20-F 1 f20f2016_kbsfashiongroup.htm ANNUAL REPORT

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 20-F

 

(Mark One)

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

 

OR

 

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

 

For the fiscal year ended December 31, 2016

 

OR

 

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

 

For the transition period from ___________ to ___________

 

OR

 

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

 

Date of event requiring this shell company report:

 

Commission file number: 001-35715

 

KBS Fashion Group Limited

 

(Exact Name of Registrant as Specified in Its Charter)

 

Not Applicable

(Translation of Registrant’s Name Into English)

 

Republic of the Marshall Islands

(Jurisdiction of Incorporation or Organization)

 

Xin Fengge Building

Yupu Industrial Park

Shishi City, Fujian Province 362700

People’s Republic of China

 

(Address of Principal Executive Offices)

 

Mr. Keyan Yan, Chief Executive Officer

Xin Fengge Building

Yupu Industrial Park

Shishi City, Fujian Province 362700

People’s Republic of China

Tel: + (86) 595 8889 6198

Fax: (86) 595 8850 5328

 

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

 

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

 

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

 

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

 

Units, Common Stock Purchase Warrants

(Title of Class)

 

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

 

None

(Title of Class)

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report (December 31, 2016): 1,767,821

 

 

 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

 

 

 

 

Annual Report on Form 20-F

Year Ended December 31, 2016

 

TABLE OF CONTENTS

 

      Page
       
PART I
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 1
  A. Directors and Senior Management 1
  B. Advisors 1
  C. Auditors 1
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE 1
  A. Offer Statistics 1
  B. Method and Expected Timetable 1
ITEM 3. KEY INFORMATION 1
  A. Selected Financial Data 1
  B. Capitalization and Indebtedness 2
  C. Reasons for the Offer and Use of Proceeds 2
  D. Risk Factors 2
ITEM 4. INFORMATION ON THE COMPANY 23
  A. History and Development of the Company 23
  B. Business Overview 25
  C. Organizational Structure 38
  D. Property, Plants and Equipment 38
ITEM 4A. UNRESOLVED STAFF COMMENTS 40
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 40
  A. Principal Factors Affecting Financial Performance 41
  B. Liquidity and Capital Resources 46
  C. Research and Development, Patents and Licenses, Etc. 47
  D. Trend Information 47
  E. Off Balance Sheet Arrangements 48
  F. Tabular Disclosure of Contractual Obligations 48
  G. Safe Harbor 51
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 51
  A. Directors and Senior Management 51
  B. Compensation 52
  C. Board Practices 52
  D. Employees 53
  E. Share Ownership 53
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 54
  A. Major Shareholders 54
  B. Related Party Transactions 54
  C. Interests of Experts and Counsel 54

 

 

 

 

ITEM 8. FINANCIAL INFORMATION 55
  A. Consolidated Statements and Other Financial Information 55
  B. Significant Changes 55
ITEM 9. THE OFFER AND LISTING 55
  A. Plan of Distribution 56
  B. Markets 56
  C. Selling Shareholders 56
  D. Dilution 56
  E. Expenses of the Issue 56
ITEM 10. ADDITIONAL INFORMATION 57
  A. Share Capital 57
  B. Memorandum and Articles of Association 57
  C. Material Contracts 60
  D. Exchange Controls 60
  E. Taxation 61
  F. Dividends and Paying Agents 66
  G. Statement by Experts 67
  H. Documents on Display 67
  I. Subsidiary Information 67
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 67
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES 68
  A. Debt Securities 68
  B. Warrants and Rights 68
  C. Other Securities 68
  D. American Depositary Shares 68
PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 69
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS 69
ITEM 15. CONTROLS AND PROCEDURES 69
  A. Disclosure Controls and Procedures 69
  B. Management’s Annual Report on Internal Control Over Financial Reporting 69
  C. Attestation Report of the Registered Public Accounting Firm 70
  D. Changes in Internal Controls over Financial Reporting 70
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT 70
ITEM 16B. CODE OF ETHICS 70
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES 70
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES 71
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS 71
ITEM 16F. CHANGES IN REGISTRANT’S CERTIFYING ACCOUNTANT 71
ITEM 16G. CORPORATE GOVERNANCE 71
ITEM 16H. MINE SAFETY DISCLOSURE 71
PART III
ITEM 17. FINANCIAL STATEMENTS 72

 

 

 

 

INTRODUCTORY NOTES

 

Use of Certain Defined Terms

 

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

 

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

 

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

 

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

 

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

 

  “BVI” are to the British Virgin Islands;

 

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

 

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

 

  “SEC” are to the Securities and Exchange Commission;

 

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

 

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

 

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

 

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

 

Forward-Looking Information

 

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

 

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

 

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

 

 

 

 

PART I

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

A.Directors and Senior Management

 

Not applicable.

 

B.Advisors

 

Not applicable.

 

C.Auditors

 

Not applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

 

A.Offer Statistics

 

Not applicable.

 

B.Method and Expected Timetable

 

Not applicable.

 

ITEM 3. KEY INFORMATION

 

A.Selected Financial Data

 

The following table presents selected financial data regarding our business. It should be read in conjunction with our consolidated financial statements and related notes contained elsewhere in this annual report and the information under Item 5 “Operating and Financial Review and Prospects.” The selected consolidated statements of comprehensive income data for the fiscal years ended December 31, 2016, 2015 and 2014, and the selected consolidated statements of financial position data as of December 31, 2016 and 2015 have been derived from our audited consolidated financial statements that are included in this annual report beginning on page F-1. The selected consolidated statements of comprehensive income data for the fiscal years ended December 31, 2013 and 2012, and the selected consolidated statements of financial position data as of December 31, 2013 and 2012 have been derived from our audited consolidated financial statements that are not included in this annual report.

 

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

 

 1 

 

 

       Years ended December 31,     
   2016   2015   2014   2013   2012 
Statement of Income Data                    
Total revenue  $41,200,205   $61,343,681   $58,832,481   $99,559,814   $71,059,678 
Total cost of sales   (39,041,932)   (46,511,274)   (39,416,973)   (57,363,839)   (35,791,977)
Gross profit   2,158,273    14,832,407    19,415,508    42,195,975    35,267,701 
Distribution and selling expenses   (3,606,010)   (6,621,256)   (7,191,606)   (6,238,995)   (7,964,770)
Administrative expenses   (3,543,993)   2,798,082    (4,649,229)   (2,211,431)   (1,618,714)
Profit for the year   (11,902,687)   1,243,670    6,876,982    25,419,366    19,536,762 
Total comprehensive income for the year   (18,028,120)   (4,801,102)   6,526,172    28,016,625    19,536,762 
Outstanding shares   1,750,142    1,694,489    1,694,489    1,694,489    1,694,489 
Earning per share, basic diluted   -6.80    0.73    4.06    15.00    11.53 
Balance Sheet Data                         
Cash and cash equivalents  $24,576,341   $21,214,080   $20,604,583   $43,700,087   $32,148,309 
Non-current assets   34,754,942    47,237,924    52,929,386    37,306,845    27,261,867 
Current assets   56,343,823    62,082,556    62,093,570    76,045,907    52,012,850 
Working capital   48,647,184    53,598,854    52,704,076    59,857,688    59,857,688 
Total assets   91,098,765    109,320,480    115,022,956    113,352,752    79,274,717 
Current liabilities   7,696,639    8,500,097    9,389,493    16,188,219    14,205,229 
Total liabilities   7,696,639    8,503,506    9,404,880    19,620,659    14,205,229 
Equity   83,402,126    100,816,974    105,618,076    93,732,093    79,214,717 

  

B.Capitalization and Indebtedness

 

Not applicable.

 

C.Reasons for the Offer and Use of Proceeds

 

Not applicable.

 

D.Risk Factors

 

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

 

RISKS RELATED TO OUR BUSINESS

 

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

 

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

 

 2 

 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 3 

 

 

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

 

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

 

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

 

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

 

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

 

A large part of our initial growth resulted from an increase in the number of our retail sales outlets, including corporate and franchised stores, and the increased sales volume and profitability provided by these sales outlets. The number of our sales outlets increased from 8 in 2006 to 56 in year 2016. In the future, we intend to invest more resources to improve brand recognition, start from year 2015 we had new channel of sales wholesaling to some online shops or multi brand shops, the profitability of these part sales are lower than franchised stores or corporate stores. For the future’s new channel of sales, we cannot guarantee increase new sales or improve profitability of it.

 

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

 

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

 

 4 

 

 

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

 

  the unavailability of additional funding to invest more in brand recognition such as advertisement, expand our production capacity, purchase additional fixed assets and purchase raw materials on favorable terms or at all;
     
  our inability to manage an online shop, hire qualified personnel and establish distribution methods;
     
  conditions in the commercial real estate market existing at the time we seek to expand;
     
  delays and cost overruns as a result of a number of factors, many of which may be beyond our control, such as problems with equipment vendors and
     
  contract manufacturers;
     
  failure to maintain high quality control standards;
     
  shortage of raw materials;
     
  our inability to obtain, or delays in obtaining, required approvals by relevant government authorities;
     
  diversion of significant management attention and other resources; and
     
  failure to execute our expansion plan effectively.

 

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

 

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

 

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

 

We anticipate that we will make substantial capital investments to expand our business within the next 3 years. For the fiscal years ended December 31, 2016 and 2015, we paid approximately -$45,445 and $927,876, respectively, for capital expenditures, which include expenses related to our second and third phase construction of production facility, purchasing production equipment, upgrading of our point-of-sale and enterprise resource, planning systems and decorating corporate stores.

 

There was approximately $3.8 million of cash released from the trust account to us immediately following the closing of our share exchange transaction with KBS International on August 1, 2014. However, there is no assurance that we will have sufficient cash to fund our anticipated capital expenditures. If we need but are unable to obtain adequate financing or financing on terms favorable to us, we may be unable to successfully maintain our operations and accomplish our growth strategy. In addition, we may be unable to generate sufficient cash internally or obtain alternative sources of capital to fund our proposed capital expenditures, take advantage of business opportunities or respond to competitive pressures. As a result, we may seek to sell additional equity securities, debt securities, or borrow from lending institutions. Any issuance of equity securities could cause dilution for our stockholders. Any incurrence of indebtedness could increase our debt service obligations and cause us to be subject to restrictive operating and finance covenants. Our ability to obtain external financing in the future is also subject to a number of uncertainties, including:

 

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

 

 5 

 

 

  general market conditions for financing activities by companies in our industry;
     
  economic, political and other conditions in China and elsewhere; and
     
  uncertain economic prospect and tightened credit markets resulting from the recent global economic slowdown and financial market crisis.

 

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

 

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

 

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

 

We experience fluctuations in operating results.

 

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

 

We have historically experienced seasonal fluctuations in our sales. A substantial portion of our revenues are typically earned during the second and fourth quarters and we generally experience lowest revenues during the first and third quarters. If sales during the second and fourth quarters are lower than expected, our operating results would be adversely affected, and it would have a disproportionately large impact on our annual operating results. The sales of our products are also affected by local spending behavior, which are typically affected by seasonal shopping patterns during major Chinese holidays. Extreme changes in weather patterns could also affect customers’ purchasing behavior, which may lead to fluctuations in our net sales. For example, extended periods of unusually warm temperatures during the winter season or cool weather during the summer season could render a portion of our inventory incompatible with such unusual weather conditions. These extreme or unusual weather conditions could have a material adverse effect on our results of operations.

 

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

 

 6 

 

 

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

 

Our distributors place advance purchase orders twice a year. From 2014 to 2016, we typically expect and receive payment within 30-120 days of product delivery. In addition, we had about 62.8% of accounts receivables are within a 120 days credit term. Starting in September 2015, we extended credit to some of our customers to 150-180 days without requiring collaterals. We perform ongoing credit evaluations of the financial condition of our customers and we generally require no collateral from our distributors and authorized retailers to secure their payment obligations. However, our sales going forward may rely more heavily on credit, and if we encounter future problems collecting amounts due from our clients or if we experience delays in the collection of amounts due from our clients, our liquidity could be negatively affected.

 

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

 

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

 

A substantial portion of our sales are made to distributors that resell our products. For the years ended December 31, 2015 and 2016, distributors accounted for approximately 67% and 78% of our total sales, respectively, and our top five distributors accounted for approximately 24.5% and 28.3% of our total sales, respectively. The marketing efforts of our distributors are critical for our success. If we fail to attract additional distributors, and our existing distributors do not promote our products at the same or at a greater level than the products of our competitors, our business, financial condition and results of operations could be adversely affected.

 

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

 

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

 

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

 

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

 

 7 

 

 

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

 

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

 

We plan to implement an enterprise resource planning system, or ERP system in next stage, which will allow us to track sales at the authorized retail outlets on a timely basis. Such system is expected to facilitate the processing of basic replenishment orders from our distributors, the movement of products through our authorized retail network, and the collection of information for planning and forecasting purposes. If we are unable to roll out the ERP system as planned, we would not be able to accurately track our inventory levels on a timely basis. Inaccurate, mistaken, incomplete or delayed data regarding inventory levels may mislead the Company to make wrong business judgments for its production, marketing efforts and sales strategies. If that happens, our operations and financial results may be materially adversely affected. In addition, if we cannot manage inventory levels properly, future orders of our products may be reduced, which would materially adversely affect our future business, financial condition, results of operation and prospects.

 

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

 

The production of our brand name products are 100% outsourced to PRC-based third party OEM contract manufacturers. In the years ended December 31, 2016 and 2015, we had 6 and 8 contract manufacturers, respectively. Purchases from our top five OEM contract manufacturers accounted for approximately 98% and 92% of our total purchases for the years ended December 31, 2016 and 2015, respectively. As we do not enter into long-term contracts with our OEM contract manufacturers, they may decide not to accept our future OEM orders on the same or similar terms, or at all. If an OEM contract manufacturer decides to substantially reduce its volume of supply to us or to terminate its business relationship with us, we may not be able to find a proper replacement in a timely manner and may be forced to default on the agreements with our distributors that sell our products. This may negatively impact our revenues and adversely affect our reputation and relationships with our distributors that sell our products, causing a material adverse effect on our financial condition, results of operations and prospects.

 

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

 

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

 

 8 

 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 9 

 

 

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

 

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

 

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

 

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

 

Environmental regulations impose substantial costs and limitations on our operations.

 

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

 

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

 

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

 

 10 

 

  

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

 

RISKS RELATED TO DOING BUSINESS IN CHINA

 

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

 

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

 

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

 

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

 

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

 

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

 

 11 

 

 

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

 

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

 

You may have difficulty enforcing judgments against us.

 

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

 

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

 

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

 

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

 

 12 

 

 

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

 

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

 

In addition, the Notice of the General Affairs Department of the State Administration of Foreign Exchange on the Relevant Operating Issues concerning the Improvement of the Administration of Payment and Settlement of Foreign Currency Capital of Foreign-Invested Enterprises, issued by the PRC State Administration of Foreign Exchange (“SAFE”), and effective as of August 29, 2008 (“Circular 142”), regulates the conversion by foreign-invested enterprises of foreign currency into RMB by restricting how the converted RMB may be used. Circular 142 requires that RMB converted from the foreign currency-dominated capital of a foreign-invested enterprise may only be used for purposes within the business scope approved by the relevant government authority and may not be used to make equity investments in PRC, unless specifically provided otherwise. SAFE further strengthened its oversight over the flow and use of RMB funds converted from the foreign currency-dominated capital of a foreign-invested enterprise. The use of such RMB may not be changed without approval from SAFE, and may not be used to repay RMB loans if the proceeds of such loans have not yet been used. Any violation of Circular 142 may result in severe penalties, including substantial fines.

 

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

 

The value of our securities will be indirectly affected by the foreign exchange rate between the U.S. dollar and RMB and between those currencies and other currencies in which our sales may be denominated. Appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue that will be exchanged into U.S. dollars, as well as earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.

 

Since July 2005, the RMB has no longer been pegged to the U.S. dollar. However, the PBOC regularly intervenes in the foreign exchange market to limit fluctuations in RMB exchange rates and achieve policy goals. Following the removal of the U.S. dollar peg, the RMB appreciated more than 20% against the U.S. dollar over the following three years. From July 2008 to June 2010, the RMB traded within a narrow range against the U.S. dollar. Since June 2010 the RMB has further appreciated against the U.S. dollar, from approximately RMB6.83 per U.S. dollar as of June 1, 2010 to approximately RMB 6.65 per U.S. dollar as of December 31, 2016. It is difficult to predict how RMB exchange rates may change going forward.

 

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

 

 13 

 

 

The implementation of the new PRC employment contract law and increases in the labor costs in China may hurt our business and profitability.

 

China adopted a new Labor Contract Law, effective on January 1, 2008, and issued its implementation rules, effective on September 18, 2008. The Labor Contract Law and related rules and regulations impose more stringent requirements on employers with regard to, among others, minimum wages, severance payment and non-fixed-term employment contracts, time limits for probation periods, as well as the duration and the times that an employee can be placed on a fixed-term employment contract. Due to the limited period of effectiveness of the Labor Contract Law and its implementation rules and regulations, and the lack of clarity with respect to their implementation and potential penalties and fines, it is uncertain how they will impact our current employment policies and practices. In particular, compliance with the Labor Contract Law and its implementation rules and regulations may increase our operating expenses. In the event that we decide to terminate some of its employees or otherwise change its employment or labor practices, the Labor Contract Law and its implementation rules and regulations may also limit its ability to effect those changes in a manner that we believe to be cost-effective or desirable, and could result in a material decrease in our profitability.

 

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

 

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

 

Failure to comply with PRC regulations relating to the investment in offshore special purpose companies by PRC residents may subject our PRC resident stockholders to personal liability, limit our ability to acquire PRC companies or to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute profits to us or otherwise materially adversely affect us.

 

On July 14, 2014, the SAFE issued the Circular Relating to Foreign Exchange Administration of Offshore Investment, Financing and Roundtrip Investment by Domestic Residents Through Special Purpose Vehicles, or Circular 37. Circular 37 repeals and replaces the Notice Concerning Foreign Exchange Controls on Domestic Residents’ Financing and Roundtrip Investment Through Offshore Special Purpose Vehicles, or Circular 75. Under Circular 37, PRC residents are required to register with the SAFE or its local branches prior to establishing, or acquiring control of, an offshore company for the purpose of investment or financing that offshore company with equity interests in, or assets of, a PRC enterprise or with offshore equity interest or assets legally held by such PRC resident. In addition, PRC residents are required to amend their registrations with the SAFE and its local branches to reflect any material changes with respect to such PRC resident’s investment in such offshore company, including changes to basic information of such PRC resident, increase or decrease in capital, share transfer or share swap, merger or division. In the event that a PRC shareholder fails to make the required registration or update the previously filed registration, the PRC subsidiaries of that offshore special purpose vehicle may be prohibited from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to their offshore parent company, and the offshore parent company may also be prohibited from contributing additional capital into its PRC subsidiaries. Furthermore, failure to comply with the various foreign exchange registration requirements described above could result in liability under the PRC laws for evasion of applicable foreign exchange restrictions.

 

We do not have control over our beneficial owners and cannot assure you that all of our PRC resident beneficial owners will comply with SAFE regulations. The failure of our beneficial owners who are PRC residents to comply with these SAFE registrations may subject such beneficial owners or our PRC subsidiaries to fines and legal sanctions. Furthermore, since Circular 37 was recently promulgated and it is unclear how this regulation, and any future regulation concerning offshore or cross-border transactions, will be interpreted, amended and implemented by the relevant PRC government authorities, we cannot predict how these regulations will affect our business operations or future strategy. Failure to register or comply with relevant requirements may also limit our ability to contribute additional capital to our PRC subsidiaries and limit our PRC subsidiaries’ ability to distribute dividends to our company. These risks may have a material adverse effect on our business, financial condition and results of operations.

 

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Our business and financial performance may be materially adversely affected if the PRC regulatory authorities determine that our acquisition of Hongri PRC constitutes a Round-trip Investment without MOFCOM approval.

 

On August 8, 2006, six PRC regulatory agencies promulgated the Regulation on Mergers and Acquisitions of Domestic Companies by Foreign Investors (the “Foreign M&A Rule”), which became effective on September 8, 2006 and was amended on June 22, 2009.

 

According to the Foreign M&A Rule, a “Round-trip Investment” is defined as having taken place when a PRC business that is owned by PRC individual(s) is sold to a non-PRC entity that is established or controlled, directly or indirectly, by those same PRC individual(s). Under the Foreign M&A Rule, any Round-trip Investment must be approved by MOFCOM, and any indirect arrangement or series of arrangements which achieves the same end result without the approval of MOFCOM is a violation of PRC law.

 

Our Hong Kong subsidiary Vast Billion Investment Limited (“Vast Billion”) acquired Hongri PRC in 2011 from Bizhen Chen and Keyan Yan. At the time of the acquisition, Hongri International, the parent company of Vast Billion, was owned and controlled by Mr. Sun Keung Chan and Ms. So Wa Cheung, both of whom are citizens of the Hong Kong Special Administrative Region. Mr. Yan entered into the Amended and Restated Option Agreement with Mr. Chan and Ms. Cheung, dated March 9, 2011, pursuant to which Mr. Yan was granted an option to acquire all of the shares of common stock that Mr. Chan and Ms. Cheung will acquire in Target in connection with the reverse acquisition, for an aggregate exercise price of RMB 131,409 (approximately $20,000). Mr. Yan may exercise this option during the period commencing on the date which is six (6) months after the date on which the first registration statement is filed by the Company under the Securities Act, and ending on the fifth anniversary thereof.

 

Because no Chinese nationals have direct stock ownership of either Hongri International or Vast Billion, we believe that the above transactions do not constitute a “Round-trip Investment” and therefore it has decided not to seek the approval from MOFCOM or China Securities Regulatory Commission (“CSRC”), pursuant to the Foreign M&A Rule. However, the PRC regulatory authorities may take the view that these transactions and the reverse acquisition of Hongri PRC are part of an overall series of arrangements which constitute a Round-trip Investment, because at the end of the transactions, the stockholders of Hongri PRC became majority owners and effective controlling parties of a foreign entity that acquired ownership of Hongri PRC.

 

If we are found to be in violation of the Foreign M&A Rule, the PRC regulatory authorities would have broad discretion in dealing with such violation, including levying fines, confiscating our income, revoking our PRC subsidiaries’ business or operating licenses, requiring us to restructure or unwind the relevant ownership structure or operations. 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. We believe that if these regulatory actions occur, we may be able to find a way to re-establish control of Hongri PRC’s business operations through a series of contractual arrangements rather than an outright purchase of the equity of Hongri PRC. But we cannot assure you that such contractual arrangements will be protected by PRC law or that we can receive as complete or effective economic benefit and overall control of Hongri PRC’s business than if we had direct ownership of Hongri PRC.

 

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

 

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

 

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

 

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

 

Heightened scrutiny of acquisition transactions by PRC tax authorities may have a negative impact on Chinese company’s business operations and its acquisition strategy.

 

Pursuant to the Notice on Strengthening Administration of Enterprise Income Tax for Share Transfers by Non-PRC Resident Enterprises, or SAT Circular 698, effective on January 1, 2008, and the Announcement on Several Issues Related to Enterprise Income Tax for Indirect Asset Transfer by Non-PRC Resident Enterprises , or SAT Announcement 7, effective on February 3, 2015, issued by the SAT, if a non-resident enterprise transfers the equity interests of or similar rights or interests in overseas companies which directly or indirectly own PRC taxable assets through an arrangement without a reasonable commercial purpose, but rather to avoid PRC corporate income tax, the transaction will be re-characterized and treated as a direct transfer of PRC taxable assets subject to PRC corporate income tax. SAT Announcement 7 specifies certain factors that should be considered in determining whether an indirect transfer has a reasonable commercial purpose. However, as SAT Announcement 7 is newly issued, there is uncertainty as to the application of SAT Announcement 7 and the interpretation of the term “reasonable commercial purpose.”

 

Under SAT Announcement 7, the entity which has the obligation to pay the consideration for the transfer to the transferring shareholders has the obligation to withhold any PRC corporate income tax that is due. If the transferring shareholders do not pay corporate income tax that is due for a transfer and the entity which has the obligation to pay the consideration does not withhold the tax due, the PRC tax authorities may impose a penalty on the entity that so fails to withhold, which may be relieved or exempted from the withholding obligation and any resulting penalty under certain circumstances if it reports such transfer to the PRC tax authorities.

 

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Although SAT Announcement 7 is generally effective as of February 3, 2015, it also applies to cases where the PRC tax treatment of a transaction that took place prior to its effectiveness has not yet been finally settled. As a result, SAT Announcement 7 could be determined by PRC tax authorities to be applicable to the historical reorganization, and it is possible that these transactions could be determined by PRC tax authorities to lack a reasonable commercial purpose. As a result, the transfer of shares by certain shareholders to other parties could be subject to corporate income tax of up to 10% on capital gains generated from such transfers, and PRC tax authorities could impose tax obligations on the transferring shareholders or subject us to penalty if the transferring shareholders do not pay such obligations and withhold such tax.

 

SAT Announcement 7 and its interpretation by relevant PRC authorities clarify that an exemption provided by SAT Circular 698 for transfers of shares in a publicly-traded entity that is listed overseas is available if the purchase of the shares and the sale of the shares both take place in open-market transactions. However, if a shareholder of an entity that is listed overseas purchases shares in the open market and sells them in a private transaction, or vice-versa, PRC tax authorities might deem such a transfer to be subject to SAT Circular 698 and SAT Announcement 7, which could subject such shareholder to additional reporting obligations or tax burdens. Accordingly, if a holder of the Company’s common stock purchases such common stock in the open market and sells them in a private transaction, or vice-versa, and fails to comply with SAT Circular 698 or SAT Announcement 7, the PRC tax authorities may take actions, including requesting to provide assistance for their investigation or impose a penalty on it, which could have a negative impact on the company’s business operations.

 

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

 

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

 

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

 

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

 

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

 

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

 

Recently, U.S. public companies that have substantially all of their operations in China, particularly companies like us which have completed so-called reverse merger transactions, have been the subject of intense scrutiny, criticism and negative publicity by investors, financial commentators and regulatory agencies, such as the SEC. Much of the scrutiny, criticism and negative publicity has centered on financial and accounting irregularities and mistakes, a lack of effective internal controls over financial accounting, inadequate corporate governance policies or a lack of adherence thereto and, in many cases, allegations of fraud. As a result of the scrutiny, criticism and negative publicity, the publicly traded stock of many U.S. listed Chinese companies has sharply decreased in value and, in some cases, has become virtually worthless. Many of these companies are now subject to stockholder lawsuits, SEC enforcement actions and are conducting internal and external investigations into the allegations. It is not clear what effect this sector-wide scrutiny, criticism and negative publicity will have on our subsidiaries, our business and our stock price after the Acquisition. If we become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, we will have to expend significant resources to investigate such allegations and/or defend our subsidiaries. This situation may be costly and time consuming and distract our management from growing our company. If such allegations are not proven to be groundless, our subsidiaries and business operations may be severely and adversely affected and your investment in our stock could be rendered worthless.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

our earnings releases, actual or anticipated changes in our earnings, fluctuations in our operating results or our failure to meet the expectations of financial market analysts and investors;
changes in financial estimates by us or by any securities analysts who might cover our shares;
speculation about our business in the press or the investment community;
significant developments relating to our relationships with our customers or suppliers;
stock market price and volume fluctuations of other publicly traded companies and, in particular, those that are in the our industries;
customer demand for our products;
investor perceptions of the our industry in general and our company in particular;
the operating and stock performance of comparable companies;
general economic conditions and trends;
major catastrophic events;
announcements by us or our competitors of new products, significant acquisitions, strategic partnerships or divestitures;
changes in accounting standards, policies, guidance, interpretation or principles;
loss of external funding sources;
sales of our shares, including sales by our directors, officers or significant shareholders; and
additions or departures of key personnel.

 

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

 

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

 

Mr. Keyan Yan, our Chairman and Chief Executive Officer, is the beneficial owner of approximately 48.8% of our outstanding voting securities. As a result, he possesses significant influence and can elect a majority of our board of directors and authorize or prevent proposed significant corporate transactions. His ownership and control may also have the effect of delaying or preventing a future change in control, impeding a merger, consolidation, takeover or other business combination or discourage a potential acquirer from making a tender offer.

 

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We have elected to use the extended transition period for complying with new or revised accounting standards under Section 102(b)(1) of the JOBS Act which allows us to delay the adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies.

 

We are an emerging growth company as defined in the JOBS Act, and will continue to be an emerging growth company until: (i) the last day of our fiscal year following the fifth anniversary of our initial public offering in 2012 (“IPO”), (ii) the date on which we become a large accelerated filer, or (iii) the date on which we have issued an aggregate of $1 billion in non-convertible debt during the preceding 3 years. As an emerging growth company, we have elected to use the extended transition period for complying with new or revised accounting standards under Section 102(b)(1) of the JOBS Act. This election allows us to delay the adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies. As a result of this election, our financial statements may not be comparable to companies that comply with public company effective dates.

 

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

 

There are currently 393,454 warrants outstanding. Each warrant entitles the holder to purchase one share of common stock at a price of $172.5. We also issued to the representative of the underwriters, concurrently with our IPO, for a purchase price of $100, an Underwriters’ Unit Purchase Option to purchase 16,667 units, each unit representing one share of common stock and one warrant. The sale or possibility of sale of the shares underlying the warrants could have an adverse effect on the market price for our shares of common stock or our ability to obtain future financing. If and to the extent these warrants are exercised, you may experience dilution to your holdings.

 

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

 

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

 

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

 

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

 

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

 

We are a foreign private issuer as defined in Rule 405 under the Securities Act and, as a result, we are not subject to certain of the requirements imposed upon U.S. domestic issuers by the SEC. For example, we are not required by the SEC or the federal securities laws to issue quarterly reports or file proxy statements with the SEC. We are also allowed to file our annual report with the SEC within four months of our fiscal year end. We are also not required to disclose certain detailed information regarding executive compensation that is required from U.S. domestic issuers. Further, our directors and executive officers are not required to report equity holdings under Section 16 of the Securities Act. As a foreign private issuer, we are also exempt from the requirements of Regulation FD (Fair Disclosure) which, generally, are meant to ensure that select groups of investors are not privy to specific information about an issuer before other investors. We are, however, still subject to the anti-fraud and anti-manipulation rules of the SEC, such as Rule 10b-5. Since many of the disclosure obligations required of us as a foreign private issuer are different than those required by U.S. domestic reporting companies, our shareholders should not expect to receive all of the same types of information about us and at the same time as information is received from, or provided by, U.S. domestic reporting companies. We are liable for violations of the rules and regulations of the SEC which do apply to us as a foreign private issuer. Violations of these rules could affect our business, results of operations and financial condition.

 

If we lose our status as a foreign private issuer at some future time, we will be required to comply fully with the reporting requirements of the Exchange Act applicable to U.S. domestic issuers and would incur significant operational, administrative, legal and accounting costs that it would not incur as a foreign private issuer.

 

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

 

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

 

have a majority of the board be independent (although all of the members of the audit committee must be independent under the U.S. Securities Exchange Act of 1934, as amended, or the Exchange Act);

 

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

 

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

 

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

 

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

 

As of the date of this report, we have 1,772,016 shares of common stock outstanding. Many of these shares will become eligible for sale in the public market, subject to limitations imposed by Rule 144 under the Securities Act. If the holders of these shares were to attempt to sell a substantial amount of their holdings at once, the market price of our common stock could decline. Moreover, the perceived risk of this potential dilution could cause shareholders to attempt to sell their shares and investors to short the common stock, a practice in which an investor sells shares that he or she does not own at prevailing market prices, hoping to purchase shares later at a lower price to cover the sale. As each of these events would cause the number of shares of our common stock being offered for sale to increase, our common stock market price would likely further decline. All of these events could combine to make it very difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate.

 

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

 

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

 

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

 

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

 

ITEM 4. INFORMATION ON THE COMPANY

 

A.History and Development of the Company

 

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

 

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On March 24, 2014, we entered into a share exchange agreement and plan of liquidation (the “Exchange Agreement”), with KBS International, Hongri International, a then wholly owned subsidiary of KBS International and Cheung So Wa and Chan Sun Keung, each an individual and shareholder of KBS International (each, a “Principal Stockholder”). The Exchange Agreement was subsequently amended on June 21, 2014. The transactions contemplated in the Exchange Agreement (the “Share Exchange”) were closed on August 1, 2014. At the closing, we acquired 100% of the issued and outstanding equity interest in Hongri International from KBS International. In exchange, we issued an aggregate of 1,530,497 shares of common stock of the Company to KBS International. In addition, on July 29, 2014, we completed a tender offer related to the Share Exchange and redeemed the 332,116 shares of common stock validly tendered and not withdrawn. Pursuant to the Exchange Agreement, KBS International was liquidated and dissolved in August 2014 and the 1,530,497 shares of common stock of the Company were distributed to each shareholder of KBS International according to their respective ownership of KBS International. As a result, following the consummation of the Share Exchange, we had a total of 1,694,489 shares of common stock outstanding. On March 29, 2016, we granted an aggregate of 73,334 restricted shares of common stock to certain executive officers and directors of the Company as compensations for their past services in 2015 and future services to be provided in 2016.

 

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

 

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

 

Corporate Structure

 

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

 

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Principal Capital Expenditures and Divestitures

 

For the years ended December 31, 2016 and 2015, our total capital expenditures and divestitures were -$45,445 and $927,876, respectively. Such expenditures were primarily used for our second and third phase construction of production facility and purchasing production equipment.

 

B.Business Overview

 

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

 

Our apparel products include outerwear, knitwear, denim, tops, bottoms, accessories and footwear. Since 2006, we have launched 2536 collections of new products, each year with a different theme to highlight the current trends in menswear for the season.

 

We have established a nationwide distribution network covering 12 of China’s 32 provinces and centrally administered municipalities. As of December 31, 2016, this network was comprised of 1 corporate store owned and operated by the company and 55 franchised stores operated by 29 third party distributors or their sub-distributors. The number of stores has grown from 1 corporate store and 7 franchised stores as of December 31, 2006. In the years ended December 31, 2016, 2015 and 2014, sales through our corporate stores accounted for 13%, 29.5% and 27.4% of our total revenues respectively, and sales through distributors and whole sellers accounted for 78%, 66.5% and 69.1%of our revenues, respectively. Total revenue from corporate stores sales for fiscal year 2016 was $5.53 million, compared to $18.09 million for 2015 and $16.13 million for 2014.

 

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From 2009 through 2016, total net sales increased from $28.1 million to $41.2 million while the net profit decreased from $9.0 million to -$12.4 million.

 

Our Competitive Strengths

 

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

 

There is a sizable market for our products. We believe that we have a sizeable potential market. Our target customers are male middle-class consumers in the 20-40 age range. According to the national census in 2010, the population in China between 15-59 years-old was 940 million. Our target group falls into this category and is estimated to be more than 200 million people. As a result of the growing affluence in the PRC and increased purchasing power of the PRC population, we believe that PRC consumers are becoming more willing and able to purchase casual menswear. In addition, we believe that the purchasing decision of PRC consumers is becoming more predicated upon brand image, product design and style, rather than just price considerations. With rising affluence and improvement in lifestyle, we also believe the overall Chinese population is generally growing more brand name conscious and style oriented and has shown a propensity for increased spending on casual menswear.

 

We have a strong focus on design and product development. We believe that our in-house design and product development capabilities allow us to create unique products that appeal to our customers. We have established a strong in-house design and product development team of 14 employees as of May 15, 2016. Our team identifies new fashion trends by attending fashion shows and exhibitions as well as by drawing from creative ideas in magazines and other media. Each spring and fall, we carefully plan and create a new product line for our fall/winter and spring/summer collections of 661 SKU that encompasses our full range of product offerings, including outerwear, tops, bottoms and accessories. We introduce new design elements into our product lines each season. With our highly skilled and creative team of designers, we have extensive experience in creating unique designs to meet the preferences and needs of our target customer base.

 

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

 

We have an extensive and well-managed nationwide distribution network. We have an extensive distribution network throughout China. As of December 31, 2016, we had 1 KBS branded corporate stores and 55 franchised stores across 12 of China’s 32 provinces and centrally administered municipalities. The KBS branded corporate stores are required to sell only our products. We have been building up our selected distributor network since 2007. As of December 31, 2016, we had 29 distributors operating 55 franchised stores. All of our distributors have been working with us from 1 to 9 years. We select our distributors based on a number of criteria, including experience in the menswear retail industry, sales channels, business resources, brand promotion capabilities and ability to help us implement our broader business strategies. Our distributors help us respond to changing consumer tastes in a timely manner by providing regular feedback on our products at our semi-annual sales fairs and frequent communications. The financial resources of our distributors allow us to expand our retail network with less working capital investment from us than would be required for establishing direct stores, as our distributors are responsible for the store rentals and cost of inventory in their stores. We sold a substantial amount of our products through our distributors, which have allowed us to distribute our products to a wide geographic area and penetrate markets by leveraging the local market knowledge of our distributors and their sub- distributors. We believe that our distribution network has enabled us to expand our business and increase our sales efficiently and with less operational risk. This model has also minimized our operational risk because we typically start production after we receive orders from our distributors. We believe that using a distribution network to sell a substantial amount of our KBS products has enabled us to devote our resources to our core competitive strengths of design, brand management and product development.

 

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We have an experienced management team. Our management team has extensive R&D, marketing and financial experience, led by our Chief Executive Officer, Mr. Keyan Yan. Mr. Yan has over 25 years of experience in the apparel industry and also has developed a differentiated product by international cooperation with a Korean designer. After working in the garment industry for more than 16 years, Mr. Yan acquired and developed the KBS brand. With his strong understanding of the apparel industry, Mr. Yan has successfully established this brand name in the market. We are committed to attract and retain top management level executives who we believe are and will continue to be the driving force behind our product development and growth.

 

Our Growth Strategy

 

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

 

  We plan to generate more wholesale sales to wholesalers who will in turn sell our products to online stores and multi-branded stores. We intend to continue to strengthen and expand our brand awareness by advertisement and developing wholesale sales to wholesalers who will in turn sell our products through online stores and multi-branded stores, such as webchat stores, which are increasingly popular in China. We plan to focus on helping our customers build our network across China through social media, which we believe can further promote awareness of our brand, showcase our complete product collections, stimulate sales in corporate stores in nearby regions and improve our overall business performance. By the end of 2016, we generated around 10.8% of total sales to wholesalers who sell our products to online stores and multi-branded stores.

 

  We plan to design our products through different channels. Starting from year 2015, the design of our products has been conducted through three channels. In addition to our in-house design team, we also outsource the design of our products to reputable third-party designers. Thirdly our ODM manufacture providers also directly sell their products to us. Through these channels, we are able to choose the designs that best match the KBS style. In 2017, we had recruited 4 highly qualified design staff and will continue to hire more design personnel in the future.
    
  We plan to continue to raise the profile of the KBS brand through enhanced advertising and promotional activities. We believe that the strong association of KBS brand with our concept of “French origin, Korean design and made for Chinese” has helped drive our brand positioning and customers’ receptivity to our products. We intend to further build our brand and deliver a consistent brand image from product design to sales and marketing. We seek to promote and enhance our presence in China’s casual menswear market by continuing to adopt proactive marketing strategies and produce high quality, well- designed casual menswear for our target market. In particular, we aim to increase awareness of our brand through: (1) multi-channel advertising strategies through national television, fashion magazines, billboards and other media channels; (2) further assisting our distributors’ regional advertising efforts; (3) distinctive store and product launch campaigns, including special events for new product launches and large-scale grand opening events for new stores, particularly new corporate stores; (4) update of the decoration and layout of a number of existing stores which have been in operation for years to improve the shopping experience; (5) participation in fashion shows; and (6) sponsorships of selected high-impact events. We believe that these advertising and promotional activities will help to further strengthen brand awareness in our target market and enhance customer loyalty.

 

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  We plan to expand and build upon our design and product development capabilities. We intend to further strengthen our design and product development capabilities by accelerating the commercialization of design concepts, expanding our product offerings and continuing to develop what we believe is unique casual menswear. We plan to further invest in design and product development and expand our design and product development team by attracting talented designers, either domestic or international, and training young graduates from leading fashion design institutes. We believe that combining western fashion design experience with our local designer’s understanding of the China market and aesthetic will enable us to create fashionable yet popular casual menswear for consumers in China. We also intend to cooperate with our suppliers to develop new materials and fabrics which we believe will give customers a unique fashion product and create new market opportunities. We believe that our focus on designing unique and quality casual menswear will allow us to maintain our competitiveness and help to enhance our sales and overall profitability.
    
  We plan to expand our production capacity to expand and diversify our product offerings. Our production facility is located in Taihu City, Anhui Province, China, consisting of total 110,557 square meters of land. Currently this facility has a production capacity of 2 million pieces of clothes per year and can accommodate 5,000 workers. This production facility mainly produces OEM products for famous sportswear producers and fulfill some overseas orders. The construction of our facility commenced in 2011 and takes place in four phases: Phase 1 consists of a 5-story dormitory; Phase 2 is to add facilities with annual production capacity of five million pieces of clothes. We have completed the construction of property by the end of 2014. Although we have the designed capacity of 5 million pieces yearly, the facility currently may only produce 2 million pieces per year. Phase 3 construction has been delayed because the local government needs additional time to conclude negotiations with local residents over appropriate resettlement terms. Once the government settles with the local residents, the phase 3 and 4 can be continued. Phase 4 will include production facilities with annual production capacity of 10 million pieces, an office building, staff quarters and living facilities. Upon completion, the new facility is expected to have a production capacity of 20 million pieces and accommodate 5,000 workers. Please see “—Production” below for a more complete explanation of our plans for the expansion of our production capacity. We anticipate that the new production facility will allow us to further refine our existing product lines by offering more styles within our existing apparel and accessories categories and to introduce additional, complementary apparel and accessories categories into our product line. We currently introduce 500 to 900 different styles of products each year and intend to increase the number of our product offerings in the future.
    
  We plan to expand our international market and attract more orders from overseas. Starting from year 2016, we have been awarded international OEM orders for producing clothes with overseas brands. Such orders are usually large and continuous. Due to the completion of phase 2 construction of our Anhui factory, we have enough production capacity to take on large orders. The current utilization rate of the Anhui factory is still quite low and we expect to invest more in attracting more large orders from overseas.
    
  We plan to expand our OEM sales by attracting more strength and strong clients. We are expanding our OEM business and we have one or two potential clients which are one of Chinese biggest and famous online sellers, they expand their market these years quickly with the change of Chinese consumer’s change and occupied large market share. By the order start, we can have continues and increasing business.

 

The KBS Brand

 

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

 

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

 

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

 

Our Products

 

Our apparel products include cotton and down jackets, sweaters, shirts, T-shirts, jeans and trousers. Accessories include shoes, bags, socks and caps. In 2016, the suggested retail prices of our products ranged from RMB 199 to RMB 1499 (approximately $29.9 to $225) for our apparel products and RMB 15 to RMB 899 (approximately $2 to $135) for our accessory products. Since 2006, we have launched 2536 collections of new products, each year with a different theme to highlight the current trends in menswear for the season.

 

Our Design

 

We believe one of our key strengths is our internal design and product development team, which designs products that reinforce our brand image. Major parts of our products are designed by our internal design and product development team with the collaboration of Korean designers. As of December 31, 2016, our design and product development team comprised 14 members, including one senior designer with over five years of working experience. Final design concepts are approved by Mr. Keyan Yan, who has more than 25 years of experience in the industry. All of the other designers are graduates of professional design schools in China. We believe that our design and product development team is innovative and passionate and that the individual experience of each of our designers helps bring new and exciting products to our customers. Our design and product development team conceptualizes each season’s collections through an interactive process, taking into account our brand strategy, product image and market feedback, drawing inspirations from domestic and international fashion trends and collaborating with both our suppliers and distributors to fine-tune our designs. In particular, we collaborate with our suppliers to develop a variety of materials and fabrics for our products. We also involve distributors in our product selection process to take advantage of their market intelligence, which helps us to adapt to constantly changing customer preferences in local markets. Our designers also attend various domestic and international fashion shows to keep abreast of the latest fashion trends.

 

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

 

In a typical year, we design and make around 1000 prototypes. After the initial product selection, internal cost analysis of approved prototypes and final selection by distributors at the sales fairs, we eventually select approximately 700 designs for mass production. Final design of all of our products will be approved by our Chairman, Mr. Yan.

 

Our Distribution Network

 

We have established a nationwide distribution network consisting of corporate stores and franchised stores covering 12 of China’s 32 provinces and centrally administered municipalities.

 

Corporate Stores

 

As of December 31, 2016, we owned and operated 1 corporate store with the floor area of approximately 120 square meters. The number of corporate stores grew significantly from 1 as of December 31, 2006, with the aggregate floor area increasing from approximately 60 square meters as of December 31, 2006 to 18 stores with the aggregate floor area of approximately 1,974 square meters as of December 31, 2014. As part of our corporate strategy, we closed 17 corporate stores in 2015 and 2016 because of the low profitability of certain corporate stores. In the years ended December 31, 2016, 2015 and 2014, sales through our corporate stores accounted for 13%, 29.5% and 27.4% of our total revenues, respectively.

 

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

 

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

 

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

 

Franchised Stores

 

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

 

We have been building up our selected franchised distributor network since 2007. As of December 31, 2016, we had 29 franchised distributors who operated 55 retail stores directly or through their sub-distributors, all of which were stand-alone stores, which were typically located in commercial centers, including department stores or shopping malls, in their cities. All these distributors have worked with us for about 1 to 8 years. We have not encountered any material dispute or financial difficulty with our key distributors. The average floor area of each retail store was approximately 75 square meters as of December 2016. The number of retail stores has grown significantly in recent years from 7 as of December 31, 2006, with the aggregate floor area increasing from 560 square meters as of December 31, 2006 to 4,125 square meters as of December 31, 2016. In the years ended December 31, 2016, 2015 and 2014, sales through our distributors accounted for 78%, 66.5% and 69.1% of our revenues, respectively.

 

During the fiscal year ended December 31, 2014, we had one customer exceeding 10% of our net sales, which accounted for 16.4% of our revenues. During the fiscal year ended December 31, 2015, we had one customer exceeding 10% of our net sales, which accounted for 10.8% of our revenues. During the fiscal year ended December 31, 2016, we had not customer exceeding 10% of our net sales.

 

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Sales generated by our five best-performing franchised distributors accounted for approximately 28.3%,27.10% and 43.93%of our revenues in the years ended December 31, 2016, 2015 and 2014, respectively. Those top distributors have been with us since 2007 or 2008 and have grown organically with us. At the same time, we are exploring more distributors in other regions including relatively small distributors to grow with their businesses. Although we rely on distributors for the sales and marketing of our products, we believe our business is not substantially dependent on any individual distributor.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

The following table lists by region the number of retail stores operated by distributors and sub-distributors as of December 31, 2016:

 

Location  As of December 31,
2016
 
Fujian   11 
Guangdong   2 
Guangxi   8 
Jiangsu   4 
Anhui   1 
Zhejiang   2 
Chongqing   6 
Inner Mongolia   1 
Tianjin   3 
Hebei   5 
Heilongjiang   5 
Sichuan   7 
Total   55 

 

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Pricing Policy

 

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

 

Production

 

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

 

Since 2011, we have been negotiating with the local government to acquire land use rights for our current facility consisting of 110,557 square meters. We obtained a portion of such land use rights for two parcels of land of 7,405 square meters and 2,440 square meters in March 2012 and May 2012, respectively, and have finished the construction of 8,572 square meters of staff dormitories and 22,292 square meters as workshop buildings and offices. We started to use the dormitory and factory in year 2015 and moved into the offices at the beginning of 2016. Due to the local government’s need for additional time to conclude negotiations with local residents over appropriate resettlement terms, the construction of the adjacent facility on the third parcel of land has been delayed. We believe we will be in a better position to schedule our construction plan once we acquire the land use right of the third parcel of land, but we currently expect the construction of the new production facilities to be completed by 2018. Once completed, our total production capacity of the facility is expected to increase to 20 million pieces per year from the current capacity of 2 million pieces per year.

 

All of the products produced by our ODM and OEM contract manufacturers bear the brand name KBS. As of December 31, 2016, we had 3 ODM contract manufacturers and 6 OEM contract manufacturers. In the years ended December 31, 2015 and 2014, we had 8 and 6 OEM contract manufacturers, respectively. Our sourcing strategy is based upon the quality of fabrics and workmanship that our customers expect from the KBS brand. The costs of our outsourced production amounted to approximately $26.1 million, $27.9 million and $23.2 million for years ended December 31, 2016, 2015 and 2014,respectively, accounting for approximately 66.8%, 92.0% and 96.6of our total cost of sales in the respective periods.

 

As of December 31 2016, our principal ODM and OEM contract suppliers included the following:

 

No.  
   
1 Shishi Bieqi Apparel Co., Ltd.
2 Shishi Kai Xi Ya Apparel Co., Ltd.
3 Shishi Hua Lai Shi Clothing Co. Ltd
4 Shishi Rongpeng Clothing Co.Ltd
5 Bai Tian Ni(Fujian) Clothing fabric Co. Ltd
6 Jingjiang City Hongtai Waisheng business and trading Co. Ltd

 

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

 

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Inventory Management

 

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

 

Quality Control

 

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

 

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

 

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

 

Marketing and Advertising

 

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

 

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

 

In the years ended December 31, 2016, 2015 and 2014 our total advertising and promotional expenses amounted to approximately $1.55 million, $1.70 million and $1.63 million, respectively, which accounted for approximately 3.8%, 2.8% and 2.8% of our revenues in the respective periods.

 

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Competition

 

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

 

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

 

Intellectual Property

 

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

 

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

 

Trademark  Registration No.   Valid Term
KBS   4342760   January 1, 2014 - December 31, 2018
         
Ka bi sports   5462336   March 14, 2010 - March 12, 2020

 

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

 

Insurance

 

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

 

Regulation

 

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

 

Foreign Invested Entity and Foreign Investment in Commerce Sectors

 

The establishment, alteration, registered capital requirement, corporate governance, and similar matters, of Hongri PRC will be governed by the Wholly Foreign Owned Enterprise Law of the PRC, which was promulgated on April 12, 1986 and amended on October 31, 2000, and its Implementation Rules which were promulgated on December 1990 and amended on April 12, 2001 and February 19, 2014.

 

In addition, on April 16, 2004, MOFCOM issued the FICE Regulation to open up the commerce sector to foreign investment, and also to provide for various market entry restrictions against foreign investment in companies engaged in the wholesale, retail, commissioned sale and/or franchise business, or FICEs. FICEs are required to obtain special approvals from the national or provincial-level MOFCOM offices to conduct the foregoing commerce business.

 

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Product Quality

 

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

 

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

 

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

 

Consumer Protection

 

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

 

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

 

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

 

Trademarks

 

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

 

Dividend Distributions

 

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

 

We are currently subject to PRC corporate income and other taxes at the level of our PRC operating subsidiaries, to a 5% dividend withholding tax on profits distributed from our PRC operating subsidiaries to their HK holding company, and, if the Company is subject to US taxation, to US taxes on amounts received in distribution from its subsidiary(ies). There is no income tax in Hong Kong, the BVI or the Marshall Islands on amounts distributed up through the entities from the PRC, or any dividend withholding tax in HK, the BVI or the Marshall Islands. The combined entities' obligation to pay dividends to the shareholders of the Company is calculated on an after-tax basis, and therefore is net of the taxes.

 

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Environmental Matters

 

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

 

We did not incur material costs in environmental compliance in fiscal years 2015, 2014 and 2013. We believe we are in material compliance with the relevant PRC environmental laws and regulations. We are not currently subject to any pending actions alleging any violations of applicable PRC environmental laws.

 

Circular 37

 

On July 14, 2014, SAFE issued the Circular on Relevant Issues Relating to Domestic Residents’ Investment and Financing and Roundtrip Investment through Special Purpose Vehicles (“Circular 37”), which replaced the Circular 75. Circular 37 requires PRC residents to register with local branches of SAFE in connection with their direct establishment or indirect control of an offshore entity, for the purpose of overseas investment and financing, with such PRC residents’ legally owned assets or equity interests in domestic enterprises or offshore assets or interests, referred to in Circular 37 as a “special purpose vehicle.” Circular 37 further requires amendment to the registration in the event of any significant changes with respect to the special purpose vehicle, such as increase or decrease of capital contributed by PRC individuals, share transfer or exchange, merger, division or other material event. In the event that a PRC shareholder holding interests in a special purpose vehicle fails to fulfill the required SAFE registration, the PRC subsidiaries of that special purpose vehicle may be prohibited from making profit distributions to the offshore parent and from carrying out subsequent cross-border foreign exchange activities, and the special purpose vehicle may be restricted in its ability to contribute additional capital into its PRC subsidiary. Furthermore, failure to comply with the various SAFE registration requirements described above could result in liability under PRC law for evasion of foreign exchange controls.

 

As we stated under “Risk factors—Risks Related to Doing Business in China— Failure to comply with PRC regulations relating to the investment in offshore special purpose companies by PRC residents may subject our PRC resident stockholders to personal liability, limit our ability to acquire PRC companies or to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute profits to us or otherwise materially adversely affect us,” we have notified substantial beneficial owners of our company who we know are PRC residents to comply with the registration obligation. However, we may not be aware of the identities of all our beneficial owners who are PRC residents. In addition, we do not have control over our beneficial owners and cannot assure you that all of our PRC resident beneficial owners will comply with Circular 37. The failure of our beneficial owners who are PRC residents to register or amend their SAFE registrations in a timely manner pursuant to Circular 37 or the failure of future beneficial owners of our company who are PRC residents to comply with the registration procedures set forth in Circular 37 may subject such beneficial owners or our PRC subsidiaries to fines and legal sanctions. Failure to register or amend the registration may also limit our ability to contribute additional capital to our PRC subsidiaries or receive dividends or other distributions from our PRC subsidiaries or other proceeds from disposal of our PRC subsidiaries, or we may be penalized by SAFE.

 

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Employee Stock Option Plans or Incentive Plans

 

In December 2006, the People’s Bank of China promulgated the Administrative Measures on Individual Foreign Exchange, or the Individual Foreign Exchange Regulations, setting forth the requirements for foreign exchange transactions by individuals (both PRC or non-PRC citizens) under the current account and the capital account. Pursuant to Circular 37, PRC residents who participate in share incentive plans in overseas non-publicly-listed companies may submit applications to SAFE or its local branches for the foreign exchange registration with respect to offshore special purpose companies. In addition, under the Notices on Issues concerning the Foreign Exchange Administration for Domestic Individuals Participating in Share Incentive Plans of Overseas Publicly-Listed Companies, or the Share Option Rules, issued by SAFE on February 15, 2012, PRC residents who are granted shares or share options by companies listed on overseas stock exchanges under share incentive plans are required to (i) register with SAFE or its local branches, (ii) retain a qualified PRC agent, which may be a PRC subsidiary of the overseas listed company or another qualified institution selected by the PRC subsidiary, to conduct the SAFE registration and other procedures with respect to the share incentive plans on behalf of the participants, and (iii) retain an overseas institution to handle matters in connection with their exercise of share options, purchase and sale of shares or interests and funds transfers. We have not granted any incentive shares or share options to our PRC citizen employees; however, if we do so in the future, our PRC citizen employees who are granted restricted shares or share options will be subject to these rules.

 

M&A Rule

 

On August 8, 2006, six PRC regulatory agencies promulgated the Foreign M&A Rule, which was later amended in June 2009.

 

The Foreign M&A Rule, among other things, govern the approval process by which a PRC company may participate in an acquisition of assets or equity interests by foreign investors. The Foreign M&A Rule allow PRC government agencies to assess the economic terms of a business combination transaction. Parties to a business combination transaction may have to submit to MOFCOM and other relevant government agencies an appraisal report, an evaluation report and the acquisition agreement, all of which form part of the application for approval, depending on the structure of the transaction. The Foreign M&A Rule also prohibit a transaction at an acquisition price obviously lower than the appraised value of the PRC business or assets and in certain transaction structures, requires that consideration must be paid within defined periods, generally not in excess of a year. The Foreign M&A Rule also limit our ability to negotiate various terms of the acquisition, including aspects of the initial consideration, contingent consideration, holdback provisions, indemnification provisions and provisions relating to the assumption and allocation of assets and liabilities. Transaction structures involving trusts, nominees and similar entities are prohibited.

 

In addition, the Foreign M&A Rule regulates “Round-trip Investments.” For further information, please see the discussion under “Risk Factors – Risks Related to Doing Business in China – our business and financial performance may be materially adversely affected if the PRC regulatory authorities determine that our acquisition of Hongri PRC constitutes a Round-trip Investment without MOFCOM approval.”

 

C.Organizational Structure

 

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

 

D.Property, Plants and Equipment

 

Our company has established a nationwide distribution network covering 12 of China’s 32 provinces and centrally administered municipalities. As of December 31, 2016, this network was comprised of 1 corporate stores owned and operated by us and 55 franchised stores operated by 29 third-party distributors or their sub-distributors.

 

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

 

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

 

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

 

In addition, the property used as our head office and corporate stores is leased from a related party, whose ownership of the property has been verified by our company. We paid a total of RMB 3,106,000, RMB 3,010,667 and RMB 720,000, as rental fees for the existing corporate stores during the fiscal years 2014, 2015 and 2016, respectively. The total area of these 18 corporate stores is 1972 square meters. The sales of each store and its location are shown below:

 

Area  Sales in
fiscal year
2014(USD)
   Sales in
fiscal year
2015(USD)
   Sales in
fiscal year
2016(USD)
 
Shop at Shishi factory   1,135,762    1,527,019    1,240,354.74 
Jinjiang Hankou   476,530    751,067      
Shishizhixiang   596,478    759,464      
ShishiYongning   395,305    635,127      
ShishiJinshang   274,625    288,100      
JinjiangLonghu   548,685    513,974      
Nanan   567,466    165,351      
Wukeng   510,592    201,032      
Yinglin   599,027    253,078      
Gouxi   605,038    322,989      
Xiamen Wanda shop   463,275    714,777      
XingjiangDongshi   580,668    568,377      
Zhangzhou Wanda   582,088    451,091      
Fuzhou Shimao   937,192    139,948      
Putian Wanda Shop   1,017,318    479,082      
Quanzhou Dayang   332,780    558,718    470,280.90 
Quanzhou Wanda   505,756    244,218      
Ningde Wanda   393,554    262,319      
Total:   10,522,137    8,835,732    1,710,635.64 

 

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ITEM 4A. UNRESOLVED STAFF COMMENTS

 

Not required.

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

We are engaged in the design, development, marketing and sale of casual menswear in China, including apparel and accessories, which we market under the KBS brand. The KBS brand was developed in 2006. Before 2012, we were engaged in the design, development, marketing and sale of fashion sportswear in China. Since our products feature a unique and stylish design that is more fashionable than traditional sportswear, as well as quality fabrics and materials and the sportswear market was becoming more and more competitive, in late 2011 we turned our focus on casual menswear market which has higher profit margin. KBS’s apparel products include cotton and down jackets, sweaters, shirts, T-shirts, Jeans and trousers. Accessories include shoes, bags, belts and caps. In 2016, the suggested retail prices of KBS’s products ranged from RMB 199 to RMB 1,499 for its apparel products and RMB 15 to RMB 899 for its accessory products. KBS holds new products launch events twice every year, one in spring and the other in autumn. Since 2006, we have launched 2536 collections of new products each year with a different theme to highlight the current trends for the season. KBS’s marketing concept is “French origin, Korean design and made for Chinese.” KBS’s customers are male middle-class consumers in the 20-40 age range, primarily located in tier two and tier three cities in China. The company has adopted “KBS” as a uniform brand name, which stands for “Keep Best Style”, and KBS are designed by us for a uniform look and feel that fits our brand image, with in-store displays that accentuate the quality and style of our products across all stores in our distribution network and on all products sold in those stores. We believe that the KBS brand has become a recognized brand name in the cities where their products are sold.

 

We have established a nationwide distribution network covering 16 of China’s 32 provinces and centrally administered municipalities. As of December 31, 2016, this network was comprised of 1 corporate stores owned and operated by us and 55 franchised stores operated by 29 third-party distributors or their sub-distributors. The number of stores grew significantly from 1 corporate store and 7 franchised stores as of December 31, 2006 to 31 corporate stores as of December 31, 2012 and 96 franchised stores as of December 31, 2013, and decreased to 84 stores as of December 31, 2014. Because of the recent softening of economic growing in China and fierce competition from our competitors, online stores sales from franchised stores and corporate stores went down in 2015 as compared with the previous year. In 2015 and 2016, the distributors closed 15 and 14 franchised stores and we closed 15 and 1 corporate stores in year 2015 and 2016. We intend to generate more revenues from OEM and online sales directly to customers in 2017.

 

KBS also acts as an original design manufacturer, or OEM, upon request. Income from such services accounted for 9%, 4.0% and 3.47%of revenue for the years ended December 31, 2016, 2015 and 2014, respectively.

 

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

 

A.Principal Factors Affecting Financial Performance

 

KBS’s operating results are primarily affected by the following factors:

 

  Growth of China’s menswear industry. With approximately one-fifth of the world’s population and a fast-growing gross domestic product, China represents a significant growth opportunity for a wide variety of retail goods, including apparel. The enhanced living standards and increased disposable income that has resulted from the vibrant economic growth has driven the rapid development of the men’s apparel market in China in recent years. China is currently one of the world’s largest men’s apparel markets and it is larger than the U.S. market based on retail sales of men’s apparel products in 2011. As a leading provider of casual menswear in China, KBS believes they are well positioned to capitalize on the favorable economic, demographic and industry trends in this sector.
     
  Brand recognition. KBS derives all of KBS’s revenues from sales of the KBS branded products in China, and KBS’s success depends on the market perception and acceptance of the KBS brand and the culture, lifestyle and images associated with this brand. Market acceptance of KBS’s brand may affect the selling prices and market demand for KBS’s products, the profit margin of KBS can achieve, and KBS’s ability to grow.
     
  Ratio of franchised stores to corporate stores in KBS’s sales network. The ratio of franchised stores to corporate stores in terms of floor area in KBS’s sales network affects KBS’s results of operations in a given period. The franchised stores operated by KBS’s distributors have been and will continue to be the main contributor to KBS’s revenue for the foreseeable future. Under the distribution business model, KBS sells directly to KBS’s distributors and recognize revenues upon delivery of KBS’s products to them. Such distribution network has enabled KBS to accelerate sales growth at a much lower cost than opening direct stores and has limited KBS’s inventory and sales risks. Corporate stores operated by us, despite incurring more significant capital expenditures as compared with franchised stores, allow KBS more control over our brand and the consumer’s shopping experience, which are important factors for the overall success of KBS’s business. In addition, KBS’s corporate store sales generally have a higher gross profit margin than sales to distributors because KBS is able to sell the products at retail prices directly to the end-consumers and because KBS recognizes expenses relating to KBS’s corporate stores as selling and distribution expenses. Therefore, the ratio of franchised stores to corporate stores in KBS’s sales network will affect KBS’s gross profit margin.

 

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  Product offering and pricing. KBS’s success depends on KBS’s ability to identify, originate and define menswear trends as well as to anticipate, gauge and react to changing consumer demands for menswear in a timely manner. Most of KBS’s products are subject to changing consumer preferences and fashion trends that cannot be predicted with certainty. KBS’s new products may not receive consumer acceptance as consumer preferences could shift rapidly, and KBS’s future success depends in part on KBS’s ability to anticipate and respond to these changes.
     
  Fluctuations in raw material supply and prices. The per unit cost of producing KBS’s products depends on the supply and price of raw materials, particularly fabrics such as cotton, wool and polyester, which have experienced volatility in past years. Increases in the price of raw materials would negatively impact KBS’s gross margins if KBS is not able to offset such price increases through increases in KBS’s selling price or changes in product offerings and mix.

 

KBS believes that the global economic crisis and macroeconomic trends could continue to put significant pressure on consumer spending in most markets worldwide, so KBS’s future performance remains subject to the inherent uncertainty presented by volatile macroeconomic conditions. These conditions could continue to affect Target’s business in a number of direct and indirect ways, including lower revenues from decreased product demand, compressed margins and/or increased costs, lack of credit availability and business disruptions due to difficulties experienced by suppliers and customers. KBS strives to position ourselves, from both a financial and an operational perspective, as a company that can react quickly and adapt effectively to evolving macroeconomic conditions, fluctuations in product demand and changes in liquidity and capital demands.

 

Financial Statement Presentation

 

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

 

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

 

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

 

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

 

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

 

Comparison of Fiscal Years Ended December 31,2016, 2015 and 2014 (on a pro forma basis)

 

The following table sets forth key components of our results of operations, for the years ended December 31, 2016, 2015 and 2014, both in U.S. dollars and as a percentage of our revenue. The financial numbers of year 2014 are on a pro forma basis as if the Share Exchange occurred at the beginning of year 2014.

 

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   Year ended
December 31, 2016
   Year ended
December 31, 2015
   Year ended
December 31, 2014
 
   Amount($)   % of Sales   Amount($)   % of Sales   Amount($)   % of Sales 
Revenue   41,200,205         61,343,681         58,832,481      
Cost of sales   -39,041,932    -95%   -46,511,274    -76%   -39,416,973    -64%
Gross profit   2,158,273    5%   14,832,407    24%   19,415,508    32%
Operating expenses                              
Distribution and selling expenses   -3,606,010    -9%   -6,621,256    -11%   -7,191,606    -12%
Administrative expenses   -3,543,993    -9%   -2,798,082    -5%   -4,649,229    -8%
Total operating expenses   -7,150,003    -17%   -9,419,338    -15%   -11,840,835    -19%
Other income   555,051    1%   302,144    0%   252,748    0%
Other gains and losses   -11,123,767    -27%   -3,877,832    -6%   -2,036,508    -3%
Profit from operations   -15,560,446    -38%   1,837,381    3%   5,790,913    9%
Finance costs   -71,783    0%   0    0%   -23,630    0%
Change in fair value of warrant liabilities   3,409    0%   11,978    0%   3,417,053    6%
Profit before tax   -15,628,820    -38%   1,849,359    3%   9,184,336    15%
Income tax   3,726,133    9%   -605,689    -1%   -2,307,354    -4%
Profit for the year   -11,902,687    -29%   1,243,670    2%   6,876,982    11%

 

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

 

By business  Distribution network   Corporate stores   OEM   Consolidated 
   Year ended December 31,
2016
   Year ended December 31,
2015
   Year ended December 31,
2014
   Year ended December 31,
2016
   Year ended December 31,
2015
   Year ended December 31,
2014
   Year ended December 31,
2016
   Year ended December 31,
2015
   Year ended December 31,
2014
   Year ended December 31,
2016
   Year ended December 31,
2015
   Year ended December 31,
2014
 
Sales to external customers   32,127,083    40,815,528    40,654,657    5,529,985    18,091,585    16,134,537    3,543,137    2,436,568    2,043,287    41,200,205    61,343,681    58,832,481 
Segment revenue   32,127,083    40,815,528    40,654,657    5,529,985    18,091,585    16,134,537    3,543,137    2,436,568    2,043,287    41,200,205    61,343,681    58,832,481 
% of Sales   78%   67%   69%   13%   29%   27%   9%   4%   3%   100%   100%   100%
Segment gross margins   6,623,617    9,668,518    12,382,562    -5,727,349    4,239,168    6,327,728    1,262,005    924,722    705,218    2,158,273    14,832,407    19,415,508 
Gross margin rate   21%   24%   30%   -104%   23%   39%   36%   38%   35%   5%   24%   33%

 

Segment sales

 

For the year ended December 31, 2016, total revenue decreased by 33% from $61.3 million in 2015 to $ 41.3 million. Our total revenue of 2015 increased 4.3% from $58.8 million for the year ended December 31, 2014. The Company reports financial and operating results in three segments: distributor network, corporate stores and OEM.

 

Distributor Network —there was a decrease of revenue from the Company's distributor network in year 2016 by 21% from $40.1 million in year 2015 primarily due to a decrease in sales volume and average unit selling price. Revenue from the Company's distributor network in 2015 remained stable at approximately $40.8 million as compared with $40.6 million of 2014. The distributor segment accounted for 78% of the total revenue in 2016, compared to 67% and 69% during years 2015 and 2014, respectively. In Year 2016, gross profit margin for the Company's distributor network decreased to 21% from 24% for year 2015. The gross profit of year 2016 decreased due to the increasing cost on improving quality of clothes which sold to our distributors at same prices to help them improve their sales. Some distributors’ sales went down in year 2016 because they overbought stock at the end of year 2014 and 2015. As they did not sell the stock well in 2016 and were unable to repay all debts to us, we suspended sales of new products to them until they repaid the outstanding debts owed to the company. Gross profit margin for the Company's distributor network decreased to 24% in 2015 from 30%of year 2014. The gross profit decreased due to the reduction of unit price in year 2015. We had some new wholesale customers to whom we sold our products at lower selling prices in order to help our distributors and wholesalers improve their sales. Revenue from old distributors decreased in year 2015 which was offset by the increase in sales from the new wholesale distributors.

 

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The Company's distributor network currently consists of 29 distributors in 12 provinces. Most of these distributors, either directly or through their sub-distributors, operate KBS-branded stores. Some wholesale distributors sold the products to multi-branded stores and online stores. As of December 31, 2016, distributors operated a total of 55 KBS-branded stores, primarily in second and third tier cities. KBS products distributed to the fourth and fifth tier cities are primarily sold in multi-branded department stores.

 

Corporate Stores — Total revenue from corporate stores sales for fiscal year 2016 was $5.53 million, compared to $18.09 million year 2015. In 2016 sales from corporate stores decreased as compared to 2015 due to a decrease in sales volume and average unit selling price. The decrease in the sales volume was mainly attributable to decrease in the number of our corporate stores. Total revenue from corporate stores sales for fiscal year 2015 was $18.09 million, compared to $16.13 million year 2014. In 2015 sales from corporate stores increased as compared to 2014 because of the increased promotion sales to improve the brand recognition. As of December 31, 2016, the Company operated 1 corporate store which located in Fujian. Total revenue from both corporate stores sales and distribution sales of 2016 decreased as compared to 2015 because of the slowdown of China’s economic growth and a challenging retail environment.

 

The corporate stores segment contributed 13% of total revenue in 2016, compared to 29% of 2015 and 27% in year 2014. Gross profit margin for the Company's corporate stores was -104% in 2016, compared to 23% in 2015 and 39% in 2014. The margin compression from 2014 to 2016 is primarily due to (1) in 2015 we closed 16 and 1 corporate stores and sold their inventory at a lower price; (2) we reduced the sale price of our goods in corporate stores to stimulate sales;(3) the decrease was attributable to loss from sales of repurchased inventory from certain distributors which sold at big discounted price.

 

OEM — The OEM segment is comprised of products that are designed by the customers but manufactured by our Company. Revenue from the OEM segment increased by $1.1 million to $3.5 million for year ended December 31 2016, compared to $2.44 million for year ended December 31, 2015. Gross profit margin decreased to 36% from 38% of year 2015. Revenue from the OEM segment increased by $0.4 million to $2.44 million for year ended December 31 2015, compared to $2.04 million for the year ended December 31, 2014. Gross profit margin increased to 38% of 2015 from 35% of year 2014. Our revenues from sales of OEM represented 9%, 4% and 3%, respectively of our total revenues for years ended December 31, 2016, 2015 and 2014.

 

Cost of sales and gross profit rate

 

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

 

Our cost of sales decreased from $46 million in year 2015 to $39 million in year 2016. The decrease was consistent with the decrease in our revenue, which resulted in a decrease in purchases by $7 million. The decrease in purchases was mainly due to the slowdown of China’s economic growth and a challenging retail environment.

 

The gross profit rate decreased from 24% in year 2015 to 5% in year 2016 due to 1) a decrease in the number of our franchised stores from 69 as of December 31, 2015 to 55 as of December 31, 2016; 2) the slowdown of China’s economic growth;3) a slowdown in demand in menswear resulted from competition from online sales and other international brand, which led to an oversupply in recent years and our distributors faced difficulties in selling their products and paying back the balance owed to the company. We reacquired excess inventory of RMB 68.36 million from certain distributors and sold at its net realizable value, which caused a loss at RMB 43.05 million. Although we are not contractually obligated to buy back the excessive inventory from any our distributors, in order to keep long-term relationships with our distributors and support their continued operation, we decided to buy back some excessive inventory from certain distributors and we may implement similar plans in the following years.

 

Our Cost of sales was $46.5 million for the year of 2015, reflecting an increase of 18% from $39.4 million for 2014. Compared with 2014, the cost of sales of year 2015 increased by 18% from $39.4 million in the year 2014. Gross profit for year 2015 was $14.8 million, decreased by 18.7% as compared to $19.4 million for year 2014 and $42.1 million for year 2013. Due to the lower selling price to multi-branded stores and online stores and the decreased unit price to improve sales in year 2015 and 2014, the gross profit rate decreased from 42% in year 2014 to 24% in year 2015. The company also launched a promotional event to sell at lower prices to attract more customers in year 2015. We sold more products at the promotional event than 2014 because we sold stock of the 16 corporate stores closed in 2015.

 

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Administrative expenses

 

Administrative expenses increased by $0.88 million or 33% to $3.54 million for year 2016 from $2.67 million for 2015. The increase was mainly due to the new depreciation expense of Anhui office building which started operations in 2016. In addition, the increase attributed to the company’s share-based compensation plan on members of company broad, non-recurring legal and professional fees on stock reverse split issue, and allowance on bad debts based on estimated amount.

 

Administrative expenses decreased by $2.03 million, or 43% to $2.67 million for 2015, from $4.70 million for 2014. The decrease was mainly due to the decrease of staff salary and rental payment of closed corporate stores.

 

Distribution and selling expenses

 

The selling and distribution expenses decreased by $3 million or 46% to $3.6 million for the year ended December 31, 2016 from $6.6 million in 2015, primarily due to the reduction of staff salary, rental payments and renovation costs as a result of the close of corporate stores. The decrease also attributed to the reduction of promotion related expenses including shopping mall rental expenses and staff bonus.

 

Selling and distribution expenses decreased by $0.57 million or 8%, to $6.6 million for the year ended December 31, 2015 from $7.19 million for 2014. Such decrease was mainly due to the reduction of staff salary and rental payment as a result of the close of 16 corporate stores.

 

The advertisement expenses of 2016, 2015 and 2014 are relatively even and selling expenses accounted for 9%, 11% and 12% for 2016, 2015 and 2014, respectively.

 

Other gains and losses

 

Other gains and losses decreased by $7.2 million, or 187%, to -$11.1 million for the year ended December 31, 2016 from -$3.9 million for year 2015. The decrease was mainly due to the impairment on prepayment of land purchase in Anhui, prepayment of construction on such land and additional provision on bad debts from three clients.

 

Other gains and losses decreased by $1.84 million, or 90%, to -$3.88 million for the year ended December 31, 2015 from -$2.04 million for year 2014. The decrease was mainly due to the impairment on prepayment of land use right in Anhui, prepayment of construction on such land and additional provision on bad debts from three clients.

 

Change in fair value of warrant liabilities

 

We currently have 394,534 warrants outstanding. The fair value of outstanding warrants decreased to zero as of December 31, 2016 from $3,409 as of December 31, 2015 and $15,369 as of December 31, 2014. Change in fair value of warrant liability decreased to $3,409 for the year ended December 31, 2016, from $11,920 and $3.4 million for years ended December 31, 2015 and 2014, respectively.

 

Profit for the year

 

Profit for the year was -$ 11.9 million in 2016 as compared to $1.38 million for 2015, representing a decrease of $13.3 million or -960%. Net margin was -29% for the year ended December 31, 2016, compared to 2% for the year ended December 31, 2015.

 

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Profit for the year decreased from 2015 to 2016 mainly due to the following reasons: (1) the full impairment of prepayment on the land use right of the third parcel of land of our Taihu facility and prepayment to the construction on such land; (2) the administrative expenses increased to a large portion of total revenue; and (3) a slowdown in demand in menswear resulted from competition from online sales and other international brand, which led to an oversupply in recent years and our distributors faced difficulties in selling their products and paying back the balance owed to the company. We reacquired an excess inventory of RMB 68.36 million from certain distributors and sold at its net realizable value, which caused a loss at RMB 43.05 million.

 

Profit for the year was $1.38 million in 2015 as compared to $6.88 million for 2014, representing a decrease of $5.5 million or 79%. Net margin was 2% for the year ended December 31, 2015, compared to 12% for the year ended December 31, 2014.

 

Profit for the year decreased from 2014 to 2015 mainly due to the following reasons: (1) the part impairment of prepayment on the land use right of the third parcel of land of our Taihu facility and prepayment to the construction on such land; (2) the decrease of unit selling price, resulting the reduction of gross profit; and (3) the profit margin from sales to multi-branded stores and online stores is usually lower than other channels of sales.

 

B.Liquidity and Capital Resources

 

As of December 31, 2016, we had cash and cash equivalents of approximately $24.58 million. Our cash and cash equivalents consist of cash on hand and cash in the banks, We believe that our current levels of cash and cash equivalent and cash flows from operations will be sufficient to meet our anticipated cash needs for at least the next 12 months. To date, we have financed our operations primarily through net cash flow from operations. Our cash flows are driven by key performance indicators including the number of orders placed by distributors, number of outlets that each distributor operates the pricing of our products, sales of our corporate stores, and the collect portion of account receivable. Currently there is only minimal cash held by offshore subsidiaries and there is no need for these subsidiaries to transfer cash to Hongri PRC.

 

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

 

   Cash Flow 
   (all amounts in U.S. dollars) 
   Fiscal Year Ended 
   31-Dec 
   2016   2015   2014 
Net cash provided (used in) by operating activities  $3,194,289   $2,234,633   $-3,558,374 
Net cash provided by (used in) investing activities   45,445    -927,876    -17,538,013 
Net cash provided by (used in) financing activities   1,679,509    330,099    -1,769,996 
Net increase (decrease) in cash and cash equivalents   4,919,243    1,636,856    -22,866,383 
Effects of exchange rate change in cash   -1,556,980    -1,027,358    -229,122 
Cash and cash equivalents at beginning of the period   21,214,080    20,604,582    43,700,087 
Cash and cash equivalent at end of the period  $24,576,341   $21,214,080   $20,604,582 

 

Operating Activities

 

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

 

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Net cash provided by operating activities in fiscal year 2016 was $3.2 million, compared with $ 2.8 million in the year ended December 31, 2015; the change is mainly due to the increase in collection of account receivable.

 

Net cash provided by operating activities was $2.8 million in the year ended December 31, 2015, compared with $3.3 million used in operating activities in 2014. The change was mainly due to a prepayment on inventory more than $2 million at the year end of 2015.

 

Investing Activities

 

Net cash used in investing activities in fiscal year 2016 was -$45,445, compared with $0.9 million net cash used in investing activities in 2015. The net cash used in investing activities in 2016 was receipt of interest income.

 

Net cash used in investing activities in the year ended December 31, 2015 was $0.9 million, compared with $17 million net cash used in investing activities in 2014. The net cash used in investing activities in 2015 was mainly for the decoration of office in Taihu facilities in Anhui and purchase of some plants.

 

Financing Activities

 

Net cash used in financing activities in fiscal year 2016 was $1.68 million, compared with $0 net cash used in financing activities. It mainly consisted of new bank loans raised in an amount of $1.58 million.

 

Net cash used in financing activities in fiscal year 2015 was $0, because we did not have financing activities in year 2015 as compared to $1.99 million of net cash used in financing activities in 2014.

 

Loans, Other Commitments, Contingencies

 

As of December 31, 2016, we do have any bank loans with $1,513,623. We may, however, in the future, require additional cash resources due to changing business conditions, implementation of our strategy to expand our business or other investments or acquisitions we may decide to pursue. If our own financial resources are insufficient to satisfy the capital requirements, we may seek to sell additional equity or debt securities or obtain additional credit facilities. The sale of additional equity securities could result in dilution to our stockholders. The incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operating and financial covenants that would restrict our operations. Financing may not be available in amounts or on terms acceptable to us, if at all. Any failure by us to raise additional funds on terms favorable to us, or at all, could limit our ability to expand our business operations and could harm our overall business prospects.

 

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

 

Our industry is characterized by rapid technological change, evolving industry standards and changing customer demands. These conditions require continuous expenditures on product research and development to enhance existing products create new products and avoid product obsolescence. For the years ended December 31, 2016, 2015 and 2014, our researched and development expenses amounted to $0.67 million, $0.69 million and $0.57 million, respectively, accounting for approximately 1.6%,1.1% and 0.97%, of our total revenue, respectively. These expenses consist primarily of outsourced design service fee and salary expenses of research and design department.

 

D.Trend Information

 

Other than as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demands, commitments or events for the year ended December 31, 2016 that are reasonably likely to have a material adverse effect on our net revenues, income, profitability, liquidity or capital resources, or that would cause the disclosed financial information to be not necessarily indicative of future operating results or financial conditions.

 

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E.Off Balance Sheet Arrangements

 

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

 

F.Tabular Disclosure of Contractual Obligations

 

The table below shows our material contractual obligations as of December 31, 2016.

 

   Payments Due by Period 
   Less than       More than 
Contractual Obligations  1 year   2-5 years   5 years 
Construction Obligations  $63,406,426           
Operating Lease Obligations  $79,035    290,289    2,237,645 
Purchase of finished goods and material               
Total  $63,485,461    290,289    2,237,645 

 

Anhui Factory Construction Contract

 

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

 

Anhui Land Use Right Acquisition Contract

 

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

 

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

 

Inflation

 

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

 

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Seasonality

 

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

 

Critical Accounting Policies

 

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

 

Revenue Recognition

 

We recognize our revenue when the amount of revenue can be reliably measured, it is probable that future economic benefits will flow to us and when specific criteria have been met for each of our activities as described below.

 

Sales of goods—wholesale Revenues are recognized upon delivery of products to distributors, and when there is no unfulfilled obligation that could affect acceptance of products by distributors. Delivery costs do not occur until the products have been delivered to the specific location and the risk of loss has been transferred to distributors. Delivery costs incurred by us are recorded in selling and distribution expenses.

 

Revenues are recorded based on the price specified in the sales contracts, net of value-added tax, and sales rebates and returns estimated at the time of sale. Provisions for estimated sales return were estimated at nil 2013, 2014 and 2015. Sales rebates are estimated based on anticipated annual purchases and the annual rebates are settled by offsetting the accounts receivables from each of these distributors at the end of the year. We accept product returns from distributors for quality reasons and only if the distributors follow our procedures in processing the returned products. Accumulated experience is used to estimate and provide for returns. No element of financing is deemed present as sales are made with a credit term of 240 days for our distributors, which is consistent with market practice. Credit terms were 90-120 days from 2013 to 2015.

 

Although none of the distributor agreements contained or contains any right of return provisions or other similar rights, we implemented an initiative in 2014 and 2015 to buyback certain excessive inventory from certain distributors so that the relationship with authorized retailers and distributors can be developed in a healthier long-term manner.

 

Sales of goods—retail We had 18 corporate shops during the year 2015 and had 2 corporate stores as of December 31, 2015. Revenues generated from these corporate shops are recognized at the time of register receipt. Retail sales returns within three days will be accepted only for quality reasons. Accumulated experience is used to estimate and provide for such returns at the time of sale. We do not operate any retail customer loyalty programs. Loyalty programs may be offered by distributors and authorized retailers, who bear all related program costs.

 

Interest income Interest income is recognized using the effective interest method.

 

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Impairment of Trade and Other Receivables

 

We assess the collectability of trade and other receivables. Such assessment is based on the credit history of our distributors and current market conditions. We reassess the impairment losses at each statement of financial position date and make provisions, if necessary.

 

Net Realizable Value of Inventories

 

Net realizable value of inventories is the estimated selling price in the ordinary course of business, less estimated costs of completion and selling expenses. These estimates are based on current market conditions and the historical expense of selling products of a similar nature. Changes in selling price could be significant as a result of changed competitive conditions.

 

Provision for Estimated Sales Return

 

We reassess the provision for estimated sales return at each statement of financial position date based on current market conditions and adjust provision, if necessary.

 

Provision for Liability

 

We reassess the provision for constructive liability at each statement of financial position date based on current market conditions and adjust provision, if necessary.

 

Capital and Reserves

 

Share capital represents the nominal value of shares that have been issued by the Group. Share capital is determined using the nominal value of shares that have been issued.

 

Retained profits include all current and prior period results as determined in the combined statement of comprehensive income.

 

Foreign currency translation reserve arising on the translation are included in the currency translation reserve.

 

In accordance with the relevant laws and regulations of PRC, the subsidiaries of the Group established in PRC are required to transfer 10% of its annual statutory net profit (after offsetting any prior years’ losses) to the statutory reserve. When the balance of such reserve reaches 50% of the subsidiary’s share capital, any further transfer of its annual statutory net profit is optional. Such reserve may be used to offset accumulated losses or to increase the registered capital of the subsidiary subject to the approval of the relevant authorities. However, except for offsetting prior years’ losses, such statutory reserve must be maintained at a minimum of 25% of the share capital after such usage. The statutory reserves are not available for dividend distribution to the shareholders.

All transactions with owners of the Group are recorded separately within equity.

 

Allowance for Bad and Doubtful debts

 

Allowances for bad and doubtful debts are based on an assessment of the recoverability of trade and other receivables. Allowances are applied to trade and other receivables where events or changes in circumstances indicate that the balances may not be collectible. The identification of bad and doubtful debts requires the use of judgment and estimates, where the expected outcome is different from the original estimate, such difference will impact carrying value of trade and other receivables and doubtful debt expenses in the period in which such estimate has been charged.

 

Impairment Losses

 

Impairment losses are based on an assessment of the investment or long lived assets’ ability to generate future cash flows when there is evidence that these assets may be impaired. The calculation of the amount of impairment loss are based on estimates made by management when applying broad accounting principles governing the accounting for these assets. The determination of these estimates requires judgment by management. The final outcome may differ from the original estimates made by management, which may impact the carrying value of the assets which management has determined to be impaired and charged to the Company’s profit loss during the period.

 

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Income Tax

 

We are required to pay income taxes in the PRC. In order to determine the provision for income taxes, we have to exercise critical judgment. During the ordinary course of our business, there may be ultimate determinations on income taxes that contain uncertainty. We recognize liabilities for expected taxes based on our estimates of whether additional taxes may be due. When the final tax outcome of these matters is different from the amounts that were initially recognized, such differences will impact the current and deferred tax provisions in the period in which such determination is made.

 

G.Safe Harbor

 

See “Introductory Notes—Forward-Looking Information.”

 

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

 

A.Directors and Senior Management

 

Our current directors and executive officers, their ages and positions are as follows:

 

NAME  AGE   POSITION
        
Keyan Yan   45   Chairman, Director and Chief Executive Officer
         
Themis Kalapotharakos   42   Executive Director
         
LixiaTu   35   Chief Financial Officer and Director
         
John Sano   47   Independent Director
         
Matthew C. Los   52   Independent Director

 

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

 

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

 

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

 

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

 

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

 

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

 

B.Compensation

 

In 2016, we paid an aggregate of approximately $324,327 in cash as compensation to our directors and senior management as a group, and some of our directors and executive officers also received compensation in the form of annual salaries and bonuses. We do not set aside or accrue any amounts for pension, retirement or other benefits for our directors and senior management. However, we reimburse our directors for out-of-pocket expenses incurred in connection with their services in such capacity.

 

On March 29,2016, the Board of Directors approved granting an aggregate of 1.1 million restricted shares of common stock to certain executive officers and directors of the Company as compensations for their past services in 2015 and 2016. All the shares vested immediately upon granting.

 

Employment Agreements

 

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

 

C.Board Practices

 

Our board of directors currently consists of five members, Keyan Yan, LixiaTu, John Sano, Themis Kalapotharakos and Matthew C. Los.

 

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

 

Audit Committee

 

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

 

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

 

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

 

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

 

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

 

reviewing and approving all proposed related-party transactions;

 

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

 

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

 

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

 

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

 

D.Employees

 

As of December 31, 2016, we employed 326 full-time employees, of which 234 employees at our production facility in Anhui Province, China, are contracted with through a labor agency. The following table sets forth the number of our full-time employees by function. 

 

Function  Number of Employees of 2016 
Management and Administration   35 
Marketing, Sales and Distribution   14 
Design and Product Development   14 
Production   234 
Procurement, Warehousing and Logistics   18 
Quality and Assurance   11 
TOTAL   326 

 

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

 

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

 

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E.Share Ownership

 

The following table sets forth information regarding beneficial ownership of each class of our voting securities as of May 12, 2017 (i) by each person who is known by us to beneficially own more than 5% of our voting securities; (ii) by each of our officers and directors; and (iii) by all of our officers and directors as a group.

 

Name   Office, If Any   Title of Class   Amount and Nature of Beneficial Ownership(1)     Percent of
Class(2)  
 
Officers and Directors
Keyan Yan(3)   Chairman, CEO and President   Common Stock     864,320       48.78 %
Lixia Tu   Chief Financial Officer   Common Stock     13,334       *  %  
Themis Kalapotharakos   Director   Common Stock     151,823       8.45 %
John Sano   Director   Common Stock     6,667       *    
Matthew C. Los   Director   Common Stock     151,823       8.45 %
All officers and directors as a group
(5 persons named above)
                    59.41 %
5% Security Holders                        
Keyan Yan (3)       Common Stock     864,320       48.78 %
Aqua Investments Corp. (4)       Common Stock     135,1567       7.52 %
Matthew C. Los(4)       Common Stock     151,823       8.45 %
Themistoklis Kalapotharakos(4)       Common Stock     151,823       8.45 %

  

* Less than 1%

 

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

 

(2)

As of May 15, 2017, a total of 1,772,016 shares of commons stock are considered to be outstanding pursuant to SEC Rule 13d-3(d)(1). For each Beneficial Owner above, any securities that are exercisable or convertible within 60 days have been included in the denominator.

 

(3) Including 844,320 shares owned by Mr. Chan Sun Keung.  On March 9, 2011, Keyan Yan entered into an option agreement with Mr. Chan Sun Keung, which was amended on August 1, 2014. Pursuant to the option agreement, as amended, upon his request, Mr. Yan has the option to acquire all of the shares of common stock of the Company that Chan Sun Keung acquired at any time.

 

(4) Including 24,534 shares underlying warrants owned by Aqua Investments Corp., control of which is shared by the indicated persons.

 

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

 

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

 

A.Major Shareholders

 

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

 

B.Related Party Transactions

 

From time to time, KBS and its all subsidiaries borrowed money from our Chairman and Chief Executive Officer, Mr. Keyan Yan, to pay for Company expenses. These amounts are interest-free, unsecured and repayable on demand. In years 2016 and 2015, Mr. Yan paid all the Company expenses in connection with the Company’s Nasdaq continued listing and SEC reporting out of his pocket. As of December 31,2016 and 2015, the balance of these amounts we borrowed from Mr. Yan was $1,1225,912 and $958,961, the balance of amounts we borrowed from Chen Bizhen was $24,416 and $ 24,430.

 

C.Interests of Experts and Counsel

 

Not applicable.

 

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ITEM 8. FINANCIAL INFORMATION

 

A.Consolidated Statements and Other Financial Information

 

Financial Statements

 

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

 

Legal Proceedings 

 

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

 

Dividend Policy

 

As required by the Exchange Agreement, promptly following the consummation of the Share Exchange, the Board of Directors will adopt a dividend policy for the payment of an annual dividend for the first two fiscal years post-closing in an amount equal to at least twenty percent (20%) of our distributable profits after tax and after compulsory statutory reserves, which can be no less than 10% of after-tax income in China. After the first two years, the Board of Directors may elect to modify the dividend policy.

 

B.Significant Changes

 

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

 

ITEM 9. THE OFFER AND LISTING

 

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

 

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

 

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The following table provides the high and low reported market prices of our securities as reported by Nasdaq Stock Market for the periods indicated. Prices of common stock have been adjusted to reflect the one-for-fifteen reverse stock split effected in February 2017.

 

   Units   Common Stocks   Warrants 
   High   Low   High   Low   High   Low 
                         
Annual Highs and Lows                        
                         
2013  $10.38    10.00   $164.70   $135.00   $7.50   $0.20 
2014   10.74    5.50    156.00    63.75    5.25    0.11 
2015   4.25    2.11    206.4    31.80    2.85    0.015 
2016   4.20    4.20    35.1    2.4    0.0305    0.001 
                               
Fiscal Quarterly Highs and Lows 2015                              
                               
First Quarter  $5.50   $5.50   $83.10   $42.45   $2.70   $0.14 
Second Quarter   4.25    3.00    206.40    47.25    0.17    0.25 
Third Quarter   4.25    2.11    97.50    45.30    0.07    0.015 
Fourth Quarter   4.20    2.11    89.40    31.80    0.19    0.03 
                               
Fiscal Quarterly Highs and Lows 2016                              
First Quarter  $4.20   $4.20   $35.1   $4.05   $0.0305   $0.001 
Second Quarter    N/A    N/A    9.75    2.40    N/A    N/A 
Third Quarter    N/A    N/A    9.30    4.20    N/A    N/A 
Fourth Quarter    N/A    N/A    6.75    4.20    N/A    N/A 
                               
Fiscal Quarterly Highs and Lows 2017                              
First Quarter  N/A    N/A   $18   $2.7    N/A    N/A 
                               
Monthly Highs and Lows                              
October 2016  N/A    N/A   $7.05   $5.25    N/A    N/A 
November 2016   N/A    N/A    6.6    4.65    N/A    N/A 
December 2016   N/A    N/A    6.9    3.9    N/A    N/A 
January 2017   N/A    N/A    4.65    2.7    N/A    N/A 
February 2017   N/A    N/A    10.87    2.85    N/A    N/A 
March 2017   N/A    N/A    7.03    4.83    N/A    N/A 
April 2017   N/A    N/A    5.59    4.96    N/A    N/A 

May 2017 (through May 15, 2017)

   N/A    N/A    5.96    5.38    N/A    N/A 

 

Approximate Number of Holders of Our Securities

 

On May 15, 2017, there was 1 holder of record of our Units, 287 shareholders of record of our common stock and 1 holders of record of our Warrants. Certain of our securities are held in nominee or street name so the actual number of beneficial owners of our securities is greater than the number of record holders set forth above.

 

A.Plan of Distribution

 

Not applicable.

 

B.Markets

 

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

 

C.Selling Shareholders

 

Not applicable. 

 

D.Dilution

 

Not applicable.

 

E.Expenses of the Issue

 

Not applicable.

 

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ITEM 10. ADDITIONAL INFORMATION

 

A.Share Capital

 

Our Amended and Restated Articles of Incorporation authorize the Company to issue up to 155,000,000 shares with a par value of $0.0001, consisting of 150,000,000 shares of common stock and 5,000,000 shares of preferred stock. As of date of this report, there are 1,772,016 shares of common stock issued and outstanding, including 1,099 shares of common stock included in the IPO Units issued in the IPO. We have never issued any preferred stock.

 

·As of date of this report, we have 1,099 IPO Units outstanding.

 

·As of date of this report, we have 393,454 warrants outstanding (including 368,920 IPO Warrants and 24,534 Placement Warrants), each warrant entitles the holder to purchase one share of common stock at a purchase price of $172.5.

 

·As of date of this report, we have one Underwriters’ Unit Purchase Option outstanding, which entities the holder to purchase 16,667 units at an exercise price of $187.5 per unit, each unit consisting of one share of common stock and one warrant, each to purchase one share of common stock at a price of $172.5.

 

B.Memorandum and Articles of Association

 

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

 

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

 

Description of Common Stock

 

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

 

Blank Check Preferred Stock.

 

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

 

Warrants

 

As of date of this report, we have 393,454 warrants outstanding, among which 368,920 warrants were issued to the public in our IPO (the “IPO Warrants”). Each of the IPO Warrants entitles the holder to purchase one share of common stock at a price of $172.5 expiring on August 1, 2019, provided that there is an effective registration statement covering the shares of common stock underlying the IPO Warrants.

 

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

 

In addition, Aqua Investments Corp., an entity controlled by certain founding shareholders of the Company, acquired 24,534 warrants, each entitles the holder to purchase one share of common stock at a price of $172.50, expiring on August 1, 2019 (the “Placement Warrants”). The Placement Warrants are identical to the IPO Warrants except that the Placement Warrants (i) may be exercised for cash or on a cashless basis; (ii) will not be redeemable by the Company and (ii) may be exercised even if there is not an effective registration statement relating to the shares underlying the warrants, so long as they are held by the initial purchaser or any of its permitted transferees.

 

As of date of this report, we also have 1,099 IPO Units outstanding and publicly trading, each including one IPO Warrant and one share of our common stock.

 

Underwriters’ Unit Purchase Option

 

In connection with our IPO, we also issued Lazard Capital Markets LLC, the representative of the underwriters, a Underwriters’ Unit Purchase Option to purchase 16,667 units, each unit consisting of one share of common stock and one warrant, each to purchase one share of common stock at a price of $172.50. The option is exercisable at any time, in whole or in part, by October 25, 2017 at an exercise price of $187.50 per unit. The units issuable upon exercise of this option are identical to those offered to the public in the IPO, except that the underlying warrants (i) will expire on October 25, 2017, (ii) may be exercised on a cashless basis and (iii) may not be redeemed by the Company. The holder of the Underwriters’ Unit Purchase Option has certain demand and piggy-back registration rights.

 

Directors

 

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

 

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

 

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

 

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

 

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Shareholder Meetings

 

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

 

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

 

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

 

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

 

Dissenters’ Rights of Appraisal and Payment.

 

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

 

Stockholders' Derivative Actions

 

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

 

Indemnification of Officers and Directors

 

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

 

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

 

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C.Material Contracts

 

Information concerning our material contracts governing the business of the Company is included elsewhere in this report or in the information incorporated by reference herein.

 

On August 1, 2014, the Company entered into an employment agreement with Keyan Yan, pursuant to which Mr. Yan agreed to act as the Chief Executive Officer of the Company. The employment agreement has a term of three years which may be extended by agreement between Mr. Yan and the Company. The annual base salary of Mr. Yan is $105,000. His compensation will be reviewed from time to time according to the Company’s policies. Mr. Yan is eligible to participate in annual performance bonus plans as may be established by the Company from time to time as well as the Company’s equity incentive plan when and if such a plan is adopted by the Board.

 

On June 25, 2015, our Hong Kong subsidiary, Vast Billion Investment Limited (“Vast Billion”) entered into an employment agreement with Lixia Tu, pursuant to which Ms. Tu agreed to act as the Chief Financial Officer of Vast Billion. The employment agreement has a term of two years. With or without cause, either Vast Billion or Ms. Tu may terminate the agreement at any time upon a 30-day written notice to the other party. Ms. Tu’s initial annual after-tax base salary was RMB 800,000 (approximately $128,000). She is eligible to participate in annual performance bonus plans as may be established by the Company from time to time as well as the Company’s equity incentive plan when and if such a plan is adopted.

 

D.Exchange Controls

 

Marshall Islands Exchange Controls

 

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

 

BVI Exchange Controls

 

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

 

PRC Exchange Controls

 

Under the Foreign Currency Administration Rules promulgated in 1996 and revised in 1997, and various regulations issued by SAFE and other relevant PRC government authorities, RMB is convertible into other currencies without prior approval from SAFE only to the extent of current account items, such as trade related receipts and payments, interest and dividends and after complying with certain procedural requirements. The conversion of RMB into other currencies and remittance of the converted foreign currency outside PRC for the purpose of capital account items, such as direct equity investments, loans and repatriation of investment, requires the prior approval from SAFE or its local office. Payments for transactions that take place within China must be made in RMB. Unless otherwise approved, PRC companies must repatriate foreign currency payments received from abroad. Foreign-invested enterprises may retain foreign exchange in accounts with designated foreign exchange banks subject to a cap set by SAFE or its local office.  Unless otherwise approved, domestic enterprises must convert all of their foreign currency proceeds into RMB.

 

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On October 21, 2005, SAFE issued the Notice on Issues Relating to the Administration of Foreign Exchange in Fund-raising and Reverse Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies, which became effective as of November 1, 2005. According to the notice, a special purpose company, or SPV, refers to an offshore company established or indirectly controlled by PRC residents for the special purpose of carrying out financing of their assets or equity interest in PRC domestic enterprises. Prior to establishing or assuming control of an SPV, each PRC resident, whether a natural or legal person, must complete the overseas investment foreign exchange registration procedures with the relevant local SAFE branch. The notice applies retroactively. As a result, PRC residents who have established or acquired control of these SPVs that previously made onshore investments in China were required to complete the relevant overseas investment foreign exchange registration procedures by March 31, 2006. These PRC residents must also amend the registration with the relevant SAFE branch in the following circumstances: (i) the PRC residents have completed the injection of equity investment or assets of a domestic company into the SPV; (ii) the overseas funding of the SPV has been completed; (iii) there is a material change in the capital of the SPV. Under the rules, failure to comply with the foreign exchange registration procedures may result in restrictions being imposed on the foreign exchange activities of the violator, including restrictions on the payment of dividends and other distributions to its offshore parent company, and may also subject the violators to penalties under the PRC foreign exchange administration regulations.

 

On August 29, 2008, SAFE promulgated Circular 142 which regulates the conversion by a foreign-funded enterprise of foreign currency into RMB by restricting how the converted RMB may be used. In addition, SAFE promulgated Circular 45 on November 9, 2011 in order to clarify the application of Circular 142. Under Circular 142 and Circular 45, the RMB capital converted from foreign currency registered capital of a foreign-invested enterprise may only be used for purposes within the business scope approved by the applicable government authority and may not be used for equity investments within the PRC. In addition, SAFE strengthened its oversight of the flow and use of the RMB capital converted from foreign currency registered capital of foreign-invested enterprises. The use of such RMB capital may not be changed without SAFE’s approval, and such RMB capital may not in any case be used to repay RMB loans if the proceeds of such loans have not been used. Violations of Circular 142 and Circular 45 could result in severe penalties, such as heavy fines as set out in the relevant foreign exchange control regulations

 

SAFE also promulgated Circular 59 in November 2010, which tightens the regulation over settlement of net proceeds from overseas offerings and requires, among other things, the authenticity of settlement of net proceeds from offshore offerings to be closely examined and the net proceeds to be settled in the manner described in the offering documents.

 

In May, 2013 SAFE promulgated Circular 21 which provides for and simplifies the operational steps and regulations on foreign exchange matters related to direct investment by foreign investors, including foreign exchange registration, account opening and use, receipt and payment of funds, and settlement and sales of foreign exchange.

 

E.Taxation

 

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

 

Marshall Islands Taxation

 

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

 

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BVI Taxation

 

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

 

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

 

Hong Kong Taxation

 

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

 

PRC Taxation

 

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

 

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

 

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

 

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

 

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

 

U.S. Federal Income Taxation

 

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

 

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

 

banks, insurance companies or other financial institutions;
   
persons subject to the alternative minimum tax;
   
tax-exempt organizations;
   
controlled foreign corporations, passive foreign investment companies and corporations that accumulate earnings to avoid United States federal income tax;
   
certain former citizens or long-term residents of the United States;
   
dealers in securities or currencies;
   
traders in securities that elect to use a mark-to-market method of accounting for their securities holdings;
   
persons that own, or are deemed to own, more than five percent of our capital stock;
   
holders who acquired our stock as compensation or pursuant to the exercise of a stock option; or
   
persons who hold our shares as a position in a hedging transaction, “straddle,” or other risk reduction transaction.

 

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

 

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

 

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

 

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

 

Distributions

 

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

 

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

 

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Sale or Other Disposition

 

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

 

Unearned Income Medicare Contribution

 

Certain U.S. holders who are individuals, trusts or estates are required to pay an additional 3.8% Medicare tax on, among other things, dividends on and capital gains from the sale or other disposition of shares of stock for taxable years beginning after December 31, 2012. U.S. holders should consult their own advisors regarding the effect, if any, of this legislation on their ownership and disposition of our common stock.

 

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

 

Distributions

 

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

 

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

 

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

 

Sale or Other Disposition

 

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

 

the gain is effectively connected with the conduct of a trade or business in the United States by such non- U.S. holder, and, if an income tax treaty applies, is attributable to a permanent establishment maintained by such non-U.S. holder in the U.S.;
   
the non-U.S. holder is an individual who is present in the United States for 183 days or more in the taxable year of the disposition, and certain other conditions are met; or
   
We are or have been a “U.S. real property holding corporation,” or USRPHC, for U.S. federal income tax purposes at any time during the shorter of the five-year period ending on the date of disposition or the period during which the holder has held our Common Stock.

 

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

 

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

 

Foreign Account Tax Compliance

 

The Foreign Account Tax Compliance provisions of the Hiring Incentives to Restore Employment Act (generally referred to as “FATCA”), when applicable, will impose a U.S. federal withholding tax of 30% on certain “withholdable payments” (generally certain U.S.-source income, including dividends, and the gross proceeds from the sale or other disposition of assets producing U.S. source dividends or interest ) to foreign financial institutions and other non-U.S. entities that fail to comply with certain certification and information reporting (generally relating to ownership by U.S persons of interests in or accounts with those entities). The obligation to withhold under FATCA applies to, among other items, (i) U.S.-source dividend income that is paid on or after July 1, 2014 and (ii) to gross proceeds from the disposition of property that can produce U.S.-source dividends paid on or after January 1, 2017. Non-U.S. holders should consult their tax advisors concerning application of FATCA to our ordinary shares in their particular circumstances.

 

Information Reporting and Backup Withholding

 

Payments of dividends or of proceeds on the disposition of stock made to a holder of our ordinary shares may be subject to information reporting and backup withholding at a current rate of 28% unless such holder provides a correct taxpayer identification number on IRS Form W-9 (or other appropriate withholding form) or establishes an exemption from backup withholding, for example by properly certifying the holder’s non-U.S. status on a Form W-8BEN, Form W-8BEN-E or another appropriate version of IRS Form W-8. Payments of dividends to holders must generally be reported annually to the IRS, along with the name and address of the holder and the amount of tax withheld, if any. A similar report is sent to the holder. Pursuant to applicable income tax treaties or other agreements, the IRS may make these reports available to tax authorities in the holder’s country of residence.

 

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

 

F.Dividends and Paying Agents

 

Not applicable.

 

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G.Statement by Experts

 

Not applicable.

 

H.Documents on Display

 

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

 

We are subject to the informational requirements of the Exchange Act as a foreign private issuer and file reports and other information with the SEC. Reports and other information filed by us with the SEC, including this report, may be inspected and copied at the public reference room of the SEC at 100 F Street, N.E., Washington D.C. 20549. You can also obtain copies of this report by mail from the Public Reference Section of the SEC, 100 F. Street, N.E., Washington D.C. 20549, at prescribed rates. Additionally, copies of this material may be obtained from the SEC’s Internet site at http://www.sec.gov. The SEC’s telephone number is 1-800-SEC-0330 free.

 

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

 

I.Subsidiary Information

 

Not applicable.

 

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Interest Rate Risk

 

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

 

Foreign Exchange Risk

 

While our reporting currency is the U.S. dollar, substantially all of our consolidated revenues and consolidated costs and expenses are denominated in RMB. Substantially all of our assets are denominated in RMB. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between the U.S. dollar and the RMB. If the RMB depreciates against the U.S. dollar, the value of our RMB revenues, earnings and assets as expressed in our U.S. dollar financial statements will decline. Assets and liabilities are translated at exchange rates at the balance sheet dates and revenue and expenses are translated at the average exchange rates and equity is translated at historical exchange rates. Any resulting translation adjustments are not included in determining net income but are included in determining other comprehensive income, a component of equity. An average appreciation (depreciation) of the RMB against the U.S. dollar of 5% would increase (decrease) our comprehensive income by $2.06 million based on our outstanding revenues, costs and expenses, assets and liabilities denominated in RMB as of December 31, 2016. As of December 31, 2016, our accumulated other comprehensive income was -$6 million. We have not entered into any hedging transactions in an effort to reduce our exposure to foreign exchange risk.

 

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

 

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Inflation

 

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

 

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

 

A.Debt Securities

 

Not applicable.

 

B.Warrants and Rights

 

Not applicable.

 

C.Other Securities

 

Not applicable.

 

D.American Depositary Shares

 

We do not have any American Depositary Shares.

 

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PART II

 

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

 

There has been no default of any indebtedness nor is there any arrearage in the payment of dividends.

 

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

 

E. Use of Proceeds

 

As of August 1, 2014, there was $57,178,033.67 held in the trust account of the Company. We used $51,314,888 in connection with the redemption of 4,981,736 shares of common stock validly tendered and not withdrawn in the tender offer. We also used a portion of the remaining cash to pay related expenses for the share exchange closed on August 1, 2014.

 

ITEM 15. CONTROLS AND PROCEDURES

 

A.Disclosure Controls and Procedures

 

An evaluation of the effectiveness of our disclosure controls and procedures as of December 31, 2016, was made under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based on that evaluation, we concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

 

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

 

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

 

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

 

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

 

As required by Section 404 of the Sarbanes-Oxley Act of 2002 and related rules as promulgated by the Securities and Exchange Commission, our management assessed the effectiveness of the our internal control over the financial reporting as of December 31, 2016, using criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment using those criteria, our management concluded that our internal control over financial reporting was effective as of December 31, 2016.

 

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C.Attestation Report of the Registered Public Accounting Firm

 

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

 

D.Changes in Internal Controls over Financial Reporting

 

There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the year ended December 31, 2016 that have materially affected, or are 5 reasonably likely to materially affect, our internal controls over financial reporting.

 

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

 

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

 

ITEM 16B. CODE OF ETHICS

 

On October 25, 2014, our Audit Committee adopted a Code of Ethics that applies to all of the directors, officers and employees of the Company and its subsidiaries, including our principal executive officer, principal financial officer and principal accounting officer. The Code of Ethics addresses, among other things, honesty and ethical conduct, conflicts of interest, compliance with laws, regulations and policies, including disclosure requirements under the federal securities laws, confidentiality, trading on inside information, and reporting of violations of the code. A copy of the Code of Ethics is filed as Exhibit 11.1 to the annual report on Form 20-F filed on October 27, 2015 and is also available on our website at www.kbsfashion.com. During the fiscal year ended December 31, 2016, there were no waivers of our Code of Ethics.

 

ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

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

 

   Fiscal Year Ended
December 31,
 
   2016   2015 
Audit Fees*  $120,000   $175,859 
Audit-Related Fees   -    - 
Tax Fees   -    - 
TOTAL  $120,000   $175,859 

 

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

 

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

 

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

 

In lieu of an audit committee comprised of three independent directors, our audit committee is comprised of two independent members of our board of directors.

 

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

 

There were no purchases of equity securities by us or by any of our affiliates during the period covered by this Annual Report.

 

ITEM 16F. CHANGES IN REGISTRANT’S CERTIFYING ACCOUNTANT

 

See our annual report on Form 20-F filed on May 2, 2016 as amended on May 16 and November 30, 2016.

 

ITEM 16G. CORPORATE GOVERNANCE

 

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

 

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

 

·in lieu of a board of directors that is comprised by a majority of independent directors, our board of directors is not comprised of a majority of independent directors;

 

·in lieu of an audit committee comprised of three independent directors, our audit committee has two independent directors;

 

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

 

·we did not hold an annual shareholder meeting in fiscal 2016; however, we may, hold annual shareholder meetings in the future if there are significant issues that require shareholders’ approvals;

 

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

 

ITEM 16H. MINE SAFETY DISCLOSURE

 

Not applicable.

 

 71 

 

 

PART III

 

ITEM 17. FINANCIAL STATEMENTS

 

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

 

ITEM 18. FINANCIAL STATEMENTS

 

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

 

ITEM 19. EXHIBITS

 

The list of exhibits in the Exhibit Index to this report is incorporated herein by reference.

 

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SIGNATURE

 

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

 

 Date: May 16, 2017 KBS Fashion Group Limited  
   
  /s/ Keyan Yan
  Keyan Yan
  Chief Executive Officer

 

 73 
 

 

 

 

 

 

 

KBS Fashion Group Limited

Consolidated Financial Statements

 

For the years ended December 31, 2016, 2015, and 2014

(Stated in US dollars)

 

 

 

 

 

 

 

 

F-1

 

 

CONTENTS   PAGES
     
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM   F-3 – F-4
     
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)   F-5
     
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION   F-6
     
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY   F-7
     
CONSOLIDATED STATEMENTS OF CASH FLOWS   F-8 – F-9
     
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS   F-10 – F-49

 

F-2

 

 

Independent Auditor’s Report

 

To: the Board of Directors and Shareholders of KBS Fashion Group Limited

 

We have audited the accompanying consolidated statements of financial position of KBS Fashion Group Limited and its subsidiaries (the “Company”), as of December 31, 2014 and the related consolidated statements of comprehensive income, statements of changes in equity and statements of cash flows for the year then ended.  These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of KBS Fashion Group Limited and its subsidiaries at December 31, 2014, and the results of its operations and its cash flows for the year then ended in conformity with International Financial Reporting Standards as issued by the International Accounting Standards Board.

 

October 27, 2015

 

/s/ BDO China Shu Lun Pan Certified Public Accountants LLP

 

Shanghai, China

 

F-3

 

 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and

Stockholders of KBS Fashion Group Limited

 

We have audited the accompanying consolidated statement of financial position of KBS Fashion Group Limited (“Company”) as of December 31, 2016 and 2015, and the related statements of comprehensive income, statement of changes in stockholders’ equity, and statement of cash flows for each of the years in the two-year period ended December 31, 2016. KBS Fashion Group Limited’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of KBS Fashion Group Limited as of December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2016, in conformity with International Financial Reporting Standards as issued by the International Accounting Standards Board.

 

We draw your attention to Note 6 to the financial statements, which describes the recognition of impairment losses by the Company for prepayments for land use rights and related construction on such land. Our opinion is not qualified in respect of this matter.

 

San Mateo, CA /s/ WWC, P.C.
May 15, 2017 Certified Public Accountants

 

 

  

F-4

 

 

KBS Fashion Group Limited

Consolidated Statements of Comprehensive Income (Loss)

For the years ended December 31, 2016, 2015, 2014

(Stated in U.S. Dollars)

 

      Year ended December 31, 
   Notes  2016   2015   2014 
Revenue  8   41,200,205    61,343,681    58,832,481 
Cost of sales  9   (39,041,932)   (46,511,274)   (39,416,973)
Gross profit      2,158,273    14,832,407    19,415,508 
                   
Other income  10   555,051    302,144    252,748 
Other gains and (losses)  11   (11,123,767)   (3,877,832)   (2,036,508)
Distribution and selling expenses  12   (3,606,010)   (6,621,256)   (7,191,606)
Administrative expenses  13   (3,543,993)   (2,798,082)   (4,649,229)
(Loss)/profit from operations      (15,560,446)   1,837,381    5,790,913 
                   
Finance costs  14   (71,783)   -    (23,630)
Change in fair value of warrant liabilities  32   3,409    11,978    3,417,053 
                   
(Loss)/profit before tax      (15,628,820)   1,849,359    9,184,336 
                   
Income tax income/(expense)  15   3,726,133    (605,689)   (2,307,354)
                   
(Loss)/profit for the year  16   (11,902,687)   1,243,670    6,876,982 
Other comprehensive loss                  
-currency translation differences      (6,125,433)   (6,044,772)   (350,810)
Total comprehensive (loss)/income for the year      (18,028,120)   (4,801,102)   6,526,172 

 

(Loss)/earnings per share of common stock attributable to the Company

 

-Basic  19   (6.80)   0.73    4.06 
-Diluted  19   (6.80)   0.73    4.06 
Weighted average shares outstanding:                  
-Basic  19   1,750,142    1,694,489    1,694,489 
-Diluted  19   1,750,142    1,694,489    1,694,489 

 

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

 

F-5

 

 

KBS Fashion Group Limited

Consolidated Statements of Financial Position

As at December 31, 2016, and 2015

(Stated in U.S. Dollars)

 

      As of December 31, 
   Notes  2016   2015 
Non-current assets           
Property, plant and equipment-net  20   26,758,749    30,536,721 
Prepayments and premiums under operating leases  21   2,491,647    2,739,311 
Prepayment for construction of new plant  22   -    7,160,523 
Prepayment for acquisition of land use right  23   -    4,774,063 
Land use rights  24   624,894    687,038 
Deferred tax assets  15   4,879,652    1,340,268 
       34,754,942    47,237,924 
Current assets             
Inventories  25   2,450,866    3,527,696 
Trade receivables  26   23,483,465    32,867,991 
Other receivables and prepayments  26   5,364,120    3,875,411 
Subsidies prepaid to distributors  27   389,996    516,231 
Prepayments and premiums under operating leases  21   79,035    81,147 
Cash and cash equivalents  28   24,576,341    21,214,080 
       56,343,823    62,082,556 
Total assets      91,098,765    109,320,480 
Current liabilities             
Short term bank loans  31   1,513,623    - 
Trade and other payables  29   4,774,628    5,114,964 
Related parties payables  30   1,150,129    983,391 
Income tax payable      258,259    2,401,742 
       7,696,639    8,500,097 
Non-current liability             
Warrant liabilities  32   -    3,409 
       -    3,409 
Total liabilities      7,696,639    8,503,506 
Equity             
Share capital  33   177    170 
Share premium  33   6,056,240    5,627,247 
Revaluation reserve  34   184,272    - 
Statutory surplus reserve  34   6,084,836    6,069,457 
Retained profits  34   78,962,407    90,880,473 
Foreign currency translation reserve  34   (7,885,806)   (1,760,373)
       83,402,126    100,816,974 
Total liabilities and equity      91,098,765    109,320,480 

 

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

 

F-6

 

 

KBS Fashion Group Limited

Consolidated Statements of Changes in Equity

For the years ended December 31, 2016, 2015, 2014

(Stated in U.S. Dollars)