 

The Group measures debt instruments at fair value through other comprehensive income if both of the following conditions are met:

 

  The financial asset is held within a business model with the objective of both holding to collect contractual cash flows and selling.

 

  The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.

 

For debt instruments at fair value through other comprehensive income, interest income, foreign exchange revaluation and impairment losses or reversals are recognised in the income statement and computed in the same manner as for financial assets measured at amortised cost. The remaining fair value changes are recognised in other comprehensive income. Upon derecognition, the cumulative fair value change recognised in other comprehensive income is recycled to the income statement.

 

Financial assets at fair value through other comprehensive income (equity investments)

 

Upon initial recognition, the Group can elect to classify irrevocably its equity investments as equity investments designated at fair value through other comprehensive income when they meet the definition of equity under HKAS 32 Financial Instruments: Presentation and are not held for trading. The classification is determined on an instrument-by-instrument basis.

 

Gains and losses on these financial assets are never recycled to the income statement. Dividends are recognised as other income in the income statement when the right of payment has been established, it is probable that the economic benefits associated with the dividend will flow to the Group and the amount of the dividend can be measured reliably, except when the Group benefits from such proceeds as a recovery of part of the cost of the financial asset, in which case, such gains are recorded in other comprehensive income. Equity investments designated at fair value through other comprehensive income are not subject to impairment assessment.

 

Financial assets at fair value through profit or loss

 

Financial assets at fair value through profit or loss include financial assets held for trading, financial assets designated upon initial recognition at fair value through profit or loss, or financial assets mandatorily required to be measured at fair value. Financial assets are classified as held for trading if they are acquired for the purpose of selling or repurchasing in the near term. Derivatives, including separated embedded derivatives, are also classified as held for trading unless they are designated as effective hedging instruments. Financial assets with cash flows that are not solely payments of principal and interest are classified and measured at fair value through profit or loss, irrespective of the business model. Notwithstanding the criteria for debt instruments to be classified at amortised cost or at fair value through other comprehensive income, as described above, debt instruments may be designated at fair value through profit or loss on initial recognition if doing so eliminates, or significantly reduces, an accounting mismatch.

 

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Financial assets at fair value through profit or loss are carried in the statement of financial position at fair value with net changes in fair value recognised in the income statement. This category includes derivative financial instruments and structured bank deposits.

 

A derivative embedded in a hybrid contract, with a financial liability or non-financial host, is separated from the host and accounted for as a separate derivative if the economic characteristics and risks are not closely related to the host; a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative; and the hybrid contract is not measured at fair value through profit or loss. Embedded derivatives are measured at fair value with changes in fair value recognised in the income statement. Reassessment only occurs if there is either a change in the terms of the contract that significantly modifies the cash flows that would otherwise be required or a reclassification of a financial asset out of the fair value through profit or loss category.

 

A derivative embedded within a hybrid contract containing a financial asset host is not accounted for separately. The financial asset host together with the embedded derivative is required to be classified in its entirety as a financial asset at fair value through profit or loss.

 

Financial instruments – impairment of financial assets (applicable from January 1, 2018)

 

The Group recognises an allowance for ECLs for all debt instruments not held at fair value through profit or loss. ECLs are based on the difference between the contractual cash flows due in accordance with the contract and all the cash flows that the Group expects to receive, discounted at an approximation of the original effective interest rate. The expected cash flows will include cash flows from the sale of collateral held or other credit enhancements that are integral to the contractual terms.

 

General approach

 

ECLs are recognised in two stages. For credit exposures for which there has not been a significant increase in credit risk since initial recognition, ECLs are provided for credit losses that result from default events that are possible within the next 12-months (a 12-month ECL). For those credit exposures for which there has been a significant increase in credit risk since initial recognition, a loss allowance is required for credit losses expected over the remaining life of the exposure, irrespective of the timing of the default (a lifetime ECL).

 

At each reporting date, the Group assesses whether the credit risk on a financial instrument has increased significantly since initial recognition. When making the assessment, the Group compares the risk of a default occurring on the financial instrument as at the reporting date with the risk of a default occurring on the financial instrument as at the date of initial recognition and considers reasonable and supportable information that is available without undue cost or effort, including historical and forward-looking information.

 

The Group considers a financial asset in default when contractual payments are 120 days past due. However, in certain cases, the Group may also consider a financial asset to be in default when internal or external information indicates that the Group is unlikely to receive the outstanding contractual amounts in full before taking into account any credit enhancements held by the Group. A financial asset is written off when there is no reasonable expectation of recovering the contractual cash flows.

 

Debt instruments at fair value through other comprehensive income and financial assets at amortised cost are subject to impairment under the general approach and they are classified within the following stages for measurement of ECLs except for trade receivables which apply the simplified approach as detailed below.

 

Stage 1 – Financial instruments for which credit risk has not increased significantly since initial recognition and for which the loss allowance is measured at an amount equal to 12-month ECLs

 

Stage 2 – Financial instruments for which credit risk has increased significantly since initial recognition but that are not credit-impaired financial assets and for which the loss allowance is measured at an amount equal to lifetime ECLs

 

Stage 3 – Financial assets that are credit-impaired at the reporting date (but that are not purchased or originated credit-impaired) and for which the loss allowance is measured at an amount equal to lifetime ECLs

 

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Simplified approach

 

For trade receivables that do not contain a significant financing component or when the Group applies the practical expedient of not adjusting the effect of a significant financing component, the Group applies the simplified approach in calculating ECLs. Under the simplified approach, the Group does not track changes in credit risk, but instead recognises a loss allowance based on lifetime ECLs at each reporting date. The Group has established a provision matrix that is based on its historical credit loss experience, adjusted for forward-looking factors specific to the debtors and the economic environment.

 

For trade receivables that contain a significant financing component and lease receivables, the Group chooses as its accounting policy to adopt the simplified approach in calculating ECLs with policies as described above.

 

Financial instruments – derecognition of financial assets (applicable from January 1, 2018)

 

A financial asset (or, where applicable, a part of a financial asset or part of a group of similar financial assets) is primarily derecognised (i.e., removed from the Group’s consolidated statement of financial position) when:

 

  the rights to receive cash flows from the asset have expired; or

 

  the Group has transferred its rights to receive cash flows from the asset or has assumed an obligation to pay the received cash flows in full without material delay to a third party under a “pass-through” arrangement; and either (a) the Group has transferred substantially all the risks and rewards of the asset, or (b) the Group has neither transferred nor retained substantially all the risks and rewards of the asset, but has transferred control of the asset.

 

When the Group has transferred its rights to receive cash flows from an asset or has entered into a pass-through arrangement, it evaluates if, and to what extent, it has retained the risk and rewards of ownership of the asset. When it has neither transferred nor retained substantially all the risks and rewards of the asset nor transferred control of the asset, the Group continues to recognise the transferred asset to the extent of the Group’s continuing involvement. In that case, the Group also recognises an associated liability. The transferred asset and the associated liability are measured on a basis that reflects the rights and obligations that the Group has retained.

 

Continuing involvement that takes the form of a guarantee over the transferred asset is measured at the lower of the original amount of the asset and the maximum amount of consideration that the Group could be required to repay.

 

Financial instruments – financial liabilities (applicable from January 1, 2018)

 

Initial recognition and measurement

 

All financial liabilities are recognised initially at fair value and, in the case of loans and borrowings, net of directly attributable transaction costs. The Group’s financial liabilities include trade payables, other payables, financial liabilities included in accruals and interest-bearing bank borrowings.

 

Subsequent measurement

 

After initial recognition, interest-bearing loans and borrowings are subsequently measured at amortised cost, using the effective interest rate method unless the effect of discounting would be immaterial, in which case they are stated at cost. Gains and losses are recognised in the income statement when the liabilities are derecognised as well as through the effective interest rate amortisation process.

 

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Amortised cost is calculated by taking into account any discount or premium on acquisition and fees or costs that are an integral part of the effective interest rate. The effective interest rate amortisation is included in finance costs in the income statement.

 

Financial instruments – derecognition of financial liabilities (applicable from January 1, 2018)

 

A financial liability is derecognised when the obligation under the liability is discharged or cancelled, or expires.

 

When an existing financial liability is replaced by another from the same lender on substantially different terms, or the terms of an existing liability are substantially modified, such an exchange or modification is treated as a derecognition of the original liability and a recognition of a new liability, and the difference between the respective carrying amounts is recognised in the income statement.

 

Financial instruments – offsetting financial instruments (applicable from January 1, 2018)

 

Financial assets and financial liabilities are offset and the net amount is reported in the statement of financial position if there is a currently enforceable legal right to offset the recognised amounts and there is an intention to settle on a net basis, or to realise the assets and settle the liabilities simultaneously.

 

Financial instruments (applicable before January 1, 2018)  

 

Financial assets and financial liabilities are recognized on the consolidated statements of financial position when a group entity becomes a party to the contractual provisions of the instrument.

 

Financial assets and financial liabilities are initially measured at fair value. Transaction costs that are directly attributable to the acquisition or issue of financial assets and financial liabilities are added to or deducted from the fair value of the financial assets or financial liabilities, as appropriate, on initial recognition.

 

The Group’s financial assets are classified as receivables.

 

Effective interest method

 

The effective interest method is a method of calculating the amortized cost of a financial asset and of allocating interest income over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash receipts (including all fees and points paid or received that form an integral part of the effective interest rate, transaction costs and other premiums or discounts) through the expected life of the financial asset, or, where appropriate, a shorter period to the net carrying amount on initial recognition.

 

Interest income is recognized on an effective interest basis for debt instruments.

 

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Receivables

 

Receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. Receivables (including trade and other receivables, related parties receivables, and cash and cash equivalents) are measured at amortized cost using the effective interest method, less any impairment (see accounting policy on impairment loss on receivables below).

 

Impairments of receivables

 

Receivables are assessed for indicators of impairment at the end of the reporting period. Receivables are impaired where there is objective evidence that, as a result of one or more events that occurred after the initial recognition of the receivables, the estimated future cash flows of the receivables have been affected.

 

Objective evidence of impairment could include:

 

significant financial difficulty of the issuer or counterparty;

 

default or delinquency in interest or principal payments;

 

it becoming probable that the borrower will enter bankruptcy or financial reorganization.

 

For certain categories of financial asset, such as trade and other receivables, assets that are assessed not to be impaired individually are subsequently assessed for impairment on a collective basis. Objective evidence of impairment for a portfolio of receivables could include the Group’s past experience of collecting payments, and increase in the number of delayed payments in the portfolio past the average credit period, observable changes in national or local economic conditions that correlate with default on receivables.

 

An impairment loss is recognized in profit or loss when there is objective evidence that the asset is impaired, and is measured as the difference between the asset’s carrying amount and the present value of the estimated future cash flows discounted at the original effective interest rate.

 

The carrying amount of the receivables is reduced by the impairment loss directly for all financial assets with exception of trade and other receivables, where the carrying amount is reduced through the use of an allowance account. Changes in carrying amount of the allowance account are recognized in profit or loss. When a trade and other receivable are considered uncollectible, it is written off against the allowance account. Subsequent recoveries of amounts previously written off are credited to profit or loss.

 

If, in a subsequent period, the amount of impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment losses was recognized, the previously recognized impairment loss is reversed through profit or loss to the extent that the carrying amount of the asset at the date the impairment is reversed does not exceed what the amortized cost would have been had the impairment not been recognized.

 

G. Safe Harbor

 

See “Introductory Notes—Forward-Looking Information.”

 

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ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

 

A. Directors and Senior Management

 

The following table sets forth certain information regarding our directors and senior management, as well as employees upon whose work we are dependent, as of the date of this annual report.

 

NAME   AGE   POSITION
Keyan Yan   47   Chairman and Chief Executive Officer
Themis Kalapotharakos   44   Executive Director
LixiaTu   37   Chief Financial Officer and Director
John Sano   49   Independent Director
Matthew C. Los   54   Independent Director
Zhongmin Zhang   76   Independent Director
Yuet Mei Chan   38   Independent Director

 

Mr. Keyan Yan . Mr. Yan has been the Chairman of our board of directors and Chief Executive Officer since the closing of the Share Exchange on August 1, 2014. Mr. Yan has over 16 years of senior management experience. He served as Chairman and Chief Executive Officer of KBS International between March 2011 and August 2014. From 1994 to present, Mr. Yan has served as general manager of Hongri PRC. Prior to joining us, Mr. Yan served as workshop manager, production manager and marketing manager of Zhenshi Knitting Factory in Shishi, China from 1989-1994. Mr. Yan obtained a certificate of corporate management from Xiamen University in 1992.

 

Ms. Lixia Tu. Ms. Tu became the Company’s Chief Financial Officer on June 25, 2015. Ms. Tu has more than night years of accounting and audit experience, familiar with IFRS, US GAAP, Sarbanes-Oxley and the compliance requirements of SEC. After she worked as a project manager at BDO China Fu Jian SHU LUN PAN Certified Public Accountants for four years, she worked as a CFO or a financial consultant for some other companies. Ms. Tu holds a Master’s degree in professional accounting from the University of Deakin in Australia. Ms. Tu is also a member of the Chartered Association of Certified Accountants.

 

Mr. Themis Kalapotharakos. Mr. Kalapotharakos became our executive director on June 15, 2015. Mr. Kalapotharakos has acquired a range of expertise of a wide spectrum of business activities. He has extensive high-level experience at the Shipping, Trading and Finance industries where he has founded, developed and operated various businesses starting from the ground up. His roles involved regular communication and coordination with investors, financial institutions, capital market authorities, custodian and administrative banks, auditors and legal counsel. He holds a Bachelor’s degree from Cardiff University and an MSc Degree from Cass Business School in the UK.

 

John Sano. Mr. Sano has been an independent director of the Company since the closing of the Share Exchange on August 1, 2014. Mr. Sano has over 20 years of experience in apparel & home furnishings concept, design, sourcing, production, and e-commerce. He has extensive experience in all aspects of the retail clothing supply chain, from conceptualization to final production and distribution. Mr. Sano has also advised and worked closely with numerous top brands in the US. He has been General Director of Sano Design Services since 2002. Mr. Sano has an associate’s degree in interior design from Traphagen School of Design.

 

Mr. Matthew C. Los. Mr. Los became our director on October 8, 2015. Mr. Los has acquired a range of expertise of a wide spectrum of business activities. He has over 20 years’ experience at high level management, and has founded, developed and operated various businesses in the shipping, energy, telecommunications real estate industries starting from the ground up. He also has experience in the capital markets and was the CEO of Aquasition Corp., the predecessor of the Company, prior to the Share Exchange. Mr. Los has a BSc in Mechanical Engineering and Computer Aided Design from University of Westminster in the UK.

 

Mr. Zhongmin Zhang. Mr. Zhang became our director on July 10, 2017. He has over 45 years of extensive experience in many facets of textile business, including in production, marketing, and management. Currently, Mr. Zhang is the president of Zhengzhou Guangda Textile Printing & Dyeing Co., Ltd. which has an annual production of 216 million meters of various textile products, with a value of RMB 800 million. Holding a title of Senior Engineer, Mr. Zhang graduated from Harbin Institute of Technology in 1965. He also has certificates in finance management and civil law.

 

Mr. Yuet Mei Chan. Ms. Chan became our director on July 10, 2017. She has over 15 years of experience in the banking industry. She held several senior positions in a prestigious bank in Hong Kong from 2001-2016. She is currently a financial consultant at AIA and specializes in analyzing financial situations and market trends. Ms. Chan holds a diploma in Computing and Business Studies from Hong Kong St. Perth College.

 

No family relationship exists between any of the persons named above.

 

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B. Compensation

 

In 2018, we paid an aggregate of approximately $207,268 in cash as compensation to our directors and senior management as a group, and some of our directors and executive officers also received compensation in the form of annual salaries and bonuses. We do not set aside or accrue any amounts for pension, retirement or other benefits for our directors and senior management. However, we reimburse our directors for out-of-pocket expenses incurred in connection with their services in such capacity.

 

On February 10, 2018, we granted an aggregate of 285,000 restricted shares of common stock to our executive officers and directors as compensations for their services. All the shares vested immediately upon granting.

 

On March 25, 2019, we granted an aggregate of 305,000 shares of common stock pursuant to the Company’s 2018 Equity Incentive Plan to the Company’s executive officers, directors and certain employees as compensations for their service. All the shares vested immediately upon granting.

 

2018 Equity Incentive Plan

 

On December 24, 2018, the Board of Directors of the Company adopted the 2018 Equity Incentive Plan, or the 2018 Plan, pursuant to which the Company may offer up to two million shares of common stock as equity incentives to its directors, employees and consultants. Such number of shares is subject to adjustment in the event of certain reorganizations, mergers, combinations, recapitalizations, stock splits, stock dividends, or other change in the corporate structure of the Company affecting the shares issuable under the 2018 Plan. As of December 31, 2018, we have not granted any equity awards under the 2018 Plan.

 

The following paragraphs summarize the terms of our 2018 Plan:

 

Purpose . The purposes of the 2018 Plan are to promote the long-term growth and profitability of the Company and its affiliates by stimulating the efforts of employees, directors and consultants of the Company and its affiliates who are selected to be participants, aligning the long-term interests of participants with those of shareholders, heightening the desire of participants to continue in working toward and contributing to our success, attracting and retaining the best available personnel for positions of substantial responsibility, and generally providing additional incentive for them to promote the success of our business through the grant of awards of or pertaining to our common stock. The 2018 Plan permits the grant of ISOs, NSOs, Restricted Shares, Restricted Share Units, Share Appreciation Rights, Performance Units and Performance Shares as the administrator of the 2018 Plan may determine.

 

Administration . The 2018 Plan is administered by our Board. The administrator has the authority to determine the specific terms and conditions of all awards granted under the 2018 Plan, including, without limitation, the number of shares of common stock subject to each award, the price to be paid for the shares and the applicable vesting criteria. The administrator has discretion to make all other determinations necessary or advisable for the administration of the 2018 Plan.

 

Eligibility . NSOs, Restricted Shares, Restricted Share Units, Share Appreciation Rights, Performance Units and Performance Shares may be granted to employees, directors or consultants either alone or in combination with any other awards. ISOs may be granted only to employees of the Company, and of any parent or subsidiary.

 

Shares Available for Issuance Under the 2018 Plan . Subject to adjustment as described below, (a) the maximum aggregate number of shares that may be issued under the 2018 Plan is 2,000,000 shares of common stock, (b) to the extent consistent with Section 422 of the Internal Revenue Code of 1986, as amended (the “Code”), not more than an aggregate of 2,000,000 shares of common stock may be issued under ISOs, and (c) not more than 200,000 shares of common stock (or for awards denominated in cash, the Fair Market Value of 200,000 shares of common stock on the Grant Date, as defined in the 2018 Plan), may be awarded to any individual participant in the aggregate in any one fiscal year of the Company, such limitation to be applied in a manner consistent with the requirements of, and only to the extent required for compliance with, the exclusion from the limitation on deductibility of compensation under Code Section 162(m). The number and class of shares available under the 2018 Plan are subject to adjustment in the event of certain reorganizations, mergers, combinations, recapitalizations, share splits, share dividends, or other similar events which change the number or kind of shares outstanding.

 

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Transferability . Unless otherwise provided in the 2018 Plan or otherwise determined by the administrator, an award may not be sold, pledged, assigned, hypothecated, transferred, or disposed of in any manner other than by will or by the laws of descent or distribution and may be exercised, during the lifetime of the participant, only by the participant. However, the administrator may, at or after the grant of an award other than an ISO, provide that such award may be transferred by the recipient to a “family member” (as defined in the 2018 Plan); provided, however, that any such transfer is without payment of any consideration whatsoever and that no transfer shall be valid unless first approved by the administrator, acting in its sole discretion, and as required by our Amended and Restated Articles of Incorporation. If the administrator makes an award transferable, such award will contain such additional terms and conditions as the administrator deems appropriate.

 

Termination of, or Amendments to, the 2018 Plan . The Board may at any time amend, alter, suspend or terminate the 2018 Plan, provided that the Company will obtain shareholder approval of any 2018 Plan amendment to the extent necessary and desirable to comply with applicable Laws. No amendment, alteration, suspension or termination of the 2018 Plan will impair the rights of any participant, unless mutually agreed otherwise between the participant and the administrator, which agreement must be in writing and signed by the participant and the Company. Termination of the 2018 Plan will not affect the administrator’s ability to exercise the powers granted to it hereunder with respect to awards granted prior to the date of such termination.

 

The 2018 Plan will terminate five years following the date it was adopted by the Board, unless sooner terminated by the Board.

 

Employment Agreements

 

Please refer to Item 10 “Additional Information—C. Material Contracts.”

 

C. Board Practices

 

Our board of directors currently consists of seven members, Keyan Yan, Lixia Tu, John Sano, Themis Kalapotharakos, Matthew C. Los, Yuet Mei Chan and Zhongmin Zhang.

 

The Board has established the Audit Committee, which is comprised entirely of independent directors. From time to time, the Board may establish other committees.

 

Audit Committee

 

Our Audit Committee is currently composed of three members: Yuet Mei Chan, John Sano and Matthew C. Los. Our Board of Directors determined that each member of the Audit Committee meets the independence criteria prescribed by applicable regulation and the rules of the SEC for audit committee membership. Each Audit Committee member also meets NASDAQ’s financial literacy requirements. Matthew C. Los serves as Chair of the Audit Committee.

 

Our Board of Directors has determined that Matthew C. Los is the “audit committee financial expert” as such term is defined in Item 407(d) of Regulation S-K promulgated by the SEC and also meets NASDAQ’s financial sophistication requirements.

 

The Audit Committee oversees our accounting and financial reporting processes and the audits of the financial statements of our Company. The Audit Committee is responsible for, among other things:

 

the appointment, compensation, retention and oversight of the work of the independent auditor;

 

reviewing and pre-approving all auditing services and permissible non-audit services (including the fees and terms thereof) to be performed by the independent auditor;

 

reviewing and approving all proposed related-party transactions;

 

discussing the interim and annual financial statements with management and our independent auditors;

 

reviewing and discussing with management and the independent auditor (a) the adequacy and effectiveness of the Company’s internal controls, (b) the Company’s internal audit procedures, and (c) the adequacy and effectiveness of the Company’s disclosure controls and procedures, and management reports thereon;

 

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reviewing reported violations of the Company’s code of conduct and business ethics; and

 

reviewing and discussing with management and the independent auditor various topics and events that may have significant financial impact on the Company or that are the subject of discussions between management and the independent auditors.

 

D. Employees

 

As of December 31, 2018, we employed 370 full-time employees. The following table sets forth the number of our full-time employees by function. 

 

Function   Number of Employees
Management and Administration   28
Marketing, Sales and Distribution   18
Design and Product Development   20
Production   281
Procurement, Warehousing and Logistics   19
Quality and Assurance   7
TOTAL   370

 

We believe that we have maintained a satisfactory working relationship with our employees, and we have not experienced any significant labor disputes or any difficulty in recruiting staff for company’s operations. None of company’s employees is represented by a labor union.

 

Our employees in China participate in a state pension plan organized by Chinese municipal and provincial governments. The company is required to make monthly contributions to the plan for each employee at the rate of 23% of his or her average assessable salary. In addition, the company is required by Chinese law to cover employees in China with various types of social insurance. The company believes that it is in material compliance with the relevant PRC laws.

 

E. Share Ownership

 

The following table sets forth information regarding beneficial ownership of each class of our voting securities as of April 26, 2019 (i) by each person who is known by us to beneficially own more than 5% of our voting securities; (ii) by each of our officers and directors; and (iii) by all of our officers and directors as a group.

 

Name   Office, If Any   Title of Class   Amount and Nature of Beneficial Ownership (1)     Percent of Class (2)  
Officers and Directors                    
Keyan Yan (3)   Chairman, CEO and President   Common Stock     964,320       37.21 %
Lixia Tu   Chief Financial Officer and Director   Common Stock     60,000       2.32 %
Themis Kalapotharakos   Director   Common Stock     40,000       1.54 %
John Sano   Director   Common Stock     5,000       0.19 %
Matthew C. Los   Director   Common Stock     40,000       1.54 %
Zhongmin Zhang   Director   Common Stock     10,000       0.39 %
Yuet Mei Chan   Director   Common Stock     10,000       0.39 %
                         
All officers and directors as a group (7 persons named above)             1,129,320       43.58 %
5% Security Holders                        
Keyan Yan (3)       Common Stock     964,320       37.21 %
Alliance Investment Management Limited (4)       Common Stock     195,488 (4)     7.54 %

 

* Less than 1%

 

(1) Beneficial Ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. Each of the beneficial owners listed above has direct ownership of and sole voting power and investment power with respect to our common stock.

 

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(2) As of April 26, 2019, a total of 2,591,299 shares of commons stock are considered to be outstanding pursuant to SEC Rule 13d-3(d)(1). For each Beneficial Owner above, any securities that are exercisable or convertible within 60 days have been included in the denominator.

 

(3) Includes 20,000 shares of common stock owned by Bizhen Chen, Mr. Yan’s wife.
   
(4)

Based solely on Schedule 13D filed with the SEC on August 8, 2018, in which Alliance Investment Management reported it has sole voting and dispositive power with respect to 195,488 shares of our common stock. The address of the reporting person is 7 Belmont Road, Kingston, Jamaica.

 

None of our existing shareholders has voting rights that differ from the voting rights of other shareholders. We are not aware of any arrangement that may, at a subsequent date, result in our change in control.

 

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

 

A. Major Shareholders

 

Please refer to Item 6 “Directors, Senior Management and Employees—E. Share Ownership.”

 

B. Related Party Transactions

 

From time to time, KBS and its subsidiaries borrowed money from our Chairman and Chief Executive Officer, Mr. Keyan Yan, to pay for Company expenses. These amounts are interest-free, unsecured and repayable on demand. In years 2017 and 2016, Mr. Yan paid all the Company expenses in connection with the Company’s Nasdaq continued listing and SEC reporting out of his pocket. As of December 31, 2018 and 2017, the balance of these amounts we borrowed from Mr. Yan was $485,302 and $35,483, respectively.

 

C. Interests of Experts and Counsel

 

Not applicable.

 

ITEM 8. FINANCIAL INFORMATION

 

A. Consolidated Statements and Other Financial Information

 

Financial Statements

 

We have appended consolidated financial statements filed as part of this report. See Item 18 “Financial Statements.”

 

Legal Proceedings 

 

We may be subject to legal proceedings, investigations and claims incidental to the conduct of our business from time to time. We are currently not party to any legal or arbitration proceedings, including those relating to bankruptcy, receivership or similar proceedings and those involving any third party, which may have, or have had in the recent past, significant effects on our financial position or profitability.

 

Dividend Policy

 

To date, we have not paid any cash dividends on our shares. As a Marshall Islands company, we may only declare and pay dividends except when the corporation is insolvent or would thereby be made insolvent or when the declaration or payment would be contrary to any restrictions contained in our Articles of Incorporation. Dividends may be declared and paid out of surplus only; but in case there is no surplus, dividends may be declared or paid out of the net profits for the fiscal year in which the dividend is declared and for the preceding fiscal year. We currently anticipate that we will retain any available funds to finance the growth and operation of our business and we do not anticipate paying any cash dividends in the foreseeable future. Additionally, our cash held in foreign countries may be subject to certain control limitations or repatriation requirements, limiting our ability to use this cash to pay dividends.

 

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B. Significant Changes

 

No significant change has occurred since the date of our consolidated financial statements filed as part of this annual report.

 

ITEM 9. THE OFFER AND LISTING

 

A. Offer and Listing Details

 

Our common stock is listed on the NASDAQ Capital Market and trade under the symbol “KBSF.” Between January 23, 2013 and November 3, 2014, our common stock was traded on the NASDAQ Capital Market under the symbol “AQU.” Our Warrants and Units are quoted on the OTC Markets under the symbols “KBSFW” and “KBSFU”, respectively. Prior to November 3, 2014, our Warrants and Units were quoted on the OTC Markets under the symbols “AQUUF” and “AQUUU”, respectively. Before their quotation on the OTC Markets, our Units commenced to trade on the Nasdaq Stock Market on October 26, 2012 and our Warrants commenced to trade separately from its Units on January 23, 2013.

 

On February 3, 2017, a special shareholder meeting was held at the Company’s headquarters in China and at the meeting, our shareholders approved a proposal to grant discretionary authority to the Board of Directors of the Company to effect a reverse stock split of issued and outstanding shares of common stock at a ratio within the range from one-for-two up to one-for-twenty; and determine whether to pay in cash the fair value of fractions of a share of common stock as of the time when those entitled to receive such fractions are determined, or to entitle shareholders to receive, in lieu of any fractional share, the number of shares of common stock rounded up to the next whole number. On February 3, 2017, after the special shareholder meeting, our Board of Directors approved a one-for-fifteen reverse stock split of the Company’s issued and outstanding common stock. In addition, in lieu of issuing any fractional share, the Board of Directors decided that shareholders are entitled to receive the number of shares of common stock rounded up to the next whole number. Our common stock began trading on the NASDAQ Stock Market on a split-adjusted basis when the market opened on February 9, 2017.

 

Approximate Number of Holders of Our Securities

 

On April 26, 2019, there was 1 holder of record of our Units, 359 shareholders of record of our common stock and 1 holder of record of our Warrants. Certain of our securities are held in nominee or street name so the actual number of beneficial owners of our securities is greater than the number of record holders set forth above.

 

B. Plan of Distribution

 

Not applicable.

 

C. Markets

 

See our disclosures above under “A. Offer and Listing Details.”

 

D. Selling Shareholders

 

Not applicable. 

 

E. Dilution

 

Not applicable.

 

F. Expenses of the Issue

 

Not applicable.

 

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ITEM 10. ADDITIONAL INFORMATION

 

A. Share Capital

 

Our Amended and Restated Articles of Incorporation authorize the Company to issue up to 155,000,000 shares with a par value of $0.0001, consisting of 150,000,000 shares of common stock and 5,000,000 shares of preferred stock. As of date of this report, there are 2,591,299 shares of common stock issued and outstanding. We have never issued any preferred stock.

 

As of date of this report, we have 717 IPO Units outstanding.

 

As of date of this report, we have 393,836 warrants outstanding (including 369,302 IPO Warrants and 24,534 Placement Warrants), each warrant entitles the holder to purchase one share of common stock at a purchase price of $172.5.

 

B. Memorandum and Articles of Association

 

The following represents a summary of certain key provisions of our articles of incorporation and bylaws. The summary does not purport to be a summary of all of the provisions of our articles of incorporation and bylaws. For more complete information you should read our amended and restated articles of incorporation and bylaws, each listed as an exhibit to this report.

 

We were incorporated in the Marshall Islands on January 26, 2012 under the Marshall Islands Business Corporations Act (“BCA”). The purpose of the Company is to engage in any lawful act or activity for which corporations may now or hereafter be organized under the BCA. Our amended and restated articles of incorporation and bylaws do not impose any limitations on the ownership rights of our stockholders.

 

Description of Common Stock

 

Each outstanding share of common stock entitles the holder to one vote on all matters submitted to a vote of stockholders. Upon our dissolution, liquidation or winding up of the affairs of the Company, after payment in full of all amounts required to be paid to creditors and to the holders of preferred stock having liquidation preferences, if any, the holders or our common stock will be entitled to receive pro rata our remaining assets available for distribution. Holders of common stock do not have conversion, redemption or preemptive rights to subscribe to any of our securities.

 

Blank Check Preferred Stock.

 

Our Board of Directors is authorized, without any further vote or action by our stockholders, to issue up to 5,000,000 shares of preferred stock in different classes and series and, with respect to each class or series, to determine the designations, powers, preferences, privileges and other rights, including dividend rights, conversion rights, terms of redemption and liquidation preferences, any or all of which may be greater than the powers and rights associated with the common stock, at such times and on such other terms as they think proper. Our Board of Directors may issue shares of preferred stock on terms calculated to discourage, delay or prevent a change of control of our company or the removal of our management.

 

Warrants

 

As of date of this report, we have 393,836 warrants outstanding, among which 369,302 warrants were issued to the public in our IPO (the “IPO Warrants”). Each of the IPO Warrants entitles the holder to purchase one share of common stock at a price of $172.5 expiring on July 31, 2019, provided that there is an effective registration statement covering the shares of common stock underlying the IPO Warrants.

 

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The Company may redeem the IPO Warrants at a price of $0.01 per warrant upon 30 days’ notice, after they become exercisable and prior to their expiration, only in the event that the last sale price of the shares of common stock is at least $17.50 per share for any 20 trading days within a 30-trading day period (“30-Day Trading Period”) ending three business days prior to the date on which notice of redemption is given, provided there is a current registration statement in effect with respect to the shares of common stock underlying such IPO Warrants throughout the 30-day redemption period. The Company is only required to use its best efforts to maintain the effectiveness of the registration statement covering the underlying common stock of the IPO Warrants. There are no contractual penalties for failure to deliver securities if a registration statement is not effective at the time of exercise. Additionally, in the event that a registration statement is not effective at the time of exercise, the holder of such warrant shall not be entitled to exercise such warrant for cash and in no event (whether in the case of a registration statement not being effective or otherwise) will the Company be required to net cash settle the warrant exercise.

 

In addition, Aqua Investments Corp., an entity controlled by certain founding shareholders of the Company, acquired 24,534 warrants, each entitles the holder to purchase one share of common stock at a price of $172.50, expiring on July 31, 2019 (the “Placement Warrants”). The Placement Warrants are identical to the IPO Warrants except that the Placement Warrants (i) may be exercised for cash or on a cashless basis; (ii) will not be redeemable by the Company and (ii) may be exercised even if there is not an effective registration statement relating to the shares underlying the warrants, so long as they are held by the initial purchaser or any of its permitted transferees.

 

As of date of this report, we also have 717 IPO Units outstanding and publicly trading, each including one IPO Warrant and one share of our common stock.

 

Directors

 

The business and affairs of the Company are managed by or under the direction of our Board of Directors.

 

Our directors are elected by the holders of the shares representing a majority of the total voting power of the then-outstanding capital stock of the Company entitled to vote generally in the election of directors (“Voting Stock”). Our amended and restated articles of incorporation provide that cumulative voting shall not be used to elect directors. Each director will be elected to serve until the next annual meeting of shareholders and until his/her successor shall have been duly elected and qualified, except in the event of his/her death, resignation, removal or the earlier termination of his/her term of office.

 

Any director or the entire Board of Directors may be removed at any time, with or without cause, by the affirmative vote of the holders of at least a majority of the total voting power of the Voting Stock entitled to vote thereon or with cause by directors constituting at least two-thirds of the entire Board.

 

Vacancies in the Board of Directors occurring by death, resignation, the creation of new directorships, the failure of the shareholders to elect the whole board at any annual election of directors, or, except as herein provided, for any other reason, including removal of directors for cause, may be filled either by the affirmative vote of a majority of the remaining directors then in office, although less than a quorum, at any special meeting called for that purpose or at any regular meeting of the Board. Vacancies occurring by removal of directors without cause may be filled only by vote of the shareholders.

 

Shareholder Meetings

 

Annual stockholder meetings will be held at a time and place selected by our board of directors. The meetings may be held in or outside of the Marshall Islands.

 

Under our amended and restated articles of incorporation, special meetings may be called by the board of directors, or by the secretary of the Company requested by stockholders representing certain amount of voting power. Our board of directors shall give not less than 15 days and not more than 60 days prior written notice of a shareholders’ meeting to each shareholder of record entitled to vote thereat and to each shareholder of record who, by reason of any action proposed at such meeting would be entitled to have his/her shares appraised if such action were taken, and the notice shall include a statement of that purpose and to that effect.

 

Our bylaws provide that a meeting of shareholders is duly constituted if, at the commencement of the meeting, there are shareholders present in person or by proxy representing not less than a majority of the votes of the shares issued and outstanding and entitled to vote on resolutions of shareholders to be considered at the meeting.

 

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If a quorum is present, the affirmative vote of a majority of the shares of stock represented at the meeting will be the act of the shareholders. At any meeting of shareholders, each shareholder entitled to vote any shares on any manner to be voted upon at such meeting shall be entitled to one vote on such matter for each such share. Any action required or permitted to be taken at a meeting, may be taken without a meeting if a consent in writing setting forth the action so taken, is signed by all the shareholders entitled to vote with respect to the subject matter thereof.

 

Dissenters’ Rights of Appraisal and Payment.

 

Under the BCA, our stockholders have the right to dissent from various corporate actions, including any merger or sale of all or substantially all of our assets not made in the usual course of our business, and receive payment of the fair value of their shares. However, the right of a dissenting stockholder to receive payment of the fair value of his or her shares shall not be available for any shares of stock of the constituent corporation surviving a merger if the merger did not require for its approval the vote of the stockholders of the surviving corporation. In the event of any further amendment of our articles of incorporation, a stockholder also has the right to dissent and receive payment for his or her shares if the amendment alters certain rights in respect of those shares. The dissenting stockholder must follow the procedures set forth in the BCA to receive payment. In the event that we and any dissenting stockholder fail to agree on a price for the shares, the BCA procedures involve, among other things, the institution of proceedings in the circuit court in the judicial circuit in the Marshall Islands in which our Marshall Islands office is situated. The value of the shares of the dissenting stockholder is fixed by the court after reference, if the court so elects, to the recommendations of a court-appointed appraiser.

 

Stockholders’ Derivative Actions

 

Under the BCA, any of our stockholders may bring an action in our name to procure a judgment in our favor, also known as a derivative action, provided that the stockholder bringing the action is a holder of common stock both at the time the derivative action is commenced and at the time of the transaction to which the action relates.

 

Indemnification of Officers and Directors

 

The BCA authorizes corporations to limit or eliminate the personal liability of directors and officers to corporations and their stockholders for monetary damages for breaches of directors’ fiduciary duties. Our amended and restated articles of incorporation include a provision that eliminates the personal liability of directors for monetary damages for actions taken as a director to the fullest extent permitted by law. We must indemnify our directors and officers to the fullest extent authorized by law. We are also expressly authorized to advance certain expenses (including attorneys’ fees and disbursements and court costs) to our directors and offices and carry directors’ and officers’ insurance providing indemnification for our directors, officers and certain employees for some liabilities.

 

The limitation of liability and indemnification provisions in our amended and restated articles of incorporation and bylaws may discourage stockholders from bringing a lawsuit against directors for breach of their fiduciary duty.  These provisions may also have the effect of reducing the likelihood of derivative litigation against directors and officers, even though such an action, if successful, might otherwise benefit us and our stockholders.  In addition, your investment may be adversely affected to the extent we pay the costs of settlement and damage awards against directors and officers pursuant to these indemnification provisions.

 

C. Material Contracts

 

We have not entered into any material contracts other than in the ordinary course of business and other than those described in Item 4 “Information on the Company,” Item 5 “Operating and Financial Review and Prospects—F. Tabular Disclosure of Contractual Obligations,” Item 7 “Major Shareholders and Related Party Transactions,” or filed (or incorporated by reference) as exhibits to this annual report or otherwise described or referenced in this annual report.

 

D. Exchange Controls

 

Marshall Islands Exchange Controls

 

Under Marshall Islands law, there are currently no restrictions on the export or import of capital, including foreign exchange controls or restrictions that affect the remittance of dividends, interest or other payments to nonresident holders of our shares.

 

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BVI Exchange Controls

 

There are no material exchange controls restrictions on payment of dividends, interest or other payments to the holders of our common stock or on the conduct of our operations in the BVI, where we were incorporated. There are no material BVI laws that impose any material exchange controls on us or that affect the payment of dividends, interest or other payments to nonresident holders of our common stock. BVI law and our memorandum and articles of association do not impose any material limitations on the right of non-residents or foreign owners to hold or vote our common stock.

 

PRC Exchange Controls

 

Regulations on Foreign Currency Exchange

 

Under the PRC Foreign Currency Administration Rules promulgated on January 29, 1996 and last amended on August 5, 2008 and various regulations issued by SAFE and other relevant PRC government authorities, payment of current account items in foreign currencies, such as trade and service payments, payment of interest and dividends can be made without prior approval from SAFE by following the appropriate procedural requirements. By contrast, the conversion of RMB into foreign currencies and remittance of the converted foreign currency outside the PRC for the purpose of capital account items, such as direct equity investments, loans and repatriation of investment, requires prior approval from SAFE or its local office.

 

On February 13, 2015, SAFE promulgated the Circular on Simplifying and Improving the Foreign Currency Management Policy on Direct Investment, effective from June 1, 2015, which cancels the requirement for obtaining approvals of foreign exchange registration of foreign direct investment and overseas direct investment from SAFE. The application for the registration of foreign exchange for the purpose of foreign direct investment and overseas direct investment may be filed with qualified banks, which, under the supervision of SAFE, may review the application and process the registration.

 

The Circular of the SAFE on Reforming the Management Approach regarding the Settlement of Foreign Capital of Foreign-invested Enterprise, or SAFE Circular 19, was promulgated on March 30, 2015 and became effective on June 1, 2015. According to SAFE Circular 19, a foreign-invested enterprise may, according to its actual business needs, settle with a bank the portion of the foreign exchange capital in its capital account for which the relevant foreign exchange bureau has confirmed monetary contribution rights and interests (or for which the bank has registered the account-crediting of monetary contribution). For the time being, foreign-invested enterprises are allowed to settle 100% of their foreign exchange capitals on a discretionary basis; a foreign-invested enterprise shall truthfully use its capital for its own operational purposes within the scope of business; where an ordinary foreign-invested enterprise makes domestic equity investment with the amount of foreign exchanges settled, the invested enterprise shall first go through domestic re-investment registration and open a corresponding Account for Foreign Exchange Settlement Pending Payment with the foreign exchange bureau (bank) at the place of registration. The Circular of the SAFE on Reforming and Regulating Policies on the Control over Foreign Exchange Settlement of Capital Accounts, or SAFE Circular 16, was promulgated and became effective on June 9, 2016. According to SAFE Circular 16, enterprises registered in PRC may also convert their foreign debts from foreign currency into Renminbi on self-discretionary basis. SAFE Circular 16 provides an integrated standard for conversion of foreign exchange under capital account items (including but not limited to foreign currency capital and foreign debts) on self—discretionary basis, which applies to all enterprises registered in the PRC. SAFE Circular 16 reiterates the principle that Renminbi converted from foreign currency-denominated capital of a company may not be directly or indirectly used for purposes beyond its business scope and may not be used for investments in securities or other investment with the exception of bank financial products that can guarantee the principal within the PRC unless otherwise specifically provided. Besides, the converted Renminbi shall not be used to make loans for related enterprises unless it is within the business scope or to build or to purchase any real estate that is not for the enterprise own use with the exception for the real estate enterprise.

 

On January 26, 2017, SAFE promulgated the Circular on Further Improving Reform of Foreign Exchange Administration and Optimizing Genuineness and Compliance Verification, or SAFE Circular 3, which stipulates several capital control measures with respect to the outbound remittance of profits from domestic entities to offshore entities, including (i) banks must check whether the transaction is genuine by reviewing board resolutions regarding profit distribution, original copies of tax filing records and audited financial statements, and (ii) domestic entities must retain income to account for previous years’ losses before remitting any profits. Moreover, pursuant to SAFE Circular 3, domestic entities must explain in detail the sources of capital and how the capital will be used, and provide board resolutions, contracts and other proof as a part of the registration procedure for outbound investment.

 

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Regulations on Foreign Exchange Registration of Overseas Investment by PRC Residents

 

SAFE issued the Circular on Relevant Issues Relating to Domestic Resident’s Investment and Financing and Roundtrip Investment through Special Purpose Vehicles, or SAFE Circular 37, which became effective in July 2014, to replace the Circular of the State Administration of Foreign Exchange on Issues Concerning the Regulation of Foreign Exchange in Equity Finance and Roundtrip Investments by Domestic Residents through Offshore Special Purpose Vehicles, to regulate foreign exchange matters in relation to the use of special purpose vehicles, or SPVs, by PRC residents or entities to seek offshore investment and financing or conduct round trip investment in China. SAFE Circular 37 defines a SPV as an offshore entity established or controlled, directly or indirectly, by PRC residents or entities for the purpose of seeking offshore financing or making offshore investment, using legitimate onshore or offshore assets or interests, while “round trip investment” is defined as direct investment in China by PRC residents or entities through SPVs, namely, establishing foreign-invested enterprises to obtain the ownership, control rights and management rights. SAFE Circular 37 stipulates that, prior to making contributions into an SPV, PRC residents or entities be required to complete foreign exchange registration with SAFE or its local branch. In addition, SAFE promulgated the Notice on Further Simplifying and Improving the Administration of the Foreign Exchange Concerning Direct Investment in February 2015, which amended SAFE Circular 37 and became effective on June 1, 2015, requiring PRC residents or entities to register with qualified banks rather than SAFE in connection with their establishment or control of an offshore entity established for the purpose of overseas investment or financing.

 

PRC residents or entities who had contributed legitimate onshore or offshore interests or assets to SPVs but had not obtained registration as required before the implementation of the SAFE Circular 37 must register their ownership interests or control in the SPVs with qualified banks. An amendment to the registration is required if there is a material change with respect to the SPV registered, such as any change of basic information (including change of the PRC residents, name and operation term), increases or decreases in investment amount, transfers or exchanges of shares, and mergers or divisions. Failure to comply with the registration procedures set forth in SAFE Circular 37 and the subsequent notice, or making misrepresentation on or failure to disclose controllers of the foreign-invested enterprise that is established through round-trip investment, may result in restrictions being imposed on the foreign exchange activities of the relevant foreign-invested enterprise, including payment of dividends and other distributions, such as proceeds from any reduction in capital, share transfer or liquidation, to its offshore parent or affiliate, and the capital inflow from the offshore parent, and may also subject relevant PRC residents or entities to penalties under PRC foreign exchange administration regulations. See “Risk Factors—Risks Related to Doing Business in China—PRC regulations relating to investments in offshore 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 or limit our PRC subsidiary’s ability to increase their registered capital or distribute profits.”

 

Regulations on Stock Incentive Plans

 

SAFE promulgated the Notice on Issues Concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly Listed Company, or the Stock Incentive Plan Notice, in February 2012, replacing the previous rules issued by SAFE in March 2007. Pursuant to the Stock Incentive Plan Notice and other relevant rules and regulations, PRC residents participating in stock incentive plan in an overseas publicly-listed company are required to register with SAFE or its local branches and follow certain other procedures. Participants of a stock incentive plan who are PRC residents must conduct the SAFE registration and other procedures with respect to the stock incentive plan through a qualified PRC agent, which could be a PRC subsidiary of the overseas publicly listed company or another qualified institution appointed by the PRC subsidiary. In addition, the PRC agent is required to update the relevant SAFE registration should there be any material change to the stock incentive plan, the PRC agent or other material changes. The PRC agent must, on behalf of the PRC residents who have the right to exercise the employee stock options, apply to SAFE or its local branches for an annual quota for the payment of foreign currencies in connection with the PRC residents’ exercise of the employee stock options. The foreign exchange proceeds received by the PRC residents from the sale of shares under the stock incentive plans granted and dividends distributed by the overseas listed companies must be remitted into the bank accounts in the PRC opened by the PRC agents prior to distribution to such PRC residents.

 

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We adopted an equity incentive plan in 2018, under which we have the discretion to award incentives and rewards to eligible participants. We have advised the recipients of awards under our equity incentive plan to handle relevant foreign exchange matters in accordance with the Stock Incentive Plan Notice. However, we cannot guarantee that all employee awarded equity-based incentives can successfully register with SAFE in full compliance with the Stock Incentive Plan Notice. See “Risk Factors—Risks Related to Doing Business in China—Any failure to comply with PRC regulations regarding employee share incentive plans may subject the PRC plan participants or us to fines and other legal or administrative sanctions.”

 

Regulations on Dividend Distribution

 

Distribution of dividends of foreign investment enterprises are mainly governed by the Foreign Investment Enterprise Law, issued in 1986 and amended in 2000 and 2016 respectively, and the Implementation Rules under the Foreign Investment Enterprise Law, issued in 1990 and amended in 2001 and 2014 respectively. Under these regulations, foreign investment enterprises in the PRC may distribute dividends only out of their accumulative profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, no less than 10% of the accumulated profits of the foreign investment enterprises in the PRC are required to be allocated to fund certain reserve funds each year unless these reserves have reached 50% of the registered capital of the enterprises. A PRC company is not permitted to distribute any profits until any losses from previous fiscal years have been offset. Profits retained from prior fiscal years may be distributed together with distributable profits from the current fiscal year. Under our current corporate structure, our BVI holding company may rely on dividend payments from IST, which is a wholly foreign-owned enterprise incorporated in China, to fund any cash and financing requirements we may have. Limitation on the ability of our consolidated VIEs to make remittance to IST and on the ability of IST to pay dividends to us could limit our ability to access cash generated by the operations of those entities. See “Risk Factors—Risks Related to Doing Business in China—Restrictions under PRC law on our PRC subsidiaries’ ability to make dividends and other distributions could materially and adversely affect our ability to grow, make investments or acquisitions that could benefit our business, pay dividends to you, and otherwise fund and conduct our business”

 

E. Taxation

 

The following is a general summary of the material Marshall Islands, Hong Kong, BVI, PRC and U.S. federal income tax consequences relevant to an investment in our units, shares of common stock and warrants to acquire our shares of common stock, sometimes referred to collectively in this summary as our “securities”. The discussion is not intended to be, nor should it be construed as, legal or tax advice to any particular prospective purchaser. The discussion is based on laws and relevant interpretations thereof in effect as of the date of this prospectus, all of which are subject to change or different interpretations, possibly with retroactive effect. The discussion does not address United States state or local tax laws, or tax laws of jurisdictions other than the Marshall Islands, Hong Kong, the BVI, the PRC and the United States. We recommend that you consult your own tax advisors with respect to the consequences of acquisition, ownership and disposition of our securities.

 

Marshall Islands Taxation

 

The following are the material Marshall Islands tax consequences of our activities to us and to our stockholders and warrant holders of investing in our Common Stock and warrants. Under current Marshall Islands law, we are not subject to tax on income or capital gains, and no Marshall Islands withholding tax or income tax will be imposed upon payments of dividends by us to our stockholders or proceeds from the disposition of our common stock and warrants, provided such stockholders or warrant holders, as the case may be, are not residents in the Marshall Islands. There is no tax treaty between the United States and the Republic of the Marshall Islands.

 

BVI Taxation

 

The BVI does not impose a withholding tax on dividends paid to us by our BVI subsidiary, nor does the BVI levy any capital gains or income taxes on us or our BVI subsidiary. However, our BVI subsidiary is required to pay the BVI government an annual license fee based on the number of shares it is authorized to issue.

 

There is no income tax treaty or convention currently in effect between the United States and the BVI.

 

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Hong Kong Taxation

 

Our Hong Kong subsidiaries, under the current laws of Hong Kong, are subject to profits tax of 16.5%. No provision for Hong Kong profits tax has been made as our Hong Kong subsidiaries have no taxable income.

 

PRC Taxation

 

We are a holding company incorporated in the Marshall Islands, which indirectly holds our equity interests in our PRC operating subsidiaries. The EIT Law and its implementation rules, both of which became effective as of January 1, 2008, provide that a PRC enterprise is subject to a standard income tax rate of 25% and China-sourced income of foreign enterprises, such as dividends paid by a PRC subsidiary to its overseas parent, will normally be subject to PRC withholding tax at a rate of 10%, unless there are applicable treaties between the overseas parent’s jurisdiction of incorporation and China to reduce such rate.

 

Under the Arrangement between the Mainland and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income, or the Double Taxation Arrangement, effective as of January 1, 2007, such dividend withholding tax rate is reduced to 5% if a Hong Kong resident enterprise owns over 25% of the PRC company distributing the dividends. Under the aforesaid arrangement, any dividends that our PRC operating subsidiaries pay to their Hong Kong holding companies may be subject to a withholding tax at the rate of 5% if they are not considered to be a PRC “resident enterprise” as described below. However, if the Hong Kong holdings companies are not considered to be the “beneficial owner” of such dividends under the Notice Regarding Interpretation and Recognition of Beneficial Owners under Tax Treaties promulgated by the State Administration of Taxation on October 27, 2009 (and not a PRC “resident enterprise”), such dividends would be subject to the withholding tax rate of 10%. The withholding tax rate of 5% or 10% applicable will have a significant impact on the amount of dividends to be received by us and ultimately by shareholders.

 

According to the Notice Regarding Interpretation and Recognition of Beneficial Owners under Tax Treaties, the term “beneficial owner” refers to a person who has the right to own and dispose of the income and the rights or properties generated from the said income. The “beneficial owner” may be an individual, a company or any other organization which is usually engaged in substantial business operations. A conduit company is not a “beneficial owner.” The term “conduit company” refers to a company which is usually established for purposes of dodging or reducing taxes, and transferring or accumulating profits. Such a company is only registered in the country of domicile to satisfy the organizational form as required by law, but it does not engage in such substantial business operations as manufacturing, distribution and management. As our Hong Kong holding companies are controlling companies and are not engaged in substantial business operations, they could be considered as conduit companies by tax authorities and we do not expect them to be a beneficial owner.

 

In addition to the changes to the current tax structure, under the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a resident enterprise and will normally be subject to an EIT of 25% on its global income. The implementing rules define the term “de facto management bodies” as “an establishment that exercises, in substance, overall management and control over the production, business, personnel, accounting, etc., of a Chinese enterprise.”

 

It remains unclear whether the PRC tax authorities would require or permit our overseas registered entities to be treated as PRC resident enterprises. We do not currently consider our company to be a PRC resident enterprise. However, if the PRC tax authorities determine that we are a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. In our case, this would mean that income such as interest on offering proceeds and non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second, although under the EIT Law and its implementing rules dividends paid to us from our PRC subsidiaries would qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes. Finally, it is possible that future guidance issued with respect to the new “resident enterprise” classification could result in a situation in which a 10% withholding tax is imposed on dividends we pay to our non-PRC shareholders and with respect to gains derived by our non-PRC shareholders from transferring our shares.

 

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U.S. Federal Income Taxation

 

The following is a discussion of certain material U.S. federal income tax consequences of the acquisition, ownership and disposition of our securities. It does not purport to be a comprehensive description of all of the tax considerations that may be relevant to a particular person’s situation. The discussion applies only to holders that hold their securities as capital assets (generally property held for investment) within the meaning of Section 1221 of the Internal Revenue Code of 1986, as amended, or the Code. This discussion is based on the Code, income tax regulations promulgated thereunder, judicial positions, published positions of the Internal Revenue Service, or the IRS, and other applicable authorities, all as in effect as of the date hereof and all of which are subject to change, possibly with retroactive effect. This discussion is general in nature and is not exhaustive of all possible tax considerations, nor does the discussion address any state, local or foreign tax considerations or any U.S. tax considerations (e.g., estate or gift tax) other than U.S. federal income tax considerations, that may be applicable to particular holders.

 

This discussion does not address all aspects of U.S. federal income taxation that may be relevant in light of particular circumstances, nor does it address the U.S. federal income tax consequences to persons who are subject to special rules under U.S. federal income tax law, including:

 

banks, insurance companies or other financial institutions;

 

persons subject to the alternative minimum tax;

 

tax-exempt organizations;

 

controlled foreign corporations, passive foreign investment companies and corporations that accumulate earnings to avoid United States federal income tax;

 

certain former citizens or long-term residents of the United States;

 

dealers in securities or currencies;

 

traders in securities that elect to use a mark-to-market method of accounting for their securities holdings;

 

persons that own, or are deemed to own, more than five percent of our capital stock;

 

holders who acquired our stock as compensation or pursuant to the exercise of a stock option; or

 

persons who hold our shares as a position in a hedging transaction, “straddle,” or other risk reduction transaction.

 

For purposes of this discussion, a U.S. holder is (i) an individual who is a citizen or resident of the United States for U.S. federal income tax purposes; (ii) a corporation, or other entity treated as a corporation for U.S. federal income tax purposes, created or organized in or under the laws of the United States (or treated as such under applicable U.S. tax laws), any state thereof, or the District of Columbia; (iii) an estate the income of which is subject to U.S. federal income tax regardless of its source; or (iv) a trust if (a) a U.S. court is able to exercise primary supervision over the administration of the trust and one or more U.S. persons have the authority to control all substantial decisions of the trust, or (b) it has a valid election in effect under applicable law and regulations to be treated as a U.S. person for U.S. federal income tax purposes. A non-U.S. holder is a holder that is neither a U.S. holder nor a partnership or other entity classified as a partnership for U.S. federal income tax purposes.

 

In the case of a partnership or entity classified as a partnership for U.S. federal income tax purposes, the U.S. federal income tax treatment of a partner generally will depend on the status of the partner and the activities of the partnership. Partners of partnerships should consult their tax advisors regarding the U.S. federal income tax consequences to them of the merger or of the ownership and disposition of our shares.

 

As a result of consummation of the Share Exchange, (i) we acquired substantially all the properties of KBS International, a U.S. corporation, and (ii) the former shareholders of KBS International held at least 80 percent of our common stock by reason of having held stock of KBS International. Accordingly, under Section 7874 of the Code, we are treated for U.S. federal tax purposes as a U.S. corporation and, among other consequences, are subject to U.S. federal income tax on our worldwide income. This discussion assumes that Section 7874 of the Code continues to apply to treat us as a U.S. corporation for all purposes under the Code. If, for some reason (e.g., future repeal of Section 7874 of the Code), we were no longer treated as a U.S. corporation under the Code, the U.S. federal income tax consequences described herein could be materially and adversely affected.

 

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U.S. Federal Income Tax Consequences for U.S. Holders

 

Distributions

 

In the event that distributions are paid on our common stock, the gross amount of such distributions will be included in the gross income of the U.S. holder as dividend income on the date of receipt to the extent that the distribution is paid out of current or accumulated earnings and profits, as determined under U.S. federal income tax principles. Such dividends will be eligible for the dividends-received deduction allowed to corporations in respect of dividends received from other U.S. corporations. Dividends received by non-corporate U.S. holders, including individuals, may be subject to reduced rates of taxation under current law. A U.S. holder may be eligible to claim a foreign tax credit with respect to any PRC withholding tax imposed on dividends paid by us. However, the foreign tax credit rules are complex, and their application in connection with Section 7874 of the Code and the Agreement Between the Government of the United States of America and the Government of the People’s Republic of China for the Avoidance of Double Taxation and the Prevention of Tax Evasion with Respect to Taxes on Income, or the U.S.-PRC Tax Treaty, is not entirely clear at this time. U.S. holders should consult their own tax advisors with respect to any benefits they may be entitled to under the foreign tax credit rules and the U.S.-PRC Tax Treaty.

 

To the extent that dividends paid on our common stock exceed current and accumulated earnings and profits, the distributions will be treated first as a tax-free return of tax basis on our common stock, and to the extent that the amount of the distribution exceeds tax basis, the excess will be treated as gain from the disposition of those common stock. Because Section 7874 of the Code has applied to treat us as a U.S. corporation only since consummation of the Share Exchange in 2014, we may not be able to demonstrate to the IRS the extent to which a distribution on our common stock exceeds our current and accumulated earnings and profits (as determined under U.S. federal income tax principles), in which case all of such distribution will be treated as a dividend for U.S. federal income tax purposes.

 

Sale or Other Disposition

 

U.S. holders of our common stock will recognize taxable gain or loss on any sale, exchange, or other taxable disposition of common stock equal to the difference between the amount realized for the common stock and the U.S. holder’s tax basis in the common stock. This gain or loss generally will be capital gain or loss. Under current law, non-corporate U.S. holders, including individuals, are eligible for reduced tax rates if the common stock has been held for more than one year. The deductibility of capital losses is subject to limitations. A U.S. holder may be eligible to claim a foreign tax credit with respect to any PRC withholding tax imposed on gain from the sale or other disposition of common stock. However, the foreign tax credit rules are complex, and their application in connection with Section 7874 of the Code and the U.S.-PRC Tax Treaty is not entirely clear at this time. U.S. holders should consult their own tax advisors with respect to any benefits they may be entitled to under the foreign tax credit rules and the U.S.-PRC Tax Treaty.

 

Unearned Income Medicare Contribution

 

Certain U.S. holders who are individuals, trusts or estates are required to pay an additional 3.8% Medicare tax on, among other things, dividends on and capital gains from the sale or other disposition of shares of stock. U.S. holders should consult their own advisors regarding the effect, if any, of this rule on their ownership and disposition of our common stock.

 

U.S. Federal Income Tax Consequences for Non-U.S. Holders

 

Distributions

 

The rules applicable to non-U.S. holders for determining the extent to which distributions on our common stock, if any, constitute dividends for U.S. federal income tax purposes are the same as for U.S. holders. See “–U.S. Federal Income Tax Consequences for U.S. Holders– Distributions.”

 

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Any dividends paid to a non-U.S. holder by us are treated as income derived from sources within the United States and generally will be subject to U.S. federal income tax withholding at a rate of 30% of the gross amount of the dividends, or at a lower rate provided by an applicable income tax treaty if non-U.S. holders provide proper certification of eligibility for the lower rate (usually on IRS Form W-8BEN or W-8BEN-E). Dividends received by a non-U.S. holder that are effectively connected with such holder’s conduct of a U.S. trade or business (and, if an income tax treaty applies, are attributable to a permanent establishment maintained by the non-U.S. holder in the U.S.) are exempt from such withholding tax, provided that applicable certification requirements are satisfied. In such case, however, non-U.S. holders will be subject to U.S. federal income tax on such dividends, net of certain deductions, at the rates applicable to U.S. persons. In addition, corporate non-U.S. holders may be subject to an additional branch profits tax equal to 30% or such lower rate as may be specified by an applicable tax treaty on dividends received that are effectively connected with the conduct of a trade or business in the United States.

 

If non-U.S. holders are eligible for a reduced rate of U.S. withholding tax pursuant to an applicable income tax treaty, such non-U.S. holders may obtain a refund of any excess amounts withheld by filing an appropriate claim for refund with the IRS.

 

Sale or Other Disposition

 

Except as described below for a reduced rate of U.S. withholding tax pursuant to an applicable income tax treaty, any gain realized by a non-U.S. holder upon the sale or other disposition of our common stock generally will not be subject to U.S. federal income tax unless:

 

the gain is effectively connected with the conduct of a trade or business in the United States by such non- U.S. holder, and, if an income tax treaty applies, is attributable to a permanent establishment maintained by such non-U.S. holder in the U.S.;

 

the non-U.S. holder is an individual who is present in the United States for 183 days or more in the taxable year of the disposition, and certain other conditions are met; or

 

We are or have been a “U.S. real property holding corporation,” or USRPHC, for U.S. federal income tax purposes at any time during the shorter of the five-year period ending on the date of disposition or the period during which the holder has held our Common Stock.

 

Non-U.S. holders whose gain is described in the first bullet point above will be subject to U.S. federal income tax on the gain derived from the sale, net of certain deductions, at the rates applicable to U.S. persons. Corporate non-U.S. holders whose gain is described in the first bullet point above may also be subject to the branch profits tax described above at a 30% rate or lower rate provided by an applicable income tax treaty. Individual non-U.S. holders described in the second bullet point above will be subject to a flat 30% U.S. federal income tax rate on the gain derived from the sale, which may be offset by U.S.-source capital losses, even though such non-U.S. holders are not considered to be residents of the United States.

 

A corporation will be a USRPHC if the fair market value of its U.S. real property interests equals or exceeds 50 percent of the aggregate of its real property interests (U.S. and non-U.S.) and its assets used or held for use in a trade or business. Because we do not currently own significant U.S. real property, we believe that we are not currently and will not become a USRPHC. However, because the determination of whether we are a USRPHC depends on the fair market value of our U.S. real property relative to the fair market value of our other business assets, there can be no assurance that we will not become a USRPHC in the future. Even if we become a USRPHC, however, as long as our common stock are regularly traded on an established securities market, such common stock will be treated as U.S. real property interests only if a non-U.S. holder actually or constructively holds more than 5% of such regularly traded common stock at any time during the applicable period that is specified in the Code.

 

Foreign Account Tax Compliance

 

The Foreign Account Tax Compliance provisions of the Hiring Incentives to Restore Employment Act (generally referred to as “FATCA”), when applicable, will impose a U.S. federal withholding tax of 30% on payments of dividends on, and (for dispositions after December 31, 2018) gross proceeds from dispositions of, our common stock that are held through “foreign financial institutions” (which is broadly defined for this purpose and in general includes investment vehicles) and certain other non-U.S. entities unless various U.S. information reporting and due diligence requirements (generally relating to ownership by U.S. persons of certain interests in or accounts with those entities) have been satisfied or an exemption applies. An intergovernmental agreement between the United States and an applicable foreign country may modify these requirements. U.S. Holders should consult their tax advisers regarding the effect, if any, of the FATCA provisions on their particular circumstances.

 

78

 

Information Reporting and Backup Withholding

 

Payments of dividends or of proceeds on the disposition of stock made to a holder of our common stock may be subject to information reporting and backup withholding at a current rate of 24% unless such holder provides a correct taxpayer identification number on IRS Form W-9 (or other appropriate withholding form) or establishes an exemption from backup withholding, for example by properly certifying the holder’s non-U.S. status on a Form W-8BEN, Form W-8BEN-E or another appropriate version of IRS Form W-8. Payments of dividends to holders must generally be reported annually to the IRS, along with the name and address of the holder and the amount of tax withheld, if any. A similar report is sent to the holder. Pursuant to applicable income tax treaties or other agreements, the IRS may make these reports available to tax authorities in the holder’s country of residence.

 

Backup withholding is not an additional tax; rather, the U.S. income tax liability of persons subject to backup withholding will be reduced by the amount of tax withheld. If withholding results in an overpayment of taxes, a refund or credit may generally be obtained from the IRS, provided that the required information is furnished to the IRS in a timely manner.

 

F. Dividends and Paying Agents

 

Not applicable.

 

G. Statement by Experts

 

Not applicable.

 

H. Documents on Display

 

We have filed this annual report on Form 20-F with the SEC under the Exchange Act. Statements made in this report as to the contents of any document referred to are not necessarily complete. With respect to each such document filed as an exhibit to this report, reference is made to the exhibit for a more complete description of the matter involved, and each such statement shall be deemed qualified in its entirety by such reference.

 

We are subject to the informational requirements of the Exchange Act as a foreign private issuer and file reports and other information with the SEC. Reports and other information filed by us with the SEC, including this report, may be inspected and copied at the public reference room of the SEC at 100 F Street, N.E., Washington D.C. 20549. You can also obtain copies of this report by mail from the Public Reference Section of the SEC, 100 F. Street, N.E., Washington D.C. 20549, at prescribed rates. Additionally, copies of this material may be obtained from the SEC’s Internet site at http://www.sec.gov. The SEC’s telephone number is 1-800-SEC-0330. In accordance with NASDAQ Stock Market Rule 5250(d), we will also post this annual report on Form 20-F on our website at www.kbsfashion.com.

 

As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing the furnishing and content of quarterly reports and proxy statements, and officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in Section 16 of the Exchange Act.

 

I. Subsidiary Information

 

Not applicable.

 

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Interest Rate Risk

 

We deposit surplus funds with Chinese banks earning daily interest. We do not invest in any instruments for trading purposes. Most of our outstanding debt instruments carry fixed rates of interest. Our operations generally are not directly sensitive to fluctuations in interest rates and we currently do not have any long-term debt outstanding. Management monitors the banks’ prime rates in conjunction with our cash requirements to determine the appropriate level of debt balances relative to other sources of funds. We have not entered into any hedging transactions in an effort to reduce our exposure to interest rate risk.

 

79

 

Foreign Exchange Risk

 

While our reporting currency is the U.S. dollar, substantially all of our consolidated revenues and consolidated costs and expenses are denominated in RMB. Substantially all of our assets are denominated in RMB. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between the U.S. dollar and the RMB. If the RMB depreciates against the U.S. dollar, the value of our RMB revenues, earnings and assets as expressed in our U.S. dollar financial statements will decline. Assets and liabilities are translated at exchange rates at the balance sheet dates and revenue and expenses are translated at the average exchange rates and equity is translated at historical exchange rates. Any resulting translation adjustments are not included in determining net income but are included in determining other comprehensive income, a component of equity. An average appreciation (depreciation) of the RMB against the U.S. dollar of 5% would increase (decrease) our comprehensive income by $0.93 million based on our outstanding revenues, costs and expenses, assets and liabilities denominated in RMB as of December 31, 2018. As of December 31, 2018, our accumulated other comprehensive income was -$1.8 million. We have not entered into any hedging transactions in an effort to reduce our exposure to foreign exchange risk.

 

The value of RMB against the U.S. dollar and other currencies is affected by, among other things, changes in China’s political and economic conditions. Since July 2005, RMB has not been pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future, PRC authorities may lift restrictions on fluctuations in RMB exchange rate and lessen intervention in the foreign exchange market.

 

Inflation

 

Inflationary factors such as increases in the cost of our product and overhead costs may adversely affect our operating results. Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of gross margin and selling, general and administrative expenses as a percentage of net revenues if the selling prices of our products do not increase with these increased costs.

 

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

 

A. Debt Securities

 

Not applicable.

 

B. Warrants and Rights

 

Not applicable.

 

C. Other Securities

 

Not applicable.

 

D. American Depositary Shares

 

We do not have any American Depositary Shares.

 

80

 

PART II

 

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

 

None.

 

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

 

None.

 

ITEM 15. CONTROLS AND PROCEDURES

 

A. Disclosure Controls and Procedures

 

An evaluation of the effectiveness of our disclosure controls and procedures as of December 31, 2018, was made under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based on that evaluation, we concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

 

Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

 

B. Management’s Annual Report on Internal Control Over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements in accordance with IFRS and includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of a company’s assets, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with generally accepted accounting principles, and that a company’s receipts and expenditures are being made only in accordance with authorizations of a company’s management and directors, and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of a company’s assets that could have a material effect on the consolidated financial statements.

 

Because of its inherent limitations, a system of internal control over financial reporting can provide only reasonable assurance with respect to consolidated financial statement preparation and presentation and may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

As required by Section 404 of the Sarbanes-Oxley Act of 2002 and related rules as promulgated by the Securities and Exchange Commission, our management assessed the effectiveness of the our internal control over the financial reporting as of December 31, 2018, using criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment using those criteria, our management concluded that our internal control over financial reporting was effective as of December 31, 2018.

 

C. Attestation Report of the Registered Public Accounting Firm

 

Because the Company is a non-accelerated filer, this annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting.

 

81

 

D. Changes in Internal Controls over Financial Reporting

 

There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the year ended December 31, 2018 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

 

The audit committee of our board of directors currently consists of three members, Matthew C. Los (who serves as chairman), John Sano andYuet Mei Chan. Our board of directors has determined that all of our audit committee members are “independent” under the Exchange Act and have the requisite financial knowledge and experience to serve as members of our audit committee. In addition, our board of directors has determined that Matthew C. Los is an “audit committee financial expert” as defined in Item 16A of the Instructions to Form 20-F and meets NASDAQ’s financial sophistication requirements due to his current and past experience in various companies in which he was responsible for, amongst others, the financial oversight responsibilities.

 

ITEM 16B. CODE OF ETHICS

 

On October 25, 2014, our Audit Committee adopted a Code of Ethics that applies to all of the directors, officers and employees of the Company and its subsidiaries, including our principal executive officer, principal financial officer and principal accounting officer. The Code of Ethics addresses, among other things, honesty and ethical conduct, conflicts of interest, compliance with laws, regulations and policies, including disclosure requirements under the federal securities laws, confidentiality, trading on inside information, and reporting of violations of the code. A copy of the Code of Ethics is filed as Exhibit 11.1 to the annual report on Form 20-F filed on October 27, 2015 and is also available on our website at www.kbsfashion.com. During the fiscal year ended December 31, 2018, there were no waivers of our Code of Ethics.

 

ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

The following table sets forth the aggregate fees by categories specified below in connection with services rendered by our principal external auditors for the periods indicated.

 

    Fiscal Year Ended
December 31,
 
    2018     2017  
Audit Fees*   $ 120,000     $ 110,000  
Audit-Related Fees             -  
Tax Fees             -  
TOTAL   $ 120,000     $ 110,000  

 

* “Audit Fees” consisted of the aggregate fees billed for professional services rendered for the audit of our annual financial statements or services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements.

 

Our Audit Committee pre-approves all auditing services and permitted non-audit services to be performed for us by our independent auditor, including the fees and terms thereof (subject to the de minimums exceptions for non-audit services described in Section 10A(i)(l)(B) of the Exchange Act that are approved by our Audit Committee prior to the completion of the audit). The percentage of services provided for which we paid audit-related fees, tax fees, or other fees that were approved by our Audit Committee pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X promulgated by the SEC was 100%.

 

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

 

Prior to July 10, 2017, in lieu of an audit committee comprised of three independent directors, our audit committee was comprised of two independent members of our board of directors. On July 10, 2017, the board of directors appointed Ms. Yuet Mei Chan as an independent director and a member of the audit committee. As a result, we are in full compliance with the Nasdaq listing rules for the audit committee.

 

82

 

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

 

There were no purchases of equity securities made by or on behalf of us or any “affiliated purchaser” as defined in Rule 10b-18 of the Exchange Act during the period covered by this Annual Report.

 

ITEM 16F. CHANGES IN REGISTRANT’S CERTIFYING ACCOUNTANT

 

None.

 

ITEM 16G. CORPORATE GOVERNANCE

 

We were incorporated in the Republic of the Marshall Islands (“RMI”) and our corporate governance practices are governed by applicable RMI law, our articles of incorporation and bylaws. In addition, because our common stock is listed on NASDAQ, we are subject to NASDAQ’s corporate governance requirements.

 

NASDAQ Listing Rule 5615(a)(3) permits a foreign private issuer like us to follow home country practices in lieu of certain requirements of Listing Rule 5600, provided that such foreign private issuer discloses in its annual report filed with the SEC each requirement of Rule 5600 that it does not follow and describes the home country practice followed in lieu of such requirement. The home country practices that we follow in lieu of NASDAQ’s corporate governance rules are as follows:

 

we currently do not have a nominating committee or a compensation committee;

 

we did not hold an annual shareholder meeting in fiscal 2018; however, we may, hold annual shareholder meetings in the future if there are significant issues that require shareholders’ approvals; and

 

in lieu of obtaining shareholder approval prior to the adoption of an agreement pursuant to which stock may be acquired by officers, directors, employees or consultants, the board of directors approves such adoption.

 

ITEM 16H. MINE SAFETY DISCLOSURE

 

Not applicable.

 

83

 

PART III

 

ITEM 17. FINANCIAL STATEMENTS

 

We have elected to provide financial statement pursuant to Item 18.

 

ITEM 18. FINANCIAL STATEMENTS

 

The financial statements are filed as part of this annual report beginning on page F-1.

 

ITEM 19. EXHIBITS

 

Exhibit No.   Description
1.1   Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.3 to the Amendment No. 4 to the registrant’s Registration Statement on Form F-1 filed on October 24, 2012 (Commission File No. 333-180571)).
1.2   Articles of Amendment, filed with the Office of the Registrar of Corporations of Republic of the Marshall Islands on October 31, 2014 (incorporated by reference to Exhibit 1.2 to the Annual Report on Form 20-F filed by the registrant on October 27, 2015)
1.3   Articles of Amendment, filed with the Office of the Registrar of Corporations of Republic of the Marshall Islands on February 3, 2017 (incorporated by reference to Exhibit 99.1 to the Report on Form 6-K furnished by the registrant on February 3, 2017)
1.4   By-laws as amended on September 22, 2014 (incorporated by reference to Exhibit 1.3 to the Annual Report on Form 20-F filed by the registrant on October 27, 2015)
2.1   Specimen of Unit Certificate (incorporated by reference to Exhibit 2.1 to the Annual Report on Form 20-F filed by the registrant on October 27, 2015)
2.2   Specimen of Common Stock Certificate (incorporated by reference to Exhibit 2.2 to the Annual Report on Form 20-F filed by the registrant on October 27, 2015)
2.3   Specimen of Public Redeemable Warrant Certificate (incorporated by reference to Exhibit 2.3 to the Annual Report on Form 20-F filed by the registrant on October 27, 2015)
2.4   Specimen Placement Unit Certificate (incorporated by reference to Exhibit 4.4 to the Amendment No. 3 to the registrant’s Registration Statement on Form F-1 filed on October 15, 2012 (Commission File No. 333-180571)).
2.5   Specimen Placement Warrant Certificate (incorporated by reference to Exhibit 4.5 to the Amendment No. 1 to the registrant’s Registration Statement on Form F-1 filed on June 5, 2012 (Commission File No. 333-180571)).
2.6   Form of Warrant Agreement (incorporated by reference to Exhibit 4.6 to the Amendment No. 4 to the registrant’s Registration Statement on Form F-1 filed on October 24, 2012 (Commission File No. 333-180571)).
2.7   Form of Unit Purchase Option (incorporated by reference to Exhibit 4.7 to the Amendment No. 3 to the registrant’s Registration Statement on Form F-1 filed on October 15, 2012 (Commission File No. 333-180571)).
4.1   Form of Registration Rights Agreement among the Registrant and the founders (incorporated by reference to Exhibit 10.5 to the Amendment No. 1 to the registrant’s Registration Statement on Form F-1 filed on June 5, 2012 (Commission File No. 333-180571)).
4.2   Form of Placement Unit Purchase Agreement between the registrant and the founders (incorporated by reference to Exhibit 10.6 to the Amendment No. 4 to the Registrant’s Registration Statement on Form F-1 filed on October 24, 2012 (Commission File No. 333-180571)).
4.3   Share Exchange Agreement and Plan of Liquidation, dated March 24, 2014, by and among Aquasition Corp., KBS International Holdings, Inc., Hongri International Holdings Limited, Cheung So Wa and Chan Sun Keung (incorporated by reference to Exhibit 10.1 to the Registration Report on Form 6-K filed by the registrant on April 4, 2014)
4.4   Frist Amendment to Share Exchange Agreement and Plan of Liquidation, dated June 21, 2014 by and among Aquasition Corp., KBS International Holdings, Inc., Hongri International Holdings Limited, Cheung So Wa and Chan Sun Keung (incorporated by reference to Exhibit (D)(3) to Amendment No.4 to the Schedule TO filed by the registrant on July 9, 2014)
4.5   Voting Agreement , dated August 1, 2014, by and among Aquasition Corp., Aquasition Investments Corp., Cheung So Wa and Chan Sun Keung (incorporated by reference to Exhibit 4.11 to Shell Company Report on Form 20-F filed by the registrant on August 7, 2014)

 

84

 

Exhibit No.   Description
4.6   Form of Resale Lock-Up Agreement, dated August 1, 2014, by and among Aquasition Corp., Aquasition Investments Corp., Cheung So Wa, Chan Sun Keung and other named parties(incorporated by reference to Exhibit 4.12 to Shell Company Report on Form 20-F filed by the registrant on August 7, 2014)
4.7   Employee Agreement with Keyan Yan, dated August 1, 2014 (incorporated by reference to Exhibit 4.13 to Shell Company Report on Form 20-F filed by the registrant on August 7, 2014)
4.8   Employee Agreement with Lixia Tu, dated June 25, 2015 (incorporated by reference to Exhibit 4.12 to the Annual Report on Form 20-F filed by the registrant on October 27, 2015)
4.9   2018 Equity Incentive Plan (incorporated by reference to Exhibit 99.1 to the Registration Statement on Form S-8 filed by the registrant on December 27, 2018)
8.1   List of the registrant’s subsidiaries (incorporated by reference to Exhibit 8.1 to Shell Company Report on Form 20-F filed by the registrant on August 7, 2014)
11.1   Code of Ethics, adopted on October 25, 2014 (incorporated by reference to Exhibit 11.1 to the Annual Report on Form 20-F filed by the registrant on October 27, 2015)
12.1   Certifications of Chief Executive Officer Pursuant to Rule 13a-14(a) or Rule 15d-1(a)
12.2   Certifications of Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-1(a)
13.1   Certifications of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
13.2   Certifications of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
15.1  

Consent from WWC, P.C., Independent Registered Public Accounting Firm

101.INS   XBRL Instance Document
101.SCH   XBRL Taxonomy Extension Schema Document
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document

 

85

 

SIGNATURE

 

The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this report on its behalf.

 

 Date: April 30, 2019 KBS Fashion Group Limited
   
  /s/ Keyan Yan
  Keyan Yan
  Chief Executive Officer

 

86

 

 

 

 

 

 

 

 

 

 

 

KBS Fashion Group Limited

Consolidated Financial Statements

 

For the years ended December 31, 2018, 2017, and 2016

(Stated in US dollars)

 

 

 

 

 

 

 

 

 

 

CONTENTS   PAGES
     
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM   F-2
     
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/ (LOSS) F- 3
     
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION   F- 4
     
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY   F- 5
     
CONSOLIDATED STATEMENTS OF CASH FLOWS   F-6 – F-7
     
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS   F- 8 – F-59

 

F- 1

 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To: The Board of Directors and Stockholders of
  KBS Fashion Group Limited

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated statements of financial position of KBS Fashion Group Limited (the Company) as of December 31, 2018 and 2017, and the related consolidated statements of comprehensive income (loss), changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2018, and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2018, in conformity with International Financial Reporting Standards as issued by the International Accounting Standards Board.

 

Emphasis of Matter

 

The Company incurred significant losses during the year ended December 31, 2018. The losses were related to the sale of products at discounted prices and impairment loss charged during the year. During the year, the Company completed its cash management strategy that was put in place in 2017.

 

Basis for Opinion

 

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ WWC, P.C.

 

WWC, P.C.

Certified Public Accountants

 

We have served as the Company’s auditor since April 25, 2016.

 

San Mateo, California

April 30, 2019

 

 

 

F- 2

 

KBS Fashion Group Limited

Consolidated Statements of Comprehensive Income/ (Loss)

For the years ended December 31, 2018, 2017, 2016

(Stated in U.S. Dollars)

 

        Year ended December 31,  
    Notes   2018     2017     2016  
Revenue   8     18,535,115       23,762,536       41,200,205  
Cost of sales   9     (20,851,252 )     (35,274,352 )     (39,041,932 )
Gross (loss)/profit         (2,316,137 )     (11,511,816 )     2,158,273  
                             
Other income   10     122,139       461,564       555,051  
Other gains and (losses)   11     (13,522,300 )     (122,243 )     (11,123,767 )
Distribution and selling expenses   12     (2,670,955 )     (3,265,380 )     (3,606,010 )
Administrative expenses   13     (4,907,020 )     (4,879,397 )     (3,543,993 )
Loss from operations         (23,294,273 )     (19,317,272 )     (15,560,446 )
                             
Finance costs   14     (96,444 )     (96,385 )     (71,783 )
Change in fair value of warrant liabilities   31     -       -       3,409  
                             
Loss before tax         (23,390,717 )     (19,413,657 )     (15,628,820 )
                             
Income tax income   15     5,422,119       4,598,061       3,726,133  
                             
Loss for the year   16     (17,968,598 )     (14,815,596 )     (11,902,687 )
Other comprehensive (loss) income                            
-currency translation differences         (3,071,697 )     4,810,715       (6,125,433 )
Total comprehensive loss for the year         (21,040,295 )     (10,004,881 )     (18,028,120 )
                             
Loss per share of common stock attributable to the Company                            
-Basic   19     (8.06 )     (7.96 )     (6.80 )
-Diluted   19     (8.06 )     (7.96 )     (6.80 )
Weighted average shares outstanding:                            
-Basic   19     2,229,915       1,860,831       1,750,142  
-Diluted   19     2,229,915       1,860,831       1,750,142  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F- 3

 

KBS Fashion Group Limited

Consolidated Statements of Financial Position

As at December 31, 2018, and 2017

(Stated in U.S. Dollars)

  

        As of December 31,  
    Notes   2018     2017  
Non-current assets                
Property, plant and equipment-net   20     12,173,808       27,824,523  
Prepayments and premiums under operating leases   21     2,371,735       2,568,199  
Prepayment for construction of new plant   22     -       -  
Prepayment for acquisition of land use right   23     -       -  
Land use rights   24     603,503       648,652  
Deferred tax assets   15     14,688,829       9,924,944  
          29,837,875       40,966,318  
Current assets                    
Inventories   25     1,245,800       1,806,212  
Trade receivables   26     8,122,223       10,501,543  
Other receivables and prepayments   26     855,473       1,901,268  
Subsidies prepaid to distributors         -       -  
Prepayments and premiums under operating leases   21     78,532       83,907  
Cash and cash equivalents   27     21,026,103       26,050,456  
          31,328,131       40,343,386  
Total assets         61,166,006       81,309,704  
Current liabilities                    
Short term bank loans   30     1,092,783       1,606,930  
Trade and other payables   28     5,278,460       5,451,830  
Related parties payables   29     445,614       154,137  
Contract liabilities         47,828       69,612  
          6,864,685       7,282,509  
Non-current liability                    
Warrant liabilities   31     -       -  
          -       -  
Total liabilities         6,864,685       7,282,509  
Equity                    
Share capital   32     227       198  
Share premium   32     8,000,561       6,686,169  
Revaluation reserve   33     184,272       184,272  
Statutory surplus reserve   33     6,084,836       6,084,836  
Retained profits   33     46,178,213       64,146,811  
Foreign currency translation reserve   33     (6,146,788 )     (3,075,091 )
          54,301,321       74,027,195  
Total liabilities and equity         61,166,006       81,309,704  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F- 4

 

KBS Fashion Group Limited

Consolidated Statements of Changes in Equity

For the years ended December 31, 2018, 2017, 2016

(Stated in U.S. Dollars)

  

                                  Foreign        
                      Statutory           currency        
    Share     Share     Revaluation     surplus     Retained     translation        
    capital     premium     reserve     reserve     profits     reserve     Total  
    (Note 32)     (Note 32)     (Note 33)     (Note 33)     (Note 33)     (Note 33)        
Balance at January 1, 2016     170       5,627,247       -       6,069,457       90,880,473       (1,760,373 )     100,816,974  
Reclassification of revaluation surplus     -       -       184,272       -       -       -       184,272  
Shares issued for stock-based compensation     7       428,993       -       -       -       -       429,000  
Loss for the year     -       -       -       -       (11,902,687 )     -       (11,902,687 )
Other comprehensive loss for the year     -       -       -       -       -       (6,125,433 )     (6,125,433 )
Appropriation to statutory surplus reserve     -       -       -       15,379       (15,379 )     -       -  
Balance at December 31, 2016     177       6,056,240       184,272       6,084,836       78,962,407       (7,885,806 )     83,402,126  
Shares issued for stock-based compensation     21       629,929       -       -       -       -       629,950  
Loss for the year     -       -       -       -       (14,815,596 )     -       (14,815,596 )
Other comprehensive income for the year     -       -       -       -       -       4,810,715       4,810,715  
Balance at December 31, 2017     198       6,686,169       184,272       6,084,836       64,146,811       (3,075,091 )     74,027,195  
Shares issued for stock-based compensation     29       1,314,392       -       -       -       -       1,314,421  
Loss for the year     -       -       -       -       (17,968,598 )     -       (17,968,598 )
Other comprehensive loss for the year     -       -       -       -       -       (3,071,697 )     (3,071,697 )
Balance at December 31, 2018     227       8,000,561       184,272       6,084,836       46,178,213       (6,146,788 )     54,301,321  

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F- 5

 

KBS Fashion Group Limited

Consolidated Statements of Cash Flows

For the years ended December 31, 2018, 2017, 2016

(Stated in U.S. Dollars)

 

    Year ended December 31,  
    2018     2017     2016  
OPERATING ACTIVITIES                  
Loss for the year     (17,968,598 )     (14,815,596 )     (11,902,687 )
Adjustments for:                        
Share-based payment     1,314,420       629,950       429,000  
Finance cost     96,444       96,385       71,783  
Change in fair value of warrant liabilities     -       -       (3,409 )
Interest income     (71,693 )     (81,517 )     (85,482 )
Depreciation of property, plant and equipment     1,521,725       1,510,213       1,942,735  
Amortization of prepaid lease payments and trademark     14,545       14,307       19,009  
Amortization of subsidies prepaid to distributors     -       401,259       910,537  
Amortization of prepayments and premiums under operating leases     107,088       105,340       118,783  
Provision/(reversal) of inventory obsolescence     196,124       101,256       (1,667 )
Bad debt provision of trade receivables     -       -       331,196  
Gain on disposal of property, plant and equipment     940       2,418       1,441  
Provision of impairment loss in property, plant and equipment     13,311,557       -       -  
Provision of impairment loss in prepayments     -       -       11,649,038  
Operating cash flows before movements in working capital     (1,477,448 )     (12,035,985 )     3,480,277  
                         
Decrease in trade and other receivables     1,941,336       13,983,781       7,265,940  
Decrease in inventories     294,204       669,923       889,384  
Increase/(decrease) in trade and other payables     2,036       522,839       (1,080,978 )
(Decrease)/increase in income tax payable     -       (263,333 )     155,632  
Increase in deferred tax assets     (5,422,119 )     (4,598,061 )     (3,779,923 )
Prepayments and premiums paid under operating leases     958,638       3,645,471       (1,761,155 )
Subsidies prepaid to distributors     -       -       (910,537 )
CASH GENERATED FROM OPERATING ACTIVITIES     (3,703,353 )     1,924,635       4,258,640  
                         
Income tax paid     -       (2,385 )