424B4 1 d424b4.htm FORM 424B4 Form 424B4
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Filed Pursuant to Rule 424b(4)
Registration No. 333-169796

11,742,857 American Depositary Shares

LOGO

Mecox Lane Limited

Representing 82,199,999 Ordinary Shares

 

 

This is the initial public offering of American depositary shares, or ADSs, of Mecox Lane Limited. We are offering 9,714,286 ADSs, and the selling shareholders disclosed in this prospectus are offering an additional 2,028,571 ADSs. Each ADS represents seven ordinary shares. We will not receive any of the proceeds from the sale of ADSs by the selling shareholders.

Prior to this offering, there has been no public market for our ADSs or ordinary shares. The initial public offering price of our ADSs is $11.00 per ADS. Our ADSs have been approved for listing on the Nasdaq Global Market under the symbol “MCOX.”

The underwriters have an option to purchase up to 571,429 additional ADSs from us and an additional 1,190,000 ADSs from certain selling shareholders at the initial public offering price less the underwriting discount to cover over-allotments of ADSs.

Investing in our ADSs involves risks. See “Risk Factors” beginning on page 15.

 

     Price to Public      Underwriting
Discount
     Proceeds,
Before Expenses,
to Mecox Lane Limited
     Proceeds,
Before Expenses,
to the Selling Shareholders
 

Per ADS

   $ 11.00       $ 0.77       $ 10.23       $ 10.23   

Total

   $ 129,171,427       $ 9,042,000       $ 99,377,146       $ 20,752,281   

The underwriters expect to deliver the ADSs against payment in U.S. dollars in New York, New York on October 29, 2010.

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

 

Credit Suisse

     UBS Investment Bank   

 

 

 

Oppenheimer & Co.

     Roth Capital Partners   

 

 

The date of this prospectus is October 26, 2010


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Table of Contents

 

TABLE OF CONTENTS

 

     Page  

PROSPECTUS SUMMARY

     1   

RISK FACTORS

     15   

FORWARD-LOOKING STATEMENTS

     43   

USE OF PROCEEDS

     44   

DIVIDEND POLICY

     45   

CAPITALIZATION

     46   

DILUTION

     47   

EXCHANGE RATE INFORMATION

     49   

ENFORCEABILITY OF CIVIL LIABILITIES

     50   

SELECTED CONSOLIDATED FINANCIAL DATA

     52   

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     54   

CORPORATE HISTORY AND STRUCTURE

     88   

INDUSTRY BACKGROUND

     96   

BUSINESS

     102   

REGULATION

     123   

MANAGEMENT

     129   

PRINCIPAL AND SELLING SHAREHOLDERS

     138   

RELATED PARTY TRANSACTIONS

     141   

DESCRIPTION OF SHARE CAPITAL

     144   

DESCRIPTION OF AMERICAN DEPOSITARY SHARES

     153   

SHARES ELIGIBLE FOR FUTURE SALE

     163   

TAXATION

     165   

UNDERWRITING

     172   

EXPENSES RELATING TO THIS OFFERING

     179   

LEGAL MATTERS

     180   

EXPERTS

     180   

WHERE YOU CAN FIND ADDITIONAL INFORMATION

     181   

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

     F-1   

 

 

You should rely only on the information contained in this prospectus or in any related free writing prospectus filed with the Securities and Exchange Commission and used or referred to in an offering to you of these securities. Neither we nor the underwriters have authorized anyone to provide information different from that contained in this prospectus. This prospectus may only be used where it is legal to offer and sell our ADSs. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our ADSs.

Until November 20, 2010, all dealers that buy, sell or trade our ADSs, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to unsold allotments or subscriptions.

 

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PROSPECTUS SUMMARY

The following summary should be read in conjunction with the more detailed information and financial statements appearing elsewhere in this prospectus. In addition to this summary, we urge you to read the entire prospectus carefully, especially the risks of investing in our ADSs discussed under “Risk Factors,” before deciding whether to buy our ADSs.

Our Company

We operate China’s leading online platform for apparel and accessories as measured by revenues in 2009, according to a report commissioned by us and prepared by Frost & Sullivan, an independent research and advisory firm. We offer a wide selection of products on our M18.com e-commerce website, evidenced by approximately 24,600 stock-keeping units, or SKUs, in 2009 and approximately 23,000 SKUs in the first six months of 2010, targeting the large demographic of young urban female shoppers with fast-growing spending power. We had approximately 1.9 million active customers, which we define as customers who made a purchase from us within the last 12 months, for our online platform as of December 31, 2009 and approximately 2.1 million as of June 30, 2010. Our online platform offers products under our own proprietary brands, such as Euromoda and Rampage, and under selected third-party brands, including established international and Chinese brands such as Adidas, Daphne, Kappa and Li Ning as well as independent and emerging brands featuring unique designs. Our online platform is attractive to independent third-party brands because we offer established third-party brands our wide customer reach and emerging third-party brands access to our existing customer base and our established logistical facilities and distribution network.

We strive to provide our customers an enjoyable shopping experience. On our well-designed and user-friendly e-commerce website, we roll out our proprietary and third-party branded products at the forefront of fashion trends, aiming to provide the best selection of products to satisfy our customer’s fashion needs. We are able to provide better “value for money” to our customers because our online platform reduces our costs and expenses for product display, rental, staffing and inventory. In addition, our favorable 10-day return policy, effective customer service, accurate order fulfillment, speedy delivery and flexible payment options have helped us to achieve strong customer loyalty and high rates of repeat purchases. In 2007, 2008, 2009 and the first six months of 2010, approximately 82%, 83%, 84% and 86%, respectively, of our orders by value were placed by repeat customers.

Our online platform is supported by our superior operational capabilities. Our customer service call center staffed by over 900 representatives provides comprehensive and real-time assistance to our customers. We outsource the production of our proprietary branded products to original equipment manufacturers, or OEM suppliers, across China, and apply rigorous quality control to ensure product quality. As of September 2010, our centralized logistics center in Shanghai had the capability to process 38,000 orders per day and our logistics centers in Beijing, Chengdu and Guangzhou had the capacity to process another 12,000 orders per day. We closely manage third-party express courier companies to provide reliable and speedy delivery to our customers nationwide. We provide our online customers the flexibility to choose from a number of payment options, including cash on delivery, or COD, online payment, wire transfer and postal remittance.

Our online platform allows us to collect customer data effectively and continuously. We systematically analyze our extensive customer database to segment customers for targeted marketing, enhancing the effectiveness of our marketing activities. We market our products through online advertising, targeted distribution of emails, SMS, catalogs, print media advertising and out-bound calls. To enhance our brand recognition and to reach target customers in second- and third-tier cities who are less familiar with Internet shopping but present substantial consumption potential, we also offer, through a network of stores, women’s apparel and accessories under our proprietary Euromoda and Rampage brands, to which we own all rights in

 

 

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China. Our store network comprised 478 stores in 182 cities across China as of June 30, 2010, including 320 franchised stores and 158 directly operated stores.

Our net revenues grew from $61.4 million in 2007 to $177.7 million in 2009, representing a compound annual growth rate, or CAGR, of 70.2%. Our net income grew from $4.1 million to $7.2 million over the same period, representing a CAGR of 32.4%. Our adjusted net income, a financial measure not in accordance with accounting principles generally accepted in the United States of America, or U.S. GAAP, grew from $4.4 million to $9.9 million over the same period, representing a CAGR of 49.4%. We generated net revenues of $108.0 million for the six months ended June 30, 2010, representing a 41.6% increase from our net revenues of $76.3 million for the six months ended June 30, 2009. We had a net income of $2.5 million for the first six months of 2010, representing a 37.7% decrease from our net income of $4.1 million for the same period in 2009 as the increases in the cost of goods sold and selling, general and marketing expenses outpaced the increase in our net revenues primarily due to unusually prolonged cold weather in the first quarter of 2010, resulting in lower than expected demand for spring apparel. Our adjusted net income decreased by 18.6% to $4.2 million from $5.1 million over the same period.

We define adjusted net income as net income excluding share-based compensation expenses. We review adjusted net income together with net income to have a better understanding of our operating performance. We believe it is useful supplemental information for investors and analysts to assess our operating performance without the effect of non-cash share-based compensation expenses. However, the use of non-GAAP financial measures has material limitations. For details on these limitations and reconciliation of adjusted net income to net income, our most directly comparable U.S. GAAP financial measure, see “—Summary Consolidated Financial Information.”

Industry Background

The market for consumer goods has expanded rapidly amid China’s robust economic growth and the increasing affluence of its urban middle class. Online platform has gained increasing popularity in China as the overall retail sector expands and consumers search for diversified retail formats to meet their needs.

The total sales revenues of the B2C e-commerce market grew from RMB1.3 billion in 2004 to RMB31.8 billion ($4.7 billion) in 2009, representing a CAGR of 89.5%, and are expected to grow to RMB920.0 billion in 2015, according to iResearch Consulting Group, or iResearch, an independent research and advisory firm. The B2C e-commerce market’s share of the total value of Internet shopping transactions, including both B2C and consumer-to-consumer, or C2C, transactions, is expected to grow from 13.3% in 2009 to 38.3% in 2012 and 56.4% in 2015. There is strong demand for fashion products in the Internet shopping marketplace, and apparel was the top category of fashion products purchased by consumers in the Internet shopping marketplace in 2008, according to iResearch.

The apparel and accessories market in China has expanded rapidly in recent years, with RMB674.2 billion ($99.4 billion) in retail value in 2009, compared to RMB314.9 billion in 2004, representing a CAGR of 16.4%, according to a report commissioned by us and prepared by Frost & Sullivan, or the Frost & Sullivan report. Total sales revenues from apparel and accessories in China are forecasted to further grow to RMB1,760.5 billion in 2015, representing a CAGR of approximately 17.3% from 2009 to 2015. Online retail revenues of apparel and accessories in China grew at a CAGR of 25.0% from 2004 to 2009 and are expected to grow at a CAGR of 33.9% from 2009 to 2015, while the retail value of apparel and accessories sold in physical stores is expected to grow at a CAGR of 15.1% from 2009 to 2015, according to the Frost & Sullivan report.

 

 

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Our Strengths and Strategies

We believe that the following competitive strengths have contributed to our success and differentiate us from our competitors:

 

   

leading online platform for apparel and accessories;

 

   

flexible “plug and play” platform business model;

 

   

compelling value, selection and convenience for customers;

 

   

superior operational capabilities;

 

   

complementary physical retail channel broadening our customer reach; and

 

   

strong management team with extensive relevant experience.

Our vision is to operate a leading online platform of fashion products in China. We intend to pursue the following growth strategies:

 

   

expand product offerings through introducing additional brands;

 

   

further grow our customer base;

 

   

promote higher margin sales, larger ticket sizes and more frequent repeat purchases;

 

   

further enhance customer experience to increase customer loyalty; and

 

   

further improve infrastructure to support our anticipated growth.

Our Risks and Challenges

The successful execution of our strategies is subject to certain risks and uncertainties that may materially affect us, including those relating to:

 

   

uncertainties regarding the growth of B2C e-commerce and market acceptance of our online platform;

 

   

rapid changes in fashion trends, customer preferences and spending patterns;

 

   

competition in our industry;

 

   

our limited history operating our online platform and physical stores;

 

   

unlimited duration of an option we granted to ICL-Rampage Limited to require us to purchase its 20% minority interest in our subsidiary and uncertainties regarding the price we may be obligated to pay to it under this option;

 

   

our limited experience in operating physical stores and working with franchisees and our ability to effectively manage the rapid growth of our physical store network and to further expand the number of our franchised stores; and

 

   

our ability to effectively promote or develop our brands and our limited experience in managing the Rampage brand.

Please see “Risk Factors” and other information included in this prospectus for a detailed discussion of these risks and uncertainties.

 

 

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Our Corporate Structure

We are a Cayman Islands company and currently do not have substantial operations outside China. We conduct our business operations in China through our PRC subsidiaries and variable interest entities, or VIEs, and these key operating entities are identified in shaded squares in the diagram below. We are able to effectively control our VIEs through our contractual arrangements with these VIEs and their shareholders, including loan agreements, exclusive purchase option agreements, powers of attorney, exclusive business cooperation agreements and equity pledge agreements.

Our executive officers include the following officers of Mecox Lane Limited: Mr. Alfred Beichun Gu, our chief executive officer, Mr. Paul Bang Zhang, our senior vice president and chief financial officer, Mr. Richard Sijie Pu, our head of e-commerce, Mr. Willy Yili Wu, the head of our health and beauty division, Mr. Yan Zhang, our chief technology officer, and Mr. Byron Zhen Wang, the head of our fulfillment division. All of such executive officers reside in Shanghai, China.

 

 

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The following diagram illustrates our anticipated shareholding and corporate structure and the place of incorporation of each of our significant operating subsidiaries and VIEs, immediately following this offering, assuming no exercise of the over-allotment option granted to the underwriters*:

LOGO

 

 

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LOGO    Direct ownership
LOGO    Contractual arrangements:    Because Chinese laws place restrictions on foreign-invested entities engaging in sales online and through physical stores, we rely on our VIEs, which are Chinese domestic companies owned by Chinese individuals, to hold licenses for operating these businesses. Chinese domestic companies engaging in sales online and through physical stores, like our VIEs, are not subject to these restrictions imposed on foreign-invested entities. The control persons of our VIEs include our company and four individuals, Messrs. Paul Bang Zhang, Guisheng Liu, Richard Sijie Pu, and Yi Xu, who are all our employees. Other than Mr. Zhang, who is our senior vice president and chief financial officer, and Mr. Pu, who is our head of e-commerce, the above control persons of the VIEs are not control persons of our company or our subsidiaries. Through these contractual arrangements, the shareholders of the VIEs grant us powers of attorney to exercise all their rights as shareholders of the VIEs, including the right to appoint board members and senior management members. Thus we have the ability to effectively control the VIEs. We are also able to receive the economic benefits of these VIEs, because we can effectively determine the services fees payable by the VIEs to us under the exclusive business cooperation agreements and exclusive service agreement, which are part of the contractual arrangements. See “Corporate History and Structure—Our Corporate Structure—Contractual Arrangements with MecoxLane Information and its Shareholders, Contractual Arrangements with MecoxLane Shopping and its Shareholders and Contractual Arrangements with Rampage Shopping and its Shareholders.” However, these contractual arrangements may not be as effective in providing us with control over the VIEs as direct ownership of these companies. In addition, these VIEs or their shareholders may breach the contractual arrangements with us. In such case, we would have to rely on legal remedies under PRC law, which may not always be effective, particularly in light of uncertainties in the PRC legal system. See “Risk Factors—Risks Related to Doing Business in China—Our contractual arrangements with MecoxLane Information, MecoxLane Shopping, Rampage Shopping and their respective shareholders, respectively, may not be as effective in providing control over MecoxLane Information, MecoxLane Shopping and Rampage Shopping as direct ownership of these companies.”
  

 

(1) Mecox Lane Limited is our holding company.

 

(2) eMecoxLane Co., Ltd. is one of our intermediate holding companies.

 

(3) eMecoxLane (Hong Kong) Co., Limited is engaged in trading and investment.

 

(4) Mai Wang Trading (Shanghai) Co., Ltd. is primarily in charge of our purchase of apparel and other products from our suppliers.

 

(5) Shanghai Mecox Lane Information Technology Co., Ltd. engages in our B2C e-commerce business. It is 67% owned by Mr. Paul Bang Zhang, our senior vice president and chief financial officer, with Mr. Richard Sijie Pu, our head of e-commerce and Mr. Yi Xu, our employee, each owning an additional 16.5%.

 

(6) Shanghai Mecox Lane Shopping Co., Ltd. engages in our store operations. It is 60% owned by Mr. Paul Bang Zhang, 10% owned by Mr. Guisheng Liu, our employee, and 30% owned by Mr. Yi Xu.

 

(7) Mecox Lane (Hong Kong) Limited is engaged in trading and investment.

 

(8) Shanghai Mecox Lane International Mailorder Co., Ltd. is in charge of our in-bound and out-bound call centers for our online platform.

 

(9) Mai Wang Information Technology (Shanghai) Co., Ltd. provides technical consulting services primarily for our e-commerce website and network systems.

 

(10) Mecox Lane Technology (China) Limited is primarily engaged in operating our new logistic center in Jiangsu Province and purchasing apparel and other products from our suppliers.

 

(11) Rampage China Limited, or Rampage Cayman, is one of our intermediate holding companies, currently holding all our Rampage-related trademarks. ICL-Rampage Limited holds 20% of the equity in Rampage Cayman.

 

(12) Rampage China (Hong Kong) Limited is one of our intermediate holding companies.

 

(13) Shanghai Rampage Shopping Co., Ltd. is in charge of business operations for Rampage branded merchandise. It is 50% owned by Mr. Paul Bang Zhang, 25% owned by Mr. Guisheng Liu and 25% owned by Mr. Yi Xu.

 

(14) Rampage Trading (Shanghai) Co., Ltd. is primarily in charge of our purchase of Rampage branded products from OEM suppliers.

 

(15) These operating subsidiaries are responsible for our directly operated stores in cities across China.

 

 

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Corporate Information

Our principal executive offices are located at 22nd Floor, Gems Tower, Building 20, No. 487, Tianlin Road, Shanghai 200233, People’s Republic of China. Our telephone number at this address is (86-21) 6495 0500. Our registered office in the Cayman Islands is located at the offices of Maples Corporate Services Limited, P.O. Box 309, Ugland House, Grand Cayman, KY1-1104, Cayman Islands. Our agent for service of process in the United States is CT Corporation System, located at 111 Eighth Avenue, New York, New York 10011.

Investors should contact us for any inquiries through the address and telephone number of our principal executive offices. Our principal website is www.M18.com. We do not incorporate the information on our e-commerce website into this prospectus and you should not consider any information on, or that can be accessed through, our e-commerce website as part of this prospectus.

Conventions which Apply to this Prospectus

Unless otherwise indicated, all information in this prospectus assumes no exercise by the underwriters of their option to purchase up to 1,761,429 additional ADSs representing 12,330,003 ordinary shares.

Except where the context otherwise requires and for purposes of this prospectus only:

 

   

“we,” “us,” “our company,” “our” and “Mecox Lane” refer to Mecox Lane Limited, a Cayman Islands company, its predecessor entity, subsidiaries, its VIEs and subsidiaries of these VIEs, if any;

 

   

“B2C e-commerce” refers to business-to-consumer e-commerce;

 

   

“China” or “PRC” refers to the People’s Republic of China, excluding, for the purpose of this prospectus only, Taiwan, Hong Kong and Macau;

 

   

“Greater China area” refers to the PRC, Taiwan, Hong Kong and Macau;

 

   

“shares” or “ordinary shares” refers to our ordinary shares, par value $0.0001 per share;

 

   

“preference shares” refers to convertible non-redeemable Series B, Series C and Series D preference shares, par value $0.0001 per share;

 

   

“ADSs” refers to our American depositary shares, each of which represents seven ordinary shares;

 

   

“online platform” refers to the combination of a channel for selling goods to consumers, including B2C and C2C e-commerce, catalog, telephonic and television direct sales, plus back office functions such as warehouse and logistics management, inventory management, customer service and payment processing. When calculating sales revenues of an online platform, only the revenues generated by the merchant which operates such platform will be counted;

 

   

“fast fashion” refers to the quick roll-out of new designs, generally less than six weeks from design to sale;

 

   

“second-tier cities” in China refer to provincial capitals and other cities with gross domestic product of at least RMB100 billion ($15 billion) in 2008 other than Beijing and Shanghai, China’s two largest cities; “third-tier cities” in China refer to any city in China that is not Beijing, Shanghai or a second-tier city;

 

 

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“comparable store sales” are reported based on net revenues, and stores are included in our comparable store sales beginning on the first anniversary of their first day of operation. Changes in our comparable store sales between two periods are based on net revenues of stores which were in operation during both of the two periods being compared and, if a store is included in the calculation of comparable store sales for only a portion of one of the two periods being compared, then that store is included in the calculation for only the comparable portion of the other period. There may be variations in the way in which some of our competitors and other apparel merchants calculate comparable or same store sales. As a result, data in this prospectus regarding our comparable store net revenues may not be comparable to similar data made available by our competitors or other apparel and accessories merchants; and

 

   

all references to “RMB” or “Renminbi” are to the legal currency of China; and all references to “$,” “US$” and “U.S. dollars” are to the legal currency of the United States.

 

 

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The Offering

Unless otherwise indicated, the information below and elsewhere in this prospectus assumes no exercise by the underwriters of their option to purchase additional ADSs in the offering.

 

Offering price

   $11.00 per ADS

ADSs offered by us

   9,714,286 ADSs

ADSs offered by the selling shareholders

   2,028,571 ADSs

ADSs outstanding immediately after this offering

   11,742,857 ADSs

Ordinary shares outstanding immediately after this offering

   401,192,254 shares

ADSs to ordinary shares ratio

   Each ADS represents seven ordinary shares

The ADSs

  

•    The depositary will hold the ordinary shares underlying your ADSs. You will have rights as provided in the deposit agreement.

 

•    If, however, we declare dividends on our ordinary shares, the depositary will pay you the cash dividends and other distributions it receives on our ordinary shares, after deducting its fees and expenses.

 

•    You may turn in your ADSs to the depositary in exchange for ordinary shares. The depositary will charge you fees for any exchange.

 

•    We may amend or terminate the deposit agreement without your consent. If you continue to hold your ADSs, you agree to be bound by the deposit agreement as amended.

 

To better understand the terms of the ADSs, you should carefully read the “Description of American Depositary Shares” section of this prospectus. You should also read the deposit agreement, which is filed as an exhibit to the registration statement that includes this prospectus.

Over-allotment option

   We and certain selling shareholders have granted to the underwriters an option, which is exercisable within 30 days from the date of this prospectus, to purchase up to an aggregate of 1,761,429 additional ADSs.

Reserved ADSs

   At our request, the underwriters have reserved for sale, at the initial public offering price, up to an aggregate of 570,000 ADSs to certain directors, officers, employees, business associates and other

 

 

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   related persons of our company through a directed share program. These reserved ADSs account for an aggregate of approximately 4.9% of the ADSs offered in the offering.

Use of proceeds

  

Our net proceeds from this offering are approximately $95.1 million. The primary purposes of this offering are to create a public market for our shares, retain talented employees by providing them with equity incentives and obtain additional capital. We intend to use the net proceeds we will receive from this offering to

 

•    approximately $15.0 million to enhance our e-commerce infrastructure;

 

•    approximately $29.5 million to build part of a new logistics center and warehouse;

 

•    approximately $6.5 million for store growth and improvement; and

 

•    the balance for working capital and other general corporate purposes.

 

See “Use of Proceeds” for additional information.

 

We will not receive any of the proceeds from the sale of ADSs by the selling shareholders.

Timing of settlement of ADSs

   The ADSs are expected to be delivered against payment on October 29, 2010. They will be deposited with a custodian for, and registered in the name of a nominee of, The Depository Trust Company, or DTC, in New York, New York. DTC and its direct and indirect participants will maintain records that will show the beneficial interests in the ADSs and facilitate any transfer of the beneficial interests.

Lock-up

   We have agreed with the underwriters to a lock-up of shares for a period of 180 days after the date of this prospectus. In addition, our executive officers and directors and substantially all of our shareholders and optionholders have also agreed with the underwriters to a lock-up of shares for a period of 180 days after the date of this prospectus. See “Shares Eligible For Future Sale” and “Underwriting.”

Listing

   Our ADSs have been approved for listing on the Nasdaq Global Market under the symbol “MCOX.” The ADSs and shares will not be listed on any other exchange or traded on any other automated quotation system.

 

 

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Depositary

   JPMorgan Chase Bank, N.A.

Risk factors

   See “Risk Factors” and other information included in this prospectus for a discussion of risks you should carefully consider before investing in our ADSs.

The number of ordinary shares that will be outstanding immediately after this offering:

 

   

assumes no exercise of the underwriters’ over-allotment option;

 

   

excludes 72,860,476 ordinary shares issuable upon the exercise of options outstanding as of the date of this prospectus, at a weighted average exercise price of $0.26 per share; and

 

   

excludes ordinary shares reserved for future issuances under our share incentive plan.

 

 

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Summary Consolidated Financial Information

You should read the following information in conjunction with our consolidated financial statements and related notes, “Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

The following summary consolidated statement of operations data for the years ended December 31, 2007, 2008, and 2009 and the consolidated balance sheet data as of December 31, 2008 and 2009 have been derived from our audited consolidated financial statements, which are included elsewhere in this prospectus. Our summary consolidated statement of operations data for the six months ended June 30, 2009 and 2010 and the summary consolidated balance sheet data as of June 30, 2010 have been derived from our unaudited financial statements included elsewhere in this prospectus. Our consolidated balance sheet data as of December 31, 2007 have been derived from our audited consolidated financial statements which are not included in this prospectus. Our consolidated financial statements are prepared and presented in accordance with U.S. GAAP. The historical results are not necessarily indicative of results to be expected in any future period.

 

 

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    For the Year Ended December 31,     For the Six Months Ended June 30,  
    2007     2008     2009     2009     2010  
    (in thousands of $, except percentage, share, per share and per ADS data)  

Consolidated Statement of Operations Data:

         

Net revenues:

         

Online platform

    56,568        92,438        129,362        58,238        84,782   

Directly operated stores

    4,786        13,915        37,388        15,644        15,991   

Franchised stores

    5        1,174        10,939        2,426        7,261   
                                       

Total net revenues

    61,359        107,527        177,689        76,308        108,034   
                                       

Cost of goods sold (excluding depreciation and amortization):

         

Online platform

    31,438        51,610        74,490        33,105        48,650   

Directly operated stores

    2,007        6,173        16,055        6,693        7,161   

Franchised stores

    4        696        6,512        1,442        4,538   
                                       

Total cost of goods sold (excluding depreciation and amortization)

    33,449        58,479        97,057        41,240        60,349   
                                       

Operating expenses:

         

Selling, general and administrative expenses

    23,124        43,300        68,505        28,550        42,580   

Depreciation and amortization

    559        1,454        3,598        1,570        2,313   

Other expense (income), net

    (177     (23     (254     (40     (159
                                       

Total operating expenses

    23,506        44,731        71,849        30,080        44,734   
                                       

Income from operations

    4,404        4,317        8,783        4,988        2,951   

Interest income

    103        510        351        148        138   
                                       

Income before income taxes

    4,507        4,827        9,134        5,136        3,089   

Income tax expense

    395        1,275        1,922        1,078        562   
                                       

Net income

    4,112        3,552        7,212        4,058        2,527   
                                       

Earnings per ordinary share:

         

Basic

  $ 0.01      $ 0.01      $ 0.02      $ 0.01      $ 0.01   

Diluted

  $ 0.01      $ 0.01      $ 0.02      $ 0.01      $ 0.01   

Weighted average ordinary shares used in per share calculation:

         

Basic

    165,338,144        204,866,943        205,381,732        205,381,732        205,381,732   

Diluted

    329,055,611        331,009,675        332,293,300        331,049,991        361,337,123   

Other Financial Data

         

Adjusted net income (1)

    4,414        5,238        9,853        5,128        4,172   

 

(1) We define adjusted net income, a non-GAAP financial measure, as net income excluding share-based compensation expenses. We review adjusted net income together with net income to obtain a better understanding of our operating performance. We also believe it is useful supplemental information for investors and analysts to assess our operating performance without the effect of non-cash share-based compensation expenses, which have been and will continue to be significant recurring expenses in our business. However, the use of adjusted net income has material limitations as an analytical tool. One of the limitations of using non-GAAP adjusted net income is that it does not include all items that impact our net income for the period. In addition, because adjusted net income is not calculated in the same manner by all companies, it may not be comparable to other similar titled measures used by other companies. In light of the foregoing limitations, you should not consider adjusted net income in isolation from or as an alternative to net income prepared in accordance with U.S. GAAP.

 

 

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     The following table sets forth the reconciliation of adjusted net income, a non-GAAP financial measure, from net income, our most directly comparable financial measure presented in accordance with U.S. GAAP, for the periods indicated.

 

     For the Year Ended December 31,      For the Six
Months Ended
June 30,
 
         2007              2008              2009          2009      2010  
     (in thousands of $)  

Net income

     4,112         3,552         7,212         4,058         2,527   

Add back: Share-based compensation expenses

     302         1,686         2,641         1,070         1,645   
                                            

Adjusted net income

     4,414         5,238         9,853         5,128         4,172   
                                            

 

     As of December 31,     As of
June 30,

2010
 
         2007             2008             2009        
     (in thousands of $)  

Consolidated Balance Sheet Data:

        

Cash and cash equivalents

     14,512        10,136        18,758        24,918   

Total assets

     23,626        38,450        63,068        71,712   

Total liabilities

     14,131        23,036        37,756        42,422   

Mezzanine equity:

        

Series B convertible non-redeemable preference shares

     18,477        18,477        18,477        18,477   

Series C convertible non-redeemable preference shares

     3,114        3,114        3,114        3,114   

Series D convertible non-redeemable preference shares

     3,764        3,764        3,764        3,764   

Redeemable noncontrolling interests

                   25        25   

Ordinary shares

     20        21        21        21   

Additional paid-in capital

     24,758        26,475        29,116        30,761   

Accumulated deficit

     (41,418     (37,866     (30,654     (28,127

Total equity (deficit)

     (15,859     (9,940     (67     3,910   

Total liabilities, mezzanine equity and equity (deficit)

     23,626        38,450        63,068        71,712   

 

 

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RISK FACTORS

You should consider carefully all of the information in this prospectus, including the risks and uncertainties described below, before making an investment in our ADSs. Any of the following risks could have a material adverse effect on our business, financial condition and results of operations. In any such case, the market price of our ADSs could decline, and you may lose all or part of your investment.

Risks Related to Our Business

We face uncertainties regarding the growth of B2C e-commerce and market acceptance of our online platform, which could adversely affect our revenues and business prospects.

B2C e-commerce, from which we derive a significant portion of our revenues, is a relatively new and evolving industry and concept. The level of demand and market acceptance of our online platform are subject to a high degree of uncertainty. Our future operating results will depend on numerous factors beyond our control. These factors include:

 

   

the growth of personal computer, Internet, broadband, mobile and other telephone users and penetration in China, and the rate of any such growth;

 

   

whether B2C e-commerce and online platform, particularly in China, continue to grow and the rate of any such growth;

 

   

general economic conditions, particularly economic conditions adversely affecting discretionary consumer spending;

 

   

changes in customer demographics and public tastes and preferences; and

 

   

the popularity and price of product offerings that we and our competitors launch and distribute.

A decline in the popularity of online sales in general, or the e-commerce website and call centers that we operate, will adversely affect our revenues and business prospects.

Rapid changes in fashion trends, customer preferences and spending patterns may affect our sales and operating results.

Our success is largely dependent upon our ability to gauge the fashion tastes of our customers and to provide merchandise that satisfies customer demand in a timely manner. The women’s apparel and accessories retail business fluctuates according to changes in customer preferences dictated, in part, by fashion and season. The demand for home products, beauty and healthcare products and other products that we offer also fluctuates according to changes in customer preferences and market trends. Some of our past product offerings have not been well received by our customer base. To the extent we misjudge the market for our merchandise or the products suitable for the Chinese market, our sales will be adversely affected and the markdowns required to move the resulting excess inventory will adversely affect our operating results.

We operate in a highly competitive industry and our business depends on consumer spending patterns. If we cannot compete successfully or a significant number of our customers reduce their spending on our products, we may lose our market share and our revenues could decline.

A majority of our revenues derive from selling apparel and accessories primarily to young urban female customers. The e-commerce market is highly competitive in China. We compete with other B2C or C2C

 

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e-commerce operators that market lines of merchandise similar to what we offer, department stores and other international or domestic store-based fashion retailers and apparel companies that distribute branded apparel and accessories through non-proprietary retail or department stores. We face a variety of competitive challenges including:

 

   

sourcing products efficiently;

 

   

competitively pricing our products and achieving customer perception of value;

 

   

anticipating and quickly responding to changing customer demands;

 

   

maintaining favorable brand recognition;

 

   

developing innovative, high-quality products in sizes, colors and styles that appeal to customers; and

 

   

conducting strong and effective marketing activities in several diverse market segments.

Our business is sensitive to a number of factors that influence the levels of consumer spending, including recession, unemployment, levels of disposable consumer income, demographic changes to our targeted customer segments, consumer debt and consumer confidence. Consumers’ spending on apparel and accessories may not grow as we expected, or at all. Declines in consumer confidence and spending on apparel and accessories could have a material adverse effect on our operating results.

We have a limited history operating our online platform and physical stores, which may make it difficult for you to evaluate our business and prospects.

We have over eight years of experience in Internet marketing. We began offering women’s apparel and accessories in physical stores in 2006. Accordingly, we have a limited history operating all of our current sales channels upon which you can evaluate the viability and sustainability of our business. We may not be able to achieve similar results or growth in future periods. You should not rely on our results of operations for any prior periods as an indication of our future performance. It is also difficult to evaluate our prospects, because we may not have sufficient experience to address the risks frequently encountered by companies operating in new and rapidly evolving markets, including the online sales market. We may not be able to successfully address these risks and difficulties, which could materially harm our business, financial condition and results of operations.

We have granted an option of unlimited duration to ICL-Rampage Limited to require us to purchase ICL-Rampage Limited’s 20% minority interest in our subsidiary, Rampage Cayman. We are not able to determine the price that we may be obligated to pay under this option, and the amount may be beyond our ability to pay. Even if we are able to meet our obligation under the option, the payment to ICL-Rampage Limited may have a material adverse effect on our results of operations, our liquidity and the value of your investment in our ADSs or ordinary shares.

In February 2009, we and Iconix China Limited, or Iconix, jointly established Rampage Cayman in the Cayman Islands. We, Iconix, and Rampage Cayman entered into a shareholders’ agreement, pursuant to which Iconix assigned and/or licensed all of its rights, titles and interests in and to certain trademarks in the Greater China area to Rampage Cayman as consideration for 20% of the shares of Rampage Cayman. In February 2010, Iconix transferred all its shares in Rampage Cayman and all of its rights and obligations under the shareholders’ agreement to ICL-Rampage Limited, its wholly-owned subsidiary.

Pursuant to the shareholders’ agreement, ICL-Rampage Limited will have the option, beginning upon the completion of this offering, to require us to purchase any or all of its shares in Rampage Cayman. This option will be exercisable at any time, though ICL-Rampage Limited has agreed not to exercise it for a period of one

 

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year immediately following the closing of this offering, and it has no termination date. The price that we would be required to pay to ICL-Rampage Limited would be determined by the following formula:

 

price = (our market capitalization) ÷ (our net income for the most recent full financial year) × (the net income of Rampage Cayman for the most recent full financial year) × (percentage of Rampage Cayman equity we are required to purchase) × 0.75

Our market capitalization would be equal to the number of ordinary shares that we have outstanding times the price per ordinary share, with the price per ordinary share based on the average closing price for our ADSs on the 20 business days immediately prior to ICL-Rampage Limited’s delivery of an option exercise notice to us. Our net income and Rampage Cayman’s net income would each be based on our audited annual financial statements.

Since we are not able to predict our future share price or market capitalization, or our net income or Rampage Cayman’s net income for future years, we are not able to determine the price we may be obligated to pay pursuant to ICL-Rampage Limited’s option under the shareholders’ agreement. Although we consolidate the results of Rampage Cayman, it is possible for Rampage Cayman to have a net income equal to or greater than our consolidated net income in any year in the future, so the price could be a significant percentage of our market capitalization or even greater. If we are unable to meet our obligation under the option, ICL-Rampage Limited may have the right to force us into liquidation, in which case you will lose a portion or all of the value of your investment. Even if we are able to meet our obligation under the option, the payment to ICL-Rampage Limited may have a material adverse effect on our results of operations, our liquidity and the value of your investment in our ADSs or ordinary shares.

Furthermore, ICL-Rampage Limited will have the right to reacquire the trademarks it assigned to Rampage Cayman, for only nominal consideration, if we fail to make a loan totaling US$10 million to Rampage Cayman or if Rampage Cayman fails to achieve annual gross revenues of RMB400.0 million (US$59.0 million) by the fifth anniversary of the date of the shareholders’ agreement. See “Corporate History and Structure - Agreements with Iconix.” Our business and results of operations may be adversely affected if we lose the right to Rampage trademarks.

We may not be able to manage the rapid growth of our physical store network effectively and the store opening costs may adversely affect our profitability in future periods.

As of June 30, 2010, we had 478 stores in 182 cities in China. We plan to open an additional approximately 20 franchised stores and an additional approximately five directly operated stores in 2010. We may not be able to successfully and effectively manage the rapid growth of our physical store network. Therefore, there is no assurance that the intended growth of our store network can be achieved or will be profitable. If we do not successfully manage the expansion of our store network, our operating costs may increase and our sales and financial results may be adversely affected. In addition, an economic downturn, which may adversely affect the profitability of our stores, could result in longer lead-time for new stores to reach their optimal operating levels.

In addition, we incur costs and expenses when a new store is opened. For our directly operated stores, we will incur rent, employee expenses, the costs of leasehold improvements and store fixtures. For our franchised stores, we will incur expenses relating to our provision of certain leasehold improvements, store fixtures and lightings to our franchisees. We record expenses relating to our provision of certain leasehold improvements for franchised stores when these expenses are incurred. The effect of store openings could potentially adversely affect our profitability, particularly in the first 12 to 18 months after store openings.

We have limited experience with franchising arrangements, and our efforts to expand across China through franchising arrangements may not be successful and could impair the value of our brands and our results of operation.

As of June 30, 2010, we had entered into franchise agreements with franchisees to operate 320 stores across China. Under these agreements, third parties operate, or will operate, stores that sell apparel and accessories

 

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purchased from us under our Euromoda and Rampage brands. Prior to 2007, we had no experience operating through these types of franchising arrangements, and we can provide no assurance that these arrangements will be successful. We plan to continue to increase these types of arrangements over time as part of our efforts to expand into less developed markets in China. The effect of these arrangements on our business and results of operations is uncertain and will depend upon various factors, including the demand for our products in new local markets and our ability to successfully identify and work with appropriate third parties to act as franchisees. In addition, these franchisees may not be able to meet their projections regarding store openings, sales and other aspects of franchising arrangements. Moreover, to the extent that these franchisees do not operate their stores in a manner consistent with our requirements regarding our brand identities and customer experience standards, the value of our brands could be impaired. Failure to protect the value of our brands or any other harmful acts or omissions by a franchisee could have an adverse effect on our results of operations and our reputation.

In addition, because we have limited contact with our end customers in the local markets covered by franchised stores, we rely substantially on our franchisees to gauge market demand. As such, we have little or no ability to independently predict sales or market demand, and it remains difficult for us, or our investors, to assess our prospective financial and operational performance in these local markets. Any failure to accurately predict demand by our franchisees in the local markets in which we offer products would adversely affect our results of operations and business.

We rely significantly on the proper operation and maintenance of our e-commerce website M18.com, and any capacity constraint or operation interruption for any extended period may have an adverse impact on our B2C e-commerce business.

A key element of our strategy is to generate a high volume of traffic and orders on the M18.com site. Accordingly, the satisfactory performance, reliability and availability of the M18.com site, transaction-processing systems and network infrastructure are critical to our reputation and our ability to attract and retain customers and maintain adequate customer service levels. Our revenues depend on the number of visitors who shop on the M18.com site and the volume of orders we fulfill. Any failure to maintain the satisfactory performance, reliability, security and availability of our network and computer infrastructure may cause significant harm to our reputation and our ability to attract and maintain Internet customers. From time to time, our Internet customers in certain locations could not gain access to our M18.com site for a period of time lasting from several minutes to several hours, due to server interruptions, power shutdowns, Internet connection problems or other reasons. Any server interruptions, break-downs or system failures, including failures which may be attributable to events within or outside our control that could result in a sustained shutdown of all or a material portion of our M18.com site, could reduce the volume of the products we sell and the attractiveness of our product offerings. In addition, any substantial increase in the volume of traffic on the M18.com site or the number of orders placed by customers will require us to expand and upgrade further our technology, transaction-processing systems and network infrastructure. There can be no assurance that we will be able to accurately project the rate or timing of increases, if any, in the use of the M18.com site or timely expand and upgrade our systems and infrastructure to accommodate such increases.

Our network systems are also vulnerable to damage from computer viruses, fire, flood, earthquake, power loss, telecommunications failures, computer hacking and similar events. We maintain limited insurance policies covering losses relating to our network systems. As a result, any operation interruptions for any expended period not covered by our insurance may have an adverse impact on our revenues and results of operations.

E-commerce security risks, such as breaches of security for confidential transactional information, may have an adverse impact on our business, prospects, financial condition and results of operations.

A significant barrier to e-commerce and communications is the secure transmission of confidential information over public networks. We rely on self-developed encryption and authentication technology to provide the security and authentication necessary to effect secure transmission of confidential information, such

 

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as customer names, addresses and credit card numbers. Currently, a portion of our Internet selling revenues is generated from sales through third-party online payment platforms. In such transactions, secured transmission of confidential information, such as customers’ credit card numbers and expiration dates, personal information and billing addresses, over public networks, in some cases including our e-commerce website as well, is essential to maintain consumer confidence. We do not have control over the security measures of third-party online payment service providers. While we have not experienced any breach of our security measures to date, there can be no assurance that advances in computer capabilities, new discoveries in the field of cryptography, or other events or developments will not result in a compromise or breach of the algorithms used by us or third-party service providers to protect customer transaction data. If any such compromise of our or such third-party service providers’ security were to occur, it could have a material adverse effect on our reputation, business, prospects, financial condition and results of operations. A party who is able to circumvent these security measures could misappropriate proprietary information or cause interruptions in our operations. We may be required to expend significant capital and other resources to protect against such security breaches or to alleviate problems caused by such breaches. Concerns over the security of transactions conducted on the Internet and other online services and the privacy of users may also inhibit the growth of the Internet and other online services generally, and our e-commerce website in particular, especially as a means of conducting commercial transactions. To the extent that activities of us or third-party service providers involve the storage and transmission of proprietary information, security breaches could damage our reputation and expose us to a risk of loss or litigation and possible liability. There can be no assurance that our or third-party service providers’ security measures will prevent security breaches or that failure to prevent such security breaches will not have a material adverse effect on our business, prospects, financial condition and results of operations.

We rely on proper operation and maintenance of our management information system. Any malfunction for any extended periods may have an adverse impact on our operational efficiency.

Our management information system, together with our experience and knowledge in this field, is a critical aspect of our capabilities in operating our business. Our e-commerce, call center and physical store operations rely on the sustained proper operation of our management information system. Our management information system provides a database of information and information gathering and management capabilities regarding customer information, sales records, inventory levels and various other facets of the business to assist business management and help ensure effective communication among various branches and stores of the business. We cannot assure you that our management information system will operate properly or without interruption. Any malfunction to any part or all of our management information system for a prolonged period may cause delays in operations or impairment of our overall business efficiency. We also cannot ensure that the level of security currently maintained will be sufficient to protect the system from third-party intrusions, viruses, lost or stolen data or similar situations.

Additionally, as one of our growth and development strategies in the next few years, we plan to upgrade and improve our management information system. We cannot assure you that there will be no interruptions to our management information system during the upgrades or that the new management information system will be able to integrate fully with the existing information system. If our existing or future management information system does not function properly, it could cause unanticipated system disruptions and slower response times, affecting data transmission, which in turn, could materially and adversely affect our business and results of operations.

We are dependent on positive public recognition of our brands. Failure to effectively promote or develop our brands could materially and adversely affect our sales and profits.

A significant portion of our total net revenues is derived from sales of our Euromoda- and Rampage-branded apparel and accessories products in China. Brand image is an important factor which affects a customer’s purchasing decision with respect to our products. Our success therefore depends on, among other things, market recognition and acceptance of our private brands and the culture, lifestyle and images associated

 

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with the brands, some of which may not be within our control. We only began designing, promoting and selling Rampage-branded products in China in 2009 and have limited experience in managing the Rampage brand. To effectively promote these brands, we would have to be able to build and maintain the brand image by focusing on a variety of promotional and marketing activities to promote brand awareness, as well as to increase their presence in the markets in which we compete. There is no assurance that we will be able to effectively promote or develop these brands and if we fail to do so, the goodwill of such brands may be undermined and our business as well as its financial results may be adversely affected. In addition, negative publicity or disputes regarding our brands, products, company or management could materially and adversely affect public perception of our brands. Any impact on our ability to continue to sell products of one or more of our brands or any significant damage to one or more of our brands’ images could materially and adversely affect our sales and profits.

Our sales may be affected by seasonality and weather conditions.

The performance of our businesses is subject to seasonal fluctuations. For example, our revenues are relatively low during the Chinese New Year period in the first quarter of each year when customers tend to do less online shopping. Our revenues in the third quarter of each year also tend to be lower than other months because we sell apparel for the summer season then, which normally has lower unit prices compared to our apparel for the autumn and winter seasons. Extreme changes in weather patterns could also affect customers’ purchasing behavior, which may lead to fluctuations in our sales revenues. For example, the unusually prolonged cold weather in the first quarter of 2010 resulted in lower than expected demand for spring apparel. As a result, we believe that comparisons of our operating results and net income over any interim periods may not be an accurate indicator of our future performance.

If we cannot market and sell third-party branded products through our online platform successfully, our brand reputation, revenue growth and results of operations will be adversely and materially impaired.

We offer third-party branded products through our online platform. We plan to introduce more new brands into our online platform and are currently in discussions with several third-party brand owners, particularly owners of apparel and accessories brands to distribute their branded products through our online platform. We have launched 159 third-party brands in the first half of 2010 and are planning to launch 160 more in the second half of 2010. We cannot assure you that this growth strategy will succeed.

We try to cooperate with those brands that are consistent with our existing brand portfolio strategy and cater to sub-segments of customers of different tastes and age. However we may misjudge the branding image and the brands we work with may turn out to be cannibalizing our existing customer base. Third-party brands reserve the rights to market and sell their products through other channels such as stores, which could cause channel conflicts and reduce our sales volume. Where we have negotiated exclusive distribution rights, we may lose such rights if we fail to meet the sales target provided in the contracts. In addition, certain aspects of these third-party products are not directly within our control, such as the ability of these third parties to deliver quality products to us on time and to maintain their brand reputation. To the extent that these third parties do not operate their business successfully or encounter a material product liability claim or other legal proceedings, the value of our brands and platform could be impaired, which could in turn, have an adverse effect on our reputation and our results of operations.

We offer Euromoda- and Rampage-branded apparel and accessories through our online platform and stores, and may be subject to price conflicts, which could adversely affect our reputation and business.

We offer our Euromoda- and Rampage- branded apparel and accessories through both of our online platform and physical stores. To avoid competition and conflicts between our online platform and stores, we generally adopt a unified price to end customers across online platform and stores for the same product during most of its life cycle. In particular, we require our franchisees to comply with our price control policy through our franchising agreements. However, there is no assurance that our policy to avoid price conflicts will be

 

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successful. If we misprice any product on our online platform or in our stores, or if any franchisee violates our policy by selling any products at a discount without our consent, our customers could be confused by different prices of the same product, and our reputation and business could be adversely affected.

We may not successfully integrate newly acquired or licensed brands or businesses into our business model, and our sales and profits may suffer as a result.

We may acquire or obtain licenses to operate additional brands to expand our brand portfolio in the future. Our ability to achieve such expansion depends on our ability to identify the appropriate additional brands and to initiate, negotiate and complete the acquisition of or obtain the license for such brands.

In addition, we may experience difficulties in integrating the newly acquired or licensed brands or businesses into our existing business model and in retaining the key personnel to manage such acquired or licensed brands or businesses. The cost and duration of integration could also exceed our original estimation. Any impact on our ability to continue to sell products of one or more of our brands, or any significant damage to one or more of our brands’ images, could materially and adversely affect our sales and profits.

We procure products from our suppliers, and our products are subject to risks associated with product sourcing, which may impair our operating margins and profitability. Potential product liability claims may adversely impact our reputation, results of operations, financial performance and business as well.

We do not possess internal manufacturing capability, and we outsource the production of nearly all of our products, including the printing of our catalogs, to third-party suppliers including OEM suppliers and third-party branded product suppliers. Such arrangements carry with them risks associated with the possibility that the relevant suppliers may: (i) have economic or business interests or goals that are inconsistent with ours; (ii) take actions contrary to our instructions or requests or contrary to our policies or objectives; (iii) be unable or unwilling to fulfill their obligations under the relevant manufacturing or contractual arrangements, including obligations to meet our production deadlines, quality standards and product specifications; (iv) have financial difficulties; (v) encounter raw material or labor shortages; (vi) encounter increases in raw material or labor costs which may impact our merchandise procurement cost; and (vii) engage in activities or employ practices that may harm our reputation. The occurrence of any of these problems, alone or together, could have a material and adverse effect on our results of operations, financial performance and business. For example, some of our OEM suppliers were not able to deliver products to us on schedule in the first quarter of 2010 partly due to labor shortages experienced by manufacturers in coastal areas of East China and South China. As reported by media in China and worldwide, the labor shortage was partly attributable to peasant workers’ expectation of higher salaries and benefits than the then market rates and their seeking working opportunities closer to home. This has triggered subsequent salary increases in some regions in China and some manufacturers’ relocation to inland China. As a result, we experienced a substantial merchandise shortage for the first quarter of 2010.

In addition, if we experience significant increases in demand, or need to replace a significant number of existing suppliers, there can be no assurance that additional manufacturing capacity will be available when required on terms that are acceptable to us, or at all, or that any supplier would allocate sufficient capacity to us in order to meet our requirements. Furthermore, suppliers may deliver products to us by third-party carriers over long distances. Delays in the shipment or delivery of our products due to transportation shortages, work stoppages, port strikes, infrastructure congestion, or other factors could adversely impact our financial performance. Manufacturing delays or unexpected demand for our products may require us to use faster, but more expensive, transportation methods such as aircraft, which could adversely affect our operating margins and profitability.

Although our dedicated quality assurance and control team is responsible for inspecting product quality at every stage of product manufacturing for our private brand products, we may not have effective or sufficient

 

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control over the quality of our products under the current outsourcing manufacturing arrangements. We maintain product liability insurance for the products sold by us with a cap of RMB8.0 million ($1.2 million), but there is no assurance that such insurance is sufficient to cover all of our losses caused by a material product liability claim. A successful product liability claim brought against us or a requirement to participate in a product recall may have a material adverse effect on our business and financial results. In addition, we may incur significant resources and time to defend ourselves if legal proceedings are brought against us. If any such claims are made, our reputation, results of operations, financial performance and business may be materially and adversely affected.

The financial soundness of our franchisees and vendors could affect our earnings and cash flow.

As a result of the disruptions in the financial markets and other macro-economic challenges currently affecting the economy of China and other parts of the world, our franchisees, product or service suppliers and other vendors may experience cash flow concerns. As a result, franchisees may order fewer products from us and vendors may increase their prices, reduce their output or change terms of sales. Additionally, if the operating and financial performance of our product or service suppliers and/or vendors deteriorates, or if they are unable to make scheduled payments or obtain credit, vendors may restrict credit or impose different payment terms. Any reduction in purchases from our franchisees or any demands by vendors for different payment terms may adversely affect our earnings and cash flow.

We may not be able to renew the leases of our directly operated stores and office, warehouse and call center space on reasonable terms or at all and our sales and financial results may be adversely affected as a result.

As of June 30, 2010, we operated 158 directly operated stores. We lease our store space primarily from mall operators or other shopping place owners generally for an initial term of no more than five years. We also leased an aggregate of approximately 70,600 square meters of office, warehouse and call center space in China as of September 30, 2010. There is no assurance that each of the leases will be renewed upon expiry or on reasonable terms. If we are unable to renew the leases of our directly operated stores or unable to renew them on reasonable terms, we would need to relocate the relevant stores, which could lead our stores to be less appealing to our customers. Renewal of leases at unfavorable terms will result in increased rental expenditure for us. In such cases, our sales and financial results may be adversely affected.

We rely on services from third parties to carry out our business, and if there is any interruption or deterioration in the quality of these services, our business and results of operations may be materially and adversely affected.

The delivery of the products from our warehouses to our individual customers and stores locally and throughout China is conducted by third-party express courier companies and EMS, the national express mail service operated by the China Postal Office. Such shipping services could be suspended and therefore interrupt the delivery of our products if unforeseen events occur which are beyond our control, such as poor handling of and damage to our products, transportation bottlenecks, natural disasters or labor strikes. Relying on express courier companies and EMS increases the risk that we may fail to deliver finished products to individual customers or retail stores on time. If our products are not delivered on time or are delivered in a damaged state, our market reputation could be adversely affected. The occurrence of any of these problems alone, or together, could have a material and adverse effect on our results of operations, financial performance and business.

We also rely on various third parties to operate our business, such as professional photographers and advertising service providers. Any interruption in our ability to obtain the services of these or other third parties or deterioration in their performance could impair the timeliness and quality of our operations. Furthermore, if our arrangements with any of these third parties are terminated or modified against our interest, we may not be able to find alternative solutions for our business on a timely basis or on terms favorable to us or at all. If any of

 

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the above factors happens, our customers may cease shopping on one or more of our platforms as a result, which could materially and adversely affect our business and results of operations.

We rely on effective marketing efforts to maintain and increase our revenues. Inefficient marketing approaches may adversely affect our revenue growth and results of operation.

We rely on effective marketing efforts tailored to our targeted customers to maintain and increase our revenues. Our marketing activities may not be well received by our customers or potential customers or promote levels of customer purchases as we predicted. We may also incur higher levels of marketing expenses to generate our anticipated levels of customer purchases, which would adversely affect results of operations. Marketing approaches and tools in the consumer product market in China are evolving. This requires us to enhance our marketing approaches to keep pace with the industry development and customer preferences. Our failure to refine our existing marketing approaches or to introduce new effective marketing approaches could reduce our market share and cause our revenues to decline.

We plan to expand our logistics center and distribution network. If we are not able to manage such expansion successfully, our growth potential, results of operations and business could be materially and adversely affected.

Our centralized logistics center has three warehouses of approximately 44,000 square meters located in Songjiang, Shanghai and is capable of handling over 38,000 orders per day as of September 2010. We also leased three logistics centers in Beijing, Chengdu and Guangzhou totaling approximately 14,000 square meters with the capability of processing, packaging and shipping more than 12,000 orders each day as of September 2010. COD via third-party express courier companies covers 100 cities in China. We intend to expand our logistics center and distribution network to accommodate more customer orders, including orders for third-party branded apparel and accessories offered via our online platform. We have plans to build a new logistics center in Jiangsu Province with an area of approximately 200,000 square meters that would be capable of handling more than 200,000 orders each day. The first stage of approximately 100,000 square meters will be completed by the end of 2012. We also plan to expand the two leased logistics centers in Beijing and Guangzhou to a total of approximately 12,000 square meters with the capability of processing, packaging and shipping more than 12,000 orders each day. In addition, we aim to retain more express courier companies across China. The expansion of our logistics center and distribution network will put pressure on our managerial, financial, operational and other resources. We may face risks and uncertainties relating to the construction of the new logistics center, such as delays and cost overruns, delays or denial of required approvals by relevant government authorities. If we are unable to effectively manage our expanded logistics operations and control increasing costs, our growth potential, results of operations and business could be materially and adversely affected.

If our lease of a warehouse located on land owned by collective farms or lease of a warehouse without required certificates is found not in compliance with applicable PRC laws, we may incur cost and expenses and operations of these warehouses could be disrupted as a result.

Since April 2010, we have leased a warehouse with approximately 3,000 square meters located in Guangzhou from an individual who built the warehouse on a piece of land he leased from collective farms. As this individual has not been able to provide us with the relevant building ownership certificate for this warehouse or an authorization letter from the competent authority of the collective farms for our lease, he may not be a qualified land lessee under applicable PRC laws, and our lease of the warehouse could have been incompliant with applicable PRC laws.

Further, since July 2010, we have leased a warehouse with approximately 6,700 square meters located in Chengdu, for which the building completion inspection and acceptance certificate and the building ownership certificate have not been obtained. As a result, our lease of this warehouse could have been incompliant with

 

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applicable PRC laws. We are informed that the owner of this warehouse is in the process of obtaining such certificates.

If the above two leases are decided by competent PRC authorities to be not in compliance with applicable PRC laws, we may have to look for replacement warehouses for our operations. Approximately 16% of our current capacity for processing orders is attributed to these two warehouses. Unplanned relocation may cause us to incur additional moving costs and expenses and part of our logistics operation may be interrupted, and we cannot assure you that we can find replacement warehouses on favorable terms, which could adversely affect our results of operations.

Our inventory may become obsolete, which could adversely affect our financial results.

We are exposed to seasonal and other changes in customer demand. Since merchandise usually must be ordered in advance of the season and frequently before fashion trends are evidenced by customer purchases, market demand for our products may fall below management expectations. In addition, the cyclical nature of the apparel and accessories business requires us to carry a significant amount of inventory, especially prior to the peak holiday selling season when we build up our inventory levels. As a result, we are vulnerable to demand and pricing shifts and to suboptimal selection and timing of merchandise purchases. In the past, we have not always predicted our customers’ preferences and acceptance levels of our products with accuracy. If sales do not meet expectations, too much inventory may lead to excessive markdowns and, therefore, lower than planned margins. We may also accumulate inventories, which may eventually lead to inventory write-downs that could adversely affect our financial results.

Our results of operations, financial performance and business may be adversely affected by intellectual property rights infringement claims against us.

In 2008, we were determined in a legal proceeding to have infringed a third party’s copyright due to certain bed clothes products we purchased from a supplier and offered to customers. We were required to compensate such third party RMB20,000 ($3,000). Currently we are not aware of any intellectual property rights infringement claims or potential disputes against us, except that a third party claimed against us for intellectual property infringement due to the alleged unauthorized use of certain of its pictures in our catalog. In addition, we could face claims by others that we are improperly using intellectual property owned by them or otherwise infringing upon their rights in intellectual property. Irrespective of the validity or the successful assertion of such claims, we could incur costs in either defending or settling any intellectual property disputes alleging infringement. Intellectual property litigation against us could potentially force us to, among other things, cease selling the challenged products, develop non-infringing alternatives or obtain licenses from the owners of the infringed intellectual property. In such case, we may not be successful in developing such alternatives or in obtaining such licenses on reasonable terms or at all and our results of operations, financial performance and business could be materially and adversely affected.

We rely on our registered trademarks and other intellectual property rights, and failure to protect our intellectual property rights may affect our ability to compete.

We regard our trademarks, copyrights, trade secrets, patents and similar intellectual property as critical to our success, and rely on a combination of data security technology, confidentiality policies, non-disclosure and other contractual arrangements, and patent, copyright and trademark laws to protect our intellectual property rights. These afford only limited protection and the actions we take to protect our intellectual property rights may

 

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not be adequate. Such protection may be compromised by, among other things, (i) the expiration of the protection period of our registered intellectual property, (ii) infringement by others of our intellectual property rights including, for example, counterfeiting of our brands, designs or products, or unauthorized usage of our customer database, (iii) breach of contractual arrangements by our suppliers or franchisees; or (iv) delay or refusal by relevant regulatory authorities to approve pending intellectual property registration applications. Any of these events or occurrences may have a material adverse effect on our operations. In addition, litigation may be necessary to enforce our intellectual property rights, protect our trade secrets or determine the validity and scope of the proprietary rights of others. We cannot assure you that the outcome of such potential litigation will be in our favor. Such litigation may be costly and may divert management attention and other resources away from our business. An adverse determination in any such litigation will impair our intellectual property rights and may harm our business, prospects and reputation. In addition, we do not have insurance that covers litigation costs. As a result, we would have to pay for the cost of litigation initially and may only be able to recover those costs if we prevail. Even if we prevail, it may be difficult to recover the costs from a third party. We cannot assure you that we would be able to recover all such costs. Consequently, the infringement or misappropriation of our proprietary intellectual property rights could have a material adverse effect on our business, financial condition or operating results.

Our business depends substantially on the continuing efforts of our management and other key personnel. If we lose their services, we could incur significant costs in finding suitable replacements and our business may be severely disrupted.

Our future success heavily depends upon the continued services of our management and other key personnel. In particular, we rely on the expertise and experience of Mr. Alfred Beichun Gu, our chief executive officer, and Mr. Paul Bang Zhang, our senior vice president and chief financial officer. If one or more of our senior management or key personnel were unable or unwilling to continue in their present positions, we might not be able to replace them easily or at all. Our business may be severely disrupted, our financial condition and results of operations may be materially and adversely affected, and we may incur additional expenses to recruit, train and retain personnel.

If any of our management or key personnel joins a competitor or forms a competing company, we may lose customers, suppliers, know-how and key professionals and staff members. Each of our executive officers has entered into employment agreements and confidentiality and non-competition agreements with us. However, if any dispute arises between our officers and us, the non-competition provisions contained in their confidentiality and non-competition agreements may not be enforceable, especially in China, where most of these executive officers and key employees reside, on the ground that we have not provided adequate compensation to these executive officers for their non-competition obligations, which is required under the relevant PRC regulations.

We may not be successful in attracting and retaining qualified personnel and our business and results of operations could be negatively impacted.

We will need to hire and retain additional qualified employees to support our existing operations and planned expansion. Our ability to anticipate and effectively respond to changing fashion trends depends in part on our ability to attract and retain experienced personnel in design, product management, marketing, and other functions. The effective operation of our information technology system, call centers, logistics and other back office functions also depends in part on our professional employees. Since our industry is characterized by high demand and intense competition for talent, we may need to offer higher compensation and other benefits in order to retain key personnel in the future. We cannot assure you that we will be able to attract or retain the qualified key personnel that we will need to achieve our business objectives. In addition, as our business has grown rapidly, our ability to train and integrate new employees into our operations may not meet the increasing demands of our business.

 

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Our principal shareholders have substantial influence over our company and their interests may not be aligned with the interests of our other holders of our ordinary shares and ADSs.

Our principal shareholders, Maxpro Holdings Limited, or Maxpro, and Ever Keen Holdings Limited, or Ever Keen, currently hold 45.9% and 30.0% of our outstanding share capital on an as-converted basis, respectively, and will hold 37.8% and 24.7% of our outstanding share capital upon completion of this offering, respectively. Maxpro is affiliated with the Sequoia China Funds and Ever Keen is affiliated with the Sequoia U.S. Funds. See “Principal and Selling Shareholders.” Accordingly, Maxpro, Ever Keen and the beneficial owners of our shares held by these entities including Mr. Neil Nanpeng Shen, have substantial influence over our business, including decisions regarding mergers, consolidations and the sale of all or substantially all of our assets, election and change of directors and other significant corporate actions. This concentration of ownership may discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our ADSs. Alternatively, our principal shareholders may cause a merger, consolidation or change of control transaction even if it is opposed by our other shareholders, including those who purchase shares in this offering.

We have a limited insurance coverage which could expose us to significant costs and business disruption.

We maintain property insurance policies covering our equipment, facilities, inventories and other properties. These insurance policies cover losses due to fire, explosions, floods and a wide range of other natural disasters or accidents. We also maintain product liability insurance, business interruption insurance, fidelity insurance, cargo transit insurance and other insurance policies related to our operations. We believe we have obtained a prudent amount of insurance for the insurable risks relating to our business. However, there is no assurance that the insurance policies we maintain are sufficient to cover our business operations. If we were to incur substantial liabilities that were not covered by our insurance, we could incur costs and losses that could materially and adversely affect our results of operations.

If we fail to establish or maintain an effective system of internal controls, we may be unable to accurately report our financial results or prevent fraud, and investor confidence and the market price of our shares may, therefore, be adversely impacted.

We will be subject to reporting obligations under the U.S. securities laws. Our reporting obligations as a public company will place a significant strain on our management, operational and financial resources and systems for the foreseeable future. Beginning with our annual report on Form 20-F for the fiscal year ending December 31, 2011, we will be required to prepare a management report on our internal controls over financial reporting containing our management’s assessment of the effectiveness of our internal controls over financial reporting. In addition, depending on our market capitalization, our independent registered public accounting firm may be required to attest to and report on our management’s assessment of the effectiveness of our internal controls over financial reporting. Our management may conclude that our internal controls over our financial reporting are not effective. Moreover, even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm may still decline to attest to our management’s assessment or may issue a report that is qualified if it is not satisfied with our controls or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us.

Prior to this offering, we have been a private company with limited numbers of accounting personnel and other resources with which to address our internal controls and procedures. In connection with the audit of our consolidated financial statements for 2007, 2008 and 2009, we noted certain significant deficiencies in our internal controls over financial reporting as defined in the standards established by the U.S. Public Company

 

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Accounting Oversight Board, or PCAOB. We have not noted any material weakness, as defined in the standards established by the PCAOB, in our internal controls over financial reporting.

We will continue to implement measures to remedy any significant deficiencies to meet the deadline imposed by Section 404 of the Sarbanes-Oxley Act. If we fail to timely achieve and maintain the adequacy of our internal controls, we may not be able to conclude that we have effective internal controls over financial reporting. Moreover, effective internal controls over financial reporting are necessary for us to produce reliable financial reports and are important to help prevent fraud. As a result, our failure to achieve and maintain effective internal controls over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the market price of our ordinary shares. Furthermore, we anticipate that we will incur considerable costs and use significant management time and other resources in an effort to comply with Section 404 of the Sarbanes-Oxley Act.

Our business could suffer if we do not successfully manage our current growth and potential future growth.

We have experienced a period of rapid growth and expansion that has placed, and continues to place, strain on our management personnel, systems and resources. To accommodate our growth pursuant to our strategies, we anticipate that we may need to implement and maintain a variety of new and upgraded operational and financial systems, procedures and controls, and improve our accounting and other internal management systems, all of which require substantial management efforts. We also will need to continue to expand, train, manage and motivate our workforce, and manage our relationships with our customers and third-party product and service providers. All of these endeavors will require substantial management effort and skill and the incurrence of additional expenditures. We cannot assure you that we will be able to efficiently or effectively implement our growth strategies and manage the growth of our operations, and any failure to do so may limit our future growth and hamper our business strategy.

We may undertake acquisitions, investments, joint ventures or other strategic alliances, which could have a material adverse effect on our ability to manage our business. In addition, such undertakings may not be successful.

Our strategy includes plans to grow both organically and through acquisitions, joint ventures or other strategic alliances. Joint ventures and strategic alliances may expose us to new operational, regulatory and market risks, as well as risks associated with additional capital requirements. We may not be able to identify suitable future acquisition candidates or alliance partners. Even if we identify suitable candidates or partners, we may be unable to complete an acquisition or alliance on terms commercially acceptable to us. If we fail to identify appropriate candidates or partners, or complete desired acquisitions, we may not be able to implement our strategies effectively or efficiently.

In addition, our ability to successfully integrate acquired companies and their operations may be adversely affected by a number of factors. These factors include:

 

   

diversion of management’s attention;

 

   

difficulties in retaining personnel of the acquired companies;

 

   

unanticipated problems or legal liabilities; and

 

   

tax and accounting issues.

 

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If we fail to integrate acquired companies efficiently, our earnings, revenues growth and business could be negatively affected.

Furthermore, the acquired companies may not perform to our expectations for various reasons, including legislative or regulatory changes that affect the products in which the acquired companies specialize, and the loss of key customers and personnel. If we are not able to realize the benefits envisioned for such acquisitions, joint ventures or other strategic alliances, our overall profitability and growth plans may be adversely affected.

We may be unable to secure additional funding in the future or to obtain such funding on favorable terms.

We believe that our current cash and cash equivalents and the anticipated cash flow from operations will be sufficient to meet our anticipated cash needs for the next 12 months. We may, however, require additional cash resources to finance our continued growth or other future developments, including any investments or acquisitions we may decide to pursue. The amount and timing of such additional financing needs will vary principally depending on the timing of new product launches, investments and/or acquisitions, and the amount of cash flow from our operations. If our resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity securities or securities convertible into our ordinary shares could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations.

Our ability to obtain additional capital on acceptable terms is subject to a variety of uncertainties, including:

 

   

investors’ perception of, and demand for, securities of e-commerce merchants or apparel and accessories merchants;

 

   

conditions of the United States and other capital markets in which we may seek to raise funds;

 

   

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

 

   

PRC governmental regulations of foreign investment in China;

 

   

economic, political and other conditions in China; and

 

   

PRC governmental policies relating to foreign currency borrowings.

Financing may not be available in amounts or on terms acceptable to us, if at all, especially if there is a recession or other events causing volatilities in the capital markets worldwide.

Risks Related to Doing Business in China

Changes in economic and political policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could adversely affect our business.

Substantially all of our business operations are conducted in China. Accordingly, our business, results of operations, financial condition and prospects are subject to a significant degree to economic, political and legal developments in China. Due to the global financial crisis, the growth of the Chinese economy also slowed down in the second half of 2008 and early 2009. There is also uncertainty with respect to the Chinese economy for 2010 and beyond. Any prolonged slowdown in the Chinese economy, in particular the apparel and accessories industry, could have a negative impact on our business, operating results and financial condition in a number of

 

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ways. For example, our customers may decrease spending on our products, while we may have difficulty expanding our customer base fast enough, or at all, to offset the impact of decreased spending by our existing customers.

Although the Chinese economy is no longer a planned economy, the PRC government continues to exercise significant control over China’s economic growth through direct allocation of resources, monetary and tax policies, and a host of other government policies such as those that encourage or restrict investment in certain industries by foreign investors, control the exchange between RMB and foreign currencies, and regulate the growth of the general or specific market. These government involvements have been instrumental in China’s significant growth in the past 30 years. If the PRC government’s current or future policies fail to help the Chinese economy achieve further growth or otherwise negatively affect our business, our growth rate or strategy, our results of operations could be adversely affected as a result.

If the PRC government determines that the contractual arrangements that establish the structure for operating our online platform and physical stores do not comply with applicable PRC laws and regulations, we could be subject to severe penalties.

We are a Cayman Islands company and, as such, we are classified as a foreign enterprise under Chinese laws, and our PRC subsidiaries, Mai Wang Trading (Shanghai) Co., Ltd., or Mai Wang Trading, and Rampage Trading (Shanghai) Co., Ltd., or Rampage Trading, are foreign-invested enterprises. Various regulations in China currently restrict or prevent foreign-invested entities from holding certain licenses required to operate e-commerce business, including Internet content provision. Chinese regulations also require foreign-invested retail enterprises to go through an additional approval process, not required of domestic retail enterprises, each time they open a new retail store. Each time a foreign-invested retail enterprise wishes to open a new store, it must submit the following documents, among others, to the PRC Ministry of Commerce or its authorized local counterpart: (i) an application letter for opening the new store, (ii) a feasibility study report for opening the new store, (iii) the applicant’s most recent fiscal year’s audit report, and (iv) documents issued by the local government on the proposed new store’s compliance with requirements for city development and development of urban commerce. The new store can only be opened after approval is received from the PRC Ministry of Commerce or its authorized local counterpart. In light of these restrictions, we rely on our VIEs, which are Chinese domestic companies not subject to these restrictions, to hold licenses for operating these businesses. We rely on Shanghai Mecox Lane Information Technology Co., Ltd., or MecoxLane Information, to hold and maintain the licenses necessary to operate our e-commerce business in China, and rely on Shanghai Mecox Lane Shopping Co., Ltd., or MecoxLane Shopping, to operate our physical stores. Therefore, our VIE, MecoxLane Shopping, is able to open new stores without going through the additional approval process required each time for a foreign-invested retail enterprise to open a new store in China. Besides, we conduct the business of wholesale and retail of apparel and accessories in the brand name of Rampage in China through Shanghai Rampage Shopping Co., Ltd., or Rampage Shopping. We do not have any equity interest in MecoxLane Information, MecoxLane Shopping or Rampage Shopping but receive their economic benefits through various contractual arrangements and certain corporate governance and shareholder rights arrangements. In addition, we have entered into agreements with MecoxLane Information, MecoxLane Shopping, Rampage Shopping and each of their shareholders which provide us with a substantial ability to control MecoxLane Information, MecoxLane Shopping and Rampage Shopping. For a description of these contractual arrangements with MecoxLane Information, see “Corporate History and Structure—Our Corporate Structure—Contractual Arrangements with MecoxLane Information and its Shareholders, Contractual Arrangements with MecoxLane Shopping and its Shareholders, and Contractual Arrangements with Rampage Shopping and its Shareholders.”

The Circular on Strengthening the Administration of Foreign Investment in and Operation of Value-added Telecommunications Business, or the Circular, issued by the Ministry of Industry and Information Technology, in July 2006, reiterated the regulations on foreign investment in telecommunications businesses, which require foreign investors to set up foreign-invested enterprises and obtain a business operating license for Internet content provision to conduct any value-added telecommunications business in China. Under the Circular, a

 

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domestic company that holds an Internet content provision license is prohibited from leasing, transferring or selling the license to foreign investors in any form, and from providing any assistance, including providing resources, sites or facilities, to foreign investors that conduct value-added telecommunications business illegally in China. Furthermore, the relevant trademarks and domain names that are used in the value-added telecommunications business must be owned by the local Internet content provision license holder. The Circular further requires each Internet content provision license holder to have the necessary facilities for its approved business operations and to maintain such facilities in the regions covered by its license. In addition, all value-added telecommunications service providers are required to maintain network and information security in accordance with the standards set forth under relevant PRC regulations. Due to a lack of interpretative materials from the regulator, it is unclear what impact the Circular will have on us or the other Chinese Internet companies that have adopted the same or similar corporate and contractual structures as ours.

In the opinion of King & Wood, our PRC counsel, (i) the ownership structure and the business and operation model of Mai Wang Trading, MecoxLane Information and MecoxLane Shopping are not in violation of any existing PRC laws and regulations, (ii) the ownership structure and the business and operation model of Rampage Trading and Rampage Shopping are not in violation of any existing PRC laws and regulations, and (iii) each contract under Mai Wang Trading’s contractual arrangements with MecoxLane Information, MecoxLane Shopping and each of their shareholders and under Rampage Trading’s contractual arrangements with Rampage Shopping and its shareholders is valid and binding and will not result in any violation of PRC laws or regulations currently in effect. However, we cannot assure you that we will not be found in violation of any current or future PRC laws and regulations. There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including the Circular. Accordingly, we cannot assure you that the PRC regulatory authorities will ultimately take a view that is consistent with the opinion of our PRC counsel.

If we are found to be in violation of any existing or future PRC laws or regulations, including the Circular, or fail to obtain or maintain any of the required permits or approvals, the relevant regulatory authorities would have broad discretion in dealing with such violation, including levying fines, confiscating our income, revoking Mai Wang Trading, MecoxLane Shopping, Rampage Trading or Rampage Shopping’s business license or MecoxLane Information’s business or operating licenses, requiring us to restructure the relevant ownership structure or operations, and requiring us to discontinue all or any portion of our e-commerce or retail business. Any of these actions could cause significant disruption to our business operations and may materially and adversely affect our business, financial condition and results of operations.

Our contractual arrangements with MecoxLane Information, MecoxLane Shopping, Rampage Shopping and their respective shareholders may not be as effective in providing control over MecoxLane Information, MecoxLane Shopping and Rampage Shopping as direct ownership of these companies.

We conduct our B2C e-commerce and store-based retailing businesses in China through MecoxLane Information and MecoxLane Shopping, respectively. Besides, we conduct the business of wholesale and retail of apparel and accessories in the brand name of Rampage in China through Rampage Shopping. Our contractual arrangements with MecoxLane Information, MecoxLane Shopping, Rampage Shopping and their respective shareholders provide us with effective control over these companies. See “Corporate History and Structure—Our Corporate Structure—Contractual Arrangements with MecoxLane Information and its Shareholders, Contractual Arrangements with MecoxLane Shopping and its Shareholders and Contractual Arrangements with Rampage Shopping and its Shareholders.” As a result of these contractual arrangements, we are considered to be the primary beneficiary of MecoxLane Information, MecoxLane Shopping and Rampage Shopping and accordingly, we consolidate the results of operations, assets and liabilities of MecoxLane Information, MecoxLane Shopping and Rampage Shopping in our financial statements.

Although we have been advised by King & Wood, our PRC legal counsel, that each contract under these contractual arrangements is valid, binding and enforceable under current PRC laws and regulations, these contractual arrangements may not be as effective in providing us with control over MecoxLane Information,

 

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MecoxLane Shopping and Rampage Shopping as direct ownership of these companies. If any VIE or its shareholders fail to perform their respective obligations under these contractual arrangements, we may have to incur substantial costs and resources to enforce such arrangements, and rely on legal remedies under PRC law, including seeking specific performance or injunctive relief, and claiming damages, which we cannot assure you will be effective.

These contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration in the PRC. Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. The legal environment in the PRC is not as developed as in other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements, which may make it difficult to exert effective control over our VIEs, and our ability to conduct our business may be negatively affected. See “—Risks Related to Doing Business in China—Uncertainties with respect to the PRC legal system could have a material adverse effect on us.”

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

Each of MecoxLane Shopping and Rampage Shopping is jointly owned by Mr. Paul Bang Zhang, our senior vice president and chief financial officer, Mr. Guisheng Liu, our employee, and Mr. Yi Xu, our employee. MecoxLane Information is jointly owned by Mr. Paul Bang Zhang, Mr. Yi Xu and Mr. Richard Sijie Pu, our head of e-commerce. Conflicts of interests between these individuals’ role as shareholders of our VIEs and their duties to our company may arise. In addition, Mr. Xu is also a director and executive officer of MecoxLane Shopping and Rampage Shopping, and Mr. Pu is also a director and executive officer of MecoxLane Information. The laws of China provide that a director or member of management owes a fiduciary duty to the company he directs or manages. Mr. Xu and Mr. Pu must therefore act in good faith and in the best interests of the relevant VIEs and must not use their respective positions for personal gain. These laws do not require them to consider our best interests when making decisions as a director or member of management of the relevant VIEs.

We cannot assure you that when conflicts of interest arise, these individuals will act in the best interests of our company or that conflicts of interest will be resolved in our favor. In addition, these individuals may breach or cause our VIEs to breach or refuse to renew the existing contractual arrangements that allow us to effectively control our VIEs and receive economic benefits from them. Currently, we do not have arrangements to address potential conflicts of interest between these individuals and our company and a conflict could result in these individuals as officers of our company violating fiduciary duties to us. If we cannot resolve any conflicts of interest or disputes between us and the shareholders of our VIEs, we would have to rely on legal proceedings, which could result in disruption of our business, and there would be substantial uncertainty as to the outcome of any such legal proceedings.

Contractual arrangements we have entered into may be subject to scrutiny by the PRC tax authorities, and a finding that we or our affiliated entities owe additional taxes could reduce our net income and the value of your investment.

As required by applicable PRC laws and regulations, arrangements and transactions among related parties may be subject to audit or challenge by the PRC tax authorities. We could face adverse tax consequences if the PRC tax authorities determine that the contractual arrangements between our subsidiaries in China on the one hand, and MecoxLane Information, MecoxLane Shopping and Rampage Shopping on the other, do not represent an arm’s-length price and adjust MecoxLane Information, MecoxLane Shopping or Rampage Shopping’s income in the form of a transfer pricing adjustment. A transfer pricing adjustment could, among other things, result in a reduction, for PRC tax purposes, of expense deductions recorded by MecoxLane Information, MecoxLane Shopping or Rampage Shopping, which could in turn increase their respective tax liabilities. In addition, the PRC tax authorities may impose late payment fees and other penalties on our affiliated entities for underpaid taxes.

 

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Our net income may be adversely affected if our affiliated entities’ tax liabilities increase or if they are found to be subject to late payment fees or other penalties.

Our business benefits from certain government tax incentives. Expiration, reduction or discontinuation of, or changes to, these incentives will increase our tax burden and reduce our net income.

Two of our PRC subsidiaries, Shanghai MecoxLane International Mailorder Co., Ltd., or MecoxLane Mailorder, and Mai Wang Trading, enjoy a preferential corporate income tax rate of 22% in 2010 and 24% in 2011, and Mai Wang Information, as a software enterprise, enjoys a corporate income tax exemption in 2009 and 2010 and will continue to be entitled to a 50% reduction of its applicable income tax rate from 2011 to 2013. The reduced applicable income tax rate of Mai Wang Information will be 12.5% from 2011 to 2013. See “Management’s Discussions and Analysis of Financial Condition and Results of Operations—Taxation.”

Various local governments in China have provided discretionary preferential tax treatments to us. However, these local governments may decide to reduce or eliminate these preferential tax treatments at any time. Furthermore, these local implementations of tax laws may be found to violate national laws or regulations and we may be subject to retroactive imposition of higher taxes as a result. Any expiration, reduction or discontinuation of, or changes to, these tax incentives will increase our tax burden and reduce our net income and thus have a material adverse effect on our operating results.

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

We are a holding company, and we rely principally on dividends and other distributions on equity from our subsidiaries in China for our cash requirements, including the funds necessary to service any debt we may incur. Current PRC regulations permit our subsidiaries to pay dividends to us only out of their accumulated profits, if any, determined in accordance with Chinese accounting standards and regulations. In addition, each of our subsidiaries in China is 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. These reserves are not distributable as cash dividends. Furthermore, if our subsidiaries in China incur 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. Most of our assets are held by, and substantially all of our earnings and cash flows are attributable to, our PRC subsidiaries. If earnings from our PRC subsidiaries were to decline, our earnings and cash flow would be materially and adversely affected. As of December 31, 2009, we had, on a consolidated basis, accumulated losses of $30 million representing accumulated losses in a number of our PRC subsidiaries, primarily in MecoxLane Mailorder. Therefore, our relevant PRC subsidiaries are not able to distribute dividends to us until their accumulated losses have been made up. Our cash flows are principally derived from dividends paid to us by our PRC subsidiaries. As a result, our ability to distribute dividends largely depends on earnings from our PRC subsidiaries and their ability to pay dividends out of those earnings. Our PRC subsidiaries do not have a history of paying dividends. We cannot assure you that our PRC subsidiaries will generate sufficient earnings and cash flows in the near future to make up the historical accumulated losses and pay dividends or otherwise distribute sufficient funds to enable us to meet our obligations, pay interest and expenses or declare dividends.

In addition, under the PRC Corporate Income Tax Law and the Implementing Rules, both of which became effective on January 1, 2008, dividends generated from the business of our PRC subsidiaries after January 1, 2008 and payable to us may be subject to a withholding tax rate of 10% if the PRC tax authorities subsequently determine that we are a non-resident enterprise, unless there is a tax treaty with China that provides for a different withholding arrangement.

 

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We may be classified as a “resident enterprise” for PRC corporate income tax purposes, which could result in our global income becoming subject to 25% PRC corporate income tax.

The PRC Corporate Income Tax Law provides that enterprises established outside China whose “effective management” are located in China are considered “resident enterprises” and will generally be subject to the uniform 25% corporate income tax rate as to their global income. Under the implementation regulations, “effective management” is defined as substantial and overall management and control over such aspects as the production and business, personnel, accounts and properties of an enterprise.

In April 2009, the State Administration of Taxation released a circular that sets out the standards and procedures for recognizing the location of the “effective management” of an enterprise registered outside of the PRC and funded by Chinese enterprises as controlling investors, or a Chinese Funded Enterprise. Under the circular, a Chinese Funded Enterprise is considered a resident enterprise if all of the following applies: (i) a Chinese Funded Enterprise’s major management department and personnel who are responsible for carrying out daily operations are located in the PRC; (ii) the department or the personnel who have the right to decide or approve the Chinese Funded Enterprise’s financial and human resource matters are located in the PRC; (iii) the major assets, account book, company seal and meeting minutes of the Chinese Funded Enterprise are located or stored in the PRC; and (iv) the directors or management personnel holding no less than 50% voting rights of the Chinese Funded Enterprise habitually reside in the PRC. The circular explicitly provides that the above standards apply to the enterprises which are registered outside the PRC and funded by Chinese enterprises as controlling investors, and therefore such standards may be cited for reference only and may not be directly adopted when considering whether our “effective management” is in the PRC or not. Accordingly, it is still uncertain whether we may be considered a resident enterprise under the PRC Corporate Income Tax Law. If we are considered a resident enterprise and earn income other than dividends from our PRC subsidiary, we will be subject to a 25% PRC income tax on our global income and such 25% PRC corporate income tax on our global income could significantly increase our tax burden and materially and adversely affect our cash flow and profitability.

If we are classified as a “resident enterprise” for PRC corporate income tax purposes, you may be subject to PRC withholding tax on dividends from us or to PRC income tax on gain realized on the transfer of our ADSs or ordinary shares.

Under the PRC Corporate Income Tax Law and related implementation regulations, PRC income tax at the rate of 10% is applicable to dividends payable to investors that are “non-resident enterprises,” which do not have an establishment or place of business in the PRC, or which have such establishment or place of business if the relevant income is not effectively connected with the establishment or place of business, to the extent such dividends have their sources within the PRC. Similarly, any gain realized on the transfer of ADSs or shares by such investors is also subject to 10% PRC income tax if such gain is regarded as income derived from sources within the PRC unless a treaty otherwise provides. If we are considered a PRC “resident enterprise,” it is unclear whether dividends we pay with respect to our ordinary shares or ADSs, or the gain you may realize from the transfer of our ordinary shares or ADSs, would be treated as income derived from sources within the PRC and be subject to PRC tax. If we are required under the PRC Corporate Income Tax Law to withhold PRC income tax on dividends payable to our non-PRC investors that are “non-resident enterprises,” or if you are required to pay PRC income tax on the transfer of our ordinary shares or ADSs, the value of your investment in our ordinary shares or ADSs may be materially and adversely affected.

The limited use of personal computers in China and the relatively high cost of Internet access may limit the development of the Internet in China and impede our growth.

Although the use of personal computers in China has increased in recent years, the penetration rate for personal computers in China is significantly lower than in the United States and other developed countries. Furthermore, despite a decrease in the cost of Internet access in China due to a decrease in the cost of personal computers and the introduction and expansion of broadband access, the cost of Internet access still remains

 

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relatively high. The limited use of personal computers in China and the relatively high cost of Internet access may limit the growth of our business. In addition, there is no assurance that there will not be any increase in Internet access or telecommunication fees in China. If that happens, the number of our online customers may decrease and the growth of our customer base may be materially impeded.

The continued growth of China’s Internet market depends on the establishment of an adequate telecommunications infrastructure.

Although private sector Internet service providers currently exist in China, almost all access to the Internet is maintained through state-owned telecommunications operators under the administrative control and regulatory supervision of the Ministry of Industry and Information Technology. We rely on this infrastructure to provide data communications capacity primarily through local telecommunications lines. Although the government has announced plans to develop aggressively the national information infrastructure, we cannot assure you that this infrastructure will be developed as planned or at all. In addition, we will have no access to alternative networks and services, on a timely basis if at all, in the event of any infrastructure disruption or failure.

Uncertainties with respect to the PRC legal system could have a material adverse effect on us.

We conduct our business primarily through our subsidiaries and affiliated entities in China. Our operations in China are governed by PRC laws and regulations. The PRC legal system is based on statutes. Prior court decisions may be cited for reference but have limited precedential value.

Since 1979, PRC legislation and regulations have 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, because these laws and regulations are relatively new, and because of the limited volume of published decisions and their nonbinding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. In addition, 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) that may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until some time after the violation. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.

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

In utilizing the proceeds of this offering in the manner described in “Use of Proceeds,” as an offshore holding company of our PRC operating subsidiaries, we may make loans to our PRC subsidiaries, or we may make additional capital contributions to our PRC subsidiaries. Loans by us to our subsidiaries in China, which are foreign-invested enterprises, to finance their activities cannot exceed statutory limits and must be registered with the SAFE or its local counterpart. Capital contributions must be approved by the PRC Ministry of Commerce or its local counterpart. We may not be able to obtain these government approvals on a timely basis, if at all, with respect to future capital contributions by us to our PRC subsidiaries. If we fail to receive such approvals, our ability to use the proceeds of this offering and to capitalize our PRC operations may be negatively affected, which could adversely affect our liquidity and our ability to fund and expand our business.

Pursuant to a circular issued by the Ministry of Commerce and the State Administration for Industry and Commerce, a number of foreign invested enterprises, including MecoxLane Mailorder, have been prohibited from expanding their construction scale. Such prohibition may make us unable to finance MecoxLane Mailorder by means of increasing capital contributions or through non-RMB loans.

 

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

Substantially all of our cash inflows and outflows are denominated in Renminbi. We may convert a portion of our revenues into other currencies to meet our foreign currency obligations such as payment of dividends declared in respect of our ordinary shares. Under China’s existing foreign exchange regulations, our PRC subsidiaries are able to make payments of current accounts, like dividends to their offshore holding companies, in foreign currencies, without prior approval from the SAFE, by complying with certain procedural requirements. However, we cannot assure you that the PRC authorities will not take further measures in the future to restrict access to foreign currencies for current account transactions. We may also have different views with the PRC authorities with respect to certain foreign exchange transactions. Our Cayman Islands holding company historically provided certain funds to our PRC subsidiaries, which we have treated as current-account transactions that did not require prior approval from the SAFE. However, if the PRC authorities do not take the same view as to these transactions, we may be subject to penalties such as fines or restrictions on remitting such funds outside China. These and other uncertainties with respect to currency exchange controls may have a material adverse impact on our operations and financial condition.

Governmental control of currency conversion may affect the value of your investment.

The PRC government imposes controls on the convertibility of the RMB into foreign currencies and, in certain cases, the remittance of currency out of China. We receive substantially all of our revenues in RMB. Under our current corporate structure, our income is primarily derived from dividend payments from our PRC subsidiaries. Shortages in the availability of foreign currency may restrict the ability of our PRC subsidiaries to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy their foreign currency denominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from trade-related transactions, can be made in foreign currencies without prior approval from SAFE by complying with certain procedural requirements. However, approval from appropriate government authorities is required where RMB 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. The PRC government may also at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay dividends in foreign currencies to our shareholders, including holders of our ADSs.

We may be subject to penalties, including restriction on our ability to inject capital into our PRC subsidiaries and our PRC subsidiaries’ ability to distribute profits to us, if our PRC resident shareholders or beneficial owners fail to comply with relevant PRC foreign exchange rules.

SAFE issued a public notice in October 2005 requiring PRC residents to register with the local SAFE branch before establishing or controlling any company outside of China for the purpose of capital financing with assets or equities of PRC companies, referred to in the notice as an “offshore special purpose vehicle.” PRC residents that are shareholders and/or beneficial owners of offshore special purpose companies established before November 1, 2005 were required to register with the local SAFE branch before March 31, 2006. In addition, any PRC resident that is a shareholder of an offshore special purpose vehicle is required to amend its SAFE registration with respect to that offshore special purpose company in connection with any increase or decrease of capital, transfer of shares, merger, division, equity investment or creation of any security interest over any assets located in China or other material changes in share capital. In May 2007, SAFE issued relevant guidance to its local branches with respect to the operational process for SAFE registration, which standardized more specific and stringent supervision on the registration relating to the SAFE notice.

We have requested our current shareholders and/or beneficial owners to disclose whether they or their shareholders or beneficial owners fall within the ambit of the SAFE notice and urge those who are PRC residents to register with the local SAFE branch as required under the SAFE notice. However, we cannot provide any

 

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assurance that all of our shareholders and beneficial owners who are PRC residents will comply with our request to make, obtain or update any applicable registrations or comply with other requirements required by the SAFE notice or other related rules. In case of any non-compliance on any of our PRC resident shareholders or beneficial owners, our PRC subsidiaries and such shareholders and beneficial owners may be subject to fines and other legal sanctions, including restriction on our ability to contribute additional capital into our PRC subsidiaries and our PRC subsidiaries’ ability to distribute dividends to our offshore holding companies, which will adversely affect our business.

Fluctuation in the value of the RMB may have a material adverse effect on the value of your investment.

The value of the RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the RMB to the U.S. dollar. Under the new policy, the RMB is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy resulted in an over 20% appreciation of the RMB against the U.S. dollar over the following three years. For almost two years after reaching a high against the U.S. dollar in July 2008, however, the Renminbi traded within a narrow band against the U.S. dollar, remaining within 1% of its July 2008 high. As a consequence, the Renminbi fluctuated sharply since July 2008 against other freely traded currencies, in tandem with the U.S. dollar. In June 2010, the PRC government announced that it would increase RMB exchange rate flexibility. However, it remains unclear how this flexibility might be implemented. There remains significant international pressure on the PRC government to adopt a more flexible currency policy, which could result in greater fluctuation of the RMB against the U.S. dollar. Substantially all of our revenues and costs are denominated in RMB, and a significant portion of our financial assets are also denominated in RMB. We principally rely on dividends and other distributions paid to us by our subsidiaries in China. Any significant revaluation of the RMB may materially and adversely affect our cash flows, revenues, earnings and financial position, and the value of, and any dividends payable on, our ADSs in U.S. dollars. Any fluctuations of the exchange rate between the RMB and the U.S. dollar could also result in foreign currency translation losses for financial reporting purposes.

The approval of the China Securities Regulatory Commission, or the CSRC, may be required in connection with this offering under a PRC regulation. The regulation also establishes more complex procedures for acquisitions conducted by foreign investors that could make it more difficult for us to grow through acquisitions.

On August 8, 2006, six PRC regulatory agencies, including the Ministry of Commerce, the State Assets Supervision and Administration Commission, or SASAC, the State Administration for Taxation, the State Administration for Industry and Commerce, the CSRC, and the SAFE, jointly adopted the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the New M&A Rule, which became effective on September 8, 2006. The regulations require offshore special purpose vehicles that are controlled by PRC companies or residents and that have been formed for the purpose of seeking a public listing on an overseas stock exchange through acquisitions of PRC domestic companies or assets to obtain CSRC approval prior to publicly listing their securities on an overseas stock exchange. On September 21, 2006, the CSRC published a notice on its website specifying the documents and materials that special purpose vehicles are required to submit when seeking CSRC approval for their listings outside of China. The interpretation and application of the above regulations remain unclear, and this offering may ultimately require approval from the CSRC, and if it does, it is uncertain how long it will take us to obtain the approval. If CSRC approval is required for this offering, our failure to obtain or delay in obtaining the CSRC approval for this offering would subject us to sanctions imposed by the CSRC and other PRC regulatory agencies, which could include fines and penalties on our operations in China, restrictions or limitations on our ability to pay dividends outside of China, and other forms of sanctions that may materially and adversely affect our business, results of operations and financial condition.

 

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Our PRC counsel, King & Wood, has advised us that, based on their understanding of the current PRC laws, regulations and rules and the procedures announced on September 21, 2006, we will not be required to submit an application to the CSRC for the approval of the listing and trading of our ADSs on the Nasdaq Global Market, partly based on the fact that no public record indicating that any of the issuers having similar corporate structures and already listed on an off-shore stock exchange has been required by the CSRC to procure the approval of the CSRC prior to its listing, and given the timing of the formation of our company and our subsidiaries and affiliated entities, as well as the sequence of the formation of our offshore holding companies and their subsidiaries in the PRC.

The new regulations also established additional procedures and requirements that are expected to make merger and acquisition activities in China by foreign investors more time-consuming and complex, including requirements in some instances that the Ministry of Commerce be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise, or that the approval from the Ministry of Commerce be obtained in circumstances where overseas companies established or controlled by PRC enterprises or residents acquire affiliated domestic companies. We may grow our business in part by acquiring other companies operating in our industry. Complying with the requirements of the new regulations to complete such transactions could be time-consuming, and any required approval processes, including approval from Ministry of Commerce, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.

We face risks of health epidemics and other disasters, which could severely disrupt our business operations.

Our business could be materially and adversely affected by the outbreak of H1N1, or swine influenza, avian influenza, severe acute respiratory syndrome, or SARS, or another epidemic. In 2009 and early 2010, there were outbreaks of swine influenza in certain regions of the world, including China. In 2006 and 2007, there were reports on the occurrences of avian influenza in various parts of China, including a few confirmed human cases and deaths. Any prolonged recurrence of swine influenza, avian influenza, SARS or other adverse public health developments in China could require the temporary closure of our offices or stores. Such closures could severely disrupt our business operations and adversely affect our results of operations.

Our operations are vulnerable to interruption and damage from man-made or natural disasters, including wars, acts of terrorism, snowstorms, earthquakes, fire, floods, environmental accidents, power loss, communications failures and similar events. In January and February of 2008, large portions of Southern and Central China were hit with a series of snowstorms, which caused extensive damage and transportation disruption. If any similar man-made or natural disaster were to occur in the future, our ability to operate our business could be seriously impaired.

New labor laws in the PRC may adversely affect our results of operations.

China adopted a new labor law effective on January 1, 2008, that establishes more restrictions and increases costs for employers to dismiss employees. For example, the new labor law requires certain terminations to be based upon seniority and not merit. In the event we decide to significantly change or decrease our workforce in the PRC, the new labor law could adversely affect our ability to effect such changes in a manner that is most advantageous to our circumstances or in a timely and cost effective manner, thus our results of operations could be adversely affected. In addition, the new labor law requires employers pay compensation to their employees who agree to bear non-competition obligations on a monthly basis after the employees’ employments expire or terminate, which will increase employers’ operating expenses.

 

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Risks Related to Our ADSs and This Offering

There has been no public market for our ordinary shares or ADSs prior to this offering, and an active trading for our ADSs may not develop after this offering so you may not be able to resell your ADSs at or above the price you paid, or at all.

Prior to this offering, there has been no public market for our ordinary shares or ADSs. Our ADSs have been approved for listing on the Nasdaq Global Market. Our ordinary shares will not be listed on any exchange or quoted for trading on any over-the-counter trading system. If an active trading market for our ADSs does not develop after this offering, the market price and liquidity of our ADSs would be materially and adversely affected.

The initial public offering price for our ADSs will be determined by negotiations between us and the underwriters and may bear no relationship to the market price for our ADSs after the offering. An active trading market for our ADSs may not develop and the market price of our ADSs may decline below the initial public offering price. You may lose parts or all of your investment in our ADSs.

The market price for our ADSs may be volatile.

The market price for our ADSs may be volatile and subject to wide fluctuations in response to factors such as actual or anticipated fluctuations in our quarterly results of operations, changes in financial estimates by securities research analysts, changes in the economic performance or market valuations of other companies operate in our industry, announcements by us or our competitors of material acquisitions, strategic partnerships, joint ventures or capital commitments, fluctuations of exchange rates between RMB and the U.S. dollar, intellectual property litigation, release of lock-up or other transfer restrictions on our outstanding shares or ADSs, and economic or political conditions in China. In addition, the performance, and fluctuation in market prices, of other companies with business operations located mainly in China that have listed their securities in the United States may affect the volatility in the price of and trading volumes of our ADSs. Volatility in global capital markets, as was experienced during the global financial crisis, could also have an adverse effect on the market price of our ADSs. Furthermore, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our ADSs.

Since the initial public offering price is substantially higher than our net tangible book value per share, you will incur immediate and substantial dilution.

As of June 30, 2010, our existing investors had paid an average of approximately $0.28 per share for our ordinary shares on an as converted basis, assuming our preference shares being converted into ordinary shares immediately upon the completion of this offering. If you purchase our ADSs in this offering, you will pay more for your ADSs than the amount paid by our existing shareholders for their ordinary shares on a per ADS basis. As a result, you will experience immediate and substantial dilution of approximately $8.85 per ADS (assuming no exercise by the underwriters of their option to purchase additional ADSs), representing the difference between our net tangible book value per ADS as of June 30, 2010, after giving effect to this offering at the initial public offering price of $11.00 per ADS. In addition, you may experience further dilution to the extent that our ordinary shares are issued upon the exercise of share options or other share-based awards. See “Dilution” for a more complete description of how the value of your investment in our ADSs will be diluted upon completion of this offering.

 

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Substantial future sales or the perception of sales of our ADSs or ordinary shares in the public market could cause the price of our ADSs to decline.

Sales of our ADSs or ordinary shares in the public market after this offering, or the perception that these sales could occur, could cause the market price of our ADSs to decline. All ADSs sold in this offering will be freely transferable without restriction or additional registration under the Securities Act of 1933, as amended, or the Securities Act. The remaining ordinary shares outstanding after this offering will be available for sale, upon the expiration of the applicable lock-up period beginning from the date of this prospectus, subject to volume and other restrictions as applicable under Rule 144 and Rule 701 under the Securities Act. See “Shares Eligible for Future Sale” and “Underwriting” for a detailed description of the lock-up restrictions. Any or all of these shares may be released prior to expiration of the lock-up period at the discretion of the lead underwriters for this offering. To the extent shares are released before the expiration of the lock-up period and these shares are sold into the market, the market price of our ADSs could decline.

In addition, as disclosed under “Description of Share Capital—Registration Rights,” certain holders of our ordinary shares have the right to cause us to register the sale of an aggregate of 295,748,248 shares under the Securities Act, subject to a 180-day lock-up period in connection with this offering. Registration of these shares under the Securities Act would result in these shares becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of the related registration statement. Sales of these registered shares in the public market could cause the price of our ADSs to decline.

You may not have the same voting rights as the holders of our ordinary shares and must act through the depositary to exercise your rights.

As an ADS holder, you may only exercise voting rights with respect to the underlying ordinary shares in accordance with the provisions of the deposit agreement. Under the deposit agreement, you must vote by giving voting instructions to the depositary. Upon receipt of your voting instructions, the depositary will vote the underlying ordinary shares in accordance with these instructions. Otherwise, you will not be able to exercise your right to vote unless you withdraw the ordinary shares underlying your ADSs.

Pursuant to our amended and restated memorandum and articles of association, we may convene a shareholders’ meeting upon 14 days’ notice. When a shareholder’s meeting is convened, you may not receive sufficient advance notice to withdraw the ordinary shares underlying your ADSs to allow you to vote with respect to any specific matter. If we give timely notice, the depositary will notify you of the upcoming vote and arrange to deliver our voting materials to you. We cannot assure you that you will receive the voting materials in time to instruct the depositary to vote the ordinary shares underlying your ADSs. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions or for the manner of carrying out voting instructions. This means that you may not be able to exercise your right to vote and there may be nothing you can do if the ordinary shares underlying your ADSs are not voted as you requested.

You may not be able to participate in rights offerings and may experience dilution of your holdings as a result.

We may from time to time distribute rights to our shareholders, including rights to acquire our securities. Under the deposit agreement for the ADSs, the depositary will not offer those rights to ADS holders unless both the rights and the underlying securities to be distributed to ADS holders are registered under the Securities Act, or the distribution of them to ADS holders is exempted from registration under the Securities Act with respect to all holders of ADSs. We are under no obligation to file a registration statement with respect to any such rights or underlying securities or to endeavor to cause such a registration statement to be declared effective. In addition, we may not be able to rely on an exemption from registration under the Securities Act to distribute such rights and securities. Accordingly, holders of our ADSs may be unable to participate in our rights offerings and may experience dilution in their holdings as a result.

 

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You may be subject to limitations on transfer of your ADSs.

Your ADSs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from time to time when it deems expedient in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers of ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary deem it advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.

You may face difficulties in protecting your interests, and your ability to protect your rights through the U.S. federal courts may be limited because we are organized under Cayman Islands law, conduct substantially all of our operations in China and the majority of our directors and officers reside outside the United States.

We are organized in the Cayman Islands and substantially all of our assets are located outside of the United States. We conduct substantially all of our current operations in China through our subsidiaries and affiliated entities in China. The majority of our officers and directors reside outside the United States and a substantial portion of the assets of those persons are located outside of the United States. As a result, it may be difficult 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 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. In addition, there is uncertainty as to whether the courts of the Cayman Islands or the PRC would recognize or enforce judgments of U.S. courts against us or such persons predicated upon the civil liability provisions of the securities laws of the United States or any state, and it is uncertain whether such Cayman Islands or PRC courts would be competent to hear original actions brought in the Cayman Islands or the PRC against us or such persons predicated upon the securities laws of the United States or any state. For more information regarding the relevant laws of the Cayman Islands and China, see “Enforceability of Civil Liabilities.”

Our corporate affairs are governed by our memorandum and articles of association and by the Companies Law (2009 Revision) and common law of the Cayman Islands. The rights of shareholders to take legal action against our directors and us, actions by minority shareholders and the fiduciary responsibilities 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 English common law, which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in some jurisdictions in the United States. In particular, because the Cayman Islands law has no legislation specifically dedicated to the rights of investors in securities, and thus no statutorily defined private causes of action to investors in securities such as those found under the Securities Act or the Securities Exchange Act of 1934 in the United States, it provides significantly less protection to investors. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action before the federal courts of the United States.

As a result of all of the above, our public shareholders may have more difficulty in protecting their interests through actions against our management, directors or major shareholders than would shareholders of a corporation organized in a jurisdiction in the United States.

Our management will have considerable discretion as to the use of the net proceeds to be received by us from this offering and you may not agree with our management on these uses.

Our management will have considerable discretion in the application of the net proceeds received by us. You will not have the opportunity, as part of your investment decision, to assess whether proceeds are being used

 

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appropriately. You must rely on the judgment of our management regarding the application of the net proceeds of this offering. The net proceeds may be used for general corporate purposes that do not improve our efforts to maintain profitability or increase our share price. The net proceeds from this offering may be placed in investments that do not produce income or lose value.

Our articles of association contain anti-takeover provisions that could discourage a third party from acquiring us, which could limit our shareholders’ opportunity to sell their shares, including ordinary shares represented by our ADSs, at a premium.

We have adopted amended and restated articles of association effective upon the effectiveness of this registration statement that contain provisions to limit the ability of others to acquire control of our company or cause us to engage in change-of-control transactions. These provisions could have the effect of depriving our shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transaction. For example, our board of directors has the authority, without further action by our shareholders, to issue preference shares in one or more series and to fix their designations, powers, preferences, privileges, and relative participating, optional or special rights and the qualifications, limitations or restrictions, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights associated with our ordinary shares, in the form of ADS or otherwise. Preference shares could be issued quickly with terms calculated to delay or prevent a change in control of our company or make removal of management more difficult. If our board of directors decides to issue preference shares, the price of our ADSs may fall and the voting and other rights of the holders of our ordinary shares and ADSs may be materially and adversely affected.

In addition, certain actions require the approval of a supermajority of at least two-thirds of our board of directors which, among other things, would allow our non-independent directors to block a variety of actions or transactions, such as a merger, asset sale or other change of control, even if all of our independent directors unanimously voted in favor of such action, thereby further depriving our shareholders of an opportunity to sell their shares at a premium.

We may be classified as a passive foreign investment company, which could result in adverse U.S. federal income tax consequences to U.S. Holders of our ADSs or ordinary shares.

Based on the current and anticipated valuation of our assets, including goodwill, and composition of our income and assets, we do not expect to be a passive foreign investment company, or PFIC, for U.S. federal income tax purposes for our current taxable year ending December 31, 2010 or the foreseeable future. However, the application of the PFIC rules is subject to uncertainty in several respects, including how the contractual arrangements between us and our affiliated entities will be treated for purposes of the PFIC rules. In addition, we must make a separate determination after the close of each taxable year as to whether we were a PFIC for that year. Accordingly, we cannot assure you that we will not be a PFIC for our current taxable year or any future taxable year. A non-U.S. corporation will be a PFIC for any taxable year if either (i) at least 75% of its gross income for such year is passive income or (ii) 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. Because the value of our assets for purposes of the PFIC test will generally be determined by reference to the market price of our ADSs or ordinary shares, fluctuations in the market price of the ADSs or ordinary shares may cause us to become a PFIC. In addition, changes in the composition of our income or assets may cause us to become a PFIC. If we are a PFIC for any taxable year during which a U.S. Holder (as defined in “Taxation—United States Federal Income Taxation”) holds an ADS or ordinary share, certain adverse U.S. federal income tax consequences could apply to such U.S. Holder. See “Taxation—United States Federal Income Taxation—Passive Foreign Investment Company.”

 

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We will incur increased costs as a public company.

As a public company, we will incur a significantly higher level of legal, accounting and other expenses than we do as a private company. In addition, the Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the SEC and the Nasdaq Global Market, have required changes in the corporate governance practices of public companies.

When we become a public company, we will establish additional board committees and will adopt and implement additional policies regarding internal controls over financial reporting and disclosure controls and procedures. In particular, compliance with Section 404 of the Sarbanes-Oxley Act, which requires public companies to include a report of management on the effectiveness of their internal control over financial reporting, will increase our costs. In addition, we will incur costs associated with public company reporting requirements, such as the requirements to file an annual report and other reports with the SEC.

We are currently evaluating and monitoring developments with respect to these rules. We expect these rules and regulations will increase our legal and financial compliance costs, but we cannot predict or estimate the additional costs or the timing of initially additional costs we may incur.

 

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FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that involve risks and uncertainties. These statements involve known and unknown risks, uncertainties and other factors that 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 these forward-looking statements by words or phrases such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “likely to” or other similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements include:

 

   

our business strategies and initiatives as well as our business plans;

 

   

our future business development, results of operations and financial condition;

 

   

expected changes in our revenues and certain cost or expense items;

 

   

our expectations with respect to increased revenue growth and our ability to sustain profitability;

 

   

our products under development or planning;

 

   

our ability to attract clients and further enhance our brand recognition; and

 

   

trends and competition in the e-commerce and apparel and accessories industry.

This prospectus also contains data related to the e-commerce and apparel and accessories industry in China, which include projections that are based on a number of assumptions. These market data include market data from (i) a report commissioned by us and prepared by Frost & Sullivan, an independent research and advisory firm, (ii) two reports prepared by iResearch, an independent research and advisory firm, including a report commissioned by us, and (iii) China Internet Network Information Center, or CNNIC. The e-commerce and apparel and accessories industry in China may not grow at the rates projected by the market data, or at all. The failure of the markets to grow at the projected rates may have a material adverse effect on our business and the market price of our ADSs. In addition, the rapidly changing nature of the e-commerce and apparel and accessories industry in China subjects any projections or estimates relating to the growth prospects or future condition of our market to significant uncertainties. If any one or more of the assumptions underlying the market data turns out to be incorrect, actual results may differ from the projections based on these assumptions. You should not place undue reliance on these forward-looking statements.

You should read thoroughly this prospectus and the documents that we refer to in this prospectus with the understanding that our actual future results may be materially different from and worse than what we expect. We qualify all of our forward-looking statements by these cautionary statements. Other sections of this prospectus include additional factors which could adversely affect our business and financial performance. Moreover, we operate in an evolving environment. New risk factors and uncertainties emerge from time to time and it is not possible for our management to predict all risk factors and uncertainties, 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.

You should not rely upon forward-looking statements as predictions of future events. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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USE OF PROCEEDS

We will receive net proceeds from this offering of approximately $95.1 million, or approximately $101.0 million if the underwriters exercise their option to purchase additional ADSs in full, after deducting the underwriting discounts and the estimated offering expenses payable by us.

The primary purposes of this offering are to create a public market for our shares, retain talented employees by providing them with equity incentives and obtain additional capital. We intend to use the net proceeds we will receive from this offering as follows:

 

   

approximately $15.0 million to enhance our e-commerce infrastructure primarily through MecoxLane Information, one of our VIEs, and Mai Wang Information, one of our PRC subsidiaries. We plan to improve our management information system software and our e-commerce website and upgrade our hardware such as servers and computers from 2010 to 2012;

 

   

approximately $29.5 million to build part of a new logistics center and warehouse primarily through Mecox Lane Technology (China) Limited, or MecoxLane Technology, one of our PRC subsidiaries. We have a plan to build a new logistics center in Jiangsu Province with an area of approximately 200,000 square meters. The first stage of approximately 100,000 square meters will be completed by the end of 2012;

 

   

approximately $6.5 million for store growth and improvement primarily through MecoxLane Shopping and Rampage Shopping, two of our VIEs. We intend to use part of this $6.5 million to open an additional approximately five directly operated stores and approximately 20 franchised stores in 2010. The remaining portion of this $6.5 million will be used to improve our existing stores and to open additional stores in future years; and

 

   

the remaining proceeds for working capital and other corporate purposes, including procuring products to diversify our merchandise offerings primarily through Mai Wang Trading and Rampage Trading, two of our PRC subsidiaries, enhancing our online advertising efforts primarily through MecoxLane Information, one of our VIEs, and recruiting additional employees to expand our design and product management teams.

We plan to transfer a majority of the net proceeds to our PRC subsidiaries by contributing to their registered capital or providing shareholder loans. We plan to transfer the remaining net proceeds to our VIEs by providing loans to the shareholders of the VIEs under new contractual arrangements. These shareholders of VIEs will then transfer such amounts to the VIEs by increasing the registered capital of these VIEs. We have not entered into any agreement for the above shareholder loans or any new contractual arrangements to transfer the net proceeds to our VIEs.

We believe the proceeds from this offering will provide sufficient capital to our expansion plans above mentioned. The foregoing represents our current intentions to use and allocate the net proceeds of this offering based upon our present plans and business conditions. Our management, however, will have significant flexibility and discretion to apply the net proceeds of this offering. If an unforeseen event occurs or business conditions change, we may use the proceeds of this offering differently than as described in this prospectus.

Pending use of the net proceeds, we intend to hold our net proceeds in demand deposits or invest them in interest-bearing government securities.

We will not receive any of the proceeds from the sale of ADSs by the selling shareholders.

 

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DIVIDEND POLICY

We have not previously declared or paid and have no plan to declare and pay in the near future any dividends on our shares or ADSs. We currently intend to retain most, if not all, of our available funds and any future earnings to operate and expand our business.

We are a holding company incorporated in the Cayman Islands. We rely principally on dividends from our subsidiaries in China for our cash requirements, including any payment of dividends to our shareholders. Current PRC regulations permit our PRC subsidiaries to pay dividends to us only out of their accumulated profits, if any, determined in accordance with Chinese accounting standards and regulations. Any accumulated losses of PRC subsidiaries will hinder their abilities to pay dividends to us. As of December 31, 2009, we had, on a consolidated basis, accumulated losses of $30 million representing accumulated losses in a number of our PRC subsidiaries, primarily in MecoxLane Mailorder. Until our PRC subsidiaries generate sufficient earnings and cash flows to make up the historical accumulated losses, they may be unable to pay dividends or otherwise distribute sufficient funds to enable us to declare dividends. In addition, each of our subsidiaries in China is required to set aside a certain amount of its after-tax profits each year, if any, to fund certain statutory reserves. These reserves are not distributable as cash dividends. Furthermore, if our subsidiaries in China incur 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.

Our board of directors has complete discretion as to whether to distribute dividends, subject to the approval of our shareholders. Even if our board of directors decides to pay dividends, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant. If we pay any dividends, we will pay our ADS holders to the same extent as holders of our ordinary shares, subject to the terms of the deposit agreement, including the fees and expenses payable thereunder. See “Description of American Depositary Shares.” Cash dividends on our ordinary shares, if any, will be paid in U.S. dollars.

 

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CAPITALIZATION

The following table sets forth our capitalization as of June 30, 2010:

 

   

on an actual basis;

 

   

on a pro forma basis to reflect the assumed conversion of all of our outstanding Series B, Series C, and Series D convertible non-redeemable preference shares into 123,961,259 ordinary shares immediately upon the completion of this offering; and

 

   

on a pro forma as-adjusted basis to reflect the assumed conversion of all of our outstanding Series B, Series C, and Series D convertible non-redeemable preference shares into 123,961,259 ordinary shares immediately upon the completion of this offering as the holders of these preference shares sent us written notice of converting their preference shares to ordinary shares immediately upon the completion of this offering if, among other things, this offering would be completed before January 31, 2011, and the issuance and sale of 68,000,002 ordinary shares in the form of ADSs by us in this offering at the initial public offering price of $11.00 per ADS, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us (assuming the over-allotment option is not exercised).

You should read this table together with our consolidated financial statements and the related notes included elsewhere in this prospectus and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

    As of June 30, 2010  
    Actual     Pro  forma(1)     Pro forma
as-adjusted
 
    (in thousands of $)  

Series B convertible non-redeemable preference shares, $0.0001 par value, 8,600,000 shares authorized and 8,551,400 shares issued and outstanding

    18,477                 

Series C convertible non-redeemable preference shares, $0.0001 par value, 1,450,000 shares authorized and 1,441,024 shares issued and outstanding

    3,114                 

Series D convertible non-redeemable preference shares, $0.0001 par value, 1,750,000 shares authorized and 1,733,832 shares issued and outstanding

    3,764                 

Redeemable noncontrolling interests

    25        25        25   

Equity (deficit):

     

Ordinary shares, $0.0001 par value, 390,000,000 shares authorized, 209,230,993 shares issued and outstanding on an actual basis, 333,192,252 shares issued and outstanding pro forma, and 401,192,254 shares issued and outstanding pro forma as adjusted

    21        33        40   

Additional paid-in capital

    30,761        56,104        151,215   

Accumulated deficit

    (28,127     (28,127     (28,127

Accumulated other comprehensive income

    1,154        1,154        1,154   
                       

Total Mecox Lane Limited equity

    3,810        29,164        124,282   
                       

Noncontrolling interests(2)

    100        100        100   
                       

Total equity

    3,910        29,264        124,382   
                       

Total capitalization

    29,290        29,289        124,407   
                       

 

(1) Shareholders of Series B, Series C and Series D preference shares were not obligated to convert such shares upon the completion of this offering as of June 30, 2010.

 

(2) Noncontrolling interest does not reflect the impact from the potential exercise of a put option and other rights held by Iconix and its assignee. See “Corporate History and Structure—Our Corporate Structure—Agreements with Iconix” for a description of such rights.

 

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DILUTION

If you invest in our ADSs, your interest will be diluted to the extent of the difference between the initial public offering price per ADS and our net tangible book value per ADS after this offering. Dilution results from the fact that the initial public offering price per ordinary share is substantially in excess of the book value per ordinary share attributable to the existing shareholders for our presently outstanding ordinary shares.

Our net tangible book value as of June 30, 2010 was approximately $2.6 million, or $0.01 per ordinary share and $0.09 per ADS. Net tangible book value represents the amount of total tangible assets, minus the amount of total liabilities and mezzanine equity. Our pro forma net tangible book value as of June 30, 2010 was approximately $28.0 million, or $0.08 per ordinary share and $0.59 per ADS. Pro forma net tangible book value adjusts net tangible book value to give effect to the assumed conversion of all our outstanding Series B, Series C, and Series D convertible preference shares into 123,961,259 ordinary shares upon the completion of this offering.

Without taking into account any other changes in such net tangible book value after June 30, 2010, other than to give effect to (i) the assumed conversion of all of our outstanding Series B, Series C, and Series D convertible preference shares into 123,961,259 ordinary shares upon the completion of this offering, and (ii) our sale of the ADSs offered in this offering, at the initial public offering price of $11.00 per ADS, after deduction of underwriting discounts and commissions and estimated offering expenses payable by us (assuming the over-allotment option is not exercised), our pro forma as adjusted net tangible book value at June 30, 2010 would have been $123.1 million, or $0.31 per outstanding ordinary share, including ordinary shares underlying our outstanding ADSs, or $2.15 per ADS. This represents an immediate increase in pro forma net tangible book value of $0.23 per ordinary share, or $1.56 per ADS, to existing shareholders and an immediate dilution in the pro forma as adjusted net tangible book value of $1.26 per ordinary share, or $8.85 per ADS, to purchasers of ADSs in this offering. Dilution is determined by subtracting pro forma as adjusted net tangible book value per ordinary share from, in the case of dilution per share, the price per ordinary share based on initial public offering price per ADS, or, in the case of dilution per ADS, the total public offering price per ADS, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

The following table illustrates this dilution:(1)

 

     Per Ordinary
Share
     Per ADS  

Initial public offering price

   $ 1.57       $ 11.00   

Net tangible book value as of June 30, 2010

   $ 0.01       $ 0.09   

Pro forma net tangible book value as of June 30, 2010

   $ 0.08       $ 0.59   

Increase in pro forma net tangible book value attributable to this offering

   $ 0.23       $ 1.56   

Pro forma as adjusted net tangible book value after the offering

   $ 0.31       $ 2.15   

Amount of dilution in the pro forma as adjusted net tangible book value to new investors in the offering

   $ 1.26       $ 8.85   

 

(1) The table does not reflect the impact from the potential exercise of a put option and other rights held by Iconix and its assignee. See “Corporate History and Structure—Our Corporate Structure—Agreements with Iconix” for a description of such rights.

 

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The following table summarizes, on a pro forma as adjusted basis as of June 30, 2010, the differences between the shareholders as of June 30, 2010, including holders of our Series B, Series C, and Series D convertible preference shares which are assumed to be converted into ordinary shares immediately upon the completion of this offering, and the new investors with respect to the number of ordinary shares (in the form of ADSs or shares) purchased from us, the total consideration paid and the average price per ordinary share paid at the initial public offering price of $11.00 per ADS, before deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. The total number of ordinary shares does not include 1,761,429 ADSs issuable pursuant to the exercise of the over-allotment option granted to the underwriters.

 

     Ordinary Shares
Purchased
    Total Consideration     Average
Price Per
Ordinary
Share
     Average
Price
Per
ADS
 
     Number      Percent     Amount      Percent       

Existing shareholders

     329,441,235         82.89   $ 93,387,033         46.64   $ 0.28       $ 1.98   

New investors

     68,000,002         17.11        106,857,146         53.36      $ 1.57       $ 11.00   
                                       

Total

     397,441,237         100.00   $ 200,244,179         100.00   $ 0.50       $ 3.53   
                                       

The discussion and tables above also assume no exercise of any outstanding stock options. As of June 30, 2010, there were 72,943,801 ordinary shares issuable upon exercise of outstanding stock options at a weighted average exercise price of $0.26 per share. To the extent that any of these options are exercised, there will be further dilution to new investors.

 

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EXCHANGE RATE INFORMATION

Our business is primarily conducted in China and substantially all of our revenues are denominated in RMB. However, periodic reports made to shareholders will be expressed in U.S. dollars using the then current exchange rates. This prospectus contains translations of RMB amounts into U.S. dollars at specific rates solely for the convenience of the reader. The conversion of RMB into U.S. dollars in this prospectus is based on the rate certified for customs purposes by the Federal Reserve Bank of New York. Unless otherwise noted, all translations from RMB to U.S. dollars and from U.S. dollars to RMB in this prospectus were made at a rate of RMB6.7815 to $1.00, the rate in effect as of June 30, 2010. We make no representation that any RMB or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or RMB, as the case may be, at any particular rate, the rates stated below, or at all. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the conversion of RMB into foreign exchange and through restrictions on foreign trade. On October 22, 2010, the rate was RMB6.6585 to $1.00.

The following table sets forth information concerning exchange rates between the RMB and the U.S. dollar for the periods indicated. These rates are provided solely for your convenience and are not necessarily the exchange rates that we used in this prospectus or will use in the preparation of our periodic reports or any other information to be provided to you.

 

     Noon Buying Rate  

Period

   Period
End
     Average (1)      Low      High  

2005

     8.0702         8.1826         8.2765         8.0702   

2006

     7.8041         7.9579         8.0702         7.8041   

2007

     7.2946         7.5806         7.8127         7.2946   

2008

     6.8225         6.9193         7.2946         6.7800   

2009

     6.8259         6.8295         6.8470         6.8176   

2010

           

Six months ended June 30

     6.7815         6.8192         6.8330         6.7815   

April

     6.8247         6.8256         6.8275         6.8229   

May

     6.8305         6.8275         6.8310         6.8245   

June

     6.7815         6.8184         6.8323         6.7815   

July

     6.7735         6.7762         6.7807         6.7709   

August

     6.8069         6.7873         6.8069         6.7670   

September

     6.6905         6.7396         6.8102         6.6869   

October (through October 22)

     6.6585         6.6665         6.6912         6.6397   

 

Source: Federal Reserve Statistical Release

 

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

 

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ENFORCEABILITY OF CIVIL LIABILITIES

We were incorporated in the Cayman Islands in order to enjoy the following benefits:

 

   

political and economic stability;

 

   

an effective judicial system;

 

   

a favorable tax system;

 

   

the absence of exchange control or currency restrictions; and

 

   

the availability of professional and support services.

However, certain disadvantages accompany incorporation in the Cayman Islands. These disadvantages include:

 

   

the Cayman Islands has a less developed body of securities laws as compared to the United States and these securities laws provide significantly less protection to investors; and

 

   

Cayman Islands companies may not have standing to sue before the federal courts of the United States.

Our constituent documents do not contain provisions requiring that disputes, including those arising under the securities laws of the United States, between us, our officers, directors and shareholders, be arbitrated.

All of our operations are conducted in China, and substantially all of our assets are located in China. A majority of our officers are nationals or residents of jurisdictions other than the United States and a substantial portion of their assets are located outside the United States. As a result, it may be difficult for a shareholder to effect service of process within the United States upon these persons, or to enforce against us or them judgments obtained in United States courts, including judgments predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States.

We have appointed CT Corporation System, located at 111 Eighth Avenue, New York, New York 10011, as our agent upon whom process may be served in any action brought against us under the securities laws of the United States.

Maples and Calder, our counsel as to Cayman Islands law, and King & Wood, our counsel as to PRC law, have advised us, respectively, that there is uncertainty as to whether the courts of the Cayman Islands and China, respectively, would:

 

   

recognize or enforce judgments of United States courts obtained against us or our directors or officers predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States; or

 

   

entertain original actions brought in each respective jurisdiction against us or our directors or officers predicated upon the securities laws of the United States or any state in the United States.

Maples and Calder has further advised us that a final and conclusive judgment in the federal or state courts of the United States under which a sum of money is payable, other than a sum payable in respect of taxes, fines, penalties or similar charges, and which was neither obtained in a manner nor is of a kind enforcement of which is contrary to natural justice or the public policy of the Cayman Islands, may be subject to enforcement proceedings as a debt in the Cayman Islands courts under the common law doctrine of obligation without any re-examination of the merits of the underlying dispute. However, the Cayman Islands courts are unlikely to enforce a punitive

 

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judgment of a United States court predicated upon the liabilities provision of the federal securities laws in the United States without a retrial on the merits if such judgment gives rise to obligations to make payments that may be regarded as fines, penalties or similar charges.

King & Wood has further advised us that the recognition and enforcement of foreign judgments are provided for under PRC Civil Procedures Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of PRC Civil Procedures Law based either on treaties between China and the country where the judgment is made or on principles of reciprocity between jurisdictions. China does not have any treaties or other agreements with the United States that provide for the reciprocal recognition and enforcement of foreign judgments. In addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates the basic principles of PRC law or national sovereignty, security or public interest. As a result, it is uncertain whether a PRC court would enforce a judgment rendered by a court in the United States.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

You should read the following information in conjunction with our consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

The following selected consolidated statement of operations data for the years ended December 31, 2007, 2008, and 2009 and the consolidated balance sheet data as of December 31, 2008 and 2009 have been derived from our audited consolidated financial statements, which are included elsewhere in this prospectus. Our selected consolidated statement of operations data for the six months ended June 30, 2009 and 2010 and the selected consolidated balance sheet data as of June 30, 2010 have been derived from our unaudited financial statements included elsewhere in this prospectus. Our consolidated balance sheet data as of December 31, 2007 have been derived from our audited consolidated financial statements which are not included in this prospectus. Our consolidated financial statements are prepared and presented in accordance with U.S. GAAP. The historical results are not necessarily indicative of results to be expected in any future period.

Our selected consolidated statement of operations data for the years ended December 31, 2005 and 2006 and our consolidated balance sheets as of December 31, 2005 and 2006 have been derived from our unaudited consolidated financial statements, which are not included in this prospectus. Our unaudited consolidated financial statements have been prepared on the same basis as our audited consolidated financial statements.

 

    For the Year
Ended December 31,
    For the Six Months 
Ended June 30,
 
    2005     2006     2007     2008     2009     2009     2010  
   

(in thousands of $, except percentage, share, per share and per ADS data)

 

Consolidated Statement of Operations Data:

             

Net revenues:

             

Online platform

    26,441        34,268        56,568        92,438        129,362        58,238        84,782   

Directly operated stores

           350        4,786        13,915        37,388        15,644        15,991   

Franchised stores

                  5        1,174        10,939        2,426        7,261   
                                                       

Total net revenues

    26,441        34,618        61,359        107,527        177,689        76,308        108,034   
                                                       

Cost of goods sold (excluding depreciation and amortization):

             

Online platform

    15,867        19,540        31,438        51,610        74,490        33,105        48,650   

Directly operated stores

           176        2,007        6,173        16,055        6,693        7,161   

Franchised stores

                  4        696        6,512        1,442        4,538   
                                                       

Total cost of goods sold (excluding depreciation and amortization)

    15,867        19,716        33,449        58,479        97,057        41,240        60,349   
                                                       

Operating expenses:

             

Selling, general and administrative expenses

    9,002        21,697        23,124        43,300        68,505       
28,550
  
    42,580   

Depreciation and amortization

    360        386        559        1,454        3,598        1,570        2,313   

Other expense (income), net

    (82     (57     (177     (23     (254     (40     (159
                                                       

Total operating expenses

    9,280        22,026        23,506        44,731        71,849        30,080        44,734   
                                                       

Income (loss) from operations

    1,294        (7,124     4,404        4,317        8,783        4,988        2,951   

Interest income

    19        75        103        510        351        148        138   
                                                       

Income (loss) before income taxes

    1,313        (7,049     4,507        4,827        9,134        5,136        3,089   

Income tax expense (benefit)

    (80     (401     395        1,275        1,922        1,078        562   
                                                       

Net income (loss)

    1,393        (6,648     4,112        3,552        7,212        4,058        2,527   
                                                       

Earnings (loss) per ordinary share:

             

Basic

    0.01        (0.05   $ 0.01      $ 0.01      $ 0.02      $ 0.01      $ 0.01   

Diluted

    0.01        (0.05   $ 0.01      $ 0.01      $ 0.02      $ 0.01      $ 0.01   

Weighted average ordinary shares used in per share calculation:

             

Basic

    1,940,459        119,443,602        165,338,144        204,866,943        205,381,732        205,381,732        205,381,732   

Diluted

    3,490,809        119,443,602        329,055,611        331,009,675        332,293,300        331,049,991        361,337,123   

Other Financial Data

             

Adjusted net income (1)

    1,393        680        4,414        5,238        9,853        5,128        4,172   

 

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(1) We define adjusted net income, a non-GAAP financial measure, as net income excluding share-based compensation expenses. We review adjusted net income together with net income to obtain a better understanding of our operating performance. We also believe it is useful supplemental information for investors and analysts to assess our operating performance without the effect of non-cash share-based compensation expenses, which have been and will continue to be significant recurring expenses in our business. However, the use of adjusted net income has material limitations as an analytical tool. One of the limitations of using non-GAAP adjusted net income is that it does not include all items that impact our net income for the period. In addition, because adjusted net income is not calculated in the same manner by all companies, it may not be comparable to other similar titled measures used by other companies. In light of the foregoing limitations, you should not consider adjusted net income in isolation from or as an alternative to net income prepared in accordance with U.S. GAAP.

 

     The following table sets forth the reconciliation of adjusted net income, a non-GAAP financial measure, from net income, our most directly comparable financial measure presented in accordance with U.S. GAAP, for the periods indicated.

 

     For the Year Ended December 31,      For the Six
Months Ended
June 30,
 
     2005      2006      2007      2008      2009      2009      2010  
    

(in thousands of $)

 

Net income

     1,393         (6,648      4,112         3,552         7,212         4,058         2,527   

Add back: Share-based compensation expenses

             7,328         302         1,686         2,641         1,070         1,645   
                                                              

Adjusted net income

     1,393         680         4,414         5,238         9,853         5,128         4,172   
                                                              

 

     As of December 31,     As of
June 30,
 
         2005             2006             2007             2008             2009         2010  
    

(in thousands of $)

 

Consolidated Balance Sheet Data:

            

Cash and cash equivalents

     4,917        6,585        14,512        10,136        18,758        24,918   

Total assets

     9,398        12,687        23,626        38,450        63,068        71,712   

Total liabilities

     6,371        8,484        14,131        23,036        37,756        42,422   

Mezzanine equity:

            

Series B convertible non-redeemable preference shares

     29,415        18,477        18,477        18,477        18,477        18,477   

Series C convertible non-redeemable preference shares

     4,957        3,114        3,114        3,114        3,114        3,114   

Series D convertible non-redeemable preference shares

     5,964        3,764        3,764        3,764        3,764        3,764   

Redeemable noncontrolling interests

                                 25        25   

Ordinary shares

     0        17        20        21        21        21   

Additional paid-in capital

     1,490        23,783        24,758        26,475        29,116        30,761   

Accumulated deficit

     (39,268     (45,531     (41,418     (37,866     (30,654     (28,127

Total equity (deficit)

     (37,310     (21,127     (15,859     (9,940     (67     3,910   

Total liabilities, mezzanine equity and equity (deficit)

     9,398        12,687        23,626        38,450        63,068        71,712   

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the section entitled “Selected Consolidated Financial Data,” and our consolidated financial statements and the related notes included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and elsewhere in this prospectus.

Overview

We operate China’s leading online platform for apparel and accessories as measured by revenues in 2009, according to the Frost & Sullivan report. We offer a wide selection of products on our M18.com e-commerce website, evidenced by approximately 24,600 SKUs in 2009 and approximately 23,000 SKUs in the first six months of 2010, targeting the large demographic of young urban female shoppers with fast-growing spending power. We had approximately 1.9 million active customers as of December 31, 2009 and approximately 2.1 million as of June 30, 2010. Our online platform offers products under our own proprietary brands, such as Euromoda and Rampage, and under selected third-party brands, including established international and Chinese brands such as Adidas, Daphne, Kappa and Li Ning as well as independent and emerging brands featuring unique designs.

We strive to provide our customers an enjoyable shopping experience. On our well-designed and user-friendly e-commerce website, we roll out our proprietary and third-party branded products at the forefront of fashion trends, aiming to provide the best selection of products to satisfy our customer’s fashion needs. We are able to provide better “value for money” to our customers because our online platform reduces our costs and expenses for product display, rental, staffing and inventory. In 2007, 2008, 2009 and the first six months of 2010, approximately 82%, 83%, 84% and 86%, respectively, of our orders by value were placed by repeat customers.

Our online platform is supported by our superior operational capabilities. Our customer service call center staffed by over 900 representatives provides comprehensive and real-time assistance to our customers. We outsource the production of our proprietary branded products to OEM suppliers across China, and apply rigorous quality control to ensure product quality. As of September 2010, our centralized logistics center in Shanghai had the capability to process 38,000 orders per day and our logistics centers in Beijing, Chengdu and Guangzhou had the capacity to process another 12,000 orders per day. We closely manage third-party express courier companies to provide reliable and speedy delivery to our customers nationwide. We provide our online customers the flexibility to choose from a number of payment options, including COD, online payment, wire transfer and postal remittance.

To enhance our brand recognition and to reach target customers in second- and third-tier cities who are less familiar with Internet shopping but present substantial consumption potential, we also offer, through a network of stores, women’s apparel and accessories under our proprietary Euromoda and Rampage brands, to which we own all rights in China. Our store network comprised 478 stores in 182 cities across China as of June 30, 2010, including 320 franchised stores and 158 directly operated stores.

Our net revenues grew from $61.4 million in 2007 to $177.7 million in 2009, representing a CAGR of 70.2%. Our net income grew from $4.1 million to US$7.2 million over the same period, representing a CAGR of 32.4%. Our adjusted net income excluding share-based compensation expenses, a non-GAAP financial measure, grew from $4.4 million to $9.9 million over the same period, representing a CAGR of 49.4%. We generated net revenues of $108.0 million for the six months ended June 30, 2010, representing a 41.6% increase from our net revenues of $76.3 million for the six months ended June 30, 2009. We had a net income of $2.5 million for the first six months of 2010, representing a 37.7% decrease from our net income of $4.1 million for the same period in 2009 as the increases in the cost of goods sold and selling, general and marketing expenses outpaced the increase in our net revenues primarily due to unusually prolonged cold weather in the first quarter of 2010 resulting in lower than expected demand for spring apparel. Our adjusted net income decreased by 18.6% to $4.2 million from $5.1 million over the same period.

 

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We use adjusted net income, a non-GAAP financial measure, as a key financial performance indicator to assess our operating results. We define adjusted net income as net income excluding share-based compensation expenses. We review adjusted net income together with net income to have a better understanding of our operating performance. We believe it is useful information for investors and analysts to assess our operating performance without the effect of non-cash share-based compensation expenses. However, the use of adjusted net income has material limitations as an analytical tool, as share-based compensation expenses have been, and will continue to be, incurred as a necessary element of our expenses. In addition, because adjusted net income is not calculated in the same manner by all companies, it may not be comparable to other similar titled measures used by other companies. In light of the foregoing limitations, you should not consider adjusted net income in isolation from or as an alternative to consolidated income data prepared in accordance with U.S. GAAP. For details on these limitations and reconciliation of adjusted net income to net income, our most directly comparable U.S. GAAP financial measure, see “Prospectus Summary—Summary Consolidated Financial Information.”

Factors Affecting Our Results of Operations

Our operating results and financial condition are affected by a number of factors, including:

 

   

levels of per capita disposable income and consumer spending;

 

   

growth of Internet penetration and B2C e-commerce in China;

 

   

effectiveness of our marketing activities;

 

   

expansion of our physical store network;

 

   

our product offerings and pricing; and

 

   

control of product sourcing cost and operating expenses.

Levels of Per Capita Disposable Income and Consumer Spending

The levels of per capita disposable income and consumer spending in China have risen significantly in recent years as a result of strong economic growth. From 2000 to 2009, according to the National Bureau of Statistics of China, per capita annual consumption expenditure among urban households in China increased at a CAGR of approximately 10.5% from approximately RMB4,998 in 2000 to approximately RMB12,265 ($1,809) in 2009.

We believe the increases in per capita disposable income and consumer spending resulted in an increase in the demand for apparel and accessories products, particularly among young urban women. From 2004 to 2009, the value of women’s apparel and accessories consumption grew at a CAGR of 17.5%, according to the Frost & Sullivan report. Apparel sales to young women between the ages of 20 to 29 demonstrated the highest growth among all age segments, at a CAGR of 19.8% from 2004 to 2009. We position our products to target primarily young urban women in China who seek fashion products. We believe that our product positioning enables us to tap into attractive consumer segments with strong growth potential. Consumers in China have also tended to shift their spending more towards the consumption of fashion apparel and accessories. According to the Frost & Sullivan report, sales revenues from fashion wear reached RMB176.5 billion ($26.0 billion) in 2009, and this segment is also expected to grow at a CAGR of 20.4% from 2009 to 2015, the fastest rate among all the segments of women’s apparel and accessories. The increase in consumption of women’s apparel and accessories products, particularly fashion apparel, has fueled our growth. We believe that the expected continued growth in this market will present us with opportunities for our further expansion.

Growth of Internet Penetration and B2C E-commerce in China

With the growing popularity of B2C e-commerce in China, sales through our online platform, particularly our e-commerce website, have achieved significant growth. China’s growing Internet user base has fueled the

 

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growth of e-commerce in China. According to the CNNIC, in June 2008, China surpassed the United States as the country of the most number of Internet users in the world. There were 384 million Internet users in China as of the end of 2009, of which 90.1% were broadband subscribers, according to CNNIC. The total sales revenues of the B2C e-commerce market in China grew from RMB1.3 billion in 2004 to RMB31.8 billion ($4.7 billion) in 2009, representing a CAGR of 89.5%, and are expected to grow to RMB920.0 billion in 2015, according to iResearch. Retail revenues of women’s apparel and accessories sold through online platform grew at a CAGR of 26.4% from 2004 to 2009 and is expected to grow at a CAGR of 37.2% from 2009 to 2015, according to the Frost & Sullivan report. With the growing popularity of B2C e-commerce, the number of orders placed via our online platform increased from approximately 3.0 million in 2007 to approximately 6.2 million in 2009, and the number of active customers of our online platform increased from approximately 1.1 million as of December 31, 2007 to approximately 1.9 million as of December 31, 2009 and further to approximately 2.1 million as of June 30, 2010. However, the Internet use and Internet shopping penetration ratios in China are still low compared to developed countries. With the Internet becoming increasingly popular among Chinese consumers, there are great growth opportunities for B2C e-commerce in China.

Effectiveness of Our Marketing Activities

We have 15 years of experience with various marketing approaches and customer segmentation in China and our sophisticated data analysis helps us achieve highly-targeted, effective and cost-efficient marketing. We utilize direct marketing tools, including online advertising, circulation of catalogs, targeted e-mails and SMS and out-bound calls, to attract new customers and increase customer spending over our online platform. We systematically analyze our extensive customer database, segment customers and circulate promotion information according to predictions based on customers’ consumption habits and preferences. To enhance efficiency of online advertising, we typically pay advertising fees based on the percentage of actual sales generated from advertising activities. Compared to mass marketing, we believe these targeted marketing efforts help us cost-effectively increase sales over our online platform. We also conduct various other marketing and promotion activities such as print media advertising, loyalty programs and fashion shows to enhance our brand awareness and increase customer loyalty. As a result, the number of our active customers of our online platform increased from approximately 1.1 million as of December 31, 2007 to approximately 1.9 million as of December 31, 2009 and further to approximately 2.1 million as of June 30, 2010. To control marketing cost, we usually conduct test marketing prior to launching new products to predict specific sources of demand, growth potential and acceptable selling prices of our products. We also carry out test marketing to analyze the effectiveness of each marketing approach before rollout of mass marketing. This approach helps us minimize customer acquisition cost and improve the return-on-investment on our marketing activities.

Expansion of Physical Store Network

Our physical store network has also grown substantially since we began selling our branded apparel and accessories in stores in 2006. The number of our stores increased from 27 as of December 31, 2007 to 402 as of December 31, 2009 and further to 478 as of June 30, 2010, which contributed to the increase in our net revenues. The expansion of our directly operated stores also increased our compensation and benefit expenses and rental expenses.

We have expanded and plan to continue to expand our store network in second- and third-tier cities by opening franchised stores in order to achieve high growth with minimum capital investment. As of June 30, 2010, we had 320 franchised stores and 158 directly operated stores. We plan to open an additional approximately 20 franchised stores and an additional approximately 5 directly operated stores in 2010. The product offerings of our franchised stores and directly operated stores are similar. We sell our apparel and accessories products to franchisees at wholesale prices, lower than the prices we charge end customers of our directly operated stores. Therefore, our franchised stores’ expansion at a faster pace compared to our directly operated stores may affect our gross margin. On the other hand, opening franchised stores allows us to minimize capital investment and rental and staffing expenses. Under our arrangements with a portion of our franchisees, we are not responsible for their inventories but

 

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allow for a 10% return rate with respect to unsold merchandise of the current season. Other franchisees selling our products on a consignment basis may return 100% of unsold merchandise.

Our Product Offerings and Pricing

Our current featured product categories consist of apparel and accessories, home products, beauty and healthcare products, and other products. The margins of different categories of products vary. Beauty and healthcare products are usually sold at the highest margins among our products. Women’s apparel and accessories are also sold at relatively high margins as compared to other products.

We generally generate higher margins by selling our proprietary brands as compared to third-party branded products, because we retain full brand premium for our own branded products. The relatively high gross margin of sales through our franchised and directly operated stores compared to our online platform was partly attributable to the fact that we only sell our own branded apparel and accessories products in our physical stores. We design our branded apparel and accessories in-house and promote the fast-fashion concept by quickly rolling out our products at the forefront of fashion trends. We offered over 5,100 SKUs and 6,100 SKUs of apparel and accessories under our proprietary Euromoda and Rampage brands in 2009 and in the six months ended June 30, 2010, respectively.

We also source third-party branded products for resale to diversify our product offering and increase revenues. The number of SKUs we offered has increased in recent years. We offered approximately 7,000 SKUs and 1,900 SKUs through our online platform and franchised and directly operated stores in 2007, respectively, and offered approximately 24,600 SKUs and 5,400 SKUs of products through our online platform and franchised and directly operated stores in 2009, respectively. We plan to further expand our product portfolio by introducing more brands, enhancing product design of our proprietary brands and sourcing more third-party products. We have launched 159 third-party brands in the first half of 2010 and are planning to launch 160 more in the second half of 2010.

We believe there is a promising market opportunity for value-for-money fashion. We have implemented a value-for-money strategy to increase sales and to provide our customers with affordable fashion apparel. We promote fast fashion apparel and accessories while pricing products as low as one third to one half of comparable products sold in department stores. We believe our beauty and healthcare products are priced as much as 50% lower than comparable products offered on television shopping programs. We generally adopt a unified price to end customers across our sales platforms for the same product during most of its lifecycle.

Control of Product Sourcing Cost and Operating Expenses

All of our products are manufactured by third-party suppliers, and the product sourcing cost accounted for a majority of our cost of goods sold. Fluctuation in our product sourcing cost affects our ability to price our product competitively and our results of operations. We strictly control our product sourcing cost. In particular, our product management team sourced products from a network of over 1,300 and 1,100 OEM suppliers across China in 2009 and in the six months ended June 30, 2010, respectively, which allowed us to benefit from low manufacturing cost while maintaining high product quality. When our product management team selects an OEM supplier for a particularly order, a separate team will contact other OEM suppliers for another quote based on the same quality requirements. This independent bidding process allows us to control cost and closely manage the sourcing process.

With the expansion of our business, we have experienced increases in operating expenses, including compensation and benefit expenses for our retail and corporate office employees, rental of and depreciation related to directly operated stores, call centers, logistics center and corporate facilities, marketing and advertising expenses. To cost efficiently manage our rapid growth in recent years, we have employed strict internal processes and policies to control our operating expenses.

 

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Net Revenues

The following table sets forth our net revenues by segment both in absolute amount and as a percentage of total net revenues for the periods indicated.

 

    For the Year Ended December 31,     For the Six Months Ended June 30,  
    2007     2008     2009     2009     2010  
   

(in thousands of $, except percentage)

 
          %           %           %           %           %  

Net revenues:

                   

Online platform

    56,568        92.2        92,438        86.0        129,362        72.8        58,238        76.3        84,782        78.5   

Directly operated stores

    4,786        7.8        13,915        12.9        37,388        21.0        15,644        20.5        15,991        14.8   

Franchised stores

    5        0.0        1,174        1.1        10,939        6.2        2,426        3.2        7,261        6.7   
                                                                               

Total net revenues

    61,359        100.0        107,527        100.0        177,689        100.0        76,308        100.0        108,034        100.0   
                                                                               

In 2007, 2008 and 2009, we generated net revenues of $61.4 million, $107.5 million and $177.7 million, respectively. For the six months ended June 30, 2009 and 2010, we generated net revenues of $76.3 million and $108.0 million, respectively. We have derived our revenues from three segments: (i) our online platform, comprising sales through our M18.com e-commerce website and call centers, (ii) directly operated stores, comprising sales through our directly operated stores and (iii) franchised stores, comprising sales to our franchisees who operate franchised stores. Our online platform accounted for 72.8% and 78.5% of our net revenues in 2009 and for the six months ended June 30, 2010, respectively, and we expect that most of our revenues will continue to be derived from our online platform as we plan to market and sell more products, including third-party branded apparel and accessories products, via our online platform. Our revenues include shipping and handling fees we charge our online platform customers and are presented net of PRC value-added tax, business tax and related surcharges.

Our net revenues are subject to seasonal fluctuations. For example, our net revenues are usually lower during the Chinese New Year period when customers tend to do less online shopping. Our net revenues in July and August also tend to be lower than other months because our summer apparel products usually have lower unit prices compared to our apparel products for the autumn and winter seasons.

Online Platform.    We directly market and sell apparel and accessories, home products, beauty and healthcare products, and other products through our online platform. Revenues are recognized at the time the end customers receive the products, which are typically within a few days of shipment.

The following table illustrates the numbers of average daily unique visitors and monthly page views of our website, customers making purchases through our online platform and purchase orders in the three years ended December 31, 2009 and for the six months ended June 30, 2009 and 2010.

 

      For the Year Ended
December 31,
     For the Six Months
Ended June 30,
 
         2007              2008              2009              2009              2010      
    

(in thousands)

 

Number of average daily unique visitors of our website in the last month of each period

     62.8         90.0         433.2         93.7         670.7   

Number of page views of our website in the last month of each period

     39,637.4         64,936.4         198,858.9         63,611.7      

 

236,713.8

  

Number of customers making purchase through our online platform

     1,146.5         1,507.1         1,878.9         1,082.4         1,417.6   

Number of purchase orders

     2,995.2         4,650.1         6,217.8         2,687.1         4,296.8   

Almost all the products we offer are available on our e-commerce website. Once a customer places an order via our M18.com e-commerce website, our logistics center will package the products to be shipped. We deliver

 

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our products nationwide via a network of third-party express courier companies and EMS. Customers have a number of payment options, including COD, online payment, wire transfer and postal remittance. COD via third- party express courier companies is available to customers in over 100 cities in China. Third-party express courier companies and EMS collect payment from customers at the point of delivery.

Certain of our customers become aware of our products primarily from our catalogs and our out-bound calls. Our catalogs feature all the main categories of our products. Among the approximately 24,600 SKUs we offered in 2009, approximately 9,100 SKUs were displayed in our catalogs. Among the approximately 23,000 SKUs we offered for the six months ended June 30, 2010, approximately 7,000 were displayed in our catalogs. Our out-bound call center primarily markets and sells beauty and healthcare products. After customers confirm orders over the telephone, generally we deliver orders via third-party express courier companies and collect payment through COD.

Stores.    We have offered women’s apparel and accessories in physical stores under our own Euromoda and Rampage brands since 2006 and 2009, respectively.

The following table presents selected operating data of our physical stores as of the dates indicated:

 

     As of December 31,      As of June 30,  
         2007              2008              2009              2009              2010      

Number of stores

              

Directly operated stores

     25         128         177         154         158   

Franchised stores

     2         39         225         66         320   
                                            

All stores

     27         167         402         220         478   
                                            

Total store size of our directly operated stores in square meter

     2,296         14,984         20,688         18,181         16,883   
                                            

The following table presents selected operating data of our physical stores for 2007, 2008 and 2009 and for the six months ended June 30, 2009 and 2010:

 

     For the Year Ended
December 31,
    For the Six Months
Ended June 30,
 
     2007     2008     2009     2009     2010  

Average number of stores in operation(1)

     14        79        256        199        453   

Average number of directly operated stores in operation

     14        64        157        145        168   

Average number of franchised stores in operation

     0        15        99        54        285   

Directly operated stores:

          

Average store size in square meters(2)

     100        104        118        119        107   

Net revenues per square meter(3)

   $ 284      $ 173      $ 168      $ 151      $ 148   

Average monthly net revenues per existing store(4)

   $ 31,694      $ 20,825      $ 20,285      $ 18,801      $ 15,726   

Comparable store sales growth(5)

     52.0     (0.8 )%      25.4     28.5     (9.4 )% 

 

(1) Average number of stores in operation equals the sum of the number of stores at the end of each month in the applicable period, divided by the number of months in the period.

 

(2) Average store size in square meters is the average of the figures for each month in the period. The figure for each month is equal to the sum of the total square meters of our directly operated stores open as of the end of the month divided by the total number of such stores open as of the end of the month.

 

(3) Net revenues per square meter is the result of dividing net revenues from our directly operated stores only for the period presented by average store size in square meter calculated as described in footnote (2) above.

 

(4) Average monthly net revenues per existing store represents (i) net revenues for the period generated from our directly operated existing stores divided by (ii) the aggregate number of the months during which such existing stores were in operation in the period. Directly operated existing stores refer to our directly operated stores that were open at the end of previous period.

 

(5) Comparable store sales percentage changes are calculated by comparing comparable store sales for the applicable period to comparable store sales for the corresponding period in the prior fiscal year. See “Prospectus Summary—Conventions which Apply to this Prospectus” for more information about how we compute comparable store sales.

 

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In order to lower our operating expenses, we have converted some of our directly operated stores, particularly those in second- and third-tier cities, to franchised stores, the owners of which are more familiar with the local market. In 2007, 2008, 2009 and for the six months ended June 30, 2010, we converted nil, nil, 21 and 17 directly operated stores to franchised stores, respectively.

Our franchisees generally enter into annual ordering agreements with us. They typically make a down payment upon placing orders, with the balance of the purchase price fully paid before shipment. Under our arrangements with a portion of the franchisees, we are not responsible for franchised stores’ inventories but allow for a 10% return rate with respect to the unsold merchandise of the current season. Other franchisees selling our products on a consignment basis may return 100% of unsold merchandise. When products are held by the franchisee on a consignment basis, we recognize revenues from sales to franchisees upon sale to the end customers. Consignment sales are recorded net of the amount retained by the franchisee. Because we do not have verifiable data on franchised stores’ sizes and their sales to end customers and these data are not directly linked to our financial results, we do not review the operating results of the franchised stores in the same way as we review those of our directly operated stores.

For our directly operated stores, we generally collect sales proceeds at the points of sale. We are generally able to shorten our receivable period compared to retailers which lease concession areas from department stores, as we usually do not need to grant department stores credit periods.

Cost of Goods Sold (Excluding Depreciation and Amortization, or ex-D&A)

The following table sets forth our cost of goods sold by platform and by type of cost for the periods indicated both in absolute amount and as a percentage of total net revenues.

 

     For the Year Ended December 31,      For the Six Months Ended
June 30,
 
     2007      2008      2009      2009      2010  
     (in thousands of $, except percentage)  
            %             %             %             %             %  

Cost of goods sold by platform:

                             

Online platform

     31,438         51.2         51,610         48.0         74,490         41.9         33,105         43.4         48,650         45.0   

Directly operated stores

     2,007         3.3         6,173         5.7         16,055         9.0         6,693         8.8         7,161         6.6   

Franchised stores

     4         0.0         696         0.6         6,512         3.7         1,442         1.8         4,538         4.2   
                                                                                         

Total

     33,449         54.5         58,479         54.4         97,057         54.6         41,240         54.0         60,349         55.8   
                                                                                         

Cost of goods sold by type of cost:

                             

Cost of merchandise sold

     29,037         47.3         51,362         47.8         86,655         48.8         36,324         47.5         53,772         49.7   

Customer shipping and handling costs

     4,412         7.2         7,117         6.6         10,027         5.6         4,555         6.0         6,249         5.8   

Merchandise inventory write-down and shortage

                                     375         0.2         361         0.5         328         0.3   
                                                                                         

Total

     33,449         54.5         58,479         54.4         97,057         54.6         41,240         54.0         60,349         55.8   
                                                                                         

Our cost of goods sold ex-D&A primarily consists of cost of merchandise sold, customer shipping and handling costs, and merchandise inventory write-down and shortage. In 2007, 2008 and 2009, our cost of goods sold ex-D&A were $33.4 million, $58.5 million and $97.1 million, representing 54.5%, 54.4% and 54.6% of our net revenues for the same periods, respectively. For the six months ended June 30, 2009 and 2010, our cost of goods sold ex-D&A were $41.2 million and $60.3 million, representing 54.0% and 55.8% of our net revenues for the same periods, respectively.

 

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Most of our products are manufactured by third-party suppliers and the product sourcing cost, or the cost of merchandise sold, accounted for a substantial portion of our cost of goods sold ex-D&A. In 2007, 2008 and 2009, cost of merchandise sold was $29.0 million, $51.4 million and $86.7 million, representing 47.3%, 47.8% and 48.8% of our net revenues for the same periods, respectively. For the six months ended June 30, 2009 and 2010, our cost of merchandise sold were $36.3 million and $53.8 million, representing 47.5% and 49.7% of our net revenues for the same periods, respectively.

In 2007, 2008 and 2009, we recorded customer shipping and handling costs of $4.4 million, $7.1 million and $10.0 million in our cost of goods sold ex-D&A, representing 7.2%, 6.6% and 5.6% of our net revenues for the same periods, respectively. For the six months ended June 30, 2009 and 2010, we recorded customer shipping and handling costs of $4.6 million and $6.2 million in our cost of goods sold ex-D&A, representing 6.0% and 5.8% our net revenues for the same periods, respectively. Our customer shipping and handling costs include the expenses for us to ship our products to our end customers and franchisees. As usually large volumes of products are delivered per shipment to our franchisees, the unit charges for such shipping are usually low compared to our shipping to end customers. The decrease in customer shipping and handling costs as a percentage of our net revenues was primarily due to our efforts in strengthening our logistics management capabilities, the reduced unit shipping charges as a result of increases in our shipments to our franchisees following the expansion of our franchised stores, our enhanced negotiating power and third-party courier companies’ enhanced economies of scale following the increases in our volumes of products shipped.

We write down the cost of slow-moving and excess inventory to the estimated market value based on the historical and forecast demand, and such write-down is recorded as part of cost of goods sold ex-D&A.

Operating Expenses

Our operating expenses were $23.5 million, $44.7 million and $71.8 million in 2007, 2008 and 2009, respectively. Our operating expenses were $30.1 million and $44.7 million for the six months ended June 30, 2009 and 2010, respectively.

Selling, General and Administrative Expenses.    Our selling, general and administrative expenses primarily consist of compensation and benefits for our directly operated store and corporate office employees, marketing and advertising expenses, rental of directly operated stores, call centers, logistics center and corporate facilities, costs for sample product development, freight expenses associated with moving merchandise from our logistics center to stores, and legal, finance, information systems and other corporate overhead expenses. Our selling, general and administrative expenses also include share-based compensation expenses, as described below. In 2007, 2008 and 2009, our selling, general and administrative expenses were $23.1 million, $43.3 million and $68.5 million, representing 37.7%, 40.3% and 38.6% of our net revenues for the same periods, respectively. For the six months ended June 30, 2009 and 2010, our selling, general and administrative expenses were $28.6 million and $42.6 million, representing 37.4% and 39.4% of our net revenues for the same periods, respectively.

In 2007, 2008 and 2009, our compensation and benefit expenses were $7.7 million, $15.3 million and $25.6 million, representing 12.5%, 14.3% and 14.6% of our net revenues for the same periods, respectively. In 2007, 2008 and 2009, our compensation and benefit expenses, excluding share-based compensation, were $7.4 million, $13.6 million and $23.3 million, representing 12.1%, 12.7% and 13.1% of our net revenues for the same periods, respectively. For the six months ended June 30, 2009 and 2010, our compensation and benefit expenses were $11.7 million and $19.3 million, representing 15.3% and 17.9% of our net revenues for the same periods, respectively. For the six months ended June 30, 2009 and 2010, our compensation and benefit expenses, excluding share-based compensation, were $10.6 million and $17.6 million, representing 13.9% and 16.4% of our net revenues for the same periods, respectively. The increase in compensation and benefit expenses was primarily due to increases in the number of our store employees in conjunction with the expansion of our directly operated store network and the number of our corporate office employees to support our growing business.

 

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In 2007, 2008 and 2009, our marketing and advertising expenses were $8.7 million, $15.6 million and $20.8 million, representing 14.2%, 14.5% and 11.7% of our net revenues for the same periods, respectively. For the six months ended June 30, 2009 and 2010, our marketing and advertising expenses were $8.7 million and $13.0 million, representing 11.5% and 12.1% of our net revenues for the same periods, respectively. We continue to analyze the effectiveness and return on investment of each marketing tool. We devote efforts to identifying cost-effective marketing approaches and optimizing our marketing activities. We believe these efforts helped reduce our marketing and advertising expenses as a percentage of our net revenues.

In 2007, 2008 and 2009, our rental expenses for our directly operated stores, call centers, logistics center and corporate facilities were $1.6 million, $4.2 million and $9.7 million, representing 2.6%, 3.9% and 5.4% of our net revenues for the same periods, respectively. For the six months ended June 30, 2009 and 2010, our rental expenses for our directly operated stores, call centers, logistics center and corporate facilities were $4.4 million and $5.1 million, representing 5.8% and 4.8% of our net revenues for the same periods, respectively. A small portion of our leases provided for variable rents according to our stores’ sales amounts. The increase in rental expenses in absolute numbers and as a percentage of our net revenues was primarily due to our expansion of directly operated stores and the increase in the sales of our stores with variable rents.

We expect that our selling, general and administrative expenses will increase in the near term as we hire additional personnel and incur additional costs in connection with the expansion of our business and becoming a publicly traded company.

Depreciation and Amortization Expenses.    Our depreciation and amortization expenses primarily consist of depreciation expenses in connection with leasehold improvements for our directly operated stores, call centers, logistics center and corporate facilities. In 2007, 2008 and 2009, our depreciation and amortization expenses were $0.6 million, $1.5 million and $3.6 million, respectively. For the six months ended June 30, 2009 and 2010, our depreciation and amortization expenses were $1.6 million and $2.3 million, respectively. The increase in our depreciation and amortization expenses was primarily due to the expansion of our directly operated stores.

Share-based Compensation Expenses.    In December 2006, we adopted our 2006 Stock Option Plan, or the 2006 Plan. The maximum number of shares that may be issued under the 2006 Plan is 63,456,083 ordinary shares. As of June 30, 2010, options to purchase 19,240,253 ordinary shares were outstanding, and there was no additional shares available under the 2006 Plan for future grants.

In January 2008, we adopted the 2008 Stock Option Plan, or the 2008 Plan. The maximum number of shares that may be issued under the 2008 Plan is 57,370,401 ordinary shares, options to purchase all of which were outstanding as of June 30, 2010. See “Management—Share Incentive Plans.”

We recognized share-based compensation expense of $0.3 million, $1.7 million and $2.6 million for the years ended December 31, 2007, 2008 and 2009, respectively. For the six months ended June 30, 2009 and 2010, we recognized share-based compensation of $1.1 million and $1.6 million, respectively. For detailed discussion see “—Critical Accounting Polices—Share-Based Compensation.”

Taxation

We are incorporated in the Cayman Islands. Under the current law of the Cayman Islands, we are not subject to income or capital gains tax. Our subsidiaries in Hong Kong are subject to a profit tax at the rate of 16.5% on assessable profit determined under relevant Hong Kong tax regulations.

Up through December 31, 2007, most of our subsidiaries operating in the PRC were subject to PRC income tax at the statutory rate of 33% (30% national income tax plus 3% local income tax) on their PRC taxable income. Two of our operating PRC subsidiaries, MecoxLane Mailorder and Mai Wang Trading, were registered in Pudong New District, Shanghai and were subject to a 15% tax rate pursuant to the local tax preferential arrangement.

 

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On January 1, 2008, the PRC Corporate Income Tax Law took effect. The PRC Corporate Income Tax Law applies a uniform 25% corporate income tax rate to both foreign-invested enterprises and domestic enterprises, unless where tax incentives are granted to special industries and projects. Because Mai Wang Information is qualified as a software enterprise, it enjoyed a corporate income tax exemption in 2009 and 2010 and will continue to be entitled to a 50% reduction of its applicable income tax rate from 2011 to 2013. The reduced applicable income tax rate of Mai Wang Information will be 12.5% from 2011 to 2013. Enterprises established prior to March 16, 2007 eligible for preferential tax treatment in accordance with the then-effective tax laws and administrative regulations continue to enjoy preferential tax treatment within the five-year transitional period starting from January 1, 2008. MecoxLane Mailorder and Mai Wang Trading were and will be subject to an income tax rate of 18%, 20%, 22% and 24% for the four years ending December 31, 2008, 2009, 2010 and 2011, respectively, and a rate of 25% thereafter. Our other significant PRC subsidiaries and VIEs are subject to the corporate income tax with the tax rate of 25%.

Under the PRC Corporate Income Tax Law and the Implementing Rules, dividends generated from the business of our PRC subsidiaries after January 1, 2008 and payable to us may be subject to a withholding tax rate of 10% as we are a non-resident enterprise incorporated outside of PRC, unless there is a tax treaty with China that provides for a different withholding arrangement. Distributions of earnings generated before January 1, 2008 are exempt from PRC withholding tax.

The PRC Corporate Income Tax Law provides that enterprises established outside China whose “effective management” are located in China are considered “resident enterprises” and will generally be subject to the uniform 25% corporate income tax rate as to their global income. Under the implementation regulations, “effective management” is defined as substantial and overall management and control over such aspects as the production and business, personnel, accounts and properties of an enterprise. We cannot assure you that we will not be deemed to be a PRC resident enterprise under the PRC Corporate Income Tax Law and be subject to the PRC corporate income tax at the rate of 25% on our worldwide income. See “Risk Factors—Risks Related to Doing Business in China—We may be classified as a ‘resident enterprise’ for PRC corporate income tax purposes, which could result in unfavorable tax consequences to us.”

Critical Accounting Policies

We prepare our financial statements in conformity with U.S. GAAP, which requires us to make judgments, estimates and assumptions. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experience and various other assumptions that we believe to be reasonable under the circumstances. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from our expectations as a result of changes in our estimates.

An accounting policy is considered critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time such estimate is made, and if different accounting estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the consolidated financial statements. We believe that the following accounting policies involve a higher degree of judgment and complexity in their application and require us to make significant accounting estimates. The following descriptions of critical accounting policies, judgments and estimates should be read in conjunction with our consolidated financial statements and other disclosures included in this prospectus.

Revenue Recognition

We recognize revenues from product sales when the following four revenue recognition criteria are met: persuasive evidence of an arrangement exists, products are delivered, the price to the buyer is fixed or determinable, and collectability is reasonably assured.

 

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We utilize delivery service providers, primarily express courier companies, when sales are made through our online platform. For products ordered through our online platform, we accept payment by COD. For COD sales, we estimate and defer revenues and the related product costs for shipments that are in-transit to the end customers. Revenues are recognized at the time the end customers receive the products, which is typically within a few days of shipment. Amounts collected by delivery service providers but not remitted to us are classified as accounts receivable on the consolidated balance sheets. Payments received in advance of delivery are classified as advances from customers.

We recognize revenues from our franchised and directly operated stores at the point of sale.

We allow customers from our online platform and directly operated stores to return product within 10 to 30 days of the sale, depending on the customer loyalty status, i.e., members of the customer loyalty program or our VIP program may enjoy longer return periods. We estimate sales returns for such sales based on our own historical return experience. If the return rate we used for the purpose of the sales return analysis for the year ended December 31, 2009 were increased by 1%, net revenues for the year ended December 31, 2009 would decrease by approximately $1.3 million.

We sell products to all of our franchisees at a fixed percentage of the retail price of the merchandise sold and require all of our franchisees to make full payment prior to the delivery of products. We do not offer any inventory credits or other allowances to our franchisees.

A portion of our franchisees are permitted to return products within certain window periods, generally based upon the seasons of the year, limited to 10% of the specific order placed. We defer the full 10% of the sales price subject to return and recognize revenue only when the right of return expires given our limited operating history under these franchising arrangements. We recognize revenues from sales to franchisees upon sale to the end customers when products are held by the franchisees on a consignment basis as the consignment agreement allows the franchisee to return 100% of the unsold merchandise at any given point of time. Consignment sales are recorded net of the amount retained by the franchisee, which is calculated based on a fixed percentage of the retail price of the merchandise sold.

We voluntarily provide discount coupons as sales incentives to selected customers. These coupons can only be utilized in conjunction with a subsequent purchase and are recorded as a reduction of revenues at the time of use. We have established a customer loyalty program wherein a customer earns certain points for the amount they spent. We regularly price certain of our products at a combination of price plus points, the combination of which is solely at our discretion. Points can only be redeemed in connection with a subsequent purchase and have no defined monetary value which would permit a customer to obtain a calculated discount per point or any form of free product. As such, we account for points earned under the customer loyalty program in the same manner as discount coupons.

Inventories

Merchandise inventory is stated at the lower of cost or market. Cost of merchandise inventory is determined using the weighted average cost method. Slow-moving or excess inventories may be disposed of through our Internet clearance sales, catalog clearance sales and other liquidations. We record valuation adjustments to our inventories if the cost of specific inventory items on hand exceeds the amount we expect to realize from the ultimate sale or disposal of the inventory. We perform a detailed review of our inventory levels and an analytical evaluation of aged inventories on a monthly basis to identify inventory items that either are currently, or will become, slow-moving. We compare the on-hand units and season-to-date unit sales (including actual selling prices) to the sales trend and estimated prices required to sell the current units in the future, which enables us to estimate the amount which may have to be sold below cost. These estimates are based on management’s judgment regarding future demand and market conditions, analysis of historical experience, the inventory level in each platform, and the effect of the expected introduction of new products. If actual demand or market conditions

 

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are different than those projected by management, future period merchandise margin rates may be unfavorably or favorably affected by adjustments to these estimates. Inventory write-downs are recorded in cost of goods sold in the consolidated statements of operations. We recorded nil, nil and $0.4 million of inventory write-downs in 2007, 2008 and 2009, respectively, and $0.4 million and $0.3 million for the six months ended June 30, 2009 and 2010, respectively.

We also record inventory loss adjustments for estimated physical inventory losses that have occurred since the date of the last physical inventory. These estimates are based on management’s analysis of historical results and operating trends. Our shortage estimate can be affected by changes in merchandise mix and changes in actual shortage trends. Historically, actual shortage has not differed materially from our estimates.

Share-Based Compensation

We measure share-based compensation cost based on the grant date fair value. The fair value of the award, net of estimated forfeitures, is recognized as compensation expenses over the period during which the recipient is required to provide services in exchange for the award, which is generally the vesting period.

We are responsible for estimating the fair value of options and ordinary shares. The determination of fair value requires us to make complex and subjective judgments about projected financial and operating results. It also requires making certain assumptions such as cost of capital, general market and macroeconomic conditions, industry trends, comparable companies, price volatility of our shares, and discount rates. These assumptions are inherently uncertain. Changes in these assumptions could significantly affect the amount of share-based compensation expenses we recognize in our consolidated financial statements.

The following table summarizes information regarding option grants during the year ended December 31, 2009:

 

Grant date

   Shares      Exercise
price
     Fair value of
ordinary shares
     Aggregate
Intrinsic 
value(1)
 

February 19, 2009

     26,675,037       $ 0.23       $ 0.22       $ 35.7 million   

July 1, 2009

     19,235,617       $ 0.26       $ 0.25       $ 25.2 million   

 

 

(1) Intrinsic value is determined based on the difference between the initial public offering price of $1.57 per ordinary share (or $11.00 per ADS), and the purchase price/exercise price of ordinary shares/options, multiplied by number of ordinary shares/options.

We did not grant any options in the six months ended June 30, 2010.

We used the discounted cash flow valuation method under the income approach to determine the fair value of the ordinary shares for our 2009 option awards. Under the discounted cash flow method, the projected cash flow estimate included, among other things, an analysis of projected revenue growth, gross margins and effective tax rates. The discount rates reflect the risks our management perceived as being associated with achieving the forecasts and are based on our estimated cost of capital after taking into account systemic risks and company-specific risks.

Specifically, the future debt-free cash flows were determined by subtracting taxes, future capital spending and future changes in working capital from, and adding future depreciation and amortization to, earnings before income and taxes. Earnings before income and taxes represents income (loss) plus interest expense and income tax provision, less interest income. The terminal or residual value at the end of the projection period was based on a terminal growth rate of 3% for each of the valuation dates. The resulting terminal value and interim debt-free cash flows were then discounted at 18.66% and 17.3% for the respective valuation dates, which was based on the weighted average cost of capital of comparable companies, as adjusted for the specific risk profile of our company. In addition, we applied a discount for lack of marketability and control premium. There is inherent uncertainty in these estimates. If different assumptions had been used, the valuations would have been different.

Other general assumptions used in deriving the fair value of the share-based awards and our total equity value include the following: (i) there will be no major changes in the existing political, legal, fiscal and economic

 

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conditions in China; (ii) there will be no major changes in the current taxation law in China, the rates of tax payable will remain unchanged and we will comply with all applicable laws and regulations; (iii) exchange rates and interest rates will not differ materially from those presently prevailing; (iv) the availability of finance will not be a constraint on the future growth of our operation; (v) we have and will retain competent management, key personnel, and technical staff to support our ongoing operation; and (vi) industry trends and market conditions for related industries will not deviate significantly from economic forecasts.

For the purpose of determining the estimated fair value of our share options, we believe that the expected volatility and estimated share price of our ordinary shares are the most sensitive assumptions since we were a privately held company at the date we granted our options. Changes in the volatility assumption and the estimated share price of our ordinary shares could significantly impact the estimated fair values of the options calculated by the Black-Scholes option pricing model. Expected volatility is estimated based upon the average stock price volatility of the comparable companies over a period commensurate with the expected term of the options. When estimating expected volatility of the share price of a nonpublic entity, historical volatility of other companies in a similar industry group was considered.

Determining the value of our share-based compensation expense in future periods requires the input of highly subjective assumptions, including estimated forfeitures. We estimate the forfeitures of our share options based on past employee retention rates and our expectations of future retention rates, and we will prospectively revise our forfeiture rates based on actual history. Our share-based compensation expense may change based on changes to our actual forfeitures. Our actual share-based compensation expense may be materially different from our current expectations.

As of December 31, 2009, we had $5.5 million of unrecognized compensation cost related to non-vested share-based compensation awards, which we expect to recognize over a weighted-average period of 1.94 years. As of June 30, 2010, we had $3.9 million of unrecognized compensation cost related to non-vested share-based compensation awards, which we expect to recognize over a weighted-average period of 1.55 years.

Consolidation of VIEs

PRC laws and regulations currently prohibit or restrict foreign-invested enterprises from operating e-commerce businesses. Chinese regulations also require foreign-invested retail enterprises to go through an additional approval process, not required of domestic retail enterprises, each time they open a new retail store. In order to comply with these foreign ownership restrictions, we operate our e-commerce business through MecoxLane Information and operate our physical stores through MecoxLane Shopping. We conduct the business of wholesale and retail of apparel and accessories in the brand name of Rampage in China through Rampage Shopping. We have entered into a series of contractual arrangements with MecoxLane Information, MecoxLane Shopping, Rampage Shopping and their respective equity owners. As a result of these contractual arrangements, we have the ability to effectively control MecoxLane Information, MecoxLane Shopping and Rampage Shopping, and we are considered the primary beneficiary of MecoxLane Information, MecoxLane Shopping and Rampage Shopping. Accordingly, MecoxLane Information, MecoxLane Shopping and Rampage Shopping are VIEs of our company under U.S. GAAP and we consolidate the results in our consolidated financial statements. We have consulted our PRC legal counsel in assessing our ability to control MecoxLane Information, MecoxLane Shopping and Rampage Shopping through these contractual arrangements. Any changes in PRC laws and regulations that affect our ability to control MecoxLane Information, MecoxLane Shopping and Rampage Shopping might preclude us from consolidating MecoxLane Information, MecoxLane Shopping and Rampage Shopping in the future.

Income Tax and Valuation Allowance against Deferred Tax Assets

We estimate income tax expense for each jurisdiction in which we operate and for each period presented, which includes estimating current tax exposure as well as assessing realizable deferred tax assets and deferred tax liabilities.

 

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As of December 31, 2007, 2008 and 2009 and as of June 30, 2010, our deferred tax assets were $1.7 million, $0.8 million, $1.7 million and $1.7 million, respectively, primarily resulting from temporary differences between accounting and tax basis. We recognize deferred income taxes for temporary differences between the tax basis of assets and liabilities and their reported amounts in the consolidated financial statements, and net operating loss carry forwards and credits by applying enacted statutory tax rates applicable to future years. In the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of their recorded amount, an adjustment to our valuation allowance would increase our net income in the period such determination was made. Likewise, if we determined that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to our valuation allowance would be charged to our consolidated statements of operations in the period such determination is made. Current income taxes are provided for in accordance with the laws of the relevant taxing authorities. Significant management judgment based upon the possible sources of taxable income, and the evidence available for each possible sources of taxable income on a jurisdiction by jurisdiction basis, is required in determining income tax expense and deferred tax assets and liabilities. We considers positive and negative evidence to determine whether some portion or all of the deferred tax assets will more likely than not be realized. This assessment considers, among other matters, the nature, frequency and severity of recent losses, forecasts of future profitability, the duration of statutory carryforward periods, our experience with tax attributes expiring unused and tax planning alternatives. Our ability to realize deferred tax assets depends on our ability to generate sufficient taxable income within the carryforward periods provided for in the tax law. We have recognized a valuation allowance against tax loss carry forwards of $347,272, $105,636 and nil at December 31, 2008, 2009 and June 30, 2010, respectively.

Internal Control over Financial Reporting

In connection with the audit of our consolidated financial statements for 2007, 2008 and 2009, we noted certain significant deficiencies in our internal controls over financial reporting as defined in the standards established by the PCAOB, primarily related to the documentation of certain non-routine transactions. We have not noted any material weakness, as defined in the standards established by the PCAOB, in our internal controls over financial reporting. We have begun the process to remediate these control deficiencies by adopting several measures, such as engaging a consulting firm to facilitate the design and implementation of our internal control system and hiring additional accounting personnel with U.S. GAAP and Sarbanes-Oxley Act compliance experience.

However, the process of designing and implementing an effective financial reporting system is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environments and to expend significant resources to maintain a financial reporting system that is adequate to satisfy our reporting obligations. See “Risk Factors—Risks Related to Our Business—If we fail to establish or maintain an effective system of internal controls, we may be unable to accurately report our financial results or prevent fraud, and investor confidence and the market price of our shares may, therefore, be adversely impacted.”

 

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Quarterly Financial Information

The following tables set forth selected results of operations data by amount and as a percentage of net revenues, each derived from our unaudited consolidated financial statements for the three-month periods ended on the dates indicated. This information should be read together with the consolidated financial information and related notes contained elsewhere in this prospectus. We have prepared the unaudited consolidated financial information on the same basis as our audited consolidated financial statements. The unaudited financial information includes all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the quarters presented. Our quarterly operating results have experienced fluctuation and may continue to fluctuate in the future. The historical quarterly results set forth below should not be relied upon as being indicative of results for any future quarters or for a full year.

 

    For the Three Months Ended  
    March 31,
2008
    June 30,
2008
    September 30,
2008
    December 31,
2008
    March 31,
2009
    June 30,
2009
    September 30,
2009
    December 31,
2009
    March 31,
2010
    June 30,
2010
 
    (in thousands of $)  

Consolidated Statement of Operations Data:

                   

Net revenues

    19,305        27,324        26,711        34,187        33,383        42,925        40,684        60,697        49,260        58,774   

Cost of goods sold (excluding depreciation and amortization)

    (10,609     (14,695     (14,443     (18,731     (19,000     (22,240     (22,915     (32,902     (28,430     (31,919

Operating expenses:

                   

Selling, General and administrative expenses

    (7,687     (9,945     (11,355     (14,313     (12,937     (15,613     (16,710     (23,244     (21,669     (20,911

Depreciation and amortization

    (188     (221     (407     (638     (700     (870     (1,019     (1,009     (1,250     (1,062

Other income (expense)

    17        2        62        (58     (78     118        141        73        113        46   
                                                                               

Total operating expenses

    (7,858     (10,164     (11,700     (15,009     (13,715     (16,365     (17,588     (24,180     (22,806     (21,927
                                                                               

Income (loss) from operations

    838        2,465        568        447        668        4,320        181        3,615        (1,976     4,928   

Interest income

    27        112        132        238        122        26        110        92        83        55   
                                                                               

Income (loss) before income tax

    865        2,577        700        685        790        4,346        291        3,707        (1,893     4,983   

Benefit (provision) for income taxes

    (228     (680     (185     (182     (166     (912     (61     (783     344        (907
                                                                               

Net (loss) income

    637        1,897        515        503        624        3,434        230        2,924        (1,549     4,076   
                                                                               

 

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    For the Three Months Ended  
    March 31,
2008
    June 30,
2008
    September 30,
2008
    December 31,
2008
    March 31,
2009
    June 30,
2009
    September 30,
2009
    December 31,
2009
    March 31,
2010
    June 30,
2010
 
    (as percentage of net revenues)  

Consolidated Statement of Operations Data:

                   

Net revenues

    100.0        100.0        100.0        100.0        100.0        100.0        100.0        100.0        100.0        100   

Cost of goods sold

    (54.9     (53.8     (54.1     (54.7     (56.9     (51.8     (56.3     (54.2     (57.7     (54.3

Operating expenses:

                   

Selling, General and administrative expenses

    (39.8     (36.4     (42.5     (41.9     (38.8     (36.4     (41.1     (38.3     (44.0     (35.6

Depreciation and amortization

    (1.0     (0.8     (1.5     (1.9     (2.1     (2.0     (2.5     (1.6     (2.5     (1.8

Other income (expense)

    0.1        0.0        0.2        (0.2     (0.2     0.3        0.3        0.1        0.2        0.1   
                                                                               

Total operating expenses

    (40.7     (37.2     (43.8     (43.9     (41.1     (38.1     (43.2     (39.8     (46.3     (37.3
                                                                               

Income (loss) from operations

    4.3        9.0        2.1        1.3        2.0        10.1        0.4        6.1        (4.0     8.4   

Interest income

    0.1        0.4        0.5        0.7        0.4        0.1        0.3        0.2        0.2        0.1   
                                                                               

Income (loss) before income tax

    4.5        9.4        2.6        2.0        2.4        10.1        0.7        6.1        (3.8     8.5   

Benefit (provision) for income taxes

    (1.2     (2.5     (0.7     (0.5     (0.5     (2.1     (0.2     (1.3     0.7        (1.5
                                                                               

Net (loss) income

    3.3        6.9        1.9        1.5        1.9        8.0        0.6        4.8        (3.1     6.9   
                                                                               

Our operating results can fluctuate from quarter to quarter and are affected by many factors such as purchase volume from our customers and seasonality. Our net revenues in the first quarter of each year are relatively low compared to the other quarters, as customers tend to do less online shopping during the Chinese New Year period. Among the other three quarters of a year, our net revenues in the third quarter tend to be lower because we then primarily sell apparel for the summer season, which normally has lower unit prices compared to our apparel for the other seasons. The decreases in our net revenues in the first and third quarters were partly due to the above seasonality factors. Our revenues in the fourth quarter tend to be higher because we sell apparel for the autumn and winter seasons, which normally has higher unit prices.

We experienced a significant increase in net revenues for the second quarter of 2009 compared to the previous quarter primarily due to recovery from the global financial crisis, which had had a negative impact on our sales of the first quarter of 2009, as well as seasonality. The substantial growth in our net revenues for the fourth quarter of 2009 compared to the previous quarter was primarily due to an increase in the net revenues generated from our online platform because we enhanced our marketing efforts, particularly online and SMS marketing.

We experienced a decrease in the net revenues for the first quarter of 2010 compared to the previous quarter. In addition to seasonality as explained above, the decrease was primarily due to unusually prolonged cold weather in the first quarter of 2010 which resulted in lower than expected demand for spring apparel. The decrease was also attributable to a substantial merchandise shortage that occurred because many of our OEM suppliers were not able to deliver products to us on schedule as they could not maintain sufficient workforce around the Chinese New Year period.

Our quarterly cost of goods sold fluctuates in correspondence to fluctuation in our quarterly net revenues. Cost of goods sold as a percentage of the net revenues for the first quarter of 2009 was slightly higher than other quarters because we made more discount sales during that period to mitigate the impact of the global financial crisis. Cost of goods sold as a percentage of the net revenues for the third quarter of 2009 was also higher than in the other quarters as we further enhanced our clearance sales efforts compared to other quarters. In addition, cost of goods sold as a percentage of the net revenues for the first quarter of 2010 was relatively high due to more promotion sales to dispose of slow-moving merchandise in our directly operated stores caused by unusually prolonged cold weather compared to other quarters.

 

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We experienced fluctuation in our quarterly selling, general and administrative expenses generally corresponding to fluctuation in our quarterly net revenues. Our selling, general and administrative expenses for the fourth quarter of 2009 and the first quarter of 2010 were relatively high primarily due to our hiring of more employees to enable the growth of our business and our enhanced marketing efforts, particularly online advertising and distribution of e-mails and SMS. The growth rate of selling, general and administrative expenses for the third quarter of 2009 outpaced the growth rate of the net revenues in the same period, primarily due to increased compensation and benefits as we hired significantly more employees for our directly operated stores and warehouses and we issued stock options to our officers and employees during that quarter. The growth rate of selling, general and administrative expenses for the third quarter of 2008 outpaced the growth rate of the net revenues in the same period, primarily due to increased rents as we opened more directly operated stores as well as to increased compensation and benefits as we hired more employees for these directly operated stores. Also, selling, general and administrative expenses as a percentage of the net revenues for the fourth quarter of 2008 was relatively high primarily due to our enhanced promotion and marketing efforts during the same period.

Our net income fluctuates from quarter to quarter for the reasons described above. We experienced net loss for the first quarter of 2010 as revenue growth did not meet our expectations, for the reasons explained above.

Results of Operations

The following table sets forth a summary of our consolidated results of operations for the periods indicated both in absolute amount and as a percentage of our total net revenues. This information should be read together with our consolidated financial statements and related notes included elsewhere in this prospectus. The operating results in any period are not necessarily indicative of the results that may be expected for any future period.

 

    For the Year
Ended December 31,
    For the Six  Months
Ended June 30,
 
    2007     2008     2009     2009     2010  
   

(in thousands of $, except percentages)

 
          %           %           %           %           %  

Net revenues:

                   

Online platform

    56,568        92.2        92,438        86.0        129,362        72.8        58,238        76.3        84,782        78.5   

Directly operated stores

    4,786        7.8        13,915        12.9        37,388        21.0        15,644        20.5        15,991        14.8   

Franchised stores

    5        0.0        1,174        1.1        10,939        6.2        2,426        3.2        7,261        6.7   
                                                                               

Total net revenues

    61,359        100.0        107,527        100.0        177,689        100.0        76,308        100        108,034        100   
                                                                               

Cost of goods sold (excluding depreciation and amortization):

                   

Online platform

    31,438        51.2        51,610        48.0        74,490        41.9        33,105        43.4        48,650        45.0   

Directly operated stores

    2,007        3.3        6,173        5.8        16,055        9.0        6,693        8.7        7,161        6.6   

Franchised stores

    4        0.0        696        0.6        6,512        3.7        1,442        1.9        4,538        4.2   
                                                                               

Total cost of goods sold (excluding depreciation and amortization)

    33,449        54.5        58,479        54.4        97,057        54.6        41,240        54.0        60,349        55.8   
                                                                               

Operating expenses:

                   

Selling, general and administrative expenses

    23,124        37.7        43,300        40.3        68,505        38.6        28,550        37.4        42,580        39.4   

Depreciation and amortization expenses

    559        0.9        1,454        1.4        3,598        2.0        1,570        2.1        2,313        2.1   

Other expenses (income), net

    (177     (0.3     (23     (0.0     (254     (0.1     (40     (0.1     (159     (0.1
                                                                               

Total operating expenses

    23,506        38.3        44,731        41.6        71,849        40.4        30,080        39.4        44,734        41.4   
                                                                               

Income from operations

    4,404        7.2        4,317        4.0        8,783        4.9        4,988        6.5        2,951        2.7   

Interest income

    103        0.2        510        0.5        351        0.2        148        0.2        138        0.1   
                                                                               

Income before income taxes

    4,507        7.3        4,827        4.5        9,134        5.1        5,136        6.7        3,089        2.9   

Income tax expense

    395        0.6        1,275        1.2        1,922        1.1        1,078        1.4        562        0.5   
                                                                               

Net income

    4,112        6.7        3,552        3.3        7,212        4.1        4,058        5.3        2,527        2.3   
                                                                               

 

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The following table sets forth our net revenues, cost of goods sold and gross profit by segment, both in absolute amount and as a percentage of total net revenues for the period indicated.

 

    For the Year Ended December 31,     For the Six Months Ended June 30,  
    2007     2008     2009     2009     2010  
   

(in thousands of $, except percentages)

 
          %           %           %           %           %  

Segment Data:

                   

Net revenues:

                   

Online platform

    56,568        92.2        92,438        86.0        129,362        72.8        58,238        76.3        84,782        78.5   

Directly operated stores

    4,786        7.8        13,915        12.9        37,388        21.0        15,644        20.5        15,991     

 

14.8

  

Franchised stores

   
5
  
    0.0        1,174