As of December 31, 2016, there were 17,312,586
shares of the registrant’s Common Shares outstanding.
Certain matters discussed in this report
may constitute forward-looking statements for purposes of the Securities Act of 1933, as amended (the “Securities Act”),
and the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and involve known and unknown risks, uncertainties
and other factors that may cause our actual results, performance or achievements to be materially different from the future results,
performance or achievements expressed or implied by such forward-looking statements. The words “expect,” “anticipate,”
“intend,” “plan,” “believe,” “seek,” “estimate,” and similar expressions
are intended to identify such forward-looking statements. Our actual results may differ materially from the results anticipated
in these forward-looking statements due to a variety of factors, including, without limitation, those discussed under “Item
3—Key Information—Risk Factors,” “Item 4—Information on the Company,” “Item 5—Operating
and Financial Review and Prospects,” and elsewhere in this report, as well as factors which may be identified from time
to time in our other filings with the Securities and Exchange Commission (the “SEC”) or in the documents where such
forward-looking statements appear. All written or oral forward-looking statements attributable to us are expressly qualified in
their entirety by these cautionary statements.
The forward-looking statements contained
in this report reflect our views and assumptions only as of the date this report is signed. Except as required by law, we assume
no responsibility for updating any forward-looking statements.
PART I
Unless the context requires
otherwise, references in this report to “Lianluo Smart”, “we”, “us”, “our
company”, and “our” refer to (i)Lianluo Smart Limited, a British Virgin Islands company, (ii) Beijing
Dehaier Medical Technology Company Limited, a PRC company (“BDL”), (iii) Lianluo Connection Medical Wearable
Device Technology (Beijing) Co., Ltd., a PRC company (“LCL”, used to be known as Connection Wearable Health
Technology(Beijing) Co., Ltd., “CWHT”), (iv) Beijing Dehaier Technology Co., Limited (“BTL”). On July
31, 2016, the Registrant’s wholly owned subsidiary Beijing Dehaier Medical Technology Co., Limited (“BDL”)
entered into a Loss Absorption Agreement Termination (“VIE Termination”) with the Registrant’s variable
interest entity (“VIE”), Beijing Dehaier Technology Co., Limited (“BTL”). According to the VIE
Termination, the Loss Absorption Agreement (the “VIE Agreement”) among BDL, BTL and its shareholders Ping Chen,
Bao Xian, Weibing Yang, Jian Sun, Zheng Liu and Yong Wang dated as of March 3, 2010 was terminated effective on July 31,
2016. There is no relationship between BTL and the Registrant and its other subsidiaries after the effectiveness of the
VIE Termination.
|
Item 1.
|
Identity of Directors, Senior Management and Advisers
|
Not applicable for annual reports on Form 20-F.
|
Item 2.
|
Offer Statistics and Expected Timetable
|
Not applicable for annual reports on Form 20-F.
|
A.
|
Selected Financial Data
|
The following table presents the selected
consolidated financial information for our company. The selected consolidated statements of income data for the three years ended
December 31, 2014, 2015 and 2016 and the consolidated balance sheet data as of December 31, 2015 and 2016 have been derived from
our audited consolidated financial statements set forth in “Item 18 – Financial Statements”. Our historical results
do not indicate results expected for any future periods. The selected consolidated financial data should be read in conjunction
with, and are qualified in their entirety by reference to, our audited consolidated financial statements and related notes and
“Item 5. Operating and Financial Review and Prospects” are shown below. Our audited consolidated financial statements
are prepared and presented in accordance with Generally Accepted Accounting Principles in the United States of America, or U.S.
GAAP.
|
|
For the years ended December 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
|
US$
|
|
|
US$
|
|
|
US$
|
|
|
|
|
|
|
|
|
|
(Restated)
|
|
Statement of Operations Data:
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
|
13,062,373
|
|
|
|
738,301
|
|
|
|
2,774,241
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Costs of revenue
|
|
|
(16,627,535
|
)
|
|
|
(927,286
|
)
|
|
|
(1,802,864
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit (Loss)
|
|
|
(3,565,162
|
)
|
|
|
(188,985
|
)
|
|
|
971,377
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service income
|
|
|
14,587
|
|
|
|
1,600,012
|
|
|
|
47,665
|
|
Service expenses
|
|
|
(21,130
|
)
|
|
|
(1,234,257
|
)
|
|
|
(29,022
|
)
|
General and administrative expenses
|
|
|
(4,643,962
|
)
|
|
|
(4,089,592
|
)
|
|
|
(1,929,206
|
)
|
Provision for doubtful accounts
|
|
|
150,280
|
|
|
|
(8,544
|
)
|
|
|
(347,891
|
)
|
Selling expenses
|
|
|
(1,018,581
|
)
|
|
|
(2,982,447
|
)
|
|
|
(138,981
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss
|
|
|
(9,083,968
|
)
|
|
|
(6,903,813
|
)
|
|
|
(1,426,058
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial expenses
|
|
|
(125,127
|
)
|
|
|
(194,773
|
)
|
|
|
(174,463
|
)
|
Other incomes
|
|
|
68,436
|
|
|
|
-
|
|
|
|
83,762
|
|
Other expense
|
|
|
-
|
|
|
|
(2,586
|
)
|
|
|
(21,850
|
)
|
Loss from warrant redemption
|
|
|
(1,091,719
|
)
|
|
|
-
|
|
|
|
-
|
|
Change in fair value of warrants liability
|
|
|
137,710
|
|
|
|
390,324
|
|
|
|
2,866,171
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before provision for income tax and non-controlling interest
|
|
|
(10,094,668
|
)
|
|
|
(6,710,848
|
)
|
|
|
1,327,562
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for income tax (expense) benefit
|
|
|
95,026
|
|
|
|
11,978
|
|
|
|
(357,726
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) from continuing operations
|
|
|
(9,999,642
|
)
|
|
|
(6,698,870
|
)
|
|
|
969,836
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) from discontinued operations
|
|
|
(251,153
|
)
|
|
|
(3,663,465
|
)
|
|
|
(26,003,708
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
(10,250,795
|
)
|
|
|
(10,362,335
|
)
|
|
|
(25,033,872
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less: net loss attributable to non-controlling interest
|
|
|
(129,020
|
)
|
|
|
(139,205
|
)
|
|
|
(735,758
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to Lianluo Smart Limited
|
|
|
(10,121,775
|
)
|
|
|
(10,223,130
|
)
|
|
|
(24,298,114
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) from continuing operations
|
|
|
(9,999,642
|
)
|
|
|
(6,698,870
|
)
|
|
|
969,836
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss from discontinued operations
|
|
|
(251,153
|
)
|
|
|
(3,663,465
|
)
|
|
|
(26,003,708
|
)
|
Other comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency translation loss
|
|
|
(567,162
|
)
|
|
|
(461,548
|
)
|
|
|
(576,891
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss
|
|
|
(10,817,957
|
)
|
|
|
(10,823,883
|
)
|
|
|
(25,610,763
|
)
|
-less comprehensive loss attributable to the non-controlling interest
|
|
|
(230,838
|
)
|
|
|
(189,670
|
)
|
|
|
(762,777
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss attributable to Lianluo Smart Limited
|
|
|
(10,587,119
|
)
|
|
|
(10,634,213
|
)
|
|
|
(24,847,986
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss per share
|
|
|
|
|
|
|
|
|
|
|
|
|
-Basic
|
|
|
(0.97
|
)
|
|
|
(1.74
|
)
|
|
|
(4.41
|
)
|
-Diluted
|
|
|
(0.97
|
)
|
|
|
(1.73
|
)
|
|
|
(4.34
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares used in computation
|
|
|
|
|
|
|
|
|
|
|
|
|
-Basic
|
|
|
10,422,765
|
|
|
|
5,862,647
|
|
|
|
5,510,076
|
|
-Diluted
|
|
|
10,428,951
|
|
|
|
5,896,534
|
|
|
|
5,597,169
|
|
|
|
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
|
|
|
|
|
|
|
(Restated)
|
|
|
|
US$
|
|
|
US$
|
|
|
US$
|
|
Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
|
10,792,823
|
|
|
|
615,517
|
|
|
|
1,639,746
|
|
Working capital
|
|
|
10,221,074
|
|
|
|
462,687
|
|
|
|
9,739,149
|
|
Total current assets
|
|
|
11,336,148
|
|
|
|
6,868,333
|
|
|
|
13,468,644
|
|
Total assets
|
|
|
16,552,137
|
|
|
|
13,875,247
|
|
|
|
21,321,309
|
|
Total current liabilities
|
|
|
1,115,074
|
|
|
|
6,405,646
|
|
|
|
3,729,495
|
|
Non-controlling interest
|
|
|
-
|
|
|
|
867,826
|
|
|
|
1,057,496
|
|
Total Lianluo Smart Limited shareholders' equity
|
|
|
15,437,063
|
|
|
|
6,439,039
|
|
|
|
15,981,258
|
|
Common shares
|
|
|
47,281
|
|
|
|
16,918
|
|
|
|
15,864
|
|
Total equity
|
|
|
15,437,063
|
|
|
|
7,306,865
|
|
|
|
17,038,754
|
|
Exchange Rate Information
Our business is primarily conducted in
China and all of our revenues are denominated in RMB. However, periodic reports made to shareholders will include current period
amounts translated into U.S. dollars using the then current exchange rates, for the convenience of the readers. The conversion
of RMB into U.S. dollars in this annual financial report is based on the noon buying rate in The City of New York for cable transfers
of RMB as certified for customs purposes by the Federal Reserve Bank of New York. Unless otherwise noted, all translations from
RMB to U.S. dollars and from U.S. dollars to RMB in this annual financial report were made at a rate of RMB 6.9448 to US $1.00,
the middle exchange rate in effect as of December 31, 2016. We make no representation that any RMB or U.S. dollar amounts could
have been, or could be, converted into U.S. dollars or RMB, as the case may be, at any particular rate, or at all. The government
of the People’s Republic of China (the “PRC”) imposes control over its foreign currency reserves in part through
direct regulation of the conversion of RMB into foreign exchange and through restrictions on foreign trade. The Company does not
currently engage in currency hedging transactions. The following table sets forth information concerning exchange rates between
the RMB and the U.S. dollar for the periods indicated.
|
|
Noon Buying Rate
|
|
Period
|
|
Period-End
|
|
|
Average (1)
|
|
|
Low
|
|
|
High
|
|
|
|
|
(RMB per U.S. dollar)
|
|
|
2011
|
|
|
6.2939
|
|
|
|
6.4475
|
|
|
|
6.2939
|
|
|
|
6.6364
|
|
2012
|
|
|
6.2301
|
|
|
|
6.2990
|
|
|
|
6.2221
|
|
|
|
6.3879
|
|
2013
|
|
|
6.0537
|
|
|
|
6.0738
|
|
|
|
6.0537
|
|
|
|
6.0927
|
|
2014
|
|
|
6.2046
|
|
|
|
6.1886
|
|
|
|
6.2256
|
|
|
|
6.1490
|
|
2015
|
|
|
6.4907
|
|
|
|
6.2154
|
|
|
|
6.0775
|
|
|
|
6.4724
|
|
2016
|
|
|
6.9448
|
|
|
|
6.6441
|
|
|
|
6.4494
|
|
|
|
7.0672
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January
|
|
|
6.8808
|
|
|
|
6.8974
|
|
|
|
6.8432
|
|
|
|
6.9525
|
|
February
|
|
|
6.8689
|
|
|
|
6.8723
|
|
|
|
6.8541
|
|
|
|
6.8842
|
|
March
|
|
|
6.8905
|
|
|
|
6.8941
|
|
|
|
6.8676
|
|
|
|
6.9149
|
|
April (through April 26, 2017)
|
|
|
6.8936
|
|
|
|
6.8845
|
|
|
|
6.7823
|
|
|
|
6.9057
|
|
Source: Federal Reserve Statistical Release
____________________
(1)
|
Annual averages are calculated using the average of month-end rates of the relevant years. Monthly averages are calculated using the average of the daily rates during the relevant periods.
|
|
B.
|
Capitalization and Indebtedness
|
Not applicable for annual reports on Form 20-F.
|
C.
|
Reasons for the Offer and Use of Proceeds
|
Not applicable for annual reports on Form 20-F.
Risks Related to Our Business
Our business is seasonal and revenues
and operating results could fall below investor expectations during certain periods, which could cause the trading price of our
common shares to decline.
Our revenues and operating results have
fluctuated in the past and may continue to fluctuate significantly depending upon numerous factors. In particular, we generally
experience an increase in revenues in the period from September through November. This increase is associated with hospital purchasing
designed to extinguish governmental budgets prior to the fiscal year end. We believe that our first quarter performance will generally
decline as a result of the lack of business conducted during the Chinese Lunar New Year Holiday. To the extent our financial performance
fluctuates significantly, investors may lose confidence in our business and the price of our common shares could decrease.
We may fail to effectively develop
and commercialize new products and services, which could materially and adversely affect our business, financial condition, results
of operations and prospects.
The sleep respiratory market is developing
rapidly and related technology trends are constantly evolving. This results in the frequent introduction of new products and services,
short product life cycles and significant price competition. Consequently, our future success depends on our ability to anticipate
technology development trends and identify, develop and commercialize in a timely and cost-effective manner the new and advanced
products that our customers demand. New products contribute significantly to our revenues. Moreover, it may take an extended period
of time for our new products to gain market acceptance, if at all. Furthermore, as the life cycle for a product matures, the average
selling price generally decreases. In the future, we may be unable to offset the effect of declining average sales prices through
increased sales volume and controlling product costs. Lastly, during a product’s life cycle, problems may arise regarding
regulatory, intellectual property, product liability or other issues that may affect the product’s continued commercial viability.
We sell our products primarily to
distributors, and our ability to add distributors will impact our revenue growth. Failure to maintain or expand our distribution
network would materially and adversely affect our business.
We depend on sales to distributors for
a significant majority of our revenues. Our distributors purchase all products ordered regardless of whether the products are ultimately
sold. Products are not purchased by distributors on consignment, and distributors have no right to return unsold products. As our
existing distributor agreements expire, we may be unable to renew such agreements on favorable terms or at all, and we do not own,
employ or control these independent distributors. Furthermore, we actively manage our distribution network and regularly review
the performance of each distributor. We may terminate agreements with distributors, without penalty, if we are not satisfied with
their performance for any reason. We periodically terminate relationships with underperforming exclusive distributors. Our distributors
may also terminate their relationship with us without penalty. When an exclusive distributor in a particular geographic area fails
to meet our expectations, then we are economically incentivized to replace that distributor with a new distributor so that area
can be served as well as possible. We occasionally terminate a relationship with a non-exclusive distributor and are more likely
to simply appoint another one; however, we have found that in some instances we are better served to replace an underperforming
non-exclusive distributor with an exclusive distributor. Additionally, we have found that even in cases where there may not be
an economic incentive to terminate a non-exclusive distributor, having the ability to replace a distributor often motivates distributors
to increase their efforts to meet our expectations. This policy may make us less attractive to some distributors. In addition,
we compete for distributors with other leading medical device companies who may enter into long-term distribution agreements, effectively
preventing many distributors from selling our products. As a result, a significant amount of time and resources must be devoted
to maintaining and growing our distribution network. Any disruption in our distribution network could have negative effects on
our ability to sell our products, which would in turn materially and adversely affect our business, financial condition and results
of operations.
We sell products for some of our
competitors, some of which compete with our branded products.
We serve as a distributor for other companies’
medical products and also sell medical products that we developed. While we rely on other suppliers’ products for some of
our revenues, our self-developed products may, from time to time, compete with these suppliers’ products. Some of our suppliers
may seek to restrict our ability sell competing products—either self-developed or developed by other third party suppliers—as
a condition of serving as a distributor for their products. Where we are permitted to sell competing products, we may find that
sales of a supplier’s products reduce demand for our self-developed products. Where our agreements with suppliers limit our
ability to sell competing branded products, we may have to forego developing potentially profitable products. Any of these results
could materially harm our business.
We rely on some of our competitors
to supply component parts for our branded products.
We obtain some components from companies
that are competitors in our market. We are not reliant on these competitors for such components and believe we could obtain these
components from other suppliers. We do, however, provide detailed technical specifications to these competitors for use in producing
components for our branded products. If these companies were to reverse-engineer or otherwise misappropriate such information,
our business could be materially harmed.
Although we do not own or control
our distributors, the actions of these distributors may affect our business operations or our reputation in the marketplace.
Our distributors are independent from us,
and as such, our ability to effectively manage their activities is limited. Distributors could take any number of actions that
could have material adverse effects on our business. If we fail to adequately manage our distribution network or if distributors
do not comply with our distribution agreements, our corporate image could be tarnished among end users, disrupting our sales. Furthermore,
we could be liable for actions taken by our distributors, including any violations of applicable law in connection with the marketing
or sale of our products, including China’s anti-corruption laws. Recently, the PRC government has increased its anti-bribery
efforts in the healthcare sector to reduce improper payments received by hospital administrators and doctors in connection with
the purchase of pharmaceutical products and medical devices. Our distributors may violate these laws or otherwise engage in illegal
practices with respect to their sales or marketing of our products. If our distributors violate these laws, we could be required
to pay damages or fines, which could materially and adversely affect our financial condition and results of operations. In addition,
our brand and reputation, our sales activities or the price of our shares could be adversely affected if our company becomes the
target of any negative publicity as a result of actions taken by our distributors.
We plan to expand our healthcare
and technical service products internationally and hope to become a leader in selected international markets. Such expansion can
be difficult and time consuming, and if unsuccessful our future profits would be materially and adversely affected.
While we currently operate primarily in
China, we envision competing in selected international markets with our healthcare and technical service products, such as medical
air compressor. We intend to enter into markets in which we have limited or no experience and in which our brand may be less recognized.
We plan to devote significant resources to marketing and promoting our brand internationally and attracting distributors in foreign
markets. Success in international markets will depend on our ability to attract a sufficient number of distributors suitable for
selling our branded products. Furthermore, in new markets we may fail to anticipate competitive conditions that are different from
those in our existing markets. These competitive conditions may make it difficult or impossible for us to operate effectively in
these markets.
Operation in international markets will
also expose us to many other risks, including but not limited to:
|
·
|
economic instability and recessions;
|
|
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difficulties of administering foreign operations generally;
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limited protection for intellectual property rights;
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obligations to comply with a wide variety of foreign
laws and other regulatory requirements;
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financial condition, expertise and performance of
international distributors;
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export license requirements;
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unauthorized re-export of our branded products;
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inability to purchase our distributed products from
international suppliers at competitive prices;
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potentially adverse tax consequences; and
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inability to effectively enforce contractual or legal
rights.
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We are highly dependent on our key
personnel such as key executives and research and development personnel.
We are highly dependent on the continued
service of our key executives and other key personnel. In particular, we substantially rely on our chairman and chief executive
officer Mr. Ping Chen to manage our business and operations. We also rely on key research and development personnel for the
development of new products. In addition, we rely on customer service personnel for the installation and support of our products
and on marketing and sales personnel, engineers and other personnel with technical and industry knowledge to market, sell, install
and service our products. We have entered into standard two-year employment contracts with all of our officers and managers and
other key personnel and two-year employment contracts with our other employees. These contracts prohibit our employees from engaging
in any conduct or activity that would be competitive with our business during the course of their employment. Loss of any of our
key personnel could severely disrupt our business. We may not be able to find suitable or qualified replacements, and will likely
incur additional expenses in order to recruit and train any new personnel.
Competition for qualified management and
key personnel in the medical technology field is intense and the pool of qualified candidates is limited. We not only compete with
other medical device companies but also universities and other research institutions to attract and retain qualified personnel.
This intense competition may force us to offer higher compensation and benefit packages in order to attract and retain the most
qualified personnel. Our future success depends on our ability to attract and retain these individuals and failure to do so could
result in severe disruptions to our business and growth.
Our business is subject to intense
competition, which may reduce demand for our products and materially and adversely affect our business, financial condition, results
of operations and prospects.
The medical device and health wearables
markets are highly competitive, and we expect competition to intensify. Given the $585 billion stimulus initiative in China and
its impact on healthcare, we expect the availability of healthcare to increase, as more hospitals and clinics are developed rurally.
We face direct competition from both
domestic and international competitors across all product lines and price points. Our competitors also vary by product.
Currently, in China our competitors include publicly traded and privately held multinational companies, such as Phillips
Respironics Inc., ResMed Inc. Covidien, Weinmann Medical Technology, Natus Medical Inc. (Embla Sleep Diagnostics), Curative
Medical and SOMNO Medics as well as domestic Chinese companies such as Beijing Yi’an, Beijing Shenlu, Guangdong Pigeon,
Tianjin Oranger, Beijing Zhonghe Beide Trading Co., Ltd., iCare Tech Healthcare Co., Ltd., Contec Medical Systems Co., Ltd.,
BMC Medical Co., Ltd, Baidu Online Network Technology (Beijing) Co., Ltd, Xiaomi Technology Co., Ltd, Shanda Group,
InWatch Technology Co., Ltd, Huawei Technologies Co., Ltd, Lenovo Group, Andon Health Co., Ltd. and Guangdong Biolight
Meditech Co., Ltd. As we expand into international markets, we expect that our competitors will primarily be publicly traded
and privately held multinational companies. We also expect to face competition in international sales from companies that
have local operations in the markets in which we sell our products. Some of our larger competitors may have:
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greater financial and other resources;
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larger variety of products;
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more products that have received regulatory approvals;
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greater pricing flexibility;
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more extensive research and development and technical
capabilities;
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patent portfolios that may present an obstacle to
our conduct of business;
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greater knowledge of local market conditions where
we seek to increase our international sales;
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stronger brand recognition; and
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larger sales and distribution networks.
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As a result, we may be unable to offer
products similar to, or more desirable than, those offered by our competitors, market our products as effectively as our competitors
or otherwise respond successfully to competitive pressures. In addition, our competitors may be able to offer discounts on competing
products as part of a “bundle” of non-competing products, systems and services that they sell to our customers, and
we may not be able to profitably match those discounts. Our competitors may develop technologies and products that are more effective
than those we currently offer or that render our products obsolete or uncompetitive. The timing of the introduction of competing
products into the market could affect the market acceptance and market share of our products. As we expect demand for our products
to increase along with the availability of healthcare, we must continue to focus on competitive pricing and innovation by being
at the forefront of market trends and improving our product and service offerings. Our failure to compete successfully could materially
and adversely affect our business, financial condition, results of operations and prospects.
Some of our internationally-based competitors
may establish production or research and development facilities in China, while others may enter into cooperative business arrangements
with Chinese manufacturers. If we are unable to develop competitive branded products, obtain regulatory approval or clearance and
supply sufficient quantities to the market as quickly and effectively as our competitors, market acceptance of our branded products
may be limited, which could result in decreased sales. In addition, we may not be able to maintain our branded product cost advantages.
We believe that corrupt practices in the
medical device industry in China still occur. To increase sales, certain manufacturers or distributors of medical devices may pay
kickbacks or provide other benefits to hospital personnel who make procurement decisions. Our company policy prohibits these practices
by our direct sales personnel and our distribution agreements require our distributors to comply with applicable law. As a result,
as competition intensifies in the medical device industry in China, we may lose sales, customers or contracts to competitors.
If we fail to accurately project
demand for our products, we may encounter problems of inadequate supply or oversupply, which would materially and adversely affect
our financial condition and results of operations, as well as damage our reputation and brand.
Our distributors typically order our products
on a purchase order basis. We project demand for our products based on rolling projections from our distributors, our understanding
of anticipated hospital procurement spending, and distributor inventory levels. Lack of significant order backlog and the varying
sales and purchasing cycles of our distributors and other customers, however, make it difficult for us to forecast future demand
accurately.
If we overestimate demand, we may purchase
more distributed products or more unassembled parts or components for our branded products than we require. If we underestimate
demand, our third party suppliers may have inadequate supply of distributed products or unassembled parts or product component
inventories, which could interrupt the assembly process and delay shipments of our branded products, and could result in lost sales.
In particular, we are seeking to reduce our procurement and inventory costs by matching our inventory closely with our projected
product needs and by, from time to time, deferring our purchase of components in anticipation of supplier price reductions. As
we seek to balance reduced inventory costs and assembly flexibility, we may fail to accurately forecast demand and coordinate our
procurement and assembly to meet demand on a timely basis. Our inability to accurately predict our demand and to timely meet our
demand could materially and adversely affect our financial conditions and results of operations as well as damage our reputation
and corporate brand.
Failure to manage our growth could
strain our management, operational and other resources, which could materially and adversely affect our business and prospects.
Our growth strategy includes building our
brand, increasing market penetration of our existing products, developing new products, increasing our targeting of the sleep respiratory
market in China, and increasing our exports. Pursuing these strategies has resulted in, and will continue to result in substantial
demands on management resources. In particular, the management of our growth will require, among other things:
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continued enhancement of our research and development
capabilities;
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information technology system enhancement;
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stringent cost controls and sufficient liquidity;
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strengthening of financial and management controls
and information technology systems; and
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increased marketing, sales and support activities;
and hiring and training of new personnel.
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If we are not able to manage our growth
successfully, our business and prospects would be materially and adversely affected.
If we fail to obtain or maintain
applicable regulatory clearances or approvals for our products, or if such clearances or approvals are delayed, we will be unable
to commercially distribute and market our products at all or in a timely manner, which could significantly disrupt our business
and materially and adversely affect our sales and profitability.
The sale and marketing of our products
are subject to regulation in China. For a significant portion of our sales, we need to obtain and renew licenses and registrations
with the CFDA. The processes for obtaining regulatory clearances or approvals can be lengthy and expensive, and the results are
unpredictable. In addition, the relevant regulatory authorities may introduce additional requirements or procedures that have the
effect of delaying or prolonging the regulatory clearance or approval for our existing or new products. If we are unable to obtain
clearances or approvals needed to market existing or new branded products, or obtain such clearances or approvals in a timely fashion,
our business would be significantly disrupted, and our sales and profitability could be materially and adversely affected. Similarly,
if the third parties from whom we buy our distributed products fail to obtain such clearance, we would be unable to sell such distributed
products, and our sales and profitability could be materially and adversely affected.
We generate a significant portion
of our revenues from a small number of products, and a reduction in demand for any of these products could materially and adversely
affect our financial condition and results of operations.
We derive a substantial percentage of our
revenues from a small number of products. We expect a small number of our key products will continue to account for a significant
portion of our net revenues for the foreseeable future. As a result, continued market acceptance and popularity of these products
is critical to our success, and a reduction in demand due to, among other factors, the introduction of competing products by our
competitors, the entry of new competitors, or end-users’ dissatisfaction with the quality of these products could materially
and adversely affect our financial condition and results of operations.
If we fail to protect our intellectual
property rights, it could harm our business and competitive position.
We rely on a combination of patent, copyright,
trademark and trade secret laws and non-disclosure agreements and other methods to protect our intellectual property rights. The
process of seeking patent protection can be lengthy and expensive, our patent applications may fail to result in patents being
issued, and our existing and future patents may be insufficient to provide us with meaningful protection or commercial advantage.
Our patents and patent applications may also be challenged, invalidated or circumvented.
We also rely on trade secret rights to
protect our business through non-disclosure provisions in employment agreements with employees. If our employees breach their non-disclosure
obligations, we may not have adequate remedies in China, and our trade secrets may become known to our competitors.
Implementation of PRC intellectual property-related
laws has historically been lacking, primarily because of ambiguities in the PRC laws and enforcement difficulties. Accordingly,
intellectual property rights and confidentiality protections in China may not be as effective as in the United States or other
western countries. Furthermore, policing unauthorized use of proprietary technology is difficult and expensive, and we may need
to resort to litigation to enforce or defend patents issued to us or to determine the enforceability, scope and validity of our
proprietary rights or those of others. Such litigation and an adverse determination in any such litigation, if any, could result
in substantial costs and diversion of resources and management attention, which could harm our business and competitive position.
We may be exposed to intellectual
property infringement and other claims by third parties which, if successful, could disrupt our business and have a material adverse
effect on our financial condition and results of operations.
Our success depends, in large part, on
our ability to use and develop our technology and know-how without infringing third party intellectual property rights. If we sell
our branded products internationally, and as litigation becomes more common in China, we face a higher risk of being the subject
of claims for intellectual property infringement, invalidity or indemnification relating to other parties’ proprietary rights.
Our current or potential competitors, many of which have substantial resources and have made substantial investments in competing
technologies, may have or may obtain patents that will prevent, limit or interfere with our ability to make, use or sell our branded
products in either China or other countries, including the United States and other countries in Asia. The validity and scope of
claims relating to medical device technology patents involve complex scientific, legal and factual questions and analysis and,
as a result, may be highly uncertain. In addition, the defense of intellectual property suits, including patent infringement suits,
and related legal and administrative proceedings can be both costly and time consuming and may significantly divert the efforts
and resources of our technical and management personnel. Furthermore, an adverse determination in any such litigation or proceedings
to which we may become a party could cause us to:
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seek licenses from third parties;
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redesign our branded products; or
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be restricted by injunctions.
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Each of the foregoing could effectively
prevent us from pursuing some or all of our business and result in our customers or potential customers deferring or limiting their
purchase or use of our branded products, which could have a material adverse effect on our financial condition and results of operations.
We are subject to product liability
exposure and have limited insurance coverage. Any product liability claims or potential safety-related regulatory actions could
damage our reputation and materially and adversely affect our business, financial condition and results of operations.
The medical devices we assemble and sell
can expose us to potential product liability claims if the use of these products causes or is alleged to have caused personal injuries
or other adverse effects. Any product liability claim or regulatory action could be costly and time-consuming to defend. If successful,
product liability claims may require us to pay substantial damages. We do not maintain product liability insurance to cover potential
product liability arising from the use of our branded products because product liability insurance available in China offers only
limited coverage compared to coverage offered in many other countries. As we expand our sales internationally and increase our
exposure to these risks in many countries, we may be unable to obtain sufficient product liability insurance coverage on commercially
reasonable terms, or at all. A product liability claim or potential safety-related regulatory action, with or without merit, could
result in significant negative publicity and could materially and adversely affect the marketability of our branded products and
our reputation, as well as our business, financial condition and results of operations.
Moreover, a material design, manufacturing
or quality failure or defect in our branded products, other safety issues or heightened regulatory scrutiny could each warrant
a product recall by us and result in increased product liability claims. Also, if these products are deemed by the authorities
in the countries where we sell our branded products to fail to conform to product quality and safety requirements, we could be
subject to regulatory action. In China, violation of PRC product quality and safety requirements may subject us to confiscation
of related earnings, penalties, an order to cease sales of the violating product, or to cease operations pending rectification.
Furthermore, if the violation is determined to be serious, our business license to assemble or sell violating and other products
could be suspended or revoked.
We may undertake acquisitions, which
may have a material adverse effect on our ability to manage our business, and may end up being unsuccessful.
Our growth strategy may involve the acquisition
of new technologies, businesses, products or services or the creation of strategic alliances in areas in which we do not currently
operate. We do not have any understanding, commitment or agreement in place with regard to any such acquisitions at this time.
These acquisitions could require that our management develop expertise in new areas, manage new business relationships and attract
new types of customers. Furthermore, acquisitions may require significant attention from our management, and the diversion of our
management’s attention and resources could have a material adverse effect on our ability to manage our business. We may also
experience difficulties integrating acquisitions into our business and operations. Future acquisitions may also expose us to potential
risks, including risks associated with:
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the integration of new operations, services and personnel;
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unforeseen or hidden liabilities;
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the diversion of resources from our existing businesses
and technologies; our inability to generate sufficient revenue to offset the costs of acquisitions; and
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potential loss of, or harm to, relationships with
employees or customers, any of which could significantly disrupt our ability to manage our business and materially and adversely
affect our business, financial condition and results of operations.
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In the event we are unable to complete
acquisitions, we have reserved the right to reallocate such funds to our working capital. If this happens, we would have broad
discretion over the ultimate us of such funds, and we could use such funds in ways with which investors might disagree.
We may need additional capital in
the future, and we may be unable to obtain such capital in a timely manner or on acceptable terms, or at all.
In order for us to grow, remain competitive,
develop new products, and expand our distribution network, we may require additional capital in the future. Our ability to obtain
additional capital in the future is subject to a variety of uncertainties, including:
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our future financial condition, results of operations
and cash flows;
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general market conditions for capital raising activities
by medical device manufacturers and other related companies; and
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economic, political and other conditions in China
and elsewhere.
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We may be unable to obtain additional capital
in a timely manner or on acceptable terms or at all. Furthermore, the terms and amount of any additional capital raised through
issuances of equity securities may result in significant shareholder dilution.
If we experience a significant number
of warranty claims, our costs could substantially increase and our reputation and brand could suffer.
We typically sell our branded products
with warranty terms covering 12 months after purchase. Our branded product warranty requires us to repair all mechanical malfunctions
and, if necessary, replace defective components. We accrue liability for potential warranty claims at the time of sale. If we experience
an increase in warranty claims or if our repair and replacement costs associated with warranty claims increase significantly, we
may have to accrue a greater liability for potential warranty claims. Moreover, an increase in the frequency of warranty claims
could substantially increase our costs and harm our reputation and brand. Our business, financial condition, results of operations
and prospects may suffer materially if we experience a significant increase in warranty claims on our branded products.
If our security measures are breached or fail, and unauthorized
access is obtained to a client’s data, our services may be perceived as not being secure, clients may curtail or stop using
our services, and we may incur significant liabilities
Our products and services involve the web-based
storage and transmission of clients’ proprietary information and protected health information of patients. Because of the
sensitivity of this information, security features of our software are very important. From time to time we may detect vulnerabilities
in our systems, which, even if they do not result in a security breach, may reduce customer confidence and require substantial
resources to address. If our security measures are breached or fail as a result of third-party action, employee error, malfeasance,
insufficiency, defective design, or otherwise, someone may be able to obtain unauthorized access to client or patient data. As
a result, our reputation could be damaged, our business may suffer, and we could face damages for contract breach, penalties for
violation of applicable laws or regulations, and significant costs for remediation and efforts to prevent future occurrences. We
rely upon our clients as users of our system for key activities to promote security of the system and the data within it, such
as administration of client-side access credentialing and control of client-side display of data. On occasion, our clients have
failed to perform these activities. Failure of clients to perform these activities may result in claims against us that this reliance
was misplaced, which could expose us to significant expense and harm to our reputation. Because techniques used to obtain unauthorized
access or to sabotage systems change frequently and generally are not recognized until launched against a target, we may be unable
to anticipate these techniques or to implement adequate preventive measures. If an actual or perceived breach of our security occurs,
the market perception of the effectiveness of our security measures could be harmed and we could lose sales and clients. In addition,
our clients may authorize or enable third parties to access their client data or the data of their patients on our systems. Because
we do not control such access, we cannot ensure the complete propriety of that access or integrity or security of such data in
our systems.
If our services fail to provide accurate
and timely information, or if our content or any other element of any of our services is associated with faulty clinical decisions
or treatment, we could have liability to clients, clinicians, or patients, which could adversely affect our results of operations.
Our products, software, content, and services
are used to assist clinical decision-making and provide information about treatment plans. If our products, software, content,
or services fail to provide accurate and timely information or are associated with faulty clinical decisions or treatment, then
clients, clinicians, or their patients could assert claims against us that could result in substantial costs to us, harm our reputation
in the industry, and cause demand for our services to decline.
The assertion of such claims and ensuing
litigation, regardless of its outcome, could result in substantial cost to us, divert management’s attention from operations,
damage our reputation, and decrease market acceptance of our products and services. We attempt to limit by contract our liability
for damages and to require that our clients assume responsibility for medical care and approve key system rules, protocols, and
data. Despite these precautions, the allocations of responsibility and limitations of liability set forth in our contracts may
not be enforceable, be binding upon patients, or otherwise protect us from liability for damages.
Our proprietary software may contain errors
or failures that are not detected until after the software is introduced or updates and new versions are released. It is challenging
for us to test our software for all potential problems because it is difficult to simulate the wide variety of computing environments
or treatment methodologies that our clients may deploy or rely upon. From time to time we have discovered defects or errors in
our software, and such defects or errors can be expected to appear in the future. Defects and errors that are not timely detected
and remedied could expose us to risk of liability to clients, clinicians, and patients and cause delays in introduction of new
services, result in increased costs and diversion of development resources, require design modifications, or decrease market acceptance
or client satisfaction with our services.
If any of these risks occur, they could
materially adversely affect our business, financial condition, or results of operations.
We rely on Internet infrastructure,
bandwidth providers, other third parties, and our own systems for providing services to our users, and any failure or interruption
in the services provided by these third parties or our own systems could expose us to litigation and negatively impact our relationships
with users, adversely affecting our brand and our business.
Our ability to deliver our Internet- and
telecommunications-based services is dependent on the development and maintenance of the infrastructure of the Internet and other
telecommunications services by third parties. This includes maintenance of a reliable network backbone with the necessary speed,
data capacity, and security for providing reliable Internet access and services. Our services are designed to operate without interruption
in accordance with our service level commitments. However, we have experienced and expect that we will experience interruptions
and delays in services and availability from time to time. We rely on internal systems as well as third-party vendors, including
data center, bandwidth, and telecommunications equipment providers, to provide our services. We do not maintain redundant systems
or facilities for some of these services. In the event of a catastrophic event with respect to one or more of these systems or
facilities, we may experience an extended period of system unavailability, which could negatively impact our relationship with
users. Any disruption in the network access, telecommunications, or co-location services provided by these third-party providers
or any failure of or by these third-party providers or our own systems to handle current or higher volume of use could significantly
harm our business. We exercise limited control over these third-party vendors, which increases our vulnerability to problems with
services they provide.
Any
errors, failures, interruptions, or delays experienced in connection with these third-party technologies and information services
or our own systems could negatively impact our relationships with users and adversely affect our business and could expose us to
third-party liabilities. The reliability and performance of the Internet may be harmed by increased usage or by denial-of-service
attacks. The Internet has experienced a variety of outages and other delays as a result of damages to portions of its infrastructure,
and it could face outages and delays in the future. These outages and delays could reduce the level of Internet usage as well as
the availability of the Internet to us for delivery of our Internet-based services.
If we are unable to keep up
with the rapid technological changes of the internet industry, our business may suffer.
The internet industry is experiencing rapid
technological changes. Our future success will depend on our ability to anticipate, adapt and support new technologies and industry
standards. If we fail to anticipate and adapt to these and other technological changes, our market share, profitability and share
price could suffer.
Foreign Operational Risks
Adverse changes in economic and political
policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could adversely
affect our business.
Substantially all of our business operations
are conducted in China. Accordingly, our results of operations, financial condition and prospects are subject to economic, political
and legal developments in China. China’s economy differs from the economies of most developed countries in many respects,
including with respect to the amount of government involvement, level of development, growth rate, control of foreign exchange,
and allocation of resources.
While the PRC economy has grown more rapidly
in the past 30 years than the world economy as a whole, growth has been uneven across different regions and among various economic
sectors of China. The PRC government has implemented various measures to encourage economic development and guide the allocation
of resources. Some of these measures benefit the overall PRC economy, but may also have a negative effect on us. For example, our
financial condition and results of operations may be adversely affected by government control over capital investments or changes
in tax regulations that are applicable to us. Since early 2004, the PRC government has implemented certain measures to control
the pace of economic growth. Such measures may cause a decrease in the level of economic activity in China, which in turn could
adversely affect our results of operations and financial condition.
We may be subject to foreign exchange
controls in the PRC.
Our PRC subsidiary and affiliates are subject
to PRC rules and regulations on currency conversion. In the PRC, the State Administration for Foreign Exchange (“SAFE”)
regulates the conversion of the RMB into foreign currencies. Currently, foreign investment enterprises (“FIEs”) are
required to apply to SAFE for “Foreign Exchange Registration Certificate for FIEs.” BDL is a FIE. With such registration
certifications (which need to be renewed annually), FIEs are allowed to open foreign currency accounts including the “current
account” and the “capital account.” Currently, conversion within the scope of the “current account”
can be effected without requiring the approval of SAFE. However, conversion of currency in the “capital account” (e.g.
for capital items such as direct investments, loans, securities, etc.) are still subject to limitations and require approvals from,
or registration with, SAFE and other relevant PRC governmental authorities.
If the investing public’s perception
of smaller companies from China worsens, our share price may decrease and we may have difficulty accessing U.S. capital markets.
In recent months, a number of smaller companies
from China have had the trading of their securities in the United States halted, delisted or otherwise affected for a variety of
reasons. As a result, investors may be concerned about purchasing the securities of any smaller Chinese company. To the extent
the investing community is reluctant to purchase such securities or discounts the value of the securities of companies that operate
primarily or exclusively in China, our share price may also be adversely affected, regardless of whether there are specific concerns
about our company. This could not only harm our share price but could also make it more difficult for us to conduct any future
offering of our securities at a price that is acceptable to our company or at all.
We do not have business interruption,
litigation or natural disaster insurance.
The insurance industry in China is still
at an early stage of development. In particular PRC insurance companies offer limited business products. As a result, we do not
have any business liability or disruption insurance coverage for our operations in China. Any business interruption, litigation
or natural disaster may result in our business incurring substantial costs and the diversion of resources.
The Chinese enterprise income tax
law will affect tax exemptions on the dividends we receive and increase the enterprise income tax rate applicable to us.
We are a holding company incorporated under
the laws of the British Virgin Islands. We conduct substantially all of our business through our wholly owned Chinese subsidiaries
and we derive all of our income from these subsidiaries. Prior to January 1, 2008, dividends derived by foreign legal persons
from business operations in China were not subject to the Chinese enterprise income tax.
On March 16, 2007, the National People’s
Congress of the PRC passed the PRC Enterprise Income Tax Law (the “EIT Law”), which took effect on January 1,
2008. Such tax exemptions ceased with the effectiveness of the EIT Law.
Under the EIT Law, if we are deemed to
be a non-resident enterprise for Chinese tax purposes, a withholding tax at the rate of 10% would be applicable to any dividends
paid by our Chinese subsidiaries to us. However, if we are deemed to have a “de facto management organization” in China,
we would be classified as a resident enterprise for Chinese tax purposes and thus would be subject to an enterprise income tax
rate of 25% on all of our income. At present, the Chinese tax authority has not issued any guidance on the application of the EIT
Law and its implementing rules on non-Chinese enterprises or group enterprise controlled entities whose structures are like ours.
As a result, it is unclear what factors will be used by the Chinese tax authorities to determine whether we are a “de facto
management organization” in China. However, as substantially all members of our management team are located in China, we
may be deemed to be a resident enterprise and therefore subject to an enterprise income tax rate of 25% on our worldwide income,
with the possible exclusion of dividends received directly from another Chinese tax resident. As a result of such changes, our
historical operating results will not be indicative of our operating results for future periods and the value of our shares may
be adversely affected.
BDL may also be required to allocate
a portion of its after-tax profits, as determined by its board of directors, to the general reserve, the staff welfare and bonus
funds, and the enterprise expansion reserve, which may not be distributed to equity owners.
Pursuant to the Law of Chinese-Foreign
Equity Joint Ventures, Chinese-foreign equity joint ventures are required to allocate a portion of their after-tax profits in accordance
with their Articles of Association, to the general reserve, the staff welfare and bonus funds, and the enterprise expansion reserve.
According to the Articles of Association of BDL, the amount of each reserve is determined by BDL’s board of directors. The
general reserve is used to offset future extraordinary losses. The subsidiaries may, upon a resolution passed by the shareholders,
convert the general reserve into capital. The employee welfare and bonus reserve is used for the collective welfare of the employees
of the subsidiaries. The enterprise expansion reserve is used for the expansion of the subsidiaries’ operations and can be
converted to capital subject to approval by the relevant authorities. These reserves represent appropriations of retained earnings
determined according to PRC law.
As of the date of this prospectus, the
amounts of these reserves have not yet been determined, and we have not committed to establishing such amounts at this time. Under
current PRC laws, BDL is required to set aside reserve amounts, but has not yet done so. BDL has not done so because PRC authorities
grant companies flexibility in making a determination. Chinese law requires such a determination to be made in accordance with
the companies’ organizational documents and BDL’s organizational documents do not require the determination to be made
within a particular timeframe. Although we have not yet been required by PRC authorities to make such determinations or set aside
such reserves, PRC authorities may require BDL to rectify its noncompliance and we may be fined if we fail to do so after warning
within the time period set in the warning.
PRC law requires allocation to the
general reserve before distribution of the after-tax profits of foreign invested companies, which could prevent us from receiving
the dividends from BDL.
PRC law requires that the after-tax profits
of foreign invested companies be distributed after a portion of after-tax profits is allocated to the reserve; therefore if for
any reason, the dividends from BDL cannot be repatriated to us or not in time, then it may detrimentally affect our cash flow and
even cause us to become insolvent.
Governmental control of currency
conversion may affect the value of your investment.
The PRC government imposes controls on
the convertibility of the Renminbi into foreign currencies and, in certain cases, the remittance of currency out of China. We receive
the majority of our revenues in Renminbi. Under our current corporate structure, our income is derived from payments from BDL.
Shortages in the availability of foreign currency may restrict the ability of BDL to remit sufficient foreign currency to pay dividends
or other payments to us, or otherwise satisfy their foreign currency denominated obligations. Under existing PRC foreign exchange
regulations, payments of current account items, including profit distributions, interest payments and expenditures from trade-related
transactions, can be made in foreign currencies without prior approval from SAFE by complying with certain procedural requirements.
However, approval from appropriate government authorities is required where Renminbi is to be converted into foreign currency and
remitted out of China to pay capital expenses such as the repayment of bank loans denominated in foreign currencies. The PRC government
may be also at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign
exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able
to pay dividends in foreign currencies to our shareholders.
Currency fluctuations and restrictions
on currency exchange may adversely affect our business, including limiting our ability to convert RMB into foreign currencies and,
if RMB were to decline in value, reducing our revenues and profits in U.S. dollar terms.
Our reporting currency is the U.S. dollar
and our operations in China use RMB as functional currency. The majority of our revenues derived and expenses incurred are in RMB
with a relatively small amount in U.S. dollars. We are subject to the effects of exchange rate fluctuations with respect to these
currencies. For example, the value of the RMB depends to a large extent on Chinese government policies and China’s domestic
and international economic and political developments, as well as supply and demand in the local market. Starting July 2005,
the Chinese government changed its policy of pegging the value of the RMB to the U.S. dollar. Under the new policy, the RMB has
fluctuated within a narrow and managed band against a basket of certain foreign currencies. It is possible that the Chinese
government will adopt a more flexible currency policy, which could result in more significant fluctuations of the RMB against the
U.S. dollar.
The income statements are translated into
U.S. dollars at the average exchange rates in each applicable period. To the extent the U.S. dollar strengthens against RMB, the
translation of these foreign currency-denominated transactions results in reduced revenues, operating expenses and net income for
our non-U.S. operations. Similarly, to the extent the U.S. dollar weakens against RMB, the translation of RMB transactions results
in increased revenues, operating expenses and net income for our non-U.S. operations. We are also exposed to foreign exchange rate
fluctuations as we convert the financial statements into U.S. dollars in consolidation. If there is a change in foreign currency
exchange rates, the conversion of the non-U.S. dollars financial statements into U.S. dollars will lead to a translation gain or
loss which is recorded as a component of other comprehensive income. In addition, we have certain assets and liabilities that are
denominated in currencies other than the relevant entity’s functional currency. Changes in the functional currency value
of these assets and liabilities create fluctuations that will lead to a transaction gain or loss. We have not entered into agreements
or purchased instruments to hedge our exchange rate risks, although we may do so in the future. The availability and effectiveness
of any hedging transaction may be limited and we may not be able to successfully hedge our exchange rate risks.
Although Chinese governmental policies
were introduced in 1996 to allow the convertibility of RMB into foreign currency for current account items, conversion of RMB
into foreign exchange for most of the capital items, such as foreign direct investment, loans or securities, requires the approval
of the State Administration of Foreign Exchange, or SAFE. These approvals, however, do not guarantee the availability of foreign
currency. We cannot be sure that we will be able to obtain all required conversion approvals for our operations or that Chinese
regulatory authority will not impose greater restrictions on the convertibility of RMB in the future. Because a significant amount
of our future revenues may be in the form of RMB, our inability to obtain the requisite approvals or any future restrictions on
currency exchanges could limit our ability to utilize revenue generated in RMB to fund our business activities outside China,
or to repay non-RMB-denominated obligations, including our debt obligations, which would have a material adverse effect on our
financial condition and results of operations.
If PRC law were to phase out the
preferential tax benefits currently being extended to certified high technology companies or if we were to fail to be certified
to receive such a benefit, we would have to pay more taxes, which could have a material and adverse effect on our financial condition
and results of operations.
Under PRC laws and regulations, a company
may enjoy preferential tax benefits if it is certified as a high technology enterprise. As a certified high technology enterprise,
we are subject to an enterprise income tax rate of 15% tax rate so long as we continue to be so certified. If the PRC law were
to phase out preferential tax benefits currently granted to certified high technology enterprises or if we were to fail to be certified
to receive such a benefit, we would be subject to the standard statutory tax rate, which currently is 25%.
If relations between the United States
and China worsen, our share price may decrease and we may have difficulty accessing U.S. capital markets.
At various times during recent years, the
United States and China have had disagreements over political and economic issues. Controversies may arise in the future between
these two countries. Any political or trade controversies between the United States and China could adversely affect the market
price of our common shares and our ability to access U.S. capital markets.
The PRC legal system embodies uncertainties
that could limit the legal protections available to you and us.
The PRC legal system is a civil law system
based on written statutes. Unlike common law systems, it is a system in which decided legal cases have limited precedential value.
In 1979, the PRC government began to promulgate a comprehensive system of laws and regulations governing economic matters in general.
The overall effect of legislation over the past three decades has significantly increased the protections afforded to various forms
of foreign investment in China. Our PRC operating subsidiary, BDL, is a foreign-invested enterprise and is subject to laws and
regulations applicable to foreign investment in China as well as laws and regulations applicable to foreign-invested enterprises.
These laws and regulations change frequently, and their interpretation and enforcement involve uncertainties. For example, we may
have to resort to administrative and court proceedings to enforce the legal protections that we enjoy either by law or contract.
However, since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory
and contractual terms, it may be more difficult to evaluate the outcome of administrative and court proceedings and the level of
legal protection we enjoy than in more developed legal systems. These uncertainties may also impede our ability to enforce the
contracts we have entered into. As a result, these uncertainties could materially and adversely affect our business and operations.
Recent PRC regulations relating to
offshore investment activities by PRC residents may increase the administrative burden we face and create regulatory uncertainties
that could restrict our overseas and cross-border investment activity, and a failure by our shareholders who are PRC residents
to make any required applications and filings pursuant to such regulations may prevent us from being able to distribute profits
and could expose us and our PRC resident shareholders to liability under PRC law.
In October 2005, SAFE promulgated regulations
that require PRC residents and PRC corporate entities to register with and obtain approvals from relevant PRC government authorities
in connection with their direct or indirect offshore investment activities. These regulations apply to our shareholders who are
PRC residents in connection with our prior and any future offshore acquisitions.
The October 2005 SAFE regulation (which
was renewed and replaced by the July 2014 SAFE regulation “Notice on Issues concerning Foreign Exchange Administration of
the Overseas Investment and Financing and the Round-tripping Investment Made by Domestic Residents through Special-Purpose Companies”)
required registration by March 31, 2006 of direct or indirect investments previously made by PRC residents in offshore companies
prior to the implementation of the Notice on Issues Relating to the Administration of Foreign Exchange in Fund-Raising and Reverse
Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies on November 1, 2005. If a PRC
shareholder with a direct or indirect stake in an offshore parent company fails to make the required SAFE registration, the PRC
subsidiaries of such offshore parent company may be prohibited from making distributions of profit to the offshore parent and from
paying the offshore parent proceeds from any reduction in capital, share transfer or liquidation in respect of the PRC subsidiaries.
Furthermore, failure to comply with the various SAFE registration requirements described above could result in liability under
PRC law for foreign exchange evasion.
We previously notified and urged our shareholders,
and the shareholders of the offshore entities in our corporate group, who are PRC residents to make the necessary applications
and filings, as required under this regulation. However, as these regulations are relatively new and there is uncertainty concerning
their reconciliation with other approval requirements, it is unclear how they, and any future legislation concerning offshore or
cross-border transactions, will be interpreted, amended and implemented by the relevant government authorities. While we believe
that these shareholders submitted applications with local SAFE offices, some of our shareholders may not comply with our request
to make or obtain any applicable registrations or approvals required by the regulation or other related legislation. The failure
or inability of our PRC resident shareholders to obtain any required approvals or make any required registrations may subject us
to fines and legal sanctions, prevent us from being able to make distributions or pay dividends, as a result of which our business
operations and our ability to distribute profits to you could be materially and adversely affected.
Because our operations are located
in China, information about our operations are not readily available from independent third-party sources.
Because the BDL is based in China, our
shareholders may have greater difficulty in obtaining information about it on a timely basis than would shareholders of a U.S.-based
company. BDL’s operations will continue to be conducted in China and shareholders may have difficulty in obtaining information
about it from sources other than BDL itself. Information available from newspapers, trade journals, or local, regional or national
regulatory agencies such as issuance of construction permits and contract awards for development projects will not be readily available
to shareholders and, where available, will likely be available only in Chinese. Shareholders will be dependent upon management
for reports of their progress, development, activities and expenditure of proceeds.
There are no related laws or regulations
to wearable medical products now in China. If there are government regulations in the future, it may create risks and challenges
with respect to our compliance efforts and our business strategies.
The health care industry is highly regulated
and is subject to changing political, legislative, regulatory, and other influences. Existing and new laws and regulations affecting
the health care industry could create unexpected liabilities for us, cause us to incur additional costs, and restrict our operations.
Many health care laws are complex, and their application to specific services and relationships may not be clear. In particular,
many existing health care laws and regulations, when enacted, did not anticipate the wearable medical products and services that
we provide, and these laws and regulations may be applied to our business in ways that we do not anticipate. Our failure to accurately
anticipate the application of these laws and regulations, or our other failure to comply, could create liability for us, result
in adverse publicity, and negatively affect our business.
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Item 4.
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Information on the Company
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A.
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History and Development of the Company
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Our founder, Mr. Ping Chen, founded
Beijing Dehaier Technology Company Limited (“BTL”), a PRC company controlled by our chief executive officer, Mr. Ping
Chen on July 5, 2001 to develop and distribute medical devices. He currently owns approximately 91% of BTL, and his wife and
several former employees of Lianluo Smart Limited own the remaining 9% of BTL. BTL previously leased some of our property to us
and provides certain transportation and repair services to medical devices for which we are not obligated to perform warranty services,
either because the warranty is expired or because the product was sold by another company. BTL served as the domestic partner to
our joint venture pursuant to which we, a British Virgin Islands company, now own 100% of Beijing Dehaier Medical Technology Company
Limited (“BDL”), a PRC company in the medical device business. At the time of the formation of the joint venture, foreign
enterprises were not permitted to own such companies without PRC partners.
In 2003, in order to continue to grow our
business, BTL engaged in a corporate restructuring. As a result of those actions, Lianluo Smart, BDL and De-haier Medical Systems
(Hong Kong) Limited (“DHK”) were established, and we created the holding company structure that is currently in place.
Lianluo Smart was incorporated as an international
business company under the International Business Companies Act, 1984, in the British Virgin Islands on July 22, 2003 under
the name “De-Haier Medical Systems Limited”
.
We changed
this name to “Dehaier Medical Systems Limited” on June 3, 2005, and to "Lianluo Smart Limited" on November
21, 2016. Lianluo Smart is a holding company. Lianluo Smart does not conduct business in China and instead relies on BDL and Lianluo
Connection Medical Wearable Device Technology (Beijing) Co., Ltd., a PRC company (“LCL”) to conduct business in China.
On September 24, 2003, we established
BDL. BDL conducts substantially all of our operations in China and is responsible for generating substantially all of our revenues.
BDL was formed as a joint venture between a Chinese entity, BTL, and a foreign invested enterprise, Lianluo Smart, in order to
allow foreign investments to be used to grow our business. Because BDL is engaged in an encouraged industry under the Foreign Investment
Industrial Guidance Catalogue, it was allowed to have foreign investments and to be established as a Chinese-foreign equity joint-venture.
This structure allowed BDL access to foreign capital that would not have been available outside this structure.
BDL has been focused on the development
and distribution of medical devices since its inception and began developing its respiratory and oxygen homecare business in 2006.
On April 22, 2010, we completed an initial
public offering of 1,500,000 common shares. The offering was completed at an issuance price of $8.00 per share. Prior to the offering,
the Company had 3,000,000 issued and outstanding shares, and after the offering, the Company had 4,500,000 issued and outstanding
shares.
On February 21, 2014, we and certain institutional
investors entered into a securities purchase agreement in connection with an offering (the “Offering”), pursuant to
which we agreed to sell an aggregate of 734,700 common shares and warrants to initially purchase an aggregate of 220,410 common
shares. The purchase price was $9.12 per common share, and the warrants were initially exercisable at $11.86 per share. The Offering
closed on February 26, 2014, and the aggregate gross proceeds from the sale of the common shares, before deducting fees to the
placement agent and other estimated offering expenses payable by us was approximately $6.7 million, not including any proceeds
from warrant exercises. The warrants were exercisable immediately as of the date of issuance at an exercise price of $11.86 per
common share and were to expire forty-two months from the date of issuance. On April 21, 2016, we entered warrant repurchase agreements
with the holders of these warrants and the placement agent involved in the offering, pursuant to which we agreed to repurchase
293,880 warrants for cash payment equal to $3.80 per share underlying the warrants. We completed the repurchase of the warrants
on June 2, 2016, and as of the date of this filing, all of such warrants have been cancelled.
On January 14, 2016, we completed an acquisition
of 0.8% equity interest of BDL from BTL. The Company now holds 100% of the equity interest of BDL. This change reflects BTL’s
reduced reliance on business with BDL in providing repair and maintenance services. Upon the Loss Absorption Agreement Termination
(“VIE Termination”) executed, we stopped all business activities with BTL as well.
On February 1, 2016, our Board of Directors
approved the formation of a wholly owned subsidiary, LCL, in Beijing. We have finished the related procedures to establish LCL.
On February 22, 2016, we discontinued part
of our medical devices business, including assembly and sales of X-ray machines and anesthesia machines, monitoring devices, general
medical products, and oxygen generators. Our Company will focus on the development of the remaining product line, such as the second
generation ventilator, general medical products laryngoscopes, compressors, sleep respiratory business and wireless medical.
On April 28, 2016, we entered into a definitive
securities purchase agreement (the “SPA”) with Hangzhou Lianluo Interactive Information Technology Co., Ltd. (“Lianluo
Interactive”) to sell 11,111,111 of our common shares to Lianluo Interactive for an aggregate purchase price of $20 million.
The purchase price was $1.80 per share, which represented a 35% premium to company’s closing price of $1.33 on April 27,
2016. We completed our first closing under the SPA on June 2, 2016, pursuant to which we sold 620,414 common shares for an aggregate
purchase price of $1,116,744. On June 28, 2016, we entered into Amendment No. 1 to the SPA to extend the closing date from June
30, 2016 to September 30, 2016. On August 18, 2016, we closed the SPA, and completed the sale of an aggregate of $20 million of
our common shares and warrants to purchase common shares.
On July 31, 2016, BDL entered into a Loss
Absorption Agreement Termination (“VIE Termination”) with the BTL. According to the VIE Termination, the Loss Absorption
Agreement (the “VIE Agreement”) among BDL, BTL and its shareholders Ping Chen, Bao Xian, Weibing Yang, Jian Sun, Zheng
Liu and Yong Wang dated as of March 3, 2010 was terminated effective July 31, 2016. There is no relationship between BTL and the
Registrant and its other subsidiaries after the effectiveness of the VIE Termination.
On November 21, 2016, the Company changed
its name from Dehaier Medical Systems Limited to Lianluo Smart Limited, and its NASDAQ stock ticker from DHRM to LLIT.
Relationship among Lianluo Smart, BTL,
LCL and BDL
BTL is a PRC company established on July
5, 2001. Lianluo Smart is a BVI company established on July 22, 2003, used to be known as Dehaier Medical Systems Limited. Lianluo
Smart and BTL jointly established BDL on September 24, 2003 as a Chinese-foreign equity joint-venture under the PRC laws. Lianluo
Smart has been and is BDL’s foreign shareholder, and BTL has been and is BDL’s domestic shareholder since BDL was established.
Currently, Lianluo Smart owns 100% of BDL, and BTL no longer owns any equity interest of BDL. Under PRC laws, the shareholders
of the equity joint-venture share the profits, risks and losses in proportion to their respective contributions of the equity joint-venture.
BTL leased its building to BDL from January
1, 2015 through December 31, 2016, and BDL no longer leases this building as of the date of this filing. At December 18, 2015,
BTL’s building was pledged to a bank as collateral for short-term borrowings of RMB 10,000,000 ($1,541,000). Pursuant to
the terms of the agreement, the line of credit is secured by BTL’s building and guaranteed by BDL and an officer of the Company.
Upon the VIE Termination executed, BTL stopped providing its property as collateral for our outstanding borrowings. As of December
31, 2016, we reported no outstanding short-term borrowings.
On July 31, 2016, the Registrant’s
wholly owned subsidiary, BDL, entered into a Loss Absorption Agreement Termination with the Registrant’s variable interest
entity (“VIE”), BTL. According to the VIE Termination, the Loss Absorption Agreement (the “VIE Agreement”)
among BDL, BTL and its shareholders Ping Chen, Bao Xian, Weibing Yang, Jian Sun, Zheng Liu and Yong Wang dated as of March 3, 2010
is terminated effective July 31, 2016. There is no relationship between BTL and the Registrant and its other subsidiaries after
the effectiveness of the VIE Termination.
On February 1, 2016, our Board of Directors
approved formation of a wholly owned subsidiary, LCL, in Beijing. We have finished the related procedures to establish LCL.
Lianluo Smart focuses on three business
sectors: medical wearable devices, smart devices and smart ecosystem platform.
The medical wearable sector will focus
on wearable sleep respiratory devices. The Company develops and distributes medical devices, focusing primarily on sleep respiratory
solutions to Obstructive Sleep Apnea Syndrome (“OSAS”) since 2010. It provides users with medical grade detection and
monitoring, long-distance treatment and integration solution of professional rehabilitation. The Company now has professional and
accurate collection and valuable big-data analytic technology, which can scientifically and accurately collect and count user data,
provide chronic and high-risk patients with long-distance treatment and professional rehabilitation.
The smart devices sector is specialized
in operating easy-using smart devices for sports, social contact, entertainment, remote-control, family health management, which
can connect things and humans in an intelligent way. The Company will constantly upgrade key algorithms based on big data and develop
smart devices based on the combination of hardware and software. This sector will cover several areas, including smart home, smart
traveling and smart entertainment.
In the smart ecosystem platform sector,
the Company will build up an ecosystem to facilitate interconnection among smart products and between smart products and users.
This ecosystem is designed to address anticipated future trends and user demands. It incorporates wearable devices, home furnishings,
mobile smart devices and other smart devices with cloud computing.
We are currently researching new products
and evaluating business opportunities in our smart devices and smart ecosystem platform sectors.
We design, develop and market our own branded
medical products and medical components. Since we do not operate any fully scaled manufacturing facilities, we contract some of
the medical components to outside manufacturers in China. Most of our branded products require light assembly by us before distribution.
We also distribute medical products designed
and manufactured by other companies. We broaden our product portfolio through distribution agreements with international manufacturers,
and most of the products we distribute are imported.
While we sell our products primarily through
distributors, we also make direct sales to hospitals, clinics and government health bureaus. We continue to further our market
reach by introducing newer and more advanced product lines that address different end-user needs.
We completed the corporate and business
restructuring plan of scaling down and discontinued, as appropriate, our unprofitable medical device business, including assembly
and sales of X-ray machines and anesthesia machines. We maintain only a few currently-profitable businesses on sales of our patented
products including medical air compressors and cardiopulmonary resuscitation (“CPR”) instruments. We aim to concentrate
our resources to develop medical wearable devices, smart devices and smart ecosystem platform, as our major business.
Recent Operational Developments
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On June 24, 2016, we signed a strategic cooperation
agreement with Hongyuan Supply Chain Management Co., Ltd. ("Hongyuan") to develop Lianluo Smart’s new Internet
medical technology business. Under the strategic cooperation agreement, we will leverage Hongyuan’s sales platform to reach
Lianluo Smart’s dealers and end users more efficiently, selling our wearable sleep apnea diagnostic system medical devices
to Hongyuan for further down chain sale and distribution.
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On July 5, 2016, Lianluo Smart partnered with China
Sciences Group (Holding) Co., Ltd. ("China Sciences") to enter the Chinese pension and health industry by providing
Lianluo Smart's products through China Sciences' elder care platform. Also, Lianluo Smart, China Sciences and another supplier,
Chia Tai Pharmaceutical Group ("Chia Tai"), have signed a strategic cooperation agreement to launch the "Elderly
Sleep Apnea Comprehensive Disease Solution Project".
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On December 2, 2016, the Company attended the 2016
Guangdong Sleep Cardiovascular Disease Diagnosis and Treatment New Progress Forum, co-hosted by the Institute of Interventional
Cardiology of Guangdong Province, Guangdong Provincial People's Hospital and Cardiology Department of Guangdong Province Cardiovascular
Institute, and the Coronary Heart Disease with Sleep Apnea Diagnosis and Treatment Strategy project promotion activities of Guangdong
Provincial Health Commission.
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Our Products
Our proprietary and distributed products
include two major categories: (i) medical devices (including supporting products) and (ii) sleep respiratory and mobile
medicine (including Internet Medical and Sleep Diagnosis Products). Our medical devices proprietary and distributed products are
mainly used in hospitals and clinics, while the sleep respiratory products are mainly for hospitals, sleep centers, physical examination
centers and at-home use by individuals.
Our Proprietary Products
Our management believes that our proprietary
products, which are generally less expensive than products from foreign companies, tend to be more attractive to hospitals and
healthcare facilities and other end-users for whom price is a significant factor in deciding whether to purchase our products.
Our proprietary products include medical devices and related supporting/technical service products, and sleep respiratory products.
Medical
Devices (Including Related Supporting Products)
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Ventilator Air Compressor.
We provide
two types of air compressors to support medical ventilators in surgery by supplying continuous airflow for the ventilator. Where
a facility lacks a central pressured air supply system, our DHR280 air compressors provide a portable source of such pressured
air. Our air compressors feature oil-less motors, large locking castors, high flow capacity, and spill-proof switches. We have
designed our air compressors to be adaptable for use with any ventilator.
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Sleep
Respiratory and Oxygen Homecare Products
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Sleep Apnea Treatment Products.
We
have designed and expect to provide several products designed for obstructive sleep apnea (“OSA”) therapy. These products
include our DHR CPAP C5. These products are all non-invasive therapy products that treat symptoms of sleep apnea. Our CPAP devices
do not cure apnea but instead use air pressure to open customers’ airways to reduce snoring and apnea disturbances during
sleep. Our automatic CPAP products provide air pressure at a customized, adjustable level, while our traditional CPAP products
provide a constant level of air pressure.
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Mobile
Medicine(including Internet Medical and Sleep Diagnosis Products)
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Sleep Apnea Diagnostic Products.
We
have designed and expect to provide two types of screening and diagnosis products are portable sleep respiratory recording devices
that can be used in a healthcare facility or in a patient’s home to assist physicians in determining whether the patient
has obstructive sleep apnea requiring use of a CPAP device. We have obtained the CFDA for DHR998 in January 2014.
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Research and Development of Our Proprietary
Products
Our success to date has in part resulted
from our strong research and development capabilities, which allow us to regularly introduce new and more advanced products at
competitive prices. Research and development costs from continuing operations were $1,196,161, $1,918,446 and $100,199 for the
years ended December 31, 2016, 2015 and 2014, respectively. Research and development costs from discontinued operations were
$0, $580,216 and $515,135 for the years ended December 31, 2016, 2015 and 2014, respectively. Our research and development
team in 2016 consists of 5 engineers, representing 11% of our employees.
Our project selection goals focus on projects
that we believe are commercially feasible, can generate significant revenue and can be introduced into the market in the near-term.
While our research and development department may conduct research into areas that are likely to lead to short-, medium- and long-range
business opportunities for our company, we focus our development of products on those solutions we believe are most likely to generate
significant near-term revenues. Thus, we would generally devote more resources to a solution expected to have an immediate financial
return (for example, a ventilator) than to a project with a potentially greater overall payoff that is more distant and tenuous
(for example, an artificial lung).
Our management seeks feedback from our
distribution network to learn about needs for future products and improvements to existing products that our research and development
department can seek to address. Once we identify a product opportunity, our sales and service, research and development, and assembly
teams work closely together to determine potential market demand for a product and how it fits with our current design and assembly
capabilities. We organize regular meetings in which our sales and service, research and development and assembly teams review progress
and, if necessary, adjust the emphasis of our research and development projects.
If we deem a new product to be commercially
feasible, our research and development team will work closely with our assembly team to move assembly forward. This integrated
approach allows us to identify potential difficulties in commercializing our proprietary product or product improvement. Furthermore,
it enables us to make adjustments as necessary and develop cost-efficient assembly processes prior to distribution. We believe
these abilities can significantly shorten the time it takes to launch a commercialized product. In the last three years, we have
developed and brought to market 5 new products, which we believe should appeal to a wide range of end-users.
Principal Suppliers – Our Proprietary
Products
We use the following principal suppliers
to manufacture the components in the products we develop and assemble:
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China Huayang Investment Holding Co., Ltd.
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Hunan Yitong Wearable Information Technology Co., Ltd.
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Jianfa (Beijing) Co., Ltd.
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Wuhan Xiruiou Technology Co., Ltd.
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Tianjin Hongshida Metals Co., Ltd.
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We believe the components provided by our
suppliers are widely available and do not anticipate that we will be unable to obtain these components from other suppliers in
the event our principal suppliers are unable or unwilling to supply us. We provide the technical specifications and files needed
for our suppliers to manufacture components. We purchase the same components from a wide variety of suppliers.
Assembly of Our Proprietary Products
After our research and development team
designs the technical specifications and computer models for our proprietary products, we typically work with an independent contractor
to fabricate working prototypes before we commence with the production run of a product. We test prototypes to confirm that they
operate as expected and with the quality we require. During the prototyping process, we apply for CFDA approval as necessary. Once
both of these processes are completed, we commission a production run of components for assembly into our proprietary products.
We depend on component and product manufacturing
and logistical services provided by third parties. All of our proprietary products are manufactured in whole or in part by a variety
of third-party manufacturers. While these arrangements may lower operating costs, they also reduce our direct control over production.
It is uncertain what effect such diminished control will have on the quality or quantity of products or services, or on our flexibility
to respond to changing conditions.
We maintain a 6,146 square foot product
center in Changping District in Beijing. This product center contains our research and development area and our assembly facilities.
Final assembly of our products is currently performed in this facility by our employees in assembly and by some of our external
vendors. Currently, the supply and manufacture of many critical components is performed by sole-sourced third-party vendors in
China.
Proprietary Rights for Our Proprietary
Products
We are developing a portfolio of
intellectual property rights in China to protect the technologies, inventions and improvements that we believe are
significant to our business in China. We have a sum of 25 patents now: 8 design patents related to our CPAP devices (2),
Sleep Diagnosis System (4), Compressor (1) and others (1); 5 practical patents related to our CPAP devices (3) and others
(2). In addition, we obtained 12 software copyrights for our CPAP devices (5), Sleep Diagnosis System (1), air compressors
(1) and other (5). Moreover, we possess proprietary technology and know-how in assembly processes, design and engineering. We
have not filed for any patent protection outside of China. To protect our brand name recognition, we have registered the
brand name “Dehaier” for trademark protection in China.
Our success in the medical equipment industry
depends in substantial part on effective management of both intellectual property assets and infringement risks. In particular,
we must be able to protect our own intellectual property as well as minimize the risk that any of our proprietary products may
infringe upon the intellectual property rights of others.
We enter into agreements with all our employees
involved in research and development, under which all intellectual property generated during their employment belongs to us, and
they waive all relevant rights or claims to such intellectual property. All our employees involved in research and development
are also bound by a confidentiality obligation and have agreed to disclose and assign to us all inventions conceived by them during
their term of employment.
We believe that we have successfully established
our brand in China. We have registered trademarks in China for the Dehaier name and logo used on our own-brand products. As part
of our overall strategy to protect and enhance the value of our brand, we actively enforce our registered trademarks against any
unauthorized use by a third party.
Our Distributed Products
Our management believes that our distributed
products, which are generally more expensive than products from Chinese companies, tend to be more attractive to larger city hospitals
and more affluent healthcare facilities and other end-users for whom perceived quality is a significant factor in deciding which
products to purchase. While we believe that the quality of our proprietary products is also strong, we understand that some consumers
in China associate more well-known international brands with higher quality than they associate with domestically produced brands.
We serve as a significant distributor
in China for laryngoscopes from Timesco Healthcare Ltd. (“Timesco”). We distribute medical devices and sleep
respiratory products for these companies.
Medical Devices
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Laryngoscopes
. We provide three lines of laryngoscopes developed by Timesco: the Optima, Optima XL and Eclipse lines. Laryngoscopes are flexible lighted tubes that are used to look at the inside of the larynx. Anesthesiologists make use of laryngoscopes to assist with intubation in surgery.
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Our Relationships with Suppliers
of Our Distributed Products
While we develop, assemble, market and
sell our proprietary products, we also serve as the distributor for a number of international companies looking to sell their brands
of products in China. We are a distribution agent for some or all products marketed in China by Timesco. In this capacity, we are
responsible for sales, marketing and after-sale services of these products.
We sign agency agreements with the international
supplier annually with the aim of settling marketing promotion modes, costs, product training and resolution of customer service
issues. The agency agreement cover purchasing price, purchasing intervals, order quantity, transportation and type of payment,
spare part supply and after-sale service terms. We negotiate renewal of the agency agreement as they expire to confirm ongoing
distributor expectations.
We seek to enlarge the scope of products
we are able to sell as agent for these companies and constantly try to identify competitive suppliers and products on the international
market to assist them with marketing and selling their products in China.
Principal Suppliers – Our Distributed
Products
In addition to the products we design,
we distribute products designed and manufactured by Timesco Healthcare Ltd. The exact products from this supplier are available
only from such supplier; however, we believe that we will be able to obtain similar products from other suppliers in the event
our principal supplier is unable or unwilling to supply us.
Our Service Centers
We maintain a customer service center in
Beijing for technical support and repair. We staff our customer service center with senior technical support engineers who provide
preliminary support. Our engineers attempt to quickly diagnose and assist in repairing problems over the phone, or determine whether
a service visit to the customer’s premises is necessary. In some instances, our engineers will provide on-site operating
guidance and repair service. We periodically review customer calls to ensure that any issues raised by our customers are resolved
to their satisfaction.
Customers
We have three categories of customers:
(i) distributors, (ii) hospitals, physical examination centers, pension and health management institutions, insurance companies
and government agencies and (iii) individual consumers to whom we sell directly. Our customer base is widely dispersed on both
a geographic and revenues basis.
Our distributors.
Sales
to our distributors make up the substantial majority of our revenues as over 99% of our sales are to distributors. Based on the
expected use of products sold to distributors, for proprietary products, we estimate that they sell approximately 90% of our products
to pension and health management institutions, 10% to hospitals; for distributed products, about 100% products are sold to hospitals.
We have contractual distribution relationships with approximate 200 independent distributors. We do not own, employ or control
these independent distributors.
Hospital, physical
examination centers, insurance companies and governmental agency customers.
Our hospital and governmental agency
customers primarily include hospitals, private physical examination centers, life insurance companies as well as provincial level
public health bureaus and population and family planning bureaus. We also refer to these customers as our “Key Accounts.”
These customers typically place large volume orders that are awarded based on bids submitted by competing medical equipment companies
through a state-owned bidding agent.
Individual consumers.
We
sell our products directly to consumers through our website platform.
Dependence
on Major Customers.
For the years ended December 31, 2016, 2015 and 2014, approximately 94%, 7% and 21% of the
Company’s total revenues were received from two customers for continuing operations. For the years ended December 31,
2016, 2015 and 2014, approximately 96%, 61% and 38% of the Company’s total revenues were received from two customers
for discontinued operations.
Dependence on
Major Suppliers.
For the years ended December 31, 2016, 2015 and 2014, purchases from three suppliers for continuing operations
were approximately 98%, 87% and 68% of the total purchases, respectively. For the years ended December 31, 2016, 2015 and 2014,
purchases from three suppliers for discontinued operations were approximately 94%, 83% and 94% of total purchases, respectively.
Competition
The medical device industry is characterized
by rapid product development, technological advances, intense competition and a strong emphasis on proprietary information. Across
all product lines and product tiers, we face direct competition from both domestic and international competitors. We compete based
on factors such as price, value, customer support, brand recognition, reputation, and product functionality, reliability and compatibility.
Each of our proprietary products competes against functionally similar products from domestic and international companies.
Our competitors include publicly
traded and privately held multinational companies, such as Phillips Respironics Inc., ResMed Inc., Covidien, Weinmann Medical
Technology, Natus Medical Inc. (Embla Sleep Diagnostics), Curative Medical and SOMNO Medics as well as domestic Chinese
companies such as Beijing Yi’an, Beijing Shenlu, Guangdong Pigeon, Tianjin Oranger, Beijing Zhonghe Beide Trading Co.,
Ltd., iCareTech Healthcare Co., Ltd., Contec Medical Systems Co., Ltd. and BMC Medical Co., Ltd. We believe that we can
continue to compete successfully in China because our established domestic distribution network and customer support and
service network allows us significantly better access to China’s small and medium-sized hospitals. In addition, our
strong investment in research and development, coupled with our low-cost operating model, allows us to compete effectively
for sales to large hospitals.
We believe our competitive position in
China varies depending on the product in question. While we are a much smaller company overall than, for example, General Electric,
Siemens or Philips and are unable to offer the range or depth of products each of those companies offers, we believe our market
position is favorable in several segments. The following charts provide our marketing department’s estimations of our primary
competitors by product, both as to our proprietary products and as to our distributed products:
Proprietary Product
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Primary Competitors in China
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Dehaier’s Estimated Competitive Position*
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DHR280 air compressors
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Beijing Yi’an, Beijing Shenlu
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Average
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DHR 998* and diagnosis products
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Foreign companies such as Respironics, ResMed, and Covidien
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Greater than average
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Timesco laryngoscope
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Kirchner & Wilhelm (GER), Welch Allyn (USA)
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Average
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*A “greater
than average” position indicates Lianluo Smart estimates its competitive position in the top third of all competitors. “Average”
indicates Lianluo Smart estimates its competitive position in the middle third of all competitors. “Smaller than average”
indicates Lianluo Smart estimates its competitive position in the bottom third of all competitors.
As we expand into international markets,
our competitors will include publicly traded and privately held multinational companies such as Respironics and ResMed. These companies
typically focus on the premium segments of the market. We believe we can successfully penetrate certain international markets by
offering products of comparable quality at lower prices. We will also face competition in international sales from companies that
have local operations in the markets in which we sell our proprietary products. We believe that we can compete successfully with
these companies by offering high quality proprietary products at comparable prices.
Methods of Competition
China’s medical device market currently
features a significant number of small distributors. We seek to distinguish our company from our competitors by being able to offer
proprietary and distributed products that address the device needs of customers that may have very different needs.
For example, China is currently investing
heavily in health care nationwide; however, money for healthcare is currently unevenly distributed. There are a number of large
hospitals that have significant resources and a number of rural clinics that have extremely limited budgets. We are able to provide
distributed products that reach the more affluent customers, as these customers frequently tend to ascribe more perceived value
to products made by well-known foreign companies, such as Timesco. We are also able to supply our proprietary products to customers
who tend to care less about perceived value and more about functionality.
We currently compete on three levels. First,
we have well-established distribution channels and close relations with around 200 dealers and distributors, reaching an estimated
900 hospitals. We maintain relationships with healthcare bureaus as well as other key accounts to actively participate in state-level
contracted procurement projects. Second, our proprietary homecare medical products are designed to provide an all-in-one solution
for end users. Third, we keep upgrading the service and products to end-users and satisfy market demands. We focus on maintaining
a high quality to price ratio in our proprietary products. In addition, being a NASDAQ-listed company has helped to build our brand
image and reputation with potential customers and business partners.
Seasonality
During the period from April to May, we
generally experience an increase in revenues associated with our attendance at the China International Medical Equipment Fair,
the largest exhibition of medical equipment, related products and services in Asia-Pacific region. This fair occurs in the spring
each year. In addition, we generally experience an increase in revenues in the period from September through November. This increase
is associated with hospital purchasing designed to extinguish governmental budgets prior to the fiscal year end. And our first
quarter performance generally decline as a result of the lack of business conducted during the Chinese Lunar New Year Holiday.
Employees
As of December 31, 2016, we have 66 full-time
employees, of which 14 are employed in assembly; 5 are in research and development; 25 are in general administration; and 22 are
in marketing and sales. As required by PRC regulations, we participate in various employee benefit plans that are organized by
municipal and provincial governments, including pension, work-related injury benefits, maternity insurance, and medical and unemployment
benefit plans. We are required under PRC law to make contributions to the employee benefit plans at specified percentages of the
salaries, bonuses, housing funds and certain allowances of our employees, up to a maximum amount specified by the local government
from time to time. We make contributions to employee benefits equal to 10% of employee salaries.
Generally, we enter into a three-year standard
employment contract with all of our officers, managers and other key employees and a one-year standard employment contract with
all other employees. According to these employment contracts, all of our employees are prohibited from engaging in any activities
that compete with our business during the period of their employment with us.
Under Chinese law, we may only terminate
employment agreements without cause and without penalty by providing notice of non-renewal one month prior to the date on which
the employment agreement is scheduled to expire. If we fail to provide this notice or if we wish to terminate an employment agreement
in the absence of cause, then we are obligated to pay the employee one month’s salary for each year we have employed the
employee. We are, however, permitted to terminate an employee for cause without penalty to our company, where the employee has
committed a crime or the employee’s actions or inactions have resulted in a material adverse effect to us.
Regulations
Our products are medical devices and are
subject to regulatory controls governing medical devices. As a distributor of medical equipment and supplies we are subject to
regulation and oversight by different levels of the food and drug administration in China, in particular the CFDA. We are also
subject to other PRC government laws and regulations. CFDA requirements include obtaining certifications, permits, compliance with
clinical testing standards, assembly practices, quality standards, applicable industry standards and adverse event reporting, and
advertising and packaging standards.
China’s Regulation of Medical
Devices
Classification of Medical Devices
In China, medical devices are classified
by the CFDA into three different categories, Class I, Class II and Class III, depending on the degree of risk associated
with each medical device and the extent of control needed to ensure safety and effectiveness. Classification of a medical device
is important because the class to which a medical device is assigned determines, among other things, whether a company needs to
obtain a permit and the level of regulatory authority involved in obtaining such permit. Classification of a device also determines
the types of registration required and the level of regulatory authority involved in effecting the product registration.
Class I devices require product certification
and are those with low risk to the human body and are subject to “general controls.” Class I devices are regulated
by the city level food and drug administration where the company is located. Class II devices are those with medium risk to
the human body and are subject to “special controls.” Class II devices require product certification, usually
through a quality system assessment, and are regulated by the provincial level food and drug administration where the company is
located. Class III devices are those with high risk to the human body, such as life-sustaining, life-supporting or implantable
devices. Class III devices also require product certification and are regulated by the CFDA under the strictest regulatory
control.
The majority of our products are classified
as Class II devices. Our products are either classified as Class II or non- categorized devices.
Assembly Permit
A company must obtain a permit from the
provincial level food and drug administration before commencing the assembly of Class II and Class III medical devices.
No assembly permit is required for Class I devices, but the company must notify the provincial level food and drug administration
where the company is located and file for record with it. An assembly permit, once obtained, is valid for five years and is renewable
upon expiration.
We have a single assembly permit, which
covers all products we assemble and is scheduled to expire on August 25, 2018. To renew an assembly permit, a company needs to
submit to the provincial level food and drug administration an application to renew the permit, along with required information
six months before the expiration date of the permit. If we are unable to renew the permit before it expires, we could lose our
ability to assemble our medical devices until the situation is rectified.
Distribution License
A manufacturer or distributor must obtain
a distribution license in order to engage in sales and distribution of Class II and Class III medical devices in China.
A distribution license is valid for five years and is renewable upon expiration. If we are unable to renew the permit before it
expires, we could lose our ability to distribute medical devices until the situation is rectified.
Registration Requirement
Before a medical device can be manufactured
for commercial distribution, a company must complete medical device registration by proving the safety and effectiveness of the
medical device to the satisfaction of respective levels of the food and drug administration. In order to conduct a clinical trial
on a Class II or Class III medical device, the CFDA requires companies to apply for and obtain in advance a favorable
inspection result for the device from an inspection center jointly recognized by the CFDA and the Administration of Quality Supervision,
Inspection and Quarantine. The application to the inspection center must be supported by appropriate data, such as animal and laboratory
testing results. If the inspection center approves the application for clinical trial, and the respective levels of the food and
drug administration approve the institutions that will conduct the clinical trials, the company may begin the clinical trial. A
registration application for a Class II or Class III device must provide required pre-clinical and clinical trial data
and information about the device and its components regarding, among other things, device design, production and labeling. The
provincial level food and drug administration, within 60 days of receiving an application for the registration of a Class II
device, and the CFDA, within 90 days of receiving an application for the registration of a Class III device, will notify
the applicant whether the application for registration is approved. If approved, a registration certificate will be issued within
ten days of written approval. If the food and drug administration requires supplemental information, the approval process may take
much longer. The registration is valid for four years.
The CFDA may change its policies, adopt
additional regulations, revise existing regulations or tighten enforcement, each of which could block or delay the approval process
for a medical device.
The following table discloses the current
registration expiration dates for the products we sell. It is the obligation of that produces the product to seek registration
and any renewals. We are responsible for registering our proprietary products but must rely on the suppliers of other products
to seek registration for those products. We will either cease to sell such product or seek comparable products from other suppliers
in the event the registration is not renewed on expiration.
Medical Devices (Including Related Supporting Products)
Product Type
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Product Model
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Registration Expiration
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Ventilator Air Compressor
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DHR280 Air Compressor for Ventilators
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June 2018
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Laryngoscope
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Timesco Laryngoscope
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April 2020
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Respiratory Products
Product Type
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Product Model
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Registration Expiration
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Sleep Apnea Treatment Products
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CPAP C5
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July 2016*
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Diagnostic Products
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DHR 998
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November 2017
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*
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We submitted this application for renewal in April 2016 and anticipate receiving the renewed registration in the near future. Currently, CFDA is reviewing our application and may need certain amount of time to approve our renewal. Before we receive the approval from the CFDA, we remain able to sell our CPAP C5 products.
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Continuing CFDA Regulation
We are subject to continuing regulation
by the CFDA. In the event of significant modification to an approved medical device, its labeling or its assembly process, a new
premarket approval or premarket approval supplement may be required. Our products are subject to, among others, the following regulations:
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•
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CFDA’s quality system regulations which require
companies to create, implement and follow certain design, testing, control, documentation and other quality assurance procedures;
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•
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medical device reporting regulations, which require
that companies report to the CFDA certain types of adverse reaction and other events involving their products; and
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•
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CFDA’s general prohibition against promoting
products for unapproved uses.
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Class II and III devices may also
be subject to special controls applicable to them, such as supply purchase information, performance standards, quality inspection
procedures and product testing devices which may not be required for Class I devices. We believe we are in compliance with
the applicable CFDA guidelines, but we could be required to change our compliance activities or be subject to other special controls
if the CFDA changes or modifies its existing regulations or adopts new requirements.
We are also subject to inspection and market
surveillance by the CFDA to determine compliance with regulatory requirements. If the CFDA decides to enforce its regulations and
rules, the agency can institute a wide variety of enforcement actions such as:
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•
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fines, injunctions and civil penalties;
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•
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recall or seizure of our products;
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•
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the imposition of operating restrictions, partial
suspension or complete shutdown of assembly; and
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Other National and Provincial Level
Laws and Regulations in China
Beyond those laws and regulations we consider
material to our business, we are subject to evolving regulations under many other laws and regulations administered by governmental
authorities at the national, provincial and city levels, some of which are, or may be, applicable to our business. Our hospital
customers are also subject to a wide variety of laws and regulations that could affect the nature and scope of their relationships
with us.
Laws regulating the conduct of business
in our industry cover a broad array of subjects. We must comply with numerous additional states and local laws relating to matters
such as safe working conditions, environmental protection and fire hazard control, which affect all companies doing business in
China. We believe we are currently in compliance with these laws and regulations in all material respects. We may be required to
incur significant costs to comply with these laws and regulations in the future. Unanticipated changes in existing regulatory requirements
or adoption of new requirements could have a material adverse effect on our business, financial condition and results of operations.
Restriction on Foreign Ownership
The principal regulation governing foreign
ownership of medical device businesses in the PRC is the 2015 Foreign Investment Industrial Guidance Catalogue (the “Catalogue”).
The Catalogue classifies the various industries into four categories: encouraged, permitted, restricted and prohibited. As confirmed
by the government authorities, BDL is engaged in an encouraged industry. Such a designation offers businesses distinct advantages.
For example, businesses engaged in encouraged industries:
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•
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are not subject to restrictions on foreign investment,
and, as such, foreign can own a majority in Sino-foreign joint ventures or establish wholly-owned foreign enterprises in the PRC;
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•
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provided such company has total investment of less
than $100 million, the company is subject to regional (not central) government examination and approval which are generally more
efficient and less time-consuming; and
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•
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may import certain equipment while enjoying a tariff
and import-stage value-added tax exemption.
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The National Development and Reform Commission
and the Ministry of Commerce periodically jointly revise the Foreign Investment Industrial Guidance Catalogue. As such, there is
a possibility that our company’s business may fall outside the scope of the definition of an encouraged industry in the future.
Should this occur, we would no longer benefit from such designation.
Regulation of Foreign Currency Exchange
The principal regulations governing foreign
currency exchange in China are the Foreign Exchange Administration Regulations (1996), as amended, and the Administration Rules
of the Settlement, Sale and Payment of Foreign Exchange (1996). Under these regulations, Renminbi are freely convertible for current
account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions,
but not for most capital account items, such as direct investment, loan, repatriation of investment and investment in securities
outside China, unless the prior approval of SAFE or its local counterparts is obtained. In addition, any loans to an operating
subsidiary in China that is a foreign invested enterprise, cannot, in the aggregate, exceed the difference between its respective
approved total investment amount and its respective approved registered capital amount. Furthermore, any foreign loan must be registered
with SAFE or its local counterparts for the loan to be effective. Any increase in the amount of the total investment and registered
capital must be approved by the PRC Ministry of Commerce or its local counterpart. We may not be able to obtain these government
approvals or registrations on a timely basis, if at all, which could result in a delay in the process of making these loans.
The dividends paid by the subsidiary to
its shareholder are deemed shareholder income and are taxable in China. Pursuant to the Administration Rules of the Settlement,
Sale and Payment of Foreign Exchange (1996), foreign-invested enterprises in China may purchase or remit foreign exchange, subject
to a cap approved by SAFE, for settlement of current account transactions without the approval of SAFE. Foreign exchange transactions
under the capital account are still subject to limitations and require approvals from, or registration with, SAFE and other relevant
PRC governmental authorities.
Regulation of Dividend Distribution
The principal regulations governing the
distribution of dividends by foreign holding companies include the Foreign Investment Enterprise Law (1986), as amended, and the
Administrative Rules under the Foreign Investment Enterprise Law (2001).
Under these regulations, foreign investment
enterprises in China may pay dividends only out of their retained profits, if any, determined in accordance with PRC accounting
standards and regulations. In addition, foreign investment enterprises in China are required to allocate at least 10% of their
respective retained profits each year, if any, to fund certain reserve funds unless these reserves have reached 50% of the registered
capital of the enterprises. These reserves are not distributable as cash dividends.
Notice 75
On October 21, 2005, SAFE issued Notice
75, which became effective as of November 1, 2005. According to Notice 75, prior registration with the local SAFE branch
is required for PRC residents to establish or to control an offshore company for the purposes of financing that offshore company
with assets or equity interests in an onshore enterprise located in the PRC. An amendment to registration or filing with the local
SAFE branch by such PRC resident is also required for the injection of equity interests or assets of an onshore enterprise in the
offshore company or overseas funds raised by such offshore company, or any other material change involving a change in the capital
of the offshore company.
Moreover, Notice 75 applies retroactively.
As a result, PRC residents who have established or acquired control of offshore companies that have made onshore investments in
the PRC in the past are required to complete the relevant registration procedures with the local SAFE branch. Under the relevant
rules, failure to comply with the registration procedures set forth in Notice 75 may result in restrictions being imposed
on the foreign exchange activities of the relevant onshore company, including the increase of its registered capital, the payment
of dividends and other distributions to its offshore parent or affiliate and capital inflow from the offshore entity, and may also
subject relevant PRC residents to penalties under PRC foreign exchange administration regulations.
PRC residents who control our company are
required to register with SAFE in connection with their investments in us. Such individuals completed this registration in 2007,
and 2008, as amended. If we use our equity interest to purchase the assets or equity interest of a PRC company owned by PRC residents
in the future, such PRC residents will be subject to the registration procedures described in Notice 75.
Trademark Rights
The PRC Trademark Law, adopted in 1982
and revised in 2001, with its implementation rules adopted in 2002, protects registered trademarks. The Trademark Office of the
State Administration of Industry and Commerce (“SAIC”), handles trademark registrations and grants trademark registrations
for a term of ten years.
Regulations on Offshore Parent Holding
Companies’ Direct Investment in and Loans to Their PRC Subsidiaries
An offshore company may invest equity in
a PRC company, which will become the PRC subsidiary of the offshore holding company after investment. Such equity investment is
subject to a series of laws and regulations generally applicable to any foreign-invested enterprise in China, which include the
Wholly Foreign Owned Enterprise Law, the Sino-foreign Equity Joint Venture Enterprise Law, the Sino-foreign Contractual Joint Venture
Enterprise Law, all as amended from time to time, and their respective implementing rules; the Tentative Provisions on the Foreign
Exchange Registration Administration of Foreign-Invested Enterprise; and the Notice on Certain Matters Relating to the Change of
Registered Capital of Foreign-Invested Enterprises.
Under the aforesaid laws and regulations,
the increase of the registered capital of a foreign-invested enterprise is subject to the prior approval by the original approval
authority of its establishment. In addition, the increase of registered capital and total investment amount shall both be registered
with SAIC and SAFE.
Shareholder loans made by offshore parent
holding companies to their PRC subsidiaries are regarded as foreign debts in China for regulatory purpose, which is subject to
a number of PRC laws and regulations, including the PRC Foreign Exchange Administration Regulations, the Interim Measures on Administration
on Foreign Debts, the Tentative Provisions on the Statistics Monitoring of Foreign Debts and its implementation rules, and the
Administration Rules on the Settlement, Sale and Payment of Foreign Exchange.
Under these regulations, the shareholder
loans made by offshore parent holding companies to their PRC subsidiaries shall be registered with SAFE. Furthermore, the total
amount of foreign debts that can be borrowed by such PRC subsidiaries, including any shareholder loans, shall not exceed the difference
between the total investment amount and the registered capital amount of the PRC subsidiaries, both of which are subject to the
governmental approval.
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C.
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Organizational structure
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Lianluo Smart is a BVI company established
on July 22, 2003. Lianluo Smart now has 2 wholly-owned subsidiaries in China—Beijing Dehaier Medical Technology Co.,
Ltd. (“BDL”) and Lianluo Connection Medical Wearable Device Technology (Beijing) Co., Ltd. (“LCL”).
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D.
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Property, Plants and Equipment
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We are headquartered and our principal
executive offices are located in Beijing. We assemble and test all our branded products at our 6,146 square foot product facility
at the Changping District in Beijing.
Office
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Address
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Rental Term Expiration
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Space
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Principal Executive Office
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Lianluo Smart Limited
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December 31, 2017
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6,405 square feet
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Room 2108, 21st Floor, China Railway Construction Building,
No. 20 Shijingshan Road, 100040,
Beijing, China
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Product Center
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2nd Floor of Lvchuang Environmental Protection Building, No. 28 Zhenxing Road, Changping District, Beijing, China
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November 30, 2018
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6,146 square feet
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At our principal executive office, material
tangible assets consist of general office equipment. Our product center consists of office buildings, a manufacturing/assembly
base, and a warehouse and administration area. In addition, we have assembly and testing machines at the product center. We do
not have any current plans to expand our facilities or acquire or build new facilities.
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Item 4A.
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Unresolved Staff Comments
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Not applicable, as we are not an accelerated filer, large accelerated
filer or well-known seasoned issuer.
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Item 5.
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Operating and Financial Review and Prospects
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The following discussion of our financial
condition and results of operations is based upon and should be read in conjunction with our consolidated financial statements
and their related notes included in this annual report. This annual report contains forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. See “Introduction —
Forward-Looking Statements.” In evaluating our business, you should carefully consider the information provided under Item
3.D, “Key Information — Risk Factors.” We caution you that our businesses and financial performance are subject
to substantial risks and uncertainties.
Overview
Our Company’s business is divided
into two parts: (i) medical devices (including supporting products such as operating room products, ventilators, medical emergency
products and medical air compressor products); (ii) mobile medicine (including wearable sleep respiratory solution for Obstructive
Sleep Apnea Syndrome (“OSAS”), hospital management and wireless solutions).
Our revenues mainly come from
medical products and mobile telemedicine. For the years ended December 31, 2016, 2015 and 2014, our total revenues from
continuing operations amounted to approximately $13.1 million, $0.74 million and $2.77 million, respectively. Our revenues
are subject to value added tax (“VAT”), sales returns and trade discounts. We deduct these amounts from our gross
revenues to arrive at our total revenues. Our net loss attributable to the Company for the years ended December 31, 2016,
2015 and 2014 was approximately $(10.12) million, $(10.22) million and $(24.30) million, respectively. The increased revenue
was mainly due to the new customer Hongyuan which develop Lianluo Smart’s new Internet medical technology business.
Under the strategic cooperation agreement, we will leverage Hongyuan’s sales platform to reach Lianluo Smart’s
dealers and end users more efficiently, selling our wearable sleep apnea diagnostic system medical devices to Hongyuan for
further down chain sale and distribution. The reduction of our net loss attributable to the Company was primarily due to the
operation restructure under our Company’s strategic transformation from a traditional medical equipment distributor to
a new mobile health products and service provider. The increased gross loss of the wearable sleep apnea diagnostic system
medical devices was due to the disposal of inventories which caused an additional cost of $2.45 million since all
the disposed inventories have been replaced by new products for the improvement of technology. We closed some traditional
product lines with the diminishing profitability and focus on the newly developing market exploration of medical products and
service based on technology of mobile internet, including comprehensive sleep respiratory solution for OSAS patients.
We discontinued, as appropriate, the unprofitable
medical device businesses, including assembly and sales of X-ray machines, anesthesia machines, the first generation ventilator,
monitoring devices, general medical products, oxygen therapy, oxygen generator and telemedicine. Only a few profitable businesses
such as sales of our patented medical air compressors will continue. Our corporate and business restructuring plan aims to concentrate
our Company’s resources to develop our mobile health business, including wearable sleep respiratory business, and to focus
more on our major businesses. As a result of the above reclassification of continued and discontinued operations, we restated our
operating results for 2014.
We believe these changes are crucial to
improve our competitive advantages in the industry in the future. By reducing our reliance on our less profitable medical devices
assembly and distribution businesses, we are able to leverage our resources to develop smart health products and services, which
we see as a positive development and focus for the future of our Company. Our long-term goal is to gradually decrease our production
business and focus instead on developing a complete mobile health operation platform.
Although our sleep respiratory business
is still in its early stages, we anticipate that it can be a key growth driver for our Company in the foreseeable future.
During the year 2016, we have intensified
our efforts to launch our wearable solutions and products for OSAS in public hospitals and private physical examination centers
throughout China, which has developed our distribution channels. Steady progress has been made for our wearable diagnosis and analysis
systems for OSAS in public hospitals and private physical examination centers throughout China.
We have continued to establish relationships
with pilot hospitals to deliver our wearable solutions and products for OSAS, driving the market growth in the hospitals in the
regions where the pilot hospitals located, which helped to push forward our strategic market expansion for public hospitals. So
far, wearable diagnosis and analysis systems for OSAS have been successfully delivered to most of major hospitals throughout China.
We aim to intensify usage of our system in those hospitals and other institutions where we have already successfully launched.
Our target is to gradually promote our business from sleep centers, respiratory departments, and E.N.T. departments to other hospital
departments with strong demand for sleep monitoring including those accommodating patients seeking care (inpatient and outpatient)
for key chronic diseases, such as hypertension, heart disease, diabetes and strokes. According to the authoritative statistics,
there are approximate 16 million patients seeking medication for hypertension, heart disease, diabetes and stroke in 800 3A grade
Chinese public hospitals in 2013. Our primary objective is to provide these patients with sleep diagnostic services.
We have also targeted the private physical
examination centers market. Our wearable OSAS diagnosis and analysis system has been successively launched in Ciming Aoya Hospital
and Sonqao’s high-end physical examination center and multiple outpatient departments of Health 100 Group and IKang Healthcare
Group in tier 1 cities. The number of customers for sleep diagnostic services has been growing and our products and services have
been well appreciated. The above mentioned two private physical examination centers, Health 100 Group and IKang Healthcare Group,
have 350 outpatient departments, and the number of customer is up to 11 million annually in the aggregate. We have currently covered
most of their outpatient departments in Beijing and Shanghai.
In addition, our Company is exploring the
feasibility of cooperating with commercial health insurance companies in the development of sleep respiratory solutions. We expect
to work with insurance companies to launch health insurance program providing OSAS diagnosis and analysis for their insurances.
We will continue to focus on sleep health with our comprehensive OSAS solution system, aiming to become the leading domestic product
and service provider in this market.
Our revenues for 2016 increased compared
to 2015, mainly due to the revenue of sleep respiratory solutions which increased $12 million during the year ended December 31,
2016. However, we still faced a challenging operating environment to open the sleep respiratory market and increase our market
share. To ensure that our sleep respiratory products can build up its brand awareness, we reduced our margin to earn customer trust
through our new clients which made our gross loss increased further during 2016. In addition, we reported an inventory obsolescence
loss of $2.45 million to replace our inventories with outdated technology. Meanwhile, due to redirection of our operations from
traditional medical devices business and unprofitable product lines to the research and development of sleep respiratory business
as well as the establishment of sales channel, we gradually slowed down our operations at traditional device business which helped
us control loss from discontinued operations. Accordingly, net loss attributable to the Company for 2016 decreased compared to
2015. In order to capture market and the strategy of sales promotion, the gross loss of the wearable sleep apnea diagnostic system
medical devices was slight, although the revenue extremely increased. The gross loss of 2016 increased $3.38 million compared to
2015, which was mainly due to disposal of inventories of $2.45 million since all the disposed inventories have been replaced by
new products for the improvement of technology. Otherwise, estimated useful lives of property and equipment were shortened from
10-15 years for machinery and equipment and 5 years for furniture and office equipment to 3 years for such equipment after July
31, 2016. So the depreciation increased $0.66 million from $0.21 million in 2015 to $0.87 million in 2016. Discontinued operations
losses of 2016 decreased $3.4 million compared to 2015 mainly due to the VIE Termination on July 31, 2016 and the discontinued
operations ceased during the early 2016. We expect our sleep respiratory business to drive significant growth of our overall revenues
in 2017.
|
|
|
|
|
|
For the years ended December 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
|
|
|
|
|
|
|
(Restated)
|
|
|
|
US$
|
|
|
US$
|
|
|
US$
|
|
Revenue
|
|
|
13,062,373
|
|
|
|
738,301
|
|
|
|
2,774,241
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Costs of revenue
|
|
|
(16,627,535
|
)
|
|
|
(927,286
|
)
|
|
|
(1,802,864
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit (loss)
|
|
|
(3,565,162
|
)
|
|
|
(188,985
|
)
|
|
|
971,377
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service incomes
|
|
|
14,587
|
|
|
|
1,600,012
|
|
|
|
47,665
|
|
Service expenses
|
|
|
(21,130
|
)
|
|
|
(1,234,257
|
)
|
|
|
(29,022
|
)
|
General and administrative expenses
|
|
|
(4,643,962
|
)
|
|
|
(4,089,592
|
)
|
|
|
(1,929,206
|
)
|
Provision for doubtful accounts
|
|
|
150,280
|
|
|
|
(8,544
|
)
|
|
|
(347,891
|
)
|
Selling expenses
|
|
|
(1,018,581
|
)
|
|
|
(2,982,447
|
)
|
|
|
(138,981
|
)
|
Operating loss
|
|
|
(9,083,968
|
)
|
|
|
(6,903,813
|
)
|
|
|
(1,426,058
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) from continuing operations
|
|
|
(9,999,642
|
)
|
|
|
(6,698,870
|
)
|
|
|
969,836
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss from discontinued operations
|
|
|
(251,153
|
)
|
|
|
(3,663,465
|
)
|
|
|
(26,003,708
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
(10,250,795
|
)
|
|
|
(10,362,335
|
)
|
|
|
(25,033,872
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to Lianluo Smart Limited
|
|
|
(10,121,775
|
)
|
|
|
(10,223,130
|
)
|
|
|
(24,298,114
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss attributable to Lianluo Smart Limited
|
|
|
(10,587,119
|
)
|
|
|
(10,634,213
|
)
|
|
|
(24,847,986
|
)
|
Factors Affecting Our Results of Operations – Generally
We believe the most significant factors
that directly or indirectly affect our sales revenues and net incomes are:
|
•
|
our ability to position our products in different
market segments, including our recent efforts to sell our products to hospitals and other healthcare facilities nationwide;
|
|
•
|
our ability to price our products at levels that provide
favorable and acceptable margins amidst increasing pressure from our competitors who also seek better pricing strategy for their
own benefit;
|
|
•
|
new products introduced by us as well as our competitors.
The introduction of new products by our competitors may lead to a decrease in sales and market share of our products, or force
us to sell our products at reduced prices or margins;
|
|
•
|
our ability to carry out our new business initiatives
effectively. As we continue to invest heavily in research and development projects and new business lines, including our new entry
to the sleep respiratory business, we may have difficulty in carrying out our strategy effectively due to factors that are beyond
our control. As a result, we may not be able to achieve our goals or generate favorable financial results from these new business
initiatives;
|
|
•
|
our ability to attract and retain distributors and
key customers;
|
|
•
|
our ability to retain key employees, including our
Chairman and Chief Executive Officer, Mr. Ping Chen, and our ability to build, expand, manage, and train our R&D engineers
and sales representatives who we believe to play a vital role in our new business initiatives;
|
|
•
|
our capability of gathering and analyzing market data,
such as market capacity, new market trends, market share, and competitive landscape;
|
|
•
|
our ability to establish, promote, and maintain the
public relations image of our Company and product brands; and
|
|
•
|
changes in macro-economic environment, both global
and domestic, as well as healthcare-related government policies and legislation.
|
For a detailed discussion of some of the
factors that may cause our net revenues to fluctuate, see Item 3.D, “Key Information — Risk Factors —Risks
Related to Our Business”.
Revenues
Our total revenues are derived from our
medical devices and sleep respiratory business. In 2016, our total revenues from continuing operations increased by 1669%, mainly
due to the strategy shift and the revenue of sleep respiratory solutions increased $12 million. Along with the development of our
Company’s business strategy transformation, we have redirected our operations from traditional medical devices business and
unprofitable product lines to the research and development of sleep respiratory business as well as the establishment of sales
channel.
We expect to allocate more resources to
our sleep respiratory business as we further our restructuring effort. During 2016, revenues from the sleep respiratory business
increased as the technology of the sleep respiratory business has been upgraded and optimized. Our management believes that sleep
respiratory business will become an important growth driver for the Company in coming years. The Company plans to maintain only
a few profitable businesses such as sales of its patented medical air compressors in the future.
Medical Devices (Including Related Supporting Products) –
Our Proprietary and Distributed Products
We derive revenues in our medical devices
product line from the sale of medical ventilators, general hospital products and related supporting products (including laryngoscope)
(previously defined as technical service products), medical compressor, sleep respiratory business and wireless medical. We continue
to strategically reduce our sales of traditional medical devices, and to fully realize our business focus shift from traditional
medical equipment distribution to the market exploration of medical products and service basing on technology of mobile internet,
including delivering comprehensive sleep respiratory solution for OSAS patient care management, distributing laryngoscope and other
medical products.
We discontinued, as appropriate, the unprofitable
medical device business, including assembly and sales of C-arm X-ray machines, anesthesia machines, the first generation ventilator,
monitoring devices, general medical products, oxygen therapy, oxygen generator and telemedicine. We plan to maintain only a few
profitable businesses on sales of our patented products including medical air compressors, the second generation ventilator and
cardiopulmonary resuscitation (“CPR”) instruments.
Sleep Respiratory Products (Previously known as “Sleep
Respiratory and Oxygen Homecare Products”)
We derive revenues in our sleep respiratory
line from sales of CPAP devices. We anticipate that, on a percentage basis, revenues from sleep respiratory product line will increase
more rapidly than total revenues in the near term as we introduce new and more advanced products. We expect to develop our market
for sleep respiratory market in China and internationally through the use of distributors as well as through our direct sales platform.
Though we are in the developing stage of sleep respiratory business, we strongly believe in the tremendous growth potential of
this business in the coming years. During the past year, the sleep respiratory business has achieved more progress in which we
have continued to expand to public hospitals and physical examination centers. In 2016, management focused on introducing more
advanced products and penetrating the market for sleep respiratory business. We have broadened and differentiated our target markets
by cooperating with different types of medical institutions and individual customers across China. We plan to expand our product
portfolio through continued investment in research and development and pursuing attractive opportunities to acquire complementary
products and technologies and strategic collaboration with partners. We will continue to pursue sustainable growth by enhancing
our capability of delivering the systems to more medical institutions and by promoting application of sleep respiratory systems
we delivered. We will also continue to focus on the development of the sleep respiratory systems in private physical examination
chains and life insurance companies which we believe to have large quantities of potential customers for sleep diagnosis.
Mobile Medicine (Including Internet
Medical and Sleep Diagnostic Products)
We derive revenues in our internet based
medical and sleep diagnostic products and services line from sales of medical consumables used for sleep diagnosis, hospital wireless
devices, healthcare management software and offering related services.
We continue to devote proactive efforts
to develop the wearable OSAS solution systems by marketing and expanding OSAS diagnosis, CPAP products and post-treatment evaluation
services in hospitals and private medical examination centers nationwide, leveraging our well-established distribution network
resources. Our portable sleep diagnostics devices business recognized 90% of the total revenue for the year 2016.
Operating Costs and Expenses
Our operating costs and expenses consist
of cost of revenues, general and administrative expenses, provision for doubtful accounts and selling expenses.
Our total operating costs and expenses
increased both as a percentage of our total revenues and in absolute amount for the year ended December 31, 2016 compared to the
same period in 2015 due to the increased related cost of products, investment expenses and selling expenses on research and development
of sleep respiratory business. The following table sets forth the components of our costs and expenses both in U.S. dollar amounts
(in thousands) and as a percentage of total revenues for the years indicated.
|
|
For
the years ended December 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Changes
|
|
|
Changes
|
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
2016 v. 2015
|
|
|
2015 v. 2014
|
|
|
|
(Restated)
|
|
|
|
USD
|
|
|
|
|
|
USD
|
|
|
|
|
|
USD
|
|
|
|
|
|
USD
|
|
|
|
|
|
USD
|
|
|
|
|
|
|
(‘000)
|
|
|
%
|
|
|
(‘000)
|
|
|
%
|
|
|
(‘000)
|
|
|
%
|
|
|
(‘000)
|
|
|
%
|
|
|
(‘000)
|
|
|
%
|
|
Revenues
|
|
|
13,062
|
|
|
|
100
|
|
|
|
738
|
|
|
|
100
|
|
|
|
2,774
|
|
|
|
100
|
|
|
|
12,324
|
|
|
|
1,670
|
|
|
|
(2,036
|
)
|
|
|
(73
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of revenues
|
|
|
(16,628
|
)
|
|
|
(127
|
)
|
|
|
(927
|
)
|
|
|
(126
|
)
|
|
|
(1,803
|
)
|
|
|
(65
|
)
|
|
|
(15,701
|
)
|
|
|
1694
|
|
|
|
876
|
|
|
|
(49
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit (loss)
|
|
|
(3,566
|
)
|
|
|
(27
|
)
|
|
|
(189
|
)
|
|
|
(26
|
)
|
|
|
971
|
|
|
|
35
|
|
|
|
(3,377
|
)
|
|
|
1786
|
|
|
|
(1,106
|
)
|
|
|
(119
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service
incomes
|
|
|
15
|
|
|
|
0
|
|
|
|
1,600
|
|
|
|
217
|
|
|
|
48
|
|
|
|
2
|
|
|
|
(1,585
|
)
|
|
|
(99
|
)
|
|
|
1,552
|
|
|
|
3,233
|
|
Service
expenses
|
|
|
(21
|
)
|
|
|
(0
|
)
|
|
|
(1,234
|
)
|
|
|
(167
|
)
|
|
|
(29
|
)
|
|
|
(1
|
)
|
|
|
1,213
|
|
|
|
(98
|
)
|
|
|
(1,205
|
)
|
|
|
4,155
|
|
General
and administrative expenses
|
|
|
(4,644
|
)
|
|
|
(36
|
)
|
|
|
(4,090
|
)
|
|
|
(554
|
)
|
|
|
(1,929
|
)
|
|
|
(70
|
)
|
|
|
(554
|
)
|
|
|
14
|
|
|
|
(2,161
|
)
|
|
|
112
|
|
Provision
for doubtful accounts
|
|
|
150
|
|
|
|
1
|
|
|
|
(9
|
)
|
|
|
(1
|
)
|
|
|
(348
|
)
|
|
|
(13
|
)
|
|
|
159
|
|
|
|
(1,767
|
)
|
|
|
(339
|
)
|
|
|
(97
|
)
|
Selling
expenses
|
|
|
(1,019
|
)
|
|
|
(8
|
)
|
|
|
(2,982
|
)
|
|
|
(404
|
)
|
|
|
(139
|
)
|
|
|
(5
|
)
|
|
|
1,963
|
|
|
|
(66
|
)
|
|
|
(2,843
|
)
|
|
|
2,045
|
|
Operating
income (loss)
|
|
|
(9,085
|
)
|
|
|
(70
|
)
|
|
|
(6,904
|
)
|
|
|
(935
|
)
|
|
|
(1,426
|
)
|
|
|
(51
|
)
|
|
|
(2,181
|
)
|
|
|
32
|
|
|
|
(5,478
|
)
|
|
|
384
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss) from continuing operations
|
|
|
(10,000
|
)
|
|
|
(77
|
)
|
|
|
(6,699
|
)
|
|
|
(907
|
)
|
|
|
970
|
|
|
|
35
|
|
|
|
(3,301
|
)
|
|
|
49
|
|
|
|
(7,669
|
)
|
|
|
(791
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss) from discontinued operations
|
|
|
(251
|
)
|
|
|
(2
|
)
|
|
|
(3,663
|
)
|
|
|
(496
|
)
|
|
|
(26,004
|
)
|
|
|
(937
|
)
|
|
|
3,412
|
|
|
|
(93
|
)
|
|
|
22,341
|
|
|
|
(86
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
(10,251
|
)
|
|
|
(78
|
)
|
|
|
(10,362
|
)
|
|
|
(1,404
|
)
|
|
|
(25,034
|
)
|
|
|
(902
|
)
|
|
|
111
|
|
|
|
(1
|
)
|
|
|
14,672
|
|
|
|
(59
|
)
|
Cost of Revenues
Cost of revenues primarily includes finished
goods, parts for assembly, wages, handling charges, and other expenses associated with the assembly and distribution of product.
General and Administrative Expenses
General and administrative expenses primarily
consist of salaries and benefits and related costs for our administrative personnel and management, stock-based compensation and
expenses associated with our research and development, registration of patents and intellectual property rights in China and abroad,
fees and expenses of our outside advisers, including legal, audit and register expenses, expenses associated with our administrative
offices, and the depreciation of equipment used for administrative purposes.
We expect our general and administration
expenses to increase in the near future as a result of further R&D expenditures and additional personnel costs to maintain
the competitive advantage of our mobile health business. In addition, we expect to continue to incur significant general and administrative
expenses in capital operation and maintaining investor relationships as a public company.
Selling Expenses
Selling expenses consist primarily of salaries
and related expenses for personnel engaged in sales, marketing and customer support functions, and costs associated with advertising
and other marketing activities, and depreciation expenses related to equipment used for sales and marketing activities.
Along with our shifting growth strategies,
we believe selling expenses will increase as we strengthen our distribution network, deepen our partnerships with customers and
expand market share of our mobile telemedicine business which we believe will generate a significant portion of our revenue stream
in the future.
Results of Operations
We believe that period-to-period comparisons
of operating results should not be relied upon as indicative of future performance.
Fiscal Year Ended December 31, 2016 Compared to Fiscal Year
Ended December 31, 2015
Revenues
Our total revenues from the continuing
operations increased by 1669% from $0.74 million for the fiscal year ended December 31, 2015 to $13.06 million for the fiscal year
ended December 31, 2016. The increase of revenues is mainly due to the significantly increased revenue from sleep respiratory solutions
in 2016. Along with the development of the Company’s shift in business strategy, we have adjusted the sales strategy of traditional
medical devices business, discontinued the unprofitable medical device business, maintained only a few profitable businesses such
as sales of its patented products including medical air compressors, the second generation ventilator and cardiopulmonary resuscitation
(“CPR”) instruments in the future, and invested more resources in the research and development of sleep respiration
business. In 2016, we have distributed our sleep respiratory detection devices and photo plethysmography “PPG” sensors
to model public hospitals and private medical centers. We have achieved certain progress in its mobile medicine to increase our
brand awareness and expand our market shares in sleep respiration market, which accounted for about 90% of total sales. Although
our mobile medicine is still in its early stage, our management believes that our mobile medicine business will become an important
growth driver for our Company in the coming years.
Cost of Revenues
Our cost of revenues from the continuing
operations increased by 1694% from $0.93 million for the fiscal year ended December 31, 2015 to $16.63 million for the fiscal year
ended December 31, 2016. The increase in cost of revenues was in line with the increase of revenues. The increasing cost of revenue
was also due to the disposal of inventories $2.45 million since all the disposed inventories have been replaced by new products
for the improvement of technology in 2016. In addition, our current strategy at developing the sleep respiratory solution market
is to rapidly expand our market share and build up our product or brand awareness with major hospitals and clinics in China. Thus,
in the short-term period, we may adopt a lower margin policy to boost our sales and distribute our products as many as possible
to various medical institutions. Consequently, our cost of revenue increased more than our revenue. However, we believe that upon
we can expand our market share in this stage and make our customers consistently use our products, we can further raise our margin
in the following and future sales. Before the factory and warehouse of the company moved to new place in the end of 2016, we had
cleaned up and disposed slow moving inventories, which were one-time expenses in 2016.
Gross Loss
Our gross loss from continuing
operations decreased from $(0.19) million in 2015 to $(3.57) million in 2016 and gross margin loss decreased from (26%) in
2015 to (27%) in 2016. The deduction was mainly due to the lower sale margin policy at expanding our market share, a loss
from the disposal of inventories, and the fixed costs allocated to the remaining production lines became higher.
Service Income
Our service income decreased from $1.60
million in 2015 to $0.01 million in 2016. Service income represents the income of repair service and technical service. The decrease
of the service income was mainly due to the technical service income happened in 2015 and there was no such service income in 2016.
Service Expense
Our service expense decreased from $1.23
million in 2015 to $0.02 million in 2016. The decrease of the service expense was in line with service income in this period.
Operating Expenses
Our operating expenses from continuing
operations decreased by 22% from $7.08 million for the fiscal year ended December 31, 2015 to $5.51 million for the fiscal year
ended December 31, 2016. The decrease of operating expenses was primarily due to the decrease of selling expenses. We analyzed
our operating expenses by general and administrative expenses, selling expenses and other expenses in the following parts.
Operating Expenses—General
and Administrative Expenses
Our general and administration expenses
from the continuing operations increased by 14% from $4.09 million for the year ended December 31, 2015 to $4.64 million for the
year ended December 31, 2016. This increase was mainly due to the increase of investment in research and development activities
of sleep respiratory business, the increase of professional service fees and the increase of external consultant fees. We expect
our general and administrative expenses to decrease in the near future as a result of the accomplishment of the discontinued operations
to maintain the competitive advantage of our respiratory sleep business.
Operating Expenses—Provision
for Doubtful Accounts
Our provision for doubtful accounts from
the continuing operations decreased by 1859% from $8,544 for the year ended December 31, 2015 to $(150,280) for the year ended
December 31, 2016. This reversed amount of provision for doubtful accounts was mainly due to that some of our accounts receivable,
other receivables and advances to suppliers with aging more than three months, which previously had an allowance for doubtful accounts,
have be collected and recovered according to our provision for aging policy for the year ended December 31, 2016.
Operating Expenses—Selling
Expenses
Our selling expenses from continuing operations
decreased by 66% from $2.98 million for the year ended December 31, 2015 to $1.02 million for the year ended December 31, 2016.
The decrease in selling expenses was mainly because the Company invested more resource and energy in market development for sleep
respiratory business, such as employing more sales staff and attending more medical device exhibitions in 2015 than it did in 2016.
Operating Loss
As a result of the foregoing, we generated
an operating loss of approximately $9.09 million in 2016, compared to operating loss of approximately $6.90 million in 2015. Operating
loss increased by 32%, which mainly because of the increased cost of revenue and general and administrative expenses.
Change in Fair Value of Warrants
Liability
For the year ended December 31, 2016, the
gain related to changes in the fair value of warrants liability relating to the warrants issued to investors and placement agents
was $137,710 before all the warrants had been redeemed, compared to a gain of $390,324 for the year ended December 31, 2015, a
decrease of $252,614 from 2015. The gain on the changes in the fair value of warrants liability was due to the change in our stock
price and volatility and redemption of warrants which led to a further decrease in the fair value of our warrants liability.
Loss from Warrant Redemption
On April 21, 2016, we entered warrant repurchase
agreements with the holders of warrants to purchase, in the aggregate, 293,880 shares, pursuant to which the company agreed to
redeem such warrants for cash payment equal to $3.80 per share underlying the warrants. The company completed the redemption of
the warrants on June 2, 2016, and as of the date of this filing, all of such warrants have been cancelled. Accordingly, there was
a loss of $1.09 million from warrant redemption.
Taxation
Our income tax benefit was approximately
$95,026 in 2016, compared to approximately $11,978 in 2015. Our income tax benefit increased $83,048 primarily due to the taxable
loss in this period.
Net Loss from Continuing Operations
As a result of the foregoing, we had net
loss from continuing operations of approximately $10.00 million in 2016, compared to approximately $6.70 million in 2015.
Net Loss from Discontinued Operations
We discontinued the unprofitable traditional
medical device businesses to concentrate the Company’s resources to develop its mobile health business, including wearable
sleep respiratory business, and to focus more on its major businesses. In addition, we deconsolidated BTL as one of our consolidated
entities due to the termination of the VIE agreement on July 31, 2016. As a result of this strategic shift and deconsolidation,
the relevant results of operations were reported as discontinued operations in our consolidated financial statements and we had
net loss from discontinued operations of approximately $0.25 million in 2016, compared to approximately a net loss from discontinued
operations of $3.66 million in 2015.
Net Loss
As a result of the foregoing, we had net
loss of approximately $10.25 million in 2016, compared to a net loss of approximately $10.36 million in 2015. After deduction of
non-controlling interest in loss, net loss attributable to the Company was approximately $10.12 million and $10.22 million in 2016
and 2015, respectively.
Fiscal Year Ended December 31, 2015 Compared to Fiscal Year
Ended December 31, 2014
Revenues
Our total revenues from the continuing
operations decreased by 73% from $2.77 million for the fiscal year ended December 31, 2014 to $0.74 million for the fiscal year
ended December 31, 2015. The decrease of revenues is mainly due to the influence of increasingly challenging markets, macroeconomic
headwinds, increased competition and market saturation. Along with the development of the Company’s business shifting strategy,
we have adjusted the sales strategy of traditional medical devices business, discontinued the unprofitable medical device business,
maintained only a few profitable businesses on such as sales of its patented products including medical air compressors, the second
generation ventilator and CPR instruments in the future, and invested more resources
in the research and development of sleep respiration business. In 2015, we have distributed our sleep respiratory detection device
and PPG sensor to model public hospitals and private medical centers. The first product batch is currently in the free testing
stage. We have achieved certain progress in its mobile medicine, which accounted for about 10% of total sales. Although our mobile
medicine is still in its early stage, our management believes that our mobile medicine business will become an important growth
driver for our Company in the coming years.
Cost of Revenues
Our cost of revenues from the continuing
operations decreased by 49% from $1.80 million for the fiscal year ended December 31, 2014 to $0.93 million for the fiscal year
ended December 31, 2015. The decrease in cost of revenues was mainly due to the decrease of revenues. The cost of revenue reduction
is also due to the gradual reduction on parts of traditional medical device business and uncompetitive product sales due to strategic
restructure.
Gross Profit (Loss)
Our gross profit from the continuing operations
decreased from $0.97 million in 2014 to ($0.19) million in 2015 and gross margin decreased from 35% in 2014 to (26%) in 2015. In
order to deal with the influence of increasingly challenging markets and new competitors, we shut down some traditional medical
device production lines and the fixed costs allocated to the remaining production lines became higher.
Service Income
Our service income increased from $0.05
million in 2014 to $1.60 million in 2015. The increase of the service income was mainly due to the after-sale repairing income
and commission in this period.
Service Expense
Our service expense increased from $29,022
in 2014 to $1.23 million in 2015. The increase of the service expense was mainly due to the after-sale repairing expense in this
period.
Operating Expenses
Our operating expenses from the continuing
operations increased by 193% from $2.41 million for the fiscal year ended December 31, 2014 to $7.08 million for the fiscal year
ended December 31, 2015. The increase of operating expenses was primarily due to the increase of general and administrative expenses
and selling expenses. We analyzed our operating expenses by general and administrative expenses, selling expenses and other expenses
in the following parts.
Operating Expenses—General
and Administrative Expenses
Our general and administration expenses
from the continuing operations increased by 112% from $1.93 million for the fiscal year ended December 31, 2014 to $4.09 million
for the fiscal year ended December 31, 2015. This increase was mainly due to the increase of investment on research and development
activities of sleep respiratory business, the increase of professional service fees and the increase of external consultant fees.
We expect our general and administrative expenses to decrease in the near future as a result of the accomplishment of the discontinued
operations to maintain the competitive advantage of our respiratory sleep business.
Operating Expenses—Provision
for Doubtful Accounts
Our provision for doubtful accounts from
the continuing operations decreased by 97% from $347,891 for the fiscal year ended December 31, 2014 to $8,544 for the fiscal year
ended December 31, 2015. This decrease was mainly due to advance to suppliers with aging more than two years cannot be recovered
according to our provision for aging policy for the year ended December 31, 2014.
Operating Expenses—Selling
Expenses
Our selling expenses from continuing operations
increased by 2045% from $0.14 million for the fiscal year ended December 31, 2014 to $2.98 million for the fiscal year ended December
31, 2015. The increased in selling expenses was mainly because the Company invested more resource and energy in market development
for sleep respiratory business, such as employ more sales staff, attending more medical device exhibitions, etc. Along with the
Company’s business shifting strategy, we believe the selling expenses will increase accordingly as we concentrate on market
development for sleep respiratory business which will become a major revenue generator of our revenues in the future.
Operating Loss
As a result of the foregoing, we generated
an operating loss of approximately $6.90 million in 2015, compared to operating loss of approximately $1.43 million in 2014. Operating
loss increased by 384%, which was mainly because of the reduced revenues, and the increased general and administrative expenses
and selling expenses.
Change in Fair Value of Warrants
Liability
For the year ended December 31, 2015, the
gain related to changes in the fair value of warrants liability relating to the warrants issued to investors and placement agents
was $390,324, compared to a gain of $2,866,171 for the year ended December 31, 2014, a decrease of $2,475,847 from 2014. The gain
on the changes in the fair value of warrants liability was due to the decrease in the price of our common stock underlying the
warrants issued on February 21, 2014, which decreased from $9.12 on the issuance date to $2.26 on December 31, 2015.
Taxation
Our income tax benefit (expense) was approximately
$11,978 in 2015, compared to approximately ($357,726) in 2014. Our income tax decreased $0.37 million primarily due to the decrease
in taxable income in this period.
Net Income(Loss) from Continuing
Operations
As a result of the foregoing, we had net
loss from continuing operations of approximately $6.70 million in 2015, compared to approximately a net income from continuing
operations of $0.97 million in 2014.
Net Loss from Discontinued Operations
We discontinued the unprofitable traditional
medical device businesses to concentrate the Company’s resources to develop its mobile health business, including wearable
sleep respiratory business, and to focus more on its major businesses. As a result of this strategy shifting, we had net loss from
discontinued operations of approximately $3.66 million in 2015, compared to approximately a net loss from discontinued operations
of $26 million in 2014.
Net Loss
As a result of the foregoing, we had net
loss of approximately $10.36 million in 2015, compared to approximately a net loss of $25.03 million in 2014. After deduction of
non-controlling interest in loss, net loss attributable to the Company was approximately $10.22 million and $24.30 million in 2015
and 2014, respectively.
|
B.
|
Liquidity and Capital Resources
|
Cash Flows and Working Capital
As of December 31, 2016, we had $10.79
million in cash and cash equivalents, increased from $615,517 at December 31, 2015. As a result of increased cash flow associated
with Lianluo Interactive's purchase of 11,111,111 shares of the company, the cash flows from financing activities in 2016 increased
$12.18 million comparing with the same period in 2015. Investments in research and development activities for sleep respiratory
business and market development activities resulted in a $2.76 million flow out in cash flow from operating activities. To the
extent of the Company’s expansion of new business and products, we may need to rely on a variety of sources of funding, including
but not limited to operating cash, and debt and/or equity financing.
Operating Activities
Net cash used in operating activities was
$2,756,711 for the year ended December 31, 2016, compared to $2,344,815 used in operating activities for the same period in 2015. The
reasons for this change are mainly as follows:
(i)
|
Net loss from continuing operations was $9,999,642 in 2016, an increase of approximately $3.3 million from net loss of $6,698,870 for the same period of 2015, as a result of the factors described above.
|
|
|
(ii)
|
Stock-based compensation expense incurred
$947,481 in 2016, while in 2015, stock-based compensation expense incurred $1,055,744. The decrease was mainly due to the resignation
of the employees and the expiration of the options.
|
(iii)
|
Depreciation and amortization was $1,232,263
in 2016, while in 2015 incurred $525,916. The increase was mainly due to the change of the policy of depreciation and amortization
from July 31, 2016 and the increased fixed assets.
|
(iv)
|
Provision for inventory obsolescence was
$2,450,213 in 2016, while in 2015 incurred $16,203. As the improvement of technology, the software of sleep respiration devices
has been replaced by new products and the relevant inventories had been reported as impaired.
|
(v)
|
Loss from warrant redemption was $1,091,719
in 2016 and nil in 2015, since the Company completed the redemption of the warrants on June 2, 2016 and did not redeem any warrants
in 2015. As all of such warrants have been redeemed, this expense is not expected to recur.
|
(vi)
|
Accrued expenses and other current liabilities
from continuing operations decreased by $1,315,779 in 2016, compared with an increase of $1,336,906 in 2015. The decrease in 2016
was mainly due to the payments for our research and development expenditures at sleep respiratory business, marketing expenses
and other costs accrued our new products.
|
(vii)
|
Advances to third party suppliers from
continuing operations decreased by $352,956 in 2016, compared with a decrease of $1,011,843 in 2015. The decrease was mainly due
to more inventory was received in 2016.
|
(viii)
|
Other receivables from continuing operations
decreased by $13,272 in 2016, compared with a decrease of $1,588,626 in 2015. The decrease in 2016 was mainly because of the decrease
of contract deposits for large contracts of traditional medical devices business in 2015. No such event happened in 2016.
|
(ix)
|
Inventories from continuing operations
decreased by $1,185,688 in 2016, compared with a decrease of $41,816 in 2015. The change was mainly to the disposal of obsolescent
inventories.
|
(x)
|
Net cash used in operating activities from discontinued operations was $146,898 in 2016, compared with the amount of $1,133,122 in 2015. The change was because of our Company’s change in business strategy and the termination of the VIE Agreement on July 31, 2016.
|
Investing Activities
Net cash used in investing activities for
the year ended December 31, 2016 was $652,467, compared to $27,861 used in investing activities for the same period of 2015. The
change in investing activities was mainly attributable to our purchases of sleep respiratory diagnosis and analysis systems and
equipment for our sleep respiratory business.
Financing Activities
We repaid $1,505,000 of short-term bank
loans in 2016 without obtaining any new short-term bank loans, as compared to receiving $4,008,975 proceeds from short-term bank
loans and repaid $4,810,770 of short-term bank loans in 2015. We repaid $2,843,698 of short-term loans from Mr. Ping Chen, who
was the major shareholder of our Company and the CEO, and entered into seven loan agreements with Mr. Ping Chen for an aggregate
amount of $718,638 in 2016. We borrowed and repaid $15,050 of short-term loans from BTL in 2016. In 2015, we repaid $1,603,590
of short-term loans from Mr. Ping Chen, who was the major shareholder of our Company and the CEO, and entered into three loan agreements
with Mr. Ping Chen for an aggregate amount of $3,867,859. We borrowed and repaid $184,460 of short-term loans from BTL in 2015.
We paid $1,116,744 for warrants redemption in 2016. We received proceeds of $18,412,462 from issuance of 11,111,111 common shares
to HLI in 2016 and the remaining outstanding subscription receivable balance of $1,492,538 was collected in 2017. The net amount
provided by financing activities was $13,675,808 in 2016, compared to $1,498,724 for the same period of 2015.
Contractual Obligations and Commercial Commitments
The following table sets forth our contractual obligations as
of December 31, 2016:
|
|
Payments due by period
|
|
Contractual obligations
|
|
Total
|
|
|
Less than 1 year
|
|
|
1-3 years
|
|
|
More than 3 years
|
|
Operating lease obligations
|
|
$
|
151,097
|
|
|
$
|
78,833
|
|
|
|
72,264
|
|
|
|
-
|
|
Total
|
|
$
|
151,097
|
|
|
$
|
78,833
|
|
|
|
72,264
|
|
|
|
-
|
|
The leased properties are principally located
in the PRC, and we use such properties for administration and warehouse facilities. The leases are renewable subject to negotiation.
Capital Expenditures
We made capital expenditures of approximately
$0.64 million, $0.03 million and $5.41 million in 2016, 2015 and 2014, respectively, representing 4.87%, 3.72% and 194.88% of our
total revenues, respectively. In 2016 and 2015, we distributed our sleep respiratory detection devices and PPG sensors to model
public hospitals and private medical centers. In 2014, our capital expenditures were used to purchase machinery for our assembly
line and obtain software copyrights.
Critical Accounting Policies
Basis of Consolidation
The consolidated financial statements include
the accounts of Lianluo Smart and its wholly-owned subsidiaries (collectively, the “Company”).All inter-company transactions
and balances are eliminated in consolidation.
A group of shareholders, including the
Chief Executive Officer, originally held more than 50% of the voting ownership interest of Lianluo Smart, BDL and BTL. Before July
31, 2016, BTL’s building was pledged as collateral for BDL’s bank loans. In exchange, BDL loaned money to BTL to finance
its operations. BTL’s primary operation is to provide repairs and transportation services to BDL’s customers. In accordance,
BDL is the primary beneficiary of BTL, as the entity that was most closely associated with BTL. BTL was considered a variable interest
entity of BDL. Upon execution of the VIE Termination on July 31, 2016, BTL was deconsolidated from Lianluo Smart and its subsidiaries.
The results of BTL’s operations were reflected in the Company’s consolidated financial statements as discontinued operations.
Reclassifications
Certain prior year balances were reclassified
to conform to the current year's presentation with consideration of reflecting the Company’s traditional medical device business
and the operating results of BTL as discontinued operations. None of these reclassifications had an impact on reported financial
position or cash flows for any of the periods presented.
Use of Estimates
The preparation of the consolidated financial
statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the reported amounts
of revenues and expenses during the reporting periods. Estimates are adjusted to reflect actual experience when necessary. Significant
accounting estimates reflected in the Company’s consolidated financial statements include revenue recognition, allowance
for doubtful accounts, warranty obligation, warrants liability, stock-based compensation and useful lives of intangible assets,
and property and equipment. Actual results could differ from those estimates.
Cash and Cash
Equivalents
Cash and cash equivalents consist of cash
on hand and highly liquid investments which are unrestricted as to withdrawal or use, and which have maturities of three months
or less when purchased. The Company maintains uninsured cash and cash equivalents with various financial institutions mainly in
the PRC and the United States.
Accounts Receivable
Accounts receivable are recorded at net
realizable value. Accounts receivable terms typically are 60-180 days from the end of the month in which services are provided
or goods are delivered. Our typical trade receivable terms vary based on the type of customer. We generally require 100% prepayment
before delivering our products to individual clients. Our contract terms general require 10%-30% prepayment for our hospital and
healthcare center clients, and the trade receivable term in contracts for those clients is generally between 60 and 90 days. Our
contract terms general require 10% prepayment from our distributor clients, and the trade receivable term in contracts for those
clients is generally between 60 and 180 days. With the exception of the prepayments we require in some cases, we generally do not
require collateral or other security to support accounts receivable. An allowance, if required, is based on a combination of historical
experience, aging analysis, and an evaluation of the collectability of specific accounts.
Other Receivables,
net
Other receivables primarily include advances
to employees and deposits to service providers. Management regularly reviews aging of receivables and changes in payment trends
and records a reserve when management believes collection of amounts due are at risk. Accounts considered uncollectible are written
off after exhaustive efforts at collection.
Advances to
Suppliers, net
The Company, as is the common practice
in the PRC, often makes advance payments to suppliers for unassembled parts. Advances to suppliers are reviewed periodically to
determine whether their carrying value has become impaired.
Fair Value
of Financial Instruments
The carrying amounts reported in the consolidated
financial statements for current assets and current liabilities approximate fair value due to the short-term nature of these financial
instruments.
The Company follows the provisions of ASC
820-10, “Fair Value Measurements and Disclosures,” which establishes a single authoritative definition of fair value
and a framework for measuring fair value and expands disclosure of fair value measurements for both financial and nonfinancial
assets and liabilities. This standard defines fair value, provides guidance for measuring fair value and requires certain disclosures.
This standard does not require any new fair value measurements, but discusses valuation techniques, such as the market approach
(comparable market prices), the income approach (present value of future income or cash flows) and the cost approach (cost to replace
the service capacity of an asset or replacement cost). For purposes of ASC 820-10-15, nonfinancial assets and nonfinancial liabilities
would include all assets and liabilities other than those meeting the definition of a financial asset or financial liability as
defined in ASC 820-10-15-15-1A.
The Company adopted the provisions of ASC
Topic 815 (formerly Emerging Issue Task Force 07-5), “Determining Whether an Instrument (or an Embedded Feature) is indexed
to an Entity’s Own Stock.” ASC Topic 815 provides a framework for determining whether an instrument is indexed to an
entity’s own stock. ASC Topic 815 became effective for the Company this period when warrants were issued in connection with
the Company’s initial public offering (“IPO”). Such warrants are indexed to the Company’s common shares,
which is traded in US dollars. Since the Company’s functional currency is the RMB, such warrants are considered liabilities.
The fair value of the warrant liabilities is measured each reporting period with the resulting change in fair value recorded in
the statement of operations. An increase of the warrants liability due to a change in fair value would decrease net income and
earnings per share. A decrease in warrants liability due to a change in fair value would increase net income and earnings per share
of the Company.
Inventories
Inventories are stated at the lower of
cost or market and consist of assembled and unassembled parts relating to medical devices. The Company reviews its inventory annually
for possible obsolete goods and to determine if any reserves are necessary.
Property and
Equipment
Property and equipment are recorded at
cost less accumulated depreciation. Depreciation is calculated on a straight-line basis over the following estimated useful lives
before July 31, 2016:
Leasehold improvements
|
Shorter of the useful lives or the lease term
|
Building and land use rights
|
20-40 years
|
Machinery and equipment
|
10-15 years
|
Furniture and office equipment
|
5 years
|
Motor vehicles
|
5 years
|
Depreciation is calculated on a straight-line
basis over the following estimated useful lives after July 31, 2016:
Leasehold improvements
|
Shorter of the useful lives or the lease term
|
Building and land use rights
|
20-40 years
|
Machinery and equipment
|
3 years
|
Furniture and office equipment
|
3 years
|
Motor vehicles
|
5 years
|
Intangible
Assets
Intangible assets are recorded at cost
less accumulated amortization. Amortization is calculated on a straight-line basis over the following estimated useful lives:
Leasehold improvements
|
Shorter of the useful lives or the lease term
|
Software copyrights
|
20 years
|
Other software
|
5 years
|
Revenue Recognition
The Company recognizes revenues when all
the followings conditions have been satisfied:
|
·
|
Persuasive evidence of an arrangement exists;
|
|
·
|
Delivery and/or installation has occurred (e.g., risks
and rewards of ownership has passed);
|
|
·
|
The sales price is fixed or determinable; and
|
|
·
|
Collectability is reasonably assured.
|
All revenues are based on firm customer
orders with fixed terms and conditions. Because the products are assembled to the customers’ specification, there is no right
of return. The Company does not provide its customers with price protection or cash rebates. For products that include software,
the software is an off-the-shelf package and an integral part of the products being delivered. The Company does not provide any
significant post-sale customer support services and does not provide customers with upgrades. The software is incidental to the
product as a whole. For products that do not require installation, revenues are recognized when the products are delivered. For
products that require installation, revenues are recognized when the installation is completed.
Cost of Revenue
Cost of revenue primarily includes wages
to assemble parts and the costs of unassembled parts, handling charges, impairment loss, and other expenses associated with the
assembly and distribution of products.
Service Income
and Expense
Service income and expense represent activities
related to repair services provided to the customers by BDL, and the commission fee from customers.
Foreign Currency
Translation
The accounts of Lianluo Smart, BDL, BTL
and Breathcare are measured using the currency of the primary economic environment in which the entity operates (the “functional
currency”). The accompanying consolidated financial statements are presented in US dollars. Foreign currency transactions
are translated into US dollars using fixed exchange rates in effect at the time of the transaction. Generally, foreign exchange
gains and losses resulting from the settlement of such transactions are recognized in the consolidated statements of income and
comprehensive income. The foreign currency accounts of BDL and BTL are translated in accordance with ASC 830-10, “Foreign
Currency Matters”. Assets and liabilities are translated at applicable exchange rates quoted by the People’s Bank of
China at the balance sheet dates and revenues and expenses are translated at average exchange rates in effect during the periods.
Because cash flows are translated based on the average translating rate, amounts related to assets and liabilities reported on
the statement of cash flows will not necessary agree with changes in the corresponding balances on the balance sheets. Equity is
translated at the historical rate of exchange at the date of capital contribution. Resulting translation adjustments are recorded
as other comprehensive income (loss) and accumulated as a separate component of equity.
Termination
of the VIE agreements with Beijing Dehaier Technology Limited (“BTL”)
In accordance with ASC 810-10-40-4, a parent
shall deconsolidate a subsidiary or derecognize a group of assets specified in the preceding paragraph as of the date the parent
ceases to have a controlling financial interest in that subsidiary or group of assets.
ASC 810-10-55-4A also states that all of
the following are circumstances that result in deconsolidation of a subsidiary under ASC 810-10-40-4:
|
a.
|
A parent sells all or part of its ownership interest in its subsidiary, and as a result, the parent
no longer has a controlling financial interest in the subsidiary.
|
|
b.
|
The expiration of a contractual agreement that gave control of the subsidiary to the parent.
|
|
c.
|
The subsidiary issues shares, which reduces the parent’s ownership interest in the subsidiary
so that the parent no longer has a controlling financial interest in the subsidiary.
|
|
d.
|
The subsidiary becomes subject to the control of a government, court, administrator, or regulator.
|
As the result, on July 31, 2016, the Company
deconsolidated BTL from its consolidated financial statements upon termination of the VIE agreement with BTL.
Income Taxes
The Company uses the asset and liability
method of accounting for income taxes in accordance with ASC 740-10, “Accounting for Income Taxes.” Under this method,
income tax expense is recognized for the amount of: (i) taxes payable or refundable for the current year; and, (ii) deferred tax
consequences of temporary differences resulting from matters that have been recognized in an entity’s financial statements
or tax returns. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in
the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities
of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation
allowance is provided to reduce the deferred tax assets reported if, based on the weight of available positive and negative evidence,
it is more likely than not that some portion or all of the deferred tax assets will not be realized.
ASC 740-10 prescribes a recognition threshold
and measurement attribute for the financial statement recognition of a tax position taken or expected to be taken on a tax return.
Under ASC 740-10, a tax benefit from an uncertain tax position taken or expected to be taken may be recognized only if it is “more
likely than not” that the position is sustainable upon examination, based on its technical merits. The tax benefit of a qualifying
position under ASC 740-10 would equal the largest amount of tax benefit that is greater than 50% likely of being realized upon
ultimate settlement with a taxing authority having full knowledge of all the relevant information. A liability (including interest
and penalties, if applicable) is established in the financial statements to the extent a current benefit has been recognized on
a tax return for matters that are considered contingent upon the outcome of an uncertain tax position. Related interest and penalties,
if any, are included as components of income tax expense and income taxes payable. The Company had filed its 2008 and 2009 Value
Added Tax (“VAT”) returns for some of its customers during the years ended December 31, 2013, 2014 and 2015. All the
potential VAT liabilities on these VAT returns occurred in current period were also accrued as incurred and included in the accompanying
consolidated financial statements.
Stock-Based
Compensation
The Company follows the provisions of ASC
718-10, “Compensation-Stock Compensation.” The Company has a share incentive plan which authorizes the issuance of
up to 10% of the number of shares outstanding. Pursuant to the plan, the Company may issue options to purchase its common shares
to employees and directors of the Company and its affiliates. The Company fair values share-based awards granted under the plan.
Accordingly, compensation is measured on the grant date using appropriate valuation models.
|
C.
|
Research and Development
|
Our success to date has in part resulted
from our strong research and development capabilities, which allow us to regularly introduce new and more advanced products at
competitive prices. Research and development costs from continuing operations were $1,196,161, $1,918,446 and $100,199 for the
years ended December 31, 2016, 2015 and 2014, respectively. Research and development costs from the discontinued operations were
$0, $580,216 and $515,135 for the years ended December 31, 2016, 2015 and 2014, respectively. Our research and development team
consists of 5 engineers, representing 11% of our employees as of December 31, 2016.
We are enhancing our research and development
ability by cooperating with the research institutes of two top ranking Universities in China: Beijing University of Aeronautics &
Astronautics and Beijing University of Technology and Science.
The information provided under Item 5.B,
"Business Overview" details the Company’s research and development activities.
In 2011, the Chinese Ministry of Science
and Technology announced a medical technology development policy under the “12th Five-Year Plan,” proposing to transfer
business focus to the development of new drugs, medical equipment and advanced traditional Chinese medicine, and to the development
of the emerging industries of biomedicine. The plan focuses on researching and developing the medium and high-level diagnostic
and curative medical devices which are in high demand and widely used, actively promoting the development of cost-effective medical
devices for use in primary health care institutions, enhancing the stability and reliability of medical services and products and
researching and developing supplementary medical equipment which can be easily operated for family and self-healthcare. Under the
12th Five-Year Plan, China will proactively promote the reform of healthcare infrastructure system and offer safe, effective, convenient
and low-cost medical services to its residents. As a result, management anticipates growth in the Chinese pharmaceutical market.
Current medical device purchases by individuals
in China are much lower than they are in Europe and the U.S. It is estimated that 20% of individual expenditures on home medical
care in China are for medical devices, compared to 50% of such expenditures in Europe and the U.S. As China’s population
continues to age, management expects a rapid increase in demand for medical devices, and, as a result, growth in China’s
medical device industry.
It is the initial stage of rapid growth
of China’s home medical equipment market. As residents’ living standards and consumption structure change, the demand
for healthcare services and self-care will substantially increase, creating growth opportunities for participants in the market.
In summary, as a vital component of China’s
current health system reform, the medical device industry has been incorporated into the national strategic development plan. In
2017, we anticipate new opportunities and combined with favorable government policies, it will position us for continued growth
in medical device industry.
In spite of these new opportunities, we
believe the landscape in China’s medical device industry is shifting, and we have taken steps to change focus accordingly.
We have seen eroding profit margins on our traditional medical device sales, which we believe is due to a combination of increasingly
available high technology and more transparent pricing models. As a result, we reduced our reliance on the traditional medical
device industry, and shifted our main business to smart medical wearable device, smart device and smart ecosystem platform. We
believe these industries are relatively immature in China and believe this status allows significant growth potential in the near
term. We are, however, aware that as the market matures, we should expect to see more transparency in pricing and margin erosion
as well.
Ministry of Industry and Information Technology of the People’s
Republic of China and National Development
and
Reform
Commission
jointly issued Specific Project of Smart Device Industry Innovative Development(2016-2018) on September 19, 2016 to support the
improvement of Chinese smart technology and supply of advanced product. With the development of "Internet+ Healthcare"
and the acceleration of "Healthy China", the medical wearable device industry is hopefully entering a rapid development
period.
Meanwhile, medical wearable devices are expected to be the most
favorable industry in the whole wearable devices market. Nowadays many companies are positively distributing in medical industry
through acquisition or release of related medical wearable devices to enlarge their market shares in medical industry. The fast
development in medical wearable device industry has drawn great attention. Many leading companies and medium and small sized innovative
companies, entrepreneurs and investors are entering medical wearable device industry. According to statistics, the scale of Chinese
medical wearable device market has grown from more than $300 million(RMB 2.2 billion) in 2014 to about $3.3 billion(RMB 22.8 billion)
in 2016, and it is estimated that the scale would reach $4.3 billion(RMB 30 billion) in 2017.
After rapid growth in 2015, the smart device market kept increasing
in 2016. The scale of the market broke $7.9 billion(RMB 55.2 billion) in 2016 from $6 billion(RMB 42.4 billion) in 2015, and is
estimated to reach $10.2 billion(RMB 71.6 billion) in 2017.
From the industry level, the scale of the smart device market
is still rapidly growing, and large companies will continue to extend their smart ecosystem. Benefitting from the maturation of
the platform, medium and small sized companies will be more concentrated on products.
From product level, optimization of connection and interactive
mode is the key point of smart device growth. Smart home will continuously be the hotspot of growth. User engagement with smart
products is closely related to its practicability. Simple and multiple interactive modes are able to meet users' demands more efficiently.
The ultimate value of smart product is
to serve users. To integrate advantages of other industries and join smart devices up with more third-party service is the key
point of service expansion. With cooperation with traditional enterprises, smart device will rapidly reach out to customers from
concept, and bring smart life to people. With the molding of platform and ecosystem, and the birth of new technologies, e.g. virtual
reality, the life style of more users will change, and the time of smart life will come.
|
E.
|
Off-Balance Sheet Arrangements
|
We have not entered into any financial
guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative
contracts that are indexed to our shares and classified as shareholder’s equity or that are not reflected in our consolidated
financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated
entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated
entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development
services with us.
|
F.
|
Tabular Disclosure of Contractual Obligations
|
The following table sets forth our contractual
obligations as of December 31, 2016:
|
|
Payments Due By Period
|
|
|
|
Less than
|
|
|
More than
|
|
|
|
Total
|
|
|
1 Year
|
|
|
1-3 Years
|
|
|
3-5 Years
|
|
|
5 Years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Lease Obligations
|
|
$
|
151,097
|
|
|
$
|
78,833
|
|
|
$
|
72,264
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Total
|
|
$
|
151,097
|
|
|
$
|
78,833
|
|
|
$
|
72,264
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
Item 6.
|
Directors,
Senior Management and Employees
|
|
A.
|
Directors and Senior Management
|
The following table sets forth our executive
officers and directors, their ages and the positions held by them:
Name
|
|
Age
|
|
Position Held
|
Zhitao He
|
|
35
|
|
Chairman and Director
|
Ping Chen
(1)(2)
|
|
54
|
|
Chief Executive Officer and Director
|
Hui Zhou
(1)(3)
|
|
34
|
|
Chief Financial Officer
|
Richard Zhiqiang Chang
(1)(3)(4)(5)(6)
|
|
54
|
|
Independent Director
|
Bin Pan
(1)(4)(5)(6)(7)
|
|
44
|
|
Independent Director
|
Mingwei Zhang
(1)(4)(5)(6)(7)6)(7)
|
|
64
|
|
Independent Director
|
|
(1)
|
The individual’s business address is Room 2108, 21th Floor, China Railway Construction Building, No. 20 Shijingshan Road, 100040, Beijing, China.
|
|
(2)
|
Class III director whose term expires in 2019.
|
|
(3)
|
Class II director whose term expires in 2018.
|
|
(4)
|
Member of audit committee.
|
|
(5)
|
Member of compensation committee.
|
|
(6)
|
Member of nominating committee.
|
|
(7)
|
Class I director whose term expires in 2017.
|
Zhitao He
. Mr. He has served as the Company chairman
and director since October 2016. Mr. Zhitao He is also the Chairman of the Board of Lianluo Interactive, a China-listed company.
Mr. Zhitao He successfully led Lianluo Interactive to list on China’s A share market (ticker: 002280). Mr. Zhitao He was
named one of the "10 Top Entrepreneurs of Post-1980s" by Hurun Report and "Top Ten Entrepreneurial Leader of Listed
Companies" by Securities Times. In the past two years, under his leadership, Lianluo Interactive has moved into the field
of smart hardware, including the purchase of leading American electronics online retailer Newegg(http://www.newegg.com), investments
in American virtual reality ("VR") device manufacturer Avegant(
www.avegant.com
)
and hardware corporation Razer(http://www.razerzone.com), and promotion of the world's biggest VR Operating System OSVR in China
together with Razer. This investment plan has allowed Lianluo Interactive to become a closed loop of "Software and Hardware
+ Platform + Channels".
Ping Chen.
Mr. Chen has served as a director
of our Company since 2003 and our Chief Executive Officer since 2000. Prior to his service as our Chief Executive Officer, from
1993 to 2000, Mr. Chen served as the CEO of Beijing Chengcheng Medical Electronic Equipment Co. Prior to 1993, Mr. Chen
served as an engineer at the No. 2 Academy, Ministry of Aeronautics and Astronautics from 1987 to 1991 and moved up to the
Head of the Civilian Products Division there from 1991 to 1993. Mr. Chen founded BTL in 2001 and has served as CEO since that
time. Mr. Chen received his bachelor’s degree in 1984 from the National University of Defense Technology and his master’s
degree in 1987 from the Ministry of Aeronautics and Astronautics. Mr. Chen has been chosen as a director because he is our
CEO, the leader of our Company and a key experienced member of management.
Hui (Cherry) Zhou
. Ms. Zhou has served as our Chief
Financial Officer since October 2016. Ms. Zhou possesses 9 years ’audit experience in big 4 accounting firm and 8 months’
accounting manager experience. Skilled in financial reporting, analysis and internal control audit, Ms. Zhou is familiar with PRC
GAAP, US GAAP and IFRS. Ms. Zhou has participated in a few of large scale domestic listed companies, MNC’s annual audit,
H share IPO audit and NASDAQ engagements, etc. Ms. Zhou possesses high sense of responsibility, good communication skills, team
spirit and team management capacity. She got Intermediate accountant certificate, CPA qualification and the qualification of securities.
Ms. Zhou earned a Bachelor degree in ZhongNan University of Economics and Law in Accounting in June 2005. Ms. Zhou has been chosen
to serve as the company CFO because of her professional in financial matters and her seasoned experience in operations.
Richard
Zhiqiang Chang
. Mr. Richard Chang has been CEO of Beijing Zhineng Technology Co., Ltd. in Beijing China since October 2015.
Prior to that position, he served as a Key Account Manager and Business VP at AREVA Inc. in Beijing, China from 2013 through October
2015 and Chief Representative and Regional VP at Ventyx Inc. in Atlanta, Georgia from July 2009 to July 2013. Mr. Chang earned
a master’s degree in computer science in 1997 from the University of Texas as Dallas, a master’s degree in automation
in 1990 from Shanghai Jiaotong University and a bachelor’s degree in automation in 1985 from the same school.
Bin Pan.
Mr. Pan has served
as a company independent director since October, 2016. Mr. Bin Pan is the Chairman of Shanghai Hubo Investment Management Co.,
Ltd. He is also the independent director of Hangzhou Lianluo Interactive Information Technology Co. Ltd., Shanghai Yaoji Playing
Card Co., Ltd, Shenzhen Prolto Supply Chain Management Co., Ltd and Shanghai Zhixin Electric Co., Ltd. Mr. Pan is a partner in
Shanghai Capital Law & Partners law firm since June 2004. He used to be the vice-president at the investment banking division
of China Southern Securities Co., Ltd. from March 1997 to June 2004. Mr. Pan earned his master’s degree in International
Economic Law from Shanghai University of International Business and Economics in 1997 and his bachelor’s degree in 1994 from
Huazhong University of Science and Technology University.
Mingwei Zhang
. Mr. Zhang has served
as an independent director of our company since 2012. Mr. Zhang has extensive knowledge and experience in accounting from the perspective
as an academic and a practicing accountant. From September 2007 to October 2013, Mr. Zhang served as Chief Financial Officer and
a Director of Sino-Global Shipping America, Ltd. (Nasdaq CM: SINO). From May 2001 until December 2007, Mr. Zhang was a partner
in Baker Tilly China, an international public accounting firm. From July 1994 to June 2003, he served as a Lecturer at Monash University
in Australia. Mr. Zhang received a Bachelor’s degree and a Master’s degree in Accounting from Tianjin University of
Finance and Economics. He also received a Master’s degree in Commerce from the University of Newcastle. Mr. Zhang is a Certified
Management Accountant in Australia. Mr. Zhang has been chosen as a director because of his financial experience.
Executive Compensation
The following table shows the annual compensation
paid by us for the year ended December 31, 2016 to Ping Chen, our principal executive officer, and Hui Zhou, our principal
financial officer.
Summary Executive Compensation Table
Name and principal position
|
|
Salary
|
|
|
Bonus
|
|
|
Option
Awards
|
|
|
All Other
Compensation
|
|
|
Total
|
Ping Chen,
Principal Executive Officer
|
|
$
|
24,292
|
|
|
$
|
1,143
|
|
|
$
|
396,430
|
(1)(2)(3)(4)(5)
|
|
$
|
-
|
|
|
$421,865
|
Hui (Cherry) Zhou
Chief Financial Officer
|
|
$
|
3,612
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$3,612
|
|
(1)
|
On December 29, 2011, 150,000 share options were awarded to Mr. Chen, which vest over a period
of five years. The expiration date of the options is December 29, 2021. The options’ exercise price is the market price of
our shares on December 29, 2011, the date the options were granted. The grant date fair value of the options is $1.222 per underlying
share. These options granted in 2011 are not reflected in the Summary Executive Compensation Table. We have amortized $36,460 of
such grant in the year ended December 31, 2016.
|
|
(2)
|
On October 7, 2013, 94,000 share options were awarded to Mr. Chen, which vest over a period of
five years. The expiration date of the options is October 7, 2023. The options’ exercise price is the market price of our
shares on October 7, 2013, the date the options were granted. The grant date fair value of the options was $2.23 per underlying
share. These options granted in 2013 are not reflected in the Summary Executive Compensation Table. We have amortized $42,030 of
such grant in the year ended December 31, 2016.
|
|
(3)
|
On August 20, 2014, 131,000 share options were awarded to Mr. Chen, which vest over a period of
five years. The expiration date of the options is August 20, 2024. The options’ exercise price is the market price of our
shares on August 20, 2014, the date the options were granted. The grant date fair value of the options was $5.15 per underlying
share. These options granted in 2014 are not reflected in the Summary Executive Compensation Table. We have amortized $135,284
of such grant in the year ended December 31, 2016.
|
|
(4)
|
On July 30, 2015, 348,800 ordinary shares were issued to Mr. Chen. The grant date fair value of
the ordinary shares was $1.96 per share. We have amortized $333,104 of such grant in the year ended December 31, 2016.
|
|
(5)
|
On March 21, 2016, 210,867 share options were awarded to Mr. Chen, which vest over a period of
two years. The expiration date of the options is March 21, 2026. The options’ exercise price is the market price of our shares
on August 20, 2014, the date the options were granted. The grant date fair value of the options was $1.88 per underlying share
and is reflected in the Summary Executive Compensation Table, even though not all options have vested. We have amortized $197,175
of such grant in the year ended December 31, 2016.
|
Director Compensation
All directors hold office until the next
annual meeting of shareholders at which their respective class of directors is re-elected or until their successors have been duly
elected and qualified. There are no family relationships among our directors or executive officers. Officers are elected by and
serve at the discretion of the Board of Directors. We do not separately set aside any amounts for pensions, retirement or other
benefits for our executive officers, other than pursuant to relevant statutory requirements. Employee directors do not receive
any compensation for their services as directors. Non-employee directors are entitled to receive payment for serving as directors
and may receive option grants from our company. For service on our Board of Directors, Mr. Zhang receives $4,000 per year, and
Mr. Richard Zhiqiang Chang and Mr. Bin Pan receive $8,000 annually. The following table shows the annual compensation paid by us
for the year ended December 31, 2016 to our directors.
Summary Director Compensation Table
Name
|
|
Fees earned or
paid
in cash
|
|
|
Stock-based
Compensation
|
|
|
Total
(1)
|
|
Zhitao He
(2)
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
0
|
|
Ping Chen
(3)
|
|
$
|
N/A
|
|
|
$
|
N/A
|
|
|
$
|
N/A
|
|
Huili (Alisa) Li
(3)(4)
|
|
|
N/A
|
|
|
$
|
N/A
|
|
|
|
N/A
|
|
Xiaoguang Shen
(5)
|
|
$
|
0
|
|
|
$
|
18,650
|
|
|
$
|
18,650
|
|
Genhui Chen
(6)
|
|
$
|
6,000
|
|
|
$
|
37,300
|
|
|
$
|
43,300
|
|
Mingwei Zhang
(7)
|
|
$
|
8,000
|
|
|
$
|
55,951
|
|
|
$
|
63,951
|
|
Bin Pan
(2)
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
0
|
|
Richard Zhiqiang Chang
(2)
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
0
|
|
(1)
|
During 2016, 5 directors received options from the 2014 Incentive Plan-Mr. Ping Chen received 210,867 options; Mr. Mingwei Zhang received 20,000 options; Mr. Xiaoguang Shen received 10,000 options; Mr. Genhui Chen received 20,000 options; Ms. Huili(Alisa) Li received 30,000 options.
|
(2)
|
Mr. Zhitao He, Mr. Bin Pan and Mr. Richard Zhiqiang Chang are newly elected directors of the Board and come into effect from October 24, 2016.
|
(3)
|
Mr. Ping Chen and Ms. Huili (Alisa) Li received compensation in their capacity as officers of our company and/or subsidiaries/affiliates but did not receive any compensation for serving as directors of our company.
|
(4)
|
Ms. Huili (Alisa) Li has resigned the Company CFO on October 24, 2016 and her granted options expired on January 23, 2017. We have amortized $44,396 of such amount in the year ended December 31, 2016
|
(5)
|
Mr. Xiaoguang Shen resigned as a director on October 24, 2016 and his granted options expired on January 23, 2017. We have amortized $17,523 of such amount in the year ended December 31, 2016.
|
(6)
|
Mr. Genhui Chen resigned as a director on October 24, 2016 and his granted options expired on January 23, 2017. We have amortized $37,962 of such amount in the year ended December 31, 2016
|
(7)
|
Mr. Mingwei Zhang received 11,975 common shares on June 16, 2014 from the company pursuant to the director compensation plan. We have amortized $0 of such amount in the year ended December 31, 2016. Mr. Mingwei Zhang received a grant of options to purchase 20,000 shares from the company on August 7, 2015, of which 50% has vested as of December 31, 2016. The expiration date of the options is August 7, 2025. The options’ exercise price is the market price of our shares on the date the options were granted. The grant date fair value of the options was $1.63 per underlying share. We have amortized $16,344 of such amount in the year ended December 31, 2016. Mr. Mingwei Zhang received a grant of options to purchase 20,000 shares from the company on March 21, 2016, of which 0% has vested as of December 31, 2016. The expiration date of the options is August 7, 2026. The options’ exercise price is the market price of our shares on the date the options were granted. The grant date fair value of the options was $1.87 per underlying share. We have amortized $28,052 of such amount in the year ended December 31, 2016.
|
See information provided in response to
Item 6.A. above as to the current directors and officers and the expiration of current director terms. In addition, the service
agreements between us and the directors do not provide benefits upon termination of their services.
Board of Directors and Board Committees
Our board of directors currently consists
of 5 directors. There are no family relationships between any of our executive officers and directors. The directors are divided
into three classes. Class I directors shall face re-election at our annual general meeting of shareholders in 2017 and every three
years thereafter. Class II directors shall face re-election at our annual general meeting of shareholders in 2018 and every three
years thereafter. Class III directors shall face re-election at our annual general meeting of shareholders in 2019 and every three
years thereafter.
A director may vote in respect of any contract
or transaction in which he is interested, provided, however that the nature of the interest of any director in any such contract
or transaction shall be disclosed by him at or prior to its consideration and any vote on that matter. A general notice or disclosure
to the directors or otherwise contained in the minutes of a meeting or a written resolution of the directors or any committee thereof
of the nature of a director’s interest shall be sufficient disclosure and after such general notice it shall not be necessary
to give special notice relating to any particular transaction. A director may be counted for a quorum upon a motion in respect
of any contract or arrangement which he shall make with our company, or in which he is so interested and may vote on such motion.
There are no membership qualifications for directors. Further, there are no share ownership qualifications for directors unless
so fixed by us in a general meeting.
The Board of Directors maintains a majority
of independent directors who are deemed to be independent under the definition of independence provided by NASDAQ Stock Market
Rule 4200(a)(15). Mr. Chang, Mr. Zhang and Mr. Pan are our independent directors.
We do not have a lead independent director
because of the foregoing reason and also because we believe our independent directors are encouraged to freely voice their opinions
on a relatively small company board. We believe this leadership structure is appropriate because we are a smaller reporting company.
Board Committees
Currently, three committees have been established
under the board: the audit committee, the compensation committee and the nominating committee. The audit committee is responsible
for overseeing the accounting and financial reporting processes of our company and audits of the financial statements of our company,
including the appointment, compensation and oversight of the work of our independent auditors. The compensation committee of the
board of directors reviews and makes recommendations to the board regarding our compensation policies for our officers and all
forms of compensation, and also administers our incentive compensation plans and equity-based plans (but our board retains the
authority to interpret those plans). The nominating committee of the board of directors is responsible for the assessment of the
performance of the board, considering and making recommendations to the board with respect to the nominations or elections of directors
and other governance issues. The nominating committee considers diversity of opinion and experience when nominating directors.
Duties of Directors
Under British Virgin Islands law, our directors
have a duty to act honestly, in good faith and with a view to our best interests. Our directors also have a duty to exercise the
care, diligence and skills that a reasonably prudent person would exercise in comparable circumstances. In fulfilling their duty
of care to us, our directors must ensure compliance with our third amended and restated memorandum and articles of association.
We have the right to seek damages if a duty owed by our directors is breached. The functions and powers of our board of directors
include, among others:
|
•
|
appointing officers and determining the term of office
of the officers;
|
|
•
|
authorizing the payment of donations to religious,
charitable, public or other bodies, clubs, funds or associations as deemed advisable;
|
|
•
|
exercising the borrowing powers of the company and
mortgaging the property of the company;
|
|
•
|
executing checks, promissory notes and other negotiable
instruments on behalf of the company; and
|
|
•
|
maintaining or registering a register of mortgages,
charges or other encumbrances of the company.
|
Limitation of Director
and Officer Liability
British Virgin Islands law does not limit
the extent to which a company’s memorandum and articles of association may provide for indemnification of officers and directors,
except to the extent any such provision may be held by the British Virgin Islands courts to be contrary to public policy, such
as to provide indemnification against civil fraud or the consequences of committing a crime.
Under our third amended and restated memorandum
and articles of association, we may indemnify our directors, officers and liquidators against all expenses, including legal fees,
and against all judgments, fines and amounts paid in settlement and reasonably incurred in connection with civil, criminal, administrative
or investigative proceedings to which they are party or are threatened to be made a party by reason of their acting as our director,
officer or liquidator. To be entitled to indemnification, these persons must have acted honestly and in good faith with a view
to the best interest of the company and, in the case of criminal proceedings, they must have had no reasonable cause to believe
their conduct was unlawful.
Insofar as indemnification for liabilities
arising under the Securities Act may be permitted for our directors or officers under the foregoing provisions, we have been informed
that in the opinion of the SEC, such indemnification is against public policy as expressed in the Securities Act and is therefore
unenforceable as a matter of United States law.
Involvement in
Certain Legal Proceedings
To the best of our knowledge, none of our
directors or executive officers has been convicted in a criminal proceeding, excluding traffic violations or similar misdemeanors,
or has been a party to any judicial or administrative proceeding during the past ten years that resulted in a judgment, decree
or final order enjoining the person from future violations of, or prohibiting activities subject to, federal or state securities
laws, or a finding of any violation of federal or state securities or commodities laws, any laws respecting financial institutions
or insurance companies, any law or regulation prohibiting mail or wire fraud in connection with any business entity or been subject
to any disciplinary sanctions or orders imposed by a stock, commodities or derivatives exchange or other self-regulatory organization,
except for matters that were dismissed without sanction or settlement.
There are no other arrangements or understandings
pursuant to which our directors are selected or nominated.
There are no family relationships among
any of the persons named above, and there are no arrangements or understandings with major shareholders, customers, suppliers or
others, pursuant to which any such person was selected as a director or member of senior management.
As of December 31, 2016, we had 66 employees,
all of whom were full-time employees and were based in China. We believe that our relations with our employees are good. We have
never had a work stoppage, and our employees are not subject to a collective bargaining agreement. As of December 31, 2016, 2015
and 2014, we had 66, 89 and 107 employees, respectively.
|
|
|
|
|
December 31,
|
|
|
|
|
|
|
2014
|
|
|
2015
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
107
|
|
|
|
89
|
|
|
|
66
|
|
Mid and high level Manager
|
|
|
29
|
|
|
|
26
|
|
|
|
25
|
|
Sales
|
|
|
50
|
|
|
|
46
|
|
|
|
22
|
|
R&D and Customization
|
|
|
9
|
|
|
|
7
|
|
|
|
5
|
|
Assembly and Procurement
|
|
|
19
|
|
|
|
10
|
|
|
|
14
|
|
The following table sets forth information
with respect to beneficial ownership of our common shares as of April 28, 2017 by:
|
•
|
Each of our directors and named executive officers;
and
|
|
•
|
All directors and named executive officers as a group.
|
The number and percentage of common shares
beneficially owned are based on 17,312,586 common shares outstanding as of April 28, 2017. Information with respect to beneficial
ownership has been furnished by each director and officer. Beneficial ownership is determined in accordance with the rules of the
SEC and generally requires that such person have voting or investment power with respect to securities. In computing the number
of common shares beneficially owned by a person listed below and the percentage ownership of such person, common shares underlying
options, warrants or convertible securities held by each such person that are exercisable or convertible within 60 days of April
28, 2017 are deemed outstanding, but are not deemed outstanding for computing the percentage ownership of any other person. Except
as otherwise indicated in the footnotes to this table, or as required by applicable community property laws, all persons listed
have sole voting and investment power for all common shares shown as beneficially owned by them. Unless otherwise indicated in
the footnotes, the address for each principal shareholder is in the care of BDL, Room 2108, 21st Floor, China Railway Construction
Building, No. 20 Shijingshan Road, 100040, Beijing, China.
Named Executive Officers and Directors
|
|
Amount of
Beneficial
Ownership
(1)
|
|
|
Percentage
Ownership
(2)
|
|
Ping Chen, CEO, Director
|
|
|
1,812,342
|
(3)
|
|
|
9.32
|
%
|
|
|
|
|
|
|
|
|
|
Genhui Chen
|
|
|
8,000
|
(4)
|
|
|
*
|
|
Mingwei Zhang
|
|
|
21,975
|
(5)
|
|
|
*
|
|
Xiaoguang Shen
|
|
|
0
|
(6)
|
|
|
*
|
|
Huili (Alisa) Li
|
|
|
0
|
(7)
|
|
|
*
|
|
|
|
|
|
|
|
|
|
|
All officers and directors as a group
|
|
|
1,834,317
|
|
|
|
9.39
|
%
|
Chen Ping Ltd.
|
|
|
1,812,342
|
|
|
|
9.32
|
%
|
Hangzhou Lianluo Interactive Information Technology Co., Ltd.
|
|
|
12,111,111
|
|
|
|
64.18
|
%
|
|
(1)
|
Beneficial ownership is determined in accordance with
the rules of the SEC and includes voting or investment power with respect to the common shares.
|
|
(2)
|
We have used 17,312,586 outstanding shares for all calculations
in this table and have not increased the number of shares outstanding to account for such shares underlying such securities in
calculating percentage ownership.
|
|
(3)
|
Represents (a) 1,104,742 shares owned by Chen Ping Ltd.;
(b) vested options to purchase 90,000 shares for an exercise price of $1.45 per share that were granted on December 29, 2011;
(c) vested options to purchase 56,400 shares for an exercise price of $2.30 per share that were granted on October 7, 2013; (d)
vested options to purchase 52,400 shares for an exercise price of $5.31 per share that were granted on August 20, 2014; (e) 100,000
shares issued on August 20, 2014; and (f) 348,800 shares granted on December 3, 2015 that are subject to full or partial forfeiture
in the event Mr. Chen does not remain an officer or director of our Company for two years after the date of grant. (g) 60,000
options that have been transferred into common shares for an exercise price of $1.45 per share that were granted on December 29,
2011. These numbers do not include (i) unvested options to purchase 37,600 shares for an exercise price of $2.30 per share that
were granted on October 7, 2013; (ii) unvested options to purchase 78,600 shares for an exercise price of $5.31 per share that
were granted on August 20, 2014; or (iii) unvested options to purchase 210,867 shares for an exercise price of $1.88 per share
that were granted on March 21, 2016.
|
|
(4)
|
Represents (a) vested options to purchase 8,000 shares
for an exercise price of $1.45 per share that were granted on December 29, 2011 and (b) not include vested options to purchase
12,000 shares for an exercise price of $1.45 per share that were granted on December 29, 2011 and vested options to purchase 10,000
shares for an exercise price of $1.64 per share that were granted on August 7, 2015 which have been invalid since his resignation
in October 2016.
|
|
(5)
|
Represents (a) 11,975 shares issued on June 16, 2014
and (b) vested options to purchase 10,000 shares for an exercise price of $1.64 per share that were granted on August 7, 2015.
These numbers do not include (i) unvested options to purchase 10,000 shares for an exercise price of $1.64 per share that were
granted on August 7, 2015; and (ii) unvested options to purchase 20,000 shares for an exercise price of $1.88 per share that were
granted on March 21, 2016.
|
|
(6)
|
Represents (a) Vested options to purchase 5,000 shares
for an exercise price of $1.64 per share that were granted on August 7, 2015 and (b) unvested options to purchase 5,000 shares
for an exercise price of $1.64 per share that were granted on August 7, 2015; and (c) unvested options to purchase 10,000 shares
for an exercise price of $1.88 per share that were granted on March 21, 2016 have all been invalid since his resignation in October
2016.
|
|
(7)
|
Represents (a) Vested options to purchase 10,000 shares
for an exercise price of $1.64 per share that were granted on August 7, 2015. (b) unvested options to purchase 10,000 shares for
an exercise price of $1.64 per share that were granted on August 7, 2015; and (c) unvested options to purchase 30,000 shares for
an exercise price of $1.88 per share that were granted on March 21, 2016 have all been invalid since her resignation in October
2016.
|
Share Option Plan and Grants
In 2009, in connection with our initial
public offering, we established a pool for share options for our employees (the “2009 Share Incentive Plan”). This
pool contains options to purchase up to 450,000 of our common shares. The options will vest at a rate of 20% per year for
five years and have an exercise price of the market price of our shares on the date the options are granted. As of the date of
this report, we have issued all 450,000 options pursuant to our 2009 Share Incentive Plan.
In 2013, we established our 2013 Share
Incentive Plan. This pool allows us to issue options, common shares and other securities exercisable or convertible into, in the
aggregate, 462,000 of our common shares. As of the date of this report, we have issued 113,200 options pursuant to our 2013 Share
Incentive Plan.
In 2014, we established our 2014 Share
Incentive Plan. This pool allows us to issue options, common shares and other securities exercisable or convertible into, in the
aggregate, 466,800 of our common shares. As of the date of this report, we have issued 366,800 options pursuant to our 2014 Share
Incentive Plan.
In 2015, we established our 2015 Share
Incentive Plan. This pool allows us to issue options, common shares and other securities exercisable or convertible into, in the
aggregate, 580,867 of our common shares. As of the date of this report, we have issued 580,867 options pursuant to our 2015 Share
Incentive Plan.
|
Item 7.
|
Major Shareholder and Related Party Transactions
|
The following table sets forth information
with respect to beneficial ownership of our common shares as of April 28, 2017 by each person who is known by us to beneficially
own 5% or more of our outstanding common shares. The number and percentage of common shares beneficially owned are based on 17,312,586
common shares outstanding as of April 28, 2017. Information with respect to beneficial ownership has been furnished by each director,
officer or beneficial owner of 5% or more of our common shares. Beneficial ownership is determined in accordance with the rules
of the SEC and generally requires that such person have voting or investment power with respect to securities. In computing the
number of common shares beneficially owned by a person listed below and the percentage ownership of such person, common shares
underlying options, warrants or convertible securities held by each such person that are exercisable or convertible within 60 days
of April 28, 2017 are deemed outstanding, but are not deemed outstanding for computing the percentage ownership of any other person.
Except as otherwise indicated in the footnotes to this table, or as required by applicable community property laws, all persons
listed have sole voting and investment power for all common shares shown as beneficially owned by them. Unless otherwise indicated
in the footnotes, the address for each principal shareholder is in the care of BDL, Room 2108, 21st Floor, China Railway Construction
Building, No. 20 Shijingshan Road, 100040, Beijing, China. During the past three years, our major shareholder, Ping Chen, has increased
his shares of stock in the company by way of incentive grants of stock and options, and we have sold 11,111,111 shares to Hangzhou
Lianluo Interactive Information Technology Co., Ltd. None of the major shareholders have special voting rights.
Shareholder
|
|
Amount of Beneficial Ownership
(1)
|
|
|
Percentage Ownership
(2)
|
|
|
|
|
|
|
|
|
Chen Ping Ltd.
|
|
|
1,812,342
|
(3)
|
|
|
9.32
|
%
|
Hangzhou Lianluo Interactive Information Technology Co., Ltd.
|
|
|
11,111,111
|
|
|
|
64.18
|
%
|
|
(1)
|
Beneficial ownership is determined in accordance with the rules of the SEC and includes voting or investment power with respect to the common shares.
|
|
(2)
|
The number of our common shares outstanding used in calculating the percentage for each listed person excludes the common shares underlying options held by such person.
|
|
(3)
|
Ping Chen has the sole power to direct the voting and disposition of the 1,613,542 shares held by Chen Ping Ltd. The number also includes 198,800 shares underlying options, which will have vested within 60 days hereof. The shares reflected for Chen Ping Ltd. include only shares held by such company and do not include shares underlying options or shares held by Ping Chen directly.
|
As of April 28, 2017, we had five shareholders
of record, all of which were located outside of the United States and held an aggregate of 17,312,586 of our common shares, representing
100% of our outstanding common shares, and one of which was located in the United States and held an aggregate of 25.44% of our
common shares of our outstanding common shares. However, this U.S. shareholder of record is CEDE & CO., a nominee of The Depository
Trust Company. Accordingly, we believe that the shares held by CEDE & CO. include common shares beneficially owned by both
holders in the United States and non-U.S. beneficial owners.
|
B.
|
Related party transactions
|
The Company entered into related party
transactions in the fiscal years ended December 31, 2016, 2015 and 2014.
The Company’s related party transactions
include purchases of property, plant and equipment. These transactions were consummated at fair market price and under similar
terms as those with the Company's customers and suppliers.
During the years ended December 31, 2016,
2015 and 2014, the Company entered into related party transactions as shown below:
|
|
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
US$
|
|
|
US$
|
|
|
US$
|
|
Deposits for purchase of property, plant and equipment – related party
|
|
|
-
|
|
|
|
-
|
|
|
|
1,498,627
|
|
Purchases from related party
|
|
|
497
|
|
|
|
1,728,676
|
|
|
|
1,142,845
|
|
Purchases of intangible assets from related party
|
|
|
-
|
|
|
|
-
|
|
|
|
325,400
|
|
|
b.
|
Loan from related party–the director and CEO, Mr. Ping Chen
|
On March 27, 2015, the Company entered
into a new loan agreement with Mr. Ping Chen, who is the CEO and a major shareholder of the Company, in the amount of $660,679
(RMB 4,120,000) with floating interest rate which was 6.96% in 2016. The loan is due on March 27, 2016 and had been repaid on October
24, 2016 with an interest payment of approximately $29,200 or RMB 194,066.
On December 2, 2015, the Company entered
into a new loan agreement with Mr. Ping Chen in the amount of $3,207,180 (RMB 20,000,000) with no floating interest rate and maturity
date. On December 18, 2015, the Company repaid half of the loan in the amount of $1,603,590 (RMB 10,000,000). The remaining had
been repaid on October 21, 2016.
During the year ended December 31, 2016,
the Company obtained loans from its related party, Mr. Ping Chen, in an aggregate amount of $718,638 (RMB 4,775,000), with no interest
charge, which had been fully repaid on October 24, 20
16.
|
c.
|
Related party transaction with BTL
|
On January 14, 2016, the Company completed
an acquisition of 0.8% equity interest of BDL from BTL, which terminated the VIE relationship with the Company and deconsolidated
from the Company’s financial statements on July 31, 2016, for a purchase price of $146,032 or RMB 920,000. As of December
31, 2016, the Company reported an outstanding payable of $146,032 to BTL.
Before the Company terminated the VIE agreement
with BTL on July, 31, 2016, the Company had various transactions with BTL. During the year ended December 31, 2016, the Company
had the following transactions with BTL:
|
(1)
|
The Company repaid loans of $69,253 or RMB 460,151 in total to BTL, including various expenses
paid by BTL on behalf of the Company and loans from BTL from prior years. Those loans were no interest free loans. As of December
31, 2016, no outstanding balance was reported in the Company’s consolidated financial statements.
|
|
(2)
|
The Company reported a technical support expense of $9,027 or RMB 59,981 to BTL for its product
maintenance. As of December 31, 2016, no outstanding balance was reported in the Company’s consolidated financial statements.
|
|
(3)
|
The Company leased an office space from BTL with an annual rental of $36,120 or RMB 240,000. The
leasing agreement had been terminated in 2016. As of December 31, 2016, no outstanding balance was reported in the Company’s
consolidated financial statements.
|
During the year ended December 31, 2015,
the Company had the following transactions with BTL:
|
(1)
|
The Company received loans of $184,460 or RMB 1,150,000 from BTL and repaid approximately $230,976
or RMB 1,440,000 to BTL, including various expenses paid by BTL on behalf of the Company. Those loans were no interest free loans.
As of December 31, 2015, the outstanding balance of $38,792 or RMB 251,731 was reported in the Company’s consolidated financial
statements.
|
|
(2)
|
The Company leased an office space from BTL with an annual rental of $38,496 or RMB 240,000. The
leasing agreement had been terminated in 2016. As of December 31, 2015, no outstanding balance was reported in the Company’s
consolidated financial statements.
|
|
d.
|
Loan to related party — Digital Grid (Hong Kong) Technology Co., Limited
|
On December 20, 2016, the Company entered
a $2 million loan agreement with Digital Grid (Hong Kong) Technology Co., Limited, one of HLI’s subsidiaries, with a fixed
interest rate 3.5%. On December 30, 2016, the Company received the repayment and related interest in total of $2,002,110 from Digital
Grid (Hong Kong) Technology Co., Limited.
|
e.
|
Related party transaction with HLI
|
On April 28, 2016, the Company entered
into a definitive securities purchase agreement (“SPA”) with Hangzhou Lianluo Interactive Information Technology Co.,
Ltd. (“HLI”), a publicly listed company on the Shenzhen Stock Exchange, pursuant to which HLI has agreed to purchase
11,111,111 restricted common shares of the Company for an aggregate of $20,000,000. The purchase price is $1.80 per share, which
represents a 35% premium to the Company’s closing price of $1.33 on April 27, 2016. As of December 31, 2016, the Company
reported a subscription receivable of $1,492,538 from HLI which had been collected on April 13, 2017. In addition, during the years
ended December 31, 2016 and 2015, the Company made inventory purchases of $497 and $0 with HLI, respectively. As of December 31,
2016, the Company reported an outstanding payable of $475 to HLI.
|
f.
|
Interests of experts and counsel
|
Not applicable for annual reports on Form 20-F.
|
Item 8.
|
Financial Information
|
We have appended consolidated financial
statements filed as part of this annual report. See information provided in response to Item 18 below. Export sales do not constitute
a material portion of our total sales.
Legal Proceedings
From time to time, we have been involved
in litigation or other disputes. No pending or known to be contemplated legal or arbitration proceedings, including any relating
to bankruptcy, receivership or similar proceedings or involving any third party, have or are anticipated to have any significant
effect on our financial position or profitability. None of the directors or members of senior management of our Company or any
of its subsidiaries or affiliate companies is engaged in any materials proceeding adverse to our Company or any of its subsidiaries
or affiliate companies.
Dividend Policy
We have never declared or paid any cash
dividends on our common shares. We anticipate that we will retain any earnings to support operations and to finance the growth
and development of our business. Therefore, we do not expect to pay cash dividends in the foreseeable future. Any future determination
relating to our dividend policy will be made at the discretion of our Board of Directors and will depend on a number of factors,
including future earnings, capital requirements, financial conditions and future prospects and other factors the Board of Directors
may deem relevant.
Under British Virgin Islands law, we may
only pay dividends from surplus (the excess, if any, at the time of the determination of the total assets of our company over the
sum of our liabilities, as shown in our books of account, plus our capital), and we must be solvent before and after the dividend
payment in the sense that we will be able to satisfy our liabilities as they become due in the ordinary course of business; and
the realizable value of assets of our company will not be less than the sum of our total liabilities, other than deferred taxes
as shown on our books of account, and our capital.
If we determine to pay dividends on any
of our common shares in the future, as a holding company, we will be dependent on receipt of funds from our majority-owned subsidiary,
BDL. Payments of dividends by BDL to our company are subject to the requirement that foreign invested enterprises may only buy,
sell and/or remit foreign currencies at those banks authorized to conduct foreign exchange business. Further, such remittances
would require BDL to provide an application for remittance that includes, in addition to the application form, a foreign registration
certificate, board resolution, capital verification report, audit report on profit and stock bonuses, and a tax certificate. There
are no such similar foreign exchange restrictions in the British Virgin Islands.
Significant Changes
Except as disclosed elsewhere in this
annual report, we have not experienced any significant changes since the date of our audited consolidated financial statements
included in this annual report.
|
Item 9.
|
The Offer and Listing
|
|
A.
|
Offer and listing details
|
Our common shares
have been listed on the NASDAQ Capital Market since April 22, 2010 under the symbol “DHRM.” The table below shows,
for the periods indicated the high and low market prices for our shares.
|
|
Market Price Per Share
|
|
|
|
High
|
|
|
Low
|
|
Yearly:
|
|
|
|
|
|
|
|
|
2012
|
|
$
|
3.95
|
|
|
$
|
1.26
|
|
2013
|
|
$
|
4.85
|
|
|
$
|
1.80
|
|
2014
|
|
$
|
12.89
|
|
|
$
|
2.52
|
|
2015
|
|
$
|
4.29
|
|
|
$
|
1.22
|
|
2016
|
|
$
|
2.88
|
|
|
$
|
0.79
|
|
|
|
|
|
|
|
|
|
|
Quarterly:
|
|
|
|
|
|
|
|
|
2014
|
|
|
|
|
|
|
|
|
First quarter
|
|
$
|
11.95
|
|
|
$
|
3.88
|
|
Second quarter
|
|
$
|
8.07
|
|
|
$
|
4.75
|
|
Third quarter
|
|
$
|
6.08
|
|
|
$
|
4.96
|
|
Fourth quarter
|
|
$
|
5.02
|
|
|
$
|
2.77
|
|
|
|
|
|
|
|
|
|
|
2015
|
|
|
|
|
|
|
|
|
First quarter
|
|
$
|
3.7609
|
|
|
$
|
2.4899
|
|
Second quarter
|
|
$
|
3.18
|
|
|
$
|
2.62
|
|
Third quarter
|
|
$
|
2.74
|
|
|
$
|
1.35
|
|
Fourth quarter
|
|
$
|
4.29
|
|
|
$
|
1.22
|
|
|
|
|
|
|
|
|
|
|
2016
|
|
|
|
|
|
|
|
|
First quarter
|
|
$
|
2.445
|
|
|
$
|
1.525
|
|
Second quarter
|
|
$
|
2.88
|
|
|
$
|
1.23
|
|
Third quarter
|
|
$
|
2.15
|
|
|
$
|
1.50
|
|
Fourth quarter
|
|
$
|
1.89
|
|
|
$
|
0.79
|
|
|
|
|
|
|
|
|
|
|
Monthly:
|
|
|
|
|
|
|
|
|
2017
|
|
|
|
|
|
|
|
|
January
|
|
$
|
1.88
|
|
|
$
|
1.42
|
|
February
|
|
$
|
1.62
|
|
|
$
|
1.50
|
|
March
|
|
$
|
1.68
|
|
|
$
|
1.47
|
|
April (through April 26, 2017)
|
|
$
|
1.70
|
|
|
$
|
1.50
|
|
Not applicable for annual reports on Form
20-F.
Our common shares are listed on the NASDAQ
Capital Market under the symbol “LLIT” and previously under the symbol “DHRM.”
Not applicable for annual reports on Form
20-F.
Not applicable for annual reports on Form
20-F.
Not applicable for annual reports on Form
20-F.
|
Item 10.
|
Additional Information
|
Not applicable for annual reports on Form
20-F.
|
B.
|
Memorandum and articles of association
|
The information required by this item is
incorporated by reference to (a) the material headed “Description of Share Capital” in our Registration Statement on
Form S-1, File no. 333-163041, filed with the SEC on November 12, 2009, as amended and (b) our amended and restated articles and
memorandum of association filed as Exhibits 1.1 and 1.2 to a current report on Form 6-K filed on November 18, 2016. Other than
as stated there, we have amended and restated our articles and memorandum of association to reflect the change of our name to Lianluo
Smart Limited.
On April 21, 2016, the Company entered
into warrant repurchase agreements (the “Warrant Repurchase Agreements”) with the holders (“Holders”) of
certain warrants pursuant to which the Company agreed to repurchase from the Holders the Company’s outstanding warrant to
purchase in aggregate 293,880 shares of the Company’s common shares, with an exercise price of $11.86 per share (the “Warrants”).
The Warrants were issued on February 21, 2014 in connection with the Company’s registered direct offering of approximately
$6.7 million of common shares and warrants.
On April 28, 2016, entered into a definitive
securities purchase agreement (the "SPA") with Hangzhou Lianluo Interactive Information Technology Co., Ltd. ("Lianluo
Interactive"), a publicly listed company on the Shenzhen Stock Exchange (Trading Ticker: 002280) pursuant to which Lianluo
Interactive agreed to purchase 11,111,111 restricted common shares of the Company (the "Shares") for an aggregate of
$20,000,000 (the "Purchase Price"). The Purchase Price is $1.80 per share, which represents a 35% premium to Lianluo
Smart's closing price of $1.33 on April 27, 2016.
In consideration of the payment by Lianluo
Interactive of the Purchase Price, Lianluo Interactive and its designees will also receive warrants to purchase 1,000,000 restricted
common shares of the Company at a purchase price of $2.20 per share (the "Warrants"). The Warrants are exercisable
by Lianluo Interactive or its designees in whole or in part and are exercisable at any time after the Closing of the SPA.
On June 6, 2016, the Company sold 620,414
of these shares to Lianluo Interactive in a first closing under the SPA. On June 28, 2016, Lianluo Smart entered into Amendment
No. 1 to the SPA with Lianluo Interactive. In accordance with Amendment No. 1 to SPA, the closing date was extended from June 30,
2016 to September 30, 2016.
On August 18, 2016, the Company sold
10,490,697 shares to Lianluo Interactive and closed the share purchase deal under the SPA with the total shares purchased of
11,111,111 shares. In addition, the Company issued warrants to purchase an additional 1 million shares.
Foreign Currency Exchange
The principal regulations governing foreign
currency exchange in China are the Foreign Exchange Administration Regulations (1996), as amended in 1997 and 2008, and the Administration
Rules of the Settlement, Sale and Payment of Foreign Exchange (1996). Under these regulations, Renminbi are freely convertible
for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange
transactions, but not for most capital account items, such as direct investment, loan, repatriation of investment and investment
in securities outside China, unless the prior approval of SAFE or its local counterparts is obtained. In addition, any loans to
an operating subsidiary in China that is a foreign invested enterprise, cannot, in the aggregate, exceed the difference between
its respective approved total investment amount and its respective approved registered capital amount. Furthermore, any foreign
loan must be registered with SAFE or its local counterparts for the loan to be effective. Any increase in the amount of the total
investment and registered capital must be approved by the PRC Ministry of Commerce or its local counterpart. We may not be able
to obtain these government approvals or registrations on a timely basis, if at all, which could result in a delay in the process
of making these loans.
The dividends paid by the subsidiary to
its shareholder are deemed shareholder income and are taxable in China. Pursuant to the Administration Rules of the Settlement,
Sale and Payment of Foreign Exchange (1996), foreign-invested enterprises in China may purchase or remit foreign exchange, subject
to a cap approved by SAFE, for settlement of current account transactions without the approval of SAFE. Foreign exchange transactions
under the capital account are still subject to limitations and require approvals from, or registration with, SAFE and other relevant
PRC governmental authorities.
Dividend Distribution
The principal regulations governing the
distribution of dividends by foreign holding companies include the Foreign Investment Enterprise Law (1986), as amended, and the
Administrative Rules under the Foreign Investment Enterprise Law (2001).
Under these regulations, foreign investment
enterprises in China may pay dividends only out of their retained profits, if any, determined in accordance with PRC accounting
standards and regulations. In addition, foreign investment enterprises in China are required to allocate at least 10% of their
respective retained profits each year, if any, to fund certain reserve funds unless these reserves have reached 50% of the registered
capital of the enterprises. These reserves are not distributable as cash dividends.
Notice 75
On October 21, 2005, SAFE issued Notice
75, which became effective as of November 1, 2005. According to Notice 75, prior registration with the local SAFE branch
is required for PRC residents to establish or to control an offshore company for the purposes of financing that offshore company
with assets or equity interests in an onshore enterprise located in the PRC. An amendment to registration or filing with the local
SAFE branch by such PRC resident is also required for the injection of equity interests or assets of an onshore enterprise in the
offshore company or overseas funds raised by such offshore company, or any other material change involving a change in the capital
of the offshore company.
Moreover, Notice 75 applies retroactively.
As a result, PRC residents who have established or acquired control of offshore companies that have made onshore investments in
the PRC in the past are required to complete the relevant registration procedures with the local SAFE branch by March 31,
2006. Under the relevant rules, failure to comply with the registration procedures set forth in Notice 75 may result in restrictions
being imposed on the foreign exchange activities of the relevant onshore company, including the increase of its registered capital,
the payment of dividends and other distributions to its offshore parent or affiliate and capital inflow from the offshore entity,
and may also subject relevant PRC residents to penalties under PRC foreign exchange administration regulations.
PRC residents who control our company are
required to register with SAFE in connection with their investments in us. Such individuals completed this registration in 2007.
If we use our equity interest to purchase the assets or equity interest of a PRC company owned by PRC residents in the future,
such PRC residents will be subject to the registration procedures described in Notice 75.
New Mergers & Acquisitions Regulations
and Overseas Listings
On August 8, 2006, six PRC regulatory
agencies, including the Ministry of Commerce, the State Assets Supervision and Administration Commission, the State Administration
for Taxation, the State Administration for Industry and Commerce, CSRC and SAFE, jointly issued the Regulations on Mergers and
Acquisitions of Domestic Enterprises by Foreign Investors, or the New M&A Rule, which became effective on September 8,
2006. This New M&A Rule, among other things, includes provisions that purport to require that an offshore special purpose vehicle
formed for purposes of overseas listing of equity interests in PRC companies and controlled directly or indirectly by PRC companies
or individuals obtain the approval of CSRC prior to the listing and trading of such special purpose vehicle’s securities
on an overseas stock exchange.
On September 21, 2006, CSRC published
on its official website procedures regarding its approval of overseas listings by special purpose vehicles. The CSRC approval procedures
require the filing of a number of documents with the CSRC and it would take several months to complete the approval process. The
application of this new PRC regulation remains unclear with no consensus currently existing among leading PRC law firms regarding
the scope of the applicability of the CSRC approval requirement.
British Virgin Islands Taxation
We are exempt from all provisions of the
Income Tax Act of the British Virgin Islands, including with respect to all dividends, interests, rents, royalties, compensation
and other amounts payable by or to persons who are not resident in the British Virgin Islands. Capital gains realized with respect
to any of our shares, debt obligations or other securities by persons who are not resident in the British Virgin Islands are also
exempt from all provisions of the Income Tax Act of the British Virgin Islands. No estate, inheritance tax succession or gift tax
rate, duty, levy or other charge is payable by persons who are not resident in the British Virgin Islands with respect to any of
our shares, debt obligations, or other securities. No stamp duty is payable in the British Virgin Islands in relation to a transfer
of shares in a British Virgin Islands Business Company.
United States Federal Income
Taxation
The following is a summary of material
United States federal income tax consequences under present law relating to the purchase, ownership, and disposition of our common
shares. This description does not provide a complete analysis of all potential tax consequences. The information provided below
is based on the Internal Revenue Code of 1986, as amended, or the Code, Treasury Regulations, proposed Treasury Regulations, Internal
Revenue Service, or the IRS, published rulings and court decisions, all as of the date hereof. These authorities may change, possibly
on a retroactive basis, or the IRS might interpret the existing authorities differently. In either case, the tax consequences of
purchasing, owning or disposing of common shares could differ from those described below. We do not intend to obtain a ruling from
the IRS with respect to the tax consequences of acquiring or holding the common shares.
This description is general in nature and
does not discuss all aspects of U.S. federal income taxation that may be relevant to a particular investor in light of the investor’s
particular circumstances, or to certain types of investors subject to special treatment under U.S. federal income tax laws, such
as:
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banks or financial institutions;
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life insurance companies;
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tax-exempt organizations;
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dealers in securities or foreign currencies;
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traders in securities that elect to apply a mark-to-market method of accounting;
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persons holding common shares as part of a position in a “straddle” or as part of a “hedging,” “conversion” or “integrated” transaction for U.S. federal income tax purposes;
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persons subject to the alternative minimum tax provisions of the Code; and
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persons that have a “functional currency” other than the U.S. dollar.
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This description generally applies to purchasers
of our common shares as capital assets. This description does not consider the effect of any foreign, state, local or other tax
laws that may be applicable to particular investors.
Investors considering the purchase of common
shares should consult their own tax advisors regarding the application of the U.S. federal income tax laws to their particular
situations and the consequences of U.S. federal estate or gift tax laws, foreign, state, or local laws, and tax treaties.
U.S. Holders
As used herein, the term “U.S. Holder”
means a beneficial owner of common shares that is:
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a citizen or resident of the U.S. or someone treated as a U.S. citizen or resident for U.S. federal income tax purposes;
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a corporation or other entity taxable as a corporation for U.S. federal income tax purposes organized in or under the laws of the U.S. or any political subdivision thereof;
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an estate the income of which is subject to U.S. federal income taxation regardless of its source; or
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a trust, if such trust validly elects to be treated as a U.S. person for U.S. federal income tax purposes, or if (a) a court within the U.S. can exercise primary supervision over its administration and (b) one or more U.S. persons have the authority to control all of the substantial decisions of such trust.
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If a partnership (including for this purpose
any entity treated as a partnership for U.S. tax purposes) is a beneficial owner of the common shares, the U.S. tax treatment of
a partner in the partnership will generally depend on the status of the partner and the activities of the partnership. A holder
of the common shares that is a partnership and partners in such partnership should consult their individual tax advisors about
the U.S. federal income tax consequences of holding and disposing of the common shares.
If you are not a U.S. Holder, this subsection
does not apply to you and you should refer to “Non-U.S. Holders” below.
Taxation of Dividends and Other Distributions
on Common shares
Subject to the passive foreign investment
company rules discussed below, all distributions to a U.S. Holder with respect to the common shares, other than certain pro rata
distributions of our shares, will be includible in a U.S. Holder’s gross income as ordinary dividend income when received,
but only to the extent that the distribution is paid out of our current or accumulated earnings and profits. For this purpose,
earnings and profits will be computed under U.S. federal income tax principles. The dividends will not be eligible for the dividends-received
deduction allowed to corporations. To the extent that the amount of the distribution exceeds our current and accumulated earnings
and profits, it will be treated first as a tax-free return of the tax basis in the common shares, and to the extent the amount
of the distribution exceeds the U.S. Holder’s tax basis, the excess will be taxed as capital gain. Any gain recognized by
a non-corporate U.S. Holder on the sale or exchange of common shares generally will be subject to a maximum tax rate of 20%.
Dividends paid in Renminbi will be included
in your income as a U.S. dollar amount based on the exchange rate in effect on the date that the U.S. Holder receives the dividend,
regardless of whether the payment is in fact converted into U.S. dollars. If the U.S. Holder does not receive U.S. dollars on the
date the dividend is distributed, the U.S. Holder will be required to include either gain or loss in income when the U.S. Holder
later exchanges the Renminbi for U.S. dollars. The gain or loss will be equal to the difference between the U.S. dollar value of
the amount that the U.S. Holder includes in income when the dividend is received and the amount that the U.S. Holder receives on
the exchange of the Renminbi for U.S. dollars. The gain or loss generally will be ordinary income or loss from United States sources.
If we distribute as a dividend non-cash property, the U.S. Holder will generally include in income an amount equal to the U.S.
dollar equivalent of the fair market value of the property on the date that it is distributed.
Dividends will constitute foreign source
income for foreign tax credit limitation purposes. The limitation on foreign taxes eligible for credit is calculated separately
with respect to specific classes of income. For this purpose, dividends distributed by us with respect to the common shares will
be “passive income” or, in the case of certain U.S. Holders, “financial services income.” In particular
circumstances, a U.S. Holder that:
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has held the common shares for less than a specified minimum period during which it is not protected from risk of loss,
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is obligated to make payments related to the dividends, or
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holds the common shares in arrangements in which the U.S. Holder’s expected economic profit, after non-U.S. taxes, is insubstantial will not be allowed a foreign tax credit for foreign taxes imposed on dividends paid on the common shares.
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Distributions to a U.S. Holder of shares
or rights to subscribe for shares that are received as part of a pro rata distribution to all our shareholders should not be subject
to U.S. federal income tax. The basis of the new shares or rights so received will be determined by allocating the U.S. Holder’s
tax basis in the common shares between the common shares and the new shares or rights received, based on their relative fair market
values on the date of distribution. However, the basis of the new shares or rights will be zero if:
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the fair market value of the new shares or rights is less than 15.0% of the fair market value of the old common shares at the time of distribution; and
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the U.S. Holder does not make an election to determine the basis of the new shares by allocation as described above.
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The U.S. Holder’s holding period
in the new shares or rights will generally include the holding period of the old common shares on which the distribution was made.
Taxation of Disposition of Common shares
Subject to the passive foreign investment
company rules discussed below, a U.S. Holder will recognize taxable gain or loss on any sale or exchange of common shares equal
to the difference between the amount realized (in U.S. dollars) for the common shares and the U.S. Holder’s tax basis (in
U.S. dollars) in the common shares. The gain or loss will be capital gain or loss. Any gain or loss that you recognize will generally
be treated as United States source income or loss, except that losses will be treated as foreign source losses to the extent you
received dividends that were includible in the financial services income basket during the 24-month period prior to the sale. If
the common shares are not stock in a passive foreign investment company with respect to a U.S. Holder in either the taxable year
of the distribution or the preceding taxable year, the distribution otherwise constitutes qualified dividend income for United
States federal income tax purposes, certain holding period and other requirements are met, and the distribution is received in
a taxable year beginning prior to January 1, 2009, the distribution will be taxable to a non-corporate U.S. Holder at a maximum
rate of 15%.
Passive Foreign Investment Company
We believe that we are not a passive foreign
investment company for U.S. federal income tax purposes, but we cannot be certain whether we will be treated as a passive foreign
investment company for any future taxable year. If we are a passive foreign investment company in any year in which a U.S. Holder
holds common shares, the U.S. Holder generally will be subject to increased U.S. tax liabilities and reporting requirements on
receipt of certain dividends or on a disposition of common shares, in that year and all subsequent years although a shareholder
election to terminate such deemed passive foreign investment company status may be made in certain circumstances. U.S. Holders
should consult their own tax advisors regarding our status as a passive foreign investment company, the consequences of an investment
in a passive foreign investment company, and the consequences of making a shareholder election to terminate deemed passive foreign
investment company status if we no longer meet the income or asset test for passive foreign investment company status in a subsequent
taxable year.
A company is considered a passive foreign
investment company for any taxable year if either:
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at least 75.0% of its gross income is passive income, or
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at least 50.0% of the value of its assets (based on an average of the quarterly values of the assets during a taxable year) is attributable to assets that produce or are held for the production of passive income.
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We will be treated as owning our proportionate
share of the assets and earning our proportionate share of the income of any other corporation in which we own, directly or indirectly,
more than 25.0% (by value) of the stock of such corporation.
Our belief that we are not a passive foreign
investment company is based on our estimate of the fair market value of our intangible assets, including goodwill, not reflected
in our financial statements under US GAAP. In the future, in calculating the value of these intangible assets, we will value our
total assets, in part, based on our total market value determined using the average of the quarterly selling prices of the common
shares for the relevant year. We believe this valuation approach is reasonable. However, it is possible that the IRS will challenge
the valuation of our intangible assets, which may result in our classification as a passive foreign investment company. In addition,
if our actual acquisitions and capital expenditures do not match our projections, the likelihood that we are or will be classified
as a passive foreign investment company may also increase.
A separate determination must be made each
year as to whether we are a passive foreign investment company. As a result, our passive foreign investment company status may
change.
If we are a passive foreign investment
company for any taxable year during which a U.S. Holder holds common shares, the U.S. Holder will be subject to special tax rules
with respect to:
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Any “excess distribution” that the U.S. Holder receives on common shares, and
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Any gain the U.S. Holder realizes from a sale or other disposition (including a pledge) of the common shares, unless the U.S. Holder makes a “mark-to-market” election as discussed below.
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Distributions the U.S. Holder receives
in a taxable year that are greater than 125% of the average annual distributions the U.S. Holder received during the shorter of
the three preceding taxable years or the U.S. Holder’s holding period for the common shares will be treated as an excess
distribution. Under these special tax rules:
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the excess distribution or gain will be allocated ratably over your holding period for the common shares,
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the amount allocated to the current taxable year, and any taxable year prior to the first taxable year in which we were a passive foreign investment company, will be treated as ordinary income, and
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the amount allocated to each other year will be subject to tax at the highest tax rate in effect for that year and the interest charge generally applicable to underpayments of tax will be imposed on the resulting tax attributable to each such year.
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The tax liability for amounts allocated
to years prior to the year of disposition or “excess distribution” cannot be offset by any net operating losses, and
gains (but not losses) realized on the sale of the common shares cannot be treated as capital, even if the U.S. Holder holds the
common shares as capital assets.
A U.S. shareholder of a passive foreign
investment company may avoid taxation under the excess distribution rules discussed above by making a “qualified electing
fund” election to include the U.S. Holder’s share of our income on a current basis. However, a U.S. Holder may make
a qualified electing fund election only if the passive foreign investment company agrees to furnish the shareholder annually with
certain tax information, and we do not presently intend to prepare or provide such information.
Alternatively, a U.S. Holder of “marketable
stock” in a passive foreign investment company may make a mark-to-market election for stock of a passive foreign investment
company to elect out of the excess distribution rules discussed above. If a U.S. Holder makes a mark-to-market election for the
common shares, the U.S. Holder will include in income each year an amount equal to the excess, if any, of the fair market value
of the common shares as of the close of your taxable year over the U.S. Holder’s adjusted basis in such common shares. A
U.S. Holder is allowed a deduction for the excess, if any, of the adjusted basis of the common shares over their fair market value
as of the close of the taxable year only to the extent of any net mark-to-market gains on the common shares included in the U.S.
Holder’s income for prior taxable years. Amounts included in a U.S. Holder’s income under a mark-to-market election,
as well as gain on the actual sale or other disposition of the common shares, are treated as ordinary income. Ordinary loss treatment
also applies to the deductible portion of any mark-to-market loss on the common shares, as well as to any loss realized on the
actual sale or disposition of the common shares, to the extent that the amount of such loss does not exceed the net mark-to-market
gains previously included for such common shares. A U.S. Holder’s basis in the common shares will be adjusted to reflect
any such income or loss amounts. The tax rules that apply to distributions by corporations which are not passive foreign investment
companies would apply to distributions by us.
The mark-to-market election is available
only for stock which is regularly traded on a national securities exchange that is registered with the SEC or on NASDAQ, or an
exchange or market that the U.S. Secretary of the Treasury determines has rules sufficient to ensure that the market price represents
a legitimate and sound fair market value. The mark-to-market election would be available to a U.S. Holder unless our common shares
are delisted from The NASDAQ Capital Market and do not subsequently become regularly traded on another qualified exchange or market.
A U.S. Holder who holds our common shares
in any year in which we are a passive foreign investment company would be required to file IRS Form 8621 regarding distributions
received on our common shares and any gain realized on the disposition of our common shares.
Non-U.S. Holders
A Non-U.S. Holder generally will not be
subject to U.S. federal income tax on dividends paid by us with respect to our common shares unless the income is effectively connected
with the Non-U.S. Holder’s conduct of a trade or business in the United States.
A Non-U.S. Holder generally will not be
subject to U.S. federal income tax on any gain attributable to a sale or other disposition of our common shares unless such gain
is effectively connected with the Non-U.S. Holder’s conduct of a trade or business within the United States or the Non-U.S.
Holder is a natural person who is present in the United States for 183 days or more and certain other conditions exist.
Dividends and gains that are effectively
connected with a Non-U.S. Holder’s conduct of a trade or business in the United States generally will be subject to tax in
the same manner as they would be if the Non-U.S. Holder were a U.S. Holder, except that the passive foreign investment company
rules will not apply. Effectively connected dividends and gains received by a corporate Non-U.S. Holder may also be subject to
an additional branch profits tax at a 30.0% rate or a lower tax treaty rate.
Information Reporting and Backup Withholding
In general, information reporting requirements
will apply to dividends in respect of our common shares or the proceeds received on the sale, exchange or redemption of our common
shares paid within the United States (and, in certain cases, outside the United States) to U.S. Holders other than certain exempt
recipients, such as corporations, and backup withholding tax may apply to such amounts if the U.S. Holder fails to provide an accurate
taxpayer identification number or to report interest and dividends required to be shown on its U.S. federal income tax returns.
The amount of any backup withholding from a payment to a U.S. Holder will be allowed as credit against the U.S. Holder’s
U.S. federal income tax liability provided that the appropriate returns are filed.
A Non-U.S. Holder generally may eliminate
the requirement for information reporting and backup withholding by providing certification of its foreign status to the payer,
under penalties of perjury, on IRS Form W-8BEN.
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Dividends and paying agents
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Not applicable for annual reports on Form
20-F.
Not applicable for annual reports on Form
20-F.
We are subject to the information requirements
of the Exchange Act. In accordance with these requirements, the Company files reports and other information with the SEC. You may
read and copy any materials filed with the SEC at the Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You
may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains
a web site at
http://www.sec.gov
that contains reports and other information regarding registrants that
file electronically with the SEC.
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I.
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Subsidiary Information
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Not applicable.
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Item 11.
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Q uantitative and Qualitative Disclosures about Market Risk
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Foreign Exchange Risk
All of our revenues and substantially all
of our expenditures are denominated in Renminbi. Although exchange of the Renminbi for foreign currency is highly regulated in
China, the value of the Renminbi against the value of the U.S. dollar may fluctuate and be affected by, among other things, changes
in China’s political and economic conditions. Under the currency policy in effect in China today, the value of the Renminbi
fluctuates within a narrow band against a basket of foreign currencies. China is currently under significant international pressures
to liberalize its currency policy, and if such liberalization were to occur, the value of the Renminbi could appreciate or depreciate
against the U.S. dollar, or any other currency.
We use U.S. dollars as the reporting currency
for our financial statements. All transactions in currencies other than U.S. dollar during the year are re-measured at the exchange
rates prevailing on the respective relevant dates of such transactions. Monetary assets and liabilities existing at the balance
sheet date denominated in currencies other than U.S. dollar are re-measured at the exchange rates prevailing on such date. Exchange
differences are recorded in our consolidated statement of operations.
Fluctuations in exchange rates may affect
our net revenues, costs, operating margins and net income. For example, in 2016, 0.4% of our net revenues were generated from sales
denominated in currencies of U.S. dollar. The fluctuations in the exchange rates between the U.S. dollar and the Renminbi resulted
in a decrease of $149 in operating income in 2016.
Fluctuations in exchange rates may also
affect our balance sheet. For example, to the extent that we need to convert U.S. dollars into Renminbi for our operations, appreciation
of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount that we receive from the conversion.
Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of paying dividends on our ordinary shares or
for other business purposes, appreciation of the Renminbi against the U.S. dollar would have a positive effect on the corresponding
U.S. dollar amount available to us.
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.
See “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in China—Fluctuations in the
value of the Renminbi may have a material adverse effect on your investment.” Any significant revaluation of the Renminbi
may materially and adversely affect our cash flows, revenues, earnings and financial position, and the value of, and any dividends
payable on, our share prices in U.S. dollars.
Our PRC subsidiaries have determined their
functional currencies to be the Renminbi based on the criteria set forth under ASC 830, Foreign Currency Matters. We use the Renminbi
as our reporting currency. We use the monthly average exchange rate for the year and the exchange rate at the balance sheet date
to translate the operating results and financial position of our PRC subsidiaries, respectively. Translation differences are recorded
in accumulated other comprehensive income, a component of shareholders’ equity. Transactions denominated in foreign currencies
are remeasured into our functional currency at the exchange rates prevailing on the transaction dates. Foreign currency denominated
financial assets and liabilities are remeasured at the balance sheet date exchange rate. Exchange gains and losses are included
in the consolidated statements of income.
Interest Rate Risk
Our exposure to interest rate risk primarily
relates to our interest income generated by our excess cash, which is mostly held in interest-bearing bank deposits and short-term
investments as well as interest expenses under our short-term bank loans. Our future interest income from our cash deposited in
bank and short-term bank loans may fall short of expectations due to changes in interest rates. Our future interest expense on
our short-term borrowings may increase or decrease due to changes in market interest rates. As of December 31, 2016, our outstanding
short-term borrowings were nil.
Inflation
According to the National Bureau of Statistics
of China, China’s overall national inflation rate, as represented by the general consumer price index, was approximately
2% in 2014, 1.4% in 2015 and 2% in 2016. We have not in the past been materially affected by any such inflation, but we can provide
no assurance that we will not be affected in the future.
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Item 12.
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Description of Securities Other than Equity Securities
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With the exception of Items 12.D.3 and
12.D.4, this Item 12 is not applicable for annual reports on Form 20-F. As to Items 12.D.3 and 12.D.4, this Item 12 is not applicable,
as the Company does not have any American Depositary Shares.