Newegg Commerce, Inc. 10-K

Item 1. Business. Company Overview We are a company in the business of developing and distributing medical devices. We have been focusing on developing respiratory and oxygen homecare products 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 equipment 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 proprietary 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 proprietary products require light assembly by us before distribution. We sell our products primarily through distributors, but we also make direct sales to hospitals, clinics, government health bureaus and individual customers. We continue to further our market reach by introducing newer and more advanced product lines that address different end-user needs. Recent Developments • On March 14, 2011, the Company signed a distribution agreement to become a regional distributor of eVent Medical’s inspiration ventilators in the Chinese market. These ventilators are used for hospitals, and are supplementary to Dehaier’s home use ventilators (including its continuous positive airway pressure (“CPAP”) and other products), thus enriching the Company’s ventilator portfolio to address broader market needs. • On April 21, 2011, the Company signed a tripartite strategic cooperation agreement with Taiyo Nippon Sanso Shenwei (Shanghai) Medical Gas Co., Ltd and Beijing Orient Medical Gas Co., Ltd to develop oxygen therapy services for the home use market in Beijing. Pursuant to the agreement, the Company will market the oxygen therapy services in Beijing. On July 18, 2011, the first oxygen filling facility and first service center for home oxygen therapy service were opened in Beijing. • On May 2, 2011, supported by China Development Bank, the Company signed a cooperation agreement worth approximately $2.05 million with Beijing Kanglian Medicines Co, Ltd, to develop, operate and implement a new rural healthcare infrastructure project in Hunan and Anhui provinces. In the process of this project, the Company cooperated with Phillips Medical System and Olympus. • On June 1, 2011, the Company won the bid to engage in a $1.32 million procurement contract to supply medical equipment to a large state-owned hospital in Beijing. The Company cooperated with German-based Leica Microsystems and U.S.-based ABI Medical in the process of completing the contracted project. • In June 2011, the Company’s international department authorized distributors in Taiwan for its CPAP devices, which marks the first distribution authorization outside of China. • In August 2011, the Company was granted export certificates for five homecare medical products by the State Food and Drug Administration (“SFDA”) of the PRC, allowing for Dehaier’s sleep diagnostics product DHR-998, Dehaier CPAP products DHR-AUTO-A8, DHR-C5, DHR-C6 and Dehaier medical air compressor to be exported without restriction. • In November 2011, the Company established a wholly-owned subsidiary in the state of Illinois, as a first step toward future global market expansion, including North America in particular. • In December 2011, the Company signed with three Romanian companies to distribute Dehaier’s DHR-5L oxygen concentrators in Romania. This marks Dehaier’s first entry into the European homecare medical product market. • In fiscal 2011, the Company obtained multiple intellectual properties. These include three design patents for products of sleep diagnostic device DHR998, CPAP DHR-C5 and air compressor DHR280, and two software copyrights for CPAP devices. I- 1 • During 2011, the Company was again honored as a “National High-Tech Enterprise” and a member of the Zhongguancun Credit Promotion Committee. Our Products When we began to sell our products in China, substantially all of the products we sold were distributed products from foreign suppliers. When we completed our Series A financing in 2003, we used some of the proceeds from that financing to establish a research and development department in order to develop products of our own to address market needs. At that time, our management concluded that it could develop its own products for sale through its existing network of independent distributors, who were already selling medical devices for our company to our desired customer base. We made this decision based in large part on our conclusion that we would be able to meet the needs of different markets with our proprietary products than we already met with our distributed products. Because our distribution team was already in place, we only needed to form research and development and assembly teams to be able to offer its proprietary products. As noted above, the Series A financing proceeds allowed us to form these teams. Based on feedback from our distribution team, our management has been able to provide guidance to our research and development team about what needs to address with new products and what improvements to make to existing products. This feedback has grown sales of our proprietary products. Our proprietary and distributed products include two major categories: (i) medical devices (including supporting products) and (ii) respiratory and oxygen homecare products. Our medical devices proprietary and distributed products are mainly used in hospitals and clinics, while our respiratory and oxygen homecare proprietary and distributed products are mainly for at-home use by individual customers. 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 smaller city and rural 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 products (previously defined as technical service products) and respiratory and oxygen homecare products. Medical Devices (Including Related Supporting Products) • Mobile Medical X-Ray Image Devices. We provide four types of DHR Explorer Series mobile and C-armed X-ray machines. X-ray is used for visualizing bone structures and other dense tissues such as tumors. These mobile and C-armed X-ray machines provide added convenience for use in hospitals and clinics. Our C-arm series of X-ray systems are suitable for ortho reduction and fixation procedures, intervertebral disc imaging and treatment, spinal operation, uterine and oviduct imaging, bladder and ureter imaging and gastric imaging. • Anesthesia Machines . We provide two types of DHR ORSA Series anesthesia machines. These machines are used by anesthesiologists to support the administration of anesthesia. These machines administer a precise and continuous supply of anesthetic gases and vapors to the patient at accurate and safe levels of pressure and flow. These machines maintain a continuous, closed-loop control over the pressure of gas within a patient’s mouth or respiratory according to the selected pressure input. In addition, these machines feature a modular design for mobility and ease of maintenance, cleaning and disinfection. • 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 C250 and C280 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. • Trolleys for Ventilators. We provide three types of trolleys to hold ventilators and their accessories for mobility. These trolleys can be fit with a monitor to further enhance the portability and utility. • Sterilizers for Ventilators. We provide one type of sterilizer to treat the air from patients in order to control cross-contamination and infection in a facility in general and for subsequent ventilator patients in particular. I- 2 Respiratory and Oxygen Homecare Products and Home Oxygen Therapy Service (“HOTS”) • Oxygen Concentrating Products . We provide two types of oxygen concentrator products, including, the DHR-3L/5L Oxi-Fairy and the DHR-3L/5L Oxi-Pioneer. These products use our patented advanced Pressure Swing Absorbing (“PSA”) technology to produce highly-concentrated, therapeutic-level oxygen (approximately 90% oxygen concentration) from air at normal temperatures. These products are used by patients with cardiovascular disease, respiratory diseases, such as chronic obstructive pulmonary disease, and geriatric patients. • Sleep Apnea Treatment Products. We have designed and expect to provide several products designed for obstructive sleep apnea therapy. These products include our DHR CPAP C5, DHR Auto CPAP A8, and DHR Auto S-CPAP A9. Our DHR CPAP C5, Auto CPAP A8 and DHR S-CPAP A9 are in the process of obtaining SFDA approval and will not be available for sale until we receive such approval. While we expect to receive this approval within the first half of 2010, we cannot guarantee that we will obtain such SFDA approval in this timeframe or all. 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. • 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 applied to SFDA for approval of our DHR 998 and DHR 999 diagnostic products, and they will not be available for sale until we receive such approval. While we expect to receive this approval within the first half of 2010, we cannot guarantee that we will obtain such SFDA approval in this timeframe or all. • Home Oxygen Therapy Service. Our home oxygen therapy service, or “HOTS” for short, is our new business initiative. The general concept of HOTS is to take orders from and deliver oxygen tanks to customers (patients) who need higher concentrations of oxygen gas. These customers generally either suffer from lung disease such as COPD or have other needs for concentrated oxygen, such as high altitude mountain climbers or coal miners who work in tunnels. We procure oxygen tanks from other companies and sell or rent the tanks to our customers. We obtain oxygen from Beijing Orient Medical Gas Corporation, China, with which we signed a strategic cooperation agreement. This business is still at an early stage, and we are first developing the business in the City of Beijing. Assuming the successful development of Beijing, we expect to apply this business model to other Chinese cities in subsequent years. 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 more competitive prices within a shorter period of time. We increased our annual investment in research and development activities as a percentage of net revenues every year since 2003. Research and development costs we re $268,038 and $82,553 for the years ended December 31, 2011 and 2010, respectively. Our research and development team consists of 27 engineers, representing more than one-tenth of our employees nationwide. 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 appeal to a wide range of end-users. I- 3 We maintain a 5,400 square foot research and development center in our facility in Beijing, which allows us to compete for skilled research and development technicians and managers. In addition, 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 University of Science & Technology Beijing. Principal Suppliers – Our Proprietary Products We use the following principal suppliers to manufacture the components in the products we develop and assemble: • Friend of Health (Chuzhou) Medical Technology Co., Ltd. • China Medical Equipment Co., Ltd. • Dalian Wande Co., Ltd. • Beijing Jianfa Co., Ltd. • IMD Beijing Medical Equipment Co., Ltd. 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. We outsource the production of some of our oxygen concentrators and air compressors to Friend of Health under production agreements. We provide the technical specifications and files needed for Friend of Health to manufacture these proprietary products. We provide separately outsourced core parts to Friend of Health to incorporate into the components they assemble and distribute for us. We test and approve each part produced by Friend of Health before they begin mass production. We require Friend of Health to maintain minimum supplies of our proprietary products and components for use in our proprietary products, and we permit them to sell our proprietary products only in Chuzhou. Friend of Health delivers products to us on credit, and we are required to make payment within 45 days after the date of delivery. Friend of Health is the only supplier that also assembles and distributes finished proprietary products for us. 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 SFDA 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 32,000 square foot product center in Changping Science Park 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 37 employees in assembly and by some of our external vendors, such as Friend of Health. 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 two practical patents issued in China for oxygen concentrators. We have five design patents related to our CPAP devices (2), portable sleep screening (2) and diagnostic services (1). 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. I- 4 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 proprietary 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 higher quality more with well-known international brands than with domestic brands. We serve as a significant distributor in China for several foreign producers of medical devices and respiratory and oxygen homecare products, including IMD, Timesco, HEYER and eVent. We believe this extensive platform allows us to be responsive to local market demand. We distribute medical devices and respiratory and oxygen homecare products for these companies. • Mobile Medical X-Ray Image Devices. We provide two types of X-ray machines developed by other companies: the IMD Radius Series mobile and C-armed X-ray machine and the IMD Compact Series mobile-X-ray machine. • Medical Ventilators. We provide one type of ventilators developed by other companies: the Inspiration Ventilators from eVent. The Inspiration Series of medical ventilators mechanically move breathable air to and from the lungs to support breathing support for patients who are physically unable to breathe or who are breathing insufficiently. • Anesthesia Machines . We provide two types of anesthesia machines developed by other companies: the Nakomat and Modular models from HEYER. These machines are used by anesthesiologists to support the administration of anesthesia. These machines administer a precise and continuous supply of anesthetic gases and vapors to the patient at accurate and safe pressure and flow levels. These machines maintain a continuous, closed-loop control over the pressure of gas within a patient’s respiratory system according to the selected pressure input. In addition, these machines feature a modular design for mobility and ease of maintenance, cleaning and disinfection. • Ultrasonic Nebulizers. We provide one type of ultrasonic nebulizers developed by other companies: the Cumulus model from HEYER. These devices are used to treat patients with respiratory disease such as asthma, bronchitis and pneumonia. The ultrasonic nebulizers convert low viscosity liquid drug into fine like particles so that the particles can reach to infectious area in the respiratory tract. Our distributed model –the Cumulus is the only model in the market to effectively treat infection in the lower respiratory tract area. • Laryngoscopes . We provide four types of laryngoscopes developed by other companies: the Optima, Optima XL and Eclipse lines of laryngoscopes from Timesco. 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. 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 IMD (Italy), Timesco (UK), HEYER (Germany) and eVent (USA). In this capacity, we are responsible for sales, marketing and after-sale services of these products. We sign agency agreements with these international suppliers annually with the aim of settling marketing promotion modes, costs, product training and resolution of customer service issues. The agency agreements cover purchasing price, purchasing intervals, order quantity, transportation and type of payment, spare part supply and after-sale service terms. We negotiate renewal of these agency agreements as they expire to confirm ongoing distributor expectations. I- 5 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 the following companies: • IMD (Italy) • Timesco (UK) • HEYER (Germany) • eVent (USA) The exact products from these suppliers are available only from such suppliers; however, we do not anticipate that we will be unable to obtain similar products from other suppliers in the event our principal suppliers are unable or unwilling to supply us. Our Service We maintain a 24-hour 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: distributors, hospitals and government agencies, and 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 90% of our sales are to distributors. Based on the expected use of products sold to distributors, we estimate that they sell approximately 60% of our products to hospitals, 20% to clinics and 10% to individuals. As a result, we estimate that approximately 67% of our products (on a revenue basis, rather than unit basis) are sold to hospitals, approximately 21% to clinics and approximately 12% to individuals. We have contractual distribution relationships with over 2,000 independent distributors. We do not own, employ or control these independent distributors. Hospital and governmental agency customers. Our hospital and governmental agency customers primarily include hospitals 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 home respiratory therapy products directly to consumers through our customer experience centers, or “CECs,” and through E-commerce platforms. Dependence on major customers. For the year ended December 31, 2011, approximately 13% of our revenue was received from each of two customers. For the year ended December 31, 2010, approximately 8% of our revenue was received from one customer. Concentration of receivables . At December 31, 2011 and 2010, receivables from four of our customers were approximately 12%, 10%, 9%, 9% and 12%, 11%, 11%, 9%, respectively . I- 6 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 Respironics, Inc., ResMed Inc., and Covidien, as well as domestic Chinese companies such as Beijing Aoji, Beijing Ya’ao, Jiangsu Yuyue and Zhejiang Longfei. 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 Primary Competitors in China Dehaier’s Estimated Competitive Position DHR Explorer Series C-armed X-ray machine Nanjing Pulang, Beijing Wantong, Beijing Smart, Shenzhen Nanyun Average DHR ORSA Series anesthesia machines Drugg, GE, Spacelab Average C250 and C280 air compressors Beijing Yi’an, Guangdong Puling Greater than average Trolleys An OEM business model, N/A N/A Sterilizers An OEM business model, N/A N/A DHR oxygen concentrator Beijing Aoji, Beijing Ya’ao, Jiangsu Yuyue and Zhejiang Longfei Smaller than average DHR CPAP C5, DHR Auto CPAP A8, DHR Auto S-CPAP A9 Foreign companies such as Respironics, ResMed, and Covidien Not on the market yet DHR 998 and DHR 999 screening and diagnosis products Foreign companies such as Respironics, ResMed, and Covidien Greater than average Distributed Product Primary Competitors in China Dehaier’s Estimated Competitive Position IMD C-armed X-ray machine Philips, GE, Siemens Smaller than average eVent Ventilators Drugg (GER), GE, TYCO (USA), Newport (USA) Smaller than average HEYER Anaesthesia Machine Drager (GER), Datex-Ohmeda (US), Primas (UK) Smaller than average HEYER Ultrasonic Nebulizer PARI (GER), YUYUE (China) Average Timesco laryngoscope Kirchner & Wilhelm (GER), WelchAllyn (USA) Greater than average A “greater than average” position indicates Dehaier estimates its competitive position in the top third of all competitors. “Average” indicates Dehaier estimates its competitive position in the middle third of all competitors. “Smaller than average” indicates Dehaier estimates its competitive position in the bottom third of all competitors. I- 7 As we expand into international markets, our competitors will include publicly traded and privately held multinational companies such as Respironics, and Covidien. 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 and HEYER. We are also able to supply our proprietary products to customers who tend to care less about perceived value and more about functionality. One of our strategies in competing in this market is to make our products as mobile as possible. For this reason, our air compressors, mobile X-ray devices, trolleys and the like are all portable. This portability addresses the budgetary limitations of, for instance, a rural clinic that can only afford to purchase a single air compressor. We currently compete on three levels. First, we have well-established distribution channels and close relations with more than 2,000 dealers and distributors, reaching an estimated 3,000 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. Together with our new home oxygen therapy service, we provide homecare medical solutions that combine products and services. Third, we have emphasized international growth, including seeking approval to sell our products in Europe and other countries and establishing a U.S. subsidiary to enable us to compete in North America. 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. Employees As of March 10, 2012, we had 167 full-time employees and no part-time employees. Out of that total, 37 were employed in assembly, 27 were in research and development, 15 were in general administration, 80 were in marketing, sales, and customer support and service, and 8 were in procurement and supply management. 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 the employee benefit 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 SFDA. We are also subject to other PRC government laws and regulations. SFDA 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. I- 8 China’s Regulation of Medical Devices Classification of Medical Devices In China, medical devices are classified by the SFDA 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 SFDA under the strictest regulatory control. The majority of our products are classified as Class II or Class III devices. Our anesthesia machines and ventilators are classified as Class III medical devices, while the remainder of our products are either classified as Class II or, in the case of our ventilator trolleys and sterilizers, not 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 September 15, 2013. 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 nine months before the expiration date of the permit. 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. Our distribution license will expire on September 15, 2013. Registration Requirement Before a medical device can be manufactured for commercial distribution, a company must effect 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 SFDA requires companies to apply for and obtain in advance a favorable inspection result for the device from an inspection center jointly recognized by the SFDA 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 which 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 SFDA, 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 SFDA 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. I- 9 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 Product Model Registration Expiration Mobile Medical X-Ray Image Devices Explorer Series mobile and C-armed X-ray machine July 2015 IMD Compact Series mobile-X-ray machine December 2012 Anesthesia Machines DHR ORSA Series anesthesia machine February 2014 Ventilator Air Compressor DHR280 Air Compressor for Ventilators September 2013 Trolleys for Ventilators - Not a medical device Sterilizers for Ventilators - Not a medical device Anesthesia Machines DHR ORSA Series anesthesia machine September 2013 Respiratory and Oxygen Homecare Products Product Type Product Model Registration Expiration Oxygen Concentrating Products Oxygen concentrator April 2014 Sleep Apnea Treatment Products CPAP C5 Auto CPAP A8 Auto S-CPAP A9 Application stage Application stage Application stage Diagnostic Products DHR 998 DHR 999 Application stage Application stage Continuing SFDA Regulation We are subject to continuing regulation by the SFDA. 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: • SFDA’s quality system regulations which require companies to create, implement and follow certain design, testing, control, documentation and other quality assurance procedures; • medical device reporting regulations, which require that companies report to the SFDA certain types of adverse reaction and other events involving their products; and • SFDA’s general prohibition against promoting products for unapproved uses. 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 SFDA guidelines, but we could be required to change our compliance activities or be subject to other special controls if the SFDA changes or modifies its existing regulations or adopts new requirements. We are also subject to inspection and market surveillance by the SFDA to determine compliance with regulatory requirements. If the SFDA decides to enforce its regulations and rules, the agency can institute a wide variety of enforcement actions such as: • fines, injunctions and civil penalties; • recall or seizure of our products; • the imposition of operating restrictions, partial suspension or complete shutdown of assembly; and • criminal prosecution. I- 10 China Compulsory Certification Requirements China Compulsory Certification, or CCC, inclusive of a certificate and a mark, serves as evidence that the covered products can be imported, marketed or used in China. The CCC mark is administered by the China National Certification and Accreditation Administration, which designates the China Quality Certification Center to process CCC mark applications. Some medical devices are required to have a CCC mark. We have received a certificate and a mark for each of our proprietary products for which a CCC mark is required. 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 state 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 Foreign Investment Industrial Guidance Catalogue, effective as of December 11, 2007 (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: • 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; • 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 • may import certain equipment while enjoying a tariff and import-stage value-added tax exemption. 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. I- 11 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. I- 12 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. Item 1A. Risk Factors. The Company is not required to provide the information required by this Item because the Company is a smaller reporting company. Item 1B. Unresolved Staff Comments. The Company is not required to provide the information required by this Item because the Company is a smaller reporting company.