ITEM 1A. RISK FACTORS
The following risk
factors apply to the business and operations of the Company. These risk factors are not exhaustive. Investors are encouraged to
perform their own investigation with respect to the business, financial condition and prospects of the Company. You should carefully
consider the following risk factors, as well as the other information included in this Report. In particular, please refer to
the section entitled “Cautionary Note Regarding Forward-Looking Statements.” We may face additional risks and uncertainties
that are not presently known to us, or that we currently deem immaterial, which may also impair our business. The following discussion
should be read in conjunction with the financial statements and notes to the financial statements included herein. For the purposes
of these risk factors, unless otherwise indicated, the term “Borqs” “we,” “us,” “our”
or “the Company” refers to Borqs Technologies, Inc. together with our consolidated subsidiaries and consolidated affiliated
entities.
Risks Related to our Business and Industry
Our future capital needs are uncertain
and our independent registered public accounting firm has expressed in its report on our 2017 audited financial statements a substantial
doubt about our ability to continue as a going concern. Our ability to continue as a going concern is dependent on our ability
to raise additional capital or obtain loans from financial institutions and our operations could be curtailed if we are unable
to obtain the required additional funding when needed. We may not be able to do so when necessary, and/or the terms of any
financings may not be advantageous to us.
Our financial statements
for the year ended December 31, 2017 included in our Annual Report on Form 10-K filed on April 2, 2018, have been prepared assuming
we will continue to operate as a going concern. However, due to our recurring losses from operations, and working capital
deficiency, there is substantial doubt about our ability to continue as a going concern. Because we continue to experience
negative cash flow, our ability to continue as a going concern is subject to our ability to obtain necessary funding from outside
sources, including obtaining additional funding from the sale of our securities, grants or other forms of financing. Our
continued negative cash flow increases the difficulty in completing such sales or securing alternative sources of funding, and
there can be no assurances that we will be able to obtain such funding on favorable terms or at all. If we are unable to
obtain sufficient financing from the sale of our securities or from alternative sources, we may be required to reduce, defer or
discontinue certain of our research and development and operating activities or we may not be able to continue as a going concern.
As a result, our independent registered public accounting firm has expressed in its auditors’ report on the financial statements
included in Item 8 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2017, a substantial doubt regarding
our ability to continue as a going concern. Our financial statements do not include any adjustments that might result from
the outcome of the uncertainty regarding our ability to continue as a going concern. If we cannot continue as a going concern,
our shareholders may lose their entire investment in our ordinary shares. Future reports from our independent registered
public accounting firm may also contain statements expressing doubt about our ability to continue as a going concern.
Due to
liquidity concerns arising from our negative cash flow, we anticipate that we will need to raise additional funds to finance operations.
As
of September 30, 2018, we had accumulated deficit of $74.067 million, net income of $1.185 million and net cash inflow from operation
of $5.973 million for the nine-month period then ended. As of December 31, 2017, we had accumulated deficit of $74.231 million and
suffered net loss of $12.359 million and negative cash flow from operating of $14.939 million for the year then ended. This condition
raises substantial doubt about our ability to continue as a going concern.
To
support our research and development activities and general corporate purposes as well as our pending acquisition of KADI, we
will need to raise additional capital to fund our future operations. Our cash needs will depend on numerous factors, including
our revenues, completion of our product development activities, our ability to realize synergies from the acquisition with KADI,
market acceptance of electric, plug-in electric and fuel cell vehicles, customer and market acceptance and use of our products,
and our ability to reduce and control costs. We expect to devote substantial capital resources to, among other things, fund operations,
and continue research and development programs in China and in India. If we are unable to secure such additional financing, it
will have a material adverse effect on our business and we may have to limit operations in a manner inconsistent with our development
and commercialization plans. If additional funds are raised through the issuance of equity securities or convertible debt securities,
it will be dilutive to our shareholders and could result in a decrease in our stock price.
We
have funded our operations primarily with proceeds from public and private offerings of our ordinary shares and secured and
unsecured debt instruments. Our negative cash flow and cash uses, our projections of the level of cash that will be required
for our operations, the terms of the private placement transactions that we completed in the past, and the restricted
availability of credit for emerging industries, may impair our ability to collect all accounts receivables and seek for
equity and/or debt financing to ensure adequate funding to execute our business plan and reduce our direct costs, such as
sales and marketing, general and administrative, research and development, and other measures, as necessary. However, there
is no assurance that the measures above can be achieved as planned, which would have a material adverse effect on our
business and ability to continue as a going concern.
The agreements governing the loan
facilities we currently have contain restrictions and limitations that could significantly affect our ability to operate our business,
raise capital, as well as significantly affect our liquidity, and therefore could adversely affect our results of operations.
Covenants governing
our loan facilities with SPD Silicon Valley Bank Co., Ltd. (“SSVB”) and Partners For Growth IV, L.P. and Partners
For Growth V, L.P. (collectively “PFG”) restrict, among other things, our ability to:
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pay dividends or
distributions, repurchase or redeem equity;
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incur or permit
to exist any additional indebtedness or liens;
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guarantee or otherwise
become liable with respect to the obligations of another party or entity;
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acquire any assets,
except in the ordinary course of business, or make any investments; and
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sell all or substantially
all of our assets.
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Our ability to comply
with these provisions may be affected by events beyond our control. Although each of SSVB and PFG have consented to our transactions
with Crave/Colmei, KADI, our repurchase of shares from Zhengqi and as to the transactions contemplated by our proposed public
offering, such covenants and obligations are ongoing, any breach of any such covenants or obligations not otherwise waived or
cured could result in a default under the applicable debt obligations and could trigger acceleration of those obligations. In
addition, the loan agreements with SSVB and PFG requires us to satisfy certain financial covenants, including quarterly EBITDA
thresholds. Any defaults under our loan agreements with SSVB and PFG could adversely affect our growth, our financial condition,
our results of operations and our ability to make payments on our debt. The ability to make payments of principal and interest
on indebtedness will depend on our financial condition, which is subject to general economic conditions, industry cycles and financial,
business and other factors affecting our operations, many of which are beyond our control. If sufficient cash flow is not generated
from operations to service such debt, we may be required, among other things, to:
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seek additional
financing in the debt or equity markets;
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delay, curtail or
abandon altogether our research & development or investment plans;
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refinance or restructure
all or a portion of our indebtedness; or
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Such measures might
be insufficient to service the indebtedness. In addition, any such financing, refinancing or sale of assets may not be available
on commercially reasonable terms, or at all. If funds are not available when needed, or available on acceptable terms, we may
be required to delay, scale back or eliminate some of our obligations, including with respect to our commitments in connection
with our investments into KADI and Crave/Colmei, the repurchase of our shares from Zhengqi. In addition, we may not be able to
grow market share, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, which
could negatively impact our business, operating results and financial condition.
Defaults under our loan agreements
with SSVB and PFG and procurement agreement with HHMC Microelectronic Co., Limited could result in a substantial loss of our assets.
We have pledged our
assets as collateral under the loan agreements with SSVB and PFG. Additionally, pursuant to a procurement agreement with HHMC
Microelectronics Co., Limited (“HHMC”), HHMC has the right to take possession of goods purchased on behalf of Borqs
to pay off any advances owed.
The initial term
of the procurement agreement was extended to May 28, 2018. We have not been notified by HHMC that they seek to accelerate the
loan payments and we are currently in discussions with HHMC for another extension. Outstanding loan amounts under revolving
loan facilities we have with SSVB were originally due on February 28, 2019 but were actually payable on demand due to breach
of financial covenants, and we may either extend or refinance the loans. A failure to repay any of the indebtedness under our
agreements with any of our lenders as it becomes due or to otherwise comply with the covenants contained in any of such
agreements could result in an event of default thereunder. If not cured or waived, an event of default under any of such
agreements could enable the lenders thereunder to declare all borrowings outstanding on such debt, together with accrued and
unpaid interest and fees, to be due and payable and terminate all commitments to extend further credit. The lenders could
also elect to foreclose on our assets securing such debt. In such an event, the Company may not be able to refinance or repay
all of its indebtedness, pay dividends or have sufficient liquidity to meet operating and capital expenditure
requirements. Any such acceleration could cause us to lose a substantial portion of our assets and will substantially
adversely affect our ability to continue our operations.
We have in the past failed to comply
with financial covenants in certain of our loan documents, which has resulted in potential defaults under certain of our loan
documents. These and similar breaches of our loan documents in the future could adversely affect our financial condition and our
ability to meet our payment obligations on our indebtedness.
We have in
the past breached certain financial covenants under our loan agreements with SSVB and PFG during 2017 and the period
ended September 30, 2018. Such breach could result in acceleration of the repayment according to the contract term.
Therefore, the outstanding balance of $8.6 million of short-term borrowings payable to SSVB and $5.6 million of long-term
borrowings payable to PFG were payable on demand and classified as current liability as of September 30, 2018. We have not
been notified by either lender that they seek to accelerate the loan payments because of such breaches and neither lender has
expressly waived such breaches and any resulting defaults. We are currently negotiating with both lenders to make
adjustments to the specific financial covenants to more appropriately reflect the business nature of the Company in 2018 and
going forward, particularly allowing for the inclusion of inventories while removing certain non-cash stock based
compensation in deriving the covenant ratios. In the event the lenders choose not to make adjustments to the covenant
ratios and consider the occurrence of these breaches as events of default under our current loan agreements, the lenders may
elect to declare all amounts outstanding to be immediately due and payable and terminate all commitments to extend further
credit to us.
In the event of the
acceleration of our indebtedness or if we are unable to otherwise maintain compliance with covenants set forth in these arrangements
or if these arrangements are otherwise terminated for any reason, management may be forced to make further reductions in spending,
extend payment terms with suppliers, liquidate assets where possible and/or curtail, suspend or cease planned programs or operations
generally, which would have a material adverse effect on our business, results of operations, financial position and liquidity.
If alternative mobile operating
system platforms become more widely used or accepted, or mobile chipset manufacturers, mobile device OEMs and mobile operators
do not continue to make product and service offerings compatible with the Android platform, our business could be materially harmed.
The mobile operating
system platform industry is intensely competitive and characterized by rapid technological changes, which often result in shifts
in market share among the industry’s participants as one operating system may become more widely used than others. For example,
in the past the Symbian mobile operating system platform, or Symbian, from Nokia Corporation, or Nokia, dominated market share
for consumer products and the BlackBerry mobile operating system platform, or BlackBerry, from Research in Motion Limited, or
RIM, dominated market share for enterprise products. In the past five years, with the rise of the iOS mobile operating system
platform, or iOS, from Apple Inc., or Apple, and the Android platform, both the Symbian and Blackberry platforms have experienced
a substantial decline. There can be no assurance that the Android platform will continue to compete effectively with alternative
mobile operating system platforms, such as the iOS platform or Windows Mobile operating system platform, or Windows Mobile, from
Microsoft Corporation. If these or other mobile operating system platforms become more widely used or accepted, such as operating
system platforms being developed by Baidu, Inc., or Baidu, and Alibaba.com Ltd., or Alibaba, in China, the market appeal of the
Android platform and our Android+ software and service platform solutions could be diminished, which could materially adversely
affect our business and financial performance.
Furthermore, the competitiveness
of our Android+ software and service platform solutions is dependent upon the continued compatibility of the Android platform
with the offerings of our customers. If these customers choose not to continue to adopt the Android platform or they are unable
to retain or increase their market share, the demand for our Android+ software and service platform solutions may be diminished,
which could materially adversely affect our business and financial performance.
We generate a significant portion
of our net revenues from a small number of major customers and key projects and any loss of business from these customers or key
projects could reduce our net revenues and significantly harm our business.
We have derived, and
believe that in the foreseeable future we will continue to derive, a significant portion of our net revenues from a small number
of major customers and key projects. Our top five customers in 2015, 2016 and 2017 accounted for 55.3%, 51.7% and 69.3% of our
net revenues in 2015, 2016 and 2017, respectively. Our top five customers in the nine months ended September 30, 2018 accounted for
79.8% of our net revenues during such period.
Our ability to maintain
close relationships with our major customers is essential to the growth and profitability of our business. However, the volume
of work performed for a specific customer is likely to vary from year-to-year and project-to-project, especially since we are
generally not the exclusive Android platform software and service solutions provider for our customers, some of our customers
have in-house research and development capabilities and we do not have long-term purchase commitments from any of our customers.
A major customer in one year may not provide the same level of net revenues for us in any subsequent year. The products we provide
to our customers, and the net revenues and income from those products, may decline or vary as the type and quantity of products
changes over time. In addition, reliance on any individual customer for a significant portion of our net revenues may give that
customer a degree of pricing leverage when negotiating contracts and terms of service with us.
In addition, a number
of factors not within our control could cause the loss of, or reduction in, business or revenues from any customer, and these
factors are not predictable. These factors include, among others, a customer’s decision to re-negotiate the royalty payment
of a contract if the volume of unit sales exceeds original expectations, pricing pressure from competitors, a change in a customer’s
business strategy, or failure of a mobile chipset manufacturer or mobile device OEM to develop competitive products. Our customers
may also choose to pursue alternative technologies and develop alternative products in addition to, or in lieu of, our products,
either on their own or in collaboration with others, including our competitors. The loss of any major customer or key project,
or a significant decrease in the volume of customer demand or the price at which we sell our products to customers, could materially
adversely affect our financial condition and results of operations.
We have limited experience with
our current product offerings, which makes it difficult to predict our future operating results.
From our inception
in 2007 through 2014, we focused primarily on providing our Android+ software platform solutions to mobile chipset manufacturers,
mobile device OEMs and mobile operators as well as complete product solutions of mobile connected devices for enterprise and consumer
applications. In 2014, after acquiring Yuantel Investment, we entered into the MVNO business. As we continue to grow our business
and markets, we plan to increase our service product offerings in both our Connected Solutions BU and MVNO BU. However, the success
of these new product offerings will depend on many factors, including timely and successful research and development, pricing,
market and consumer acceptance of such new products and the product offerings of our competitors. If new product offerings are
not successful, our revenue growth will suffer and our results of operations may be harmed. Further, we do not have significant
experience in the MVNO business and cannot be assured that our investments in the development of our MVNO business will result
in increased revenue.
We provide mobile communication
services as a mobile virtual network operator in China. The current license to operate such services is based on a MVNO license
issued to us in July 2018 by the MIIT which is valid until July 12, 2023. If we cannot maintain this license we will need to cease
operating as a MVNO and our total revenues will be significantly reduced.
In 2014, after acquiring
Yuantel Investment, we entered into the MVNO business. Our MVNO BU contributed 26.6%, 29.1% and 20.8% of our net revenues in 2015,
2016 and 2017, respectively. Our MVNO BU contributed 21.1% of our net revenues for the quarter ended September 30, 2018.
The ability of our
MVNO to provide mobile communication services in China was based on trial licenses granted by the Ministry of Industry and Information
Technology of China (the “MIIT”), under the mobile virtual network trial program initiated by the MIIT in 2013
to implement the Chinese State Council’s encouragement of private investments in various industries, including telecommunication
industry. The trial program and all trial licenses issued thereunder, including our own, were originally set to expire as of December
31, 2015. According to the trial program policies issued by the MIIT, the MIIT will work on formalizing commercial policies regarding
the operation of MVNO based on the development of the trial program. On December 28, 2015, the MIIT issued a notice stating that
while the government is “diligently researching and determining the formal commercial policies regarding the operation of
MVNO, the temporary licenses issued continue to allow MVNO enterprises to operate, and the base telecommunication enterprises
shall continue to provide cooperation, support and maintenance services”, as translated from the MIIT’s notice. All
MVNOs in China, including us, will continue to operate and provide mobile communication services for subscribers based on the
trial licenses.
The MIIT issued a
Notice on the Official Commercial Use of Mobile Communication Resale Business (the “Official Notice”) on April 28,
2018, which took effect on May 1, 2018. The Official Notice requires an enterprise that has obtained a trial license, or the Pilot
Enterprise to execute commercial contracts with a basic telecommunications company and apply for the telecommunications business
license to replace the trial license. The Pilot Enterprise is allowed to continue to carry out its MVNO business during such application
period. According to the Official Notice, the Pilot Enterprise will be ordered to terminate its MVNO business under certain circumstances,
including (1) termination of cooperation between the Pilot Enterprise and the basic telecommunications enterprise resulting in
Pilot Enterprise’s failure to operate its business; (2) failure to obtain the telecommunications business license within
2 years of the date of promulgation of the Official Notice; (3) occurrence of serious telecommunication fraud cases or malignant
group accidents due to the Pilot Enterprise’s malpractice. In addition, the Official Notice requires the MVNO enterprise
to establish network security management systems, deploy corresponding management personnel, implement the real-name registration
for telephone users, protect users’ personal information, effectively implement the prevention and crackdown of communication
information fraud, and standardize its user service agreements and financial management systems. We submitted our application
for the official MVNO license. In July 2018, the MIIT has issued the MVNO license to us which will expire on July 12, 2023. However,
uncertainties exist with respect to the interpretation and implementation of the newly issued Official Notice, and thus we cannot
assure you that we will be able to maintain the MVNO license.
If we cannot maintain
the official MVNO license, we will be forced to cease this operation, and our total revenues will be significantly reduced and
our investment into this business will be completely lost. We rely on China United Network Communications Group Co., Ltd (“China
Unicom”), the incumbent operator, to provide us with attractive and competitive bulk wholesale rates of voice-per-minute
and MB-of-data to compete with our competitors. If we are not provided competitive bulk wholesale rates from China Unicom, we
will not be able to maintain our gross margin and will not be able to operate profitably, which may lead to shutting down the
MVNO BU entirely.
Failure to complete real-name registration
of all users of our MVNO services could subject us to penalties, damage our reputation and brand, and harm our business and results
of operations.
Chinese laws require
telecommunication business operators to verify and register real names and identification information of users of mobile phones.
For example, in September 2016, the MIIT and certain other governmental departments issued the Notice regarding Prevention of
and Cracking Down Telecommunication or Online Frauds to emphasize the real-name registration requirements and to further require
telecommunication business operators, including MVNOs, to complete the real-name registration for all of their existing users
by end of 2016. In August 2016 and February 2017, we were given a warning by the MIIT for our failure to strictly comply with
the real-name registration requirement. We have since rectified such failure in accordance with the MIIT’s requirements
and have also established internal policies and require all our staff to strictly comply with the real-name registration requirements
for new users. However, we cannot assure you that all our staff will strictly implement our internal policies or that all users
will provide authentic information to us. If we are found by the authorities not to comply with the real-name registration requirement,
we may be subject to penalties, or be required to suspend or terminate our MVNO business. In addition, complying with these laws
and regulations could cause us to incur substantial costs.
PRC laws and regulations governing
our businesses and the validity of certain of our contractual arrangements are uncertain. If we are found to be in violation,
we could be subject to sanctions. In addition, changes in PRC laws and regulations or changes in interpretations thereof may materially
and adversely affect our business.
The PRC government
restricts or imposes conditions on foreign investment in telecommunication business. We and our PRC subsidiaries are considered
foreign persons or foreign-invested enterprises under PRC foreign investment related laws. As a result, we are subject to PRC
legal restrictions on or conditions for foreign ownership of telecommunication business. Due to these restrictions and conditions,
we conduct our MVNO business in China through BC-NW, our variable interest entity and the subsidiaries of BC-NW. As all the registered
shareholders of BC-NW are PRC citizens and all other shareholders of the subsidiaries of BC-NW are also PRC citizens or PRC domestic
enterprises, BC-NW and our subsidiaries are therefore considered PRC domestic enterprises under PRC law. The “registered
shareholders” of BC-NW refer to those shareholders who have pledged their equity interest in BC-NW to Borqs Beijing and
entered into exclusive option agreements with Borqs Beijing as part of the contractual arrangements. Our contractual arrangements
with BC-NW and the registered shareholders of BC-NW allow it to have the power to direct the activities of BC-NW and our subsidiaries
that most significantly impact economic performance.
There are substantial
uncertainties regarding the interpretation and application of PRC laws and regulations, including, but not limited to, the laws
and regulations governing the MVNO business, or the enforcement and performance of our contractual arrangements with BC-NW. These
laws and regulations may be subject to change, and their official interpretation and enforcement may involve substantial uncertainty.
New laws and regulations that affect existing and proposed future businesses may also be applied retroactively.
Although we believe
we are in compliance with current PRC laws and regulations, we cannot assure you that the PRC government would agree that our
contractual arrangements comply with PRC licensing, registration or other regulatory requirements, with existing policies or with
requirements or policies that may be adopted in the future. The PRC government has broad discretion in determining penalties for
violations of laws and regulations. If the PRC government determines that we do not comply with applicable law, it could revoke
our business and operating licenses, require us to discontinue or restrict our operations, restrict our right to collect revenues,
block our websites, require us to restructure our operations, impose additional conditions or requirements with which we may not
be able to comply, impose restrictions on our business operations or on our customers, or take other regulatory or enforcement
actions against us that could be harmful to our business. Any of these or similar occurrences could significantly disrupt our
business operations or restrict us from conducting a substantial portion of our business operations, which could materially and
adversely affect our business, financial condition and results of operations. If any of these occurrences results in our inability
to direct the activities of any of our consolidated affiliated entities that most significantly impact our economic performance,
and/or our failure to receive the economic benefits from any of our consolidated affiliated entities, we may not be able to consolidate
such entity in our consolidated financial statements in accordance with U.S. GAAP.
Our MVNO
business is dependent upon China Unicom for voice and data service as well as reliability and accessibility of to China’s
telecommunications and Internet infrastructure.
We
provide our MVNO services via telecommunications and Internet networks, and therefore our ability to fulfill our contracts and
generate revenue and profits is dependent on those systems remaining available and accessible with minimal disruption or interruption.
Just as we are dependent on the reliability of our software and systems and the telecommunications networks of our customers,
we are also dependent on the operational reliability and capacity of China’s overall telecommunications and Internet infrastructure.
Should this infrastructure or key portions of it be disabled or become nonfunctional, we may not be able to secure alternate means
of communication or alternate means of accessing needed information. Our operational results could suffer as a result.
Through
our subsidiary, Yuantel Investment, we purchase wholesale rates for mobile voice and data services from China Unicom, a PRC state-owned
telecommunications service provider, and repackage the voice and data services into competitive bundles for our Chinese customers.
We purchase bulk voice-per-minute and MB-of-data service from China Unicom at attractive wholesale rates pursuant to a Business
Cooperation Agreement with China Unicom dated as of January 10, 2018. The agreement is for a one year term, ending December
31, 2018. There is no guarantee that the supply of telecommunications resources or competitive rates provided by China
Unicom will be renewed when the contract term ends. If the agreement is not renewed, we will not be able to maintain our
gross margin and will not be able to operate profitably, which may lead us to cease operations of the MVNO BU entirely.
We operate in multiple rapidly evolving
industries. If we fail to keep up with technological developments and changing requirements of our customers, business, financial
condition and results of operations may be materially and adversely affected.
The mobile industry
is rapidly evolving and subject to continuous technological developments. Our success depends on our ability to keep up with these
technological developments and the resulting changes in customers’ demands. There may also be changes in the industry landscape
as different types of platforms compete with one another for market share. If we do not adapt our Android+ software and service
platform solutions to such changes in an effective and timely manner as more mobile operating system platforms become available
in the future, we may suffer a loss in market share. Given that we operate in a rapidly evolving industry, we also need to continuously
invest significant resources in research and development in order to enhance our existing products and to respond to changes in
customer preference, new challenges and industry changes in a timely and effective manner. If we fail to keep up with technological
developments and continue to innovate to meet the needs of our customers, our Android+ software and service platform solutions
may become less attractive to customers, which in turn may adversely affect our reputation, competitiveness, results of operations
and prospects.
We face intense competition from
onshore and offshore third party software providers in the Android platform and software market, and, if we are unable to compete
effectively, it may lose customers and our revenues may decline.
The Android platform
and software market is highly fragmented and competitive, and we expect competition to persist and intensify from both existing
competitors and new market entrants. We believe that the principal competitive factors in our industry are reliability and efficiency,
performance, product features and functionality, development complexity and time-to-market, price, support for multiple architectures
and processors, interoperability with other systems, support for emerging industry and customer standards and protocols and levels
of training, technical services and customer support.
Our business model
is to provide a full suite of Android+ software and service platform solutions to a broad range of customers, including mobile
chipset manufacturers, mobile device OEMs and mobile operators. As of the date of this report, we are not aware of any significant
independent competitor that provides a full range of Android platform software and service solutions as we do to the range of
customers it has, although we have a number of competitors that provide one or several Android platform software and/or service
solutions to one or more of our range of customers. See “Business — Competition.”
In addition, we face
competition from companies seeking to compete with the Android platform by developing their own operating systems, such as Baidu
and Alibaba in China, and major mobile device OEMs, such as Foxconn Technology Group and BYD Electronic (International) Company
Limited, which are able to develop low-level software for mobile chipsets, as well as Huawei, GTE and Xiaomi.
We believe that we
presently compete favorably with respect to each segment identified above. However, the market for Android platform software and
service solutions is still rapidly evolving, and we may not be able to compete successfully against current and potential competitors
in the future. In addition, some of our independent competitors are more focused on one or several particular segments of the
value chain and may deliver better services in those segments than we do. Furthermore, some of our competitors may have significantly
greater financial, technical, marketing, sales and other resources and significantly greater name recognition than we have. If
we are unable to compete successfully on the principal competitive factors described above or otherwise, our business could be
harmed.
As an MVNO, we face intense competition
in the wireless communications market and if we cannot compete effectively our revenues, profits, cash flows and growth may be
adversely affected.
The wireless communications
market is extremely competitive, and competition for customers is increasing. We compete with other MVNOs such as Snail Mobile,
d.Mobile and Soshare. We are one of the top MVNOs in China as measured in terms of registered subscribers, and we intend to expand
our market share organically or by acquiring smaller MVNOs. However, we continue to face intense competition from the dozens of
other MVNOs and we may not be able to compete successfully in the future. In addition, continued consolidation in the industry
creates even large competitors, and such competitors may have greater financial, technical, personnel and marketing resources
and a larger market share than us, and we may not be able to compete successfully against them. If we are unable to compete successfully
on the principal competitive factors described above or otherwise, our MVNO business could be harmed.
We may undertake acquisitions, investments,
joint ventures or other strategic alliances in the future, which could expose us to new operational, regulatory and market risks.
In addition, such future and past undertakings may not be successful, which may adversely affect our business, results of operations,
financial condition and prospects.
We intend to grow
both organically by expanding our current business lines and geographic coverage and through acquisitions, investments, joint
ventures or other strategic alliances if the appropriate opportunities arise. These potential business plans, acquisitions, investments,
joint ventures and strategic alliances may expose us to new operational, regulatory and market risks, as well as risks associated
with additional capital requirements. In addition, we may not be able to identify suitable future acquisition or investment candidates
or joint venture or alliance partners. Even if we identify suitable candidates or partners, we may be unable to complete an acquisition,
investment or alliance on terms commercially acceptable to us. If we fail to identify appropriate candidates or partners, or complete
desired acquisitions, investments or alliances, including but not limited to the proposed KADI acquisition, we may not be able
to implement our strategies effectively or efficiently.
In addition, our ability
to successfully integrate acquired companies and their operations may be adversely affected by a number of factors, including,
among others, the ability to capitalize on anticipated synergies, diversion of resources and management’s attention, difficulties
in retaining personnel of the acquired companies, unanticipated problems or legal liabilities and tax and accounting issues. If
we fail to integrate any acquired company efficiently, our earnings, revenues, gross margins, operating margins and business operations
could be adversely affected. The integration of acquired companies is a complex, time-consuming and expensive process.
We are dependent upon the Android
platform and, if Google determines to no longer develop the Android platform and our further development is not taken up by reliable
alternative sources, our business could be materially harmed.
Our business model
is dependent upon the Android platform, which is a free and fully open source mobile software platform developed by Google. The
Android platform has been updated frequently since our original release and the development of the Android platform is an ongoing
process which we do not control. If Google determines to no longer develop the Android platform or our further development is
not taken up by reliable alternative sources, such as another third party or the open source community, demand for our Android+
software and service platform solutions could decline significantly and our revenue and financial condition could be materially
harmed.
If our customers move more research
and development work in-house, lower demand for our solutions could reduce our net revenues and harm our business.
Collaboration with
customers is essential to the growth and profitability of our business. However, our customers may elect to move more research
and development work in-house, and reduce collaboration with us for Android platform projects. There are many factors beyond our
control that could cause our customers to move their work in-house, such as spending reductions due to a challenging economic
environment, corporate restructuring, cost control, pricing pressure and concerns regarding the protection of technology know-how,
trade secrets and other intellectual property rights. If our customers decide to change their strategy by moving more research
and development work in-house, our net revenues may decline, and our business, financial condition and results of operations may
be adversely affected.
Our quarterly results may fluctuate
significantly and may not fully reflect the underlying performance of our business.
Our quarterly operating
results, including the levels of our revenue, gross margin, profitability, cash flow and deferred revenue, may vary significantly
in the future, and period-to-period comparisons of our operating results may not be meaningful. Accordingly, the results of any
one quarter should not be relied upon as an indication of future performance. Our quarterly financial results may fluctuate as
a result of a variety of factors, many of which are outside of our control and, as a result, may not fully reflect the underlying
performance of our business. Fluctuations in quarterly results may negatively impact the value of our ordinary shares. Factors
that may cause fluctuations in our quarterly financial results include, but are not limited to:
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our ability to attract new customers;
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our ability to convert users of our limited
free versions to paying customers;
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the addition or loss of large customers, including
through acquisitions or consolidations;
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our customer retention rate;
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the timing of recognition of revenue;
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the amount and timing
of operating expenses related to the maintenance and expansion of our business, operations and infrastructure;
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network outages or security breaches;
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general economic, industry and market conditions;
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increases or decreases
in the number of features in our services or pricing changes upon any renewals of customer agreements;
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changes in our pricing
policies or those of our competitors;
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the timing and success
of new services and service introductions by us and our competitors or any other change in the competitive dynamics of our
industry, including consolidation among competitors, customers or strategic partners; and
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the timing of expenses
related to the development or acquisition of technologies or businesses and potential future charges for impairment of goodwill
from acquired companies.
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If we fail to effectively manage
our technical operations infrastructure, our customers may experience service outages and delays in the further deployment of
our services, which may adversely affect our business.
We have experienced
significant growth in the number of users and the amount of data that our operations infrastructure supports. We seek to maintain
sufficient excess capacity in our operations infrastructure to meet the needs of all of our customers. We also seek to maintain
excess capacity to facilitate the rapid provisioning of new customer deployments and the expansion of existing customer deployments.
In addition, we need to properly manage our technological operations infrastructure in order to support version control, changes
in hardware and software parameters and the evolution of our services. However, the provision of new hosting infrastructure requires
significant lead-time. We have experienced, and may in the future experience, website disruptions, outages and other performance
problems. These problems may be caused by a variety of factors, including infrastructure changes, human or software errors, viruses,
security attacks, fraud, spikes in customer usage and denial of service issues. In some instances, we may not be able to identify
the cause or causes of these performance problems within an acceptable period of time, which may harm our reputation and operating
results. Furthermore, if we do not accurately predict our infrastructure requirements, our existing customers may experience service
outages that may subject us to financial penalties, financial liabilities and customer losses. If our operations infrastructure
fails to keep pace with increased sales, customers may experience delays as we seek to obtain additional capacity, which could
adversely affect our reputation and our revenue.
Most of our engagements with customers
are for a specific project only and do not provide for subsequent engagements. If we are unable to generate a substantial number
of new engagements for projects on a continuing basis, our business and results of operations will be adversely affected.
Our customers
generally retain us on project-by-project basis in connection with specific projects rather than on a recurring basis under
long-term contracts. Historically, a significant portion of our net revenues has been comprised of software fees, relating to
one-time research and engineering work performed for customers. For 2015, 2016 and 2017, our net revenues from software fees
were $22.5 million, $14.9 million and $11.2 million, respectively, representing 29.9%, 12.4% and 7.3% of total net revenues.
For the nine months ended September 30, 2018, our net revenues from software fees were $5.6 million, representing 3.9%
of total net revenues. Although a significant amount of our net revenues are generated from repeat business, which we define
as revenues from a customer who also contributed to our revenues during the prior fiscal year, our engagements with
our customers are typically for individual projects that are often on a non-exclusive, project-by-project basis. In addition,
a majority of our customer contracts from which we generate product fees can be terminated by customers with or without
cause. There are many factors outside of our control that might lead customers to terminate a contract or project with
us, including, among others:
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financial difficulties
for our customers;
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business going to
our competitors or remaining in-house;
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unsuccessful launch
of a product;
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disclosure of core
technology by a third party; and
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mergers and acquisitions
or significant corporate restructurings by our customers.
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Furthermore, some
of our customer contracts specify that if a change of control occurs during the term of the contract, the customer has the right
to terminate the contract upon advance notice. If our customers terminate our contracts before completion or choose not to renew
their contracts, our business, financial condition and results of operations may be materially and adversely affected.
Therefore, we have
to continuously seek new engagements while our current engagements are being performed or are completed or terminated, and we
are constantly seeking to expand our business with existing customers and secure new customers. If we are unable to generate a
substantial number of new engagements on a continuing basis, our business and results of operations will be adversely affected.
Because of the characteristics of
open source software, there may be fewer technology barriers to entry in the Android platform and software market in which we
compete, and it may be relatively easy for competitors, some of which may have greater resources than we have, to enter our markets
and compete with us.
One of the characteristics
of open source software is that anyone can modify and redistribute the existing open source software and use it to compete against
us. Such competition can develop without the degree of overhead and lead time required by traditional proprietary software companies.
It is possible for new competitors with greater resources than us to develop their own Android platform software and service solutions,
potentially reducing the demand for, and putting pricing pressure on, our Android+ software and service platform solutions. In
addition, some competitors make their open source software available for free download and use on an
ad hoc
basis, or may
position their open source software as a loss leader in order to win customers. There can be no assurance that we will be able
to compete successfully against current and future competitors or that competitive pressure and/or the availability of open source
software will not result in price reductions, reduced operating margins and loss of market share, any of which could seriously
harm our business.
Security and privacy breaches may
expose us to liability and harm our reputation and business.
As part of our business
we receive and process information about our employees, customers and partners, and we may store (or contract with third parties
to store) our customers’ data. There are numerous laws governing privacy and the storage, sharing, use, disclosure and protection
of personally identifiable information and user data. Specifically, personally identifiable and other confidential information
is increasingly subject to legislation and regulations in numerous domestic and international jurisdictions. The regulatory framework
for privacy protection in China and worldwide is currently evolving and is likely to remain uncertain for the foreseeable future.
We could be adversely affected if legislation or regulations in China and elsewhere on the world where we have business operations
are expanded to require changes in business practices or privacy policies, or if the relevant governmental authorities in China
and elsewhere on the world where we have business operations interpret or implement their legislation or regulations in ways that
negatively affect our business, financial condition and results of operations. For example, in November 2016, China released the
Cybersecurity Law, which took effect in June 2017. The Cybersecurity Law requires network operators to perform certain functions
related to cybersecurity protection and the strengthening of network information management. For instance, under the Cybersecurity
Law, network operators of key information infrastructure, including network operators of key information infrastructures in public
communications and information industry, generally shall, during their operations in the PRC, store the personal information and
important data collected and produced within the territory of the PRC and their purchase of network products and services that
may affect national securities shall be subject to national cybersecurity review. While we take security measures relating to
our Android+ software and service platform solutions, specifically, and our operations (including MVNO business operation), generally,
those measures may not prevent security breaches that could harm our business and we cannot assure you that the measures we have
taken or will take are adequate under the Cybersecurity Law and other relevant laws and regulations. Advances in computer capabilities,
inadequate technology or facility security measures or other factors may result in a compromise or breach of our systems and the
data we store and process. Our security measures may be breached as a result of actions by third parties or employee error or
malfeasance. A party who is able to circumvent our security measures or exploit inadequacies in our security measures, could,
among other things, misappropriate proprietary information (including information about our employees, customers and partners
and our customers’ information), cause the loss or disclosure of some or all of this information, cause interruptions in
our operations or our customers’ or expose our customers to computer viruses or other disruptions or vulnerabilities. Any
compromise of our systems or the data it stores or processes could result in a loss of confidence in the security of our Android+
software and service platform solutions, damage our reputation, disrupt our business, lead to legal liability and adversely affect
our financial condition and results of operations. Moreover, a compromise of our systems could remain undetected for an extended
period of time, exacerbating the impact of that compromise. Actual or perceived vulnerabilities may lead to claims against us
by our customers, partners or other third parties, which could be material. While our customer agreements typically contain provisions
that seek to limit our liability, there is no assurance these provisions will be enforceable and effective under applicable law.
In addition, the cost and operational consequences of implementing further data protection measures could be significant.
We are vulnerable to technology
infrastructure failures, which could harm our reputation and business.
We rely on our technology
infrastructure for many functions, including selling our Android+ software and service platform solutions, supporting our customers
and billing, collecting and making payments. We also rely on our own technology infrastructure, which is located on a third-party
site, as well as the technology infrastructure of third parties, to provide some of our back-end services. This technology infrastructure
may be vulnerable to damage or interruption from natural disasters, power loss, telecommunication failures, terrorist attacks,
computer intrusions and viruses, software errors, computer denial-of-service attacks and other events. A significant number of
the systems making up this infrastructure are not redundant, and our disaster recovery planning is not sufficient for every eventuality.
This technology infrastructure is also subject to break-ins, sabotage and intentional acts of vandalism by internal employees,
contractors and third parties. Despite any precautions we or our third-party partners may take, such problems could result in,
among other consequences, interruptions in our services and loss of data, which could harm our reputation, business and financial
condition. We do not carry business interruption insurance sufficient to protect us from all losses that may result from interruptions
in our services as a result of technology infrastructure failures or to cover all contingencies. Any interruption in the availability
of our websites and on-line interactions with customers and partners would create a large volume of questions and complaints that
would need to be addressed by our support personnel. If our support personnel cannot meet this demand, customer and partner satisfaction
levels may fall, which in turn could cause additional claims, reduced revenue, reputation damage or loss of customers.
We may not be able to continue to
use or adequately protect our intellectual property rights, which could harm our business reputation and competitive position.
Although Android is
an open source mobile software platform for mobile devices, we are not required to share the source code for our Android software,
which we have invested significant resources to develop. Accordingly, we believe that patents, trademarks, trade secrets, copyright,
software registration and other intellectual property we use are important to our business. We rely on a combination of patent,
trademark, copyright, software registration and trade secret protection laws in China and other jurisdictions, as well as confidentiality
procedures and contractual provisions to protect our intellectual property and brand name. Any failure by us to maintain or protect
our intellectual property rights, including any unauthorized use of our intellectual property by third parties or use of “Borqs”
as a company name to conduct software or services business, may adversely affect our current and future revenues and our reputation.
In addition, the validity,
enforceability and scope of protection available under intellectual property laws with respect to the mobile and Internet industries
in China, where a significant part of our business and operations are located, are uncertain and still evolving. Implementation
and enforcement of PRC intellectual property-related laws have historically been deficient, ineffective and hampered by corruption
and local protectionism. Accordingly, protection of intellectual property rights in China may not be as effective as in the United
States or other 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.
We also may be required
to enter into license agreements with certain third parties to use their intellectual property for our business operations. If
such third parties fail to perform under these license agreements or if the agreements are terminated for any reason, our business
and results of operations may be negatively impacted. Furthermore, if we are deemed to be using third parties’ intellectual
property without due authorization, we may become subject to legal proceedings or sanctions, which may be time-consuming and costly
to defend, divert management attention and resources or require us to enter into licensing agreements, which may not be available
on commercial terms, or at all.
The international nature of our
business exposes it to risks that could adversely affect our financial condition and results of operations.
We conduct our business
throughout the world in multiple locations. Our corporate structure also spans multiple jurisdictions, with our parent holding
company incorporated in the British Virgin Islands and intermediate and operating subsidiaries incorporated in China, Hong Kong,
India and Brazil, with branch offices in Japan and South Korea. In addition, one of our growth strategies is to further expand
our business in Europe and into the United States. As a result, we are exposed to risks typically associated with conducting business
internationally, many of which are beyond our control. These risks include, among others:
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significant currency
fluctuations between the Renminbi and the U.S. dollar and other currencies in which we transact business;
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difficulty in identifying
appropriate mobile chipset manufacturers, mobile device OEMs, mobile operators and/or joint venture partners, and establishing
and maintaining good relationships with them;
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legal uncertainty
owing to the overlap and inconsistencies of different legal regimes, problems in asserting contractual or other rights across
international borders and the burden and expense of complying with the laws and regulations of various jurisdictions;
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potentially adverse
tax consequences, such as scrutiny of transfer pricing arrangements by authorities in the countries in which we operate;
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adverse effect of
inflation and increase in labor costs;
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current and future
tariffs and other trade barriers, including restrictions on technology and data transfers;
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general global economic
downturn;
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unexpected changes
in political environment and regulatory requirements; and
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terrorist attacks
and other acts of violence or war.
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The occurrence of
any of these events could have a material adverse effect on our results of operations and financial condition.
Furthermore, we are
in the process of implementing policies and procedures designed to facilitate compliance with laws and regulations in various
jurisdictions applicable to us, but there can be no assurance that our employees, contractors or agents will not violate such
laws and regulations or our policies. Any such violations could, individually or in the aggregate, materially and adversely affect
our financial condition and operating results.
We may not be able to manage our
anticipated growth and our current and planned resources may not be adequate to support our expanding operations; consequently,
our business, results of operations and prospects may be materially and adversely affected.
We have experienced
rapid growth since we commenced operations. Our rapid expansion may expose us to new challenges and risks. To manage the further
expansion of our business and the growth of our operations and personnel, we need to continuously expand and enhance our infrastructure
and technology, and improve our operational and financial systems and procedures and controls. For example, we currently manage
all of our human resources functions manually and expect that we will need to upgrade our current system as we continue to increase
our headcount. We also need to expand, train and manage our growing employee base. In addition, our management will be required
to obtain, maintain or expand relationships with mobile chipset manufacturers, mobile device OEMs and mobile operators, as well
as other third-party business partners. We cannot assure you that our current and planned personnel, infrastructure, systems,
procedures and controls will be adequate to support our expanding operations. If we fail to manage our expansion effectively,
our business, results of operations and prospects may be materially and adversely affected.
Due to intense competition for highly
skilled personnel, we may fail to attract and retain qualified personnel to support our research and development operations; as
a result, our ability to bid for and obtain new projects may be adversely affected and our net revenues could decline.
The mobile industry
relies on the talents and efforts of highly skilled personnel, and our success depends to a significant extent on our ability
to recruit, train, develop, retain and motivate qualified personnel for all areas of our organization. The mobile industry in
China has experienced significant levels of employee attrition. Our attrition rates were 18% in 2015, 12% in 2016 and 14% in 2017.
We may encounter higher attrition rates in the future, particularly if the mobile industry continues to experience strong growth.
Competition in our
industry for qualified employees, especially technical employees, is intense, and our competitors directly target our employees
from time to time. We have also experienced employees leaving us to start competing businesses or to join the in-house research
and development teams of our customers. The loss of the technical knowledge and industry expertise of any of these individuals
could seriously impede our success. Moreover, the loss of these individuals, particularly to a competitor, some of which are in
a position to offer greater compensation, and any resulting loss of customers or trade secrets and technological expertise could
further lead to a reduction in our market share and adversely affect our business. If we are required to increase the compensation
payable to our qualified employees to compete with certain competitors with greater resources than we have or to discourage employees
from leaving us to start competing businesses, our operating expenses will increase which, in turn, will adversely affect our
results or operations.
Our success depends substantially
on the continuing efforts of our senior executives and other key personnel, and our business may be severely disrupted if we lose
their services.
Our future success
heavily depends upon the continued services of our senior executives and other key employees. In particular, we rely on the expertise,
experience, customer relationships and reputation of Pat Chan, our founder, chairman and chief executive officer. We currently
do not maintain key man life insurance for any of the senior members of our management team or other key employees. If one or
more of our senior executives or key employees are unable or unwilling to continue in their present positions, it could disrupt
our business operations, and we may not be able to replace them easily or at all. In addition, competition for senior executives
and key employees in our industry is intense, and we may be unable to retain our senior executives and key employees or attract
and retain new senior executive and key employees in the future, in which case our business may be severely disrupted, and our
financial condition and results of operations may be materially and adversely affected.
If any of our senior
executives or key employees joins a competitor or forms a competing company, it may lose customers, know-how and other key employees
and staff members to them. Also, if any of our business development managers, who generally keep a close relationship with our
customers, joins a competitor or forms a competing company, we may lose customers, and our net revenues may be materially and
adversely affected. Additionally, there could be unauthorized disclosure or use of our technical knowledge, practices or procedures
by such employees. All of our executives and key employees have entered into employment agreements with us that contain non-competition
provisions, non-solicitation and nondisclosure covenants. However, if any dispute arises between our executive officers or key
employees and us, such non-competition, non-solicitation and nondisclosure provisions might not provide effective protection to
us, especially in China, where most of these executive officers and key employees reside, in light of the uncertainties with China’s
legal system. See “Risk Factors — Risks Related to Doing Business in China — Uncertainties with respect to the
PRC legal system could harm us.”
A significant majority of our outstanding
ordinary shares are held by a small number of shareholders, which may have significantly greater influence on us due to the size
of their shareholdings relative to other shareholders.
As of September 30,
2018, Zhengqi International Holding Limited, Intel Capital Corporation, Norwest Venture Partners X, L.P., Asset Horizon International
Limited, Keytone Ventures L.P., and GSR Ventures II and affiliates, beneficially own approximately 11.0%, 12.8%, 11.3%, 11.1%
10.2%, and 8.8% respectively, of our outstanding ordinary shares. These major shareholders have significant influence in determining
the outcome of any corporate transactions or other matters submitted to our shareholders for approval, including mergers, consolidations
and schemes of arrangement, election and removal of directors and other significant corporate actions. They may not act in our
best interests or our minority shareholders’ interests. In addition, without the consent of these major shareholders, we
could be prevented from entering into transactions that could be beneficial to us. This concentration of ownership may also discourage,
delay or prevent a change in control, which could deprive our shareholders of an opportunity to receive a premium for their shares
as part of a sale of our company and might reduce the price of our ordinary shares. These actions may be taken even if they are
opposed by our other shareholders.
In the course of preparing our consolidated
financial statements, we identified material weaknesses, significant deficiencies and other deficiencies in our internal controls
over financial reporting.
Prior to our acquisition
of Borqs International by way of merger, Borqs International was a private company with limited accounting personnel and other
resources with which to address our internal controls and procedures for financial reporting. As of December 31, 2017, we identified
a material weakness in our internal controls over financial reporting, and are in the process of implementing remedial steps to
improve our internal controls over financial reporting. If we fail to timely achieve and maintain the adequacy of our internal
controls, we may not be able to conclude that we have effective internal control over financial reporting. Moreover, effective
internal control over financial reporting is necessary for us to produce reliable financial reports and is important to help prevent
fraud. If we fail to maintain effective internal control over financial reporting, investors could lose confidence in the reliability
of our financial statements, which could harm our business and the trading price of our ordinary shares. For instance, on September
25, 2017, we received a letter from Zhengqi International Holding Limited (“Zhengqi”), which stated that Zhengqi believed
the Company had supplied to it material untrue and falsified financial statement information. Zhengqi also alleged it was damaged
by the alleged untrue and falsified financial statement information. We concluded that the allegations by Zhengqi were unfounded,
and responded on October 9, 2017, seeking additional information. Zhengqi has not responded to our inquiry. In addition, we anticipate
that we will incur considerable costs and devote significant management time and efforts and other resources to our efforts to
maintain effective internal control over financial reporting.
Our management is
responsible for establishing and maintaining adequate internal controls over financial reporting. Our internal controls over financial
reporting is a process designed under the supervision of our Chief Executive Officer and Chief Financial Officer to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of our consolidated financial statements for external
reporting purposes in accordance with U.S. generally accepted accounting principles.
We identified two
material weaknesses in internal controls over financial reporting during our preparation of the financial statements for the fiscal
year ended December 31, 2016: (i) an insufficient number of financial reporting personnel with an appropriate level of knowledge
and experience in U.S. GAAP and SEC reporting requirements and financial reporting programs; and (ii) insufficient controls to
ensure that appropriate accruals are made for expenses. Since then, the Company has undertaken or is in the process of undertaking
certain remedial steps to improve its internal controls over financial reporting.
Following the above-mentioned
efforts, as of December 31, 2017, based on an assessment performed by our management on the performance of the remediation measures
described above, we determined that the material weakness in providing for effective accruals in internal control over financial
reporting had been remediated. However the material weakness relating to hiring sufficient U.S. GAAP-qualified accounting personal
had not yet been fully remediated. We plan to take additional measures to improve our internal control over financial reporting,
including (i) hiring additional qualified professionals with U.S. GAAP accounting experience in the year 2018; (ii) providing
U.S. GAAP and SEC reporting training to our accounting personnel; and (iii) preparing a comprehensive written accounting policies
and procedures manual that can effectively and efficiently guide our finance and accounting personnel in addressing significant
accounting issues and preparing financial statements that are in compliance with U.S. GAAP and SEC requirements. In addition,
we intend to engage an external service provider by the end of 2018 to assist management in evaluating our current internal control
over financial reporting and implementing necessary controls and measures to assist it in preparing for compliance with internal
control reporting.
If we fail to maintain effective
internal controls over financial reporting, we may not be able to accurately and timely report our financial results or prevent
fraud, and investor confidence and the market price of our ordinary shares may be adversely impacted.
We are required to
evaluate the effectiveness of disclosure controls and procedures and internal controls over financial reporting. Any failure to
develop or maintain effective controls or any difficulties encountered in their implementation or improvement could harm our operating
results or cause us to fail to meet our reporting obligations and may result in a restatement of our financial statements for
prior periods. Any failure to implement and maintain effective internal controls over financial reporting also could adversely
affect the results of periodic management evaluations and annual independent registered public accounting firm attestation reports
regarding the effectiveness of our internal controls over financial reporting that we will eventually be required to include in
our periodic reports that will be filed with the SEC. As described elsewhere in our Annual Report on Form 10-K for the year ended
December 31, 2017, we have identified a material weakness in our internal controls over financial reporting. If we fail to timely
achieve and maintain the adequacy of our internal controls, we may not be able to conclude that we have effective internal controls
over financial reporting. Additionally, such weaknesses in internal controls has adversely affected our disclosure controls and
procedures, and as of December 31, 2017, such disclosure controls and procedures were ineffective. Ineffective disclosure controls
and procedures and internal controls over financial reporting could also cause material misstatements in our financial statements
and investors to lose confidence in our reported financial and other information, which could have a negative effect on the trading
price of our ordinary shares.
Our independent registered
public accounting firm is not required to attest to and report on the effectiveness of our internal controls over financial reporting
until after we are no longer an emerging growth company. At that time, our independent registered public accounting firm may issue
a report that is adverse in the event it is not satisfied with the level at which our internal controls over financial reporting
is documented, designed, or operating. Failing to maintain effective disclosure controls and internal controls over financial
reporting could have a material and adverse effect on our business and operating results and could cause a decline in the price
of our ordinary shares. In addition, if we are unable to continue to meet these requirements, we may not be able to remain listed
on the Nasdaq Stock Market.
We are subject to various anti-corruption
and anti-bribery laws, including the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act, and PRC and Indian anti-corruption
and anti-bribery laws; any determination that we have violated such laws could damage our business and reputation, limit our ability
to bid for certain business opportunities, and subject us to significant criminal and civil penalties, civil litigation (such
as shareholder derivative suits), and commercial liabilities.
We are subject to
anti-corruption and anti-bribery laws in the United States, United Kingdom, China, and India that prohibit certain improper payments
made directly or indirectly to government departments, agencies, and instrumentalities; officials of those government departments,
agencies, and instrumentalities; political parties and their officials; candidates for political office; officials of public international
organizations; persons acting on behalf of the foregoing; and commercial counterparties. These laws include the U.S. Foreign Corrupt
Practices Act, the U.K. Bribery Act 2010, the PRC Criminal Law, the PRC Anti-Unfair Competition Law, the Indian Prevention of
Corruption Act 1988, the Indian Penal Code and anti-corruption laws in various Indian states.
We are engaged in
business in a number of countries that are regarded as posing significant risks of corruption. Of particular note, we conduct
operations, have agreements with state-controlled enterprises and other third parties and make sales in the PRC, and we have research
and development activities in India, each of which may be exposed to corruption risk. It is our policy to implement safeguards
and procedures to prohibit these practices by our employees, officers, directors, or by third parties acting on our behalf. However,
we cannot rule out the risk that any of our employees, officers, directors, or third parties acting on our behalf may engage in
breaches of our policies or anti-corruption laws, for which we might be held responsible.
Allegations of violations
of these anti-corruption and anti-bribery laws, and investigation into such allegations, could negatively affect our reputation,
business, operating results, and financial condition. The violation of these laws may result in substantial monetary and even
criminal sanctions, follow-on civil litigation (such as shareholder derivative suits), and monitoring of our compliance program
by the United States or other governments, each of which could negatively affect our reputation, business, operating results,
and financial condition. In addition, the United States or other governments may seek to hold us liable for violations of these
laws committed by companies in which we invest or acquire.
There can be no assurance that our
securities, including our ordinary shares, will continue to be listed on Nasdaq or, if listed, that we will be able to comply
with the continued listing standards of Nasdaq, which could limit investors’ ability to make transactions in our securities
and subject us to additional trading restrictions.
To continue listing
our ordinary shares on The Nasdaq Stock Market, we will be required to demonstrate compliance with Nasdaq’s continued listing
requirements, particularly the requirement to maintain a minimum number of holders (300 round-lot holders). We were previously
not in compliance with Nasdaq’s listing requirement that we have at least 300 round-lot shareholders but regained compliance
with this requirement on April 12, 2018 by implementing a restricted shares purchase program with eligible employees of Borqs
Software Solutions Private Ltd., our wholly-owned subsidiary in India, pursuant to which 222 employees voluntarily purchased an
aggregate of 29,170 ordinary shares at a purchase price of $9.40 per share. Program participants paid for their purchase of shares
by having the purchase amounts deducted from their regular compensation on March 23, 2018. On April 12, 2018, Nasdaq informed
us that we had regained compliance with the listing requirement of 300 round lot holders and that our ordinary shares would continue
to be listed on Nasdaq.
On December 11, 2017,
Nasdaq advised the Company that it had determined to delist the Company’s public warrants. Our public warrants have been
trading on the OTC Markets system under the symbol “BRQSW” since October 23, 2017. Our ordinary shares have continued
to trade on Nasdaq regardless of the Panel’s decision to delist our public warrants.
We cannot assure you
that we will be able to meet Nasdaq’s continued listing requirement or maintain other listing standards. If our ordinary
shares are delisted by Nasdaq, and we are not able to list our securities on another national securities exchange, we expect our
securities could be quoted on an over-the-counter market. If this were to occur, then, as with our public warrants, which have
been delisted from Nasdaq and are trading on the OTC Markets, we could face significant material adverse consequences, including:
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less liquid trading
market for our securities;
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more limited market
quotations for our securities;
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determination that
our ordinary shares and/or warrants are a “penny stock” that requires brokers to adhere to more stringent rules
and possibly resulting in a reduced level of trading activity in the secondary trading market for our securities;
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more limited research
coverage by stock analysts;
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loss of reputation;
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more difficult and
more expensive equity financings in the future.
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The National Securities
Markets Improvement Act of 1996, which is a federal statute, prevents or preempts the states from regulating the sale of certain
securities, which are referred to as “covered securities.” If our ordinary shares remain listed on NASDAQ, our ordinary
shares will be covered securities. Although the states are preempted from regulating the sale of our securities, the federal statute
does allow the states to investigate companies if there is a suspicion of fraud, and, if there is a finding of fraudulent activity,
then the states can regulate or bar the sale of covered securities in a particular case. If our securities were no longer listed
on Nasdaq and therefore not “covered securities”, we would be subject to regulation in each state in which we offer
our securities.
We may, from time to time, be involved in future litigation
in which substantial monetary damages are sought.
We may from time to
time be involved in future litigation in which substantial monetary damages are sought. Litigation claims may relate to intellectual
property, contracts, employment, securities and other matters arising out of the conduct of our current and past business activities.
For instance, we are currently in arbitration with Samsung Electronics Co., Ltd. (“Samsung”) to resolve a dispute
regarding royalties payable to us under a software license agreement we had with Samsung. Samsung alleges that, for the period
starting the fourth quarter of 2010 through mid-2012, we were overpaid royalties in the amount of approximately $1.67 million
due to a clerical error in their accounting department that enabled us to receive royalties on sales of Samsung handsets that
did not contain our software. Samsung is seeking repayment of the $1.67 million plus accrued interest of 12% per annum and as
well as reimbursements of reasonable fees including attorney fees and arbitration costs. After arbitration hearings that were
held in May 2018, the parties are awaiting a ruling from the arbitrator on Samsung’s claim and the result is unpredictable.
Any claims, whether with or without merit, could be time consuming, expensive to defend and could divert management’s attention
and resources. We may maintain insurance against some, but not all, of these potential claims, and the levels of insurance we
do maintain may not be adequate to fully cover any and all losses. Nonetheless, the results of any future litigation or claims
are inherently unpredictable, and such outcomes could have a material adverse effect on our results of operations, cash from operating
activities or financial condition.
Risks Related to Doing Business in
China
China’s economic, political
and social conditions, as well as changes in any government policies, laws and regulations, could have a material adverse effect
on our business.
A substantial portion
of our operations are conducted in China, and a significant portion of our net revenues are derived from customers where the contracting
entity is located in China. Accordingly, our business, financial condition, results of operations, prospects and certain transactions
we may undertake are subject, to a significant extent, to economic, political and legal developments in China.
China’s economy
differs from the economies of most developed countries in many respects, including the amount of government involvement, level
of development, growth rate, control of foreign exchange and allocation of resources. While the PRC economy has experienced significant
growth in the past two to three decades, growth has been uneven, both geographically and among various sectors of the economy.
Demand for our services and products depends, in large part, on economic conditions in China. Any slowdown in China’s economic
growth may cause our potential customers to delay or cancel their plans to purchase our services and products, which in turn could
reduce our net revenues.
Although China’s
economy has been transitioning from a planned economy to a more market-oriented economy since the late 1970s, the PRC government
continues to play a significant role in regulating industry development by imposing industrial policies. The PRC government also
exercises significant control over China’s economic growth through allocating resources, controlling the incurrence and
payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular
industries or companies. Changes in any of these policies, laws and regulations could adversely affect the economy in China and
could have a material adverse effect on our business.
The PRC government
has implemented various measures to encourage foreign investment and sustainable economic growth and to guide the allocation of
financial and other resources, which have for the most part had a positive effect on our business and growth. However, we cannot
assure you that the PRC government will not repeal or alter these measures or introduce new measures that will have a negative
effect on us. China’s social and political conditions may also not be as stable as those of the United States and other
developed countries. Any sudden changes to China’s political system or the occurrence of widespread social unrest could
have a material adverse effect on our business and results of operations.
Uncertainties with respect to the
PRC legal system could harm us.
Our operations in
China are governed by PRC government laws and regulations. The PRC legal system is a civil law system based on written statutes.
Unlike common law systems, prior court decisions have limited precedential value. Borqs Beijing is generally subject to laws and
regulations applicable to foreign investments in China and, in particular, laws applicable to wholly foreign-owned enterprises,
and our other wholly-owned subsidiaries in China may be subject to certain laws and regulations in connection with investments
made by foreign-invested enterprises.
Since 1979, PRC legislation
and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However,
China has not developed a fully integrated legal system and recently-enacted laws and regulations may not sufficiently cover all
aspects of economic activities in China. In particular, because these laws and regulations are relatively new, and because of
the limited volume of published decisions and their nonbinding nature, the interpretation and enforcement of these laws and regulations
involve uncertainties. In addition, the PRC legal system is based in part on government policies and internal rules (some of which
are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware of our violation
of these policies and rules until sometime after the violation. Moreover, some regulatory requirements issued by certain PRC government
authorities may not be consistently applied by other government authorities, including local government authorities, thus making
strict compliance with all regulatory requirements impractical, or in some circumstances, impossible. In addition, any litigation
in China may be protracted and result in substantial costs and diversion of resources and management attention.
Recent trade policy initiatives
announced by the United States administration against the PRC may adversely affect our business.
On August 14, 2017,
the President of the United States issued a memorandum instructing the U.S. Trade Representative (“USTR”) to determine
whether to investigate under section 301 of the U.S. Trade Act of 1974 (Trade Act), laws, policies, practices, or actions of the
PRC government that may be unreasonable or discriminatory and that may be harming U.S. intellectual property rights, innovation,
or technology development. Based on information gathered in that investigation, the USTR published a report on March 22, 2018
on the acts, policies and practices of the PRC government supporting findings that such are unreasonable or discriminatory and
burden or restrict U.S. commerce.
On March 8, 2018,
the President exercised his authority to issue the imposition of significant tariffs on imports of steel and aluminum from a number
of countries, including the PRC. Subsequently, the USTR announced an initial proposed list of 1,300 goods imported from the PRC
that could be subject to additional tariffs and initiated a dispute with the World Trade Organization against the PRC for alleged
unfair trade practices. The President has indicated that his two primary concerns to be addressed by the PRC are (i) a mandatory
$100 billion reduction in the PRC/U.S. trade deficit and (ii) limiting the planned $300 billion PRC government support for advanced
technology industries including artificial intelligence, semiconductors, electric cars and commercial aircraft. On June 15, 2018,
the President announced that the U.S. would go ahead with tariffs on $50 billion worth of Chinese goods, including agriculture
and industrial machinery, which prompted the PRC government to consider imposing tariffs on $50 billion worth of goods from the
U.S., including beef, poultry, tobacco and cars. In response to the PRC’s proposed retaliatory measures, the President announced
on June 19, 2018 that the U.S. would compile a list of $200 billion in China goods for levies should the PRC move forward with
their proposed tariffs. On August 7, 2018, the U.S. announced a tariff of 25% on approximately $16 billion worth of mostly industrial
goods from China, including tractors, plastic tubes and antennas, which went into effect on August 23, 2018. In response, on August
8, 2018, China announced a 25% tariff on $16 billion worth of US goods, including large passenger cars, motorcycles, chemical
items and diesel fuel, which also went into effect on August 23, 2018. On September 7, 2018, the President warned that he was
prepared to impose tariffs on another $267 billion of Chinese goods, which in addition to the other previously announced tariffs,
would cover virtually all of China’s imports into the U.S. Despite a September 12, 2018 invitation by the U.S. to China
to restart trade talks, which China has welcomed, the President has instructed his administration to proceed with a 10% tariff
on Chinese goods worth $200 billion, which China intends to match with tariffs on $60 billion of US goods.
In addition to the
proposed retaliatory tariffs, the President has also directed the U.S. Secretary of the Treasury to develop new restrictions on
PRC investments in the U.S. aimed at preventing PRC-controlled companies and funds from acquiring U.S. firms with sensitive technologies.
Congress is currently considering new legislation, the Foreign Investment Risk Review Modernization Act, to modernize the restrictive
powers imposed by the Committee on Foreign Investment in the United States.
This evolving policy
dispute between the PRC and the U.S. is likely to have significant impact on the industries in which we participate, directly
and indirectly, and no assurance can be given that any individual customer or product for whom we develop software solutions,
or significant groups of companies or a particular industry, will not be adversely affected by any governmental actions taken
by either the PRC or the U.S., perhaps materially. In view of the positions of the respective trade representatives, it is not
possible to predict with any certainty the outcome of this dispute or whether it will involve other agencies or entities brought
in to resolve the policy differences of the two countries.
Our subsidiaries in China are subject
to restrictions on making dividends and other payments to it or any other affiliated company.
We are a holding company
and may rely on dividends paid by our PRC subsidiaries for our cash needs, including the funds necessary to pay dividends and
other cash distributions to our shareholders to the extent we choose to do so, to service any debt it may incur and to pay our
operating expenses. Current PRC regulations permit our PRC subsidiaries to pay dividends to us only out of their accumulated profits,
if any, determined in accordance with Chinese accounting standards and regulations. In addition, each of our PRC subsidiaries
are required to set aside at least 10% of our after-tax profits each year, if any, to fund a statutory reserve until such reserve
reaches 50% of our registered capital. Appropriations to the employee welfare funds are at the discretion of the board of directors
of Borqs Beijing. These reserves are not distributable as cash dividends.
In addition, under
the PRC Enterprise Income Tax Law, or the EIT Law, which became effective on January 1, 2008, dividends paid to us by our PRC
subsidiaries are subject to withholding tax. Currently, the withholding tax rate is 10.0% (subject to reductions by the relevant
tax treaties, if applicable).
Furthermore, if our
PRC subsidiaries incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability to
pay dividends or make other payments to us.
To date, our PRC subsidiaries
have not paid dividends to us out of their accumulated profits. In the future, we do not expect to receive dividends from our
PRC subsidiaries because the accumulated profits of these PRC subsidiaries are expected to be used for their own business or expansions.
Any limitation on the ability of our PRC subsidiaries to distribute dividends or other payments to us could materially and adversely
limit our ability to grow, make investments or acquisitions that could be beneficial to our businesses, pay dividends or otherwise
fund and conduct our business.
The discontinuation of any of the
preferential tax treatments currently available to our PRC subsidiaries could materially increase our tax liabilities.
Preferential tax treatments
and incentives granted to our PRC subsidiaries by PRC governmental authorities are subject to review and may be adjusted or revoked
at any time in the future. The discontinuation or revocation of any preferential tax treatments and incentives currently available
to them will cause their effective tax rate to materially increase, which will decrease our net income and may adversely affect
our financial condition and results of operations.
We face uncertainty with respect
to indirect transfers of equity interests in PRC resident enterprises by their non-PRC holding companies.
On February 3, 2015,
the State Administration of Taxation, or the SAT issued a Public Notice Regarding Certain Enterprise Income Tax Matters on Indirect
Transfer of Properties by Non-Tax Resident Enterprises, or Public Notice 7, where a non-resident enterprise transfers taxable
assets, through the offshore transfer of a foreign intermediate holding company, the non-resident enterprise, being the transferor,
maybe subject to PRC enterprise income tax, if the indirect transfer is considered to be an arrangement which does not have a
reasonable commercial purpose to circumvent enterprise income tax payment obligations. In addition, Public Notice 7 further provides
certain criteria on how to assess reasonable commercial purposes and has introduced safe harbors for internal group restructurings
and the purchase and sale of equity through a public securities market. Public Notice 7 also brings challenges to both the foreign
transferor and transferee (or other person who is obligated to pay for the transfer) of the taxable assets. Where a non-resident
enterprise conducts an “indirect transfer” by transferring the taxable assets indirectly by disposing of the equity
interests of an overseas holding company, the non-resident enterprise being the transferor, or the transferee, or the PRC entity
which directly owned the taxable assets may report to the relevant tax authority such indirect transfer. Using a “substance
over form” principle, the PRC tax authority may re-characterize such indirect transfer as a direct transfer of the equity
interests in the PRC tax resident enterprise and other properties in China. As a result, gains derived from such indirect transfer
may be subject to PRC enterprise income tax, and the transferee or other person who is obligated to pay for the transfer is obligated
to withhold the applicable taxes, currently at a rate of up to 10% for the transfer of equity interests in a PRC resident enterprise.
Both the transferor and the transferee may be subject to penalties under PRC tax laws if the transferee fails to withhold the
taxes and the transferor fails to pay the taxes.
On October 17, 2017,
the SAT issued the Announcement on Issues Relating to Withholding at Source of Income Tax of Non-Resident Enterprises, or Announcement
37, which became effective on December 1, 2017. The Announcement 37 further clarifies the practice and procedure of the withholding
of non-resident enterprise income tax.
We face uncertainties
with respect to the reporting and consequences of private equity financing transactions, share exchange or other transactions
involving the transfer of our ordinary shares by investors that are non-PRC resident enterprises, or sale or purchase of shares
in other non-PRC resident companies or other taxable assets by us. We and other non-resident enterprises in our group may be subject
to filing obligations or being taxed if we and other non-resident enterprises affiliated with us are transferors in such transactions,
and may be subject to withholding obligations if we and other non-resident enterprises affiliated with us are transferees in such
transactions, under Public Notice 7 and Announcement 37. For the transfer of shares in us by investors that are non-PRC resident
enterprises, our PRC subsidiaries may be requested to assist in the filing under Public Notice 7 and Announcement 37. As a result,
we may be required to expend valuable resources to comply with Public Notice 7 and Announcement 37 or to request the relevant
transferors from whom we purchase taxable assets to comply with these circulars, or to establish that we and other non-resident
enterprises affiliated with us should not be taxed under these circulars. The PRC tax authorities have the discretion under Public
Notice 7 and Announcement 37 to make adjustments to the taxable capital gains based on the difference between the fair value of
the taxable assets transferred and the cost of investment. If the PRC tax authorities make adjustments to the taxable income of
the transactions under Public Notice 7 and Announcement 37, our income tax costs associated with such transactions will be increased
in the event that we are a transferee of such transactions, which may have an adverse effect on our financial condition and results
of operations. Heightened scrutiny over acquisition transactions by the PRC tax authorities may also have a negative impact on
potential acquisitions we may pursue in the future.
It is unclear whether we will be
considered a PRC “resident enterprise” under the EIT Law and, depending on the determination of our PRC “resident
enterprise” status, we may be subject to 25.0% PRC enterprise income tax on our worldwide income, and holders of our ordinary
shares may be subject to PRC withholding tax on dividends paid by us and gains realized on their transfer of our ordinary shares.
The EIT Law and our
Implementing Regulations, both of which became effective on January 1, 2008, provide that enterprises established outside of China
whose “
de facto
management bodies” are located in China are considered “resident enterprises.”
The Implementing Regulations of the EIT Law define the term “
de facto
management bodies” as a body which
substantially manages, or has control over the business, personnel, finance and assets of an enterprise. On April 22, 2009, the
SAT issued the Notice Regarding Determination of Chinese-Controlled Offshore Incorporated Enterprises as PRC Tax Resident Enterprises
on the Basis of De Facto Management Bodies, or Circular 82, which provides certain specific criteria for determining whether the
“de facto management body” of a PRC-controlled enterprise that is incorporated offshore is located in China. According
to Circular 82, certain PRC-controlled enterprises will be classified as “resident enterprises” if all of the following
conditions are met: (a) the senior management and core management departments in charge of our daily operations function have
their presence mainly in the PRC; (b) our financial and human resources decisions are subject to determination or approval by
persons or bodies in the PRC; (c) our major assets, accounting books, company seals, and minutes and files of our board and shareholders’
meetings are located or kept in the PRC; and (d) more than half of the enterprise’s directors or senior management with
voting rights habitually reside in the PRC. Further, the Administrative Measures of Enterprise Income Tax of Chinese controlled
Offshore Incorporated Resident Enterprises (Trial), or Bulletin No. 45, took effect on September 1, 2011, and provides more guidance
on the implementation of Circular 82. The State Administration of Taxation issued an amendment to Circular 82 delegating the authority
to our provincial branches to determine whether a Chinese-controlled overseas-incorporated enterprise should be considered a PRC
resident enterprise, in January 2014.
Although Circular
82, our amendment and Bulletin No. 45 only apply to offshore enterprises controlled by PRC enterprises or PRC enterprise groups,
not those controlled by PRC individuals or foreigners, the determining criteria set forth in Circular 82 and Bulletin No. 45 may
reflect the SAT’s general position on how the “de facto management body” text should be applied in determining
the tax resident status of all offshore enterprises, regardless of whether they are controlled by PRC enterprises or individuals.
Although we do not believe that our legal entities organized outside of the PRC constitute PRC resident enterprises, it is possible
that the PRC tax authorities could reach a different conclusion.
If we are treated
as a PRC “resident enterprise,” we will be subject to PRC enterprise income tax on our worldwide income, as well as
PRC enterprise income tax reporting obligations. Our income such as interest on other non-PRC sourced income may be subject to
PRC enterprise income tax at a rate of 25.0%. In addition, although under the EIT Law and our Implementing Rules dividends paid
to us by our PRC subsidiaries would qualify as “tax-exempt income,” we cannot assure you that such dividends will
not be subject to a 10.0% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax,
have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises
for PRC enterprise income tax purposes.
Furthermore, if we
are considered a PRC resident enterprise under the EIT Law, shareholders who are deemed non-resident enterprises may be subject
to the PRC enterprise income tax at the rate of 10% upon the dividends payable by us or upon any gains realized from the transfer
of our ordinary shares, if such income is deemed derived from China, provided that (i) such foreign enterprise investor has no
establishment or premises in China, or (ii) it has establishment or premises in China but our income derived from China has no
real connection with such establishment or premises. If we are required under the EIT Law to withhold PRC income tax on our dividends
payable to our non-PRC resident enterprise shareholders, or if any gains realized from the transfer of our ordinary shares by
our non-PRC resident enterprise shareholders are subject to the PRC enterprise income tax, your investment in our ordinary shares
could be materially and adversely affected.
In addition, if we
are considered a PRC resident enterprise and relevant PRC tax authorities consider dividends we pay with respect to our shares
and the gains realized from the transfer of our shares to be income derived from sources within the PRC, it is possible that such
dividends and gains earned by non-resident individuals may be subject to PRC individual income tax at a rate of 20%. If we are
required under PRC tax laws to withhold PRC income tax on dividends payable to our non-PRC investors that are non-resident individuals
or if you are required to pay PRC income tax on the transfer of our ordinary shares, the value of your investment in our ordinary
shares may be materially and adversely affected.
We may not be able to obtain certain
treaty benefits on dividends paid by our PRC subsidiary to us through our Hong Kong Subsidiary.
Under the EIT Law,
dividends generated from retained earnings after January 1, 2008 from a PRC company to a foreign parent company are subject to
a withholding tax rate of 10.0% unless the foreign parent’s jurisdiction of incorporation has a tax treaty with China that
provides for a preferential withholding arrangement. Pursuant to the Arrangement between Mainland China and the Hong Kong Special
Administrative Region for the Avoidance of Double Taxation and Prevention of Fiscal Evasion with respect to Taxes on Income or
the Hong Kong Tax Treaty, which became effective on August 21, 2006, a company incorporated in Hong Kong, such as Borqs Hong Kong,
will be subject to withholding income tax at a rate of 5% on dividends it receives from our PRC subsidiary if it holds a 25.0%
or more interest in that particular PRC subsidiary at all times within the 12-month period immediately preceding the distribution
of dividends and be a “beneficial owner” of the dividends. In February 2018, the SAT issued the
Announcement on
Issues Relating to Beneficial Owners under Tax Treaties
, or the SAT Announcement 9, which became effective from April 1, 2018
and supersedes the
Notice on Interpretation and Determination of Beneficial Owners under Tax Treaties
issued by the SAT
on October 27, 2009 (or the Circular 601) and the
Announcement Regarding Recognition of Beneficial Owners under Tax Treaties
released by the SAT on June 29, 2012 (or the Announcement 30). Pursuant to Announcement 9, applicants who intend to prove
their status of the “beneficial owner” shall submit the relevant documents to the relevant tax bureau according to
the
Announcement on Issuing the Measures for the Administration of Non-Resident Taxpayers’ Enjoyment of the Treatment
under Tax Agreements
and the SAT Announcement 9. “Beneficial Owners” are residents who have ownership and the
right to dispose of the income or the rights and properties giving rise to the income. These rules also set forth certain adverse
factors against the recognition of a “Beneficial Owner”, such as not carrying out substantive business activities.
Whether a non-resident enterprise may obtain tax benefits under the relevant tax treaty will be subject to approval of the relevant
PRC tax authority and will be determined by the PRC tax authority on a case-by-case basis. SAT Announcement 9 further provides
that a comprehensive analysis should be made when determining the beneficial owner status based on various factors that supported
by various types of documents including the articles of association, financial statements, records of cash movements, board meeting
minutes, board resolutions, staffing and materials, relevant expenditures, functions and risk assumption as well as relevant contracts
and other information. In August 2015, the SAT promulgated the Administrative Measures for Non-Resident Taxpayers to Enjoy Treatments
under Tax Treaties, or SAT Circular 60, which became effective on November 1, 2015. SAT Circular 60 provides that non-resident
enterprises are not required to obtain pre-approval from the relevant tax authority in order to enjoy the reduced withholding
tax rate. Instead, non-resident enterprises may, if they determine by self-assessment that the prescribed criteria to enjoy the
tax treaty benefits are met, directly apply for the reduced withholding tax rate, and file necessary forms and supporting documents
when performing tax filings, which will be subject to post-filing examinations by the relevant tax authorities.
As a result, although
our PRC subsidiary, Borqs Beijing, is currently wholly owned by Borqs Hong Kong, we cannot assure you that we would be entitled
to the tax treaty benefits and enjoy the favorable 5.0% rate applicable under the Hong Kong Tax on dividends. If Borqs Hong Kong
cannot be recognized as the beneficial owner of the dividends to be paid by our PRC subsidiaries to us, such dividends will be
subject to a normal withholding tax of 10% as provided by the EIT Law.
Restrictions on foreign currency
may limit our ability to receive and use our revenue effectively.
The PRC government
imposes controls on the conversion of the Renminbi into foreign currencies and, in certain cases, the remittance of foreign currency
out of China. We receive part of our revenue in Renminbi. Under our current corporate structure, our British Virgin Islands holding
company primarily relies on dividend payments from our PRC and Hong Kong subsidiaries to fund any cash and financing requirements
we may have. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions,
interest payments and trade and service-related foreign exchange transactions, can be made in foreign currencies without prior
approval of SAFE, by complying with certain procedural requirements. Specifically, under the existing exchange restrictions, without
prior approval of SAFE, accumulated after-tax profits generated from the operations of Borqs Beijing in China may be used to pay
dividends to us. However, approval from or registration with 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 loans denominated
in foreign currencies. As a result, we need to obtain approval from SAFE to use cash generated from the operations of our PRC
subsidiaries to pay off any debt in a currency other than Renminbi owed to entities outside China, or to make other capital expenditure
payments outside China in a currency other than Renminbi. The PRC government may at our discretion restrict access to foreign
currencies for current account transactions in the future. If the foreign exchange control system prevents us from obtaining sufficient
foreign currencies to satisfy our foreign currency demands, we may not be able to pay dividends in foreign currencies to our shareholders.
Fluctuations in the value of the
RMB may have a material adverse effect on your investment.
The value of the RMB
against the U.S. Dollar and other currencies is affected by, among other things, changes in China’s political and economic
conditions and China’s foreign exchange policies. On July 21, 2005, the PRC government changed its policy of pegging the
value of the Renminbi to the U.S. Dollar, and the RMB appreciated more than 20.0% against the U.S. Dollar over the following three
years. However, the People’s Bank of China regularly intervenes in the foreign exchange market to limit fluctuations in
Renminbi exchange rates and achieve policy goals. During the period between July 2008 and June 2010, the exchange rate between
the RMB and the U.S. Dollar had been stable and traded within a narrow band. However, the Renminbi fluctuated significantly during
that period against other freely traded currencies, in tandem with the U.S. Dollar. Since June 2010, the Renminbi has fluctuated
against the U.S. Dollar, at times significantly and unpredictably, and in recent months the RMB has depreciated significantly
against the U.S. Dollar. It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange
rate between the RMB and the U.S. Dollar in the future.
Approximately half
of our revenues and costs are denominated in RMB. Any significant revaluation of RMB may materially and adversely affect our cash
flows, revenues, earnings and financial position, and the value of, and any dividends payable on, our ordinary shares in U.S.
dollars. For example, an appreciation of RMB against the U.S. dollar would make any new RMB denominated investments or expenditures
more costly to us, to the extent that it needs to convert U.S. dollars into RMB for such purposes. An appreciation of RMB against
the U.S. dollar would also result in foreign currency translation losses for financial reporting purposes when we translate our
U.S. dollar denominated financial assets into RMB, as RMB is our reporting currency. Conversely, a significant depreciation of
the RMB against the U.S. dollar may significantly reduce the U.S. dollar equivalent of our earnings, which in turn could adversely
affect the price of our ordinary shares. Furthermore, a significant depreciation of the RMB against the U.S. dollar may have a
material adverse impact on our cash flow in the event we need to convert our RMB into U.S. dollars to repay our U.S. dollar denominated
payment obligations.
PRC regulations relating to the
establishment of offshore holding companies by PRC residents may subject our PRC resident beneficial owners or our PRC subsidiaries
to liability or penalties, limit our ability to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability
to increase their registered capital or distribute profits to us, or may otherwise adversely affect us.
The SAFE issued the
Notice on Issues Relating to the Administration of Foreign Exchange in Fund-Raising and Round-Trip Investment Activities of Domestic
Residents Conducted via Offshore Special Purpose Companies on October 26, 2005, or Circular 75, requiring PRC residents, including
PRC resident individuals and PRC companies, to register with the local SAFE branch before establishing or controlling any company
outside of China for the purpose of capital financing with assets or equities of PRC companies owned by such PRC residents, referred
to in the notice as an “offshore special purpose vehicle.” The PRC resident individuals include not only PRC citizens,
but also foreign natural persons who habitually reside in China due to economic interests. SAFE promulgated the Circular on Relevant
Issues Concerning Foreign Exchange Control on Domestic Residents’ Offshore Investment and Financing and Roundtrip Investment
through Special Purpose Vehicles, or Circular 37, on July 4, 2014, which replaced the Circular 75. Circular 37 requires PRC residents
to register with local branches of SAFE in connection with their direct establishment or indirect control of an offshore entity,
for the purpose of overseas investment and financing, with such PRC residents’ legally owned assets or equity interests
in domestic enterprises or offshore assets or interests, referred to in Circular 37 as a “special purpose vehicle.”
Under Circular 37, a PRC resident who is a foreign nature person is not required to complete the registration if he/she uses assets
outside China or equity interests in offshore entities to special purpose vehicles. The term “control” under Circular
37 is broadly defined as the operation rights, beneficiary rights or decision-making rights acquired by the PRC residents in the
offshore special purpose vehicles or PRC companies by such means as acquisition, trust, proxy, voting rights, repurchase, convertible
bonds or other arrangements. Circular 37 further requires amendment to the registration in the event of any changes with respect
to the basic information of the special purpose vehicle, such as changes in a PRC resident individual shareholder, name or operation
period; or any significant changes with respect to the special purpose vehicle, such as increase or decrease of capital contributed
by PRC individuals, share transfer or exchange, merger, division or other material event. If the shareholders of the offshore
holding company who are PRC residents do not complete their registration with the local SAFE branches, the PRC subsidiaries may
be prohibited from distributing their profits and proceeds from any reduction in capital, share transfer or liquidation to the
offshore company, and the offshore company may be restricted in our ability to contribute additional capital to our PRC subsidiaries.
Moreover, failure to comply with SAFE registration and amendment requirements described above could result in liability under
PRC law for evasion of applicable foreign exchange restrictions. On February 28, 2015, SAFE promulgated a Notice on Further Simplifying
and Improving Foreign Exchange Administration Policy on Direct Investment, or Circular 13, which became effective on June 1, 2015.
In accordance with Circular 13, entities and individuals are required to apply for foreign exchange registration of foreign direct
investment and overseas direct investment, including those required under the Circular 37, with qualified banks, instead of SAFE.
The qualified banks, under the supervision of SAFE, directly examine the applications and conduct the registration.
We requested all of
our current shareholders and/or beneficial owners to disclose whether they or their shareholders or beneficial owners fall within
the ambit of Circular 37 and Circular 13 and to register with the local SAFE branch as required under Circular 37 and Circular
13 as applicable. As of the date of this report, we are aware that a few of our natural person shareholders who are not PRC citizens
may otherwise be deemed as PRC residents pursuant to the definitions under the SAFE regulations, but we are not aware that any
of them uses assets inside China or equity interest in PRC companies to invest in the Company. Before the issuance of Circular
37, we had attempted to submit applications to the Beijing branch of SAFE for such individual shareholders in accordance with
Circular 75, but those applications were not accepted by the Beijing branch of SAFE because those individuals are not PRC citizens.
After Circular 37 became effective, we understand these individuals are not required to conduct the registrations since they do
not use assets within China or equity interests in PRC companies to invest in the Company. We cannot assure you, however, that
the SAFE’s opinion will be the same as our opinion and all of these individuals can successfully complete required filings
or updates on a timely manner, or at all in the event these individuals required to conduct the filings. Besides, we have issued
and may in future issue shares to certain PRC citizens for the purpose of acquisition of other companies and we have or will request
them to register with the local SAFE branch as required under Circular 37 and Circular 13. We cannot assure you, however, that
the all of these individuals can successfully complete required filings or updates on a timely manner, or at all. Furthermore,
as there is uncertainty concerning the reconciliation of the new regulations with other approval requirements, it is unclear how
these regulations, and any further regulation concerning offshore or cross-border transactions, will be interpreted, amended and
implemented by the relevant government authorities. We can provide no assurance that we currently are, and we will in the future
continue to be, fully informed of identities of all our shareholders or beneficial owners who are PRC residents, and we cannot
provide any assurance that all of our shareholders and beneficial owners who are PRC residents will comply with our request to
make, obtain or update any applicable registrations or comply with other requirements required by Circular 37 and Circular 13
or other related rules in a timely manner. Any failure or inability by any of our shareholders or beneficial owners who are PRC
residents to comply with SAFE regulations may subject them to fines or other legal sanctions, such as potential liability for
our PRC subsidiaries and, in some instances, for their legal representatives and other liable individuals, as well as restrictions
on our ability to contribute additional capital into our PRC subsidiaries or our PRC subsidiaries’ ability to distribute
dividends to, or obtain foreign-exchange-denominated loans from our offshore holding companies. As a result, our business operations
and our ability to make distributions to you could be materially and adversely affected.
Failure to comply with PRC regulations
regarding the registration requirements for employee stock incentive plans may subject the PRC plan participants or us to fines
and other legal or administrative sanctions.
In December 2006,
the People’s Bank of China promulgated the Administrative Measures of Foreign Exchange Matters for Individuals, which set
forth the respective requirements for foreign exchange transactions by individuals (both PRC or non-PRC citizens) under either
the current account or the capital account. In January 2007, SAFE issued implementing rules for the Administrative Measures of
Foreign Exchange Matters for Individuals, which, among other things, specified approval requirements for certain capital account
transactions such as a PRC citizen’s participation in the employee stock ownership plans or stock option plans of an overseas
publicly-listed company. In February 2012, SAFE promulgated the Notices on Issues Concerning the Foreign Exchange Administration
for Domestic Individuals Participating in Stock Incentive Plans of Overseas Publicly-Listed Companies, or the Stock Option Rules,
which replaced the Application Procedures of Foreign Exchange Administration for Domestic Individuals Participating in Employee
Stock Ownership Plans or Stock Option Plans of Overseas Publicly-Listed Companies issued by SAFE in March 2007. Under these rules,
PRC residents who participate in stock incentive plans in an overseas publicly-listed company are required to register with SAFE
or our local branches and complete certain other procedures. Participants of a stock incentive plan who are PRC residents must
retain a qualified PRC agent, which could be a PRC subsidiary of such overseas publicly-listed company or another qualified institution
selected by such PRC subsidiary, to conduct the SAFE registration and other procedures with respect to the stock incentive plan
on behalf of our participants. Such participants must also retain an overseas entrusted institution to handle matters in connection
with their exercise of stock options, the purchase and sale of corresponding stocks or interests and fund transfers. In addition,
the PRC agent is required to amend the SAFE registration with respect to the stock incentive plan if there is any material change
to the stock incentive plan, the PRC agent or the overseas entrusted institution or other material changes.
We and our PRC resident
employees who participate in our employee stock incentive plans are subject to these regulations. If we or our PRC option grantees
fail to comply with these regulations, we or our PRC option grantees may be subject to fines and other legal or administrative
sanctions. We plan to process the SAFE application for our ESOP within the year 2018.
PRC regulations establish complex
procedures for some acquisitions conducted by foreign investors, which could make it more difficult for us to pursue growth through
acquisitions in China.
The Regulations on
Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, adopted by six PRC regulatory agencies in August 2006 and
amended in June 2009, among other things, established additional procedures and requirements that could make merger and acquisition
activities by foreign investors more time-consuming and complex. In addition, the Implementing Rules Concerning Security Review
on the Mergers and Acquisitions by Foreign Investors of Domestic Enterprises, issued by the Ministry of Commerce in August 2011,
specify that mergers and acquisitions by foreign investors involved in “an industry related to national security”
are subject to strict review by the Ministry of Commerce, and prohibit any activities attempting to bypass such security review,
including by structuring the transaction through a proxy or contractual control arrangement. We believe that our business is not
in an industry related to national security, but it cannot preclude the possibility that the Ministry of Commerce or other government
agencies may publish explanations contrary to our understanding or broaden the scope of such security reviews in the future, in
which case our future acquisitions in the PRC, including those by way of entering into contractual control arrangements with target
entities, may be closely scrutinized or prohibited. Moreover, the Anti-Monopoly Law requires that the Ministry of Commerce be
notified in advance of any concentration of undertaking if certain filing thresholds are triggered. We may grow our business in
part by directly acquiring complementary businesses in China. Complying with the requirements of the laws and regulations mentioned
above and other PRC regulations to complete such transactions could be time-consuming, and any required approval processes, including
obtaining approval from the Ministry of Commerce, may delay or inhibit our ability to complete such transactions, which could
affect our ability to expand our business or maintain our market share. Our ability to expand our business or maintain or expand
our market share through future acquisitions would as such be materially and adversely affected.
Substantial uncertainties exist
with respect to the enactment timetable, interpretation and implementation of draft PRC Foreign Investment Law and how it may
impact the viability of our current corporate structure, corporate governance and business operations.
The Ministry of Commerce,
or the MOFCOM, published a discussion draft of the proposed Foreign Investment Law in January 2015 aiming to, upon its enactment,
replace the trio of existing laws regulating foreign investment in China, namely, the Sino-foreign Equity Joint Venture Enterprise
Law, the Sino-foreign Cooperative Joint Venture Enterprise Law and the Wholly Foreign-invested Enterprise Law, together with their
implementation rules and ancillary regulations. The draft Foreign Investment Law embodies an expected PRC regulatory trend to
rationalize its foreign investment regulatory regime in line with prevailing international practice and the legislative efforts
to unify the corporate legal requirements for both foreign and domestic investments. A draft Foreign Investment Law drafted by
the MOFCOM and the National Development and Reform Commission, or the NDRC, has been included in the list of draft laws submitted
to the Standing Committee of the National People’s Congress for deliberation under the 2018 Legislation Plan of the State
Council. However, it is uncertain when the draft would be signed into law and whether the draft version submitted for deliberation
or the final version would have any substantial changes from the draft version published by the MOFCOM. The draft Foreign Investment
Law, if enacted as proposed, may materially impact the viability of our current corporate structure, corporate governance and
business operations in many aspects.
Among other things,
the draft Foreign Investment Law expands the definition of foreign investment and introduces the principle of “actual control”
in determining whether a company should be treated as a foreign-invested enterprise, or an FIE. According to the definition set
forth in the draft Foreign Investment Law, FIEs refer to enterprises established in China pursuant to PRC law that are solely
or partially invested by foreign investors. The draft Foreign Investment Law specifically provides that entities established in
China (without direct foreign equity ownership) but “controlled” by foreign investors, through contract or trust for
example, will be treated as FIEs. Once an entity falls within the definition of FIE, it may be subject to foreign investment “restrictions”
or “prohibitions” set forth in a “negative list” to be separately issued by the State Council later. If
an FIE proposes to conduct business in an industry subject to foreign investment “restrictions” in the “negative
list,” the FIE must go through a market entry clearance by the Ministry of Commerce before being established. An FIE is
prohibited from conducting business in an industry subject to foreign investment “prohibitions” in the “negative
list”. However, an FIE, during the market entry clearance process, may apply in writing to be treated as a PRC domestic
enterprise if its foreign investor(s) is/are ultimately “controlled” by PRC government authorities and its affiliates
and/or PRC citizens. In this connection, “control” is broadly defined in the draft law to cover the following summarized
categories: (i) holding 50% or more of the voting rights of the subject entity; (ii) holding less than 50% of the voting
rights of the subject entity but having the power to secure at least 50% of the seats on the board or other equivalent decision
making bodies, or having the voting power to exert material influence on the board, the shareholders’ meeting or other equivalent
decision making bodies; or (iii) having the power to exert decisive influence, via contractual or trust arrangements, over the
subject entity’s operations, financial matters or other key aspects of business operations.
The “variable
interest entity” structure, or VIE structure, has been adopted by many PRC-based companies, including us with respect to
our MVNO business, to obtain necessary licenses and permits in the industries that are currently subject to foreign investment
restrictions in China. Under the draft Foreign Investment Law, variable interest entities that are controlled via contractual
arrangement would also be deemed as FIEs, if they are ultimately “controlled” by foreign investors. Therefore, for
any companies with a VIE structure in an industry category that is included in the “negative list” as restricted industry,
the VIE structure may be deemed legitimate only if the ultimate controlling person(s) is/are of PRC nationality (either PRC government
authorities and its affiliates or PRC citizens). Conversely, if the actual controlling person(s) is/are of foreign nationalities,
then the variable interest entities will be treated as FIEs and any operation in the industry category on the “negative
list” without market entry clearance may be considered as illegal.
The draft Foreign
Investment Law has not taken a position on what actions shall be taken with respect to the existing companies with a VIE structure,
whether or not these companies are controlled by Chinese parties, while it is soliciting comments from the public on this point.
Moreover, it is uncertain whether the telecommunication business, in which our variable interest entity operates, will be subject
to the foreign investment restrictions or prohibitions set forth in the “negative list” to be issued. If the enacted
version of the Foreign Investment Law and the final “negative list” mandate further actions, such as Ministry of Commerce
market entry clearance, to be completed by companies with existing VIE structure like us, we face uncertainties as to whether
such clearance can be timely obtained, or at all.
The draft Foreign
Investment Law, if enacted as proposed, may also materially impact our corporate governance practice and increase our compliance
costs. For instance, the draft Foreign Investment Law imposes stringent ad hoc and periodic information reporting requirements
on foreign investors and the applicable FIEs.
Aside from investment
implementation report and investment amendment report that are required at each investment and alteration of investment specifics,
an annual report is mandatory, and large foreign investors meeting certain criteria are required to report on a quarterly basis.
Any company found to be non-compliant with these information reporting obligations may potentially be subject to fines and/or
administrative or criminal liabilities, and the persons directly responsible may be subject to criminal liabilities.
The enforcement of the labor laws
and other labor-related regulations in the PRC may adversely affect our results of operations.
On June 29, 2007,
the Standing Committee of the National People’s Congress of China enacted the Labor Contract Law, which became effective
on January 1, 2008 and revised on December 28, 2012. The Labor Contract Law introduces specific provisions related to fixed-term
employment contracts, part-time employment, probation, consultation with labor union and employee assemblies, employment without
a written contract, dismissal of employees, severance, and collective bargaining, which together represent enhanced enforcement
of labor laws and regulations. According to the Labor Contract Law, an employer is obliged to sign an unlimited-term labor contract
with any employee who has worked for the employer for ten consecutive years. Further, if an employee requests or agrees to renew
a fixed-term labor contract that has already been entered into twice consecutively, the resulting contract must have an unlimited
term, with certain exceptions. The employer must pay severance to an employee where a labor contract is terminated or expires,
with certain exceptions. In addition, the government has continued to introduce various new labor-related regulations after the
effectiveness of the Labor Contract Law. Among other things, it is required that that annual leave ranging from five to 15 days
be made available to employees and that the employee be compensated for any untaken annual leave days in the amount of three times
of the employee’s daily salary, subject to certain exceptions. As a result of these regulations designed to enhance labor
protection and increasing labor costs in China, our labor costs have increased. In addition, as the interpretation and implementation
of these new regulations are still evolving, we cannot assure you that our employment practice will at all times be deemed in
compliance with the new regulations. If we are subject to severe penalties or incur significant liabilities in connection with
labor disputes or investigations, our business and results of operations may be adversely affected.
Our failure to make adequate contributions
to various employee benefit plans as required by PRC regulations may subject us to penalties.
Companies operating
in China are required to participate in various government sponsored employee benefit plans, including certain social insurance,
housing funds and other welfare-oriented payment obligations. Our failure to make contributions to various employee benefit plans
and to comply with applicable PRC labor-related laws may subject us to late payment penalties. If we are subject to such penalties
in relation to the underpaid employee benefits, our financial condition and results of operations may be adversely affected.
If the custodians or authorized
users of our controlling non-tangible assets, including corporate chops and seals, fail to fulfill their responsibilities or misappropriate
or misuse those assets, our business and operations could be materially and adversely affected.
In China, a company
chop or seal serves as the legal representation of the company towards third parties even when unaccompanied by a signature. Under
PRC law, legal documents for corporate transactions, including contracts and leases that our business relies upon, are executed
using “corporate chops,” which are instruments that contain either the official seal of the signing entity or the
signature of a legal representative whose designation is registered and filed with the State Administration for Industry and Commerce,
or SAIC.
Our PRC subsidiaries
generally execute legal documents with corporate chops. One or more of our corporate chops may be used to, among other things,
execute commercial sales or purchase contracts, procurement contracts and office leases, open bank accounts, issue checks and
to issue invoices. We believe that it has sufficient controls in place over access to and use of the chops. Our chops, or chops,
including the chops at headquarters level and of each PRC subsidiary, are kept securely at our legal department under the direction
of the executive officers at vice president level or higher. Use of chops requires proper approvals in accordance with our internal
control procedures. The custodian at our legal department also maintains a log to keep a detailed record or each use of the chops.
However, we cannot
assure you that unauthorized access to or use of those chops can be prevented. Our designated employees who hold the corporate
chops could abuse their authority by, for example, binding us to contracts against our interests or intentions, which could result
in economic harm, disruption or our operations or other damages to them as a result of any contractual obligations, or resulting
disputes, that might arise. If the party contracting with us asserted that we did not act in good faith under such circumstances,
then we could incur costs to nullify such contracts. Such corporate or legal action could involve significant time and resources,
while distracting management from our operations. In addition, we may not be able to recover corporate assets that are sold or
transferred out of our control in the event of such a misappropriation if a transferee relies on the apparent authority of the
representative and acts in good faith.
If a designated employee
uses a chop in an effort to obtain control over one or more of our PRC subsidiaries, we would need to take legal action to seek
the return of the applicable chop(s), apply for a new chop(s) with the relevant authorities or otherwise seek legal redress for
the violation of their duties. During any period where we lose effective control of the corporate activities of one or more of
our PRC subsidiaries as a result of such misuse or misappropriation, the business activities of the affected entity could be disrupted
and we could lose the economic benefits of that aspect of our business. To the extent those chops are stolen or are used by unauthorized
persons or for unauthorized purposes, the corporate governance of these entities could be severely and adversely compromised and
the operations of those entities could be significantly and adversely impacted.
Our independent registered public
accounting firm is not inspected by the Public Company Accounting Oversight Board and, as such, you are deprived of the benefits
of such inspection.
Our independent registered
public accounting firm, as auditors of companies that are traded publicly in the United States and a firm registered with the
PCAOB, is required by the laws of the United States to undergo regular inspections by the PCAOB to assess our compliance with
the laws of the United States and professional standards. Because our auditors are located in the PRC, a jurisdiction where the
PCAOB is currently unable to conduct inspections without the approval of the Chinese authorities, our auditors are not currently
inspected by the PCAOB. In May 2013, PCAOB announced that it had entered into a Memorandum of Understanding on Enforcement Cooperation
with the CSRC and the Ministry of Finance, which establishes a cooperative framework between the parties for the production and
exchange of audit documents relevant to investigations undertaken by PCAOB, the China Securities Regulatory Commission, or
the CSRC, or the Ministry of Finance in the United States and the PRC, respectively. PCAOB continues to be in discussions with
the CSRC and the Ministry of Finance to permit joint inspections in the PRC of audit firms that are registered with PCAOB and
audit Chinese companies that trade on U.S. exchanges.
Inspections of other
firms that the PCAOB has conducted outside China have identified deficiencies in those firms’ audit procedures and quality
control procedures, which may be addressed as part of the inspection process to improve future audit quality. This lack of PCAOB
inspections in China prevents the PCAOB from regularly evaluating our auditor’s audits and our quality control procedures.
As a result, investors may be deprived of the benefits of PCAOB inspections.
The inability of the
PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of our auditor’s
audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections.
Investors may lose confidence in our reported financial information and procedures and the quality of our financial statements.
If additional remedial measures
are imposed on China-based accounting firms, including our independent registered public accounting firm, in administrative proceedings
brought by the SEC alleging those firms’ failure to meet specific criteria with respect to requests for the production of
documents, we could be unable to timely file our future financial statements in compliance with the requirements of U.S. securities
law.
In December 2012,
the SEC instituted proceedings against five China-based accounting firms, including our independent registered public accounting
firm, alleging that these firms had violated U.S. securities laws and the SEC’s rules and regulations thereunder by
failing to provide to the SEC the firms’ work papers related to their audits of China-based companies that are publicly
traded in the U.S. The SEC has the authority to deny to any person, temporarily or permanently, the ability to practice before
the SEC who is found by to have willfully violated any such laws or rules and regulations. On January 22, 2014, an initial
administrative law decision was issued, censuring these accounting firms and suspending four of the five firms from practicing
before the SEC for a period of six months. Four of these China-based accounting firms appealed to the SEC against this decision
and, on February 6, 2015, each of the four China-based accounting firms agreed to a censure and to pay a fine to the SEC
to settle the dispute and avoid suspension of their ability to practice before the SEC. These firms’ ability to continue
to serve all their respective clients is not affected by the settlement. The settlement requires the firms to follow detailed
procedures to seek to provide the SEC with access to the firms’ audit documents via the China Securities Regulatory Commission.
If the firms do not follow these procedures, the SEC could impose penalties such as suspensions, or it could restart the administrative
proceedings. The settlement did not require the firms to admit to any violation of law and preserves the firms’ legal defenses
in the event the administrative proceeding is restarted
In the event that
the SEC restarts the administrative proceedings, depending upon the final outcome, companies listed in the U.S. with major
Chinese operations may find it difficult or impossible to retain auditors in respect of their operations in China, which could
result in financial statements being determined to not be in compliance with the requirements of the Exchange Act, including possible
delisting. Moreover, any negative news about any such future proceedings against these audit firms may cause investor uncertainty
regarding China-based, U.S.-listed companies and the market price of our ordinary shares may be adversely affected.
If our independent
registered public accounting firm was denied, even temporarily, the ability to practice before the SEC and we were unable to timely
find another registered public accounting firm to audit and issue an opinion on our financial statements, our financial statements
could be determined not to be in compliance with the requirements of the Exchange Act. Such a determination could ultimately lead
to the delay or abandonment of our capital raising, delisting of our ordinary shares from The Nasdaq Stock Market or deregistration
from the SEC, which would substantially reduce or effectively terminate the trading of our ordinary shares in the U.S.
Our contractual arrangements may
not be as effective in providing control over the variable interest entity as direct ownership.
We rely on contractual
arrangements with our variable interest entity to operate our MVNO business in China. These contractual arrangements may not be
as effective as direct ownership in providing us with control over our variable interest entity and our subsidiaries. If we had
direct ownership of the variable interest entity, we would be able to exercise our rights as an equity holder directly to effect
changes in the board of directors of the variable interest entity, which could effect changes at the management and operational
level. Under our contractual arrangements, we may not be able to directly change the members of the board of directors of the
variable interest entity and would have to rely on the variable interest entity and the variable interest entity equity holders
to perform their obligations in order to exercise control over the variable interest entity. The variable interest entity equity
holders may have conflicts of interest with us or our shareholders, and they may not act in the best interests of us or may not
perform their obligations under these contracts. For example, our variable interest entity and our respective equity holders could
breach their contractual arrangements with them by, among other things, failing to conduct their operations, including maintaining
our websites and using our domain names and trademarks which the variable interest entity has exclusive rights to use, in an acceptable
manner or taking other actions that are detrimental to our interests. Pursuant to the call option, we may replace the equity holders
of the variable interest entity at any time pursuant to the contractual arrangements. However, if any equity holder is uncooperative
and any dispute relating to these contracts or the replacement of the equity holders remains unresolved, we will have to enforce
our rights under the contractual arrangements through the operations of PRC law and arbitral or judicial agencies, which may be
costly and time-consuming and will be subject to uncertainties in the PRC legal system.
Any failure by our variable interest
entity or our equity holders to perform their obligations under the contractual arrangements would have a material adverse effect
on our business, financial condition and results of operations.
If our variable interest
entity or our equity holders fail to perform their respective obligations under the contractual arrangements, we may have to incur
substantial costs and expend additional resources to enforce such arrangements. Although we have entered into exclusive option
agreements in relation to the variable interest entity, which provide that we may exercise an option to acquire, or nominate a
person to acquire, ownership of the equity in that entity to the extent permitted by applicable PRC laws, rules and regulations,
the exercise of these call options is subject to the review and approval of the relevant PRC governmental authorities. We have
also entered into share pledge agreements with respect to the variable interest entity to secure certain obligations of the variable
interest entity or our equity holders to us under the contractual arrangements. However, the enforcement of such agreements through
arbitral or judicial agencies may be costly and time-consuming and will be subject to uncertainties in the PRC legal system. Moreover,
our remedies under the share pledge agreements are primarily intended to help it collect debts owed to us by the variable interest
entity or the variable interest entity equity holders under the contractual arrangements and may not help us in acquiring the
assets or equity of the variable interest entity.
In addition, although
the terms of the contractual arrangements provide that they will be binding on the successors of the variable interest entity
equity holders, as those successors are not a party to the agreements, it is uncertain whether the successors in case of the death,
bankruptcy or divorce of a variable interest entity equity holder will be subject to or will be willing to honor the obligations
of such variable interest entity equity holder under the contractual arrangements. If the variable interest entity or our equity
holder (or our successor), as applicable, fails to transfer the shares of the variable interest entity according to the respective
exclusive option agreement or share pledge agreement, we would need to enforce our rights under the exclusive option agreement
or share pledge agreement, which may be costly and time-consuming and may not be successful. The contractual arrangements are
governed by PRC law and provide for the resolution of disputes through arbitration or court proceedings in China. Accordingly,
these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal
procedures. The legal system in the PRC is not as developed as in some other jurisdictions, such as the United States. Moreover,
there are very few precedents and little formal guidance as to how contractual arrangements in the context of a variable interest
entity should be interpreted or enforced under PRC law, and as a result it may be difficult to predict how an arbitration panel
or court would view such contractual arrangements. As a result, uncertainties in the PRC legal system could limit our ability
to enforce the contractual arrangements. Under PRC law, if the losing parties fail to carry out the arbitration awards or court
judgments within a prescribed time limit, the prevailing parties may only enforce the arbitration awards or court judgments in
PRC courts, which would require additional expense and delay. In the event we are unable to enforce the contractual arrangements,
we may not be able to exert effective control over the variable interest entity and our subsidiaries, and our ability to conduct
our business, as well as our financial condition and results of operations, may be materially and adversely affected.
We may lose the ability to use,
or otherwise benefit from, the licenses, approvals and assets held by our variable interest entity, which could severely disrupt
our business, render us unable to conduct some or all of our business operations and constrain our growth.
Although the significant
majority of our revenues are generated, and the significant majority of our operational assets are held, by our wholly-foreign
owned enterprises, which are our subsidiaries, our variable interest entity hold licenses and approvals and assets that are necessary
for our business operations, as well as equity interests in a series of our portfolio companies, to which foreign investments
are typically restricted or prohibited under applicable PRC law. The contractual arrangements contain terms that specifically
obligate variable interest entity equity holders to ensure the valid existence of the variable interest entity and restrict the
disposal of material assets of the variable interest entity. However, in the event the variable interest entity equity holders
breach the terms of these contractual arrangements and voluntarily liquidate the variable interest entity or any of our subsidiary,
or any of these entities declares bankruptcy and all or part of our assets become subject to liens or rights of third-party creditors,
or are otherwise disposed of without our consent, we may be unable to conduct some or all of our business operations or otherwise
benefit from the assets held by the variable interest entity or our subsidiaries, which could have a material adverse effect on
our business, financial condition and results of operations. Furthermore, if our variable interest entity undergoes a voluntary
or involuntary liquidation proceeding, our equity holders or unrelated third-party creditors may claim rights to some or all of
the assets of such variable interest entity, thereby hindering our ability to operate our business as well as constrain our growth.
The equity holders, directors and
executive officers of the variable interest entity, as well as our employees who execute other strategic initiatives may have
potential conflicts of interest with us.
PRC laws provide that
a director and an executive officer owes a fiduciary duty to the company he or she directs or manages. The directors and executive
officers of the variable interest entity must act in good faith and in the best interests of the variable interest entity and
must not use their respective positions for personal gain. We control our variable interest entity through contractual arrangements
and the business and operations of our variable interest entity are closely integrated with the business and operations of our
subsidiaries. Nonetheless, conflicts of interests for these individuals may arise due to dual roles both as directors and executive
officers of the variable interest entity and as our directors or employees, and may also arise due to dual roles both as variable
interest entity equity holders and as our directors or employees. We cannot assure you that these individuals will always act
in our best interests should any conflicts of interest arise, or that any conflicts of interest will always be resolved in our
favor. Moreover, we also cannot assure you that these individuals will ensure that the variable interest entity will not breach
the existing contractual arrangements. If we cannot resolve any such conflicts of interest or any related disputes, we would have
to rely on legal proceedings to resolve these disputes and/or take enforcement action under the contractual arrangements. There
is substantial uncertainty as to the outcome of any such legal proceedings.
The contractual arrangements with
our variable interest entity may be subject to scrutiny by the PRC tax authorities. Any adjustment of related party transaction
pricing could lead to additional taxes, and therefore substantially reduce our consolidated net income and the value of your investment.
The tax regime in
China is rapidly evolving and there is significant uncertainty for taxpayers in China as PRC tax laws may be interpreted in significantly
different ways. The PRC tax authorities may assert that we or our subsidiaries or the variable interest entity or their equity
holders owe and/or are required to pay additional taxes on previous or future revenue or income. In particular, under applicable
PRC laws, rules and regulations, arrangements and transactions among related parties, such as the contractual arrangements with
our variable interest entity, may be subject to audit or challenge by the PRC tax authorities. If the PRC tax authorities determine
that any contractual arrangements were not entered into on an arm’s length basis and therefore constitute a favorable transfer
pricing, the PRC tax liabilities of the relevant subsidiaries and/or variable interest entity and/or variable interest entity
equity holders could be increased, which could increase our overall tax liabilities. In addition, the PRC tax authorities may
impose late payment interest. Our net income may be materially reduced if our tax liabilities increase.
Risks Related to the Electric Vehicle Industry
Future growth is dependent upon consumers’ willingness
to adopt electric vehicles.
Due to our contemplated
acquisition of a controlling position of Shanghai KADI Technologies Co., Ltd (“KADI”), our future prospects are highly
dependent upon the timing and pace of consumer adoption of alternative fuel vehicles in general and electric vehicles in particular.
The market for alternative fuel vehicles is relatively new and rapidly evolving, characterized by rapidly changing technologies,
price and product competition, newly-emerging competitors, evolving government regulation and industry standards, frequent new
vehicle announcements and changing consumer demands and behaviors. If the market for electric vehicles in China does not develop
as we expect or develops more slowly than we expect, our business, prospects, financial condition and operating results will be
harmed.
Developments in alternative technologies
or improvements in the internal combustion engine may materially adversely affect the demand for our electric vehicle products.
Significant developments
in alternative technologies, such as advanced diesel, ethanol, fuel cells or compressed natural gas, or improvements in the fuel
economy of the internal combustion engine, may materially and adversely affect our business and prospects in ways we do not currently
anticipate. Any failure by us to develop new or enhanced technologies or processes, or to react to changes in existing technologies,
could materially delay our development and introduction of new and enhanced electric vehicle products, which could result in the
loss of competitiveness of our vehicles, decreased revenue and a loss of market share to competitors.
If we are unable to keep up with advances in
electric vehicle technology, we may suffer a decline in our competitive position.
We may be unable to
keep up with changes in electric vehicle technology, and we may suffer a resulting decline in our competitive position. Any failure
to keep up with advances in electric vehicle technology would result in a decline in our competitive position which would materially
and adversely affect our business, prospects, operating results and financial condition. Our research and development efforts
may not be sufficient to adapt to changes in electric vehicle technology.
Extended periods of low diesel or
other petroleum-based fuel prices could adversely affect demand for electric vehicles, which would adversely affect our business
and operating results.
We believe that much
of the present and projected demand for commercial electric vehicles results from concerns about volatility in the cost of petroleum-based
fuel, government regulations and economic incentives promoting fuel efficiency and alternative forms of energy, as well as the
belief that climate change results in part from the burning of fossil fuels. If the cost of petroleum-based fuel decreased significantly,
the government eliminated or modified its regulations or economic incentives related to fuel efficiency and alternative forms
of energy, or if there is a change in the perception that the burning of fossil fuels negatively impacts the environment, the
demand for commercial electric vehicles could be reduced, and our business and revenue could be harmed.
We may be subject to product liability
claims or recalls which could be expensive, damage our reputation or result in a diversion of management resources.
We may be subject
to lawsuits resulting from injuries associated with the use of the vehicles in which the modules products of KADI are involved.
We may incur losses relating to these claims or the defense of these claims. There is a risk that claims or liabilities will exceed
our insurance coverage. In addition, we may be unable to retain adequate liability insurance in the future.
We may also be required
to participate in recalls involving vehicles with our products, if any prove to be defective, or we may voluntarily initiate a
recall or make payments related to such claims as a result of various industry or business practices or the need to maintain good
customer relationships. Such a recall would result in a diversion of resources. While we do maintain product liability insurance,
we cannot assure investors that it will be sufficient to cover all product liability claims, that such claims will not exceed
our insurance coverage limits or that such insurance will continue to be available on commercially reasonable terms, if at all.
Any product liability claim brought against us could have a material adverse effect on the results of our operations.
Since KADI’s
products primarily involve the central control mechanism of electric vehicles, defective designs or defective components parts
can cause significant damage or injury, and our liability risks will increase. While we have had no product liability claims to
date, we have relatively little experience with these products, and our insurance coverage may not be sufficient to cover potential
claims in the future.
Changes to the government subsidy support policies in
the PRC and further delays in subsidy payments may have negative impacts on the electric vehicle
market.
The subsidy support
polices effective as of April 22, 2015 and the newly announced government subsidy support policies available in the PRC effective
as of January 1, 2017, call for a 20% of reduction in central government subsidies per car in 2017 from the 2016 level, and a
20% of reduction in the subsidies for purchasers of certain new energy vehicles (except for fuel cell vehicles) in 2019 and 2020
as compared to 2017 subsidies and the total local government subsidy match to be not more than 50% of the total central government
subsidies per car. The reduction of subsidies from both the central government and local governments will inevitably increase
the costs to the consumers, which may cause temporary pressure for the EV market. The change in subsidy payment methods in 2017
from paid in advance to paid post-sale and any further delay in releasing subsidy payments for the EVs manufactured and sold in
the prior years might also cause the adverse effects on the EV market.
Any of the above factors
could result in a significant or material adverse effect on our results of operations or financial condition. Additional risk
factors presently not known to us or that we currently deem immaterial may also impair our business or results of operations.
Although the production and sales of finished electric vehicles is subject to certain restrictions, we are not aware of any PRC
regulations or proposed regulations that will specifically restrict or limit the electric vehicle component business currently
conducted by KADI from foreign participation. As a result, we do not currently expect our pending ownership of KADI, or KADI’s
relationships within the electric vehicle industry, to be adversely affected by our foreign ownership structure.
Risks Related to Our Recent Transactions
Our proposed acquisition of KADI
may not be completed or may be delayed if we cannot obtain sufficient capital to fund the acquisition.
We have entered into
a letter of intent to acquire a 60% equity interest in KADI, a Chinese company that develops software and hardware solutions for
electric vehicle control modules, such as charging, battery management and vehicle controls. We have not yet finalized a definitive
agreement to complete this acquisition, but we have made four scheduled cash advances to KADI totaling $600,000 which will be
deducted from our initial cash payments to KADI under the definitive agreement being negotiated. We intend to use a portion of
the proceeds from our equity financing to support the funding of the KADI acquisition. Since we may not be able to raise enough
capital to fund the acquisition, we are in discussions with KADI to negotiate a modified payment schedule and may need to find
alternative funding sources, or else we will not be able to consummate the acquisition of KADI. If the acquisition is not consummated
within nine months after signing of the letter of intent, the advance payments will be converted into shares representing five
percent of the outstanding capital stock of KADI. There are no termination fees or penalties under the letter of intent.
If we are unable to
sign a definitive agreement and complete the acquisition of KADI, our directors, executive officers and other employees will have
expended extensive time and effort and will have experienced significant distractions from their work during the period the transaction
was pending and we will have incurred significant third party transaction costs, in each case, without any commensurate benefit.
In addition, the current market price of our ordinary shares may reflect a market assumption that the KADI acquisition will occur,
and a failure to complete the transaction could result in a negative perception by the market of ours generally and a resulting
decline in the market price of our ordinary shares. Any delay in the consummation of the acquisition or any uncertainty about
the consummation of the acquisition could also negatively impact our stock price and future business and results of operations.
Even if we complete the acquisition of KADI, we may be
unsuccessful at integrating the KADI business.
Our proposed acquisition
of KADI involves multiple steps in seeing through the procurement of the supply contract awarded to KADI, and there is no assurance
that KADI can satisfy its customer in the delivery of the products at this scale either in time or up to the quality standards
acceptable to the customer. Assuming we proceed to enter into a definite agreement with KADI and consummate the proposed acquisition,
there is no assurance that we can support KADI with the necessary funds in time for KADI to set up correctly for the manufacturing
of the products. These and other factors unforeseen by both the Company and KADI, including but not limited to new competition,
can also appear to affect the demand and pricing of the KADI products and ultimately cause our acquisition of KADI to fail. Also,
there is no assurance that the management of KADI will successfully integrate with our management team to ensure a smooth operation
going forward and to gain the intended benefits of this acquisition.
Dependency on key personnel of KADI.
There is no assurance
that the management of KADI will successfully integrate with our management team to realize the intended benefits of the acquisition
transaction. The business of KADI is dependent on Mr. Hu Lin, KADI’s chairman and chief executive. In the event that Mr.
Lin were unable or unwilling to dedicate his full time to KADI’s business, or if he were to resign or start a competing
business, our business and financial results would be adversely affected. KADI has no “key person” insurance on Mr.
Lin or any other employee, and no employment agreement with Mr. Lin.
Our repurchase of shares from Zhengqi
may adversely affect our liquidity and working capital.
We have agreed to
repurchase 966,136 of our ordinary shares from one of our largest shareholders, Zhengqi, at the original purchase price and for
an aggregate amount of $10.05 million. The repurchase transaction has not yet completed, and although the purchase price for the
transaction has been remitted, the 966,136 repurchase shares currently remain outstanding. This repurchase will limit our available
cash and may adversely affect our ability to carry out our operations normally due to this reduction in working capital.
We have been working
with Zhengqi to satisfy certain conditions and make necessary arrangements before completing the repurchase, including submitting
the shares to the transfer agent for cancellation. We obtained the consent of our existing lenders with respect to the repurchase
and anticipate closing the transaction in 2018. As of August 3, 2018, the 1,278,776 escrow shares were forfeited and released
from escrow, of which 51,151 shares were placed in the indemnity escrow account established in connection with our acquisition
of Borqs International and 1,227,625 shares were distributed to the former Borqs International shareholders in proportion to their
ownership prior to the completion of the business combination on August 18, 2017. The return and cancellation of the 966,136 shares
remain in process.
Our repurchase of shares from Zhengqi
may trigger litigation by other shareholders.
Our agreement to repurchase
shares from Zhengqi was not extended to all investors who purchased shares in the August 2017 private placement. Since we are
repurchasing those shares at a premium to current market prices, other purchasers may seek similar treatment. In addition, a minority
of our shareholders did not benefit from the return of 1,227,625 escrowed earnout shares to the former Borqs International shareholders
on August 3, 2018. Those minority shareholders will receive no direct benefit of proposed repurchase and return, and there is
no assurance that those minority holders will not make claims against us. Any such litigation brought by such minority shareholders
could be time-consuming and costly, and could materially adversely affect our financial condition and results of operations.
Dependency on Crave and Colmei and financial risks.
Our agreement to purchase
shares of Crave and Colmei from the shareholders of those companies may lead us to be more dependent on Crave and Colmei for both
components and manufacturing. There is no assurance that Crave and Colmei continue to provide competitive pricing of components
and for manufacturing services. There is no assurance that the value of our ownership of Crave and Colmei will not decline, potentially
causing a material adverse effect on our financial condition.