Item 1. Description of Business.

Hemptown was incorporated under the laws of British Columbia, Canada on October 6, 1998.  The current corporate structure is a single public company, incorporated under the Company Act (British Columbia).

We currently market and sell a line of hemp/cotton activewear: T-shirts, sweatshirts and ball caps to wholesalers for imprinting as well as directly to consumers.  Consumer awareness, acceptance and demand for this product are beginning to grow.

As of January 1, 2004, we were dealing with 1,500 resellers and 4 distributors located in both Canada and the U.S.  We have no obsolete inventory.  Inventory today is as viable as it was a year ago.  Management estimates that we will be able to turn our inventory approximately four times per year under current conditions.

We currently employ 12 employees, of which nine are full-time employees and two are part-time employees.  In addition to the current staff, we can also call upon 26 independent sewers and two cloth cutters, located in Vancouver, British Columbia, and several more independent sewers and cutters in China.  Additional sewers and cutters are available as foreseeable demand warrants.

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The majority of our production currently takes place in China, with design, product testing and pattern production in Vancouver, British Columbia.  In Vancouver we occupy 6,000 square feet of warehouse/office space on a long-term lease.  The lease is set to expire January 31, 2006.  We pay CDN$6.47 per square foot, plus common fees for a monthly rent of CDN$4,700.31.  We have been granted a right of first refusal as to the purchase of the building.  We do not maintain offices in China, although we do have a representative there.  We have an arrangement with a third party logistics provider located in Kent, Washington, who handles the bulk of distribution to our U.S. customers.

The Vancouver premises serve as head office, a display showroom, inventory storage and shipping facilities.

We have obtained trademark protection for the name "Hemptown" within Canada and the United States.  We also own the web sites www.hemptown.com, www.hemptownclothing.com and www.hemptown.ca.

Currently, we have access to enough hemp fiber to produce upwards of one million garments per month.  Management expects this fiber availability to increase over the next 12 months.

Why Hemp?

Hemp is a centuries old plant that is hardy, strong and grows largely pest free.  The common sense advantages of this rugged crop are many, and they extend right through the value chain.  Benefits to the farmers include little requirement for pesticides, high climate adaptability and growing hemp even improves soil quality.  The processing and manufacturing steps also are less environmentally taxing than those of many other fibers (notably cotton), requiring less toxic chemicals and dyes to create finished fabric.  High quality consumer goods are the end result, as hemp yields a fiber with four times the tensile strength and twice the abrasion resistance of cotton.  Hemp products are naturally resistant to mold, mildew and UV rays.

A colorful and illegal cousin of hemp has created an historical resistance to the product.  Since 1998, this resistance has been reduced through the legalization of industrial hemp growing in Canada. Governments and consumers are beginning to recognize that there is as much a connection between a Hemp T-shirt and marijuana as there is to a poppy seed bagel and heroin.  However, the confusion is only beginning to recede.  Despite this confusion, hemp based products are legal for sale throughout North America.  Management considers it to be possible, but unlikely, that a North American government will choose to impose any hemp specific regulation on this industry, except in the area of farming.

Cotton is simply not as eco-friendly as hemp.  A typical 100% cotton T-shirt requires one-third of a pound of pesticide and synthetic fertilizer to produce. (Sustainable Cotton Project, 1995).  As a cleaner crop, hemp has no such pesticide or synthetic fertilizer requirement.  Our 55 / 45% blend of hemp/cotton reduces this pollution by more than half, while maintaining a comfortable, cost efficient garment.  We intend for our products to play an ever-growing role in the activewear industry.  Management sees an analogy to other products that eliminate environmentally damaging goods such as CFC producing Styrofoam in coffee cups, food packaging, etc., and the toxic refrigerants in air conditioners and refrigerators.  As with these analogous products, we intend to promote the movement of market share from cotton products to a cleaner, better alternative.

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Currently, industrial hemp is being grown in almost every Province in Canada, primarily for food and cosmetic oil production.  Hemp grows easily in the Canadian climate, and when grown for textile, a secondary revenue stream is available.  When hemp is used for textile, only the long fibers of the plant are required, which leaves the short, "woody" fibers as a by-product.  This surplus substance is ideal for the production of fiberboard, paper and agricultural bedding.

Hemp is experiencing a renaissance.  In a world made smaller with the reach of technology, the adage "think globally, act locally" is becoming a common way of thought.  As the full costs of cotton production are being realized and companies are being held responsible and accountable (i.e. big tobacco) for all the environmental and health damage that they do, the market is changing.  Our goal is to help build this awakening market space, and be positioned to supply this market - offering high quality, eco-smart products to a global village.  As a business for the new millennium, we intend to build on a strong and sustainable foundation, leveraging the growing demands of an eco-aware consumer.

The Activewear Industry

As of January 1, 2004, management has not become aware of any meaningful competitors in the hemp activewear market.  To the best of management's knowledge, the only companies that are or have been involved in this market are "mom-and-pop" operations that were likely not intended to be grown into a large-scale business.  In the past, these small companies have tended to go bankrupt for a variety of reasons.  We appear to be the only serious company to fill this market space and have the longest operating history of any of the hemp-related companies that management is aware of.  Many of the remaining "mom-and-pop" operations are beginning to purchase their T-shirts from us.

There are a number of companies that are manufacturing and/or distributing a variety of hemp or hemp blended products.  Many of these companies have significant distribution and are enjoying considerable success.  Hemptown does not consider these companies as competition since they are more concerned with the retail fashion industry, whereas Hemptown is concerned with wholesaling “blanks” that are usually customized before final sale.

We intend to gain market share in the activewear sector by converting suppliers, distributors, retailers and the buying public from environmentally unfriendly cotton products to eco-friendly hemp-based products.

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Our primary focus is on sales of T-shirts, golf shirts and sweatshirts, in "blank" form, to the wholesale imprinted activewear market.  "Blank" activewear is typically imprinted or embroidered with a logo, design or character before it reaches the consumer.  Activewear is either branded or private label.  Branded products reach consumers carrying the manufacturer's label, whereas products sold on a private label basis reach consumers carrying the brand name of the customer.

Based on publicly available information, we believe that sales of imprinted T-shirts at the wholesale level in the U.S. were approximately US$6.1 billion for 1997 and are believed to be growing at an annual rate of 4-5%.  Management believes that growth in the imprinted activewear market has been driven primarily by:

Over the past several years casual wear has become increasingly acceptable in a wider array of settings.  In the workplace, for example, many employers have adopted more flexible dress codes, resulting in greater consumer demand for casual wear, including T-shirts, knit shirts and sweatshirts.  Based on publicly available information, management believes that 90% of U.S. companies now allow their employees to wear casual clothing to work, either regularly or on special occasions, as compared to 63% in 1992.

In addition, a growing emphasis on physical fitness has spurred a substantial increase in sports participation and, as a result, has created a heightened demand for activewear.  For example, based on published reports, from 1987 to 1996, the number of people in the U.S. participating more than once in the ten most popular sports increased by approximately 36.8 million.  Furthermore, significant improvements in activewear apparel, ranging from enhanced product characteristics – pre-shrunk fabrics, improved fabric weight, blends and construction – to increased product variety – including new sizes, colors and styles have enhanced consumer appeal.  We believe these trends will continue to generate demand for activewear products for the foreseeable future.

The activewear market is characterized by low fashion risk compared to many other apparel markets. While opportunity exists for product innovations and differentiation, trends or fads generally do not drive basic garment styles.  The activewear industry is also characterized by significant barriers to entry, including:

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The wholesale imprinted activewear segment of the North American apparel market includes a number of significant competitors, and the activewear segment overall is extremely competitive.  The primary competitors in this market are Gildan Activewear Inc., based in Canada, and the major U.S.-based manufacturers of basic branded activewear for the wholesale and retail channels. These U.S. manufacturers include Anvil Knitwear, Inc., the Bassett-Walker division of VF Corporation, the Delta Apparel division of Delta Woodside Industries, Inc., Fruit of the Loom, Inc., the Hanes Corporation division of Sara Lee Corporation, and the Jerzees division of Russell Corporation.  Some of these manufacturers have moved the majority of their sewing operations offshore to reduce operating costs by lowering labor costs.  There are other manufacturers of activewear outside the U.S., which may have substantially lower labor costs.  All of these competitors are multi-million dollar corporations, any one of which dwarfs Hemptown in terms of sales.

Competition

The wholesale imprinted activewear segment of the North American apparel market includes a number of large corporations, and the activewear segment overall is extremely competitive.  The primary competitors in the North American activewear market are the major Canadian and U.S.-based manufacturers of basic branded activewear for the wholesale and retail channels.  These manufacturers include Gildan Inc., Anvil Knitwear, Inc., the Bassett-Walker division of VF Corporation, the Delta Apparel division of Delta Woodside Industries, Inc., Fruit of the Loom, Inc., the Hanes Corporation division of Sara Lee Corporation, and the Jerzees division of Russell Corporation.  All of these manufacturers are considerably larger and better funded than Hemptown.  These companies compete primarily on the basis of quality and price.  There are also many manufacturers of activewear outside North America.

Because of our use of hemp and our message of environmental responsibility, we are able to compete in the activewear market without having to compete on price.  Although price is a factor, our differentiation of products provides a niche market in which we are able to sell our products without having to compete directly with the much larger corporations already established in the activewear market.

We are able to price our products reasonably competitively because of our success in maintaining low production and operating costs. We accomplish this by outsourcing to efficient, low cost sewing operations in China where we benefit from competitive labor costs. 

We attend the same trade shows as the primary activewear competitors, and sell to the same wholesale distributors; however, due to our niche market, we do not compete directly.  When a person is considering the purchase of a Hemptown garment, there is a value added aspect in the environmental message that allows us to charge more for a similar garment than any of the activewear competitors that are offering only cotton and synthetics in their garments.

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There are a number of other small producers of hemp and hemp-blended garments.  Management is not aware of any serious competitors in this niche area.  Most of these competitors are small two or three person operations.  Many of these have begun purchasing from us, as they are unable to match our price due to their volume limitations.  We are also aware of some manufacturers of hemp and hemp-blended garments that have focused on specialty clothing for activities such as yoga, hiking and rock climbing.  We do not consider these companies to be direct competitors in our market.

Trade Regulatory Environment

The textile and apparel industries in both the U.S. and Canada have historically received a relatively higher degree of international trade protection than some other industries.  However, this protection is diminishing as a result of the implementation of trade agreements reached in the last ten years.  Taken as a whole, we believe that the current regulatory trade regime is no more burdensome to us than to our competitors.

Recent trade sanctions against China imposed by the U.S. in the area of cloth and garments has had no effect on Hemptown’s product line.  Since the majority of the fiber used in Hemptown products is hemp, our products were not included in the schedule of affected products.  We expect tariffs to be removed in 2005.

The Hemptown Way

Unlike cotton, working with hemp is still as much an art as it is a science.  Because production lines are still small relative to cotton, and because of the diverse supply of raw material, hemp cloth is prone to considerably more inconsistencies than cotton based cloth.  The inconsistencies can be in the weave, the color, the percentage of shrinkage as well as the shrink patterns.

As a result of these inconsistencies, we have invested a considerable amount of time and effort into product research and development, as well as developing close relationships with suppliers.  In the fiscal year ended December 31, 2003, we spent US$1,026 on research and development.  In the fiscal year ended December 31, 2002, we spent US$5,889 on research and development.  It is likely that the difficulties outlined above with dealing with hemp material are the key reasons many of the major producers of cotton activewear have stayed away from this market.  We believe that years of "hands on" experience with hemp cloth will give us a competitive advantage as the industry matures.

We currently have the majority of our products manufactured in China and some are manufactured in Canada.  We source our hemp and cotton material in bulk from several manufacturers in Asia.  Although there are only several dozen suppliers of hemp material found in both Asia and Europe, consistency can become an issue when comparing one supplier's product to another.  Through the development of good relationships with our key suppliers, we have been able to ensure the consistency of the cloth is maintained and have also been able to negotiate favorable payment terms.

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In China, our representative manages, under our direction, oversee all aspects of production, from the quality of the fabric to the shipping of products to our warehouses in Canada and the U.S.  Our representative works closely with the farmers, the fabric suppliers and sewers to ensure our quality control standards are maintained. 

Our product line consists of the following core items, all marketed under the Hemptown brand:

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We intend to focus on our ubiquitous core line of products for the foreseeable future.  We will, however, consider expanding the above core imprintable product line when consumer demand warrants.  Such ancillary products may include jackets, shorts, pants, infant wear, towels, bed sheets and other products.

A Hemptown Friendly Tomorrow

Our main focus is the sale of activewear aimed directly at the imprinted apparel market.  Units are sold to value added distributors in this market as blanks, ready to be customized as required.  The nature of our product lends itself perfectly to the active lifestyle market.  Our market research indicates a strong market interest by the retail sector for our products.

Internet sales and marketing are integral parts of our vision (www.hemptown.com).  E-commerce on both retail and wholesale (password required) levels are important aspects of the site as well as direct access to inventory and manufacturing schedules for our authorized representatives.  We currently process retail orders through our website and will add B2B functions if, and when, our customers start demanding it.  A simple Vendor Managed Inventory (VMI) System may eventually be initiated to ensure our distributors never run out of Hemptown product.

In addition to being positioned in a market (the hemp blended garment market) that management expects to increase significantly over the next several years, we are aggressively marketing ourselves in order to ensure that "Hemptown" is the premier name in hemp activewear.  The marketing initiatives currently being planned by us include the following:

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Our primary marketing initiatives for our products are Imprinted Sportswear Tradeshows and Industry Trade Magazines that cover all of North America.  Details of the tradeshows are available at www.issshows.com.

We are currently focusing on the use of a small sales force to market our products.  Our sales staff is currently comprised of seven in-house commissioned sales representatives and three companies.  We have enjoyed considerable success through the attendance of trade shows where hundreds of leads can be obtained.  In addition, we also supply four major North American distributors with a combined customer base of approximately 100,000 customers.  We currently have no backlog of orders and we can fill all orders placed.

One of our long-term objectives is to vertically integrate our organization.  Hemp is currently being grown within every Province of Canada.  Unfortunately, there are currently no mills within Canada or the U.S. that create cloth from the hemp being farmed.  We intend to vertically integrate our business by expanding into the business of creating cloth from raw hemp.  This strategy will be realized as funds permit.

Since industrial hemp was re-legalized in Canada in 1998, it has generated much interest from farmers and the Canadian Government.

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Governmental Regulations

Currently, we are not subject to any unique government regulations, beyond that of any other garment manufacturer.  Hemp apparel may be manufactured, imported and exported to and from the U.S. and Canada with no special regulations.  We must of course adhere to the Textile Labeling Laws of North America which stipulate what information is to be included on the garment tags and where those tags are to be located on the garment.

Environmental Regulation

Our operations are subject to various environmental and occupational health and safety laws and regulations.  We believe that we are in compliance with the regulatory requirements of British Columbia.  We will continue to make expenditures to comply with these requirements, and we do not believe that compliance will have a material adverse effect on our business.  As is the case with manufacturers in general, if a release of hazardous substances occurs on or from our properties or any associated offsite disposal locations, or if contamination from prior activities is discovered at any of our properties, we may be held liable.  While the amount of such liability could be material, we endeavor to conduct our operations in a manner that reduces such risks.

Reports to Security Holders

This 10-KSB outlining Hemptown’s activities for fiscal year 2003 is our first annual report to security holders.  We are currently required to deliver an annual report to our stockholders prior to or with the distribution of proxy materials relating to annual stockholder meetings.

We are currently a reporting issuer in the U.S. and are subject to reporting requirements under section 13 or 15(d) of the U.S. Securities Exchange Act of 1934 , as amended.  We are required to file the following with the U.S. Securities and Exchange Commission (the “SEC”): (i) quarterly reports on Form 10-QSB; (ii) an annual report on Form 10-KSB; and (iii) a Form 8-K to report the occurrence of certain reportable events.

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Copies of this, and all future reporting materials filed with the SEC, may be obtained at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549.  Information as to the operation of the Public Reference Room may be obtained by calling 1-800-SEC-0330.  The SEC also maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically at www.sec.gov.  A direct link to Hemptown's filings kept at the SEC's web site can be found on our web site at www.hemptown.com.

Enforceability of Civil Liabilities Against Foreign Persons

Because we are a Canadian company our investors may not be able to enforce civil liabilities under the U.S. federal securities laws against us.  We are a company incorporated under the laws of the Province of British Columbia, Canada.  A majority of our directors and officers reside in Canada.  Because all or a substantial portion of our assets and the assets of these persons are located outside the U.S., it may be difficult for an investor to sue, for any reason, us or any of our directors or officers outside the U.S..  If an investor was able to obtain a judgment against us or any of our directors or officers in a U.S. court based on U.S. securities laws or other reasons, it may be difficult, if not impossible, to enforce such judgment in Canada.  We have been advised by our Canadian counsel that there is doubt as to the enforceability, in original actions in Canadian courts, of liability based upon the U.S. federal securities laws and as to the enforceability in Canadian courts of judgments of U.S. courts obtained in actions based upon the civil liability provisions of the U.S. federal securities laws.  Therefore, it may not be possible to enforce those actions against us or any of our directors or officers.