Newegg Commerce, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis of the company’s financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes included elsewhere in this report. In this report, the terms “we,” “the Company” and “our” refer to Dehaier Medical Systems Limited, a British Virgin Islands company (“Dehaier”), Dehaier Medical Systems (Hong Kong) Limited, our subsidiary in Hong Kong (“DHK”), Beijing Dehaier Technology Company Limited, our variable interest entity in the People’s Republic of China (“BTL”) and Beijing Dehaier Medical Technology Company Limited, our operating subsidiary in the People’s Republic of China (“BDL”). This discussion contains forward-looking statements that involve risks and uncertainties. Actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors. This section should be read together with the consolidated financial statements and related notes thereto in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010, as well as the condensed consolidated financial statements for the nine- and three-month periods ended September 30, 2011 and related notes thereto. Overview We are a company in the business of developing and distributing medical devices. We have been focusing on developing the respiratory and oxygen homecare business in particular since 2006. We distribute 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. Our distribution offerings are mostly equipments used in the operating room, the intensive care unit (“ICU”) and the emergency room. Besides distributing medical devices, we also design, develop and market our own branded products and medical components. Because we do not run any 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 sell our products primarily through distributors, but 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. In July 2011, we commenced our home oxygen therapy service and we plan to grow this early-stage business starting with the Beijing market. Business Development In July 2011, we opened our first oxygen filling facility and service center for home oxygen therapy in the Haidian District of Beijing. We have marketed this service to more than 50 hospitals in Beijing. The number of potential customers for home oxygen therapy service is increasing and so is our professional team for this line of business. We have also continued to implement our existing contract projects with Hospital 301 of Beijing for a medical supply agreement and with Beijing Kanglian Medicine Co, Ltd for a rural healthcare project in Hunan and Anhui Provinces. During the third quarter, we recruited several professionals to further build our team for state-level contract projects. It is expected that we will continue to establish further cooperative relations with the different levels of the government on more projects. 1 Growth Strategies • We will develop our home oxygen services and expand the service platform to dominate the domestic market for this service in China, and we will also implement value-added business based on the same platform. Eventually, we seek to provide customers with an all-in-one solution in the home healthcare field. • We will expand our product portfolio through continued investment in research and development and acquisition of companies having proper products complementary to our core business. We plan to release the second generation of home use continuous positive airway pressure products and oxygen concentrators in early 2012. We have received CE mark approval for our sleep diagnostic device DHR-998, which will be marketed in European countries soon. • We will expand our distribution channels into e-commerce platforms. We plan to create more cross-selling opportunities for our homecare products, while providing oxygen delivery through the service platform. • We will build our brand name domestically as both a distributor and a trusted partner by leveraging our relationships with healthcare professionals, agents and other downstream distributors, maintaining and expanding our customer base, and promoting business growth steadily. • We will expand into overseas markets and establish a distribution network, through distribution agreements, OEM partnerships, direct sales force and e-commerce platforms. We will build our brand name by actively participating in international trade shows. We will attempt to have all our homecare medical products approved by the U.S. Food and Drug Administration and its counterpart in Europe. Results of Operations For the nine and three months ended September 30, 2011 and 2010, our total revenues amounted to approximately $16.35 million, $12.93 million, $5.69 million and $5.46 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 income attributable to Dehaier for the nine and three months ended September 30, 2011 and 2010 was approximately $3.32 million, $3.07 million, $1.38 million and $1.41 million, respectively. Such increase in net income for the nine months ended September 30, 2011 was mainly due to the increase in sales. The decrease in net income for the three months ended September 30, 2011 was mainly due to increased expense on marketing for the new home oxygen therapy line of business. Factors Affecting Our Results of Operations – Generally We believe the most significant factors that directly or indirectly affect our sales revenues and net income are: • the level of acceptance of our products among hospitals and other healthcare facilities; • our ability to price our products at levels that are competitive yet provide favorable margins; • our ability to develop and introduce new products and services; • our ability to attract and retain distributors and key customers; • our continued investment in research and development activities and our retention of key employees; • changes in China’s macro-economic environment and healthcare-related government policies and legislation; and • global economic conditions. 2 Revenues Our total revenues are derived from products we sell in our three product lines: (i) medical devices, (ii) respiratory and oxygen homecare products, and (iii) technical service products. Generally, we focus our resources on developing products that we believe are commercially feasible, can generate significant revenues and high margins, and can be quickly introduced into the market. Medical devices . We derive revenues in our medical devices product line from the sale of C-arm X-ray systems, anesthesia machines, patient monitors and general hospital products. Medical devices, our largest product line, have the most extensive market reach among our three product lines. We anticipate continued revenue growth in our medical devices product line as we further our market reach through the development and distribution of new product and the participation in favorable government health programs. Respiratory and oxygen homecare products . We derive revenues in our respiratory and oxygen homecare product line from sales of oxygen concentrators, continuous positive airway pressure devices, portable sleep diagnostics and rhinitis hyperthermia devices. We anticipate that, on a percentage basis, net revenues in our respiratory and oxygen homecare product line will increase more rapidly than our total net revenues in the near term, as we introduce more advanced products. We expect to increase our market penetration in the respiratory and oxygen homecare sector both in China and internationally through the use of distributors as well as our direct sales platform. Technical service products . We derive revenues in our technical service product line from sales of our air compressors and ventilator trolleys. We anticipate continued growth in revenues from our technical service products as we further expand our market reach by increasing the number of our distributors and maintaining a competitive pricing model. Our ability to increase revenues depends in large part on our ability to (i) increase the market reach of our existing products, (ii) successfully identify, develop, introduce and commercialize, in a timely and cost-effective manner, newer and more advanced products, and (iii) continue to expand our international markets. Operating Costs and Expenses Our operating costs and expenses consist of cost of revenues, general and administrative expenses, selling expenses and other expenses. Our total operating costs and expenses increased as a percentage of our total revenues for the nine and three months ended September 30, 2011 compared to the same periods in 2010, primarily due to increased professional fees, mainly investor relations, legal, accounting and consulting fees, by virtue of being a publicly traded company since March 26, 2010. Cost of Revenues Cost of revenues primarily includes wages, parts for assembly, handling charges, depreciation of fixed assets and other expenses associated with the assembly and distribution of products. General and Administrative Expenses General and administrative expenses consist primarily of salaries, benefits and related costs for our administrative personnel and management, fees and expenses from our outside advisers including investor relations, legal, auditing and valuation expenses, expenses associated with our administrative offices, and the depreciation of equipment used for administrative purposes. We expect that our general and administrative expenses will increase, both on an absolute basis and as a percentage of revenues, as we incur costs related to the anticipated growth of our business. In addition, we expect to incur additional general and administrative expenses associated with being a public company. 3 Selling Expenses Selling expenses consist primarily of compensation and benefits for our sales and marketing staff, expenses for promotional, advertising, travel and entertainment activities, lease payments for our sales offices, and depreciation expenses related to equipment used for sales and marketing activities. Going forward, we expect our selling expenses to increase, both on an absolute basis and as a percentage of revenues, as we increase our efforts to promote our products and services, especially our new respiratory and oxygen homecare line of business. Nine Months Ended September 30, 2011 Compared to Nine Months Ended September 30, 2010 As our business grows, we look forward to having more opportunities in the market. We believe that period-to-period comparisons of operating results should not be relied upon as indicative of future performance. Revenues Our total revenues increased by 26% from $12.93 million for the nine months ended September 30, 2010 to $16.35 million for the same period in 2011. This was due to the increased acceptance of our products resulting in additional units sold among hospitals and other healthcare facilities, as many of our end users such as hospitals became repeat customers when they needed new medical equipment. We maintained good relationships with our clients during the three quarters of 2011, which contributed to our revenue growth. We continued to expand our homecare oxygen business in China, which promoted a greater market presence for our brand name and our products. In addition, we have further plans for strategic development to create cooperative opportunities with government programs and hospitals. Cost of Revenues Our cost of revenues increased by 30.0% from $7.78 million for the nine months ended September 30, 2010 to $10.10 million for the same period in 2011. Because our cost of revenues grew slightly faster than our revenues, our gross margin decreased. The cost of medical components and parts are the major cause for the increase in cost of revenues. Operating Expenses Our operating expenses increased by 47.0% from $1.71 million for the nine months ended September 30, 2010 to $2.51 million for the nine months ended September 30, 2011. This increase was due to an increase in general and administrative expenses and selling expenses, for the reasons described below. General and Administrative Expenses General and administrative expenses consist primarily of salaries, benefits and related costs for our administrative personnel and management, expenses associated with our research and development, and expenses for the registration of foreign exchange certificate. Our general and administrative expenses increased by 60% from $0.88 million for the nine months ended September 30, 2010 to $1.41 million for the same period in 2011. This increase was mainly due to three factors: • Public company expense . After listing on the NASDAQ stock market on April 22, 2010, we incurred implementation expenses to comply with Sarbanes-Oxley Act, Section 404. In order to improve our visibility and exposure on the capital markets, we hired professional employees and retained professional consulting firms. • Research and development expense . We have been involved in the research and development activities for sleep and respiratory products. In 2011, these research and developing activities moved to the clinical test stage, which increased the associated cost. 4 • Labor expense . Our labor costs increased as we implemented an employee reward program to incentivize the company personnel. We expect that our general and administration expenses will increase in the near term. First, we expect our expenses to increase as our business expands. Second, we anticipate continued spending in the research and development of sleep, respiratory and other related products. Third, as a publicly traded company, we will continue to incur professional service fees from our attorneys and our auditor. Selling Expenses Our 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 marketing activities. Our selling expenses increased by 31% from $0.83 million for the nine months ended September 30, 2010 to $1.09 million for the same period in 2011, mainly due to an increase in the number of our sales staff to strengthen our distribution network. We also participated in several international medical exhibitions to network with existing and prospective customers. Finally, we recruited several professionals in order to better implement our government medical projects as well as our home oxygen therapy business, which resulted in an increase in labor costs. We expect that our selling expenses in absolute numbers will continue to increase in the near term after our series of new products are introduced in the market. We expect to promote our new products through a variety of advertising methods, including participation in domestic and overseas medical exhibitions to showcase our products. In addition, because our home oxygen therapy business is still in a relatively early stage, we expect to incur initial costs in its marketing and promotion, together with maintenance expenses in relation to our customer experience centers. Operating Income As a result of the foregoing, we generated an operating income of approximately $3.88 million for the nine months ended September 30, 2011, compared to approximately $3.61 million in the same period of 2010. Operating income increased by 7% mainly due to the increase in sales. Taxation Our income tax expense was approximately $0.67 million during the nine months of 2011, compared to approximately $0.54 million in the same period of 2010. Our income tax expense increased primarily due to the increase in taxable income. Net Income As a result of the foregoing, we had net income of approximately $3.33 million for the nine months ended September 30, 2011, compared to approximately $3.08 million in the same period of 2010. After deduction of non-controlling interest in income, net income attributable to the Company was approximately $3.32 million and $3.07 million for the nine months ended September 30, 2011 and 2010, respectively. Three Months Ended September 30, 2011 Compared to Three Months Ended September 30, 2010 Revenues Our total revenues increased by 4% from $5.46 million for the three months ended September 30, 2010 to $5.69 million for the same period in 2011. This was due to the increased acceptance of our products among hospitals and other healthcare facilities, many of which became our repeat customers. We maintained good relationship with our clients in the third quarter of 2011, which contributed to our revenue growth. 5 Cost of Revenues Our cost of revenues increased by 2% from $3.2 million for the three months ended September 30, 2010 to $3.27 million for the same period in 2011. As our revenue from homecare medical products sales increased, the gross profit margin increased slightly over the same period last year. Operating Expenses Our operating expenses increased by 11% from $0.71 million for the three months ended September 30, 2010 to $0.79 million for the same period in 2011. This increase was due to an increase in general and administrative expenses and selling expenses, for the reasons described below. General and Administrative Expenses General and administrative expenses consist primarily of salaries, benefits and related costs for our administrative personnel and management, and expenses associated with our research and development. Our general and administration expenses increased by 12% from $0.36 million for the three months ended September 30, 2010 to $0.4 million for the same period in 2011. This increase was mainly due to three factors: • Public company expense . After listing on the NASDAQ stock market on April 22, 2010, we incurred implementation expenses to comply with Section 404 of Sarbanes-Oxley Act. In order to improve our visibility and exposure on the capital markets, we also hired professional employees and retained professional consulting firms. • Research and development expense . We have been involved in the research and development activities for sleep and respiratory products. In 2011, these research and developing activities moved to the clinical test stage, which increased research and development expenses. Besides, research and development of the second generation products requires higher expenses in industrial design and testing. • Labor expense . Our labor costs increased as we implemented an employee reward policy to strengthen our corporate culture. We expect that our general and administration expenses will increase in the near term as a result of our growing business, spending on research and development and expenses related to our continued public listing. Selling Expense Our selling expenses primarily consist of salaries and related expenses for personnel engaged in sales, marketing and customer support functions, and costs associated with advertising and marketing activities. Our selling expenses increased by 14% from $0.35 million for the three months ended September 30, 2010 to $0.4 million for the same period in 2011, mainly due to an increase in the number of our sales staff to strengthen our distribution network. We also participated in several international medical exhibitions to network with existing and prospective customers. We expect that our selling expenses in absolute numbers will continue to increase in the near term after our series of new products are introduced in the market. We expect to promote our new products through a variety of advertising methods, including participation in domestic and overseas medical exhibitions to showcase our products. In addition, because our home oxygen therapy business is still in a relatively early stage, we expect to incur initial costs in its marketing and promotion, together with maintenance fees in relation to our customer experience centers. 6 Operating Income As a result of the foregoing, we generated operating income of approximately $1.66 million in the third quarter of 2011, compared to approximately $1.61 million in the same period of 2010. Operating income increased by 3%, mainly due to the increase in sales. Taxation Our income tax expense was approximately $0.27 million during the three months ended September 30, 2011, compared to approximately $0.25 million in the same period of 2010. Our income tax expense increased primarily due to the increase in taxable income. Net Income As a result of the foregoing, we had net income of approximately $1.38 million in the three months ended September 30, 2011, compared to approximately $1.41 million in the same period of 2010. After deduction of non-controlling interest in income, net income attributable to Dehaier was approximately $1.38 million and $1.41 million for the three-month periods ended September 30, 2011 and 2010, respectively. Liquidity and Capital Resources Cash Flows and Working Capital To date, we have financed our operations primarily through cash flows from operations, short-term borrowings, and proceeds from our initial public offering. As of September 30, 2011, we had approximately $2.6 million in cash and cash equivalents. As a result of the total cash activities, net cash decreased from $5,923,386 at December 31, 2010 to $2,600,907 at September 30, 2011. We believe that our currently available working capital of $26,841,099, including cash of $2,600,907, should be adequate to meet our anticipated cash needs and sustain our current operations for at least twelve months. Operating Activities Net cash used in operating activities was $4,054,851 for the nine months ended September 30, 2011 as compared to $5,696,022 net cash used in operating activities for the same period in 2010. The reasons for this change are as follows: • Increase of $252,380 in net income . Our net income increased primarily due to the increase in sales for the nine months ended September 30, 2011. • Increase of $3,767,238 in accounts receivable . The increase of accounts receivable is mainly attributable to our extension of the credit period for our customers with good credit records. • Decrease of $1,906,742 in inventories . The decrease in inventories is mainly due to better inventory management that sped up the inventory turnover. • Decrease of $1,361,738 in prepayments . The decrease of prepayments is mainly due to our efforts to shorten the purchase period and decrease the upper limit for each purchase. • Decrease of $1,066,854 in other receivables . The decrease in other receivables is attributable to the better aging management, which enhanced the collection of other receivables. Investing Activities Net cash used in investing activities for the nine months ended September 30, 2011 was $98,100, compared to that of $843,317 for the same period of 2010. The cash used in investing activities was mainly attributable to capital expenditures for the purchase of new equipment. 7 Financing Activities Net cash provided by financing activities for the nine months ended September 30, 2011 and 2010 were $9,076 and $9,944,207, respectively. The cash provided by financing activities for the nine months ended September 30, 2011 was attributable to bank loan proceeds and repayments. The cash proceeds provided by financing activities for the nine months ended September 30, 2010 was attributable to proceeds from the issuance of common shares in our initial public offering. Capital Expenditures We made capital expenditures of approximately $95,742 and $839,456 in the nine months ended September 30, 2011 and 2010, respectively, representing 0.59% and 6.49% of our total revenues, respectively. Our capital expenditures are mainly used to purchase machineries for our research and development projects and our assembly line. The capital expenditures may increase in the near term as our business continues to grow and expand. Off-Balance Sheet Commitments and 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 shareholders’ 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. Tax Matters Applicable to the Company Generally Dehaier is a tax-exempt company incorporated in the British Virgin Islands. BDL and BTL were incorporated in the People’s Republic of China (“PRC”) and are governed by PRC laws. DHK is subject to Hong Kong profits tax rate. The Company pays PRC enterprise income taxes, value added taxes and business taxes in China for revenues from BDL, and is governed by British Virgin Islands tax laws as to Dehaier. British Virgin Islands Tax 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. PRC Enterprise Income Taxes PRC enterprise income tax is calculated based on taxable income determined under PRC accounting principles. According to the Foreign-invested Enterprises and Foreign Enterprises Income Tax Law (the “FIE Income Tax Law”) and the related implementing rules, both of which issued in 1991, foreign-invested enterprises established in China are generally subject to an income tax rate of 33% (consisting of 30% enterprise income tax and 3% local income tax). The FIE Income Tax Law and the related implementing rules provide certain favorable tax treatments to qualified foreign invested enterprises. 8 The FIE Income Tax Law was replaced by the Enterprise Income Tax Law (the “EIT Law”) as of January 1, 2008. Under the EIT Law, a unified enterprise income tax rate of 25% and unified tax deduction standards will be applied equally to both domestic-invested enterprises and foreign-invested enterprises. Enterprises established prior to March 16, 2007 eligible for preferential tax treatment in accordance with the currently prevailing tax laws and administrative regulations shall, under the regulations of the State Council, gradually become subject to the EIT Law rate over a five-year transition period starting from the date of effectiveness of the EIT Law. The details of the transitional arrangement for the five-year period from January 1, 2008 to December 31, 2012 applicable to enterprises approved for establishment prior to March 16, 2007, such as us, were adopted in January 2008. Furthermore, under the EIT Law, an enterprise established outside of the PRC with “de facto management bodies” within the PRC is considered a resident enterprise and will normally be subject to the enterprise income tax at the rate of 25% on its global income. If the PRC tax authorities subsequently determine that we or any of our non-PRC subsidiaries should be classified as a PRC resident enterprise, then such entity’s global income will be subject to PRC income tax at a tax rate of 25%. In addition, under the EIT Law, payments from BDL to us may be subject to a withholding tax. The EIT Law currently provides for a withholding tax rate of 20%. If Dehaier is deemed to be a non-resident enterprise, then it will be subject to a withholding tax at the rate of 10% on any dividends paid by its Chinese subsidiaries to Dehaier. In practice, the tax authorities typically impose the withholding tax rate of 10% rate, as prescribed in the implementation regulations; however, there can be no guarantee that this practice will continue as more guidance is provided by relevant government authorities. We are actively monitoring the proposed withholding tax and are evaluating appropriate organizational changes to minimize the corresponding tax impact. The State Council issued the “Notice on Implementation of the Transition Period for Preferential Enterprise Income Tax,” or the “Transition Implementation Notice,” on December 26, 2007, which provides detailed rules on how preferential tax rates under previous income tax laws or regulations would transition to the uniform 25% EIT rate. In addition, entities that qualify as “high and new technology enterprises” will enjoy a 15% preferential tax rate under the EIT Law. The Ministry of Science and Technology, the Ministry of Finance and the State Administration of Taxation issued the “Measures on Qualification of High and New Technology Enterprises,” or “Circular 172,” on April 14, 2008, which provides detailed standards for “high and new technology enterprises.” In addition, according to the Notice on Prepayment of Enterprise Income Tax issued by the State Administration of Taxation, enterprises that have been certified as “high and new technology enterprises” shall pre-pay EIT at the rate of 25% temporarily until re-certified as “high and new technology enterprises” under Circular 172. Under the current PRC laws, PRC government grants a preferential income tax rate of 15% to government-certified high technology companies, and under the new standard the period of validity for the certification of high technology companies is three years. In 2009, BDL updated its certification for “high technology” company. Therefore, BDL used a 15% income tax rate to calculate the income tax expense for periods ended September 30, 2011 and 2010. The tax rate for BTL is 25% for periods ended September 30, 2011 and 2010. PRC Value Added Tax All entities and individuals that are engaged in the businesses of sales of goods, provision of repair and placement services and importation of goods into China are generally subject to a VAT at a rate of 17% (with the exception of certain goods which are subject to a rate of 13%) of the gross sales proceeds received, less any VAT already paid or borne by the taxpayer on the goods or services purchased by it and utilized in the production of goods or provisions of services that have generated the gross sales proceeds. PRC Business Tax Companies in China are generally subject to business tax and related surcharges by various local tax authorities at rates ranging from 3% to 20% on revenue generated from providing services and revenue generated from the transfer of intangibles. 9 Critical Accounting Policies Presentation in Accordance with US GAAP We prepared our accompanying condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“US GAAP”). These accounting principles require us to make judgments, estimates and assumptions on the reported amounts of assets and liabilities at the end of each fiscal period, and the reported amounts of revenues and expenses during each fiscal period. We continually evaluate these judgments and estimates based on our own historical experience, knowledge and assessment of current business and other conditions, our expectations regarding the future based on available information and assumptions that we believe to be reasonable. Basis of Consolidation The condensed consolidated financial statements include the accounts of Dehaier, BDL, its majority-owned subsidiary, and its wholly-owned subsidiary, DHK as well as BTL. All significant 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 Dehaier, BDL and BTL. BTL is a variable interest entity (“VIE”), and BDL is the primary beneficiary. BTL owns a building, which is pledged as collateral for BDL’s bank loans. In exchange, BDL loans money to BTL to finance its operations. BTL’s primary operation is to provide repairs and transportation services to BDL’s customers. Because of these arrangements, BDL is the primary beneficiary of BTL, as the entity that is most closely associated with BTL. Dehaier has included BTL in its condensed consolidated financial statements through the consolidation with BDL since December 31, 2006. Dehaier, BDL and BTL were under common control until October 31, 2009, when each share of preferred share was converted into a common share. Because the chief executive officer held more than 50% of the voting ownership interest of each of Dehaier, BDL, BTL and DHK at December 31, 2006, the Company initially measured the assets, liabilities and non-controlling interest of the VIE at the amounts at which they were carried in the accounts of the reporting entity that controls the VIE. On October 31, 2009, BDL reconsidered whether it is the primary beneficiary of BTL when Dehaier’s preferred stock was converted into common shares. While such conversion dilutes the Chief Executive Officer’s interest in BDL such that BDL and BTL are not under common control after October 31, 2009, BDL still has the obligation to absorb the expected losses of BTL. BTL is still a VIE because all of its activities either involve or are conducted on behalf of the reporting enterprise and its related parties. BDL is BTL’s only customer referral source. On March 3, 2010, BDL entered into a Loss Absorption Agreement memorializing the understanding that BDL would continue to loan money to BTL as needed to fund its working capital such that BDL would absorb BTL’s losses. Management makes ongoing reassessments of whether BDL is the primary beneficiary of BTL. The accounts of BTL are consolidated in the accompanying financial statements pursuant to Accounting Standards Codification (“ASC”) 810-10, “Consolidation.” As a VIE, BTL’s revenues are included in the Company’s service income, and its income from operations is consolidated with the Company’s. Because of the arrangements, the Company had a pecuniary interest in BTL that requires consolidation of the Company’s and BTL’s financial statements. Use of Estimates The preparation of the condensed consolidated financial statements in conformity with US GAAP 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 condensed consolidated financial statements include revenue recognition, allowance for doubtful accounts, inventory obsolescence, warranty obligation, warrants liability, Stock-based compensation and useful lives of property and equipment. Actual results could differ from those estimates. 10 Accounts Receivabl e 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 general 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. Receivables are considered past due after 3 years and written off. Management has determined this write-off policy by reviewing the decrease in likelihood of collection as a function of time and concluded that collectability of accounts receivable after three years was significantly impaired compared with collectability prior to such time. 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. Revenue Recognition The Company recognizes revenues when all the followings conditions have been satisfied: • Persuasive evidence an arrangement exists; • Delivery and/or installation has occurred (e.g., risks and rewards of ownership have 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 which 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. 11 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 is awaiting resolution of certain complex tax issues and has not yet filed its previous years’ Value Added Tax (“VAT”) returns for some of its customers. However, all the potential VAT liabilities on these VAT returns were accrued and included in the accompanying condensed consolidated financial statements. Item 3. Quantitative and Qualitative Disclosures about Market Risk. Not applicable.