20-F 1 v460666_20f.htm FORM 20-F

 

 

 

UNITED STATES

 

SECURITIES AND EXCHANGE COMMISSION

 

WASHINGTON, D.C. 20549

 

FORM 20-F

(Mark One)

 

  ¨ REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

 

OR

 

  x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2016

 

OR

 

  ¨ TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
     
  ¨ SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    Date of event requiring this shell company report __________ 

 

For the transition period from __________ to __________

 

Commission file number: 001-34661

 

Lianluo Smart Limited

 (Exact name of Registrant as specified in its charter)

 

British Virgin Islands

(Jurisdiction of incorporation or organization)

 

Room 2108, 21st Floor,

China Railway Construction Building,

No. 20 Shijingshan Road, 100040, Beijing, China

 (Address of principal executive offices)

 

Securities registered or to be registered pursuant to Section 12(b) of the Act:  

Title of each class   Name of each exchange on which registered
Common shares, par value $0.002731 per share   NASDAQ Capital Market

 

Securities registered or to be registered pursuant to Section 12(g) of the Act:  None.

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:  None.

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:

As of December 31, 2016, there were 17,312,586 shares of the registrant’s Common Shares outstanding.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes ¨ No x

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.  Yes ¨ No x

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act). (Check one):

 

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x

 

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

US GAAP x International Financial Reporting Standards as issued
by the International Accounting Standards Board ¨
Other ¨

 

 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

 

 

 

 

 

 

 

TABLE OF CONTENTS

 

PART I 4
Item 1.  Identity of Directors, Senior Management and Advisers 4
Item 2.   Offer Statistics and Expected Timetable 4
Item 3.  Key Information 4
Item 4.   Information on the Company 20
Item 4A.    Unresolved Staff Comments 34
Item 5.    Operating and Financial Review and Prospects 34
Item 6.  Directors, Senior Management and Employees 53
Item 7.   Major Shareholder and Related Party Transactions 60
Item 8.  Financial Information 63
Item 9.  The Offer and Listing 64
Item 10.  Additional Information 65
Item 11.  Quantitative and Qualitative Disclosures about Market Risk 72
Item 12.   Description of Securities Other than Equity Securities 73
PART II 73
Item 13.   Defaults, Dividend Arrearages and Delinquencies 73
Item 14.   Material Modifications to the Rights of Securities Holders and Use of Proceeds 73
Item 15.   Controls and Procedures 73
Item 15T.   Controls and Procedures 75
Item 16.   [Reserved] 75
Item 16A.   Audit Committee Financial Expert 75
Item 16B.    Code of Ethics 75
Item 16C.   Principal Accountant Fees and Services 75
Item 16D.  Exemptions from the Listing Standards for Audit Committees 76
Item 16E.   Purchases of Equity Securities by the Issuer and Affiliated Purchasers 76
Item 16F.    Change in Registrant’s Certifying Accountant. 77
Item 16G.  Corporate Governance. 77
Item 16H.   Mine Safety Disclosure. 77
PART III 78
Item 17.   Financial Statements 78
Item 18.  Financial Statements 78
Item 19.    Exhibits 78

 

 

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SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS

 

Certain matters discussed in this report may constitute forward-looking statements for purposes of the Securities Act of 1933, as amended (the “Securities Act”), and the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from the future results, performance or achievements expressed or implied by such forward-looking statements. The words “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “estimate,” and similar expressions are intended to identify such forward-looking statements. Our actual results may differ materially from the results anticipated in these forward-looking statements due to a variety of factors, including, without limitation, those discussed under “Item 3—Key Information—Risk Factors,” “Item 4—Information on the Company,” “Item 5—Operating and Financial Review and Prospects,” and elsewhere in this report, as well as factors which may be identified from time to time in our other filings with the Securities and Exchange Commission (the “SEC”) or in the documents where such forward-looking statements appear. All written or oral forward-looking statements attributable to us are expressly qualified in their entirety by these cautionary statements.

 

The forward-looking statements contained in this report reflect our views and assumptions only as of the date this report is signed. Except as required by law, we assume no responsibility for updating any forward-looking statements.

 

 

 

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PART I

 

Unless the context requires otherwise, references in this report to “Lianluo Smart”, “we”, “us”, “our company”, and “our” refer to (i)Lianluo Smart Limited, a British Virgin Islands company, (ii) Beijing Dehaier Medical Technology Company Limited, a PRC company (“BDL”), (iii) Lianluo Connection Medical Wearable Device Technology (Beijing) Co., Ltd., a PRC company (“LCL”, used to be known as Connection Wearable Health Technology(Beijing) Co., Ltd., “CWHT”), (iv) Beijing Dehaier Technology Co., Limited (“BTL”). On July 31, 2016, the Registrant’s wholly owned subsidiary Beijing Dehaier Medical Technology Co., Limited (“BDL”) entered into a Loss Absorption Agreement Termination (“VIE Termination”) with the Registrant’s variable interest entity (“VIE”), Beijing Dehaier Technology Co., Limited (“BTL”). According to the VIE Termination, the Loss Absorption Agreement (the “VIE Agreement”) among BDL, BTL and its shareholders Ping Chen, Bao Xian, Weibing Yang, Jian Sun, Zheng Liu and Yong Wang dated as of March 3, 2010 was terminated effective on July 31, 2016. There is no relationship between BTL and the Registrant and its other subsidiaries after the effectiveness of the VIE Termination.

 

Item 1.Identity of Directors, Senior Management and Advisers

 

Not applicable for annual reports on Form 20-F.

 

Item 2.Offer Statistics and Expected Timetable

 

Not applicable for annual reports on Form 20-F.

 

Item 3.Key Information

 

A.Selected Financial Data

 

The following table presents the selected consolidated financial information for our company. The selected consolidated statements of income data for the three years ended December 31, 2014, 2015 and 2016 and the consolidated balance sheet data as of December 31, 2015 and 2016 have been derived from our audited consolidated financial statements set forth in “Item 18 – Financial Statements”. Our historical results do not indicate results expected for any future periods. The selected consolidated financial data should be read in conjunction with, and are qualified in their entirety by reference to, our audited consolidated financial statements and related notes and “Item 5. Operating and Financial Review and Prospects” are shown below. Our audited consolidated financial statements are prepared and presented in accordance with Generally Accepted Accounting Principles in the United States of America, or U.S. GAAP.

 

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   For the years ended December 31, 
   2016   2015   2014 
   US$   US$   US$ 
           (Restated) 
Statement of Operations Data:            
Revenue   13,062,373    738,301    2,774,241 
                
Costs of revenue   (16,627,535)   (927,286)   (1,802,864)
                
Gross profit (Loss)   (3,565,162)   (188,985)   971,377 
                
Service income   14,587    1,600,012    47,665 
Service expenses   (21,130)   (1,234,257)   (29,022)
General and administrative expenses   (4,643,962)   (4,089,592)   (1,929,206)
Provision for doubtful accounts   150,280    (8,544)   (347,891)
Selling expenses   (1,018,581)   (2,982,447)   (138,981)
                
Operating loss   (9,083,968)   (6,903,813)   (1,426,058)
                
Financial expenses   (125,127)   (194,773)   (174,463)
Other incomes   68,436    -    83,762 
Other expense   -    (2,586)   (21,850)
Loss from warrant redemption   (1,091,719)   -    - 
Change in fair value of warrants liability   137,710    390,324    2,866,171 
                
Income (loss) before provision for income tax and non-controlling interest   (10,094,668)   (6,710,848)   1,327,562 
                
Provision for income tax (expense) benefit   95,026    11,978    (357,726)
                
Net income (loss) from continuing operations   (9,999,642)   (6,698,870)   969,836 
                
Net income (loss) from discontinued operations   (251,153)   (3,663,465)   (26,003,708)
                
Net loss   (10,250,795)   (10,362,335)   (25,033,872)
                
Less: net loss attributable to non-controlling interest   (129,020)   (139,205)   (735,758)
                
Net loss attributable to Lianluo Smart Limited   (10,121,775)   (10,223,130)   (24,298,114)
                
Net income (loss) from continuing operations   (9,999,642)   (6,698,870)   969,836 
                
Net loss from discontinued operations   (251,153)   (3,663,465)   (26,003,708)
Other comprehensive loss               
Foreign currency translation loss   (567,162)   (461,548)   (576,891)
                
Comprehensive loss   (10,817,957)   (10,823,883)   (25,610,763)
-less comprehensive loss attributable to the non-controlling interest   (230,838)   (189,670)   (762,777)
                
Comprehensive loss attributable to Lianluo Smart Limited   (10,587,119)   (10,634,213)   (24,847,986)
                
Loss per share               
-Basic   (0.97)   (1.74)   (4.41)
-Diluted   (0.97)   (1.73)   (4.34)
                
Weighted average number of common shares used in computation               
-Basic   10,422,765    5,862,647    5,510,076 
-Diluted   10,428,951    5,896,534    5,597,169 

 

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   December 31, 
   2016   2015   2014 
           (Restated) 
   US$   US$   US$ 
Balance Sheet Data:               
Cash and cash equivalents   10,792,823    615,517    1,639,746 
Working capital   10,221,074    462,687    9,739,149 
Total current assets   11,336,148    6,868,333    13,468,644 
Total assets   16,552,137    13,875,247    21,321,309 
Total current liabilities   1,115,074    6,405,646    3,729,495 
Non-controlling interest   -    867,826    1,057,496 
Total Lianluo Smart Limited shareholders' equity   15,437,063    6,439,039    15,981,258 
Common shares   47,281    16,918    15,864 
Total equity   15,437,063    7,306,865    17,038,754 

 

Exchange Rate Information

 

Our business is primarily conducted in China and all of our revenues are denominated in RMB. However, periodic reports made to shareholders will include current period amounts translated into U.S. dollars using the then current exchange rates, for the convenience of the readers. The conversion of RMB into U.S. dollars in this annual financial report is based on the noon buying rate in The City of New York for cable transfers of RMB as certified for customs purposes by the Federal Reserve Bank of New York. Unless otherwise noted, all translations from RMB to U.S. dollars and from U.S. dollars to RMB in this annual financial report were made at a rate of RMB 6.9448 to US $1.00, the middle exchange rate in effect as of December 31, 2016. We make no representation that any RMB or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or RMB, as the case may be, at any particular rate, or at all. The government of the People’s Republic of China (the “PRC”) imposes control over its foreign currency reserves in part through direct regulation of the conversion of RMB into foreign exchange and through restrictions on foreign trade. The Company does not currently engage in currency hedging transactions. The following table sets forth information concerning exchange rates between the RMB and the U.S. dollar for the periods indicated.

 

   Noon Buying Rate 
Period  Period-End   Average (1)   Low   High 
    (RMB per U.S. dollar)  
2011   6.2939    6.4475    6.2939    6.6364 
2012   6.2301    6.2990    6.2221    6.3879 
2013   6.0537    6.0738    6.0537    6.0927 
2014   6.2046    6.1886    6.2256    6.1490 
2015   6.4907    6.2154    6.0775    6.4724 
2016   6.9448    6.6441    6.4494    7.0672 
2017                    
January   6.8808    6.8974    6.8432    6.9525 
February   6.8689    6.8723    6.8541    6.8842 
March   6.8905    6.8941    6.8676    6.9149 
April (through April 26, 2017)   6.8936    6.8845    6.7823    6.9057 

 

Source: Federal Reserve Statistical Release

____________________

(1) Annual averages are calculated using the average of month-end rates of the relevant years. Monthly averages are calculated using the average of the daily rates during the relevant periods.

 

 

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  B. Capitalization and Indebtedness

 

Not applicable for annual reports on Form 20-F.

 

  C. Reasons for the Offer and Use of Proceeds

 

Not applicable for annual reports on Form 20-F.

 

  D. Risk Factors

 

Risks Related to Our Business

 

Our business is seasonal and revenues and operating results could fall below investor expectations during certain periods, which could cause the trading price of our common shares to decline.

 

Our revenues and operating results have fluctuated in the past and may continue to fluctuate significantly depending upon numerous factors. In particular, we generally experience an increase in revenues in the period from September through November. This increase is associated with hospital purchasing designed to extinguish governmental budgets prior to the fiscal year end. We believe that our first quarter performance will generally decline as a result of the lack of business conducted during the Chinese Lunar New Year Holiday. To the extent our financial performance fluctuates significantly, investors may lose confidence in our business and the price of our common shares could decrease.

 

We may fail to effectively develop and commercialize new products and services, which could materially and adversely affect our business, financial condition, results of operations and prospects.

 

The sleep respiratory market is developing rapidly and related technology trends are constantly evolving. This results in the frequent introduction of new products and services, short product life cycles and significant price competition. Consequently, our future success depends on our ability to anticipate technology development trends and identify, develop and commercialize in a timely and cost-effective manner the new and advanced products that our customers demand. New products contribute significantly to our revenues. Moreover, it may take an extended period of time for our new products to gain market acceptance, if at all. Furthermore, as the life cycle for a product matures, the average selling price generally decreases. In the future, we may be unable to offset the effect of declining average sales prices through increased sales volume and controlling product costs. Lastly, during a product’s life cycle, problems may arise regarding regulatory, intellectual property, product liability or other issues that may affect the product’s continued commercial viability.

 

We sell our products primarily to distributors, and our ability to add distributors will impact our revenue growth. Failure to maintain or expand our distribution network would materially and adversely affect our business.

 

We depend on sales to distributors for a significant majority of our revenues. Our distributors purchase all products ordered regardless of whether the products are ultimately sold. Products are not purchased by distributors on consignment, and distributors have no right to return unsold products. As our existing distributor agreements expire, we may be unable to renew such agreements on favorable terms or at all, and we do not own, employ or control these independent distributors. Furthermore, we actively manage our distribution network and regularly review the performance of each distributor. We may terminate agreements with distributors, without penalty, if we are not satisfied with their performance for any reason. We periodically terminate relationships with underperforming exclusive distributors. Our distributors may also terminate their relationship with us without penalty. When an exclusive distributor in a particular geographic area fails to meet our expectations, then we are economically incentivized to replace that distributor with a new distributor so that area can be served as well as possible. We occasionally terminate a relationship with a non-exclusive distributor and are more likely to simply appoint another one; however, we have found that in some instances we are better served to replace an underperforming non-exclusive distributor with an exclusive distributor. Additionally, we have found that even in cases where there may not be an economic incentive to terminate a non-exclusive distributor, having the ability to replace a distributor often motivates distributors to increase their efforts to meet our expectations. This policy may make us less attractive to some distributors. In addition, we compete for distributors with other leading medical device companies who may enter into long-term distribution agreements, effectively preventing many distributors from selling our products. As a result, a significant amount of time and resources must be devoted to maintaining and growing our distribution network. Any disruption in our distribution network could have negative effects on our ability to sell our products, which would in turn materially and adversely affect our business, financial condition and results of operations.

 

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We sell products for some of our competitors, some of which compete with our branded products.

 

We serve as a distributor for other companies’ medical products and also sell medical products that we developed. While we rely on other suppliers’ products for some of our revenues, our self-developed products may, from time to time, compete with these suppliers’ products. Some of our suppliers may seek to restrict our ability sell competing products—either self-developed or developed by other third party suppliers—as a condition of serving as a distributor for their products. Where we are permitted to sell competing products, we may find that sales of a supplier’s products reduce demand for our self-developed products. Where our agreements with suppliers limit our ability to sell competing branded products, we may have to forego developing potentially profitable products. Any of these results could materially harm our business.

 

We rely on some of our competitors to supply component parts for our branded products.

 

We obtain some components from companies that are competitors in our market. We are not reliant on these competitors for such components and believe we could obtain these components from other suppliers. We do, however, provide detailed technical specifications to these competitors for use in producing components for our branded products. If these companies were to reverse-engineer or otherwise misappropriate such information, our business could be materially harmed.

 

Although we do not own or control our distributors, the actions of these distributors may affect our business operations or our reputation in the marketplace.

 

Our distributors are independent from us, and as such, our ability to effectively manage their activities is limited. Distributors could take any number of actions that could have material adverse effects on our business. If we fail to adequately manage our distribution network or if distributors do not comply with our distribution agreements, our corporate image could be tarnished among end users, disrupting our sales. Furthermore, we could be liable for actions taken by our distributors, including any violations of applicable law in connection with the marketing or sale of our products, including China’s anti-corruption laws. Recently, the PRC government has increased its anti-bribery efforts in the healthcare sector to reduce improper payments received by hospital administrators and doctors in connection with the purchase of pharmaceutical products and medical devices. Our distributors may violate these laws or otherwise engage in illegal practices with respect to their sales or marketing of our products. If our distributors violate these laws, we could be required to pay damages or fines, which could materially and adversely affect our financial condition and results of operations. In addition, our brand and reputation, our sales activities or the price of our shares could be adversely affected if our company becomes the target of any negative publicity as a result of actions taken by our distributors.

 

We plan to expand our healthcare and technical service products internationally and hope to become a leader in selected international markets. Such expansion can be difficult and time consuming, and if unsuccessful our future profits would be materially and adversely affected.

 

While we currently operate primarily in China, we envision competing in selected international markets with our healthcare and technical service products, such as medical air compressor. We intend to enter into markets in which we have limited or no experience and in which our brand may be less recognized. We plan to devote significant resources to marketing and promoting our brand internationally and attracting distributors in foreign markets. Success in international markets will depend on our ability to attract a sufficient number of distributors suitable for selling our branded products. Furthermore, in new markets we may fail to anticipate competitive conditions that are different from those in our existing markets. These competitive conditions may make it difficult or impossible for us to operate effectively in these markets.

 

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Operation in international markets will also expose us to many other risks, including but not limited to:

 

·political instability;

·economic instability and recessions;

·changes in tariffs;

·difficulties of administering foreign operations generally;

·limited protection for intellectual property rights;

·obligations to comply with a wide variety of foreign laws and other regulatory requirements;

·financial condition, expertise and performance of international distributors;

·export license requirements;

·unauthorized re-export of our branded products;

·inability to purchase our distributed products from international suppliers at competitive prices;

·potentially adverse tax consequences; and

·inability to effectively enforce contractual or legal rights.

 

We are highly dependent on our key personnel such as key executives and research and development personnel.

 

We are highly dependent on the continued service of our key executives and other key personnel. In particular, we substantially rely on our chairman and chief executive officer Mr. Ping Chen to manage our business and operations. We also rely on key research and development personnel for the development of new products. In addition, we rely on customer service personnel for the installation and support of our products and on marketing and sales personnel, engineers and other personnel with technical and industry knowledge to market, sell, install and service our products. We have entered into standard two-year employment contracts with all of our officers and managers and other key personnel and two-year employment contracts with our other employees. These contracts prohibit our employees from engaging in any conduct or activity that would be competitive with our business during the course of their employment. Loss of any of our key personnel could severely disrupt our business. We may not be able to find suitable or qualified replacements, and will likely incur additional expenses in order to recruit and train any new personnel.

 

Competition for qualified management and key personnel in the medical technology field is intense and the pool of qualified candidates is limited. We not only compete with other medical device companies but also universities and other research institutions to attract and retain qualified personnel. This intense competition may force us to offer higher compensation and benefit packages in order to attract and retain the most qualified personnel. Our future success depends on our ability to attract and retain these individuals and failure to do so could result in severe disruptions to our business and growth.

 

Our business is subject to intense competition, which may reduce demand for our products and materially and adversely affect our business, financial condition, results of operations and prospects.

 

The medical device and health wearables markets are highly competitive, and we expect competition to intensify. Given the $585 billion stimulus initiative in China and its impact on healthcare, we expect the availability of healthcare to increase, as more hospitals and clinics are developed rurally.

 

We face direct competition from both domestic and international competitors across all product lines and price points. Our competitors also vary by product. Currently, in China our competitors include publicly traded and privately held multinational companies, such as Phillips Respironics Inc., ResMed Inc. Covidien, Weinmann Medical Technology, Natus Medical Inc. (Embla Sleep Diagnostics), Curative Medical and SOMNO Medics as well as domestic Chinese companies such as Beijing Yi’an, Beijing Shenlu, Guangdong Pigeon, Tianjin Oranger, Beijing Zhonghe Beide Trading Co., Ltd., iCare Tech Healthcare Co., Ltd., Contec Medical Systems Co., Ltd., BMC Medical Co., Ltd, Baidu Online Network Technology (Beijing) Co., Ltd, Xiaomi Technology Co., Ltd, Shanda Group, InWatch Technology Co., Ltd, Huawei Technologies Co., Ltd, Lenovo Group, Andon Health Co., Ltd. and Guangdong Biolight Meditech Co., Ltd. As we expand into international markets, we expect that our competitors will primarily be publicly traded and privately held multinational companies. We also expect to face competition in international sales from companies that have local operations in the markets in which we sell our products. Some of our larger competitors may have:

 

·greater financial and other resources;

·larger variety of products;

 

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·more products that have received regulatory approvals;

·greater pricing flexibility;

·more extensive research and development and technical capabilities;

·patent portfolios that may present an obstacle to our conduct of business;

·greater knowledge of local market conditions where we seek to increase our international sales;

·stronger brand recognition; and

·larger sales and distribution networks.

 

As a result, we may be unable to offer products similar to, or more desirable than, those offered by our competitors, market our products as effectively as our competitors or otherwise respond successfully to competitive pressures. In addition, our competitors may be able to offer discounts on competing products as part of a “bundle” of non-competing products, systems and services that they sell to our customers, and we may not be able to profitably match those discounts. Our competitors may develop technologies and products that are more effective than those we currently offer or that render our products obsolete or uncompetitive. The timing of the introduction of competing products into the market could affect the market acceptance and market share of our products. As we expect demand for our products to increase along with the availability of healthcare, we must continue to focus on competitive pricing and innovation by being at the forefront of market trends and improving our product and service offerings. Our failure to compete successfully could materially and adversely affect our business, financial condition, results of operations and prospects.

 

Some of our internationally-based competitors may establish production or research and development facilities in China, while others may enter into cooperative business arrangements with Chinese manufacturers. If we are unable to develop competitive branded products, obtain regulatory approval or clearance and supply sufficient quantities to the market as quickly and effectively as our competitors, market acceptance of our branded products may be limited, which could result in decreased sales. In addition, we may not be able to maintain our branded product cost advantages.

 

We believe that corrupt practices in the medical device industry in China still occur. To increase sales, certain manufacturers or distributors of medical devices may pay kickbacks or provide other benefits to hospital personnel who make procurement decisions. Our company policy prohibits these practices by our direct sales personnel and our distribution agreements require our distributors to comply with applicable law. As a result, as competition intensifies in the medical device industry in China, we may lose sales, customers or contracts to competitors.

 

If we fail to accurately project demand for our products, we may encounter problems of inadequate supply or oversupply, which would materially and adversely affect our financial condition and results of operations, as well as damage our reputation and brand.

 

Our distributors typically order our products on a purchase order basis. We project demand for our products based on rolling projections from our distributors, our understanding of anticipated hospital procurement spending, and distributor inventory levels. Lack of significant order backlog and the varying sales and purchasing cycles of our distributors and other customers, however, make it difficult for us to forecast future demand accurately.

 

If we overestimate demand, we may purchase more distributed products or more unassembled parts or components for our branded products than we require. If we underestimate demand, our third party suppliers may have inadequate supply of distributed products or unassembled parts or product component inventories, which could interrupt the assembly process and delay shipments of our branded products, and could result in lost sales. In particular, we are seeking to reduce our procurement and inventory costs by matching our inventory closely with our projected product needs and by, from time to time, deferring our purchase of components in anticipation of supplier price reductions. As we seek to balance reduced inventory costs and assembly flexibility, we may fail to accurately forecast demand and coordinate our procurement and assembly to meet demand on a timely basis. Our inability to accurately predict our demand and to timely meet our demand could materially and adversely affect our financial conditions and results of operations as well as damage our reputation and corporate brand.

 

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Failure to manage our growth could strain our management, operational and other resources, which could materially and adversely affect our business and prospects.

 

Our growth strategy includes building our brand, increasing market penetration of our existing products, developing new products, increasing our targeting of the sleep respiratory market in China, and increasing our exports. Pursuing these strategies has resulted in, and will continue to result in substantial demands on management resources. In particular, the management of our growth will require, among other things:

 

·continued enhancement of our research and development capabilities;

·information technology system enhancement;

·stringent cost controls and sufficient liquidity;

·strengthening of financial and management controls and information technology systems; and

·increased marketing, sales and support activities; and hiring and training of new personnel.

 

If we are not able to manage our growth successfully, our business and prospects would be materially and adversely affected.

 

If we fail to obtain or maintain applicable regulatory clearances or approvals for our products, or if such clearances or approvals are delayed, we will be unable to commercially distribute and market our products at all or in a timely manner, which could significantly disrupt our business and materially and adversely affect our sales and profitability.

 

The sale and marketing of our products are subject to regulation in China. For a significant portion of our sales, we need to obtain and renew licenses and registrations with the CFDA. The processes for obtaining regulatory clearances or approvals can be lengthy and expensive, and the results are unpredictable. In addition, the relevant regulatory authorities may introduce additional requirements or procedures that have the effect of delaying or prolonging the regulatory clearance or approval for our existing or new products. If we are unable to obtain clearances or approvals needed to market existing or new branded products, or obtain such clearances or approvals in a timely fashion, our business would be significantly disrupted, and our sales and profitability could be materially and adversely affected. Similarly, if the third parties from whom we buy our distributed products fail to obtain such clearance, we would be unable to sell such distributed products, and our sales and profitability could be materially and adversely affected.

 

We generate a significant portion of our revenues from a small number of products, and a reduction in demand for any of these products could materially and adversely affect our financial condition and results of operations.

 

We derive a substantial percentage of our revenues from a small number of products. We expect a small number of our key products will continue to account for a significant portion of our net revenues for the foreseeable future. As a result, continued market acceptance and popularity of these products is critical to our success, and a reduction in demand due to, among other factors, the introduction of competing products by our competitors, the entry of new competitors, or end-users’ dissatisfaction with the quality of these products could materially and adversely affect our financial condition and results of operations.

 

If we fail to protect our intellectual property rights, it could harm our business and competitive position.

 

We rely on a combination of patent, copyright, trademark and trade secret laws and non-disclosure agreements and other methods to protect our intellectual property rights. The process of seeking patent protection can be lengthy and expensive, our patent applications may fail to result in patents being issued, and our existing and future patents may be insufficient to provide us with meaningful protection or commercial advantage. Our patents and patent applications may also be challenged, invalidated or circumvented.

 

We also rely on trade secret rights to protect our business through non-disclosure provisions in employment agreements with employees. If our employees breach their non-disclosure obligations, we may not have adequate remedies in China, and our trade secrets may become known to our competitors.

 

Implementation of PRC intellectual property-related laws has historically been lacking, primarily because of ambiguities in the PRC laws and enforcement difficulties. Accordingly, intellectual property rights and confidentiality protections in China may not be as effective as in the United States or other western countries. Furthermore, policing unauthorized use of proprietary technology is difficult and expensive, and we may need to resort to litigation to enforce or defend patents issued to us or to determine the enforceability, scope and validity of our proprietary rights or those of others. Such litigation and an adverse determination in any such litigation, if any, could result in substantial costs and diversion of resources and management attention, which could harm our business and competitive position.

 

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We may be exposed to intellectual property infringement and other claims by third parties which, if successful, could disrupt our business and have a material adverse effect on our financial condition and results of operations.

 

Our success depends, in large part, on our ability to use and develop our technology and know-how without infringing third party intellectual property rights. If we sell our branded products internationally, and as litigation becomes more common in China, we face a higher risk of being the subject of claims for intellectual property infringement, invalidity or indemnification relating to other parties’ proprietary rights. Our current or potential competitors, many of which have substantial resources and have made substantial investments in competing technologies, may have or may obtain patents that will prevent, limit or interfere with our ability to make, use or sell our branded products in either China or other countries, including the United States and other countries in Asia. The validity and scope of claims relating to medical device technology patents involve complex scientific, legal and factual questions and analysis and, as a result, may be highly uncertain. In addition, the defense of intellectual property suits, including patent infringement suits, and related legal and administrative proceedings can be both costly and time consuming and may significantly divert the efforts and resources of our technical and management personnel. Furthermore, an adverse determination in any such litigation or proceedings to which we may become a party could cause us to:

 

·pay damage awards;

·seek licenses from third parties;

·pay ongoing royalties;

·redesign our branded products; or

·be restricted by injunctions.

 

Each of the foregoing could effectively prevent us from pursuing some or all of our business and result in our customers or potential customers deferring or limiting their purchase or use of our branded products, which could have a material adverse effect on our financial condition and results of operations.

 

We are subject to product liability exposure and have limited insurance coverage. Any product liability claims or potential safety-related regulatory actions could damage our reputation and materially and adversely affect our business, financial condition and results of operations.

 

The medical devices we assemble and sell can expose us to potential product liability claims if the use of these products causes or is alleged to have caused personal injuries or other adverse effects. Any product liability claim or regulatory action could be costly and time-consuming to defend. If successful, product liability claims may require us to pay substantial damages. We do not maintain product liability insurance to cover potential product liability arising from the use of our branded products because product liability insurance available in China offers only limited coverage compared to coverage offered in many other countries. As we expand our sales internationally and increase our exposure to these risks in many countries, we may be unable to obtain sufficient product liability insurance coverage on commercially reasonable terms, or at all. A product liability claim or potential safety-related regulatory action, with or without merit, could result in significant negative publicity and could materially and adversely affect the marketability of our branded products and our reputation, as well as our business, financial condition and results of operations.

 

Moreover, a material design, manufacturing or quality failure or defect in our branded products, other safety issues or heightened regulatory scrutiny could each warrant a product recall by us and result in increased product liability claims. Also, if these products are deemed by the authorities in the countries where we sell our branded products to fail to conform to product quality and safety requirements, we could be subject to regulatory action. In China, violation of PRC product quality and safety requirements may subject us to confiscation of related earnings, penalties, an order to cease sales of the violating product, or to cease operations pending rectification. Furthermore, if the violation is determined to be serious, our business license to assemble or sell violating and other products could be suspended or revoked.

 

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We may undertake acquisitions, which may have a material adverse effect on our ability to manage our business, and may end up being unsuccessful.

 

Our growth strategy may involve the acquisition of new technologies, businesses, products or services or the creation of strategic alliances in areas in which we do not currently operate. We do not have any understanding, commitment or agreement in place with regard to any such acquisitions at this time. These acquisitions could require that our management develop expertise in new areas, manage new business relationships and attract new types of customers. Furthermore, acquisitions may require significant attention from our management, and the diversion of our management’s attention and resources could have a material adverse effect on our ability to manage our business. We may also experience difficulties integrating acquisitions into our business and operations. Future acquisitions may also expose us to potential risks, including risks associated with:

 

·the integration of new operations, services and personnel;

·unforeseen or hidden liabilities;

·the diversion of resources from our existing businesses and technologies; our inability to generate sufficient revenue to offset the costs of acquisitions; and

·potential loss of, or harm to, relationships with employees or customers, any of which could significantly disrupt our ability to manage our business and materially and adversely affect our business, financial condition and results of operations.

 

In the event we are unable to complete acquisitions, we have reserved the right to reallocate such funds to our working capital. If this happens, we would have broad discretion over the ultimate us of such funds, and we could use such funds in ways with which investors might disagree.

 

We may need additional capital in the future, and we may be unable to obtain such capital in a timely manner or on acceptable terms, or at all.

 

In order for us to grow, remain competitive, develop new products, and expand our distribution network, we may require additional capital in the future. Our ability to obtain additional capital in the future is subject to a variety of uncertainties, including:

 

·our future financial condition, results of operations and cash flows;

·general market conditions for capital raising activities by medical device manufacturers and other related companies; and

·economic, political and other conditions in China and elsewhere.

 

We may be unable to obtain additional capital in a timely manner or on acceptable terms or at all. Furthermore, the terms and amount of any additional capital raised through issuances of equity securities may result in significant shareholder dilution.

 

If we experience a significant number of warranty claims, our costs could substantially increase and our reputation and brand could suffer.

 

We typically sell our branded products with warranty terms covering 12 months after purchase. Our branded product warranty requires us to repair all mechanical malfunctions and, if necessary, replace defective components. We accrue liability for potential warranty claims at the time of sale. If we experience an increase in warranty claims or if our repair and replacement costs associated with warranty claims increase significantly, we may have to accrue a greater liability for potential warranty claims. Moreover, an increase in the frequency of warranty claims could substantially increase our costs and harm our reputation and brand. Our business, financial condition, results of operations and prospects may suffer materially if we experience a significant increase in warranty claims on our branded products.

 

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If our security measures are breached or fail, and unauthorized access is obtained to a client’s data, our services may be perceived as not being secure, clients may curtail or stop using our services, and we may incur significant liabilities

 

Our products and services involve the web-based storage and transmission of clients’ proprietary information and protected health information of patients. Because of the sensitivity of this information, security features of our software are very important. From time to time we may detect vulnerabilities in our systems, which, even if they do not result in a security breach, may reduce customer confidence and require substantial resources to address. If our security measures are breached or fail as a result of third-party action, employee error, malfeasance, insufficiency, defective design, or otherwise, someone may be able to obtain unauthorized access to client or patient data. As a result, our reputation could be damaged, our business may suffer, and we could face damages for contract breach, penalties for violation of applicable laws or regulations, and significant costs for remediation and efforts to prevent future occurrences. We rely upon our clients as users of our system for key activities to promote security of the system and the data within it, such as administration of client-side access credentialing and control of client-side display of data. On occasion, our clients have failed to perform these activities. Failure of clients to perform these activities may result in claims against us that this reliance was misplaced, which could expose us to significant expense and harm to our reputation. Because techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventive measures. If an actual or perceived breach of our security occurs, the market perception of the effectiveness of our security measures could be harmed and we could lose sales and clients. In addition, our clients may authorize or enable third parties to access their client data or the data of their patients on our systems. Because we do not control such access, we cannot ensure the complete propriety of that access or integrity or security of such data in our systems.

 

If our services fail to provide accurate and timely information, or if our content or any other element of any of our services is associated with faulty clinical decisions or treatment, we could have liability to clients, clinicians, or patients, which could adversely affect our results of operations.

 

Our products, software, content, and services are used to assist clinical decision-making and provide information about treatment plans. If our products, software, content, or services fail to provide accurate and timely information or are associated with faulty clinical decisions or treatment, then clients, clinicians, or their patients could assert claims against us that could result in substantial costs to us, harm our reputation in the industry, and cause demand for our services to decline.

 

The assertion of such claims and ensuing litigation, regardless of its outcome, could result in substantial cost to us, divert management’s attention from operations, damage our reputation, and decrease market acceptance of our products and services. We attempt to limit by contract our liability for damages and to require that our clients assume responsibility for medical care and approve key system rules, protocols, and data. Despite these precautions, the allocations of responsibility and limitations of liability set forth in our contracts may not be enforceable, be binding upon patients, or otherwise protect us from liability for damages.

 

Our proprietary software may contain errors or failures that are not detected until after the software is introduced or updates and new versions are released. It is challenging for us to test our software for all potential problems because it is difficult to simulate the wide variety of computing environments or treatment methodologies that our clients may deploy or rely upon. From time to time we have discovered defects or errors in our software, and such defects or errors can be expected to appear in the future. Defects and errors that are not timely detected and remedied could expose us to risk of liability to clients, clinicians, and patients and cause delays in introduction of new services, result in increased costs and diversion of development resources, require design modifications, or decrease market acceptance or client satisfaction with our services.

 

If any of these risks occur, they could materially adversely affect our business, financial condition, or results of operations.

 

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We rely on Internet infrastructure, bandwidth providers, other third parties, and our own systems for providing services to our users, and any failure or interruption in the services provided by these third parties or our own systems could expose us to litigation and negatively impact our relationships with users, adversely affecting our brand and our business.

 

Our ability to deliver our Internet- and telecommunications-based services is dependent on the development and maintenance of the infrastructure of the Internet and other telecommunications services by third parties. This includes maintenance of a reliable network backbone with the necessary speed, data capacity, and security for providing reliable Internet access and services. Our services are designed to operate without interruption in accordance with our service level commitments. However, we have experienced and expect that we will experience interruptions and delays in services and availability from time to time. We rely on internal systems as well as third-party vendors, including data center, bandwidth, and telecommunications equipment providers, to provide our services. We do not maintain redundant systems or facilities for some of these services. In the event of a catastrophic event with respect to one or more of these systems or facilities, we may experience an extended period of system unavailability, which could negatively impact our relationship with users. Any disruption in the network access, telecommunications, or co-location services provided by these third-party providers or any failure of or by these third-party providers or our own systems to handle current or higher volume of use could significantly harm our business. We exercise limited control over these third-party vendors, which increases our vulnerability to problems with services they provide.

 

Any errors, failures, interruptions, or delays experienced in connection with these third-party technologies and information services or our own systems could negatively impact our relationships with users and adversely affect our business and could expose us to third-party liabilities. The reliability and performance of the Internet may be harmed by increased usage or by denial-of-service attacks. The Internet has experienced a variety of outages and other delays as a result of damages to portions of its infrastructure, and it could face outages and delays in the future. These outages and delays could reduce the level of Internet usage as well as the availability of the Internet to us for delivery of our Internet-based services.

 

 If we are unable to keep up with the rapid technological changes of the internet industry, our business may suffer.

 

The internet industry is experiencing rapid technological changes. Our future success will depend on our ability to anticipate, adapt and support new technologies and industry standards. If we fail to anticipate and adapt to these and other technological changes, our market share, profitability and share price could suffer.

 

Foreign Operational Risks

 

Adverse changes in economic and political policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could adversely affect our business.

 

Substantially all of our business operations are conducted in China. Accordingly, our results of operations, financial condition and prospects are subject to economic, political and legal developments in China. China’s economy differs from the economies of most developed countries in many respects, including with respect to the amount of government involvement, level of development, growth rate, control of foreign exchange, and allocation of resources.

 

While the PRC economy has grown more rapidly in the past 30 years than the world economy as a whole, growth has been uneven across different regions and among various economic sectors of China. The PRC government has implemented various measures to encourage economic development and guide the allocation of resources. Some of these measures benefit the overall PRC economy, but may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us. Since early 2004, the PRC government has implemented certain measures to control the pace of economic growth. Such measures may cause a decrease in the level of economic activity in China, which in turn could adversely affect our results of operations and financial condition.

 

We may be subject to foreign exchange controls in the PRC.

 

Our PRC subsidiary and affiliates are subject to PRC rules and regulations on currency conversion. In the PRC, the State Administration for Foreign Exchange (“SAFE”) regulates the conversion of the RMB into foreign currencies. Currently, foreign investment enterprises (“FIEs”) are required to apply to SAFE for “Foreign Exchange Registration Certificate for FIEs.” BDL is a FIE. With such registration certifications (which need to be renewed annually), FIEs are allowed to open foreign currency accounts including the “current account” and the “capital account.” Currently, conversion within the scope of the “current account” can be effected without requiring the approval of SAFE. However, conversion of currency in the “capital account” (e.g. for capital items such as direct investments, loans, securities, etc.) are still subject to limitations and require approvals from, or registration with, SAFE and other relevant PRC governmental authorities.

 

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If the investing public’s perception of smaller companies from China worsens, our share price may decrease and we may have difficulty accessing U.S. capital markets.

 

In recent months, a number of smaller companies from China have had the trading of their securities in the United States halted, delisted or otherwise affected for a variety of reasons. As a result, investors may be concerned about purchasing the securities of any smaller Chinese company. To the extent the investing community is reluctant to purchase such securities or discounts the value of the securities of companies that operate primarily or exclusively in China, our share price may also be adversely affected, regardless of whether there are specific concerns about our company. This could not only harm our share price but could also make it more difficult for us to conduct any future offering of our securities at a price that is acceptable to our company or at all.

 

We do not have business interruption, litigation or natural disaster insurance.

 

The insurance industry in China is still at an early stage of development. In particular PRC insurance companies offer limited business products. As a result, we do not have any business liability or disruption insurance coverage for our operations in China. Any business interruption, litigation or natural disaster may result in our business incurring substantial costs and the diversion of resources.

 

The Chinese enterprise income tax law will affect tax exemptions on the dividends we receive and increase the enterprise income tax rate applicable to us.

 

We are a holding company incorporated under the laws of the British Virgin Islands. We conduct substantially all of our business through our wholly owned Chinese subsidiaries and we derive all of our income from these subsidiaries. Prior to January 1, 2008, dividends derived by foreign legal persons from business operations in China were not subject to the Chinese enterprise income tax.

 

On March 16, 2007, the National People’s Congress of the PRC passed the PRC Enterprise Income Tax Law (the “EIT Law”), which took effect on January 1, 2008. Such tax exemptions ceased with the effectiveness of the EIT Law.

 

Under the EIT Law, if we are deemed to be a non-resident enterprise for Chinese tax purposes, a withholding tax at the rate of 10% would be applicable to any dividends paid by our Chinese subsidiaries to us. However, if we are deemed to have a “de facto management organization” in China, we would be classified as a resident enterprise for Chinese tax purposes and thus would be subject to an enterprise income tax rate of 25% on all of our income. At present, the Chinese tax authority has not issued any guidance on the application of the EIT Law and its implementing rules on non-Chinese enterprises or group enterprise controlled entities whose structures are like ours. As a result, it is unclear what factors will be used by the Chinese tax authorities to determine whether we are a “de facto management organization” in China. However, as substantially all members of our management team are located in China, we may be deemed to be a resident enterprise and therefore subject to an enterprise income tax rate of 25% on our worldwide income, with the possible exclusion of dividends received directly from another Chinese tax resident. As a result of such changes, our historical operating results will not be indicative of our operating results for future periods and the value of our shares may be adversely affected.

 

BDL may also be required to allocate a portion of its after-tax profits, as determined by its board of directors, to the general reserve, the staff welfare and bonus funds, and the enterprise expansion reserve, which may not be distributed to equity owners.

 

Pursuant to the Law of Chinese-Foreign Equity Joint Ventures, Chinese-foreign equity joint ventures are required to allocate a portion of their after-tax profits in accordance with their Articles of Association, to the general reserve, the staff welfare and bonus funds, and the enterprise expansion reserve. According to the Articles of Association of BDL, the amount of each reserve is determined by BDL’s board of directors. The general reserve is used to offset future extraordinary losses. The subsidiaries may, upon a resolution passed by the shareholders, convert the general reserve into capital. The employee welfare and bonus reserve is used for the collective welfare of the employees of the subsidiaries. The enterprise expansion reserve is used for the expansion of the subsidiaries’ operations and can be converted to capital subject to approval by the relevant authorities. These reserves represent appropriations of retained earnings determined according to PRC law.

 

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As of the date of this prospectus, the amounts of these reserves have not yet been determined, and we have not committed to establishing such amounts at this time. Under current PRC laws, BDL is required to set aside reserve amounts, but has not yet done so. BDL has not done so because PRC authorities grant companies flexibility in making a determination. Chinese law requires such a determination to be made in accordance with the companies’ organizational documents and BDL’s organizational documents do not require the determination to be made within a particular timeframe. Although we have not yet been required by PRC authorities to make such determinations or set aside such reserves, PRC authorities may require BDL to rectify its noncompliance and we may be fined if we fail to do so after warning within the time period set in the warning.

 

PRC law requires allocation to the general reserve before distribution of the after-tax profits of foreign invested companies, which could prevent us from receiving the dividends from BDL.

 

PRC law requires that the after-tax profits of foreign invested companies be distributed after a portion of after-tax profits is allocated to the reserve; therefore if for any reason, the dividends from BDL cannot be repatriated to us or not in time, then it may detrimentally affect our cash flow and even cause us to become insolvent.

 

Governmental control of currency conversion may affect the value of your investment.

 

The PRC government imposes controls on the convertibility of the Renminbi into foreign currencies and, in certain cases, the remittance of currency out of China. We receive the majority of our revenues in Renminbi. Under our current corporate structure, our income is derived from payments from BDL. Shortages in the availability of foreign currency may restrict the ability of BDL to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy their foreign currency denominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from trade-related transactions, can be made in foreign currencies without prior approval from SAFE by complying with certain procedural requirements. However, approval from appropriate government authorities is required where Renminbi is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of bank loans denominated in foreign currencies. The PRC government may be also at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay dividends in foreign currencies to our shareholders.

 

Currency fluctuations and restrictions on currency exchange may adversely affect our business, including limiting our ability to convert RMB into foreign currencies and, if RMB were to decline in value, reducing our revenues and profits in U.S. dollar terms.

 

Our reporting currency is the U.S. dollar and our operations in China use RMB as functional currency. The majority of our revenues derived and expenses incurred are in RMB with a relatively small amount in U.S. dollars. We are subject to the effects of exchange rate fluctuations with respect to these currencies. For example, the value of the RMB depends to a large extent on Chinese government policies and China’s domestic and international economic and political developments, as well as supply and demand in the local market. Starting July 2005, the Chinese government changed its policy of pegging the value of the RMB to the U.S. dollar. Under the new policy, the RMB has fluctuated within a narrow and managed band against a basket of certain foreign currencies.  It is possible that the Chinese government will adopt a more flexible currency policy, which could result in more significant fluctuations of the RMB against the U.S. dollar.

 

The income statements are translated into U.S. dollars at the average exchange rates in each applicable period. To the extent the U.S. dollar strengthens against RMB, the translation of these foreign currency-denominated transactions results in reduced revenues, operating expenses and net income for our non-U.S. operations. Similarly, to the extent the U.S. dollar weakens against RMB, the translation of RMB transactions results in increased revenues, operating expenses and net income for our non-U.S. operations. We are also exposed to foreign exchange rate fluctuations as we convert the financial statements into U.S. dollars in consolidation. If there is a change in foreign currency exchange rates, the conversion of the non-U.S. dollars financial statements into U.S. dollars will lead to a translation gain or loss which is recorded as a component of other comprehensive income. In addition, we have certain assets and liabilities that are denominated in currencies other than the relevant entity’s functional currency. Changes in the functional currency value of these assets and liabilities create fluctuations that will lead to a transaction gain or loss. We have not entered into agreements or purchased instruments to hedge our exchange rate risks, although we may do so in the future. The availability and effectiveness of any hedging transaction may be limited and we may not be able to successfully hedge our exchange rate risks.

 

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Although Chinese governmental policies were introduced in 1996 to allow the convertibility of RMB into foreign currency for current account items, conversion of RMB into foreign exchange for most of the capital items, such as foreign direct investment, loans or securities, requires the approval of the State Administration of Foreign Exchange, or SAFE. These approvals, however, do not guarantee the availability of foreign currency. We cannot be sure that we will be able to obtain all required conversion approvals for our operations or that Chinese regulatory authority will not impose greater restrictions on the convertibility of RMB in the future. Because a significant amount of our future revenues may be in the form of RMB, our inability to obtain the requisite approvals or any future restrictions on currency exchanges could limit our ability to utilize revenue generated in RMB to fund our business activities outside China, or to repay non-RMB-denominated obligations, including our debt obligations, which would have a material adverse effect on our financial condition and results of operations. 

 

If PRC law were to phase out the preferential tax benefits currently being extended to certified high technology companies or if we were to fail to be certified to receive such a benefit, we would have to pay more taxes, which could have a material and adverse effect on our financial condition and results of operations.

 

Under PRC laws and regulations, a company may enjoy preferential tax benefits if it is certified as a high technology enterprise. As a certified high technology enterprise, we are subject to an enterprise income tax rate of 15% tax rate so long as we continue to be so certified. If the PRC law were to phase out preferential tax benefits currently granted to certified high technology enterprises or if we were to fail to be certified to receive such a benefit, we would be subject to the standard statutory tax rate, which currently is 25%.

 

If relations between the United States and China worsen, our share price may decrease and we may have difficulty accessing U.S. capital markets.

 

At various times during recent years, the United States and China have had disagreements over political and economic issues. Controversies may arise in the future between these two countries. Any political or trade controversies between the United States and China could adversely affect the market price of our common shares and our ability to access U.S. capital markets.

 

The PRC legal system embodies uncertainties that could limit the legal protections available to you and us.

 

The PRC legal system is a civil law system based on written statutes. Unlike common law systems, it is a system in which decided legal cases have limited precedential value. In 1979, the PRC government began to promulgate a comprehensive system of laws and regulations governing economic matters in general. The overall effect of legislation over the past three decades has significantly increased the protections afforded to various forms of foreign investment in China. Our PRC operating subsidiary, BDL, is a foreign-invested enterprise and is subject to laws and regulations applicable to foreign investment in China as well as laws and regulations applicable to foreign-invested enterprises. These laws and regulations change frequently, and their interpretation and enforcement involve uncertainties. For example, we may have to resort to administrative and court proceedings to enforce the legal protections that we enjoy either by law or contract. However, since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory and contractual terms, it may be more difficult to evaluate the outcome of administrative and court proceedings and the level of legal protection we enjoy than in more developed legal systems. These uncertainties may also impede our ability to enforce the contracts we have entered into. As a result, these uncertainties could materially and adversely affect our business and operations.

 

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Recent PRC regulations relating to offshore investment activities by PRC residents may increase the administrative burden we face and create regulatory uncertainties that could restrict our overseas and cross-border investment activity, and a failure by our shareholders who are PRC residents to make any required applications and filings pursuant to such regulations may prevent us from being able to distribute profits and could expose us and our PRC resident shareholders to liability under PRC law.

 

In October 2005, SAFE promulgated regulations that require PRC residents and PRC corporate entities to register with and obtain approvals from relevant PRC government authorities in connection with their direct or indirect offshore investment activities. These regulations apply to our shareholders who are PRC residents in connection with our prior and any future offshore acquisitions.

 

The October 2005 SAFE regulation (which was renewed and replaced by the July 2014 SAFE regulation “Notice on Issues concerning Foreign Exchange Administration of the Overseas Investment and Financing and the Round-tripping Investment Made by Domestic Residents through Special-Purpose Companies”) required registration by March 31, 2006 of direct or indirect investments previously made by PRC residents in offshore companies prior to the implementation of the Notice on Issues Relating to the Administration of Foreign Exchange in Fund-Raising and Reverse Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies on November 1, 2005. If a PRC shareholder with a direct or indirect stake in an offshore parent company fails to make the required SAFE registration, the PRC subsidiaries of such offshore parent company may be prohibited from making distributions of profit to the offshore parent and from paying the offshore parent proceeds from any reduction in capital, share transfer or liquidation in respect of the PRC subsidiaries. Furthermore, failure to comply with the various SAFE registration requirements described above could result in liability under PRC law for foreign exchange evasion.

 

We previously notified and urged our shareholders, and the shareholders of the offshore entities in our corporate group, who are PRC residents to make the necessary applications and filings, as required under this regulation. However, as these regulations are relatively new and there is uncertainty concerning their reconciliation with other approval requirements, it is unclear how they, and any future legislation concerning offshore or cross-border transactions, will be interpreted, amended and implemented by the relevant government authorities. While we believe that these shareholders submitted applications with local SAFE offices, some of our shareholders may not comply with our request to make or obtain any applicable registrations or approvals required by the regulation or other related legislation. The failure or inability of our PRC resident shareholders to obtain any required approvals or make any required registrations may subject us to fines and legal sanctions, prevent us from being able to make distributions or pay dividends, as a result of which our business operations and our ability to distribute profits to you could be materially and adversely affected.

 

Because our operations are located in China, information about our operations are not readily available from independent third-party sources.

 

Because the BDL is based in China, our shareholders may have greater difficulty in obtaining information about it on a timely basis than would shareholders of a U.S.-based company. BDL’s operations will continue to be conducted in China and shareholders may have difficulty in obtaining information about it from sources other than BDL itself. Information available from newspapers, trade journals, or local, regional or national regulatory agencies such as issuance of construction permits and contract awards for development projects will not be readily available to shareholders and, where available, will likely be available only in Chinese. Shareholders will be dependent upon management for reports of their progress, development, activities and expenditure of proceeds.

 

There are no related laws or regulations to wearable medical products now in China. If there are government regulations in the future, it may create risks and challenges with respect to our compliance efforts and our business strategies.

 

The health care industry is highly regulated and is subject to changing political, legislative, regulatory, and other influences. Existing and new laws and regulations affecting the health care industry could create unexpected liabilities for us, cause us to incur additional costs, and restrict our operations. Many health care laws are complex, and their application to specific services and relationships may not be clear. In particular, many existing health care laws and regulations, when enacted, did not anticipate the wearable medical products and services that we provide, and these laws and regulations may be applied to our business in ways that we do not anticipate. Our failure to accurately anticipate the application of these laws and regulations, or our other failure to comply, could create liability for us, result in adverse publicity, and negatively affect our business.

 

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Item 4.Information on the Company

 

  A. History and Development of the Company

 

Our founder, Mr. Ping Chen, founded Beijing Dehaier Technology Company Limited (“BTL”), a PRC company controlled by our chief executive officer, Mr. Ping Chen on July 5, 2001 to develop and distribute medical devices. He currently owns approximately 91% of BTL, and his wife and several former employees of Lianluo Smart Limited own the remaining 9% of BTL. BTL previously leased some of our property to us and provides certain transportation and repair services to medical devices for which we are not obligated to perform warranty services, either because the warranty is expired or because the product was sold by another company. BTL served as the domestic partner to our joint venture pursuant to which we, a British Virgin Islands company, now own 100% of Beijing Dehaier Medical Technology Company Limited (“BDL”), a PRC company in the medical device business. At the time of the formation of the joint venture, foreign enterprises were not permitted to own such companies without PRC partners.

 

In 2003, in order to continue to grow our business, BTL engaged in a corporate restructuring. As a result of those actions, Lianluo Smart, BDL and De-haier Medical Systems (Hong Kong) Limited (“DHK”) were established, and we created the holding company structure that is currently in place.

 

Lianluo Smart was incorporated as an international business company under the International Business Companies Act, 1984, in the British Virgin Islands on July 22, 2003 under the name “De-Haier Medical Systems Limited”. We changed this name to “Dehaier Medical Systems Limited” on June 3, 2005, and to "Lianluo Smart Limited" on November 21, 2016. Lianluo Smart is a holding company. Lianluo Smart does not conduct business in China and instead relies on BDL and Lianluo Connection Medical Wearable Device Technology (Beijing) Co., Ltd., a PRC company (“LCL”) to conduct business in China.

 

On September 24, 2003, we established BDL. BDL conducts substantially all of our operations in China and is responsible for generating substantially all of our revenues. BDL was formed as a joint venture between a Chinese entity, BTL, and a foreign invested enterprise, Lianluo Smart, in order to allow foreign investments to be used to grow our business. Because BDL is engaged in an encouraged industry under the Foreign Investment Industrial Guidance Catalogue, it was allowed to have foreign investments and to be established as a Chinese-foreign equity joint-venture. This structure allowed BDL access to foreign capital that would not have been available outside this structure.

 

BDL has been focused on the development and distribution of medical devices since its inception and began developing its respiratory and oxygen homecare business in 2006.

 

On April 22, 2010, we completed an initial public offering of 1,500,000 common shares. The offering was completed at an issuance price of $8.00 per share. Prior to the offering, the Company had 3,000,000 issued and outstanding shares, and after the offering, the Company had 4,500,000 issued and outstanding shares.

 

On February 21, 2014, we and certain institutional investors entered into a securities purchase agreement in connection with an offering (the “Offering”), pursuant to which we agreed to sell an aggregate of 734,700 common shares and warrants to initially purchase an aggregate of 220,410 common shares. The purchase price was $9.12 per common share, and the warrants were initially exercisable at $11.86 per share. The Offering closed on February 26, 2014, and the aggregate gross proceeds from the sale of the common shares, before deducting fees to the placement agent and other estimated offering expenses payable by us was approximately $6.7 million, not including any proceeds from warrant exercises. The warrants were exercisable immediately as of the date of issuance at an exercise price of $11.86 per common share and were to expire forty-two months from the date of issuance. On April 21, 2016, we entered warrant repurchase agreements with the holders of these warrants and the placement agent involved in the offering, pursuant to which we agreed to repurchase 293,880 warrants for cash payment equal to $3.80 per share underlying the warrants. We completed the repurchase of the warrants on June 2, 2016, and as of the date of this filing, all of such warrants have been cancelled.

 

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On January 14, 2016, we completed an acquisition of 0.8% equity interest of BDL from BTL. The Company now holds 100% of the equity interest of BDL. This change reflects BTL’s reduced reliance on business with BDL in providing repair and maintenance services. Upon the Loss Absorption Agreement Termination (“VIE Termination”) executed, we stopped all business activities with BTL as well.

 

On February 1, 2016, our Board of Directors approved the formation of a wholly owned subsidiary, LCL, in Beijing. We have finished the related procedures to establish LCL.

 

On February 22, 2016, we discontinued part of our medical devices business, including assembly and sales of X-ray machines and anesthesia machines, monitoring devices, general medical products, and oxygen generators. Our Company will focus on the development of the remaining product line, such as the second generation ventilator, general medical products laryngoscopes, compressors, sleep respiratory business and wireless medical.

 

On April 28, 2016, we entered into a definitive securities purchase agreement (the “SPA”) with Hangzhou Lianluo Interactive Information Technology Co., Ltd. (“Lianluo Interactive”) to sell 11,111,111 of our common shares to Lianluo Interactive for an aggregate purchase price of $20 million. The purchase price was $1.80 per share, which represented a 35% premium to company’s closing price of $1.33 on April 27, 2016. We completed our first closing under the SPA on June 2, 2016, pursuant to which we sold 620,414 common shares for an aggregate purchase price of $1,116,744. On June 28, 2016, we entered into Amendment No. 1 to the SPA to extend the closing date from June 30, 2016 to September 30, 2016. On August 18, 2016, we closed the SPA, and completed the sale of an aggregate of $20 million of our common shares and warrants to purchase common shares.

 

On July 31, 2016, BDL entered into a Loss Absorption Agreement Termination (“VIE Termination”) with the BTL. According to the VIE Termination, the Loss Absorption Agreement (the “VIE Agreement”) among BDL, BTL and its shareholders Ping Chen, Bao Xian, Weibing Yang, Jian Sun, Zheng Liu and Yong Wang dated as of March 3, 2010 was terminated effective July 31, 2016. There is no relationship between BTL and the Registrant and its other subsidiaries after the effectiveness of the VIE Termination.

 

On November 21, 2016, the Company changed its name from Dehaier Medical Systems Limited to Lianluo Smart Limited, and its NASDAQ stock ticker from DHRM to LLIT.

 

Relationship among Lianluo Smart, BTL, LCL and BDL

 

BTL is a PRC company established on July 5, 2001. Lianluo Smart is a BVI company established on July 22, 2003, used to be known as Dehaier Medical Systems Limited. Lianluo Smart and BTL jointly established BDL on September 24, 2003 as a Chinese-foreign equity joint-venture under the PRC laws. Lianluo Smart has been and is BDL’s foreign shareholder, and BTL has been and is BDL’s domestic shareholder since BDL was established. Currently, Lianluo Smart owns 100% of BDL, and BTL no longer owns any equity interest of BDL. Under PRC laws, the shareholders of the equity joint-venture share the profits, risks and losses in proportion to their respective contributions of the equity joint-venture.

 

BTL leased its building to BDL from January 1, 2015 through December 31, 2016, and BDL no longer leases this building as of the date of this filing. At December 18, 2015, BTL’s building was pledged to a bank as collateral for short-term borrowings of RMB 10,000,000 ($1,541,000). Pursuant to the terms of the agreement, the line of credit is secured by BTL’s building and guaranteed by BDL and an officer of the Company. Upon the VIE Termination executed, BTL stopped providing its property as collateral for our outstanding borrowings. As of December 31, 2016, we reported no outstanding short-term borrowings.

 

On July 31, 2016, the Registrant’s wholly owned subsidiary, BDL, entered into a Loss Absorption Agreement Termination with the Registrant’s variable interest entity (“VIE”), BTL. According to the VIE Termination, the Loss Absorption Agreement (the “VIE Agreement”) among BDL, BTL and its shareholders Ping Chen, Bao Xian, Weibing Yang, Jian Sun, Zheng Liu and Yong Wang dated as of March 3, 2010 is terminated effective July 31, 2016. There is no relationship between BTL and the Registrant and its other subsidiaries after the effectiveness of the VIE Termination.

 

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On February 1, 2016, our Board of Directors approved formation of a wholly owned subsidiary, LCL, in Beijing. We have finished the related procedures to establish LCL.

 

B.Business Overview

 

Lianluo Smart focuses on three business sectors: medical wearable devices, smart devices and smart ecosystem platform.

 

The medical wearable sector will focus on wearable sleep respiratory devices. The Company develops and distributes medical devices, focusing primarily on sleep respiratory solutions to Obstructive Sleep Apnea Syndrome (“OSAS”) since 2010. It provides users with medical grade detection and monitoring, long-distance treatment and integration solution of professional rehabilitation. The Company now has professional and accurate collection and valuable big-data analytic technology, which can scientifically and accurately collect and count user data, provide chronic and high-risk patients with long-distance treatment and professional rehabilitation.

 

The smart devices sector is specialized in operating easy-using smart devices for sports, social contact, entertainment, remote-control, family health management, which can connect things and humans in an intelligent way. The Company will constantly upgrade key algorithms based on big data and develop smart devices based on the combination of hardware and software. This sector will cover several areas, including smart home, smart traveling and smart entertainment.

 

In the smart ecosystem platform sector, the Company will build up an ecosystem to facilitate interconnection among smart products and between smart products and users. This ecosystem is designed to address anticipated future trends and user demands. It incorporates wearable devices, home furnishings, mobile smart devices and other smart devices with cloud computing.

 

We are currently researching new products and evaluating business opportunities in our smart devices and smart ecosystem platform sectors.

 

We design, develop and market our own branded medical 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 medical 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.

 

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.

 

We completed the corporate and business restructuring plan of scaling down and discontinued, as appropriate, our unprofitable medical device business, including assembly and sales of X-ray machines and anesthesia machines. We maintain only a few currently-profitable businesses on sales of our patented products including medical air compressors and cardiopulmonary resuscitation (“CPR”) instruments. We aim to concentrate our resources to develop medical wearable devices, smart devices and smart ecosystem platform, as our major business.

 

Recent Operational Developments

 

·On June 24, 2016, we signed a strategic cooperation agreement with Hongyuan Supply Chain Management Co., Ltd. ("Hongyuan") to develop Lianluo Smart’s new Internet medical technology business. Under the strategic cooperation agreement, we will leverage Hongyuan’s sales platform to reach Lianluo Smart’s dealers and end users more efficiently, selling our wearable sleep apnea diagnostic system medical devices to Hongyuan for further down chain sale and distribution.

 

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·On July 5, 2016, Lianluo Smart partnered with China Sciences Group (Holding) Co., Ltd. ("China Sciences") to enter the Chinese pension and health industry by providing Lianluo Smart's products through China Sciences' elder care platform. Also, Lianluo Smart, China Sciences and another supplier, Chia Tai Pharmaceutical Group ("Chia Tai"), have signed a strategic cooperation agreement to launch the "Elderly Sleep Apnea Comprehensive Disease Solution Project".

 

·On December 2, 2016, the Company attended the 2016 Guangdong Sleep Cardiovascular Disease Diagnosis and Treatment New Progress Forum, co-hosted by the Institute of Interventional Cardiology of Guangdong Province, Guangdong Provincial People's Hospital and Cardiology Department of Guangdong Province Cardiovascular Institute, and the Coronary Heart Disease with Sleep Apnea Diagnosis and Treatment Strategy project promotion activities of Guangdong Provincial Health Commission.

 

Our Products

 

Our proprietary and distributed products include two major categories: (i) medical devices (including supporting products) and (ii) sleep respiratory and mobile medicine (including Internet Medical and Sleep Diagnosis Products). Our medical devices proprietary and distributed products are mainly used in hospitals and clinics, while the sleep respiratory products are mainly for hospitals, sleep centers, physical examination centers and at-home use by individuals.

 

Our Proprietary Products

 

Our management believes that our proprietary products, which are generally less expensive than products from foreign companies, tend to be more attractive to hospitals and healthcare facilities and other end-users for whom price is a significant factor in deciding whether to purchase our products. Our proprietary products include medical devices and related supporting/technical service products, and sleep respiratory products.

 

Medical Devices (Including Related Supporting Products)

 

Ventilator Air Compressor. We provide two types of air compressors to support medical ventilators in surgery by supplying continuous airflow for the ventilator. Where a facility lacks a central pressured air supply system, our DHR280 air compressors provide a portable source of such pressured air. Our air compressors feature oil-less motors, large locking castors, high flow capacity, and spill-proof switches. We have designed our air compressors to be adaptable for use with any ventilator.

 

Sleep Respiratory and Oxygen Homecare Products

  

Sleep Apnea Treatment Products. We have designed and expect to provide several products designed for obstructive sleep apnea (“OSA”) therapy. These products include our DHR CPAP C5. These products are all non-invasive therapy products that treat symptoms of sleep apnea. Our CPAP devices do not cure apnea but instead use air pressure to open customers’ airways to reduce snoring and apnea disturbances during sleep. Our automatic CPAP products provide air pressure at a customized, adjustable level, while our traditional CPAP products provide a constant level of air pressure.

 

Mobile Medicine(including Internet Medical and Sleep Diagnosis Products)

 

Sleep Apnea Diagnostic Products. We have designed and expect to provide two types of screening and diagnosis products are portable sleep respiratory recording devices that can be used in a healthcare facility or in a patient’s home to assist physicians in determining whether the patient has obstructive sleep apnea requiring use of a CPAP device. We have obtained the CFDA for DHR998 in January 2014.

 

Research and Development of Our Proprietary Products

 

Our success to date has in part resulted from our strong research and development capabilities, which allow us to regularly introduce new and more advanced products at competitive prices. Research and development costs from continuing operations were $1,196,161, $1,918,446 and $100,199 for the years ended December 31, 2016, 2015 and 2014, respectively. Research and development costs from discontinued operations were $0, $580,216 and $515,135 for the years ended December 31, 2016, 2015 and 2014, respectively. Our research and development team in 2016 consists of 5 engineers, representing 11% of our employees.

 

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Our project selection goals focus on projects that we believe are commercially feasible, can generate significant revenue and can be introduced into the market in the near-term. While our research and development department may conduct research into areas that are likely to lead to short-, medium- and long-range business opportunities for our company, we focus our development of products on those solutions we believe are most likely to generate significant near-term revenues. Thus, we would generally devote more resources to a solution expected to have an immediate financial return (for example, a ventilator) than to a project with a potentially greater overall payoff that is more distant and tenuous (for example, an artificial lung).

 

Our management seeks feedback from our distribution network to learn about needs for future products and improvements to existing products that our research and development department can seek to address. Once we identify a product opportunity, our sales and service, research and development, and assembly teams work closely together to determine potential market demand for a product and how it fits with our current design and assembly capabilities. We organize regular meetings in which our sales and service, research and development and assembly teams review progress and, if necessary, adjust the emphasis of our research and development projects.

 

If we deem a new product to be commercially feasible, our research and development team will work closely with our assembly team to move assembly forward. This integrated approach allows us to identify potential difficulties in commercializing our proprietary product or product improvement. Furthermore, it enables us to make adjustments as necessary and develop cost-efficient assembly processes prior to distribution. We believe these abilities can significantly shorten the time it takes to launch a commercialized product. In the last three years, we have developed and brought to market 5 new products, which we believe should appeal to a wide range of end-users.

 

Principal Suppliers – Our Proprietary Products

 

We use the following principal suppliers to manufacture the components in the products we develop and assemble:

 

China Huayang Investment Holding Co., Ltd.
Hunan Yitong Wearable Information Technology Co., Ltd.
Jianfa (Beijing) Co., Ltd.
Wuhan Xiruiou Technology Co., Ltd.
Tianjin Hongshida Metals Co., Ltd.

 

We believe the components provided by our suppliers are widely available and do not anticipate that we will be unable to obtain these components from other suppliers in the event our principal suppliers are unable or unwilling to supply us. We provide the technical specifications and files needed for our suppliers to manufacture components. We purchase the same components from a wide variety of suppliers.

 

Assembly of Our Proprietary Products

 

After our research and development team designs the technical specifications and computer models for our proprietary products, we typically work with an independent contractor to fabricate working prototypes before we commence with the production run of a product. We test prototypes to confirm that they operate as expected and with the quality we require. During the prototyping process, we apply for CFDA approval as necessary. Once both of these processes are completed, we commission a production run of components for assembly into our proprietary products.

 

We depend on component and product manufacturing and logistical services provided by third parties. All of our proprietary products are manufactured in whole or in part by a variety of third-party manufacturers. While these arrangements may lower operating costs, they also reduce our direct control over production. It is uncertain what effect such diminished control will have on the quality or quantity of products or services, or on our flexibility to respond to changing conditions.

 

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We maintain a 6,146 square foot product center in Changping District in Beijing. This product center contains our research and development area and our assembly facilities. Final assembly of our products is currently performed in this facility by our employees in assembly and by some of our external vendors. Currently, the supply and manufacture of many critical components is performed by sole-sourced third-party vendors in China.

 

Proprietary Rights for Our Proprietary Products

 

We are developing a portfolio of intellectual property rights in China to protect the technologies, inventions and improvements that we believe are significant to our business in China. We have a sum of 25 patents now: 8 design patents related to our CPAP devices (2), Sleep Diagnosis System (4), Compressor (1) and others (1); 5 practical patents related to our CPAP devices (3) and others (2). In addition, we obtained 12 software copyrights for our CPAP devices (5), Sleep Diagnosis System (1), air compressors (1) and other (5). Moreover, we possess proprietary technology and know-how in assembly processes, design and engineering. We have not filed for any patent protection outside of China. To protect our brand name recognition, we have registered the brand name “Dehaier” for trademark protection in China.

 

Our success in the medical equipment industry depends in substantial part on effective management of both intellectual property assets and infringement risks. In particular, we must be able to protect our own intellectual property as well as minimize the risk that any of our proprietary products may infringe upon the intellectual property rights of others.

 

We enter into agreements with all our employees involved in research and development, under which all intellectual property generated during their employment belongs to us, and they waive all relevant rights or claims to such intellectual property. All our employees involved in research and development are also bound by a confidentiality obligation and have agreed to disclose and assign to us all inventions conceived by them during their term of employment.

 

We believe that we have successfully established our brand in China. We have registered trademarks in China for the Dehaier name and logo used on our own-brand products. As part of our overall strategy to protect and enhance the value of our brand, we actively enforce our registered trademarks against any unauthorized use by a third party.

 

Our Distributed Products

 

Our management believes that our distributed products, which are generally more expensive than products from Chinese companies, tend to be more attractive to larger city hospitals and more affluent healthcare facilities and other end-users for whom perceived quality is a significant factor in deciding which products to purchase. While we believe that the quality of our proprietary products is also strong, we understand that some consumers in China associate more well-known international brands with higher quality than they associate with domestically produced brands.

 

We serve as a significant distributor in China for laryngoscopes from Timesco Healthcare Ltd. (“Timesco”). We distribute medical devices and sleep respiratory products for these companies.

 

Medical Devices

   

  Laryngoscopes. We provide three lines of laryngoscopes developed by Timesco: the Optima, Optima XL and Eclipse lines. Laryngoscopes are flexible lighted tubes that are used to look at the inside of the larynx. Anesthesiologists make use of laryngoscopes to assist with intubation in surgery.

 

Our Relationships with Suppliers of Our Distributed Products

 

While we develop, assemble, market and sell our proprietary products, we also serve as the distributor for a number of international companies looking to sell their brands of products in China. We are a distribution agent for some or all products marketed in China by Timesco. In this capacity, we are responsible for sales, marketing and after-sale services of these products.

 

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We sign agency agreements with the international supplier annually with the aim of settling marketing promotion modes, costs, product training and resolution of customer service issues. The agency agreement cover purchasing price, purchasing intervals, order quantity, transportation and type of payment, spare part supply and after-sale service terms. We negotiate renewal of the agency agreement as they expire to confirm ongoing distributor expectations.

 

We seek to enlarge the scope of products we are able to sell as agent for these companies and constantly try to identify competitive suppliers and products on the international market to assist them with marketing and selling their products in China.

 

Principal Suppliers – Our Distributed Products

 

In addition to the products we design, we distribute products designed and manufactured by Timesco Healthcare Ltd. The exact products from this supplier are available only from such supplier; however, we believe that we will be able to obtain similar products from other suppliers in the event our principal supplier is unable or unwilling to supply us.

 

Our Service Centers

 

We maintain a customer service center in Beijing for technical support and repair. We staff our customer service center with senior technical support engineers who provide preliminary support. Our engineers attempt to quickly diagnose and assist in repairing problems over the phone, or determine whether a service visit to the customer’s premises is necessary. In some instances, our engineers will provide on-site operating guidance and repair service. We periodically review customer calls to ensure that any issues raised by our customers are resolved to their satisfaction.

 

Customers

 

We have three categories of customers: (i) distributors, (ii) hospitals, physical examination centers, pension and health management institutions, insurance companies and government agencies and (iii) individual consumers to whom we sell directly. Our customer base is widely dispersed on both a geographic and revenues basis.

 

Our distributors. Sales to our distributors make up the substantial majority of our revenues as over 99% of our sales are to distributors. Based on the expected use of products sold to distributors, for proprietary products, we estimate that they sell approximately 90% of our products to pension and health management institutions, 10% to hospitals; for distributed products, about 100% products are sold to hospitals. We have contractual distribution relationships with approximate 200 independent distributors. We do not own, employ or control these independent distributors.

 

Hospital, physical examination centers, insurance companies and governmental agency customers.  Our hospital and governmental agency customers primarily include hospitals, private physical examination centers, life insurance companies as well as provincial level public health bureaus and population and family planning bureaus. We also refer to these customers as our “Key Accounts.” These customers typically place large volume orders that are awarded based on bids submitted by competing medical equipment companies through a state-owned bidding agent.

 

Individual consumers. We sell our products directly to consumers through our website platform.

 

Dependence on Major Customers. For the years ended December 31, 2016, 2015 and 2014, approximately 94%, 7% and 21% of the Company’s total revenues were received from two customers for continuing operations. For the years ended December 31, 2016, 2015 and 2014, approximately 96%, 61% and 38% of the Company’s total revenues were received from two customers for discontinued operations.

 

Dependence on Major Suppliers. For the years ended December 31, 2016, 2015 and 2014, purchases from three suppliers for continuing operations were approximately 98%, 87% and 68% of the total purchases, respectively. For the years ended December 31, 2016, 2015 and 2014, purchases from three suppliers for discontinued operations were approximately 94%, 83% and 94% of total purchases, respectively.

 

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Competition

 

The medical device industry is characterized by rapid product development, technological advances, intense competition and a strong emphasis on proprietary information. Across all product lines and product tiers, we face direct competition from both domestic and international competitors. We compete based on factors such as price, value, customer support, brand recognition, reputation, and product functionality, reliability and compatibility. Each of our proprietary products competes against functionally similar products from domestic and international companies.

 

Our competitors include publicly traded and privately held multinational companies, such as Phillips Respironics Inc., ResMed Inc., Covidien, Weinmann Medical Technology, Natus Medical Inc. (Embla Sleep Diagnostics), Curative Medical and SOMNO Medics as well as domestic Chinese companies such as Beijing Yi’an, Beijing Shenlu, Guangdong Pigeon, Tianjin Oranger, Beijing Zhonghe Beide Trading Co., Ltd., iCareTech Healthcare Co., Ltd., Contec Medical Systems Co., Ltd. and BMC Medical Co., Ltd. We believe that we can continue to compete successfully in China because our established domestic distribution network and customer support and service network allows us significantly better access to China’s small and medium-sized hospitals. In addition, our strong investment in research and development, coupled with our low-cost operating model, allows us to compete effectively for sales to large hospitals.

 

We believe our competitive position in China varies depending on the product in question. While we are a much smaller company overall than, for example, General Electric, Siemens or Philips and are unable to offer the range or depth of products each of those companies offers, we believe our market position is favorable in several segments. The following charts provide our marketing department’s estimations of our primary competitors by product, both as to our proprietary products and as to our distributed products:

 

Proprietary Product   Primary Competitors in China   Dehaier’s Estimated Competitive Position*
         
DHR280 air compressors   Beijing Yi’an, Beijing Shenlu   Average

 

DHR 998* and diagnosis products   Foreign companies such as Respironics, ResMed, and Covidien   Greater than average
         
Timesco laryngoscope   Kirchner & Wilhelm (GER), Welch Allyn (USA)   Average

 

*A “greater than average” position indicates Lianluo Smart estimates its competitive position in the top third of all competitors. “Average” indicates Lianluo Smart estimates its competitive position in the middle third of all competitors. “Smaller than average” indicates Lianluo Smart estimates its competitive position in the bottom third of all competitors.

 

As we expand into international markets, our competitors will include publicly traded and privately held multinational companies such as Respironics and ResMed. These companies typically focus on the premium segments of the market. We believe we can successfully penetrate certain international markets by offering products of comparable quality at lower prices. We will also face competition in international sales from companies that have local operations in the markets in which we sell our proprietary products. We believe that we can compete successfully with these companies by offering high quality proprietary products at comparable prices.

 

Methods of Competition

 

China’s medical device market currently features a significant number of small distributors. We seek to distinguish our company from our competitors by being able to offer proprietary and distributed products that address the device needs of customers that may have very different needs.

 

For example, China is currently investing heavily in health care nationwide; however, money for healthcare is currently unevenly distributed. There are a number of large hospitals that have significant resources and a number of rural clinics that have extremely limited budgets. We are able to provide distributed products that reach the more affluent customers, as these customers frequently tend to ascribe more perceived value to products made by well-known foreign companies, such as Timesco. We are also able to supply our proprietary products to customers who tend to care less about perceived value and more about functionality.

 

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We currently compete on three levels. First, we have well-established distribution channels and close relations with around 200 dealers and distributors, reaching an estimated 900 hospitals. We maintain relationships with healthcare bureaus as well as other key accounts to actively participate in state-level contracted procurement projects. Second, our proprietary homecare medical products are designed to provide an all-in-one solution for end users. Third, we keep upgrading the service and products to end-users and satisfy market demands. We focus on maintaining a high quality to price ratio in our proprietary products. In addition, being a NASDAQ-listed company has helped to build our brand image and reputation with potential customers and business partners.

 

Seasonality

 

During the period from April to May, we generally experience an increase in revenues associated with our attendance at the China International Medical Equipment Fair, the largest exhibition of medical equipment, related products and services in Asia-Pacific region. This fair occurs in the spring each year. In addition, we generally experience an increase in revenues in the period from September through November. This increase is associated with hospital purchasing designed to extinguish governmental budgets prior to the fiscal year end. And our first quarter performance generally decline as a result of the lack of business conducted during the Chinese Lunar New Year Holiday.

 

Employees

 

As of December 31, 2016, we have 66 full-time employees, of which 14 are employed in assembly; 5 are in research and development; 25 are in general administration; and 22 are in marketing and sales. As required by PRC regulations, we participate in various employee benefit plans that are organized by municipal and provincial governments, including pension, work-related injury benefits, maternity insurance, and medical and unemployment benefit plans. We are required under PRC law to make contributions to the employee benefit plans at specified percentages of the salaries, bonuses, housing funds and certain allowances of our employees, up to a maximum amount specified by the local government from time to time. We make contributions to employee benefits equal to 10% of employee salaries.

 

Generally, we enter into a three-year standard employment contract with all of our officers, managers and other key employees and a one-year standard employment contract with all other employees. According to these employment contracts, all of our employees are prohibited from engaging in any activities that compete with our business during the period of their employment with us.

 

Under Chinese law, we may only terminate employment agreements without cause and without penalty by providing notice of non-renewal one month prior to the date on which the employment agreement is scheduled to expire. If we fail to provide this notice or if we wish to terminate an employment agreement in the absence of cause, then we are obligated to pay the employee one month’s salary for each year we have employed the employee. We are, however, permitted to terminate an employee for cause without penalty to our company, where the employee has committed a crime or the employee’s actions or inactions have resulted in a material adverse effect to us.

 

Regulations

 

Our products are medical devices and are subject to regulatory controls governing medical devices. As a distributor of medical equipment and supplies we are subject to regulation and oversight by different levels of the food and drug administration in China, in particular the CFDA. We are also subject to other PRC government laws and regulations. CFDA requirements include obtaining certifications, permits, compliance with clinical testing standards, assembly practices, quality standards, applicable industry standards and adverse event reporting, and advertising and packaging standards.

 

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China’s Regulation of Medical Devices

 

Classification of Medical Devices

 

In China, medical devices are classified by the CFDA into three different categories, Class I, Class II and Class III, depending on the degree of risk associated with each medical device and the extent of control needed to ensure safety and effectiveness. Classification of a medical device is important because the class to which a medical device is assigned determines, among other things, whether a company needs to obtain a permit and the level of regulatory authority involved in obtaining such permit. Classification of a device also determines the types of registration required and the level of regulatory authority involved in effecting the product registration.

 

Class I devices require product certification and are those with low risk to the human body and are subject to “general controls.” Class I devices are regulated by the city level food and drug administration where the company is located. Class II devices are those with medium risk to the human body and are subject to “special controls.” Class II devices require product certification, usually through a quality system assessment, and are regulated by the provincial level food and drug administration where the company is located. Class III devices are those with high risk to the human body, such as life-sustaining, life-supporting or implantable devices. Class III devices also require product certification and are regulated by the CFDA under the strictest regulatory control.

 

The majority of our products are classified as Class II devices. Our products are either classified as Class II or non- categorized devices.

 

Assembly Permit

 

A company must obtain a permit from the provincial level food and drug administration before commencing the assembly of Class II and Class III medical devices. No assembly permit is required for Class I devices, but the company must notify the provincial level food and drug administration where the company is located and file for record with it. An assembly permit, once obtained, is valid for five years and is renewable upon expiration.

 

We have a single assembly permit, which covers all products we assemble and is scheduled to expire on August 25, 2018. To renew an assembly permit, a company needs to submit to the provincial level food and drug administration an application to renew the permit, along with required information six months before the expiration date of the permit. If we are unable to renew the permit before it expires, we could lose our ability to assemble our medical devices until the situation is rectified.

 

Distribution License

 

A manufacturer or distributor must obtain a distribution license in order to engage in sales and distribution of Class II and Class III medical devices in China. A distribution license is valid for five years and is renewable upon expiration. If we are unable to renew the permit before it expires, we could lose our ability to distribute medical devices until the situation is rectified.

 

Registration Requirement

 

Before a medical device can be manufactured for commercial distribution, a company must complete medical device registration by proving the safety and effectiveness of the medical device to the satisfaction of respective levels of the food and drug administration. In order to conduct a clinical trial on a Class II or Class III medical device, the CFDA requires companies to apply for and obtain in advance a favorable inspection result for the device from an inspection center jointly recognized by the CFDA and the Administration of Quality Supervision, Inspection and Quarantine. The application to the inspection center must be supported by appropriate data, such as animal and laboratory testing results. If the inspection center approves the application for clinical trial, and the respective levels of the food and drug administration approve the institutions that will conduct the clinical trials, the company may begin the clinical trial. A registration application for a Class II or Class III device must provide required pre-clinical and clinical trial data and information about the device and its components regarding, among other things, device design, production and labeling. The provincial level food and drug administration, within 60 days of receiving an application for the registration of a Class II device, and the CFDA, within 90 days of receiving an application for the registration of a Class III device, will notify the applicant whether the application for registration is approved. If approved, a registration certificate will be issued within ten days of written approval. If the food and drug administration requires supplemental information, the approval process may take much longer. The registration is valid for four years.

 

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The CFDA may change its policies, adopt additional regulations, revise existing regulations or tighten enforcement, each of which could block or delay the approval process for a medical device.

 

The following table discloses the current registration expiration dates for the products we sell. It is the obligation of that produces the product to seek registration and any renewals. We are responsible for registering our proprietary products but must rely on the suppliers of other products to seek registration for those products. We will either cease to sell such product or seek comparable products from other suppliers in the event the registration is not renewed on expiration.

 

Medical Devices (Including Related Supporting Products)

 

Product Type   Product Model   Registration Expiration  
         
Ventilator Air Compressor   DHR280 Air Compressor for Ventilators   June 2018
Laryngoscope   Timesco Laryngoscope   April 2020
         

 

Respiratory Products

 

Product Type   Product Model   Registration Expiration
         
Sleep Apnea Treatment Products   CPAP C5   July 2016*
Diagnostic Products   DHR 998   November 2017

 

* We submitted this application for renewal in April 2016 and anticipate receiving the renewed registration in the near future. Currently, CFDA is reviewing our application and may need certain amount of time to approve our renewal. Before we receive the approval from the CFDA, we remain able to sell our CPAP C5 products.

 

Continuing CFDA Regulation

 

We are subject to continuing regulation by the CFDA. In the event of significant modification to an approved medical device, its labeling or its assembly process, a new premarket approval or premarket approval supplement may be required. Our products are subject to, among others, the following regulations:

 

CFDA’s quality system regulations which require companies to create, implement and follow certain design, testing, control, documentation and other quality assurance procedures;

 

medical device reporting regulations, which require that companies report to the CFDA certain types of adverse reaction and other events involving their products; and

 

CFDA’s general prohibition against promoting products for unapproved uses.

 

Class II and III devices may also be subject to special controls applicable to them, such as supply purchase information, performance standards, quality inspection procedures and product testing devices which may not be required for Class I devices. We believe we are in compliance with the applicable CFDA guidelines, but we could be required to change our compliance activities or be subject to other special controls if the CFDA changes or modifies its existing regulations or adopts new requirements.

 

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We are also subject to inspection and market surveillance by the CFDA to determine compliance with regulatory requirements. If the CFDA decides to enforce its regulations and rules, the agency can institute a wide variety of enforcement actions such as:

 

fines, injunctions and civil penalties;

recall or seizure of our products;

the imposition of operating restrictions, partial suspension or complete shutdown of assembly; and

criminal prosecution.

  

Other National and Provincial Level Laws and Regulations in China

 

Beyond those laws and regulations we consider material to our business, we are subject to evolving regulations under many other laws and regulations administered by governmental authorities at the national, provincial and city levels, some of which are, or may be, applicable to our business. Our hospital customers are also subject to a wide variety of laws and regulations that could affect the nature and scope of their relationships with us.

 

Laws regulating the conduct of business in our industry cover a broad array of subjects. We must comply with numerous additional states and local laws relating to matters such as safe working conditions, environmental protection and fire hazard control, which affect all companies doing business in China. We believe we are currently in compliance with these laws and regulations in all material respects. We may be required to incur significant costs to comply with these laws and regulations in the future. Unanticipated changes in existing regulatory requirements or adoption of new requirements could have a material adverse effect on our business, financial condition and results of operations.

 

Restriction on Foreign Ownership

 

The principal regulation governing foreign ownership of medical device businesses in the PRC is the 2015 Foreign Investment Industrial Guidance Catalogue (the “Catalogue”). The Catalogue classifies the various industries into four categories: encouraged, permitted, restricted and prohibited. As confirmed by the government authorities, BDL is engaged in an encouraged industry. Such a designation offers businesses distinct advantages. For example, businesses engaged in encouraged industries:

 

are not subject to restrictions on foreign investment, and, as such, foreign can own a majority in Sino-foreign joint ventures or establish wholly-owned foreign enterprises in the PRC;

 

provided such company has total investment of less than $100 million, the company is subject to regional (not central) government examination and approval which are generally more efficient and less time-consuming; and

 

may import certain equipment while enjoying a tariff and import-stage value-added tax exemption.

 

The National Development and Reform Commission and the Ministry of Commerce periodically jointly revise the Foreign Investment Industrial Guidance Catalogue. As such, there is a possibility that our company’s business may fall outside the scope of the definition of an encouraged industry in the future. Should this occur, we would no longer benefit from such designation.

 

Regulation of Foreign Currency Exchange

 

The principal regulations governing foreign currency exchange in China are the Foreign Exchange Administration Regulations (1996), as amended, and the Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996). Under these regulations, Renminbi are freely convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions, but not for most capital account items, such as direct investment, loan, repatriation of investment and investment in securities outside China, unless the prior approval of SAFE or its local counterparts is obtained. In addition, any loans to an operating subsidiary in China that is a foreign invested enterprise, cannot, in the aggregate, exceed the difference between its respective approved total investment amount and its respective approved registered capital amount. Furthermore, any foreign loan must be registered with SAFE or its local counterparts for the loan to be effective. Any increase in the amount of the total investment and registered capital must be approved by the PRC Ministry of Commerce or its local counterpart. We may not be able to obtain these government approvals or registrations on a timely basis, if at all, which could result in a delay in the process of making these loans.

 

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The dividends paid by the subsidiary to its shareholder are deemed shareholder income and are taxable in China. Pursuant to the Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996), foreign-invested enterprises in China may purchase or remit foreign exchange, subject to a cap approved by SAFE, for settlement of current account transactions without the approval of SAFE. Foreign exchange transactions under the capital account are still subject to limitations and require approvals from, or registration with, SAFE and other relevant PRC governmental authorities.

 

Regulation of Dividend Distribution

 

The principal regulations governing the distribution of dividends by foreign holding companies include the Foreign Investment Enterprise Law (1986), as amended, and the Administrative Rules under the Foreign Investment Enterprise Law (2001).

 

Under these regulations, foreign investment enterprises in China may pay dividends only out of their retained profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, foreign investment enterprises in China are required to allocate at least 10% of their respective retained profits each year, if any, to fund certain reserve funds unless these reserves have reached 50% of the registered capital of the enterprises. These reserves are not distributable as cash dividends.

 

Notice 75

 

On October 21, 2005, SAFE issued Notice 75, which became effective as of November 1, 2005. According to Notice 75, prior registration with the local SAFE branch is required for PRC residents to establish or to control an offshore company for the purposes of financing that offshore company with assets or equity interests in an onshore enterprise located in the PRC. An amendment to registration or filing with the local SAFE branch by such PRC resident is also required for the injection of equity interests or assets of an onshore enterprise in the offshore company or overseas funds raised by such offshore company, or any other material change involving a change in the capital of the offshore company.

 

Moreover, Notice 75 applies retroactively. As a result, PRC residents who have established or acquired control of offshore companies that have made onshore investments in the PRC in the past are required to complete the relevant registration procedures with the local SAFE branch. Under the relevant rules, failure to comply with the registration procedures set forth in Notice 75 may result in restrictions being imposed on the foreign exchange activities of the relevant onshore company, including the increase of its registered capital, the payment of dividends and other distributions to its offshore parent or affiliate and capital inflow from the offshore entity, and may also subject relevant PRC residents to penalties under PRC foreign exchange administration regulations.

 

PRC residents who control our company are required to register with SAFE in connection with their investments in us. Such individuals completed this registration in 2007, and 2008, as amended. If we use our equity interest to purchase the assets or equity interest of a PRC company owned by PRC residents in the future, such PRC residents will be subject to the registration procedures described in Notice 75.

 

Trademark Rights

 

The PRC Trademark Law, adopted in 1982 and revised in 2001, with its implementation rules adopted in 2002, protects registered trademarks. The Trademark Office of the State Administration of Industry and Commerce (“SAIC”), handles trademark registrations and grants trademark registrations for a term of ten years.

 

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Regulations on Offshore Parent Holding Companies’ Direct Investment in and Loans to Their PRC Subsidiaries

 

An offshore company may invest equity in a PRC company, which will become the PRC subsidiary of the offshore holding company after investment. Such equity investment is subject to a series of laws and regulations generally applicable to any foreign-invested enterprise in China, which include the Wholly Foreign Owned Enterprise Law, the Sino-foreign Equity Joint Venture Enterprise Law, the Sino-foreign Contractual Joint Venture Enterprise Law, all as amended from time to time, and their respective implementing rules; the Tentative Provisions on the Foreign Exchange Registration Administration of Foreign-Invested Enterprise; and the Notice on Certain Matters Relating to the Change of Registered Capital of Foreign-Invested Enterprises.

 

 

Under the aforesaid laws and regulations, the increase of the registered capital of a foreign-invested enterprise is subject to the prior approval by the original approval authority of its establishment. In addition, the increase of registered capital and total investment amount shall both be registered with SAIC and SAFE.

 

Shareholder loans made by offshore parent holding companies to their PRC subsidiaries are regarded as foreign debts in China for regulatory purpose, which is subject to a number of PRC laws and regulations, including the PRC Foreign Exchange Administration Regulations, the Interim Measures on Administration on Foreign Debts, the Tentative Provisions on the Statistics Monitoring of Foreign Debts and its implementation rules, and the Administration Rules on the Settlement, Sale and Payment of Foreign Exchange.

 

Under these regulations, the shareholder loans made by offshore parent holding companies to their PRC subsidiaries shall be registered with SAFE. Furthermore, the total amount of foreign debts that can be borrowed by such PRC subsidiaries, including any shareholder loans, shall not exceed the difference between the total investment amount and the registered capital amount of the PRC subsidiaries, both of which are subject to the governmental approval.

 

  C. Organizational structure

 

Lianluo Smart is a BVI company established on July 22, 2003. Lianluo Smart now has 2 wholly-owned subsidiaries in China—Beijing Dehaier Medical Technology Co., Ltd. (“BDL”) and Lianluo Connection Medical Wearable Device Technology (Beijing) Co., Ltd. (“LCL”).

 

D.Property, Plants and Equipment

 

We are headquartered and our principal executive offices are located in Beijing. We assemble and test all our branded products at our 6,146 square foot product facility at the Changping District in Beijing.

 

Office   Address   Rental Term Expiration   Space 
Principal Executive Office   Lianluo Smart Limited   December 31, 2017   6,405 square feet
   

Room 2108, 21st Floor, China Railway Construction Building, No. 20 Shijingshan Road, 100040,

Beijing, China

       
             
             
Product Center   2nd Floor of Lvchuang Environmental Protection Building, No. 28 Zhenxing Road, Changping District, Beijing, China   November 30, 2018   6,146 square feet

 

At our principal executive office, material tangible assets consist of general office equipment. Our product center consists of office buildings, a manufacturing/assembly base, and a warehouse and administration area. In addition, we have assembly and testing machines at the product center. We do not have any current plans to expand our facilities or acquire or build new facilities.

 

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Item 4A.Unresolved Staff Comments

  

Not applicable, as we are not an accelerated filer, large accelerated filer or well-known seasoned issuer.

 

Item 5.Operating and Financial Review and Prospects

  

  A. Operating Results

 

The following discussion of our financial condition and results of operations is based upon and should be read in conjunction with our consolidated financial statements and their related notes included in this annual report. This annual report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. See “Introduction — Forward-Looking Statements.” In evaluating our business, you should carefully consider the information provided under Item 3.D, “Key Information — Risk Factors.” We caution you that our businesses and financial performance are subject to substantial risks and uncertainties.

 

Overview

 

Our Company’s business is divided into two parts: (i) medical devices (including supporting products such as operating room products, ventilators, medical emergency products and medical air compressor products); (ii) mobile medicine (including wearable sleep respiratory solution for Obstructive Sleep Apnea Syndrome (“OSAS”), hospital management and wireless solutions).

 

Our revenues mainly come from medical products and mobile telemedicine. For the years ended December 31, 2016, 2015 and 2014, our total revenues from continuing operations amounted to approximately $13.1 million, $0.74 million and $2.77 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 loss attributable to the Company for the years ended December 31, 2016, 2015 and 2014 was approximately $(10.12) million, $(10.22) million and $(24.30) million, respectively. The increased revenue was mainly due to the new customer Hongyuan which develop Lianluo Smart’s new Internet medical technology business. Under the strategic cooperation agreement, we will leverage Hongyuan’s sales platform to reach Lianluo Smart’s dealers and end users more efficiently, selling our wearable sleep apnea diagnostic system medical devices to Hongyuan for further down chain sale and distribution. The reduction of our net loss attributable to the Company was primarily due to the operation restructure under our Company’s strategic transformation from a traditional medical equipment distributor to a new mobile health products and service provider. The increased gross loss of the wearable sleep apnea diagnostic system medical devices was due to the disposal of inventories which caused an additional cost of $2.45 million since all the disposed inventories have been replaced by new products for the improvement of technology. We closed some traditional product lines with the diminishing profitability and focus on the newly developing market exploration of medical products and service based on technology of mobile internet, including comprehensive sleep respiratory solution for OSAS patients.

 

We discontinued, as appropriate, the unprofitable medical device businesses, including assembly and sales of X-ray machines, anesthesia machines, the first generation ventilator, monitoring devices, general medical products, oxygen therapy, oxygen generator and telemedicine. Only a few profitable businesses such as sales of our patented medical air compressors will continue. Our corporate and business restructuring plan aims to concentrate our Company’s resources to develop our mobile health business, including wearable sleep respiratory business, and to focus more on our major businesses. As a result of the above reclassification of continued and discontinued operations, we restated our operating results for 2014.

 

We believe these changes are crucial to improve our competitive advantages in the industry in the future. By reducing our reliance on our less profitable medical devices assembly and distribution businesses, we are able to leverage our resources to develop smart health products and services, which we see as a positive development and focus for the future of our Company. Our long-term goal is to gradually decrease our production business and focus instead on developing a complete mobile health operation platform.

 

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Although our sleep respiratory business is still in its early stages, we anticipate that it can be a key growth driver for our Company in the foreseeable future.

 

During the year 2016, we have intensified our efforts to launch our wearable solutions and products for OSAS in public hospitals and private physical examination centers throughout China, which has developed our distribution channels. Steady progress has been made for our wearable diagnosis and analysis systems for OSAS in public hospitals and private physical examination centers throughout China.

 

We have continued to establish relationships with pilot hospitals to deliver our wearable solutions and products for OSAS, driving the market growth in the hospitals in the regions where the pilot hospitals located, which helped to push forward our strategic market expansion for public hospitals. So far, wearable diagnosis and analysis systems for OSAS have been successfully delivered to most of major hospitals throughout China. We aim to intensify usage of our system in those hospitals and other institutions where we have already successfully launched. Our target is to gradually promote our business from sleep centers, respiratory departments, and E.N.T. departments to other hospital departments with strong demand for sleep monitoring including those accommodating patients seeking care (inpatient and outpatient) for key chronic diseases, such as hypertension, heart disease, diabetes and strokes. According to the authoritative statistics, there are approximate 16 million patients seeking medication for hypertension, heart disease, diabetes and stroke in 800 3A grade Chinese public hospitals in 2013. Our primary objective is to provide these patients with sleep diagnostic services.

 

We have also targeted the private physical examination centers market. Our wearable OSAS diagnosis and analysis system has been successively launched in Ciming Aoya Hospital and Sonqao’s high-end physical examination center and multiple outpatient departments of Health 100 Group and IKang Healthcare Group in tier 1 cities. The number of customers for sleep diagnostic services has been growing and our products and services have been well appreciated. The above mentioned two private physical examination centers, Health 100 Group and IKang Healthcare Group, have 350 outpatient departments, and the number of customer is up to 11 million annually in the aggregate. We have currently covered most of their outpatient departments in Beijing and Shanghai.

 

In addition, our Company is exploring the feasibility of cooperating with commercial health insurance companies in the development of sleep respiratory solutions. We expect to work with insurance companies to launch health insurance program providing OSAS diagnosis and analysis for their insurances. We will continue to focus on sleep health with our comprehensive OSAS solution system, aiming to become the leading domestic product and service provider in this market.

 

Our revenues for 2016 increased compared to 2015, mainly due to the revenue of sleep respiratory solutions which increased $12 million during the year ended December 31, 2016. However, we still faced a challenging operating environment to open the sleep respiratory market and increase our market share. To ensure that our sleep respiratory products can build up its brand awareness, we reduced our margin to earn customer trust through our new clients which made our gross loss increased further during 2016. In addition, we reported an inventory obsolescence loss of $2.45 million to replace our inventories with outdated technology. Meanwhile, due to redirection of our operations from traditional medical devices business and unprofitable product lines to the research and development of sleep respiratory business as well as the establishment of sales channel, we gradually slowed down our operations at traditional device business which helped us control loss from discontinued operations. Accordingly, net loss attributable to the Company for 2016 decreased compared to 2015. In order to capture market and the strategy of sales promotion, the gross loss of the wearable sleep apnea diagnostic system medical devices was slight, although the revenue extremely increased. The gross loss of 2016 increased $3.38 million compared to 2015, which was mainly due to disposal of inventories of $2.45 million since all the disposed inventories have been replaced by new products for the improvement of technology. Otherwise, estimated useful lives of property and equipment were shortened from 10-15 years for machinery and equipment and 5 years for furniture and office equipment to 3 years for such equipment after July 31, 2016. So the depreciation increased $0.66 million from $0.21 million in 2015 to $0.87 million in 2016. Discontinued operations losses of 2016 decreased $3.4 million compared to 2015 mainly due to the VIE Termination on July 31, 2016 and the discontinued operations ceased during the early 2016. We expect our sleep respiratory business to drive significant growth of our overall revenues in 2017.

 

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   For the years ended December 31, 
   2016   2015   2014 
           (Restated) 
   US$   US$   US$ 
Revenue   13,062,373    738,301    2,774,241 
                
Costs of revenue   (16,627,535)   (927,286)   (1,802,864)
                
Gross profit (loss)   (3,565,162)   (188,985)   971,377 
                
Service incomes   14,587    1,600,012    47,665 
Service expenses   (21,130)   (1,234,257)   (29,022)
General and administrative expenses   (4,643,962)   (4,089,592)   (1,929,206)
Provision for doubtful accounts   150,280    (8,544)   (347,891)
Selling expenses   (1,018,581)   (2,982,447)   (138,981)
Operating loss   (9,083,968)   (6,903,813)   (1,426,058)
                
Net income (loss) from continuing operations   (9,999,642)   (6,698,870)   969,836 
                
Net loss from discontinued operations   (251,153)   (3,663,465)   (26,003,708)
                
Net loss   (10,250,795)   (10,362,335)   (25,033,872)
                
Net loss attributable to Lianluo Smart Limited   (10,121,775)   (10,223,130)   (24,298,114)
                
Comprehensive loss attributable to Lianluo Smart Limited   (10,587,119)   (10,634,213)   (24,847,986)

 

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Factors Affecting Our Results of Operations – Generally

 

We believe the most significant factors that directly or indirectly affect our sales revenues and net incomes are:

 

our ability to position our products in different market segments, including our recent efforts to sell our products to hospitals and other healthcare facilities nationwide;

 

our ability to price our products at levels that provide favorable and acceptable margins amidst increasing pressure from our competitors who also seek better pricing strategy for their own benefit;

 

new products introduced by us as well as our competitors. The introduction of new products by our competitors may lead to a decrease in sales and market share of our products, or force us to sell our products at reduced prices or margins;

 

our ability to carry out our new business initiatives effectively. As we continue to invest heavily in research and development projects and new business lines, including our new entry to the sleep respiratory business, we may have difficulty in carrying out our strategy effectively due to factors that are beyond our control. As a result, we may not be able to achieve our goals or generate favorable financial results from these new business initiatives;

 

our ability to attract and retain distributors and key customers;

 

our ability to retain key employees, including our Chairman and Chief Executive Officer, Mr. Ping Chen, and our ability to build, expand, manage, and train our R&D engineers and sales representatives who we believe to play a vital role in our new business initiatives;

 

our capability of gathering and analyzing market data, such as market capacity, new market trends, market share, and competitive landscape;

 

our ability to establish, promote, and maintain the public relations image of our Company and product brands; and

 

changes in macro-economic environment, both global and domestic, as well as healthcare-related government policies and legislation.

 

For a detailed discussion of some of the factors that may cause our net revenues to fluctuate, see Item 3.D, “Key Information — Risk Factors —Risks Related to Our Business”.

 

Revenues

 

Our total revenues are derived from our medical devices and sleep respiratory business. In 2016, our total revenues from continuing operations increased by 1669%, mainly due to the strategy shift and the revenue of sleep respiratory solutions increased $12 million. Along with the development of our Company’s business strategy transformation, we have redirected our operations from traditional medical devices business and unprofitable product lines to the research and development of sleep respiratory business as well as the establishment of sales channel.

 

We expect to allocate more resources to our sleep respiratory business as we further our restructuring effort. During 2016, revenues from the sleep respiratory business increased as the technology of the sleep respiratory business has been upgraded and optimized. Our management believes that sleep respiratory business will become an important growth driver for the Company in coming years. The Company plans to maintain only a few profitable businesses such as sales of its patented medical air compressors in the future.

 

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Medical Devices (Including Related Supporting Products) – Our Proprietary and Distributed Products

 

We derive revenues in our medical devices product line from the sale of medical ventilators, general hospital products and related supporting products (including laryngoscope) (previously defined as technical service products), medical compressor, sleep respiratory business and wireless medical. We continue to strategically reduce our sales of traditional medical devices, and to fully realize our business focus shift from traditional medical equipment distribution to the market exploration of medical products and service basing on technology of mobile internet, including delivering comprehensive sleep respiratory solution for OSAS patient care management, distributing laryngoscope and other medical products.

 

We discontinued, as appropriate, the unprofitable medical device business, including assembly and sales of C-arm X-ray machines, anesthesia machines, the first generation ventilator, monitoring devices, general medical products, oxygen therapy, oxygen generator and telemedicine. We plan to maintain only a few profitable businesses on sales of our patented products including medical air compressors, the second generation ventilator and cardiopulmonary resuscitation (“CPR”) instruments.

 

Sleep Respiratory Products (Previously known as “Sleep Respiratory and Oxygen Homecare Products”)

 

We derive revenues in our sleep respiratory line from sales of CPAP devices. We anticipate that, on a percentage basis, revenues from sleep respiratory 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 sleep respiratory market in China and internationally through the use of distributors as well as through our direct sales platform. Though we are in the developing stage of sleep respiratory business, we strongly believe in the tremendous growth potential of this business in the coming years. During the past year, the sleep respiratory business has achieved more progress in which we have continued to expand to public hospitals and physical examination centers. In 2016, management focused on introducing more advanced products and penetrating the market for sleep respiratory business. We have broadened and differentiated our target markets by cooperating with different types of medical institutions and individual customers across China. We plan to expand our product portfolio through continued investment in research and development and pursuing attractive opportunities to acquire complementary products and technologies and strategic collaboration with partners. We will continue to pursue sustainable growth by enhancing our capability of delivering the systems to more medical institutions and by promoting application of sleep respiratory systems we delivered. We will also continue to focus on the development of the sleep respiratory systems in private physical examination chains and life insurance companies which we believe to have large quantities of potential customers for sleep diagnosis.

 

Mobile Medicine (Including Internet Medical and Sleep Diagnostic Products)

 

We derive revenues in our internet based medical and sleep diagnostic products and services line from sales of medical consumables used for sleep diagnosis, hospital wireless devices, healthcare management software and offering related services.

 

We continue to devote proactive efforts to develop the wearable OSAS solution systems by marketing and expanding OSAS diagnosis, CPAP products and post-treatment evaluation services in hospitals and private medical examination centers nationwide, leveraging our well-established distribution network resources. Our portable sleep diagnostics devices business recognized 90% of the total revenue for the year 2016.

 

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Operating Costs and Expenses

 

Our operating costs and expenses consist of cost of revenues, general and administrative expenses, provision for doubtful accounts and selling expenses.

 

Our total operating costs and expenses increased both as a percentage of our total revenues and in absolute amount for the year ended December 31, 2016 compared to the same period in 2015 due to the increased related cost of products, investment expenses and selling expenses on research and development of sleep respiratory business. The following table sets forth the components of our costs and expenses both in U.S. dollar amounts (in thousands) and as a percentage of total revenues for the years indicated. 

 

   For the years ended December 31, 
                           Changes   Changes 
   2016   2015   2014   2016 v. 2015   2015 v. 2014 
   (Restated) 
   USD       USD       USD       USD       USD     
   (‘000)   %   (‘000)   %   (‘000)   %   (‘000)   %   (‘000)   % 
Revenues   13,062    100    738    100    2,774    100    12,324    1,670    (2,036)   (73)
                                                   
Cost of revenues   (16,628)   (127)   (927)   (126)   (1,803)   (65)   (15,701)   1694    876    (49)
                                                   
Gross profit (loss)   (3,566)   (27)   (189)   (26)   971    35    (3,377)   1786    (1,106)   (119)
                                                   
Service incomes   15    0    1,600    217    48    2    (1,585)   (99)   1,552    3,233 
Service expenses   (21)   (0)   (1,234)   (167)   (29)   (1)   1,213    (98)   (1,205)   4,155 
General and administrative expenses   (4,644)   (36)   (4,090)   (554)   (1,929)   (70)   (554)   14    (2,161)   112 
Provision for doubtful accounts   150    1    (9)   (1)   (348)   (13)   159    (1,767)   (339)   (97)
Selling expenses   (1,019)   (8)   (2,982)   (404)   (139)   (5)   1,963    (66)   (2,843)   2,045 
Operating income (loss)   (9,085)   (70)   (6,904)   (935)   (1,426)   (51)   (2,181)   32    (5,478)   384 
                                                   
Net income (loss) from continuing operations   (10,000)   (77)   (6,699)   (907)   970    35    (3,301)   49    (7,669)   (791)
                                                   
Net income (loss) from discontinued operations   (251)   (2)   (3,663)   (496)   (26,004)   (937)   3,412    (93)   22,341    (86)
                                                   
Net loss   (10,251)   (78)   (10,362)   (1,404)   (25,034)   (902)   111    (1)   14,672    (59)

 

39 

 

 

Cost of Revenues

 

Cost of revenues primarily includes finished goods, 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 primarily consist of salaries and benefits and related costs for our administrative personnel and management, stock-based compensation and expenses associated with our research and development, registration of patents and intellectual property rights in China and abroad, fees and expenses of our outside advisers, including legal, audit and register expenses, expenses associated with our administrative offices, and the depreciation of equipment used for administrative purposes.

 

We expect our general and administration expenses to increase in the near future as a result of further R&D expenditures and additional personnel costs to maintain the competitive advantage of our mobile health business. In addition, we expect to continue to incur significant general and administrative expenses in capital operation and maintaining investor relationships as a public company.

 

Selling Expenses

 

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, and depreciation expenses related to equipment used for sales and marketing activities.

 

Along with our shifting growth strategies, we believe selling expenses will increase as we strengthen our distribution network, deepen our partnerships with customers and expand market share of our mobile telemedicine business which we believe will generate a significant portion of our revenue stream in the future.

 

Results of Operations

 

We believe that period-to-period comparisons of operating results should not be relied upon as indicative of future performance.

 

Fiscal Year Ended December 31, 2016 Compared to Fiscal Year Ended December 31, 2015

 

Revenues

 

Our total revenues from the continuing operations increased by 1669% from $0.74 million for the fiscal year ended December 31, 2015 to $13.06 million for the fiscal year ended December 31, 2016. The increase of revenues is mainly due to the significantly increased revenue from sleep respiratory solutions in 2016. Along with the development of the Company’s shift in business strategy, we have adjusted the sales strategy of traditional medical devices business, discontinued the unprofitable medical device business, maintained only a few profitable businesses such as sales of its patented products including medical air compressors, the second generation ventilator and cardiopulmonary resuscitation (“CPR”) instruments in the future, and invested more resources in the research and development of sleep respiration business. In 2016, we have distributed our sleep respiratory detection devices and photo plethysmography “PPG” sensors to model public hospitals and private medical centers. We have achieved certain progress in its mobile medicine to increase our brand awareness and expand our market shares in sleep respiration market, which accounted for about 90% of total sales. Although our mobile medicine is still in its early stage, our management believes that our mobile medicine business will become an important growth driver for our Company in the coming years.

 

40 

 

 

Cost of Revenues

 

Our cost of revenues from the continuing operations increased by 1694% from $0.93 million for the fiscal year ended December 31, 2015 to $16.63 million for the fiscal year ended December 31, 2016. The increase in cost of revenues was in line with the increase of revenues. The increasing cost of revenue was also due to the disposal of inventories $2.45 million since all the disposed inventories have been replaced by new products for the improvement of technology in 2016. In addition, our current strategy at developing the sleep respiratory solution market is to rapidly expand our market share and build up our product or brand awareness with major hospitals and clinics in China. Thus, in the short-term period, we may adopt a lower margin policy to boost our sales and distribute our products as many as possible to various medical institutions. Consequently, our cost of revenue increased more than our revenue. However, we believe that upon we can expand our market share in this stage and make our customers consistently use our products, we can further raise our margin in the following and future sales. Before the factory and warehouse of the company moved to new place in the end of 2016, we had cleaned up and disposed slow moving inventories, which were one-time expenses in 2016.

 

Gross Loss

 

Our gross loss from continuing operations decreased from $(0.19) million in 2015 to $(3.57) million in 2016 and gross margin loss decreased from (26%) in 2015 to (27%) in 2016. The deduction was mainly due to the lower sale margin policy at expanding our market share, a loss from the disposal of inventories, and the fixed costs allocated to the remaining production lines became higher.

 

Service Income

 

Our service income decreased from $1.60 million in 2015 to $0.01 million in 2016. Service income represents the income of repair service and technical service. The decrease of the service income was mainly due to the technical service income happened in 2015 and there was no such service income in 2016.

 

Service Expense

 

Our service expense decreased from $1.23 million in 2015 to $0.02 million in 2016. The decrease of the service expense was in line with service income in this period.

 

Operating Expenses

 

Our operating expenses from continuing operations decreased by 22% from $7.08 million for the fiscal year ended December 31, 2015 to $5.51 million for the fiscal year ended December 31, 2016. The decrease of operating expenses was primarily due to the decrease of selling expenses. We analyzed our operating expenses by general and administrative expenses, selling expenses and other expenses in the following parts.

 

Operating Expenses—General and Administrative Expenses

 

Our general and administration expenses from the continuing operations increased by 14% from $4.09 million for the year ended December 31, 2015 to $4.64 million for the year ended December 31, 2016. This increase was mainly due to the increase of investment in research and development activities of sleep respiratory business, the increase of professional service fees and the increase of external consultant fees. We expect our general and administrative expenses to decrease in the near future as a result of the accomplishment of the discontinued operations to maintain the competitive advantage of our respiratory sleep business. 

 

Operating Expenses—Provision for Doubtful Accounts

 

Our provision for doubtful accounts from the continuing operations decreased by 1859% from $8,544 for the year ended December 31, 2015 to $(150,280) for the year ended December 31, 2016. This reversed amount of provision for doubtful accounts was mainly due to that some of our accounts receivable, other receivables and advances to suppliers with aging more than three months, which previously had an allowance for doubtful accounts, have be collected and recovered according to our provision for aging policy for the year ended December 31, 2016.

 

41 

 

 

Operating Expenses—Selling Expenses

 

Our selling expenses from continuing operations decreased by 66% from $2.98 million for the year ended December 31, 2015 to $1.02 million for the year ended December 31, 2016. The decrease in selling expenses was mainly because the Company invested more resource and energy in market development for sleep respiratory business, such as employing more sales staff and attending more medical device exhibitions in 2015 than it did in 2016.

 

Operating Loss

 

As a result of the foregoing, we generated an operating loss of approximately $9.09 million in 2016, compared to operating loss of approximately $6.90 million in 2015. Operating loss increased by 32%, which mainly because of the increased cost of revenue and general and administrative expenses.

 

Change in Fair Value of Warrants Liability

 

For the year ended December 31, 2016, the gain related to changes in the fair value of warrants liability relating to the warrants issued to investors and placement agents was $137,710 before all the warrants had been redeemed, compared to a gain of $390,324 for the year ended December 31, 2015, a decrease of $252,614 from 2015. The gain on the changes in the fair value of warrants liability was due to the change in our stock price and volatility and redemption of warrants which led to a further decrease in the fair value of our warrants liability.

 

Loss from Warrant Redemption

 

On April 21, 2016, we entered warrant repurchase agreements with the holders of warrants to purchase, in the aggregate, 293,880 shares, pursuant to which the company agreed to redeem such warrants for cash payment equal to $3.80 per share underlying the warrants. The company completed the redemption of the warrants on June 2, 2016, and as of the date of this filing, all of such warrants have been cancelled. Accordingly, there was a loss of $1.09 million from warrant redemption.

 

Taxation

 

Our income tax benefit was approximately $95,026 in 2016, compared to approximately $11,978 in 2015. Our income tax benefit increased $83,048 primarily due to the taxable loss in this period.

 

Net Loss from Continuing Operations

 

As a result of the foregoing, we had net loss from continuing operations of approximately $10.00 million in 2016, compared to approximately $6.70 million in 2015.

 

Net Loss from Discontinued Operations

 

We discontinued the unprofitable traditional medical device businesses to concentrate the Company’s resources to develop its mobile health business, including wearable sleep respiratory business, and to focus more on its major businesses. In addition, we deconsolidated BTL as one of our consolidated entities due to the termination of the VIE agreement on July 31, 2016. As a result of this strategic shift and deconsolidation, the relevant results of operations were reported as discontinued operations in our consolidated financial statements and we had net loss from discontinued operations of approximately $0.25 million in 2016, compared to approximately a net loss from discontinued operations of $3.66 million in 2015.

 

Net Loss

 

As a result of the foregoing, we had net loss of approximately $10.25 million in 2016, compared to a net loss of approximately $10.36 million in 2015. After deduction of non-controlling interest in loss, net loss attributable to the Company was approximately $10.12 million and $10.22 million in 2016 and 2015, respectively.

 

42 

 

 

Fiscal Year Ended December 31, 2015 Compared to Fiscal Year Ended December 31, 2014

 

Revenues

 

Our total revenues from the continuing operations decreased by 73% from $2.77 million for the fiscal year ended December 31, 2014 to $0.74 million for the fiscal year ended December 31, 2015. The decrease of revenues is mainly due to the influence of increasingly challenging markets, macroeconomic headwinds, increased competition and market saturation. Along with the development of the Company’s business shifting strategy, we have adjusted the sales strategy of traditional medical devices business, discontinued the unprofitable medical device business, maintained only a few profitable businesses on such as sales of its patented products including medical air compressors, the second generation ventilator and CPR instruments in the future, and invested more resources in the research and development of sleep respiration business. In 2015, we have distributed our sleep respiratory detection device and PPG sensor to model public hospitals and private medical centers. The first product batch is currently in the free testing stage. We have achieved certain progress in its mobile medicine, which accounted for about 10% of total sales. Although our mobile medicine is still in its early stage, our management believes that our mobile medicine business will become an important growth driver for our Company in the coming years.

 

Cost of Revenues

 

Our cost of revenues from the continuing operations decreased by 49% from $1.80 million for the fiscal year ended December 31, 2014 to $0.93 million for the fiscal year ended December 31, 2015. The decrease in cost of revenues was mainly due to the decrease of revenues. The cost of revenue reduction is also due to the gradual reduction on parts of traditional medical device business and uncompetitive product sales due to strategic restructure.

 

Gross Profit (Loss)

 

Our gross profit from the continuing operations decreased from $0.97 million in 2014 to ($0.19) million in 2015 and gross margin decreased from 35% in 2014 to (26%) in 2015. In order to deal with the influence of increasingly challenging markets and new competitors, we shut down some traditional medical device production lines and the fixed costs allocated to the remaining production lines became higher.

 

Service Income

 

Our service income increased from $0.05 million in 2014 to $1.60 million in 2015. The increase of the service income was mainly due to the after-sale repairing income and commission in this period.

 

Service Expense

 

Our service expense increased from $29,022 in 2014 to $1.23 million in 2015. The increase of the service expense was mainly due to the after-sale repairing expense in this period.

 

Operating Expenses

 

Our operating expenses from the continuing operations increased by 193% from $2.41 million for the fiscal year ended December 31, 2014 to $7.08 million for the fiscal year ended December 31, 2015. The increase of operating expenses was primarily due to the increase of general and administrative expenses and selling expenses. We analyzed our operating expenses by general and administrative expenses, selling expenses and other expenses in the following parts.

 

43 

 

 

Operating Expenses—General and Administrative Expenses

 

Our general and administration expenses from the continuing operations increased by 112% from $1.93 million for the fiscal year ended December 31, 2014 to $4.09 million for the fiscal year ended December 31, 2015. This increase was mainly due to the increase of investment on research and development activities of sleep respiratory business, the increase of professional service fees and the increase of external consultant fees. We expect our general and administrative expenses to decrease in the near future as a result of the accomplishment of the discontinued operations to maintain the competitive advantage of our respiratory sleep business.

 

Operating Expenses—Provision for Doubtful Accounts

 

Our provision for doubtful accounts from the continuing operations decreased by 97% from $347,891 for the fiscal year ended December 31, 2014 to $8,544 for the fiscal year ended December 31, 2015. This decrease was mainly due to advance to suppliers with aging more than two years cannot be recovered according to our provision for aging policy for the year ended December 31, 2014.

 

Operating Expenses—Selling Expenses

 

Our selling expenses from continuing operations increased by 2045% from $0.14 million for the fiscal year ended December 31, 2014 to $2.98 million for the fiscal year ended December 31, 2015. The increased in selling expenses was mainly because the Company invested more resource and energy in market development for sleep respiratory business, such as employ more sales staff, attending more medical device exhibitions, etc. Along with the Company’s business shifting strategy, we believe the selling expenses will increase accordingly as we concentrate on market development for sleep respiratory business which will become a major revenue generator of our revenues in the future.

 

Operating Loss

 

As a result of the foregoing, we generated an operating loss of approximately $6.90 million in 2015, compared to operating loss of approximately $1.43 million in 2014. Operating loss increased by 384%, which was mainly because of the reduced revenues, and the increased general and administrative expenses and selling expenses.

 

Change in Fair Value of Warrants Liability

 

For the year ended December 31, 2015, the gain related to changes in the fair value of warrants liability relating to the warrants issued to investors and placement agents was $390,324, compared to a gain of $2,866,171 for the year ended December 31, 2014, a decrease of $2,475,847 from 2014. The gain on the changes in the fair value of warrants liability was due to the decrease in the price of our common stock underlying the warrants issued on February 21, 2014, which decreased from $9.12 on the issuance date to $2.26 on December 31, 2015.

  

Taxation

 

Our income tax benefit (expense) was approximately $11,978 in 2015, compared to approximately ($357,726) in 2014. Our income tax decreased $0.37 million primarily due to the decrease in taxable income in this period.

 

Net Income(Loss) from Continuing Operations

 

As a result of the foregoing, we had net loss from continuing operations of approximately $6.70 million in 2015, compared to approximately a net income from continuing operations of $0.97 million in 2014.

  

Net Loss from Discontinued Operations

 

We discontinued the unprofitable traditional medical device businesses to concentrate the Company’s resources to develop its mobile health business, including wearable sleep respiratory business, and to focus more on its major businesses. As a result of this strategy shifting, we had net loss from discontinued operations of approximately $3.66 million in 2015, compared to approximately a net loss from discontinued operations of $26 million in 2014.

 

Net Loss

 

As a result of the foregoing, we had net loss of approximately $10.36 million in 2015, compared to approximately a net loss of $25.03 million in 2014. After deduction of non-controlling interest in loss, net loss attributable to the Company was approximately $10.22 million and $24.30 million in 2015 and 2014, respectively.

 

44 

 

 

B.Liquidity and Capital Resources

 

Cash Flows and Working Capital

 

As of December 31, 2016, we had $10.79 million in cash and cash equivalents, increased from $615,517 at December 31, 2015. As a result of increased cash flow associated with Lianluo Interactive's purchase of 11,111,111 shares of the company, the cash flows from financing activities in 2016 increased $12.18 million comparing with the same period in 2015. Investments in research and development activities for sleep respiratory business and market development activities resulted in a $2.76 million flow out in cash flow from operating activities. To the extent of the Company’s expansion of new business and products, we may need to rely on a variety of sources of funding, including but not limited to operating cash, and debt and/or equity financing.

 

Operating Activities

 

Net cash used in operating activities was $2,756,711 for the year ended December 31, 2016, compared to $2,344,815 used in operating activities for the same period in 2015. The reasons for this change are mainly as follows:

 

 (i) Net loss from continuing operations was $9,999,642 in 2016, an increase of approximately $3.3 million from net loss of $6,698,870 for the same period of 2015, as a result of the factors described above.
   
(ii)

Stock-based compensation expense incurred $947,481 in 2016, while in 2015, stock-based compensation expense incurred $1,055,744. The decrease was mainly due to the resignation of the employees and the expiration of the options.

 

(iii)

Depreciation and amortization was $1,232,263 in 2016, while in 2015 incurred $525,916. The increase was mainly due to the change of the policy of depreciation and amortization from July 31, 2016 and the increased fixed assets.

 

(iv)

Provision for inventory obsolescence was $2,450,213 in 2016, while in 2015 incurred $16,203. As the improvement of technology, the software of sleep respiration devices has been replaced by new products and the relevant inventories had been reported as impaired.

 

(v)

Loss from warrant redemption was $1,091,719 in 2016 and nil in 2015, since the Company completed the redemption of the warrants on June 2, 2016 and did not redeem any warrants in 2015. As all of such warrants have been redeemed, this expense is not expected to recur.

 

(vi)

Accrued expenses and other current liabilities from continuing operations decreased by $1,315,779 in 2016, compared with an increase of $1,336,906 in 2015. The decrease in 2016 was mainly due to the payments for our research and development expenditures at sleep respiratory business, marketing expenses and other costs accrued our new products.

 

(vii)

Advances to third party suppliers from continuing operations decreased by $352,956 in 2016, compared with a decrease of $1,011,843 in 2015. The decrease was mainly due to more inventory was received in 2016.

 

(viii)

Other receivables from continuing operations decreased by $13,272 in 2016, compared with a decrease of $1,588,626 in 2015. The decrease in 2016 was mainly because of the decrease of contract deposits for large contracts of traditional medical devices business in 2015. No such event happened in 2016.

 

(ix)

Inventories from continuing operations decreased by $1,185,688 in 2016, compared with a decrease of $41,816 in 2015. The change was mainly to the disposal of obsolescent inventories.

 

(x) Net cash used in operating activities from discontinued operations was $146,898 in 2016, compared with the amount of $1,133,122 in 2015. The change was because of our Company’s change in business strategy and the termination of the VIE Agreement on July 31, 2016.

  

Investing Activities

 

Net cash used in investing activities for the year ended December 31, 2016 was $652,467, compared to $27,861 used in investing activities for the same period of 2015. The change in investing activities was mainly attributable to our purchases of sleep respiratory diagnosis and analysis systems and equipment for our sleep respiratory business.

 

Financing Activities

 

We repaid $1,505,000 of short-term bank loans in 2016 without obtaining any new short-term bank loans, as compared to receiving $4,008,975 proceeds from short-term bank loans and repaid $4,810,770 of short-term bank loans in 2015. We repaid $2,843,698 of short-term loans from Mr. Ping Chen, who was the major shareholder of our Company and the CEO, and entered into seven loan agreements with Mr. Ping Chen for an aggregate amount of $718,638 in 2016. We borrowed and repaid $15,050 of short-term loans from BTL in 2016. In 2015, we repaid $1,603,590 of short-term loans from Mr. Ping Chen, who was the major shareholder of our Company and the CEO, and entered into three loan agreements with Mr. Ping Chen for an aggregate amount of $3,867,859. We borrowed and repaid $184,460 of short-term loans from BTL in 2015. We paid $1,116,744 for warrants redemption in 2016. We received proceeds of $18,412,462 from issuance of 11,111,111 common shares to HLI in 2016 and the remaining outstanding subscription receivable balance of $1,492,538 was collected in 2017. The net amount provided by financing activities was $13,675,808 in 2016, compared to $1,498,724 for the same period of 2015.

 

45 

 

 

Contractual Obligations and Commercial Commitments

 

The following table sets forth our contractual obligations as of December 31, 2016:

 

   Payments due by period 
Contractual obligations  Total   Less than 1 year   1-3 years   More than 3 years 
Operating lease obligations  $151,097   $78,833    72,264    - 
Total  $151,097   $78,833    72,264    - 

 

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.

 

Capital Expenditures

 

We made capital expenditures of approximately $0.64 million, $0.03 million and $5.41 million in 2016, 2015 and 2014, respectively, representing 4.87%, 3.72% and 194.88% of our total revenues, respectively. In 2016 and 2015, we distributed our sleep respiratory detection devices and PPG sensors to model public hospitals and private medical centers. In 2014, our capital expenditures were used to purchase machinery for our assembly line and obtain software copyrights.

 

Critical Accounting Policies

 

Basis of Consolidation

 

The consolidated financial statements include the accounts of Lianluo Smart and its wholly-owned subsidiaries (collectively, the “Company”).All 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 Lianluo Smart, BDL and BTL. Before July 31, 2016, BTL’s building was pledged as collateral for BDL’s bank loans. In exchange, BDL loaned money to BTL to finance its operations. BTL’s primary operation is to provide repairs and transportation services to BDL’s customers. In accordance, BDL is the primary beneficiary of BTL, as the entity that was most closely associated with BTL. BTL was considered a variable interest entity of BDL. Upon execution of the VIE Termination on July 31, 2016, BTL was deconsolidated from Lianluo Smart and its subsidiaries. The results of BTL’s operations were reflected in the Company’s consolidated financial statements as discontinued operations.

 

Reclassifications

 

Certain prior year balances were reclassified to conform to the current year's presentation with consideration of reflecting the Company’s traditional medical device business and the operating results of BTL as discontinued operations. None of these reclassifications had an impact on reported financial position or cash flows for any of the periods presented.

 

Use of Estimates

 

The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Estimates are adjusted to reflect actual experience when necessary. Significant accounting estimates reflected in the Company’s consolidated financial statements include revenue recognition, allowance for doubtful accounts, warranty obligation, warrants liability, stock-based compensation and useful lives of intangible assets, and property and equipment. Actual results could differ from those estimates.

 

46 

 

 

Cash and Cash Equivalents

 

Cash and cash equivalents consist of cash on hand and highly liquid investments which are unrestricted as to withdrawal or use, and which have maturities of three months or less when purchased. The Company maintains uninsured cash and cash equivalents with various financial institutions mainly in the PRC and the United States.

 

 

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 generally 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.

 

Other Receivables, net

 

Other receivables primarily include advances to employees and deposits to service providers. Management regularly reviews aging of receivables and changes in payment trends and records a reserve when management believes collection of amounts due are at risk. Accounts considered uncollectible are written off after exhaustive efforts at collection.

 

Advances to Suppliers, net

 

The Company, as is the common practice in the PRC, often makes advance payments to suppliers for unassembled parts. Advances to suppliers are reviewed periodically to determine whether their carrying value has become impaired.

 

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. An increase of the warrants liability due to a change in fair value would decrease net income and earnings per share. A decrease in warrants liability due to a change in fair value would increase net income and earnings per share of the Company.

 

47 

 

Inventories

 

Inventories are stated at the lower of cost or market and consist of assembled and unassembled parts relating to medical devices. The Company reviews its inventory annually for possible obsolete goods and to determine if any reserves are necessary.

 

Property and Equipment

 

Property and equipment are recorded at cost less accumulated depreciation. Depreciation is calculated on a straight-line basis over the following estimated useful lives before July 31, 2016:

 

Leasehold improvements Shorter of the useful lives or the lease term
Building and land use rights 20-40 years
Machinery and equipment 10-15 years
Furniture and office equipment 5 years
Motor vehicles 5 years

 

Depreciation is calculated on a straight-line basis over the following estimated useful lives after July 31, 2016:

 

Leasehold improvements Shorter of the useful lives or the lease term
Building and land use rights 20-40 years
Machinery and equipment 3 years
Furniture and office equipment 3 years
Motor vehicles 5 years

  

Intangible Assets

 

Intangible assets are recorded at cost less accumulated amortization. Amortization is calculated on a straight-line basis over the following estimated useful lives:

 

Leasehold improvements Shorter of the useful lives or the lease term
Software copyrights 20 years
Other software 5 years

 

48 

 

 

Revenue Recognition

 

The Company recognizes revenues when all the followings conditions have been satisfied:

 

·Persuasive evidence of an arrangement exists;
·Delivery and/or installation has occurred (e.g., risks and rewards of ownership has passed);
·The sales price is fixed or determinable; and
·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.

 

Cost of Revenue

 

Cost of revenue primarily includes wages to assemble parts and the costs of unassembled parts, handling charges, impairment loss, and other expenses associated with the assembly and distribution of products.

 

Service Income and Expense

 

Service income and expense represent activities related to repair services provided to the customers by BDL, and the commission fee from customers.

 

Foreign Currency Translation

 

The accounts of Lianluo Smart, BDL, BTL and Breathcare are measured using the currency of the primary economic environment in which the entity operates (the “functional currency”). The accompanying consolidated financial statements are presented in US dollars. Foreign currency transactions are translated into US dollars using fixed exchange rates in effect at the time of the transaction. Generally, foreign exchange gains and losses resulting from the settlement of such transactions are recognized in the consolidated statements of income and comprehensive income. The foreign currency accounts of BDL and BTL are translated in accordance with ASC 830-10, “Foreign Currency Matters”. Assets and liabilities are translated at applicable exchange rates quoted by the People’s Bank of China at the balance sheet dates and revenues and expenses are translated at average exchange rates in effect during the periods. Because cash flows are translated based on the average translating rate, amounts related to assets and liabilities reported on the statement of cash flows will not necessary agree with changes in the corresponding balances on the balance sheets. Equity is translated at the historical rate of exchange at the date of capital contribution. Resulting translation adjustments are recorded as other comprehensive income (loss) and accumulated as a separate component of equity.

 

Termination of the VIE agreements with Beijing Dehaier Technology Limited (“BTL”)

 

In accordance with ASC 810-10-40-4, a parent shall deconsolidate a subsidiary or derecognize a group of assets specified in the preceding paragraph as of the date the parent ceases to have a controlling financial interest in that subsidiary or group of assets.

 

49 

 

 

ASC 810-10-55-4A also states that all of the following are circumstances that result in deconsolidation of a subsidiary under ASC 810-10-40-4:

 

a.A parent sells all or part of its ownership interest in its subsidiary, and as a result, the parent no longer has a controlling financial interest in the subsidiary.
b.The expiration of a contractual agreement that gave control of the subsidiary to the parent.
c.The subsidiary issues shares, which reduces the parent’s ownership interest in the subsidiary so that the parent no longer has a controlling financial interest in the subsidiary.
d.The subsidiary becomes subject to the control of a government, court, administrator, or regulator.

 

As the result, on July 31, 2016, the Company deconsolidated BTL from its consolidated financial statements upon termination of the VIE agreement with BTL.

 

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 had filed its 2008 and 2009 Value Added Tax (“VAT”) returns for some of its customers during the years ended December 31, 2013, 2014 and 2015. All the potential VAT liabilities on these VAT returns occurred in current period were also accrued as incurred and included in the accompanying consolidated financial statements.

 

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Stock-Based Compensation

 

The Company follows the provisions of ASC 718-10, “Compensation-Stock Compensation.” The Company has a share incentive plan which authorizes the issuance of up to 10% of the number of shares outstanding. Pursuant to the plan, the Company may issue options to purchase its common shares to employees and directors of the Company and its affiliates. The Company fair values share-based awards granted under the plan. Accordingly, compensation is measured on the grant date using appropriate valuation models.

 

C.Research and Development

 

Our success to date has in part resulted from our strong research and development capabilities, which allow us to regularly introduce new and more advanced products at competitive prices. Research and development costs from continuing operations were $1,196,161, $1,918,446 and $100,199 for the years ended December 31, 2016, 2015 and 2014, respectively. Research and development costs from the discontinued operations were $0, $580,216 and $515,135 for the years ended December 31, 2016, 2015 and 2014, respectively. Our research and development team consists of 5 engineers, representing 11% of our employees as of December 31, 2016.

 

We are enhancing our research and development ability by cooperating with the research institutes of two top ranking Universities in China: Beijing University of Aeronautics & Astronautics and Beijing University of Technology and Science.

 

The information provided under Item 5.B, "Business Overview" details the Company’s research and development activities.

 

D.Trend Information

 

In 2011, the Chinese Ministry of Science and Technology announced a medical technology development policy under the “12th Five-Year Plan,” proposing to transfer business focus to the development of new drugs, medical equipment and advanced traditional Chinese medicine, and to the development of the emerging industries of biomedicine. The plan focuses on researching and developing the medium and high-level diagnostic and curative medical devices which are in high demand and widely used, actively promoting the development of cost-effective medical devices for use in primary health care institutions, enhancing the stability and reliability of medical services and products and researching and developing supplementary medical equipment which can be easily operated for family and self-healthcare. Under the 12th Five-Year Plan, China will proactively promote the reform of healthcare infrastructure system and offer safe, effective, convenient and low-cost medical services to its residents. As a result, management anticipates growth in the Chinese pharmaceutical market.

 

Current medical device purchases by individuals in China are much lower than they are in Europe and the U.S. It is estimated that 20% of individual expenditures on home medical care in China are for medical devices, compared to 50% of such expenditures in Europe and the U.S. As China’s population continues to age, management expects a rapid increase in demand for medical devices, and, as a result, growth in China’s medical device industry.

 

It is the initial stage of rapid growth of China’s home medical equipment market. As residents’ living standards and consumption structure change, the demand for healthcare services and self-care will substantially increase, creating growth opportunities for participants in the market.

 

In summary, as a vital component of China’s current health system reform, the medical device industry has been incorporated into the national strategic development plan. In 2017, we anticipate new opportunities and combined with favorable government policies, it will position us for continued growth in medical device industry.

 

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In spite of these new opportunities, we believe the landscape in China’s medical device industry is shifting, and we have taken steps to change focus accordingly. We have seen eroding profit margins on our traditional medical device sales, which we believe is due to a combination of increasingly available high technology and more transparent pricing models. As a result, we reduced our reliance on the traditional medical device industry, and shifted our main business to smart medical wearable device, smart device and smart ecosystem platform. We believe these industries are relatively immature in China and believe this status allows significant growth potential in the near term. We are, however, aware that as the market matures, we should expect to see more transparency in pricing and margin erosion as well. 

 

Ministry of Industry and Information Technology of the People’s Republic of China and National Development and Reform Commission jointly issued Specific Project of Smart Device Industry Innovative Development(2016-2018) on September 19, 2016 to support the improvement of Chinese smart technology and supply of advanced product. With the development of "Internet+ Healthcare" and the acceleration of "Healthy China", the medical wearable device industry is hopefully entering a rapid development period.

 

Meanwhile, medical wearable devices are expected to be the most favorable industry in the whole wearable devices market. Nowadays many companies are positively distributing in medical industry through acquisition or release of related medical wearable devices to enlarge their market shares in medical industry. The fast development in medical wearable device industry has drawn great attention. Many leading companies and medium and small sized innovative companies, entrepreneurs and investors are entering medical wearable device industry. According to statistics, the scale of Chinese medical wearable device market has grown from more than $300 million(RMB 2.2 billion) in 2014 to about $3.3 billion(RMB 22.8 billion) in 2016, and it is estimated that the scale would reach $4.3 billion(RMB 30 billion) in 2017.

 

After rapid growth in 2015, the smart device market kept increasing in 2016. The scale of the market broke $7.9 billion(RMB 55.2 billion) in 2016 from $6 billion(RMB 42.4 billion) in 2015, and is estimated to reach $10.2 billion(RMB 71.6 billion) in 2017.

 

From the industry level, the scale of the smart device market is still rapidly growing, and large companies will continue to extend their smart ecosystem. Benefitting from the maturation of the platform, medium and small sized companies will be more concentrated on products.

 

From product level, optimization of connection and interactive mode is the key point of smart device growth. Smart home will continuously be the hotspot of growth. User engagement with smart products is closely related to its practicability. Simple and multiple interactive modes are able to meet users' demands more efficiently.

 

The ultimate value of smart product is to serve users. To integrate advantages of other industries and join smart devices up with more third-party service is the key point of service expansion. With cooperation with traditional enterprises, smart device will rapidly reach out to customers from concept, and bring smart life to people. With the molding of platform and ecosystem, and the birth of new technologies, e.g. virtual reality, the life style of more users will change, and the time of smart life will come.

 

E.Off-Balance Sheet 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.

 

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F.Tabular Disclosure of Contractual Obligations

 

The following table sets forth our contractual obligations as of December 31, 2016:

 

   Payments Due By Period 
   Less than   More than 
   Total   1 Year   1-3 Years   3-5 Years   5 Years 
                     
Operating Lease Obligations  $151,097   $78,833   $72,264   $-   $- 
Total  $151,097   $78,833   $72,264   $-   $- 

  

Item 6.Directors, Senior Management and Employees

 

  A. Directors and Senior Management

 

The following table sets forth our executive officers and directors, their ages and the positions held by them:

 

Name   Age   Position Held
Zhitao He   35   Chairman and Director
Ping Chen(1)(2)   54   Chief Executive Officer and Director
Hui Zhou(1)(3)   34   Chief Financial Officer
Richard Zhiqiang Chang(1)(3)(4)(5)(6)   54   Independent Director
Bin Pan(1)(4)(5)(6)(7)   44   Independent Director
Mingwei Zhang(1)(4)(5)(6)(7)6)(7)   64   Independent Director

 

  (1) The individual’s business address is Room 2108, 21th Floor, China Railway Construction Building, No. 20 Shijingshan Road, 100040, Beijing, China.
  (2) Class III director whose term expires in 2019.
  (3) Class II director whose term expires in 2018.
  (4) Member of audit committee.
  (5) Member of compensation committee.
  (6) Member of nominating committee.
  (7) Class I director whose term expires in 2017.

 

Zhitao He. Mr. He has served as the Company chairman and director since October 2016. Mr. Zhitao He is also the Chairman of the Board of Lianluo Interactive, a China-listed company. Mr. Zhitao He successfully led Lianluo Interactive to list on China’s A share market (ticker: 002280). Mr. Zhitao He was named one of the "10 Top Entrepreneurs of Post-1980s" by Hurun Report and "Top Ten Entrepreneurial Leader of Listed Companies" by Securities Times. In the past two years, under his leadership, Lianluo Interactive has moved into the field of smart hardware, including the purchase of leading American electronics online retailer Newegg(http://www.newegg.com), investments in American virtual reality ("VR") device manufacturer Avegant(www.avegant.com) and hardware corporation Razer(http://www.razerzone.com), and promotion of the world's biggest VR Operating System OSVR in China together with Razer. This investment plan has allowed Lianluo Interactive to become a closed loop of "Software and Hardware + Platform + Channels".

 

Ping Chen. Mr. Chen has served as a director of our Company since 2003 and our Chief Executive Officer since 2000. Prior to his service as our Chief Executive Officer, from 1993 to 2000, Mr. Chen served as the CEO of Beijing Chengcheng Medical Electronic Equipment Co. Prior to 1993, Mr. Chen served as an engineer at the No. 2 Academy, Ministry of Aeronautics and Astronautics from 1987 to 1991 and moved up to the Head of the Civilian Products Division there from 1991 to 1993. Mr. Chen founded BTL in 2001 and has served as CEO since that time. Mr. Chen received his bachelor’s degree in 1984 from the National University of Defense Technology and his master’s degree in 1987 from the Ministry of Aeronautics and Astronautics. Mr. Chen has been chosen as a director because he is our CEO, the leader of our Company and a key experienced member of management.

 

Hui (Cherry) Zhou. Ms. Zhou has served as our Chief Financial Officer since October 2016. Ms. Zhou possesses 9 years ’audit experience in big 4 accounting firm and 8 months’ accounting manager experience. Skilled in financial reporting, analysis and internal control audit, Ms. Zhou is familiar with PRC GAAP, US GAAP and IFRS. Ms. Zhou has participated in a few of large scale domestic listed companies, MNC’s annual audit, H share IPO audit and NASDAQ engagements, etc. Ms. Zhou possesses high sense of responsibility, good communication skills, team spirit and team management capacity. She got Intermediate accountant certificate, CPA qualification and the qualification of securities. Ms. Zhou earned a Bachelor degree in ZhongNan University of Economics and Law in Accounting in June 2005. Ms. Zhou has been chosen to serve as the company CFO because of her professional in financial matters and her seasoned experience in operations.

 

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Richard Zhiqiang Chang. Mr. Richard Chang has been CEO of Beijing Zhineng Technology Co., Ltd. in Beijing China since October 2015. Prior to that position, he served as a Key Account Manager and Business VP at AREVA Inc. in Beijing, China from 2013 through October 2015 and Chief Representative and Regional VP at Ventyx Inc. in Atlanta, Georgia from July 2009 to July 2013. Mr. Chang earned a master’s degree in computer science in 1997 from the University of Texas as Dallas, a master’s degree in automation in 1990 from Shanghai Jiaotong University and a bachelor’s degree in automation in 1985 from the same school.

 

Bin Pan. Mr. Pan has served as a company independent director since October, 2016. Mr. Bin Pan is the Chairman of Shanghai Hubo Investment Management Co., Ltd. He is also the independent director of Hangzhou Lianluo Interactive Information Technology Co. Ltd., Shanghai Yaoji Playing Card Co., Ltd, Shenzhen Prolto Supply Chain Management Co., Ltd and Shanghai Zhixin Electric Co., Ltd. Mr. Pan is a partner in Shanghai Capital Law & Partners law firm since June 2004. He used to be the vice-president at the investment banking division of China Southern Securities Co., Ltd. from March 1997 to June 2004. Mr. Pan earned his master’s degree in International Economic Law from Shanghai University of International Business and Economics in 1997 and his bachelor’s degree in 1994 from Huazhong University of Science and Technology University.

 

Mingwei Zhang. Mr. Zhang has served as an independent director of our company since 2012. Mr. Zhang has extensive knowledge and experience in accounting from the perspective as an academic and a practicing accountant. From September 2007 to October 2013, Mr. Zhang served as Chief Financial Officer and a Director of Sino-Global Shipping America, Ltd. (Nasdaq CM: SINO). From May 2001 until December 2007, Mr. Zhang was a partner in Baker Tilly China, an international public accounting firm. From July 1994 to June 2003, he served as a Lecturer at Monash University in Australia. Mr. Zhang received a Bachelor’s degree and a Master’s degree in Accounting from Tianjin University of Finance and Economics. He also received a Master’s degree in Commerce from the University of Newcastle. Mr. Zhang is a Certified Management Accountant in Australia. Mr. Zhang has been chosen as a director because of his financial experience.

 

B.Compensation

 

Executive Compensation

 

The following table shows the annual compensation paid by us for the year ended December 31, 2016 to Ping Chen, our principal executive officer, and Hui Zhou, our principal financial officer.

 

Summary Executive Compensation Table

 

Name and principal position  Salary   Bonus   Option 
Awards
   All Other 
Compensation
   Total
Ping Chen,
Principal Executive Officer
  $24,292   $1,143   $396,430(1)(2)(3)(4)(5)  $-   $421,865
Hui (Cherry) Zhou
Chief Financial Officer
  $3,612   $-   $-   $-   $3,612

 

(1)On December 29, 2011, 150,000 share options were awarded to Mr. Chen, which vest over a period of five years. The expiration date of the options is December 29, 2021. The options’ exercise price is the market price of our shares on December 29, 2011, the date the options were granted. The grant date fair value of the options is $1.222 per underlying share. These options granted in 2011 are not reflected in the Summary Executive Compensation Table. We have amortized $36,460 of such grant in the year ended December 31, 2016.

 

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(2)On October 7, 2013, 94,000 share options were awarded to Mr. Chen, which vest over a period of five years. The expiration date of the options is October 7, 2023. The options’ exercise price is the market price of our shares on October 7, 2013, the date the options were granted. The grant date fair value of the options was $2.23 per underlying share. These options granted in 2013 are not reflected in the Summary Executive Compensation Table. We have amortized $42,030 of such grant in the year ended December 31, 2016.

 

(3)On August 20, 2014, 131,000 share options were awarded to Mr. Chen, which vest over a period of five years. The expiration date of the options is August 20, 2024. The options’ exercise price is the market price of our shares on August 20, 2014, the date the options were granted. The grant date fair value of the options was $5.15 per underlying share. These options granted in 2014 are not reflected in the Summary Executive Compensation Table. We have amortized $135,284 of such grant in the year ended December 31, 2016.

 

(4)On July 30, 2015, 348,800 ordinary shares were issued to Mr. Chen. The grant date fair value of the ordinary shares was $1.96 per share. We have amortized $333,104 of such grant in the year ended December 31, 2016.

 

(5)On March 21, 2016, 210,867 share options were awarded to Mr. Chen, which vest over a period of two years. The expiration date of the options is March 21, 2026. The options’ exercise price is the market price of our shares on August 20, 2014, the date the options were granted. The grant date fair value of the options was $1.88 per underlying share and is reflected in the Summary Executive Compensation Table, even though not all options have vested. We have amortized $197,175 of such grant in the year ended December 31, 2016.

 

Director Compensation

 

All directors hold office until the next annual meeting of shareholders at which their respective class of directors is re-elected or until their successors have been duly elected and qualified. There are no family relationships among our directors or executive officers. Officers are elected by and serve at the discretion of the Board of Directors. We do not separately set aside any amounts for pensions, retirement or other benefits for our executive officers, other than pursuant to relevant statutory requirements. Employee directors do not receive any compensation for their services as directors. Non-employee directors are entitled to receive payment for serving as directors and may receive option grants from our company. For service on our Board of Directors, Mr. Zhang receives $4,000 per year, and Mr. Richard Zhiqiang Chang and Mr. Bin Pan receive $8,000 annually. The following table shows the annual compensation paid by us for the year ended December 31, 2016 to our directors.

 

 

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Summary Director Compensation Table

 

 

 

Name  Fees earned or
paid in cash
   Stock-based
Compensation
   Total(1) 
Zhitao He(2)  $0   $0   $0 
Ping Chen(3)  $N/A   $N/A   $N/A 
Huili (Alisa) Li(3)(4)  N/A   $N/A   N/A 
Xiaoguang Shen(5)  $0   $18,650   $18,650 
Genhui Chen(6)  $6,000   $37,300   $43,300 
Mingwei Zhang(7)  $8,000   $55,951   $63,951 
Bin Pan(2)  $0   $0   $0 
Richard Zhiqiang Chang(2)  $0   $0   $0 

 

(1) During 2016, 5 directors received options from the 2014 Incentive Plan-Mr. Ping Chen received 210,867 options; Mr. Mingwei Zhang received 20,000 options; Mr. Xiaoguang Shen received 10,000 options; Mr. Genhui Chen received 20,000 options; Ms. Huili(Alisa) Li received 30,000 options.
(2) Mr. Zhitao He, Mr. Bin Pan and Mr. Richard Zhiqiang Chang are newly elected directors of the Board and come into effect from October 24, 2016.
(3) Mr. Ping Chen and Ms. Huili (Alisa) Li received compensation in their capacity as officers of our company and/or subsidiaries/affiliates but did not receive any compensation for serving as directors of our company.
(4) Ms. Huili (Alisa) Li has resigned the Company CFO on October 24, 2016 and her granted options expired on January 23, 2017. We have amortized $44,396 of such amount in the year ended December 31, 2016
(5) Mr. Xiaoguang Shen resigned as a director on October 24, 2016 and his granted options expired on January 23, 2017. We have amortized $17,523 of such amount in the year ended December 31, 2016.
(6) Mr. Genhui Chen resigned as a director on October 24, 2016 and his granted options expired on January 23, 2017. We have amortized $37,962 of such amount in the year ended December 31, 2016
(7) Mr. Mingwei Zhang received 11,975 common shares on June 16, 2014 from the company pursuant to the director compensation plan. We have amortized $0 of such amount in the year ended December 31, 2016. Mr. Mingwei Zhang received a grant of options to purchase 20,000 shares from the company on August 7, 2015, of which 50% has vested as of December 31, 2016. The expiration date of the options is August 7, 2025. The options’ exercise price is the market price of our shares on the date the options were granted. The grant date fair value of the options was $1.63 per underlying share. We have amortized $16,344 of such amount in the year ended December 31, 2016. Mr. Mingwei Zhang received a grant of options to purchase 20,000 shares from the company on March 21, 2016, of which 0% has vested as of December 31, 2016. The expiration date of the options is August 7, 2026. The options’ exercise price is the market price of our shares on the date the options were granted. The grant date fair value of the options was $1.87 per underlying share. We have amortized $28,052 of such amount in the year ended December 31, 2016.

  

C.Board Practices

 

See information provided in response to Item 6.A. above as to the current directors and officers and the expiration of current director terms. In addition, the service agreements between us and the directors do not provide benefits upon termination of their services.

 

Board of Directors and Board Committees

 

Our board of directors currently consists of 5 directors. There are no family relationships between any of our executive officers and directors. The directors are divided into three classes. Class I directors shall face re-election at our annual general meeting of shareholders in 2017 and every three years thereafter. Class II directors shall face re-election at our annual general meeting of shareholders in 2018 and every three years thereafter. Class III directors shall face re-election at our annual general meeting of shareholders in 2019 and every three years thereafter.

 

A director may vote in respect of any contract or transaction in which he is interested, provided, however that the nature of the interest of any director in any such contract or transaction shall be disclosed by him at or prior to its consideration and any vote on that matter. A general notice or disclosure to the directors or otherwise contained in the minutes of a meeting or a written resolution of the directors or any committee thereof of the nature of a director’s interest shall be sufficient disclosure and after such general notice it shall not be necessary to give special notice relating to any particular transaction. A director may be counted for a quorum upon a motion in respect of any contract or arrangement which he shall make with our company, or in which he is so interested and may vote on such motion. There are no membership qualifications for directors. Further, there are no share ownership qualifications for directors unless so fixed by us in a general meeting.

 

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The Board of Directors maintains a majority of independent directors who are deemed to be independent under the definition of independence provided by NASDAQ Stock Market Rule 4200(a)(15). Mr. Chang, Mr. Zhang and Mr. Pan are our independent directors.

 

We do not have a lead independent director because of the foregoing reason and also because we believe our independent directors are encouraged to freely voice their opinions on a relatively small company board. We believe this leadership structure is appropriate because we are a smaller reporting company.

 

Board Committees

 

Currently, three committees have been established under the board: the audit committee, the compensation committee and the nominating committee. The audit committee is responsible for overseeing the accounting and financial reporting processes of our company and audits of the financial statements of our company, including the appointment, compensation and oversight of the work of our independent auditors. The compensation committee of the board of directors reviews and makes recommendations to the board regarding our compensation policies for our officers and all forms of compensation, and also administers our incentive compensation plans and equity-based plans (but our board retains the authority to interpret those plans). The nominating committee of the board of directors is responsible for the assessment of the performance of the board, considering and making recommendations to the board with respect to the nominations or elections of directors and other governance issues. The nominating committee considers diversity of opinion and experience when nominating directors.

 

Duties of Directors

 

Under British Virgin Islands law, our directors have a duty to act honestly, in good faith and with a view to our best interests. Our directors also have a duty to exercise the care, diligence and skills that a reasonably prudent person would exercise in comparable circumstances. In fulfilling their duty of care to us, our directors must ensure compliance with our third amended and restated memorandum and articles of association. We have the right to seek damages if a duty owed by our directors is breached. The functions and powers of our board of directors include, among others:

 

appointing officers and determining the term of office of the officers;

 

authorizing the payment of donations to religious, charitable, public or other bodies, clubs, funds or associations as deemed advisable;

 

exercising the borrowing powers of the company and mortgaging the property of the company;

 

executing checks, promissory notes and other negotiable instruments on behalf of the company; and

 

maintaining or registering a register of mortgages, charges or other encumbrances of the company.

 

Limitation of Director and Officer Liability

 

British Virgin Islands law does not limit the extent to which a company’s memorandum and articles of association may provide for indemnification of officers and directors, except to the extent any such provision may be held by the British Virgin Islands courts to be contrary to public policy, such as to provide indemnification against civil fraud or the consequences of committing a crime.

 

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Under our third amended and restated memorandum and articles of association, we may indemnify our directors, officers and liquidators against all expenses, including legal fees, and against all judgments, fines and amounts paid in settlement and reasonably incurred in connection with civil, criminal, administrative or investigative proceedings to which they are party or are threatened to be made a party by reason of their acting as our director, officer or liquidator. To be entitled to indemnification, these persons must have acted honestly and in good faith with a view to the best interest of the company and, in the case of criminal proceedings, they must have had no reasonable cause to believe their conduct was unlawful.

 

Insofar as indemnification for liabilities arising under the Securities Act may be permitted for our directors or officers under the foregoing provisions, we have been informed that in the opinion of the SEC, such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable as a matter of United States law.

 

Involvement in Certain Legal Proceedings

 

To the best of our knowledge, none of our directors or executive officers has been convicted in a criminal proceeding, excluding traffic violations or similar misdemeanors, or has been a party to any judicial or administrative proceeding during the past ten years that resulted in a judgment, decree or final order enjoining the person from future violations of, or prohibiting activities subject to, federal or state securities laws, or a finding of any violation of federal or state securities or commodities laws, any laws respecting financial institutions or insurance companies, any law or regulation prohibiting mail or wire fraud in connection with any business entity or been subject to any disciplinary sanctions or orders imposed by a stock, commodities or derivatives exchange or other self-regulatory organization, except for matters that were dismissed without sanction or settlement.

 

There are no other arrangements or understandings pursuant to which our directors are selected or nominated.

 

There are no family relationships among any of the persons named above, and there are no arrangements or understandings with major shareholders, customers, suppliers or others, pursuant to which any such person was selected as a director or member of senior management.

 

  D. Employees

 

As of December 31, 2016, we had 66 employees, all of whom were full-time employees and were based in China. We believe that our relations with our employees are good. We have never had a work stoppage, and our employees are not subject to a collective bargaining agreement. As of December 31, 2016, 2015 and 2014, we had 66, 89 and 107 employees, respectively.

 

       December 31,     
   2014   2015   2016 
             
Total   107    89    66 
Mid and high level Manager   29    26    25 
Sales   50    46    22 
R&D and Customization   9    7    5 
Assembly and Procurement   19    10    14 

 

  E. Share ownership

 

The following table sets forth information with respect to beneficial ownership of our common shares as of April 28, 2017 by:

 

Each of our directors and named executive officers; and

All directors and named executive officers as a group.

 

The number and percentage of common shares beneficially owned are based on 17,312,586 common shares outstanding as of April 28, 2017. Information with respect to beneficial ownership has been furnished by each director and officer. Beneficial ownership is determined in accordance with the rules of the SEC and generally requires that such person have voting or investment power with respect to securities. In computing the number of common shares beneficially owned by a person listed below and the percentage ownership of such person, common shares underlying options, warrants or convertible securities held by each such person that are exercisable or convertible within 60 days of April 28, 2017 are deemed outstanding, but are not deemed outstanding for computing the percentage ownership of any other person. Except as otherwise indicated in the footnotes to this table, or as required by applicable community property laws, all persons listed have sole voting and investment power for all common shares shown as beneficially owned by them. Unless otherwise indicated in the footnotes, the address for each principal shareholder is in the care of BDL, Room 2108, 21st Floor, China Railway Construction Building, No. 20 Shijingshan Road, 100040, Beijing, China.

 

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Named Executive Officers and Directors 

Amount of 
Beneficial

Ownership(1)

   Percentage 
Ownership(2)
 
Ping Chen, CEO, Director   1,812,342(3)   9.32%
           
Genhui Chen   8,000(4)   * 
Mingwei Zhang   21,975(5)   * 
Xiaoguang Shen   0(6)   * 
Huili (Alisa) Li   0(7)   * 
           
All officers and directors as a group   1,834,317    9.39%
Chen Ping Ltd.   1,812,342    9.32%
Hangzhou Lianluo Interactive Information Technology Co., Ltd.   12,111,111    64.18%

 

*Less than 1%.

 

(1)Beneficial ownership is determined in accordance with the rules of the SEC and includes voting or investment power with respect to the common shares.

 

(2)We have used 17,312,586 outstanding shares for all calculations in this table and have not increased the number of shares outstanding to account for such shares underlying such securities in calculating percentage ownership.

 

(3)Represents (a) 1,104,742 shares owned by Chen Ping Ltd.; (b) vested options to purchase 90,000 shares for an exercise price of $1.45 per share that were granted on December 29, 2011; (c) vested options to purchase 56,400 shares for an exercise price of $2.30 per share that were granted on October 7, 2013; (d) vested options to purchase 52,400 shares for an exercise price of $5.31 per share that were granted on August 20, 2014; (e) 100,000 shares issued on August 20, 2014; and (f) 348,800 shares granted on December 3, 2015 that are subject to full or partial forfeiture in the event Mr. Chen does not remain an officer or director of our Company for two years after the date of grant. (g) 60,000 options that have been transferred into common shares for an exercise price of $1.45 per share that were granted on December 29, 2011. These numbers do not include (i) unvested options to purchase 37,600 shares for an exercise price of $2.30 per share that were granted on October 7, 2013; (ii) unvested options to purchase 78,600 shares for an exercise price of $5.31 per share that were granted on August 20, 2014; or (iii) unvested options to purchase 210,867 shares for an exercise price of $1.88 per share that were granted on March 21, 2016.

 

(4)Represents (a) vested options to purchase 8,000 shares for an exercise price of $1.45 per share that were granted on December 29, 2011 and (b) not include vested options to purchase 12,000 shares for an exercise price of $1.45 per share that were granted on December 29, 2011 and vested options to purchase 10,000 shares for an exercise price of $1.64 per share that were granted on August 7, 2015 which have been invalid since his resignation in October 2016.

 

(5)Represents (a) 11,975 shares issued on June 16, 2014 and (b) vested options to purchase 10,000 shares for an exercise price of $1.64 per share that were granted on August 7, 2015. These numbers do not include (i) unvested options to purchase 10,000 shares for an exercise price of $1.64 per share that were granted on August 7, 2015; and (ii) unvested options to purchase 20,000 shares for an exercise price of $1.88 per share that were granted on March 21, 2016.

 

(6)Represents (a) Vested options to purchase 5,000 shares for an exercise price of $1.64 per share that were granted on August 7, 2015 and (b) unvested options to purchase 5,000 shares for an exercise price of $1.64 per share that were granted on August 7, 2015; and (c) unvested options to purchase 10,000 shares for an exercise price of $1.88 per share that were granted on March 21, 2016 have all been invalid since his resignation in October 2016.

 

(7)Represents (a) Vested options to purchase 10,000 shares for an exercise price of $1.64 per share that were granted on August 7, 2015. (b) unvested options to purchase 10,000 shares for an exercise price of $1.64 per share that were granted on August 7, 2015; and (c) unvested options to purchase 30,000 shares for an exercise price of $1.88 per share that were granted on March 21, 2016 have all been invalid since her resignation in October 2016.

 

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Share Option Plan and Grants

 

In 2009, in connection with our initial public offering, we established a pool for share options for our employees (the “2009 Share Incentive Plan”). This pool contains options to purchase up to 450,000 of our common shares. The options will vest at a rate of 20% per year for five years and have an exercise price of the market price of our shares on the date the options are granted. As of the date of this report, we have issued all 450,000 options pursuant to our 2009 Share Incentive Plan.

 

In 2013, we established our 2013 Share Incentive Plan. This pool allows us to issue options, common shares and other securities exercisable or convertible into, in the aggregate, 462,000 of our common shares. As of the date of this report, we have issued 113,200 options pursuant to our 2013 Share Incentive Plan.

 

In 2014, we established our 2014 Share Incentive Plan. This pool allows us to issue options, common shares and other securities exercisable or convertible into, in the aggregate, 466,800 of our common shares. As of the date of this report, we have issued 366,800 options pursuant to our 2014 Share Incentive Plan.

 

In 2015, we established our 2015 Share Incentive Plan. This pool allows us to issue options, common shares and other securities exercisable or convertible into, in the aggregate, 580,867 of our common shares. As of the date of this report, we have issued 580,867 options pursuant to our 2015 Share Incentive Plan.

 

Item 7.Major Shareholder and Related Party Transactions

  

  A. Major shareholders

 

The following table sets forth information with respect to beneficial ownership of our common shares as of April 28, 2017 by each person who is known by us to beneficially own 5% or more of our outstanding common shares. The number and percentage of common shares beneficially owned are based on 17,312,586 common shares outstanding as of April 28, 2017. Information with respect to beneficial ownership has been furnished by each director, officer or beneficial owner of 5% or more of our common shares. Beneficial ownership is determined in accordance with the rules of the SEC and generally requires that such person have voting or investment power with respect to securities. In computing the number of common shares beneficially owned by a person listed below and the percentage ownership of such person, common shares underlying options, warrants or convertible securities held by each such person that are exercisable or convertible within 60 days of April 28, 2017 are deemed outstanding, but are not deemed outstanding for computing the percentage ownership of any other person. Except as otherwise indicated in the footnotes to this table, or as required by applicable community property laws, all persons listed have sole voting and investment power for all common shares shown as beneficially owned by them. Unless otherwise indicated in the footnotes, the address for each principal shareholder is in the care of BDL, Room 2108, 21st Floor, China Railway Construction Building, No. 20 Shijingshan Road, 100040, Beijing, China. During the past three years, our major shareholder, Ping Chen, has increased his shares of stock in the company by way of incentive grants of stock and options, and we have sold 11,111,111 shares to Hangzhou Lianluo Interactive Information Technology Co., Ltd. None of the major shareholders have special voting rights.

 

Shareholder  Amount of Beneficial Ownership(1)   Percentage Ownership(2) 
         
Chen Ping Ltd.   1,812,342(3)   9.32%
Hangzhou Lianluo Interactive Information Technology Co., Ltd.   11,111,111    64.18%

 

  (1) Beneficial ownership is determined in accordance with the rules of the SEC and includes voting or investment power with respect to the common shares.

 

  (2) The number of our common shares outstanding used in calculating the percentage for each listed person excludes the common shares underlying options held by such person.

 

  (3) Ping Chen has the sole power to direct the voting and disposition of the 1,613,542 shares held by Chen Ping Ltd. The number also includes 198,800 shares underlying options, which will have vested within 60 days hereof. The shares reflected for Chen Ping Ltd. include only shares held by such company and do not include shares underlying options or shares held by Ping Chen directly.

 

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As of April 28, 2017, we had five shareholders of record, all of which were located outside of the United States and held an aggregate of 17,312,586 of our common shares, representing 100% of our outstanding common shares, and one of which was located in the United States and held an aggregate of 25.44% of our common shares of our outstanding common shares. However, this U.S. shareholder of record is CEDE & CO., a nominee of The Depository Trust Company. Accordingly, we believe that the shares held by CEDE & CO. include common shares beneficially owned by both holders in the United States and non-U.S. beneficial owners.

 

  B. Related party transactions

 

a.Purchase transactions

 

The Company entered into related party transactions in the fiscal years ended December 31, 2016, 2015 and 2014.

 

The Company’s related party transactions include purchases of property, plant and equipment. These transactions were consummated at fair market price and under similar terms as those with the Company's customers and suppliers.

 

During the years ended December 31, 2016, 2015 and 2014, the Company entered into related party transactions as shown below:

 

   December 31, 
   2016   2015   2014 
             
   US$   US$   US$ 
Deposits for purchase of property, plant and equipment – related party   -    -    1,498,627 
Purchases from related party   497    1,728,676    1,142,845 
Purchases of intangible assets from related party   -    -    325,400 

 

b.Loan from related party–the director and CEO, Mr. Ping Chen

 

On March 27, 2015, the Company entered into a new loan agreement with Mr. Ping Chen, who is the CEO and a major shareholder of the Company, in the amount of $660,679 (RMB 4,120,000) with floating interest rate which was 6.96% in 2016. The loan is due on March 27, 2016 and had been repaid on October 24, 2016 with an interest payment of approximately $29,200 or RMB 194,066.

 

On December 2, 2015, the Company entered into a new loan agreement with Mr. Ping Chen in the amount of $3,207,180 (RMB 20,000,000) with no floating interest rate and maturity date. On December 18, 2015, the Company repaid half of the loan in the amount of $1,603,590 (RMB 10,000,000). The remaining had been repaid on October 21, 2016.

 

During the year ended December 31, 2016, the Company obtained loans from its related party, Mr. Ping Chen, in an aggregate amount of $718,638 (RMB 4,775,000), with no interest charge, which had been fully repaid on October 24, 2016.

 

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c.Related party transaction with BTL

 

On January 14, 2016, the Company completed an acquisition of 0.8% equity interest of BDL from BTL, which terminated the VIE relationship with the Company and deconsolidated from the Company’s financial statements on July 31, 2016, for a purchase price of $146,032 or RMB 920,000. As of December 31, 2016, the Company reported an outstanding payable of $146,032 to BTL.

 

Before the Company terminated the VIE agreement with BTL on July, 31, 2016, the Company had various transactions with BTL. During the year ended December 31, 2016, the Company had the following transactions with BTL:

 

(1)The Company repaid loans of $69,253 or RMB 460,151 in total to BTL, including various expenses paid by BTL on behalf of the Company and loans from BTL from prior years. Those loans were no interest free loans. As of December 31, 2016, no outstanding balance was reported in the Company’s consolidated financial statements.

 

(2)The Company reported a technical support expense of $9,027 or RMB 59,981 to BTL for its product maintenance. As of December 31, 2016, no outstanding balance was reported in the Company’s consolidated financial statements.

 

(3)The Company leased an office space from BTL with an annual rental of $36,120 or RMB 240,000. The leasing agreement had been terminated in 2016. As of December 31, 2016, no outstanding balance was reported in the Company’s consolidated financial statements.

 

During the year ended December 31, 2015, the Company had the following transactions with BTL:

 

(1)The Company received loans of $184,460 or RMB 1,150,000 from BTL and repaid approximately $230,976 or RMB 1,440,000 to BTL, including various expenses paid by BTL on behalf of the Company. Those loans were no interest free loans. As of December 31, 2015, the outstanding balance of $38,792 or RMB 251,731 was reported in the Company’s consolidated financial statements.

 

(2)The Company leased an office space from BTL with an annual rental of $38,496 or RMB 240,000. The leasing agreement had been terminated in 2016. As of December 31, 2015, no outstanding balance was reported in the Company’s consolidated financial statements.

 

d.Loan to related party — Digital Grid (Hong Kong) Technology Co., Limited

 

On December 20, 2016, the Company entered a $2 million loan agreement with Digital Grid (Hong Kong) Technology Co., Limited, one of HLI’s subsidiaries, with a fixed interest rate 3.5%. On December 30, 2016, the Company received the repayment and related interest in total of $2,002,110 from Digital Grid (Hong Kong) Technology Co., Limited.

 

e.Related party transaction with HLI

 

On April 28, 2016, the Company entered into a definitive securities purchase agreement (“SPA”) with Hangzhou Lianluo Interactive Information Technology Co., Ltd. (“HLI”), a publicly listed company on the Shenzhen Stock Exchange, pursuant to which HLI has agreed to purchase 11,111,111 restricted common shares of the Company for an aggregate of $20,000,000. The purchase price is $1.80 per share, which represents a 35% premium to the Company’s closing price of $1.33 on April 27, 2016. As of December 31, 2016, the Company reported a subscription receivable of $1,492,538 from HLI which had been collected on April 13, 2017. In addition, during the years ended December 31, 2016 and 2015, the Company made inventory purchases of $497 and $0 with HLI, respectively. As of December 31, 2016, the Company reported an outstanding payable of $475 to HLI.

 

f.Interests of experts and counsel

 

Not applicable for annual reports on Form 20-F.

 

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Item 8.Financial Information

  

We have appended consolidated financial statements filed as part of this annual report. See information provided in response to Item 18 below. Export sales do not constitute a material portion of our total sales.

 

Legal Proceedings

 

From time to time, we have been involved in litigation or other disputes. No pending or known to be contemplated legal or arbitration proceedings, including any relating to bankruptcy, receivership or similar proceedings or involving any third party, have or are anticipated to have any significant effect on our financial position or profitability. None of the directors or members of senior management of our Company or any of its subsidiaries or affiliate companies is engaged in any materials proceeding adverse to our Company or any of its subsidiaries or affiliate companies.

 

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.

 

Under British Virgin Islands law, we may only pay dividends from surplus (the excess, if any, at the time of the determination of the total assets of our company over the sum of our liabilities, as shown in our books of account, plus our capital), and we must be solvent before and after the dividend payment in the sense that we will be able to satisfy our liabilities as they become due in the ordinary course of business; and the realizable value of assets of our company will not be less than the sum of our total liabilities, other than deferred taxes as shown on our books of account, and our capital.

 

If we determine to pay dividends on any of our common shares in the future, as a holding company, we will be dependent on receipt of funds from our majority-owned subsidiary, BDL. Payments of dividends by BDL to our company are subject to the requirement that foreign invested enterprises may only buy, sell and/or remit foreign currencies at those banks authorized to conduct foreign exchange business. Further, such remittances would require BDL to provide an application for remittance that includes, in addition to the application form, a foreign registration certificate, board resolution, capital verification report, audit report on profit and stock bonuses, and a tax certificate. There are no such similar foreign exchange restrictions in the British Virgin Islands.

 

Significant Changes

 

Except as disclosed elsewhere in this annual report, we have not experienced any significant changes since the date of our audited consolidated financial statements included in this annual report.

 

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Item 9.The Offer and Listing

 

  A. Offer and listing details

 

Our common shares have been listed on the NASDAQ Capital Market since April 22, 2010 under the symbol “DHRM.” The table below shows, for the periods indicated the high and low market prices for our shares.

 

  Market Price Per Share 
  High   Low 
Yearly:          
2012  $3.95   $1.26 
2013  $4.85   $1.80 
2014  $12.89   $2.52 
2015  $4.29   $1.22 
2016  $2.88   $0.79 
           
Quarterly:          
2014          
First quarter  $11.95   $3.88 
Second quarter  $8.07   $4.75 
Third quarter  $6.08   $4.96 
Fourth quarter  $5.02   $2.77 
           
2015          
First quarter  $3.7609   $2.4899 
Second quarter  $3.18   $2.62 
Third quarter  $2.74   $1.35 
Fourth quarter  $4.29   $1.22 
           
2016          
First quarter  $2.445   $1.525 
Second quarter  $2.88   $1.23 
Third quarter  $2.15   $1.50 
Fourth quarter  $1.89   $0.79 
           
Monthly:          
2017          
January  $1.88   $1.42 
February  $1.62   $1.50 
March  $1.68  $1.47 
April (through April 26, 2017)  $1.70   $1.50 

 

  B. Plan of distribution

 

Not applicable for annual reports on Form 20-F.

 

  C. Markets

 

Our common shares are listed on the NASDAQ Capital Market under the symbol “LLIT” and previously under the symbol “DHRM.”

 

  D. Selling shareholders

 

Not applicable for annual reports on Form 20-F.

 

  E. Dilution

 

Not applicable for annual reports on Form 20-F.

 

  F. Expenses of the issue

 

Not applicable for annual reports on Form 20-F.

 

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Item 10.Additional Information

 

  A. Share capital

 

Not applicable for annual reports on Form 20-F.

 

  B. Memorandum and articles of association

 

The information required by this item is incorporated by reference to (a) the material headed “Description of Share Capital” in our Registration Statement on Form S-1, File no. 333-163041, filed with the SEC on November 12, 2009, as amended and (b) our amended and restated articles and memorandum of association filed as Exhibits 1.1 and 1.2 to a current report on Form 6-K filed on November 18, 2016. Other than as stated there, we have amended and restated our articles and memorandum of association to reflect the change of our name to Lianluo Smart Limited.

 

  C.

Material contracts 

 

On April 21, 2016, the Company entered into warrant repurchase agreements (the “Warrant Repurchase Agreements”) with the holders (“Holders”) of certain warrants pursuant to which the Company agreed to repurchase from the Holders the Company’s outstanding warrant to purchase in aggregate 293,880 shares of the Company’s common shares, with an exercise price of $11.86 per share (the “Warrants”). The Warrants were issued on February 21, 2014 in connection with the Company’s registered direct offering of approximately $6.7 million of common shares and warrants.

 

On April 28, 2016, entered into a definitive securities purchase agreement (the "SPA") with Hangzhou Lianluo Interactive Information Technology Co., Ltd. ("Lianluo Interactive"), a publicly listed company on the Shenzhen Stock Exchange (Trading Ticker: 002280) pursuant to which Lianluo Interactive agreed to purchase 11,111,111 restricted common shares of the Company (the "Shares") for an aggregate of $20,000,000 (the "Purchase Price"). The Purchase Price is $1.80 per share, which represents a 35% premium to Lianluo Smart's closing price of $1.33 on April 27, 2016.

 

In consideration of the payment by Lianluo Interactive of the Purchase Price, Lianluo Interactive and its designees will also receive warrants to purchase 1,000,000 restricted common shares of the Company at a purchase price of $2.20 per share (the "Warrants"). The Warrants are exercisable by Lianluo Interactive or its designees in whole or in part and are exercisable at any time after the Closing of the SPA.

 

On June 6, 2016, the Company sold 620,414 of these shares to Lianluo Interactive in a first closing under the SPA. On June 28, 2016, Lianluo Smart entered into Amendment No. 1 to the SPA with Lianluo Interactive. In accordance with Amendment No. 1 to SPA, the closing date was extended from June 30, 2016 to September 30, 2016.

 

On August 18, 2016, the Company sold 10,490,697 shares to Lianluo Interactive and closed the share purchase deal under the SPA with the total shares purchased of 11,111,111 shares. In addition, the Company issued warrants to purchase an additional 1 million shares.

 

  D. Exchange controls

 

Foreign Currency Exchange

 

The principal regulations governing foreign currency exchange in China are the Foreign Exchange Administration Regulations (1996), as amended in 1997 and 2008, and the Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996). Under these regulations, Renminbi are freely convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions, but not for most capital account items, such as direct investment, loan, repatriation of investment and investment in securities outside China, unless the prior approval of SAFE or its local counterparts is obtained. In addition, any loans to an operating subsidiary in China that is a foreign invested enterprise, cannot, in the aggregate, exceed the difference between its respective approved total investment amount and its respective approved registered capital amount. Furthermore, any foreign loan must be registered with SAFE or its local counterparts for the loan to be effective. Any increase in the amount of the total investment and registered capital must be approved by the PRC Ministry of Commerce or its local counterpart. We may not be able to obtain these government approvals or registrations on a timely basis, if at all, which could result in a delay in the process of making these loans.

 

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The dividends paid by the subsidiary to its shareholder are deemed shareholder income and are taxable in China. Pursuant to the Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996), foreign-invested enterprises in China may purchase or remit foreign exchange, subject to a cap approved by SAFE, for settlement of current account transactions without the approval of SAFE. Foreign exchange transactions under the capital account are still subject to limitations and require approvals from, or registration with, SAFE and other relevant PRC governmental authorities.

 

Dividend Distribution

 

The principal regulations governing the distribution of dividends by foreign holding companies include the Foreign Investment Enterprise Law (1986), as amended, and the Administrative Rules under the Foreign Investment Enterprise Law (2001).

 

Under these regulations, foreign investment enterprises in China may pay dividends only out of their retained profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, foreign investment enterprises in China are required to allocate at least 10% of their respective retained profits each year, if any, to fund certain reserve funds unless these reserves have reached 50% of the registered capital of the enterprises. These reserves are not distributable as cash dividends.

 

Notice 75

 

On October 21, 2005, SAFE issued Notice 75, which became effective as of November 1, 2005. According to Notice 75, prior registration with the local SAFE branch is required for PRC residents to establish or to control an offshore company for the purposes of financing that offshore company with assets or equity interests in an onshore enterprise located in the PRC. An amendment to registration or filing with the local SAFE branch by such PRC resident is also required for the injection of equity interests or assets of an onshore enterprise in the offshore company or overseas funds raised by such offshore company, or any other material change involving a change in the capital of the offshore company.

 

Moreover, Notice 75 applies retroactively. As a result, PRC residents who have established or acquired control of offshore companies that have made onshore investments in the PRC in the past are required to complete the relevant registration procedures with the local SAFE branch by March 31, 2006. Under the relevant rules, failure to comply with the registration procedures set forth in Notice 75 may result in restrictions being imposed on the foreign exchange activities of the relevant onshore company, including the increase of its registered capital, the payment of dividends and other distributions to its offshore parent or affiliate and capital inflow from the offshore entity, and may also subject relevant PRC residents to penalties under PRC foreign exchange administration regulations.

 

PRC residents who control our company are required to register with SAFE in connection with their investments in us. Such individuals completed this registration in 2007. If we use our equity interest to purchase the assets or equity interest of a PRC company owned by PRC residents in the future, such PRC residents will be subject to the registration procedures described in Notice 75.

 

New Mergers & Acquisitions Regulations and Overseas Listings

 

On August 8, 2006, six PRC regulatory agencies, including the Ministry of Commerce, the State Assets Supervision and Administration Commission, the State Administration for Taxation, the State Administration for Industry and Commerce, CSRC and SAFE, jointly issued the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the New M&A Rule, which became effective on September 8, 2006. This New M&A Rule, among other things, includes provisions that purport to require that an offshore special purpose vehicle formed for purposes of overseas listing of equity interests in PRC companies and controlled directly or indirectly by PRC companies or individuals obtain the approval of CSRC prior to the listing and trading of such special purpose vehicle’s securities on an overseas stock exchange.

 

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On September 21, 2006, CSRC published on its official website procedures regarding its approval of overseas listings by special purpose vehicles. The CSRC approval procedures require the filing of a number of documents with the CSRC and it would take several months to complete the approval process. The application of this new PRC regulation remains unclear with no consensus currently existing among leading PRC law firms regarding the scope of the applicability of the CSRC approval requirement.

 

  E. Taxation

 

British Virgin Islands Taxation

 

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.

 

United States Federal Income Taxation

 

The following is a summary of material United States federal income tax consequences under present law relating to the purchase, ownership, and disposition of our common shares. This description does not provide a complete analysis of all potential tax consequences. The information provided below is based on the Internal Revenue Code of 1986, as amended, or the Code, Treasury Regulations, proposed Treasury Regulations, Internal Revenue Service, or the IRS, published rulings and court decisions, all as of the date hereof. These authorities may change, possibly on a retroactive basis, or the IRS might interpret the existing authorities differently. In either case, the tax consequences of purchasing, owning or disposing of common shares could differ from those described below. We do not intend to obtain a ruling from the IRS with respect to the tax consequences of acquiring or holding the common shares.

 

This description is general in nature and does not discuss all aspects of U.S. federal income taxation that may be relevant to a particular investor in light of the investor’s particular circumstances, or to certain types of investors subject to special treatment under U.S. federal income tax laws, such as:

 

  · banks or financial institutions;
  · life insurance companies;
  · tax-exempt organizations;
  · dealers in securities or foreign currencies;
  · traders in securities that elect to apply a mark-to-market method of accounting;
  · persons holding common shares as part of a position in a “straddle” or as part of a “hedging,” “conversion” or “integrated” transaction for U.S. federal income tax purposes;
  · persons subject to the alternative minimum tax provisions of the Code; and
  · persons that have a “functional currency” other than the U.S. dollar.

 

This description generally applies to purchasers of our common shares as capital assets. This description does not consider the effect of any foreign, state, local or other tax laws that may be applicable to particular investors.

 

Investors considering the purchase of common shares should consult their own tax advisors regarding the application of the U.S. federal income tax laws to their particular situations and the consequences of U.S. federal estate or gift tax laws, foreign, state, or local laws, and tax treaties.

 

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U.S. Holders

 

As used herein, the term “U.S. Holder” means a beneficial owner of common shares that is:

 

  · a citizen or resident of the U.S. or someone treated as a U.S. citizen or resident for U.S. federal income tax purposes;
  · a corporation or other entity taxable as a corporation for U.S. federal income tax purposes organized in or under the laws of the U.S. or any political subdivision thereof;
  · an estate the income of which is subject to U.S. federal income taxation regardless of its source; or
  · a trust, if such trust validly elects to be treated as a U.S. person for U.S. federal income tax purposes, or if (a) a court within the U.S. can exercise primary supervision over its administration and (b) one or more U.S. persons have the authority to control all of the substantial decisions of such trust.

 

If a partnership (including for this purpose any entity treated as a partnership for U.S. tax purposes) is a beneficial owner of the common shares, the U.S. tax treatment of a partner in the partnership will generally depend on the status of the partner and the activities of the partnership. A holder of the common shares that is a partnership and partners in such partnership should consult their individual tax advisors about the U.S. federal income tax consequences of holding and disposing of the common shares.

 

If you are not a U.S. Holder, this subsection does not apply to you and you should refer to “Non-U.S. Holders” below.

 

Taxation of Dividends and Other Distributions on Common shares

 

Subject to the passive foreign investment company rules discussed below, all distributions to a U.S. Holder with respect to the common shares, other than certain pro rata distributions of our shares, will be includible in a U.S. Holder’s gross income as ordinary dividend income when received, but only to the extent that the distribution is paid out of our current or accumulated earnings and profits. For this purpose, earnings and profits will be computed under U.S. federal income tax principles. The dividends will not be eligible for the dividends-received deduction allowed to corporations. To the extent that the amount of the distribution exceeds our current and accumulated earnings and profits, it will be treated first as a tax-free return of the tax basis in the common shares, and to the extent the amount of the distribution exceeds the U.S. Holder’s tax basis, the excess will be taxed as capital gain. Any gain recognized by a non-corporate U.S. Holder on the sale or exchange of common shares generally will be subject to a maximum tax rate of 20%.

 

Dividends paid in Renminbi will be included in your income as a U.S. dollar amount based on the exchange rate in effect on the date that the U.S. Holder receives the dividend, regardless of whether the payment is in fact converted into U.S. dollars. If the U.S. Holder does not receive U.S. dollars on the date the dividend is distributed, the U.S. Holder will be required to include either gain or loss in income when the U.S. Holder later exchanges the Renminbi for U.S. dollars. The gain or loss will be equal to the difference between the U.S. dollar value of the amount that the U.S. Holder includes in income when the dividend is received and the amount that the U.S. Holder receives on the exchange of the Renminbi for U.S. dollars. The gain or loss generally will be ordinary income or loss from United States sources. If we distribute as a dividend non-cash property, the U.S. Holder will generally include in income an amount equal to the U.S. dollar equivalent of the fair market value of the property on the date that it is distributed.

 

Dividends will constitute foreign source income for foreign tax credit limitation purposes. The limitation on foreign taxes eligible for credit is calculated separately with respect to specific classes of income. For this purpose, dividends distributed by us with respect to the common shares will be “passive income” or, in the case of certain U.S. Holders, “financial services income.” In particular circumstances, a U.S. Holder that:

 

  · has held the common shares for less than a specified minimum period during which it is not protected from risk of loss,
  · is obligated to make payments related to the dividends, or
  · holds the common shares in arrangements in which the U.S. Holder’s expected economic profit, after non-U.S. taxes, is insubstantial will not be allowed a foreign tax credit for foreign taxes imposed on dividends paid on the common shares.

 

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Distributions to a U.S. Holder of shares or rights to subscribe for shares that are received as part of a pro rata distribution to all our shareholders should not be subject to U.S. federal income tax. The basis of the new shares or rights so received will be determined by allocating the U.S. Holder’s tax basis in the common shares between the common shares and the new shares or rights received, based on their relative fair market values on the date of distribution. However, the basis of the new shares or rights will be zero if:

 

  · the fair market value of the new shares or rights is less than 15.0% of the fair market value of the old common shares at the time of distribution; and
  · the U.S. Holder does not make an election to determine the basis of the new shares by allocation as described above.

 

The U.S. Holder’s holding period in the new shares or rights will generally include the holding period of the old common shares on which the distribution was made.

 

Taxation of Disposition of Common shares

 

Subject to the passive foreign investment company rules discussed below, a U.S. Holder will recognize taxable gain or loss on any sale or exchange of common shares equal to the difference between the amount realized (in U.S. dollars) for the common shares and the U.S. Holder’s tax basis (in U.S. dollars) in the common shares. The gain or loss will be capital gain or loss. Any gain or loss that you recognize will generally be treated as United States source income or loss, except that losses will be treated as foreign source losses to the extent you received dividends that were includible in the financial services income basket during the 24-month period prior to the sale. If the common shares are not stock in a passive foreign investment company with respect to a U.S. Holder in either the taxable year of the distribution or the preceding taxable year, the distribution otherwise constitutes qualified dividend income for United States federal income tax purposes, certain holding period and other requirements are met, and the distribution is received in a taxable year beginning prior to January 1, 2009, the distribution will be taxable to a non-corporate U.S. Holder at a maximum rate of 15%.

 

Passive Foreign Investment Company

 

We believe that we are not a passive foreign investment company for U.S. federal income tax purposes, but we cannot be certain whether we will be treated as a passive foreign investment company for any future taxable year. If we are a passive foreign investment company in any year in which a U.S. Holder holds common shares, the U.S. Holder generally will be subject to increased U.S. tax liabilities and reporting requirements on receipt of certain dividends or on a disposition of common shares, in that year and all subsequent years although a shareholder election to terminate such deemed passive foreign investment company status may be made in certain circumstances. U.S. Holders should consult their own tax advisors regarding our status as a passive foreign investment company, the consequences of an investment in a passive foreign investment company, and the consequences of making a shareholder election to terminate deemed passive foreign investment company status if we no longer meet the income or asset test for passive foreign investment company status in a subsequent taxable year.

 

A company is considered a passive foreign investment company for any taxable year if either:

 

  · at least 75.0% of its gross income is passive income, or
  · at least 50.0% of the value of its assets (based on an average of the quarterly values of the assets during a taxable year) is attributable to assets that produce or are held for the production of passive income.

 

We will be treated as owning our proportionate share of the assets and earning our proportionate share of the income of any other corporation in which we own, directly or indirectly, more than 25.0% (by value) of the stock of such corporation.

 

Our belief that we are not a passive foreign investment company is based on our estimate of the fair market value of our intangible assets, including goodwill, not reflected in our financial statements under US GAAP. In the future, in calculating the value of these intangible assets, we will value our total assets, in part, based on our total market value determined using the average of the quarterly selling prices of the common shares for the relevant year. We believe this valuation approach is reasonable. However, it is possible that the IRS will challenge the valuation of our intangible assets, which may result in our classification as a passive foreign investment company. In addition, if our actual acquisitions and capital expenditures do not match our projections, the likelihood that we are or will be classified as a passive foreign investment company may also increase.

 

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A separate determination must be made each year as to whether we are a passive foreign investment company. As a result, our passive foreign investment company status may change.

 

If we are a passive foreign investment company for any taxable year during which a U.S. Holder holds common shares, the U.S. Holder will be subject to special tax rules with respect to:

 

  · Any “excess distribution” that the U.S. Holder receives on common shares, and
  · Any gain the U.S. Holder realizes from a sale or other disposition (including a pledge) of the common shares, unless the U.S. Holder makes a “mark-to-market” election as discussed below.

 

Distributions the U.S. Holder receives in a taxable year that are greater than 125% of the average annual distributions the U.S. Holder received during the shorter of the three preceding taxable years or the U.S. Holder’s holding period for the common shares will be treated as an excess distribution. Under these special tax rules:

 

  · the excess distribution or gain will be allocated ratably over your holding period for the common shares,
  · the amount allocated to the current taxable year, and any taxable year prior to the first taxable year in which we were a passive foreign investment company, will be treated as ordinary income, and
  · the amount allocated to each other year will be subject to tax at the highest tax rate in effect for that year and the interest charge generally applicable to underpayments of tax will be imposed on the resulting tax attributable to each such year.

 

The tax liability for amounts allocated to years prior to the year of disposition or “excess distribution” cannot be offset by any net operating losses, and gains (but not losses) realized on the sale of the common shares cannot be treated as capital, even if the U.S. Holder holds the common shares as capital assets.

 

A U.S. shareholder of a passive foreign investment company may avoid taxation under the excess distribution rules discussed above by making a “qualified electing fund” election to include the U.S. Holder’s share of our income on a current basis. However, a U.S. Holder may make a qualified electing fund election only if the passive foreign investment company agrees to furnish the shareholder annually with certain tax information, and we do not presently intend to prepare or provide such information.

 

Alternatively, a U.S. Holder of “marketable stock” in a passive foreign investment company may make a mark-to-market election for stock of a passive foreign investment company to elect out of the excess distribution rules discussed above. If a U.S. Holder makes a mark-to-market election for the common shares, the U.S. Holder will include in income each year an amount equal to the excess, if any, of the fair market value of the common shares as of the close of your taxable year over the U.S. Holder’s adjusted basis in such common shares. A U.S. Holder is allowed a deduction for the excess, if any, of the adjusted basis of the common shares over their fair market value as of the close of the taxable year only to the extent of any net mark-to-market gains on the common shares included in the U.S. Holder’s income for prior taxable years. Amounts included in a U.S. Holder’s income under a mark-to-market election, as well as gain on the actual sale or other disposition of the common shares, are treated as ordinary income. Ordinary loss treatment also applies to the deductible portion of any mark-to-market loss on the common shares, as well as to any loss realized on the actual sale or disposition of the common shares, to the extent that the amount of such loss does not exceed the net mark-to-market gains previously included for such common shares. A U.S. Holder’s basis in the common shares will be adjusted to reflect any such income or loss amounts. The tax rules that apply to distributions by corporations which are not passive foreign investment companies would apply to distributions by us.

 

The mark-to-market election is available only for stock which is regularly traded on a national securities exchange that is registered with the SEC or on NASDAQ, or an exchange or market that the U.S. Secretary of the Treasury determines has rules sufficient to ensure that the market price represents a legitimate and sound fair market value. The mark-to-market election would be available to a U.S. Holder unless our common shares are delisted from The NASDAQ Capital Market and do not subsequently become regularly traded on another qualified exchange or market.

 

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A U.S. Holder who holds our common shares in any year in which we are a passive foreign investment company would be required to file IRS Form 8621 regarding distributions received on our common shares and any gain realized on the disposition of our common shares.

 

Non-U.S. Holders

 

A Non-U.S. Holder generally will not be subject to U.S. federal income tax on dividends paid by us with respect to our common shares unless the income is effectively connected with the Non-U.S. Holder’s conduct of a trade or business in the United States.

 

A Non-U.S. Holder generally will not be subject to U.S. federal income tax on any gain attributable to a sale or other disposition of our common shares unless such gain is effectively connected with the Non-U.S. Holder’s conduct of a trade or business within the United States or the Non-U.S. Holder is a natural person who is present in the United States for 183 days or more and certain other conditions exist.

 

Dividends and gains that are effectively connected with a Non-U.S. Holder’s conduct of a trade or business in the United States generally will be subject to tax in the same manner as they would be if the Non-U.S. Holder were a U.S. Holder, except that the passive foreign investment company rules will not apply. Effectively connected dividends and gains received by a corporate Non-U.S. Holder may also be subject to an additional branch profits tax at a 30.0% rate or a lower tax treaty rate.

 

Information Reporting and Backup Withholding

 

In general, information reporting requirements will apply to dividends in respect of our common shares or the proceeds received on the sale, exchange or redemption of our common shares paid within the United States (and, in certain cases, outside the United States) to U.S. Holders other than certain exempt recipients, such as corporations, and backup withholding tax may apply to such amounts if the U.S. Holder fails to provide an accurate taxpayer identification number or to report interest and dividends required to be shown on its U.S. federal income tax returns. The amount of any backup withholding from a payment to a U.S. Holder will be allowed as credit against the U.S. Holder’s U.S. federal income tax liability provided that the appropriate returns are filed.

 

A Non-U.S. Holder generally may eliminate the requirement for information reporting and backup withholding by providing certification of its foreign status to the payer, under penalties of perjury, on IRS Form W-8BEN.

 

F.Dividends and paying agents

 

Not applicable for annual reports on Form 20-F.

 

G.Statement by experts

 

Not applicable for annual reports on Form 20-F.

 

H.Documents on display

 

We are subject to the information requirements of the Exchange Act. In accordance with these requirements, the Company files reports and other information with the SEC. You may read and copy any materials filed with the SEC at the Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a web site at http://www.sec.gov that contains reports and other information regarding registrants that file electronically with the SEC.

 

 

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I.Subsidiary Information

 

Not applicable.

 

Item 11.Q uantitative and Qualitative Disclosures about Market Risk

  

Foreign Exchange Risk

 

All of our revenues and substantially all of our expenditures are denominated in Renminbi. Although exchange of the Renminbi for foreign currency is highly regulated in China, the value of the Renminbi against the value of the U.S. dollar may fluctuate and be affected by, among other things, changes in China’s political and economic conditions. Under the currency policy in effect in China today, the value of the Renminbi fluctuates within a narrow band against a basket of foreign currencies. China is currently under significant international pressures to liberalize its currency policy, and if such liberalization were to occur, the value of the Renminbi could appreciate or depreciate against the U.S. dollar, or any other currency.

 

We use U.S. dollars as the reporting currency for our financial statements. All transactions in currencies other than U.S. dollar during the year are re-measured at the exchange rates prevailing on the respective relevant dates of such transactions. Monetary assets and liabilities existing at the balance sheet date denominated in currencies other than U.S. dollar are re-measured at the exchange rates prevailing on such date. Exchange differences are recorded in our consolidated statement of operations.

 

Fluctuations in exchange rates may affect our net revenues, costs, operating margins and net income. For example, in 2016, 0.4% of our net revenues were generated from sales denominated in currencies of U.S. dollar. The fluctuations in the exchange rates between the U.S. dollar and the Renminbi resulted in a decrease of $149 in operating income in 2016.

 

Fluctuations in exchange rates may also affect our balance sheet. For example, to the extent that we need to convert U.S. dollars into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount that we receive from the conversion. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of paying dividends on our ordinary shares or for other business purposes, appreciation of the Renminbi against the U.S. dollar would have a positive effect on the corresponding U.S. dollar amount available to us.

 

The Renminbi’s exchange rate with the U.S. dollar and other currencies is affected by, among other things, changes in China’s political and economic conditions. See “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in China—Fluctuations in the value of the Renminbi may have a material adverse effect on your investment.” Any significant revaluation of the Renminbi may materially and adversely affect our cash flows, revenues, earnings and financial position, and the value of, and any dividends payable on, our share prices in U.S. dollars.

 

Our PRC subsidiaries have determined their functional currencies to be the Renminbi based on the criteria set forth under ASC 830, Foreign Currency Matters. We use the Renminbi as our reporting currency. We use the monthly average exchange rate for the year and the exchange rate at the balance sheet date to translate the operating results and financial position of our PRC subsidiaries, respectively. Translation differences are recorded in accumulated other comprehensive income, a component of shareholders’ equity. Transactions denominated in foreign currencies are remeasured into our functional currency at the exchange rates prevailing on the transaction dates. Foreign currency denominated financial assets and liabilities are remeasured at the balance sheet date exchange rate. Exchange gains and losses are included in the consolidated statements of income.

 

Interest Rate Risk

 

Our exposure to interest rate risk primarily relates to our interest income generated by our excess cash, which is mostly held in interest-bearing bank deposits and short-term investments as well as interest expenses under our short-term bank loans. Our future interest income from our cash deposited in bank and short-term bank loans may fall short of expectations due to changes in interest rates. Our future interest expense on our short-term borrowings may increase or decrease due to changes in market interest rates. As of December 31, 2016, our outstanding short-term borrowings were nil.

 

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Inflation

 

According to the National Bureau of Statistics of China, China’s overall national inflation rate, as represented by the general consumer price index, was approximately 2% in 2014, 1.4% in 2015 and 2% in 2016. We have not in the past been materially affected by any such inflation, but we can provide no assurance that we will not be affected in the future.

 

Item 12.Description of Securities Other than Equity Securities

  

With the exception of Items 12.D.3 and 12.D.4, this Item 12 is not applicable for annual reports on Form 20-F. As to Items 12.D.3 and 12.D.4, this Item 12 is not applicable, as the Company does not have any American Depositary Shares.

 

PART II

 

Item 13.Defaults, Dividend Arrearages and Delinquencies

  

We do not have any material defaults in the payment of principal, interest, or any installments under a sinking or purchase fund.

 

Item 14.Material Modifications to the Rights of Securities Holders and Use of Proceeds

  

Material Modifications to the Rights of Security Holders

 

We have not made any material modifications to the rights of our security holders. For a description of the rights of securities holders, see “Item 10. Additional Information — B. Memorandum and Articles of Association — Ordinary Shares”, which remain unchanged.

 

Use of Proceeds

 

Not applicable.

  

Item 15.Controls and Procedures

  

Evaluation of Disclosure Controls and Procedures

 

As of December 31, 2016 (the “Evaluation Date”), the Company carried out an evaluation, under the supervision of and with the participation of management, including the Company’s chief executive officer and chief financial officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based on the foregoing, the chief executive officer and chief financial officer concluded that as of the Evaluation Date the company’s disclosure controls and procedures were not effective and designed to ensure that all material information required to be included in our reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decision regarding required disclosure.

 

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Management’s Annual Report on Internal Control over Financial Reporting

 

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Rule 13a-15(f) under the Securities and Exchange Act of 1934, as amended. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that:

 

(1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the recording of transactions of the Company’s assets;
   
(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with U.S. GAAP, and that the Company’s receipts and expenditures are being made only in accordance with the authorization of its management and directors; and
   
(3) Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the consolidated financial statements.

 

Because of its inherent limitations, a system of internal control over financial reporting can provide only reasonable assurance with respect to consolidated financial statement preparation and presentation and may not prevent or detect misstatements, Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

The Company’s management assessed the effectiveness of its internal control over financial reporting as of December 31, 2016. In making this assessment, management used the 2013 COSO framework set forth in the report entitled Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO.

 

The COSO framework summarizes each of the components of a company’s internal control system, including (i) the control environment, (ii) risk assessment, (iii) control activities, (iv) information and communication, and (v) monitoring. Our management has implemented and tested our internal control over financial reporting based on these criteria and did not identify any significant deficiencies and material weaknesses as of December 31, 2016. However, based on the fact that the system of our inventory management is not automatically, which could not prevent some manual errors. Although the errors can be detective in review process and revised timely, it impacts our efficiency during the inventory management. Otherwise, this annual report does not include an attestation report of the Company’s registered public accounting firm because the Company is not an accelerated or large accelerated filer and does not otherwise elect to include such an attestation report.

 

In an effort to remedy this material weakness in the future, we intend to do the following:

 

(1)

Optimize the system of our inventory management and install Kingdee ERP system that is consistent with Lianluo Interactive.

   
(2) Involve engineers of Kingdee Company to help us optimize the process of inventory management and strengthen our IT internal control.
   
(3) Design and implement a program to provide ongoing company-wide training regarding ERP system.  
   

 

Despite the material weakness reported above, our management believes that our consolidated financial statements included in this report fairly present in all material respects our financial condition, results of operations and cash flows for the periods presented. We have completed the transition from the 1992 COSO framework for internal controls to the 2013 COSO framework in 2015 and the 2013 COSO framework formalized the principles embedded in the original framework more explicitly incorporated business and operating environment changes over the past two decades, and which improved the framework’s ease of use and application.

 

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Changes in Internal Control over Financial Reporting

 

There were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934) during the three or twelve months ended December 31, 2016 that have materially affected, or are reasonably likely to materially affect, the company’s internal control over financial reporting.

 

Item 15T.Controls and Procedures

  

Not applicable.

 

Item 16.[Reserved]

  

Item 16A.Audit Committee Financial Expert

  

The Company’s Board of Directors has determined that Mr. Mingwei Zhang qualifies as an “audit committee financial expert” in accordance with applicable NASDAQ Capital Market standards. The Company’s Board of Directors has also determined that Mr. Zhang and the other members of the Audit Committee are all “independent” in accordance with the applicable NASDAQ Capital Market standards.

 

Item 16B.Code of Ethics

 

The Company has adopted a Code of Business Conduct and Ethics that applies to the Company’s employees, including its principal executive officer, principal financial officer, principal accounting officer, controller and persons performing similar functions. A copy of the Code of Business Conduct and Ethics was filed as an exhibit to our Registration Statement on Form S-1, File no. 333-163041, filed on November 12, 2009, as amended. In addition, the Company has posted this information on its website at www.dehaier.com.cn. The Company will provide any person a copy of its Code of Business Conduct and Ethics, without charge, upon request. Such request should be addressed to the Company at:

 

Room 2108, 21st Floor,

China Railway Construction Building,

No. 20 Shijingshan Road, 100040,

Beijing, China

Attention: Secretary

 

Item 16C.Principal Accountant Fees and Services

 

HHC served as the Company’s independent registered public accounting firm for fiscal 2016. Audit services provided by HHC for fiscal 2016 included the examination of the consolidated financial statements of the Company; and services related to periodic filings made with the SEC.

 

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Fees Paid To Independent Registered Public Accounting Firm

 

Audit Fees

 

HHC’s fees for the annual audit of our financial statements were $150,000 and $240,000 for fiscal 2016 and 2015, respectively. In addition, we paid the predecessor auditor Friedman LLP $180,035 for fiscal 2015.

 

Audit-Related Fees

 

The Company has not paid HHC for audit-related services in fiscal 2016 or 2015.

 

Tax Fees

 

The Company has not paid HHC for tax services in fiscal 2016 or 2015.

 

All Other Fees

 

The Company has not paid HHC for any other services in fiscal 2016 or 2015.

 

Audit Committee Pre-Approval Policies

 

Before HHC was engaged by the Company to render audit or non-audit services, the engagement was approved by the Company’s audit committee. All services rendered by HHC have been so approved.

 

Item 16D.Exemptions from the Listing Standards for Audit Committees

 

Not applicable.

 

Item 16E.Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

Neither the Company nor any affiliated purchaser has purchased any shares or other units of any class of the Company’s equity securities registered by the Company pursuant to Section 12 of the Securities Exchange Act during the fiscal year ended December 31, 2016.

 

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Item 16F.Change in Registrant’s Certifying Accountant.

  

On June 17, 2016, our Audit Committee and Board of Directors approved the appointment of HHC and the dismissal of Friedman LLP. The decision was due to Friedman’s inability to commit to a timeline in which to complete the 2015 audit and to form an opinion based on the information provided to Friedman. Friedman’s report on the financial statements for the year ended December 31, 2014 did not contain an adverse opinion or a disclaimer of opinion, and was not qualified or modified as to uncertainty, audit scope, or accounting principles. During the registrant's fiscal year ended December 31, 2015 and preceding such dismissal, Friedman notified us that they had not received sufficient information to satisfy their audit procedures of the Company’s consolidated financial statements and, therefore, could not form an opinion due to the lack of such information. Friedman has advised us that we have not provided sufficient evidence to establish the timing and nature of write-offs and reserves related to certain accounts receivable, inventory, prepayments and other receivables, which, if investigated further, could impact the previously-issued audit report or the underlying financial statements for the year ended December 31, 2014. Other than as mentioned here, there were no disagreements with Friedman on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Friedman, would have caused it to make reference to the subject matter of the disagreements in connection with its report. 

 

Item 16G.Corporate Governance.

 

Other than as described in this section, our corporate governance practices do not differ from those followed by domestic companies listed on the NASDAQ Capital Market. NASDAQ Listing Rule 5635 generally provides that shareholder approval is required of U.S. domestic companies listed on the NASDAQ Capital Market prior to issuance (or potential issuance) of securities (i) equaling 20% or more of the company’s common stock or voting power for less than the greater of market or book value or (ii) resulting in a change of control of the company. Notwithstanding this general requirement, NASDAQ Listing Rule 5615(a)(3)(A) permits foreign private issuers like the Company to follow their home country practice rather than these shareholder approval requirements. The British Virgin Islands does not require shareholder approval prior to either of the foregoing sorts of issuances. The Company, therefore, is not required to obtain such shareholder approval prior to entering into a transaction with the potential to issue securities as described above. The Board of Directors of the Company has elected to follow home BVI country rule as to such issuances and will not be required to seek shareholder approval prior to entering into such a transaction.

 

Item 16H.Mine Safety Disclosure.

 

Not applicable.

 

 

 

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PART III

 

Item 17.Financial Statements

 

See Item 18.

 

Item 18.Financial Statements

  

The consolidated financial statements of Lianluo Smart Limited are included at the end of this annual report, beginning with page F-1.

 

Item 19.Exhibits

 

Exhibit  
Number Document
   
1.1 Third Amended and Restated Articles of Association of the Registrant(1)
   
1.2 Third Amended and Restated Memorandum of Association of the Registrant(1)
   
2.1 Specimen Share Certificate(1)
   
2.2 Form of Warrant to purchase Common Shares by the Company.(2)
   
4.1 2009 Share Incentive Plan(1)
   
4.2 2013 Share Incentive Plan(3)
   
4.3 2014 Share Incentive Plan(4)
   
4.4 Warrant Repurchase Agreement(5)
   
4.5 Share Purchase Agreement(6)
   
4.6 First Amendment to Share Purchase Agreement(6)
   
8.1 Subsidiaries of the Registrant(7)
   
11.1 Code of Business Conduct and Ethics(1)
   
12.1 Certifications pursuant to Rule 13a-14(a) or 15(d)-14(a) under the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(7)
   
12.2 Certifications pursuant to Rule 13a-14(a) or 15(d)-14(a) under the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(7)
   
13.1 Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(8)
   
13.2 Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(8)
   
15.1 Audit Committee Charter(9)

 

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101.INS XBRL Instance Document(7)
   
101.SCH XBRL Taxonomy Extension Schema Document(7)
   
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document(7)
   
101.DEF XBRL Taxonomy Extension Definition Linkbase Document(7)
   
101.LAB XBRL Taxonomy Extension Label Linkbase Document(7)
   
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document(7)

 

 

(1) Incorporated by reference to the registrant’s registration statement on Form S-1, File no. 333-163041, filed on November 12, 2009, as amended.
(2) Incorporated by reference to the registrant’s Form 6-K, File no. 001-34661, filed on February 21, 2014.
(3) Incorporated by reference to the registrant’s Form 6-K, File no. 001-34661, filed on November 29, 2013.
(4) Incorporated by reference to the registrant’s proxy statement for the registrant’s annual meeting of shareholders for the fiscal year ended December 31, 2013, File no. 001-34661, filed on July 1, 2014.
(5) Incorporated by reference to the registrant’s Form 6-K, File no. 001-34661, filed on April 22, 2016.
(6) Incorporated by reference to the registrant’s Form 6-K, File no. 001-34661, filed on June 30, 2016.
(7) Filed herewith.
(8) Furnished herewith.
(9) Incorporated by reference to the registrant’s Form 10-K, File no. 001-34661, filed on March 31, 2010.

 

 

 

 

 

79 

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the undersigned certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form 20-F and has duly caused this Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 on Form 20-F to be signed on its behalf by the undersigned, thereunto duly authorized, in the People’s Republic of China, on the 28th day of April, 2017.

 

Lianluo Smart LIMITED
   
By: /s/ Ping Chen
Name:   Ping Chen
Title: Chief Executive Officer
   
  Date:  April 28, 2017

 

 

80 

 

 

  

LIANLUO SMART LIMITED AND SUBSIDIARIES

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

CONSOLIDATED FINANCIAL STATEMENTS PAGE
   
Report of Independent Registered Public Accounting Firm F-2
   
Consolidated Balance Sheets as of December 31, 2016 and 2015 F-3
   
Consolidated Statements of Operations and Comprehensive Loss for the Years Ended December 31, 2016, 2015, and 2014 F-4
   
Consolidated Statements of Equity for the Years Ended December 31, 2016, 2015, and 2014 F-5
   
Consolidated Statements of Cash Flows for the Years Ended December 31, 2016, 2015, and 2014 F-6
   
Notes to the Consolidated Financial Statements F-7

 

 F-1 

 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

 

 

To the Shareholders and Directors of

Lianluo Smart Limited and Subsidiaries

 

 

We have audited the accompanying consolidated balance sheets of Lianluo Smart Limited and Subsidiaries (the "Company") as of December 31, 2016 and 2015, and the related consolidated statements of operations and comprehensive income (loss), stockholders' equity and cash flows for each of the three years in the period ended December 31, 2016. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company's internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2016 and 2015 and the results of operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America.

 

 

/s/ HHC

Forest Hills, New York

April 28, 2017

 

 

 F-2 

 

 

 

LIANLUO SMART LIMITED AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

   December 31,    December 31, 
   2016    2015 
          
ASSETS           
CURRENT ASSETS:           
Cash and cash equivalents  $10,792,823    $615,517 
Accounts receivable, net   78,113     54,251 
Other receivables, net   89,520     61,002 
Advances to suppliers–third parties   238,776     590,637 
Advance to supplier–related party   -     875,044 
Inventories, net   136,916     3,975,114 
Current assets held for discontinued operations   -     

696,768

 
Total Current Assets   11,336,148     6,868,333 
            
Property and equipment, net   1,406,140     1,755,001 
Intangible assets, net   3,809,849     4,448,804 
Long-term prepaid expenses   -     290,036 
Other assets held for discontinued operations   -     513,073 
Total Assets  $16,552,137    $13,875,247 
            
LIABILITIES AND EQUITY           
CURRENT LIABILITIES:           
Short-term borrowings  $-    $1,541,000 
Short-term borrowings -related party   -     2,175,892 
Accounts payable   72,451     20,872 
Advances from customers   106,521     42,980 
Accrued expenses and other current liabilities   643,324     1,789,481 
Taxes payable   -     113,429 
Warranty obligation   146,271     11,708 
Due to related parties   

146,507

     

38,792

 
Current liabilities held for discontinued operations   -     671,492 
Total Current Liabilities   

1,115,074

     6,405,646 
            
OTHER LIABILITIES           
Warrants liability   -     162,736 
Total Liabilities   

1,115,074

     6,568,382 
            
Commitments and Contingency           
            
Equity           
Common shares, $0.002731 par value, 50,000,000 shares authorized, 17,312,586 and 6,194,475 shares issued and outstanding at December 31, 2016 and 2015, respectively   47,281     16,918 
Additional paid in capital   39,150,635     19,810,905 
Accumulated deficit   

(26,499,675

)    

(16,377,900

)
Accumulated other comprehensive income   2,738,822     2,989,116 
Total Lianluo Smart Limited shareholders' equity   15,437,063     6,439,039 
Non-controlling interest   -     867,826 
Total equity   15,437,063     7,306,865 
Total liabilities and equity  $16,552,137    $13,875,247 

  

The accompanying notes are an integral part of these consolidated financial statements.

 

 F-3 

 

 

LIANLUO SMART LIMITED AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

 

     For the Years Ended
December 31,
 
   2016   2015   2014 
           (restated) 
Revenues  $13,062,373  $738,301   $2,774,241 
                
Costs of revenue   (16,627,535)   (927,286)   (1,802,864)
                
Gross profit (loss)   (3,565,162)   (188,985)   971,377 
                
Service incomes   14,587    1,600,012    47,665 
Service expenses   (21,130)   (1,234,257)   (29,022)
General and administrative expenses   (4,643,962)   (4,089,592)   (1,929,206)
Recovery gain from doubtful accounts (provision for doubtful accounts)   150,280    (8,544)   (347,891)
Selling expenses   (1,018,581)   (2,982,447)   (138,981)
                
Operating loss   (9,083,968)   (6,903,813)   (1,426,058)
                
Financial expenses   (125,127)   (194,773)   (174,463)
Other incomes   68,436    -    83,762 
Other expenses   -    (2,586)   (21,850)
Loss from warrant redemption   (1,091,719)   -    - 
Change in fair value of warrants liability   137,710    390,324    2,866,171 
                
Income (loss) before provision for income tax and non-controlling interest   (10,094,668)   (6,710,848)   1,327,562 
                
Provision for income tax (expense) benefit   95,026    11,978    (357,726)
                
Net income (loss) from continuing operations   (9,999,642)   (6,698,870)   969,836 
                
Discontinued operations:               
Loss from disposal of discontinued component, net of taxes   (82,579)   -    - 
Loss from operations of discontinued component, net of taxes   (168,574)   (3,663,465)   (26,003,708)
                
Net loss   (10,250,795)   (10,362,335)   (25,033,872)
                
Less: net loss attributable to non-controlling interest   (129,020)   (139,205)   (735,758)
                
Net loss attributable to Lianluo Smart Limited  $(10,121,775)  $(10,223,130)  $(24,298,114)
                
Net income (loss) from continuing operations  $(9,999,642)  $(6,698,870)  $969,836 
                
Net loss from discontinued operations   (251,153)   (3,663,465)   (26,003,708)
                
Other comprehensive income (loss):               
Foreign currency translation gain (loss)   

(567,162

)   (461,548)   (576,891)
                
Comprehensive loss   (10,817,957)   (10,823,883)   (25,610,763)
-less comprehensive loss attributable to the non-controlling interest   (230,838)   (189,670)   (762,777)
                
Comprehensive loss attributable to Lianluo Smart Limited  $(10,587,119)  $(10,634,213)  $(24,847,986)
                
Loss per share               
-Basic  $(0.97)  $(1.74)  $(4.41)
-Diluted  $(0.97)  $(1.73)  $(4.34)
                
Weighted average number of common shares used in computation               
-Basic   10,422,765    5,862,647    5,510,076 
-Diluted   10,428,951    5,896,534    5,597,169 

  

The accompanying notes are an integral part of these consolidated financial statements.

 

 F-4 

 

 

LIANLUO SMART LIMITED AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF EQUITY

 

                   Accumulated         
               Retained Earnings   other         
   Common stock   Additional   (Accumulated   comprehensive   Non-controlling     
   Shares   Amount   Paid-in Capital   Deficit)   income   interest   Total 
Balance as of January 1, 2014   4,668,000   $12,749   $13,752,187   $18,143,344   $3,950,071   $1,820,273   $37,678,624 
                                    
Issuance of 134,000 shares upon excise of share-based awards   134,000    366    193,934    -    -    -    194,300 
Issuance of 160,000 shares to non-employee   160,000    437    643,564    -    -    -    644,001 
Issuance of 734,700 shares to investors   734,700    2,006    3,366,165    -    -    -    3,368,171 
Issuance shares to employees, directors and officers   111,975    306    603,502    -    -    -    603,808 
Stock based compensation   -    -    160,613    -    -    -    160,613 
Foreign currency translation loss   -    -    -    -    (549,872)   (27,019)   (576,891)
Net income   -    -    -    (24,298,114)        (735,758)   (25,033,872)
                                    
Balance as of December 31, 2014   5,808,675    15,864    18,719,965    (6,154,770)   3,400,199    1,057,496    17,038,754 
                                    
Issuance of 25,000 shares upon excise of share-based awards   25,000    68    36,182    -    -    -    36,250 
Issuance of 12,000 shares to non-employee   12,000    33    32,307    -    -    -    32,340 
Issuance of 348,800 shares to employee   348,800    953    665,255    -    -    -    666,208 
Issuance of 349,000 options to employees   -    -    113,771    -    -    -    113,771 
Stock based compensation   -    -    243,425    -    -    -    243,425 
Foreign currency translation   -    -    -    -    (411,083)   (50,465)   (461,548)
Net loss   -    -    -    (10,223,130)   -    (139,205)   (10,362,335)
                                    
Balance as of December 31, 2015   6,194,475