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Exceed Co Ltd. 20-F 2010
Unassociated Document


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 20-F/A
Amendment No. 1

(Mark One)

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

OR

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

For the fiscal year ended December 31, 2009

OR

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

For the transition period from ___________________to ___________________.

OR

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

Date of event requiring this shell company report ________________.

Commission file number:

EXCEED COMPANY LTD.

(Exact name of Registrant as specified in its charter)
N/A
(Translation of Registrant’s name into English)
British Virgin Islands
(Jurisdiction of incorporation or organization)
Tai Yau Ting
Suite 8, 20/F, One International Finance Centre
1 Harbour View Street, Central, Hong Kong.
T: +852 3669 8105
(Address of principal executive office)
 (Name, Telephone, E-mail and/or Facsimile Number and Address of Company Contact Person)
Securities registered or to be registered pursuant to Section 12(b) of the Act:

(Title of each class)
(Name of each exchange on which registered)
Ordinary shares of par value US$0.0001 per share
The NASDAQ Global Market
Warrants
The NASDAQ Global Market
Units consisting of one ordinary share and one warrant
The NASDAQ Global Market

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

None

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

None

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: 19,654,904 ordinary shares, par value US$0.0001 per share.

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted 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 and post such files).
£ Yes  o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.
£ Large accelerated filer £ Accelerated filer  R Non-accelerated filer

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing.
£ U.S. GAAP    RInternational Financial Reporting Standards as issued by the International Accounting Standard Boards    £ Other

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

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



 

 
 
EXPLANATORY NOTE
 
We are filing this Amendment No. 1 to our Annual Report on Form 20-F to reflect a restatement of our consolidated financial statements for the year ended December 31, 2007, 2008 and 2009. During the preparation of the June 30, 2010 interim consolidated financial statements, we determined that the number of shares outstanding following the business combination was incorrectly computed, resulting in an error in the basic and diluted earnings per share contained in our consolidated financial statements for the years ended December 31, 2007, 2008 and 2009. The restatement resulted in an increase in the basic earnings per share from RMB7.93 to RMB23.48 for the year ended December 31, 2007, RMB9.91 to RMB29.35 for the year ended December 31, 2008 and RMB12.68 to RMB29.91 for the year ended December 31, 2009 and an increase in the diluted earnings per share from RMB7.93 to RMB23.48 for the year ended December 31, 2007, RMB9.91 to RMB27.71 for the year ended December 31, 2008 and RMB11.98 to RMB21.56 for the year ended December 31, 2009. In addition, the amount of shares reported as outstanding were reduced by the amount of the escrow shares that had not been released. These changes do not impact any other income statement or balance sheet items.

The error related to our interpretation of “contingently issuable shares” under IAS33. In our original interpretation, we considered all contingently issuable shares as outstanding for all periods presented in the calculation of basic and diluted earnings per share. Under the correct interpretation, basic earnings per share should include only the number of contingently issuable shares of which all necessary conditions for their release were satisfied as of the end of the financial period, and diluted earnings per share should include only the number of contingently issuable shares that would be issuable from the date of the Acquisition and Redomestication if the conditions were satisfied as of the reporting period.

The restated calculation of basic earnings per share for the year ended December 31, 2009 does not include shares held in escrow that are subject to profit targets for the years ending December 31, 2010 and 2011. In accordance with IAS 33, escrow shares in relation to 2009 profit are effectively excluded in the calculation of basic earnings per share as the target was not met until the end of the day on December 31, 2009. The restated calculation of diluted earnings per share for the year ended December 31, 2009 includes 2009 escrow shares that are considered issued from the date of the Acquisition and Redomestication as if the conditions were satisfied for the period. There were no contingently issuable shares included in both of the restated basic and diluted earnings per share for the years ended December 31, 2007 and 2008 as the Acquisition and Redomestication was completed on October 21, 2009.

As a result of the above, we are re-filing our annual report on Form 20-F for the year ended December 31, 2009 to reflect our restated consolidated financial statements for the years ended December 31, 2007, 2008 and 2009.  The restated consolidated financial statements will be available on EDGAR, as part of an amendment to our annual report on Form 20-F for the year ended December 31, 2009, at www.sec.gov/edgar.shtml. Upon request, we will provide a hard copy of our restated audited consolidated financial statements free of charge.

In addition to the restated consolidated financial statements, which begin on page F-1 hereof, we have also revised Item 3, including the basic and diluted earnings per share for the years ended December 31, 2005 and 2006 in order to reflect the effects of this restatement, Item 15, Item 18 and Item 19. Except with respect to these matters, this amended report does not reflect events occurring after the filing of the original Form 20-F on April 7, 2010. The filing of this Form 20-F/A shall not be deemed an admission that the original Form 20-F, when filed, included any untrue statement of a material fact or omitted to state a material fact necessary to make a statement not misleading.
 
 

 

TABLE OF CONTENTS
   
Page
Introduction
 
Item 1.
Identity of Directors, Senior Management and Advisors
4
Item 2.
Offer Statistics and Expected Timetable
4
Item 3.
Key Information
4
Item 4.
Information on the Company
22
Item 4A.
Unresolved Staff Comments
43
Item 5.
Operating and Financial Review and Prospects
43
Item 6.
Directors, Senior Management and Employees
66
Item 7.
Major Shareholders and Related Party Transactions
71
Item 8.
Financial Information
73
Item 9.
The Offer and Listing
73
Item 10.
Additional Information
74
Item 11.
Quantitative and Qualitative Disclosures About Market Risk
82
Item 12.
Description of Securities Other Than Equity Securities
83
Item 13.
Defaults, Dividend Arrearages and Delinquencies
83
Item 14.
Material Modifications to the Rights of Security Holders and Use of Proceeds
83
Item 15.
Controls and Procedures
84
Item 16A.
Audit Committee Financial Expert
84
Item 16B.
Code of Ethics
84
Item 16C.
Principal Accountant Fees and Services
84
Item 16D.
Exemptions from the Listing Standards for Audit Committees
85
Item 16E.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
85
Item 16F. 
Change in Registrant’s Certifying Accountant 
85
Item 16G. 
Corporate Governance 
85
Item 17.
Financial Statements
85
Item 18.
Financial Statements
85
Item 19.
Exhibits
85

 
2

 

CONVENTIONS WHICH APPLY TO THIS FORM

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

 
o
“Acquisition” refers to the purchase by 2020 Chinacap Acquirco, Inc., or 2020, and Exceed of all the issued and outstanding ordinary shares of Windrace pursuant to as sales and purchase agreement dated May 8, 2009;

 
o
“business combination” refers to the completion of the Acquisition effective on October 21, 2009;

 
o
“China” or “PRC” refers to the People’s Republic of China;

 
o
“Elevatech” refers to Elevatech Limited;

 
o
“Exceed” refers to Exceed Company Ltd.;

 
o
“Exceed Brand Management (BVI)” refers to Exceed Brand Management (BVI) Co. Ltd.;

 
o
“Exceed Brand Management (HK)” refers to Exceed Brand Management (Hong Kong) Company Limited;

 
o
“IFRS” refers to International Financial Reporting Standards;

 
o
“RichWise” refers to RichWise International Investment Group Limited;

 
o
“we”, “us”, “our company” and “our” refer to Windrace and its consolidated subsidiaries prior to the Acquisition and Exceed and its consolidated subsidiaries following the Acquisition;

 
o
“Windrace” refers to Windrace International Company Limited;

 
o
“XDLong China” refers to Xidelong (China) Co. Ltd.;

 
o
“XDLong Fujian” refers to Fujian Xidelong Sports Goods Co., Ltd.;

 
o
“XDLong HK” refers to Hei Dai Lung Group Company Limited; and

 
o
“XDLong Investment” refers to Windrace Investment Holding Limited.

This annual report contains translations of Renminbi amounts into U.S. dollars at specified rates solely for the convenience of the reader. Unless otherwise noted, for all dates and periods through December 31, 2008, exchange rates of Renminbi into U.S. dollars are based on the noon buying rate in The City of New York for cable transfers of Renminbi as certified for customs purposes by the Federal Reserve Bank of New York. For January 1, 2009 and all later dates and periods, the exchange rate refers to the exchange rate as set forth in the H.10 statistical release of the Federal Reserve Board. Translation of amounts Renminbi into U.S. dollars was calculated at the rate of US$ 1.00 = RMB 6.8259 on December 31, 2009 solely for the convenience of the reader. We make no representation that the Renminbi amounts referred to in this form could have been or could be converted into U.S. dollars at any particular rate or at all. On April 2, 2010, the exchange rate was RMB6.8255 to US$1.00.

 
3

 

PART I

Item 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS

Not Applicable

Item 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not Applicable

Item 3. KEY INFORMATION

A.      SELECTED FINANCIAL DATA

The following selected consolidated statement of operations data for the five years ended December 31, 2009 and the consolidated balance sheet data as of December 31, 2005, 2006, 2007, 2008 and 2009 have been derived from our consolidated financial statements. The report of Crowe Horwath LLP, an independent registered public accounting firm, on our consolidated financial statements as of December 31, 2008 and 2009 and for each of the years in the three year period ended December 31, 2009 is included elsewhere in this annual report on Form 20-F. Our selected consolidated statement of operations data for the years ended December 31, 2005 and 2006 and our consolidated balance sheets as of December 31, 2005, 2006 and 2007 have been derived from our audited consolidated financial statements, which are not included in this annual report on Form 20-F. You should read the selected consolidated financial data in conjunction with those financial statements and the related notes and “Item 5. Operating and Financial Review and Prospects” included elsewhere in this annual report on Form 20-F. Our consolidated financial statements are prepared and presented in accordance with IFRS. Our historical results do not necessarily indicate our results expected for any future periods.

   
For the year ended December 31,
 
   
2005
   
2006
   
2007
   
2008
   
2009
 
   
(in thousands, except per share data)
 
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
US$ (1)
 
Consolidated Statements of Operations and Comprehensive Income Data
                                   
Revenues
    301,554       687,569       1,296,402       1,820,282       2,077,958       304,423  
Cost of sales
    (241,242 )     (511,068 )     (959,526 )     (1,323,262 )     (1,464,856 )     (214,603 )
Gross profit
    60,312       176,501       336,876       497,020       613,102       89,820  
Other income and gains
    214       235       889       1,188       5,855       858  
Selling and distribution costs
    (34,520 )     (76,560 )     (137,077 )     (225,752 )     (268,123 )     (39,280 )
Administrative expenses
    (6,208 )     (15,541 )     (29,984 )     (29,205 )     (44,509 )     (6,521 )
Aborted IPO expenses
                      (31,382 )            
Research and development expenses
    (2,009 )     (5,489 )     (12,784 )     (17,649 )     (24,953 )     (3,656 )
Finance costs
    (1,315 )     (1,332 )     (1,352 )     (23,511 )     (29,566 )     (4,332 )
Share of loss in jointly-controlled entity
                            (16 )     (2 )
Profit before tax
    16,474       77,814       156,568       170,709       251,790       36,887  
Tax
    (1,990 )     (9,974 )     (21,783 )     (2,181 )     (3,771 )     (552 )
Profit for the year
    14,484       67,840       134,785       168,528       248,019       36,335  
Earnings per share (2)
                                               
Basic
    2.52       11.82       23.48       29.35       29.91       4.38  
Diluted
    2.52       11.82       23.48       27.71       21.56       3.16  

   
As December 31,
 
   
2005
   
2006
   
2007
   
2008
   
2009
 
   
(in thousands)
 
   
RMB
   
RMB
   
RMB
   
RMB
   
RMB
   
US$ (1)
 
Consolidated Balance Sheets Data:
                                   
Cash and cash equivalents
   
5,469
     
14,714
     
67,725
     
120,068
     
262,204
     
38,413
 
Working capital (3)
   
11,666
     
(43,158
)
   
(403
)
   
9,095
     
846,507
     
124,014
 
Total assets
   
112,995
     
302,184
     
597,011
     
815,387
     
1,467,785
     
215,031
 
Total liabilities
   
85,288
     
206,173
     
281,784
     
489,549
     
319,353
     
46,785
 
Total stockholders’ equity
   
27,707
     
96,011
     
315,227
     
325,838
     
1,148,432
     
168,246
 
  
(1)
Translations of RMB amounts into U.S. dollars were made at a rate of RMB6.8259 to US$1.00, the noon buying rate in New York City for cable transfers as certified for customs purposes by the Federal Reserve Bank of New York on December 31, 2009.

 
4

 
 
(2)
Calculated on the basis of the business combination completed on October 21, 2009. See note 25 of our consolidated financial statements included elsewhere in this form.
(3)
Working capital represents total current assets less total current liabilities.

EXCHANGE RATE INFORMATION

This annual report contains translations of Renminbi amounts into U.S. dollars at specific rates solely for the convenience of the reader. For all dates and periods through December 31, 2008, exchange rates of Renminbi into U.S. dollars are based on the noon buying rate in The City of New York for cable transfers of Renminbi as certified for customs purposes by the Federal Reserve Bank of New York. For January 1, 2009 and all later dates and periods, the exchange rate refers to the exchange rate as set forth in the H.10 statistical release of the Federal Reserve Board. These rates are provided solely for your convenience and we make no representation that any Renminbi or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or Renminbi, as the case may be, at any particular rate, the rates stated below, or at all.

The following table sets forth information concerning the exchange rates in Renminbi and U.S. dollars for the periods indicated.

   
Renminbi per U.S. Dollar Noon Buying Rate (1)
 
   
Average (2)
   
High
   
Low
   
Period End
 
2005
   
8.1826
     
8.2765
     
8.0702
     
8.0702
 
2006
   
7.9579
     
8.0702
     
7.8041
     
7.8087
 
2007
   
7.5806
     
7.8127
     
7.2946
     
7.2946
 
2008
   
6.9193
     
7.2946
     
6.7800
     
6.8225
 
2009
   
6.8300
     
6.8438
     
6.8180
     
6.8259
 

   
Renminbi per U.S. Dollar
Exchange Rate
 
   
High
   
Low
 
December 2009
    6.8299       6.8244  
January 2010
    6.8295       6.8258  
February 2010
    6.8330       6.8258  
March 2010
    6.8270       6.8254  
April 2010 (through April 2)
    6.8263       6.8255  



(1)
For December 2008 and prior periods, the exchange rate refers to the noon buying rate as reported by the Federal Reserve Bank of New York. For January 2009 and later periods, the exchange rate refers to the exchange rate as set forth in the H.10 statistical release of the Federal Reserve Board.
(2)
Annual averages are calculated using the average of the exchange rates on the last day of each month during the period.

On April 2, 2010, the daily exchange rate was RMB6.8255 to US$1.00.
 
B. CAPITALIZATION AND INDEBTEDNESS

Not applicable
 
C. REASONS FOR THE OFFER AND USE OF PROCEEDS

Not applicable
 
D. RISK FACTORS

Risks Relating to Our Business

Deterioration of economic conditions and a resulting decrease in consumer demand for our products could materially adversely affect our financial condition and results of operations.

Demand for our products, and the resulting purchase orders from its distributors, is largely dependent upon prevailing economic conditions. The recent financial crisis and economic downturns in global markets have impacted, and could further impact, the purchase orders from our distributors. For example, although our revenue decreased in the first half of 2009 compared to the same period in 2008, demand for our products started to improve in the second half of 2009 and our revenues increased 14.2% from RMB1,820.3 million for the year ended December 31, 2008 to RMB2,078.0 million for the year ended December 31, 2009. In the event the demand for consumer products declines in China as a result of a downturn in global economic conditions, demand our sports products could decrease.

 
5

 

We distribute our products mainly through the Xidelong retail stores operated by independent third party distributors over which we have limited control.

We distribute our products mainly through the Xidelong retail stores, which offer our products exclusively and do not carry other brands’ products. Our 22 distributors own and operate all Xidelong retail stores. They operate some of the Xidelong retail stores directly and delegate operation of the remaining stores to third parties. We have limited control over the Xidelong retail stores operated by our distributors and authorized third party retail store operators. We have contractual relationships only with our distributors and not with authorized third party retail store operators. There can be no assurance that these current distribution arrangements provide us with sufficient control to ensure the Xidelong retail stores sell our products on an exclusive basis or to prevent our Xidelong brand from being associated with any negative image relating to quality or customer service. Such association could damage our brand image and reputation and could have a material adverse effect on our business, results of operations and financial condition. Further, if distributors experience financial difficulties, they may unilaterally attempt to liquidate their inventory build-up through discounts at their Xidelong retail stores without our approval, which may damage the image and the value of our “ “ (Xidelong) brand.

Adverse changes in the business and creditworthiness of our distributors could materially adversely affect our financial condition and results of operations.

We derive all of our revenue from sales to distributors. Such arrangement is risky for the following reasons:
 
 
Our distributors generally do not have any contractual obligation to purchase minimum quantities of our products and may reduce purchases of our products on short notice.

 
Our sources purchase orders primarily at sales fairs, and such orders constitute approximately 80% to 90% of our annual revenue. Purchase order quantities may be subsequently adjusted upward or downward by amounts ranging from 10% to 15% before finalization. In 2008, we agreed with certain distributors to reduce orders by 15% to 20% before finalization to prevent overflow of inventory among such distributors arising out of any decreased consumer demand resulting from the reduction of delivery due to anticipated reduced consumer demand arising from the financial crisis and economic downturn that began in 2008. The products we ship to our distributors are based on actual orders received from distributors after upward or downward adjustments, if any.

 
Certain distributors, especially those adversely affected by the worsened economic conditions, may delay or default on their payments to us. Increased credit risk of distributors may materially adversely affect our financial condition and results of operations and limit our growth prospects.

If our distributors perform poorly or if we fail to maintain good relationship with our distributors or retain them in our distribution network, our sales, financial condition and operating results may be adversely affected.

We rely on our distributors for the expansion of our retail sales network but they may not be willing to accommodate the needs of our business plans.

As of December 31, 2009, our distribution network consisted of 3,694 Xidelong retail stores covering 28 provinces and municipalities in China, 1,000 of which were operated directly by 22 distributors and the remaining 2,694 were operated indirectly through authorized third party retail store operators. We rely on our existing and new distributors to assist us in exploring new markets for our products and identifying potential locations for new stores. Some of our distributors, however, also distribute other brands of sports and leisurewear products, including competitor brands. Although these distributors are required to operate separate retail stores for other brands’ products, there can be no assurance that they will always provide favorable retail store locations and marketing resources to us. There can be no assurance that their expansion would be timely or sufficient in scope to satisfy the needs of our business.

 
6

 

We rely on several large distributors for a significant portion of our sales.

We derive a significant portion of our sales from several large distributors. For 2007, 2008 and 2009, sales to our top five distributors accounted for approximately 43.4%, 43.1% and 46.0%, respectively, of our total revenue. For 2007, 2008 and 2009, sales to our single largest distributor accounted for approximately 13.8%, 12.3% and 13.0%, respectively, of our total revenue. We generally enter into distributorship agreements with our distributors for up to a term of 12 months. Starting from 2009, the duration of the renewal for distribution agreement has been extended from one year to three years. The duration of our contractual relationships with each of our top five distributors has been for more than three years. We do not manufacture our products on a make-to-order basis, but take orders for our prototype products at sales fairs before entering into sale contracts with our distributors to manufacture our products. Our purchase orders at sales fairs constitute approximately 80% to 90% of our revenue. There can be no assurance that our top distributors will renew their distributorship agreements with us on commercially acceptable terms or at all.

Under our agreements with our distributors, we appoint only one distributor instead of multiple competing distributors for one designated geographical area or region. This enables us to manage and monitor the distributor and the Xidelong retail stores in the designated region more effectively. While we may rely on a sole distributor in a designated region to sell our products, we believe that we would be able to appoint a replacement distributor in the designated region if the need arises. However, to the extent that any distributor for any particular market ceases to cooperate with us for any reason and we are not able to find a suitable replacement distributor for that market in a timely manner, we may lose significant business in that market. Furthermore, our top distributors are not obliged to continue to place orders with us at the same levels as before or at all. There can be no assurance that we would be able to obtain orders from other distributors to replace any such lost sales. Any substantial reduction in purchases from our top distributors, or any failure to renew their agreements with us, may result in a significant loss of sales and our business, financial condition and results of operation may be materially adversely affected.

The wholesale prices at which we sell our products to our distributors are determined by factors beyond our control. In addition, sales of our products at a discount to suggested retail price to end customers could have an adverse effect on our business and brand name.

The prices at which we sell our products are affected by supply and demand fluctuations inherent in the market for our products. Under our business model, we sell our products to distributors and do not sell directly to consumers. We do not have any agreements with our distributors that provide for a minimum purchase price at which the distributors buy our products. We do, however, provide suggested retail prices. As such, the wholesale prices we offer for our products to our distributors must match the distributors’ expectations for the retail sale of our products to consumers. If distributors believe that our suggested retail prices do not justify the wholesale prices at which we are offering them, they may require us to lower our wholesale prices. If the wholesale prices of our products should decrease, our growth targets, financial condition, and results of operations may be materially adversely affected.

 During the years ended December 31, 2007, 2008 and 2009, a number of distributors notified us of certain products with minor deviation from specification. Because such deviation and the amounts involved were immaterial, we allowed the distributors and their authorized third-party retailers to sell these products at a discount to the suggested retail prices to end consumers. The amounts of any such discount were decided and approved by us on a case-by-case basis. Further, such discounts only affected the suggested retail prices to end consumers and had no impact on our revenue because the wholesale price at which we sold these products to the distributors remained unchanged. However, if the deviation from specification and the amounts involved were to become material in the future, the distributors could potentially negotiate for a reduction in wholesale prices, which would adversely affect our business. Increased sales of products with deviation from specifications could also damage our brand image.

We are exposed to credit risks of our distributors, some of which may experience financial difficulties, which could in turn adversely affect our financial condition and results of operations.

We provide credit terms to our distributors based on our assessment of each distributor’s financial condition. Our distributors place advance orders at sales fairs but the risk of default may increase when dealing with financially ailing distributors or distributors struggling with economic uncertainty. Our increased sales going forward may rely heavily on credit, and we may be unable to collect these accounts receivable in full or at all. The loss of, or significant decrease in, sales to these distributors, or their failure to pay us in a timely manner or at all, could materially adversely affect our business, financial condition and results of operation.

 
7

 

Our sales to distributors may not directly correlate to the demand for our products by end consumers, which could adversely affect our ability to accurately track market trends and preferences of end consumers for our products and respond to such changing market dynamics.

We sell our products to distributors and do not sell directly to end consumers. We neither accept returns from distributors of unsold stock nor track information on a real-time basis with respect to the inventory levels and movements of our products at all of the Xidelong retail stores. Our distributors do not provide us with any sales reports. Therefore, in order to monitor consumer demand for our products, we require our distributors to submit inventory reports that provide information on the sales of our products by our distributors. These reports enable us to identify whether our products are gaining consumer acceptance at the Xidelong retail stores. However, such reporting system requires the cooperation of the distributors to report accurately and submit the relevant inventory data to us on a timely basis. If our distributors do not provide accurate and timely inventory data, we are not able to assess accurately whether our sales to distributors track sales of our products to end consumers. Further, we are only able to obtain inventory data from the retail stores directly operated by the distributors but not the authorized third party retail store operators because we do not have contractual relationships with them. Therefore, we rely on our distributors to monitor inventory levels and overall sales performance of authorized third party retail store operators. If we are unable to track end-consumer sales accurately, we may not be able to assess market trends and preferences, which ultimately could have a material adverse effect on our revenue.

We face increasing labor costs and other costs of production in the PRC, which could materially adversely affect our profitability.

The sportswear manufacturing industry is labor intensive. Labor costs in China have been increasing in recent years and our labor costs in the PRC could continue to increase in the future. If labor costs in the PRC continue to increase, our production costs, including both our own manufacturing and outsourcing costs, will likely increase. This may in turn affect the selling prices of our products, which may then affect the demand of such products and thereby adversely affect our sales, financial condition and results of operations. Moreover, increases in costs of product parts required for production of our products, such as natural and synthetic leather, and semi-finished rubber soles, increases in electricity costs and other increases in production costs, may cause similar adverse effects, particularly if we are unable to identify and employ other appropriate means to reduce our costs of production. Furthermore, we may not be able to pass on these increased costs to consumers by increasing the selling prices of our products in light of competitive pressure in the markets where we operate. In such circumstances, our profit margin may decrease and our financial results may be adversely affected.

Interruptions in our supply of raw materials and product parts could adversely affect our business, financial condition and results of operations.

We purchase a large portion of our raw materials and product parts from a small number of suppliers. For 2007 and 2008, our standard supply agreements were for one year. Starting from 2009, such agreements have been extended to two years. For 2007, 2008 and 2009, we purchased raw materials for our products from 38, 36 and 53 suppliers, respectively, most of which are located in Quanzhou, which is adjacent to Jinjiang. Our contractual relationships with most of our suppliers have been in place since 2004. For 2007, 2008 and 2009, our top five raw material suppliers and subcontractors accounted for approximately 35.6%, 40.4% and 43.7%, respectively, of our total purchases from raw material suppliers and subcontractors. During the same periods, our single largest supplier accounted for approximately 7.9%, 9.9% and 9.6%, respectively, of our total purchases. There can be no assurance that our top suppliers will continue to deliver raw materials or product parts to us in a timely manner or at acceptable prices and quality, or at all. Any disruption in supply of raw materials or product parts from our suppliers may adversely affect our business, financial condition and results of operations.

Our profitability may decrease if we are unable to pass on increased cost of raw materials and product parts to our customers.

Our manufacturing operations depend on adequate supplies of raw materials and product parts. We purchase all of our raw materials on an order-by-order basis with suppliers. The prices of certain of our key raw materials, such as synthetic leather, are subject to factors beyond our control, such as fluctuations in crude oil prices. We may also experience difficulty in obtaining other acceptable quality materials on a timely basis and the prices that we pay for such materials may increase due to increased demand or other factors. We may not be able to pass on the increased cost to our customers by increasing the selling prices due to competitive pressure in the markets. In such circumstances, our business, financial condition and results of operations may be adversely affected.

 
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We rely on third party contract manufacturers for a portion of our footwear production and all of our apparel and accessories production and failure of such parties to provide products in a timely fashion could adversely affect our business, financial condition and results of operations.

During 2007 and 2008, we outsourced a portion of our footwear production to three contract manufacturers and all of our apparel and accessories production to more than 30 contract manufacturers. During 2009, we outsourced production of a portion of our footwear to three contract manufacturers and all of our apparel and accessories to more than 20 contract manufacturers.  The table below sets forth the percentages of the products that we outsourced to these contract manufacturers in terms of sales volume for the periods indicated:

   
For the year ended December 31,
 
   
2007
   
2008
   
2009
 
Footwear
   
37.1
%
   
47.8
%
   
39.2
%
Apparel
   
100.0
%
   
100.0
%
   
100.0
%
Accessories
   
100.0
%
   
100.0
%
   
100.0
%

For 2007 and 2008, the duration of agreements with our contract manufacturers for footwear, apparel and accessories had been one year. Starting from 2009, the duration of agreements with our contract manufacturers has been extended to two years.

For 2007, 2008 and 2009, our single largest contract manufacturer of footwear accounted for approximately 35.2%, 40.8% and 37.9%, respectively, of our total purchases of footwear. For 2007, 2008 and 2009, our single largest contract manufacturer for apparel and accessories accounted for approximately 14.8%, 15.7% and 17.7%, respectively, of our total purchases of apparel and accessories. For 2007, 2008 and 2009, our top five contract manufacturers for apparel and accessories accounted for approximately 48.0%, 57.1%, and 64.3%, respectively, of our total purchases of apparel and accessories.

 We have not entered into any long term contracts with these contract manufacturers. As such, there can be no assurance that we can renew these contracts upon expiry, on commercially acceptable terms, or at all. Contract manufacturers may unilaterally terminate our supply contracts or they may seek to increase the prices that they charge. As a result, we are not assured of an uninterrupted supply of footwear, apparel and accessories of acceptable quality or at acceptable prices from our contract manufacturers. We may not be able to offset any interruption or decrease in supply of our products by increasing production at our own production facilities due to capacity constraints, and we may not be able to substitute suitable alternative contract manufacturers in a timely manner at commercially acceptable terms. Any disruption in our supply of products from contract manufacturers may adversely affect our business and could result in loss of sales and increase in production costs, which would adversely affect our business and results of operations.

We may be involved in legal proceedings arising from violation of relevant laws, rules or regulations particularly in respect of labor and environmental protection by third party contract manufacturers and suffer from damage to our reputation.

We contract with third-party contract manufacturers and raw material suppliers. In order to protect the reputation of our brand, we strive to adhere to all relevant laws, rules and regulations, particularly in respect of labor and environmental protection. However, we do not exercise any control over the operations of our contract manufacturers or suppliers and are therefore not able to ensure their compliance with applicable laws and regulations. Therefore, there can be no assurance that our contract manufacturers or suppliers are in compliance with, or will comply with, all applicable labor and environmental laws, rules and regulations with respect to their manufacturing operations. In the event that our contract manufacturers or suppliers violate any of these laws, rules or regulations, any resulting negative publicity may damage our brand and defeat our brand building efforts. In the event that we are named as a defendant in a lawsuit or any other proceeding arising from violations by our contract manufacturers or suppliers of any applicable laws, rules or regulations with respect to their manufacturing operations, we will incur costs and resources in defending ourselves in such a lawsuit or proceeding. As a result of the foregoing factors, our business, profitability and results of operations may be adversely affected.

 
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Failure to continue to obtain high quality endorsers to promote our products could harm our business.

We engage external educational institutions, former professional athletes and celebrities to promote our products and establish the credibility of our products with consumers. If any of the endorsers associated with our products were to stop using our products in violation of their endorsement agreements, our business could be adversely affected. In addition, actions taken by these endorsers that harm their reputations could in turn also harm our brand image with consumers, which could have an adverse effect on our sales and financial condition. In addition, poor performance by our endorsers in their fields, our failure to continue to identify correctly promising athletes and/or celebrities to use and endorse its products, or our failure to enter into endorsement arrangements with prominent athletes and sports organizations, could adversely affect our brand and result in decreased sales of our products.

Failure to effectively promote or maintain the Xidelong brand may affect our performance and sales and cause us to incur significant costs.

The image of the Xidelong brand is an important factor in influencing consumer preferences and building brand loyalty. Promoting and maintaining the Xidelong brand is therefore crucial to our success and growth within the PRC sportswear market. We have a branding and promotional department that deals mainly with media arrangements, sponsorships and other endorsement activities. We use a variety of media, such as television, newspapers, magazines, the Internet and outdoor billboard displays to build both regional and national brand recognition. We collaborate with athletes, media celebrities and industry experts on marketing and endorsement arrangements and they act as spokespersons for the Xidelong brand. For 2007, 2008 and 2009, we spent approximately 7.2%, 7.5% and 7.8%, respectively, of our annual revenue on advertising and promotional activities. If we are unsuccessful in promoting our Xidelong brand among its targeted consumer groups, the goodwill and consumer acceptance of our Xidelong brand may be eroded, and our business, financial condition, results of operations and prospects may be adversely affected. As we also promote our brand through athletes, media celebrities and spokespersons, our brand is partly dependent on the public perception of these individuals, over which we have no control. Any negative publicity, whether in the PRC or abroad, in relation to our brand or our brand representatives could have an adverse effect on the public’s perception of our brands, which could have a negative impact on our business and results of operations.

In addition, we have incurred and expect to continue to incur significant costs and expenses arising out of our brand-building activities, including sponsorships and increased advertising in regional and national newspapers, magazines, the Internet, television and billboard displays. These activities may not be successful in building the goodwill and profile of our brand, which could have a negative effect on our sales and results of operations.

Our sales may be affected by seasonality, weather conditions and a number of other factors.

We operate our business in the PRC and derive all of our revenue from these operations. Generally, PRC consumers’ spending behavior is stable year-on-year but varies seasonally, particularly during the Chinese New Year in early spring, the Labor Day holiday in early May, the summer months and the National Day holiday in early October.

Generally, we experience moderate fluctuations in our aggregate sales volume during the year. Historically, revenues in the third and fourth fiscal quarters have slightly exceeded those in the first and second fiscal quarters. However, the mix of product sales may vary considerably from time to time as a result of changes in seasonal and geographic demand for particular types of footwear, apparel and accessories. In addition, unexpected and abnormal changes in climate may affect sales of our products that are timed for release during a particular season. For example, the climate change resulted in an extended winter season from 2008 to 2009 in many regions in China. A longer winter adversely affected the delivery schedules to the distributors and the sales volumes of our spring and summer collections in the first quarter of 2009.

Fluctuations in our sales may also result from a number of other factors including:

 
o
the timing of our competitors’ launch of new products;

 
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o
the timing of international and domestic sports events;

 
o
consumer acceptance of our new and existing products;

 
o
changes in the overall sportswear industry growth rates;

 
o
economic and demographic conditions that affect consumer spending and retail sales;

 
o
the mix of products ordered by our distributors;

 
o
the timing of the placement and delivery of distributor orders; and

 
o
variation in the expenditure necessary to support our business.

As a result, we believe that comparisons of our operating results between any interim periods may not be meaningful and that these comparisons may not be an accurate indicator of our future performance.

Our operations may be disrupted and our business, financial condition and/or results of operations may be adversely affected by a failure in our facilities for reasons beyond our control.

Our manufacturing operations could be disrupted for reasons beyond our control. The causes of disruptions may include extreme weather conditions, landslides, earthquakes, fires, natural catastrophes, raw material supply disruptions, equipment and system failures, labor force shortages, energy shortages, workforce actions or environmental issues. Any significant disruption to our operations could adversely affect our ability to make and sell products.

In addition, the occurrence of any of these events could have a material adverse effect on the productivity and profitability of any of our manufacturing facilities and on our business, financial condition or results of operations, and/or the operations of our distributors.

In May 2008, Wenchuan County of Sichuan Province, a region that is approximately 360 kilometers away from Chongqing City, suffered an earthquake with an 8.0 magnitude on the Richter Scale. 87 retail stores of our distributors were shut down as a result of the earthquake. There can be no assurance that we will not suffer any further losses in the future as a result of similar reasons beyond our control.

We have a limited operating history and our historical results of operations of our apparel business may not be indicative of our future performance.

Our business began when XDLong Fujian was established in September 2001. We therefore have a limited history of operation and the historical financial information in this registration statement may not necessarily reflect our future results of operation. There also may not be a sufficient basis to evaluate our future prospects.

Further, since the commencement of our apparel business in 2003, we have outsourced all of our apparel production to contract manufacturers. We are currently examining plans to commence our own production of apparel. We have a limited operating history in the sale and marketing of apparel and do not have any experience in manufacturing apparel. As a result, the historical operating results of our apparel business may not provide a meaningful basis for evaluating the performance of our apparel business going forward and may not be indicative of our future performance.

If we are unable to increase our production capacity due to our internal production constraints or our inability to locate suitable contract manufacturers with sufficient production capacity of their own, our operating results may be adversely affected.

We manufacture a significant portion of our footwear at our production facility in Jinjiang, Fujian province. We outsource the manufacturing of a portion of our footwear and all of our apparel and accessories to contract manufacturers. Although we produce a portion of our footwear products in house, we expect to continue to rely on contract manufacturers for the production of a portion of our footwear and all of our apparel and accessories. Therefore, our ability to continue to increase our sales depends on the successful expansion of our footwear production capacity at our production facility and the availability of contract manufacturers with sufficient production capacity of their own. If we are unable to continue to increase our internal production capacity or engage suitable contract manufacturers, our operating results may be adversely affected.

 
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We may not be able to manage our growth effectively and our growth may slow down in the future.

We have been expanding our business rapidly and intend to continue to do so either through organic growth or through acquisitions and investments in related businesses as we deem appropriate. Such expansion may place a significant strain on our managerial, operational and financial resources. Further, we have no prior experience in engaging in the management and operation of retail stores or retail business. We will need to manage our growth effectively, which may entail devising and implementing business plans, training and managing our growing workforce, managing costs and implementing adequate control and reporting systems in a timely manner. There can be no assurance that our personnel, procedures and controls will be managed effectively to support our future growth adequately. Failure to manage our expansion effectively may affect our success in executing our business plan and adversely affect our business, financial condition and results of operation. In addition, our growth in percentage terms may slow in the future. Accordingly, you should not rely on our historic growth rate as an indicator for our future growth rate.

We may not be successful in our future expansion plans and may be unable to secure sufficient funding for such plans to further grow our business.

Our business expansion plans will require us to increase investments in, and devote significant resources to, our brand promotion efforts, internal production capacities, research and design capabilities and the Xidelong sales distribution network operated by our distributors. If we fail to implement our future expansion plans, we may not achieve our growth target. Furthermore, our ability to obtain adequate funds to finance our expansion plans depends on our financial condition and results of operations, as well as other factors that may be outside our control, such as general market conditions, the performance of the PRC sportswear industry, and political and economic conditions in China. If additional capital is unavailable, we may be forced to abandon some or all of our expansion plans, as a result of which our business, financial condition and results of operations could be adversely affected.

Loss of any key executive personnel or any failure to attract such personnel in the future will adversely impact our business and growth prospects.

Our future success will depend on the continued service of our senior management. In particular, Mr. Lin Shuipan, chairman of the board and chief executive officer, has over 15 years’ experience in the sportswear industry and is responsible for our overall corporate strategies, planning and business development. His experience and leadership is critical to our operations and financial performance. We do not maintain any “key-man” insurance policy. If we lose the services of Mr. Lin or any of our key executive personnel and cannot replace them in a timely manner, such loss may reduce our competitiveness, and may adversely affect our financial condition, operating results and future prospects. In addition, our success depends significantly on other personnel and, in particular, our team of designers. Other international and domestic competitors that operate in the PRC may be able to offer more favorable compensation packages to recruit personnel whom we consider desirable. Our continued success will depend on our ability to attract and retain qualified personnel in order to manage our existing operations as well as our future growth. We may not be able to attract, assimilate or retain the personnel whom we need. Our staff expenses in relation thereto may increase significantly. This may adversely affect our ability to expand our business effectively.

Failure to develop technically innovative products could adversely affect our competitiveness.

While design and aesthetics of our products are important factors for consumer acceptance of our products, technical innovation in the design of footwear, apparel, and sports equipment is also essential to the commercial success of our products. Research and development plays a key role in technical innovation. We rely upon specialists in the fields of biomechanics, exercise physiology, engineering, industrial design and related fields, and other experts to develop cutting edge performance products. While we strive to produce products that help to reduce injury, enhance athletic performance and maximize comfort, our failure to introduce technical innovation in our products could result in a decline in consumer demand for our products.

 
12

 

Our research and development capabilities may be adversely affected if we are unable to renew the technology cooperation agreement with the China Institute of Sport Science.

One element of our growth strategy is to continue to design and manufacture products through further investment in product design and research and development initiatives. We primarily rely on the China Institute of Sport Science for such research and development initiatives. Our technology cooperation agreement with the China Institute of Sport Science, General Administration of Sport of China is for a term of five years from October 20, 2006, which we may renew at our option. There can be no assurance, however, that the China Institute of Sport Science will comply with the terms and conditions of the agreement and the renewal provisions. If we do not renew the agreement or if the China Institute of Sport Science breaches the agreement prior to the expiration of its term for any reason, our research and development capabilities may be adversely affected. This could in turn have an indirect adverse effect to our results of operations and financial condition.

We may be involved in litigation on intellectual property infringement or other litigation or regulatory proceedings, which could adversely affect our reputation, financial condition and results of operations.

We may design products with elements that may inadvertently infringe copyright or other intellectual property rights, as a result of which other parties may initiate litigation or other proceedings against us. Responding to and defending these proceedings may require substantial costs and diversion of resources, and the result of these proceedings may be uncertain. Furthermore, our reputation may be adversely affected.

We may be subject to other lawsuits and regulatory actions relating to its business from time to time. Due to the inherent uncertainties of litigation and regulatory proceedings, we cannot accurately predict the ultimate outcome of any such proceedings. An unfavorable outcome could have an adverse impact on our business, financial condition and results of operations. In addition, any significant litigation in the future, regardless of its merits, could divert management’s attention from our operations and result in substantial legal fees.

If we are unable to protect adequately our intellectual property, we may be involved in legal proceedings, which could be expensive and time consuming, and consumers may shift their preference away from our products.

We believe that our trademarks, patents, and other intellectual property rights are important to our brand, success and competitive position. We consider the Xidelong and ““ trademarks to be among our most valuable assets, and we have registered these trademarks in the PRC. In addition, we own other trademarks that we use in marketing our products. We periodically discover products that we believe are counterfeit reproductions of our products or that otherwise infringe on our intellectual property rights. We may pursue litigation in the future to enforce our intellectual property rights. Any such litigation could result in substantial costs and a diversion of our resources. If we are unsuccessful in challenging a party’s products based on trademark or design or utility patent infringement, continued sales of these products could adversely affect our sales and our brand and result in the shift of consumer preference away from our products. The actions we take to establish and protect trademarks, patents, and other intellectual property rights may not be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products on grounds of violations of proprietary rights.

Changes in existing laws and regulations or additional or stricter laws and regulations on environmental protection in the PRC may cause us to incur additional capital expenditures.

Our production facility is located in Jinjiang, Fujian province and is subject to PRC environmental protection laws and regulations. These laws and regulations require enterprises engaged in manufacturing that may generate industrial waste to adopt effective measures to control and properly dispose of such waste. The relevant administrative department for environmental protection can levy fines for any violations of such environmental laws or regulations. For material violations, the PRC government may suspend or close any or all of our operations. There can also be no assurance that the PRC government will not change the existing laws or regulations or impose additional or stricter laws or regulation. Compliance with any of these additional or stricter laws or regulations may cause us to incur additional capital expenditure, which we may be unable to pass on to customers through higher prices for our products.

 
13

 

Our current insurance coverage may not be sufficient to cover the risks related to our operations.

Our operations are subject to hazards and risks normally associated with manufacturing operations, which may cause damage to persons or property. Currently, we maintain insurance policies for damage to real property and for employer liability for personal injury of employees. We are not required under PRC law to maintain, and we do not maintain, any product liability insurance. If we were found liable for any product liability claim, we may be required to pay substantial damages. Even if we were successful in defending such a claim, we may incur substantial financial and other resources in defending such a claim. Under such circumstances, our financial results will be adversely affected. Depending on the outcome of any such claim, the reputation of Xidelong brand may also be adversely affected. Further, we do not maintain business interruption insurance or third party liability insurance against claims for property damage, personal injury and environmental liabilities. The occurrence of any of these events may result in interruption of our operations and subject us to significant losses or liabilities. Any losses or liabilities that are not covered by our current insurance policies may have a material adverse effect on our business, financial condition and results of operations.

If we are not in compliance with PRC laws and regulations, we may be subject to certain legal consequences under PRC law.

Pursuant to the State-owned Land Use Right Transfer Contract for the grant of land use rights for the production site in Jinjiang, XDLong Fujian was required to commence construction by February 28, 2006. However, XDLong Fujian did not commence construction by such date. XDLong Fujian is applying to relevant local government agency to postpone construction on the land. However, it is possible that the local government will repossess the land before XDLong Fujian obtains an approval to postpone construction. The land covers an area of approximately 15,000 square meters and XDLong Fujian paid approximately RMB531,000 to the government as land grant fees. If the local government repossesses the land, we will lose our land use rights over the land and we will not be able to recover the land grant fees previously paid to the government. In addition, we will not be able to construct additional facilities on the land to implement our expansion plans.

Under PRC law, a company must apply to the environmental protection authority in the PRC for an environmental protection examination and acceptance after completion of a construction project. XDLong China has not applied for an environmental protection examination and acceptance for a construction project that it finished. As a result, the environmental protection authority has the right to request XDLong China to rectify such non-compliance by applying for an environmental protection examination and acceptance within a specified period. If XDLong China fails to obtain an environmental protection examination and acceptance within the specified period of time, XDLong may be subject to a fine up to RMB50,000 or be ordered to suspend its operations.

Difficulties in obtaining new credit facilities or acceleration of payments under existing credit facilities could have an adverse effect on our liquidity.

Under the current economic situation, banks and other financial institutions have tightened lending to businesses. As a result, businesses have difficulties in obtaining credit at commercially acceptable terms, or at all. While we obtained a new bank borrowing of RMB90.5 million in the year ended December 31, 2009, there can be no assurance that we will continue to be able to obtain additional funding when the need arises if current economic situation persists. If we are unable to obtain new credit facilities and are unable to finance our liquidity or working capital requirements through cash flows from operating activities or other sources, our financial condition and results of operations could be adversely affected.

In addition, certain of our existing credit facilities require consent from lenders in advance of a material change of ownership or change of business operations, including restructuring, mergers and acquisitions. As of December 31, 2009, an aggregate outstanding amount of RMB83.0 million of our outstanding loans requires such consent. Jingtian & Gongcheng, Windrace’s PRC counsel, is of the opinion that these loan agreements require consent for transactions that occur in the PRC. Therefore, offshore transactions such as the Acquisition should not require consents from the banks. In the event that the banks are of a different opinion and believe that the Acquisition constitutes a material change of ownership or change of business operations and therefore require consents in advance of such changes, we could be deemed as in breach of these agreements for not having obtained such consents in advance of relevant changes. If the banks accelerate our payment obligations under these agreements, our liquidity could be adversely affected.

We relied on loans from Mr. Lin Shuipan, our Chief Executive Officer, in 2007, 2008 and 2009 for our expansion and the cessation of such shareholder support may affect our cash flows.

We had advances from Mr. Lin Shuipan, our Chief Executive Officer, in the amount of approximately RMB82.5 million, RMB0.9 million, and RMB1.7 million in 2007, 2008 and 2009. These advances mainly served as short term funds to support the expansion of our footwear production facilities and the construction of our office building in Jinjiang. In the event that we fail to generate sufficient cash flows from our operations or obtain alternative financing to meet our operating expenditures in the future, our working capital will be constrained.

 
14

 

Our risk management and internal control systems improvements may not be adequate or effective, which could adversely affect our business, financial condition and results of operations.

We have established risk management and internal control systems consisting of relevant organizational framework, policies, procedures and risk management methods that we believe are appropriate for our business operations, and we seek to continue to improve such risk management and internal control systems from time to time. However, due to the inherent limitations in the design and implementation of risk management and internal control systems, there can be no assurance that our risk management and internal control systems will be sufficiently effective in identifying and preventing all such risks.

In addition, as some of our risk management and internal control policies and procedures are relatively new, we may need to establish and implement additional risk management and internal control policies and procedures to improve further our systems from time to time. Our risk management and internal control systems also depend on their implementation by our employees, there can be no assurance that such implementation will not involve any human errors or mistakes. If we fail to timely adapt and implement our risk management and internal control policies and procedures, our business, results of operations and financial condition could be materially adversely affected.

While we believe that we currently have adequate internal control procedures in place, we are still exposed to potential risks from legislation requiring companies to evaluate controls under Section 404 of the Sarbanes-Oxley Act of 2002.

We are subject to the reporting obligations under the U.S. securities laws. The Securities and Exchange Commission, or the SEC, as required under Section 404 of the Sarbanes-Oxley Act of 2002, has adopted rules requiring public companies to include a report of management on the effectiveness of such companies’ internal control over financial reporting in their respective annual reports.  This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Our management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities & Exchange Commission that permit us to provide only our management’s report in this annual report.  Our management conducted an evaluation of the effectiveness of our internal control over financial reporting and concluded that our internal control over financial reporting was effective as of December 31, 2009. If we fail to maintain the effectiveness of our internal control over financial reporting, we may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with the Sarbanes-Oxley Act. Moreover, effective internal control over financial reporting is necessary for us to produce reliable financial reports. As a result, any failure to maintain effective internal control over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could negatively impact the trading price of our ordinary shares. Furthermore, we may need to incur additional costs and use additional management and other resources in an effort to comply with Section 404 of the Sarbanes-Oxley Act and other requirements going forward.

Risks Relating to the Industry in Which We Operate

Our products face intense competition, and we may not have the resources necessary to compete with competitors.

We are a sports and leisure footwear, apparel and accessories company. This industry is highly competitive in the PRC and the competitors in this market include both international and domestic companies. Some of our competitors may have greater financial, research and development and design, marketing, distribution, management or other resources. Our results of operations could be affected by a number of competitive factors, including entry by new competitors into our current markets, expansion by existing competitors, better marketing/advertising leading to stronger brand equity for the competitors, and competition with other companies for the production capacity of contract manufacturers. Our results of operations and market position may be adversely impacted by these competitive pressures.

 
15

 

There can be no assurance that our strategies will remain competitive or that we will continue to be successful in the future. Increased competition could result in a loss of our market share. In particular, if our competitors adopt aggressive pricing policies, we may be forced to adjust the pricing of our products to level their competitiveness. This could adversely affect our profitability and financial results.

We may not be able to predict or meet consumer preferences or demand accurately.

We derive a significant amount of revenue from the sale of sports and leisurewear products that are subject to rapidly changing consumer preferences. Our sales and profits are sensitive to these changing preferences and our success depends on our ability to identify, originate and define product and fashion trends as well as to anticipate, gauge and react to changing consumer demands in a timely manner. All of our products are subject to changing consumer preferences that we cannot predict with certainty. Our new products may not receive consumer acceptance as consumer preferences could shift rapidly to different types of performance or other sports footwear or apparel or away from these types of products altogether, and our future success depends in part on our ability to anticipate and respond to these changes. If we fail to anticipate accurately and respond to trends and shifts in consumer preferences by adjusting the mix of existing product offerings, developing new products, designs and styles, or influencing sports and fitness preferences through vigorous marketing, we could experience lower sales, excess inventories and lower profit margins, any of which could have an adverse effect on our results of operations and financial condition.

Consolidation of distributors or concentration of retail market share among a few distributors may increase and concentrate our credit risk and impair our ability to sell our products.

The sports and leisure footwear, apparel, and accessories retail markets in the PRC are dominated by a few large sports and leisure footwear, apparel, and accessories distributors with many stores. These significant distributors may increase their market share by expanding through acquisitions or through the establishment of additional stores. The consolidation of distributors concentrates our credit risk in a relatively small number of distributors and, if any of these retailers were to experience a shortage of liquidity, it would increase the risk of nonpayment of their outstanding payables to us. In addition, any shifting concentration of market share to a small number of distributors in a particular county or region increases operational risks. If any one of them substantially reduces their purchases of our products, we may be unable to find a sufficient number of other retail stores for our products to sustain the same level of sales and revenues. Further, the consolidation of distributors could limit our ability to negotiate contract terms in our favor. For example, due to a small number of distributors existing in the industry to whom we can sell our products, our ability to sell products at the price level that we wish to may be adversely affected. If the selling prices to the distributors decrease, our profitability would be adversely affected.

Risks Relating to the PRC

All of the business and assets of Windrace, our wholly-owned subsidiary in which our business is conducted, are located in the PRC. Accordingly, our results of operations, financial condition and prospects are subject, to a significant degree, to economic, political and legal developments in the PRC.

Our future performance is dependent on the PRC economy and, in particular, the level of growth of the PRC consumer market.

We derive all of our revenue from sales of our products in the PRC. The success of our business depends on the condition and growth of the PRC consumer market, which in turn depends on macro-economic conditions and individual income levels in the PRC. There is no assurance that projected growth rates of the PRC economy and the PRC consumer market will be realized under current economic situation. Any future slowdowns or declines in the PRC economy or consumer spending may adversely affect our business, operating results and financial condition. We believe that consumer spending habits may be adversely affected during a period of recession in the economy or that uncertainties regarding future economic prospects could also affect consumer spending habits, all of which may have an adverse effect on certain enterprises operating within the consumer and retail sectors, including us. The consumer and retail market may be affected by the changing operating conditions in the PRC. With accession of the PRC to the World Trade Organization (the “WTO”), changes and developments in the consumer and retail market may be volatile and unpredictable. For instance, the reduction in tariffs on foreign products after the liberalization of the PRC market and further entry of international brands may intensify the competition in the PRC market. This may have a material adverse impact on our business, operating results and financial condition.

 
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Political, economic and social policies of the PRC government and PRC laws and regulations could affect our business and results of operations and may result in our inability to sustain our growth.

The economy of the PRC differs from the economies of most developed countries in a number of respects, including:
 
 
o
its structure;

 
o
level of government involvement;

 
o
level of development;

 
o
level of capital reinvestment;

 
o
control of capital reinvestment;

 
o
control of foreign exchange; and

 
o
allocation of resources.

Before its adoption of reform and open door policies beginning in 1978, China was primarily a planned economy. Since then, the PRC government has been reforming the PRC’s economic system, and has begun reforming the government structure in recent years. These reforms have resulted in significant economic growth and social progress. Although the PRC government still owns a significant portion of the productive assets in the PRC, economic reform policies since the late 1970s have emphasized autonomous enterprises and the utilization of market mechanisms, especially where these policies apply to privately-owned businesses such as Windrace. Although we believe these reforms will have a positive effect on our overall and long-term development, we cannot predict whether changes in the PRC’s political, economic and social conditions, laws, regulations and policies will have an adverse impact on our current or future business, results of operations or financial condition.

Our ability to continue to expand our business is dependent on a number of factors, including general economic and capital market conditions, and credit availability from banks or other lenders. In the past few years, the PRC government has articulated a need to control the rate of economic growth and may tighten its monetary policies, including increasing interest rates on bank loans and deposits and tightening the money supply to control growth in lending. Under current economic situation, financial institutions have tightened their lending. Stricter lending policies may, among other things, affect our ability to obtain financing, which may, in turn, adversely affect our growth and financial condition.

As we conduct a significant portion of our business through subsidiaries in China, we are subject to PRC laws and regulations on labor and employee benefits. In recent years, the PRC government has implemented policies to strengthen the protection of employees and obligate employers to provide more benefits to their employees. In addition, an employment contract law came into effect in China on January 1, 2008. The PRC employment contract law and related legislations require more benefits to be provided to employees, such as an increase in pay or compensation for termination of employment contracts. As a result, we expect to incur higher labor costs, which could have an adverse impact on our current or future business, results of operations or financial condition. Additional changes in the PRC’s political, economic and social conditions, laws, regulations and policies could have an adverse effect on our business, results of operations or financial condition.

Failure to comply with the State Administration of Foreign Exchange regulations relating to registration of interests before the establishment of offshore special purpose companies by our beneficial owners may adversely affect our business operations.

On October 21, 2005, the State Administration of Foreign Exchange issued a public notice that became effective on November 1, 2005. The notice requires PRC residents to register with the local State Administration of Foreign Exchange branch before establishing or controlling any company, referred to in the notice as an “offshore special purpose company,” outside of the PRC for the purpose of capital financing (the “No. 75 SAFE Initial Registration”). Besides that, an alteration registration shall be filed after completing an investment in or acquisition of any operating subsidiaries in the PRC, which we refer to herein as a “round-trip investment,” and any change of shareholding or any other material capital alteration in such offshore special purpose company involving a round-trip investment shall also be filed within 30 days from the date of shareholding transfer or capital alteration, and the registration conducted under the above two situations is defined as the “No. 75 SAFE Alteration Registration.”

 
17

 

Mr. Lin Shuipan, Mr. Shi Jinlei and Ms. Chen Shuli are subject to the registration requirements under the No. 75 SAFE Notice, and have conducted the No. 75 SAFE Initial Registration with the Fujian Provincial State Administration of Foreign Exchange. After the offshore special purpose companies were established by the aforementioned persons, some round-trip investments by, and change of shareholders or other material capital alteration in, such offshore special purpose companies occurred, and Mr. Lin Shuipan, Mr. Shi Jinlei and Ms Chen are subject to the No. 75 Alteration Registration for the above events.

Our PRC beneficial owners must comply with these requirements in connection with our future investments and financing activities. If our PRC beneficial owners fail to comply with the relevant requirements, such failure may subject the beneficial owners to fines and legal sanctions, which may adversely affect our business operations.

Our revenues are denominated in Renminbi, which is not freely convertible for capital account transactions and may be subject to exchange rate volatility.

We are exposed to the risks associated with foreign exchange controls and restrictions in China, as our revenues are denominated in Renminbi, which is currently not freely exchangeable. The PRC government imposes control over the convertibility of Renminbi into foreign currencies. Under the rules promulgated under the PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and operation-related expenditures, may be made in foreign currencies without prior approval but are subject to procedural requirements. Strict foreign exchange control continues to apply to capital account transactions. These transactions must be approved by or registered with the PRC State Administration of Foreign Exchange and repayment of loan principal, distribution of return on direct capital investment and investments in negotiable instruments are also subject to restrictions. There can be no assurance that we will be able to meet all of our foreign currency obligations or to remit profits out of China.

Fluctuation in the value of the Renminbi and of the U.S. dollar may have a material adverse effect on your investment.

Any significant revaluation of the Renminbi may have a material adverse effect on our revenues and financial condition as well as on the value of, and any dividends payable on, our ordinary shares in foreign currency terms. For instance, a decline in the value of Renminbi against the U.S. dollar could reduce the U.S. dollar equivalent amounts of our financial results, the value of your investment in us and the dividends we may pay in the future, if any.

There remains significant international pressure on the PRC government to liberalize further its currency policy, which could result in a further and more significant appreciation in the value of the Renminbi against the U.S. dollar. The Renminbi may be revalued further against the U.S. dollar or other currencies, or may be permitted to enter into a full or limited free float, which may result in an appreciation or depreciation in the value of the Renminbi against the U.S. dollar or other currencies.

We rely principally on dividends paid by our subsidiaries to fund any cash and financing requirements we may have, and any limitation on the ability of our PRC subsidiaries to pay dividends to us could have a material adverse effect on our ability to conduct our business.

Windrace and Exceed are holding companies incorporated in British Virgin Islands and rely principally on dividends paid by their subsidiaries for cash requirements, including the funds necessary to service any debt we may incur. If any of our subsidiaries incurs debt in their own name in the future, the instruments governing the debt may restrict dividends or other distributions on its equity interest to Windrace and Exceed.

 
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Furthermore, applicable PRC laws, rules and regulations permit payment of dividends by the consolidated PRC entities only out of their retained earnings, if any, determined in accordance with PRC accounting standards, which differ in many aspects from generally accepted accounting principles in other jurisdictions including IFRS. Based on PRC accounting standards, the consolidated PRC entities are also required to set aside a certain percentage of their after-tax profit each year to their reserve fund in accordance with the requirements of relevant laws and provisions in their respective articles of associations, which are not available for distribution as cash dividends. As a result, the consolidated PRC entities are restricted in their ability to transfer a portion of their net income to Windrace or Exceed whether in the form of dividends, loans or advances. Any limitation on the ability of our subsidiaries to pay dividends could materially adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our businesses, pay dividends or otherwise fund and conduct our business. Under the new PRC Enterprise Income Tax Law and implementation regulations issued by the State Council, PRC income tax at the rate of 10%, unless relevant treaties provide for a lower rate, is applicable to dividends paid by enterprises incorporated in the PRC to “non-resident enterprises” (enterprises that do not have an establishment or place of business in the PRC, or that have such establishment or place of business but the relevant income is not effectively connected with the establishment or place of business) subject to the application of any relevant income tax treaty that the PRC has entered into. If Windrace, Exceed or our non-PRC incorporated subsidiaries are considered “nonresident enterprises,” any dividend that Windrace, Exceed or any such subsidiary receives from the PRC subsidiaries may be subject to PRC taxation at the 10% rate (or lower treaty rate).

Any changes in PRC policies on enterprise income tax may adversely affect our ability to pay dividends and our financial condition.

Our subsidiaries are incorporated in the PRC, Hong Kong or the British Virgin Islands. On March 16, 2007, the new PRC Enterprise Income Tax Law (the “new tax law”) was issued and on December 6, 2007, the Rules on the Implementation of Enterprise Income Tax Law of the PRC (“Implementation Rules”) were issued, both of which became effective on January 1, 2008. Under the new tax law, non-PRC tax resident enterprises will be taxed at a withholding tax rate of 5% for Hong Kong companies and 10% for British Virgin Islands companies. If an entity is deemed to be a PRC tax resident enterprise, which is an enterprise that is set up under PRC law within the territory of the PRC, or set up under the law of a foreign country or region but which has “de facto management organization” within the PRC, then qualified dividend and profit distribution from equity investment between them shall be exempted from withholding tax and income tax. Among other things, qualified dividend and profit distribution as stated in the new tax law shall refer to investment income derived by a PRC tax resident enterprise from the direct investment in other PRC tax resident enterprises, which shall exclude investment income from circulating stock issued publicly by PRC tax resident enterprises and traded on stock exchanges where the holding period is less than 12 months.

Our subsidiaries may trigger withholding tax requirements in the future under the new tax law and the Implementation Rules, depending on their classification as a PRC or non-PRC tax resident enterprise. The new tax law provides that if an enterprise incorporated outside of the PRC has “de facto management organization” within the PRC, it may be recognized as a PRC tax resident enterprise and may be subject to a 25% enterprise income tax on its worldwide income. According to the Implementation Rules, “de facto management organization” means the institution that materially and comprehensively manages and controls the enterprise’s business, personnel, finance and assets. Given the short history of the tax law and the Implementation Rules, how an enterprise qualifies for tax exemptions remains unclear. Our ability to pay dividends and our financial condition may be adversely affected as a result of the new tax law and other changes in PRC policies and regulations on dividend distributions, withholding tax, and enterprise income tax.

All of our management is currently substantially based in the PRC, and may remain in the PRC after the new tax law takes effect. Therefore, we may be treated as a PRC resident enterprise for new tax law purposes. The tax consequences of such treatment are currently unclear as they will depend on the implementation regulations and on how local tax authorities apply or enforce the new tax law or the implementation regulations.

The levy and collection of enterprise income tax in China are handled by various local governments, which in turn submit such tax revenues to their respective higher administrative authorities. Each local government has its own administrative practice with regard to the manner and the amount of tax submitted by the local government to its higher administrative authorities. PRC enterprises, including us, have no participation in or control over such administrative practices. Any discrepancies in implementation among the local governments of such administrative practice may result in uncertainties over the amount of tax for which a PRC enterprise is liable.

 
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Fluctuations in the exchange rate may adversely affect us.

Substantially all of our revenues and expenditures are denominated in Renminbi. As a result, fluctuations in the exchange rate between the U.S. dollars and Renminbi will affect our financial results in U.S. dollars terms without giving effect to any underlying change in our business or results of operations. The Renminbi’s exchange rate with the U.S. dollar and other currencies is affected by, among other things, changes in China’s political and economic conditions. The exchange rate for conversion of Renminbi into foreign currencies is heavily influenced by intervention in the foreign exchange market by the People’s Bank of China. From 1995 until July 2005, the People’s Bank of China intervened in the foreign exchange market to maintain an exchange rate of approximately 8.3 Renminbi per U.S. dollar. On July 21, 2005, the PRC government changed this policy and began allowing modest appreciation of the Renminbi versus the U.S. dollar. However, the Renminbi is restricted to a rise or fall of no more than 0.5% per day versus the U.S. dollar, and the People’s Bank of China continues to intervene in the foreign exchange market to prevent significant short-term fluctuations in the Renminbi exchange rate. Nevertheless, under China’s current exchange rate regime, the Renminbi may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. There remains significant international pressure on the PRC government to adopt a substantial liberalization of its currency policy, which could result in a further and more significant appreciation in the value of the Renminbi against the U.S. dollar.

An outbreak of the H1N1 swine flu, H5N1 strain of bird flu (Avian Flu), Severe Acute Respiratory Syndrome (SARS) or any other similar epidemic may, directly or indirectly, adversely affect Windrace’s operating results.

The recent outbreak of the H1N1 swine flu in North America and Europe has caused governments to take measures to prevent spread of the virus. In addition, there have been reports of swine flu cases in Asia. If the H1N1 virus further spreads in Asia, including China, epidemic could negatively affect the Asian economy. Past occurrences of epidemics have caused different degrees of damage to the national and local economies in China. China encountered epidemics such as SARS and incidents of the Avian Flu, which is spread through poultry populations, and is capable in certain circumstances of being transmitted to humans causing death. If any of our employees are identified as a possible source of spreading the swine flu, the Avian Flu or any other similar epidemic, we may be required to quarantine employees that are suspected of being infected, as well as others that have come into contact with those employees. We may also be required to disinfect our affected premises, which could cause a temporary suspension of our manufacturing capacity, thus adversely affecting operations. An outbreak of swine flu or a recurrence of an outbreak of SARS, Avian Flu or any other similar epidemic could restrict the level of economic activities generally and/or slow down or disrupt our business activities, which could in turn adversely affect our results of operations.

Power shortages in the PRC may disrupt our business.

Our manufacturing processes consume substantial amounts of electricity supplied by local power grids. Certain cities in the PRC have experienced power shortages in the past or been subjected to restrictions in electricity consumption. A power shortage could affect or delay our production schedule. We maintain backup power generators to provide electricity to our machinery and equipment in case of electricity supply interruptions. However, there is no assurance that we will always have adequate supply of electricity to meet our production requirements and our results of operations may be adversely affected in the event of any material interruption in electricity supply. An extended interruption in the power supply may also affect the operations of the Xidelong retail stores and result in a decrease in revenue.

Risks Related to Investment in our Ordinary Shares

The market price for our ordinary shares may be volatile.

 The trading price of our ordinary shares may be subject to fluctuations. During the period from October 13, 2009, the first day on which our ordinary shares were listed on the NASDAQ Capital Market, until April 6, 2010, the trading prices of our ordinary shares ranged from $7.85 to $13.69 per ordinary shares and the closing sale price on April 6, 2010 was $9.78 per ordinary share. The market price for our ordinary shares may continue to be volatile and subject to fluctuations in response to factors including the following:

o            regulatory developments in our target markets affecting us, our customers or our competitors;

o            actual or anticipated fluctuations in our quarterly operating results;

 
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o
changes in financial estimates by securities research analysts;

 
o
changes in the economic performance or market valuations of other sportswear companies;

 
o
additions or departures of our directors, executive officers and key research personnel; and

 
o
release or expiry of lock-up or other transfer restrictions on our outstanding ordinary shares.

 In addition, securities markets may from time to time experience significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may have a material adverse effect on the market price of our ordinary shares. In addition, the performance and fluctuation of the market prices of other companies with business operations located mainly in China that have listed their securities in the United States may affect the volatility in the price and trading volumes for our ordinary shares. Some of these companies have experienced significant volatility. The trading performances of these companies’ securities at the time of or after their offerings may affect the overall investor sentiment towards PRC companies listed in the United States and consequently may impact the trading performance of our ordinary shares.

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

 Sales of our ordinary shares in the public market, or the perception that these sales could occur, could cause the market price of our ordinary shares to decline. Such sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate. If any existing shareholder or shareholders sell a substantial amount of our ordinary shares, the prevailing market price for our ordinary shares could be adversely affected. In addition, we may issue additional ordinary shares for future acquisitions. If we pay for our future acquisitions in whole or in part with additionally issued ordinary shares, your ownership interests in our company would be diluted and this, in turn, could have a material adverse effect on the price of our ordinary shares.

Your right to participate in any future rights offerings may be limited, which may cause dilution to your holdings.

 We may from time to time distribute rights to our shareholders, including rights to acquire our securities. However, we cannot make rights available to you in the United States unless we register the rights and the securities to which the rights relate under the U.S. Securities Act of 1933, as amended, or the Securities Act or an exemption from the registration requirements is available. We are under no obligation to file a registration statement with respect to any such rights or securities or to endeavor to cause such a registration statement to be declared effective. Moreover, we may not be able to establish an exemption from registration under the Securities Act. Accordingly, in the event we conduct any rights offerings in the future, you may be unable to participate in such offerings and may experience dilution in your holdings.

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

 We are a company incorporated under the laws of the British Virgin Islands. We conduct our operations in China and substantially all of our assets are located in China. In addition, our directors and executive officers, and some of the experts named in this annual report, reside within China, and most of the assets of these persons are located within China. 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 British Virgin Islands and of the PRC may render you unable to enforce a judgment against our assets or the assets of our directors and officers.

Since we are a British Virgin Islands company, the rights of our shareholders may be more limited than those of shareholders of a company organized in the United States.

 Under the laws of some jurisdictions in the United States, majority and controlling shareholders generally have certain fiduciary responsibilities to the minority shareholders. Shareholder action must be taken in good faith, and actions by controlling shareholders which are obviously unreasonable may be declared null and void. British Virgin Island law protecting the interests of minority shareholders may not be as protective in all circumstances as the law protecting minority shareholders in some U.S. jurisdictions. In addition, the circumstances under which a shareholder of a British Virgin Islands company may file derivative actions against the company, and the procedures and defenses that may be available to the company, may result in the rights of shareholders of a British Virgin Islands company being more limited than those of shareholders of a company organized in the United States.

 
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Item 4. INFORMATION ON THE COMPANY

A.           HISTORY AND DEVELOPMENT OF THE COMPANY

 We were established in China as Xdlong Fujian in September 2001. In January 2002, we rented a production facility in Jinjiang, Fujian province and commenced designing, manufacturing and selling footwear under the brand ‘‘XDLONG’’. In 2003, we began designing and selling Xdlong apparel and accessories. Our products are designed for sports and leisurewear consumers who seek performance and lifestyle activities products.

 In March 2007, we established our own production facility in Jinjiang, Fujian province, which currently operates nine production lines with each having a designed production capacity of approximately one million pairs of footwear per year. In 2007, 2008 and 2009, we manufactured 6.4 million, 7.0 million and 9.7 million pairs of footwear, respectively, from our production facility. As at December 31, 2009, we had 22 distributors who operated 3,694 Xdlong retail stores located in 28 provinces and municipalities in China.

Exceed was incorporated in the British Virgin Islands on April 21, 2009 as a wholly-owned subsidiary of 2020, a blank check company formed in Delaware for the purpose of acquiring, through a merger, stock exchange, asset acquisition or other similar business combination, an operating business that either: (1) was located in China, (2) had its principal operations located in China, or, (3) in 2020’s view, would benefit from establishing operations in China.

On October 20, 2009, 2020 merged with and into Exceed, making Exceed the surviving entity. On October 21, 2009, Exceed acquired all of the outstanding securities of Windrace from its shareholders, resulting in Windrace becoming a wholly-owned subsidiary of Exceed.

The merger of 2020 with and into Exceed resulted in the redomestication of 2020 to the British Virgin Islands on October 21, 2009 and Exceed, the surviving entity following the merger, became a foreign private issuer.

Prior to the business combination with Windrace, neither 2020 nor Exceed had an operating business.

 Our principal executive offices are located at Suite 8, 20/F, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong. Our telephone number is (852) 3669 8105 .

B.      BUSINESS OVERVIEW

We design, develop and wholesale footwear, apparel and accessories under the “ “ (Xidelong) brand name and the “ “ logo. We have three principal categories of products: (i) footwear, which mainly comprises running, leisure, basketball, skateboarding, canvas, tennis and outdoor footwear, (ii) apparel, which mainly comprises sports tops, pants, jackets, track suits and coats, and (iii) accessories, which mainly comprise bags, socks, hats and caps. Our footwear, apparel and accessories represented 53.0%, 45.7% and 1.3% of our total revenue for the year ended December 31, 2009, respectively. Our primary footwear is running footwear, which represented 14.1% of our total revenue for the year ended December 31, 2009, the market for which has been growing rapidly in China due to the increasing demand for lifestyle and leisure products and heightened interest in health consciousness among Chinese customers.

We focus primarily on second and third tier cities in China characterized by increasing urbanization and strong economic development, which we believe present the best opportunity for retail sales growth. Our target customers are between 15 to 35 years old. We plan to focus our market penetration in these areas using a medium-end pricing strategy, with an average retail price of approximately RMB200 to RMB300 for a pair of sports or leisure footwear. We also aim to establish and further widen our regional leadership particularly in the Southwestern Region and Northwestern Region in China.

 
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We sell our products mainly through the Xidelong retail stores, which sell our products exclusively and do not carry or sell other brands’ products. Our 22 distributors own and operate all Xidelong retail stores. They operate some of the Xidelong retail stores directly and delegate operation of the remaining stores to third parties. We have contractual relationships only with our distributors and not with authorized third party retail store operators. We believe that the sale of our products through distributors has enabled us to grow by leveraging on their regional retail expertise and economies of scale. We provide retail policies and guidelines, training, advertising and marketing support as well as renovation subsidies to assist distributors in the management and expansion of the Xidelong retail sales network. As of December 31, 2009, there were 3,694 Xidelong retail stores, of which 1,000 were operated directly by distributors and the remaining were operated indirectly through authorized third party retail store operators. The number of the Xidelong retail stores grew from 2,519 as of December 31, 2007 to 3,694 as of December 31, 2009, representing a CAGR of 21.1%.

We place great emphasis on the comfort and functionality of our products. We tailor our sports and leisure footwear, especially running footwear, to the needs of PRC consumers. The China Institute of Sport Science, General Administration of Sport of China, the research center established by the General Administration of Sport of China engaging in research in the field of sport science, works with us exclusively in its research and development efforts in China. Under the agreement with the China Institute of Sport Science, we pay an annual fee to the China Institute of Sport Science for their assistance in the research and development of technologies for our sports footwear and apparel and their promotion of the technology content of our products. Further, we have the exclusive right to use the endorsement “ The Strategic Partner of the China Institute of Sport Science ” on our products and the first right of refusal to use the know-how developed through our collaboration with the China Institute of Sport Science. As the exclusive partner of the China Institute of Sport Science, we allow the China Institute of Sport Science to use our research and development facilities in Jinjiang. We believe that combined with our existing strengths and market position, footwear, especially running footwear, present the largest growth potential in the sports and leisure footwear sector in China. Our commitment to the comfort and quality of its footwear for each individual is represented by promotional slogans such as “ The Foot Knows Comfort, ” “ Run Freely ” and “ Respect Yourself.

We manufacture our products through a combination of internal and external production. Our production facility has a gross floor area of approximately 66,102 square meters and houses nine production lines with an aggregate annual production capacity of approximately nine million pairs of footwear. During the years ended December 31, 2007, 2008 and 2009, we manufactured some footwear at our own production facility and outsourced the remaining footwear, generally with a lower technology content, and all of our apparel and accessories to third party contract manufacturers. As of December 31, 2009, we had three subcontractors for footwear, 19 subcontractors for apparel and four subcontractors for accessories.

All of our products, whether manufactured at our production facility or outsourced to contract manufacturers, undergo testing by our stringent quality control system before being distributed for retail sale. During the years ended December 31, 2007, 2008 and 2009, the percentages of footwear production that we outsourced to these contract manufacturers in terms of sales volume increased from 37.1% in 2007 to 47.8% in 2008 but decreased to 39.2% in 2009. The percentages of footwear production that we outsourced to our contract manufacturers decreased in 2009 because we increased production of our footwear products in-house due to increased production capacity and decreased purchases from contract manufacturers. Increased in-house production gives us more control over footwear production and allows us to save costs.

Brand and Products

Xidelong brand

We market our products under the Xidelong ( ) brand name and the “ “ logo. We use the Chinese promotional slogan “Respect Yourself” to market our products, which is designed to symbolize our emphasis on individualism.

In June 2006, our “Xidelong” trademark was recognized as “China’s Well-Known Trademark” by the Hubei Province Jingzhou City Intermediate People’s Court.

To achieve consistency in our brand image, we set management and operational guidelines for all distributors to follow at the Xidelong retail stores. These guidelines include inventory control, pricing and sale procedures, product and window display requirements and customer service standards.

 
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Products

We have three principal products: (i) footwear, (ii) apparel and (iii) accessories.

The table below lists our current main products under each product type:

Footwear
 
Apparel
 
Accessories
         
•Running
 
•Sports tops
 
•Bags
•Leisure
 
•Pants
 
•Socks
•Basketball
 
•Jackets
 
•Hats
•Skateboarding
 
•Track suits
 
•Caps
•Canvas
 
•Coats
   
•Tennis
       
•Outdoor
       

The table below sets forth our sales volume and revenue by product type:

   
Year ended December 31,
 
   
2007
   
2008
   
2009
 
   
Sales
volume
   
Revenue
   
Percentage
of total
revenue
   
Sales
volume
   
Revenue
   
Percentage
of total
revenue
   
Sales
volume
   
Revenue
   
Percentage
of total
revenue
 
   
(units in
thousands)
   
(RMB in
thousands)
         
(units in
thousands)
   
(RMB in
thousands)
         
(units in
thousands)
   
(RMB in
thousands)
       
Running
    5,496       364,741       28.1 %     5,892       425,627       23.4 %     4,382       293,174       14.1 %
Leisure
    2,369       131,462       10.2 %     3,405       218,769       12.0 %     4,147       274,370       13.2 %
Basketball
    1,151       99,652       7.7 %     787       71,337       3.9 %     955       88,666       4.2 %
Skateboarding
    1,229       74,887       5.8 %     2,403       155,796       8.6 %     3,962       262,893       12.7 %
Canvas
    79       3,035       0.2 %     616       27,373       1.5 %     313       12,864       0.6 %
Tennis
    -       -       -       137       11,572       0.6 %     1,403       104,083       5.0 %
Outdoor
    -       -       -       124       10,708       0.6 %     854       66,229       3.2 %
Beach
    -       -       -       47       1,879       0.1 %                  
Footwear subtotal
    10,324       673,777       52.0 %     13,411       923,061       50.7 %     16,016       1,102,279       53.0 %
Apparel (1)
    13,158       598,122       46.1 %     16,824       857,203       47.1 %     17,691       948,738       45.7 %
Accessories (2)
          24,503       1.9 %     -       40,018       2.2 %     1,861       26,941       1.3 %
Total
    23,482       1,296,402       100.0 %     30,235       1,820,282       100.0 %     35,568       2,077,958       100.0 %

Notes:
 
(1)
We do not record apparel sales based on categories.
 
(2)
We did not keep sales volume records for accessories during 2007, 2008 and 2009 as volume information for accessories was not material to our overall operations.

Business Model

The diagram below illustrates our business model:

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Product design, research and development
 
Our design team at the research and development center formulates new designs for footwear and apparel, and tests prototype designs. We carry out other research and development activities at our research and development center. See “Design, Research & Development.”
     
Sales Fairs
 
We display samples of our new products at sales fairs biannually and take orders for our new products. See “Sales Fairs.”
     
Purchase orders from distributors
 
At the sales fairs, distributors place purchase orders for new products. See “Sales Fairs.”
     
Raw materials and product parts procurement
 
Based on the purchase orders received at the sales fairs, our purchasing team procures the requisite quantity of raw materials and product parts. Raw materials and product parts undergo our quality control. See “Procurement” and “Quality Control.”
     
Production
 
The footwear production department carries out the production plan. See “Production.”

 
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Outsourcing
 
We outsource some of our footwear and all of our apparel and accessories production to contract manufacturers. See “Outsourcing.”
     
Quality Control
 
We sample and check finished goods against our quality and performance standards at the science and technology laboratory located in the research and development center. See “Quality Control.”
     
Distribution Management
 
We deliver our products to distributors. We then monitor and oversee their operations of the Xidelong retail stores. We work with them to renovate the Xidelong retail stores, achieve performance targets and expand the sales distribution network. See “Sales and Distribution.”
 
Production
 
We manufacture a portion of our footwear at our production facility covering an aggregate gross floor area of approximately 66,102 square meters located in Jinjiang, Fujian province. This production facility was established in March 2007. Prior to that, we manufactured footwear at a rented production facility, also located in Jinjiang, Fujian province. As of December 31, 2009, our production facility had 2,419 production staff.
 
In 2007, we operated five production lines occupying an aggregate gross floor area of 6,000 square meters with an annual production capacity of approximately five million pairs. After the establishment of our facility in March 2007, we increased our production lines to seven production lines with an annual production capacity of approximately seven million pairs. In June 2008, we further increased our production lines to nine production lines with an annual production capacity of approximately nine million pairs. The utilization rates of our production facility for 2007, 2008 and 2009 were approximately 93%, 78% and 98%, respectively.
 
Production process
 
Footwear
 
The following diagram illustrates the production process for our footwear:

 
26

 


Raw materials procurement
 
We procure raw materials such as natural and synthetic leather, nylon, canvas, rubber and plastics for our manufacturing requirements. We may also recommend raw materials suppliers to our subcontractors for product parts.
     
Preparation and processing of raw materials
 
Our quality control department inspects and tests raw materials for processing. Our quality control department also instructs and tests product parts supplied by our subcontractors.
     
Sewing and stitching
 
Our footwear production department sews and stitches individual parts created from raw materials and product parts from subcontractors.
     
Shaping and assembly of soles
 
Our footwear production department manufactures the upper soles and midsoles of the footwear and assembles them together.
     
Assembly
 
Our footwear production department assembles all unfinished footwear parts. The assembly process includes gluing the soles to the body of the shoe and pressing and drying the products.
     
Quality Control
 
Finished footwear undergoes our quality control tests.
Packaging
 
We package our finished products according to customer orders.

 
27

 

Apparel and accessories
 
We outsource the production of all our apparel and accessories to contract manufacturers in the PRC. See “Outsourcing.”
 
Our apparel business department handles matters relating to outsourcing such as the selection and appointment of contract manufacturers and the contracts with contract manufacturers.
 
Outsourcing
 
In 2007, 2008 and 2009, we outsourced production of a portion of our footwear, generally products with lower technology content, to three contract manufacturers and all of our apparel and accessories to more than 20 contract manufacturers. The table below sets forth the percentages of the products that we outsourced to these contract manufacturers in terms of sales volume for the periods indicated:

   
For the year ended December 31,
 
   
2007
   
2008
   
2009
 
Footwear
   
37.1
%
   
47.8
%
   
39.2
%
Apparel
   
100.0
%
   
100.0
%
   
100.0
%
Accessories
   
100.0
%
   
100.0
%
   
100.0
%

We generally outsource production of our lower-priced footwear range. We outsource our footwear production when production capacity is at or near full capacity. We produce our higher-priced footwear in house, particularly higher-priced running and basketball footwear which uses our proprietary intellectual property and technology.
 
We manufacture our products through a combination of internal and external production. We purchase finished products from contract manufacturers. Other than finished products, we do not purchase other products from contract manufacturers. For semi-finished rubber soles, a key part of our footwear, and other product parts, we purchase them from subcontractors. See “— Procurement.” Contract manufacturers only carry out production activities and do not conduct product design for us. We provide our contract manufacturers with the designs and specifications of our products. We protect our intellectual property rights from unauthorized use by our contract manufacturers through the registration of trademarks, and also through engaging the appropriate legal services and assistance to ensure that our trademarks are effectively protected and enforced against any unauthorized use.
 
We recommend raw material suppliers to our contract manufacturers for their production and to subcontractors.
 
We select and evaluate our contract manufacturers carefully. We assess contract manufacturers on an annual basis based on factors such as their product quality and ability to meet production orders on a timely basis. We engage contract manufacturers based on sales orders receives at our sales fairs. For 2007, 2008 and 2009, our contract manufacturers contributed 37.1%, 47.8% and 39.2%, respectively, of our total footwear sales volume. All of our contract manufacturers are independent third parties and are located in Fujian province. For 2007 and 2008, the duration of agreements with our contract manufacturers for footwear, apparel and accessories had been one year. Beginning in 2009, the duration of agreements with our contract manufacturers has been extended to two years. We have not terminated our contractual relationships with any of our contract manufacturers of footwear during the term of the agreements. However, there have been some incidents of contract termination with our contract manufacturers of apparel and accessories. When this occurs, we have been able to appoint replacement contract manufacturers readily due to the large number of replacement contract manufacturers from which we can select. See “Risk Factors — We rely on third party contract manufacturers for the production of a portion of our footwear and all of our apparel and accessories.”
 
We require our contract manufacturers to comply with our manufacturing standards and specifications. We do not allow contract manufacturers to sub-contract our production orders without prior consent. We subject outsourced products to our quality control procedures. We return defective product parts or unused product parts to the relevant contract manufacturers. We pay our contract manufacturers by way of bank or telegraphic transfer. Before 2009, we generally paid 30% of the contract price upon delivery with the remaining 70% paid within 60 days thereafter. Starting from 2009, the payment of the second installment representing 70% of the contract price has been extended from 60 days to 120 days after delivery.

 
28

 

We do not oversee the manufacturing operations of our contract manufacturers except to ensure their compliance with our order specifications and quality control. Therefore, we believe that we will not be liable for any violations of applicable laws, rules or regulations with respect to their manufacturing operations.
 
Procurement
 
We procure raw materials and product parts for our manufacturing requirements.
 
We procure raw materials for our footwear production at our production facility in Jinjiang. The major raw materials used in the production of our footwear products include natural and synthetic leather, nylon, canvas, rubber and plastics. Our raw material suppliers are primarily located in Quanzhou, which is adjacent to Jinjiang. We select raw material suppliers based on our selection criteria, which include product quality, reliability, price, and speed of delivery. We place orders for raw material requirements only after we receive sales orders at our sales fairs.
 
We also procure semi-finished rubber soles and other product parts from subcontractors. Other than these semi-finished rubber soles and other product parts, we do not purchase other finished products from subcontractors. Subcontractors manufacture semi-finished rubber soles to our specifications. We also recommend raw material suppliers to our subcontractors. We select subcontractors based on location, product quality, reliability, price, and speed of delivery. Similar to our raw materials suppliers, our product part suppliers are primarily located in Quanzhou. We pay our subcontractors a subcontracting fee. The subcontracting fees for 2007, 2008 and 2009 were approximately RMB21.5 million, RMB18.5 million and RMB18.8 million, respectively.
 
We generally pay our raw material suppliers on a monthly basis. For amounts payable that are below RMB2 million, we generally make payment within 30 days. For amounts that exceed RMB2 million, we generally pay 40% within 30 days, with the remaining 60% payable within 60 days.
 
We do not rely on any one supplier or subcontractor. As of December 31, 2009, we had 53 raw materials suppliers, three subcontractors for footwear, 19 subcontractors for apparel and four subcontractors for accessories.
 
For 2007, 2008 and 2009, our top five raw material suppliers and subcontractors accounted for approximately 35.6%, 40.4% and 43.7%, respectively, of total purchases from raw material suppliers and subcontractors. Our single largest supplier accounted for approximately 7.9%, 9.9% and 9.6%, respectively, of our total purchases during the same periods.
 
Inventory Control and Management
 
Our inventory consists of (i) raw materials for footwear production; (ii) product parts and (iii) finished products. We keep generally low inventory levels of raw materials and product parts because we commence production only after receiving confirmed sales orders from our distributors. We have established an inventory management ports system to monitor inventory levels.
 
We do not have any information relating to the sales of our products by the distributors and the authorized third party retail store operators. After we sell our products to the distributors, the products become part of the inventories of the distributors, over which we have no control. We require our distributors to provide us with inventory reports that give us information on their inventory levels. Prior to 2008, our distributors submitted quarterly inventory reports to us. Since 2008, we have required the distributors to submit the inventory reports on a monthly basis. We monitor and verify the accuracy of the distributors’ inventory reports in the following manner:

 
¨
we agree with distributors on the date for stocktaking;

 
¨
on the date scheduled for stocktaking, distributors record the inventory levels of Xidelong products at their warehouses and the Xidelong retail stores which they operate directly;

 
29

 

 
¨
distributors then compare their records on the opening balance of stocks after the last stocktaking against the results of the stocktaking, and prepare inventory reports;

 
¨
distributors submit the inventory reports to us and our sales representatives then make arrangements with the distributors to carry out on-site stocktaking inspections based on the distributors’ inventory reports; and

 
¨
our sales representatives prepare a report of the on-site inspection and identify any unusual inventory levels. We review the report and provide recommendations to the relevant distributors on the improvement of their sales performance.

The above procedures enable us to gather information on the levels of market acceptance of our products so that we can reflect the consumers’ preferences on the designs of our new products. The tracking of the inventories also provides us information on the market recognition of our products in a particular region so that we can realign our strategy if necessary. This information can also assist in our coordination with distributors to reallocate products to other regions where necessary. We believe that this inventory control system helps to reduce inventory build-up at the Xidelong retail stores.
 
Our policy is to review regularly obsolete inventories based on the age and the expected future salability of a product. In addition, we carry out our physical inventory inspection on a timely basis to identify any obsolete or damaged inventories. We will make specific provisions for a damaged item or an item of inventory that has a carrying amount lower than the net realizable value. During 2007, 2008 and 2009, we did not make any provisions for obsolete inventories.
 
We maintain our finished goods inventory in two warehouses, one for storage of footwear and the other for storage of apparel and accessories. We generally store finished goods according to types of footwear in our warehouses. For 2007, 2008 and 2009, our average inventory turnover days were 19, 19 and 18, respectively, while our inventory balances at December 31, 2007, 2008 and 2009 accounted for approximately 8.4%, 10.6% and 3.8%, respectively, of our total assets.
 
Quality Control
 
We manufacture our products in accordance with our strict quality control system and quality standards. From selecting raw materials to packaging finished products, each stage of the production process is subject to our quality control procedures. We conduct regular inspections of the production facilities of our contract manufacturers and require the facilities and outsourced products to meet both our internal quality control standards and all applicable national and industry quality standards. We test our new products at the science and technology laboratory in our research and development center in Jinjiang to help ensure the products conform to quality and performance standards.
 
Raw materials and product parts quality control
 
We implement stringent selection criteria for raw materials suppliers and product parts subcontractors as the first step towards maintaining the quality of our products. We randomly test samples of raw materials and product parts from suppliers and return any goods that do not meet our specifications or standards.
 
Design prototypes quality control
 
Before commencing mass production, we test prototype designs for any design or functional issues and the suitability of materials used. We implement test production runs in order to identify and isolate any potential production issues or defects.
 
Production process quality control
 
We employ on-site quality control staff to inspect each stage of the production process. Our quality control staff inspect semi-finished products at two stages, the first being the sewing and stitching stage, where we sew and stitch individual parts together, and the second at the final assembly stage of our footwear where we glue soles to the footwear, and press and dry the footwear. We also require our quality control staff to inspect individual product parts and semi-finished products to monitor compliance with our internal quality control over the production process standards and measures. These inspection checks provide us with a degree of control whereby we can detect defects during the production process, and take steps to rectify these defects, where appropriate.

 
30

 

Finished products quality control
 
We randomly select products from our finished product runs to undergo various quality control sampling tests before these products are shipped for delivery or stored at warehouses. We customize these tests for each product type and include, for example, for footwear, shoe bending tests, abrasion resistance tests, waterproofing tests, adhesive application tests, temperature tolerance tests, and various other tests.
 
In December 2005, the General Administration of Quality Supervision, Inspection and Quarantine of the PRC designated our Xidelong footwear and apparel as “State-designated Products Exempted from Quality Inspection.” In 2008, we obtained ISO 9001 certification for the design, development and production of our footwear, and the design, development and production management of our apparel.
 
Sales and Distribution
 
Our sales operations are managed and coordinated from our headquarters at Jinjiang, Fujian province. As of December 31, 2009, our sales and marketing center comprised a team of 171 staff. The sales department devises and implements policies for our distributors to assist them in operating the Xidelong retail stores, which include policies relating to marketing and promotion, sales management, pricing, recording of sales and human resources. The sales department also sets sales targets and monitors inventory levels of distributors.
 
Sales network
 
We sell all of our products on a wholesale basis to distributors. These distributors operate, either directly or indirectly through third parties, the Xidelong retail stores that sell our products. We do not sell products directly to consumers. Distributors place wholesale orders (which include purchase orders that the distributors secure from authorized third party retail store operators) for our products at our sales fairs for retail sale at the Xidelong retail stores. See “Sales Fairs.”
 
As of December 31, 2009, our 22 distributors operated 3,694 Xidelong retail stores directly and indirectly, of which the top five distributors accounted for approximately 13.0%, 9.3%, 8.7%, 7.5% and 7.5% of our total revenue, respectively.
 
We categorize the Xidelong retail stores into the following: (i) department store concessions and (ii) stand-alone shops. Department store concessions are designated sections of department stores that sell our products. Stand-alone shops are retail shops, usually on the street level.

The following chart illustrates the structure of the sales network for our products:

 
31

 


The following map shows the geographical distribution of our distributors’ network of 3,694 Xidelong retail stores across the PRC as of December 31, 2009:

 
32

 

 
As of December 31, 2009, our 22 distributors established 3,694 Xidelong retail stores. The table below sets forth the number of the distributors and the Xidelong retail stores by sales regions:

   
As of December 31,
 
   
2007
   
2008
   
2009
 
   
No. of
Distributors
   
No. of 
Retail
stores (1)
   
No. of
Distributors
   
No. of 
Retail
stores (1)
   
No. of
Distributors
   
No. of 
Retail
stores (1)
 
Northern Region
   
4
     
169
     
4
     
327
     
4
     
411
 
Northeastern Region
   
3
     
243
     
2
     
336
     
2
     
359
 
Northwestern Region
   
3
     
409
     
3
     
498
     
3
     
515
 
Eastern Region
   
3
     
453
     
3
     
586
     
4
     
678
 
Southern Region
   
3
     
267
     
4
     
373
     
3
     
438
 
Southwestern Region
   
6
     
978
     
6
     
1,157
     
6
     
1,293
 
Total
   
22
     
2,519
     
22
     
3,277
     
22
     
3,694
 
 

 
  Note:
 
(1)
The number of retail stores listed includes both stores operated directly by distributors and those operated indirectly through third parties, located in each region as defined in this registration statement.
 
The table below sets forth the numbers of the Xidelong retail stores operated by authorized third party retail store operators by region:

 
33

 

   
As of December 31,
 
   
2007
   
2008
   
2009
 
Northern Region
   
93
     
234
     
322
 
Northeastern Region
   
185
     
256
     
273
 
Northwestern Region
   
214
     
303
     
317
 
Eastern Region
   
239
     
362
     
446
 
Southern Region
   
178
     
274
     
336
 
Southwestern Region
   
655
     
850
     
1,000
 
Total
   
1,564
     
2,279
     
2,694
 

The table below sets forth the number of the Xidelong retail stores opened and closed for the periods indicated:

   
As of December 31,
 
   
2007
   
2008
   
2009
 
New retail stores opened
   
1,183
     
920
     
562
 
Retail stores closed
   
147
     
162
     
145
 

The table below sets out the length of relationship between us and distributor by region:
 
 
For the year ended December 31, 2009
Northern Region
1 to 4 years
Northeastern Region
1 to 2  years
Northwestern Region
1 to 7 years
Eastern Region
1 to 5 years
Southern Region
1 to 4 years
Southwestern Region
1 to 7 years
 
The table below sets out the percentage of sales to distributors by region for the periods indicated:

   
As of December 31,
 
   
2007
   
2008
   
2009
 
Northern Region
   
11.4
%
   
10.8
%
   
10.5
%
Northeastern Region
   
16.1
%
   
13.6
%
   
11.4
%
Northwestern Region
   
12.2
%
   
11.3
%
   
11.3
%
Eastern Region
   
13.5
%
   
16.8
%
   
16.0
%
Southern Region
   
13.3
%
   
13.9
%
   
14.7
%
Southwestern Region
   
33.5
%
   
33.6
%
   
36.1
%
     
100.0
%
   
100.0
%
   
100.0
%

We have sales teams comprising regional managers, accounts managers and accounts representatives who manage our sales in the various regions. Our sales teams are responsible for monitoring and managing the performance of the distributors and the Xidelong retail stores within their respective regions, as well as managing the distributors’ compliance with our retail policies. These regional sales teams report to our headquarters.
 
We have formulated an internal expansion plan that entails opening, through our distributors, approximately 700, 1,000 and 1,000 Xidelong retail stores in each of 2010, 2011 and 2012, respectively.
 
Selection of distributors
 
We select distributors based on a range of criteria that we considers important for the operation of the Xidelong distribution sales network of sportswear retail stores. We do not require our distributors to have any minimum number of years of relevant experience. We assess the suitability of a candidate to be a distributor based on, but not limited to, the following:

 
¨
its relevant experience in the management and operation of sportswear retail stores;

 
¨
its creditworthiness;

 
¨
its ability to develop and operate a network of retail stores in its designated sales region;
 
 
¨
its ability to meet our sales targets; and

 
34

 

 
¨
the suitability of its store location and size.

We identify suitable distributors and enter into distributorship agreements, generally for a term of up to 12 months. Beginning in 2008, the duration of distributorship agreements with our distributors has been extended to three years.
 
Our distributors directly operated 1,000 Xidelong retail stores out of 3,694 Xidelong retail stores at December 31, 2009. They have their own regional management teams that oversee the overall supervision, management (including the formulation of operational guidelines for the Xidelong retail stores) and inspection of the Xidelong retail stores.
 
We set guidelines for our distributors in respect of the location, store layout and product display of their Xidelong retail stores. Distributors require our prior approval before opening new Xidelong retail stores. We typically visit potential locations for new Xidelong retail stores with distributors and consider the suitability of such locations before approving a new Xidelong retail store opening.
 
We also allow our distributors to use authorized third party retail store operators to operate the Xidelong retail stores. Distributors must obtain our approval before appointing such retail store operators. As of December 31, 2009, authorized third party retail store operators operated 2,694 Xidelong retail stores out of 3,694 total Xidelong retail stores.
 
We do not have direct contractual relationships with the authorized third party retail store operators and thus we require our distributors to implement, monitor compliance with and enforce our retail store guidelines on the authorized third party retail store operators.
 
Save for the provision of subsidies to our distributors for new store openings, renovation subsidies for the renovation and expansion of existing retail stores selling Xidelong products, and the provision of credit terms for settlement of its invoices, we do not make any payment, give any sales incentives, or pay any fee to our distributors. Our distributors do not pay us any fee other than the purchase price for the purchase of our products. Our distributors are independent third parties.
 
For 2007, 2008 and 2009, sales to our top five distributors accounted for approximately 43.4%, 46.3% and 46.0%, respectively, of our total revenue. During the same periods, sales to our single largest distributor accounted for approximately 13.8%, 12.3% and 13.0%, respectively, of our total revenue.
 
Distributorship agreements
 
The common principal terms of the distributorship agreements are as follows:
 
 
¨
Distribution exclusivity — the distributorship agreements allow our distributors to sell our products under the Xidelong brand on an exclusive basis.

 
¨
Geographic exclusivity — distributors must sell our products under the Xidelong brand within a defined geographical area.

 
¨
Product exclusivity — distributors must sell our products exclusively at the Xidelong retail stores.

 
¨
Security deposit — distributors must pay us a fixed sum as security for the performance of their obligations under the agreement.

 
¨
Sale price — distributors pay a wholesale price for our products, which represents a discount to the suggested retail price of our products. Different discount rates apply to footwear, apparel and accessories.

 
¨
Payment and credit terms — we set payment and credit terms on a case-by-case basis with each distributor. Starting from 2009, we extended credit terms granted to our distributors from two months to four months.

 
35

 
 
 
¨
Sales target — we have the right to terminate the agreement if a distributor fails to meet sales targets for two consecutive years.

 
¨
Training — we provide training to employees of the distributors on a periodic basis. Our training includes knowledge of our products, marketing skills, product display, window display and operation management. Distributors pay for all costs associated with such training.

 
¨
Support — we provide our distributors with free promotional material such as newspaper advertisements, product descriptions and video of our advertisements.

We can renew the distributorship agreements on an annual basis solely at our option. Beginning in 2009, we have allowed distribution agreements of three years in length to strengthen our distribution relationships. We are entitled to terminate a distributorship agreement if the distributor fails to adhere to our market management policies or fails to meet the sales target.
 
If a distributor terminates a distributorship agreement with us and there is no replacement distributor, we are not required to repurchase any stock held by the departing distributor. However, we will require any replacement distributor to purchase inventories held by the departing distributor and will coordinate the sale of inventories (including obsolete inventories) from the former distributor to the replacement distributor. The terms on which such sales are made are determined between the departing distributor and the replacement distributor. For out-of-season stock, we coordinate with our distributors in reallocating products to different regions or conducting sales promotional activities.
 
Ordering of our products
 
The distributors attend sales fairs organized by us to place orders for our products. Prior to 2008, we organized two major sales fairs each year, usually in March to introduce the autumn/winter collections and in September to introduce spring/summer collections to the distributors. Beginning in 2008, we organized three sales fairs each year, usually in March to introduce the autumn collection, in June to introduce the winter collection and in September to introduce spring/summer collections to its distributors.
 
We usually introduce our new collections to our distributors and third-party retailers at our sales fairs, which are normally held four to six months before the introduction of a new season’s products to end consumers. Our distributors place most of their orders for these new products at the sales fairs, and we use the orders collected at the sales fairs to determine production schedules for each season and to plan future sales targets. We then manufacture products in house or though third party contract manufacturers. After completion of production, the products are delivered to distributors, which in turn either sell the products directly to consumers or to their respective third-party retailers for eventual sales to consumers. We believe that our streamlined order, production and sales process allows us to manage our raw material procurement and credit exposure, minimize inventory exposure and increase sales.
 
Payments for our products
 
We give our distributors an invoice of the contract price payable at the time the products are delivered. At the same time, we recognize revenue from the sales. See “ Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates — Revenue recognition.”
 
Prior to 2009, we generally required our distributors to pay 30% of the contract price upon delivery with the remaining 70% paid within 60 days after delivery. Beginning in 2009 and to complement the new policy on length of distribution agreements, we extended the payment of the second installment representing 70% of the contract price from 60 days to 120 days after delivery. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Factors Affecting Our Results of Operations and Financial Condition — The effect of the recent economic downturns on us.”
 
We generally assess the creditworthiness of our distributors based on their credit history and historical sales performance before entering into agreements with them. We require our distributors to comply with our credit policy. Our management team monitors the receivable balances on an ongoing basis and makes periodic assessment as to whether a bad debt provision needs to be made on a timely basis. During 2007, 2008 and 2009, we did not make any bad debt provisions.

 
36

 

As of December 31, 2009, over 99% of the accounts receivable were current in nature. The remaining 1% of the receivables that were due but not impaired related to a number of distributors that had a good repayment record. Based on the experience of transacting with our distributors in the past, we considered that no provision of doubtful accounts was necessary because there had not been a significant change in the credit quality of the distributors and we believed that the accounts receivable were fully recoverable.
 
Management of distributors and retail stores
 
We collect, review and analyze data on the performance of our distributors. We monitor the distributors’ performance in the following manner:
 
 
¨
We agree with the distributors on sales target figures, which vary on a case-by-case basis depending on a distributor’s historical sales figures and prevailing market conditions;

 
¨
We require the distributors to submit inventory reports to us, which contain information on inventory levels of the distributors. The inventory reports, however, do not record information on the sales of our products to end consumers, whether by the distributors or the authorized third party retail store operators. This reporting system enables us to obtain up-to-date information on the sales performance and inventory movement at distributors’ level. See “Inventory Control and Management;”

 
¨
We appoint one to three regional managers for every province where our distributors operate. These regional managers carry out monthly on-site inspections of the Xidelong retail stores and prepare reports on such inspections. This enables us to identify and inform distributors of any non-performing Xidelong retail stores; and

 
¨
in addition to sales target figures, we discuss with our distributors at the beginning of each year their annual performance targets, which includes evaluation criteria such as the number of new retail stores opened and the timeliness of settlement of invoices. At the end of each year, we meet with our distributors and review their performance and assign scores based on such criteria. However, our agreements with the distributors do not envisage our inspection of the financial statements of the distributors. If a distributor fails to meet its annual performance targets or scores below an acceptable level, or does not fulfill sales network expansion plans, we have the option to terminate the distributorship agreements. In determining whether to renew or terminate a distributorship, we also assess their compliance with our policies in respect of marketing activities, daily operations and customer service.

We do not maintain any policy limiting the number of the Xidelong retail stores in any particular region. When a region can sustain more than one store, and before we approve the opening of the additional retail stores, we assess any additional store’s viability and that of the existing store should any additional store be opened. In particular, we consider factors such as the distributor’s ability to manage and operate the new retail store effectively and, the proximity between the new retail stores and the existing retail stores in the particular region, with a view to avoiding an over concentration of retail stores. We further assess market conditions such as customer demands, economic growth and development, and any new governmental policies in a particular region to ensure each store in the same area can operate without taking market share away from other stores.
 
We provide our operational and retail guidelines, policy and procedures to distributors, which govern store layout, product display, customer service and after-sale service standards. We monitor our distributors to ensure that they operate the Xidelong retail stores in accordance with our guidelines, through the following measures:
 
 
¨
We conduct regular site inspections at both distributor and retail store levels. We currently employ more than 55 sales representatives who carry out on-site inspections of random retail stores every quarter. In areas where there are fewer retail stores, we conduct on-site inspections on a monthly basis. At the on-site inspections, our sales representatives inspect the major conditions of the retail stores such as location, layout, display shelves and products, quality of sales staff to ensure that they are consistent with our operations procedures;

 
37

 

 
¨
Beginning in 2008, we implemented a policy requiring our sales representatives to conduct monthly on-site inspections of at least 20 retail stores in order to monitor more effectively the distributors’ and authorized third party retail store operators’ compliance with our operational and retail guidelines, policy and procedures, including whether our uniform retail prices are enforced;

 
¨
We require our distributors to provide records of their sales and promotional activities; and

 
¨
We provide training to the staff of our distributors and retailers to ensure that they are able to follow sales and promotional guidelines and policies effectively.

As we do not have any direct contractual relationship with authorized third party retail store operators, we rely on our distributors to implement and enforce our operational and retail guidelines, policy and procedures on the authorized third party retail store operators through the distributors’ agreement with the authorized third party retail store operators. As such, we only have limited control over whether authorized third party retail store operators adhere to our guidelines. We adopt the same measures with authorized third party retail store operators that we use to monitor our distributors’ compliance with these guidelines. Our regular site inspections of the retail stores include both the retail stores directly operated by the distributors and the retail stores operated by authorized third party retail store operators. We carry out inspections of retail stores operated by authorized third parties together with the distributors who appoint the relevant authorized third party retail store operators.
 
If a distributor or authorized third party retail store operator fails to comply with our operational guidelines, policy and procedures, we give a non-compliance warning and requires it to take corrective measures. In the event of its continued non-compliance, we have the option of terminating the distributorship agreements or to demand the operations of a particular Xidelong retail store to cease.
 
We determine a time period during which a non-compliant distributor or authorized third party retail store operator must rectify its non-compliance on a case-to-case basis depending on the seriousness of the breach, but it will not normally exceed three months.
 
Subsidies
 
We subsidize our distributors for renovation costs of new, and refurbishment of existing, Xidelong retail stores based on the size of such stores. For 2007, 2008 and 2009, we subsidized approximately RMB34.7 million, RMB71.6 million and RMB85.3 million, respectively.
 
Sales fairs
 
We hold sales fairs where we showcase our prototype products to potential and existing distributors. Distributors place orders for our products at these sales fairs. We launch and sell our new collection of products for each season at these sales fairs. Our purchase orders at the sales fairs constitute approximately 80% to 90% of annual revenue. We review orders placed at these sales fairs before entering into corresponding sales contracts with the distributors. We began holding three sales fairs a year since 2008.
 
We generally informally offer distributors the flexibility to make downward or upward adjustments to their purchase orders placed at the sales fairs by 10% to 15% before finalization to prevent overflow of inventory among our distributors. We use orders received from the sales fairs to formulate our production schedules for the relevant season. Before commencement of mass production, our senior management reviews orders received from the sale fairs, coordinates with managers of various departments and finalizes a plan of production quantity, type and schedule for confirmation with relevant distributors. After such confirmation, the distributors are not permitted to cancel or adjust these confirmed sales. The distributors receive an invoice at the time the products are delivered and we recognize revenue at the same time because we recognize revenue from the sale of goods when a sale is made and the significant risks and rewards of ownership have been transferred to the distributors, which generally occurs when the product is sold and delivered to the distributors. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates.”

 
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Return policy
 
We do not have any formal return policy with our distributors. We only accept returns of defective products. However, instead of returning defective products to us, distributors generally choose to sell any defective products at a discount to end customers. Since distributors are required to comply with our pricing policy, distributors must obtain our prior written consent before they can sell any products at a discount to the suggested retail price. We determine the amount of discounts on a case-by-case basis. We do not provide any compensation to distributors for defective products. To date, the number and value of defective products have been nominal.
 
In addition, we do not have any obsolete stock arrangements with our distributors. Therefore, we do not have any arrangements with distributors to accept returns of out-of season stock.
 
Promotion and Marketing
 
Our marketing department deals with sales fairs, contracts with distributors, market research and management of distributors. We also have a branding and promotional department that deals mainly with media arrangements, sponsorships and other endorsement activities. We use a variety of media, such as television, newspapers, magazines, the Internet and outdoor billboard displays to build both regional and nationwide brand recognition. We collaborate with athletes, media celebrities and industry experts on marketing and endorsement arrangements and they act as spokespersons for the Xidelong brand.
 
For 2007, 2008 and 2009, advertising and promotional expenses constituted approximately 7.2%, 7.5% and 7.8% of our total revenue, respectively.
 
Spokespersons
 
We actively seek reputable spokespersons to promote our brand. From October 2001 to September 2003, Mr. Cai Zhenhua  was a brand spokesperson for our products. Mr. Cai is a former table-tennis player and holder of various team and individual titles from numerous World Championships and the Atlanta 1996 Olympic Games. From February 2003 to May 2007, Mr. Aaron Kwok  was a brand spokesperson for our products. Mr. Aaron Kwok is a Hong Kong entertainment celebrity who promoted our brand name and, we believe, raised our profile across the PRC, especially among younger consumers. As a result, in 2004, we were named the company with the “Most Popular Spokesperson” by SINA Corporation.
 
In 2007, we engaged Professor Sun Yining  to be a brand spokesperson and strategic marketing consultant. Professor Sun is a research member of the Hefei Institute of Intelligent Machines and is a leading scholar on sensor technology and artificial intelligence in the PRC. The appointment of Professor Sun is in line with our objective of branding as a manufacturer of sports and leisurewear products with innovative designs and high technological performance.
 
Sponsorship and endorsement
 
We actively seek and are also invited to sponsor various sporting or festive events related to our products. In 2003, we sponsored an “Xidelong Fashion Night” event during China Fashion Week. In 2007, we sponsored an “Xidelong award” at the “Qzone” web design awards. Qzone is a Chinese social networking internet site that is geared toward young designers. In 2008, we sponsored a series of magic shows on Anhui TV Channel. We believe our sponsorship of these events helped promote and increase awareness of our brand among young designers, students and net surfers.
 
Under their cooperation agreements, the China Institute of Sport Science and the Hefei Institute of Intelligent Machines agreed to help promote our products and Xidelong brand at various marketing and promotion events during the respective agreement periods. See “Research and Development.”
 
Pricing
 
We determine the prices of our products based on a variety of factors, including the costs of raw materials and production, market conditions (including the spending power of consumers) and the prices of competitors’ products. The prices of our products increased relatively steadily in 2007, 2008 and 2009 due to increasing awareness of our brand name, product quality and research and development. We believe that could increase our prices without losing market shares despite fierce competition. See “ Management’s Discussion and Analysis of Financial Condition and Results of Operations — Factors Affecting Our Results of Operations and Financial Condition — The effect of the recent economic downturns on us.”

 
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We have adopted a suggested retail price system that is applied nationwide to all retail stores operated by our distributors or third-party retailers to maintain brand image and avoid price competition among distributors and third-party retailers. In addition, our distributors must obtain our prior written approval before carrying out any promotional events or selling our products (including newly launched products) at a discount. For sales of our products with deviation from specification at a discount to suggested retail prices to end customers, see “Risk Factors — Risks Relating to Our Business — The wholesale prices at which we sell our products to distributors are determined by factors beyond our control.” In addition, sales of our products at a discount to suggested retail price to end customers could have an adverse effect on our business and brand name.”
 
The table below sets forth the retail price range of our products for the periods indicated:

   
Year ended December 31,
 
   
2007
 
2008
 
2009
 
       
(in RMB)
     
Footwear
 
85 to 338
 
109 to 346
 
129 to 354
 
Apparel
 
36 to 499
 
41 to 500
 
68 to 418
 
Accessories
 
6 to 159
 
6 to 219
 
13 to 168
 

We intend to keep the pricing of our products at reasonable levels in the foreseeable future in order to stay competitive and maintain product demand.
 
Competition
 
The sports and leisure industry is highly competitive in the PRC. We compete with an increasing number of international and domestic sports and leisure footwear companies, sports and leisure apparel companies, sports accessories companies, and large companies with diversified lines of sports and leisure shoes, apparel and accessories. We expect competition to further intensify due to the entry of new foreign and domestic sports and leisurewear retailers in the PRC and as a result we may be required to adjust our prices in response to competitors’ pricing policies. Our ability to maintain or further increase our profitability will primarily depend on our ability to compete effectively by leveraging our leading market position in the PRC, brand recognition and product portfolio, distributors’ extensive retail distribution network, experienced management and product designs to differentiate us from competitors.
 
Performance style and quality of footwear, apparel and accessories, new product development, price, product identity through marketing and promotion, and support to distributors and customer service are important aspects of competition in the sports footwear, apparel and accessories business. We believe that we are competitive in all these areas particularly as a result of, what we believe is, our brand name, product quality and research and development.
 
Insurance
 
We believe that we maintain insurance in line with industry standards. Our insurance coverage primarily relates to property insurance.
 
We do not maintain general product liability insurance for any of our products. Nevertheless, we believe that our practice is in line with the general industry practice in the PRC as product liability insurance is not required under PRC law. In 2007, 2008 and 2009, we did not receive any material claims from customers or consumers relating to our products.
 
C.      ORGANIZATIONAL STRUCTURE

Exceed is our investment holding company incorporated in the British Virgin Islands and we conduct our operations through our PRC subsidiaries, which are our indirect wholly owned subsidiaries. The following diagram illustrates our significant direct and indirect subsidiaries as of March 31, 2010:

 
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Subsidiaries

The following table sets forth information relating to our direct and indirect subsidiaries as of December 31, 2009.

   
Beneficial Ownership
Percentage
 
Jurisdiction of
Incorporation
Windrace
   
100
%
Cayman Islands
XDLong Investment
   
100
%
British Virgin Islands
Exceed Brand Management (BVI)
   
50
%
British Virgin Islands
Exceed Brand Management (HK)
   
50
%(1)
Hong Kong
XDLong HK
   
100
%
Hong Kong
XDLong Fujian
   
100
%
PRC
XDLong China
   
100
%
PRC

Note: (1) Exceed Brand Management (HK) is a wholly owned subsidiary of Exceed Brand Management (BVI), in which we own a 50% interest.
 
D.      PROPERTY, PLANTS AND EQUIPMENT
 
XDLong China owned and occupied a parcel of land with an aggregate site area of approximately 38,784 square meters together with buildings on such land. The buildings comprise our production facility, a research and development center, an office space, staff quarters, a recreation center and sports facilities, with an aggregate gross floor area of approximately 99,024 square meters. We have obtained the land use rights certificate in relation to the land and the property ownership certificates for the buildings. The land use rights were granted for industrial use for a term of 50 years from December 25, 2006.
 
XDLong Fujian owns a parcel of land located within our production complex in Jinjiang, which has an aggregate site area of approximately 15,277 square meters. Pursuant to the State-owned Land Use Right Transfer Contract, construction on this land must commence by February 28, 2006. XDLong Fujian did not commence construction by such date because we decided to construct our production facilities on another larger parcel of land owned by XDLong China. We have plans to construct additional production facilities on the XDLong Fujian parcel of land. XDLong Fujian is applying to relevant local government agency for postponing construction on the land. However, there is a risk that the local government may repossess the land before XDLong Fujian obtains an approval to postpone construction.

 
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Our principal executive offices are located at Suite 8, 20/F, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong .
 
Environmental Protection
 
Our manufacturing operations are subject to PRC environmental laws and regulations on air emission, solid waste emission, sewage and waste water, discharge of waste and pollutants, and noise pollution. These laws and regulations include Law of the PRC on Environmental Protection, Law of the PRC on the Prevention and Control of Water Pollution, Law of the PRC on the Prevention and Control of Atmospheric Pollution, Law of the PRC on the Prevention and Control of Pollution from Environmental Noise and Law of the PRC on the Prevention and Control of Environmental Pollution of Solid Waste. We are also subject to periodic monitoring by relevant local government environmental protection authorities.
 
According to these environmental laws and regulations, all business operations that may cause environmental pollution and other public hazards are required to incorporate environmental protection measures into their operations and establish a reliable system for environmental protection. Such a system must adopt effective measures to prevent and control pollution levels and harm caused to the environment in the form of waste gas, waste water and solid waste, dust, malodorous gas, radioactive substance, noise, vibration and electromagnetic radiation generated in the course of production, construction or other activities.
 
Companies in the PRC are also required to carry out an environment impact assessment before commencing construction of production facilities and the installation of pollution treatment facilities that meet the relevant environmental standards and treat pollutants before discharge. We carried out the required environment impact assessment before commencing construction of our production facilities and have obtained all the required permits and environmental approvals for our production facilities.
 
Our production facility in Jinjiang received ISO 14001 certification in 2007, which certifies that our environmental management system in respect of the design, development, production and service of our products conforms to the environmental management standards.
 
The main environmental impact from our operations is the generation of wastewater and noise pollution from the operation of production machinery. In order to comply with the relevant environmental protection laws and regulations, we have implemented an environmental protection system to ensure the emissions from production operations meet the pollution indicators. In addition, our production plant is located in an open area, away from residential areas and equipped with an appropriate convection and ventilation system. In order to reduce the impact on the environment, we have enhanced the convection and ventilation system at our production facilities to improve air quality and adopted various measures to prevent and minimize the noise pollution from our production operations.
 
Health and Safety Matters
 
The PRC Production Safety Law (the “Production Safety Law”) requires that we maintain safe working conditions under the Production Safety Law and other relevant laws, administrative regulations, national standards and industrial standards. We are required to offer education and training programs to our employees regarding production safety. The design, manufacture, installation, use and maintenance of our safety equipment are required to conform with applicable national and industrial standards. In addition, we are required to provide employees with safety and protective equipment that meet national and industrial standards and to supervise and educate them to wear or use such equipment according to the prescribed rules.
 
We consider the safety of our employees to be a priority. We have implemented internal health and safety policies in the workplace, available through our handbook on production safety and security procedures, which incorporate safety laws and regulations in the PRC. We have implemented safety guidelines on production procedures for the safe operation of production equipment and machinery during each stage of the production process. We require our employees to attend occupational safety education training courses on our safety policies and procedures to enhance their awareness of safety issues. We provide and require our employees to wear suitable protective devices to ensure their safety. We also provide employees with free annual medical check-ups.

 
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As required under the Regulation of Insurance for Labor Injury, Provisional Insurance Measures for Maternity of Employees, Interim Regulation on the Collection and Payment of Social Insurance Premiums and Interim Provisions on Registration of Social Insurance, we provide our employees in the PRC with welfare schemes covering pension insurance, unemployment insurance, maternity insurance, injury insurance and medical insurance.
 
In 2007, 2008 and 2009, we believe that we were in compliance with all applicable labor and safety laws and regulations in all material respects, and implemented internal safety guidelines and operating procedures. Further, we believe that we are in compliance with the new PRC Labor Contract Law, which came into effect on January 1, 2008, in all respects, and do not believe this new law will have any impact on our business and operations. Since the commencement of our business, none of our employees has been involved in any major accident in the course of their employment and we have never been subject to disciplinary actions with respect to the labor protection issues.

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 on Form 20-F. 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 on Form 20-F.

Overview

 We design, develop and wholesale footwear, apparel and accessories under the “ “ (Xidelong) brand name and the “ “ trademark in China. Since we began our operations in January 2002, we have experienced significant growth in second and third tier cities in China. We have three principal categories of products: (i) footwear, which mainly comprises running, leisure, basketball, skateboarding, canvas, tennis and outdoor footwear, (ii) apparel, which mainly comprises sports tops, pants, jackets, track suits and coats, and (iii) accessories, which mainly comprise bags, socks, hats and caps. Our footwear, apparel and accessories represented 53.0%, 45.7% and 1.3% of our total revenue for the year ended December 31, 2009, respectively, the market for which has been rapidly growing in China recently due to an increasing demand for lifestyle and leisure products and what we believe is a heightened interest in health consciousness among Chinese customers.
 
We place great emphasis on the comfort and functionality of our products. In particular, we focus our research and development efforts on designing sports and leisure footwear, especially running footwear, tailored to the needs of PRC consumers. The China Institute of Sport Science, which is the research center established by the General Administration of Sport of China and China’s first government agency engaging in research in the field of sport science, selected us exclusively to collaborate on research and development efforts in China. Under our agreement with the China Institute of Sport Science, we are required to pay an annual fee to the China Institute of Sport Science for its assistance with the research and development of technology for our sports footwear and apparel and the promotion of the technology content of our products. In addition, we have the exclusive right to use the endorsement “ The Strategic Partner of the China Institute of Sport Science ” on our products and the first right to use the expertise developed through our activities with the China Institute of Sport Science. As the exclusive partner of the China Institute of Sport Science, we allow the China Institute of Sport Science to use our research and development center in Jinjiang. Our commitment to the comfort and quality of our footwear for each individual is represented by slogans in our promotional campaigns such as “ The Foot Knows Comfort, ” “ Run Freely ” and “ Respect Yourself .”
 
We distribute our products mainly through the Xidelong retail stores, which sell our products exclusively and do not carry or sell other brands’ products. As of December 31, 2009, all Xidelong retail stores were owned and operated by our 22 distributors. Some of the stores are operated directly and the remaining indirectly through third parties. We have contractual relationships only with our distributors and not with authorized third-party retail store operators. We believe that the sale of our products through distributors has enabled us to grow by exploiting their regional retail expertise and economies of scale. We provide retail policies and guidelines, training, advertising and marketing support as well as renovation subsidies to assist our distributors in the management and expansion of the Xidelong retail sales network. As of December 31, 2009, there were 3,694 Xidelong retail stores, of which 1,000 were operated directly by distributors and the remaining 2,694 were operated indirectly through authorized third-party retail store operators. The number of the Xidelong retail stores grew from 2,519 as of December 31, 2007 to 3,694 as of December 31, 2009, representing a CAGR of 21.1%.

 
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W e manufacture our products through a combination of internal and external production. Our production facility has a gross floor area of approximately 66,102 square meters and houses nine production lines with an aggregate annual production capacity of approximately nine million pairs of footwear. During the year ended December 31, 2009, we outsourced a portion of our footwear production to three contract manufacturers, and all of our apparel and accessories production to more than 20 contract manufacturers. The percentages of the production of our footwear that we outsourced to our contract manufacturers in terms of sales volume increased from 37.1% in 2007 to 47.8% in 2008 but decreased to 43.7% in 2009. The percentages of footwear production that we outsourced to our contract manufacturers decreased in 2009 because we increased production of our footwear products in-house due to increased production capacity and decreased purchases from contract manufacturers. Increased in-house production gives us more control over footwear production and allows us to save costs.
 
Our revenues increased significantly at a CAGR of 26.6% from RMB1,296.4 million in 2007 to RMB2,078.0 million in 2009. The growth during these periods was attributable to our business expansion and increased demand for our products.

Factors Affecting Our Results of Operations and Financial Condition
 
Our financial condition and results of operations have been and will continue to be affected by a number of factors, including those set forth below.
 
The PRC economic growth
 
Our financial condition and results of operations have been driven by macro-economic conditions, increased disposable income and consumer spending in the PRC. In 2007, 2008 and 2009, we derived all of our revenue from domestic sales in the PRC. According to the National Bureau of Statistics of China, the PRC economy grew at a CAGR of approximately 15.1% from 1999 to 2009. From 1999 to 2009, the per capita annual disposable income of urban households in China grew at a CAGR of approximately 11.4% and consumer spending as measured by total retail sales value grew at a CAGR of approximately 14.9%. In addition, although the global economy has been affected by the financial crisis and economic downturns that began in 2008, per capita consumption expenditure of urban residents in China increased by 10.1% in 2009 compared to 2008 according to the National Bureau of Statistics of China. Statistics published by the General Administration of Sport of China suggest that there is a general correlation between disposable income and sports participation in China. We expect that our results of operations will continue to be driven by the growth of the PRC economy and increased disposable income and consumer spending in the PRC, particularly in the provinces and municipalities in which we operate.
 
The effect of the global economic downturn on us
 
The financial crisis and global economic downturn that began in 2008 have presented challenges to economies worldwide, including China. The Chinese government has adopted a stimulus package aimed at stimulating domestic consumer demand to address the global financial crisis. China's economy started to recover in the second half of 2009 as the increase in domestic consumption outpaced the decrease in exports. We experienced an increase in sales volumes and revenues due to increased consumer spending in the year ended December 31, 2009 compared to the year ended December 31, 2008. The average selling prices of our products increased in the year ended December 31, 2009 compared to the year ended December 31, 2008 due to increased recognition of the Xidelong brand in China as a result of marketing and brand promotion efforts over the years. We believe that we will be able to continue to increase the selling prices of our products in the future due to increasing awareness of our brand name, product quality and research and development efforts.

 
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We source purchase orders primarily at sales fairs, and such orders constituted approximately 80% to 90% of our annual revenue. Purchase order quantities may be subsequently adjusted upward or downward by amounts ranging from 10% to 15% before finalization. In 2008, we agreed with certain distributors to reduce orders by 15% to 20% to prevent overflow of inventory among such distributors due to anticipated reduced consumer demand arising from the financial crisis and economic downturn that began in 2008. However, we received an increased number of orders during the sales fair held in September 2009 compared to that held in May 2009 as consumer confidence improved and signs of economic recovery started to emerge in China. According to the National Bureau of Statistics of China, total retail sales of consumer products, the primary gauge of consumer spending in China, increased by 15.5% in 2009 compared to 2008. We believe that our financial performance will continue to improve if consumer spending continues to increase in China.
 
According to the National Bureau of Statistics of China, urban retail sales accounted for nearly 67.8% of total retail sales in 2009. Urban consumption is expected to continue to be the primary contributor to consumer consumption in China. We focus our business in second and third tier cities in inland China, which are not as adversely affected by the financial crisis and the economic downturns as the coastal cities in China. We believe that we will be able to continue to capture the retail sales growth opportunities in second and third tier cities in China characterized by increasing urbanization, strong economic development and significant room for future growth.
 
Management of collection of trade receivables
 
One of our strategies during the financial crisis and the economic downturn is to grow the distribution network through our distributors by enhancing our relationship with them. Beginning in 2009, we extended the payment of the second installment representing 70% of the contract price from 60 days to 120 days after delivery as the duration of distributorship agreements has been extended from one to three years. The extended agreements allow us to establish long-term relationships with our distributors. For our distributors that experienced difficulties in their liquidity, the longer credit period allows them to overcome the unfavorable market condition confronting businesses worldwide. For our distributors that do not have difficulties in their liquidity, the longer credit period gives them more flexibility to grow the distribution network during the economic downturn in a cost effective manner.
 
We have adopted tightened credit verification procedures for every distributor who would like to apply for credit terms. Distributors are required to make a 30% down payment on every purchase order they made. The balance of the payment will then be due after four months from the invoice date. Trade receivables are monitored on an ongoing basis, and we have the sole discretion to cease doing business with distributors who fail to make payment within the credit period.
 
For any distributor whose balance is overdue for more than 30 days, the sales manager in charge will closely monitor such distributor and investigate the reason it is overdue. If the overdue amount is caused by the financial difficulties of the distributors, we will stop the shipment of all undelivered products and we will make allowances for uncollectable receivables in accordance with our assessment of the recoverability of the outstanding balance. No provision for uncollectibility of the overdue balance will be made if (1) the distributor has good trading record in the past and agrees to settle the overdue balance within 30 days; (2) the distributor continues to settle the outstanding balance; and (3) there is a dispute on the overdue balance with the distributor that is subject to clarification.
 
Moreover, we have maintained good relationships with all the distributors for many years and have rarely encountered any difficulties on collection of account receivables. As of December 2009, over 99.5% of the trade receivables that were neither past due nor impaired relate to customers with no recent history of default. The receivables that were past due but not impaired relate to a number of independent customers that have a good repayment record with the Group, however, those past due amounts were subsequently settled in January 2010. Therefore, our management believes that it has already taken adequate measures to ensure timely settlement by the distributors and the extended credit period has not materially adversely affected our liquidity and working capital or affected management’s judgment on the collectability of the outstanding balances from distributors.
 
Increased consumer demand for sportswear products in the PRC
 
Consumer demand for sportswear in the PRC is one of the key drivers of our revenue. The success of our business depends in large part on the growth in the PRC consumer market, particularly consumer demand for sportswear products. As general living standards in the PRC continue to improve, we expect consumer demand in the PRC to shift increasingly towards lifestyle enhancing products, such as sportswear, which we believe will increase our sales. We also believe that the 16th Asian Games in Guangzhou in 2010 will generate more interest in sports and corresponding consumer demand for sportswear products in the PRC.

 
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Competitive pricing of our products to increase profitability
 
We have been able to increase our gross profit margins through competitive pricing of our products and effective cost management. To increase sales volumes, our pricing policy is to offer a range of products which are set at different price points with the aim of targeting different segments within the mid-range market. Currently, the average retail prices for our sports and leisure footwear range from approximately RMB200 to RMB300. The gross profit margin for footwear has increased from 26.1% in 2007 to 30.6% in 2009. The gross profit margin for apparel has increased from 26.0% in 2007 to 28.2% in 2009. The gross profit margin for accessories has increased from 23.4% in 2007 to 28.9% in 2009. The sales volumes and revenues increased in the year ended December 31, 2009 compared to the year ended December 31, 2008 as a result of the increase in consumer spending in 2009. The average selling prices of our products increased in the year ended December 31, 2009 compared to the year ended December 31, 2008 due to increased recognition of the Xidelong brand in China as a result of marketing and brand promotion efforts over the years.  In order to maintain our price competitiveness and sales volumes, we review our pricing strategy regularly to make adjustments based on various factors, including the market response to existing recommended retail prices, the level of sales, the expected product margin on individual products, the prices of our competitors’ products and the anticipated market trends and expected demand from customers.
 
Diversified product portfolio to increase revenue
 
We believe that a diversified product mix and a wide range of merchandise available in the Xidelong retail stores have been important factors in attracting customers and to increases our revenue. In 2007, 2008 and 2009, we changed the mix of our footwear products with an aim to increase our revenues generated from different footwear product categories. To further diversify revenue sources, we introduced three types of new footwear products, i.e., tennis, outdoor and beach footwear, in 2008. To allocate resources to produce other footwear products that are more popular to consumers, we discontinued the sales of beach footwear in 2009. In addition to footwear products, sales of apparel and accessories also contributed to the growth in our revenue. We will continue to monitor customer demand and adjust our product mix as we deem necessary to increase our average selling prices, revenue and gross profit margins.
 
The growth of our network through distributors
 
We distribute our products mainly through the Xidelong retail stores, which offer our products exclusively and do not carry other brands. Our 22 distributors own and operate all Xidelong retail stores. They operate some of the Xidelong retail stores directly and delegate operation of the remaining stores to third parties. As of December 31, 2009, our 22 distributors operated a network of 3,694 Xidelong retail stores located in 28   provinces and municipalities in the PRC. Our growth is largely driven by the business performance of our distributors and the pace of expansion of the network of the Xidelong retail stores. As of December 31, 2007, 2008 and 2009, we had 22 distributors. We believe that our ability to supervise and manage our distributors is critical to their continued performance and contribution to increase our revenue.
 
Competitive advantage
 
We focus primarily on second and third tier cities in China, particularly in the Southwestern Region, Northeastern Region and Northwestern Region of China, characterized by increasing urbanization and strong economic development, which we believe present the best opportunity for retail sales growth. We believe that we will be able to leverage our leading market position, brand recognition and product portfolio, extensive retail distribution network, experienced management and product designs in the PRC to maintain our competitive advantage. For risks relating to competition in the sportswear manufacturing industry in China, see “ Risk Factors — Risks Relating to the Industry in Which We Operate — Our products face intense competition .”
 
Effective cost management
 
The major raw materials used in the production of our footwear products are natural and synthetic leather, nylon, canvas, rubber and plastics. To meet production requirements and to remain profitable, we must obtain sufficient quantities of good quality raw materials from our suppliers in a timely manner and at commercially reasonable prices. In addition, we use crude oil and electricity in our production. Therefore, increases in crude oil prices and electricity costs would increase our production costs. We believe that we will be able to offset a portion of any such increased costs through improvement of production efficiency and utilization of economies of scale. Historically, we have been successful in reducing cost of raw materials as a percentage of total cost of sales. For 2007, 2008 and 2009, the purchase of raw materials for our own production requirements accounted for 21.3%, 18.0% and 18.4%, respectively, of our total cost of sales. We seek to capitalize on our purchasing and bargaining power to continue to obtain favorable prices from our major suppliers. Because we use a cost-plus pricing policy to determine the selling price of our products, we are able to pass on increased costs to our distributors. We believe that effective cost management and ability to pass on increased costs to distributors will enable us to maintain and increase our profitability.

 
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Relationship with quality contract manufacturers
 
In 2009, we outsourced 39.2% of our footwear production by sales volume to three contract manufacturers and all of our apparel and accessories production to more than 20 contract manufacturers. For 2007 and 2008, the duration of agreements with our contract manufacturers for footwear, apparel and accessories had been one year. Starting from 2009, the duration of agreements with our contract manufacturers has been extended to two years. We have not terminated our contractual relationships with any of our contract manufacturers of our footwear during the term of the agreements. Due to a larger pool of contract manufacturers of apparel and accessories available for selection, we have been using apparel and accessories contract manufacturers capable of supplying goods with better quality at more competitive prices. We believe that long-term contracts with contract manufacturers as well as the relationships we have established with them over the years will enable us to procure quality contract manufacturers to meet our requirements at commercially reasonable terms. For risks relating to reliance on contract manufacturers, see “Risk Factors — Risks Relating to Our Business — We rely on our contract manufacturers for the production of a portion of our footwear and all of our apparel and accessories.”
 
Ability to maintain brand recognition and marketing success
 
We believe that brand recognition is crucial to customers’ purchasing decisions. We position our Xidelong brand as a high quality sports and leisurewear brand for consumers in the PRC. We place great emphasis on brand building and promote Xidelong products through advertisements in the media, sponsorship of PRC sports events and various other promotional activities. For 2007, 2008 and 2009, our advertising and promotion expenses accounted for 7.2%, 7.5% and 7.8%, respectively, of our total revenue. We intend to increase our marketing budgets for promotional activities in the future in order to further strengthen our brand and market position. We believe that we will be able to maintain the position of our Xidelong brand in the market through enhanced marketing efforts to increase market share and promote sales growth.
 
Seasonality
 
Our results of operations have fluctuated from season to season and are likely to remain seasonal. Historically, revenues in the third and fourth quarters have slightly exceeded those in the first and second quarters. The seasonality of our results of operations is primarily attributable to the seasonal nature of our footwear and apparel products and the fact that our autumn and winter collections generally command higher selling prices than our spring and summer collections. In addition, other factors such as weather conditions, holiday seasons, the timing of the launch of our new products and the timing of delivery of our products also affect our sales from season to season. Due to the seasonal fluctuations of our business, comparisons of sales and results of operations between different periods within a financial year, or between different periods in different financial years, are not necessarily meaningful and cannot be relied on as accurate indicators of our future performance.
 
Level of income tax and preferential tax treatment
 
Our profits are affected by the income tax that we pay and any preferential tax treatment that we are able to receive. As a foreign-invested enterprise engaged in the manufacturing business, XDLong Fujian is entitled to the preferential tax treatments provided under the Foreign Enterprise Income Tax Law. Accordingly, XDLong Fujian is subject to an enterprise income tax rate of 27% but it is fully exempted from the enterprise income tax during its first two profitable years, followed by a 50% tax reduction for the next three years. Such tax treatment had a significant positive effect on our profit after taxation for 2007. XDLong China is qualified for the same type of preferential tax treatments as XDLong Fujian because XDLong China is also a foreign-invested enterprise engaged in the manufacturing business. XDLong China started generating profits in 2008. Therefore, it enjoyed tax exemption in 2008 and 2009 and is expected to enjoy a 50% corporate income tax reduction in 2010, 2011 and 2012.

 
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Pursuant to the new PRC Corporate Income Tax Law (the “New Corporate Income Tax Law”) and its Implementation Rules (effective on January 1, 2008), domestic-invested and foreign-invested enterprises are subject to PRC corporate income tax at the same rate of 25%. Foreign-invested enterprises established prior to the promulgation of the New Corporate Income Tax Law and entitled to tax benefits are able to continue to enjoy the tax benefits before they expire over a 5-year period after January 1, 2008. Consequently, XDLong China is able to continue to enjoy its tax benefits, commencing from its first profitable year but subject to expiration within 5 years from January 1, 2008. With effect from January 1, 2008, the applicable tax rate for XDLong Fujian and XDLong China is 25%.

A.           OPERATING RESULTS

Basis of Presentation
 
The following discussion and analysis of our financial condition and results of operations is based on the selected financial information at and for the years ended December 31, 2007, 2008 and 2009 and has been prepared based on the financial statements of the companies that comprised Windrace and its consolidated subsidiaries, or the Windrace group, after elimination of inter-company transactions. This information should be read in conjunction with the financial information and notes thereto included in the consolidated financial statements and notes thereto included elsewhere in this registration statement.

The reorganization of Windrace involved a combination of entities under the common control of Mr. Lin Shuipan and Ms. Chen Xiayu. Under paragraphs 10 through 13 of IFRS 3, “Business Combinations” (“IFRS 3”), a combination of entities under common control is deemed to be outside the scope of IFRS 3. Since the reorganization of Windrace did not result in any change in the effective control of Windrace or the relative shareholder interests before and after the reorganization, the accompanying financial statements have been prepared on a consolidated (combined) basis at historical cost for all periods presented. On this basis, Windrace has been treated as the holding company of its subsidiaries for all periods presented.
 
Our consolidated income statements, consolidated statements of changes in equity and consolidated cash flow statements include the results of operations and cash flows of Windrace and its consolidated subsidiaries and have been prepared as if the current group structure had been in existence at January 1, 2007, or since the respective dates of their incorporation or establishment. Our consolidated balance sheets at December 31, 2007, 2008 and 2009 have been prepared to present the assets and liabilities of Windrace and its consolidated subsidiaries at the respective dates as if the current group structure had been in existence at those dates.
 
The financial information has been prepared in accordance with IFRS (which comprise standards and interpretation approved by the IASB and the International Accounting Standards (“IAS”) and Standing Interpretations Committee interpretations approved by the International Accounting Standards Committee). All IFRS effective for the accounting periods commencing January 1, 2007, 2008 and 2009, together with the relevant transitional provision, have been adopted by us in the preparation of the financial information throughout the years ended December 31, 2007, 2008 and 2009.
 
The financial information has been prepared under the historical cost convention and in accordance with the accounting policies set out in the financial statements included elsewhere in this registration statement, which conform with IFRS, and is presented in Renminbi with all values rounded to the nearest thousand except when otherwise indicated.
 
Consolidated Income Statements
 
The following table sets forth our results for the periods indicated:

   
Year ended December 31,
 
   
2007
   
2008
   
2009
 
   
(RMB in thousands)
 
Revenue
   
1,296,402
     
1,820,282
     
2,077,958
 
Cost of sales
   
(959,526