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 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 Fiscal year 2009 Price per common share: High $ N/A $ N/A $ N/A $ N/A $ N/A Low $ N/A $ N/A $ N/A $ N/A $ N/A Approximate Number of Holders of Our Common Shares As of the date of this report there are eight (8) 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. 2 Table of Contents (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, 2010, the Company has spent proceeds from the Offering in accordance with the following table: Description of Use Proposed Expenditure Amount Actual Expenditures through December 31, 2010 Product Research and Development $ 2,650,333 $ 2,383,677 Marketing 3,180,399 4,093,708 Potential Acquisitions 2,120,266 — Working Capital 2,650,333 3,347,927 Total $ 10,601,331 $ 9,825,312 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 marketing expenditures by $913,309 and our anticipated working capital expenditures by $697,594, in part by participating in several international medical device manufacturer fairs. To the extent we are able to engage in acquisitions, we will need to rely on a variety of sources of funding, including but not limited to remaining offering proceeds, operating cash and debt and/or equity financing. (c) None. 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. Overview We have been focused on the development and distribution of medical devices since our inception, and we began developing our respiratory and oxygen homecare business in 2006. We design, develop and market our branded products in China. We import the majority of the products and medical components we sell to our customers. We design and develop some of the medical components that are part of the branded products to be distributed. Some of these medical components are manufactured by contractors in China because we do not have a manufacturing facility. Most of our branded products require light assembly. In addition to our branded products, we also serve as a distributor of products designed and manufactured by other companies. We sell products from HEYER (Germany), Welch Allyn (US), IMD (Italy), Timesco (UK), ResMed (Australia) and JMS (Japan). We sell products primarily to distributors; however, we also sell products directly to hospitals, clinics and government health bureaus. We continually seek to broaden our market reach by introducing new and more advanced products and new product lines that address different end-user populations. For the past two fiscal years ended December 31, 2009 and 2010, our total revenues amounted to approximately $12.37 million and $19.60 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 years ended December 31, 2009 and 2010 was $2.67 million and $4.54 million, respectively. 3 Table of Contents Macro-Economic Factors and Business Trends In 2009, the Chinese government committed RMB850 billion (US$123 billion) to develop the country’s healthcare system over a three-year period. The plan is to create a solid platform for universal healthcare access for all by 2020. We believe the prospects for medical device spending in China are substantial. The government has committed heavily in the construction of thousands of hospitals, healthcare centers, and clinics. We expect this will lead to increase in spending on capital goods, including medical devices, equipment and furniture in the near term. Priority will be given to the construction and renovation of around 2,000 county-level hospitals, so that each county will have at least one such facility. County-level hospitals are usually the most well equipped hospitals in the country and must have at least 250 beds. The central government will fund the construction of 29,000 township hospitals, and the upgrading of another 5,000, according to the plan. The government will also fund the construction of village clinics in remote areas so that every village will have at least one unit by the end of the three-year period. Since opening its economy to the West in the late 1970s, China has experienced rapid growth. For 2010, China’s GDP is estimated at US$5.7 trillion. While this makes China one of the world’s largest economies, the size of the population means that per capita wealth was around US$4,280 in 2010. The Chinese government expanded the health insurance program to cover all rural residents by the end of 2008. Urban health insurance was already well established, covering nearly all working citizens, and will be extended to cover all urban dwellers, including the unemployed and children who were not covered previously, by 2010. China imposed lower import tariffs on more than 600 commodities effective January 1, 2010, including medical products and pharmaceuticals, in a move to honor commitments made when it joined the WTO in 2001. The government said it hopes the cuts will increase domestic spending on foreign products to boost industrial and rural development. From an industry perspective, the lower tariffs should result in lower retail prices and higher spending on foreign medical devices. Based on the data shown above and actions taken by Chinese government, we still believe that our company is likely to continue to grow in 2011 because our business is poised to directly benefit from China’s increasingly enhanced investment in its health care system as China is exerting more focus and efforts on sustaining the social development and stability. New Opportunities in Our Business According to China’s Health Statistics Yearbook 2010, healthcare spending in China totaled $259 billion (5.1% of total Chinese GDP) in 2009, which lagged behind other developed countries. We anticipate that the increasing affluence in larger cities is likely to increase awareness of health and wellness, and desire to improve overall quality of life. For 2010, Espicom estimates medical device market growth to be in the region of 13.6%; 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. 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. 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. Recently, Shanghai’s government launched medical insurance to subsidize cost of homecare oxygen tanks, and we anticipate other cities will be pushing for similar legislation. We will seek to participate if such a program is implemented 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 planning to enlarge our Customer Experience Center (CEC) network penetration across China. We believe that the favorable market conditions will trigger tremendous market volume and our market expansion strategy will benefit our business growth in the future. 4 Table of Contents Growth Strategy We will continue building our domestic brand to increase penetration of the medical device market and homecare solution from the key initiatives below: • Expand footprint of Customer Experience Centers (CECs) as a sales and marketing tool for consumers and healthcare professionals • Leverage strong relationships with healthcare professionals to increase awareness of DHRM’s homecare products • Build international business through establishment of distribution agreements, OEM partnerships and direct sales force • Diversify base of third party distributed products through expansion of existing relationships and pursuit of new distribution partners • Increase portfolio of DHRM-branded medical devices and homecare products through R&D and potential strategic acquisition Revenues Our total revenues are derived from products we provide in our three product lines, (i) Medical Devices (ii) Respiratory and Oxygen Homecare Products and (iii) Technical Service Products. We currently operate in one business segment for all of our products we distribute. Medical Devices – Our Branded and Distributed Products We derive revenues in our medical devices product line from the sale of C-arm X-ray systems, anesthesia machines, patient monitors and general hospital products. Our medical device line is our largest business line of products and has the most extensive market penetration of our three product lines. We anticipate that we will continue to experience revenue growth in our medical devices line as we further penetrate the market through the development and introduction of new advanced product offerings and the participation of favorable government policies. Respiratory and Oxygen Homecare Products – Our Branded and Distributed Products We derive revenues in our respiratory and oxygen homecare line from sales of oxygen concentrators, CPAP devices, portable sleep diagnostics and Rhinitis hyperthermia devices. We anticipate that, on a percentage basis, net revenues in our respiratory and oxygen homecare product line will increase more rapidly than total net revenues in the near term, as we introduce new and more advanced products in this product line. We expect to increase our market penetration in the respiratory and oxygen homecare market both in China and internationally through the use of distributors as well as through our direct sales platform. Technical Service Products – Our Branded Products We derive revenues in our technical service products line from sales of our air compressors and ventilator trolleys. We anticipate continued growth in revenues from our technical service products as we further penetrate this market by increasing the number of our distributors and maintaining a competitive pricing model. 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. 5 Table of Contents 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 decreased a little as a percentage of our total revenues for the year ended December 31, 2010 compared to the same period in 2009 primarily due to increased economies of scale and an increase in revenue. 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 net revenues for the years indicated. For the year ended December 31, 2010 2009 USD (‘000) % USD (‘000) % Revenues 19,598 100.00 12,370 100.00 Costs and expenses Cost of revenues 11,982 61.14 7,511 60.72 General and administrative expense 1,258 6.42 1,092 8.83 Selling expense 1,421 7.25 700 5.66 Total costs and expenses 14,661 74.81 9,303 75.21 Cost of revenues Cost of revenues primarily includes wages, parts for assembly, 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 incur additional 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. 6 Table of Contents Results of Operations Our limited operating history makes it difficult to predict future operating results. 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, 2010 Compared to Fiscal Year Ended December 31, 2009. Revenues Our total revenues increased by 58.45% from $12.37 million for the fiscal year ended December 31, 2009 to $19.60 million for the fiscal year ended December 31, 2010. The increase in revenues was due to the increased acceptance of our products among hospitals and other healthcare facilities as many of our end users such as hospitals became repeat customers when they needed new medical equipment. We also signed exclusive distribution agreements with HEYER and Welch Allyn, expanding our product lines in 2010 and contributing to our revenue growth. In addition, we have further expanded our Customer Experience Centers (CEC) network in China, which help leading to greater market presence in 2010. Cost of Revenues Our cost of revenues increased 59.52% from $7.51 million for the fiscal year ended December 31, 2009 to $11.98 million for the fiscal year ended December 31, 2010. Our cost of revenues grew in U.S. dollars as our revenues grew. Our gross margin decreased slightly because of the increase of labor cost. Operating Expenses Our operating expenses increased by 49.72% from $1.79 million for the fiscal year ended December 31, 2009 to $2.68 million for the fiscal year ended December 31, 2010. This increase was due to increase in general and administrative and selling expenses, for the reasons described below. 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 and the registration of foreign exchange certificate. Our general and administration expenses increased by 15.60% from $1.09 million for the fiscal year ended December 31, 2009 to $1.26 million for the fiscal year ended December 31, 2010. This increase was small and mainly because of three reasons. First, in accordance with our market expansion strategy, we opened new CECs (Customer Experience Centers) in China during 2010, which require an initial investment before we expect them to generate any revenues. Second, we incurred implementation expenses for Sarbanes-Oxley Section 404 compliance, as we hired an employee to carry out these functions, which did not apply to us before our initial public offering. Third, our labor costs increased as a result of our employee reward policy, which is designed to improve company culture and morale. We expect that our general and administration expenses will increase in the near future as a result of expansion of business. We anticipate using a portion of the net proceeds from our initial public offering to expand our marketing efforts to continue to grow our revenues in China and internationally. Among other strategies to expand our business, we plan to open more CECs, in order to strengthen our market presence in China. These CECs give our potential customers an opportunity to experience our products first-hand in an environment that is similar to the environment in which they will use the products, whether that is a home or healthcare facility. Operating Expenses—Selling Expense Our selling expense increased by 102.86% from $0.70 million for the fiscal year ended December 31, 2009 to $1.42 million for the fiscal year ended December 31, 2010. 7 Table of Contents Our selling expenses primarily consist of salaries and related expenses for personnel engaged in sales, marketing and customer support functions and costs associated with advertising and other marketing activities. Our selling expenses increased in 2010, mainly due to an increase in our sales staff in further strengthening our distribution network. We also participated in several medical exhibitions in and outside of China to network with our old and new customers. We expect that our selling expenses will increase in the next year after new products are introduced in the market. We tend to promote our new products by different advertising methods, such as to participate in domestic and overseas medical exhibitions to show our products to the public and potential purchasers. Operating Income As a result of the foregoing, we generated an operating income of approximately $5.13 million in 2010, compared to approximately $3.35 million in 2009. Operating income increased 53.13% largely due to the increase of revenue. Taxation Our income tax expense was approximately $0.85 million in 2010, compared to approximately $0.53 million in 2009. Our taxable income increased primarily due to the increase in net income. Net Income As a result of the foregoing, we had net income of approximately $4.56 million in 2010, compared to approximately $2.73 million in 2009. After deduction of non-controlling interest in income, net income attributable to Dehaier was approximately $4.54 million and $2.67 million in 2010 and 2009, respectively. Make-Good Escrow On March 22, 2010, the founders of the Company placed an aggregate of 600,000 common shares of the Company into escrow. Such shares equaled 40% of the maximum number of shares which were sold in the initial public offering (“IPO”). The shares were required to remain in escrow until the Company files its 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 the Company will not recognize any compensation expense upon the return of such Make-Good Shares to the holders. To the extent the Company’s earnings per share for the year ended December 31, 2010 were less than $0.80, the Company would have been required to redeem, pro rata, such shares in order to cause the effective earnings per share to equal $0.80. For the year ended December 31, 2010, however, the earnings per share of the company was $1.09, or approximately 36% higher than the per share price upon which the Company’s initial public offering valuation was based. Thus, the Company does not need to redeem or prorate such shares. The shares will be returned to the founders 45 days after the filing of this Form 10-K. These shares are included as part of the calculation of the basic and diluted earnings per share for all the periods presented in the accompanying consolidated financial statements. Liquidity and Capital Resources Cash Flows and Working Capital In 2009, we financed our operations primarily through cash flows from operations. In 2010, we financed our operations primarily from proceeds of common stock issuances. As of December 31, 2010, we had approximately $5.92 million in cash and cash equivalents. As a result of the total cash activities, net cash increased from $1,151,721 at December 31, 2009 to $5,923,386 at December 31, 2010. We believe that our currently available working capital of $22,618,735, including cash of $5,923,386, should be adequate to meet our anticipated cash needs and sustain our current operations for at least 12 months. 8 Table of Contents Operating Activities Net cash used in operating activities was $4,977,955 for the year ended December 31, 2010 as compared to $1,789,967 net cash provided in operating activities for the same period in 2009. (i) Cash flow due to increase of $1,829,219 in net income . Our net income increased primarily because of a growth in sales volume in 2010. (ii) Cash outflow due to increase of $3,609,438 in prepayment . The increase in prepayment is attributable to signing some large new sales contracts in fourth quarter of 2010, which required us to order and pay for products in advance. (iii) Cash outflow due to increase of $1,665,312 in other receivables . The increase in other receivable is mainly caused by our contract bidding deposits and guaranty. As we begin to expand our business and our product lines, we need to pay a portion of the contract amounts to our customers as bidding deposits or guaranty, and our customers will return these deposits to us, generally in 3-6 months. (iv) Cash outflow due to increase of $4,042,481 in inventories . The increase in inventories is attributable to the following two reasons: 1) We increased inventory on hand to meet anticipated sales needs. 2) As we signed some exclusive distribution agreements with HEYER, and Welch Allyn to expand our product line in third quarter of 2010, we had to stock our inventories with these manufacturers’ products. Investing Activities Net cash used in investing activities for the year ended December 31, 2010 was $878,702, compared to net cash used in investing activities of $914,527 for the year ended December 31, 2009. The cash used in investing activities was mainly attributable to capital expenditures for the purchase of new equipment. Financing Activities Net cash provided by financing activities for the year 2010 and 2009 was $9,944,207 and $0, respectively. The cash provided by financing activities for year ended December 31, 2010 was due to net proceeds from our IPO. Contractual Obligations and Commercial Commitments The following table sets forth our contractual obligations as of December 31, 2010: Contractual obligations Payments due by period Total Less than 1 year 1-3 years More than 3 years Operating Lease Obligations $ 219,000 $ 187,000 $ 32,000 — Short-term borrowings $ 1,514,620 $ 1,514,620 — — Total $ 1,733,620 $ 1,701,620 $ 32,000 — 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 2011. Capital Expenditures We made capital expenditures of approximately $0.89 million and $0.92 million in 2010 and 2009, respectively, representing 4.54%, 7.44%, of our total revenues, respectively. In the past, our capital expenditures were used to purchase machines for our assembly line. Our capital expenditures may increase in the near term as our business continues to grow and as we expand and improve our financial and accounting systems and infrastructure. 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 9 Table of Contents 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. 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. 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 10 Table of Contents 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 December 31, 2010 and 2009. The tax rate for BTL is 25% in 2009 and 2010. PRC Value Added Tax Pursuant to the Provisional Regulation of China on Value Added Tax and its implementing rules, issued in December 1993, 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 Basis of Consolidation The consolidated financial statements include the accounts of Dehaier, BDL, its majority-owned subsidiary, and its wholly-owned subsidiary, DHK as well as BTL. All significant inter-company transactions and balances are eliminated in consolidation. A group of shareholders, including the Chief Executive officer, originally held more than 50% of the voting ownership interest of Dehaier, BDL and BTL. BTL is a variable interest entity, 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, BTL and DHK at December 31, 2006, the Company initially measured the assets, liabilities and noncontrolling interest of the variable interest entity at the amounts at which they were carried in the accounts of the reporting entity that controls the variable interest entity pursuant to FASB ASC 810-10. On October 31, 2009, BDL reconsidered whether it was 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 variable interest entity 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. 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 11 Table of Contents 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 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 consolidated financial statements include revenue recognition, allowance for doubtful accounts, inventory obsolescence, warranty obligation, warrants liability 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 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, our 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 collectability of specific accounts. Receivables are considered past due after 3 years and written off. Management has determined this write-off policy by reviewing the decrease in likelihood of collection as a function of time and concluded that collectability of accounts receivable after three years was significantly impaired, compared with collectability prior to such time. Fair Value of Financial Instruments The carrying amounts reported in the consolidated financial statements for current assets and current liabilities approximate fair value due to the short-term nature of these financial instruments. The Company follows the provisions of ASC 820-10, “Fair Value Measurements and Disclosures”, which establishes a single authoritative definition of fair value and a framework for measuring fair value and expands disclosure of fair value measurements for both financial and nonfinancial assets and liabilities. This standard defines fair value, provides guidance for measuring fair value and requires certain disclosures. This standard does not require any new fair value measurements, but discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flows) and the cost approach (cost to replace the service capacity of an asset or replacement cost). For purposes of ASC 820-10-15, nonfinancial assets and nonfinancial liabilities would include all assets and liabilities other than those meeting the definition of a financial asset or financial liability as defined in ASC 820-10-15-15-1A. The Company adopted the provisions of ASC Topic 815 (formerly Emerging Issue Task Force 07-5), “Determining Whether an Instrument (or an Embedded Feature) is Indexed to an Entity’s Own Stock”. ASC Topic 815 provides a framework for determining whether an instrument is indexed to an entity’s own stock. ASC Topic 815 became effective for the Company this period when warrants were issued in connection with the Company’s initial public offering (“IPO”). Such warrants are indexed to the Company’s common shares, which is traded in US dollars. Since the Company’s functional currency is the RMB, such warrants are considered liabilities. The fair value of the warrant liabilities is measured each reporting period with the resulting change in fair value recorded in the statement of operations. 12 Table of Contents 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 market value of the asset, is recognized. Revenue Recognition The Company recognizes revenues when all the followings conditions have been satisfied: • Persuasive evidence an arrangement exists; • Delivery and/or installation has occurred (e.g., risks and rewards of ownership have passed); • The sales price is fixed or determinable; and • Collectability is reasonably assured. All revenues are based on firm customer orders with fixed terms and conditions. Because the products are assembled to the customers’ specification, there is no right of return. The Company does not provide its customers with price protection or cash rebates. For products which include software, the software is an off-the-shelf package and an integral part of the products being delivered. The Company does not provide any significant post-sale customer support services and does not provide customers with upgrades. The software is incidental to the product as a whole. For products that do not require installation, revenues are recognized when the products are delivered. For products that require installation, revenues are recognized when the installation is completed. Warranty Costs The Company provides for the estimated cost of product warranties at the time revenue is recognized. Warranty costs are included in general and administrative expenses. The Company’s warranty obligation is affected by product failure rates and material usage and service delivery costs incurred in correcting product failure. Should actual product failure rates, material usage or service delivery costs differ from the Company’s estimates, the Company may be required to revise its estimated product warranty liability. The term of the product warranty is generally twelve months. 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 2008 and 2009 Value Added Tax (“VAT”) tax 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. 13 Table of Contents The implementation of ASC 740-10 resulted in no material liability for unrecognized tax benefits and no material change to the beginning retained earnings of the Company. As of December 31, 2010 and 2009, 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. 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.