Filed Pursuant to Rule 424(b)(4)

Registration Nos. 333-230051 and 333-232840

 

PROSPECTUS

 

2,000,000 Ordinary Shares

 

 

Blue Hat Interactive Entertainment Technology

 

We are offering 2,000,000 ordinary shares. This is the initial public offering of ordinary shares of Blue Hat Interactive Entertainment Technology. The offering price of our ordinary shares in this offering is $4.00 per share. Prior to this offering, there has been no public market for our ordinary shares.

Our ordinary shares have been approved for listing on the Nasdaq Capital Market under the symbol “BHAT.”

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 13 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  $4.00      $8,000,000
Underwriting discounts and commissions(1)  $0.28      $560,000
Proceeds, before expenses, to us  $3.72      $7,440,000
     
 

(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 106.

 

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 $614,255, 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 underwriter exercises the option in full, the total underwriting discounts and commissions payable will be $644,000 based on the initial public offering price of $4.00 per ordinary share, and the total gross proceeds to us, before underwriting discounts and commissions and expenses, will be $9,200,000. 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 37.

 

The underwriters expect to deliver the ordinary shares against payment as set forth under “Underwriting”, on or about July 30, 2019.

 

ViewTrade Securities, Inc.

The date of this prospectus is July 26, 2019. 

 

   

 

 

TABLE OF CONTENTS

 

  Page
Prospectus Summary 1
Risk Factors 13
Special Note Regarding Forward-Looking Statements 35
Industry and Market Data 36
Use of Proceeds 37
Dividend Policy 38
Capitalization 39
Dilution 40
Exchange Rate Information 41
Corporate History and Structure 42
Selected Consolidated Financial Data 47
Management’s Discussion and Analysis of Financial Condition and Results of Operations 48
Business 63
Management 86
Related Party Transactions 90
Principal Shareholders 91
Description of Share Capital and Governing Documents 92
Shares Eligible for Future Sale 99
Material Income Tax Considerations 101
Underwriting 106
Expenses Related to this Offering 112
Legal Matters 113
Experts 113
Enforcement of Liabilities 114
Where You Can Find Additional Information 116
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 August 20, 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.

 

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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 “$” 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, as set forth in Note 2 of the notes to the consolidated financial statements included elsewhere in this prospectus. 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 6.8755 to $1.00, the noon buying rate on December 31, 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 April 26, 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 6.7282 to $1.00.

 

 

 

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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 believe 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 March 31, 2019, our intellectual property portfolio included 178 authorized patents, 44 patents in various stages of the patent application process, 14 applications for Patent Cooperation Treaty, or PCT, international patents, 71 registered trademarks, 645 copyrights for art work and 27 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 55.6% of our total revenues in 2018.

 

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 33.9% of our total revenues in 2018.

 

 

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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 0.001% of our total revenues in 2018.

 

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 0.03% of our total revenues in 2018.

 

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, Fidolle in 2019 and QI in 2021, and two additional new products in 2020. We intend to launch new generations of our four existing products within the next three years. We are currently developing 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 AR technologies, we differentiate ourselves from traditional toy companies that lack the technological sophistication required to enter the AR interactive toy industry. We believe 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.
Proprietary 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 three additional stores in Xiamen in 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, or Blue Hat Cayman. We have no substantive operations other than holding all of the issued and outstanding shares of Brilliant Hat Limited, or 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, or 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., or Blue Hat WFOE, which was established on July 26, 2018 under the laws of the PRC.

 

We, through our variable interest entity, or VIE, Fujian Blue Hat Interactive Entertainment Technology Ltd., or Blue Hat Fujian, a PRC company, and through its wholly owned subsidiaries, including Hunan Engaomei Animation Culture Development Co., Ltd., or Blue Hat Hunan, and Shenyang Qimengxing Trading Co., Ltd., or 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., or Fujian Youth, a PRC company. As of December 31, 2018 and December 31, 2017, Fujian Youth had no operations.

 

On January 25, 2018, Blue Hat Fujian established its wholly owned subsidiary, Chongqing Lanhui Technology Co. Ltd., or Blue Hat Chongqing, a PRC company. As of December 31, 2018, Blue Hat Chongqing had no operations.

 

On September 10, 2018, Blue Hat Fujian established its wholly owned subsidiary, Pingxiang Blue Hat Technology Co. Ltd., or 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., or 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., or 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:

 

 

 

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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, or 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.
         
                 

 

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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, or POAs, and irrevocable commitment letters, or 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 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 Accounting Standards Codification, or 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 13. 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.

 

 8 

 

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, or 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.

 

 9 

 

 

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.

 

 10 

 

 

The Offering

 

Securities being offered

 

2,000,000 ordinary shares on a firm commitment basis.

   
Initial offering price $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

35,000,000 ordinary shares, assuming no exercise of the underwriters’ over-allotment option and excluding 200,000 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 37.
   
 Lock-up

All of our directors and officers and our principal shareholders (5% or more shareholders) 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. All of our other shareholders 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 6 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.
   
Nasdaq symbol Our ordinary shares have been approved for listing 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 13.

 

 11 

 

 

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, 2018 and 2017 and the summary consolidated balance sheet as of December 31, 2018 and 2017 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 Years Ended December 31,  
  2018     2017  
       
  $     $  
Consolidated Statements of Income and
Comprehensive Income:
             
Revenues   18,531,178       14,144,894  
Cost of revenues   6,108,676     5,300,087
Gross profit   12,422,502       8,844,807  
Operating expenses   4,105,037     2,900,349
Income from operations   8,317,465       5,944,458  
Other non-operating income, net   207,371       135,709  
Provision for income taxes   605,428       955,194  
Net income   7,919,408       5,124,973  

Foreign currency translation adjustment*

  (1,474,126 )     958,667  
Comprehensive Income   6,445,282       6,083,640  
Earnings per share, basic and diluted   0.24       0.16  
Weighted average ordinary Shares outstanding   33,000,000       33,000,000  

 

 

* Foreign currency translation adjustment resulted from the translation of the consolidated financial statements between RMB and U.S. dollar and is included in accumulated other comprehensive income (loss).

 

    December 31, 2018     December 31, 2017  
           
Consolidated Balance Sheet Data:   $     $  
Current assets     25,659,179       29,243,641  
Total assets     35,470,864       33,582,177  
Current liabilities     7,122,833       11,594,387  
Total liabilities     7,214,819       11,771,414  
Total equity     28,256,045       21,810,763  

 

 

 12 

 

 

 

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.

 13 

 

 

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 2018, we primarily relied on five Chinese distributors for the sale of our products, which each accounted for approximately 5.4% to 6.7% of our total annual revenue and together accounted for 30.1% of our total annual revenue. In 2018, approximately 99.3% of our products were sold in China and, of these sales in China, approximately 99.1% 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.

 14 

 

 

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 March 31, 2019, we had 107 employees, all of which were 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 three additional stores in Xiamen in 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 ($43,633) 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.

 15 

 

 

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.

 16 

 

 

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, or 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.

Our current corporate structure and business operations may be affected by the newly enacted Foreign Investment Law.

On March 15, 2019, the National People’s Congress approved the Foreign Investment Law, which will take effect on January 1, 2020. Since it is relatively new, uncertainties exist in relation to its interpretation and its implementation rules that are yet to be issued. The Foreign Investment Law does not explicitly classify whether variable interest entities that are controlled through contractual arrangements would be deemed as foreign-invested enterprises if they are ultimately "controlled" by foreign investors. However, it has a catch-all provision under definition of "foreign investment" that includes investments made by foreign investors in China through other means as provided by laws, administrative regulations or the State Council. Therefore it still leaves leeway for future laws, administrative regulations or provisions of the State Council to provide for contractual arrangements as a form of foreign investment. Therefore, there can be no assurance that our control over our consolidated VIE through contractual arrangements will not be deemed as foreign investment in the future.

The Foreign Investment Law grants national treatment to foreign-invested entities, except for those foreign-invested entities that operate in industries specified as either "restricted" or "prohibited" from foreign investment in a "negative list" that is yet to be published. It is unclear whether the "negative list" to be published will differ from the current Special Administrative Measures for Market Access of Foreign Investment (Negative List). The Foreign Investment Law provides that foreign-invested entities operating in "restricted" or "prohibited" industries will require market entry clearance and other approvals from relevant PRC government authorities. If our control over our consolidated VIE through contractual arrangements are deemed as foreign investment in the future, and any business of our consolidated VIE is "restricted" or "prohibited" from foreign investment under the "negative list" effective at the time, we may be deemed to be in violation of the Foreign Investment Law, the contractual arrangements that allow us to have control over our consolidated VIE may be deemed as invalid and illegal, and we may be required to unwind such contractual arrangements and/or restructure our business operations, any of which may have a material adverse effect on our business operation.

Furthermore, if future laws, administrative regulations or provisions mandate further actions to be taken by companies with respect to existing contractual arrangements, we may face substantial uncertainties as to whether we can complete such actions in a timely manner, or at all. Failure to take timely and appropriate measures to cope with any of these or similar regulatory compliance challenges could materially and adversely affect our current corporate structure and business operations.

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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. 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.

On February 3, 2015, the SAT issued the Announcement of the State Administration of Taxation on Several Issues Relating to Enterprise Income Tax on Transfers of Assets between Non-resident Enterprises, or SAT Bulletin 7, which was partially abolished on December 29, 2017. SAT Bulletin 7 extends its tax jurisdiction to transactions involving transfer of taxable assets through the offshore transfer of a foreign intermediate holding company. In addition, SAT Bulletin 7 has introduced safe harbors for internal group restructurings and the purchase and sale of equity through a public securities market. SAT Bulletin 7 also brings challenges to both foreign transferor and transferee (or other person who is obligated to pay for the transfer) of taxable assets.

On October 17, 2017, the SAT issued the Announcement of the State Administration of Taxation on Issues Concerning the Withholding of Non-resident Enterprise Income Tax at Source, or SAT Bulletin 37, which was partially revised. SAT Bulletin 37 came into effect on December 1, 2017. The SAT Bulletin 37 further clarifies the practice and procedure of withholding of non-resident enterprise income tax.

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 Bulletin 7 and/or SAT Bulletin 37. For transfer of shares in our company by investors who are non-PRC resident enterprises, our PRC subsidiary may be requested to assist in the filing under SAT Bulletin 7 and/or SAT Bulletin 37. As a result, we may be required to expend valuable resources to comply with SAT Bulletin 7 and/or SAT Bulletin 37 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 year ended December 31, 2018, our two largest suppliers, Fujian Wei Ya Culture Communication Co., Ltd. and Dongxin Intelligent Technology Co. Ltd., accounted for 49.2% and 43.6%, respectively, of our total purchases, and together accounted for 92.8% of our total purchases. 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.

Our dependence on a limited number of customers could adversely affect our business and results of operations.

One or a few customers have in the past, and may in the future, represent a substantial portion of our total revenues in any one year or over a period of several years. For example, in 2018, two customers under the same ownership, Jinan Kangdian Trade Co. Ltd. and Qingdao Oudian Trading Co. Ltd., accounted for 10.8% of our total revenues. Therefore, the loss of business from any one of such customers could have a material adverse effect on our business or results of operations. In addition, a default or delay in payment on a significant scale by a customer could materially adversely affect our business, results of operations, cash flows and financial condition.

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 stock will initially trade under $5.00 per ordinary share and thus will be known as 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 will initially trade below $5.00 per share. As a result, our stock will 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 $3.12 per share, representing the difference between the initial public offering price of $4.00 per share and our pro forma as adjusted net tangible book value per share as of December 31, 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 35,000,000 ordinary shares, based on the number of ordinary shares outstanding as of December 31, 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 holding more than 5% of our ordinary shares, collectively, will control approximately 68% 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.

Recently introduced economic substance legislation of the Cayman Islands may impact us and our operations.

The Cayman Islands, together with several other non-European Union jurisdictions, has recently introduced legislation aimed at addressing concerns raised by the Council of the European Union as to offshore structures engaged in certain activities which attract profits without real economic activity. With effect from January 1, 2019, the International Tax Co-operation (Economic Substance) Law, 2018, or the Substance Law, and issued Regulations and Guidance Notes came into force in the Cayman Islands introducing certain economic substance requirements for “relevant entities” which are engaged in certain “relevant activities,” which in the case of exempted companies incorporated before January 1, 2019, will apply in respect of financial years commencing July 1, 2019 and onwards. A “relevant entity” includes an exempted company incorporated in the Cayman Islands; however, it does not include an entity that is tax resident outside the Cayman Islands. Accordingly, for so long as we are a tax resident outside the Cayman Islands, we are not required to satisfy the economic substance test. Although it is presently anticipated that the Substance Law will have little material impact on us and our operations, as the legislation is new and remains subject to further clarification and interpretation it is not currently possible to ascertain the precise impact of these legislative changes on us and our operations.

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, or 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 2,000,000 ordinary shares in this offering will be approximately $6,745,745, after deducting the underwriting discounts and commissions, non-accountable expense allowance and estimated offering expenses payable by us, based on the 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 $7,861,745, 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 December 31, 2018 on:

an actual basis; and

 

a pro forma as adjusted basis to give effect to the sale of 2,000,000 ordinary shares in this offering at the 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 December 31, 2018
  Actual       Pro Forma As
    Adjusted (1) 
Shareholders’ Equity $       $

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

35,000,000 shares issued and outstanding pro forma

33,000        35,000
Additional paid-in capital 12,831,969        19,575,714
Statutory reserves 1,178,432        1,178,432
Retained earnings 15,169,573        15,169,573
Accumulated other comprehensive loss (956,929 )      (956,929)
           
Total shareholders’ equity 28,256,045        35,001,790
Total capitalization 28,256,045       35,001,790

  

(1) Reflects the sale of ordinary shares in this offering at an 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. 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 $6,745,745.

 

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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 December 31, 2018, we had a historical net tangible book value of $24.0 million, or $0.73 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 December 31, 2018.


After giving effect to the sale of 2,000,000 ordinary shares in this offering at the 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 December 31, 2018 would have been $31.0 million, or $0.88 per ordinary share. This represents an immediate increase in pro forma as adjusted net tangible book value of $0.15 per ordinary share to existing investors and immediate dilution of $3.12 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

Initial public offering price per ordinary share $4.00   $4.00
Net tangible book value per ordinary share as of December 31, 2018 $0.73   $0.73
Increase in pro forma as adjusted net tangible book value per ordinary share attributable to new investors purchasing ordinary shares in this offering $0.15   $0.17
Pro forma as adjusted net tangible book value per ordinary share after this offering $0.88   $0.90
Dilution per ordinary share to new investors in this offering $3.12   $3.10

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 $0.90, the increase in net tangible book value per ordinary share to existing shareholders would be $0.17, and the immediate dilution in net tangible book value per ordinary share to new investors in this offering would be $3.10. 

The table and discussion above is based on 33,000,000 ordinary shares outstanding as of December 31, 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 6.8755 to $1.00, the noon buying rate on December 31, 2018, as set forth in the H.10 statistical release of the Board of Governors of the Federal Reserve System. On April 26, 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 6.7282 to $1.00.

 

    Certified Exchange Rate      
Period   Period End     Average(1)     Low     High      
    (RMB per $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     6.8755           6.6292             6.2649         6.9737    
2019                                                    
January         6.6958           6.7863             6.6958         6.8708      
February         6.6912           6.7367             6.6822         6.7907      
March         6.7112           6.7119             6.6916         6.7381      
April (through April 26, 2019)         6.7282           6.7143             6.6870         6.7418      

(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

 

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CORPORATE HISTORY AND STRUCTURE

Corporate History

 

We are a holding company incorporated on June 13, 2018, under the laws of the Cayman Islands, or Blue Hat Cayman. We have no substantive operations other than holding all of the issued and outstanding shares of Brilliant Hat Limited, or 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, or 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., or Blue Hat WFOE, which was established on July 26, 2018 under the laws of the PRC.

 

We, through our variable interest entity, or VIE, Fujian Blue Hat Interactive Entertainment Technology Ltd., or Blue Hat Fujian, a PRC company, and through its wholly owned subsidiaries, including Hunan Engaomei Animation Culture Development Co., Ltd., or Blue Hat Hunan, and Shenyang Qimengxing Trading Co., Ltd., or 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., or Fujian Youth, a PRC company. As of December 31, 2018 and December 31, 2017, Fujian Youth had no operations.

 

On January 25, 2018, Blue Hat Fujian established its wholly owned subsidiary, Chongqing Lanhui Technology Co. Ltd., or Blue Hat Chongqing, a PRC company. As of December 31, 2018, Blue Hat Chongqing had no operations.

 

On September 10, 2018, Blue Hat Fujian established its wholly owned subsidiary, Pingxiang Blue Hat Technology Co. Ltd., or 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., or 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., or 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:

 

 

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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.

 

 

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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, or 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 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, 2018 and 2017 and the summary consolidated balance sheets as of December 31, 2018 and 2017 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 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 Years Ended December 31,  
  2018     2017  
       
  $     $  
Consolidated Statements of Income and
Comprehensive Income:
             
Revenues   18,531,178       14,144,894  
Cost of revenues   6,108,676     5,300,087
Gross profit   12,422,502       8,844,807  
Operating expenses   4,105,037     2,900,349  
Income from operations   8,317,465       5,944,458  
Other non-operating income, net   207,371       135,709  
Provision for income taxes   605,428       955,194  
Net income   7,919,408       5,124,973  

Foreign currency translation adjustment*

  (1,474,126 )     958,667  
Comprehensive Income   6,445,282       6,083,640  
Earnings per share, basic and diluted   0.24       0.16  
Weighted average ordinary Shares outstanding   33,000,000       33,000,000  

 

 

* Foreign currency translation adjustment resulted from the translation of the consolidated financial statements between RMB and U.S. dollar and is included in accumulated other comprehensive income (loss).

 

    December 31, 2018     December 31, 2017  
           
Consolidated Balance Sheet Data:   $     $  
Current assets     25,659,179       29,243,641  
Total assets     35,470,864       33,582,177  
Current liabilities     7,122,833       11,594,387  
Total liabilities     7,214,819       11,771,414  
Total equity     28,256,045       21,810,763  

 

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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 believe 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 March 31, 2019, our intellectual property portfolio included 178 authorized patents, 44 patents in various stages of the patent application process, 14 applications for PCT international patents, 71 registered trademarks, 645 copyrights for art work and 27 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 and mobile games. Our total revenues increased by $4,386,284, or 31.0%, to $18,531,178 for the year ended December 31, 2018 as compared to $14,144,894 for the year ended December 31, 2017.

 

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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 slightly lower level of investment in research and development internally in the year ended December 31, 2018, totaling $286,842. However, we have collaborated with two external developers in the AR interactive toys and games industry. As of December 31, 2018, we prepaid approximately $3.4 million to such developers for the development of more advanced technology for our AR interactive toys and games.

 

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 99.3% of our products sold in 2018 were sold domestically in China, and 99.1% 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 Years Ended December 31, 2018 and December 31, 2017

 

   For the Years ended December 31,
            Percentage
   2018  2017  Change  Change
Revenues  $18,531,178   $14,144,894   $4,386,284    31.0%
Cost of revenues   6,108,676    5,300,087    808,589    15.3%
Gross profit   12,422,502    8,844,807    3,577,695    40.4%
Selling expenses   759,647    629,424    130,223    20.7%
General and administrative expenses   3,058,548    1,915,195    1,143,353    59.7%
Research and development   286,842    355,730    (68,888)   (19.4)%
Income from operations   8,317,465    5,944,458    2,373,007    39.9%
Other (expense) income, net   207,371    135,709    71,662    52.8%
Provision for income taxes   605,428    955,194    349,766    (36.6)%
Net income  $7,919,408    5,124,973    2,794,435    54.5%

 

   

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Revenues

 

Our revenues are derived from sales of interactive toys, animation and game series, and mobile games. Total revenues increased by $4,386,284, or 31.0%, to $18,531,178 for the year ended December 31, 2018 as compared to $14,144,894 for the year ended December 31, 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 revenues from each of our revenue categories are summarized as follows:

 

  

For the Year ended

December 31, 2018

  For the Year ended
December 31, 2017
  Change  Change (%)
             
Revenues                    
Interactive toys - animation series  $522,638   $1,060,330   $(537,692)   (50.7)%
Interactive toys - game series   16,896,944    12,956,131    3,940,813    30.4%
Mobile games   1,111,596    128,433    983,163    765.5%
Total revenues  $18,531,178   $14,144,894   $4,386,284    31.0%

Interactive Toys - Game Series

Revenues from sales of interactive toys - game series increased by $3.9 million, or 30.4%, from $13.0 million for the year ended December 31, 2017 to $16.9 million for the year ended December 31, 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 66.8% for the year ended December 31, 2018 as compared to interactive toys – animation series, which had an average gross profit percentage of 27.5% for the same period. 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 $0.5 million, or 50.7%, from $1.1 million for the year ended December 31, 2017 to $0.5 million for the year ended December 31, 2018. 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 66.8% for the year ended December 31, 2018 as compared to interactive toys – animation series, which had an average gross profit percentage of 27.5% 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 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 our mobile game revenues increased by $1.0 million, or 765.5%, from $128,000 for the year ended December 31, 2017 to $1.1 million for the year ended December 31, 2018. This increase is a result of the implementation of purchase options for virtual currency and/or virtual goods into our mobile game platform and the addition of another mobile game in a third party gaming platform. 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. In addition, in September 2018, we added another mobile game in a third party gaming platform. As a result, our mobile game revenues increased in 2018. We expect our mobile game revenues to continue to increase in 2019.

 

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Cost of Revenues

Total cost of revenues increased by $0.8 million, or 15.37%, to $6.1 million for the year ended December 31, 2018 as compared to $5.3 million for the year ended December 31, 2017. This increase is a direct result of our increase of revenues.

 

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

 

   For the Year ended
December 31, 2018
  For the Year ended
December 31, 2017
  Change  Change (%)
             
Cost of revenues                    
Interactive toys - animation series  $379,069   $653,118   $(274,049)   (42.0)%
Interactive toys - game series   5,612,915    4,627,337    985,578    21.3%
Mobile games   116,692    19,632    97,060    494.4%
Total cost of revenues  $6,108,676   $5,300,087   $808,589    15.3%

  

Our cost of revenues from interactive toys – game series increased by $1.0 million, or 21.3%, from $4.6 million for the year ended December 31, 2017 to $5.6 million for the year ended December 31, 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 $0.3 million, or 42.0%, from $0.7 million for the year ended December 31, 2017 to $0.4 million for the year ended December 31, 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 $80,000, or 494.4%, from $20,000 for the year ended December 31, 2017 to $0.1 million for the year ended December 31, 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 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 summarized as follows:

 

   For the Year ended
December 31, 2018
  For the Year ended
December 31, 2017
  Change  Change (%)
             
Interactive toys - animation series                    
Gross profit  $143,569   $407,212   $(263,644)   (64.7)%
Gross margin   27.5%   38.4%   (10.9)%     
                     
Interactive toys - game series                    
Gross profit  $11,284,029   $8,328,793   $2,955,235    35.5%
Gross margin   66.8%   64.3%   2.5%     
                     
Mobile games                    
Gross profit  $994,904   $108,802   $886,102    814.4%
Gross margin   89.5%   84.7%   4.8%     
                     
Total                    
Gross profit  $12,422,502   $8,844,807   $3,577,696    40.4%
Gross margin   67.0%   62.5%   4.5%     

  

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Our gross profit increased by $3.6 million, or 4.5%, to $12.4 million during the year ended December 31, 2018, from $8.8 million for the year ended December 31, 2017. The increase in gross profit was 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, 2018 and 2017, our overall gross profit percentage was 67.0% and 62.5%, respectively. The increase in gross profit percentage was primarily due to the increase of revenues from our interactive toys – game series, which contributed 91.2% of our total revenues with a gross profit percentage of 66.8% for the year ended December 31, 2018 as compared to the year ended December 31, 2017, where our interactive toys – game series contributed 91.6% of our total revenues with a gross profit percentage of 64.3%.

 

Gross profit percentage for our interactive toys – game series was 66.8% and 64.3% for the years ended December 31, 2018 and 2017, respectively. The increase of gross profit percentage was 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 2.5%.

 

Gross profit percentage for our interactive toys – animation series was 27.5% and 38.4% for the years ended December 31, 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 year ended December 31, 2017, but did not get approved and refunded for in the year ended December 31, 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 year ended December 31, 2018 as compared to the same period in 2017 by 10.9%.

 

Gross profit percentage for our mobile games was 89.5% and 84.7% for the years ended December 31, 2018 and 2017, respectively. The gross profit percentage of our mobile games will fluctuate as our cost of sales are fixed costs while our revenue is primarily determined by the playing habit of our users and when they will recharge virtual goods purchases.

Operating Expenses

Total operating expenses increased by $1.2 million, or 41.5%, from $2.9 million during the year ended December 31, 2017 to $4.1 million during the year ended December 31, 2018. This increase was mainly attributable to the $0.1 million decrease in selling expenses, the $1.1 million increase in general and administrative, or G&A, expenses, and the $69,000 decrease in research and development, or R&D, expenses for the year ended December 31, 2018 as compared to the year ended December 31, 2017.

 

The $0.1 million increase in selling expenses was primarily attributable to (i) a $0.4 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. This increase is offset by (i) the $0.2 million decrease in advertising publication fees and (ii) the $0.1 million decrease in product packaging fees.

 

The $1.1 million increase in G&A expenses was primarily attributable to (i) the $0.4 million increase in professional fees as we had incurred fees in connection with this offering, (ii) the $0.4 million increase in bad debt allowance, (iii) the $0.2 million increase in depreciation and amortization expenses and (iv) the $0.1 million increase in other various miscellaneous G&A expenses, such as expenses for meals and entertainment, automobile, travel, recruitment and a guarantee fee due to the increase of our operating needs.

 

The $69,000 decrease in R&D expenses was 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 began outsourcing our external R&D teams to develop cutting-edge technologies. As of December 31, 2018, we prepaid approximately $3.4 million to such developers for the development of more advanced technology for our AR interactive toys and games.

Other (expense) income, net

Total other income, net increased by $72,000, or 52.8%, from $136,000 during the year ended December 31, 2017 to $207,000 during the year ended December 31, 2018. This increase was primarily attributable to (i) the $58,000 increase in interest income as we invested more short-term investments of certificate deposits and (ii) the $41,000 decrease in interest expense as we repaid certain of our short-term bank loans. This increase is offset by the $26,000 decrease in other income.

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Income tax expense

Our income tax expense amounted to $605,000 and $955,000 for the years ended December 31, 2018 and 2017, respectively. This decrease of $350,000 is a result of a favorable income tax rate being granted to Blue Hat Pingxiang, which we are applying using 10% of gross revenue to apply its 25% tax rate as compared to the standard income tax rate of 25%.

Net income

 

Our net income increased by $2.8 million, or 54.5%, to $7.9 million for the year ended December 31, 2018, from $5.1 million for the year ended December 31, 2017. Such change was the result of the combination of the changes as discussed above.

  

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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 December 31, 2018, our working capital was $18.5 million and cash and cash equivalents amounted to $11.8 million. Our current assets were $25.7 million and our current liabilities were $17.1 million with shareholders’ equity of $28.3 million as of December 31, 2018. We generated net income of $7.9 million and $5.1 million from our operations for the years ended December 31, 2018 and 2017, 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.

 

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 ($43,633) per store in such endeavors, consisting of approximately RMB 100,000 ($14,544) for equipment, approximately RMB 50,000 ($7,272) to RMB 80,000 ($11,636) for renovations, and approximately RMB 120,000 ($17,453) to RMB 150,000 ($21,817) 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.

 

As of December 31, 2018, the following were outstanding balances on our short-term bank loans:

 

Bank Name Maturities Interest Rate Collateral/Guarantee December 31, 2018
China Construction Bank March 2019  (Repaid in March 2019) 5.71%

Guarantee by Xiamen

Jingyuan Finance Guarantee

Co. Ltd.

$1,090,354
China Construction Bank March 2019  (Repaid in March 2019) 5.71%

Guarantee by Xiamen

Jingyuan Finance Guarantee

Co. Ltd.

$944,973
Industrial Bank December 2019 6.09% Guarantee by Xiaodong Chen, Juanjuan Cai, and Yong Chen $436,142
Industrial Bank December 2019 6.09% Guarantee by Xiamen Siming Technology Financing Guarantee Co. Ltd, Xiaodong Chen, Juanjuan Cai, and Yong Chen $654,212

 

In April 2017, we entered into a line of credit agreement with China Construction Bank pursuant to which we may borrow up to $2,035,327 (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 $1,090,354 (RMB 7,500,000) and $944,973 (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 of December 31, 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.

 

 

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

 

      
 

For the Years Ended

December 31,

  2018  2017
      
Net cash (used in) provided by operating activities $(414,604)  $6,989,680 
Net cash provided by (used in) investing activities  10,801,986     (15,814,920 )
Net cash (used in) provided by financing activities  (426,221)   10,167,330 
Effect of exchange rate change on cash and cash equivalents  (501,935)   72,267 
Net change in cash and cash equivalents $9,459,226   $1,414,357 

Operating activities

Net cash used in operating activities was $0.4 million for the year ended December 31, 2018 and was primarily attributable to (i) a $6.6 million increase in accounts receivables as we expanded our operations by providing more credit sales in the fourth quarter of 2018 which had not been collected as of December 31, 2018 and (ii) the $4.2 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 $7.9 million, (ii) various non-cash items of $0.9 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 $0.3 million decrease in inventories, as we improved inventory management and now keep a minimal amount of inventories on hand, (iv) a $0.8 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, (vi) a $0.3 million increase in taxes payable due to increase in value-added tax on sales.

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.

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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Investing activities

Net cash provided by investing activities was $10.8 million for the year ended December 31, 2018 and was primarily attributable to $19.5 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 $0.9 million payment on intangible assets, prepayments for research and development of $3.4 million, and purchase of short-term investments of certificate deposits of $2.4 million.

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.
 

Financing activities

Net cash used in financing activities was $0.4 million for the year ended December 31, 2018 and was primarily attributable to $3.6 million in payments of short-term bank loans, offset by proceeds from short-term bank loans of $3.2 million.

Net cash provided by financing activities was $10.2 million for the year ended December 31, 2017 and 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.

 

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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 December 31, 2018 for the next five years is as follow:

 

Twelve months ending December 31,   Minimum lease payment  
2019   $  327,131  
2020      306,796  
2021      278,419  
2022      42,902  
2023      -  
Total minimum payments required   $ 955,248  

 

Rent expense for the years ended December 31, 2018 and 2017 was $387,191 and $314,718, respectively.

 

Purchase commitments

 

We have entered into five research and development agreements for the development of certain educational platforms and application systems. As of December 31, 2018, our commitment under these agreements amounted to $13,375,009, and $11,630,443 of these commitments were paid in January 2019.

 

Contingencies
 

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 was RMB 3,643,385 ($529,908). 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 ($225,229). 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 ($2,725) shall be borne by Fujian Xin Wei Electronic Industry Co., Ltd., and the case acceptance fee of counter-claim of RMB 9,150 ($1,331) 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 ($140,750), to be paid within 5 days of the effective date of the judgment; (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 ($2,725), RMB 4,769 ($694) of which was to be paid by Fujian Xin Wei Electronic Industry Co., Ltd., and RMB 13,969 ($2,031) of which was to be paid by Blue Hat Fujian. Blue Hat Fujian will also pay the property preservation measures fee of RMB 5,000 ($727). 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 ($3,362) shall be borne by the appealer, Blue Hat Fujian, and (3) such judgment shall be final. As of December 31, 2017, 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 ($140,750) 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 December 31, 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 December 31, 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  $3,125,681   $3,125,681   $—     $—     $—   
Operating leases obligations   955,248    327,131    585,215    42,902    —   
Due to related party   62,368    62,368    —      —      —   
Purchase obligations   13,375,009    13,375,009    —      —      —   
Long-term debt obligations*   175,245    80,882    94,363    —      —   
Total  $17,693,551   $16,971,071   $679,578   $42,902   $—   

*Represent 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 December 31, 2018 and 2017:

 

Financial Assets  

Carrying Value 

as of 

December 31, 2018

   

Fair Value Measurements at December 31, 2018

Using Fair Value Hierarchy

 
        Level 1     Level 2     Level 3  
Short-term investments   $ -     $ -     $ -     $ -  

 

 

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     $ -     $ -  

  

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, or VAT. VAT taxes are presented as a reduction of revenue.

 

On January 1, 2019, we adopted Accounting Standards Update, or ASU, 2014-09 Revenue from Contracts with Customers (ASC 606) using the modified retrospective method for contracts that were not completed as of January 1, 2019. This did not result in an adjustment to retained earnings upon adoption of this new guidance for our Sales of interactive toys revenue as the revenue was recognized based on the amount of consideration we expect to receive in exchange for satisfying the performance obligations and based on when control of goods transfer to a customer at a point in time, which is generally similar to when its delivery has occurred prior to January 1, 2019.

 

 

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Mobile games

 

a.Internal developed platform

 

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.

 

a.Third-party platform

 

In addition, third parties operate our mobile games developed internally through mobile platforms and we receive revenue-based royalty payments from all of the third-party licensee operators on a monthly basis. The revenue-based royalty payments are recognized when all other revenue recognition criteria are met. We record the mobile game royalty revenue on a net basis, as we do not have the primary responsibility for fulfillment and acceptability of the game services.

 

Animation design service

 

Revenue from fixed-price animation design service contracts require us to perform services for animation design based on customers’ specific needs. We recognize our animation design service revenues upon completion of the design after the acceptance by our customers with no more future obligation of the design project using completed contract method as the duration of the design period is short, usually approximately 3 months or less.

 

We did not have any animated design service revenue for the years ended December 31, 2018 and 2017.

 

Accounts receivable, net

 

Accounts receivable include trade accounts due from customers. Accounts are considered overdue after 30 days. In establishing the required allowance for doubtful accounts, management considers historical collection experience, aging of the receivables, the economic environment, industry trend analysis, and the credit history and financial conditions of the customers. Management reviews its receivables on a regular basis to determine if the bad debt allowance is adequate, and adjusts the allowance when necessary. Delinquent account balances are written-off against allowance for doubtful accounts after management has determined that the likelihood of collection is not probable.

 

Intangible assets

 

Our intangible assets with definite useful lives primarily consist of software development costs, patents and licensed software. We amortize our intangible assets with definite useful lives over their estimated useful lives and review these assets for impairment. We typically amortize our intangible assets with definite useful lives on a straight-line basis over the shorter of the contractual terms or the estimated useful lives of five to ten years.

 

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Software development costs

We follow the provisions of ASC 350-40, “Internal Use Software” to capitalize certain direct development costs associated with internal-used software. ASC 350-40 provides guidance on capitalization of the costs incurred for computer software developed or obtained for internal use. We expense all costs incurred during the preliminary project stage of its development, and capitalizes costs incurred during the application development stage. Costs incurred relating to upgrades and enhancements to the application are capitalized if it is determined that these upgrades or enhancements add additional functionality to the application. The capitalized development cost is amortized on a straight-line basis over the estimated useful life, which is generally five years. Management evaluates the useful lives of these assets on an annual basis and tests for impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets.

 

Impairment for Long-lived Assets

 

Long-lived assets, including property and equipment and intangible assets with finite lives are reviewed for impairment whenever events or changes in circumstances (such as a significant adverse change to market conditions that will impact the future use of the assets) indicate that the carrying value of an asset may not be recoverable. We assess the recoverability of the assets based on the undiscounted future cash flows the assets are expected to generate and recognize an impairment loss when estimated undiscounted future cash flows expected to result from the use of the asset plus net proceeds expected from disposition of the asset, if any, are less than the carrying value of the asset. If an impairment is identified, we would reduce the carrying amount of the asset to its estimated fair value based on a discounted cash flows approach or, when available and appropriate, to comparable market values. As of December 31, 2018 and 2017, no impairment of long-lived assets was recognized. 

 

Income taxes

 

We account for current income taxes in accordance with the laws of the relevant tax authorities. The charge for taxation is based on the results for the fiscal year as adjusted for items, which are non-assessable or disallowed. It is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date.

 

Deferred taxes are accounted for using the asset and liability method in respect of temporary differences arising from differences between the carrying amount of assets and liabilities in the consolidated financial statements and the corresponding tax basis used in the computation of assessable tax profit. In principle, deferred tax liabilities are recognized for all taxable temporary differences. Deferred tax assets are recognized to the extent that it is probable that taxable profit will be available against which deductible temporary differences can be utilized. Deferred tax is calculated using tax rates that are expected to apply to the period when the asset is realized or the liability is settled. Deferred tax is charged or credited in the income statement, except when it is related to items credited or charged directly to equity, in which case the deferred tax is also dealt with in equity. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Current income taxes are provided for in accordance with the laws of the relevant taxing authorities.

 

An uncertain tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. No penalties and interest incurred related to underpayment of income tax are classified as income tax expense in the period incurred. PRC tax returns filed in 2015 to 2017 are subject to examination by any applicable tax authorities.

Recent Accounting Pronouncements

See Note 2 of the notes to the consolidated financial statements included elsewhere in this prospectus for a discussion of recently issued accounting standards.

Quantitative and Qualitative Disclosures about Market Risk

 

Interest Rate Risk

 

We are exposed to interest rate risk while we have short-term bank loans outstanding. Although interest rates for our short-term loans are typically fixed for the terms of the loans, the terms are typically twelve months and interest rates are subject to change upon renewal.

 

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Credit Risk

 

Credit risk is controlled by the application of credit approvals, limits and monitoring procedures. We manage credit risk through in-house research and analysis of the Chinese economy and the underlying obligors and transaction structures. We identify credit risk collectively based on industry, geography and customer type. In measuring the credit risk of our sales to our customers, we mainly reflect the “probability of default” by the customer on its contractual obligations and consider the current financial position of the customer and the current and likely future exposures to the customer.

 

Liquidity Risk

 

We are also exposed to liquidity risk which is risk that it we will be unable to provide sufficient capital resources and liquidity to meet our commitments and business needs. Liquidity risk is controlled by the application of financial position analysis and monitoring procedures. When necessary, we will turn to other financial institutions and related parties to obtain short-term funding to cover any liquidity shortage.

 

Foreign Exchange Risk

While our reporting currency is the U.S. dollar, almost all of our consolidated revenues and consolidated costs and expenses are denominated in RMB. All of our assets are denominated in RMB. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between the U.S. dollar and RMB. If the RMB depreciates against the U.S. dollar, the value of our RMB revenues, earnings and assets as expressed in our U.S. dollar financial statements will decline. We have not entered into any hedging transactions in an effort to reduce our exposure to foreign exchange risk.

 

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BUSINESS

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 believe 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 March 31, 2019, our intellectual property portfolio included 178 authorized patents, 44 patents in various stages of the patent application process, 14 applications for PCT international patents, 71 registered trademarks, 645 copyrights for art work and 27 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, and mobile games. Our total revenues increased by $4,386,284, or 31.0%, to $18,531,178 for the year ended December 31, 2018 as compared to $14,144,894 for the year ended December 31, 2017.

 

Products

 

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 slightly lower level of investment in research and development internally in the year ended December 31, 2018, totaling $286,842. However, we have collaborated with two external developers in the AR interactive toys and games industry. As of December 31, 2018, we prepaid approximately $3.4 million to such developers for the development of more advanced technology for our AR interactive toys and games. We currently offer four primary AR interactive product lines: AR Racer, AR Need a Spanking, AR 3D Magic Box and AR Picture Book. We release new mobile applications annually, and intend to continue doing so, in an effort to extend the life cycle of our products and create new, fun experiences for our users.

 

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Products in the Market

 

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 55.6% of our total revenues in 2018.

 

 

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 33.9% of our total revenues in 2018.

 

 

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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 0.001% of our total revenues in 2018.

 

 

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 0.03% of our total revenues in 2018.

 

 

 

Products in Development

 

We plan to continue to invest significant amounts of our resources towards product development and bringing new and exciting 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, Fidolle in 2019 and QI in 2021, and two additional new products in 2020. We intend to launch new generations of our four existing products within the next three years. We are currently developing Fidolle and QI.

 

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Fidolle

 

Fidolle, a ball-jointed “smart doll”, is an educational, interactive product that we plan to launch 2019. We also plan to develop five additional unique Fidolle characters, with the second character expected to launch in 2020. We expect Fidolle to aid users in the development of communication and interpersonal skills. Fidolle is composed of a physical life-like “smart doll” and features a mobile game application and an online user community. Users will be able to influence the character of, and their relationship with, Fidolle by playing the game through the mobile application as well as by physically interacting with the doll. Fidolle contains multiple built-in sensor chips that will allow users to trigger challenges in the game through Bluetooth technology. Our next step in the development of Fidolle is to enable the doll to verbally communicate with users. We are also partnering with Zerodiv Inc., a Japanese company, through D&S Technology to design the mobile application to be high quality and user friendly. In addition, we intend to build a Fidolle community that will integrate online and offline relationships and activities. Users will have access to a dedicated communications forum where they will be able to interact with others in the community. We intend to promote frequent interactions between users through the Fidolle platform, including by hosting a variety of social games to provide further entertainment content for users.

 

The trend of collecting and interacting with ball-jointed dolls originated in Japan. We believe that the fans of ball-jointed dolls have formed a community in Japan as well as in China. We believe that customers in China have a preference towards ball-jointed dolls with Japanese elements. For this reason, we have cooperated with a Japanese company in developing Fidolle.

 

We believe that Fidolle will generate revenue through in-application purchases of virtual objects and sales of derivative products, such as clothing and merchandise. We do not believe that there are current products comparable to Fidolle in the major toy markets of Fuzhou, and we believe Fidolle will attract the large group of anime fans in China. The target demographic for Fidolle includes teenagers and adults between the ages of 18 and 35, although we also expect Fidolle to appeal to users outside of this demographic.

 

 

 

“QI” Platform

 

QI is a community-based gaming platform powered by multi-bus technology, designated self-organization technology and near field communication. We plan to launch QI in 2021. QI is composed of foundational network communication terminals with a chessboard layered above such foundation. QI is connected to a tablet computer for the online gaming aspect of the product. The foundational communication terminals will enable users to customize and adjust the chessboard settings, allowing users to play various different board games on the same mobile device. QI connects physical board game play with video game content and graphics, which will allow users to physically interact with one another as if they were playing a board game in reality, while enjoying the animation and sound effects of a video game. We believe QI will be popular among a variety of users, particularly users ages 14 and above, although we also expect QI to appeal to users outside of this demographic.

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Manufacturing and Distribution

 

The initial design, appearance and structure of our products are created in our on-site studio located in Xiamen. We outsource the manufacture of our products to more than 20 factories through purchase contracts. We contract with multiple suppliers in an effort to mitigate any risk that our business will be restricted by a single supply shortage or manufacturing delay. In addition, our continuing relationships with multiple manufacturers allow us to quickly adjust to changing market demands.

 

Manufacturers are responsible solely for production of our products and rely on us for design and technology support, as we maintain all of the proprietary rights to our products. The standard production process, from initial design to final manufacture, typically takes between 35 to 40 days. Our two largest manufacturers in the year ended December 31, 2018 were Fujian Wei Ya Culture Communication Co., Ltd. and Dongxin Intelligent Technology Co. Ltd., which accounted for 49.2% and 43.6% of our total purchases, respectively, and together accounted for 92.8% of our total purchases. Our three largest manufacturers in the year ended December 31, 2017 were Guangdong Eastcoms Intelligent Technology Co., Ltd., Dongguan Hou Jie Sheng Ping Toy Factory, and Fujian Wei Ya Culture Communication Co., Ltd., which accounted for 35.3%, 27.4%, and 26.1% of our total purchases, respectively, and together accounted for 88.8% of our total purchases.

 

Our distribution channels include domestic distributors, e-commerce platforms, supermarkets and export distributors. We intend to minimize direct selling and shift our focus towards selling to distributors and e-commerce platforms. Approximately 99.3% of our products sold in 2018 were sold domestically in China and the remaining 0.7% were exported overseas. Of our domestic sales in China, approximately 99.1% were generated from Chinese distributors and 0.9% were generated from supermarkets and e-commerce sites. Our Chinese distributors are organized regionally by province, including Zhejiang, Hubei, Jiangsu, Hunan, Guizhou, Liaoning, and Shandong. Our products are sold in several supermarkets and specialty stores, including Walmart, Carrefour, Toys-R-Us, Vanguard, Tesco and Lotus.

 

Our continuing partnerships with regional distributors allow us to penetrate the market in numerous provinces in China. Our five largest customers are all domestic distributors and each covers a provincial geological market – Zhejiang, Shanxi, Fujian, Hunan and Jiangsu. In 2018, each of our five largest domestic distributors accounted for approximately 5.4% to 6.7% of our total annual revenue and together accounted for 30.1% of our total annual revenue. In addition, we primarily sell domestically within China. In 2018, 99.3% of our revenue was derived from domestic distributors, while 0.7% was derived from exported products.

 

One or a few customers have in the past and may in the future represent a substantial portion of our revenues and gross profits in any one year or over a period of several consecutive years. For example, in 2018, two customers under the same ownership, Jinan Kangdian Trade Co. Ltd. and Qingdao Oudian Trading Co. Ltd., accounted for 10.8% of our total revenues. Therefore, the loss of business from any one of such customers could have a material adverse effect on our business or results of operations.

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We are in the process of expanding our brand to physical experience stores. We are leveraging our experience and insight into traditional toy and gaming park industries and our strength in AR technologies to build experience stores that provide customers with a variety of AR interactive activities, as well as a location to purchase AR interactive toys. We expect such stores will generate revenues from sales of membership cards and direct sales of our products. Five types of membership cards, (i) one-year cards, (ii) half-year cards, (iii) three-month cards, (iv) monthly cards and (v) one-time cards, may be purchased by customers, and, depending on the type of membership card purchased, customers may purchase multiple toys in the stores for the same value of the membership card. For example, if a customer purchased a one-year membership card, the customer may take home multiple toys from the stores up to the total price paid for the membership card. If the price of the toys exceeds the price of the membership card, the customer would pay the difference between the price of the toys and the price of the membership cards. In April 2019, we began selling membership cards.

 

Our Position

 

We have positioned our company as a leading producer, developer and operator of AR interactive entertainment games and toys as a result of the following key factors:

 

Market Expansion due to Two-Child Policy. The size of the toy market in China has increased significantly in the recent past. We believe this growth is a direct result of the implementation of China’s two-child policy. The Chinese government began to gradually disregard the one-child policy in the early 2010s and the two-child policy was fully implemented in 2016. According to Frost & Sullivan, China’s two-child policy is expected to drive an increase in the total population of the 0-14 age group from 230 million in 2016 to 262 million in 2021, representing a compound annual growth rate, or CAGR of 2.7%, compared to an overall expected population growth CAGR of 0.4% over the same period. Such a large increase in the 0-14 age population group necessarily indicates expansion and growth for those markets that cater to children and young adults.
Shift Towards Intelligent Toys. Chinese culture is experiencing a fundamental shift away from traditional, medium- to low-end toys towards intelligent, interactive and innovative toys and games.
Rapid AR Industry Growth. The global AR industry is still in its infancy, with many companies currently investing heavily in research and development. Digi-Capital predicts that by 2023, the global AR industry could reach $85 billion to $90 billion in revenue, compared to $10 billion to $15 billion for the virtual reality industry. Industry experts also believe that the Chinese AR industry could represent RMB 55 billion in 2020. While there are many varied forecasts and estimates on the future market size of the AR industry, we believe industry experts tend to agree that the industry will experience rapid growth in the coming years.
Supportive Economic Conditions in China. According to the National Bureau of Statistics of China, per capita annual disposable income of urban residents in China is expected to increase from RMB 33,616 in 2016 to RMB 48,620 in 2021, representing a CAGR of 7.7%. According to Frost & Sullivan, per capita expenditure on education, cultural and recreational activities of urban residents in China is expected to grow from RMB 2,638 in 2016 to RMB 4,233 in 2021 at a CAGR of 9.9%. Increases in annual disposable income and per capita expenditure correlate to increases in market growth for recreational, educational and leisure markets in China, such as the AR interactive toy market.
Few Direct Competitors in China. The AR interactive toy industry in China is new and evolving. We do not believe that large traditional toy companies, or companies that focus on high-tech toys and games, have captured a significant portion of the AR interactive toy market in China.

 

We have received a number of industry, trade association and governmental awards relating to our business and operations, which serve to enhance our brand and reputation, including:

 

Best Industrial Value Excellence Award in the Fifth International Animation Expo and the National First Animation and Derivatives Design and Development Competition (2010);
Vice-Chairman of Animation and Game Industry in Fujian Province by Fujian Association of Animation and Game Industry (2013);
High and New Technology Enterprises by Xiamen Municipal Bureau for Science and Technology, Finance Bureau of Xiamen, Xiamen Provincial Office of State Administration of Taxation and Xiamen Local Taxation Bureau (2015);
Leading Company As a Technology Small Giant by Fujian Provincial Department of Science and Technology, Fujian Development and Reform Commission, Fujian Provincial Commission of Economy and Information Technology, and Fujian Provincial Department of Finance (2016); and
The Best Growth Medium- to Small-Scaled Enterprises in Xiamen City by Xiamen Municipal Bureau for Economics and Informatization (2018).

 

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Industry Background

 

Toy and Game Industry

 

The toy and game market in China can be classified broadly into electronic, mechanical, plastic and wooden toys. Electronic toys, models, licensed toys (including spin-off toys from movies and cartoon characters), dolls, high-tech toys, educational toys, internet-connected toys and toys for adult recreation and entertainment are increasingly being introduced to the market.

 

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.

 

AR Industry

 

AR uses technology to add information — sounds, images and text — to the world we see. AR presents virtual information as reality and enables people to interact with the virtual environment. With AR, users perceive the real world with the addition of computer-generated sounds, images and text that are overlaid on specific objects. Users employ a mobile-connected device that is equipped with a camera, such as a smart phone or a tablet computer. The camera on the device scans the environment, feeding the mobile application’s image recognition capability. The mobile application’s AR content is triggered when specific images are recognized, such as quick response codes, borders and faces. For example, users manipulate the physical toy associated with the mobile game and the associated character in the mobile game will act accordingly. Regarding motion capture technology, the camera on the mobile device scans and captures the physical toy associated with the mobile game while the mobile game synchronizes the image of the physical toy in the mobile game, creating an immersive gaming experience. Location-based AR works in a similar manner, using devices equipped with a global positioning system or other location sensors. By using the device in a specific location or area, the mobile application’s AR content is triggered. AR seamlessly connects reality with virtual information by means of technology, and constructs virtual scenery.

 

The advancement and development of AR technology has brought additional creativity and engaging game play to traditional toy products. We believe the continued integration of AR technology into toys is a sustainable trend for the toy industry. We believe there are few direct competitors in the AR interactive toy market in China, and we hope to quickly seize the majority of this market share through our technological advantages and continued development and sales of our differentiated and innovative products.

 

We believe that China’s domestic environment is conducive to the development of the AR industry as a result of increases in annual disposable income and per capita expenditure and increases in the population aged 0-14 due to China’s two-child policy. Additionally, the Chinese government recently issued policies in support of the development of the AR industry. In December 2016, the State Council issued the 13th Five-Year National Informationization Plan, or the Informationization Plan, which emphasizes strengthening basic research and development of new technologies, such as AR. The Informationization Plan stated that “[t]he new playing area must be built to lead the AR industry.” Chinese national macroeconomic policies also support the AR industry. In May 2017, the General Office of the Central Committee of the Communist Party of China and the General Office of the State Council issued the Outline of the National Plan for Cultural Development and Reform during the Period of the Thirteenth Five-year Plan. Pursuant to this outline, between 2017 and 2022, the Chinese government has indicated that it intends to vigorously support the development of the game industry and to promote and encourage companies to produce high-tech, as opposed to traditional, gaming products.

 

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The global AR industry is a new and evolving market, and we believe several companies are currently investing heavily in AR research and development. Digi-Capital predicts that by 2023, the global AR industry could reach $85 billion to $90 billion in revenue, compared to $10 billion to $15 billion for the virtual reality industry. Industry experts also believe that the Chinese AR industry could represent RMB 55 billion in 2020. While there are several varied forecasts and estimates concerning the future market size of the AR industry, we believe industry experts tend to agree that the industry is expected to experience rapid growth in the coming years.

 

We believe the presence of AR in the education field is also expected to increase. We believe the immersive AR experience is particularly attractive to children as it requires more engagement, and is more entertaining, than traditional learning methods. We believe AR can be used to trigger subconscious memorization, which tends to be more permanent than the memorization of text and we believe this can lead to longer and more accurate information retention.

 

The integration of wireless networks, such as the 5G network, with big data, artificial intelligence, virtualization, AR and other technologies creates constant internet connectivity within society. The increasing popularity of smart phones and smart portable devices together with the development of mobile internet technologies has promoted the use of AR interactive toys in China. The 5G network provides a key infrastructure for the development of the AR game industry. As a next-generation communication technology, the 5G network will provide users with more real-life experiences, such as ultra-high-definition video, social networks, and immersive games, which promote upgraded human interaction and intensifies crossover between the online and offline world. By using 5G networks, AR technology redefines the way humans interact with information, with their internet devices, and with their communities.

 

We believe that AR interactive toys and games will likely continue to be more appealing to children than traditional toys and games as a result of the cultural shift towards high-tech toys and the increased use of mobile-connected platforms. As a result, we believe AR interactive toys will dominate a significant portion of the toy market in the near future. The AR interactive toy industry in China is new and evolving. We believe that our innovative products, favorable government policies, increases in annual disposable income and per capita expenditure, and our patent portfolio provide us with substantial opportunities for growth within the AR interactive toy market and the more generalized AR and toy and game markets.

 

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 proprietary AR technologies, we differentiate ourselves from traditional toy companies that lack the technological sophistication required to enter the AR interactive toy industry. We believe 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. We maintain two high quality research and development teams, responsible for hardware and software design.
Proprietary 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. 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.

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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 and targets a large span of customers. We have created numerous original products that are well known and loved by our users such as “AR Need a Spanking”, “AR Racer”, and “AR 3D Magic Box.” We have also obtained the usage rights to various internationally well-known intellectual property designs. Using our expertise in AR technology, we are able to develop a variety of products that cater to the rapidly changing AR interactive toy and game market. We believe that our comprehensive business model, integrating research and development of AR technologies, original content and appearance design, and promotion and sales of AR interactive toys through various channels, including e-commerce, distributors and our newly launched experience stores, 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. We promote our brand through a series of marketing and public relationship activities, including traditional marketing means, including internet, outdoor displays, and events such as hosting a national gaming competition, the National AR Racer Championship 2017.
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. Our management team also has a defined vision of the market and a directive growth strategy. Their global professional experience continues to propel us to the forefront of the AR interactive toy industry in China and set us apart from our peers. Our team’s collective experience and strong execution capabilities enable us to grow successfully, manage our operations, and promote our premium brand.
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.

 

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. We also intend to cater our product design towards children’s expressions, interests, creativity, memory, and logic, manipulation and physical coordination abilities. By enhancing game and product content, we hope to both retain existing customers and attract new ones.
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 by implementing a new product development plan to enhance the quality and novelty of our products, maintain and grow our intellectual property portfolio, and design our product appearances with images that are welcomed by children. We also intend to implement a technical innovation plan to increase our market share in the children’s toy market and to emphasize our research and development of (i) unique appearances and structural designs, (ii) technical optimization and (iii) maintenance of user-friendly operations.
Increase the Variety of AR Entertainment Products – We intend to devote significant resources to enhancing our current products and developing new products. We plan to expand our product lines on four fronts: (i) over the next two years, we intend to develop two complementary products to AR Racer: AR Plane and AR Tank; (ii) we intend to continue to obtain usage rights to various internationally well-known intellectual property designs from video games, comics and animations, and (iii) we intend to launch two new product lines: Fidolle and Qi.

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Enhance Sales and Marketing – In September 2018, we opened our first physical experience store in Xiamen, China. We plan to open three additional stores in Xiamen in 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. We also plan to expand our e-commerce sales team in 2019, and to operate flagship e-commerce stores via large online retailers, such as Amazon, Alibaba, including Tmall.com and Taobao.com, and JD.com, to further penetrate the market. We expect e-commerce stores to synergize with physical experience stores. If consumers do not purchase our products in-store immediately after playing with our products in the experience store, they can easily place orders at home through e-commerce stores.

 

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

 

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 ($43,633) per store in such endeavors, consisting of approximately RMB 100,000 ($14,544) for equipment, approximately RMB 50,000 ($7,272) to RMB 80,000 ($11,636) for renovations, and approximately RMB 120,000 ($17,453) to RMB 150,000 ($21,817) for rental expenses.

 

In the process of such expansion, we will inevitably face challenges, including discovering suitable locations, hiring knowledgeable staff and potentially facing increased competition from competitors. We believe that our competitive advantages in the AR market, including our proprietary technology and product lines, as well as effective control of key components of our business, such as research and development and sales, will assist in potentially overcoming challenges that we may face.

 

The successful expansion through physical experience stores 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. We recognize that these risks exist and understand that implementation of our expansion plan could be put on hold or cease altogether if any such risks are realized. In order to potentially mitigate such challenges, we have organized a devoted marketing team to conduct a due diligence study of each physical experience store, including location selection, staff recruitment and other details. Throughout the process, we intend to accumulate and study such experiences of opening or franchising stores in order to work towards achievement of our goal to have opened or franchised several physical experience stores across China by 2021.

 

Sales and Marketing

 

Our marketing operations consist of a planning department, a sales department, an e-commerce department and a product department. 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, thus increasing our brand awareness.

 

We have an experienced sales team with more than 35 staff members, many of which several years of sales experience. Currently, our sales are primarily derived from developed regions in China such as Jiangsu and Zhejiang. We intend to expand into more diverse regions of China in an effort to increase our market share. Currently, we have four subsidiaries located in Chongqing, Hunan, Fujian and Shenyang, responsible for sales and marketing.

 

We intend to continue building our salesforce and enhancing our sales power. We plan to penetrate the market further through our physical presence in stores and our e-commerce platforms. We also plan to establish flexible and diversified sales channels. For sales in China, we plan to continue to use distributors and our sales team will engage e-commerce channels. We also intend to continue to partner with provincial Chinese distributors to expand both our online and offline sales channels and to further infiltrate sales regions.

 

We believe that the key factors influencing our sales patterns are as follows:

 

Consumer Groups – We believe that China’s extensive population base demonstrates the market potential in China. We believe that demand for AR interactive toys will continue to expand as China’s population continues to grow.
Consumption Patterns and Consumption Habits – We believe that the development and increasing popularity of mobile payment systems and applications, internet and e-commerce shopping, along with the rapid growth of the Chinese social economy have greatly impacted the consumption patterns of Chinese society. Increased consumption habits of the general public allow for significant growth of AR products as people are more likely to spend money on entertainment, particularly entertainment that operates on the same wireless technology platforms as their computers and mobile devices, such as our products.
Seasonal Factors – The majority of our sales typically occur in the second half of the year during traditional Chinese holidays due to promotional activities and increased sales that typically accompany holiday shopping.

 

Our long-term branding development plan centers around brand recognition and increasing our brand awareness through the use of branding strategies such as market surveys, series designs and after-sales investigations. Our goal is to obtain a thorough understanding of user preferences and purchasing trends in order to increase confidence in our product quality, heighten brand loyalty, and increase the overall value of our brand. We intend to alter our product designs to meet consumers’ needs and adjust to market changes accordingly.

 

As described above, we are in the process of expanding our brand to physical experience stores in order to engage consumers, create user loyalty and introduce new users to our products. We are leveraging our experience and insight into traditional toy and gaming industries and our strength in AR technologies to build experience stores that provide customers with a variety of AR interactive activities, as well as a location to purchase AR interactive toys.

 

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Product Quality

 

We emphasize the importance of quality and safety in our products throughout our product life cycle. During the product development stage, our specialized quality control engineers submit sample products for inspection before the products leave our on-site studio. Each product design also undergoes stringent tests for sample confirmation and material selection before any orders are placed with suppliers. All product changes are repeatedly tested repeatedly and fully verified before production is altered accordingly.

 

Our manufacturers are selected based on their productivity and are then evaluated based on our production requirements, including management needs, technical skills, file management, quality control, and company size. After a supplier is examined and confirmed by each of our relevant departments, it will be included in our supplier directory. We also conduct field assessments of our long-term suppliers from time to time.

 

Our products also undergo a series of quality inspections throughout the manufacturing process, including material confirmation, initial workpiece inspection, process inspection and delivery inspection. All of our products currently comply with China 3C standards, China’s toy industry safety standards, as revised on January 1, 2016 by GB6675-2003 National Toy’s Safety Technical Specifications, and the American Society for Testing and Materials standards.

 

Intellectual Property

 

The core of our business is our proprietary technology. As a result, we strive to maintain a robust intellectual property portfolio. Our patents, trademarks, copyrights, and other intellectual property rights serve to distinguish and 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 March 31, 2019, we held 178 authorized patents, 44 patents in various stages of the patent application process, 14 applications for PCT international patents, 71 registered trademarks, 645 copyrights of art work and 27 software copyrights.

 

Research and Development

 

We believe the key to success in the AR interactive toy market is research and development. As such, we have invested, and intend to continue to invest, substantial resources in the research and development of AR interactive technologies. We maintain two high quality research and development teams responsible for hardware and software design. Both research and development teams consist of 49 AR specialists, including many top talented individuals in the AR field, and are led by individuals with experience from China’s prominent internet game developers and operators. Approximately 28 members of our research and development team are based in Xiamen, mainly focusing on the research and development of electronic toys, AR games and products for licensing. Approximately 21 members of our research and development team are based at our Fuzhou branch, focusing on mobile games and AR game research and development. We also cooperate with several third party research and development teams. For example, we are partnering with Fujian Normal University Embedded Development Laboratory on the development of our Qi Platform. For example, we provide the funding for the project with Fujian Normal University, and in turn, we are able to use the facilities of Fujian Normal University and retain the intellectual property developed during the project.

 

Our research and development process for a new or enhanced product typically starts with our research and development team brainstorming with our marketing and sales team to create new ideas and designs containing popular elements. Our marketing and sales team will gather information about the market demand from distributors through exhibitions that they attend. Our marketing and sales team and our research and development team will hold meetings to discuss and summarize the information and determine which potential products they expect to be popular among existing and new customers. Our research and development team will then determine the feasibility of the proposed new products. From time to time, our research and development team will generate ideas for new products from a technological perspective and communicate such ideas with the marketing and sales team. These ideas are then presented to our senior management team for approval. If the proposal is approved by senior management, the company will officially establish the project of developing the new product.

 

Our standard research and development cycle per product is approximately eight months. Initial product development usually takes two to three months in order to produce quality product samples. For product samples put into production, it usually takes an additional four to eight months for further development and design.

 

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Our research and development department is currently focusing on the further advancement of the technology used in our products, including photosensitive induction technology, gesture-sensor technology, infrared induction technology and AR identification technology. We have invested, and will continue to invest, substantial resources in our research and development activities, including technology and game development.

 

Competition

 

Our business is characterized by innovation, rapid change and disruptive technology. We compete with AR interactive toy companies located around the world, and we may also face competition from new and emerging companies, including new competitors from the PRC. We consider our principal competitors to be those companies that provide educational AR game products to the market, including Shanghai Putao Technology Co., Ltd. and Sphero, Inc. We also compete with Nintendo of America Inc.’s amiibo product line.

Compared to our company, our current and potential competitors may have:

better established credibility and market reputations, longer operating histories, and broader product offerings;
significantly greater financial, technical, marketing and other resources, which may allow them to pursue design, development, manufacturing, sales, marketing, distribution and service support of their products;
more extensive customer and partner relationships, which may position them to identify and respond more successfully to market developments and changes in customer demands; and
multiple product offerings, which may enable them to offer bundled discounts for customers purchasing multiple products or other incentives that we cannot match or offer.

The principal competitive factors in our market include:

brand recognition and reputation;
ability to build customer loyalty, retain existing users and attract new users;
continually-evolving innovation and research and development; and
the performance and reliability of products and platforms.

We believe we compete favorably with respect to the factors described above.

 

Facilities

Our principal executive office is located at 7th Floor, Building C, No. 1010 Anling Road, Huli District, Xiamen, China 361009, where we lease 15,336 square feet of office space. We lease this space under a lease that terminates on January 9, 2022. We also lease 2,314 square feet of office space located at Room 402, Floor 4, Industrial Design Center, Cross-Straight Longshan Culture Creative Industry Park, No. 84 South Longshan Road, Siming District, Xiamen, China under a lease that terminates on January 5, 2020. In addition, we lease 23,343 square feet of factory space located at Building 3, Dong Wai Yi Road, East Industrial Park, Datong Road, Tongan District, Xiamen, China under a lease that terminates on December 19, 2022. In addition, we lease 5,166 square feet of office space located at Room 713-723, Floor 7, Building #34, District C, Fuzhou Software Park, No. 89 Software Avenue, Tong Pan Road, Fuzhou, China under a lease that terminates on July 24, 2019.

 

We believe that our facilities are adequate to meet our needs for the immediate future, and that, should it be needed, suitable additional space will be available on commercially reasonable terms to accommodate any such expansion of our operations.

 

Employees

As of March 31, 2019, we had 107 employees, all of which were full-time employees.

 

We have also engaged subcontractors to assist us with our manufacturing. None of our employees are represented by a labor union or covered by a collective bargaining agreement. We have never experienced any employment related work stoppages, and we consider our relations with our employees to be good.

 

Legal Proceedings

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 was RMB 3,643,385 ($529,908). 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.

 

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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 ($225,229). 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 ($2,725) shall be borne by Fujian Xin Wei Electronic Industry Co., Ltd., and the case acceptance fee of counter-claim of RMB 9,150 ($1,331) 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 ($140,750), 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 ($2,725), RMB 4,769 ($694) of which was to be paid by Fujian Xin Wei Electronic Industry Co., Ltd., and RMB 13,969 ($2,031) of which was to be paid by Blue Hat Fujian. Blue Hat Fujian will also pay the property preservation measures fee of RMB 5,000 ($727).

 

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 ($3,362) shall be borne by the appealer, Blue Hat Fujian, and (3) such judgment shall be final.

 

As of December 31, 2017, 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 ($140,750) to Fujian Xin Wei Electronic Industry Co., Ltd. As of the date of this prospectus, the dispute has been concluded.

 

Other than the above mentioned dispute, we are not currently a party to any legal proceedings that in the opinion of our management would have a material adverse effect on our business. However, from time to time, we may be involved in legal proceedings or be subject to claims arising out of our operations. 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. 

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REGULATION

 

The following sets forth a summary of the most significant rules and regulations that affect our business activities in China.

 

Legal Regulations on Intellectual Property in the PRC

Copyright

Pursuant to the Copyright Law of the PRC, which was first promulgated by the Standing Committee of the National People’s Congress on September 7, 1990 and became effective from June 1, 1991, and was last amended on February 26, 2010 and became effective as of April 1, 2010, copyrights include personal rights such as the right of publication and that of attribution as well as property rights such as the right of production and that of distribution. Reproducing, distributing, performing, projecting, broadcasting or compiling a work or communicating the same to the public via an information network without permission from the owner of the copyright therein, unless otherwise provided in the Copyright Law of the PRC, shall constitute infringements of copyrights. The infringer shall, according to the circumstances of the case, undertake to cease the infringement, take remedial action, and offer an apology, pay damages, etc.

Trademark

Pursuant to the Trademark Law of the PRC, which was promulgated by the Standing Committee of the National People’s Congress on August 23, 1982 and became effective from March 1, 1983, and was most recently amended on August 30, 2013 and became effective on May 1, 2014, the right to exclusive use of a registered trademark shall be limited to trademarks which have been approved for registration and to goods for which the use of such trademark has been approved. The period of validity of a registered trademark shall be ten years, counted from the day the registration is approved. According to this law, using a trademark that is identical to or similar to a registered trademark in connection with the same or similar goods without the authorization of the owner of the registered trademark constitutes an infringement of the exclusive right to use a registered trademark. The infringer shall, in accordance with the regulations, undertake to cease the infringement, take remedial action, and pay damages, etc.

Patent

Pursuant to the Patent Law of the PRC, which was promulgated by the Standing Committee of the National People’s Congress on March 12, 1984 and became effective from April 1, 1985, and was most recently amended on December 27, 2008, and was most recently amended on December 27, 2008 and became effective on October 1, 2009, after the grant of the patent right for an invention or utility model, except where otherwise provided for in the Patent Law, no entity or individual may, without the authorization of the patent owner, exploit the patent, that is, make, use, offer to sell, sell or import the patented product, or use the patented process, or use, offer to sell, sell or import any product which is a direct result of the use of the patented process, for production or business purposes. And after a patent right is granted for a design, no entity or individual shall, without the permission of the patent owner, exploit the patent, that is, for production or business purposes, manufacture, offer to sell, sell, or import any product containing the patented design. Where the infringement of patent is decided, the infringer shall, in accordance with the regulations, undertake to cease the infringement, take remedial action, and pay damages, etc.

Domain Name

Pursuant to the Administrative Measures on Internet Domain Names of China, which was recently amended by the Ministry of Industry and Information Technology on August 24, 2017 and became effective on November 1, 2017, "domain name" shall refer to the character mark of hierarchical structure, which identifies and locates a computer on the internet and corresponds to the internet protocol (IP) address of that computer. And the principle of "first come, first serve" is followed for the domain name registration service. After completing the domain name registration, the applicant becomes the holder of the domain name registered by him/it. Furthermore, the holder shall pay operation fees for registered domain names on schedule. If the domain name holder fails to pay the corresponding fees as required, the original domain name registrar shall write it off and notify the holder of the domain name in written form.

Legal Regulations on Labor Protection in the PRC

According to the Labor Law of the PRC, or the Labor Law, which was promulgated by the Standing Committee of the NPC on July 5, 1994, came into effect on January 1, 1995, and was most recently amended on December 29, 2018, an employer shall develop and improve its rules and regulations to safeguard the rights of its workers. An employer shall develop and improve its labor safety and health system, stringently implement national protocols and standards on labor safety and health, conduct labor safety and health education for workers, guard against labor accidents and reduce occupational hazards. Labor safety and health facilities must comply with relevant national standards. An employer must provide workers with the necessary labor protection gear that complies with labor safety and health conditions stipulated under national regulations, as well as provide regular health checks for workers that are engaged in operations with occupational hazards. Laborers engaged in special operations shall have received specialized training and have obtained the pertinent qualifications. An employer shall develop a vocational training system. Vocational training funds shall be set aside and used in accordance with national regulations and vocational training for workers shall be carried out systematically based on the actual conditions of the company.

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The Labor Contract Law of the PRC, which was promulgated by the SCNPC on June 29, 2007, came into effect on January 1, 2008, and was amended on December 28, 2012 and became effective as of July 1, 2013, and the Implementation Regulations on Labor Contract Law, which was promulgated on September 18, 2008, and became effective since the same day, regulate both parties through a labor contract, namely the employer and the employee, and contain specific provisions involving the terms of the labor contract. It is stipulated under the Labor Contract Law and the Implementation Regulations on Labor Contract Law that a labor contract must be made in writing. An employer and an employee may enter into a fixed-term labor contract, an un-fixed term labor contract, or a labor contract that concludes upon the completion of certain work assignments, after reaching agreement upon due negotiations. An employer may legally terminate a labor contract and dismiss its employees after reaching agreement upon due negotiations with the employee or by fulfilling the statutory conditions. Labor contracts concluded prior to the enactment of the Labor Law and subsisting within the validity period thereof shall continue to be honored. With respect to a circumstance where a labor relationship has already been established but no formal written contract has been made, a written labor contract shall be entered into within one month from the commencement date of the employment.

According to the Interim Regulations on the Collection and Payment of Social Insurance Premiums, the Regulations on Work Injury Insurance, the Regulations on Unemployment Insurance and the Trial Measures on Employee Maternity Insurance of Enterprises, enterprises in the PRC shall provide benefit plans for their employees, which include basic pension insurance, unemployment insurance, maternity insurance, work injury insurance and basic medical insurance. An enterprise must provide social insurance by processing social insurance registration with local social insurance agencies, and shall pay or withhold relevant social insurance premiums for or on behalf of employees. The Law on Social Insurance of the PRC, which was promulgated by the Standing Committee of the National People’s Congress on October 28, 2010, and became effective on July 1, 2011, and was most recently updated on December 29, 2018, has consolidated pertinent provisions for basic pension insurance, unemployment insurance, maternity insurance, work injury insurance and basic medical insurance, and has elaborated in detail the legal obligations and liabilities of employers who do not comply with relevant laws and regulations on social insurance.

According to the Interim Measures for Participation in the Social Insurance System by Foreigners Working within the Territory of China, which was promulgated by the Ministry of Human Resources and Social Security on September 6, 2011, and became effective on October 15, 2011, employers who employ foreigners shall participate in the basic pension insurance, unemployment insurance, basic medical insurance, occupational injury insurance, and maternity leave insurance in accordance with the relevant law, with the social insurance premiums to be contributed respectively by the employers and foreigner employees as required. In accordance with such Interim Measures, the social insurance administrative agencies shall exercise their right to supervise and examine the legal compliance of foreign employees and employers and the employers who do not pay social insurance premiums in conformity with the laws shall be subject to the administrative provisions provided in the Social Insurance Law and the relevant regulations and rules mentioned above.

According to the Regulations on the Administration of Housing Provident Fund, which was promulgated by the State Counsel and became effective on April 3, 1999, and was amended on March 24, 2002 and was partially revised on March 24, 2019 by Decision of the State Council on Revising Some Administrative Regulations (Decree No. 710 of the State Council), housing provident fund contributions by an individual employee and housing provident fund contributions by his or her employer shall belong to the individual employee. Registration by PRC companies at the applicable housing provident fund management center is compulsory and a special housing provident fund account for each of the employees shall be opened at an entrusted bank.

The employer shall timely pay up and deposit housing provident fund contributions in full amount and late or insufficient payments shall be prohibited. The employer shall process housing provident fund payment and deposit registrations with the housing provident fund administration center. With respect to companies who violate the above regulations and fail to process housing provident fund payment and deposit registrations or open housing provident fund accounts for their employees, such companies shall be ordered by the housing provident fund administration center to complete such procedures within a designated period. Those who fail to process their registrations within the designated period shall be subject to a fine ranging from RMB 10,000 to RMB 50,000. When companies breach these regulations and fail to pay up housing provident fund contributions in full amount as due, the housing provident fund administration center shall order such companies to pay up within a designated period, and may further apply to the People's Court for mandatory enforcement against those who still fail to comply after the expiry of such period.

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Legal Regulations on Tax in the PRC

Income Tax

In January 2008, the PRC Enterprise Income Tax Law took effect, which was last amended by the Standing Committee of the National People’s Congress on December 29, 2018. The PRC Enterprise Income Tax Law applies a uniform 25 percent enterprise income tax rate to both FIEs and domestic enterprises, except where tax incentives are granted to special industries and projects. The PRC Enterprise Income Tax Law defines “resident enterprise” as an enterprise established outside of the territory of China but with its “de facto management body” within China, which will also be subject to the 25% enterprise income tax rate. The implementation rules define the term “de facto management body” as the body that exercises full and substantial control and overall management over the business, productions, personnel, accounts, and properties of an enterprise. Under the PRC Enterprise Income Tax Law and its implementation regulations, dividends generated from the business of a PRC subsidiary after January 1, 2008, and payable to its foreign investor may be subject to a withholding tax rate of 10 percent if the PRC tax authorities determine that the foreign investor is a Non-resident Enterprise, unless there is a tax treaty with China that provides for a preferential withholding tax rate. Distributions of earnings generated before January 1, 2008, are exempt from PRC withholding tax.

In January 2009, the SAT promulgated the Provisional Measures for the Administration of Withholding of Enterprise Income Tax for Non-resident Enterprises, or the Non-resident Enterprises Measures, which was repealed by Announcement of the State Administration of Taxation on Issues Relating to Withholding at Source of Income Tax of Non-resident Enterprises in December 2017. According to the new announcement, it shall apply to handling of matters relating to withholding at source of income tax of non-resident enterprises pursuant to the provisions of Article 37, Article 39 and Article 40 of the Enterprise Income Tax Law. According to Article 37, Article 39 of the Enterprise Income Tax Law, income tax over non-resident enterprise income pursuant to the provisions of the third paragraph of Article 3 shall be subject to withholding at the source, where the payer shall act as the withholding agent. The tax amount for each payment made or due shall be withheld by the withholding agent from the amount paid or payable. Where a withholding agent fails to withhold tax or perform tax withholding obligations pursuant to the provisions of Article 37, the taxpayer shall pay tax at the place where the income is derived. Where the taxpayer fails to pay tax pursuant to law, the tax authorities may demand payment of the tax amount payable, from a payer of the taxpayer with payable tax amounts from other taxable income items in China.

On April 30, 2009, the MOF and the SAT jointly issued the Circular on Issues Concerning Treatment of Enterprise Income Tax in Enterprise Restructuring Business, or Circular 59, which became effective retroactively as of January 1, 2008 and was partially revised on January 1, 2014. By promulgating and implementing this circular, the PRC tax authorities have enhanced their scrutiny over the direct or indirect transfer of equity interests in a PRC resident enterprise by a Non-resident Enterprise.

On February 3, 2015, the SAT issued the Announcement of the State Administration of Taxation on Several Issues Relating to Enterprise Income Tax of Transfers of Assets between Non-resident Enterprises, or SAT Bulletin 7, which was partially abolished on December 29, 2017. SAT Bulletin 7 extends its tax jurisdiction to transactions involving transfer of immovable property in China and assets held under the establishment, and placement in China, of a foreign company through the offshore transfer of a foreign intermediate holding company. SAT Bulletin 7 also addresses transfer of the equity interest in a foreign intermediate holding company broadly. In addition, SAT Bulletin 7 introduces safe harbor scenarios applicable to internal group restructurings. However, it also brings challenges to both the foreign transferor and transferee of the Indirect Transfer as they have to assess whether the transaction should be subject to PRC tax and to file or withhold the PRC tax accordingly.

On October 17, 2017, the SAT issued the Announcement of the State Administration of Taxation on Issues Concerning the Withholding of Non-resident Enterprise Income Tax at Source, or SAT Bulletin 37, which came into effect on December 1, 2017 and was revised on June 15, 2018. The SAT Bulletin 37 further clarifies the practice and procedure of withholding of non-resident enterprise income tax.

If non-resident investors were involved in our private equity financing, if such transactions were determined by the tax authorities to lack reasonable commercial purpose, we and our non-resident investors may be at risk of being required to file a return and be taxed under SAT Bulletin 7 and we may be required to expend valuable resources to comply with SAT Bulletin 7 or to establish that we should not be held liable for any obligations under SAT Bulletin 7.

Value-Added Tax

According to the Temporary Regulations on Value-added Tax, which was most recently amended on November 19, 2017, and the Detailed Implementing Rules of the Temporary Regulations on Value-added Tax, which was amended on October 28, 2011, and became effective on November 1, 2011, all taxpayers selling goods, providing processing, repair or replacement services or importing goods within the PRC shall pay Value-Added Tax. The tax rate of 17 percent shall be levied on general taxpayers selling or importing various goods; the tax rate of 17 percent shall be levied on the taxpayers providing processing, repairing or replacement service; the applicable rate for the export of goods by taxpayers shall be nil, unless otherwise stipulated. On April 4, 2018, the Ministry of Finance and the SAT jointly issued the Notice of Adjustment of Value-added Tax Rates which declared that the VAT tax rate in regard to the sale of goods, provision of processing, repairs and replacement services and importation of goods into China shall be reduced from the previous 17% to 16% from May 1, 2018.

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Furthermore, according to the Trial Scheme for the Conversion of Business Tax to Value-added Tax, which was promulgated by the MOF and the SAT, the PRC began to launch taxation reforms in a gradual manner in January 1, 2012, whereby the collection of value-added tax in lieu of business tax items was implemented on a trial basis in regions showing significant radiating effects in economic development and providing outstanding reform examples, beginning with production service industries such as transportation and certain modern service industries.

In accordance with a SAT circular that took effect on May 1, 2016, upon approval of the State Council, the pilot program of the collection of value-added tax in lieu of business tax shall be promoted nationwide in a comprehensive manner starting May 1, 2016, and all taxpayers of business tax engaged in the building industry, the real estate industry, the financial industry and the life service industry shall be included in the scope of the pilot program with regard to payment of value-added tax instead of business tax.

Regulations on Foreign Exchange

Foreign Currency Exchange

Pursuant to the Foreign Currency Administration Rules, as amended, and various regulations issued by SAFE and other relevant PRC government authorities, Renminbi is freely convertible to the extent of current account items, such as trade related receipts and payments, interest and dividends. Capital account items, such as direct equity investments, loans and repatriation of investment, unless expressly exempted by laws and regulations, still require prior approval from SAFE or its provincial branch for conversion of Renminbi into a foreign currency, such as U.S. dollars, and remittance of the foreign currency outside of the PRC. Payments for transactions that take place within the PRC must be made in Renminbi. Foreign currency revenues received by PRC companies may be repatriated into China or retained outside of China in accordance with requirements and terms specified by SAFE.

Dividend Distribution

Wholly foreign-owned enterprises and Sino-foreign equity joint ventures in the PRC may pay dividends only out of their accumulated profits, if any, as determined in accordance with PRC accounting standards and regulations. Additionally, these FIEs may not pay dividends unless they set aside at least 10 percent of their respective accumulated profits after tax each year, if any, to fund certain reserve funds, until such time as the accumulative amount of such fund reaches 50 percent of the enterprise's registered capital. In addition, these companies also may allocate a portion of their after-tax profits based on PRC accounting standards to employee welfare and bonus funds at their discretion. These reserves are not distributable as cash dividends.

Regulations Relating to Foreign Exchange Registration of Overseas Investment by PRC Residents

Circular 37, issued by SAFE and effective on July 4, 2014, regulates foreign exchange matters in relation to the use of SPVs by PRC residents or entities to seek offshore investment and financing and conduct round trip investment in China. Under Circular 37, a SPV refers to an offshore entity established or controlled, directly or indirectly, by PRC residents or entities for the purpose of seeking offshore financing or making offshore investment, using legitimate domestic or offshore assets or interests, while "round trip investment" refers to the direct investment in China by PRC residents or entities through SPVs, namely, establishing FIEs to obtain the ownership, control rights and management rights. Circular 37 requires that, before making contribution into a SPV, PRC residents or entities are required to complete foreign exchange registration with the SAFE or its local branch. SAFE Circular 37 further provides that option or share-based incentive tool holders of a non-listed SPV can exercise the options or share incentive tools to become a shareholder of such non-listed SPV, subject to registration with SAFE or its local branch.

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PRC residents or entities who have contributed legitimate domestic or offshore interests or assets to SPVs but have yet to obtain SAFE registration before the implementation of the Circular 37 shall register their ownership interests or control in such SPVs with SAFE or its local branch. An amendment to the registration is required if there is a material change in the registered SPV, such as any change of basic information (including change of such PRC "resident's name" and operation term), increases or decreases in investment amounts, transfers or exchanges of shares, or mergers or divisions. Failure to comply with the registration procedures set forth in Circular 37, or making misrepresentation on or failure to disclose controllers of a FIE that is established through round-trip investment, may result in restrictions on the foreign exchange activities of the relevant FIEs, including payment of dividends and other distributions, such as proceeds from any reduction in capital, share transfer or liquidation, to its offshore parent or affiliate, and the capital inflow from the offshore parent, and may also subject relevant PRC residents or entities to penalties under PRC foreign exchange administration regulations. On February 13, 2015, SAFE further promulgated the Circular on Further Simplifying and Improving the Administration of the Foreign Exchange Concerning Direct Investment, or SAFE Circular 13, which took effect on June 1, 2015. This SAFE Circular 13 has amended SAFE Circular 37 by requiring PRC residents or entities to register with qualified banks rather than SAFE or its local branch in connection with their establishment or control of an offshore entity established for the purpose of overseas investment or financing.

On March 30, 2015, the SAFE promulgated Circular 19, which came into effect on June 1, 2015. According to Circular 19, the foreign exchange capital of FIEs shall be subject to the Discretional Foreign Exchange Settlement. The Discretional Foreign Exchange Settlement refers to the foreign exchange capital in the capital account of a FIE for which the rights and interests of monetary contribution has been confirmed by the local foreign exchange bureau (or the book-entry registration of monetary contribution by the banks) can be settled at the banks based on the actual operational needs of the FIE. The proportion of Discretional Foreign Exchange Settlement of the foreign exchange capital of a FIE is temporarily determined to be 100%. The Renminbi converted from the foreign exchange capital will be kept in a designated account and if a FIE needs to make further payment from such account, it still needs to provide supporting documents and go through the review process with the banks.

SAFE issued the Circular on Reforming and Regulating Policies on the Control over Foreign Exchange Settlement of Capital Accounts, or Circular 16, on June 9, 2016, which became effective simultaneously. Pursuant to Circular 16, enterprises registered in the PRC may also convert their foreign debts from foreign currency to Renminbi on a discretionary basis. Circular 16 provides an integrated standard for conversion of foreign exchange under capital account items (including foreign currency capital and foreign debts) on a discretionary basis which applies to all enterprises registered in the PRC. Circular 16 reiterates the principle that Renminbi converted from foreign currency-denominated capital of a company may not be directly or indirectly used for purposes beyond its business scope or prohibited by PRC laws or regulations, while such converted Renminbi shall not be provided as loans to its non-affiliated entities. As Circular 16 is newly issued and SAFE has not provided detailed guidelines with respect to its interpretation or implementations, it is uncertain how these rules will be interpreted and implemented.

Regulations on loans to and direct investment in the PRC entities by offshore holding companies

According to the Implementation Rules for the Provisional Regulations on Statistics and Supervision of Foreign Debt promulgated by SAFE on September 24, 1997 and the Interim Provisions on the Management of Foreign Debts promulgated by SAFE, the NDRC and the MOF and effective from March 1, 2003, loans by foreign companies to their subsidiaries in China, which accordingly are FIEs, are considered foreign debt, and such loans must be registered with the local branches of the SAFE. Under the provisions, the total amount of accumulated medium-term and long-term foreign debt and the balance of short-term debt borrowed by a FIE is limited to the difference between the total investment and the registered capital of the foreign- invested enterprise.

On January 12, 2017, the People's Bank of China promulgated the Circular of the People's Bank of China on Matters relating to the Macro-prudential Management of Comprehensive Cross-border Financing, or PBOC Circular 9, which took effect on the same date. The PBOC Circular 9 established a capital or net assets-based constraint mechanism for cross-border financing. Under such mechanism, a company may carry out cross-border financing in Renminbi or foreign currencies at their own discretion. The total cross-border financing of a company shall be calculated using a risk-weighted approach and shall not exceed an upper limit. The upper limit is calculated as capital or assets multiplied by a cross-border financing leverage ratio and multiplied by a macro-prudential regulation parameter.

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In addition, according to PBOC Circular 9, as of the date of the promulgation of PBOC Circular 9, a transition period of one year is set for foreign-invested enterprises and during such transition period, FIEs may apply either the current cross-border financing management mode, namely the mode provided by Implementation Rules for the Provisional Regulations on Statistics and Supervision of Foreign Debt and the Interim Provisions on the Management of Foreign Debts, or the mode in this PBOC Circular 9 at its sole discretion. After the end of the transition period, the cross-border financing management mode for FIEs will be determined by the People's Bank of China and SAFE after assessment based on the overall implementation of this PBOC Circular 9.

According to applicable PRC regulations on FIEs, capital contributions from a foreign holding company to its PRC subsidiaries, which are considered FIEs, may only be made when approval by or registration with the MOFCOM or its local counterpart is obtained.

Regulations Relating to Foreign Investment

The Guidance Catalogue of Industries for Foreign Investment

Investment activities in the PRC by foreign investors are governed by the Guidance Catalogue of Industries for Foreign Investment, or the Catalogue, which was promulgated and is amended from time to time by the MOFCOM and the NDRC. The latest version of the Catalogue became effective from July 28, 2017, which was partially abolished by Special Administrative Measures (Negative List) for Foreign Investment Access (Edition 2018). The Catalogue divides industries into three categories in terms of foreign investment: “encouraged”, “restricted” and “prohibited.” The purpose of the Catalogue is to direct foreign investment into certain priority industry sectors while restricting or prohibiting investment in other sectors. If the investment falls within the “encouraged” category, foreign investment can be conducted through the establishment of a WFOE. If the investment falls within the “restricted” category, foreign investment may be conducted through the establishment of a WFOE if certain requirements are met or in some cases must be conducted through the establishment of a joint venture enterprise, with varying minimum shareholdings for the Chinese party, depending on the particular industry. If the investment falls within the “prohibited” category, foreign investment of any kind is not allowed. Any investment that occurs within an industry not falling into any of three categories is classified as a permitted industry for foreign investment.

On June 28, 2018, the National Development and Reform Commission and Ministry of Commerce promulgated the Special Administrative Measures (Negative List) for Foreign Investment Access (Edition 2018), which took effect on July 28, 2018. The Special Administrative Measures (Negative List) for Foreign Investment Access specified in the Catalogue of Industries for Foreign Investment (Revision 2017) issued by the National Development and Reform Commission and the Ministry of Commerce on June 28, 2017 are repealed simultaneously, while the Catalogue is still valid.

The Foreign Investment Law

On March 15, 2019, the National People’s Congress approved the Foreign Investment Law, which will take effect on January 1, 2020 and replace three existing laws on foreign investments in China, namely, the PRC Equity Joint Venture Law, the PRC Cooperative Joint Venture Law and the Wholly Foreign-owned Enterprise Law, together with their implementation rules and ancillary regulations. The Foreign Investment Law embodies an expected PRC regulatory trend to rationalize its foreign investment regulatory regime in line with prevailing international practice and the legislative efforts to unify the corporate legal requirements for both foreign and domestic invested enterprises in China. The Foreign Investment Law establishes the basic framework for the access to, and the promotion, protection and administration of foreign investments in view of investment protection and fair competition.

According to the Foreign Investment Law, “foreign investment” refers to investment activities directly or indirectly conducted by one or more natural persons, business entities, or otherwise organizations of a foreign country (collectively referred to as “foreign investor”) within China, and the investment activities include the following situations: (i) a foreign investor, individually or collectively with other investors, establishes a foreign-invested enterprise within China; (ii) a foreign investor acquires stock shares, equity shares, shares in assets, or other like rights and interests of an enterprise within China; (iii) a foreign investor, individually or collectively with other investors, invests in a new project within China; and (iv) investments in other means as provided by laws, administrative regulations, or the State Council.

According to the Foreign Investment Law, the State Council will publish or approve to publish the “negative list” for special administrative measures concerning foreign investment. The Foreign Investment Law grants national treatment to foreign-invested entities, or FIEs, except for those FIEs that operate in industries deemed to be either “restricted” or “prohibited” in the “negative list”. Because the “negative list” has yet to be published, it is unclear whether it will differ from the current Special Administrative Measures for Market Access of Foreign Investment (Negative List). The Foreign Investment Law provides that FIEs operating in foreign restricted or prohibited industries will require market entry clearance and other approvals from relevant PRC governmental authorities. If a foreign investor is found to invest in any prohibited industry in the “negative list”, such foreign investor may be required to, among other aspects, cease its investment activities, dispose of its equity interests or assets within a prescribed time limit and have its income confiscated. If the investment activity of a foreign investor is in breach of any special administrative measure for restrictive access provided for in the “negative list”, the relevant competent department shall order the foreign investor to make corrections and take necessary measures to meet the requirements of the special administrative measure for restrictive access. 

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Besides, the PRC government will establish a foreign investment information reporting system, according to which foreign investors or foreign-invested enterprises shall submit investment information to the competent department for commerce concerned through the enterprise registration system and the enterprise credit information publicity system, and a security review system under which the security review shall be conducted for foreign investment affecting or likely affecting the state security.

Furthermore, the Foreign Investment Law provides that foreign invested enterprises established according to the existing laws regulating foreign investment may maintain their structure and corporate governance within five years after the implementing of the Foreign Investment Law.

In addition, the Foreign Investment Law also provides several protective rules and principles for foreign investors and their investments in the PRC, including, among others, that a foreign investor may freely transfer into or out of China, in Renminbi or a foreign currency, its contributions, profits, capital gains, income from disposition of assets, royalties of intellectual property rights, indemnity or compensation lawfully acquired, and income from liquidation, among others, within China; local governments shall abide by their commitments to the foreign investors; governments at all levels and their departments shall enact local normative documents concerning foreign investment in compliance with laws and regulations and shall not impair legitimate rights and interests, impose additional obligations onto FIEs, set market access restrictions and exit conditions, or intervene with the normal production and operation activities of FIEs; except for special circumstances, in which case statutory procedures shall be followed and fair and reasonable compensation shall be made in a timely manner, expropriation or requisition of the investment of foreign investors is prohibited; and mandatory technology transfer is prohibited. 

Company Law

Pursuant to the PRC Company Law, promulgated by the Standing Committee of the National People’s Congress on December, 29 1993, effective as of July 1, 1994, and as revised on December 25, 1999, August 28, 2004, October 27, 2005, December 28, 2013 and October 26, 2018, the establishment, operation and management of corporate entities in the PRC are governed by the PRC Company Law. The PRC Company Law defines two types of companies: limited liability companies and limited stock companies.

Our PRC operating subsidiary is a limited liability company. Unless otherwise stipulated in the related laws on foreign investment, foreign invested companies are also required to comply with the provisions of the PRC Company Law.

Laws and Regulations on the Protection of Consumer Rights and Interests

Business operators in the business of supplying and selling manufactured goods or services to consumers, shall comply with the Law of the PRC on the Protection of Consumer Rights and Interests, or the Consumer Rights Protection Law, promulgated by the SCNPC on October 31, 1993, and effective as of January 1, 1994, and revised on August 27, 2009 and October 25, 2013.

According to the Consumer Rights Protection Law, business operators must ensure that the goods or services provided by them meet the requirements for safeguarding personal and property safety. For goods and services that may endanger personal and property safety, consumers should be provided with a true description and an explicit warning, as well as a description and indication of the proper way to use the goods or accept the services and the methods of preventing the occurrence of a hazard. If the goods or services provided by the business operators cause personal injuries to consumers or third parties, the business operators shall compensate the injured parties for their losses.

Contract Law

All of our contracts are subject to the PRC contract law. Under PRC contract law, a natural person, legal person or other legally established organization shall have full capacity of civil right and civil conduct while entering into a contact. Except as otherwise required by other laws and regulations, the formation, validity, performance, modification, assignment, termination, and liability for breach of a contract are stipulated by PRC contract law. A contracting party who failed to perform or failed to fulfill its contractual obligation shall bear the responsibility of a continued duty to perform or to provide remedies and compensation as provided by PRC laws.

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Product Quality Law

Pursuant to Product Quality Law of the PRC, promulgated on September 1, 1993 and amended in 2000, 2009 and 2018 respectively, producing or selling products that do not meet the standards or requirements for safeguarding human health or that constitute unreasonable threats to the safety of human life or property is prohibited. Where a defective product causes physical injury to a person or damage to his/her property, the injured party may claim compensation against the manufacturer or the distributor of such product.

Where any person produces or sells products that do not comply with the relevant national or industrial standards for safeguarding human health or constitute unreasonable threats to the safety of human life or property, the relevant authority will order the specific manufacturer or distributor to suspend the production or sale of defective products, confiscate the products produced or for sale, and impose a fine in an amount of up to three times the value of the defective products. Where illegal earnings were made or were involved, the relevant earnings will be confiscated accordingly. If the breach of regulation is serious, the business license of the relevant manufacturer and distributor may be revoked. If the relevant activities constitute a crime, the offender may be prosecuted.

PRC Laws and Regulations Relating to Advertising Business

The State Administration for Industry and Commerce, or SAI, is the primary governmental authority regulating advertising activities in China. The Advertisement Law of the PRC, which was most recently amended on October 26, 2018, the Administrative Regulations for Advertising, effective as of December 1, 1987, and the Administrative Provisions on Registration of Publishing of Advertisements, effective as of December 1, 2016, are the relevant regulations that apply to advertising businesses.

According to the above laws, regulations and rules, a company engaged in advertising activities must obtain, from the SAIC or its local branches, a business license that specifically includes operating an advertising business in its business scope. Failure to do so may lead to orders to rectify, fines and other penalties. An enterprise engaging in advertising not need to apply for registration of releasing advertisement, provided that such enterprise is not a radio station, television station, newspaper or magazine publisher or any other entity otherwise specified in the relevant laws or regulations. A radio station, television station, newspaper, magazine publisher or any other entity otherwise specified in the relevant laws or regulations may be subject to penalties, including fines, confiscation of advertising income and orders to rectify if it conducts advertising releasing activities without completing the required registration. The business license of an advertising company is valid for the duration of its existence, unless the license is suspended or revoked due to a violation of any relevant laws or regulations. Foreign investors are permitted to own all equity interests in PRC advertising companies.

Regulations on Toy Recall System

Pursuant to Article 3 of the Regulations on the Administration of Recall of Children's Toys (Order No. 101 of the State Administration of Quality Supervision, Inspection and Quarantine), the term "children's toys" refers to products processed, sold, and designed or intended for children under 14 years of age to play. “Defects” referred to in the Regulations on the Administration of Recall of Children's Toys refer to unreasonable dangers that are common in certain batches, models or categories of children's toys and that endanger children's health and safety due to design, production, instructions and other reasons. The term “recall” in the Regulations on the Administration of Recall of Children's Toys refers to a situation in which manufacturers and distributors must recall defective toys in accordance with prescribed procedures and requirements. The producer or the sellers organized by the producer can effectively prevent and eliminate the damage caused by defects by supplementing or amending the consumption instructions, returning goods, changing goods, repairing goods, and so on.

Article 12 of the Regulations on the Administration of Recall of Children's Toys stipulates that producers shall strengthen the management of information concerning the design of children's toys, the purchase of raw materials, the production and sale of toys and the labeling of products, as well as consumer complaints, product injury accidents, product injury disputes and recalls of products abroad, and establish and improve relevant information archives. Article 13 of the Regulations on the Administration of Recall of Children's Toys stipulates that sellers shall strengthen the management of children's toys, information management such as purchasing and sales, and proper preservation of consumer complaints, product injury accidents, product injury disputes and other information files.

Article 14 of the Regulations on the Administration of Recall of Children's Toys states that where the producer is aware that the children’s toy provided by him may be defective, the defect investigation shall be commenced immediately to confirm whether there is a defect.

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Article 19 of the Regulations on the Administration of Recall of Children's Toys states that where a defect in a children’s toy is confirmed by investigation, a risk assessment shall be made on the basis of the possibility, extent and scope of the damage to the child's health and safety caused by the defect in the child's toy, and a recall shall be carried out according to the result of the risk assessment.

Children's Toy Recall Information and Risk Assessment Management Method

Children's Toy Recall Information and Risk Assessment Management Method was formulated pursuant to the provisions of the Administrative Provisions on the Recall of Children's Toys, promulgated and enforced as of January 31, 2008. This method is formulated for the purposes of scientifically and orderly managing the defect investigation and risk assessment of children’s toys. The Defective Products Management Center of State Administration of Quality Supervision, Inspection and Quarantine is in charge of the routine management of children’s toys recall, and mainly assists the State Administration of Quality Supervision, Inspection and Quarantine to establish and maintain information system for recall management, to organize expert database, to select testing and experimental institution, organizing defect investigation and risk assessment, etc. In the event of children’s toys recall, its basic information, consumers' complaints, injury accidents, injury disputes and overseas recalls of its products, etc. shall be filed with the local quality supervision department by manufacturer in writing or electronically.

Law of the People's Republic of China on Import and Export Commodity Inspection

Law on Import and Export Commodity Inspection became effective on August 1, 1989 for the first time, and was later revised and enforced on December 29, 2018. Law on Import and Export Commodity Inspection is the legal basis for inspection and supervision of import and export commodities. This law is formulated for the purposes of improving and regulating the inspection of import and export commodities, guaranteeing the quality of commodities, promoting the smooth development of China's economic and trade relations with other countries. This law highlights the emphasis of inspection of import and export commodities, stipulates that commodity inspection agencies shall conduct compulsory inspection to import and export commodities which are listed in the Catalogue or required by other laws and regulations.

Law on Import and Export Commodity Inspection stipulates that import commodities subject to statutory inspection that have not been inspected must not be sold or used; export commodities subject to statutory inspection that have failed to pass the inspection must not be exported; packaging containers for dangerous export commodities shall apply for a test of the performance and use of such packaging containers, and no permission shall be granted for the export of dangerous commodities kept in packaging containers which have not passed the test. This Law applies to the management of 11 categories of import and export toy products, including soft toy, bamboo toy, plastic toy, ride-on toy, toy car, electric toy, paper toy, stationery like toy, soft modelling toy, ejecting toy and metal toy.

Implementation Regulations for the Law of the People’s Republic of China on Import and Export Commodity Inspection

Implementation Regulations for the Law of the People’s Republic of China on Import and Export Commodity Inspection was formulated pursuant to the provisions of the Law of the People's Republic of China on Import and Export Commodity Inspection, adopted at the 101st executive meeting of the State Council on August 10, 2005 and effective as of December 1, 2005, later revised and enforced on March 2, 2019.

This regulation applies to the management of 11 categories of import and export toy products, including soft toy, bamboo toy, plastic toy, ride-on toy, toy car, electric toy, paper toy, stationery like toy, soft modelling toy, ejecting toy and metal toy.

Standardization Law of the People’s Republic of China

Standardization Law of the People’s Republic of China was passed by the fifth session of the Standing Committee of the Seventh National People's Congress on December 29, 1988, and revised on November 4, 2017. This law is formulated for the purposes of developing socialist commodity economy, promoting scientific and technological advancement, improving the quality of products, adapting standardization work to the need for socialist modernization and external economic relationship development. This law applies to industrial product including toy product.

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Regulations of the People’s Republic of China on Certification and Accreditation

Regulations of the People’s Republic of China on Certification and Accreditation became effective as of September 3, 2003, and was later revised on February 6, 2016. This regulation is formulated for the purposes of standardizing certification and accreditation, improving the quality of products and services and management standard. This regulation applies to all certification agencies, certification services and accreditation services in the PRC.

Administrative Regulations on Compulsory Product Certification

Administrative Regulations on Compulsory Product Certification was formulated pursuant to the provisions of the Regulations of the People’s Republic of China on Certification and Accreditation and other laws, regulations and relevant provisions of the State, was adopted by the General Administration of Quality Supervision, Inspection and Quarantine on July 3, 2009 and became effective as of September 1, 2009. For products that are subject to compulsory product certification, the PRC will unify the product catalogue (hereinafter referred to as catalogue), the compulsory requirements, standards and conformity assessment procedures for technical specifications, the certification marks. The particular products specified by the PRC may not be delivered, sold, imported or used in other business activities until they are certified and labeled with a certification mark. The product catalogue includes manufactured toy product.

GB 6675-2014

To guarantee the safety and quality of children’s toy, protect children’s health and safety, the Standardization Administration of the People's Republic of China has revised GB 6675-2003 National Safety Technical Code for Toys and documented to GB 6675-2014 Safety of Toys National Standard 1-4 Parts, which were enforced as of January 1, 2016.

Four Mandatory National Standards are Part 1 of Safety of Toys: Basic Norm, Part 2 of Safety of Toys: Mechanical and Physical Properties, Part 3 of Safety of Toys: Flammability and <Part 4 of Safety of Toys: Migration of Specific Elements.

Since the date of enforcement, all toy products enter into Chinese mainland market shall meet the requirement of new Mandatory National Standards, and the old GB 6675-2003 National Safety Technical Code for Toys was invalidated with the enforcement of new Mandatory National Standards.

Measures for the Inspection, Supervision and Administration of Import and Export Toys

Measures for the Inspection, Supervision and Administration of Import and Export Toys was promulgated by the State Administration of Quality Supervision, Inspection and Quarantine on March 2, 2009 and became effective as of September 15, 2009, and was most recently amended by the General Administration of Customs of the PRC on November 23, 2018, which formulates the entry conditions of import and export toys, the inspection of import and export toys, the registration of export toys, and the supervision and legal liability of import and export toys. This measure applies to the enterprises engaged in the production and trade of import and export toys and the inspection and quarantine institutions. This measure is formulated for the purposes of regulating the inspection and supervision of import and export toys, strengthening the administration of import and export toys and protecting the human health and safety of consumers.

 

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MANAGEMENT

 

Directors and Executive Officers

 

The following table sets forth information regarding our directors and executive officers as of the date of this prospectus. Unless otherwise stated, the business address for our directors and executive officers is that of our principal executive offices at 7th Floor, Building C, No. 1010 Anling Road, Huli District, Xiamen, China 361009.

 

Name Age Position
Xiaodong Chen 51 Chief Executive Officer and Director
Caifan He 46 Chief Financial Officer and Director
Jianyong Cai 57 Chief Technology Officer and Director
Qinyi Fu(1) 34 Independent Director
Jun Ouyang(1)(2)(3) 36 Independent Director
Huibin Shen(3) 47 Independent Director
Can Su(1)(2) 30 Independent Director

 

(1)Member of audit committee.
(2)Member of remuneration committee.
(3)Member of nomination and governance committee.

 

Xiaodong Chen has served as chief executive officer of Blue Hat Cayman since December 2018, as a member of the board of directors of Blue Hat Cayman since its incorporation in June 2018 and as the chairman of the board of directors and general manager of Blue Hat Fujian since August 2015. Mr. Chen is a director of Victory Hat Limited, a shareholder of Blue Hat Cayman. From July 1987 to November 1989, Mr. Chen served as an office worker of the Inspection Department of Fuzhou Second People's Hospital. From December 1989 to June 1995, Mr. Chen served as the manager of Fuzhou Liming Footwear Co., Ltd. From December 1996 to January 2002, Mr. Chen served as a manager of Fuzhou Changdong Trading Co. Ltd. From February 2002 to January 2008, Mr. Chen served as general manager of Huanyu International Co. Ltd. From March 2008 to March 2015, Mr. Chen served as the general manager of Guangzhou Taihao Trading Co., Ltd. From January 2010 to March 2013, Mr. Chen served as the chairman and general manager of Xiamen Blue Hat Culture Communication Ltd. Mr. Chen received his EMBA from Renmin University of China. We believe Mr. Chen’s extensive experience qualifies him to serve on our board of directors.

 

Caifan He has served as chief financial officer and a member of the board of directors of Blue Hat Cayman since December 2018. Mr. He has served as a director, deputy general manager and financial controller of Blue Hat Fujian since August 2015. Mr. He is a director of Celebrate Hat Limited, a shareholder of Blue Hat Cayman. Mr. He served as a middle school teacher in Cangchang Village from July 1994 to December 1996 in Anhua County. From January 1997 to January 2000, Mr. He served as the accountant, accounting supervisor and account manager of Guangzhou Changdong Industrial Co., Ltd. From February 2000 to March 2008, Mr. He served as the finance manager and financial director of Guangzhou Tiandixing Telecommunications Co., Ltd. From March 2008 to January 2012, Mr. He served as the finance manager of Guangzhou Taihao Trading Co., Ltd. From March 2013 to August 2015, Mr. He served as a director and financial controller of Blue Hat (Xiamen) Culture Communication Co., Ltd. Mr. He received a College Diploma in Finance from Hunan University of Finance and Economics. We believe Mr. He’s extensive experience qualifies him to serve on our board of directors.

 

Jianyong Cai has served as chief technology officer and a member of the board of directors of Blue Hat Cayman since December 2018. Mr. Cai has served as a director, deputy general manager and chief engineer of Blue Hat Fujian since January 2010. Mr. Cai taught in the School of Optoelectronics and Information Engineering of Fujian Normal University from August 1983 to June 2002. Since July 2002, Mr. Cai has served as an associate professor at the School of Optoelectronics and Information Engineering at Fujian Normal University, where he mainly works on Data Communication Principles, Communication Network Foundation, Software Engineering and other undergraduate courses as well as Communication Network Theory and Technology, Computer Network Architecture and other postgraduate courses. Mr. Cai received a Bachelor’s Degree in Data Communication Principles, Communication Network Foundation and Software Engineering from University of Science and Technology of China. We believe Mr. Cai’s extensive experience qualifies him to serve on our board of directors.

 

Qinyi Fu has served as a member of the board of directors of Blue Hat Cayman since December 2018. Mr. Fu served as a auditor of Ernst & Young China Certified Public Accountants from October 2010 to January 2012.Mr. Fu served as a senior auditor of Deloitte China Certified Public Accountants from January 2012 to December 2015. Mr. Fu served as a partner of Ruihua Certified Public Accountants from December 2015 to May 2018. Mr. Fu has served as a partner of Dahua Certified Public Accountants since June 2018. Mr. Fu received a Bachelor’s Degree in International Economics and Trade and a Master’s Degree in International Economics from Xiamen University. We believe Mr. Fu’s extensive experience qualifies him to serve on our board of directors.

 

Jun Ouyang has served as a member of the board of directors of Blue Hat Cayman since December 2018. Mrs. Ouyang served as a professional teacher in the Department of Economic Management of Zhangzhou City College from August 2009 to August 2016. Mrs. Ouyang has been studying for a Ph.D. in Marketing from Xiamen University since September 2016. Mrs. Ouyang received a Bachelor’s Degree in Computer Science and Engineering from Xi'an University of Finance and Economics and a Master’s Degree in Management Science and Engineering from Fuzhou University. We believe Mrs. Ouyang’s extensive experience qualifies her to serve on our board of directors.

 

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Huibin Shen has served as a member of the board of directors of Blue Hat Cayman since December 2018. Mr. Shen has served as the director of the capital market department of Beijing Jingshi Law Firm (Xiamen) since November 2017. Mr. Shen served as vice director of the capital market department of Beijing Dentons Law Offices, LLP (Xiamen) from March 2009 to November 2017. Mr. Shen is also an arbitrator of the Xiamen Arbitration Commission. Mr. Shen received a Bachelor’s Degree in Law from East China University of Political Science and Law and a Master’s Degree in Civic and Commercial Law from China University of Political Science and Law. We believe Mr. Shen’s extensive experience qualifies him to serve on our board of directors.

 

Can Su has served as a member of the board of directors of Blue Hat Cayman since December 2018. Mr. Su has served as account manager of Xiamen Rural Commercial Financing Guarantee Co., Ltd. since January 2018. Mr. Su served as account manager of Xiamen Rural Commercial Bank Asset Management Co., Ltd. from December 2015 to December 2017. Mr. Su received a Bachelor’s Degree in Logistics Management from Xiamen University Tan Kah Kee College and a MBA from High Point University. We believe Mr. Su’s extensive experience qualifies him to serve on our board of directors.

 

None of the events listed in Item 401(f) of Regulation S-K has occurred during the past ten years that is material to the evaluation of the ability or integrity of any of our directors or executive officers.

 

Employment Agreements, Director Agreements and Indemnification Agreements

 

In December 2018, we entered into employment agreements with each of Xiaodong Chen, Caifan He and Jianyong Cai, pursuant to which such individuals agreed to serve as our executive officers until December 2023. Such terms will be automatically extended for six-month periods, unless the agreements are terminated in accordance with their terms. We may terminate the employment for cause at any time for certain acts, such as conviction or plea of guilty to a felony or any crime involving moral turpitude, negligent or dishonest acts to our detriment, or misconduct or a failure to perform agreed duties. We may also terminate the employment without cause at any time upon 60 days’ advance written notice. Each executive officer may resign at any time upon 60 days’ advance written notice.

 

Each executive officer has agreed to hold, both during and after the termination or expiry of his employment agreement, in strict confidence and not to use, except as required in the performance of his duties in connection with the employment or pursuant to applicable law, any of our confidential or proprietary information or the confidential or proprietary information of any third party received by us and for which we have confidential obligations. Each executive officer has also agreed to disclose in confidence to us all inventions, designs and trade secrets which he conceives, develops or reduces to practice during his employment with us and to assign all right, title and interest in them to us, and assist us in obtaining and enforcing patents, copyrights and other legal rights for these inventions, designs and trade secrets.

 

In addition, each executive officer has agreed to be bound by non-competition and non-solicitation restrictions during the term of his employment and for one year following the last date of employment. Specifically, each executive officer has agreed not to: (i) engage or assist others in engaging in any business or enterprise that is competitive with our business, (ii) solicit, divert or take away the business of our clients, customers or business partners, or (iii) solicit, induce or attempt to induce any employee or independent contractor to terminate his or her employment or engagement with us. The employment agreements also contain other customary terms and provisions.

 

We have also entered into indemnification agreements with each of our executive officers and directors. Under these agreements, we have agreed to indemnify our directors and executive officers against certain liabilities and expenses incurred by such persons in connection with claims made by reason of their being a director or officer of our company.

 

We have also entered into director agreements with each of our directors which agreements set forth the terms and provisions of their engagement. 

 

Board of Directors

 

Duties of Directors

 

Under Cayman Islands law, our board of directors has the powers necessary for managing, and for directing and supervising, our business affairs. The functions and powers of our board of directors include, among others:

 

convening shareholders' annual and extraordinary general meetings and reporting its work to shareholders at such meetings;

 

declaring dividends and distributions;

 

appointing officers and determining the term of office of the officers;

 

exercising the borrowing powers of our company and mortgaging the property of our company; and

 

approving the transfer of shares in our company, including the registration of such shares in our share register.

 

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Under Cayman Islands law, all of our directors owe fiduciary duties to our company, including a duty of loyalty, a duty to act honestly and a duty to act in what they consider in good faith to be in our best interests. Our directors must also exercise their powers only for a proper purpose. Our directors also have a duty to exercise the skill they actually possess and such care and diligence that a reasonably prudent person would exercise in comparable circumstances. In fulfilling their duty of care to us, our directors must ensure compliance with our memorandum and articles of association, as amended from time to time. Our company has the right to seek damages if a duty owed by any of our directors is breached. You should refer to “Description of Share Capital and Governing Documents — Comparison of Cayman Islands Corporate Law and U.S. Corporate Law” for additional information on the standard of corporate governance under Cayman Islands law.

Composition of our Board of Directors

 

Our board of directors currently consists of seven directors. Our board of directors has determined that each of Qinyi Fu, Jun Ouyang, Huibin Shen and Can Su is an “independent director” as defined under the Nasdaq rules. Our board of directors is composed of a majority of independent directors.

 

Family Relationships

 

Jianyong Cai, our chief technology officer and director, is the brother of Juanjuan Cai, a director and shareholder of Blue Hat Fujian and the wife of Xiaodong Chen, our chief executive officer and director. There are no other family relationships between any of Blue Hat Cayman’s executive officers and directors.

 

Shaohong Chen, the owner of Prosper Hat Limited and Shaohong Holding Limited and a shareholder of Blue Hat Fujian, is the sister of Xiaodong Chen.

 

Committees of our Board of Directors

 

Our board of directors has established an audit committee, a remuneration committee and a nomination and governance committee, which have the responsibilities and authority necessary to comply with applicable Nasdaq rules. The audit committee is comprised of Qinyi Fu, Jun Ouyang, and Can Su. The remuneration committee is comprised of Jun Ouyang and Can Su. The nomination and governance committee is comprised of Jun Ouyang and Huibin Shen.

 

Audit Committee

 

Qinyi Fu, Jun Ouyang and Can Su serve as members of the audit committee. Qinyi Fu serves as the chair of the audit committee. All of the audit committee members satisfy the independence requirements of the Nasdaq rules and the independence standards of Rule 10A-3 under the Exchange Act. Our board of directors has determined that Qinyi Fu possesses accounting or related financial management experience that qualifies him as an “audit committee financial expert” as defined by the rules and regulations of the SEC and Nasdaq. The audit committee will oversee our accounting and financial reporting processes and the audits of our financial statements. The audit committee will be responsible for, among other things:

 

appointing the independent auditors and pre-approving all auditing and non-auditing services permitted to be performed by the independent auditors;
reviewing with the independent auditors any audit problems or difficulties and management's response;
discussing the annual audited financial statements with management and the independent auditors;
reviewing the adequacy and effectiveness of our accounting and internal control policies and procedures and any steps taken to monitor and control major financial risk exposures;
reviewing and approving all proposed related party transactions;
meeting separately and periodically with management and the independent auditors; and
monitoring compliance with our code of business conduct and ethics, including reviewing the adequacy and effectiveness of our procedures to ensure proper compliance.

 

Remuneration Committee

 

Jun Ouyang and Can Su serve as members of the remuneration committee. Jun Ouyang serves as the chair of the remuneration committee.  All of our remuneration committee members satisfy the independence requirements of the Nasdaq rules and the independence standards of Rule 10A-3 under the Exchange Act. The remuneration committee will be responsible for overseeing and making recommendations to our board of our directors regarding the salaries and other compensation of our executive officers and general employees and providing assistance and recommendations with respect to our compensation policies and practices. 

 

Nomination and Governance Committee

 

Jun Ouyang and Huibin Shen serve as members of the nomination and governance committee. Jun Ouyang serves as the chair of the nomination and governance committee.  All of the nomination and governance committee members satisfy the independence requirements of the Nasdaq rules and the independence standards of Rule 10A-3 under the Exchange Act. The nomination and governance committee will be responsible for identifying and proposing new potential director nominees to the board of directors for consideration and for reviewing our corporate governance policies.

 

Prior to the completion of this offering, the composition of these committees will meet the criteria for independence under, and the functioning of these committees will comply with the applicable requirements of the Nasdaq and SEC rules and regulations. We intend to comply with future requirements as they become applicable to us.

Code of Business Conduct and Ethics

 

We have adopted a code of business conduct and ethics, which is applicable to all of our directors, executive officers and employees.

 

Foreign Private Issuer Exemption

We are a “foreign private issuer,” as defined by the SEC. As a result, in accordance with the rules and regulations of Nasdaq, we may choose to 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:

 

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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.

Other Corporate Governance Matters

The Sarbanes-Oxley Act of 2002, as well as related rules subsequently implemented by the SEC, requires foreign private issuers, including us, to comply with various corporate governance practices. In addition, Nasdaq rules provide that foreign private issuers may follow home country practice in lieu of the Nasdaq corporate governance standards, subject to certain exceptions and except to the extent that such exemptions would be contrary to U.S. federal securities laws.

 

Because we are a foreign private issuer, our members of our board of directors, executive board members and senior management are not subject to short-swing profit and insider trading reporting obligations under section 16 of the Exchange Act. They will, however, be subject to the obligations to report changes in share ownership under section 13 of the Exchange Act and related SEC rules.

 

Compensation of Director and Executive Officers

For the year ended December 31, 2018, we paid an aggregate of approximately RMB 1,162,500 ($169,078) in cash to our directors and executive officers.

We have not set aside or accrued any amount to provide pension, retirement or other similar benefits to our director and executive officers. Our subsidiaries and VIE are required by law to make contributions equal to certain percentages of each employee's salary for his or her pension insurance, medical insurance, unemployment insurance and other statutory benefits and a housing provident fund.

Equity Awards

We have not granted any equity awards to our executive officers or directors during the fiscal year ended December 31, 2018.

 

Incentive Compensation

 

The Company does not maintain any cash incentive or bonus programs.

 

2018 Director and Executive Officer Compensation Table

The following table sets forth information regarding the compensation paid to our directors and our executive officers for service on our board of directors or as an executive officer during the year ended December 31, 2018.

 

Name

Fees Earned

in Cash

 All Other Compensation

 Total

Xiaodong Chen   RMB 686,700  ($99,876) - RMB 686,700 ($99,876)
Caifan He   RMB 475,800 ($69,202) - RMB 475,800 ($69,202)

 

During the year ended December 31, 2018, Jianyong Cai, Qinyi Fu, Jun Ouyang, Huibin Shen and Can Su did not receive any compensation.

 

Employees

As of March 31, 2019, we had 107 employees, all of which were full-time employees.

We have also engaged, and may continue to engage, subcontractors to assist us with our manufacturing. None of our employees are represented by a labor union or covered by a collective bargaining agreement. We have never experienced any employment related work stoppages, and we consider our relations with our employees to be good.

Indemnification

We have entered into indemnification agreements with each of our directors and executive officers. Under these agreements, we have agreed to indemnify our directors and executive officers against certain liabilities and expenses incurred by such persons in connection with claims made by reason of their being a director or officer of our company.

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RELATED PARTY TRANSACTIONS

During the last three years, we have engaged in the following transactions with our directors, executive officers or holders of more than 5% of our outstanding share capital and their affiliates, which we refer to as our related parties:

 

As of December 31, 2018, December 31, 2017 and December 31, 2016, we owed $62,368, $33,654 and $6,048, respectively, to Xiaodong Chen, our chief executive officer, director and a shareholder of Blue Hat Fujian, as a result of a loan from Xiaodong Chen who paid for certain leases on our behalf. These loans are unwritten, interest free and due on demand. These amounts are included in the consolidated financial statements as related party payables. See Note 9 of the notes to the consolidated financial statements included elsewhere in this prospectus. As of December 31, 2018, Lin Zhao, general manager of Blue Hat Shenyang, and Liang Yuan, general manager of Blue Hat Hunan, owed $3,419 and $8,617, respectively, to us as a result of employee advances. These amounts are included in the consolidated financial statements as other receivables - related parties. See Note 9 of the notes to the consolidated financial statements included elsewhere in this prospectus.

In February 2017, Xiaodong Chen and Blue Hat Fujian entered into a vehicle rental agreement which provides that Xiaodong Chen rents a self-owned vehicle to Blue Hat Fujian for office use. The rental fee was RMB 3,500 ($509) per month and the rental term was from February 3, 2017 to February 2, 2019. As of February 2, 2019, the vehicle was no longer being used and the parties do not intend to enter into a new vehicle rental agreement.

 

Xiaodong Chen and Juanjuan Cai, a director and shareholder of Blue Hat Fujian and the wife of Xiaodong Chen, were, and are, guarantors of certain of our short-term loans. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 9 and Note 10 of the notes to the consolidated financial statements included elsewhere in this prospectus.

 

Jianyong Cai, our chief technology officer and director, is the brother of Juanjuan Cai, the wife of Xiaodong Chen.

 

Shaohong Chen, the owner of Prosper Hat Limited and Shaohong Holding Limited and a shareholder of Blue Hat Fujian, is the sister of Xiaodong Chen.

 

Contractual Arrangements with our VIE and its Shareholders
See “Corporate History and Structure—Contractual Arrangements.”
Policies and Procedures for Related Party Transactions

Our board of directors has created an audit committee in connection with this offering which will be tasked with review and approval of all related party transactions. 

Employment Agreements, Director Agreements and Indemnification Agreements

 

In December 2018, we entered into employment agreements with each of our executive officers pursuant to which such individuals agreed to serve as our executive officers.

 

We have also entered into indemnification agreements with each of our executive officers and directors. Under these agreements, we have agreed to indemnify our directors and executive officers against certain liabilities and expenses incurred by such persons in connection with claims made by reason of their being a director or officer of our company.

 

We have also entered into director agreements with each of our directors which agreements set forth the terms and provisions of their engagement.

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PRINCIPAL SHAREHOLDERS

The following table sets forth information with respect to the beneficial ownership of our ordinary shares as of the date of this prospectus for:

each beneficial owner of 5% or more of our outstanding ordinary shares;
each of our directors and executive officers; and
all of our directors and executive officers as a group.

 

Beneficial ownership is determined in accordance with the rules of the SEC. These rules generally attribute beneficial ownership of securities to persons who possess sole or shared voting power or investment power with respect to those securities and include ordinary shares issuable upon the exercise of options that are immediately exercisable or exercisable within 60 days of the date of this prospectus. Percentage ownership calculations are based on 33,000,000 ordinary shares outstanding as of the date of this prospectus.