UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 20-F
(Mark One)
☐ REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934
☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
For the fiscal year ended December 31, 2019
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
OR
☐ SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Date of event requiring this shell company report
Commission file number: 001-39001
Blue Hat Interactive Entertainment Technology
(Exact Name of Registrant as Specified in Its Charter)
N/A
(Translation of Registrant’s Name Into English)
Cayman Islands
(Jurisdiction of Incorporation or Organization)
7th Floor, Building C, No. 1010 Anling Road
Huli District, Xiamen, China 361009
(Address of Principal Executive Offices)
Xiaodong Chen
Chief Executive Officer
7th Floor, Building C, No. 1010 Anling Road
Huli District, Xiamen, China 361009
People’s Republic of China
E-mail: ir@bluehatgroup.net
Telephone: + 86-592-228-0081
(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Title of each class
Ordinary Shares, par value $0.001 per share
Trading symbol(s)
BHAT
Name of each exchange on which registered
The Nasdaq Stock Market LLC
Securities registered or to be registered pursuant to Section 12(g) of the Act:
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
None
(Title of Class)
None
(Title of Class)
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual
report:
As of December 31, 2019, there were 35,141,114 ordinary shares issued and outstanding, par value $0.001 per ordinary share.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934.
Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934 from their obligations under those Sections.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
☐ Yes ☒ No
☐ Yes ☒ No
☒ Yes ☐ No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of
Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
☒ Yes ☐ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or an emerging growth company. See
definition of “large accelerated filer,” “accelerated filer,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐
Accelerated filer ☐
Non-accelerated filer ☒
Emerging growth company ☒
If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected
not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the
Exchange Act. ☐
† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting
Standards Codification after April 5, 2012.
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control
over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or
issued its audit report.
☐
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
U.S. GAAP ☒
International Financial Reporting Standards as issued
by the International Accounting Standards Board ☐
Other ☐
If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to
follow.
☐ Item 17 ☐ Item 18
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.
☐ Yes ☒ No
☐ Yes ☐ No
TABLE OF CONTENTS
INTRODUCTION
FORWARD-LOOKING STATEMENTS
PART I
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
ITEM 3. KEY INFORMATION
ITEM 4. INFORMATION ON THE COMPANY
ITEM 4A. UNRESOLVED STAFF COMMENTS
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
ITEM 8. FINANCIAL INFORMATION
ITEM 9. THE OFFER AND LISTING
ITEM 10. ADDITIONAL INFORMATION
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
ITEM 15. CONTROLS AND PROCEDURES
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
ITEM 16B. CODE OF ETHICS
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT
ITEM 16G. CORPORATE GOVERNANCE
ITEM 16H. MINE SAFETY DISCLOSURE
PART III
ITEM 17. FINANCIAL STATEMENTS
ITEM 18. FINANCIAL STATEMENTS
ITEM 19. EXHIBITS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
i
ii
iii
1
1
1
1
23
41
41
53
58
59
59
60
69
69
70
70
70
70
72
72
72
72
72
73
73
73
73
74
74
74
F-1
Unless otherwise indicated or the context otherwise requires, references in this annual report on Form 20-F to:
INTRODUCTION
● “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 annual report, Taiwan, Hong Kong and Macau.
“RMB” or “Renminbi” refers to the legal currency of China and “$”, “US$” or “U.S. Dollars” refers to the legal currency of the United States.
● We have made rounding adjustments to some of the figures included in this annual report. Accordingly, numerical figures shown as totals in some
tables may not be an arithmetic aggregation of the figures that preceded them.
● 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 annual report. Assets and liabilities denominated in Renminbi are translated
into U.S. dollars at the rates of exchange as of the balance sheet date, equity accounts are translated at historical exchange rates, and revenues and
expenses are translated using the average rate of exchange in effect during the reporting period. With respect to amounts not recorded in our
consolidated financial statements included elsewhere in this annual report, unless otherwise stated, The average translation rates applied to
statement of income accounts for the periods ended December 31, 2019 and 2018 were RMB 6.88 and RMB 6.62 to $1.00, respectively. The
balance sheet amounts as of December 31, 2019 and 2018 were translated at RMB 6.98 and RMB 6.88, respectively.
ii
FORWARD-LOOKING STATEMENTS
This annual report on Form 20-F contains forward-looking statements that reflect our current expectations and views of future events. Known and unknown
risks, uncertainties and other factors, including those listed under “Item 3. Key Information—D. Risk Factors”, may cause our actual results, performance
or achievements to be materially different from those expressed or implied by the forward-looking statements.
You can identify some of these forward-looking statements by words or phrases such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,”
“plan,” “believe,” “is/are likely to,” “potential,” “continue” or other similar expressions. We have based these forward-looking statements largely on our
current expectations and projections about future events that we believe may affect our financial condition, results of operations, business strategy and
financial needs. Factors that could cause our actual results, performance or achievements to be materially different from those expressed or implied by the
forward-looking statements, include, but are not limited to, the factors summarized below:
● We depend upon Blue Hat Fujian to conduct our business in China and control Blue Hat Fujian through contractual arrangements (the
“Contractual Arrangements”), which may not be as effective as direct ownership;
● We face risks related to health epidemics, severe weather conditions and other outbreaks, in particular, the current escalating coronavirus
pandemic.
● 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.
You should read this annual report and the documents that we refer to in this annual report and have filed as exhibits to this annual report completely and
with the understanding that our actual future results may be materially different from what we expect. Other sections of this annual report discuss factors
which could adversely impact our business and financial performance. Moreover, we operate in an evolving environment. New risk factors emerge from
time to time and it is not possible for our management to predict all risk factors, nor can we assess the impact of all factors on our business or the extent to
which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. We
qualify all of our forward-looking statements by these cautionary statements.
You should not rely upon forward-looking statements as predictions of future events. The forward-looking statements made in this annual report relate only
to events or information as of the date on which the statements are made in this annual report. Except as required by law, we undertake no obligation to
update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, after the date on which the
statements are made or to reflect the occurrence of unanticipated events.
iii
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
Not applicable.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
PART I
Not applicable.
ITEM 3. KEY INFORMATION
A. Selected Financial Data
The following table presents the selected consolidated financial information for our business. You should read the following information in conjunction
with Item 5 “Operating and Financial Review and Prospects” below. The following data for the years ended December 31, 2017, 2018 and 2019 and as of
December 31, 2017, 2018 and 2019 have been derived from our audited consolidated financial statements for those years, which were prepared in
accordance with accounting principles generally accepted in the United States, or U.S. GAAP, and should be read in conjunction with those statements,
which are included in this annual report beginning on page F-1.
Selected Consolidated Balance Sheet Data:
Total current assets
Total assets
Total current liabilities
Total liabilities
Total shareholders’ equity
Total liabilities and shareholders’ equity
Selected Consolidated Statements of Operations Data:
REVENUES
COST OF REVENUES
GROSS PROFIT
OPERATING EXPENSES:
Selling
General and administrative
Research and development
Total operating expenses
INCOME FROM OPERATIONS
OTHER INCOME (EXPENSE)
Interest income
Interest expense
Other finance expenses
Other (expense) income, net
Total other income, net
INCOME BEFORE INCOME TAXES
PROVISION FOR INCOME TAXES
NET INCOME
OTHER COMPREHENSIVE INCOME (LOSS)
Foreign currency translation adjustment
COMPREHENSIVE INCOME
Basic and diluted
EARNINGS PER SHARE
Basic and diluted
$
December 31, December 31, December 31,
2018
25,659,179 $
35,470,864
7,122,833
7,214,819
28,256,045
35,470,864 $
2019
42,717,316 $
58,815,689
13,680,028
14,065,407
44,750,282
58,815,689 $
2017
29,243,641
33,582,177
11,594,387
11,771,414
21,810,763
33,582,177
$
For the Years Ended December 31,
2018
18,531,178 $
(6,108,676)
12,422,502
2019
23,834,129 $
(7,531,800)
16,302,329
2017
14,144,894
(5,300,087)
8,844,807
(928,680)
(4,860,189)
(1,031,204)
(6,820,073)
9,482,256
(759,647)
(3,058,548)
(286,842)
(4,105,037)
8,317,465
629
(171,938)
(4,415)
221,146
45,422
9,527,678
(453,724)
9,073,954
219,001
(142,641)
(3,656)
134,667
207,371
8,524,836
(605,428)
7,919,408
(629,424)
(1,915,195)
(355,730)
(2,900,349)
5,944,458
161,382
(183,291)
(3,473)
161,091
135,709
6,080,167
955,194
5 ,124,973
(521,738)
8,552,216 $
35,141,114
(1,474,126)
6,445,282 $
33,000,000
958,667
6,083,640
33,000,000
0.26 $
0.24 $
0.16
$
$
$
1
Selected Consolidated Cash Flow Data:
Net cash (used in) provided by operating activities
Net cash provided by (used in) investing activities
Net cash (used in) provided by financing activities
EFFECT OF EXCHANGE RATE ON CASH
NET CHANGE IN CASH AND CASH EQUIVALENTS
Cash paid for income tax
Cash paid for interest
Cash and cash equivalents
Restricted cash
Total cash, cash equivalents, and restricted cash shown in the consolidated statements of cash flows $
$
B. Capitalization and Indebtedness
Not applicable.
C. Reasons for the Offer and Use of Proceeds
Not applicable.
D. Risk Factors
Risks Related to Our Business
For the Years Ended December 31,
2018
(414,604) $
10,801,986
(426,221)
(501,935)
9,459,226
1,713,763
142,641
11,829,509
-
11,829,509 $
2019
12,309,246 $
(19,111,780)
10,596,581
(144,969)
3,649,078
119,243
171,938
10,478,587
5,000,000
15,478,587 $
2017
6,989,680
(15,814,920)
10,167,330
72,267
1,414,357
-
183,291
2,370,283
-
2,370,283
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 annual report, 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.
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. Prior to our initial public offering, we had 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.
2
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.
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 2019, we primarily relied on five Chinese distributors for the sale of our products, which accounted for 34.9% of our total
revenue In 2019, 100% of our products were sold in China and, of these sales in China, approximately 98.4% 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 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.
3
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.
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 “Directors, Senior Management and Employees”
located elsewhere in this annual report, 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 December 31, 2019, we had 100 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.
4
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.
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 contractual arrangements, or 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.
5
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.
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 proceeds from our initial public 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.
6
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, or the NPC, approved the Foreign Investment Law, which took 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 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 VIE through contractual arrangements are deemed as foreign investment in the
future, and any business of our 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 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 operations.
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.
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.
7
We face risks related to health epidemics, severe weather conditions and other outbreaks, in particular, the current escalating coronavirus
pandemic.
In recent years, there have been outbreaks of epidemics in various countries, including China. Recently, there was an outbreak of a novel strain of
coronavirus (COVID-19) in China, which has spread rapidly to many parts of the world. The outbreak has resulted in quarantines, travel restrictions, and
the temporary closure of stores and facilities throughout China and other parts of the world. In March 2020, the World Health Organization declared
COVID-19 a pandemic.
Substantially all of our revenues and our workforce are concentrated in China. Consequently, our results of operations will likely be adversely, and
may be materially, affected, to the extent that the COVID-19 or any other epidemic harms the Chinese and global economy in general. Any potential impact
to our results will depend on, to a large extent, future developments and new information that may emerge regarding the duration and severity of the
COVID-19 outbreak and the actions taken by government authorities and other entities to contain the COVID-19 outbreak or treat its impact, almost all of
which are beyond our control. Potential impacts include, but are not limited to, the following:
● temporary closure of offices, travel restrictions or suspension of services of our customers and suppliers have negatively affected, and could
continue to negatively affect, the demand for our services;
● our customers may require additional time to pay us or fail to pay us at all, which could significantly increase the amount of accounts receivable
and require us to record additional allowances for doubtful accounts;
● the business operations of our distributors have been and could continue to be negatively impacted by the outbreak, which may negatively impact
our distribution channel, or result in loss of customers or disruption of our services, which may in turn materially adversely affect our financial
condition and operating results; and
● any disruption of our supply chain, logistics providers or customers could adversely impact our business and results of operations.
Because of the uncertainty surrounding the COVID-19 outbreak, the financial impact related to the outbreak cannot be reasonably estimated at this
time, but our consolidated results for the first quarter of 2020 and full year 2020 may be adversely affected. We expect our total revenues in the first quarter
of 2020 to decrease, and there is no guarantee that our total revenues will grow or remain at a similar level in the next three quarters of 2020. We may have
to record downward adjustments or impairment in the fair value of investments in the first quarter of 2020, if conditions have not been significantly
improved and global stock markets have not recovered from recent declines.
In general, our business could be adversely affected by the effects of epidemics, including, but not limited to, COVID-19, avian influenza, severe acute
respiratory syndrome (SARS), the influenza A virus, Ebola virus, severe weather conditions such as a snowstorm, flood or hazardous air pollution, or other
outbreaks. In response to an epidemic, severe weather conditions, or other outbreaks, government and other organizations may adopt regulations and
policies that could lead to severe disruption to our daily operations, including temporary closure of our offices and other facilities. These severe conditions
may cause us and/or our partners to make internal adjustments, including but not limited to, temporarily closing down business, limiting business hours,
and setting restrictions on travel and/or visits with clients and partners for a prolonged period of time. Various impacts arising from severe conditions may
cause business disruption, resulting in material, adverse impact to our financial condition and results of operations.
8
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.
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.
9
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.
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.
10
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.
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.
11
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.
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.
12
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.
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 annual report 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.
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Fluctuations in exchange rates could have a material and adverse effect on our results of operations and the value of your investment.
The value of the Renminbi against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and
economic conditions in China and by China’s foreign exchange policies. On July 21, 2005, the PRC government changed its decade-old policy of pegging
the value of the Renminbi to the U.S. dollar, and the Renminbi appreciated more than 20% against the U.S. dollar over the following three years. Between
July 2008 and June 2010, this appreciation halted and the exchange rate between the Renminbi and the U.S. dollar remained within a narrow band. Since
June 2010, the Renminbi has fluctuated against the U.S. dollar, at times significantly and unpredictably. On November 30, 2015, the Executive Board of the
International Monetary Fund (IMF) completed the regular five-year review of the basket of currencies that make up the Special Drawing Right, or the SDR,
and decided that with effect from October 1, 2016, Renminbi is determined to be a freely usable currency and will be included in the SDR basket as a fifth
currency, along with the U.S. dollar, the Euro, the Japanese yen and the British pound. In the fourth quarter of 2016, the Renminbi depreciated significantly
in the backdrop of a surging U.S. dollar and persistent capital outflows of China. With the development of the foreign exchange market and progress
towards interest rate liberalization and Renminbi internationalization, the PRC government may in the future announce further changes to the exchange rate
system, and we cannot assure you that the Renminbi will not appreciate or depreciate significantly in value against the U.S. dollar in the future. It is
difficult to predict how market forces or PRC or U.S. government policy may impact the exchange rate between the Renminbi and the U.S. dollar in the
future.
Significant revaluation of the Renminbi may have a material and adverse effect on your investment. For example, to the extent that we need to convert
U.S. dollars from our initial public 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.
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.
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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.
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 in 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.
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We face uncertainty with respect to indirect transfers of equity interests in PRC resident enterprises by their non-PRC holding companies.
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.
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, 2019, our two largest suppliers accounted for 54.84% and 31.53%, respectively, 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 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 2019, two customers under the same ownership together accounted for 12.1% 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
An active trading market for our ordinary shares may not be sustained.
Our ordinary shares have been listed on Nasdaq only since July 26, 2019, and we cannot assure you that an active trading market for our ordinary
shares will be sustained or maintained. 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 continued 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 your shares at or above the price you
purchased the shares at.
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The market price of our ordinary shares is likely to be highly volatile and may fluctuate substantially due to many factors, including:
● 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.
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 ordinary shares are considered to be penny stock. Trading in penny stocks has certain restrictions and these restrictions could negatively affect
the price and liquidity of our ordinary shares.
Our ordinary shares trade below $5.00 per share. 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. As a result, our ordinary shares are considered “penny stock”. A penny
stock is subject to rules that impose additional sales practice requirements on broker/dealers who sell 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.
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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. We have issued and outstanding 35,141,114 ordinary shares. Of that
amount, 24,784,800 shares are restricted as of May 8, 2020 as a result of securities laws and/or lock-up agreements, but will be able to be sold in the future
subject to securities laws and/or lock-up agreements. If held by one of our affiliates, the resale of those securities will also be subject to volume limitations
under Rule 144 of the Securities Act.
Our directors, officers and principal shareholders have significant voting power and may take actions that may not be in the best interests of our
other shareholders.
Our officers, directors and principal shareholders holding more than 5% of our ordinary shares, collectively, control approximately 67% of our
outstanding ordinary shares. As a result, these shareholders, if they act together, will be able to control the management and affairs of our Company and
most matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions. The interests of these
shareholders may not be the same as or may even conflict with your interests. For example, these shareholders could attempt to delay or prevent a change
in control of our Company, even if such change in control would benefit our other shareholders which could deprive our shareholders of an opportunity to
receive a premium for their ordinary shares as part of a sale of our 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 shareholders.
We have broad discretion in the use of proceeds from our initial public offering designated for working capital and general corporate purposes,
and we may not succeed in using those net proceeds effectively.
In July 2019, we issued and sold 2,000,000 ordinary shares in our initial public offering. In connection with our initial public offering, we also issued
and sold an additional 141,114 shares pursuant to the partial exercise of the underwriter’s over-allotment option. We intended to use the net proceeds from
our initial public 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. In 2019, we used approximately $1.8 million of the net proceeds from our initial public
offering for research and development, selling and marketing, and working capital and other general corporate purposes. Our management has broad
discretion over the use and investment of the net proceeds from the initial public offering within those categories. Accordingly, investors have only limited
information concerning management’s specific intentions and need to rely upon the judgment of our management with respect to the use of proceeds.
We incur significant additional costs as a result of being a public company, which may adversely affect our business, financial condition and
results of operations.
As a public company, we incur significant additional costs associated with corporate governance requirements that apply 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 Nasdaq. Compliance with these rules and regulations will significantly increase our accounting, legal and financial
compliance costs and make some activities more time-consuming. We also expect these rules and regulations could 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, such increases in costs incurred as a result of becoming a public company may adversely affect our
business, financial condition and results of operations.
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Our disclosure controls and procedures may not prevent or detect all errors or acts of fraud.
We are 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.
We have identified material weaknesses in our internal control over financial reporting. 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 our initial public 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. In preparing our consolidated
financial statements for the years ended December 31, 2018 and December 31, 2019, three material weaknesses were identified in our internal control over
financial reporting, as defined in the standards established by the Public Company Accounting Oversight Board of the United States, and other significant
deficiencies. A “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a
reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely
basis. The three material weaknesses identified are as follows: (i) no sufficient personnel with appropriate levels of accounting knowledge and experience
to address complex U.S. GAAP accounting issues and to prepare and review financial statements and related disclosures under U.S. GAAP; (ii) ineffective
oversight of our financial reporting and internal control by those charged with governance; and (iii) inadequate design of internal control over the
preparation of the financial statements being audited. These material weaknesses remained as of December 31, 2019. As a result of inherent limitations, our
internal control over financial reporting may not prevent or detect misstatements, errors or omissions.
We are now a public company in the United States subject to the Sarbanes-Oxley Act of 2002. Section 404 of the Sarbanes-Oxley Act of 2002 requires
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, 2020. In addition, once we cease to be an “emerging growth company” as such term is defined under the Jumpstart
Our Business Startups Act, or 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, 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, errors or omissions
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.
We have 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.
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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.
The trading market for our ordinary shares is 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. 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.
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 amended and restated
memorandum and articles of association, the Companies Law (as amended) 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. Under our amended and restated memorandum and articles of association, our directors have
discretion 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 are not be subject to U.S. proxy rules and are subject to Exchange Act reporting
obligations that permit less detailed and less frequent reporting than that of a U.S. domestic public company.
We 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.
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. 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.
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There can be no assurance that we will not be a passive foreign investment company, or PFIC, for U.S. federal income tax purposes for any
taxable year, which could result in adverse U.S. federal income tax consequences to U.S. holders of our ordinary shares.
A non-U.S. corporation will be a PFIC for any taxable year if either (1) at least 75% of its gross income for such year consists of certain types of
“passive” income; or (2) at least 50% of the value of its assets (based on an average of the quarterly values of the assets) during such year is attributable to
assets that produce passive income or are held for the production of passive income (the “asset test”). Based on our current and expected income and assets
(taking into account the expected cash proceeds and our market capitalization), 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 our initial public 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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ITEM 4. INFORMATION ON THE COMPANY
A. History and Development of the Company
Our company, Blue Hat Interactive Entertainment Technology, is a holding company incorporated on June 13, 2018 under the laws of the Cayman
Islands, or Blue Hat.
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, 2019, 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, 2019, 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 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 prior to the reorganization. Blue Hat, 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 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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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 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 remain in effect 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.
On July 30, 2019, we completed our initial public offering, and since July 26, 2019, our ordinary shares have been listed on the Nasdaq Capital Market
under the symbol “BHAT”.
Our principal executive office is located at 7th Floor, Building C, No. 1010 Anling Road, Huli District, Xiamen, China 361009. Our telephone number
is 86-592-228-0081. Our registered office in the Cayman Islands is located at the offices of Walkers Corporate Limited, Cayman Corporate Centre, 27
Hospital Road, George Town, Grand Cayman KY1-9008, Cayman Islands.
The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically
with the SEC on www.sec.gov. You can also find information on our website located at http://www.irbluehatgroup.com. 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 annual report.
We have not had any material commitments for capital expenditures for the last three financial years.
B. Business Overview
We are a producer, developer and operator of augmented reality, or 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 December
31, 2019, we had 199 authorized patents, 37 patents pending in various stages of the application process, 13 applications for PCT international patents and
1 authorized patent for PCT international patents, and 37 patents pending in various stages of the application process. As of December 31, 2019, we also
had 645 copyrights of art work, 29 software copyrights and 95 registered trademarks.
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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, interact 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.
For information on our financial performance, see “Item 5.A. Operating Results.”
Our Products
We currently offer the following primary AR interactive product lines: AR Racer, AR Crazy Bug (previously named “AR Need a Spanking”), AR 3D
Magic Box, AR Dinosaur, “Talking Tom and Friends” Bouncing Bubble, and Immersive Education Classes.
AR Racer
AR Racer is a car-racing mobile game played using a physical toy car stuck onto the user’s mobile device screen using non-adhesive materials. Blue
Hat’s photosensitive recognition technology allows the toy car to be used as a controller, so that users can virtually race one another via the simulated
racing track, as well as engage in individual races.
AR Crazy Bug (previously named “AR Need a Spanking”)
AR Crazy Bug is an exciting combat game played using a ladybug-shaped electronic toy. Blue Hat’s infrared induction technology allows the user to
control the toy’s movement via their mobile device for game play in battle dynamics, while simultaneously moving the toy in reality. The mobile device
shows virtual enemies while also capturing the position of the toy in the real world, allowing the user to approach or escape its combatants.
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 onto a set background, for example, under the sea.
AR Dinosaur
AR Dinosaur is an educational toy that comes in a variety of five different types of dinosaur, each of which has their own personality and emotions.
Through interacting with the toy and its accompanying mobile app, children can learn a wealth of information about dinosaurs. The product comes with
five physical “AR cards”, which when placed under the toy will activate its AR features.
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“Talking Tom and Friends” Bouncing Bubble
Bouncing Bubble is a product designed using environmentally-friendly and toxic-free liquid, allowing for larger, stronger bubbles that won’t easily
pop. Children can bounce these bubbles using a paddle or gloves as if they were ping pong balls. The new “Talking Tom and Friends” Bouncing Bubble
product range features images of characters from the universe of the globally renowned “Talking Tom and Friends” media franchise.
Immersive Education Classes
Immersive Education Classes is Blue Hat’s range of immersive educational products that utilize AR technology to create a dynamic and engaging
model for teaching in China’s preschools, including “Smart Screen Immersive Education Classes”, “Smart Immersive Physical Education Classes” and
“Smart Immersive Cognitive Education Classes.” The three products are suitable for different teaching scenarios, and can be used independently or
together with one another to promote children’s overall development.
“Smart Screen Immersive Education Classes” use a projector to cast education-related content and games onto the classroom wall. Activities featured
within the product aim to improve students’ hand-eye coordination and analytical abilities, and students are guided by teachers trained in the product’s use.
After students have completed a task, their results are shown on the screen and specific feedback for improvement is provided.
“Smart Immersive Physical Education Classes” integrate a projector and motion-capture system to project activities and games onto the floor of the
teaching area. Students who participate in activities are required to imitate movements and react in time, while competing or coordinating with others for
the best score. Data is analyzed simultaneously for each student, with feedback, including scores and suggestions for improvement, that can be reviewed by
teachers and parents. All activities are carefully guided by teachers trained in the product’s use.
“Smart Immersive Cognitive Education Classes” offer a wide variety of AR-enabled tasks designed to exercise the cognitive abilities of children
between the ages of three and six years old by projecting images and activities onto a classroom tabletop. As the images projected on the tabletop react to
children’s movements, they can learn for themselves, with feedback, including scores and suggestions for improvement, projected onto the table after
completion. A tabletop can be used by up to six children at one time, supporting both independent learning and group activities or competitions. The
product’s content has been designed by our in-house team of educational experts and all activities are carefully guided by teachers trained in the product’s
use.
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 have several years of sales experience. Currently, our sales are
primarily derived from developed eastern regions of 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.
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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 discussed, 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.
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 December 31, 2019, we had 199 authorized patents, 37 patents pending in various stages of the
application process, 13 applications for PCT international patents, 1 authorized patent for PCT international patents, and 37 patents pending in various
stages of the application process. As of December 31, 2019, we also had 645 copyrights of art work, 29 software copyrights and 95 registered trademarks.
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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.
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.
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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.
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.
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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.
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.
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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.
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.
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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.
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.
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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.
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.
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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.
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 took effect on January 1, 2020 and replaced 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 (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.
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.
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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.
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.
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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.
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