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 our 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,” “our company,” and “our” refer to Dehaier Medical Systems Limited, a British Virgin Islands company (“Dehaier”), Dehaier Medical Systems (Hong Kong) Limited, our subsidiary in Hong Kong (“DHK”), Beijing Dehaier Technology Company Limited, our variable interest entity in the People’s Republic of China (“BTL”) and Beijing Dehaier Medical Technology Company Limited, our operating subsidiary in the People’s Republic of China (“BDL”). This discussion contains forward-looking statements that involve risks and uncertainties. Actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors. This section should be read together with the consolidated financial statements and related notes thereto in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010, as well as the condensed consolidated financial statements for the three month period ended March 31, 2011 and accompanying notes included elsewhere in this document. 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), eVent (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. Recent Developments On April 21, 2011, we announced that our affiliate, Beijing Dehaier Technology Company Limited (“BTL”), signed a strategic cooperation agreement with Taiyo Nippon Sanso Shenwei (Shanghai) Medical Gas Co., Ltd (“Taiyo-Shanghai”) and Beijing Orient Medical Gas Co., Ltd (“Beijing Orient”) to develop oxygen therapy services for the home use market in Beijing. Leveraging the expertise of each company, this agreement incorporates oxygen production, filling, selling and service for home medical oxygen in Beijing. Additionally, Shanghai’s government launched medical insurance to subsidize cost of home oxygen therapy, and we anticipate other cities will pursue similar legislation. If other cities pass similar legislation, we will seek to participate in such programs. In particular, we expect to see increased opportunities in the oxygen therapy service market in Beijing, given Beijing’s advances in health care technology and coverage. On April 29, 2011, our majority-owned subsidiary, Beijing Dehaier Medical Technology Company Limited (“BDL”), signed a cooperation agreement with Beijing Kanglian Medicines Co, Ltd, to develop, operate and implement a new rural healthcare construction project in Hunan and Anhui provinces. The project is supported by China Development Bank Corp (“CDB”), one of China’s three national policy banks. It is aimed at improving the 1 Table of Contents national healthcare system through the development and upgrade of medical facilities and health centers in nearly 2,900 counties, cities and districts across China. BDL was selected for this project as a result of its broad product portfolio, which includes solutions at a variety of price points, including those that meet the requirements of cost conscious facilities. We continue to use our broad sales network to introduce additional products from leading international brands into the Chinese market. We plan to enlarge our Customer Experience Center (“CEC”) network penetration across China and implement our home oxygen therapy service program. We believe favorable market conditions will increase market volume and our market expansion strategy will position us for further business growth. Growth Strategy The healthcare market in China is poised for significant growth as a result of increasing government investment in improving the quality and availability of healthcare in China to fall more closely in line with healthcare in other developed nations. In addition, Chinese citizens are spending a growing percentage of their personal wealth on health and wellness-related initiatives. We believe that Dehaier is positioned to capitalize the growth of China’s emerging healthcare industry and, more importantly, its nascent medical device and homecare market. While a favorable market is necessary for sustained growth, the market alone will not be enough to propel Dehaier to the next level of success. We constantly review and refine our business strategies in an effort to capture additional market share, continue building brand equity and expand our business, both domestically and internationally, with the ultimate goal of increasing shareholder value. Our primary strategic foci are currently on: • Business growth: Building our brand domestically as both a manufacturer and a trusted partner by leveraging our relationships with healthcare professionals, agents and distributors, to maintain and enlarge our customer resources that ensures business growth, and leveraging the customer resources to expand homecare products sales in the future. • Product R&D: Expanding our product portfolio through continuous investment in R&D personnel and hardware. We are focusing on oxygen and respiratory homecare solutions and targeting to introduce four to eight new products this year. • Distribution channels: (1) Medical devices : Becoming a well known Chinese distributor by diversifying our base of third party distributed products by expanding relationships with existing partners and establishing partnerships with additional well-regarded international device manufacturers. Developing our key account sales department to participate in new rural healthcare construction projects and other large hospital procurements. (2) Homecare products : Expanding our CEC concept as a marketing tool and homecare products sales platform for both consumers and medical professionals. • International market expansion: Expanding into the US and Europe through establishment of distribution agreements, OEM partnerships and direct sales force. Several of our homecare products are currently under review in the US by the Food and Drug Administration (“FDA”) and in Europe by Conformité Européenne (“CE”). • Service implementation: Planning to open Dehaier home oxygen therapy service center in the second half of 2011 in Beijing. China’s home oxygen therapy market is fragmented and not yet supported by medical insurance programs in cities other than Shanghai. We believe there are tremendous opportunities and more potential can be triggered in such cities once medical insurance arrives. Moreover, we are targeting to replicate our oxygen therapy service network in other tier 1 and tier 2 cities in China to further solidify our leading market position. 2 Table of Contents Results of Operations For the three months ended March 31, 2011 and 2010, our total revenues amounted to approximately $2.95 million and $2.64 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 periods ended March 31, 2011 and 2010 was $0.21 million and $0.52 million, respectively. Such decrease in net income was mainly due to the decrease in gross margin and increase in expenses. 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. 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. 3 Table of Contents 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 rapidly as a percentage of our total revenues for the three months ended March 31, 2011 compared to the same period in 2010 primarily due to increased professional fees, mainly attorney, accounting and consulting fees, by virtue of being a public-traded company since March 26, 2010. Cost of Revenues Cost of revenues primarily includes wages, parts for assembly, handling charges, depreciation of fixed assets and other expenses associated with the assembly and distribution of 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 associated with being 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 As our business grows fast, we are looking forward to having more opportunities in the market. We believe that period-to-period comparisons of operating results should not be relied upon as indicative of future performance. Three Months Ended March 31, 2011 Compared to Three Months Ended March 31, 2010. Revenues Our total revenues increased by 11.8% from $2.64 million for the three months ended March 31, 2010 to $2.95 million for the three months ended March 31, 2011. 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; moreover, the increase in sales was mainly attributable to the increases in units sold for three months ended March 31, 2011. We maintained good relationship with our clients in the first quarter of 2011 and that contributed to our revenue growth. In addition, we have further strategic development plan to create cooperation opportunity with government projects, hospitals and continue to expand our Customer Experience Centers (CEC) network in China, which help leading to greater market presence. Cost of Revenues Our cost of revenues increased 17.37% from $1.67 million for the three months ended March 31, 2010 to $1.96 million for the three months ended March 31, 2011. Our cost of revenues remained relatively constant in U.S. dollars, thus the gross margin decreased. The increase of registration fee for new homecare products and renewal for existing products and fixed assets depreciation also resulted in the increase of cost. Operating Expenses Our operating expenses increased by 89.97% from $0.39 million for the three months ended March 31, 2010 to $0.74 million for the three months ended March 31, 2011. This increase was due to increase in general and administrative and selling expenses, for the reasons described below. 4 Table of Contents 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 127.00% from $0.22 million for the three months ended March 31, 2010 to $0.50 million for the three months ended March 31, 2011. This increase was mainly because of three reasons: • Market Expansion Expenses . We started to build five additional CECs (Customer Experience Centers) in the reporting period, which require an upfront investment at commencement of construction. • Public Company Expense . After listing on NASDAQ market on April 22, 2010, we incurred implementation expenses for Sarbanes-Oxley Section 404 compliance. In order to improve our visibility and exposure on the capital market, we also hired professional employees and retained professional consulting firms. • Labor Expenses . Our labor costs increased as we implemented an employee reward policy to strengthen our corporate culture. We expect that our general and administration expenses will increase in the near period as a result of expansion of business. We anticipate expanding our marketing efforts in order to continue to grow our revenues in China and internationally. Among other strategies to expand our business, we plan to open more CECs. 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 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 by 41.18% from $0.17 million for the three months ended March 31, 2010 to $0.24 million for the three months ended March 31, 2011, mainly due to an increase in our sales staff to strengthen our distribution network. We also participated in several medical exhibitions in and outside of China to network with existing and new customers. We expect that our selling expenses in absolute numbers will continue to increase in the near term after our series of new products are introduced in the market. We expect to promote our new products 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 $0.30 million in the first three months of 2011, compared to approximately $0.65 million in the same period of 2010. Operating income decreased 55.38%, largely due to the decrease in gross margin and increase in expenses. Taxation Our income tax expense was approximately $0.08 million during the first three months of 2011, compared to approximately $0.09 million in the same period of 2010. Our taxable income decreased primarily due to the decrease in gross margin and increase in expenses. Net Income As a result of the foregoing, we had net income of approximately $0.21 million in the first three months of 2011, compared to approximately $0.53 million in the same period of 2010. After deduction of non-controlling interest in income, net income attributable to Dehaier was approximately $0.21 million and $0.52 million in the first quarters of 2011 and 2010, respectively. 5 Table of Contents Liquidity and Capital Resources Cash Flows and Working Capital To date, we have financed our operations primarily through cash flows from operations, short-term borrowings and, after completion of our initial public offering, proceeds from that offering. As of March 31, 2011, we had approximately $3.37 million in cash and cash equivalents. As a result of the total cash activities, net cash decreased from $5,923,386 on December 31, 2010 to $3,372,673 on March 31, 2011. We believe that our currently available working capital of $23,148,929, including cash of $3,372,673, should be adequate to meet our anticipated cash needs and sustain our current operations for at least 12 months. Operating Activities Net cash used in operating activities was $2,113,734 for the three months ended March 31, 2011 as compared to $663,988 net cash provided by operating activities for the same period in 2010. The reasons for this change are as follows: (i) Decrease of $324,228 in net income . Our net income decreased primarily due to the decrease in gross margin and increase in expenses for the three months ended March 31, 2011. (ii) Increase of $2,884,433 in prepayment . The increase in prepayment is attributable to signing some large new sales contracts in first quarter of 2011, which required us to order and pay for products in advance. Investing Activities Net cash used in investing activities for the three months ended March 31, 2011 was $10,632, compared to net cash used in investing activities of $8,439 for same period of 2010. The cash used in investing activities was mainly attributable to capital expenditures for the purchase of new equipment. Financing Activities Net cash used in financing activities for the three months ended March 31, 2011 and 2010 were $610,816 and $585,764, respectively. The cash used in financing activities for the three months ended March 31, 2011 and 2010 was attributable to repayment of bank loans. Capital Expenditures We made capital expenditures of approximately $8,274 and $4,578 in the first three months ended March 31, 2011 and 2010, respectively, representing 0.28% and 0.17%, of our total revenues, respectively. Our capital expenditures are mainly used to purchase machines for our R&D projects and our assembly line. The capital expenditures may increase in the near term as our business continues to grow and as expand. Off-Balance Sheet Commitments and Arrangements We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as 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. 6 Table of Contents 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 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 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 March 31, 2011 and 2010. The tax rate for BTL is 25% for periods ended March 31, 2011 and 2010. 7 Table of Contents 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 condensed consolidated financial statements include the accounts of Dehaier, BDL, its majority-owned subsidiary, and its wholly-owned subsidiary, DHK as well as BTL. All significant inter-company transactions and balances are eliminated in consolidation. A group of shareholders, including the Chief Executive officer, originally held more than 50% of the voting ownership interest of Dehaier, BDL and BTL. BTL is a variable interest entity, 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 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. 8 Table of Contents 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, 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. At March 31, 2011, our accounts receivable aging was as follows: Total Accounts Receivable 1 to 3 months 3 to 6 months 6 months to 1 year 1 to 2 years $9,864,974 $ 2,834,648 $ 3,965,298 $ 3,031,761 $ 33,267 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. At March 31, 2011 and December 31, 2010, an allowance for doubtful accounts has been provided based on historical experience and management’s analysis of performance and current aging of accounts receivable. Based on this analysis, management believes that its historical bad debt rates and long-term accounts receivable (over one year) are relatively low and that, as a result, the allowance for doubtful accounts is adequate. 9 Table of Contents Fair Value of Financial Instruments 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. The fair value of warrants is $308,583, an increase of $9,526 since the grant date. 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. Management has determined no impairment exists at the balance sheet dates. 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. 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 10 Table of Contents 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 March 31, 2011 and December 31, 2010, the Company was not required to record any deferred tax assets or liabilities. 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. 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 March 31, 2011 and December 31, 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. Item 3. Quantitative and Qualitative Disclosures about Market Risk Not applicable.