UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 20-F

 

(Mark One)

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

 

OR

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2020

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

OR

 

SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Date of event requiring this shell company report: Not applicable

 

For the transition period from _______ to _______

 

Commission file number: 001-37593

 

BORQS TECHNOLOGIES, INC.

(Exact name of Registrant as specified in its charter)

 

 

(Translation of Registrant’s name into English)

 

British Virgin Islands

(Jurisdiction of incorporation or organization)

 

Suite 309, 3/F, Dongfeng KASO, Dongfengbeiqiao

Chaoyang District, Beijing 100016, China

(Address of principal executive offices)

 

Pat Sek Yuen Chan, Chairman & Chief Executive Officer
Borqs Technologies, Inc.
Suite 309, 3/F, Dongfeng KASO, Dongfengbeiqiao

Chaoyang District, Beijing 100016, China
Telephone: +86 10 6437 8678, Fax: +86 1086 6437 2678

(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

 

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

 

Title of class   Trading Symbol   Name of exchange on which registered
Ordinary shares, no par value   BRQS   Nasdaq Capital Market

 

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

 

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

 

 

 

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or ordinary shares as of the close of the period covered by the annual report: As of December 31, 2020, there were 59,943,310 shares of the registrant’s ordinary shares, no par value, issued and outstanding.

 

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

 

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

 

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

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒ Yes     ☐ No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   Accelerated filer   Non-accelerated filer  
        Emerging growth company  

 

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the Exchange Act. ☐

 

† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

 

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

 

U.S. GAAP ☒   International Financial Reporting Standards as issued by the International Accounting Standards Board ☐   Other ☐

 

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.

 

☐ Item 17     ☐ Item 18

 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

☐ Yes     ☒ No

 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.

 

☐ Yes     ☐ No

 

 

 

 

 

 

TABLE OF CONTENTS

 

       

Page

PART I        
ITEM 1.   IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS   1
ITEM 2.   OFFER STATISTICS AND EXPECTED TIMETABLE   1
ITEM 3.   KEY INFORMATION   1
ITEM 4.   INFORMATION ON THE COMPANY   36
ITEM 4A.   UNRESOLVED STAFF COMMENTS   48
ITEM 5.   OPERATING AND FINANCIAL REVIEW AND PROSPECTS   48
ITEM 6.   DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES   68
ITEM 7.   MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS   79
ITEM 8.   FINANCIAL INFORMATION   80
ITEM 9.   THE OFFER AND LISTING   80
ITEM 10.   ADDITIONAL INFORMATION   81
ITEM 11.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK   84
ITEM 12.   DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES   84
         
PART II        
ITEM 13.   DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES   85
ITEM 14.   MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OR PROCEEDS   85
ITEM 15.   CONTROLS AND PROCEDURES   85
ITEM 16.   RESERVED   87
ITEM 16A.   AUDIT COMMITTEE FINANCIAL EXPERT   87
ITEM 16B.   CODE OF ETHICS   87
ITEM 16C.   PRINCIPAL ACCOUNTANT FEES AND SERVICES   87
ITEM 16D.   EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES   87
ITEM 16E.   PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS   87
ITEM 16F.   CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT   88
ITEM 16G.   CORPORATE GOVERNANCE   89
ITEM 16H.   MINE SAFETY DISCLOSURE   89
         
PART III        
ITEM 17.   FINANCIAL STATEMENTS   90
ITEM 18.   FINANCIAL STATEMENTS   90
ITEM 19.   EXHIBITS   90

 

i

 

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

This annual report contains certain forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, but are not limited to, statements regarding our or our management’s expectations, hopes, beliefs, intentions or strategies regarding the future and other statements that are other than statements of historical fact. In addition, any statements that refer to projections, forecasts or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. The words “anticipate”, “believe”, “continue”, “could”, “estimate”, “expect”, “intend”, “may”, “might”, “plan”, “possible”, “potential”, “predict”, “project”, “should”, “would” and similar expressions may identify forward-looking statements, but the absence of these words does not mean that a statement is not forward-looking.

 

The forward-looking statements in this report are based upon various assumptions, many of which are based, in turn, upon further assumptions, including without limitation, management’s examination of historical operating trends, data contained in our records and other data available from third parties. Although we believe that these assumptions were reasonable when made, because these assumptions are inherently subject to significant uncertainties and contingencies which are difficult or impossible to predict and are beyond our control, we cannot assure you that we will achieve or accomplish these expectations, beliefs or projections. As a result, you are cautioned not to rely on any forward-looking statements.

 

Many of these statements are based on our assumptions about factors that are beyond our ability to control or predict and are subject to risks and uncertainties that are described more fully in “Item 3. Key Information—D. Risk Factors”. Any of these factors or a combination of these factors could materially affect our future results of operations and the ultimate accuracy of the forward-looking statements. Fluctuations in our future financial results may negatively impact the value of our ordinary shares. In addition to these important factors, important factors that, in our view, could cause actual results to differ materially from those discussed in the forward-looking statements include among other things:

 

  our ability to attract new customers:

 

  our ability to convert users of our limited free versions to paying customers;

 

  the addition or loss of large customers, including through acquisition or consolidations;

 

  our customer retention rate;

 

  the timing of recognition of revenue;

 

  the amount and timing of operating expenses related to the maintenance and expansion of our business, operations and infrastructure;

 

  network outages or security breaches;

 

  general economic, industry and market conditions;

 

  increases or decreases in the number of features in our services or pricing changes upon any renewals of customer agreements;

 

  changes in our pricing policies or those of our competitors;

 

ii

 

 

  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;

 

  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; and
     
  other factors discussed in “Item 3. Key Information – D. Risk Factors”.

 

Should one or more of the foregoing risks or uncertainties materialize, or should any of our assumptions prove incorrect, actual results may vary in material respects from those projected in these forward-looking statements. Consequently, there can be no assurance that actual results or developments anticipated by us will be realized or, even if substantially realized, that they will have the expected consequences to, or effects, on us. Given these uncertainties, prospective investors are cautioned not to place undue reliance on such forward-looking statements.

 

We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required under applicable laws. If one or more forward-looking statements are updated, no inference should be drawn that additional updates will be made with respect to those or other forward-looking statements.

 

iii

 

 

PART I

 

Unless the context otherwise requires, as used in this annual report, the terms “Company”, “Borqs”, “we”, “us”, and “our” refer to Borqs Technologies, Inc. and any or all of its subsidiaries. Unless otherwise noted, all industry and market data in this prospectus is presented in U.S. dollars. Unless otherwise noted, all financial and other data related to the Company in this annual report is presented in U.S. dollars. All references to “$” or “US” in this annual report refer to U.S. dollars. All references to “RMB” in this annual report refer to Chinese Rmb Yuan.

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS

 

Not applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

 

Not applicable.

 

ITEM 3. KEY INFORMATION

 

A. Selected Financial Data

 

The following selected consolidated financial data should be read in conjunction with “Item 5. Operating and Financial Review and Prospects” and our consolidated financial statements and notes thereto included elsewhere in this Annual Report. The selected consolidated statements of operations data for each of the years in the three-year period ended December 31, 2020, and the consolidated balance sheet data as of December 31, 2019 and 2020, are derived from our audited consolidated financial statements and notes which have been prepared in accordance with U.S. generally accepted accounting principles, or U.S. GAAP.

 

In 2018, the Company decided to sell its mobile virtual network operator business unit (“MVNO”, “MVNO BU”, “MVNO Business Unit” or “MVNO business unit”) which included the sale of voice and data services provided by the incumbent mobile operator China Unicom and certain traditional telephony business activities. As of December 31, 2018, the Company owned a 75% interest in the MVNO BU via a variable interest entity (“VIE”) contractual structure of Yuantel (Beijing) Telecommunications Technology Co., Ltd. (“Yuantel” or “Yuantel Telecom”) which operated the MVNO BU. The Company executed agreements, and amendments thereof, to sell all of its interest in the MVNO BU for RMB 108.70 million, equivalent to $15.58 million, the sale was originally scheduled to be completed by the end of 2019. Due to an on-going investigation by the Yunnan Public Securities Bureau, as described in “Item 4. Information on the Company” below, the Company received only $5.98 million from the buyers within the year ended December 31, 2019, the Company, then amended the agreement with the another third-party buyers (the “New Buyers”) of Yuantel as of September 1, 2020 to sell the remaining percentage of Yuantel owned by the Company for $4.54 million, of which approximately $0.4 million were received and the balance of $4.14 million was to be received by September 30, 2020, which was later postponed to October 2020 by both parties. The Company received the last payment of $1.2 million on October 27, 2020, and completed the disposition of Yuantel on October 29, 2020. The New Buyers also purchased the ownership of Yuantel that was first sold to other purchasers in 2019. Due to this transaction, the Company’s financial statements for the year ended December 31, 2020 and prior years for comparison purposes, are presented with the MVNO BU as discontinued operations. The Company opted for the rule that only three years of operating results are required to be presented in accordance with the applicable regulations of the British Virgin Islands.

  

1

 

 

    Fiscal Years Ended December 31,  
Consolidated Statements of Income and Comprehensive Income Data:   2018     2019     2020  
    ($’000)  
Net revenues     128,420       98,958       26,751  
Gross profit (loss)*     (6,023 )     569       1,596
Operating expenses**     (60,825 )     (31,578 )     (42,216 )
Other operating income     180       1,854       -  
Operating income (loss)     (66,668 )     (29,155 )     (40,620 )
Income (loss) from continuing operations, before income taxes     (68,727 )     (32,532 )     (35,683 )
Income tax (expense) benefit     (331 )     949       (406 )
Net income (loss) from continuing operations     (69,058 )     (31,583 )     (36,089 )
                         
Discontinued operations                        
(Loss) income from discontinued operations, before income taxes     (1,300 )     (4,151 )     1,302  
Income tax benefit (expense)     (1,640 )     -       -  
(Loss) income from operations of discontinued entities     (2,941 )     (4,151 )     1,302  
                         
Net income (loss)     (71,999 )     (35,734 )     (34,787 )

 

 

(*

Gross profit for 2018 included $6.2 million in cost of goods for one transaction in which the related revenue was not recognized in 2018, due to uncertainty in collectability and resulted in a negative gross margin. Such unusual treatment for the hardware cost of goods did not happen for 2019. For the year 2020, cost of goods included $3.2 million of hardware costs from projects that were cancelled due to the COVID-19 pandemic.)  

(** Operating expenses for 2018 included non-recurring charges of $4.3 million in arbitration loss, write-off and provision for doubtful accounts and current assets of $22.2 million, write-down of historical inventory due to loss & obsolescence of $0.9 million, impairment of long-term investment of $13.0 million.)
(**

Operating expenses for 2019 included provision for doubtful accounts of $13.6 million, non-recurring penalties of $3.4 million and reversal of historical inventory of $0.3 million.)

(**

Operating expenses for 2020 included stock based compensation of $20.0 million and non-recurring penalties of $1.1 million, and a contingency loss of $3.1 million from the disposal of a business unit.)

 

    Fiscal Years Ended December 31,  
Consolidated Balance Sheets Data:   2019     2020  
    ($’000)  
Cash and cash equivalents     1,001       3,044  
Restricted cash     5,011       37  
Accounts receivable, net     1,699       944  
Inventories     4,543       2,675  
Property, plant and equipment, net     241       152  
Total assets     56,798       29,352  
Total liabilities     105,503       91,593  
Total shareholders’ equity (deficit)     (48,705 )     (62,241 )

 

2

 

 

Held for sale assets and liabilities

 

The Company decided to sell Yuantel, our MVNO BU, or the Consolidated VIEs, which operations were classified as discontinued operations, and the assets and liabilities were classified as held for sale for the years 2018 and 2019. The sale was finally completed as of October 29, 2020.

 

    As of December 31,  
    2019     2020  
    ($’000)  
Carrying amounts of major classes of assets included as part of the assets held for sale                
Cash and cash equivalents     1,528       -  
Restricted cash     768       -  
Accounts receivable     1,614       -  
Receivable from MVNO franchisees     374       -  
Inventories     210       -  
Prepaid expenses and other current assets     1,503       -  
              -  
Current assets held for sale     5,997          
                 
Property and equipment, net     719       -  
Intangible assets, net     7,786       -  
Goodwill     689       -  
Deferred tax assets     -       -  
Other non-current assets     1,111       -  
                 
Non-current assets held for sale     10,305       -  
                 
Total assets of the Consolidated VIEs classified as held for sale in the Consolidated Balance Sheets     16,302       -  
                 
Carrying amounts of major classes of liabilities included as part of liabilities held for sale                
Accounts payable     6,317       -  
Accrued expenses and other payables     9,715       -  
Amounts due to continuing operations     933       -  
Advances from customers     4,018       -  
Deferred revenues     -       -  
Short-term bank borrowings     -       -  
Current liabilities held for sale     20,983       -  
                 
Deferred tax liabilities     1,750       -  
Deferred revenues non-current     -       -  
                 
Non-current liabilities held for sale     1,750       -  
                 
Total liabilities of the Consolidated VIEs classified as held for sale in the Consolidated Balance Sheets     22,733       -  

 

B. Capitalization and Indebtedness

 

Not applicable.

 

C. Reasons for the Offer and Use of Proceeds

 

Not applicable.

 

3

 

 

D. Risk Factors

 

Investing in our ordinary shares involves a high degree of risk. You should carefully consider the risks described below, as well as the other information in this report, including our consolidated financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” before deciding whether to invest in our ordinary shares. The occurrence of any of the events or developments described below could materially and adversely affect our business, financial condition, results of operations and growth prospects. In such an event, the market price of our ordinary shares could decline, and you may lose all or part of your investment. Additional risks and uncertainties not presently known to us or that we currently believe are not material may also impair our business, financial condition, results of operations and growth prospects.

 

Ricks due to the COVID-19 pandemic.

 

We have experienced and expect to continue to experience unpredictable reductions in demand for certain of our products and services, and adverse effects on our operations, supply chains and financing possibilities.

 

Since February 2020, we have experienced reductions and cancellations of orders due to effects of the COVID-19 pandemic on the demand from certain of our customers. We expect this negative effect on global business activities will continue to have pressure on the Company’s sales as the pandemic environment persists and perhaps even post the pandemic. In addition, since our operations span the United States, India, China and South Korea, international and intra-country travel restrictions will continue to hamper our operations and have negative effects including delays and uncertainties on our supply chain delivery schedules and our abilities to secure financing for our working capital needs. We expect the impacts of COVID-19 to have an adverse effect on our business, financial condition and results of operations. Our revenue for the year 2020 was negatively impacted by the pandemic by as much as a reduction of 73.0% as compared to 2019; and our ability to obtain debt financing or raise equity-based capital may not be adequate for the Company’s current operations. As the assessable risks due to COVID-19 change in India and China, our operations can be affected, including due to the restrictions from accessing office facilities and limitations on domestic travels which can hamper our ability to efficiently manage the manufacturing of products since our contracted factories are located over various cities in China.

 

As our sales were negatively impacted by the pandemic in 2020, we cut back our operational costs by reduction of approximately 20% of our workforce in India and 40% of our headcount in China. We constantly evaluate our financial position according to changes in the international business environment and depending on forecast of orders from our customers in the near future, we may further reduce staffing as necessary.

 

Also as a result of stringent cash flows as of the date of filing of this annual report and given that the pandemic situation is foreseeable to last through a substantial part of the year of 2021, we will postpone further investment into the acquisition target of KADI and we are in negotiation with the owners of KADI to decrease our potential ownership percentage in their company.

 

Risks Related to our Business and Industry

 

We incurred loss and total cash outflows from operations, and we had a deteriorated net current assets position. There is substantial doubt about our ability to continue as a going concern.

 

As of December 31, 2020, we had cash and cash equivalents of approximately $3.08 million and generated a net loss from continuing operations of approximately $36.09 million and cash outflows for continuing operations of approximately $5.23 million for the year then ended. We cannot anticipate when, if ever, we will become profitable. Although we have improved the efficiency of our networks and operations and adopted related cost reduction measures, we cannot assure you that we will continue to achieve such efficiency or sustain such cost reductions. If we are unable to generate revenues that significantly exceed our costs and expenses, we will continue to incur losses in the future.

 

Our ability to continue as a going concern is dependent upon our continued operations, which in turn is dependent upon our ability to meet our financial requirements. Our ability to meet the working capital requirements is subject to the risks relating to the demand for and prices of our services in the market, the economic conditions in our target markets, the successful operation of our connected solution, timely collection of payment from our customers and the availability of additional funding. In the next 12 months, we will use the cash inflows including short-term supply chain financing, advances from customers and financing possibilities from financial institutions, and cash from the sale of our MVNO business unit. However, there is no guarantee such financing mechanism will be available at terms acceptable to us.

 

4

 

 

The audited consolidated financial statements included in this annual report on Form 20-F were prepared on the basis of our continuing as a going concern. Facts and circumstances including recurring losses, net cash outflows and deteriorated net current assets position raise substantial doubt about our ability to continue as a going concern. If we become unable to continue as a going concern, we may have to liquidate our assets, and the value we receive for our assets in liquidation or dissolution could be significantly lower than the values reflected in our audited consolidated financial statements. Our lack of cash resources and our potential inability to continue as a going concern may materially and adversely affect the price of our shares and our ability to raise new capital or to continue our operations.

 

We were in default of the agreements governing outstanding loan facilities as of December 31, 2020 and although these defaulted loans were completely paid off as of February 17, 2021, we may become in default with loans in the future and the following risks will reappear.

 

Covenants governing our loan facilities restrict, among other things, our ability to:

 

  pay dividends or distributions, repurchase or redeem equity;

 

  incur or permit to exist any additional indebtedness or liens;

 

  guarantee or otherwise become liable with respect to the obligations of another party or entity;

 

  acquire any assets, except in the ordinary course of business, or make any investments; and

 

  sell all or substantially all of our assets.

 

Our ability to comply with these provisions may be affected by events beyond our control. Any defaults under our future loan agreements 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:

 

  seek additional financing in the debt or equity markets;

 

  delay, curtail or abandon altogether our research & development or investment plans;

 

  refinance or restructure all or a portion of our indebtedness; or

 

  sell selected assets.

 

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 reduction of operations and deliveries of products to our customers. 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.

 

The Company entered into agreements on December 14, 2020 with PFG and LMFA Financing LLC (“LMFA”), a Florida limited liability company and wholly owned subsidiary of LM Funding America, Inc. (Nasdaq: LMFA), in which LMFA will purchase approximately $18 million of debt in tranches. As of February 10, 2021, LMFA completed the purchase of $17.87 million of principal, accrued interest and applicable fees (the “Debt”), converted into and sold all 22.73 million shares of the Company’s ordinary shares by February 10, 2021. With the Company settling another $1.27 million of Debt directly with the senior lender by the issuance of 1.51 million shares on February 17, 2021 which the senior lender subsequently sold, the Company’s defaulted Debts with the senior lender totaling $19.14 million have been eliminated since then.

 

5

 

 

We have more current liabilities than current assets as of December 31, 2020.

 

Our balance sheet as of December 31, 2020 showed current assets of $23.87 million and current liabilities of $86.81 million. Although profit margin improvements coupled with better financing facilities in future periods may reverse this situation, there is no assurance of how long this situation may remain or if we can ever achieve healthier liquidity ratios. If this situation persists for too long, it will hamper the Company’s ability to operate effectively and will likely create pressure on the market price of our ordinary shares.

 

If alternative mobile operating system platforms become more widely used or accepted, or mobile chipset manufacturers, mobile device Original Equipment Manufacturers (“OEMs” and each an “OEM”) 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 accounted for 74.8%, 87.2% and 88.2% of our net revenues in 2018, 2019 and 2020, respectively.

 

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.

 

6

 

 

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, we entered into the MVNO business. However, the success of these businesses depends 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. In November 2018, our board of directors approved the sale of the MVNO business unit, and we entered into agreements with buyers in February 2019 to sell all of the Consolidated VIEs that hold the MVNO operation. Due to an investigation into several individuals employed by the MVNO business unit as described in “Item 4. Information of the Company” below, only partial sales proceeds were received in 2019. The Company executed a new agreement with the buyers of the MVNO business unit as of September 1, 2020 and the balance of the sales proceeds was received by October 29, 2020 and the sale was deemed completed on the same date.

 

For our MVNO business unit that we classified as discontinued operation due to the sale of this unit which was finalized by October 29, 2020, prior to its sale we provided mobile communication services as a mobile virtual network operator in China. The current license to operate such services is based on an MVNO license issued to us in July 2018 by the Ministry of Industry and Information Technology of China (“MIIT”) which is valid until July 12, 2023.

 

The ability of our MVNO to provide mobile communication services in China was based on the license granted by MIIT. 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, for which we did in 2014, 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, and in July 2018, the MIIT issued the MVNO license to us which will expire on July 12, 2023.

 

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.

 

7

 

 

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, we 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.

 

The investigation into Yuantel.

 

As described in “Item 4. Information on the Company” below, there is an on-going investigation by the Yunnan Public Security Bureau in connection with the former president, the operating officer, and one former employee of Yuantel, our MVNO Business Unit (accordingly, the “Investigation”). It is still not known as of the date of filing of this report, whether results from this investigation may or not have any significant adverse effects over the Company as a result of events which occurred prior to our sale of the MVNO BU, which may include fines and certain limitation of its activities. We completed the sale on October 29, 2020. However, at this point, it is not entirely clear whether or not, the Company may have any liabilities arising from events which occurred prior to our sale. The on-going investigation by the Yunnan Public Security Bureau has been focused on the individual level only and has not named the Company or Yuantel as accused in any way as of the filing of this annual report. Management assessed that the investigation may not have any impact on Yuantel’s abilities to operate under the MVNO license.

 

In September 2019, the Bureau issued official orders and detained three individuals, including the president of Yuantel at that time, who was placed under arrest at the Panlong District First Detention Center, under suspicion of failure to administer information network security, this individual has not been formally charged as of the date of this report; the operating officer of Yuantel who was released on bail but may be summoned in the future for further investigations; and one former employee. Neither, the Company nor any of its subsidiaries were named in the case, and no official notice has been received by the Company as of the date of filing of this annual report in connection with this investigation. There was approximately $0.3 million retained by the buyer regarding disposal of Yuantel. It was due to the possibility of Yuantel being charged with penalties in the Yunnan Public Securities Bureau’s investigation on the previous executives. If Yuantel is fined, the penalties up to $0.3 million will be paid out from this retained amount. If there are no penalties assessed by the authorities onto Yuantel by April 30, 2021, the buyer will release the amount to the Group. The Company dismissed both employees undergoing the investigation in October 2020. For further details regarding this investigation, please see Section 4 Information on the Company, page 40-41 “Investigation into the MVNO Business Unit.” 

 

Potential dispute on the ownership of Big Cloud Network

 

In order to comply with PRC laws and regulations that prohibit direct foreign ownership in certain telecommunication related businesses, the Group conducted its businesses of the MVNO BU in the PRC through the use of VIE contractual agreements (the “VIE Agreements”).

 

The Group funds Beijing Big Cloud Network Technology Co., Ltd. (“Big Cloud Network”) through loans to the two Big Cloud Network’s shareholders, (collectively the “Nominee Shareholders”). The effective control of Big Cloud Network is held by the Group, through a series of contractual agreements between Borqs Beijing and Big Cloud Network whereby Big Cloud Network became the Consolidated VIE of the Group. Through the contractual agreements, the Group receives substantially all of the economic benefits of Big Cloud Network.

 

8

 

 

One of the nominee shareholders of Big Cloud Network denied his entrustment relationship with the Group and claimed his rights and interests proceeds of the disposal of Yuantel. Although there were agreements between the Group and the nominee shareholder, there was no direct evidence to show the entrustment relationship between both parties, which may not be supported by the existing PRC laws and regulation. As a result, the Group assessed it was probable a loss would be incurred. The Group estimated a loss ranged from $3.2 million to $3.6 million based on the best estimate of the information available. Because of there was no amount within the range would be a better estimate than any other amount, the minimum amount in the range of $3.2 million recorded as a contingent liability as of December 31, 2020. Even though the minimum amount in the range is not necessarily the amount of loss that will be ultimately determined, it is not likely that the ultimate loss will be less than the minimum amount. The ultimate amount could result in a loss of up to $0.4 million in excess of the amount accrued.

 

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. As discussed above in this report, due to stringent cash flows as of the filing of this annual report and the pandemic situation foreseeably lasting through a substantial part of year 2021, we will postpone further investment into the acquisition target of KADI and we are in negotiation with the owners of KADI to decrease our ownership percentage in KADI. For the acquisition of Colmei and Crave, since both of these companies are insolvent, we have ceased to make additional payments for ownership and have written off the value of the equity we paid to the owners previously.

 

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.

 

9

 

 

Our yearly results may fluctuate significantly and may not fully reflect the underlying performance of our business.

 

Our yearly 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 year should not be relied upon as an indication of future performance. Our yearly 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 yearly results may negatively impact the value of our ordinary shares. Factors that may cause fluctuations in our yearly financial results include, but are not limited to:

 

  our ability to attract new customers;

 

  our ability to convert users of our limited free versions to paying customers;

 

  the addition or loss of large customers, including through acquisitions or consolidations;

 

  our customer retention rate;

 

  the timing of recognition of revenue;

 

  the amount and timing of operating expenses related to the maintenance and expansion of our business, operations and infrastructure;

 

  network outages or security breaches;

 

  general economic, industry and market conditions;

 

  increases or decreases in the number of features in our services or pricing changes upon any renewals of customer agreements;

 

  changes in our pricing policies or those of our competitors;

 

  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

 

  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.

 

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.

 

10

 

 

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 a 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 2018, 2019 and 2020, our net revenues from software fees were $9.5 million, $14.7 million and $10.6 million, respectively, representing 7.4%, 15.0% and 39.5% of total net revenues, respectively. 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:

 

  financial difficulties for our customers;

 

  business going to our competitors or remaining in-house;

 

  unsuccessful launch of a product;

 

  disclosure of core technology by a third party; and

 

  mergers and acquisitions or significant corporate restructurings by our customers.

 

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.

 

11

 

 

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 unit), 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.

 

12

 

 

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:

 

  significant currency fluctuations between the Renminbi and the U.S. dollar and other currencies in which we transact business;

 

  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;

 

  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;

 

  potentially adverse tax consequences, such as scrutiny of transfer pricing arrangements by authorities in the countries in which we operate;

 

  adverse effect of inflation and increase in labor costs;

 

  current and future tariffs and other trade barriers, including restrictions on technology and data transfers;

 

  general global economic downturn;

 

13

 

 

  for 2019, our revenues were 63.9% concentrated with one customer in India, and the financial status of this customer together with the state of the Indian economy can greatly affect our business;

 

for 2020, our revenues were 41.9% concentrated with one customer in the U.S., and the financial status of this customer together with the state of the U.S. economy can greatly affect our business;

 

  unexpected changes in political environment and regulatory requirements; and

 

  terrorist attacks and other acts of violence or war.

 

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, and enlarge our financing resources. 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. 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.

 

14

 

 

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.”

 

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 are 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 to 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.

 

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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.

 

On May 17, 2019, we received a notification from the Listing Qualifications Department of Nasdaq indicating our non-compliance with Nasdaq Listing Rule 5250(c)(1) due to our failure to timely file our Annual Report on Form 20-F for fiscal year 2018.

 

On January 9, 2020, the Nasdaq Hearings Panel issued its decision (“Decision”) to grant our request for continued listing on Nasdaq, subject to the conditions that: (i) on or before January 23, 2020, we had informed the Panel that the Company’s independent auditor had completed its audit of our financial statements for fiscal year 2018; and (ii) on or before March 1, 2020, we had filed with the Securities and Exchange Commission (the “SEC”) the annual report for fiscal year 2018 in order to regain compliance with Nasdaq Listing Rule 5250(c)(1). As a result of the Decision, during this period our ordinary shares continued to trade on Nasdaq under symbol “BRQS”.

 

On January 17, 2020, we received a letter from the Nasdaq Listing Qualifications Staff (the “Staff”) in which the Staff intended to delist the Company’s securities from The Nasdaq Capital Market based upon our failure to hold our annual general meeting of shareholders in 2019 as a result of our inability to file the annual report for fiscal year 2018.

 

Pursuant to Nasdaq Listing Rule 5250(d)(1), a listed company is required to distribute its annual report to its shareholders, either by mailing, posting to the company’s website, or by other internet posting consistent with Rule 14a-16 of the Securities and Exchange Act of 1934. Consistent with past practice, promptly after the filing of the annual report with the SEC, we mailed a copy of the annual report together with our proxy materials for an annual general meeting of shareholders.

 

On February 4, 2020, we filed our annual report for the year ended December 31, 2018 and on March 9, 2020, we held our annual general meeting of shareholders.

 

On March 10, 2020, we received a letter from the Nasdaq Office of General Counsel notifying that the Company had regained compliance with the periodic filing and annual shareholder meeting requirements.

 

Due to the COVID-19 pandemic, we were unable to file the annual report for the year ended December 31, 2019 by the deadline of June 30, 2020; and on July 9, 2020 we received a delisting determination letter from the Staff notifying the Company that due to the non-filing of the annual report, our ordinary shares were subject to delisting from the Nasdaq Capital Market. We filed an appeal of Nasdaq’s determination to delist, and a hearing was held on August 27, 2020. On September 14, 2020, we received a letter from Nasdaq informing us that the Panel had decided to grant the Company’s request to remain listed on Nasdaq on the condition that we had filed the 2019 annual report on form 20-F by September 30, 2020 which we did.

 

On October 2, 2020, we received a letter from the Nasdaq Office of General Counsel notifying that the Company had regained compliance with the Nasdaq Listing Rule 5250(c)(1).

 

Additionally, 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:

 

  less liquid trading market for our securities;

 

  more limited market quotations for our securities;

 

  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;

 

  more limited research coverage by stock analysts;

 

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  loss of reputation; and

 

  more difficult and more expensive equity financings in the future.

 

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. Any claims, whether with or without merit, could be time consuming, expensive to defend, and could divert management’s attention and resources. We 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.

 

We were in arbitration before the International Chamber of Commerce with Samsung Electronics Co., Ltd. (“Samsung”) to resolve a dispute regarding royalties payable to the Company under a software license agreement the Company had with Samsung. Samsung alleged that, for the period starting the fourth quarter of 2010 through mid-2012, the Company was overpaid royalties in the amount of approximately $1.67 million due to a clerical error in Samsung’s accounting department that enabled the Company to receive royalties on sales of Samsung handsets that did not contain its software. Samsung was 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 held in May 2018, on November 27, 2018, the International Chamber of Commerce notified the Company of its decision and issuance of an arbitration award (the “Award”), which the Company received on November 29, 2018. Pursuant to the Award, the Company was obligated to pay Samsung an aggregate of $2,546,401 plus an interest of 9% per annum starting May 16, 2018 until full payment is paid. Samsung was also awarded its attorney’s fees and expenses in the aggregate amount of approximately $1.73 million. The Company has reached an agreement with Samsung for settling the payments due to Samsung by making 24 monthly payments beginning in April 2019. The Company has pledged $5 million worth of ordinary shares in escrow as security for the payments and in the event that the Company is in default of the scheduled payments, Samsung has the right to seize the escrow shares. If we fail to make timely payments to Samsung, we may be subject to additional potential litigation damages resulting in a material adverse impact to the Company. Due to cash flow constraints resulting from the COVID-19 pandemic, we have not made additional payments to Samsung in the year 2020, and are seeking alternative means to pay off this liability including via the issuance of shares to Samsung.

 

If we fail to implement and maintain effective internal control over financial reporting, we may be unable to accurately report our results of operations, meet our reporting obligations 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 control over financial reporting. As defined in standards established by the United States Public Company Accounting Oversight Board, or the PCAOB, a “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis; and a “significant deficiency” is less severe than a material weakness in that it is unlikely to have a material impact on financial statements but is important enough to merit attention by those responsible for oversight of the company’s financial reporting. Based on that evaluation, our management concluded that these controls were ineffective as of December 31, 2020. In the years ended December 31, 2020 and 2019, we did not maintain sufficient controls over financial reporting processes due to 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 to properly address complex U.S. GAAP accounting issues and to prepare and review our consolidated financial statements and related disclosures to fulfill U.S. GAAP and SEC financial reporting requirements. This deficiency constitutes as a material weakness of our internal control over financial reporting.

 

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During 2018, the Company began to seek for professional services for U.S. GAAP and SEC financial reporting related matters. The Company made efforts in recruitment and hired a financial reporting controller and an accounting manager in 2018. In addition, the Company identified a qualified external professional consultant for a senior financial and reporting role from its selection process in 2018, and the individual officially joined the Company as a financial director in January 2019. We have taken multiple steps to implement measures designed to improve our internal control over financial reporting to remediate the material weakness and hence our management concluded that the material weakness was being mitigated as of December 31, 2019 by multiple factors including: (a) hiring of a financial director with over 15 years of US GAAP audit experience in 2019 to help set up workflows for the strengthening of internal controls and preserving accuracy in preparing consolidated financial statements, (b) hiring of a senior manager of finance who is a licensed accountant from Australia and has US GAAP reporting experience with several firms before joining our Company; and (c) since December 2018, our Chairperson of the Audit Committee, a member of the Washington State board of Accountancy since the year 1989, has been regularly providing the Company with advice on procedures and interpretation of US GAAP rules and regulations. In addition, we plan to take a number of other measures to strengthen our internal control over financial reporting, including (i) continuing to hire additional qualified professionals with experience in U.S. GAAP accounting and SEC reporting to lead accounting and financial reporting matters; (ii) organizing regular training for our accounting staffs, especially the trainings related to U.S. GAAP and SEC reporting requirements; and (iii) establishing effective oversight and clarifying reporting requirements for non-recurring and complex transactions to ensure consolidated financial statements and related disclosures are accurate, complete and in compliance with U.S. GAAP and SEC reporting requirements. Due to the COVID-19 pandemic, it was difficult for the Company to hire additional finance and accounting staff.

 

As of December 31, 2020, management had identified two significant deficiencies relating to the information technologies (“IT”) controls in our MVNO (discontinued) business.

 

  1) Large amounts of customer personal information, account balances and usage details were only provided by MVNO BU’s incumbent operator, China Unicom, on a six-month basis; and through strenuous efforts MVNO BU were still not able to convince China Unicom to keep the data longer than a historical rolling 6-month interval; and

 

  2) Super system administrator access of key business information systems of MVNO BU can be obtained by out-sourced third-party developers. Such super system administrator access can be used to add, delete, or modify the business data in the key business information systems.

 

Following the identification of the significant deficiencies, we planned to take measures to remediate by i) negotiating with the incumbent operator to allow access to data older than six months, and ii) incorporating control mechanisms within the MVNO management and out-sourced developers. For more details about remediation, see “Item 15. Controls and Procedures”. Our failure to correct the significant deficiencies and control the deficiencies or our failure to discover and address any other weakness or deficiencies could result in inaccuracies in our financial statements and could also impair our ability to comply with applicable financial reporting requirements. As a result, our business, financial condition, results of operations and prospects, as well as the market price of our ordinary shares, may be materially and adversely affected. Moreover, ineffective internal control over financial reporting significantly hinders our ability to prevent fraud.

 

We are a public company in the United States subject to the Sarbanes Oxley Act of 2002. Section 404 of the Sarbanes Oxley Act, or Section 404, requires us to include a report from management on the effectiveness of our internal control over financial reporting in our annual report on Form 20-F. Our management concluded that our internal control over financial reporting is not effective. In addition, once we cease to be an “emerging growth company” as such term is defined in the JOBS Act, our independent registered public accounting firm must attest to and report on the effectiveness of our internal control over financial reporting. Even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm, after conducting its own independent testing, may issue an adverse opinion if it is not satisfied with our internal controls or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us. In addition, our reporting obligations may place a significant strain on our management, operational and financial resources and systems for the foreseeable future. We may be unable to timely complete our evaluation testing and any required remediation.

 

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During the course of documenting and testing our internal control procedures, in order to satisfy the requirements of Section 404, we may identify other weaknesses and deficiencies in our internal control over financial reporting. In addition, if we fail to maintain the adequacy of our internal control over financial reporting, as these standards are modified, supplemented or amended from time to time, we may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404. Moreover, our internal control over financial reporting may not prevent or detect all errors and -fraud. A control system, no matter how well it is designed and operated, it cannot provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud will be detected.

 

We believe that the Company’s financial reporting persons possess significant US GAAP experience to be a valuable resource for us with respect to financial reporting work. We believe we have adequate personnel with knowledge and experience with US GAAP for the preparation of our annual report for the year 2020. Since December 2018, our Chairperson of the Audit Committee has been regularly providing the Company with advice on procedures and interpretation of US GAAP rules and regulations. The Chairperson of the Audit Committee has been a member of the Washington State Board of Accountancy since the year 1989. However, if we fail to achieve and maintain an effective internal control environment, we could suffer material misstatements in our financial statements and fail to meet our reporting obligations, which would likely cause investors to lose confidence in our reported financial information. This could in turn limit our access to capital markets, harm our results of operations, and lead to a decline in the market price of our ordinary shares. Additionally, ineffective internal control over financial reporting could expose us to increased risk of fraud or misuse of corporate assets and subject us to potential delisting from the stock exchange on which we list, regulatory investigations and civil or criminal sanctions. We may also be required to restate our financial statements from prior periods.

 

Risks Related to Doing Business in China

 

There are significant legal and other obstacles to obtaining information needed for shareholder investigations or litigation outside China or otherwise with respect to foreign entities.

 

We conduct a significant part of our business operations in China, and a majority of our directors and senior management are based in China, which is an emerging market. The SEC, U.S. Department of Justice and other authorities often have substantial difficulties in bringing and enforcing actions against non-U.S. companies and non-U.S. persons, including company directors and officers, in certain emerging markets, including China. Additionally, our public shareholders may have limited rights and few practical remedies in emerging markets where we operate, as shareholder claims that are common in the United States, including class action securities law and fraud claims, generally are difficult to pursue as a matter of law or practicality in many emerging markets, including China. For example, in China, there are significant legal and other obstacles to obtaining information needed for shareholder investigations or litigation outside China or otherwise with respect to foreign entities. Although the local authorities in China may establish a regulatory cooperation mechanism with the securities regulatory authorities of another country or region to implement cross-border supervision and administration, the regulatory cooperation with the securities regulatory authorities in the Unities States has not been efficient in the absence of a mutual and practical cooperation mechanism. According to Article 177 of the PRC Securities Law which became effective in March 2020, no foreign securities regulator is allowed to directly conduct investigation or evidence collection activities within the territory of the PRC. Accordingly, without the consent of the competent PRC securities regulators and relevant authorities, no organization or individual may provide the documents and materials relating to securities business activities to foreign securities regulators.

 

As a result, our public shareholders may have more difficulty in protecting their interests in the face of actions taken by management, members of the board of directors or controlling shareholders than they would as public shareholders of a company incorporated in the United States.

 

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.

 

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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 depend, 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 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.

 

In the year ended December 31, 2020, we derived about 20.3% of our revenues from customers located in India. In May 2020, skirmishes occurred over the Sino-Indian border and the relationship between the two countries has been in distress. Although there had been no official statements from either governments that directly affected commercial activities between the two countries, tension may escalate in the future to have a negative impact on our businesses.

 

Due to social unrest in Hong Kong SAR throughout 2019 which also extended into 2020, China passed a new national security law for Hong Kong which became effective on June 30, 2020. In reaction, the United States has imposed sanctions against Hong Kong’s chief executive and ten other senior officials. Although the U.S. sanctions so far do not implicate any commercial activities involving Hong Kong, it is an area of concern if more sanctions from the U.S. may impact our Company’s ability to maintain a sound business relationship with our customers in the U.S.

 

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. Any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.

 

Additionally, some of the PRC laws and regulations governing our business operations in China are vague and their official interpretation and enforcement may involve substantial uncertainty. These include, but are not limited to, laws and regulations governing our business and the enforcement and performance of our contractual arrangements in the event of the imposition of statutory liens, death, bankruptcy and criminal proceedings. Despite their uncertainty, we will be required to comply.

 

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Recent trade policy initiatives announced by the United States administration against the PRC may adversely affect our business.

 

On January 15, 2020, the United States and China executed an enforceable agreement on a Phase One trade deal that requires structural reforms and other changes to China’s economic and trade regime in the areas of intellectual property, technology transfer, agriculture, financial services, and currency and foreign exchange. The Phase One agreement also includes a commitment by China that it will make substantial additional purchases of U.S. goods and services in the coming years. Importantly, the agreement establishes a strong dispute resolution system that ensures prompt and effective implementation and enforcement. The United States agreed to modify its Section 301 tariff actions in a significant way. The United States first imposed tariffs on imports from China based on the findings of the Section 301 investigation on China’s acts, policies, and practices related to technology transfer, intellectual property, and innovation. The United States will be maintaining 25 percent tariffs on approximately $250 billion of Chinese imports, along with 7.5 percent tariffs on approximately $120 billion of Chinese imports.

 

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.

 

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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 (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.

 

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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 the State Administration of Foreign Exchange (“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.

 

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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.

 

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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 started to process the SAFE application for our employee stock option plan during fiscal 2021.

 

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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 (“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 a 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 a 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. A FIE is prohibited from conducting business in an industry subject to foreign investment “prohibitions” in the “negative list”. However, a 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.

 

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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 this 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 was 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.

 

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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.

 

Although our MVNO business unit was classified as discontinued operation due to a sale that was completed as of October 29, 2020, prior to the completion of the sale 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 affect 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.

 

One of the nominee shareholders of Big Cloud Network denied his entrustment relationship with the Group and claimed his rights and interests proceeds of the disposal of Yuantel. Although there were agreements between the Group and the nominee shareholder, there was no direct evidence to show the entrustment relationship between both parties, which may not be supported by the existing PRC laws and regulation. As a result, the Group assessed that a probable loss could be incurred.

 

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Although our MVNO business unit was classified as discontinued operation due to a sale that was completed as of October 29, 2020, prior to the completion of the sale 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.

 

One of the nominee shareholders of Big Cloud Network denied his entrustment relationship with the Group and claimed his rights and interests proceeds of the disposal of Yuantel. Although there were agreements between the Group and the nominee shareholder, there was no direct evidence to show the entrustment relationship between both parties, which may not be supported by the existing PRC laws and regulation. As a result, the Group assessed that a probable loss could be incurred. The Group estimated a loss ranged from $3.2 million to $3.6 million based on the best estimate of the information available. Because of there was no amount within the range would be a better estimate than any other amount, the minimum amount in the range of $3.2 million recorded as a contingent liability as of December 31, 2020. Even though the minimum amount in the range is not necessarily the amount of loss that will be ultimately determined, it is not likely that the ultimate loss will be less than the minimum amount. The ultimate amount could result in a loss of up to $0.4 million in excess of the amount accrued.

   

Although our MVNO business unit was classified as discontinued operation due to a sale that was completed as of October 29, 2020, prior to the completion of the sale 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.

 

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Although our MVNO business unit was classified as discontinued operation due to a sale that was completed as of October 29, 2020, prior to the completion of the sale 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.

 

 

Although our MVNO business unit was classified as discontinued operation due to a sale that was completed as of October 29, 2020, prior to the completion of the sale 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. The amount of current income tax liability  related to disposal of Yuantel was approximate $0.7 million. The Group expected to pay the related income tax within year 2021.

 

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 potential controlling position of 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. As of the filing of this annual report, the acquisition has not yet been completed due to complication in the change of ownership at the local jurisdiction. We are working with the owners of KADI and the local authorities, and we may have to resolve to own less than the original intended target of 60% of KADI. Further, due to the financial impact on the Company by the COVID-19 pandemic and that our flow of cash was stringent in year 2020, we have determined to postpone further investment into the acquisition target of KADI and we are in negotiation with the owners of KADI to decrease our ownership percentage in their company.

 

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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.

 

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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 electric vehicle (“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

 

The terms of our previously announced KADI acquisition may subject to change or rescission.

 

Certain commercial registrations with the local jurisdictions regarding our acquisition of KADI have not been completed as of the date of the report. If such filings cannot be completed with local government agencies in a reasonable time frame, it may affect our ability to capture the KADI business. Due to certain changes in the electrical vehicle industry and its technologies, such as increases in component pricing, both the Company and KADI have an interest in amending the agreement signed as of December 15, 2018. As discussed above in this report, due to stringent cash flows as of the filing of this annual report due for the most part to the pandemic situation which is foreseeable to last through the remainder of year 2021, we will postpone further investment into the acquisition target of KADI, our intended acquisition of KADI has not been completed and we are in negotiation with the owners of KADI to decrease our potential ownership percentage of their company.

 

Even if we complete the acquisition of KADI, we may be unsuccessful at integrating the KADI business.

 

KADI’s future business 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. Additionally, 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.

 

We depend on key personnel of KADI and 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.

 

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 officer. 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.

 

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Risks Related to Our Securities

 

We have a substantial number of convertible securities outstanding. The exercise of our outstanding options and conversion of our outstanding convertible notes can have a dilutive effect on our common stock.

 

We have a substantial number of convertible securities outstanding. The exercise of our outstanding options and conversion of our outstanding convertible notes can have a dilutive effect on our common stock. As of April 15, 2021, we had (i) outstanding options to purchase approximately 3.25 million shares of our common stock at a weighted average exercise price of $1.25 per share, (ii) outstanding warrants to purchase approximately 0.4 million shares at a weighted average exercise price of $5.36 per share and (iii) outstanding convertible notes that, upon conversion without regard to any beneficial ownership limitations, would provide note holders with an aggregate of 19.7 million shares of our common stock; and warrants which upon exercise without regard to any beneficial ownership limitations or advance conversion notice, would provide the holders with an aggregate of 17.8 million shares of our common stock. The issuance of shares of common stock upon exercise of outstanding options and or conversion of outstanding convertible notes could result in substantial dilution to our stockholders, which may have a negative effect on the price of our common stock.

 

If equity research analysts publish unfavorable commentary or downgrade our ordinary shares, the price and trading volume of our ordinary shares could decline.

 

The trading market for our ordinary shares could be affected by whether equity research analysts publish research or reports about us and our business. We cannot predict at this time whether any research analysts will publish research and reports on us and our ordinary shares. If one or more equity analysts do cover us and our ordinary shares and publish research reports about us, the price of our stock could decline if one or more securities analysts downgrade our stock or if those analysts issue other unfavorable commentary or cease publishing reports about us or our business.

 

If any of the analysts who elect to cover us downgrades our stock, our stock price could decline rapidly. If any of these analysts ceases coverage of us, we could lose visibility in the market, which in turn could cause our ordinary shares price or trading volume to decline and our ordinary shares to be less liquid.

 

Future equity issuances could result in dilution, which could cause our ordinary shares price to decline.

 

We are generally not restricted from issuing additional ordinary shares, and there is no limit to the number of ordinary shares that we are authorized to issue by our memorandum and articles of association. We may issue additional ordinary shares in the future pursuant to current or future equity compensation plans, upon conversions of preferred shares or debt, upon exercise of warrants or in connection with future acquisitions or financings. If we choose to raise capital by selling our ordinary shares for any reason, the issuance would have a dilutive effect on the holders of our ordinary shares and could have a material negative effect on the market price of our ordinary shares.

 

Future sales of our ordinary shares by existing shareholders may cause our ordinary shares price to decline.

 

If our existing shareholders sell, or indicate an intent to sell, amounts of our ordinary shares in the public market after the contractual lock-up and other legal restrictions on resale lapse, the trading price of our ordinary shares could decline.

 

We may issue additional preferred shares in the future, which could make it difficult for another company to acquire us or could otherwise adversely affect holders of our ordinary shares, which could depress the price of our ordinary shares.

 

Our board also has the power, without shareholder approval, to set the terms of any series of preferred shares that may be issued, including voting rights, dividend rights and preferences over our ordinary shares with respect to dividends or in the event of a dissolution, liquidation or winding up and other terms. In the event that we issue preferred shares in the future that have preference over our ordinary shares with respect to payment of dividends or upon our liquidation, dissolution or winding up, or if we issue preferred shares with voting rights that dilute the voting power of our ordinary shares, the rights of the holders of our ordinary shares or the market price of our ordinary shares could be adversely affected. In addition, the ability of our Board to issue preferred shares without any action on the part of our shareholders may impede a takeover of us and prevent a transaction perceived to be favorable to our shareholders.

 

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We may be classified as a passive foreign investment company, which could result in adverse U.S. federal income tax consequence to U.S. holders of our ordinary shares.

 

We have not made a determination as to whether we would be classified as a “passive foreign investment company,” or PFIC, for U.S. federal income tax purposes for our preceding taxable year nor can we assure you that we will not be a PFIC for our current taxable year or any future taxable year. A foreign (non-U.S) corporation will be considered a PFIC for any taxable year if either (1) at least 75% of its gross income is passive income or (2) or least 50% of the value of its assets (generally based on an average of the quarterly values of the assets during a taxable year) is attributable to assets that produce or are held for the production of passive income. PFIC status depends on the composition of our assets and income and the value of our assets (including, among others, a pro rata portion of the income and assets of each subsidiary in which we own, directly or indirectly, at least 25% (by value) of the equity interest) from time to time. Depending on the amount of cash or cash equivalents we currently hold, which are generally treated as passive assets, and because the calculation of the value of our assets may be based in part on the value of our ordinary shares, which is likely to fluctuate, we may be a PFIC for any taxable year. If we were treated as a PFIC for any taxable year during which a U.S. Holder (as defined in the section entitled “Taxation – U.S. Federal Income Taxation – General”) held an ordinary share or warrant, certain adverse U.S. federal income tax consequences could apply to such U.S. Holder. For more information, see “Taxation – U.S. Federal Income Taxation – U.S. Holders – Passive Foreign Investment Company Rules.”

 

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This report contains forward-looking statements in the sections captioned “Business,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Plan of Operations” and elsewhere. Any and all statements contained in this report that are not statements of historical fact may be deemed forward-looking statements. Terms such as “may,” “might,” “would,” “should,” “could,” “project,” “estimate,” “pro-forma,” “predict,” “potential,” “strategy,” “anticipate,” “attempt,” “develop,” “plan,” “help,” “believe,” “continue,” “intend,” “expect,” “future,” and terms of similar import (including the negative of any of these terms) may identify forward-looking statements. However, not all forward-looking statements may contain one or more of these identifying terms. Forward-looking statements in this report may include, without limitation, statements regarding the plans and objectives of management for future operations, earnings or loss per share, capital expenditures, dividends, capital structure or other financial items, our future financial performance, including any such statement contained in a discussion and analysis of financial condition by management or in the results of operations included pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”), and the assumptions underlying or relating to any such statement.

 

The forward-looking statements are not meant to predict or guarantee actual results, performance, events or circumstances and may not be realized because they are based upon our current projections, plans, objectives, beliefs, expectations, estimates and assumptions and are subject to a number of risks and uncertainties and other influences, many of which we have no control over. Actual results and the timing of certain events and circumstances may differ materially from those described by the forward-looking statements as a result of these risks and uncertainties. Factors that may influence or contribute to the accuracy of the forward-looking statements or cause actual results to differ materially from expected or desired results may include, without limitation:

 

  Market acceptance of our products and services;

 

  Competition from existing products or new products that may emerge;

 

  The implementation of our business model and strategic plans for our business and our products;

 

  Estimates of our future revenue, expenses, capital requirements and our need for financing;

 

  Our financial performance;

 

  Current and future government regulations;

 

  Developments relating to our competitors;
     
  The impact of COVID-19 on our business and operations; and

 

  Other risks and uncertainties, including those listed under the section titled “Risk Factors.”

 

Readers are cautioned not to place undue reliance on forward-looking statements because of the risks and uncertainties related to them and to the risk factors. We disclaim any obligation to update the forward-looking statements contained in this report to reflect any new information or future events or circumstances or otherwise, except as required by law. Readers should read this report in conjunction with the discussion under the caption “Risk Factors,” our financial statements and the related notes thereto in this report, and other documents which we may file from time to time with the SEC.

 

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ITEM 4. INFORMATION ON THE COMPANY

 

Overview

 

Borqs Technologies, Inc. (formerly known as “Pacific Special Acquisition Corp.”, and hereinafter referred to as the “Company” “Borqs Technologies”, “Borqs” or “we”) was incorporated in the British Virgin Islands on July 1, 2015. The Company was formed for the purpose of acquiring, engaging in a share exchange, share reconstruction and amalgamation, purchasing all or substantially all of the assets of, entering into contractual arrangements, or engaging in any other similar business combination with one or more businesses or entities.

 

On August 18, 2017, the Company acquired 100% of the equity interest of BORQS International Holding Corp. (“Borqs International”) and its subsidiaries, variable interest entities (the “VIE”) and the VIE’s subsidiaries (collectively referred to as “Borqs Group” hereinafter) (the Company and Borqs Group collectively referred to as the “Group”) in an all-stock merger transaction. Concurrent with the completion of the acquisition of Borqs International, the Company changed its name from Pacific Special Acquisition Corp.”, to Borqs Technologies, Inc.

 

Our principal place of business is located at Suite 309, 3/F, Dongfeng KASO, Dongfengbeiqiao, Chaoyang District, Beijing 100016, People’s Republic of China. Our telephone number is +86 10 6437 8678. Our agent in the BVI is Kingston Chambers and their address is P.O. Box 173, Road Town, Tortola, British Virgin Islands.

 

We are a global leader in software, development services and products providing customizable, differentiated and scalable Android-based smart connected devices and cloud service solutions. We are a leading provider of commercial grade Android platform software for mobile chipset manufacturers, mobile device OEMs and mobile operators, as well as complete product solutions of mobile connected devices for enterprise and consumer applications.

 

Our Connected Solutions business unit (the “Connected Solutions BU”) works closely with chipset partners to develop new connected devices. Borqs developed the reference Android software platform and hardware platform for Intel and Qualcomm phones and tablets. We provide Connected Solutions customers with customized, integrated, commercial grade Android platform software and service solutions to address vertical market segment needs through the targeted BorqsWare software platform solutions. The BorqsWare software platform consists of BorqsWare Client Software and BorqsWare Server Software. The BorqsWare Client Software platform has been used in Android phones, tablets, watches and various Internet-of-things (“IoT”) devices. The BorqsWare Server Software platform consists of back-end server software that allows customers to develop their own mobile end-to-end services for their devices.

 

Our MVNO business unit provides a full range 2G/3G/4G voice and data services for general consumer usage and IoT devices, as well as traditional telecom services such as voice conferencing. We decided to sell the MVNO BU in order to focus on the growing IoT industry via our Connected Solutions BU, especially with the coming of 5G.

 

In November 2018, the Company’s board of directors approved the plan to dispose all of its tangible and intangibles assets related to Yuantel, our MVNO BU, the Consolidated VIEs through a series of agreements, signed in November 2018 and February 2019, with Jinan Yuantel Communication Technology LLP (“Jinan Yuantel”) and Jinggangshan Leiyi Venture Capital LLP (“JGS Venture”). According to the agreements, all of the Company’s 75% equity interest in Yuantel would be disposed at a consideration of RMB108.7 million. The Company received only $5.98 million from the buyers within the year ended December 31, 2019, the Company, then amended the agreement with the another third-party buyers (the “New Buyers”) of Yuantel as of September 1, 2020 to sell the remaining percentage of Yuantel owned by the Company for $4.54 million, of which approximately $0.4 million were received and the balance of $4.14 million was to be received by September 30, 2020, which was later postponed to October 2020 by both parties. The Company received the last payment of $1.2 million on October 27, 2020, and completed the disposition of Yuantel on October 29, 2020. The New Buyers also purchased the ownership of Yuantel that was first sold to other purchasers in 2019. The disposal of the Consolidated VIEs represents a strategic shift for the Company and has a major effect on the Company’s results of operations. Accordingly, assets and liabilities related to the Consolidated VIEs were reclassified as held for sale as the carrying amounts would be recovered principally through the sale and revenues, and expenses related to the Consolidated VIEs were reclassified in the accompanying consolidated financial statements as discontinued operations for all periods presented. The consolidated balance sheets as of December 31, 2019 and 2020 and consolidated statements of operations for the years ended December 31, 2018, 2019 and 2020 were adjusted to reflect this change. There was no gain or loss recognized on the reclassification of the discontinued operations as held for sale. The sale of the MVNO business unit was finally completed as of October 29, 2020.

 

In the years ended December 31, 2018, 2019 and 2020, Borqs generated 96.7%, 98.3% and 98.4% of its Connected Solutions BU revenues from customers headquartered outside of China and 3.3%, 1.7% and 1.6%   from customers headquartered in China. As of December 31, 2020, Borqs had collaborated with six mobile chipset manufacturers and 29 mobile device OEMs to commercially launch Android based connected devices in 11 countries, and sales of connected devices with the BorqsWare software platform solutions are embedded in more than 17 million units worldwide. The discontinued MVNO BU generated all of its revenue from China.

 

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We have dedicated significant resources to research and development, and have research and development centers in Beijing, China and Bangalore, India. As of December 31, 2020, 234 out of the 286 persons under our employ were technical professionals dedicated to platform research and development and product specific customization.

 

The following customers accounted for near 10% or more of our total revenues, not including discontinued operations, for the years indicated:

 

2020   GreatCall, Inc.   41.9 %
    ECOM Instruments   23.1 %
    Qualcomm India Ltd.   14.4 %
           
2019   Reliance Retail Limited   63.9 %
    GreatCall, Inc.   7.8 %
           
2018   Reliance Retail Limited   59.6 %
    E La Carte, Inc.   8.0 %

 

History and Development of the Company

 

Corporate Organizational Chart

 

The following diagram illustrates our current corporate structure and the place of formation, ownership interest and affiliation of each of our subsidiaries and un-consolidated minority interests in certain entities as of the date of this report. The corporate organization chart reflects our completed sale of the MVNO BU which removed the VIE structure by which it was held.

 

 

 

 

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Wholly-Owned Subsidiaries and Consolidated Affiliated Entities

 

The following is a summary of our material subsidiaries and affiliated entities:

 

Borqs Hong Kong Limited (“Borqs Hong Kong”), a limited company established under the laws of Hong Kong in 2007, engages in the software and services business and is 100% owned by Borqs International Holding Corp.

 

Borqs Beijing, a wholly foreign owned enterprise established under the laws of the PRC in 2007, is our primary operating entity for supply chain management and is 100% owned by Borqs Hong Kong Limited.

 

Beijing Borqs Software Technology Co, Ltd. (“Borqs Software”), a company established under the laws of the PRC in 2008, engages in government subsidized software development and engineering projects as well as other software and services business and is 100% owned by Beijing Big Cloud Century Technology Limited (“BC-Tech”), which is 100% owned by Borqs Beijing.

 

Beijing Borqs Wireless Technology Co, Ltd. (“Borqs Wireless”), a company established under the laws of the PRC in 2013, engages in software development and engineering projects as well as other software and services business and is 100% owned by BC-Tech, which is 100% owned by Borqs Beijing.

 

Borqs Software Solutions Private Limited (“Borqs Software Solutions”), a private limited company established under the laws of India in 2009, engages in the R&D for software and is 99.99% owned by Borqs International Holding Corp and 0.01% owned by Borqs Hong Kong.

 

Borqs Korea, a company established under the laws of South Korea in 2012, engages in the R&D of software and is 100% owned by Borqs Hong Kong.

 

Borqs KK, a company established under the laws of Japan in 2014, engages in business development and is 100% owned by Borqs Hong Kong.

 

Yuantel (Beijing) Telecommunications Technology Co., Ltd. (“Yuantel” or “Yuantel Telecom”), a company established under the laws of the PRC in 2004, engages in MVNO services and is 95% owned by Yuantel (Beijing) Investment Management Co., Ltd., which is 79% owned by Beijing Big Cloud Network Technology Co., Ltd. (“BC-NW”) resulting in an ownership of 75% of Yuantel by the Company as of December 31, 2018. BC-NW is 100% beneficially owned and controlled by Borqs International through contractual control arrangements. The board of directors approved of the sale of Yuantel which was originally scheduled to be completed by the end of 2019. The agreement with the one of the buyers was further amended for the closing of the sale to be completed by October 20, 2020. In the year 2019, the Company received partial payment for the sale, and as of December 31, 2019, the Company owned 45% of Yuantel. On September 1, 2020, the Company executed a new agreement with the buyers and the sale was completed as of October 29, 2020. The Company received only $5.98 million from the buyers within the year ended December 31, 2019, the Company, then amended the agreement with the another third-party buyers (the “New Buyers”) of Yuantel as of September 1, 2020 to sell the remaining percentage of Yuantel owned by the Company for $4.54 million, of which approximately $0.4 million were received and the balance of $4.14 million was to be received by September 30, 2020, which was later postponed to October 2020 by both parties. The Company received the last payment of $1.2 million on October 27, 2020, and completed the disposition of Yuantel on October 29, 2020. The New Buyers also purchased the ownership of Yuantel that was first sold to other purchasers in 2019.

 

One of the nominee shareholders of Big Cloud Network denied his entrustment relationship with the Group and claimed his rights and interests proceeds of the disposal of Yuantel. Although there were agreements between the Group and the nominee shareholder, there was no direct evidence to show the entrustment relationship between both parties, which may not be supported by the existing PRC laws and regulation. As a result, the Group assessed that a probable loss could be incurred. The Group estimated a loss ranged from $3.2 million to $3.6 million based on the best estimate of the information available. Because of there was no amount within the range would be a better estimate than any other amount, the minimum amount in the range of $3.2 million recorded as a contingent liability as of December 31, 2020. Even though the minimum amount in the range is not necessarily the amount of loss that will be ultimately determined, it is not likely that the ultimate loss will be less than the minimum amount. The ultimate amount could result in a loss of up to $0.4 million in excess of the amount accrued.

 

Borqs Chongqing Ltd., a wholly foreign owned enterprise established under the laws of the PRC in 2019, engages in supply chain management and is 100% owned by Borqs Hong Kong Limited.

 

Borqs Technology USA, Inc., a corporation formed in the State of Nevada in July 2019, is 100% owned by Borqs International.

 

For additional information, see Note 1 in our consolidated financial statements.

 

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Business Units

 

We have two business units (“BU”), Connected Solutions and MVNO. The Connected Solutions BU develops wireless smart connected devices and cloud solutions. The MVNO BU, which we are in the process of phasing out, operates a mobile virtual network in China that provides a full range of 2G/3G/4G mobile communication services at the consumer level and some traditional commercial telephony services. In November 2018, the Company’s board of directors approved the plan to dispose all of its tangible and intangibles assets related to the Consolidated VIEs through a series of agreements, signed in November 2018 and February 2019, with Jinan Yuantel Communication Technology LLP (“Jinan Yuantel”) and Jinggangshan Leiyi Venture Capital LLP (“JGS Venture”). The consolidated balance sheets as of December 31, 2019 and 2020 and consolidated statements of operations for the years ended December 31, 2018, 2019 and 2020 have been adjusted to reflect this change. There was no gain or loss recognized on the reclassification of the discontinued operations as held for sale. The disposal transaction was completed as of October 29, 2020. The Company received only $5.98 million from the buyers within the year ended December 31, 2019, the Company, then amended the agreement with the another third-party buyers (the “New Buyers”) of Yuantel as of September 1, 2020 to sell the remaining percentage of Yuantel owned by the Company for $4.54 million, of which approximately $0.4 million were received and the balance of $4.14 million was to be received by September 30, 2020, which was later postponed to October 2020 by both parties. The Company received the last payment of $1.2 million on October 27, 2020, and completed the disposition of Yuantel on October 29, 2020. The New Buyers also purchased the ownership of Yuantel that was first sold to other purchasers in 2019.

 

Borqs provides Connected Solutions’ customers with customized, integrated, commercial grade Android platform software and service solutions to address vertical market segment needs through the targeted BorqsWare software platform solutions. The BorqsWare software platform consists of BorqsWare Client Software and BorqsWare Server Software. The BorqsWare Client Software platform consists of three major components: the latest commercial grade Android software that works with particular mobile chipsets, functionality enhancements of the open source Android software and mobile operator required services. Based on the BorqsWare Client Software platform, customers may require Borqs to provide further customization based on their specific market needs. The BorqsWare Client Software platform has been used in Android phones, tablets, watches and various Internet-of-things (“IoT”) devices. The BorqsWare Server Software platform consists of back-end server software that allows customers to develop their own mobile end-to-end services for their devices. The BorqsWare Server Software provides software necessary for upgrades, charging and various APIs that enhance the customers’ services. Based on BorqsWare Server Software service platform, customers may require us to provide further customization based on their specific needs.

 

The MVNO BU provides bundled voice and data services to Chinese consumers, serving as the principal in doing so and recognizing revenue on a gross basis. As sales of bundled services are mostly pre-paid by the consumers, cash received in advance of voice and data consumption are recognized as deferred revenue. Revenue is recognized when the services are actually used.

 

Connected Solutions

 

The Connected Solutions BU helps customers design, develop and realize the commercialization of their connected devices.

 

Ideation & Design — Based on customer requirements on the type of connected device the customer want to have, we can help customers design the product ID and user interface. We have the design engineering to provide 2D/3D rendering. The Company can provide physical mockup with different color, material and finishes, so the customer can hold and “feel” the mockup before finalizing the product ID.

 

Software IP Development — IoT devices are often highly customized and require special software to display the data (e.g. circular watch display and user interface), to reduce the power consumption (e.g., a small battery in a wearable device), to perform specific functions (e.g., push-to-talk) and to connect to the network (e.g., 3G/4G connection). The Company has developed a large number of software libraries that can be reused for various connected devices.

 

Product Realization — Some customers have limited hardware design capabilities. The Company has a strong hardware research and development team to help customers to design the hardware, including the PCBA design and mechanical design. The Company can also provide turn-key services to help customer to handle the manufacturing logistics (including supply chain and EMS management) in order to manufacture the product. The Company has the experiences and resources to manage the factory supply chain, quality control and other manufacturing logistics.

 

Our Connected Solutions business unit works closely with chipset partners to develop new connected devices. Borqs developed the reference Android software platform and hardware platform for Intel and Qualcomm phones and tablets. We provide Connected Solutions customers with customized, integrated, commercial grade Android platform software and service solutions to address vertical market segment needs through the targeted BorqsWare software platform solutions. The BorqsWare software platform consists of BorqsWare Client Software and BorqsWare Server Software. The BorqsWare Client Software platform has been used in Android phones, tablets, watches and various Internet-of-things (“IoT”) devices. The BorqsWare Server Software platform consists of back-end server software that allows customers to develop their own mobile end-to-end services for their devices.

 

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The Connected Solutions BU has a global customer base covering the core parts of the Android platform value chain, including mobile chipset manufacturers, mobile device OEMs and mobile operators. As of December 2018, Borqs has collaborated with six mobile chipset manufacturers and 29 mobile device OEMs to commercially launch Android based connected devices in 11 countries, and sales of connected devices with the BorqsWare software platform solutions are embedded in more than 17 million units worldwide.

 

Our discontinued MVNO business unit provides a full range 2G/3G/4G voice and data services for general consumer usage and IoT devices, as well as traditional telecom services such as voice conferencing, and acts as a sales and promotion channel for the products developed by the Connected Solutions BU.

 

Prospective Business Units

 

On December 15, 2018, the Company and its indirect wholly owned subsidiaries, Borqs Beijing Ltd. (“Borqs Beijing”) and Borqs Hong Kong Ltd. (“Borqs HK”), entered into a Share Purchase Agreement (“Purchase Agreement”) with Shanghai KADI Technologies Co., Ltd (“KADI Shanghai” and, collectively with its subsidiaries and affiliated entities, “KADI”), KADI Technologies Limited (“KADI HK”) and Lin Hu and Shou Huajun, the sole shareholders of KADI Shanghai and KADI HK (the “Selling Shareholders”), pursuant to which Borqs Beijing purchased 60% of the issued and outstanding ordinary shares of KADI Shanghai (“KADI SH Shares”) and Borqs Beijing purchased 60% of the issued and outstanding ordinary shares of KADI HK (“KADI HK Shares, together with the KADI SH Shares, the “KADI Shares”) in accordance with and subject to the terms and conditions set forth in the Purchase Agreement (the “KADI Acquisition”).

 

KADI is a Chinese company that develops software and hardware solutions for electric vehicle control modules, such as charging, battery management and vehicle controls. KADI has worked with the leading automotive companies in China, including Chery, Dong Feng Motors, Geely Auto and Shenzhen Pin Chuan Electric Energy Co. Its founder, Dr. Hu Lin, has nearly 20 years of professional experience working with companies in the automotive industry, including Volkswagen and Delphi. KADI is not a customer or a supplier of Borqs.

 

As of the filing of this annual report, we are still in the process of completing certain commercial registrations in connection with this acquisition at the local jurisdictions where KADI operates. Due to the inability of KADI to effectively change the ownership registration at the local government authorities which thereby delayed the closing of the acquisition, we have withheld further payments of cash and shares accordingly. Because of changes in the electrical vehicle industry and its technologies, such as pricing of components, both the Company and KADI see the need to amend the agreement signed as of December 15, 2018. The resulting amendments, if reachable between the parties, may change the percentage of ownership of KADI by Borqs; or if agreeable amendments cannot be reached, Borqs may enforce the originally signed agreement or decide to terminate the agreement and seek damages, if any, due to Borqs.

 

Since the beginning of 2020, the COVID-19 pandemic has caused constraints on the Company’s cash flows and the pandemic situation is foreseeable to last through the remainder of 2021. Therefore, we will postpone further investment into KADI. We are in negotiation with the owners of KADI to decrease our ownership percentage of their company.

 

Investigation into the MVNO Business Unit

 

As disclosed on Forms 6-K on September 24 and October 24, 2019, there is an on-going investigation by the Yunnan Public Security Bureau (the “Bureau”) on Yuantel, our MVNO Business Unit (the “Yuantel Investigation”). As of the date of filing of this report, neither the Company nor the MVNO Business Unit has received any correspondence from any official authority within the PRC regarding the possible outcome of the investigation.

 

On September 11, 2019, the Yunnan Public Security Bureau (the “Bureau”) detained the president, one employee and one former employee of Yuantel, the MVNO business unit which disposition was completed as of October 29, 2020, for questioning. Under applicable PRC laws, the Bureau has the authority to detain an individual for investigation for up to the standard procedural period of 5 weeks without filing charges. Officers of the Bureau also took copies of contracts between Yuantel and Shandong Yafeida Information Technology Co., Ltd. (“Yafeida”) and a copy of Yuantel’s accounting records.

 

According to an article published online in China on June 10, 2019 by the Economic Report, four persons from the management of Yafeida had been arrested and accused of fraudulent activities, and no further details have been released as of the date hereof. Yafeida purchases SIM cards from Yuantel and other MVNOs and mobile operators in China.

 

On October 18, 2019, the Bureau issued official orders to the immediate families of the detained staff and former staff of Yuantel, according to which:

 

  The then president of Yuantel, as approved by the People’s Prosecutor’s Office of Kunming City Panlong District, was placed under arrest at the Panlong District First Detention Center (“Panlong”), for suspicion on the failure to administer information network security and the individual has not been formally charged as of the date of this report; and

 

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  The operating officer of Yuantel has not been approved for arrest by the People’s Prosecutor’s office but may be summoned for further investigations, and was released as of October 19, 2019 on bail of RMB 9,000 Yuan (approximately $1,270).

 

The Company understands from the family of the former Yuantel president that two similar orders were issued to two former employees of Yuantel who are still currently placed under arrest at the Panlong District First Detention Center. Since the Company or any of its subsidiaries were named in the case, no official notice has been provided to the Company as of the date of filing of this annual report.

 

As normal procedure in China, the Kunming City Panlong District Branch of the Yunnan Province Public Security Bureau will have up to 150 days to perform its supplementary investigation of the accused individual. After the supplementary investigation period, if the Prosecutor considers there is adequate evidence to prosecute, the Prosecutor will initiate a public prosecution in which the suspect will be charged and the case will be presented to the court. Otherwise, according to PRC criminal law, if the Prosecutor considers there is inadequate evidence to prosecute, the suspect will be released and the case will be dismissed. As of the date of this annual report, neither Yuantel or the Company, or anyone else associated with Yuantel or the Company, has received any notice or received any other information from the Bureau or other PRC authorities regarding the Investigation.

 

On November 4, 2019, the Bureau requested another employee of Yuantel to go to Yunnan for questioning. Upon the person’s arrival at the Bureau in Yunnan, he was detained for cooperation with the investigation.

 

As of the date of this report, no charges have been made against the individuals held at Panlong. All of the individuals’ positions at Yuantel have been replaced by other staff. The Company or any of its subsidiary entities has not been named in connection with this investigation. The operations of Yuantel and the Company are continuing as in the past. There have been no other details released by the Bureau as of the date of this report, and neither Yuantel or the Company, or anyone else associated with Yuantel or the Company, has received any notice or received any other information from the Bureau or other PRC authorities regarding the Investigation.

 

The Company made a whole disposition of Yuantel, which was originally supposed to be completed by the end of year 2019. Due to the investigation referenced in the preceding paragraphs, the Company received only $6.05 million from the buyers by year end December 31, 2019 and amended the agreement with the buyers of Yuantel on September 1, 2020 to sell the remaining percentage of Yuantel owned by the Company for $4.54 million, of which approximately $0.4 million was received and the balance of $4.14 million was supposed to be received by September 30, 2020, which was later postponed to October 2020 by both parties. The transaction was completed on October 29, 2020. Due to probable ownership dispute at the VIE level discussed in the risk factors, the Company reserved the amount of $3.2 million in contingency loss due to such dispute. There was approximately $0.3 million is retained by the buyer regarding disposal of Yuantel. It was due to the possibility of Yuantel being charged with penalties in the Yunnan Public Securities Bureau’s investigation on the executives. If Yuantel is fined, the penalties up to $0.3 million will be paid out from this retained amount. If there are no penalties assessed by the authorities onto Yuantel by April 30, 2021, the buyer will release the amount to the Group.

 

Customers

 

The Company’s primary customers are mobile chipset manufacturers, mobile device OEMs and mobile operators. For the year ended December 31, 2020, GreatCall, Inc., ECOM Instruments and Qualcomm India Ltd accounted for 41.9%, 23.1% and 14.4% of our net revenues, respectively. For the year ended December 31, 2019, Reliance Retail Limited and GreatCall, Inc. accounted for 63.9% and 7.8% of our net revenues, respectively. For the year ended December 31, 2018, Reliance Retail Limited and E La Carte, Inc. accounted for 59.6% and 8.0% of our net revenues, respectively.

 

The Connected Solutions BU designs chipsets and related software for mobile connected devices. The Company outsources manufacturing of connected devices to third-party factories, buying key components for devices and consigning them to the factories to manufacture and assemble. The Company serves as a contract manufacturer of the products for Reliance. The Company sells the final products to its customers, which are responsible for marketing and retail distribution.

 

The MVNO BU serves all the domestic China market. Operating under the brand name Yuantel, the MVNO BU leverages the network coverage China Unicom, which is China’s incumbent mobile operator. Subscribers purchase prepaid services, and are charged by the amount of data consumed, minutes of voice calls made, number of text messages sent, and other value-added services (such as caller ID display) used. As needed, subscribers may refresh the mobile phone SIM card, on a pay-as-you-go basis. Each month, we pay China Unicom for the total amount of traffic (MB of data, minutes of voice call made, etc.) actually consumed by subscribers. We renewed the operating agreement with China Unicom as of January 16, 2019, which was for a two-year period until December 31, 2020.

 

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The Company uses MVNO franchisees and agents as distribution channels. Those franchisees sell our prepaid services to their subscribers, on SIM cards. The Company compensates franchisees under a profit-sharing arrangement that is based on gross margin on franchisee sales of our services to subscribers. Agents sell our services on behalf of the Company and pay us a discount price for those services.

 

The MVNO BU was sold as of October 29, 2020.

 

Research and Development

 

The Company has dedicated significant resources to research and development, with research and development centers in Beijing, China and Bangalore, India. As of December 31, 2020, 234 of our 286 employees & contractors were technical professionals dedicated to platform research and development and product specific customization. Technical professionals have diverse backgrounds and experience gained through employment with leading mobile chipset designers and manufacturers, mobile device OEMs, internet content providers and other software and hardware enterprises.

 

The Company’s research and development centers work together to develop core proprietary software, and each center focuses on project specific implementation related to specific hardware platforms and customer specifications. The Company technical professionals are divided into two core groups, one focused on our Android+ software platform solutions, and one focused on our Android+ service platform solutions. Each group is further divided into sub-groups for platform development, system engineering and architecture, low-level software development, high-level application development, program management, system testing and verification and software configuration management.

 

Our current research and development efforts are focused on developing the BorqsWare software and service platform solutions to improve and enhance the following aspects of the Android platform:

 

  stability and reliability;

 

  performance and power management;

 

  Android platform integration with various kinds of chipsets;

 

  usability, input mechanism and display mechanism;

 

  security and anti-hacking of applications;

 

  in-country localization;

 

  automated cross applications software testing;

 

  4G radio network specific functionality, such as FDD-LTE and TD-LTE; and

 

  mobile operator end-to-end services; and integration of mobile Internet services with traditional telecommunication services, such as integration of instant messaging with short messaging.

 

A typical research and development project is staffed with members of the sales team, a research and development team comprised of a project manager, a platform development team, a customer development team and a system testing team, as well as finance personnel. At the beginning of a project, a member of the sales team will work with a project manager to simultaneously track research and development and commercial milestones. The project manager is responsible for ensuring the research and development milestones are achieved in a timely manner, including system testing, and a member of the sales team is responsible for tracking sales milestones. Finance personnel review each invoice and determine the appropriate accounting treatment under U.S. Generally Accepted Accounting Principles (“U.S. GAAP”). A typical research and development project takes between six to nine months to complete. In general, a significant portion of each research and development project consists of existing Android platform software and service solutions, while incorporating necessary customizations for a particular customer.

 

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Intellectual Property

 

The Company regards patents, copyrights, trademarks, software registrations, trade secrets and similar intellectual property as critical to its success. The Company relies on a combination of trademark, copyright, patent, software registration and trade secret laws, and enters into confidentiality agreements with employees and relevant third parties to protect our intellectual property rights. All employees enter into agreements requiring them to keep confidential all proprietary and other information relating to customers, methods, technologies, business practices and trade secrets.

 

The Company has been granted 130 patents in China and six patents in the United States, and as of December 31, 2020 it had 18 pending patent applications in China and three pending patent applications in the United States. The Company also has 91 software copyrights and 47 trademarks registered and 17 pending trademarks in China. In addition, the Company has registered its domain name with various domain name registration services.

 

Competition

 

The Company believes that the marketplace for connected devices and MVNO solutions is highly fragmented, but that few are capable of providing an end-to-end solution with software, hardware, product realization and bundling with a SIM card with voice/data plan (via a MVNO or mobile operator). In 2018 we intended to sell the MVNO BU, and in February 2019 we signed agreements with buyers to sell all of our interest in the MVNO BU. The sale was finally completed as of October 29, 2020.

 

The market for connected devices and MVNO solutions is rapidly evolving, and in the future the Company may not be able to compete successfully against current and potential competitors. The Company expects competition to intensify as new competitors enter the market, and as existing competitors attempt to diversify and expand their software and service solutions offerings across the Android platform. The primary competitors for the Company include traditional hardware-centric OEMs and software development companies.

 

  The traditional OEMs are strong in hardware design and own factories, but they are very weak in software development as well as not familiar with operator and mobile chipset requirement;

 

  The large software development companies have sizable software teams and global coverage, but they are very weak in hardware design and manufacturing expertise;

 

  Some of the Company’s competitors have significantly greater financial, technical, marketing, sales and other resources and significantly greater name recognition than we have.

 

Competitive Strengths

 

We believe the following factors differentiate us from our competitors and contribute to our success:

 

Strategic relationships with leading chipset vendors.

 

The Company works closely with leading chipset vendors in their software development, including software for their latest state-of-the-art chipsets. The Company develops connected device products and solutions based on these chipsets. These relationships enable the Company to develop a competitive product portfolio.

 

Strong software capabilities across core parts of the Android platform value chain drive a full suite of BorqsWare software and services platform solutions and a significant time to market advantage for customers.

 

The Company has focused on building its innovative technology platform to serve customers across the core parts of the Android platform value chain. We believe the Company was first to develop commercial grade software to support video telephony for Android. In collaboration with China Mobile, the Company developed the base chipset software to deploy Android-based mobile devices to support China Mobile’s TD-SCDMA network.

 

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Global customer base and extensive industry relationships.

 

The Company had more than 50 customers as of December 31, 2020, including some of the world’s leading companies in the mobile industry. Its diversified customer base includes mobile chipset manufacturers, mobile device original equipment manufacturers (“OEMs”) and mobile operators. Through 2020, the Company has collaborated with more than six mobile chipset manufacturers (including Intel, Qualcomm, Marvell) and 29 connected device OEMs (including LGE, Micromax, Acer, Motorola and Vizio) to commercially launch Android-based devices in 11 countries, and more than 17 million mobile devices sold worldwide have BorqsWare software platform solutions embedded. Our products have been deployed by more than 10 service providers (including AT&T, China Mobile, Claro, Orange, Reliance Jio, Sprint, Verizon) on four continents.

 

Significant resources dedicated to research and development; Patents.

 

The Company dedicated significant financial and human resources to research and development needed to build a full suite of connected device software and service platform solutions to address evolving customer needs across the core parts of the Android platform value chain.

 

Government Regulation

 

The Company’s operations are subject to extensive and complex state, provincial and local laws, rules and regulations. The PRC government restricts or imposes conditions on foreign investment in telecommunication business. Borqs International Holding Corp and its PRC subsidiaries are considered foreign persons or foreign-invested enterprises under PRC foreign investment related laws. As a result, they are subject to PRC legal restrictions on or conditions for foreign ownership of telecommunication business. Due to these restrictions, the Company conducts its discontinued operations of the MVNO business in China through BC-NW, its 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 its subsidiaries are therefore considered as 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 Ltd., or WFOE, and entered into exclusive option agreements with WFOE as part of the contractual arrangements. The Company’s 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 its subsidiaries that most significantly impact their economic performance.

 

The Company’s operations are also subject to trial licenses granted by the Ministry of Industry & Information Technology of China (“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 those of the Company, 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 the Company, continued 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.

 

The MVNO Business Unit as sold as of October 29, 2020.

 

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Employees

 

As of December 31, 2020, we had 286 employees and contractors. None of our employees are represented by a labor union. Out of our total staff, 211 are located in Bangalore, India engaged in research and development activities, 75 are located in Beijing and other cities in China engaged in our Connected Solutions BU activities.

 

The Company pays most of employees a base salary and performance-based bonuses, including annual incentive bonuses and project-based bonuses. It pays commissions to sales personnel. Employees are also eligible to participate in the Company’s stock incentive program.

 

The Company is required under PRC laws and regulations to participate in a government-mandated, defined benefit plan for its full-time employees, pursuant to which we provide social welfare benefits, such as pension, medical care, unemployment insurance, work-related injury insurance, maternity insurance and employee housing fund. The Company employees are not covered by any collective bargaining agreement. The Company believes it has good relations with its employees.

 

The Company uses a variety of methods to recruit technical professionals to ensure that it has sufficient research and development and other expertise on an ongoing basis, including the company website, an external online recruiting website, targeted technical forums, campus recruitment at leading technical universities and institutions, job fairs and internal referrals from current employees.

 

The Company offers training programs to its employees covering professional training such as training related to customer service and product management and technical training such as training related to telephony and project management. The Company holds periodic workshops to enhance the leadership skills of management personnel.

 

Description of Properties

 

The Company’s principal executive offices are located in Beijing, China. The Company leased approximately 3,600 square meters of office space pursuant to a lease that expired on August 31, 2020. The Company has signed a new lease for a smaller space beginning on September 1, 2020. The Company also occupies leased facilities of 4,400 square meters for other offices and research and development facilities in India. In addition, the company leased an existing plant of 5,500 square meters in Huzhou, and plans to gradually put it into production line for the R&D investment of 5G technology. The following table sets forth the location, approximate size and primary use and expiration date of all the Company’s materially important physical facilities as of December 31, 2020. Extension beyond the expiration of both leases will be up to negotiation with the property owners.

 

Locations   Approximate Size   Primary Uses   Lease Expiration Date  
Beijing, China
  3600 sq. meters   Principal executive office   August 31, 2020  
Beijing, China   738 sq. meters   Principal executive office   Begins Sep 1, 2020 & expires Aug 31, 2022  
Bangalore, India   4400 sq. meters   Research and development   May 31, 2023  

Huzhou Zhejiang, China 

  5348 sq. meters  

Research and development 

  Feb 18, 2024  
Total   10486 sq. meters   (from September 1, 2020 onwards)      

 

Segments

 

We operate in two reportable segments, one is the mobile virtual network operator services (“MVNO” or “Yuantel”), and the other one is Connected Solutions. See Note 2, Segment Reporting, of our notes to consolidated financial statements.

 

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Geographic Concentration

 

The following table sets forth the Company’s connected solutions net revenues from customers, in absolute amount and as a percentage of net revenues, based on location of the customer’s headquarters.

 

    For the years ended December 31,  
    2018     2019     2020  
    $     %     $     %     $     %
      ($’000)  
United States     15,663       12.2 %     21,746       22.0 %     13,495       50.5 %
India     96,550       75.2 %     69,645       70.4 %     5,437       20.3 %
China     4,282       3.3 %     1,701       1.7 %     428       1.6 %
Rest of the World     11,925       9.3 %     5,866       5.9 %     7,391       27.6 %
Net Revenues     128,420       100.0 %     98,958       100.0 %     26,751       100.0 %

 

The Company’s connected solutions net revenues from customers with headquarters in the United States are attributed to its ongoing collaboration with a prominent mobile chipset vendor and other mobile device OEMs. From 2018 to 2020, we engaged with one significant customer in India who continued to place significant orders with us in all three years.

 

Recent Developments

 

Cooperation with AWP

 

On December 6, 2019, the Company entered into a letter of engagement (the “Original LOE”) with American West Pacific International Investment Corp. (“AWP”). The Original LOE had a term of one (1) year, renewing automatically each year for another one (1)-year term unless terminated by one party with notice to the other. The Original LOE provides that AWP will serve as a non-exclusive representative to identify, review and advise the Company with respect to strategic alliances, including identifying strategic business and governmental contacts, partners, customers and entities which may assist or are synergistic to the Company’s business. In addition, AWP will assist the Company to identify and negotiate with sources of financing including debt and/or equity during the term of this agreement. It will be the Company’s sole decision whether it will acquire or invest in the businesses or products identified by AWP, or to proceed with any financing transaction provided for consideration to the Company through the efforts of AWP.

 

On January 17, 2020, the Company and AWP entered into an amended letter of engagement (the “Amended LOE”), which amends the fees to be paid to AWP. The fees to be paid to AWP include:

 

  An initial cash retainer of $25,000 upon engagement.

 

  A second cash payment (the “Second Cash Payment”) of $25,000 to be paid upon the delivery to and acceptance by the Company of the supporting document from an institutional party and/or bank, which such payment is to be credited against any success cash fee payable by the Company.

 

  For the successful arrangement of debt financing for replacement loans the Company would pay (a) a cash success fee of 4% of the cash raised, plus (b) 4% of the value of funds raised in shares (collectively, (the “Loan Replacement Fees,” and, together with the Working Capital Financing Fees, the “Financing Fees). The fees were related to financing to be arranged by China National Technical Import & Export Corp (“CNTIC”).  As of the filing of the 2020 annual report, the financing has not yet happened.

 

  Ordinary shares issuable for the Financing Fees will be calculated with a per share price of $1.50.

 

  Upon the execution of a Strategic Cooperation Agreement (“SCA”), (a) a cash fee equal to $25,000 plus (b) the issuance of 1,250,000 ordinary shares of the Company plus (the “Retainer Shares”) warrants (the “Retainer Warrants” and together with the Retainer Shares, the “Retainer Securities”) to purchase 1,250,000 ordinary shares of the Company, with each Retainer Warrant exercisable into one ordinary share at $2.25 per share. Each Retainer Warrant will have an expiration of 36 months, and will have a cashless exercise feature payable in ordinary shares.

 

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  The ordinary shares to be issued and the ordinary shares issuable upon the exercise of the warrants pursuant to the Amended LOE must be registered on a registration statement within 90 days from the execution of the SCA. Any other ordinary shares issued in connection with Amended LOE have piggy-back registration rights.

 

  The Financing Fees earned in accordance with the foregoing will be credited against the Second Cash Payment.

 

On January 17, 2020, the SCA was executed by the Company, China National Technical Import & Export Corp. (“CNTIC”), and Genertec America Inc. The SCA provides for a strategic partnership including, without, limitation (i) CNTIC will arrange finance from Chinese financial institutions for the Company’s current purchase orders; and (ii) CNTIC will arrange financing for the Company for all of its purchase orders if they are in line with regulation of Chinese financial institutions. As of the filing of this annual report, financing from CNTIC has not occurred.

 

On December 30, 2020, the Company entered into a loan agreement with AWP as lender for $1 million due and payable in 6 months and has a 12% interest rate per annum. This loan is guaranteed by the Company which caused 4,000,000 ordinary shares to be issued immediately after the Company received the loan, and such shares were held in escrow at Continental Stock Transfer & Trust Company as collateral for the loan.

 

Account payables Settlement

 

In May 2020, we issued ordinary shares to settle debt due to Coming Technologies Ltd valued per agreement at a total amount of $2.0 million which comprised of:

 

a. $0.9 million in payables for products Borqs ordered from TianFu in the amount of $0.7 million and EPIC in the amount of $0.2 million. TianFu and EPIC in turn ordered the manufacturing of components and parts from Coming Tech. Coming Tech had delivered such products, via TianFu and EPIC, to Borqs which delivered them to Borqs’ customer in the year 2018. Borqs had recorded these amounts as accounts payable to TianFu and EPIC; and by settling the amount of $0.9 million directly with Coming Tech, we reduced our payables with TianFu and EPIC for their respective amounts.

 

b. $0.9 million with purchase orders placed with EPIC in January of 2020 which EPIC in turn placed with Coming Tech to manufacture the products. We determined that the project was cancelled by April 2020 most significantly due to the fact that the COVID-19 virus was spreading worldwide and turning into a pandemic, and the cancellation came prior to the delivery of our products to the customer. However Coming Tech had already manufactured the products and Borqs became liable for the total of amount of $0.9 million.

 

c. $0.2 million in an extra compensation to Coming Tech because the ordinary shares issued to Coming Tech were not registered and not sellable until a minimum of a 6-month holding period was satisfied.

 

For the year ended December 31, 2020, the Group issued ordinary shares to settle the payables of $2.0 million.

 

Loan Agreement with Run He

 

On November 27, 2020, the Company entered into a loan agreement with Run He, as lender for $1.25 million due and payable within 15 months and with a 6% interest rate per annum. The debt is convertible at borrower’s discretion into shares of the borrower valued at a 30% discount from the market price of the borrower’s ordinary shares as traded on the Nasdaq stock market. The market price is defined as the average of each of the high and low averages for the five preceding trading days prior to the date of payment.

 

Senior Debt Purchased by LMFA Financing LLC

 

The Company entered into Agreements dated December 14, 2020 with Partners For Growth which was its senior lender and LMFA Financing LLC (“LMFA”), a Florida limited liability company and wholly owned subsidiary of LM Funding America, Inc. (Nasdaq: LMFA), in which LMFA was committed to purchase up to be approximately $18 million of debt in tranches, which when completed would eliminate substantially all of the debt with the Company’s senior lender. LMFA would convert the purchased debt into common shares of the Company, pursuant to a court order that allows the conversion shares to be issued as unrestricted securities in a transaction that is exempt from registration under Section 3(a)(10) of the Securities Act of 1933, as amended.

 

As of February 10, 2021, LMFA has completed the purchase of $17.87 million of principal, accrued interest and applicable fees, converted into and sold all 22.73 million shares of the Company’s ordinary shares. With the Company settling another $1.27 million of debt, accrued interest and applicable fees directly with the senior lender by the issuance of 1.51 million shares on February 17, 2021 which the senior lender subsequently sold, the Company’s defaulted Debts with the senior lender totaling $19.14 million have been eliminated since.

 

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Convertible Notes Sold

 

The Company signed agreements with institutional and individual investors for sale of convertible notes on February 25, 2021 for $20 million (the “Feb 25 Notes”) and on April 14, 2021 for $3 million (the “April 14 Notes”). The notes are due in two years, have an annual interest rate of 8%, convertible into ordinary shares of Borqs at 10% discount from the market price and has 90% warrant coverage with the warrants exercisable cashless or for cash at $2.222 per share for the Feb 25 Notes and $1.540 for the Apr 14 Notes. The conversion price is at $1.539 per share for the Feb 25 Notes and $1.071 per share for the Apr 14 Notes, or at a one-time reset at 90% of the market price at the time of effectiveness of the required registration statement, whichever is lower. One-third of the notes are sold at the execution of definitive agreements and two-thirds of the notes will be sold upon the effectiveness of a registration statement to be filed by the Company. Proceeds will be used for the procurement of orders the Company expects to receive from its customers this year and also for development of the next generation 5G products.

 

Available Information

 

Our annual reports on Form 20-F, current reports on Form 6-K, and other forms and periodic reports as a foreign private issuer, are available free of charge on our website (www.borqs.com) as soon as reasonably practicable after we have electronically filed such materials with, or furnished such materials to the Securities and Exchange Commission. They are also available at www.sec.gov.

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

The following discussion of the results of our operations and our financial condition should be read in conjunction with the financial statements and the notes to those statements included in “Item 18. Financial Statements”. This discussion contains forward-looking statements that involve risks, uncertainties, and assumptions. Actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those set forth in “Item 3. Key Information–D. Risk Factors”.

 

References in this Annual Report to “we,” “us” or the “Company” refer to Borqs Technologies, Inc. References to our “management” or our “management team” refers to our officers and directors. The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the financial statements and the notes thereto contained elsewhere in this Annual Report. Certain information contained in the discussion and analysis set forth below includes forward-looking statements that involve risks and uncertainties.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Special Note Regarding Forward-Looking Statements

 

This Annual Report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that are not historical facts, and involve risks and uncertainties that could cause actual results to differ materially from those expected and projected. All statements, other than statements of historical fact included in this Annual Report including, without limitation, statements in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” regarding the Company’s financial position, business strategy and the plans and objectives of management for future operations, are forward-looking statements. Words such as “expect,” “believe,” “anticipate,” “intend,” “estimate,” “seek” and variations and similar words and expressions are intended to identify such forward-looking statements. Such forward-looking statements relate to future events or future performance, but reflect management’s current beliefs, based on information currently available. A number of factors could cause actual events, performance or results to differ materially from the events, performance and results discussed in the forward-looking statements. For information identifying important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements, please refer to the Risk Factors section of this Annual Report. The Company’s securities filings can be accessed on the EDGAR section of the SEC’s website at www.sec.gov. Except as expressly required by applicable securities law, the Company disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

 

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Overview

 

Borqs Technologies, Inc. (“we”, “the Company” or “Borqs”) is a company focused on software, development services and products providing customizable, differentiated and scalable Android-based smart connected devices and cloud service solutions. We are a leading provider of commercial grade Android platform software for 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 recent years, we have been awarded significant business contracts from Intel and Qualcomm, leading global chipset manufacturers. Particularly, significant contracts from Qualcomm were awarded to us in 2018, 2019 and also in 2020.

 

Pursuant to the Company’s acquisition of Borqs International Holding Corp (“Borqs International”) by way of merger, which completed on August 18, 2017, Borqs International became a wholly-owned subsidiary of the Company, with the Company adopting the business of Borqs International and its consolidated subsidiaries going forward and reporting the historical consolidated financial statements of Borqs International on future SEC filings as those of the Company, which was renamed Borqs Technologies, Inc.

 

Our Connected Solutions business unit works closely with chipset partners to develop new connected devices. Borqs developed the reference Android software platform and hardware platform for Intel and Qualcomm phones and tablets. We provide Connected Solutions customers with customized, integrated, commercial grade Android platform software and service solutions to address vertical market segment needs through the targeted BorqsWare software platform solutions. The BorqsWare software platform consists of BorqsWare Client Software and BorqsWare Server Software. The BorqsWare Client Software platform has been used in Android phones, tablets, watches and various Internet-of-things (“IoT”) devices. The BorqsWare Server Software platform consists of back-end server software that allows customers to develop their own mobile end-to-end services for their devices.

 

Our MVNO business unit provides a full range 2G/3G/4G voice and data services for general consumer usage and IoT devices, as well as traditional telecom services such as voice conferencing. The MVNO business unit was sold as of October 29, 2020.

 

In the year ended December 31, 2018, 2019 and 2020, Borqs generated 96.7%, 98.3% and 98.4% of its connected solutions net revenues from customers headquartered outside of China and 3.3%, 1.7% and 1.6%   of its net revenues from customers headquartered within China. As of December 31, 2020, Borqs had collaborated with six mobile chipset manufacturers and 29 mobile device OEMs to commercially launch Android based connected devices in 11 countries, and sales of connected devices with the BorqsWare software platform solutions are embedded in more than 17 million units worldwide.

 

We have dedicated significant resources to research and development, and have research and development centers in Beijing, China and Bangalore, India. As of December 31, 2020, 234 of our 286 employees and contractors were technical professionals dedicated to platform research and development and product specific customization.

 

We have achieved significant growth since inception in 2007. Not including our MVNO BU activities which are now represented as discontinued operations due to our intended sale of the MVNO BU, net revenues from continuing operations of the Connected Solutions BU increased for the years ended December 31, from $75.1 million in 2015 to $85.4 million in 2016, to $122.2 million in 2017, to $128.4 million in 2018, but scaled back to $98.9 million in 2019. Our operations were significantly affected by the COVID-19 pandemic in 2020, and recorded only $26.8 million in revenues for the year 2020. We recorded a net loss of $12.8 million in 2017 which included non-cash merger related costs of $14.5 million. In the year 2018 we incurred a net loss of $72.0 million which included $6.2 million in cost of goods for one transaction in which the related revenue was not recognized in 2018 due to uncertainty in collectability, non-recurring charges of $5.3 million in arbitration loss, write-off and provision for doubtful accounts and current assets of $30.1 million, write-down of historical inventory due to loss & obsolescence of $11.8 million, impairment of long-term investment of $13.0 million, deferred income tax benefits of $1.7 million, impairment of intangible assets due to the pending sale of the MVNO business unit of $0.8 million, share based compensation of $1 million, and $3.0 million in stock offering expenses. In the year 2019, we incurred a net loss of $35.7 million which included a provision for doubtful accounts of $13.6 million, non-recurring penalties of $3.4 million and reversal of historical inventory of $0.3 million. In the year 2020, we incurred a net loss of $34.8 million which included professional fees of $3.6 million, salaries and welfare of $2.6 million, non-recurring penalties of $1.1 million, share-based compensation expense of $20.0 million and contingency loss of $3.1 million   and allowance for doubtful accounts of $4.4 million, offset by gain on disposal of Yuantel of $10.1 million.

 

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Key Factors Affecting Results of Operations

 

Revenue mix impacts our overall gross profit and gross margin. In particular:

 

Connected Solutions BU. Revenue from product sales is the largest component of Connected Solutions BU revenue. Product sales gross margin is primarily affected by competition, cost of components and intellectual property royalties. Gross margin for engineering design fees and software royalties tends to be higher because the associated cost of revenues is lower than that for hardware products and pricing is less subject to competitive pressure. In addition, because product sales and software royalties are generally calculated on a per-unit basis, our revenue will vary depending upon the volume of product sales. Engineering design fees are generally not related to volume of product sales.

 

Connected Solutions BU net revenues and gross profits are affected by general factors in the highly competitive mobile industry, such as shifts in consumer preferences and customer demands, technological innovations, competing mobile operating systems, and pricing trends. Results are also affected by developments in the Android platform and software market specifically, such as Google’s continued support of the Android platform, continued availability of a free and open source software license for that platform, continued deployment of the Android platform, and continued outsourcing of software development to third party providers. Unfavorable changes in any of these factors could affect market demand for our solutions and materially adversely affect our revenues and results of operations. Revenues and gross profit in the Connected Solutions BU are also affected by Company-specific factors, including:

 

  We rely on a limited number of customers for a significant portion of our net revenues, particularly our relationship with a customer that is a prominent mobile chipset manufacturer. We also rely on this mobile chipset manufacturer from a strategic viewpoint, since products that we develop for this customer may also be scaled to other mobile device OEM customers. We devote a significant portion of our research and development resources to this effort. Our results of operations would be significantly harmed if our collaboration with this customer was to decline or its Android-related product development efforts were not successful.

 

  Our ability to grow our net revenues depends on our ability to expand our customer base, both in terms of number of customers and geographic concentration, and also increase the number of projects we undertake for existing and new customers. Our ability to do so depends on the success of our products and services and those of our customers, and on our marketing and sales performance.

 

  Our ability to maintain our position as one of the largest independent Android platform software company will require us to continue to strengthen our technology expertise and capabilities by focusing our research and development to maintain technology leadership and offer advanced Android platform software and service solutions on our customers’ demanding timelines. In addition, our ability to grow our revenues will largely depend on how quickly we and our customers can roll out new products and services.

 

  Competing successfully in the Android platform and software market requires us to maintain a competitive pricing structure, including labor costs and operating expenses. Competition for software engineers is intense, particularly in mainland China and in India.

 

MVNO BU. Gross margin of the MVNO BU is affected by the wholesale rates obtained from the incumbent operator, as well as the competition in the market.

 

MVNO BU revenues and gross profit are affected by general factors in the mobile telecom industry in China, such as the voice/data pricing trends offered by other MVNOs and incumbent operators. We enter into profit sharing arrangements with franchisees, under which franchisees receive a percentage of profits on sales of bundled services as they are used by the consumers. Profit sharing amounts are recognized as selling expenses, and limited discounts provided by franchisees to consumers are recognized as reductions of revenue. Competitive factors in voice/data pricing could affect the demand for our MVNO services and affect our mobile subscriber growth, which could materially and adversely affect our revenues and result of operations. MVNO BU revenues and gross profit are also directly affected by Company-specific factors, including:

 

  The bulk wholesale rates for voice and data service. We rely on 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.

 

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  The Chinese government policy on MVNO services. We rely on China’s government to continue to grant us a license to operate the MVNO services.

 

The aggregate amount of cash and cash equivalent and restricted cash are not materially affected by currency fluctuations because the majority of our revenues are denominated in U.S. Dollars based on contracts made in Hong Kong. Financings from sales of equity and working capital loans are denominated in U.S. Dollars and executed in Hong Kong and the Cayman Islands, and repayments have been made in U.S. Dollars outside of China, thus not requiring approval from the PRC State Administration of Foreign Exchange. The MVNO business, and small amounts of Connected Solutions BU activities within China, generate revenue in Renminbi. Personnel and personnel-related expenses are primarily paid in Renminbi, and costs of components used in Connected Solutions BU hardware revenues are primarily paid in U.S. Dollars. As of December 31, 2020, we held cash and cash equivalents totaling $3.08 million on a consolidated basis.

 

Results of Operations

 

The following table sets forth a summary of the Company’s consolidated results of operations for the periods indicated. The activities indicated herewith were from our Connected Solutions BU, our continuing operations; they did not include activities from our MVNO BU which were classified as discontinued operations. This information should be read in conjunction with our consolidated financial statements and related notes included elsewhere or incorporated by reference in this Annual Report. The operating results in any period are not necessarily indicative of results that may be expected for any future period.

 

Comparisons of Fiscal Years Ended December 31, 2018, 2019 and 2020

 

Consolidated Statement of Operations Data:   Fiscal Years Ended December 31,  
  2018     2019     2020  
    ($’000)  
Net revenues     128,420       98,958       26,751  
Cost of revenues     (134,443 )     (98,389 )     (25,155 )
Gross profit (loss)     (6,023 )     569       1,596
                         
Operating expenses     (60,825 )     (31,578 )     (42,216 )
Other operating income     180       1,854       -  
Operating income (loss)     (66,668 )     (29,155 )     (40,620 )
                         
Other income (expense)     (2,059 )     (3,377 )     4,937  
Income (loss) from continuing operations, before income taxes     (68,727 )     (32,532 )     (35,683 )
                         
Income tax (expense) benefit     (331 )     949       (409 )
Net income (loss) from continuing operations     (69,058 )     (31,583 )     (36,089 )
                         
Discontinued operations                        
(Loss) income from operations of discontinued operations     (1,300 )     (4,151 )     1,302  
Income tax benefit (expense)     (1,641 )     -       -  
(Loss) income on discontinued operations     (2,941 )     (4,151 )     1,302  
                         
Net income (loss)     (71,999 )     (35,734 )     (34,787 )
                         
Less: net (loss) income attributable to noncontrolling interests     (235 )     (1,325 )     715  
Net income (loss) attributable to Borqs Technologies, Inc.     (71,764 )     (34,409 )     (35,502 )

 

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For year ended December 31, 2018 we incurred a net loss of $72.0 million which included $6.2 million in cost of goods for one transaction in which the related revenue was not recognized in 2018 due to uncertainty in collectability, non-recurring charges of $5.3 million in arbitration loss, write-off and provision for doubtful accounts and current assets of $30.1 million, write-down of historical inventory due to loss & obsolescence of $11.8 million, impairment of long-term investment of $13.0 million, deferred income tax benefits of $1.7 million, impairment of intangible assets due to the pending sale of the MVNO business unit of $0.8 million, share based compensation of $1 million, and $3.0 million in stock offering expenses. For year ended December 31, 2019, we incurred a net loss of $35.7 million which included a provision for doubtful accounts of $13.6 million, non-recurring penalties of $3.4 million and reversal of historical inventory of $0.3 million. The write-offs and provisions recorded in 2019 were still high for the level of business activities in the year, although comparatively less than those recorded in 2018. We have taken this approach as we realized that the COVID-19 pandemic, in the first half of the year 2020, has significant negative effects on our industry and particularly on certain of our customers and business partners; and it is prudent to write down some of our assets as of December 31, 2019. For year ended December 31, 2020 we incurred a net loss of $34.8 million which included professional fees of $3.6 million, salaries and welfare of $2.6 million, non-recurring penalties of $1.1 million, share-based compensation expense of $20.0 million, impairment of intangible assets of $0.7 million and contingency loss of $3.1 million   and allowance for doubtful accounts of $4.4 million, offset by gain on disposal of a subsidiary of $10.1 million.

 

Net Revenue

 

Our net revenues represent our gross revenues, less PRC value added taxes and other deductions. Connected Solutions BU net revenues consist of engineering design fees, software royalties and product sales. MVNO BU net revenues, which were classified as discontinued operations, consist primarily of monthly recurring revenue.

 

For the year ended December 31, 2018, net revenues from Connected Solutions BU, or our continuing operations, was $128.4 million and net revenues from MVNO BU, presented here as discontinued operations, was $27.4 million, as compared to $98.9 million and $39.8 million in the year ended December 31, 2019, respectively. This represented a 23.0% decrease for Connected Solutions BU revenues and a 45.3% increase for the discontinued MVNO BU from 2018 to 2019. For the year ended December 31, 2020, net revenues from Connected Solutions BU was $26.8 million representing a 73.0% decrease from the previous year. Our MVNO BU has sold as of October 29, 2020 and brought in $1.3 million as net income from discontinued operations prior to the completion of the sale. The decline in business activities in 2020 was mainly attributable to the effects of the COVID-19 pandemic.

 

As our Connected Solutions BU did not engage in any retail activities in the countries where our customers were located and also not within China; and we concluded the fluctuations in our revenues between the years were not indicative of market conditions. Instead, our hardware sales of our Connected Solution BU comprised of all made-to-order products with quantities as stipulated by our customers, and also included consumer and industrial use devices as well. As such, the orders we receive from our customers may not adhere to seasonality and therefore fluctuations in our business activity levels may not conform to any particular trend.

 

Net Revenues — Connected Solutions BU

 

Connected Solutions BU net revenues consist of engineering design fees, software royalties and product sales. MVNO BU net revenues consist primarily of monthly recurring revenue.

 

BorqsWare software platform solutions are based on the Company’s core proprietary software and include base chipset software supporting various radio network chipsets and application processors, commercial grade software to differentiate the Android platform for our customers and mobile operator required services. BorqsWare software platform solutions are embedded directly into connected devices. We generate revenues from our BorqsWare software platform solutions by charging our customers a product fee for project-based design contracts and/or a service fee for research and development services on a time and material basis, depending upon the nature of the contracts we entered into with our customers. In addition, we charge usage-based royalties in a majority of our project-based software contracts, which royalties are determined based on the customer’s volume of sales of products in which a mobile chipset or connected device with BorqsWare software platform solutions embedded.

 

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As discussed more fully under “— Critical Accounting Policies and Estimates — Revenue Recognition — Project-Based Software Contracts,” the Company’s project-based software contracts include post-contract support, or PCS, where the customer has the right to receive unspecified upgrades/enhancements on a when-and-if available basis. Since we are unable to establish vendor-specific objective evidence of fair value of post contract services, or PCS, revenues from project-based software contracts are recognized on a straight-line basis over the longest expected delivery period of undelivered elements of the arrangement, which is typically the PCS period. Project-based software contracts that include PCS, which have a typical PCS period of 12 months. As a result of this revenue recognition method, some portion of the net revenues we report in each period is recognition of deferred revenues from contracts entered into in prior periods and for which the research and development and engineering work has already been completed. In addition, a majority of the project-based software contracts provide for usage-based royalties. We recognize royalties upon the receipt of quarterly usage reports provided by customers.

 

The following table sets forth our net revenues, as well as the components of such revenues, for the periods indicated, both in absolute amount and as a percentage of total net revenues:

 

    For the years ended December 31,  
    2018     2019     2020  
    $     %     $     %     $     %  
    ($’000)  
Software     9,503       7.4 %     14,975       15.1 %     10,570       39.5 %
Hardware     118,917       92.6 %     83,983       84.9 %     16,181       60.5 %
Connected Solutions BU net revenues     128,420       100.0 %     98,958       100.0 %     26,751       100.0 %

 

Software

 

Software net revenues were $9.5, $15.0 and $10.6 million in the years ended December 31, 2018, 2019 and 2020, respectively, representing 7.4%, 15.1% and 39.5%of our continuing operations Connected Solutions BU net revenues. The $5.5 million increase in the year ended December 31, 2019 compared to the year ended December 31, 2018 mainly reflected increases in software engineering activities completed for customers in 2019 as well as the recognition of PCS delivered during 2019 for projects completed in 2018. We captured more software engineering activities in the year ended December 31, 2019 and recorded $15.0 million in software revenues in the year ended December 31, 2019, representing a 57.6% increase over the previous year. For the year ended December 31, 2020, our software net revenues were $10.6 million which represented 39.5% of total net revenues, as our software activities were not affected as severely as our hardware activities by the COVID-19 pandemic.

 

Hardware

 

Hardware net revenues were $$118.9 million, $84.0 million and $16.2 million in the years ended December 31, 2018, 2019 and 2020, respectively, representing 92.6%, 84.9% and 60.5% of our continuing operations Connected Solutions BU net revenues. Again, as discussed above, these fluctuations may not be attributed to any particular market trend since our sales were all made to order for our industrial customers. The significant decrease in hardware sales for 2020 was mainly attributable to the COVID-19 pandemic. Types of products include wearables such as trackers and smart watches, ruggedized handsets, tablets and smart phones and mobile connectivity modules. As described above, hardware sales comprised of all made-to-order products with quantities as stipulated by our customers and included consumer and industrial use devices as well. As such, the orders we receive from our customers may not adhere to seasonality and therefore fluctuations in our business activity levels may not conform to any particular trend.

 

All hardware sales were contracted and made to order, and our sales were final without taking returns. Small percentages of replacement units and parts were provided to customers and those costs were included in cost of revenues. We provide engineering design work as specified by our customers, and production begins after the customer accepts the design. We are responsible for procurement of all components, materials and tooling, and for selection of third-party factories for product assembly. Revenue is recognized when ownership of products is transferred to the customers. We are not engaged in the marketing and distribution of the hardware products.

 

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Customer Concentration

 

We were initially focused on research and development efforts for providing BorqsWare software platform solutions to mobile device OEMs. We have since leveraged our deep technology expertise to provide BorqsWare software platform solutions to mobile chipset manufacturers. The following table sets forth net revenues by type of customer, both in absolute amount and as a percentage of net revenues for the periods presented:

 

    For the years ended December 31,  
    2018     2019     2020  
    $     %     $     %     $     %  
    ($’000)  
Mobile device OEMs     118,667       92.4 %     94,313       95.3 %     22,905       85.6 %
Mobile Chipset Vendors     9,753       7.6 %     4,645       4.7 %     3,846       14.4 %
Connected Solutions BU Net Revenues     128,420       100 %     98,958       100 %     26,751       100 %

 

We expect our net revenues from mobile device OEMs to continue to grow as we develop more connected devices, especially IoT products.

 

Geographic Concentration

 

The following table sets forth our net revenues from customers based on location of the customer’s headquarters, both in absolute amount and as a percentage of net revenues. These figures do not take into account the geographic location of end-users of customer products:

 

    For the years ended December 31,  
    2018     2019     2020  
    $     %     $     %     $     %  
    ($’000)  
United States     15,663       12.2 %     21,746       22.0 %     13,495       50.5 %
India     96,550       75.2 %     69,645       70.4 %     5,437       20.3 %
China     4,282       3.3 %     1,701       1.7 %     428       1.6 %
Rest of the world     11,925       9.3 %     5,866       5.9 %     7,391       27.6 %
Net revenues     128,420       100.0 %     98,958       100.0 %     26,751       100.0 %

 

The Company net revenues from customers with headquarters in the United States are attributed to its ongoing collaboration with a prominent mobile chipset vendor and other mobile device OEMs. From 2018 to 2020, revenues from customers with headquarters in China declined, while our main customer in India, Reliance Retail Limited, continued to place significant orders with us through 2020. Our main customer in the United States for the year 2020 was GreatCall, Inc.

 

Net Revenues from discontinued operations — MVNO BU

 

The MVNO BU provides a full range of 2G/3G/4G mobile communication services to consumers, as well as some traditional commercial telephony services. In 2014, the MVNO BU entered into a business agreement with China Unicom, the incumbent mainland China mobile network operator to obtain bulk access to network services at wholesale rates in 2014. The MVNO BU has its own brand in mainland China, “Yuantel.” MVNO BU net revenues, consisting of “MVNO” and “Other” revenues are entirely from mainland China. “Other” revenues are primarily related to traditional commercial telephony services, such as conference call services. We intended to sell the MVNO BU in 2018 and as of February 2019, we signed agreements with buyers for all of our interests in the MVNO BU. The sale was originally scheduled to be completed by the end of 2019. Due to the on-going investigation by the Yunnan Public Security Bureau, we received only partial payment from the sale in 2019. A new agreement was executed with the buyers as of September 1, 2020 and the sale was finally completed as of October 29, 2020.

 

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    For the years ended December 31,     January 1 to October 29  
    2018     2019     2020  
    $     %     $     %     $     %  
    ($’000)  
MVNO     25,468       93.1 %     37,495       94.1 %     29,023       100.0 %
Other     1,891       6.9 %     2,340       5.9 %     -       - %
MVNO BU net revenues     27,359       100.0 %     39,835       100.0 %     29,023       100.0 %

 

Cost of Revenues

 

Cost of our continuing operations Connected Solutions BU revenues primarily consists of personnel and personnel-related costs associated with engineering projects paid for by customers, and costs of hardware components used to manufacture products. Cost of our discontinued operations MVNO BU revenues primarily consists of wholesale traffic fees, paid to the incumbent operator, based on traffic consumed by subscribers to the MVNO network. The incumbent operator also charges us a minimum wholesale tariff based on the number of mobile phone numbers issued to the Company.

 

The following table sets forth cost of revenues, both in absolute amount and as a percentage of total cost of revenues, for Connected Solutions BU revenue and MVNO BU revenue. Activities for the MVNO BU only included those from January 1 through October 29, 2020.

 

    For the years ended December 31,  
    2018     2019     2020  
    $     %     $     %     $     %  
  ($’000)  
Continuing operation:      
Connected Solutions BU     134,443       88.0 %     98,389       79.9 %     25,155       53.8 %
Discontinued operations:                                                
MVNO BU     18,587       12.0 %     24,748       20.1 %     21,637       46.2 %
Total cost of revenues     153,030       100.0 %     123,137       100.0 %     46,792       100.0 %

 

Connected Solutions BU cost of revenues varied from 2018 to 2020 in attribution to similar changes in our volume of hardware products sales during these years. The cost of revenues in the year ended December 31, 2018 included $6.2 million in costs for one transaction in which the corresponding revenue was not yet recognized in the year ended December 31, 2018 due to uncertainty in collectability.

 

Cost of MVNO BU revenues increased from $18.6 million in the year ended December 31, 2018 to $24.7 million in the year ended December 31, 2019, generally in line with the sales volume of the MVNO BU over that period. MVNO BU cost decreased since 2018 due to increased security requirements at the point of sales of signing up new mobile customers as stipulated by the Ministry of Industry and Information Technology of China. The cost of MVNO revenues was $21.6 million from the beginning of 2020 through October 29, 2020 when the business unit was sold.

 

Gross Profit and Gross Margin

 

Gross profit represents net revenues less cost of revenues. Gross margin represents gross profit as a percentage of revenues.

 

Gross profits for our continuing operations Connected Solutions BU in the years ended December 31, 2018, 2019 and 2020 were a gross loss of $6.1 million, a gross profit of $0.6 million and a gross profit of $1.6 million, respectively. The gross loss in the year ended December 31, 2018 included $6.1 million in costs where the corresponding revenues were not yet recognized in the year ended December 31, 2018 and thereby causing a negative gross margin for 2018.

 

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    For the years ended December 31,  
    2018     2019     2020  
    $     %     $     %     $     %  
    (Gross Profit in $’000, Gross Margin in %)  
Continuing operations:                                                
Connected Solutions BU     (6,023 )     (4.7 )%     569       0.6 %     1,596     6.0 %

 

In the last quarter of the year ended December 31, 2018, there were deliveries of hardware products to India and other Asian countries, where the products were shipped but sales were not yet recognized due to (i) long lead time in payment terms from customers and (ii) further assembly of the parts we supplied needed to take place outside of China and then delivered to the final customer. The costs of such goods were recognized in the year ended December 31, 2018 but the related sales were not yet recognized. This accounting procedure resulted in lowered gross margin for the Connected Solutions BU in the year ended December 31, 2018.

 

Connected Solutions BU gross profits include gross profits from software projects and gross profits from hardware projects. As shown in the following table, software gross margins decrease from 8.2% in the year ended December 31, 2018 to -19.0% in the year ended December 31, 2019. In the year ended December 31, 2020, gross margin returned to a healthy 8.3% although the level of business activities decrease significantly due to the COVID-19 pandemic.

 

Hardware gross margins were held with a small increase to 4.4% in 2020 from 4.1% in 2019. We experience an overall price tightening of this industry of micro-electronics manufacturing and are seeking means to reduce manufacturing costs. 

 

In the year ended December 31, 2018, included in hardware cost of goods were $6.2 million in costs for one transaction in which the corresponding revenue was not yet recognized in the year ended December 31, 2018 due to uncertainty in collectability. Since the corresponding sales was not recorded but the COGs was included, the gross margin in the year ended December 31, 2018 became negative.

 

      For the years ended December 31,  
      2018     2019     2020  
      $     %     $     %     $     %  
      (Gross Profit in $’000, Gross Margin in %)  
Software       783       8.2 %     (2,847 )     (19.0 )%     879       8.3 %
Hardware       (6,806 )     (5.7 )%     3,416       4.1 %     717     4.4 %
Total       (6,023 )     (4.7 )%     569       0.6 %     1,596     6.0 %

 

Software projects are further categorized as design, royalty and service projects, reflecting the nature of the work:

 

  Design projects consist primarily of non-recurring engineering fees for which we provide customized work according to our clients’ required functionalities and needs;
     
  Royalty projects consist of per unit royalties based on customer usage of our previously completed software products; and
     
  Service projects where our engineers perform engineering services following the instructions of the customers, charging them hourly fees on full time equivalent basis.

 

For our discontinued operations MVNO BU gross profits were $8.8 million in the year ended December 31, 2018, $15.1 million in the year ended December 31, 2019 and $7.4 million from January 1 through October 29, 2020 when the MVNO BU was sold. Gross margin as a percentage of sales is presented in the following table.

 

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    For the years ended December 31,  
    2018     2019     2020 (up to Oct 29)  
    $     %     $     %     $     %  
    (Gross Profit in $’000, Gross Margin in %)  
Discontinued operations:                                                
MVNO BU     8,772       32.1 %     15,088       37.9 %     7,387       25.5 %

 

Operating Expenses

 

For our continuing operations Connected Solutions BU, the operating expenses principally consist of sales and marketing expenses, general and administrative expenses, and research and development expenses. The following table sets forth operating expenses for the periods indicated, both in absolute amount and as a percentage of net revenues:

 

    For the years ended December 31,  
    2018     2019     2020  
    $     As % of Revenue     $     As % of Revenue     $     As % of Revenue  
    ($’000)  
Sales and marketing expenses     (2,456 )     1.9 %     (1,524 )     1.5 %     (750 )     2.8 %
General and administrative expenses     (52,031 )     40.5 %     (24,776 )     25.0 %     (33,304 )     124.5 %
Research and development expenses     (6,338 )     4.9 %     (5,277 )     5.3 %     (8,162 )     30.5 %
Changes in fair value of warrant     -       - %     -       - %     -       -%  
Total     (60,825 )     47.4 %     (31,578 )     31.8 %     (42,216 )     157.8 %

 

General and administrative expenses in the year ended December 31, 2018 included non-recurring charges of $5.3 million in arbitration loss, write-off and provision for doubtful accounts and current assets of $30.1 million, write-down of historical inventory due to loss & obsolescence of $11.8 million, impairment of long-term investment of $13.0 million, deferred income tax benefits of $1.7 million, impairment of intangible assets due to the pending sale of the MVNO business unit of $0.8 million, share based compensation of $1 million, and $3.0 million in stock offering expenses. General and administrative expenses in the year ended December 31, 2019 included a provision for doubtful accounts of $13.6 million, non-recurring penalties of $3.4 million and reversal of historical inventory of $0.3 million. As previously discussed, the write-offs and provisions recorded in 2019 were still high for the level of business activities in the year, although comparatively less than those recorded in 2018. We have taken this approach as we realized that the COVID-19 pandemic, in the first half of the year 2020, has significant negative effects on our industry and particularly on certain of our customers and business partners; and it is prudent to write down some of our assets as of December 31, 2019. For the year ended December 31, 2020, G&A expenses were $33.3 million which included professional fees of $3.6 million, salaries and welfare of $2.6 million, impairment of intangible assets of $0.7 million, non-recurring penalties of $1.1 million, share-based compensation expense of $18.1 million and allowance for doubtful accounts of $4.4 million.

 

For our discontinued operations MVNO BU, the operating expenses which consisted of selling, administrative and research expenses were $10.1 million or 36.9% of revenues in the year ended December 31, 2018, and $19.3 million or 48.4% of revenues in the year ended. December 31, 2019. For the year 2020 up to October 29, 2020 when the MVNO BU was sold, the operating expenses was $6.1 million or 20.9% of revenues.

 

Research and Development Expenses

 

Research and development expenses include payroll, employee benefits, share-based compensation and other headcount-related expenses associated with the development of the BorqsWare software platform, as well as outsourcing and third party service expenses. Research and development expenses also include rent, depreciation and other expenses for platform development and other projects that are not customer-specific.

 

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Selling and Marketing Expenses

 

Selling and marketing expenses include payroll, employee benefits and other expenses relating to our sales and marketing personnel, travel, rent and other expenses relating to our marketing activities, including entertainment and advertising. For the discontinued operations MVNO BU, we paid our franchisees commission to sell products, which are recognized as selling and marketing expenses.

 

General and Administrative Expenses

 

Our general and administrative expenses include payroll, employee benefits, professional fees, rent, travel and other administrative costs.

 

General and administrative expenses comprised 40.5%, 25.0% and 124.5% of net revenues for the years ended December 31, 2018, 2019 and 2020, respectively. The significantly higher percentage in the year ended December 31, 2018 was attributed to non-recurring and one-time charges of which some were non-cash. We expect our general and administrative expenses to increase in absolute terms now that we are a public company and as we continue to grow, but to become relatively stable over time as a percentage of net revenues as net revenues increase. For our continuing operations Connected Solutions BU, the G&A expense in the year ended December 31, 2018 was $42.0 million which included non-recurring charge of $4.3 million in loss expense from our arbitration case with Samsung, write-off and provision for doubtful accounts and current assets of $22.2 million, write-down of historical inventory due to loss & obsolescence of $0.9 million, and impairment of long-term investment of $13.0 million. G&A expenses in the year ended December 31, 2019 included a provision for doubtful accounts of $13.6 million, non-recurring penalties of $3.4 million and reversal of historical inventory of $0.3 million. For the year ended December 31, 2020, G&A expenses included professional fees of $3.6 million, salaries and welfare of $2.6 million, non-recurring penalties of $1.1 million, share-based compensation expense of $18.1 million and allowance for doubtful accounts of $4.4 million included a rebate receivable of $1.4 million written off due to the circumstance changed and lack of collectability for the year ended December 31, 2020.

 

Other Operating Income – or expenses

 

We received subsidies from local government authorities in China as financial support for certain technology development projects. These subsidies are classified as “Other operating income”. We recognized $0.18 million, $1.9 million and nil of other operating income in the years ended December 31, 2018, 2019 and 2020, respectively. Subsidies are recorded as a liability when received and recognized as other operating income when the related projects are completed and the subsidies are not subject to future return. Under the requirements of the government subsidies, we are obligated to make progress on the related technology development projects, based on the timetable established by the government authorities, and to appropriately allocate the government subsidies for various purposes.

 

Income Tax Expense

 

Our effective tax rate was -1.0% and 0.7% for years ended December 31, 2019 and 2020, respectively. The fluctuation through these years was primarily due to the fact that the loss experienced by certain of our subsidiaries could not be used to offset gains in other subsidiaries. The Group recorded valuation allowance for the entities, which were considered more likely than not that a portion of the deferred tax assets will not be realized through sufficient future earnings.

 

Liquidity and Capital Resources

 

Cash used in operating activities for the year ended December 31, 2020 was $8.1 million, primarily consisted of net loss of $34.8 million, provisions on accounts receivable and other current assets of $4.4 million, impairment of inventory of $0.8 million but adding back non-cash items including share-based compensation expenses to employees of $3.0 million and to non-employees of $17.0 million, amortization of intangible assets of $5.4 million, depreciation of property and equipment of $0.1 million, impairment of intangible assets of $0.7 million, gain on disposal of a subsidiary of $10.1 million and contingency loss of $3.1 million. Cash used in operating assets and liabilities included decrease in accounts payable of $3.0 million, increase in prepaid expenses and other current assets of $7.7 million and decrease in long term payable of $0.4 million, while cash generated from changes in operating assets and liabilities included decrease in inventories of $2.2 million, increase in accounts receivable of $1.6 million, increase in accrued expenses of $13.0 million, increase in income tax payables of $1.0 million and increase in advance from customers and contract liabilities of $0.5 million.

 

Cash generated by investing activities for the year ended December 31, 2020 was $4.0 million, which mainly included $4.2 million generated related to the disposal of the MVNO subsidiary, offset by purchase of property and equipment of $0.1 million and purchase of intangible assets of $0.1 million.

 

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Cash used in financing activities for the year ended December 31, 2020 was $1.4 million which included the repayment of short-term borrowings of $7.9 million, and generated $5.3 million from short-term loans and $1.25 million from long-term loans.

 

We entered into a loan agreement with Partners for Growth V, L.P. (“PFG5”) effective April 30, 2018, for a term loan in the maximum amount of $3 million at an interest rate of 8.0% per annum with a maturity date of April 30, 2021 (the “PFG5 Loan”). On May 16, 2018, after payment of a $45,000 commitment fee to PFG5, $2,955,000 was made available to us for general corporate purposes. PFG5’s rights under the PFG5 Loan are pari passu with the rights of Partners For Growth IV, L.P. (“PFG4” and, together with PFG5, “PFG”), a related party of PFG5, under the existing Loan and Security Agreement, dated August 26, 2016, by and between Borqs Hong Kong Limited and PFG4, as amended (the “PFG4 Loan”), which remains in full force and effect according to its terms. Except for increased thresholds with respect to the financial covenants described below, the terms of the PFG5 Loan are substantially similar to those of the PFG4 Loan. Our financial covenants under the PFG5 Loan included the covenants to meet or exceed (i) quarterly revenues (as required to be classified as such under U.S. GAAP) of $32,500,000 and (ii) a three-month trailing EBITDA target of $2,000,000, with compliance for each covenant determined as of the last day of each calendar quarter for revenues and each calendar month for EBITDA.

 

We have in the past breached certain financial covenants under our loan agreements with SPD Silicon Valley Bank Co., Ltd. (“SVB”) and PFG4 during 2017 and the year ended December 31, 2018. No liabilities were generated by the breaches. Such breach could result in acceleration of the repayment according to the contract term. For the year ended December 31, 2018, certain covenants were not met; but we had not been notified by lenders that they intend to seek to accelerate the loan payments because of such breaches and neither lender had expressly waived such breaches and any resulting defaults. As of April 18, 2019, all of the SSVB loans were replaced by PFG, which became our sole commercial lender. Although all of the covenants obligated to SSVB no longer existed since the SSVB loans were paid off, the Company did not meet certain financial covenants according to the loan agreements with PFG.

 

On June 28, 2019, PFG executed an agreement with the Company effective in July 2019, which waived our covenant defaults up through the end of June 2019, and allowed the Company to begin testing of newly agreed upon revenue and EBITDA covenants which are more reflective of the operations of the Company without the MVNO BU, starting with the month of August 2019. Specifically, (i) quarterly revenue requirements were reduced to $27,500,000 commencing with the quarter ending September 30, 2019; provided that any failure to meet such requirement may be cured by evidencing at least $120,000,000 in trailing 12-month revenue; and (ii) the three-month trailing EBITDA target was reduced to $1,350,000, commencing with the month ended August 31, 2019. In connection with the execution of such waiver agreement, the Company paid a waiver and modification fee of $30,000, subject to an additional $20,000 fee in the event that the above-referenced financial covenants are not met in future periods.

 

On March 8, 2019, the Group entered into a new revolving line of credit facility (the “RLOC”) with PFG5 for $12,500,000. Under the agreement: (i) $9,500,000 may be drawn upon request at any time on or after the closing date and (ii) so long as there is no uncured default at the time of drawdown and if the Company has received at least US$10,000 in cash proceeds from the sale of its equity securities to investors, then an additional $3,000,000 may be drawn. Any outstanding amounts under the RLOC will accrue interest at a rate of 11% per annum with a maturity date of March 8, 2021 (the “Maturity Date”). The Group shall pay interest only on principal outstanding on the RLOC until the Maturity Date, on which date the entire unpaid principal balance on the RLOC plus any and all accrued and unpaid interest shall be repaid. In March 2019, the Company drew down $9,500,000 from the RLOC.

 

As of October 2019, due to geographic changes in our business activities, significant amounts of our accounts receivable shifted from our Hong Kong subsidiary to our Indian subsidiary. This reduction of accounts receivable from our Hong Kong entity has caused a covenant breach according to the PFG loan agreements and caused the interest rate of the PFG loans to be increased to 18%.

 

Senior Debt Purchased by LMFA Financing LLC

 

The Company entered into Agreements dated December 14, 2020 with PFG and LMFA Financing LLC (“LMFA”), a Florida limited liability company and wholly owned subsidiary of LM Funding America, Inc. (Nasdaq: LMFA), in which LMFA was committed to purchase up to be approximately $18 million of debt in tranches, which when completed would eliminate substantially all of the debt with the Company’s senior lender. LMFA would convert the purchased debt into common shares of the Company, pursuant to a court order that allows the conversion shares to be issued as unrestricted securities in a transaction that is exempt from registration under Section 3(a)(10) of the Securities Act of 1933, as amended.

 

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As of February 10, 2021, LMFA completed the purchase of $17.87 million of principal, accrued interest and applicable fees, converted and sold all 22.73 million shares of the Company’s ordinary shares. With the Company settling another $1.27 million of debt, accrued interest and applicable fees directly with the senior lender by the issuance of 1.51 million shares on February 17, 2021 which the senior lender subsequently sold, the Company’s defaulted Debts with the senior lender totaling $19.14 million have been eliminated since.

 

Convertible Notes Sold

 

The Company signed agreements with institutional and individual investors for sale of convertible notes on February 25, 2021 for $20 million (the “Feb 25 Notes”) and on April 14, 2021 for $3 million (the “Apr 14 Notes”). The notes are due in two years, have an annual interest rate of 8%, convertible into ordinary shares of Borqs at 10% discount from the market price and has 90% warrant coverage with the warrants exercisable cashless or for cash at $2.222 per share for the Feb 25 Notes and $1.540 for the Apr 14 Notes. The conversion price is at $1.539 per share for the Feb 25 Notes and $1.071 per share for the Apr 14 Notes, or at a one-time reset at 90% of the market price at the time of effectiveness of the required registration statement, whichever is lower. One-third of the notes are sold at the execution of definitive agreements and two-thirds of the notes will be sold upon the effectiveness of a registration statement to be filed by the Company. Proceeds will be used for the procurement of orders the Company expects to receive from its customers this year and also for development of the next generation 5G products. As of the filing of this Form 20-F, the Company has received $7.67 million from the selling of one-third of the notes to institutional and individual investors.

 

We were operating at a loss for the years ended December 31, 2019 and 2020. Our ability to meet the working capital requirements is subject to the risks relating to the demand for and prices of our services in the market, the economic conditions in our target markets, the successful operation of our connected solution, timely collection of payment from our customers and the availability of additional funding. In the next 12 months, we will rely on the sale of convertible notes of which one-third has been completed and the other two-third to be completed upon the effectiveness of a registration statement to be filed by the Company.

 

The sale of equity and convertible debt securities may result in dilution to our shareholders and certain of those securities may have rights senior to those of our shares of capital stock. If we raise additional funds through the issuance of preferred stock, convertible debt securities or other debt financing, these securities or other debt could contain covenants that would restrict our operations. Any other third-party funding arrangement could require us to relinquish valuable rights. Economic conditions may affect the availability of funds and activity in equity markets. We do not know whether additional funding will be available on acceptable terms, or at all. If we are not able to secure additional funding when needed, we may have to delay, reduce the scope of, or eliminate certain of our programs, or make changes to our operating plans.

 

Impact of the COVID-19 pandemic

 

As discussed earlier in the Rick Factors section of this report, we have experienced since February 2020 reductions and cancellations of orders due to effects of the COVID-19 pandemic has on the demand from certain of our customers. We expect this negative effect on global business activities will continue to have pressure on the Company’s sales as the pandemic environment persists and perhaps even post the pandemic. In addition, since our operations span over the countries of the United States, India, China and South Korea, international and intra-country travel restrictions will continue to hamper our operations and have negative effects including delays and uncertainties on our supply chain delivery schedules and our abilities to secure financing for our working capital needs. We expect the impacts of COVID-19 to have an adverse effect on our business, financial condition and results of operations. Our revenue for the year 2020 was negatively impacted by the pandemic by a reduction of 73.0% as compared to 2019. As the assessable risks due to COVID-19 change in the countries of India and China, our operations can be affected, including the restrictions from accessing office facilities and limitations on domestic travels which can hamper our ability to efficiently manage the manufacturing of products since our contracted factories are located over various cities in China.

 

As our sales have been negatively impacted by the pandemic in 2020, we cut back our operational costs by reduction of approximately 20% of our workforce in India and 40% of our headcount in China. We constantly evaluate our financial position according to changes in the international business environment and depending on forecast of orders from our customers in the near future, we may further reduce staffing as necessary.

 

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Also as a result of stringent cash flows from operations and the pandemic situation is foreseeable to continue through the remainder of the year 2021, we will postpone further investment into the acquisition target of KADI and we are in negotiation with the owners of KADI to decrease our potential ownership percentage of their company. For the acquisition of Colmei and Crave, since both of these companies are insolvent, we have ceased to make additional payments for ownership and have written off the value of the equity we have paid to the owners previously.

 

Cash transfers from our subsidiaries inside China to our subsidiaries outside of China are subject to PRC government control of foreign exchange. Restrictions on the availability of foreign currency may affect the ability of our subsidiaries inside China to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy their obligations. See “Item 1A. Risk Factors — Risks Related to Doing Business in China — Our subsidiaries in China are subject to restrictions on making dividends and other payments to it or any other affiliated company” and “Item 1A. Risk Factors — Risks Related to Doing Business in China —Restrictions on foreign currency may limit our ability to receive and use our revenue effectively.”

 

Critical Accounting Policies

 

The Company prepares its financial statements in accordance with U.S. GAAP, which requires it to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the end of each fiscal period and the reported amounts of revenues and expenses during each fiscal period. The Company continually evaluates these judgments and estimates based on its own historical experience, knowledge and assessment of current business and other conditions, and expectations regarding the future based on available information and assumptions that it believes to be reasonable, which together form the basis for making judgments that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from those estimates. Some of the Company’s accounting policies require a higher degree of judgment than others in their application.

 

The selection of critical accounting policies, the judgments and other uncertainties affecting application of those policies and the sensitivity of reported results to changes in conditions and assumptions are factors that should be considered when reviewing the Company’s financial statements. The Company believes the following accounting policies involve the most significant judgments and estimates used in the preparation of its financial statements.

 

Revenue Recognition

 

The Company recognizes revenue when persuasive evidence of an arrangement exists, as evidenced by signed contracts, delivery has occurred, the sales price is fixed or determinable and collection is reasonably assured.

 

Project-based Contracts

 

The Company accounts for revenue from project-based software contracts as “Software” revenue. The Company’s project-based contracts are generally considered multiple element arrangements since they include perpetual software licenses, development services, such as customization, modification, implementation and integration, and post-contract support where customers have the right to receive unspecified upgrades and enhancements on a when-and-if-available basis.

 

The Company provides customized Android+ software platform solutions that are developed to maximize the commercial grade quality or performance of open source Android+ software for integration with particular chipsets. The Group also provides customized Android+ service platform solutions that are end-to-end software developed for mobile operators to allow data synchronization between their platform and mobile devices. The Company charges its customers, mainly including mobile device manufacturers and mobile operators, fixed fees for project-based software contracts, as well as per chip or per mobile device royalty fees.

 

As of January 1, 2019, the Company adopted ASC 606 for revenue recognition from contracts with customers. For the sales derived from software development project in which the customer’s contract specifies the technical requirements of the software product, the Company recognizes revenue upon the customers sign off the final acceptance and it is probable that the Company will collect the payments. For the sales derived from this type of software development project with a post-contract-service period (“PCS Period”), the Company recognizes revenue upon the PCS period ends and it is probable that the Company will collect the payments. The Company recognizes non-recurring engineering fees upon the customers sign off the final acceptance and it is probable that the Company will collect the payments (start of hardware product delivery schedule).

 

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Additional discussions on ASC 606 are provided in below Note 2 of the Accompanying Notes to Financial Statements, under the heading (q) Revenue recognition.

 

Service Contracts

 

The Company provides research and development services to certain customer to develop software where fees are charged on a time and material basis and the Company is not responsible for the outcome of such development projects. The revenue is recognized as the “Software” revenue as the services are delivered.

 

Connected Devices Sales Contracts

 

The Company accounts for revenue from sales of connected devices as “Hardware” revenue. Revenue is recognized when sale of each final hardware product to the customers are delivered.

 

Warranty is provided to all connected device customers as an integral part of the product sales. The Company has determined that the likelihood of claims arising from warranties is remote, based on historical experience. The basis for the warranty accrual is reviewed periodically based on actual experience.

 

MVNO Subscriber Usage Payment

 

The Company’s MVNO subscribers pay a fee based on the actual minutes of voice call made, megabytes of data consumed, number of SMS/MMS sent and supplementary services (e.g. caller-ID display) subscribed. These are considered as “MVNO” revenue. The Company is the principal in providing the bundled voice and data services to Chinese consumers, thus revenue is recognized on a gross basis. Revenue is recognized when the services are actually used. Our MVNO business unit was sold as of October 29, 2020.

 

Traditional Telecom Services

 

The Company provides traditional telecom services such as voice conferencing services and 400 toll free services. These are considered as “Others” revenue and are recognized based on the actual consumption by customers. This activity also ended with the sale of the MVNO business unit.

 

Discontinued operations

 

A component of a reporting entity or a group of components of a reporting entity that are disposed or meet the criteria to be classified as held for sale, such as the management, having the authority to approve the action, commits to a plan to sell the disposal group, should be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results. Discontinued operations are reported when a component of an entity comprising operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity is classified as held for disposal or has been disposed of, if the component either (1) represents a strategic shift or (2) have a major impact on an entity’s financial results and operations. In the consolidated statement of operations, result from discontinued operations is reported separately from the income and expenses from continuing operations and prior periods are presented on a comparative basis. Cash flows for discontinued operations are presented separately. Assets and liabilities of the discontinued operations are classified as held for sale when the carrying amounts will be recovered principally through a sale transaction.

 

Income Taxes

 

In preparing its consolidated financial statements, the Company must estimate its income taxes in each of the jurisdictions in which it operates. The Company estimates actual tax exposure and assess temporary differences resulting from different treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which is included in the consolidated balance sheet. The Company must then assess the likelihood that it will recover its deferred tax assets from future taxable income. If the Company believes that recovery is not likely, it must establish a valuation allowance. To the extent it establishes a valuation allowance or increases this allowance, the Company must include an expense within the tax provision in its consolidated statement of operations. If actual results differ from these estimates or the Company adjusts these estimates in future periods, it may need to establish an additional valuation allowance, which could materially impact its financial position and results of operations.

 

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U.S. GAAP requires that an entity recognize the impact of an uncertain income tax position on the income tax return at the largest amount that is more likely than not to be sustained upon audit by the relevant tax authority. If the Company ultimately determines that payment of these liabilities will be unnecessary, it will reverse the liability and recognize a tax benefit during that period. Conversely, the Company records additional tax charges in a period in which it determines that a recorded tax liability is less than the expected ultimate assessment. The Company did not recognize any significant unrecognized tax benefits during the periods presented in this Annual Report.

 

Uncertainties exist with respect to the application of the EIT Law and its implementation rules to the Company’s operations, specifically with respect to tax residency status. The EIT Law specifies that legal entities organized outside of the PRC will be considered residents for PRC income tax purposes if their “de facto management bodies” are located within the PRC. The EIT Law’s implementation rules define the term “de facto management bodies” as establishments that carry out substantial and overall management and control over the manufacturing and business operations, personnel, accounting, properties, etc. of an enterprise. On April 22, 2009, the Notice Regarding the Determination of Chinese-Controlled Offshore Incorporated Enterprises as PRC Tax Resident Enterprises on the Basis of De Facto Management Bodies, or Circular 82, was issued. Circular 82 provides certain specific criteria for determining whether the “de facto management body” of a Chinese-controlled offshore-incorporated enterprise is located in China. 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.

 

According to Circular 82, a Chinese-controlled offshore-incorporated enterprise will be regarded as a PRC tax resident by virtue of having a “de facto management body” in China and will be subject to PRC enterprise income tax on its worldwide income only if all of the following conditions set forth in Circular 82 are met: (i) the primary location of the day-to-day operational management is in the PRC; (ii) decisions relating to the enterprise’s financial and human resource matters are made or are subject to approval by organizations or personnel in the PRC; (iii) the enterprise’s primary assets, accounting books and records, company seals and board and shareholder resolutions are located or maintained in the PRC; and (iv) at least 50.0% of voting board members or senior executives habitually reside in the PRC. In addition, Bulletin No. 45 provides clarification in resident status determination, post-determination administration and competent tax authorities. It also specifies that when provided with a copy of Chinese tax resident determination certificate from a resident Chinese-controlled offshore- incorporated enterprise, the payer should not withhold 10% income tax when paying certain Chinese-sourced income, such as dividends, interest and royalties to the Chinese-controlled offshore-incorporated enterprise.

 

Although both the circular and the bulletin only apply to offshore enterprises controlled by PRC enterprises and not those by PRC or foreign individuals, the determination criteria set forth in the circular and administration clarification made in the bulletin may reflect the SAT’s general position on how the “de facto management body” test should be applied in determining the tax residency status of offshore enterprises and the administration measures should be implemented, regardless of whether they are controlled by PRC enterprises or PRC individuals.

 

Despite the uncertainties resulting from limited PRC tax guidance on the issue, the Company does not believe that its legal entities organized outside of the PRC are tax residents under the EIT Law. If one or more of its legal entities organized outside of the PRC were characterized as PRC tax residents, the Company’s results of operations would be materially and adversely affected.

 

Recent Accounting Pronouncements

 

Refer to Note 2, Summary of Significant Accounting Policies - Recent accounting pronouncements, of the notes to our consolidated financial statements included in this Annual Report for information regarding the effect of newly adopted accounting pronouncements on our financial statements.

 

Off-Balance Sheet Arrangements

 

With the exception of items discussed under “Contractual Obligations” below we do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, results of operations, liquidity or capital resources that are material to investors.

 

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Contractual Obligations

 

As of December 31, 2020, payment obligations under long-term debt, operating leases, and other long-term liabilities were as following:

 

    Amount
($’000)
 
Obligations less than one year      
Current portion of long-term borrowings   $ 12,975  
Operating facilities leases   $ 409  
Arbitration loss to Samsung Electronics Co., Ltd.   $ 3,749  
Contingent liability in relation to disposal of a subsidiary    

3,240

 
         
Obligations from 1 to 3 years        
Operating facilities leases   $ -  
Long term borrowings   $ 1,250  
Operating facilities leases     421  
Arbitration loss to Samsung Electronics Co., Ltd.   $ -  
         
Obligations from 3 to 5 years        
Operating facilities leases   $ -  

 

Related Party Transactions

 

(a) Related parties

 

Names of related parties   Relationship
Bluecap   A company controlled by a key management of the Group
Cloudminds (Hong Kong) Ltd. (“Cloudminds”)   A company controlled by a director of the Company*
Hareesh Ramanna   Executive Vice President and Co-General Manager of Connected Solutions Business Unit

 

 

(* On December 18, 2018, the entity ceased to be a related party of the Company due to the resignation of this director.)

 

(b) Other than disclosed elsewhere, The Group had the following significant related party transactions for the years ended December 31, 2018, 2019 and 2020:

 

    For the years ended December 31,