As filed with the Securities and Exchange Commission on March 18, 2019.

 

Registration Statement No. 333-230051

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Amendment No.1

to

 

Form F-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

Blue Hat Interactive Entertainment Technology

(Exact name of registrant as specified in its charter)

 

 

Not Applicable

(Translation of Registrant’s name into English)

 

 

 

Cayman Islands   3942   Not Applicable

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

 

 

 

 

 

 

 

 

 

 

 

7th Floor, Building C, No. 1010 Anling Road

Huli District, Xiamen, China 361009

86-592-228-0081

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

 

 

Puglisi & Associates

850 Library Avenue, Suite 204

Newark, DE 19711

302-738-6680

 

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

 

Copies of all communications, including communications sent to agent for service, should be sent to:

 

Clayton E. Parker, Esq.

Matthew Ogurick, Esq.

Hillary O’Rourke, Esq.

K&L Gates LLP

Southeast Financial Center, Suite 3900

200 South Biscayne Boulevard

Miami, Florida 33131-2399

Telephone: 305-539-3300

Fax: 305-358-7095

 

Louis Taubman, Esq.

Guillaume de Sampigny, Esq.

Hunter Taubman Fischer & Li LLC

1450 Broadway, 26th Floor

New York, NY 10018

Telephone: 917-512-0827

Fax: 212-201-6380

 

 

Approximate date of commencement of proposed sale to public: As soon as practicable after this Registration Statement becomes effective.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

CALCULATION OF REGISTRATION FEE

 

Title of Each Class of Securities to be Registered Amount to be registered Proposed Maximum Aggregate Price Per Share Proposed Maximum Aggregate Offering Price(1) Amount of Registration Fee(2)
Ordinary shares, par value US$0.001 per share(3)  5,175,000 US$4.00 US$20,700,000 US$2,508.84
Underwriters’ Warrants(4) - - - -
Ordinary shares underlying Underwriters’ Warrants  450,000 US$4.80 US$2,160,000 US$261.79
Total  5,625,000 US$22,860,000 US$2,770.63

 

(1) Estimated solely for the purpose of calculating the amount of the registration fee in accordance with Rule 457(a) under the Securities Act. Includes the offering price attributable to 675,000 additional shares that the underwriters have the option to purchase to cover over-allotments, if any.
(2) Calculated pursuant to Rule 457(a) under the Securities Act, based on an estimate of the proposed maximum aggregate offering price. Previously paid.
(3) In accordance with Rule 416(a), we are also registering an indeterminate number of additional ordinary shares that shall be issuable pursuant to Rule 416 to prevent dilution resulting from share splits, share dividends or similar transactions.
(4) We have agreed to issue, on the closing date of this offering, warrants, or the underwriters' warrants, to the representative of the underwriters, ViewTrade Securities, Inc., in an amount equal to 10% of the aggregate number of ordinary shares sold by us in this offering. The exercise price of the underwriters' warrants is equal to 120% of the price of our ordinary shares offered hereby. The underwriters' warrants are exercisable for a period of five years from the effective date of the registration statement of which this prospectus forms a part and will terminate on the fifth anniversary of the effective date of the registration statement.

 

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

 

 

   

 

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

Subject to Completion, DATED March 18, 2019

PRELIMINARY PROSPECTUS

 

4,500,000 Ordinary Shares

 

 

 

We are offering 4,500,000 ordinary shares. This is the initial public offering of our ordinary shares. The offering price of our ordinary shares in this offering is expected to be $4.00 per share. Prior to this offering, there has been no public market for our ordinary shares.

We have applied to list our ordinary shares on the Nasdaq Capital Market under the symbol “BHAT.” There is no assurance that such application will be approved, and if our application is not approved, this offering may not be completed.

Investing in our ordinary shares involves a high degree of risk. Before buying any shares, you should carefully read the discussion of material risks of investing in our ordinary shares in “Risk Factors” beginning on page 15 of this prospectus.

We are an “emerging growth company” as defined under the federal securities laws and, as such, will be subject to reduced public company reporting requirements. See “Prospectus Summary—Implications of Being an Emerging Growth Company and a Foreign Private Issuer” for additional information.

Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

 
 

PER SHARE

TOTAL

Initial public offering price  $      $
Underwriting discounts and commissions(1)  $      $
Proceeds, before expenses, to us  $      $
     
 

(1) We have agreed to issue, on the closing date of this offering, underwriters’ warrants to the representative of the underwriters, ViewTrade Securities, Inc., in an amount equal to 10% of the aggregate number of ordinary shares sold by us in this offering. For a description of other terms of the underwriters’ warrants and a description of the other compensation to be received by the underwriters, see “Underwriting” beginning on page 108.

 

We expect our total cash expenses for this offering (including cash expenses payable to our underwriters for their out-of-pocket expenses) to be approximately $618,021, exclusive of the above commissions. In addition, we will pay additional items of value in connection with this offering that are viewed by the Financial Industry Regulatory Authority, or FINRA, as underwriting compensation. These payments will further reduce proceeds available to us before expenses. See “Underwriting.”

 

   

 

 

This offering is being conducted on a firm commitment basis. The underwriter, ViewTrade Securities Inc., is obligated to take and pay for all of the shares if any such shares are taken. We have granted the underwriters an option for a period of 45 days after the closing of this offering to purchase up to 15% of the total number of our ordinary shares to be offered by us pursuant to this offering (excluding shares subject to this option), solely for the purpose of covering over-allotments, at the initial public offering price less the underwriting discount. If the underwriters exercise the option in full, the total underwriting discounts and commissions payable will be $1,449,000 based on an assumed offering price of $4.00 per ordinary share, and the total gross proceeds to us, before underwriting discounts and commissions and expenses, will be $20,700,000. If we complete this offering, net proceeds will be delivered to us on the closing date. We will not be able to use such proceeds in China, however, until we complete capital contribution procedures which require prior approval from each of the respective local counterparts of China’s Ministry of Commerce, the State Administration for Industry and Commerce, and the State Administration of Foreign Exchange. See remittance procedures in the section titled “Use of Proceeds” beginning on page 39.

 

The underwriters expect to deliver the ordinary shares against payment as set forth under “Underwriting”, on or about     , 2019.

 

 

 

The date of this prospectus is , 2019.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   

 

 

TABLE OF CONTENTS

 

  Page
Prospectus Summary 3
Risk Factors 15
Special Note Regarding Forward-Looking Statements 37
Industry and Market Data 38
Use of Proceeds 39
Dividend Policy 40
Capitalization 41
Dilution 42
Exchange Rate Information 43
Corporate History and Structure 44
Selected Consolidated Financial Data 49
Management’s Discussion and Analysis of Financial Condition and Results of Operations 50
Business 67
Management 89
Related Party Transactions 92
Principal Shareholders 93
Description of Share Capital and Governing Documents 94
Shares Eligible for Future Sale 101
Material Income Tax Considerations 103
Underwriting 108
Expenses of this Offering 114
Legal Matters 115
Experts 115
Enforcement of Liabilities 116
Where You Can Find Additional Information 118
Index to Consolidated Financial Statements F-1

 

We are responsible for the information contained in this prospectus and any free writing prospectus we prepare or authorize. We have not, and the underwriters have not, authorized anyone to provide you with different information, and we and the underwriters take no responsibility for any other information others may give you. We are not, and the underwriters are not, making an offer to sell our ordinary shares in any jurisdiction where the offer or sale is not permitted. You should not assume that the information contained in this prospectus is accurate as of any date other than the date on the front cover of this prospectus, regardless of the time of delivery of this prospectus or the sale of any ordinary shares.

For investors outside the United States: Neither we nor the underwriters have done anything that would permit this offering or possession or distribution of this prospectus in any jurisdiction, other than the United States, where action for that purpose is required. Persons outside the United States who come into possession of this prospectus must inform themselves about, and observe any restrictions relating to, the offering of the ordinary shares and the distribution of this prospectus outside the United States.

We are incorporated under the laws of the Cayman Islands as an exempted company with limited liability and a majority of our outstanding securities are owned by non-U.S. residents. Under the rules of the U.S. Securities and Exchange Commission, or the SEC, we currently qualify for treatment as a “foreign private issuer.” As a foreign private issuer, we will not be required to file periodic reports and financial statements with the Securities and Exchange Commission, or the SEC, as frequently or as promptly as domestic registrants whose securities are registered under the Securities Exchange Act of 1934, as amended, or the Exchange Act.

 

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

 

 i 

 

 

CONVENTIONS THAT APPLY TO THIS PROSPECTUS

 

 

Unless otherwise indicated or the context otherwise requires, all references in this prospectus to the terms “Blue Hat,” the “Company,” “we,” “us” and “our” refer to Blue Hat Interactive Entertainment Technology and its subsidiaries, its variable interest entity and the subsidiaries of its variable interest entity.

 

“PRC” or “China” refers to the People’s Republic of China, excluding, for the purpose of this prospectus, Taiwan, Hong Kong and Macau. “RMB” or “Renminbi” refers to the legal currency of China and “$”, “US$” or “U.S. Dollars” refers to the legal currency of the United States.

 

We have made rounding adjustments to some of the figures included in this prospectus. Accordingly, numerical figures shown as totals in some tables may not be an arithmetic aggregation of the figures that preceded them.

 

Unless the context indicates otherwise, all information in this prospectus assumes no exercise by the underwriters of their over-allotment option.

 

Our functional currency is Renminbi, or RMB. Our consolidated financial statements are presented in U.S. dollars. We use U.S. dollars as the reporting currency in our consolidated financial statements and in this prospectus. Assets and liabilities denominated in Renminbi are translated into U.S. dollars at the rates of exchange as of the balance sheet date, equity accounts are translated at historical exchange rates, and revenues and expenses are translated using the average rate of exchange in effect during the reporting period. With respect to amounts not recorded in our consolidated financial statements included elsewhere in this prospectus, unless otherwise stated, all translations from Renminbi to U.S. dollars were made at RMB 6.8680 to US$1.00, the noon buying rate on September 30, 2018, as set forth in the H.10 statistical release of the Board of Governors of the Federal Reserve System. We make no representation that the Renminbi or U.S. dollar amounts referred to in this prospectus could have been or could be converted into U.S. dollars or Renminbi, as the case may be, at any particular rate or at all. On March 8, 2019, the noon buying rate set forth in the H.10 statistical release of the Board of Governors of the Federal Reserve System was RMB 6.7201 to US$1.00.

 

 

 

 ii 

 

 

 

PROSPECTUS SUMMARY

 

The following summary highlights information contained elsewhere in this prospectus and does not contain all of the information you should consider before investing in our ordinary shares. You should read the entire prospectus carefully, including “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements and the related notes thereto, in each case included in this prospectus. You should carefully consider, among other things, the matters discussed in the section of this prospectus titled “Business” before making an investment decision.

 

Overview

 

We are a producer, developer and operator of augmented reality (AR) interactive entertainment games and toys in China, including interactive educational materials, mobile games, and toys with mobile game features. Our mobile-connected entertainment platform enables us to connect physical items to mobile devices through wireless technologies, creating a unique interactive user experience. Our goal is to create a rich visual and interactive environment for users through the integration of real objects and virtual scenery. We believe this combination provides users with a more natural form of human-computer interaction and enhances users’ perception of reality, thus providing a more diversified entertainment experience. By leveraging our strong technological capabilities and infrastructure, we are able to deliver a superior user experience and conduct our operations in a highly efficient manner.

 

The core of our business is our proprietary technology. Our patents, trademarks, copyrights, and other intellectual property rights serve to distinguish our products, protect our products from infringement, and contribute to our competitive advantages. To secure the value of our technology and developments, we are aggressive in pursuing a combination of patent, trademark and copyright protection for our proprietary technologies. As of January 31, 2019, our intellectual property portfolio includes 161 authorized patents, 40 patents in various stages of the patent application process, 14 applications for Patent Cooperation Treaty, or PCT, international patents, 56 registered trademarks, 645 copyrights for art work and 25 software copyrights.

 

We strive to create an engaging, interactive and immersive community for users of our products. The majority of our users are among the young Chinese generation between the ages of 3 and 23, although many of our products appeal to users outside of this demographic. We intend to further penetrate the Chinese market with new products that will target users ages 14 and above. Specifically, our strategies include marketing Fidolle, a ball-jointed “smart doll”, and QI, a gaming and entertainment platform designed for both family home use and amusement arcades. We believe our high-quality content is a magnet for users with common interests to connect and share their passions on our platform, which helps to cultivate a strong sense of belonging, effectively strengthening our user retention.

 

Our Business

We currently offer four primary AR interactive product lines: AR Racer, AR Need a Spanking, AR 3D Magic Box and AR Picture Book.

AR Racer

 

AR Racer provides an innovative way for users to interact and play a traditional game. AR Racer is a car-racing mobile game with a small physical toy car that is placed onto the user’s mobile device screen. AR Racer allows users to virtually race one another via a simulated racing track and to also engage in individual races. The physical toy car uses non-adhesive materials to stick to a designated area of the mobile device. Our photosensitive recognition technology allows the toy car to be used as a controller such that when a player encounters an obstacle in the mobile game, the toy car will respond with entertaining actions, such as flashing lights and vibrations that enhance the user experience. AR Racer accounted for approximately 57% of our total revenues in 2017.

 

AR Need a Spanking

 

AR Need a Spanking is an exciting combat game with a ladybug shaped electronic toy. AR Need a Spanking lets the user physically control the outcome of the game. Our infrared induction technology allows the user’s mobile device to serve as a control panel by which the user controls the movement of the toy for game play in battle dynamics, while simultaneously moving the toy in reality. The user’s mobile device shows a display of virtual enemies while also capturing the position of the toy in the real world, allowing the user to approach or escape its combatants. The program embedded in the toy is used to establish a variety of fun, unique game play mechanics. AR Need a Spanking accounted for approximately 31% of our total revenues in 2017.

 

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AR 3D Magic Box

 

AR 3D Magic Box has the unique ability to transport children’s drawings into diverse backgrounds, giving the user a discovery based experience. AR 3D Magic Box uses AR recognition technology to allow children to draw shapes or objects onto a physical card while the mobile game captures the drawings and animates them in a set background, for example, under the sea. AR 3D Magic Box is an educational toy with built in quizzes and games targeted for users between the ages of 3 and 9. AR 3D Magic Box accounted for approximately 0.08% of our total revenues in 2017.

 

AR Picture Book

 

AR Picture Book is a new and exciting way to introduce children to the rich and diverse world we live in. AR Picture Book provides an educational and interactive experience that allows stories to come to life. AR Picture Book is an AR platform that allows mobile devices to read aloud the pages of a physical book while the users interact with the pictures and graphics on the pages of the book. AR Picture Book reads the story back to the users as the mobile device recognizes the pages of the book. AR Picture Book is designed for children between the ages of 3 and 5 and has been adopted for use by several kindergarten schools in China. There are two series of AR Picture Book: a 12-book Chinese Core Values series and a Sexual Harassment Prevention Series. The Sexual Harassment Prevention Series was initially developed with the China Teenagers and Children Development Service Center and the Municipal Procuratorate of Tong’an District Xiamen City. AR Picture Book educates children on interpersonal skills, logical thinking and more specific topics, such as sexual harassment. AR Picture Book is used in over ten kindergartens in Xiamen and accounted for approximately 0.16% of our total revenues in 2017.

 

We plan to continue to invest significant amounts of our resources towards product development and bringing new products to the market. We believe our current reserves are sufficient for product development for the next three to five years. We intend to introduce two new products in 2019, Fidolle and QI, and two new products in 2020. We intend to launch new generations of our four existing products within the next three years. We are currently developing two additional product lines, Fidolle and QI.

 

Industry Background

 

According to market research data, the total retail sales of toys and games in China have soared from RMB 111.8 billion in 2012 to RMB 276.5 billion in 2017, registering an average annual growth rate of 19.9%. In 2017, retail sales of traditional toys and games increased by 7.4% annually to RMB 74.43 billion, representing 26.9% of total market turnover, while retail sales of electronic toys and games increased by 24.1% annually to RMB 202.07 billion, accounting for 73.1% of total market turnover.

 

As incomes of urban residents in China continue to rise and quality of life continues to improve, toy demands are beginning to change. There is a shift away from traditional, medium- to low-end battery-operated toys, construction sets and decorative toys, towards innovative electronic toys and intelligent toys. Despite this economic and cultural shift, many industry players believe that toy and game companies continue to underestimate the spending power of China’s low-income groups. With average income rising at a rate of 8%-11% annually in China, wage earners are enjoying higher disposable incomes, which we believe will lead to an increase in demand for toys and games in China, particularly innovative and exciting products.

 

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Competitive Strengths

We believe the following competitive strengths will continue to contribute to our success in the AR interactive toy and game market:

 

Advanced AR Technology in Interactive Entertainment – Our business model centers around toys, mobile games, and original intellectual property. By focusing on the development of our superior AR technologies, we differentiate ourselves from traditional toy companies that lack the technological sophistication required to enter the AR interactive toy industry. Our core technological advantage lies in the superiority of our image recognition and motion capture technologies.
Community-Based Platform – We build gaming communities that integrate online and offline relationships and activities. We promote gaming events by hosting national gaming competitions, such as the AR Racer Championship 2017, and by attending at least two gaming exhibitions per year. These activities allow us to attract new users.
Multi-Platform Coverage – Our products cover multiple platforms including PCs, iOS and Android. Such multi-platform approach allows us to attract a broad base of users with diverse entertainment preferences.
Highly Engaged and Interactive Community – We build our brand and retain our users by promoting frequent interactions between users. Our content is highly dynamic, as our users are able to interact with each other which in turn bolsters their overall entertainment and the social experience offered by our platform.
Strong Research and Development – We believe the key to success in the AR interactive toy market is research and development. As such, we invest substantially in the research and development of AR technologies.
Superior Intellectual Property – The core of our business is our proprietary technology. Our patents, trademarks, copyrights, and other intellectual property rights serve to distinguish our products, protect our products from infringement, and contribute to our competitive advantages.
Variety of Products and Comprehensive Business Model - We currently offer four primary product lines, each of which extends to several derivative products and mobile games. Our comprehensive business model, integrating research and development of AR technologies, original content design, and promotion and sales encourages our sustained growth in the marketplace.
Strong Sales and Marketing Distribution - Our sales and marketing team is experienced and has fostered successful, long-term relationships with our partnered distributors.
Experienced Management Team – Our management team consists of seasoned executives with several years of experience in broad management roles. We foster and encourage a highly committed management team that includes employees specialized in AR technology and equipment, as well as sales and marketing.
Award Winning and Recognized Brand –In March 2012, we were appointed as vice-chairman of the Animation Game Industry in the Fujian Province. In February 2014, we were approved as a Xiamen Technology-based Medium and Small-Sized Enterprise of 2014. We were named Xiamen Intellectual Property Pilot Enterprise of 2014-2015. In May 2016, Blue Hat Fujian was officially listed on the New Third Board in China. China’s over-the-counter stock market, and was subsequently delisted in May 2018, per Blue Hat Fujian’s request. These accolades contribute to our brand recognition.

 

Our Strategy

Our mission is to provide high quality, cutting edge interactive entertainment products and services to our users and we aspire to become one of the most popular technology-enabled entertainment communities for the young generation in China.

 

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We intend to continue to focus our efforts on our AR interactive toys to combine technology, physical toys and mobile application games to add interactive gameplay to traditional toys. We plan to pursue the following growth strategies to expand our business and further extend our position in the AR interactive toy market in China:

 

Enhance Game Content –As a direct result of our advanced AR technologies, we are, and must continue to be, able to alter game content quickly to adapt to the fast changing market.
Substantial Investment in Research and Development – We intend to continue to increase our investment in research and development and improve our research and innovation capacity.
Increase the Variety of AR Entertainment Products – We intend to devote significant resources to enhancing our current products and developing new products.
Enhance Sales and Marketing – In September 2018, we opened our first physical experience store in Xiamen, China. We plan to open two additional stores in Xiamen in the first half of 2019.

 

To implement our growth strategy, we intend to hire talented personnel to enrich our management team and strengthen our business.

 

Corporate History

 

We are a holding company incorporated on June 13, 2018, under the laws of the Cayman Islands (“Blue Hat Cayman”). We have no substantive operations other than holding all of the issued and outstanding shares of Brilliant Hat Limited (“Blue Hat BVI”) established under the laws of the British Virgin Islands on June 26, 2018.

 

Blue Hat BVI is also a holding company holding all of the outstanding equity of Blue Hat Interactive Entertainment Technology Limited (“Blue Hat HK”) which was established in Hong Kong on June 26, 2018. Blue Hat HK is also a holding company holding all of the outstanding equity of Xiamen Duwei Consulting Management Co., Ltd. (“Blue Hat WFOE”) which was established on July 26, 2018 under the laws of the PRC.

 

We, through our variable interest entity (“VIE”), Fujian Blue Hat Interactive Entertainment Technology Ltd. (“Blue Hat Fujian”), a PRC company, and through its wholly owned subsidiaries, including Hunan Engaomei Animation Culture Development Co., Ltd. (“Blue Hat Hunan”) and Shenyang Qimengxing Trading Co., Ltd. (“Blue Hat Shenyang”), each a PRC company, engage in designing, producing, promoting and selling animated toys with mobile games features, original intellectual property and peripheral derivatives features worldwide.

 

On September 18, 2017, Blue Hat Fujian formed a joint venture with Xiamen Youth Education Development Co., Ltd. and Youying Wang, contributing a 48.5% equity interest in Fujian Youth Hand in Hand Educational Technology Co., Ltd. (“Fujian Youth”), a PRC company. As of September 30, 2018 and December 31, 2017, Fujian Youth has no operations.

 

On January 25, 2018, Blue Hat Fujian established its wholly owned subsidiary, Chongqing Lanhui Technology Co. Ltd. (“Blue Hat Chongqing”) a PRC company. As of September 30, 2018, Blue Hat Chongqing has no operations.

 

On September 10, 2018, Blue Hat Fujian established its wholly owned subsidiary, Pingxiang Blue Hat Technology Co. Ltd. (“Blue Hat Pingxiang”), a PRC company. Blue Hat Pingxiang also engages in designing, producing, promoting and selling interactive toys with mobile games features, original intellectual property and peripheral derivatives features worldwide.

 

On September 20, 2018, Blue Hat Fujian formed a joint venture with Fujian Jin Ge Tie Ma Information Technology Co., Ltd., contributing a 20.0% equity interest in Xiamen Blue Wave Technology Co. Ltd. (“Xiamen Blue Wave”), a PRC company.

On October 16, 2018, Blue Hat Fujian formed a joint venture with Renchao Huyu (Shanghai) Culture Development Co. Ltd., contributing a 49% ownership interest in Renchao Huyu (Shanghai) Culture Propagation Co. Ltd. (“Renchao Huyu”), with the remaining 51% ownership owned by Renchao Huyu (Shanghai) Culture Development Co. Ltd.

 

On November 13, 2018, Blue Hat Cayman completed a reorganization of entities under common control of its then existing shareholders, who collectively owned a majority of the equity interests of Blue Hat Cayman prior to the reorganization. Blue Hat Cayman, Blue Hat BVI, and Blue Hat HK were established as the holding companies of Blue Hat WFOE. Blue Hat WFOE is the primary beneficiary of Blue Hat Fujian and its subsidiaries, and all of these entities included in Blue Hat Cayman are under common control which results in the consolidation of Blue Hat Fujian and subsidiaries which have been accounted for as a reorganization of entities under common control at carrying value. The consolidated financial statements are prepared on the basis as if the reorganization became effective as of the beginning of the first period presented in the consolidated financial statements.

 

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The charts below summarize our corporate legal structure and identify our subsidiaries, our VIE and its subsidiaries:

 

 

 

 7 

 

 

Name   Background   Ownership
Brilliant Hat Limited  

•      A British Virgin Islands company

•      Incorporated on June 26, 2018 

•      A holding company

  100% owned by Blue Hat Interactive Entertainment Technology
Blue Hat Interactive Entertainment Technology Limited  

•      A Hong Kong company

•      Incorporated on June 26, 2018

•      A holding company

  100% owned by Brilliant Hat Limited
Xiamen Duwei Consulting Management Co., Ltd.  

•      A PRC limited liability company and deemed a wholly foreign owned enterprise (“WFOE”)

•      Incorporated on July 26, 2018

•      Registered capital of $ 736,073 (RMB 5,000,000)

•      A holding company

  100% owned by Blue Hat Interactive Entertainment Technology Limited
Fujian Blue Hat Interactive Entertainment Technology Ltd.  

•      A PRC limited liability company

•      Incorporated on January 7, 2010

•      Registered capital of $4,697,526 (RMB 31,054,000)

•      Designing, producing, promoting and selling animated toys with mobile games features, original intellectual property and peripheral derivatives features.

  VIE of Blue Hat Xiamen Duwei Consulting Management Co., Ltd.
Hunan Engaomei Animation Culture Development Co., Ltd.  

•      A PRC limited liability company

•      Incorporated on October 19, 2017

•      Registered capital of $302,540 (RMB 2,000,000)

•      Designing, producing, promoting and selling animated toys with mobile games features, original intellectual property and peripheral derivatives features.

  100% owned by Fujian Blue Hat Interactive Entertainment Technology Ltd.
Shenyang Qimengxing Trading Co., Ltd.  

•      A PRC limited liability company

•      Incorporated on July 27, 2017

•      Registered capital of $302,540 (RMB 2,000,000)

•      Designing, producing, promoting and selling animated toys with mobile games features, original intellectual property and peripheral derivatives features.

  100% owned by Fujian Blue Hat Interactive Entertainment Technology Ltd.
Chongqing Lanhui Technology Co. Ltd.  

•      A PRC limited liability company

•      Incorporated on January 25, 2018

•      Registered capital of $302,540 (RMB 2,000,000)

•      Designing, producing, promoting and selling animated toys with mobile games features, original intellectual property and peripheral derivatives features.

  100% owned by Fujian Blue Hat Interactive Entertainment Technology Ltd.
Pingxiang Blue Hat Technology Co. Ltd.  

•      A PRC limited liability company

•      Incorporated on September 10, 2018

•      Registered capital of $302,540 (RMB 2,000,000)

•      Designing, producing, promoting and selling animated toys with mobile games features, original intellectual property and peripheral derivatives features.

  100% owned by Fujian Blue Hat Interactive Entertainment Technology Ltd.
         
                 

 

 8 

 

 

Contractual Arrangements

 

Due to legal restrictions on foreign ownership and investment in, among other areas, the production, development and operation of AR interactive entertainment games and toys in China, including interactive educational materials, mobile games, and toys with mobile game features, we operate our businesses in which foreign investment is restricted or prohibited in the PRC through certain PRC domestic companies. As such, Blue Hat Fujian is controlled through contractual arrangements in lieu of direct equity ownership by us or any of our subsidiaries. Such contractual arrangements consist of a series of three agreements, along with shareholders’ powers of attorney (“POAs”) and irrevocable commitment letters (collectively, the “Contractual Arrangements”), which were signed on November 13, 2018.

 

The significant terms of the Contractual Arrangements are as follows:

 

Exclusive Business Cooperation Agreement

 

Pursuant to the exclusive business cooperation agreement between Blue Hat WFOE and Blue Hat Fujian, Blue Hat WFOE has the exclusive right to provide Blue Hat Fujian with technical support services, consulting services and other services, including technical support, technical assistance, technical consulting, and professional training necessary for Blue Hat Fujian’s operation, network support, database support, software services, business management consulting, grant use rights of intellectual property rights, lease hardware and device, provide system integration service, research and development of software and system maintenance, provide labor support and to develop the related technologies based on Blue Hat Fujian’s needs. In exchange, Blue Hat WFOE is entitled to a service fee that equals to all of the consolidated net income after offsetting previous year’s loss (if any) of Blue Hat Fujian. The service fee may be adjusted by Blue Hat WFOE based on the actual scope of services rendered by Blue Hat WFOE and the operational needs and expanding demands of Blue Hat Fujian.

 

Pursuant to the exclusive business cooperation agreement, Blue Hat WFOE has the unilateral right to adjust the service fee at any time, and Blue Hat Fujian has no right to adjust the service fee. We believe that such conditions under which the service fee may be adjusted will be primarily based on the needs of Blue Hat Fujian to operate and develop its business in the AR market. For example, if Blue Hat Fujian needs to expand its business, increase research input or consummate mergers or acquisitions in the future, Blue Hat WFOE has the right to decrease the amount of the service fee, which would allow Blue Hat Fujian to have additional capital to operate and develop its business in the AR market. 

 

The exclusive business cooperation agreement remains in effect for 10 years until November 13, 2028 and shall be automatically renewed for one year at the expiration date of the validity term. However, Blue Hat WFOE has the right to terminate this agreement upon giving 30 days’ prior written notice to Blue Hat Fujian at any time.

 

Call Option Agreements

 

Pursuant to the call option agreements, among Blue Hat WFOE, Blue Hat Fujian and the shareholders who collectively owned all of Blue Hat Fujian, such shareholders jointly and severally grant Blue Hat WFOE an option to purchase their equity interests in Blue Hat Fujian. The purchase price shall be the lowest price then permitted under applicable PRC laws. Blue Hat WFOE or its designated person may exercise such option at any time to purchase all or part of the equity interests in Blue Hat Fujian until it has acquired all equity interests of Blue Hat Fujian, which is irrevocable during the term of the agreements.

 

The call option agreements remains in effect for 10 years until November 13, 2028 and shall be automatically renewed for one year at the expiration date of the validity term. However, Blue Hat WFOE has the right to terminate these agreements upon giving 30 days’ prior written notice to Blue Hat Fujian at any time.

 

Equity Pledge Agreement

 

Pursuant to the equity pledge agreement among the shareholders who collectively owned all of Blue Hat Fujian, such shareholders pledge all of the equity interests in Blue Hat Fujian to Blue Hat WFOE as collateral to secure the obligations of Blue Hat Fujian under the exclusive business cooperation agreement and call option agreements. These shareholders are prohibited or may not transfer the pledged equity interests without prior consent of Blue Hat WFOE unless transferring the equity interests to Blue Hat WFOE or its designated person in accordance to the call option agreements.

 

The equity pledge agreement shall come into force the date on which the pledged interests is recorded, which is three days after signing of the Agreement on November 13, 2018, under Blue Hat Fujian’s register of shareholders and is registered with competent administration for industry and commerce of Blue Hat Fujian until all of the liabilities and debts to Blue Hat WFOE have been fulfilled completely by Blue Hat Fujian. Blue Hat Fujian and the shareholders who collectively owned all of Blue Hat Fujian shall not terminate these agreements in any circumstance for any reason. However, Blue Hat WFOE has the right to terminate these agreements upon giving 30 days’ prior written notice to Blue Hat Fujian at any time.

 

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Shareholders’ POAs

 

Pursuant to the shareholders’ POAs, the shareholders of Blue Hat Fujian give Blue Hat WFOE an irrevocable proxy to act on their behalf on all matters pertaining to Blue Hat Fujian and to exercise all of their rights as shareholders of Blue Hat Fujian, including the right to attend shareholders meetings, to exercise voting rights and all of the other rights, and to sign transfer documents and any other documents in relation to the fulfillment of the obligations under the call option agreements and the equity pledge agreement. The POAs shall remain in effect while the shareholders of Blue Hat Fujian hold the equity interests in Blue Hat Fujian.

 

Irrevocable Commitment Letters

 

Pursuant to the irrevocable commitment letters, the shareholders of Blue Hat Fujian commit that their spouses or inheritors have no right to claim any rights or interest in relation to the shares that they hold in Blue Hat Fujian and have no right to impose any impact on the daily managing duties of Blue Hat Fujian, and commit that if any event which refrains them from exercising shareholders’ rights as a registered shareholder, such as death, incapacity, divorce or any other event, could happen to them, the shareholders of Blue Hat Fujian will take corresponding measures to guarantee the rights of other registered shareholders and the performance of the Contractual Arrangements. The letters are irrevocable and shall not be withdrawn without the consent of Blue Hat WFOE.

 

Based on the foregoing contractual arrangements, which grant Blue Hat WFOE effective control of Blue Hat Fujian and enable Blue Hat WFOE to receive all of their expected residual returns, we account for Blue Hat Fujian as a VIE. Accordingly, we consolidates the accounts of Blue Hat Fujian for the periods presented herein, in accordance with Regulation S-X-3A-02 promulgated by the SEC and Accounting Standards Codification (“ASC”) 810-10, Consolidation.

 

Risks Associated with Our Business

Our business is subject to a number of risks, including risks that may prevent us from achieving our business objectives or may adversely affect our business, financial condition, results of operations, cash flows and prospects that you should consider before making a decision to invest in our ordinary shares. These risks are discussed more fully in “Risk Factors” beginning on page 15. These risks include, but are not limited to, the following:

 

We depend upon the Contractual Arrangements in conducting our business in China, which may not be as effective as direct ownership;

 

We operate in a highly competitive market and the size and resources of many of our competitors may allow them to compete more effectively than we can, preventing us from achieving profitability;

 

Issues with products may lead to product liability, personal injury or property damage claims, recalls, withdrawals, replacements of products, or regulatory actions by governmental authorities that could divert resources, affect business operations, decrease sales, increase costs, and put us at a competitive disadvantage, any of which could have a significant adverse effect on our financial condition;

 

As a developer and seller of consumer products, we are subject to various government regulations and may be subject to additional regulations in the future, violation of which could subject us to sanctions or otherwise harm our business;

 

If we are not able to adequately protect our proprietary intellectual property and information, and protect against third party claims that we are infringing on their intellectual property rights, our results of operations could be adversely affected; and

 

Uncertainties with respect to China’s legal system could adversely affect us.

 

 10 

 

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

 

As a company with less than $1.07 billion in revenue during our last fiscal year, we qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act, or JOBS Act, enacted in April 2012, and may take advantage of reduced reporting requirements that are otherwise applicable to public companies. These provisions include, but are not limited to:

 

             being permitted to present only two years of audited financial statements and only two years of related Management’s Discussion and Analysis of Financial Condition and Results of Operations in our filings with the SEC;

 

             not being required to comply with the auditor attestation requirements in the assessment of our internal control over financial reporting;

 

             reduced disclosure obligations regarding executive compensation in periodic reports, proxy statements and registration statements; and

 

             exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved.

 

We may take advantage of these provisions until the last day of our fiscal year following the fifth anniversary of the date of the first sale of our ordinary shares pursuant to this offering. However, if certain events occur before the end of such five-year period, including if we become a “large accelerated filer,” our annual gross revenues exceed $1.07 billion or we issue more than $1.0 billion of non-convertible debt in any three-year period, we will cease to be an emerging growth company before the end of such five-year period.

 

In addition, Section 107 of the JOBS Act provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933, as amended (the “Securities Act”), for complying with new or revised accounting standards. We have elected to take advantage of the extended transition period for complying with new or revised accounting standards and acknowledge such election is irrevocable pursuant to Section 107 of the JOBS Act.

 

 11 

 

 

We are a “foreign private issuer,” as defined by the SEC. As a result, in accordance with the rules and regulations of The Nasdaq Stock Market LLC, or Nasdaq, we may comply with home country governance requirements and certain exemptions thereunder rather than complying with Nasdaq corporate governance standards. We may choose to take advantage of the following exemptions afforded to foreign private issuers:

  • Exemption from filing quarterly reports on Form 10-Q or provide current reports on Form 8-K disclosing significant events within four days of their occurrence.
  • Exemption from Section 16 rules regarding sales of ordinary shares by insiders, which will provide less data in this regard than shareholders of U.S. companies that are subject to the Exchange Act.
  • Exemption from the Nasdaq rules applicable to domestic issuers requiring disclosure within four business days of any determination to grant a waiver of the code of business conduct and ethics to directors and officers. Although we will require board approval of any such waiver, we may choose not to disclose the waiver in the manner set forth in the Nasdaq rules, as permitted by the foreign private issuer exemption.
  • Exemption from the requirement that our board of directors have a remuneration committee that is composed entirely of independent directors with a written charter addressing the committee's purpose and responsibilities.
  • Exemption from the requirements that director nominees are selected, or recommended for selection by our board of directors, either by (1) independent directors constituting a majority of our board of directors’ independent directors in a vote in which only independent directors participate, or (2) a committee comprised solely of independent directors, and that a formal written charter or board resolution, as applicable, addressing the nominations process is adopted.

 

Furthermore, Nasdaq Rule 5615(a)(3) provides that a foreign private issuer, such as us, may rely on our home country corporate governance practices in lieu of certain of the rules in the Nasdaq Rule 5600 Series and Rule 5250(d), provided that we nevertheless comply with Nasdaq's Notification of Noncompliance requirement (Rule 5625), the Voting Rights requirement (Rule 5640) and that we have an audit committee that satisfies Rule 5605(c)(3), consisting of committee members that meet the independence requirements of Rule 5605(c)(2)(A)(ii). If we rely on our home country corporate governance practices in lieu of certain of the rules of Nasdaq, our shareholders may not have the same protections afforded to shareholders of companies that are subject to all of the corporate governance requirements of Nasdaq. If we choose to do so, we may utilize these exemptions for as long as we continue to qualify as a foreign private issuer.

 

Although we are permitted to follow certain corporate governance rules that conform to Cayman Island requirements in lieu of many of the Nasdaq corporate governance rules, we intend to comply with the Nasdaq corporate governance rules applicable to foreign private issuers. 

Corporate Information

 

Our principal executive office is located at 7th Floor, Building C, No. 1010 Anling Road, Huli District, Xiamen, China 361009. Our telephone number is 86-592-2280081. Our registered office in the Cayman Islands is located at the office of Walkers Corporate Limited, Cayman Corporate Centre, 27 Hospital Road, George Town, Grand Cayman KY1-9008, Cayman Islands.

 

Our agent for service of process in the United States is Puglisi & Associates, located at 850 Library Ave., Suite 204, Newark, DE 19711. Our website is located at http://www.bluehatgroup.net. Information contained on, or that can be accessed through, our website is not a part of, and shall not be incorporated by reference into, this prospectus.

 

 12 

 

 

The Offering

 

Securities being offered

 

4,500,000 ordinary shares on a firm commitment basis.

   
Initial offering price We estimate the initial public offering price will be between $4.00 per ordinary share.
   
Number of ordinary shares outstanding before the offering 33,000,000 ordinary shares.
   
Number of ordinary shares outstanding after the offering

37,500,000 ordinary shares, assuming no exercise of the underwriters’ over-allotment option and excluding 450,000 ordinary shares underlying the underwriters’ warrants.

 

Use of proceeds We intend to use approximately 40% of the net proceeds of this offering for research and development, including expanding our research and development team and continuing to invest in and develop our products, approximately 40% for selling and marketing, particularly strengthening our sales channels and establishing physical experience stores, and the remainder for working capital and general corporate purposes. For more information on the use of proceeds, see “Use of Proceeds” on page 39.
   
 Lock-up

All of our directors and officers and our principal shareholders (5% or more shareholders, provided that the representative of the underwriters may in its discretion require a lower percentage threshold) have agreed with the underwriters, subject to certain exceptions, not to sell, transfer or dispose of, directly or indirectly, any of our ordinary shares or securities convertible into or exercisable or exchangeable for our ordinary shares for a period of 12 months after the date of this prospectus. See “Shares Eligible for Future Sale” and “Underwriting” for more information.

 

Indemnification Escrow

Net proceeds of this offering in the amount of $600,000 shall be used to fund an escrow account for a period of 24 months following the closing date of this offering, which account shall be used in the event we have to indemnify the underwriters pursuant to the terms of an underwriting agreement with the underwriters.

 

Underwriters’ Warrants Upon the closing of this offering, we will issue to ViewTrade Securities, Inc., as representative of the underwriters, underwriters’ warrants entitling the representative to purchase 10% of the aggregate number of ordinary shares issued in this offering. The underwriters’ warrants will be exercisable for a period of five years from the effective date of the registration statement of which this prospectus forms a part.
   
Proposed Nasdaq Symbol: We have applied to have our ordinary shares listed on the Nasdaq Capital Market under the symbol “BHAT”.
   
Risk factors: Investing in our ordinary shares involves a high degree of risk. As an investor you should be able to bear a complete loss of your investment. You should carefully consider the information set forth in the “Risk Factors” section beginning on page 15.

 

 13 

 

 

Summary Consolidated Financial Data

The following tables summarize our consolidated financial data for the periods and as of the dates indicated. The summary consolidated statement of income and comprehensive income for the years ended December 31, 2016 and 2017 and for the nine months ended September 30, 2018 and 2017 and the summary consolidated balance sheet as of December 31, 2017 and 2016 and September 30, 2018 have been derived from our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, or U.S. GAAP, and included elsewhere in this prospectus. Our historical results are not necessarily indicative of the results that may be expected in the future. The following summary consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Exchange Rate Information” and our consolidated financial statements included elsewhere in this prospectus.

 

    For the Nine Months Ended September 30,     For the Years Ended December 31,  
    2018     2017     2017     2016  
    (Unaudited)     (Unaudited)              
    US$     US$     US$     US$  
Consolidated Statements of Income and
Comprehensive Income:
                               
Revenues     9,632,860       6,316,574       14,144,894       9,352,650  
Cost of revenues     (3,536,760 )     (2,549,650 )     (5,300,087 )     (4,577,319 )
Gross profit     6,096,100       3,766,924       8,844,807       4,775,331  
Operating expenses     (2,462,006 )     (1,692,724 )     (2,900,349 )     (1,957,108 )
Income from operations     3,634,094       2,074,200       5,944,458       2,818,223  
Other non-operating income, net     60,661       62,081       135,709       241,752  
Provision for income taxes     (435,325     (294,540     (955,194     (485,658
Net income     3,259,430       1,841,741       5,124,973       2,574,317  

Other comprehensive

Income (Loss)

    (1,308,285 )     438,956       958,667       (364,997 )
Comprehensive Income     1,951,145       2,280,697       6,083,640       2,209,320  
Earnings per share, basic and diluted     0.10       0.06       0.16       0.08  
Weighted average ordinary Shares outstanding     33,000,000       33,000,000       33,000,000       33,000,000  

 

 

    September 30, 2018     December 31, 2017     December 31, 2016  
    (Unaudited)              
Consolidated Balance Sheet Data:   US$     US$     US$  
Current assets     25,594,519       29,243,641       10,409,749  
Total assets     31,983,431       33,582,177       12,482,213  
Current liabilities     8,110,189       11,594,387       5,527,445  
Total liabilities     8,221,523       11,771,414       5,527,445  
Total equity     23,761,908       21,810,763       6,954,768  

 

 

 14 

 

 

 

RISK FACTORS

 

An investment in our ordinary shares involves a high degree of risk. You should carefully consider the following information about these risks, together with the other information appearing elsewhere in this prospectus, before deciding to invest in our ordinary shares. The occurrence of any of the following risks could have a material adverse effect on our business, financial condition, results of operations and future growth prospects. In these circumstances, the market price of our ordinary shares could decline, and you may lose all or part of your investment.

 

Risks Related to Our Business

We have a limited operating history. There is no assurance that our future operations will result in profitable revenues. If we cannot generate sufficient revenues to operate profitably, we may suspend or cease operations.

Given our limited operating history, there can be no assurance that we can build our business such that we can earn a significant profit or any profit at all. The future of our business will depend upon our ability to obtain and retain customers and when needed, obtain sufficient financing and support from creditors, while we strive to achieve and maintain profitable operations. The likelihood of success must be considered in light of the problems, expenses, difficulties, complications and delays encountered in connection with the operations that we undertake. There is no history upon which to base any assumption that our business will prove to be successful, and there is significant risk that we will not be able to generate the sales volumes and revenues necessary to achieve profitable operations. To the extent that we cannot achieve our plans and generate revenues which exceed expenses on a consistent basis, our business, results of operations, financial condition and prospects will be materially adversely affected.

Our management team has limited public company experience. We have never operated as a public company in the United States and several of our senior management positions are currently held by employees who have been with us for a short period of time. Our entire management team, as well as other company personnel, will need to devote substantial time to compliance, and may not effectively or efficiently manage our transition into a public company. If we are unable to effectively comply with the regulations applicable to public companies or if we are unable to produce accurate and timely financial statements, which may result in material misstatements in our financial statements or possible restatement of financial results, our stock price may be materially adversely affected, and we may be unable to maintain compliance with the listing requirements of Nasdaq. Any such failures could also result in litigation or regulatory actions by the SEC or other regulatory authorities, loss of investor confidence, delisting of our securities, harm to our reputation and diversion of financial and management resources from the operation of our business, any of which could materially adversely affect our business, financial condition, results of operations and growth prospects. Additionally, the failure of a key employee to perform in his or her current position could result in our inability to continue to grow our business or to implement our business strategy.

We operate in a highly competitive market and the size and resources of many of our competitors may allow them to compete more effectively than we can, preventing us from achieving profitability.

The market for animated toys is highly competitive, particular in China, where our operations are located. Competition may result in pricing pressures, reduced profit margins or lost market share, or a failure to grow our market share, any of which could substantially harm its business and results of operations. We compete directly against manufacturers of games and toys, including large, diversified entertainment companies with substantial market share. In addition, we compete with other companies who are focused on building their brands across multiple product and consumer categories. Across our business, we face competitors who are constantly monitoring and attempting to anticipate consumer tastes and trends, seeking ideas which will appeal to consumers and introducing new products that compete with our products for consumer acceptance and purchase. Many of our competitors have significant competitive advantages, including longer operating histories, larger and broader customer bases, less-costly production, more established relationships with a broader set of suppliers, greater brand recognition and greater financial, research and development, marketing, distribution and other resources than we do.

In addition to existing competitors, the barriers to entry for new participants in the entertainment industry and in the consumer products industry are low, and the increasing importance of digital media, and the heightened connection between digital media and consumer interest, has further increased the ability for new participants to enter our markets, and has broadened the array of companies we may compete with. New participants with a popular product idea or entertainment property can gain access to consumers and become a significant source of competition for our products in a very short period of time. These existing and new competitors may be able to respond more rapidly than us to changes in consumer preferences. Our competitors’ products may achieve greater market acceptance than our products and potentially reduce demand for our products, lower our revenues and lower our profitability.

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Our business depends significantly on our ability to maintain an efficient distribution network for our products. Failure by us to maintain such distribution network could adversely affect our financial condition, competitiveness and growth prospects.

Our success depends on our ability to maintain efficient distribution methods for our products. We primarily sell our products in China through local China-based distributors. In 2017, we primarily relied on five Chinese distributors for the sale of our products, which accounted for 41.7% of our total revenue. In 2017, approximately 96.0% of our products were sold in China and, of these sales in China, approximately 97.6% were generated from Chinese distributors.

The impact of economic conditions on any of our distributors, such as bankruptcy, could result in sales channel disruption. In the event our distributors fail to sell our products in sufficient amounts, such failure could have a material adverse effect on our revenue. We intend to expand our distribution network; however, we cannot make any assurances that we will be successful in doing so or if such relationships will be on favorable terms. Moreover, the functioning of our products distribution could be disrupted for reasons either within or beyond the our control, including: extremes of weather or longer-term climatic changes; accidental damage; disruption to the supply of material or services; product quality and safety issues; systems failure; workforce actions; or environmental contamination. Such disruption or failures may materially adversely affect our ability to sell products and therefore materially adversely affect our financial condition, competitiveness and growth prospects.

Our business depends in large part on the success of our vendors and outsourcers, and our brand and reputation may be harmed by actions taken by third-parties that are outside of our control. In addition, any material failure, inadequacy, or interruption resulting from such vendors or outsourcings could harm our ability to effectively operate our business.

We rely on vendor and outsourcing relationships with third parties for services and systems including manufacturing, transportation and logistics. Any shortcoming of a vendor or outsourcer, particularly an issue affecting the quality of these services or systems, may be attributed by customers to us, thus damaging our reputation and brand value, and potentially affecting our results of operations. In addition, problems with transitioning these services and systems to or operating failures with these vendors and outsourcers could cause delays in product sales, and reduce efficiency of our operations, and significant capital investments could be required to remediate the problem.

Issues with products may lead to product liability, personal injury or property damage claims, recalls, withdrawals, replacements of products, or regulatory actions by governmental authorities that could divert resources, affect business operations, decrease sales, increase costs, and put us at a competitive disadvantage, any of which could have a significant adverse effect on our financial condition.

We may experience issues with products that may lead to product liability, personal injury or property damage claims, recalls, withdrawals, replacements of products, or regulatory actions by governmental authorities. Any of these activities could result in increased governmental scrutiny, harm to our reputation, reduced demand by consumers for products, decreased willingness by retailer customers to purchase or provide marketing support for those products, adverse impacts on our ability to enter into licensing agreements for products on competitive terms, absence or increased cost of insurance, or additional safety and testing requirements. Such results could divert development and management resources, adversely affect our business operations, decrease sales, increase legal fees and other costs, and put us at a competitive disadvantage compared to other companies not affected by similar issues with products, any of which could have a significant adverse effect on our financial condition and results of operations.

Our business is seasonal and therefore our annual operating results will depend, in large part, on our sales during the relatively brief holiday shopping season.

Sales of our toys are seasonal, with a majority of sales occurring during the period from August through December in anticipation of the holiday season. This seasonality in our industry has increased over time, as retailers become more efficient in their control of inventory levels through quick response inventory management techniques. The majority of retail sales of toys generally occur in the fourth quarter, close to the holiday season.

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If we or our customers determine that one of our products is more popular at retail than was originally anticipated, there may not be sufficient time to produce enough additional products to fully meet consumer demand. Additionally, the logistics of supplying more and more product within shorter time periods increases the risk that we, or our third-party providers, will fail to achieve tight and compressed shipping schedules, which also may reduce our sales and harm our financial performance. This seasonal pattern requires accurate forecasting of demand for products during the holiday season in order to avoid losing potential sales of popular products or producing excess inventory of products that are less popular with consumers. Our failure to accurately predict and respond to consumer demand, resulting in our under producing popular items and/or overproducing less popular items, would reduce our total sales and harm our results of operations. In addition, as a result of the seasonal nature of our business, we would be significantly and adversely affected, in a manner disproportionate to the impact on a company with sales spread more evenly throughout the year, by unforeseen events such as a terrorist attack or economic shock that harm the retail environment or consumer buying patterns during our key selling season, or by events such as strikes or port delays that interfere with the shipment of goods during the critical months leading up to the holiday shopping season.

Our future success depends on our ability to retain key executives and to attract, retain and motivate qualified personnel.

We are highly dependent on the principal members of our executive team listed in the section entitled “Management” located elsewhere in this prospectus, the loss of whose services may adversely impact the achievement of our objectives. Recruiting and retaining other qualified employees for our business, including scientific and technical personnel, will also be critical to our success. Competition for skilled personnel is intense and the turnover rate can be high. We may not be able to attract and retain personnel on acceptable terms given the competition among numerous companies for individuals with similar skill sets. The inability to recruit or loss of the services of any executive or key employee could adversely affect our business.

We will need to expand our organization, and we may experience difficulties in managing this growth, which could disrupt our operations.

As of January 31, 2019, we had 100 full-time employees. As our company matures, we expect to expand our employee base to increase our sales and marketing department. Future growth would impose significant additional responsibilities on our management, including the need to identify, recruit, maintain, motivate and integrate additional employees, consultants and contractors. Also, our management may need to divert a disproportionate amount of its attention away from our day-to-day activities and devote a substantial amount of time to managing these growth activities. We may not be able to effectively manage the expansion of our operations, which may result in weaknesses in our infrastructure, give rise to operational mistakes, loss of business opportunities, loss of employees and reduced productivity among remaining employees. Future growth could require significant capital expenditures and may divert financial resources from other projects, such as the development of our existing or future product candidates. If our management is unable to effectively manage our growth, our expenses may increase more than expected, our ability to generate and grow revenue could be reduced, and we may not be able to implement our business strategy. Our future financial performance and our ability to commercialize our product candidates, if approved, and compete effectively will depend, in part, on our ability to effectively manage any future growth.

We intend to physically expand our business by opening or franchising experience stores, and we may experience difficulties in successfully achieving such expansion, which could harm our ability to effectively operate our business. 

In September 2018, we opened our first physical experience store in Xiamen, China. We plan to open two additional stores in Xiamen in the first half of 2019. By 2021, we intend to have opened or franchised over 100 physical experience stores across China to increase our physical presence in China and strengthen our brand recognition. Our strategy is to initially capture the AR market in China’s first tier, or largest, cities, where consumers typically have the strongest purchasing power, and then expand to other cities in China. 

The anticipated material steps involved in our physical expansion strategy include, among other things, location selection, staff recruitment, purchase of equipment, execution of leases, and conducting renovations. We currently expect to invest approximately RMB 300,000 ($43,680) per store in such endeavors. 

Successful expansion depends on several factors, many of which are outside of our control, including effective control of management and operations, reasonable rent levels, appropriate labor costs, and adequate financial support. The realization of any of these risks could cause the implementation of our expansion plan to be put on hold or cease altogether, which could harm our ability to effectively operate our business.

Failure of beneficial owners of our shares who are PRC residents to comply with certain PRC foreign exchange regulations could restrict our ability to distribute profits, restrict our overseas and cross-border investment activities and subject us to liability under PRC law.

The State Administration of Foreign Exchange, or SAFE, has promulgated regulations, including the Notice on Relevant Issues Relating to Foreign Exchange Control on Domestic Residents' Investment and Financing and Round-Trip Investment through Special Purpose Vehicles, or Circular 37, and its appendices. These regulations require PRC residents, including PRC institutions and individuals, to register with local branches of 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 Circular 37 as a "special purpose vehicle", or SPV. The term "control" under Circular 37 is broadly defined as the operation rights, beneficiary rights or decision-making rights acquired by the PRC residents in the offshore SPVs by such means as acquisition, trust, proxy, voting rights, repurchase, convertible bonds or other arrangements. Circular 37 further requires amendment to the registration in the event of any significant changes with respect to the SPV, 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 SPV fails to fulfill the required SAFE registration, the PRC subsidiaries of that SPV may be prohibited from making profit distributions to the offshore parent and from carrying out subsequent cross-border foreign exchange activities, and the SPV may be restricted in its ability to contribute additional capital into its PRC subsidiaries. Further, failure to comply with the various SAFE registration requirements described above could result in liability under PRC law for foreign exchange evasion.

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These regulations apply to our direct and indirect shareholders who are PRC residents and may apply to any offshore acquisitions or share transfers that we make in the future if our shares are issued to PRC residents. However, in practice, different local SAFE branches may have different views and procedures on the application and implementation of SAFE regulations, and there remains uncertainty with respect to its implementation. We cannot assure you that these direct or indirect shareholders of our company who are PRC residents will be able to successfully update the registration of their direct and indirect equity interest as required in the future. If they fail to update the registration, our PRC subsidiary could be subject to fines and legal penalties, and SAFE could restrict our cross-border investment activities and our foreign exchange activities, including restricting our PRC subsidiary’s ability to distribute dividends to, or obtain loans denominated in foreign currencies from, our company, or prevent us from contributing additional capital into our PRC subsidiary. As a result, our business operations and our ability to make distributions to you could be materially and adversely affected.

Failure to make adequate contributions to various employee benefits plans as required by PRC regulations may subject us to penalties.

Companies operating in China are required to participate in various government sponsored employee benefit plans, including certain social insurance, housing funds and other welfare-oriented payment obligations, and contribute to the plans in amounts equal to certain percentages of salaries, including bonuses and allowances, of employees up to a maximum amount specified by the local government from time to time at locations where they operate their businesses. The requirement of employee benefit plans has not been implemented consistently by the local governments in China given the different levels of economic development in different locations. If we fail to make contributions to various employee benefit plans and to comply with applicable PRC labor-related laws in the future, we may be subject to late payment penalties. We may be required to make up the contributions for these plans as well as to pay late fees and fines. If we are subject to late fees or fines in relation to the underpaid employee benefits, our financial condition and results of operations may be adversely affected.

Risks Relating to Our Corporate Structure

We depend upon the Contractual Arrangements in conducting our business in China, which may not be as effective as direct ownership.

Our affiliation with Blue Hat Fujian is managed through the Contractual Arrangements, which agreements may not be as effective in providing us with control over Blue Hat Fujian as direct ownership. The Contractual Arrangements are governed by and would be interpreted in accordance with the laws of the People’s Republic of China, or the PRC. If Blue Hat Fujian fails to perform the obligations under the Contractual Arrangements, we may have to rely on legal remedies under the laws of the PRC, including seeking specific performance or injunctive relief, and claiming damages. There is a risk that we may be unable to obtain any of these remedies. The legal environment in the PRC is not as developed as in other jurisdictions. As a result, uncertainties in the PRC legal system could limit our ability to enforce the Contractual Arrangements, or could affect the validity of the Contractual Arrangements.

We may not be able to consolidate the financial results of some of our affiliated companies or such consolidation could materially adversely affect our operating results and financial condition.

All of our business is conducted through Blue Hat Fujian, which is considered a VIE for accounting purposes, and we, through Blue Hat WFOE, are considered the primary beneficiary, thus enabling us to consolidate our financial results in our consolidated financial statements. In the event that in the future a company we hold as a VIE no longer meets the definition of a VIE under applicable accounting rules, or we are deemed not to be the primary beneficiary, we would not be able to consolidate line by line that entity’s financial results in our consolidated financial statements for reporting purposes. Also, if in the future an affiliate company becomes a VIE and we become the primary beneficiary, we would be required to consolidate that entity’s financial results in our consolidated financial statements for accounting purposes. If such entity’s financial results were negative, this would have a corresponding negative impact on our operating results for reporting purposes.

Because we rely on the Contractual Arrangements for our revenue, the termination of these agreements would severely and detrimentally affect our continuing business viability under our current corporate structure.

We are a holding company and all of our business operations are conducted through the Contractual Arrangements. Blue Hat Fujian may terminate the Contractual Arrangements for any or no reason at all. Because neither we, nor our subsidiaries, own equity interests of Blue Hat Fujian, the termination of the Contractual Arrangements would sever our ability to receive payments from Blue Hat Fujian under our current holding company structure. While we are currently not aware of any event or reason that may cause the Contractual Arrangements to terminate, we cannot assure you that such an event or reason will not occur in the future. In the event that the Contractual Arrangements are terminated, this would have a severe and detrimental effect on our continuing business viability under our current corporate structure, which, in turn, may affect the value of your investment.

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

Under applicable PRC laws and regulations, arrangements and transactions among related parties may be subject to audit or challenge by the PRC tax authorities within ten years after the taxable year when the transactions are conducted. We could face material and adverse tax consequences if the PRC tax authorities determine that the VIE contractual arrangements were not entered into on an arm’s-length basis in such a way as to result in an impermissible reduction in taxes under applicable PRC laws, rules and regulations, and adjust the income of our VIE in the form of a transfer pricing adjustment. A transfer pricing adjustment could, among other things, result in a reduction of expense deductions recorded by our VIE for PRC tax purposes, which could in turn increase its tax liabilities without reducing our subsidiary's tax expenses. In addition, the PRC tax authorities may impose late payment fees and other penalties on our VIE for the adjusted but unpaid taxes according to the applicable regulations. Our financial position could be materially and adversely affected if our VIE’s tax liabilities increase or if it is required to pay late payment fees and other penalties.  

We conduct our business through Blue Hat Fujian by means of Contractual Arrangements. If the PRC courts or administrative authorities determine that these contractual arrangements do not comply with applicable regulations, we could be subject to severe penalties and our business could be adversely affected. In addition, changes in such PRC laws and regulations may materially and adversely affect our business.

There are uncertainties regarding the interpretation and application of PRC laws, rules and regulations, including the laws, rules and regulations governing the validity and enforcement of the contractual arrangements between Blue Hat WFOE and Blue Hat Fujian. We have been advised by our PRC counsel, Beijing Dentons Law Offices, LLP (“Dentons”), based on their understanding of the current PRC laws, rules and regulations, that (i) the structure for operating our business in China (including our corporate structure and contractual arrangements with Blue Hat Fujian, Blue Hat Fujian and their shareholders) will not result in any violation of PRC laws or regulations currently in effect; and (ii) the contractual arrangements among Blue Hat WFOE and Blue Hat Fujian and their shareholders governed by PRC law are valid, binding and enforceable, and will not result in any violation of PRC laws or regulations currently in effect. However, there are substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations concerning foreign investment in the PRC, and their application to and effect on the legality, binding effect and enforceability of the contractual arrangements. In particular, we cannot rule out the possibility that PRC regulatory authorities, courts or arbitral tribunals may in the future adopt a different or contrary interpretation or take a view that is inconsistent with the opinion of our PRC legal counsel.

If any of our PRC entities or their ownership structure or the Contractual Arrangements are determined to be in violation of any existing or future PRC laws, rules or regulations, or any of our PRC entities fail to obtain or maintain any of the required governmental permits or approvals, the relevant PRC regulatory authorities would have broad discretion in dealing with such violations, including:

         revoking the business and operating licenses;
         discontinuing or restricting the operations;
         imposing conditions or requirements with which the PRC entities may not be able to comply;
         requiring us and our PRC entities to restructure the relevant ownership structure or operations;
         restricting or prohibiting our use of the proceeds from this offering to finance our business and operations in China; or
         imposing fines.
     

The imposition of any of these penalties would severely disrupt our ability to conduct business and have a material adverse effect on our financial condition, results of operations and prospects.

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

The shareholders of our VIE may have actual or potential conflicts of interest with us. These shareholders may refuse to sign or breach, or cause our VIE to breach, or refuse to renew, the existing contractual arrangements we have with them and our VIE, which would have a material and adverse effect on our ability to effectively control our VIE and receive economic benefits from it. For example, the shareholders may be able to cause our agreements with our VIE to be performed in a manner adverse to us by, among other things, failing to remit payments due under the contractual arrangements to us on a timely basis. We cannot assure you that when conflicts of interest arise any or all of these shareholders will act in the best interests of our company or such conflicts will be resolved in our favor. Currently, we do not have any arrangements to address potential conflicts of interest between these shareholders and our company. If we cannot resolve any conflict of interest or dispute between us and these shareholders, we would have to rely on legal proceedings, which could result in disruption of our business and subject us to substantial uncertainty as to the outcome of any such legal proceedings.

The draft Foreign Investment Law proposes sweeping changes to the PRC foreign investment legal regime and will likely to have a significant impact on businesses in China controlled by foreign invested enterprises primarily through contractual arrangements, such as our business.

On January 19, 2015, the PRC Ministry of Commerce or MOFCOM published a draft of the PRC Law on Foreign Investment (Draft for Comment), or the Foreign Investment Law, which was open for public comments until February 17, 2015. At the same time, MOFCOM published an accompanying explanatory note of the draft Foreign Investment Law (or the Explanatory Note), which contains important information about the draft Foreign Investment Law, including its drafting philosophy and principles, main content, plans to transition to the new legal regime and treatment of business in China controlled by foreign invested enterprises or FIEs, primarily through contractual arrangements. The draft Foreign Investment Law is intended to replace the current foreign investment legal regime consisting of three laws: the Sino-Foreign Equity Joint Venture Enterprise Law, the Sino-Foreign Cooperative Joint Venture Enterprise Law and the Wholly Foreign-Invested Enterprise Law, as well as their respective detailed implementing rules. The draft Foreign Investment Law, if enacted as proposed, may materially impact the viability of our current corporate structure, corporate governance and business operations in many aspects. The draft Foreign Investment Law expands the definition of foreign investment and introduces the principle of “actual control” in determining whether a company is considered a FIE. The draft Foreign Investment Law specifically provides that entities established in China but “controlled” by foreign investors will be treated as FIEs, whereas an entity set up in a foreign jurisdiction would nonetheless be, upon market entry clearance by MOFCOM, treated as a PRC domestic investor provided that the entity is “controlled” by PRC entities and/or citizens. Once an entity is determined to be a FIE, it will be subject to the foreign investment restrictions or prohibitions set forth in a “catalogue of special administrative measures for foreign investments,” which is classified into the “catalogue of prohibitions” and the “catalogue of restrictions”, to be separately issued by the State Council later. Foreign investors are not allowed to invest in any sector set forth in the catalogue of prohibitions. However, unless the underlying business of the FIE falls within the catalogue of restrictions, which calls for market entry clearance by MOFCOM, prior approval from governmental authorities as mandated by the existing foreign investment legal regime would no longer be required for establishment of the FIE.

The specifics of the draft Foreign Investment Law’s application to variable interest entity structures have yet to be proposed, but it is anticipated that the draft Foreign Investment Law will regulate variable interest entities. MOFCOM suggests both registration and approval as potential options for the regulation of variable entity structures, depending on whether they are “Chinese” or “foreign-controlled”. One of the core concepts of the draft Foreign Investment Law is “de facto control”, which emphasizes substance over form in determining whether an entity is “Chinese” or “foreign-controlled”. This determination requires considering the nature of the investors that exercise control over the entity. “Chinese investors” are natural persons who are Chinese nationals, Chinese government agencies and any domestic enterprise controlled by Chinese nationals or government agencies. “Foreign investors” are foreign citizens, foreign governments, international organizations and entities controlled by foreign citizens and entities. Blue Hat Fujian is majority controlled by Xiaodong Chen, our chief executive officer and director, who is a PRC resident, therefore, it increases the likelihood that our company may be deemed “Chinese” controlled. In its current form, the draft Foreign Investment Law will make it difficult for foreign financial investors, including private equity and venture capital firms, to obtain a controlling interest of a Chinese enterprise in a foreign restricted industry. However, under the proposed new law, we may no longer need to hold interests in our operating affiliate through contractual arrangements and may be able to have control through direct equity ownership.

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On December 26, 2018, the Standing Committee of the National People's Congress reviewed Foreign Investment Law of the People’s Republic of China (Draft) and published it to solicit public opinions. According to Foreign Investment Law of the People’s Republic of China (Draft), it has revised the stipulation in Foreign Investment Law of the People’s Republic of China (Exposure Draft) which treated “control domestic enterprises or hold equity in domestic enterprises by contracts, trust or other ways” as “foreign investments”. It is Dentons’ understanding that, according to the current stipulation of Foreign Investment Law of the People’s Republic of China (Draft), even after its entry into force, it would not constitute a negative impact on our structure or business. However, there are still substantial uncertainties regarding the draft Foreign Investment Law, including, among others, what the actual content of the law will be as well as the adoption timeline or effective date of the final form of the law. While such uncertainties exist, we cannot determine whether the new foreign investment law, when it is adopted and becomes effective, will have a material positive or negative impact on our corporate structure and business.

If any of our affiliated entities becomes the subject of a bankruptcy or liquidation proceeding, we may lose the ability to use and enjoy assets held by such entity, which could materially and adversely affect our business, financial condition and results of operations.

We currently conduct our operations in China through our Contractual Arrangements. As part of these arrangements, substantially all of our assets that are significant to the operation of our business are held by our affiliated entities. If any of these entities becomes bankrupt and all or part of their assets become subject to liens or rights of third-party creditors, we may be unable to continue some or all of our business activities, which could materially and adversely affect our business, financial condition and results of operations. In addition, if any of our affiliated entities undergoes a voluntary or involuntary liquidation proceeding, its equity owner or unrelated third-party creditors may claim rights relating to some or all of these assets, which would hinder our ability to operate our business and could materially and adversely affect our business, our ability to generate revenue and the market price of our ordinary shares.

Risks Related to Intellectual Property

If we are not able to adequately protect our proprietary intellectual property and information, and protect against third party claims that we are infringing on their intellectual property rights, our results of operations could be adversely affected.

The value of our business depends on our ability to protect our intellectual property and information, including our trademarks, copyrights, patents, trade secrets, and rights under agreements with third parties, in China and around the world, as well as our customer, employee, and consumer data. Third parties may try to challenge our ownership of our intellectual property in China and around the world. In addition, our business is subject to the risk of third parties counterfeiting our products or infringing on our intellectual property rights. The steps we have taken may not prevent unauthorized use of our intellectual property. We may need to resort to litigation to protect our intellectual property rights, which could result in substantial costs and diversion of resources. If we fail to protect our proprietary intellectual property and information, including with respect to any successful challenge to our ownership of intellectual property or material infringements of our intellectual property, this failure could have a significant adverse effect on our business, financial condition, and results of operations.

If we are unable to adequately protect our intellectual property rights, or if we are accused of infringing on the intellectual property rights of others, our competitive position could be harmed or we could be required to incur significant expenses to enforce or defend our rights.

Our commercial success will depend in part on our success in obtaining and maintaining issued patents, trademarks and other intellectual property rights in China and elsewhere and protecting our proprietary technology. If we do not adequately protect our intellectual property and proprietary technology, competitors may be able to use our technologies or the goodwill we have acquired in the marketplace and erode or negate any competitive advantage we may have, which could harm our business and ability to achieve profitability.

We cannot provide any assurances that any of our patents have, or that any of our pending patent applications that mature into issued patents will include, claims with a scope sufficient to protect our products, any additional features we develop for our products or any new products. Other parties may have developed technologies that may be related or competitive to our system, may have filed or may file patent applications and may have received or may receive patents that overlap or conflict with our patent applications, either by claiming the same methods or devices or by claiming subject matter that could dominate our patent position. Our patent position may involve complex legal and factual questions, and, therefore, the scope, validity and enforceability of any patent claims that we may obtain cannot be predicted with certainty. Patents, if issued, may be challenged, deemed unenforceable, invalidated or circumvented. Proceedings challenging our patents could result in either loss of the patent or denial of the patent application or loss or reduction in the scope of one or more of the claims of the patent or patent application. In addition, such proceedings may be costly. Thus, any patents that we may own may not provide any protection against competitors. Furthermore, an adverse decision in an interference proceeding can result in a third party receiving the patent right sought by us, which in turn could affect our ability to commercialize our products.

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Though an issued patent is presumed valid and enforceable, its issuance is not conclusive as to its validity or its enforceability and it may not provide us with adequate proprietary protection or competitive advantages against competitors with similar products. Competitors could purchase our products and attempt to replicate some or all of the competitive advantages we derive from our development efforts, willfully infringe our intellectual property rights, design around our patents, or develop and obtain patent protection for more effective technologies, designs or methods. We may be unable to prevent the unauthorized disclosure or use of our technical knowledge or trade secrets by consultants, suppliers, vendors, former employees and current employees.

Our ability to enforce our patent rights depends on our ability to detect infringement. It may be difficult to detect infringers who do not advertise the components that are used in their products. Moreover, it may be difficult or impossible to obtain evidence of infringement in a competitor's or potential competitor's product. We may not prevail in any lawsuits that we initiate and the damages or other remedies awarded if we were to prevail may not be commercially meaningful.

In addition, proceedings to enforce or defend our patents could put our patents at risk of being invalidated, held unenforceable or interpreted narrowly. Such proceedings could also provoke third parties to assert claims against us, including that some or all of the claims in one or more of our patents are invalid or otherwise unenforceable. If any of our patents covering our products are invalidated or found unenforceable, or if a court found that valid, enforceable patents held by third parties covered one or more of our products, our competitive position could be harmed or we could be required to incur significant expenses to enforce or defend our rights.

The degree of future protection for our proprietary rights is uncertain, and we cannot ensure that:

any of our patents, or any of our pending patent applications, if issued, will include claims having a scope sufficient to protect our products;
any of our pending patent applications will issue as patents;
we will be able to successfully commercialize our products on a substantial scale, if approved, before our relevant patents we may have expire;
we were the first to make the inventions covered by each of our patents and pending patent applications;
we were the first to file patent applications for these inventions;
others will not develop similar or alternative technologies that do not infringe our patents; any of our patents will be found to ultimately be valid and enforceable;
any patents issued to us will provide a basis for an exclusive market for our commercially viable products, will provide us with any competitive advantages or will not be challenged by third parties;
we will develop additional proprietary technologies or products that are separately patentable; or
our commercial activities or products will not infringe upon the patents of others.

 

We rely, in part, upon unpatented trade secrets, unpatented know-how and continuing technological innovation to develop and maintain our competitive position. Further, our trade secrets could otherwise become known or be independently discovered by our competitors.

Litigation or other proceedings or third-party claims of intellectual property infringement could require us to spend significant time and money and could prevent us from selling our products or affect our stock price.

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Our commercial success will depend in part on not infringing the patents or violating the other proprietary rights of others. Significant litigation regarding patent rights occurs in our industry. Our competitors in both the United States and abroad, many of which have substantially greater resources and have made substantial investments in patent portfolios and competing technologies, may have applied for or obtained or may in the future apply for and obtain, patents that will prevent, limit or otherwise interfere with our ability to make, use and sell our products. We do not always conduct independent reviews of patents issued to third parties. In addition, patent applications in China and elsewhere can be pending for many years before issuance, or unintentionally abandoned patents or applications can be revived, so there may be applications of others now pending or recently revived patents of which we are unaware. These applications may later result in issued patents, or the revival of previously abandoned patents, that will prevent, limit or otherwise interfere with our ability to make, use or sell our products. Third parties may, in the future, assert claims that we are employing their proprietary technology without authorization, including claims from competitors or from non-practicing entities that have no relevant product revenue and against whom our own patent portfolio may have no deterrent effect. As we continue to commercialize our products in their current or updated forms, launch new products and enter new markets, we expect competitors may claim that one or more of our products infringe their intellectual property rights as part of business strategies designed to impede our successful commercialization and entry into new markets. The large number of patents, the rapid rate of new patent applications and issuances, the complexities of the technology involved, and the uncertainty of litigation may increase the risk of business resources and management's attention being diverted to patent litigation. We have, and we may in the future, receive letters or other threats or claims from third parties inviting us to take licenses under, or alleging that we infringe, their patents.

Moreover, we may become party to future adversarial proceedings regarding our patent portfolio or the patents of third parties. Patents may be subjected to opposition, post-grant review or comparable proceedings lodged in various foreign, both national and regional, patent offices. The legal threshold for initiating litigation or contested proceedings may be low, so that even lawsuits or proceedings with a low probability of success might be initiated. Litigation and contested proceedings can also be expensive and time-consuming, and our adversaries in these proceedings may have the ability to dedicate substantially greater resources to prosecuting these legal actions than we can. We may also occasionally use these proceedings to challenge the patent rights of others. We cannot be certain that any particular challenge will be successful in limiting or eliminating the challenged patent rights of the third party.

Any lawsuits resulting from such allegations could subject us to significant liability for damages and invalidate our proprietary rights. Any potential intellectual property litigation also could force us to do one or more of the following:

stop making, selling or using products or technologies that allegedly infringe the asserted intellectual property;

lose the opportunity to license our technology to others or to collect royalty payments based upon successful protection and assertion of our intellectual property rights against others; incur significant legal expenses;
pay substantial damages or royalties to the party whose intellectual property rights we may be found to be infringing;
pay the attorney's fees and costs of litigation to the party whose intellectual property rights we may be found to be infringing;
redesign those products that contain the allegedly infringing intellectual property, which could be costly, disruptive and infeasible; and
attempt to obtain a license to the relevant intellectual property from third parties, which may not be available on reasonable terms or at all, or from third parties who may attempt to license rights that they do not have.

Any litigation or claim against us, even those without merit, may cause us to incur substantial costs, and could place a significant strain on our financial resources, divert the attention of management from our core business and harm our reputation. If we are found to infringe the intellectual property rights of third parties, we could be required to pay substantial damages (which may be increased up to three times of awarded damages) and/or substantial royalties and could be prevented from selling our products unless we obtain a license or are able to redesign our products to avoid infringement. Any such license may not be available on reasonable terms, if at all, and there can be no assurance that we would be able to redesign our products in a way that would not infringe the intellectual property rights of others. We could encounter delays in product introductions while we attempt to develop alternative methods or products. If we fail to obtain any required licenses or make any necessary changes to our products or technologies, we may have to withdraw existing products from the market or may be unable to commercialize one or more of our products.

If we are unable to protect the confidentiality of our trade secrets, our business and competitive position could be harmed.

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In addition to patent protection, we also rely upon copyright and trade secret protection, as well as non-disclosure agreements with our employees, consultants and third parties, to protect our confidential and proprietary information. In addition to contractual measures, we try to protect the confidential nature of our proprietary information using commonly accepted physical and technological security measures. Such measures may not, for example, in the case of misappropriation of a trade secret by an employee or third party with authorized access, provide adequate protection for our proprietary information. Our security measures may not prevent an employee or consultant from misappropriating our trade secrets and providing them to a competitor, and recourse we take against such misconduct may not provide an adequate remedy to protect our interests fully. Unauthorized parties may also attempt to copy or reverse engineer certain aspects of our products that we consider proprietary. Enforcing a claim that a party illegally disclosed or misappropriated a trade secret can be difficult, expensive and time-consuming, and the outcome is unpredictable. Even though we use commonly accepted security measures, trade secret violations are often a matter of state law, and the criteria for protection of trade secrets can vary among different jurisdictions. In addition, trade secrets may be independently developed by others in a manner that could prevent legal recourse by us. If any of our confidential or proprietary information, such as our trade secrets, were to be disclosed or misappropriated, or if any such information was independently developed by a competitor, our business and competitive position could be harmed.

Third parties may assert ownership or commercial rights to inventions we develop.

Third parties may in the future make claims challenging the inventorship or ownership of our intellectual property. We incorporate licensed technology in some of our products. Any infringement claims or lawsuits, even if not meritorious, could be expensive and time consuming to defend, divert management’s attention and resources, require us to redesign our products and services, if feasible, require us to pay royalties or enter into licensing agreements in order to obtain the right to use necessary technologies, and/or may materially disrupt the conduct of our business.

In addition, we may face claims by third parties that our agreements with employees, contractors or consultants obligating them to assign intellectual property to us are ineffective or in conflict with prior or competing contractual obligations of assignment, which could result in ownership disputes regarding intellectual property we have developed or will develop and interfere with our ability to capture the commercial value of such intellectual property. Litigation may be necessary to resolve an ownership dispute, and if we are not successful, we may be precluded from using certain intellectual property or may lose our exclusive rights in that intellectual property. Either outcome could harm our business and competitive position.

Third parties may assert that our employees or consultants have wrongfully used or disclosed confidential information or misappropriated trade secrets.

We may employ individuals who previously worked with other companies, including our competitors or potential competitors. Although we try to ensure that our employees and consultants do not use the proprietary information or know-how of others in their work for us, we may be subject to claims that we or our employees, consultants or independent contractors have inadvertently or otherwise used or disclosed intellectual property or personal data, including trade secrets or other proprietary information, of a former employer or other third party. Litigation may be necessary to defend against these claims. If we fail in defending any such claims or settling those claims, in addition to paying monetary damages or a settlement payment, we may lose valuable intellectual property rights or personnel. Even if we are successful in defending against such claims, litigation could result in substantial costs and be a distraction to management and other employees.

Our computer systems and operations may be vulnerable to security breaches.

We expect that the cloud-based applications embedded in our toys will be an important foundation for establishing our company as a leading source of technology. For that reason, among others, the safety of our network and our secure transmission of information over the internet will be essential to our operations and our services. Our network and our computer infrastructure are potentially vulnerable to physical breaches or to the introduction of computer viruses, abuse of use and similar disruptive problems and security breaches that could cause loss (both economic and otherwise), interruptions, delays or loss of services to our users. It is possible that advances in computer capabilities or new technologies could result in a compromise or breach of the technology we use to protect user transaction data. A party that is able to circumvent our security systems could misappropriate proprietary information, cause interruptions in our operations or utilize our network without authorization. Security breaches also could damage our reputation and expose us to a risk of loss, litigation and possible liability. We cannot guarantee you that our security measures will prevent security breaches.

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Risks Related to Doing Business in China

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

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

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

Uncertainties with respect to China’s legal system could adversely affect us.

The PRC legal system is a civil law system based on written statutes. Unlike the common law system, prior court decisions under the civil law system may be cited for reference but have limited precedential value.

In 1979, the PRC government began to promulgate a comprehensive system of laws and regulations governing economic matters in general. The overall effect of legislation over the past three decades has significantly enhanced the protections afforded to various forms of foreign investments in China. However, China has not developed a fully integrated legal system, and recently enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, the interpretation and enforcement of these laws and regulations involve uncertainties. Since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory provisions and contractual terms, it may be difficult to evaluate the outcome of administrative and court proceedings and the level of legal protection we enjoy. These uncertainties may affect our judgment on the relevance of legal requirements and our ability to enforce our contractual rights or tort claims. In addition, the regulatory uncertainties may be exploited through unmerited or frivolous legal actions or threats in attempts to extract payments or benefits from us.

Furthermore, the PRC legal system is based in part on government policies and internal rules, some of which are not published on a timely basis or at all and may have a retroactive effect. As a result, we may not be aware of our violation of any of these policies and rules until sometime after the violation. In addition, any administrative and court proceedings in China may be protracted, resulting in substantial costs and diversion of resources and management attention.

We must remit the offering proceeds to China before they may be used to benefit our business in China, and we cannot assure that we can finish all necessary governmental registration processes in a timely manner.

The proceeds of this offering must be sent back to China, and the process for sending such proceeds back to China may take several months after the closing of this offering. In utilizing the proceeds of this offering in the manner described in “Use of Proceeds,” as an offshore holding company of our PRC subsidiary, we may make loans to our PRC subsidiary, or we may make additional capital contributions to our PRC subsidiary. Any shareholder loan or additional capital contribution are subject to PRC regulations. For example, loans by us or making additional capital contribution to our subsidiaries in China, which are FIEs, to finance their activities cannot exceed statutory limits, while the shareholder loan must be also registered with the SAFE. The statutory limit for the total amount of foreign debts of a foreign-invested company is the difference between the amount of total investment as approved by MOFCOM or its local counterpart and the amount of registered capital of such foreign-invested company.

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To remit the proceeds of the offering, we must take the steps legally required under the PRC laws.

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 by us to our PRC subsidiary or PRC consolidated VIE or with respect to future capital contributions by us to our PRC subsidiary. If we fail to complete such registrations or obtain such approvals, our ability to use the proceeds from this offering and to capitalize or otherwise fund our PRC operations may be negatively affected, which could materially and adversely affect our liquidity, our ability to fund and expand our business and our ordinary shares.

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

We are a holding company incorporated under the laws of the Cayman Islands. We conduct substantially all of our operations in China and substantially all of our assets are located in China. In addition, all our senior employees reside within China for a significant portion of the time and most are PRC residents. As a result, it may be difficult for our shareholders to effect service of process upon us or those persons inside mainland China. In addition, China does not have treaties providing for the reciprocal recognition and enforcement of judgments of courts with the Cayman Islands and many other countries and regions. Therefore, recognition and enforcement in China of judgments of a court in any of these non-PRC jurisdictions in relation to any matter not subject to a binding arbitration provision may be difficult or impossible.

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

We are a Cayman Islands holding company and we rely principally on dividends and other distributions on equity from our PRC subsidiary for our cash requirements, including for services of any debt we may incur. Our PRC subsidiary's ability to distribute dividends is based upon its distributable earnings. Current PRC regulations permit our PRC subsidiary to pay dividends to its respective shareholders only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, each of our PRC subsidiary, our VIE and its subsidiaries are required to set aside at least 10% of its after-tax profits each year, if any, to fund a statutory reserve until such reserve reaches 50% of its registered capital. Our PRC subsidiary as a FIE is also required to further set aside a portion of its after-tax profits to fund the employee welfare fund, although the amount to be set aside, if any, is determined at its discretion. These reserves are not distributable as cash dividends. If our PRC subsidiary incurs debt on their own behalf in the future, the instruments governing the debt may restrict their ability to pay dividends or make other payments to us. Any limitation on the ability of our PRC subsidiary to distribute dividends or other payments to their respective shareholders could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our businesses, pay dividends or otherwise fund and conduct our business.

In addition, the Enterprise Income Tax Law and its implementation rules provide that a withholding tax rate of up to 10% will be applicable to dividends payable by Chinese companies to non-PRC-resident enterprises unless otherwise exempted or reduced according to treaties or arrangements between the PRC central government and governments of other countries or regions where the non-PRC resident enterprises are incorporated.

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

Any funds we transfer to our PRC subsidiary, either as a shareholder loan or as an increase in registered capital, are subject to approval by or registration with relevant governmental authorities in China. According to the relevant PRC regulations on FIEs in China, capital contributions to our PRC subsidiary are subject to the approval of the MOFCOM or its local branches and registration with other governmental authorities in China. In addition, (a) any foreign loan procured by our PRC subsidiary is required to be registered with SAFE or its local branches, and (b) our PRC subsidiary may not procure loans which exceed the statutory amount as approved by the MOFCOM or its local branches. Any medium-or long- term loan to be provided by us to our VIE must be approved by the National Development and Reform Commission, or NDRC and the SAFE or its local branches. We may not obtain these government approvals or complete such registrations on a timely basis, with respect to future capital contributions or foreign loans by us to our PRC subsidiary. If we fail to receive such approvals or complete such registration, our ability to use the proceeds of this offering and to capitalize our PRC operations may be negatively affected, which could adversely affect our liquidity and our ability to fund and expand our business.

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In 2008, SAFE promulgated 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 SAFE Circular 142. SAFE Circular 142 regulates the conversion by FIEs of foreign currency into Renminbi by restricting the usage of converted Renminbi. SAFE Circular 142 provides that any Renminbi capital converted from registered capitals in foreign currency of FIEs may only be used for purposes within the business scopes approved by PRC governmental authority and such Renminbi capital may not be used for equity investments within China unless otherwise permitted by PRC law. In addition, the SAFE strengthened its oversight of the flow and use of Renminbi capital converted from registered capital in foreign currency of FIEs. The use of such Renminbi capital may not be changed without SAFE approval, and such Renminbi capital may not in any case be used to repay Renminbi loans if the proceeds of such loans have not been utilized. On July 4, 2014, SAFE issued the Circular of the SAFE on Relevant Issues Concerning the Pilot Reform in Certain Areas of the Administrative Method of the Conversion of Foreign Exchange Funds by Foreign-invested Enterprises, or SAFE Circular 36, which launched the pilot reform of administration regarding conversion of foreign currency registered capitals of FIEs in 16 pilot areas. According to SAFE Circular 36, some of the restrictions under SAFE Circular 142 will not apply to the settlement of the foreign exchange capitals of an ordinary FIE in the pilot areas, and such FIE is permitted to use Renminbi converted from its foreign-currency registered capital to make equity investments in the PRC within and in accordance with the authorized business scope of such FIEs, subject to certain registration and settlement procedure as set forth in SAFE Circular 36. As this circular is relatively new, there remains uncertainty as to its interpretation and application and any other future foreign exchange related rules. On March 30, 2015, the SAFE promulgated the Circular on Reforming the Management Approach Regarding the Foreign Exchange Capital Settlement of Foreign-Invested Enterprises, or SAFE Circular 19. SAFE Circular 19 took effect as of June 1, 2015 and superseded SAFE Circular 142 on the same date. SAFE Circular 19 launched a nationwide reform of the administration of the settlement of the foreign exchange capitals of FIEs and allows FIEs to settle their foreign exchange capital at their discretion, but continues to prohibit FIEs from using the Renminbi fund converted from their foreign exchange capitals for expenditure beyond their business scopes, providing entrusted loans or repaying loans between non-financial enterprises. Violations of these Circulars could result in severe monetary or other penalties. SAFE Circular 19 may significantly limit our ability to use Renminbi converted from the net proceeds of this offering to fund the establishment of new entities in China by our VIE or its subsidiaries, to invest in or acquire any other PRC companies through our PRC subsidiary, or to establish new consolidated variable interest entities in the PRC, which may adversely affect our business, financial condition and results of operations.

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

The value of the Renminbi against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions in China and by China's foreign exchange policies. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the Renminbi to the U.S. dollar, and the Renminbi appreciated more than 20% against the U.S. dollar over the following three years. Between July 2008 and June 2010, this appreciation halted and the exchange rate between the Renminbi and the U.S. dollar remained within a narrow band. Since June 2010, the Renminbi has fluctuated against the U.S. dollar, at times significantly and unpredictably. On November 30, 2015, the Executive Board of the International Monetary Fund (IMF) completed the regular five-year review of the basket of currencies that make up the Special Drawing Right, or the SDR, and decided that with effect from October 1, 2016, Renminbi is determined to be a freely usable currency and will be included in the SDR basket as a fifth currency, along with the U.S. dollar, the Euro, the Japanese yen and the British pound. In the fourth quarter of 2016, the Renminbi has depreciated significantly in the backdrop of a surging U.S. dollar and persistent capital outflows of China. With the development of the foreign exchange market and progress towards interest rate liberalization and Renminbi internationalization, the PRC government may in the future announce further changes to the exchange rate system, and we cannot assure you that the Renminbi will not appreciate or depreciate significantly in value against the U.S. dollar in the future. It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange rate between the Renminbi and the U.S. dollar in the future.

Significant revaluation of the Renminbi may have a material and adverse effect on your investment. For example, to the extent that we need to convert U.S. dollars we receive from this offering into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount we would receive from the conversion. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or for other business purposes, appreciation of the U.S. dollar against the Renminbi would have a negative effect on the U.S. dollar amount available to us. In addition, appreciation or depreciation in the value of the Renminbi relative to U.S. dollars would affect our financial results reported in U.S. dollar terms regardless of any underlying change in our business or results of operations.

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

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

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

Certain PRC regulations may make it more difficult for us to pursue growth through acquisitions.

Among other things, the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rules, adopted by six PRC regulatory agencies in 2006 and amended in 2009, established additional procedures and requirements that could make merger and acquisition activities by foreign investors more time-consuming and complex. Such regulation requires, among other things, that the MOFCOM be notified in advance of any change-of-control transaction in which a foreign investor acquires control of a PRC domestic enterprise or a foreign company with substantial PRC operations, if certain thresholds under the Provisions on Thresholds for Prior Notification of Concentrations of Undertakings, issued by the State Council in 2008, are triggered. Moreover, the Anti-Monopoly Law promulgated by the Standing Committee of the NPC which became effective in 2008 requires that transactions which are deemed concentrations and involve parties with specified turnover thresholds must be cleared by the MOFCOM before they can be completed. In addition, PRC national security review rules which became effective in September 2011 require acquisitions by foreign investors of PRC companies engaged in military related or certain other industries that are crucial to national security be subject to security review before consummation of any such acquisition. We may pursue potential strategic acquisitions that are complementary to our business and operations. Complying with the requirements of these regulations to complete such transactions could be time-consuming, and any required approval processes, including obtaining approval or clearance from the MOFCOM, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.

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

In July 2014, 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, to replace the Notice on Relevant Issues Concerning Foreign Exchange Administration for Domestic Residents' Financing and Roundtrip Investment Through Offshore Special Purpose Vehicles, or SAFE Circular 75, which ceased to be effective upon the promulgation of SAFE Circular 37. SAFE Circular 37 requires PRC residents (including PRC individuals and PRC corporate entities) to register with SAFE or its local branches in connection with their direct or indirect offshore investment activities. SAFE Circular 37 is applicable to our shareholders who are PRC residents and may be applicable to any offshore acquisitions that we make in the future.

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Under SAFE Circular 37, PRC residents who make, or have prior to the implementation of SAFE Circular 37 made, direct or indirect investments in offshore SPVs will be required to register such investments with the SAFE or its local branches. In addition, any PRC resident who is a direct or indirect shareholder of a SPV is required to update its filed registration with the local branch of SAFE with respect to that SPV, to reflect any material change. Moreover, any subsidiary of such SPV in China is required to urge the PRC resident shareholders to update their registration with the local branch of SAFE. If any PRC shareholder of such SPV fails to make the required registration or to update the previously filed registration, the subsidiary of such SPV in China may be prohibited from distributing its profits or the proceeds from any capital reduction, share transfer or liquidation to the SPV, and the SPV may also be prohibited from making additional capital contributions into its subsidiary in China. On February 13, 2015, the SAFE promulgated a Notice on Further Simplifying and Improving Foreign Exchange Administration Policy on Direct Investment, or SAFE Notice 13, which became effective on June 1, 2015. Under SAFE Notice 13, applications for foreign exchange registration of inbound foreign direct investments and outbound overseas direct investments, including those required under SAFE Circular 37, will be filed with qualified banks instead of the SAFE. The qualified banks will directly examine the applications and accept registrations under the supervision of the SAFE.

We cannot assure you that all of our shareholders that may be subject to SAFE regulations have completed all necessary registrations with the local SAFE branch or qualified banks as required by SAFE Circular 37, and we cannot assure you that these individuals may continue to make required filings or updates on a timely manner, or at all. We can provide no assurance that we are or will in the future continue to be informed of identities of all PRC residents holding direct or indirect interest in our company. Any failure or inability by such individuals to comply with the SAFE regulations may subject us to fines or legal sanctions, such as restrictions on our cross-border investment activities or our PRC subsidiary's ability to distribute dividends to, or obtain foreign exchange-denominated loans from, our company or prevent us from making distributions or paying dividends. As a result, our business operations and our ability to make distributions to you could be materially and adversely affected.

Furthermore, as these foreign exchange regulations are still relatively new and their interpretation and implementation has been constantly evolving, it is unclear how these regulations, and any future regulation concerning offshore or cross-border transactions, will be interpreted, amended and implemented by the relevant government authorities. For example, we may be subject to a more stringent review and approval process with respect to our foreign exchange activities, such as remittance of dividends and foreign-currency-denominated borrowings, which may adversely affect our financial condition and results of operations. In addition, if we decide to acquire a PRC domestic company, we cannot assure you that we or the owners of such company, as the case may be, will be able to obtain the necessary approvals or complete the necessary filings and registrations required by the foreign exchange regulations. This may restrict our ability to implement our acquisition strategy and could adversely affect our business and prospects.

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

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

On February 3, 2015, the SAT issued a Public Notice Regarding Certain Corporate Income Tax Matters on Indirect Transfer of Properties by Non-Tax Resident Enterprises, or SAT Public Notice 7. SAT Public Notice 7 supersedes the rules with respect to the Indirect Transfer under SAT Circular 698, but does not touch upon the other provisions of SAT Circular 698, which remain in force. SAT Public Notice 7 has introduced a new tax regime that is significantly different from the previous one under SAT Circular 698. SAT Public Notice 7 extends its tax jurisdiction to not only Indirect Transfers set forth under SAT Circular 698 but also transactions involving transfer of other taxable assets through offshore transfer of a foreign intermediate holding company. In addition, SAT Public Notice 7 provides clearer criteria than SAT Circular 698 for assessment of reasonable commercial purposes and has introduced safe harbors for internal group restructurings and the purchase and sale of equity through a public securities market. SAT Public Notice 7 also brings challenges to both foreign transferor and transferee (or other person who is obligated to pay for the transfer) of taxable assets. Where a non-resident enterprise transfers taxable assets indirectly by disposing of the equity interests of an overseas holding company, which is an Indirect Transfer, the non-resident enterprise as either transferor or transferee, or the PRC entity that directly owns the taxable assets, may report such Indirect Transfer to the relevant tax authority. Using a "substance over form" principle, the PRC tax authority may disregard the existence of the overseas holding company if it lacks a reasonable commercial purpose and was established for the purpose of reducing, avoiding or deferring PRC tax. As a result, gains derived from such Indirect Transfer may be subject to PRC enterprise income tax, and the transferee or other person who is obligated to pay for the transfer is obligated to withhold the applicable taxes, currently at a rate of 10% for the transfer of equity interests in a PRC resident enterprise. Both the transferor and the transferee may be subject to penalties under PRC tax laws if the transferee fails to withhold the taxes and the transferor fails to pay the taxes.

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We face uncertainties as to the reporting and other implications of certain past and future transactions where PRC taxable assets are involved, such as offshore restructuring, sale of the shares in our offshore subsidiaries and investments. Our company may be subject to filing obligations or taxed if our company is transferor in such transactions, and may be subject to withholding obligations if our company is transferee in such transactions, under SAT Circular 698 and SAT Public Notice 7. For transfer of shares in our company by investors who are non-PRC resident enterprises, our PRC subsidiary may be requested to assist in the filing under SAT Circular 698 and SAT Public Notice 7. As a result, we may be required to expend valuable resources to comply with SAT Circular 698 and SAT Public Notice 7 or to request the relevant transferors from whom we purchase taxable assets to comply with these circulars, or to establish that our company should not be taxed under these circulars, which may have a material adverse effect on our financial condition and results of operations.

Our use of third-party manufacturers to produce our products presents risks to our business.

For the foreseeable future, all of our products will be manufactured by third-party manufacturers, the majority of which are, and we expect will continue to be, located in China. For the nine month period ended September 30, 2018, our two largest suppliers, Fujian Wei Ya Culture Communication Co., Ltd. and Dongguan Hou Jie Sheng Ping Toy Factory, accounted for 47.0% and 46.5%, respectively, of our total production. If we were prevented or delayed in obtaining products or components for a material portion of our product line due to political, civil, labor or other factors beyond our control, including natural disasters or pandemics, our operations may be substantially disrupted, potentially for a significant period of time. This delay could significantly reduce our revenues and profitability and harm our business while alternative sources of supply are secured. Additionally, the suspension of the operations of a third-party manufacturer by government inspectors in China could result in delays to us in obtaining products and may harm sales.

Additional factors outside of our control related to doing business in China could negatively affect our business.

Additional factors that could negatively affect our business include a potential significant revaluation of the Renminbi, which may result in an increase in the cost of producing products in China, labor shortages and increases in labor costs in China as well as difficulties in moving products manufactured in China out of the country, whether due to port congestion, labor disputes, slow downs, product regulations and/or inspections or other factors. Prolonged disputes or slowdowns can negatively impact both the time and cost of transporting goods. Natural disasters or health pandemics impacting China can also have a significant negative impact on our business. Further, the imposition of trade sanctions or other regulations against products imported by us from, or the loss of “normal trade relations” status with, China, could significantly increase our cost of products exported outside of China and harm our business.

Risks Related to our Ordinary Shares and this Offering

There has been no prior public market for our ordinary shares and an active trading market may never develop or be sustained.

Prior to this offering, there has been no public market for our ordinary shares. An active trading market for our ordinary shares may never develop following completion of this offering or, if developed, may not be sustained. The lack of an active trading market may impair the value of your shares and your ability to sell your shares at the time you wish to sell them. An inactive trading market may also impair our ability to raise capital by selling shares of our ordinary shares and enter into strategic partnerships or acquire other complementary products, technologies or businesses by using shares of our ordinary shares as consideration. In addition, if we fail to satisfy exchange listing standards, we could be de-listed, which would have a negative effect on the price of our ordinary shares.

We expect that the price of our ordinary shares will fluctuate substantially and you may not be able to sell the shares you purchase in this offering at or above the offering price.

The initial public offering price for the shares of our ordinary shares sold in this offering is determined by negotiation between the representative of the underwriters and us. This price may not reflect the market price of our ordinary shares following this offering. In addition, the market price of our ordinary shares is likely to be highly volatile and may fluctuate substantially due to many factors, including:

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the volume and timing of sales of our products;
the introduction of new products or product enhancements by us or others in our industry;
disputes or other developments with respect to our or others' intellectual property rights;

our ability to develop, obtain regulatory clearance or approval for, and market new and enhanced products on a timely basis;
product liability claims or other litigation;

quarterly variations in our results of operations or those of others in our industry;
media exposure of our products or of those of others in our industry;

changes in governmental regulations or in reimbursement;

changes in earnings estimates or recommendations by securities analysts; and
general market conditions and other factors, including factors unrelated to our operating performance or the operating performance of our competitors.

 

In recent years, the stock markets generally have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Broad market and industry factors may significantly affect the market price of our ordinary shares, regardless of our actual operating performance. These fluctuations may be even more pronounced in the trading market for our ordinary shares shortly following this offering. If the market price of shares of our ordinary shares after this offering does not ever exceed the initial public offering price, you may not realize any return on your investment in us and may lose some or all of your investment.

In addition, in the past, class action litigation has often been instituted against companies whose securities have experienced periods of volatility in market price. Securities litigation brought against us following volatility in our stock price, regardless of the merit or ultimate results of such litigation, could result in substantial costs, which would hurt our financial condition and operating results and divert management's attention and resources from our business.

Our shares will initially trade under $5.00 per ordinary share and thus will be a penny stock. Trading in penny stocks has certain restrictions and these restrictions could negatively affect the price and liquidity of our ordinary shares.

Our stock is expected to trade below $5.00 per share upon listing. As a result, our stock would be known as a “penny stock”, which is subject to various regulations involving disclosures to be given to you prior to the purchase of any penny stock. The SEC has adopted regulations which generally define a “penny stock” to be any equity security that has a market price of less than $5.00 per share, subject to certain exceptions. Depending on market fluctuations, our ordinary shares could be considered to be a “penny stock”. A penny stock is subject to rules that impose additional sales practice requirements on broker/dealers who sell these securities to persons other than established Members and accredited investors. For transactions covered by these rules, the broker/dealer must make a special suitability determination for the purchase of these securities. In addition, a broker/dealer must receive the purchaser’s written consent to the transaction prior to the purchase and must also provide certain written disclosures to the purchaser. Consequently, the “penny stock” rules may restrict the ability of broker/dealers to sell our ordinary shares, and may negatively affect the ability of holders of shares of our ordinary shares to resell them. These disclosures require you to acknowledge that you understand the risks associated with buying penny stocks and that you can absorb the loss of your entire investment. Penny stocks generally do not have a very high trading volume. Consequently, the price of the stock is often volatile and you may not be able to buy or sell the stock when you want to.

If you purchase our ordinary shares in this offering, you will incur immediate and substantial dilution in the book value of your shares.

Investors purchasing our ordinary shares in this offering will pay a price per share that substantially exceeds the pro forma as adjusted net tangible book value per share. As a result, investors purchasing ordinary shares in this offering will incur immediate dilution of $3.02 per share, representing the difference between our assumed initial public offering price of $4.00 per share and our pro forma as adjusted net tangible book value per share as of September 30, 2018. For more information on the dilution you may experience as a result of investing in this offering, see the section of this prospectus entitled "Dilution."

A significant portion of our total outstanding shares are restricted from immediate resale but may be sold into the market in the near future. This could cause the market price of our ordinary shares to drop significantly, even if our business is doing well.

Sales of a substantial number of our ordinary shares in the public market could occur at any time. These sales, or the perception in the market that these sales may occur, could result in a decrease in the market price of our ordinary shares. Immediately after this offering, we will have outstanding 37,500,000 ordinary shares, based on the number of ordinary shares outstanding as of September 30, 2018, assuming no exercise of the underwriters' over-allotment option. This includes the shares that we are selling in this offering, which may be resold in the public market immediately without restriction, unless purchased by our affiliates or existing stockholders. Of that amount, 33,000,000 shares are currently restricted as a result of securities laws and/or lock-up agreements, but will be able to be sold after the closing of this offering, subject to securities laws and/or lock-up agreements. If held by one of our affiliates, the resale of those securities will be subject to volume limitations under Rule 144 of the Securities Act. See "Shares Eligible for Future Sale."

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Our directors, officers and principal stockholders have significant voting power and may take actions that may not be in the best interests of our other stockholders.

After this offering, our officers, directors and principal stockholders each holding more than 5% of our ordinary shares, collectively, will control approximately 63% of our outstanding ordinary shares. As a result, these stockholders, if they act together, will be able to control the management and affairs of our Company and most matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. The interests of these stockholders may not be the same as or may even conflict with your interests. For example, these stockholders could attempt to delay or prevent a change in control of the Company, even if such change in control would benefit our other stockholders, which could deprive our stockholders of an opportunity to receive a premium for their ordinary shares as part of a sale of the Company or our assets, and might affect the prevailing market price of our ordinary shares due to investors' perceptions that conflicts of interest may exist or arise. As a result, this concentration of ownership may not be in the best interests of our other stockholders.

We will have broad discretion in the use of proceeds of this offering designated for working capital and general corporate purposes.

We intend to use the net proceeds from this offering for research and development, including expanding our research and development team and continuing to invest in and develop our products, for selling and marketing, particularly strengthening our sales channels and establishing physical experience stores, and for working capital and general corporate purposes, including increasing our liquidity. Within those categories, we have not determined the specific allocation of the net proceeds of this offering. Our management will have broad discretion over the use and investment of the net proceeds of this offering within those categories. Accordingly, investors in this offering have only limited information concerning management's specific intentions and will need to rely upon the judgment of our management with respect to the use of proceeds.

We expect to incur significant additional costs as a result of being a public company, which may adversely affect our business, financial condition and results of operations.

Upon completion of this offering, we expect to incur costs associated with corporate governance requirements that will become applicable to us as a public company, including rules and regulations of the SEC, under the Sarbanes-Oxley Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, and the Exchange Act, as well as the rules of the Nasdaq. These rules and regulations are expected to significantly increase our accounting, legal and financial compliance costs and make some activities more time-consuming. We also expect these rules and regulations to make it more expensive for us to obtain and maintain directors' and officers' liability insurance. As a result, it may be more difficult for us to attract and retain qualified persons to serve on our board of directors or as executive officers. Accordingly, increases in costs incurred as a result of becoming a publicly traded company may adversely affect our business, financial condition and results of operations.

Our disclosure controls and procedures may not prevent or detect all errors or acts of fraud.

Upon the closing of this offering, we will become subject to the periodic reporting requirements of the Exchange Act. We designed our disclosure controls and procedures to provide reasonable assurance that information we must disclose in reports we file or submit under the Exchange Act is accumulated and communicated to management, and recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. We believe that any disclosure controls and procedures, no matter how well-conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.

These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by an unauthorized override of the controls. Accordingly, because of the inherent limitations in our control system, misstatements due to error or fraud may occur and not be detected.

If we fail to implement and maintain an effective system of internal control, we may be unable to accurately report our operating results, meet our reporting obligations or prevent fraud.

Prior to this offering, we were a private company with limited accounting personnel and other resources with which to address our internal controls and procedures. Our management has not completed an assessment of the effectiveness of our internal control over financial reporting, and our independent registered public accounting firm has not conducted an audit of our internal control over financial reporting.

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Upon completion of this offering, we will become a public company in the United States subject to the Sarbanes-Oxley Act of 2002. Section 404 of the Sarbanes-Oxley Act of 2002 will require that we include a report of management on our internal control over financial reporting in our annual report on Form 20-F beginning with our annual report for the fiscal year ending December 31, 2019. In addition, once we cease to be an “emerging growth company” as such term is defined under the JOBS Act, our independent registered public accounting firm must attest to and report on the effectiveness of our internal control over financial reporting. Our management may conclude that our internal control over financial reporting is not effective. Moreover, even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm, after conducting its own independent testing, may issue a report that is qualified if it is not satisfied with our internal controls or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us. In addition, after we become a public company, our reporting obligations may place a significant strain on our management, operational and financial resources and systems for the foreseeable future. We may be unable to timely complete our evaluation testing and any required remediation.

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

Because we do not anticipate paying any cash dividends on our capital stock in the foreseeable future, capital appreciation, if any, will be your sole source of gain.

Blue Hat Cayman has never declared or paid cash dividends. We currently intend to retain all of our future earnings, if any, to finance the growth and development of our business. As a result, capital appreciation, if any, of our ordinary shares will be your sole source of gain for the foreseeable future.

Securities analysts may not publish favorable research or reports about our business or may publish no information at all, which could cause our stock price or trading volume to decline.

If a trading market for our ordinary shares develops, the trading market will be influenced to some extent by the research and reports that industry or financial analysts publish about us and our business. We do not control these analysts. As a newly public company, we may be slow to attract research coverage and the analysts who publish information about our ordinary shares will have had relatively little experience with us or our industry, which could affect their ability to accurately forecast our results and could make it more likely that we fail to meet their estimates. In the event we obtain securities or industry analyst coverage, if any of the analysts who cover us provide inaccurate or unfavorable research or issue an adverse opinion regarding our stock price, our stock price could decline. If one or more of these analysts cease coverage of us or fail to publish reports covering us regularly, we could lose visibility in the market, which in turn could cause our stock price or trading volume to decline and result in the loss of all or a part of your investment in us.

The approval of the China Securities Regulatory Commission, or the CSRC, may be required in connection with this offering under PRC law.

The M&A Rules purport to require offshore SPVs that are controlled by PRC companies or individuals and that have been formed for the purpose of seeking a public listing on an overseas stock exchange through acquisitions of PRC domestic companies or assets to obtain CSRC approval prior to publicly listing their securities on an overseas stock exchange. In September 2006, the CSRC published a notice on its official website specifying documents and materials required to be submitted to it by a SPV seeking CSRC approval of its overseas listings. The interpretation and application of the regulations remain unclear, and this offering may ultimately require approval from the CSRC. If CSRC approval is required, it is uncertain whether it would be possible for us to obtain the approval, and any failure to obtain or delay in obtaining CSRC approval for this offering would subject us to sanctions imposed by the CSRC and other PRC regulatory agencies.

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Our PRC legal counsel has advised us that, based on its understanding of the current PRC laws and regulations, we will not be required to submit an application to the CSRC for the approval of the listing and trading of our ordinary shares on Nasdaq because (i) we established our WFOE by means of direct investment and not through a merger or acquisition of the equity or assets of a "PRC domestic company" as such term is defined under the M&A Rules; and (ii) no provision in the M&A Rules classifies the contractual arrangements under the Contractual Arrangements as a type of acquisition transaction falling under the M&A Rules.

However, our PRC legal counsel has further advised us that there remains some uncertainty as to how the M&A Rules will be interpreted or implemented in the context of an overseas offering, and its opinions summarized above are subject to any new laws, rules and regulations or detailed implementations and interpretations in any form relating to the M&A Rules. We cannot assure you that relevant PRC government agencies, including the CSRC, would reach the same conclusion as our PRC legal counsel, and hence we may face regulatory actions or other sanctions from the CSRC or other PRC regulatory agencies. These regulatory agencies may impose fines and penalties on our operations in China, limit our ability to pay dividends outside of China, limit our operating privileges in China, delay or restrict the repatriation of the proceeds from this offering into China or take other actions that could have a material adverse effect on our business, financial condition, results of operations and prospects, as well as the trading price of the ordinary shares. The CSRC or other PRC regulatory agencies also may take actions requiring us, or making it advisable for us, to halt this offering before settlement and delivery of the ordinary shares offered hereby. Consequently, if you engage in market trading or other activities in anticipation of and prior to settlement and delivery, you do so at the risk that settlement and delivery may not occur. In addition, if the CSRC or other regulatory agencies later promulgate new rules or explanations requiring that we obtain their approvals for this offering, we may be unable to obtain a waiver of such approval requirements, if and when procedures are established to obtain such a waiver. Any uncertainties and/or negative publicity regarding such approval requirement could have a material adverse effect on the trading price of the ordinary shares.

You may face difficulties in protecting your interests, and your ability to protect your rights through U.S. courts may be limited, because we are incorporated under Cayman Islands law.

We are an exempted company incorporated under the laws of the Cayman Islands. Our corporate affairs are governed by our memorandum and articles of association, the Companies Law (2018 Revision) of the Cayman Islands and the common law of the Cayman Islands. The rights of shareholders to take action against our directors, actions by our minority shareholders and the fiduciary duties of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from the common law of England, the decisions of whose courts are of persuasive authority, but are not binding, on a court in the Cayman Islands. The rights of our shareholders and the fiduciary duties of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedent in some jurisdictions in the United States. In particular, the Cayman Islands have a less developed body of securities laws than the United States. Some U.S. states, such as Delaware, have more fully developed and judicially interpreted bodies of corporate law than the Cayman Islands. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action in a federal court of the United States.

Shareholders of Cayman Islands exempted companies like us have no general rights under Cayman Islands law to inspect corporate records or to obtain copies of lists of shareholders of these companies. Our amended and restated memorandum and articles of association, or our post-offering memorandum and articles of association, will become effective and replace our current memorandum and articles of association in its entirety immediately prior to the completion of this offering. Our directors will have discretion under our post-offering memorandum and articles of association to determine whether or not, and under what conditions, our corporate records may be inspected by our shareholders, but are not obliged to make them available to our shareholders. This may make it more difficult for you to obtain the information needed to establish any facts necessary for a shareholder motion or to solicit proxies from other shareholders in connection with a proxy contest.

Certain corporate governance practices in the Cayman Islands, which is our home country, differ significantly from requirements for companies incorporated in other jurisdictions such as the United States. Currently, we do not plan to rely on home country practice with respect to any corporate governance matter. To the extent we choose to follow home country practice with respect to corporate governance matters, our shareholders may be afforded less protection than they otherwise would under rules and regulations applicable to U.S. domestic issuers.

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

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

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

We are an emerging growth company within the meaning of the Securities Act and may take advantage of certain reduced reporting requirements.

We are an "emerging growth company," as defined in the JOBS Act, and we may take advantage of certain exemptions from requirements applicable to other public companies that are not emerging growth companies, including, most significantly, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002 for so long as we remain an emerging growth company. As a result, if we elect not to comply with such auditor attestation requirements, our investors may not have access to certain information they may deem important.

The JOBS Act also provides that an emerging growth company does not need to comply with any new or revised financial accounting standards until such date that a private company is otherwise required to comply with such new or revised accounting standards. We do not plan to "opt out" of such exemptions afforded to an emerging growth company. As a result of this election, our financial statements may not be comparable to companies that comply with public company effective data.”

We qualify as a foreign private issuer and, as a result, we will not be subject to U.S. proxy rules and will be subject to Exchange Act reporting obligations that permit less detailed and less frequent reporting than that of a U.S. domestic public company.

Upon the closing of this offering, we will report under the Exchange Act as a non-U.S. company with foreign private issuer status. Because we qualify as a foreign private issuer under the Exchange Act, we are exempt from certain provisions of the Exchange Act that are applicable to U.S. domestic public companies, including (i) the sections of the Exchange Act regulating the solicitation of proxies, consents or authorizations in respect of a security registered under the Exchange Act; (ii) the sections of the Exchange Act requiring insiders to file public reports of their stock ownership and trading activities and liability for insiders who profit from trades made in a short period of time; and (iii) the rules under the Exchange Act requiring the filing with the SEC of quarterly reports on Form 10-Q containing unaudited financial and other specified information, or current reports on Form 8-K upon the occurrence of specified significant events. In addition, our officers, directors and principal shareholders are exempt from the reporting and “short-swing” profit recovery provisions of Section 16 of the Exchange Act and the rules thereunder. Therefore, our shareholders may not know on a timely basis when our officers, directors and principal shareholders purchase or sell our ordinary shares. In addition, foreign private issuers are not required to file their annual report on Form 20-F until 120 days after the end of each fiscal year, while U.S. domestic issuers that are accelerated filers are required to file their annual report on Form 10-K within 75 days after the end of each fiscal year. Foreign private issuers also are exempt from Regulation Fair Disclosure, aimed at preventing issuers from making selective disclosures of material information. As a result of the above, you may not have the same protections afforded to shareholders of companies that are not foreign private issuers.

If we lose our status as a foreign private issuer, we would be required to comply with the Exchange Act reporting and other requirements applicable to U.S. domestic issuers, which are more detailed and extensive than the requirements for foreign private issuers. We may also be required to make changes in our corporate governance practices in accordance with various SEC and Nasdaq rules. The regulatory and compliance costs to us under U.S. securities laws if we are required to comply with the reporting requirements applicable to a U.S. domestic issuer may be significantly higher than the cost we would incur as a foreign private issuer. As a result, we expect that a loss of foreign private issuer status would increase our legal and financial compliance costs and would make some activities highly time consuming and costly. We also expect that if we were required to comply with the rules and regulations applicable to U.S. domestic issuers, it would make it more difficult and expensive for us to obtain and maintain directors’ and officers’ liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These rules and regulations could also make it more difficult for us to attract and retain qualified members of our board of directors.

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As a foreign private issuer, we are permitted to adopt certain home country practices in relation to corporate governance matters that differ significantly from Nasdaq corporate governance listing standards. These practices may afford less protection to shareholders than they would enjoy if we complied fully with corporate governance listing standards.

As a foreign private issuer, we are permitted to take advantage of certain provisions in the Nasdaq rules that allow us to follow our home country law for certain governance matters. Certain corporate governance practices in our home country, the Cayman Islands, may differ significantly from corporate governance listing standards. Currently, we do not plan to rely on home country practice with respect to our corporate governance after we complete this offering. However, if we choose to follow home country practice in the future, our shareholders may be afforded less protection than they would otherwise enjoy under the Nasdaq corporate governance listing standards applicable to U.S. domestic issuers.

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

A non-U.S. corporation will be a PFIC for any taxable year if either (1) at least 75% of its gross income for such year consists of certain types of "passive" income; or (2) at least 50% of the value of its assets (based on an average of the quarterly values of the assets) during such year is attributable to assets that produce passive income or are held for the production of passive income (the "asset test"). Based on our current and expected income and assets (taking into account the expected cash proceeds and our anticipated market capitalization following this offering), we do not presently expect to be a PFIC for the current taxable year or the foreseeable future. However, no assurance can be given in this regard because the determination of whether we are or will become a PFIC is a fact-intensive inquiry made on an annual basis that depends, in part, upon the composition of our income and assets. In addition, there can be no assurance that the Internal Revenue Service, or IRS, will agree with our conclusion or that the IRS would not successfully challenge our position. Fluctuations in the market price of our ordinary shares may cause us to become a PFIC for the current or subsequent taxable years because the value of our assets for the purpose of the asset test may be determined by reference to the market price of our ordinary shares. The composition of our income and assets may also be affected by how, and how quickly, we use our liquid assets and the cash raised in this offering. If we were to be or become a PFIC for any taxable year during which a U.S. Holder holds our ordinary shares, certain adverse U.S. federal income tax consequences could apply to such U.S. Holder. See “Taxation— Passive Foreign Investment Company Consequences.”

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

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

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that involve substantial risks and uncertainties. In some cases, you can identify forward-looking statements by the words “may,” “might,” “will,” “could,” “would,” “should,” “expect,” “intend,” “plan,” “objective,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue” and “ongoing,” or the negative of these terms, or other comparable terminology intended to identify statements about the future. These statements involve known and unknown risks, uncertainties and other important factors that may cause our actual results, levels of activity, performance or achievements to be materially different from the information expressed or implied by these forward-looking statements. The forward-looking statements and opinions contained in this prospectus are based upon information available to us as of the date of this prospectus and, while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. Forward-looking statements include statements about:

 

our ability to develop and market new products;
the continued market acceptance of our products;
exposure to product liability and defect claims;
protection of our intellectual property rights;
changes in the laws that affect our operations;
inflation and fluctuations in foreign currency exchange rates;
our ability to obtain all necessary government certifications, approvals, and/or licenses to conduct our business;
continued development of a public trading market for our securities;
the cost of complying with current and future governmental regulations and the impact of any changes in the regulations on our operations; and
managing our growth effectively;
fluctuations in operating results;
dependence on our senior management and key employees; and
other factors set forth under “Risk Factors.”

You should refer to the section titled “Risk Factors” for a discussion of important factors that may cause our actual results to differ materially from those expressed or implied by our forward-looking statements. As a result of these factors, we cannot assure you that the forward-looking statements in this prospectus will prove to be accurate. Furthermore, if our forward-looking statements prove to be inaccurate, the inaccuracy may be material. In light of the significant uncertainties in these forward-looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame, or at all. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

You should read this prospectus and the documents that we reference in this prospectus and have filed as exhibits to the registration statement, of which this prospectus forms a part, completely and with the understanding that our actual future results may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements.

 

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INDUSTRY AND MARKET DATA

This prospectus includes statistical and other industry and market data that we obtained from industry publications and research, surveys and studies conducted by third parties, as well estimates by our management based on such data. The market data and estimates used in this prospectus involve a number of assumptions and limitations, and you are cautioned not to give undue weight to such data and estimates. While we believe that the information from these industry publications, surveys and studies is reliable, the industry in which we operate is subject to a high degree of uncertainty and risk due to a variety of important factors, including those described in the section titled “Risk Factors.” These and other factors could cause results to differ materially from those expressed in the estimates made by the independent parties and by us.

 

 

 

 

 

 

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USE OF PROCEEDS

We estimate that the net proceeds from the sale of 4,500,000 ordinary shares in this offering will be approximately $15,941,979, after deducting the underwriting discounts and commissions, non-accountable expense allowance and estimated offering expenses payable by us, based on the assumed initial public offering price of $4.00 per ordinary share. If the underwriters exercise their over-allotment option in full, we estimate that the net proceeds to us from this offering will be approximately $18,452,979, after deducting the underwriting discounts and commissions, non-accountable expense allowance and estimated offering expenses payable by us.

Each $1.00 increase (decrease) in the assumed initial public offering price of $4.00 per share would increase (decrease) the net proceeds to us from this offering by $4.1 million, assuming that the number of ordinary shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting the underwriting discounts and commissions, non-accountable expense allowance and estimated offering expenses payable by us. An increase (decrease) of 1.0 million in the number of ordinary shares we are offering would increase (decrease) the net proceeds to us from this offering by $3.7 million, assuming the assumed initial public offering price remains the same, and after deducting the underwriting discounts and commissions, non-accountable expense allowance and estimated offering expenses payable by us.

The primary purposes of this offering are to create a public market for our shares for the benefit of all shareholders, retain talented employees, and obtain additional capital. We plan to use the net proceeds of this offering as follows:

approximately 40% for research and development, including expanding our research and development team and continuing to invest in and develop our products;
approximately 40% for selling and marketing, particularly strengthening our sales channels and establishing physical experience stores; and
the remainder for working capital and general corporate purposes, including increasing our liquidity.

This expected use of the net proceeds from this offering represents our intentions based upon our current plans and prevailing business conditions, which could change in the future as our plans and prevailing business conditions evolve. Predicting the cost necessary to develop product candidates can be difficult and the amounts and timing of our actual expenditures may vary significantly depending on numerous factors, including the progress of our development, the status of and results from clinical trials, any collaborations that we may enter into with third parties for our product candidates and any unforeseen cash needs. As a result, our management will retain broad discretion over the allocation of the net proceeds from this offering.

Pending any use described above, we plan to invest the net proceeds in short-term, interest-bearing, debt instruments.

 

We have agreed with the underwriters in this offering to establish an escrow account in the United States and to fund such account with $600,000 from this offering that may be utilized by the underwriters to fund any bona fide indemnification claims of the underwriters arising during a 24 month period following the offering. The escrow account will be interest bearing, and we will be free to invest the assets in securities. All funds that are not subject to an indemnification claim will be returned to us after the applicable period expires.

The net proceeds from this offering must be remitted to China before we will be able to use the funds to grow our business. The procedure to remit funds may take several months after completion of this offering, and we will be unable to use the offering proceeds in China until remittance is completed. See “Risk Factors” for further information.

 

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DIVIDEND POLICY

Blue Hat Cayman has never declared or paid a dividend, and we do not anticipate declaring or paying dividends in the foreseeable future. We intend to retain all available funds and any future earnings to fund the development and expansion of our business.

We are a holding company incorporated in the Cayman Islands. We may rely on dividends from our subsidiaries in China for our cash requirements, including any payment of dividends to our shareholders. PRC, Hong Kong and British Virgin Islands regulations may restrict the ability of our PRC, Hong Kong and British Virgin Islands subsidiaries to pay dividends to us.

 

 

 

 

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CAPITALIZATION

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

an actual basis; and

 

a pro forma as adjusted basis to give effect to the sale of 4,500,000 ordinary shares in this offering at the assumed initial public offering price of $4.00 per ordinary share after deducting the underwriting discounts and commissions, non-accountable expense allowance and estimated offering expenses payable by us.

 

You should read this information together with our audited consolidated financial statements appearing elsewhere in this prospectus and the information set forth under the sections titled “Selected Consolidated Financial Data,” “Exchange Rate Information,” “Use of Proceeds” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

  As of September 30, 2018 (unaudited)
  Actual       Pro Forma As
    Adjusted (1) 
Shareholders’ Equity US$       US$

Ordinary shares, $0.001 par value: 50,000,000 shares authorized; 33,000,000 shares issued and outstanding;

37,500,000 shares issued and outstanding pro forma

33,000        37,500
Additional paid-in capital 12,831,969        28,769,448
Statutory reserves 1,244,087        1,244,087
Retained earnings 10,443,940        10,443,940
Accumulated other comprehensive loss (791,088 )      (791,088)
           
Total shareholders’ equity 23,761,908        39,703,887
Total capitalization 23,761,908       39,703,887

  

(1) Reflects the sale of ordinary shares in this offering at an assumed initial public offering price of $4.00 per share, and after deducting the estimated underwriting discounts and commissions, non-accountable expense allowance and estimated offering expenses payable by us. The pro forma as adjusted information is illustrative only, and we will adjust this information based on the actual initial public offering price and other terms of this offering determined at pricing. Additional paid-in capital reflects the net proceeds we expect to receive, after deducting the underwriting discounts and commissions, non-accountable expense allowance and estimated offering expenses payable by us. We estimate that such net proceeds will be approximately $15,941,979.

Each $1.00 increase (decrease) in the assumed initial public offering price of $4.00 per ordinary share would increase (decrease) the pro forma as adjusted amount of total capitalization by $4.1 million, assuming that the number of ordinary shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting underwriting discounts and commissions, non-accountable expense allowance and estimated offering expenses payable by us. An increase (decrease) of 1.0 million in the number of ordinary shares offered by us, as set forth on the cover page of this prospectus, would increase (decrease) the pro forma as adjusted amount of total capitalization by $3.7 million, assuming no change in the assumed initial public offering price per ordinary share as set forth on the cover page of this prospectus.

 

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DILUTION 

If you invest in our ordinary shares in this offering, your interest will be immediately diluted to the extent of the difference between the initial public offering price per ordinary share in this offering and the net tangible book value per ordinary share after this offering. Dilution results from the fact that the initial public offering price per ordinary share is substantially in excess of the net tangible book value per ordinary share. As of September 30, 2018, we had a historical net tangible book value of $19.4 million, or $0.59 per ordinary share. Our net tangible book value per share represents total tangible assets less total liabilities, all divided by the number of ordinary shares outstanding on September 30, 2018.

After giving effect to the sale of 4,500,000 ordinary shares in this offering at the assumed initial public offering price of $4.00 per ordinary share and after deducting the underwriting discounts and commissions, non-accountable expense allowance and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value at September 30, 2018 would have been $35.3 million, or $0.94 per ordinary share. This represents an immediate increase in pro forma as adjusted net tangible book value of $0.35 per ordinary share to existing investors and immediate dilution of $3.06 per ordinary share to new investors. The following table illustrates this dilution to new investors purchasing ordinary shares in this offering:

  Post- Offering (1)  

Full

Exercise

of Over-

allotment

Option

Assumed initial public offering price per ordinary share $4.00   $4.00
Net tangible book value per ordinary share as of September 30, 2018 $0.59   $0.59
Increase in pro forma as adjusted net tangible book value per ordinary share attributable to new investors purchasing ordinary shares in this offering $0.35   $0.40
Pro forma as adjusted net tangible book value per ordinary share after this offering $0.94   $0.99
Dilution per ordinary share to new investors in this offering $3.06   $3.01

Each $1.00 increase (decrease) in the assumed initial public offering price of $4.00 per ordinary share would increase (decrease) our pro forma as adjusted net tangible book value as of September 30, 2018 after this offering by approximately $0.11 per ordinary share, and would increase (decrease) dilution to new investors by $0.89 per ordinary share, assuming that the number of ordinary shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting the underwriting discounts and commissions, non-accountable expense allowance and estimated offering expenses payable by us. An increase (decrease) of 1.0 million ordinary shares in the number of ordinary shares we are offering would increase (decrease) our pro forma as adjusted net tangible book value as of September 30, 2018 after this offering by approximately $0.08 per ordinary share, and would increase (decrease) dilution to new investors by approximately $0.08 per ordinary share, assuming the assumed initial public offering price per ordinary share, as set forth on the cover page of this prospectus remains the same, and after deducting the estimate underwriting discounts and commissions, non-accountable expense allowance and estimated offering expenses payable by us. The pro forma as adjusted information is illustrative only, and we will adjust this information based on the actual initial public offering price and other terms of this offering determined at pricing.

If the underwriters exercise their over-allotment option in full, the pro forma as adjusted net tangible book value per ordinary share after the offering would be $0.99, the increase in net tangible book value per ordinary share to existing shareholders would be $0.40, and the immediate dilution in net tangible book value per ordinary share to new investors in this offering would be $3.01. 

The table and discussion above is based on 33,000,000 ordinary shares outstanding as of September 30, 2018.

To the extent that we issue additional ordinary shares in the future, there will be further dilution to new investors participating in this offering.

 

(1) Assumes that the underwriters’ over-allotment option has not been exercised.

 

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EXCHANGE RATE INFORMATION

 

Our business is primarily conducted in China, and the financial records of our subsidiaries in China are maintained in RMB, their functional currency. However, we use the U.S. dollar as our reporting and functional currency; therefore, periodic reports made to shareholders will include current period amounts translated into U.S. dollars using the then-current exchange rates, for the convenience of the readers. Our consolidated financial statements have been translated into U.S. dollars in accordance with ASC Topic 830, “Foreign Currency Matters.” The financial information is first prepared in RMB and then is translated into U.S. dollars at period-end exchange rates as to assets and liabilities and average exchange rates as to revenue and expenses. Capital accounts are translated at their historical exchange rates when the capital transactions occurred. The effects of foreign currency translation adjustments are included as a component of accumulated other comprehensive income in shareholders’ equity.

 

We make no representation that any RMB or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or RMB, as the case may be, at any particular rate, or at all. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the conversion of RMB into foreign exchange and through restrictions on foreign trade. We do not currently engage in currency hedging transactions.

 

The following table sets forth, for the periods indicated, information concerning exchange rates between the RMB and the U.S. dollar based on the exchange rates set forth in the H.10 statistical release of the Board of Governors of the Federal Reserve System. These rates are provided solely for your reference and convenience and are not necessarily the exchange rates that we used in this prospectus or will use in the preparation of our periodic reports or any other information to be provided to you. Unless otherwise stated, all translations of RMB into U.S. dollars in this prospectus were made at the rate of RMB 6.8680 to US$1.00, the noon buying rate on September 30, 2018, as set forth in the H.10 statistical release of the Board of Governors of the Federal Reserve System. On March 8, 2019, the noon buying rate set forth in the H.10 statistical release of the Board of Governors of the Federal Reserve System was RMB 6.7201 to US$1.00.

 

    Certified Exchange Rate      
Period   Period End     Average(1)     Low     High      
    (RMB per US$1.00)      
2013     6.2301           6.2990             6.2221         6.3879    
2014     6.2046           6.1704             6.0402         6.2591    
2015       6.4778           6.2869             6.1870         6.4896    
2016       6.9430            6.6549              6.4480         6.9430    
2017     6.5063           6.7350             6.4773         6.9575    
2018                                              
January         6.2841           6.4233             6.2841         6.5263      
February         6.3280           6.3183             6.2649         6.3471      
March     6.2726           6.3174             6.2685         6.3565      
April     6.3325           6.2967             6.2655         6.3340      
May     6.4096           6.3701             6.3325         6.4175      
June     6.6171           6.4651             6.3850         6.6235      
July     6.8038           6.7164             6.6123         6.8102      
August         6.8300           6.8453             6.8018         6.9330      
September     6.8680           6.8551             6.8270         6.8880      
October         6.9737           6.9191             6.8680         6.9737      
November         6.9558           6.9367             6.8894         6.9558      
December         6.8755           6.8837             6.8343         6.9077      
2019                                                    
January         6.6958           6.7863             6.6958         6.8708      
February         6.6912           6.7367             6.6822         6.7907      
March (through March 8, 2019)         6.7201           6.7098             6.7045         6.7201      

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

 

Source: Federal Reserve Statistical Release

 

 43 

 

 

CORPORATE HISTORY AND STRUCTURE

Corporate History

 

We are a holding company incorporated on June 13, 2018, under the laws of the Cayman Islands (“Blue Hat Cayman”). We have no substantive operations other than holding all of the issued and outstanding shares of Brilliant Hat Limited (“Blue Hat BVI”) established under the laws of the British Virgin Islands on June 26, 2018.

 

Blue Hat BVI is also a holding company holding all of the outstanding equity of Blue Hat Interactive Entertainment Technology Limited (“Blue Hat HK”) which was established in Hong Kong on June 26, 2018. Blue Hat HK is also a holding company holding all of the outstanding equity of Xiamen Duwei Consulting Management Co., Ltd. (“Blue Hat WFOE”) which was established on July 26, 2018 under the laws of the PRC.

 

We, through our variable interest entity (“VIE”), Fujian Blue Hat Interactive Entertainment Technology Ltd. (“Blue Hat Fujian”), a PRC company, and through its wholly owned subsidiaries, including Hunan Engaomei Animation Culture Development Co., Ltd. (“Blue Hat Hunan”) and Shenyang Qimengxing Trading Co., Ltd. (“Blue Hat Shenyang”), each a PRC company, engage in designing, producing, promoting and selling animated toys with mobile games features, original intellectual property and peripheral derivatives features worldwide.

 

On September 18, 2017, Blue Hat Fujian formed a joint venture with Xiamen Youth Education Development Co., Ltd. and Youying Wang , contributing a 48.5% equity interest in Fujian Youth Hand in Hand Educational Technology Co., Ltd. (“Fujian Youth”), a PRC company. As of September 30, 2018 and December 31, 2017, Fujian Youth has no operations.

 

On January 25, 2018, Blue Hat Fujian established its wholly owned subsidiary, Chongqing Lanhui Technology Co. Ltd. (“Blue Hat Chongqing”), a PRC company. As of September 30, 2018, Blue Hat Chongqing has no operations.

 

On September 10, 2018, Blue Hat Fujian established its wholly owned subsidiary, Pingxiang Blue Hat Technology Co. Ltd. (“Blue Hat Pingxiang”), a PRC company. Blue Hat Pingxiang also engages in designing, producing, promoting and selling interactive toys with mobile games features, original intellectual property and peripheral derivatives features worldwide.

 

On September 20, 2018, Blue Hat Fujian formed a joint venture with Fujian Jin Ge Tie Ma Information Technology Co., contributing a 20.0% equity interest in Xiamen Blue Wave Technology Co. Ltd. (“Xiamen Blue Wave”), a PRC company.

On October 16, 2018, Blue Hat Fujian formed a joint venture with Renchao Huyu (Shanghai) Culture Development Co. Ltd., contributing a 49% ownership interest in Renchao Huyu (Shanghai) Culture Propagation Co. Ltd. (“Renchao Huyu”), with the remaining 51% ownership owned by Renchao Huyu (Shanghai) Culture Development Co. Ltd.

 

On November 13, 2018, Blue Hat Cayman completed a reorganization of entities under common control of its then existing shareholders, who collectively owned a majority of the equity interests of Blue Hat Cayman prior to the reorganization. Blue Hat Cayman, Blue Hat BVI, and Blue Hat HK were established as the holding companies of Blue Hat WFOE. Blue Hat WFOE is the primary beneficiary of Blue Hat Fujian and its subsidiaries, and all of these entities included in Blue Hat Cayman are under common control which results in the consolidation of Blue Hat Fujian and subsidiaries which have been accounted for as a reorganization of entities under common control at carrying value. The consolidated financial statements are prepared on the basis as if the reorganization became effective as of the beginning of the first period presented in the consolidated financial statements.

 44 

 

 

The charts below summarize our corporate legal structure and identify our subsidiaries, our VIE and its subsidiaries:

 

 

 45 

 

 

Name   Background   Ownership
Brilliant Hat Limited  

•       A British Virgin Islands company

•       Incorporated on June 26, 2018 

•       A holding company

  100% owned by Blue Hat Interactive Entertainment Technology
Blue Hat Interactive Entertainment Technology Limited  

•       A Hong Kong company

•       Incorporated on June 26, 2018

•       A holding company

  100% owned by Brilliant Hat Limited
Xiamen Duwei Consulting Management Co., Ltd.  

•      A PRC limited liability company and deemed a WFOE

•      Incorporated on July 26, 2018

•      Registered capital of $ 736,073 (RMB 5,000,000)

•       A holding company

  100% owned by Blue Hat Interactive Entertainment Technology Limited
Fujian Blue Hat Interactive Entertainment Technology Ltd.  

•       A PRC limited liability company

•       Incorporated on January 7, 2010

•       Registered capital of $4,697,526 (RMB 31,054,000)

•       Designing, producing, promoting and selling animated toys with mobile games features, original intellectual property and peripheral derivatives features.

  VIE of Xiamen Duwei Consulting Management Co., Ltd.
Hunan Engaomei Animation Culture Development Co., Ltd.  

•       A PRC limited liability company

•       Incorporated on October 19, 2017

•       Registered capital of $302,540 (RMB 2,000,000)

•       Designing, producing, promoting and selling animated toys with mobile games features, original intellectual property and peripheral derivatives features.

  100% owned by Fujian Blue Hat Interactive Entertainment Technology Ltd.
Shenyang Qimengxing Trading Co., Ltd.  

•       A PRC limited liability company

•       Incorporated on July 27, 2017

•       Registered capital of $302,540 (RMB 2,000,000)

•       Designing, producing, promoting and selling animated toys with mobile games features, original intellectual property and peripheral derivatives features.

  100% owned by Fujian Blue Hat Interactive Entertainment Technology Ltd.
Chongqing Lanhui Technology Co. Ltd.  

•       A PRC limited liability company

•       Incorporated on January 25, 2018

•       Registered capital of $302,540 (RMB 2,000,000)

•       Designing, producing, promoting and selling animated toys with mobile games features, original intellectual property and peripheral derivatives features.

  100% owned by Fujian Blue Hat Interactive Entertainment Technology Ltd.
Pingxiang Blue Hat Technology Co. Ltd.  

•       A PRC limited liability company

•       Incorporated on September 10, 2018

•       Registered capital of $302,540 (RMB 2,000,000)

•       Designing, producing, promoting and selling animated toys with mobile games features, original intellectual property and peripheral derivatives features.

  100% owned by Fujian Blue Hat Interactive Entertainment Technology Ltd.

 

 

 46 

 

Contractual Arrangements

 

Due to legal restrictions on foreign ownership and investment in, among other areas, the production, development and operation of AR interactive entertainment games and toys in China, including interactive educational materials, mobile games, and toys with mobile game features, we operate our businesses in which foreign investment is restricted or prohibited in the PRC through certain PRC domestic companies. As such, Blue Hat Fujian is controlled through contractual arrangements in lieu of direct equity ownership by us or any of our subsidiaries. Such contractual arrangements consist of a series of three agreements, along with shareholders’ POAs and irrevocable commitment letters (collectively, the “Contractual Arrangements”), which were signed on November 13, 2018.

 

The significant terms of the Contractual Arrangements are as follows:

 

Exclusive Business Cooperation Agreement

 

Pursuant to the exclusive business cooperation agreement between Blue Hat WFOE and Blue Hat Fujian, Blue Hat WFOE has the exclusive right to provide Blue Hat Fujian with technical support services, consulting services and other services, including technical support, technical assistance, technical consulting, and professional training necessary for Blue Hat Fujian’s operation, network support, database support, software services, business management consulting, grant use rights of intellectual property rights, lease hardware and device, provide system integration service, research and development of software and system maintenance, provide labor support and to develop the related technologies based on Blue Hat Fujian’s needs. In exchange, Blue Hat WFOE is entitled to a service fee that equals to all of the consolidated net income after offsetting previous year’s loss (if any) of Blue Hat Fujian. The service fee may be adjusted by Blue Hat WFOE based on the actual scope of services rendered by Blue Hat WFOE and the operational needs and expanding demands of Blue Hat Fujian.

 

Pursuant to the exclusive business cooperation agreement, Blue Hat WFOE has the unilateral right to adjust the service fee at any time, and Blue Hat Fujian has no right to adjust the service fee. We believe that such conditions under which the service fee may be adjusted will be primarily based on the needs of Blue Hat Fujian to operate and develop its business in the AR market. For example, if Blue Hat Fujian needs to expand its business, increase research input or consummate mergers or acquisitions in the future, Blue Hat WFOE has the right to decrease the amount of the service fee, which would allow Blue Hat Fujian to have additional capital to operate and develop its business in the AR market.

 

The exclusive business cooperation agreement remains in effect for 10 years until November 13, 2028 and shall be automatically renewed for one year at the expiration date of the validity term. However, Blue Hat WFOE has the right to terminate this agreement upon giving 30 days’ prior written notice to Blue Hat Fujian at any time.

 

Call Option Agreements

 

Pursuant to the call option agreements, among Blue Hat WFOE, Blue Hat Fujian and the shareholders who collectively owned all of Blue Hat Fujian, such shareholders jointly and severally grant Blue Hat WFOE an option to purchase their equity interests in Blue Hat Fujian. The purchase price shall be the lowest price then permitted under applicable PRC laws. Blue Hat WFOE or its designated person may exercise such option at any time to purchase all or part of the equity interests in Blue Hat Fujian until it has acquired all equity interests of Blue Hat Fujian, which is irrevocable during the term of the agreements.

 

The call option agreements remains in effect for 10 years until November 13, 2028 and shall be automatically renewed for one year at the expiration date of the validity term. However, Blue Hat WFOE has the right to terminate these agreements upon giving 30 days’ prior written notice to Blue Hat Fujian at any time.

 

Equity Pledge Agreement

 

Pursuant to the equity pledge agreement among the shareholders who collectively owned all of Blue Hat Fujian, such shareholders pledge all of the equity interests in Blue Hat Fujian to Blue Hat WFOE as collateral to secure the obligations of Blue Hat Fujian under the exclusive business cooperation agreement and call option agreements. These shareholders are prohibited or may not transfer the pledged equity interests without prior consent of Blue Hat WFOE unless transferring the equity interests to Blue Hat WFOE or its designated person in accordance to the call option agreements.

 

The equity pledge agreement shall come into force the date on which the pledged interests is recorded, which is three days after signing of the Agreement on November 13, 2018, under Blue Hat Fujian’s register of shareholders and is registered with competent administration for industry and commerce of Blue Hat Fujian until all of the liabilities and debts to Blue Hat WFOE have been fulfilled completely by Blue Hat Fujian. Blue Hat Fujian and the shareholders who collectively owned all of Blue Hat Fujian shall not terminate these agreements in any circumstance for any reason. However, Blue Hat WFOE has the right to terminate these agreements upon giving 30 days’ prior written notice to Blue Hat Fujian at any time.

 

 47 

 

 

Shareholders’ POAs

 

Pursuant to the shareholders’ POAs, the shareholders of Blue Hat Fujian give Blue Hat WFOE an irrevocable proxy to act on their behalf on all matters pertaining to Blue Hat Fujian and to exercise all of their rights as shareholders of Blue Hat Fujian, including the right to attend shareholders meeting, to exercise voting rights and all of the other rights, and to sign transfer documents and any other documents in relation to the fulfillment of the obligations under the call option agreements and the equity pledge agreement. The POAs shall remain in effect while the shareholders of Blue Hat Fujian hold the equity interests in Blue Hat Fujian.

 

Irrevocable Commitment Letters

 

Pursuant to the irrevocable commitment letters, the shareholders of Blue Hat Fujian commit that their spouses or inheritors have no right to claim any rights or interest in relation to the shares that they hold in Blue Hat Fujian and have no right to impose any impact on the daily managing duties of Blue Hat Fujian, and commit that if any event which refrains them from exercising shareholders’ rights as a registered shareholder, such as death, incapacity, divorce or any other event, could happen to them, the shareholders of Blue Hat Fujian will take corresponding measures to guarantee the rights of other registered shareholders and the performance of the Contractual Arrangements. The letters are irrevocable and shall not be withdrawn without the consent of Blue Hat WFOE.

 

Based on the foregoing contractual arrangements, which grant Blue Hat WFOE effective control of Blue Hat Fujian and enable Blue Hat WFOE to receive all of their expected residual returns, we account for Blue Hat Fujian as a VIE. Accordingly, we consolidate the accounts of Blue Hat Fujian for the periods presented herein, in accordance with Regulation S-X-3A-02 promulgated by the SEC, and ASC 810-10, Consolidation.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

The following tables summarize our selected consolidated financial data for the periods and as of the dates indicated. The summary consolidated statements of income and comprehensive income for the years ended December 31, 2016 and 2017 and the summary consolidated balance sheets as of December 31, 2017 and 2016 are derived from our consolidated financial statements, which have been prepared in accordance with U.S. GAAP and audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), and included elsewhere in this prospectus. The unaudited condensed consolidated financial statements for the nine months ended September 30, 2018 and 2017 have been prepared on the same basis as our audited consolidated financial statements for the years ended December 31, 2017 and 2016. The unaudited condensed financial statements include all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair representation of our financial position and operating results for the periods presented. Our consolidated financial statements are prepared and presented in accordance with U.S. GAAP. Our historical results do not necessarily indicate results expected for any future periods. Our historical results are not necessarily indicative of the results that may be expected in the future. The following summary consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements included elsewhere in this prospectus.

 

 

  For the Nine Months Ended September 30,   For the Years Ended December 31,  
  2018   2017   2017   2016  
  (Unaudited)   (Unaudited)          
  US$   US$   US$   US$  
Consolidated Statements of Income and Comprehensive Income:                        
Revenues   9,632,860     6,316,574     14,144,894     9,352,650  
Cost of revenues   (3,536,760 )   (2,549,650 )   (5,300,087 )   (4,577,319 )
Gross profit   6,096,100     3,766,924     8,844,807     4,775,331  
Operating expenses   (2,462,006 )   (1,692,724 )   (2,900,349 )   (1,957,108 )
Income from operations   3,634,094     2,074,200     5,944,458     2,818,223  
Other non-operating income, net   60,661     62,081     135,709     241,752  
Provision for income taxes   (435,325   (294,540   (955,194   (485,658
Net income   3,259,430     1,841,741     5,124,973     2,574,317  
Other comprehensive Income (Loss)   (1,308,285 )   438,956     958,667     (364,997 )
Comprehensive Income   1,951,145     2,280,697     6,083,640     2,209,320  
Earnings per share, basic and diluted   0.10     0.06     0.16     0.08  
Weighted average ordinary Shares outstanding   33,000,000     33,000,000     33,000,000     33,000,000  

 

    September 30, 2018     December 31, 2017     December 31, 2016  
    (Unaudited)              
Consolidated Balance Sheet Data:   US$     US$     US$  
Current assets     25,594,519       29,243,641       10,409,749  
Total assets     31,983,431       33,582,177       12,482,213  
Current liabilities     8,110,189       11,594,387       5,527,445  
Total liabilities     8,221,523       11,771,414       5,527,445  
Total equity     23,761,908       21,810,763       6,954,768  

 

 49 

 

 

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this prospectus. This discussion and analysis and other parts of this prospectus contain forward-looking statements based upon current beliefs, plans and expectations that involve risks, uncertainties and assumptions. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of several factors, including those set forth under “Risk Factors” and elsewhere in this prospectus. You should carefully read the “Risk Factors” section of this prospectus to gain an understanding of the important factors that could cause actual results to differ materially from our forward-looking statements.

 

Overview

 

We are a producer, developer and operator of augmented reality (AR) interactive entertainment games and toys in China, including interactive educational materials, mobile games, and toys with mobile game features. Our mobile-connected entertainment platform enables us to connect physical items to mobile devices through wireless technologies, creating a unique interactive user experience. Our goal is to create a rich visual and interactive environment for users through the integration of real objects and virtual scenery. We believe this combination provides users with a more natural form of human-computer interaction and enhances users’ perception of reality, thus providing a more diversified entertainment experience. By leveraging our strong technological capabilities and infrastructure, we are able to deliver a superior user experience and conduct our operations in a highly efficient manner.

 

The core of our business is our proprietary technology. Our patents, trademarks, copyrights, and other intellectual property rights serve to distinguish our products, protect our products from infringement, and contribute to our competitive advantages. To secure the value of our technology and developments, we are aggressive in pursuing a combination of patent, trademark and copyright protection for our proprietary technologies. As of January 31, 2019, our intellectual property portfolio includes 161 authorized patents, 40 patents in various stages of the patent application process, 14 applications for PCT international patents, 56 registered trademarks, 645 copyrights for art work and 25 software copyrights.

 

We strive to create an engaging, interactive and immersive community for users of our products. The majority of our users are among the young Chinese generation between the ages of 3 and 23, although many of our products appeal to users outside of this demographic. We intend to further penetrate the Chinese market with new products that will target users ages 14 and above. Specifically, our strategies include marketing Fidolle, a ball-jointed “smart doll”, and QI, a gaming and entertainment platform designed for both family home use and amusement arcades. We believe our high-quality content is a magnet for users with common interests to connect and share their passions on our platform, which helps to cultivate a strong sense of belonging, effectively strengthening our user retention.

 

Our products resemble traditional children’s toys - including cars, ladybugs, picture books, and dolls - which are enabled with wireless technology to facilitate a broad variety of interactive functions. The interactive functionality of our products broadens the user experience, creates a communicative environment, and facilitates an ongoing relationship between us and our end users and between our end users and our products. We believe such an immersive entertainment experience allows our users to build strong emotional connections to our products, resulting in our products typically having longer life cycles than traditional toys.

 

Our proprietary technology, product research and development, marketing channels and brand operation are the cornerstones of our business. We focus on the combination of “online” and “offline” activity and the interaction between “entertainment” and “product” to create a high-tech entertainment platform combining mobile games and AR. With the help of computer graphics and visualization technologies, we are able to accurately “place” virtual objects into the physical world, thus creating a new and stimulating visual environment for our users.

 

We have grown rapidly since our inception. We generate revenues primarily from sales of our interactive toys, specifically our animation and game series, mobile games and animation design services. Our total revenues increased by $3,316,286, or 52.5%, to $9,632,860 for the nine months ended September 30, 2018 as compared to $6,316,574 for the nine months ended September 30, 2017. Our total revenues increased by $4,792,244, or 51.2%, to $14,144,894 for the year ended December 31, 2017 as compared to $9,352,650 for the year ended December 31, 2016.

 

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In an effort to capture a substantive share of the AR interactive toy market in China, we have increased our investment in the research and development of our AR interactive toys and games from $159,186 in 2016 to $355,730 in 2017. We maintained a similar level of investment in research and development in the nine months ended September 30, 2018, totaling $175,016.

 

Key Factors that Affect Operating Results

 

Investment in technology and talent

 

We believe the key to success in the AR interactive toy market is research and development. We release new mobile applications annually, and intend to continue doing so, in an effort to extend the life cycle of our products. The advancement of our technology is critical as it enables us to retain and attract users. We must continue to innovate, develop and produce technologies in order to keep pace with the growth of our business and the industry. Therefore, we invest substantially in the research and development of AR interactive technologies. Our current research and development efforts are primarily focused on further advancement of the technology used in our products, including photosensitive induction technology, gesture-sensor technology, infrared induction technology and AR identification technology.

 

Our ability to build our brand and expand our sales distribution channel

 

Our distribution channels include domestic distributors, e-commerce platforms, supermarkets and export distributors. Approximately 96% of our products sold in 2017 were sold domestically in China, and 97.6% of those products sold in China were generated from Chinese distributors. We are in the process of expanding our e-commerce sales team, and we are transitioning from single, offline promotional activities to diversified, online interactive marketing and digital marketing. We intend to increase our branding and advertising activities via online communities, social media and television. Our revenue growth will be affected by our ability to effectively execute our shifting marketing strategies and expand our sales distribution channel through e-commence.

Our ability to expand our portfolio of products and business

We intend to pursue strategic acquisitions and investments in selective technologies and businesses that will enhance our technology capabilities, expand our offerings and increase our market penetration. We believe our strategic acquisition and investment strategy is critical for us to accelerate our growth and strengthen our competitive position. Our ability to identify and execute strategic acquisitions and investments will have an effect on our operating results.

 

PRC economy

 

Although the PRC economy has grown in recent years, the pace of growth has slowed, and growth rates may continue to decline. According to the PRC National Bureau of Statistics of China, the annual rate of growth in the PRC declined from 7.6% in 2014, to 7.0% in 2015, 6.8% in 2016, 6.9% in 2017 and 6.8% in 2018. A further slowdown in overall economic growth, an economic downturn, a recession or other adverse economic development in the PRC may materially reduce the purchasing power of Chinese consumers and thus lead to a decrease in the demand for our products. Such a decrease in demand may have a materially adverse effect on our business.

 

Results of Operations

 

Comparison of Nine Months Ended September 30, 2018 and September 30, 2017

 

    For the Nine Months ended September 30,  
                      Percentage  
   

2018

(unaudited)

   

2017

(unaudited)

    Change     Change  
Revenues   $  9,632,860     $ 6,316,574     $ 3,316,286       52.5 %
Cost of revenues      (3,536,760 )     (2,549,650 )     987,110     38.7 %
Gross profit      6,096,100       3,766,924       2,329,176       61.8 %
Selling expenses      (578,199 )     (429,661 )     148,538       34.6 %
General and administrative expenses      (1,708,791 )     (1,042,166 )     666,625       64.0 %
Research and development      (175,016 )     (220,897 )      (45,881 )     (20.8 )%
Income from operations     3,634,094       2,074,200       1,559,894       75.2 %
Other income, net     60,661       62,081       (1,420 )     (2.3 )%
Provision for income taxes     (435,325 )     (294,540 )     140,785       47.8 %
Net income   $ 3,259,430       1,841,741       1,417,689       77.0 %

   

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Revenues

 

Our revenues are derived from sales of interactive toys, animation and game series, mobile games and animation design services. Total revenues increased by $3,316,286, or 52.5%, to $9,632,860 for the nine months ended September 30, 2018 as compared to $6,316,574 for the nine months ended September 30, 2017. The overall increase was primarily attributable to the increase of our sales of interactive toys – game series, offset by the decrease of our sales of interactive toys – animation series.

 

Our revenue from each of our revenue categories is as follows:

 

  

For the Nine Months ended

September 30, 2018

(unaudited)

 

For the Nine Months ended

September 30, 2017

(unaudited)

  Change  Change (%)
             
Revenues                    
Interactive toys - animation series  $470,838   $763,086   $(292,248)   (38.3)%
Interactive toys - game series   9,142,521    5,525,788    3,616,733    65.5%
Mobile games   19,501    27,700    (8,199)   (29.6)%
Total revenues  $9,632,860   $6,316,574   $3,316,286    52.5%

Interactive Toys - Game Series

Revenues from sales of interactive toys - game series increased by $3.6 million or 65.5% from $5.5 million for the nine months ended September 30, 2017 to $9.1 million for the nine months ended September 30, 2018. This increase is a result of our business strategy to focus on higher profit margin products, and therefore shift away from interactive toys - animation series and towards interactive toys - game series, as interactive toys - games series generates higher profit margins, with an average gross profit percentage of 65.2% for the nine months ended September 30, 2018 as compared to interactive toys – animation series, which had an average gross profit percentage of 27.1%. As a result, we intend to focus on promoting our interactive toys - games series.

Interactive Toys - Animation Series

Revenues from sales of interactive toys - animation series decreased by $0.3 million or 38.3% from $0.8 million for the nine months ended September 30, 2017 to $0.5 million for the nine months ended September 30, 2018. This increase is a result of our business strategy to shift away from interactive toys - animation series and towards interactive toys - game series, as interactive toys - games series generates higher profit margins, with an average gross profit percentage of 65.2% for the nine months ended September 30, 2018 as compared to interactive toys – animation series, which had an average gross profit percentage of 27.1% for the same period. As a result, we intend to focus on promoting interactive toys - games series. The decrease in sales of interactive toys - animation series was also attributable to the decrease of export sales outside of the PRC which generally has a lower gross profit margin as compare to our PRC sales. We intend to promote more of our products in the PRC, and we believe that our mobile game platform will provide potential add-on revenues.

Mobile Games

Revenues from mobile games decreased by $8,000 or 29.6% from $28,000 for the nine months ended September 30, 2017 to $20,000 for the nine months ended September 30, 2018. We expected our mobile game revenues to fluctuate during 2017 and 2018 as our mobile game platform is in its early stages. As a result, the slight decrease or fluctuation in our mobile game revenues is within our expectations. In September 2018, we added another mobile game in our platform. As a result, we expect our mobile game revenues will increase in 2019.

 

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Cost of Revenues

Total cost of revenues increased by $1.0 million, or 38.7%, to $3.5 million for the nine months ended September 30, 2018 as compared to $2.5 million for the nine months ended September 30, 2017. The increase in cost of revenues is a direct result of our increase of revenues.

 

Our cost of revenues from each of our revenue categories is as follows: 

 

  

For the Nine Months ended

September 30, 2018

(unaudited)

 

For the Nine Months ended

September 30, 2017

(unaudited)

  Change  Change (%)
             
Cost of revenues                    
Interactive toys - animation series  $343,292   $458,811   $(115,519)   (25.2)%
Interactive toys - game series   3,177,216    2,076,340    1,100,876    53.0%
Mobile games   16,252    14,499    1,753    12.1%
Total cost of revenues  $3,536,760   $2,549,650   $987,110    38.7%

 

Our cost of revenues from interactive toys – game series increased by $1.1 million or 53.0% from $2.1 million for the nine months ended September 30, 2017 to $3.2 million for the nine months ended September 30, 2018. The increase in cost of revenues from interactive toys – game series is in line with our increase of revenues from interactive toys – game series as we shifted our business strategy to focus on higher profit margin products, our interactive toys – game series.

 

Our cost of revenues from interactive toys – animation series decreased by $0.1 million or 25.2% from $0.4 million for the nine months ended September 30, 2017 to$0.3 million for the nine months ended September 30, 2018. The decrease in cost of revenues from interactive toys – animation series is in line with our decrease of revenues from interactive toys – animation series as we shifted our business strategy to focus on higher profit margin products, our interactive toys – game series.

 

Our cost of revenues from mobile games increased by $2,000 or 12.1% from $15,000 for the nine months ended September 30, 2017 to $16,000 for the nine months ended September 30, 2018. We implemented purchase options for virtual currency and/or virtual goods into our mobile game platform in late 2016. Players can purchase virtual goods in the mobile games, including characters, garments, tools and other accessories. We expected our mobile game revenue to fluctuate in 2017 and 2018 as our mobile game platform is in its early stages. As a result, the slight increase or fluctuation in our cost of mobile game revenues is within our expectations.

 

Gross Profit

 

Our gross profit from each of our revenue categories is as follows:

 

   

For the Nine Months ended

September 30,  2018

(unaudited)

   

For the Nine Months ended

September 30,  2017

(unaudited)

    Change     Change (%)  
                         
Interactive toys - animation series                                
Gross profit   $ 127,546     $ 304,275     $ (176,729 )     (58.1 )%
Gross margin     27.1 %     39.9 %     (12.8 )%        
                                 
Interactive toys - game series                                
Gross profit   $ 5,965,305     $ 3,449,448     $ 2,515,857       72.9 %
Gross margin     65.2 %     62.4 %     2.8 %        
                                 
Mobile games                                
Gross profit   $ 3,249     $ 13,201     $ (9,952     (75.4 )%
Gross margin     16.7 %     47.7 %     (31.0 )%        
                                 
Total                                
Gross profit   $ 6,096,100     $ 3,766,924     $ 2,329,176       61.8 %
Gross margin     63.3 %     59.6 %     3.6 %        

 

 53 

 

 

Our gross profit increased by $2.3 million, or 61.8%, to $6.1 million during the nine months ended September 30, 2018 from $3.8 million for the nine months ended September 30, 2017. The increase in gross profit is primarily due to the significant increase in revenues as a result of increased sales of the interactive toys – game series business line. This series of products generally has a higher gross profit percentage as compared to our other products.

 

For the nine months ended September 30, 2018 and 2017, our overall gross profit percentage was 63.3% and 59.6%, respectively. The increase in gross profit percentage was primarily due to the increase of revenues from our interactive toys – game series, which contributed 94.9% of our total revenues with a gross profit percentage of 65.2% for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017 where our interactive toys – game series contributed 87.5% of our total revenues. During the nine months ended September 30, 2017, our interactive toys – animation series contributed 12.1% of our total revenues with a gross profit percentage of 39.9% as compared to 62.4% for interactive toys – game series for the same period.

 

Gross profit percentage for our interactive toys – game series was 65.2% and 62.4% for the nine months ended September 30, 2018 and 2017, respectively. The increase of gross profit percentage is mainly attributable to the 2018 reduction of the VAT rate from 17% to 16%. Because our customers are paying the same price for our products as they did when the higher VAT rate was included in the price, our gross profit percentage increased by 2.8%.

 

Gross profit percentage for our interactive toys – animation series was 27.1% and 39.9% for the nine months ended September 30, 2018 and 2017, respectively. The decrease of gross profit percentage was mainly attributable to a certain export tax credit that we normally receive in the nine months ended September 30, 2017, but did not get approved and refunded for in the nine months ended September 30, 2018, as the majority of our interactive toys – animation series sales are mainly exported outside of the PRC market, thus driving down gross profit percentage during the nine months ended September 30, 2018 as compared to the same period in 2017 by 12.8%.

Operating Expenses

Total operating expenses increased by $0.8 million or 45.4% from $1.7 million during the nine months ended September 30, 2017 to $2.5 million during the nine months ended September 30, 2018. The increase is mainly attributable to the $0.1 million increase in selling expenses, the $0.7 million increase in general and administrative (“G&A”) expenses, and the $46,000 decrease in research and development (“R&D”) expenses for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017.

 

The $0.1 million increase in selling expenses is attributable to the $0.1 million increase in salary and benefit expenses in our sales department, as we have increased our sales personnel to expand our marketing and promotional activities.

 

The $0.7 million increase in G&A expenses is mainly attributable to (i) a $2.0 million increase in salary and benefits as we required more employees to support our increased of operations in 2018, (ii) a $0.1 million increase in provision for doubtful accounts as we estimated to have more accounts receivable allowance incurred based on our historical collection pattern, (iii) a $0.1 million increase in depreciation and amortization expenses, and (iv) a $0.3 million increase in other various miscellaneous G&A expenses, such as expenses for meals and entertainment, retirement plan, accommodation, travel, toll charges, and a guarantee fee due to the increase of our operating needs.

 

The $46,000 decrease in R&D expenses is mainly attributable to management efforts in efficiency and cost control of our R&D expenses. We remain committed to the innovation, development and production of technologies in order to keep pace with the growth of our business and the industry. In addition to our existing internal R&D team, we plan to begin outsourcing our external R&D teams to develop cutting-edge technologies.

Other income, net

Total other income, net decreased by $1,000 or 2.3% from $62,000 during the nine months ended September 30, 2017 to $61,000 during the nine months ended September 30, 2018. The decrease in total income is mainly attributable to the $155,000 decrease in other income, as we did not generate any government subsidiaries during the nine months ended September 30, 2018 as compared to $235,000 during the same period in 2017. The decrease is offset by the $80,000 increase in other miscellaneous income and the $134,000 increase in interest income as we invested in short-term investments of certificate deposits during the nine months ended September 30, 2018 as compared to $235,000 during the same period in 2017.

 

 54 

 

Income tax expense

Our income tax expense amounted to $435,000 and $295,000 for the nine months ended September 30, 2018 and 2017, respectively. The $140,000 increase is a result of our increase in income before income taxes.

Net income

 

Our net income increased by $1.4 million, or 77.0%, to $3.3 million for the nine months ended September 30, 2018, from $1.8 million for the nine months ended September 30, 2017. Such change was the result of the combination of the changes as discussed above.

 

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

 

    For the Years ended December 31,  
                      Percentage  
    2017     2016     Change     Change  
Revenues   $ 14,144,894     $ 9,352,650     $ 4,792,244       51.2 %
Cost of revenues     (5,300,087 )     (4,577,319 )     722,768       15.8 %
Gross profit     8,844,807       4,775,331       4,069,476       85.2 %
Selling expenses     (629,424 )     (310,668 )     318,756       102.6 %
General and administrative expenses     (1,915,195 )     (1,487,254 )     427,941       28.8 %
Research and development     (355,730 )     (159,186 )     196,544       123.5 %
Income from operations     5,944,458       2,818,223       3,126,235       110.9 %
Other income, net     135,709       241,752       (106,043 )     (43.9) %
Provision for income taxes     (955,194 )     (485,658 )     469,536       96.7 %
Net income   $ 5,124,973       2,574,317       2,550,656       99.1  

Revenues

 

Our revenues are derived from sales of interactive toys, animation and game series, mobile games and animation design services. Total revenues increased by $4,792,244, or 51.2%, to $14,144,894 for the year ended December 31, 2017 as compared to $9,352,650 for the year ended December 31, 2016. The overall increase is primarily attributable to the increase of our sales of interactive toys – game series and the increase of sales of mobile games, offset by the decrease of our sales of interactive toys – animation series and animation design services.

 

Our revenue from each of our revenue categories is as follows:

 

    For the Year ended
December 31, 2017
    For the Year ended
December 31, 2016
    Change     Change (%)  
                         
Revenues                                
Interactive toys - animation series   $ 1,060,330     $ 5,211,289     $ (4,150,959 )     (79.7) %
Interactive toys - game series     12,956,130       3,287,011       9,669,119       294.2 %
Mobile games     128,434       9,113       119,321       1,309.4 %
Animation design services     -       845,237       (845,237     (100.0) %
Total revenues   $ 14,144,894     $ 9,352,650     $ 4,792,244       51.2 %

 

Interactive Toys - Game Series

Revenues from sales of interactive toys - game series increased by $9.7 million or 294.2% from $3.3 million for the year ended December 31, 2016 to $13.0 million for the year ended December 31, 2017. This increase is a result of our business strategy to focus on higher profit margin products, and therefore shift away from interactive toys - animation series and towards interactive toys - game series, as interactive toys - games series generates higher profit margins, with an average gross profit percentage of 64.3% for the year ended December 31, 2017 as compared to interactive toys – animation series, which had an average gross profit percentage of 38.4% for the same period. As a result, we intend to focus on promoting our interactive toys - games series.

 

 55 

 

Interactive Toys - Animation Series

Revenues from sales of interactive toys - animation series decreased by $4.1 million or 79.7% from $5.2 million for the year ended December 31, 2016 to $1.1 million for the year ended December 31, 2017. This decrease is a result of our business strategy to shift away from interactive toys - animation series and towards interactive toys - game series, as interactive toys - games series generates higher profit margins, with an average gross profit percentage of 64.3% for the year ended December 31, 2017 as compared to interactive toys – animation series, which had an average profit percentage of 38.4% for the same period. As a result, we intend to focus on promoting our interactive toys - games series. The decrease in sales of interactive toys - animation series was also attributable to the decrease of export sales outside of the PRC which generally has a lower gross profit margin as compared to our PRC sales. We also intend to promote more of our products in the PRC, and we believe that our mobile game platform will provide potential add-on revenues.

Mobile Games

Revenues from mobile games increased by $119,000 or 1,309.4% from $9,000 for the year ended December 31, 2016 to $128,000 for the year ended December 31, 2017. This increase is a result of the implementation of purchase options for virtual currency and/or virtual goods into our mobile game platform in late 2016. Players can purchase virtual goods in the mobile games, including characters, garments, tools and other accessories. As a result, we have generated more mobile game revenues in 2017.

Animation Design Services

Revenues from animation design services decreased by $0.8 million or 100.0% from $0.8 million for the year ended December 31, 2016 to $0 for the year ended December 31, 2017 as we are no longer providing such services in 2017. Our sales strategy is now solely focused on our sales of interactive toys and mobile games business.

Cost of Revenues

Total cost of revenues increased by $0.7 million, or 15.8%, to $5.3 million for the year ended December 31, 2017 as compared to $4.6 million for the year ended December 31, 2016. The increase is a direct result of our increase in revenues.

 

Our cost of revenues from each of our revenue categories is as follows:

 

 

    For the Year ended
December 31, 2017
    For the Year ended
December 31, 2016
    Change     Change (%)  
                         
Cost of revenues                                
Interactive toys - animation series   $ 653,118     $ 3,302,089     $ (2,648,971 )     (80.2) %
Interactive toys - game series     4,627,337       1,245,880       3,381,457       271.4 %
Mobile games     19,632       3,438       16,194       471.0 %
Animation design services     -       25,912       (25,912     (100.0) %
Total cost of revenues   $ 5,300,087     $ 4,577,319     $ 722,768       15.8 %

 

Our cost of revenues from interactive toys – game series increased by approximately $3.4 million or 271.4% from approximately $1.2 million for the year ended December 31, 2016 to approximately $4.6 million for the year ended December 31, 2017. The increase in cost of revenues from interactive toys – game series is in line with our increase of revenues from interactive toys – game series as we shifted our business strategy to focus on higher profit margin products, our interactive toys – game series.

Our cost of revenues from interactive toys – animation series decreased by approximately $2.6 million or 80.2% from approximately $3.3 million for the year ended December 31, 2016 to approximately $0.6 million for the year ended December 31, 2017. The decrease in cost of revenues from interactive toys – animation series is in line with our increase of revenues from interactive toys – animation series as we shifted our business strategy to focus on higher profit margin products, our interactive toys – game series.

 

 56 

 

Our cost of revenues from mobile games increased by approximately $16,000 or 471.0% from approximately $3,000 for the year ended December 31, 2016 to approximately $19,000 for the year ended December 31, 2017. We started incorporating the purchase of virtual currency and/or virtual goods option into our mobile game platform in late 2016. As a result, we have incurred more cost of mobile game revenues in 2017. 

 

Gross Profit

 

Our gross profit from each of our revenue categories is as follows:

 

    For the Year ended
December 31, 2017
    For the Year ended
December 31, 2016
    Change     Change (%)  
                         
Interactive toys - animation series                                
Gross profit   $ 407,212     $ 1,909,200     $ (1,501,988 )     (78.7 )%
Gross margin     38.4 %     36.6 %     1.8 %        
                                 
Interactive toys - game series                                
Gross profit   $ 8,328,793     $ 2,041,131     $ 6,287,662       308.0 %
Gross margin     64.3 %     62.1 %     2.2 %        
                                 
Mobile game                                
Gross profit   $ 108,802     $ 5,675     $ 103,127       1,817.3 %
Gross margin     84.7 %     62.3 %     22.4 %        
                                 
Animation design service                                
Gross profit   $ -     $ 819,325     $ (819,325     (100.0) %
Gross margin     - %     96.9 %     (96.9) %        
                                 
Total                                
Gross profit   $ 8,844,807     $ 4,775,331     $ 4,069,476       85.2 %
Gross margin     62.5 %     51.1 %     11.4 %        

 

Our gross profit increased by $4.1 million, or 85.2%, to $8.8 million for the year ended December 31, 2017, from $4.8 million for the year ended December 31, 2016. The increase in gross profit is primarily due to the significant increase in revenues as a result of increased sales of the interactive toys – game series business line. This series of products generally has a higher gross profit percentage as compared to our other products.

 

For the years ended December 31, 2017 and 2016, our overall gross profit percentage was 62.5% and 51.1%, respectively. The increase in gross profit percentage is primarily due to the increase in revenues from our interactive toys – game series, which contributed 91.6% of our total revenues with a gross profit percentage of 64.3% for the year ended December 31, 2017 as compared to the year ended December 31, 2016 where our interactive toys – game series contributed 35.1% of our total revenues. For the year ended December 31, 2016, our interactive toys – animation series contributed 55.7% of our total revenues with a gross profit percentage of 36.6% as compared to interactive toys - game series which had a gross profit percentage of 62.1% in 2016.

 

Gross profit percentage for our interactive toys – game series was 64.3% and 62.1% for the years ended December 31, 2017 and 2016, respectively. The 2.2% increase in gross profit percentage is mainly attributable to a slight increase in the price of our best selling product, AR Racer, which had an average selling price of $6.45 in 2017 as compared to $5.78 in 2016.

 

Gross profit percentage for our interactive toys – animation series was 38.4% and 36.6% for the years ended December 31, 2017 and 2016, respectively. The 1.8% increase in gross profit percentage is mainly attributable to the decrease in sales of several animation series products typically sold outside of the PRC market that have lower gross profit percentages due to export tax.

Operating Expenses

Total operating expenses increased by $0.9 million or 48.2% from $2.0 million for the year ended December 31, 2016 to $2.9 million for the year ended December 31, 2017. This increase is mainly attributable to the $0.3 million increase in selling expenses, the $0.4 million increase in G&A expenses and the $0.2 million increase in R&D expenses for the year ended December 31, 2017 as compared to the year ended December 31, 2016.

 

 57 

 

 

The $0.3 million increase in selling expenses is primarily attributable to (i) a $0.2 million increase in advertising expenses as a result of our efforts to build our brand and to attract more customers, and (ii) a $0.1 million increase in packing expenses as a result of the increase in products sold.

 

The $0.4 million increase in G&A expenses is primarily attributable to the $0.3 million increase in salary and benefit expenses, the $0.2 million increase in rental expenses is a result of our increased operations and overall growth, as we require more employees, office, and warehouse spaces., and the increase in amortization expenses by $0.1 million as a result of capitalized software development costs. This increase is offset by (i) the $0.1 million decrease in professional fees, as we incurred some professional fees in connection with our preparation to list as a public company in 2016, but our plans were paused in 2017 and resumed in 2018 and (ii) the decrease of $0.1 million in provisions for doubtful accounts.

 

The $0.2 million increase in R&D expenses is mainly attributable to increases in the salaries and benefits of our R&D team members.

Other income (expense), net

Total other income, net decreased by $0.1 million or 43.9% from $0.2 million for the year ended December 31, 2016 to $0.1 million for the year ended December 31, 2017. This decrease is primarily attributable to the increase in foreign currency exchange losses of $0.2 million, as we generated foreign currency exchange gains of $0.1 million in 2016 while also incurring foreign currency exchange losses of $0.1 million due to fluctuations in the currency exchange rate of our export sales. This decrease is offset by the increase of $0.2 million of interest income primarily attributable to interest from our short-term certificate deposits investments in 2017.

Income tax expense

Our income tax expense amounted to $955,000 and $486,000 for the years ended December 31, 2017 and 2016, respectively. This increase of $469,000 is a result of our increase in income before income taxes.

Net income

 

Our net income increased by $2.5 million, or 99.1%, to $5.1 million for the year ended December 31, 2017, from $2.6 million for the year ended December 31, 2016. Such change was the result of the combination of the changes as discussed above.

Liquidity and Capital Resources

 

In assessing our liquidity, we monitor and analyze our cash on-hand and our operating expenditure commitments. Our liquidity needs are to meet our working capital requirements and operating expenses obligations. To date, we have financed our operations primarily through cash flows from operations and short-term borrowing from banks.

 

As of September 30, 2018, our working capital was $17.5 million and cash and cash equivalents amounted to $11.8 million. Our current assets were $25.6 million and our current liabilities were $8.1 million with shareholders’ equity of $23.8 million as of September 30, 2018. We generated net income of $3.3 million and $1.8 million from our operations for the nine months ended September 30, 2018 and 2017, respectively and we generated net income of $5.1 million and $2.6 million from our operations for the years ended December 31, 2017 and 2016, respectively. We believe our revenues and operations will continue to grow and our current working capital is sufficient to support our operations for the next twelve months. 

 

We intend to use the funds raised from this offering to grow our business primarily by:

 

  expanding our R&D team and further strengthening the capacity of our independent R&D and innovation;

 

 

establishing physical experience stores and expanding our sales distribution channels; and

  investing in working capital purposes.

 

As of September 30, 2018, the following were outstanding balances on our short-term bank loans:

 

Bank Name Maturities Interest Rate Collateral/Guarantee September 30, 2018 (unaudited)
China Construction Bank March 2019 5.71%

Guarantee by Xiamen

Jingyuan Finance Guarantee

Co. Ltd.

$1,092,254
China Construction Bank March 2019 5.71%

Guarantee by Xiamen

Jingyuan Finance Guarantee

Co. Ltd.

$946,620

 

In April 2017, we entered into a line of credit agreement with China Construction Bank pursuant to which we may borrow up to $2,038,874 (RMB 14,000,000). The line of credit agreement will expire in April 2020. The line of credit agreement entitles us to enter into separate loan contracts under such line of credit. For each withdraw from the line of credit, a separate loan was entered into with a one year term from the credit line withdraw date. On March 1, 2018, we withdrew $1,092,254 (RMB 7,500,000) and $946,620 (RMB 6,500,000) under such line of credit and entered into two separate loan contracts with China Construction Bank which had one year terms. As at September 30, 2018 and December 31, 2017, we utilized all of this line of credit and recorded it as short term bank loan. On March 13, 2019, we fully repaid such loans.

 

In December 2018, we obtained a loan in the amount of $0.7 million from Industrial Bank Co. Ltd. with an annual interest rate of 6.1% to be due in December 2019. This loan is guaranteed by Xiamen Siming Technology Financing Guarantee Co. Ltd., Xiaodong Chen, Juanjuan Cai, and Yong Chen.

 

In December 2018, we obtained a loan in the amount of $0.4 million from Industrial Bank Co. Ltd. with an annual interest rate of 6.1% to be due in December 2019. This loan is guaranteed by Xiaodong Chen, Juanjuan Cai, and Yong Chen.

 

 

 58 

 

 

The anticipated material steps involved in our physical expansion strategy include, among other things, location selection, staff recruitment, purchase of equipment, execution of leases, and conducting renovations. In terms of the anticipated material costs involved in such expansion, we currently expect to invest approximately RMB 300,000 ($43,680) per store in such endeavors, consisting of approximately RMB 100,000 ($14,560) for equipment, approximately RMB 50,000 ($7,280) to RMB 80,000 ($11,648) for renovations, and approximately RMB 120,000 ($17,472) to RMB 150,000 ($21,840) for rental expenses.

 

Current foreign exchange and other regulations in the PRC may restrict our PRC entities, Blue Hat WFOE, Blue Hat Fujian, Blue Hat Hunan, Blue Hat Shenyang, Blue Hat Chongqing, and Blue Hat Pingxiang, in their ability to transfer their net assets to the Company and its subsidiaries in Cayman Islands, British Virgin Islands, and Hong Kong. However, because we have no present plans to declare dividends, these restrictions will likely have no impact on us. Instead, we plan to use our retained earnings to continue to grow our business. These restrictions also have no impact on our ability to meet our cash obligations as all of our current cash obligations are due within the PRC.

 

The following summarizes the key components of our cash flows for the nine months ended September 30, 2018 and 2017 and the years ended December 31, 2017 and 2016:

 

    For the Nine Months Ended September 30,    

For the Years Ended

December 31,

    2018     2017     2017     2016
    (Unaudited)     (Unaudited)            
Net cash (used in) provided by operating activities

 

$

 

(1,102,713

 

)

 

$

 

702,338

    $ 6,989,680     $ 2,273,913
Net cash provided by (used in) investing activities  

 

12,671,169

   

 

2,557,161

      (15,814,920 )     (4,754,367)
Net cash (used in) provided by financing activities  

 

(1,503,056

 

)

 

 

10,425,373

      10,167,330       2,043,824
Effect of exchange rate change on cash, cash equivalents and restricted cash  

 

 

(641,206

 

 

)

 

 

 

378,520

      72,267       (69,965)
Net change in cash, cash equivalents and restricted cash

 

$

 

9,424,194

 

 

$

 

14,063,392

    $ 1,414,357     $ (506,595)

Operating activities

Net cash used in operating activities was $1.1 million for the nine months ended September 30, 2018 and was primarily attributable to (i) a $3.4 million increase in accounts receivables as we expanded our operations by providing more credit sales and (ii) the $3.6 million decrease in accounts payable, as we generated more timely cash flow to repay our vendors. This cash outflow is offset by (i) net income of $3.3 million, (ii) various non-cash items of $0.5 million, such as depreciation and amortization expense, and the provision for allowance for doubtful accounts, deferred income taxes expenses and loss on disposal of equipment, (iii) a $0.4 million decrease in inventories, as we improved inventory management in 2017 and now keep a minimal amount of inventories on hand, (iv) a $0.2 million decrease in prepayment due to obtaining a better credit term with our suppliers, (v) a $0.2 million increase in other payables and accrued liabilities due to payables to a software development vendor, and (vi) a $1.4 million increase in taxes payable, due to increased income and incurred value-added taxes.

Net cash provided by operating activities for the nine months ended September 30, 2017 was mainly due to (i) net income of $1.8 million, (ii) various non-cash items of $0.2 million, such as depreciation and amortization expense, and provision for allowance for doubtful accounts, and deferred income taxes benefit, (iii) a decrease in inventories of $0.3 million, as we improved inventory management in 2017 and now keep a minimal amount of inventories on hand, (iv) a $0.6 million increase in accounts payable as we incurred more payables on credit due to our increased operations, and (v) a $0.2 million increase in tax payables due to increased income and incurred value-added taxes. This cash inflow is offset by the $1.9 million increase in accounts receivable, as we expanded our operations by providing more credit sales, the $0.4 million increase in other receivables due to employee advances for business development purposes, and the $0.2 million decrease in other payables and accrued liabilities.

Net cash provided by operating activities was $7.0 million for the year ended December 31, 2017 and was primarily attributable to (i) our net income of $5.1 million, (ii) various non-cash items of $0.3 million, such as depreciation and amortization expense and provision for allowance for doubtful accounts, and deferred income taxes benefit, (iii) a $0.4 million decrease in inventories as we improved inventory management in 2017 and now keep a minimal amount of inventories on hand, (iv) a $3.1 million increase in accounts payable, and (v) a $0.9 million increase in taxes payable. This increase is offset by a $2.3 million increase in accounts receivables as a result of our expanded operations, the provision of more credit sales and a $0.4 million increase in prepayments, as we were required to make prepayments to secure our raw materials purchase for the anticipated increase in sales orders in 2018.

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Net cash provided by operating activities for the year ended December 31, 2016 was mainly attributable to (i) our net income of $2.6 million, (ii) various non-cash items of $0.3 million, such as depreciation and amortization expense, provision for allowance for doubtful accounts and deferred income taxes benefit , (iii) a $0.3 million decrease in other receivables, as our employees returned the advances for business operations that we previously provided to them in 2016, (iv) a $0.3 million decrease in inventories, as we improved inventory management in 2016 and now keep a minimal amount of inventories on hand as compared to 2015, (v) a $0.2 million increase in accounts payable, (vi) a $0.2 million increase in other payables and accrued liabilities, as we incurred more payables on credit due to our expanded operations, and (vii) a $0.6 million increase in tax payables due to our increased income and incurred value-added taxes. This cash inflow was offset by a $1.2 million increase in accounts receivables as we expanded our operations by providing more credit sales and the increase of prepayments of $1.0 million, as we were required to make more prepayments to secure the purchase of our raw materials for the anticipated increase in sales order in 2017.

Investing activities

Net cash provided by investing activities was $12.7 million for the nine months ended September 30, 2018 and was primarily attributable to $17.3 million in proceeds from short-term investments of certificate deposits. This cash inflow is offset by a payment of $1.8 million on our 20% investment in Xiamen Blue Wave Technology Co. Ltd., a $0.4 million payment on intangible assets, and purchase of short-term investments of certificate deposits of $2.4 million.

Net cash provided by investing activities for the nine months ended September 30, 2017 was mainly attributable to $3.5 million in proceeds from short-term investments of certificate deposits. This cash inflow is offset by the $0.4 million payment on intangible assets and the $0.6 million in purchase of short-term investments of certificate deposits.

Net cash used in investing activities was $15.8 million for the year ended December 31, 2017 and was primarily attributable to a $2.0 million payment on capitalized software development costs and $17.4 million in purchase of short-term investments for certificate deposits. This cash outflow is offset by $3.6 million in proceeds from short-term investments of certificate deposits.

Net cash used in investing activities for the year ended December 31, 2016 is primarily due to a $1.7 million payment on intangible assets and $4.1 million in purchase of short-term investments of certificate deposits. The cash outflow is offset by $1.1 million in proceeds from short-term investments of certificate deposits.

 

Financing activities

Net cash used in financing activities was $1.5 million for the nine months ended September 30, 2018 was primarily attributable to $3.6 million in payments of short-term loans, offset by proceeds from short-term loans of $2.2 million.

Net cash provided by financing activities for the nine months ended September 30, 2017 is mainly attributable to capital contributions from our shareholders of $8.8 million and proceeds from short-term bank loans of $3.5 million, offset by $1.8 million in payments of short-term bank loans.

Net cash provided by financing activities was $10.2 million for the year ended December 31, 2017 was a result of $8.8 million in capital contributions from our shareholders and proceeds from short-term bank loans of $3.5 million, offset by payments of short-term bank loans of $2.1 million.

Net cash provided by financing activities for the year ended December 31, 2016 is mainly attributable to capital contributions from our shareholders of $2.3 million and proceeds from short-term bank loans of $2.6 million, offset by $2.8 million in payments of short-term bank loans.

 

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Commitments and Contingencies

 

Lease commitments

 We have entered into four non-cancellable operating lease agreements for one office space, one research center and two employee housing. Our commitment for minimum lease payments under these operating leases as of September 30, 2018 for the next five years is as follow:

 

Twelve months ending September 30,   Minimum lease payment  
2019   $  318,200  
2020      284,587  
2021      278,904  
2022      101,959  
2023      8,954  
Thereafter     -  
Total minimum payments required   $ 992,604  

 

Rent expense for the nine months ended September 30, 2018 and 2017 was $252,834 and $243,951, respectively. Rent expense for the years ended December 31, 2017 and 2016 was $314,718 and $153,069, respectively.

 

Contingencies

 From time to time, we are party to certain legal proceedings, as well as certain asserted and un-asserted claims. Amounts accrued, as well as the total amount of reasonably possible losses with respect to such matters, individually and in the aggregate, are not deemed to be material to the consolidated financial statements.

 

On February 11, 2015, Fujian Xin Wei Electronic Industry Co., Ltd. filed a lawsuit in Putian Intermediate People’s Court against Blue Hat Fujian on a sales contract dispute of which the subject matter amount is RMB 3,643,385 ($530,487). On April 7, 2015, Blue Hat Fujian submitted a Civil Pleading. On July 20, 2015, Putian Intermediate People’s Court issued a Civil Ruling Letter ([2015] Pu Min Chu Zi No.274), which granted the withdrawal of lawsuit of Fujian Xin Wei Electronic Industry Co., Ltd.

 

On August 12, 2015, Fujian Xin Wei Electronic Industry Co., Ltd. filed a lawsuit in Putian Hanjiang District People’s Court against Blue Hat Fujian on the aforesaid dispute, claiming compensation from Blue Hat Fujian for an economic loss of RMB 1,548,560 ($225,475). On August 31, 2015, Blue Hat Fujian filed a counter-claim in Putian Hanjiang District People’s Court, claiming continued performance of the contract involved and a default fine from Fujian Xin Wei Electronic Industry Co., Ltd.

 

On February 4, 2016, Putian Hanjiang District People’s Court issued a Civil Judgement ([2015] Han Min Chu Zi No.2566), which (1) ruled that the notice of terminating purchase contract issued by Fujian Xin Wei Electronic Industry Co., Ltd. to Blue Hat Fujian shall take effect; (2) rejected other claims of the Fujian Xin Wei Electronic Industry Co., Ltd.; (3) rejected claims of Blue Hat Fujian; and (4) stated that the case acceptance fee of claim of RMB 18,737 ($2,728) shall be borne by Fujian Xin Wei Electronic Industry Co., Ltd., and the case acceptance fee of counter-claim of RMB 9,150 ($1,332) shall be borne by Blue Hat Fujian.

 

Fujian Xin Wei Electronic Industry Co., Ltd. and Blue Hat both filed appeals with the Civil Judgement ([2015] Han Min Chu Zi No.2566) issued by Putian Hanjiang District People’s Court. On September 2, 2016, Fujian Putian Intermediate People’s Court issued a Civil Ruling Letter ([2016] Min 03 Min Zhong No.1067), which: (1) revoked the Civil Judgement ([2015] Han Min Chu Zi No.2566) issued by Putian Hanjiang District People’s Court; (2) and remanded the case to Putian Hanjiang District People’s Court for re-trial.

 

On May 8, 2018, Putian Hanjiang District People’s Court issued a Civil Judgement ([2016] Min 0303 Min Chu No.3621), (a) declaring as effective, the notice of termination of purchase contract issued by Fujian Xin Wei Electronic Industry Co., Ltd. to Blue Hat Fujian and that three purchase contracts and relevant supplemental agreements will be terminated as of January 14, 2015; (b) ordering Blue Hat Fujian to compensate Fujian Xin Wei Electronic Industry Co., Ltd. for its financial loss in the amount of RMB 967,727 ($140,904), to be paid within 5 days of the effective date of the judgement; (c) rejecting other claims of Fujian Xin Wei Electronic Industry Co., Ltd.; and (d) rejecting claims made by Blue Hat Fujian. The total case acceptance fee was RMB 18,737 ($2,728), RMB 4,769 ($694) of which to be paid by Fujian Xin Wei Electronic Industry Co., Ltd., and RMB 13,969 ($2,034) of which to be paid by Blue Hat Fujian. Blue Hat Fujian will also pay the property preservation measures fee of RMB 5,000 ($728). Blue Hat Fujian filed appeals to Fujian Putian Intermediate People’s Court. On October 16, 2018, Fujian Putian Intermediate People's Court issued a Civil Judgement ([2018] Min 03 Min Zhong No.2038), which ruled that (1) the appeal was rejected and the original judgment was affirmed; (2) the case acceptance fee of second instance of RMB 23,118 ($3,366) shall be borne by the appealer, Blue Hat Fujian, and (3) such judgement shall be final. As of September 30, 2018, we had accrued a loss of approximately $156,000 based on available information and management’s best estimates. On November 23, 2018, Blue Hat Fujian paid RMB 967,727 ($140,904) to Fujian Xin Wei Electronic Industry Co., Ltd. As of the date of this prospectus, the dispute has been concluded.

 

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In addition, the Labor Contract Law of the PRC requires employers to assure the liability of severance payments if employees are terminated and have been working for at least two years prior to January 1, 2008. The employers will be liable for one month of severance pay for each year of the service provided by the employees. As of September 30, 2018, we estimated our contingency for severance payments to be approximately $0.3 million; these have not been reflected in the consolidated financial statements because management cannot predict the actual payments, if any, that will be paid in the future.

Contractual Obligations

As of September 30, 2018, the future minimum payments under certain of our contractual obligations were as follows:

          Payments Due In
Contractual obligations   Total     Less than 1 year     1 – 3 years     3 – 5 years     Thereafter
Loans obligations $  2,038,874    2,038,874   -   -   -
Operating leases obligations    992,603      318,200     563,491     110,912     -
Due to related party    31,894      31,894     -     -     -
Long-term debt obligations*   195,806      81,023      114,783     -     -
Total $ 3,259,177   $  2,469,991   $  678,274   $ 110,912   $ -

 

*Represents future value of long-term debt obligations.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements including arrangements that would affect our liquidity, capital resources, market risk support and credit risk support or other benefits.

Critical Accounting Policies and Estimates

 

Our financial statements and accompanying notes have been prepared in accordance with U.S. GAAP. The preparation of these financial statements and accompanying notes requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis of making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We have identified certain accounting policies that are significant to the preparation of our financial statements. These accounting policies are important for an understanding of our financial condition and results of operation. Critical accounting policies are those that are most important to the portrayal of our financial conditions 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. While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements included elsewhere in this registration statement, we believe the following critical accounting policies involve the most significant estimates and judgments used in the preparation of our financial statements.

Use of Estimates and Assumptions

 

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the periods presented. Significant accounting estimates reflected in our consolidated financial statements include the useful lives of plant and equipment and intangible assets, capitalized development costs, impairment of long-lived assets, allowance for doubtful accounts, revenue recognition, allowance for deferred tax assets and uncertain tax position, and inventory allowance. Actual results could differ from these estimates.

 

Fair Value Measurement

 

The accounting standard regarding fair value of financial instruments and related fair value measurements defines financial instruments and requires disclosure of the fair value of financial instruments held by us.

 

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The accounting standards define fair value, establish a three-level valuation hierarchy for disclosures of fair value measurement and enhance disclosure requirements for fair value measures. The three levels are defined as follow:

 

  Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
  Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.
  Level 3 inputs to the valuation methodology are unobservable and significant to the fair value.

 

Financial instruments included in current assets and current liabilities are reported in the consolidated balance sheets at face value or cost, which approximate fair value because of the short period of time between the origination of such instruments and their expected realization and their current market rates of interest.

 

The following table sets forth by level within the fair value hierarchy, our financial assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2018, December 31, 2017 and 2016:

 

Financial Assets  

Carrying Value 

as of 

September 30, 2018

    Fair Value Measurements at September 30, 2018 (Unaudited)  Using Fair Value Hierarchy  
    (Unaudited)     Level 1     Level 2     Level 3  
Short-term investments   $ 2,330,142     $ 2,330,142     $ -     $ -  

 

 

Financial Assets  

Carrying Value 

as of 

December 31, 2017

    Fair Value Measurements at December 31, 2017
Using Fair Value Hierarchy
 
          Level 1     Level 2     Level 3  
Short-term investments   $ 17,390,432     $ 17,390,432     $ -     $ -  

 

 

Financial Assets  

Carrying Value 

as of 

December 31, 2016

    Fair Value Measurements at December 31, 2016
Using Fair Value Hierarchy
 
          Level 1     Level 2     Level 3  
Short-term investments   $ 2,879,863     $ 2,879,863     $ -     $ -  

 

Revenue Recognition

 

Revenue is recognized when all of the following have occurred: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the price is fixed or determinable, and (iv) the ability to collect is reasonably assured.

 

Sales of interactive toys

 

We recognize sales of interactive toys revenues upon shipment or upon receipt of products by the customer, depending on the terms, provided that: there are no uncertainties regarding customer acceptance; persuasive evidence of an agreement exists documenting the specific terms of the transaction; the sales price is fixed or determinable; and collectability is reasonably assured. Management assesses the business environment, the customer’s financial condition, historical collection experience, accounts receivable aging, and customer disputes to determine whether collectability is reasonably assured. If collectability is not considered reasonably assured at the time of sale, we do not recognize revenue until collection occurs. We routinely enter into arrangements with its customers to provide sales incentives, support customer promotions, and provide allowances for returns and defective merchandise. Such programs are based primarily on customer purchases, customer performance of specified promotional activities, and other specified factors such as sales to consumers. The costs of these programs are recorded as sales adjustments that reduce gross sales in the period the related sale is recognized.

 

The products sold in the PRC are subject to a Chinese value-added tax (“VAT”). VAT taxes are presented as a reduction of revenue.

 

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Mobile games

 

We operate our mobile games as live services that allow players to play for free. Within these games, players can purchase virtual currency to obtain virtual goods to enhance the game-playing experience. On the platform, players purchase virtual currency and/or virtual goods through various widely accepted payment methods offered in the games, including Alipay or WeChat and online bank transfer service providers. Advance payments from customers for virtual goods that are non-refundable that specify our obligations are recorded to deferred revenue. All other advance payments that do not meet these criteria are recorded as advances from customers. For virtual goods purchases upon immediate use with no future game-playing benefits, we recognize such virtual goods purchase upon receipt of payment from the paying players. For virtual goods purchases for the conversion of future game-playing benefits or throughout the players’ playing life, we recognize such virtual goods purchases ratably over the estimated average playing period of paying players for the applicable game, starting from the point in time when virtual items are delivered to the players’ accounts and all other revenue recognition criteria are met. We record revenue generated from mobile games on a gross basis as we are acting as the principal to fulfill all obligations related to the game operation. Fees paid to distribution channels and payment channels are recorded as cost of revenues.

 

We consider the average period that players typically play the games and other game player behavior patterns, as well as various other factors, to arrive at the best estimates for the estimated playing period of the paying players for each game. On a quarterly basis, we determine the estimated average playing period for paying players by analyzing paying players for that game who made their first virtual goods purchase during that period and counting their cumulative login days for each game. We then average the time periods to determine the estimated paying playing period for that game. If a new game is launched and only a limited period of paying player data is available, then we consider other qualitative factors, such as the playing patterns for paying players for other games with similar characteristics and playing patterns of paying players, such as targeted players and purchasing frequency. While we believe our estimates to be reasonable based on available game player information, we may revise such estimates based on new information indicating a change in the game player behavior patterns and any adjustments are applied prospectively.

 

Based on our analysis, the estimated average playing period of paying players is approximately one to three months, and this estimate has been consistent since our initial analysis. No change has been made in such estimate during any of the periods presented. Future usage patterns may differ from historical usage patterns and therefore the estimated average playing periods may change in the future.

 

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