Newegg Commerce, Inc. 10-K

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. (a) Market for Our Common Shares Our common shares are traded on the NASDAQ Stock Market under the symbol DHRM. The high and low common stock sales prices per share during the periods indicated were as follows: Quarter Ended Mar. 31 June 30 Sept. 30 Dec. 31 Year Fiscal year 2011 Price per common share: High $ 7.74 $ 5.30 $ 3.30 $ 2.08 $ 7.74 Low $ 4.90 $ 2.18 $ 1.95 $ 1.40 $ 1.40 Fiscal year 2010 Price per common share: High $ N/A $ 13.46 $ 7.50 $ 7.50 $ 13.46 Low $ N/A $ 6.24 $ 3.48 $ 4.34 $ 3.48 Approximate Number of Holders of Our Common Shares As of the date of this report there are eleven (11) holders of record of our common shares. This number excludes our common shares owned by shareholders holding under nominee security position listings. Dividend Policy We have never declared or paid any cash dividends on our common shares. We anticipate that we will retain any earnings to support operations and to finance the growth and development of our business. Therefore, we do not expect to pay cash dividends in the foreseeable future. Any future determination relating to our dividend policy will be made at the discretion of our Board of Directors and will depend on a number of factors, including future earnings, capital requirements, financial conditions and future prospects and other factors the Board of Directors may deem relevant. (b) The section entitled “Use of Proceeds” from our registration statement filed on November 12, 2009, as amended (the “Registration Statement”) is incorporated herein by reference. The effective date of the Registration Statement is March 26, 2010, and the Commission file number assigned to the Registration Statement is 333-163041. The Registration Statement registered the offering of up to 1,500,000 common shares (the “Offering”). As of December 31, 2011, the Company has spent all of the proceeds from the Offering in accordance with the following table: Description of Use Proposed Expenditure Amount Actual Expenditures through December 31, 2011 Product Research and Development $ 2,650,333 $ 2,661,630 Marketing 3,180,399 4,518,391 Potential Acquisitions 2,120,266 — Working Capital 2,650,333 3,421,310 Total $ 10,601,331 $ 10,601,331 Because we have not yet completed any acquisitions, our management determined that it was in the best interest of the company to devote IPO proceeds to continue to grow our business. In particular, we exceeded our anticipated the R&D expenditures by $11,297, our anticipated marketing expenditures by $ 1,337,992 and our anticipated working capital expenditures by $ 770,977 in part by participating in several international medical device manufacturer fairs. To the extent we engage in acquisitions in the future, we will need to rely on a variety of sources of funding, including but not limited to operating cash, and debt and/or equity financing. (c) None. II- 1 Item 6. Selected Financial Data. The Company is not required to provide the information required by this Item because the Company is a smaller reporting company. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion contains, in addition to historical information, forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those described herein. 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. Macro-Economic Factors and Business Trends In 2011, the Chinese Ministry of Science and Technology announced a medical technology development policy under the “12th Five-Year Plan,” proposing to transfer business focus to the development of new drugs, medical equipment and advanced traditional Chinese medicine, and to the development of the emerging industries of biomedicine. The plan focuses on researching and developing the medium- and high-level diagnostic and curative medical devices which are in high demand and widely used, actively promoting the development of cost-effective medical devices for use in primary health care institutions, enhancing the stability and reliability of medical services and products, and researching and developing supplementary medical equipment which can be easily operated for family and self healthcare. Under the 12th Five-Year Plan, China will proactively promote the reform of healthcare infrastructure system and offer safe, effective, convenient and low-cost medical services to its residents. According to China’s medical device industry analysis and forecast report of 2011 released by S&P Consulting, it is estimated that the entire medical instrument and equipment market in China will double, reaching $53.7 billion by 2015. The compound annual growth rate (“CAGR”) of the Chinese medical device industry is expected to remain at 20% to 30% during this period. Currently, the output of global medical devices account for 42% of the total global pharmaceutical market, while in China, medical devices only account for 14% of the total Chinese pharmaceutical market. As a result, management anticipates growth in the Chinese pharmaceutical market. Current medical device purchases by individuals in China are much lower than they are in Europe and the U.S. Twenty percent of individual expenditures on home medical care in China are for medical devices, compared to 50% of such expenditures in Europe and the U.S. As China’s population continues to age, management expects rapid increase in demand for medical devices, and, as a result, growth in China’s medical device industry. It is the initial stage of rapid growth of China’s home medical equipment market. As residents’ living standards and consumption structure change, the demand for healthcare services and self-care will substantially increase, creating growth opportunities for participants in the market. In summary, as a vital component of China’s current health system reform, the medical device industry has been incorporated into the national strategic development plan. In 2012, we anticipate new opportunities, combined with favorable government policies, will position us for continued growth. II- 2 New Opportunities in Our Business For 2011, Espicom, a highly regarded market research company, estimates Chinese medical device market growth to be in the region of 13.1%, one of the fastest growing markets in the world. High rates of growth are not uncommon in the Asian region, but on the back of a huge market size, China’s growth is particularly pronounced. Also according to Espicom, the medical device market in China is expected to reach $28 billion by 2014, doubled compared with the total sales in 2006. Chinese government programs are aimed at rebuilding and renovating urban health centers, and building hospitals and medical centers in rural areas. The government is setting up the goal of having one up-to-standard hospital in every county, one government-run medical center in every township and one clinic in every administrative village. Major portion of the domestic large-scale medical equipment procurement is government centralized procurement. For example, China Development Bank launched the “Supporting Health Infrastructure in Rural Areas” Program with a $690 million budget in the three years from 2011 through 2013. Fortune magazine predicted homecare medical equipment to be ranked first among the fastest-growing industries in the 21st century. In western countries with mature and large health care markets, home medical equipment accounts for 40% of the entire medical device output. However, in China because of the limited coverage and level of treatment in the public health systems, residents tend to be more aware of their health and wellness and to seek treatment at home before resorting to public health systems. Thus management expects that homecare medical equipment could become as ubiquitous as home appliances. In addition, the UN estimates that the Chinese population over the age of 60 will increase from 167 million in 2010 to 440 million in 2050; hence, the aging population and increasing incidence of respiratory disorders are expected to drive additional growth in respiratory homecare products in the Chinese marketplace. In 2011, the Shanghai government launched its medical insurance program to subsidize its citizens on homecare oxygen tanks. We anticipate Beijing and other cities will be pushing for similar legislation. Accordingly, in 2011 we partnered with two other companies to provide homecare oxygen tank services in Beijing. Based on the data shown above, both from a market and a government perspective, we are leveraging our broad sales network in order to introduce additional products from leading international brands into the Chinese market and participating in government healthcare projects. At the same time, we will also increase our investment in R&D, continue marketing penetration for our proprietary products, expand coverage for home oxygen therapy service and focus on broadening international markets. We believe that the favorable market conditions will support growth in sales and that our market expansion strategy will benefit our business growth in the future. Growth Strategy 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 our product portfolio through continued investment in research and development and pursuing attractive opportunities to acquire complementary companies. We have had steady growth in our brand name homecare medical products. We will expand our distribution channels through tools such as 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 develop our home oxygen service business and expand the service platform to dominate the domestic market for this service in China and to implement value-added business based on this platform. Eventually, we seek to provide customers with an all-in-one solution in the home healthcare field. We plan to leverage our existing network of consumer experience centers, or CECs, to showcase our home oxygen service business in those markets in which we offer home oxygen services. We will expand our distribution channels through tools such as 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 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 and other marketing activities. To the extent we have adequate demand for our homecare medical products abroad, we will seek regulatory approval to sell these products in the United States and Europe. II- 3 Revenues Our total revenues are derived from our medical devices and our respiratory and oxygen homecare products and services. Medical Devices (Including Related Supporting Products) – Our Proprietary and Distributed Products We derive revenues in our medical devices product line from the sale of C-arm X-ray systems, anesthesia machines, medical ventilators, general hospital products and related supporting products. Our medical device line is our largest product line and has the most extensive market penetration. We anticipate that we will continue to experience revenue growth in our medical devices line as we further develop our market through the introduction of new advanced product offerings and the participation in favorable government programs. In addition, we have begun to engage in state-level healthcare projects recently. We may procure high-end medical equipment for our clients, which may not necessarily be part of our existing distributed brands portfolio. We refer to these kinds of contracted projects as “key account business.” Although this business may carry lower margins, the contract value for such business is typically larger and can contribute materially to our revenues. Respiratory and Oxygen Homecare Products and HOTS We derive revenues in our respiratory and oxygen homecare line from sales of oxygen concentrators, CPAP devices, and portable sleep diagnostics devices. We anticipate that, on a percentage basis, revenues from our respiratory and oxygen homecare product line will increase more rapidly than total revenues in the near term, as we introduce new and more advanced products. We expect to develop our market for respiratory and oxygen homecare market in China and internationally through the use of distributors as well as through our direct sales platform. In addition, we launched our home oxygen therapy service (“HOTS”) in Beijing in the third quarter of 2011. While we strongly believe in the tremendous growth potential of HOTS business in the coming years, we are still in the early stage of this business. In 2012, management will focus on laying a solid foundation, such as the delivery network, rather than generating considerable revenue. Our ability to increase our revenues depends in large part on our ability to (i) increase the market penetration of our existing products, (ii) successfully identify, develop, introduce and commercialize, in a timely and cost-effective manner, new and upgraded products and (iii) enter into international markets in the future. Generally, we choose to devote our resources to product development efforts that we believe are commercially feasible, can generate significant revenues and margins, and can be introduced into the market quickly. 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: • global economic conditions; • the changes in China’s macro-economic environment and healthcare-related government strategies and policies; • the level of acceptance of our products among hospitals and other healthcare facilities; • our ability to attract and retain distributors, key customers and our direct sales force; • new product introductions by us and our competitors; and • our ability to price our products at levels that provide favorable margins. 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 both as a percentage of our total revenues and in absolute amount for the year ended December 31, 2011 compared to the same period in 2010, primarily due to the development of government-related projects, homecare and oxygen therapy clients and international market development. Further, our research and development investments and efforts in maintaining capital market relationships contributed to our operating expenses. The following table sets forth the components of our costs and expenses both in U.S. dollar amounts (in thousands) and as a percentage of total revenues for the years indicated. II- 4 For the Year Ended December 31, 2011 2010 USD (‘000) % USD (‘000) % Revenues 21,639 100.00 19,598 100.00 Costs and expenses Cost of revenues 13,697 63.30 11,982 61.14 General and administrative expenses 2,621 12.11 1,258 6.42 Selling expenses 1,877 8.67 1,421 7.25 Total costs and expenses 18,195 84.08 14,661 74.81 Cost of Revenues Cost of revenues primarily includes raw materials, parts for assembly, wages, handling charges, and other expenses associated with the assembly and distribution of product. General and Administrative Expenses General and administrative expenses consist primarily of salaries and benefits and related costs for our administrative personnel and management, fees and expenses of our outside advisers, including legal, audit 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 revenue, as we hire additional personnel and incur costs related to the anticipated growth of our business. In addition, we expect to continue to incur significant general and administrative expenses as a public company. 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 revenue, as we increase our efforts to promote our products, especially our new respiratory and oxygen homecare products. Results of Operations We believe that period-to-period comparisons of operating results should not be relied upon as indicative of future performance. Fiscal Year Ended December 31, 2011 Compared to Fiscal Year Ended December 31, 2010. Revenues Our total revenues increased by 10.41% from $19.60 million for the fiscal year ended December 31, 2010 to $21.64 million for the fiscal year ended December 31, 2011. In 2011, we changed our development strategy that not only focused on traditional medical devices sales but also government procurement projects and the burgeoning r espiratory and oxygen homecare market . Overall, revenue of traditional medical devices, including centralized government procurement projects, was 89.47% of the total revenues, while r espiratory and oxygen homecare was 10.53% of revenues in 2011. In 2010, revenue of traditional medical devices was 97.75% and r espiratory and oxygen homecare was only 2.25%. This shift in revenue mix reflects management’s efforts to focus on driving growth in homecare medical devices. Cost of Revenues Our cost of revenues increased by 14.36% from $11.98 million for the fiscal year ended December 31, 2010 to $13.70 million for the fiscal year ended December 31, 2011. Our cost of revenues grew in tandem with our revenue growth. Our gross margin decreased due to the increased cost of the products and assembly parts we purchased and increased labor cost, which were mainly affected by country-wide inflation in China. To the extent inflation pressures persist, we could see continued increase in our cost of revenues. II- 5 Gross Profit Our gross profit increased from $7.62 million in the year ended December 31, 2010 to $7.94 million in the same period of 2011, while the gross margin decreased from 38.86% in 2010 to 36.70% in 2011. We are seeking to address these trends by focusing on higher-margin projects and seeking some lower margin yet high contract value projects that help stabilize our revenue base. Operating Expenses Our operating expenses increased by 67.91% from $2.68 million for the fiscal year ended December 31, 2010 to $4.50 million for the fiscal year ended December 31, 2011. The expenses increased more quickly than revenues, largely due to the increase in general and administrative and selling expenses, which include higher expenses in relation to government projects and the research and development. Operating Expenses—General and Administrative Expenses General and administrative expenses consist primarily of salaries and benefits and related costs for our administrative personnel and management, and expenses associated with our research and development, registration of patent and intellectual property rights in China and abroad. Our general and administration expenses increased by 107.93% from $1.26 million for the fiscal year ended December 31, 2010 to $2.62 million for the fiscal year ended December 31, 2011. This increase was mainly due to: • Provision for Doubtful Accounts . Provision for doubtful accounts was approximately $0.75 million for the year ended December 31, 2011, an increase of approximately $0.77 million, compared to a recovery of doubtful accounts of approximately $0.018 million for the year ended December 31, 2010. We have experienced delays in payments from our distributors. Due to increasing competition, the distributors experienced a deterioration of the operating environment and were under pressure to repay its debts incurred during the years of expansion. We expect longer collection periods on accounts receivable and higher probability of uncollectable accounts receivable, and therefore have changed the accounting estimate on allowance for doubtful accounts. Our collection policy treats account receivables older than one year as past due. As a result, our provision for doubtful accounts increased. To address this issue, we have engaged accounts collection personnel to seek prompt payment from customers to increase the likelihood that our internal payment periods are met. • Research and Development Expense . We have been involved in 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 developing expenses. Management expects these expenses to continue to increase in the coming year as our development moves through the clinical test stage to production and as we move to secure intellectual property rights in our products. Further, we plan to start new research and developing projects for our homecare medical devices. Research and development expenses were $0.27 million and $0.08 million for the years ended December 31, 2011 and 2010, respectively. • Public Company Expense . After listing on the NASDAQ Capital Market on April 22, 2010, we hired employees and engaged experienced consulting firms to improve our visibility and exposure on the capital market. We expect that our general and administration expenses will increase in the near future as a result of business expansion and public company compliance in the U.S. Operating Expenses - Selling Expenses Our selling expenses increased by 32.39% from $1.42 million for the fiscal year ended December 31, 2010 to $1.88 million for the fiscal year ended December 31, 2011. 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 other marketing activities. Our selling expenses increased in 2011 mainly because we have invested in strengthening our distribution network, relationship with government and other customers, and development of the homecare device market (in particular our oxygen therapy service initiative). We expect our selling expenses will continue to grow as we drive top-line growth in these areas. II- 6 Operating Income As a result of the foregoing, we generated an operating income of approximately $3.61 million in 2011, compared to approximately $5.13 million in 2010. Operating income decreased by 29.57% largely due to the increase in operating expenses. Taxation Our income tax expense was approximately $0.66 million in 2011, compared to approximately $0.85 million in 2010. Our taxable income decreased primarily due to the decrease in net income. Net Income As a result of the foregoing, we had net income of approximately $3.13 million in 2011, compared to approximately $4.56 million in 2010. After deduction of non-controlling interest in income, net income attributable to Dehaier was approximately $3.10 million and $4.54 million in 2011 and 2010, respectively. Make-Good Escrow On March 22, 2010, our founders placed an aggregate of 600,000 common shares into escrow. Such shares equaled 40% of the maximum number of shares that were sold in the initial public offering (“IPO”). The shares remained in escrow until we filed our Form 10-K with the Securities and Exchange Commission for the year ended December 31, 2010. The shares in escrow (Make-Good Shares) were accounted for as an element in the IPO and we did not recognize any compensation expense upon the return of such Make-Good Shares to the holders. To the extent our earnings per share for the year ended December 31, 2010 were less than $0.80, we would have redeemed the make good shares, pro rata. At December 31, 2010, our earnings per share were $1.09. Thus, we did not need to redeem any of the Make-Good Shares. The shares were returned to our founders on May 5, 2011 and are included as part of the calculation of the basic and diluted earnings per share in the accompanying consolidated financial statements. Liquidity and Capital Resources Cash Flows and Working Capital In 2010, we financed our operations primarily from proceeds of common stock issuances. In 2011, we mainly used the cash proceeds from our IPO and from our operations. As of December 31, 2011, we had approximately $3.69 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 $3,694,486 at December 31, 2011. We believe that our currently available working capital of $26,981,557, including cash of $3,694,486, should be adequate to meet our anticipated cash needs and sustain our current operations for at least 12 months. To the extent we engage in acquisitions in the future, we will need to rely on a variety of sources of funding, including but not limited to operating cash and debt/equity financings. Operating Activities Net cash used in operating activities was $3,161,752 for the year ended December 31, 2011 as compared to $4,977,955 for the same period in 2010. (i) Cash flow due to decrease of $1,435,560 in net income . Our net income decreased primarily because of the increase of operating costs and expenses in 2011. (ii) Cash outflow due to decrease of $2,196,262 in prepayment . The decrease in prepayment is attributable to the change to our cooperating strategy with our suppliers. (iii) Cash outflow due to decrease of $2,307,599 in other receivables . The decrease in other receivables is mainly because we collected refundable deposits from suppliers. II- 7 Investing Activities Net cash used in investing activities for the year ended December 31, 2011 was $155,419, compared to $878,702 for the same period of 2010. The cash used in investing activities in each year was mainly attributable to capital expenditures for the purchase of new equipment. Financing Activities We received $1.5 million in proceeds from a short-term bank loan in 2011, which was fully paid during the year. The cash provided by financing activities for the year ended December 31, 2010 was due to the net proceeds from our IPO. Contractual Obligations and Commercial Commitments The following table sets forth our contractual obligations as of December 31, 2011: Payments due by period Contractual obligations Total Less than 1 year 1-3 years More than 3 years Operating Lease Obligations $ 50,000 $ 50,000 - - Short-term borrowings $ 1,585,890 $ 1,585,890 - - Total $ 1,635,890 $ 1,635,890 - - The leased properties are principally located in the PRC, and we use such properties for administration and warehouse facilities. The leases are renewable subject to negotiation. Short-term borrowings represent short-term loans from a bank, which is due in June 2012. Capital Expenditures We made capital expenditures of approximately $0.15 million and $0.89 million in 2011 and 2010, respectively, representing 0.69% and 4.54% of our total revenues, respectively. Our capital expenditures were used to purchase machinery for our assembly line. 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 shareholder’s equity or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us. Tax Matters Applicable to Our Company Generally Dehaier is a tax-exempt company incorporated in the British Virgin Islands. BDL and BTL were incorporated in the PRC and are governed by PRC laws. DHK is subject to Hong Kong profits tax rate. Our 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. II- 8 PRC Enterprise Income Taxes PRC enterprise income tax is calculated based on taxable income determined under PRC accounting principles. In accordance with the Enterprise Income Tax Law (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 our company, 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. 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 renewed its certification for “high technology” company, and qualified for the 15% income tax rate to calculate the income tax expense for the periods ended December 31, 2011 and 2010. The income tax rate for BTL was 25% in 2010 and 2011. PRC Value Added Tax Pursuant to the Provisional Regulation of China on Value Added Tax and its implementing rules, 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. United States Tax As of December 31, 2011, Breathcare LLC was inactive. Treated as a pass-through entity under the Internal Revenue Code, Breathcare LLC does not pay U.S. federal income tax at the entity level. Critical Accounting Policies Basis of Consolidation The consolidated financial statements include the accounts of Dehaier, and its majority-owned and wholly-owned subsidiaries (collectively, the “Company”). All significant inter-company transactions and balances are eliminated in consolidation. II- 9 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 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 and BTL 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. Use of Estimates The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Estimates are adjusted to reflect actual experience when necessary. Significant accounting estimates reflected in the Company’s consolidated financial statements include revenue recognition, allowance for doubtful accounts, warranty obligation, warrants liability, stock-based compensation and useful lives of property and equipment. Actual results could differ from those estimates. Accounts Receivable Accounts receivable are recorded at net realizable value. Accounts receivable terms typically are net 60-180 days from the end of the month in which the services were provided, or when goods were delivered. The company generally does 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 collectibility of specific accounts. Prior to 2011, receivables were considered past due after 3 years. In 2011, after assessing the distributors’ economic factors and Company’s historic experience, management decided that receivables over 1 year will be considered past due. 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 adopted the provisions of ASC topic 815, “Derivatives and Hedging.” 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 when warrants were issued in connection with the Company’s initial public offering. Such warrants are indexed to the Company’s stock, 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 warrants liability is measured each reporting period with the resulting change in fair value recorded in the consolidated statement of income and comprehensive income. The accounting standards regarding fair value of financial instruments and related fair value measurements define fair value, establish a three-level valuation hierarchy for disclosures of fair value measurement, and enhance disclosure requirements for fair value measures. The three levels are defined as follows: Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. II- 10 Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement. Warrants liabilities qualify as financial instruments, and are carried on the balance sheet at its fair value. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The fair value of the warrants was determined using the Black Scholes Model, with level 2 inputs, and the change is recorded in earnings. Our earnings increased in 2011 and decreased in 2010 due to the change in fair value of these warrants. Impairment of Long-Lived Assets The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may no longer be recoverable. When these events occur, the Company measures impairment by comparing the carrying value of the long-lived assets to the estimated undiscounted future cash flows expected to result from the use of the asset and eventual disposition. If the sum of the expected future cash flows is less than the carrying amount of the asset, an impairment loss, equal to the excess of the carrying amount over the fair value of the asset, is recognized. Revenue Recognition The Company recognizes revenues when all the followings conditions have been satisfied: · Persuasive evidence of an arrangement exists; · Delivery and/or installation has occurred (e.g., risks and rewards of ownership has passed); · The sales price is fixed or determinable; and · Collectibility 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. 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. As of December 31, 2011, the Company recorded deferred tax assets for the temporary differences arising from allowance for doubtful accounts and certain accrued expenses. We believe we can utilize this deferred tax benefit to offset future taxable income and have not provided a valuation allowance against our deferred tax asset. This deferred tax benefit increased our net income in 2011 by approximately $118,000. II- 11 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 2008 and 2009 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 consolidated financial statements. The implementation of ASC 740-10 resulted in no material liability for unrecognized tax benefits. As of December 31, 2011 and 2010, the Company did not have a liability for any unrecognized tax benefits. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits as income tax expense in the statement of operations. During the years ended December 31, 2011 and 2010, the Company did not incur any interest or penalties. Stock-Based Compensation The Company follows the provisions of ASC 718-10, “Compensation-Stock Compensation.” The Company has a share incentive plan which authorizes the issuance of up to 10% of the number of shares outstanding. Pursuant to the plan, the Company may issue options to purchase its common shares to employees and directors of the Company and its affiliates. The Company fair values share-based awards granted under the plan. Accordingly, compensation is measured on the grant date using appropriate valuation models. Item 7A. Quantitative and Qualitative Disclosures about Market Risk. The Company is not required to provide the information required by this Item because the Company is a smaller reporting company.