Newegg Commerce, Inc. 10-Q

Item 1. Financial Statements. See the financial statements following the signature page of this report, which are incorporated herein by reference. Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis of the company’s financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes included elsewhere in this report. In this report, the terms “we,” “the Company” and “our” refer to Dehaier Medical Systems Limited, a British Virgin Islands company (“Dehaier”), Beijing Dehaier Technology Company Limited, our variable interest entity in the People’s Republic of China (“BTL”) and Beijing Dehaier Medical Technology Company Limited, our operating subsidiary in the People’s Republic of China (“BDL”). This discussion contains forward-looking statements that involve risks and uncertainties. Actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors. This section should be read together with the consolidated financial statements and related notes thereto in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, which was filed on March 19, 2012. Overview We are a company in the business of developing and distributing medical devices. We have been focusing on developing the respiratory and oxygen homecare business in particular since 2006. We design, develop and market our own branded products and medical components. Since we do not operate any fully scaled manufacturing facilities, we contract some of the medical components to outside manufacturers in China. Most of our branded products require light assembly by us before distribution. We also distribute 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 medical equipment used in the operating room, the intensive care unit (“ICU”) and the emergency room. While we sell our products primarily through distributors, we also make direct sales to hospitals, clinics and government health bureaus. We continue to further our market reach by introducing newer and more advanced product lines that address different end-user needs. Business Development In January 2012, we received Conformité Européenne (CE) certification for our sleep diagnostic devices and air compressors. The CE mark recognizes that the two products meet European Union (EU) health and safety standards and are approved for sale in the 27 member states of the EU and in the four members of the European Free Trade Association (EFTA). In March2012, we won a new bid to implement a government procurement project to provide imaging equipment for township hospitals in Xi’an, Shaanxi, China. Also in March2012, we obtained two software copyrights for our CPAP devices. The addition of these copyrights to our intellectual property portfolio reflects progress in our ongoing research and development efforts into the new generation of homecare CPAP devices. 2 Growth Strategies We plan to 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 plan to broaden our portfolio of products we distribute for other companies by cooperating with more internationally recognized medical equipment manufacturers. We also intend to take advantage of our well-established distribution network to grow sales revenues. By actively participating in state-level contracted healthcare programs, we will continue to expand our key account business and build a higher level of contact and relationships with the government and other healthcare industrial insiders. We plan to 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 many new options, such as third party e-commerce platforms and chain drug stores. We plan to create more cross-selling opportunities for our homecare products while providing oxygen delivery through the service platform. We have started and intend to continue developing our home oxygen service business in Beijing and eventually expand this service platform to all major markets in China. We also plan to offer more value-added services to our customers based on this platform. Our long-term goal is to provide our customers an all-in-one solution in the home healthcare field. Furthermore, we will continue to leverage our existing network of consumer experience centers, or CECs, to showcase our new products as well as service, such as home oxygen service. We will continue to expand into overseas markets and establish a distribution network, through distribution agreements, OEM partnerships, direct sales force efforts 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 continue seeking regulatory approval to sell these products in the United States and Europe. Results of Operations For the three months ended March 31, 2012 and 2011, our total revenues amounted to approximately $3.32 million and $2.95 million, respectively. Our revenues are subject to value added tax (“VAT”), sales returns and trade discounts. We deduct these amounts from our gross revenues to arrive at our total revenues. Our net income attributable to Dehaier for the three months ended March 31, 2012 and 2011 was approximately $0.13 million and $0.21 million, respectively. Such decrease in net income was mainly due to the increase in non-cash change in fair value of warrants liability in Q1 of 2012. Excluding the effects of non-cash change in fair value of warrants liability (which resulted in a loss of $199,508 and a gain of $9,526 for three months ended March 31, 2012 and 2011, respectively), the Company’s net income for the quarter ending March 31, 2012 would have been$325,529, an increase of 66.18% compared to $195,888 for the same period of 2011. Factors Affecting Our Results of Operations – Generally We believe the most significant factors that directly or indirectly affect our sales revenues and net income are: • the level of acceptance of our products among hospitals and other healthcare facilities; • our ability to price our products at levels that provide favorable margins; • new products introduced by us and our competitors; • our ability to attract and retain distributors and key customers; • Our continued investment in research and development activities and our retention of key employees; • changes in China’s macro-economic environment and healthcare-related government policies and legislation; and • global economic conditions. 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 Home Oxygen Therapy Service (or “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. 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. 3 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 three months ended March 31, 2012 compared to the same period in 2011, 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 the increase of 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 three months indicated. For the Three months Ended March 31, 2012 2011 USD USD (‘000) % (‘000) % Revenues 3,316 100.00 2,953 100.00 Costs and expenses Cost of revenues 2,075 62.57 1,955 66.22 General and administrative expenses 491 14.80 504 17.07 Selling expenses 319 9.61 240 8.12 Total costs and expenses 2,885 86.98 2,699 91.41 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. Three Months Ended March 31, 2012 Compared to Three Months Ended March 31, 2011. Revenues Our total revenues increased by12.30% from $2.95 million for the three months ended March 31, 2011 to $3.32 million for the three months ended March 31, 2012. In the first quarter of 2012, we continuously developed our sales channels on traditional medical devices sales as well as government procurement projects and the burgeoning respiratory and oxygen homecare market. 4 Cost of Revenues Our cost of revenues increased by 6.11% from $1.96 million for the three months ended March 31, 2011 to $2.07 million for the three months ended March 31, 2012. Our cost of revenues grew at a slower rate than our revenue growth. Our gross margin increased due to reduced material consumption during product production through effective and efficient inventory and cost management starting from the last quarter in 2011. However, we predict inflation pressures are likely to persist, which could lead increase our cost of revenues in the coming period. Gross Profit Our gross profit increased from $1.00 million in the three months ended March 31, 2011 to $1.24 million in the same period of 2012, while the gross margin increased from 33.78% in 2011 to 37.43% in 2012. The management believes such increase in gross margin is a result of operating effectiveness. Operating Expenses Our operating expenses increased by 8.90% from $0.74 million for the three months ended March 31, 2011 to $0.81 million for the three months ended March 31, 2012. Operating expense increases were 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. The expenses increased slightly more slowly than revenues because we enhanced performance appraisals for our employees, which allowed us to manage labor expenses while incentivizing revenue growth. 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 decreased by 2.54% from $0.50 million for the three months ended March 31, 2011 to $0.49 million for the three months ended March 31, 2012. This decrease was mainly due to the improvement in on budget management and cost accounting effectiveness. We expect that our general and administration expenses may increase in the near future as a result of further development in our R&D projects and professional fees for being a public company in the U.S. Operating Expenses - Selling Expenses Our selling expenses consist primarily of salaries and related expenses for personnel engaged in sales, marketing and customer support functions, and costs associated with advertising and other marketing activities. Our selling expenses increased by 32.95% from $0.24 million for the three months ended March 31, 2011 to $0.32 million for the three months ended March 31, 2012.These selling expense increases primarily because we have invested in strengthening our distribution network, relationships with customers, and development of the homecare device market (in particular our oxygen therapy service initiative). We expect our selling expenses will continue to grow (possibly more quickly than revenues) as we drive top-line growth in these areas. Operating Income As a result of the foregoing, we generated an operating income of approximately $0.45 million in the three months ended March 31, 2012, compared to approximately $0.30 million in the same period of 2011. Operating income increased by 52.44%, largely due to the increase in gross margin. 5 Taxation Our income tax expense was approximately $0.10 million in the three months ended March 31, 2012, compared to approximately $0.08 million in the same period of 2011was primarily due to an increase in our taxable income. Net Income We had net income of approximately $0.13 million in the three months ended March 31, 2012, compared to approximately $0.21 million in 2011, decreased by 37.73%. The decrease in net income was mainly affected by the change in fair value of our warrants liability. Excluding the effects of non-cash change in fair value of our warrants liability (which was a loss of $199,508 and a gain of $9,526 for three months ended March 31, 2012 and 2011,respectively), the Company’s net income for the quarter ending March 31, 2012 would have been$325,529, an increase of 66.18% as comparing to $195,888 for the same period of 2011. After deduction of non-controlling interest in income, net income attributable to Dehaier was approximately $0.21 million and $0.13 million in the three months ended March 31, 2012 and 2011, respectively. Liquidity and Capital Resources Cash Flows and Working Capital As of March 31, 2012, we had approximately $2.30 million in cash and cash equivalents. As a result of the total cash activities, net cash decreased from $3,694,486 at December 31, 2011 to $2,299,270 at March 31, 2012. We believe that our currently available working capital of $27,524,771, including cash of $2,299,270, 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 or other business expansion 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 $1,590,597 for the three months ended March 31, 2012, as compared to $2,113,734 for the same period in 2011 because management’s focus on operating effectiveness resulted in the improvement of turnover of accounts receivable and inventory. Investing Activities Net cash used in investing activities for the three months ended March 31, 2012 was $5,758, compared to $10,632for the same period of 2011. The cash used in investing activities in each quarter was mainly attributable to capital expenditures for the purchase of new equipment. Financing Activities During the first quarter 2012, the Company repaid $631,428 of its short-term bank loan on maturity and entered into a new loan agreement for $791,315.The net amount provided by financing activities was $0.16 million at March 31, 2012. Capital Expenditures We made capital expenditures of approximately $6 thousand and $8 thousand in the three months of 2012 and 2011, respectively. Our capital expenditures were used to purchase machinery for our assembly line. 6 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 the 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. The Company pays PRC enterprise income taxes, value added taxes and business taxes in China for revenues from BDL, and is governed by British Virgin Islands tax laws as to Dehaier. British Virgin Islands Tax We are exempt from all provisions of the Income Tax Act of the British Virgin Islands, including with respect to all dividends, interests, rents, royalties, compensation and other amounts payable by or to persons who are not resident in the British Virgin Islands. Capital gains realized with respect to any of our shares, debt obligations or other securities by persons who are not resident in the British Virgin Islands are also exempt from all provisions of the Income Tax Act of the British Virgin Islands. No estate, inheritance tax succession or gift tax rate, duty, levy or other charge is payable by persons who are not resident in the British Virgin Islands with respect to any of our shares, debt obligations, or other securities. No stamp duty is payable in the British Virgin Islands in relation to a transfer of shares in a British Virgin Islands Business Company. PRC Enterprise Income Taxes PRC enterprise income tax is calculated based on taxable income determined under PRC accounting principles. According to the Foreign-invested Enterprises and Foreign Enterprises Income Tax Law (the “FIE Income Tax Law”) and the related implementing rules, both of which issued in 1991, foreign-invested enterprises established in China are generally subject to an income tax rate of 33% (consisting of 30% enterprise income tax and 3% local income tax). The FIE Income Tax Law and the related implementing rules provide certain favorable tax treatments to qualified foreign invested enterprises. The FIE Income Tax Law was replaced by the Enterprise Income Tax Law (the “EIT Law”) as of January 1, 2008. Under the EIT Law, a unified enterprise income tax rate of 25% and unified tax deduction standards will be applied equally to both domestic-invested enterprises and foreign-invested enterprises. Enterprises established prior to March 16, 2007 eligible for preferential tax treatment in accordance with the currently prevailing tax laws and administrative regulations shall, under the regulations of the State Council, gradually become subject to the EIT Law rate over a five-year transition period starting from the date of effectiveness of the EIT Law. The details of the transitional arrangement for the five-year period from January 1, 2008 to December 31, 2012 applicable to enterprises approved for establishment prior to March 16, 2007, such as us, were adopted in January 2008. Furthermore, under the EIT Law, an enterprise established outside of the PRC with “de facto management bodies” within the PRC is considered a resident enterprise and will normally be subject to the enterprise income tax at the rate of 25% on its global income. If the PRC tax authorities subsequently determine that we or any of our non-PRC subsidiaries should be classified as a PRC resident enterprise, then such entity’s global income will be subject to PRC income tax at a tax rate of 25%. In addition, under the EIT Law, payments from BDL to us may be subject to a withholding tax. The EIT Law currently provides for a withholding tax rate of 20%. If Dehaier is deemed to be a non-resident enterprise, then it will be subject to a withholding tax at the rate of 10% on any dividends paid by its Chinese subsidiaries to Dehaier. In practice, the tax authorities typically impose the withholding tax rate of 10% rate, as prescribed in the implementation regulations; however, there can be no guarantee that this practice will continue as more guidance is provided by relevant government authorities. We are actively monitoring the proposed withholding tax and are evaluating appropriate organizational changes to minimize the corresponding tax impact. 7 The State Council issued the “Notice on Implementation of the Transition Period for Preferential Enterprise Income Tax,” or the “Transition Implementation Notice,” on December 26, 2007, which provides detailed rules on how preferential tax rates under previous income tax laws or regulations would transition to the uniform 25% EIT rate. In addition, entities that qualify as “high and new technology enterprises” will enjoy a 15% preferential tax rate under the EIT Law. The Ministry of Science and Technology, the Ministry of Finance and the State Administration of Taxation issued the “Measures on Qualification of High and New Technology Enterprises,” or “Circular 172,” on April 14, 2008, which provides detailed standards for “high and new technology enterprises.” In addition, according to the Notice on Prepayment of Enterprise Income Tax issued by the State Administration of Taxation, enterprises that have been certified as “high and new technology enterprises” shall pre-pay EIT at the rate of 25% temporarily until re-certified as “high and new technology enterprises” under Circular 172. Under the current PRC laws, PRC government grants a preferential income tax rate of 15% to government-certified high technology companies, and under the new standard the period of validity for the certification of high technology companies is three years. In 2009, BDL updated its certification for “high technology” company. Therefore, BDL used a 15% income tax rate to calculate the income tax expense for periods ended September 30, 2011 and2010. The tax rate for BTL is 25% for periods ended September 30, 2011 and 2010. PRC Value Added Tax All entities and individuals that are engaged in the businesses of sales of goods, provision of repair and placement services and importation of goods into China are generally subject to a VAT at a rate of 17% (with the exception of certain goods which are subject to a rate of 13%) of the gross sales proceeds received, less any VAT already paid or borne by the taxpayer on the goods or services purchased by it and utilized in the production of goods or provisions of services that have generated the gross sales proceeds. PRC Business Tax Companies in China are generally subject to business tax and related surcharges by various local tax authorities at rates ranging from 3% to 20% on revenue generated from providing services and revenue generated from the transfer of intangibles. Critical Accounting Policies Presentation in Accordance with US GAAP We prepared our accompanying condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“US GAAP”). These accounting principles require us to make judgments, estimates and assumptions on the reported amounts of assets and liabilities at the end of each fiscal period, and the reported amounts of revenues and expenses during each fiscal period. We continually evaluate these judgments and estimates based on our own historical experience, knowledge and assessment of current business and other conditions, our expectations regarding the future based on available information and assumptions that we believe to be reasonable. Basis of Consolidation The condensed consolidated financial statements include the accounts of Dehaier, BDL, its majority-owned subsidiary, and BTL. All significant inter-company transactions and balances are eliminated in consolidation. A group of shareholders, including the Chief Executive officer, originally held more than 50% of the voting ownership interest of Dehaier, BDL and BTL. BTL is a variable interest entity (“VIE”), and BDL is the primary beneficiary. BTL owns a building, which is pledged as collateral for BDL’s bank loans. In exchange, BDL loans money to BTL to finance its operations. BTL’s primary operation is to provide repairs and transportation services to BDL’s customers. Because of these arrangements, BDL is the primary beneficiary of BTL, as the entity that is most closely associated with BTL. Management makes ongoing reassessments of whether BDL is the primary beneficiary of BTL. 8 The accounts of BTL are consolidated in the accompanying financial statements pursuant to Accounting Standards Codification (“ASC”) 810-10, “Consolidation.” As a VIE, BTL’s revenues are included in the Company’s service income, and its income from operations is consolidated with the Company’s. Because of the arrangements, the Company had a pecuniary interest in BTL that requires consolidation of the Company’s and BTL’s financial statements. Use of Estimates The preparation of the condensed consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Estimates are adjusted to reflect actual experience when necessary. Significant accounting estimates reflected in the Company’s condensed consolidated financial statements include revenue recognition, allowance for doubtful accounts, inventory obsolescence, warranty obligation, warrants liability, Stock-based compensation and useful lives of property and equipment. Actual results could differ from those estimates. Accounts Receivabl e Accounts receivable are recorded at net realizable value. Accounts receivable terms typically are 60-180 days from the end of the month in which services are provided or goods are delivered. Our typical trade receivable terms vary based on the type of customer. We general require 100% prepayment before delivering our products to individual clients. Our contract terms general require 10%-30% prepayment for our hospital and healthcare center clients, and the trade receivable term in contracts for those clients is generally between 60 and 90 days. Our contract terms general require 10% prepayment from our distributor clients, and the trade receivable term in contracts for those clients is generally between 60 and 180 days. With the exception of the prepayments we require in some cases, we generally do not require collateral or other security to support accounts receivable. An allowance, if required, is based on a combination of historical experience, aging analysis, and an evaluation of the collectability of specific accounts. Prior to 2011, receivables were considered past due after 3 years and written off. Management determined this write-off policy by reviewing the decrease in likelihood of collection as a function of time and concluded that collectability of accounts receivable after three years was significantly impaired compared with collectability prior to such time. In 2011, after assessing the distributors’ economic factors and the Company’s historic experiences, management decided that receivables over 1 year are considered past due. Because this change was not retroactive, the current period’s net income and earnings per share are lower than the comparable period in 2011. Fair Value of Financial Instruments The carrying amounts reported in the consolidated financial statements for current assets and current liabilities approximate fair value due to the short-term nature of these financial instruments. The Company follows the provisions of ASC 820-10, “Fair Value Measurements and Disclosures,” which establishes a single authoritative definition of fair value and a framework for measuring fair value and expands disclosure of fair value measurements for both financial and nonfinancial assets and liabilities. This standard defines fair value, provides guidance for measuring fair value and requires certain disclosures. This standard does not require any new fair value measurements, but discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flows) and the cost approach (cost to replace the service capacity of an asset or replacement cost). For purposes of ASC 820-10-15, nonfinancial assets and nonfinancial liabilities would include all assets and liabilities other than those meeting the definition of a financial asset or financial liability as defined in ASC 820-10-15-15-1A. 9 The Company adopted the provisions of ASC Topic 815 (formerly Emerging Issue Task Force 07-5), “Determining Whether an Instrument (or an Embedded Feature) is Indexed to an Entity’s Own Stock.” ASC Topic 815 provides a framework for determining whether an instrument is indexed to an entity’s own stock. ASC Topic 815 became effective for the Company this period when warrants were issued in connection with the Company’s initial public offering (“IPO”). Such warrants are indexed to the Company’s common shares, which is traded in US dollars. Since the Company’s functional currency is the RMB, such warrants are considered liabilities. The fair value of the warrant liabilities is measured each reporting period with the resulting change in fair value recorded in the statement of operations. An increase of the warrants liability would decrease net income and earnings per share. A decrease in warrants liability would increase net income and earnings per share of the Company. Revenue Recognition The Company recognizes revenues when all the followings conditions have been satisfied: • Persuasive evidence an arrangement exists; • Delivery and/or installation has occurred (e.g., risks and rewards of ownership have passed); • The sales price is fixed or determinable; and • Collectability is reasonably assured. All revenues are based on firm customer orders with fixed terms and conditions. Because the products are assembled to the customers’ specification, there is no right of return. The Company does not provide its customers with price protection or cash rebates. For products that include software, the software is an off-the-shelf package and an integral part of the products being delivered. The Company does not provide any significant post-sale customer support services and does not provide customers with upgrades. The software is incidental to the product as a whole. For products that do not require installation, revenues are recognized when the products are delivered. For products that require installation, revenues are recognized when the installation is completed. Income Taxes The Company uses the asset and liability method of accounting for income taxes in accordance with ASC 740-10, “Accounting for Income Taxes.” Under this method, income tax expense is recognized for the amount of: (i) taxes payable or refundable for the current year; and, (ii) deferred tax consequences of temporary differences resulting from matters that have been recognized in an entity’s financial statements or tax returns. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation allowance is provided to reduce the deferred tax assets reported if, based on the weight of available positive and negative evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. ASC 740-10 prescribes a recognition threshold and measurement attribute for the financial statement recognition of a tax position taken or expected to be taken on a tax return. Under ASC 740-10, a tax benefit from an uncertain tax position taken or expected to be taken may be recognized only if it is “more likely than not” that the position is sustainable upon examination, based on its technical merits. The tax benefit of a qualifying position under ASC 740-10 would equal the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with a taxing authority having full knowledge of all the relevant information. A liability (including interest and penalties, if applicable) is established in the financial statements to the extent a current benefit has been recognized on a tax return for matters that are considered contingent upon the outcome of an uncertain tax position. Related interest and penalties, if any, are included as components of income tax expense and income taxes payable. The Company is awaiting resolution of certain complex tax issues and has not yet filed its previous years’ Value Added Tax (“VAT”) returns for some of its customers. However, all the potential VAT liabilities on these VAT returns were accrued and included in the accompanying condensed consolidated financial statements. 10 Item 3. Quantitative and Qualitative Disclosures about Market Risk. Not applicable.