Company Quick10K Filing
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Ruhnn Holding Ltd.
20-F 2019-03-31 Annual: 2019-03-31
DYNR Dynaresource 22
TTLO Torotel 8
SBSAA Spanish Broadcasting System 2
CETC Cyber Apps World 0
CHP CNL Healthcare Properties 0
QVC QVC 0
OBMP OncBioMune 0
VIST Vist Financial 0
GLDG Golden Global 0
INRD Inrad Optics 0
RUHN 2019-03-31
Part I.
Item 1. Identity of Directors, Senior Management and Advisers
Item 2. Offer Statistics and Expected Timetable
Item 3. Key Information
Item 4. Information on The Company
Item 4A. Unresolved Staff Comments
Item 5. Operating and Financial Review and Prospects
Item 6. Directors, Senior Management and Employees
Item 7. Major Shareholders and Related Party Transactions
Item 8. Financial Information
Item 9. The Offer and Listing
Item 10. Additional Information
Item 11. Quantitative and Qualitative Disclosures About Market Risk
Item 12. Description of Securities Other Than Equity Securities
Part II.
Item 13. Defaults, Dividend Arrearages and Delinquencies
Item 14. Material Modifications To The Rights of Security Holders and Use of Proceeds
Item 15. Controls and Procedures
Item 16A. Audit Committee Financial Expert
Item 16B. Code of Ethics
Item 16C. Principal Accountant Fees and Services
Item 16D. Exemptions From The Listing Standards for Audit Committees
Item 16E. Purchases of Equity Securities By The Issuer and Affiliated Purchasers
Item 16F. Change in Registrant's Certifying Accountant
Item 16G. Corporate Governance
Item 16H. Mine Safety Disclosure
Part III.
Item 17. Financial Statements
Item 18. Financial Statements
Item 19. Exhibits
EX-8.1 a19-12983_1ex8d1.htm
EX-12.1 a19-12983_1ex12d1.htm
EX-12.2 a19-12983_1ex12d2.htm
EX-13.1 a19-12983_1ex13d1.htm
EX-13.2 a19-12983_1ex13d2.htm

Ruhnn Holding Ltd. Earnings 2019-03-31

RUHN 20F Annual Report

Balance SheetIncome StatementCash Flow

20-F 1 a19-12983_120f.htm 20-F

Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 20-F

 


 

(Mark One)

 

o

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

 

 

OR

 

 

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 2019

 

 

OR

 

 

o

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

 

 

OR

 

 

o

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

 

For the transition period from                       to                        

 

Commission file number 001-38852

 


 

Ruhnn Holding Limited

(Exact name of Registrant as specified in its charter)

 

Cayman Islands

(Jurisdiction of incorporation or organization)

 

4F, Building 1, Blue Collar Garment Industrial Park

7-1 North Hong Pu Road

Yu Hang District, Hangzhou 311100

People’s Republic of China

+86-571-2882-5222

(Address of principal executive offices)

 

CHI Zhenbo, Chief Financial Officer

Telephone: +86-571-2882-5222

Email: chizb@ruhnn.com

At the address of the Company set forth above

(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

 

Trading Symbol(s)

 

Name of each exchange on which registered

American Depositary Shares, each representing five Class A ordinary shares

 

RUHN

 

The Nasdaq Stock Market

Class A ordinary shares, par value US$0.000000001 per share*

 

 

 

The Nasdaq Stock Market

 


*          Not for trading, but only in connection with the listing on The Nasdaq Stock Market of American depositary shares.

 

Securities registered or to be registered pursuant to Section 12(g)

 

None

(Title of Class)

 


Table of Contents

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None

 

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.

 

363,572,659 ordinary shares were outstanding as of March 31, 2019

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

o Yes   x 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.

o Yes   x 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.

x Yes   o No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

x Yes   o 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 the definitions of “large accelerated filer,” “accelerated filer,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

 

Accelerated filer o

 

Non-accelerated filer x

 

Emerging growth company x

 

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. o

 

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 registration has used to prepare the financial statements included in this filing:

 

U.S. GAAP x

 

International Financial Reporting Standards as issued
by the International Accounting Standards Board
o

 

Other o

 

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

o Item 17   o 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 Securities Exchange Act of 1934).

o Yes   x No

 

(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)

 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.

 

o Yes   o No

 


Table of Contents

 

Table of Contents

 

 

 

Page

 

 

 

PART I.

 

4

 

 

 

ITEM 1.

IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

4

ITEM 2.

OFFER STATISTICS AND EXPECTED TIMETABLE

4

ITEM 3.

KEY INFORMATION

4

ITEM 4.

INFORMATION ON THE COMPANY

39

ITEM 4A.

UNRESOLVED STAFF COMMENTS

66

ITEM 5.

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

66

ITEM 6.

DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

82

ITEM 7.

MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

91

ITEM 8.

FINANCIAL INFORMATION

92

ITEM 9.

THE OFFER AND LISTING

93

ITEM 10.

ADDITIONAL INFORMATION

94

ITEM 11.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

101

ITEM 12.

DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

102

 

 

 

PART II.

 

104

 

 

 

ITEM 13.

DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

104

ITEM 14.

MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

104

ITEM 15.

CONTROLS AND PROCEDURES

104

ITEM 16A.

AUDIT COMMITTEE FINANCIAL EXPERT

105

ITEM 16B.

CODE OF ETHICS

106

ITEM 16C.

PRINCIPAL ACCOUNTANT FEES AND SERVICES

106

ITEM 16D.

EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

106

ITEM 16E.

PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

106

ITEM 16F.

CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

106

ITEM 16G.

CORPORATE GOVERNANCE

106

ITEM 16H.

MINE SAFETY DISCLOSURE

107

 

 

 

PART III.

 

107

 

 

 

ITEM 17.

FINANCIAL STATEMENTS

107

ITEM 18.

FINANCIAL STATEMENTS

107

ITEM 19.

EXHIBITS

107

 

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Table of Contents

 

CONVENTIONS THAT APPLY TO THIS ANNUAL REPORT ON FORM 20-F

 

Except where the context otherwise requires, references in this annual report to:

 

·                  “ADRs” are to the American depositary receipts, which, if issued, evidence our ADSs;

 

·                  “ADSs” are to our American depositary shares, each of which represents five Class A ordinary shares;

 

·                  “AI” are to artificial intelligence;

 

·                  “CAGR” are to compound annual growth rate;

 

·                  “China” and the “PRC” are to the People’s Republic of China, excluding, for the purposes of this annual report only, Taiwan, the Hong Kong Special Administrative Region and the Macao Special Administrative Region;

 

·                  “DeepFashion” are to an AI solution developed by one of our investee companies that improves fashion design process;

 

·                  “Equity Restructuring” are to a series of equity transactions that our company, our founders and the institutional shareholders of Hangzhou Ruhnn Holdings Co., Ltd., or Hangzhou Ruhnn, effected in October 2018 to re-domicile the holding entity of our business from the PRC to the Cayman Islands as described in more detail under “Item 4. Information on the Company — A. History and Development of the Company” section of this annual report;

 

·                  “fans” are to followers to KOLs on social media platforms and e-commerce platforms, and references to the number of fans in this annual report are to the simple sum of the followers of the relevant KOL(s) on different social media platforms and e-commerce platforms, and therefore, a single fan may be included multiple times if the fan follows more than one KOL, follows the same KOL across multiple platforms, or both;

 

·                  “fiscal year” is to the period from April 1 of the previous calendar year to March 31 of the concerned calendar year;

 

·                  “GMV” is to gross merchandize value, which represents the aggregate value of merchandize ordered in our online stores and third-party online stores to which we provide KOL sales services (but not including online stores to which we only provide KOL advertising services), regardless of whether the merchandise is actually sold, delivered or returned. Our calculation of GMV includes shipping charges paid by buyers. GMV of third-party online stores to which we provide KOL sales services includes the GMV of all products ordered on such stores because we generally provide KOL sales services for all products sold on such stores; Since January 2019, we have provided KOL sales services for specified products in certain third-party online stores, and in such cases, only the GMV of such products for which we provided KOL sales services are included in our GMV for the relevant period.

 

·                  “Hangzhou Dayi Minority Interest Acquisition” are to the transactions completed in March 2019, whereby we acquired the remaining 49% of equity interests in Hangzhou Dayi from Hangzhou Wunai Yidui Trade Co., Ltd., a company wholly owned by ZHANG Yi, and issued 44,165,899 ordinary shares, which have been re-designated as Class A ordinary shares, to China Himalaya Investment Limited, a company wholly owned by ZHANG Yi;

 

·                  “Hangzhou Ruhnn” are to Hangzhou Ruhnn Holdings Co., Ltd., a joint stock limited liability company established under the laws of the PRC;

 

·                  “KOLs” are to key opinion leaders;

 

1


Table of Contents

 

·                  “millennials” are to people born in the early 1980s to the early 2000s;

 

·                  “number of our KOLs’ fans” are to the simple sum of fans of all of our KOLs on all major social media platforms and e-commerce platforms, and as a result, if an individual is a fan of more than one KOL or is a fan of a KOL on multiple social media platforms and e-commerce platforms, he or she will be counted multiple times;

 

·                  “ordinary shares” prior to the completion of our initial public offering are to our ordinary shares, par value US$0.000000001 per share, and upon and after the completion of our initial public offering are to our Class A and Class B ordinary shares, par value 0.000000001 per share;

 

·                  “ordinary shares issued and outstanding” are to our ordinary shares issued and outstanding;

 

·                  “our company” are to Ruhnn Holding Limited, an exempted company with limited liability incorporated under the laws of the Cayman Islands;

 

·                  “our KOLs” or “our signed KOLs” are to KOLs who have entered into cooperation agreements with us;

 

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

 

·                  “US$,” “U.S. dollars,” or “dollars” are to the legal currency of the United States;

 

·                  “variable interest entity,” “VIE” or “Hanyi E-Commerce” is to Hangzhou Hanyi E-Commerce Co., Ltd., a limited liability company established under the laws of the PRC and 100% owned by PRC citizens and entities; and

 

·                  “we,” “us,” “our” and “Ruhnn” are to (i) prior to the consummation of the Equity Restructuring on October 4, 2018, our predecessor, Hanyi E-Commerce, and its consolidated subsidiaries, and (ii) following the consummation of the Equity Restructuring, our company and its consolidated subsidiaries and affiliated entities.

 

The translations from Renminbi to U.S. dollars and from U.S. dollars to Renminbi in this annual report were made at a rate of RMB6.7112 to US$1.00, the exchange rates set forth in the H.10 statistical release of the Federal Reserve Board on March 29, 2019. We make no representation that the Renminbi or U.S. dollar amounts referred to in this annual report could have been or could be converted into U.S. dollars or Renminbi, as the case may be, at any particular rate or at all. On July 26, 2019, the noon buying rate for Renminbi was RMB6.8785 to US$1.00.

 

We listed our ADSs on the Nasdaq Global Select Market under the symbol “RUHN” on April 3, 2019.

 

2


Table of Contents

 

FORWARD-LOOKING INFORMATION

 

This annual report on Form 20-F contains statements of a forward-looking nature. All statements other than statements of historical facts are forward-looking statements. These forward-looking statements are made under the “safe harbor” provision under Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and as defined in the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from those expressed or implied by the forward-looking statements. In some cases, these forward-looking statements can be identified by words or phrases such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “potential,” “continue,” “is/are likely to” or other similar expressions. These forward-looking statements relate to, among others:

 

·                  our goals and growth strategies;

 

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

 

·                  trends in the internet KOL facilitator industry in the PRC and globally;

 

·                  competition in our industry;

 

·                  fluctuations in general economic and business conditions in China and other regions where we operate;

 

·                  the regulatory environment in which we and companies integral to our ecosystem operate;

 

·                  our proposed use of proceeds from this offering; and

 

·                  assumptions underlying or related to any of the foregoing.

 

We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs.

 

You should read these statements in conjunction with the risks disclosed in “Item 3. Key Information—D. Risk Factors” of this annual report and other risks outlined in our other filings with the Securities and Exchange Commission, or the SEC. Moreover, we operate in an emerging and evolving environment. New risks may emerge from time to time, and it is not possible for our management to predict all risks, nor can we assess the impact of such risks on our business or the extent to which any risk, or combination of risks, may cause actual results to differ materially from those contained in any forward-looking statements. The forward-looking statements made in this annual report relate only to events or information as of the date on which the statements are made in this annual report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date on which the statements are made or to reflect the occurrence of unanticipated events. You should read this annual report and the documents that we have referred to in this annual report, completely and with the understanding that our actual future results may be materially different from what we expect.

 

3


Table of Contents

 

PART I.

 

ITEM 1.                                                IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

Not Applicable.

 

ITEM 2.                                                OFFER STATISTICS AND EXPECTED TIMETABLE

 

Not Applicable.

 

ITEM 3.                                                KEY INFORMATION

 

A.                                    Selected Financial Data

 

The following summary combined and consolidated statements of operations data for fiscal years ended March 31, 2017, 2018 and 2019 and summary combined and consolidated balance sheet data as of March 31, 2018 and 2019 have been derived from our combined and consolidated financial statements included elsewhere in this annual report. The summary combined and consolidated balance sheet data as of March 31, 2017 has been derived from our audited combined and consolidated financial statements that are not included in this annual report.

 

You should read the following summary combined and consolidated financial data in conjunction with our combined and consolidated financial statements and the related notes included elsewhere in this annual report and “Item 5. Operating and Financial Review and Prospects.” Our combined and consolidated financial statements are prepared and presented in accordance with U.S. GAAP. Our historical results do not necessarily indicate our results expected for any future periods.

 

 

 

Fiscal Year Ended March 31,

 

 

 

2017

 

2018

 

2019

 

 

 

RMB

 

%

 

RMB

 

%

 

RMB

 

US$

 

%

 

 

 

(in thousands, except for percentages)

 

Net revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product sales

 

572,445

 

99.1

 

912,512

 

96.3

 

942,781

 

140,479

 

86.2

 

Services

 

5,457

 

0.9

 

35,068

 

3.7

 

150,657

 

22,449

 

13.8

 

Total net revenues

 

577,902

 

100.0

 

947,580

 

100.0

 

1,093,438

 

162,928

 

100.0

 

Cost of revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of product sales

 

(362,609

)

(62.7

)

(625,263

)

(66.0

)

(683,057

)

(101,779

)

(62.5

)

Cost of services

 

(2,619

)

(0.5

)

(18,122

)

(1.9

)

(68,336

)

(10,182

)

(6.2

)

Total cost of revenue

 

(365,228

)

(63.2

)

(643,385

)

(67.9

)

(751,393

)

(111,961

)

(68.7

)

Gross Profit

 

212,674

 

36.8

 

304,195

 

32.1

 

342,045

 

50,967

 

31.3

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fulfillment expenses

 

(69,412

)

(12.0

)

(100,071

)

(10.6

)

(126,850

)

(18,901

)

(11.6

)

Sales and marketing expenses

 

(97,813

)

(16.9

)

(146,207

)

(15.4

)

(205,660

)

(30,644

)

(18.8

)

General and administrative expenses

 

(67,106

)

(11.6

)

(130,978

)

(13.8

)

(92,005

)

(13,709

)

(8.4

)

Other operating (loss) income, net

 

(168

)

 

710

 

0.1

 

927

 

138

 

0.1

 

Loss from operations

 

(21,825

)

(3.7

)

(72,351

)

(7.6

)

(81,543

)

(12,149

)

(7.4

)

Interest income

 

42

 

 

88

 

 

595

 

89

 

0.1

 

Interest expense

 

(1,574

)

(0.3

)

 

 

(107

)

(16

)

 

Foreign exchange gain (loss)

 

56

 

 

(241

)

 

34

 

5

 

 

Gains from deemed sales of investments

 

 

 

 

 

7,600

 

1,132

 

0.7

 

Loss before income taxes

 

(23,301

)

(4.0

)

(72,504

)

(7.6

)

(73,421

)

(10,939

)

(6.6

)

Income tax expenses

 

(15,243

)

(2.6

)

(15,843

)

(1.7

)

(10,413

)

(1,552

)

(1.0

)

Loss from equity method investees

 

(1,593

)

(0.3

)

(1,607

)

(0.2

)

(1,090

)

(162

)

(0.1

)

Net loss

 

(40,137

)

(6.9

)

(89,954

)

(9.5

)

(84,924

)

(12,653

)

(7.7

)

Net loss per ordinary share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

(0.17

)

 

 

(0.33

)

 

 

(0.23

)

(0.03

)

 

 

Weighted average shares used in calculating net loss per ordinary share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

319,407

 

 

 

319,407

 

 

 

321,585

 

321,585

 

 

 

 

4


Table of Contents

 

 

 

As of March 31,

 

 

 

2017

 

2018

 

2019

 

 

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

(in thousands)

 

Selected Combined and Consolidated Balance Sheet:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

21,369

 

9,714

 

89,960

 

13,405

 

Restricted cash

 

 

21,208

 

13,861

 

2,065

 

Accounts receivable, net

 

219

 

6,240

 

29,372

 

4,377

 

Inventories

 

234,579

 

320,383

 

220,151

 

32,804

 

Advances to suppliers, net

 

40,977

 

24,695

 

42,145

 

6,280

 

Prepaid expenses and other current assets

 

31,238

 

30,295

 

32,969

 

4,913

 

Total current assets

 

333,031

 

412,829

 

428,459

 

63,842

 

Total assets

 

342,292

 

424,644

 

689,291

 

102,708

 

Accounts payable

 

68,697

 

72,890

 

78,061

 

11,631

 

Amounts due to related parties

 

285,570

 

374,558

 

574,860

 

85,657

 

Total liabilities

 

385,509

 

558,669

 

781,137

 

116,393

 

Total shareholders’ deficit

 

(43,217

)

(134,025

)

(91,846

)

(13,685

)

Total liabilities and shareholders’ deficit

 

342,292

 

424,644

 

689,291

 

102,708

 

 

Exchange Rate Information

 

Substantially all of our operations are conducted in China and all of our revenues is denominated in Renminbi. This annual report contains translations of Renminbi amounts into U.S. dollars at specific rates solely for the convenience of the reader. Unless otherwise noted, all translations from Renminbi to U.S. dollars and from U.S. dollars to Renminbi in this annual report were made at a rate of RMB6.7112 to US$1.00, the exchange rate set forth in the H.10 statistical release of the Federal Reserve Board on March 29, 2019. We make no representation that the Renminbi or U.S. dollar amounts referred to in this annual report could have been or could be converted into U.S. dollars or Renminbi, as the case may be, at any particular rate or at all. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the conversion of Renminbi into foreign exchange and through restrictions on foreign trade. On July 26, 2019, the noon buying rate for Renminbi was RMB6.8785 to US$1.00.

 

B.                                    Capitalization and Indebtedness

 

Not Applicable.

 

C.                                    Reasons for the Offer and Use of Proceeds

 

Not Applicable.

 

5


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D.      Risk Factors

 

Risks Relating to Our Business and Industry

 

We may not be able to maintain and optimize our KOL ecosystem.

 

Our ability to maintain our KOL ecosystem which creates strong network effects among our ecosystem participants is critical to our success. The extent to which we are able to maintain and strengthen the attractiveness of our ecosystem depends on our ability to offer a mutually beneficial platform for all participants, including our KOLs, their fans who are potential buyers in our online stores, designers, brands and online retailers, manufacturers and suppliers. To this end, we need to maintain the quality of our products and services, develop attractive opportunities and create profits for our ecosystem participants, expand the scope and scale of our ecosystem, and retain our participants. We must also continue utilizing data to enhance our KOL selection and cultivation, increase fan engagement, develop our product design and merchandising, improve operational efficiency and upgrade our technology infrastructure.

 

Changes made to enhance our ecosystem or balance the interests of participants may be viewed positively by one participant but may have negative effects upon another. If we fail to balance the interests of all participants in our ecosystem, we may fail to attract and retain additional ecosystem participants, which could adversely impact our business, financial condition and results of operations.

 

Our limited operating history makes it difficult to evaluate our business and prospects. We cannot guarantee that we will be able to maintain the growth rate that we have experienced to date.

 

We have a limited operating history. Our founders started to explore the commercialization of KOLs through e-commerce in 2014, and the first company in our current corporate structure commenced operations in 2016. Revenues from our product sales through full-service model increased by 59.4% from RMB572.4 million for fiscal year 2017 to RMB912.5 million for fiscal year 2018, and increased by 3.3% to RMB942.8 million (US$140.5 million) for fiscal year 2019. Revenues from our services through platform model increased by approximately 5.4 times from RMB5.5 million for fiscal year 2017 to RMB35.1 million for fiscal year 2018, and increased by approximately 3 times to RMB150.7 million (US$22.4 million) for fiscal year 2019. However, our historical performance may not be indicative of our future growth or financial results. We cannot assure you that we will grow at the same rate as we did in the past or avoid any decline in the future. Our growth may slow down or become negative, and revenues may decline for a number of possible reasons, some of which are beyond our control, including decreasing consumer spending, increasing competition, declining growth of our overall market or industry, the emergence of alternative business models, changes in rules, regulations, government policies or general economic conditions. It is difficult to evaluate our prospects, as we may not have sufficient experience in addressing the risks to which companies operating in rapidly evolving markets may be exposed. If our growth rate declines, investors’ perceptions of our business and prospects may be materially and adversely affected and the market price of our ADSs could decline. You should consider our prospects in light of the risks and uncertainties that companies with a limited operating history may encounter.

 

A substantial portion of our GMV and revenue is generated from online stores opened in the names of a limited number of KOLs. We may experience a decrease in purchases on our online stores.

 

Online stores opened in the names of our top-tier KOLs accounted for 65.1%, 66.1% and 53.5% of our GMV for fiscal years 2017, 2018 and 2019, respectively, and 67.2%, 69.0% and 68.0% of our revenue for fiscal years 2017, 2018 and 2019, respectively. In particular, online stores opened in the name of Zhang Dayi, one of our top-tier KOLs, accounted for 49.6%, 51.0% and 43.7% of our GMV for fiscal years 2017, 2018 and 2019, respectively, and 50.8%, 52.4% and 55.3% of our revenue for fiscal years 2017, 2018 and 2019, respectively. The success of our online stores is largely determined by the popularity of the KOLs in whose names such stores are opened. KOLs with more fans are able to reach a wider audience when they promote our products on their social media pages and to direct more potential customers to our online stores to purchase such products. As of March 31, 2019, our top-tier KOLs had approximately 34.6 million fans and Zhang Dayi had approximately 24.2 million fans on various social media platforms, representing 22.3% and 15.6%, respectively, of the total number of fans of our KOLs.

 

Our concentration on online stores opened in the names of a few KOLs exposes us to the risk of substantial decreases in, or impediments to the growth of, our GMV and revenue if the number of fans or the popularity of any of such KOLs is reduced or fails to grow. We anticipate that our top-tier KOLs will continue to contribute to the majority of our total net revenues in the near future, as it will take time for other KOLs to develop their fan bases and thus our customer base. We cannot assure you that our top-tier KOLs will be able to retain their popularity, or our other KOLs will be able to increase their number of fans. Any failure to do so will materially and adversely affect our business, prospects, financial performance and results of operations.

 

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We have incurred net losses in the past, and we may continue to incur losses in the future.

 

We have incurred net losses in our history. For fiscal years 2017, 2018 and 2019, we incurred net losses of RMB40.1 million, RMB90.0 million and RMB84.9 million (US$12.7 million), respectively, and negative cash flows from operations of RMB240.5 million, RMB27.6 million and RMB9.4 million (US$1.4 million), respectively. We expect our operating expenses to increase in absolute amounts in the future due to (i) the continued expansion of our business, (ii) the continued investment in AI solutions and technology infrastructure, and (iii) the continued identification and cultivation of new KOLs, which will affect our ability to achieve profitability.

 

Our ability to achieve profitability depends on our ability to, among other things, increase the number of fans and consumers, grow and diversify our product and service offerings and optimize our cost structure. However, we may not be able to achieve any of the above. In particular, our sales and marketing expenses increased by 49.5% from RMB97.8 million for fiscal year 2017 to RMB146.2 million for fiscal year 2018, because we opened a number of new online stores in fiscal year 2018 and we paid more service fees to e-commerce platforms and social media for promoting our new online stores. Moreover, our sales and marketing expenses further increased by 40.7% to RMB205.7 million (US$30.6 million) for fiscal year 2019, primarily due to the increased expenses of KOL incubation, cultivation, content production and training in order to support increased activities in the Company’s KOL sales and advertising businesses. If we continue to incur substantial sales and marketing expenses without being able to achieve the anticipated consumer and GMV growth, our operating results may be materially and adversely affected. As a result, we may fail to improve our operating margin and may continue to incur net losses in the future.

 

We and our KOLs may fail to anticipate or influence changes in fans’ buying preferences and develop our product offering and merchandising.

 

The success of our business depends on our and our KOLs’ ability to anticipate and influence the purchase decisions of our KOLs’ fans. The market for products sold in our online stores, in particular women’s apparel, changes rapidly in ways that are often difficult to predict. Consequently, we must stay abreast of emerging consumer preferences, anticipate product trends that will appeal to our KOLs’ existing and potential fans and take them into account during our product design and manufacturing process. This requires a combination of various elements, including but not limited to accurate analysis and prediction of market trends, timely collection of fans’ feedback, strong research and development capability, and access to flexible product production. If we are unable to accurately predict or timely react to evolving preferences or trends, or if we misjudge the market for our products, the continued success and future growth of our business could be materially and adversely affected, potentially resulting in significant decreases in revenue.

 

We may not be able to attract new KOLs or retain our existing KOLs.

 

We rely on our KOLs to promote our products and to drive traffic to our online stores. See “Item 4. Information on the Company — B. Business Overview — Our KOLs — Key Information of Our Selected KOLs.” We enter into cooperation agreements with our KOLs. The term of the cooperation agreements typically ranges from three to five years. If any of our KOLs cease to cooperate with us during the term of the cooperation agreement or employment agreement, sales and marketing efforts of that KOL will reduce. If we are unable to enforce our rights against him or her, there may be less or no traffic to our online stores opened in his or her name and we may generate less revenue from such online stores. Even if we are able to enforce our rights against the relevant KOL, the gross compensation that we receive through enforcement may be substantially less than the revenue we would have earned were the cooperation agreement performed in full by the relevant KOL.

 

Starting from 2017, the cooperation agreements we entered into with our KOLs normally provide that, if the KOL’s revenue or number of new fans reaches a certain threshold during the initial contract term, it will automatically renew for a period of three years upon expiration of the original term. However, the cooperation agreements entered into before 2017 do not have such provision. If, after the term, any of our KOLs is able to sustain his or her popularity and decides to open his or her own online store or to cooperate with other KOL sales and marketing platforms, he or she may compete with our KOLs and our online stores and our ability to generate revenue could be reduced.

 

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We may not be successful in cultivating KOLs and may be unable to recoup the costs incurred in cultivating our KOLs.

 

We incurred a significant amount of operating expenses in training and providing professional support to our KOLs for fiscal years 2017, 2018 and 2019. A significant portion of such expenses in respect of each KOL are incurred before the KOL has developed a sufficiently large fan base to generate any revenue for us.

 

The cultivation of successful KOLs is subject to many uncertainties, including their personal style, charisma, attitude and professionalism, the receptiveness of social media users to our KOLs and other circumstances beyond our control. If any of our KOLs fails to develop a fan base to our expectations, we may not open any online store in his or her name or such online store may not be successful, and in such case, we may fail to receive the expected revenue from online stores or fail to recoup the costs incurred in training and supporting such KOL, which may adversely impact our business, financial condition and results of operations.

 

Negative publicity about our KOLs or our products may materially and adversely affect our reputation, our business and the trading price of our ADSs.

 

Negative publicity about our KOLs or our products may arise and appear on the internet and other media from time to time, and negative publicity of a more serious nature may arise in the future. For example, our KOLs may post unlawful, false, offensive or controversial content on their social media pages, notwithstanding any terms of use of the social media platforms and our guidelines, which may result in negative comments and complaints or even cause their accounts to be closed by social media platforms. In addition, they may also receive negative publicity if they are involved in any illegal activities, scandals or rumors.

 

Our products may also be subject to negative publicity for various reasons, such as complaints about the quality of our and their products and related services or other public relation incidents of us, which may adversely affect our reputation and the sales of our products of those of third-party online retailers in our online stores. Any such negative publicity, regardless of veracity, could result in the expenditure of funds and management time and may have a material and adverse effect on our reputation, our business and the trading price of our ADSs.

 

We have experienced rapid growth since our inception, but we may fail to adequately manage our expansion.

 

Our rapid growth has placed, and continues to place, significant strain on our management and our technology infrastructure, as well as our operational, financial and administrative systems. To accommodate our growth, we anticipate that we will need to implement a variety of new and upgraded systems, procedures and controls. We will also need to continue expanding, training, managing and motivating our KOLs and employees and manage our relationships with our customers, suppliers and other service providers. All of these endeavors involve risks and will require substantial management effort and additional expenditures. We cannot assure you that we will be able to manage our growth or execute our strategies effectively, and any failure to do so may have a material adverse effect on our business, financial condition and results of operations.

 

We face challenges and risks associated with diversifying our monetization channels.

 

We have in the past generated most of our revenue from our full-service model. In the future, under our full-service model, we intend to establish our online stores on more popular e-commerce platforms, diversify our product portfolio and expand into additional verticals. Further, under our platform model, we plan to diversify our service offerings to include more KOL services such as additional forms of advertising and casting. Such plans may require us to devote significant financial and managerial resources and may not perform as expected. In addition, we may not be able to successfully anticipate and address customer demands and preferences in connection with new product offerings and our existing network may not be adaptable to the new product offerings.

 

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We also expect to explore new monetization opportunities and expand our revenue sources, and to adjust the proportion of our revenue from different revenue sources in response to changes in market conditions. This may make predicting our future results of operations more difficult than it otherwise would be. Therefore, our past results of operations should not be taken as indicative of our future performance. We may also be inexperienced with the operations associated with new monetization opportunities.

 

If we cannot successfully address challenges, we may not be able to recoup our investments with respect to any new initiatives, in which case our business, financial condition and results of operations could be materially and adversely affected.

 

We may fail to manage our inventories effectively.

 

To operate our business successfully and meet our consumers’ demands and expectations, we must maintain a certain level of finished goods inventory to ensure immediate delivery when required. However, forecasts are inherently uncertain. For example, as we allow consumers to cancel their pre-orders, we may not be able to make accurate forecasts and actual orders may be lower than our forecasted orders, and therefore, we may not be able to maintain an appropriate level of inventory of fabrics and raw materials for production. In addition, if our forecasted demands are lower than actual demand, we may not be able to maintain an adequate inventory level of our finished goods or produce our products in a timely manner and may lose sales and market share to our competitors. On the other hand, if our forecasted demand is higher than actual demand, we may be exposed to increased inventory risks due to accumulated excess inventory of our finished products, fabrics or raw materials. Excess inventory levels may lead to increases in inventory holding costs, risk of inventory obsolescence, increases in markdown allowances and write-offs.

 

Our return and exchange policies may adversely affect our results of operations.

 

We have adopted consumer-friendly return and exchange policies that make it convenient for consumers to change their minds after completing purchases. We may also be required by law to adopt new or amend existing return and exchange policies from time to time. For example, pursuant to the recently amended Consumer Protection Law, which became effective in March 2014, consumers are generally entitled to return the products purchased within seven days upon receipt without giving any reasons when they purchase the products from business operators on the internet. See “Item 4. Information on the Company — B. Business Overview — Regulation — Regulations Relating to Tort Liability, Product Quality and Consumer Protection.” These policies subject us to additional costs and expenses, which we may not recoup through increased revenue. Our ability to handle a large volume of returns is unproven. If our return and exchange policy is misused by a significant number of consumers, our costs may increase significantly, and our results of operations may be materially and adversely affected.

 

Our results of operations are subject to fluctuations due to the seasonality of our business and other events.

 

We have experienced, and we expect to continue to experience, seasonal fluctuations in our revenues, which have caused, and will continue to cause, fluctuations in our results of operations. We generally experience a lower level of sales in the fourth quarter of each fiscal year due to the Chinese New Year holiday, during which consumers generally spend less time on our KOLs’ social media spaces and on online shopping, while we usually have higher sales in the third quarter of each fiscal year due to sales on Singles Day in November, Double Twelve in December and sales of fall and winter apparel, which typically have a higher average selling price than spring and summer apparel. In addition, our logistics and fulfillment service hours will be impacted by holidays.

 

We make planning, inventory and personnel decisions based on our estimates of demand. If we fail to adequately increase inventory levels for popular products or do not have sufficient staff to handle purchase orders in a timely manner, we may fail to meet consumer demand, which may reduce the volume of transactions in our online stores as well as the attractiveness or such online stores. On the other hand, if we overstock products or if we hire more staff than required, we may be required to take inventory markdowns or write-offs or we may incur unnecessary costs, which could reduce our profits.

 

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We may be subject to product liability claims that could be costly and time-consuming.

 

We sell our products and promote third-party merchants’ products on our KOL sales and marketing platform; some of the products may be defective. If any product that we sell were to cause personal injury or injury to property, the injured party or parties could bring claims against us. We could also be subject to claims that consumers were harmed due to their reliance on our KOLs’ promotion of third-party brands’ products. If a successful claim were brought against us, it could adversely affect our business. We may have the right under applicable laws, rules and regulations to recover from the relevant manufacturers or third-party merchants compensation that we are required to make to consumers in connection with a product liability, personal injury or a similar claim, if such relevant party is found responsible. However, there can be no assurance that we will be able to recover all or any amounts from these parties. Any product liability claim, regardless of its merit or success, could result in the expenditure of funds and management time and adverse publicity and could have a negative impact on our reputation, business, financial condition and results of operations.

 

We may incur liability for counterfeit, unauthorized, illegal, or infringing products sold or misleading information available on our KOL sales and marketing platform.

 

Under our platform model, our KOLs represent reputable brands and online retailers on our KOL sales and marketing platform. However, brands’ and online retailers’ measures of safeguarding against counterfeit, unauthorized, illegal, or infringing products sold through e-commerce platforms may not be adequate. Although we have indemnity clauses in most of our contracts with our brands and online retailers, sales could decline and our reputation may be adversely affected. We may be subject to sanctions under applicable laws and regulations if we are deemed to have participated or assisted in infringement activities associated with counterfeit goods, which may include injunctions to cease infringing activities, rectification, compensation, administrative penalties and even criminal liability, depending on the gravity of such misconduct. Furthermore, counterfeit products may be defective or inferior in quality as compared to authentic products and may pose safety risks to consumers. If consumers are injured by counterfeit, unauthorized, illegal, or infringing products sold on our KOL sales and marketing platform, we may be subject to lawsuits, severe administrative penalties and criminal liability. See “— We may be subject to product liability claims that could be costly and time-consuming.” We believe our reputation is extremely important to our success and our competitive position. The discovery of counterfeit, unauthorized, illegal, or infringing products promoted by our KOLs or sold on our KOL sales and marketing platform may severally damage our reputation among brand partners, and they may refrain from using our services in the future, which would materially and adversely affect our operations and financial results.

 

We rely on a limited number of online social media platforms and e-commerce platforms to conduct our business. However, operators of the platforms may curtail or inhibit our ability to use the platforms, or there may be material disruption of the platforms.

 

Our KOLs use social media platforms such as Weibo, Weitao and WeChat to promote our and third-party products and to drive traffic to online stores on Taobao.

 

While they are generally open to all users, these social media and e-commerce platforms have no obligation to allow us or our KOLs to use their platforms in the long term. If we or our KOLs breach the terms of use of such platforms, or for any other reason, the platform operators may decide at any time to curtail or inhibit our ability to use such platforms, for example, by banning or closing our or our KOLs’ user accounts. Additionally, these platforms may increase their fees or make changes to their respective business models, terms of use, policies or systems, and those changes could impair or restrict our or our KOLs’ ability to post content and sell products. Further, social media platforms and e-commerce platforms could cease operations unexpectedly due to a number of events, including interruptions in telecommunication services, computer viruses and security breaches.

 

Any of the above could reduce our KOLs’ ability to post promotional content, fans’ and consumers’ engagement time, our ability to serve third-party online retailers, and traffic and sales on our online stores, any of which could affect our ability to achieve profitability or have a material adverse effect on our business, financial condition and results of operations.

 

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If we fail to manage and expand our relationships with suppliers, or otherwise fail to procure products at favorable terms, our business and growth prospects may suffer.

 

As of March 31, 2019, we had over 800 fabric suppliers, wholesale clothing providers and manufacturers on our supplier list who had worked with us and with which we expect to continue our business relationships in the near future. Maintaining strong relationships with these suppliers is important to the growth of our business. In particular, we depend significantly on our suppliers to provide fabrics and sample clothes or to produce apparel for us on favorable pricing terms. We typically enter into framework agreements with suppliers on an annual basis, and these framework agreements do not ensure the availability of products or the continuation of particular pricing practices or payment terms beyond the end of the relevant contractual terms. We cannot assure you that our current suppliers will continue to sell products or provide services to us on commercially acceptable terms, or at all, after the term of the current agreement expires. If our suppliers cease to provide us with favorable payment terms, our requirements for working capital may increase and our operations may be materially and adversely affected.

 

Moreover, we may also become involved in disputes with our suppliers on the required prepayments and relevant settlement afterwards. If we fail to maintain business relationships with our suppliers due to such disputes, and we will need to establish new supplier relationships promptly to ensure that we have access to a steady supply of products or services on favorable commercial terms. However, we cannot assure you that we will be able to find new suppliers who can satisfy our requirements.

 

The success of our platform model is linked to the success of third-party merchants whose products and services our KOLs promote or who publish advertisements on the social media space of our KOLs.

 

For our platform model, our success and our growth are partly dependent upon the success of third-party merchants who hire our KOLs to promote their products and services or who place advertisements on our KOL sales and marketing platform. As we continue growing our business under our platform model, our future success will be dependent more on the success of such third-party merchants, including brands and online retailers. As we negotiate with third-party merchants on a case-by-case basis, the rates we charge for our KOL service fees may vary from merchant to merchant. Some third-party merchants may contribute significantly to our total GMV while accounting for a much smaller portion of our service revenue. We cannot assure you that our efforts to optimize our customer base under our platform model will be successful or will not have any material adverse impact on our business performance or results of operations. If our customers under our platform model were to have financial difficulties, suffer impairment of their brands or if the profitability of, or demand for, their products or services decreases, it could adversely affect our results of operations and our ability to maintain and grow our business. Our business could also be adversely affected if our customers’ marketing, brands or retail stores are not successful or if they reduce their marketing efforts.

 

We depend on logistics service providers to deliver products to customers, and they may fail to provide reliable logistics services.

 

We rely on logistics service providers to deliver products to our customers. See “Item 4. Information on the Company — B. Business Overview — Our Suppliers —Logistics Service Providers.” Any major interruptions to or failures in these logistics service providers could prevent the timely or successful delivery of products. These interruptions may be due to unforeseen events that are beyond our control or the control of these third-party logistics providers, such as inclement weather, natural disasters, transportation interruptions or labor unrest or shortage. If products are not delivered on time or are delivered in a damaged state, customers may return the products and may claim refund from us, third-party brands or other online retailers who cooperate with us, and these third-party brands or other online retailers may have less confidence in our services. As a result, we may lose brand and online retailer partners, and our business, financial condition and results of operations could suffer.

 

We are subject to payment processing related risks.

 

Our online stores accept payments through third party online payment platforms such as Alipay. For certain payment methods, we pay interchange and other fees, which may increase over time and raise our operating costs and lower our profitability. We may be subject to fraud and other illegal activities in connection with online payment. We are also subject to various rules, regulations and requirements, regulatory or otherwise, governing electronic funds transfers, which could change or be reinterpreted to make it difficult or impossible for us to comply. If we fail to comply with these rules or requirements, we may be subject to fines and higher transaction fees and lose our ability to process electronic funds transfers or facilitate other types of online payments, and our business, financial condition and results of operations could be materially and adversely affected.

 

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In addition, as restricted by Alipay, one corporate entity can only be associated with a maximum of five online store accounts and receive revenues generated from these stores via Alipay. As we can associate our online store accounts to a limited number of our VIE’s subsidiaries, we directly receive payments from a minority of our online store accounts via Alipay, while the majority of our online stores transfer their sale proceeds to us through bank accounts opened in the names of the respective KOLs. We have taken measures to maintain control over such KOLs’ bank accounts and avoid KOLs’ misappropriation or any other misconduct in connection with our revenues generated from online stores. For example, we create and keep the passcodes required to access the online payment system. However, we cannot assure you that these measures will be effective and keep us from being harmed by KOLs’ misappropriation or misconduct. In addition, according to the Administrative Measures for RMB Bank Settlement Account, a corporation is not allowed to misuse personal accounts to receive payments from customers. Therefore, if our control over the KOL bank accounts is deemed as misuse by relevant government authorities, we may be subject to fines.

 

We may not be able to provide high-quality customer service.

 

We depend on our customer service representatives and online store managers to provide assistance to customers on our online stores. See “Item 4. Information on the Company — B. Business Overview — Our Customers — Consumers.” If they fail to satisfy the individual needs of customers, our sales could be negatively affected and we may lose potential or existing third-party online retailers, which could have a material and adverse effect on our business, financial condition and results of operations.

 

We may not be able to compete successfully against current and future competitors.

 

We face competition in the internet KOL facilitator market and e-commerce market in China, and we expect greater competition in the future from new market entrants. Intensified competition may result in a decrease in our market share or reduction in revenue or difficulty in recruiting new KOLs, any of which could negatively affect our business, financial condition, results of operations and our ability to grow our business.

 

In addition, competition may intensify as our competitors raise additional capital and as established companies in other market segments expand into our market segments. If we cannot compete successfully against our current and future competitors, our business, financial condition and results of operations could be adversely affected.

 

We depend on our senior management as well as experienced and capable personnel generally, but we may fail to attract, motivate and retain them.

 

Our future success is significantly dependent upon the continued service of our senior management and other key employees, including FENG Min, SUN Lei (Ray), SHEN Chao (Eric) and CHI Zhenbo (Nick). If members of our senior management team or other key personnel resign, join a competitor or form a competing company, we may not be able to locate suitable or qualified replacements and may face uncertainty and incur additional expenses as we seek to recruit and train new staff, which could severely disrupt our business and growth.

 

We have entered into employment, non-compete, non-solicitation and confidentiality agreements with our senior management and other key personnel. However, these employment, non-compete, non-solicitation and confidentiality agreements do not ensure the continued service of these senior management and key personnel, and we may not be able to enforce these agreements. In addition, we do not maintain key person life insurance for any of the senior members of our management team or other key personnel.

 

Competition for discovering and signing talents in the internet KOL facilitator industry and e-commerce industry in China is intense, and the availability of suitable and qualified candidates in China is limited. Competition for these individuals could cause us to offer higher compensation and other benefits to attract and retain them. Even if we were to offer higher compensation and other benefits, there is no assurance that these individuals will choose to join or continue to work for us. Any failure to attract or retain key management and personnel could severely disrupt our business and growth.

 

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We may fail to obtain requisite approvals, licenses or permits applicable to our business or fail to comply with PRC laws and regulations.

 

Our business is subject to supervision and regulation by relevant PRC government authorities, including the State Administration for Market Supervision, the Ministry of Industry and Information Technology of the PRC, the National Development and Reform Commission, the Ministry of Culture and Tourism of the PRC, China Food and Drug Administration and/or their relevant local counterparts. These government authorities promulgate and/or enforce regulations that cover many aspects of operation of online retailing such as Interim Measures for the Administration of Online Commodities Trading and Relevant Services, Product Quality Law of the PRC, Pricing Law of the PRC, Administrative Measures for Food Business Licensing, Regulations for the Administration of Commercial Performances and E-commerce Law of the PRC. We are required to hold a number of licenses and permits in connection with our operations, such as business license, commercial performance permit and food business license. While we currently hold all material licenses and permits required for our operations, we may be required to renew these licenses and permits upon their expiration or obtain new licenses or permits in the future as a result of our business expansion, change in our operations or change in laws and regulations applicable to us.

 

As the e-commerce industry is still evolving in China, new laws and regulations may be adopted from time to time, and substantial uncertainties exist regarding the interpretation and implementation of current and future PRC laws and regulations applicable to our operations. Our current business activities could be found in violation of any future laws and regulations or any of the laws and regulations currently in effect due to changes in the relevant authorities’ interpretation of these laws and regulations. In addition, although relevant PRC government authorities currently do not have any laws or regulations governing KOLs’ qualifications, activities, behaviors and other elements that may have an impact to our business, they could tighten the restrictions on KOL-related business and promulgate new laws and regulations in the future.

 

If we fail to adapt to any new regulatory requirement or any competent government authority considers that we operate our business without any requisite license, permit or approval, or otherwise fails to comply with applicable regulatory requirements, we may be subject to administrative actions and penalties against us, including fines, confiscation of our incomes, revocation of our licenses or permits, or, in severe cases, cessation of certain business. Any of these actions may have a material and adverse effect on our business, financial condition and results of operations.

 

We may fail to renew our leases upon expiration or comply with relevant PRC laws that require registration of lease agreements as well as other title certificates, in which case we may have to relocate our offices or warehouses.

 

As of March 31, 2019, we leased 11,282 square meters of office space in Hangzhou and Shanghai, and leased an aggregate of over 59,080 square meters of warehouses in Haining and Hangzhou, Zhejiang Province, and we may have to relocate for a number of reasons.  For example, we may not be able to successfully renew leases upon expiration of the current term and may decide to move to more premium locations or have to relocate our operations as required by relevant PRC laws and regulations. In particular, one of our warehouses which is not located at our registered corporate addresses in China has not registered as our branches with the competent government authority and we may be subject to fines of up to RMB100,000 for each of such warehouses or may need to relocate our warehouses. In those cases, we may not be able to locate desirable alternative sites for our offices or warehouses under favorable terms. Nevertheless, we are in the process of establishing an operating entity to modify the registration of our corporate addresses to cover the said warehouse.

 

We have not been able to receive from our lessors of some of our leased properties copies of title certificates or proof of authorization to lease the properties to us. In addition, we have not registered most of our lease agreements with relevant government authorities as required by PRC law. As of the date of this annual report, we are not aware of any actions, claims or investigations threatened against us or our lessors with respect to the defects in our leasehold interests. However, if any of our leases is terminated as a result of challenges by third parties or governmental authorities for lack of title certificates or proof of authorization to lease, we do not expect to be subject to any fines or penalties but we may be forced to relocate the affected offices or warehouses and incur additional expenses relating to such relocation. In addition, failure to complete the lease registration will not affect the legal effectiveness of the lease agreements according to PRC law, but the real estate administrative authorities may require the parties to the lease agreements to complete lease registration within a prescribed period of time and the failure to do so may subject the parties to fines from RMB1,000 to RMB10,000 for each of such lease agreements.

 

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In addition, in connection with the Equity Restructuring, Hangzhou Ruhnn sold us office spaces which Hangzhou Ruhnn purchased from a third-party seller in 2017. We have taken possession of these office spaces and currently use them as offices. However, we have not obtained the building ownership certificates for these office spaces and we are in the process of obtaining such certificates. Without these building ownership certificates, we cannot assure you that our title to the given office spaces will not be challenged by third parties.

 

We may not be able to adequately protect our intellectual property rights and exclusive rights.

 

We rely on a combination of trademark, patent, copyright and trade secret protection laws in China and other jurisdictions, as well as confidentiality procedures and contractual provisions, to protect our intellectual property rights and other exclusive rights. Our cooperation agreements with KOLs typically provide that we own their portrait rights or right of publicity on social media platforms, social media accounts and online store accounts. Our cooperation agreements with KOLs also include provisions on confidentiality and intellectual property rights protections. We also enter into confidentiality agreements with our employees and any third parties who may access our proprietary information, and we rigorously control access to our proprietary technology and information. Our success also depends in part upon the technology and AI solutions that we utilize in designing and manufacturing products as well as certain systems we use in managing the entire fulfillment and transaction process.

 

Nevertheless, it may be possible for third parties to obtain and use our intellectual property and exclusive rights without authorization. Intellectual property protection may not be sufficient or consistent in China. Moreover, cooperation agreements and confidentiality agreements may be breached by counterparties, and there may not be adequate remedies available to us for any such breach. Accordingly, we may not be able to effectively protect our intellectual property rights and exclusive rights or to enforce our contractual rights in China or elsewhere. In addition, policing any unauthorized use of our intellectual property and exclusive rights is difficult, time-consuming and costly and the steps we have taken may be inadequate to prevent the misappropriation of our intellectual property and exclusive rights. In the event that we resort to litigation to enforce our intellectual property rights and exclusive rights, such litigation could result in substantial costs and a diversion of our managerial and financial resources. We can provide no assurance that we will prevail in such litigation or that that we would be able to halt any unauthorized use of our intellectual property and exclusive rights. In addition, our trade secrets may be leaked or otherwise become available to, or be independently discovered by, our competitors. Any failure in protecting or enforcing our intellectual property rights could have a material adverse effect on our business, financial condition and results of operations.

 

We may be accused of infringing intellectual property rights of others and content restrictions of relevant laws.

 

Third parties may claim that the technology or content used in our KOLs’ social media pages or our operation of online stores infringe upon their intellectual property rights. For example, while offering our advertising services, we may be subject to liabilities such as infringement of copyrights or trademarks and to other claims based on the materials and content posted on our KOL sales and marketing platform. We have been in the past subject to claims relating to infringement of the intellectual property rights of others. The possibility of intellectual property claims against us increases as we continue to grow. Such claims, whether or not having merit, may result in our expenditure of significant financial and management resources, injunctions against us or payment of damages. We may need to obtain licenses from third parties who allege that we have infringed their rights, but such licenses may not be available on terms acceptable to us or at all. These risks have been amplified by the increase in the number of third parties whose sole or primary business is to assert such claims.

 

China has enacted laws and regulations governing internet access and the distribution of products, services, news, information, audio-video programs and other content through the internet. The PRC government has prohibited the distribution of information through the internet that it deems to be in violation of PRC laws and regulations. If any of the information disseminated through our KOLs’ social media pages or our online stores were deemed by the PRC government to violate any content restrictions, we would not be able to continue displaying such content and could become subject to penalties, including confiscation of income, fines, suspension of business and revocation of required licenses, which could materially and adversely affect our business, financial condition and results of operations.

 

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The outcome of any claims, investigations and proceedings is inherently uncertain, and in any event, defending against these claims could be both costly and time-consuming and could significantly divert the efforts and resources of our management and other personnel. An adverse determination in any such litigation or proceedings could cause us to pay damages, legal fees and other costs, as well as limit our ability to conduct business or require us to change the manner in which we operate. Even if such assertions against us are unsuccessful, they may cause us to lose existing and future business and incur reputational harm and substantial legal fees.

 

The proper functioning of our information technology systems is essential to our business. We may fail to maintain the satisfactory performance of our systems.

 

Our business relies on the proper functioning of our information technology systems. We use information technology systems to enable us to conduct our operations, including product design and procurement, inventory control, supplier management, market data analysis, sales, logistics, KOL identification, cultivation and support, customer service, budgeting and financial reporting. Although we did not experience any material failure or breakdown of our information technology systems during fiscal years 2017, 2018 and 2019, we cannot assure you that our information technology systems will always operate without interruptions. Any malfunction of our information technology systems, whether caused by computer viruses, hacking or other security breaches, errors encountered during system upgrades or other issues, that result in the unavailability or slowdown of our information technology systems may, individually or collectively, materially and adversely affect our business, financial condition and results of operations.

 

In addition, computer viruses, security breaches and information theft may lead to delays or errors in transaction processing, inability to fulfill purchase orders or loss of data. We cannot assure you that our security mechanisms will be sufficient to protect our information technology systems from any such occurrences, which could materially and adversely affect our business, reputation and prospects.

 

Further, we must continue to upgrade and improve our information technology systems and software to support our business growth, and failure to do so could impede our growth. However, we cannot assure you that we will be successful in implementing these system and software upgrades and improvement plans. In particular, our systems may experience interruptions during upgrades, and any new technologies may not be fully integrated with our existing systems on a timely basis, or at all. If our existing or future technology systems or software do not function properly, we could experience disruptions and failures, which in turn could materially and adversely affect our business, financial condition and results of operations.

 

Our business generates, collects and processes a large quantity of data, and any improper use or disclosure of or unauthorized access to such data may harm our reputation.

 

Our business generates, collects and processes a large quantity of personal, transaction, demographic and behavioral data. We face risks inherent in handling large volumes of data and in protecting the security of such data. In particular, we face challenges related to protecting the data in our system, including against attacks on our system by outside parties or fraudulent behavior by our employees, addressing concerns related to privacy and sharing, safety, security and other factors, and complying with applicable laws, rules and regulations relating to the collection, use, disclosure and security of personal information, including requests from regulatory and government authorities relating to such data.

 

The PRC regulatory and enforcement regime with regard to data security and data protection has continued to evolve. There are uncertainties on how certain laws and regulations will be implemented in practice. PRC regulators have been increasingly focused on regulating data security and data protection. We expect that these areas will receive greater attention from regulators, as well as attract public scrutiny and attention going forward. This greater attention, scrutiny and enforcement, including more frequent inspections, could increase our compliance costs and subject us to heightened risks and challenges associated with data security and protection. If we are unable to manage these risks, our reputation and results of operations could be materially and adversely affected.

 

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Failure to protect confidential information of KOLs, fans and consumers, brands and other merchants on our KOL sales and marketing platform against security breaches could damage our reputation and substantially harm our business and results of operations.

 

A significant challenge to the e-commerce business is the secure storage of confidential information and its secure transmission over public networks. A majority of the product orders and purchase payments are made through online transactions. Maintaining complete security on our KOL sales and marketing platform for the storage and transmission of confidential or private information, such as consumers’ personal information, payment-related information and transaction information, is essential to maintain consumer confidence in our platform.

 

We have adopted strict security policies and measures, including encryption technology, to protect our proprietary data and buyer information. However, advances in technology, skills of hackers, new discovery in the field of cryptography or other events or development could result in a compromise or breach of the technology that we use to protect confidential information. We may not be able to prevent third parties from illegally obtaining such confidential or private information we hold with respect to KOLs, fans and consumers, brands and other merchants on our platform. Such individuals obtaining confidential or private information may further engage in various illegal activities using such information. In addition, we have limited control or influence over the security policies or measures adopted by third-party online payment service providers through which most of our consumers may choose to make payment for purchases. Any negative publicity about our online stores’ safety or privacy protection mechanisms and policies, and any claims asserted against us or fines imposed upon us as a result of actual or perceived failures, could have a material and adverse effect on our public image, reputation, financial condition and results of operations. Any compromise of our information security or the information security measures of third-party online payment service providers could have a material and adverse effect on our reputation, business, prospects, financial condition and results of operations.

 

We may not be able to obtain sufficient capital to maintain or expand our business operations.

 

Our business operations and expansion require a substantial amount of capital. We had negative cash flows from operations of RMB240.5 million, RMB27.6 million and RMB9.4 million (US$1.4 million) for fiscal years 2017, 2018 and 2019, respectively. We expect that our business operations will continue to require a substantial amount of working capital and we cannot assure you that we will be able to achieve positive cash flows from operations in the near future. To expand our business, we have also incurred, and expect to continue to incur, substantial costs to expand our KOL pool and develop our diversified monetization channels and we may only be able to recover such costs over the long term.

 

We have historically funded our operations with contributions and advances from our shareholders. There can be no assurance that we will be able to generate sufficient cash from our operations to fund our capital requirements or raise additional funds through equity or debt financings on satisfactory terms or at all, in which case we may be required to prioritize projects or curtail capital expenditures, and our results of operations could be adversely affected. On the other hand, if we raise funds through debt financings, we may also become subject to restrictive covenants that could limit our future capital raising activities and other financial and operational matters. If we raise funds through further issuances of equity or equity-linked securities, our existing shareholders could suffer significant dilution in their percentage ownership of our company.

 

We may engage in acquisitions, investments or strategic alliances in the future, which could require significant management attention and materially and adversely affect our business and results of operations.

 

We may identify strategic partners to form strategic alliances and invest in or acquire additional assets, technologies or businesses that are complementary to our existing business. These investments may involve minority stakes in other companies, acquisitions of entire companies or acquisitions of selected assets.

 

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Any future strategic alliances, investments or acquisitions and the subsequent integration of the new assets and businesses obtained or developed from such transactions into our own may divert management from their primary responsibilities and subject us to additional liabilities. In addition, the costs of identifying and consummating investments and acquisitions may be significant. We may also incur costs and experience uncertainties in completing necessary registrations and obtaining necessary approvals from relevant government authorities in China and elsewhere in the world. The costs and duration of integrating newly acquired assets and businesses could also materially exceed our expectations. Any such negative developments could have a material adverse effect on our business, financial condition, results of operations and cash flow.

 

We may not have sufficient insurance coverage.

 

We maintain various insurance policies to safeguard against risks and unexpected events. We have purchased property insurance covering our inventory. However, we do not maintain business interruption insurance, general third-party liability insurance or key-man insurance. This could leave us exposed to potential claims and losses. Any business disruption, litigation, regulatory action, outbreak of epidemic disease or natural disaster could also expose us to substantial costs and diversion of resources. We cannot assure you that our insurance coverage is sufficient to prevent us from any losses or that we will be able to successfully claim for losses under our current insurance policies on a timely basis, or at all. If we incur losses that are not covered by our insurance policies, or if the amount reimbursed is significantly less than our actual losses, our business, financial condition and results of operations could be materially and adversely affected.

 

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

 

Prior to our initial public offering, we have been a private company with limited accounting personnel and other resources with which to address our internal control over financial reporting. Our management has not completed an assessment of the effectiveness of our internal control over financial reporting, and our independent registered public accounting firm has not conducted an audit of our internal control over financial reporting. In the course of auditing our combined and consolidated financial statements included in this annual report, we and our independent registered public accounting firm identified two material weakness in our internal control over financial reporting, which relate to (i) a lack of sufficient accounting personnel with U.S. GAAP knowledge and SEC financial reporting requirements and lack of accounting policies and procedures relating to financial reporting in accordance with U.S. GAAP, and (ii) a lack of formal risk assessment process over financial reporting and internal control framework. The material weaknesses, if not remediated timely, may lead to material misstatements in our combined and consolidated financial statements in the future.

 

Following the identification of the material weaknesses and other control deficiencies, we have taken measures, and plan to continue to take measures, to remediate these control deficiencies. See “Item 15. Controls and Procedures — Internal Control Over Financial Reporting”. However, the implementation of these measures may not fully address these deficiencies in our internal control over financial reporting, and we cannot conclude that they have been fully remediated. Our failure to correct these control deficiencies or our failure to discover and address any other control deficiencies could result in inaccuracies in our financial statements and impair our ability to comply with applicable financial reporting requirements and related regulatory filings on a timely basis. Moreover, ineffective internal control over financial reporting could significantly hinder our ability to prevent fraud.

 

Upon completion of our initial public offering, we will become subject to the Sarbanes-Oxley Act of 2002. Section 404 of the Sarbanes-Oxley Act, or Section 404, requires that we include a report from management on the effectiveness of our internal control over financial reporting in our annual report on Form 20-F beginning with our annual report for fiscal year ending March 31, 2020. In addition, once we cease to be an “emerging growth company” as defined in the JOBS Act, our independent registered public accounting firm must attest to and report on the effectiveness of our internal control over financial reporting. Our management may conclude that our internal control over financial reporting is not effective. Moreover, even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm, after conducting its own independent testing, may issue a report that is qualified if it is not satisfied with our internal control or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us. In addition, after we become a public company, our reporting obligations may place a significant strain on our management, operational and financial resources and systems for the foreseeable future. We may be unable to timely complete our evaluation testing and any required remediation.

 

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

 

We may experience a severe or prolonged downturn in the global or Chinese economy.

 

Any prolonged slowdown in the Chinese or global economy may have a negative impact on our business, results of operations and financial condition. In particular, general economic factors and conditions in China or worldwide, including the general interest rate environment and unemployment rates, may affect advertising customers’ willingness to advertise or consumers’ willingness to spend on entertainment. Economic conditions in China are sensitive to global economic conditions. The global financial markets have experienced significant disruptions since 2008 and the United States, Europe and other economies have experienced periods of recession. The recovery from the lows of 2008 and 2009 has been uneven and is facing new challenges, including the escalation of the European sovereign debt crisis from 2011 and the slowdown of the Chinese economy since 2012. There is considerable uncertainty over the long-term effects of the expansionary monetary and fiscal policies adopted by the central banks and financial authorities of some of the world’s leading economies, including the United States and China. There have been concerns over unrest in North Korea, Ukraine, the Middle East and Africa, which have resulted in volatility in financial and other markets. There have also been concerns over the expected withdrawal of the United Kingdom from the European Union as well as concerns about the economic effect of the tensions in the relationship between the United States, China and neighboring Asian countries. Starting from early 2018, U.S. President Donald J. Trump announced the imposition of tariffs on Chinese goods entering the United States, and recently both China and the U.S. have each imposed additional tariffs. The United States may also in the future impose tariffs on the importation of consumer products. Although we do not currently export any of our products to the United States, we may do so in the near future. It is not yet clear what impact these tariffs may have or what actions other governments, including the Chinese government, may take in retaliation. In addition, these developments could have a material adverse effect on global economic conditions, the stability of global financial markets and the Chinese economy. If present Chinese and global economic uncertainties persist, we may have difficulty in attracting advertising customers or spending by consumers on entertainment. Additionally, continued turbulence in the international markets may adversely affect our ability to access the capital markets to meet liquidity needs.

 

Any occurrence of a natural disaster, widespread health epidemic or other outbreaks could have a material adverse effect on our business, financial condition and results of operations.

 

Our business could be materially and adversely affected by natural disasters, such as snowstorms, earthquakes, fires or floods, the outbreak of a widespread health epidemic, such as swine flu, avian influenza, severe acute respiratory syndrome, or SARS, Ebola or other events, such as wars, acts of terrorism, environmental accidents, power shortage or communication interruptions. The occurrence of such a disaster or a prolonged outbreak of an epidemic illness or other adverse public health developments in China or elsewhere in the world could materially disrupt our business and operations. Such events could also significantly impact our industry and cause a temporary closure of the facilities we use for our operations, which would severely disrupt our operations and have a material adverse effect on our business, financial condition and results of operations. Our operations could be disrupted if any of our employees or employees of our business partners were suspected of having the swine flu, avian influenza, SARS or Ebola, since this could require us or our business partners to quarantine some or all of such employees or disinfect the facilities used for our operations. In addition, our revenues and profitability could be materially reduced to the extent that a natural disaster, health epidemic or other outbreak harms the global or PRC economy in general. Our operations could also be severely disrupted if our buyers, sellers or other participants were affected by such natural disasters, health epidemics or other outbreaks.

 

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The enforcement of the PRC Labor Contract Law and other labor-related regulations in the PRC may adversely affect our business and results of operations.

 

The Standing Committee of the National People’s Congress enacted the Labor Contract Law in 2008, and amended it on December 28, 2012. The Labor Contract Law introduced specific provisions related to fixed-term employment contracts, part-time employment, probationary periods, consultation with labor unions and employee assemblies, employment without a written contract, dismissal of employees, severance, and collective bargaining to enhance previous PRC labor laws. Under the Labor Contract Law, an employer is obligated to sign an unlimited-term labor contract with any employee who has worked for the employer for ten consecutive years. Further, if an employee requests or agrees to renew a fixed-term labor contract that has already been entered into twice consecutively, the resulting contract, with certain exceptions, must have an unlimited term, subject to certain exceptions. With certain exceptions, an employer must pay severance to an employee where a labor contract is terminated or expires. In addition, the PRC governmental authorities have continued to introduce various new labor-related regulations since the effectiveness of the Labor Contract Law.

 

Under the PRC Social Insurance Law and the Administrative Measures on Housing Fund, employees are required to participate in pension insurance, work-related injury insurance, medical insurance, unemployment insurance, maternity insurance, and housing funds and employers are required, together with their employees or separately, to pay the social insurance premiums and housing funds for their employees. To comply with such laws and regulations, we provide social security insurance including pension insurance, unemployment insurance, work-related injury insurance to our employees. Additionally, we provide supplementary medical insurance for all management and research and development personnel. We currently make social insurance and housing fund contributions according to the minimum standards announced by local governments, but we may be deemed as violating relevant PRC laws and regulations that require companies to make social insurance and housing fund contributions based on actual wages. We may be deemed as violating the PRC Social Insurance Law and the Administrative Measures on Housing Fund, and we may be subject to fines and legal sanctions, including a late charge and a fine ranging from one to three times the amount due, and our business, financial condition and results of operations may be adversely affected.

 

These laws designed to enhance labor protection tend to increase our labor costs. In addition, as the interpretation and implementation of these regulations are still evolving, our employment practices may not be at all times be deemed in compliance with the regulations. As a result, we could be subject to penalties or incur significant liabilities in connection with labor disputes or investigations.

 

Risks Relating to Our Corporate Structure

 

The PRC government may find that the contractual arrangements that establish our corporate structure for operating our business do not comply with applicable PRC laws and regulations.

 

Pursuant to the Circular on Lifting the Restriction to Foreign Shareholding Percentage in Online Data Processing and Transaction Processing Business (Operational E-commerce), or the New E-commerce Circular, while foreign investors are allowed to hold up to 100% equity interest of an entity operating online data processing and transaction processing business (operational e-commerce) in China, such foreign investors still need to satisfy certain stringent qualification requirements, for instance, the major foreign investors must have good track records and operating experience in the value-added telecommunications service industry. Further, there remain significant uncertainties with respect to the interpretation and implementation of the New E-commerce Circular as well as the applications for the license regarding online data processing and transaction processing business by a wholly foreign funded enterprise in practice.

 

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To maintain our flexbility to engage in operational e-commerce business in the future and to ensure compliance with PRC laws and regulations, we conduct our businesses in China mainly through our PRC affiliates, Hangzhou Hanyi E-Commerce Co., Ltd., or Hanyi E-Commerce or VIE, and its subsidiaries. Hanyi E-Commerce is 1% owned by FENG Min and 99% owned by Hangzhou Xinghui, which is a company incorporated in the PRC and wholly owned by FENG Min. FENG Min is a PRC citizen. We entered into a series of contractual arrangements with Hanyi E-Commerce, which enable us to:

 

·                  exercise effective control over Hanyi E-Commerce and its subsidiaries;

 

·                  receive substantially all of the economic benefits from Hanyi E-Commerce and its subsidiaries; and

 

·                  have a call option to purchase all or part of the equity interests in Hanyi E-Commerce when and to the extent permitted by the relevant laws.

 

Because of these contractual arrangements, we are the primary beneficiary of Hanyi E-Commerce and its subsidiaries and treat them as our PRC affiliates under U.S. GAAP. We consolidate the financial results of Hanyi E-Commerce and its subsidiaries in our financial statements in accordance with U.S. GAAP. For a detailed discussion of these contractual arrangements, see “Item 4. Information on the Company — C. Organizational Structure — Contractual Arrangements with Our VIE and Its Shareholders.”

 

There are, however, substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations concerning foreign investment in the PRC, and their application to and effect on the legality, binding effect and enforceability of the contractual arrangements. In particular, we cannot rule out the possibility that PRC regulatory authorities, courts or arbitral tribunals may in the future adopt a different or contrary interpretation or take a view that is inconsistent with the opinion of our PRC legal counsel.

 

It is uncertain whether any new PRC laws, rules or regulations relating to VIE structures will be adopted or if adopted, what affect they may have on our corporate structure. On March 15, 2019, the National People’s Congress promulgated the Foreign Investment Law, which will become effective on January 1, 2020 and replace the Sino-Foreign Equity Joint Venture Enterprise Law, the Sino-Foreign Cooperative Joint Venture Enterprise Law and the Foreign Owned Enterprise Law to become the legal foundation for foreign investment in the PRC. The Foreign Investment Law stipulates three forms of foreign investment, but does not explicitly stipulate the contractual arrangements as a form of foreign investment. Notwithstanding the above, the Foreign Investment Law stipulates that the concept of a foreign investment includes foreign investors investing in China through “any other methods” under laws, administrative regulations, or provisions prescribed by the State Council. Therefore, contractual arrangements could be deemed as a form of foreign investment under future laws, administrative regulations or provisions of the State Council of the PRC. If the other laws, administrative regulations and provisions of the State Council do not incorporate contractual arrangements as a form of foreign investment, the contractual arrangements as a whole and each of the agreements comprising the contractual arrangements will not be materially affected and will continue to be legal, valid and binding on the parties. See “Item 4. Information on the Company — B. Business Overview — Regulation — Regulations Relating to Foreign Investment” and “—We face uncertainties with respect to the implementation of the Foreign Investment Law.” If, as a result of such contractual arrangement, we or Hanyi E-Commerce and its subsidiaries are found to be in violation of any existing or future PRC laws or regulations, or such contractual arrangement is determined as illegal and invalid by the PRC court, arbitral tribunal or regulatory authorities, or we fail to obtain, maintain or renew any of the required permits or approvals, the relevant PRC regulatory authorities would have broad discretion to take action in dealing with such violations or failures, including:

 

·                  being unable to exert control over affiliated entities;

 

·                  revoking the business licenses and/or operating licenses of Hangzhou Yihan Technology Co., Ltd., or Yihan Technology or WFOE, and/or Hanyi E-Commerce and its subsidiaries;

 

·                  discontinuing or restricting the conduct of any transactions between Yihan Technology and Hanyi E-Commerce and its subsidiaries, which includes receiving the economic benefits of our affiliated entities under such contractual arrangements;

 

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·                  limiting our business expansion in China by way of entering into contractual arrangements;

 

·                  imposing fines and penalties, confiscating the income from Hanyi E-Commerce and its subsidiaries, or imposing other requirements with which we or Hanyi E-Commerce and its subsidiaries may not be able to comply with;

 

·                  shutting down our servers or blocking our websites;

 

·                  requiring us to restructure our ownership structure or operations, including terminating the contractual arrangements with Hanyi E-Commerce and its subsidiaries and deregistering the equity pledges of Hanyi E-Commerce;

 

·                  restricting or prohibiting our use of the proceeds of our initial public offering to finance our business and operations in China;

 

·                  restricting the use of financing sources by us or Hanyi E-Commerce and its subsidiaries or otherwise restricting our or their ability to conduct business;

 

·                  imposing additional conditions or requirements with which we may not be able to comply with; or

 

·                  taking other regulatory or enforcement actions against us that could be harmful to our business.

 

The imposition of any of these penalties could result in a material and adverse effect on our ability to conduct our business and on our results of operations. If any of these penalties results in our inability to direct the activities of Hanyi E-Commerce and its subsidiaries that most significantly impact their economic performance, and/or our failure to receive the economic benefits from Hanyi E-Commerce and its subsidiaries, we may not be able to consolidate them in our financial statements in accordance with U.S. GAAP.

 

We face uncertainties with respect to the implementation of the Foreign Investment Law.

 

On March 15, 2019, the National People’s Congress promulgated the Foreign Investment Law, which will become effective on January 1, 2020 and replace the Sino-Foreign Equity Joint Venture Enterprise Law, the Sino-Foreign Cooperative Joint Venture Enterprise Law and the Foreign Owned Enterprise Law to become the legal foundation for foreign investment in the PRC. The Foreign Investment Law stipulates three forms of foreign investment, but does not explicitly stipulate the contractual arrangements as a form of foreign investment. Notwithstanding the above, the Foreign Investment Law stipulates that the concept of a foreign investment includes foreign investors investing in China through “any other methods” under laws, administrative regulations, or provisions prescribed by the State Council. Therefore, there are possibilities that future laws, administrative regulations or provisions prescribed by the State Council may regard contractual arrangements as a form of foreign investment, at which time it will be uncertain whether the contractual arrangements will be deemed to be in violation of the foreign investment access requirements and how the above-mentioned contractual arrangements will be handled. There is no guarantee that the contractual arrangements and our business will not be materially and adversely affected in the future due to changes in PRC laws and regulations. If future laws, administrative regulations or provisions prescribed by the State Council mandate further actions to be completed by companies with existing contractual arrangements, we may face substantial uncertainties as to the timely completion of such actions. In the extreme case scenario, we may be required to unwind the contractual arrangements and/or dispose our VIEs, which could have a material and adverse effect on our business, financial condition and result of operations.

 

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We rely on contractual arrangements with Hanyi E-Commerce and its shareholders for our operations in China, which may not be as effective in providing control as direct ownership.

 

We have relied and expect to continue to rely on the contractual arrangements with Hanyi E-Commerce and its shareholders to operate our KOL sales and marketing business. For a description of these contractual arrangements, see “Item 4. Information on the Company — C. Organizational Structure — Contractual Arrangements with Our VIE and Its Shareholders.” The revenue contribution of Hanyi E-Commerce and its subsidiaries accounted for all of our total revenues for fiscal years 2017, 2018 and 2019. However, these contractual arrangements may not be as effective as direct equity ownership in providing us with control over Hanyi E-Commerce and its subsidiaries. Any failure by Hanyi E-Commerce and its subsidiaries or the shareholders of Hanyi E-Commerce to perform their obligations under the contractual arrangements would have a material adverse effect on the financial position and performance of our company. For example, the contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration in China. Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with arbitral procedures as contractually stipulated. The commercial arbitration system in China is not as developed as some other jurisdictions, such as the United States.

 

As a result, uncertainties in the commercial arbitration system or legal system in China could limit our ability to enforce these contractual arrangements. In addition, if the legal structure and the contractual arrangements were found to violate any existing or future PRC laws and regulations, we may be subject to fines or other legal or administrative sanctions.

 

If the imposition of government actions causes us to lose our right to direct the activities of Hanyi E-Commerce and its subsidiaries or our right to receive substantially all the economic benefits from Hanyi E-Commerce and its subsidiaries and we are not able to restructure our ownership structure and operations in a satisfactory manner, we would no longer be able to consolidate the financial results of Hanyi E-Commerce and its subsidiaries.

 

Hanyi E-Commerce and its shareholders may fail to perform their obligations under the contractual arrangements.

 

Hanyi E-Commerce and its shareholders may fail to take certain actions required for our business or to follow our instructions despite their contractual obligations to do so. If they fail to perform their obligations under their respective agreements with us, we may have to rely on legal remedies under PRC law, including seeking specific performance or injunctive relief, which may not be effective.

 

The shareholders of Hanyi E-Commerce may have actual or potential conflict of interest with us and not act in the best interests of our company.

 

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

 

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

 

We are a holding company and rely principally on dividends and fees paid by our subsidiaries for our cash needs, including paying dividends and other cash distributions to our shareholders to the extent we choose to do so, servicing any debt we may incur and paying our operating expenses. The income for our subsidiaries in turn depends on the service fees paid by our VIE. Current PRC regulations permit our subsidiaries in China to pay dividends to us only out of their accumulated profits, if any, determined in accordance with Chinese accounting standards and regulations. Under the applicable requirements of PRC law, our PRC subsidiary may only distribute dividends after they have made allowances to fund certain statutory reserves. These reserves are not distributable as cash dividends. Furthermore, if our subsidiaries or our VIE in China incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability to pay dividends or make other payments to us. Any such restrictions may materially affect such entities’ ability to make dividends or make payments, in service fees or otherwise, to us, which may materially and adversely affect our business, financial condition and results of operations.

 

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Contractual arrangements between Hanyi E-Commerce and us may be subject to scrutiny by the PRC tax authorities who may find that we or Hanyi E-Commerce and its subsidiaries owe additional taxes.

 

Under PRC laws and regulations, transactions between related parties should be conducted on an arm’s-length basis and may be subject to audit or challenge by the PRC tax authorities. We could face material adverse tax consequences if the PRC tax authorities determine that the contractual arrangements among our subsidiary in China, Hanyi E-Commerce and its shareholders are not conducted on an arm’s-length basis and adjust the income of Hanyi E-Commerce and its subsidiaries through the transfer pricing adjustment. A transfer pricing adjustment could, among other things, result in, for PRC tax purposes, increased tax liabilities of our subsidiary in China and affiliates. In addition, the PRC tax authorities may require us to disgorge our prior tax benefits, and require us to pay additional taxes for prior tax years and impose late payment fees and other penalties on our subsidiary in China and affiliates for underpayment of prior taxes. To date, similar contractual arrangements have been used by many public companies, including companies listed in the United States, and, to our knowledge, the PRC tax authorities have not imposed any material penalties on those companies. However, we cannot assure you that such penalties will not be imposed on any other companies or us in the future. Our net income may be reduced if the tax liabilities of Hanyi E-Commerce and its subsidiaries materially increase or if they are found to be subject to additional tax obligations, late payment fees or other penalties.

 

Hanyi E-Commerce and its subsidiaries may become the subject of a bankruptcy or liquidation proceeding.

 

We currently conduct our operations in China through contractual arrangements with Hanyi E-Commerce and its shareholders. As part of these arrangements, substantially all of our assets that are critical to the operation of our business are held by Hanyi E-Commerce and its subsidiaries. If any of these entities goes bankrupt and all or part of their assets become subject to liens or rights of third-party creditors, we may be unable to continue some or all of our business activities, which could materially and adversely affect our business, financial condition and results of operations. If any of Hanyi E-Commerce and its subsidiaries undergoes a voluntary or involuntary liquidation proceeding, its equity owner or unrelated third-party creditors may claim rights relating to some or all of these assets, which would hinder our ability to operate our business and could materially and adversely affect our business, our ability to generate revenue and the market price of our ADSs.

 

Our corporate actions are significantly influenced by our principal shareholders, including our founders, FENG Min, SUN Lei (Ray) and SHEN Chao (Eric), who have the ability to exert significant influence over important corporate matters that require approval of shareholders, which may deprive you of an opportunity to receive a premium for your ADSs and materially reduce the value of your investment.

 

Each of our Class A ordinary shares is entitled to one vote and each of our Class B ordinary shares is entitled to ten votes at general meetings of our shareholders. Immediately after the completion of our initial public offering, FENG Min, SUN Lei (Ray) and SHEN Chao (Eric) will beneficially own, in aggregate, 100% of our Class B ordinary shares, representing approximately 88.2% of the aggregate voting power of our issued and outstanding share capital, while FENG Min will beneficially own 56.4% of our Class B ordinary shares, representing approximately 49.8% of the aggregate voting power of our issued and outstanding share capital, assuming the underwriters do not exercise their option to purchase additional ADSs. This concentration of ownership and the protective provisions in our second amended and restated memorandum and articles of association, which will become effective upon the completion of our initial public offering, may discourage, delay or prevent a change in control of our company, which could have the dual effect of depriving our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and reducing the price of the ADSs. As a result of the foregoing, the value of your investment could be materially reduced.

 

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The custodians or authorized users of our controlling non-tangible assets, including chops and seals, may fail to fulfill their responsibilities, or misappropriate or misuse these assets.

 

Under PRC law, legal documents for corporate transactions, including agreements and contracts that our business relies on, are executed using the chop or seal of the signing entity or with the signature of a legal representative whose designation is registered and filed with the relevant PRC industry and commerce authorities.

 

In order to maintain the physical security of our chops, we generally have them stored in secured locations accessible only to authorized employees. Although we monitor such authorized employees, the procedures may not be sufficient to prevent all instances of abuse or negligence. There is a risk that our employees could abuse their authority, for example, by entering into a contract not approved by us or seeking to gain control of one of our subsidiaries or affiliates. If any employee obtains, misuses or misappropriates our chops and seals or other controlling intangible assets for whatever reason, we could experience disruption to our normal business operations. We may have to take corporate or legal action, which could involve significant time and resources to resolve and divert management from our operations.

 

Risks Relating to Doing Business in China

 

The economic, political and social conditions in China, as well as government policies, laws and regulations, could affect our business, financial condition and results of operations.

 

Our operations are in China and our revenue is derived from our operations in China. Accordingly, our results of operations and prospects are, to a significant degree, subject to economic, political and legal developments in China. The economy of China differs from the economies of most developed countries in many respects, including the extent of government involvement, its level of development, its growth rate and its control over foreign exchange. China’s economy has been transitioning from a planned economy to a more market-oriented economy. In recent years, the PRC government has implemented measures emphasizing market forces for economic reform, the reduction of State ownership of productive assets and the establishment of sound corporate governance in business enterprises. However, a significant portion of productive assets in China is still owned by the PRC government. The PRC government continues to play a significant role in regulating industrial development. It also exercises significant control over China’s economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policies and providing preferential treatments to particular industries or companies. All of these factors could affect the economic conditions in China and, in turn, our business.

 

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

 

Our operating subsidiaries are incorporated under and governed by the laws of the PRC. The PRC legal system is based on written statutes. Prior court decisions may be cited for reference, but have limited precedential value. In 1979, the PRC government began to promulgate a comprehensive system of laws and regulations governing economic matters in general, such as foreign investment, corporate organization and governance, commerce, taxation and trade. As a significant part of our business is conducted in China, our operations are principally governed by PRC laws and regulations. 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 involves uncertainties, which may limit legal protections available to us. Furthermore, intellectual property rights and confidentiality protections in China may not be as effective as in the United States or other countries. In addition, we cannot predict the effect of future developments in the PRC legal system, including the promulgation of new laws, changes to existing laws or the interpretation or enforcement thereof, or the preemption of local regulations by national laws. These uncertainties could limit the legal protections available to us and other foreign investors, including you. In addition, any litigation in China may be protracted and result in substantial costs and diversion of our resources and management attention.

 

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PRC regulation of loans to, and direct investment in, PRC entities by offshore holding companies and governmental control of currency conversion may restrict or prevent us from using the proceeds of our initial public offering to make loans to our PRC subsidiary and our VIE, or to make additional capital contributions to our PRC subsidiary.

 

In utilizing the proceeds of our initial public offering, we, as an offshore holding company, are permitted under PRC laws and regulations to provide funding to our PRC subsidiary, which is treated as a foreign investment enterprise, or FIE, under PRC laws, through loans or capital contributions. However, loans by us to our PRC subsidiary to finance its activities cannot exceed statutory limits and must be registered with the local counterpart of the State Administration of Foreign Exchange, or the SAFE, and capital contributions to our PRC subsidiary are subject to the requirement of making necessary filings in the Foreign Investment Comprehensive Management Information System, and registration with other governmental authorities in China.

 

The SAFE promulgated the Notice of the State Administration of Foreign Exchange on Reforming the Administration of Foreign Exchange Settlement of Capital of Foreign-invested Enterprises, or Circular 19, effective on June 1, 2015. According to Circular 19, the flow and use of the Renminbi capital converted from foreign currency-denominated registered capital of a FIE is regulated such that Renminbi capital may not be used for the issuance of Renminbi entrusted loans, the repayment of inter-enterprise loans or the repayment of banks loans that have been transferred to a third party. Although Circular 19 allows Renminbi capital converted from foreign currency-denominated registered capital of a FIE to be used for equity investments within the PRC, it also reiterates the principle that Renminbi converted from the foreign currency-denominated capital of a FIE may not be directly or indirectly used for purposes beyond its business scope. Thus, it is unclear whether the SAFE will permit such capital to be used for equity investments in the PRC in actual practice. The SAFE promulgated the Notice of the State Administration of Foreign Exchange on Reforming and Standardizing the Foreign Exchange Settlement Management Policy of Capital Account, or Circular 16, effective on June 9, 2016, which reiterates some of the rules set forth in Circular 19, but changes the prohibition against using Renminbi capital converted from foreign currency-denominated registered capital of a foreign-invested company to issue Renminbi entrusted loans to a prohibition against using such capital to issue loans to non-associated enterprises. Violations of SAFE Circular 19 and Circular 16 could result in administrative penalties. Circular 19 and Circular 16 may significantly limit our ability to transfer any foreign currency we hold, including the net proceeds from our initial public offering, to our PRC subsidiary, which may adversely affect our liquidity and our ability to fund and expand our business in the PRC.

 

Due to the restrictions imposed on loans in foreign currencies extended to any PRC domestic companies, we are not likely to make such loans to our VIE and its subsidiaries, each a PRC domestic company. Meanwhile, we are not likely to finance the activities of our VIE and its subsidiaries by means of capital contributions given the restrictions on foreign investment in the businesses that are currently conducted by our VIE and its subsidiaries.

 

In light of the various requirements imposed by PRC regulations on loans to, and direct investment in, PRC entities by offshore holding companies, we cannot assure you that we will be able to complete the necessary government registrations or obtain the necessary government approvals on a timely basis, if at all, with respect to future loans to our PRC subsidiary or VIE or future capital contributions by us to our PRC subsidiary. As a result, uncertainties exist as to our ability to provide prompt financial support to our PRC subsidiary or VIE and its subsidiaries when needed. If we fail to complete such registrations or obtain such approvals, our ability to use foreign currency, including the proceeds we received from our initial public offering, and to capitalize or otherwise fund our PRC operations may be negatively affected, which could materially and adversely affect our liquidity and our ability to fund and expand our business.

 

PRC regulations relating to offshore investment activities by PRC residents may limit our overseas investments or limit our PRC subsidiary’s ability to distribute profits to us or otherwise expose us to liability and penalties under PRC law.

 

PRC enterprises’ overseas direct investment is under the supervision of the MOFCOM, the NDRC and the SAFE, and shall be subject to relevant governing rules such as the Administrative Measures for the Outbound Investment of Enterprises promulgated by the NDRC on December 26, 2017, Administrative Measures for Outbound Investment promulgated by the MOFCOM on September 6, 2014 and the Circular of the State Administration of Foreign Exchange on Further Simplifying and Improving the Direct Investment-related Foreign Exchange Administration Policies promulgated by the SAFE on February 13, 2015. Where PRC enterprises make overseas direct investment, they shall file with or obtain the approval from the MOFCOM and the NDRC, or their local counterparts, and register with the banks as well.

 

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The SAFE promulgated the Circular on Relevant Issues Relating to Domestic Resident’s Investment and Financing and Roundtrip Investment through Special Purpose Vehicles, or SAFE Circular 37, in July 2014 that requires PRC residents or entities to register with the SAFE or its local branch in connection with their establishment or control of an offshore entity established for the purpose of overseas investment or financing. In addition, such PRC residents or entities must update their SAFE registrations when the offshore special purpose vehicle undergoes material events relating to any change of basic information (including change of such PRC citizens or residents, name and operation term), increases or decreases in investment amount, transfers or exchanges of shares, or mergers or divisions. According to the Notice on Further Simplifying and Improving Policies for the Foreign Exchange Administration of Direct Investment released in February 2015 by the SAFE, local banks will examine and handle foreign exchange registration for overseas direct investment, including the initial foreign exchange registration and amendment registration, under SAFE Circular 37 from June 2015.

 

If our shareholders who are PRC residents or entities do not complete their registration with the local SAFE branches, our PRC subsidiary may be prohibited from distributing their profits and proceeds from any reduction in capital, share transfer or liquidation to us, and we may be restricted in our ability to contribute additional capital to our PRC subsidiary. Moreover, failure to comply with the SAFE registration described above could result in liability under PRC laws for evasion of applicable foreign exchange restrictions.

 

FENG Min, SUN Lei (Ray), SHEN Chao (Eric), ZHANG Yi, also known as ZHANG Dayi, have completed initial SAFE registration in connection with our financings and will update their registration filings with the SAFE under SAFE Circular 37 when any changes should be registered under SAFE Circular 37.

 

However, we may not at all times be fully aware or informed of the identities of all our shareholders or beneficial owners that are required to make or update such registrations, and we cannot compel our beneficial owners to comply with SAFE registration requirements. As a result, we cannot assure you that all of our shareholders or beneficial owners who are PRC residents or entities have complied with, and will in the future make or obtain any applicable registrations or approvals required by, SAFE regulations. Failure by such shareholders or beneficial owners to comply with SAFE regulations or failure by us to amend the foreign exchange registrations of our PRC subsidiary, could subject us to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our subsidiaries’ ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.

 

If any of our shareholders regulated by such policies fails to satisfy the applicable overseas direct investment filing or approval requirement timely or at all, it may be subject to penalties from the relevant PRC authorities.

 

We rely on dividends paid by our subsidiaries for our cash needs, and any limitation on the ability of our subsidiaries to make payments to us could have a material and adverse effect on our ability to conduct our business.

 

We are a holding company incorporated in the Cayman Islands and operate our business through our operating entities in China and Hong Kong. We rely on dividends paid by our subsidiaries for our cash needs, including the funds necessary to pay any dividends and other cash distributions to our shareholders, to service any debt we may incur and to pay our operating expenses. The payment of dividends by entities established in China is subject to limitations. Regulations in China currently permit payment of dividends only out of accumulated profits as determined in accordance with accounting standards and regulations in China. Our PRC subsidiary is also required to set aside at least 10% of its after-tax profit based on PRC accounting standards each year to its general reserves or statutory capital reserve fund until the aggregate amount of such reserves reaches 50% of its respective registered capital. Its statutory reserves are not distributable as loans, advances or cash dividends. We anticipate that in the foreseeable future our PRC subsidiary will need to continue to set aside 10% of its after-tax profits to its statutory reserves. In addition, if our PRC subsidiary incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other distributions to us. Any limitations on the ability of our PRC subsidiary 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.

 

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In addition, under the Enterprise Income Tax Law, or the EIT Law, the Notice of the State Administration of Taxation on Negotiated Reduction of Dividends and Interest Rates, or Notice 112, which was issued on January 29, 2008, the Arrangement between the PRC and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion, or the Double Taxation Arrangement (Hong Kong), which became effective on December 19, 2006, and the Announcement of the State Administration of Taxation on Issues concerning the “Beneficial Owner” in Tax Treaties, or Announcement No. 9, which became effective on April 1, 2018, dividends from our PRC subsidiary paid to us through our Hong Kong subsidiary may be subject to a withholding tax at a rate of 10%, or at a rate of 5% if our Hong Kong subsidiary is considered as a “beneficial owner” that is generally engaged in substantial business activities and entitled to treaty benefits under the Double Taxation Arrangement (Hong Kong). Furthermore, the ultimate tax rate will be determined by treaty between the PRC and the tax residence of the holder of the PRC subsidiary. We are actively monitoring the withholding tax and are evaluating appropriate organizational changes to minimize the corresponding tax impact.

 

We may be classified as a “resident enterprise” for PRC enterprise income tax purposes, which could result in unfavorable tax consequences to us and our non-PRC shareholders.

 

The EIT Law provides that enterprises established outside of the PRC whose “de facto management bodies” are located in the PRC are considered “resident enterprises” and are generally subject to the uniform 25% enterprise income tax rate on their worldwide income. In addition, a circular issued by the State Administration of Taxation, or the SAT, on April 22, 2009 regarding the standards used to classify certain PRC-invested enterprises controlled by PRC enterprises or PRC group enterprises and established outside of the PRC as “resident enterprises” clarified that dividends and other income paid by such “resident enterprises” will be considered to be PRC-source income, subject to PRC withholding tax, currently at a rate of 10%, when recognized by non-PRC enterprise shareholders. This circular also subjects such “resident enterprises” to various reporting requirements with PRC tax authorities. Under the implementation regulations to the enterprise income tax, a “de facto management body” is defined as a body that has material and overall management and control over the manufacturing and operations, personnel and human resources, finances and properties of an enterprise. In addition, the circular mentioned above sets out criteria for determining whether “de facto management bodies” are located in the PRC for overseas incorporated, domestically controlled enterprises. However, as this circular only applies to enterprises established outside of the PRC that are controlled by PRC enterprises or groups of PRC enterprises, it remains unclear how the tax authorities will determine the location of “de facto management bodies” of overseas incorporated enterprises that are controlled by foreign enterprises or individuals. Therefore, although substantially all of our management is currently located in the PRC, 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 consider our company to be a PRC resident enterprise. However, if PRC tax authorities disagree with our assessment and determine that we are a “resident enterprise”, we may be subject to enterprise income tax at a rate of 25% on our worldwide income and dividends paid by us to our non-PRC shareholders as well as capital gains recognized by them with respect to the sale of our shares or ADSs may be subject to a PRC withholding tax. This will have an impact on our effective tax rate, a material adverse effect on our net income and results of operations, and may require us to withhold tax on our non-PRC shareholders.

 

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

 

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

 

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

 

In October 2017, the SAT issued an Announcement on Issues Relating to Withholding at Source of Income Tax of Non-resident Enterprises, or SAT Circular 37. Effective December 2017, SAT Circular 37, among others, repealed the Circular 698 and amended certain provisions in SAT Circular 7. According to SAT Circular 37, where the non-resident enterprise fails to declare the tax payable pursuant to Article 39 of the Enterprise Income Tax, the tax authority may order it to pay the tax due within required time limits, and the non-resident enterprise shall declare and pay the tax payable within such time limits specified by the tax authority. However, if the non-resident enterprise voluntarily declares and pays the tax payable before the tax authority orders it to do so within the required time limits, it shall be deemed that such enterprise has paid the tax in time.

 

We face uncertainties as to the reporting and other implications of certain past and future transactions where PRC taxable assets are involved, such as offshore restructuring, sale of the shares in our offshore subsidiaries and investments. Our company may be subject to filing obligations or taxed if our company is the transferor in such transactions, and may be subject to withholding obligations if our company is the transferee in such transactions, under SAT Circular 7 and SAT Circular 37. For transfer of shares in our company by investors who are non-PRC resident enterprises, our PRC subsidiary may be requested to assist in the filing under the SAT circulars. As a result, we may be required to expend valuable resources to comply with the SAT circulars, to request the relevant transferors from whom we purchase taxable assets to comply with these circulars, or to establish that our company should not be taxed under these circulars, any of which may have a material adverse effect on our financial condition and results of operations.

 

It may be difficult to effect service of process upon us or our directors or executive officers who reside in China or to enforce against them in China any judgments obtained from non-PRC courts.

 

Most of our directors and executive officers reside within China, and most of our assets and the assets of those persons are located within China. It may not be possible for investors to effect service of process upon us or those persons inside China or to enforce against us or them in China any judgments obtained from non-PRC courts. China does not have treaties providing for the reciprocal recognition and enforcement of judgments of courts in the United States, the United Kingdom, Japan or most other western countries. However, judgments rendered by Hong Kong courts may be recognized and enforced in China if the requirements set forth by the Arrangement on Mutual Recognition and Enforcement of Judgments in Civil and Commercial Matters by Courts of Mainland and of the Hong Kong Special Administrative Region Pursuant to Agreed Jurisdiction by Parties Concerned are met.

 

Therefore, recognition and enforcement in China of judgments of a court in any of these jurisdictions other than Hong Kong in relation to any matter not subject to binding arbitration provisions may be difficult or impossible.

 

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The PRC government’s control over foreign currency conversion may adversely affect our business and results of operations and our ability to remit dividends.

 

Conversion and remittance of foreign currencies are subject to the PRC foreign exchange regulations. It cannot be guaranteed that under a certain exchange rate, we shall have sufficient foreign exchange to meet our foreign exchange needs. Under the current PRC foreign exchange control system, foreign exchange transactions under the current account conducted by us, including the payment of dividends, do not require advance approval from the SAFE, but we are required to present relevant documentary evidence of such transactions and conduct such transactions at designated foreign exchange banks within China that have the licenses to carry out foreign exchange business. Foreign exchange transactions under the capital account, however, normally need to be approved by or registered with the SAFE or its local branch unless otherwise permitted by law. The PRC government may also at its discretion restrict access in the future to foreign currencies for current account transactions. Any insufficiency of foreign exchange may restrict our ability to obtain sufficient foreign exchange for dividend payments to shareholders or satisfy any other foreign exchange obligation. If we fail to obtain approvals from the SAFE to convert RMB into any foreign exchange for any of the above purposes, our potential offshore capital expenditure plans and even our business may be materially and adversely affected.

 

In light of the flood of capital outflows of China in 2016 due to the weakening RMB, the PRC government has imposed more restrictive foreign exchange policies and stepped up scrutiny of major outbound capital movement including overseas direct investment. More restrictions and substantial vetting process are put in place by the SAFE to regulate cross-border transactions falling under the capital account. If any of our shareholders regulated by such policies fails to satisfy the applicable overseas direct investment filing or approval requirement timely or at all, it may be subject to penalties from the relevant PRC authorities. The PRC government may at its discretion further restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currencies to satisfy our foreign currency demands, we may not be able to pay dividends in foreign currencies to our shareholders, including holders of our ADSs.

 

Inflation in China could negatively affect our profitability and growth.

 

Economic growth in China has, during certain periods, been accompanied by periods of high inflation, and the Chinese government has implemented various policies from time to time to control inflation. For example, the PRC government introduced measures in certain sectors to avoid overheating of the Chinese economy, including increasing interest rates and capital reserve thresholds at Chinese commercial banks. The effects of the stimulus measures implemented by the PRC government since the global economic crisis that commenced in 2008 and the continued growth in the overall economy since then have resulted in sustained inflationary pressures. If these inflationary pressures continue and are not mitigated by PRC government measures, our cost of sales will likely increase and our profitability could be materially reduced, as there is no assurance that we would be able to pass any cost increases onto our customers.

 

The audit report included in this annual report is prepared by an auditor who is not inspected by the Public Company Accounting Oversight Board and, as such, you are deprived of the benefits of such inspection.

 

Our independent registered public accounting firm that issues the audit reports included in this annual report, as an auditor of companies that are traded publicly in the United States and a firm registered with the Public Company Accounting Oversight Board, or the PCAOB, is required by the laws of the United States to undergo regular inspections by the PCAOB to assess its compliance with the laws of the United States and professional standards. Because our auditors are located in China, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of the Chinese authorities, our auditors are not currently inspected by the PCAOB. On May 24, 2013, PCAOB announced that it had entered into a Memorandum of Understanding on Enforcement Cooperation with the China Securities Regulatory Commission and the Ministry of Finance which establishes a cooperative framework between the parties for the production and exchange of audit documents relevant to investigations in the United States and China.  Based on publicly available information, it appears that the PCAOB has continued discussions with the Chinese regulators about permitting inspections of audit firms that are registered with PCAOB in relation to the audit of Chinese companies whose securities are traded on U.S. stock exchanges.

 

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On December 7, 2018, the SEC and the PCAOB issued a joint statement highlighting continued challenges faced by the U.S. regulators in their oversight of financial statement audits of U.S.-listed companies with significant operations in China. The joint statement reflects a heightened interest in this issue. However, it remains unclear what further actions the SEC and PCAOB will take and its impact on Chinese companies listed in the U.S.

 

Inspections of other firms that the PCAOB has conducted outside of China have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality. The lack of PCAOB inspections in China prevents the PCAOB from regularly evaluating our auditors’ audits and its quality control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections.

 

The inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of our auditors’ audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections. Investors may lose confidence in our reported financial information and procedures and the quality of our financial statements.

 

Proceedings instituted by the SEC against Chinese affiliates of the “big four” accounting firms, including our independent registered public accounting firm, could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act.

 

Starting in 2011, the Chinese affiliates of the “big four” accounting firms, including our independent registered public accounting firm, were affected by a conflict between U.S. and Chinese law. Specifically, for certain U.S.-listed companies operating and audited in mainland China, the SEC and the PCAOB sought to obtain from the Chinese firms access to their audit work papers and related documents. The firms were, however, advised and directed that, under the PRC law, they could not respond directly to the U.S. regulators on those requests, and that requests by foreign regulators for access to such papers in China had to be channeled through the CSRC.

 

In late 2012, this impasse led the SEC to commence administrative proceedings under Rule 102(e) of its Rules of Practice and also under the Sarbanes-Oxley Act of 2002 against the Chinese accounting firms, including our independent registered public accounting firm. A first instance trial of the proceedings in July 2013 in the SEC’s internal administrative court resulted in an adverse judgment against the firms. The administrative law judge proposed penalties on the firms including a temporary suspension of their right to practice before the SEC, although that proposed penalty did not take effect pending review by the Commissioners of the SEC. On February 6, 2015, before a review by the Commissioner had taken place, the firms reached a settlement with the SEC. Under the settlement, the SEC accepted that future requests by the SEC for the production of documents would normally be made to the CSRC. The firms would receive matching Section 106 requests, and would be required to abide by a detailed set of procedures with respect to such requests, which in substance would require them to facilitate production via the CSRC. The CSRC for its part initiated a procedure whereby, under its supervision and subject to its approval, requested classes of documents held by the accounting firms could be sanitized of problematic and sensitive content so as to render them capable of being made available by the CSRC to U.S. regulators.

 

Under the settlement, the SEC accepted that future requests by the SEC for the production of documents would normally be made to the CSRC. The firms would receive matching Section 106 requests, and would be required to abide by a detailed set of procedures with respect to such requests, which in substance would require them to facilitate production via the CSRC. The CSRC for its part initiated a procedure whereby, under its supervision and subject to its approval, requested classes of documents held by the accounting firms could be sanitized of problematic and sensitive content so as to render them capable of being made available by the CSRC to US regulators.

 

Under the terms of the settlement, the underlying proceeding against the four PRC-based accounting firms was deemed dismissed with prejudice at the end of four years starting from the settlement date, which was on February 6, 2019. Despite the final ending of the proceedings, the presumption is that all parties will continue to apply the same procedures, i.e. the SEC will continue to make its requests for the production of documents to the CSRC, and the CSRC will normally process those requests applying the sanitisation procedure.  We cannot predict whether, in cases where the CSRC does not authorize production of requested documents to the SEC, the SEC will further challenge the four PRC-based accounting firms’ compliance with U.S. law. If additional challenges are imposed on the Chinese affiliates of the “big four” accounting firms, we could be unable to timely file future financial statements in compliance with the requirements of the Exchange Act.

 

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In the event that the SEC restarts the administrative proceedings, depending upon the final outcome, listed companies in the United States with major PRC operations may find it difficult or impossible to retain auditors in respect of their operations in the PRC, which could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act, including possible delisting. Moreover, any negative news about any such future proceedings against these audit firms may cause investor uncertainty regarding China-based, U.S.-listed companies and the market price of our common stock may be adversely affected.

 

If our independent registered public accounting firm was denied, even temporarily, the ability to practice before the SEC and we were unable to timely find another registered public accounting firm to audit and issue an opinion on our financial statements, our financial statements could be determined not to be in compliance with the requirements of the Exchange Act. Such a determination could ultimately lead to the delisting of our ADSs from the Nasdaq Global Select Market or deregistration from the SEC, or both, which would substantially reduce or effectively terminate the trading of our ADSs in the United States.

 

Risks Relating to Our ADSs

 

The trading price of our ADSs may be volatile, which could result in substantial losses to you.

 

The trading prices of our ADSs have fluctuated since we first listed our ADSs. Since our ADSs became listed on the Nasdaq Global Select Market on April 3, 2019, the trading prices of our ADSs ranged from US$12.14 to US$3.06 per ADS, and the last reported trading price on July 29, 2019 was US$3.66 per ADS. The trading price of our ADSs may continue to fluctuate widely due to factors beyond our control. This may happen because of broad market and industry factors, like the performance and fluctuation of the market prices of other companies with operations located mainly in China that have listed their securities in the United States. A number of the PRC companies or companies with operations located mainly in China have listed or are in the process of listing their securities on U.S. stock markets. The securities of some of these companies have experienced significant volatility, including price declines in connection with their initial public offerings. The trading performances of those companies’ securities after their offerings may affect the attitudes of investors toward companies with operations located mainly in China listed in the United States in general and consequently may impact the trading performance of our ADSs, regardless of our actual operating performance.

 

In addition to the above factors, the price and trading volume of our ADSs may be highly volatile due to multiple factors, including the following:

 

·                  variations in our revenues, earnings, cash flow and operating data;

 

·                  announcements of new investments, acquisitions, strategic partnerships or joint ventures by us or our competitors;

 

·                  announcements of new products, services and expansions by us or our competitors;

 

·                  changes in financial estimates by securities analysts;

 

·                  detrimental adverse publicity about us, our services or our industry;

 

·                  additions or departures of key personnel;

 

·                  release of lock-up or other transfer restrictions on our outstanding equity securities or sales of additional equity securities; and

 

·                  potential litigation or regulatory investigations.

 

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Any of these factors may result in large and sudden changes in the volume and price at which our ADSs will trade.

 

In the past, shareholders of public companies have often brought securities class action suits against those companies following periods of instability in the market price of their securities. If we are involved in a class action suit, it could divert a significant amount of our management’s attention and other resources from our business and operations and require us to incur significant expenses to defend the suit, which could harm our results of operations. Any such class action suit, whether or not successful, could harm our reputation and restrict our ability to raise capital in the future. In addition, if a claim is successfully made against us, we may be required to pay significant damages, which could have a material adverse effect on our financial condition and results of operations.

 

If securities or industry analysts do not publish research reports about us or our business, or if they adversely change their recommendations regarding our ADSs, the market price for our ADSs and trading volume could decline.

 

The trading market for our ADSs will be influenced by research reports that industry or securities analysts publish about us or our business. If one or more analysts who cover us downgrade our ADSs, the market price for our ADSs would likely decline. If one or more of these analysts cease to cover us or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause the market price or trading volume for our ADSs to decline.

 

We currently do not expect to pay dividends in the foreseeable future and you must rely on price appreciation of our ADSs for return on your investment.

 

We currently intend to retain most, if not all, of our available funds and any future earnings to fund the development and growth of our business. As a result, we do not expect to pay any cash dividends in the foreseeable future. Therefore, you should not rely on an investment in our ADSs as a source for any future dividend income.

 

Our board of directors has complete discretion as to whether to distribute dividends subject to our memorandum and articles of association and certain restrictions under Cayman Islands law. In addition, our shareholders may by ordinary resolution declare a dividend, but no dividend may exceed the amount recommended by our directors. Even if our board of directors decides to declare and pay dividends, the timing, amount and form of future dividends, if any, will depend on, among other things, our future results of operations and cash flow, our capital requirements and surplus, the amount of distributions, if any, received by us from our subsidiary, our financial condition, contractual restrictions and other factors deemed relevant by our board of directors. Accordingly, the return on your investment in our ADSs will likely depend entirely upon any future price appreciation of our ADSs. There is no guarantee that our ADSs will appreciate in value or even maintain the price at which you purchased the ADSs. You may not realize a return on your investment in our ADSs and you may even lose your entire investment in our ADSs.

 

Substantial future sales or the expectation of substantial sales of our ADSs in the public market could cause the price of our ADSs to decline.

 

Sales of our ADSs in the public market after our initial public offering, or the perception that these sales could occur, could cause the market price of our ADSs to decline. As of June 30, 2019, we have 413,572,659 ordinary shares outstanding, comprising 236,238,409 Class A ordinary shares and 177,334,250 Class B ordinary shares, including 50,000,000 Class A ordinary shares represented by ADSs newly issued in connection with our initial public offering, assuming the underwriters do not exercise their option to purchase additional ADSs. All ADSs sold in our initial public offering will be freely transferable without restriction or additional registration under the U.S. Securities Act of 1933, as amended, or the Securities Act. The remaining Class A ordinary shares outstanding after our initial public offering, including any Class A ordinary shares that may be converted from Class B ordinary shares outstanding after our initial public offering, will be available for sale in the form of ADSs upon the expiration of the 180-day lock-up period beginning from April 2, 2019, being the date of the final prospectus of our initial public offering, subject to volume and other restrictions as applicable under Rule 144 and Rule 701 under the Securities Act. Any or all of these shares may be released prior to expiration of the lock-up period at the discretion of the underwriters. To the extent shares are released before the expiration of the lock-up period and these shares are sold into the market, the market price of our ADSs could decline.

 

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If we are a passive foreign investment company for United States federal income tax purposes for any taxable year, United States holders of our ADSs or Class A ordinary shares could be subject to adverse United States federal income tax consequences.

 

A non-United States corporation will be a passive foreign investment company, or PFIC, for United States federal income tax purposes for any taxable year if either (i) at least 75% of its gross income for such year is passive income or (ii) at least 50% of the value of its assets (based on an average of the quarterly values of the assets) during such year is attributable to assets that produce or are held for the production of passive income. A separate determination must be made after the close of each taxable year as to whether a non-United States corporation is a PFIC for that year. Based on the past and projected composition of our income and assets, and the valuation of our assets, including goodwill (which we have determined based on the price of our ADSs), we do not believe we were a PFIC for our most recent taxable year, and we do not expect to become a PFIC in the current taxable year or in the foreseeable future, although there can be no assurance in this regard.

 

It is possible that we may become a PFIC in the current or any future taxable year due to changes in our asset or income composition. The composition of our assets and income may be affected by how, and how quickly, we use our liquid assets and the cash raised in our initial public offering. Because we have valued our goodwill based on the market value of our ADSs, a decrease in the price of our ADSs may also result in our becoming a PFIC.

 

In addition, there is uncertainty as to the treatment of our corporate structure and ownership of our consolidated VIE for United States federal income tax purposes. For United States federal income tax purposes, we consider ourselves to own the equity of our consolidated VIE. If it is determined, contrary to our view, that we do not own the equity of our consolidated VIE for United States federal income tax purposes (for instance, because the relevant PRC authorities do not respect these arrangements), we may be treated as a PFIC.

 

If we are a PFIC for any taxable year during which a United States person holds ADSs or Class A ordinary shares, certain adverse United States federal income tax consequences could apply to such United States person. See “Item 10. Additional Information — E. Taxation — Material United States Federal Income Tax Considerations — Passive Foreign Investment Company.”

 

Our second amended and restated memorandum and articles of association contain anti-takeover provisions that could have a material adverse effect on the rights of holders of our Class A ordinary shares and ADSs.

 

We have adopted the second amended and restated memorandum and articles of association, which became effective immediately prior to completion of our initial public offering. The second memorandum and articles of association contain provisions to limit the ability of others to acquire control of our company or cause us to engage in change-of-control transactions, including a provision that entitles each Class B ordinary share to ten votes in respect of all matters subject to a shareholders’ vote. These provisions could have the effect of depriving our shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transaction. Although all of our authorized Class B ordinary shares were issued upon the completion of our initial public offering, if any of such Class B ordinary shares are converted into Class A ordinary shares or cancelled for any reasons, our board of directors will have the authority without further action by our shareholders to issue additional Class B ordinary shares, which will be dilutive to our Class A ordinary shareholders. In addition, our board of directors has the authority, without further action by our shareholders, to issue preferred shares in one or more series and to fix their designations, powers, preferences, privileges, and relative participating, optional or special rights and the qualifications, limitations or restrictions, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights associated with our Class A ordinary shares, in the form of ADS or otherwise. Preferred shares could be issued quickly with terms calculated to delay or prevent a change in control of our company or make removal of management more difficult. If our board of directors decides to issue preferred shares, the price of our ADSs may fall and the voting and other rights of the holders of our Class A ordinary shares and ADSs may be materially and adversely affected.

 

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The dual-class structure of our ordinary shares may adversely affect the trading market for our ADSs.

 

Certain shareholder advisory firms have announced changes to their eligibility criteria for inclusion of shares of public companies on certain indices, including the S&P 500, to exclude companies with multiple classes of shares and companies whose public shareholders hold no more than 5% of total voting power from being added to such indices. In addition, several shareholder advisory firms have announced their opposition to the use of multiple class structures. As a result, the dual class structure of our ordinary shares may prevent the inclusion of our ADSs representing Class A ordinary shares in such indices and may cause shareholder advisory firms to publish negative commentary about our corporate governance practices or otherwise seek to cause us to change our capital structure. Any such exclusion from indices could result in a less active trading market for our ADSs. Any actions or publications by shareholder advisory firms critical of our corporate governance practices or capital structure could also adversely affect the value of our ADSs.

 

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

 

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

 

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

 

Certain corporate governance practices in the Cayman Islands, which is our home country, differ significantly from requirements for companies incorporated in other jurisdictions such as the U.S. We intend to rely on some of these exemptions. As a result, you may not be provided with the benefits of certain corporate governance requirements of the Nasdaq Global Select Market.

 

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

 

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

 

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

 

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

 

We are an “emerging growth company,” as defined in the JOBS Act, and we may take advantage of certain exemptions from requirements applicable to other public companies that are not emerging growth companies including, most significantly, not being required to comply with the auditor attestation requirements of Section 404 for so long as we are an emerging growth company. We will remain an emerging growth company until the earliest of (a) the last day of fiscal year during which we have total annual gross revenue of at least US$1.07 billion; (b) the last day of our fiscal year following the fifth anniversary of the completion of our initial public offering; (c) the date on which we have, during the preceding three-year period, issued more than US$1.0 billion in non-convertible debt; or (d) the date on which we are deemed to be a “large accelerated filer” under the Exchange Act, which would occur if the market value of the ADSs that are held by non-affiliates exceeds US$700 million as of the last business day of our most recently completed second fiscal quarter. Once we cease to be an emerging growth company, we will not be entitled to the exemptions provided by the JOBS Act. The JOBS Act also provides that an emerging growth company does not need to comply with any new or revised financial accounting standards until such date that a private company is otherwise required to comply with such new or revised accounting standards and we have not elected to “opt out” of this provision. As a result, our operating results and financial statements may not be comparable to the operating results and financial statements of other companies who have adopted the new or revised accounting standards.

 

As a company incorporated in the Cayman Islands, we are permitted to adopt certain home country practices for corporate governance matters that differ significantly from the Nasdaq Global Select Market corporate governance listing standards; these practices may afford less protection to shareholders than they would enjoy if we complied fully with the corporate governance listing standards.

 

Our ADSs are listed on the Nasdaq Global Select Market. The Nasdaq Global Select Market corporate governance listing standards permit a foreign private issuer like us to follow the corporate governance practices of its home country. Certain corporate governance practices in the Cayman Islands, which is our home country, may differ significantly from the Nasdaq Global Select Market corporate governance listing standards.

 

For instance, we are not required to: (i) have a majority of the board be independent; (ii) have a compensation committee or a nominations or corporate governance committee consisting entirely of independent directors; or (iii) have regularly scheduled executive sessions with only independent directors each year. We intend to rely on some of these exemptions. As a result, you may not be provided with the benefits of certain corporate governance requirements of the Nasdaq Global Select Market.

 

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We are a foreign private issuer within the meaning of the rules under the Exchange Act, and as such we are exempt from certain provisions applicable to United States domestic public companies.

 

Because we are a foreign private issuer under the Exchange Act, we are exempt from certain provisions of the securities rules and regulations in the United States that are applicable to U.S. domestic issuers, including:

 

·                  the rules under the Exchange Act requiring the filing of quarterly reports on Form 10-Q or current reports on Form 8-K with the SEC;

 

·                  the sections of the Exchange Act regulating the solicitation of proxies, consents, or authorizations in respect of a security registered under the Exchange Act;

 

·                  the sections of the Exchange Act requiring insiders to file public reports of their stock ownership and trading activities and liability for insiders who profit from trades made in a short period of time; and

 

·                  the selective disclosure rules by issuers of material nonpublic information under Regulation FD.

 

We are required to file an annual report on Form 20-F within four months of the end of each fiscal year. In addition, we intend to publish our results on a quarterly basis through press releases, distributed pursuant to the rules and regulations of the Nasdaq Global Select Market. Press releases relating to financial results and material events will also be furnished to the SEC on Form 6-K. However, the information we are required to file with or furnish to the SEC will be less extensive and less timely compared to that required to be filed with the SEC by U.S. domestic issuers. As a result, you may not be afforded the same protections or information, which would be made available to you, were you investing in a U.S. domestic issuer.

 

The voting rights of holders of ADSs are limited by the terms of the deposit agreement, and you may not be able to exercise your right to vote your ordinary shares.

 

As a holder of our ADSs, you are only able to exercise the voting rights with respect to the underlying ordinary shares in accordance with the provisions of the deposit agreement. Under the deposit agreement, you must vote by giving voting instructions to the depositary. Upon receipt of your voting instructions, (a) if voting is by poll, the depositary will vote the underlying ordinary shares in accordance with these instructions and (b) if voting is by show of hands, the depositary will vote the underlying Class A ordinary shares in accordance with the voting instructions received from a majority of holders of ADSs who provided truly voting instructions. You are not able to directly exercise your right to vote with respect to the underlying shares unless you withdraw the shares. Under our second amended and restated memorandum and articles of association, which became effective immediately prior to the completion of our initial public offering, the minimum notice period required for convening a general meeting is seven days. When a general meeting is convened, you may not receive sufficient advance notice to withdraw the shares underlying your ADSs to allow you to vote with respect to any specific matter. If we ask for your instructions, the depositary will notify you of the upcoming vote and will arrange to deliver our voting materials to you. We cannot assure you that you will receive the voting materials in time to ensure that you can instruct the depositary to vote your shares. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions or for their manner of carrying out your voting instructions. This means that you may not be able to exercise your right to vote and you may have no legal remedy if the shares underlying your ADSs are not voted as you requested.

 

Your rights to pursue claims against the depositary as a holder of ADSs are limited by the terms of the deposit agreement and the deposit agreement may be amended or terminated without your consent.

 

Under the deposit agreement, any action or proceeding against or involving the depositary, arising out of or based upon the deposit agreement or the transactions contemplated thereby or by virtue of owning the ADSs (including any such action or proceeding that may arise under the Securities Act or Exchange Act) may only be instituted in a state or federal court in New York, New York, and you, as a holder of our ADSs, will have irrevocably waived any objection which you may have to the laying of venue of any such proceeding, and irrevocably submitted to the exclusive jurisdiction of such courts in any such action or proceeding. Also, we may amend or terminate the deposit agreement without your consent. If you continue to hold your ADSs after an amendment to the deposit agreement, you will be deemed to have agreed to be bound by the deposit agreement as amended, unless such amendment is found to be invalid under any applicable laws, including the federal securities law.

 

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ADSs holders may not be entitled to a jury trial with respect to claims arising under the deposit agreement, which could result in less favorable outcomes to the plaintiffs in any such action.

 

The deposit agreement governing the ADSs representing our Class A ordinary shares provides that, to the fullest extent permitted by applicable law, ADSs holders waive the right to a jury trial of any claim they may have against us or the depositary arising out of or relating to our shares, the ADSs or the deposit agreement, including any claim under the U.S. federal securities laws. The waiver to right to a jury trial of the deposit agreement is not intended to be deemed a waiver by any holder or beneficial owner of ADSs or the depositary’s compliance with the U.S. federal securities laws and the rules and regulations promulgated thereunder.

 

If we or the depositary oppose a jury trial demand based on the waiver, the court would determine whether the waiver was enforceable based on the facts and circumstances of that case in accordance with the applicable state and federal law. The enforceability of a contractual pre-dispute jury trial waiver in connection with claims arising under the federal securities laws has not been finally adjudicated by the United States Supreme Court. However, we believe that a contractual pre-dispute jury trial waiver provision is generally enforceable, including under the laws of the State of New York, which govern the deposit agreement. In determining whether to enforce a contractual pre-dispute jury trial waiver provision, courts will generally consider whether a party knowingly, intelligently and voluntarily waived the right to a jury trial. We believe that this is the case with respect to the deposit agreement and the ADSs. It is advisable that you consult legal counsel regarding the jury waiver provision before investing in the ADSs.

 

If you or any other holders or beneficial owners of ADSs bring a claim against us or the depositary in connection with matters arising under the deposit agreement or the ADSs, including claims under federal securities laws, you or such other holder or beneficial owner may not be entitled to a jury trial with respect to such claims, which may have the effect of limiting and discouraging lawsuits against us and/or the depositary. If a lawsuit is brought against us and/or the depositary under the deposit agreement, it may be heard only by a judge or justice of the applicable trial court, which would be conducted according to different civil procedures and may result in different outcome than a trial by jury would have had, including results that could be less favorable to the plaintiffs in any such action.

 

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The depositary for our ADSs will give us a discretionary proxy to vote Class A ordinary shares underlying your ADSs if you do not vote at shareholders’ meetings, except in limited circumstances, which could adversely affect your interests.

 

Under the deposit agreement for the ADSs, if you do not vote, the depositary will give us a discretionary proxy to vote our Class A ordinary shares underlying your ADSs at shareholders’ meetings unless:

 

·                       we have failed to timely provide the depositary with notice of meeting and related voting materials;

 

·                       we have instructed the depositary that we do not wish a discretionary proxy to be given;

 

·                      we have informed the depositary that there is substantial opposition as to a matter to be voted on at the meeting;

 

·                       a matter to be voted on at the meeting may have a material adverse impact on shareholders; or

 

·                       the voting at the meeting is to be made on a show of hands.

 

The effect of this discretionary proxy is that if you do not vote at shareholders’ meetings, you cannot prevent our Class A ordinary shares underlying your ADSs from being voted, except under the circumstances described above. This may make it more difficult for shareholders to influence the management of our company. Holders of our Class A ordinary shares are not subject to this discretionary proxy.

 

You may not receive dividends or other distributions on our Class A ordinary shares and you may not receive any value for them, if it is illegal or impractical to make them available to you.

 

The depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian receives on Class A ordinary shares or other deposited securities underlying our ADSs, after deducting its fees and expenses. You will receive these distributions in proportion to the number of Class A ordinary shares your ADSs represent. However, the depositary is not responsible if it decides that it is unlawful or impractical to make a distribution available to any holders of ADSs. For example, it would be unlawful to make a distribution to a holder of ADSs if it consists of securities that require registration under the Securities Act but that are not properly registered or distributed under an applicable exemption from registration. The depositary may also determine that it is not feasible to distribute certain property through the mail. Additionally, the value of certain distributions may be less than the cost of mailing them. In these cases, the depositary may determine not to distribute such property. We have no obligation to register under U.S. securities laws any ADSs, Class A ordinary shares, rights or other securities received through such distributions. We also have no obligation to take any other action to permit the distribution of ADSs, Class A ordinary shares, rights or anything else to holders of ADSs. This means that you may not receive distributions we make on our Class A ordinary shares or any value for them if it is illegal or impractical for us to make them available to you. These restrictions may cause a material decline in the value of our ADSs.

 

You may experience dilution of your holdings due to inability to participate in rights offerings.

 

We may, from time to time, distribute rights to our shareholders, including rights to acquire securities. Under the deposit agreement, the depositary will not distribute rights to holders of ADSs unless the distribution and sale of rights and the securities to which these rights relate are either exempt from registration under the Securities Act with respect to all holders of ADSs, or are registered under the provisions of the Securities Act. The depositary may, but is not required to, attempt to sell these undistributed rights to third parties, and may allow the rights to lapse. We may be unable to establish an exemption from registration under the Securities Act, and we are under no obligation to file a registration statement with respect to these rights or underlying securities or to endeavor to have a registration statement declared effective. Accordingly, holders of ADSs may be unable to participate in our rights offerings and may experience dilution of their holdings as a result.

 

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

 

Your ADSs are transferable on the books of the depositary. However, the depositary may close its books at any time or from time to time when it deems expedient in connection with the performance of its duties. The depositary may close its books from time to time for a number of reasons, including in connection with corporate events such as a rights offering, during which time the depositary needs to maintain an exact number of ADS holders on its books for a specified period. The depositary may also close its books in emergencies, and on weekends and public holidays. The depositary may refuse to deliver, transfer or register transfers of our ADSs generally when our share register or the books of the depositary are closed, or at any time if we or the depositary thinks it is advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.

 

The requirements of being a public company may strain our resources and divert management’s attention.

 

As a public company, we are subject to the reporting requirements of the U.S. Securities Exchange Act of 1934, as amended, or the Exchange Act, the U.S. Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, the Dodd-Frank Act and the listing standards of the Nasdaq Global Select Market as applicable to a foreign private issuer, which are different in some material respects from those required for a U.S. public company. We expect that the requirements of these rules and regulations will increase our legal, accounting and financial compliance costs, make some activities more difficult, time consuming and costly, and place significant strain on our personnel, systems and resources. As a result of disclosure of information in this annual report and in filings required of a public company, our business and financial condition will become more visible, which we believe may result in threatened or actual litigation, including by competitors, shareholders or third parties. If such claims are successful, our business and operating results could be harmed, and even if the claims do not result in litigation or are resolved in our favor, these claims, and the time and resources necessary to resolve them, could divert the resources of our management and harm our business, financial condition and results of operations.

 

ITEM 4.                             INFORMATION ON THE COMPANY

 

A.                 History and Development of the Company

 

In March 2016, our predecessor, Hanyi E-Commerce, was established in the PRC by Hangzhou Ruhnn Holdings Co., Ltd., or Hangzhou Ruhnn, which was owned by our founders, FENG Min, SUN Lei (Ray) and SHEN Chao (Eric) and several institutional investors.

 

In preparation for our initial public offering, our founders and the institutional investors of Hanyi E-Commerce undertook a series of equity transactions as described below, or the Equity Restructuring, to re-domicile the holding entity of our business from the PRC to the Cayman Islands.

 

In May 2018, our company, Ruhnn Holding Limited, was incorporated in the Cayman Islands as the proposed listing entity. The address of its registered office is 89 Nexus Way, Camana Bay, Grand Cayman, KY1-9009, Cayman Islands. In June 2018, WuHan Investment Limited, or WuHan Investment, was incorporated in the British Virgin Islands as a wholly owned subsidiary of our company. In August 2018, YiHnn (Hong Kong) Limited, or YiHnn HK, was incorporated in Hong Kong as a wholly owned subsidiary of WuHan Investment. In September 2018, Hangzhou Yihan Technology Co., Ltd., or Yihan Technology or the WFOE, was established in the PRC as a wholly owned subsidiary of YiHnn HK.

 

On October 4, 2018, our company, our founders and the institutional investors of Hangzhou Ruhnn entered into a series of agreements whereby our company issued 319,406,660 ordinary shares to these founders and institutional shareholders at substantially identical ownership percentages as their existing indirect ownership in Hanyi E-Commerce. On the same date, we obtained 100% control over Hanyi E-Commerce through a series of contractual arrangements among the WFOE, Hanyi E-Commerce and its shareholders. These contractual agreements enabled the WFOE to have effective control over and receive the economic benefits of Hanyi E-Commerce. Accordingly, we are considered the primary beneficiary of Hanyi E-Commerce, and are able to consolidate Hanyi E-Commerce and its operating subsidiaries in our financial statements. For more details, please see “—C. Organizational Structure—Contractual Arrangements with Our VIE and Its Shareholders” Under the restructuring agreements, Hangzhou Ruhnn agreed to return to its institutional investors the amounts of their original Renminbi investments in Hangzhou Ruhnn while these investors agreed to pay the U.S. dollar equivalent of such amounts to our company as subscription price for the ordinary shares we issued to them. Hanyi E-Commerce also had amounts due to Hangzhou Ruhnn that were approximately the same as the amounts Hangzhou Ruhnn agreed to return to the investors. As of the date of this annual report, Hanyi E-Commerce has fully repaid the amount due to Hangzhou Ruhnn, Hangzhou Ruhnn has returned the original Renminbi investments to its institutional investors, the investors have fully paid the subscription price to our company, and the Equity Restructuring was fully completed.

 

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In March 2019, in order to acquire the remaining ownership of Hangzhou Dayi, and convert it from a 51%-owned subsidiary to a wholly owned subsidiary of Hanyi E-Commerce, we entered into the following agreements with ZHANG Yi, one of our top KOLs, and her affiliated entities: (i) an equity interest transfer agreement pursuant to which Hangzhou Wunai Yidui Trade Co., Ltd. agreed to transfer 49% equity interest in Hangzhou Dayi to Hanyi E-Commerce; and (ii) a share purchase agreement pursuant to which we agreed to issue 44,165,899 ordinary shares, which have been re-designated to Class A ordinary shares, to China Himalaya Investment Limited, a company wholly owned by ZHANG Yi. These transactions were completed in the same month. In connection with these transactions, ZHANG Yi also agreed to continue her exclusive cooperation with us in online sales of women apparel products until the later of five years after the completion of our initial public offering or when her beneficial interests in our company fall below 5%.

 

B.                 Business Overview

 

Overview

 

We are the largest internet KOL facilitator in China as measured by revenue in 2018 according to the Frost & Sullivan report. We are also China’s largest internet KOL facilitator in e-commerce as measured by the number of online stores and GMV in 2018 and number of signed KOLs and fans as of March 31, 2018 according to the same source. As of March 31, 2019, we had 128 signed KOLs with an aggregate of 155.1 million fans across major social media platforms in China. Through our KOLs, we facilitated the sale of an aggregate GMV of RMB1.2 billion, RMB2.0 billion and RMB2.9 billion on various e-commerce platforms in fiscal years 2017, 2018 and 2019, respectively.

 

KOLs, also known as influencers, are individuals who have the power to engage and impact people within a specific community or field, such as fashion, culture, entertainment and gaming, and internet KOLs are KOLs who have gained their popularity through the internet. Our founders were among the earliest entrepreneurs in China to identify and capture the commercial opportunities created by the emergence of internet KOLs in China and started to cooperate with KOLs in e-commerce in 2014. We created a KOL ecosystem in China according to the Frost & Sullivan report by connecting a large number of KOLs and their fans to create a vast network and connecting this network to a large number of businesses, including brands, online retailers, designers, manufacturers and suppliers, based on existing e-commerce and social media platforms in China, to create value for participants in the ecosystem.

 

According to the Frost & Sullivan report, we pioneered the commercialization of the KOL ecosystem through a full-service model whereby we integrate key steps of the e-commerce value chain, from product design and sourcing and online store operation to logistics and after sales services. Under this model, we own and operate online stores on third-party e-commerce platforms, a majority of which are opened in the name of our KOLs, and generate revenue through online sales of our self-designed products to consumers, especially the fans of our KOLs’ social media accounts that we manage. We provide professional training and support to our KOLs and help them develop distinctive characters, enhance popularity and grow their fan bases. We also set up different brands for different KOLs and design and produce branded products based on each KOL’s distinctive character to cater to the tastes of different KOLs’ fan bases, while our KOLs endorse such products in their social media spaces.

 

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As we established our “Ruhnn” brand and attracted more talented KOLs, we launched our platform model in 2017 to provide KOL sales and advertising services to brands and other merchants. Under this model, we connect our KOLs with third-party online stores and merchants to promote products sold in third-party online stores or provide advertising services on KOLs’ social media spaces to third-party merchants. This new model allows us to operate in a more asset-light manner and collaborate with a greater number and variety of KOLs and brands.

 

We pride ourselves on our ability to identify and cultivate a large number of promising internet KOLs in an efficient and sustainable manner. The flexibility of our business and revenue model also enables us to work with a diversified KOL pool, including KOLs with different fashion styles, personalities and fan bases, and serve the different needs of various types of businesses. The number of our KOLs increased from 62 as of March 31, 2017 to 83 as of March 31, 2018 and further to 128 as of March 31, 2019, including three top-tier KOLs each with annual GMV of above RMB100.0 million and eight established KOLs each with annual GMV of between RMB30.0 million and RMB100.0 million in the past twelve months. One of our KOLs is among top ten fashion internet KOLs in China as measured by number of fans according to the Frost & Sullivan report. As of March 31, 2019, we cooperated with 632 brands and 132 third-party online stores to promote their brands and products to consumers.

 

Our KOLs have a large, young, active and loyal fan base. The aggregate number of our KOLs’ fans increased from 52.1 million as of March 31, 2017 to 103.4 million as of March 31, 2018, and further increased to 155.1 million as of March 31, 2019, which primarily included 101.5 million on Weibo, 32.4 million on Weitao and 6.1 million on WeChat.  As of March 31, 2019, more than 84% of our KOLs’ fans were millennials, and more than 75% of them were female, fashion pursuers and frequent online shoppers. The interactions between our KOLs and their fans enable them to learn more about our products, which we believe have significantly increased the likelihood of their fans placing orders with us. We believe our KOLs’ fans are also loyal customers and have strong emotional bonds with our KOL brands. Approximately 38% and 37% of customers of our online stores made two or more purchases with us in fiscal years 2018 and 2019, respectively. As we launched our platform model, we believe our KOLs’ fan base also helps brands and third-party online retailers that use our KOL sales and advertising services to more effectively market and sell their products.

 

We have utilized the latest technology to improve our operations and maintain competitiveness. We rely on data analysis and innovative technology to help our KOLs produce engaging content and more effectively interact with their fans to increase their popularity. We have also invested in companies that develop AI solutions relevant to our business, such as DeepFashion, and implemented big data analytics to optimize our business and operations.

 

We have two revenue streams. Revenues from our product sales through full-service model increased by 59.4% from RMB572.4 million for fiscal year 2017 to RMB912.5 million for fiscal year 2018, and increased by 3.3% to RMB942.8 million (US$140.5 million) for fiscal year 2019. Revenues from our services through platform model increased by approximately 5.4 times from RMB5.5 million for fiscal year 2017 to RMB35.1 million for fiscal year 2018, and increased by approximately 3.3 times to RMB150.7 million (US$22.4 million) for fiscal year 2019. We continue prioritizing our investment in growth and incurred a net loss of RMB40.1 million for fiscal year 2017, RMB90.0 million for fiscal year 2018 and RMB84.9 million (US$12.7 million) for fiscal year 2019.

 

Our KOL Ecosystem

 

With the emergence of KOL economy, a new ecosystem centered around KOLs has formed and changed the manner in which businesses are connected to consumers. It is also transforming the online retail industry in China. As the largest China internet KOL facilitator in e-commerce, we help connect a large number of KOLs and their fans to create a vast network and connect this network to a large number of businesses, including brands, online retailers, designers, manufacturers and suppliers to create value for participants in the ecosystem.

 

Our first-mover advantage in the KOL ecosystem enables us to partner with players in the new retail industry, integrating online, offline, supply chain and data. In the KOL ecosystem, KOLs replace traditional sales and marketing channels and enable two-way communication between businesses and consumers. Based on a deep understanding of the social relationship between KOLs and their fans, we are able to identify potential customers, stimulate consumer needs and promote consumers into becoming brand ambassadors who effectively co-create a brand with the respective KOLs. Moreover, we have developed a business model that brings online retail into a new era from push to pull whereby consumers influence businesses on what to produce and sell and businesses anticipate demand before production.

 

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More participants in the ecosystem lead to greater value for each participant, which in turn attracts more participants with more usage, and thereby creates a self-reinforcing network effect. Such network effect has brought us a variety of brands and merchants, including those who sell apparel, accessories, electric appliances, as well as a number of popular cosmetics brands. It also enables us to explore more monetization opportunities by leveraging the extensive KOL pool and fan base on our KOL sales and marketing platform.

 

Our Business Models

 

We currently generate revenue from the following two business models:

 

·                      product sales through our full-service model that mainly includes sale of our self-designed products in our online stores and we also manage the entire e-commerce value chain; and

 

·                      services through our platform model that mainly include (i) KOL sales services to third-party merchants who hire our KOLs for a period of time to promote their products or services in their online stores; and (ii) KOL advertising services to third-party merchants who use our KOLs in one-off nature to promote their products or services.

 

The following table sets forth the revenue breakdown by product sales and services for the fiscal years presented:

 

 

 

Fiscal Year Ended March 31,

 

 

 

2017

 

2018

 

2019

 

 

 

RMB

 

%

 

RMB

 

%

 

RMB

 

US$

 

%

 

 

 

(in thousands, except for percentages)

 

Net revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product sales under full-service model

 

572,445

 

99.1

 

912,512

 

96.3

 

942,781

 

140,479

 

86.2

 

Services under platform service model

 

5,457

 

0.9

 

35,068

 

3.7

 

150,657

 

22,449

 

13.8

 

Total net revenues

 

577,902

 

100.0

 

947,580

 

100.0

 

1,093,438

 

162,928

 

100.0

 

 

We are a leading pioneer who capitalized on the commercial value of our KOL ecosystem and started with a full-service model whereby we carry out the entire e-commerce operation and collaborate with top-tier KOLs who have attracted tens of millions of fans. Under the full-service model, we leverage our top-tier KOLs’ popularity to promote and sell products on our online stores. We owned and operated 56 online stores as of March 31, 2019, through which we sell our self-designed products. KOLs post photographs, video clips and microblogs on their social media pages to promote the products sold on our online stores, and include hyperlinks to the online stores to direct and convert social media traffic to online store purchases. Products sold in our online stores mainly include women’s apparel, cosmetics, shoes and handbags, and we expect to expand into additional product categories in the future.

 

We and our KOLs have clearly delineated responsibilities and devoted resources to make the collaborations successful. A majority of our online stores are opened in the name of our KOLs and only sell products catering to the tastes of the respective KOLs’ fans and endorsed by the KOLs in their social media spaces. The KOLs agree to use their images and social networks accounts exclusively for the promotion and sale of products designated by us. They post lifestyle content on social media platforms, such as Weibo and WeChat, that promote brands and products designated by us, interact with their fans, share thoughts and ideas, convey messages about our products to potential consumers and solicit feedback that help us design products that fit the style of our KOLs and customers. To convert traffic on social media to purchases in online stores, KOLs provide hyperlinks to our online stores from their blogs to help fans find and purchase our products conveniently. On the other hand, we own and directly control and operate the online stores and are responsible for store setup and maintenance, merchandising, payment collection, supply chain management and customer service. We have an operations team that helps ensure that our online stores are artfully presented, and refreshed in keeping up-to-date with our new product launches. Our operation team regularly works with our KOLs in producing the most updated digital content, including product photography, site banners and other promotional content.

 

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Our product sales revenues are generated from sales of various fashion and lifestyle products to consumers mainly through our online stores under the full-service model. Our full service model contributed the vast majority of our total revenue generated from fiscal years 2017, 2018 and 2019, accounting for 99.1%, 96.3% and 86.2% of our total revenues, respectively. Revenues from our full-service model increased by 59.4% from RMB572.4 million for fiscal year 2017 to RMB912.5 million for fiscal year 2018, and increased by 3.3% to RMB942.8 million (US$140.5 million) for fiscal year 2019. While we expect to continue increasing revenue from our full-service model, sales volume as a percentage of our total revenues will likely decrease in the future as we strive to achieve dynamic balance between our business models according to industry trends and our working capital levels.

 

We generally enter into cooperation agreements with our KOLs. Cooperation agreements provide a contractual term, general work description and certain rights and obligations of a KOL. In particular, cooperation agreements render us the exclusive right to operate online stores in the name of KOLs and enable us to use the KOLs’ portrait rights, name rights and other intellectual property rights free of charge. For details, please see “— Our KOLs — Key Information of Our Selected KOLs.” As of March 31, 2019, there were 128 KOLs that entered into cooperation agreements with us. Under the cooperation agreements, KOLs are entitled to KOL service fees. The amount of KOL service fees is determined based on a variety of factors, including GMV sold in the online store, types of products and services facilitated, popularity of the KOL and other market factors. Our KOLs under full-service model are entitled to different ranges of service fees according to the products they sell and promote. For example, KOLs on our clothing online stores are typically entitled to approximately 15% of operating cash inflows or approximately 13% to 17% of revenue from such online stores, while KOLs on our cosmetics online stores are typically entitled to approximately 8% to 30% of operating cash inflows or approximately 9% to 35% of revenue from such online stores. ZHANG Dayi, one of our KOLs, established a joint venture with us and used to enjoy 49% of net profit from our online stores opened in her name. In March 2019, we acquired such joint venture and it has become a wholly-owned subsidiary of our VIE.

 

Platform Model

 

We launched the platform model in 2017 which allows us to operate in a more asset-light manner and collaborate with a greater number and variety of KOLs. Under the platform model, we serve as a platform where we provide KOL sales and advertising services to brands and other merchants. Leveraging the greater flexibility of our platform, we are able to collaborate with more established and emerging KOLs in addition to top-tier KOLs. Established and emerging KOLs have smaller fan bases on social media platforms but they manage to maintain closer bonds with their fans who belong to the same peer group with similar interests, backgrounds, social status, wealth and aesthetic preferences. We usually reach out to KOLs who have already built their fan bases ranging from five to twenty thousand. We invest in their social media accounts by developing their distinctive characters and providing industry insights, market trends and other resources. After we have successfully built up KOLs’ social media accounts and enlarge their fan bases, we begin to look for brands whose products are suitable for each KOL’s style and charisma.

 

We leverage our platform to provide a variety of services, including KOL sales services and KOL advertising services. For example, with respect to KOL sales services, we cooperate with third-party online retailers to leverage the popularity of our KOLs to promote products and services, in which case we charge online retailers a service fee based on the GMV. To further leverage the popularity of our KOLs and explore additional monetization channels, we have been devoted to creating innovative KOL advertising services. Customers of our KOL advertising services primarily include global leading brands and other merchants who use our KOLs to promote their products or services either on their social media spaces or offline. Our KOLs participate in numerous types of advertising campaigns, such as graphic advertisements, short films and live streaming.

 

Our KOLs worked with global leading brands. Additionally, our KOLs have worked with a variety of businesses, including travel agencies, app designers and child care institutions to promote their products and services. For example, we organized an advertising campaign for a laundry detergent brand whereby a number of KOLs promoted and sold one product on different social media platforms.

 

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For KOL sales services, we typically enter into cooperation agreements with third-party merchants for specified terms under which our KOLs promote and sell either all or some of the products or services for them in third-party online stores, while they pay us service fees based on GMV sold in such third-party online stores or GMV of specified products sold in such third-party online stores. The amount of KOL service fees is determined based on a variety of factors, including GMV sold in third-party online store or of GMV of specified products sold in third-party online store, types of products and services facilitated, popularity of the KOL and other market factors. Our KOLs under platform model are typically entitled to 30%-50% of the sales and marketing service revenues we obtain from third-party merchants.

 

For KOL advertising services, we typically enter into advertising contracts with third-party merchants in one-off nature under which we place advertisements on a number of KOLs’ social media spaces to promote their products, while they pay us a fixed and pre-determined service fee. As such, our service revenues are generated from provision of various KOL sales and advertising services to brands, online retailers and other merchants under the platform model. We, in turn, pay our KOLs a fixed and pre-determined KOL service fee for using their social media spaces.

 

Platform services revenues increased by approximately 5.4 times from RMB5.5 million for fiscal year 2017 to RMB35.1 million for fiscal year 2018, and further increased by approximately 3.3 times to RMB150.7 million (US$22.4 million) for fiscal year 2019.

 

We continue increasing our revenues from our platform model and we also expect the sales volume under our platform model as a percentage of our total sales volume will grow in the near future. Some of our KOLs who sell and promote products designed by us under our full-service model also leverage their influence on social media to sell and promote products designed by third-party merchants under our platform model. In order to avoid compromising our KOLs’ sales efforts between two models, we set annual product release plans for our new product launches, so our KOLs can arrange their work schedules to accommodate both work streams in advance. In addition, products designed by us and sold in our online stores under our full-service model are mainly women’s apparel while products designed by third-party merchants and sold in their online stores under our platform model are primarily cosmetics and daily necessities such as laundry detergent. Products designed by us and sold in our online stores under our full-service model generally do not compete with products designed by third-party merchants and sold in their online stores under our platform model. Moreover, KOLs’ cooperation with third-party brands also helps increase KOLs’ exposure to the public and attract more fans and potential buyers of products designed by us. For example, KOLs who work with third-party major brands and design collaborated products are able to grow their fan bases leveraging the popularity of major brands and in turn, promote our products to new fans, thus forming a virtuous circle. As such, we believe KOLs serving under our platform model are also able to efficiently sell and promote products designed by us. We expect to continue exploring new monetization opportunities and further expand our revenue sources. We expect to dynamically adjust the proportion of our revenues from different revenue sources in response to changes in industry trends and our financial condition.

 

Our KOLs

 

KOLs are individuals who have established credibility and authority in a particular field through public exposure and social interaction and therefore have substantial influence over their peers and fans. In the digital social media era, most KOLs built up their popularity through posting content and interacting with their fans on social media platforms, such as Weibo and WeChat. Our KOLs function as lifestyle gurus who present a particular lifestyle or attitude to their fans and, in such role, they become crucial influencers to their fans in fashion and lifestyle-related purchase decisions.

 

The following present our key operating data as of the dates and for the fiscal years indicated:

 

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As of and for fiscal year ended March 31,

 

 

 

2017

 

2018

 

2019

 

 

 

Number of
KOLs

 

Number
of fans
(4)
(in millions)

 

GMV
(RMB in
millions)

 

Number of
KOLs

 

Number
of fans
(4)
(in millions)

 

GMV
(RMB in
millions)

 

Number of
KOLs

 

Number
of fans
(4)
(in millions)

 

GMV
(RMB in
millions)

 

Top-tier KOLs(1)

 

2

 

12.0

 

750.6

 

3

 

21.0

 

1,333.7

 

3

 

34.6

 

1,530.5

 

Established KOLs(2)

 

3

 

4.4

 

139.3

 

7

 

17.5

 

321.4

 

8

 

31.4

 

406.0

 

Emerging KOLs(3)

 

57

 

35.7

 

346.4

 

73

 

64.9

 

390.1

 

117

 

89.1

 

924.1

 

Total

 

62

 

52.1

 

1,236.3

 

83

 

103.4

 

2,045.2

 

128

 

155.1

 

2,860.6

 

 


(1)              Top-tier KOLs facilitated GMV of above RMB100.0 million in the past twelve months.

(2)              Established KOLs facilitated GMV of RMB30.0 million to RMB100.0 million in the past twelve months.

(3)              Emerging KOLs facilitated GMV of less than RMB30.0 million in the past twelve months.

(4)              The number of fans presented may include a single fan who was included multiple times if the fan follows more than one KOL, follows the same KOL across multiple platforms, or both.

 

 

 

As of and for the fiscal year ended March 31,

 

 

 

2017

 

2018

 

2019

 

Full-Service Model

 

 

 

 

 

 

 

Number of our KOLs serving such business model(1)

 

37

 

33

 

14

 

Number of our online stores

 

57

 

86

 

56

 

Number of orders placed through our online stores

 

5.1 million

 

7.5 million

 

7.0 million

 

GMV of our online stores

 

RMB1,236.3 million

 

RMB1,944.4 million

 

RMB2,147.1 million

 

 

 

 

 

 

 

 

 

Platform Model

 

 

 

 

 

 

 

Number of our KOLs serving such business model(1)

 

18

 

57

 

122

 

Number of brands using our services

 

18

 

166

 

632

 

Number of third-party online stores(2)

 

nil

 

6

 

132

 

GMV of third-party online stores(3)

 

nil

 

RMB100.8 million

 

RMB713.5 million

 

 


(1)              Certain KOLs under our full-service model overlap with those under our platform model. On the other hand, our KOLs that were undergoing training and had not started generating GMV under either of our business models as of the relevant date were not included in these numbers.

(2)              Includes third-party online stores to which we provide KOL sales services and KOL advertising services.

(3)              Includes GMV from third-party online stores to which we only provide KOL sales services.

 

Key Information of Our Selected KOLs

 

We enter into cooperation agreements with our KOLs, under which we have the exclusive right to operate online stores in the name of KOLs, and we are entitled to use KOLs’ portrait rights, name rights and other intellectual property rights free of charge.

 

Below is a summary of key information of our top-tier KOLs and established KOLs in fiscal year 2019:

 

Top-tier KOLs

 

Name

 

Online stores

 

Social media
accounts
(1)

 

Term(2)

 

Exclusivity

ZHANG Yi, a.k.a. ZHANG Dayi (张大奕)

 

·    My Favorite Wardrobe (吾欢喜的衣橱)

 

·    Milk Scent/Fragrance Best Lingerie (奶香的奶罩)

 

·    Sold-out Lipsticks (口红卖掉了呢)

 

·    Sold-out Dresses Outlet (裙子卖掉了Outlets)

 

·    Sold-out Candles (蜡烛卖掉了)

 

·    Big Eve Flagship Store(3)

 

Weibo name:
Zhang Dayi eve (张大奕eve)
(4)

 

Over 20 million fans in total

 

The later of (i) April 3, 2024, or (ii) when the beneficial ownership of ZHANG Yi in our company falls below 5% after our initial public offering

 

We are Ms. ZHANG’s exclusive partner for her e-commerce business.(5)

 

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Name

 

Online stores

 

Social media
accounts
(1)

 

Term(2)

 

Exclusivity

JIN Lingjia, a.k.a. Dajin (大金)

 

·    BIGKING (大金家)(6)

 

Weibo name:
Delicious Dajin (delicious 大金)
(7)

 

Over 7 million fans in total

 

Effective from April 30, 2016 to February 9, 2020

 

We are Ms. JIN’s exclusive partner for her e-commerce business.

 

 

 

 

 

 

 

 

 

CHEN Sijia, a.k.a. Libeilin (莉贝林)(8)

 

·    Libeilin sisy (莉贝林sisy)

 

Weibo name:
Libeilin (莉贝林)

 

Over 2 million fans in total

 

Effective from April 1, 2016 to March 31, 2021

 

We are Ms. CHEN’s exclusive partner for her e-commerce business.

 

Established KOLs

 

Name

 

Online stores

 

Social media
accounts
(1)

 

Term(2)

 

Exclusivity

PIAO Zhengyi (朴正义)

 

·    Piao Zhengyi Jeongyee (朴正义Jeongyee)(9)

 

Weibo name:
Piao Zhengyi (朴正义)
(10)

 

Over 4 million fans in total

 

Effective from June 1, 2016 to May 31, 2022, and will automatically renew for three years on the date of expiry

 

We are Ms. PIAO’s exclusive agent for commercial activities.

 

 

 

 

 

 

 

 

 

WANG Chong, a.k.a. Chongchong (虫虫)

 

·    Chonny Cosmetics (虫虫Chonny美妆店)(6)

 

Weibo name:
Chongchong Chonny (虫虫Chonny)
(7)

 

Over 6 million fans in total

 

Effective from July 30, 2016 to April 29, 2021

 

We are Ms. WANG’s exclusive partner for her e-commerce business and agent for commercial activities.

 

 

 

 

 

 

 

 

 

ZOU Meiyan, a.k.a. Zouzou (邹邹)

 

·    HiZZ Zouzou Small Custom Women’s Apparel (HiZZ邹邹小个子定制女装)

·    Zouzou Cosmetics (邹邹美妆店)(6)

 

Weibo name:
Stylist Zouzou (造型师邹邹)
(7)

 

Over 3 million fans in total

 

Effective from April 30, 2016 to March 21, 2020

 

We are Ms. ZOU’s exclusive partner for her e-commerce business.

 

 

 

 

 

 

 

 

 

WEI Yanni (魏彦妮)

 

·    SantaRita (老妮定制)(6)

 

Weibo name:
Wei Yanni Yanni (魏彦妮Yanni)
(7)

 

Over 5 million fans in total

 

Effective from March 27, 2019 to March 26, 2022

 

We are Ms. WEI’s exclusive partner for her e-commerce business.

 

 

 

 

 

 

 

 

 

LI Xiaoyu (李小宇)

 

·    Naughty Child (顽童大人Onetong)(6)

 

Weibo name:
Naughty Child (顽童大人)
(7)

 

Over 2 million fans in total

 

Effective from February 5, 2018 to February 5, 2023

 

We are Ms. LI’s exclusive agent for commercial activities.

 

 

 

 

 

 

 

 

 

ZUO Jiaojiao (左娇娇)

 

·    19UP Zuojiaojiao Apparel (19UP 左娇娇私服店)(6)

·    Zuojiaojiao Cosmetics (左娇娇的美妆盒)

 

Weibo name:
Zuo Jiaojiao Rosemary (左娇娇Rosemary)
(7)

 

Over 3 million fans in total

 

Effective from April 30, 2016 to August 9, 2021

 

We are Ms. ZUO’s exclusive partner for her e-commerce business.

 

 

 

 

 

 

 

 

 

MEI Wenting (梅文婷)

 

·    Wenwenting MOWENTI (文文婷MOWENTI)(6)

 

Weibo name:
Mt Wenwenting (MT文文婷)
(7)

 

Over 1 million fans in total

 

Effective from April 13, 2018 to April 12, 2023

 

We are Ms. Mei’s exclusive agent for commercial activities.

 

 

 

 

 

 

 

 

 

CHAO Ran(晁然)

 

·    Get up early and listen to bird (起个大早听鸟叫)(6)

 

Weibo name:
CHAORanranranran
(晁然然然然)
(7)

 

Over 4 million fans in total

 

Effective from July 15, 2016 to July 14, 2021

 

We are Ms. CHAO’s exclusive partner for her e-commerce business.

 

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(1)         Contains KOLs’ names on Weibo and the numbers of their respective fans as of March 31, 2019.

(2)         Starting from 2017, the cooperation agreements we entered into with our KOLs normally provide that the contractual term will automatically renew for a period of three years if the KOL’s revenue or number of new fans reaches a certain threshold during the initial contract term. However, KOLs may decline automatic renewal by notice to the company prior to the expiration of the initial contract term but cannot terminate the agreement prior to the end of the contractual term.

(3)         We manage the online stores of and provide relevant training and advice to Ms. ZHANG.

(4)         Ms. ZHANG authorizes us to use her image, name and articles/photos published on her social media accounts free of charge.

(5)         Following the completion of the Hangzhou Dayi Minority Interest Acquisition, the exclusivity obligation of online sales of women apparel products is extended to the later of (i) five years after the completion of our initial public offering, or (ii) when the beneficial ownership of ZHANG Yi in our company falls below 5% after our initial public offering.

(6)         We develop products for the brand created in collaboration with the KOL and market/sell those products through the KOL’s social media accounts and our partnered online shops. The KOL authorizes the use of her image and provide marketing services for us. We own the trademarks of the collaborated brands unless the parties choose to use the KOL’s own existing registered trademark, in which case the KOL grants us the exclusive license to use her trademark free of charge. The KOL and us collectively have the ownership and IP rights for the collaborated clothing brands.

(7)         We have the right to use and manage the KOL’s social media accounts. The KOL authorizes us to use her name, image and articles/photos published on her social media accounts free of charge.

(8)         Libeilin is the spouse of FENG Min. She was previously our design director who had entered into an employment contract with us. She resigned in May 2019 and has since entered into a cooperation agreement with us.

(9)         We are authorized to manage Ms. PIAO’s commercial activities. Ms. PIAO has confirmed that she is not bound by any similar agreement with any third party and that she will be responsible for any damages to third parties caused by her entering into this agreement. Ms. PIAO grants us the exclusive license to use her name and image in commercial activities free of charge.

(10)  Both parties have the right to use and manage Ms. PIAO’s Weibo account, which was created prior to this agreement. Any other social media accounts created by Ms. PIAO pursuant to our arrangement shall be owned by us.

 

Identification, Cultivation and Management of Our KOLs

 

We seek to identify talented KOLs to attract more fans and potential customers. To this end, we capitalize on our extensive experience in the industry. Our founders started cooperating with KOLs to sell products on online marketplaces in 2014 and have experienced a rapid growth since then. Our success lies in the ability to identify and bring to our ecosystem talented KOLs that we believe have strong potential. We scout new KOLs via social media, such as Weibo, WeChat, Tik Tok and various other social media platforms. Our selection criteria include a KOL candidate’s number of fans, skills to interact with fans, personal charisma, attitude, market tactics and distinctive character. To test our KOL candidates’ potential, we may also provide certain training, such as styling and use of social media, to the candidates before we enter into agreements with them in order to evaluate their ability to learn and improve in a short period of time.

 

We invest in our signed KOLs through training, professional support and online marketing efforts to increase their exposure on social media platforms. We offer training courses, such as styling, photography and photo editing, still modeling, clothing selection, use of social media, supply chain fundamentals and e-commerce fundamentals. It usually takes us five to eight months to fully develop a KOL after we enter into agreement with her.

 

In order to avoid negative publicity and maintain our brands’ reputation, we manage and monitor our KOLs’ social media platforms closely. We have the right to terminate the cooperation agreements with our KOLs who are involved in any inappropriate conducts that would damage our reputation.

 

Marketing and Fashion Capabilities to Support Our KOLs

 

We provide marketing support to our KOLs, including social media planning capabilities, AI solutions, and data analytics. We identify social media platforms that our intended audience is most likely to visit and design advertising campaigns crafted to have the most impact on the targeted audience. Our social media planning capabilities enable us to strategically target the reach of online advertising campaigns. We also engage in search engine optimization and marketing for our online stores.

 

We worked with our investee company to developed a proprietary AI system, DeepFashion, which assists KOLs with clothing design and selection. In addition, by leveraging AI solution, we help KOLs to produce creative content to be used on their respective social media platforms as well as our online stores. We operate an in-house, professional photography studio in Hangzhou to create digital product images for product features, promotions and advertising campaigns. We also employ a team of copywriters who produce product descriptions and related content, such as consumers’ guides, sizing charts, product tours and comparison shopping tools.

 

Moreover, we use the data we collect from our database and reporting system to understand customers’ online shopping habits and apply these insights to help KOLs to create impactful marketing campaigns. We believe performance-based marketing is key in boosting visitor traffic on KOLs’ social medial platforms and our online stores and increasing conversion and overall transaction volume.

 

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Our Customers

 

Consumers

 

Under the full-service model, our customers are consumers who purchase our products on our online stores. We had a dedicated customer service team of 50 employees and 102 contractors as of March 31, 2019. Our customer service team responds to inquiries made through our online stores and handles customer complaints. We assign one manager to each KOL online store to handle daily operations and customer communication. In particular, pre-sale questions relating to product details comprise most of the questions we receive from customers, and we believe that a great pre-sale customer service experience could encourage customers’ purchases.

 

We provide our consumers product warranties and return policy. As most of our online stores are opened on Taobao, we typically accept Taobao’s consumer protection agreement, which provides that within 15 days of receipt of product the consumer can return the product and obtain a refund if the product has quality issues or does not match the description. In addition, our online stores typically promise that within seven days of receipt of product the consumer can return the product without specifying reasons. Orders placed by consumers on our online stores may also be cancelled for various other reasons. First, Taobao’s settlement system will cancel the order if the buyer fails to make a payment within one day after placing an order. Second, Taobao’s settlement system will also cancel the order and refund the buyer if (i) the buyer has paid but the seller fails to put the product in transit within 72 hours after the buyer’s payment or a predetermined timeframe, (ii) the buyer did not receive the product and the seller fails to respond to the buyer’s inquiry within five days after receiving such inquiry, or (iii) the buyer has paid but the seller fails to notify Taobao that the product has been delivered within 365 days after the buyer’s payment. The consumer can also cancel the order and receive a refund if he or she did not receive the product on the expected delivery date. Our order cancellation rate was approximately 23.3% and 17.7% and our product return rate was approximately 11.4% and 22.3% in fiscal years 2018 and 2019, respectively. We did not experience any material product recall orders, penalties, claims or customer complaints due to product quality issues for fiscal years 2017, 2018 and 2019.

 

Brands and Online Retailers

 

Under the platform model, our customers are brands and other online retailers, who use our KOLs to promote and sell their products and services. As of March 31, 2019, we cooperated with 632 brands and 132 other online retailers.

 

Seasonality

 

We generally experience a lower level of sales in the fourth quarter of each fiscal year due to the Chinese New Year holiday, during which consumers generally spend less time on our KOLs’ social media spaces and on online shopping, while we usually have higher sales in the third quarter of each fiscal year due to sales on Singles Day in November, Double Twelve in December and sales of fall and winter apparel, which typically have a higher average selling price than spring and summer apparel. See “Item 3. Key Information— D. Risk Factors — Risks Relating to Our Business and Industry — Our results of operations are subject to fluctuations due to the seasonality of our business and other events.”

 

Our Suppliers

 

We outsource the manufacturing process to third-party manufacturers and we manage sales orders and payment collection through our proprietary ERP system, which integrates with our other technology platforms to help ensure smooth online transactions. As such, our suppliers mainly include fabric suppliers, wholesaler clothing providers, manufacturers and logistics service providers. As of March 31, 2019, we had over 800 fabric suppliers, wholesale clothing providers and manufacturers on our supplier list who had worked with us and with which we expect to continue our business relationship in the near future. We carefully evaluate market demands for each product based on KOLs’ interaction with their fans and other marketing intelligence and we take a conservative approach to minimize our inventory risk.

 

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Fabric Suppliers, Wholesale Clothing Providers and Manufacturers

 

Fabric Suppliers and Wholesale Clothing Providers

 

Our designers work closely with trendy wholesale clothing providers and fabric suppliers to source sample clothes and fabrics required for mass production. We invite our KOLs to try on these sample clothes, and we make alterations, adjust sizes and patterns, and add decorations and other personal elements on these sample clothes to highlight each KOL’s personal style. In addition, we leverage our AI solution, DeepFashion, to improve design process by critiquing design choices and providing alternatives after considering design variables. Our KOLs wear these tailor-made sample clothes and post pictures on their social media spaces inviting comments and feedback.

 

We enter into framework agreements with fabric suppliers and wholesale clothing providers which set out key terms, including quality standards, process requirements, delivery methods, packaging, quality assurance process, payment methods, exclusivity as to certain fabrics and sample clothes, service periods and other standard terms. We are typically required to prepay 30% of the purchase price to the fabric suppliers and wholesale clothing providers. In addition to framework agreements, we place orders one-off in nature that specify good specification, quantity, price, delivery time and location.

 

Manufacturers

 

By taking into consideration KOLs’ and fans’ feedback, we decide which items are more attractive and popular and send them to third-party manufacturers for commercial production. We engage third-party manufactures to produce our self-designed products, primarily including apparel, accessories and cosmetics. We typically allow manufacturers to source their own materials and fabrics according to our specifications, and we provide fabrics to manufacturers where we have special requirements as to the products.

 

We enter into framework agreements with manufacturers which set out key terms, including work allocation, quality and technology standards, packaging, delivery methods, risk allocation, quality control process, payment methods, service period and other standard terms. In addition to framework agreements, we place orders one-off in nature that specify product specification, quantity, price, delivery time and location. We evaluate each manufacturer’s performance after each transaction based on a variety of factors, such as timely delivery of products, costs effectiveness, product quality, sufficiency of working capital and satisfactory communication. In addition, we conduct annual review of each of our manufactures to decide if such manufacturer is suitable for future cooperation. For fiscal years 2017, 2018 and 2019, respectively, purchases of goods from our top five suppliers accounted for 26.0%, 20.9% and 17.6% of our total purchase amount.

 

Logistic Service Providers

 

We partner with leading nationwide and local logistics service providers to ensure reliable and timely delivery. For example, we engage a number of trustworthy logistics service providers, including SF Express, one of the largest express delivery services in China. We are able to achieve delivery within 32 hours across China, except for certain rural areas in Xinjiang and Tibet.

 

We track and manage logistics on our enterprise resource planning system, or ERP system. It not only ensures smooth logistics but also manages the entire fulfillment process, including procurement, order tracking, production, logistics and payment receipt. For more details, please see “— Technology — Management Systems — ERP System”.

 

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Selection Process and Quality Control

 

We have a prudent supplier selection process, which involves trustworthy referral, background check, preliminary review, on-site visit, trial production and sampling, and the team in charge usually consists of product managers, supplier management staff, quality control staff and internal control staff. We conduct an overall evaluation of each supplier’s facility capacities, worker qualifications, raw material quality, cost structure, production plans and technological capabilities.

 

We strictly follow our internal quality control and assurance policies throughout the sourcing and production process. Our quality control team conducts site visits at the manufacturers’ facilities and monitors closely the quality of fabrics, materials and finished products as well as the manufacturing process. We also examine product samples at the production testing stage to try to make sure they satisfy all requirements set forth in the agreements before mass production.

 

Warehouse Management

 

We operate two warehouses with an aggregate gross floor area of approximately 59,080 sq.m. in Zhejiang province. Our warehouses cater to different raw materials, product categories and brands. At each warehouse, inventory is bar-coded and tracked through our warehouse management system, allowing real-time monitoring of inventory levels across our network. We purchased a warehouse management system, or WMS, which is customized to account for variance in arrangements between KOLs and their respective consumers and differences in product specifications, and we are able to closely monitor each step of the fulfillment process from the time a purchase order is confirmed and the product stocked in our warehouses, up to when the product is packaged and picked up by a logistics services provider for delivery to a consumer. For more details about our WMS, please see “— Technology — Management Systems — WMS”. In addition, we leased and installed an automated warehouse system in one of our warehouses that features automatic storage and retrieval handling. This system not only improves management efficiency of the warehouse but also increases the capacity of the warehouse by approximately three times. During the week following Singles Day in 2018, our warehouse management system processed over 564,000 orders, showcasing our ability to support an enormous flow of transaction and order traffic.

 

As of March 31, 2019, we have a dedicated team of 21 employees and 156 contractors responsible for warehouse management and processing. They also closely monitor the speed and service quality of the logistics services providers through consumer surveys and feedbacks from consumers to help ensure their satisfaction.

 

Technology

 

In the emerging new retail industry, technology is key to our success in achieving efficiency for our business, improving the user experience, and enabling innovation. We have made significant investments and plan to continue to invest in developing our technology platform to deliver solutions that aim to address e-commerce needs for our brand partners. The principal components of our technology infrastructure include:

 

Big Data Analytics

 

As we operate a unique full-service model and provide end-to-end solutions, we have access to all kinds of data throughout the entire value chain in the KOL ecosystem. We collect and analyze a massive amount of data daily through tracking fashion posts and images on social media and brands’ official websites, and we also collect and analyze historical sales records and our consumer profiles on Taobao. With such data, we are able to provide satisfactory products and services to our fans, consumers, brands and other customers, and to understand and meet their changing needs. In addition, we collect and analyze our warehousing and shipment data to design a more efficient logistics plan.

 

AI Solutions

 

With access to a massive amount of data that we have accumulated over time, we believe we are in a unique position to develop innovative AI solutions for the benefit of our e-commerce value chain. We have utilized DeepFashion, an AI solution that we developed with our investee company. DeepFashion improves the design process by critiquing design choices and providing alternatives after considering key design variables. It establishes personalized databases for KOLs by collecting a massive amount of data daily by tracking fashion posts and images on social media and brands’ official websites, and categorizing them according to different types, styles, fabrics, colors of apparel and different ways to match clothing. DeepFashion also integrates historical sales records of each category of apparel and clothes on Taobao for KOLs’ and designers’ reference. It not only guides KOLs’ extensive recommendations on their social media platforms, creating fashion trends among fans, but also guides designers to launch new customized products on KOL online stores to fit variable demands of KOLs’ fans.

 

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KOLs and designers can access our DeepFashion via both mobile application and computer webpage. It provides subscribers advanced functions. For example, subscribers can opt in or opt out of certain categories of apparel or certain online stores where they do or do not want to collect relevant images or historical sales records to create a customized database.

 

Management Systems

 

·                      WMS: it is a real-time system that assists us in major aspects of our logistics operations, such as managing stock keeping units, palletizing, replenishing stocks, receiving and shipping merchandises, sorting and organizing inventories, keeping transaction records, pick-and-pack, and monitoring progress to increase efficiency. In addition, the WMS allows us to lower the cost of labor as it has the ability to follow operating procedure presets and automatically create and execute an action plan upon receiving an order.

 

·                      ERP system: it is a real-time proprietary technology that manages the entire transaction process, including procurement, order tracking, production, logistics and payment receipt. Our ERP system is built on an order management system and is integrated with our WMS. It has the ability to consolidate and process orders from our various online stores. Once the order is processed, a notice is sent to our WMS to arrange for distribution and dispatch of the merchandise. Our ERP system also tracks order statuses, creates customer profiles, and manages post-sales services such as order canceling, product returns and refunds. These functions help us increase the efficiency and lower the cost of our order fulfillment process. In addition, KOLs are able to track the status of each product in their respective online stores, including its launch, pre-order amount, commercial production, warehouse arrival, delivery to consumers, historical sales record and other information that is helpful for KOLs to communicate with fans and consumers.

 

As of March 31, 2019, we had a technology team with more than 40 engineers. Many of our engineers have post-graduate degrees and have prior working experience in leading internet companies in China. For fiscal years 2017, 2018 and 2019, our expenses related to IT department, which undertakes many of our research and development activities, amounted to RMB3.7 million, RMB11.7 million and RMB10.3 million (US$1.5 million), respectively.

 

Marketing

 

In addition to leveraging our KOLs’ popularity and influence, we employ a variety of methods to attract potential fans, consumers, merchants and other ecosystem participants and promote our products, services and brands. Our marketing capabilities include a dedicated marketing team and word-of-mouth marketing. We have built a dedicated marketing team that is responsible for communicating with branded merchants and online stores on social media to promote the effect of the marketing services of Ruhnn. We also leverage the influence of word-of-mouth, which is information from industry players and customers about our products, services or brands. We initiated a slogan “For KOL Sales, Look to Ruhnn” to attract more brands, merchants and other participants to join our KOL ecosystem. We believe our word-of-mouth strategies and campaigns encourage KOL ecosystem participants’ engagement with our brands and drive their desire to purchase our products or use our services.

 

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Competition

 

We face competition principally from other China internet KOL facilitators in e-commerce. These competitors generate significant traffic and have established brand recognition, significant technological capabilities and significant financial resources.

 

We compete to attract, engage and retain talented KOLs based on the wide range of training and professional support we provide. We also compete for motivated and effective talent and personnel, including product designers and engineers to develop compelling products and communication tools and functions for participants in our ecosystem.

 

In addition, we compete to attract and retain brands, online retailers and other merchants based on our size and the engagement of fans and consumers, the effectiveness and value of the marketing services our KOLs offer, commission rates and the usefulness of the services we provide including data and analytics for potential customer targeting, cloud computing services and the availability of support services including payment settlement and logistics services.

 

Based on the foregoing, we believe that our ability to compete effectively depends upon many factors, including the size, composition and engagement of our fan base, our ability to adjust to rapid advancements in technology and consumer tastes, the strength and reputation of our brands and our selling and marketing abilities, including targeted advertising and mobile marketing services.

 

Intellectual Property and Other Exclusive Rights

 

We rely on a combination of trademark, fair trade practice, intellectual property laws in China and other jurisdictions, as well as confidentiality procedures and contractual provisions to protect our intellectual property and our trademarks. As of March 31, 2019, we had over 1,045 trademarks, one patent and 24 domain names in China and overseas. As of the same date, we publicly filed 136 trademark applications in China and overseas.

 

In addition, we rely on a number of exclusive rights, especially know-how, portrait rights, right of publicity on social media platforms, social media accounts and online store accounts. We also enter into confidentiality agreement with our employees, and we rigorously control access to our proprietary technology and information. As such, we believe the protection of our trademarks, copyrights, domain names, trade names, patents trade secrets, know-how, portrait rights, right of publicity or personality and other proprietary rights is critical to our business. For risk factors relating to our intellectual properties, please see “Item 3. Key Information— D. Risk Factors — Risks Relating to Our Business and Industry — We may not be able to adequately protect our intellectual property rights and exclusive rights.”

 

Insurance

 

We maintain various insurance policies to safeguard against risks and unexpected events. We have purchased property insurance covering our inventory. We also provide social security insurance, including pension insurance, unemployment insurance, work-related injury insurance and medical insurance, for our employees. We do not maintain other property insurance, business interruption insurance, general third-party liability insurance or key-man insurance. We believe the insurance coverage we maintain is in line with the industry. For risk factors relating to our insurance policies, please see “Item 3. Key Information — D. Risk Factors — Risks Relating to Our Business and Industry — We may not have sufficient insurance coverage”.

 

Regulation

 

This section sets forth a summary of the most significant rules and regulations that affect our business activities in China or the rights of our shareholders to receive dividends and other distributions from us.

 

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Regulations Relating to Foreign Investment

 

Investment activities in the PRC by foreign investors are principally governed by the Guidance Catalogue of Industries for Foreign Investment, which was promulgated and is amended from time to time by the Ministry of Commerce, or the MOFCOM, and the National Development and Reform Commission, or the NDRC. In June 2017, the MOFCOM and the NDRC promulgated a revision of the Guidance Catalogue of Industries for Foreign Investment, or the Catalogue, effective in July 2017. Industries listed in the Catalogue are divided into three categories: encouraged, restricted and prohibited. Industries not listed in the Catalogue are generally deemed as constituting a fourth “permitted” category. Establishment of wholly foreign-owned enterprises is generally allowed in encouraged and permitted industries. Some restricted industries are limited to equity or contractual joint ventures, while in some cases Chinese partners are required to hold the majority interests in such joint ventures. In addition, foreign investment in restricted category projects is subject to government approvals. Foreign investors are not allowed to invest in industries in the prohibited category. Industries not listed in the Catalogue are generally open to foreign investment unless specifically restricted by other PRC regulations. On June 30, 2019, the MOFCOM and the NDRC promulgated the Catalogue of Industries Encouraging Foreign Investment (2019), or the Encouraging Catalogue, effective on July 30, 2019, from which time encouraged categories under the Catalogue shall be void and replaced by the Encouraging Catalogue.

 

In June 2018, the MOFCOM and the NDRC promulgated the Special Management Measures (Negative List (2018)) for the Access of Foreign Investment, or the Negative List (2018), effective in July 2018. Foreign investment in talent agency services falls within the Negative List (2018), which required the talent agency services to be controlled by PRC shareholders. On June 30, 2019, the MOFCOM and the NDRC promulgated the Special Management Measures (Negative List (2019)) for the Access of Foreign Investment, or the Negative List (2019), which became effective on July 30, 2019. The Negative List (2019) expands the scope of permitted industries by foreign investment by reducing the number of industries that fall within the Negative List (2019) where restrictions on the shareholding percentage or requirements on the composition of board or senior management still exists. Foreign investment in talent agency services is deleted from Negative List (2019). Therefore, talent agency service became a “permitted” industry under the Catalogue since July 30, 2019.

 

To comply with PRC laws and regulations, we rely on contractual arrangements with our VIE to operate our relevant business in China. See “Item 3. Key Information — D. Risk Factors — Risks Relating to Our Corporate Structure — The PRC government may find that the contractual arrangements that establish our corporate structure for operating our business do not comply with applicable PRC laws and regulations.”

 

Foreign Investment Law

 

On March 15, 2019, the National People’s Congress promulgated the Foreign Investment Law, which will become effective on January 1, 2020 and replace the Sino-Foreign Equity Joint Venture Enterprise Law, the Sino-Foreign Cooperative Joint Venture Enterprise Law and the Foreign Owned Enterprise Law to become the legal foundation for foreign investment in the PRC. The Foreign Investment Law stipulates three forms of foreign investment, but does not explicitly stipulate the contractual arrangements as a form of foreign investment. Notwithstanding the above, the Foreign Investment Law stipulates that the concept of a foreign investment includes foreign investors investing in China through “any other methods” under laws, administrative regulations, or provisions prescribed by the State Council. Therefore, there are possibilities that future laws, administrative regulations or provisions prescribed by the State Council may regard contractual arrangements as a form of foreign investment, at which time it will be uncertain whether the contractual arrangements will be deemed to be in violation of the foreign investment access requirements and how the above-mentioned contractual arrangements will be handled. For the potential impact of the Foreign Investment Law on our Company, please see “Item 3. Key Information — D. Risk Factors — Risks Relating to Our Corporate Structure — We face uncertainties with respect to the implementation of the Foreign Investment Law.”

 

Regulations Relating to Online Data Processing and Transaction Processing Business (Operational E-commerce)

 

The Regulations for Administration of Foreign-invested Telecommunications Enterprises, which was promulgated by the State Council of the PRC in December 2001 and subsequently amended in September 2008 and February 2016, respectively, set forth detailed requirements with respect to capitalization, investor qualifications and application procedures in connection with the establishment of a foreign-invested telecommunications enterprise. These regulations prohibit a foreign entity from owning more than 50% of the total equity interest in any value-added telecommunications service business in China and require the major foreign investor in any value-added telecommunications service business in China to have a good and profitable record and operating experience in this industry.

 

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In July 2006, the Ministry of Information Industry, the predecessor of the Ministry of Industry and Information Technology, or the MIIT, issued the Circular on Strengthening the Administration of Foreign Investment in the Operation of Value-added Telecommunications Business, pursuant to which a domestic PRC company that holds an ICP license is prohibited from leasing, transferring or selling the ICP license to foreign investors in any form and from providing any assistance, including resources, sites or facilities, to foreign investors that conduct a value- added telecommunications business illegally in China. Further, the domain names and registered trademarks used by an operating company providing value-added telecommunications services must be legally owned by that company or its shareholders. In addition, the company’s operational premises and equipment must comply with the approved coverage region on its ICP license, and the company must establish and improve its internal internet and information security policies and standards and emergency management procedures. If an ICP license holder fails to comply with the above requirements and also fails to remediate such non-compliance within a specified period of time, the MIIT or its local counterparts have the discretion to impose administrative measures on such license holder, including revoking its ICP license.

 

On June 19, 2015, the MIIT issued the Circular on Lifting the Restriction to Foreign Shareholding Percentage in Online Data Processing and Transaction Processing Business (Operational E-commerce), or the New E-commerce Circular, pursuant to which, foreign investors are allowed to hold up to 100% equity interest of an entity operating online data processing and transaction processing business (operational e-commerce) in China. While the New E-commerce Circular removed the shareholding percentage restriction for foreign investors in the online data processing and transaction processing business, foreign investors still need to satisfy certain stringent requirements under the Regulations for Administration of Foreign-invested Telecommunications Enterprises. For example, major foreign investors seeking to obtain the license for their online data processing and transaction processing businesses must have good track records and operating experiences in the value-added telecommunications service industry.

 

Currently, there remain significant uncertainties with respect to the interpretation and implementation of the New E-commerce Circular as well as the application for the license regarding online data processing and transaction processing business by a wholly foreign funded enterprise in practice. For example, the term “operational e-commerce” is undefined in either the New E-commerce Circular or other relevant laws and regulations. Considering the uncertainty of the implementation of the New E-Commerce Circular and to maintain our flexibility, we rely on contractual arrangements with our VIE to operate our businesses including any operational e-commerce business that we may engage in the future.

 

Regulations Relating to E-commerce

 

China’s e-commerce industry is at an early stage of development. In May 2010, the State Administration for Market Regulation, or the SAMR, formerly known as State Administration for Industry and Commerce, adopted the Interim Measures for the Administration of Online Commodities Trading and Relevant Services. Under these measures, enterprises or other operators that are engaging in online commodities trading or other services and are registered with the SAMR or its local branches must make the information stated in their business licenses available to the public or provide links to their business licenses on their websites. Online distributors must adopt measures to ensure the safety of online transactions, protect online shoppers’ rights and prevent the sale of counterfeit goods. Information on products and transactions released by online distributors must be authentic, accurate, complete and sufficient. The above interim measures were replaced by the Measures for the Administration of Online Commodities Trading, which was issued by the SAMR on January 26, 2014 and became effective on March 15, 2014. These newly issued measures further impose more stringent requirements and obligations on the online trading or service operators. We are subject to such rules as a result of our online sales business.

 

In January 2017, the SAMR adopted the Interim Measures for Seven-day Unconditional Return of Online Purchased Goods. Pursuant to such interim measures, customers are entitled to return goods without reason, except for customized goods, fresh and perishable goods, delivered newspapers or periodicals, and audio-visual products, computer software and other digital products which are downloaded online or of which the packages have been opened by customers.

 

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On August 31, 2018, the Standing Committee of the National People’s Congress promulgated the E-commerce Law of the PRC, or the new E-commerce Law, which came into effect on January 1, 2019. The new E-commerce Law regulates e-commerce platform operators, or platform operators, as well as e-commerce operators who sell products or provide services on e-commerce platforms. Specifically, the new E-commerce Law provides that e-commerce operators shall (i) register themselves as market subjects according to the law, except for individuals selling self-produced agricultural and sideline products or family handicrafts, applying their own skills in labor activities that are exempted from registration, or engaged in odd small-amount transaction activities that do not require any license under the law; (ii) fulfill their tax obligations and enjoy tax incentives in accordance with the law; (iii) always have information about its own business license, the administrative license issued for its business, and its status as a party that is not required to register itself as a market subject, or the link to a webpage with such information published in a prominent position on its homepage; (iv) bear the likely risks and responsibilities when commodities are in transit, except for when consumers select separate express logistics service providers; and (v) provide clear notice to consumers for tie-in sales and shall not set tie-in commodities or services as the default option. Further, e-commerce operators that possess dominant market positions shall not abuse their market dominance to eliminate or restrict competition.

 

In addition, the new E-commerce Law provides that platform operators shall (i) verify and register the identity, address, contact and administrative license of e-commerce operators applying to sell commodities or provide services on its platform, establish registration archives and have them verified and updated regularly; (ii) record and save information released on its platform about commodities and services and deals concluded for a period of three years (unless otherwise stipulated), and ensure the completeness, confidentiality and availability of such information; (iii) use noticeable labels to clearly identify any business that it conducts on its own platform. A platform operator shall not impose unreasonable restrictions over or add unjustified conditions to transactions concluded on its platform by e-commerce operators, nor shall a platform operator charge e-commerce operators on its platform any unreasonable fees.

 

If a platform operator knows, or should have known, that an e-commerce operator has conducted acts infringing on the legitimate rights and interests of consumers, but the platform operator fails to take any necessary measure, the platform operator shall be held jointly and severally liable with the e-commerce operator. Where a platform operator fails to examine the qualifications of the e-commerce operators on its platform or fails to protect the safety of its consumers in respect of goods or services that may affect the consumer’s health, the platform operator shall bear corresponding liability to the consumers. Where a platform operator fails to take necessary measures against violations of intellectual property rights by e-commerce operators on its platform, the administrative department for intellectual property may order the platform operator to make corrections within the required time limit; where it fails to make corrections within the required time limit, the platform operator may face administrative fines of up to RMB2 million.

 

Regulations Relating to Foreign Trade

 

Pursuant to the Foreign Trade Law of the PRC (revised in 2016), which was promulgated by the Standing Committee of the National People’s Congress on May 12, 1994, amended on April 6, 2004 and further amended on November 7, 2016, a foreign trade dealer engaged in import or export of goods or technologies shall register with the authority responsible for foreign trade under the State Council of the PRC or its authorized bodies. Where a foreign trade dealer fails to register as required, the Customs authority shall not process the declaration and clearance procedures for the imported or exported goods.

 

Regulations Relating to Tort Liability, Product Quality and Consumer Protection

 

The Tort Liability Law of the PRC was enacted by the Standing Committee of the National People’s Congress on December 26, 2009. Under this law, in the event of damage arising from a defective product, the victim may seek compensation from either the manufacturer or seller of such a product. If the defect is caused by the seller, the manufacturer shall be entitled to seek full reimbursement from the seller upon compensation of the victim.

 

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The PRC Product Quality Law (revised in 2000, 2009 and 2018) applies to all production and sales activities in China. Pursuant to this law, products offered for sale must satisfy the relevant quality and safety standards. Enterprises may not produce or sell counterfeit products in any manner, including forging brand labels or giving false information regarding a product’s manufacturer. Violations of state or industrial standards for health and safety and any other related requirements may result in civil liabilities and administrative penalties, such as compensation for damages, fines, suspension or revocation of business license and confiscation of products that were illegally produced and sold as well as the proceeds from such sales. Severe violations may subject the responsible individual or enterprise to criminal liabilities. Where a defective product causes physical injury to a person or damage to another person’s property, the victim may claim compensation from the manufacturer or from the seller of the product. If the seller pays compensation for damages caused by the manufacturer, the seller may seek full reimbursement from the manufacturer. Similarly, if the manufacturer pays compensation for damages caused by the seller, the manufacturer may seek full reimbursement from the seller.

 

The PRC Consumer Protection Law, as amended on October 25, 2013 and effective on March 15, 2014, or the amended PRC Consumer Protection Law, requires business operators to guarantee that the commodities they sell satisfy the requirements for personal or property safety, provide consumers with authentic information about the commodities, and guarantee the quality, function, usage and term of validity of the commodities. The amended PRC Consumer Protection Law imposes even more stringent requirements and obligations on business operators selling goods or services through the internet. For example, consumers are entitled to return the goods (except for certain specific goods) within seven days upon receipt without any reasons when they purchase the goods from business operators via the internet. Failure to comply with the amended Consumer Protection Law may subject business operators to civil liabilities and, where crimes are committed during the infringement of the lawful rights and interests of consumers, criminal liabilities.

 

As to legal liabilities of the platform operator, the amended PRC Consumer Protection Law set forth that, where a consumer’s interest are prejudiced when purchasing products or services via an e-commerce platform, and the platform operator fails to provide the name, address and valid contact information of the seller, the manufacturer or the service provider, the consumer may demand compensation from the platform operator. Once the online trading platform operator has paid compensation, it shall have a right of recourse against the seller, the manufacturer or the service provider. If the platform operator knew, or should have known, that a seller, manufacturer or service provider is using the online platform to infringe upon the lawful rights and interests of consumers, and the platform operator fails to take necessary measures, it shall bear joint and several liabilities with the seller, the manufacturer or service provider.

 

We are subject to the above laws and regulations as an online retailer of commodities and believe that we are currently in compliance with these regulations in all material aspects.

 

Regulations Relating to Pricing

 

In China, only the prices of a very small number of products and services are guided or fixed by the government. According to the PRC Pricing Law, business operators must display prices clearly and in accordance with the requirements set out by the relevant authority. Further, business operators must indicate the name, origin of production, specifications and other relevant information. Business operators shall not charge any price different from the displayed price or fees that are not explicitly indicated. Business operators must not engage in any specified unlawful pricing activities, such as colluding with others to manipulate the market price, using false or misleading prices to lure consumers into concluding a transaction, or conducting price discrimination against other business operators. Failure to comply with the PRC Pricing Law may subject business operators to administrative sanctions such as the issuance of a warning, an order to make a rectification, confiscation of illegal gains, imposition of fines, suspension of business operations or revocation of business licenses under severe circumstances, as well as potential civil and criminal liabilities.

 

We are subject to the PRC Pricing Law as an online retailer and believe that our pricing activities are currently in compliance with the law in all material aspects.

 

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Regulations Relating to Intellectual Property

 

The Copyright Law of the PRC, promulgated in 1990 and revised in 2001 and 2010, and the Regulations on Computer Software Protection, promulgated by the State Council of the PRC on December 20, 2001 and revised on January 8, 2011 and January 30, 2013, provide protection to the rights and interests of computer software copyright holders. Pursuant to the Regulations on Computer Software Protection, software developed by PRC citizens, legal entities or other organizations is automatically protected immediately after its development, regardless of whether the software was published. A software copyright owner may register with the designated registration authorities and obtain a registration certificate, which serves as preliminary proof of ownership of the copyright and other registered matters. The operational procedures for the registration of software copyright and the registration of software copyright license and transfer agreements are set forth in the Measures on Computer Software Copyright Registration promulgated by the National Copyright Administration on February 20, 2002.

 

Trademarks are protected by the Trademark Law of the PRC (Revised in 2019), which was promulgated on August 23, 1982 and subsequently amended on February 22, 1993, October 27, 2001, August 30, 2013 and April 23, 2019 (effective on November 1, 2019), as well as the Implementation Regulation of the PRC Trademark Law adopted by the State Council of the PRC on August 3, 2002 (Revised in 2014). Pursuant to the PRC Trademark Law, registered trademarks refer to trademarks registered with the Trademark Office under the SAMR, including trademarks for goods and services, collective trademarks and certification trademarks. The PRC Trademark Law has adopted a “first come, first file” principle with respect to trademark registration. A registration application may be rejected if the trademark concerned is identical or similar to another trademark which has already been registered or been given a preliminary examination and approval for use on similar or same kind of goods or services. No applicant may prejudice the existing rights of others, nor may any person register a trademark that has already been used by another party and has already gained a “sufficient degree of reputation” through such party’s use. A registered trademark is valid for a period of 10 years and can be renewed within 12 months prior to the expiry date. Each renewal of registration will be valid for 10 years.

 

The PRC Trademark Law further provides that a trademark registrant may license its registered trademark to another party by entering into a trademark license contract. Trademark license agreements must be filed with the Trademark Office. The licensor shall supervise the quality of the goods on which the trademark is used, and the licensee shall guarantee the quality of such goods.

 

The MIIT promulgated the Administrative Measures on Internet Domain Name, or the Domain Name Measures, on August 24, 2017. According to the Domain Name Measures, domain name owners are required to register their domain names with the domain name registries, which are supervised and administered by the MIIT. The domain name registration follow a “first come, first file” principle. Applicants for the registration of domain names are required to provide true, accurate and complete information in their application, including the identity of the domain name holder, as well as enter into registration agreements with the domain name registry. The applicant becomes the holder of the applied domain name upon the completion of the registration procedure.

 

According to the Patent Law of the PRC (Revised in 2008), promulgated by the Standing Committee of the National People’s Congress, and its Implementation Rules (Revised in 2010), promulgated by the State Council of the PRC, the State Intellectual Property Office of the PRC is responsible for administering patents in the PRC. The patent administration departments of the provincial, autonomous regions or municipal governments are responsible for administering patents within their respective jurisdictions. The Patent Law of the PRC and its implementation rules provide for three types of patents, namely “invention”, “utility model” and “design”. Invention patents are valid for 20 years, while design patents and utility model patents are valid for 10 years, from the date of application. The Chinese patent system adopts a “first come, first file” principle, which means that where more than one person files a patent application for the same invention, a patent will be granted to the person who files the application first. To be patentable, invention or utility models must meet three criteria: novelty, inventiveness and practicability. The use of a patent without the consent of or a proper license from the patent owner constitutes an infringement of the owner’s patent rights.

 

Regulations Relating to Foreign Exchange

 

Under the PRC Regulations on Foreign Exchange Control, promulgated on January 29, 1996 and last amended on August 1, 2008, and various regulations issued by the SAFE and other relevant PRC government authorities, Renminbi may be converted into other currencies for the purpose of current account items, such as trade related receipts and payments and payment of interests and dividends. The conversion of Renminbi into other currencies and remittance of the converted foreign currency outside the PRC for the purpose of capital account items, such as direct equity investments, loans and repatriation of investments, requires the prior approval from the SAFE or its local office. Payments for transactions that take place within the PRC must be made in Renminbi. Subject to the conditions and requirements set by the SAFE, PRC companies may repatriate or deposit overseas the foreign currency payments received abroad. Foreign-invested enterprises may retain foreign exchange proceeds from the current account items in accounts with designated foreign exchange banks subject to a cap set by the SAFE or its local office or sell the foreign exchange proceeds to a financial institution engaging in settlement and sale of foreign exchange pursuant to the relevant rules and regulations of the State. For foreign exchange proceeds under the capital accounts, approval from the SAFE is required for its retention or sale to a financial institution engaging in settlement and sale of foreign exchange, except otherwise provided under the relevant rules and regulations of the PRC.

 

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Pursuant to the Notice of the SAFE on Further Improving and Adjusting Foreign Exchange Administration Policies for Direct Investment, or the SAFE Notice No. 59, promulgated by the SAFE on November 19, 2012 and amended on May 4, 2015 and October 10, 2018, approval is not required for opening of foreign exchange accounts for direct investment or for conducting domestic transfer of the foreign exchange for direct investment. The SAFE Notice No. 59 also simplified the capital verification and confirmation formalities for FIEs, the foreign capital and foreign exchange registration formalities required for foreign investors to acquire equities of a Chinese company. The SAFE Notice No. 59 further improves the exchange settlement administration of the foreign exchange capital of foreign-invested entities.

 

The Notice of the SAFE on Reforming the Management Approach Regarding the Settlement of Foreign Capital of Foreign-invested Enterprise, or the SAFE Notice No. 19, was promulgated on March 30, 2015 and became effective on June 1, 2015. According to the SAFE Notice No. 19, a FIE may, in response to its actual business needs, settle with a bank the portion of the foreign exchange capital in its capital account for which the relevant foreign exchange bureau has confirmed monetary contribution rights and interests (or for which the bank has registered the account-crediting of monetary contribution). For the time being, FIEs are allowed to settle 100% of their foreign exchange capital on a discretionary basis; a FIE shall truthfully use its capital for its own operational purposes and within its scope of business; where an ordinary FIE makes domestic equity investments with the amount of foreign exchanges settled, the invested enterprise shall first go through domestic reinvestment registration and open a corresponding Account for Foreign Exchange Settlement Pending Payment with the foreign exchange bureau (bank).

 

According to Circular 16, all enterprises registered in PRC may convert their foreign exchange under capital account items (including but not limited to foreign currency capital and foreign debts) to Renminbi on a self-discretionary basis. The Circular 16 reiterates the principle that a company may not use Renminbi converted from foreign currency-denominated capital directly or indirectly for purposes beyond its business scope, for investments in securities or for other investments with the exception of principal-guaranteed bank financial products within the PRC unless otherwise specifically provided. Further, the converted Renminbi shall not be used to make loans for related companies unless it is within the business scope or to build or purchase any real estate that is not for the company’s own use unless the company’s business is in real estate.

 

SAFE Circular 37 promulgated by the SAFE in July 2014, requires PRC residents or entities to register with the SAFE or its local branch their establishment or control of an offshore entity established for the purpose of overseas investment or financing. In addition, such PRC residents or entities must update their SAFE registrations when the offshore special purpose vehicle undergoes material events relating to any change of its basic information (including change of such PRC citizens or residents, name and operation term, and etc.), increases or decreases in investment amount, transfers or exchanges of shares, or mergers or divisions, etc.

 

SAFE further enacted the Notice of the SAFE on Further Simplifying and Improving the Foreign Exchange Management Policies for Direct Investment, or the SAFE Notice 13, on February 13, 2015, which allows PRC residents or entities to register with qualified banks their establishment or control of an offshore entity established for the purpose of overseas investment or financing. However, remedial registration applications made by PRC residents that previously failed to comply with the SAFE Circular 37 will continue to fall under the jurisdiction of the relevant local branch of the SAFE. 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 distributing profits to the offshore parent and from carrying out subsequent cross-border foreign exchange activities. Further, the special purpose vehicle may be restricted in its ability to contribute additional capital into its PRC subsidiary.

 

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All of our shareholders who, to our knowledge, are subject to the above SAFE regulations have completed the necessary registrations with the qualified banks as required by SAFE Circular 37.

 

On January 26, 2017, SAFE issued the Notice on Further Promoting the Reform of Foreign Exchange Administration and Improving Authenticity and Compliance Review, or the SAFE Notice 3, which stipulates several capital control measures with respect to the outbound remittance of profit from domestic entities to offshore entities, including the requirements that: (i) under the principle of genuine transaction, banks shall review board resolutions regarding profit distribution, the original version of tax filing records and audited financial statements; and (ii) domestic entities shall hold income to account for losses incurred in previous years before remitting the profits. Moreover, pursuant to SAFE Notice 3, domestic entities shall make detailed explanations of the sources of capital and utilization arrangements, and provide board resolutions, contracts and other proof when completing the registration procedures in connection with an outbound investment.

 

Regulations Relating to Dividend Distribution

 

The principal laws and regulations regulating the distribution of dividends by FIEs in the PRC include the Company Law of the PRC, as amended in 1999, 2004, 2005, 2013 and 2018, the Wholly Foreign-owned Enterprise Law of the PRC promulgated in 1986 and last amended in 2016 and its implementation regulations promulgated in 1990 and subsequently amended in 2001 and 2014, the Equity Joint Venture Law of the PRC promulgated in 1979 and last amended in 2016 and its implementation regulations promulgated in 1983 and last amended in 2014, and the Cooperative Joint Venture Law of the PRC promulgated in 1988 and last amended in 2017 and its implementation regulations promulgated in 1995 and last amended in 2017. Under the current regulatory regime in the PRC, FIEs in the PRC may pay dividends only out of their accumulated profit, if any, determined in accordance with PRC accounting standards and regulations. Except otherwise provided by the laws regarding foreign investment, a PRC company is required to set aside at least 10% of its after-tax profit as general reserves until the cumulative amount of such reserves reaches 50% of the company’s registered capital. A PRC company shall not distribute any profits until any losses from prior fiscal years have been offset. Profits retained from prior fiscal years may be distributed together with distributable profits from the current fiscal year.

 

Regulations Relating to Employment and Social Welfare

 

The Labor Contract Law, which was implemented on January 1, 2008 and amended on December 28, 2012, is primarily aimed at regulating employee/employer rights and obligations, including matters with respect to the establishment, performance and termination of labor contracts. Pursuant to the Labor Contract Law, labor contracts shall be concluded in writing if labor relationships are to be or have been established between enterprises or institutions and the laborers. Enterprises and institutions are forbidden to force employees to work beyond the time limit, and employers shall pay employees for overtime work in accordance with national regulations. In addition, labor wages shall not be lower than local standards on minimum wages and shall be paid to employees in a timely manner. In addition, according to the Labor Contract Law: (i) an employer must pay an employee double income if the employer fails to enter into an employment contract with the employee after the lapse of more than one month but less than one year from the date of employment, and, if the failure to enter into an employment contract persists for more than one year, the parties will be deemed to have entered into a labor contract with an “unfixed term”; (ii) employees who fulfill certain criteria, including having worked for the same employer for ten years or more, may demand that the employer execute a labor contract with them with an unfixed term; (iii) employees must adhere to regulations in the labor contracts concerning commercial confidentiality and non-competition; (iv) if an employee breaches the provisions concerning term of services in the labor contract, an employer may seek an amount of compensation not exceeding the cost of training the employee; (v) employees may terminate their employment contracts with their employers if their employers fail to make social insurance contributions in accordance with the law; (vi) employers who demand money or property from employees as guarantee may be subject to a fine of more than RMB500 but less than RMB2,000 per employee; and (vii) employers who intentionally deprive employees of any part of their salary must, in addition to their full salary, pay such employees compensation ranging from 50% to 100% of the amount of salary so deprived if they fail to pay the salary deprived within the period specified by the labor administration authorities.

 

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According to the Labor Law of the PRC, promulgated on July 5, 1994 and effective on January 1, 1995 and amended on August 27, 2009 and December 29, 2018, enterprises and institutions shall establish and improve their system of workplace safety and sanitation, strictly abide by state rules and standards on workplace safety and sanitation as well as other relevant articles of labor protection, and educate laborers in labor safety and sanitation in the PRC. Labor safety and sanitation facilities shall comply with standards prescribed by the State.

 

As required under the Regulation of Insurance for Labor Injury implemented on January 1, 2004 and amended in 2010, the Provisional Measures for Maternity Insurance of Employees of Corporations implemented on January 1, 1995, the Decisions on the Establishment of a Unified Program for Basic Old-Aged Pension Insurance of the State Council of the PRC issued on July 16, 1997, the Decisions on the Establishment of the Medical Insurance Program for Urban Workers of the State Council of the PRC promulgated on December 14, 1998, the Regulations on Unemployment Insurance promulgated on January 22, 1999 and the Social Insurance Law of the PRC implemented on July 1, 2011 and amended on December 29, 2018, enterprises are obliged to provide their employees in the PRC with welfare schemes covering pension insurance, unemployment insurance, maternity insurance, labor injury insurance and medical insurance. These payments are made to local administrative authorities, and any employer that fails to contribute may be fined and ordered to make the payment within a prescribed time limit.

 

According to the Regulations on the Management of Housing Provident Funds, which was promulgated by the State Council of the PRC in 1999, amended in 2002 and 2019 respectively, newly established enterprises must register at the competent housing provident fund managing center. These enterprises shall then use the verification documents provided by such managing center to open housing provident fund accounts for their employees at the relevant bank. Enterprises are also required to pay and deposit housing funds on behalf of their employees in full and in a timely manner.

 

Regulations Relating to Tax

 

On March 16, 2007, the National People’s Congress promulgated the Law of the PRC on Enterprise Income Tax, which was amended on February 24, 2017 and December 29, 2018, and on December 6, 2007, the State Council of the PRC enacted The Regulations for the Implementation of the Law on Enterprise Income Tax, or collectively, the EIT Law. The EIT Law came into effect on January 1, 2008. According to the EIT Law, taxpayers consist of resident enterprises and non-resident enterprises. Resident enterprises are defined as enterprises that are established in China in accordance with PRC laws, or that are established in accordance with the laws of foreign countries but whose “de facto management body” is located in the PRC. Non-resident enterprises are defined as enterprises that are set up in accordance with the laws of foreign countries and whose de facto management body is located outside the PRC, but have either established institutions or premises in the PRC or have income generated from inside the PRC. Under the EIT Law and relevant implementing regulations, enterprises are subject to a uniform corporate income tax rate of 25%. However, if non-resident enterprises have not formed permanent establishments or premises in the PRC, or if they have formed permanent establishments or premises in the PRC but their relevant income derived in the PRC is not related to those establishments, then their enterprise income tax would be set at a rate of 10% for their income sourced from inside the PRC.

 

The Notice Regarding the Determination of Chinese-Controlled Offshore Incorporated Enterprises as PRC Tax Resident Enterprises on the Basis of De Facto Management Bodies, promulgated by the SAT on April 22, 2009 and last amended on December 29, 2017, sets out the standards and procedures for determining whether an overseas China-funded enterprise shall be identified as a resident enterprise of the actual organizational management within the territory of the PRC, and shall be subject to relevant taxation management and collection of enterprise income tax on its income derived from within and out of the territory of the PRC.

 

As noted, the EIT Law provides that an income tax rate of 10% will be applicable to dividends or other gains received by investors who are “non-resident enterprises” and who meet the aforementioned requirements for the lower enterprise income tax rate. Such income tax on dividends may be reduced further by the tax treaties between China and the jurisdictions in which non-PRC shareholders of our PRC subsidiary reside. Specifically, pursuant to an Arrangement between the PRC and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion, or the Double Tax Avoidance Arrangement, and other applicable PRC laws, if a Hong Kong enterprise (being the beneficial owner of dividends from a PRC enterprise) is determined by the competent PRC tax authority to have satisfied the relevant conditions and requirements under such Double Tax Avoidance Arrangement and other applicable laws, the 10% withholding tax on the dividends that the Hong Kong enterprise receives from the PRC enterprise may be reduced to 5% subject to approval from the relevant tax authority. However, based on the Notice on Certain Issues with Respect to the Enforcement of Dividend Provisions in Tax Treaties, or Notice No. 81, issued on February 20, 2009 by the SAT, if the relevant PRC tax authorities determine, in their discretion, that a company benefits from such reduced income tax rate due to a corporate structure or arrangement that is primarily tax-driven, such PRC tax authorities may adjust the preferential tax treatment. Moreover, based on the Announcement No. 9, conduit companies, which are established for the purpose of evading or reducing tax, or transferring or accumulating profits, shall not be recognized as beneficial owners and are thus not entitled to the above tax benefits.

 

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The Provisional Regulations of the PRC on Value-added Tax were promulgated by the State Council of the PRC on December 13, 1993 and subsequently amended on November 5, 2008, February 6, 2016 and November 19, 2017. The Detailed Rules for the Implementation of the Provisional Regulations of the PRC on Value-added Tax (Revised in 2011) was promulgated by the Ministry of Finance and the SAT on December 15, 2008 and subsequently amended on October 28, 2011 (collectively, the “VAT Law”). According to the VAT Law, all enterprises and individuals engaged in the sale of goods, provision of processing, repair and replacement services, and importation of goods within the territory of the PRC must pay value-added tax, or VAT. Other than exports (subject to 0% VAT rate) and certain products listed in the VAT Law (subject to 11% VAT rate), the sale and importation of goods were generally subject to a VAT rate of 17%. Pursuant to the Circular of the Ministry of Finance and the State Administration of Taxation on Adjusting Value-added Tax Rates, which became effective on May 1, 2018, the previous applicable VAT rate of 17% and 11% are adjusted to 16% and 10%, respectively.

 

On January 1, 2012, the State Council of the PRC officially launched a pilot VAT reform program, or the Pilot Program, which is applicable to businesses in selected industries. Businesses in the Pilot Program would pay VAT instead of the business tax. The Pilot Program initially applied only to the transportation industry and “modem service industries”, or collectively, the Pilot Industries, in Shanghai. The research and development and technical services and information technology services included in the Pilot Industries are subject to the VAT tax rate of 6%. Subsequently, the Pilot Program has been expanded to ten additional regions, including, among others, the Beijing and Guangdong provinces, and has been expanded nationwide for certain designated pilot industries. According to the Notice Regarding the Inclusion of the Telecommunications Sector under the Pilot Program of Replacing Business Tax with Value-Added Tax, which was promulgated on April 29, 2014 and became effective on June 1, 2014, the entities and individuals providing telecommunications services within the territory of PRC shall pay VAT instead of business tax. The Trial Implementing Measures of the Conversion of Business Tax to Value-added Tax, or the Trial Implementing Measures, which was promulgated on March 23, 2016, amended on July 11, 2017 and became effective retroactively as of July 1, 2017 and last amended on March 20, 2019, superseded the Notice Regarding the Inclusion of the Telecommunications Sector under the Pilot Program of Replacing Business Tax with Value-Added Tax. The Trial Implementing Measures provides that VAT will be collected in lieu of business tax in all regions and industries.

 

Regulations on Stock Incentive Plans

 

Pursuant to the Notice on Issues Concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly Listed Company issued by the SAFE in February 2012, employees, directors, supervisors and other senior management participating in any stock incentive plan of an overseas publicly listed company who are PRC citizens or who are non-PRC citizens residing in China for a continuous period of not less than one year, subject to a few exceptions, are required to register with the SAFE through a domestic qualified agent and complete certain other procedures. The domestic qualified agent could be a PRC subsidiary of the overseas listed company. We and our directors, executive officers and other employees who are PRC citizens or who reside in the PRC for a continuous period of not less than one year and who have been granted options will be subject to these regulations when our company becomes an overseas-listed company upon the completion of our initial public offering.

 

In addition, the SAT has issued certain circulars concerning employee share options or restricted shares. Under these circulars, the employees working in the PRC who exercise share options or are granted restricted shares will be subject to PRC individual income tax. The PRC subsidiaries of such overseas listed company have obligations to file documents related to employee share options or restricted shares with relevant tax authorities and to withhold individual income taxes of those employees who exercise their share options. If the employees fail to pay or the PRC subsidiaries fail to withhold their income taxes according to relevant laws and regulations, the PRC subsidiaries may face sanctions imposed by the tax authorities or other relevant PRC government authorities.

 

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Regulations Relating to Mergers and Acquisitions

 

On August 8, 2006, six PRC regulatory agencies, including the China Securities Regulatory Commission, or the CSRC, jointly promulgated the Rules on Acquisition of Domestic Enterprises by Foreign Investors, or the M&A Rules, which became effective on September 8, 2006 and was amended on June 22, 2009. The M&A Rules, among other things, requires that an offshore special purpose vehicle formed for overseas listing purposes and controlled directly or indirectly by PRC companies or individuals shall obtain the approval of the CSRC prior to the listing and trading securities of such offshore special purpose vehicle on an overseas stock exchange.

 

Our PRC legal counsel has advised us that based on its understanding of the current PRC laws and regulations, we will not be required to submit an application to the CSRC for the approval of the listing and trading of our ADSs on the Nasdaq Global Select Market. However, our PRC legal counsel has further advised us that there remains some uncertainties as to how the M&A Rules will be interpreted or implemented in the context of an overseas offering, and its opinions summarized above are subject to any new laws, rules and regulations or detailed implementations and interpretations in any form relating to the M&A Rules.

 

C.                                    Organizational Structure

 

The chart below summaries our corporate and shareholding structure and identifies the significant subsidiaries and affiliates described above and the places of incorporation as of the date of this annual report:

 

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GRAPHIC

 


(1)             On October 4, 2018, as part of the Equity Restructuring, Hangzhou Ruhnn, the former parent of Hanyi E-Commerce transferred 1% equity interest in Hanyi E-Commerce to FENG Min for the purpose of creating a new nominee shareholder to enter into the contractual arrangements.

(2)             Wholly owned by FENG Min. On October 4, 2018, as part of the Equity Restructuring, Hangzhou Ruhnn, the former parent of Hanyi E-Commerce transferred 99% equity interest in Hanyi E-Commerce to this entity for the purpose of creating a new nominee shareholder to enter into the contractual arrangements.

(3)             Exclusive Business Corporation Agreement, Exclusive Call Option Agreement, Power of Attorney and Equity Interest Pledge Agreement.

(4)             Exclusive Call Option Agreement, Power of Attorney, Equity Interest Pledge Agreement and Spousal Consent Letter.

(5)             Exclusive Call Option Agreement, Power of Attorney and Equity Interest Pledge Agreement.

 

Contractual Arrangements with Our VIE and its Shareholders

 

As a Cayman Island company, our holding company is classified as a foreign enterprise under PRC laws and regulations, and our WFOE is an FIE. FIEs are subject to a number of restrictions under PRC laws and regulations. In particular, we currently hold a commercial performance license for introducing our KOLs to participate in TV shows and other performances, which is classified as talent agency services. Moreover, we plan to expand our e-commerce-related businesses in the future, some of which may be classified as value-added telecommunication services. As these businesses may be subject to strict business licensing requirements, including limitations on foreign ownership and in order to have greater flexibility in carrying out our business and implementing our business strategies in compliance with PRC laws and regulations, we operate our businesses in China mainly through our VIE and its subsidiaries. Our VIE and most of its subsidiaries are domestic PRC companies. We and our WFOE have entered into a series of contractual arrangements with our VIE and its direct and indirect shareholders, through which we are able to consolidate the financial results of our VIE and its subsidiaries. These contractual arrangements allow us to:

 

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·             exercise effective control over our VIE through our power to direct the activities of our VIE that most significantly impact its economic performance;

 

·             receive economic benefits of our VIE that potentially could be significant to our VIE; and

 

·             have a call option to purchase all or part of the equity interests and/or assets in our VIE when and to the extent permitted by PRC law.

 

As a result of these contractual arrangements, we are the primary beneficiary of our VIE and its subsidiaries and have their financial results in our combined and consolidated financial statements in accordance with U.S. GAAP. However, these contractual arrangements may not be as effective in providing operational control as direct ownership and the use of the contractual arrangements exposes us to certain risks. For example, our VIE or its direct or indirect shareholders may breach the contractual arrangements with us. In such cases, we would have to rely on legal remedies under PRC law, which may not always be effective, particularly in light of uncertainties in the PRC legal system. See “Item 3. Key Information — D. Risk Factors—Risks Relating to Our Corporate Structure”.

 

If the VIE or its direct or indirect shareholders fail to perform their obligations under the contractual arrangements, we could be limited in our ability to enforce the contractual arrangements that give us effective control over the VIE and its subsidiaries. See “Item 3. Key Information — D. Risk Factors — Risks Relating to Our Corporate Structure — We rely on contractual arrangements with Hanyi E-Commerce and its shareholders for our operations in China, which may not be as effective in providing control as direct ownership.” If we are unable to maintain effective control over our VIE and its subsidiaries, we will not be able to continue consolidating their financial results into our financial results. Our VIE and its subsidiaries contributed substantially all of our total revenues. Further, we rely on dividends and other distributions paid to us by our offshore and PRC subsidiaries, which in turn depends on the service fees paid from our VIE and its subsidiaries. In practice, we evaluate on a case-by-case basis the performance and future plans of our VIE and its subsidiaries before determining the amount of fees we will collect from them. We do not have unfettered access to the revenues from our WFOE, our VIE or its subsidiaries due to the significant legal restrictions on the payment of dividends by PRC companies, foreign exchange control restrictions, and restrictions on foreign investment, among others. See “Item 3. Key Information — D. Risk Factors — Risks Relating to Our Corporate Structure — We rely on dividends, fees and other distributions paid by our PRC subsidiary to fund any cash and financing requirements we may have, and any limitation on the ability of our PRC subsidiary to make payments to us could hinder our ability to conduct our business.”

 

The following is a summary of the currently effective contractual arrangements.

 

Agreements that Provide Us with Effective Control over Our VIE and Its Shareholders

 

Equity Interest Pledge Agreement. Pursuant to the Equity Interest Pledge Agreement, Hangzhou Xinghui Corporate Management Consulting Co., Ltd., or Hangzhou Xinghui, and FENG Min have pledged all of their equity interest in Hanyi E-Commerce to guarantee the performance of obligations by Hanyi E-Commerce, Hangzhou Xinghui and FENG Min under the relevant contractual arrangements, which include the Power of Attorney Agreement, Exclusive Business Cooperation Agreement and Exclusive Call Option Agreement. If Hangzhou Xinghui, Hanyi E-Commerce and FENG Min breach their contractual obligations under these agreements, our WFOE, as pledgee, will have the right to auction or sell all or part of the pledged equity interests of Hangzhou Xinghui and FENG Min, and receive proceeds from such auction or sale. Hangzhou Xinghui and FENG Min agree, among other things, that, during the term of the Equity Interest Pledge Agreement, Hangzhou Xinghui will not dispose of the pledged equity interests or create or allow creation of any encumbrance on the pledged equity interests or any portion thereof, without the prior written consent of our WFOE, except for the performance of the Exclusive Call Option Agreement. The Equity Interest Pledge Agreement will remain effective until the termination of the Exclusive Business Cooperation Agreement and all of the obligations thereunder have been fulfilled.

 

Power of Attorney Agreement. Pursuant to the Power of Attorney Agreement, Hangzhou Xinghui and FENG Min have irrevocably authorized our WFOE and certain person(s) designated by our WFOE to act on Hangzhou Xinghui and FENG Min’s behalf as exclusive agent and attorney, to the extent permitted by law, with respect to all shareholder rights, including but not limited to the right to call, attend and vote on shareholder’s meetings and serve as directors and executive officers. The Power of Attorney Agreement is irrevocable and continuously effective from the execution date unless our WFOE provides a written termination notice to Hangzhou Xinghui and FENG Min or other conditions of termination under the Power of Attorney Agreement have been met.

 

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Agreement that Allows Us to Receive Economic Benefits from Our VIE and Its Shareholders

 

Exclusive Business Cooperation Agreement. Under the Exclusive Business Cooperation Agreement, our WFOE has the exclusive right to provide Hanyi E-Commerce with comprehensive technical support, consulting services and other services. In exchange, our WFOE is entitled to receive an annual service fee from Hanyi E-Commerce at an amount that is equal to 100% of its net profit. The WFOE has the right to adjust the service fee payment frequency at its sole discretion. In addition, our WFOE owns the intellectual property rights arising out of the performance of the Exclusive Business Cooperation Agreement. Unless otherwise terminated in accordance with the provisions of the Exclusive Business Cooperation Agreement or in accordance with applicable PRC laws or terminated by our WFOE in writing 30 days in advance, the Exclusive Business Cooperation Agreement remains continuously effective.

 

Agreement that Provides Us with the Option to Purchase the Equity Interest in Our VIE

 

Exclusive Call Option Agreement. Pursuant to the Exclusive Call Option Agreement, Hangzhou Xinghui and FENG Min have irrevocably granted our WFOE an exclusive option to purchase by itself or by its designate person(s), at our WFOE’s sole discretion at any time, to the extent permitted under PRC law, all or part of Hangzhou Xinhui’s and FENG Min’s equity interests in Hanyi E-Commerce. The purchase price of the equity interests shall be a nominal price, unless otherwise required by the relevant government authority or PRC law, in which case, the price shall be the minimum price permitted by the government authority or PRC law. Hangzhou Xinghui, FENG Min and Hanyi E-Commerce have agreed that, without our WFOE’s prior written consent, they will not, among other things, amend Hanyi E-Commerce’s articles of association, change Hanyi E-Commerce’s registered capital or scope of business, allow Hanyi E-Commerce to be separated or dissolved, sell or otherwise dispose of Hanyi E-Commerce’s assets and beneficial interest that is worth RMB1,000,000 or more, or provide any loans or guarantees. In addition, Hangzhou Xinghui and FENG Min undertake, among other things, that it will not sell or otherwise dispose of its equity interests in Hanyi E-Commerce or create any pledge or encumbrance on their equity interests in Hanyi E-Commerce without our WFOE’s prior written consent. The Exclusive Call Option Agreement will remain effective until all equity interests in and all assets of Hanyi E-Commerce have been transferred or assigned to our WFOE or its designated person(s).

 

Spousal Consent Letter. Pursuant to the Spousal Consent Letter executed by the spouse of FENG Min, our chairman of board of directors, the signing spouse confirmed and agreed that Mr. FENG’s direct or indirect equity interests in Hanyi E-Commerce are his own property and that the spouse does not enjoy and right or interest in connection with such equity interests of Hanyi E-Commerce held by Mr. FENG’s. The spouse also irrevocably agreed that she would not claim in the future any right or interest in connection with such equity interests in Hanyi E-Commerce held directly or indirectly by Mr. FENG’s.

 

D.                                    Property, Plants and Equipment

 

Our headquarters are located in Hangzhou, Zhejiang Province, and our principal warehouses are located in Haining, Zhejiang Province. As of March 31, 2019, we leased 11,282 square meters of office space in Hangzhou and Shanghai and leased an aggregate of over 59,080 square meters of warehouses in Haining and Hangzhou, Zhejiang Province.

 

In connection with the Equity Restructuring, Hangzhou Ruhnn Holdings Co., Ltd., or Hangzhou Ruhnn, sold us office spaces with an aggregate gross floor area of 8,158 square meters which Hangzhou Ruhnn purchased from a third-party seller in 2017 for a total purchase price of approximately RMB125.4 million. Hangzhou Ruhnn paid the full purchase price to the third-party seller and we have subsequently paid the same price to Hangzhou Ruhnn as part of our Equity Restructuring. We have taken possession of these office spaces and currently use them as offices. However, we have not obtained the building ownership certificates for these office spaces and we are in the process of obtaining such certificates.

 

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ITEM 4A.             UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 5.                OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included elsewhere in this annual report. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Item 3. Key Information — D. Risk Factors” or in other parts of this annual report.

 

A.            Operating Results

 

Key Factors Affecting Our Results of Operations

 

Macroeconomic factors and regulatory environment and our ability to maintain our leading position in the industry

 

The growth of our business depends on the development and popularity of the internet KOL economy, which in turn depends on the growth of the online retail market, continued increase in consumer spending, and increasing popularity and influence of internet KOLs. Our results of operations are also affected by changes in regulatory environment. For example, the new E-Commerce Law of the PRC has come into effect on January 1, 2019 and imposed various new regulatory requirements on e-commerce business operators. While these regulatory requirements may increase industry-wide compliance costs, we believe we, as an industry leader with substantial operating experience, are better positioned to attract internet KOLs in China who are trying to monetize their success on social media platforms through e-commerce channels as we can help ensure their compliance with the new regulatory requirements. As a result, we believe the regulatory change would create significant opportunities for us to further expand our business and increase our market share.

 

Moreover, the success of our business depends on our ability to maintain our market position as the largest internet KOL facilitator in China. Our leading market position and first-mover advantage has enabled us to establish strong brand recognition among KOLs in China and various players in the new retail industry. We believe our brand “Ruhnn” will continue to attract more KOLs and businesses to join our ecosystem in an efficient and sustainable manner. Our ability to maintain a market leading position and increase the reputation and attractiveness of our brand to KOLs, brands and other merchants will continue to be critical to our future business and financial performance.

 

Our ability to attract and retain popular KOLs and grow fan and customer base

 

We rely on KOLs to sell and promote products and services on our KOL sales and marketing platform. As such, our revenues and results of operations are directly affected by our ability to attract, and retain talents and grow a popular and diversified KOL pool. We aim to develop a balanced KOL talent pool to accommodate various fashion styles, personalities and fan bases, and cater to changing consumer demands. As we mainly sell and promote products and services to our KOLs’ fans, our business and financial performance are affected by our ability to help our KOLs grow their fan base, improve their fans’ engagement and convert more fans into paying customers and repeated buyers so that we can sell, or promote on behalf of brands and other merchants, more products and services to our KOLs’ fans.

 

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Our ability to effectively monetize the KOL ecosystem through different business models

 

We monetize the KOL ecosystem through our full-service model and platform model, by selling products to fans and providing KOL sales and advertising services to brands, online retailers and other merchants. Our financial performance, results of operations and financial condition are affected by the contributions of our different business models and monetization channels to our overall business. Our full-service model captures the value of the entire value chain, while our platform model is asset-light and flexible. Revenues from our product sales under our full-service model accounted for 99.1%, 96.3% and 86.2% of our total net revenues for fiscal years 2017, 2018 and 2019, respectively, while our service revenues under the platform model accounted for 0.9%, 3.7% and 13.8% of our total net revenues for fiscal years 2017, 2018 and 2019, respectively. Gross margin of our full-service model was 36.7%, 31.5% and 27.5% for fiscal years 2017, 2018 and 2019, respectively, while gross margin of our platform model reached 52.0%, 48.3% and 54.6% for the same periods. As we continue to strengthen our business relationships with brands, online retailers and other merchants as well as explore additional monetization opportunities by leveraging our established “Ruhnn” brand, we expect our service revenues under our platform model to increase in absolute amount and as a percentage of our total revenues in the near future. We also expect to continuously adjust our business models and monetization channels to respond to market conditions and expect our financial performance and condition to be affected by such adjustments.

 

Our ability to manage our costs and expenses

 

Our results of operations depend on our ability to manage our costs and expenses while continuing to grow our business. This includes our ability to, among others, (i) leverage our long-term relationships with suppliers as well as the scale of our business to negotiate preferential terms with suppliers and thereby reduce unit production costs, (ii) continually optimize economic arrangements with our KOLs to provide both strong incentives to our KOLs on one hand, and grow our revenue faster than the increase in fees payable to our KOLs on the other, (iii) improve our supply chain management capabilities, more accurately predict market trends and demand, and accelerate our inventory turnover; and (iv) increase the scale of our business to achieve economies of scale, and (v) diversify our business models and monetization channels to realize potential synergies. We expect the changing revenue contributions of our different businesses will also affect our overall cost structure. For example, as we continue to expand our business under our platform model, we expect our cost of revenue as a percentage of our total revenue may decrease in the future.

 

Investments in data-driven technology and AI solutions

 

Our results of operations are affected by our investments in data-driven technology and AI solutions. We have utilized the latest technology to improve our business and maintain competitiveness and made significant investments in data-driven technology and AI solutions. As we operate a unique full-service model and provide end-to-end solutions, we have access to various kinds of data throughout the entire value chain in the KOL ecosystem. We collect and analyze a significant amount of data daily, which enable us to provide better products and services to our fans, consumers, brands and other merchants, and to understand and meet their changing needs. In addition to our own efforts, we have invested in companies that develop AI solutions relevant to our business and operations, such as DeepFashion. Our investments in technology have increased, and are expected to continue to increase, which will affect our ability to rapidly grow our business, respond to changing market demands and control our costs and expenses, and in turn will significantly affect our results of operations.

 

Key Components of Results of Operations

 

Total Net Revenues

 

Our net revenues primarily include (i) product sales revenues from sales of various fashion and lifestyle products to consumers through our KOL online stores under our full-service model and (ii) service revenues from provision of various KOL sales and advertising services to third-party merchants under our platform model. The following table sets forth the breakdown of our total net revenues, both in absolute amount and as a percentage of our total net revenues, for the fiscal years presented:

 

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Fiscal Year Ended March 31,

 

 

 

2017

 

2018

 

2019

 

 

 

RMB

 

%

 

RMB

 

%

 

RMB

 

US$

 

%

 

 

 

(in thousands, except for percentages)

 

Net revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product sales under full-service model

 

572,445

 

99.1

 

912,512

 

96.3

 

942,781

 

140,479

 

86.2

 

Services under platform model

 

5,457

 

0.9

 

35,068

 

3.7

 

150,657

 

22,449

 

13.8

 

Total net revenues

 

577,902

 

100.0

 

947,580

 

100.0

 

1,093,438

 

162,928

 

100.0

 

 

We rely on KOLs to promote and sell products to fans and consumers as well as provide services to third-party merchants on our KOL sales and marketing platform. The following table sets forth our key performance indicators under each business model as of the dates or during the fiscal years indicated:

 

 

 

As of and for the fiscal year ended March 31,

 

 

 

2017

 

2018

 

2019

 

Full-Service Model

 

 

 

 

 

 

 

Number of our KOLs serving such business model(1)

 

37

 

33

 

14

 

Number of our online stores

 

57

 

86

 

56

 

Number of orders placed through our online stores

 

5.1 million

 

7.5 million

 

7.0 million

 

GMV of our online stores

 

RMB1,236.3 million

 

RMB1,944.4 million

 

RMB2,147.1 million

 

Platform Model

 

 

 

 

 

 

 

Number of our KOLs serving such business model(1)

 

18

 

57

 

122

 

Number of brands using our services

 

18

 

166

 

632

 

Number of third-party online stores(2)

 

nil

 

6

 

132

 

GMV of third-party online stores(3)

 

nil

 

RMB100.8 million

 

RMB713.5 million

 

 


(1)              Certain KOLs under our full-service model overlap with those under our platform model. On the other hand, our KOLs that were undergoing training and had not started generating GMV under either of our business models as of the relevant date were not included in these numbers.

(2)              Includes third-party online stores to which we provide KOL sales services and KOL advertising services.

(3)              Includes GMV from third-party online stores to which we only provide KOL sales services.

 

We expect that both of our product sales revenue and service revenue will continue to increase in absolute amounts as we continue to expand our overall business operations, while our service revenues as a percentage of our total net revenues will increase as we continue to accelerate the expansion of our platform model.

 

Our net revenues as a percentage of our total GMV slightly decreased from 46.7% for fiscal year 2017 to 46.3% for fiscal year 2018 and further decreased to 38.2% for fiscal year 2019, which was due to an increase in the proportion of our net revenues generated from services. The trend of our net revenues as a percentage of our total GMV in the future depends on the relative proportion of our product sales revenues and service revenue. As we continue to expand our business under the platform model, we expect the proportion of our net revenues from services will continue to increase and therefore our net revenues as a percentage of our total GMV may continue to decrease in the near future.

 

Cost of Revenues

 

The table below sets forth a breakdown of our cost of revenues by business model for the periods indicated, both in absolute amount and as a percentage of our total net revenues:

 

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Fiscal Year Ended March 31,

 

 

 

2017

 

2018

 

2019

 

 

 

RMB

 

%

 

RMB

 

%

 

RMB

 

US$

 

%

 

 

 

(in thousands, except for percentages)

 

Cost of revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of product sales under full-service model

 

(362,609

)

(62.7

)

(625,263

)

(66.0

)

(683,057

)

(101,779

)

(62.5

)

Cost of services under platform model

 

(2,619

)

(0.5

)

(18,122

)

(1.9

)

(68,336

)

(10,182

)

(6.2

)

Total

 

(365,228

)

(63.2

)

(643,385

)

(67.9

)

(751,393

)

(111,961

)

(68.7

)

 

Cost of product sales under our full-service model mainly consist of (i) purchase prices of products, including manufacturing fees and purchase price of fabrics and other materials, (ii) KOL service fees, and (iii) inventory write-downs.

 

Our cost of product sales primarily includes:

 

·                  Purchase prices of products amounted to RMB282.4 million, RMB479.7 million and RMB540.2 million (US$80.5 million) for the fiscal years 2017, 2018 and 2019, respectively;

 

·                  Inventory write-downs amounted to RMB25.5 million, RMB42.1 million and RMB40.6 million (US$6.0 million) for the fiscal years 2017, 2018 and 2019, respectively; and

 

·                  KOL service fees amounted to RMB54.8 million, RMB103.6 million and RMB96.6 million (US$14.4 million) for the fiscal years 2017, 2018 and 2019, respectively.

 

Cost of revenues under our full-service model does not include other direct costs related to product sales such as shipping costs, payroll and benefits of logistic staff or logistic centers, and rental expenses. Therefore, our cost of revenues may not be comparable to other companies which include such costs and expenses in their cost of revenues.

 

Cost of services under our platform model mainly consists of KOL service fees for providing sales and advertising services to third-party customers.

 

Our cost of revenues as a percentage of total net revenues increased from 63.2% for fiscal year 2017 to 67.9% for fiscal year 2018 primarily because of (i) increased inventory write-downs, and (ii) the fact that in fiscal year 2017, our top KOL was primarily entitled to a dividend distribution under the joint venture agreement entered into in 2016. In fiscal year 2018, we made a one-off adjustment to our commercial arrangement and paid more service fees to the KOL, which contributed to a RMB36.6 million increase in our total fees paid to KOLs and a decrease in dividend distribution to the KOL. Our cost of revenues as a percentage of total net revenues increased from 67.9% for fiscal year 2018 to 68.7% for fiscal year 2019. Such increase was primarily due to discounted sales of apparel and cosmetic products of certain brands we ceased in fiscal year 2019, partially offset by the rapid expansion of our business under the platform model which generally requires lower cost of revenues as compared to product sales under the full-service model. We ceased sales of certain brands of apparel and cosmetic products in the full-service model in fiscal year 2019 and transformed such business into the platform model. In connection with such transition, we engaged in more discounted sales in order to dispose of our inventory, especially for discontinued products, in fiscal year 2019. We expect that our cost of revenues will increase in absolute amount as we continue to expand our overall operations. Our cost of revenues as a percentage of total net revenues may or may not increase in future periods depending on various factors such as the relative revenue contributions from our full-service model and platform model, our pricing strategies, and changing market conditions.

 

Operating Expenses

 

Our operating expenses consist of fulfillment expenses, sales and marketing expenses, general and administrative expenses and other operating income/loss. The following table sets forth a breakdown of our operating expenses, both in absolute amount and as a percentage of our total net revenues, for the periods indicated:

 

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Fiscal Year Ended March 31,

 

 

 

2017

 

2018

 

2019

 

 

 

RMB

 

%

 

RMB

 

%

 

RMB

 

US$

 

%

 

 

 

(in thousands)

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fulfillment expenses

 

(69,412

)

(12.0

)

(100,071

)

(10.6

)

(126,850

)

(18,901

)

(11.6

)

Sales and marketing expenses

 

(97,813

)

(16.9

)

(146,207

)

(15.4

)

(205,660

)

(30,644

)

(18.8

)

General and administrative expenses

 

(67,106

)

(11.6

)

(130,978

)

(13.8

)

(92,005

)

(13,709

)

(8.4

)

Other operating (loss) income, net

 

(168

)

(0.0

)

710

 

0.1

 

927

 

138

 

0.1

 

Total Operating Expenses

 

(234,499

)

(40.5

)

(376,546

)

(39.7

)

(423,588

)

(63,116

)

(38.7

)

 

Fulfillment expenses

 

Fulfillment expenses consist primarily of (i) warehousing related expenses such as costs